Exhibit 99.1
- --------------------------------------------------------------------------------
Gruntal Financial, L.L.C.
Consolidated Statements of Financial Condition as of December 31, 2001 and
2000 and Consolidated Statements of Operations, Cash Flows and Changes in
Subordinated Borrowings and Members' Interest for the three years ended
December 31, 2001 and Independent Auditors' Report
GRUNTAL FINANCIAL, L.L.C.
TABLE OF CONTENTS
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Page
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INDEPENDENT AUDITORS' REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Statements of Financial Condition as of December 31, 2001 and 2000 2
Consolidated Statements of Operations for the three years ended December 31, 2001 3
Consolidated Statements of Changes in Subordinated Borrowings for the three years
ended December 31, 2001 4
Consolidated Statements of Cash Flows for the three years ended December 31, 2001 5
Consolidated Statements of Changes in Members' Interest for the three years ended
December 31, 2001 6
Notes to Consolidated Financial Statements 7 - 16
</Table>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Gruntal Financial, L.L.C.:
We have audited the accompanying consolidated statements of financial condition
of Gruntal Financial, L.L.C. and subsidiaries (the "Company") as of December 31,
2001 and 2000, and the related consolidated statements of operations, cash flows
and changes in subordinated borrowings and members' interest for each of the
three years in the period ended December 31, 2001. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall consolidated financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the accompanying consolidated financial statements present
fairly, in all material respects, the consolidated financial position of Gruntal
Financial, L.L.C. and subsidiaries at December 31, 2001 and 2000, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 10 to
the consolidated financial statements, the Company's recurring losses from
operations and members' interest deficiency raise substantial doubt about its
ability to continue as a going concern. Management's plans concerning these
matters are also described in Note 10. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
/s/ DELOITTE & TOUCHE LLP
New York, New York
May 17, 2002
GRUNTAL FINANCIAL, L.L.C.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31,
----------------------------
(Dollars in Thousands) 2001 2000
- ---------------------- ---------- ----------
ASSETS
Cash $ 1,229 $ 1,836
Cash and securities segregated under federal and other regulations 778 1,336
Securities borrowed 1,510,904 2,189,311
Receivables from brokers and dealers 9,904 18,924
Financial instruments owned - at fair value, held by Clearing Broker:
U.S. Government, state, and municipal obligations 99,532 120,838
Corporate and other debt 4,124 458,437
Equity securities 6,060 20,084
Office facilities, net of accumulated depreciation and amortization of $26,807
and $21,745, respectively 25,063 25,880
Secured demand note 5,000 --
Other assets 65,896 52,723
---------- ----------
TOTAL ASSETS $1,728,490 $2,889,369
========== ==========
LIABILITIES AND MEMBERS' INTEREST
Drafts payable $ 2,474 $ 4,082
Securities loaned 1,517,799 2,212,316
Payables:
Clearing Broker 44,953 101,795
Brokers and dealers 2,093 12,927
Customers 400 451
Financial instruments sold, not yet purchased - at fair value:
U.S. Government, state, and municipal obligations 5,844 35,818
Corporate and other debt 785 293,612
Equity securities 1,878 12,042
Other liabilities and accrued expenses 59,102 74,117
---------- ----------
1,635,328 2,747,160
Long-term borrowings 9,709 12,000
Subordinated borrowings, under secured demand note collateral agreement 5,000 --
Minority interest 6 477
Members' interest 78,447 129,732
---------- ----------
TOTAL LIABILITIES AND MEMBERS' INTEREST $1,728,490 $2,889,369
========== ==========
See notes to consolidated financial statements.
2
GRUNTAL FINANCIAL, L.L.C.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
--------------------------------------------
(Dollars in Thousands) 2001 2000 1999
- ---------------------- --------- --------- ---------
REVENUES
Interest $ 111,647 $ 215,453 $ 131,386
Commissions 90,481 142,951 133,335
Principal transactions 85,729 161,048 164,716
Underwriting and investment banking 15,340 18,496 18,693
Asset management fees 14,935 14,018 12,371
Other 4,673 4,630 8,337
--------- --------- ---------
Total revenues 322,805 556,596 468,838
INTEREST EXPENSE 91,438 185,616 105,457
--------- --------- ---------
NET REVENUES 231,367 370,980 363,381
--------- --------- ---------
NONINTEREST EXPENSES
Compensation and benefits 180,041 243,269 240,427
Occupancy and equipment 29,612 30,147 31,309
Depreciation and amortization 7,894 5,456 7,263
Communications and market data 16,274 18,137 21,278
Brokerage, clearing, and exchange fees 12,754 24,530 25,197
Legal fees, settlements and other professional fees 12,171 16,759 13,523
Management fees 6,819 3,844 4,510
Sales promotion 5,168 6,271 6,276
Postage and stationery 4,184 5,071 6,092
Other 7,670 12,038 13,514
--------- --------- ---------
Total noninterest expenses 282,587 365,522 369,389
--------- --------- ---------
Income (loss) before income taxes and minority interest (51,220) 5,458 (6,008)
Provision for income taxes 68 336 310
Minority interest in net loss of consolidated subsidiary 3 23 --
--------- --------- ---------
NET INCOME (LOSS) $ (51,285) $ 5,145 $ (6,318)
========= ========= =========
</Table>
See notes to consolidated financial statements.
3
GRUNTAL FINANCIAL, L.L.C.
CONSOLIDATED STATEMENTS OF CHANGES IN SUBORDINATED BORROWINGS
(Dollars in Thousands)
- ----------------------
BALANCE, JANUARY 1, 1999 $ --
Increases: --
Decreases: --
-------
BALANCE, DECEMBER 31, 1999 --
Increases: --
Decreases: --
-------
BALANCE, DECEMBER 31, 2000 --
Increases:
Secured demand note collateral agreements 55,000
Decreases:
Termination of secured demand note collateral agreement 50,000
-------
BALANCE, DECEMBER 31, 2001 $ 5,000
=======
See notes to consolidated financial statements.
4
GRUNTAL FINANCIAL, L.L.C.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-----------------------------------------------
(Dollars in Thousands) 2001 2000 1999
- ---------------------- ----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (51,285) $ 5,145 $ (6,318)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation and amortization 7,894 5,456 7,263
(Increase) decrease in operating assets:
Cash and securities segregated under federal and other regulations 558 1,279 493
Securities borrowed 678,407 549,643 (1,334,462)
Receivables from brokers and dealers 9,020 668 (8,148)
Financial instruments owned 489,643 6,879 (97,244)
Other assets (13,173) (8,232) (15,679)
Increase (decrease) in operating liabilities:
Drafts payable (1,608) 364 (935)
Securities loaned (694,517) (527,192) 1,333,457
Payable to Clearing Broker (56,842) (35,636) 78,842
Payables to brokers and dealers (10,834) 2,288 4,573
Payables to customers (51) (462) 137
Financial instruments sold, not yet purchased (332,965) 13,088 26,220
Other liabilities and accrued expenses (15,015) (9,033) 19,997
----------- ----------- -----------
Net cash provided by operating activities 9,232 4,255 8,196
CASH FLOWS FROM INVESTING ACTIVITIES -
Purchases of office facilities, net (7,077) (3,799) (10,630)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term borrowings (14,291) -- (2,000)
Proceeds from long-term borrowing 12,000 -- 4,000
Proceeds from minority shareholder 6 477 --
Dissolution of general partnership interest,
net of loss of consolidated subsidiary (477) -- --
----------- ----------- -----------
Net cash provided by (used in) financing activities (2,762) 477 2,000
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH (607) 933 (434)
CASH, BEGINNING OF YEAR 1,836 903 1,337
----------- ----------- -----------
CASH, END OF YEAR $ 1,229 $ 1,836 $ 903
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest payments $ 102,339 $ 182,874 $ 101,095
=========== =========== ===========
Income tax payments $ 26 $ 722 $ 50
=========== =========== ===========
Non cash financing activities:
Borrowings under secured demand note collateral agreements $ 55,000 $ -- $ --
=========== =========== ===========
Termination of secured demand note collateral agreement $ (50,000) $ -- $ --
=========== =========== ===========
See notes to consolidated financial statements.
5
GRUNTAL FINANCIAL, L.L.C.
CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS' INTEREST
(Dollars in Thousands)
- ----------------------
BALANCE, JANUARY 1, 1999 $ 130,905
Net loss (6,318)
---------
BALANCE, DECEMBER 31, 1999 124,587
Net income 5,145
---------
BALANCE, DECEMBER 31, 2000 129,732
Net loss (51,285)
---------
BALANCE, DECEMBER 31, 2001 $ 78,447
=========
See notes to consolidated financial statements.
6
GRUNTAL FINANCIAL, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001
(Dollars in Thousands)
1. ORGANIZATION
At December 31, 2000, Gruntal Financial, L.L.C. (the "Company") was 60.84%
owned by The 1880 Group LLC, 34.22% owned by The Home Insurance Company
("Home Insurance"), a wholly-owned subsidiary of THIC Holdings LLC, and
4.94% owned by the Pershing Division of Donaldson, Lufkin & Jenrette
Securities Corporation (the "Clearing Broker"). On January 4, 2001, the
Company restructured its equity, whereby the Company redeemed all of its
common and preferred membership interests owned by The 1880 Group LLC,
Home Insurance and the Clearing Broker. The redeemed membership interests
were subsequently cancelled and The 1880 Group LLC was dissolved. In
exchange for the redeemed membership interests originally held by The 1880
Group LLC and the Clearing Broker, The 2000 Group LLC, a Delaware limited
liability company formed in December 2000, issued three classes of limited
liability interests. Certain senior executives and employees received
Class A and Class B interests and the Clearing Broker received Class C
interests in The 2000 Group LLC. In exchange for the membership interests
previously held by Home Insurance, the Company issued a preferred interest
having an initial nominal value of $130,000 with a preferred return of
7.50%. Pursuant to certain contracts between Home Insurance and Orange
Stone Reinsurance, an affiliate of Home Insurance, any proceeds up to a
certain threshold received by Home Insurance relating to a sale of the
Company will reduce certain obligations owed by Orange Stone Reinsurance
to Home Insurance. Orange Stone, LLC, of which Orange Stone Reinsurance is
the indirect owner of 100% of its membership interests, has the right to
appoint three members to the Company's seven member Executive Committee
and has approval rights over certain actions by the Company. The 2000
Group LLC owns 100% of the common membership interests of the Company.
The Company, through its wholly-owned subsidiary Gruntal & Co., L.L.C.
("Gruntal") and Gruntal's wholly-owned subsidiary, The GMS Group, L.L.C.
("GMS"), operates as a broker-dealer. Gruntal and GMS are each
broker-dealers registered under the Securities Exchange Act of 1934. The
primary activities of the Company, through its subsidiaries, include
providing a wide range of retail and institutional brokerage services and
the trading of equity and fixed-income securities and commodities. Gruntal
also trades for its own account in equity securities, corporate and
municipal fixed-income securities, and certain commodities; engages in
fully- or partially-hedged option/equity arbitrage and risk arbitrage;
makes a market in certain corporate and municipal debt and equity
securities; and participates in and at times originates underwritings and
distributions of equity and corporate and municipal fixed-income
securities. Other activities include corporate and municipal finance,
investment research, and retail and institutional product origination. See
discussion below regarding the downsizing of certain business units.
The Company clears its equity and fixed-income securities transactions
through the Clearing Broker on a fully-disclosed basis. The Payable to
Clearing Broker represents amounts due in connection with the financing of
proprietary positions, amounts on deposit, and the clearance of customer
securities transactions. The Clearing Broker is the primary source of
short-term financing for the Company, which is collateralized by the
financial instruments inventory of the Company. The financial instruments
inventory is held and may be pledged by the Clearing Broker.
7
1. ORGANIZATION (Continued)
Gruntal is also a futures commission merchant registered with the
Commodity Futures Trading Commission and clears its commodities
transactions on an omnibus basis through commodities futures brokerage
firms, Refco, Inc. and ED&F Man International Inc.
Gruntal MedScience Partners LLC ("MedScience"), a wholly-owned subsidiary
of Gruntal, was formed as a limited liability company in the state of
Delaware in February 2000. MedScience had a 50% interest in the asset
management company and in the general partner of the S/G MedScience Fund,
L.P. (the "Fund"), a limited partnership, which invests in securities of
entities in the healthcare industry with the objective of achieving above
average, long-term capital appreciation for its members. On May 31, 2001,
Gruntal became a limited partner in the Fund and ended its relationship
with the Fund's general partner and the asset management company.
In July 2001, in connection with the implementation of its strategic plan
to focus on its core individual and institutional distribution businesses,
Gruntal ceased its high-grade corporate bond proprietary trading and
market making activities. The corporate bond portfolio was transferred
from Gruntal to BondInvest LLC ("BondInvest"), a registered broker-dealer
and subsidiary of Gruntal, which entered into an agreement with another
financial institution to manage the liquidation of the portfolio.
Financing of the transaction was effected through a secured demand note
collateral agreement with Orange Stone Holdings Delaware Ltd. ("Orange
Stone Holdings"), an affiliate of Orange Stone, LLC, in the amount of
$50,000. In addition, Orange Stone Holdings holds a 1% membership interest
in BondInvest. The portfolio was liquidated and, effective October 31,
2001, BondInvest was deregistered as a broker-dealer. The secured demand
note collateral agreement was terminated in November 2001 and the $50,000
in collateral was returned. For more information, see note 5 to the
consolidated financial statements.
As a result of the events of September 11, 2001, as described in note 6,
Gruntal shifted its strategic plan. In October 2001, Gruntal ceased its
small capitalization street-side over-the-counter market making
activities, eliminated its technology research and investment banking
practice, and made certain other changes that resulted in an overall staff
reduction of approximately ten percent. For more information, see note 10
to the consolidated financial statements.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All material intercompany balances and
transactions have been eliminated in consolidation. The consolidated
financial statements are presented in accordance with accounting
principles generally accepted in the United States of America and
prevailing industry practices, both of which require management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities as of
December 31, 2001, as well as the reported amounts of revenues and
expenses during the period then ended. Estimates, by their nature, are
based on judgment and available information. Management believes that the
estimates utilized in the preparation of the consolidated financial
statements are prudent and reasonable. Actual results could differ
materially from those estimates.
8
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
SECURITIES LENDING ACTIVITIES - Securities borrowed and loaned are
recorded at the amount of cash collateral advanced or received in
connection with the transactions. Securities borrowed transactions require
the Company to provide the counterparty with collateral in the form of
cash. The Company receives collateral in the form of cash for securities
loaned transactions. For these transactions, the fee received or paid by
the Company is recorded as interest revenue or expense. On a daily basis,
the Company monitors the market value of securities borrowed or loaned and
requests or is requested to provide additional collateral as deemed
necessary. Collateral received under securities borrowed is allowed by
contract or custom to be sold or repledged. The fair value of such
collateral that has been repledged was $1,451,612 and $2,096,492 at
December 31, 2001 and 2000, respectively.
PROPRIETARY SECURITIES TRANSACTIONS - Financial instruments owned and
financial instruments sold, not yet purchased are recorded on a trade date
basis and at fair value. The resulting unrealized gains and losses are
included in revenues from principal transactions. The fair value of
trading positions is generally based on listed market prices. If listed
market prices are not available or if liquidating the positions would
reasonably be expected to impact market prices, fair value is determined
based on other relevant factors, including dealer price quotations, price
quotations for similar instruments traded in different markets or
management's estimates of amounts to be realized on settlement.
FAIR VALUE OF FINANCIAL INSTRUMENTS - Substantially all of the Company's
financial instruments are carried at fair value or amounts that
approximate fair value.
OFFICE FACILITIES - Office facilities consist of furniture, leasehold
improvements, equipment, and capitalized software costs and are reported
at historical cost, net of accumulated depreciation and amortization.
Depreciation and amortization are computed using the straight-line method.
Furniture, equipment, and capitalized software are depreciated over the
estimated useful lives of the assets, while leasehold improvements are
amortized over the lesser of the estimated economic useful life of the
leasehold improvements or the term of the applicable lease. Maintenance
and repair costs are expensed as incurred.
STATEMENT OF CASH FLOWS - For the purposes of the Consolidated Statement
of Cash Flows, cash includes noninterest-bearing deposits at banks.
EMPLOYEE BENEFIT PLANS - Eligible employees of the Company who have met
certain service requirements participate in the Company's 401(k) defined
contribution plan. The Company matches certain employee contributions;
additional contributions to this plan are at the discretion of the
Company. Total Company contribution expense was $1,240, $1,138 and $948
for the years ended December 31, 2001, 2000 and 1999, respectively.
Gruntal offers a nonqualified deferred compensation plan to a select group
of employees that provides the opportunity to defer up to 20 percent of
cash compensation in self-directed investments. Gruntal provides an annual
matching contribution at specific percentages and may contribute other
special allocations that vest if the employee remains with Gruntal for 10
years from the plan year of the match.
9
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The obligations under the terms of this plan are not required to be
funded. The obligations are unsecured general obligations to pay in the
future the value of the deferred compensation, adjusted to reflect the
performance of selected investment measurement options chosen by each
participant during the deferral period. At December 31, 2001 and 2000, the
liabilities accrued pursuant to the deferred compensation plan totaled
$21,339 and $20,457, and is included in other liabilities and accrued
expenses on the Consolidated Statement of Financial Condition. The
matching contribution expense, including special allocations, was $686,
$94 and $283 for the years ended December 31, 2001, 2000 and 1999,
respectively.
ACCOUNTING PRONOUNCEMENTS - In September 2000, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities - a Replacement of
FASB Statement No. 125," which revises the standards of accounting for
securitizations and other transfers of financial assets and collateral.
The provisions of SFAS No. 140 carry over most of the guidance outlined in
SFAS No. 125 and further establish accounting and reporting standards with
a financial-components approach that focuses on control. Under this
approach, financial assets or liabilities are recognized when control is
established and are derecognized when control has been surrendered or the
liability has been extinguished. In addition, specific implementation
guidelines have been established to further distinguish transfers of
financial assets that are sales from transfers that are secured
borrowings. SFAS No. 140 was effective prospectively, for transfers
occurring after March 31, 2001 and for disclosures relating to
securitization transactions and collateral for fiscal years ended after
December 15, 2000. During 2001, the Company adopted the provisions of SFAS
No. 140, which did not have a material effect on the Company's
consolidated financial statements.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets", which establishes new standards for accounting for goodwill and
intangible assets. This statement requires that goodwill and certain
intangible assets with an indefinite useful life not be amortized. This
statement also requires that goodwill and certain intangibles be tested at
least annually under new impairment criteria. The Company adopted this
statement on January 1, 2002 and does not expect it to have a material
effect on the Company's consolidated financial statements.
3. RELATED PARTY TRANSACTIONS
On January 4, 2001, pursuant to the restructuring of its equity, the
Company issued to Home Insurance a preferred interest having an initial
nominal value of $130,000 with a preferred return of 7.50%. The preferred
return is cumulative and retroactive to September 1, 2000. The cumulative
unpaid preferred return at December 31, 2001 was $13,244. The payout of
the preferred return is at the discretion of the Company or upon the
occurrence of certain future events.
10
3. RELATED PARTY TRANSACTIONS (Continued)
On January 4, 2001, the services agreements between certain senior
executives and The 1880 Group LLC were terminated. In exchange for their
agreement to terminate the existing agreements, the Company granted
forgivable loans in the amount of $6,458 to these senior executives. The
loans are to be forgiven in equal installments in 2002 and 2003, provided
that the senior executives are employed by the Company through such dates
or under certain other circumstances. New services agreements were entered
into between the Company and these and certain other senior executives
(the "Members") to provide administrative services to the Company and its
subsidiaries. For services rendered during 2001, 2000 and 1999, the
Company accrued or paid to the Members $7,464, $8,247 and $10,750,
respectively, including contract settlements and severance for Members who
were terminated. As of December 31, 2001 and 2000, the payable to the
Members was $2,356 and $4,041, respectively, which are included in other
liabilities and accrued expenses on the Consolidated Statement of
Financial Condition.
At December 31, 2001 and 2000, the Company had loans and advances to
employees, including the forgivable loans to senior executives mentioned
above, of $19,958 and $11,531 respectively. Loans and advances are
included in other assets on the Consolidated Statement of Financial
Condition.
For the years ended December 31, 2001, 2000 and 1999, the Company accrued
or paid $9,500, $19,813 and $23,423, respectively, to the Clearing Broker
for securities clearance and other services and $5,682 $8,074 and $9,791,
respectively, in net interest expense on the net payable to the Clearing
Broker.
For more information on related party transactions, see notes 1, 4 and 5
to the consolidated financial statements.
4. LONG-TERM BORROWINGS
In December 2000, Gruntal Facilities Management LLC ("GFM") was formed as
a limited liability company in the state of Delaware and was capitalized
by the Company in January 2001. GFM is a wholly-owned subsidiary of the
Company organized to provide certain administrative and office facilities
services to the Company and its affiliates, pursuant to facilities
management service agreements between the entities.
On February 13, 2001, Gruntal prepaid the $12,000 outstanding balance of
the long-term borrowings and made a dividend of certain office facilities
to the Company. The Company made a capital contribution of those office
facilities to GFM that are used as collateral for a new long-term
borrowing (the "Borrowing") in the amount of $12,000. GFM remitted the
$12,000 proceeds of the Borrowing as a dividend to the Company. In
addition, the Company made a $12,000 capital contribution to Gruntal. The
Borrowing is guaranteed by the Company and the remaining principal balance
will mature as follows: 2002 - $3,055; 2003 - $3,055; and 2004 - $3,600.
The Borrowing has a variable interest rate that resets quarterly to the
three-month London Interbank Offered Rate plus 265 basis points, which was
4.67% at December 31, 2001.
Pursuant to the Borrowing agreement, the Company must maintain certain
minimum liquidity and net worth levels, and Gruntal must maintain certain
minimum net capital levels and must not exceed certain additional
indebtedness levels. At December 31, 2001, the Company and Gruntal were
not in compliance with certain of these covenants. On May 17, 2002, GFM
reached a settlement with the lender and the Borrowing was retired.
11
5. SUBORDINATED BORROWINGS
As described in note 1, in July 2001, Gruntal ceased its high-grade
corporate bond proprietary trading business and BondInvest entered into a
$50,000 secured demand note collateral agreement with Orange Stone
Holdings. The agreement was terminated in November 2001 and the $50,000 in
collateral was returned. The secured demand note had an interest rate of
4.67% per annum and, during 2001, interest was paid to Orange Stone
Holdings totaling $940.
In November 2001, Gruntal entered into a funding agreement with ZGA US
Limited ("ZGA"), an affiliate of Orange Stone, LLC, whereby ZGA agreed to
lend up to $15,000 to Gruntal under certain conditions. Under this
agreement, Gruntal executed a secured demand note collateral agreement for
$5,000 on November 30, 2001 with a scheduled maturity date of November 30,
2002 and bearing interest at a rate of 7.5% per annum. During 2001,
Gruntal accrued $32 in interest expense under the secured demand note
agreement.
A second secured demand note collateral agreement for $5,000 was executed
by Gruntal pursuant to this funding agreement on February 19, 2002, which
has a scheduled maturity date of February 19, 2003 and bearing an interest
rate of 7.5% per annum. The remaining amount available under the funding
agreement expired unused on February 20, 2002.
The subordinated borrowings are covered by the secured demand note
collateral agreements approved by the New York Stock Exchange, Inc. and
are available to Gruntal as described below in computing its net capital
pursuant to Rule 15c3-1 under the Securities Exchange Act of 1934. To the
extent that such borrowings are required for the Gruntal's continued
compliance with minimum net capital requirements, they may not be repaid.
6. COMMITMENTS AND CONTINGENCIES
LITIGATION AND REGULATORY MATTERS - In the ordinary course of its
business, the Company (i) has been named as a defendant or co-defendant in
a number of lawsuits, including class actions and arbitration proceedings,
some of which involve claims for damages in substantial or unspecified
amounts and (ii) is the subject of certain regulatory inquiries and
proceedings. Although the ultimate outcome of the foregoing lawsuits,
arbitrations, and regulatory inquiries and proceedings cannot be predicted
with certainty, in the opinion of management, based on information
provided by both in-house and outside legal counsel, the outcome of these
matters will not have a material adverse effect on the Company's
consolidated financial condition, but may be material to the Company's
operating results for any particular period, depending on the level of the
Company's income for such period.
12
6. COMMITMENTS AND CONTINGENCIES (Continued)
LEASES AND LONG-TERM OBLIGATIONS - The Company occupies office space and
uses equipment under noncancelable operating leases to which the Company,
Gruntal, or GMS is a party. Gruntal has also entered into certain
long-term service agreements whereby Gruntal pays a monthly fee in
exchange for certain equipment, software and maintenance services. These
leases and obligations expire at various dates through the year 2013.
Future minimum rental payments under operating leases and long-term
obligations at December 31, 2001 are presented below:
2002 $ 23,750
2003 17,716
2004 15,344
2005 13,355
2006 12,081
Thereafter 54,249
--------
$136,495
========
Minimum rental payments on operating leases have not been reduced by
minimum sublease rental income of $755 to be received in the future under
noncancelable leases. Certain occupancy leases are subject to escalations
based on specified costs incurred by the landlords. Certain equipment
leases contain provisions for renewal or purchase options at the end of
the lease term. Occupancy and equipment lease expense was $25,095, $25,519
and $26,353 for the years ending December 31, 2001, 2000 and 1999,
respectively.
OTHER - The Company has $4,000 of letters of credit outstanding used to
satisfy lease commitments, which expire at various dates through January
31, 2006.
On May 17, 2002, the Company reached settlement under certain of its
operating leases, whereby its future minimum rental payments at December
31, 2001, were reduced by $76,062 and the letters of credit were retired.
For more information, see note 10 to the consolidated financial
statements.
DISASTER RECOVERY - On September 11, 2001, terrorist attacks on the World
Trade Center in New York City impacted the Company's home office
facilities at One Liberty Plaza located adjacent to the disaster site.
Significant collateral damage was sustained to the facilities and its
contents and the business of the Company was materially disrupted. The
Company activated its disaster recovery plan, whereby home office
personnel were deployed to various branch offices and space provided by
several vendors. For more information, see note 10 to the consolidated
financial statements.
The Company is in the process of preparing claims to be filed with its
insurance carrier for property damage and business interruption
recoveries. New equipment, primarily computer hardware and software, was
purchased to facilitate the access to and functionality of the Company's
existing backup systems and to reestablish the Company's disaster recovery
site at a new location. At December 31, 2001, this equipment totaled $846,
net of accumulated depreciation and amortization, and is included in
office facilities on the Consolidated Statement of Financial Condition.
The consolidated financial statements do not include an estimate of the
full benefit that will be realized from recoveries under the Company's
property damage and business interruption policies, as it is not possible
to reasonably estimate the amount of such recoveries at this time.
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7. INCOME TAXES
The Company is a limited liability company and has elected to be treated
as a partnership for U.S. income tax purposes. Accordingly, no provision
for Federal income taxes is required in the accompanying financial
statements. State income taxes are only required in states that do not
recognize limited liability company status. Accordingly, for those states,
a provision for taxes is reflected in the accompanying financial
statements. In addition, the Company is required to pay New York City
unincorporated business tax ("UBT"), and such a provision is reflected in
the accompanying financial statements.
The provision for (benefit from) income taxes for the year ended December
31, 2001, 2000 and 1999 consists of the following:
2001 2000 1999
------- ------- -------
State and local $ 0 $ 494 $ 222
Deferred state and local (1,133) (158) 88
------- ------- -------
Total (1,133) 336 310
Less: valuation allowance 1,201 0 0
------- ------- -------
Total provision $ 68 $ 336 $ 310
======= ======= =======
Deferred state and local tax assets of approximately $1,201 at December
31, 2001 are included in other assets on the Consolidated Statement of
Financial Condition. The deferred tax assets result primarily from certain
accruals for litigation reserves and deferred compensation that are
recognized in different years for financial and tax reporting purposes, as
well as the net operating loss carryforward. Since the Company has
commenced an orderly wind-down of its remaining businesses (see note 10),
the benefit of these assets will more likely not be realized. As such, a
100% valuation allowance has been recorded.
8. OFF-BALANCE-SHEET RISK
CUSTOMER ACTIVITIES - The Company is engaged in various types of brokerage
activities servicing a diverse group of institutional and individual
investors. Customer securities transactions are cleared through the
Company's Clearing Broker on a fully-disclosed basis. These activities may
expose the Company to off-balance-sheet risk in the event the customer is
unable to fulfill its contractual obligations. As a result, the Company's
exposure to credit risk can be directly impacted by volatile trading
markets, which may impair the customers' ability to satisfy their
obligations.
The agreement between the Company and its Clearing Broker provides that
the Company is obligated to assume any exposure related to nonperformance
by its customers. The Company seeks to control the risk associated with
nonperformance by monitoring all customer activity and reviewing
information it receives from its Clearing Broker on a daily basis. In
addition, the Company has a policy of reviewing, as considered necessary,
the credit standing of customers and counterparties with which it conducts
business.
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8. OFF-BALANCE-SHEET RISK (Continued)
The Company seeks to control the risks associated with its customers'
commodity activities by requiring customers to maintain margin collateral
in compliance with various regulatory and internal guidelines. The Company
monitors required margin levels daily and, pursuant to such guidelines,
may require customers to deposit additional cash or collateral, or to
reduce positions, when deemed necessary.
PROPRIETARY ACTIVITIES - The Company, in its capacity as a market-maker
and dealer in corporate and municipal fixed-income and equity securities,
may enter into transactions in a variety of cash and derivative financial
instruments in order to facilitate customer order flow and hedge market
risk exposures. These financial instruments include securities sold, not
yet purchased and futures contracts. Securities sold, not yet purchased
represent obligations of the Company to deliver specified financial
instruments at contracted prices, thereby creating a liability to purchase
the financial instrument in the market at prevailing prices. Accordingly,
these transactions result in off-balance-sheet risk as the Company's
ultimate obligation may exceed the amount recognized in the Consolidated
Statement of Financial Condition.
In connection with the corporate bond proprietary trading activities,
which the Company ceased in July 2001 as described in note 1, the Company
entered into futures contracts on United States Government Treasury
Obligations to hedge the inventory of financial instruments owned. This
hedging practice enabled the Company to reduce its exposure to the change
in market value of financial instruments owned from fluctuations in
interest rates. At December 31, 2001, as a result of the termination of
these activities, there were no futures contracts outstanding. The average
fair value of futures contracts during the year ended December 31, 2001
and 2000 was approximately $8 and $340, respectively. During 2001 and
2000, the Company recorded net realized losses of approximately $411 and
$4,488, respectively, on futures contracts, which is included in principal
transactions in the Consolidated Statement of Operations. For the year
ended December 31, 1999, the Company recorded a net realized gain of
approximately $6,652 on futures contracts, which is included in principal
transactions in the Consolidated Statement of Operations.
9. NET CAPITAL REQUIREMENTS
Gruntal is a registered broker-dealer and futures commission merchant and,
accordingly, is subjected to minimum net capital requirements of the
Uniform Net Capital Rule 15c3-1 under the Securities Exchange Act of 1934
(the "Net Capital Rule"), Regulation 1.17 of the Commodity Exchange Act,
and the capital rules of the New York Stock Exchange, Inc. ("NYSE") and of
other principal exchanges of which Gruntal is a member. Under these rules,
Gruntal is required to maintain minimum net capital of not less than the
greater of (a) $1,500, (b) 2% of aggregate debit items arising from
customer transactions, as defined, or (c) 4% of funds required to be
segregated for customers' regulated commodity accounts, as defined. The
NYSE may require a member organization to reduce its business if net
capital is less than 4% of aggregate debit items and may prohibit a member
organization from expanding its business and declaring cash dividends if
net capital is less than 5% of such aggregate debit items. At December 31,
2001, Gruntal's net capital of approximately $19,270 exceeded these
minimum requirements by approximately $17,770.
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9. NET CAPITAL REQUIREMENTS (Continued)
GMS is also subject to minimum net capital requirements of the Net Capital
Rule. For GMS, the Net Capital Rule requires that aggregate indebtedness,
as defined, not exceed 15 times net capital, as defined. At December 31,
2001, the net capital and excess net capital of GMS were approximately
$8,400 and $8,150, respectively, and its aggregate indebtedness was
approximately 0.41 times its net capital.
10. SUBSEQUENT EVENTS
As a result of the events of September 11, 2001 and the difficult market
conditions that existed before and after that date, the Company
experienced significant losses in 2001. The Company was unable to raise
sufficient capital to ensure its ability to continue as a going concern.
Accordingly, on April 26, 2002 (the "Closing Date"), Gruntal sold all of
the issued and outstanding equity interest of GMS, and certain of
Gruntal's assets, primarily relating to its retail brokerage business, to
Ryan, Beck & Co., L.L.C. ("Ryan Beck"), a full service securities firm
that is a wholly-owned subsidiary of BankAtlantic Bancorp, Inc., for
$6,047 and Ryan Beck's assumption of certain liabilities relating to the
retail brokerage business. Ryan Beck may, in accordance with the terms of
the sale, return certain of these liabilities to Gruntal within 90 days of
the Closing Date, provided certain conditions are met.
Subsequent to this transaction, the Company has commenced an orderly
wind-down of its remaining businesses.
11. BROKER-DEALER DEREGISTRATION & 401(K) DEFINED CONTRIBUTION PLAN
(UNAUDITED)
On May 22, 2002, Gruntal filed for withdrawal of its broker-dealer
registration and its membership from the New York Stock Exchange and all
other regulatory and self-regulatory organization memberships, as
applicable. Gruntal's withdrawal from the New York Stock Exchange became
effective on June 20, 2002. It is anticipated that Gruntal's
withdrawal as a registered broker-dealer will become effective on or
before July 21, 2002.
The Company's 401(k) defined contribution plan was terminated effective
June 12, 2002.
* * * * *
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