================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
|X| SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD
ENDED SEPTEMBER 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 |X| No
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: 18,511,553 shares of Common
Stock were outstanding at November 14, 2006.
02
FIRST MONTAUK FINANCIAL CORP.
FORM 10-Q
SEPTEMBER 30, 2006
INDEX
Page
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Consolidated Statements of Financial Condition
as of September 30, 2006 (unaudited) and December 31, 2005 .. F-1
Consolidated Statements of Operations for the Nine Months
and Three Months Ended September 30, 2006 (unaudited)
and 2005 (unaudited) ........................................ F-2
Consolidated Statements of Changes in Stockholders'
Equity (Deficit) for the period from January 1, 2005
to September 30, 2006 .......................................F-3-F-4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2006 (unaudited) and 2005 (unaudited) ... F-5
Notes to Consolidated Financial Statements ..................... 6-16
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................. 17-26
Item 3. Risk Management ........................................ 26-27
Item 4. Controls and Procedures ................................ 28
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings ...................................... 29
Item 1A. Risk Factors ........................................... 29
Item 2. Unregistered Sales of Equity Securities................. 29
Item 3. Defaults Upon Senior Securities ........................ 29
Item 4. Submission of Matters to a Vote of
Securities Holders .................................... 29
Item 5. Other Information ..................................... 29-30
Item 6. Exhibits ............................................... 31
Signatures ...................................................... 31
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September December
2006 2005
----------- ---------
(unaudited)
ASSETS
Cash and cash equivalents $ 873,883 $ 1,990,815
Due from clearing firm 5,262,388 4,756,646
Securities owned, at market value 292,613 303,612
Prepaid expenses 544,658 287,394
Employee and broker receivables - net of reserve for bad debt
of $1,018,242 and $1,085,135 respectively 417,921 310,289
Property and equipment - net 260,278 449,460
Other assets 530,647 622,804
--------- ---------
Total assets $ 8,182,388 $ 8,721,020
========= =========
LIABILITIES
6% convertible debentures 25,000 1,250,000
Securities sold, not yet purchased, at market value 4,750 3,564
Commissions payable 2,309,340 2,027,379
Accounts payable 411,462 486,676
Accrued expenses 743,953 1,373,354
Income taxes payable 32,667 32,167
Capital leases payable 1,630 8,555
Note payable -- 200,000
Other liabilities 74,231 111,474
--------- ---------
Total liabilities 3,603,033 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,
18,503,553 and 15,937,407 shares issued and outstanding, respectively 11,645,674 10,444,110
Additional paid-in capital 1,930,810 1,930,810
Accumulated deficit (9,047,448) (8,809,203)
Less: deferred compensation -- (388,185)
--------- -----------
Total stockholders' equity 4,579,355 3,227,851
--------- ----------
Total liabilities and stockholders' equity $ 8,182,388 $ 8,721,020
========= =========
See notes to consolidated financial statements.
F-1
04
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Nine months ended September 30 Three months ended September 30
2006 2005 2006 2005
---------- ---------- ---------- -----------
(unaudited) (unaudited) (unaudited) (unaudited)
Revenues:
Commissions $29,509,203 $28,130,672 $9,081,813 $9,594,354
Principal transactions 3,318,729 4,374,706 833,929 1,468,303
Investment banking 2,914,197 4,221,343 596,963 395,283
Interest and other income 2,449,776 7,943,791 761,470 1,066,426
---------- ---------- ---------- ----------
Total revenue 38,191,905 44,670,512 11,274,175 12,524,366
---------- ---------- ---------- ----------
Expenses:
Commissions, employee compensation and benefits 31,712,982 33,063,647 9,592,676 10,306,231
Executive separation 951,266 1,432,937 - -
Clearing and floor brokerage 1,111,675 1,591,748 415,896 621,522
Communications and occupancy 1,369,832 1,744,033 486,539 582,792
Legal matters and related costs 772,193 1,043,929 159,642 728,985
Other operating expenses 2,296,864 2,842,866 762,089 909,846
Interest 74,803 72,145 8,057 28,752
---------- ---------- ---------- ----------
Total expenses 38,289,615 41,791,305 11,424,899 13,178,128
---------- ---------- ---------- ----------
Net income (loss) before income taxes (97,710) 2,879,207 (150,724) (653,762)
Provision (benefit) for income taxes 14,331 22,615 (30,730) 3,095
---------- ---------- ----------- ----------
Net income (loss) $ (112,041) $2,856,592 $(119,994) $(656,857)
Preferred stock dividends (126,204) (285,340) (42,866) (42,906)
---------- ---------- ----------- ----------
Net income (loss) applicable to common stockholders $ (238,245) $2,571,252 $(162,860) $(699,763)
========== ========== =========== ==========
Earnings/(loss) per share:
Basic $ (0.01) $ 0.19 $ (0.01) $ (0.05)
Diluted $ (0.01) $ 0.14 $ (0.01) $ (0.04)
Weighted average number of shares of stock outstanding:
Basic 16,531,580 13,859,366 18,496,886 14,622,209
Diluted 16,531,580 20,116,007 18,496,886 14,622,209
See notes to consolidated financial statements.
F-2
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STODKHOLDERS' EQUITY (DEFICIT)
FOR THE PERIOD FROM JANUARY 1, 2005 TO SEPTEMBER 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
Amortization of deferred compensation
Reclass to common stock (105,288)
Exercise of incentive stock options 45,800 22,034
Cashless exercise of incentive stock options 27,586 -
Cashless exercise of warrants 42,760 22,211
Expired warrant obligation -- 37,607
Conversion of bonds into common stock 2,450,000 1,225,000
Payment of preferred stock dividends
Net loss for the period
---------------------- --------------------- ------------------------- -------------
Balances at September 30, 2006
(unaudited) 305,369 $30,537 197,824 $19,782 18,503,553 $11,645,674 $ 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 SEPTEMBER 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
Amortization of deferred compensation 282,897 282,897
Reclass to common stock 105,288 -
Exercise of incentive stock options 22,034
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 (126,204) (126,204)
Net loss for the period (112,041) (112,041)
----------- ------------- --------------------- -----------
Balances at September 30, 2006 (unaudited) $(9,047,448) $ - - - $4,579,355
============= ============= ===================== ============
See notes to consolidated financial statements.
F-4
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30
2006 2005
(unaudited) (unaudited)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (112,041) $ 2,856,592
Adjustments to reconcile net income (loss) to net cash (used in)
provided by operating activities:
Depreciation and amortization of property and equipment 202,413 303,144
Amortization of deferred costs 351,752 902,700
Amortization of deferred income - (5,105,116)
Preferred shares issued in connection with separation agreement - 1,000,000
Increase (decrease) in cash attributable to changes in assets
and liabilities:
Payment on note payable (200,000) -
Due from clearing firm (505,741) (269,283)
Securities owned 10,999 (121,172)
Prepaid expenses (257,264) (287,272)
Employee and broker receivables (107,632) 164,101
Income taxes receivable - 40,525
Other assets 23,301 (12,045)
Warrants subject to put options - (122,073)
Securities sold, not yet purchased 1,186 (150,194)
Commissions payable 281,961 (316,570)
Accounts payable (75,213) (93,290)
Accrued expenses (629,401) 264,273
Income taxes payable 500 (15,023)
Other liabilities 22,575 232,860
----------- ---------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (992,605) (727,843)
----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (13,232) (37,826)
----------- ---------
NET CASH USED IN INVESTING ACTIVITIES (13,232) (37,826)
----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of capital leases (6,925) (51,739)
Proceeds from exercise of incentive stock option 22,034 340,201
Payment of preferred stock dividends (126,204) (240,249)
----------- --------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (111,095) 48,213
----------- --------
Net decrease in cash and cash equivalents (1,116,932) (717,456)
Cash and cash equivalents at beginning of period 1,990,815 1,034,681
----------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 873,883 $ 317,225
=========== ==========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 33,891 $ 92,949
=========== ==========
Income taxes $ 118,018 $ 63,020
=========== ==========
Noncash financing activity:
Proceeds from 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 September 30, 2006 and
for the nine-month and three-month periods ended September 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 September 30, 2006, and
results of operations and cash flows for the nine months and
three months ended September 30, 2006 and 2005, as applicable,
have been made. The results of operations for the nine and
three months ended September 30, 2006 are not necessarily
indicative of the operating results for the full fiscal year
or any future periods.
NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENTS
SEC Staff Accounting Bulletin 108 ("SAB 108"), Considering the
Effects of Prior Year Misstatements when Qualifying
Misstatements in Current Year Financial Statements:
In September 2006, the SEC staff issued Staff Accounting
Bulletin No. 108, "Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year
Financial Statements." SAB 108 was issued in order to
eliminate the diversity of practice surrounding how public
companies quantify financial statement misstatements.
Traditionally, there have been two widely recognized methods
for quantifying the effects of financial statement
misstatements: the "roll-over" method and the "iron curtain"
method. The roll-over method focuses primarily on the impact
of a misstatement on the income statement--including the
reversing effect of prior year misstatements--but its use can
lead to the accumulation of misstatements in the balance
sheet. The iron-curtain method, on the other hand, focuses
primarily on the effect of correcting the period-end balance
sheet with less emphasis on the reversing effects of prior
year errors on the income statement.
In SAB 108, the SEC staff established an approach that
requires quantification of financial statement misstatements
based on the effects of the misstatements on each of the
company's financial statements and the related financial
statement disclosures. This model is commonly referred to as a
"dual approach" because it requires quantification of errors
under both the iron curtain and the roll-over methods.
SAB 108 permits existing public companies to initially apply
its provisions either by (i) restating prior financial
statements as if the "dual approach" had always been used or
(ii) recording the cumulative effect of initially applying the
"dual approach" as adjustments to the carrying values of
assets and liabilities as of January 1, 2006 with an
offsetting adjustment recorded to the opening balance of
retained earnings.
We will adopt the provisions of SAB 108 in connection with the
preparation of our annual financial statements for the year
ending December 31, 2006. We are in the process of evaluating
the impact, if any, on our financial statements of initially
applying the provisions of SAB 108.
Statement of Financial Accounting Standard 157, Fair Value
Measurements ("SFAS 157"):
On September 15, 2006, the Financial Accounting Standard Board
issued a standard that provides enhanced guidance for using
fair value to measure assets and liabilities. The standard
applies whenever other standards require (or permit) assets or
liabilities to be measured at fair value. The standard does
not expand the use of fair value in any new circumstances.
This Statement is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. Earlier application
is encouraged, provided that the reporting entity has not yet
issued financial statements for that fiscal year, including
financial statements for an interim period within that fiscal
year. The Company will adopt this pronouncement effective for
periods beginning January 1, 2008. We are currently evaluating
the impact of adopting this pronouncement on our financial
statements.
FSP FAS 123(R )-5, Amendment of FASB Staff Position
FAS 123(R)-1
FSP FAS 123(R)-5 was issued on October 10, 2006. The FSP
provides that instruments that were originally issued as
employee compensation and then modified, and that modification
is made to the terms of the instrument solely to reflect an
equity restructuring that occurs when the holders are no
longer employees. No change in the recognition or the
measurement (due to a change in classification) of those
instruments will result if both of the following conditions
are met: (a). There is no increase in fair value of the award
(or the ratio of intrinsic value to the exercise price of the
award is preserved, that is, the holder is made whole), or the
antidilution provision is not added to the terms of the award
in contemplation of an equity restructuring; and (b). All
holders of the same class of equity instruments (for example,
stock options) are treated in the same manner. The provisions
in this FSP shall be applied in the first reporting period
beginning after the date the FSP is posted to the FASB
website. We will adopt this FSP from its effective date. We
currently do not believe that its adoption will have any
impact on our financial statements.
NOTE 3 - 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.
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 as defined in the plans.
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.
As a result of the adoption of FAS 123(R), the Company's
results for the nine and three month periods ended September
30, 2006 include share-based compensation expense for employee
options and shares totaling approximately $235,000 and
$22,000, 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 a
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 nine and three months ended September 30, 2005 totaled
$959,000 and $389,000, 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
the 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
$48,000 for the nine months ended September 30, 2006 compared
to $102,000 for the nine months ended September 30, 2005. For
the three months ended September 30, 2006, the Company had a
$2,000 reversal due to the reduction in the market price of
the stock. This compares with stock compensation expense of
$37,000 for the three months ended September 30, 2005. These
amounts are included in the Consolidated Statements of
Operations within commissions, employee compensation and
benefits.
The weighted average estimated fair value of all stock options
granted in the nine months ended September 30, 2006 and 2005
was $0.59 and $0.41, 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.
The assumptions made in calculating the fair values of all
options are as follows:
Nine Months Ended Three Months Ended
----------------- ------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
---- ---- ---- ----
Expected volatility 66% 102% 66% 102%
Expected dividend yield
0% 0% 0% 0%
Risk-free interest rate 3.71%-5.10% 2.93%-3.72% 3.71%-4.59% 2.93%-3.72%
Expected term (in years) 0-5 years 0-5 years 0-4.5 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
doption 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.
Nine months ended Three months ended
September 30, 2005 September 30, 2005
------------------ ------------------
(unaudited) (unaudited)
Net income (loss), as reported $2,856,592 ($656,857)
Add: Employee stock-based
compensation expense determined
under the fair value based method
for all awards (no tax effect) (308,900) (272,809)
---------- ---------
Pro forma net income (loss)
attributable to common
stockholders 2,547,692 (929,666)
Add: preferred stock dividends 285,340 42,906
Add: convertible debenture interest 56,250 18,750
--------- ---------
Pro forma net income (loss) $2,889,282 ($868,010)
========== =========
Earnings (loss) per share:
Basic - as reported $ 0.19 $ (0.05)
Basic - pro forma $ 0.16 $ (0.07)
Diluted - as reported $ 0.14 $ (0.04)
Diluted - pro forma $ 0.14 $ (0.06)
The following table represents all our stock options granted,
exercised, and forfeited during the nine 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 (240,400) $0.71
Forfeited/expired (213,500) $1.35
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Outstanding at September 2,256,402 $0.81 2.7 $485,459
30, 2006
----------------------------------------------------------------------------------------------------------------
================================================================================================================
Exercisable at September 1,832,121 $0.81 2.7 $424,355
30, 2006
================================================================================================================
The weighted-average grant date fair value of all share
options granted during the nine months ended September 30,
2006 and 2005 was $0.59 and $0.41, respectively. The
intrinsic value of all stock options exercised during the
nine months of 2006 and 2005 was $49,000 and $171,000,
respectively. Cash received from the exercise of all stock
options in the nine months ended September 30, 2006 and 2005
was $22,000 and $302,701, respectively.
The Company has issued shares that vest over time (as the
term is defined in FAS 123(R)) to its senior officers. The
following table summarizes the activity during the nine
months ended September 30, 2006:
----------------------------------- -------------------------------- -----------------------------
Weighted-Average
Grant-Date
Nonvested Shares Shares Fair Value
----------------------------------- -------------------------------- -----------------------------
----------------------------------- -------------------------------- -----------------------------
Nonvested January 1, 2006 950,000 $0.47
----------------------------------- -------------------------------- -----------------------------
----------------------------------- -------------------------------- -----------------------------
Granted -- --
----------------------------------- -------------------------------- -----------------------------
----------------------------------- -------------------------------- -----------------------------
Vested (850,000) $0.46
----------------------------------- -------------------------------- -----------------------------
----------------------------------- -------------------------------- -----------------------------
Forfeited -- --
----------------------------------- -------------------------------- -----------------------------
----------------------------------- -------------------------------- -----------------------------
Nonvested September 30, 2006 100,000 $0.57
----------------------------------- -------------------------------- -----------------------------
The total fair value of shares vested during the nine months
ended September 30, 2006 and 2005, was $773,500 and $935,000,
respectively.
As of September 30, 2006, there was $123,000 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 4 - PREPAID EXPENSES
Prepaid expenses at September 30, 2006 include a payment for
errors and omissions insurance coverage. The unamortized
amount at September 30, 2006 is $343,000, which will be
written off over the next four months.
NOTE 5 - ACCOUNTS PAYABLE
Accounts payable at September 30, 2006 includes an insurance
premium financing agreement with a current balance of
$105,000, payable in one remaining monthly installment,
including interest at the rate of 4.97% per annum.
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.
On September 29, 2006, First Montauk Securities Corp. ("FMSC")
entered into a Consent Order with the New Jersey Bureau of
Securities relating to an investigation into FMSC's sale of
certain high yield bonds to it's clients from 1998 to 2001,
and the subsequent resale of those securities to other
customers in 2001. As a result, FMSC paid a civil monetary
penalty of $475,000 on September 29, 2006, which was fully
reserved for in previous periods, and agreed to retain an
independent consultant to review FMSC's business practices and
procedures for branch office supervision, suitability
standards, and monitoring of agent sales activities.
As of September 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 nine and three months
ended September 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:
Nine months ended Three months ended
September 30 September 30
-------------------------- ---------------------------
2006 2005 2006 2005
---- ---- ---- ----
Numerator - basic:
Net income (loss) $ (112,041) $ 2,856,592 $ (119,994) $ (656,857)
Deduct: preferred stock dividends (126,204) (285,340) ( 42,866) ( 42,906)
---------- ----------- ----------- -----------
Numerator for basic earnings
(loss) per share $ (238,245) $ 2,571,252 $ (162,860) $ (699,763)
========= =========== =========== ===========
Numerator - diluted:
Numerator for basic
earnings (loss) per share $ (238,245) $ 2,571,252 $ (162,860) $ (699,763)
Add: preferred stock dividends -- 285,340 -- 42,906
Add: convertible debenture
interest, net of tax -- 56,250 -- 18,750
---------- ----------- ----------- -----------
Numerator for diluted $ (238,245) $ 2,912,842 $ (162,860) $ (638,107)
earnings (loss) per share ========== =========== =========== ===========
Denominator:
Weighted average common
shares outstanding 16,531,580 13,859,366 18,382,826 14,622,209
Effect of dilutive securities:
Stock options and warrants -- 1,219,094 -- --
Convertible preferred stock -- 1,978,240 -- --
Nonvested employee stock -- 559,307 -- --
Convertible debentures -- 2,500,000 -- --
----------- ----------- ----------- -----------
Denominator for diluted
earnings (loss) per share 16,531,580 20,116,007 18,382,826 14,622,209
=========== =========== =========== ===========
The following securities have been excluded from the dilutive
per share computation, as they are antidilutive:
Nine months ended Three months ended
September 30 September 30
2006 2005 2006 2005
----------------------- -----------------------
Stock options -- 1,916,275 -- 2,721,102
Warrants -- 50,457 -- 464,724
Convertible debt -- -- -- 2,500,000
Convertible preferred stock -- 610,738 -- 2,588,978
Nonvested employee stock -- 724,027 -- 1,283,334
As required by FAS 128, "Earnings per Share", cumulative
preferred stock dividends for the nine and three months ended
September 30, 2006 and 2005 were deducted from net income
(loss) 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.
On August 17, 2006, shareholders representing 98.2% of the
shares voting at a special meeting approved the proposed
merger with AcquisitionCo. The merger is subject to, among
other conditions, compliance with state and federal securities
laws and regulations, and regulatory approval. The transaction
is anticipated 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 September 27, 2006, the Company and AcquisitionCo., entered
into Amendment No. 1 to the merger agreement extending the
termination date of the merger agreement from October 31, 2006
to December 31, 2006. All other terms of the merger agreement
were unchanged.
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 continued to
serve as Chairman of the Board of the Company until he
resigned effective November 9, 2006 (See Note 13). 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.
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.
Due to the change in control provisions in the Separation
Agreement and Promissory Note, on July 17, 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, FMFG Ownership, Inc. 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, 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
New Lease Agreement - On September 22, 2006, the Company, as
tenant, and IPofA Water View, LLC, a Delaware limited
liability company, as landlord ("Landlord"), entered into a
Deed of Lease Agreement ("Lease") for general office space
consisting of approximately 29,800 useable square feet located
at 10 Highway 35, Red Bank, New Jersey ("Leased Premises").
The Company will use the Leased Premises as its corporate
headquarters and general office space for its business
operations. The Lease is for a term of ten years (120 months)
with a commencement date of September 22, 2006, however since
the Landlord was unable to give the Company possession on that
date, the commencement date will be adjusted to the date the
Company is given possession of the premises, and the
expiration date will be adjusted to reflect the term of the
Lease. Since the Leased Premises are scheduled to undergo
renovations, the actual commencement date is anticipated to be
during the second calendar quarter of 2007. Pursuant to the
Lease the rent will be $61,090.00 per month.
Landlord is an indirect wholly owned subsidiary of Edward H.
Okun, a private investor and controlling person of FMFG
Ownership, Inc. and FMFG AcquisitionCo, Inc.
Resignation of Board Members - In a letter agreement with the
New Jersey Bureau of Securities, Herbert Kurinsky and William
J. Kurinsky, each have agreed to resign from the Company's
Board of Directors. On November 9, 2006, the Company received
the written resignations from William J. Kurinsky and Herbert
Kurinsky, effective on November 8 and November 9, 2006,
respectively.
Separation Agreement - On November 14, 2006, the Company
entered into a separation agreement with Robert I.
Rabinowitz, the Company's executive vice president,
secretary and general counsel. Under the terms of the
agreement, Mr. Rabinowitz's employment contract will not
be renewed and will terminate effective January 31, 2007.
Pursuant to the terms of the separation agreement,
Mr. Rabinowitz will be provided with severance pay equal to
one year's base salary, and benefits for a period of one year
in accordance with the terms of his employment agreement. He
will also be paid an additional consideration for his
continued cooperation in providing assistance to the
Company in the transition of his responsibilities to
new personnel. The additional consideration is conditioned
upon the closing of the merger with FMFG AcquisitionCo.,
Inc. and Mr. Rabinowitz's full compliance with his
obligations under the separation agreement.
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
wholly owned subsidiary, First Montauk Securities Corp., ("FMSC") has operated
as a full service retail and institutional securities brokerage firm since 1987.
Since July 2000, FMSC 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 286 registered
representatives and services over 50,000 retail and institutional customers,
which comprise over $3.2 billion in customer assets. All of our 116 branch
office and satellite locations in 28 states are owned and operated by
affiliates; who are 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 Boston, MA, and Penson Financial Services Inc of Dallas,
TX, 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 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. 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.
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.
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).
On August 17, 2006, shareholders representing 98.2% of the shares
voting at a special meeting approved the proposed merger with AcquisitionCo. The
merger is subject to, among other conditions, compliance with state and federal
securities laws and regulations, and regulatory approval. The transaction is
anticipated 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 September 27, 2006, we and AcquisitionCo., entered into Amendment
No. 1 to the merger agreement extending the termination date of the merger
agreement from October 31, 2006 to December 31, 2006. All other terms of the
merger agreement were unchanged.
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. Both the Separation Agreement and Promissory Note
contained a change of control provision requiring the acceleration of certain
payments in the event of a change in control of the Company. 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, 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.
On September 22, 2006, we, as tenant, and IPofA Water View, LLC, a
Delaware limited liability company, as landlord ("Landlord"), entered into a
Deed of Lease Agreement ("Lease") for general office space consisting of
approximately 29,800 useable square feet located at 10 Highway 35, Red Bank, New
Jersey ("Leased Premises"). We will use the Leased Premises as our corporate
headquarters and general office space for our business operations. The Lease is
for a term of ten years (120 months) with a commencement date of September 22,
2006, however since the Landlord was unable to give us possession on that date,
the commencement date will be adjusted to the date we are given possession of
the premises, and the expiration date will be adjusted to reflect the term of
the Lease. Since the Leased Premises are scheduled to undergo renovations, the
actual commencement date is anticipated to be during the second calendar quarter
of 2007. Pursuant to the Lease the rent will be $61,090.00 per month.
Landlord is an indirect wholly owned subsidiary of Edward H. Okun, a
private investor and controlling person of FMFG Ownership, Inc. and FMFG
AcquisitionCo, Inc.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2006 Compared to Three Months Ended
September 30, 2005
Revenues by Source
The following provides a breakdown of total revenues by source for the
three-month periods ended September 30, 2006 and 2005 (in thousands of dollars).
Three Months Ended
-----------------------------------------------------------------
------------------------------ --- ------------------------------
September 30, 2006 September 30, 2005
------------------------------ ------------------------------
Amount % of Total Amount % of Total
Revenues Revenues
Commissions
Equities $ 4,223 37% $ 5,219 42%
Mutual Funds 1,320 12% 1,564 12%
Insurance 1,584 14% 1,073 8%
Alternative Products 946 8% 952 8%
Asset Management Fees 980 9% 766 7%
Fixed Income 29 1% 20 <1%
-------------- --------------- -------------- ---------------
-------------- --------------- -------------- ---------------
Total 9,082 81% 9,594 77%
Principal Transactions 834 7% 1,468 12%
Investment Banking 597 5% 395 3%
Interest and Other
Interest 588 5% 605 4%
Other 173 2% 462 4%
-------------- --------------- -------------- ---------------
-------------- --------------- -------------- ---------------
Total 761 7% 1,067 8%
-------------- --------------- -------------- ---------------
-------------- --------------- -------------- ---------------
Total revenues $ 11,274 100% $ 12,524 100%
============== =============== ============== ===============
Overview
Total revenues decreased $1.25 million, or 10%, for the three months
ended September 30, 2006 (the "2006 quarter"), to $11.3 million, compared to
$12.5 million for the three months ended September 30, 2005 (the "2005
quarter"). The decrease was primarily attributable to a reduction in commissions
from equity and principal transactions of $1.6 million and mutual fund
commissions of $243,000. These decreases were offset by increases in revenues
from insurance, asset management fees and investment banking revenues of
$927,000, inclusively. Other income decreased by $289,000 as a result of a
reduction in the recovery of receivables previously written off and unrealized
gains on marketable securities of $223,000.
Expenses decreased in the 2006 quarter by $1.75 million, or 15%,
compared to the 2005 quarter. There were reductions in all expenses categories,
most notably being the reduction in legal matters and related costs of $569,000
and commission expense of $457,000 in the 2006 quarter when compared to the 2005
quarter.
The net loss attributable to common stockholders for the 2006 quarter
decreased approximately $537,000 from a loss of $700,000, or ($.05) and ($.04)
per basic and diluted share, respectively, in the 2005 quarter to a loss of
$163,000, or ($.01) per basic and diluted share for the 2006 quarter.
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 $9.1 million compared to $9.6
million for the 2005 quarter, a decrease of approximately $500,000. Commissions
from the sale of equities and mutual funds decreased $996,000 and $244,000,
respectively, when compared to the 2005 quarter. On the other hand, commissions
from insurance products and asset management fees increased approximately
$511,000, or 48%, and $214,000, or 28%, respectively in the 2006 quarter.
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 $634,000, or 43%, from $1.5 million for the
2005 quarter to $834,000 for the 2006 quarter. This decrease highlights the
change that our business mix has been going through over the last several years,
moving primarily from transactional to more fee based in nature.
Investment Banking
Investment banking revenues for the 2006 quarter increased $202,000
from $395,000 in the 2005 quarter, to $597,000 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.
Interest and Other Income
Interest and other income for the 2006 quarter totaled $761,000, as
compared to $1.07 million for the 2005 quarter, a decrease of $306,000. Other
income, which includes the recovery of receivables previously written off and
unrealized gains on marketable securities, decreased by $223,000 when compared
to the 2005 quarter.
Commissions, Employee Compensation and Benefits
Commission expense, consistently the largest expense category and
directly related to commission revenue, decreased 5%, or $457,000, from $8.67
million for the 2005 quarter, to $8.21 million for the 2006 quarter.
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 $1.38 million (12% of total revenues) from $1.63 million (13%
of total revenues), a reduction of approximately $247,000 over the 2005 quarter.
Salaries, bonuses accruals and payroll taxes decreased by approximately
$120,000, from $1.38 million for the 2005 quarter, to $1.26 million for the 2006
quarter. Stock and option compensation costs decreased approximately $122,000
for the 2006 quarter as compared to the 2005 quarter.
Clearing and Floor Brokerage
Clearing and floor brokerage costs which are greatly affected by volume
and type of transactions, decreased $206,000 in the 2006 quarter when compared
to the 2005 quarter. As a result of the amendment to our clearing agreement in
June 2006, clearing costs, as a percentage of transaction-based commissions,
decreased from 7.8% in the 2005 period to 6.7% in the 2006 quarter. Clearing
costs, as a percentage of gross revenues, fluctuate depending upon the product
mix.
Communications and Occupancy
Communications and occupancy costs decreased $96,000, from $583,000 in
the 2005 quarter to $487,000 in the 2006 quarter primarily due to a reduction
in quote services of approximately $93,000.
Legal matters and related costs
Legal matters and related settlement costs decreased $569,000, from
$729,000 during the 2005 quarter to $160,000 for the 2006 quarter. Legal fees
during the 2006 quarter decreased $269,000. During the 2005 quarter, we expensed
$245,000 related to the proposed merger with Olympic Cascade, which was
terminated in October 2005. These fees were previously deferred and carried as
other assets on our statement of financial condition. Settlement costs decreased
by $300,000 for the 2006 quarter when compared to the 2005 quarter. During the
2005 quarter we reserved for six legal claims totaling in excess of $180,000
compared to no claims during the 2006 quarter
Other Operating Expenses
Other operating costs decreased approximately $148,000, to $762,000 in
the 2006 quarter from $910,000 during the 2005 quarter. The largest decreases in
other operating expenses during the 2006 quarter were for consulting fees of
$76,000, accounting fees of $69,000 and depreciation of $33,000.
Nine Months Ended September 30, 2006 Compared to Nine Months Ended
September 30, 2005
Revenues by Source
The following provides a breakdown of total revenues by source for the
nine-month periods ended September 30, 2006 and 2005 (in thousands of dollars).
Nine Months Ended
-----------------------------------------------------------------
------------------------------ --- ------------------------------
September 30, 2006 September 30, 2005
------------------------------ ------------------------------
Amount % of Total Amount % of Total
Revenues Revenues
Commissions
Equities $ 14,987 39% $ 15,325 34%
Mutual Funds 4,531 12% 4,821 11%
Insurance 3,774 10% 3,402 8%
Alternative Products 3,201 8% 2,083 5%
Asset Management Fees 2,884 8% 2,409 5%
Fixed Income 132 <1% 91 <1%
-------------- --------------- -------------- ---------------
Total 29,509 76% 28,131 63%
Principal Transactions 3,319 9% 4,375 10%
Investment Banking 2,914 8% 4,221 9%
Interest and Other
Interest 1,915 5% 1,936 4%
Deferred revenue -- -- 5,105 12%
Other 535 1% 903 2%
-------------- --------------- -------------- ---------------
Total 2,450 6% 7,944 18%
-------------- --------------- -------------- ---------------
Total revenues $ 38,192 100% $ 44,671 100%
============== =============== ============== ===============
Overview
Overall, revenues decreased $6.5 million, or 15%, for the nine months
ended September 30, 2006 (the "2006 period"), to $38.2 million, compared to
$44.7 million for the nine months ended September 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 $1.4 million while revenues from principal transactions and
investment banking decreased by $1.05 million and $1.31 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. This was as a result of an amendment to Exhibit A of the clearing
agreement signed by our wholly owned subsidiary, First Montauk Securities Corp.
("FMSC") on June 29, 2006. 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 $1.04
million, or 3%, compared to the same period in 2005.
Expenses in the 2006 period decreased by approximately $3.5 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 $2.68 million during the 2006
period, when compared to the 2005 period, a decrease of 6%. Included in the 2006
decrease is a reduction in executive separation costs of $482,000, clearing
costs of $480,000, communications and occupancy of $374,000, legal matters and
related costs of $272,000 and other operating expenses of $546,000.
Net loss applicable to shareholders in the 2006 period was ($238,000),
or ($0.01) per basic and diluted share, compared to net income of $2.6 million,
or $0.19 and $0.14 per basic and diluted shares, respectively, for the 2005
period.
Commission Revenue
Commission revenue for the nine months ended September 30, 2006
increased $1.4 million to $29.5 from $28.1 million in the same period in 2005.
Although agency and mutual fund commissions declined by $518,000, revenues from
alternative investments, which includes sales of REIT's, 1031 exchanges and oil
& gas programs, as well as insurance and asset management fees, increased
overall by $1.96 million during the 2006 period.
Principal Transactions
Principal transactions decreased $1.06 million, or 24%, from $4.4
million for the 2005 period to $3.3 million for the 2006 period. Revenues from
all fixed income sources, which include municipal, government, and corporate
bonds and unit investment trusts decreased for the 2006 period by $704,000, from
$3.2 million in the 2005 period to $2.5 million in the 2006 period. Revenues
from riskless principal trades of equity securities decreased $419,000, from
$954,000 in the 2005 period to $535,000 in the 2006 period.
Investment Banking
Investment banking revenues for the 2006 period decreased $1.3 million,
or 31%, from $4.2 million in the 2005 period, to $2.9 million in the 2006
period. The decrease in investment banking revenues was primarily due to an
overall reduction in the number of closings of private offerings in 2006 when
compared to 2005. In 2005, however, we reported our highest investment banking
revenues, and although revenues decreased during the nine months ended September
30, 2006 when compared to the same period in 2005. The 2006 revenues are higher
than any other similar period reported prior to 2005.
Interest and Other Income
Interest and other income decreased $5.5 million during the 2006 period
when compared to the 2005 period. Other income in the 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
Commission expense decreased approximately $274,000, from $27.6 million
for the 2005 period to $27.3 million for the 2006 period. Compensation and
benefits expense for management, operations and clerical personnel decreased
$1.08 million in the 2006 period to $4.4 million compared to $5.5 million in the
2005 period. A reduction in officer bonus accruals and amortization of deferred
compensation from $1.04 million in the 2005 period to $283,000 in the 2006
period contributed to the decrease.
Executive Separation
During the 2005 period, we recorded compensation expense of
approximately $1.43 million in connection with a separation agreement with our
former CEO. This compares to $951,000 of recorded expense in connection with the
termination of an employment agreement with our former Chairman of the Board
during the 2006 period.
Clearing and Floor Brokerage
Clearing and floor brokerage costs decreased approximately $480,000,
from $1.6 million for the 2005 period, to $1.1 million 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 $64,000. 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 $374,000 during the 2006
period, from $1.74 million in the 2005 period to $1.37 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 decreased approximately
$272,000, from $1.04 million for the 2005 period to $772,000 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 $56,000. During the 2005 period,
we expensed $245,000 related to the proposed merger with Olympic Cascade, which
was terminated in October 2005. The 2006 period includes legal fees of $271,000
in connection with the anticipated acquisition of the Company by a private
investor.
Other Operating Expenses
Other operating costs decreased by approximately $546,000, to $2.3
million in the 2006 period, from $2.8 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, accounting,
consulting fees, depreciation, postage and liability insurance costs of $484,000
accounted for the majority of the decrease.
Liquidity and Capital Resources
We maintain a highly liquid balance sheet with approximately 79% 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 nine months
ended September 30, 2006 by $1.1 million. Net cash used in operating activities
during the 2006 period was $993,000, which consists of net loss of $112,000,
increased by non-cash charges including depreciation of $202,000, amortization
of deferred costs of $352,000 offset by the payment of a $200,000 note issued in
connection with a separation agreement. Cash was reduced by increases in due
from clearing firm, prepaid expenses and broker receivables of $506,000,
$257,000 and $108,000, respectively, and decreases in accrued expenses and
accounts payable of $629,000 and $75,000, respectively. Cash was increased by
reductions in commission's payable of $282,000 and other assets of $23,000 and a
decrease in other liabilities of $23,000.
Additions to property and equipment of $13,000 accounted for the use of
cash from investing activities during the nine months ended September 30, 2006.
Financing activities used net cash of $111,000 due to the payment of
preferred stock dividends of $126,000 and capital leases of $6,900 offset by
proceeds from option exercises of $22,000 during the first nine months of 2006.
During the first quarter of 2006, $30,000 of the Company's convertible
debentures was converted into shares of common stock, and in June 2006, FMFG
Ownership Inc. purchased $1,190,000 principal amount of debentures, from
holders, which were sold in privately negotiated transactions. Subsequently,
Ownership converted such debentures into 2,380,000 common shares. As of
September 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, 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 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 September 30, 2006 of
approximately $105,000, payable in one remaining monthly installment, including
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 September 30,
2006. This table does not include any projected payment amounts related to our
potential exposure to arbitrations and other legal matters.
As of September 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
$1,630 0 0 0 0 0 $ 1,630
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
Operating Lease
Obligations $264,114 $912,183 $659,057 $619,376 $50,762 0 $2,505,492
-------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- ----------
Total $265,744 $937,183 $659,057 $619,376 $50,762 0 $2,532,122
- -------------------------- ---------------- ----------------- ---------------- ---------------- -------------- --------- -----------
Net Capital
At September 30, 2006, Montauk Financial Group had net capital of
$2,982,589, which was $2,732,589 in excess of its required net capital of
$250,000, and the ratio of aggregate indebtedness to net capital was 1.13 to 1.
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%.
As of September 30, 2006, we have 305,369 Series A preferred shares
issued and outstanding. Quarterly dividends of $23,532 were paid during the
three months ended September 30, 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
September 2006.
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.
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 September 30, 2006 and
December 31, 2005, the balances of our securities positions owned, and sold, not
yet purchased were approximately $293,000 and $5,000, 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 September 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 quarter ended September 30, 2006, that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
PART II
OTHER INFORMATION
Item 1. Legal proceedings
On September 29, 2006, FMSC entered into a Consent Order with the New
Jersey Bureau of Securities relating to an investigation into FMSC's sale of
certain high yield bonds to it's clients from 1998 to 2001, and the subsequent
resale of those securities to other customers in 2001. As a result, FMSC paid
a civil monetary penalty of $475,000 on September 29, 2006,
and agreed to retain an independent consultant to review FMSC's business
practices and procedures for branch office supervision, suitability standards,
and monitoring of agent sales activities.
Item 1A. Risk Factors
Refer to December 31, 2005 Form 10-K.
Item 2. Unregistered Sales of Equity Securities
(a) Not applicable.
(b) Not applicable.
(c) Not applicable.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. Other Information
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.
On August 17, 2006, shareholders representing 98.2% of the shares voting
at a special meeting approved the proposed merger with AcquisitionCo. The merger
is subject to, among other conditions, compliance with state and federal
securities laws and regulations, and regulatory approval. The transaction is
anticipated 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 September 27, 2006, the Company and AcquisitionCo., entered into
Amendment No. 1 to the merger agreement extending the termination date of the
merger agreement from October 31, 2006 to December 31, 2006. All other terms of
the merger agreement were unchanged.
On November 14, 2006, we entered into a separation agreement with
Robert I. Rabinowitz, Executive Vice President and General Counsel, effective
January 31, 2007.
Change in Control
During June 2006, FMFG Ownership, Inc. 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).
Item 6. Exhibits
The exhibits designated with an asterisk (*) are filed herewith. All
other exhibits have been previously filed with the Commission and, pursuant to
17 C.F.R. ss. 230.411, are incorporated by reference to the document referenced
in brackets following the description of such exhibits.
- ----------------- ----------------------------------------------------------------------------------------------------
10.1 Form of Deed of Lease Agreement dated as of September 22, 2006 between IPofA Water View, LLC
and First Montauk Financial Corp. (Filed as Exhibit 10.1 to the Form 8-K dated
September 26, 2006)
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
2.01 Amendment No. 1, dated as of September 25, 2006, to the Agreement and Plan of Merger, by and among
First Montauk Financial Corp., FMFG Ownership, Inc. and FMFG AcquisitionCo, Inc. (Filed as Exhibit
2.01 to the Form 8-K dated September 28, 2006)
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
*10.2 Agreement and Release dated November 14, 2006 between First Montauk Financial Corp. and
Robert I. Rabinowitz
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
*31.1 Certification of President and Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
*31.2 Certification of Acting Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
*32.1 Certification of President and Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
*32.2 Certification of Acting Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
- ----------------- ----------------------------------------------------------------------------------------------------
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: November 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