There were no non-recurring charges for the three months ended September 30, 2017. Included in the nine months ended September 30, 2017 is $342,000 primarily due to relocating the firm’s call center and costs associated with staff reductions.
The Company earned revenue and incurred expenses of $2,916,000 and $307,000, respectively, from StockCross for the three months ended September 30, 2018. The Company earned revenue and incurred expenses of $8,694,000 and $1,271,000, respectively, from StockCross for the nine months ended September 30, 2018.
As of September 30, 2018, the Company is owed a receivable from StockCross of $1,625,000. For the three months and nine months ended September 30, 2018, the Company received $14,000 in commissions and fees for a StockCross insurance policy.
Included in the September 30, 2018 condensed consolidated statements of financial condition is $312,000 of commissions payable as part of accounts payable and accrued liabilities.
In addition to the leases stated in our 2017 Form 10-K, the Company committed to the below lease. The future minimum base rental payments under this operating lease are as follows:
On August 21, 2018, the Company signed a purchase agreement to acquire from KCA all of the issued and outstanding membership interests of KCAT. The net assets of KCAT included cash and capitalized software related to the Robo Platform. We have concluded that KCAT did not constitute a business in accordance with ASC Topic 805 and thus we accounted for this transaction as an asset acquisition. The majority of the shares of KCA were owned by the same shareholders who owned the majority of the shares of the Company. The Company's Board of Directors unanimously approved the acquisition of KCAT. The acquisition of KCAT was completed on August 21, 2018. The total consideration for the acquisition of KCAT was approximately $690,000. We believe that the Robo Platform will increase the breadth of our product offering and will generate substantial opportunity for the Company by appealing to customers within new demographics.
The software acquired from KCAT is accounted for under ASC Topic 985, Software, and shall be amortized over a 3 year period beginning in Q2 of 2019, the date we estimate the software will launch for commercial purposes.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion should be read in conjunction with our consolidated financial statements for the year ended December 31, 2017, and our condensed consolidated financial statements and the notes thereto contained elsewhere in this Quarterly Report.
Business Environment
Our cash is invested primarily in bank accounts with large financial institutions. Our cash and working capital are sufficient to service the firm’s operations.
The following table presents certain metrics for, and as of, various periods within 2018 and 2017, which we use in evaluating our business.
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Three Months
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Nine Months
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|
|
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Ended September 30,
|
|
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Ended September 30,
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Retail Customer Activity
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2018
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|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Total retail trades
|
|
|
82,120
|
|
|
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50,025
|
|
|
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262,610
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|
|
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155,043
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Average commission per retail trade
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$
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23.43
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|
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$
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20.35
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|
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$
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22.87
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|
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$
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20.63
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|
|
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As of September 30,
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Retail Customer Metrics
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2018
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|
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2017
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Retail customer net worth (in billions)
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$
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11.7
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|
|
$
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7.5
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Retail customer money market fund value (in billions)
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$
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0.6
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$
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0.7
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Retail free credit balances (in billions)
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$
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0.4
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$
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0.3
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Retail customer margin debit balances (in billions)
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$
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0.4
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$
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0.3
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Retail customer accounts with positions
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|
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39,247
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|
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27,020
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Description
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·
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Total retail trades represents retail trades that generate commissions.
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·
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Average commission per retail trade represents the average commission generated for all types of retail customer trades.
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·
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Retail customer net worth represents the total value of securities and cash in the retail customer accounts before deducting margin debits.
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·
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Retail customer money market fund value represents all retail customers accounts invested in money market funds.
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·
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Retail customer margin debit balances represents credit extended to our customers to finance their purchases against current positions.
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·
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Retail customer accounts with positions represents retail customers with cash and/or securities in their accounts.
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We, like other securities firms, are directly affected by general economic and market conditions including fluctuations in volume and prices of securities, changes and prospects for changes in interest rates, and demand for brokerage and advisory services, all of which can affect our relative profitability. In periods of reduced financial market activity, profitability is likely to be adversely affected because certain expenses remain relatively fixed, such as salaries and related costs, as well as portions of communications and occupancy expenses. Accordingly, earnings for any period should not be considered representative of any other period.
Critical Accounting Policies
We generally follow accounting policies standard in the brokerage industry and believe that our policies appropriately reflect our financial position and results of operations. Our management makes significant estimates that affect the reported amounts of assets, liabilities, revenue, and expenses as well as the related disclosure of contingent assets and liabilities included in the financial statements. The estimates relate primarily to revenue and expenses in the normal course of business as to which we receive no confirmations, invoices, or other documentation at the time the books are closed. We use our best judgment, based on our knowledge of these revenue transactions and expenses incurred, to estimate the amount of such revenue and expenses. We are not aware of any material differences between the estimates used in closing our books for the last five years and the actual amounts of revenue and expenses incurred when we subsequently receive the actual confirmations, invoices, or other documentation. Estimates are also used in determining the useful lives of intangible assets and the fair market value of intangible assets. We also estimate the valuation allowance relating to the deferred tax asset based on more likely than not criteria. Our analysis includes positive and negative evidence available such as past operating history, estimated projected taxable income, industry and economic statistics, and the impact of the Tax Cuts and Jobs Act. Our management believes that its estimates are reasonable.
We are planning to capitalize certain costs related to the development of the Robo Platform upon completion. As indicated in footnote 12, we are in the development and testing phase as there are additional features and functionalities needed to be built out. The types of costs we will capitalize include expenses such as consulting fees for third-party developers working on the project. Costs related to post-implementation activities will be expensed as incurred. Internal-use software is amortized on a straight-line basis over the estimated useful life of the asset, which is expected to be three years.
Significant Events in the Third Quarter of 2018
KCAT Acquisition and Software
Post-acquisition of KCAT and the AdvisorNXT code, we are continuing to enhance and tailor the Robo Platform to fit our strategic needs. As part of the most recent wave of development, our goals were to streamline the online account opening process, build out new automation for money movement, and improve the visuals and branding for a better client experience.
As of the end of this quarter we have met these goals and have successfully launched the Robo Platform with the ability to onboard clients. In addition, we have made significant progress in the development of key algorithms and have remastered the portfolio selection process. The Robo Platform onboarding application is currently located at https://app.advisornxt.com/get-started.
Going forward, we are working on streamlining connectivity between the Robo Platform and the client website, our back office databases, and our clearing providers. In addition, we are continuing to automate trading and back office tasks related to rebalancing client portfolios and processing fees. These improvements will be critical as we continue to scale the Robo Platform and we anticipate the majority of these new features to become fully operational during Q2 of 2019. We are excited to offer our dynamic Robo Platform to our current client base and when the application becomes fully operational, we will implement a strategic plan focused on customer acquisition.
Deferred Tax Asset
Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we considered all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. In projecting future taxable income, we began with historical results and incorporated assumptions about the amount of future state and federal pretax operating income adjusted for items that did not have tax consequences. The assumptions about future taxable income required significant judgment and are consistent with the plans and estimates we use to manage the underlying businesses.
In evaluating the objective evidence that historical results provide, we considered three years of cumulative operating loss.
Evaluation of Deferred Tax Asset as of December 31, 2017 through June 30, 2018
We did not recognize a deferred tax asset as of December 31, 2017 through June 30, 2018 based on our analysis of positive and negative evidence available. In assessing the amount to be recorded as a deferred tax asset, we considered the following factors:
Positive Evidence
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Positive earnings for 2017.
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•
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Preliminary positive earnings for first six months of 2018 and positive projections for the full year.
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Negative Evidence
•
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Track record of positive earnings in 2018 is limited.
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•
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Significant losses in 2016, 2015, and 2014.
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•
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The unpredictable nature of future revenue streams.
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•
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The potential correction in the market, which could result in losses to the Company and the inability to use the tax asset.
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•
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The uncertainty in the political environment which could result in a change in the tax code that may cause market repercussions.
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•
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The effect of the tariffs on the economy.
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•
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Increased competitive pressures.
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ASC 740-10-30-22(c), provides examples of positive evidence that might support a conclusion that a valuation allowance is not needed when there is negative evidence. According to ASC 740-10-30-22(c), an example of positive evidence that might overcome negative evidence is "a strong earnings history exclusive of the loss that created the future deductible amount (tax loss carryforward or deductible temporary difference) coupled with evidence indicating that the loss (for example, an unusual, infrequent, or extraordinary item) is an aberration rather than a continuing condition."
In consideration of the guidance shown above, as of December 31, 2017, we believe that the Company did not have enough financial track record to be classified as having a “strong earnings history” as identified above. As of June 30, 2018, we considered the improved operating results post-acquisition of the retail assets from StockCross; however, we still believed that there was not enough financial track record for the Company to be classified as having a “strong earnings history.” In addition, a significant piece of objective negative evidence evaluated was the cumulative loss incurred over the three-year period ended December 31, 2016. Such objective evidence limited the ability to consider other subjective evidence such as our projections for future growth.
Accordingly, the positive financial performance was insufficient to outweigh the negative evidence as indicated above, and we concluded, using the more likely than not criteria, that a full valuation allowance for the deferred tax asset was appropriate as of December 31, 2017, March 31, 2018, and June 30, 2018 and the evidence did not support recording a partial valuation allowance.
Evaluation of Deferred Tax Asset as of September 30, 2018
As of September 30, 2018, we recognized a deferred tax asset based on the additional positive evidence available. In assessing the amount to be recorded as a deferred tax asset, we considered the positive and negative evidence referenced above, as well as the below evidence:
Subsequent Positive Evidence
•
|
Three quarters of significantly improved operating results in comparison to 2017 and historical years.
|
•
|
Almost a full year of positive earnings post-acquisition of the retail assets from StockCross.
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•
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Taxable income of approximately $6 million as of September 30, 2018.
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•
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Revised projected taxable income for fiscal year 2018, 2019 and 2020 exceeding original projections performed at the end of 2017.
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As of September 30, 2018, we considered the guidance from ASC 740-10-30-22(c) and believed that with three quarters of significantly improved operating results from the acquisition of the retail assets from StockCross, we concluded that the Company had a sufficient track record of positive performance as well as a trend of improving results to be classified as having a “strong earnings history.” While the negative evidence considered as of December 31, 2017 through June 30, 2018 was still relevant, the objective evidence of the Company’s performance during 2018 supported the positive evidence outweighing the negative.
As such, as of September 30, 2018, we believe that it was reasonable to record a deferred tax asset (net of valuation allowance) of approximately $1,393,000 as projected for the next three years. In assessing the amount to be recorded as a deferred tax asset, we concluded that a period not exceeding 3 years was a reasonable projection period due to increasing competitive pressures, regulatory costs, and the volatile political and economic environment.
Results of Operations
Three Months Ended September 30, 2018 Compared to Three Months Ended September 30, 2017
Net income for the three months ended September 30, 2018 was $3,119,000, an increase of $2,118,000 or 212% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross, the recognition of a deferred tax asset, and an increase in interest bearing earnings.
Total revenue for the three months ended September 30, 2018 was $7,884,000, an increase of $4,795,000 or 155% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross and an increase in interest bearing earnings.
Margin interest, marketing and distribution fees for the three months ended September 30, 2018 were $2,731,000, an increase of $881,000 or 48% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross and an increase in interest rates.
Principal transactions for the three months ended September 30, 2018 were $2,634,000, an increase of $2,480,000 or 1,610% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Commissions and fees for the three months ended September 30, 2018 were $2,465,000, an increase of $1,388,000 or 129% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Interest for the three months ended September 30, 2018 was $34,000, an increase of $30,000 or 750% from the corresponding period in 2017 primarily due to increased cash balances.
Advisory fees for the three months ended September 30, 2018 were $20,000, an increase of $16,000 or 400% from the corresponding period in 2017 due to the preliminary launch of the robo technology.
Total expenses for the three months ended September 30, 2018 were $5,800,000, an increase of $3,712,000 or 178% from the corresponding period in 2017 due to items related to the retail assets acquired from StockCross such as additional personnel and office space requirements.
Employee compensation and benefits for the three months ended September 30, 2018 were $3,668,000, an increase of $2,637,000 or 256% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Other general and administrative expenses for the three months ended September 30, 2018 were $650,000, an increase of $375,000 or 136% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Clearing fees, including floor brokerage expenses for the three months ended September 30, 2018 were $631,000, an increase of $379,000 or 150% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Professional fees for the three months ended September 30, 2018 were $477,000, an increase of $105,000 or 28% from the corresponding period in 2017 primarily due to activities and developments related to expanding our business.
Occupancy expenses for the three months ended September 30, 2018 were $248,000, an increase of $162,000 or 188% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Communications expenses for the three months ended September 30, 2018 were $120,000, an increase of $64,000 or 114% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Advertising and promotion expenses for the three months ended September 30, 2018 were $6,000, a decrease of $10,000 or 63% from the corresponding period in 2017.
Provision for income taxes for the three months ended September 30, 2018 was a credit of $1,035,000, a decrease of $1,035,000 from the corresponding period in 2017 which consisted of a credit of $1,393,000 due to the recognition of a deferred tax asset partially offset by income taxes of $358,000.
Nine Months Ended September 30, 2018 Compared to Nine Months Ended September 30, 2017
Net income for the nine months ended September 30, 2018 was $6,611,000, an increase of $5,186,000 or 364% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross, the recognition of a deferred tax asset, and an increase in interest bearing earnings. Included in net income for the nine months ended September 30, 2017 is $342,000 of non-recurring costs primarily due to relocating the firm’s call center and costs associated with staff reductions.
Total revenue for the nine months ended September 30, 2018 was $23,549,000, an increase of $15,392,000 or 189% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross and an increase in interest bearing earnings.
Margin interest, marketing and distribution fees for the nine months ended September 30, 2018 were $7,953,000, an increase of $3,476,000 or 78% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross and an increase in interest rates.
Principal transactions for the nine months ended September 30, 2018 were $7,838,000, an increase of $7,478,000 or 2,077% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Commissions and fees for the nine months ended September 30, 2018 were $7,651,000, an increase of $4,356,000 or 132% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Interest for the nine months ended September 30, 2018 was $69,000, an increase of $60,000 or 667% from the corresponding period in 2017 primarily due to increased cash balances.
Advisory fees for the nine months ended September 30, 2018 were $38,000, an increase of $22,000 or 138% from the corresponding period in 2017 primarily due to the preliminary launch of the robo technology.
Total expenses for the nine months ended September 30, 2018 were $17,423,000, an increase of $10,691,000 or 159% from the corresponding period in 2017 primarily due to items related to the retail assets acquired from StockCross such as additional personnel and office space requirements.
Employee compensation and benefits for the nine months ended September 30, 2018 were $10,619,000, an increase of $7,550,000 or 246% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Other general and administrative expenses for the nine months ended September 30, 2018 were $1,874,000, an increase of $854,000 or 84% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Clearing fees, including floor brokerage expenses for the nine months ended September 30, 2018 were $2,212,000, an increase of $1,393,000 or 170% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Professional fees for the nine months ended September 30, 2018 were $1,572,000, an increase of $307,000 or 24% from the corresponding period in 2017 primarily due to activities and developments related to expanding our business.
Occupancy expenses for the nine months ended September 30, 2018 were $737,000, an increase of $431,000 or 141% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Communications expenses for the nine months ended September 30, 2018 were $369,000, an increase of $177,000 or 92% from the corresponding period in 2017 primarily due to the retail assets acquired from StockCross.
Advertising and promotion expenses for the nine months ended September 30, 2018 were $40,000, a decrease of $21,000 or 34% from the corresponding period in 2017.
Provision for income taxes for the nine months ended September 30, 2018 was a credit of $485,000, a decrease of $485,000 from the corresponding period in 2017 which consisted of a credit of $1,393,000 due to the recognition of a deferred tax asset partially offset by income taxes of $908,000.
Liquidity and Capital Resources
Our working capital is invested in cash and cash equivalents. Our total assets as of September 30, 2018 were $13,493,000, of which $7,341,000, or 54%, is highly liquid.
MSCO is subject to the SEC’s Uniform Net Capital Rule (Rule 15c3-1 or “Uniform Net Capital Rule”), which requires the maintenance of minimum net capital. As of September 30, 2018, MSCO’s regulatory net capital was $9,701,000, which was $9,451,000 in excess of its minimum capital requirement of $250,000.