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
For the fiscal year ended December 31, 2004
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OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File No. 0-6729
FIRST MONTAUK FINANCIAL CORP.
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(Exact name of registrant as specified in its charter)
New Jersey 22-1737915
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
328 Newman Springs Road, Red Bank, NJ 07701
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (732) 842-4700
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
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None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
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(Title of class)
[ Cover Page 1 of 2 Pages ]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined by rule 12b-2 of the Act) Yes __ No X
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates computed by reference to the price at which the common
equity was last sold, or the average bid and asked price of such common equity,
as of the last business day of the registrant's most recently completed second
quarter (June 30, 2004): $2,004,055 (based upon $0.30 per share).
APPLICABLE ONLY TO CORPORATE REGISTRANTS
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: 15,324,051 as of
March 31, 2005.
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and the
Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is
incorporated: (1) Any annual report to security holders; (2) Any proxy or
information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or
(c) under the Securities Act of 1933.
Not Applicable
[Cover Page 2 of 2 Pages]
Table of Contents
PART I
PAGE
Item 1. Business 2
Item 2. Properties 17
Item 3. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security Holders 18
PART II
Item 5. Market For the Company's Common Equity and Related Stockholder Matters 19
Item 6. Selected Financial Data 21
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 23
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 33
Item 8. Financial Statements and Supplemental Data 34
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 34
Item 9A. Controls and Procedures 34
Item 9B. Other Information 34
PART III
Item 10. Directors and Executive Officers of the Registrant 35
Item 11. Executive Compensation 39
Item 12. Security Ownership of Certain Beneficial Owners and Management 46
Item 13. Certain Relationships and Related Transactions 48
Item 14. Principal Accounting Fees and Services 48
PART IV
Item 15. Exhibits and Financial Statement Schedules 49
1
PART I
Item 1. Business
Introduction
First Montauk Financial Corp. is a New Jersey-based financial services
holding company whose principal subsidiary, First Montauk Securities Corp., has
operated as a full service retail and institutional securities brokerage firm
since 1987. Since July 2000, First Montauk Securities Corp. has operated under
the registered trade name "Montauk Financial Group". References in this Annual
Report on Form 10-K to Montauk Financial Group shall refer solely to our
subsidiary First Montauk Securities Corp. Montauk Financial Group 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, Montauk Financial Group
established Century Discount Investments, a discount brokerage division. First
Montauk Financial Corp. also sells insurance products through its subsidiary
Montauk Insurance Services, Inc.
Montauk Financial Group has approximately 370 registered representatives
and services over 61,000 retail and institutional customer accounts, which
comprise over $3.2 billion in customer assets. With the exception of a company
leased branch office in New York City, all of Montauk Financial Group's 132
other branch office and satellite locations in 30 states are owned and operated
by affiliates; independent owners who maintain all applicable licenses and are
responsible for all office overhead and expenses. Montauk Financial Group also
employs registered representatives directly at its corporate headquarters.
Montauk Financial Group is registered as a broker-dealer with the
Securities and Exchange Commission, the National Association of Securities
Dealers, the Municipal Securities Rule Making Board, the National Futures
Association, and the Securities Investor Protection Corporation and is licensed
to conduct its brokerage activities in all 50 states, the District of Columbia,
the Commonwealth of Puerto Rico, and registered as an International
broker-dealer to conduct business with institutional clients in the province of
Ontario, Canada. All securities transactions are cleared through Fiserv
Securities, Inc. of Philadelphia, Pennsylvania with various floor brokerage and
specialist firms also providing execution services. These arrangements provide
Montauk Financial Group 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 Montauk
Financial Group to offer products and services comparable to larger brokerage
firms.
Our revenues consist primarily of commissions and fee income from
individual and institutional securities transactions, mutual fund and annuity
sales and investment banking services, such as private and public securities
offerings and limited market making activities. The following table represents
the percentage of revenues generated in each of these activities during the year
ended December 31, 2004:
2
Equities:
Listed and Over-The-Counter Stocks 44%
Debt Instruments:
Municipal, Government and Corporate Bonds and
Unit Investment Trusts 6%
Mutual Funds 10%
Options: Equity & Index 4%
Insurance and Annuities 8%
Corporate Finance and Investment Banking 5%
Investment Advisory Fees 4%
Alternative Investments (1) 4%
Proprietary trading 4%
Miscellaneous (2) 11%
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Total 100%
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(1) Alternative Investments include REITs, 1031 Exchanges and promissory
notes.
(2) Miscellaneous includes interest income, amortization of deferred
revenue and operations and marketing fees.
The following table reflects our various sources of revenue and the
percentage of total revenues for 2004. Revenues from agency transactions in
securities for individual customers of Montauk Financial Group are shown as
commissions. Montauk Financial Group also executes customer orders on a riskless
principal basis, which are reflected as part of "Riskless Principal trades" on
the table below.
Year Ended December 31, 2004
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Agency commissions from equity securities,
options and mutual funds, insurance, management
fees and alternative investments................ $42,767,158 72.26%
Riskless Principal trades in equity and fixed
income securities on behalf of customers........ $6,711,281 11.34%
Proprietary trading................... $2,346,978 3.97%
Interest and other income........... $4,645,782 7.85%
Investment banking(1)............... $2,716,042 4.58%
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Total Revenues........................ $59,187,241 100.00%
(1) Investment banking revenues consists of commissions, selling concessions,
consulting fees and other income from underwriting and syndicate
activities and placement agent fees.
3
Affiliated Registered Representative Program
Montauk Financial Group's primary method of operations is through its
affiliated registered representatives, who operate as independent contractors. A
registered representative who becomes affiliated with Montauk Financial Group
establishes his/her 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, market data services, and general office
supplies. Under this program, the affiliated representative retains a
significantly higher percentage of the commissions and fees generated by his/her
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.
Affiliated representatives must possess a sufficient level of sales 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 become registered with Montauk Financial Group to provide
securities products and services to their clients.
Montauk Financial Group provides full support services to each of the
affiliated representatives, including access to stock and options execution and
over-the-counter stock trading; products such as insurance, mutual funds, unit
trusts and investment advisory programs; and compliance, supervision, accounting
and related services.
Each affiliated representative is required to obtain and maintain in good
standing each license required by the SEC and NASD 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. Montauk Financial
Group is ultimately responsible for supervising each affiliated registered
representative. Montauk Financial Group can incur substantial liability from
improper actions of any of the affiliated representatives. Montauk Financial
Group maintains a professional liability errors and omissions insurance policy
which provides coverage for certain actions taken and/or omissions made by its
registered representatives, employees and other agents in connection with the
purchase and sale of securities and other financial products and services.
Revenue Sources
Through our affiliate program we derive a substantial portion of our
revenues from customer commissions on brokerage transactions in equity and debt
securities for retail and institutional investors such as investment advisors,
hedge funds, and pension and profit sharing plans. In addition, in the regular
course of our business, we take limited securities positions as a market maker
to facilitate customer transactions and for investment purposes. In trading for
our own account, we expose our own capital to the risk of fluctuations in market
value. Trading profits (or losses) depend primarily upon the skills of the
employees engaged in market making and position taking, the amount of capital
allocated to positions in securities and the general trend of prices in the
securities markets. We monitor our risk by maintaining our securities positions
at or below certain pre-established levels. These levels reduce certain
opportunities to realize profits in the event that the value of such securities
increases. However, they also reduce the risk of loss in the event of a decrease
in such value and minimize interest costs incurred on funds provided to maintain
such positions.
Montauk Insurance Services
In 1991, we formed Montauk Insurance Services, Inc. for the purpose of
offering and selling variable annuities, variable and traditional life, and
health insurance products. Currently, Montauk Insurance is licensed to sell life
insurance and annuities in all 50 states. Montauk Insurance derives revenue from
the sale of insurance-related products and services to the customers of Montauk
Financial Group's registered representatives, who are also licensed to sell
certain insurance products. In 2004, we earned gross commissions of $4.7 million
from the sale of insurance and annuity products.
Asset Management Advisory Services
Montauk Financial Group is registered as an Investment Adviser with the
SEC. We provide investment advisory services to clients through independent,
third party sponsored advisory programs. Montauk Financial Group is registered
or eligible to conduct business as an investment adviser in 37 states and the
District of Columbia.
Managed account programs generally require the client to pay a fee for
portfolio advisory services, brokerage execution and custody and periodic
account performance reports. These fees are calculated as a percentage of client
assets under management. Historically, we have only derived a relatively small
percentage of our overall revenues from this business line. However in recent
years, this segment of our business has continued to grow.
4
Investment Banking
Montauk Financial Group participates in private and public offerings of
equity and debt securities and provides general investment banking consulting
services to various public and private corporations. We continue to review
investment banking opportunities and anticipate that we will engage in
additional public and private offerings in the future as business and market
conditions warrant. Our investment banking services include bridge and senior
loan financing, private placements and public offerings of debt and equity
securities, and exclusive banking consultation. Under circumstances where we act
as an underwriter, we may assume greater risk than would normally be assumed in
our normal trading activity. Under the federal securities laws, an underwriter
is subject to substantial potential liability for material misstatements or
omissions in prospectuses and other communications with respect to underwritten
offerings. Further, underwriting commitments constitute a charge against net
capital and our underwriting commitments may be limited by the requirement that
we must, at all times, be in compliance with the Uniform Net Capital Rule 15c3-1
of the Securities and Exchange Commission. During 2004, we did not serve as
managing underwriter in any public offerings, but participated as a selling
group member on numerous occasions. Members of selling groups do not have the
same level of capital requirements in an underwritten offering as underwriters
under NASD rules.
Clearing Arrangement
In May 2000, Montauk Financial Group entered into a 10-year clearing
agreement with Fiserv Securities, Inc. under which Fiserv acts as Montauk
Financial Group's primary clearing broker to process and clear customer and
proprietary transactions, and acts as custodian for customer and firm funds and
securities. In connection with the clearing agreement, we also entered into a
financial agreement that was amended and restated in February 2001, under which
Fiserv provided an aggregate of $7.75 million in cash advances to us over the
initial three-year term of the agreement. In November 2003, we received the
final cash advance of $1.25 million from Fiserv. In connection with this
amendment, we granted Fiserv a first priority lien in all of the outstanding
shares of Montauk Financial Group stock. We are required to repay any unearned
portion of the cash advances in the event we fail to achieve certain minimum
performance criteria, or terminate the agreement under certain circumstances
prior to the expiration date, as well as penalties for early termination. As of
the date of this report, we are current on all performance requirements.
In December 2004, Fiserv Securities, Inc. announced that it had been
acquired by National Financial Services ("NFS"), a unit of Fidelity Investments.
NFS has initiated discussions with us to negotiate the terms of a new clearing
relationship. The final terms of a clearing relationship with NFS are still
being negotiated. If these negotiations are successfully completed, we
anticipate moving onto the NFS clearing platform in May 2005.
Competition
We encounter intense competition in all aspects of our business and compete
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 Inc., Salomon Smith
Barney, Inc. and Morgan Stanley/Dean Witter dominate the industry; however, we
also compete with numerous regional and local firms. Montauk Financial Group
also competes for experienced brokers with other firms offering an independent
affiliate program such as National Securities Corp., 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. In 1997, we entered the
discount brokerage arena through our Century Discount Investments division.
Additionally, the emergence of online trading has further intensified the
competition for brokerage customers. Century Discount Investments maintains a
limited clientele and has not grown in revenue over the years.
Other financial institutions, notably commercial and savings banks, offer
customers some of the same services and products currently 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 that banks and other
institutions ultimately may offer to customers, we may be adversely affected to
the extent those services are offered on a large-scale basis.
5
Montauk Financial Group competes through its advertising and recruiting
programs for registered representatives interested in joining its affiliate
program. Montauk Financial Group may offer incentives to qualified registered
representatives to join. 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. Through its
clearing relationship, Montauk Financial Group has implemented on-line
information systems to service its affiliates and to attract new brokers. These
systems enable brokers from any office to instantly access customer accounts,
determine cash positions, send and receive electronic mail, and receive product
information and compliance memoranda via the firm's intranet component of its
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, principally the NASD, and in
the case of New York Stock Exchange, Inc. member firms, the New York Stock
Exchange. The self-regulatory organizations, among other things, promulgate
regulations and provide oversight in areas of:
o sales practices,
o trade practices among broker-dealers,
o capital requirements,
o record keeping, and
o conduct of employees and affiliates of member organizations.
In addition to promulgating regulations and providing oversight, the SEC
and the self-regulatory organizations 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 SEC and the
self-regulatory organizations, 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.
Net Capital Requirements. Every U.S. registered broker-dealer doing
business with the public is subject to the Commission's Uniform Net Capital Rule
(the "Rule"), which specifies minimum net capital requirements. Although we are
not directly subject to the Rule, Montauk Financial Group, as a registered
broker-dealer is. The Rule provides that a broker-dealer doing business with the
public shall not permit its aggregate indebtedness to exceed 15 times its
adjusted net capital (the "basic method") or, alternatively, that it not permit
its adjusted net capital to be less than 2% of its aggregate debit balances
(primarily receivables from customers and broker-dealers) computed in accordance
with such Rule (the "alternative method"). Montauk Financial Group applies the
basic method of calculation.
Compliance with applicable net capital rules could limit our operations,
such as underwriting and trading activities, that require the use of significant
amounts of capital, and may also restrict loans, advances, dividends and other
payments by our subsidiaries to us. As of December 31, 2004, Montauk Financial
Group has $1,992,574 of net capital and $1,685,619 of excess net capital.
Employees
Currently, we have approximately 370 registered representatives of which
288 are associated with affiliate offices. These affiliated registered
representatives are not employees. In addition, we employ approximately 68
support personnel in the areas of operations, compliance, accounting, and
administration. We believe our relationship with our employees is satisfactory.
Fidelity Bond and SIPC Account Protection
As required by the NASD and certain other authorities, Montauk Financial
Group 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 Securities Investor
Protection Corporation protects accounts 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 aggregate protection for all of our clearing firms'
customers provided by a private insurance company. The Securities Investor
Protection Corporation is funded through assessments on registered
broker-dealers and charges a flat annual fee of $150.
6
Securities Broker/Dealer Professional Liability Insurance
Montauk Financial Group carries a securities Broker/Dealer professional
liability insurance policy underwritten by National Union First Insurance
Company of Pittsburgh, PA, a subsidiary of American International Group. This
policy provides coverage for any negligent act, error or omission by an insured
individual acting on behalf of the insured Broker/Dealer in providing securities
transactions, investment management services, financial investment advice and
the purchase and/or sale of securities. This policy excludes coverage for
certain types of business activities, including but not limited to, claims
involving the sale of penny stocks and limited partnerships, accounts handled on
a discretionary basis and deliberately fraudulent and/or criminal acts. The
policy term is from February 1, 2005 to January 31, 2006, with a $1 million
limit of liability for each covered event and a $3 million aggregate liability
limit. We are responsible for a $100,000 deductible payment per claim. In the
event that the cost of this coverage becomes cost prohibitive or otherwise
unavailable, the lack of coverage may have an adverse impact on our financial
condition in the event of future material claims, which may not be covered by
our existing policy.
Executive and Organization Liability Insurance Policy
We carry an executive and organization liability insurance policy (also
known as Directors and Officers liability insurance), which covers our executive
officers, directors and counsel against any claims for monetary damages arising
from the covered individuals actual or alleged breach of duty, neglect, error,
misstatement, misleading statement or omission when acting in the capacity of
his/her position as an executive officer, director and/or counsel on our behalf.
Policy exclusions include, but are not limited to, claims made against covered
individuals attributable to the committing of any deliberate criminal or
fraudulent acts, illegal or improper payments, and others. Our carrier has
issued an extension to our current policy to run through June 30, 2005. This
coverage is underwritten by XL Specialty Insurance Company of Stamford,
Connecticut, and provides for coverage in the amount of $5 million with a
deductible of $250,000 for all claims.
General Business Developments During the
2004 Year and Subsequent Events
Recent Management Changes
Effective January 1, 2004, we restructured our senior management. As of
such date, Mr. Victor K. Kurylak commenced his service as our President and
Chief Operating Officer. Mr. Herbert Kurinsky, who had served as our Chairman,
President and Chief Executive Officer, continued to serve as Chairman of the
Board of Directors, but relinquished his other offices. Mr. William J. Kurinsky,
who had served as our Vice President, Chief Operating and Chief Financial
Officers and Secretary began service as our Vice Chairman and Chief Executive
Officer from January 1, 2004 through February 8, 2005. In January 2005, Ms.
Mindy Horowitz, our Senior Vice President of Finance, became the Chief Financial
Officer and Financial Operations Principal for Montauk Financial Group and our
Acting Chief Financial Officer.
On February 8, 2005 we entered into a Separation Agreement with William J.
Kurinsky, which provided for Mr. Kurinsky to terminate his employment with us
effective on that date. Under the terms of the Separation Agreement, Mr.
Kurinsky agreed to relinquish his position as Chief Executive Officer of First
Montauk and its subsidiaries, including Montauk Financial Group. Mr. Kurinsky
remains on our board of directors. In connection with Mr. Kurinsky's termination
as the Chief Executive Officer, we appointed Mr. Victor K. Kurylak as our new
Chief Executive Officer and President. In 2004, Mr. Kurylak had served as our
President and Chief Operating Officer. For more information on the employment
agreements for Mr. Herbert Kurinsky and Mr. Victor K. Kurylak, and the
Separation Agreement with Mr. William J. Kurinsky, please see Item 11,
"Executive Compensation".
Proposed Merger with Olympic Cascade Financial Corporation
On February 10, 2005 we executed a definitive Agreement and Plan of Merger
with Olympic Cascade Financial Corporation, ("Olympic"). Under the terms of the
agreement, our shareholders will receive 0.5055 shares of Olympic Cascade Common
Stock for each share of First Montauk Common Stock. As of the date of this
report, Olympic Cascade has 4,995,878 shares of common stock outstanding and
2,078,465 of common stock issuable upon conversion of its Series A Preferred
stock, compared to First Montauk that has 15,274,051 shares of common stock
outstanding and 2,588,977 issuable upon conversion of its outstanding Series A
and Series B Preferred stock. Additionally, Olympic Cascade will issue
equivalent shares of newly created preferred stock to the holders of our Series
A and Series B Preferred shares, giving effect to the 0.5055 exchange ratio.
Assuming the merger is completed, Olympic Cascade will have approximately
15,800,000 shares of common stock assuming conversion of all their then
outstanding preferred shares (and excluding other outstanding options, warrants
and debentures). Our outstanding options and warrants will be exchanged for like
securities of Olympic, subject to the exchange ratio.
7
Pursuant to the Merger Agreement, the Board of Directors of Olympic,
following the closing, will be comprised of seven persons. We will each appoint
three representatives to the newly constituted Board of Directors. Mr. Victor K.
Kurylak and Mr. William J. Kurinsky are expected to be our initial two
representatives with the third decided on prior to closing. In connection with
the merger, Olympic and we have executed letters of intent with St. Cloud
Capital LLC, a Los Angeles based investment firm, to provide approximately $4.0
million of capital to the combined entities. Mr. Marshall Geller, a Senior
Managing Director of St. Cloud Capital, is expected to be named non-executive
chairman of the seven-person board of directors of Olympic following completion
of the merger. The investment by St. Cloud Capital is subject to due diligence
investigation, execution of definitive agreements and customary closing
conditions.
The terms of the merger include provisions that Mr. Mark Goldwasser,
current President and CEO of Olympic, and Mr. Kurylak will comprise the Office
of the Chief Executive Officer. Mr. Kurylak will serve as the Chief Executive
Officer and Mr. Goldwasser will serve as President and Chief Operating Officer.
Both will report directly to the Board of Directors. As a condition to closing,
Olympic and Messrs. Goldwasser and Kurylak will negotiate the definitive terms
of their new respective employment agreements.
In addition, under the terms of the Merger Agreement, Mr. Herbert Kurinsky,
the current Chairman of First Montauk, Mr. William J. Kurinsky, the former Chief
Executive Officer of First Montauk, Mr. Victor K. Kurylak, the new Chief
Executive Officer of First Montauk and One Clark LLC, an affiliate of Mr.
Goldwasser, delivered voting agreements whereby they have agreed to vote their
respective shares in favor of the merger.
Completion of the transaction is subject to several conditions which are
usual and customary conditions for transactions of this nature, including
shareholder approval, completion of the anticipated financing in an amount of at
least $4.0 million in gross proceeds and completion of regulatory review and
approval of the proposed transaction by the NASD. There are also conditions
related to the maintenance and operation of each parties business and financial
condition required for a closing. We expect to file a joint proxy registration
statement with the SEC and to close the transaction during the third quarter of
2005.
As a result of the foregoing conditions, there can be no assurances that
the transaction will be completed or if completed, by such date. Regulatory
review by the SEC and/or NASD could delay the anticipated closing date. If the
transaction is not consummated by August 31, 2005, the parties have the option
not to proceed.
8
Debenture Conversions
Between October 2004 and March 2005 we received notices that holders of
$1,875,000 of convertible debentures that were sold through private offerings in
2002 and 2003, have elected to convert their debentures into shares of our
common stock in accordance with the terms of the debentures. As a result, we
have issued 3,750,000 shares of our common stock during that time period. As of
the date of this Annual Report, there is an aggregate principal amount of
$1,260,000 of convertible debentures outstanding. The debentures are convertible
at $.50 per share.
Change of Auditing Firms
On July 9, 2004 we dismissed Schneider & Associates, LLP ("Schneider") as
the Company's independent public accountants. The reports issued by Schneider on
the financial statements of the Company for each of the past two fiscal years,
the years ended December 31, 2003 and 2002, contained no adverse opinion or
disclaimer of opinion and were not qualified or modified as to uncertainty,
audit scope or accounting principles.
On July 9, 2004, we engaged Lazar, Levine & Felix LLP ("Lazar") as our new
independent registered public accountants to audit our financial statements for
the year ended December 31, 2004. For more information on the change of auditing
firms, please see Item 9, "Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure".
New Lease Agreement
On September 22, 2004, Montauk Financial Group entered into a 4th Amendment
to its Master Lease dated March 1997 for our corporate headquarters in Red Bank,
New Jersey. The amendment provides for a lease term of five (5) years commencing
on February 1, 2005, for a reduced space of 27,255 square feet. The lease
provides for monthly rent payments of $50,762. For more information regarding
the new lease terms, please see Item 2, "Properties".
Change of Clearing Firms
In December 2004, Fiserv Securities, Inc., our clearing agent, announced
that it had been acquired by National Financial Services ("NFS"), a unit of
Fidelity Investments. The final terms of a new clearing relationship with NFS
are still being negotiated. If these negotiations are successfully completed, we
anticipate moving onto the NFS clearing platform in May 2005.
Risk Factors
Our business, results of operations and financial condition may be
materially and adversely affected due to any of the following risks. The risks
described below are not the only ones we face. Additional risks we are not
presently aware of or that we currently believe are immaterial may also impair
our business operations. The trading price of our common stock could decline due
to any of these risks. In assessing these risks, you should also refer to the
other information contained or incorporated by reference in this Form 10-K,
including our financial statements and related notes.
Our business is inherently risky and we have suffered losses in previous years
For the years ended December 31, 2004, 2003 and 2002, we reported revenues
of $59,187,000, $58,227,000 and $47,967,000, respectively. We recognized net
income in 2004 of $730,000 and net losses of $3,518,000 and $2,960,000 for the
years ended December 31, 2003 and 2002, respectively. The losses for the 2003
and 2002 periods were primarily due to costs associated with litigation expenses
and settlements. We may incur further losses in the future, and such losses
would necessarily affect the nature, scope and level of our future operations.
Our results of operations to date are not necessarily indicative of the results
of future operations. The securities business, by its very nature, is subject to
various risks and contingencies, many of which are beyond the ability of our
management to control. These contingencies include economic conditions generally
and in particular those affecting securities markets, interest rates,
discretionary income available for investment; losses which may be incurred from
underwriting and trading activities; customer inability to meet commitments,
such as margin obligations; customer fraud; and employee misconduct and errors.
Further, the nature and extent of underwriting, trading and market making
activities, and hence the volume and scope of our business is directly affected
by our available net capital.
9
Fluctuations in securities volume and prices increase the potential for future
losses
We, and the securities industry in general, are directly affected by
national and international economic and political conditions, broad trends in
business and finance, the level and volatility of interest rates, changes in and
uncertainty regarding tax laws and substantial fluctuations in the volume and
price levels of securities transactions. We and the securities industry in
general, are subject to other risks, including risks of loss from the
underwriting of securities, counter party (a party to which we have credit or
performance exposure) failures to meet commitments, customer fraud, employee
errors or misconduct and litigation. In addition, price fluctuations may cause
losses on securities positions. As we expand our investment banking activities
and more frequently serve as manager or co-manager of public offerings of
securities, we can expect to make increased commitments of capital to
market-making activities in securities of those issuers. The expected additional
concentration of capital in the securities of those issuers held in inventory
will increase the risk of loss from reductions in the market price. Low trading
volume or declining prices generally result in reduced revenues. Under these
conditions, profitability is adversely affected since many costs, other than
commission compensation and bonuses, are fixed. Heavy trading volume has caused
serious operating problems, including delays in clearing and processing, for
many securities firms in the past and may do so in the future.
Principal and brokerage transactions and lending activities expose us to losses
Our trading, market making and underwriting activities involve the
purchase, sale or short sale of securities as a principal and, accordingly,
involve the risk of changes in the market prices of those securities and the
risk of a decrease in the liquidity of markets which would limit our ability to
resell securities purchased or to repurchase securities sold in principal
transactions. Montauk Financial Group's brokerage activities and principal
transactions are subject to credit risk. For example, a customer may not respond
to a margin call, and since the securities being held as collateral have
diminished in value, there is a risk that we may not recover the funds loaned to
the customer.
There are numerous contingencies and risks associated with our recent entry into
an agreement to merge with Olympic Cascade
On February 10, 2005, we announced that we had entered into an agreement to
merge with Olympic Cascade Financial Corporation for the merger of the two
companies in a transaction where the outstanding shares of our common stock
would convert into the right to receive shares of common stock of Olympic
Cascade at a ratio of 0.5055 Olympic shares for each share of our common stock.
There are numerous contingencies and risks associated with our having entered
into this agreement, including the following:
We cannot assure you that all conditions to the merger will be completed
and the merger consummated. The merger is subject to the satisfaction of closing
conditions, including the approval of our and Olympic's stockholders and the
consummation of a financing arrangement. Accordingly, and we cannot assure you
that the merger will be completed. In the event the merger is not completed, we
may be subject to many risks, including the costs related to the proposed
merger, such as legal, accounting and advisory fees, which must be paid even if
the merger is not completed. If the merger is not completed, the market price of
our common stock could decline.
Completion of the merger may result in dilution of per share operating
results. The completion of the merger may not result in improved per share
operating results of the combined company or a financial condition superior to
that which would have been achieved by our company on a stand-alone basis. The
merger could fail to produce the benefits that we anticipate, or could have
other adverse effects that we currently do not foresee. In addition, some of the
assumptions that we have relied upon, such as the achievement of operating
synergies, may not be realized. In this event, the merger could result in a
reduction of per-share earnings of the combined company as compared to the
per-share earnings that would have been achieved by our company if the merger
had not occurred.
10
If we and Olympic Cascade fail to successfully integrate our operations,
the combined company may not realize the potential benefits of the merger. If
the merger is completed, the integration of First Montauk and Olympic Cascade
will be a time consuming and expensive process and may disrupt our operations if
it is not completed in a timely and efficient manner. If this integration effort
is not successful, our results of operations could be harmed, employee morale
could decline, key employees could leave and we may lose customers. In addition,
we may not achieve anticipated synergies or other benefits of the merger.
Following the merger, First Montauk and Olympic Cascade must operate as a
combined organization utilizing common information and communication systems,
operating procedures, financial controls and human resources practices. We may
encounter the following difficulties, costs and delays involved in integrating
these operations:
o failure to successfully manage relationships with customers and other
important relationships;
o failure of customers to continue using the services of the combined
company;
o difficulties in successfully integrating the management teams and
employees of First Montauk and Olympic Cascade;
o challenges encountered in managing larger operations;
o the loss of key employees;
o diversion of the attention of management from other ongoing business
concerns;
o potential incompatibility of technologies and systems; and
o potential impairment charges incurred to write down the carrying
amount of intangible assets generated as a result of the
merger; and
o potential incompatibility of business cultures.
If the combined company's operations after the merger do not meet the
expectations of existing customers of First Montauk and Olympic Cascade, then
these customers may cease doing business with the combined company altogether,
which would harm our results of operations and financial condition.
Costs associated with the merger are difficult to estimate, may be higher
than expected and may harm the financial results of the combined company. We
will incur substantial direct transaction costs associated with the merger, and
additional costs associated with consolidation and integration of operations. If
the total costs of the merger exceed estimates or the benefits of the merger do
not exceed the total costs of the merger, our financial results could be
adversely affected.
Competition in the brokerage industry may adversely impact our retail business
We encounter intense competition in all aspects of our business and compete
directly with many other securities firms, a significant number of which offer
their customers a broader range of financial services, have substantially
greater resources and may have greater operating efficiencies. In addition, a
number of firms offer discount brokerage services to individual retail customers
and generally effect transactions at lower commission rates on an "execution
only" basis without offering other services such as investment recommendations
and research. The further expansion of discount brokerage firms could adversely
affect our retail business. Moreover, there is substantial commission
discounting by full-service broker-dealers competing for institutional and
individual brokerage business. The possible increase of this discounting could
adversely affect us. Other financial institutions, notably commercial banks and
savings and loan associations, offer customers some of the services and products
currently 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 that banks
and other institutions ultimately may offer to customers, we may be adversely
affected to the extent those services are offered on a large scale.
11
We are subject to various risks in the securities industry
As a securities broker-dealer, our subsidiary is subject to uncertainties
that are common in the securities industry. These uncertainties include:
o the volatility of capital markets;
o governmental regulation;
o litigation;
o intense competition;
o substantial fluctuations in the volume and price level of
securities; and
o dependence on third parties.
As a result, revenues and earnings may vary significantly from period to
period. In periods of low volume, profitability is impaired because certain
expenses remain relatively fixed. Due to our size, we have less capital than
many competitors in the securities industry. In the event of a market downturn,
our business could be adversely affected in many ways, including those described
herein. Our revenues are likely to decline in such circumstances and, if we are
unable to reduce expenses accordingly, our financial condition and results of
operations would be adversely affected.
We have incurred liability due to securities-related litigation
Many aspects of our business involve substantial risks of liability,
including exposure to liability under applicable federal and state securities
laws in connection with the activity of our associated persons, as well the
underwriting and distribution of securities. In recent years, there has been an
increasing incidence of litigation involving the securities industry in general,
which seeks both rescissionary and punitive damages. During the year ended
December 31, 2004, we incurred $2,715,000 in litigation costs and expenses
related to various legal claims and settlements. As of December 31, 2004, we
have accrued for litigation costs that are probable and can be reasonably
estimated based on a review of existing claims, arbitrations and unpaid
settlements. Management cannot give assurance that this accrual will be adequate
to cover actual costs that may be subsequently incurred. It is not possible to
predict the outcome of other matters pending against Montauk Financial Group.
All such cases are, and will continue to be, vigorously defended. However,
litigation is subject to many uncertainties, and some of these actions and
proceedings may result in adverse awards or judgments. After considering all
relevant facts, available insurance coverage and consultation with litigation
counsel, it is possible that our consolidated financial condition, results of
operations, or cash flows could be materially affected by unfavorable outcomes
or settlements of certain pending litigation.
We remain subject to extensive regulation and the failure to comply with these
regulations could subject us to penalties or sanctions
The securities industry in general and our business in particular is
subject to extensive regulation by the SEC, state securities regulators and
other governmental regulatory authorities. The broker-dealer is also regulated
by industry self-regulatory organizations, including the NASD and the Municipal
Securities Rulemaking Board. Montauk Financial Group is a registered
broker-dealer with the SEC and a member firm of the NASD. Broker-dealers are
subject to regulations which cover all aspects of the securities business,
including:
o sales practices and supervision;
o trading practices among broker-dealers;
o use and safekeeping of customers' funds and securities;
o capital structure of securities firms;
o record keeping; and
o the conduct of directors, officers, agents and employees.
Much of the regulation of broker-dealers has been delegated to
self-regulatory organizations, principally the NASD, which is Montauk Financial
Group's primary regulator. NASD adopts rules, subject to approval by the SEC,
that govern its members and conducts periodic examinations of member firms'
operations.
12
Compliance with these regulations involves a number of risks, particularly
where the regulations may be subject to varying interpretation. If we are found
to have violated an applicable regulation, an administrative or judicial action
may be initiated against us that may result in penalties which could have a
material adverse effect on our operating results and financial condition,
including but not limited to:
o censure;
o fine;
o civil damage awards, including treble damages for insider trading
violations;
o the issuance of cease-and-desist orders; or
o the deregistration or suspension of our broker-dealer activities
and/or our employees.
We depend upon our registered representatives
Most aspects of our business are dependent on highly skilled and
experienced individuals. We have devoted considerable efforts to recruiting and
compensating those individuals and provide incentives to encourage them to
remain employed by or associated with us. Individuals associated with us may
leave our company at any time to pursue other opportunities.
We face significant competition for registered representatives
We are continuously adding new registered representatives to our company to
either grow our operations or to replace registered representatives that have
left our company. We compete with other financial services firms for these
persons and the level of competition for registered representatives remains
intense. The loss of a significant number of registered representatives could
materially and adversely affect our operating results.
We depend upon our senior management
For the foreseeable future, we will be substantially dependent upon the
personal efforts and abilities of our senior management, including our Chief
Executive Officer and President, Mr. Victor K. Kurylak, Mr. Robert I.
Rabinowitz, our General Counsel and Executive Vice President and Ms. Mindy A.
Horowitz, our acting Chief Financial Officer and Senior Vice President, to
coordinate, implement and manage our business plans and programs. The loss or
unavailability of the services of any of them would likely have a material
adverse affect on our business, operations and prospects. In addition, loss of
key members of management could require us to invest capital to search for a
suitable replacement. Such a search could serve as a distraction to the
remaining members of management preventing them from focusing on the ongoing
development of our business which, in turn, could cause us to lose money.
Montauk Financial Group must comply with Net Capital Requirements
The business of our broker-dealer, like that of other securities firms, is
capital intensive. The SEC and the NASD have stringent provisions with respect
to net capital requirements applicable to the operation of securities firms. A
significant operating loss or any charge against net capital could adversely
affect our ability to significantly expand or, depending upon the magnitude of
the loss or charge, to maintain our present level of business.
We are exposed to risks due to our investment banking activities
Participation in an underwriting syndicate or a selling group involves both
economic and regulatory risks. An underwriter may incur losses if it is unable
to resell the securities it is committed to purchase, or if it is forced to
liquidate its commitment at less than the purchase price. In addition, under
federal securities laws, other laws and court decisions with respect to
underwriters' liabilities and limitations on the indemnification of underwriters
by issuers, an underwriter is subject to substantial potential liability for
misstatements or omissions of material facts in prospectuses and other
communications with respect to such offerings. Acting as a managing underwriter
increases these risks. Underwriting commitments constitute a charge against net
capital and our ability to make underwriting commitments may be limited by the
requirement that it must at all times be in compliance with the Net Capital
Rule.
13
We rely on one clearing firm and the termination of the clearing agreement with
this firm could disrupt Montauk Financial Group's business
Montauk Financial Group uses one clearing broker, Fiserv Securities, Inc.,
to process its securities transactions, maintain customer accounts, control,
receive, custody and deliver securities, on a fee basis. We depend on the
operational capacity and ability of the clearing broker for the orderly
processing of transactions. If the clearing agreement is terminated for any
reason, or if the clearing broker fails to provide its functions for us in the
normal course of business, we would be forced to find an alternative clearing
broker. There is no assurance that we would be able to find an alternative
clearing broker on acceptable terms to us or at all.
We do not pay dividends on our common stock
We do not pay dividends on the issued and outstanding shares of our common
stock. However, we pay 6% quarterly dividends on the outstanding shares of our
Series A Preferred Stock, pay interest at the rate of 6% on our outstanding
debentures and our Series B Preferred Stock will accrue cumulative dividends at
the rate of 8% per annum. Applicable laws, rules and regulations under the New
Jersey Business Corporation Act and the Securities Act of 1933, as amended, have
affected our ability to declare and pay dividends.
The conversion or exercise of outstanding convertible securities may result in
dilution to our common shareholders
Dilution of the per share value of our common shares could result from the
conversion of most or all of the currently outstanding debentures and shares of
Series A Preferred Stock and Series B Convertible Redeemable Preferred Stock. We
issued an aggregate of $1,240,000 principal amount of debentures in a private
offering completed in March 2003 and subsequently issued an aggregate of
$1,895,000 principal amount of debentures in a private placement completed in
December 2003. The debentures are convertible into a total of 6,270,000 shares
of our common stock at an initial conversion rate of $0.50. To date, holders of
$1,875,000 principal amount of debentures have converted into 3,750,000 shares
of our common stock. In 1999, we issued an aggregate of 349,511 shares of Series
A Preferred Stock in connection with an exchange offer. Currently, 305,369
Series A Preferred Shares remain outstanding and convertible into 610,738 shares
of common stock at the rate of $2.50 per share. However, if the last sale price
of the common stock is $3.50 or more a share for 20 consecutive trading days, as
listed on the Over-the-Counter Bulletin Board, the Series A Shares will
automatically be converted into shares of common stock. In 2005 we issued
197,824 shares of Series B Convertible Redeemable Preferred Stock that are
convertible into 1,978,240 shares of our common stock.
In addition, as of March 31, 2005, there were outstanding:
o warrants to purchase 313,500 shares of common stock at an
exercise price of $0.50 per share;
o warrants to purchase 500,000 shares of common stock at an
exercise price of $.40 issued in a settlement of certain
claims; and
o options to purchase 2,533,832 shares of common stock, at
exercise prices ranging from $.20 to $2.50 per share.
The conversion or exercise of these convertible securities and the sale of
the underlying common stock, or even the potential of such conversion or
exercise and sale, may have a depressive effect on the market price of our
securities and will cause dilution to our shareholders. Moreover, the terms upon
which we will be able to obtain additional equity capital may be adversely
affected, since the holders of the outstanding convertible securities can be
expected to convert or exercise them at a time when we would, in all likelihood,
be able to obtain any needed capital on terms more favorable to us than the
exercise terms provided by the outstanding options and warrants. Dilution could
create significant downward pressure on the trading price of our common stock if
the conversion or exercise of these securities encouraged short sales. Even the
mere perception of eventual sales of common shares issued on the conversion of
these securities could lead to a decline in the trading price of our common
stock.
14
We have sold restricted shares which may depress the common stock price
As of March 31, 2005, of the 15,324,051 issued and outstanding shares of
our common stock, approximately 9,069,741 shares may be deemed restricted shares
and, in the future, may be sold in compliance with Rule 144 under the securities
Act of 1933, as amended. Rule 144 provides that a person holding restricted
securities for a period of one year may sell in brokerage transactions an amount
equal to 1% of our outstanding common stock every three months. A person who is
not affiliated with us and who has held restricted securities for over two years
is not subject to the aforesaid volume limitations as long as the other
conditions of the Rule are met. Possible or actual sales of our common stock by
certain of our present shareholders under Rule 144 may, in the future, have a
depressive effect on the price of the common stock in any market which may
develop for such shares. Such sales at that time may have a depressive effect on
the price of the common stock in the open market.
There is a limited public market for our securities
Our common stock and warrants are traded in the over-the-counter market and
reported by the National Daily Quotation Service published by the National
Quotation Bureau, Inc and the Electronic Bulletin board maintained by the NASD.
Although we may apply for inclusion of our common stock in the Nasdaq Smallcap
Market and/or on the American Stock Exchange, we do not currently satisfy the
minimum listing requirements. Accordingly, there can be no assurance that we
will be successful in obtaining listing on Nasdaq or on the Amex, or if
obtained, that it will be able to maintain the Nasdaq or Amex listing.
The price of our common stock is volatile
The price of our common stock has fluctuated substantially (See Part II,
Item 5). This volatility may be caused by factors specific to our company and
the securities markets in general. Factors affecting volatility may include:
variations in our annual or quarterly financial results or those of our
competitors; conditions in the economy in general; and changes in applicable
laws or regulations, or their judicial or administrative interpretations
affecting us or the securities industry in general. In addition, volatility of
the market price of our common stock is affected by the relatively low trading
volume it has experienced and the fact that it is not listed for trading on a
national securities exchange.
15
Our broker-dealer subsidiary faces limitations on trading and market-making
activities in our securities
Due to regulatory positions and requirements of both the SEC and the NASD
relating to the circumstances and extent to which a registered broker-dealer and
NASD member may engage in market-making transactions in the securities of its
parent company, Montauk Financial Group does not engage in trading or
market-making activities relating to our common stock or warrants where Montauk
Financial Group would speculate in, purchase or sell our securities for its own
account. The purpose and effect of such limitation restricts Montauk Financial
Group from being a factor in the determination of the market or price of our
securities. Montauk Financial Group does, however, execute transactions for its
customers on an "agency basis" where it does not acquire our securities for its
own proprietary account. It will, however, earn usual and customary brokerage
commissions in connection with the execution of such brokerage transactions. If,
under current or future regulations of both the SEC and NASD, Montauk Financial
Group is permitted to participate as a market maker, it may do so on the basis
of showing a bid and offer for our securities at specified prices representing
customer interest.
We have limited the liability of our directors
We have amended our certificate of incorporation to include provisions
eliminating the personal liability of our directors, except for breach of a
director's duty of loyalty to the company or to our shareholders, acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of the law, and in respect of any transaction in which a director
receives an improper personal benefit. These provisions pertain only to breaches
of duty by directors as such, and not in any other corporate capacity, e.g., as
an officer. As a result of the inclusion of such provisions, neither the company
nor its shareholders may be able to recover monetary damages against directors
for actions taken by them which are ultimately found to have constituted
negligence or gross negligence, or which are ultimately found to have been in
violation of their fiduciary duties, although it may be possible to obtain
injunctive or other equitable relief with respect to such actions. If equitable
remedies are found not to be available to shareholders in any particular case,
shareholders may not have an effective remedy against the challenged conduct.
We believe that, based upon recent developments in the market for
directors' and officers' liability insurance, such provisions are necessary to
attract and retain qualified individuals to serve as directors. In addition,
such provisions will allow directors to perform their duties in good faith
without concern for the application of monetary liability on a retroactive basis
in the event that a court determines their conduct to have been negligent or
grossly negligent. On the other hand, such provisions significantly limit the
potential remedies available to the company or a shareholder, and it is possible
that the protection afforded by such provisions may reduce the level of
diligence or care demonstrated by such directors.
Our Certificate of Incorporation and By-Laws contain provisions which may have
an anti-takeover effect
Our amended and restated certificate of incorporation and by-laws contain
provisions which may discourage certain transactions which involve an actual or
threatened change in control of the company. These provisions include a
classified or staggered board of directors. As permitted by the New Jersey
Corporation Law, our certificate of incorporation provides that a director or
officer of our company will not be personally liable to the company or its
stockholders for monetary damages for breach of the fiduciary duty of care as a
director, except under certain circumstances including a breach of the
director's duty of loyalty to the company or our stockholders or any transaction
from which the director derived an improper personal benefit. The provisions
referred to above may make the company a less attractive acquisition candidate.
They may also discourage or impede offers to acquire the business not approved
by the board of directors, including offers for some or all of the shares of any
class or series of capital stock at substantial premiums above the then current
market value of such shares.
16
Item 2. Properties
Offices and Facilities
The Corporate Headquarters
We maintain our corporate headquarters and executive offices at Parkway 109
Office Center, 328 Newman Springs Road, Red Bank, New Jersey. In March 1997, we
entered into a seven-year lease (the "Master Lease"), commencing February 1,
1998 for 22,762 square feet of gross rentable space. In March 1998, we 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. On September 22, 2004
we entered into a 4th Amendment to our Master Lease dated March 1997 for our
corporate headquarters in Red Bank, New Jersey. The amendment provides for a
lease term of five (5) years commencing on February 1, 2005, for a reduced space
of 27,255 square feet. The lease provides for monthly rent payments of $50,762.
As additional rent, we are required to pay a proportional share of any increases
in real estate taxes and operating expenses above the amount paid during the
2005 calendar year, insurance premiums relating to the premises, and all utility
charges related to the premises. The amendment contains a five-year option to
renew at a rental payment equal to the then-current fair market rate per square
foot applicable to the leased premises.
Leased Branch Offices
In June 2001 we entered into a sub-lease agreement for 4,269 square feet of
office space on Wall Street in New York City that had been sublet to an
affiliate and operated as a branch office. This sublease expired on January 30,
2005 and was not renewed.
In January 2002 we entered into a sub-lease agreement for 4,520 square feet
of office space in Midtown Manhattan which is used as a retail branch office.
The sub-lease term runs until September 29, 2006 and provides for a monthly rent
payment of $18,830 until January 31, 2004 and thereafter increases to $19,963
for the balance of the sub-lease term.
Item 3. Legal Proceedings
Many aspects of our business involve substantial risks of liability. In
recent years, there has been an increasing incidence of litigation and
arbitration involving the securities industry.
In July 2003 we, along with Montauk Financial Group, entered into a
settlement agreement with certain claimants in order to settle pending
arbitration proceedings that were brought against us. The covered proceedings
arose out of customer purchases of certain high-yield corporate bonds which
declined in market value and subsequently defaulted. The settlement agreement
covers eleven separate claims that sought an aggregate of approximately $12.3
million in damages. In exchange for the consideration we provided, each claimant
granted a general release of claims in favor of our company and all individual
respondents, with the exception of the registered representative who had handled
the claimants' accounts. In consideration for the release granted by the
claimants, we agreed to pay to the claimants an aggregate of $1,000,000 cash and
to issue to the claimants warrants to purchase an aggregate of 750,000 shares of
our common stock in three separate classes of warrants and 500,000 shares of our
common stock.
In addition, the settlement agreement provides that we may be obligated to
make additional payments of up to $600,000, in the event that claimants elect to
exercise the warrants on certain dates. Specifically, upon the election of the
majority of then existing warrant holders to exercise up to a maximum of 250,000
warrants, respectively, during the months of June 2004, June 2005 and June 2006,
the claimants, upon exercising their warrants, will be required to sell the
shares in the open market. Thereafter, we would pay to the claimants up to an
aggregate amount of $200,000 less the amount received by the claimants from the
sale of their shares net of commissions. In the event that warrant holders do
not elect to exercise the warrants during a particular period, we will not be
required to make a payment for that period. In June 2004 we redeemed all
outstanding Class A warrants for an aggregate of $200,000.
We are currently defending four additional claims relating to the sale of
the high-yield bonds referenced in the preceding paragraphs. The claimants in
these matters seek compensatory damages in excess of $2.1 million, plus punitive
damages and the recovery of various costs. We are vigorously defending theses
actions and believe that there are meritorious defenses in each case. There is
no insurance coverage available for the payment of settlements and/or judgments
that may result from these particular claims.
17
Montauk Financial Group is also a respondent or co-respondent in various
other legal proceedings which are related to its securities business. Montauk
Financial Group is contesting these claims and believes there are meritorious
defenses in each case. However, litigation is subject to many uncertainties, and
some of these actions and proceedings may result in adverse judgments. Further,
the availability of insurance coverage in any particular case is determined on a
case by case basis by the insurance carrier, and is limited to the coverage
limits within the policy for any individual claim and in the aggregate. After
considering all relevant facts, available insurance coverage and consultation
with litigation counsel, management believes that significant judgments or other
unfavorable outcomes from pending litigation could have a material adverse
impact on our consolidated financial condition, results of operations and cash
flows in any particular quarterly or annual period, or in the aggregate could
impair our ability to meet the net capital requirements relating to our
securities business.
A shareholder, BMAC Corp., has filed a report on Form 13d with the
Securities and Exchange Commission stating that it holds approximately 13.3% of
our outstanding shares. BMAC Corp. failed to identify any individuals associated
with it. For this and other reasons, it is our opinion that the filing by BMAC
Corp. did not satisfy the federal securities regulations related to the filing
of Form 13d. Although no litigation has been commenced, the Company has been
advised that they may undertake certain actions, which may include an attempt to
change or influence control over the company, including recommendation of
management changes and structure of the board of directors. In addition, certain
former registered representatives of Montauk Financial Group have contacted
management of the Company and advised us that they represent BMAC Corp. and seek
management changes in the company. These former brokers have stated it is their
intention to put themselves in place as management of Montauk Financial Group.
We are aware that many of the clients of these former registered representatives
held convertible debentures that we had issued in a prior private placement and
substantially all of these debenture holders converted their debentures into our
Common Stock at the same time, including persons affiliated with BMAC Corp. We
are also aware that a law firm which represents these former brokers has sent
letters to customers and brokers of Montauk Financial Group disparaging Montauk
Financial Group's management and Board of Directors. Despite the existence of
these facts, these former brokers deny that they are a "group" within the
meaning of federal securities regulations. We have advised the SEC and NASD of
our belief that the persons involved have not complied with applicable law
regarding Section 13d of the Securities and Exchange Act of 1934, as well as
other provisions of the Securities and Exchange Act of 1934 and SEC regulations.
We fully intend to seek all defenses available to us in this matter and are
reviewing all available legal options against these persons.
As of December 31, 2004, we have accrued for litigation costs that are
probable and can be reasonably estimated based on a review of existing claims,
arbitrations and unpaid settlements. Management cannot give assurance that this
accrual will be adequate to cover actual costs that may be subsequently
incurred. It is not possible to predict the outcome of other matters pending
against Montauk Financial Group. All such cases are, and will continue to be,
vigorously defended.
Item 4. Submission of Matters on a Vote of Security Holders
We did not submit any matters to our shareholders for a vote during the
fourth quarter of the year ended December 31, 2004. We anticipate that the next
meeting of shareholders will include a vote upon the proposed transaction with
Olympic Cascade, assuming that the parties proceed with the transaction as
contemplated.
18
PART II
Item 5. Market of and Dividends on our Common Equity and
Related Stockholder Matters
A. Principal Market
Our common stock is traded in the over-the-counter market. Trading in the
our common stock is reported on the NASD Bulletin Board system and in the pink
sheets published by Pink Sheets LLC. We believe that there is an established
public trading market for our common stock based on the volume of trading in our
common stock and the existence of market makers who regularly publish quotations
for our common stock. Our Class A, Class B and Class C Warrants commenced
trading in the over-the-counter market upon their issuance in March 1998. The
Class A Warrants and Class B Warrants expired on February 17, 2003. The Class C
Warrants expired on February 17, 2005.
B. Market Information
Our common stock commenced trading in the over-the-counter market in 1987.
On March 30, 2005, our common stock had bid and offer prices of $1.02 and $1.03,
respectively. At December 31, 2004 our Common Stock had a closing price of $0.55
per share.
The following is the range of high and low bid prices for such securities
for the periods indicated below:
Common Stock
Fiscal Year 2005 High Bid Low Bid
1st Quarter $1.09 $.47
(through 3/30/05)
Fiscal Year 2004 High Bid Low Bid
1st Quarter $.42 $.30
2nd Quarter $.39 $.27
3rd Quarter $.42 $.24
4th Quarter $.80 $.49
Fiscal Year 2003 High Bid Low Bid
1st Quarter $.22 $.20
2nd Quarter $.32 $.17
3rd Quarter $.32 $.20
4th Quarter $.40 $.24
C. Number of Record Holders
The approximate number of record holders of our common stock as of March
28, 2005 was 505. Such number of record holders was determined from our
stockholder records, and does not include beneficial owners of our common stock
whose shares are held in the names of various security holders, dealers and
clearing agencies. We believe there are in excess of 3,000 beneficial holders of
our common stock.
D. Dividend Policy
We have not paid any dividends upon our common stock since our inception,
and do not expect to pay any dividends upon our common stock in the foreseeable
future and plan to retain earnings, if any, to finance the development and
expansion of our business. We pay quarterly dividends on outstanding shares of
our Series A Preferred Stock at the rate of 6% per annum, subject to the
limitations under the New Jersey Business Corporation Act. There are currently
outstanding 305,369 shares of Series A Preferred Stock. We have not paid
dividends on our outstanding shares of Series A Preferred Stock since the first
quarter of 2003. Dividend in arrears, but not accrued for, is $164,000 at year
end. There can be no assurance that we will continue to pay dividends in the
future.
E. Issuance of Unregistered Securities
Restricted Shares Issuance
In January 2004 and February 2005 we issued an aggregate of 2,300,000
shares of restricted common stock to our top five executive officers and a
senior employee. These shares were granted in conjunction with new employment
agreements for each executive officer, and were issued in conjunction with the
provisions of our 1996 Senior Management Stock Option Plan, as amended. In
addition, in connection with the Severance Agreement entered into with William
J. Kurinsky, we issued to him an aggregate of 197,824 shares of newly created
Series B Preferred Stock. We relied upon the exemptions from registration
provided upon in Section 4(2) of the Securities Act of 1933 in connection with
these issuances.
19
During the year ended December 31, 2004, holders of an aggregate principal
amount of $120,000 of convertible debentures have elected to convert their
debentures into shares of common stock in accordance with the terms of the
debentures. Subsequent to the year end, holders of an additional aggregate
principal amount of $1,755,000 of convertible debentures elected to convert
their debentures into shares of our common stock. The debentures were sold in
private placements in 2002 and 2003. We have issued an aggregate amount of
3,750,000 shares of Common Stock in connection with these conversion events. The
debentures are convertible at $.50 per share. We relied upon the exemptions from
registration provided upon in Section 3(a)(9) of the Securities Act of 1933 in
connection with these issuances.
In addition, during the year ended December 31, 2004, we granted options to
purchase 891,000 shares of common stock pursuant to our stock option plans to
certain of our employees and registered representatives, which plans were not
registered at the time of grant. The options were granted at exercise prices
between $.25 and $.75 per share. In March 2005, a registration statement on Form
S-8 was filed with the SEC registering all common shares issuable from our stock
option plans.
Stock Repurchases
During 2004, we repurchased and canceled 60,217 shares of our common stock
for $21,162. In the third quarter of 2004, we repurchased 250,000 Series A
Warrants for an aggregate of $200,000. There were no repurchases of any
securities during the fourth quarter of 2004.
F. Securities Authorized For Issuance Under Equity Compensation Plans
See the discussion and tables at pages 61 to 62 below.
20
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with
the Consolidated Financial Statements, including the related notes, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Year Ended December 31,
2004 2003 2002 2001 2000
Operations Results:
Revenues:
Commissions $42,767,158 $41,950,392 $36,513,802 $37,807,870 $46,529,771
Principal transactions 9,058,259 9,466,359 6,727,642 8,021,887 7,131,079
Investment banking 2,716,042 2,439,144 1,007,700 1,483,210 2,416,711
Interest and other income 4,645,782 4,370,787 3,717,600 3,907,448 3,252,325
--------- --------- --------- --------- ---------
Total 59,187,241 58,226,682 47,966,744 51,220,415 59,329,886
---------- ---------- ---------- ---------- ----------
revenues
Expenses:
Commissions, employee 46,851,474 46,218,107 39,572,851 42,356,207 46,800,661
compensation and benefits
Clearing and floor 2,466,027 2,934,164 2,666,376 3,247,219 4,003,345
brokerage
Communications and 2,664,256 2,659,105 3,006,017 3,249,389 2,731,681
occupancy
Legal matters and related 2,714,769 5,836,960 1,259,502 2,415,374 1,181,115
costs
Write-down of note -- -- -- -- 239,183
receivable - Global Financial
Corp.
Other operating expenses 3,489,425 3,393,335 4,029,515 5,076,806 4,862,158
Interest 284,093 204,054 98,918 174,632 160,230
------- ------- ------ ------- -------
Total expenses 58,470,044 61,245,725 50,633,179 56,519,627 59,978,373
---------- ---------- ---------- ---------- ----------
Income (loss) before income 717,197 (3,019,043) (2,666,435) (5,299,212) (648,487)
taxes
Provision for income taxes (13,305) 499,000 294,000 (90,989) 6,721
(benefit) -------- ------- ------- -------- -----
Income (loss) before 730,502 (3,518,043) (2,960,435) (5,208,223) (655,208)
extraordinary loss
21
Year Ended December 31,
2004 2003 2002 2001 2000
Operations Results:
Extraordinary loss -
extinguishment of debt, net
of tax 34,200
------
Net income (loss) $730,502 $(3,518,043) $(2,960,435) $(5,208,223) $(689,408)
======== ============ ============ ============ ==========
Net income (loss) available
to common stockholders $639,813 $(3,542,882) $(3,059,722) $(5,306,976) $(792,136)
======== ============ ============ ============ ==========
Per share of
Common Stock:
Basic: $0.07 $(0.40) $(0.36) $(0.61) $(0.08)
Diluted: $0.04 $(0.40) $(0.36) $(0.61) $(0.08)
Weighted average common
shares outstanding-- Basic 9,270,350 8,784,103 8,551,932 8,704,355 9,450,055
Weighted average common and
common share equivalents
outstanding - Diluted 15,629,920 8,784,103 8,551,932 8,704,355 9,450,055
Financial condition:
Total assets $9,834,374 $12,193,101 $11,425,506 $14,227,562 $16,913,063
Total liabilities $12,932,991 $16,280,540 $12,203,196 $11,934,884 $ 9,203,672
Temporary Equity-Shares
subject to redemption 6,500 6,500
Stockholders' equity (deficit) $(3,098,617) $(4,087,439) $(777,690) $2,286,181 $7,702,891
22
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Factors Affecting "Forward Looking Statements"
From time to time, we 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. These risks and uncertainties, many of which are
beyond our 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 and political 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 us. We do
not undertake any obligation to publicly update or revise any forward-looking
statements.
Overview
We are a New Jersey-based financial services holding company whose
principal subsidiary, First Montauk Securities Corp., has operated as a full
service retail and institutional securities brokerage firm since 1987. Since
July 2000, First Montauk Securities Corp. has operated under the trade name
"Montauk Financial Group" and 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, Montauk Financial Group established Century Discount
Investments, a discount brokerage division. We also sell insurance products
through our subsidiary, Montauk Insurance Services, Inc.
Montauk Financial Group has approximately 370 registered representatives
and services over 61,000 retail and institutional customers, which comprise over
$3.2 billion in customer assets. With the exception of a company leased branch
office in New York City, all of our other 132 branch office and satellite
locations in 30 states are owned and operated by affiliates; independent
representatives who maintain all appropriate licenses and are responsible for
all office overhead and expenses. Montauk Financial Group also employs
registered representatives directly at its corporate headquarters.
Montauk Financial Group is registered as a broker-dealer with the
Securities and Exchange Commission, the National Association of Securities
Dealers, the Municipal Securities Rule Making Board, the National Futures
Association, and the Securities Investor Protection Corporation and is licensed
to conduct its brokerage activities in all 50 states, the District of Columbia,
and the Commonwealth of Puerto Rico, and registered as an International
broker-dealer to conduct business with institutional clients in the province of
Ontario, Canada. All securities transactions are cleared through Fiserv
Securities, Inc. of Philadelphia, Pennsylvania with various floor brokerage and
specialist firms also providing execution services. These arrangements provide
Montauk Financial Group 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 Montauk
Financial Group to offer products and services comparable to larger brokerage
firms.
On February 10, 2005 we executed a definitive Agreement and Plan of Merger
with Olympic Cascade Financial Corporation, ("Olympic"). Under the terms of the
agreement, our shareholders will receive 0.5055 shares of Olympic Cascade Common
Stock for each share of First Montauk Common Stock. Our outstanding preferred
stock, options and warrants will also be exchanged for like securities of
Olympic, subject to the exchange ratio. In connection with the merger, Olympic
and we have executed letters of intent with an investment firm, to provide
approximately $4.0 million of capital to the combined entity. Completion of the
transaction is subject to several conditions which are usual and customary for
transactions of this nature, including shareholder approval, completion of the
anticipated financing in an amount of at least $4.0 million in gross proceeds
and completion of regulatory review and approval of the proposed transaction by
the NASD. We expect to file a joint proxy registration statement with the SEC
and to close the transaction during the third quarter of 2005.
23
Our revenues consist primarily of commissions and fee income from
individual and institutional securities transactions, mutual fund and annuity
sales and investment banking services, such as private and public securities
offerings and limited market making activities. The following table represents
the percentage of revenues generated by each of these activities during the
years ended December 31, 2004, 2003 and 2002, respectively:
Equities: 2004 2003 2002
---- ---- ----
Listed and Over-The-Counter Stocks 44% 54% 44%
Debt Instruments:
Municipal, Government and Corporate Bonds and
Unit Investment Trusts 6% 6% 6%
Mutual Funds 10% 10% 12%
Options: Equity and Index 4% 5% 6%
Insurance and Annuities 8% 7% 11%
Investment Banking and Corporate Finance 5% 2% 1%
Investment Advisory Fees 4% 3% 2%
Alternative Investments (1) 4% 2% 4%
Proprietary Trading 4% 3% 3%
Miscellaneous (2) 11% 8% 11%
------------------------------
Total 100% 100% 100%
==============================
(1) Alternative Investments include REITs, 1031 Exchanges and promissory notes
(2) Miscellaneous includes interest income, amortization of deferred revenue and operations and marketing fees.
We engage in a highly competitive business. Therefore, our earnings, like
those of others in the industry, reflect the activity in the markets and can and
do fluctuate accordingly.
24
Results of Operations
Three Years Ended December 31, 2004
The results of operations for 2004 showed an increase in revenues of
$960,000 to $59,187,000 over 2003. The following discussion reflects
reclassification of certain categories to conform to the 2004 presentation.
Year Ended December 31,
------------------------------------------------------------------------------------
2004 2002
2003
------------------------------------------------------------------------------------
------------ ------------------------------ ---------------------------
Revenues: (000's) % Change (000's) % Change (000's)
------------ ------------------------------ ---------------------------
Commissions $42,767 2 $41,950 15 $36,514
Principal Transactions 9,058 (4) 9,466 41 6,728
Investment Banking 2,716 11 2,439 142 1,008
Interest/Other 4,646 6 4,372 18 3,717
------ ------ ------
Total Revenues $59,187 2 $58,227 21 $47,967
======= ======= =======
The primary source of our revenue is commissions generated from securities
transactions, mutual funds, syndicate offerings and insurance products. Total
revenues from commissions increased $817,000, or 2%, from 2003 to 2004 and
$5,436,000, or 15%, from 2002 to 2003. The components of the change in
commission revenues are as follows:
Revenues from agency transactions decreased $2,010,000, or 7%, from
$27,165,000 in 2003, to $25,155,000 in 2004, and increased $6,393,000, or 31%,
in 2003 from $20,772,000 in 2002. As a percentage of total revenues, agency
commissions, which consist primarily of equity and options transactions, was 43%
in 2002, 47% in 2003, and 43% in 2004. The decrease in revenues from agency
transactions from 2003 to 2004 was due in part to a reduction in the number of
producing registered representatives. The increased revenues from 2002 to 2003
were primarily attributable to favorable market conditions.
Mutual fund revenues increased from $5,717,000 in 2003, to $6,131,000 in
2004, an increase of 7%. This was in large part due to increased investor
interest in mutual fund investments. In 2003, mutual fund commissions decreased
from $5,756,000 in 2002 to $5,717,000 in 2003.
Revenues from insurance commissions also increased in 2004, from $4,212,000
in 2003 to $4,750,000 in 2004. The 2003 insurance commissions declined $889,000
compared to 2002 revenues of $5,101,000. This was due to a shift of investor
focus from insurance related investments toward equity markets.
Fees generated from managed accounts have consistently increased by about
39% each year since 2001. In 2004, revenues increased $734,000, from $1,880,000
in 2003, to $2,614,000 in 2004. We generated fees of $1,343,000 in 2002. These
year-over-year increases are attributable to the continuing interest by
investors who prefer to pay a fee based on a percentage of asset value, rather
than commissions paid on transactions. As this structure has increased in
popularity industry-wide, we have increased our focus on growing and servicing
this segment of our business.
Commissions generated from alternative investment products, such as Real
Estate Investment Trusts (REITs), IRS Section 1031 Real Estate Exchanges and
medical receivables, increased 125% from $1,034,000 in 2003 to $2,325,000 in
2004, following a decrease of $927,000 when compared to 2002 revenue. In 2004,
we increased our emphasis in these product offerings to qualified investors
seeking tax advantaged and higher yielding investments.
Total revenues from principal transactions, which include
mark-ups/mark-downs on transactions in which we act as principal, proprietary
trading and the sale of fixed income and equity securities, decreased in 2004.
Gross revenue from principal transactions fell by 4% or $408,000, from
$9,466,000 in 2003, to $9,058,000 in 2004, compared to a significant increase in
2003 of $2,738,000 over 2002 revenues of $6,728,000. This is primarily due to a
$1,203,000 decrease in revenues generated in riskless principal transactions
attributable to a reduction in the number of registered representatives who
conducted more of these types of transactions. Riskless principal trades are
transacted through the firm's proprietary account with a customer order in hand,
resulting in no market risk to the firm. Riskless principal revenues nearly
doubled from $2,103,000 in 2002, to $4,094,000 in 2003, in part because of
favorable market conditions. Revenues from all fixed income sources, which
include municipal, government, and corporate bonds and unit investment trusts
increased in 2004 by $746,000, due to the addition of several new branch offices
whose primary business focus is on fixed income products. The 2003 increase of
$1,124,000 over the 2002 period was due primarily to favorable market
conditions.
25
Investment banking revenues for 2004 increased $277,000, to $2,716,000.
Revenues from syndicate offerings of closed end mutual funds decreased by
approximately 50%, or $800,000, while revenues from private placements increased
about 100%, or approximately $1 million. Revenues for 2003 increased to
$2,439,000, an increase of $1,431,000 over 2002, as investment banking and
syndicate business continued its increase over the prior year. This category
includes new issues of equity and preferred stock offerings in which we
participated as a selling group or syndicate member, as well as private
placements and other investment banking activities.
Interest and other income for 2004 totaled $4,646,000, as compared to
$4,372,000 for 2003, a 6% increase of $274,000. The primary reason for the
increase in other income in 2004 is attributable to an increase in marketing
fees, unrealized investment income and the recognition of deferred income,
whereas in 2003 there was a one-time recovery of bad debts. If not for the
one-time recovery, the increase in interest and other income would have been
approximately $676,000. Interest and other income for 2003 totaled $4,372,000 as
compared to $3,717,000 for 2002, an increase of $655,000 primarily due to the
one-time bad debt recovery previously mentioned. For financial reporting
purposes, the cash advances that were received from our clearing firm, Fiserv
Securities, Inc., are deferred and amortized on a straight-line basis over the
remaining contract term of six years. Other income included amortization of
approximately $875,000, $726,000, and $577,000 in 2004, 2003 and 2002,
respectively.
Year Ended December 31,
--------------------------------------------------------------------
2004 2003 2002
--------------------------------------------------------------------
----------- ------------------------- --------------------------
(000's) % Change (000's) % Change (000's)
----------- ------------------------- --------------------------
Expenses:
Commissions, employee
compensation and benefits $46,852 1 $46,218 17 $39,573
Clearing and floor brokerage 2,466 (16) 2,934 10 2,666
Communications and occupancy 2,664 0 2,659 (12) 3,006
Legal matters and related costs
2,715 (53) 5,837 363 1,260
Other operating expenses 3,489 3 3,394 (16) 4,029
Interest 284 39 204 106 99
--- --- --
Total operating expenses $58,470 (5) $61,246 21 $50,633
======= ======= =======
Provision (benefit) for income
taxes
$(13) $499 $294
Total expenses decreased by $2,776,000, or 5%, to $58,470,000 in 2004, from
$61,246,000 in 2003. Expenses in 2003 increased $10,613,000 from $50,633,000.
The components of the changes in total expenses follow:
Compensation and benefits expense for management, operations and clerical
personnel increased in 2004, from $6,901,000 (12 % of revenues) to $6,963,000
(12% of revenues), an increase of $62,000 over the 2003 year. A reduction in
force, which was implemented in late 2003, resulted in a decrease in non-officer
compensation, which was offset by an increase in officer salaries and stock
compensation due to new employment agreements and the addition of a new officer
in 2004. When compared with the 2002 year, compensation and benefits increased
$35,000. Commission expense, the largest expense category, which is directly
related to commission revenues, increased $627,000, from $39,177,000 for the
2003 year to $39,804,000 for the 2004 year. Commissions as a percentage of total
revenues remained relatively constant at about 67% for all three years.
26
Clearing and floor brokerage costs, which are determined by the volume and
type of transactions, decreased $468,000 to $2,466,000 in 2004, and increased
$268,000 in 2003 from $2,666,000 in 2002. The reduction in 2004 is primarily due
to the change in the type and volume of transactions as well as an increase in
expense rebates provided by our clearing firm. The percentage of clearing costs
to gross revenues can fluctuate depending upon the product mix. As a percent of
revenues, clearing costs were approximately 4.2% for 2004 as compared with 5.0%
and 5.6% in years 2003 and 2002, respectively.
Communications and occupancy costs are relatively fixed and remained
basically unchanged for 2004 when compared to 2003. For 2003, these costs
decreased from $3,006,000 to $2,659,000, or $347,000, when compared to 2002 due
to the elimination of three corporate-leased branch offices and their related
costs and equipment rental expenses. As a percentage of revenue, communications
and occupancy was 4.5% in 2004 compared to 4.6% and 6.3% respectively, for the
2003 and 2002 years.
Legal matters and related settlement costs decreased significantly from
$5,837,000 in 2003 to $2,715,000 in 2004, a decrease of $3,122,000, or 54%, due
to a reduction in claims and cost control measures implemented by management in
2004. During 2003, legal fees and settlement costs increased to $5,837,000
compared to $1,260,000 in 2002. In 2003, we reached an agreement with certain
claimants to settle arbitration proceedings that arose out of customer purchases
of certain high-yield corporate bonds, which declined in market value and
subsequently defaulted. In the settlement, we paid an aggregate of $1,000,000
cash, issued 500,000 shares of our common stock and warrants to purchase an
additional 750,000 shares of our common stock to those claimants.
In addition, the settlement agreement provides that we may be obligated to
make additional payments of up to $600,000, in the event that claimants elect to
exercise the warrants on certain dates. Specifically, upon the election of the
majority of then existing warrant holders to exercise up to a maximum of 250,000
warrants each during the months of June 2004, June 2005 and June 2006, the
claimants, upon exercising their warrants, will be required to sell the shares
in the open market. Thereafter, we would pay to the claimants up to an aggregate
amount of $200,000 less the amount received by the claimants from the sale of
their shares net of commissions. In the event that warrant holders do not elect
to exercise the warrants during a particular period, we will not be required to
make a payment for that period. In June 2004, we redeemed all outstanding Class
A warrants for an aggregate of $200,000.
We are currently defending four additional claims related to the sale of
the high-yield bonds referenced in the preceding paragraphs. The claimants in
these matters seek compensatory damages in excess of $2.1 million, plus punitive
damages and the recovery of various costs. We are vigorously defending these
actions and believe that there are meritorious defenses in each case. There is
no insurance coverage available for the payment of settlements and/or judgments
that may result from these particular claims.
We are also a respondent or co-respondent in various other legal
proceedings which are related to our securities business and are contesting
these claims and believe there are meritorious defenses in each case. However,
litigation is subject to many uncertainties, and some of these actions and
proceedings may result in adverse judgments. Further, the availability of
insurance coverage in any particular case is determined on a case by case basis
by the insurance carrier, and is limited to the coverage limits within the
policy for any individual claim and in the aggregate. After considering all
relevant facts, available insurance coverage and consultation with litigation
counsel, management believes that significant judgments or other unfavorable
outcomes from pending litigation could have a material adverse impact on our
consolidated financial condition, results of operations and cash flows in any
particular quarterly or annual period, or in the aggregate, and could impair our
ability to meet the statutory net capital requirements relating to our
securities business.
As of December 31, 2004, we have accrued for litigation costs that are
probable and can be reasonably estimated based on a review of existing claims,
arbitrations and unpaid settlements. Management cannot give assurance that this
accrual will be adequate to cover actual costs that may be subsequently
incurred. It is not possible to predict the outcome of other matters pending
against us. All such cases are, and will continue to be, vigorously defended.
Other operating costs increased $95,000, to $3,489,000 in 2004, from
$3,394,000 in 2003, primarily resulting from an increase in professional
liability insurance of $237,000 offset by a decrease in office and printing
costs and consulting fees of $114,000. From 2002 to 2003, other operating
expenses decreased $635,000, from $4,029,000 to $3,394,000. In 2002, we wrote
off customer and broker bad debts of $1,021,000 compared to $73,000 in 2003.
27
Professional liability insurance costs have increased substantially due to
a hardening in the market for broker-dealer professional liability and directors
and officers insurance coverage. Many insurance carriers have opted out of this
market, while others have substantially increased premiums and deductible
limits. Our registered representatives have historically paid the full cost of
errors and omission insurance. However, to stay competitive in the marketplace,
we absorbed a large portion of these premiums in 2004 and 2003. The net cost to
us for errors and omissions insurance increased by $237,000 in 2004 and $331,000
in 2003. The amount of our cost for this coverage will continue to be dependent
on the number of registered representatives associated with us throughout the
year.
Income tax expense (benefit) for the years ended December 31, 2004, 2003
and 2002 was $(13,000), $499,000, and $294,000 respectively. The effective tax
rate on pre-tax income (loss) was 2.0%, 16.5% and 11.0% during 2004, 2003 and
2002, respectively. The difference in the rate between 2004 and 2003 was due to
the impact of the decrease of the valuation allowance relating to an adjustment
of the deferred tax asset previously recorded. The difference in the rate
between 2003 and 2002 was due primarily to a reduction in the 2002 provision to
reflect a federal loss carry back refund claim of approximately $212,000. During
the fourth quarter of 2002 and 2003 we received the final two payments of
$1,250,000 each under the financing agreement with our clearing firm. The 2002
payment was taxable in the year of receipt and the 2003 payment was deferred
until 2004. Previously recorded deferred tax assets were charged against that
income in both years. As of December 31, 2004 and 2003, other future tax
benefits have been entirely offset by a valuation allowance because, based on
the weight of available evidence, it is more likely than not that the recorded
deferred tax assets will not be realized in future periods.
For 2004, we reported a net income applicable to common stockholders of
$640,000, or $.07 per basic and .04 per diluted share, as compared to a net loss
applicable to common stockholders reported in 2003 of $3,543,000, or ($.40) per
basic and diluted share. For 2002, we reported a net loss applicable to common
stockholders of $3,060,000, or ($.36) per basic and diluted share.
Liquidity and Capital Resources
We maintain a highly liquid balance sheet with approximately 73% of assets
in 2004 and 72% of assets in 2003 consisting of cash and cash equivalents,
securities owned, and receivables from our clearing firm and other
broker-dealers. The balances in these accounts can and do fluctuate
significantly from day to day, depending on general economic and market
conditions, volume of activity, and investment opportunities. These accounts are
monitored on a daily basis in order to ensure compliance with regulatory net
capital requirements and to preserve liquidity.
Overall, cash and cash equivalents decreased for 2004 by $2,407,000. Net
cash used in operating activities during 2004 was $2,020,000, as a result of net
income of $731,000, adjusted by non-cash charges including depreciation and
amortization of property and equipment and deferred financing costs of $762,000
and the amortization of deferred income of $875,000. Cash was further reduced by
net decreases in commissions, accounts payable, accrued expenses and income
taxes payable of $2,227,000, an increase in our clearing receivable of $597,000
and securities owned of $201,000, offset by a decrease in employee and broker
receivables of $100,000, securities sold, not yet purchased of $105,000.
We received our fourth and final advance of $1,250,000 in November 2003
under the financing agreement with Fiserv.
Investing activities required cash of $212,000 in 2004 for additions to
capital expenditures. In 2003 investing activities consumed $139,000 for
additions to capital expenditures of $166,000, offset by decreases in other
assets of $27,000.
Financing activities in 2004 used $175,000 in cash primarily related to
capital leases and the repurchase of common shares. Financing activities
provided cash of $1,567,000 during the 2003 year. We received gross proceeds in
2003 of $2,105,000 from private offerings of our 6% convertible debentures. This
was partially offset by notes and capital lease repayments of $269,000, dividend
payments to preferred shareholders of $25,000 and a decrease in the cash portion
of deferred financing costs of $244,000.
28
In connection with the settlement agreement we entered into in July 2003,
regarding the settlement of eleven pending arbitration proceedings discussed
above, we issued 750,000 five-year warrants in three classes of 250,000 warrants
each. Class A warrants have an exercise price of $.40 per share; Class B and
Class C warrants have exercise prices of $.25 per share. The settlement
agreement provides that we may be obligated to make additional cash payments of
up to $600,000 in the event that claimants elect to exercise the warrants on
certain dates. Specifically, if a majority of then existing Class A warrant
holders elect to exercise the remaining warrants in their particular class
during the month of June 2004 (the "Required Exercise Event"), the claimants,
upon exercising their warrants, will be required to sell the shares in the open
market. If the warrants are exercised and the shares sold, we will pay to the
claimants up to an aggregate amount of $200,000 less the amount received by the
claimants from the sale of their shares, net of commissions. This process will
be repeated for remaining Class B and Class C warrant holders during the months
of June 2005 and June 2006, respectively. In June 2004, we redeemed all of the
outstanding Class A warrants by paying the claimants $200,000.
In the alternative, we may elect or be required to redeem the unexercised
warrants for up to $.80 per warrant, or a maximum of $200,000 per class,
depending upon the then prevailing market price of our common stock on or about
the date of the Required Exercise Event of a particular class. We may call a
warrant class for redemption if the average market price of the underlying
common shares during the ten trading days immediately preceding the date upon
which we receive notice that the warrant holders of a particular class have
elected to declare a Required Exercise Event is less than $1.20. We will be
required to redeem the warrants for $.80 per warrant in cash if the average
market price of the underlying common shares during the ten trading days
immediately preceding the date upon which we receive notice that the warrant
holders of a particular class have elected to declare a Required Exercise Event
is less than or equal to the warrant exercise price. In the event that warrant
holders of a particular class elect not to declare a Required Exercise Event,
our guarantee will be canceled with respect to that class.
Financing Activities
In 1999, we completed a private offering of Series A Convertible Preferred
Stock in connection with the settlement with holders of leases of Global
Financial Corp. 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 Common Stock and pays a
quarterly dividend of 6%. Pursuant to the offering, we issued an aggregate of
349,511 shares of Series A Preferred Stock. The offering was exempt from
registration pursuant to Sections 4(2) and 4(6) of the Securities Act of 1933,
as amended, and Regulation D, promulgated thereunder. Conversion of the Series A
Preferred Stock into shares of common stock amounted to 44,142 during the years
2001-2004, with 305,369 preferred shares remaining at December 31, 2004. We have
suspended the quarterly payments of our Series A Preferred Stock dividend in
accordance with applicable state law. (See Footnote 16 to the consolidated
financial statements).
In October 2002, we commenced a private offering of up to $3,000,000 of 6%
convertible debentures to accredited investors. Each debenture is convertible at
an initial conversion price of $0.50 per share, subject to adjustment for stock
dividends, combinations, splits, recapitalizations, and like events. Interest on
the debentures accrues at the rate of 6% per annum and is payable in cash on a
semi-annual basis on April 1st and October 1st of each year until maturity or
conversion. Each debenture is due and payable five (5) years from issuance,
unless previously converted into shares of Common Stock. The offering expired on
March 1, 2003. In the offering, we sold an aggregate amount of $1,240,000 of
debentures, $1,030,000 in 2002 and $210,000 in 2003. The proceeds of the
financing will be used to satisfy general working capital needs. Neither the
debentures nor the shares underlying the debentures have been registered for
offer or sale under the Securities Act; such securities are being issued on the
basis of the statutory exemption provided by Section 4(2) of the Securities Act,
as amended, and/or Rule 506 of Regulation D, promulgated thereunder relating to
transactions by an issuer not involving any public offering.
In September 2003, we commenced an additional private offering of up to
$3,000,000 of 6% convertible debentures to accredited investors. Each debenture
is convertible at an initial conversion price of $0.50 per share, subject to
adjustment for stock dividends, combinations, splits, recapitalizations, and
like events. Interest on the debentures accrues at the rate of 6% per annum and
is payable in cash on a semi-annual basis on April 1st and October 1st of each
year until maturity or conversion. Each debenture is due and payable five (5)
years from issuance, unless previously converted into shares of Common Stock.
The offering was completed on December 31, 2003. In the offering, we sold an
aggregate principal amount of $1,895,000 of debentures. The proceeds of the
financing will be used to satisfy general working capital needs. The debentures
have not been registered for offer or sale under the Securities Act; such
securities are being issued on the basis of the statutory exemption provided by
Section 4(2) of the Securities Act, as amended, and/or Rule 506 of Regulation D,
promulgated thereunder relating to transactions by an issuer not involving any
public offering. For more information, see a discussion of the debentures under
the captions "Item 1. Business -- Debenture Conversions."
29
Between October 2004 and March 2005 we received notices that holders of
$1,875,000 of convertible debentures that were sold through private offerings in
2002 and 2003, have elected to convert their debentures into shares of our
common stock in accordance with the terms of the debentures. As a result, we
have issued 3,750,000 shares of our common stock during that time period. As of
the date of this Annual Report, there is an aggregate principal amount of
$1,260,000 of convertible debentures outstanding. The debentures are convertible
at $.50 per share.
In connection with the Separation Agreement we entered into with Mr.
William Kurinsky, we issued him an aggregate of 197,824 shares of a newly
created class of Series B Preferred Stock, par value $0.10 per share, which will
have a deemed issue price of $1,000,000, and will be convertible into Common
Stock on the basis of ten shares of Common Stock for each share of Series B
Preferred Stock. The Series B Stock also provides that the Series B Preferred
shares have voting rights based upon the number of shares of Common Stock into
which it would be converted. The Series B Preferred Stock also includes a
cumulative dividend of 8% per year. The shares are restricted securities under
the Securities Act of 1933 and the regulations of the SEC and we relied upon the
exemption from registration under Section 4(2) of the Securities Act of 1933 to
issue the shares of Series B Preferred Stock.
Consolidated Contractual Obligations and Lease Commitments
The table below provides information about our commitments related to debt
obligations, leases, guarantees and investments as of December 31, 2004. This
table does not include any projected payment amounts related to our potential
exposure to arbitrations and other legal matters.
As of December 31, 2004
Expected Maturity Date
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
After
Category 2005 2006 2007 2008 2009 2009 Total
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
Debt Obligations(2) 0 0
0 $950,000 $2,065,000 0 $3,015,000
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
Capital Lease Obligations
$53,905 $8,555 0 0 0 0 $62,460
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
Operating Lease
Obligations $955,171 $830,130 $631,790 $609,149 $609,419 0 $3,635,389
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
Purchase Obligations 0 0 0 0 0 0 0
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
Other Long-Term
Obligations Reflected on
Balance Sheet under GAAP $200,000(1) $200,000(1) 0 0 0 0 $400,000(1)
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
Total $1,209,076 $1,038,685 $1,581,790 $2,674,149 $609,149 0 $7,112,849
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
(1) Maximum expected payment obligations embodied in the warrants subject to put
options. For more detailed information please refer to Footnote No. 10 of the
consolidated financial statements.
(2) Subsequent to the year end, certain debentures were converted. See footnote
9.
Net Capital
At December 31, 2004, Montauk Financial Group had net capital of
$1,992,574, which was $1,685,619 in excess of its required net capital of
$306,955, and the ratio of aggregate indebtedness to net capital was 2.31 to 1.
Off-Balance Sheet Arrangements
We execute securities transactions on behalf of our customers. If either
the customer or a counter-party fail to perform, we, by agreement with our
clearing broker, may be required to discharge the obligations of the
non-performing party. In such circumstances, we may sustain a loss if the market
value of the security is different from the contract value of the transaction.
We seek 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, our clearing firm requires
additional collateral or reduction of positions, when necessary. We also
complete credit evaluations where there is thought to be credit risk.
Critical accounting policies
We prepare our financial statements in accordance with accounting
principles generally accepted in the United States of America. Preparing
financial statements in accordance with generally accepted accounting principles
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities as
of the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. The following paragraphs include a
discussion of some of the significant accounting policies and methods applied to
the preparation of our consolidated financial statements. Review Note 2 to the
financial statements for further discussion of significant accounting policies.
30
Warrants subject to put options
We have issued common stock purchase warrants that embody obligations
requiring us to make cash redemption payments under certain circumstances. FAS
150 requires us to classify these financial instruments as liabilities and to
record them at fair value initially and at the end of subsequent reporting
periods. The valuation of the warrants involves the use of significant judgments
and assumptions. At December 31, 2004, we valued the warrants using the
discounted cash flow method, assuming, based on available evidence, that we will
be required to pay the full redemption liability. Actual results could differ
from these estimates as circumstances change.
Use of Estimates
In presenting the consolidated financial statements, management makes
estimates regarding the valuation of certain securities owned, the carrying
value of investments, the realization of deferred tax assets, the outcome of
litigation, and other matters that affect the reported amounts and disclosure of
contingencies in the financial statements. Estimates, by their nature, are based
on judgment and available information. Therefore, actual results could differ
from those estimates and could have a material impact on the consolidated
financial statements and it is possible that such changes could occur in the
near term.
Revenue recognition
Securities transactions, commission income, sales concessions from
participation in syndicated offerings and related expenses are recorded on a
trade date basis. Insurance and mutual fund commissions received from outside
vendors are recognized as income when received. 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. Advances received under our
financial agreement with our clearing firm are deferred and amortized over the
remaining term of the agreement on a straight-line basis.
Long-lived Assets
We evaluate impairment losses on long-lived assets used in operations,
primarily fixed assets, when events and circumstances indicate that the carrying
value of the assets, might not be recoverable in accordance with FASB Statement
No. 144 "Accounting for the Impairment or Disposal of Long-lived Assets". For
purposes of evaluating the recoverability of long-lived assets, the undiscounted
cash flows estimated to be generated by those assets would be compared to the
carrying amounts of those assets. If and when the carrying values of the assets
exceed their fair values, the related assets will be written down to fair value.
Clearing Agreement
Montauk Financial Group introduces all of its customer transactions, which
are not reflected in the financial statements, to its clearing broker, which
maintains the customers' accounts and clears such transactions. Additionally,
the clearing broker provides the clearing and depository operations for Montauk
Financial Group's proprietary securities transactions. These activities may
expose us to off-balance sheet risk in the event that customers do not fulfill
their obligations with the clearing broker, as Montauk Financial Group has
agreed to indemnify the clearing broker for any resulting losses. We will record
a loss from a client transaction when information becomes available to
management that allows it to estimate its impact on our financial statements.
Income taxes
Due to significant operating losses from 2001-2003 we have established a
valuation allowance against all of our deferred tax benefits as of December 31,
2004, and we intend to maintain it until we determine that it is more likely
than not that deferred tax assets will be realized. Our income tax expense
recorded in the future will be reduced to the extent of offsetting decreases in
our valuation allowance. The realization of our remaining deferred tax assets is
primarily dependent on forecasted future taxable income.
Recent pronouncements of the Financial Accounting Standards Board
In November 2004, the FASB issued Statement of Financial Accounting
Standards No. 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4"
("SFAS 151"), effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. This statement amends the guidance in Accounting
Research Bulletin (ARB) No. 43, Chapter 4, "Inventory Pricing" to clarify the
accounting for abnormal amounts of idle facility expense, freight, handling
costs and wasted material (spoilage). SFAS No. 151 requires that such items be
recognized as current period charges. In addition, this Statement requires that
allocation of fixed production overheads to the costs of conversion be based on
the normal capacity of the production facilities. This statement is not
applicable to the Company's current operations.
31
In December 2004, the FASB issued Statement No. 152, "Accounting for Real
Estate Time-Sharing Transactions". This statement amends SFAS No. 66 (Accounting
for Sales of Real Estate) and SFAS No. 67 (Accounting for Costs and Initial
Rental Operations of Real Estate Projects). This standard, which is effective
for financial statements for fiscal years beginning after June 15, 2005, is not
applicable to the Company's current operations.
In December 2004, the FASB issued SFAS No. 153 "Exchange of Non-monetary
Assets - an amendment of APB Opinion No. 29". Statement 153 eliminates the
exception for nonmonetary exchanges of similar productive assets and replaces it
with a general exception for exchanges of nonmonetary assets that do not have
commercial substance, defined as transactions that are not expected to result in
significant changes in the cash flows of the reporting entity. This standard,
which is effective for exchanges of nonmonetary assets occurring after June 15,
2005, is not applicable to the Company's current operations.
In December 2004, FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment"(SFAS 123 (revised 2004)"), effective as of the beginning of the first
interim or annual reporting period that begins after June 15, 2005. This
Statement is a revision of FASB Statement No. 123, "Account for Stock-Based
Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued
to Employees," and its related implementation guidance. SFAS 123 (revised 2004)
eliminates the alternative to use Opinion No. 25's intrinsic value method of
accounting that was provided in Statement 123 as originally issued. Under
Opinion 25, issuing stock options to employees generally resulted in recognition
of no compensation cost. This Statement requires entities to recognize the cost
of employee services received in exchange for awards of equity instruments based
on the grant-date fair value of those awards (with limited exceptions).
Recognition of that compensation cost helps users of financial statements to
better understand the economic transactions affecting an entity and to make
better resource allocation decisions. The Company will adopt SFAS 123 (revised
2004) for the quarter beginning July 1, 2005. The effect of the adoption of this
Statement has not yet been determined.
In accordance with the provisions of FAS 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity," we
have classified our obligations under the warrants as liabilities in the
Statement of Financial Condition. The fair value of the obligations embodied in
the warrants remaining were initially valued at $269,123 using the discounted
cash flow method, assuming, based on available evidence, that the Company will
be required to pay the full redemption liability. The Company measures the value
of the warrant obligations as of the end of each reporting period using the
discounted cash flow method until the obligations are settled. The recorded
value at December 31, 2004 was $333,261. Changes in value are recognized in
earnings as interest expense.
Impact of Inflation
We believe 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 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, or
has other adverse effects on the securities markets and the value of securities
held in inventory, it may adversely affect our financial position and results of
operations.
Risk Management
Risk is an inherent part of our business and activities. The extent to
which we properly and effectively identify, assess, monitor and manage the
various types of risk involved in our activities is critical to our soundness
and profitability. We seek to identify, assess, monitor and manage the following
principal risks involved in its business activities: market, credit, operational
and legal. Senior management takes an active role in the risk management process
and requires specific administrative and business functions to assist in the
identification, assessment and control of various risks. Our risk management
policies and procedures are subject to ongoing review and modification.
Market Risk. Certain of our business activities expose us 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 rating of issuers of debt securities.
This risk relates to financial instruments we hold as investment and for
trading. Securities inventories are exposed to risk of loss in the event of
unfavorable price movements. Securities positions are marked to market on a
daily basis. Market-making activities are client-driven, with the objective of
meeting clients' needs while earning a positive spread. At December 31, 2004 and
December 31, 2003, equity securities positions owned and sold, not yet purchased
were approximately $370,720 and $174,326, and $169,534 and $69,330,
respectively. In our view, 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 its financial position.
32
Credit Risk. Credit risk represents the loss that we would incur if a
client, counterparty or issuer of securities or other instruments that we hold
fails to perform its contractual obligations. Client activities involve the
execution, settlement, and financial of various transactions on behalf of its
clients. Client activities are transacted on either a cash or margin basis.
Client activities may expose us to off-balance sheet credit risk. We 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. We seek to control the risks
associated with client activities by requiring clients to maintain collateral in
compliance with various regulations and company policies.
Operational Risk. Operational risk generally refers to the risk of loss
resulting from our operations, including, but not limited to, improper or
unauthorized execution and processing of transactions, deficiencies in our
operating systems, business disruptions and inadequacies or breaches in our
internal control processes. We operate in diverse markets and rely on the
ability of our employees and systems to process high numbers of transactions
often within short time frames. In the event of a breakdown or improper
operation of systems, human error or improper action by employees, we could
suffer financial loss, regulatory sanctions or damage to our reputation. In
order to mitigate and control operational risk, we have developed and continue
to enhance policies and procedures that are designed to identify and manage
operational risk at appropriate levels. Included in our operational risk
management practice is disaster recovery for our critical systems. We believe
that our disaster recovery program, including off-site back-up technology and
operational facilities, is adequate to handle a reasonable business disruption.
However, there can be no assurances that a disaster directly affecting our
headquarters or operations center would not have a material adverse impact.
Insurance and other safeguards might only partially reimburse us for our losses.
Legal Risk. Legal risk includes the risk of non-compliance with applicable
legal and regulatory requirements. We are subject to extensive regulation in the
different jurisdictions in which we conduct our business. We have various
procedures addressing issues such as regulatory capital requirements, sales and
trading practices, use of and safekeeping of customer funds, credit granting,
collection activities, anti money-laundering and record keeping.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our activities often involve the purchase, sale or short sale of securities
as principal. Such activities subject our capital to significant risks from
markets that may be characterized by relative illiquidity or may be particularly
susceptible to rapid fluctuation in price or liquidity. Such market conditions
could limit our ability to resell securities purchased or to purchase securities
sold short. These activities subject our capital to significant risks, including
market, credit and liquidity risks. Market risk relates to the risk of
fluctuating values based on market prices without action on our part. Our
primary credit risk is settlement risk, which relates to whether counterparty
will fulfill its contractual obligations, such as delivery of securities or
payment of funds. Liquidity risk relates to our inability to liquidate assets or
redirect the deployment of assets contained in illiquid investments. Additional
information pertaining to the foregoing risks is included under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Risk Management."
33
Item 8. Financial Statements
See Financial Statements attached hereto at pages F-1 to F-25.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
On July 9, 2004, we dismissed Schneider & Associates, LLP as our
independent public accountants. The reports of Schneider & Associates on our
financial statements for each of the past two fiscal years, contained no adverse
opinion or disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principles. The decision to dismiss
Schneider & Associates was made and approved by the Audit Committee of the Board
of Directors on July 9, 2004. During our two most recent fiscal years and
through the date of our dismissal, we had no disagreements with Schneider &
Associates on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements if not
resolved to the satisfaction of Schneider & Associates would have caused the to
make reference to the subject matter of the disagreement in its report on our
financial statements for such years. During our two most recent fiscal years we
had no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K.
On July 9, 2004, we engaged Lazar, Levine & Felix LLP as our new
independent registered public accountants to audit our financial statements for
the fiscal year ended December 31, 2004. Prior to the engagement of Lazar, we
had not consulted with Lazar during our two most recent fiscal in any matter
regarding: (A) either the application of accounting principles to a specified
transaction, either completed or proposed, or the type of audit opinion that
might be rendered on our financial statements, and neither was a written report
provided to us nor was oral advice provided that Lazar concluded was an
important factor considered by us in reaching a decision as to the accounting,
auditing or financial reporting issue, or (B) the subject of either a
disagreement or a reportable event defined in Item 304(a)(1)(iv) and (v) of
Regulation S-K.
Item 9A. Controls and Procedures
Our management, including the President and the Chief Executive Officer and
Chief Financial Officer, carried out an evaluation of our disclosure controls
and procedures (as defined in Rule 15d-15(e) under the Securities Exchange Act
of 1934, as amended) as of the end of the period covered by this report. Based
on that evaluation, our President and our Chief Executive Officer and Chief
Financial Officer concluded that we had effective controls and procedures for
(i) recording, processing, summarizing and reporting information that is
required to be disclosed in its reports under the Securities Exchange Act of
1934, as amended, within the time periods specified in the Securities and
Exchange Commission's rules and forms and (ii) ensuring that information
required to be disclosed in such reports is accumulated and communicated to our
management, including our President and our Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding
disclosure.
No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the year
ended December 31, 2004 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
Item 9B. Other Information
None
34
PART III
Item 10. Directors and Executive Officers
Our directors and executive officers for the year ending December 31, 2005
are as follows:
Board Of Directors
Name Age Position
Herbert Kurinsky 73 Class I Director and Chairman of the Board of
Directors- First Montauk Financial Corp.
William J. Kurinsky 44 Class I Director, Vice-Chairman of the Board of
Directors- First Montauk Financial Corp.
Norma Doxey 66 Class II Director, First Montauk Financial Corp., and
Vice President of Operations, Montauk Financial Group
Ward R. Jones 73 Class III Director, First Montauk Financial Corp.
Barry D. Shapiro 63 Class II Director, First Montauk Financial Corp.
Executive Officers
Name Age Position
Victor K. Kurylak 48 President and Chief Executive Officer, First Montauk
Financial Corp. and Montauk Financial Group
Robert I. Rabinowitz 47 Executive Vice President, General Counsel and Secretary
-First Montauk Financial Corp., Montauk Financial Group
Mindy A. Horowitz 47 Acting Chief Financial Officer, Vice President of
Finance -First Montauk Financial Corp., Chief Financial
Officer, Treasurer, Fin.Op.- Montauk Financial Group
Our 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 our 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 our company (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 company which
is materially and demonstrably injurious to the company, 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.
35
Herbert Kurinsky, our Chairman, became a Director and the President of
First Montauk Financial Corp. on November 16, 1987. Mr. Kurinsky is a co-founder
of Montauk Financial Group. and has been its President, one of its Directors and
its Registered Options Principal since September of 1986. Effective January 1,
2004, Mr. Kurinsky relinquished his duties as our Chief Executive Officer. 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, serves as our Vice Chairman of the Board of Directors.
In 2004, Mr. Kurinsky served as our Chief Executive Officer, Vice Chairman,
Chief Financial Officer and Secretary. Mr. Kurinsky relinquished these offices
on February 8, 2005. Mr. Kurinsky previously served as our Vice President, a
Director and Chief Operating Officer, in addition to serving as Chief Financial
Officer and Secretary, since November 16, 1987. Mr. Kurinsky relinquished the
office of Chief Operating Officer and became our Chief Executive Officer and
Vice Chairman, effective January 1, 2004. He is a co-founder of Montauk
Financial Group 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.
Norma L. Doxey has been a member of our Board of Directors since December
6, 1988. Ms. Doxey has been a Vice President of Operations and a Registered
Representative with Montauk Financial Group since September 1986. From September
1986, she was operations 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 member of our Board of Directors 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.
Barry D. Shapiro, CPA has been a member of our Board of Directors 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 CPAs 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.
Victor K. Kurylak became our Chief Executive Officer on February 8, 2005,
and retains his position as President. From January 1, 2004, Mr. Kurylak was our
President and Chief Operating Officer through February 8, 2005. From January
2001 through December 2003, Mr. Kurylak was a self-employed business consultant,
and was retained by us prior to his becoming our President and Chief Operating
Officer. From November 1995 through December 2000 he was the owner and Executive
Vice President for Madison Consulting Group/Summit Insurance, an independent
insurance brokerage firm. From February 1990 through October 1995, Mr. Kurylak
was the Chief Information Officer for Rockefeller Financial Services in New York
City. Mr. Kurylak received his Bachelor of Sciences degree in Engineering from
Princeton University in 1979. Mr. Kurylak is registered as a general securities
representative and registered principal and is licensed as a life, health and
property and casualty insurance producer.
Robert I. Rabinowitz, Esq. has been our General Counsel since 1987. In
February 2005 he became our secretary, and retained the position of Executive
Vice President and General Counsel. Previously, he served as General Counsel of
Montauk Financial Group from 1986 until 1998 when a new general counsel was
named. Thereafter, he became the Chief Administrative Officer of Montauk
Financial Group 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.
36
Mindy A. Horowitz, CPA, was appointed acting Chief Financial Officer of
First Montauk Financial Corp. effective February 8, 2005. In January 2005, she
became the Chief Financial Officer and Financial and Operations Principal of
Montauk Financial Group. She had previously been Vice President of Finance for
Montauk Financial Group since September 1995. Prior to that, Ms. Horowitz was a
tax partner with and held other positions at the accounting firm of Broza, Block
& Rubino from 1981 through 1995 when she joined First Montauk Securities Corp.
Ms. Horowitz is a Certified Public Accountant.
Significant Employees
Mark D. Lowe, 46, 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, a Chartered Financial Planner (Chfc) in 2001 and a Chartered Life
Underwriter (CLU) in 2003. Mr. Lowe graduated Ocean County College in Toms
River, NJ. Mr. Lowe is the past President of the Estate and Financial Planning
Council of Central New Jersey.
Certain Reports
No person who, during the fiscal year ended December 31, 2004, was a
Director, officer or beneficial owner of more than ten percent of our common
stock (which is the only class of our securities registered under Section 12 of
the Securities Exchange Act of 1934 failed to file on a timely basis, reports
required by Section 16 of the Securities Exchange Act during the most recent
fiscal year or prior years. The foregoing is based solely upon our review of
Forms 3 and 4 during the most recent fiscal year as furnished us under Rule
16a-3(d) under the Securities Exchange Act, and Forms 5 and amendments thereto
furnished to us with respect to its most recent fiscal year, and any
representation received by us from any reporting person that no Form 5 is
required.
We believe that certain shareholders, including BMAC Corp. have failed to
comply with their reporting requirements under the Securities and Exchange Act
of 1934, including the requirement to file Forms 3 and 4 with respect to their
holdings and sale and purchases of our Common Stock. However, as a result of
these failures, we cannot ascertain with certainty the extent of any potential
failure to comply with the rules regarding these filings.
Compensation of Directors; Meetings of Directors
We pay our directors who are not also our employees 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. In 2004 the board authorized additional payments to our directors who
are not our employees, to include an annual payment of $5,000 payable in
quarterly installments. Members of the audit committee are also entitled to any
additional $750 per annum payment. Directors that are also our employees are not
entitled to any additional compensation as such. During fiscal year 2004, the
Board of Directors met on seven occasions and voted by unanimous written consent
on two occasions. No member of the Board of Directors attended less than 75% of
the aggregate number of (i) the total number of meetings of the Board of
Directors or (ii) the total number of meetings held by all Committees of the
Board of Directors.
37
Committees of the Board of Directors
The Board of Directors has two committees: Audit and Compensation. Our
Board of Directors currently consists of five individuals, two of whom are
independent directors as defined in Rule 4200(a)(154) of the listing standards
of the National Association of Securities Dealers. Our independent directors are
Ward R. Jones, Jr. and Barry D. Shapiro.
For the year ended December 31, 2004, the members of the committees, and a
description of the duties of the Committees were as follows:
Audit Committee. Our audit Committee acts to:
o review with management our finances, financial condition and
interim financial statements;
o review with our independent auditors the year-end financial
statements; and
o review implementation with the independent auditors and
management any action recommended by the independent auditors
and the retention and termination of our independent auditors.
During the fiscal year ended December 31, 2004, the audit committee met on
two occasions. One of those meeting was to approve the appointment of Lazar
Levine & Felix, LLP as our new auditing firm for fiscal year 2004. The audit
committee adopted a written charter governing its actions effective June 23,
2000. During the fiscal year, the members of the audit committee were Ward R.
Jones and Barry Shapiro. Both of the members of our audit committee were
"independent" within the definition of that term as provided by Rule
4200(a)(154) of the listing standards of the National Association of Securities
Dealers. The Board has determined that Mr. Barry D. Shapiro qualified as the
audit committee financial expert as defined under applicable Securities and
Exchange Commission rules. Mr. Barry Shapiro serves as chairman of this
committee.
Compensation Committee. The compensation committee functions include
administration of our 2002 Incentive Stock Option Plan and 1996 Senior
Management Option Plan and the negotiation and review of all employment
agreements with our executive officers. The compensation committees' members are
Ward R. Jones and Barry Shapiro. Mr. Ward Jones serves as chairman of this
committee. During the year ended December 31, 2004, the committee met on two
occasions.
Compensation Committee Interlocks and Insider Participation
There are no compensation committee interlocks between the members of our
compensation committee and any other entity. None of the members of the Board's
compensation committee are executive officers of our company. Mr. Jones is a
registered representative of our broker-dealer subsidiary, First Montauk
Securities Corp., but does not engage in any securities business.
38
Code of Ethics
On March 29, 2004, our Board of Directors approved the Code of Ethics and
Business Conduct for our company. Our Code of Ethics and Conduct covers all our
employees and Directors, including our Chief Executive Officer and Chief
Financial Officer and our President. A copy of our Code of Ethics and Conduct
was filed as Exhibit 14 to our annual report on Form 10-K for 2003. We did not
amend or waive any provisions of the Code of Ethics and Business Conduct during
the year ended December 31, 2004.
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 us during the years ended December 31, 2004,
2003 and 2002 to each of our named executive officers.
Long Term
Compensation Awards
No. of
Restricted Stock Securities
Fiscal Other Annual Award(s) Underlying
Name and Principal Position Year Salary Bonus Compensation Options/ SARs
Herbert Kurinsky 2004 $200,000 $ 42,570 $93,748 (2) 375,000 (1) 0
Chairman of the Board of Directors 2003 $231,218 $ 200,000 $ 2,500 (2) 0 0
- - FMFC (1) 2002 $181,218 $ 0 $ 2,500 (2) 0 0
William J. Kurinsky 2004 $300,000 $31,590 $97,269 (4) 375,000 (3) 0
Chief Executive and Chief Financial 2003 $231,218 $50,000 $ 0 (4) 0 0
Officer and Secretary - FMFC and 2002 $181,218 $ 0 $ 2,000 (4) 0 0
Montauk Financial Group (3)
Victor K. Kurylak, President and 2004 $250,000 $63,181 $65,356 (6) 250,000 (5) 500,000 (7)
Chief Opearting Officer, FMFC and
Montauk Financial Group (5)
Robert I. Rabinowitz 2004 $180,000 $25,000 $ 3,663 (9) 0 100,000 (10)
General Counsel - FMFC and Montauk 2003 $150,000 $10,000 $ 2,500 (9) 0 0
Financial Group (8) 2002 $150,000 $ 0 $ 2,500 (9) 0 0
Mindy A. Horowitz 2004 $125,000 $20,000 $ 3,663 (12) 0 0
Acting Chief Financial Officer, 2003 $125,000 $15,000 $ 2,500 (12) 0 100,000 (11)
FMFC, and Chief Financial Officer, 2002 $125,000 $ 0 $ 2,500 (12) 0 0
Fin. Op. Montauk Financial Group
(13)
1) Mr. Herbert Kurinsky is the beneficial owner of 461,518 shares of the
Company's Common Stock as of December 31, 2004, which shares had a market
value of $253,835 as of that date, without giving effect to the diminution
in value attributable to the restriction on said shares. In January 2004,
Mr. Herbert Kurinsky was issued 375,000 shares of restricted common stock
in conjunction with his employment agreement. The shares vest equally over
a three-year period on December 31, 2004, December 3, 2005 and December
2006.
2) Includes: (i) for 2004 stock compensation of $90,562 and an automobile
allowance of $3,186 (ii) for 2003, an automobile allowance of $2,500; and
(iii) for 2002, an automobile allowance of $2,500.
39
3) Effective February 8, 2005, Mr. William Kurinsky relinquished the office of
Chief Executive Officer. He is the beneficial owner of 1,780,823 shares of
the Company's Common Stock as of December 31, 2004, which shares had a
market value of $979,453 as of that date, without giving effect to the
diminution in value attributable to the restriction on said shares. In
January 2004, Mr. William J. Kurinsky was issued 375,000 shares of
restricted common stock in conjunction with his employment agreement. The
shares vest equally over a three-year period on December 31, 2004, December
3, 2005 and December 2006. In February 2005, we issued 197,824 shares of
newly created Series B Preferred Stock valued at $1,000,000 to Mr. William
Kurinsky pursuant to the terms of a Separation Agreement as discussed below
in greater detail. Mr. Kurinsky's previously granted options to purchase
325,000 shares of our common stock with exercise prices of $0.83 to $2.00
per share have been cancelled. Mr. Kurinsky, in connection with his
services as a consultant, will receive new options to purchase an aggregate
of 200,000 shares of Common Stock with an exercise price of $0.83 per
share. The new options will have a three-year exercise term. Mr. Kurinsky's
existing restricted stock grant of 250,000 common shares are also
immediately vested.
4) Includes: (i) for 2004 stock compensation of $90,526, commission of $2,142
and an automobile allowance of $4,565 (ii) for 2003 no automobile allowance
was paid, (iii) for 2002, an automobile allowance of $2,000.
5) Mr. Victor K. Kurylak is the beneficial owner of 250,000 shares of the
Company's Common Stock as of December 31, 2004, which shares had a market
value of $137,500 as of that date, without giving effect to the diminution
in value attributable to the restriction on said shares. In February 2005
we issued 1,000,000 restricted shares of common stock pursuant to the terms
of his new employment agreement. These shares were granted to Mr. Kurylak
pursuant to the terms of his new employment agreement as discussed below in
greater detail.
6) Includes: for 2004 stock compensation of $60,375 and an automobile
allowance of $4,981.
7) In 2004 the Compensation Committee authorized an option grant to Mr. Victor
K. Kurylak to purchase 250,000 shares of Common Stock at an exercise price
of $.75 per share for 5 years, and an option grant to purchase 250,000
shares of Common Stock at an exercise price of $.50 per share for 5 years.
Mr. Kurylak returned the option grant exercisable at $.75 in February 2005
in conjunction with a new employment agreement, as discussed in greater
detail below.
8) Mr. Robert I. Rabinowitz is the beneficial owner of 29,500 shares of the
Company's Common Stock as of December 31, 2004, which shares had a market
value of $16,225 as of that date, without giving effect to the diminution
in value attributable to the restriction on said shares. Subsequent to the
fiscal year ended December 31, 2004, we granted the named executive officer
the right to receive an aggregate of 100,000 restricted shares of common
stock, which vest in equal amounts of 33.3%, on February 1, 2005, February
1, 2006 and February 1, 2007. These shares were granted to Mr. Rabinowitz
pursuant to the terms of his new employment agreement as discussed below in
greater detail.
9) Includes: (i) for 2004, an automobile allowance of $3,663 (ii) for 2003, an
automobile allowance of $2,500; and (ii) for 2002, an automobile allowance
of $2,500.
10) In 2004 the Compensation Committee authorized an option grant to Mr. Robert
Rabinowitz to purchase 100,000 shares of common stock at an exercise price
of $.50 for five years. In 2001, the Committee authorized an option grant
to Mr. Rabinowitz to purchase 43,750 shares of Common Stock at an exercise
price of $1.50 per share for 5 years.
11) In 2003 the Compensation Committee authorized an option grant to Ms. Mindy
Horowitz to purchase 100,000 shares of common stock at an exercise price of
$.50 for five years.
12) Includes: (i) for 2004, an automobile allowance of $3,663 (ii) for 2003, an
automobile allowance of $2,500; and (ii) for 2002, an automobile allowance
of $2,500.
13) Subsequent to the fiscal year ended December 31, 2004, we granted the named
executive officer the right to receive an aggregate of 100,000 restricted
shares of common stock, which vest in equal amounts of 33.3%, on February
1, 2005, February 1, 2006 and February 1, 2007. These shares were granted
to Ms. Horowitz pursuant to the terms of her new employment agreement as
discussed below in greater detail.
40
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table contains information with respect to the named
executive officers concerning options granted during the year ended December 31,
2004.
INDIVIDUAL GRANTS
Potential Realizable Value
At Assumed Annual Rates of
Stock
Price Appreciation For
Option
Term
Percent of
Number of Total
Securities Option/
Underlying SARs Granted Exercise of
Option/SARs To Employees Base Price Expiration
Name Granted (#) In Fiscal Year (S/Sh) Date
(a) (b) (c) (1) (d) (c)
5% ($) 10% ($)
(f) (g)
Victor K. Kurylak 250,000 28% $0.50 12/31/08 $19,375 $26,250
Victor K. Kurylak 250,000 28% $0.75 12/31/08 $0 $0
(2)
Robert I. Rabinowitz 100,000 11% $0.50 2/16/09 $7,750 $10,500
(1) Includes options granted to non-employee registered representatives
under the 2002 Incentive Stock Option Plan, as amended.
(2) In February 2005 Mr. Kurylak surrendered these options pursuant to a new
employment agreement.
41
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, 2004 December 31, 2004 (1)
---- -------- -------- ----------------- ---------------------
Exercisable/Unexercisable Exercisable/Unexercisable
Herbert Kurinsky -- $0 325,000/0 $0/$0
William J. Kurinsky (2) -- $0 200,000/0 $0/$0
Victor K. Kurylak (3) -- $0 500,000/0 $12,500/$0
Robert I. Rabinowitz -- $0 203,750/0 $5,000/$0
Mindy A. Horowitz -- $0 100,000/0 $5,000/$0
- ----------------------
(1) Based upon the closing bid price of our common stock on December 31, 2004 ($.55 per share), less the exercise
price for the aggregate number of shares subject to the options.
(2) In February 2005, Mr. William J. Kurinsky surrendered 325,000 options and was awarded a new option grant for 200,000
options exercisable at $.83 per share for five years.
(3) In February 2005 Mr. Kurylak surrendered 250,000 options to purchase common stock at $.75 per share.
Employment Agreements and Separation Agreement
In January 2004, we entered into employment agreements with Herbert
Kurinsky, William J. Kurinsky and Victor K. Kurylak, as our Chairman of the
Board, Chief Executive Officer and President and Chief Operating Officer,
respectively. In February 2005 Mr. William J. Kurinsky stepped down as our Chief
Executive Officer and Victor K. Kurylak was appointed Chief Executive Officer
pursuant to a new three-year employment agreement, as described below.
Herbert Kurinsky
Pursuant to his employment agreement, Mr. Herbert Kurinsky resigned as Chief
Executive Officer and remained as our Chairman. This agreement, which will
expire on December 31, 2006, provides for a base salary of $200,000 for each
year of the agreement. The agreement automatically renews for an additional
one-year term, unless we elect not to renew it. Mr. Kurinsky will also be
entitled to receive a portion of a bonus pool consisting of 15% of our pre-tax
profits, to be determined by our compensation committee. The bonus pool would
require a minimum of $500,000 pretax profit per year in order to become
effective. He is also entitled to receive commissions at the same rate as paid
to our other non-affiliate registered representatives. Mr. Kurinsky is also
entitled to a portion of the finance pool as defined as, up to 20% of all
underwriters and/or placement agent warrants or options that are granted to
Montauk Financial Group upon the same price, terms and conditions afforded to
Montauk Financial Group as the underwriter or placement agent, but not to exceed
50% of what is retained by Montauk Financial Group after issuance to the
registered representatives who participated in the placements. Mr. Kurinsky also
receives health insurance benefits and life insurance as generally made
available to our regular full-time employees, and reimbursement for expenses
incurred on our behalf and the use of an automobile, or in the alternative, an
automobile allowance. The contracts also provide for a severance of one years
salary in the event Mr. Kurinsky's employment is terminated without cause or the
contract is not renewed and a severance benefit equal to three times the five
year average compensation paid to him in the event Mr. Kurinsky is terminated
after a change in our control as defined in the agreement. As additional
compensation under the agreement, we granted Mr. Kurinsky the right to receive
an aggregate of 375,000 restricted shares of common stock, which vest in equal
amounts of 33.3%, on December 31, 2004, December 31, 2005 and December 31, 2006.
William J. Kurinsky
Pursuant to his 2004 employment agreement, Mr. William J. Kurinsky was appointed
as our Chief Executive Officer, remained as our Chief Financial Officer and a
director and relinquished his positions as Executive Vice President and Chief
Operating Officer. This agreement provided for a base salary of $300,000 for
each year of the agreement. On February 8, 2005 we entered into a Separation
Agreement with William J. Kurinsky, which provides for Mr. Kurinsky to terminate
his employment with us effective on that date. Under the terms of the Separation
Agreement, Mr. Kurinsky has relinquished his position as our Chief Executive
Officer and that of our subsidiaries, including our broker dealer subsidiary
First Montauk Securities Corp. Mr. Kurinsky will remain as a member of our board
of directors.
The Separation Agreement includes the following provisions:
o Mr. Kurinsky's employment agreement dated January 1, 2004, which had a
term set to expire in December 2008, was terminated in full.
42
o Mr. Kurinsky was retained as a consultant to the Registrant for a term of
two years with consulting fee of approximately $12,600 per month.
o Mr. Kurinsky was issued an aggregate of 197,824 shares of a newly created
class of Series B Preferred Stock, par value $0.10 per share, which will have a
deemed issue price of $1,000,000, and will be convertible into Common Stock on
the basis of ten shares of Common Stock for each share of Series B Preferred
Stock. The Series B Stock also provides that the Series B Preferred shares have
voting rights based upon the number of shares of Common Stock into which it
would be converted. The Series B Preferred Stock also includes a cumulative
dividend of 8% per year.
o We will issue to Mr. Kurinsky a promissory note in the principal amount
of $200,000 payable in one year and bearing interest at 8% per annum.
o We will make a lump sum cash payment to Mr. Kurinsky in the amount of
$136,000.
o Mr. Kurinsky's existing options to purchase 325,000 shares of our common
stock with exercise prices of $0.83 to $2.00 per share have been cancelled. Mr.
Kurinsky, in connection with his services as a consultant, will receive new
options to purchase an aggregate of 200,000 shares of Common Stock with an
exercise price of $0.83 per share. The new options will have a three-year
exercise term. Mr. Kurinsky's existing restricted stock grant of 250,000 common
shares also immediately vested.
o We will continue to pay for the benefits such as health and medical plans
that Mr. Kurinsky was otherwise entitled to under his employment agreement for a
period of 24 months.
o Mr. Kurinsky will be entitled to receive his portion of the securities
that he would have been entitled to under our corporate finance bonus pool and
also his pro rata bonus which he had been entitled to under his employment
agreement through his date of termination.
Victor K. Kurylak
Pursuant to his 2004 employment agreement, Mr. Victor K. Kurylak was hired as
our President and Chief Operating Officer. In connection with Mr. Kurinsky's
termination as the Chief Executive Officer, the Board approved the appointment
of Mr. Victor K. Kurylak as the our Chief Executive Officer. The Board also
approved a new employment agreement for Mr. Kurylak and the issuance, as a bonus
payment for our performance for the year ended December 31, 2004, and in
consideration of Mr. Kurylak assuming the position of Chief Executive Officer,
1,000,000 shares of our common stock. His prior agreement entered into effective
January 1, 2004 was terminated. Mr. Kurylak agreed to the cancellation of
250,000 of his outstanding stock options with an exercise price of $0.75 per
share. The 1,000,000 shares vest in annual increments of one third commencing on
February 1, 2005. In the event of a change of control of the Company, all
unvested shares would vest.
Under the terms of Mr. Kurylak's employment agreement, which has a term of three
years expiring December 31, 2007 and is effective as of February 8, 2005, Mr.
Kurylak receives a base salary of $275,000 per year, subject to annual increases
of 10% provided the Registrant has net profits of at least $500,000 per annum.
In addition, Mr. Kurylak is entitled to receive medical and other benefits that
we have is effect for its executives, as well as other benefits and automobile
expenses. Mr. Kurylak is entitled to participate in the Registrant's executive
bonus pool which has been established by the Board to constitute 15% of our net
pre tax profit and would receive a bonus from such pool as determined by the
Compensation Committee. Further, Mr. Kurylak is also entitled to a portion of
the finance pool as defined as, up to 20% of all underwriters and/or placement
agent warrants or options that are granted to Montauk Financial Group upon the
same price, terms and conditions afforded to Montauk Financial Group as the
underwriter or placement agent, but not to exceed 50% of what is retained by
Montauk Financial Group after issuance to the registered representatives who
participated in the placements. In the event of termination without cause, Mr.
Kurylak would be entitled to a severance payment consisting of accrued
compensation, continuation of his benefits and payment of his base salary for a
period of the greater of three months or the unexpired term.
43
Other Executive Officers
In 2005 we also entered into new employment agreements with three senior
executive officers, namely, Robert Rabinowitz, Mindy Horowitz and Brian Cohen.
Mr. Rabinowitz serves as Executive Vice President, General Counsel and
Secretary; Ms. Horowitz serves as Chief Financial Officer and Mr. Cohen serves
as Senior Vice President-Information Systems. The Board also approved restricted
stock awards to each of these persons, of 100,000 shares as a performance bonus
award and as an incentive to continue their employment with us. The agreements
are for one-year terms ending February 8, 2006 and are renewable for successive
one year terms unless we provide 120 prior notice of our intention not to renew
the agreements.
Mr. Rabinowitz will receive a base salary of $190,000 per year and is eligible
to participate in our bonus and option plans, receives health and benefits as
provided to our executives and is entitled to a car allowance. In the event of
termination of his employment without cause, Mr. Rabinowitz would be entitled to
receive a severance payment equal to the sum of (i) one year's salary and (ii)
his portion of the bonus pool payments he would otherwise be entitled to and
(iii) payment of the costs of health and other benefits for 12 months.
The agreements with Ms. Horowitz and Mr. Cohen have similar terms except that
Ms. Horowitz receives a base salary of $140,000 and Mr. Cohen receives a base
salary of $130,000.
Incentive Stock Option Plan
In June 2002, we adopted the 2002 Incentive Stock Option Plan, which
provides for the grant of options to purchase up to 5,000,000 shares of our
common stock by our employees, registered representatives and consultants. Under
the terms of the Incentive Plan, options granted thereunder may be designated as
options which qualify for incentive stock option treatment under Section 422A of
the Code, or options which do not so qualify.
The Plan is administered by our 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 Incentive Stock
Options or Non-Incentive Stock Options; 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 Incentive Plan and to establish and amend
rules and regulations relating thereto.
Under the Incentive Plan, the exercise price of an option designated as an
Incentive Stock Option 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 Incentive Stock Option is granted to a ten percent stockholder
such exercise price shall be at least 110% of such fair market value. Exercise
prices of Non-Incentive Stock 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 Incentive Stock Options 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 Incentive Plan will expire in 2012.
Effective as of the date of this Annual Report, since the adoption of the
2002 Incentive Plan, we have issued 1,135,600 options to registered
representatives and employees which have not been exercised or cancelled. There
remain 425,732 options outstanding from our 1992 Incentive Stock Option Plan,
resulting in a total of 1,561,332 options outstanding.
Director Plan
In June 2002, we adopted the Non-Executive Director Stock Option Plan (the
"Director Plan"). 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. A Non-Executive Director who has not served as a
director for an entire year prior to September 1st of each year shall receive a
pro rata number of options determined as follows:
Date of Membership Options Granted
- ------------------ ---------------
September 1 through November 30 20,000
December 1 through February 28 15,000
March 1 through May 30 10,000
June 1 through August 31 5,000
44
Options are granted under the Director Plan until 2012 to non-executive
directors who are not our full time employees.
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 Director 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 our common stock 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 two persons who are our officers (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 120,000 options have been granted to our Non-Executive members
of the Board of Directors under the 2002 Plan. An additional 40,000 options
remain outstanding from grants made pursuant to the 1992 Non-Executive Director
Stock Option Plan, which terminated in June 2002, and which was replaced by the
2002 Non-Executive Director Stock Option Plan.
Senior Management Plan
In 1996, we 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 Management Plan or grants of restricted stock or incentive stock rights. The
Board of Directors or a committee of the board may grant awards under the
Management Plan to executive management employees, if one is appointed for this
purpose. The Management Plan provides for four types of awards: stock options,
incentive stock rights, stock appreciation rights, and restricted stock purchase
agreements. The stock options granted under the Management Plan can be either
incentive stock options or non-incentive stock options, similar to the options
granted under the Incentive Plan, except that the exercise price of
non-Incentive Stock Option 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 us. 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 stock appreciation rights, which become
exercisable upon a "change of control" of our company. A change of control
includes the purchase by any person of 25% or more of the voting power of our
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 our company. Awards under
the Management Plan may be made until 2006.
In June 2000, at our 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. Options to purchase
812,500 shares of our common stock are currently outstanding under the Senior
Management Plan. In January 2004 we granted an aggregate of 1,000,000 restricted
shares of common stock to Mr. Herbert Kurinsky, Mr. William J. Kurinsky and Mr.
Victor K. Kurylak, pursuant to their employment agreements. In February 2005 we
granted an aggregate of 1,300,000 restricted shares of common stock to Mr.
Victor K. Kurylak, Mr. Robert I. Rabinowitz, Ms. Mindy A. Horowitz and Mr. Brian
M. Cohen, pursuant to their employment agreements.
45
Item 12. Security Ownership of Certain
Beneficial Owners and Management
The following table sets forth certain information as of March 31, 2005
with respect to (i) each director and each executive officer, (ii) all directors
and officers as a group, and (iii) the persons (including any "group" as that
term is used in Section l3(d)(3) of the Securities Exchange Act of l934), known
by us to be the beneficial owner of more than five (5%) percent of our common
stock. Shares of common stock subject to options exercisable within 60 days from
the date of this table are deemed to be outstanding and beneficially owned for
purposes of computing the percentage ownership of such person but are not
treated as outstanding for purposes of computing the percentage ownership of
others.
Directors, Officers Amount and Percentage
and 5% Shareholders (1) Of Beneficial Ownership (1)
----------------------- ---------------------------
Number of Shares Percent
Herbert Kurinsky
Parkway 109 Office Center
328 Newman Springs Road
Red Bank, NJ 07701 661,518(2) 4.3%
William J. Kurinsky
Parkway 109 Office Center
328 Newman Springs Road
Red Bank, NJ 07701 3,959,063(3) 21.5%
Victor K. Kurylak
Parkway 109 Office Center
328 Newman Springs Road 1,500,000(4) 8.2%
Red Bank, NJ 07701
Robert I. Rabinowitz, Esq.
Parkway 109 Office Center
328 Newman Springs Road
Red Bank, NJ 07701 273,250(5) 1.8%
Mindy A. Horowitz
Parkway 109 Office Center
328 Newman Springs Road
Red Bank, NJ 07701 200,000(6) 1.1%
Ward R. Jones
300 West Jersey Road
Lehigh Acres, FL 33936 110,000(7) *
Norma Doxey
Parkway 109 Office Center
328 Newman Springs Road 124,900(8) *
Red Bank, NJ 07701
Barry Shapiro, CPA
Parkway 109 Office Center
328 Newman Springs Road 60,000(9) *
Red Bank, NJ 07701
BMAC Corp.
502 E. John Street
Carson City, NV 89706 1,965,500(10) 10.7%
All Directors and Officers
as a group (8 persons in
number) (2, 3, 4, 5, 6, 7,
8 and 9) 7,073,731 38.5%
- ------------------------------------------
* Indicates less than 1%
46
(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 200,000 shares of common stock. Amounts and percentages
indicated for Mr. Kurinsky include an aggregate of 375,000 shares of
restricted common stock, which shares vest in equal amounts of 33.3%, on
December 31, 2004, December 31, 2005 and December 31, 2006.
(3) Includes vested and presently exercisable options of Mr. William J.
Kurinsky to purchase 200,000 shares of common stock. Amounts and
percentages indicated for Mr. Kurinsky also include an aggregate 1,978,240
shares of common stock issuable upon conversion of 197,824 shares of Series
B Convertible Redeemable Preferred Stock.
(4) Amounts and percentages indicated for Mr. Kurylak include an aggregate of
1,250,000 restricted shares of restricted common stock and options to
purchase 250,000 shares of common stock, all of which securities vest in
equal amounts over a three-year period commencing: a) on December 31, 2004,
December 31, 2005 and December 31, 2006 with respect to 250,000 common
shares and 250,000 options, and b) on February 1, 2005, February 1, 2006
and February 1, 2007 with respect to 1,000,000 shares of common stock.
(5) Includes vested and presently exercisable options of Mr. Robert Rabinowitz
to purchase 143,750 shares of common stock. Amounts and percentages
indicated for Mr. Rabinowitz include an aggregate of 100,000 shares of
restricted common stock, which shares vest in equal amounts of 33.3%, on
February 1, 2005, February 1, 2006 and February 1, 2007. Mr. Rabinowitz's
children own 2,000 shares of common stock.
(6) Includes vested and presently exercisable options of Ms. Mindy Horowitz to
purchase 100,000 shares of common stock. Amounts and percentages indicated
for Ms. Horowitz include an aggregate of 100,000 shares of restricted
common stock, which shares vest in equal amounts of 33.3%, on February 1,
2005, February 1, 2006 and February 1, 2007.
(7) Includes vested and presently exercisable options of Mr. Ward Jones to
purchase 100,000 shares of common stock. (8) Includes vested and presently
exercisable options of Ms. Norma Doxey to purchase 112,500 shares of common
stock. (9) Includes vested and presently exercisable options of Mr. Barry
Shapiro to purchase 60,000 shares of common stock. 10) As reported under
Schedule 13D filing made by BMAC Corp. dated October 1, 2004 as amended on
March 4, 2005.
Equity Compensation Plan Information
The following table provides information about our common stock that may be
issued upon the exercise of options and rights under all of our existing equity
compensation plans as of December 31, 2004, including the 2002 Incentive Stock
Option Plan, the 2002 Non-Executive Director Stock Option Plan, the 1992
Incentive Stock Option Plan, as amended, the 1992 Non-Employee Director Stock
Option Plan, as amended and the 1996 Senior Management Stock Option Plan, as
amended. Information concerning each of the aforementioned plans is set forth
below following the caption "Shareholder Approved Option Plans." Each of the
1992 Incentive Stock Option Plan and 1992 Non-Executive Director Stock Option
Plan has expired and no additional options may be granted under such plans.
Unexpired options granted pursuant to such plans prior to their expiration,
however, remain exercisable (when vested) until the expiration of the individual
option grant.
============================== =========================== =========================== ==============================
Number of Securities
Remaining Available for
Future Issuance Under
Number of Securities to Equity Compensation
be Issued upon Exercise Weighted Average Plans Excluding
of Outstanding Options Exercise Price of Securities reflected in
and Rights Outstanding Options Column (a)
Plan Category (a) (b) (c)
============================== =========================== =========================== ==============================
- ------------------------------ --------------------------- --------------------------- ------------------------------
Equity Compensation Plans 2,924,498(1) $1.01 4,707,700(2)(3)
Approved by Stockholders
- ------------------------------ --------------------------- --------------------------- ------------------------------
Equity Compensation Plans N/A N/A N/A
Not Approved by Stockholders
- ------------------------------ --------------------------- --------------------------- ------------------------------
Total 2,924,498(1) $1.01 4,707,700(2)(3)
- ------------------------------ --------------------------- --------------------------- ------------------------------
47
1. Includes 1,168,600 options issued pursuant to the our 2002 Incentive Stock
Option Plan, 473,398 options issued pursuant to our 1992 Incentive Stock
Option Plan, as amended, 120,000 options issued pursuant to our 2002
Director Stock Option Plan, 40,000 options issued pursuant to our 1992
Director Stock Option Plan, as amended, and 1,122,500 options and shares
issued pursuant to our 1996 Senior Management Stock Option Plan, as
amended.
2. Includes 3,690,200 options available for issuance under our 2002 Incentive
Stock Option Plan and an aggregate of 577,500 shares reserved for issuance
as options, incentive stock rights or pursuant to restricted stock purchase
agreements under our 1996 Senior Management Stock Option Plan, as amended.
3. Includes 440,000 options assumed available for issuance under our 2002
Directors Stock Option Plan. We expect to have three outside directors,
each of whom will receive 20,000 options over the ten years of the plan.
Item 13. Certain Relationships and Related Transactions
For information concerning the terms of the employment agreements entered
into between us and Messrs. Herbert Kurinsky, William J. Kurinsky, Victor K.
Kurylak, Robert I. Rabinowitz and Ms. Mindy A. Horowitz, and the Separation
Agreement entered into with William J. Kurinsky, see "Executive Compensation".
Item 14. Principal Accountant Fees and Service.
Our Audit Committee has selected Lazar Levine & Felix LLP, Certified Public
Accountants, as its independent accountants for the current fiscal year. The
audit services provided by Lazar Levine & Felix LLP consist of examination of
financial statements, services relative to filings with the Securities and
Exchange Commission, and consultation in regard to various accounting matters.
Our former accountants, Schneider & Associates, LLP, audited our 2003 financial
statements. The following table presents the total fees paid for professional
audit and non-audit services rendered by our independent auditors for the audit
of our annual financial statements to Lazar Levine & Felix LLP for the year
ended December 31, 2004 and to Schneider & Associates, LLP for the year ended
December 31, 2003, and fees billed for other services rendered by our
independent auditors during those periods.
- ---------------------------------------- ------------------------------------- -------------------------------------
Fiscal Year Ended December 31, 2004 Fiscal Year Ended
December 31, 2003
- ---------------------------------------- ------------------------------------- -------------------------------------
Audit Fees (1) $185,035 $149,000
- ---------------------------------------- ------------------------------------- -------------------------------------
Audit-Related Fees (2) $0 $5,025
- ---------------------------------------- ------------------------------------- -------------------------------------
Tax Fees (3) $11,600 $29,300
- ---------------------------------------- ------------------------------------- -------------------------------------
All Other Fees (4) $24,960 $12,000
- ---------------------------------------- ------------------------------------- -------------------------------------
Total $221,595 $195,325
- ---------------------------------------- ------------------------------------- -------------------------------------
- -------------------------
(1) Audit services consist of audit work performed in the preparation of
financial statements for the fiscal year and for the review of financial
statements included in Quarterly Reports on Form 10-Q during the fiscal
year, as well as work that generally only the independent auditor can
reasonably be expected to provide, including consents for registration
statement flings and responding to SEC comment letters on annual and
quarterly filings.
(2) Audit-related services consist of assurance and related services that are
traditionally performed by the independent auditor, including due diligence
related to mergers and acquisitions, agreed upon procedures report and
accounting and regulatory consultations.
(3) Tax services consist of all services performed by the independent auditor's
tax personnel, except those services specifically related to the audit of
the financial statements, and includes fees in the areas of tax compliance,
tax planning, and tax advice.
(4) Other services consist of those service not captured in the other
categories.
48
Our Audit Committee has determined that the services provided by our
independent auditors and the fees paid to them for such services has not
compromised the independence of our independent auditors.
Consistent with SEC policies regarding auditor independence, the Audit
Committee has responsibility for appointing, setting compensation and overseeing
the work of the independent auditor. In recognition of this responsibility, the
Audit Committee has established a policy to pre-approve all audit and
permissible non-audit services provided by the independent auditor. Prior to
engagement of the independent auditor for the next year's audit, management will
submit a detailed description of the audit and permissible non-audit services
expected to be rendered during that year for each of four categories of services
described below to the Audit Committee for approval. In addition, management
will also provide to the Audit Committee for its approval a fee proposal for the
services proposed to be rendered by the independent auditor. Prior to the
engagement of the independent auditor, the Audit Committee will approve both the
description of audit and permissible non-audit services proposed to be rendered
by the independent auditor and the budget for all such services. The fees are
budgeted and the Audit Committee requires the independent auditor and management
to report actual fees versus the budget periodically throughout the year by
category of service.
During the year, circumstances may arise when it may become necessary to
engage the independent auditor for additional services not contemplated in the
original pre-approval. In those instances, the Audit Committee requires separate
pre-approval before engaging the independent auditor. To ensure prompt handling
of unexpected matters, the Audit Committee may delegate pre-approval authority
to one or more of its members. The member to whom such authority is delegated
must report, for informational purposes only, any pre-approval decisions to the
Audit Committee at its next scheduled meeting. The four categories of services
provided by the independent auditor are as defined in the footnotes to the fee
table set forth above.
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) 1. Financial Statements
See the Consolidated Financial Statements and Notes thereto, together with
the reports thereon of Lazar Levine & Felix, LLP dated March 18, 2005 beginning
on page F-1 of this report.
2. Schedules
Valuation and Qualifying Accounts
- --------------------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- --------------------------------------------------------------------------------------------------------------------------------
Charged
Balance at (credited) to Charged to Balance at
beginning to costs and other end
Description of period expenses accounts Deductions of period
- --------------------------------------- -------------------------------------------------------------------------------
Deferred tax assets:
Year ended December 31, 2004 $ 5,381,000 $ (260,000) $5,121,000
Year ended December 31, 2003 3,723,131 1,657,869 5,381,000
Year ended December 31, 2002 2,393,456 1,329,675 3,723,131
Broker loan reserves:
Year ended December 31, 2004 $ 1,805,322 (402,691) $1,402,631
Year ended December 31, 2003 1,699,395 105,927 1,805,322
Year ended December 31, 2002 826,809 872,586 1,699,395
3. Exhibits
Incorporated by reference to the Exhibit Index at the end of this report.
49
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/ Victor K. Kurylak
--------------------------------------
Dated: March 31, 2005 Victor K. Kurylak
Chief Executive Officer and President
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 March 31, 2005
- ---------------------------------
Herbert Kurinsky,
Chairman
/s/ William J. Kurinsky March 31, 2005
- ---------------------------------
William J. Kurinsky,
Vice Chairman, Director
/s/ Mindy A. Horowitz March 31, 2005
- ---------------------------------
Mindy A. Horowitz, Acting Chief
Financial Officer and Principal
Accounting Officer
/s/ Norma Doxey March 31, 2005
- ---------------------------------
Norma Doxey, Director
/s/ Ward R. Jones, Jr. March 31, 2005
- ---------------------------------
Ward R. Jones, Jr., Director
/s/ Barry Shapiro March 31, 2005
- ---------------------------------
Barry Shapiro, Director
50
EXHIBIT INDEX
The exhibits designated with an asterisk (*) are filed herewith. All other
exhibits have been previously filed with the Commission and, pursuant to 17
C.F.R. ss.230.411, are incorporated by reference to the document referenced in
brackets following the descriptions of such exhibits.
- -------------------- ----------------------------------------------------------------------------------------
Exhibit No. Description
2.1 Agreement and Plan of Merger dated as of February 10, 2005 by and among First
Montauk Financial Corp., Olympic Cascade Financial Corp. and FMFC Acquisition
Corporation (Previously filed as Exhibit 10.1 to our Current Report on Form 8-K dated
February 11, 2005).
3.1 Amended and Restated Certificate of Incorporation adopted at 1989 Special Meeting in
lieu of Annual Meeting of Shareholders (Previously filed with the Commission as an
exhibit to our Registration Statement on Form S-l, File No. 33-24696).
3.2 Amended and Restated By-Laws (Previously filed with the Commission as an exhibit to
our Registration Statement on Form S-l, File No. 33-24696).
3.3 Certificate of Designations of Series A Preferred Stock. (Previously filed with the
Commission as an exhibit to our Annual Report on Form 10-K for the fiscal year ended
December 31, 2002).
3.4 Form of Certificate of Amendment of Certificate of Designation of Rights and
Preferences of Series B Preferred Stock (Previously filed as Exhibit 3.1 to our
Current Report on Form 8-K dated February 9, 2005).
4.1 Form of Common Stock. (Previously filed with the Commission as an exhibit to our
Registration Statement on Form S-l, File No. 33-24696).
4.2 Form of Debenture Sold in Private Placement. (Previously filed with the Commission as
Exhibit 4.1 to Report on Form 8-K dated March 27, 2003).
4.3 Form of Placement Agent Warrant (Previously filed with the Commission as Exhibit 4.2
to Report on Form 8-K dated March 27, 2003).
4.4 Form of Debenture Sold in Private Placement. (Previously filed with the Commission as
Exhibit 4.1 to Report on Form 8-K dated January 5, 2004).
4.5 Form of Placement Agent Warrant (Previously filed with the Commission as Exhibit 4.2
to Report on Form 8-K dated January 5, 2004).
10.1 Office Lease Agreement between First Montauk Securities Corp. and River Office Equities
dated March 5, 1997 (Previously filed with the Commission as an exhibit to our Annual
Report on Form 10-KSB for the fiscal year ended December 31, 1997).
10.2 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 with
the Commission as Exhibit 28.8 to Form 10-K for the fiscal year ended December 31,
1998).
10.3 Employment Agreement between First Montauk Securities Corp. and Mark Lowe dated
October 15, 1998 (Previously filed with the Commission as an exhibit to our Annual
Report on Form 10-K for the fiscal year ended December 31, 1998).
10.4 Employment Agreement between First Montauk Securities Corp. and Seth Rosen dated
January 25, 1999 (Previously filed with the Commission as an exhibit to our Annual
Report Form 10-K for the fiscal year ended December 31, 1998).
10.5 Clearing Agreement dated May 8, 2000 between Fiserv Securities, Inc. and First Montauk
Securities Corp. (Previously filed with the Commission as an exhibit to our Annual
Report on Form 10-K for the fiscal year ended December 31, 2000).
10.6 Financial Agreement dated May 8, 2000 between Fiserv Securities, Inc. and First
Montauk Securities Corp. (Previously filed with the Commission as an exhibit to our
Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
10.7 Amended and Restated Financial Agreement dated February 1, 2001 between Fiserv
Securities, Inc., First Montauk Financial Corp. and First Montauk Securities Corp.
(Previously filed with the Commission as an exhibit to our Annual Report on Form 10-K
for the fiscal year ended December 31, 2000).
51
10.8 Security Agreement dated February 1, 2001 between Fiserv Securities, Inc. and First
Montauk Financial Corp. (Previously filed with the Commission as an exhibit to our
Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
10.9 Sublease Agreement between Eloquent, Inc. and First Montauk Financial Corp. dated May
31, 2001 (Previously filed with the Commission as an exhibit to our Annual Report on
Form 10-K for the fiscal year ended December 31, 2001).
10.10 Sublease Agreement between Aim net Solutions, Inc. and First Montauk Financial Corp.
dated January 15, 2002 (Previously filed with the Commission as an exhibit to our
Annual Report on Form 10-K for the fiscal year ended December 31, 2001).
10.11 Employment Agreement dated August 21, 2002 between Herbert Kurinsky and First Montauk
Financial Corp. (Previously filed with the Commission as an exhibit to our Quarterly
Report on Form 10-Q for the Quarter ended September 20, 2002).
10.12 Employment Agreement dated August 21, 2002 between William J. Kurinsky and First
Montauk Financial Corp. (Previously filed with the Commission as an exhibit to our
Quarterly Report on Form 10-Q for the quarter ended September 30, 2002).
10.13 Employment Agreement dated as of January 1, 2004 between Herbert Kurinsky and First
Montauk Financial Corp. (Previously filed as Exhibit 10.13 to our Annual Report on
Form 10-K for the fiscal year ended December 31, 2004).
10.14 Employment Agreement dated as of January 1, 2004 between William J. Kurinsky and First
Montauk Financial Corp. (Previously filed as Exhibit 10.14 to our Annual Report on
Form 10-K for the fiscal year ended December 31, 2004).
10.15 Employment Agreement dated as of January 1, 2004 between Victor K. Kurylak and First
Montauk Financial Corp. (Previously filed as Exhibit 10.15 to our Annual Report on
Form 10-K for the fiscal year ended December 31, 2004).
10.16 1992 Incentive Stock Option Plan (Previously filed with the Commission as an exhibit
to our Registration Statement on Form S-l, File No. 33-24696).
10.17 1992 Non-Executive Director Stock Option Plan (Previously filed with the Commission as
an exhibit to our Registration Statement on Form S-l, File No. 33-24696).
10.18 Amended and Restated 1992 Incentive Stock Option Plan. (Previously filed with the
Commission as an exhibit to our Proxy Statement dated May 30, 1996).
10.19 Non-Executive Director Stock Option Plan - Amended and Restated June 28, 1996
(Previously filed with the Commission as an exhibit to our Proxy Statement dated May
30, 1996).
10.20 1996 Senior Management Incentive Stock Option Plan (Previously filed with the
Commission as an exhibit to our Proxy Statement dated May 30, 1996).
10.21 Second Amended and Restated 1992 Incentive Stock Option Plan (Previously filed with the
Commission as an exhibit to our Proxy Statement dated May 23, 2000).
10.22 1996 Senior Management Incentive Plan Amended as of June 23, 2000 (Previously filed with
the Commission as an exhibit to our Proxy Statement dated May 23, 2000).
10.23 2002 Incentive Stock Option Plan. (Previously filed with the Commission as an Exhibit
A to our Proxy Statement dated May 20, 2002).
10.24 2002 Non-Executive Director Stock Option Plan. (Previously filed with the Commission
as Exhibit B to our Proxy Statement dated May 20, 2002).
10.25 Form of Non-Executive Director Stock Option Award. (Previously filed as Exhibit 10.1
to our Report on Form 8-K dated September 2, 2004).
10.26* Form of Stock Option Award pursuant to Incentive Stock Option Plan.
10.27* Form of Stock Option Award pursuant to 1996 Senior Management Stock Option Plan.
10.28 Fourth Amendment to Office Lease Agreement dated September 22, 2004 between First
Montauk Securities Corp. and River Office Equities (Previously filed with the Commission
as Exhibit 10.1 to Form 8-K dated September 28, 2004).
52
10.29* Separation Agreement between First Montauk Financial Corp. and William J. Kurinsky,
dated February 8, 2005.
10.30* Consulting Agreement between First Montauk Financial Corp. and William J. Kurinsky,
dated February 8, 2005.
10.31* Employment Agreement dated as of February 1, 2005 between Victor K. Kurylak and First
Montauk Financial Corp.
10.32* Employment Agreement dated as of February 8, 2005 between Robert I. Rabinowitz and
First Montauk Financial Corp.
10.33* Employment Agreement dated as of February 8, 2005 between Mindy A. Horowitz and First
Montauk Financial Corp.
14 Code of Ethics (Filed as Exhibit 14 to our Annual Report on Form 10-K for the year
ended December 31, 2003.
21* Subsidiary Companies
23.1* Consent of Lazar, Levine & Felix.
31.1* Certification of Chief Executive Officer and President
31.2* Certification of Acting Chief Financial Officer
32.1 * Certification of Victor K. Kurylak pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 * Certification of Mindy A. Horowitz pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- --------------------- ----------------------------------------------------------------------------------------
53
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
First Montauk Financial Corp.
Red Bank, New Jersey
We have audited the accompanying consolidated statement of financial condition
of First Montauk Financial Corp. and Subsidiaries (the "Company") as of December
31, 2004 and the related consolidated statements of income, changes in
stockholders' equity (deficit), and cash flows for the year ended December 31,
2004. Our audit also included the financial statement schedule listed in Part
IV, Item 15 of this Form 10-K. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Montauk
Financial Corp. and Subsidiaries at December 31, 2004 and the results of their
operations and their cash flows for the year ended December 31, 2004, in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, the related financial statement schedule for the
year ended December 31, 2004, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/s/ Lazar Levine & Felix LLP
--------------------------------------
LAZAR LEVINE & FELIX LLP
Morristown, New Jersey
March 18, 2005
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have audited the accompanying consolidated statement of financial
condition of First Montauk Financial Corp. and subsidiaries as of December 31,
2003, and the related statements of operations, stockholders' deficit, and cash
flows for each of the two years in the period ended December 31, 2003. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits 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 financial statements referred to above present fairly,
in all material respects, the financial position of First Montauk Financial
Corp. and subsidiaries as of December 31, 2003, and the results of their
operations and their cash flows for each of the two years in the period ended
December 31, 2003, in conformity with U. S. generally accepted accounting
principles. Also in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
/s/ Schneider & Associates LLP
-------------------------------
Schneider & Associates LLP
Jericho, New York
March 18, 2004
F-2
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, December 31,
2004 2003
ASSETS
Cash and cash equivalents $ 1,034,681 $ 3,441,743
Due from clearing firm 5,815,819 5,219,267
Securities owned, at market value 370,720 169,534
Employee and broker receivables 548,240 648,642
Property and equipment - net 790,909 1,052,564
Income taxes receivable 40,525 2,625
Other assets 1,233,480 1,658,726
------------------ -----------------
Total assets $ 9,834,374 $ 12,193,101
================== =================
LIABILITIES AND STOCKHOLDERS' DEFICIT
LIABILITIES
Deferred income $ 5,105,116 $ 5,980,124
6% convertible debentures 3,015,000 3,135,000
Warrants subject to put options 333,261 479,066
Securities sold, not yet purchased, at market value 174,326 69,330
Commissions payable 2,499,793 3,679,696
Accounts payable 614,784 872,572
Accrued expenses 1,078,185 1,803,973
Income taxes payable 44,546 107,911
Capital leases payable 62,460 146,836
Other liabilities 5,520 6,032
------------------ -----------------
Total liabilities 12,932,991 16,280,540
------------------ -----------------
Commitments and contingencies (See notes)
STOCKHOLDERS' DEFICIT
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, 305,369 and 311,089 shares issued and
outstanding, respectively; liquidation preference: $1,526,845 30,537 31,109
Common stock, no par value, 30,000,000 shares authorized,
10,258,509 and 9,065,486 shares issued and outstanding,
respectively 7,257,292 6,724,853
Additional paid-in capital 950,592 950,592
Accumulated deficit (10,948,157) (11,678,659)
Less deferred compensation (388,881) (115,334)
------------------ -----------------
Total stockholders' deficit (3,098,617) (4,087,439)
------------------ -----------------
Total liabilities and stockholders' deficit $ 9,834,374 $ 12,193,101
================== =================
See notes to financial statements.
F-3
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Years ended ended December 31,
2004 2003 2002
Revenues:
Commissions $ 42,767,158 $41,950,392 $36,513,802
Principal transactions 9,058,259 9,466,359 6,727,642
Investment banking 2,716,042 2,439,144 1,007,700
Interest and other income 4,645,782 4,370,787 3,717,600
-------------------- ----------------- ----------------
Total revenue 59,187,241 58,226,682 47,966,744
-------------------- ----------------- ----------------
Expenses:
Commissions, employee compensation and benefits 46,851,474 46,218,107 39,572,851
Clearing and floor brokerage 2,466,027 2,934,164 2,666,376
Communications and occupancy 2,664,256 2,659,105 3,006,017
Legal matters and related costs 2,714,769 5,836,960 1,259,502
Other operating expenses 3,489,425 3,393,335 4,029,515
Interest 284,093 204,054 98,918
-------------------- ----------------- ----------------
Total expenses 58,470,044 61,245,725 50,633,179
-------------------- ----------------- ----------------
Income (loss) before income taxes 717,197 (3,019,043) (2,666,435)
Provision (benefit) for income taxes (13,305) 499,000 294,000
-------------------- ----------------- ----------------
Net income (loss) $ 730,502 $ (3,518,043) $ (2,960,435)
==================== ================= ================
Net income (loss) applicable to common stockholders $ 639,813 $ (3,542,882) $ (3,059,722)
==================== ================= ================
Earnings (loss) per share:
Basic $ 0.07 $ (0.40) $ (0.36)
Diluted $ 0.04 $ (0.40) $ (0.36)
Weighted average number of shares of stock outstanding:
Basic 9,270,350 8,784,103 8,551,932
Diluted 15,629,920 8,784,103 8,551,932
See notes to financial statements.
F-4
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE PERIOD FROM JANUARY 1, 2002 TO DECEMBER 31, 2004
Series A Convertible
Preferred Stock Common Stock
----------------------------- -------------------------------
Additional
Shares Amount Shares Amount Paid-in Capital
----------------------------- ------------------------------- ----------------
Balances at Janaury 1, 2002 331,190 $ 33,119 8,622,284 $ 6,434,592 $ 950,592
Transfer of common shares from
temporary equity to permanent
capital 3,000 6,500
Reversal of deferred compensation (42,994)
Amortization of deferred compensation
Repurchase of common stock
Cancellation of treasury shares (100,000) (25,016)
Issuance of common stock purchase
warrants for services 11,382
Conversion of preferred stock into
common stock (940) (94) 1,880 94
Payment of dividends
Net loss for the year
----------------------------- ------------------------------- ----------------
Balances at December 31, 2002 330,250 33,025 8,527,164 6,384,558 950,592
Increase in deferred compensation 142,402
Amortization of deferred compensation
Common stock issued in connection
with legal settlements 500,000 160,000
Issuance of common stock purchase
warrants for services 35,977
Conversion of preferred stock into
common stock (19,161) (1,916) 38,322 1,916
Payment of dividends
Net loss for the year
----------------------------- ------------------------------- ----------------
Balances at December 31, 2003 311,089 31,109 9,065,486 6,724,853 950,592
Increase in deferred compensation 82,471
Amortization of deferred compensation
Repurchase of common stock
Cancellation of treasury shares (60,217) (21,162)
Issuance of restricted stock in connection
with employment agreements 1,000,000 350,000
Conversion of preferred stock into
common stock (5,720) (572) 11,440 572
Exercise of incentive stock options 1,800 558
Conversion of bonds into common stock 240,000 120,000
Net income for the year
----------------------------- ------------------------------- ----------------
Balances at December 31, 2004 305,369 $ 30,537 10,258,509 $ 7,257,292 $ 950,592
============================= =============================== ================
See notes to financial statements.
F-5
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE PERIOD FROM JANUARY 1, 2002 TO DECEMBER 31, 2004
Retained
Earnings Treasury Stock Stockholders'
(Accumulated Deferred ------------------------------ Equity
Deficit) Compensation Shares Amount (Deficit)
----------------- ------------------------------------------------ ----------------
Balances at Janaury 1, 2002 $ (5,076,055) $ (56,067) $ 2,286,181
Transfer of common shares from
temporary equity to permanent
capital 6,500
Reversal of deferred compensation 42,994
Amortization of deferred compensation 2,985 2,985
Repurchase of common stock (100,000) $ (25,016) (25,016)
Cancellation of treasury shares 100,000 25,016
Issuance of common stock purchase
warrants for services 11,382
Conversion of preferred stock into
common stock
Payment of dividends (99,287) (99,287)
Net loss for the year (2,960,435) (2,960,435)
----------------- ---------------- ------------------------------ ----------------
Balances at December 31, 2002 (8,135,777) (10,088) (777,690)
Increase in deferred compensation (142,402)
Amortization of deferred compensation 37,156 37,156
Common stock issued in connection
with legal settlements 160,000
Issuance of common stock purchase
warrants for services 35,977
Conversion of preferred stock into
common stock
Payment of dividends (24,839) (24,839)
Net loss for the year (3,518,043) (3,518,043)
----------------- ---------------- ------------------------------ ----------------
Balances at December 31, 2003 (11,678,659) (115,334) (4,087,439)
Increase in deferred compensation (432,471) (350,000)
Amortization of deferred compensation 158,924 158,924
Repurchase of common stock (60,217) (21,162) (21,162)
Cancellation of treasury shares 60,217 21,162
Issuance of restricted stock in connection
with employment agreements 350,000
Conversion of preferred stock into
common stock
Exercise of incentive stock options 558
Conversion of bonds into common stock 120,000
Net income for the year 730,502 730,502
----------------- ---------------- ------------------------------ ----------------
Balances at December 31, 2004 $ (10,948,157) $ (388,881) $ (3,098,617)
================= ================ ============================== ================
See notes to financial statements.
F-6
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended ended December 31,
2004 2003 2002
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 730,502 $ (3,518,043) $ (2,960,435)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 538,549 509,968 526,816
Amortization of deferred costs 223,708 57,932 6,837
Amortization of deferred income (875,008) (726,199) (577,010)
Deferred income taxes - net 460,000 470,000
Common stock issued in legal settlement 160,000
Loss on disposition of property and equipment 4,692 5,964
Loss on investment 23,147
Increase (decrease) in cash attributable to changes in assets
and liabilities:
Due from clearing firm (596,552) (627,566) (445,291)
Securities owned (201,186) 14,410 992,011
Loans receivable - officers 178,936 24,028
Employee and broker receivables 100,402 415,877 1,035,533
Other assets 360,461 (736,366) 482,103
Income tax refund receivable (37,900) 212,300 857,142
Deferred income 1,250,000 1,250,000
Warrants subject to put options (145,804) 479,066
Securities sold, not yet purchased 104,996 69,330 (245,078)
Commissions payable (1,179,903) 998,568 (966,042)
Accounts payable (257,789) 350,429 38,412
Income taxes payable (63,365) 52,829 47,971
Accrued expenses (725,788) (183,898) 552,986
Other liabilities (512) (43,207) (466,094)
----------------- ---------------- --------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (2,020,497) (625,634) 653,000
----------------- ---------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (212,000) (165,640) (266,854)
Other assets 26,873 31,821
----------------- ---------------- --------------
NET CASH USED IN INVESTING ACTIVITIES (212,000) (138,767) (235,033)
----------------- ---------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of notes payable (48,057) (233,171)
Payments of capital leases (153,961) (220,949) (198,528)
Repurchase of common shares (21,162) (25,016)
Proceeds from issuance of 6% convertible debentures 2,105,000 1,030,000
Proceeds from exercise of incentive stock option 558
Payments of preferred stock dividends (24,839) (99,287)
Other assets (243,830) (32,700)
----------------- ---------------- --------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (174,565) 1,567,325 441,298
----------------- ---------------- --------------
Net increase (decrease) in cash and cash equivalents (2,407,062) 802,924 859,265
Cash and cash equivalents at beginning of period 3,441,743 2,638,819 1,779,554
----------------- ---------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,034,681 $ 3,441,743 $ 2,638,819
================= ================ ==============
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest $ 212,080 $ 134,055 $ 95,522
================= ================ ==============
Income taxes $ 67,960 $ (187,707) $ (1,113,636)
================= ================ ==============
Noncash financing activity:
Equipment acquired through capital lease financing $ 69,585
Equipment acquired through vendor financing $ 31,017
Warrants charged to deferred financing costs in
connection with debenture offering $ 35,987 $ 11,382
See notes to financial statements.
F-7
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
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), operates a securities broker-dealer registered
with the Securities and Exchange Commission (SEC). Through
FMSC, the Company executes principal and agency transactions
primarily for retail customers, performs investment banking
services, and trades securities on a proprietary basis.
Montauk Insurance Services, Inc. (MISI) sells a variety of
insurance products. The Company operates in one business
segment. Customers are located primarily throughout the United
States.
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. FMSC
is a member of the National Association of Securities Dealers,
Inc. (NASD).
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of
the Company and its subsidiaries, all of which are
wholly-owned. All intercompany accounts and transactions have
been eliminated in consolidation.
Revenue Recognition
Securities transactions, commission income, sales concessions
from participation in syndicated offerings and related
expenses are recorded on a trade date basis. Insurance and
mutual fund commissions received from outside vendors are
recognized as income when received.
Securities owned and securities sold, not yet purchased are
stated at quoted market value with unrealized gains and losses
included in earnings. Securities not readily marketable are
carried at estimated fair value as determined by management.
Advances received under the Company's financial agreement with
its clearing firm are deferred and amortized to income over
the remaining term of the agreement on a straight-line basis
(see Note 7).
Advertising
Advertising costs are expensed as incurred and totaled
$114,829, $246,357 and $221,576 in 2004, 2003 and 2002,
respectively.
Property and Equipment
Furniture, equipment and leasehold improvements are stated at
cost. Depreciation of furniture and equipment is computed over
the estimated useful lives of the assets, ranging from three
to ten years. Capitalized lease equipment is amortized over
the lease term. Leasehold improvements are amortized over the
shorter of either the asset's useful life or the related lease
term. Depreciation is computed on the straight-line method for
financial reporting purposes and on an accelerated basis for
income tax purposes.
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 consisted of money market funds
at December 31, 2004 and 2003.
F-8
Earnings (Loss) per Share
Basic earnings (loss) per share is computed by dividing net
income (loss) attributable to common stockholders by the
weighted-average number of common shares outstanding for the
period. In determining basic earnings (loss) per share for the
periods presented, dividends paid on Series A Convertible
Preferred Stock are added (deducted) to the net income (loss).
Diluted earnings (loss) per share reflects the potential
dilution from the exercise or conversion of other securities
into common stock, but only if dilutive. Diluted loss per
share for 2003 and 2002 is the same as basic loss per share,
since the effects of the calculation for these years were
anti-dilutive.
The following table sets forth the weighted average number of
shares of common stock and dilutive securities outstanding
used in the computation of basic and diluted earnings per
share:
Twelve months ended
December 31,
2004 2003 2002
---- ---- ----
Numerator - basic:
Net income $730,502 $(3,518,043) $(2,960,435)
Deduct: dividends earned/paid during the quarter (90,689) (24,839) (99,287)
-------- --------- -------
Numerator for basic earnings per share $639,813 $(3,542,882) $(3,059,722)
======= ========= ==========
Numerator - diluted:
Numerator for basic earnings per share $639,813 $(3,542,882) $(3,059,722)
Add: convertible debenture interest, net of tax 45,735
-------- --------- ----------
Numerator for diluted earnings per share $ 685,548 $(3,542,882) $(3,059,722)
======= ========= ==========
Denominator:
Weighted average common shares outstanding 9,270,350 8,784,103 8,551,932
Effect of dilutive securities:
Stock options and warrants 235,820
Restricted shares 93,750
Convertible debentures 6,030,000
--------- --------- ----------
Denominator for diluted earnings per share 15,629,920 8,784,103 8,551,932
========== ========= ==========
The following securities, presented on a common share
equivalent basis, have been excluded from the per share
computations:
Year ended December 31,
2004 2003 2002
---- ---- ----
Stock options 3,514,998 3,556,498 4,072,498
Warrants 3,385,946 4,160,946 9,345,338
Convertible debt - 6,270,000 2,084,028
Convertible preferred stock 610,738 622,178 660,500
In January 2004, the Company issued a total of 1,000,000
restricted common shares and 500,000 stock options to various
executive officers pursuant to employment agreements (see Note
12). In February 2005, the Company issued a total of 1,300,000
restricted common shares to various executive officers
pursuant to new employment agreements (see Note 21).
F-9
Use of Estimates
The consolidated financial statements are prepared in
conformity with accounting principles generally accepted in
the United States of America, which require management to make
estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Management
periodically evaluates estimates used in the preparation of
financial statements for continued reasonableness. Appropriate
adjustments, if necessary, to the estimates used are made
prospectively based upon such periodic evaluation. Actual
results could differ from those estimates.
Long-lived Assets
The Company evaluates impairment losses on long-lived assets
used in operations, primarily property and equipment, when
events and circumstances indicate that the carrying value of
the assets might not be recoverable in accordance with FAS No.
144 "Accounting for the Impairment or Disposal of Long-lived
Assets". For purposes of evaluating the recoverability of
long-lived assets, the undiscounted cash flows estimated to be
generated by those assets would be compared to the carrying
amounts of those assets. If and when the carrying values of
the assets exceed their fair values, the related assets will
be written down to fair value.
Income Taxes
The Company uses the liability method to determine its income
tax expense as required under Statement of Financial
Accounting Standards No. 109 (FAS 109). Under FAS 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.
Stock-based Compensation
The Company periodically grants stock options to employees in
accordance with the provisions of its stock option plans, with
the exercise price of the stock options being set at the
greater of $ .50 or 120% of the closing market price of the
common stock on the date of grant. The Company accounts for
stock-based compensation plans under Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to
Employees", and accordingly accounts for employee stock-based
compensation utilizing the intrinsic value method. FAS No.
123, "Accounting for Stock-Based Compensation", establishes a
fair value based method of accounting for stock-based
compensation plans. The Company has adopted the disclosure
only alternative under FAS No. 123, which requires disclosure
of the pro forma effects on earnings and earnings per share as
if FAS No. 123 had been adopted as well as certain other
information.
Stock options granted to non-employees are recorded at their
fair value, as determined in accordance with FAS No. 123 and
Emerging Issues Task Force Consensus No. 96-18, and recognized
over the related service period. Deferred charges for options
granted to non-employees are periodically re-measured until
the options vest.
In December 2002, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation--Transition
and Disclosure" ("FAS 148"), which (i) amends FAS Statement
No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for an entity that
voluntarily changes to the fair value based method of
accounting for stock-based employee compensation (ii) amends
the disclosure provisions of FAS 123 to require prominent
disclosure about the effects on reported net income of an
entity's accounting policy decisions with respect to
stock-based employee compensation and (iii) amends APB opinion
No. 28, "Interim Financial Reporting," to require disclosure
about those effects in interim financial information. The
additional disclosures required by FAS 148 are as follows:
F-10
Years ended December 31,
2004 2003 2002
---- ---- ----
Net income (loss) applicable to
common stockholders, as reported $639,813 $(3,542,882) $(3,059,722)
Deduct: total stock based
employee compensation expense
determined under the fair value
based method for all awards, net
of tax (160,457) (105,862) (178,642)
--------- --------- ---------
Pro forma net income (loss) $479,356 $(3,648,744) $(3,238,364)
applicable to common stockholders ======== ========== ==========
Net income (loss) per share:
Basic - as reported $.07 $(0.40) $(0.36)
Diluted - as reported $.04 $(0.40) $(0.36)
Basic - pro forma $.05 $(0.42) $(0.38)
Diluted - pro forma $.03 $(0.42) $(0.38)
Pro forma net income (loss) and income (loss) per share
information, as required by FAS 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 2004, 2003 and 2002:
2004 2003 2002
---- ---- ----
Risk free interest rates 3.41% 3.14% 1.97%
Expected option lives 4 years 4 years 2.4 years
Expected volatilities 104.19% 105.11% 87.64%
Expected dividend yields 0% 0% 0%
Recent Pronouncements of the Financial Accounting Standards
Board
In November 2004, the FASB issued Statement of Financial
Accounting Standards No. 151, "Inventory Costs - an amendment
of ARB No. 43, Chapter 4" ("SFAS 151"), effective for
inventory costs incurred during fiscal years beginning after
June 15, 2005. This statement amends the guidance in
Accounting Research Bulletin (ARB) No. 43, Chapter 4,
"Inventory Pricing" to clarify the accounting for abnormal
amounts of idle facility expense, freight, handling costs and
wasted material (spoilage). SFAS No. 151 requires that such
items be recognized as current period charges. In addition,
this Statement requires that allocation of fixed production
overheads to the costs of conversion be based on the normal
capacity of the production facilities. This statement is not
applicable to the Company's current operations.
In December 2004, the FASB issued Statement No. 152,
"Accounting for Real Estate Time-Sharing Transactions". This
statement amends SFAS No. 66 (Accounting for Sales of Real
Estate) and SFAS No. 67 (Accounting for Costs and Initial
Rental Operations of Real Estate Projects). This standard,
which is effective for financial statements for fiscal years
beginning after June 15, 2005, is not applicable to the
Company's current operations.
F-11
In December 2004, the FASB issued SFAS No. 153 "Exchange of
Non-monetary Assets - an amendment of APB Opinion No. 29".
Statement 153 eliminates the exception for nonmonetary
exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do
not have commercial substance, defined as transactions that
are not expected to result in significant changes in the cash
flows of the reporting entity. This standard, which is
effective for exchanges of nonmonetary assets occurring after
June 15, 2005, is not applicable to the Company's current
operations.
In December 2004, FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment"(SFAS 123 (revised 2004)"), effective as
of the beginning of the first interim or annual reporting
period that begins after June 15, 2005. This Statement is a
revision of FASB Statement No. 123, "Account for Stock-Based
Compensation," and supersedes APB Opinion No. 25, "Accounting
for Stock Issued to Employees," and its related implementation
guidance. SFAS 123 (revised 2004) eliminates the alternative
to use Opinion No. 25's intrinsic value method of accounting
that was provided in Statement 123 as originally issued. Under
Opinion 25, issuing stock options to employees generally
resulted in recognition of no compensation cost. This
Statement requires entities to recognize the cost of employee
services received in exchange for awards of equity instruments
based on the grant-date fair value of those awards (with
limited exceptions). Recognition of that compensation cost
helps users of financial statements to better understand the
economic transactions affecting an entity and to make better
resource allocation decisions. The Company will adopt SFAS 123
(revised 2004) for the quarter beginning July 1, 2005. The
effect of the adoption of this Statement has not yet been
determined.
Reclassifications
Certain reclassifications have been made to 2003 and 2002
financial statements to conform to 2004 presentation.
NOTE 3 - SECURITIES OWNED and SOLD, NOT YET PURCHASED
December 31,
2004 2003
---- ----
Sold Sold
not yet not yet
Owned Purchased Owned Purchased
Corporate stocks $ 133,475 $173,826 $80,710 $ 69,330
U. S. government agency and
municipal obligations 2,320 73,875
Corporate bonds 14,805 10,016
Other 6,550 500 4,933
------ ----- ------
$157,150 $174,326 $169,534 $ 69,330
======= ======= ======= =======
Securities owned and securities sold, not yet purchased
consist of trading securities at quoted market values. The
Company also owns investment securities, consisting of shares
of common stock and common stock purchase warrants, some of
which are publicly offered and can be sold and some of which
cannot be publicly offered or sold until registered under the
Securities Act of 1933. At December 31, 2004, these securities
at estimated fair values consist of the following:
Corporate Stocks $123,830
Warrants 89,740
-------
$213,570
=======
F-12
NOTE 4 - EMPLOYEE AND BROKER RECEIVABLES
December 31,
2004 2003
---- ----
Commission advances $ 431,362 $ 759,872
Forgivable loans 247,649 380,170
Other loans 1,271,860 1,313,922
---------- ----------
1,950,871 2,453,964
Less reserve for bad debts (1,402,631) (1,805,322)
----------- -----------
$548,240 $648,642
======== ========
The Company has arrangements 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 five years, or meet specified performance goals. The
loans are being amortized to commission expense for financial
reporting purposes over the term of the loan. Loan
amortization charged to compensation was $112,171, $230,578
and $235,528 in 2004, 2003, and 2002, respectively. Other
loans to employees and registered representatives are payable
in installments generally over periods of one to five years
with interest rates ranging up to 8% per annum.
NOTE 5 - PROPERTY AND EQUIPMENT
December 31, Estimated
2004 2003 Useful Life
---- ---- -----------
Computer and office equipment $2,834,811 $ 2,960,830 3 to 7 years
Furniture and fixtures 1,689,787 1,299,343 7 to 10 years
Leasehold improvements 807,227 804,654 Term of lease
--------- ---------
5,331,825 5,064,827
Less accumulated depreciation
and amortization expense (4,540,916) (4,012,263)
---------- ----------
$ 790,909 $ 1,052,564
======== ==========
Depreciation and amortization expense was $538,549, $509,968,
and $526,816 in 2004, 2003 and 2002, respectively.
F-13
NOTE 6 - OTHER ASSETS
December 31,
Other assets consist of the following: 2004 2003
---- ----
Commissions and concessions receivable $ 374,182 $ 306,442
Deferred financing costs-net 238,328 303,113
Insurance claim receivable 245,000
Security deposits 244,764 285,129
Prepaid expenses and other 376,206 519,042
------- --------
$1,233,480 $1,658,726
========= =========
Commissions and concessions receivable include amounts earned
on mutual fund, insurance transactions and concessions on
syndicate offerings.
NOTE 7 - DEFERRED INCOME
In May 2000, FMSC entered into a ten-year clearing agreement
with Fiserv Securities, Inc. ("Fiserv"). In connection with
the clearing agreement, FMSC and Fiserv also entered into a
financial agreement under which Fiserv was to provide cash
advances to FMSC under certain terms and conditions. Upon the
conversion of FMSC's accounts to Fiserv in November 2000, FMSC
received an initial cash advance of $4,000,000. As of February
1, 2001, the Company and FMSC 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 without recourse to FMSC. 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 on all the
Company's ownership interest in First Montauk Securities Corp.
The Company received additional cash advances of $1,250,000 in
each of November 2001, 2002 and 2003, respectively. All
advances have been recorded as deferred income and are being
amortized to earnings over the term of the agreement.
Amortization of approximately $875,000, $726,000 and $577,000
in 2004, 2003 and 2002, respectively, is included in Other
Income. Advances were subject to income taxes in the year of
receipt with the exception of the advance received in 2003,
which the Company elected to include in taxable income in
2004.
NOTE 8 - ACCRUED EXPENSES
December 31,
Accrued expenses consist of the following: 2004 2003
---- ----
Accrued litigation costs $ 666,013 $1,364,169
Accrued penalty bid 84,750
Accrued payroll 137,341 123,886
Accrued professional fees 109,679 97,254
Other accrued expenses 80,402 218,664
---------- ----------
$1,078,185 $1,803,973
========= =========
F-14
NOTE 9 - 6% CONVERTIBLE DEBENTURES
In 2002 and 2003, the Company raised gross proceeds of
$1,030,000 and $2,105,000, respectively, in private placements
of 6% convertible debentures to accredited investors. The
offerings were made in reliance upon the exemption under
Sections 4(2) of the Securities Act of 1933 and the provisions
of Regulation D. The debentures are convertible into shares of
common stock at $.50 per share, subject to adjustment for
stock dividends and stock splits, and mature five years from
the date of issuance unless previously converted. Interest is
payable in cash on a semi-annual basis until maturity or
conversion.
In the event that the closing bid price of the Company's
common stock is 200% of the conversion price for the twenty
(20) consecutive trading days prior to the date of notice of
conversion or prepayment, the Company may, at its option and
only if the underlying shares have been registered, upon
thirty (30) days written notice to the holders, demand the
conversion of some or all of the debentures, or prepay some or
all of the debentures at 120% of the principal amount. The
debentures contain certain covenants that, among other things,
prevent the sale of all or substantially all of the Company's
assets without provision for the payment of the debentures
from such sales proceeds, and making loans to any executive
officers or 5% stockholders. The debentures provide for
piggy-back registration rights relating to the underlying
shares.
FMSC was the Placement Agent for the offerings. Offering costs
of approximately $324,000, consisting of the value of warrants
issued to selling brokers, commissions and other cash
expenses, have been capitalized and are being amortized on a
straight-line basis over the respective terms of the
debentures.
In October 2004, holders of $120,000 of the subordinated
convertible debentures presented their debentures to the
Company for conversion. The Company issued 240,000 shares of
common stock and retired $120,000 of the debentures.
Subsequent to December 31, 2004, holders of $1,755,000 of
subordinated convertible debentures presented their debentures
to the Company for conversion. The Company issued an
additional 3,510,000 shares of common stock and retired
$1,755,000 of the debentures.
The debentures outstanding as of December 31, 2004 are
$3,015,000 and are due to mature in 2007 and 2008, as follows:
2007 - $950,000; 2008 - $2,065,000.
NOTE 10 - WARRANTS SUBJECT TO PUT OPTIONS
In July 2003, the Company issued 750,000 five-year warrants to
various plaintiffs as part of a legal settlement (See Note
12). The warrants were issued in three classes of 250,000
warrants each. The Class A warrants which had an exercise
price of $.40 per share, were redeemed for $200,000 during the
third quarter of 2004. Class B and Class C warrants have
exercise prices of $.25 per share. The settlement agreement
provides that the Company may be obligated to make additional
cash payments of up to $400,000 in the event that claimants
elect to exercise the warrants on certain dates. Specifically,
if a majority of then existing Class B warrant holders elect
to exercise the outstanding warrants in their particular class
during the month of June 2005 (the "Required Exercise Event"),
the claimants, upon exercising their warrants, will be
required to sell the shares in the open market. If the
warrants are exercised and the shares sold, the Company will
pay to the claimants up to an aggregate amount of $200,000
less the amount received by the claimants from the sale of
their shares, net of commissions. This process will be
repeated for outstanding Class C warrant holders during the
month of June 2006.
F-15
In the alternative, the Company may elect or be required to
redeem the unexercised warrants for up to $.80 per warrant, or
a maximum of $200,000 per class, depending upon the then
prevailing market price of the Company's common stock on or
about the date of the Required Exercise Event of a particular
class. The Company may call a warrant class for redemption if
the average market price of the underlying common shares
during the ten trading days immediately preceding the date
upon which the Company receives notice that the warrant
holders of a particular class have elected to declare a
Required Exercise Event is less than $1.20. The Company will
be required to redeem the warrants for $.80 per warrant in
cash if the average market price of the underlying common
shares during the ten trading days immediately preceding the
date upon which the Company receives notice that the warrant
holders of a particular class have elected to declare a
Required Exercise Event is less than or equal to the warrant
exercise price. In the event that warrant holders of a
particular class elect not to declare a Required Exercise
Event, the Company's guarantee will be canceled with respect
to that class.
In accordance with the provisions of FAS 150, "Accounting for
Certain Financial Instruments with Characteristics of both
Liabilities and Equity," the Company has classified its
obligations under the warrants as liabilities in the Statement
of Financial Condition. The fair value of the obligations
embodied in the warrants remaining were initially valued at $
269,123 using the discounted cash flow method, assuming, based
on available evidence, that the Company will be required to
pay the full redemption liability. The Company measures the
value of the warrant obligations as of the end of each
reporting period using the discounted cash flow method until
the obligations are settled. The recorded value at December
31, 2004 was $333,261. Changes in value are recognized in
earnings as interest expense.
NOTE 11 - INCOME TAXES
The provision (benefit) for income taxes consists of the
following:
Year ended December 31,
2004 2003 2002
---- ---- ----
Currently payable (refundable):
Federal $(212,300)
State (13,000) 39,000 36,300
--------- ------- -------
(13,000) 39,000 (176,000)
--------- ------- --------
Deferred:
Federal 425,000 425,000
State 35,000 45,000
-------- ------- -------
460,000 470,000
-------- -------- --------
Provision (benefit) for income taxes $ (13,000) $ 499,000 $ 294,000
========= ======== =========
F-16
Following is a reconciliation of the income tax provision
(benefit) with income taxes based on the federal statutory
rate:
Year ended December 31,
2004 2003 2002
---- ---- ----
Expected federal tax benefit at
statutory rate $ 244,000 $(1,043,000) $(926,000)
State taxes, net of federal tax effect (7,000) (145,000) (145,000)
Non-deductible expenses 10,000 29,000 35,000
Increase (decrease) in valuation allowance (260,000) 1,658,000 1,330,000
------------ --------- ---------
Provision (benefit) for income taxes $ (13,000) $ 499,000 $ 294,000
============= ======== ========
The tax effects of the temporary differences that give rise to
significant portions of the deferred tax assets and
liabilities as of December 31, 2004 and 2003 are:
Year ended December 31,
2004 2003
---- ----
Deferred tax assets:
Deferred income $2,042,000 $ 2,392,000
Reserves and allowances 986,000 1,356,000
Federal tax loss carryforwards 1,152,000 909,000
State tax loss carryforwards 389,000 207,000
Stock-based compensation 454,000 447,000
Other 98,000 70,000
---------- ----------
Subtotal 5,121,000 5,381,000
Valuation allowance (5,121,000) (5,381,000)
---------- ----------
Net deferred tax assets
========== ==========
F-17
The Company has determined that, based upon available
information, the probability of utilizing its deferred tax
assets does not meet the "more likely than not" test under
SFAS 109. As such, a valuation allowance has been provided
against all deferred tax assets as of December 31, 2004 and
2003.
The Company and its subsidiaries file a consolidated federal
tax return and separate state returns. At December 31, 2004,
the Company has approximately $3,400,000 and $6,470,000 of
federal and state operating loss carryforwards, respectively,
available to offset future taxable income. These losses expire
at various dates through 2024.
During 2003, the Company recovered approximately $212,000 of
federal income taxes and during 2004 $38,000 of state income
taxes through loss carryback refund claims.
NOTE 12 - COMMITMENTS AND CONTINGENT LIABILITIES
Operating Leases
The Company leases office facilities and equipment under
operating leases expiring at various dates through 2006. The
lease for the Company's headquarters has a six-year renewal
option through 2011. Certain leases require the Company to pay
increases in real estate taxes, operating costs and repairs
over certain base year amounts. Operating lease expense for
the years ended December 31, 2004, 2003 and 2002 was
approximately $1,154,000, $1,192,000, and $1,393,000,
respectively.
Future minimum rental commitments under all non-cancelable
leases with terms greater than one year are as follows:
Year ending December 31,
2005 $955,171
2006 830,130
2007 631,790
2008 609,149
2009 and beyond 609,149
-------
$3,635,389
=========
Employment agreements
In January 2004, the Company entered into employment
agreements with its three top executive officers. The
agreements provide for annual base salary, customary fringe
benefits, severance and participation in an executive bonus
pool and a corporate finance bonus pool. The agreements have
terms ranging from two to five years with a one-year extension
provision. The agreements also provide for stock and option
grants vesting over three year periods. Two of these three
agreements were superceded by new agreements approved by
FMFC's board in February 2005 (see Note 21).
Mutual fund breakpoints
The NASD has directed member firms to assess mutual fund
transactions executed during the five-year period from 1999 to
2003 for the purpose of determining potential breakpoint
commission refunds to customers. At December 31, 2004, the
Company has paid out $4,483 in customer claims and has a
remaining reserve of $5,517. Management believes, but cannot
give assurance, that this amount will be sufficient to cover
eventual payouts.
F-18
Legal matters
On July 17, 2003, the Company and FMSC entered into an
agreement with certain claimants in order to settle pending
arbitration proceedings. The litigation arose out of customer
purchases of certain high-yield corporate bonds that declined
in market value or defaulted. The settlement agreement covers
eleven separate claims, which sought an aggregate of
approximately $12.3 million in damages. In exchange for the
consideration provided by the Company, each claimant granted a
general release of claims in favor of the Company and all
individual respondents, with the exception of the former
registered representative who had handled the claimants'
accounts. The Company paid an aggregate of $1,000,000 cash,
and issued to the claimants 500,000 shares of the Company's
common stock valued at $160,000 based on the stock's quoted
market price. The Company also issued to the claimants
five-year warrants to purchase an aggregate of 750,000 common
shares. The first class of 250,000 warrants was redeemed in
the third quarter of 2004. (see Note 10).
The Company is currently defending four additional claims
relating to the sale of the high-yield bonds. The claimants
seek compensatory damages in excess of $2.1 million plus
punitive damages and the recovery of various costs. The
Company is vigorously defending these actions and believes
that there are meritorious defenses in each case. There is no
insurance coverage available for the payment of settlements
and/or judgments that may result from these particular claims.
The Company is a respondent or co-respondent in various other
legal proceedings, which are related to its securities
business. Management is contesting these claims and believes
that there are meritorious defenses in each case. However,
litigation is subject to many uncertainties, and some of these
actions and proceedings may result in adverse judgments.
Further, the availability of insurance coverage is determined
on a case-by-case basis by the insurance carrier, and is
limited to the coverage limits within the policy for any
individual claim and in the aggregate. After considering all
relevant facts, available insurance coverage and consultation
with litigation counsel, management believes that significant
judgments or other unfavorable outcomes from pending
litigation could have a material adverse impact on the
Company's consolidated financial condition, results of
operations, and cash flows in any particular quarterly or
annual period, or in the aggregate, and could impair the
Company's ability to meet the statutory net capital
requirements of its securities business.
As of December 31, 2004, the Company has accrued litigation
costs that are probable and can be reasonably estimated based
on a review of existing claims, arbitrations and unpaid
settlements. Management cannot give assurance that this amount
will be adequate to cover actual costs that may be
subsequently incurred. Further, it is not possible to predict
the outcome of other matters pending against the Company. All
such cases will continue to be vigorously defended.
NOTE 13- CAPITAL LEASE OBLIGATIONS
The Company leases certain equipment under non-cancelable
lease agreements, which meet the criteria for capitalization.
The cost, accumulated depreciation and net book value of
equipment under the capital leases as of December 31, 2004
were $66,062, $11,010 and $55,052, respectively.
Future minimum lease payments under capital lease obligations
at December 31, 2004 are as follows:
Year ending December 31,
2005 $56,772
2006 9,110
------
Total minimum payments 65,882
Less amount representing interest (3,422)
------
Total principal $62,460
======
F-19
NOTE 14 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND
CONCENTRATION 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 of $174,326 and $69,330 at December 31, 2004 and
2003, 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. Cash balances held at
commercial banks may periodically exceed federal insurance
limits.
NOTE 15 - PENSION PLAN
The Company sponsors a defined contribution 401(k) pension
plan covering substantially all employees who meet minimum age
and service requirements. The Company may elect to contribute
up to 100% of each participant's annual contribution to the
plan. There were no employer contributions in 2004, 2003 or
2002.
NOTE 16 - STOCKHOLDERS' EQUITY (DEFICIT)
Preferred Stock - Series A
In 1999, the Company's board of directors designated a Series
A Convertible Preferred Stock with the following features:
Shares authorized: 625,000
Par value: $.10 per share
Dividends: 6% per annum, payable quarterly at the rate of
$.075 per share until conversion
Voting rights: None
Liquidation preference: $5.00 per share
Conversion: Convertible at the option of the holder anytime
into two shares of Common Stock at $2.50 per share; automatic
conversion 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.
The Company issued 349,511 Series A shares in a private
exchange offering in 1999. As of December 31, 2004, a total of
44,142 preferred shares have been converted into 88,284 shares
of common stock.
F-20
During the quarter ended June 30, 2003, the Company suspended
the payment of cash dividends on its Series A Preferred stock.
New Jersey Business Corporation Act prohibits the payment of
any distribution by a corporation to, or for the benefit of
its shareholders, if the corporation's total assets would be
less than its total liabilities. Unpaid preferred dividends
will continue to accumulate at 6% per annum. Arrearages must
be fully paid before any distribution can be declared or paid
on the Company's common stock. Cumulative dividends in
arrears, and not accrued, at December 31, 2004 were
approximately $164,000.
Preferred Stock - Series B
In February 2005, the Company's board of directors designated
a Series B Convertible Redeemable Preferred Stock with the
following features:
Shares authorized: 445,102
Par value: $.10 per share
Dividends: 8% per annum, payable quarterly at the rate of $.10
per share until conversion or redemption. Voting rights:
Holders of Series B Preferred Stock are entitled to vote
together with common stockholders on all matters in which they
are entitled to vote. The number of votes to which holders of
Series B Preferred are entitled to cast are ten per each share
of Series B Preferred Stock subject to certain adjustments.
Liquidation preference: $5.055 per share
Conversion: Convertible at the option of the holder anytime
into ten shares of Common Stock; automatic
conversion once the closing price for the Common Stock is
$1.01 for more than 60 trading days if the average daily
trading volume exceeds 20,000 shares, or $1.26 for more than
60 trading days if the average daily trading volume exceeds
10,000 shares, or $1.51 for more than 60 trading days.
Redemption: Optional redemption, the holder may require the
Company to redeem all or a portion of Series B Preferred Stock
by paying cash equal to the issue price plus all accrued and
unpaid dividends within 180 days after a Redemption Event, as
defined.
In February 2005 the Company issued 197,824 Series B Preferred
Shares in connection with a separation agreement entered into
with its former Chief Executive Officer.
The Company's charter authorizes the issuance of up to
5,000,000 shares of Preferred Stock. After the issuance of the
Series A and Series B Preferred Shares described above, the
Company is authorized to issue an additional 3,929,898 of
Preferred Stock. The rights and preferences, if any, to be
given to these preferred shares would be designated by the
board of directors at the time of issuance.
Common Stock
In connection with a legal settlement in 2003, the Company
issued 500,000 shares of common stock to various litigants.
The shares were valued at $160,000 based on the quoted market
price of the shares on the issuance date. The Company has
provided demand registration rights with respect to 250,000
shares and piggy-back registration rights with respect to the
remaining 250,000 shares.
Warrants
During 2003 and 2002, the Company issued 210,500 and 103,000
common stock purchase warrants, respectively, to FMSC
registered representatives as compensation in connection with
the sale of convertible debentures. The Company valued the
warrants at $35,977 and $11,382 respectively, using the
Black-Scholes option pricing method. The warrants are
exercisable at $.50 per share for five years from the date of
issuance.
At December 31, 2004, the Company had outstanding 3,072,446
Class C Redeemable Common Stock Purchase Warrants, which
expired in February 2005.
During 1999, the Company issued 25,000 common stock purchase
warrants in connection with a legal settlement. The warrants
expired in the third quarter of 2004.
F-21
NOTE 17 - STOCK OPTION PLANS
2002 Stock Incentive Plan
In June 2002, the Company adopted and its stockholders
approved the 2002 Incentive Stock Option Plan (the "2002
Plan"), replacing the 1992 Incentive Stock Option Plan (the
"1992 Plan"), which expired in September 2002. The 1992 Plan
provided for the granting of options to employees, consultants
and registered representatives of the Company, but only
options issued to employees qualify for incentive stock option
treatment ("ISOs"). Option exercise periods were fixed by the
Board of Directors on the grant date but no exercise period
could be less than one year nor more than ten years from the
date of grant. As of December 31, 2004, a total of 761,698
options issued under this plan remain outstanding.
The Company has reserved up to 5,000,000 shares of common
stock for issuance under the 2002 Plan. The 2002 Plan provides
for the grant of options, including ISOs to employees;
non-qualified stock options (NQSOs) to employees, consultants
and independent registered representatives; and stock
appreciation rights or any combination thereof (collectively,
"Awards"). The Board of Directors determines the terms and
provisions of each award granted under the 2002 Plan,
including the exercise price, term and vesting schedule. In
the case of ISO's, the per share exercise price must be equal
to at least 100% of the fair market value of a share of common
stock on the date of grant, and no individual will be granted
ISOs corresponding to shares with an aggregate fair value in
excess of $100,000 in any calendar year. The 2002 Plan will
terminate in 2012. As of December 31, 2004, options to
purchase a total of 1,017,000 shares were outstanding and
3,983,000 shares remained available for future issuance under
the 2002 Plan.
2002 Non-Executive Director Stock Option Plan
In June 2002, the Company adopted and its stockholders
approved the 2002 Non-Executive Director Stock Option Plan
(the "2002 Director Plan"), replacing the Non-Executive
Director Stock Option Plan, which expired in September 2002.
Under the 2002 Director Plan, each non-executive director will
automatically be granted an option to purchase 20,000 shares,
pro rata, on September 1st of each year or partial year of
service. The Plan will be administered by the Board of
Directors or a committee of the Board, which shall at all
times consist of not less than two officer/directors of the
Company who are ineligible to participate in the 2002 Director
Plan. The 2002 Director Plan does not contain a reserve for a
specific number of shares available for grant. Each option
issued under the 2002 Director Plan will be immediately vested
NQSOs, and will have a five-year term and an exercise price
equal to the 100% of the fair market value of the shares
subject to such option on the date of grant. The 2002 Director
Plan will terminate in 2012. As of December 31, 2004, 40,000
options were outstanding under the 1992 Non-Executive Director
Stock Plan and 120,000 options were outstanding under the 2002
Non-Executive Director Stock Plan.
1996 Senior Management Plan
In June 2000, the Company's stockholders approved an amendment
to the 1996 Senior Management Plan (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. As of December 31, 2004, options to purchase
1,717,500 shares and 1,000,000 shares of restricted common
stock were outstanding. Subsequent to year end an additional
1,300,000 restricted common shares were issued under the Plan
with 577,500 shares available for future issuance under the
Plan.
F-22
A summary of the activity in the Company's stock option plans
for the three-year period ended December 31, 2004 is presented
below:
Weighted
Average
Exercise
Shares Prices
Options outstanding, December 31, 2001 5,243,998 1.73
Granted 573,000 .55
Canceled (1,744,500) 1.84
----------
Options outstanding, December 31, 2002 4,072,498 1.52
Granted 873,000 .54
Canceled (1,389,000) 1.75
----------
Options outstanding, December 31, 2003 3,556,498 $1.19
Granted 891,000 .57
Exercised (1,800) .31
Canceled (789,500) 1.17
-----------
Options outstanding, December 31, 2004 3,656,198
==========
Shares of common stock available for future grant under
Company plans totaled 5,170,500 as of December 31, 2004. This
number does not include options that are expected to be issued
during the remaining term of the 2002 Director's Plan, but for
which no specific reserve has been established.
The Company has elected to use the intrinsic value-based
method of APB Opinion No. 25 to account for all of its
employee stock-based compensation plans. Accordingly, no
compensation cost has been recognized in the accompanying
financial statements for stock options issued to employees
because the exercise price of each option equals or exceeds
the fair value of the underlying common stock as of the grant
date for each stock option. Accordingly, compensation is
recognized in the consolidated financial statements only for
the fair value of options issued to consultants and
independent registered representatives. Such compensation is
amortized to expense over the related options' vesting
periods. Compensation expense recognized in 2004, 2003 and
2002 totaled $42,256, $37,156 and $2,985, respectively. The
weighted-average grant date fair value of options granted
during 2004, 2003 and 2002 was $.28, $.22, and $.08,
respectively.
Additional information as of December 31, 2004 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 Prices Exercisable Prices
$0.20 - $0.30 127,000 3.16 $.25 105,800 $.25
$0.30 - $0.49 76,200 2.61 .40 62,720 .40
$0.50 - $0.75 2,014,000 3.34 .60 1,152,460 .60
$.83 - $1.09 283,000 1.48 .89 259,735 .88
$1.44 - $2.16 1,087,998 .45 1.85 1,081,498 1.85
$2.38 - $2.50 68,000 1.55 2.56 66,000 2.56
- -------------------------------------------------------------------------------------------------------------------
$0.20 - $2.50 3,656,198 2.28 $1.01 2,728,213 $1.15
- -------------------------------------------------------------------------------------------------------------------
F-23
NOTE 18 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial instruments reported in the Company's consolidated
statement of financial condition consist of cash, securities
owned and sold, not yet purchased, loans receivable, warrants
subject to put options, 6% convertible debentures, accounts
payable and accrued expenses, and capital leases payable, the
carrying value of which approximated fair value at December
31, 2004 and 2003. The fair value of the financial instruments
disclosed is not necessarily representative of the amount that
could be realized or settled nor does the fair value amount
consider the tax consequences of realization or settlement.
NOTE 19 - 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,
2004, FMSC had net capital of $1,992,574, which was $1,685,619
in excess of its required net capital of $306,955. FMSC's
ratio of aggregate indebtedness to net capital was 2.31 to 1.
NOTE 20 - UNAUDITED QUARTERLY RESULTS OF OPERATIONS
March 31, June 30, September 30, December 31,
2004 2004 2004 2004
---- ---- ---- ----
Revenues $18,821,406 $14,241,684 $11,747,309 $14,376,842
Expenses 18,583,432 14,216,838 11,707,408 13,962,366
Net income 237,974 24,846 39,901 427,781
Net income
applicable to
common stockholders 215,071 2,251 17,306 405,185
Income per common share:
Net income applicable
to common stockholders -
basic .02 -0- .03 .04
diluted .02 -0- .02 .03
March 31, June 30, September 30, December 31,
2003 2003 2003 2003
---- ---- ---- ----
Revenues $10,956,167 $15,902,470 $15,171,548 $16,196,497
Expenses 11,427,511 17,241,938 15,460,089 17,116,187
Net loss (471,344) (1,339,468) (288,541) (1,418,690)
Net loss applicable
to common
stockholders (496,183) (1,339,468) (288,541) (1,418,690)
Loss per common share:
Net loss applicable
to common
stockholders - basic
and diluted (.06) (.16) (.03) (.16)
For the quarter ended December 31, 2004, the Company revised
its vesting period for restricted stock issued to two of its
executive officers on January 1, 2004, resulting in additional
income of $175,000 in the fourth quarter.
Net income (loss) per share is computed independently for each
of the quarters presented. Therefore, the sum of the quarterly
net income (loss) per share figures in 2004 and 2003 does not
necessarily equal the total computed for the entire year.
F-24
NOTE 21 - SUBSEQUENT EVENTS
Separation Agreement:
On February 8, 2005, the Company entered into a Separation
Agreement ("Agreement") with its Chief Executive Officer
("CEO"), which provides for the CEO to terminate his
employment and his positions as CEO of both the Company and
FMSC as of that date. The Agreement provides for the CEO to
remain as a director of the Company. The Agreement also
terminated the CEO's employment agreement dated January 1,
2004.
Pursuant to the terms of the Agreement, the Company entered
into a two year consulting agreement, issued 197,824 shares of
FMFC Series B Convertible Redeemable Preferred Stock
convertible into 1,978,240 shares of the Company's common
stock, with voting privileges and will execute a promissory
note for $200,000 with interest of 8% per annum. The Company
is also responsible for a one time payment of $136,000 that
will be payable in early 2005. The Company also issued 200,000
options to purchase common stock at $0.83 per share for three
years, vesting over two years, and cancelled 325,000 options
with various exercise prices. All restricted common shares not
previously vested were automatically vested upon his
termination.
Employment Agreements:
In February 2005, the Chief Operating Officer ("COO") was
appointed the role of CEO of FMFC and FMSC. The Company
entered into an employment agreement with the new CEO, which
superseded his existing agreement, and allowed for issuance,
as a bonus payment for our performance for the year ended
December 31, 2004, and in consideration of the CEO assuming
the position of Chief Executive Officer, 1,000,000 shares of
our common stock. The 1,000,000 shares vest in annual
increments of one third commencing on February 1, 2005. In
addition, the new CEO agreed to the cancellation of 250,000 of
his outstanding stock options with an exercise price of $0.75
per share. In the event of a change of control of the Company,
all unvested shares would vest. In the event of termination
without cause, the new CEO is entitled to a severance payment
consisting of accrued compensation, benefit continuation and
payment of base salary for the greater of three months or the
unexpired term. Three other executive officers received
100,000 shares of restricted stock, each with the same vesting
schedule as the new CEO.
Merger Agreement:
The Company executed a definitive Agreement and Plan of Merger
("Merger Agreement") dated February 10, 2005 with Olympic
Cascade Financial Corporation ("Olympic"). Under the terms of
the Merger Agreement, the stockholders of FMFC will receive
0.5055 shares of Olympic common stock for each share of FMFC
stock. Under the merger plan currently contemplated, the
Company will become a 100% owned subsidiary of Olympic. The
completion of the merger is subject to stockholder and
regulatory approval and the finalization of financing
arrangements.
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