Converted by FileMerlin









SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


Form 10-Q


[ X ]

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2004

- 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 0-14140



FIRST ALBANY COMPANIES INC.

(Exact name of registrant as specified in its charter)


New York                                                                                                          22 - 2655804

(State or other jurisdiction of                                                                       (I.R.S. Employer

incorporation or organization)                                                                   Identification No.)


30 South Pearl St., Albany, NY                                                                                    12207

(Address of principal executive offices)                                                               (Zip Code)


(518) 447-8500

(Registrant’s telephone number, including area code)



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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   (1)   No         


Indicate by check mark whether the registrant is an accelerated filer (as defined by rule 12b-2 of the Act)


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.


­­­­­­­­­­­­­­­­14,584,097 shares of Common Stock were outstanding as of the close of business on July 29, 2004




#





FIRST ALBANY COMPANIES INC. AND SUBSIDIARIES


FORM 10-Q


INDEX






     

Page

Part I

Financial Information

    
 
 

Item 1.

Financial Statements

 
 
 

Condensed Consolidated Statements of Financial Condition at June 30, 2004 (unaudited) and December 31, 2003

 

3

 
 

Condensed Consolidated Statements of Operations for the Three Months and Six Months Ended June 30, 2004 and June 30, 2003 (unaudited)

 

4

 
 

Consolidated Statement of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2004 (unaudited)

 

5

 
 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and June 30, 2003 (unaudited)

 

6

 
 

Notes to Condensed Consolidated Financial Statements

 

7-20

 
 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

21-32

                               

 

Item 3.

Quantitative and Qualitative Disclosure About Market Risk

 

33-34

 
 

Item 4.

Controls and Procedures

 

35

 

Part II

Other Information

 
 
 

Item 1.

Legal Proceedings

36

 
 

Item 4.

Submission of matters to a vote of security holders

37

 
 

Item 6.

Exhibits and Reports on Form 8-K

38

 
    



#



FIRST ALBANY COMPANIES INC.

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)




Item 1.  Financial Statements


(In thousands of dollars)

   

As of

  

June 30, 2004

 

December 31, 2003

Assets

    

Cash

$

3,561

$

92

Cash and securities segregated for regulatory purposes

 

3,800

 

-

Securities purchased under agreement to resell

 

80,768

 

56,261

Receivables from:

    

Brokers, dealers and clearing agencies

 

57,300

 

12,550

Customers, net

 

7,610

 

3,867

Others

 

7,050

 

7,149

Securities owned

 

283,458

 

239,888

Investments

 

47,258

 

55,864

Office equipment and leasehold improvements, net

 

6,538

 

6,176

Other assets

 

40,878

 

12,500

Total assets

$

538,221

$

394,347

Liabilities and Stockholders’ Equity

    

Liabilities

    

Short-term bank loans

$

215,890

$

138,500

Payables to:

    

Brokers, dealers and clearing agencies

 

19,503

 

20,375

Customers

 

21,638

 

5,585

Others

 

13,431

 

4,654

Securities sold, but not yet purchased

 

108,376

 

58,069

Accounts payable

 

3,794

 

3,749

Accrued compensation

 

17,414

 

46,693

Accrued expenses

 

8,700

 

10,211

Notes payable

 

33,178

 

14,422

Deferred tax liability

 

-

 

1,751

Obligations under capitalized leases

 

2,756

 

3,183

Total liabilities

 

444,680

 

307,192

Commitments and Contingencies

    

Subordinated debt

 

3,695

 

3,721

Stockholders’ Equity

    

Common stock

 

153

 

120

Additional paid-in capital

 

148,254

 

109,531

Unearned compensation

 

(17,964)

 

(5,229)

Deferred compensation

 

3,527

 

2,699

Retained (deficit)

 

(39,725)

 

(20,160)

Treasury stock, at cost

 

(4,399)

 

(3,527)

Total stockholders’ equity

 

89,846

 

83,434

Total liabilities and stockholders’ equity

$

538,221

$

394,347







See notes to condensed consolidated financial statements.

FIRST ALBANY COMPANIES INC.

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(Unaudited)



FIRST ALBANY COMPANIES INC.

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(Unaudited)


FIRST ALBANY COMPANIES INC.

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(Unaudited)


  

Three Months Ended

 

Six Months Ended

(In thousands of dollars except for per share amounts and shares outstanding)

 

June 30, 2004

 

June 30, 2003

 

June 30, 2004

 

June 30, 2003

Revenues:

        

Commissions

$

5,360

$

3,708

$

11,158

$

7,895

Principal transactions

 

20,300

 

30,176

 

45,263

 

58,584

Investment banking

 

9,228

 

7,720

 

19,457

 

12,970

Investment gains (losses)

 

4,141

 

2,913

 

3,864

 

7,760

Interest

 

2,188

 

1,385

 

3,925

 

3,207

Fees and other

 

1,100

 

1,725

 

2,257

 

3,680

Total revenues

 

42,317

 

47,627

 

85,924

 

94,096

Interest expense

 

1,365

 

730

 

2,379

 

1,491

Net revenues

 

40,952

 

46,897

 

83,545

 

92,605

Expenses (excluding interest):

        

Compensation and benefits

 

29,098

 

31,477

 

61,860

 

63,064

Clearing, settlement and brokerage costs

 

1,491

 

1,365

 

2,875

 

2,429

Communications and data processing

 

3,950

 

3,722

 

8,064

 

7,204

Occupancy and depreciation

 

2,418

 

2,375

 

4,731

 

4,644

Selling

 

1,991

 

1,806

 

3,766

 

3,476

Other

 

2,065

 

2,258

 

6,232

 

4,402

Total expenses (excluding interest)

 

41,013

 

43,003

 

87,528

 

85,219

(Loss) income before income taxes

 

(61)

 

3,894

 

(3,983)

 

7,386

Income tax (benefit) expense

 

(2,465)

 

1,514

 

(4,460)

 

2,803

Income from continuing operations

 

2,404

 

2,380

 

477

 

4,583

Income from discontinued operations,

net of taxes

 

267

 

146

 

267

 

146

Net income

$

2,671

$

2,526

$

744

$

4,729

Per share data:

        

Basic earnings:

        

Continued operations

$

0.19

$

0.23

$

0.04

$

0.45

Discontinued operations

 

0.02

 

0.01

 

0.02

 

0.01

Net income

$

0.21

$

0.24

$

0.06

$

0.46

Diluted earnings:

        

Continued operations

$

0.17

$

0.21

$

0.04

$

0.42

Discontinued operations

 

0.02

 

0.01

 

0.02

 

0.01

Net income

$

0.19

$

0.22

$

0.06

$

0.43

Weighted average common and common equivalent shares outstanding:

        

Basic

 

12,666,236

 

10,469,444

 

11,838,724

 

10,353,924

Diluted

 

14,037,589

 

11,603,547

 

13,283,777

 

11,089,606







See notes to condensed consolidated financial statements.



FIRST ALBANY COMPANIES INC.

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(Unaudited)




For the Six Months Ended June 30, 2004

(In thousands of dollars except for number of shares)



      
 

Additional

 

Retained

  
 

Common Stock

Paid-In

Unearned

Deferred

Earnings

Treasury Stock

 

Shares

Amount

Capital

Compensation

Compensation

(Deficit)

Shares

Amount

Balance as of December 31, 2003

11,995,247

$120

$109,531

$(5,229)

$2,699

$(20,160)

(541,867)

$ (3,527)

Amortization of unearned compensation

-

-

-

3,219

-

-

-

-

Forfeitures of restricted stock

-

-

(804)

1,658

-

-

(195,342)

(854)

Issuance of restricted stock

964,490

10

15,829

(14,822)

-

-

11,317

55

Issuance of restricted stock, Descap acquisition

270,843

3

2,787

(2,790)

-

-

-

-

Issuance of shares, Descap acquisition

549,476

5

5,654

-

-

-

-

-

Cash dividends paid

-

-

-

-

-

(1,463)

-

-

Options exercised

505,654

5

4,791

-

-

-

111,274

552

Options expense recognized

-

-

181

-

-

-

-

-

Employee stock trust

85,089

1

725

-

828

-

(81,618)

(689)

Employee benefit plans

-

-

242

-

-

-

13,017

64

Private placement

896,040

9

9,318

-

-

-

-

-

Special dividend – distribution of PLUG

-

-

-

-

-

(18,846)

-

-

Net income

-

-

-

-

-

744

-

-

Balance as of June 30, 2004

15,266,839

$153

$148,254

$(17,964)

$3,527

$(39,725)

(683,219)

$ (4,399)



























See notes to condensed consolidated financial statements




FIRST ALBANY COMPANIES INC.

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(Unaudited)



 (In thousands of dollars)

 

June 30,

2004

 

June 30,

2003

Cash flows from operating activities:

    

Net income

$

744

$

4,772

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

    

Depreciation and amortization

 

1,485

 

1,483

Deferred compensation

 

864

 

641

Deferred income taxes

 

(7,051)

 

3,496

Unrealized investment (gains) losses

 

5,717

 

(7,816)

Realized (gains) losses on sale of investments

 

(9,581)

 

56

Loss on abandonment of fixed assets

 

-

 

12

Services provided in exchange for common stock

 

6,064

 

1,265

(Increase) decrease in operating assets:

    

Cash and securities segregated under federal regulations

 

(3,800)

 

9,900

Securities purchased under agreement to resell

 

(24,507)

 

13,734

Net receivables from brokers, dealers and clearing agencies

 

(80,318)

 

44,775

Securities owned, net

 

44,474

 

79,126

Other assets

 

(457)

 

(3,064)

Increase (decrease) in operating liabilities:

    

Net payables to others

 

3,959

 

(15)

Net payable to customers

 

12,310

 

(22,017)

Accounts payable and accrued expenses

 

(32,544)

 

(25,765)

Income taxes payable, net

 

-

 

(3,068)

Net cash (used in) provided by operating activities

 

(82,641)

 

97,515

Cash flows from investing activities:

    

Acquisition of Descap Securities, Inc.

 

(21,132)

 

-

Purchase of furniture, equipment, and leaseholds, net

 

(389)

 

(603)

Purchase of investments

 

(5,201)

 

(646)

Proceeds from sale of investments

 

12

 

21

Net cash (used in) provided by investing activities

 

(26,710)

 

(1,228)

Cash flows from financing activities:

    

Net (payment) proceeds of short-term bank loans

 

77,390

 

(96,100)

Payments on notes payable

 

(1,343)

 

(1,490)

Payments on subordinated debt

 

(26)

 

-

Proceeds of notes payable

 

20,000

 

8,994

Proceeds from issuance of warrants

 

-

 

1,006

Payments of obligations under capitalized leases

 

(1,061)

 

(838)

Payments for purchases of common stock for treasury

 

-

 

(102)

Proceeds from issuance of common stock

 

13,387

 

1,766

Net increase (decrease) from borrowing under line-of-credit agreements

 

5,936

 

(6,791)

Dividends paid

 

(1,463)

 

(1,109)

Net cash provided by (used in) financing activities

 

112,820

 

(94,664)

Increase in cash

 

3,469

 

1,623

Cash at beginning of the year

 

92

 

176

Cash at end of period

 

3,561

 

1,799

In 2004 the Company entered into capital leases for office and computer equipment totaling approximately $0.6 million.

Refer to “Investments” footnote for non-cash investing activity.

Refer to “Acquisitions” footnote for asset and liabilities acquired related to the Acquisition of Descap Securities, Inc.

See notes to condensed consolidated financial statements

FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)









1.

Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all normal, recurring adjustments necessary for a fair presentation of results for such periods.  The results for any interim period are not necessarily indicative of those for the full year.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes for the year ended December 31, 2003.


2.

Reclassification

Certain 2003 amounts have been reclassified to conform to the 2004 presentation.


3.

Comprehensive Income

The Company has no components of other comprehensive income; therefore comprehensive income equals net income.


4.

Earnings Per Common Share

Basic earnings per share have been computed based upon the weighted average number of common shares outstanding.  Dilutive earnings per share have been computed based upon the weighted average number of common shares outstanding plus the effect of all potentially dilutive common stock equivalents outstanding during the reporting period.


 

Three Months Ended

Six Months Ended

 

June 30,

June 30,

 

2004

2003

2004

2003

Weighted average shares for basic earnings per share

12,666,236

10,469,444

11,838,724

10,353,924

Effect of dilutive common stock equivalents (stock options and stock issuable under employee benefit plans)

1,371,353

1,134,103

1,445,053

735,682

Weighted average shares and dilutive common stock equivalents for dilutive earnings per share

14,037,589

11,603,547

13,283,777

11,089,606



5.

Receivables from and Payables to Brokers, Dealers and Clearing Agencies

Amounts receivable from brokers, dealers and clearing agencies consisted of the following at:


(In thousands of dollars)

 

June 30,

2004

 

December 31,

2003

Adjustment to record securities owned on a trade date basis, net


$

45,723


$

-

Securities borrowed

 

431

 

6,004

Securities failed-to-deliver

 

4,493

 

3,311

Receivable from clearing organizations

 

6,653

 

3,235

Total

$

57,300

$

12,550






FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)






Amounts payable to brokers, dealers and clearing agencies consisted of the following at:


(In thousands of dollars)

 

June 30,

2004

 

December 31,

2003

Adjustment to record securities owned on a trade date basis, net


$

-


$

16,593

Payable to clearing organizations

 

11,760

 

-

Securities failed-to-receive

 

7,743

 

3,782

Total

$

19,503

$

20,375


Proprietary securities transactions are recorded on trade date, as if they had settled.  The related amounts receivable and payable for unsettled securities transactions are recorded net in receivables or payables to brokers, dealers and clearing agencies on the Statement of Financial Condition.


6.

Receivables from Customers

The majority of the Company’s non-institutional customer securities transactions, including those of officers, directors, employees and related individuals, are cleared through a third party under a clearing agreement.  Under this agreement, the clearing agent executes and settles customer securities transactions, collects margin receivables related to these transactions, monitors the credit standing and required margin levels related to these customers and, pursuant to margin guidelines, requires the customer to deposit additional collateral with them or to reduce positions, if necessary.  In the event the customer is unable to fulfill its contractual obligations, the clearing agent may purchase or sell the financial instrument underlying the contract, and as a result may incur a loss.


If the clearing agent incurs a loss, it has the right to pass the loss through to the Company which exposes the Company to off-balance-sheet risk.  The Company has retained the right to pursue collection or performance from customers who do not perform under their contractual obligations and monitors customer balances on a daily basis along with the credit standing of the clearing agent.  As the potential amount of losses during the term of this contract has no maximum, the Company believes there is no maximum amount assignable to this right.  At June 30, 2004, substantially all customer obligations were fully collateralized and the Company has not recorded a liability related to the clearing agent’s right to pass losses through to the Company.


At June 30, 2004, receivables from customers are mainly comprised of the purchase of securities by institutional clients. Delivery of these securities is made only when the Company is in receipt of the funds from the institutional client.


7.

Securities Owned And Sold, But Not Yet Purchased

Securities owned and sold, but not yet purchased consisted of the following at:


  

June 30, 2004

 

December 31, 2003

(In thousands of dollars)

 

Owned

 

Sold, but not yet Purchased

 

Owned

 

Sold, but not yet Purchased

Marketable Securities

        

U.S. Government and federal agency obligations

$

59,444

$

103,529

$

11,103

$

55,815

State and municipal bonds

 

152,816

 

2,811

 

190,163

 

96

Corporate obligations

 

59,282

 

137

 

27,837

 

534

Corporate stocks

 

9,880

 

1,897

 

9,077

 

1,620

Options

 

70

 

2

 

153

 

4

Not Readily Marketable Securities

        

Securities with no publicly quoted market

 

117

 

-

 

117

 

-

Securities subject to restrictions

 

1,849

 

-

 

1,438

 

-

Total

$

283,458

$

108,376

$

239,888

$

58,069


Securities not readily marketable include securities (a) for which there is no market on a securities exchange or no independent publicly quoted market, (b) that cannot be publicly offered or sold unless registration has been effected under the Securities Act of 1933, or (c) that cannot be offered or sold because of other arrangements, restrictions or conditions applicable to the securities or to the Company.


8.

Investments

The Company’s investment portfolio includes interests in publicly and privately held companies. Information regarding these investments has been aggregated and is presented below.



(In thousands of dollars)

 

June 30,

2004

 

December 31,

2003

Carrying Value

    

Public

$

26,528

$

41,505

Private

 

14,744

 

11,511

Consolidation of Employee Investment Funds,
net of Company’s ownership interest

 

5,986

 

2,848

Total carrying value

$

47,258

$

55,864


For the six months ending:

 

June 30, 2004

 

June 30,

 2003

     

Net realized gains (losses)

    

Public

$

9,549

$

14

Private

 

32

 

(70)

Total net realized gains (losses)

$

9,581

$

(56)

     

Net unrealized gains (losses)

    

Public

$

(5,700)

$

6,634

Private

 

(17)

 

1,182

Total net unrealized gains (losses)

$

(5,717)

$

7,816

     

Investment gains (losses)

$

3,864

$

7,760


Publicly held investments include 853,924 shares of META Group Inc. (“METG”) with a market value of $3.5 million. These shares are freely tradable and transferable. Also, included in publicly held investments are 2,991,040 shares of Mechanical Technology Incorporated (“MKTY”). As of June 30, 2004, the MKTY shares have a market value of $17.9 million and cannot be sold until after December 23, 2004 as a result of a lock-up agreement entered into by the Company with MKTY. Following the expiration of the lock-up period, the MKTY shares are subject to the trading restrictions provisions of Rule 144 of the Securities Act of 1933 (“Rule 144”).


In April 2004, the Company declared a special dividend of one share of Plug Power (PLUG) stock for every seven shares of the Company’s stock, payable May 18, 2004 to shareholders of record as of May 4, 2004.  In May 2004, the Company distributed approximately 2 million shares of PLUG as a special dividend to the Company’s shareholders, which represents a reduction of retained earnings of $18.8 million.  Due to this distribution, the Company recorded a realized investment gain of $9.5 million offset by unrealized losses  relating to Plug for the six months ended June 30, 2004 of $5.4 million.  The Company also realized an approximate $2.2 million tax benefit due to a difference in the accounting versus tax treatment of this distribution.  After the distribution, the Company holds 676,834 shares of PLUG with a market value of $5.1 million at June 30, 2004.  The remaining PLUG shares may only be sold pursuant to Rule 144.  Under the restrictions of Rule 144, the Company’s sale of PLUG stock for a three month period may not exceed the greater of one percent of the outstanding shares of PLUG or the average weekly volume of trading in PLUG during the four calendar weeks preceding the sale. PLUG currently has 73.0 million shares outstanding and had an average weekly volume for the four calendar weeks ended June 30, 2004 of approximately 3,300,000 shares.


Privately held investments include an investment of $6.6 million in FA Technology Ventures Corporation (the “Partnership”).  At June 30, 2004, $6.6 million is the Company’s maximum exposure to loss in the Partnership.  The Partnership’s primary purpose is to provide investment returns consistent with risks of investing in venture capital.  At June 30, 2004 total Partnership capital for all investors in the Partnership equaled $26.3 million.  FA Technology Ventures Corporation (“FATV”), a wholly owned subsidiary of the Company, is the investment advisor for the Partnership.  Revenues derived from management of this investment for the six months ended June 30, 2004 were $0.7 million in consolidation.  


The Company has consolidated its Employee Investment Funds (EIF). The EIF are limited liability companies, established by the Company for the purpose of having select employees invest in private equity placements. The EIF is managed by FAC Management Corp., a wholly owned subsidiary of the Company, which has contracted with FATV to act as an investment advisor with respect to funds invested.  At June 30, 2004, the Company’s exposure to loss as a result of its involvement with the EIF includes the following: the Company’s direct investment of $0.8 million in the EIF and a $3.7 million loan to the EIF and a commitment to loan an additional $0.5 million to the EIF. The effect of consolidating the EIF was to increase Investments by $6.0 million, decrease Receivable from Others by $3.7 million (to reclassify the amount loaned by the Company to the EIF) and increase Payable to Others by $2.2 million.  The Payable to Others amount relates to the value of the EIF owned by employees.


9.

Intangible Assets

(In thousands of dollars)

June 30,

2004

December 31, 2003

Amortized intangible assets

    

Customer related:

    

Descap Securities, Inc.- Acquisition

$

641

$

-

Institutional convertible bond arbitrage group - Acquisition

 

1,418

 

1,418

Accumulated amortization

 

(182)

 

(102)

Total

$

1,877

$

1,316

     

Unamortized intangible assets

    

Goodwill:

    

Descap Securities, Inc. – Acquisition

$

21,125

$

-

Institutional convertible bond arbitrage group - Acquisition

 

438

 

354

Total

$

21,563

$

354


Both customer related intangible assets and goodwill increased due to the acquisition of Descap Securities, Inc. (see “Acquisitions” footnote).  


The carrying amount of goodwill for the institutional convertible bond arbitrage group acquisition increased by $84 thousand for the six months ended June 30, 2004, related primarily to additional cash consideration under the purchase agreement based on the amount of assets under management.


Aggregate amortization expense for the six-month period ending June 30, 2004 and 2003 was $80 thousand and $50 thousand, respectively.






FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)






Customer related intangible assets are being amortized over 10 to 12 years.


Estimated Amortization Expense
(year ended December 31)

  

2004 (remainder)

$

101

2005

 

195

2006

 

195

2007

 

195

2008

 

195

Thereafter

 

996

Total

$

1,877


The intangible assets are recorded in Other assets on the Statement of Financial Condition, and will be tested annually for impairment in the quarter ending December 31 of each fiscal year.


10.

Payables to Others

Amounts payable to others consisted of the following at:


(In thousands of dollars)

 

June 30, 2004

 

December 31, 2003

Drafts payable

$

7,585

$

1,649

Others

 

3,608

 

2,012

Payable to Employees for the Employee Investment Funds (see “Investments” footnote)

 

2,238

 

993

Total

$

13,431

$

4,654


Drafts payable represent amounts drawn by the Company against bank overdrafts under a sweep agreement with a bank.


11.

Notes Payable


Notes payable include a note for $4.0 million collateralized by marketable securities included in the Company’s investment portfolio, which is payable in quarterly principal payments of $525,000 plus interest.  The interest rate is fixed at 7% for the term of the loan.  This loan matures September 1, 2006.  


Notes payable also include Senior Notes dated June 13, 2003 for $10 million with a fixed interest rate of 8.5%, payable semiannually, maturing on June 30, 2010. Principal payments of $2 million are due on June 30th of each year, commencing June 30, 2006 through June 30, 2010.  The purchasers of these notes are customers of the Company.


There were 437,000 warrants issued to the purchasers of the Senior Notes, which are exercisable between $10.08 and $11.54 per share through June 13, 2010.  The value assigned to the warrants was $1 million.  The value of the Senior Notes was discounted by the value of the warrants and is being amortized over the term of the notes.


The Senior Notes contain various covenants, as defined in the agreements, including restrictions on the incurrence of debt, the maintenance of not less than $50 million of net worth  (as of June 30,2004, the Company’s net worth was $89.8 million) and an adjusted cash flow coverage rate for First Albany Capital Inc. (a wholly owned subsidiary) of not less than 1.2 to 1 as at the end of each fiscal quarter based on a the most recently concluded period of four consecutive quarters (at the end of the June 2004 quarter, the Company’s adjusted cash flow coverage rate was 27.0 to 1). As of June 30, 2004, the Company was in compliance with these covenants.


Notes payable also include a $20 million Term Loan to finance the acquisition of Descap Securities, Inc.  Interest rate is 2.4% over the 30-day London InterBank Offered Rate (“LIBOR”) (1.37% at June 30, 2004).  Interest only is payable for first six months, and thereafter monthly payments of principal and interest over the life of loan which matures on May 14, 2011.


The Term Loan contains various covenants, as defined in the agreement, including maintenance of not less than $22.5 million of earnings before interest, taxes, depreciation, amortization and lease expense (“EBITDAR”) (for the twelve months period ending June 30, 2004, the Company’s EBITDAR was $32.1 million), operating cash flow to total fixed charge ratio of not less than 1.15 to 1(for the twelve months period ending June 30, 2004, the operating cash flow to total fixed charge ratio was 1.57 to 1) and modified total funded debt to EBITDAR ratio of less than 1.75 to 1 (for the twelve months period ending June 30, 2004, modified total funded debt to EBITDAR ratio was 1.15 to 1). As of June 30, 2004, the Company was in compliance with these covenants.



Principal payments for all notes, which include $797,000 discounted on the Senior Notes, are due as follows:


(In thousands of dollars)

  

2004 (remaining)

$

1,279

2005

 

4,897

2006

 

5,722

2007

 

5,000

2008

 

5,106

Thereafter

 

11,971

Total principal payments

 

33,975

Less: remaining amortization of value of warrants

 

797

Total principal payments remaining

$

33,178


12.

Obligations Under Capitalized Leases

The following is a schedule of future minimum lease payments under capital leases for office equipment together with the present value of the net minimum lease payments at June 30, 2004


(In thousands of dollars)

  

2004 (remaining)

$

1,039

2005

 

873

2006

 

592

2007

 

307

2008

 

134

Thereafter

 

4

Total minimum lease payments

 

2,949

Less:  amount representing interest

 

193

Present value of minimum lease payments

$

2,756


13.

Commitments and Contingencies

Commitments:  As of June 30, 2004, the Company had a commitment through July 2006 to invest up to $11.5 million in FA Technology Ventures Corporation (the “Partnership”).  The Company intends to fund this commitment from the sale of other investments and operating cash flow. The Partnership’s primary purpose is to provide investment returns consistent with risks of investing in venture capital. In addition to the Company, certain other limited partners of the Partnership are officers or directors of the Company. The majority of the commitments to the Partnership are from non-affiliates of the Company.


The General Partner for the Partnership is FATV GP LLC. The General Partner is responsible for the management of the Partnership, including among other things, making investments for the Partnership. The members of the General Partnership are George McNamee, Chairman of the Company, First Albany Enterprise Funding, Inc., a wholly owned subsidiary of the Company, and other employees and former employees of the Company or its subsidiaries. Mr. McNamee is required under the Partnership agreement to devote a majority of his business time to the conduct of the affairs of the Partnership and any parallel funds. Subject to the terms of the Partnership agreement, under certain conditions, the General Partnership is entitled to share in the gains received by the Partnership in respect of its investment in a portfolio company. The General Partner will receive a carried interest on customary terms. The General Partner has contracted with FA Technology Ventures Corporation (“FATV”) , a wholly owned subsidiary of the Company, to act as investment advisor to the General Partner.


As of June 30, 2004, the Company had an additional commitment through July 2006 to invest up to $8.8 million in funds that invest in parallel with the Partnership, which it intends to fund, at least in part, through current and future Employee Investment Funds (EIF). EIF are limited liability companies, established by the Company for the purpose of allowing select employees to invest their own funds in private equity placements.  


The EIF are managed by FAC Management Corp., a wholly owned subsidiary of the Company, which has contracted with FATV to act as an investment advisor with respect to funds invested in parallel with the Partnership. The Company anticipates that the portion of the commitment that is not funded by employees through the EIF will be funded by the Company through the sale of other investments and operating cash flow.


In 1999, the Company acted as a placement agent for a $7.5 million bond issue.  In July 2002, as a result of a dispute between the Company and the buyer of the bonds, the Company entered into an agreement which indemnified the buyer for up to $3.7 million of potential realized losses which might be incurred on the outstanding principal amount of the bonds.  At March 31, 2004, the Company had accrued $3.1 million as a liability related to the agreement.  During the second quarter of 2004 a final settlement was reached for a total of $3.0 million.  In entering into this agreement, the Company and the buyer of the bonds did not admit or concede to any liability, wrongdoing, misconduct or damages of any kind.


Litigation: In 1998 the Company was named in lawsuits by Lawrence Group, Inc. and certain related entities (the “Lawrence Parties”) in connection with a private sale of Mechanical Technology Incorporated stock from the Lawrence Parties that was previously approved by the United States Bankruptcy Court for the Northern District of New York (the "Bankruptcy Court").  The Company acted as placement agent in that sale, and a number of employees and officers of the Company, who have also been named as defendants, purchased shares in the sale.  The complaints alleged that the defendants did not disclose certain information to the sellers and that the price approved by the court was therefore not proper. The cases were initially filed in the Bankruptcy Court and the United States District Court for the Northern District of New York (the "District Court"), and were subsequently consolidated in the District Court.  The District Court dismissed the cases, and that decision was subsequently vacated by the United States Court of Appeals for the Second Circuit, which remanded the cases for consideration of the plaintiffs' claims as motions to modify the Bankruptcy Court sale order.  The plaintiffs’ claims have now been referred back to the Bankruptcy Court for such consideration. The Company believes that it has strong defenses to, and intends to vigorously defend itself against the plaintiffs’ claims, and believes that the claims lack merit.


In the normal course of business, the Company has been named a defendant, or otherwise has possible exposure, in several claims.  Certain of these are class actions, which seek unspecified damages, which could be substantial.  Although there can be no assurance as to the eventual outcome of litigation in which the Company has been named as a defendant or otherwise has possible exposure, the Company has provided for those actions most likely of adverse dispositions.  Although further losses are possible, the opinion of management, based upon the advice of its attorneys and General Counsel, is that such litigation will not, in the aggregate, have a material adverse effect on the Company's liquidity or financial position, although it could have a material effect on quarterly or annual operating results in the period in which it is resolved.  


Other: The Company enters into underwriting commitments to purchase securities, as part of its investment banking business and may also purchase or sell securities on a when-issued basis.  As of June 30, 2004, the Company had $1.6 million in outstanding underwriting commitments and had purchased no securities on a when-issued basis.


In connection with a $47.4 million underwriting transaction, the Company sent unauthorized emails to 223 addressees, each of which may have constituted a nonconforming prospectus under the Securities Act of 1933.  A recipient of the unauthorized emails may be entitled to rescission rights if they purchased shares of common stock issued through the underwriting transaction.  The rescission rights would allow any recipient of the communication, for a period of one year from March 30, 2004, the date of such recipient’s purchase of shares of common stock issued through the underwriting, to seek recovery of the consideration paid in connection with the purchase.  The Company has agreed to indemnify the company whose common stock was underwritten for losses, costs and expenses that might be incurred as a result of the unauthorized communications.  In an effort to avoid further Securities Act implications and to minimize the risk related to the indemnification provided as a result of the unauthorized communication, the Company took a number of steps to control the solicitation, allocation and distribution of the shares of common stock issued in the transaction, which included selling only to institutional investors and prohibiting sales to those who were among the 223 original addressees.  As of June 30, 2004, the Company has not accrued any liability related to this agreement.


14.

Stockholders’ Equity

Dividend

In July 2004, the Board of Directors declared a quarterly dividend of $.05 per share for the second quarter ended June 30, 2004, payable August 30, 2004 to stockholders of record on August 16, 2004.


In April 2004, the Board of Directors declared a quarterly dividend of $.05 per share for the first quarter ended March 31, 2004, payable on May 28, 2004 to stockholders of record on May 14, 2004.


Special Dividend

In May 2004, the Company distributed approximately 2 million shares of PLUG as a special dividend (see “Investments” footnote).


Private Placement

The Company raised $9.3 million, net of issuance costs in equity through a private placement of approximately 896,000 shares of the Company’s stock.


Acquisitions – Descap Securities, Inc.

On May 14, 2004, the Company acquired 100% of the outstanding common shares of Descap Securities, Inc., a New York-based broker-dealer and investment bank.  The value of the transaction is approximately $31 million, which consists of $25 million in cash and 549,476 shares of the Company’s common stock, plus future consideration based on financial performance. These shares issued to the sellers of Descap Securities, Inc. provide the sellers the right to require the Company to purchase back these shares at a price of $6.14 per share.  The Company also has the right to purchase back these shares from the sellers at a price of $14.46.  Both the put and call rights expires on May 31, 2007. The Company also issued 270,843 shares of restricted stock to employees of Descap Securities, which vests over a three-year period (see “Acquisitions” footnote).


Deferred Compensation and Employee Stock Trust

The Company has adopted various nonqualified deferred compensation plans (the “Plans”) for the benefit of a select group of highly compensated employees who contribute significantly to the continued growth and development and future business success of the Company.  Plan participants may elect under the Plans to have the value of their Plans accounts track the performance of one or more investment benchmarks available under the Plans, including First Albany Companies Common Stock Investment Benchmark, which tracks the performance of First Albany Companies Inc. common stock (“Company Stock”).  With respect to the First Albany Companies Common Stock Investment Benchmark, the Company contributes Company Stock to a rabbi trust (the “Trust”) it has established in connection with meeting its related liability under the Plans.


Assets of the Trust have been consolidated with those of the Company.  The value of the Company’s stock at the time contributed to the Trust has been classified in stockholders’ equity as treasury stock.  The deferred compensation arrangement requires the related liability to be settled by delivery of a fixed number of shares of Company Stock.  Accordingly, the related liability is classified in stockholders’ equity as deferred compensation and changes in the fair market value of the amount owed to the participant in the Plan is not recognized.


Unearned Compensation

The Company has established several stock incentive plans through which employees of the Company may be awarded stock options, stock appreciation rights and restricted common stock.  The unamortized amount related to restricted common stocks awarded under these plans is classified in equity under unearned compensation.


15.

Benefit Plans

First Albany Companies Inc. has established several stock incentive plans through which eligible employees of the Company may be awarded stock options, stock appreciation rights and restricted common stock of the Company. The purpose of these stock incentive plans are to promote the interests of the Company, its subsidiaries and its stockholders by enabling the Company and its subsidiaries to attract, retain and motivate employees and officers or those who will become employees or officers of the Company and/or its subsidiaries, and to align the interest of those individuals with the Company’s stockholders.  To do this, these plans offer performance-based incentive awards and equity-based opportunities to provide such persons with a proprietary interest in maximizing the growth, profitability and overall success of the Company.


Restricted Stock:  975,807 shares of restricted stock were awarded under the plans during the six months of 2004, at a weighted average grant date price of $15.19.  270,843 shares of restricted stock were awarded to employees of Descap Securities at a weighted average grant price of $10.30.  The fair market value of the awards will be amortized over the three-year period in which the restrictions are outstanding.


Options:  Stock-based compensation cost related to stock options awards is measured at the grant date based on the value of the award and is recognized as expense over the vesting period for awards granted after December 31, 2002.


The following table reflects the effect on net income if the fair value based method had been applied to all outstanding and unvested stock options in each period.


  

Six Months Ended


(In thousands of dollars)

 

June 30, 2004

 

June 30, 2003

Net income, as reported

$

744

$

4,729

Add: Stock-based employee compensation expense included in reported net income, net of tax

 

123

 

35

Less: Total stock-based employee compensation expense determined under fair value based method for all stock options, net of tax

 

(778)

 

(666)

Pro forma net income

$

89

$

4,098

Earnings per share

    

As reported

    

Basic

$

0.06

$

0.46

Diluted

$

0.06

$

0.43

Pro forma

    

Basic

$

0.01

$

0.40

Diluted

$

0.01

$

0.37






FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)







16.

Net Capital Requirements

The Company’s broker-dealer subsidiary, First Albany Capital Inc. (the “Corporation”) is subject to the Securities and Exchange Commission’s Uniform Net Capital Rule, which requires the maintenance of a minimum net capital.  The Corporation has elected to use the alternative method permitted by the rule, which requires the Corporation to maintain a minimum net capital amount of 2% of aggregate debit balances arising from customer transactions as defined or $1 million, whichever is greater.  As of June 30, 2004, the Corporation had aggregate net capital, as defined, of $13.3 million, which equaled 138.51% of aggregate debit balances and $12.3 million in excess of required minimum net capital.


Descap is subject to the Securities and Exchange Commission Uniform Net Capital Rule (15c3-1), which requires the maintenance of minimum net capital and that the ratio of aggregate indebtedness to net capital, both as defined by the rule, shall not exceed 15:1.  The rule also provides that capital may not be withdrawn or cash dividends paid if the resulting net capital ratio would exceed 10:1.  At June 30, 2004, Descap had net capital of $6.0 million, which was $5.9 million in excess of its required net capital.  Descap’s ratio of Aggregate Indebtedness to Net Capital was 0.24 to 1.


17.

Segment Analysis

The Company has announced it will discontinue its asset management business – FA Asset Management Inc. – with the exception of the institutional convertible bond arbitrage advisory group.  The convertible bond arbitrage advisory group is now included in the Parent and Affiliates segment.  The FA Asset Management Inc. segment, includes those operations which are expected to be discontinued in the future.


The Company’s reportable segments include Taxable Fixed Income, Municipal Capital Markets, Equity Capital Markets, Fixed Income-Other and Corporate-Other, which collectively comprise First Albany Capital Inc. The Company’s brokerage operations include both First Albany Capital Inc. and Descap Securities, Inc., the newly acquired broker-dealer and investment bank specializing in mortgage-based securities. The Company’s reportable segments also include Parent & Affiliates, FA Asset Management Inc. (future discontinued operations) and Investments. The Company evaluates the performance of its segments and allocates resources to them based on various factors, including prospects for growth, return on revenue and expected profitability.


The Taxable Fixed Income segment includes institutional sales and trading of corporate, federal government and agency securities.  The Municipal Capital Markets segment includes underwriting and institutional sales and trading of municipal securities as well as financial advisory services for municipalities.  The Equity Capital Markets segment includes institutional sales and trading of equity securities, corporate finance advisory services and underwritings.  The Fixed Income-Other segment includes institutional sales and trading of fixed income middle markets and taxable municipal securities. The Corporate-Other segment includes internal operations and support costs, along with other unallocated revenues and expenses.


The Parent and Affiliates segment includes the Parent company, excluding its investment portfolio, the asset management services of FATV, and the Company’s institutional convertible bond arbitrage advisory group.  The Investment segment includes realized gains and losses and unrealized gains and losses from the Company’s investment portfolio. The Investment segment does not include revenues the Company receives through FATV for management of some of its private investments, which are eliminated in consolidation in investment gains (losses).  These revenues are included in the Parent and Affiliates segment.


Intersegment revenue have been eliminated for purposes of presenting net revenue so that total net revenue presented is from external sources. Interest revenue is allocated to the operating segments and is presented net of interest expense for purposes of assessing the performance of the business segment. Depreciation and amortization is allocated to the business segments.






FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)






Information concerning operations in these segments is as follows for the three months and six months ending June 30:


 


Three Months Ended

 

Six Months Ended

 


June 30,

 

June 30,

(In thousands of dollars)


2004

 

2003

 

2004

 

2003

Net revenues (including net interest income)



      

Taxable Fixed Income

$

5,271

$

15,486

$

14,545

$

31,217

Municipal Capital Markets

 

9,834

 

9,866

 

16,647

 

18,887

Equity Capital Markets

 

16,604

 

11,991

 

38,384

 

21,732

Fixed Income-Other

 

1,380

 

4,680

 

4,880

 

8,824

Corporate-Other

 

668

 

711

 

1,548

 

1,363

First Albany Capital Inc.

 

33,757

 

42,734

 

76,004

 

82,023

Descap Securities, Inc.

 

2,475

 

-

 

2,475

 

-

Total Brokerage Operations

 

36,232

 

42,734

 

78,479

 

82,023

Parent and Affiliates

 

213

 

723

 

403

 

1,815

FA Asset Management Inc.

 

497

 

651

 

1,061

 

1,264

Investments

 

4,010

 

2,789

 

3,602

 

7,503

Discontinued Operations

 

458

 

250

 

458

 

250

Total net revenues

$

41,410

$

47,147

$

84,003

$

92,855

Net interest income (included in total net revenues)

        

Taxable Fixed Income

$

97

$

151

$

116

$

349

Municipal Capital Markets

 

287

 

223

 

626

 

590

Equity Capital Markets

 

13

 

7

 

23

 

14

Fixed Income-Other

 

61

 

(36)

 

145

 

(14)

Corporate-Other

 

808

 

610

 

1,540

 

1,281

First Albany Capital Inc.

 

1,266

 

955

 

2,450

 

2,220

Descap Securities, Inc.

 

17

 

-

 

17

 

-

Total Brokerage Operations

 

1,283

 

955

 

2,467

 

2,220

Parent and Affiliates

 

(426)

 

(291)

 

(855)

 

(490)

FA Asset Management Inc.

 

(34)

 

(9)

 

(66)

 

(14)

Total net interest income

$

823

$

655

$

1,546

$

1,716


Income (loss) before income taxes:

        

Taxable Fixed Income

$

179

$

3,240

$

1,741

$

6,559

Municipal Capital Markets

 

1,641

 

1,821

 

360

 

3,433

Equity Capital Markets

 

599

 

51

 

3,259

 

(1,064)

Fixed Income-Other

 

365

 

2,289

 

2,278

 

4,583

Corporate-Other

 

(4,905)

 

(4,853)

 

(10,567)

 

(9,489)

First Albany Capital Inc.

 

(2,121)

 

2,548

 

(2,929)

 

4,022

Descap Securities, Inc.

 

409

 

-

 

409

 

-

Total Brokerage Operations

 

(1,712)

 

2,548

 

(2,520)

 

4,022

Parent and Affiliates

 

(1,756)

 

(1,062)

 

(3,300)

 

(3,458)

FA Asset Management Inc.

 

(603)

 

(381)

 

(1,765)

 

(681)

Investments

 

4,010

 

2,789

 

3,602

 

7,503

Discontinued Operations

 

458

 

250

 

458

 

250

Income (loss) before income taxes

$

397

$

4,144

$

(3,525)

$

7,636





FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)







 


Three Months Ended

 

Six Months Ended

 


June 30,

 

June 30,

(In thousands of dollars)


2004

 

2003

 

2004

 

2003

Depreciation and amortization expense (charged to each segment in measuring the income (loss) before income taxes)

        

Taxable Fixed Income

$

65

$

74

$

134

$

145

Municipal Capital Markets

 

91

 

105

 

185

 

201

Equity Capital Markets

 

263

 

284

 

530

 

578

Fixed Income-Other

 

8

 

12

 

18

 

25

Corporate-Other

 

173

 

199

 

362

 

423

First Albany Capital Inc.

 

600

 

674

 

1,229

 

1,372

Descap Securities, Inc.

 

5

 

-

 

5

 

-

Total Brokerage Operations

 

605

 

674

 

1,234

 

1,372

Parent and Affiliates

 

104

 

47

 

202

 

81

FA Asset Management Inc.

 

24

 

14

 

49

 

30

Total

$

733

$

735

$

1,485

$

1,483


The financial policies of the Company’s segments are the same as those described in the “Summary of Significant Accounting Policies” footnote (Note 1 to the annual report on Form 10-K).  Asset information by segment is not reported since the Company does not produce such information.  All assets are located in the United States of America. Prior periods’ financial information has been reclassified to conform to the current presentation.


18.

Discontinued Operations

In 2000, the Company sold assets of its Private Client Group, its retail brokerage branch network, to First Union Securities, a subsidiary of First Union Corp. now known as Wachovia Securities.


In accordance with Accounting Principles Board Opinion No. 30 (APB 30), “Reporting the Results of Operations – Reporting the Effect of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”, the results of the Private Client Group have been reported separately as a discontinued operation for all periods presented.


Components of amounts reflected in condensed consolidated statement of financial condition and condensed consolidated statement of operations are presented in the following tables:






FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)










FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)






  

Three Months Ended

 

Six Months Ended

(In thousands of dollars)

 

June 30, 2004

 

June 30, 2003

 

June 30, 2004

 

June 30, 2003

Net revenues

$

458

$

250

$

458

$

250

Expenses

 

-

 

-

 

-

 

-

Income before income taxes

 

458

 

250

 

458

 

250

Income tax expense

 

(191)

 

(104)

 

(191)

 

(104)

Income from discontinued

operations, net of taxes

 


267

 


146

 


267

 


146


Revenues from discontinued operations for 2004 are the result of a $0.3 million refund from Wachovia Securities for costs relating to the jointly enhanced financial consultant retention program relating to the Private Client Group and the reversal of $0.2 million in costs related to previously impaired space which was put into service.





FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)







19.

New Accounting Standards

In January 2003, the FASB issued FIN No. 46R, "Consolidation of Variable Interest Entities (Revised)”.  FIN No. 46R requires a company to consolidate a variable interest entity (VIE) if the company has variable interests that give it a majority of the expected losses or a majority of the expected residual returns of the entity.  FIN No. 46R is effective for VIEs as of March 31, 2004.  FIN No. 46R was adopted March 31, 2004 and did not result in the consolidation of any VIE.


20.

Acquisitions

Descap Securities, Inc.

On May 14, 2004, the Company acquired 100% of the outstanding common shares of Descap Securities, Inc. (“Descap”), a New York-based broker-dealer and investment bank.  Descap specializes in the primary issuance and secondary trading of mortgage-backed securities, asset-backed securities, collateralized mortgage obligations and derivatives, and commercial mortgage-backed securities.  Its investment banking group provides advisory and capital raising services, and specializes in structured finance and asset-backed securities.  Descap will continue to operate under its current name.


The value of the transaction is approximately $31 million, which consists of $25 million in cash and 549,476 shares of the Company’s common stock, plus future consideration based on financial performance.  Approximately $9.4 million of the purchase price was to acquire the net assets of the business, which consisted of assets of $68.7 million and liabilities of $59.3 million (see table below).  The purchase price in excess of net assets ($21.7 million) was preliminarily allocated to intangible assets based upon an independent third party valuation (see “Intangible Asset” footnote). The Company also issued 270,843 shares of restricted stock to employees of Descap Securities, which vests over a three-year period.


The following table summarizes the estimated fair value of assets acquired and liabilities assumed at the date of the acquisition:


(In thousands of dollars)

  

As of

 

May 14, 2004

Assets

  

Cash

$

3,868

Receivables from:

  

Brokers, dealers and clearing agencies

 

225

Others

 

2,510

Securities owned

 

60,336

Investments

 

203

Office equipment and leasehold improvements, net

 

645

Other assets

 

931

Total assets acquired

$

68,718

Liabilities

  

Payables to:

  

Brokers, dealers and clearing agencies

$

34,921

Securities sold, but not yet purchased

 

22,599

Accounts payable

 

1,445

Accrued compensation

 

275

Accrued expenses

 

79

Total liabilities assumed

$

59,319

   

Net assets acquired

$

9,399







FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)






The following table presents pro forma information as if the acquisition of Descap Securities, Inc. had occurred on January 1, 2004 and 2003.






FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)










FIRST ALBANY COMPANIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)






  

Three Months Ended

 

Six Months Ended

(In thousands of dollars except for per share amounts and shares outstanding)

 

June 30, 2004

 

June 30, 2003

 

June 30, 2004

 

June 30, 2003

Net revenues (including interest)

$

43,761

$

55,968

$

90,008

$

108,548

Total expenses (excluding interest)

 

43,047

 

48,017

 

93,447

 

94,339

Income before income taxes

 

714

 

7,951

 

(3,439)

 

14,209

Income tax (benefit) expense

 

(2,147)

 

3,177

 

(4,237)

 

5,600

Income from continuing operations

 

2,861

 

4,774

 

798

 

8,609

Income from discontinued operations, net of

 taxes

 

267

 

146

 

267

 

146

Net income (loss)

$

3,128

$

4,920

$

1,065

$

8,755

Per share data:

        

Basic earnings:

        

Continued operations

$

0.22

$

0.44

$

0.07

$

0.79

Discontinued operations

 

0.02

 

0.01

 

0.02

 

0.01

Net income

$

0.24

$

0.45

$

0.09

$

0.80

Diluted earnings:

        

Continued operations

$

0.19

$

0.39

$

0.06

$

0.74

Discontinued operations

 

0.02

 

0.01

 

0.02

 

0.01

Net income

$

0.21

$

0.40

$

0.08

$

0.75







FIRST ALBANY COMPANIES INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS




Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations


FIRST ALBANY COMPANIES INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS



FIRST ALBANY COMPANIES INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS



  

Three Months Ended

(In thousands of dollars)

 

June 30, 2004

 

June 30, 2003

Revenues:

    

Commissions

$

5,360

$

3,708

Principal transactions

 

20,300

 

30,176

Investment banking

 

9,228

 

7,720

Investment gains (losses)

 

4,141

 

2,913

Interest

 

2,188

 

1,385

Fees and other

 

1,100

 

1,725

Total revenues

 

42,317

 

47,627

Interest expense

 

1,365

 

730

Net revenues

 

40,952

 

46,897

Expenses (excluding interest):

    

Compensation and benefits

 

29,098

 

31,477

Clearing, settlement and brokerage costs

 

1,491

 

1,365

Communications and data processing

 

3,950

 

3,722

Occupancy and depreciation

 

2,418

 

2,375

Selling

 

1,991

 

1,806

Other

 

2,065

 

2,258

Total expenses (excluding interest)

 

41,013

 

43,003

Income (loss) before income taxes

 

(61)

 

3,894

Income tax (benefit) expense

 

(2,465)

 

1,514

Income (loss) from continuing operations

 

2,404

 

2,380

Income from discontinued operations

net of taxes

 

267

 

146

Net income (loss)

$

2,671

$

2,526

Net interest income:

    

Interest income

$

2,188

$

1,385

Interest expense

 

1,365

 

730

Net interest income

$

823

$

655



The following is management’s discussion and analysis of certain significant factors, which have affected the Company’s financial position and results of operations during the periods included in the accompanying condensed consolidated financial statements.


Business Environment


First Albany Companies Inc. (the “Company”) is the parent company whose principal subsidiaries include First Albany Capital Inc. (“First Albany Capital”), Descap Securities, Inc. (“Descap Securities”), FA Technology Ventures Corporation and FA Asset Management Inc.  First Albany Capital Inc. provides investment banking services to corporate and public clients, and engages in market making and trading of corporate, government and municipal securities.  Descap Securities is a New York-based broker-dealer and investment bank specializing in mortgage-backed securities.  FA Technology Ventures Corporation provides venture capital and merchant banking to the investment and corporate communities, and FA Asset Management Inc. provides asset management services to individuals and institutions.


The investment banking and brokerage businesses generate revenues in direct correlation with the general level of trading activity in the stock and bond markets.  The Company cannot control this level of activity, however many of the Company’s costs are fixed.  Therefore, the Company’s earnings, like those of others in the industry, reflect the activity in the markets and can fluctuate accordingly.


BUSINESS OVERVIEW


The Company’s 2004 second quarter net revenues were $41.0 million compared to $46.9 million for the same period in 2003.   The Company had net income of $2.7 million for the second quarter 2004, compared to net income of $2.5 million for the same period in 2003.  Second quarter 2004 net income per diluted share was $0.19 compared to net income of $0.22 per diluted share in the second quarter of 2003.  Net income from continuing operations was $2.4 million for the second quarter of 2004 compared to $2.4 million in the second quarter of 2003.  Diluted earnings per share from continuing operations for the second quarter of 2004 was $0.17 per share compared to $0.21 in the second quarter of 2003.


For the six months ended June 30, 2004, net revenues were $83.5 million compared to $92.6 million for the same period in 2003, and net income was $0.7 million compared to $4.7 million for the same period in 2003. Earnings per diluted share for the six months ended June 30, 2004 was $0.06 compared to $0.43 per diluted share for the same period in 2003.  Net income from continuing operations was $0.5 million for the six months ended June 30, 2004 compared to $4.6 million in the same period of 2003.  Diluted earnings per share from continuing operations for the six months ended June 30, 2004 was $0.04 per share compared to $0.42 for the six months ended June 30, 2003.   


Major Segment Operating Results


Brokerage Operations

Brokerage Operations is comprised of First Albany Capital, the securities brokerage and investment banking operation of the Company, and its wholly owned subsidiary, Descap Securities, a broker-dealer and investment bank specializing in mortgage-backed securities.


Net revenues from the Company’s Brokerage Operations were $36.2 million for the second quarter ended June 30, 2004, compared to $42.7 million for the same period in 2003.  The Company’s Brokerage Operations had a net loss of $0.9 million for the second quarter 2004, compared to net income of $1.6 million for the same period in 2003.  For the first half of 2004, net revenues from the Brokerage Operations were $78.5 million, as compared with $82.0 million for the first half of 2003.  Net income for the first half of 2004 was a net loss of $0.9 million compared to net income of $2.6 million for the same period in 2003.


Results for the divisions of the Company’s Brokerage Operations are:


•

Net revenues for Equity Capital Markets were $16.6 million for the second quarter of 2004, up from $12.0 million in the second quarter of 2003.  Continued strength in investment banking fees and improvement in listed trading revenue were the primary reasons for the year-over-year improvement for the quarter. Compared to the second quarter of 2003, investment banking revenues were $3.8 million up from $1.2 million and listed net revenue was up $1.5 million.  During the second quarter of 2004, the Company acted as a co-manager on seven equity transactions and an advisor on two transactions. For the first six months of 2004, net revenues for Equity Capital Markets were $38.4 million as compared to $21.7 million for the first six months of 2003.


•

The Municipal Capital Markets group net revenue was $9.8 million for the second quarter of 2004 as compared to $9.9 million for the same period in 2003.  During the second quarter the firm acted as a sole or senior manager on twelve transactions, a co-manager on twenty transactions and an advisor on seventeen transactions. For the first six months of 2004, net revenues for Municipal Capital Markets were $16.6 million as compared to $18.9 million for the first six months of 2003.  The Public Finance group acted as senior-manager and lead accounts runner on a $500 million offering for the state of California, which was the group’s largest senior-managed transaction in its history.


•

The Taxable Fixed Income unit reported net revenue for the second quarter of $5.3 million compared to $15.5 million in the second quarter of 2003. Declining institutional investor transaction activity and the overall compression spreads in their markets continued to negatively impact net revenue in Taxable Fixed Income.  For the first six months of 2004, net revenues were $14.5 million as compared to $31.2 million for the first six months of 2003.


Parent & Affiliates


•

The Company is continuing to review alternatives with regard to the discontinuance of its asset management business, other than its convertible bond arbitrage group, and anticipates it will become a discontinued operation as of the end of the 2004 third quarter.


•

FA Technology Ventures (FATV) added two new portfolio companies in the second quarter.  FATV acted as a co-lead investor in CreditSights, Inc., an internet-enabled, independent research firm providing capital market research to institutional investors, and also invested in Autotask, Inc., which develops, markets, and hosts professional services automation software.  As of June 30, 2004 the fund was 50% invested/reserved.


•

Investment gains for the quarter ended June 30, 2004 were $4.7 million, net of tax, due primarily to an increase in fair market value of the investment portfolio held by First Albany Companies.  


Three-Month Period Ended June 30, 2004


Commissions

Commission revenue represents revenues generated by the Company in executing customers' orders to buy or sell listed securities and securities in which it does not make a market, the Company generally acts as an

agent and charges a commission.  Commission revenue was generated from the following business segments:


  

Three Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

17

$

22

Municipal Capital Markets

 

7

 

14

Equity Capital Markets

 

5,335

 

3,666

Fixed Income - Other

 

-

 

-

Parent & Affiliates/Corporate-Other

 

1

 

6

Total Commissions Revenue

$

5,360

$

3,708


The increase in commission revenue in 2004 was a result of the increase in listed agency transactions by the Equity Capital Markets segment.


Principal Transactions

Principal transactions revenue represents trading of municipal debt (tax-exempt and taxable) through its Municipal Capital Markets segment, U.S. government and federal agency obligations, corporate debt and convertible securities through its Taxable Fixed Income and Descap Securities segments and equity securities through its Equity Capital Markets segment as a "market maker" for sale of those securities to other dealers and to customers.  Most of the trading is for the purpose of generating sales credits for the institutional sales force.  Principal transactions revenue was generated from the following business segments:

FIRST ALBANY COMPANIES INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS




  

Three Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

5,132

$

15,063

Municipal Capital Markets

 

4,252

 

3,192

Equity Capital Markets

 

7,373

 

6,999

Fixed Income - Other

 

1,227

 

4,831

Descap Securities

 

2,458

 

-

Parent & Affiliates/Corporate-Other

 

(142)

 

91

Total Principal Transactions Revenue

$

20,300

$

30,176


Principal transactions in 2004 decreased $9.9 million or 33%.  These revenues were negatively impacted by declining institutional investor transaction activity and by overall compression in price spreads in the secondary corporate bond market, which resulted in a $9.9 million decline in revenue from the Taxable Fixed Income segment and a $3.6 million decline in revenues in the Fixed Income-Other segment.  These declines were offset by $2.5 million in revenues from the newly acquired Descap Securities, along with the Equity Capital Markets segment revenues increasing $0.4 million and Municipal Capital Markets revenue increasing $1.1 million.


Investment Banking

Investment Banking revenue represents revenues generated by the Company managing, co-managing, and participating in corporate securities offerings through its Equity Capital Markets segment and municipal securities offerings through its Municipal Capital Markets segment.  Investment Banking revenue was generated from the following business segments:



  

Three Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

25

$

203

Municipal Capital Markets

 

5,275

 

6,409

Equity Capital Markets

 

3,836

 

1,223

Fixed Income - Other

 

92

 

(115)

Total Investment Banking

$

9,228

$

7,720


Investment banking revenues increased $1.5 million or 20% in 2004.  The increase was comprised mainly of an increase in the Equity Capital Markets segment where the number of managed and co-managed corporate equity offerings and financial advisory transactions increased to 9 compared to 3 in 2003.


Investment Gains (losses)

Investment gains increased $1.2 million in 2004 due primarily to an increase in fair market value of the Investment portfolio held by the Parent & Affiliates segment.


Fees and Other

A majority of the fees the Company earns relates to the activity of FA Technology Ventures Corporation (managing private equity funds, and providing venture financing to emerging growth companies) and the institutional convertible bond arbitrage advisory group, both of which are included in the Parent and

Affiliates segment along with FA Asset Management Inc., acting as an investment advisor, managing the assets of institutions and individuals.

FIRST ALBANY COMPANIES INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS




  

Three Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

-

$

47

Municipal Capital Markets

 

14

 

28

Equity Capital Markets

 

47

 

96

Parent & Affiliates/Corporate-Other

 

509

 

894

FA Asset Management

 

530

 

660

Total Fees and Other

$

1,100

$

1,725


Fees and other in 2004 decreased $0.6 million or 36% primarily due to decrease in revenues related to the institutional convertible bond arbitrage advisory group.


Compensation and Benefits

Compensation and benefits expense includes salaries, sales-related compensation and benefits.


  

Three Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

4,016

$

11,156

Municipal Capital Markets

 

6,615

 

6,196

Equity Capital Markets

 

9,926

 

6,597

Fixed Income - Other

 

820

 

2,183

Parent & Affiliates/Corporate-Other

 

5,283

 

4,581

Descap Securities

 

1,659

 

-

FA Asset Management

 

779

 

764

Total Compensation and Benefits

$

29,098

$

31,477


Compensation and benefits expense decreased $2.4 million or 8% in 2004. In the Taxable Fixed Income segment compensation and benefits decreased $7.1 million and decreased $1.4 million in the Fixed Income-Other segment, both due primarily to a decrease in net revenues.  This decrease was offset by an increase in the Equity Capital Markets segment of $3.3 million and a $1.7 million increase in the Descap Securities segment, due primarily to an increase in net revenues in these segments.  


Income Tax (Benefit) Expense

Income tax expense decreased $4.0 million in 2004 due mainly to a decrease in income (loss) before income tax and to the difference in accounting versus tax treatment of the Plug Power stock distribution (see “Investments” footnote in the Notes to Condensed Consolidated Financial Statements).

FIRST ALBANY COMPANIES INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS







FIRST ALBANY COMPANIES INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS



FIRST ALBANY COMPANIES INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS



  

Six Months Ended

(In thousands of dollars)

 

June 30, 2004

 

June 30, 2003

Revenues:

    

Commissions

$

11,158

$

7,895

Principal transactions

 

45,263

 

58,584

Investment banking

 

19,457

 

12,970

Investment gains (losses)

 

3,864

 

7,760

Interest

 

3,925

 

3,207

Fees and other

 

2,257

 

3,680

Total revenues

 

85,924

 

94,096

Interest expense

 

2,379

 

1,491

Net revenues

 

83,545

 

92,605

Expenses (excluding interest):

    

Compensation and benefits

 

61,860

 

63,064

Clearing, settlement and brokerage costs

 

2,875

 

2,429

Communications and data processing

 

8,064

 

7,204

Occupancy and depreciation

 

4,731

 

4,644

Selling

 

3,766

 

3,476

Other

 

6,232

 

4,402

Total expenses (excluding interest)

 

87,528

 

85,219

Income (loss) before income taxes

 

(3,983)

 

7,386

Income tax (benefit) expense

 

(4,460)

 

2,803

Income (loss) from continuing operations

 

477

 

4,583

Income from discontinued operations

net of taxes

 

267

 

146

Net income (loss)

$

744

$

4,729

Net interest income:

    

Interest income

$

3,925

$

3,207

Interest expense

 

2,379

 

1,491

Net interest income

$

1,546

$

1,716


FIRST ALBANY COMPANIES INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS



Six-Month Period Ended June 30, 2004


Commissions

Commission revenue represents revenues generated by the Company in executing customers' orders to buy or sell listed securities and securities in which it does not make a market, the Company generally acts as an agent and charges a commission.  Commission revenue was generated from the following business segments:


  

Six Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

109

$

38

Municipal Capital Markets

 

14

 

26

Equity Capital Markets

 

11,034

 

7,816

Fixed Income - Other

 

-

 

-

Parent & Affiliates/Corporate-Other

 

1

 

15

Total Commissions Revenue

$

11,158

$

7,895


The increase in commission revenue in 2004 was a result of the increase in listed agency transactions by the Equity Capital Markets segment.


Principal Transactions

Principal transactions revenue represents trading of municipal debt (tax-exempt and taxable) through its Municipal Capital Markets segment, U.S. government and federal agency obligations, corporate debt and convertible securities through its Taxable Fixed Income and Descap Securities segments and equity securities through its Equity Capital Markets segment as a "market maker" for sale of those securities to other dealers and to customers.  Most of the trading is for the purpose of generating sales credits for the institutional sales force.  Principal transactions revenue was generated from the following business segments:


  

Six Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

13,788

$

30,517

Municipal Capital Markets

 

6,475

 

7,296

Equity Capital Markets

 

17,890

 

11,775

Fixed Income - Other

 

4,646

 

8,935

Descap Securities

 

2,458

 

-

Parent & Affiliates/Corporate-Other

 

6

 

61

Total Principal Transactions Revenue

$

45,263

$

58,584


Principal transactions in 2004 decreased $13.3 million or 23%.  These revenues were negatively impacted by the overall compression in price spreads in the secondary corporate bond market and declining institutional investor transaction activity, which resulted in a $16.8 million decline in revenue from the Taxable Fixed Income segment.  Also, revenues in the Municipal Capital Market segment and the Fixed Income-Other segment were negatively impacted by the current interest rate environment.  These declines were offset by an increase in the Equity Capital Markets segment revenues of $6.1 million as a result of the Company’s NASDAQ trading effort and improved NASDAQ markets and in revenues of $2.5 million in the newly acquired Descap Securities segment..


Investment Banking

Investment Banking revenue represents revenues generated by the Company managing, co-managing, and participating in corporate securities offerings through its Equity Capital Markets segment and municipal securities offerings through its Municipal Capital Markets segment.  Investment Banking revenue was generated from the following business segments:

FIRST ALBANY COMPANIES INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS




  

Six Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

532

$

220

Municipal Capital Markets

 

9,509

 

10,914

Equity Capital Markets

 

9,327

 

1,932

Fixed Income - Other

 

89

 

(96)

Parent & Affiliates/Corporate-Other

 

-

 

-

Total Investment Banking

$

19,457

$

12,970


Investment banking revenues increased $6.5 million or 50% in 2004.  The increase was comprised mainly of an increase in the Equity Capital Markets segment where the number of managed, co-managed and mergers and acquisitions transactions in corporate offerings and debt transactions increased to 19 compared to 7 in 2003.


Investment Gains (losses)

Investment gains decreased $3.9 million in 2004 compared to the same period in 2003.  In the first six months of 2003, the fair market value of investments increased $7.8 million, while in the first six months of 2004, the market fair value of investments increased only $3.9 million.


Fees and Other

A majority of the fees the Company earns relates to the activity of FA Technology Ventures Corporation (managing private equity funds, and providing venture financing to emerging growth companies) and the institutional convertible bond arbitrage advisory group, both of which are included in the Parent and Affiliates segment along with FA Asset Management Inc., acting as an investment advisor, managing the assets of institutions and individuals.

  

Six Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

-

$

94

Municipal Capital Markets

 

24

 

61

Equity Capital Markets

 

110

 

193

Parent & Affiliates/Corporate-Other

 

997

 

2,054

FA Asset Management

 

1,126

 

1,278

Total Fees and Other

$

2,257

$

3,680


Fees and other in 2004 decreased $1.4 million or 39% primarily due to decrease in revenues related to the institutional convertible bond arbitrage advisory group included in the Parent & Affiliates segment.


Compensation and Benefits

Compensation and benefits expense includes salaries, sales-related compensation and benefits.


  

Six Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

10,669

$

22,571

Municipal Capital Markets

 

11,642

 

12,042

Equity Capital Markets

 

22,489

 

12,650

Fixed Income - Other

 

2,206

 

3,853

Parent & Affiliates/Corporate-Other

 

10,997

 

10,516

Descap Securities

 

1,659

 

-

FA Asset Management

 

2,198

 

1,432

Total Compensation and Benefits

$

61,860

$

63,064


Compensation and benefits expense decreased $1.2 million or 2% in 2004. In the Taxable Fixed Income segment compensation and benefits decreased $11.9 million and decreased $1.6 million in the Fixed Income-Other segment, both due primarily to a decrease in net revenues.  This decrease was offset by an increase in the Equity Capital Markets segment of $9.8 million and a $1.7 million increase in the Descap Securities segment, due primarily to an increase in net revenues in these segments.  


Communications and Data Processing

Communications and Data Processing includes telecommunication costs, market data services and data processing costs mainly related to transactions of the Company’s securities brokerage operations.

  

Six Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

1,023

$

985

Municipal Capital Markets

 

1,001

 

1,003

Equity Capital Markets

 

5,656

 

4,553

Fixed Income - Other

 

193

 

198

Parent & Affiliates/Corporate-Other

 

(214)

 

293

Descap Securities

 

122

 

-

FA Asset Management

 

283

 

172

Total Communications and Data Processing

$

8,064

$

7,204


Communications and Data Processing expense increased $0.9 million or 12% in 2004 due primarily to an increase in service bureau related data processing costs due to the increase in the number of equity securities transactions and market data related services in the Equity Capital Markets segment.


Other

Other expense mainly includes litigation costs, professional fees, postage and printing costs and insurance costs.

  

Six Months Ended June 30

(In thousands of dollars)

 

2004

 

2003

Taxable Fixed Income

$

68

$

45

Municipal Capital Markets

 

2,093

 

926

Equity Capital Markets

 

972

 

462

Fixed Income - Other

 

7

 

3

Parent & Affiliates/Corporate-Other

 

2,995

 

2,890

Descap Securities

 

19

 

-

FA Asset Management

 

78

 

76

Total Other

$

6,232

$

4,402


Other expense increased $1.8 million in 2004 due mainly to increases in reserves related to a previously-disclosed customer dispute (Municipal Capital Markets segment) and an arbitration award in an employment dispute (Equity Capital Markets segment).


Income Tax (Benefit) Expense

Income tax expense decreased $7.3 million in 2004 due mainly to a decrease in income (loss) before income tax and to the difference in accounting versus tax treatment of the Plug Power stock distribution (see “Investments” footnote in the Notes to Condensed Consolidated Financial Statements).



FIRST ALBANY COMPANIES INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS



Liquidity and Capital Resource


A substantial portion of the Company's assets, similar to other brokerage and investment banking firms, are liquid, consisting of cash and assets readily convertible into cash.  These assets are financed primarily by the Company's payables to brokers, dealers and clearing agencies, bank lines of credit and customer payables.  The level of assets and liabilities will fluctuate as a result of the changes in the level of positions held to facilitate customer transactions and changes in market conditions.


As of June 30, 2004, First Albany Capital Inc. and Descap Securities, Inc., both registered broker-dealer subsidiaries of First Albany Companies Inc., were in compliance with the net capital requirements of the Securities and Exchange Commission. The net capital rules restrict the amount of a broker-dealer’s net assets that may be distributed. Also, a significant operating loss or extraordinary charge against net capital may adversely affect the ability of the Company’s broker-dealer subsidiary to expand or even maintain its present levels of business and the ability to support the obligations or requirements of the Company. As of June 30, 2004, First Albany Capital Inc. had net capital of $13.3 million, which exceeded minimum net capital requirements by $12.3 million, while Descap Securities, Inc. had net capital of $6.0 million, which exceeded minimum net capital requirements by $5.9 million.


As of June 30, 2004, the Company had a commitment through July 2006 to invest up to $11.5 million in FA Technology Ventures, LP (the “Partnership”).  The Company intends to fund this commitment from the sale of other investments and operating cash flow. The Partnership’s primary purpose is to provide investment returns consistent with risks of investing in venture capital. In addition to the Company, certain other limited partners of the Partnership are officers or directors of the Company. The majority of the commitments to the Partnership are from non-affiliates of the Company.


The General Partner for the Partnership is FATV GP LLC. The General Partner is responsible for the management of the Partnership, including among other things, making investments for the Partnership. The members of the General Partnership are George McNamee, Chairman of the Company, First Albany Enterprise Funding, Inc., a wholly owned subsidiary of the Company, and other employees and former employees of the Company or its subsidiaries. Mr. McNamee is required under the Partnership agreement to devote a majority of his business time to the conduct of the affairs of the Partnership and any parallel funds. Subject to the terms of the Partnership agreement, under certain conditions, the General Partnership is entitled to share in the gains received by the Partnership in respect of its investment in a portfolio company. The General Partner will receive a carried interest on customary terms. The General Partner has contracted with FA Technology Ventures Corporation, a wholly owned subsidiary of the Company,  to act as investment advisor to the General Partner.


As of June 30, 2004, the Company had an additional commitment through July 2006 to invest up to $8.8 million in funds that invest in parallel with the Partnership, which it intends to fund, at least in part, through current and future Employee Investment Funds (EIF). EIF are limited liability companies, established by the Company for the purpose of allowing select employees to invest their own funds in private equity placements.


The Company has deferred tax assets of $12.5 million and deferred tax liabilities of $7.2 million as of June 30, 2004. The Company expects that it will realize the benefit of the deferred tax assets through the combination of future taxable income and income available in years in which the reversal of the asset can be carried back.


The Company enters into underwriting commitments to purchase securities as part of its investment banking business and may also purchase and sell securities on a when-issued basis. As of June 30, 2004, the Company had $1.6 million outstanding underwriting commitments and had purchased no securities on a when-issued basis.


On May 14, 2004, the Company acquired 100% of the outstanding common shares of Descap Securities, Inc., a New York-based broker-dealer and investment bank.  The value of the transaction was approximately $31 million, which consisted of $25 million in cash and 549,476 shares of the Company’s common stock, plus future consideration based on financial performance (see “Acquisitions” footnote in the Notes to Condensed Consolidated Financial Statements). The shares of the Company’s stock issued to the sellers of Descap Securities, Inc. provide the sellers the right to require the Company to purchase back these shares at a price of $6.14 per share.  The Company also has the right to purchase back these shares from the sellers at a price of $14.46.  Both the put and call rights expires on May 31, 2007.


The Company’s notes payable include Senior Notes for $10 million which contain various covenants, as defined in the agreements, including restrictions on the incurrence of debt, the maintenance of not less than $50 million of net worth (at June 30,2004, the Company’s net worth was $89.8 million) and an adjusted cash flow coverage rate for First Albany Capital Inc. (a wholly owned subsidiary) of not less than 1.2 to 1 as at the end of each fiscal quarter based on a the most recently concluded period of four consecutive quarters (as of the end of the June 2004 quarter, the Company’s adjusted cash flow coverage rate was 27.0 to 1). As of June 30, 2004, the Company was in compliance with these covenants.


The Company’s notes payable also include a $20 million Term Loan to finance the acquisition of Descap Securities, Inc. which contains various covenants, as defined in the agreement, including maintenance of not less than $22.5 million of earnings before interest, taxes, depreciation, amortization and lease expense (“EBITDAR”) (for the twelve months period ending June 30, 2004, the Company’s EBITDAR was $32.1 million), operating cash flow to total fixed charge ratio of not less than 1.15 to 1 (for the twelve months period ending June 30, 2004, the operating cash flow to total fixed charge ratio was 1.57 to1) and modified total funded debt to EBITDAR ratio of less than 1.75 to 1(for the twelve months period ending June 30, 2004, modified total funded debt to EBITDAR ratio was 1.15 to 1).  As of June 30, 2004, the Company was in compliance with these covenants.


Management believes that funds provided by operations and a variety of bank lines of credit totaling at least $300 million, of which approximately $84 million were unused as of June 30, 2004, will provide sufficient resources to meet present and reasonably foreseeable short-term and long-term financial needs.  These bank lines of credit consist of credit lines that the Company has been advised are available but for which no contractual lending obligations exist and are repayable on demand.  These bank lines of credit are limited to financing securities eligible for collateralization, which includes Company owned securities.


CONTRACTUAL OBLIGATIONS


First Albany Companies Inc. has contractual obligations to make future payments in connection with our short-term debt, long-term debt, capital leases, and operating leases. See Notes to Consolidated Financial Statements for additional disclosures related to our commitments.


The following table sets forth these contractual obligations by fiscal year:


(In thousands of dollars)

 

2004

 

2005

 

2006

 

2007

 

2008

Thereafter

 

Total

Short-term bank loans

$

215,890

$

-

$

-

$

-

$

-

$

-

$

215,890

Long term debt (1)

 

1,279

 

4,897

 

5,722

 

5,000

 

5,106

 

11,971

 

33,975

Capital lease obligations

 

1,039

 

873

 

592

 

307

 

134

 

4

 

2,949

Operating leases (2)

 

3,070

 

5,770

 

5,195

 

5,264

 

4,530

 

13,205

 

37,034

Subordinated debt (3)

 

-

 

-

 

1,328

 

1,442

 

93

 

832

 

3,695

Total

$

221,278

$

11,540

$

12,837

$

12,013

$

9,863

$

26,012

$

293,543


(1)

The Company has several notes payable which have principal payments associated with each.  See Notes to the Consolidated Financial Statements.


(2)

The Company’s headquarters and sales offices, and certain office and communication equipment, are leased under non-cancelable operating leases, certain of which contain escalation clauses and which expire at various times through 2015.


(3)

A select group of management and highly compensated employees are eligible to participate in the First Albany Companies Inc. Deferred Compensation Plan for Key Employees (the “Plan”).  The employees enter into subordinate loans with the Company to provide for the deferral of compensation and employer allocations under the Plan.  The accounts of the participants of the Plan are credited with earnings and/or losses based on the performance of various investment benchmarks selected by the participants.  Maturities of the subordinated debt are based on the distribution election made by each participant, which may be deferred to a later date by the participant.


FIRST ALBANY COMPANIES INC.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





Item 3.  Quantitative and Qualitative Disclosures about Market Risk


MARKET RISK


Market risk generally represents the risk of loss that may result from the potential change in the value of a financial instrument as a result of fluctuations in interest rates and equity prices, changes in the implied volatility of interest rates and equity prices and also changes in the credit ratings of either the issuer or its related country of origin.  Market risk is inherent to both derivative and non-derivative financial instruments, and accordingly, the scope of the Company's market risk management procedures extends beyond derivatives to include all market-risk-sensitive financial instruments.  The Company's exposure to market risk is directly related to its role as a financial intermediary in customer-related transactions and to its proprietary trading.


The Company trades tax exempt and taxable debt obligations, including U.S. Treasury bills, notes, and bonds; U.S. Government agency notes and bonds; bank certificates of deposit; mortgage-backed securities, and corporate obligations.  The Company is also an active market maker in the NASDAQ equity markets.  In connection with these activities, the Company may be required to maintain inventories in order to ensure availability and to facilitate customer transactions.  In connection with some of these activities, the Company attempts to mitigate its exposure to such market risk by entering into hedging transactions, which may include highly liquid future contracts, options and U.S. Government securities.


The following table categorizes the Company’s market risk sensitive financial instruments by type of security and maturity date.  The amounts shown are net of long and short positions.


(In thousands of dollars)

 

2004

 

2005

 

2006

 

2007

 

2008

Thereafter

 

Total

Fair value of securities

              

Corporate bonds

$

113

$

524

$

11,820

$

3,436

$

6,875

$

38,139

$

60,907

State and municipal bonds

 

4,719

 

4,981

 

8,406

 

8,362

 

3,313

 

120,277

 

150,058

US Government obligations

 

349

 

(1,903)

 

(19,776)

 

(10,223)

 

86

 

(12,618)

 

(44,085)

Subtotal

 

5,181

 

3,602

 

450

 

1,575

 

10,274

 

145,798

 

166,880

Equity securities

 

-

 

-

 

-

 

-

 

-

 

8,202

 

8,202

Fair value of securities

$

5,181

$

3,602

$

450

$

1,575

$

10,274

$

154,000

$

175,082


Following is a discussion of the Company's primary market risk exposures as of June 30, 2004, including a discussion of how those exposures are currently managed.


Interest Rate Risk


Interest rate risk is a consequence of maintaining inventory positions and trading in interest-rate-sensitive financial instruments.  In connection with trading activities, the Company exposes itself to interest rate risk, arising from changes in the level or volatility of interest rates or the shape and slope of the yield curve. The Company's fixed income activities also expose it to the risk of loss related to changes in credit spreads.  The Company attempts to hedge its exposure to interest rate risk primarily through the use of U.S. Government securities, highly liquid futures and options designed to reduce the Company's risk profile.


A sensitivity analysis has been prepared to estimate the Company's exposure to interest rate risk of its net inventory positions.  The fair market value of these securities included in the Company's inventory at June 30, 2004 was $136.3 million and $147.2 million at December 31, 2003 (net of municipal futures positions).  Interest rate risk is estimated as the potential loss in fair value resulting from a hypothetical one-half percent change in interest rates.   At June 30, 2004, the potential change in fair value using a yield to maturity calculation and assuming this hypothetical change, was $5.0 million and at year-end 2003 was $4.5 million.  The actual risks and results of such adverse effects may differ substantially.

Equity Price Risk


The Company is exposed to equity price risk as a consequence of making markets in equity securities.  Equity price risk results from changes in the level or volatility of equity prices, which affect the value of equity securities or instruments that derive their value from a particular stock.  The Company attempts to reduce the risk of loss inherent in its inventory of equity securities by monitoring those security positions constantly throughout each day.


Marketable equity securities included in the Company's inventory were recorded at a fair value of $8.2 million at June 30, 2004 and $7.6 million at December 31, 2003, have exposure to equity price risk.  This risk is estimated as the potential loss in fair value resulting from a hypothetical 10% adverse change in prices quoted by stock exchanges and amounts to $0.8 million at June 30, 2004 and $0.8 million at year-end 2003.


The Company's investment portfolio excluding the consolidation of Employee Investment Fund (see “Investments” footnote in the Notes to Condensed Consolidated Financial Statements) at June 30, 2004 and December 31, 2003, had a fair market value of $41.3 million and $53.0 million, respectively.  This equity price risk is also estimated as the potential loss in fair value resulting from a hypothetical 10% adverse change in prices quoted by stock exchanges and amounts to $4.1 million at June 30, 2004 and $5.3 million at year-end 2003.  The actual risks and results of such adverse effects may differ substantially.


CREDIT RISK

The Company is engaged in various trading and brokerage activities whose counter parties primarily include broker-dealers, banks, and other financial institutions.  In the event counter parties do not fulfill their obligations, the Company may be exposed to risk.  The risk of default depends on the credit worthiness of the counter party or issuer of the instrument.  The Company seeks to control credit risk by following an established credit approval process, monitoring credit limits, and requiring collateral where it deems appropriate.


The Company purchases debt securities and may have significant positions in its inventory subject to market and credit risk.  In order to control these risks, security positions are monitored on at least a daily basis.  Should the Company find it necessary to sell such a security, it may not be able to realize the full carrying value of the security due to the size of the position sold.  The Company attempts to reduce its exposure to changes in municipal securities valuation with the use as hedges of highly liquid municipal bond index futures contracts.


OPERATING RISK

Operating risk is the potential for loss arising from limitations in the Company's financial systems and controls, deficiencies in legal documentation and the execution of legal and fiduciary responsibilities, deficiencies in technology and the risk of loss attributable to operational problems.  These risks are less direct than credit and market risk, but managing them is critical, particularly in a rapidly changing environment with increasing transaction volumes.  In order to reduce or mitigate these risks, the Company has established and maintains an internal control environment that incorporates various control mechanisms at different levels throughout the organization and within such departments as Finance and Accounting, Operations, Legal, Compliance and Internal Audit.  These control mechanisms attempt to ensure that operational policies and procedures are being followed and that the Company's various businesses are operating within established corporate policies and limits.


OTHER RISKS

Other risks encountered by the Company include political, regulatory and tax risks.  These risks reflect the potential impact that changes in local laws, regulatory requirements or tax statutes have on the economics and viability of current or future transactions.  In an effort to mitigate these risks, the Company seeks to review new and pending regulations and legislation and their potential impact on its business.

FIRST ALBANY COMPANIES INC.

CONTROLS AND PROCEDURES



Item 4.  Controls and Procedures


As of the end of the period covered by this Form 10-Q, the Company’s management, including the Chief Executive Officer and the Principal Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures.  Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Principal Financial Officer, concluded that the Company’s disclosure controls and procedures were effective in timely alerting management, including the Chief Executive Officer and the Principal Financial Officer, of material information about the Company required to be included in periodic Securities and Exchange Commission filings.  However, in evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect its internal controls subsequent to the date of the evaluation.




Part II-Other Information


Item 1.  Legal Proceedings

In 1998 the Company was named in lawsuits by Lawrence Group, Inc. and certain related entities (the “Lawrence Parties") in connection with a private sale of Mechanical Technology Incorporated stock from the Lawrence Parties that was previously approved by the United States Bankruptcy Court for the Northern District of New York (the "Bankruptcy Court").  The Company acted as placement agent in that sale, and a number of employees and officers of the Company, who have also been named as defendants, purchased shares in the sale.  The complaints alleged that the defendants did not disclose certain information to the sellers and that the price approved by the court was therefore not proper. The cases were initially filed in the Bankruptcy Court and the United States District Court for the Northern District of New York (the "District Court"), and were subsequently consolidated in the District Court.  The District Court dismissed the cases, and that decision was subsequently vacated by the United States Court of Appeals for the Second Circuit, which remanded the cases for consideration of the plaintiffs' claims as motions to modify the Bankruptcy Court sale order.  The plaintiffs' claims have now been referred back to the Bankruptcy Court for such consideration.  The Company believes that it has strong defenses to and intends to vigorously defend itself against the plaintiffs' claims, and believes that the claims lack merit.


In the normal course of business, the Company has been named a defendant, or otherwise has possible exposure, in several claims.  Certain of these are class actions, which seek unspecified damages, which could be substantial.  Although there can be no assurance as to the eventual outcome of litigation in which the Company has been named as a defendant or otherwise has possible exposure, the Company has provided for those actions most likely of adverse dispositions.  Although further losses are possible, the opinion of management, based upon the advice of its attorneys and General Counsel, is that such litigation will not, in the aggregate, have a material adverse effect on the Company's liquidity or financial position, although it could have a material effect on quarterly or annual operating results in the period in which it is resolved.  




Item 4.  Submission of matters to a vote of security holders

A.

Annual meeting was held on April 27, 2004


B.

Election of Directors:  (There were no broker non-votes with respect to the election of Directors)


 

Votes For

Against

Withheld Authority

Robert F. Campbell

11,055,412

0

1,639,535

Carl P. Carlucci

12,034,192

0

660,755

Alan P. Goldberg

11,042,557

0

1,653,390

Arthur T. Murphy

11,056,092

0

1,638,855

Arthur J. Roth

12,249,441

0

445,506


C.

Other matters voted on at the Annual Meeting


1.

To ratify the appointment of PricewaterhouseCoopers LLP as independent auditors of the Company for the fiscal year ending December 31, 2004.


For:

11,224,186

Against:

670,350

Abstain:

800,411

Broker non-votes:

0


2.

To consider and act upon a proposal to approve the adoption of the Third Amendment to the First Albany Companies Inc. 1999 Long-Term Incentive Plan to increase the number of shares available for issuance.


For:

5,589,099

Against:

2,663,461

Abstain:

155,933

Broker non-votes:

4,286,454                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             


3.

To transact such other business as may properly come before the meeting or any adjournment thereof.







Item 6. Exhibits and Reports on Form 8-K

(a)   Exhibits

Item

Number

Item

  

10.16

Stock Purchase Agreement by and among the Shareholders of Descap Securities, Inc. and First Albany Companies Inc., dated February 18, 2004 (filed as Exhibit 10.16 to Form 10-Q for quarter ended March 31, 2004)

  

10.17

Loan Agreement dated February 18, 2004 between First Albany Companies Inc. and KeyBank National Association (filed as Exhibit 10.17 to Form 10-Q for quarter ended March 31, 2004)

  

10.18

Stock Purchase Agreement by and among First Albany Companies Inc. and certain purchasers in a private placement, dated February 29, 2004 (filed as Exhibit 10.18 to Form 10-Q for quarter ended March 31, 2004)

  

10.19

Employment Agreement with Robert Fine, an executive officer of the Company, dated May 14, 2004 (filed herewith)

  

(31)

Certification of CEO and CFO pursuant to Section 302 of the Sarbanes-Oxley Act

  

(32)

Certification of CEO and CFO pursuant to Section 906 of the Sarbanes-Oxley Act

  

(b)   Reports on Form 8-K

The following reports on Form 8-K were filed during the quarter ended June 30, 2004:


1.

Form 8-K filed June 1, 2004, announcing the acquisition of the assets of Descap Securities, Inc.

  

2.

Form 8-K filed April 26, 2004, announcing First Albany Companies Inc.’s financial results for the first quarter ending March 31, 2004.

  

3.

Form 8-K filed April 22, 2004 announcing the record and distribution dates for the special dividend of its holdings in Plug Power Inc.




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 hereunto duly authorized.




First Albany Companies Inc.

(Registrant)




Date:

    8/4/2004

 

/S/ALAN P. GOLDBERG

   

Alan P. Goldberg

   

Chief Executive Officer

    

Date:

8/4/2004

 

/S/STEVEN R. JENKINS

   

Steven R. Jenkins

   

Chief Financial Officer

   

(Principal Accounting Officer)