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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Act
of 1934
For the quarterly period ended March 31, 2004
--------------
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ___________________ to ____________________
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 of (I.R.S. Employer
Incorporation or Organization) Identification No.)
6901 Jericho Turnpike, Syosset, New York 11791
----------------------------------------------
(Address of Principal Executive Offices)
(800) 899-9400
---------------------------------------------------
(Registrant's Telephone Number Including Area Code)
- --------------------------------------------------------------------------------
Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report
Check whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes X No .
State the number of shares outstanding of each of the registrant's classes of
common equity, as of the latest practicable date: At May 11, 2004, Issuer had
outstanding 2,077,068 shares of Common Stock, par value $.0001 per share.
KIRLIN HOLDING CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
MARCH 31, DECEMBER 31,
2004 2003
------------- ------------
(Unaudited)
ASSETS:
Cash $ 4,126,441 $ 3,032,931
Due from Clearing Brokers 523,818 3,175,650
Securities Owned:
U.S. government and agency obligations, at market value 127,211 53,532
State and municipal obligations, at market value 1,078,550 283,101
Corporate bonds and other securities, at market value 5,298,618 3,008,844
Non-marketable securities, at fair value 108,613 130,044
Rebate Receivable 1,391,000 1,241,000
Representative Loans 102,509 136,341
Furniture, Fixtures and Leasehold Improvements, at cost, net of
accumulated depreciation and amortization of $3,013,678 and
$2,963,955, respectively 94,195 142,498
Deferred Tax Assets, net of valuation allowances of $1,272,807 and
$1,425,043, respectively 1,771,731 2,165,805
Other Assets 867,933 850,669
------------ ------------
Total assets $ 15,490,619 $ 14,220,415
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Securities sold, not yet purchased, at market value $ 88,641 $ 123,972
Accrued compensation 1,814,134 1,892,160
Accounts payable and accrued expenses 4,758,825 4,180,279
------------ ------------
Total liabilities 6,661,600 6,196,411
------------ ------------
Subordinated borrowings 2,000,000 2,062,500
------------ ------------
Commitments and Contingencies
Stockholders' Equity:
Common stock, $.0001 par value; authorized 7,000,000 shares, issued
and outstanding 2,053,937 and 2,036,853 shares, respectively 205 204
Additional paid-in capital 16,866,437 16,644,939
Unearned stock compensation (70,618) (106,002)
Accumulated deficit (9,967,005) (10,577,637)
------------ ------------
Total stockholders' equity 6,829,019 5,961,504
------------ ------------
Total liabilities and stockholders' equity $ 15,490,619 $ 14,220,415
============ ============
See Notes to Condensed Consolidated Financial Statements
2
KIRLIN HOLDING CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31,
---------------------------
2004 2003
----------- -----------
(Unaudited)
Revenues:
Principal transactions, net $ 61,932 $ 159,631
Commissions 6,600,456 4,247,980
Investment banking 273,226 -
Other income 769,485 593,187
----------- -----------
Total revenues 7,705,099 5,000,798
----------- -----------
Expenses:
Employee compensation and benefits 5,255,422 3,324,228
Promotion and advertising 58,625 74,141
Clearance and execution charges 151,830 110,747
Occupancy and communications 579,271 787,656
Professional fees 188,149 140,958
Interest 5,603 (14,206)
Other 397,950 178,644
----------- -----------
Total expenses 6,636,850 4,602,168
----------- -----------
Income before income tax (provision) benefit 1,068,249 398,630
Income tax (provision) benefit (457,617) 798,253
----------- -----------
Net income $ 610,632 $ 1,196,883
=========== ===========
Basic earnings per common share (See Note 2) $ 0.37 $ 0.75
=========== ===========
Weighted-average shares outstanding (See Note 2) 1,631,192 1,594,250
=========== ===========
Diluted earnings per common share (See Note 2) $ 0.25 $ 0.66
=========== ===========
Weighted-average shares of common stock and common stock
equivalents outstanding (See Note 2) 2,448,768 1,827,022
=========== ===========
See Notes to Condensed Consolidated Financial Statements
3
KIRLIN HOLDING CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the Three Months Ended March 31, 2004
(Unaudited)
Common Stock Additional Unearned
----------------------------- Paid-in Stock Accumulated
Shares Par Value Capital Compensation Deficit Total
-------------- ------------- ------------- --------------- -------------- --------------
Stockholders' equity
at January 1, 2004 2,036,853 $ 204 $ 16,644,939 $(106,002) $(10,577,637) $ 5,961,504
Issuance of restricted
stock to employees
under stock plans 383 - 3,983 - - 3,983
Issuance of stock to
employees under
deferred commission
plan 24,606 2 265,724 - - 265,726
Amortization of
unearned stock
compensation - - - 35,176 - 35,176
Forfeitures of
restricted stock by
employees (938) - (7,500) 208 - (7,292)
Forfeitures of stock
by employees under
deferred commission
plan (6,967) (1) (40,709) - - (40,710)
Net income - - - - 610,632 610,632
---------- ----- ------------ --------- ------------ -----------
Stockholders' equity
at March 31, 2004 2,053,937 $ 205 $ 16,866,437 $ (70,618) $ (9,967,005) $ 6,829,019
========== ===== ============ ========= ============ ===========
See Notes to Condensed Consolidated Financial Statements
4
KIRLIN HOLDING CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31,
-----------------------------
2004 2003
----------- -----------
(Unaudited)
Cash flows from operating activities:
Net income $ 610,632 $ 1,196,883
----------- -----------
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 49,723 116,196
Deferred income taxes 394,074 (815,659)
Decrease in nonmarketable securities 21,431 9,852
Non-cash compensation 256,883 (86,052)
Decrease (increase) in operating assets:
Due from clearing brokers 2,651,832 (230,041)
Securities owned, at market value (3,158,902) (26,604)
Rebate receivable (150,000) (151,000)
Representative loans 33,832 89,655
Other assets (17,264) (25,825)
(Decrease) increase in operating liabilities:
Securities sold, not yet purchased, at market value (35,331) (61,704)
Accrued compensation (78,026) 258,754
Accounts payable and accrued expenses 578,546 578,441
----------- -----------
Total adjustments 546,798 (343,987)
----------- -----------
Net cash provided by operating activities 1,157,430 852,896
----------- -----------
Cash flows from investing activities:
Purchase of furniture, fixtures and leasehold improvements (1,420) -
----------- -----------
Net cash used in investing activities (1,420) -
----------- -----------
Cash flows from financing activities:
Repayment of subordinated borrowings (62,500) -
----------- -----------
Net cash used in financing activities (62,500) -
----------- -----------
Net increase in cash 1,093,510 852,896
Cash at beginning of year 3,032,931 3,035,084
----------- -----------
Cash at end of period $ 4,126,441 $ 3,887,980
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 5,603 $ 807
Income taxes $ 43,550 $ 6,192
See Notes to Condensed Consolidated Financial Statements
5
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION AND STOCK-BASED COMPENSATION
The accompanying condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q.
Accordingly, they do not include all of the information and footnotes as
required by generally accepted accounting principles for annual financial
statements. In the opinion of management of the Company, all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation have been included. The operations for the three-month period
ended March 31, 2004 are not necessarily indicative of the results that may
be expected for the full year ending December 31, 2004. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2003.
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 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:
THREE-MONTHS ENDED MARCH 31,
----------------------------
2004 2003
--------- -----------
Net income as reported $ 610,632 $ 1,196,883
Deduct: Total stock based employee
compensation expense determined under
the fair value based method (91,608) (439,250)
--------- -----------
Proforma net income $ 519,024 $ 757,633
========= ===========
Basic income per common share as reported $ 0.37 $ 0.75
Proforma basic income per common share $ 0.32 $ 0.48
Diluted income per common share as reported $ 0.25 $ 0.66
Proforma diluted income per common share $ 0.21 $ 0.41
6
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. 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
three-month periods ended March 31, 2004 and 2003, potential common shares
amount to 559,815 and 1,026,893, respectively, and have not been included
in the computation of diluted EPS since the effect would be antidilutive.
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 basic and diluted earnings per
share amounts for the three-month period ended March 31, 2003 than
previously reported.
The following table sets forth the components of basic and diluted earnings
per share for the three-month periods ended March 31, 2004 and 2003,
respectively:
2004 2003
---------- ----------
Numerator:
Net income $ 610,632 $1,196,883
========== ==========
Denominator:
Weighted average shares outstanding 1,631,192 1,594,250
Effect of dilutive securities:
Stock options 415,151 -
Nonvested stock 402,425 232,772
---------- ----------
Denominator for diluted earnings per
share - weighted average shares of
common stock and common stock
equivalents after assumed conversion 2,448,768 1,827,022
========== ==========
7
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. CONTINGENCIES
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 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
8
KIRLIN HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 condensed
consolidated statement of financial condition at March 31, 2004 and
December 31, 2003.
4. SUBSEQUENT EVENTS
On April 19, 2004, the Company received a letter of complaint from a
customer. The Company is in discussions with the client and its counsel
concerning the possible resolution of the complaint. The Company is
investigating the matter and at present time is unable to determine the
financial exposure related to this complaint.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING STATEMENTS
When used in this Form 10-Q 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," "it is
the opinion of management" or similar expressions are intended to identify
"forward-looking statements" within the meaning of 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 Form
10-K for the year ended December 31, 2003. 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 with our 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. At March 31, 2004, the valuation allowance
was approximately 40% of the Company's deferred tax assets related to its
net operating loss carryforwards and other temporary differences.
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
10
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.
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 March 31, 2004 resulted in an accrued liability in the
amount of $140,000.
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 II, Item 1, 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
March 31, 2004 in the consolidated statement of financial condition.
OVERVIEW
The following discussion and analysis should be read in conjunction with
the Company's condensed consolidated financial statements and the notes
presented following the condensed 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 the three-month period ended March 31, 2004
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.
11
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 for the three-month periods ended March 31, 2004 and
2003, respectively, and should be read in conjunction with the condensed
consolidated financial statements included elsewhere in this Quarterly Report on
Form 10-Q:
Three-Months Ended March 31,
----------------------------------------
2004 2003
------------------- -------------------
Revenues:
Principal transactions, net $ 61,932 0.8% $ 159,631 3.2%
Commissions 6,600,456 85.7% 4,247,980 84.9%
Investment banking 273,226 3.5% - -
Other income 769,485 10.0% 593,187 11.9%
----------- ----- ----------- ----
Total revenues 7,705,099 100.0% 5,000,798 100.0%
----------- ----- ----------- ----
Expenses:
Employee compensation and benefits 5,255,422 68.2% 3,324,228 66.5%
Promotion and advertising 58,625 0.8% 74,141 1.5%
Clearance and execution charges 151,830 2.0% 110,747 2.2%
Occupancy and communications 579,271 7.5% 787,656 15.7%
Professional fees 188,149 2.4% 140,958 2.8%
Interest 5,603 0.1% (14,206) (0.3)%
Other 397,950 5.1% 178,644 3.6%
----------- ----- ----------- ----
Total expenses 6,636,850 86.1% 4,602,168 92.0%
----------- ----- ----------- ----
Income before income tax (provision)
benefit 1,068,249 13.9% 398,630 8.0%
Income tax (provision) benefit (457,617) (5.9)% 798,253 16.0%
----------- ----- ----------- ----
Net income $ 610,632 8.0% $ 1,196,883 24.0%
=========== ===== =========== ====
RESULTS OF OPERATIONS
Revenues
Principal transactions, net for the three month-period ended March 31, 2004
decreased 61.2% to $61,932 from $159,631 in 2003. The decrease is attributable
to a decrease in revenue related to equity and fixed income business for which
the Company maintained an inventory as well as unrealized gains in the Company's
investment account during the three-month period March 31, 2003. Principal
transactions, net for the three-month period ended March 31, 2004 consisted of
trading revenue of approximately $62,000.
Commissions for the three month-period ended March 31, 2004 increased 55.4%
to $6,600,456 from $4,247,980 in 2003. The change during the quarter is
primarily attributable to the Company's increased business in equity securities,
unit investment trusts, and commissions generated from one private placement,
which the Company believes was due to the improvement in the market. Commissions
for the three month-period ended March 31, 2004 consisted of agency commissions
of approximately $5,808,000, syndicate commissions of approximately $362,000 and
mutual fund, variable annuity, life insurance and managed money commissions of
approximately $430,000.
Investment banking for the three month-period ended March 31, 2004
increased to $273,226 from
12
$0 in 2003. During the three month-period ended March 31, 2004 the Company acted
as the placement agent for one private placement.
Other income for the three month-period ended March 31, 2004 increased
29.7% to $769,485 from $593,187 in 2003. 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 $185,000 for the three-month period ended March 31, 2004 as
compared to approximately $68,000 for the same period in 2003. 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 $42,000 as well as an increase in other
income for approximately $17,000.
Expenses
Employee compensation and benefits for the three month-period ended March
31, 2004 increased 58.1% to $5,255,422 from $3,324,228 in 2003. 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 increase
is also attributable to the reduction in the first quarter of 2003 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. During
that time period other key management personnel also agreed to reduce their base
salaries. 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. These reductions were
not continued in 2004. Additionally, during the three-month period ended March
31, 2003 the Company collected outstanding loans from three former employees
that were written off in a prior year for approximately $291,000.
Promotion and advertising for the three month-period ended March 31, 2004
decreased 20.9% to $58,625 from $74,141 in 2003 as a result of the Company's
decrease in car allowances arising from the termination of certain employees as
well as a decrease in travel expenses and radio advertising.
Clearance and execution charges for the three month-period ended March 31,
2004 increased 37.1% to $151,830 from $110,747 in 2003. The increase is a result
of a higher ticket volume.
Occupancy and communications costs for the three month-period ended March
31, 2004 decreased 26.5% to $579,271 from $787,656 in 2003. This decrease is
primarily a result of the closing of the New York City, Fort Lauderdale and Red
Bank offices in the prior year and resulted in the reduction of rent and
depreciation expenses during the three month-period ended March 31, 2004 as
compared to the same period in 2003. Rent and depreciation expenses decreased
approximately $134,000 and $66,000, respectively.
Professional fees for the three month-period ended March 31, 2004 increased
33.5% to $188,149 from $140,958 in 2003. The increase is reflective of strategic
business consulting fees to increase the Company's revenues and expand its
business lines as well as legal fees incurred related to regulatory matters.
Interest expense for the three month-period ended March 31, 2004 increased
to $5,603 from $(14,206) in 2003. Interest for the three month-period ended
March 31, 2004 relates to inventory positions purchased on margin and securities
sold short, which are held at a clearing broker and charged interest. The
increase for the three month-period ended March 31, 2004 compared to the same
period in 2003 also results from the reversal of non-vested deferred commission
interest which arose during the 2003 period as a result of terminated
representatives where any accrued interest is immediately forfeited.
Other expenses for the three month-period ended March 31, 2004 increased
123% to $397,950 from $178,644 in 2003 primarily as a result of municipal bond
syndicate participation losses and customer expenses. Municipal bond syndicate
participation losses were approximately $91,000 for the three month-
13
period ended March 31, 2004 as compared to approximately $38,000 in 2003.
Customer expenses were approximately $26,000 for the three month-period ended
March 31, 2003 as compared to approximately $(150,000) in 2003. The credit
amount recorded for 2003 resulted from 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. Other expenses for the three
month-period ended March 31, 2004 consisted of municipal syndicate participation
losses of approximately $91,000, clearing broker non-trade processing costs of
approximately $19,000, office insurance (property, casualty, and umbrella)
related to each office, directors and officers insurance and automobile
insurance of approximately $40,000, directors fees of approximately $8,000,
regulatory listing, registration and assessment expenses of approximately
$79,000, customer expenses of approximately $26,000, and general office expenses
net of clearing broker conversion reimbursements of approximately $135,000.
Income tax provision for the three month-period ended March 31, 2004 was
$457,617 as compared to an income tax benefit of $798,253 for the three
month-period ended March 31, 2003. At March 31, 2004 the Company's valuation
allowance was 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. For
the three-month period ended March 31, 2003 the income tax benefit arose due to
a reduction of the valuation allowance due to an improved profitability trend.
Net income of $610,632 for the three month-period ended March 31, 2004
compares unfavorably to net income of $1,196,883 for the three month-period
ended March 31, 2003 basically because of the income tax provision recorded for
2004 as compared to the income tax benefit recorded for 2003. On a pretax basis,
the Company recorded income of $1,068,249 in 2004 versus $398,630 in 2003, a
168% increase.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2004, approximately 72% of the Company's assets were comprised
of cash and highly liquid securities.
Cash amounted to $4,126,441 at March 31, 2004 as compared to $3,032,931 at
December 31, 2003. This increase is reflective of the collection of the annual
maintenance fee on client accounts that occurred during March 2004.
Due from Clearing Brokers amounted to $523,818 at March 31, 2004 as
compared to $3,175,650 at December 31, 2003. This 83.5% decrease is primarily
attributable to monies owed on security positions purchased on margin in the
Company's investment account, which are netted against amounts otherwise due
from clearing brokers. These securities are reflected in the "Securities Owned"
line item in the condensed consolidated statement of financial condition.
Securities Owned at March 31, 2004 were $6,612,992 as compared to
$3,475,521 at December 31, 2003. 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, as well as state and municipal obligations held in inventory
with respect to the Company's syndicate activities.
Rebate Receivable amounted to $1,391,000 at March 31, 2004 as compared to
$1,241,000 at December 31, 2003. This 12.1% 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 $212,500 offset by the collection of $62,500 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.
14
Representative Loans at March 31, 2004 amounted to $102,509 as compared to
$136,341 at December 31, 2003. This 24.8% decrease is reflective of the
forgiveness and amortization of some of the 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 March 31, 2004,
decreased to $94,195 as compared to $142,498 at December 31, 2003. This 33.9%
decrease results from the depreciation of the Company's furniture, fixtures and
leasehold improvements.
Deferred Tax Assets, net at March 31, 2004 amounted to $1,771,731 as
compared to $2,165,805 at December 31, 2003. The deferred tax assets changed
during the period due to the expected utilization of the Company's net operating
loss carryforward and other temporary differences which resulted in a decrease
in its valuation allowance. At March 31, 2004 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 March 31, 2004
the deferred tax assets amount to approximately $3,045,000 and the recorded
valuation allowance amounted to approximately $1,273,000. If the Company
continues to be profitable then it anticipates being able to use a substantial
portion of the deferred tax assets.
Other assets increased by 2% to $867,933 at March 31, 2004, from $850,669
at December 31, 2003. The net increase is primarily attributable to two loans
made to a potential investment banking client, receipt of clearing broker
conversion cost reimbursement receivable, and an increase in unit investment
trust commission receivables related to the Company's retail activities,
partially offset by a net decrease in prepaid expenses and deposits related to
the Company's general operations. Other assets at March 31, 2004 consists of a
loan to a potential investment banking client of $100,000, unit investment trust
and mutual fund commissions receivable of approximately $332,000, prepaid
expenses of approximately $120,000, rent and other deposits inclusive of a
letter of credit deposit of approximately $218,000, and other assets of
approximately $98,000. 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.
Securities sold, not yet purchased amounted to $88,641 at March 31, 2004 as
compared to $123,972 at December 31, 2003. Management monitors these positions
on a daily basis and covers short positions when deemed appropriate.
Accrued compensation was $1,814,134 at March 31, 2004 as compared to
$1,892,160 at December 31, 2003, a 4.1% decrease. The revenues upon which
commission income to registered representatives is based directly affect this
line item, which was higher at the end of the current quarter compared as
compared to 2003 offset by a decrease in the accrual related to bonuses accrued
at December 31, 2003 and paid during January 2004.
Accounts payable and accrued expenses at March 31, 2004 were $4,758,825 as
compared to $4,180,279 at December 31, 2003, a 13.8% increase. The change is
primarily attributable to the collection in March 2004 of the annual maintenance
fee charged to client accounts and the recordation on the Company's consolidated
statement of financial condition of an offsetting liability. The income related
to the annual maintenance fee will be recognized monthly as the annual fee is
amortized. The increase is also due to selling group commissions and associated
expenses related to a private placement the Company was a placement agent,
municipal syndicate payout loss accrual. 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. To a lesser extent this line item
increased due to the increase in payables related to the Company's general
business. Accounts payable
15
and accrued expenses at March 31, 2004 consists of accrued professional fees of
approximately $603,000, accrued communication charges of approximately $198,000,
accrued computer and copier charges of approximately $205,000, accrued
arbitration settlements of $140,000, accrued lease expense of approximately
$598,000, accrued regulatory expense of approximately $1,250,000 and other
accounts payable and accrued expenses of approximately $1,765,000. Accounts
payable and accrued expenses at December 31, 2003 consists of accrued
professional fees of approximately $588,000, accrued communication charges of
approximately $233,000, accrued computer and copier charges 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.
Subordinated borrowings amounted to $2,000,000 at March 31, 2004 as
compared to $2,062,500 at December 31, 2003. During March 2002, Kirlin
Securities received from its clearing broker a $2,500,000 three-year
subordinated loan that requires payments over various periods of time during
this three-year period. During the three-month period ended March 31, 2004 the
Company repaid $62,500 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 itself 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 condensed
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 from 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.
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 March 31, 2004 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.
16
2008 and
Total 2004 2005 2006 2007 thereafter
---------- ---------- ---------- ---------- ---------- ----------
Equipment lease obligations $ 464,632 $ 164,679 $ 193,032 $ 106,921 $ - $ -
Office lease obligations 1,577,969 673,092 663,402 147,492 93,983 -
Employment contract obligations 3.334,583 566,250 755,000 755,000 755,000 503,333
---------- ---------- ---------- ---------- ---------- ----------
$5,377,184 $1,404,021 $1,611,434 $1,009,413 $ 848,983 $ 503,333
========== ========== ========== ========== ========== ==========
ITEM 3. 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.
ITEM 4. CONTROLS AND PROCEDURES.
An evaluation of the effectiveness of the Company's disclosure controls and
procedures as of March 31, 2004 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 significant 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.
17
PART II: OTHER INFORMATION
ITEM 2: 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
- --------------------------------------------------------------------------------------------------------------------------
1/2/04 Options to purchase 5,179 Options granted under 4(2) Fully exercisable
Common Stock 1994 Stock Plan - no cash on 1/2/07, for a
consideration received by period of 10 years
the Company. from date of grant,
at an exercise price
of $10.80 per share.
- ---------------- ---------------------- ----------------- --------------------------- --------------- --------------------
2/2/04 Options to purchase 10,186 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
$10.38 per share.
- ---------------- ---------------------- ----------------- --------------------------- --------------- --------------------
2/2/04 Options to purchase 11,000 Options granted under 4(2) Fully exercisable
Common Stock 1994 Stock Plan - no cash on 2/2/07, for a
consideration received by period of 10 years
the Company. from date of grant,
at an exercise price
of $10.38 per share.
==========================================================================================================================
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) 31.1 Section 302 Certification of Chief Executive Officer.
31.2 Section 302 Certification of Chief Financial Officer.
32 Section 906 Certification.
(b) Reports on Form 8-K
On March 31, 2004 a Form 8-K dated March 30, 2004 was filed solely to
file a press release reporting the Company's results of income for the
year ended December 31, 2003.
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Kirlin Holding Corp.
--------------------
(Registrant)
Dated: May 17, 2004 By: /s/ Anthony J. Kirincic
----------------------------------
Anthony J. Kirincic
President
Dated: May 17, 2004 By: /s/ Barry E. Shapiro
----------------------------------
Barry E. Shapiro
Chief Financial Officer
(and principal accounting officer)
19