================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION placeCityWASHINGTON, StateD.C. PostalCode20549 FORM 10-Q (Mark One) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY |X| PERIOD ENDED JUNE 30, 2006 |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO Commission File Number: 0-6729 FIRST MONTAUK FINANCIAL CORP. - -------------------------------------------------------------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) New Jersey 22-1737915 ----------------- -------------------- (State of Incorporation) (I.R.S. Employer Identification No.) Parkway 109 Office Center, 328 Newman Springs Road, Red Bank, New Jersey 07701 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (732) 842-4700 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) 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 the filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d)of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. |_| Yes |_| No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 18,503,553 shares of Common Stock were outstanding at August 14, 2006. FIRST MONTAUK FINANCIAL CORP. FORM 10-Q JUNE 30, 2006 INDEX Page PART I. FINANCIAL INFORMATION: Item 1. Financial Statements Consolidated Statements of Financial Condition as of June 30, 2006 (unaudited) and December 31, 2005 .............................................. F-1 Consolidated Statements of Operations for the Six Months and Three Months Ended June 30, 2006 (unaudited) and 2005 (unaudited and restated) ..................................................................... F-2 Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the period from January 1, 2005 to June 30, 2006 ......................................... F-3 - F4 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 (unaudited) and 2005 (unaudited and restated) .................................. F-5 Notes to Consolidated Financial Statements .................................................. 6-15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................................................. 16-24 Item 3. Risk Management ....................................................................... 24-25 Item 4. Controls and Procedures ............................................................... 25 PART II. OTHER INFORMATION: Item 1. Legal Proceedings .................................................................... 26 Item 1A. Risk Factors ........................................................................ 26 Item 2. Unregistered Sales of Equity Securities ............................................... 26 Item 3. Defaults Upon Senior Securities ....................................................... 26 Item 4. Submission of Matters to a Vote of Security Holders ................................... 27 Item 5. Other Information .................................................................... 27 Item 6. Exhibits .............................................................................. 28 Signatures ..................................................................................... 29 Officers' Certifications ..................................................................... 30-33 FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION June 30, December 31, 2006 2005 (unaudited) ASSETS Cash and cash equivalents $ 1,831,983 $ 1,990,815 Due from clearing firm 4,794,258 4,756,646 Securities owned, at market value 474,833 303,612 Prepaid expenses 971,761 287,394 Employee and broker receivables - net of reserve for bad debt of $1,018,242 and $1,085,135 respectively 251,286 310,289 Property and equipment - net 303,507 449,460 Other assets 434,299 622,804 --------------------- ------------------- Total assets $ 9,061,927 $ 8,721,020 ===================== =================== LIABILITIES 6% convertible debentures 25,000 1,250,000 Securities sold, not yet purchased, at market value 8,926 3,564 Commissions payable 1,781,214 2,027,379 Accounts payable 730,958 486,676 Accrued expenses 1,151,859 1,373,354 Income taxes payable 35,167 32,167 Capital leases payable 4,012 8,555 Note payable 495,547 200,000 Other liabilities 119,704 111,474 --------------------- ------------------- Total liabilities 4,352,387 5,493,169 --------------------- ------------------- Commitments and contingencies (See notes) STOCKHOLDERS' EQUITY Preferred stock, 3,929,898 shares authorized, $.10 par value, no shares issued and outstanding -- -- Series A convertible preferred stock, 625,000 shares authorized, $.10 par value 305,369 shares issued and outstanding; liquidation preference $1,526,845 30,537 30,537 Series B convertible redeemable preferred stock, 445,102 shares authorized, $.10 par value, 197,824 shares issued and outstanding, liquidation preference: $1,000,000 19,782 19,782 Common stock, no par value, 60,000,000 and 30,000,000 shares authorized, 18,483,553 and 15,937,407 shares issued and outstanding, respectively 11,615,302 10,055,925 Additional paid-in capital 1,930,810 1,930,810 Accumulated deficit (8,886,891) (8,809,203) Less: deferred compensation -- (388,185) --------------------- ------------------- Total stockholders' equity 4,709,540 3,227,851 --------------------- ------------------- Total liabilities and stockholders' equity $ 9,061,927 $ 8,721,020 ===================== =================== See notes to consolidated financial statements. F-1 FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Six months ended June 30 Three months ended June 30 ---------------------------------- ---------------------------------- 2006 2005 2006 2005 (unaudited) (unaudited and (unaudited) (unaudited and restated) restated) Revenues: Commissions $ 20,427,390 $ 18,536,318 $ 9,904,625 $ 8,594,155 Principal transactions 2,484,800 2,906,403 1,120,246 1,203,646 Investment banking 2,317,234 3,826,060 1,571,673 927,348 Interest and other income 1,688,306 6,877,365 1,009,164 5,855,352 ------------ ------------- ------------ ----------- Total revenue 26,917,730 32,146,146 13,605,708 16,580,501 ------------ ------------- ------------ ----------- Expenses: Commissions, employee compensation and benefits 22,120,306 22,675,416 11,040,703 9,881,752 Executive separation 951,266 1,432,937 -- -- Clearing and floor brokerage 695,779 1,052,226 (3,156) 490,883 Communications and occupancy 883,293 1,161,241 345,485 581,351 Legal matters and related costs 612,551 314,944 414,048 72,677 Other operating expenses 1,534,775 1,933,020 699,886 1,132,264 Interest 66,746 43,393 32,795 1,189 ------------ ------------- ------------ ----------- Total expenses 26,864,716 28,613,177 12,529,761 12,160,116 ------------ ------------- ------------ ----------- Net income before income taxes 53,014 3,532,969 1,075,947 4,420,385 Provision for income taxes 45,061 19,520 24,200 196,251 ------------ ------------- ------------ ----------- Net income $ 7,953 $ 3,513,449 $ 1,051,747 $ 4,224,134 Preferred stock dividends (85,641) (242,434) (42,866) $ (207,976) ------------ ------------- ------------ ----------- Net income (loss) applicable to common stockholders $ (77,688) $ 3,271,015 $ 1,008,881 $ 4,016,158 ============ ============= ============ =========== Earnings (loss) per share: Basic $ - $ 0.24 $ 0.06 $ 0.28 Diluted $ - $ 0.18 $ 0.05 $ 0.20 Weighted average number of shares of stock outstanding: Basic 15,594,185 13,421,349 15,842,628 14,411,053 Diluted 16,515,509 20,251,184 19,363,508 21,251,791 See notes to consolidated financial statements. F-2 FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) FOR THE PERIOD FROM JANUARY 1, 2005 TO JUNE 30, 2006 Series A Convertible Series B Convertible Preferred Stock Preferred Stock Common Stock --------------------- --------------------- ------------------------ --------------------------------------------------------------------- Additional Shares Amount Shares Amount Shares Amount Paid-in Capital --------------------------------------------------------------------- --------------------- Balances at January 1, 2005 305,369 $30,537 - - 10,258,509 $7,257,292 $ 950,592 Increase in deferred compensation 154,464 Amortization of deferred compensation Common stock issued in connection with legal settlements 25,000 25,000 Issuance of restricted stock in connection with employment agreements 1,300,000 741,000 Issuance of preferred stock in connection with separation agreement 197,824 $19,782 980,218 Exercise of incentive stock options 560,998 343,071 Cashless exercise of warrants 262,900 158,283 Conversion of bonds into common stock 3,530,000 1,765,000 Payment of preferred stock dividends Net income for the year --------------------- --------------------- ------------------------ ------------ Balances at December 31, 2005 305,369 30,537 197,824 19,782 15,937,407 10,444,110 1,930,810 Increase in deferred compensation 61,211 Amortization of deferred compensation Reclass to common stock (185,871) Exercise of incentive stock options 19,800 11,034 Cashless exercise of incentive stock options 27,586 Cashless exercise of warrants 28,603 22,211 Expired warrant obligation 47,009 37,607 Conversion of bonds into common stock 2,450,000 1,225,000 Payment of preferred stock dividends Net income for the period --------------------- --------------------- ------------------------ ------------ Balances at June 30, 2006 (unaudited) 305,369 $30,537 197,824 $19,782 18,510,405 $11,801,173 $ 1,930,810 ===================== ===================== ======================== ============ See notes to consolidated financial statements. F-3 FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) FOR THE PERIOD FROM JANUARY 1, 2005 TO JUNE 30, 2006 Retained Earnings Stockholders' (Accumulated Deferred Treasury Stock Equity Deficit) Compensation Shares Amount (Deficit) ---------------- -------------------------------------------- -------------- Balances at January 1, 2005 $ (10,948,157) $ (388,881) $ (3,098,617) Increase in deferred compensation (154,464) - Amortization of deferred compensation 896,160 896,160 Common stock issued in connection with legal settlements 25,000 Issuance of restricted stock in connection - with employment agreements (741,000) - Issuance of preferred stock in connection with separation agreement 1,000,000 Exercise of incentive stock options 343,071 Exercise of warrants 158,283 Conversion of bonds into common stock 1,765,000 Payment of preferred stock dividends (285,340) (285,340) Net income for the year 2,424,294 2,424,294 ---------------- -------------- ---------------------------- -------------- Balances at December 31, 2005 (8,809,203) (388,185) -- -- 3,227,851 Increase in deferred compensation (61,211) - Amortization of deferred compensation 263,525 263,525 Reclass to common stock 185,871 - Exercise of incentive stock options 11,034 Cashless exercise of incentive stock options - Cashless exercise of warrants 22,211 Expired warrant obligation 37,607 Conversion of bonds into common stock 1,225,000 Payment of preferred stock dividends (85,641) (85,641) Net income for the period 7,953 7,953 ---------------- -------------- ---------------------------- -------------- Balances at June 30, 2006 (unaudited) $ (8,886,891) $ (185,871) -- -- $ 4,709,540 ================ ============== ============================ ============== See notes to consolidated financial statements. F-4 FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Six months ended June 30 ------------------------------------------ 2006 2005 (unaudited) (unaudited and restated) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 7,953 $ 3,513,449 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation and amortization of property and equipment 151,260 218,965 Amortization of deferred costs 332,178 755,077 Amortization of deferred income -- (5,105,116) Preferred shares issued in connection with separation agreement 1,000,000 Note payable issued in connection with separation agreement 295,547 200,000 Increase (decrease) in cash attributable to changes in assets and liabilities: Due from clearing firm (37,613) 217,087 Securities owned (171,220) (167,204) Prepaid expenses (684,368) (581,526) Employee and broker receivables 57,913 266,011 Income taxes receivable - 40,503 Other assets 119,851 (49,045) Securities sold, not yet purchased 5,362 (167,178) Commissions payable (246,164) 29,186 Accounts payable 244,282 305,368 Accrued expenses (221,495) 256,581 Income taxes payable 3,000 (19,460) Other liabilities 69,139 (156,438) ------------------- ------------------- NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (74,375) 556,260 ------------------- ------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (5,307) (31,530) ------------------- ------------------- NET CASH USED IN INVESTING ACTIVITIES (5,307) (31,530) ------------------- ------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Payment of capital lease (4,543) (49,641) Proceeds from exercise of incentive stock option 11,034 334,935 Payment of preferred stock dividends (85,641) -- ------------------- ------------------- NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (79,150) 285,294 ------------------- ------------------- Net increase (decrease) in cash and cash equivalents (158,832) 810,024 Cash and cash equivalents at beginning of period 1,990,815 1,034,681 ------------------- ------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,831,983 $ 1,844,705 =================== =================== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 63,176 $ 88,377 =================== =================== Income taxes $ 108,644 $ 32,784 =================== =================== Noncash financing activity: Cashless exercise of warrants $ 22,211 $ 119,196 6% convertible debentures converted into common stock $ 1,225,000 $ 1,755,000 See notes to consolidated financial statements. F-5 FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION The interim financial information as of June 30, 2006 and for the six-month and three-month periods ended June 30, 2006 and 2005 has been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although management believes that the disclosures made are adequate to provide for fair presentation. These Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto, included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2005, previously filed with the SEC. In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of financial position as of June 30, 2006, and results of operations and cash flows for the six months and three months ended June 30, 2006 and 2005, as applicable, have been made. The results of operations for the six and three months ended June 30, 2006 are not necessarily indicative of the operating results for the full fiscal year or any future periods. Subsequent to the issuance of the Company's unaudited financial statements in its Form 10-Q for the six months and three months ended June 30, 2005, the Company concluded that it did not properly account for the issuance of its restricted stock awards to certain senior executives in February 2005. Therefore, the Company amended its June 30, 2005 Form 10-Q to correct the amounts previously reported for amortization of deferred compensation which is included in the Consolidated Statements of Income as part of "Commissions, Employee Compensation and Benefits". NOTE 2 - STOCK-BASED COMPENSATION The Company periodically issues common stock to employees, non-employee consultants and non-employee independent registered representatives in accordance with the provisions of the following shareholder approved equity compensation plans ("the Plans"): 2002 Stock Incentive Plan The 2002 Incentive Stock Option Plan, which replaced the 1992 Incentive Stock Option Plan that expired in September 2002, has reserved up to 5,000,000 shares of common stock for issuance to employees, non-employee consultants and non-employee registered representatives of the Company. Only options issued to employees qualify for incentive stock option treatment ("ISOs"). The Board of Directors determines the terms and provisions of each award granted under the 2002 Plan, including the exercise price, term and vesting schedule. In the case of ISO's, the per share exercise price must be equal to at least 100% of the fair market value of a share of common stock on the date of grant, and no individual will be granted ISOs corresponding to shares with an aggregate fair value in excess of $100,000 in any calendar year. The 2002 Incentive Stock Plan will terminate in 2012. 2002 Non-Executive Director Stock Option Plan Under the 2002 Director Plan, which replaced the 1992 Non-Executive Director Stock Option Plan that expired in September 2002, each non-executive director will automatically be granted an option to purchase 20,000 shares, pro rata, on September 1st of each year or partial year of service. The 2002 Director Plan does not contain a reserve for a specific number of shares available for grant. Each option issued under the 2002 Director Plan will be immediately vested non-qualified stock options, and will have a five-year term and an exercise price equal to 100% of the fair market value of the shares subject to such option on the date of grant. The 2002 Director Plan will terminate in 2012. 6 1996 Senior Management Plan In June 2000, the Company's stockholders approved an amendment to the 1996 Senior Management Plan (the "1996 Plan") to increase the number of shares reserved for issuance to key management employees from 2,000,000 to 4,000,000 shares. Awards can be granted through the issuance of incentive stock rights, stock options, stock appreciation rights, limited stock appreciation rights, and shares of restricted common stock. The exercise price of an option designated as an ISO may in no event be less than 100% of the then fair market price of the stock (110% with respect to ten percent stockholders), and not less than 85% of the fair market price in the case of other options. The 1996 Plan terminated in June 2006. The Plans provide for accelerated vesting if there is a change in control. Accounting for Employee Awards: Effective January 1, 2006, the Plans are accounted for in accordance with the recognition and measurement provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment ("FAS 123(R)"), which replaces SFAS No. 123, Accounting for Stock-Based Compensation ("FAS 123"), and supersedes Accounting Principles Board Opinion No. 25 ("APB 25"), Accounting for Stock Issued to Employees, and related interpretations. FAS 123(R) requires compensation costs related to share-based payment transactions, including employee stock options, to be recognized in the financial statements. In addition, the Company adheres to the guidance set forth within Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 107, which provides the Staff's views regarding the interaction between FAS 123(R) and certain SEC rules and regulations and provides interpretations with respect to the valuation of share-based payments for public companies. Prior to January 1, 2006, the Company accounted for similar employee transactions in accordance with APB 25 which employed the intrinsic value method of measuring compensation cost. Accordingly, compensation expense was not recognized for employee fixed stock options if the exercise price of the option equaled or exceeded the fair value of the underlying stock at the grant date. While FAS 123, for employee options, encouraged recognition of the fair value of all stock-based awards on the date of grant as expense over the vesting period, companies were permitted to continue to apply the intrinsic value-based method of accounting prescribed by APB 25 and disclose certain pro-forma amounts as if the fair value approach of FAS 123 had been applied. In December 2002, FAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FAS 123, was issued, which, in addition to providing alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation, required more prominent pro-forma disclosures in both the annual and interim financial statements. The Company complied with these disclosure requirements for all applicable periods prior to January 1, 2006. In adopting FAS 123(R), the Company applied the modified prospective approach to the transition. Under the modified prospective approach, the provisions of FAS 123(R) are to be applied to new employee awards and to employee awards modified, repurchased, or cancelled after the required effective date. Additionally, compensation cost for the portion of employee awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is rendered on or after the required effective date. The compensation cost for that portion of employee awards shall be based on the grant-date fair value of those awards as calculated for either recognition or pro-forma disclosures under FAS 123. 7 As a result of the adoption of FAS 123(R), the Company's results for the six and three month periods ended June 30, 2006 include share-based compensation expense for employee options and shares totaling approximately $213,000 and $114,000, respectively. Such amounts have been included in the Consolidated Statements of Operations within commissions, employee compensation and benefits. No income tax benefit has been recognized in the income statement for share-based compensation arrangements as the Company has provided for 100% valuation allowance on net deferred tax assets. Stock compensation expense for employee options and shares recorded under APB 25 in the Consolidated Statements of Operations for the six and three months ended June 30, 2005 totaled $534,000 and $116,000, respectively. Employee stock option compensation expense in 2006 is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for entire portion of the award. The Company has not adjusted the expense by estimated forfeitures, as required by FAS 123(R) for employee options, since the forfeiture rate based upon historical data was determined to be immaterial. Accounting for Non-employee Awards: The Company previously accounted for options granted to its non-employee consultants and non-employee registered representatives using the fair value cost in accordance with FAS 123 and EITF No. 96-18. The adoption of FAS 123(R) and SAB 107 as of January 1, 2006, had no material impact on the accounting for non-employee awards. The Company continues to consider the additional guidance set forth in EITF Issue No. 96-18 ("EITF 96-18"), "Accounting for Equity Instruments That Are Issued to Other Than Employees". Stock compensation expense related to non-employee options was $50,000 and $13,000 respectively for the six and three month periods ended June 30, 2006 compared to $65,000 and $27,000 respectively for the six and three months ended June 30, 2005. These amounts are included in Consolidated Statements of Operations within commissions, employee compensation and benefits. The weighted average estimated fair value of all stock options granted in the six months ended June 30, 2006 and 2005 was $0.59 and $0.56, respectively. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. During 2006, the Company took into consideration guidance under FAS 123(R) and SEC Staff Accounting Bulletin No. 107 ("SAB 107") when reviewing and updating assumptions. The expected volatility is based upon historical volatility of our stock and other contributing factors. The expected term is based upon observation of actual time elapsed between date of grant and exercise of options for all employees. Previously such assumptions were determined based on historical data. 8 The assumptions made in calculating the fair values of all options are as follows: Six Months Ended Three Months Ended June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005 Expected volatility 68% 102% 68% 102% Expected dividend yield 0% 0% 0% 0% Risk-free interest rate 3.71%-5.10% 2.93%- 3.72% 3.71%- 5.10% 2.93%- 3.72% Expected term (in years) 0-5 years 0-5 years 0-5 years 0-5 years In the fourth quarter of 2005, the Company changed the basis for estimating the volatility component of the Black Scholes model. Previously the Company used historical daily price observations of its stock as a basis for determining expected volatility. The Company determined that monthly price observations provide a more reliable measure of its stock trading activity and resulting volatility estimate. This change is considered a change in estimate and is accounted for prospectively to new grants. Pro Forma Information under SFAS No. 123 for Periods Prior to Adoption of FAS 123(R): The following table illustrates the effect on the net income and earnings per share as if the fair value recognition provisions of FAS 123 had been applied to all outstanding and unvested employee awards in the prior year comparable period. Six months ended Three months ended June 30, 2005 June 30, 2005 ------------- ------------- (unaudited &restated) (unaudited & restated) Net income attributable to common stockholders, as reported $3,271,015 $4,016,158 Add: Employee stock-based compensation expense determined under the fair value based method for all awards (no tax effect) (36,091) (17,542) -------- -------- Pro forma net income attributable to common stockholders $3,234,924 $3,998,616 Add: preferred stock dividends 242,434 207,976 Add: convertible debenture interest 47,075 18,810 ------ ------ Pro forma net income $3,524,433 $4,225,402 ========= ========= Earnings per share: Basic - as reported $ .24 $ .28 Basic - pro forma $ .24 $ .28 Diluted - as reported $ .18 $ .20 Diluted - pro forma $ .17 $ .20 9 The following table represents all our stock options granted, exercised, and forfeited during the six months of 2006. ------------------------------ --------- -------------------- --------------- ------------ ------------------- Weighted Weighted Average Average Remaining Number Exercise Price Contractual Aggregate Stock Options of Shares per Share Term Intrinsic Value ------------------------------ --------- -------------------- --------------- ------------ ------------------- Outstanding at January 1, 2006 2,707,302 $0.85 -------------------------------------------------------------------------------------------------------------- Granted 3,000 $1.04 Exercised (220,400) $0.72 Forfeited/expired (213,500) $1.35 -------------------------------------------------------------------------------------------------------------- Outstanding at June 30, 2006 2,276,402 $0.81 2.6 $213,435 ============================================================================================================== Exercisable at June 30, 2006 1,703,836 $0.82 2.5 $138,723 ============================================================================================================== The weighted-average grant date fair value of all share options granted during the six months ended June 30, 2006 and 2005 was $0.59 and $0.56, respectively. The intrinsic value of all stock options exercised during the six months of 2006 and 2005 was $55,000 and $118,000, respectively. Cash received from the exercise of all stock options in the six months ended June 30, 2006 and 2005 was $11,034 and $297,435, respectively. The Company has issued nonvested shares (as the term is defined in FAS 123(R)) to its senior officers. The following table summarizes the activity during the six months ended June 30, 2006: ----------------------------------- -------------------------------- ----------------------------- Nonvested Shares Shares Weighted-Average Grant-Date Fair Value ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Nonvested January 1, 2006 950,000 $0.47 ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Granted -- -- ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Vested (850,000) $0.46 ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Forfeited -- -- ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Nonvested June30, 2006 100,000 $0.57 ----------------------------------- -------------------------------- ----------------------------- 10 The total fair value of shares vested during the six months ended June 30, 2006 and 2005, was $825,000 and $956,000, respectively. As of June 30, 2006, there was $186,000 of total unrecognized compensation cost, net of estimated forfeitures, related to all unvested stock options and shares, which is expected to be recognized over a weighted average period of approximately 1.8 years. NOTE 3 - PREPAID EXPENSES Prepaid expenses at June 30, 2006 include a payment for errors and omissions insurance coverage. The unamortized amount at June 30, 2006 is $601,000, which will be written off over the next seven months. NOTE 4 - ACCOUNTS PAYABLE Accounts payable at June 30, 2006 includes an insurance premium financing agreement with a current balance of $415,000 payable in four remaining monthly installments of approximately $105,000. All installments include interest at the rate of 4.97% per annum. NOTE 5 - 6% CONVERTIBLE DEBENTURES During the quarter ended June 30, 2006, holders of $1,190,000 of the Company's 6% subordinated convertible debentures sold their debentures, in privately negotiated transactions, to FMFG Ownership Inc. ("Ownership"), the entity with which the Company has entered into a definitive merger agreement (See Note 8). Subsequent to the purchase of the debentures, Ownership converted its entire debenture holdings into 2,380,000 of the Company's common shares. There remains $25,000 of outstanding debentures which are due to mature in 2007. NOTE 6 - LEGAL MATTERS The Company is a respondent or co-respondent in various legal proceedings, including customer arbitrations and regulatory investigations. Management is contesting these claims and believes that there are meritorious defenses in each case. However, litigation is subject to many uncertainties, and some of these actions and proceedings may result in an adverse judgment. Further, the availability of insurance coverage 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. After considering all relevant facts, available insurance coverage and consultation with litigation counsel, management believes that significant judgments or other unfavorable outcomes from pending litigation could have a material adverse impact on the Company's consolidated financial condition, results of operations, and cash flows in any particular quarterly or annual period, or in the aggregate, and could impair the Company's ability to meet the statutory net capital requirements of its securities business. The Company is in the final stages of resolving a New Jersey Bureau of Securities investigation into First Montauk Securities Corp.'s sale of certain high-yield bonds to the firm's clients from 1998 to 2001, and the subsequent resale of those securities to other customers in 2001. The final terms of the settlement are still being negotiated but will likely include a monetary fine and the retention of a compliance consultant to review the firm's procedures. The exact amount of the fine, as well as the precise language of the proposed consent order, are still being negotiated with the Bureau. The Company believes that it has adequately reserved for the anticipated financial impact of this matter in the financial statements. We anticipate that a final consent order will be issued during the third quarter of 2006. 11 As of June 30, 2006, the Company has accrued for potential legal liabilities that are probable and can be reasonably estimated based on a review of existing claims and arbitrations. Management cannot give assurance that this amount will be adequate to cover actual costs that may be subsequently incurred. Further, it is not possible to predict the outcome of other matters pending against the Company. All such cases will continue to be vigorously defended. NOTE 7 - EARNINGS (LOSS) PER SHARE Basic earnings (loss) per share for the six and three months ended June 30, 2006 and 2005 is based on the weighted average number of shares of common stock outstanding. The following table sets forth the weighted average number of shares of common stock and dilutive securities outstanding used in the computation of basic and diluted earnings (loss) per share: Six months ended Three months ended June 30 June 30 ---------------- -------------------- 2006 2005 2006 2005 ---- ---- ---- ---- (Restated) (Restated) Numerator - basic: Net income $ 7,953 $ 3,513,449 $ 1,051,747 $ 4,224,134 Deduct: preferred stock dividends ( 85,641) (242,434) ( 42,866) (207,976) --------- --------- --------- --------- Numerator for basic earnings (loss) per share $ (77,688) $ 3,271,015 $ 1,008,881 $ 4,016,158 ======== ========= ========== ========= Numerator - diluted: Numerator for basic earnings (loss) per share $ (77,688) $ 3,271,015 $ 1,008,881 $ 4,016,158 Add: preferred stock dividends 85,641 242,434 42,866 207,976 Add: convertible debenture interest, net of tax 35,061 47,075 375 18,810 -------- ------ ------------ --------- Numerator for diluted $ 43,014 $ 3,560,524 $ 1,052,122 $ 4,242,944 earnings per share ======== ========= ============ ========= Denominator: Weighted average common shares outstanding 15,594,185 13,421,349 15,842,628 14,411,053 Effect of dilutive securities: Stock options and warrants 879,487 1,216,404 841,276 1,183,763 Convertible preferred stock 2,588,978 2,588,978 2,588,978 Nonvested employee stock 41,837 524,453 40,625 567,997 Convertible debentures -- 2,500,000 50,000 2,500,000 ------------ ---------- ----------- ---------- Denominator for diluted earnings per share 16,515,509 20,251,184 19,363,507 21,251,791 ============ ========== =========== ========== 12 The following securities have been excluded from the dilutive per share computation, as they are antidilutive: Six months ended Three months ended June 30 June 30 2006 2005 2006 2005 ----------------------- ------------------------- Stock options 1,655,300 1,349,854 1,685,552 1,349,854 Warrants 149,133 -- 157,092 -- Convertible debt 50,000 -- -- -- Convertible preferred stock 2,588,978 -- -- -- Nonvested employee stock 58,153 -- 59,375 -- As required by FAS 128, "Earnings per Share", cumulative preferred stock dividends for the six and three months ended June 30, 2006 and 2005 were deducted from net income to arrive at the numerator for basic and diluted earnings (loss) per share. NOTE 8 - DEFINITIVE MERGER AGREEMENT On May 5, 2006, the Company entered into a definitive merger agreement with FMFG Ownership, Inc. ("Ownership"), and FMFG AcquisitionCo, Inc. ("AcquisitionCo"), affiliates of Investment Properties of America, LLC ("IPofA"), a privately owned, diversified real estate investment and management company. Pursuant to the agreement, upon the completion of the merger, each holder of the Company's common stock will receive $1.00 per share in cash, each holder of the Company's Series A preferred stock, which is convertible into two shares of common stock, will be entitled to receive $2.00 per Series A preferred share in cash, and each holder of the Company's Series B preferred stock, which is convertible into ten shares of common stock, will be entitled to receive $10.00 per Series B preferred share in cash. In addition, the purchaser has agreed to contribute at least $3,000,000 of new equity capital to the surviving corporation in the merger on or before the closing date. In conjunction with the signing of the merger agreement, certain directors and officers of the Company, who beneficially own approximately 26.1% of the outstanding voting shares of the Company, as of the record date, June 26, 2006, have entered into voting agreements with the purchaser to vote their shares in favor of the merger. A special committee of the Board of Directors of the Company consisting of all independent directors received an opinion from Capitalink, L.C., an independent investment banking firm, that the merger consideration was fair from a financial point of view to the Company's shareholders. 13 The Company has filed a proxy statement in connection with this proposed transaction and has scheduled a special meeting of shareholders for August 17, 2006 to consider and vote upon the proposed merger. Shareholders of record on June 26, 2006 of the Company's common stock, Series A preferred stock and Series B preferred stock will be entitled to vote at the special meeting of shareholders. Prior to the record date, Ownership purchased an aggregate of 2,159,348 shares of the Company's common stock in the open market and privately negotiated transactions, and in privately negotiated transactions purchased 283,087 shares of the Company's outstanding Series A preferred stock at a price of $4.00 per share, providing Ownership with 92.7% of the outstanding shares of Series A preferred stock as of the record date. In addition, Ownership purchased $1,190,000 principal amount of the Company's convertible debentures from holders, in privately negotiated transactions, which were subsequently converted into 2,380,000 shares of the Company's common stock. As a result of all of these purchases, as of the record date, Ownership beneficially owns 24.6% of the Company's common stock (assuming no shares of Series A preferred stock are converted into common stock). The completion of the merger is subject to, among other conditions, compliance with state and federal securities laws and regulations, and shareholder and regulatory approvals. The transaction is expected to close during the fourth quarter of 2006. However, as a result of the foregoing uncertainties, there can be no assurances that the transaction will be completed. NOTE 9 - SEPARATION AGREEMENT On February 1, 2006, the Company entered into a Separation Agreement with Herbert Kurinsky, the Chairman of the Board of Directors. Under the terms of the Separation Agreement, the parties agreed to terminate the employment relationship and the rights and obligations of the parties under the employment agreement dated January 1, 2004. Mr. Kurinsky continues to serve as Chairman of the Board of the Company. As a result of the separation agreement, the Company expensed a total of $951,266 which includes the following: o A lump sum severance payment of $300,000. o A promissory note in the principal amount of $550,217, payable in monthly installments of $12,500 over a period of 48 months and bearing interest at the rate of 4.5% per annum, the remaining balance of which was paid pursuant to the change of control provisions in the Separation Agreement and Promissory Note. (See Notes 10 and 13) o Medical and dental benefits to Mr. Kurinsky and his wife for a period of 48 months. 14 o Automobile allowance of $600 per month for a period of 36 months, the remaining balance of which was subsequently paid pursuant to the change of control provisions in the Separation Agreement. (See Notes 10 and 13) o The full vesting of all restricted stock in accordance with his employment agreement. Subsequent to June 30, 2006, the Company paid the remaining balances, including accrued interest, on the note payable and automobile allowance of $486,000 and $19,000, respectively. The Company and Mr. Kurinsky have also exchanged mutual releases except to the extent each has reserved their rights as provided in the Separation Agreement. NOTE 10 - CHANGE IN CONTROL During June 2006, through purchases of common stock and convertible debentures which were subsequently converted to common stock, Ownership obtained beneficial ownership of 24.6% of the Company's common stock, as of the record date, triggering the change of control provisions in certain agreements. As a result, in June 2006 the Company expensed $73,000 for stock and options that became immediately vested in accordance with its CEO's employment agreement. In addition, in July 2006 the remaining note payable balance and automobile allowance totaling $505,000 was paid to Mr. Herbert Kurinsky in accordance with the change of control provisions of his Separation Agreement and Promissory Note. (See Notes 9 and 13) NOTE 11 - AMENDMENT TO CLEARING AGREEMENT During the second quarter of 2006, First Montauk Securities Corp. ("FMSC") signed an amendment to Exhibit A of its clearing agreement with National Financial Services LLC ("NFS"), adopting, among other things, a schedule of reduced clearing rates. NOTE 12 - SIGNED RELEASE WITH NFS During the second quarter of 2006, FMSC signed a release with NFS for and in consideration of the payment of $1,000,000 by NFS relating to conversion and transition expenses incurred by FMSC in prior periods, as a result of its conversion from Fiserv Securities Inc. to NFS in 2005. The payment was received on June 29, 2006 and was recorded by FMSC among various expense and revenue categories. NOTE 13 - SUBSEQUENT EVENTS In July 2006, pursuant to change in control provisions in its Promissory Note and Separation Agreement with its former Chairman of the Board, the Company paid Mr. Herbert Kurinsky the remaining balances on his note payable and automobile allowance. (See Notes 9 and 10) 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Factors Affecting "Forward-Looking Statements" From time to time, we 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, we caution readers that a variety of factors could cause our actual results to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. These risks and uncertainties, many of which are beyond our control, include, but are not limited to: (i) transaction volume in the securities markets, (ii) the volatility of the securities markets, (iii) fluctuations in interest rates, (iv) changes in regulatory requirements which could affect the cost of doing business, (v) fluctuations in currency rates, (vi) general economic conditions, both domestic and international, (vii) changes in the rate of inflation and related impact on securities markets, (viii) competition from existing financial institutions and other new participants in the securities markets, (ix) legal developments affecting the litigation experience of the securities industry, (x) the timely completion of the acquisition of the Company by a private investor, and (xi) changes in federal and state tax laws which could affect the popularity of products sold by us. We do not undertake any obligation to publicly update or revise any forward-looking statements. The reader is referred to our previous filings with the Commission, including our Form 10-K for the year ended December 31, 2005. Overview We are a New Jersey-based financial services holding company whose principal subsidiary, First Montauk Securities Corp., has operated as a full service retail and institutional securities brokerage firm since 1987. Since July 2000, First Montauk Securities Corp. has operated under the trade name "Montauk Financial Group" and 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. We also sell insurance products through our subsidiary, Montauk Insurance Services, Inc. Montauk Financial Group has approximately 290 registered representatives and services over 50,000 retail and institutional customers, which comprise over $3.2 billion in customer assets. With the exception of a company leased branch office in New York City, all of our other 117 branch office and satellite locations in 30 states are owned and operated by affiliates; independent representatives who maintain all appropriate licenses and are responsible for all office overhead and expenses. Montauk Financial Group also employs registered representatives directly at its corporate headquarters. Montauk Financial Group is registered as a broker-dealer with the Securities and Exchange Commission, the National Association of Securities Dealers, the Municipal Securities Rule Making Board, the National Futures Association, 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, and registered as an International broker-dealer to conduct business with institutional clients in the province of Ontario, Canada. Securities transactions are cleared through National Financial Services LLC ("NFS") of StateBoston, StateMA, and Penson Financial Services Inc of StateStateDallas, StateTX, with various floor brokerage and specialist firms also providing execution services. These arrangements provide Montauk Financial Group with back office support and transaction processing services on all principal, national and international securities exchanges, and access to many other financial services and products which allows Montauk Financial Group to offer products and services comparable to larger brokerage firms. On May 5, 2006, we entered into a definitive merger agreement with Ownership and AcquisitionCo, affiliates of IPofA. Ownership and AcquisitionCo are wholly-owned subsidiaries of Edward H. Okun, a private investor who is the controlling person of IPofA. Pursuant to the merger agreement, upon completion of the merger, each holder of our common stock will receive $1.00 per share in cash, each holder of our Series A preferred stock, which is convertible into two shares of common stock, will be entitled to receive $2.00 per Series A preferred share in cash, and each holder of our Series B preferred stock, which is convertible into ten shares of common stock, will be entitled to receive $10.00 per Series B preferred share in cash. 16 In addition, the purchaser has agreed to contribute at least $3,000,000 of new equity capital to the surviving corporation in the merger on or before the closing date. In conjunction with the signing of the merger agreement, certain of our directors and officers, who beneficially own approximately 26.1% of our outstanding voting shares as of the record date, have entered into voting agreements with the purchaser to vote their shares in favor of the merger. We filed a proxy statement in connection with this proposed transaction and have scheduled a special meeting of shareholders for August 17, 2006 to consider and vote upon the proposed merger. Shareholders of record on June 26, 2006 of our common stock, Series A preferred stock and Series B preferred stock will be entitled to vote at the special meeting of shareholders. Prior to the record date, Ownership purchased, from holders, an aggregate of 2,159,348 shares of our common stock in the open market and privately negotiated transactions, and in privately negotiated transactions purchased 283,087 shares of our Series A preferred stock at a price of $4.00 per share, providing Ownership with 92.7% of the outstanding shares of our Series A preferred stock. In addition, Ownership purchased $1,190,000 principal amount of our outstanding convertible debentures, from holders, in privately negotiated transactions, which were subsequently converted by Ownership into 2,380,000 shares of our common stock. As a result of all of these purchases, as of the record date, Ownership beneficially owns 24.6% of our common stock (assuming no shares of Series A preferred stock are converted into common stock). The definitive merger agreement is subject to, among other conditions, compliance with state and federal securities laws and regulations, and shareholder and regulatory approvals. The transaction is expected to close during the fourth quarter of 2006. However, as a result of the foregoing uncertainties, there can be no assurances that the transaction will be completed. On February 1, 2006, we entered into a Separation Agreement with Herbert Kurinsky, our Chairman of the Board of Directors, which provided for the termination of his employment as of that date. Pursuant to the terms of the Agreement, we paid the Chairman a cash payment of $300,000 and issued a promissory note in the amount of $550,217 plus interest at the rate of 4.5% per annum for 48 months. Furthermore, the Separation Agreement provided for a continuation of medical insurance coverage for 48 months for the Chairman and his wife, an automobile allowance of $600 for 36 months, which resulted in a charge to earnings of $64,691, and the immediate vesting of all stock grants in accordance with his employment agreement, which resulted in an additional charge to earnings of $36,458. In the event of a change in control, any remaining note principal and automobile allowance is immediately payable. As a result of Ownership's purchase of 24.6% of our stock, the change of control provisions of Mr. Kurinsky's promissory note and separation agreement were triggered, and consequently, in July 2006 we paid Mr. Kurinsky $505,000. During the second quarter of 2006, First Montauk Securities Corp. ("FMSC") signed an amendment to Exhibit A of its clearing agreement with NFS, adopting, among other things, a schedule of reduced clearing rates. Also during the second quarter of 2006, FMSC signed a release with NFS for and in consideration of the payment of $1,000,000 by NFS relating to conversion and transition expenses incurred by the broker-dealer in prior periods, as a result of its conversion from its prior clearing firm, Fiserv Securities Inc., to NFS in 2005. The payment was received on June 29, 2006 and was recorded by FMSC among various expense and revenue categories as described in more detail below. 17 RESULTS OF OPERATIONS Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005 Revenues by Source The following provides a breakdown of total revenues by source for the three-month periods ended June 30, 2006 and 2005 (in thousands of dollars). Three Months Ended ----------------------------------------------------------------- ------------------------------ --- ------------------------------ June 30, 2006 June 30, 2005 ------------------------------ ------------------------------ Amount % of Total Amount % of Total Revenues Revenues Commissions Equities $ 4,757 35% $ 4,338 26% Mutual Funds 1,610 12% 1,568 9% Insurance 1,080 8% 1,084 7% Alternative Products 1,373 10% 672 4% Asset Management Fees 1,009 7% 866 5% Fixed Income 76 1% 66 <1% -------------- --------------- -------------- --------------- Total 9,905 73% 8,594 52% Principal Transactions 1,120 8% 1,204 7% Investment Banking 1,572 12% 927 6% Interest and Other Interest 767 6% 710 4% Deferred revenue -- -- 4,886 29% Other 242 1% 259 2% -------------- --------------- -------------- --------------- Total 1,009 7% 5,855 35% -------------- --------------- -------------- --------------- Total revenues $ 13,606 100% $ 16,580 100% ============== =============== ============== =============== Overview Total revenues decreased $3.0 million, or 18%, for the three months ended June 30, 2006 (the "2006 quarter"), to $13.6 million, compared to $16.6 million for the three months ended June 30, 2005 (the "2005 quarter"). The decrease was primarily attributable to the inclusion of $4.9 million during the 2005 quarter, from the acceleration of the remaining deferred revenue in connection with the termination of our Financial Agreement with Fiserv Securities, Inc. ("Fiserv"), our prior clearing firm. This decrease in 2006 was offset by increases in commissions of $1.3 million and investment banking revenues of $644,000. Included in interest and other income for the 2006 quarter is an additional $180,000 of margin interest rebate; a partial allocation of the $1.0 million received from NFS on June 29, 2006. Taking into consideration the $180,000 of additional interest income in the 2006 quarter and the $4.9 million of deferred revenue recognition in the 2005 quarter, revenue in the 2006 quarter increased $1.7 million, or 15%, compared to the same period in 2005. Expenses increased in the 2006 quarter by $370,000, or 3%, compared to the 2005 quarter. Included in expenses in 2006 is $820,000 of expense offsets, a partial allocation of the $1.0 million received from NFS on June 29, 2006 (as discussed above). Taking into consideration the $820,000 received from NFS, expenses increased by $1.2 million during the 2006 quarter, when compared to the 2005 quarter, an increase of 10%. Commission expense increased $1.6 million, or 20%, from $8.0 million for the 2005 quarter to $9.6 million for the 2006 quarter, as a result of the increase in commissionable revenues for the 2006 quarter. In addition, legal matters and related costs increased $341,000 in the 2006 quarter compared to 2005, offset by decreases in professional fees, quote services, and amortization and depreciation expenses. 18 Net income attributable to common stockholders for the 2006 quarter decreased approximately $3.0 million to $1.0 million, or $.06 and .05 per basic and diluted share, respectively, from a net income of $4.0 million for the 2005 quarter, or $.28 and $.20 per basic and diluted share, respectively, due to the adjustments mentioned above. Commission Revenue Commissions are comprised of revenues from the sale of equities, fixed income, mutual funds, insurance, asset management fees and alternative products. Commission revenue for the 2006 quarter was $9.9 million compared to $8.6 million for the 2005 quarter. Commissions on alternative products, which include REIT's, 1031 exchanges and oil & gas programs, increased $701,000, or 104%, from $672,000 in the 2005 quarter to $1,373,000 in the 2006 quarter. In addition, agency commissions and asset management fees increased $438,000 and $143,000, respectively, while revenues from mutual funds and insurance products remained relatively constant. Principal Transactions Principal transactions, which include mark-ups/mark-downs on customer transactions in which we act as principal, proprietary trading, and the sale of fixed income securities, decreased $83,000, or 7%, from $1.20 million for the 2005 quarter to $1.12 million for the 2006 quarter. Investment Banking Investment banking revenues for the 2006 quarter increased $644,000 from $927,000 in the 2005 quarter, to $1.57 million in the 2006 quarter. This category includes private offerings of securities in which we act as placement agent and new issues of equity and preferred stock offerings in which we participate as a selling group or syndicate member. The number and size of private placement transactions during the 2006 quarter increased compared to the 2005 quarter. Interest and Other Income Interest and other income for the 2006 quarter totaled $1.0 million, as compared to $5.9 million for the 2005 quarter, a decrease of $4.9 million. This decrease was due mostly to the acceleration of the remaining deferred revenue in connection with the termination of our Financial Agreement with Fiserv Securities, Inc. ("Fiserv"), our prior clearing firm during the 2005 quarter. Included in interest income for the 2006 quarter is an additional $180,000 of margin interest, a partial allocation of the $1.0 million received from NFS on June 29, 2006. Commissions, Employee Compensation and Benefits Commission expense, consistently the largest expense category and directly related to commission revenue, increased 20%, or $1.6 million, from $8.0 million for the 2005 quarter, to $9.6 million for the 2006 quarter. Commissions represent 76% and 74% of commissionable revenues for the 2006 and 2005 quarters, respectively. Compensation and benefits expense for management, operations and clerical personnel, which include salaries and payroll taxes, stock and option compensation, health insurance premiums, and bonus accruals, decreased for the 2006 quarter, to $1.4 million from $1.9 million, a reduction of approximately $500,000 over the 2005 quarter. Salaries, bonuses accruals and payroll taxes decreased by approximately $170,000, from $1.33 million for the 2005 quarter, to $1.16 million for the 2006 quarter. The decrease for the 2006 quarter was primarily attributable to $86,000 of salary offsets, a partial allocation of the $1.0 million received from NFS on June 29, 2006. Stock and option compensation costs decreased approximately $16,000 for the 2006 quarter as compared to the 2005 quarter. Clearing and Floor Brokerage Clearing and floor brokerage costs decreased $494,000 in the 2006 quarter when compared to the 2005 quarter. In June 2006, we allocated approximately $544,000 of the $1 million received in the settlement from NFS to clearing fees for costs incurred in prior periods. Actual clearing costs for the 2006 quarter, excluding the settlement amount from NFS of $544,000, would have been $540,000, an increase of $50,000, or 10%, compared to the 2005 quarter. As a percentage of transaction based revenues, clearing costs remained relatively constant between the two periods. Clearing costs, as a percentage of gross revenues, fluctuate depending upon the product mix. 19 Communications and Occupancy Communications and occupancy costs decreased $236,000, from $581,000 in the 2005 quarter to $345,000 in the 2006 quarter due to a reduction in quote services of approximately $68,000, and a $135,000 reduction in costs incurred in prior periods related to data aggregation as part of the $1.0 million received from NFS on June 29, 2006. Legal matters and related costs Legal matters and related settlement costs increased $341,000, from $73,000 during the 2005 quarter to $414,000 for the 2006 quarter. Settlement costs of $124,500 for the 2006 quarter include an additional reserve of $75,000 in connection with the investigation by the New Jersey Bureau of Securities (See Note 6). Legal expense during the 2006 quarter increased $166,000, of which $122,000 was in connection with the anticipated acquisition of the Company by a private investor. Settlement costs increased by $175,000 for the 2006 quarter compared to the 2005 quarter. The 2005 quarter included a $164,000 credit adjustment for the valuation of warrants issued in settlement of an arbitration claim that occurred in a previous period. Other Operating Expenses Other operating costs decreased approximately $432,000, or 38%, to $700,000 in the 2006 quarter from $1.13 million during the 2005 quarter. The largest decrease in other operating expenses during the 2006 quarter was for consulting fees of $122,000, amortization of deferred financing of $77,000, depreciation of $35,000 and advertising of $43,000. In addition, we allocated approximately $55,000 of the $1.0 million received from NFS on June 29, 2006 against professional fees. Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005 Revenues by Source The following provides a breakdown of total revenues by source for the six-month periods ended June 30, 2006 and 2005 (in thousands of dollars). Six Months Ended ----------------------------------------------------------------- June 30, 2006 June 30, 2005 ------------------------------ ------------------------------ Amount % of Total Amount % of Total Revenues Revenues Commissions Equities $ 11,097 41% $ 10,105 31% Mutual Funds 3,211 12% 3,257 10% Insurance 2,190 8% 2,329 7% Alternative Products 1,937 7% 1,131 4% Asset Management Fees 1,904 7% 1,643 5% Fixed Income 89 <1% 71 <1% -------------- --------------- -------------- --------------- Total 20,428 76% 18,536 58% Principal Transactions 2,485 9% 2,907 9% Investment Banking 2,317 9% 3,826 12% Interest and Other Interest 1,334 5% 1,342 4% Deferred revenue -- -- 5,105 16% Other 354 1% 430 1% -------------- --------------- -------------- --------------- Total 1,688 6% 6,877 21% -------------- --------------- -------------- --------------- Total revenues $ 26,918 100% $ 32,146 100% ============== =============== ============== =============== 20 Overview Overall, revenues decreased $5.2 million for the six months ended June 30, 2006 (the "2006 period"), to $26.9 million, compared to $32.1 million for the six months ended June 30, 2005 (the "2005 period"). The decrease was primarily attributable to the inclusion of $4.9 million during the 2005 period, from the recognition of the remaining deferred revenue in connection with the termination of our Financial Agreement with Fiserv Securities, Inc. ("Fiserv"), our prior clearing firm. Commission revenues increased by $1.9 million while revenues from principal transactions and investment banking decreased by $422,000 and $1.5 million, respectively. Included in interest and other income for the 2006 period is an additional $180,000 of margin interest, a partial allocation of the $1.0 million received from NFS on June 29, 2006, as discussed previously. Taking into consideration the $180,000 of additional interest income in the 2006 period and the $4.9 million of deferred revenue recognition in the 2005 period, revenue in the 2006 period decreased $522,000, or 2%, compared to the same period in 2005. Expenses in the 2006 period decreased by approximately $1.75 million, which includes an $820,000 credit due to a partial allocation of the $1.0 million received from NFS on June 29, 2006. Taking into consideration the $820,000 received from NFS, expenses decreased by $928,000 during the 2006 period, when compared to the 2005 period, a decrease of 3%. Included in the 2006 decrease is a reduction in executive separation costs of $482,000, clearing costs of $356,000, communications and occupancy of $278,000 and other operating expenses of $398,000. These were offset in part by increases in legal matters and related costs of $298,000. Commission expense increased approximately $300,000, or 2%, from $18.8 million for the 2005 period to $19.1 million for the 2006 period. Net loss applicable to shareholders in the 2006 period was ($77,000), or $0.00 per basic and diluted shares, compared to net income of $3.3 million, or $0.24 and $0.18 per basic and diluted shares, respectively, for the 2005 period. Commission Revenue Commission revenue for the six months ended 2006 increased $1.9 million to $20.4 from $18.5 million in the same period in 2005. The increase was primarily attributable to revenue from agency equity transactions which increased $1.0 million and commissions from alternative products, which include commissions on REIT's, 1031 exchanges and oil & gas programs, which increased 71%, from $1.13 million in the 2005 period to $1.93 million in the 2006 period. An increase in revenue from asset management fees of $260,000 was partially offset by decreases in commissions earned on insurance products and mutual funds of $186,000. Principal Transactions Principal transactions decreased $422,000, or 15%, from $2.9 million for the 2005 period to $2.5 million for the 2006 period. Revenues from all fixed income products accounted for the decrease in 2006. The reduction in activity in fixed income securities is associated with lower prices on domestic fixed income securities in the current quarter, due in part to consistent increases in interest rates by the Federal Reserve. Investment Banking Investment banking revenues for the 2006 period decreased $1.5 million, or 39%, from $3.8 million in the 2005 period, to $2.3 million in the 2006 period. Investment banking revenues for the first quarter of 2005 were $2.9 million compared to $746,000 for the first quarter of 2006. Although investment banking revenues for the 2006 quarter increased over the 2005 quarter by $644,000, it was not enough to make up for the decrease during the first quarter of 2006. The decrease in investment banking revenues was primarily due to an overall reduction in the number of closings of private offerings when compared to 2005. In 2005, however, we reported our highest investment banking revenues, and although revenues decreased during the six months ended 2006 when compared to the same period in 2005, 2006 revenues are higher than any other similar period reported prior to 2005. Interest and Other Income Interest and other income decreased $5.2 million during the 2006 period when compared to the 2005 period. Other income in 2005 period includes the recognition of the remaining deferred revenue for cash advances received in prior years from Fiserv Inc., our former clearing firm. During 2005, we terminated our financing agreement with Fiserv and recorded the remaining unamortized balance of $4.9 million to other income. Commissions, Employee Compensation and Benefits 21 Commission expense increased approximately $300,000, or 2%, from $18.8 million for the 2005 period to $19.1 million for the 2006 period. Compensation and benefits expense for management, operations and clerical personnel decreased $849,000 in the 2006 period to $3.0 million compared to $3.8 million in the 2005 period. A reduction in officer bonus accruals and amortization of deferred compensation from $1,018,000 in the 2005 period to $397,000 in the 2006 period contributed to the decrease. Clearing and Floor Brokerage Clearing and floor brokerage costs decreased approximately 350,000, from $1.05 million for the 2005 period, to $696,000 for the 2006 period. In June 2006, we allocated approximately $544,000 of the $1 million received in the settlement from NFS to clearing fees. Excluding this reduction, clearing and floor brokerage costs would have increased by approximately $188,000. This category for the 2005 period includes expense rebates provided by our former clearing firm of $143,000. Communications and Occupancy Communications and occupancy costs decreased $277,000 during the 2006 period, from $1.16 million in the 2005 period to $883,000 in 2006. In addition to a $135,000 reduction in reports, as part of the $1.0 million received from NFS on June 29, 2006, the decrease in expense is due to reductions in occupancy and related costs from the elimination of a company leased branch office in New York City in 2005 and reductions in quote services due to a decrease in brokers and discounted market data pricing received from our clearing firm. Legal matters and related costs Legal matters and related settlement costs increased $297,000, from $315,000 for the 2005 period to $612,000 for the 2006 period. The 2006 period includes an additional reserve of $75,000 in connection with the investigation by the New Jersey Bureau of Securities (See Note 6). The 2005 period included a $164,000 credit adjustment for the valuation of warrants issued in settlement of an arbitration claim that occurred in a previous period. Legal expense during the 2006 period increased $232,000, of which $183,000 was in connection with the anticipated acquisition of the Company by a private investor. Other Operating Expenses Other operating costs decreased $398,000, to $1.5 million in the 2006 period, from $1.9 million in the 2005 period. Due to the exercise of the majority of our outstanding convertible debentures in 2005, we accelerated $130,000 of the amortization of the deferred financing costs related to these debentures during the 2005 period, compared to an acceleration of $56,000 during the 2006 period. In 2006, reductions in advertising, consulting fees, depreciation, and liability insurance costs were offset by additional fees we paid to our directors for due diligence performed with respect to the anticipated acquisition of the Company by a private investor. Liquidity and Capital Resources We maintain a highly liquid balance sheet with approximately 78% of our assets consisting of cash, securities owned, and receivables from our clearing firm and other broker-dealers and insurance companies. The balances in these accounts can and do fluctuate significantly from day to day, depending on general economic and market conditions, volume of activity, and investment opportunities. These accounts are monitored on a daily basis in order to ensure compliance with regulatory capital requirements and to preserve liquidity. Overall, cash and cash equivalents decreased during the six months ended 2006 by $159,000. Net cash used in operating activities during the 2006 period was $74,000, which consists of net income of $8,000, increased by non-cash charges including depreciation of $151,000, amortization of deferred costs of $332,000 and a net increase in the issuance of notes payable of $296,000 issued in connection with separation agreements. Cash was reduced by increases in due from clearing firm, securities owned and prepaid expenses of $38,000, $171,000 and $684,000, respectively, and decreases in accrued expenses and commissions' payable of $221,000 and $246,000, respectively. Cash was increased by reductions in broker receivables of $58,000 and other assets of $120,000 and an increase in accounts payable and other liabilities of $244,000 and $69,000 respectively. 22 Additions to property and equipment of $5,000 accounted for the use of cash from investing activities during the six months ended 2006. Financing activities used net cash of $79,000 due to the payment of preferred stock dividends of $86,000 and capital leases of $4,500 offset by proceeds from option exercises of $11,000 during the six month period of 2006. During the first quarter of 2006, $30,000 of the Company's convertible debentures were converted into shares of common stock, and in June 2006, Ownership purchased $1,190,000 principal amount of debentures, from holders, were sold in privately negotiated transactions. Subsequently, Ownership converted such debentures into 2,380,000 common shares. As of June 30, 2006, there is an aggregate principal amount of $25,000 of convertible debentures outstanding which is convertible at $.50 per share. During the second quarter of 2006, First Montauk Securities Corp. signed a release with NFS for and in consideration of the payment of $1,000,000 by NFS relating to conversion and transition expenses incurred by the broker-dealer as a result of its conversion from Fiserv Securities Inc. to NFS in 2005. The payment was received on June 29, 2006. The financing agreement with Premium Assignment for the renewal of our errors and omissions insurance policy had a balance at June 30, 2006 of approximately $415,000, payable in four remaining monthly installments of approximately $105,000 each. All installments include interest at the rate of 4.97% per annum. Consolidated Contractual Obligations and Lease Commitments The table below provides information about our commitments related to debt obligations, leases, guarantees and investments as of June 30, 2006. This table does not include any projected payment amounts related to our potential exposure to arbitrations and other legal matters. As of June 30, 2006 Expected Maturity Date - ------------------------- -------------------- --------------- ----------------- -------------- -------------- --------- ----------- After Category 2006 2007 2008 2009 2010 2010 Total - ------------------------- -------------------- --------------- ----------------- -------------- -------------- --------- ----------- Debt Obligations 0 $25,000 0 0 0 0 $ 25,000 - ------------------------- -------------------- --------------- ----------------- -------------- -------------- --------- ----------- Capital Lease Obligations $4,012 0 0 0 0 0 $4,012 - ------------------------- -------------------- --------------- ----------------- -------------- -------------- --------- ----------- Operating Lease Obligations $588,116 $912,183 $659,057 $619,376 $50,762 0 $2,829,494 - ------------------------- -------------------- --------------- ----------------- -------------- -------------- --------- ----------- Note Payable $495,547 0 0 0 0 0 $495,547 - ------------------------- -------------------- --------------- ----------------- -------------- -------------- --------- ----------- Total $1,087,675 $937,183 $659,057 $619,376 $50,762 0 $3,354,053 ----------------------- -------------------- --------------- ----------------- -------------- -------------- --------- ----------- The note payable of $495,547 was paid subsequent to June 30, 2006 (See Notes 10 & 13). Net Capital At June 30, 2006, Montauk Financial Group had net capital of $3,331,105, which was $2,958,226 in excess of its required net capital of $250,000, and the ratio of aggregate indebtedness to net capital was 1.12 to 1. Debenture Conversions During the three months ended June 2006, Ownership purchased $1,190,000 principal amount of the Company's convertible debentures from holders, in privately negotiated transactions, and subsequently converted such debentures into 2,380,000 shares of the Company's common stock. As of the date of this report, there is an aggregate principal amount of $25,000 of convertible debentures outstanding convertible at $.50 per share. 23 Series A Convertible Preferred Stock In 1999, we issued 349,511 shares of Series A Convertible Preferred Stock in an exchange offering related to a settlement with holders of certain leases. Each share of the Preferred Stock is convertible into two shares of Common Stock and pays a quarterly dividend of 6%. In June 2006, Ownership purchased 283,087 shares of Series A preferred stock, from holders, in privately negotiated transactions at a price of $4.00 per share. As of June 30, 2006, we have 305,369 Series A preferred shares issued and outstanding. Quarterly dividends of $22,866 were paid during the three months ended June 2006. Series B Convertible Redeemable Preferred Stock In connection with a Separation Agreement we entered into with Mr. William J. Kurinsky in 2005, we issued an aggregate of 197,824 shares of a newly created class of Series B Convertible Redeemable Preferred Stock ("Series B"), par value $0.10 per share, which will have a deemed issue price of $1,000,000, and is convertible into common stock on the basis of ten shares of common stock for each share of Series B. The Series B also provides that the preferred shares have voting rights based upon the number of shares of common stock into which it would be converted. The Series B also includes a cumulative dividend of 8% per year. The shares are restricted securities under the Securities Act of 1933 and the regulations of the SEC and we relied upon the exemption from registration under Section 4(2) of the Securities Act of 1933 to issue the shares of Series B. A quarterly dividend of $20,000 was paid during the three months ended June 2006. Pursuant to a voting agreement between Mr. Kurinsky and Ownership, he has agreed to vote all of his Series B preferred shares in favor of the merger and the acquisition of the Company by a private investor. 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. Our management must use assumptions and estimates to apply these principles where actual measurement is not possible or practical. For a complete discussion of our significant accounting policies, see "Management Discussion and Analysis" and "Notes to the Consolidated Financial Statements" in our 2005 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. Off-Balance Sheet Arrangements We execute securities transactions on behalf of our customers. If either the customer or counter-party fails to perform, we, by agreement with our clearing broker may be required to discharge the obligations of the non-performing party. In such circumstances, we may sustain a loss if the market value of the security is different from the contract value of the transaction. We seek to control off-balance-sheet risk by monitoring the market value of securities held or given as collateral in compliance with regulatory and internal guidelines. Pursuant to such guidelines, our clearing firm requires additional collateral or reduction of positions, when necessary. We also complete credit evaluations where there is thought to be credit risk. Item 3. Risk Management Risk is an inherent part of our business and activities. The extent to which we properly and effectively identify, assess, monitor and manage the various types of risk involved in our activities is critical to our soundness and profitability. We seek to identify, assess, monitor and manage the following principal risks involved in its business activities: market, credit, operational and legal. Senior management takes an active role in the risk management process and requires specific administrative and business functions to assist in the identification, assessment and control of various risks. Our risk management policies and procedures are subject to ongoing review and modification. 24 Market Risk. Certain of our business activities expose us 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 we hold as investment and for trading. Securities inventories are exposed to risk of loss in the event of unfavorable price movements. Securities positions are marked to market on a daily basis. Market-making activities are client-driven, with the objective of meeting clients' needs while earning a positive spread. At June 30, 2006 and December 31, 2005, the balances of our securities positions owned, and sold, not yet purchased were approximately $475,000 and $9,000, and $304,000 and $4,000, respectively. In our view, 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 its financial position. Credit Risk. Credit risk represents the loss that we would incur if a client, counterparty or issuer of securities or other instruments that we hold fails to perform its contractual obligations. Client activities involve the execution, settlement, and financial of various transactions on behalf of its clients. Client activities are transacted on either a cash or margin basis. Client activities may expose us to off-balance sheet credit risk. We 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. We seek to control the risks associated with client activities by requiring clients to maintain collateral in compliance with various regulations and company policies. Operational Risk. Operational risk generally refers to the risk of loss resulting from our operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our operating systems, business disruptions and inadequacies or breaches in our internal control processes. We operate in diverse markets and rely on the ability of our employees and systems to process high numbers of transactions often within short time frames. In the event of a breakdown or improper operation of systems, human error or improper action by employees, we could suffer financial loss, regulatory sanctions or damage to our reputation. In order to mitigate and control operational risk, we have developed and continue to enhance policies and procedures that are designed to identify and manage operational risk at appropriate levels. Included in our operational risk management practice is disaster recovery for our critical systems. We believe that our disaster recovery program, including off-site back-up technology and operational facilities, is adequate to handle a reasonable business disruption. However, there can be no assurances that a disaster directly affecting our headquarters or operations center would not have a material adverse impact. Insurance and other safeguards might only partially reimburse us for our losses. Legal Risk. Legal risk includes the risk of non-compliance with applicable legal and regulatory requirements. We are subject to extensive regulation in the different jurisdictions in which we conduct our business. We have various procedures addressing issues such as regulatory capital requirements, sales and trading practices, use of and safekeeping of customer funds, credit granting, collection activities, anti money-laundering and record keeping. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 13a-15(e). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in designing and evaluating the controls and procedures. Based on their evaluation, as of June 30, 2006, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective. Changes in Internal Controls There have not been any changes in our internal control over financial reporting (as defined in Rules 13a-15(f) under the Exchange Act) that occurred during the our fiscal quarter ended June 30, 2006, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 25 PART II OTHER INFORMATION Item 1. Legal proceedings We are a respondent or co-respondent in various legal proceedings, including customer arbitrations and regulatory investigations. Management is contesting these claims and believes that there are meritorious defenses in each case. However, litigation is subject to many uncertainties, and some of these actions and proceedings may result in an adverse judgment. Further, the availability of insurance coverage 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. After considering all relevant facts, available insurance coverage and consultation with litigation counsel, management believes that significant judgments or other unfavorable outcomes from pending litigation could have a material adverse impact on the Company's consolidated financial condition, results of operations, and cash flows in any particular quarterly or annual period, or in the aggregate, and could impair the Company's ability to meet the statutory net capital requirements of its securities business. The Company is in the final stages of resolving an investigation by the New Jersey Bureau of Securities into First Montauk Securities Corp.'s sale of certain high-yield bonds to the firm's clients from 1998 to 2001, and the subsequent resale of those securities to other customers in 2001. The final terms of the settlement are still being negotiated but will likely include a monetary fine and the retention of a compliance consultant to review the firm's procedures. The exact amount of the fine, as well as the precise language of the proposed consent order, are still being negotiated with the Bureau. The Company believes that it has adequately reserved for the anticipated financial impact of this matter in the financial statements. We anticipate that a final consent order will be issued during the third quarter of 2006. As of June 30, 2006, the Company has accrued for potential legal liabilities that are probable and can be reasonably estimated based on a review of existing claims and arbitrations. Management cannot give assurance that this amount will be adequate to cover actual costs that may be subsequently incurred. Further, it is not possible to predict the outcome of other matters pending against the Company. All such cases will continue to be vigorously defended. Item 1A. Risk Factors Refer to December 31, 2005 Form 10-K. Item 2. Unregistered Sales of Equity Securities (a) During the three months ended June 2006, we issued 2,380,000 common shares upon conversion of $1,190,000 of convertible debentures. These shares of common stock were issued in reliance upon Section 3(a)(9) of the Securities Act of 1933 and are restricted and may therefore not be offered or sold other than pursuant to an effective registration statement or in reliance upon an exemption to such registration requirements. (b) Not applicable. (c) Not applicable. Item 3. Defaults Upon Senior Securities. None. 27 Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. Item 5. Other Information Definitive Merger Agreement On May 8, 2006, the Company announced that on May 5, 2006, it had entered into a definitive merger agreement with Ownership and AcquisitonCo, affiliates of IPofA, a privately owned, diversified real estate investment and management company. Pursuant to the agreement, upon completion of the merger, each holder of the Company's common stock will receive $1.00 per share in cash, each holder of the Company's Series A preferred stock, which is convertible into two shares of common stock, will be entitled to receive $2.00 per Series A preferred share in cash, and each holder of the Company's Series B preferred stock, which is convertible into ten shares of common stock, will be entitled to receive $10.00 per Series B preferred share in cash. In addition, the purchaser has agreed to contribute at least $3,000,000 of new equity capital to the surviving corporation in the merger on or before the closing date. In conjunction with the signing of the merger agreement, certain directors and officers of the Company, who beneficially own approximately 26.1% of the outstanding voting shares of the Company, as of the record date, have entered into voting agreements with the purchaser to vote their shares in favor of the merger. The Company has filed a proxy statement in connection with this proposed transaction and has scheduled a special meeting of shareholders for August 17, 2006 to consider and vote upon the proposed merger. Shareholders of record on June 26, 2006 for the Company's common stock, Series A preferred stock and Series B preferred stock will be entitled to vote at the special meeting of shareholders. Prior to the record date, Ownership purchased an aggregate of 2,159,348 shares of the Company's common stock in the open market and privately negotiated transactions, and, in privately negotiated transactions purchased 283,087 shares of Series A preferred stock at a price of $4.00 per share, providing them with 92.7% of the outstanding shares of Series A preferred stock. In addition, Ownership purchased $1,190,000 principal amount of the Company's convertible debentures, from holders, in privately negotiated transactions, which were subsequently converted into 2,380,000 shares of the Company's common stock. As a result of all of these purchases, as of the record date, Ownership beneficially owns 24.6% of the Company's common stock (assuming no shares of Series A preferred stock are converted into common stock). The completion of the merger is subject to, among other conditions, compliance with state and federal securities laws and regulations, and shareholder and regulatory approvals. The transaction is expected to close during the fourth quarter of 2006. However, as a result of the foregoing uncertainties, there can be no assurances that the transaction will be completed. Change in Control During June 2006, Ownership an affiliate of IPofA, purchased, from holders, an aggregate of 2,159,348 shares of the Company's common stock in the open market and privately negotiated transactions, and, in privately negotiated transactions purchased 283,087 shares of Series A preferred stock at a price of $4.00 per share, providing them with 92.7% of the outstanding shares of Series A preferred stock. In addition, Ownership purchased $1,190,000 principal amount of the Company's convertible debentures, from holders, in privately negotiated transactions, which were subsequently converted into 2,380,000 shares of the Company's common stock. As a result of all of these purchases, as of the record date, Ownership beneficially owns 24.6% of the Company's common stock (assuming no shares of Series A preferred stock are converted into common stock). 28 Item 6. Exhibits Exhibits The exhibits designated with an asterisk (*) are filed herewith. All other exhibits have been previously filed with the Commission and, pursuant 17 C.F.R. ss. 230.411, are incorporated by reference to the document referenced in brackets following the description of such exhibits. Number Description 2.1 Agreement and Plan of Merger dated as of May 5, 2006 by and among FMFG Ownership, Inc., FMFG AcquisitionCo, Inc. and First Montauk Financial Corp. (Previously filed as Exhibit 10.1 to our Current Report on Form 8-K dated May 9, 2006). 10.2 Voting Agreement dated as of May 5, 2006, among FMFG Ownership, Inc. and certain shareholders of First Montauk Financial Corp. (Previously filed as Exhibit 10.2 to our Current Report on Form 8-K dated May 9, 2006). 10.3 Escrow Deposit Agreement dated as of May 5, 2006, by and among FMFG Ownership, Inc., First Montauk Financial Corp. and Signature Bank, as escrow agent (Previously filed as Exhibit 10.3 to our Current Report on Form 8-K dated May 9, 2006). *31.1 Certification of Victor K. Kurylak, Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *31.2 Certification of Mindy A. Horowitz, Acting Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *32.1 Certification of Victor K. Kurylak, President and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *32.2 Certification of Mindy A. Horowitz, Acting Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 29 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: August 14, 2006 /s/ Mindy A. Horowitz -------------------------------------------- Mindy A. Horowitz Acting Chief Financial Officer /s/ Victor K. Kurylak -------------------------------------------- Victor K. Kurylak President and Chief Executive Officer 30 Exhibit 31.1 CERTIFICATION I, Victor K. Kurylak, Chief Executive Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of First Montauk Financial Corp.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) (Not applicable). c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 14, 2006 /s/ Victor K. Kurylak - -------------------------------------- VICTOR K. KURYLAK CHIEF EXECUTIVE OFFICER 31 Exhibit 31.2 CERTIFICATION I, Mindy A. Horowitz, Acting Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of First Montauk Financial Corp.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) (Not applicable). c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 14, 2006 /s/ Mindy A. Horowitz - ------------------------------------ MINDY A. HOROWITZ ACTING CHIEF FINANCIAL OFFICER 32 Exhibit 32.1 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 June 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Victor K. Kurylak, President and 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/ Victor K. Kurylak - ----------------------------------------- Victor K. Kurylak President and Chief Executive Officer August 14, 2006 33 Exhibit 32.2 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 June 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Mindy A. Horowitz, Acting 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/ Mindy A. Horowitz - ------------------------------------- Mindy A. Horowitz Acting Chief Financial Officer August 14, 2006 34