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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 1-9727
FRANKLIN CAPITAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-3419202
(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
100 WILSHIRE BOULEVARD, SUITE 1500
SANTA MONICA, CALIFORNIA 90401
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 752-1416
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, par value The American Stock Exchange
$1.00 per share
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2) Yes |_| No |X|.
The aggregate market value of common stock held by non-affiliates of the
Registrant on June 30, 2004, based on the closing price on that date of $4.00
on the American Stock Exchange, was $3,142,092. For the purposes of calculating
this amount only, all directors and executive officers of the Registrant have
been treated as affiliates. There were 1,758,776 shares of the Registrant's
common stock outstanding as of March 28, 2005.
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FRANKLIN CAPITAL CORPORATION
FORM 10-K FOR THE FISCAL YEAR
ENDED DECEMBER 31, 2004
TABLE OF CONTENTS
PAGE
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PART I
Item 1. BUSINESS............................................................................................. 1
Item 2. PROPERTIES........................................................................................... 38
Item 3. LEGAL PROCEEDINGS.................................................................................... 39
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................................. 39
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES......................................................................................... 42
Item 6. SELECTED FINANCIAL DATA.............................................................................. 43
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................ 44
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................................... 52
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......................................................... 54
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE................. 75
Item 9A. CONTROLS AND PROCEDURES.............................................................................. 75
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................................................... 75
Item 11. EXECUTIVE COMPENSATION............................................................................... 78
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS................................................................................ 86
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................................................... 89
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES............................................................... 89
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT AND SCHEDULES.......................................................... 89
Signatures
PART I
ITEM 1. BUSINESS
GENERAL
Franklin Capital Corporation ("Franklin", or the "Company") is a
publicly traded, non-diversified internally managed, closed-end investment
company that elected to be treated as a business development company ("BDC")
under the Investment Company Act of 1940, as amended (the "1940 ACT") on
November 18, 1997. We were incorporated on March 31, 1987 as a Delaware
corporation and have been listed on the American Stock Exchange ("AMEX") since
October 1, 1987. We are currently involved in providing capital and managerial
assistance to early stage companies in the medical products, health care
solutions, financial services and real estate industries.
In the first half of 2004, we focused our investment strategy on the
achievement of capital appreciation through long-term equity investments in
start-up and early stage companies in the radio and telecommunications
industries. However, beginning in June 2004, we undertook a strategic
restructuring and recapitalization plan (the "RESTRUCTURING PLAN") which
ultimately culminated in a subsequent change in control in our management and a
shift in our business focus away from the radio and telecommunications
industries toward the medical products, health care solutions, financial
services and real estate industries. For more information SEE, "SUMMARY OF 2004
RESTRUCTURING PLAN AND CHANGE IN CONTROL."
OVERVIEW OF OUR BUSINESS PLAN AND RESTRUCTURING
The Restructuring Plan shifted our primary investment focus from the
radio and telecommunications industry to the medical products, health care
solutions, financial services and real estate industries. Accordingly, our
primary investment objective has also shifted and is now focused on maximizing
long-term capital growth through the appreciation of our investments in
health care and medical products related companies, and to a lesser extent
in the financial services and real estate industries. Franklin Capital
Properties, LLC, a real estate development and management company and Franklin
Medical Products, LLC, a healthcare consulting services company, both
wholly-owned subsidiaries of Franklin, were created to augment our investments
in these industries.
The Company and its operating subsidiaries are currently engaged in
the acquisition of controlling interests in companies and research and
development of products and services focused on the health care and medical
products field, particularly, the patient safety market, as well as the
financial services and real estate industries.
On February 25, 2005, in furtherance of the implementation of the
Company's Restructuring Plan the Company purchased SurgiCount, a privately held,
California-based developer of patient safety devices. SurgiCount is the
Company's first major acquisition in its plan to become a leader in what
it believes to be the multi-billion dollar patient safety field market and
management believes that the acquisition is a significant milestone in the
Company's plan to shift its focus from radio and telecommunications to products
and services targeting patient safety.
Given the changing nature of our business and investment focus from
investing, reinvesting, owning, holding, or trading in investment securities in
the radio and telecommunications industries toward that of an operating company
whose focus will be on acquisitions of controlling investments in operating
companies and assets in the healthcare and medical products industries, as well
as the financial services and real estate industries, we believe that the
regulatory regime governing BDC's is no longer appropriate and will hinder our
future growth. Accordingly, among other things, we are seeking shareholder
approval at the upcoming annual meeting to withdraw our election to be treated
as a BDC. For more information see, "WITHDRAWAL OF THE COMPANY'S ELECTION TO BE
TREATED AS A BDC."
Milton "Todd" Ault III and Louis Glazer, M.D., Ph. G. currently
serve as the principal executives in the management group responsible for the
operations and allocation of the resources of the Company and its subsidiaries.
Messrs. Ault and Glazer oversee and coordinate the activities of the Company's
health care, medical products, financial services and real estate companies.
1
Our capital is generally used to finance research and development of
products in the health care and patient safety markets, organic growth,
acquisitions, recapitalizations and working capital. Our investment decisions
are based on extensive analysis of potential portfolio companies' business
operations supported by an in-depth understanding of the quality of their
revenues and cash flow potential, variability of costs and the inherent value of
their assets, including proprietary intangible assets and intellectual property.
Our current target industries are heavily regulated. In the U.S.,
the principal authority regulating the operations of our medical companies is
the Food and Drug Administration ("FDA"). The FDA regulates the safety and
efficacy of the products we offer, our research quality, our manufacturing
processes and our promotion and advertising. In addition, we are also currently
subject to the requirements of the 1940 Act applicable to BDC's. For more
information see "BDC AND HEALTHCARE REGULATION" below.
WITHDRAWAL OF THE COMPANY'S ELECTION TO BE TREATED AS A BDC
General
On December 30, 2004, the Board unanimously approved a proposal to
authorize the Board to withdraw the Company's election to be treated as a BDC as
soon as practicable so that it may begin conducting business as an operating
company rather than an investment company subject to the 1940 Act. Such proposal
is scheduled to be voted upon by stockholders at the company's 2004 Annual
Meeting.
The Board believes that given the changing nature of the Company's
business and investment focus from investing, reinvesting, owning, holding, or
trading in investment securities in the radio and telecommunications industries
toward that of an operating company whose focus will be on acquisitions of
controlling investments in operating companies and assets in our current target
industries, that the regulatory regime governing BDC's is no longer appropriate
and will hinder the Company's future growth. In addition, the Board believes
that the Company will not be required to be regulated under the 1940 Act under
these circumstances.
Over the years, since the Company commenced operating as a BDC, the
business, regulatory and financial climates have shifted gradually but greatly,
making operations as a BDC more challenging and difficult. Given the investment
focus, asset mix, business and operations of the Company that will result from
the implementation of the Restructuring Plan, the Board believes that it is
prudent for the Company to withdraw its election as a BDC as soon as practicable
to eliminate many of the regulatory, financial reporting and other requirements
and restrictions imposed by the 1940 Act discussed below. For example:
o BUSINESS FOCUS. As a result of the Restructuring Plan, the nature of
the Company's business is changing from a business that has
historically been in the business of investing, reinvesting, owning,
holding, or trading in investment securities in the radio and
telecommunications industry toward that of an operating company
whose primary focus is on acquiring controlling interests in
companies in the medical products and health care industries, and to
a lesser extent in the financial services and real estate
industries. The Board believes that BDC regulation would be
inappropriate for such activities.
o ISSUANCE OF COMMON STOCK. By virtue of its BDC election, the Company
may not issue new shares of Common Stock at a per share price less
than the then net asset value per share of outstanding Common Stock
without prior stockholder approval. Historically, the market prices
for BDC stocks that invest primarily in equity securities have been
lower than net asset value, making it much more difficult for such
BDC's to raise equity capital. While this restriction provides
stockholders of an investment company with
2
appropriate and meaningful protection against dilution of their
indirect investment interest in portfolio securities, the Board
believes that this would essentially be irrelevant to the interests
of investors in an operating company, who look to its consolidated
earnings stream and cash flow from operations for investment value.
o ISSUANCE OF SECURITIES OTHER THAN COMMON STOCK. BDC's are limited or
restricted as to the type of securities other than common stock they
issue. The issuance of convertible securities and rights to acquire
shares of common stock (e.g., warrants and options) is restricted
primarily because of the statutory interest in facilitating
computation of the Company's net asset value per share. In addition,
issuances of senior debt and senior equity securities require that
certain "asset coverage" tests and other criteria be satisfied on a
continuing basis. This significantly affects the use of these types
of securities because asset coverage continuously changes by
variations in market prices of the Company's investment securities.
Operating companies, including holding companies operating through
subsidiaries, benefit from having maximum flexibility to raise
capital through various financing structures and means.
o RELATED PARTY TRANSACTIONS. The 1940 Act significantly restricts,
among other things, (a) transactions involving transfers of property
between the Company and certain affiliated persons of the Company
(or the affiliated persons of such affiliated persons), and (b)
transactions in which the Company and such affiliated persons (or
the affiliated persons of such affiliated persons) participate
jointly vis-a-vis third parties on the other. To overcome these
investment company restrictions, approval of the United States
Securities and Exchange Commission ("SEC") is required, which is
often a time-consuming and expensive procedure, regardless of the
intrinsic fairness of such transactions or the approval thereof by
the independent directors of the Company. The Board also believes
that situations may arise in which a company's best interests are
served by such transactions. The Board believes that even with the
protections afforded under the 1940 Act, stockholders are adequately
protected by the fiduciary obligations imposed on directors under
state corporate law, which generally requires that the independent
directors determine fairness to the Company of an interested-party
transaction (provided full disclosure of all material facts
regarding the transaction and the interested party's relationship
with the Company is made), and SEC disclosure rules, which require
the Company to include specified disclosure regarding transactions
with related parties in its SEC filings.
o COMPENSATION OF EXECUTIVES. The 1940 Act limits the extent to which,
and the circumstances under which executives of a BDC may be paid
compensation other than in the form of salary payable in cash. For
example, the issuance of equity compensation in the form of
restricted stock is generally prohibited. However, the Board
believes that by achieving greater flexibility in the structuring of
employee compensation packages, the Company will be able to attract
and retain additional talented and qualified personnel and to more
fairly reward and more effectively motivate its personnel in
accordance with industry practice.
o ELIGIBLE INVESTMENTS. As a BDC, the Company may not acquire any
asset other than "Qualifying Assets" unless, at the time the
acquisition is made, Qualifying Assets represent at least 70% of the
value of the total assets (the "70% TEST"). Because of the
limitations on the type of investments the Company may make, as well
as the Company's total asset composition, the Company may be
foreclosed from participating in prudent investment opportunities.
Moreover, the Company incurs significant costs in order to comply
with the regulations imposed by the 1940 Act. Management devotes considerable
time to issues relating to compliance with the 1940 Act and the Company incurs
substantial legal and accounting fees with respect to such matters. While these
protections are for the benefit of the Company's stockholders, the costs of this
regulation are none
3
the less borne by the stockholders of the Company. The Board believes that
resources now being expended on 1940 Act compliance matters could be utilized
more productively if devoted to the operation of the Company's business. The
Board has determined that the costs of compliance with the 1940 Act are
substantial, especially when compared to the Company's relative size and net
income, and that it would therefore be in the financial interests of the
stockholders for the Company to cease to be regulated under the 1940 Act
altogether.
The Board believes that the above reasons, among others, confirm
that the restrictions of the 1940 Act would have the effect of hindering the
Company's financial growth in the future. The Board has determined that the most
efficacious way to reduce these costs, improve profitability, and eliminate the
competitive disadvantages the Company experiences due to compliance with the
many requirements and restrictions associated with operating under the 1940 Act
would be to withdraw the Company's election to be treated as a BDC.
Effect of Election to Withdrawal as a BDC
In the event that the Board withdraws the Company's election to be
treated as a BDC and the Company becomes an operating company, the fundamental
nature of the Company's business will change from that of investing in a
portfolio of securities, with the goal of achieving gains on appreciation and
dividend income, to that of being actively engaged in the ownership and
management of operating businesses, with the goal of generating income from the
operations of those businesses.
The election to withdraw the Company as a BDC under the 1940 Act
will result in a significant change in the Company's method of accounting. BDC
financial statement presentation and accounting utilizes the value method of
accounting used by investment companies, which allows BDC's to recognize income
and value their investments at fair value as opposed to historical cost. As an
operating company, the required financial statement presentation and accounting
for securities held will be either fair value or historical cost methods of
accounting, depending on the classification of the investment and the Company's
intent with respect to the period of time it intends to hold the investment.
Change in the Company's method of accounting could reduce the market value of
its investments in privately held companies by eliminating the Company's ability
to report an increase in value of its holdings as they occur. Also, as an
operating company, the Company would have to consolidate its financial
statements with subsidiaries, thus eliminating the portfolio company reporting
benefits available to BDC's.
The pro forma unaudited balance sheet presented below gives effect
to the withdrawal of the Company's election to be regulated as a business
development company. The pro forma unaudited balance sheet assumes the
withdrawal had occurred as of January 1, 2003. The pro forma unaudited balance
sheet includes the historical amounts of the Company adjusted to reflect the
effects of the Company's withdrawal of its election to be regulated as a
business development company. The pro forma information should be read in
conjunction with the historical financial statements of the Company.
4
FRANKLIN CAPITAL CORPORATION AND SUBSIDIARIES PRO FORMA
UNAUDITED PRO FORMA BALANCE SHEET
DECEMBER 31, 2004 2003
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ASSETS
Cash and cash equivalents $ 846,404 $ 224,225
Trading assets 4,020,154 1,955,169
Other current assets 255,510 58,432
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TOTAL CURRENT ASSETS 5,122,068 2,237,826
Property, plant and equipment, net 23,657 20,206
Other long-term investments 1,788,518 1,000,000
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TOTAL ASSETS $ 6,934,243 $ 3,258,032
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable $ 892,530 $ 915,754
Accounts payable and accrued liabilities 939,568 318,140
Trading assets sold short 1,075,100
Due to broker 460,776
TOTAL CURRENT LIABILITIES 3,367,974 1,233,894
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STOCKHOLDERS' EQUITY
Convertible preferred stock, $1 par value, cumulative 7% dividend:
10,000,000 shares authorized; 10,950 issued and outstanding
at December 31, 2004 and 2003
(Liquidation preference $1,095,000) 10,950 10,950
Common stock, $1 par value: 50,000,000 shares authorized;
2,042,689 and 1,505,888 shares issued: 1,556,901 and 1,020,100 shares
outstanding at December 31, 2004 and 2003, respectively 2,042,689 1,505,888
Paid-in capital 13,925,253 10,439,610
Accumulated deficit (9,795,791) (7,315,478)
------------ ------------
6,183,101 4,640,970
Deduct: 485,788 shares of common stock held in treasury
at cost, at December 31, 2004 and 2003, respectively (2,616,832) (2,616,832)
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Total stockholders' equity 3,566,269 2,024,138
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 6,934,243 $ 3,258,032
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The Company does not believe that the withdrawal of its election to
be treated as a BDC will have any impact on its federal income tax status, since
it has never elected to be treated as a regulated investment company under
Subchapter M of the Internal Revenue Code. (Electing for treatment as a
regulated investment company under Subchapter M generally allows a qualified
investment company to avoid paying corporate level federal income tax on income
it distributes to its stockholders.) Instead, the Company has always been
subject to corporate level federal income tax on its income (without regard to
any distributions it makes to its stockholders) as a "regular" corporation under
Subchapter C of the Code. There will be no change in its federal income tax
status as a result of it becoming an operating company.
In addition, withdrawal of the Company's election to be treated as a
BDC will not affect the Company's registration under Section 12(b) of the
Exchange Act. Under the Exchange Act, the Company is required to file periodic
reports on Form 10-K, Form 10-Q, Form 8-K, proxy statements and other reports
required under the Exchange Act. Withdrawal of the Company's election to be
treated as a BDC is not expected to have any affect on the Company's listing
status on the AMEX.
Steps Toward Withdrawal
The Company is using maximum efforts to qualify for this change of
status and has undertaken several steps to meet the requirements for withdrawal
of its election to be treated as a BDC, including: (i) preparing a detailed plan
of operations in contemplation of such a change to the status for the Company
5
and (ii) consulting with outside counsel as to the requirements for withdrawing
its election as a BDC and exemption or exclusion from being deemed an
"investment company" under the 1940 Act. As of the date hereof, the Company
believes that the Company meets the requirements for filing an application to
withdraw its election to be treated as a BDC. However, we may not change the
nature of our business so as to cease to be, or withdraw our election as, a BDC
unless authorized by vote of a "majority of the outstanding voting securities,"
as defined in the 1940 Act. A majority of the outstanding voting securities of a
company is defined under the 1940 Act as the lesser of: (i) 67% or more of such
company's shares present at a meeting if more than 50% of the outstanding shares
of such company are present and represented by proxy or (ii) more than 50% of
the outstanding shares of such company.
On June 24, 2004, we received a letter from AMEX inquiring as to the
Company's ability to remain listed on AMEX. Specifically, AMEX indicated that
the Company's common stock was subject to delisting under sections 1003(a)(i)
and 1003(a)(ii) of AMEX Company Guide because the Company's stockholders' equity
was below the level required by AMEX's continued listing standards. Accordingly,
AMEX requested information relating to the Company's plan to retain its listing.
On September 13, 2004, the Company presented the final components of
its proposed plan to AMEX to comply with AMEX's continued listing standards and
on September 15, 2004, AMEX notified the Company that it had accepted the
Company's plan and had granted the Company an extension until December 26, 2005
to be in compliance with the AMEX contained listing standards, during which time
AMEX will continue the Company's listing subject to certain conditions. The
Company cooperated, and has continue to cooperate, with AMEX regarding these
issues and intends to make every effort to remain listed on AMEX. AMEX has
notified the Company, however, that failure to make progress consistent with the
plan of compliance or to be in compliance with the continued listing standards
could result in the Company's common stock being delisted from AMEX, and no
assurances can be made that the Company will be able to maintain its AMEX
listing. A delisting from AMEX would have a material adverse effect on the price
and liquidity of Franklin's common stock.
On November 11, 2004, our Board adopted and approved certain
corporate governance-related documents, including a code of business conduct and
ethics, and revised audit and compensation committee charters, in order to
comply with certain of AMEX's corporate governance listing standards.
The Company believes that it is currently in compliance with the
AMEX requirements.
If the stockholders approve this proposal to permit the Company to
withdraw its BDC election, the withdrawal will become effective upon receipt by
the SEC of the Company's application for withdrawal. The Company does not
anticipate filing the application of withdrawal until it can be reasonably
certain that the Company will not be deemed to be an investment company without
the protection of its BDC election. After the Company's application for
withdrawal of its BDC election is filed with the SEC, the Company will no longer
be subject to the regulatory provisions of the 1940 Act applicable to BDC's
generally, including regulations related to insurance, custody, composition of
its Board, affiliated transactions and any compensation arrangements.
INITIATION OF THE RESTRUCTURING PLAN AND CHANGE IN CONTROL
On May 11, 2004, Ault Glazer & Company Investment Management, LLC
("AULT GLAZER"), a private investment management firm headquartered in Santa
Monica, California that manages approximately $20 million in individual client
accounts and private investment funds and is owned by Milton "Todd" Ault III,
Lynne Silverstein, and Louis and Melanie Glazer began acquiring shares of our
common stock, par value $1.00 (the "COMMON STOCK") through open-market
purchases.
By May 12, 2004, Ault Glazer indirectly beneficially owned or
controlled approximately 11% of the outstanding shares of Common Stock. On May
18, 2004, in its original filing with the SEC on Schedule 13D, Ault Glazer
disclosed its concerns regarding the ability and willingness of Franklin's
then-current management to maximize stockholder value and stated its intention
to recommend that Franklin's management coordinate with Ault Glazer to effect
certain fundamental changes within Franklin. Both prior to and following the
filing of the Schedule 13D, Ault had several conversations with Stephen L.
Brown, Franklin's then Chairman and Chief Executive Officer ("Brown"), and other
members of the Board regarding Ault Glazer's ideas with respect to changing
Franklin's leadership and business.
On May 19, 2004, by which time Ault Glazer indirectly beneficially
owned or controlled over 30% of the outstanding shares of Common Stock, the
Board met to discuss Ault Glazer's acquisitions of Common Stock and the Board's
responsibilities and obligations to Franklin's stockholders in connection with
these acquisitions, as well as an appropriate response. At the meeting, Ault
confirmed to the Board that Ault Glazer, in an effort to maximize long-term
stockholder value, intended to effect a change of control and a restructuring of
Franklin involving, among other things, the introduction of a new management
team to replace the existing directors and officers of Franklin, the liquidation
of Franklin's current investment portfolio, the recapitalization of Franklin
with new outside financing, and the relocation of Franklin's headquarters to
Santa Monica, California. During the meeting, Franklin and Ault Glazer also
entered into a confidentiality and "standstill" agreement, pursuant to which
Ault Glazer agreed, among other things, not to acquire any additional securities
of Franklin until May 30, 2004. On June 1, 2004, Ault Glazer and Ault also
amended their existing filing on Schedule 13D to confirm their intention to
effect a change of control of Franklin.
6
In response to the Board's request, Ault Glazer, through private
discussions with the Board between June 3, 2004 and June 9, 2004, presented the
basic terms of the Restructuring Plan. On June 9, 2004, the Board met to discuss
the Restructuring Plan. Following the discussion, the Board concluded that the
Restructuring Plan was in the best interests of Franklin and its stockholders.
As a result, the Board authorized and directed Franklin's management to hold
further discussions and negotiations with Ault Glazer with respect to the
Restructuring Plan.
IMPLEMENTING THE RESTRUCTURING PLAN
On June 23, 2004, the Company entered into a Letter of Understanding
(the "LOU") with Ault Glazer. This LOU set forth the understandings and
agreements of the Company and Ault Glazer with respect to the Restructuring
Plan. The Restructuring Plan was intended to maximize stockholder value through,
among other things, (i) a shift in the Company's investment strategy away from
the radio and telecommunications industry toward a primary focus on the health
care and medical products related companies, and to a lesser extent in the
financial services and real estate industries, (ii) the liquidation of the
Company's investments (including Excelsior Radio Networks, Inc. ("EXCELSIOR")),
(iii) the raising of new capital to fund new investments, and (iv) the election
of new directors and officers with experience and expertise in the medical
products, health care solutions, financial services and real estate industries.
In connection with the Restructuring Plan, Franklin also entered
into a Termination Agreement and Release (the "TERMINATION AND RELEASE
AGREEMENT") with Brown that contains the terms of Brown's prospective
resignation from Franklin. Franklin and Brown amended the Termination Agreement
on September 30, 2004. See "TERMINATION AGREEMENT AND RELEASE" BELOW.
On October 22, 2004, the Company held a special meeting of
stockholders to approve certain proposals relating to the Restructuring Plan
(the "SPECIAL MEETING"). At the Special Meeting, the Company's stockholders
approved proposals relating to: (1) the election of Louis Glazer, M.D., Ph.G.,
Herbert Langsam, Alice Campbell and Brigadier General (Ret.) Lytle Brown III to
serve on the Company's Board of Directors; (2) the amendment and restatement of
the Company's certificate of incorporation to increase the authorized number of
shares of the Company's common stock from 5,000,000 shares to 50,000,000 shares;
(3) the amendment and restatement of the Company's certificate of incorporation
to increase the authorized number of shares of the Company's preferred stock
from 5,000,000 shares to 10,000,000 shares; (4) the amendment and restatement of
the Company's certificate of incorporation to provide for the exculpation of
director liability to the fullest extent permitted by law; (5) the amendment and
restatement of the Company's certificate of incorporation to provide for the
classification of the Board into three classes of directors; (6) the sale by the
Company to Quince Associates, LP of all of the shares of, and warrants to
purchase shares of, common stock of Excelsior Radio Networks, Inc. beneficially
owned by the Company; and (7) the prospective sale by the Company of up to
5,000,000 shares of common stock and warrants to purchase up to an additional
1,500,000 shares of common stock. The proposal relating to the prospective sale
by the Company of Common Stock and warrants to purchase Common Stock to certain
"interested stockholders" under Delaware law was not approved by the requisite
stockholder vote.
On October 22, 2004, Stephen L. Brown, resigned from his positions
as the Company's Chairman and Chief Executive Officer, Hiram M. Lazar resigned
from his positions as the Company's Chief Financial Officer and Secretary. To
fill the vacancies created by these resignations, the newly elected Board
(consisting of Louis Glazer, Alice Campbell, Herbert Langsam, and Lytle Brown
III) appointed Ault to serve as the Company's Chairman and Chief Executive
Officer and Silverstein to serve as the Company's President and Secretary.
7
TERMINATION AGREEMENT AND RELEASE
In connection with the Restructuring Plan, the Company entered into
a Termination Agreement and Release (the "TERMINATION AGREEMENT") with Mr. Brown
that contained the terms of his resignation from the Company. Pursuant to the
terms of the Termination Agreement, we paid Mr. Brown a severance payment of
$250,000. In addition, we also agreed to: (i) pay Mr. Brown an aggregate amount
of $200,000 payable over eight months for consulting services to the Company on
historical matters concerning the Company's operations and stock portfolio as
may be reasonably requested from time to time by a designee of the Board, and
(ii) continue to provide coverage to Mr. Brown and his wife under our medical,
dental and vision plans for a period of three years following the date of
termination. The Company recorded a charge to operations of approximately
$483,000 in 2004 under the Termination Agreement.
A copy of the Termination Agreement was included as an exhibit to
the Company's report on Form 8-K filed with the SEC on June 24, 2004 and a copy
of Amendment No. 1 to the Termination Agreement was included as an exhibit to
the Company's current report on Form 8-K filed with the SEC on September 30,
2004.
All of the foregoing events are discussed in more detail in the
definitive proxy materials filed with the SEC on September 30, 2004, and March
3, 2005.
OUR CURRENT BUSINESS PLAN
THE MEDICAL PRODUCTS AND HEALTHCARE SOLUTIONS INDUSTRY
The Company believes that the healthcare delivery system is under
tremendous pressure to identify and commercialize simple medical solutions
quickly to lower costs, control infections, reduce liability and eliminate
preventable errors. Increased litigation and a renewed focus on patient safety
by regulators is spurring demand for new innovative medical devices. With the
convergence of scientific, electronic and digital technologies, new
breakthroughs in medical devices will play a critical role in solving the
problems in healthcare and enhancing patient safety in the future.
Surgeries are increasing in both number and complexity, creating a
need for newer, more efficient and safer medical devices. The urgency to reduce
the high level of preventable medical errors, reduce liability issues, control
infection and offer new health care services, will focus command attention and
resources as never before.
The medical community recognizes the importance of improving patient
safety, not only to enhance the quality of care, but also to help manage
skyrocketing medical costs and related litigation costs. We are confident the
medical profession and healthcare professionals will rise to the occasion and
help develop the medical solutions to revolutionize health care.
Franklin is dedicated to leading this effort through the development
and introduction of ground-breaking patient safety products such as its lead
product, the patented Safety-Sponge(TM) System, which management believes will
allow the Company to capture a significant portion of what we believe, based on
industry sources, to be approximately $650 million in annual U.S., European and
Japanese surgical sponge sales. In addition, the Company believes that its
innovative Safety-Sponge(TM) System could save up to an estimated $1.5 billion
annually in retained sponge litigation, based upon information from industry
sources.
To augment the Company's focus in the medical products industry the
Company formed Franklin Medical Products, LLC, a wholly-owned healthcare
consulting services company. Effective February 23, 2005, Franklin Medical
Products, LLC changed its name to Patient Safety Consulting Group, LLC.
8
("PSCG"). Initially, efforts at PSCG will be directed at products and services
that promote usage of our lead product.
CUSTOMERS
The Company intends to target hospitals, physicians, nurses and
clinics as its initial source of customers. In addition, the Company also plans
to develop strategic alliances with universities, medical facilities and notable
medical researchers around the United States, that will provide research,
development and promotional support for the Company's products and services.
9
GEOGRAPHIC AREAS
The Company intends to market and sell its patient safety products
and services in the United States and in Europe. However, the principal markets,
products and methods of distribution will vary by country based on a number of
factors, including, healthcare regulations, insurance coverage and customer
demographics. Investments and activities in some countries outside the United
States are subject to higher risks than comparable U.S. activities because the
investment and commercial climate is influenced by restrictive economic policies
and political uncertainties.
PRODUCT DEVELOPMENT
The Company's current patient safety products such as the
Safety-Sponge(TM) System are presently in the optimization and commercialization
phase. The Safety-Sponge(TM) System allows for faster and more accurate counting
of surgical sponges. SurgiCount has obtained FDA 510k exempt status for the
Safety-Sponge(TM) line. The Safety-Sponge(TM) line of sponges has passed
required FDA biocompatibility tests including ISO sensitization, cytotoxicity
and skin irritation tests. SurgiCount is now a wholly-owned subsidiary of the
Company. It is anticipated in the future that distribution of the Company's
medical products to health care professional markets will be done both directly
and through surgical supply and other dealers.
The Company intends to do further research and development to
advance its products as is normal for any other company. However, we intend to
outsource much of the R&D functions and focus our direct efforts on optimizing
this product and establishing distribution channels with strategic alliances
with hospitals to deploy the products. We also seek qualified input from
professionals in the healthcare profession as well as individuals at University
hospitals such as Harvard and the University of California, San Francisco. These
independent physicians and researchers maintain medical practices primarily at
University hospitals and are involved in various research and clinical
development programs. We meet on an as needed basis to discuss medical,
technology and development issues.
MANUFACTURING AND RAW MATERIALS
The Company has not begun commercial manufacturing of its
Safety-Sponge(TM) System. Upon such initiative, the Company intends to enter
into agreements or relationships with several vendors to commercially produce
our products. We believe that the materials used in our products are readily
available and can be purchased and/or produced by several different vendors and,
therefore, we do not anticipate being dependent on any one vendor.
RESEARCH AND DEVELOPMENT
Research and development activities are important to the Company's
business. However, at this time the Company does not have a research facility
but rather focuses its efforts on acquisitions of companies operating within our
target industries that have demonstrated product viability through their own
research and development activities. We intend to outsource much of the research
and development activities relating to improving our existing products or
expanding our intellectual property to similar products or products that have
similar characteristics in our target industries. The Company did not incur any
costs in 2004 relating to the development of new products, the improvement of
existing products, technical support of products and compliance with
governmental regulations for the protection of the consumer. In the future,
these costs will be charged directly to income in the year in which they are
incurred.
PATENTS AND TRADEMARKS
The Company intends to make a practice of obtaining patent
protection on its products and processes where possible. The Company's patents
and trademarks are protected by registration in the United States and other
countries where its products are marketed.
10
The Company currently owns patents issued in the United States and
Europe related to the Safety-Sponge(TM) System. Sales of the Safety-Sponge(TM)
System in the future will be expected to play a significant part of the
Company's total revenues. The Company considers these patents and trademarks in
the aggregate to be of material importance in the operation of its business. The
loss or expiration of any product patent or trademark could result in a loss of
market exclusivity and can result in a significant reduction in sales.
COMPETITION
The medical products and healthcare solutions industry is highly
competitive. We expect that if our investment model proves to be successful, our
current competitors in the medical products and healthcare solutions market may
duplicate our strategy and new competitors may enter the market. We compete
against other medical products and healthcare solutions companies, some of which
are much larger and have significantly greater financial resources than we do.
In addition, these companies will be competing with our portfolio companies to
acquire technologies from universities and research laboratories. We also
compete against large companies that seek to license medical products and
healthcare solutions technologies for themselves. We cannot assure you that we
will be able to successfully compete against these competitors in the
acquisition, development, or commercialization of any medical products and
healthcare solutions, funding of medical products and healthcare solutions
companies or marketing of our products and solutions.
Competition in research, involving the development of new products
and processes and the improvement of existing products and processes, is
particularly significant and results from time to time in product and process
obsolescence. The development of new and improved products is important to the
Company's success in all areas of its business. This competitive environment
requires substantial investments in continuing research, multiple sales forces
and strategic alliances. In addition, the winning and retention of customer
acceptance of the Company's patient safety products involves heavy expenditures
for health care regulatory compliance, advertising, promotion and selling.
COMPETITIVE ADVANTAGES
We believe that we are well positioned to provide financing and
research and development resources to medical products and health care-related
companies for the following reasons:
o Focus on innovative technologies, products and services;
o Network of well respected industry affiliations and medical
expertise;
o Expertise in originating, structuring and monitoring investments;
11
o Flexible investment approach; and
o Established deal sourcing network.
FINANCIAL SERVICES INDUSTRY
In recent years there has been substantial convergence among
companies in the financial services industry. A large number of corporate
entities, including, commercial banks, insurance companies and other broad-based
financial services companies have established or acquired broker-dealers and
asset management firms to compliment their existing lines of business. In
general, there are two types of institutions that will be the initial focus of
the Company's entry into the financial services industry -- broker-dealers and
investment management firms. Other types of entities in which the Company may
acquire or invest in the future, include, but are not necessarily limited to:
finance companies (including real-estate and mortgage related finance
companies), mutual fund companies, collection companies, technology companies
related to the financial services industry and companies engaged in financing
activities.
The Company intends to enter the financial services business through
the establishment of a broker-dealer or asset management subsidiary or through a
majority or minority acquisition or joint venture interest in a company engaged
in the provision of brokerage, asset management and/or similarly related
services. The Company also intends to provide financial advice on mergers,
acquisitions, restructurings and similar corporate finance matters in
furtherance of its financial services business line.
The Company has not invested in the financial services industry in
the past and therefore has not compiled a track record regarding the financial
performance to be expected in connection with the operation of this line of
business. However, the Company intends to utilize and rely on its relationship
with Ault Glazer, a private investment management firm owned and managed by
Milton "Todd" Ault III and other principals of the Company as well as other
third parties, to facilitate its acquisitions and/or joint investments the
forgoing types of financial services companies.
COMPETITION
The financial services industry is a highly competitive environment
where there are no long-term contracted sources of revenue. Each engagement is
separately awarded and negotiated. Our competitors are other investment banking
firms, merchant banks, broker dealers and investment management firms. We
compete with our competitors primarily on a regional, product or niche basis. We
compete on the basis of a number of factors, including our range of products and
services, innovation, and reputation.
As we expand our financial services business, we face competition to
acquire investments in attractive portfolio companies. The activity of
identifying, completing and realizing attractive private equity investments of
the types we expect to make is competitive and involves a high degree of
uncertainty. We may be competing with other investors and corporate buyers for
the investments that we make.
Competition is also intense for the attraction and retention of
qualified employees. Our ability to compete effectively in financial services
industry will depend upon our ability to attract new employees and retain and
motivate our existing employees.
THE REAL ESTATE INDUSTRY
The Company's real estate operations will eventually include a
mixture of commercial properties, residential land development projects and
other unimproved land, all in various stages of development and all available
for sale. Therefore, performance of the real estate operations will largely be
dependent upon the performance of the operating properties, the current status
of the Company's development projects and non-recurring gains or losses
recognized when and if real estate assets are sold. As a result, the results of
operations for the Company's real estate operations are likely to be
unpredictable and may experience significant year-over-year fluctuations.
The Company had several real estate investments at December 31,
2004. These investments consisted of eight vacant single family buildings and
two multi-unit buildings in Baltimore, Maryland, approximately 8.5 acres of
undeveloped land in Heber Springs, Arkansas, and various loans secured by real
estate in Heber Springs, Arkansas. The Company's real estate investments are
held in Franklin Properties. Franklin Properties primary focus is on the
acquisition and management of income producing real estate holdings.
COMPETITION
The Company's real estate operations are in competitive
environments. The Company has concentrations of investments in Baltimore,
Maryland and Heber Springs, Arkansas. The Company competes with a large number
of real estate property owners and developers. Principal factors of competition
are rent charged, attractiveness of location, the quality of the property and
breadth and quality of services provided. The success of the Company's real
estate operations depends upon, among other factors, trends of the national and
local economies, financial condition and operating results of prospective
tenants and customers, availability and cost of capital, construction and
renovation costs, taxes, governmental regulations, legislation and population
trends.
RECENT DEVELOPMENTS
On February 25, 2005, in furtherance of the implementation of the
Company's Restructuring Plan the Company purchased SurgiCount, a privately held,
California-based developer of patient safety devices. SurgiCount is the
Company's first major acquisition in its plan to become a leader in the
multi-billion dollar patient safety field market and management believes that
the acquisition is a significant milestone in the Company's plan to shift its
focus from radio and telecommunications to products and services targeting
patient safety.
On March 2, 2005, the Company made an investment in the common stock
of Administration for International Credit & Investments, Inc. ("AICI"), valued
at $450,000. As part of its investment, the Company received 225,000 warrants to
purchase common stock at $1.50 per share and 225,000 warrants to purchase common
stock at $2.00 per share. The warrants are exercisable for a period of five
years and are callable by AICI in certain instances. AICI operates an electronic
market for collecting, detecting, converting, enhancing and routing
telecommunication traffic and digital content. Members of the exchange
anonymously exchange information based on route quality and price through a
centralized, web accessible database and then route traffic. AICI's
fully-automatic, highly scalable Voice over Internet Protocol routing platform
updates routes based on availability, quality and price and executes the
capacity request of the orders using proprietary software and delivers them
through AICI's system. AICI invoices and processes payments for its members'
transactions and offsets credit risk through its credit management programs with
third parties. AICI's name changed to Ipex, Inc and began trading on the OTC
Bulletin Board on March 29, 2005.
On March 16, 2005, Ault Glazer filed a Schedule 13D with the SEC
relating to its holdings in Tuxis Corporation ("Tuxis"). Tuxis, a Maryland
corporation, currently is registered under the 1940 Act, as a closed-end
management investment company. Tuxis previously received Board of Directors and
shareholder approval to change the nature of its business so as to cease to be
an investment company and on May 3, 2004, filed an application with the SEC to
de-register. At March 16, 2005, the Company directly held 36,000 shares and
indirectly, by virtue of its relationship with Ault Glazer, held 98,000 shares
of Tuxis common stock, which represented approximately 3.66% and 9.96%,
respectively, of the total outstanding shares. At December 31, 2004, Tuxis had
reportable net assets of approximately $9.1 million.
INVESTMENT PROCESS
The Company identifies investment opportunities in our target
industries through an extensive network of contacts in the medical products and
health care solutions industries, relationships with venture capital firms and
other associations with individuals at University hospitals such as those
operated by Harvard and the University of California, San Francisco. Upon
identification of an investment opportunity the Company relies upon the
executive management team to conduct a thorough evaluation of the company and
its technology. As required, the executive management team may consult with
individuals that have specialized expertise in the target industry. In the case
of an investment where Franklin is the sole or lead investor and the executive
management team is satisfied with its evaluation, the basic terms of an
investment are negotiated directly by the executive management team and,
depending on the amount of the transaction, presented to the Board for approval.
Upon mutual acceptance of the basic terms, outside counsel would prepare the
transaction investment documents.
12
On March 2, 2005, the Company filed definitive proxy materials with
the Securities and Exchange Commission in connection with its 2004 Annual
Meeting of the Stockholders (the "ANNUAL MEETING"). The Annual Meeting is being
held on March 30, 2005 in order to vote on the following proposals: (i) the
election of Lytle Brown III as a Class I Director to hold office for a
three-year term expiring in 2007, or until his successor has been duly elected
and qualified or until his earlier death, resignation or removal, in accordance
with the Company's bylaws, as amended; (ii) the ratification of the appointment
by the Board of Directors of the Company (the "BOARD") of Rothstein, Kass &
Company, P.C. ("ROTHSTEIN KASS") to serve as independent auditors for the fiscal
year ended December 31, 2004; (iii) the authorization and approval of the stock
option component of the stock option and restricted stock plan for the Company
(the "NEW PLAN"); (iv) the authorization and approval of the restricted stock
component of the New Plan; (v) the authorization and approval of the payment of
cash and equity compensation to Milton "Todd" Ault III ("AULT"), Lynne
Silverstein ("SILVERSTEIN"), and Louis Glazer and Melanie Glazer (the
"GLAZERS"), each of whom may be deemed to be an "interested stockholder" (as
defined in Section 203 of the Delaware General Corporate Law ("DGCL")) of the
Company; (vi) the authorization and approval of the sale of common stock par
value $1.00 of the Company ("COMMON STOCK"), warrants to purchase Common Stock
("WARRANTS") and other securities representing indebtedness convertible into
Common Stock to Ault, Silverstein and the Glazers, each of whom may be deemed to
be an "interested stockholder" (as defined in Section 203 of the DGCL), on terms
that are approved by the Board consistent with its fiduciary duties and market
terms existing at the time of such offering, including those relating to price
per share, interest rate, warrant coverage and registration rights for such
issuances and the requirements of applicable law, including the 1940 Act, as
described in this proxy statement; (vii) the authorization and approval of the
certificate of amendment to the Amended and Restated Certificate of
Incorporation of the Company (the "CERTIFICATE OF AMENDMENT") to reduce the par
value of the Common Stock from $1.00 per share to $0.33 per share and effect a
three-for-one split of the Common Stock (the "STOCK SPLIT"); (viii) the
authorization and approval of the prospective issuance of bonds, notes or other
evidences of indebtedness that are convertible into Common Stock ("CONVERTIBLE
BONDS," "CONVERTIBLE NOTES" or "OTHER CONVERTIBLE INDEBTEDNESS") in accordance
with the requirements of the 1940 Act; (ix) the authorization and approval of
the Board to withdraw the Company's election to be treated as a BDC pursuant to
Section 54(c) under the 1940 Act; (x) the authorization and approval of the
Certificate of Amendment to change the name of the Company to "Patient Safety
Technologies, Inc."; and (xi) the authorization and approval of the Certificate
of Amendment to decrease the authorized number of shares of Common Stock from
50,000,000 shares to 25,000,000 shares and decrease the authorized number of
shares of Preferred Stock from 10,000,000 shares to 1,000,000 shares.
Please refer to our definitive proxy statement filed with the SEC on
March 2, 2005 and September 30, 2004, our quarterly reports on Form 10-Q filed
with the SEC for the quarters ended March 31, 2004, June 30, 2004 and September
30, 2004, and our Form 8-K's filed with the SEC on October 27, 2004, November 3,
2004, November 9, 2004, November 19, 2004, December 8, 2004, December 27, 2004,
January 4, 2005, February 9, 2005, February 9, 2005, and March 3, 2005 for
additional descriptions of, and information relating to, the Restructuring Plan,
the proposals voted on by the Company's stockholders at the Special Meeting of
Stockholders held on October 28, 2004, press releases related to the
announcement of the Company's future plans, and the proposals to be voted at the
Company's upcoming Annual Meeting.
PORTFOLIO OF INVESTMENTS
The Company has historically invested in long-term equity securities
of start-up and early stage companies in the radio and telecommunications
industry. However, as a result of the Restructuring Plan, the Company has
shifted its investment focus toward that of investments in companies in the
medical products/health care solutions and financial services and real estate
industries. These private businesses may be thinly
13
capitalized, unproven, small companies that lack management depth, are dependent
on new, commercially unproven technologies and have little or no history of
operations.
The following is a discussion of our most significant investments at
February 25, 2005. Pursuant to the Restructuring Plan, the Company shifted its
primary investment focus from the radio and telecommunications industry to the
medical products and health care solutions industries, and to a lesser extent in
the financial services and real estate industries. In conjunction with this
shift, on October 22, 2004, we sold our remaining equity interests in Excelsior
Radio Networks, Inc.("EXCELSIOR") to Quince Associates, LP ("QUINCE") for
$1,489,210. For a more detailed discussion of this transaction, see
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" - "OVERVIEW" and "INVESTMENTS - EXCELSIOR RADIO NETWORKS, INC."
SurgiCount
On February 25, 2005, the Company purchased SurgiCount Medical Inc.
("SURGICOUNT"), a privately held, California-based developer of patient safety
devices. Under the terms of the agreement, the Company paid to Brian Stewart and
Dr. William Stewart, the holders of 100% of the outstanding capital stock of
SurgiCount (the "Shareholders"), consideration in the amount of $340,000 in cash
and 200,000 shares of Common Stock, of which 10,000 shares of Common Stock will
be held in escrow until August 2005. In addition, if certain milestones are
satisfied, the Company will issue up to an additional 33,334 shares of Common
Stock to the Shareholders.
SurgiCount is the Company's first major acquisition in its plan to
become a leader in the multi-billion dollar patient safety field market.
Management believes that the acquisition is a significant milestone in the
Company's plan to shift its focus from radio and telecommunications to products
and services targeting health care and patient safety. SurgiCount owns patents
issued in the United States and Europe related to patient safety, among them,
the Safety-Sponge(TM) System, an innovation which management believes will allow
the Company to capture a significant portion of what we believe, based on
industry sources, to be approximately $650 million in annual U.S., European and
Japanese surgical sponge sales.
The Safety-Sponge(TM) System allows for faster and more accurate
counting of surgical sponges. SurgiCount has obtained FDA 510k exempt status for
the Safety-Sponge(TM) line. The Safety-Sponge(TM) line of sponges has passed
required FDA biocompatibility tests including ISO sensitization, cytotoxicity
and skin irritation tests. SurgiCount is now a wholly-owned subsidiary of the
Company.
China Nurse
On November 23, 2004, the Company entered into a strategic
relationship with China Nurse LLC ("China Nurse"), an international
nurse-recruiting firm based in New York that focuses on recruiting and training
qualified nurses from China and Taiwan for job placement with hospitals and
other health care facilities in the United States. In connection with this
strategic relationship, the Company has agreed to provide referrals and other
assistance and has also made a small capital investment in that company.
Digicorp
On December 29, 2004, the Company entered into a Common Stock
Purchase Agreement with certain shareholders of DigiCorp (the "Agreement"), to
purchase an aggregate of 3,453,527 shares of DigiCorp common stock. Of such
shares, 2,229,527 shares were purchased for $.135 per share on December 29,
2004, 100,787 shares were purchased for $.145 on December 29, 2004. Franklin
agreed to
14
purchase an additional 1,224,000 shares of DigiCorp common stock from the
selling shareholders at such time as the shares are registered for resale with
the SEC. The purchase price for such shares is $.135 or $.145 per share,
depending on when the closing occurs. Digicorp's common stock is traded on the
OTC Bulletin Board. In connection with the Agreement, Franklin is entitled to
designate two members to the Board of Directors of Digicorp. Franklin's first
designee, Melanie Glazer, was appointed on December 29, 2004. The Company is
currently evaluating several strategic alternatives for the use of the DigiCorp
entity, however, no definitive plan has been decided upon at this time.
Alacra Corporation
At December 31, 2004, the Company had an investment in shares of
Series F convertible preferred stock of Alacra Corporation, valued at
$1,000,000, which represented 14.4% of the corporation's total assets and 28.0%
of its net assets. Franklin has the right to have the Series F convertible
preferred stock redeemed by Alacra for face value plus accrued dividends on
December 31, 2006. Alacra, based in New York, is a global provider of business
and financial information. Alacra provides a diverse portfolio of fast,
sophisticated online services that allow users to quickly find, analyze, package
and present mission-critical business information. Alacra's customers include
more than 750 financial institutions, management consulting, law and accounting
firms and other corporations throughout the world.
Real Estate Investments
At December 31, 2004, the Company held a portfolio of real estate
investments through Franklin Capital Properties, LLC ("Franklin Properties"), a
Delaware limited liability company and a wholly owned subsidiary. As of December
31, 2004 Franklin Properties was valued at $738,518, which represents 10.7% of
the Company's total assets and 20.7% of its net assets. Franklin Properties
primary focus is on the acquisition and management of income producing real
estate holdings. Franklin Properties real estate holdings consist of eight
vacant single family buildings and two multi-unit buildings in Baltimore,
Maryland, approximately 8.5 acres of undeveloped land in Heber Springs,
Arkansas, and various loans secured by real estate in Heber Springs, Arkansas.
Franklin Properties intends to renovate the single family buildings and engage
in an active rental program.
For more information about the Company's other investments,
including its real estate holdings, see Item 7 "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION."
Excelsior Radio Networks, Inc.
At December 31, 2003, the Company had an investment in Excelsior
Radio Networks, Inc., formerly known as eCom Capital, Inc., valued at $1,921,270
which represented 59.0% of the Company's total assets and 94.9% of its net
assets. Excelsior produces and syndicates programs and services heard on more
than 2,000 radio stations nationwide across most major formats.
Franklin along with Sunshine initially purchased Excelsior on August
28, 2001. On October 3, 2002, Franklin sold 773,196 common shares for $1.94 per
share for $1,500,000 realizing a gain of $726,804. On January 31, 2003, Franklin
purchased and subsequently on May 29, 2003, Franklin cancelled the purchase,
33,750 common shares for $1.625 per share and 65,199 warrants to acquire shares
of Excelsior common stock at an exercise price of $1.125 per share for $0.50 per
warrant. On August 12, 2003, Franklin sold 193,000 common shares for $1.30 per
share for $250,900 realizing a gain of $57,900. Franklin has stock appreciation
rights on these common shares as follows, a) in the event that Excelsior is sold
on or before August 8, 2004 for gross proceeds of no less than $40,000,000, then
Franklin shall be
15
entitled to receive fifty percent (50%) of any net value above $1.30 per share
not to exceed total proceeds to Franklin of $1.94 per share, and b) in the event
that Excelsior is sold on or before August 8, 2005 for gross proceeds of no less
than $40,000,000, then Franklin shall be entitled to receive fifty percent (50%)
of any net value above $1.30 per share not to exceed proceeds to Franklin of
$1.625 per share. On October 8, 2003, Franklin sold to Sunshine 375,000 shares
of the common stock of Excelsior for an aggregate purchase price of $750,000,
realizing a gain of $375,000, pursuant to a stock purchase agreement between
Sunshine and Franklin. On March 19, 2004 Franklin sold an additional 58,804
shares of the common stock of Excelsior to Sunshine for an aggregate purchase
price of $117,608, $2.00 per common share. Franklin has stock appreciation
rights on the common shares sold to Sunshine on October 8, 2003 and March 19,
2004, such that if Excelsior is sold and the purchaser of the common shares from
Franklin receives more than $3.50 per share, Franklin is entitled to receive 80%
of the value greater than $3.50 per share.
On June 30, 2004, Franklin sold 200,000 common shares of Excelsior
to Quince Associates, LP ("Quince") for an aggregate purchase price of $500,000,
$2.50 per common share. On July 5, 2004, Franklin entered into an agreement with
Quince to sell Franklin's remaining interest in Excelsior. The transactions
contemplated by this agreement were subject to shareholder approval. On October
22, 2004, Franklin's shareholders approved the sale and Franklin agreed to sell
its remaining 550,000 shares of Excelsior common stock at $2.50 per share and
warrants exercisable for 74,232 shares of Excelsior common stock at an exercise
price of $1.20 per share at $1.30 per warrant and warrants exercisable for
12,879 shares of Excelsior common stock at an exercise price of $1.125 per share
at $1.375 per warrant. On September 24, 2004, 100,000 shares of common stock of
Excelsior were sold for an aggregate purchase price of $250,000 as an advance to
the final sale. On October 22, 2004, Franklin sold its remaining interest in
Excelsior to Quince for an aggregate purchase price of $1,489,210. Cumulative
realized gains on the sale of Excelsior common stock and warrants to purchase
Excelsior common stock to Quince amounted to $1,389,210.
The purchase price in connection with the June 30, 2004, September
24, 2004 and October 22, 2004 sales of our equity interests in Excelsior to
Quince is subject to a potential adjustment whereby, in the event that the per
share net proceeds from any liquidation of Excelsior exceeds $3.00 (or an amount
equal to $3.00 plus $.050 multiplied by the number of years, up to five, elapsed
since the closing date of the sale), Franklin will be entitled to receive 80% of
the value greater than $3.00 (or such other applicable amount) per share. The
purchase price adjustment for the sale will expire as of a date 5 years
following the closing of each sale transaction.
Other Investments
In 2001, Franklin maintained group life and dental insurance with
Principal Financial Group ("PFG"). Upon the demutualization of PFG in October
2001, Franklin received 4,338 common shares of PFG. However, Franklin did not
receive notification for the receipt of such shares. In 2004, Franklin became
aware of its ownership of PFG common shares, and recorded the fair value of such
shares within marketable investments. On April 23, 2004, Franklin sold the
common shares of PFG for $151,400, which was recorded as other realized gains in
the accompanying statement of operations.
16
EMPLOYEES
As of December 31, 2004, we had 7 employees in our offices, all
based in our Santa Monica office. We believe our relations with our employees
are good.
MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS
For federal and state income tax purposes, we are taxed at regular
corporate rates on ordinary income and recognize gains on distributions of
appreciated property. We are not entitled to the special tax treatment available
to BDCs that elect to be treated as regulated investment companies under the
Internal Revenue Code because, among other reasons, we do not distribute at
least 90% of "investment company taxable income" as required by the Internal
Revenue Code for such treatment. As of December 31, 2004, we had a net operating
loss carryforward of approximately $8.6 million to offset future taxable income
for federal income tax purposes. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--RESULTS OF OPERATIONS--TAXES."
Distributions in excess of current or accumulated earnings and profits will be
treated first as a return of capital to the extent of the holder's tax basis and
then as gain from the sale or exchange of property.
In the event that the company withdraws its election to be treated
as a BDC, the Company does not believe that the withdrawal of its election to be
treated as a BDC will have any impact on its federal income tax status, since it
has never elected to be treated as a regulated investment company under
Subchapter M of the Internal Revenue Code. (Electing for treatment as a
regulated investment company under Subchapter M generally allows a qualified
investment company to avoid paying corporate level federal income tax on income
it distributes to its stockholders.) Instead, the Company has always been
subject to corporate level federal income tax on its income (without regard to
any distributions it makes to its stockholders) as a "regular" corporation under
Subchapter C of the Code. There will be no change in its federal income tax
status as a result of it becoming an operating company.
For more information about the Company's plans to withdraw its
election as a BDC, see "WITHDRAWAL OF THE COMPANY'S ELECTION TO BE TREATED AS A
BDC MAY INCREASE THE RISKS TO OUR SHAREHOLDERS SINCE THE COMPANY WOULD NOT BE
SUBJECT TO MANY OF THE REGULATORY RESTRICTIONS IMPOSED BY, OR RECEIVE THE
FINANCIAL REPORTING BENEFITS, OF THE 1940 ACT" below.
REGULATION OF THE MEDICAL PRODUCTS AND HEALTHCARE INDUSTRY
The healthcare industry is affected by extensive government
regulation at the Federal and state levels. In addition, the Company's business
may also be subject to varying degrees of governmental
17
regulation in the countries in which operations are conducted, and the general
trend is toward regulation of increasing stringency. In the United States, the
drug, device, diagnostics and cosmetic industries have long been subject to
regulation by various federal, state and local agencies, primarily as to product
safety, efficacy, advertising and labeling. The exercise of broad regulatory
powers by the FDA continues to result in increases in the amounts of testing and
documentation required for FDA clearance of new drugs and devices and a
corresponding increase in the expense of product introduction. Similar trends
toward product and process regulation are also evident in a number of major
countries outside of the United States, especially in the European Economic
Community where efforts are continuing to harmonize the internal regulatory
systems.
The costs of human health care have been and continue to be a
subject of study, investigation and regulation by governmental agencies and
legislative bodies in the United States and other countries. In the United
States, attention has been focused on drug prices and profits and programs that
encourage doctors to write prescriptions for particular drugs or recommend
particular medical devices. Managed care has become a more potent force in the
market place and it is likely that increased attention will be paid to drug and
medical device pricing, appropriate drug and medical device utilization and the
quality of health care.
The regulatory agencies under whose purview the Company operates
have administrative powers that may subject the Company to such actions as
product recalls, seizure of products and other civil and criminal sanctions. In
some cases the Company may deem it advisable to initiate product recalls
voluntarily. We are also subject to the Safe Medical Devices Act of 1990, which
imposes certain reporting requirements on distributors in the event of an
incident involving serious illness, injury or death caused by a medical device.
In addition, sales and marketing practices in the health care
industry have come under increased scrutiny by government agencies and state
attorney generals and resulting investigations and prosecutions carry the risk
of significant civil and criminal penalties.
Changes in regulations and healthcare policy occur frequently and
may impact our results, growth potential and the profitability of products we
sell. There can be no assurance that changes to governmental reimbursement
programs will not have a material adverse effect on the Company.
REGULATION AS A BUSINESS DEVELOPMENT COMPANY
GENERAL
A BDC is regulated by the 1940 Act. A BDC must be organized in the
United States for the purpose of investing in or lending to primarily private
companies and making managerial assistance available to them. A BDC may use
capital provided by public stockholders and from other sources to invest in
long-term, private investments in businesses.
We may not change the nature of our business so as to cease to be,
or withdraw our election as, a BDC unless authorized by vote of a majority of
the outstanding voting securities, as required by the 1940 Act. A majority of
the outstanding voting securities of a company is defined under the 1940 Act as
the lesser of: (i) 67% or more of such company's voting securities present at a
meeting if more than 50% of the outstanding voting securities of such company
are present or represented by proxy, or (ii) more than 50% of the outstanding
voting securities of such company. We do not anticipate any substantial change
in the nature of our business.
As with other companies regulated by the 1940 Act, a BDC must adhere
to certain substantive regulatory requirements. A majority of our directors must
be persons who are not interested persons, as that term is defined in the 1940
Act. Additionally, we are required to provide and maintain a bond issued by a
reputable fidelity insurance company to protect the BDC. Furthermore, as a BDC,
we are prohibited from protecting any director or officer against any liability
to the company or our stockholders arising from willful misfeasance, bad faith,
gross negligence or reckless disregard of the duties involved in the conduct of
such person's office.
As a BDC, we are required to meet a coverage ratio of the value of
total assets to total senior securities, which include all of our borrowings and
any preferred stock we may issue in the future, of at least 200%. We may also be
prohibited under the 1940 Act from knowingly participating in certain
transactions with our affiliates without the prior approval of our directors who
are not interested persons and, in some cases, prior approval by the SEC.
We are not generally able to issue and sell our common stock at a
price below net asset value per share. See "RISK FACTORS--RISKS RELATING TO OUR
BUSINESS AND STRUCTURE--REGULATIONS GOVERNING OUR OPERATION AS A BDC AFFECT OUR
ABILITY TO, AND THE WAY IN WHICH WE RAISE ADDITIONAL CAPITAL." We may, however,
sell our common stock, or warrants, options or rights to acquire our common
stock, at a price below the then-current net asset value of our common stock if
our Board of Directors determines that such sale is in our best interests and
the best interests of our stockholders, and our stockholders approve such sale.
In addition, we may generally issue new shares of our common stock at a price
below net asset value in rights offerings to existing stockholders, in payment
of dividends and in certain other limited circumstances.
We will be periodically examined by the SEC for compliance with the
1940 Act.
As a BDC, we are subject to certain risks and uncertainties. See
"RISK FACTORS--RISKS RELATING TO OUR BUSINESS AND STRUCTURE."
In addition, the Company currently has plans, subject to shareholder
approval at the Annual Meeting, to withdraw the Company's election to be treated
as a BDC regulated under the 1940 Act. See "WITHDRAWAL OF THE COMPANY'S ELECTION
TO BE TREATED AS A BDC MAY INCREASE THE RISKS TO OUR SHAREHOLDERS SINCE THE
COMPANY WOULD NOT BE SUBJECT TO MANY OF THE REGULATORY RESTRICTIONS IMPOSED BY,
OR RECEIVE THE FINANCIAL REPORTING BENEFITS, OF THE 1940 ACT" below.
REGULATION OF THE FINANCIAL SERVICES INDUSTRY
FINANCIAL SERVICES INDUSTRY REGULATION
The growth and earnings performance of a financial institution are
affected not only by management decisions (such as the development of a business
plan and lending decisions) and general economic conditions (such as interest
rates, housing demand and business cycles), but also by the various governmental
regulations and authorities, including, but not limited to, regulation by the
Board of Governors of the Federal Reserve System ("FRB"), the Federal Deposit
Insurance Corporation ("FDIC"), the Office of the Comptroller of the Currency
("OCC"), the Office of Thrift Supervision ("OTS"), the Internal Revenue Service
("IRS"), and other federal and state authorities.
In addition, the Company will also be subject to extensive
regulation by self-regulatory bodies, including the New York Stock Exchange
(NYSE) and various other stock exchanges, the Securities and Exchange Commission
(SEC), the National Association of Securities Dealers Regulation, Inc. (NASDR)
and foreign regulatory bodies.
Federal and state laws and regulations generally applicable to
financial institutions regulate, among other things, the scope of business,
investment activities, capital levels, reserves against deposits, collateral
requirements, transactions with insiders and certain affiliates, the
establishment of branches, mergers, acquisitions, consolidations, the issuance
of equity and debt, and the payment of dividends.
Broker-dealers and investment advisers are subject to regulation
covering virtually all aspects of their businesses. These regulatory authorities
have adopted rules that govern the securities industry and, as a normal part of
their procedures, conduct periodic examinations of the Company's securities
brokerage and asset management operations. Additional legislation, changes in
rules promulgated by the SEC, foreign regulatory agencies, or any
self-regulatory organization, or changes in the interpretation or enforcement of
existing laws and rules, may directly affect the mode of operation and
profitability of the Company. In the United States, brokerage firms and certain
investment advisers also are subject to regulation by state securities
commissions in the states in which they conduct business. These regulatory
authorities, including state securities commissions, may conduct administrative
proceedings which can result in censure, fine, suspension or expulsion of a
broker-dealer or investment adviser, its officers or employees.
REGULATION OF THE REAL ESTATE INDUSTRY
The real estate development industry is subject to substantial
environmental, building, construction, zoning and real estate regulations that
are imposed by various federal, state and local authorities. In order to develop
its properties, the Company must obtain the approval of numerous
18
governmental agencies regarding such matters as permitted land uses, density,
the installation of utility services (such as water, sewer, gas, electric,
telephone and cable television) and the dedication of acreage for various
community purposes. Furthermore, changes in prevailing local circumstances or
applicable laws may require additional approvals or modifications of approvals
previously obtained. Delays in obtaining required approvals and authorizations
could adversely affect the profitability of the Company's projects.
19
QUALIFYING ASSETS
As a BDC, we may not acquire any asset other than "qualifying
assets" unless, at the time we make the acquisition, the value of our qualifying
assets represent at least 70% of the value of our total assets. The principal
categories of qualifying assets relevant to our business are:
o Securities of an eligible portfolio company that are purchased in
transactions not involving any public offering. An eligible
portfolio company is defined under the 1940 Act to include any
issuer that:
o is organized and has its principal place of business in the
U.S.;
o is not an investment company or a company operating pursuant
to certain exemptions under the 1940 Act, other than a small
business investment company wholly owned by a BDC; and
o does not have any class of publicly traded securities with
respect to which a broker may extend margin credit (i.e., a
"marginable security").
o Securities received in exchange for or distributed with respect to
securities described in the bullet above or pursuant to the exercise
of options, warrants, or rights relating to those securities; and
o Cash, cash items, government securities, or high quality debt
securities (as defined in the 1940 Act), maturing in one year or
less from the time of investment.
Amendments promulgated in 1998 by the Federal Reserve expanded the
definition of a marginable security under the Federal Reserve's margin rules to
include any non-equity security. Thus, any debt securities issued by any entity
are marginable securities under the Federal Reserve's current margin rules. As a
result, the staff of the SEC has raised the question to the BDC industry as to
whether a private company that has outstanding debt securities would qualify as
an "eligible portfolio company" under the 1940 Act.
The SEC has recently issued proposed rules to correct the unintended
consequence of the Federal Reserve's 1998 margin rule amendments of apparently
limiting the investment opportunities of business development companies. In
general, the SEC's proposed rules would define an eligible portfolio company as
any company that does not have securities listed on a national securities
exchange or association. We are currently in the process of reviewing the SEC's
proposed rules and assessing their impact, to the extent such proposed rules are
subsequently approved by the SEC, on our investment activities. We do not
believe that these proposed rules will have a material adverse effect on our
operations.
Until the SEC or its staff has taken a final public position with
respect to the issue discussed above, we will continue to monitor this issue
closely, and may be required to adjust our investment focus to comply with
and/or take advantage of any future administrative position, judicial decision
or legislative action.
20
In addition, a BDC must have been organized and have its principal
place of business in the United States and must be operated for the purpose of
making investments in eligible portfolio companies, or in other securities that
are consistent with its purpose as a BDC.
SIGNIFICANT MANAGERIAL ASSISTANCE
To include certain securities described above as qualifying assets
for the purpose of the 70% test, a BDC must offer to make available to the
issuer of those securities significant managerial assistance such as providing
guidance and counsel concerning the management, operations, or business
objectives and policies of a portfolio company. We offer to provide managerial
assistance to our portfolio companies.
INVESTMENT CONCENTRATION
Our investment objective is to maximize our portfolio's total
return, principally by investing in the debt and/or equity securities of
companies in the medical products, healthcare solutions, financial services and
real estate industries. In this respect, we concentrate in these sectors and
invest, under normal circumstances, at least 80% of the value of our net assets
(including the amount of any borrowings for investment purposes) in the medical
products, healthcare solutions, financial services and real estate industries.
This 80% policy is not a fundamental policy and therefore may be changed without
the approval of our stockholders. However, we may not change or modify this
policy unless we provide our stockholders with at least 60 days prior notice,
pursuant to Rule 35d-1 of the 1940 Act. See "RISK FACTORS--RISKS RELATED TO OUR
INVESTMENTS--OUR PORTFOLIO MAY BE CONCENTRATED IN A LIMITED NUMBER OF PORTFOLIO
COMPANIES."
1940 ACT CODE OF ETHICS
As required by the 1940 Act, we maintain a code of ethics that
establishes procedures for personal investments and restricts certain
transactions by our personnel. See "Risk factors--Risks relating to our business
and structure--There are significant potentiaL conflicts of interest." Our code
of ethics generally does not permit investments by our employees in securities
that may be purchased or held by us. A copy of the code of ethics may be
obtained, without charge, upon a written request mailed to: Franklin Capital
Corporation c/o Corporate Secretary, 100 Wilshire Boulevard, Suite 1500, Santa
Monica, California 90401.
CODE OF BUSINESS CONDUCT AND ETHICS
Each executive officer and director as well as every employee of the
Company is subject to the Company's Code of Business Conduct and Ethics which
was adopted by the Board on November 11, 2004 and filed as Appendix D to the
definitive proxy materials filed with the SEC on March 2, 2005. The code of
ethics applies to all the directors, officers and certain employees of the
Company, including the principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing similar
functions. A copy of the Code of Business Conduct and Ethics may be obtained,
without charge, upon a written request mailed to: Franklin Capital Corporation
c/o Corporate Secretary, 100 Wilshire Boulevard, Suite 1500, Santa Monica,
California 90401.
COMPLIANCE POLICIES AND PROCEDURES
We have adopted and implemented written policies and procedures
reasonably designed to prevent violation of the federal securities laws, and are
required to review these compliance policies and procedures annually for their
adequacy and the effectiveness of their implementation, and to designate a
21
Chief Compliance Officer to be responsible for administering the policies and
procedures. Lynne Silverstein serves as Chief Compliance Officer for the
Company.
SARBANES-OXLEY ACT OF 2002
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley
Act of 2002. The Sarbanes-Oxley Act, as well as the rules and regulations
promulgated thereunder, imposed a wide variety of new regulatory requirements on
publicly-held companies and their insiders. Many of these requirements affect
us. For example:
o Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as
amended (the "1934 Act"), our Chief Executive Officer and Chief
Financial Officer must certify the accuracy of the financial
statements contained in our periodic reports;
o Pursuant to Item 307 of Regulation S-K, our periodic reports must
disclose our conclusions about the effectiveness of our disclosure
controls and procedures;
o Pursuant to Rule 13a-15 of the 1934 Act, our management must prepare
a report regarding its assessment of our internal control over
financial reporting, which must be audited by our independent
registered public accounting firm; and
o Pursuant to Item 308 of Regulation S-K and Rule 13a-15 of the 1934
Act, our periodic reports must disclose whether there were
significant changes in our internal controls or in other factors
that could significantly affect these controls subsequent to the
date of their evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
The Sarbanes-Oxley Act requires us to review our current policies
and procedures to determine whether we comply with the Sarbanes-Oxley Act and
the regulations promulgated thereunder. We will continue to monitor our
compliance with all regulations that are adopted under the Sarbanes-Oxley Act
and will take actions necessary to ensure that we are in compliance therewith.
22
AVAILABLE INFORMATION
Copies of the Company quarterly reports on Form 10-Q, annual reports
on Form 10-K and current reports on Form 8-K, and any amendments to the
foregoing, will be provided without charge to any shareholder submitting a
written request to the Corporate Secretary, Franklin Capital Corporation, 100
Wilshire Boulevard, Suite 1500, Santa Monica, CA 90401 or by calling (310)
752-1416. You may also obtain the documents filed by Franklin Capital with the
Securities and Exchange Commission for free at the Internet website maintained
by the Securities and Exchange Commission at www.sec.gov. The Company does not
currently make these documents available on its website.
RISK FACTORS
AN INVESTMENT IN OUR SECURITIES INVOLVES A HIGH DEGREE OF RISK
RELATING TO OUR BUSINESS, STRATEGY, STRUCTURE AND INVESTMENT OBJECTIVES. THE
RISKS SET OUT BELOW ARE NOT THE ONLY RISKS WE FACE, AND WE FACE OTHER RISKS
WHICH ARE NOT YET PREDICTABLE OR IDENTIFIABLE. IF ANY EVENTS UNDERLYING OR
RELATING TO THE FOLLOWING RISKS OCCUR, OUR BUSINESS, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS COULD BE MATERIALLY ADVERSELY AFFECTED. IN SUCH CASE, OUR
NET ASSET VALUE AND THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU
MAY LOSE ALL OR PART OF YOUR INVESTMENT. IN ADDITION TO THE RISK FACTORS
DESCRIBED BELOW, OTHER FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY GENERALLY INCLUDE:
o CHANGES IN OR CONDITIONS AFFECTING THE ECONOMY;
o RISK ASSOCIATED WITH POSSIBLE DISRUPTION IN THE COMPANY'S OPERATIONS DUE
TO TERRORISM;
o FUTURE REGULATORY ACTIONS AND CONDITIONS IN THE COMPANY'S OPERATING AREAS
OR TARGET INDUSTRIES FOR INVESTMENTS; AND
o OTHER RISKS AND UNCERTAINTIES AS MAY BE DETAILED FROM TIME TO TIME IN THE
COMPANY'S PUBLIC ANNOUNCEMENTS AND SEC FILINGS.
23
RISKS RELATING TO OUR BUSINESS AND STRUCTURE
WE RECENTLY RESTRUCTURED OUR INVESTMENT STRATEGY AND OBJECTIVE AND HAVE LIMITED
OPERATING HISTORY UNDER OUR NEW STRUCTURE.
Upon the change of control that occurred in October 2004, we
restructured our investment strategy and objective to focus on the medical
products, healthcare solutions, financial services and real estate industries
instead of the radio and telecommunications industries. We have a limited
operating history under this new structure. We are subject to all of the
business risks and uncertainties associated with any new investment strategy or
objective, including the risk that we will not achieve our investment objective
and that the value of your investment in us could decline substantially.
THE COMPANY MAY NOT SUCCESSFULLY IMPLEMENT ITS RESTRUCTURING PLAN
The Restructuring Plan has shifted Franklin's investment strategy
away from the radio and telecommunications industry and refocused it on the
medical products, healthcare solutions, financial services and real estate
industries. Franklin has not typically invested in these industries in the past
and therefore has not compiled a track record regarding the financial
performance to be expected in connection with these new investments. There can
be no assurance regarding the return on, or the recovery of, Franklin's
investments in businesses in these industries, and whether such investments will
be profitable.
Moreover, there are a number of inherent risks for entities doing
business in the medical products, healthcare solutions, financial services and
real estate industries, including a complex array of regulatory requirements.
These risks could have a material adverse effect on the profitability of the
businesses in which Franklin invests, which in turn could have a material
adverse effect on the return on, or the recovery of, Franklin's investment in
such businesses.
WITHDRAWAL OF THE COMPANY'S ELECTION TO BE TREATED AS A BDC MAY INCREASE THE
RISKS TO OUR SHAREHOLDERS SINCE THE COMPANY WOULD NOT BE SUBJECT TO MANY OF THE
REGULATORY RESTRICTIONS IMPOSED BY, OR RECEIVE THE FINANCIAL REPORTING BENEFITS,
OF THE 1940 ACT
If the Company withdraws its election to be treated as a BDC, the
Company would no longer be subject to regulation under the 1940 Act, which is
designed to protect the interests of investors in investment companies. As a
non-BDC, the Company will not be subject to many of the regulatory, financial
reporting and other requirements and restrictions imposed by the 1940 Act
including, but not necessarily limited to, limitations on the amounts, types and
prices at which securities which may be issued, participation in related party
transactions, the payment of compensation to executives, and the scope of
eligible investments.
In the event that the Company withdraws its election to be treated
as a BDC and becomes an operating company, the fundamental nature of the
Company's business will change from that of investing in a portfolio of
securities in the radio and telecommunications industries, with the goal of
achieving gains on appreciation and dividend income, to that of being actively
engaged in the ownership and management of operating businesses in the medical
products, health care solutions, financial services and real estate industries,
with the goal of generating income from the operations of those businesses. No
assurance can be given that our business strategy or investment objectives will
be achieved by withdrawing our election to be treated as a BDC.
Further, the election to withdraw the Company as a BDC under the
1940 Act will result in a significant change in the Company's method of
accounting. BDC financial statement presentation and accounting utilizes the
value method of accounting used by investment companies, which allows BDCs to
recognize income and value their investments at market value as opposed to
historical cost. As an operating company, the required financial statement
presentation and accounting for securities held will be either fair value or
historical cost methods of accounting, depending on the classification of the
investment and the Company's intent with respect to the period of time it
intends to hold the investment.
24
A change in the Company's method of accounting could reduce the market value of
its investments in privately held companies by eliminating the Company's ability
to report an increase in the value of its holdings as they occur. Also, as an
operating company, the Company would have to consolidate its financial
statements with subsidiaries, thus eliminating the portfolio company reporting
benefits available to BDCs.
WE ARE DEPENDENT UPON OUR KEY MANAGEMENT PERSONNEL FOR OUR FUTURE SUCCESS,
PARTICULARLY MILTON "TODD" AULT III.
The Company is dependent on the diligence and skill of its senior
management and other key personnel for the selection, structuring, closing and
monitoring of its investments. The future success of the Company depends to a
significant extent on the continued service and coordination of its senior
management team, principally our Chief Executive Officer and Chairman, Milton
"Todd" Ault III. Mr. Ault is not currently subject to an employment contract
with us. The departure of any key management personnel, or Mr. Ault in
particular, could have a material adverse effect on the Company's ability to
implement its business strategy or achieve its investment objective.
As a result of the implementation of the Restructuring Plan and
pursuant to the Termination Agreement, on October 22, 2004, Stephen Brown
resigned as the Chairman and Chief Executive Officer of the Company. In
addition, certain other members of senior management and the board of directors
either resigned or were replaced with new directors and/or officers. These new
directors and/or officers have not previously been involved with the Company.
Profitability of the Company would be dependent on this new management, as
opposed to former management. As a result, there can be no assurance that the
new senior management would operate the Company in a profitable manner.
OUR MANAGEMENT HAS LIMITED EXPERIENCE IN MANAGING AND OPERATING AS A PUBLIC
COMPANY UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR THE SECURITIES EXCHANGE
ACT OF 1934, AS AMENDED, OR A BDC UNDER THE 1940 ACT, AS AMENDED.
Prior to the change in control that occurred in October 2004, our
senior management were primarily engaged in operating a private investment
management firm. In this capacity they developed a general understanding of the
administrative and regulatory environment in which public companies operate.
However, our senior management lacks practical experience operating a public
company and relies in many instances on the professional experience and advice
of third parties including its consultants, attorneys and accountants.
Additionally, utilization of professionals is expensive and in the event we fail
to reach profitability and/or raise additional capital there can be no assurance
that these resources will be available to the Company in the future.
Failure to comply or adequately comply with any laws, rules, or
regulations applicable to our business or us may result in fines or regulatory
actions, which may materially adversely affect our business, results of
operation, or financial condition.
OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS WILL DEPEND ON OUR ABILITY TO
MANAGE OUR FUTURE GROWTH EFFECTIVELY.
As part of the Restructuring Plan, we changed our investment
strategy and objective and are currently recapitalizing our business. As such,
our success in achieving our investment objective will depend on our ability to
grow effectively and efficiently, including our ability to identify, analyze,
and invest in and finance companies in a timely manner. Accomplishing this
result will also require us to raise capital on a cost-effective and timely
basis. As we grow, we will need to hire, train, supervise and manage new
employees. Our failure to manage our future growth effectively could have a
material adverse effect on our business, financial condition and results of
operations.
25
OUR BUSINESS MODEL DEPENDS UPON THE DEVELOPMENT OF STRONG REFERRAL RELATIONSHIPS
WITH PRIVATE EQUITY AND VENTURE CAPITAL FUNDS AND INVESTMENT BANKING FIRMS.
If we fail to maintain our relationships with key firms, or if we
fail to establish strong referral relationships with other firms or other
sources of investment opportunities, we will not be able to grow our portfolio
of private companies and achieve our investment objective. In addition, persons
with whom we have informal relationships are not obligated to provide us with
investment opportunities, and therefore there is no assurance that such
relationships will lead to the origination of debt or other investments.
WE MAY EXPERIENCE FLUCTUATIONS IN OUR QUARTERLY RESULTS.
We may experience fluctuations in our quarterly operating results
due to a number of factors, including the rate at which we identify and make new
investments, the success rate of our new investments, the level of our expenses,
variations in and the timing of the recognition of realized and unrealized gains
or losses, the degree to which we encounter competition in our markets and
general economic conditions. As a result of these factors, results for any
period should not be relied upon as being indicative of performance in future
periods.
ECONOMIC RECESSIONS OR DOWNTURNS COULD IMPAIR OUR INVESTMENTS AND HARM OUR
OPERATING RESULTS.
Many of the companies in which we have made or will make investments
may be susceptible to economic slowdowns or recessions. An economic slowdown may
affect the ability of a company to engage in a liquidity event such as a sale,
recapitalization, or initial public offering. Our nonperforming assets are
likely to increase and the value of our portfolio is likely to decrease during
these periods. These conditions could lead to financial losses in our portfolio
and a decrease in our revenues, net income, and assets.
Our business of making private equity investments and positioning
them for liquidity events also may be affected by current and future market
conditions. The absence of an active senior lending environment may slow the
amount of private equity investment activity generally. As a result, the pace of
26
our investment activity may slow. In addition, significant changes in the
capital markets could have an effect on the valuations of private companies and
on the potential for liquidity events involving such companies. This could
affect the amount and timing of gains realized on our investments.
THE INABILITY OF THE COMPANIES IN WHICH WE INVEST TO SUCCESSFULLY MARKET THEIR
PRODUCTS WOULD HAVE A NEGATIVE IMPACT ON OUR INVESTMENT RETURNS
Even if the companies in which we invest are able to develop commercially viable
products, the market for new products and services is highly competitive and
rapidly changing. Commercial success is difficult to predict and the marketing
efforts of our portfolio companies may not be successful.
WE MAY NEED TO UNDERTAKE ADDITIONAL FINANCINGS TO MEET OUR GROWTH, OPERATING
AND/OR CAPITAL NEEDS.
We anticipate that monetizable revenue from our operations for the
foreseeable future may not be sufficient to meet our growth, operating and/or
capital requirements. We believe that we currently have the financial resources
to meet our operating requirements for the next twelve months. We may however
undertake additional equity financings to better enable the Company to meet its
future growth, operating and/or capital requirements. We have no commitments for
any financings, and there can be no assurance that any such commitments can be
obtained on terms acceptable to us, if at all. Any equity financing may be
dilutive to our stockholders, and debt financing, if available, may involve
restrictive covenants or other adverse terms with respect to raising future
capital and other financial and operational matters. If we are unable to obtain
financing as needed, we may be required to reduce the scope of our expansion and
growth plans, as well as operations, which could have a material adverse effect
on us.
THERE ARE SIGNIFICANT POTENTIAL CONFLICTS OF INTEREST, WHICH COULD IMPACT OUR
INVESTMENT RETURNS.
Our executive officers and directors serve or may serve as officers
and directors of entities who operate in the same or related line of business as
we do. Accordingly, they may have obligations to investors in those entities,
the fulfillment of which might not be in the best interests of us or our
stockholders. For example, certain of the Company's officers, directors and/or
their family members have existing responsibilities and, in the future, may have
additional responsibilities, to act and/or provide services as executive
officers, directors, owners and/or managers of Ault Glazer. Accordingly, certain
conflicts of interest between the Company and Ault Glazer will occur from time
to time. The Company will attempt to resolve any such conflicts of interest in
its favor. Because of these possible conflicts of interest, such individuals may
direct potential business and investment opportunities to other entities rather
than to us.
The Board does not believe that the Company has any conflicts of
interest with the business of Ault Glazer, other than certain of the Company's
officers responsibility to provide certain management and administrative
services to Ault Glazer and its clients from time-to-time. However, subject to
applicable law, the Company may engage in transactions with Ault Glazer and
related parties in the future. These related party transactions may raise
conflicts of interest and, although the Company does not have a formal policy to
address such conflicts of interest, the Audit Committee intends to evaluate
relationships and transactions involving conflicts of interest on a case by case
basis and the approval of the Audit Committee shall be required for all such
transactions. The Audit Committee intends that any related party transactions
will be on terms and conditions no less favorable to the Company than those
terms and conditions reasonably obtainable from third parties and in accordance
with applicable law.
In order to minimize the potential conflicts of interest that might
arise, we have adopted a Code of Ethics in accordance with the requirements of
Investment Company Act that applies to all the directors,
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officers and certain employees of the Company. A copy of the Code of Ethics may
be obtained, without charge, upon a written request mailed to the Company.
ANY TRANSACTIONS WE ENGAGE IN WITH AFFILIATES WILL INVOLVE CONFLICTS OF
INTEREST.
Affiliated transactions between us and any of our affiliates,
including our officers, directors or employees and principal stockholders are
subject to inherent conflicts of interest. In many cases, the 1940 Act, as well
as Federal and State securities laws and applicable State corporate regulations,
prohibit transactions between such persons and ourselves unless we first apply
for and obtain an exemptive order from the SEC. Delays and costs in obtaining
necessary approvals may decrease or even eliminate any profitability of such
transactions or make it impracticable or impossible to consummate such
transactions. These affiliations could cause circumstances that would require
the SEC's approval in advance of proposed transactions by us in portfolio
companies. Further, depending upon the extent of our management's influence and
control with respect to such portfolio companies, the selection of the
affiliates of management to perform such services may not be a disinterested
decision, and the terms and conditions for the performance of such services and
the amount and terms of such compensation may not be determined at arm's-length
negotiations.
THE SALE OR ISSUANCE OF SECURITIES TO INTERESTED STOCKHOLDERS MAY BE DILUTIVE TO
OUR EXISTING SHAREHOLDERS
In the event that the Company is no longer a BDC, and subject to
approval of the stockholders at the Annual Meeting of the sale of securities to
"interested stockholders" (as defined in Sect