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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003
--------------------------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-25336
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KIRLIN HOLDING CORP.
------------------------
(Exact name of registrant as specified in its charter)
Delaware 11-3229358
- ------------------------------------------------ ---------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
6901 Jericho Turnpike, Syosset, New York 11791
- ------------------------------------------------ --------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (800) 899-9400
---------------
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: common stock, par
value $.0001
per share
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 [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). [ ] Yes [X] No
As of June 30, 2003 (the last business day of the registrant's most
recently completed second fiscal quarter), the aggregate market value of the
registrant's common stock (based on its reported last sale price on the Nasdaq
SmallCap Market) held by non-affiliates of the registrant was $5,763,311.
At March 24, 2004, 2,053,937 shares of the registrant's common stock
were outstanding.
The information required in Part III by Items 10, 11, 12, 13 and 14 is
incorporated by reference to the registrant's proxy statement in connection with
the 2004 Annual Meeting of Stockholders, which will be filed by the registrant
within 120 days after the close of its fiscal year.
PART I
ITEM 1. BUSINESS.
GENERAL
Kirlin Holding Corp. (the "Company") is a holding company engaged in
securities brokerage, securities trading and investment and merchant banking
through its wholly owned operating subsidiary, Kirlin Securities, Inc. ("Kirlin
Securities"). The Company was incorporated under the laws of the State of
Delaware on July 28, 1994.
Kirlin Securities commenced operations in 1988 and is registered as a
broker-dealer with the Securities and Exchange Commission (the "Commission") and
is a member of the National Association of Securities Dealers, Inc. (the "NASD")
and the Securities Investor Protection Corporation. Kirlin Securities is a full
service retail-oriented brokerage firm, specializing in the trading and sale of
both equity and fixed income securities, including mutual funds. At March 24,
2004, Kirlin Securities maintained over 12,000 active customer accounts, which
held over $750 million in assets. Kirlin Securities employs approximately 90
registered representatives. Kirlin Securities is licensed to conduct activities
as a broker-dealer in Puerto Rico, the District of Columbia and in 49 states,
and operates primarily from its headquarters in Syosset, New York, as well as
four branch offices located in California, New Jersey and New York.
BROKERAGE OPERATIONS
Commission Business
The most significant portion of the Company's revenues are derived from
commissions generated by its brokerage activities in which the Company buys and
sells securities for its customers from other dealers on an agency basis, and
charges its customers a commission for its services. The Company's commission
revenue is derived from brokerage transactions in listed and over-the-counter
securities and mutual fund securities. The Company has agreements with numerous
mutual fund management companies pursuant to which the Company sells shares in a
variety of mutual funds. Mutual fund commissions are derived from standard
dealers' discounts, which are a small percentage of the purchase price of the
shares depending upon the terms of the dealer agreement and the size of the
transaction. In addition, most funds permit the Company to receive additional
periodic fees based upon the customer's investment maintained in particular
funds. 82.8%, 86.3% and 58.1% of the Company's revenues for 2003, 2002 and 2001,
respectively, were derived from commissions generated from its brokerage
activities.
Principal Transactions
A smaller portion of the Company's revenues are derived from principal
trading activities in equity and fixed income securities, including merchant
banking investments. As a principal, the Company buys and sells securities, both
for proprietary trading and, more significantly, to facilitate sales to its
retail customers and other dealers. These securities are purchased in secondary
markets or from the underwriters of new issues. Principal transactions with
customers are effected at a net price equal to the current inter-dealer price
plus or minus a mark-up or mark-down within the guidelines of applicable
securities regulations.
The Company also engages in proprietary trading in an attempt to
realize trading gains. The Company's trading activities as a principal require
the commitment of capital and create an opportunity for profits and risk of loss
due to trading strategies and market fluctuations. Trading profits or losses
depend upon, among other things, the skills of the Company's employees engaged
in trading, the capital allocated to securities positions, the financial
condition and business prospects of particular issuers and general trends in the
securities markets. As a result of structural changes in the Nasdaq marketplace
(e.g., decimalization), in March 2002, the Company determined to cease its
market-making activities in equity securities. 3.4%, (2.1)% and 33.4% of the
Company's revenues for 2003, 2002 and 2001, respectively, were derived from
principal trading activities.
2
Investment and Merchant Banking
Investment banking revenue is derived principally from underwriting
fees, commissions and expense allowances, as well as the realization of gains
from the exercise of warrants received in connection with underwriting public
offerings or acting as placement agent in private offerings. In addition, the
Company also is engaged from time to time as a financial consultant to other
companies for which it generally receives a cash fee and warrants. During the
last three years, the Company's more significant investment banking activities
have consisted of:
o acting as placement agent for three private placements and as a
financial advisor for Montana Mills Bread Co., Inc. in connection with
its acquisition by Krispy Kreme Donuts in 2003;
o acting as placement agent for three private placements and acting
as underwriter in one initial public offering (Montana Mills Bread Co.,
Inc.) in 2002; and
o acting as placement agent for two private placements in 2001
(including the Company's own private placement).
The Company also participates as a member of the underwriting syndicate and
selling group member from time to time in unit trust and equity offerings.
Underwriting public offerings involves certain risks. Because
underwriters commit to purchase securities at a discount from the initial public
offering price, they are exposed to substantial losses in the event that the
securities cannot be sold or must be sold below syndicate cost. Under federal
securities laws, other laws and court decisions with respect to underwriter's
liability and limitations on indemnification by issuers, an underwriter is
exposed to substantial potential liability for misstatements or omissions of
material facts in prospectuses or other communications with respect to
securities offerings.
In addition and as a complement to its investment banking business, the
Company also engages in merchant banking activities, although this activity has
been limited since the Company decided to focus on its core brokerage business
at the end of 2000. From time to time, the Company is presented with
opportunities to invest, through debt or equity or combination of both, in other
companies in a variety of industries. These investments generally are
speculative and involve a high degree of risk for which the Company may receive
significant profits, but no assurance can be given that this will be the case.
Merchant banking investments typically are of a longer-term nature than the
Company's trading activities and therefore increase the Company's exposure to
market risks and restrict the use of the Company's capital for longer periods of
time.
Money Management
The Company established and maintains a Managed Asset Portfolio Program
("MAPP") to manage the financial assets of its clients, for which it receives a
quarterly management fee based upon the value of assets under management. The
program's focus is to manage money to achieve long-term growth or income while
attempting to limit risk. Economic conditions are monitored to determine which
sectors will perform well in order to strategically allocate assets to these
sectors. Under the program, an individual portfolio plan is developed to fit
each client's risk/reward relationship.
The Company was also engaged in money management activities through
Greenleaf Management Corp., the manager of Greenleaf Capital Partners II, LLC, a
private investment fund capitalized in June 1999 to invest in one or more
selected companies and take advantage of investment opportunities that may
arise. The investment period for this fund has expired and it is currently in
the process of dissolution.
Clearing Broker
The Company does not hold any funds or securities of its customers, but
instead utilizes, on a fully disclosed basis, the services of Pershing LLC (a
BNY Securities Group Co.) as its clearing broker. As a clearing broker, Pershing
LLC processes securities transactions for Kirlin Securities and the accounts of
its
3
customers for which Kirlin Securities pays a fee. Pursuant to the terms of the
agreement with its clearing broker, Kirlin Securities has agreed to indemnify
and holds its clearing broker harmless from certain liabilities and claims,
including claims arising from the transactions of its customers. If customers
fail to pay for their purchases or fail to supply the securities that they have
sold, and the clearing broker satisfies customer obligations, Kirlin Securities
would be obligated to indemnify the clearing broker for any resulting losses.
Kirlin Securities has not experienced any material losses as a result of the
failure of its customers to satisfy their obligations.
Government Regulation
The securities business is subject to extensive and frequently changing
federal and state laws and substantial regulation by the Securities and Exchange
Commission, state securities agencies and self-regulatory organizations, such as
NASD Regulation, Inc. ("NASDR"), the regulatory arm of the NASD, and the
Municipal Securities Rulemaking Board ("MSRB"). Kirlin Securities is registered
as a broker-dealer with the Commission and is a member firm of the NASD. The
Commission has designated the NASDR as the Company's primary regulator and it
also enforces the rules of the MSRB with respect to the Company. NASDR adopts
rules, which are subject to approval by the Commission, that govern the members
of the NASD and conducts periodic examinations of member firms' operations.
Kirlin Securities also is registered as an investment advisor with the State of
New York and is subject to its laws and regulations regarding investment
advisors.
Broker-dealers are subject to regulations which cover all aspects of
the securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of customers' funds and securities, capital
structure of securities firms, advertising, record keeping and the conduct of
directors, officers and employees. Additional legislation, changes in rules
promulgated by the Commission and self-regulatory organizations, or changes in
the interpretation or enforcement of existing laws and rules, may directly
affect the mode of operation and profitability of broker-dealers. The
Commission, self-regulatory organizations and state securities commissions may
conduct administrative proceedings which can result in censure, fine, the
issuance of cease-and-desist orders or the suspension or expulsion of a
broker-dealer, its officers or employees. The principal purpose of regulation
and discipline of broker-dealers is the protection of customers and the
integrity of the securities markets. The Company believes it is currently in
compliance with all such regulations governing its business.
As a registered broker-dealer, Kirlin Securities is subject to the
Commission's net capital rule. The net capital rule, which specifies minimum net
capital requirements for registered brokers and dealers, is designed to measure
the general financial integrity and liquidity of a broker-dealer and requires
that at least a minimum part of its assets be kept in relatively liquid form.
Net capital is essentially defined as net worth (assets minus liabilities), plus
qualifying subordinated borrowings and less certain mandatory deductions that
result from excluding assets not readily convertible into cash and from valuing
certain other assets, such as a firm's positions in securities, conservatively.
Among these deductions are adjustments in the market value of securities to
reflect the possibility of a market decline prior to disposition. As of December
31, 2003, Kirlin Securities had total net capital of $1,068,602 or $702,396 in
excess of its minimum net capital.
Failure to maintain the required net capital may subject a firm to
suspension or expulsion by the NASD, the Commission and other regulatory bodies
and ultimately may require its liquidation. The net capital rule also prohibits
payments of dividends, redemption of stock and the prepayment or payment in
respect of principal of subordinated indebtedness if net capital, after giving
effect to the payment, redemption or repayment, would be less than specified
percentages of the minimum net capital requirement (120%). Compliance with the
net capital rule could limit those operations of the broker-dealer subsidiary
that requires the intensive use of capital, such as underwriting and trading
activities, and also could restrict the Company's ability to withdraw capital
from the subsidiary, which in turn, could limit the Company's ability to pay
dividends, repay debt and redeem or purchase shares of its outstanding capital
stock.
4
COMPETITION
The Company encounters intense competition in all aspects of its
business and competes directly with other securities firms, a significant number
of which offer their customers a broader range of financial services, have
greater capital and other resources and may have greater operating efficiencies
than the Company. In addition to competition from firms currently in the
securities business, there has been increasing competition from other sources,
such as commercial banks and insurance companies offering financial services,
and from other investment alternatives. Competition among financial services
firms for professional personnel is intense.
PERSONNEL
At March 24, 2004, the Company had approximately 120 full-time and 5
part-time employees, including approximately 90 registered representatives in
its broker-dealer subsidiary. None of the Company's personnel is covered by a
collective bargaining agreement. The Company considers its relationships with
its employees to be good.
ITEM 2. PROPERTIES.
The principal executive offices of the Company and its subsidiary,
Kirlin Securities, are located at 6901 Jericho Turnpike, Syosset, New York 11791
where the Company leases approximately 18,600 square feet of office space at
rent of approximately $329,000 per year, which includes annual increases of
3.6%. The initial term of the lease expires in December 2004, with one option to
renew for an additional three-year period. Kirlin has renewed this lease with
respect to approximately 15,000 square feet of office space at a base rent of
approximately $262,000 for one year until December 2005. Kirlin Securities also
operates the following branch offices:
APPROXIMATE
APPROXIMATE ANNUAL
OFFICE LOCATION SQUARE FOOTAGE LEASE RENTAL EXPIRATION
- --------------- -------------- ------------ ----------
400 Andrews Street 4,400 $62,000 June 2005
Rochester, New York
485 Route 1 South 5,300 $102,000 March 2004*
Iselin, New Jersey
29 Emmons Drive 2,800 $38,000 August 2005
Princeton, New Jersey
612 Howard Street 8,400 $126,000 March 2005
San Francisco, California
- -------------------------
* During March 2004, Kirlin renewed this lease with respect to
approximately 2,700 square feet of office space at a base rent of
approximately $54,000 per year for three years until March 2007.
In January 2003, Kirlin Securities closed its New York City branch
office consisting of 4,500 square feet of office space prior to the October 2005
lease expiration date. In September 2003, Kirlin Securities entered into a
sublease for this space for the remainder of the term at an approximate annual
lease rental of $132,000 plus increases based on increases in operating costs
incurred in connection with the lease.
During 2003, Kirlin Securities closed its Ft. Lauderdale branch office
consisting of 4,400 square feet of office space at a base rent of $89,000 prior
to the October 2007 lease expiration date. As this lease is non-cancelable and
Kirlin Securities has not entered into a sublease for this space, the Company is
required to continue to make payments under the lease for the remainder of the
term.
5
ITEM 3. LEGAL PROCEEDINGS.
In March 2003, the NASD Department of Enforcement commenced a
disciplinary proceeding against Kirlin Securities and two of its officers or
employees, including the Co-Chief Executive Officer of Kirlin Securities,
related to sales of certain fixed income securities to clients of Kirlin
Securities from November 1995 to late 1999. Certain of these securities were
issued in $250,000 denominations. The NASD alleged that Kirlin Securities
violated provisions of the NASD Conduct Rules and/or federal securities laws
related to the following (all of which activity occurred prior to December
1999): (i) sales of unregistered securities stemming from the sale of these
securities in smaller denominations; (ii) placement of false and misleading
advertising relating to these securities; (iii) charging markups on the sale of
the securities in excess of NASD policy allegedly in the amount of approximately
$1,420,000 and in violation of the federal securities laws allegedly in the
amount of approximately $44,000; (iv) failure to maintain inventory sheets as
distributed to certain employees in connection with the sale of the securities;
and (v) failure to establish and enforce supervisory procedures to assure
compliance with federal laws and NASD Rules to prevent the aforementioned
alleged violations. The NASD Complaint seeks the imposition of sanctions,
restitution and costs. As discussed below, the Company has reached an agreement
in principle with the NASD Department of Enforcement concerning the resolution
of this disciplinary proceeding and other regulatory or enforcement matters
involving Kirlin Securities. The proposed settlement is pending final regulatory
approval. If the settlement is not consummated, the Company intends to contest
vigorously all claims asserted by the NASD Department of Enforcement in this
proceeding but cannot predict the outcome of this disciplinary action at this
time and is unable to determine whether this matter will have a material adverse
effect on the consolidated financial condition of the Company.
In July 2003, the NASD Department of Enforcement commenced a
disciplinary proceeding against Kirlin Securities and three of its former
registered representatives alleging violations of the NASD Conduct Rules in
connection with certain purchases or sales of equity securities by customers of
Kirlin Securities in 1999 and 2000. In particular, the NASD staff contends that
the transaction charges imposed on a small percentage of the transactions
emanating from a single branch office of Kirlin Securities during this period
were excessive or unreasonable in light of the circumstances surrounding those
trades, in violation of NASD rules. The NASD staff also contends that Kirlin
Securities and a former branch manager failed to supervise reasonably certain
registered representatives regarding these transactions and did not maintain or
enforce supervisory procedures reasonably designed to ensure compliance with
applicable rules. The NASD Complaint seeks the imposition of sanctions,
including disgorgement, and costs. As discussed below, the Company has reached
an agreement in principle with the NASD Department of Enforcement concerning the
resolution of this disciplinary proceeding and other regulatory or enforcement
matters involving Kirlin Securities. The proposed settlement is pending final
regulatory approval. If the settlement is not consummated, the Company intends
to contest vigorously all claims asserted by the NASD Department of Enforcement
in this proceeding but cannot predict the outcome of this disciplinary action at
this time and is unable to determine whether this matter will have a material
adverse effect on the consolidated financial condition of the Company.
Also in July 2003, the NASD staff informed Kirlin Securities that it
had made a preliminary determination to recommend the commencement of a
disciplinary proceeding against Kirlin Securities and four of its present or
former employees concerning alleged violations of NASD rules and/or federal
securities laws or regulations related to transactions effected during late 1999
in three securities accounts associated with a single customer. The potential
allegations include violations of the antifraud provisions of the federal
securities laws and NASD Conduct Rules related to: (i) undisclosed markups or
markdowns in the amount of approximately $692,000; (ii) the falsification or
destruction of certain trade tickets or other records; (iii) false and
misleading confirmation statements; (iv) failures to obtain best execution; and
(v) numerous trade reporting errors. In addition, the NASD staff has indicated
that it may allege that Kirlin Securities and a former branch manager failed to
supervise reasonable conduct by a registered representative and a sales
supervisor related to these customer accounts and that Kirlin Securities failed
to maintain adequate supervisory procedures. As discussed below, the Company has
reached an agreement in principle with the NASD Department of Enforcement
concerning the resolution of possible claims against Kirlin Securities that
could result from this contemplated enforcement recommendation, as well as the
pending disciplinary proceedings and other regulatory or enforcement matters
involving Kirlin Securities. The proposed settlement is pending
6
final regulatory approval. If the settlement is not consummated, the Company
cannot predict with certainty whether the NASD Department of Enforcement will
commence a disciplinary proceeding related to these matters, and if so, the
precise nature or scope of any such disciplinary proceeding. The Company intends
to contest any such charges that ultimately may be brought by the NASD
Department of Enforcement with respect to these matters, if the proposed
settlement is not finalized but it is unable to determine whether this matter
will have a material adverse effect on the consolidated financial condition of
the Company.
In January 2004, the Company reached an agreement in principle with the
staff of the NASD Department of Enforcement regarding a resolution of the above
pending regulatory matters. The terms of the proposed settlement would include:
(i) a payment by Kirlin Securities in the amount of $1,200,000, which is
expected to be comprised of approximately $156,000 in fines and approximately
$1,044,000 in restitution to customers; (ii) the retention by Kirlin Securities
of an independent consultant to review and report regarding its compliance and
supervisory policies and procedures; (iii) fines paid by or for certain present
or former associated persons of Kirlin Securities in the aggregate amount of
approximately $50,000; and (iv) a thirty-day supervisory suspension of one of
its officers. The proposed settlement is subject to formal regulatory approval
by NASD's National Adjudicatory Council ("NAC"). It cannot be stated with
reasonable certainty when or if the proposed settlement will be approved by the
NAC. If the proposed settlement is not approved, it is anticipated that the
subject matters will be re-calendared for hearings later in 2004. Based on the
above, the Company has recorded an accrual in the amount of $1,250,000 in the
consolidated statement of financial condition at December 31, 2003.
The Company's business involves substantial risks of liability,
including exposure to liability under federal and state securities laws in
connection with the underwriting or distribution of securities and claims by
dissatisfied customers for fraud, unauthorized trading, churning, mismanagement
and breach of fiduciary duty. The Company does not presently maintain an errors
and omissions insurance policy insuring it against these risks. In the normal
course of the Company's business, the Company from time to time is involved in
claims, lawsuits and arbitrations brought by its customers and former employees.
It is the opinion of management, based upon its evaluation of each of these
matters and the reserves established by the Company, that the resolution of all
claims presently pending would not have a material adverse effect on the
consolidated financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
7
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock commenced quotation on the Nasdaq SmallCap
Market on January 19, 1995 following its initial public offering, and from
December 6, 1999 through November 24, 2002, the Company's common stock traded on
the Nasdaq National Market. In July 2002, the Nasdaq National Market advised the
Company that it was not in compliance with its bid price requirement. On
November 25, 2002, the Company transferred to the Nasdaq SmallCap Market in
order to obtain additional time in which to regain compliance with the minimum
bid price requirement. The following table sets forth, for the periods
indicated, the last sale prices for the Common Stock as reported by Nasdaq
(representing interdealer sales which do not include retail markups, markdowns
or commissions), with prices adjusted to reflect the Company's one-for-eight
stock split effected on January 6, 2003:
PERIOD HIGH($) LOW($)
------ ------- ------
Fiscal 2003
Fourth Quarter 16.50 8.89
Third Quarter 10.40 4.50
Second Quarter 5.26 1.35
First Quarter 3.76 1.63
Fiscal 2002
Fourth Quarter 6.00 2.80
Third Quarter 7.52 4.00
Second Quarter 9.28 5.28
First Quarter 8.48 5.12
On March 24, 2004, the last sale price of the common stock as reported
by the Nasdaq SmallCap Market was $7.45. On March 24, 2004, there were 152
holders of record of the Company's common stock and, the Company believes, over
1,100 beneficial owners of the Company's stock.
The Company presently intends to retain all earnings for the Company's
continued growth. Depending upon the Company's capital resources and needs, the
Company may pay cash dividends in the future. The payment of dividends, if any,
in the future is within the discretion of the Board of Directors and will depend
upon the Company's earnings, its capital requirements and financial condition,
and other relevant factors, although this may change based upon the foregoing
factors. The Company's ability to pay dividends in the future also may be
restricted by the obligations of its broker-dealer subsidiaries to comply with
the net capital requirements imposed on broker-dealers under regulations and
rules promulgated by the Commission and the NASDR.
8
Recent Sales of Unregistered Securities
During the three months ended December 31, 2003, the Company made the
following sales of unregistered securities:
=====================================================================================================================
CONSIDERATION RECEIVED
AND DESCRIPTION OF IF OPTION, WARRANT
UNDERWRITING OR EXEMPTION OR CONVERTIBLE
OTHER DISCOUNTS TO FROM SECURITY, TERMS OF
MARKET PRICE AFFORDED REGISTRATION EXERCISE OR
DATE OF SALE TITLE OF SECURITY NUMBER SOLD TO PURCHASERS CLAIMED CONVERSION
- ---------------------------------------------------------------------------------------------------------------------
10/1/03 Options to purchase 6,456 Options granted under 4(2) Fully exercisable
Common Stock 1994 Stock Plan - no cash on 10/1/06, for a
consideration received by period of 10 years
the Company. from date of
grant, at an
exercise price of
$8.88 per share.
- ---------------------------------------------------------------------------------------------------------------------
10/1/03 Options to purchase 7,500 Options granted under 4(2) Fully exercisable
Common Stock 1994 Stock Plan - no cash at varying periods
consideration received by of 1-3 years from
the Company. date of grant at
an exercise price of
$8.88 per share, all
of which expire 10
years from date of
grant.
- ---------------------------------------------------------------------------------------------------------------------
11/3/03 Options to purchase 10,022 Options granted under 4(2) Fully exercisable
Common Stock 1994 Stock Plan - no cash on date of grant
consideration received by for a period of 10
the Company. years from date of
grant, at an
exercise price of
$11.95 per share.
=====================================================================================================================
9
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data at and for the years ended
December 31, 2003, 2002, 2001, 2000 and 1999 has been derived from the Company's
audited consolidated financial statements for each of the years. Such
information should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the consolidated
financial statements and the notes thereto appearing elsewhere in this Report.
YEAR ENDED DECEMBER 31,
-----------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
INCOME STATEMENT DATA:
Total revenues $26,452,482 $21,362,180 $22,992,888 $31,030,364 $42,673,096
Total expenses $24,756,175 $27,911,639 $29,015,853 $46,887,580 $30,671,871
Income (loss) before income taxes
and minority interest $1,696,307 $(6,549,459) $(6,022,965) $(19,673,076) $12,001,222
Net income (loss) $3,797,084 $(8,802,638) $(3,689,055) $(11,296,166) $7,455,086
Basic income (loss) per common share (1) $2.36 $(5.17) $(2.34) $(7.44) $5.14
Diluted income (loss) per common share $1.73 $(5.17) $(2.34) $(7.44) $4.95
(1)
Weighted average shares outstanding - 1,609,458 1,701,888 1,580,156 1,518,447 1,448,396
basic (1)
Weighted average shares outstanding - 2,191,484 1,701,888 1,580,156 1,518,447 1,505,612
diluted (1)
BALANCE SHEET DATA:
Total assets $14,220,415 $8,175,456 $14,874,956 $16,136,194 $31,073,019
Total liabilities, subordinated $8,258,911 $6,607,060 $4,104,762 $5,354,919 $13,330,838
borrowings and minority interest
in subsidiaries
Stockholders' equity $5,961,504 $1,568,396 $10,770,194 $10,781,275 $17,742,181
(1) See Note 1 to the consolidated financial statements related to the change in
previously stated earnings (loss) per share.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING STATEMENTS
When used in this Form 10-K and in future filings by the Company with
the Commission, the words or phrases "will likely result," "management expects"
or "the Company expects," "will continue," "is anticipated," "estimated" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of
10
the Private Securities Litigation Reform Act of 1995. Readers are cautioned not
to place undue reliance on any such forward-looking statements, each of which
speak only as of the date made. Such statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from
historical earnings and those presently anticipated or projected. These risks
are included in "Item 1: Business," "Item 7: Management's Discussion and
Analysis of Financial Condition and Results of Operations" and in "Exhibit 99:
Risk Factors" included in this Form 10-K. The Company has no obligation to
publicly release the result of any revisions which may be made to any
forward-looking statements to reflect anticipated or unanticipated events or
circumstances occurring after the date of such statements.
CRITICAL ACCOUNTING POLICIES
An understanding of our accounting policies is necessary for a complete
analysis of our results, financial position, liquidity and trends. Note 1 to our
consolidated financial statements filed in this Annual Report on Form 10-K for
the year ended December 31, 2003 includes a summary of the significant
accounting policies and methods used in the preparation of our consolidated
financial statements. We focus your attention on the following, which provides a
brief discussion of the more significant accounting policies and methods used by
us:
Valuation of Investments. The major portion of the Company's securities
owned and securities sold, not yet purchased, are stated at quoted
market values. Included in securities owned are stock warrants and
investments in privately held companies not readily marketable, which
have been valued at fair value as determined by management. The
warrants are valued based on a percentage of the market value of the
underlying securities. The resulting unrealized gains and losses are
reflected in principal transactions, investment banking and merchant
banking income. The liquidation of the Company's position could result
in substantial differences from the market and fair value prices used
in the consolidated financial statements.
Impairment of Deferred Tax Assets. The carrying value of the Company's
net deferred tax assets assumes that it will be able to generate future
taxable income, based on estimates and assumptions. If these estimates
and assumptions change in the future, the Company may be required to
increase valuation allowances against its deferred tax assets, which
would result in additional income tax expense. During 2003 the Company
reduced its valuation allowance. At December 31, 2003, the valuation
allowance was approximately 40% of the Company's deferred tax assets
related to its net operating loss carryforwards and other temporary
differences. This change was due to developments during the year,
including the recordation of income from operations for the year ended
December 31, 2003. Management believes that the Company is prepared to
return to long-term profitability as a result of its strategic
downsizing of the Company's branch office network and its decision to
return to its core business of retail brokerage, investment and
merchant banking, and money management.
Market, Credit, and Liquidity Risk. The Company's investing and
underwriting activities often involve the purchase, sale or short sale
of securities as principal. Such activities subject our capital to
significant risks from markets that may be characterized by relative
illiquidity or may be particularly susceptible to rapid fluctuation in
liquidity. Such market conditions could limit the Company's ability to
resell securities purchased or to purchase securities sold short. These
activities subject our capital to significant risks, including market,
credit counterparty and liquidity risks. Market risks relate to the
risk of fluctuating values based on market prices without action on our
part. The Company's primary credit risk is settlement or counterparty
risk, which relates to whether a counterparty will fulfill its
contractual obligations, such as delivery of securities or payment of
funds. Liquidity risk relates to the Company's inability to liquidate
assets or redirect the deployment of assets contained in illiquid
investments. In addition, our market and liquidity risks and risks
associated with asset revaluation are increased because these risks for
us are concentrated. The areas related to the above risks are valued
based on listed market prices, where possible. If listed market prices
are not available then these items are carried at fair value as
determined by management, with related unrealized gains and losses
recognized in the consolidated statement of operations. Actual results
could differ from the values used in these consolidated financial
statements.
11
Contingencies. The Company's business involves substantial risks of
liability, including exposure to liability under federal and state
securities laws in connection with the underwriting or distribution of
securities and claims by dissatisfied customers for fraud, unauthorized
trading, churning, mismanagement and breach of fiduciary duty. The
Company does not presently maintain an errors and omissions insurance
policy insuring it against these risks. In the normal course of the
Company's business, the Company from time to time is involved in
claims, lawsuits and arbitrations brought by its customers. The Company
consults its attorneys in order to estimate amounts that should be
reflected in the Company's consolidated financial statements relating
to pending or threatened claims. If pending or threatened claims result
in damages to be paid by the Company, these amounts could be different
from the amounts previously estimated and reflected in the Company's
consolidated financial statements. The Company's review of existing
claims, arbitrations and unpaid settlements at December 31, 2003
resulted in an accrued liability of approximately $191,000.
The Company has reached an agreement in principle with the NASD
Department of Enforcement concerning the resolution of several
disciplinary proceedings and other regulatory or enforcement matters
involving the Company that are discussed in Part I, Item 3, Legal
Proceedings. The proposed settlement is pending final regulatory
approval. If the settlement is not consummated, the Company intends to
contest vigorously all claims asserted by the NASD Department of
Enforcement in this proceeding. As a result, the Company has recorded
an accrual in the amount of $1,250,000 at December 31, 2003 in the
consolidated statement of financial condition.
OVERVIEW
The following discussion and analysis should be read in conjunction
with the Company's consolidated financial statements and the notes presented
following the consolidated financial statements. The discussion of results,
causes and trends should not be construed to imply any conclusion that such
results or trends will necessarily continue in the future.
The Company's revenues during 2003 were generated primarily from
brokerage transactions. Revenues from brokerage transactions result in the
Company earning commissions charged to customers for purchasing and selling
securities and is comprised of equity securities, unit trusts, and mutual funds.
To a lesser extent, the Company's revenues were generated from principal trading
activities. As a principal, the Company buys and sells securities, both for
proprietary trading and, more significantly, to facilitate sales to its retail
customers and other dealers. Principal transactions with customers are effected
at a net price equal to the current interdealer price plus or minus a mark-up or
mark-down within the guidelines of applicable securities regulations. As a
result of its principal trading activities, the amount of the Company's
liabilities and assets can vary widely from period-to-period.
The Company pays its registered representatives commissions equal to
varying percentages of gross commissions and mark-ups and mark-downs in
connection with the purchases and sales of securities on behalf of its
customers. In addition, the Company pays ticket charges to its clearing brokers
for the processing of security transactions. The Company maintains some
inventories of securities in order to facilitate sales to customers. In this
regard, the Company may pay interest on the securities held in inventory since
its securities can be purchased on margin through its clearing brokers.
In December 2000, after pursuing its Internet-based business plan,
VentureHighway.com Inc., a majority-owned subsidiary of the Company, suspended
its Internet operations while it considered its strategic alternatives. On
August 24, 2001, Kirlin Securities acquired most of the assets of Princeton
Securities Corporation, an independently wholly-owned subsidiary of
VentureHighway. Following the sale of the Princeton assets, Princeton
relinquished its license as a broker-dealer and was dissolved in 2003. In
December 2001, the board of directors and stockholders of VentureHighway adopted
a plan of dissolution and liquidation, which dissolution was completed during
2003.
In January 2001, the Company's ownership interest in GMST World
Markets, Inc. was reduced to 61% when GMST received a capital infusion from a
member of its management. On December 31, 2001, the
12
Company sold its remaining interest in GMST, except for a 5% interest, to two
members of GMST's management. During the period of time the Company owned its
interest in GMST, the statement of operations of GMST has been consolidated with
the Company's consolidated statement of operations. This sale agreement entitled
the Company to various percentages of GMST's net trading revenue over the next
ten years. GMST ceased its operations in 2003.
On August 29, 2001, Kirlin Securities completed its agreement to
acquire certain assets of M.S. Farrell & Co., Inc., a retail-oriented brokerage
and investment banking firm, in consideration for the issuance of a ten year
warrant to purchase 150,000 shares of the common stock of the Company at an
exercise price equal to $12.00 per share and the assumption of liabilities under
real estate and equipment leases relating to offices of M.S. Farrell to be used
by Kirlin Securities following completion of the transaction.
The Company is directly affected by general economic conditions,
interest rates and market conditions. All of these factors have an impact on its
principal trading and overall business volume. The Company's costs associated
with occupancy, communications and equipment costs are relatively fixed and, in
periods of reduced revenues, can have an adverse effect on earnings.
The following table shows each specified item as a dollar amount and as
a percentage of revenues in each fiscal period, and should be read in
conjunction with the consolidated financial statements included elsewhere in
this Annual Report on Form 10-K:
Years ended December 31,
--------------------------------------------------------------------------------
2003 2002 2001
------------------------- ------------------------- -------------------------
Revenues:
Principal transactions, net $ 894,760 3.4% $ (449,896) (2.1)% $ 7,685,602 33.4%
Commissions 21,909,669 82.8% 18,436,602 86.3% 13,361,772 58.1%
Merchant banking (29,752) (0.1)% (37,998) (0.2)% 202,024 0.9%
Investment banking 798,476 3.0% 983,829 4.6% 69,209 0.3%
Other income 2,879,329 10.9% 2,429,643 11.4% 1,502,976 6.5%
Increase in value attributable to
subsidiary -- -- -- -- 171,305 0.8%
--------------- -------- --------------- -------- --------------- -------
Total revenues 26,452,482 100.0% 21,362,180 100.0% 22,992,888 100.0%
--------------- -------- --------------- -------- --------------- -------
Expenses:
Employee compensation and benefits 17,034,548 64.4% 16,626,723 77.8% 18,046,801 78.5%
Promotion and advertising 300,325 1.1% 349,514 1.7% 697,114 3.0%
Clearance and execution charges 539,217 2.1% 582,674 2.7% 1,508,097 6.6%
Occupancy and communications 3,416,820 12.9% 4,043,779 18.9% 4,880,427 21.2%
Impairment of intangible assets and
goodwill - - 2,081,661 9.8% - -
Professional fees 970,623 3.7% 1,050,155 4.9% 1,635,622 7.1%
Interest 2,634 0.0% 28,431 0.1% 113,323 0.5%
Other 2,492,008 9.4% 3,148,702 14.8% 2,134,469 9.3%
--------------- -------- --------------- -------- ------------- -------
Total expenses 24,756,175 93.6% 27,911,639 130.7% 29,015,853 126.2%
--------------- -------- --------------- -------- ------------- -------
Income (loss) before income tax
(provision) benefit and minority
interest in (income) loss of
subsidiaries 1,696,307 6.4% (6,549,459) (30.7)% (6,022,965) (26.2)%
Income tax (provision) benefit 2,100,777 8.0% (2,139,428) (10.0)% 1,969,479 8.6%
--------------- -------- ------------- -------- ------------- -------
Income (loss) before minority interest
in (income) loss of subsidiaries 3,797,084 14.4% (8,688,887) (40.7)% (4,053,486) (17.6)%
Minority interest in (income) loss of
subsidiaries -- -- (113,751) (0.5)% 364,431 1.6%
--------------- -------- --------------- -------- --------------- -------
Net income (loss) $ 3,797,084 14.4% $ (8,802,638) (41.2%) $ (3,689,055) (16.0)%
=============== ======== =============== ======== =============== =======
13
RESULTS OF OPERATIONS
Year Ended December 31, 2003 Compared with Year Ended December 31, 2002
Revenues
Principal transactions, net for the year ended December 31, 2003
increased 299% to $894,760 from $(449,896) in 2002. The increase is attributable
to realized and unrealized gains in the Company's investment account and the
value of warrants the Company received in connection with its investment banking
activities, and an increase in revenue related to equity and fixed income
business for which the Company maintained an inventory, which the Company
believes was due to the improvement in the market. Principal transactions, net
for the year ended December 31, 2003 consisted of realized and unrealized gains
in the Company's investment account and value of warrants received in connection
with its investment banking activities of approximately $161,000 and $118,000,
respectively, and trading revenue of approximately $614,000.
Commissions for the year ended December 31, 2003 increased 18.8% to
$21,909,669 from $18,436,602 in 2002. The change during the year is primarily
attributable to the Company's increased business in equity securities, unit
investment trusts, and commissions generated from three private placements,
which the Company believes was due to the improvement in the market. Commissions
for the year ended December 31, 2003 consisted of agency commissions of
approximately $18,610,000, syndicate commissions of approximately $642,000 and
mutual fund, variable annuity, life insurance and managed money commissions of
approximately $2,657,000.
Merchant banking for the year ended December 31, 2003 was $(29,752) as
a result of the write-down of one of the Company's investments. While there were
no new merchant banking transactions during the past year, the Company continues
to pursue situations that it believes will be profitable.
Investment banking for the year ended December 31, 2003 decreased 18.8%
to $798,476 from $983,829 in 2002. During 2003 the Company acted as the
placement agent for three private placements, and acted as a financial advisor
for Montana Mills Bread Co. in connection with its acquisition by Krispy Kreme
Donuts. In the prior year the Company earned investment banking fees from a debt
conversion, an initial public offering and two private placements, which
generated more fees than the transactions completed during 2003.
Other income for the year ended December 31, 2003 increased 18.5% to
$2,879,329 from $2,429,643 in 2002. The increase is primarily attributable to
the income related to the annual maintenance fee instituted during March 2003,
which is recognized monthly as the annual fee is amortized and amounted to
approximately $648,000. The increase is also attributable to transactional and
account balance rebates the Company is entitled to receive from its clearing
broker under its clearing agreement, which resulted in an increase of
approximately $27,000 as well as an increase in other income for approximately
$30,000. The increases previously identified are offset by decreases in the one
time World Trade Center recovery grant received during 2002 for $150,000,
financial advisory consulting income by approximately $36,000, earnout payment
income related to the GMST World Markets, Inc. transaction by approximately
$49,000, and equity orderflow rebates by approximately $21,000.
Expenses
Employee compensation and benefits for the year ended December 31, 2003
increased 2.5% to $17,034,548 from $16,626,723 in 2002. Since employee
compensation related to the Company's retail brokerage traders and registered
representatives is directly related to revenue they generate, a portion of
employee compensation follows the change in the Company's revenues. This line
item is also reflective of the reduction of base salary by the Company's Chief
Executive Officer and its President by 68% and by its Chief Financial Officer by
35% during the first three months of 2003. Other key management personnel also
agreed to reduce their base salaries during this period. In addition the Chief
Executive Officer and President of the Company reduced the variable portion of
their base salaries by 100% during this period. The salary reductions amounted
to approximately $117,000. Additionally, during the year the Company collected
outstanding loans from three former employees that were written off in a prior
year for approximately
14
$291,000. Finally, the Company's roster of employees decreased as a result of
planned reductions to reduce expenses which caused a decrease in base salaries
and commission payouts related to its deferred commission plans.
Promotion and advertising for the year ended December 31, 2003
decreased 14.1% to $300,325 from $349,514 in 2002 as a result of the Company's
decrease in car allowances arising from the termination of certain employees as
well as a decrease in meals and entertainment, and travel expenses, partially
offset by a planned increase in expenditures for radio advertising to attract
new customers.
Clearance and execution charges for the year ended December 31, 2003
decreased 7.5% to $539,217 from $582,674 in 2002. The decrease is a result of a
shift towards commission products carrying a lower average ticket charge.
Occupancy and communications costs for the year ended December 31, 2003
decreased 15.5% to $3,416,820 from $4,043,779 in 2002. This decrease is
primarily a result of the relocation of one of the Company's branch offices to
smaller and less expensive office space, the elimination of depreciation expense
related to assets that were fully depreciated in the prior year, the completion
of the furniture financing related to the Company's corporate offices in the
prior year, and the reduction of communication and telephone expenses due to a
reduction of the number of employees as compared to the prior year. As part of
the Company's long distance telephone contract, it received a credit for
telephone expenses during 2003. Additionally, the Company recognized a loss for
approximately $72,000 related to the disposal of fixed assets in the Company's
New York City, Fort Lauderdale and Red Bank offices. The New York City and Fort
Lauderdale offices were closed prior to the lease expiration date, while the Red
Bank lease expired. Additionally, the Company subleased its New York City office
lease through the remainder of the lease term which ends during October 2005 and
reduced the accrued lease loss amount for the remaining lease period to
approximately $144,000. The representative's located in these closed offices
were primarily relocated to other offices. Finally, the closing of the Fort
Lauderdale office resulted in the Company recognizing a loss amounting to
approximately $575,000 which represents the remaining lease and operating
commitments related to this office lease (approximately $365,000 of the loss
relates to the remaining office lease payments and approximately $210,000 of the
loss relates to the remaining operating commitments which are reflected in the
"Other expenses" line item in the consolidated statement of operations.)
Impairment of intangible assets and goodwill for the year ended
December 31, 2003 was $0 as compared to $2,081,661 in 2002. During the year
ended December 31, 2002, the Company recorded an impairment of intangible assets
and goodwill as a result of the write-off of intangible assets and goodwill
amounts related to the acquisitions of Princeton Securities Corporation and M.S.
Farrell & Co. This write-off decision was made based on an analysis that
identified a market decline not experienced in quite some time, changing
conditions surrounding the broker-dealer industry, and comparison of post- and
pre-acquisition factors which identified a reduction in the registered
representatives formerly employed by those entities and a decline in expected
revenues.
Professional fees for the year ended December 31, 2003 decreased 7.6%
to $970,623 from $1,050,155 in 2002. The decrease is reflective of non-recurring
legal fees in the prior year, the shift toward more legal work being performed
internally by the Company, and cost reductions derived from all of the Company's
outside professionals. Outside counsel has been and continues to be used in
certain customer arbitrations and regulatory matters related to potential
violations of NASD Conduct Rules and Federal securities laws. Professional fees
are reflective of legal fees related to the Company's vacated office space in
San Diego. In December 2001 the Company's sub-tenant abandoned the San Diego
office space and stopped paying rent to the Company. Based on the nature of the
sub-tenant's relationship with the Company's landlord, the Company decided to
stop paying rent as well, however, it continued to accrue on a monthly basis an
amount equivalent to the straight-line rent related to the San Diego lease. The
Company's landlord pursued legal action and during 2003 the court ruled in favor
of the landlord and required the Company to pay $227,000 to the landlord, which
amount was accrued by the Company prior to the final settlement payment. The
Company pursued legal action against its subtenant and was awarded $300,000,
which it is currently trying to collect.
15
Interest expense for the year ended December 31, 2003 decreased 90.7%
to $2,634 from $28,431 in 2002. This decrease was primarily due to the reversal
during the comparable period in 2002 of accrued interest related to Kirlin
Securities' deferred commission plan and arose from the termination of
employment of certain registered representatives. Non-vested deferred commission
interest related to terminated representatives is immediately forfeited. During
2003 the interest related to terminated representatives which was reversed
amounted to approximately $53,000.
Other expenses for the year ended December 31, 2003 decreased 20.9% to
$2,492,008 from $3,148,702 in 2002 primarily as a result of lower accruals for
customer arbitrations and reversal of prior accruals which arose due to the
Company satisfying unpaid awards for less than the awarded amount. Shareholder
administration expenses and franchise taxes decreased due to lower than expected
expenses for 2002, which resulted in lower incurred charges paid during 2003.
Additionally, general office expenses decreased due to the decrease in the
number of employees and offices, however, during February 2003 the Company
entered into a new two-year licensing agreement with an outside vendor to
provide trade compliance monitoring support on all executed trades at a cost of
approximately $4,000 per month. The Company may terminate this agreement with
sixty days written notice. The decrease is also attributable to impairment of
goodwill due to the write-off of intangible assets and goodwill amounts in 2002
as discussed in the "Impairment of intangible assets and goodwill" line item in
the consolidated statement of operations as well as a one time filing fee
incurred in the prior year to transfer the Company's Common Stock quotation from
the Nasdaq National Market to the Nasdaq SmallCap Market. The above items were
offset by an accrual in the amount of $1,250,000 related to the potential
settlement of pending regulatory enforcement matters related to potential
violations of NASD Conduct Rules and/or Federal securities laws by the Company's
broker-dealer subsidiary, Kirlin Securities, Inc. In addition to the settlement
amount, the broker-dealer subsidiary will retain an independent consultant to
review and report regarding its compliance and supervisory policies and
procedures. The proposed settlement is subject to formal regulatory approval by
NASD's National Adjudicatory Council ("NAC"). It cannot be stated with
reasonable certainty when or if the proposed settlement will be approved by the
NAC. If the proposed settlement is not approved, it is anticipated that the
subject matters will be re-calendared for hearings later in 2004. Other expenses
for the year ended December 31, 2003 consisted of municipal syndicate
participation losses of approximately $161,000, clearing broker non-trade
processing costs of approximately $49,000, office lease operating and tax
expense write-offs related to the closing of the Fort Lauderdale office of
approximately $210,000 (as identified in the in the "Occupancy and
communications costs" line item in the consolidated statement of operations,
during the year the Fort Lauderdale office was closed, which resulted in the
Company recognizing a loss amounting to approximately $575,000 which represents
the remaining lease and operating commitments related to this office lease where
approximately $365,000 of the loss relates to the remaining office lease
payments and approximately $210,000 of the loss relates to the remaining
operating commitments), office insurance (property, casualty, and umbrella)
related to each office, directors and officers insurance and automobile
insurance of approximately $121,000, directors fees of approximately $50,000,
NASD settlement of $1,250,000, regulatory listing, registration and assessment
expenses of approximately $372,000, general office expenses net of clearing
broker conversion reimbursements of approximately $249,000, and miscellaneous
expenses of approximately $30,000.
Income tax benefit for the year ended December 31, 2003 was $2,100,777
as compared to an income tax provision of $2,139,428 for the year ended December
31, 2002. This income tax benefit incorporates the expected usage of the
Company's net operating loss carryforward and other deferred tax asset amounts.
At December 31, 2003 the Company reduced its valuation allowance to
approximately 40% of the Company's gross deferred tax assets (which relate to
its net operating loss carryforwards and other temporary differences) based upon
the Company's estimation of future taxable income.
Net income of $3,797,084 for the year ended December 31, 2003 compares
to net loss of $8,802,638 for the year ended December 31, 2002. Overall this
resulted primarily from an increase in revenues during 2003 which the Company
believes was due to the improvement in the market, a reduction in expenses due
to the Company's operating cost reduction emphasis in 2003, and the
non-recurring impairment of intangible assets and goodwill expense that occurred
in 2002.
16
Year Ended December 31, 2002 Compared with Year Ended December 31, 2001
Revenues
Principal transactions, net for the year ended December 31, 2002
decreased 106% to $(449,896) from $7,685,602 in 2001. The decrease is primarily
attributable to a shift away from principal business to commission business
identified in the next paragraph, as well as a decrease in the value of warrants
the Company received in connection with its investment banking activities.
Commissions for the year ended December 31, 2002 increased 38% to
$18,436,602 from $13,361,772 in 2001. The increase is primarily attributable to
the Companies decision to limit its market-making activities, in which it buys
and sells securities as principal, and to conduct its brokerage business
primarily on an agency basis, for which the Company earns commissions and which
reduced the Company's exposure to market risk. Commission business is comprised
of equity securities, unit trusts, and mutual funds, which, except for equity
securities for which the Company maintains an inventory, are bought and sold on
an agency basis for which the Company receives a commission. The change is also
reflective of the increase in commissions resulting from the addition of
registered representatives which arose from the acquisition of certain assets of
M.S. Farrell & Co. during August 2001.
Merchant banking for the year ended December 31, 2002 decreased 119% to
$(37,998) from $202,024 in 2001. The loss for 2002 results from the write-down
of one of the Company's investments.
Investment banking for the year ended December 31, 2002 was $983,829 as
compared to $69,209 in 2001 as a result of fees the Company generated in 2002
from acting as the underwriter for an initial public offering and as a placement
agent related to a debt conversion and two private placements.
Other income for the year ended December 31, 2002 increased 61.7% to
$2,429,643 from $1,502,976 in 2001. The increase is primarily attributable to
the increases in transactional and account balance rebates the Company is
entitled to receive from its clearing broker under its clearing agreement,
consulting income related to investment banking and earnout payment income the
Company is entitled to receive from GMST World Markets, Inc. Other income for
the year ended December 31, 2002 consisted of rebates on customer balances and
transactions for approximately $1,229,000, clearing fee rebates for
approximately $359,000, interest and dividend income for approximately $473,000,
financial advisory consulting income for approximately $141,000, and other
income for approximately $227,000.
Increase in value attributable to subsidiaries for the year ended
December 31, 2002 was $0 as compared to $171,305 in 2001. This line item changes
based on the value of the Company's investment in its subsidiaries. During the
year ended December 31, 2002 none of the Company's subsidiaries had any changes
which affected this line item.
Expenses
Employee compensation and benefits for the year ended December 31, 2002
decreased 7.9% to $16,626,723 from $18,046,801 in 2001. Since employee
compensation related to the Company's retail brokerage traders and registered
representatives is directly related to revenue they generate, a portion of
employee compensation follows the change in the Company's revenues. The results
are reflective of the compensation costs directly related to the increase in
commission structure for its registered representatives and branch managers
which was initiated during September 2001, as well as the compensation costs
directly related to the hiring of additional personnel following the acquisition
of certain assets of M.S. Farrell & Co. during August 2001. Employee
compensation and benefits for the year ended December 31, 2002 consisted of
commission and override payouts of approximately $9,731,000, salary and bonus
payouts inclusive of restricted stock and loan amortization benefits and taxable
loan write-off's of approximately $5,724,000, taxes related compensation (i.e.
social security, medicare, state unemployment insurance) of approximately
$965,000, and benefits of approximately $207,000.
Promotion and advertising for the year ended December 31, 2002
decreased 49.9% to $349,514 from
17
$697,114 in 2001 primarily as a result of the Company's decrease in advertising
expenditures related to Kirlin Securities' radio campaign and due to the
expiration of VentureHighway's advertising commitment during December 2001. To a
lesser extent this line item decreased due to the promotional expenses related
to GMST during 2001, which was sold during December 2001, and therefore not a
factor in 2002.
Clearance and execution charges for the year ended December 31, 2002
decreased 61.4% to $582,674 from $1,508,097 in 2001 primarily as a result of the
change in clearing brokers during October 2001 which resulted in reduced fees.
Occupancy and communications costs for the year ended December 31, 2002
decreased 17.1% to $4,043,779 from $4,880,427 in 2001. This decrease is
primarily a result of the elimination of these costs directly related to
VentureHighway which was formally dissolved during 2002 and the sale of the
Company's majority interest in GMST during December 2001, partially offset by
the increase in occupancy and communications costs as a result of the prior year
acquisition of certain assets and the assumption of liabilities under real
estate and equipment leases of M.S. Farrell & Co. Other expenses for the year
ended December 31, 2002 consisted of rent expense of approximately $1,410,000,
office utilities, maintenance and moving expenses of approximately $120,000,
depreciation expense of approximately $626,000, furniture financing of
approximately $84,000, communication charges of approximately $989,000,
telephone expenses of approximately $522,000, and printing and postage expenses
of approximately $293,000.
Impairment of intangible assets and goodwill for the year ended
December 31, 2002 amounted to $2,081,661 and is a result of the write-off of
intangible assets and goodwill amounts related to the acquisitions of Princeton
Securities Corporation and M.S. Farrell & Co. This write-off decision was made
based on an analysis that identified a market decline not experienced in quite
some time, changing conditions surrounding the broker-dealer industry, and
comparison of post- and pre-acquisition factors which identified a reduction in
the registered representatives formerly employed by those entities and a decline
in expected revenues.
Professional fees for the year ended December 31, 2002 decreased 35.8%
to $1,050,155 from $1,635,622 in 2001. The decrease is reflective of
non-recurring legal fees in the prior year as well as the shift toward more
legal work being performed internally by the Company.
Interest expense for the year ended December 31, 2002 decreased 74.9%
to $28,431 from $113,323 in 2001. Interest expense decreased primarily due to
the reversal of accrued interest related to Kirlin Securities' deferred
commission plan due to the termination of employment of certain registered
representatives. To a lesser extent interest expense decreased as a result of a
reduction of inventory positions purchased on margin and securities sold short,
which are held at a clearing broker and charged interest. The Company seeks to
minimize its cash balances and withdraws cash for operations from its trading
accounts as needed. To the extent necessary, inventory positions are utilized as
collateral for such withdrawals.
Other expenses for the year ended December 31, 2002 increased 47.5% to
$3,148,702 from $2,134,469 in 2001 primarily a result of the settlement of and
accrual for customer arbitrations, as well as a result of general office
expenses related to the acquisition of certain assets of a retail oriented
brokerage firm during August 2001 which resulted in an increase in the number of
branch offices operated by the Company. Other expenses for the year ended
December 31, 2002 consisted of municipal syndicate participation loses of
approximately $151,000, clearing broker non-trade processing costs of
approximately $99,000, office insurance (property, casualty, and umbrella)
related to each office, directors and officers insurance and automobile
insurance of approximately $143,000, directors fees of approximately $38,000,
regulatory listing, registration and assessment expenses of approximately
$480,000, customer settlement of approximately $1,362,000, general office
expenses of approximately $661,000, goodwill amortization expense of
approximately $200,000 and miscellaneous expenses of approximately $14,000
Income tax provision for the year ended December 31, 2002 was
$2,139,428 as compared to an income tax benefit of $1,969,479 for the year ended
December 31, 2001, which is reflective of the valuation allowance of 100% of the
Company's deferred tax assets which relate to its net operating loss
carryforwards and other temporary differences.
18
Net loss of $8,802,638 for the year ended December 31, 2002 compares to
net loss of $3,689,055 for the year ended December 31, 2002. This resulted
primarily from the change in revenues and expenses discussed above.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2003, approximately 67% of the Company's assets were
comprised of cash and highly liquid securities.
Cash and cash equivalents amounted to $3,032,931 at December 31, 2003
as compared to $3,035,084 at December 31, 2002 and is basically unchanged.
Due from Clearing Brokers amounted to $3,175,650 at December 31, 2003
as compared to $559,303 at December 31, 2002. This 468% increase is primarily
attributable to increased receivables related to agency commissions owed to the
Company and cash balances maintained in the Company's trading accounts at the
end of the year.
Securities Owned at December 31, 2003 were $3,475,521 as compared to
$1,856,245 at December 31, 2002. This increase is primarily reflective of the
increase in equity securities maintained in the Company's investment account
which should yield a higher paying dividend as compared to the current money
market fund rate. The above increase is offset by decreases in U.S. government
and agency obligations and state and municipal obligations held in inventory
with respect to the Company's retail and syndicate activities.
Rebate Receivable amounted to $1,241,000 at December 31, 2003 as
compared to $964,000 at December 31, 2002. This 28.7% increase is reflective of
the rebate the Company is entitled to receive from its clearing broker as
provided in the clearing agreement. The Company generated income and fees which
increased this line item by $714,500 offset by the collection of $437,500 of
this rebate receivable. The clearing broker will rebate, in amounts and at dates
specified in the agreement, 50% of the clearing fees and other items (as
defined) up to a maximum of $2,500,000. The rebate is supposed to be paid by the
clearing broker up to maximum installments of $62,500 at the end of each
subsequent calendar quarter through March 31, 2005, at which time the balance
will be payable.
Representative Loans at December 31, 2003 amounted to $136,341 as
compared to $547,914 at December 31, 2002. This 75.1% decrease is reflective of
the net change resulting from the reduction in the disbursement of new loans
provided to registered representatives as part of the Company's recruitment
efforts net of the amortization, collections, and write-offs related to loans
disbursed in the current and prior years. A majority of the loans will be
forgiven based on the recipient's production or employment through a specific
time period. The Company amortizes the principal amount of the loan over the
performance period or the employment period, whichever is shorter.
Furniture, Fixtures and Leasehold Improvements, net, at December 31,
2003, decreased to $142,498 as compared to $574,986 at December 31, 2002. This
75.2% decrease primarily results from the depreciation of fixed assets and the
write-off of fixed assets for approximately $72,000 located in three branch
offices as previously discussed in the "Occupancy and communications" line item
in the Result of Operations.
Deferred Tax Assets, net at December 31, 2003 amounted to $2,165,805 as
compared to $0 at December 31, 2002. The deferred tax asset changed during the
period due to the expected utilization of the Company's net operating loss
carryforward and other temporary differences which results in a reduction in its
valuation allowance. At December 31, 2003 the valuation allowance is
approximately 40% of its deferred tax assets related to its net operating loss
carryforwards and other temporary differences as a result of events giving rise
to greater expectation of a return to long-term profitability. At December 31,
2003 the deferred tax assets amount to approximately $3,591,000 and the recorded
valuation allowance amounted to approximately $1,425,000. If the Company
continues to be profitable then it anticipates being able to use a substantial
portion of the deferred tax asset.
19
Other assets increased by 33.4% to $850,669 at December 31, 2003, from
$637,924 at December 31, 2002. The increase is attributable to increases in a
receivable related to the nonpayment of a trade by a customer which led to the
initiation of legal action by the Company, commissions receivable related to
mutual funds and unit investment trusts, and a receivable related to conversion
cost reimbursements by the broker-dealers clearing broker. The above increase is
offset by the following decreases: (i) net receivable related to two legal
matters whereby the receivables that existed at December 31, 2002 were
satisfied; and (ii) a decrease in the rent deposits related to three of the
Company's leases, two of which were forfeited as part of the early termination
of those leases. Other assets at December 31, 2003 consists of clearing broker
conversion cost reimbursement receivable of $300,000, unit investment trust and
mutual fund commissions receivable of approximately $108,000, prepaid expenses
of approximately $146,000, rent deposits inclusive of a letter of credit deposit
of approximately $224,000, and other assets of approximately $73,000. Other
assets at December 31, 2002 consists of unit investment trust and mutual fund
commissions receivable and trade facilitation fees of approximately $98,000,
prepaid expenses of approximately $151,000, rent deposits inclusive of a letter
of credit deposit of approximately $252,000, and other assets of approximately
$137,000.
Securities sold, not yet purchased amounted to $123,972 at December 31,
2003 as compared to $143,205 at December 31, 2002. Management monitors these
positions on a daily basis and covers short positions when deemed appropriate.
Accrued compensation was $1,892,160 at December 31, 2003 as compared to
$1,694,183 at December 31, 2002, a 11.7% increase. The revenues upon which
commission income to registered representatives is based directly affect this
line item, which was higher at the end of 2003 as compared to 2002.
Accounts payable and accrued expenses at December 31, 2003 were
$4,180,279 as compared to $2,269,672 at December 31, 2002, a 84.2% increase. The
change is primarily attributable to the accrual in the amount of $1,250,000
related to the potential settlement of the potential violations of NASD Conduct
Rules and/or Federal securities laws and $200,000 related to professional fees
associated with this settlement as previously discussed in the "Other expenses"
line item in the consolidated statement of operations. The change is also
attributable to two office lease write-off's which arose due to the closing of
two branch offices as previously discussed in the "Occupancy and communications"
line item in the consolidated statement of operations." The increase is also
reflective of the collection in March 2003 of the annual maintenance fee charged
to client accounts and the recordation in the Company's Consolidated Statement
of Financial Condition of an offsetting liability. The income related to the
annual maintenance fee is recognized monthly as the annual fee is amortized.
This increase is also attributable to current state income taxes payable
reflective of the adjustment for the current period's earnings. The Company
reports its income for federal tax purposes on a consolidated basis while the
Company files separate state and local income tax returns. As a result,
different tax regulations exist between each government body causing certain
items that are utilizable in one jurisdiction being postponed in their
utilization in others. Net operating losses is one such item which was suspended
for 2002 and 2003 only by California and New Jersey but is currently allowed by
New York State and the Internal Revenue Service. Additionally, permanent and
temporary differences can result in higher or lower amounts due. One such item
is the $1,250,000 NASD settlement as previously discussed in the "Other
expenses" line item in the Results of Operations. The portion of the settlement
classified as a fine is not deductible and is considered a permanent difference
while the portion that is considered restitution to customers is considered a
temporary difference that is not deductible in 2003 since payment was not made
by March 15, 2004, however, is deductible in 2004 if paid by March 15, 2005. The
above increase is offset by a decrease in the accrued liability related to
existing claims, arbitrations and unpaid settlements, which decreased due to the
payment of some settlement amounts and the reversal of prior accruals due to the
Company satisfying unpaid awards for less than the awarded amount. This line
item also decreased due to the payment of the rent accrual related to the
Company's vacated office space in San Diego, which is described in the previous
discussion regarding Professional Fees in Results of Operations. The increase is
also attributable to the override payments to be made to the former owners of
Princeton Securities, where the Company is required to pay an override on the
commissions generated by the representatives directly hired as part of the
transaction through March 2003. The final payment was expected to be made during
May 2003, however, accrued amounts related to one of the former owners is being
withheld due to a disagreement over
20
amounts owed to the Company and its attorneys in relation to GMST World Market's
arbitration. To a lesser extent this line item increased due to the increase in
payables related to the Company's general business. Accounts payable and accrued
expenses at December 31, 2003 consists of accrued professional fees of
approximately $588,000, accrued communications of approximately $233,000,
accrued computer and copier of approximately $202,000, accrued arbitration
settlements of approximately $191,000, accrued lease expense of approximately
$648,000, accrued regulatory expense of approximately $1,250,000 and other
accounts payable and accrued expenses of approximately $1,069,000. Accounts
payable and accrued expenses at December 31, 2002 consists of accrued
professional fees of approximately $331,000, accrued communications of
approximately $245,000, accrued computer and copier of approximately $202,000,
accrued arbitration settlements of approximately $536,000, and other accounts
payable and accrued expenses of approximately $903,000.
Subordinated borrowings amounted to $2,062,500 at December 31, 2003 as
compared to $2,500,000 at December 31, 2002. During March 2002, Kirlin
Securities received from its clearing broker a $2,500,000 three-year
subordinated loan and calls for payments over various periods of time during
this three-year period. During the year ended December 31, 2003 the Company
repayed $437,500 of this subordinated loan back to the clearing broker, which
payment was made from the funds received from the clearing broker under the
rebate agreement.
The Company, as guarantor of its customer accounts to its clearing
brokers, is exposed to off-balance-sheet risks in the event that its customers
do not fulfill their obligations with the clearing brokers. In addition, to the
extent the Company maintains a short position in certain securities, it is
exposed to a further off-balance-sheet market risk, since the Company's ultimate
obligation may exceed the amount recognized in the financial statements.
The Company's business involves substantial risks of liability,
including exposure to liability under federal and state securities laws in
connection with the underwriting or distribution of securities and claims by
dissatisfied customers for fraud, unauthorized trading, churning, mismanagement
and breach of fiduciary duty. The Company does not presently maintain an errors
and omissions insurance policy insuring it against these risks. In the normal
course of the Company's business, the Company from time to time is involved in
claims, lawsuits and arbitrations brought by its customers and former employees.
It is the opinion of management, based upon its evaluation of each of these
matters and the reserves established by the Company, that the resolution of all
claims presently pending will not have a material adverse effect on the
consolidated financial condition of the Company.
The Company's operations historically have been the principal source of
cash needed by the Company's business. Retained earnings and cash generally were
sufficient to carry the Company through periods when operations used more cash
than was generated. However, the Company experienced significant losses in 2000
through 2002 and the Company sought capital form external sources. This was
provided by the $2,500,000 three-year subordinated loan Kirlin Securities
obtained from its clearing broker in 2002 and by a private placement of the
Company's securities in 2001 that raised $1,500,000. Alternatively, the Company
was able to implement through its operations an annual account maintenance fee
that was instituted during 2003 and generated approximately $800,000.
The Company believes its financial resources will be sufficient to fund
the Company's operations and capital requirements for the foreseeable future.
The Company, however, continues to explore the possibility of a financing to
assist it in pursuing its plans for growth.
CONSOLIDATED CONTRACTUAL OBLIGATIONS AND LEASE COMMITMENTS
The table below summarizes information about our consolidated
contractual obligations as of December 31, 2003 and the effects these
obligations are expected to have on our consolidated liquidity and cash flow in
future years. This table does not include any projected payment amounts related
to the Company's potential exposure to arbitrations and other legal matters.
21
2008 and
Total 2004 2005 2006 2007 thereafter
------------ ------------- ------------- -------------- ------------ --------------
Equipment lease
obligations $ 184,043 $ 110,742 $ 53,304 $ 19,997 $ -- $ --
Office lease obligations 1,419,801 910,234 335,592 93,492 80,483 --
Employment contract
obligations 3,523,333 755,000 755,000 755,000 755,000 503,333
----------- ----------- ----------- ------------ ---------- ------------
$ 5,127,177 $ 1,775,976 $ 1,143,896 $ 868,489 $ 835,483 $ 503,333
=========== =========== =========== ============ ========== ============
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our investing and underwriting activities often involve the purchase,
sale or short sale of securities as principal. Such activities subject our
capital to significant risks from markets that may be characterized by relative
illiquidity or may be particularly susceptible to rapid fluctuation in
liquidity. Such market conditions could limit our ability to resell securities
purchased or to purchase securities sold short. These activities subject our
capital to significant risks, including market, credit counterparty and
liquidity risks. Market risk relates to the risk of fluctuating values based on
market prices without action on our part. Our primary credit risk is settlement
or counterparty risk, which relates to whether a counterparty will fulfill its
contractual obligations, such as delivery of securities or payment of funds.
Liquidity risk relates to our inability to liquidate assets or redirect the
deployment of assets contained in illiquid investments. In addition, our market
and liquidity risks and risks associated with asset revaluation are increased
because these risks for us are concentrated.
22
ITEM 8. FINANCIAL STATEMENTS.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT - MARCUM & KLIEGMAN LLP F-1
INDEPENDENT AUDITORS' REPORT - GOLDSTEIN GOLUB KESSLER LLP F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Statements of Financial Condition as of December 31, 2003 and 2002 F-3
Statements of Operations for the Years Ended December 31, 2003, 2002 and 2001 F-4
Statements of Changes in Stockholders' Equity for the Years Ended
December 31, 2003, 2002 and 2001 F-5
Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001 F-6
Notes to Consolidated Financial Statements F-7 - F-24
23
INDEPENDENT AUDITORS' REPORT
To the Audit Committee of the Board of Directors and Stockholders of
Kirlin Holding Corp.
We have audited the accompanying consolidated statement of financial condition
of Kirlin Holding Corp. and Subsidiaries as of December 31, 2003, and the
related consolidated statements of operations, changes in stockholders' equity,
and cash flows for the year then ended. 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
audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Kirlin
Holding Corp. and Subsidiaries as of December 31, 2003 and the results of their
operations and their cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States of America.
/s/ Marcum & Kliegman LLP
MARCUM & KLIEGMAN LLP
New York, New York
March 10, 2004
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Kirlin Holding Corp.
We have audited the accompanying consolidated statement of financial condition
of Kirlin Holding Corp. and Subsidiaries as of December 31, 2002, and the
related consolidated statements of operations, changes in stockholders' equity,
and cash flows for each of the two years in the period ended December 31, 2002.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Kirlin Holding
Corp. and Subsidiaries as of December 31, 2002 and the results of their
operations and their cash flows for each of the two years in the period ended
December 31, 2002 in conformity with accounting principles generally accepted in
the United States of America.
/s/ Goldstein Golub Kessler LLP
GOLDSTEIN GOLUB KESSLER LLP
New York, New York
March 22, 2003
F-2
KIRLIN HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, DECEMBER 31,
2003 2002
-------------- -------------
ASSETS:
Cash $ 3,032,931 $ 3,035,084
Due from Clearing Brokers 3,175,650 559,303
Securities Owned:
U.S. government and agency obligations, at market value 53,532 320,103
State and municipal obligations, at market value 283,101 757,450
Corporate bonds and other securities, at market value 3,008,844 705,967
Non-marketable securities, at fair value 130,044 72,725
Rebate Receivable 1,241,000 964,000
Representative Loans 136,341 547,914
Furniture, Fixtures and Leasehold Improvements, at cost, net of
accumulated depreciation and amortization of $2,963,955 and
$2,944,342, respectively 142,498 574,986
Deferred Tax Assets, net of valuation allowances of $1,425,043 and
$4,119,640, respectively 2,165,805 --
Other Assets 850,669 637,924
-------------- -------------
Total assets $ 14,220,415 $ 8,175,456
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Securities sold, not yet purchased, at market value $ 123,972 $ 143,205
Accrued compensation 1,892,160 1,694,183
Accounts payable and accrued expenses 4,180,279 2,269,672
-------------- -------------
Total liabilities 6,196,411 4,107,060
-------------- -------------
Subordinated borrowings 2,062,500 2,500,000
-------------- -------------
Commitments and Contingencies
Stockholders' Equity:
Common stock, $.0001 par value; authorized 7,000,000 shares, issued
and outstanding 2,036,853 and 1,798,224 shares, respectively 204 180
Additional paid-in capital 16,644,939 16,226,346
Unearned stock compensation (106,002) (283,409)
Accumulated deficit (10,577,637) (14,374,721)
-------------- -------------
Total stockholders' equity 5,961,504 1,568,396
-------------- -------------
Total liabilities and stockholders' equity $ 14,220,415 $ 8,175,456
============== =============
See Notes to Consolidated Financial Statements
F-3
KIRLIN HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
-------------------------------------------
2003 2002 2001
------------ ----------- ------------
Revenues:
Principal transactions, net $ 894,760 $ (449,896) $ 7,685,602
Commissions 21,909,669 18,436,602 13,361,772
Merchant banking (29,752) (37,998) 202,024
Investment banking 798,476 983,829 69,209
Other income 2,879,329 2,429,643 1,502,976
Increase in value attributable to subsidiaries -- -- 171,305
------------ ----------- ------------
Total revenues 26,452,482 21,362,180 22,992,888
------------ ----------- ------------
Expenses:
Employee compensation and benefits 17,034,548 16,626,723 18,046,801
Promotion and advertising 300,325 349,514 697,114
Clearance and execution charges 539,217 582,674 1,508,097
Occupancy and communications 3,416,820 4,043,779 4,880,427
Impairment of intangible assets and goodwill -- 2,081,661 --
Professional fees 970,623 1,050,155 1,635,622
Interest 2,634 28,431 113,323
Other 2,492,008 3,148,702 2,134,469
------------ ----------- ------------
Total expenses 24,756,175 27,911,639 29,015,853
------------ ----------- ------------
Income (loss) before income tax (provision) benefit and
minority interest in (income) loss of subsidiaries 1,696,307 (6,549,459) (6,022,965)
Income tax (provision) benefit 2,100,777 (2,139,428) 1,969,479
------------ ----------- ------------
Income (loss) before minority interest in (income) loss of
subsidiaries 3,797,084 (8,688,887) (4,053,486)
Minority interest in (income) loss of subsidiaries -- (113,751) 364,431
------------ ----------- ------------
Net income (loss) $ 3,797,084 $(8,802,638) $(3,689,055)
============ =========== ===========
Basic earnings (loss) per common share (See Note 1) $ 2.36 $ (5.17) $ (2.34)
============ =========== ===========
Weighted-average shares outstanding (See Note 1) 1,609,458 1,701,888 1,580,156
============ =========== ===========
Diluted earnings (loss) per common share (See Note 1) $ 1.73 $ (5.17) (2.34)
============ =========== ===========
Weighted-average shares of common stock and common stock
equivalents outstanding (See Note 1) 2,191,484 1,701,888 1,580,156
============ =========== ===========
See Notes to Consolidated Financial Statements
F-4
KIRLIN HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years ended December 31, 2003, 2002 and 2001
Common Stock Additional Unearned
---------------------------- Paid-in Stock Accumulated
Shares Par Value Capital Compensation Deficit Total
------------ ------------ ------------ ------------ ------------ ------------
Stockholders' equity
at January 1, 2001 1,583,755 $ 158 $ 12,664,145 -- $ (1,883,028) $ 10,781,275
Stock and warrant
issuances 289,152 29 2,288,278 $ (294,433) -- 1,993,874
Equity enhancement -- -- 445,238 -- -- 445,238
Stock forfeitures (10,096) (1) (117,137) -- -- (117,138)
Warrant issued in
connection with
acquisition -- -- 1,356,000 -- -- 1,356,000
Net loss -- -- -- -- (3,689,055) (3,689,055)
------------ ------------ ------------ ------------ ------------ ------------
Stockholders' equity
at December 31, 2001 1,862,811 186 16,636,524 (294,433) (5,572,083) 10,770,194
Stock issuances 165,090 17 1,107,424 (7,559) -- 1,099,882
Stock forfeitures (44,514) (4) (454,211) 18,583 -- (435,632)
Repurchases and
retirements of stock (185,163) (19) (1,063,391) -- -- (1,063,410)
Net loss -- -- -- -- (8,802,638) (8,802,638)
------------ ------------ ------------ ------------ ------------ ------------
Stockholders' equity
at December 31, 2002 1,798,224 180 16,226,346 (283,409) (14,374,721) 1,568,396
Issuance of restricted
stock to employees
under stock plans 42,116 4 69,171 (69,175) -- --
Exercise of stock
options 3,334 -- 25,063 -- -- 25,063
Issuance of stock to
employees under
deferred commission
plan 277,248 28 959,583 -- -- 959,611
Issuance of stock for
services 20,037 2 52,498 (22,500) -- 30,000
Amortization of
unearned stock
compensation -- -- -- 210,803 -- 210,803
Forfeitures of stock
by employees under
deferred commission
plan (77,742) (7) (457,175) -- -- (457,182)
Forfeitures of
restricted stock by
employees (26,364) (3) (230,547) 58,279 -- (172,271)
Net income -- -- -- -- 3,797,084 3,797,084
------------ ------------ ------------ ------------ ------------ ------------
Stockholders' equity
at December 31, 2003 2,036,853 $ 204 $ 16,644,939 $ (106,002) $(10,577,637) $ 5,961,504
============ ============ ============ ============ ============ ============
See Notes to Consolidated Financial Statements
F-5
KIRLIN HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
-----------------------------------------
2003 2002 2001
----------- ----------- -----------
Cash flows from operating activities:
Net income (loss) $ 3,797,084 $(8,802,638) $(3,689,055)
----------- ----------- -----------
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 346,776 800,229 867,436
Deferred income taxes (2,165,805) 2,120,115 (1,184,236)
Minority interest adjustments -- (113,751) (146,739)
Minority interest in income (loss) of subsidiaries -- 113,751 (364,431)
(Increase) decrease in nonmarketable securities (57,319) 534,523 383,402
Non-cash compensation 570,960 664,250 567,327
Impairment of intangible assets and goodwill -- 2,081,662 --
Loss on disposal of subsidiary -- -- 249,800
Loss on disposal of furniture and fixtures 74,053 8,568 164,260
Decrease (increase) in operating assets, net of
acquisitions and dispositions:
Due from clearing brokers (2,616,347) 2,309,851 1,655,039
Securities owned, at market value (1,561,957) (45,136) (411,102)
Deferred tax asset -- 1,337,740 --
Rebate receivable (277,000) (714,000) (250,000)
Representative loans 411,573 454,548 482,562
Other assets (212,745) 84,605 1,570,302
(Decrease) increase in operating liabilities, net
of acquisitions and dispositions:
Securities sold, not yet purchased, at market value (19,233) (81,166) (73,558)
Accrued compensation 197,977 (419,104) 32,194
Accounts payable and accrued expenses 1,910,607 502,568 (252,384)
----------- ----------- -----------
Total adjustments (3,398,460) 9,639,253 3,289,872
----------- ----------- -----------
Net cash provided by (used in) operating
activities 398,624 836,615 (399,183)
----------- ----------- -----------
Cash flows from investing activities:
Purchase of furniture, fixtures and leasehold improvements (5,841) (118,877) (334,213)
Proceeds from sale of furniture and fixtures 17,500 -- --
Acquisition of other businesses inclusive of contingent
payments, net of cash -- (91,330) (183,580)
----------- ----------- -----------
Net cash provided by (used in) investing
activities 11,659 (210,207) (517,793)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock 25,064 -- 1,309,410
Repurchase of common stock -- (1,063,410) --
(Repayment of) proceeds from subordinated borrowings (437,500) 2,500,000 --
----------- ----------- -----------
Net cash (used in) provided by financing
activities (412,436) 1,436,590 1,309,410
----------- ----------- -----------
Net (decrease) increase in cash (2,153) 2,062,998 392,434
Cash at beginning of year 3,035,084 972,086 579,652
----------- ----------- -----------
Cash at end of year $ 3,032,931 $ 3,035,084 $ 972,086
=========== =========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 31,652 $ 7,255 $ 51,875
Income taxes $ 9,108 $ 22,777 $ 22,145
Supplemental disclosures of noncash investing and financing activities:
Common stock issued for:
Issuance of warrant for acquisition $ -- $ -- $ 1,356,000
Common stock awards, net of forfeitures $ 570,960 $ 664,250 $ 567,326
Non-cash equity enhancement $ -- $ -- $ 445,238
See Notes to Consolidated Financial Statements
F-6
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Operations
The consolidated financial statements include the accounts of Kirlin
Holding Corp. ("KHC") and its wholly owned subsidiaries, Kirlin
Securities, Inc. ("Kirlin"), Greenleaf Management Corp. ("Greenleaf"),
its former majority-owned subsidiary, GMST World Markets, Inc. ("GMST")
(formerly First Long Island Securities, Inc.), and its majority-owned
(63.7%) subsidiary, VentureHighway.com Inc. ("VentureHighway")
(collectively, the "Company"). VentureHighway's consolidated financial
statements include the accounts of Princeton Investment Holding Corp.
("PIHC") and Princeton Securities Corporation ("Princeton"). During the
year ended December 31, 2001, the Company's percentage ownership of
capital stock of GMST ranged from approximately 61% to 5%. All material
intercompany transactions and balances have been eliminated in
consolidation.
The Company's principal subsidiary, Kirlin, is a full-service,
retail-oriented brokerage firm specializing in the trading and sale of
both equity and fixed income securities, including mutual funds. Kirlin
also offers a managed asset portfolio program to manage the financial
assets of its clients. VentureHighway was incorporated March 1, 1999
and commenced operations on June 1, 1999. VentureHighway operated a
branded Web site designed to match companies seeking funding with
qualified investors. On April 3, 2000, VentureHighway acquired all of
the outstanding stock of Princeton, which continued its operations as a
retail-oriented brokerage firm through August 24, 2001. In December
2000, VentureHighway suspended its operations and on November 28, 2001,
the board of directors and stockholders of VentureHighway adopted a
plan of liquidation and dissolution. Greenleaf was formed in January
1999 to serve as the manager of a private investment fund, which was
capitalized in June 1999 to invest in one or more selected companies.
On March 17, 2000, the Company acquired all of the outstanding stock of
GMST, which was a retail-oriented brokerage firm. On August 29, 2000,
the Company sold 20% of the outstanding stock of GMST. In January 2001,
GMST received a capital infusion from a member of GMST's management and
the Company's ownership was reduced to 61%. Effective December 31,
2001, the Company sold its remaining interest in GMST, except for a 5%
interest, to two members of GMST's management.
Securities Transactions, Commission Revenue and Commission Expenses
Securities transactions, commission revenue and commission expenses are
recorded on a trade date basis. Unrealized gains and losses on
securities transactions are included in principal transactions in the
consolidated statements of operations. Investment banking revenues
include fees, arising from securities offerings in which the Company
acts as an underwriter or agent, net of syndicate expenses, along with
fees earned from providing financial advisory services. Investment
banking fees are recognized at the time the transaction is consummated.
Substantially all of the Company's financial instruments are carried at
market value with the exception of non-marketable securities which are
valued at fair value as determined by management.
Use of Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
F-7
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Furniture, Fixtures and Leasehold Improvements
Furniture, fixtures and leasehold improvements are recorded at cost.
Furniture and fixtures and office equipment are depreciated on a
straight-line basis over the economic useful lives of assets, which
range from three to five years. Leasehold improvements are amortized
over the lesser of their economic useful lives or the expected term of
the related lease. When assets are retired or otherwise disposed of,
the costs and related accumulated depreciation or amortization are
removed from the accounts and any gain or loss on disposal is
recognized.
Representative Loans
The Company loans money to certain registered representatives as an
incentive for their affiliation with the Company. The registered
representatives sign an employment agreement and promissory note with
the Company for a specified term. The loans are then amortized on a
straight-line basis over a period as specified in the agreement.
Advertising Costs
The Company expenses the costs of advertising the first time the
advertising takes place. Advertising expense was approximately
$124,000, $50,000 and $368,000 for the years ended December 31, 2003,
2002 and 2001, respectively.
Other Income
Included in other income for the years ended December 31, 2003, 2002
and 2001 is interest income in the amount of approximately $675,000,
$473,000 and $136,000, respectively, as well as, trailer and other
income in the amount of approximately $2,204,000, $1,957,000 and
$1,367,000, respectively. Interest income represents income earned
through interest rebates paid by the Company's clearing broker to the
Company for the maintaining of customer balances at the clearing
broker. Trailer and other income represents income generated from
rebates from the Company's clearing broker, as well as, consulting
services provided by the Company.
Income Taxes
The Company recognizes deferred tax assets and liabilities based on the
differences between the consolidated financial statements carrying
amounts and the tax basis of assets and liabilities, using the
effective tax rates in the years in which the differences are expected
to reverse. A valuation allowance is established when necessary to
reduce deferred tax assets to the amount expected to be realized.
Change of Previously Stated Earnings Per Share
In connection with the audit of the Company's consolidated financial
statements for the year ended December 31, 2003 it was determined that
the earnings per share calculation should be changed in order to
exclude nonvested and contingently returnable shares in the Company's
restricted and deferred commission plans from the basic earnings per
share calculation and a modification of those shares in the calculation
of diluted earnings per share. This change resulted in different
quarterly and annual basic and diluted earnings per share amounts for
prior periods than previously reported.
Stock-Based Compensation
At December 31, 2003, the Company had two stock-based employee
compensation plans (see Note 9). As permitted under Statement of
Financial Accounting Standards ("SFAS") No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure", which amended
SFAS No. 123, "Accounting for Stock-Based Compensation", the Company
has elected to continue to follow the intrinsic value method in
accounting for its stock-based employee compensation
F-8
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
arrangements as defined in Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees", and the related
interpretations including Financial Accounting Standards Board
Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation", an interpretation of APB No. 25. No stock-based
employee compensation cost is reflected in operations, as all options
granted by the Parent to employees of the Company under those plans had
an exercise price equal to the market value of the underlying common
stock at the date of grant.
The following summary illustrates the effect on net income (loss) as if
the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation:
YEAR ENDED DECEMBER 31,
-------------------------------------------
2003 2002 2001
---------- ------------ -----------
Net income (loss) as reported $3,797,084 $ (8,802,638) $(3,689,055)
Deduct: Total stock based employee
compensation expense determined under
the fair value based method (574,139) (1,757,173) (1,620,189)
---------- ------------ -----------
Proforma net income (loss) $3,222,945 $(10,559,811) $(5,309,244)
========== ============ ===========
Basic income (loss) per common share as
reported $ 2.36 $ (5.17) $ (2.34)
Proforma basic income (loss) per common
share $ 2.00 $ (6.20) $ (3.36)
Diluted income (loss) per common share as
reported $ 1.73 $ (5.17) $ (2.34)
Proforma diluted income (loss) per common
share $ 1.47 $ (6.20) $ (3.36)
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model. For options granted in
2001, the following assumptions were used: expected volatility of
approximately 136%, risk-free interest rate of approximately 5%, annual
rate of dividends of 0%, and expected option lives of up to 10 years.
For options granted in 2002, the following assumptions were used:
expected volatility of approximately 145%, risk-free interest rate of
approximately 5%, annual rate of dividends of 0%, and expected option
lives of up to 10 years. For options granted in 2003, the following
assumptions were used: expected volatility of approximately 80%,
risk-free interest rate of approximately 4%, annual rate of dividends
of 0%, and expected option lives of up to 10 years.
The fair value of options granted during the year ended December 31,
2003 based on the Black-Scholes option pricing model amounted to
approximately $1,156,000.
The pro forma disclosures are not likely to be representative of the
effects on reported net income (loss) for future periods.
Options granted to non-employees are accounted for at fair value.
F-9
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Effect of Recent Accounting Pronouncements
Management does not believe that any recently issued, but not yet
effective, accounting standards, if currently adopted, would have a
material effect on the accompanying consolidated financial statements.
Concentrations of Credit Risk
The Company is engaged in trading and a broad range of securities
brokerage and investment services to a primarily retail clientele, as
well as corporate finance and investment banking services to
corporations and businesses. Counterparties to the Company's business
activities include broker-dealers and clearing organizations, and can
include banks and other financial institutions. The Company uses
clearing brokers to process transactions and maintain customer accounts
on a fee basis for the Company. The Company uses one clearing broker
for substantially all of their business. The Company permits the
clearing firms to extend credit to their clientele secured by cash and
securities in the client's account. The Company's exposure to credit
risk associated with the non-performance by their customers and
counterparties in fulfilling their contractual obligations can be
directly impacted by volatile or illiquid trading markets, which may
impair the ability of customers and counterparties to satisfy their
obligations to the Company. The Company has agreed to indemnify the
clearing brokers for losses they incur while extending credit to the
Company's clients. It is the Company's policy to review, as necessary,
the credit standing of their customers and each counterparty. Amounts
due from customers that are considered uncollectible are charged back
to the Company by the clearing broker when such amounts become
determinable. At December 31, 2003 and 2002, there were no amounts due
from customers included in the accompanying consolidated statements of
financial condition.
The Company's activities can include the purchase and sale of stock
options and warrants. Stock options and warrants give the buyer the
right to purchase or sell securities at a specific price until a
specified expiration date. These financial instruments are used to
conduct trading activities and manage market risk.
The Company may receive warrants as part of its underwriting activities
for initial public offerings. Such transactions may result in credit
exposure in the event the counter-party to the transaction is unable to
fulfill its contractual obligations. Substantially all of the stock
options and warrants are traded on national exchanges, which can be
subject to market risk in the form of price fluctuations.
In addition, the Company has sold securities that it does not currently
own and will, therefore, be obligated to purchase such securities at a
future date. The Company has recorded these obligations in the
consolidated financial statements at December 31, 2003, at the market
values of the related securities and will incur a loss if the market
value of these securities increases subsequent to December 31, 2003.
The Company maintains cash with major financial institutions. Cash is
insured by the Federal Deposit Insurance Corporation ("FDIC") up to
$100,000 at each institution except for two accounts which are insured
up to $1,000,000. At times, such amounts may exceed these limits. At
December 31, 2003, the Company had balances in excess of the above
limits for approximately $105,000 and $656,000, respectively. At
December 31, 2002, the Company had balances in excess of the above
limits for approximately $241,000 and $431,000, respectively.
F-10
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. ACQUISITIONS AND DISPOSITIONS
On March 17, 2000, the Company acquired all of the outstanding capital
stock of GMST. The purchase price was approximately $708,000 plus
acquisition costs of approximately $60,000. The purchase price included
approximately $150,000 payable monthly over two years which commenced
April 2000. The acquisition has been treated as a purchase for
accounting purposes with the purchase price allocated to the assets
acquired and liabilities assumed based on a preliminary determination
of estimated fair values at the date of acquisition. The Company
acquired assets with a fair value of approximately $435,000 and assumed
liabilities of approximately $77,000. The Company sold 20% of GMST on
August 29, 2000. In January 2001, GMST received a capital infusion from
a member of GMST's management and the Company's ownership was reduced
to 61%.
Effective December 31, 2001, KHC entered into an agreement to sell its
shares to members of GMST's management, which resulted in a reduction
of KHC's ownership at December 31, 2001 to 5%. Pursuant to the stock
purchase agreement, KHC received $150,000 and a 10-year payout
commencing January 1, 2001, based upon an annual percentage of net
trading revenue, as defined in the agreement.
Pursuant to the agreement, in the event that a majority of the shares
of GMST held by the two majority stockholders of GMST are sold to an
unrelated person prior to the fifth anniversary of the closing date,
the stockholders shall remit to the Company an amount equal to
$1,000,000 less the payments made prior to such sale. In addition, if
GMST sells all or substantially all of its assets to an unrelated
person or entity prior to the fifth anniversary of the closing date,
GMST will remit to the Company an amount equal to $1,000,000 less any
payments made prior to such sale.
The agreement also states that in the event that a majority of the
shares held by the two majority stockholders of GMST are sold to an
affiliated person or entity prior to the fifth anniversary date of the
closing date the affiliated person is bound to the agreement.
On April 3, 2000, VentureHighway acquired all of the outstanding
capital stock of PIHC. The purchase price was approximately $391,000
plus acquisition costs of approximately $210,000. The acquisition
agreement called for VentureHighway to make monthly payments for a
period of three years, up to an amount equal to 10% of the monthly
commissions generated by registered representatives of Princeton, as
defined in the agreement. The acquisition was treated as a purchase for
accounting purposes with the purchase price allocated to the assets
acquired and liabilities assumed based on a preliminary determination
of estimated fair values at the date of acquisition. The Company
acquired assets with a fair value of approximately $517,000 and assumed
liabilities of approximately $433,000.
On August 24, 2001, KHC transferred certain assets and liabilities of
Princeton to Kirlin in consideration for the payment of $100,000. The
assets were transferred at book value, consisting of goodwill of
approximately $890,000 and other assets of approximately $436,000,
resulting in a reduction of minority interest and an equity enhancement
of approximately $445,000. In connection with this transaction, Kirlin
offered employment to certain employees of Princeton. Contingent
consideration paid under the terms of the original acquisition of
Princeton were added to goodwill. Following the transfer of the
Princeton assets and liabilities, Princeton relinquished its license as
a broker-dealer and was dissolved during 2003.
On August 29, 2001, Kirlin acquired certain assets and assumed certain
lease commitments of M.S. Farrell & Co., Inc. ("Farrell"), a
retail-oriented brokerage and investment banking firm, in
F-11
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
consideration for the issuance by KHC of a 10-year warrant to purchase
150,000 shares of common stock of KHC at an exercise price equal to
$12.00 per share. The fair value of the warrant was estimated to be
$1,356,000 on the date of grant, using the Black-Scholes option pricing
model. This acquisition was treated as a purchase for accounting
purposes with the purchase price allocated to the assets acquired and
liabilities assumed based on a preliminary determination of estimated
fair values at the date of acquisition. The Company acquired a customer
base with an estimated fair value of $850,000 and other assets with a
fair value of approximately $21,000, resulting in an excess of cost
over the fair value of net assets acquired of approximately $485,000.
The Company adopted the provisions of SFAS No. 142, Goodwill and Other
Intangible Assets, as of January 1, 2002. Under these provisions,
goodwill is no longer amortized; instead, it is tested for impairment
at least annually. During the year ended December 31, 2002, the Company
performed a test for impairment which resulted in the write-off of
intangible assets and goodwill in the amount of approximately
$2,082,000 related to the acquisition of Farrell and Princeton in prior
years. This write-off decision was made by management based on an
analysis that identified a market decline not experienced in quite some
time, changing conditions surrounding the broker-dealer industry and
comparison of post- and pre-acquisition factors which identified a
decline in production results and registered representatives associated
with the acquisitions.
The changes in the carrying amount of goodwill and intangibles for the
years ended December 31, 2002 and 2001 were as follows:
Intangibles
Goodwill - Net
----------- -----------
BALANCE AT JANUARY 1, 2001 $ 1,057,956 $ --
Acquisitions during the year 426,684 850,000
Amortization (89,223) (75,000)
----------- -----------
BALANCE AT DECEMBER 31, 2001 1,395,417 775,000
Reclassification (650,000) 650,000
Goodwill recorded during the year 91,330 --
Amortization -- (180,086)
Impairment loss (836,747) (1,244,914)
----------- -----------
BALANCE AT DECEMBER 31, 2002 $ -- $ --
=========== ===========
3. DUE FROM CLEARING BROKERS
The Company does not carry accounts for customers or perform custodial
functions related to customers' securities. The Company introduces all
of its customer transactions on a fully disclosed basis, which are not
reflected in these consolidated financial statements, to its clearing
brokers, which maintain the customers' accounts and clear such
transactions. Additionally, these clearing brokers provide the clearing
and depository operations for the Company's proprietary securities
transactions. These activities may expose the Company to
off-balance-sheet risk in the
F-12
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
event that customers do not fulfill their obligations with these
clearing brokers as the Company has agreed to indemnify its clearing
broker for any resulting losses.
As of December 31, 2003 and 2002, there were no material unsecured
amounts owed to the clearing broker by these customers in connection
with normal margin, cash and delivery against payment transactions.
At December 31, 2003 and 2002, substantially all of the securities
owned and securities sold, not yet purchased, and the amount due from
the clearing brokers reflected in the consolidated statement of
financial condition are security positions with and amounts due
primarily from one clearing broker.
4. CLEARING AGREEMENT AND REBATE RECEIVABLE
The Company has a clearing agreement with a clearing broker, under
which clearing and other related services are provided to the Company.
As provided in the clearing agreement, the clearing broker will rebate
in amounts and at dates specified in the agreement, 50% of the clearing
fees and other items (as defined) up to a maximum of $2,500,000. During
the year ended December 31, 2003, the Company received cash from their
clearing broker in the amount of $437,500, which was used by the
Company to pay off $437,500 of the subordinated borrowings (see Note
8). The remaining rebate will be paid by the clearing broker in the
amount of $62,500 at the end of each remaining calendar quarter through
March 31, 2005, at which time the remaining balance will be payable. As
of December 31, 2003 and 2002, the total rebate earned by the Company
but not yet received amounted to $1,241,000 and $964,000, respectively.
The total rebate revenue earned by the Company under this agreement for
the years ended December 31, 2003, 2002 and 2001 amounted to $714,500,
$714,000 and $250,000, respectively.
5. SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED
Securities sold, not yet purchased, consist of the following:
DECEMBER 31,
-------------------------
2003 2002
----------- -----------
State and municipal obligations $ 64,628 $ 64,989
Corporate bonds and other securities 59,344 29,253
U.S. government and agency obligations -- 48,963
----------- -----------
$ 123,972 $ 143,205
=========== ===========
Securities owned and securities sold, not yet purchased, are stated at
quoted market values.
Securities sold, not yet purchased, represent obligations of the
Company to deliver specified securities by purchasing the securities in
the market at prevailing market prices. Accordingly, these transactions
result in off-balance-sheet market risk, as the Company's ultimate
obligation may exceed the amount recognized in the consolidated
financial statements.
F-13
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Non-marketable securities represent investments in restricted shares in
public companies and shares in privately held companies not readily
marketable, which have been valued at fair value as determined by
management. The resulting unrealized gains and losses are reflected in
principal transactions and investment banking income.
6. FURNITURE, FIXTURES AND LEASEHOLD IMPROVEMENTS
Furniture, fixtures and leasehold improvements are stated at cost, and
consist of the following:
DECEMBER 31,
----------------------------------------
DEPRECIATION/
AMORTIZATION
2003 2002 PERIOD
---------- ----------- ---------------
Furniture and fixtures $ 534,046 $ 610,700 5 years
Office equipment 2,099,290 2,319,660 3 years
Leasehold improvements 473,117 588,968 Term of lease
---------- -----------
3,106,453 3,519,328
Less: accumulated depreciation
and amortization 2,963,955 2,944,342
---------- -----------
$ 142,498 $ 574,986
========== ===========
During the year ended December 31, 2003, the Company sold and disposed
of furniture and fixtures with a net book value of $91,553 for gross
proceeds of $17,500, resulting in a loss on sale and disposal of
$74,053. Depreciation and amortization expense of furniture, fixtures
and leasehold improvements for the years ended December 31, 2003, 2002
and 2001 were $346,776, $620,143, and $703,213, respectively.
7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of the following:
DECEMBER 31,
------------------------------
2003 2002
-------------- --------------
Accrued professional fees $ 587,651 $ 331,297
Accrued communications 233,508 244,596
Accrued computer and copier 202,166 201,569
Accrued arbitration settlements 190,513 535,765
Accrued lease expense 647,865 -
Accrued regulatory expense 1,250,000 -
Other 1,068,576 956,445
------------- --------------
$ 4,180,279 $ 2,269,672
============= ==============
F-14
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. SUBORDINATED BORROWINGS
Subordinated borrowings represent a subordinated loan arrangement with
the Kirlin's main clearing broker (the "Lender"), in the original
amount of $2,500,000. The agreement is noninterest-bearing and calls
for principal payments of $250,000 on March 31, 2003 and equal
installments of $62,500 at the end of each subsequent calendar quarter
through March 31, 2005, on which date the entire unpaid principal
balance of $1,812,500 is due. As of December 31, 2003, total payments
made by the Company on this loan amount to $437,500 and the remaining
unpaid principal balance is $2,062,500.
This loan has been approved by the National Association of Securities
Dealers, Inc. (the "NASD") for inclusion in computing Kirlin's net
capital pursuant to the Securities and Exchange Commission's (the
"SEC") Uniform Net Capital Rule. Under the terms of the subordinated
loan agreement, the Lender may withdraw the loan principal either at
maturity (March 31, 2005) or six months after the Lender has provided
Kirlin with written notice of its intent to withdraw the loan amount.
Any subordinated debt can be repaid only if, after giving effect to
such repayment, Kirlin meets the SEC's capital regulations governing
withdrawal of subordinated debt..
In addition, under the terms of the subordinated loan agreement, Kirlin
is required to maintain net capital at all times through December 31,
2003 in an amount at least equal to the sum of $250,000 plus 100% of
the net capital amount Kirlin is required to maintain in accordance
with SEC rule 15c3-1 and thereafter, in an amount at least equal to the
sum of the outstanding principal balance of the loan plus 100% of the
net capital amount Kirlin is required to maintain in accordance with
rule 15c3-1.
Using the prime interest rate of 4.25%, the estimated fair value of the
subordinated borrowings was approximately $1,968,000 and $2,235,000 at
December 31, 2003 and 2002, respectively.
9. STOCKHOLDERS' EQUITY
During January 2003, the Company effected a 1-for-8 reverse stock
split. All references to shares and price per share have been adjusted
to reflect this reverse stock split for all periods presented on a
retroactive basis.
The Company authorized 1,000,000 shares of preferred stock, par value
$.0001 per share. No shares have been issued as of December 31, 2003.
On October 30, 2001, the Company completed a private placement in which
it raised $1,500,000 and issued 187,500 shares of common stock, along
with 93,750 Class A redeemable warrants with an exercise price of
$12.00, and 93,750 Class B redeemable warrants with an exercise price
of $20.00. Each warrant will entitle the holder to purchase one
additional share of common stock at the specified price for a period of
four years commencing on May 1, 2002. Each warrant contains a
redemption provision where the Company may redeem each warrant for
$0.01 per share if the last sale price of a share of common stock
exceeds certain thresholds and other covenants are satisfied. In
addition, the Company issued warrants to designees of the placement
agent, Kirlin, to purchase an additional 10% of the shares and warrants
sold in this offering.
In August 1994, the Company adopted the 1994 Stock Plan ("1994 Plan")
covering 600,000 shares of the Company's common stock pursuant to which
officers, directors, key employees and consultants of the Company are
eligible to receive incentive or nonqualified stock options, stock
F-15
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
appreciation rights, restricted stock awards, deferred stock, stock
reload options and other stock-based awards. In April 1996, the Company
adopted the 1996 Stock Plan ("1996 Plan") covering 1,000,000 shares of
the Company's common stock pursuant to which officers, directors, key
employees and consultants of the Company are eligible to receive
incentive or nonqualified stock options, stock appreciation rights,
restricted stock awards, deferred stock, stock reload options and other
stock-based awards. During 2003 an amendment was made to the 1996 Plan
increasing the number of shares of common stock available for issuance
under the plan from 1,000,000 shares of common stock to 2,500,000
shares of common stock. The Company segregated 350,000 shares from the
1996 Plan for Kirlin's deferred commission plan (250,000 effective
September 25, 2000 and 100,000 on May 8, 2003.) During the years ended
December 31, 2003 and 2002, the Company issued 277,248 and 118,765
shares of common stock in connection with the deferred commission plan,
valued at approximately $960,000 and $837,000, respectively, and there
were forfeitures of 77,742 and 40,889 shares valued at approximately
$457,000 and $413,000, respectively. The nonvested deferred commission
shares at December 31, 2003 amounts to 335,035 shares.
At December 31, 2003, options and warrants to purchase 1,348,006 shares
of common stock at an exercise price between $1.45 and $48.00 per share
are outstanding. Such options and warrants vest over periods of up to
four years and are exercisable at various dates through October 2013.
The following table summarizes the 2003 and 2002 activity in the
Company's stock options and warrants:
Number of Exercise
Shares Price per Share
--------- ---------------------
BALANCE AT JANUARY 1, 2001 154,629 $7.752 - $48.000
Granted during the year 735,118 $8.800 - $20.000
Forfeited during the year (38,125) $12.000 - $48.000
--------- ------- -------
BALANCE AT DECEMBER 31, 2001 851,622 $ 7.752 - $48.000
Granted during the year 71,194 $ 4.540 - $9.011
Forfeited during the year (30,544) $ 7.597 - $48.000
--------- ------- -------
BALANCE AT DECEMBER 31, 2002 892,272 $ 4.540 - $48.000
Granted during the year 713,430 $ 1.450 - $11.950
Exercised during the year (3,334) $ 6.080 - $8.800
Forfeited during the year (254,362) $ 1.450 - $48.000
--------- ------- -------
BALANCE AT DECEMBER 31, 2003 1,348,006 $ 1.450 - $48.000
========= ======= =======
During 2003, 3,334 options were exercised resulting in proceeds of
$25,063.
The following table summarizes information about stock options and
warrants outstanding at December 31, 2003:
F-16
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Weighted
Average
Remaining
Range of Number Number Contractual
Exercise Prices Outstanding Exercisable Life
----------------------- --------------- ------------- --------------
$1.4500 - $1.6500 615,250 -- 6.3 years
$1.9200 - $2.8000 22,321 9,284 9.2 years
$3.4840 - $5.1000 46,160 28,028 9.2 years
$6.0800 - $8.8800 124,208 96,856 6.4 years
$9.0112 - $12.0000 399,442 396,845 5.9 years
$20.0000 - $27.2500 104,375 104,375 1.9 years
$32.2520 33,250 29,417 6.1 years
$48.0000 3,000 3,000 6.3 years
----------------------- -------------- -------------
1,348,006 667,805
============== =============
During the years ended December 31, 2003, 2002 and 2001, the Company
granted 42,116, 32,021 and 43,987 shares, respectively, of restricted
stock to employees of Kirlin with a market value of approximately
$69,000, $179,000 and $395,000, respectively. During the year ended
December 31, 2003, 26,364 of the granted shares, with a market value of
approximately $172,000 (net of unearned stock compensation of
approximately $58,000), were forfeited and 9,249 shares were vested.
The restricted shares remaining vest as follows:
Year Shares
-------------------------- ----------
2004 62,482
2005 19,876
2006 417
2007 416
----------
83,191
==========
10. NET CAPITAL REQUIREMENT
As a registered broker-dealer, Kirlin is subject to the SEC's Uniform
Net Capital Rule (rule 15c3-1), which requires the maintenance of
minimum net capital and requires that the ratio of aggregate
indebtedness to net capital, both as defined, shall not exceed 15 to 1.
Kirlin computes its net capital under the aggregate indebtedness method
permitted by rule 15c3-1, which requires that the they maintain minimum
net capital, as defined, of 6-2/3% of aggregate indebtedness, as
defined, or $250,000, whichever is greater.
At December 31, 2003 and 2002, Kirlin had net capital, as defined, of
$1,068,602 and $1,363,016, respectively, which exceeded the minimum net
capital requirements by $702,396 and $1,113,016, respectively. Kirlin's
ratio of aggregate indebtedness to net capital was 5.14-to-1 and
2.45-to-1 at December 31, 2003 and 2002, respectively.
F-17
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. RETIREMENT AND SAVINGS PLAN
The Company sponsors a retirement and savings plan for all full-time
employees over the age of 21 pursuant to Section 401(k) of the Internal
Revenue Code. Employees become eligible to contribute to the plan after
3 months of employment. Under the plan, eligible employees may
contribute up to 15% of their pre-tax compensation (up to the legal
limit.) Through March 31, 2002 the Company matched a percentage of each
participant's contribution based on specific parameters at which time,
the Company ceased matching any of the participant's contributions. The
Company did not match any of the employee's contributions during the
year ended December 31, 2003. The Company's contributions to the plan
for the years ended December 31, 2002 and 2001 were approximately
$60,000 and $140,000, respectively.
12. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases office space at several locations under
non-cancelable leases expiring at various times through October 31,
2007. Several leases contain provisions for escalations based on
increases in certain costs incurred by the lessor.
The minimum annual rental payments for these leases are as follows:
For the Year
Ending December 31, Amount
------------------- ------
2004 $ 910,234
2005 335,592
2006 93,492
2007 80,483
----------
$1,419,801
==========
During March 2004 the Company extended two of its office leases, which
includes a reduction of space and results in additional rental payments
of $423,810 ($38,475 for 2004, $315,135 for 2005, $56,025 for 2006, and
$14,175 for 2007).
Rent expense was approximately $1,633,000, $1,410,000 and $1,262,000
for the years ended December 31, 2003, 2002 and 2001, respectively.
During the year ended December 31, 2003, the Company vacated its rental
leases in New York City and Florida. As these leases were
non-cancelable, the Company is required to pay the remaining balances
on these lease commitments. As a result of the Company vacating the New
York City lease, the Company has recorded approximately $108,000 in
accounts payable and accrued expenses in the accompanying consolidated
statement of financial condition, which represents the difference
between the Company's remaining obligations to the lessor after taking
into account, the sub-lease payments as defined below. The Company has
recorded approximately $542,000 in accounts payable and accrued
expenses in the accompanying consolidated statement of financial
condition related to the Company vacating its Florida lease.
F-18
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the year ended December 31, 2003, the Company entered into a
non-cancelable sub-lease of its former New York City office space to a
third party which expires on October 30, 2005. Minimum lease payments
under this lease amount to $11,035 per month and the total amount of
these sub-lease rental payments received through December 31, 2003
amounted to $49,658.
Letter of Credit
Other assets include a certificate of deposit, which is collateralizing
a letter of credit, for the benefit of a landlord, in the amount of
$100,000. At December 31, 2003, there were no amounts drawn down on
this letter of credit.
Legal Matters
In the normal course of the Company's business, the Company from time
to time is involved in claims, lawsuits and arbitrations brought by its
customers and former employees. It is the opinion of management, based
upon its evaluation of each of these matters and the reserves
established by the Company, that the resolution of all claims presently
pending will not have a material adverse effect on the consolidated
financial condition of the Company.
In March 2003, the NASD Department of Enforcement commenced a
disciplinary proceeding against Kirlin and two of its officers or
employees, including the Co-Chief Executive Officer of Kirlin, related
to sales of certain fixed income securities to clients of the Company
from November 1995 to late 1999. Certain of these securities were
issued in $250,000 denominations. The NASD alleged that Kirlin violated
provisions of the NASD Conduct Rules and/or federal securities laws
related to the following (all of which activity occurred prior to
December 1999): (i) sales of unregistered securities stemming from the
sale of these securities in smaller denominations; (ii) placement of
false and misleading advertising relating to these securities; (iii)
charging markups on the sale of the securities in excess of NASD policy
allegedly in the amount of approximately $1,420,000 and in violation of
the federal securities laws allegedly in the amount of approximately
$44,000; (iv) failure to maintain inventory sheets as distributed to
certain employees in connection with the sale of the securities; and
(v) failure to establish and enforce supervisory procedures to assure
compliance with federal laws and NASD Rules to prevent the
aforementioned alleged violations. The NASD Complaint seeks the
imposition of sanctions, restitution and costs. As discussed below,
Kirlin has reached an agreement in principle with the NASD Department
of Enforcement concerning the resolution of this disciplinary
proceeding and other regulatory or enforcement matters involving
Kirlin. The proposed settlement is pending final regulatory approval.
If the settlement is not consummated, Kirlin and its Co-Chief Executive
Officer intend to contest vigorously all claims asserted by the NASD
Department of Enforcement in this proceeding.
In July 2003, the NASD Department of Enforcement commenced a
disciplinary proceeding against Kirlin and three of its former
registered representatives alleging violations of the NASD Conduct
Rules in connection with certain purchases or sales of equity
securities by customers of Kirlin in 1999 and 2000. In particular, the
NASD staff contends that the transaction charges imposed on a small
percentage of the transactions emanating from a single branch office of
Kirlin during this period were excessive or unreasonable in light of
the circumstances surrounding those trades, in violation of NASD rules.
The NASD staff also contends that Kirlin and a former branch manager
failed to supervise reasonably certain registered representatives
regarding these transactions and did not maintain or enforce
supervisory procedures reasonably designed to ensure compliance with
applicable rules. The NASD Complaint seeks the imposition of sanctions,
including disgorgement, and costs. As discussed below, Kirlin has
reached an agreement in principle with the NASD Department of
Enforcement concerning the resolution of this disciplinary proceeding
and other regulatory or enforcement matters involving Kirlin. The
proposed settlement is pending final regulatory approval. If the
settlement is not consummated, Kirlin and its former
F-19
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
personnel intend to contest vigorously all claims asserted by the NASD
Department of Enforcement in this proceeding.
Also in July 2003, the NASD staff informed Kirlin that it had made a
preliminary determination to recommend the commencement of a
disciplinary proceeding against Kirlin and four of its present or
former employees concerning alleged violations of NASD rules and/or
federal securities laws or regulations related to transactions effected
during late 1999 in three securities accounts associated with a single
customer. The potential allegations include violations of the antifraud
provisions of the federal securities laws and NASD Conduct Rules
related to: (i) undisclosed markups or markdowns in the amount of
approximately $692,000; (ii) the falsification or destruction of
certain trade tickets or other records; (iii) false and misleading
confirmation statements; (iv) failures to obtain best execution; and
(v) numerous trade reporting errors. In addition, the NASD staff has
indicated that it may allege that Kirlin and a former branch manager
failed to supervise reasonably conduct by a registered representative
and a sales supervisor related to these customer accounts and that
Kirlin failed to maintain adequate supervisory procedures. As discussed
below, Kirlin has reached an agreement in principle with the NASD
Department of Enforcement concerning the resolution of possible claims
against Kirlin that could result from this contemplated enforcement
recommendation, as well as the pending disciplinary proceedings and
other regulatory or enforcement matters involving Kirlin. The proposed
settlement is pending final regulatory approval. If the settlement is
not consummated, Kirlin cannot predict with certainty whether the NASD
Department of Enforcement will commence a disciplinary proceeding
related to these matters, and if so, the precise nature or scope of any
such disciplinary proceeding. Kirlin intends to contest any such
charges that ultimately may be brought by the NASD Department of
Enforcement with respect to these matters, if the proposed settlement
is not finalized.
In January 2004, Kirlin reached an agreement in principle with the
staff of the NASD Department of Enforcement regarding a resolution of
the above pending regulatory matters. The terms of the proposed
settlement would include: (i) a payment by Kirlin in the amount of
$1,200,000, which is expected to be comprised of approximately $156,000
in fines and approximately $1,044,000 in restitution to customers; (ii)
the retention by Kirlin of an independent consultant to review and
report regarding its compliance and supervisory policies and
procedures; (iii) fines paid by or for certain present or former
associated persons of Kirlin in the aggregate amount of approximately
$50,000; and (iv) a thirty day supervisory suspension of one of its
officers. The proposed settlement is subject to formal regulatory
approval by NASD's National Adjudicatory Council ("NAC"). It cannot be
stated with reasonable certainty when or if the proposed settlement
will be approved by the NAC. If the proposed settlement is not
approved, it is anticipated that the subject matters will be
re-calendared for hearings later in 2004. Based on the above, Kirlin
has recorded an accrual in the amount of $1,250,000 in the accompanying
consolidated statement of financial condition.
Employment Contracts
As of December 31, 2003, Kirlin has employment agreements with certain
executives through August 2008. The agreements provide for base
salaries, discretionary bonuses, brokerage commissions and allowances.
The minimum base salary and allowance payments are as follows:
F-20
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Year
Ending December 31, Amount
------------------- ------
2004 $ 755,000
2005 755,000
2006 755,000
2007 755,000
2008 503,333
----------
$3,523,333
==========
13. INCOME TAXES
The Company files consolidated federal income tax returns and separate
Company state income tax returns.
The income tax benefit (provision) consists of:
YEAR ENDED DECEMBER 31,
-----------------------------------------
2003 2002 2001
----------- ----------- -----------
Current:
Federal $ -- $ 1,368,641 $ 786,748
State and local (65,028) (50,214) (1,504)
----------- ----------- -----------
(65,028) 1,318,427 785,244
----------- ----------- -----------
Deferred:
Federal 1,922,781 (2,386,522) 801,296
State and local 243,024 (1,071,333) 382,939
----------- ----------- -----------
2,165,805 (3,457,855) 1,184,235
----------- ----------- -----------
$ 2,100,777 $(2,139,428) $ 1,969,479
=========== =========== ===========
The benefit (provision) for income taxes differs from the amount
computed using the federal statutory rate of 34% as a result of the
following:
YEAR ENDED DECEMBER 31,
----------------------------------
2003 2002 2001
-------- ------- -------
Tax at federal statutory rate (34) % 34 % 34 %
State and local income taxes, net of federal benefit (3) 7 7
Impairment of goodwill and intangibles -- (14) --
Valuation allowance change 159 (62) (7)
Other 2 2 (1)
-------- ------- -------
124 % (33) % 33 %
======== ======= =======
F-21
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The deferred tax asset results from the following:
DECEMBER 31,
------------------------------
2003 2002
------------ ------------
Net operating and capital loss carryforwards $ 673,676 $ 1,511,000
Unrealized depreciation on non-marketable securities 546,525 826,000
Accrued expenses and other temporary differences 2,370,647 1,782,640
------------ ------------
3,590,848 4,119,640
Less: valuation allowance (1,425,043) (4,119,640)
------------ ------------
$ 2,165,805 $ --
============ ============
During the year ended December 31, 2003, the Company has recorded net
deferred tax assets of $2,165,805, as described above. In recognition
of the uncertainty regarding the ultimate amount of future income tax
benefits to be derived from these deferred tax items, the Company has
recorded a valuation allowance of approximately $1,425,000 and
$4,120,000 at December 31, 2003 and 2002, respectively. A reduction in
the valuation allowance of approximately $2,695,000 has been recorded
during the year ended December 31, 2003 because it is more likely than
not that a significant portion of the deferred tax assets will be
realized.
The Company has net operating loss carryforwards of approximately
$5,986,000 and $1,572,000 for Kirlin and KHC, respectively, available
to offset state and local taxable income through 2022. In addition, KHC
and Greenleaf have federal and state capital loss carryovers of
approximately $2,200,000 available to offset capital gains through
2005.
14. EARNINGS PER SHARE
The Company follows SFAS No. 128, Earnings Per Share, which provides
for the calculation of "basic" and "diluted" earnings per share
("EPS"). Basic EPS includes no dilution and is computed by dividing
income or loss available to common stockholders by the weighted-average
number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur through the effect of
common shares issuable upon exercise of stock options and warrants and
convertible securities. For the years ended December 31, 2003, 2002 and
2001, potential common shares amount to 761,395, 1,106,329 and
978,323 shares, respectively, and have not been included in the
computation of diluted EPS since the effect would be antidilutive.
The following table sets forth the components of basic and diluted
earnings per share for the year ended December 31, 2003:
F-22
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Numerator:
Net income $ 3,797,084
============
Denominator:
Weighted average shares outstanding 1,609,458
Effect of dilutive securities:
Stock options 249,175
Nonvested stock 332,851
------------
Denominator for diluted earnings per
share - weighted average shares of
common stock and common stock
equivalents after assumed conversion 2,191,484
============
15. SUMMARIZED QUARTERLY DATA (UNAUDITED)
QUARTER ENDED
---------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
---------- --------- ------------ -----------
Year ended December 31, 2003:
Revenue $5,000,798 7,120,840 $ 7,217,453 $ 7,113,391
Net income (loss) 1,196,883 1,519,820 1,254,037 (173,656)
Net income (loss) per share -
basic (See Note 1) 0.75 0.95 0.78 (0.11)
Net income (loss) per share -
diluted (See Note 1) 0.66 0.72 0.53 (0.11)
Year ended December 31, 2002:
Revenue $6,281,150 5,599,164 $ 5,002,380 $ 4,479,486
Net loss (659,006) (338,937) (3,280,433) (4,524,262)
Net loss per share - basic and
diluted (See Note 1) (0.38) (0.20) (1.94) (2.73)
Earnings (loss) per share for each quarter were computed independently
using the weighted-average number of shares outstanding during the
quarter. However, earnings (loss) per share for the year were computed
using the weighted-average number of shares outstanding during the
year. As a result, the sum of the earnings per share for the four
quarters may not equal the full-year earnings (loss) per share.
During the fourth quarter of 2002, the Company recorded a valuation
allowance on the deferred tax asset and recorded impairment of goodwill
and intangible assets resulting in charges of approximately $2,440,000.
F-23
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. SUBSEQUENT EVENTS
On January 2, 2004, the Company granted 24,606 shares of its common
stock to employees of Kirlin relating to Kirlin's deferred commission
plan for the fourth quarter of 2003 valued at approximately $266,000.
F-24
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On November 17, 2003, the Company dismissed its independent
accountants, Goldstein Golub Kessler LLP, and replaced them with Marcum &
Kliegman LLP. The Company's audit committee and Board of Directors approved the
change. In connection with the Company's audits for the most recent two fiscal
years and through November 17, 2003, there were no disagreements with Goldstein
Golub Kessler LLP on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements if not
resolved to the satisfaction of Goldstein Golub Kessler LLP, would have caused
them to make reference to the subject matter of the disagreement in connection
with their reports on the financial statements for such years.
ITEM 9A. CONTROLS AND PROCEDURES.
An evaluation of the effectiveness of the Company's disclosure controls
and procedures as of December 31, 2003 was made under the supervision and with
the participation of the Company's management, including the chief executive
officer and chief financial officer. Based on that evaluation, they concluded
that the Company's disclosure controls and procedures are effective to ensure
that information required to be disclosed by the Company in reports that it
files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms. During the most recently
completed fiscal quarter, there has been no change in the Company's internal
control over financial reporting that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
See Item 14.
ITEM 11. EXECUTIVE COMPENSATION.
See Item 14.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
See Item 14.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
See Item 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The information required by Items 10, 11, 12, 13 and 14 is incorporated
by reference to the information included in the Company's definitive proxy
statement in connection with the 2004 Annual Meeting of Stockholders.
48
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Exhibits Filed.
See Exhibit Index appearing later in this Report.
(b) Reports on Form 8-K.
Current Report on Form 8-K, dated November 13, 2003, filed
with the Commission on November 14, 2003, reporting events under Items 7 and 12.
Current Report on Form 8-K, dated November 17, 2003, filed
with the Commission on November 20, 2003, reporting events under Items 4 and 7.
49
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, the Registrant caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
KIRLIN HOLDING CORP.
(Registrant)
Dated: March 30, 2004
By: /s/ Anthony J. Kirincic
-----------------------
Name: Anthony J. Kirincic
Title: President
In accordance with the Securities Exchange Act of 1934, this Report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
Signatures Title Date
- ---------- ----- ----
/s/ David O. Lindner Chairman of the Board of Directors and March 30, 2004
- -------------------- Chief Executive Officer (Principal
David O. Lindner Executive Officer)
/s/ Anthony J. Kirincic Director and President March 30, 2004
- -----------------------
Anthony J. Kirincic
/s/ Barry E. Shapiro Chief Financial Officer (and Principal March 30, 2004
- -------------------- Accounting Officer)
Barry E. Shapiro
/s/ Edward J. Casey Director March 30, 2004
- -------------------
Edward J. Casey
/s/ Harold Paul Director March 30, 2004
- ---------------
Harold Paul
/s/ John Milcetich Director March 30, 2004
- ------------------
John Milcetich
50
EXHIBIT INDEX
Incorporated
Exhibit By Reference No. in
Number Description from Document Document Page
- ------ ----------- ------------- -------- ----
3.1 Certificate of Incorporation A 3.1
3.1.1 Certificate of Correction to Certificate of A 3.1.1
Incorporation, dated July 29, 1994
3.1.2 Certificate of Amendment of Certificate of P 3.1.2
Incorporation, dated December 18, 2002
3.2 Amended and Restated By-Laws A 3.2
4.1 Form of Common Stock Certificate A 4.1
4.2 Form of Subscription Agreement between the M 4.2
Registrant and Investors, accepted by the
Registrant on October 30, 2001
4.3 Form of Purchase Option between the Registrant and M 4.3
designees of Kirlin Securities, Inc. dated October
30, 2001
4.4 Form of Class A Redeemable Common Stock Purchase M 4.4
Warrant
4.5 Form of Class B Redeemable Common Stock Purchase M 4.5
Warrant
10.1 1994 Stock Plan A 10.2
10.2 Clearing Agreement between Kirlin Securities, Inc. M 10.2
and BNY Clearing Corp.
10.2.1 Substitute Exhibit 3 to the Clearing Agreement N 10.2.1
between Kirlin Securities, Inc. and BNY Clearing
Corp.
10.3 1996 Stock Plan C Appendix A
10.3.1 Amendment to 1996 Stock Plan, approved by Q 10.3.1
stockholders on June 23, 2003
10.4 Indemnification Agreement, dated November 14, B 10.9
1995, between the Registrant and Edward J. Casey
10.5 Indemnification Agreement, dated February 5, 1998, D 10.6
between the Registrant and Edmund McCormick
10.6 Stock Option Agreement, dated January 11, 1999, F 10.7
between the Registrant and David O. Lindner
10.6.1 Schedule of Omitted Document in the form of F 10.7.1
Exhibit 10.6, including material detail in which
such document differs from Exhibit 10.6
10.7 Stock Option Agreement, dated January 11, 1999, F 10.8
between the Registrant and Edward J. Casey
10.7.1 Schedule of Omitted Document in the form of F 10.8.1
Exhibit 10.7, including material detail in which
such document differs from Exhibit 10.7
51
Incorporated
Exhibit By Reference No. in
Number Description from Document Document Page
- ------ ----------- ------------- -------- ----
10.8 Restricted Stock Agreement, dated January 11, F 10.9
1999, between the Registrant and Barry Shapiro
10.9 Stock Option Agreement, dated as of July 8, 1999, H 10.10
between the Company and Harold Paul
10.10 Stock Option Agreement, dated as of February 2, J 10.13
2000, between the Registrant and David Lindner
10.10.1 Schedule of Omitted Document in the form of J 10.13.1
Exhibit 10.10, including material detail in which
such document differs from Exhibit 10.10
10.11 Stock Option Agreement, dated as of February 2, J 10.14
2000, between the Registrant and Barry Shapiro
10.12 Stock Option Agreement, dated as of February 2, J 10.15
2000, between the Registrant and Edward Casey
10.13.1 Schedule of Omitted Document in the form of J 10.15.1
Exhibit 10.13, including material detail in which
such document differs from Exhibit 10.13
10.14 Agreement, dated April 3, 2001, among the K 10.16
Registrant and Kirlin Securities, Inc., on the one
hand, and M.S. Farrell & Co., Inc. and certain
stockholders of M.S. Farrell Holdings, Inc., on
the other hand
10.15 Amendment, dated August 29, 2001, to Agreement, K 10.17
dated April 3, 2001, among the Registrant and
Kirlin Securities, Inc., on the one hand, and M.S.
Farrell & Co., Inc., M.S. Farrell Holdings, Inc.
and certain stockholders of M.S. Farrell Holdings,
Inc., on the other hand
10.16 Warrant, dated August 29, 2001, issued to M.S. K 10.18
Farrell & Co., Inc.
10.17 Stock Option Agreement, dated April 3, 2001, K 10.20
between the Registrant and Martin F. Schacker.
10.18 Employment Agreement, dated August 29, 2001, L 10.21
between Registrant and David O. Lindner.
10.18.1 Amendment, dated June 23, 2003, to Employment Q 10.21.1
Agreement, dated August 29, 2001 between
Registrant and David O. Lindner
10.19 Employment Agreement, dated August 29, 2001 L 10.22
between Registrant and Anthony J. Kirincic.
10.19.1 Amendment, dated June 23, 2003, to Employment Q 10.22.1
Agreement, dated August 29, 2001 between
Registrant and Anthony J. Kirincic
52
Incorporated
Exhibit By Reference No. in
Number Description from Document Document Page
- ------ ----------- ------------- -------- ----
10.20 Form of Stock Option Agreement to reflect L 10.23
quarterly option grants by Registrant to David O.
Lindner and Anthony J. Kirincic.
10.20.1 Schedule of Omitted Document in form of Exhibit N 10.27
10.20, including material detail in which such
document differs form Exhibit 10.20.
10.20.2 Schedule of Omitted Document in form of Exhibit P
10.27.1 10.20, including material detail in which
such document differs form Exhibit 10.20.
10.21 Indemnification Agreement, dated August 29, 2001, L 10.24
between Registrant and Martin F. Schacker
10.21.1 Schedule of Omitted Documents in Form of Exhibit L
10.24.1 10.21, including material detail in which
such documents differ from Exhibit 10.21.
10.21.2 Schedule of Omitted Documents in the Form of O
10.24.2 Exhibit 10.21, including material detail in
which such document differs from Exhibit 10.21.
10.22 Stock Option Agreement, dated September 7, 2001, L 10.26
between Registrant and Edward Casey.
10.22.1 Schedule of Omitted Document in form of Exhibit L 10.27
10.22, including material detail in which such
document differs form Exhibit 10.22.
10.22.2 Schedule of Omitted Documents in the Form of O
10.25.2 Exhibit 10.22, including material detail in
which such document differs from Exhibit 10.22.
10.23 NASD Subordination Loan Agreement SL-1 between N 10.28
Kirlin Securities, Inc. and BNY Clearing Services
LLC.
21 List of Subsidiaries. -- -- Filed
Herewith
23.1 Consent of Marcum & Kliegman LLP -- -- Filed
Herewith
23.2 Consent of Goldstein Golub Kessler LLP -- -- Filed
Herewith
31.1 Section 302 Certification of Chief Executive -- -- Filed
Officer Herewith
31.2 Section 302 Certification of Chief Financial -- -- Filed
Officer Herewith
32 Section 906 Certification -- -- Filed
Herewith
99 Risk Factors. -- -- Filed
Herewith
53
Incorporated
Exhibit By Reference No. in
Number Description from Document Document Page
- ------ ----------- ------------- -------- ----
- -----------------
A. Registrant's Form SB-2 Registration Statement (No. 33-84512), declared
effective November 14, 1994.
B. Registrant's Form 10-KSB for the fiscal year ended December 31, 1995.
C. Registrant's Definitive Proxy Statement dated May 8, 1996.
D. Registrant's Form 10-KSB for the fiscal year ended December 31, 1997.
E. Registrant's Form 10-KSB for the fiscal quarter ended March 31, 1998.
F. Registrant's Form 10-KSB for the fiscal year ended December 31, 1998.
G. Current Report on Form 8-K of Individual Investor Group, Inc. (SEC File
No. 1-10932), dated June 16, 1999.
H. Registrant's Form 10-QSB for the fiscal quarter ended June 30, 1999.
I. Registrant's Form 10-KSB for the fiscal year ended December 31, 1999.
J. Registrant's Form 10-KSB for the fiscal year ended December 31, 2000.
K. Registrant's Current Report on Form 8-K, dated August 29, 2001.
L. Registrant's Form 10-Q for the fiscal quarter ended September 30, 2001.
M. Registrant's Form S-3 Registration Statement (No. 333-74366) as filed
with the Securities and Exchange Commission on November 30, 2001.
N. Registrant's Form 10-K for the fiscal year ended December 31, 2001.
O. Registrant's Form 10-Q for the fiscal quarter ended June 30, 2002.
P. Registrant's Form 10-K for the fiscal year ended December 31, 2002.
Q. Registrant's Form 10-Q for the fiscal quarter ended June 30, 2003.
54