SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
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 No. 0-6729
FIRST MONTAUK FINANCIAL CORP
(Exact name of registrant as specified in its charter)
New Jersey 22-1737915
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
Parkway 109 Office Center, 328 Newman Springs Rd., Red Bank, NJ 07701
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (732) 842-4700
Former name, former address and former fiscal year, if changed since last
report.
Indicate by check mark whether the Registrant (l) 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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
APPLICABLE ONLY TO CORPORATE ISSUERS:
- -------------------------------------
8,527,164 Common Shares, no par value, were outstanding as of May 12,
2003.
Page 1 of 21
2
FIRST MONTAUK FINANCIAL CORP
FORM 10-Q
MARCH 31, 2003
INDEX
Page
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Consolidated Statements of Financial Condition
as of March 31, 2003 and December 31, 2002 ......... 3
Consolidated Statements of Operations for the
Three Months ended March 31, 2003 and 2002 ........... 4
Consolidated Statements of Cash Flows for
the Three Months ended March 31, 2003 and 2002 ...... 5
Notes to Consolidated Financial Statements ............ 6-8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ...... 9-13
Item 3. Market Risk ................................... 13
Item 4. Controls and Procedures ....................... 14
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings ............................ 15
Item 2. Changes in Securities and Use of Proceeds .... 15
Item 3. Defaults Upon Senior Securities .............. 15
Item 4. Submission of Matters to a Vote of Security
Holders ...................................... 15
Item 5. Other Information............................. 16
Item 6. Exhibits and Reports on Form 8-K.............. 16
Signatures ............................................ 17
Officers' Certifications .............................. 18-19
3
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, December 31,
2003 2002
(unaudited)
ASSETS
Cash and cash equivalents $ 1,971,788 $ 2,638,819
Due from clearing firm 4,075,210 4,591,701
Trading and investment account securities 442,821 183,944
Employee and broker receivables 1,091,003 1,070,087
Loans receivable - officers 172,340 178,936
Property and equipment - net 1,284,923 1,396,892
Income tax refunds receivable 212,300 212,300
Deferred income taxes - net 460,000 460,000
Other assets 1,971,702 692,827
---------- ----------
Total assets $11,682,087 $11,425,506
========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
LIABILITIES
Deferred income $ 5,282,213 $ 5,456,323
Securities sold, not yet purchased, at market value 229,629 --
Notes payable -- 48,057
Commissions payable 2,956,812 2,681,128
Accounts payable 1,586,681 577,225
Accrued expenses 1,304,857 1,987,871
Capital leases payable 290,645 343,682
6% convertible debentures 1,240,000 1,030,000
Other liabilities 62,199 78,910
---------- ----------
Total liabilities 12,953,036 12,203,196
---------- ----------
Commitments and contingencies (See Notes)
STOCKHOLDERS' DEFICIT
Preferred Stock, 4,375,000 shares authorized, $.10 par
value, no shares issued and outstanding -- --
Series A Convertible Preferred Stock, 625,000 shares
authorized, $.10 par value, 330,250 and 331,190 shares
issued and outstanding, respectively; liquidation
preference: $1,651,250 33,025 33,025
Common Stock, no par value, 30,000,000 shares
authorized, 8,527,164 shares issued and outstanding 3,416,220 3,416,220
Additional paid-in capital 3,921,108 3,918,930
Accumulated deficit (8,631,960) (8,135,777)
Less: Deferred compensation (9,342) (10,088)
---------- ----------
Total stockholders' deficit (1,270,949) (777,690)
---------- ----------
Total liabilities and stockholders' deficit $11,682,087 $11,425,506
========== ==========
See notes to financial statements.
4
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended March 31,
2003 2002
(unaudited) (unaudited)
Revenues:
Commissions $ 7,649,259 $ 9,683,706
Principal transactions 2,261,330 2,120,539
Investment banking 195,328 63,035
Interest and other income 850,250 881,188
---------- ----------
Total revenues 10,956,167 12,748,468
---------- ----------
Expenses:
Commissions, employee compensation and benefits 9,097,622 10,477,779
Clearing and floor brokerage 568,270 680,914
Communications and occupancy 693,579 676,285
Legal matters and related costs 401,066 267,156
Other operating expenses 629,161 909,090
Interest 37,813 32,906
---------- ----------
Total expenses 11,427,511 13,044,130
---------- ----------
Net Loss $ (471,344) $ (295,662)
========== ==========
Net loss applicable to common stockholders $ (496,183) $ (320,502)
========== ==========
Per share of Common Stock:
Basic and diluted $ (0.06) $ (0.04)
========== ==========
Number of common shares used in
basic and diluted loss per share 8,527,164 8,622,284
========== ==========
See notes to financial statements.
5
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31,
2003 2002
(unaudited) (unaudited)
INCREASE (DECREASE) IN CASH
Cash flows from operating activities:
Net loss $ (471,344) $ (295,662)
--------- ----------
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 133,997 128,689
Amortization 3,563 4,852
Increase (decrease) in cash attributable to
changes in assets and liabilities:
Due from clearing firm 516,491 (2,330,485)
Trading and investment account securities (258,877) 388,215
Loans receivable - officers 6,596 (45,445)
Employee and broker receivables (20,916) 266,521
Other assets (1,279,514) (66,158)
Deferred income (174,110) (146,729)
Securities sold but not yet purchased 229,629 863,754
Commissions payable 275,684 104,679
Accounts payable 1,009,456 (123)
Accrued expenses (683,014) (260,186)
Income taxes payable -- (7,111)
Other liabilities (16,711) (52,321)
---------- -----------
Total adjustments (257,726) (1,151,848)
---------- -----------
Net cash used in operating activities (729,070) (1,447,510)
---------- -----------
Cash flows from investing activities:
Additions to property and equipment (22,028) (45,104)
---------- -----------
Cash flows from financing activities:
Payment of notes payable (48,057) (99,210)
Payments of capital lease (53,037) (47,664)
Proceeds from issuance of 6% convertible debentures 210,000 --
Payments of preferred stock dividends (24,839) (24,840)
---------- -----------
Net cash provided by (used in) financing activities 84,067 (171,714)
---------- -----------
Net decrease in cash and cash equivalents (667,031) (1,664,328)
Cash and cash equivalents at beginning of period 2,638,819 1,779,554
---------- -----------
Cash and cash equivalents at end of period $1,971,788 $ 115,226
========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 19,625 $ 32,906
========== ===========
Income taxes $ 20,170 $ 4,704
========== ===========
Noncash financing activity:
Warrants charged to deferred financing costs in
connection with debenture offering $ 2,178 $ --
========== ===========
See notes to financial statements.
6
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - MANAGEMENT REPRESENTATION
The accompanying financial statements are unaudited for the interim period,
but include all adjustments (consisting only of normal recurring accruals) which
management considers necessary for the fair presentation of results at March 31,
2003 and 2002. The preparation of financial statements in conformity with GAAP
requires the Company to make estimates and assumptions that affect the reported
amounts of revenues and expenses during the reporting period. Actual results
could vary from these estimates. These financial statements should be read in
conjunction with the Company's Annual Report at, and for the year ended December
31, 2002, as filed with the Securities and Exchange Commission on Form 10-K.
The results reflected for the three-month period ended March 31, 2003, are
not necessarily indicative of the results for the entire fiscal year to end on
December 31, 2003.
NOTE 2 - NET LOSS PER SHARE
Basic loss per share is computed by dividing net loss by the
weighted-average number of common shares outstanding for the period. Diluted
loss per share reflects the potential dilution from the exercise or conversion
of other securities into common stock, but only if dilutive. The following
securities have been excluded from the dilutive per share computation as they
are antidilutive:
Three months ended March 31,
2003 2002
Stock options 3,961,998 4,630,498
Warrants 3,221,446 9,242,338
Convertible debt 2,480,000 90,201
Convertible preferred stock 660,500 662,380
NOTE 3 - OTHER ASSETS
Other assets consist of the following:
March 31, December 31,
2003 2002
Prepaid insurance $1,264,421 $256,215
Other assets 707,281 436,612
--------- -------
$1,971,702 $692,827
========= =======
Prepaid insurance includes unamortized premiums for various corporate
insurance policies. The March 2003 balance reflects a significant increase for
errors and omissions (E&O) coverage for the policy period that commenced January
31, 2003.
NOTE 4 - ACCOUNTS PAYABLE
Accounts payable at March 31, 2003 includes a balance of $880,847 due under
an insurance premium finance agreement. The balance is payable in seven monthly
installments of $127,687, including interest at the rate of 4.4% per annum.
NOTE 5 - 6% CONVERTIBLE DEBENTURES
In December 2002 and January 2003, the Company raised gross proceeds of
$1,240,000 in a private placement of 6% convertible debentures. The debentures
are convertible into 2,480,000 shares of common stock at $.50 per share, subject
to adjustment for stock dividends and stock splits, and mature five years from
the date of issuance unless previously converted. Interest is payable in cash on
a semi-annual basis until maturity or conversion, commencing on April 1, 2003.
In the event that the closing bid price of the Company's common stock is 200% of
the conversion price for the twenty (20) consecutive trading days prior to the
date of notice of conversion or prepayment, the Company, at its option, may upon
thirty (30) days written notice to the holders, demand the conversion of some or
all of the debentures, or prepay some or all of the debentures at the following
prepayment prices: 130% of the principal amount if prepaid from the date of
issuance until the first anniversary of the date of issuance; 120% of the
principal amount if prepaid anytime thereafter. The debentures contain certain
covenants which, among other things, prevent the sale of all or substantially
all of the Company's assets without provision for the payment of the debentures
from such sales proceeds, and making loans to any executive officers or 5%
stockholders.
Offering costs of approximately $46,000 have been capitalized and are being
amortized on a straight-line basis over the term of the debentures.
7
NOTE 6 - STOCK OPTIONS
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation -- Transition and
Disclosure" ("FAS 148"), which (i) amends FAS Statement No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for an
entity that voluntarily changes to the fair value based method of accounting for
stock-based employee compensation; (ii) amends the disclosure provisions of, FAS
123 to require prominent disclosure about the effects on reported net income of
an entity's accounting policy decisions with respect to stock-based employee
compensation; and iii) amends APB opinion No. 28, "Interim Financial Reporting,"
to require disclosure about those effects in interim financial information.
Items (ii) and (iii) of the new requirements in FAS 148 are effective for
financial statements for fiscal years ending after December 15, 2002. The
Company has adopted FAS 148 for the fiscal year ended December 31, 2002 and
continues to account for stock-based compensation utilizing the intrinsic value
method. The additional disclosures required by FAS 148 are as follows:
Three months ended March 31,
2003 2002
Net loss applicable to common
stockholders, as reported $(496,183) $(320,502)
Add: Stock based employee compensation
expense included in reported net loss, net of tax 746 4,852
Deduct: Total stock based employee compensation
expense determined under the fair value based
method for all awards, net of tax (23,058) (40,402)
--------- ---------
Pro forma net loss $(518,495) $(356,052)
========= =========
Loss per share:
Basic and diluted - as reported $(0.06) $ (0.04)
Basic and diluted - pro forma $(0.06) $ (0.04)
Pro forma net loss and loss per share information, as required
by SFAS No. 123, have been determined as if the Company had
accounted for employee stock options under the fair value method.
There were no options granted during the three months ended March 31,
2003 and 2002.
NOTE 7 - LEGAL MATTERS
FMSC is a respondent in numerous arbitrations arising from customer
purchases of high yield corporate bonds which declined in market value after the
purchases were made. The claims allege, among other charges, unsuitable
recommendations and/or improper use of margin, and seek aggregate compensatory
damages in excess of $12 million. Some of the claims seek punitive damages and
the recovery of various costs. The Company is vigorously defending these actions
and believes that there are meritorious defenses in each case. There is no
remaining insurance coverage available for the payment of settlements and/or
judgments that may result from these particular claims.
FMSC is also a respondent or co-respondent in various other legal
proceedings which are related to its securities business. FMSC is contesting
these claims and believes there are meritorious defenses in each case. The
availability of insurance coverage in any particular case is determined on a
case by case basis by the insurance carrier, and is limited to the coverage
limits within the policy for any individual claim and in the aggregate.
As of March 31, 2003, the Company has accrued $972,500 for litigation costs
that are probable and can be reasonably estimated based on a review of existing
claims, arbitrations and unpaid settlements. Management cannot give assurance
that this accrual will be adequate to cover actual costs that may be
subsequently incurred. It is not possible to predict the outcome of other
matters pending against FMSC. All such cases are, and will continue to be,
vigorously defended.
8
However, litigation is subject to many uncertainties, and some of these
actions and proceedings may result in adverse judgments. After considering all
relevant facts, available insurance coverage and the advice of litigation
counsel, it is possible that the Company's consolidated financial condition,
results of operations, or cash flows could be materially affected by unfavorable
outcomes or settlements of certain pending litigation.
FMSC has also filed a claim against one of its competitors for raiding,
unfair competition and use of proprietary and confidential information. The
Company has obtained temporary injunctive relief from the Supreme Court of New
York, as well as a consent injunctive order from an NASD arbitration panel. A
hearing will be held later this year to determine the damages portion of the
Company's claims. Management is unable to determine at this time what damages,
if any, might be awarded.
NOTE 8 - INCOME TAXES
For the 2003 and 2002 periods, the effective tax rate of 0% was higher than
the expected tax rate of approximately (39%) and (37%), respectively, due to an
increase in the tax valuation allowance to offset the benefits of each period's
operating losses and other temporary differences because management is uncertain
as to the ultimate realization of such benefits.
NOTE 9 - WARRANTS
The Company's 3,072,446 Class A warrants and 3,072,446 Class B warrants
expired on February 17, 2003.
The Company issued 124,000 common stock purchase warrants as compensation
to registered representatives in connection with the convertible debenture
offering. The Company valued the warrants at approximately $13,500 using the
Black-Scholes option pricing method, and included the warrant value in deferred
financing costs.
NOTE 10 - SUSPENSION OF PREFERRED STOCK DIVIDENDS
The Company has suspended the payment of cash dividends on its Series A
Preferred stock. New Jersey Business Corporation Act prohibits the payment of
any distribution by a corporation to, or for the benefit of its shareholders, if
the corporation's total assets would be less than its total liabilities. Unpaid
preferred dividends will continue to accumulate at 6% per annum. Arrearages must
be fully paid before any distribution can be declared or paid on the Company's
common stock.
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Factors Affecting "Forward-Looking Statements"
From time to time, the Company may publish "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities and Exchange Act of 1934, as amended, or make oral
statements that constitute forward-looking statements. These forward-looking
statements may relate to such matters as anticipated financial performance,
future revenues or earnings, business prospects, projected ventures, new
products, anticipated market performance, and similar matters. The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In order to comply with the terms of the safe
harbor, the Company cautions readers that a variety of factors could cause the
Company's actual results to differ materially from the anticipated results or
other expectations expressed in the Company's forward-looking statements. These
risks and uncertainties, many of which are beyond the Company's control,
include, but are not limited to: (i) transaction volume in the securities
markets, (ii) the volatility of the securities markets, (iii) fluctuations in
interest rates, (iv) changes in regulatory requirements which could affect the
cost of doing business, (v) fluctuations in currency rates, (vi) general
economic conditions, both domestic and international, (vii) changes in the rate
of inflation and related impact on securities markets, (viii) competition from
existing financial institutions and other participants in competition from
existing financial institutions and other participants in the securities
markets, (ix) legal developments affecting the litigation experience of the
securities industry, and (x) changes in federal and state tax laws which could
affect the popularity of products sold by the Company. The Company does not
undertake any obligation to publicly update or revise any forward-looking
statements. The reader is referred to the Company's previous filings on Form
10-Q for the periods ended March 31, 2002, June 30, 2002, September 30, 2002 and
Form 10-K for the year ended December 31, 2002.
Overview
First Montauk Financial Corp. ("FMFC" or the "Company") is a New
Jersey-based financial services holding company whose principal subsidiary,
First Montauk Securities Corp. ("FMSC"), has operated as a full service retail
and institutional securities brokerage firm since 1987. FMSC provides a broad
range of securities brokerage and investment services to a diverse retail and
institutional clientele, as well as corporate finance and investment banking
services to corporations and businesses. In 1997, FMSC established Century
Discount Investments, a discount brokerage division. FMFC also sells insurance
products through its subsidiary Montauk Insurance Services, Inc.
FMSC has approximately 500 registered representatives and services over
60,000 retail and institutional customer accounts. With the exception of two
Company-leased branch offices, all of FMSC's 150 other branch office and
satellite locations in 33 states are owned and operated by affiliates,
independent owners who maintain all appropriate licenses and are responsible for
all office overhead and expenses. FMSC also employs registered representatives
directly at its corporate office and the Company-leased branch offices.
FMSC is registered as a broker-dealer with the Securities and Exchange
Commission, the National Association of Securities Dealers Regulation, Inc., the
Municipal Securities Rule Making Board, and the Securities Investor Protection
Corporation and is licensed to conduct its brokerage activities in all 50
states, the District of Columbia, and the Commonwealth of Puerto Rico. All
securities transactions are cleared through Fiserv Securities, Inc. of
Philadelphia, PA. and various floor brokerage and specialist firms provide
execution services. These arrangements provide FMSC with back office support,
transaction processing services on all principal, national and international
securities exchanges, and access to many other financial services and products
which allows FMSC to offer products and services comparable to large brokerage
firms.
Results of Operations
The results of operations for the quarter ended March 31, 2003 (the "2003
period") showed a decrease in revenues over the same period in the prior year
(the "2002 period"). The continued lack of investor confidence in the U.S.
equity markets and the gloomy economic forecast combined with global political
uncertainties, have continued to negatively impact revenues, thus reducing the
net cash available to cover fixed costs and overhead.
10
For the 2003 period, the Company reported a net loss applicable to common
stockholders of $496,000, or $0.06 per basic and diluted share, as compared to
the net loss applicable to common stockholders reported in the 2002 period, of
$321,000, or $0.04 per basic and diluted share.
The Company's primary source of revenue is derived from commissions from
the sale of securities, both listed and over-the-counter executed on an agency
basis, mutual funds, variable insurance and managed accounts. Revenues from
these sources decreased $2,035,000, to $7,649,000 in the 2003 period, from
$9,684,000 in the 2002 period. As a percent of total revenues, commissions were
70% in the 2003 period, as compared to 76% in the 2002 period. A decrease in
registered representatives, from 568 at the end of the 2002 period to 484 at the
end of the 2003 period, contributed to this decline. A significant number of
terminated brokers are the subjects of an arbitration proceeding against one of
the company's competitors, more fully discussed below.
Agency commissions declined $1,353,000, from $6,191,000 in the 2002 period,
to $4,838,000 in the 2003 period. Mutual funds and insurance also contributed to
the decline, posting decreases of $253,000 and $397,000, respectively, to
$1,211,000 and $887,000, respectively, in the 2003 period.
Revenues from principal transactions increased $140,000, from $2,121,000 in
the 2002 period, to $2,261,000 in the 2003 period. Principal transaction revenue
includes gains or losses from both equity and fixed income proprietary trading,
riskless principal commissions, and unrealized gains or losses on inventory held
in the firm's proprietary accounts. Revenues in the firm's equity proprietary
accounts decreased by approximately $266,000 in the 2003 period, as compared to
the 2002 period. Overall, revenues from principal transactions in the fixed
income sector increased $414,000 from the 2002 period, to $1,160,000 in the 2003
period. Revenues from corporate, municipal and government agency bonds all
increased as investors sought more secure, income-producing investments.
Included in the fixed income sector is a substantial increase in revenues from
the corporate bond market of $326,000, from $142,000 in the 2002 period, to
$468,000 in the 2003 period.
Interest and other income decreased by $31,000, from $881,000 in the 2002
period, to $850,000 in the 2003 period.
Commissions, employee compensation and benefits decreased $1,380,000, or
13%, to $9,098,000 in the 2003 period, from $10,478,000 in the 2002 period.
Commission expense, which accounts for the largest dollar amount in this
category, decreased 15%, or $1,317,000, from $8,667,000 in the 2002 period, to
$7,350,000 in the 2003 period, primarily as a result of lower commission-based
revenues. Employee compensation and benefits expense decreased $63,000, or 3%,
from $1,811,000 in the 2002 period, to $1,748,000 in the 2003 period. This
decrease was primarily due to the continuation of staff reductions implemented
during the latter part of 2002 and into 2003, partially offset by an increase in
benefits due to increases in health care and long-term disability insurance
premiums. For both quarterly periods, compensation expense was reduced by
reversals of 2002 and 2001 401(k) employer matching contributions of $86,000 and
$100,000, respectively.
Communication and occupancy expenses increased $17,000, from $676,000 for
the 2002 period, to $693,000 for the 2003 period. Charges for customer on-line
account access, implemented by the Company's clearing firm in the 2003 period,
amounted to $15,000, while increases in rent expense of $43,000 was offset by a
decrease of $46,000 for market data services. Rent expense increased due to the
addition of a second Company-leased branch office in New York City, which opened
in the second quarter of 2002, while market data service costs decreased due to
elimination of several services.
Legal matters and related costs increased $134,000, from $267,000 in the
2002 period, to $401,000 in the 2003 period, a 50% increase. The 2003 expense
includes approximately $120,000 of additional reserves for legal settlements;
with the balance related to the costs of counsel fees and other litigation
costs.
FMSC is currently a respondent in numerous arbitrations arising from
customer purchases of high yield corporate bonds, which either have defaulted or
declined in market value. The claims allege, among other charges, unsuitable
recommendations and/or improper use of margin, and seek aggregate compensatory
damages in excess of $12 million. In addition, some of the claims seek punitive
damages and the recovery of various costs. The Company is vigorously defending
these actions and believes that there are meritorious defenses in each case.
There is no remaining insurance coverage available for the payment of
settlements and/or judgments that may result from these particular claims.
FMSC is also a respondent or co-respondent in various other legal
proceedings related to our securities business. FMSC is contesting these claims
and believes there are meritorious defenses in each case. The availability of
insurance coverage in any particular case is determined on a case by case basis
by our insurance carrier, and is limited to the coverage limits within the
policy for any individual claim and in the aggregate.
11
As of March 31, 2003, the Company has recorded a liability of $972,500 for
litigation costs that are probable and can be reasonably estimated based on a
review of existing claims, arbitrations and unpaid settlements. Management
cannot give assurance that this accrual will be adequate to cover actual costs
that may be subsequently incurred. It is not possible to predict the outcome of
other matters pending against FMSC. All such cases are, and will continue to be,
vigorously defended. However, litigation is subject to many uncertainties, and
some of these actions and proceedings may result in adverse awards or judgments.
After considering all relevant facts, available insurance coverage and
consultation with litigation counsel, it is possible that the Company's
consolidated financial condition, results of operations, or cash flows could be
materially affected by unfavorable outcomes or settlements of certain pending
litigation.
FMSC has also filed a claim against one of its competitors for raiding,
unfair competition and use of proprietary and confidential information. The
Company has obtained temporary injunctive relief from the Supreme Court of New
York, as well as a consent injunctive order from an NASD arbitration panel. A
hearing will be held later this year to determine the damages portion of the
Company's claims. Management is unable to determine at this time what damages,
if any, might be awarded.
Other operating expenses decreased $280,000, from $909,000 in the 2002
period, to $629,000 in the 2003 period. Bad debt expense decreased $144,000,
from $142,000 in the 2002 period, to a recovery of $2,000 in the 2003 period.
The 2002 period included an accrual of $140,000 for bad debts related to broker
loans. There was no additional accrual or write-off for this expense in the 2003
period. However, the Company continually monitors broker loans for
collectibility. Professional fees and office expenses also decreased from the
2002 period by $40,000 and $47,000, respectively, for the 2003 period, while
errors and omissions insurance increased by $44,000 from the 2002 period to the
2003 period due to an increase in the premium. Professional liability insurance
premiums have substantially increased in fiscal 2003 due to a hardening in the
market for broker-dealer professional liability and directors and officers
insurance coverages. Many insurance carriers have eliminated these types of
coverages, while others have substantially increased premiums and deductible
limits. The Company's registered representatives have historically paid the cost
of errors and omission insurance. However, to stay competitive in the
marketplace for registered representatives, the Company will absorb a portion of
these premiums for fiscal 2003. The amount of this cost will be determined by
the number of registered representatives associated with the Company throughout
the year.
The Company did not incur any income tax liabilities during the three-month
periods ended March 31, 2003 and 2002 due to operating losses. For the 2003 and
2002 periods, the effective tax rate of 0% was lower than the expected tax rate
of approximately (39%) and (37%), respectively, due to an increase in the tax
valuation allowance to offset the benefits of each period's operating losses and
other temporary differences because management is uncertain as to the ultimate
realization of such benefits.
Liquidity and Capital Resources
As with most financial firms, the Company maintains a highly liquid balance
sheet with 56% of the Company's assets consisting of cash, securities owned, and
receivables from the Company's clearing firm and other broker-dealers. The
balances in the Company's cash, inventory and clearing firm accounts can and do
fluctuate significantly from day to day, depending on market conditions, daily
trading activity, and investment opportunities. The Company monitors these
accounts on a daily basis in order to ensure compliance with regulatory capital
requirements and to preserve liquidity.
Cash and cash equivalents decreased during the first three months of 2003
by $667,000, to $1,972,000. Net cash used in operating activities was $709,000
for the 2003 period. The primary components of the decrease in cash are the net
operating loss of $471,000, decreases in accrued expenses and deferred income of
$857,000, and increases in the value of securities and other assets of
$1,538,000. These reductions are offset by a decrease in the amount due from
clearing firm of $516,000, increases in commissions payable, accounts payable
and securities sold short of $1,515,000 and non-cash adjustments of $138,000.
Under the financing agreement with Fiserv, the Company is eligible to
receive its fourth and final advance of $1,250,000 in November 2003, subject to
meeting certain performance criteria. Advances are subject to income taxes in
the year of receipt.
12
Additions to capital expenditures accounted for the entire use of cash for
investing activities of $22,000 during the 2003 period. The Company projects
$150,000 in capital expenditures over the next twelve months.
Financing activities provided cash of $84,000 during the 2003 period. The
Company received gross proceeds of $210,000 from the second closing of its
private offering of 6% convertible debentures. This was offset by payments of
notes payable, capital leases and preferred stock dividends of $48,000, $53,000
and $25,000, respectively. During fiscal 2001, the Company entered into two
capital leases under a sale-leaseback financing with a leasing company. The sale
of the fixed assets resulted in a gain of approximately $45,000, which has been
deferred and is being amortized over the related lease terms. The leases,
totaling $662,000, are together payable in 36 monthly installments of $21,000
and an additional 12 installments of $3,900. The Company has suspended the
$25,000 quarterly payments of its Series A Preferred Stock dividend in
accordance with applicable state law (See Note 10 to the financial statements
and Part II Item 5.)
Consolidated Contractual Obligations and Lease Commitments
The tables below summarize information about the consolidated contractual
obligations as of March 31, 2003 and the effects these obligations are expected
to have on the Company's consolidated liquidity and cash flows in future years.
These tables do not include any projected payment amounts related to the
Company's potential exposure to arbitrations and other legal matters.
Future minimum operating lease payments as of March 31, 2003 are as
follows:
Operating
Leases
2003 $ 841,097
2004 1,103,126
2005 296,302
2006 169,500
---------
Total minimum lease payments $2,410,025
=========
Future minimum lease payments as of March 31, 2003 are as follows:
Capital
Leases
2003 $186,687
2004 114,396
2005 15,711
2006 --
-------
Total minimum lease payments 316,794
Less: Amount representing interest (26,150)
-------
$290,644
=======
In 1999, the Company completed a private offering of Series A Convertible
Preferred Stock in connection with the settlement with holders of leases of
Global Financial Corp. Under the terms of the offering, each Global lease
investor who participated in the offering received one share of Preferred Stock
in exchange for every $5 of lease investment value that the investor was
entitled to receive from Global after certain adjustments. Each leaseholder was
required to assign their interest in all lease payments to which they were
entitled. Each share of the Preferred Stock is convertible into two shares of
Common Stock and pays a quarterly dividend of 6%. Pursuant to the offering, the
Company issued an aggregate of 349,511 shares of Series A Preferred Stock. The
offering was exempt from registration pursuant to Sections 4(2) and 4(6) of the
Securities Act of 1933, as amended, and Regulation D, promulgated thereunder.
13
In October 2002, the Company commenced a private offering of up to
$3,000,000 of 6% convertible debentures to accredited investors. Each debenture
is convertible at an initial conversion price of $0.50 per share, subject to
adjustment for stock dividends, combinations, splits, recapitalizations, and
like events. Interest on the debentures accrues at the rate of 6% per annum and
is payable in cash on a semi-annual basis on April 1st and October 1st of each
year until maturity or conversion. Each debenture is due and payable five (5)
years from issuance, unless previously converted into shares of Common Stock.
The offering expired on March 1, 2003. In the offering, the Company sold an
aggregate amount of $1,240,000 of debentures, $1,030,000 in fiscal 2002 and
$210,000 in fiscal 2003. The proceeds of the financing will be used to satisfy
general working capital needs. The debentures have not been registered for offer
or sale under the Securities Act; such securities are being issued on the basis
of the statutory exemption provided by Section 4(2) of the Securities Act, as
amended, and/or Rule 506 of Regulation D, promulgated thereunder relating to
transactions by an issuer not involving any public offering. For more
information, see a discussion of the debentures under the captions "Item 1.
Business -- Debenture Offering" and "Item 5. Sale of Unregistered Securities."
Application of Critical Accounting Policies
Generally accepted accounting principles are complex and require management
to apply significant judgments to various accounting, reporting and disclosure
matters. Management of the Company must use assumptions and estimates to apply
these principles where actual measurement is not possible or practical.
For a complete discussion of the Corporation's significant accounting
policies, see "Management Discussion Analysis" and "Notes to the Consolidated
Financial Statements" in the Company's 2002 Annual Report filed on Form 10-K.
Certain policies are considered critical because they are highly dependent upon
subjective or complex judgments, assumptions and estimates. Changes in such
estimates may have a significant impact on the financial statements.
Item 3. Market Risk.
Certain of the Company's business activities expose it to market risk. This
market risk represents the potential for loss that may result from a change in
value of a financial instrument as a result of fluctuations in interest rates,
equity prices or changes in credit rating of issuers of debt securities. This
risk relates to financial instruments held by the company as investment and for
trading purposes.
The Company's securities inventories are exposed to risk of loss in the
event of unfavorable price movements. The Company's securities inventories are
marked to market on a daily basis. The Company's market-making activities are
client-driven, with the objective of meeting clients' needs while earning a
positive spread. The Company has significantly curtailed its market-making
activities during the current fiscal year. At March 31, 2003 and December 31,
2002, the balances of the Company's securities positions owned and securities
positions sold but not yet purchased were approximately $443,000 and $230,000
and $184,000 and $0, respectively. In the opinion of management, the potential
exposure to market risk, trading volatility and the liquidity of securities held
in the firm's inventory accounts could potentially have a material effect on the
Company's financial position.
The Company's activities involve the execution of various financial
transactions on behalf of its clients. Client activities are transacted on
either a cash or margin basis. The Company's client activities may expose it to
off-balance sheet credit risk. The Company may have to purchase or sell
financial instruments at the prevailing market price in the event of the failure
of a client to settle a trade on its original terms, or in the event that cash
and securities in the client margin accounts are not sufficient to fully cover
the client losses. The Company seeks to control the risks associated with client
activities by requiring clients to maintain collateral in compliance with
various regulations and Company policies.
14
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
The Company's management, under the supervision and with the participation
of the chief executive officer and chief financial officer, conducted an
evaluation of the Company's "disclosure controls and procedures" (as defined in
Securities Exchange Act of 1934 (the "Exchange Act") Rules 13a-14(c)) within 90
days of the filing date of this Quarterly Report on Form 10-Q (the "Evaluation
Date"). Based on their evaluation, the chief executive officer and chief
financial officer have concluded that as of the Evaluation Date, the Company's
disclosure controls and procedures are effective to ensure that all material
information required to be filed in this Quarterly Report on Form 10-Q has been
made known to them in a timely fashion.
Changes in Internal Controls
There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the Evaluation Date set forth above.
15
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
Not applicable.
Item 2. Changes in Securities and Use of Proceeds.
The Company completed a private offering of its securities as of March 1,
2003. In the offering, First Montauk sold an aggregate of $1,240,000 of
convertible debentures to certain "accredited investors" only. The offering
consisted of up to $3,000,000 principal amount of 6% convertible debentures.
First Montauk issued $1,030,000 of debentures on December 12, 2002 and an
additional $210,000 of debentures on January 7, 2003. The proceeds of the
financing will be used to satisfy the general working capital needs of the
Company.
Each debenture earns interest at the rate of 6% per annum, payable
semi-annually, and is convertible at an initial conversion price of $0.50 per
share, subject to adjustment for stock dividends, combinations, splits,
recapitalizations, and like events. Each holder shall have the right to convert
its debentures, at the option of such holder, at any time, into shares of First
Montauk common stock at the then applicable conversion price. In addition, First
Montauk at its option, may demand the holders convert some or all of the
debentures into shares of common stock in the event that the closing bid price
of its common stock is 200% of the conversion price for the twenty consecutive
trading days prior to the date of the notice of conversion.
Further, First Montauk, at its option, may prepay some or all of the
debentures in the event that the closing bid price of its common stock is 200%
of the conversion price for the twenty consecutive trading days prior to the
date of the notice of prepayment. The prepayment amount shall be 130% of the
principal amount of the debentures from the date of issuance until the first
anniversary of the date of issuance, together with accrued and unpaid interest.
Thereafter, the prepayment amount shall be equal to 120% of the principal amount
of the debentures, together with accrued and unpaid interest through the date of
prepayment.
Holders of debentures shall have notice of and the right to include the
shares of common stock issuable upon conversion of the debentures in a
registration statement filed by the First Montauk other than a registration
statement on Form S-4 or S-8, or a successor form.
First Montauk Securities Corp. served as the exclusive agent for the sale
of the debentures. The Placement Agent received commissions of 10% of the
principal amount of debentures sold in the oOffering and warrants to purchase
such number of shares of common stock as equals 10% of the principal amount of
debentures sold . These warrants are exercisable for a period of five years at
an exercise price of equal to the conversion price of the debentures.
The debentures have not been registered for offer or sale under the
Securities Act; such securities are being issued on the basis of the statutory
exemption provided by Section 4(2) of the Securities Act, as amended, and/or
Rule 506 of Regulation D, promulgated thereunder relating to transactions by an
issuer not involving any public offering; and the transaction has not been
reviewed by, passed on or submitted to any Federal or state agency or
self-regulatory organization where an exemption is being relied upon. The
securities may not be sold, assigned or transferred unless (i) the sale,
assignment or transfer of such securities is registered under the Securities
Act, or (ii) the securities are sold, assigned or transferred in accordance with
all the requirements and limitations of Rule 144 under the Securities Act.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
16
Item 5. Other Information.
Suspension of Preferred Stock Dividend
The Company has declared and paid dividends on its Series A Preferred Stock
at the rate of 6% per annum on a quarterly basis since the third quarter of
1999. Currently, the Company is unable to continue to pay such dividends
pursuant to the New Jersey Business Corporation Act. The New Jersey Business
Corporation Act prohibits a corporation from paying dividends if its total
assets would be less than its total liabilities. Dividends will continue to
accrue on the outstanding shares of Series A Preferred Stock and will be paid
when the Company is legally authorized to do so under the New Jersey Business
Corporation Act.
Expiration of Class A and Class B Warrants
The Company's 3,072,446 Class A warrants and 3,072,446 Class B warrants
expired on February 17, 2003.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
Date of Report: March 27, 2003
Item Reported: Item 5 and Item 9, disclosing private placement of
debentures.
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FIRST MONTAUK FINANCIAL CORP.
(Registrant)
Dated: May 15, 2003 /s/ William J. Kurinsky
----------------------------------
William J. Kurinsky
Secretary/Treasurer
Chief Financial Officer and
Principal Accounting Officer
/s/ Herbert Kurinsky
----------------------------------
Herbert Kurinsky
President
18
CERTIFICATIONS
I, Herbert Kurinsky, Chief Executive Officer of First Montauk Financial
Corp. certify that:
1. I have reviewed this quarterly report on Form 10-Q of First Montauk
Financial Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d- 14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ Herbert Kurinsky
- -------------------------------------------
Herbert Kurinsky, Chief Executive Officer
First Montauk Financial Corp.
19
CERTIFICATIONS
I, William J. Kurinsky, Chief Financial Officer of First Montauk Financial
Corp. certify that:
1. I have reviewed this quarterly report on Form 10-Q of First Montauk
Financial Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d- 14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ William J. Kurinsky
- ---------------------------------------------
William J. Kurinsky, Chief Financial Officer
First Montauk Financial Corp.
20
Exhibit 99.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of FIRST MONTAUK FINANCIAL CORP.
(the "Company") on Form 10-Q for the period ending March 31, 2003 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Herbert Kurinsky, Chief Executive Officer of the Company, certify, pursuant to
18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
/s/ Herbert Kurinsky
- -----------------------------------
Herbert Kurinsky
Chief Executive Officer
May 15, 2003
21
Exhibit 99.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of FIRST MONTAUK FINANCIAL CORP.
(the "Company") on Form 10-Q for the period ending March 31, 2003 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
William J. Kurinsky, Chief Financial Officer of the Company, certify, pursuant
to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
/s/ William J. Kurinsky
- -----------------------------------
William J. Kurinsky
Chief Financial Officer
May 15, 2003