SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 2000 ----------------- OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from _______________________ to Commission File No. 0-6729 FIRST MONTAUK FINANCIAL CORP. ------------------------------------------------------------------- (Exact name of registrant as specified in its charter) New Jersey 22-1737915 - ------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 328 Newman Springs Road, Red Bank, NJ 07701 - ------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (732) 842-4700 - ------------------------------------------------------------------------------- Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered None Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value - ------------------------------------------------------------------------------- (Title of class) [Cover Page 1 of 2 Pages] Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(D) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The issuer's revenues for its most recent fiscal year: $59,330,000 The aggregate market value of the voting stock held by non-affiliates computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of bid and asked prices of such stock, as of April 12, 2001 was $4,344,993. The number of shares of Common Stock outstanding, as of April 12, 2001 was 8,862,035. DOCUMENTS INCORPORATED BY REFERENCE Not Applicable [Cover Page 2 of 2 Pages] PART I Item 1. Business Introduction First Montauk Financial Corp. ("FMFC" or the "Company") is a New Jersey-based financial services holding company whose principal subsidiary, First Montauk Securities Corp. ("FMSC"), has operated as a full service retail and institutional securities brokerage firm since 1987. FMSC provides a broad range of securities brokerage and investment services to a diverse retail and institutional clientele, as well as corporate finance and investment banking services to corporations and businesses. In 1997, FMSC established Century Discount Investments, a discount brokerage division through which it operates an online brokerage operation. FMFC also sells insurance products through its subsidiary Montauk Insurance Services, Inc. ("MISI"). FMSC has approximately 440 registered representatives and services over 50,000 retail and institutional customer accounts. All of FMSC's 162 branch offices, located in 28 states and Saudi Arabia, are owned and operated by affiliates; independent owners who maintain all appropriate licenses and are responsible for all office overhead and expenses. FMSC also employs registered representatives directly at its corporate office. FMSC is registered as a broker-dealer with the Securities and Exchange Commission ("SEC"), the National Association of Securities Dealers Regulation, Inc. ("NASDR"), the Municipal Securities Rule Making Board ("MSRB"), and the Securities Investor Protection Corporation ("SIPC") and is licensed to conduct its brokerage activities in all 50 states, the District of Columbia, and the Commonwealth of Puerto Rico. All securities transactions are cleared through Fiserv Securities, Inc. of Philadelphia, PA. and execution services are provided by various floor brokerage and specialist firms. These arrangements provide FMSC with back office support, transaction processing services on all principal, national and international securities exchanges, and access to many other financial services and products which allows FMSC to offer products and services comparable to large brokerage firms. FMSC's revenues consist primarily of commissions and fee income from individual and institutional securities transactions, market making activities and investment banking services, such as private and public securities offerings. The following table represents the percentage of revenues generated by each of these activities during the last fiscal year: Equities: Listed 15% Over-The-Counter 41% Municipal and Government Bonds 1% Corporate Bonds 4% Unit Investment Trusts 2% Mutual Funds 13% Options 6% Insurance and Annuities 9% Corporate Finance 4% ---- Total(1) 95% - ------------------- (1) Does not include interest and other income. The following table reflects FMSC's various sources of revenues and the percentage of total revenues for fiscal 2000. Revenues from agency transactions in securities for individual customers of FMSC are shown as commissions. Revenues from transactions in securities for individual customers where FMSC acted in a principal capacity are reflected in principal transactions. Also reflected in principal transactions are trading profits from market making and proprietary trading activities. Year Ended December 31, 2000 Amount Percent ------ ------- Agency commissions from Equity Securities, Options and Mutual Funds $46,529,771 78% Principal Transactions in Equity Securities, Municipal, Government and Corporate Bonds $ 7,131,079 12% Interest and other Income $ 3,252,325 6% Investment Banking(1) $ 2,416,711 4% ---------- --- Total Revenues $59,329,886 100% (1) Investment banking revenues consist of commissions, selling concessions; consulting fees and other income from underwriting and syndicate activities and placement agent fees. The Affiliate Program FMSC's primary method of operation is through its affiliate program, which allows registered representatives to operate as independent contractors. A registered representative who becomes an affiliate of FMSC establishes his own office and is solely responsible for the payment of all expenses associated with the operation of the branch office, including rent, utilities, furniture, equipment, stock quotation machines, and general office supplies. In return, the affiliate representative is entitled to retain a significantly higher percentage of the commissions generated by his sales than a registered representative in a traditional brokerage arrangement. The affiliate program is designed to attract experienced brokers with existing clientele who desire to operate their own offices, as well as other professionals in all facets of the financial services industry. Affiliates must possess a sufficient level of commission brokerage business and experience to enable the individual to independently support his/her own office. Financial professionals such as insurance agents, real estate brokers, financial planners, and accountants, who already provide financial services to their clients, can affiliate with FMSC and obtain the required licenses to become registered representatives. Affiliation enables these professionals to offer securities products and services to their clients through FMSC, and insurance products through MISI, and earn commissions and fees for these transactions. FMSC provides full support services to each of the affiliates, including access to stock and options execution and over-the-counter stock trading; products such as insurance, mutual funds and investment advisory programs; and research, compliance, supervision and related services. Each affiliate is required to obtain and maintain in good standing each license required by the SEC and NASDR to conduct the type of securities business in which the affiliate will engage, and to register in the various states in which he/she intends to service customers. FMSC is ultimately responsible for supervising each affiliate and related registered representative. FMSC can incur substantial liability from improper actions of any of the affiliate representatives. The Company maintains a professional liability errors and omissions insurance policy which provides coverage for certain actions taken by the Company's registered representatives, employees and other agents in connection with the purchase and sale of securities and the administration of individual retirement plans. Century Discount Investments In June 1997, FMSC established a discount brokerage division, "Century Discount Investments", to offer investors convenient and prompt retail brokerage services at significantly reduced commission rates. Century is designed to serve investors who do their own research and make their own investment decisions. These customers seek to avoid the higher brokerage commissions for securities research, investment recommendations or portfolio management associated with full service brokerage accounts. FMSC believes that this market segment has become increasingly significant to the brokerage industry and will continue to grow in the future. Century's business concentrates on the execution of unsolicited transactions, on an agency basis, from retail customers. Century is able to offer customers reduced commission rates since its service is not dependent on individual broker-customer relationships to generate orders. Century does not assign customer accounts to individual brokers and all Century registered representatives have immediate access to customer accounts and market information necessary to respond to any customer inquiry and order. Century, through its clearing firm, has developed the capability to offer online, discount brokerage and related investment services. The online services provide customers with automated securities order placement, market information and research capabilities through the Internet. In the future, Century intends to offer a broader range of investment services to the self- directed, sophisticated retail customer. Montauk Insurance Services In 1991, FMFC formed Montauk Insurance Services, Inc ("MISI") for the purpose of offering and selling variable annuity, variable life as well as traditional life and health insurance products. Currently, MISI is licensed in 28 states. MISI derives revenue from the sale of insurance-related products and services to the customers of FMSC's registered representatives, who are also licensed to sell certain insurance products. In fiscal year 2000, the Company earned gross commissions of $5.1 million from the sale of insurance and annuity policies. Asset Management and Portfolio Advisory Services FMSC is a SEC Registered Investment Adviser, providing investment advisory services to clients through independent, third-party sponsored advisory programs offered to individual and institutional clients. FMSC is registered or eligible to conduct business as an investment adviser in 31 states. Managed account programs generally require the client to pay a single fee for portfolio advisory services, brokerage execution and custody and periodic account performance evaluation, rather than a fee plus commissions. Revenues from asset-managed accounts and portfolio advisory services are generated from accounts that charge a fee based on a percentage of assets under management. Investment Banking FMSC participates in private and public offerings of equity securities and provides general investment banking consulting services to various public and private corporations. Historically, FMSC has not derived a significant amount of its revenues from investment banking. However, the Company did complete a public offering of Common Stock of Jeremy's MicroBatch Ice Creams, Inc. in February 2000 in which FMSC acted as the managing underwriter. The offering consisted of 1,200,000 shares of Common Stock at an offering price of $6.00 per share. FMSC received gross commissions of $720,000 as well as warrants to purchase 120,000 shares of Jeremy's Common Stock at an exercise price of $9.00 per share. The Company continues to review other underwriting candidates and anticipates that it will engage in additional public and private offerings in the future. Strategic Relationships During the year, the Company formulated several strategic relationships with financial product vendors and other companies. These relationships provide cross-marketing opportunities as well as new product offerings to its customers. One such relationship is with a nationally recognized residential mortgage provider. Another, involves a relationship with an Internet-based financial planning firm. The Company expects to expand these relationships in the current fiscal year to provide for additional sources of revenue and lead generation for its registered representatives. Recent Developments New Clearing Arrangement In May 2000, FMSC entered into a 10-year clearing agreement with Fiserv Securities, Inc. under which Fiserv will act as FMSC's primary clearing broker. In connection with the clearing agreement, FMSC and Fiserv also entered into a financial agreement under which Fiserv has provided a cash advance of $4,000,000 to FMSC on the date of conversion to Fiserv. The funds, net of federal and state income taxes, will be used primarily to enable FMSC to pay for the cost of conversion to Fiserv and expand FMSC's business. For financial reporting purposes, the Company will earn the advance in accordance with an amortization schedule established by the parties; however, FMSC will incur an income tax liability at its effective tax rate on the entire advance in the year in which it is received. FMSC is required to repay any unearned portion of the $4,000,000 in the event it fails to achieve certain minimum performance criteria, or terminates the agreement under certain circumstances prior to the expiration date, as well as penalties for early termination. Fiserv has also agreed to provide certain additional advances to FMSC in the second, third and fourth years of the agreement under similar conditions, provided FMSC achieves certain performance criteria, and subject to certain other conditions. These advances, if received, will also be amortized to income as earned during the term of the clearing agreement. As of February 1, 2001, FMSC and FMFC amended and restated the financial agreement with Fiserv. Under the restated terms, FMFC, rather than FMSC, will be the recipient of any additional cash advances payable under the financial agreement. FMFC has further assumed FMSC's obligation with respect to the initial payment received in November 2000, and will be solely responsible for any performance and early termination penalties. In consideration of FMSC's release from its obligations under the financial agreement and to secure Fiserv's interest, FMFC has granted to Fiserv a first priority lien in all of the outstanding shares of FMSC stock that it owns. New Trade Name In July 2000 the broker/dealer adopted a new trade name and logo, "Montauk Financial Group" to be used in advertising, marketing and communications with customers. The new trade name was designed in connection with the expansion of financial services from the general securities products and services which had been the Company's core offering. It is anticipated that the new name and modernized ship logo, will reflect the growth in all aspects of the Company's financial services, including asset management, financial and estate planning and insurance, in addition to general securities products and services. Common Stock Repurchase Program In August 1999, the Company's board of directors authorized the repurchase of an unspecified number of the Company's outstanding common shares in market transactions. From that time until the end of fiscal 2000, the Company has purchased an aggregate of 1,285,534 shares of common stock for a total of $1,695,560. In fiscal 2000, repurchases of 1,105,034 shares were made at a cost of $1,460,740. The repurchase of common shares on the open market has the effect of reducing the number of outstanding common shares. Extension of Class A Warrants In December 2000, the Company's Board of Directors authorized the extension of the Company's Class A Warrants for an additional two year period. The Class A Warrants originally provided the holder with the right to purchase one share of the Company's Common Stock at an exercise price of $3.00 per share until February 17, 2001. With the two year extension, holders of Class A Warrants now have the right to purchase one share of Common Stock at an exercise price of $3.00 per share until February 17, 2003. Competition FMSC encounters intense competition in all aspects of its business and competes directly with many other securities firms for clients, as well as registered representatives. A significant number of such competitors offer their customers a broader range of financial services and have substantially greater resources. Retail firms such as Merrill Lynch Pierce Fenner & Smith Incorporated, Salomon Smith Barney, Inc. and Morgan Stanley/Dean Witter dominate the industry; however, the Company also competes with numerous regional and local firms. FMSC also competes for experienced brokers with other firms offering an independent affiliate program such as Corporate Securities Group, Inc., Raymond James Financial Services, Inc. and Linsco/Private Ledger Corp. In addition, a number of firms offer discount brokerage services to individual retail customers and generally effect transactions at substantially lower commission rates on an "execution only" basis, without offering other services such as investment recommendations and research. Moreover, there is substantial commission discounting by full-service broker-dealers competing for institutional and individual brokerage business. The Company has recently entered the discount brokerage arena through its Century Discount Investments division. Additionally, the recent emergence of online trading has further intensified the competition for brokerage customers. The continued expansion of discount brokerage firms and online trading could adversely affect the Company's retail business. Other financial institutions, notably commercial banks and savings and loan associations, offer customers some of the same services and products presently provided by securities firms. In addition, certain large corporations have entered the securities industry by acquiring securities firms. While it is not possible to predict the type and extent of competitive services which banks and other institutions ultimately may offer to customers, FMSC may be adversely affected to the extent those services are offered on a large scale basis. FMSC competes through its advertising and recruiting programs for registered representatives interested in joining its affiliate program. FMSC often offers incentives to qualified registered representatives to join the Company. These incentives can include cash loans, both forgivable based on duration of association and/or production levels, as well as non-forgivable, incentive stock options and a higher payout during a transitional period. FMSC has recently implemented new programs to better service its affiliates and to attract new brokers. The systems will enable brokers at any office to instantly access customer accounts, determine cash positions, send and receive electronic mail, and receive research reports and compliance memoranda via the firm's intranet component of its newly redesigned website. Government Regulation The securities industry in the United States is subject to extensive regulation under various federal and state laws and regulations. The SEC is the federal agency charged with the administration of most of the federal securities laws. Much of the regulation of the securities industry, however, has been assigned to various self regulatory organizations ("SROs"), principally the NASDR, and in the case of New York Stock Exchange, Inc. ("NYSE") member firms, the NYSE. The SROs, among other things, promulgate regulations and provide oversight in areas of (i) sales practices, (ii) trade practices among broker-dealers, (iii) capital requirements, (iv) record keeping and (v) conduct of employees and affiliates of member organizations. In addition to promulgating regulations and providing oversight, the Commission and the SROs have the authority to conduct administrative proceedings which can result in the censure, fine, suspension or expulsion of a broker-dealer, its officers or employees. Furthermore, new legislation, changes in the rules and regulations promulgated by the Commission and SROs, or changes in the interpretation or enforcement of existing laws and rules often directly affect the operation and profitability of broker-dealers. The stated purpose of much of the regulation of broker-dealers is the protection of customers and the securities markets rather than the protection of creditors and shareholders of broker-dealers. Employees The Company currently has approximately 440 registered representatives of which 390 are associated with affiliate offices. In addition, the Company employs 120 support personnel in the areas of operations, compliance, accounting, and administration. FMFC believes its relationship with its employees is satisfactory. Fidelity Bond As required by the NASDR and certain other authorities, FMSC carries a fidelity bond covering loss or theft of securities, as well as embezzlement and forgery. The bond provides total coverage of $5,000,000 (with a $10,000 deductible provision per incident). In addition, the accounts of its customers are protected by the Securities Investor Protection Corporation ("SIPC") for up to $500,000 for each customer, subject to a limitation of $100,000 for claims for cash balances, with an additional $99,000,000 of protection provided by a private insurance company for the benefit of each customer. SIPC is funded through assessments on registered broker-dealers. SIPC charges a flat annual fee of $150. Item 2. Properties Offices and Facilities In March 1997, the Company entered into a new seven year lease (the "Master Lease"), commencing February 1, 1998 for 22,762 square feet of gross rentable area at its executive offices which are located at Parkway 109 Office Center, 328 Newman Springs Road, Red Bank, New Jersey. The rent for the premises is $35,850 per month, and in addition to the base rent, the Company pays as additional rent, a proportional share of any increases in real estate taxes above the amount paid during the 2000 calendar year, insurance premiums relating to the premises, and all utility charges relating to the use of the premises. In March 1998, the Company signed a First Amendment to the Master Lease incorporating all of the other rented space in the Red Bank facility into the March 1997 Master Lease. The First Amendment to the Lease covers an aggregate of 32,442 gross rentable square feet at a monthly rental payment of $52,000 through January 2005. The Master Lease and First Amendment also contain a six-year option to renew providing for a base rental payment of approximately $65,000 per month. In June 1996, Montauk Insurance Services, the Company's insurance subsidiary, leased 3,150 square feet in Paramus, New Jersey to house its administrative offices. In September 1997 the insurance division relocated to the Company's corporate offices in Red Bank, New Jersey, and the Paramus office became the home of Century Discount Investments, the Company's discount division. The three year lease provides for monthly base rent of $5,053 for the first year, $5,315 for the second year, and $5,578 for the third year. In 1999 MISI extended the term of this lease for an additional one year. In February 2000, MISI again extended the lease term for an additional three years at a monthly base rent of $6,890. In December 1999 FMSC entered into a 3-year lease commencing December 31, 1999 for 3,254 square feet of gross rentable area in the Vantage Ponte Building, Glen Allen, Virginia for offices for its former Montauk Affinity Marketing Corp. and for an affiliate retail brokerage office. The rent for the premises is $4,474.25 per month and in addition to the base rent, the company is responsible for additional rent comprising an operating expense pass through of approximately 5% annually. During October 2000, the company terminated its affiliation with Montauk Affinity Marketing Corp. and the lease premises became entirely used by an affiliate for retail brokerage. Effective June 1, 2001, this lease will be assigned to and assumed by an FMSC affiliate, Millenium Capital Management Co. This affiliate will then be responsible for the complete lease obligations. On March 31, 2001, the Company entered into a lease assignment and assumption agreement for a 3-year lease for 3,272 gross rentable square feet at a new branch office at 2250 Glades Road, Boca Raton, Florida. The rent for the premises is $7,433 per month, which includes in the base rate common area, maintenance charges, and taxes. This office will maintain a portion of leased space for administrative offices, with the balance of the space for affiliate retail offices. Item 3. Legal Proceedings Many aspects of the Company's business involve substantial risks of liability. In recent years, there has been an increasing incidence of litigation and arbitration involving the securities industry. FMSC is a respondent in a customer arbitration seeking rescissionary damages of approximately $19 million plus punitive damages. The claimant alleges violations of various provisions of the federal and state securities laws. FMSC has filed its answer to the claims and is vigorously defending the action. FMSC is also a defendant or co-defendant in various other legal proceedings incidental to its securities business. FMSC is contesting the allegations of these claims and believes that there are meritorious defenses in each case. In view of the inherent difficulty of predicting the outcome of litigation, management is unable to derive a meaningful estimate of the amount or range of possible loss that may arise out of pending legal proceedings in any particular quarterly or annual period, or in the aggregate. However, it is possible that the ultimate outcome of these matters could have a material adverse impact on the Company's financial condition, results of operations, and cash flows. As of December 31, 2000, the Company has not established a loss provision in the accompanying financial statements for any liability that may result from these contingencies. Item 4. Submission of Matters on a Vote of Security Holders Not Applicable. PART II Item 5. Market of and Dividends on the Company's Common Equity and Related Stockholder Matters A. Principal Market The Company's Common Stock is traded in the over-the-counter market. Trading in the Company's Common Stock is reported on the NASDR Bulletin Board system and in the pink sheets published by Pink Sheets LLC. The Company believes that there is an established public trading market for the Company's Common Stock based on the volume of trading in the Company's Common Stock and the existence of market makers who regularly publish quotations for the Company's Common Stock. The Company's Class A, Class B and Class C Warrants commenced trading in the over-the-counter market upon their issuance in March 1998. B. Market Information The Company's Common Stock commenced trading in the over-the-counter market in 1987. On April 12, 2001, the Company's common stock had a high and low bid price of $.55 and $.53, respectively. The following is the range of high and low bid prices for such securities for the periods indicated below: Common Stock Fiscal Year 2000 High Bid Low Bid 1st Quarter $ 1.97 $ 1.13 2nd Quarter 1.75 1.25 3rd Quarter 1.56 1.00 4th Quarter 1.22 0.60 Fiscal Year 1999 High Bid Low Bid 1st Quarter $ 3.75 $ 1.4375 2nd Quarter 3.00 1.5938 3rd Quarter 2.7188 1.5313 4th Quarter 1.9375 1.1250 Fiscal Year 1998 High Bid Low Bid 1st Quarter $ 2.875 $ 2.00 2nd Quarter 3.28 2.41 3rd Quarter 2.53 1.01 4th Quarter 1.875 1.125 Item 6. Selected Financial Data Year ended December 31, 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- Operating results: Revenues: Commissions $46,529,771 $40,516,625 $30,741,404 $ 27,018,244 $ 25,749,690 Principal transactions 7,131,079 14,000,680 8,795,599 7,257,576 7,660,700 Investment banking 2,416,711 439,065 767,312 1,433,100 634,329 Insurance recovery - - - 650,000 - Interest and other income 3,252,325 2,628,246 1,572,063 1,383,713 1,044,969 --------- --------- --------- --------- ----------- Total revenues 59,329,886 57,584,616 41,876,378 37,742,633 35,089,688 ---------- ---------- ---------- ---------- ----------- Expenses: Commissions, employee compensation and benefits 46,800,661 42,137,968 31,766,060 26,785,205 25,428,184 Clearing and floor brokerage 4,003,345 4,109,961 3,674,859 3,021,709 3,139,142 Communications and occupancy 2,731,681 2,697,433 2,557,313 1,860,350 1,662,936 Legal matters and related costs 1,181,115 1,395,008 2,377,336 1,452,001 2,731,997 Write-down of Note Receivable - Global Financial Corp. 239,183 100,000 1,775,000 -- -- Loss on Global lease Settlements -- 600,416 3,524 -- -- Other operating expenses 4,862,158 3,545,308 2,958,450 2,093,670 2,006,615 Interest 160,230 166,104 131,215 84,695 105,772 ---------- --------- --------- ---------- --------- Total expenses 59,978,373 54,752,198 45,243,757 35,297,630 35,074,646 ---------- ---------- ---------- ---------- Income (loss) before income taxes (648,487) 2,832,418 (3,367,379) 2,445,003 15,042 Provision for income taxes (income tax benefit) 6,721 549,140 (604,532) 968,178 (17,747) ---------- ---------- --------- ---------- ---------- Income (loss) before extraordinary loss (655,208) 2,283,278 $(2,762,847) $ 1,476,825 $ 32,789 ========== ========== =========== ========== =========== Extraordinary loss - extinguishment of debt, net of tax (34,200) -- -- -- -- ---------- ---------- ---------- ---------- ----------- Net income (loss) $ (689,408) $ 2,283,278 $ (2,762,847) $ 1,476,825 $ 32,789 ========== ========== ========== =========== =========== Net income (loss) available to common stockholders $ (792,136) $2,215,528 $(2,762,847) $ 1,476,825 $ 32,789 ========== ========= =========== =========== =========== Per share of Common Stock: Basic $ (.08) $ .22 $ (.28) $ .17 $ .01 Diluted $ (.08) $ .21 $ (.28) $ .14 $ .01 Item 6. Selected Financial Data (continued) Year ended December 31, 2000 1999 1998 1997 1996 Weighted average common shares outstanding - Basic 9,450,055 9,878,129 9,725,116 8,788,734 7,767,224 ========== ========= ========= ========= ========= Weighted average common and common equivalent shares outstanding - Diluted 9,450,055 11,262,708 9,725,116 10,351,032 8,623,538 ========== ========== ========= ========== ========= Financial condition: Total assets $16,913,063 $17,059,184 $11,543,734 $11,971,934 $8,742,039 Total liabilities $ 9,203,672 $ 7,429,046 $ 5,320,107 $ 4,732,467 $4,625,260 Common Stock issued with guaranteed selling price $ 6,500 $ 36,500 $ 36,500 $ 346,500 $ 421,500 Stockholders' equity $ 7,702,891 $ 9,593,638 $ 6,187,127 $ 6,892,967 $3,695,279 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations - Three Years Ended December 31, 2000 Fiscal 2000 was the Company's twelfth consecutive year of record revenues, with total revenues exceeding $59 million. The year began strong as Y2K fears were eliminated by a smooth transition into the new millennium and the U.S. stock market came roaring into 2000. As the year progressed, diminishing investor confidence in the financial markets, coupled with more realistic valuations in the technology sector and a general slow down in the economy, reflected poorly on the Company's results of operations during the second half of the year, as trading volume dropped significantly. Year Ended December 31, 2000 1999 1998 (000's) % Change (000's) Change (000's) ------------------------------------------------------------------ Revenues: Commissions $46,530 15 $40,517 32 $30,741 Principal transactions 7,131 (50) 14,001 59 8,796 Investment banking 2,417 450 439 ( 43) 767 Interest and other income 3,252 24 2,628 67 1,572 ------------------------------------------------------------------ Total Revenues $59,330 3 $57,585 38 $41,876 ------------------------------------------------------------------ The year-to-year revenue growth resulted from increased commissions from general securities transactions and insurance related products, particularly from the sale of variable annuities. This overall increase in commission revenue was due primarily to the addition of new affiliated representatives, a direct result of the increase in, and maturation of, our recruiting and marketing efforts. The Company also benefited from the exceptional performance in the equities markets of the first quarter of 2000, during which we earned 41% of our total revenues for the year. The insurance segment, consisting primarily of variable annuity products, increased $2,180,000, or 73%, from 1999 to 2000. Through training, education and marketing, the Company has succeeded in increasing its insurance sales with its existing base of financial professionals. The rise in revenues in fiscal 1999 when compared with 1998 resulted from increased commissions from general securities transactions (stocks, bonds and options). That increase was primarily attributable to the addition of new affiliated representatives, as well as an increase in the production from existing affiliated representatives on a year-to-year comparative basis. Market-making and principal trading activities accounted for the only decrease in the Company's revenues for fiscal 2000. Revenues for 2000 were $7.1 million, down from $14 million in 1999, a decrease of 50%. The decrease is due to investment and trading losses primarily in Nasdaq and other securities held in the firm's proprietary accounts. The firm has taken steps in 2001 to reduce market exposure by closely monitoring inventory position limits and implementing stop loss levels. In 1999, the largest increase as a percentage of revenues over 1998 resulted from increased principal transactions and trading profits in equity securities. Revenues from these areas increased 59% in 1999 when compared with 1998. Several of the firm's proprietary equity traders achieved significantly improved profitability in 1999 over 1998. The Company also realized a significant increase in investment banking revenues as a result of the completion of an initial public offering in the first quarter of 2000. The investor market for new offerings declined substantially in the latter part of the year, with the trend continuing into fiscal 2001. Therefore, it is anticipated that the Company will be unable to sustain these revenue levels in this business sector for 2001. Year Ended December 31, 2000 1999 1998 (000's) % Change (000's) % Change (000's) ----------------------------------------------------------------------- Expenses: Commissions, employee compensation and benefits $46,801 11 42,138 33 $ 31,766 Clearing and floor brokerage 4,003 (3) 4,110 12 3,675 Communications and occupancy 2,732 1 2,697 5 2,557 Legal matters and related costs 1,181 (15) 1,395 (41) 2,377 Write-down of Note receivable - Global Financial Corp. 239 1 100 (94) 1,775 Loss on lease settlements -- (100) 600 50 100 Other operating expenses 4,862 37 3,546 24 2,862 Interest 160 (4) 166 27 131 ---------------------------------------------------------------------- Total expenses $59,978 10 $ 54,752 21 $45,243 ---------------------------------------------------------------------- Total expenses increased by $5,226,000, or 10% to $59,978,000 for 2000, up from $54,752,000 for 1999. Expenses increased in most areas due to the Company's continued expansion of operations, enhanced marketing efforts and staffing, and increased commission payouts to a greater number of registered representatives. During 2000, the Company paid commissions, employee compensation and employee benefits of $46,801,000 (79% of total revenues) as compared to $42,138,000 (73% of total revenues) in 1999. This category includes salaries, commission expense, and benefits for salaried employees. Commissions paid to registered representatives for fiscal 2000 totaled $39,289,000 (66% of total revenues) compared to $35,502,000 (62% of total revenues) in 1999, and accounted for almost $4,000,000, or 80% of the total increase in this expense category over fiscal 1999. The dollar increase in commissions paid is due primarily to the increase in commission revenues, as well as the increase in commission payout percentages, which is required to remain competitive in the independent brokerage arena. For 2000, the Company paid salaries, bonuses and benefits of $7,512,000 for management, operations and clerical personnel, as compared to $6,636,000 in 1999 and $5,294,000 in 1998. During the second half of 2000, the Company hired additional management and support staff for various departments, primarily in sales, recruiting and compliance. In 2000, the Company also added employees to its mutual fund and insurance departments, as well as on the equity order desk. The Company employed approximately 120 salaried employees as of December 31, 2000, 78 salaried employees as of December 31, 1999 and 68 salaries employees as of December 31, 1998. These increases in personnel were required to service and support the Company's growing network of affiliated registered representatives. Clearing costs, which are associated with the level of transaction volume and type, remained fairly constant during 2000. For 2000, clearing costs were $4 million (7% of total revenues) as compared to $4.1 million (7% of total revenues) in 1999. In 1999, clearing costs increased by $435,000 from 1998. The dollar increase in 1999 reflected the increased volume in securities transactions, which carry clearance and floor brokerage charges. The percentage of clearing costs to gross revenues can, and does, fluctuate depending upon the product mix. Certain transactions, such as options and bonds, have a higher execution and clearing cost than others. In 1998 clearing costs were $3.6 million (9% of total revenues). Clearing costs as a percentage of revenues has decreased over the period from 1998 to 2000 due in part to volume discounts negotiated with the Company's clearing firm. Communications and occupancy costs remained relatively constant during fiscal 2000, increasing only slightly from $2,697,000 in 1999 to $2,732,000 in 2000. Communications and occupancy costs rose by $140,000 in 1999, an increase of 5% from 1998. The largest increase in this category was in the area of technology support and software enhancements. In 1999, the Company contracted with a data management consultant to upgrade the existing database and provide management with better information retrieval systems and reporting capabilities. For the third consecutive year, legal matters and related costs decreased as a result of the enhanced supervision and compliance measures implemented in 1999. These costs totaled $1,181,000 in 2000, down 15% from 1999 and 50% from 1998. FMSC is a respondent in a new customer arbitration (See Legal Proceedings). FMSC is also a defendant or co-defendant in various other legal proceedings incidental to its securities business. FMSC is contesting the allegations of these claims and believes that there are meritorious defenses in each case. In view of the inherent difficulty of predicting the outcome of litigation, management is unable to derive a meaningful estimate of the amount or range of possible loss that may arise out of pending legal proceedings. In December 1999, the Company accepted a $500,000 cash payment in settlement of an arbitration against another securities firm. The Company commenced the arbitration in an effort to recover customer settlements that it had previously paid on claims arising from the activities of a former affiliate office. The settlement was received in February 2000. The Company has also filed suit against one of its insurers to compel coverage of several settled claims. There can be no assurance that the Company will be successful in its efforts to recover additional funds from its insurers on settled claims, or that monetary losses, if any, from future claims, settlements or adverse judgments will be covered under the Company's existing insurance policies. Other operating expenses increased from $3,546,000 in 1999 to $4,861,000 in 2000, an increase of 37%. The increase is due primarily to the write-off of the balance of the receivable from Global Financial Corp. and various broker loan receivables, costs associated with the conversion to the new clearing firm, and increased sales and marketing initiatives. Other operating expenses increased from $2,862,000 in 1998 to $3,546,000 in 1999, an increase of 24%. That increase was due primarily to higher bad debts, depreciation expense and increased sales and marketing initiatives. The Company's effective tax rate in 2000 was 1% as compared to 19% in 1999 and (18)% in 1998. The rate in 2000 was higher than expected because of the effect of non-deductible expenses and an increase in the tax valuation allowance during the year. Management increased the tax valuation allowance in 2000 to offset tax benefits arising from state tax loss carryforwards and stock-based compensation because their realization is uncertain. The rate in 1999 was lower than expected because income tax expense was offset by the reversal of a valuation allowance established against deferred tax assets (principally reserves and net operating losses) in 1998. Based on an assessment of all available evidence, including improved operating results, management concluded that it was more likely than not that deferred tax assets as of December 31, 1999 would be realized. Accordingly, the balance of the valuation allowance at December 31, 1999 ($542,000) was reversed. The rate in 1998 was higher than expected because the existence of uncertainties regarding the resolution of various pending claims and the previously discussed Global matter led management to record a valuation allowance of $731,000 to offset deferred tax benefits. For the year 2000, the Company reported a net loss of $792,000 or $.08 per basic and diluted share, as compared to net income of $2,216,000, or $.22 per basic share and $.21 per diluted share, for 1999. For 1998, the Company reported a net loss of $2,763,000, or $.28 per basic and diluted share. Liquidity and Capital Resources The Company maintains a highly liquid balance sheet with 60% of the Company's assets consisting of cash and cash equivalents, securities owned, and receivables from the Company's clearing firm and other broker-dealers. Market making and other securities dealer activities require the Company to carry significant levels of securities inventories in order to meet customer and internal trading needs. The balances in the Company's cash, inventory and clearing firm accounts can and do fluctuate significantly from day to day, depending on market conditions, daily trading activity, and investment opportunities. The Company monitors these accounts on a daily basis in order to ensure compliance with regulatory capital requirements and to preserve liquidity. Net cash provided by operating activities during 2000 was $5,333,000. Cash was generated in part from the $4 million advance received under the financial agreement with Fiserv in November 2000. For financial reporting purposes, the Company will earn the advance on a straight-line basis over the term of the clearing agreement. Amortization can be accelerated based on performance. The entire advance is subject to income taxes in the year of receipt. Fiserv has agreed to provide additional advances of $1,750,000 in each of the next three years of the agreement, provided FMSC meets certain performance and other criteria. Operating cash flows were also provided by funds drawn from FMSC's clearing firms of $4,057,000. These increases were partially offset by a net loss in 2000, increases in employee and broker receivables of $1,157,000, increases in deferred income taxes of $1,057,000, and decreases in commissions payable of $1,073,000. In an effort to compete with other broker-dealers for registered representatives, FMSC has increasingly made loans to brokers as an inducement to join the Company. Some of these loans are forgivable if the registered representative remains licensed with the Company for an agreed upon period of time, generally 1-2 years, and/or meets specified production goals. The unamortized balance of these loans at December 31, 2000 was $606,473. Other loans to registered representatives are payable in installments, generally over periods from 1-2 years, with interest rates ranging from 0% to 8% per annum. Investing activities required cash of $37,000 during 2000. Additions to fixed assets consumed $722,000, primarily for the purchase of computers, office furniture and equipment. The collection of Global leases receivable provided cash of $650,000. The Global leases were assigned to the Company in various settlement transactions with Global customers during 1999 (See Note 11 to the consolidated financial statements). In 1999, the Company completed a private offering of Series A Convertible Preferred Stock with the majority of the Global lease investors. Under the terms of the offering, each Global lease investor who participated in the offering received one share of Preferred Stock in exchange for every $5 of lease investment value that the investor was entitled to receive from Global after certain adjustments. Each leaseholder was required to assign their interest in all lease payments to which they were entitled. Each share of the Preferred Stock is convertible into two shares of the Company's Common Stock and pays a quarterly dividend of $.075 per Preferred Share. Financing activities used cash of $2,282,000 in 2000. A total of $1,461,000 was used to repurchase 1,105,034 shares of the Company's outstanding shares pursuant to a stock repurchase program authorized by the board of directors in August 1999. In addition, the Company made note and capital lease repayments of $1,019,000 and dividend payments to preferred stockholders of $103,000. A total of $56,000 was received from the exercise of 57,000 stock options by various individuals during the year. At December 31, 2000, the Company's broker-dealer subsidiary had net capital of $1,194,000, which was $682,000 in excess of its required net capital of $512,000, and the ratio of aggregate indebtedness to net capital was 6.43 to 1. The Company has various bank notes totaling $53,000. These notes bear interest at the prime rate (9.5% at December 31, 2000), and are collateralized by equipment owned by the Company. The loans are payable in monthly installments of $7,994. In 1998, the Company issued convertible promissory notes in the aggregate amount of $570,000 to a private investor and his affiliated entities in connection with a Global lease settlement. The principal amount was originally due in October 2003. In 2000, the Company redeemed the notes for 110% of the note principal, and recorded an extraordinary loss of $57,000 before income taxes from the early extinguishment. In 1999, the Company issued additional convertible notes in the original aggregate amount of $690,526 to several private investors in connection with a Global lease settlement. The notes are payable in thirty-six monthly non-interest bearing installments of $16,404, plus balloon payments of $112,000, which include interest of $12,000 calculated on the basis of 8% of the balloon amount beginning in month nineteen of the note term. The Company had recorded a loan discount on the notes of $64,609, which is being amortized over the note terms using the interest method. The notes are convertible into 345,263 shares of the Company's common stock based on a conversion price of $2.00 per share. Once the underlying shares are registered, the Company can request that the noteholders convert their shares. Proceeds from the sale of the shares must be applied towards the unpaid principal of the notes. Any excess proceeds or unsold shares will be returned to the Company. As of December 31, 2000, the Company had an aggregate of $100,000 of subordinated notes outstanding. The notes are payable in annual installments of $50,000 plus interest at 8% per annum. The notes are subordinated to the claims of FMSC's general creditors under a subordination agreement approved by the NASDR. Impact of Inflation Management of the Company believes that the impact of inflation has an effect upon the amount of capital generally available for investment purposes and also may affect the attitude or willingness of investors to buy and sell securities. The nature of the business of the Company's broker-dealer subsidiary and the securities industry in general is directly affected by national and international economic and political conditions, broad trends in business and finance and volatility of interest rates, changes in and uncertainty regarding tax laws, and substantial fluctuation in the volume and price levels of securities transactions and the securities markets. To the extent inflation results in higher interest rates and has other adverse effects on the securities markets and the value of securities held in inventory, it may adversely affect the Company's financial position and results of operations. Factors Affecting "Forward-Looking Statements" From time to time, the Company may publish "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, or make oral statements that constitute forward-looking statements. These forward-looking statements may relate to /such matters as anticipated financial performance, future revenues or earnings, business prospects, projected ventures, new products, anticipated market performance, and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, the Company cautions readers that a variety of factors could cause the Company's actual results to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. These risks and uncertainties, many of which are beyond the Company's control, include, but are not limited to: (i) transaction volume in the securities markets, (ii) the volatility of the securities markets, (iii) fluctuations in interest rates, (iv) changes in regulatory requirements which could affect the cost of doing business, (v) fluctuations in currency rates, (vi) general economic conditions, both domestic and international, (vii) changes in the rate of inflation and related impact on securities markets, (viii) competition from existing financial institutions and other new participants in competition from existing financial institutions and other new participants in the securities markets, (ix) legal developments affecting the litigation experience of the securities industry, and (x) changes in federal and state tax laws which could affect the popularity of products sold by the Company. The Company does not undertake any obligation to publicly update or revise any forward-looking statements. Effects of Recently Issued Accounting Pronouncement In June 1998 and June 2000, the FASB issued SFAS No. 133, "Accounting for derivative instruments and hedging activities" and SFAS No. 138, "Accounting for certain derivative instrument and certain hedging activities." These statements establish accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 and 138 also require that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The Company will adopt SFAS No. 133 and No. 138 in the first quarter of fiscal 2001, and does not expect that the adoption of these new standards will have a material impact on its earnings or financial positions. Market Risk Certain of the Company's business activities expose it to market risk. This market risk represents the potential for loss that may result from a change in value of a financial instrument as a result of fluctuations in interest rates, equity prices or changes in credit ratings of issuers of debt securities. This risk relates to financial instruments held by the company as investment and for trading. The Company's securities inventories are exposed to risk of loss in the event of unfavorable price movements. The Company's securities inventories are marked to market on a daily basis. The Company's market-making activities are client-driven, with the objective of meeting clients' needs while earning a positive spread. At December 31, 2000 and December 31,1999, the balances of the Company's equity securities positions owned and sold but not yet purchased were approximately $3,689,000 and $386,000 and $2,931,000 and $99,000, respectively. In the opinion of management, the potential exposure to market risk, trading volatility and the liquidity of securities held in the firm's inventory accounts, could potentially have a material effect on the Company's financial position. The Company's client activities involve the execution, settlement, and financing of various transactions on behalf of its clients. Client activities are transacted on either a cash or margin basis. The Company's client activities may expose it to off-balance sheet credit risk. The Company may have to purchase or sell financial instruments at the prevailing market price in the event of the failure of a client to settle a trade on its original terms or in the event that cash and securities in the client margin accounts are not sufficient to fully cover the client losses. The Company seeks to control the risks associated with client activities by requiring clients to maintain collateral in compliance with various regulations and Company policies. Item 8. Financial Statements See Financial Statements attached hereto. Item 9. Disagreements on Accounting and Financial Disclosure Not Applicable. PART III Item 10. Directors and Executive Officers The Directors and Executive Officers of the Company and its subsidiaries are as follows: Name Age Position ---- --- -------- Herbert Kurinsky 69 Director, President and Chief Executive Officer of FMFC and of FMSC and Registered Options Principal of FMSC William J. Kurinsky 40 Director, Vice President, Chief Operating and Chief Financial Officer and Secretary of FMFC and of FMSC and Financial/Operations Principal of FMSC Robert I. Rabinowitz, Esq. 43 General Counsel, FMFC, Chief Administrative Officer, Vice President and General Securities Principal of FMSC Norma Doxey 61 Director, Vice President of Operations, FMSC Ward R. Jones, Jr. 70 Director David I. Portman 60 Director Barry D. Shapiro, C.P.A. 58 Director The Company's Certificate of Incorporation provides for the classification of the Board of Directors into three classes of Directors, each class as nearly equal in number as possible but not less than one Director, each director to serve for a three-year term, staggered by class. The Certificate of Incorporation further provides that a Director or the entire Board of Directors may be removed only for cause and only by the affirmative vote of the holders of at least 70% of the combined voting power of the Company's voting stock, with vacancies on the Board being filled only by a majority vote of the remaining Directors then in office. "Cause" is defined as the willful failure of a director to perform in any substantial respect such Director's duties to the Corporation (other than any such failure resulting from incapacity due to physical or mental illness), willful malfeasance by a Director in the performance of his duties to the Corporation which is materially and demonstrably injurious to the Corporation, the commission by a Director of an act of fraud in the performance of his duties, the conviction of a Director for a felony punishable by confinement for a period in excess of one year, or the ineligibility of a Director for continuation in office under any applicable rules, regulations or orders of any federal or state regulatory authority. All officers serve at the discretion of the Board of Directors. Family relationships exist among the following officers and directors: Mr. Herbert Kurinsky is the uncle of Mr. William J. Kurinsky. Mr. Robert I. Rabinowitz is the brother-in-law of Mr. William J. Kurinsky. Herbert Kurinsky became a Director and the President of the Company on November 16, 1987. Mr. Kurinsky is a co-founder of First Montauk Securities Corp. and has been its President, one of its Directors and its Registered Options Principal since September of 1986. From March 1984 to August 1986, Mr. Kurinsky was the President of Homestead Securities, Inc., a New Jersey broker/dealer. From April 1983 to March 1984, Mr. Kurinsky was a branch office manager for Phillips, Appel & Waldon, a securities broker/dealer. From February 1982 to March 1983, Mr. Kurinsky was a branch office manager for Fittin, Cunningham and Lauzon, a securities broker/dealer. From November 1977 to February 1982, he was a branch office manager for Advest Inc., a securities broker/dealer. Mr. Kurinsky received a B.S. degree in economics from the University of Miami, Florida in 1954. William J. Kurinsky became Vice President, a Director and Financial and Operations Principal of the Company on November 16, 1987. He is a co-founder of First Montauk Securities and has been one of its Vice Presidents, a Director and its Financial/Operations Principal since September of 1986. Prior to that date, Mr. Kurinsky was Treasurer, Chief Financial Officer and Vice President of Operations of Homestead Securities, Inc., a securities broker/dealer. Mr. Kurinsky received a B.S. from Rutgers University in 1984. He is the nephew of Herbert Kurinsky. Robert I. Rabinowitz, Esq. is General Counsel of the Company since 1987. He concurrently served as General Counsel of First Montauk Securities from 1986 until 1998 when a new general counsel was named. Thereafter, he became the Chief Administrative Officer of FMSC as well as a General Securities Principal. From January 1986 until November 1986, he was an associate attorney for Brodsky, Greenblatt & Renahan, a private practice law firm in Rockville, Maryland. Mr. Rabinowitz is an attorney at law licensed to practice in New Jersey, Maryland and the District of Columbia, and is a member of the Board of Arbitrators for the National Association of Securities Dealers, Department of Arbitration. Mr. Rabinowitz's wife is a niece of Mr. Herbert Kurinsky and a sister of Mr. William Kurinsky. Norma L. Doxey has been a Director of the Company since December 6, 1988. Ms. Doxey has been a Vice President of Operations and a Registered Representative with First Montauk Securities Corp. since September 1986. From August through September, 1986, she was operation's manager and a Registered Representative with Homestead Securities, Inc. From July 1984 through August 1985 she held the same position with Marvest Securities. Ward R. Jones, Jr. has been a director of the Company since June 1991. From 1955 through 1990, Mr. Jones was employed by Shearson Lehman Brothers as a registered representative, eventually achieving the position of Vice President. Mr. Jones is currently a registered representative of First Montauk Securities Corp., but does not engage in any securities business. David I. Portman has been a director of the Company since June 15, 1993. From 1978 to the present, Mr. Portman served as the President of Triad Property Management, Inc., a private corporation which builds, invests in and manages real estate properties in the State of New Jersey. Mr. Portman was a Director of Ultra Med, Inc. from 1986 to 1991, a high tech medical equipment manufacturer. Mr. Portman also serves as a director and officer of Pacific Health Laboratories, Inc., a position he has held since August 1995. In 1997, FMSC underwrote an initial public offering of the common stock of Pacific Health Laboratories, Inc., and is currently a market maker in the stock. Barry D. Shapiro, C.P.A. has been a director of the Company since December 6, 2000. From October 2000 to the present, Mr. Shapiro is a shareholder of the accounting firm, Withum, Smith + Brown in its Red Bank office. Mr. Shapiro was a partner of Shapiro & Weisman C.P.A.'s P.A. from 1976 thru 1996 when he became a partner of Rudolf, Cinnamon & Calafato, P.A. until joining Withum Smith + Brown. Mr. Shapiro was previously employed with the Internal Revenue Service from 1965 thru 1971, where he was responsible for audit, review and conference functions. Mr. Shapiro is a member of the New Jersey Society of Certified Public Accountants, where he currently participates on the IRS Co-Op and State Tax Committees. Mr. Shapiro is a past Trustee, Treasurer and Vice President of the NJSCPA. He has been involved and is in many civic and community activities, as well as charitable organizations, including the Monmouth County New Jersey Chapter of the American Cancer Society and the Ronald McDonald House of Long Branch, New Jersey. Mr. Shapiro received a B.S. in accounting from Rider University in 1965. Significant Employees Dave M. McCoy, 39, has been director of retail sales since June 2000. Prior to that he was an affiliate registered representative with First Montauk Securities Corp. in the Boca Raton, Florida branch office since August 1992. From October 1991 through August 1992, Mr. McCoy was a Manager at Chelsea Street Securities, and from October 1990 through October 1991, he was a trader/manager in Biltmore Securities, both in Boca Raton, FL. Mr. McCoy holds a General Securities Agent and Principal licenses. Mark D. Lowe, 41, has been President of Montauk Insurance Services, Inc. since October 1998. From 1982 to 1998 Mr. Lowe was a Senior Consultant with Congilose & Associates, a financial services firm specializing in insurance and estate planning. Mr. Lowe became a Certified Financial Planner (CFP) in July 1991. Mr. Lowe attended Ocean County College in Toms River, NJ. Mr. Lowe is the Treasurer of the Estate and Financial Planning Council of Central New Jersey. Certain Reports No person who, during the fiscal year ended December 31, 2000, was a Director, officer or beneficial owner of more than ten percent of the Company's Common Stock (which is the only class of securities of the Company registered under Section 12 of the Securities Exchange Act of 1934 (the "Act") (a "Reporting Person") failed to file on a timely basis, reports required by Section 16 of the Act during the most recent fiscal year or prior years. The foregoing is based solely upon a review by the Company of Forms 3 and 4 during the most recent fiscal year as furnished to the Company under Rule 16a-3(d) under the Act, and Forms 5 and amendments thereto furnished to the Company with respect to its most recent fiscal year, and any representation received by the Company from any reporting person that no Form 5 is required. Item 11. Executive Compensation Summary of Cash and Certain Other Compensation The following table provides certain information concerning all Plan and Non-Plan (as defined in Item 402 (a)(ii) of Regulation S-K) compensation awarded to, earned by, paid or accrued by the Company during the years ended December 31, 2000, 1999 and 1998 to each of the named executive officers of the Company. SUMMARY COMPENSATION TABLE Annual Compensation Long Term Compensation Securities Underlying Name & Principal Other Annual Options/ SARs Position Year Salary Bonus Compensation Granted - ---------------- ---- ------ ----- ------------ ------------- Herbert Kurinsky 2000 $256,217.78 $ 29,306.21 $ 2,000 (4) 125,000(1) Chairman, Chief 1999 $232,925 $100,000 $ 925(4) 0 Executive Officer (7) 1998 $175,000 $ 0 $ 10,096(4) 100,000(1) William J. Kurinsky 2000 $256,217.78 $ 0 $ 2,000 (5) 125,000(2) Vice President, 1999 $232,925 $100,000 $ 1,925(5) 0 Chief Operating and 1998 $175,000 $ 0 $ 10,221(5) 100,000(2) Financial Officer and Secretary (8) Robert I. Rabinowitz 2000 $150,000 $24,234.64 $ 2,000 (6) 60,000(3) General Counsel, FMFC, 1999 $125,000 $25,000 $ 1,200(6) 0 Chief Administrative 1998 $125,000 $15,000 $ 295(6) 100,000(3) Officer, FMSC (9) - -------------------------- 1) In 2000, the Compensation Committee of the Board of Directors (the "Committee") authorized an option grant to Mr. Herbert Kurinsky to purchase 125,000 shares of Common Stock at an exercise price of $2.00 per share. In 1998, the Board of Directors authorized a grant to purchase 100,000 shares at an exercise prices of $1.9375 to Herbert Kurinsky. See "Aggregated Options/Sar Exercises in Last Fiscal Year and Fy-End Option/Sar Values." 2) In 2000, the Compensation Committee of the Board of Directors (the "Committee") authorized an option grant to Mr. William J. Kurinsky to purchase 125,000 shares of Common Stock at an exercise price of $2.00 per share. In 1998, the Board of Directors authorized a grant to purchase 100,000 shares at an exercise prices of $2.13 to William J. Kurinsky. See "Aggregated Options/Sar Exercises in Last Fiscal Year and Fy-End Option/Sar Values." 3) In 2000, the Board of Directors authorized an option grant to Mr. Robert Rabinowitz to purchase 60,000 shares of Common Stock at an exercise price of $2.00 per share. In 1998, the Board of Directors authorized a grant to purchase 100,000 shares at an exercise prices of $1.9375 to Robert Rabinowitz. See "Aggregated Options/Sar Exercises in Last Fiscal Year and Fy-End Option/Sar Values." 4) Includes (i) for 2000, automobile allowance of $2000; (ii) for 1999, auto allowance of $925; (iii) for 1998, vacation pay of $10,096. 5) Includes: (i) for 2000, automobile allowance of $2,000; (ii) for 1999, auto allowance of $1928; (iii) for 1998, commissions of $125 and vacation pay of $10,096. 6) Includes (i) for 2000, automobile allowance of $2,000; (ii) for 1999, automobile allowance of $1200; (iii) for 1998, commissions of $295. 7) Mr. Herbert Kurinsky is the beneficial owner of 51,518 shares of the Company's Common Stock as of December 31, 2000, which shares had a market value of $36,578 as of that date, without giving effect to the diminution in value attributable to the restriction on said shares. 8) Mr. William Kurinsky is the beneficial owner of 1,065,823 shares of the Company's Common Stock as of December 31, 2000, which shares had a market value of $756,734 as of that date, without giving effect to the diminution in value attributable to the restriction on said shares. 9) Mr. Robert I. Rabinowitz is the beneficial owner of 29,500 shares of the Company's Common Stock as of December 31, 2000, which shares had a market value of $20,945 as of that date, without giving effect to the diminution in value attributable to the restriction on said shares. Compensation of Directors The Company pays directors, who are not employees of the Company, a retainer of $250 per meeting of the Board of Directors attended and for each meeting of a committee of the Board of Directors not held in conjunction with a Board of Directors meeting. Directors employed by the Company are not entitled to any additional compensation as such. During fiscal year 2000, the Board of Directors met on four (4) occasions and all directors were present, either in person or by telephonic conference call. Committees of the Board of Directors The Board of Directors has established an Audit Committee comprised of Ward R. Jones, David Portman and Barry Shapiro. The Audit Committee met on one (1) occasion during fiscal year 2000. The Audit Committee reviews (i) the Company's audit functions, (ii) the finances, financial condition, and interim financial statements of the Company with management, and (iii), the year end financial statements of the Company with the Company's independent auditors. Members of the Audit Committee do not receive additional compensation for such service. OPTION/SAR GRANTS IN LAST FISCAL YEAR The following table contains information with respect to the named executive officers concerning options granted during the year ended December 31, 2000. INDIVIDUAL GRANTS Number of % of Total Underlying Granted to Exercise Options/SARs Employees in or Base Expiration Name Granted(#) Fiscal Year Price ($Sh) Date ---- ------------ ------------ ----------- ---------- Herbert Kurinsky 125,000 6.3% $2.00 3/27/05 William J. Kurinsky 125,000 6.3% $2.00 3/27/05 Robert I. Rabinowitz 60,000 3% $2.00 3/27/05 AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES Value of Shares Number of Unexercised Acquired Unexercised In-the-money on Value Options as of Options at Name Exercise Realized December 31,2000 December 31, 2000(1) ---- -------- -------- ---------------- -------------------- Exercisable/Unexercisable Exercisable/Unexercisable Herbert Kurinsky -- $0 475,000/0 $0/$0 William J. Kurinsky -- $0 500,000/0 $0/$0 Robert I. Rabinowitz -- $0 328,750/0 $0/$0 (1) Based upon the closing bid price of the Company's Common Stock on December 31, 2000 ($.71 per share), less the exercise price for the aggregate number of shares subject to the options. Employment Agreements In January 2000, the Company entered into new three-year employment contracts with Herbert Kurinsky, as President and William J. Kurinsky, as Executive Vice President. The contracts provide for base salaries of $256,218 for the first year of the agreement for each, increasing in each case at the rate of 10% per year. Each will also be entitled to receive a portion of a bonus pool consisting of 10% of the pre-tax profits of the Company, to be determined by the executive management (e.g. Herbert Kurinsky and William J. Kurinsky). The bonus pool would require a minimum of $500,000 pretax profit per year in order to become effective. Each is also entitled to receive commissions at the same rate as paid to other non-affiliate registered representatives of the Company. They are also entitled to purchase from FMSC, up to 20% of all underwriters and/or placement agent warrants or options which are granted to FMSC upon the same price, terms and conditions afforded to FMSC as the underwriter or placement agent. Each employee also receives health insurance benefits and life insurance as generally made available to regular full-time employees of the Company, and reimbursement for expenses incurred on behalf of the Company and the use of an automobile, or in the alternative, an automobile allowance. The contracts also provide for severance benefits equal to three times the previous year's salary in the event either of the employees is terminated or their duties significantly changed after a change in management of the Company as defined in the agreement. Incentive Stock Option Plan In 1992, the Company adopted the 1992 Incentive Stock Option Plan (the "1992 Plan") which provides for the grant of options to purchase up to 6,000,000 shares of the Company's Common Stock by employees of the Company and consultants. Under the terms of the Plan, options granted thereunder may be designated as options which qualify for incentive stock option treatment ("ISOs") under Section 422A of the Code, or options which do not so qualify ("Non-ISOs"). The Plan is administered by the Board of Directors which has the discretion to determine the eligible employees to whom, and the times and the price at which, options will be granted; whether such options shall be ISOs or Non-ISOs; the periods during which each option will be exercisable; and the number of shares subject to each option. The Board has full authority to interpret the Plan and to establish and amend rules and regulations relating thereto. Under the Plan, the exercise price of an option designated as an ISO shall not be less than the fair market value of the Common Stock on the date the option is granted. However, in the event an option designated as an ISO is granted to a ten percent stockholder (as defined in the Amended Plan) such exercise price shall be at least 110% of such fair market value. Exercise prices of Non-ISO options may be less than such fair market value. The aggregate fair market value of shares subject to options granted to a participant which are designated as ISOs which become exercisable in any calendar year may not exceed $100,000. The Board may, in its sole discretion, grant bonuses or authorize loans to or guarantee loans obtained by an optionee to enable such optionee to pay any taxes that may arise in connection with the exercise or cancellation of an option. Unless sooner terminated, the Plan will expire in 2002. In June 2000 at the Company's Annual Meeting of Shareholders, a resolution was passed amending the Incentive Stock Option Plan to increase the number of shares reserved for issuance from 6,000,000 to 8,000,000. To date, options to purchase a total of 6,504,998 shares of the Company's Common Stock have been issued under the 1992 Plan. Director Plan In September 1992, the Company adopted the Non-Executive Director Stock Option Plan (the "Director Plan"). The Director Plan provides for issuance of a maximum of 1,000,000 shares of Common Stock upon the exercise of stock options granted under the Director Plan. Options are granted under the Director Plan until 2002 to non-executive directors who are not full time employees of the Company or any of its subsidiaries. The Director Plan provides that each non-executive director will automatically be granted an option to purchase 20,000 shares each September 1, provided such person has served as a director for the 12 months immediately prior to such September 1st. The exercise price for options granted under the Director Plan shall be 100% of the fair market value of the Common Stock on the date of grant. Until otherwise provided in the Stock Option Plan the exercise price of options granted under the Director Plan must be paid at the time of exercise, either in cash, by delivery of shares of Common Stock of the Company or a combination of both. The term of each option commenced on the date it is granted and unless terminated sooner as provided in the Director Plan, expires five years from the date of grant. The Director Plan is administered by a committee of the board of directors composed of not fewer than three persons who are officers of the Company (the "Committee"). The Committee has no discretion to determine which non-executive director will receive options or the number of shares subject to the option, the term of the option or the exercisability of the option. However, the Committee will make all determinations of the interpretation of the Director Plan. Options granted under the Director Plan are not qualified for incentive stock option treatment. To date, a total of 380,000 options have been granted to the Company's Non-Executive members of the Board of Directors. Senior Management Plan In 1996, the Company adopted the 1996 Senior Management Incentive Plan (the "Management Plan"). The Management Plan provides for the issuance of up to 2,000,000 shares of Common Stock either upon issuance of options issued under the Plan or grants of restricted stock or incentive stock rights. Awards may be granted under the Management Plan to executive management employees by the Board of Directors or a committee of the board, if one is appointed for this purpose. The Management Plan provides for four types of awards: stock options, incentive stock rights, stock appreciation rights ("SARs"), and restricted stock purchase agreements. The stock options granted under the Management Plan can be either ISOs or non-ISOs similar to the options granted under the Employee Stock Option Plan, except that the exercise price of non-ISOs shall not be less than 85% of the fair market value of the Common Stock on the date of grant. Incentive stock rights consist of incentive stock units equivalent to one share of Common Stock in consideration for services performed for the Company. If services of the holder terminate prior to the incentive period, the rights become null and void unless termination is caused by death or disability. Stock appreciation rights allow a Grantee to receive an amount in cash equal to the difference between the fair market value of the stock and the exercise price, payable in cash or shares of Common Stock. The Board or committee may grant limited SARs, which become exercisable upon a "change of control" of the Company. A change of control includes the purchase by any person of 25% or more of the voting power of the Company's outstanding securities, or a change in the majority of the Board of Directors. Awards granted under the Management Plan are also entitled to certain acceleration provisions that cause awards granted under the Plan to immediately vest in the event of a change of control or sale of the Company. Awards under the Management Plan may be made until 2006. In June 2000 at the Company's Annual Meeting of Shareholders, a resolution was passed amending the Senior Management Stock Option Plan to increase the number of shares reserved for issuance from 2,000,000 to 4,000,000. To date, options to purchase a total of 2,375,000 shares of the Company's Common Stock have been issued under the Senior Management Plan. Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth, as of April 12, 2001, the number and percentage of outstanding shares of Common Stock beneficially owned by each person known by the Company to own beneficially more than 5% of the Company's outstanding shares of Common Stock and Common Stock Warrants, by each director of the Company, and by all directors and officers of the Company as a group. Directors, Officers Amount and Percentage and 5% Shareholders (1) of Beneficial Ownership (1) Number of Shares Percent Herbert Kurinsky 526,518(2) 5.6 Parkway 109 Office Center 328 Newman Springs Road Red Bank, NJ 07701 William J. Kurinsky 1,925,823(3) 19.8 Parkway 109 Office Center 328 Newman Springs Road Red Bank, NJ 07701 Robert I. Rabinowitz, Esq. 375,749(4) 4.0 Parkway 109 Office Center 328 Newman Springs Road Red Bank, NJ 07701 Ward R. Jones 110,000(5) 1.2 7 Leda Lane Guilderland, NY 12084 Norma Doxey 74,900(6) * Parkway 109 Office Center 328 Newman Springs Road Red Bank, NJ 07701 David I. Portman 219,800(7) 2.4 300 Ocean Avenue, Apt. 6A Long Branch, NJ 07740 Barry Shapiro, C.P.A. 0 N/A - ------------ - ------------ All Directors and 3,232,790 29.8 Officers as a group (7 persons in number) * Indicates less than 1% _____________________ (1) Unless otherwise indicated below, each director, officer and 5% shareholder has sole voting and sole investment power with respect to all shares that he beneficially owns. (2) Includes vested and presently exercisable options of Mr. Herbert Kurinsky to purchase 475,000 shares of Common Stock. (3) Includes vested and presently exercisable options of Mr. William J. Kurinsky to purchase 500,000 shares of Common Stock, and 120,000 Class A Warrants, 120,000 Class B Warrants and 120,000 Class C Warrants. (4) Includes vested and presently exercisable options of Mr. Robert Rabinowitz to purchase 328,750 shares of Common Stock; 50,000 of which are owned by Mr. Rabinowitz's wife. Mr. Rabinowitz's children own 2,000 shares of Common Stock. Mr. Rabinowitz also owns 5,833 Class A Warrants, 5,833 Class B Warrants and 5,833 Class C Warrants. (5) Includes vested and presently exercisable options of Mr. Ward Jones to purchase 100,000 shares of Common Stock. (6) Includes vested and presently exercisable options of Ms. Norma Doxey to purchase 44,500 shares of Common Stock, and 18,000 non-vested stock options. (7) Includes vested and presently exercisable options of Mr. David Portman to purchase 100,000 shares of Common Stock. Mr. Portman also owns 16,600 Class A Warrants, 16,600 Class B Warrants and 16,600 Class C Warrants. - --------------------------- NOTE: All Class A Warrants are exercisable at $3.00 per share for a period of five (5) years from February 17, 1998. All Class B Warrants are exercisable at $5.00 per share for a period of five (5) years from February 17, 1998. All Class C Warrants are exercisable at $7.00 per share for a period of seven (7) years from February 17, 1998. Item 13. Certain Relationships and Related Transactions For information concerning the terms of the employment agreements entered into between the Company and Messrs. Herbert Kurinsky and William J. Kurinsky, see "Executive Compensation". PART IV Item 14. Exhibits, Financial Statements and Reports on Form 8-K (A) 1. Financial Statements See Financial Statements Attached Hereto. 2. Exhibits Incorporated by reference to the Exhibit Index at the end of this report. (B) Reports on Form 8-K During the last quarter of the period covered by this Report, there were no reports filed on Form 8-K. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST MONTAUK FINANCIAL CORP. By /s/ Herbert Kurinsky --------------------------------- Herbert Kurinsky, President Dated: April 12, 2001 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated. /s/ Herbert Kurinsky April 12, 2001 - ------------------------------- Herbert Kurinsky President, Chief Executive Officer and Director /s/ William J. Kurinsky April 12, 2001 - -------------------------------- William J. Kurinsky Vice-President, Chief Operating and Chief Financial Officer, and Principal Accounting Officer, Secretary and Director /s/ Norma Doxey - -------------------------------- April 12, 2001 Norma Doxey, Director /s/ Ward R. Jones, Jr. - -------------------------------- April 12, 2001 Ward R. Jones, Jr., Director /s/ David I. Portman - -------------------------------- April 12, 2001 David I. Portman, Director /s/ Barry Shapiro - -------------------------------- April 12, 2001 Barry Shapiro, Director EXHIBITS INDEX The exhibits designated with an asterisk (*) have previously been filed with the Commission in connection with the Company's Registration Statement on Form S-l, File No. 33-24696, those designated (**) have been filed with the Company's Form 10-KSB for the fiscal year ended December 31, 1993, those designated (***) have been previously filed with the Company's Registration Statement on Form S-3, File No. 33-65770, and pursuant to 17 C.F.R. Sections 201.24 and 240.12b-32, are incorporated by reference to this document. Those designated (****) denotes exhibits which have been filed with the Company's Form 10-KSB for the fiscal year ended December 31, 1994. Those designated (******) denotes exhibits which have been filed with the Company's Proxy Statement dated May 30, 1996. Those designated (*******) denotes exhibits which have been filed with the Company's Form 10-KSB for the fiscal year ended December 31, 1996. Those designated (*******) denotes exhibits which have been filed with the Company's Form 10-KSB for the fiscal year ended December 31, 1997, (++) denotes exhibits filed with the Company's Form 10-K for the fiscal year ended December 31, 1998. Those designated (+++) denotes exhibits which have been filed with the Company's Proxy Statement dated May 23, 2000 and are incorporated by reference herewith. Those designated (++++) denotes exhibits filed with herewith. Exhibit No. Description 3.1* Amended and Restated Certificate of Incorporation adopted at 1989 Special Meeting in lieu of Annual Meeting of Shareholders. 3.2* Amended and Restated By-Laws. 10.8* Clearing Agreement between the Registrant and Wertheim Schroder & Co., Incorporated dated January 21, 1991. 10.17******* Office Lease Agreement between First Montauk Securities Corp. and River Office Equities dated March 5, 1997. 10.17.1 First Amendment to Office Lease Agreement dated March 5, 1997 between First Montauk Securities Corp. and River Office Equities dated March 3, 1998 (previously filed under 28.8 in Form 10-K for the fiscal year ended December 31, 1998). 10.18++ Employment Agreement between First Montauk Securities Corp. and Mark Lowe dated October 15, 1998. 10.19++ Employment Agreement between First Montauk Securities Corp. and Seth Rosen dated January 25, 1999. 10.20++++ Employment Agreement between First Montauk Financial Corp. and Herbert Kurinsky dated January 1, 2000. 10.21++++ Employment Agreement between First Montauk Financial Corp. and William J. Kurinsky dated January 1, 2000. 10.22++++ Clearing Agreement dated May 8, 2000 between Fiserv Securities, Inc. and First Montauk Securities Corp. 10.23++++ Financial Agreement dated May 8, 2000 between Fiserv Securities, Inc. and First Montauk Securities Corp. 10.24++++ Amended and Restated Financial Agreement dated February 1, 2001 between Fiserv Securities, Inc., First Montauk Financial Corp. and First Montauk Securities Corp. 10.25++++ Security Agreement dated February 1, 2001 between Fiserv Securities, Inc. and First Montauk Financial Corp. 11++++ Computation of Earnings Per Share. 27++++ Financial Data Schedule. 28.1* 1992 Incentive Stock Option Plan. 28.2* 1992 Non-Executive Director Stock Option Plan. 28.3****** Amended and Restated 1992 Incentive Stock Option Plan. 28.4****** Non-Executive Director Stock Option Plan - Amended and Restated June 28, 1996 28.5****** 1996 Senior Management Incentive Stock Option Plan. 28.6+++ Second Amended and Restated 1992 Incentive Stock Option Plan. 28.7+++ 1996 Senior Management Incentive Plan Amended as of June 23, 2000. REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders First Montauk Financial Corp. We have audited the accompanying consolidated statements of financial condition of First Montauk Financial Corp. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income (loss), changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Montauk Financial Corp. and subsidiaries as of December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. Schneider & Associates LLP Jericho, New York March 19, 2001 FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION December 31, 2000 1999 ASSETS Cash and cash equivalents $ 3,701,010 $ 686,980 Due from clearing firms 2,405,666 6,462,346 Commissions receivable 39,200 345,996 Trading and investment account securities 3,975,309 3,475,891 Employee and broker receivables 1,609,666 452,285 Global leases receivable 174,661 824,313 Notes receivable 18,000 482,531 Due from officers 175,068 132,754 Property and equipment - net 2,304,533 2,193,506 Deferred income taxes - net 1,721,262 664,256 Other assets 788,688 1,338,326 ---------- ---------- Total assets $16,913,063 $17,059,184 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deferred income $ 3,933,333 $ -- Securities sold, but not yet purchased, at market 386,459 180,280 Notes payable 559,179 1,477,428 Commissions payable 1,637,733 2,710,736 Accounts payable 450,974 525,809 Accrued expenses 840,578 1,072,552 Income taxes payable 875,786 510,226 Other liabilities 519,630 952,015 --------- --------- Total liabilities 9,203,672 7,429,046 --------- --------- Temporary equity - stock subject to redemption 6,500 36,500 Commitments and contingencies (See Notes) STOCKHOLDERS' EQUITY Preferred Stock, 4,375,000 shares authorized, $.10 par value, no shares issued and outstanding -- -- Series A Convertible Preferred Stock, 625,000 shares authorized, $.10 par value, 349,511 shares issued and outstanding; liquidation preference: $1,747,555 34,951 34,951 Common Stock, no par value, 30,000,000 shares authorized, 9,309,309 and 10,035,943 shares issued, 8,822,409 and 9,855,443 shares outstanding, respectively 4,063,397 5,185,818 Additional paid-in capital 4,253,765 4,080,730 Retained earnings 230,921 1,023,057 Less: Deferred compensation (393,120) (508,294) Less: Treasury stock, at cost (486,900 and 180,500 shares, respectively) (487,023) (222,624) ---------- ---------- Total stockholders' equity 7,702,891 9,593,638 ---------- ---------- Total liabilities and stockholders' equity $16,913,063 $17,059,184 ========== ========== See notes to consolidated financial statements. FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (LOSS) Years ended December 31, 2000 1999 1998 Revenues: Commissions $46,529,771 $40,516,625 $30,741,404 Principal transactions 7,131,079 14,000,680 8,795,599 Investment banking 2,416,711 439,065 767,312 Interest and other income 3,252,325 2,628,246 1,572,063 ---------- ----------- ---------- 59,329,886 57,584,616 41,876,378 ---------- ----------- ---------- Expenses: Commissions, employee compensation and benefits 46,800,661 42,137,968 31,766,060 Clearing and floor brokerage 4,003,345 4,109,961 3,674,859 Communications and occupancy 2,731,681 2,697,433 2,557,313 Legal matters and related costs 1,181,115 1,395,008 2,377,336 Write down of Notes Receivable - Global Financial Corp. 239,183 100,000 1,775,000 Loss on Global lease settlements -- 600,416 99,899 Other operating expenses 4,862,158 3,545,308 2,862,075 Interest 160,230 166,104 131,215 ---------- ---------- ---------- 59,978,373 54,752,198 45,243,757 ---------- ---------- ---------- Income (loss) before income taxes (648,487) 2,832,418 (3,367,379) Provision for income taxes (income tax benefit) 6,721 549,140 (604,532) ---------- ---------- ---------- Income (loss) before extraordinary loss (655,208) 2,283,278 (2,762,847) Extraordinary loss - extinguishment of debt, net of tax (34,200) -- -- ---------- ---------- ---------- Net income (loss) $ (689,408) $ 2,283,278 $ (2,762,847) ========== ========== ========== Net income (loss) available to common stockholders $ (792,136) $ 2,215,528 $ (2,762,847) ========== ========== ========== Per share of Common Stock: Basic: Before extraordinary loss $ (0.08) $ 0.22 $ (0.28) Extraordinary loss -- -- -- --------- ---------- ---------- Net income (loss) available to common stockholders $ (0.08) $ 0.22 $ (0.28) ========= ========== ========== Diluted: Before extraordinary loss $ (0.08) $ 0.21 $ (0.28) Extraordinary loss -- -- -- --------- ---------- ---------- Net income (loss) available to common stockholders $ (0.08) $ 0.21 $ (0.28) ========= ========== ========== Weighted average common shares outstanding - basic 9,450,055 9,878,129 9,725,116 ========= ========== ========== Weighted average common and common equivalent shares outstanding - diluted 9,450,055 11,262,708 9,725,116 ========= ========== ========== See notes to consolidated financial statements. FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE PERIOD FROM JANUARY 1, 1998 TO DECEMBER 31, 2000 Series A Convertible Additional Common Stock Preferred Stock Paid-in Shares Amount Shares Amount Capital Balances at January 1, 1998 9,198,444 $4,334,173 -- -- $1,173,437 Proceeds from rights offering -- -- -- -- 1,382,751 Registration costs -- -- -- -- (236,317) Exercise of stock options 432,050 342,419 -- -- -- Exercise of common stock purchase warrants 999 4,995 -- -- -- Deferred compensation -- -- -- -- 544,179 Amortization of deferred compensation -- -- -- -- -- Transfer from temporary equity 170,000 299,390 -- -- -- Tax benefit related to exercise of stock options -- -- -- -- 115,781 Net loss for the year -- -- -- -- -- --------- --------- -------- --------- --------- Balances at December 31, 1998 9,801,493 4,980,977 -- -- 2,979,831 Exercise of stock options 234,450 204,841 -- -- -- Deferred compensation -- -- -- -- 122,925 Amortization of deferred compensation -- -- -- -- -- Repurchase of common stock -- -- -- -- -- Issuance of common stock purchase warrants -- -- -- -- 27,382 Issuance of preferred stock -- -- 349,511 34,951 950,592 Payment of dividends -- -- -- -- -- Net income for the year -- -- -- -- -- ---------- --------- ------- ------ --------- Balances at December 31, 1999 10,035,943 5,185,818 349,511 34,951 4,080,730 Exercise of stock options 57,000 55,920 -- -- -- Transfer from temporary equity 15,000 18,000 -- -- -- Deferred compensation -- -- -- -- 173,035 Amortization of deferred compensation -- -- -- -- -- Repurchase of common stock -- -- -- -- -- Cancellation of treasury shares (798,634) (1,196,341) -- -- -- Payment of dividends -- -- -- -- -- Net loss for the year -- -- -- -- -- --------- --------- ------- ------ --------- Balances at December 31, 2000 9,309,309 $4,063,397 349,511 $34,951 $4,253,765 ========= ========= ======= ====== ========= See notes to consolidated financial statements. FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE PERIOD FROM JANUARY 1, 1998 TO DECEMBER 31, 2000 Retained Earnings (Accumulated Deferred Treasury Stock Stockholders' Deficit) Compensation Shares Amount Equity Balances at January 1, 1998 $1,570,376 $(185,019) -- -- $6,892,967 Proceeds from rights offering -- -- -- -- 1,382,751 Registration costs -- -- -- -- (236,317) Exercise of stock options -- -- -- -- 342,419 Exercise of common stock purchase warrants -- -- -- -- 4,995 Deferred compensation -- (544,179) -- -- -- Amortization of deferred compensation -- 147,988 -- -- 147,988 Transfer from temporary equity -- -- -- -- 299,390 Tax benefit related to exercise of stock options -- -- -- -- 115,781 Net loss for the year (2,762,847) -- -- -- (2,762,847) --------- ------- --------- --------- --------- Balances at December 31, 1998 (1,192,471) (581,210) -- -- 6,187,127 Exercise of stock options -- -- -- -- 204,841 Deferred compensation -- (122,925) -- -- -- Amortization of deferred compensation -- 195,841 -- -- 195,841 Repurchase of common stock -- -- (180,500) (222,624) (222,624) Issuance of common stock purchase warrants -- -- -- -- 27,382 Issuance of preferred stock -- -- -- -- 985,543 Payment of dividends (67,750) -- -- -- (67,750) Net income for the year 2,283,278 -- -- -- 2,283,278 --------- ------- --------- --------- --------- Balances at December 31, 1999 1,023,057 (508,294) (180,500) (222,624) 9,593,638 Exercise of stock options -- -- -- -- 55,920 Transfer from temporary equity -- -- -- -- 18,000 Deferred compensation -- (173,035) -- -- -- Amortization of deferred compensation -- 288,209 -- -- 288,209 Repurchase of common stock -- -- (1,105,034) (1,460,740) (1,460,740) Cancellation of treasury shares -- -- 798,634 1,196,341 -- Payment of dividends (102,728) -- -- -- (102,728) Net loss for the year (689,408) -- -- -- (689,408) --------- ------- --------- --------- --------- Balances at December 31, 2000 $ 230,921 $(393,120) (486,900) $ (487,023) $ 7,702,891 ========= ======= ========= ========= ========= See notes to consolidated financial statements. FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2000 1999 1998 Cash flows from operating activities: Net income (loss) $ (689,408) $ 2,283,278 $(2,762,847) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Common stock issued with guaranteed selling price -- -- 30,000 Tax benefit related to exercise of stock options -- -- 115,781 Depreciation and amortization 600,626 539,306 357,831 Amortization of deferred compensation 288,209 195,841 147,988 Amortization of bond discount 31,736 10,988 -- Loan reserves and write-offs 389,823 100,000 1,775,000 Loss on Global lease settlements -- 377,667 -- Other (1,448) -- (15,086) Increase (decrease) in cash attributable to changes in assets and liabilities: Due from clearing firms 4,056,680 (3,586,144) (168,420) Commissions receivable 306,796 (95,193) (4,553) Trading and investment account securities (499,418) (742,631) 924,244 Employee and broker receivables (1,157,381) 145,927 328,983 Due from officers (42,314) (1,253) 15,190 Deferred income taxes - net (1,057,006) 36,499 (664,787) Other assets 344,209 (152,692) 22,224 Deferred income 3,933,333 -- -- Securities sold, but not yet purchased 206,179 (146,767) (482,476) Commissions payable (1,073,003) 1,179,092 (92,672) Accounts payable (74,835) (276,689) 301,229 Accrued expenses (231,974) 167,398 70,564 Income taxes payable 365,560 510,226 -- Other liabilities (363,337) 378,631 67,715 --------- --------- --------- Total adjustments 6,022,435 (1,359,794) 2,728,755 Net cash provided by (used in) --------- --------- --------- operating activities 5,333,027 923,484 (34,092) --------- --------- --------- Cash flows from investing activities: Issuance of notes receivable -- (207,000) (2,091,704) Collection of notes receivable 74,708 102,197 777,029 Payment for Global leases receivable -- (12,532) -- Collection of Global leases receivable 649,652 619,497 -- Additions to property and equipment (722,205) (658,342) (986,315) Other assets (39,150) (23,867) 109,344 --------- --------- --------- Net cash used in investing activities (36,995) (180,047) (2,191,646) --------- --------- --------- Cash flows from financing activities: Proceeds from notes payable -- -- 300,000 Payments of notes payable (896,364) (227,943) (145,925) Proceeds from capital lease financing -- -- 304,068 Repurchase of common stock (1,460,740) (222,624) -- Payments of capital leases payable (122,669) (111,915) (18,621) Payment of preferred stock dividends (102,728) (67,750) -- Proceeds from rights offering -- -- 1,382,751 Registration costs -- -- (120,320) Proceeds from exercise of stock options and warrants 55,920 204,841 347,415 Other assets 244,579 (244,579) -- --------- -------- --------- Net cash provided by (used in) financing activities (2,282,002) (669,970) 2,049,368 --------- -------- --------- Net increase (decrease) in cash and cash equivalents 3,014,030 73,467 (176,370) Cash and cash equivalents at beginning of year 686,980 613,513 789,883 --------- -------- --------- Cash and cash equivalents at end of year $ 3,701,010 $ 686,980 $ 613,513 ========= ======== ========= See notes to consolidated financial statements. FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) Years ended December 31, 2000 1999 1998 Supplemental disclosures of cash flow information: Cash paid (refunded) during the period for: Interest $ 160,230 $ 166,104 $ 131,215 Income taxes $ 725,800 $ 5,232 $ (223,871) Debt issued in exchange for Global leases receivable $ -- $ 266,054 $ 170,101 Preferred stock issued in exchange for Global leases receivable $ -- $ 985,543 $ -- Common stock purchase warrants issued in exchange for Global leases receivable $ -- $ 27,382 $ -- Equipment financed under capital leases $ -- $ -- $ 88,132 Transfer of temporary equity to permanent capital $ 18,000 $ -- $ 299,390 See notes to consolidated financial statements. NOTE 1 - NATURE OF BUSINESS First Montauk Financial Corp. (the Company) is a holding company whose principal subsidiary, First Montauk Securities Corp. (FMSC), is primarily engaged in securities brokerage, investment banking and trading. FMSC is a broker-dealer registered with the Securities and Exchange Commission and the National Association of Securities Dealers, Inc. Through FMSC, the Company executes principal and agency transactions, makes markets in over-the-counter securities, and performs underwriting and investment banking services. Customers are located throughout the United States. Montauk Insurance Services, Inc. (MISI) sells a range of insurance products. Montauk Advisors, Inc. (MAI) previously sold investments in equipment leases, but is no longer active. The Company operates in one business segment. FMSC clears all customer transactions on a fully disclosed basis through an independent clearing firm. Accordingly, FMSC does not carry securities accounts for customers nor does it perform custodial functions related to those securities. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Reclassification Certain items in the 1998 and 1999 financial statements have been reclassified to conform with the current year's presentation. These reclassifications are not material to the consolidated financial statements. Revenue Recognition Securities transactions, commission income and related expenses are recorded on a trade date basis. Underwriting fees are recorded at the time the underwriting is completed and the income is reasonably determinable. Sales concessions from participation in syndicated offerings are recorded on settlement date. Securities owned and securities sold but not yet repurchased are stated at quoted market value with unrealized gains and losses included in earnings. Investment account securities not readily marketable are carried at estimated fair value as determined by management with unrealized gains and losses included in earnings. Advertising Advertising costs are expensed as incurred and totaled $348,000, $398,000, and $230,000 in 2000, 1999, and 1998, respectively. Depreciation and Amortization Furniture and equipment and leasehold improvements are stated at cost. Depreciation of furniture and equipment and amortization of capital leases are computed generally on a straight-line basis over the estimated useful lives of the assets, ranging from three to seven years or terms of the leases, respectively. Leasehold improvements are amortized over the shorter of either the asset's useful life or the related lease term. Cash Equivalents For purposes of the Statement of Cash Flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents consist of money market funds. Net Income (Loss) per Share Basic EPS is computed by dividing net income or net loss by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from the exercise or conversion of other securities into common stock, but only if dilutive. The following securities have been excluded from the dilutive per share computation as they are antidilutive: Years ended December 31, 2000 1999 1998 ---- ---- ---- Stock options 4,509,698 -- 3,253,300 Warrants 9,242,338 9,242,338 9,217,338 Convertible debt 345,263 -- 380,000 Convertible preferred stock 699,022 -- 699,022 Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the year. Actual results could differ from those estimates. Long-lived assets In accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", the Company records impairment losses on long-lived assets used in operations, when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. Income Taxes The Company uses the liability method to determine its income tax expense as required under Statement of Financial Accounting Standards No. 109 (SFAS 109). Under SFAS 109, deferred tax assets and liabilities are computed based on differences between financial reporting and tax basis of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance if, based on the weight of the available evidence, it is more likely than not that all or some portion of the deferred tax assets will not be realized. The ultimate realization of the deferred tax asset depends on the Company's ability to generate sufficient taxable income in the future. The Company and its subsidiaries file a consolidated federal income tax return and separate state returns. Stock-based compensation The Company uses the intrinsic value method to value stock options issued to employees and directors, as permitted by SFAS No. 123, "Accounting for Stock-Based Compensation". Stock options granted to nonemployees are recorded at their fair value, which is measured initially at the grant date using the Black-Scholes options pricing model, and recognized over the related service period. These options are periodically remeasured during the vesting period. Comprehensive Income In January 1998, the Company adopted SFAS No. 130, which establishes requirements for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income is the total of net income and all other nonowner changes in equity. The Company has no comprehensive income components to report for any period presented. Accounting Pronouncements In June 1998 and June 2000, the FASB issued SFAS No. 133, "Accounting for derivative instruments and hedging activities" and SFAS No. 138, "Accounting for certain derivative instrument and certain hedging activities." These statements establish accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 and 138 also require that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The Company will adopt SFAS No. 133 and No. 138 in the first quarter of fiscal 2001, and does not expect that the adoption of these new standards will have a material impact on its earnings or financial positions. NOTE 3 - TRADING AND INVESTMENT SECURITIES December 31, 2000 1999 Sold but Sold but not yet not yet Owned Purchased Owned Purchased ----- --------- ----- --------- Marketable: Municipal obligations $ 5,995 $ -- $ 73,310 $ -- Stocks 3,490,353 110,113 2,922,437 97,204 Corporate obligations 191,362 -- 346,420 80,952 Options 163,867 276,346 -- -- Other 35,249 -- 8,500 2,124 Nonmarketable securities 88,483 -- 125,224 -- --------- ------- --------- ------- $3,975,309 $386,459 $3,475,891 $180,280 ========= ======= ========= ======= Securities owned, and securities sold, but not yet purchased consist of trading securities at quoted market values. Nonmarketable securities consist of investment securities recorded at estimated fair value that cannot be publicly offered or sold unless registration has been effected under the Securities Act of 1933. NOTE 4 - EMPLOYEE AND BROKER RECEIVABLES December 31, 2000 1999 Commission advances $ 251,512 $ 28,880 Forgivable loans 606,473 82,634 Other loans 751,681 340,771 --------- ------- $1,609,666 $452,285 The Company has an arrangement with certain registered representatives to forgive their loans if they remain licensed with the Company for an agreed upon period of time, generally one to two years, and/or if they meet specified production goals. The loans are being amortized to expense for financial reporting purposes over the term of the loan. Loan amortization expense was $129,986, $88,253 and $206,851 in 2000, 1999 and 1998, respectively. Other loans to employees and registered representatives are payable in installments generally over periods from one to two years with interest rates ranging from 0% to 8% per annum. NOTE 5 - PROPERTY AND EQUIPMENT December 31, 2000 1999 Computer and office equipment $ 2,793,518 $ 2,359,275 Furniture and fixtures 1,140,170 929,373 Leasehold improvements 785,190 728,797 --------- --------- 4,718,878 4,017,445 Less: Accumulated depreciation and amortization (2,414,345) (1,823,939) --------- --------- $ 2,304,533 $ 2,193,506 ========= ========= Depreciation expense was $600,626, $539,306 and $357,831 in 2000, 1999 and 1998, respectively. NOTE 6 - NOTES RECEIVABLE December 31, 2000 1999 ---- ---- a) Environmental Coupon Marketing, Inc. (ECM) $ -- $149,640 b) Global Financial Corp. (Global) 18,000 332,891 ------ ------- $18,000 $482,531 ====== ======= a) ECM is a closely-held marketer of recycling programs to retailers. During 2000, the Company wrote off the ECM note balance after evaluating prospects for collection, including a review of ECM's financial condition and the note's default status. b) From 1997 through 1999, the Company provided working capital loans of approximately $2.3 million to Global, an independent company that packaged and sold lease investments through MAI. The MAI loans are evidenced by notes guaranteed by Global, FCS, Global's affiliated equipment vendor, and Biblio, Inc., an affiliate of FCS. The notes are further collateralized by mortgage liens on real estate owned by the shareholder of FCS and Biblio, a pledge of all of the outstanding shares in Global, and various recorded liens on the assets of FCS and Biblio. During 1998, the Company undertook a full review of the Global loans to evaluate their collectability, and determined that, based on various events and circumstances, including the insolvency of Global and FCS, and steadily declining collections on the lease portfolio serviced by Global, the loans to Global were impaired. Accordingly, the Company recorded an impairment loss of $1,775,000 in its financial statements for 1998, and increased the reserve by $100,000 in 1999 after further review. During 2000, the Company applied $75,000 from a property sale to the note, and recorded an additional impairment charge of $239,000 due to uncertainty as to the timing and the amount of proceeds that might be realized from future asset sales. The balance of the note ($18,000) was subsequently collected. NOTE 7 - DUE FROM OFFICERS Advances to officers are unsecured and currently bear interest at the rate of 6% per annum. These loans are due on demand. NOTE 8 - NEW CLEARING/FINANCIAL AGREEMENTS In May 2000, FMSC entered into a 10-year clearing agreement with Fiserv Securities, Inc. ("Fiserv") under which Fiserv will act as FMSC's primary clearing broker. In connection with the clearing agreement, the parties also entered into a financial agreement under which Fiserv agreed to provide a cash advance of $4,000,000 (the "initial payment") to FMSC upon the date of conversion of customer accounts to Fiserv. The conversion occurred in November 2000, at which time the advance was paid. For financial reporting purposes, the Company will earn the advance on a straight-line basis over the term of the clearing agreement. Amortization can be accelerated based on performance. FMSC is obligated to repay any unearned portion of the initial payment in the event it fails to achieve certain minimum performance criteria by the end of the agreement, or terminates the agreement under certain circumstances prior to expiration. FMSC could also be subject to monetary penalties for nonperformance. Fiserv has agreed to provide additional advances to FMSC in the second, third and fourth years of the clearing agreement under conditions similar to the initial payment, provided FMSC meets certain performance and other criteria. These advances, if received, will also be amortized to income as earned during the term of the clearing agreement. Subsequent to December 31, 2000, the Company and FMSC amended and restated the financial agreement with Fiserv (see Note 22). NOTE 9 - NOTES PAYABLE December 31, 2000 1999 ---- ---- a) Notes payable - bank $ 52,994 $ 148,919 b) 10% convertible promissory notes payable -- 570,000 c) Convertible promissory notes, net of discount 406,185 608,509 d) Subordinated notes payable 100,000 150,000 ------- --------- $559,179 $1,477,428 ======= ========= a) Term loans bearing interest at the prime rate (9.5% at December 31, 2000); payable in monthly installments of $7,994, plus interest; collateralized by equipment. b) Notes in the aggregate amount of $570,000 issued to a private investor and his affiliated entities in connection with a Global lease settlement (see Note 10); interest was payable semiannually at 10% per annum. Principal was due in October 2003. The notes were callable at the Company's option upon thirty days' written notice at a redemption price of 105% of outstanding principal plus accrued interest. The noteholder had the right to convert the notes into up to 380,000 shares of the Company's common stock based on a conversion price of $1.50 per share. During 2000, the Company redeemed the loans for 110% of the note principal, and recorded an extraordinary loss of $57,000 before income taxes from the early extinguishment. c) Notes in the original aggregate amount of $690,526 issued to private investors in connection with a Global lease settlement (see Note 10). The notes are payable in thirty-six monthly non-interest bearing installments of $16,404, plus balloon payments of $112,000, which include interest of $12,000 calculated on the basis of 8% of the balloon amount beginning in month nineteen of the note term. The Company has recorded a loan discount on the notes of $64,609, which is being amortized over the note terms using the interest method. The notes are convertible into 345,263 common shares of the Company's common stock based on a conversion price of $2.00. Once the underlying shares are registered, the Company can request that the noteholders convert their shares. Proceeds from the sale of the shares must be applied towards the unpaid principal of the notes. Any excess proceeds or unsold shares will be returned to the Company. d) Notes payable in annual installments of $50,000 plus interest at 8% per annum. The notes are subordinated to the claims of FMSC's general creditors under a subordination agreement approved by the NASD. Aggregate annual maturities of long-term debt are as follows: 2001 $281,803 2002 277,376 ------- $559,179 ======= NOTE 10 - ACCRUED EXPENSES Accrued expenses consist of the following: December 31, 2000 1999 ---- ---- Reserves for legal matters $ -- $ 595,476 Other 840,578 477,076 ------- ------- $840,578 $1,072,552 In 1999, the Company established an allowance of $595,476 to absorb losses from customer claims and other legal matters that were probable and could be reasonably estimated. NOTE 11 - GLOBAL LEASE SETTLEMENTS During 1998 and 1999, the Company entered into settlement agreements with various Global lease investors. In 1998, the Company issued a series of convertible promissory notes aggregating $570,000 to a lease investor in consideration of $300,000 in cash and the assignment of his Global lease investments (see Note 8). In 1999, the Company exchanged $235,282 in cash payments, 25,000 common stock purchase warrants valued at $27,382, and convertible note principal of $690,526 (see Note 8) for the assignment of Global leases. The difference between the cash, debt and warrant consideration issued by the Company, and the present value of the lease receivables assigned in the exchange was accounted for as a charge to operations of $600,416 and $99,899 in 1999 and 1998, respectively. Also in 1999, the Company completed a private offering of its Series A Convertible Preferred Stock (see Note 17 for rights and privileges of the preferred shares). Under terms of the offering, each Global lease investor that subscribed to the offering received one share of Preferred Stock in exchange for every $5.00 of lease investment value that the investor was entitled to receive from Global after certain adjustments. The Company issued a total of 349,511 preferred shares, which have been valued at $985,543, the present value of the lease receivables assigned in the offering. NOTE 12 - INCOME TAXES The provision for income taxes (income tax benefit) consists of the following: December 31, 2000 1999 1998 ---- ---- ---- Currently payable: Federal $ 838,225 $ 301,058 $ -- State 225,502 211,583 60,255 --------- ------- ------- 1,063,727 512,641 60,255 --------- ------- ------- Deferred: Federal (817,223) 138,673 (727,531) State (239,783) (102,174) 62,744 --------- ------- ------- (1,057,006) 36,499 (664,787) --------- ------- ------- $ 6,721 $ 549,140 $ (604,532) ========= ======= ======== Following is a reconciliation of the income tax provision (benefit) with income taxes based on the federal statutory rate: December 31, 2000 1999 1998 ---- ---- ---- Expected federal tax at statutory rate $(220,319) $ 963,421 $(1,144,909) Non-deductible expenses 32,219 20,998 11,456 State taxes, net of federal tax effect (44,355) 172,956 (200,021) Other -- (66,395) (2,527) Change in valuation allowance 239,176 (541,840) 731,469 -------- ------- --------- $ 6,721 $ 549,140 $ (604,532) ======== ======= ========= The tax effects of the temporary differences that give rise to significant portions of the deferred tax assets and liabilities as of December 31, 2000 and 1999 are: December 31, 2000 1999 ---- ---- Deferred tax assets: Deferred income $1,573,333 $ -- Accrued expenses 75,188 500,936 Tax loss carryforwards 180,986 189,629 Stock-based compensation 247,819 146,272 Other 72,741 33,993 --------- ------- 2,150,067 870,830 --------- ------- Deferred tax liabilities: Property and equipment -- 14,855 Other -- 2,090 --------- ------- -- 16,945 --------- ------- -- 853,885 Valuation allowance (428,805) (189,629) -------- ------- Net deferred tax assets $1,721,262 $ 664,256 ========= ======= The Company has recorded valuation allowances to offset tax benefits arising from state tax loss carryforwards and stock-based compensation because their realization is uncertain. NOTE 13 - COMMITMENTS AND CONTINGENT LIABILITIES Leases The Company leases office facilities and equipment under operating leases expiring at various dates through 2005. The lease for the Company's headquarters has a six-year renewal option through 2011. The Company has also entered into various agreements classified as capital leases. Future minimum lease payments as of December 31, 2000 are as follows: Capital Operating Leases Leases ------- --------- 2001 $146,986 $ 828,003 2002 -- 773,173 2003 -- 666,150 2004 -- 641,071 2005 -- 53,333 ------- ------- Total minimum lease payments 146,986 $2,961,730 Less: Amount representing interest on ========= capital leases 7,991 ------- Present value of minimum lease payments $138,995 ======= Operating lease expense for 2000, 1999 and 1998 totaled $955,866, $947,732 and $857,715, respectively. Employment agreements In January 2000, the Company entered into new employment agreements with its president and vice-president. The agreements run for three years and provide for 10% annual increases in base salaries, and customary fringe benefits. The officers will also be entitled to share in a bonus pool equal to 10% of the net pre-tax profit of the Company, as defined. Legal matters FMSC is a respondent in a customer arbitration seeking rescissionary damages of approximately $19 million plus punitive damages. The claimant alleges violations of various provisions of federal and state securities laws. FMSC has filed its answer to the claims and is vigorously defending the action. FMSC is also a defendant or co-defendant in various other legal proceedings incidental to its securities business. The Company is contesting the allegations of these claims and believes that there are meritorious defenses in each case. In view of the inherent difficulty of predicting the outcome of litigation, management is unable to derive a meaningful estimate of the amount or range of possible loss that may arise out of pending legal proceedings in any particular quarterly or annual period, or in the aggregate. However, it is possible that the ultimate outcome of these matters could have a material adverse impact on the Company's financial condition, results of operations, and cash flows. As of December 31, 2000, the Company has not established a loss provision in the accompanying financial statements for any liability that may result from these contingencies. In December 1999, the Company agreed to accept a $500,000 cash payment in settlement of an arbitration against another securities firm. The Company commenced the arbitration in an effort to recover customer settlements that it had previously paid on claims arising from the activities of a former affiliate office. Income tax audits The Internal Revenue Service is currently conducting a field audit of the Company's federal income tax returns for the years 1995 through 1998. Based on discussions with its representatives, management does not expect the outcome of these audits to have a material impact on the Company's financial statements. NOTE 14 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK and CONCENTRATIONS OF CREDIT RISK The Company executes securities transactions on behalf of its customers. If either the customer or a counter-party fail to perform, the Company by agreement with its clearing broker may be required to discharge the obligations of the non-performing party. In such circumstances, the Company may sustain a loss if the market value of the security is different from the contract value of the transaction. The Company seeks to control off-balance-sheet risk by monitoring the market value of securities held or given as collateral in compliance with regulatory and internal guidelines. Pursuant to such guidelines, the Company's clearing firm requires additional collateral or reduction of positions, when necessary. The Company also completes credit evaluations where there is thought to be credit risk. The Company has sold securities that it does not currently own and will therefore be required to purchase such securities at a future date. The Company has recorded these obligations in the financial statements at market values of the related securities ($386,459 and $180,280 at December 31, 2000 and 1999, respectively) and will incur a loss if the market value of the securities increases subsequent to year-end. Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and securities inventories. The Company maintains all inventory positions and a significant portion of its cash balances at its clearing firm. Asset balances may periodically exceed insurance coverage. NOTE 15 - DEFINED CONTRIBUTION PLAN The Company sponsors a defined contribution pension plan [401(k)] covering all participating employees. The Company may elect to contribute up to 100% of each participant's annual contribution to the plan. Employer contributions for 2000, 1999 and 1998 were $-0-, $74,132 and $38,077, respectively. NOTE 16 - TEMPORARY EQUITY - STOCK SUBJECT TO REDEMPTION From time to time, the Company has issued unregistered shares of its Common Stock in settlement of various customer claims and invoices for legal services. With respect to these shares, the Company provides a guarantee to pay to the selling stockholder the difference between a target price and the actual selling price of the shares upon expiration of the statutory holding period. The holders of the shares may elect to retain the shares once the holding period lapses. Such an election will release the Company from any further obligation to the stockholders. The Company has established a temporary equity account to record its maximum liability from the guarantees. Payment of any shortfall is charged to this account. Any balance remaining at the end of the respective holding periods is credited to permanent capital. Following is a schedule of activity in this account for the year ended December 31, 2000 (there was no activity during 1999): Shares Amount ------ ------ Balances, December 31, 1999 18,000 $ 36,500 Payments -- (12,000) Transfer to permanent capital (15,000) (18,000) ------ ------ Balances, December 31, 2000 3,000 $ 6,500 ====== ====== NOTE 17 - STOCK OPTION PLANS The Company currently has three option plans in place: The 1992 Incentive Stock Option Plan (the "1992 Plan"), the 1992 Non-Executive Director Stock Option Plan (the "Director Plan"), and the 1996 Senior Management Incentive Plan (the "1996 Plan"). In June 2000, the Company's stockholders approved an amendment to the 1992 Plan to increase the number of shares reserved for issuance from 6,000,000 to 8,000,000 shares. Under the 1992 Plan, options may be granted to employees, consultants and registered representatives of the Company, but only options issued to employees will qualify for incentive stock option treatment (ISOs). The exercise price of an option designated as an ISO may not be less than the fair market value of the Common Stock on the date of grant. However, ISOs granted to a ten percent stockholder must have an exercise price of at least 110% of such fair market value. At the time an option is granted, the Board of Directors will fix the period within which it may be exercised. Such exercise period may not be less than one year nor more than ten years from the date of grant. The 1992 plan will expire in May 2002. The Company has reserved 1,000,000 shares of its Common Stock for issuance under the Director Plan. Options to purchase 20,000 shares of Common Stock are granted to each Non-Executive Director on August 1 of each year, provided such individual has continually served as a Non-Executive Director for the twelve-month period immediately preceding the date of grant. The options will expire in five years from the date of grant. The exercise price of such options shall be equal to the fair market value of the Company's Common Stock on the date of grant. The Director Plan will terminate in May 2002. In June 2000, the Company's stockholders approved an amendment to the 1996 Plan to increase the number of shares reserved for issuance to key management employees from 2,000,000 to 4,000,000 shares. Awards can be granted through the issuance of incentive stock rights, stock options, stock appreciation rights, limited stock appreciation rights, and shares of restricted Common Stock. The exercise price of an option designated as an ISO may in no event be less than 100% of the then fair market price of the stock (110% with respect to ten percent stockholders), and not less than 85% of the fair market price in the case of other options. The 1996 Plan will terminate in June 2006. A summary of the activity in the Company's stock option plans for the three-year period ended December 31, 2000 is presented below: Weighted Average Exercise Shares Prices ------ ------ Options outstanding, December 31, 1997 2,624,100 $1.34 Granted 1,442,500 1.99 Canceled (381,250) 2.17 Exercised (432,040) .79 Options outstanding, December 31, 1998 3,253,300 1.61 Granted 710,000 2.01 Canceled (209,150) 2.45 Exercised (234,450) .91 Options outstanding, December 31, 1999 3,519,700 1.68 Granted 2,014,498 1.87 Canceled (967,500) 1.37 Exercised (57,000) .98 Options outstanding, December 31, 2000 4,509,698 $1.84 Additional information with respect to options under the Company's option plans is as follows: Shares of common stock available for future grant 6,582,702 Weighted-average grant date fair value of options granted during each year using the Black-Scholes option pricing model 1998 $.71 1999 $.70 2000 $.49 Compensation is recognized in the financial statements only for the fair value of options issued to consultants and affiliate brokers. Such compensation is amortized to expense over the related options' vesting periods. Compensation expense recognized in 2000, 1999 and 1998 totaled $288,209, $195,840 and $147,988, respectively. Pro forma net income (loss) and EPS information, as required by SFAS No. 123, have been determined as if the Company had accounted for employee stock options under the fair value method. The fair value of these options was estimated at grant date using a Black-Scholes option pricing model with the following weighted-average assumptions for 2000, 1999 and 1998: 2000 1999 1998 ---- ---- ---- Risk free interest rates 6.07% 5.76% 5.03% Expected option lives 2.4 years 2.5 years 2.4 years Expected volatilities 72% 48.5% 46.5% Expected dividend yields 0% 0% 0% The Company's pro forma information follows: Net income (loss) 2000 1999 1998 ---- ---- ---- As reported $ (689,408) $2,283,278 $(2,762,847) Pro forma (1,152,958) 2,109,706 (3,292,291) Basic income (loss) per share As reported $(.08) $.22 $(.28) Pro forma $(.13) $.21 $(.34) Diluted income (loss) per share As reported $(.08) $.21 $(.28) Pro forma $(.13) $.19 $(.34) The full impact of calculating compensation expense for stock options under SFAS No. 123 is not reflected in pro forma net income, since such expense is amortized over the vesting period of those options as they vest. Additional information as of December 31, 2000 with respect to all outstanding options is as follows: Options Outstanding Options Exercisable Weighted Average Weighted Weighted Remaining Average Average Number Contractual Exercise Number Exercise Range of prices Outstanding Life Price Exercisable Price --------------- ----------- ---- ----- ----------- -------- $.75 - 1.09 520,000 2.03 years $1.02 423,400 $1.04 1.20 - 1.80 1,282,698 3.11 1.52 634,160 1.49 1.94 - 2.75 2,707,000 3.53 2.16 1,467,400 2.17 4,509,698 3.24 $1.84 2,524,960 $1.81 NOTE 18 - STOCKHOLDERS' EQUITY Rights offering In February 1998, the Company completed an offering of 3,072,779 Units, each Unit consisting of one Class A Redeemable Common Stock Purchase Warrant, one Class B Redeemable Common Stock Purchase Warrant, and one Class C Redeemable Common Stock Purchase Warrant. The Warrants have the following exercise prices and terms: Exercise Price Exercise Period Warrant Per Share from Date of Issuance ------- -------------- --------------------- Class A $3.00 Three years (see below) Class B 5.00 Five years Class C 7.00 Seven years Each shareholder of record as of December 15, 1997 received three rights for each share of Common Stock held as of the record date, with three rights required to subscribe for a single Unit at a price of $.45 per Unit. The offering raised gross proceeds of $1,382,750 before deducting registration costs of approximately $236,000. There are currently 3,072,446 Class A, Class B and Class C warrants outstanding, respectively. In December 2000, the Company's board of directors approved a two-year extension of the Class A Warrants to February 17, 2003. Preferred Stock In 1999, the Company's board of directors authorized the issuance of up to 625,000 shares of a Series A Convertible Preferred Stock with the following features: Par value: $.10 per share Dividends: 6% payable quarterly at the rate of $.075 per share until conversion Voting rights: None Liquidation preference: $5.00 per share Conversion: Automatic conversion into two shares of Common Stock at $2.50 per share once the closing price for the Common Stock is $3.50 or above for 20 consecutive trading days, and the shares are registered for public sale. During 1999, the Company issued 349,511 Series A shares in a private exchange offering to Global lease investors (see Note 10). The shares were valued at $985,543, the present value of the lease payments assigned to the Company in the exchange. The Company is presently authorized to issue 4,375,000 shares of Preferred Stock, none of which has been issued at December 31, 2000. The rights and preferences, if any, to be given to these preferred shares will be determined at the time of issuance. Stock Repurchase Program On August 5, 1999, the Company's board of directors authorized the repurchase of an unspecified number of the Company's outstanding common shares. During 1999, the Company repurchased 180,500 shares for $222,624. During 2000, the Company repurchased 1,105,034 shares for $1,460,740. Warrants During 1999, the Company issued 25,000 common stock purchase warrants in connection with a Global lease settlement. The warrants are exercisable at $1.75 per share for a five-year period. The Company valued the warrants at $27,382 using the Black-Scholes option pricing model. NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS Substantially all of the Company's financial instruments at December 31, 1999 and 2000, consisting primarily of marketable equity securities, amounts due from FMSC's clearing firms, and notes payable are carried at, or approximate fair value due to their short-term nature, the use of mark-to-market accounting for marketable securities, or in the case of notes payable, because they carry market rates of interest, or rates that management estimates are comparable to those available for issuance of debt with similar terms and remaining maturities. NOTE 20 - NET CAPITAL REQUIREMENTS FMSC is subject to the Securities and Exchange Commission Uniform Net Capital Rule (Rule 15c3-1), which requires FMSC to maintain minimum net capital, as defined. At December 31, 2000, FMSC had net capital of $1,193,770, which was $682,041 in excess of its required net capital of $511,729. FMSC's ratio of aggregate indebtedness to net capital was 6.43 to 1. NOTE 21 - VALUATION AND QUALIFYING ACCOUNTS Additions Balance at Charged to Charged to Balance at beginning costs and other end of period expenses accounts Deductions of period ---------- ---------- ---------- ---------- --------- Valuation allowance for deferred tax assets: Year ended December 31, 2000 $189,629 $ 239,176 $ -- $ -- $ 428,805 Year ended December 31, 1999 731,469 -- -- (541,840) 189,629 Year ended December 31, 1998 -- 731,469 -- -- 731,469 Reserve for notes receivable: Year ended December 31, 2000 $ -- $ 239,000 $ -- $ (239,000) (a) $ -- Year ended December 31, 1999 -- 100,000 -- (1,875,000) (a) -- Year ended December 31, 1998 -- 1,775,000 -- -- 1,775,000 (a) Amounts determined not to be collectible. NOTE 22 - UNAUDITED QUARTERLY RESULTS OF OPERATIONS March 31, June 30, September 30, December 31, 2000 2000 2000 2000 ---- ---- ---- ---- Revenues $24,486,906 $13,346,260 $12,671,033 $ 8,825,687 Income (loss) before extraordinary loss 1,888,320 143,847 (390,173) (2,297,202) Net income (loss) available to common stockholders 1,862,781 84,107 (414,876) (2,324,148) Income (loss) per common share: Basic: Income (loss) before extraordinary loss .19 .01 (.04) (.25) Net income (loss) available to common stockholders .19 .01 (.04) (.25) Diluted: Income (loss) before extraordinary loss .17 .01 (.04) (.25) Net income (loss) available to common stockholders .17 .01 (.04) (.25) March 31, June 30, September 30, December 31, 1999 1999 1999 1999 --- ---- ---- ---- Revenues $12,521,300 $15,068,415 $12,146,742 $17,848,159 Net income available to common stockholders 647,969 709,069 56,955 801,535 Income per common share: Net income available to common stockholders - basic .07 .07 .01 .08 Net income available to common stockholders - diluted .06 .07 .01 .07 NOTE 22 - SUBSEQUENT EVENT As of February 1, 2001, the Company and FMFC amended and restated the financial agreement with Fiserv. Under the restated terms, the Company, rather than FMSC, will be the recipient of any additional cash advances payable under the financial agreement. The Company has further assumed FMSC's obligation with respect to the initial payment received in November 2000, and will be solely responsible for any performance and early termination penalties. In consideration of FMSC's release from its obligations under the financial agreement and to secure Fiserv's interest, the Company has granted to Fiserv a first priority lien in all of the outstanding shares of FMSC that it owns.