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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission file number: 1-10024

BKF Capital Group, Inc.

(212) 332-8400

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes þ          No o

      As of October 31, 2004, 7,077,808 shares of the registrant’s common stock, $1.00 par value, were outstanding.

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PART I.     FINANCIAL INFORMATION

BKF CAPITAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

See accompanying notes.

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BKF CAPITAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes.

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BKF CAPITAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(1)	compensation expense incurred relating to dividend

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BKF CAPITAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes.

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BKF CAPITAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

      The consolidated interim financial statements of BKF Capital Group, Inc. (formerly Baker, Fentress & Company, hereto referred to as “BKF” or the “Company”) and its subsidiaries included herein have been prepared in accordance with generally accepted accounting principles for interim financial information and Rule 10-01 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. These consolidated financial statements are unaudited and should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. The Company follows the same accounting policies in the preparation of interim reports. In the opinion of management, the consolidated financial statements reflect all adjustments, which are of a normal recurring nature, necessary for a fair presentation of the financial condition, results of operations and cash flows of the Company for the interim periods presented and are not necessarily indicative of a full year’s results.

      In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates.

      The use of estimates is important in the determining compensation expense for interim periods.

      A substantial portion of our compensation expense is comprised of discretionary bonuses, generally determined and paid at year end. On a quarterly basis management estimates discretionary bonuses to be paid based on a variety of factors, including accrued revenues generated by the long-only and the alternative strategies. Consequently, at the end of each interim period, we estimate the bonus compensation expense and accrue such amounts on a year-to-date basis.

      The Company operates through a wholly-owned subsidiary, Levin Management Co., Inc. and its subsidiaries, all of which are referred to as “Levco”. The Company trades on the New York Stock Exchange, Inc. (“NYSE”) under the symbol “BKF”.

      The Consolidated Financial Statements of Levco include its wholly-owned subsidiary, John A. Levin & Co., Inc. (“JALCO”), JALCO’s two wholly-owned subsidiaries, Levco GP Inc. (“Levco GP”) and LEVCO Securities, Inc. (“LEVCO Securities”) and certain affiliated investment partnerships for which the Company is deemed to have controlling interest of the applicable partnership. No investment partnerships were consolidated at September 30, 2004. Two investment partnerships were consolidated at December 31, 2003. The operations of one investment partnership was consolidated for the period January 1, 2004 through June 30, 2004. The fund was no longer consolidated after such period. The operations of five investment partnerships (of which two terminated in March 2003) were included in the consolidated statements of operations and cash flows for the nine-month period ended September 30, 2003.

      JALCO is an investment advisor registered under the Investment Advisers Act of 1940, as amended, which provides investment advisory services to its clients which include U.S. and foreign corporations, mutual funds, limited partnerships, universities, pension and profit sharing plans, individuals, trusts, not-for-profit organizations and foundations. JALCO also participates in broker consulting programs (Wrap Accounts) with several nationally recognized financial institutions. LEVCO Securities is registered with the SEC as a broker-dealer and is a member of the National Association of Securities Dealers, Inc. Levco GP acts as the managing general partner of several affiliated investment partnerships and is registered with the Commodities Futures Trading Commission as a commodity pool operator.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Generally, investment advisory fees are billed quarterly, in arrears, and are based upon a percentage of the market value of each account at the end of the quarter. Wrap account fees are billed quarterly based upon a percentage of the market value of each account as of the previous quarter end. Incentive fees, general partner incentive allocations earned from affiliated investment partnerships, and incentive fees from other accounts are accrued on a quarterly basis and are billed quarterly or at the end of their respective contract year, as applicable. Such accruals may be reversed as a result of subsequent investment performance prior to the conclusion of the applicable contract year.

      Commissions earned on securities transactions executed by LEVCO Securities and related expenses are recorded on a trade-date basis net of any sales credits.

      Commissions earned on distribution of an unaffiliated investment advisor’s funds are recorded once a written commitment is obtained from the investor.

      Marketable securities owned and securities sold short, are valued at independent market prices with the resultant unrealized gains and losses included in operations.

      Security transactions are recorded on a trade date basis.

      Interest income and expense are accrued as earned or incurred.

      Dividend income and expense are recorded on the ex-dividend date.

      The Company has not presented consolidated statements of comprehensive income in accordance with SFAS No. 130 “Reporting Comprehensive Income,” because it does not have any items of “other comprehensive income.”

      Levco GP serves as the managing general partner for several affiliated investment partnerships (“AIP”), which primarily engage in the trading of publicly traded equity securities, and in the case of one partnership, distressed corporate debt. The assets and liabilities and results of operations of the AIP are not included in the Company’s consolidated statements of financial condition with the exception of Levco GP’s equity ownership and certain AIP whereby Levco GP is deemed to have a controlling interest in the partnership (see Note 4). The limited partners of the AIP have the right to redeem their partnership interests at least quarterly. Additionally, the unaffiliated limited partners of the AIP may terminate Levco GP as the general partner of the AIP at any time. Levco GP does not maintain control over the unconsolidated AIP, has not guaranteed any of the AIP obligations, nor does it have any contractual commitments associated with them. Investments in the unconsolidated AIP held through Levco GP, are recorded based upon the equity method of accounting. Levco GP’s investment amount in the unconsolidated AIP equals the sum total of its capital accounts, including incentive allocations, in the AIP. Each AIP values its underlying investments in accordance with policies as described in its audited financial statements and underlying offering memoranda. It is the Company’s general practice to withdraw the incentive allocations earned from the AIP within three months after the fiscal year end. Levco GP has general partner liability with respect to its interest in each of the AIP and has no investments in the AIP other than its interest in these partnerships (See Note 5).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company accounts for income taxes under the liability method prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” Deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amount of existing assets and liabilities and their respective tax basis. Future tax benefits are recognized only to the extent that realization of such benefits is more likely than not to occur.

      The Company files consolidated Federal and combined state and local income tax returns.

      The cost in excess of net assets of Levco acquired by BKF in June 1996 is reflected as goodwill, investment advisory contracts, and employment contracts in the Consolidated Statements of Financial Condition. Through December 31, 2001, goodwill was amortized straight line over 15 years. Effective January 1, 2002 the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets”. Under SFAS No. 142, goodwill is no longer amortized but is subject to an impairment test at least annually or when indicators of potential impairment exist. Other intangible assets with finite lives are amortized over their useful lives. Investment contracts are amortized straight line over 10 years. These contracts will be fully amortized by June 30, 2006.

      The Company accounts for Earnings Per Share under SFAS No. 128, “Earnings Per Share”. Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the year. Diluted earnings (loss) per share are computed by dividing net income (loss) by the total of the weighted average number of shares of common stock outstanding and dilutive common stock equivalents.

      The following table sets forth the computation of basic and diluted (loss) per share (dollar amounts in thousands, except per share data):

      In calculating diluted (loss) per share for the three and nine months ended September 30, 2004 and 2003, common stock equivalents of 1,798,162 and 2,211,136, respectively, were excluded due to their anti-dilutive effect on the calculation.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company follows SFAS No. 123, “Accounting for Stock-Based Compensation,” and has adopted the intrinsic value method under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” for all arrangements under which employees receive shares of stock or other equity instruments of the Company, or if the Company incurs liabilities to employees in amounts based on the price of its stock. In December 2002, the FASB Issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123 to require prominent disclosures about the method of accounting for stock-based compensation. The Company has elected to apply the disclosure provisions of SFAS No. 123. Under APB Opinion No. 25, no compensation costs were recognized relating to the option grants because the exercise prices of the options awarded were equal to the fair market price of the common stock on the dates of the grants.

      The following table illustrates the effect on net (loss) and (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123 (dollar amounts in thousands, except per share amounts):

      Certain prior period amounts reflect reclassifications to conform with the current year’s presentation.

      Securities sold short represent obligations to deliver the underlying securities sold at prevailing market prices and option contracts written represent obligations to purchase or deliver the specified security at the contract price. The future satisfaction of these obligations may be at amounts that are greater or less than that recorded on the consolidated statements of financial condition. The CAP monitor their positions continuously to reduce the risk of potential loss due to changes in market value or failure of counterparties to perform.

      The Company’s investments in unaffiliated investment partnerships result from the consolidation of an affiliated investment partnership that invests in unaffiliated investment partnerships. Investments in unaffili-

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

ated investment partnerships are recorded at fair value, which generally is equal to the CAP pro rata interest in the net assets of each unaffiliated investment partnership (based upon the net asset values reported by the unaffiliated investment partnerships). The CAP has substantially liquidated as of December 31, 2003 and is therefore no longer consolidated subsequent to that date.

      Minority interests in the accompanying consolidated statements of financial condition represent the minority owners’ share of the equity of consolidated investment partnerships. Minority interest in the accompanying consolidated statements of operations represents the minority owners’ share of the income or loss of consolidated investment partnerships.

      Typically, contributions are accepted monthly and withdrawals are made quarterly upon the required notification period having been met. The notification period ranges from thirty to sixty days.

      LEVCO Securities acts as an introducing broker and all transactions for its customers are cleared through and carried by a major U.S. securities firm on a fully disclosed basis. LEVCO Securities has agreed to indemnify its clearing broker for losses that the clearing broker may sustain from the customer accounts introduced by LEVCO Securities. In the ordinary course of its business, however, LEVCO Securities does not accept orders with respect to client accounts if the funds required for the client to meet its obligations are not on deposit in the client account at the time the order is placed.

      In the normal course of business, the CAP enter into transactions in various financial instruments, including derivatives, for trading purposes, in order to reduce their exposure to market risk. These transactions include option contracts and securities sold short.

      Substantially all of the CAP cash and securities positions are deposited with one clearing broker for safekeeping purposes. The broker is a member of major securities exchanges.

      Included in investment advisory fees receivable are approximately $13.9 million and $680,000 of accrued incentive fees as of September 30, 2004 and December 31, 2003, respectively, for which the full contract measurement period has not been reached. The Company has provided for the applicable expenses relating to this revenue. If the accrued incentive fees are not ultimately realized, a substantial portion of the related accrued expenses will be reversed.

      In January 2003, the FASB issued Financial Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”) which addresses the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to variable interest entities (“VIEs”). The interpretation provides a framework for determining whether an entity should be evaluated for consolidation based on voting interests or significant financial support provided to the entity (“variable interests”). FIN 46 generally would require that the assets, liabilities and results of operations of a VIE be consolidated into the financial statements of the enterprise that is the primary beneficiary.

      An entity is classified as a VIE if (a) total equity is not sufficient to permit the entity to finance its activities without additional subordinated financial support or (b) its equity investors lack (i) the direct or

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

indirect ability to make decisions about an entity’s activities through voting rights or absorb the expected losses of the entity if they occur or (ii) the right to receive the expected residual returns of the entity if they occur. Once an entity is determined to be a VIE, its assets, liabilities and results of operations should be consolidated with those of its primary beneficiary. The primary beneficiary of a VIE is the entity which either will absorb a majority of the VIE’s expected losses or has the right to receive a majority of the VIE’s expected residual returns. The expected losses and residual returns of a VIE include expected variability in its net income or loss and may include fees to decision makers and fees to guarantors of substantially all VIE assets or liabilities.

      Initially, FIN 46 required a public enterprise with a variable interest in a VIE created before January 31, 2003, to apply FIN 46 to that VIE as of the beginning of the first interim or annual reporting period beginning after June 15, 2003. The Company adopted FIN 46 for the applicable periods presented. The consolidation of these partnerships does not impact the Company’s equity or net income. Levco GP has general partner liability with respect to its interest in each of the CAP.

5.     Investments in Affiliated Investment Partnerships and Related Revenue

      Summary financial information, including the Company’s carrying value and income from the unconsolidated AIP is as follows (dollar amounts in thousands):

      Included in investments in AIP at September 30, 2004 are accrued but unearned incentive allocations approximating $3.9 million.

      Included in the Company’s incentive fees and general partner incentive allocations are approximately $900,000 and $1.9 million payable directly to employee owned and controlled entities (“Employee Entities”) for the three months ended September 30, 2004 and 2003, and $3.0 million and $5.2 million for the nine months ended September 30, 2004 and 2003, respectively. These amounts are included in the Company’s carrying value of the AIP at the end of the applicable period. These Employee Entities, which serve as non-managing general partners of several AIP, also bear the liability for all compensation expense relating to the allocated revenue, amounting to approximately $900,000 and $1.9 million for the three months ended September 30, 2004 and 2003, and $3.0 million and $5.2 million for the nine months ended September 30, 2004 and 2003, respectively. These amounts are included in the Consolidated Statement of Operations.

      The Company recorded investment advisory fees and incentive allocations/fees from affiliated domestic investment partnerships and affiliated offshore investment vehicles of approximately $17.3 million and $15.5 million for the three months ended September 30, 2004, and 2003, and $47.3 million and $39.8 million for the nine months ended September 30, 2004 and 2003, respectively.

      Included in investment advisory and incentive fees receivable at September 30, 2004 and December 31, 2003 are $4.0 million and $4.3 million, respectively, of advisory fees from AIP and sponsored offshore vehicles. Also included in investment advisory and incentive fees receivable are $12.8 million and $25.2 million of incentive fees from sponsored offshore investment vehicles (similar to several domestic AIP) at September 30, 2004 and December 31, 2003, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

6.     Contractual Obligations

      In the ordinary course of business, BKF enters into contracts with third parties pursuant to which BKF or the third party provides services to the other. In many of the contracts, BKF agrees to indemnify the third party under certain circumstances. The terms of the indemnity vary from contract to contract and the amount of the indemnification liability, if any, cannot be determined.

7.     Non-Cash Transactions

      On December 11, 2002 the Company commenced a tender offer to exchange 333,308 outstanding options for RSU, on a three for one exchange basis. On January 10, 2003 the tender offer was complete, with a total of 111,105 RSU being granted in exchange for the options tendered.

First Quarter 2003:

	•	The Company granted 10,500 restricted stock units (“RSU”) to non-employee directors of the Company with a value of approximately $192,000. This amount was used to reduce cash payments for Board of Directors and Committee meetings.
	•	Certain executive officers of the Company, who are subject to performance based criteria with regard to their 2002 compensation, and several employees were granted 347,365 RSU with a value of approximately $5.7 million.
	•	The Company withheld 1,520 shares of common stock for required withholding taxes in connection with the delivery of 3,894 RSU.

Third Quarter 2003:

	•	The Company withheld 3,794 shares of common stock in for required withholding taxes connection with the exercise of 20,000 stock options.

First Quarter 2004:

	•	Certain executive officers of the Company, who are subject to performance based criteria with regard to their 2003 compensation, and several employees were granted 56,105 shares of restricted stock with a value of approximately $1.4 million, which vest over a three-year period. The amount unearned as of March 31, 2004 is recorded as unearned compensation in the consolidated statement of financial condition.
	•	The Company withheld 2,389 shares of common stock for required withholding taxes in connection with the delivery of 7,002 RSU.
	•	The Company withheld 3,111 shares of common stock for required withholding taxes in connection with the exercised of 15,049 stock options.

Second Quarter 2004:

	•	The Company granted 9,600 shares of restricted stock to non-employee directors of the Company with a value of approximately $275,000. This amount was used to reduce cash payments for Board of Directors and Committee meetings.
	•	4,500 RSU and 437 Restricted Stock, which were unvested, were forfeited.
	•	The Company withheld 1,970 shares of common stock for required withholding taxes in connection with the exercise of 10,000 stock options.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Third Quarter 2004:

	•	48,660 RSU, which were unvested, were forfeited.
	•	The Company withheld 681 shares of common stock for required withholding taxes in connection with the delivery of 2,000 RSU.
	•	The Company withheld 7,599 shares of common stock for required withholding taxes in connection with the exercise of 40,454 stock options.

8.     Income Taxes

      The Company’s provision for income taxes differs from the amount of income tax determined by applying the applicable U.S. federal statutory income tax rate principally due to state and local taxes and non-deductible amortization. The Company has determined that the amortization expense on intangible assets is non-deductible since the purchase method of accounting has been applied retroactive to June 1996.

      Deferred tax assets arise from the future tax benefit on deferred and non-cash compensation, unrealized losses on investments, depreciation, accrued lease amendment expense, and utilization of capital losses. Deferred tax liabilities arise from deferred revenues, unrealized gains on investments, and state and local taxes.

9.     Other

      Pursuant to a separation agreement between the Company and its former Chief Operating Officer (dated September 30, 2004) the Company paid $29.30 per share (aggregating $97,686) in lieu of delivery of 3,334 shares of BKF common stock underlying restricted stock units previously granted. The amount is included in accrued expenses at September 30, 2004.

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INTRODUCTION

      BKF operates entirely through Levco, an investment adviser registered with the Securities and Exchange Commission. Levco specializes in managing equity portfolios for institutional and individual investors. Levco offers long-only equity strategies as well as a range of alternative investment products and other more specialized investment programs. Most clients are based in the United States, though a significant portion of investors in the alternative investment products are located outside the United States.

      Levco acts as the managing general partner of a number of investment partnerships and also acts as an adviser to private investment vehicles organized outside the United States.

      With respect to accounts managed pursuant to its long-only equity strategies, Levco generally receives advisory fees based on a percentage of the market value of assets under management, including market appreciation or depreciation and client contributions and withdrawals. In some cases, Levco receives performance-based fees from accounts pursuing long-only equity strategies. With respect to private investment vehicles and separate accounts managed pursuant to similar strategies, Levco is generally entitled to receive both a fixed management fee based on a percentage of the assets under management and a share of net profits.

      At September 30, 2004, assets under management at Levco were $13.0 billion, up from $11.7 billion a year earlier. Following is a comparison of Levco’s assets under management as defined by product and client type:

      Levco also has a wholly-owned broker-dealer subsidiary that clears through Bear Stearns Securities Corp. on a fully disclosed basis. Generally, the customers of the broker-dealer subsidiary are advisory clients of Levco, and the trades executed through the broker-dealer are generally placed by Levco in its capacity as investment adviser.

RISK FACTORS

      The following risks, among others, sometimes have affected, and in the future could affect BKF’s business, financial condition or results of operations. The risks described below are not the only ones facing BKF. Additional risks not presently known to BKF or that BKF currently deems insignificant may also impact its business.

      Levco is largely dependent on the efforts of its senior investment professionals managing the long-only strategies and the event driven, long-short and short-biased equity products. Levco is also dependent on the

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      Levco’s future success depends on its ability to retain and attract qualified personnel to conduct its investment management business. To the extent that Levco further diversifies its products and strategies, BKF anticipates that it will be necessary for Levco to add portfolio managers and investment analysts. No assurance can be given that Levco will succeed in its efforts to recruit and retain the required personnel. Because of its relatively smaller size, Levco may have relatively fewer resources with which to recruit and retain personnel. The loss of key personnel or the inability to recruit and retain qualified portfolio managers, business and marketing personnel could have a material adverse effect on Levco’s business.

      In December 1998, BKF adopted an incentive compensation plan (most recently amended in 2001) to give Levco the ability to attract and retain talented professionals with equity-based and cash compensation. Determinations with regard to the implementation of this plan are made by the Compensation Committee of the board of directors of BKF on a regular basis. Because BKF is a relatively small public company, the value of the equity awards that may be offered to professionals may be limited relative to what competitors may offer. If the price of BKF stock decreases, no assurance can be given that the equity-based compensation will serve its purpose to attract and retain talented professionals.

      Levco currently derives most of its revenues from two investment products — a large cap value strategy and an event-driven alternative investment product. While the large cap value strategy and the event-driven investment products may often perform differently in a given investment environment, adverse developments with regard to any of these products could have a material adverse effect on Levco’s business.

      Levco’s operations are affected by many economic factors, including the performance of the securities markets. Declines in the securities markets, in general, and the equity markets, in particular, would likely reduce Levco’s assets under management and consequently reduce its revenues. In addition, any continuing decline in the equity markets, failure of these markets to sustain their prior rates of growth, or continued volatility in these markets could result in investors’ withdrawing from the equity markets or decreasing their rate of investment, either of which would likely adversely affect Levco. Levco’s rates of growth in assets under management and revenues have varied from year to year, and there can be no assurance that the growth rates sustained in the past will continue. Levco is generally a “value” manager, and a general decline in the performance of “value” securities could have an adverse effect on Levco’s revenues. Levco also offers event-driven and other alternative investment strategies. The failure to implement these strategies effectively could likewise impact Levco’s revenues.

      Success in the investment management industry depends largely on investment performance. Good performance generally stimulates sales of services and investment products and tends to keep withdrawals and redemptions low. This generates higher management fees, which are based on the amount of assets under management and sometimes on investment performance. If Levco experiences poor performance, this will likely result in decreased sales, decreased assets under management and the loss of accounts, with corresponding decreases in revenue.

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      As of September 30, 2004, the ten largest customers of Levco’s long-only equity strategies (counting as single customers each wrap fee program and related family and institutional accounts) generated approximately $14.6 million of revenues for Levco in the first nine months of 2004 (including incentive fees), or approximately 18% of BKF’s total fees for the period. The five largest customers for long-only equity products accounted for approximately 18% of all asset-based investment advisory fees earned in the first nine months of 2004 with respect to such products. The loss of any of these customers could have an adverse effect on BKF’s revenues.

      In the institutional marketplace, consultants play a key role in selecting investment managers for their clients. In the event that a consultant advising current clients of Levco takes a negative view of Levco, Levco could lose a number of accounts related to that consultant.

      Management Fees. Some segments of the investment management industry have experienced a trend toward lower management fees. Levco must maintain a level of investment returns and service that is acceptable to clients given the fees they pay. No assurance can be given that Levco will be able to maintain its current fee structure or client base. Reduction of the fees for new or existing clients could have an adverse impact on Levco’s profits.

      Cancellation of Investment Management Agreements. It is expected that Levco will derive almost all of its revenue from investment management agreements. For registered investment companies, a majority of the disinterested members of each fund’s board must approve these agreements at least annually and the agreements are terminable without penalty on 60 days’ notice. The agreements with Levco’s separately-managed account clients generally are terminable by the client without penalty and with little or no notice. Any failure to renew, or termination of, a significant number of these agreements could have an adverse effect on Levco.

      Poor Investment Performance of the Private Investment Funds. BKF derives revenue from incentive fees and general partner incentive allocations earned with respect to its proprietary unregistered investment funds. Stronger positive performance by these funds generates higher incentive fees and incentive allocations because those fees and allocations are based on the performance of the assets under management. On the other hand, relatively poor performance will result in lower or no incentive fees or allocations, and will tend to lead to decreased assets under management and the loss of accounts, with corresponding decreases in revenue.

      Levco competes with a large number of domestic and foreign investment management firms, commercial banks, insurance companies, broker-dealers and other firms offering comparable investment services. Many of the financial services companies with which Levco competes have greater resources and assets under management than Levco does and offer a broader array of investment products and services.

      Management believes that the most important factors affecting Levco’s ability to attract and retain clients are the abilities, performance records and reputations of its portfolio managers, the ability to hire and retain key investment personnel, the attractiveness of investment strategies to potential investors and competitive fees and investor service. Levco’s ability to increase and retain client assets could be adversely affected if client accounts underperform client expectations or if key investment personnel leave Levco. Levco’s ability to compete with other investment management firms also depends, in part, on the relative attractiveness of its investment philosophies and methods under prevailing market conditions. The absence of significant barriers to entry by new investment management firms in the institutional managed accounts business increases competitive pressure. Since Levco is a relatively smaller asset management company, changes in customers,

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      Levco is highly dependent on information systems and technology and depends, to a great extent, on third parties who are responsible for managing, maintaining and updating these systems. No assurance can be given that Levco’s current systems will continue to be able to accommodate its growth or that the costs of its outsourcing arrangements will not increase. The failure to accommodate growth or an increase in costs could have an adverse effect on Levco.

      Success in the investment management industry also depends on the ability of an investment manager, and third parties with whom the investment manager contracts, to successfully perform administrative, back-office and trade execution functions. A failure by Levco or a third party contracted by Levco to perform such functions could adversely impact Levco’s revenues.

      From time to time, Levco’s officers, directors and employees may own securities which one or more of its clients also own. Although Levco maintains internal policies regarding individual investments by its officers, directors and employees which require them to report securities transactions and restrict certain transactions so as to minimize possible conflicts of interest, possible conflicts of interest may arise that could have adverse effects on Levco. Similarly, conflicting investment positions may develop among various investment strategies managed by Levco. Although Levco has internal policies in place to address such situations, such conflicts could have adverse effects on Levco.

      Virtually all aspects of Levco’s business are subject to various federal and state laws and regulations. Levco is registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940, as amended. The Investment Advisers Act imposes numerous obligations on registered investment advisers, including fiduciary, recordkeeping, operational and disclosure obligations. John A. Levin & Co. is also registered with the Commodity Futures Trading Commission as a commodity trading advisor and a commodity pool operator, and Levco GP is registered with that agency as a commodity pool operator. John A. Levin & Co. and Levco GP are members of the National Futures Association. LEVCO Securities is registered as a broker-dealer under the Securities Exchange Act of 1934, is a member of the National Association of Securities Dealers, Inc. and is a member of the Municipal Securities Rulemaking Board. In addition, Levco is subject to the Employee Retirement Income Security Act of 1974 and its regulations insofar as it is a “fiduciary” with respect to certain clients. Furthermore, BKF, as a publicly traded company listed on the New York Stock Exchange, is subject to the federal securities laws, including the Securities Exchange Act of 1934, as amended, and the requirements of the exchange.

      These laws and regulations generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict Levco or BKF from conducting its business if it fails to comply with these laws and regulations. If Levco or BKF fails to comply with these laws and regulations, these agencies may impose sanctions, including the suspension of individual employees, limitations on business activities for specified periods of time, revocation of registration, and other censures and fines. Even if in compliance with all laws and regulations, changes in these laws or regulations could adversely affect BKF’s profitability and operations and its ability to conduct certain businesses in which it is currently engaged.

      Terrorist attacks, including biological or chemical weapons attacks, and the response to such terrorist attacks, could have a significant impact on New York City, the local economy, the United States economy, the global economy, and global financial markets. It is possible that the above factors could have a material adverse effect on BKF’s business, especially given the fact that all operations are conducted from a single

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      Certain statements under this caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”). See “Part II — Other Information.”

RESULTS OF OPERATIONS

      The following discussion and analysis of the results of operations is based on the Consolidated Statements of Financial Condition and Consolidated Statements of Operations for BKF Capital Group, Inc. and Subsidiaries. It should be noted that certain affiliated investment partnerships in which BKF may be deemed to have a controlling interest have been consolidated. The number and identity of the partnerships being consolidated may change over time as the percentage interest held by BKF and its affiliates in affiliated partnerships changes. The assets, liabilities and related operations of these partnerships and related minority interest have been reflected in the consolidated financial statements for the nine month period ended September 30, 2004 and the three and nine month periods ended September 30, 2003. The consolidation of the partnerships does not impact BKF’s equity or net income.

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      Total revenues for the third quarter of 2004 were $27.84 million, reflecting an increase of 3.4% from $26.92 million in revenues in the same period in 2003. This increase is primarily attributable to a 29.3% increase in investment advisory fees from $15.55 million in the third quarter of 2003 to $20.10 million in the third quarter of 2004. This increase in investment advisory fees was partly offset by a decline in incentive fees and general partner incentive allocations from $9.89 million in the third quarter of 2003 to $7.25 million in the third quarter of 2004. The revenues generated by the various investment strategies were as follows (all amounts are in thousands):

      The increase in asset-based advisory fees with respect to the event driven and long-short equity strategies was attributable to net contributions and appreciation through performance. With respect to long-only investment strategies, the appreciation in assets under management that was generated through performance (and partly offset by net withdrawals) did not generate higher revenues, as the average fees generated by such assets declined. It should be noted that alternative investment products tend to operate with targeted asset levels that may fluctuate depending on a variety of factors, and that contributions to such products may be limited in order to keep the products near their targeted asset levels. Currently, the primary event driven strategies are not accepting additional contributions that would bring them above their present asset levels. For this reason, the rates of growth recently experienced by BKF’s largest alternative investment products may not be sustained.

      The decrease in incentive fees and allocations was primarily attributable to the decline in performance in event driven and long-short alternative strategies, the impact of which was partly reduced by the increases in

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      Incentive fees and general partner allocations are accrued on a quarterly basis but are primarily determined or billed and allocated, as the case may be, at the end of the applicable contract year or upon investor withdrawal. Such accruals may be reversed prior to being earned or allocated as the result of investment performance.

      Through June 30, 2004, Levco was on hold in the wrap program in which it managed approximately 81% of its wrap program assets as of June 30, 2004. In July 2004, the hold status on which Levco had been placed in the second quarter of 2003 was lifted, enabling the firm to open new accounts in the program. Despite the change in status, in the third quarter of 2004 Levco experienced net withdrawals with respect to the accounts in the program. In addition, the fee rate paid to Levco by the sponsor of the program will decrease by approximately 7% commencing December 2004.

      Revenue generated by the broker-dealer business (net of clearing charges) declined 47.2% to $271,000 in the third quarter of 2004 from $513,000 in the third quarter of 2003. This decline was primarily the result of a decrease in the number of accounts maintained at the broker-dealer and reduced trading activity in such accounts.

      Net realized and unrealized gains on investments decreased by 75.5% to $49,000 in the third quarter of 2004 from $200,000 in the third quarter of 2003, primarily as the result of a decrease in performance of the investments in non-consolidated investment funds.

      No investment partnerships were consolidated in the third quarter of 2004, while consolidated affiliated partnerships generated realized and unrealized gains on investments of $596,000 and interest and dividend income of $81,000 in the third quarter of 2003. The gains/losses on investments from consolidated affiliated partnerships include minority interests, i.e., the portion of the gains or losses generated by the partnerships allocable to all partners other than Levco GP, Inc., which are separately identified on the consolidated statements of operations.

      Total expenses for the third quarter of 2004 were $27.43 million, reflecting a decrease of 16.7% from $32.92 million in expenses in the same period in 2003. Total expenses excluding amortization of finite life intangibles and the $5.13 million loss on lease amendment (incurred in the third quarter of 2003) were $25.68 million in the third quarter of 2004, reflecting a decrease of 1.4% from $26.04 million for the third quarter of 2003.

      Employee compensation and benefit expense, including compensation relating to the vesting of equity grants, was $21.15 million in the third quarter of 2004, reflecting a decrease of 0.8% from $21.31 million in the third quarter of 2003. This decrease primarily reflects the decline in compensation relating to equity grants resulting from the forfeiture of restricted stock units in connection with employee departures.

      The conditions in the industry with respect to both alternative investment and long-only professionals remain intense. The investment teams responsible for the management of alternative investment products are compensated on a number of different bases, which differ from the basis on which the investment team managing long-only products is compensated. This can be expected to result in a higher percentage of the revenues generated by such alternative strategies being paid as compensation to personnel directly associated with the investment teams. In addition, it should be noted that the accruals for bonus compensation relating to personnel associated with alternative investment products are estimates that are subject to change as developments warrant. Based on the status of discussions with the senior portfolio managers of Levco’s largest long-short equity product relating to their employment arrangements, the estimated percentage of revenues payable to the members of this investment team increased. Revenues associated with this long-short strategy grew by $549,000. As a result of the change in estimate and the increased revenues, compensation expense relating to the strategy (including a portion of internal sales personnel) grew by approximately $900,000. With respect to the event driven strategies, revenues increased by $679,000, while compensation expense relating to the event driven products increased by of $126,000. The investments made with respect to new products that

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      Compensation expense in the third quarter was impacted by a change in estimate with respect to compensation accrued for personnel associated with Levco’s multi-manager, multi-strategy products. Internal referral fees otherwise payable to such personnel in connection with marketing Levco’s alternative investment strategies are now being reduced by certain expenses relating to the management of the multi-manager, multi-strategy accounts.

      Compensation expense accruals made for personnel not affiliated with a particular alternative investment strategy were made in accordance with compensation guidelines approved by the board of directors. As was the case in 2003, a year end review of compensation could result in compensation expense in excess of the amount that would be determined pursuant to such guidelines.

      Occupancy and equipment rental was $1.54 million in the third quarter of 2004, reflecting a 4.8% decrease from $1.62 million in the same period in 2003, as increases in depreciation and amortization expense were mostly offset by a lease amendment entered into in the fourth quarter of 2003 pursuant to which a portion of the space at BKF’s primary facility was relinquished.

      Other operating expenses were $2.97 million in the third quarter of 2004, reflecting a 3.8% decrease from $3.08 million in the same period in 2003. Reductions in third party referral fees and telecommunications and portfolio management software expense were offset by (i) increased professional fees to consultants, lawyers and auditors relating to public company issues and (ii) increased insurance costs for directors and officers/errors and omissions coverage.

      Operating income for the third quarter of 2004 was $415,000, as compared to an operating loss of $6.00 million in the same period in 2003. Operating income excluding the amortization of finite life intangibles, the loss on lease amendment and the total income from consolidated affiliated partnerships was $2.17 million in the third quarter of 2004, as compared to $204,000 in the same period in 2003.

      Total income tax expense was $1.15 million in the third quarter of 2004, as compared to an income tax benefit of $2.17 million for the same period in 2003. This increase primarily reflects the increase in income before taxes (as determined without a deduction for the amortization of intangibles). An effective tax rate of approximately 53% (before amortization) was used to make the determination with respect to the provision for taxes at September 30, 2004, while an effective tax rate of approximately 46% (before amortization) was used to calculate the provision for taxes at September 30, 2003.

      Total revenues for the nine months ended September 30, 2004 were $82.31 million, reflecting an increase of 11.5% from $73.84 million in revenues in the same period in 2003. This increase is primarily attributable to a 33.0% increase in investment advisory fees to $58.25 million in the first nine months of 2004 from $43.80 million in the same period in 2003. This was partly offset by a 15.1% decline in incentive fees and general partner incentive allocations to $21.60 million in the first nine months of 2004 from $25.45 million in

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