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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 [FEE REQUIRED]
For the fiscal year ended December 31, 1997
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _______________________ to ______________________
Commission File No. 0-6729
FIRST MONTAUK FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
New Jersey 22-1737915
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
328 Newman Springs Road, Red Bank, NJ 07701
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (732) 842-4700
- - -------------------------------------------------------------------------------
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of class)
[Cover Page 1 of 2 Pages]
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(D) of the Exchange Act during the past 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 ___
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will 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. [ ]
The issuer's revenues for its most recent fiscal year: $37,742,633.
The aggregate market value of the voting stock held by non-affiliates computed
by reference to the price at which the stock was sold, or the average bid and
asked prices of such stock, as of April 7, 1998 was $20,661,935.
The number of shares of Common Stock outstanding, as of April 7, 1998 was
9,630,444.
DOCUMENTS INCORPORATED BY REFERENCE
Not Applicable
[Cover Page 2 of 2 Pages]
PART I
Item 1. Business
Introduction
First Montauk Financial Corp. ("FMFC") is a holding company, which,
through its wholly-owned subsidiary, First Montauk Securities Corp. ("FMSC"), is
primarily engaged in the operation of an investment banking and securities
brokerage firm. FMFC also sells insurance products through its subsidiary
Montauk Insurance Services, Inc. ("MISI"). FMSC is a broker-dealer registered
with the Securities and Exchange Commission ("SEC"), a member of the National
Association of Securities Dealers Regulation, Inc. ("NASD"), the Municipal
Securities Rule Making Board ("MSRB"), and the Securities Investor Protection
Corporation ("SIPC"). FMSC's business activities consist primarily of retail
sales and trading of listed and unlisted equity and fixed-income securities;
sales of government, municipal and corporate securities; options; commissions
earned from individual and institutional securities transactions; and market
making activities. FMSC also provides investment banking activities such as
private and public securities offerings. In fiscal 1995, FMSC become a
registered advisor under the Investment Advisors Act of 1940 and began offering
investment advisory services.
FMSC is currently licensed to conduct its broker-dealer business in 49
states and the District of Columbia. FMSC maintains approximately 124 branch
and/or satellite offices, all of which are maintained by affiliates. The Company
has approximately 388 registered representatives and services approximately
35,000 retail and institutional customer accounts.
FMSC's primary method of operation is through its affiliate program.
The affiliate program is designed to attract experienced brokers with existing
clientele who desire to operate their own office. It is through this affiliate
program that FMSC has expanded its customer base and retail activities by adding
brokers with established clientele. In order to become an affiliate of FMSC, the
registered representative must enter into an affiliate agreement with FMSC. The
Company believes that one of the primary reasons its affiliate program is
attractive to such individuals is because the affiliate arrangement entitles the
affiliate representative to obtain a significantly higher percentage of the
commissions generated by his sales than a registered representative would
normally receive. Based on the experience of FMSC's management, and information
derived from professional associations, FMSC believes that standard commission
payout rates for registered representatives of retail firms is approximately
40%-50%, whereas affiliates receive commissions of approximately 80%-85% if as
an affiliate representative. The terms of the affiliate agreement provide that
the affiliate establishes his own office and is solely responsible for the
payment of all expenses associated with the operation of the branch office,
including rent, utilities, furniture, equipment, stock quotation machines, and
general office supplies. All securities transactions are cleared through FMSC's
clearing firm on a fully disclosed basis. FMSC receives a percentage (generally
15%-20% after deduction of clearing costs) of the affiliate's commissions with
no operating expenses directly attributable to the maintenance of the specific
affiliate office.
FMSC has also expanded its general securities business by adding registered
representatives to its main corporate office. FMSC is continuously seeking to
establish additional branch offices at sites and locations to be selected, the
timing and location of which will be based upon prevailing business and economic
conditions.
In 1991, MISI was formed for the purpose of offering and selling
variable annuity, variable life as well as traditional life and health insurance
products. Currently, MISI is licensed in the states of Alabama, Alaska, Arizona,
California, Connecticut, Delaware, Florida, Georgia, Illinois, Indiana, Kansas,
Kentucky, Maine, Maryland, Michigan, New Jersey, New York, North Carolina,
Pennsylvania, Rhode Island, South Carolina, Virginia, Washington and Wisconsin.
MISI derives revenue from insurance-related products and services from the
existing base of FMSC's Registered Representatives who are insurance licensed.
In fiscal year 1997, the Company earned $1,813,000 in gross commissions from the
sale of insurance and insurance related products.
In 1993, the Company formed Montauk Advisors, Inc. ("MAI") as a
wholly-owned subsidiary. MAI engages in the sale of equipment leasing contracts
as agent for various leasing companies. The equipment financed to date includes
copiers, facsimile machines and other business machines. These leases are sold
to various customers from which MAI derives a commission. In fiscal year 1997,
MAI suspended this business due to financial concerns with the leasing agent
which was furnishing the leases. See "Global Loans" below.
FMFC and its subsidiaries (with the exception of MISI) each maintain
their principal executive offices at Parkway 109 Office Center, 328 Newman
Springs Road, Red Bank, New Jersey 07701, telephone (732) 842-4700. MISI
maintains its principal offices at One Mack Centre Drive, Paramus, New Jersey
07652, telephone (201) 634-0700.
In early 1995, FMSC became registered with the Securities and Exchange
Commission as an Investment Advisor under the Investment Advisors Act of 1946
for the purpose of providing investment advisory services and fee-based managed
accounts to clients of FMSC. Currently, FMSC is licensed as an Investment
Advisor in the States of Alaska, Arizona, California, Connecticut, Florida,
Hawaii, Indiana, New Jersey, New York, North Carolina, Pennsylvania, Texas, and
West Virginia. Although to date FMSC has received minimal revenue from its
advisory services, management's goal is to derive revenue by providing
investment advisory services to FMSC's existing client base as well as to
additional clientele seeking fee-based managed accounts.
Recent Developments
Rights Offering
FMFC recently completed an offering (the "Rights Offering") of
3,072,779 units (the "Units"), to holders ("Shareholders") of record of its
common stock, no par value (the "Common Stock") at the close of business on
December 15, 1997 (the "Record Date"), pursuant to non-transferable rights (the
"Rights") to purchase Units at a price of $.45 per Unit (the "Subscription
Price"). All of the Units were sold with the Company's shareholders purchasing
1,784,491 Units through the exercise of their basic subscription rights and
1,288,288 Units through the exercise of their over subscription rights. Holders
of Rights ("Rights Holders") were not required to pay any brokerage fees for the
subscription of Units under the Rights Offering. Rights Holders were able to
exercise their Rights until 5:00 p.m. Eastern time on February 16, 1998. The
Rights Offering was completed on February 17, 1998 with all of the Units sold.
Each Unit consisted of one Class A Redeemable Common Stock Purchase
Warrant, one Class B Redeemable Common Stock Purchase Warrant and one Class C
Redeemable Common Stock Purchase Warrant. Each Class A Redeemable Common Stock
Purchase Warrant (the "Class A Warrants"), entitles the holder to purchase from
February 17, 1998 to February 17, 2001 one share of Common Stock of the Company
(the "Class A Warrant Shares"), at an exercise price of $3.00 per share, subject
to adjustment in certain circumstances. Each Class B Redeemable Common Stock
Purchase Warrant (the "Class B Warrants"), entitles the holder to purchase from
February 17, 1998 to February 17, 2003 one share of Common Stock of the Company,
at an exercise price of $5.00 per share, subject to adjustment in certain
circumstances. Each Class C Redeemable Common Stock Purchase Warrants (the
"Class C Warrants"), entitles the holder to purchase from February 17, 1998 to
February 17, 2005 one share of Common Stock of the Company (the "Class C Warrant
Shares"), at an exercise price of $7.00 per share, subject to adjustment in
certain circumstances.
Discount Brokerage Business
In June 1997 two registered representatives who formerly ran a discount
brokerage firm joined FMSC to establish a discount brokerage operation in the
Company's Paramus, New Jersey office. To date, the company has earned $167,540
in commissions from Century Discount Securities ("CDS"), which operated as a
separate division of FMSC. The primary employees who assisted FMSC in
establishing CDS receive a salary and are eligible to receive up to 90% of the
commissions generated from CDS after the deduction of operation expenses and
salaries. It is anticipated that CDS will continue to expand through the
implementation of a new advertising programs. However, the discount brokerage
business is highly competitive and there can be no assurance the Company will be
able to successfully expand this new business line.
Global Loans
Montauk Advisors, Inc. ("MAI") has made various loans totaling $1,094,500
to Global Financial Corp. ("Global"), the financing company which sold leasing
contracts through MAI. These loans were made for the purpose of assisting Global
in meeting cash flow deficiencies arising from the nonpayment of scheduled
monthly installments on certain delinquent and non-performing leases. The loans
bear interest at 8% per annum and are due in April and May 1998. MAI, at its
sole option, may accept payment on the loans on an installment basis, and may
extend any or all of the loans. The first note which was due on April 1, 1998
has been extended to September 1, 1998. Most of the arrears are due from Fem-Com
Systems Inc. ("FCS"), Global's affiliated equipment vendor, and Biblio, Inc.
"Biblio"), an affiliate of FCS. The notes are guaranteed by Global, FCS, Biblio
and the shareholder of FCS and Biblio. The notes are further collateralized by
mortgage liens on real estate owned by the principal shareholder of FCS and
Biblio, the shareholder's personal guarantee, a pledge of the shares of Global
and FCS, and various liens on the assets of Global. MAI expects that Global will
seek additional loans from MAI in the short-term which will be evaluated on a
case by case basis.
Additionally, MAI has provided certain financing for the purchase of
equipment by FCS. FCS is indebted to Global for payment on certain leases and is
paying Global from time to time based on its available cash flow. The Company
believes that MAI's assistance to FCS in financing current and future equipment
purchases, will enable FCS to generate additional cash flow to pay Global, which
will eventually enable Global to repay the loans made by MAI. However, there can
be no assurance that Global will be able to repay the loans or that the
collateral will be sufficient to cover the outstanding principal of the loans in
the event of a default.
PacificHealth Laboratories, Inc. Initial Public Offering
In December 1997 FMSC completed the underwriting of PacificHealth
Laboratories, Inc. initial public offering. FMSC, acting as managing
underwriter, sold 1,200,000 shares of Common Stock at an offering price of $6.00
per share. FMSC received gross commissions of $673,500 as well as 120,000
Underwriter's Warrants exercisable at $8.70 per share.
Montauk Strategic Alliance Group
In 1997 the Company created a division called Montauk Strategic Alliance
Group ("MSAG"). MSAG was created to provide investment, insurance and financial
planning products, services and consulting to certified and public accountants
and their clients. The program requires CPAs and PAs to become affiliated
registered representatives with the firm and expand the financial services
offered to their clients.
Uptick Technologies Agreement
The Company entered into an agreement (the "Agreement') with Uptick
Technologies, Inc. ("Uptick") on August 1, 1997 whereby Uptick agreed to
develop, deliver and install certain computer software (the "Uptick software")
for FMSC. The Uptick Software consist of certain pre-existing Uptick proprietary
software and components specifically developed for FMSC by Uptick. The Uptick
Software will be used by FMSC for sales production and operation management.
FMSC shall have a perpetual, except as it may be terminated in accordance with
the terms of the Agreement, non-exclusive, royalty free license to use the
Uptick Software. Uptick will also provide, at FMSC's request, computer
consulting services customarily rendered by software consultants in the
financial services industry.
New Office Lease
In March 1997 the Company entered into a new seven year lease commencing
February 1, 1998 for 22,762 square feet of gross rentable area in the building
currently occupying the Company's headquarters in Red Bank, New Jersey. (See
Item II. Properties/Offices and Facilities).
Advertising/Marketing/Recruiting Campaigns
In Fiscal 1997 the Company embarked on a new advertising/marketing
campaign designed to recruit new account executives for the Company's Affiliate
program. The campaign, entitled "The Freedom to Succeed," is directed at
recruiting new registered representatives and expanding the affiliate base and
encompasses a comprehensive program which includes video and print advertising
materials. FMSC produced and filmed a ten minute video titled the "Freedom to
Succeed," which introduces First Montauk to registered representatives
considering FMSC, as well as advertising material, brochures, folders, and a
Product & Services Guide for recruiting purposes.
FMSC has also expanded the marketing and advertising materials
available to existing affiliates. FMSC provides affiliates with compliance
approved, personalized ads for newspapers and magazines; 30 second television
commercials which can be customized with the affiliates name and photograph; and
full color booklets explaining the "independent advantage" to clients.
FMSC also has a presence on Internet. Phase I of www.firstmontauk.com is
complete and serves dual purposes: investor relations and recruiting. Phase II
will be complete during the current fiscal year and will enable existing
affiliates to access research, accounts, and internal literature on-line.
Description of Business
FMSC is a New Jersey based broker-dealer registered with the Securities
and Exchange Commission, and a member of the National Association of Securities
Dealers, Inc., the Municipal Securities Rule Making Board and the Securities
Investor Protection Corporation. Its business activities include sales and
trading of listed and OTC equity and fixed-income securities; sales of
government, municipal and corporate securities; options; commissions earned from
individual and institutional securities transactions and market making
activities. FMSC is registered to conduct its business in 49 states and the
District of Columbia.
As of March 11, 1998, FMSC operated 124 affiliate branch and satellite
offices in addition to its main office located in Red Bank, New Jersey. There
are approximately 388 registered representatives in these offices, as well as 55
support staff employees in the main office. Affiliate branch and satellite
offices are located in the following 27 states:
AFFILIATE BRANCH/ AFFILIATE BRANCH/
STATE SATELLITE OFFICE STATE SATELLITE OFFICE
Alaska 1 New Hampshire 2
Arizona 2 North Carolina 10
California 6 New Jersey 20
Connecticut 5 New Mexico 1
Delaware 1 New York 24
Florida 9 Ohio 2
Georgia 3 Pennsylvania 12
Illinois 2 Rhode Island 3
Indiana 1 Texas 3
Massachusetts 1 Virginia 5
Maryland 1 Washington 4
Minnesota 1 West Virginia 1
Mississippi 1 Wisconsin 1
Missouri 1
FMSC transacts business in the following areas in:
Equities:
Listed 28%
Over-The-Counter 38%
Municipal, Government 3%
Corporate Bonds 4%
Unit Investment Trusts 2%
Mutual Funds 19%
Options 1%
Insurance* 5%
- - ---------------------------
* A portion of the insurance commission is payable to Montauk Insurance
Services, Inc. while variable annuity commission is payable through FMSC.
Approximately 85% of the customers accounts are cash accounts. The
balance of the accounts consists of margin, Individual Retirement Accounts
("IRA") and KEOGH accounts.
Approximately 50% of the over-the-counter equities and 90% of the fixed
income transactions are transacted on a principal basis, with the balance
representing agency transactions.
The following table reflects FMSC's various sources of revenues and the
percentage of total revenues that each source represents for the periods
indicated. Revenues from agency transactions in securities for individual
customers of FMSC are shown as commissions. Revenues from transactions in
securities for individual customers where FMSC acted in a principal capacity are
reflected in principal transactions. Also reflected in principal transactions
are trading profits from market making and other trading activities.
Period
Year Ended December 31, 1997
Amount Percent
Commissions:
Equity Securities,
Options and Mutual Funds $27,018,244 72%
Principal Transactions:
Equity Securities, Municipal, Government
and Corporate Bonds $ 7,257,576 19%
Interest and Other Income(1) $ 2,033,713 5%
Investment Banking(2) $ 1,433,100 4%
----------- ----
Total Revenues $37,742,633 100%
- - --------------------------
1. "Other Income" consists primarily of rental income, dividends, and
an insurance recovery.
2. Investment banking revenues consists of commissions,
selling concessions, consulting fees and other income from syndicate
activities and placement agent fees.
Registered Representative Recruitment and
Registered Representative Affiliate Program
FMSC derives its customer base from its registered representatives'
accounts. FMSC's goal is to recruit well-trained, experienced registered
representatives who require little training and who have proven production
records with an established customer account base.
Since all registered representatives are paid on a commission earned
basis, the costs associated with the hiring of new registered representatives
are limited to general expenses consisting of orientation materials, compliance
manuals and operational information.
Competition among securities brokerages and registered representatives is
intense. Larger, more established securities firms with greater financial
resources possess an advantage in competing with FMSC and attracting
representatives, clients and investment dollars. (See "Business - Competition".)
The Affiliate Program
FMSC's affiliate program is designed to attract professionals in all
phases of the financial services industry to affiliate with FMSC as registered
representatives. Management believes that the affiliate program is attractive to
established brokers because it combines the flexibility of operating an
independent office with the structure and support of an established firm.
Currently FMSC has 122 locations operated by registered representatives
participating in the affiliate program. It is through this affiliate program
that FMSC seeks to continue to expand its customer base and retail activities by
adding brokers with established clientele.
The program's goal is to recruit securities brokers with a sufficient
level of commission brokerage business to enable the individual to independently
support his own office. The program also enables financial professionals such as
insurance agents, real estate brokers, financial planners, tax preparation
experts and accountants who already provide some type of financial or brokerage
services to their clients, to become a registered representative with FMSC. This
is intended to allow the professional to offer securities products and services
to their clients and insurance products through MISI. Affiliates operate in
their own office or location which function as a registered branch office or
satellite location of FMSC. A location is considered a registered branch if it
contains three or more registered individuals, and indicates the location as one
in which securities business is being offered to the public. A registered branch
is designated as either an Office of Supervisory Jurisdiction (OSJ) or non-OSJ
branch office depending on whether the office contains a registered principal
responsible for the supervision of registered representatives at that location.
A satellite location is one in which less than three individuals are conducting
business, does not contain a registered principal, and does not indicate
publicly that it is a location where securities business is being conducted.
Registered representatives within a satellite location are supervised by a
registered principal at an OSJ or FMSC's headquarters.
In each case, the affiliate is solely responsible for the payment of
all expenses associated with the operation of his office location, including
rent, utilities, furniture, equipment, stock quotation machines, supplies etc.
Under the program, the affiliate receives a significantly higher percentage of
the commissions generated by his sales than a registered representative would
normally receive. Based on the experience of FMSC's management, and information
derived from professional associations, FMSC believes that standard commission
payout rates for registered representatives of retail firms is approximately 40%
to 50%, whereas FMSC pays affiliates approximately 80% to 85%. An affiliate
establishes his own office and is solely responsible for the payment of all
expenses associated with the operation of his office, including rent, utilities,
furniture, equipment, stock quotation machines, and general office supplies. All
securities transactions are cleared through FMSC's clearing firm on a
fully-disclosed basis. FMSC receives a flat percentage (generally 15% to 20%
after deduction of clearing costs) of the affiliate's commissions with no
operating expenses directly attributable to the maintenance of the specific
affiliate office. (See "Administration, Operations, Transaction Processing and
Customer Accounts").
For FMSC's percentage of commission obtained, FMSC provides full support
services to each of the affiliates including listed stock and options execution,
over-the-counter stock trading, research, compliance, supervision and related
services. Currently, Schroder & Co., Inc. transacts clearing services for FMSC,
and E.D. & F Man International Securities, Inc. and others provide execution
services.
Each affiliate is required to obtain and maintain in good standing each
license required by the SEC and NASD to conduct the type of securities business
in which the affiliate will engage and to register in the various states in
which he intends to service customers. If the affiliate wishes to expand his
operation, he controls the hiring and immediate supervision of any additional
registered representatives subject to FMSC's policies and procedures and overall
approval and supervision. If the affiliate office contains three or more
registered representatives, the affiliate must obtain a principal's license to
insure proper supervision. The office will then be designated as an Office of
Supervisory Jurisdiction.
FMSC is ultimately responsible for supervising each and every affiliate
and related registered representative. FMSC can incur substantial liability from
improper actions of any of the affiliate representatives. (See "Legal
Proceedings"). Effective January 1, 1996, the Company implemented a professional
liability errors and omissions insurance program which provides coverage for
actions taken by the Company's registered representatives, employees and other
agents for actions in connection with the purchase and sale of securities and
the administration of individual retirement plans. The program provides coverage
for each incident up to $1,000,000 with an aggregate policy limit of $5,000,000,
with a deductible per incident of $50,000, the first $5,000 of which is the
responsibility of individual representatives. The policy period for these limits
is twenty-four (24) months commencing January 31, 1998. Each registered
representative is assessed a premium which is payable monthly. The policy
excludes claims involving the sale of low-priced or "penny stocks" or
partnerships, criminal or deliberate fraudulent acts, defamation and company
sponsored employee benefit plans, as well as other exclusions.
There are other, larger broker-dealers with greater resources than
FMSC, engaged in similar programs with whom FMSC must compete. These companies,
some national in scope, compete with FMSC to attract registered representatives
as well as clients. Some of these companies are larger, well-known firms with
substantially greater financial and other resources than those of FMSC. (See
"Business-Competition".)
Retail Commission Business
All of FMSC's revenues are currently, and will in the future, be
derived from commissions, concessions, mark-ups and mark-downs (collectively,
"Commissions") from retail (individual) and institutional customers on brokerage
transactions in exchange-listed and over-the-counter equity and fixed income
securities. Commissions are charged to clients for executing buy and sell orders
of securities. When a buy or sell order for a security in which FMSC makes a
market or has inventory, FMSC may act as a principal and purchase from, or sell
to, its customers the desired security on a disclosed basis at a price set in
accordance with applicable securities regulations.
Investment Banking Activities
The Company's investment banking revenues are principally derived from
participation in public offerings of equity securities and acting as placement
agent in the private placement of securities. For the fiscal year ended December
31, 1997, investment banking activities, including sales concessions, accounted
for approximately 4% of the Company's revenues.
To date, the Company has not derived significant or material revenues
from its investment banking services. Through its relationships with investment
banking clients, the Company intends to expand this business. There can be no
assurance that the Company will be successful in these efforts or that future
efforts will result in significant revenue or increased profit to the Company.
The corporate finance function of the Company seeks to raise capital for
corporations in a variety of businesses. In December 1997, FMSC completed its
second underwriting of an initial public offering for $7,200,000 of the common
stock of PacificHealth Laboratories, Inc. The PacificHealth Laboratories, Inc.
offering was the second public offering following the Manhattan Bagel Company,
Inc. public offering in 1994, in which FMSC also acted as the managing
underwriter. FMSC also participates in other underwritings of corporate
securities as a syndicate or selling group member. FMSC participated as a
syndicate or selling group member in approximately 90 offerings in fiscal 1997.
Potential underwriting opportunities in which FMSC may act as managing
or co-managing underwriter may be presented by FMSC's officers, directors,
employees and professional advisors. The Company has utilized and will continue
to utilize the services of outside consultants to assist the officers in making
corporate finance decisions.
Participation as a managing underwriter or in an underwriting syndicate
or a selling group involves both economic and regulatory risks. An underwriter
may incur losses if it is unable to resell the securities it is committed to
purchase, or if it is forced to liquidate its commitment at less than the
purchase price. In addition, under federal securities law, other laws and court
decisions with respect to underwriters' liabilities and limitations on the
indemnification of underwriters by issuers, an underwriter is subject to
substantial potential liability for misstatements or omissions of material facts
in prospectuses and other communications with respect to such offerings. Acting
as a managing underwriter increases these risks. Underwriting commitments
constitute a charge against net capital and FMSC's ability to make underwriting
commitments may be limited by the requirement that it must at all times be in
compliance with the Net Capital Rule. See "Net Capital Requirements".
FMSC also acted as a placement agent in three private placements during
the fiscal year ended December 31, 1997. FMSC is continuously reviewing
potential private offerings for future participation. See "Certain Relationships
and Related Transactions".
Principal Transactions
Market-Making. FMSC acts as both principal and agent in the execution
of its customers' orders in the over-the-counter market. FMSC buys, sells and
maintains an inventory of various securities in order to "make a market" in
those securities. In executing customer orders for over-the-counter securities
in which it does not make a market, the Company charges a commission and acts as
agent between its customers and another firm which is a market-maker. However,
when the buy or sell order is in a security in which FMSC makes a market, the
Company may act as principal and purchase from or sell to its customers plus or
minus a mark-up or mark-down in accordance with applicable regulations.
Trading profits or losses depend upon the skills of the employees
engaged in market-making activities, the capital allocated to positions in
securities and the general trend of prices in the securities markets. Trading as
principal requires the commitment of capital and creates an opportunity for
profits and risk of loss due to market fluctuations. FMSC may take both long and
short positions in those securities in which it makes a market.
Investment Activities
FMSC also seeks to realize investment or trading gains by purchasing,
selling and holding securities for its own account. FMSC is required to commit
the capital necessary for use in its investment activities. The amount of such
capital to be committed at any particular time will vary according to market,
economic and other factors, including the other aspects of the Company's
business. Additionally, in connection with its investment banking activities,
FMSC from time to time receives warrants which entitle it to purchase securities
of the corporate issuers for which FMSC raises capital or provides advisory
services. These warrants, which are placed in FMSC's investment account, vary in
value based upon the market price, if any, of the underlying security and the
terms of the warrant.
Research Services
Securities research is intended to play a significant role in FMSC's
investment banking business as a service to its customers. Research activities
include the review and analysis of general market conditions, industries and
specific companies; the issuance of in-depth written reports on companies, with
recommendations of specific action to buy, sell or hold; the furnishing of
information to retail and institutional customers; and responses to inquiries
from customers and account executives. Research services are directed primarily
at identifying attractive investment opportunities in small, medium and emerging
growth companies, and in special situation investments. FMSC presently conducts
a limited amount of research activities directly through a research analyst
employed by it and also utilizes external sources. These direct research
activities principally relate to the preparation of specialized reports on
selected securities for general distribution to FMSC's retail customers, and/or
research assistance to the Company's retail sales force. The Company also
obtains additional research reports and information from various other sources,
including through subscription from Solomon Brothers, Schroder Wertheim and
Deutsche Morgan Greenfell/C.J. Lawrence.
Asset Management and Portfolio Advisory Service Fees
Since 1995, FMSC has been an SEC registered Investment Adviser,
providing investment advisory services to clients through both firm-sponsored as
well as independent, third-party sponsored advisory programs offered to
individual and institutional clients. FMSC is registered as an investment
adviser in those states requiring registration, including:
Alaska New Jersey
California New York
Connecticut North Carolina
Delaware Pennsylvania
Florida Rhode Island
Indiana Texas
Massachusetts Washington
Michigan West Virginia
Some of the programs available to clients are discretionary management, while
others are non-discretionary. Certain programs require the client to pay a
single fee for portfolio advisory services, brokerage execution and custody and
periodic account performance evaluation.
Revenues from asset management, asset-based products and portfolio
advisory service fees rose to $438,377 in 1997 primarily due to an increase in
the number of Company's registered representatives who have established advisory
accounts which charge a fee, based on a percentage of assets under management.
Fee-based revenues rose due to increases in the number of client fee-based
accounts, and a wider choice of fee-based products available to clients and
registered representatives.
Management's goal is to increase fee-based revenues by continuing to
provide diversified advisory services to its affiliates that meet the
requirements of both individual as well as institutional clients.
Competition
FMSC encounters intense competition in all aspects of its business and
competes directly with many other securities firms for clients as well as
registered representatives. A significant number of such competitors offer their
customers a broader range of financial services, have substantially greater
resources and may have greater operating efficiencies. Retail firms such as
Merrill Lynch Pierce Fenner & Smith Incorporated, Smith Barney, Inc. and Paine
Webber Incorporated dominate the industry; however, the Company also competes
with numerous regional and local firms. In addition, a number of firms offer
discount brokerage services to individual retail customers and generally effect
transactions at lower commission rates (as low as 50% of standard commission
rates) on an "execution only" basis without offering other services such as
investment recommendations and research. The further expansion of discount
brokerage firms could adversely affect the Company's retail business. Moreover,
there is substantial commission discounting by full-service broker-dealers
competing for institutional and individual brokerage business. The possible
increase of this discounting could adversely affect the Company.
FMSC also competes for experienced brokers with other firms offering an
independent affiliate program such as Corporate Securities Group, Inc., Robert
Thomas Securities, Inc. and Linsco/Private Ledger Corp.
Other financial institutions, notably commercial banks and savings and
loan associations, offer customers some of the services and products presently
provided by securities firms. In addition, certain large corporations have
entered the securities industry by acquiring securities firms. While it is not
possible to predict the type and extent of competitive services which banks and
other institutions ultimately may offer to customers, FMSC may be adversely
affected to the extent those services are offered on a large scale.
FMSC competes through its advertising and recruiting programs for
registered representatives interested in joining its affiliate program. FMSC is
further developing customized computer programs to better service its affiliates
and to attract new brokers. The system will enable brokers at any office to
instantly access customer accounts, determine cash positions, send and receive
electronic mail, and receive research reports and compliance memoranda through a
computer work station.
Administration, Operations, Transaction
Processing and Customer Accounts
FMSC currently utilizes the services of Schroder & Co., Inc. as its
clearing broker (the "Clearing Broker"). FMSC does not hold any funds or
securities of its customers.
The Clearing Broker, on a fee basis, processes all securities
transactions for FMSC's account and the accounts of its customers. Services of
the Clearing Broker include billing and credit control, and receipt, custody and
delivery of securities, for which FMSC pays a portion of the commissions it
receives from customer transactions. By engaging the processing services of a
clearing broker, FMSC is exempt from certain reserve requirements imposed by
Rule 15c3-3 under the Securities Exchange act of 1934 (the "1934 Act"). See "Net
Capital Requirements". The Clearing Broker is neither a partner nor a joint
venturer with FMSC, nor does the Clearing Broker have any direct or indirect
interest in FMSC, financial or otherwise, or any control of FMSC's business,
affairs or internal operations. The Clearing Broker, however, does provide
secured margin loans to FMSC and its customers to finance the purchase of
securities. Under its clearing agreement with the Clearing Broker, FMSC has
agreed to indemnify and hold the Clearing Broker harmless from certain
liabilities or claims.
As required by the NASD and certain other authorities, FMSC carries a
fidelity bond covering loss or theft of securities, as well as embezzlement and
forgery. The amount of the bond provides total coverage of $5,000,000 (with a
$10,000 deductible provision per incident). In addition, the accounts of its
customers are protected by the Securities Investor Protection Corporation
("SIPC") for up to $500,000 for each customer, subject to a limitation of
$100,000 for claims for cash balances with an additional $25,000,000 of
protection provided by a private insurance company for the benefit of each
customer. SIPC is funded through assessments on registered broker-dealers. SIPC
assessments were .00065% of net operating revenues (as defined).
Government Regulation
The securities industry is subject to extensive regulation and
frequently changing under federal and state laws and substantial regulations
under such laws by the SEC and various state agencies and self-regulatory
organizations such as the NASD. The principal purpose of regulation and
discipline of broker-dealers is the protection of customers and the securities
markets rather than protection of creditors and stockholders of broker-dealers.
The SEC is the federal agency charged with administration of the federal
securities laws. Much of the regulation of broker-dealers, however, has been
delegated to self-regulatory organizations, principally the NASD and the
national securities exchanges. These self-regulatory organizations adopt rules
(subject to approval by the SEC) which govern the industry and conduct periodic
examinations of member broker-dealers. Securities firms are also subject to
regulation by state securities commissions in the states in which they are
registered. FMSC is registered with, and subject to, the state securities
commissions in 49 states and the District of Columbia.
The regulations to which broker-dealers are subject cover all aspects
of the securities business, including sales methods, trading practices among
broker-dealers, capital structure of securities firms, record keeping and the
conduct of directors, officers and employees. Additional legislation, changes in
rules promulgated by the SEC and by self-regulatory bodies or changes in the
interpretation or enforcement of existing laws and rules often affect directly
the method of operation and profitability of brokers and dealers. The SEC and
the self-regulatory bodies may conduct administrative proceedings which can
result in censure, fine, suspension or expulsion of a broker-dealer, its
officers, representatives or employees.
Net Capital Requirements
As a registered broker-dealer and member of the NASD, FMSC is subject
to the SEC's Net Capital Rule which is designed to measure the general financial
integrity and liquidity of a broker-dealer.
Net capital is defined as the net worth of a broker or dealer subject
to certain adjustments, and computed by FMSC pursuant to the "aggregate
indebtedness method". Aggregate Indebtedness is deemed to mean the total money
liabilities of a broker or dealer arising in connection with any transaction
whatsoever, and includes, among other things, money borrowed, money payable
against securities loaned and securities "failed to receive," the market value
of securities borrowed to the extent to which no equivalent value is paid or
credited. For broker-dealers using this method, the Net Capital Rule requires
that the ratio of aggregate indebtedness, as defined, to net capital, as
defined, not exceed 15 to 1, and imposes restrictions on operations as described
below. In computing net capital, various adjustments to net worth are made with
a view to excluding assets which are not readily convertible into cash and
making a conservative statement of other assets, such as a firm's position in
securities. Compliance with the Net Capital Rule limits those operations of
securities firms which require the intensive use of their capital, such as
underwriting commitments and principal trading activities, and limits the
ability of securities firms to pay dividends.
In addition to the above requirements, funds invested as equity capital
may not be withdrawn, nor may any unsecured advances or loans be made to any
stockholder of a registered broker-dealer, if, after giving effect to such
withdrawal, advance or loan and to any other such withdrawal, advance or loan as
well as to any scheduled payments of subordinated debt which are scheduled to
occur within six months, the net capital of the broker-dealer would fail to
equal 120% of the minimum dollar amount of net capital required or the ratio of
aggregate indebtedness to net capital would exceed 10 to 1. Further, any funds
invested in the form of subordinated debt generally must be invested for a
minimum term of one year and repayment of such debt may be suspended if the
broker-dealer fails to maintain certain minimum net capital levels. For example,
scheduled payments of subordinated debt are suspended in the event that the
ratio of aggregate indebtedness to net capital of the broker-dealer would exceed
12 to 1 or if its net capital would be less than 120% of the minimum dollar
amount of net capital required.
At December 31, 1997, FMSC had net capital of approximately $2,398,817
which was $2,148,817 in excess of required net capital, and its ratio of
aggregate indebtedness to net capital was 1.28 to 1.
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
percentage (120%) of the minimum net capital requirement. Compliance with the
net capital rule could limit those operations of the Company's brokerage
subsidiaries that require the intensive use of capital, such as underwriting and
trading activities, and also could restrict the Company's ability to withdraw
capital from its operating subsidiaries, which in turn, could limit the
Company's ability to pay dividends, repay debt and redeem or purchase shares of
its outstanding capital stock.
Employees
The Company currently utilizes approximately 388 registered
representatives of which 326 are associated with affiliate offices. In addition,
the Company employs 55 support employees in the areas of operations, compliance,
accounting, administrative and clerical.
There is an intense competition among securities firms for executives with
extensive sales experience. To a large degree, FMSC's future success will depend
upon its continuing ability to locate, hire and retain highly skilled investment
executives. FMSC considers its relations with its employees to be satisfactory.
Item 2. Properties
Offices and Facilities
In March 1997, the Company entered into a new seven year lease (the "Master
Lease"), commencing February 1, 1998 for 22,762 square feet of gross rentable
area at its executive offices which are located at Parkway 109 Office Center,
328 Newman Springs Road, Red Bank, New Jersey. The rent for the premises is
$35,850 per month, and in addition to the base rent, the Company pays as
additional rent, a proportional share of any increases in real estate taxes
above the amount paid during the 1998 calendar year, insurance premiums relating
to the premises, and all utility charges relating to the use of the premises. In
March 1998, the Company signed a First Amendment to the Master Lease
incorporating all of the other rented space in the Red Bank facility into the
March 1997 Master Lease. The First Amendment to the Lease covers an aggregate of
32,442 gross rentable square feet at a monthly rental payment of $52,000 through
January 2005. The Master Lease and First Amendment also contain a six-year
option to renew providing for a base rental payment of approximately $65,000 per
month.
In June 1996, Montauk Insurance Services, the Company's insurance
subsidiary, leased 3,150 square feet in Paramus, New Jersey to house its
administrative offices. In September 1997 the Paramus office also became the
home of Century Discount Securities, the Company's new discount brokerage
operation. The three year lease provides for monthly base rent of $5,053 for the
first year, $5,315 for the second year, and $5,578 for the third year.
The use of facilities for all branch and/or satellite offices are provided
for by the individual registered representatives at such facility at no cost,
expense or obligation to the Company. Similarly, all furnishings, fixtures,
telephone systems, office equipment and quotation retrieval systems are the
responsibility of the affiliated registered representative at no cost, expense
or obligation to the Company.
Item 3. Legal Proceedings
Many aspects of the Company's business involve substantial risks of
liability. In recent years, there has been an increasing incidence of litigation
and arbitration involving the securities industry, including shareholder class
actions which generally seek compensatory damages and rescission.
In June, 1997, the Securities and Exchange Commission entered an Order
against FMSC relating to an alleged failure to supervise a former affiliate
office in Houston, TX. Without admitting or denying the findings of the SEC,
FMSC consented to the issuance of an Order making findings and imposing remedial
sanctions and a Cease-and-Desist Order in the matter of First Montauk Securities
Corp., Admin. Proc. File No. 3-9342, Release No. 34-38775 (June 25, 1997) (the
"Order"). FMSC was (1) ordered to cease and desist from present or future
violations of Securities (15)(c) and 17(a) of the Securities Exchange Act of
1934 ("Exchange Act") and Rules 15c3-1, 17a-3, 17a-5 and 17a-11 thereunder, and
(2) censured and required to pay disgorgement in the amount of $175,458,
pre-judgment interest in the amount of $51,584 and a civil money penalty in the
amount of $50,000. In addition, FMSC was required to retain an independent
Consultant to conduct a review of, and to report and make recommendations as to,
FMSC's supervisory and compliance policies and procedures, particularly as they
relate to the firm's affiliate program and the supervision of the firm's branch
offices by the main office. The Consultant issued its draft report during
January, 1998. FMSC prepared its response to the Consultant in early February
and await receipt of the Final Report. FMSC will then commence implementation of
the Consultant's recommendations within the time frame set forth in the order.
In February, 1997, FMSC entered into a Consent Decree with the State of
Florida, without admitting or denying the findings, relating to the alleged
failure to supervise a former affiliate office in Houston. FMSC agreed to pay a
fine of $15,000, engage an independent consultant, as well as other provisions
temporarily limiting brokerage activities in the State of Florida. (See above)
FMSC has been the subject of other legal actions relating to the sale
of securities by the Houston office. In 1996, the Company, without admitting
liability or wrongdoing, settled various claims asserted by Escambia County,
Florida for $900,000 in cash. In January 1997, the Company settled another
customer lawsuit for $750,000, with $500,000 payable upon execution of
settlement documents, and the balance of $250,000 payable in five annual
installments of $50,000 plus interest at 8% per annum. The five installments are
evidenced by notes payable, which have been subordinated to the claims of the
Company's general creditors under a subordination agreement approved by the
NASD.
In fiscal 1997, the Company settled two civil lawsuits and one
arbitration in the aggregate amount of $1,706,455. Each of these cases resulted
from claims made by customers of the former Houston branch office registered
representatives in connection with the purchase of certain Mortgage Backed
Securities ("MBS").
The Company is a defendant in one remaining civil action relating to
these matters which is currently pending in the United States District Court for
the Northern District of Ohio, Eastern Division, (case number 1:96CV 1063), City
of Painesville, Ohio v. First Montauk Financial Corp., First Montauk Securities
Corp. et al. The Plaintiff seeks compensatory damages of an unspecified amount
estimated by Plaintiff to be not less than $5,000,000 plus punitive damages,
attorney's fees, interest and cost. A similar arbitration proceeding was
commenced in November 1997 seeking $1,000,000 in damages. The Company is
vigorously defending these cases and based upon discussions with special counsel
and other information, it believes that it has a meritorious defense to this
action. This belief is derived from, among other things, discussions with the
Company's counsel.
In 1997, FMSC settled a customer arbitration for $500,000 in cash.
Under terms of the settlement, the Company also issued to the customer and her
counsel a total of 150,000 five-year warrants to purchase FMFC common stock for
$1.25 per share. Two of the Company's officers agreed to guarantee a minimum
selling price of $1.917 per share with respect to the shares underlying the
warrants and established a $100,000 escrow account with personal funds to secure
the guarantee. The warrantholders had a sixty-day period in which to exercise
the warrants and sell the shares, commencing from the date that the warrants
were registered for resale. The warrant registration became effective in June
1997. The individuals exercised their warrants in 1997 at various dates on which
the quoted market price for the shares exceeded the guaranteed price.
FMSC is also a respondent in certain pending customer arbitrations, and
other matters relating to its securities business. These claims are in various
stages of progress and are being vigorously contested.
Management is unable to derive a meaningful estimate of the amount or
range of possible loss that may arise out of pending litigation (including
litigation costs in any particular subsequent quarterly or annual period, or in
the aggregate). However, it is possible that the financial condition, results of
operations, or cash flows of the Company in subsequent quarterly or annual
periods could be materially affected by the ultimate outcome of such pending
litigation or proceedings.
The Company is presently reviewing the extent to which settled and
pending claims may be covered under its insurance policies. In January 1997, the
Company negotiated a $650,000 settlement with one of its insurance carriers in
consideration of a general release from coverage on various matters. Discussions
with other carriers for reimbursement of settlements paid by the Company are
continuing. There can be no assurance that the Company will be successful in its
efforts to recover additional funds from its insurers on settled claims, or that
monetary losses, if any, from future claims, settlements or adverse judgments
will be covered under the Company's existing insurance policies.
Item 4. Submission of Matters on a Vote of Security Holders
Not Applicable.
PART II
Item 5. Market of and Dividends on the Company's
Common Equity and Related Stockholder Matters
A. Principal Market
The Company's Common Stock is traded in the over-the-counter market.
Trading in the Company's Common Stock is reported on the NASD Bulletin Board
system and by the National Daily Quotation Service published by the National
Quotation Bureau, Inc. The Company believes that there is an established public
trading market for the Company's Common Stock based on the volume of trading in
the Company's Common Stock and the existence of market makers who regularly
publish quotations for the Company's Common Stock. The Company's Class A, Class
B and Class C Warrants commenced trading in the over-the-counter market upon
their issuance in March 1998.
B. Market Information
The Company's Common Stock commenced trading in the over-the-counter market
in 1987. On April 7, 1998, the Company's common stock had a high and low bid
price of $2.71875 and $2.53125, respectively.
The following is the range of high and low bid prices for such securities
for the periods indicated below:
Common Stock
Fiscal Year 1998 High $ Low $
1st Quarter 2.875 2.00
2nd Quarter 2.75 2.50
(through April 6, 1998)
Fiscal Year 1997 High $ Low $
1st Quarter 3.125 .96
2nd Quarter 2.78125 2.4375
3rd Quarter 2.75 2.15625
4th Quarter 2.875 2.1875
Fiscal Year 1996 High $ Low $
1st Quarter 1.0625 .84375
2nd Quarter 2.1875 .8125
3rd Quarter 1.53 1.03125
4th Quarter 1.13 .80
Item 6. Selected Financial Data
Year ended December 31,
1997 1996 1995 1994 1993
Operating results:
Revenues:
Commissions $ 27,018,244 $ 25,749,690 $ 17,113,296 $ 9,861,294 $ 9,075,148
Net dealer
inventory amd
trading gains 7,257,576 7,660,700 9,763,940 7,781,667 8,956,755
Investment banking 1,433,100 634,329 388,249 766,013 531,314
Insurance recovery 650,000 - - - -
Interest and other
income 1,383,713 1,044,969 1,076,718 691,413 454,425
---------- ---------- ---------- ---------- ----------
Total revenues 37,742,633 35,089,688 28,342,203 19,100,387 19,017,642
---------- ---------- ---------- ---------- ----------
Expenses:
Commissions, employee
compensation and
benefits 26,785,205 25,428,184 19,542,578 14,242,933 15,072,621
Clearing and floor
brokerage 3,021,709 3,139,142 3,112,474 1,828,197 1,672,127
Communications and
occupancy 1,860,350 1,662,936 1,260,209 961,582 583,257
Legal matters and
related costs 1,452,001 2,731,997 1,542,328 345,735 108,502
Other operating
expenses 2,093,670 2,006,615 1,439,926 1,247,345 810,011
Interest 84,695 105,772 192,752 157,660 70,008
--------- --------- --------- --------- -------
Total expenses 35,297,630 35,074,646 27,090,267 18,783,452 18,316,526
---------- ---------- --------- ---------- ----------
Income before
income taxes 2,445,003 15,042 1,251,936 316,935 701,116
Income taxes
(benefit) 968,178 (17,747) 483,848 124,799 (52,525)
------- ------- ------- ------- -------
Net income $ 1,476,825 $ 32,789 $ 768,088 $ 192,136 $ 753,641
Net income
applicable to
common stock $ 1,476,825 $ 32,789 $ 768,088 $ 192,136 $ 740,564
Net income per
common share:
Basic $ 0.17 $ 0.01 $ 0.10 $ 0.02 $ 0.11
Diluted $ 0.14 $ 0.01 $ 0.09 $ 0.02 $ 0.09
Weighted average
shares outanding
Basic 8,788,734 7,767,224 8,044,622 8,070,406 6,723,342
Diluted 10,351,032 8,623,538 8,380,906 8,409,267 8,066,476
Financial condition:
Total assets $ 11,971,934 $8,742,039 $10,486,967 $7,082,267 $6,800,407
Long-term debt $ 444,844 $ 362,380 $ 21,612 $ 47,544 $ -
Other liabili-
ties $ 4,287,623 $4,262,880 $ 6,864,409 $4,019,001 $4,743,730
Common Stock
issued with
guaranteed
selling price $ 346,500 $ 421,500 $ - $ - $ 11,500
Stockholders'
equity $ 6,892,967 $3,695,279 $ 3,600,946 $3,063,266 $2,056,677
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Results of Operations
Fiscal 1997 as Compared to Fiscal 1996
Total revenues for 1997 were $37,742,633, the best revenue performance in
the Company's history, as compared to 1996's record levels of $35,089,688. The
Company benefited with the rest of the brokerage industry in 1997 from record
gains in the U.S. equity markets. Despite continued strong revenue growth, the
Company's performance was again negatively impacted by costs totaling $1,452,001
to defend and settle various legal matters during 1997. These costs eroded what
would have been additional operating profits for the year.
Commission income from the sale of listed and over-the-counter securities,
mutual funds, insurance products and other agency transactions rose 5% to a
record $27,018,244 (72% of total revenues) as compared to $25,749,690 (73% of
total revenues) in 1996. The largest revenue increase in 1997 once again came
from the rise of mutual fund investments among retail customers, who have
continued to participate in the securities markets in record numbers. Mutual
fund commission revenues rose from $3,851,731 in 1996 to $5,480,434 in 1997, an
increase of 42%. These commissions accounted for 15% of the Company's total
revenues in 1997. Commissions from the insurance products division, which began
operations in 1995, continued its steady growth rate, increasing sales from
$1,719,102 in 1996 to $2,025,967 in 1997, as the Company continued to promote
the sale of insurance related products and pursue insurance licensing among its
existing registered representatives. Management is making a continued effort to
expand the asset management and fee based segments of the Company's business, as
these areas continue to increase in favor within the investing public. The
Company has increased the number of fee-based packaged products and services to
its customers, including insurance, annuity and managed account providers.
Revenues from principal transactions decreased by 5% from 1996 levels of
$7,660,700 (22% of total revenues) to $7,257,576 (19% of total revenues) in
1997. Revenues from market-making activities in over-the-counter equities and
trading profits decreased slightly during 1997 as the major focus of the
Company's business continued to shift away from executing principal transactions
and towards commission and fee based revenue. In addition, the implementation of
new order handling and "price improvement" rules have made market-making
activities less profitable. The Company has continued to execute more of its
over-the-counter equity business on an agency basis, whereby the Company earns
commissions for serving as an agent between its customer and another brokerage
firm making a market in the particular security being traded.
Investment banking revenues rose from $634,329 in 1996 to $1,433,100 in
1997. This increase was principally due to the completion of an underwriting for
PacificHealth Laboratories, Inc. in December 1997. The Company also participated
in approximately 90 syndicate transactions and acted as placement agent for
three private placements during the fiscal year. The Company intends to continue
exploring various opportunities in the investment banking area, including
securities private placements and underwritings.
Interest income increased by $223,723 to $1,063,092 in 1997, due primarily
to higher credit balances in the Company's proprietary accounts, as well as
higher credit and margin debit balances in customer accounts during the current
fiscal year.
During 1997 the Company paid commissions, employee compensation and
employee benefits of $26,785,205 (71% of total revenues) as compared to
$25,428,184 (72% of total revenues) in 1996. This category includes salaries,
commission expense, and fringe benefits for salaried employees. Commissions paid
to registered representatives for 1997 were $22,356,878 (59% of total revenues)
as compared to $21,932,573 (63% of total revenues) in 1996. The percentage
decrease in 1997 was partially due to the increased level of investment banking
income, which involves a lower commission payout. In addition, commission
expense as a percentage of total revenues fluctuates depending upon the mix of
commission-based business and trading profits or losses, as well as the relative
contribution to revenues from the Company's in-house brokers and affiliate
offices. In-house brokers receive a lower commission payout than independent
affiliates, but are not generally required to pay their own overhead.
For 1997, the Company paid salaries of $3,658,010 for management,
operations and clerical personnel, as compared to $2,752,482 in 1996. This
increase was due in part to the addition of several new key employees, including
individuals retained to establish the Company's new discount division, Century
Discount Securities. The Company also hired additional trading assistants and
other operational and clerical personnel for transactions processing.
Clearing costs declined slightly from $3,139,142 (9% of revenues) in 1996
to $3,021,709 (8% of revenues) in 1997. The percentage of clearing costs to
total revenue will fluctuate depending upon the combination of agency business
and proprietary trading, as well as the average revenue per transaction in a
particular period.
Communications and occupancy costs rose by $197,414 to $1,860,350 in 1997,
an increase of 12% over 1996. The increase is due to the expansion of the
Company's headquarters and higher charges for communication networks and market
data services. Management expects this expense category to increase as a result
of a new master lease agreement effective February 1998 which expands the
Company's facilities. The new seven year lease, as amended, covers an aggregate
of 32,442 gross rentable square feet at a monthly rental payment of $52,000
through January 2005. The master lease and amendment also contain a six year
renewal option providing for a base rental payment of approximately $65,000 per
month. The expanded office will house additional registered representatives as
well as administrative and clerical personnel. The new facility will also
include an expanded order and trading room, as well as improved distribution and
operation areas.
Legal matters and related costs include payments to settle customer claims,
professional fees and other defense costs, and provisions for pending
litigation. These costs totaled $1,452,001 in 1997, a decrease of 47% from a
total of $2,731,997 in the prior year.
The Company is a defendant in a civil action relating to FMSC's former
Houston affiliate office which sold mortgage-backed securities to its customers.
The Plaintiff seeks compensatory damages of an unspecified amount estimated by
Plaintiff to be not less than $5,000,000 plus punitive damages, attorney's fees,
interest and cost. A similar arbitration proceeding was commenced in November
1997 seeking $1,000,000 in damages. The Company is vigorously defending these
cases and based upon discussions with special counsel and other information, it
believes that it has meritorious defenses to these actions.
In 1996, FMSC settled a customer arbitration for $500,000 in cash. In 1997,
FMSC paid the cash settlement, and also issued 150,000 five-year Warrants to
purchase FMFC Common Stock for $1.25 per share to the customer and her counsel.
In 1997 the individuals exercised their Warrants from which the Company received
proceeds of $187,500.
The Company has also been the subject of a Securities and Exchange
Commission Administrative Order that was entered in June 1997, which resulted in
a $50,000 fine and censure. The Company also agreed to disgorge profits of
$175,000 from gains on securities sold from the Houston office. The SEC has
informally consented to credit the disgorgement against amounts already paid by
FMSC in settlement of civil litigations brought by former customers of the
Houston office. The settlement also includes the requirement to engage an
independent compliance examiner to audit FMSC's compliance procedures.
FMSC is also a respondent in certain pending customer arbitrations, and
other matters relating to its securities business. These claims are in various
stages of progress and are being vigorously contested.
Management is unable to derive a meaningful estimate of the amount or range
of possible loss that may arise out of pending litigation (including litigation
costs in any particular subsequent quarterly or annual period, or in the
aggregate). However, it is possible that the financial condition, results of
operations, or cash flows of the Company in subsequent quarterly or annual
periods could be materially affected by the ultimate outcome of such pending
litigation or proceedings.
The Company is presently reviewing the extent to which settled and pending
claims may be covered under its insurance policies. In January 1997, the Company
negotiated a $650,000 settlement with one of its insurance carriers in
consideration of a general release from coverage on various matters. Discussions
with other carriers for reimbursement of settlements paid by the Company are
continuing. There can be no assurance that the Company will be successful in its
efforts to recover additional funds from its insurers on settled claims, or that
monetary losses, if any, from future claims, settlements or adverse judgments
will be covered under the Company's existing insurance policies.
In an effort to reduce future legal claims and liabilities, the Company has
hired an additional staff attorney, a new director of compliance and has engaged
the services of an independent compliance consultant to provide recommendations
to the Company's management in connection with supervisory and regulatory
matters. Management believes that these measures, along with other planned
action, will assist in the reduction of customer claims. However, there is no
assurance that the Company will be successful in its efforts to reduce such
claims in the future.
Other operating expenses increased from $2,006,615 in 1996 to $2,093,670 in
1997. The Company is continuing to invest in its affiliate recruitment program
through increased advertising and marketing campaigns. The Company expects
insurance premiums to increase due to additional errors and omissions and
fidelity bond coverages.
The Company's record revenues and profits were achieved as a result of the
continued robust economy and favorable investment climate in the United States
during 1997. The Company continued its trend of building its infrastructure for
future growth, including expansion of the corporate headquarters, new marketing
and advertising campaigns, the investment in a new data management system, and
the hiring of additional legal and compliance personnel.
Fiscal 1996 as Compared to Fiscal 1995
Total revenues for 1996 increased to $35,089,688, the best revenue
performance in the Company's history, surpassing 1995's record levels by
$6,747,485, or nearly 24%. The Company benefitted with the rest of the brokerage
industry in 1996 from record gains in the U.S. equity markets. Despite strong
revenue growth, the Company's performance was negatively impacted by costs
totalling $2,731,997 to defend and settle various legal matters during 1996. The
most significant costs arose from the activities of a former affiliate office in
Houston, Texas. These costs essentially negated what would have been record
operating profits for the year.
Commission income from the sale of listed and over-the-counter securities,
mutual funds, leasing, and other agency transactions rose 50% to a record
$25,749,690 (73% of total revenues) as compared to $17,113,296 (60% of total
revenues) in 1995. The Company's commission revenues have steadily increased in
absolute dollars and as a percentage of total revenues due to several factors,
including the addition of leasing and insurance products, the increasing
popularity of mutual fund investment among retail customers, the decline in
principal revenues from the sale of mortgage-backed securities, and the trend
towards executing more over-the-counter equity orders on an agency basis. The
largest revenue increases in 1996 once again came from stock and mutual fund
transactions, as retail investment volume maintained strength throughout the
year. Commissions from the insurance products division, which began operations
in 1995, increased significantly from $121,417 in 1995 to $1,719,102 in 1996. As
the Company's operations shift towards a greater reliance on volume driven
revenues, significant swings in market activity from quarter-to-quarter are
expected to have a more dramatic impact on operating profits.
Revenues from principal transactions decreased by 22% from 1995 levels of
$9,763,940 (34% of total revenues) to $7,660,701 (22% of total revenues).
Revenues from market-making activities in over-the-counter equities and trading
profits reached record levels in the first half of 1996 as the U.S. equity
markets continued to reach record levels. During the third and fourth quarters,
however, net revenues in this category trailed off considerably, due to a
combination of lower transactions' volume, particularly in the seasonally slow
third quarter, and losses sustained in the Company's equity and municipal bond
trading portfolios. In addition, the Company has begun to execute more of its
over-the-counter equity business on an agency basis, whereby the Company earns
commissions for serving as an agent between its customer and another brokerage
firm making a market in the particular security being traded. In so doing, the
Company can reduce its inventory levels, the corresponding amount of capital
required to maintain those levels, and its exposure to losses from fluctuations
in market values. The Company also discontinued trading in mortgage-backed
securities ("MBS") in 1995 and closed the affiliate office conducting MBS
operations. Revenues from MBS transactions totalled $361,158 in 1995.
Investment banking revenues were $634,329 in 1996 as compared to $388,249
in 1995 due to an increase in sales concessions from participation in selling
groups and the completion of a private placement during the current year. The
Company intends to continue exploring various opportunities in the investment
banking area, including securities private placements and underwritings.
Interest income increased by 14% to $839,369 in 1996, due primarily to
higher credit balances in the Company's trading accounts during the year as
inventory levels dropped. The increase was slightly more than offset by declines
in clearing rebates and other fees.
During 1996 the Company paid commissions, employee compensation and
employee benefits of $25,428,184 (72% of total revenues) as compared to
$19,542,578 (69% of total revenues) in 1995. This category includes salaries,
commission expense, and fringe benefits for salaried employees. Commissions paid
to registered representatives for 1996 were $21,932,573 (62% of total revenues)
as compared to $16,539,208 (58% of total revenues) in 1995. The dollar increase
in 1996 resulted primarily from a higher volume of agency transactions, as was
the case in 1995. Commission expense as a percentage of total revenues will
fluctuate in the future depending upon the mix of commission-based business and
trading profits or losses, as well as the relative contribution to revenues from
the Company's in-house brokers and affiliate offices. In-house brokers usually
receive a lower commission payout than independent affiliates, but are not
generally required to pay their own overhead.
For 1996 the Company paid salaries of $2,752,482 for management, operations
and clerical personnel, as compared to $2,196,905 in 1995. This increase was due
in part to growth in 1996 revenues, which required additional trading assistants
and other personnel for transactions processing. The Company also added
employees to its computer, marketing and finance departments in the latter part
of 1995.
Clearing costs increased from $3,112,474 (11% of revenues) in 1995 to
$3,139,142 (9% of revenues) in 1996 due to higher transactions' volume. The
percentage of clearing costs to total revenue will fluctuate depending upon the
combination of agency business and proprietary trading, as well as the average
revenue per transaction in a particular period. The Company also negotiated a
more favorable fee structure with its clearing firm in 1996.
Communications and occupancy costs rose by $402,727 to $1,662,936 in 1996,
an increase of 32% over 1995. The increase is due to higher telephone charges,
market data services, and computer consulting costs associated with the addition
of trading personnel and in-house brokers, and higher market volume. Management
believes that growth in this expense category will slow due to recent
negotiations with a long distance carrier establishing lower rates for telephone
service, as well as to planned reductions in the cost of operating the Company's
wide area network. One partial offsetting factor is expected to be higher
occupancy costs, owing to the further expansion of the Company's headquarters in
January 1998.
Legal matters and related costs include payments to settle customer claims,
professional fees and other defense costs, and provisions for pending
litigation. These costs increased to $2,731,997 in 1996 from $1,542,328 in the
prior year. Costs incurred in 1995 include expense provisions of $204,000
relating to the settlement with plaintiffs in a federal lawsuit, and $900,000 to
settle a lawsuit with Escambia County, Florida stemming from MBS sales by the
former affiliate office. In 1996, the Company became the subject of additional
litigation and regulatory investigations relating to its MBS operations. One of
these cases was settled in January 1997 for $750,000. The Company is also
expected to enter into an Offer of Settlement with the Securities and Exchange
Commission, which will likely result in a $50,000 fine and censure. Another
customer arbitration unrelated to the MBS activities was also settled in January
1997 for $500,000 plus the issuance of common stock purchase warrants. (See Note
11 to the financial statements). Apart from the costs of settling various
matters and providing for future settlements, the Company incurred substantial
fees for legal representation in 1995 and 1996 in connection with the MBS
litigations as well as others. Management is unable to derive a meaningful
estimate of the amount or range of possible loss relating to pending litigation
(including litigation costs) in any particular quarterly or annual period, or in
the aggregate. However, it is possible that the financial condition, results of
operations or cash flows of the Company in particular quarterly or annual
periods could be materially affected by the ultimate outcome of certain pending
litigation. The Company is presently reviewing the extent to which settled and
pending claims may be covered under it insurance policies. In January 1997, the
Company negotiated a $650,000 cash settlement with one of its carriers, and is
continuing discussions with other carriers. There can be no assurance that the
Company will be successful in its efforts to recover additional funds from these
insurers.
Other operating expenses increased from $1,439,926 in 1995 to $2,006,615 in
1996. The increase was due primarily to an increase in business development
costs associated with the Company's affiliate recruitment program, as well as
higher insurance and administrative overhead costs.
While the Company achieved record revenue and profits' growth in the first
half of 1996, operating results continued to be sensitive to general economic
conditions, particularly the interest rate environment, and the outlook of
retail investors on the financial markets. These markets became more uncertain
and volatile in the third and fourth quarters of 1996, and transactions volume
in mutual funds and equity trading, the principal sources of the Company's
commission-based revenues, declined. However, trading losses and legal costs
were the primary causes of the weak operating results in 1996. Accordingly, the
Company is reviewing its trading operations with a view towards improving the
management of its trading risks, and is seeking to resolve pending legal claims
and regulatory problems as expeditiously as possible.
Liquidity and Capital Resources
Operating activities contributed cash of $420,867 during 1997. Inventory
positions of securities held by the Company increased by $1,528,069. A
substantial portion of the Company's assets are liquid, consisting of cash and
assets readily convertible into cash, such as securities inventories, and
receivables due from the Company's clearing firm, which increased by $842,357 to
$2,707,782 at the end of 1997. The balances in the Company's cash, inventory and
clearing firm accounts can and do fluctuate significantly from day to day,
depending on market conditions, daily trading activity, and investment
opportunities. The Company monitors these accounts on a daily basis in order to
ensure compliance with regulatory capital requirements and to preserve
liquidity.
In 1997 and 1996, the Company realized tax benefits of $722,605 and
$23,789, respectively, related to the exercise of stock options during the
fiscal year. (See Note 2 to the consolidated financial statements). These tax
benefits are available to reduce actual corporate tax liabilities. Under
applicable accounting rules, such benefits are reported as an increase in
stockholders' equity rather than as an item of income.
Investing activities used cash of $1,456,277 in 1997. Capital expenditures
of $534,005 consisted primarily of an investment in a new securities back office
data management system, additional computer equipment, and furniture and
fixtures for the company's home office expansion. The cost to develop the new
data management system will continue into 1998. On August 1, 1997, the Company
entered into a Software License and Development Agreement with Uptick
Technologies, Inc. ("Uptick") to develop, deliver and install a sales production
and operations management system, based upon Uptick proprietary software
programs and the Company's functional specifications. In payment of the license
fee, the Company caused its parent to issue 58,400 shares of its Common Stock to
Uptick and to use its best efforts to prepare, file and effect registration of
the Shares pursuant to the Securities Act of 1933 with an option to put the
stock back to the Company in the event that the Company fails to effect
registration of the shares. The license fee and Common Stock have been valued at
$175,000. In addition, the Company is obligated to pay Uptick development
services charges and consulting service fees at an hourly rate billed monthly
and reimburse Uptick for certain costs and expenses. The Company retained the
ability to receive from Uptick certain stated percentages (ranging from 20% to
5%) of all license fees earned and received by Uptick for license of the sales
production and operations management system to unrelated third parties up to
July 7, 2000. The amount of revenue-sharing from license fees will be limited to
the total of all contract payments made by the Company to Uptick.
Amounts advanced to brokers and affiliates increased by $185,592 to
$927,195. The increase is attributable to loans to new affiliates as an
inducement to join the Company, advances to employees, and receivables from
brokers as a result of trading losses and customer debits which are broker
obligations. The Company, through its subsidiary, Montauk Advisors, Inc.,
("MAI") made loans to Global of $569,500 in 1997. During the first quarter of
1998, MAI made additional loans to Global of $525,000. The loans bear interest
at 8% per annum and are due in April and May 1998. MAI at its sole option, may
accept payment of the loans on an installment basis, and may extend any or all
of the loans. The first note which was due on April 1, 1998 has been extended to
September 1, 1998. Global is the finance company, which packaged and sold leases
to investors through MAI. These loans were made for the purpose of assisting
Global in meeting cash flow deficiencies arising from the nonpayment of
scheduled monthly installments on certain delinquent and non-performing leases.
Most of the arrears are due from Fem-Com Copy Systems, Inc. ("FCS"), Global's
affiliated equipment vendor and Biblio, Inc. ("Biblio"), an affiliate of FCS.
The MAI notes are guaranteed by Global; FCS; Biblio and the shareholder of FCS
and Biblio. The notes are further collateralized by mortgage liens on real
estate owned by the shareholder of FCS and Biblio, a pledge of all of the
outstanding shares in Global, and various recorded liens on the assets of FCS
and Biblio. MAI expects that Global will seek additional funds to meet its
continuing lease payment obligations.
MAI has provided FCS with working capital financing to purchase equipment
for resale to FCS customers. MAI believes, but cannot assure, that by continuing
to provide this kind of financial assistance, FCS will be better positioned to
repay its indebtedness to Global. MAI charges a 1% commitment fee on the loans
plus interest at the rate of 12% per annum. The loans are evidenced by a note
which is payable with interest on September 30, 1998.
Financing activities provided cash of $755,745 in 1997. Proceeds from
exercise of stock options and warrants of $850,254 and the receipt of $23,027
from the issuance of shares of common stock was partially offset by payments on
bank loans during the year of $117,536, under term notes bearing interest at
prime (8.5% at December 31, 1997).
At December 31, 1997, the Company's broker-dealer subsidiary had net
capital of $2,398,817, which was $2,148,817 in excess of its required net
capital of $250,000, and the ratio of aggregate indebtedness to net capital was
1.28 to 1.
Management believes that the Company's liquidity needs at least through the
next fiscal year, will be provided by operating income and the proceeds of a
rights offering to stockholders of record on December 15, 1997. In March 1998
the Company received gross proceeds of $1,382,750 from the offering of 3,072,779
units; each unit consisting of one Class A Warrant, one Class B Warrant and one
Class C Warrant. The warrants have exercise prices and expiration dates as
follows:
Warrant Exercise Price Expiration Date
------- -------------- ---------------
Class A $3.00 February 17, 2001
Class B $5.00 February 17, 2003
Class C $7.00 February 17, 2005
Should the market price of the Company's common stock increase to the level
where any or all of the classes or a portion of the classes of warrants become
exercisable, the Company will obtain additional proceeds from the exercise of
the warrants.
In 1997 the Company converted a portion of one of its legal settlement
obligations into a subordinated loan with the debtor. The five year $250,000
loan bears interest at the rate of 8% per annum, with payments of $50,000
principal and interest on the declining balance due on the first of April of
each of the five years of the loan. The first payment of principal and interest
was made on April 1, 1998. The loan is subordinated to the liabilities of FMSC's
general creditors, and has been approved as to its form by the NASD.
Purchase Commitments
In 1997, the Company entered into a three-year agreement with a long
distance carrier under which the Company has committed to pay minimum annual
charges of $300,000 in each of the three contract years, in consideration of
favorable rates on telephone and data communications service during the
commitment period.
Year 2000 Issue
The onset of the year 2000 brings challenges to companies who use and rely
on computers and technology as a function of their businesses. Many existing
computer programs use only two digits to identify a year in the date field.
These programs were designed and developed without considering the impact of the
upcoming change in the century. If not corrected, many computer applications
could fail or create erroneous results by or at the Year 2000.
The Company has commenced reviewing its compliance with what has come to be
known as the Year 2000 issue ("Y2K"). The Company does not create or develop
computer programs on its own. Rather, it is reliant on outside vendors for
verification of the compliance of their applications which are utilized by the
Company. The Company has currently identified 17 programs which are utilized by
the Company in various departments, which require compliance with Y2K. We have
requested each of these vendors to supply verification that the software which
is utilized by the firm is or will be Y2K compliant by the Year 2000. The most
significant of these outside vendors is the Company's clearing firm, Schroder &
Co., Inc.
The Company has already received some verbal notices of compliance, but is
awaiting a final written confirmation from these vendors. The Company has
designated an individual within the organization to coordinate the Y2K
compliance issue, to communicate with each of the software and service vendors,
to ensure Y2K compliance before the turn of the century. While management has
not finalized an estimate of the cost of internal system modifications, it does
not believe that these costs will have a material impact on the Company's
operations in fiscal 1998.
Impact of Inflation and Other Factors
Management of the Company believes that the impact of inflation has an
effect upon the amount of capital generally available for investment purposes
and also may affect the attitude or willingness of investors to buy and sell
securities. The nature of the business of the Company's broker-dealer subsidiary
and the securities industry in general is directly affected by national and
international economic and political conditions, broad trends in business and
finance and volatility of interest rates, changes in and uncertainty regarding
tax laws, and substantial fluctuation in the volume and price levels of
securities transactions and the securities markets. To the extent inflation
results in higher interest rates and has other adverse effects on the securities
markets and the value of securities held in inventory, it may adversely affect
the Company's financial position and results of operations.
Factors Affecting "Forward-Looking Statements"
From time to time, the Company may publish "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities and Exchange Act of 1934, as amended, or make oral
statements that constitute forward-looking statements. These forward-looking
statements may relate to /such matters as anticipated financial performance,
future revenues or earnings, business prospects, projected ventures, new
products, anticipated market performance, and similar matters. The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In order to comply with the terms of the safe
harbor, the Company cautions readers that a variety of factors could cause the
Company's actual results to differ materially from the anticipated results or
other expectations expressed in the Company's forward-looking statements. These
risks and uncertainties, many of which are beyond the Company's control,
include, but are not limited to: (i) transaction volume in the securities
markets, (ii) the volatility of the securities markets, (iii) fluctuations in
interest rates, (iv) changes in regulatory requirements which could affect the
cost of doing business, (v) fluctuations in currency rates, (vi) general
economic conditions, both domestic and international, (vii) changes in the rate
of inflation and related impact on securities markets, (viii) competition from
existing financial institutions and other new participants in competition from
existing financial institutions and other new participants in the securities
markets, (ix) legal developments affecting the litigation experience of the
securities industry, and (x) changes in federal and state tax laws which could
affect the popularity of products sold by the Company. The Company does not
undertake any obligation to publicly update or revise any forward-looking
statements.
Effects of Recently Issued Accounting Standards
In June 1997, SFAS 130, "Reporting Comprehensive Income," and SFAS 131,
"Disclosures About Segments of an Enterprise and Related Information," were
issued. SFAS 130 addresses standards for reporting and display of comprehensive
income and its components, and SFAS 131 requires disclosure of reportable
operating segments. In February 1998, SFAS 132, "Employers' Disclosures About
Pensions and Other Post-retirement Plans" was issued. SFAS 132 standardizes
pension disclosures. These statements are effective in 1998. The Company will be
reviewing these pronouncements to determine their applicability to the Company,
if any.
Item 8. Financial Statements
See Financial Statements attached hereto.
Item 9. Disagreements on Accounting and Financial Disclosure
Not Applicable.
PART III
Item 10. Directors and Executive Officers
The Directors and Executive Officers of the Company and its subsidiaries
are as follows:
Name Age Position
- - ---- --- --------
Herbert Kurinsky 66 Director, President and Chief Executive Officer of
FMFC and of FMSC and Registered Options Principal
of FMSC
William J. Kurinsky 37 Director, Vice President, Chief Operating and
Chief Financial Officer and Secretary of FMFC and
of FMSC and Financial/Operations Principal of FMSC
Brian M. Cohen 39 Vice President and General and Municipal Securities
Principal of FMSC
Edward L. Bayarski 47 President, MISI
Norma Doxey 58 Director
Ward R. Jones, Jr. 67 Director
David I. Portman 57 Director
The Company's Certificate of Incorporation provides for the classification
of the Board of Directors into three classes of Directors, each class as nearly
equal in number as possible but not less than one Director, each director to
serve for a three-year term, staggered by class. The Certificate of
Incorporation further provides that a Director or the entire Board of Directors
may be removed only for cause and only by the affirmative vote of the holders of
at least 70% of the combined voting power of the Company's voting stock, with
vacancies on the Board being filled only by a majority vote of the remaining
Directors then in office. "Cause" is defined as the willful failure of a
director to perform in any substantial respect such Director's duties to the
Corporation (other than any such failure resulting from incapacity due to
physical or mental illness), willful malfeasance by a Director in the
performance of his duties to the Corporation which is materially and
demonstrably injurious to the Corporation, the commission by a Director of an
act of fraud in the performance of his duties, the conviction of a Director for
a felony punishable by confinement for a period in excess of one year, or the
ineligibility of a Director for continuation in office under any applicable
rules, regulations or orders of any federal or state regulatory authority.
All officers serve at the discretion of the Board of Directors. No family
relationship exists between any officer or director except for Mr. Herbert
Kurinsky who is the uncle of Mr. William J. Kurinsky; and Mr. Brian M. Cohen who
is a cousin of both Messrs. Kurinsky.
Herbert Kurinsky became a Director and President of the Company on November
16, 1987. Mr. Kurinsky is a co-founder of First Montauk Securities Corp. and has
been its President, one of its Directors and its Registered Options Principal
since September of 1986. From March 1984 to August 1986, Mr. Kurinsky was the
President of Homestead Securities, Inc., a New Jersey broker-dealer. From April
1983 to March 1984, Mr. Kurinsky was a branch office manager for Phillips, Appel
& Waldon, a securities broker-dealer. From February 1982 to March 1983, Mr.
Kurinsky was a branch office manager for Fittin, Cunningham and Lauzon, a
securities broker-dealer. From November 1977 to February 1982, he was a branch
office manager for Advest Inc., a securities broker-dealer. Mr. Kurinsky
received a B.S. degree in economics from the University of Miami, Florida in
1954.
William J. Kurinsky became Vice President, a Director and Financial and
Operations Principal of the Company on November 16, 1987. He is a co-founder of
First Montauk Securities and has been one of its Vice Presidents, a Director and
its Financial/Operations Principal since September of 1986. Prior to that date,
Mr. Kurinsky was Treasurer, Chief Financial Officer and Vice President of
Operations of Homestead Securities, Inc., a securities broker-dealer. Mr.
Kurinsky received a B.S. from Rutgers University in 1984. He is the nephew of
Herbert Kurinsky.
Brian M. Cohen is a General Securities and Municipal Securities Principal,
of FMSC from August, 1986, to present. He is the manager of the fixed-income and
government securities department of FMSC. From August, 1984, to August, 1986, he
was a vice president and registered representative with Homestead Securities,
Inc. Mr. Cohen is a cousin to Mr. Herbert Kurinsky and Mr. William Kurinsky.
Brian M. Cohen, one of FMSC's principals, submitted a Settlement Offer in
connection with an SEC administrative proceeding which provides for a two month
suspension from association with any broker/dealer and an eighteen month bar
from acting in any supervisory capacity thereafter. Mr. Cohen also agreed to pay
a monetary fine of $5,000.
Edward L. Bayarski is President of Montauk Insurance Services, Inc. from
June, 1995 to the present. From April, 1993 to June, 1995, he was an investment
planner with New England Securities in Fairfield, New Jersey. From October, 1984
to April, 1993 Mr. Bayarski was an insurance specialist with Merrill Lynch in
Paramus, New Jersey. Mr. Bayarski received a B.A. degree in Economics in 1972
from Seton Hall University, Newark, New Jersey and obtained a Chartered Life
Underwriter designation in 1978.
Norma L. Doxey has been a Director of the Company since December 6, 1988.
Ms. Doxey is the Vice President for Operations and a Registered Representative
with First Montauk Securities Corp. since September, 1986. From August through
September, 1986, she was operation's manager and a Registered Representative
with Homestead Securities, Inc. From July 1984 through August 1985 she held the
same position with Marvest Securities.
Ward R. Jones, Jr. has been a director of the Company since June, 1991.
From 1955 through 1990, Mr. Jones was employed by Shearson Lehman Brothers as a
registered representative, eventually achieving the position of Vice President.
Mr. Jones is currently a registered representative of First Montauk Securities
Corp., but does not engage in any securities business.
David I. Portman has been a director of the Company since June 15, 1993.
From 1978 to the present, Mr. Portman served as the President of Triad Property
Management, Inc., a private corporation which builds, invests in and manages
real estate properties in the State of New Jersey. Mr. Portman was a Director of
Ultra Med, Inc. from 1986 to 1991, a high tech medical equipment manufacturer.
Mr. Portman also serves as a director and officer of Pacific Health
Laboratories, Inc., positions he has held since August 1995. See "Certain
Relationships and Related Transactions."
Certain Reports
No person who, during the fiscal year ended December 31, 1997, was a
Director, officer or beneficial owner of more than ten percent of the Company's
Common Stock (which is the only class of securities of the Company registered
under Section 12 of the Securities Exchange Act of 1934 (the "Act") (a
"Reporting Person") failed to file on a timely basis, reports required by
Section 16 of the Act during the most recent fiscal year or prior years. The
foregoing is based solely upon a review by the Company of Forms 3 and 4 during
the most recent fiscal year as furnished to the Company under Rule 16a-3(d)
under the Act, and Forms 5 and amendments thereto furnished to the Company with
respect to its most recent fiscal year, and any representation received by the
Company from any reporting person that no Form 5 is required.
Item 11. Executive Compensation
Summary of Cash and Certain Other Compensation
The following provides certain information concerning all Plan and Non-Plan
(as defined in Item 402 (a)(ii) of Regulation S-B) compensation awarded to,
earned by, paid or accrued by the Company during the years ended December 31,
1997, 1996 and 1995 to each of the named executive officers of the Company.
SUMMARY COMPENSATION TABLE
Annual Compensation Long Term
Compensation
------------
Securities
Underlying
Name & Principal Other Annual Options/ SARs
Position Year Salary Bonus Compensation Granted(1)
- - -------- ---- ------ ----- ------------ ----------
Herbert Kurinsky 1997 $168,269 0 $ 2,724(2) 50,000
Chairman, Chief 1996 $175,000 $40,000 $ 41,070(2) 0
Executive Officer(3)1995 $101,000 90,000 $ 8,594(2) 200,000
William J. Kurinsky 1997 $158,173 0 $ 1,534(4) 75,000
Vice President, 1996 $175,000 0 $ 11,884(4) 0
Chief Operating and 1995 $121,000 $90,000 $ 39,409(4) 200,000
Financial Officer
and Secretary (5)
Brian M. Cohen 1997 $100,000 $ 2,500 $ 2,126(6) 50,000
Vice President and 1996 $100,000 0 $ 17,385(6) 0
General Securities 1995 $ 87,115 $15,000 $ 6,365(6) 5,000
Principal, FMSC
Edward L. Bayarski 1997 $125,000 0 $ 55,275(7) 0
President, MISI 1996 $ 87,308 $ 7,256 $ 38,061(7) 60,000
1995 $ 33,654 $ 9,000 $ 8,639(7) 40,000
1) In 1995, the Board of Directors authorized a grant to purchase 200,000
shares of the Company's Common Stock each to Herbert Kurinsky and William J.
Kurinsky at an exercise price of $.75 and $.8352 respectively. Mr. Cohen was
granted an option to purchase 5,000 shares at $.75. These options have vested
and are exercisable until November 5, 2000 for Messrs. Kurinsky, and until
December 14, 2000 for Mr. Cohen. In 1996, Edward L. Bayarski was granted an
option to purchase 60,000 shares of Common Stock at an exercise price of $1.02
per share. These options vest at 20% a year from the date of grant and expire in
2001. In 1997, the Board of Directors authorized an additional grant to purchase
50,000 shares and 75,000 shares at exercise prices of $.96 and $1.05 to Herbert
Kurinsky and William J. Kurinsky, respectively. Mr. Cohen was also granted an
additional 50,000 options to purchase stock at an exercise price of $.96 per
share. All 1997 option grants expire five years from the date of grant. See
"Aggregated Options/Sar Exercises in Last Fiscal Year and Fy-End Option/Sar
Values."
2) Includes: (i) for 1997, commissions of $2,724; (ii) for 1996, an
automobile allowance of $7,512, commissions of $10,512, dues of $7,440 and loan
forgiveness of $15,606; and (iii) for 1995, an automobile allowance of $8,594.
3) Mr. Herbert Kurinsky is the beneficial owner of 1,518 shares of the
Company's Common Stock as of December 31, 1997, which shares had a market value
of approximately $4,317 as of that date, without giving effect to the diminution
in value attributable to the restriction on said shares.
4) Includes: (i) for 1997, commissions of $1,534; (ii) for 1996, loan
forgiveness in the amount of $11,884; and (iii) for 1995, commissions of
$39,409.
5) Mr. William Kurinsky is the beneficial owner of 1,348,423 shares of the
Company's Common Stock as of December 31, 1997, which shares had a market value
of approximately $3,834,578 as of that date, without giving effect to the
diminution in value attributable to the restriction on said shares.
6) Includes: (i) for 1997, commissions of $2,126; (ii) for 1996,
commissions of $7,578, and automobile allowance of $4,650 and loan forgiveness
of $5,157; and (iii) for 1995, commissions of $2,045 and an automobile allowance
of $4,320.
7) Includes: (i) for 1997, commissions of $55,275; (ii) for 1996,
commissions of $38,061; and (iii) for 1995, includes commissions of $8,639.
Compensation of Directors
The Company pays directors, who are not employees of the Company, a
retainer of $250 per meeting of the Board of Directors attended and for each
meeting of a committee of the Board of Directors not held in conjunction with a
Board of Directors meeting. Directors employed by the Company are not entitled
to any additional compensation as such. During fiscal year 1997, the Board of
Directors met on 5 occasions. Committees of the Board of Directors
The Board of Directors has established an Audit Committee comprised of
William J. Kurinsky and David Portman. The Audit Committee met on 1 occasion
during fiscal year 1997. The Audit Committee reviews (i) the Company's audit
functions, (ii) with management, the finances, financial condition, and interim
financial statements of the Company, and (iii) with the Company's independent
auditors, the year end financial statements of the Company. Members of the Audit
Committee do not receive additional compensation for such service.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table contains information with respect to the named
executive officers concerning options held as of the year ended December 31,
1997.
INDIVIDUAL GRANTS
Number of % of Total
Underlying Granted to Exercise
Options/SARs Employees in or Base
Name Granted(#) Fiscal Year Price ($Sh) Expiration Date
---- ------------ ----------- ----------- ---------------
Herbert Kurinsky 50,000 3.4% $ .96 1/15/02
William J. Kurinsky 75,000 5.0% 1.05 1/15/02
Brian M. Cohen 50,000 3.4% .96 1/15/02
Edward L. Bayarski -- -- -- --
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION/SAR VALUES
Value of
Shares Number of Unexercised
Acquired Unexercised In-the-money
on Value Options as of Options at
Name Exercise Realized December 31,1997 December 31,1997(1)
---- -------- -------- ---------------- -------------------
Exercisable/Unexer. Exercisable/Unexer.
Herbert Kurinsky 200,000 $412,711 290,000/0 $ 596,688/$0
William J. Kurinsky --- --- 515,000/0 $1,064,281/$0
Brian M. Cohen 95,000 $177,247 55,000/0 $ 103,406/$0
Edward L. Bayarski 28,000 $ 64,750 24,000/48,000 $ 43,770/93,780
(1) Based upon the closing bid price of the Company's Common Stock on
December 31, 1997 ($2.84375 per share), less the exercise price for the
aggregate number of shares subject to the options.
Employment Agreements
In January 1996, the Company entered into new three-year employment
contracts with Herbert Kurinsky, as President and William J. Kurinsky, as
Executive Vice President. The contracts provide for base salaries of $175,000
for the first year of the agreement for each, increasing in each case at the
rate of 10% per year. Each will also be entitled to receive a portion of a bonus
pool consisting of 10% of the pre-tax profits of the Company, to be determined
by the executive management (e.g. Herbert Kurinsky and William J. Kurinsky). The
bonus pool would require a minimum of $500,000 pretax profit per year in order
to become effective. In 1997, each formally waived his right to receive a cash
bonus for fiscal year 1997. Each is also entitled to receive commissions at the
same rate as paid to other non-affiliate registered representatives of the
Company. They are also entitled to purchase up to 20% of all underwriters and/or
placement agent warrants or options which are granted to First Montauk
Securities Corp. from FMSC upon the same price, terms and conditions afforded to
FMSC as the underwriter or placement agent. Each employee also receives health
insurance benefits and life insurance as generally made available to regular
full-time employees of the Company, and reimbursement for expenses incurred on
behalf of the Company and the use of an automobile or in the alternative an
automobile allowance. The contracts also provide for severance benefits equal to
three times the previous year's salary in the event either of the employees is
terminated or their duties significantly changed after a change in management of
the Company as defined in the agreement.
Incentive Stock Option Plan
In September 1992, the Company adopted the 1992 Incentive Stock Option Plan
(the "1992 Plan"). The 1992 Plan provided for the grant of options to purchase
up to 2,000,000 shares of the Company's Common Stock and is intended for
employees of the Company and consultants. In June 1996 the Company's
shareholders approved an amendment to the 1992 Plan (the "Amended Plan") to
increase the number of shares reserved for issuance from 2,000,000 to 3,500,000.
Under the terms of the Amended Plan, options granted thereunder may be
designated as options which qualify for incentive stock option treatment
("ISOs") under Section 422A of the Code, or options which do not so qualify
("Non-ISOs").
The Amended Plan is administered by the Board of Directors or by a Stock
Option Committee designated by the Board of Directors. The Board or the Stock
Option Committee, as the case may be, has the discretion to determine the
eligible employees to whom, and the times and the price at which, options will
be granted; whether such options shall be ISOs or Non-ISOs; the periods during
which each option will be exercisable; and the number of shares subject to each
option. The Board or Committee has full authority to interpret the Amended Plan
and to establish and amend rules and regulations relating thereto.
Under the Amended Plan, the exercise price of an option designated as an
ISO shall not be less than the fair market value of the Common Stock on the date
the option is granted. However, in the event an option designated as an ISO is
granted to a ten percent stockholder (as defined in the Amended Plan) such
exercise price shall be at least 110% of such fair market value. Exercise prices
of Non-ISO options may be less than such fair market value. The aggregate fair
market value of shares subject to options granted to a participant which are
designated as ISOs which become exercisable in any calendar year may not exceed
$100,000.
The Board or the Stock Option Committee, as the case may be, may, in its
sole discretion, grant bonuses or authorize loans to or guarantee loans obtained
by an optionee to enable such optionee to pay any taxes that may arise in
connection with the exercise or cancellation of an option. Unless sooner
terminated, the Amended Plan will expire in 2006. To date, options to purchase a
total of 3,379,000 shares of the Company's Common Stock have been issued under
the Amended 1992 Plan.
Director Plan
In September 1992, the Company adopted the Non-Executive Director Stock
Option Plan (the "Director Plan"). The Director Plan provides for issuance of a
maximum of 1,000,000 shares of Common Stock upon the exercise of stock options
granted under the Director Plan. Options are granted under the Director Plan
until 2002 to (i) non-executive directors as defined and (ii) members of any
advisory board established by the Company who are not full time employees of the
Company or any of its subsidiaries. The Director Plan provides that each
non-executive director will automatically be granted an option to purchase
20,000 shares each September 1, provided such person has served as a director
for the 12 months immediately prior to such September 1st.
In June 1996, the Company's shareholders approved an amendment to the
Non-Executive Director Stock Option Plan to provide for the elimination of
non-discretionary stock grants to members of any advisory board established by
the Company. An eligible member of an advisory board may receive an option to
purchase shares of the Company's Common Stock under the Director Plan as
provided for in the discretion of the Company's Board of Directors.
The exercise price for options granted under the Director Plan shall be
100% of the fair market value of the Common Stock on the date of grant. Until
otherwise provided in the Stock Option Plan the exercise price of options
granted under the Director Plan must be paid at the time of exercise, either in
cash, by delivery of shares of Common Stock of the Company or by a combination
of each. The term of each option commenced on the date it is granted and unless
terminated sooner as provided in the Director Plan, expires five years from the
date of grant. The Director Plan is administered by a committee of the board of
directors composed of not fewer than three persons who are officers of the
Company (the "Committee"). The Committee has no discretion to determine which
non-executive director or advisory board member will receive options or the
number of shares subject to the option, the term of the option or the
exercisability of the option. However, the Committee will make all
determinations of the interpretation of the Director Plan. Options granted under
the Director Plan are not qualified for incentive stock option treatment. To
date, a total of 260,000 options have been granted to the Company's
Non-Executive members of the Board of Directors.
Senior Management Plan
In 1996, the Company adopted the 1996 Senior Management Incentive Plan (the
"Management Plan"). The Management Plan provides for the issuance of up to
2,000,000 shares of Common Stock either upon issuance of options issued under
the Plan or grants of restricted stock or incentive stock rights. Awards may be
granted under the Management Plan to executive management employees by the Board
of Directors or a committee of the board, if one is appointed for this purpose.
The Management Plan provides for four types of awards--stock options, incentive
stock rights, stock appreciation rights, and restricted stock purchase
agreements. The stock options granted under the Management Plan can be either
ISOs or non-lSOs similar to the options granted under the Employee Stock Option
Plan, except that the exercise price of non-lSOs shall not be less than 85% of
the fair market value of the Common Stock on the date of grant. Incentive stock
rights consist of incentive stock units equivalent to one share of Common Stock
in consideration for services performed for the Company. If services of the
holder terminate prior to the incentive period, the rights become null and void
unless termination is caused by death or disability. Stock appreciation rights
allow a Grantee to receive an amount in cash equal to the difference between the
fair market value of the stock and the exercise price, payable in cash or shares
of Common Stock. The Board or committee may grant limited SARs which become
exercisable upon a "change of control" of the Company. A change of control
includes the purchase by any person of 25% or more of the voting power of the
Company's outstanding securities, or a change in the majority of the Board of
Directors.
Awards granted under the Management Plan are also entitled to certain
acceleration provisions which cause awards granted under the Plan to immediately
vest in the event of a change of control or sale of the Company. Awards under
the Management Plan may be made until 2006.
In 1997, the Company granted a total of 175,000 options to three executive
officers.
Item 12. Security Ownership of Certain
Beneficial Owners and Management
The following table sets forth, as of March 24, 1998, the number and
percentage of outstanding shares of Common Stock beneficially owned by each
person known by the Company to own beneficially more than 5% of the Company's
outstanding shares of Common Stock and Common Stock Warrants, by each director
of the Company, and by all directors and officers of the Company as a group.
Directors, Officers Amount and Percentage
and 5% Shareholders (1) of Beneficial Ownership (1)
- - ----------------------- ---------------------------
Number of Shares Percent
---------------- -------
Herbert Kurinsky 291,518(2) 2.95%
Parkway 109 Office Center
328 Newman Springs Road
Red Bank, NJ 07701
William J. Kurinsky 1,663,423(3) 16.19%
Parkway 109 Office Center
328 Newman Springs Road
Red Bank, NJ 07701
Brian M. Cohen 60,563(4) *
Parkway 109 Office Center
328 Newman Springs Road
Red Bank, NJ 07701
Edward L. Bayarski 72,000 (5) *
One Mack Centre Drive
Paramus, NJ 07652
Ward R. Jones 100,000(6) *
7 Leda Lane
Guilderland, NY 12084
Norma Doxey 42,400(7) *
Parkway 109 Office Center
328 Newman Springs Road
Red Bank, NJ 07701
David I. Portman 159,800(8) 1.64%
19 Pal Drive
Wayside, NJ 07712
All Directors and 2,389,704(2-8) 20.78%
Officers as a group
(7 persons in number)
* Less than 1%.
_____________________
(1) Unless otherwise indicated below, each director, officer and 5%
shareholder has sole voting and sole investment power with respect to all shares
that he beneficially owns.
(2) Includes vested and presently exercisable options of Mr. Herbert
Kurinsky, to purchase 290,000 shares of Common Stock.
(3) Includes vested and presently exercisable options of Mr. William J.
Kurinsky to purchase 315,000 shares of Common Stock, and 120,000 Class A
Warrants, 120,000 Class B Warrants and 120,000 Class C Warrants.
(4) Includes 55,000 shares of Common Stock reserved for issuance upon the
exercise of vested and presently exercisable stock options, and 1,521 Class A
Warrants, 1,521 Class B Warrants and 1,521 Class C Warrants.
(5) Includes 72,000 shares of Common Stock reserved for issuance upon the
exercise of 24,000 vested and presently exercisable stock options and 48,000
shares non-vested stock options.
(6) Includes 100,000 shares of Common Stock reserved for issuance upon the
exercise of vested and presently exercisable stock options.
(7) Includes 35,000 shares of Common Stock reserved for issuance upon the
exercise of 18,000 vested and presently exercisable stock options and 17,000
shares non-vested stock options.
(8) Includes 60,000 shares of Common Stock reserved for issuance upon the
exercise of vested and presently exercisable stock options, 16,600 Class A
Warrants, 16,600 Class B Warrants and 16,600 Class C Warrants.
NOTE: All Class A Warrants are exercisable at $3.00 per share for a
period of three (3) years from February 17, 1998.
All Class B Warrants are exercisable at $5.00 per share for a
period of five (5) years from February 17, 1998.
All Class C Warrants are exercisable at $7.00 per share for a
period of seven (7) years from February 17, 1998.
Item 13. Certain Relationships and Related Transactions
For information concerning the terms of the employment agreements entered
into between the Company and Messrs. Herbert Kurinsky and William J. Kurinsky,
see "Executive Compensation".
Advances and loans to the Company's three Executive Officers, Herbert
Kurinsky, William J. Kurinsky and Brian M. Cohen and Director Norma Doxey,
totaling $136,300 are unsecured and currently bear interest at the rate of 6%
per annum. These loans are due on demand.
The Company served as placement agent in a private placement offering by
PacificHealth Laboratories which commenced in August 1995 and was completed in
April 1996. PacificHealth sold 250,000 shares of 10% Convertible Preferred Stock
in the private placement at $10.00 per share. The Company received commissions
of approximately $250,000 from the private placement offering. In December 1997,
the Company underwrote an initial public offering of PacificHealth Laboratories
from which the Company realized gross commissions of approximately $720,000
before sales concessions, plus reimbursement for expenses (See "Business"). Mr.
David Portman, a director of the Company, also serves as an officer and director
of PacificHealth, and is a significant stockholder of PacificHealth.
Additionally, in June 1996 the Company conducted a second private placement
on behalf of PacificHealth and received commissions and expenses of
approximately $116,000. The second offering consisted of the sale of 287,750
shares of Common Stock of PacificHealth.
In July 1995, the Company commenced a private placement on behalf of
Environmental Coupon Marketing, Inc. ("ECM") a closely-held marketer of
recycling programs to retailers featuring store coupons and cash incentives to
consumers. In anticipation of the offering, in August 1995, the Company loaned a
total of $282,000 to ECM. The first loan, in the amount of $100,000, bears
interest at the rate of 6% per annum and was scheduled to mature on the earlier
of a proposed private placement of ECM securities, or August 5, 1996. In August
1996, the Company extended repayment of the loan to July 15, 1997. The Company
received a payment of $11,360 in 1997, which was applied against principal. The
balance of the loan is currently in default. The second loan, in the original
amount of $182,000, is non-interest bearing and may be converted into up to
350,000 shares of ECM common stock at the rate of $.52 per share. The Company
sold $52,000 of principal amount of this loan to four unaffiliated investors for
face value in 1996. This loan was scheduled to mature on October 5, 1996, at
which time the Company extended it for one year to October 5, 1997. The loan is
currently in default. Both loans are partially secured by certain equipment
owned by ECM. Management has reduced the combined loan balance by $69,000 to its
estimated realizable value as of December 31, 1997. The Company does not accrue
interest on the ECM notes.
The Company also purchased 150,000 shares of ECM common stock for $.40 per
share, or $60,000 in 1995, and an additional 150,000 shares for $60,000 in 1996.
Subsequent to the 1996 purchase, the Company sold 37,500 and 52,500 shares,
respectively, to an officer of the Company and a consultant, for cost, or
$36,000. In 1997, the Company wrote off the $84,000 balance of its ECM stock
investment.
PART IV
Item 14. Exhibits, Financial Statements
and Reports on Form 8-K
(A) 1. Financial Statements
See Financial Statements Attached Hereto.
2. Exhibits
Incorporated by reference to the Exhibit Index at the end of this report.
(B) Reports on Form 8-K During the last quarter of the period covered by
this Report, there were no reports filed on Form 8-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST MONTAUK FINANCIAL CORP.
By /s/ Herbert Kurinsky
Herbert Kurinsky, President
Dated: April 15, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.
/s/ Herbert Kurinsky April 15, 1998
Herbert Kurinsky
President, Chief Executive
Officer and Director
/s/ William J. Kurinsky_ April 15, 1998
William J. Kurinsky
Vice-President, Chief Operating
and Chief Financial Officer, and
Principal Accounting Officer,
Secretary and Director
/s/ Norma Doxey April 15, 1998
Norma Doxey, Director
/s/ Ward R. Jones, Jr., April 15, 1998
Ward R. Jones, Jr., Director
/s/ David I. Portman April 15, 1998
David I. Portman, Director
EXHIBITS INDEX
The exhibits designated with an asterisk (*) have previously been filed
with the Commission in connection with the Company's Registration Statement on
Form S-l, File No. 33-24696, those designated (**) have been filed with the
Company's Form 10-KSB for the fiscal year ended December 31, 1993, those
designated (***) have been previously filed with the Company's Registration
Statement on Form S-3, File No. 33-65770, and pursuant to 17 C.F.R. Sections
201.24 and 240.12b-32, are incorporated by reference to the document referenced
in brackets following the description of such exhibits. Those designated (****)
denotes exhibits which have been filed with the Company's Form 10-KSB for the
fiscal year ended December 31, 1994. Those designated (******) denotes exhibits
which have been filed with the Company's Proxy Statement dated May 30, 1996.
Those designated (*******) denotes exhibits which have been filed with the
Company's Form 10-KSB for the fiscal year ended December 31, 1996, and
(********) denotes exhibits filed herewith.
Exhibit No. Description
3.1* Amended and Restated Certificate of Incorporation adopted at
1989 Special Meeting in lieu of Annual Meeting of Shareholders.
3.2* Amended and Restated By-Laws.
4.1* Form of Common Stock Certificate.
4.4* Form of Underwriter's Warrant.
10.7* Sublease between Prime Asset Management Corp. and the Registrant
dated December 6, 1989.
10.8* Clearing Agreement between the Registrant and Wertheim Schroder
& Co., Incorporated dated January 21, 1991.
10.10* Lease Agreement between the Registrant and Hovchild dated
May 25, 1990.
10.11*** Employment Agreement between First Montauk Financial Corp. and
Herbert Kurinsky dated January 1, 1993.
10.12*** Employment Agreement between First Montauk Financial Corp. and
William Kurinsky dated January 1, 1993.
10.13*** Lease Agreement between First Montauk Securities Corp. and River
Office Equities dated September 7, 1993.
10.14**** Lease Addendum Agreement between First Montauk Securities Corp.
and River Office Equities dated June 21, 1994.
10.15***** Sublease Agreement between First Montauk Securities Corp.
and Pilot Laboratories, Inc. dated September 19, 1995, and
Master Lease Agreement between River Office Equities and Pilot
Laboratories, Inc. dated August 31, 1987.
10.16***** Office Lease Agreement between First Montauk Securities Corp.
and River Office Equities dated January 31, 1996.
10.17******* Office Lease Agreement between First Montauk Securities Corp.
and River Office Equities dated March 5, 1997.
27 Financial Data Schedule
28.1* 1992 Incentive Stock Option Plan.
28.2* 1992 Non-Executive Director Stock Option Plan.
28.3****** Amended and Restated 1992 Incentive Stock Option Plan.
28.4****** Non-Executive Director Stock Option Plan - Amended and Restated
June 28, 1996
28.5****** 1996 Senior Management Incentive Stock Option Plan.
28.6******* Employment Agreement between First Montauk Financial Corp. and
Herbert Kurinsky dated January 1, 1996.
28.7******* Employment Agreement between First Montauk Financial Corp. and
William J. Kurinsky dated January 1, 1996.
28.8******** First Amendment to Office Lease Agreement dated March 5, 1997
between First Montauk Securities Corp. and River Office
Equities dated March 3, 1998.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
First Montauk Financial Corp.
Red Bank, New Jersey
We have audited the accompanying consolidated statements of financial
condition of First Montauk Financial Corp. and subsidiaries as of December 31,
1997 and 1996, and the related consolidated statements of operations, changes in
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of First
Montauk Financial Corp. and subsidiaries as of December 31, 1997 and 1996, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1997 in conformity with
generally accepted accounting principles.
Schneider Ehrlich & Wengrover LLP
Woodbury, New York
March 12, 1998
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31,
1997 1996
ASSETS
Cash $ 789,883 $ 1,069,548
Due from clearing firm 2,707,782 1,865,425
Securities owned, at market 3,150,772 2,129,435
Securities owned, not readily marketable,
at estimated fair value 506,732 --
Commissions receivable 246,250 156,413
Employee and broker receivables 927,195 741,603
Furniture, equipment and leasehold
improvements - net 1,357,854 1,200,933
Notes receivable 938,054 230,000
Due from officers 146,691 171,978
Other assets 1,164,753 624,536
Deferred tax asset - net 35,968 552,168
------ -------
Total assets $11,971,934 $ 8,742,039
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Securities sold, but not yet purchased,
at market $ 809,523 $ 127,627
Notes payable - bank 340,769 458,305
Subordinated notes payable 250,000 --
Commissions payable 1,624,316 1,552,218
Accounts payable 501,267 494,697
Accrued expenses 812,590 1,811,897
Other liabilities 394,002 180,516
------- -------
Total liabilities 4,732,467 4,625,260
--------- ---------
Common stock issued with guaranteed
selling price -
no par value, 173,000 and 210,500
shares issued and outstanding,
respectively 346,500 421,500
------- -------
Commitments and contingent liabilities
(See Notes)
STOCKHOLDERS' EQUITY
Preferred Stock, 5,000,000 shares authorized, $.10
par value, no shares issued and outstanding -- --
Common Stock, no par value, 30,000,000 shares
authorized, 9,198,444 and 8,222,481 shares issued
and outstanding, respectively 4,334,173 3,588,273
Additional paid-in capital 1,173,437 243,961
Retained earnings 1,570,376 93,551
Less: Deferred compensation (185,019) --
-------- ---------
6,892,967 3,925,785
Less: 196,802 common shares in treasury in
1996, at cost -- (230,506)
----- -------- ---------
Total stockholders' equity 6,892,967 3,695,279
--------- ---------
Total liabilities and stockholders' equity $11,971,934 $ 8,742,039
=========== ===========
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31,
1997 1996 1995
Revenues:
Commissions $27,018,244 $25,749,690 $17,113,296
Net dealer inventory and trading gains 7,257,576 7,660,700 9,763,940
Investment banking 1,433,100 634,329 388,249
Insurance recovery 650,000 -- --
Interest and other income 1,383,713 1,044,969 1,076,718
--------- --------- ---------
Total revenues 37,742,633 35,089,688 28,342,203
---------- ---------- ----------
Expenses:
Commissions, employee compensation
and benefits 26,785,205 25,428,184 19,542,578
Clearing and floor brokerage 3,021,709 3,139,142 3,112,474
Communications and occupancy 1,860,350 1,662,936 1,260,209
Legal matters and related costs 1,452,001 2,731,997 1,542,328
Other operating expenses 2,093,670 2,006,615 1,439,926
Interest 84,695 105,772 192,752
---------- ---------- ----------
35,297,630 35,074,646 27,090,267
---------- ---------- ----------
Income before income taxes 2,445,003 15,042 1,251,936
Provision (benefit) for income taxes 968,178 (17,747) 483,848
--------- ---------- ---------
Net income $ 1,476,825 $ 32,789 $ 768,088
=========== =========== ==========
Earnings per share data:
Basic $ .17 $ .01 $ .10
=========== =========== ==========
Diluted $ .14 $ .01 $ .09
=========== =========== ==========
Number of common shares used in
basic earnings per share 8,788,734 7,767,224 8,044,622
Incremental shares from assumed
conversion of options 1,562,298 856,314 336,284
--------- ------- -------
Number of common shares used in
diluted earnings per share 10,351,032 8,623,538 8,380,906
========== ========= =========
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
1997 1996 1995
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Cash flows from operating activities:
Net income $ 1,476,825 $ 32,789 $ 768,088
----------- ---------- ----------
Adjustments to reconcile net income to
net cash provided by operating
activities:
Shares issued to settle legal claims -- 178,650 --
Loan reserves 69,000 -- --
Common stock issued with guaranteed
selling price 28,125 421,500 --
Tax benefit related to exercise of
stock options 722,605 23,789 --
Depreciation and amortization 348,508 272,050 184,818
Amortization of deferred compensation 21,852 -- --
Increase (decrease) in cash attributable
to changes in assets and liabilities
Commissions receivable (89,837) 227,455 (250,901)
Securities owned - at market (1,021,337) 4,985,072 (2,197,289)
Securities owned - not readily
marketable (506,732) -- --
Other assets (532,728) (338,846) (34,863)
Due from/to clearing firm (842,357) (4,171,457) 26,781
Securities sold but not yet purchased 681,896 (38,755) (288,600)
Commissions payable 72,098 85,028 714,994
Accounts payable 12,570 105,385 63,363
Accrued expenses (749,307) 419,782 1,372,891
Income taxes payable -- (621,690) 615,636
Other liabilities 213,486 (315,240) 334,345
Deferred income taxes 516,200 (182,995) (309,778)
--------- --------- ---------
Total adjustments (1,055,958) 1,049,728 231,397
--------- --------- ---------
Net cash provided by operating activities 420,867 1,082,517 999,485
--------- --------- ---------
Cash flows from investing activities:
Due from officers 25,287 (16,454) (4,370)
Employee and broker receivables (185,592) (384,078) 156,742
Capital expenditures (534,005) (668,314) (435,539)
Collection of notes receivable 11,360 52,000 (276,000)
Issuance of notes receivable (788,414) -- --
Purchase of stock in ECM -- (60,000) --
Sale of stock in ECM -- 36,000 --
Other assets 15,087 (87,460) (60,000)
--------- --------- -------
Net cash used in investing activities (1,456,277) (1,128,306) (619,167)
---------- ---------- --------
Cash flows from financing activities:
Proceeds from notes payable - bank -- 479,625 --
Payment of notes payable - bank (117,536) (68,864) (25,934)
Stock registration costs -- -- (2,814)
Issuance of common stock 23,027 -- --
Proceeds from exercise of stock options
and warrants 850,254 89,611 13,985
Repurchase of common stock -- (230,506) (194,035)
--------- -------- --------
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
Years ended December 31,
1997 1996 1995
Net cash provided by (used in) financing
activities 755,745 269,866 (208,798)
--------- ------- --------
Net increase (decrease) in cash and cash
equivalents (279,665) 224,077 171,520
Cash and cash equivalents at beginning of
year 1,069,548 845,471 673,951
--------- ------- -------
Cash and cash equivalents at end of year $ 789,883 $ 1,069,548 $ 845,471
=========== =========== ==========
Supplemental disclosures of cash flow
information:
Cash paid (refunded) during the period for:
Interest $ 84,695 $ 105,772 $ 192,752
Income taxes $ (203,480) $ 1,019,242 $ 149,722
Transfer of temporary equity to
permanent capital $ 103,125
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE PERIOD FROM JANUARY 1, 1995 TO DECEMBER 31, 1997
Additional
Common Stock Paid-in Retained Treasury Stock Deferred Stockholders'
Shares Amount Capital Earnings Shares Amount Compensation Equity
Balances at January 1, 1995 8,112,406 $3,306,027 $ 417,021 $(707,326) -- -- -- $3,015,722
Exercise of stock options 23,500 13,985 -- -- -- -- -- 13,985
Stock registration costs -- -- (2,814) -- -- -- -- (2,814)
Repurchase of common stock (215,800) -- (194,035) -- -- -- -- (194,035)
Net income for the year -- -- -- 768,088 -- -- -- 768,088
------- ------ --------- ------- ----- -------- --------- -------
Balances at December 31,
1995 7,920,106 3,320,012 220,172 60,762 -- -- -- 3,600,946
Exercise of stock options 137,375 89,611 -- -- -- -- -- 89,611
Tax benefit related to
exercise of stock options -- -- 23,789 -- -- -- -- 23,789
Repurchase of common stock -- -- -- -- (196,802) $(230,506) -- (230,506)
Shares issued to settle legal
claims 165,000 178,650 -- -- -- -- -- 178,650
Net income for the year -- -- -- 32,789 -- -- -- 32,789
------- ------- --------- ------ --------- ---------- ---------- --------
Balances at December 31,
1996 8,222,481 $3,588,273 $243,961 $ 93,551 (196,802) $(230,506) -- $3,695,279
Exercise of stock options 973,025 662,754 -- -- -- -- -- 662,754
Exercise of common stock
purchase warrants 150,000 187,500 -- -- -- -- -- 187,500
Deferred compensation -- -- 206,871 -- -- -- (206,871) --
Amortization of deferred
compensation -- -- -- -- -- -- 21,852 21,852
Cancellation of shares
held in treasury (196,802) (230,506) -- -- 196,802 230,506 -- --
Sale of restricted stock 12,240 23,027 -- -- -- -- -- 23,027
Transfer from temporary
equity 37,500 103,125 -- -- -- -- -- 103,125
Tax benefit related to
exercise of stock
otions -- -- 722,605 -- -- -- -- 722,605
Net income for the year -- -- -- 1,476,825 -- -- -- 1,476,825
-------- ------- -------- --------- ------ --------- -------- ----------
Balances at December 31,
1997 9,198,444 $4,334,173 $1,173,437 $1,570,376 -- -- (185,019) $6,892,967
========= ========== ========== ========== ======= ========== ========= ==========
See notes to consolidated financial statements.
40
NOTE 1 - NATURE OF BUSINESS
First Montauk Financial Corp. and subsidiaries (the "Company") are
primarily engaged in securities brokerage, investment banking and trading. The
Company's principal subsidiary, First Montauk Securities Corp. ("FMSC"), is a
broker-dealer registered with the Securities and Exchange Commission ("SEC") and
the National Association of Securities Dealers, Inc. ("NASD"). Through FMSC, the
Company executes principal and agency transactions, makes markets in
over-the-counter securities, and performs underwriting and investment banking
services. Customers are located throughout the United States.
FMSC clears all customer transactions on a fully disclosed basis through an
independent clearing firm. Accordingly, FMSC does not carry securities accounts
for customers nor does it perform custodial functions related to those
securities.
The Company also sells insurance products and investments in equipment
leases, respectively, through two other subsidiaries, Montauk Insurance
Services, Inc. ("MISI") and Montauk Advisors, Inc. ("MAI").
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All intercompany accounts and transactions are eliminated
in consolidation.
Certain reclassifications have been made to prior year financial statements
to conform to the 1997 presentation.
Revenue Recognition
Securities transactions, investment banking revenues, and commission income
and related expenses are recorded on a trade date basis. Securities owned and
securities sold but not yet repurchased are stated at quoted market values with
unrealized gains and losses reflected in earnings. Investment account securities
not readily marketable are carried at estimated fair value as determined by
management with unrealized gains and losses included in earnings.
Commissions earned from the sale of insurance products are recognized upon
approval of the customer application by the insurance carrier.
Depreciation and Amortization
Furniture and equipment and leasehold improvements are stated at cost.
Depreciation is computed generally on a straight-line basis over the estimated
useful lives of the assets, ranging from three to seven years. Leasehold
improvements are amortized over the shorter of either the asset's useful life or
the related lease term. Depreciation is computed on the modified accelerated
cost recovery system (MACRS) for income tax purposes.
Statement of Cash Flows
For purposes of the Statement of Cash Flows, the Company considers all
highly liquid debt instruments purchased with an original maturity of three
months or less to be cash equivalents. Cash equivalents consist of money market
mutual funds.
Net Income per Share
The Company has adopted Statement of Financial Accounting Standards No.128
(SFAS 128), "Earnings per Share," which supersedes APB Opinion No. 15 (APB No.
15). Earnings per Share is effective for all periods ending after December 15,
1997. SFAS 128 requires dual presentation of basic and diluted earnings per
share (EPS) for complex capital structures on the face of the Statements of
Operations. Basic EPS is computed by dividing net income by the weighted-average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution from the exercise or conversion of other securities into
common stock. Earnings per share data have been restated to conform with the
provision of SFAS 128. The impact of the change was not material.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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 financial
statements and the reported amounts of revenues and expenses during the year.
Actual results could differ from those estimates.
Long-lived assets
In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of", the Company
records impairment losses on long-lived assets used in operations, when events
and circumstances indicate that the assets might be impaired and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amounts of those assets.
Stock-based Compensation
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-based Compensation". SFAS No. 123 requires that the
Company either recognize in its financial statements costs related to its
employee stock-based compensation plans, such as stock option and stock purchase
plans, or make pro forma disclosures of such costs in a footnote to the
financial statements. The Company has elected to continue to use the intrinsic
value-based method of APB Opinion no. 25, as allowed under SFAS 123, to account
for all of its employee stock-based compensation plans. The compensatory value
of options issued to outside directors, affiliate brokers, and other
non-employees is charged to operations over the vesting period of the option
grants.
Income Taxes
The Company uses the liability method to determine its income tax expense
as required under Statement of Financial Accounting Standards No. 109 (SFAS
109). Under SFAS 109, deferred tax assets and liabilities are computed based on
differences between financial reporting and tax basis of assets and liabilities,
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
Deferred tax assets are reduced by a valuation allowance if, based on the
weight of the available evidence, it is more likely than not that all or some
portion of the deferred tax assets will not be realized. The ultimate
realization of the deferred tax asset depends on the Company's ability to
generate sufficient taxable income in the future.
The Company and its subsidiaries file a consolidated federal income tax
return and separate state returns.
Under APB No. 25, compensation expense arising from the exercise of certain
employee stock options is deductible for income tax purposes only. Accordingly,
the related tax benefits from these deductions do not affect net income for
financial reporting purposes, and are accounted for as increases in additional
paid-in capital.
Deferred Registration Costs
Costs incurred in 1997 in connection with the Company's rights offering
(see Note 20) have been deferred and will be changed to capital on the effective
date of the registration. Such costs totaled $116,000 in 1997 and are included
in Other Assets in the Statement of Financial Condition.
Recently Issued Accounting Pronouncements
In June 1997, SFAS 130, "Reporting Comprehensive Income," and SFAS 131,
"Disclosures About Segments of an Enterprise and Related Information," were
issued. SFAS 130 addresses standards for reporting and display of comprehensive
income and its components, and SFAS 131 requires disclosure of reportable
operating segments. In February 1998, SFAS 132, "Employers' Disclosures About
Pensions and Other Post-retirement Plans" was issued. SFAS 132 standardizes
pension disclosures. These statements are effective in 1998. The Company will be
reviewing these pronouncements to determine their applicability to the Company,
if any.
NOTE 3 - TRADING AND INVESTMENT SECURITIES
Marketable securities owned and sold but not yet purchased consist of
trading securities stated at quoted market values, as indicated below:
December 31,
1997 1996
Sold but Sold but
not yet not yet
Owned Purchased Owned Purchased
Obligations of U. S. government
and its agencies $ 304,815 $ -- $ 29,647 $ --
State and municipal obligations 515,781 -- 203,428 20,735
Corporate stocks and bonds 2,042,020 799,503 1,896,360 105,736
Corporate bonds 288,156 2,466 -- --
Options and warrants -- 7,554 -- 1,156
------- ------- --------- --------
$3,150,772 $809,523 $2,129,435 $127,627
========== ======== ========== ========
Securities not readily marketable include investment securities (a) for
which there is no market on a securities exchange or no independent publicly
quoted market, (b) that cannot be publicly offered or sold unless registration
has been effected under the Securities Act of 1933, or (c) that cannot be
offered or sold because of other arrangements, restrictions or conditions
applicable to the securities or to the Company. At December 31, 1997, these
securities at estimated fair values consist of the following:
Corporate stocks $236,640
Options and warrants 270,092
-------
$506,732
========
NOTE 4 - EMPLOYEE AND BROKER RECEIVABLES
This account consists of the following:
December 31,
1997 1996
Commission advances $215,119 $ 99,172
Loans to brokers and non-executive
employees 712,076 642,431
------- -------
$927,195 $741,603
======== ========
Receivables are generally non-interest bearing and due on demand. Loan
principal totaling approximately $96,000 at December 31, 1997 is secured by
collateral consisting of cash and securities; the balance is unsecured.
NOTE 5 - FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Furniture, equipment and leasehold improvements consist of the following:
December 31,
1997 1996
Furniture and fixtures $ 672,988 $ 615,683
Computer and office equipment 1,442,108 1,030,521
Leasehold improvements 169,560 163,368
------- -------
2,284,656 1,809,572
Less: Accumulated depreciation
and amortization (926,802) (608,639)
-------- --------
$1,357,854 $1,200,933
========== ==========
Depreciation expense was $348,508, $272,050 and $184,818 in 1997, 1996 and
1995, respectively.
NOTE 6 - NOTES RECEIVABLE
1997 1996
Environmental Coupon
Marketing, Inc. $149,640 $230,000
Global Financial Corp. 582,804 --
Fem-Com Copy Systems, Inc. 205,610 --
------- -------
$938,054 $230,000
======== ========
a) In 1995, the Company loaned a total of $282,000 to Environmental Coupon
Marketing, Inc. ("ECM"), a closely-held marketer of recycling programs to
retailers featuring store coupons and cash incentives to consumers. The first
loan, in the amount of $100,000, bears interest at the rate of 6% per annum and
was scheduled to mature on the earlier of a proposed private placement of ECM
securities, or August 5, 1996. In August 1996, the Company extended repayment of
the loan to July 15, 1997. The Company received a payment of $11,360 in 1997,
which was applied against principal. The balance of the loan is currently in
default. The second loan, in the original amount of $182,000, is non-interest
bearing and may be converted into up to 350,000 shares of ECM common stock at
the rate of $.52 per share. The Company sold $52,000 of principal amount of this
loan to four unaffiliated investors for face value in 1996. This loan was
scheduled to mature on October 5, 1996, at which time the Company extended it
for one year to October 5, 1997. The loan is currently in default. Both loans
are partially secured by certain equipment owned by ECM. Management has reduced
the combined loan balance by $69,000 to its estimated realizable value as of
December 31, 1997. The Company does not accrue interest on the ECM notes.
The Company also purchased 150,000 shares of ECM common stock for $60,000
in 1995, and an additional 150,000 shares for $60,000 in 1996. Subsequent to the
1996 purchase, the Company sold 37,500 and 52,500 shares, respectively, to an
officer of the Company and a consultant, for cost, or $36,000. In 1997, the
Company wrote off the $84,000 balance of its ECM stock investment.
b) In 1997, MAI made loans to Global Financial Corp. ("Global"), the
financing company that packages and sells leasing contracts through MAI. The
loans bear interest at the rate of 8% per annum and are payable in April and May
1998. MAI, at its sole option, may accept payment of the loans on an installment
basis over terms of up to thirty-six months. The purpose of the loans is to
assist Global in meeting cash flow deficiencies arising from the nonpayment of
scheduled monthly installments on certain delinquent and non-performing leases.
Most of the arrears are due from Fem-Com Copy Systems, Inc.("FCS"), Global's
affiliated equipment vendor, and Biblio, Inc. ("Biblio"), an affiliate of FCS.
The MAI notes are guaranteed by Global; FCS; Biblio, and the shareholder of FCS
and Biblio. The notes are further collateralized by mortgage liens on real
estate owned by the shareholder of FCS and Biblio, a pledge of all of the
outstanding shares in Global, and various recorded liens on the assets of FCS
and Biblio. MAI subsequently advanced additional funds to Global (See Note 20).
c) MAI has provided FCS with working capital financing to purchase
equipment for resale to FCS customers. FCS generally pledges profits from these
sales towards the repayment of its indebtedness to Global. MAI charges a 1%
commitment fee on the loans plus interest at the rate of 12% per annum. The
loans are evidenced by a note which is payable with interest on September 30,
1998. FCS may prepay the note in whole or in part prior to maturity.
NOTE 7 - DUE FROM OFFICERS
Advances to officers are unsecured and currently bear interest at the rate
of 6% per annum. These loans are due on demand. Interest on these loans totaled
$7,817, $9,428 and $6,127 in 1997, 1996 and 1995, respectively.
NOTE 8 - NOTES PAYABLE - BANK
These notes evidence three secured term loans: the first loan, obtained in
1994 in the original amount of $77,800 and subsequently repaid, was payable in
36 monthly principal installments of $2,161 plus interest at the prime rate
(8-1/2% at December 31, 1997). The other two loans, obtained in 1996 in the
original amounts of $179,625 and $300,000, are each payable in 60 monthly
principal installments of $2,994 and $5,000, respectively, plus interest at the
prime rate. The loans are collateralized by equipment owned by the parent
corporation. Principal maturities are scheduled as follows: 1998 - $95,925, 1999
- - - $95,925, 2000 - $95,925, and 2001 - $52,994.
NOTE 9 - ACCRUED EXPENSES
Accrued expenses consist of the following:
December 31,
1997 1996
Reserves for legal matters $640,000 $1,573,000
Other 172,590 238,897
------- -------
$812,590 $1,811,897
======== ==========
NOTE 10 - INCOME TAXES
The provision (benefit) for income taxes consists of the following:
December 31,
1997 1996 1995
Currently payable
(refundable):
Federal $ 299,584 $ 150,505 $ 620,196
State 161,134 37,103 181,315
------- ------ -------
460,718 187,608 801,511
------- ------- -------
Deferred:
Federal 470,277 (198,875) (213,867)
State 77,183 (6,480) (75,147)
------ ------ -------
507,460 (205,355) (289,014)
------- -------- --------
Tax benefit of net
operating loss
carryforward -- -- (28,649)
$ 968,178 $ (17,747) $ 483,848
========= ========= =========
The current portion of the federal income tax benefit reflects refundable
taxes from the carryback of net operating losses of approximately $260,000.
Following is a reconciliation of the income tax provision (benefit) with
income taxes based on federal statutory rates:
December 31,
1997 1996 1995
Expected statutory federal
income tax $831,301 $ 2,256 $425,658
Non-taxable income (12,080) (5,457) --
Non-deductible expenses 10,200 4,576 10,200
State taxes, net of federal
tax benefit 146,700 (19,122) 76,639
Tax benefit of net operating
loss carryforward -- -- (28,649)
Other (7,943) -- --
------ ------- -------
$968,178 $(17,747) $483,848
======== ======== ========
The tax effects of the temporary differences that give rise to significant
portions of the deferred tax assets and liabilities as of December 31, 1997 and
1996 are:
December 31,
1997 1996
Deferred tax assets:
Accrued reserves $171,465 $576,705
Net operating loss 87,504 34,511
Other 33,349 19,529
------ ------
292,318 630,745
------- -------
Deferred tax liabilities:
Unrealized investment gains 197,990 --
Depreciation 58,360 56,563
Other -- 22,014
------ ------
256,350 78,577
------- ------
Net deferred tax asset $ 35,968 $552,168
======== ========
Management has determined that the Company will be able to realize the tax
benefits of the net deferred tax asset based on the expected future reversal of
the taxable temporary differences.
NOTE 11 - COMMITMENTS AND CONTINGENT LIABILITIES
Operating leases
The Company leases office facilities and equipment under operating leases
expiring at various dates through 2005. The lease for the Company's headquarters
has a six-year renewal option through 2011. Following is a schedule of future
minimum payments due under non-cancelable leases with terms in excess of one
year:
1998 $ 733,102
1999 730,575
2000 672,691
2001 627,444
2002 627,444
2003 and beyond 1,307,175
---------
$4,698,431
==========
Rent expense for 1997, 1996 and 1995 totaled $309,183, $245,208 and
$225,683, respectively.
Employment agreements
Effective January 1, 1996, the Company approved new employment contracts
for two of its officers. The contracts will run for three years, and provide for
annual salaries of $175,000 for the first year, with a provision for a 10%
annual increase in the second and third years. The agreement also provides for a
bonus pool of up to 10% of consolidated pre-tax profits. The bonus pool becomes
effective each year only upon the achievement of pre-tax profits exceeding
$500,000. The officers waived their bonuses for 1997.
Legal matters
In 1997, FMSC entered into an Offer of Settlement with the SEC relating to
the activities of a former affiliate office located in Houston, Texas. Under
terms of the settlement, FMSC paid a $50,000 fine and agreed to disgorge profits
of $175,000 from gains on securities sold by the Houston office. The SEC has
informally consented to credit the disgorgement assessment against amounts
already paid by FMSC in settlement of civil litigation brought by former
customers of the Houston office. The settlement also includes the requirement to
engage an independent compliance examiner to audit FMSC's compliance procedures.
FMSC entered into a similar consent decree with the State of Florida, pursuant
to which FMSC paid a $15,000 fine and agreed to temporary restrictions on
brokerage activities in the state. FMSC has been cooperating with ongoing
investigations by the SEC and other regulatory authorities into activities of
the Houston office.
FMSC has been the subject of other legal actions relating to the sale of
securities by the Houston office. In 1996, the Company, without admitting
liability or wrongdoing, settled various claims asserted by Escambia County,
Florida for $900,000 in cash. In January 1997, the Company settled another
customer lawsuit for $750,000, with $500,000 payable upon execution of
settlement documents, and the balance of $250,000 payable in five annual
installments of $50,000 plus interest at 8% per annum. The five installments are
evidenced by notes payable, which have been subordinated to the claims of FMSC's
general creditors under a subordination agreement approved by the NASD.
In 1997, the FMSC settled a customer arbitration for $500,000 in cash.
Under terms of the settlement, the Company also issued to the customer and her
counsel a total of 150,000 five-year warrants to purchase FMFC common stock for
$1.25 per share. Two of the Company's officers agreed to guarantee a minimum
selling price of $1.917 per share with respect to the shares underlying the
warrants and established a $100,000 escrow account with personal funds to secure
the guarantee. The warrantholders had a sixty-day period in which to exercise
the warrants and sell the shares, commencing from the date that the warrants
were registered for resale. The warrant registration became effective in June
1997. The individuals exercised their warrants and sold their shares at various
dates in 1997 on which the quoted market price for the shares exceeded the
guaranteed price.
FMSC is also a respondent in certain pending customer arbitrations and
other matters relating to its securities business. These claims are in various
stages of progress and are being vigorously contested. Management is unable to
derive a meaningful estimate of the amount or range of possible loss that may
arise out of pending litigation (including litigation costs) in any particular
subsequent quarterly or annual period, or in the aggregate. However, it is
possible that the financial condition, results of operations, or cash flows of
the Company in subsequent quarterly or annual periods could be materially
affected by the ultimate outcome of such pending litigation.
The Company is presently reviewing the extent to which settled and pending
claims may be covered under its insurance policies. In January 1997, the Company
negotiated a $650,000 settlement with one of its insurance carriers in
consideration of a general release from coverage on various matters. Discussions
with other carriers for reimbursement of settlements paid by the Company are
continuing. There can be no assurance that the Company will be successful in its
efforts to recover additional funds from its insurers on settled claims, or that
monetary losses, if any, from future settlements or adverse judgments will be
covered under the Company's existing insurance policies.
Consulting Agreement
In August 1997, the Company and FMSC entered into a contract with a
technology consulting firm for computer systems consulting and the development
of sales compensation and operations management software. In consideration of
the license to use preexisting proprietary software and source code, the Company
has agreed to issue the firm a total of 58,400 unregistered shares of its Common
Stock. The Company has further committed to register the shares for resale. If
the Company fails to register the shares in 1998 as specified in the agreement,
the firm will be entitled to put the shares back to the Company for a total of
$175,000, or $3.00 per share. In the event the shares are registered, but unsold
in whole or in part within 60 days subsequent to delivery of the first phase of
development, as defined, the firm may request the Company to pay the difference
between $175,000 and the net proceeds from the sale of shares to date. The firm
would then be required to surrender any unsold shares to the Company.
The firm has agreed to share with FMSC a percentage of license fee revenue,
as defined, that it earns under future licensing agreements covering the product
developed under its contract with FMSC. The amount of revenue-sharing will be
limited to the total of all contract payments that FMSC makes to the firm.
Purchase commitments
In 1997, the Company entered into a three-year agreement with a long
distance carrier under which the Company has committed to pay minimum annual
charges of $300,000 in each of the three contract years, in consideration of
favorable rates on telephone and data communications service during the
commitment period.
NOTE 12 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK and
CONCENTRATION OF CREDIT RISK
The Company executes securities transactions on behalf of its customers. If
either the customer or a counter-party fail to perform, the Company by agreement
with its clearing broker may be required to discharge the obligations of the
non-performing party. In such circumstances, the Company may sustain a loss if
the market value of the security is different from the contract value of the
transaction. As part of its normal brokerage activities, FMSC also assumes short
positions in its inventory. The establishment of short positions exposes FMSC to
off-balance-sheet risk in the event prices increase, as FMSC may be obligated to
acquire the securities at prevailing market prices.
FMSC seeks to control off-balance-sheet risk by monitoring the market value
of securities held or given as collateral in compliance with regulatory and
internal guidelines. Pursuant to such guidelines, FMSC's clearing firm requires
additional collateral or reduction of positions, when necessary. FMSC also
completes credit evaluations where there is thought to be credit risk.
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and securities
inventories. The Company places its cash primarily in commercial checking
accounts. Balances may from time to time exceed federally insured limits. Cash
and securities inventories maintained at FMSC's clearing firm are uninsured.
NOTE 13 - DEFINED CONTRIBUTION PLAN
The Company sponsors a defined contribution pension plan [401(k)] covering
all participating employees. The Company may elect to contribute up to 100% of
each participant's annual contribution to the plan. Employer contributions for
1997, 1996 and 1995 amounted to $33,060, $44,400, and $36,122, respectively.
NOTE 14 - COMMON STOCK ISSUED WITH GUARANTEED SELLING PRICE
During 1996, the Company issued a total of 421,500 restricted shares of its
Common Stock in settlement of various customer claims and invoices for legal
services. With respect to these shares, the Company has provided a guarantee to
pay to the selling stockholder the difference between $2.00 per share and the
selling price of the shares upon expiration of the statutory holding period. In
1997, the Company increased the guarantee to $2.75 per share with respect to
37,500 shares. The holders of the restricted shares may elect to retain the
shares once the holding period lapses. Such an election will release the Company
from any further obligation to the stockholders.
The Company has established a temporary equity account to record its
maximum liability from the guarantees. Payment of any shortfall will be charged
to this account. Any balance remaining at the end of the respective holding
periods will be credited to permanent capital. In 1997, a total of 37,500 shares
were sold in the open market at prices exceeding the guarantee, resulting in a
reclassification of $103,125 to permanent capital. The Company has placed a
total of $70,000 into escrow accounts to secure some of the remaining
guarantees.
NOTE 15 - STOCK OPTION PLANS
The Company currently has three option plans in place: The 1992 Incentive
Stock Option Plan (the "1992 Plan"), the 1992 Non-Executive Director Stock
Option Plan (the "Director Plan"), and the 1996 Senior Management Incentive Plan
(the "1996 Plan").
In June 1996, the Company's stockholders approved an amendment to the 1992
Plan to increase the number of shares reserved for issuance from 2,000,000 to
3,500,000 shares. Under the 1992 Plan, options may be granted to employees,
consultants and registered representatives of the Company, but only options
issued to employees will qualify for incentive stock option treatment (ISOs).
The exercise price of an option designated as an ISO shall not be less than the
fair market value of the Common Stock on the date of grant. However, ISOs
granted to a ten percent stockholder shall have an exercise price of at least
110% of such fair market value. At the time an option is granted, the Board of
Directors shall fix the period within which it may be exercised. Such exercise
period shall not be less than one year nor more than ten years from the date of
grant. The 1992 plan will expire in May 2002.
The Company has reserved 1,000,000 shares of its Common Stock for issuance
under the Director Plan. Options to purchase 20,000 shares of Common Stock are
granted to each Non-Executive Director on August 1 of each year, provided such
individual has continually served as a Non-Executive Director for the
twelve-month period immediately preceding the date of grant. The options will
expire in five years from the date of grant. The exercise price of such options
shall be equal to the fair market value of the Company's Common Stock on the
date of grant. The Director Plan will terminate in May 2002. In June 1996 the
Company's stockholders approved an amendment to the Director Plan to eliminate
non-discretionary grants to members of advisory boards established by the board
of directors.
In 1996, the Company's stockholders also ratified the 1996 Plan. The
Company has reserved 2,000,000 shares for issuance to key management employees.
Awards can be granted through the issuance of incentive stock rights, stock
options, stock appreciation rights, limited stock appreciation rights, and
shares of restricted Common Stock. The exercise price of an option designated as
an ISO shall in no event be less than 100% of the then fair market price of the
stock (110% with respect to ten percent stockholders), and not less than 85% of
the fair market price in the case of other options. The 1996 Plan will terminate
in June 2006.
A summary of the activity in the Company's stock option plans for the
three-year period ended December 31, 1997 is presented below:
Range of
Exercise
Shares Prices
Options outstanding, December 31, 1994 1,331,500 $.41 - 2.625
Granted 863,500 .50 - 1.00
Canceled (54,000) .75 - 2.625
Exercised (23,500) .41 - .75
- - -------------------------------------------------------------------------------
Options outstanding, December 31, 1995 2,117,500 $.41 - 1.75
Granted 279,000 .875 - 1.33
Canceled (123,000) .56 - 1.00
Exercised (137,375) .50 - 1.00
- - -------------------------------------------------------------------------------
Options outstanding, December 31, 1996 2,136,125 $.41 - 1.75
Granted 1,517,500 .96 - 2.75
Canceled (56,500) .56 - .875
Exercised (973,025) .41 - 1.75
- - -------------------------------------------------------------------------------
Options outstanding, December 31, 1997 2,624,100 $.41 - 2.75
Additional information with respect to options under the Company's option
plans is as follows:
Shares of common stock available
for future grant 2,669,800
Weighted-average grant date fair value of options
granted during each year using the Black-Scholes
option pricing model
1995 $.52
1996 $.55
1997 $.73
The Company applies APB No. 25 in accounting for employee stock options.
Accordingly, compensation is recognized in the financial statements only for the
fair value of options issued to non-employee directors, consultants and
affiliate brokers.
Such compensation is amortized to expense over the related options' vesting
periods. Compensation expense recognized in 1997 totaled $21,652.
Pro forma net earnings and earnings per share information, as required by
SFAS No. 123, has been determined as if the Company had accounted for employee
stock options under the fair value method. The fair value of these options was
estimated at grant date using a Black-Scholes option pricing model with the
following weighted-average assumptions for 1997, 1996 and 1995:
1997 1996 1995
Risk free interest rates 6.23% 6.05% 5.73%
Expected option lives 3.75 years 5 years 5 years
Expected volatilities 46.5% 76.5% 70.04%
Expected dividend yields 0% 0% 0%
The Company's pro forma
information follows:
Net income (loss) 1997 1996 1995
As reported $1,476,825 $ 32,789 $768,088
Proforma 1,246,276 (26,597) 677,124
Basic income (loss) per share
As reported $.17 $ .01 $.10
Proforma .14 (.01) .08
Diluted income (loss) per share
As reported $.14 $ .01 $.09
Proforma .12 (.01) .08
The full impact of calculating compensation expense for stock options under
SFAS No. 123 is not reflected in pro forma net income, since such expense is
amortized over the vesting period of those options as they vest.
Additional information as of December 31, 1997 with respect to all
outstanding options is as follows:
Options Outstanding Options Exercisable
Weighted
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Range of prices Outstanding Life Price Exercisable Price
$ .41 - .61 214,000 0.25 $0.60 202,000 $0.61
.69 - 1.05 1,031,400 2.79 0.84 655,070 0.83
1.06 - 1.30 661,700 4.44 1.13 227,532 1.14
1.69 - 2.50 597,000 4.24 2.42 478,600 2.42
2.59 - 2.75 120,000 4.50 2.67 200,000 2.63
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2,624,100 1,763,202 $1.48
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NOTE 16 - STOCKHOLDERS' EQUITY
Recapitalization
In June 1997, the Company's stockholders approved an amendment to the
Company's Certificate of Incorporation to increase the number of shares of
Common Stock authorized for issuance from 15,000,000 to 30,000,000.
Preferred Stock
The Company is presently authorized to issue 5,000,000 shares of Preferred
Stock, none of which have been issued at December 31, 1996. The preference, if
any, to be given to preferred shares is determinable at the time of issuance.
Stock Repurchases
In 1996 and 1995, respectively, the Company repurchased a total of 196,802
and 215,800 shares of its Common Stock in the open market for $230,506 and
$194,035 under now expired stock buy-back programs authorized by the Board of
Directors. All of the repurchased shares have been cancelled.
Sale of Restricted Stock
In 1997, the Company sold 12,240 unregistered shares of its Common Stock to
an affiliate broker for total consideration of $23,027.
Issuance of Common Stock
During fiscal 1996, the Company issued a total of 165,000 shares of its
Common Stock to settle various customer claims. The Company recorded a charge to
earnings of $178,650 upon issuance of the shares.
NOTE 17 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 107, Disclosures About Fair Value of Financial
Instruments, which requires that all entities disclose the fair value of
financial instruments, as defined, for both assets and liabilities recognized
and not recognized in the statement of financial condition. Substantially all of
the Company's financial instruments at December 31, 1997, consisting primarily
of marketable debt and equity securities, amounts due from FMSC's clearing firm,
accounts payable and accrued expenses, and notes payable - bank, are carried at,
or approximate fair value due to their short-term nature, the use of
mark-to-market accounting for trading securities, or because they carry market
rates of interest.
NOTE 18 - NET CAPITAL REQUIREMENTS
FMSC is subject to the Securities and Exchange Commission Uniform Net
Capital Rule (Rule 15c3-1), which requires FMSC to maintain minimum net capital,
as defined. At December 31, 1997, FMSC had net capital $2,398,817, which was
$2,148,817 in excess of its required net capital of $250,000. FMSC's ratio of
aggregate indebtedness to net capital was 1.28 to 1.
NOTE 19 - RELATED PARTY TRANSACTIONS
In 1997, FMSC served as underwriter for an initial public offering of
PacificHealth Laboratories ("PHL") common stock. One of the directors of the
Company is a director, officer and major stockholder of PHL. FMSC also served as
placement agent for two private placements of PHL securities in 1996, from which
it earned placement fees of $366,000. Management believes that the fees earned
by FMSC on the PHL financings represent arm's-length compensation.
NOTE 20 - SUBSEQUENT EVENTS
Rights offering
In February 1998, the Company completed an offering of 3,072,779 Units,
each Unit consisting of one Class A Redeemable Common Stock Purchase Warrant,
one Class B Redeemable Common Stock Purchase Warrant, and one Class C Redeemable
Common Stock Purchase Warrant. The Warrants have the following exercise prices
and terms:
Exercise Price Exercise Period
Warrant Per Share from Date of Issuance
Class A $3.00 Three years
Class B 5.00 Five years
Class C 7.00 Seven years
Each shareholder of record as of December 15, 1997 received three rights
for each share of Common Stock held as of the record date, with three rights
required to subscribe for a single Unit at a price of $.45 per Unit. The
offering raised gross proceeds of $1,382,750 before deducting related costs. As
of December 31, 1997, the Company had incurred offering costs of approximately
$116,000. The Class A, Class B and Class C warrants will unbundle from the Units
and trade separately.
Loans to Global
During the period from January 1, 1998 to March 11, 1998, MAI advanced
additional funds of $490,000 to Global to repay lease investors. These loans
bear interest at 8% per annum and are secured by the same collateral securing
earlier MAI loans (see Note 6).