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 JUNE 30, 2007
|_| 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: 13,254,248 shares of Common
Stock were outstanding at August 14, 2007.
FIRST MONTAUK FINANCIAL CORP.
FORM 10-Q
June 30, 2007
INDEX
Page
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Condensed Consolidated Statements of Financial Condition as of
June 30, 2007 (unaudited) and December 31, 2006 .................................. F-1
Condensed Consolidated Statements of Operations for the Six Months and
Three Months Ended June 30, 2007 (unaudited) and 2006 (unaudited)................. F-2
Condensed Consolidated Statements of Changes in Stockholders' Equity
for the period from January 1, 2006 to June 30, 2007 (unaudited)............. F-3 - F-4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2007 (unaudited) and 2006 (unaudited) .................................... F-5
Notes to Condensed Consolidated Financial Statements .............................. 6-19
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ...................................... 20-27
Item 3. Risk Management ............................................................ 28-30
Item 4. Controls and Procedures ..................................................... 30
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings ........................................................... 31
Item 1A. Risk Factors ................................................................ 31
Item 2. Unregistered Sales of Equity Securities .................................... 31
Item 3. Defaults Upon Senior Securities ............................................ 31
Item 4. Submission of Matters to a Vote of Security Holders ........................ 31
Item 5. Other Information .......................................................... 32
Item 6. Exhibits ................................................................... 33
Signatures .......................................................................... 34
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, December 31,
2007 2006
(unaudited) (restated)
ASSETS
Cash and cash equivalents $ 430,655 $ 1,145,751
Due from clearing firm 3,745,445 4,988,747
Securities owned, at market value 284,776 198,447
Prepaid expenses 722,565 285,480
Employee and broker receivables - net of reserve for bad debt
of $783,122 and $807,536 respectively 313,275 343,491
Property and equipment - net 178,999 239,033
Other assets 1,424,145 597,968
------------------- -------------------
Total assets $ 7,099,860 $ 7,798,917
==================== ===================
LIABILITIES
Accounts payable $ 1,375,318 $ 313,427
Accrued expenses 759,938 1,195,426
Income taxes payable 12,000 4,167
Commissions payable 2,217,862 2,378,935
Securities sold, not yet purchased, at market value 11 495
6% convertible debentures 25,000 25,000
Capital leases payable - 820
Other liabilities 52,577 67,156
-------------------- -------------------
Total liabilities 4,442,706 3,985,426
-------------------- -------------------
Commitments and contingencies
Series B convertible redeemable preferred stock, 445,102 shares authorized,
$.10 par value, 0 and 197,824 shares issued and outstanding, respectively
liquidation preference: $0 and $1,000,000, respectively - 1,000,000
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
22,282 and 305,369 shares issued and outstanding, respectively;
liquidation preference: $111,410 and $1,526,845, respectively 2,228 30,537
Common stock, no par value, 60,000,000 shares authorized,
13,254,248 and 18,526,553 shares issued and outstanding, respectively 9,627,127 11,646,620
Additional paid-in capital 4,035,064 950,592
Accumulated deficit (11,007,265) (9,814,258)
------------------- -------------------
Total stockholders' equity 2,657,154 2,813,491
------------------- -------------------
Total liabilities and stockholders' equity $ 7,099,860 $ 7,798,917
==================== ===================
See notes to condensed consolidated financial statements.
F-1
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Six Months Ended June 30, Three Months Ended June 30,
2007 2006 2007 2006
(unaudited) (unaudited) (unaudited) (unaudited)
Revenues:
Commissions $17,233,155 $20,427,390 $8,406,159 $9,904,625
Principal transactions 954,976 2,484,800 360,560 1,120,246
Investment banking 2,479,420 2,317,234 468,932 1,571,673
Interest and other income 1,522,131 1,688,306 709,414 1,009,164
------------- ------------ ----------- ------------
Total revenue 22,189,682 26,917,730 9,945,065 13,605,708
------------- ------------ ----------- ------------
Expenses:
Commissions, employee compensation and benefits 19,226,882 22,120,306 8,478,812 11,040,703
Executive separation - 951,266 - -
Clearing and floor brokerage 799,553 695,779 391,993 (3,156)
Communications and occupancy 834,544 883,293 410,778 345,485
Legal matters and related costs 984,251 612,551 553,707 414,048
Other operating expenses 1,423,214 1,534,775 685,692 699,886
Interest 12,843 66,746 8,761 32,795
------------- ------------ ----------- -------------
Total expenses 23,281,287 26,864,716 10,529,743 12,529,761
Income (loss) before income taxes (1,091,605) 53,014 (584,678) 1,075,947
Provision for income taxes 15,599 45,061 4,978 24,200
------------- ------------ ----------- --------------
Net income (loss) (1,107,204) 7,953 (589,656) 1,051,747
Preferred stock dividends (85,803) (85,641) (42,900) (42,866)
------------- ------------- ----------- --------------
Net income (loss) applicable to common stockholders $ (1,193,007) $ (77,688) $(632,556) $1,008,881
================= ============= =========== ==============
Income (loss) per share:
Basic $ (0.07) $ - $ (0.04) $ 0.06
Diluted $ (0.07) $ - $ (0.04) $ 0.05
Weighted average number of shares of stock outstanding:
Basic 18,063,724 15,594,185 17,648,721 15,842,628
Diluted 18,063,724 15,594,185 17,648,721 19,363,508
See notes to condensed consolidated financial statements.
F-2
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2006 (RESTATED) AND THE SIX MONTHS ENDED JUNE 30, 2007 (UNAUDITED)
Series A Convertible Series B Convertible Additional
Preferred Stock Preferred Stock (Restated) Common Stock Paid-in
Shares Amount Shares Amount Shares Amount Capital
Balances at January 1, 2006, as
previously reported 305,369 $30,537 197,824 $ 19,782 15,937,407 $10,444,110 $ 1,930,810
Restatement to reclassify Series B
stock as temporary equity (197,824) (19,782) (980,218)
-------------------- --------------------- ------------------------- ----------
Balances at January 1, 2006, as restated 305,369 30,537 - - 15,937,407 10,444,110 950,592
Increase in deferred compensation (76,266)
Amortization of deferred compensation
Reclass to common stock (39,546)
Exercise of incentive stock options 68,800 33,504
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 December 31, 2006 305,369 30,537 - - 18,526,553 11,646,620 950,592
Amortization of deferred compensation 36,670
Payment of preferred stock dividends
Redemption of preferred A stock (1,629,549) 1,629,549
Cancellation of preferred A stock (283,087) 1,601,240 (1,601,240)
Cancellation of preferred B stock 1,000,000
Cancellation of common stock (5,272,305) (2,056,163) 2,056,163
Net loss for the period
-------------------- --------------------- ------------------------- ----------
Balances at June 30, 2007 22,282 $2,228 - $ - 13,254,248 $9,627,127 $ 4,035,064
==================== ===================== ========================= ==========
See notes to condensed consolidated financial statements.
F-3
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2006 (RESTATED) AND THE SIX MONTHS ENDED JUNE 30, 2007 (UNAUDITED)
(Accumulated Deferred Stockholders'
Deficit) Compensation Equity
Balances at January 1, 2006, as previously reported $ (8,809,203) $ (388,185) $3,227,851
Restatement to reclassify Series B stock
as temporary equity (1,000,000)
------------------ ---------------- -------------------
Balances at January 1, 2006, as restated (8,809,203) (388,185) 2,227,851
Increase in deferred compensation 76,266 -
Amortization of deferred compensation 272,373 272,373
Reclass to common stock 39,546 -
Exercise of incentive stock options 33,504
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 (168,506) (168,506)
Net loss for the period (836,549) (836,549)
------------------ ---------------- -------------------
Balances at December 31, 2006 (9,814,258) - 2,813,491
Amortization of deferred compensation 36,670
Payment of preferred stock dividends (85,803) (85,803)
Cancellation of preferred A stock
Cancellation of preferred B stock 1,000,000
Cancellation of common stock
Net loss for the period (1,107,204) (1,107,204)
------------------ ---------------- -------------------
Balances at June 30, 2007 $ (11,007,265) $ - $2,657,154
================== ================ ===================
See notes to condensed consolidated financial statements.
F-4
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30,
2007 2006
(unaudited) (unaudited)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (1,107,204) $ 7,953
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation of property and equipment 71,947 151,260
Amortization of stock compensation and deferred costs 36,670 332,178
Note payable issued in connection with separation agreement - 295,547
Increase (decrease) in cash attributable to changes in assets
and liabilities:
Due from clearing firm 1,243,302 (37,613)
Securities owned (86,329) (171,220)
Prepaid expenses (437,085) (684,368)
Employee and broker receivables 30,216 57,913
Other assets (826,177) 119,851
Accounts payable 1,061,891 244,282
Accrued expenses (435,488) (221,495)
Income taxes payable 7,833 3,000
Commissions payable (161,073) (246,164)
Securities sold, not yet purchased (484) 5,362
Other liabilities (14,579) 69,139
-------------- ----------------
NET CASH USED IN OPERATING ACTIVITIES (616,560) (74,375)
-------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (11,913) (5,307)
-------------- ----------------
NET CASH USED IN INVESTING ACTIVITIES (11,913) (5,307)
-------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of capital lease (820) (4,543)
Proceeds from exercise of incentive stock option - 11,034
Payment of preferred stock dividends (85,803) (85,641)
-------------- ----------------
NET CASH USED IN FINANCING ACTIVITIES (86,623) (79,150)
-------------- ----------------
Net decrease in cash and cash equivalents (715,096) (158,832)
Cash and cash equivalents at beginning of period 1,145,751 1,990,815
-------------- ----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 430,655 $ 1,831,983
============== ================
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 12,843 $ 63,176
============== ================
Income taxes $ 8,361 $ 108,644
============== ================
Noncash investing and financing activities:
Proceeds from exercise of warrants $ - $ 22,211
6% convertible debentures converted into common stock $ - $ 1,225,000
Cancellation and Redemption of Preferred A stock $ 28,309 $ -
Cancellation of Preferred B Stock $ 1,000,000 $ -
Cancellation of Common stock $ 2,056,199 $ -
See notes to condensed consolidated financial statements.
F-5
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The interim financial information as of June 30, 2007 and for
the six-month and three-month periods ended June 30, 2007 and
June 30, 2006 has been prepared without audit, in accordance
with accounting principles generally accepted in the United
States of America and pursuant to the interim financial
statements 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 in the United States of America 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 condensed consolidated
financial statements should be read in conjunction with
management's discussion and analysis of financial condition
and results of operations ("MD&A") included elsewhere in this
report on Form 10-Q and the Company's Annual Report on Form
10-K/A for the fiscal year ended December 31, 2006, previously
filed with the SEC on May 4, 2007.
In the opinion of management, all adjustments (which include
normal recurring adjustments) necessary to present a fair
statement of financial position as of June 30, 2007, and
results of operations for the six months and three months
ended June 30, 2007 and 2006, cash flows for the six months
ended June 30, 2007 and 2006 and changes in stockholders'
equity for the six months ended June 30, 2007, as applicable,
have been made. The results of operations for the six and
three months ended June 30, 2007 are not necessarily
indicative of the operating results for the full fiscal year
or any future periods.
The condensed consolidated statement of financial condition
for December 31, 2006 has been restated. The restatement
reflects a change in the accounting for the Series B
redeemable preferred stock from stockholder's equity to
temporary equity resulting from a redemption feature in the
Series B that was not in the control of the Company. The
result of the restatement was the reduction of stockholders'
equity at December 31, 2006 by $1 million and an increase in
temporary equity of $1 million. In June 2007, the Series B
preferred stock was surrendered by its owner and cancelled by
the Company resulting in an increase in paid-in capital by the
$1 million temporary equity.
We believe that our cash resources will be sufficient to meet
our minimum planned operating needs for the next 6 months.
Beyond that period, management has other plans for increasing
cash flow, including pursuing additional financing and
reductions in overhead costs. Although we have plans to pursue
additional financing, there can be no assurance that we will
be able to secure financing when needed or obtain such
financing on terms satisfactory to us, if at all, or that any
additional funding we do obtain will be sufficient to meet our
needs in the long term. If additional funding cannot be
obtained, we will review alternative courses of action to
conserve our cash flow.
6
NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENTS
Financial Accounting Standards Board (FASB) No. 48,
Accounting for Uncertainty in Income Taxes ("FIN 48")
-----------------------------------------------------
In June 2006, the Financial Accounting Standards Board (FASB)
issued FASB Interpretation No. 48, Accounting for Uncertainty
in Income Taxes--an interpretation of FASB Statement No. 109
(FIN 48), which provides clarification related to the process
associated with accounting for uncertain tax positions
recognized in consolidated financial statements. FIN 48
prescribes a more-likely-than-not threshold for financial
statement recognition and measurement of a tax position taken,
or expected to be taken, in a tax return. FIN 48 also provides
guidance related to, among other things, classification,
accounting for interest and penalties associated with tax
positions, and disclosure requirements. We are required to,
and have adopted FIN 48 effective January 1, 2007 and there is
no impact of adopting FIN 48 on our condensed consolidated
financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair
Value Option for Financial Assets and Financial Liabilities",
which permits entities to measure many financial instruments
and certain other items at fair value that are not currently
required to be measured at fair value. An entity would report
unrealized gains and losses on items for which the fair value
option has been elected in earnings at each subsequent
reporting date. The objective is to improve financial
reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to
apply complex hedge accounting provisions. The decision about
whether to elect the fair value option is applied instrument
by instrument, with a few exceptions; the decision is
irrevocable; and it is applied only to entire instruments and
not to portions of instruments. SFAS No. 159 requires
disclosures that facilitate comparisons (a) between entities
that choose different measurement attributes for similar
assets and liabilities and (b) between assets and liabilities
in the financial statements of an entity that selects
different measurement attributes for similar assets and
liabilities. SFAS No. 159 is effective for financial
statements issued for fiscal years beginning after November
15, 2007. Upon implementations, an entity shall report the
effect of the first remeasurement to fair value as a
cumulative effect adjustment to the opening balance of
retained earnings. Since the provisions of SFAS No. 159 are
applied prospectively, any potential impact will depend on the
instruments selected for fair value measurement at the time of
implementation. The Company is currently evaluating the impact
of adopting this pronouncement on our condensed consolidated
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.
7
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.
This Plan provides for accelerated vesting if there is a
change in control as defined in the plan. All shares had been
fully vested prior to the change in control due to the Okun
transaction (See Note 7).
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.
8
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 six and three month periods ended June 30,
2007 includes share-based compensation expense for employee
options and shares totaling approximately $5,373 and $1,023,
respectively. The Company's results for the six and three
month periods ended June 30, 2006 includes share-based
compensation expense for employee options and shares totaling
approximately $213,000 and $114,000, respectively. Such
amounts have been included in the condensed 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.
Employee stock option compensation expense in 2007 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
approximately $31,297 and $(1,959) for the six and three
month periods ended June 30, 2007 compared to approximately
$50,000 and $13,000 for the six and three month periods ended
June 30, 2006. These amounts are included in the condensed
consolidated statements of operations within commissions,
employee compensation and benefits.
The fair value of options at the date of grant was estimated
using the Black-Scholes option pricing model. During 2007, 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.
9
The assumptions made in calculating the fair values of all
options are as follows:
--------------- ----------------------------- ----------------------------------
Six Months Ended Three Months Ended
--------------- ----------------------------- ----------------------------------
--------------- -------------- -------------- ----------------- ----------------
June 30, 2007 June 30, 2006 June 30, 2007 June 30, 2006
--------------- -------------- -------------- ----------------- ----------------
--------------- -------------- -------------- ----------------- ----------------
Expected 69% 68% 69% 68%
volatility
--------------- -------------- -------------- ----------------- ----------------
--------------- -------------- -------------- ----------------- ----------------
Expected
dividend yield 0% 0% 0% 0%
--------------- -------------- -------------- ----------------- ----------------
--------------- -------------- -------------- ----------------- ----------------
Risk-free
interest rate 3.71%-5.05% 3.71%-5.10% 3.71%-5.05% 3.71%-5.10%
--------------- -------------- -------------- ----------------- ----------------
--------------- -------------- -------------- ----------------- ----------------
Expected term
(in years) 1-5 years 1-5 years 1-5 years 1-5 years
--------------- -------------- -------------- ----------------- ----------------
The following table represents all of our stock options
granted, exercised and forfeited/expired during the first six
months of 2007.
----------------------------- -------------- ------------------ --------------------- ------------------
Weighted Average Weighted Average
Number Exercise Price Remaining Aggregate
Stock Options of Shares per Share Contractual Term Intrinsic Value
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Outstanding at
January 1, 2007 2,137,402 $0.79 2.5 92,954
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Granted 278,000 $0.59
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Exercised - -
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Forfeited/expired (448,002) $0.74
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Outstanding at 1,967,400 $0.77 2.6 9,464
June 30, 2007
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Exercisable at
June 30, 2007 1,620,600 $0.78 2.4 9,350
----------------------------- -------------- ------------------ --------------------- ------------------
The weighted-average grant date fair value of all share
options granted during the six months ended June 30, 2007 and
2006 was $0.21 and $0.59, respectively. The intrinsic value
of all stock options exercised during the first six months of
2007 and 2006 was $0 and $55,000, respectively. Cash received
from the exercise of all stock options in the first six
months of 2007 and 2006 was $0 and $11,034, respectively.
10
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 six months
ended June 30, 2007:
----------------------------------- -------------------------------- -----------------------------
Weighted-Average
Grant-Date
Nonvested Shares Shares Fair Value
----------------------------------- -------------------------------- -----------------------------
----------------------------------- -------------------------------- -----------------------------
Nonvested January 1, 2007 100,000 $0.57
----------------------------------- -------------------------------- -----------------------------
----------------------------------- -------------------------------- -----------------------------
Granted -- --
----------------------------------- -------------------------------- -----------------------------
----------------------------------- -------------------------------- -----------------------------
Vested (100,000) $0.57
----------------------------------- -------------------------------- -----------------------------
----------------------------------- -------------------------------- -----------------------------
Forfeited -- --
----------------------------------- -------------------------------- -----------------------------
----------------------------------- -------------------------------- -----------------------------
Nonvested June 30, 2007 -- --
----------------------------------- -------------------------------- -----------------------------
The total fair value of shares vested during the six months
ended June 30, 2007 and 2006, was $51,000 and $825,000,
respectively.
NOTE 4 - PREPAID EXPENSES
Prepaid expenses at June 30, 2007 include a payment for errors
and omissions insurance coverage. The unamortized amount at
June 30, 2007 is $435,000, which will be written off over the
next seven months.
NOTE 5 - OTHER ASSETS
Other assets include receivables due from vendors for
insurance and mutual funds commissions of $335,000, deposits
of $395,000 and a receivable of $600,000 based upon a
negotiated settlement with our insurance carrier.
NOTE 6 - ACCOUNTS PAYABLE
Accounts payable at June 30, 2007 includes an insurance
premium financing agreement with a current balance of
$368,000, payable in five remaining monthly installments of
$74,781 each, including interest at the rate of 5.87% per
annum, legal fees due of $522,000 and an amount owed for the
Company's annual conference of $111,000.
NOTE 7 - DEFINITIVE MERGER AGREEMENT
On May 5, 2006, the Company entered into a definitive merger
agreement with FMFG Ownership, Inc. and FMFG AcquisitionCo,
Inc., (collectively referred to as the "Okun Purchasers")
which are wholly-owned by Mr. Edward H. Okun. Mr. Okun is the
controlling person of Investment Properties of America, LLC
("IPofA"), a privately owned, diversified real estate
investment and management company. Pursuant to the merger
agreement, the Okun Purchasers were to purchase all of the
Company's outstanding securities for an aggregate purchase
price of $23 million, or $1.00 in cash per common share, $2.00
in cash per Series A Preferred Stock (convertible into two
shares of common stock), and $10.00 in cash per share of
Series B Preferred Stock (convertible into ten shares of
common stock).
11
In June 2006, the Okun Purchasers purchased in the open market
and privately negotiated transactions, 2,159,348 shares of the
Company's common stock, and in privately negotiated
transactions, 283,087 shares of Series A Preferred Stock at a
price of $4.00 per share (convertible into 566,174 shares of
the Company's common stock) and $1,190,000 principal amount of
the Company's convertible debentures (convertible into
2,380,000 shares of the Company's common stock).
On June 20 and 23, 2006, the Okun Purchasers converted the
$1,190,000 principal amount of the convertible debentures into
2,380,000 shares of the Company's common stock. As a result of
these purchases and conversions, the Okun Purchasers
beneficially owned 24.6% of the Company's common stock
(assuming none of the shares of Series A Preferred Stock were
converted into common stock).
On August 17, 2006, the Company's shareholders (including the
Okun Purchasers) voted at a special meeting of shareholders to
approve the merger agreement and the merger. At the meeting,
the Okun Purchasers voted all of the Company's shares
beneficially owned by them in favor of the merger agreement
and the merger.
Subsequently, the deadline for completing the merger was
extended from October 31, 2006 to December 31, 2006 in order
to allow the parties to fulfill certain conditions to the
merger, including obtaining the necessary consent of the NASD.
On December 29, 2006, the Company received notification from
representatives of the Okun Purchasers that they were
terminating the merger agreement and not proceeding with the
merger. They alleged the Company's failure to satisfy
conditions and the Company's alleged breach of various
representations, warranties, covenants and agreements in the
merger agreement (See Note 8-Legal Matters-Termination of
Merger Agreement; Litigation and Settlement).
NOTE 8 - COMMITMENTS AND CONTINGENCIES
Operating Leases:
The Company leases office facilities and equipment under
operating leases expiring at various dates through 2010.
Certain leases require the Company to pay increases in real
estate taxes, operating costs and repairs over certain base
year amounts.
Future minimum rental commitments under all non-cancelable
leases with terms greater than one year are as follows:
Year ending December 31,
2007 $ 430,903
2008 690,496
2009 648,337
2010 50,762
2011 and beyond --
--------
$ 1,820,498
=========
12
Master Services Agreement:
Effective November 2006, the Company entered into a master
services agreement with an outside entity for development of
certain software, data integration and business processing
improvement consulting services. The term of the agreement is
for a minimum of 3 years and under the agreement the Company
will pay $480,000 over an initial 12 month period and then
$20,000 a month thereafter.
Employment Agreements:
In January 2007, First Montauk Securities Corp. ("FMSC"), the
Company's broker-dealer subsidiary, entered into an employment
agreement with a new Executive Vice President, Secretary and
General Counsel which provides him with a base salary of
$200,000 per year through December 31, 2008 and bonuses of
$100,000 per year through December 31, 2008, provided he is
still employed by the Company at the end of each year.
As of May 9, 2007, the Company and Victor K. Kurylak,
President and Chief Executive Officer of the Company, executed
an Amended and Restated Employment Agreement ("Amended
Employment Agreement"). The Amended Employment Agreement was
executed in connection with the execution of the May
Settlement Agreement. Pursuant to the Amended Employment
Agreement, Mr. Kurylak was to continue his employment with the
Company as President. Mr. Kurylak was to resign, however,
from the position of Chief Executive Officer of the Company in
connection with the May Settlement Agreement upon appointment
of his successor and execution by his successor of an
employment agreement with the Company. However, since the
May Settlement Agreement was vacated and set aside,
Mr. Kurylak's resignation was not accepted and thus cancelled.
On June 15, 2007, the Company and Mr. Kurylak executed an
Amendment Number One to the Amended and Restated Employment
Agreement ("Amendment to Amended Employment Agreement") to
correctly state that Mr. Kurylak is employed in the capacity
of President and Chief Executive Officer of both the Company
and FMSC.
The Amended Employment Agreement will expire on December 31,
2007 ("Term"), subject to renewal for one additional period of
one year unless the Company provides written notice of its
intention not to renew the Amended Employment Agreement at
least 120 days prior to December 31, 2007. During the term of
the Amended Employment Agreement, Mr. Kurylak will be
compensated at the rate of $300,000 on an annualized basis.
He is eligible for customary fringe benefits and to
participate in the Company's executive bonus pool.
13
In the event of the termination of Mr. Kurylak's employment by
the Company without "cause" or by Mr. Kurylak for "good
reason" as these terms are defined in the Amended Employment
Agreement, he would be entitled to: (a) all compensation
accrued but not paid as of the termination date; (b) base
salary for the remainder of the Term; (c) a severance payment
equal to $300,000 payable in a lump sum payment; (d) continued
participation in the Company's benefit plans (or comparable
plans); and (e) any applicable bonus. If Mr. Kurylak's
employment is terminated by the Company for "cause" or by him
without "good reason", he will be entitled only to accrued
compensation. If termination of the Amended Employment
Agreement occurs as a result of the expiration of such
agreement without renewal by the Company at the end of the
Term, Mr. Kurylak will be entitled to the accrued
compensation, any applicable bonus and the severance payment.
In the event Mr. Kurylak is a member of the board of directors
of the Company on the termination date, the payment of any and
all compensation due under the Amended Employment Agreement,
except the accrued compensation, is expressly conditioned on
Mr. Kurylak's resignation from the board of directors of the
Company within five (5) business of the termination date.
The Amended Employment Agreement contains confidentiality
obligations that survive indefinitely and non-solicitation and
non-competition obligations that end on the first anniversary
of the date of cessation of Mr. Kurylak's employment.
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 condensed 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.
14
SEC Investigation
The SEC is investigating whether FMSC, and/or certain former
employees failed reasonably to supervise the securities
trading and research activities of a former analyst. The
investigation covered the time period from approximately March
2000 until January 2004 when the analyst resigned. The SEC has
recently advised us that it intends to recommend bringing an
enforcement proceeding against FMSC, one of its former
principals and another former employee for failing to
supervise reasonably. The SEC will be seeking a monetary
penalty and an order suspending the former principal from
acting in a supervisory capacity for a period of time. FMSC is
entitled to make a Wells submission to the SEC Staff and
intends to make such a submission or otherwise attempt to
negotiate a resolution with the SEC. FMSC is currently engaged
in a process of negotiating a resolution to this matter with
the SEC Staff but it is too early in such process to determine
what the ultimate resolution may be. The Company believes that
any resolution may include a monetary penalty that could have
a materially adverse effect on our financial condition.
NASD Enforcement Sales Practice Investigation
The NASD Department of Enforcement is conducting an
investigation of the sales practice activities of certain
individuals who were formerly registered representatives of
FMSC, as well as the supervision of those activities by FMSC.
On April 9, 2007, NASD notified FMSC through a "Wells call"
that it intends to file an administrative action against it in
connection with an alleged failure to reasonably supervise the
activities of three former registered representatives of FMSC.
NASD has indicated that it will be seeking a monetary penalty
and certain undertakings by FMSC. FMSC is entitled to make a
Wells submission to the NASD Staff and currently intends to
make such a submission or otherwise attempt to negotiate a
resolution with NASD. FMSC is currently engaged a process of
negotiating a resolution to this matter with the NASD Staff
but it is too early in such process to determine what the
ultimate resolution may be. The Company believes that any
resolution may include a monetary penalty that could have a
materially adverse effect on our financial condition.
Termination of Merger Agreement; Litigation and Settlement
On December 29, 2006, the Company received notification from
representatives of the Okun Purchasers that they were
terminating the merger agreement and not proceeding with the
merger. They alleged the Company's failure to satisfy
conditions and the Company's alleged breach of various
representations, warranties, covenants and agreements in the
merger agreement.
On January 8, 2007, the Company filed a lawsuit in the Supreme
Court of New Jersey, Monmouth County, Chancery Division
against the Okun Purchasers, Mr. Okun, IPofA and several other
affiliated entities which Mr. Okun controls (collectively, the
"Okun Defendants"). The purpose of this lawsuit was to enforce
the terms of the merger pursuant to the merger agreement
executed on May 5, 2006. Pursuant to the merger agreement
shareholders of the Company's common stock would have received
$1.00 in cash for each share of common stock. The lawsuit
alleged, among other things, that the Okun Purchasers breached
the merger agreement by terminating the agreement on December
29, 2006 without cause or justification. The Company's
complaint demanded specific performance of the merger
agreement and completion of the merger. In the alternative,
the Company sought compensatory damages for breach of contract
and breach of the covenant of good faith and fair dealing as
well as payment of $2 million held in escrow to secure the
performance of the Okun Purchasers under the merger agreement.
The lawsuit also sought to void the lease agreement that the
Company entered into with another Okun affiliate to relocate
the Company's corporate offices to a building purchased by
that Okun affiliate in Red Bank, NJ. The Company claimed that
the Okun Defendants fraudulently induced the Company to
execute this new lease by falsely representing that the Okun
Purchasers would consummate the merger.
15
On February 12, 2007, the Company received the Okun
Purchasers' answer to the lawsuit which contained several
counterclaims against it. In their counterclaims, the Okun
Purchasers alleged that the Company breached the merger
agreement and failed to disclose certain material facts about
the Company, and sought the return of $2 million held in
escrow as well as compensatory damages, interest and costs.
The Okun Purchasers filed two additional actions; one on
February 2, 2007, in the Circuit Court of the State of Florida
against the Company's President and Chief Executive Officer,
and the other, a shareholder derivative action in the Federal
District Court for the District of New Jersey against the
Company and certain of its directors and officers, filed on
February 16, 2007. The Company believes these actions are
based on the same facts and circumstances as the previous
action that the Company filed against the Okun Purchasers, Mr.
Okun and the other Okun Defendants for their breach of the
merger agreement, and are part of their response to the
original lawsuit the Company filed in the New Jersey Superior
Court. The Company and the individual defendants believe that
they acted properly on behalf of the Company's shareholders
and have meritorious defenses against all of these claims.
On February 26, 2007, Mr. Okun and certain of his affiliates
filed an amendment to their Schedule 13D with the SEC
disclosing that they now beneficially own 52.8% of the
Company's voting securities. According to the amended Schedule
13D, additional shares of the Company's common stock were
purchased in privately negotiated transactions for $1.00 per
share and the 197,824 shares of Series B Redeemable
Convertible Preferred Stock ("Series B Preferred Stock")
outstanding were purchased for $10.00 per share. Each share of
Series B Preferred Stock is convertible into 10 shares of
common stock. The Series B Preferred Stock and certain of the
shares of common stock were purchased from two of the
Company's former officers and directors. (See Note 7-
Definitive Merger Agreement)
On May 9, 2007, the Company announced that it had reached an
agreement with Mr. Okun and the Okun Defendants ("May
Settlement Agreement") to settle the three separate lawsuits
arising out of the termination of the merger agreement.
However, on May 23, 2007 the Company announced that it and the
Okun Defendants had agreed to consent to the entry of a court
order to vacate and set aside the May Settlement Agreement.
The Company filed with the SEC Forms 8-K relating to the May
Settlement Agreement and its subsequent setting aside on May
11 and 23, 2007, respectively.
On June 15, 2007, the Company announced that it had reached an
agreement with Mr. Okun and the Okun Defendants ("June
Settlement Agreement") to settle the three separate lawsuits
arising out of the termination of the merger agreement. The
June Settlement Agreement provided that Okun's affiliated
entities would surrender all of their First Montauk preferred
stock holdings and 5,272,305 of their common share holdings,
such that the Okun's affiliates would hold less than 25% of
the outstanding common shares of stock in First Montauk. These
shares have since been surrendered and cancelled. The Company
also obtained an exclusive 60 day option (the "Option Period")
to purchase the balance of the shares held by the Okun
affiliated entities (the "Option Securities") for the
aggregate purchase price of $2,500,000 (the "Option"). During
the Option Period, the Company shall be entitled to vote the
Option Securities on any matter before the Company's
shareholders. The June Settlement Agreement also provided that
the lease between an Okun affiliated entity and the Company
shall be deemed void ab initio.
16
In return, the Company agreed to direct the escrow agent,
Signature Bank New York, to pay to an Okun affiliated entity
the $2 million on deposit by Mr. Okun and the Okun Defendants
under the Escrow Agreement executed and delivered pursuant to
the May 5, 2006 Merger Agreement.
The foregoing description of the June Settlement Agreement is
qualified in its entirety by reference to the full text of the
Settlement Agreement which is filed as Exhibit 10.1 to the
Report on Form 8-K filed with the SEC on June 15, 2007.
As of June 30, 2007, 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. As of June 30, 2007, it was not
possible to predict the outcome of these legal matters pending
against the Company.
NOTE 9 - EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share for the six and three months
ended June 30, 2007 and 2006 is based on the weighted average
number of shares of common stock outstanding.
The following table sets forth the weighted average number of
shares of common stock and dilutive securities outstanding
used in the computation of basic and diluted earnings (loss)
per share:
Six months ended June 30, Three months ended June 30,
----------------------------------------- -----------------------------------------
----------------------- ----------------- ------------------- ---------------------
2007 2006 2007 2006
---- ---- ---- ----
(unaudited) (unaudited) (unaudited) (unaudited)
Numerator - basic:
Net income (loss) $ (1,107,204) $ 7,953 $ (589,656) $ 1,051,747
Add:: preferred stock dividends (85,803) (85,641) (42,900) (42,866)
----------------------- ----------------- ------------------- ---------------------
Numerator for basic earnings (loss) $ (1,193,007) $ (77,688) $ (632,556) $ 1,008,881
per share
======================= ================= =================== =====================
Numerator - diluted:
Net income (loss) $ (1,107,204) $ (77,688) $ (589,656) $ 1,008,881
Add: preferred stock dividends (85,803) 85,641 (42,900) 42,866
Add: convertible debentures
interest, net of tax (750) 35,061 (375) 375
----------------------- ----------------- ------------------- ---------------------
Numerator for diluted earnings
(loss) per share $ (1,193,757) $ 43,041 $ (632,931) $ 1,052,122
======================= ================= =================== =====================
Denominator:
Weighted average common shares
outstanding 18,063,724 15,594,185 17,648,721 15,842,628
Effect of dilutive securities:
Stock options and warrants -- -- -- 841,276
Convertible preferred stock -- -- -- 2,588,978
Nonvested employee stock -- -- -- 40,625
Convertible debentures -- -- -- 50,000
----------------------- ----------------- ------------------- ---------------------
Denominator for basic and diluted 18,063,724 15,594,185 17,648,721 19,363,507
loss per share (weighted average)
======================= ================= =================== =====================
17
The following securities have been excluded from the dilutive
per share computation, as they are antidilutive:
------------------ ----------------------------- -----------------------------------------
Six months ended Three months ended
June 30, June 30,
2007 2006 2007 2006
---- ---- ---- ----
------------------ -------------- -------------- --------------------- -------------------
------------------ -------------- -------------- --------------------- -------------------
Stock options 1,967,400 1,655,300 1,730,400 1,685,552
------------------ -------------- -------------- --------------------- -------------------
------------------ -------------- -------------- --------------------- -------------------
Warrants 407,518 149,133 407,518 157,092
------------------ -------------- -------------- --------------------- -------------------
------------------ -------------- -------------- --------------------- -------------------
Convertible
debentures 50,000 50,000 50,000 --
------------------ -------------- -------------- --------------------- -------------------
------------------ -------------- -------------- --------------------- -------------------
Convertible
preferred stock 44,564 2,588,978 44,564 --
------------------ -------------- -------------- --------------------- -------------------
------------------ -------------- -------------- --------------------- -------------------
Nonvested
employee stock -- 58,153 - 59,375
------------------ -------------- -------------- --------------------- -------------------
As required by FAS 128, "Earnings per Share", cumulative
preferred stock dividends for the six months and three months
ended June 30, 2007 and 2006 were deducted from net loss to
arrive at the numerator for basic and diluted loss per share.
NOTE 10 - NET CAPITAL REQUIREMENTS
FMSC is subject to the SEC Uniform Net Capital Rule (Rule
15c3-1), which requires FMSC to maintain minimum net capital,
as defined. At June 30, 2007, FMSC had net capital of
$1,222,915, which was $972,915 in excess of its required net
capital of $250,000. FMSC's ratio of aggregate indebtedness to
net capital was 2.78 to 1.
NOTE 11 - SUBSEQUENT EVENT - SHAREHOLDER RIGHTS PLAN
The Board of Directors of First Montauk declared a dividend of
one preferred share purchase right for each outstanding share
of First Montauk's common stock pursuant to a Rights Agreement
dated as of August 8, 2007, between First Montauk and
Continental Stock Transfer & Trust Company, as Rights Agent
(the "Rights Agreement"). The dividend was paid on August 8,
2007 to the Company's shareholders of record on that date
("Record Date"). In addition, the Board of Directors
authorized the issuance of one preferred share purchase right
for each additional share of common stock that becomes
outstanding between August 8, 2007 and the earliest of:
o the "distribution date", which is the earlier of: (1) the close of
business on the tenth (10th) business day (unless further extended by
a resolution adopted by a majority of the Continuing Directors of the
Board of Directors of the Company as of the close of business on
August 9, 2007 (the date of the Company's 2007 Annual Meeting)) after
a public announcement that (i) a person has acquired beneficial
ownership of 10% or more of the outstanding shares of common stock (the
"Requisite Percentage") or (ii) in the case of Edward H. Okun,
FMFG Ownership Inc., FMFG Ownership II, Inc. and any of their
respective Affiliates and Associates (collectively, the "Okun
Parties") and their respective successors and assigns acquired
additional shares of the common stock and beneficially own more than
an aggregate of 3,300,308 shares of common stock after the Record
Date (each person specified in (i) and (ii) hereafter referred
to as an Acquiring Person" ); and (2) a date that the Board of
Directors designates following the commencement of, or first public
disclosure of an intent to commence, a tender or exchange offer
for outstanding shares of common stock that could result in the
offeror becoming an Acquiring Person ;
o the date on which the rights expire, which is August 8, 2017; and
o the date, if any, on which the Board of Directors redeems the
preferred share purchase rights.
18
Each preferred share purchase right entitles its registered
holder to purchase from the Company one one-hundredth of a
share of a new Series C Participating Cumulative Preferred
Stock, at a price of $2.00 per one one-hundredth of a
preferred share, subject to adjustment as described below.
If an Acquiring Person acquires beneficial ownership of the
Requisite Percentage or more of the outstanding shares of
common stock after August 8, 2007 , after the distribution
date the preferred share purchase rights will entitle each
right holder, other than the Acquiring Person or any affiliate
or associate of the Acquiring Person (whose preferred share
purchase rights shall be null and void and nontransferable),
to purchase, for the purchase price, the number of shares of
common stock which at the time of the transaction would have
a market value of twice the purchase price.
After an Acquiring Person becomes the beneficial owner of the
Requisite Percentage or more of the outstanding shares of
common stock but before the Acquiring Person becomes the
beneficial owner of more than 50% of the common shares, the
Board of Directors may elect to exchange each preferred share
purchase right, other than those that have become null and
void and nontransferable as described above, for shares of
common stock, without payment of the purchase price. The
exchange rate in this situation would be one-half of the
number of shares of common stock that would otherwise be
issuable at that time upon the exercise of one preferred share
purchase right.
At any time prior to an Acquiring Person acquiring beneficial
ownership of the Requisite Percentage or more of the
outstanding shares of common stock, the Board of Directors may
redeem the preferred share purchase rights in whole, but
not in part. the redemption price of $0.0001 per preferred
share purchase right, subject to adjustment as provided in the
Rights Agreement, may be paid in cash, shares of common stock
or other First Montauk securities deemed by the Board of
Directors to be at least equivalent in value. The Board of
Directors may also supplement or amend any provision of the
Rights Agreement, including the date on which the distribution
date or expiration date would occur, the time during which the
preferred share purchase rights may be redeemed and the terms
of the preferred shares. In the case of a redemption, the
preferred share purchase rights are designed to ensure that
the Board of Directors has adequate time to consider any
proposed acquisition transaction involving First Montauk and
to protect First Montauk and its shareholders against any
proposed acquisition transaction in which all shareholders are
not treated equitably and do not receive fair value for their
shares of common stock. The preferred share purchase rights
have certain antitakeover effects and will cause substantial
dilution to a person that attempts to acquire First Montauk on
terms not approved by the Board of Directors. The preferred
share purchase rights should not affect any prospective
offeror willing to make an all-cash offer at a full and fair
price, or willing to negotiate with the Board of Directors.
Similarly, the preferred share purchase rights will not
interfere with any merger or other business combination
approved by the Board of Directors since the Board of
Directors may, at its option, redeem all, but not less than
all, of the then outstanding preferred share purchase rights
at the redemption price.
The foregoing description of the Shareholder Rights Plan is
qualified in its entirety by reference to the full text of the
Rights Agreement, which is filed as Exhibit 4.1 to the
Company's Report on Form 8-K filed on August 8, 2007.
19
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/A for the year ended
December 31, 2006.
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 225 registered
representatives and services approximately 48,000 retail and institutional
customers, which comprise approximately $3 billion in customer assets. All of
our 93 branch office and satellite locations in 24 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.
20
RESULTS OF OPERATIONS
Three Months Ended June 30, 2007 Compared to Three Months Ended June 30, 2006
Revenues by Source
The following provides a breakdown of total revenues by source for the
three-month periods ended June 30, 2007 and 2006 (in thousands of dollars).
Three Months Ended
-----------------------------------------------------------------
------------------------------ --- ------------------------------
June 30, 2007 June 30, 2006
------------------------------ ------------------------------
Amount % of Total Amount % of Total
Revenues Revenues
Commissions
Equities $ 3,384 34% $ 4,757 35%
Mutual Funds 1,593 16% 1,610 12%
Insurance 1,229 12% 1,080 8%
Alternative Products 1,070 11% 1,373 10%
Asset Management Fees 1,026 10% 1,009 7%
Fixed Income 104 1% 76 1%
-------------- --------------- -------------- ---------------
Total 8,406 84% 9,905 73%
Principal Transactions 361 4% 1,120 8%
Investment Banking 469 5% 1,572 12%
Interest and Other
Interest 588 6% 767 6%
Other 121 1% 242 1%
-------------- --------------- -------------- ---------------
Total 709 7% 1,009 7%
-------------- --------------- -------------- ---------------
Total revenues $ 9,945 100% $ 13,606 100%
============== =============== ============== ===============
Overview
Total revenues decreased $3.66 million, or 27%, for the three months
ended June 30, 2007 (the "2007 quarter"), to $9.95 million from $13.61 million
for the three months ended June 20, 2006 (the "2006 quarter"). The decrease in
revenues is primarily attributable to a decline in the number of producing
registered representatives from 256 at June 30, 2006 to 191 at June 30, 2007, a
decrease of approximately 65 representatives. There were decreases in each
category of revenues, the largest coming from equity commissions and principal
transactions of $2.1 million and investment banking of $1.1 million.
Expenses decreased in the 2007 quarter by $2 million, or 16%, compared
to the 2006 quarter. The Company received $1 million from NFS in June 2006 as
reimbursement for costs previously incurred. Included in expenses in 2006 is
$820,000 of these expense offsets. Without taking this credit into account
expenses would have decreased by $2.8 million for the 2007 quarter.
The net loss applicable to common stockholders for the 2007 quarter was
$633,000, or ($.04) per basic and diluted share compared to a net income
attributable to common stockholders for the 2006 quarter of $1,009,000, or $0.06
per basic and $0.05 per diluted share.
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 2007 quarter was $8.4 million compared to $9.9
million for the 2006 quarter, a decrease of approximately $1.5 million.
Decreases in commissions from the sale of equities of $1.4 million accounted for
the majority of the reduction in commission revenues, while all other revenue
categories remained fairly constant. This decrease highlights the result of the
reduction in producing registered representatives' from the 2006 quarter to the
2007 quarter.
21
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 $759,000, or 68%, from $1.1 million for the
2006 quarter to $361,000 for the 2007 quarter. The decrease is primarily due to
the reduction in the number of registered representatives who engaged in these
types of transactions and the use of our clearing firm to handle more of our
fixed income securities transactions on an agency basis.
Investment Banking
Investment banking revenues for the 2007 quarter decreased $1.1 million
from $1.57 million in the 2006 quarter, to $469,000 in the 2007 quarter, a
decrease of approximately 70%. The decrease in investment banking revenues is
attributable to the Company having completed a smaller number of investment
banking transactions in the second quarter of 2007 when compared to the same
quarter in 2006. 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 2007 quarter decreased by
approximately $300,000 when compared to the 2006 quarter. Included in interest
and other income for the 2006 quarter is an additional $180,000 of margin
interest rebate, a partial allocation of the $1.0 million received from NFS in
June 2006.
Commissions, Employee Compensation and Benefits
Commission expense, consistently the largest expense category and
directly related to commission revenue, decreased 27%, or $2.62 million, from
$9.6 million for the 2006 quarter, to $6.98 million for the 2007 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, increased for the
2007 quarter, to $1.5 million from $1.4 million, an increase of approximately
$100,000 over the 2006 quarter.
Clearing and Floor Brokerage
Clearing and floor brokerage costs which are greatly affected by volume
and type of transactions, increased $395,000, to $392,000 in the 2007 quarter
when compared to the 2006 quarter. In June 2006, we allocated approximately
$544,000 of the $1 million received in the settlement from NFS to clearing fees
for costs incurred in prior periods. Actual clearing costs for the 2006 quarter,
excluding the settlement amount from NFS of $544,000, would have been $540,000.
Therefore, clearing costs for the 2007 quarter would have decreased
approximately $148,000 compared to the 2006 quarter. As a percentage of
transaction-based commissions, clearing costs remained relatively constant at
approximately 7%. Clearing costs, as a percentage of gross revenues, fluctuate
depending upon the product mix.
Communications and Occupancy
Communications and occupancy costs increased $66,000, from $345,000 in
the 2006 quarter to $411,000 in the 2007 period. In the 2006 quarter there was a
$135,000 reduction in costs incurred in prior periods related to data
aggregation as part of the $1 million received from NFS in June 2006. Excluding
this reduction, communications and occupancy costs would have decreased by
approximately $69,000.
Legal matters and related costs
Legal matters and related settlement costs increased $140,000, from
$414,000 during the 2006 quarter to $554,000 for the 2007 quarter, most of which
was related to legal fees. Legal settlements decreased by $59,000 during the
2007 quarter when compared to the 2006 quarter. The 2006 quarter included an
additional reserve of $75,000 in connection with the settlement with the New
Jersey Bureau of Securities. Legal fees during the second quarter of 2007 were
$488,000 compared to $290,000 during the second quarter of 2006. In 2006, we
incurred $122,000 in legal fees in connection with the anticipated acquisition
of the Company by a private investor, compared to $240,000, net of a negotiated
agreement with our insurance carrier to reimburse $600,000 for legal fees
related to various lawsuits involving the termination of the proposed merger in
December 2006 (See Note 8-Legal Matters).
22
Other Operating Expenses
Other operating expenses remained relatively constant for the 2007 and
2006 quarters at $686,000 and $700,000, respectively.
Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006
Revenues by Source
The following provides a breakdown of total revenues by source for the six-month
periods ended June 30, 2007 and 2006 (in thousands of dollars).
Six Months Ended
-----------------------------------------------------------------
------------------------------ --- ------------------------------
June 30, 2007 June 30, 2006
------------------------------ ------------------------------
Amount % of Total Amount % of Total
Revenues Revenues
Commissions
Equities $ 6,816 31% $ 11,097 41%
Mutual Funds 3,292 15% 3,211 12%
Insurance 2,314 10% 2,190 8%
Alternative Products 2,614 12% 1,937 7%
Asset Management Fees 2,070 9% 1,904 7%
Fixed Income 127 1% 89 <1%
-------------- --------------- -------------- ---------------
Total 17,233 78% 20,428 76%
Principal Transactions 955 4% 2,485 9%
Investment Banking 2,480 11% 2,317 9%
Interest and Other
Interest 1,168 5% 1,334 5%
Other 354 2% 354 1%
-------------- --------------- -------------- ---------------
Total 1,522 7% 1,688 6%
-------------- --------------- -------------- ---------------
Total revenues $ 22,190 100% $ 26,918 100%
============== =============== ============== ===============
Overview
Overall, revenues decreased $4.7 million for the six months ended June
30, 2007 (the "2007 period"), to $22.2 million, compared to $26.9 million, for
the six months ended June 30, 2006 (the "2006 period"). Commission revenues
decreased by $3.2 million while revenues from principal transactions decreased
by $1.5 million. The decrease in revenues is primarily attributable to a decline
in the number of producing registered representatives from 256 at June 30, 2006
to 191 at June 30, 2007, a decrease of approximately 65 representatives.
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 in June 2006, as discussed previously.
Expenses in the 2007 period decreased by approximately $3.58 million,
which includes an $820,000 credit in 2006 due to a partial allocation of the
$1.0 million received from NFS in June 2006 and $951,000 of executive separation
costs during the 2006 period. Taking into consideration these two items,
expenses decreased by $3.45 million during the 2007 period when compared to the
2006 period, a decrease of 13%.
Net loss applicable to shareholders in the 2007 period was $1,193,000,
or ($0.07) per basic and diluted shares compared to a net loss applicable to
shareholders of $77,000, or $0.00 per basic and diluted shares for the same
period in 2006 .
23
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 2007 period decreased $3.2 million to $17.2 from
$20.4 million in the same period in 2006, again related to the reduction in the
number of registered representatives from the 2006 period to the 2007 period.
The decrease was primarily attributable to a reduction in revenue from agency
equity transactions of $4.3 million, offset by increases in commissions from
alternative products, which include commissions on REIT's, 1031 exchanges and
oil & gas programs, of $677,000, fees from managed accounts of $166,000 and
insurance revenues of $124.000.
Principal Transactions
Principal transactions decreased $1.5 million, from $2.5 million for
the 2006 period to $955,000 for the 2007 period. The decrease is primarily due
to the reduction in the number of registered representatives who engaged in
these types of transactions and the use of our clearing firm to handle more of
our fixed income securities transactions.
Investment Banking
Investment banking revenues increased by $163,000 for the 2007 period,
from $2.32 million in the 2006 period, to $2.48 million in the 2007 period.
Interest and Other Income
Interest and other income for the 2007 period decreased by $166,000
when compared to the 2006 period, which period included an additional $180,000
of margin interest rebate, a partial allocation of the $1.0 million received
from NFS in June 2006.
Commissions, Employee Compensation and Benefits
Commission expense, consistently the largest expense category and
directly related to commission revenue, decreased 18%, or $3.3 million, from
$19.1 million for the 2006 period, to $15.8 million for the 2007 period.
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, increased for the
2007 period, to $3.4 million from $3.0 million, an increase of approximately
$387,000 over the 2006 period. Included in the 2007 period was approximately
$232,000 of severance costs for various personnel and additional bonus accruals
of $154,000.
Executive Separation
Executive separation costs decreased $951,266 for the 2007 period when
compared with the 2006 period. In February 2006, the Company entered into a
separation agreement with our then Chairman of the Board, which provided for the
termination of his employment as of that date. In the 2007 period, there was no
separation agreements entered into with any executives.
Clearing and Floor Brokerage
Clearing and floor brokerage costs which are greatly affected by volume
and type of transactions, increased from $696,000 in the 2006 period to $799,000
in the 2007 period, an increase of $103,000. In June 2006, we allocated
approximately $544,000 of the $1 million received in the settlement from NFS to
clearing fees for costs incurred in prior periods. Actual clearing costs for the
2006 period, excluding the settlement amount from NFS of $544,000, would have
been $1.24 million, a decrease of $441,000 for the 2007 period. As a percentage
of transaction-based commissions, clearing costs remained relatively constant at
approximately 7%. Clearing costs, as a percentage of gross revenues, fluctuate
depending upon the product mix.
Communications and Occupancy
Communications and occupancy costs decreased $48,000, from $883,000 in
the 2006 period to $835,000 in the 2007 period. In the 2006 period there was a
$135,000 reduction in costs incurred in prior periods related to data
aggregation as part of the $1 million received from NFS in June 2006. Excluding
this reduction, communications and occupancy costs would have decreased by
approximately $183,000. This decrease is primarily due to the termination of our
New York City branch office lease in September 2006 and costs related to the
operating of that office.
24
Legal matters and related costs
Legal matters and related settlement costs increased $371,000, from
$613,000 during the 2006 period to $984,000 for the 2007 period, most of which
was related to legal fees. Legal settlements decreased by $53,000 during the
2007 period when compared to the 2006 period. The 2006 period included an
additional reserve of $75,000 in connection with the settlement with the New
Jersey Bureau of Securities. Legal fees during the first six months of 2007 were
$920,000 compared to $496,000 during the first six months of 2006. In 2006, we
incurred $183,000 in legal fees connection with the anticipated acquisition of
the Company by a private investor, compared to $379,000, net of a negotiated
agreement with our insurance carrier to reimburse $600,000 for legal fees
related to various lawsuits involving the termination of the proposed merger in
December 2006 (See Note 8-Legal Matters).
Other Operating Expenses
Other operating expenses decreased $112,000 for the 2007 period, from
$1.53 million in the 2006 period to $1.42 million in the 2007 period. The
largest decreases were in depreciation expense of $79,000 and errors and
omission insurance premiums of $64,000.
Liquidity and Capital Resources
Approximately 63% of our assets consist of cash, securities owned, and
receivables from our clearing firm and other broker-dealers and insurance
companies. The balances in these accounts can and do fluctuate significantly
from day to day, depending on general economic and market conditions, volume of
activity, and investment opportunities. These accounts are monitored on a daily
basis in order to ensure compliance with regulatory capital requirements and to
preserve liquidity.
Overall, cash and cash equivalents decreased during the six months
ended June 30, 2007 by $715,000. Net cash used in operating activities during
the 2007 quarter was $616,000, which consists of a net loss of $1,107,000,
increased by non-cash charges including depreciation of $72,000, amortization of
stock compensation and deferred costs of $37,000. Cash was reduced by increases
in securities owned, prepaid expenses and receivable from insurance and deposits
of $86,000, $437,000, $600,000 and $241,000, respectively, and decreases in
accrued expenses and commissions' payable of $435,000 and $161,000,
respectively. Cash was increased by a decrease in the amount due from clearing
firm of $1,243,000 and increases in accounts payable of $1,062,000.
Additions to property and equipment of $11,900 accounted for the use of
cash from investing activities during the six months ended June 30, 2007.
Financing activities used net cash of $87,000 due to the payment of
preferred stock dividends of $86,000 and capital leases of $820 during the first
six months of 2007.
The financing agreement with AICCO Inc. for the renewal of our errors
and omissions insurance policy had a balance at June 30, 2007 of approximately
$368,000, payable in five remaining monthly installments of $74,781 each,
including interest at the rate of 5.87% per annum.
We believe that our cash and cash equivalents will be sufficient to
meet our minimum planned operating needs for the next 6 months. Beyond that
period, management has other plans for increasing cash flow, including pursuing
additional financing and reductions in overhead costs. Although we have plans to
pursue additional financing, there can be no assurance that we will be able to
secure financing when needed or obtain such financing on terms satisfactory to
us, if at all, or that any additional funding we do obtain will be sufficient to
meet our needs in the long term. If additional funding cannot be obtained, we
will review alternative courses of action to conserve our cash flow.
25
Contractual Obligations
The Company has contractual obligations to make future payments in
connection with its short-term debt, severance payments and non-cancelable lease
agreements. The following table sets forth these contractual obligations by
year. This table does not include any projected payment amounts related to our
potential exposure to arbitrations and other legal matters.
Expected Maturity Date
Category 2007 2008 2009 2010 Total
-------------------------------------- -------------- ------------- ------------ ------------ --------------
-------------------------------------- -------------- ------------- ------------ ------------ --------------
Short-term debt (1) $26,048 $0 $0 $0 $26,048
Guaranteed Severance (2) 116,667 16,667 0 0 133,334
Operating Leases 430,903 690,496 648,337 50,762 1,820,498
Master Services Agreement (3) 200,000 240,000 200,000 0 640,000
-------------- ------------- ------------ ------------ --------------
Total $773,618 $947,163 $848,337 $50,762 $2,619,880
============== ============= ============ ============ ==============
(1) Short-term debt in 2007 includes a convertible debenture in
the amount of $25,000 with accrued interest of $1,048 maturing
on 12/11/07.
(2) Guaranteed severance payments are due and owing to our prior
General Counsel of $133,334. Payments are made bi monthly at
the rate of $16,667 per month with the last payment due in
January 2008.
(3) In 2007, the Company entered into a master services agreement
with an outside entity for development of certain software, data
integration and business process improvement consulting
services. The term of the agreement is for a minimum of 3
years.
Net Capital
At June 30, 2007, Montauk Financial Group had net capital of
$1,222,915, which was $972,915 in excess of its required net capital of
$250,000, and the ratio of aggregate indebtedness to net capital was 2.78 to 1.
Common Stock
On June 15, 2007, the Company announced that it had reached an
agreement with Mr. Okun and the Okun Defendants ("June Settlement Agreement") to
settle the three separate lawsuits arising out of the termination of the merger
agreement between the Company and the Okun Purchasers. The June Settlement
Agreement provided that Okun's affiliated entities would surrender 5,272,305 of
their common share holdings. These shares have since been surrendered and
cancelled. (See Note 8 - Legal Matters - Termination of Merger Agreement;
Litigation and Settlement).
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%.
On June 15, 2007, as part of the settlement with Mr. Okun and the Okun
Defendants (See Note 8-Legal Matters-Termination of Merger Agreement; Litigation
and Settlement) an agreement was reached which required the parties to surrender
all shares of Series A Preferred Stock previously owned by the Okun Defendants.
On June 15, 2007, 283,087 shares of Series A Preferred Stock were surrendered
and cancelled by the Company.
26
As of June 30, 2007, we have 22,282 Series A preferred shares issued
and outstanding. Quarterly dividends of $22,903 and $22,866 were paid during the
three months ended June 30, 2007 and 2006, respectively.
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 had a deemed issue price of $1,000,000, and was
convertible into common stock on the basis of ten shares of common stock for
each share of Series B. The Series B also provided 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 included a cumulative dividend of 8% per
year. The shares are restricted securities under the Securities Act of 1933 and
the regulations of the SEC and we relied upon the exemption from registration
under Section 4(2) of the Securities Act of 1933 to issue the shares of Series
B. A quarterly dividend of $20,000 was paid during the three months ended June
30, 2007 and 2006.
Mr. Okun purchased all the shares of Series B Preferred Stock in a
private transaction on February 23, 2007 at a price of $10.00 per share of
Series B Preferred Stock. On June 15, 2007, as part of the settlement with Mr.
Okun and the Okun Defendants (See Note 8-Legal Matters-Termination of Merger
Agreement; Litigation and Settlement) an agreement was reached which required
the parties to surrender all shares of Series B Preferred Stock previously owned
by the Okun Defendants. On June 15, 2007, 197,824 shares of Series B Preferred
Stock were surrendered and cancelled by the Company. There are currently no
shares of Series B Preferred Stock outstanding.
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 2006 Annual Report filed on Form 10-K/A. 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.
27
Item 3. Risk Management
Business Risk. Our business is subject to significant risk from a decline in
revenues due to the loss of registered representatives, expenses related to
legal matters associated with our terminated merger plans and regulatory
exposure. We may incur further losses in the future and such losses would
necessarily affect the nature, scope and level of our future business.
Our ability to continue as a going concern is dependent on our ability
to maintain and increase operating revenues, reduce operating expenses, and
raise additional capital. We believe that our cash resources will be sufficient
to meet our minimum planned operating needs for the next 6 months. Beyond that
period, management has other plans for increasing cash flow, including pursuing
additional financing and reductions in overhead costs. We cannot make any
assurances that we will be successful in these activities, which would therefore
have a materially adverse affect on our financial condition.
Our ability to obtain additional financing from other sources depends
on many factors, some of which are beyond our control, including the state of
the capital markets and the uncertainties that are common in the securities
industry. The necessary additional financing may not be available to us or may
be available only on terms that would result in dilution to the current owners
of our common stock. If additional funding cannot be obtained, we will review
alternative courses of action to conserve our cash flow.
As a securities broker-dealer, we are subject to uncertainties that are
common in the securities industry. These uncertainties include:
o the volatility of capital markets;
o governmental regulation;
o litigation;
o intense competition;
o substantial fluctuations in the volume and price level of
securities; and
o dependence on third parties.
As a result, revenues and earnings may vary significantly from period
to period. In periods of low volume, profitability is impaired because certain
expenses remain relatively fixed. In the event of a substantial change in market
conditions or a loss of a substantial number of registered representatives from
whom our revenues are derived, our financial condition and results of operations
would be adversely affected.
Market Risk. Market risk is the risk of loss to the Company resulting from
changes in interest rates and equity prices. The Company has exposure to market
risk primarily through its broker-dealer. The Company's broker-dealer, First
Montauk Securities Corp., carries debt obligations on behalf of its customers
and acts as a market maker in approximately 15 over-the-counter equity
securities. In connection with these activities, the Company maintains
inventories to facilitate client transactions. Occasionally, the Company invests
for its own proprietary equity investment accounts.
28
The following table represents the fair value of trading inventories
associated with the Company's broker-dealer client facilitation, market-making
activities and proprietary trading activities.
June 30, 2007 December 31, 2006
----------------------------------- ----------------------------------------
Securities Sold
Securities but not yet Securities Sold but
Owned Purchased Securities Owned not yet Purchased
------------------------------- --------------- ------------------- ------------------ ---------------------
Marketable:
Government $ 6,931 $ 0 $ 2,015 $ 0
Corporate 0 0 0 0
Municipal 0 0 0 0
Certificates of deposit 2,970 0 0 0
--------------- ------------------- ------------------ ---------------------
Total debt securities 9,901 0 2,015 0
Equity securities 169,726 0 97,941 495
Mutual funds 0 11 6,008 0
Options 0 0 0 0
Warrants 105,149 0 92,483 0
--------------- ------------------- ------------------ ---------------------
Total $284,776 $ 11 $198,447 $495
=============== =================== ================== =====================
Changes in value of the Company's inventory may result from
fluctuations in interest rates, credit ratings of the issuer, equity prices and
the correlation among these factors. The Company's primary method of controlling
risk is through the establishment and monitoring of limits on the dollar amount
of securities positions that can be entered into. Position limits in inventory
accounts are monitored on a daily basis. Management also monitors inventory
levels and trading results, as well as inventory aging, pricing, concentration
and securities ratings.
Since the inventory accounts are used primarily to facilitate customer
transactions the number of positions and absolute dollar amounts are maintained
well within Company limits and therefore represents minimal market risk to the
Company. Our policy is to hold securities pending customer transactions and
therefore we generally do not maintain positions longer than one year.
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.
29
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 Acting
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure based closely on the definition of "disclosure controls and
procedures" in Rule 13a-15(e). In designing and evaluating the disclosure
controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives, and management necessarily was
required to apply its judgment in designing and evaluating the controls and
procedures.
Based on their evaluation, as of June 30, 2007, our Chief Executive
Officer and our Acting 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 June 30, 2007, that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
30
PART II
OTHER INFORMATION
Item 1. Legal proceedings
SEC Investigation
The SEC is investigating whether FMSC, and/or certain former employees
failed reasonably to supervise the securities trading and research activities of
a former analyst. The investigation covered the time period from approximately
March 2000 until January 2004 when the analyst resigned. The SEC has recently
advised us that it intends to recommend bringing an enforcement proceeding
against FMSC, one of its former principals and another former employee for
failing to supervise reasonably. The SEC will be seeking a monetary penalty and
an order suspending the former principal from acting in a supervisory capacity
for a period of time. FMSC is entitled to make a Wells submission to the SEC
Staff and intends to make such a submission or otherwise attempt to negotiate a
resolution with the SEC. FMSC is currently engaged in a process of negotiating a
resolution to this matter with the SEC Staff but it is too early in such process
to determine what the ultimate resolution may be. The Company believes that any
resolution may include a monetary penalty that could have a materially adverse
effect on our financial condition.
NASD Enforcement Sales Practice Investigation
The NASD Department of Enforcement is conducting an investigation of the
sales practice activities of certain individuals who were formerly registered
representatives of FMSC, as well as the supervision of those activities by FMSC.
On April 9, 2007, NASD notified FMSC through a "Wells call" that it intends to
file an administrative action against it in connection with an alleged failure
to reasonably supervise the activities of three former registered
representatives of FMSC. NASD has indicated that it will be seeking a monetary
penalty and certain undertakings by FMSC. FMSC is entitled to make a Wells
submission to the NASD Staff and currently intends to make such a submission or
otherwise attempt to negotiate a resolution with NASD. FMSC is currently engaged
a process of negotiating a resolution to this matter with the NASD Staff but it
is too early in such process to determine what the ultimate resolution may be.
The Company believes that any resolution may include a monetary penalty that
could have a materially adverse effect on our financial condition.
Termination of Merger Agreement, Litigation and Settlement
See Note 8 - Legal Matters - Termination of Merger Agreement; Litigation
and Settlement.
Item 1A. Risk Factors
Refer to December 31, 2006 Form 10-K/A.
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.
31
Item 5. Other Information
Amended and Restated Employment Agreement with Victor Kurylak
As of May 9, 2007, the Company and Victor K. Kurylak, President and Chief
Executive Officer of the Company, executed an Amended and Restated Employment
Agreement ("Amended Employment Agreement"). The Amended Employment Agreement was
executed in connection with the execution of the May Settlement Agreement.
Pursuant to the Amended Employment Agreement, Mr. Kurylak was to continue his
employment with the Company as President . Mr. Kurylak was to resign, however,
from the position of Chief Executive Officer of the Company in connection with
the May Settlement Agreement upon appointment of his successor and execution by
his successor of an employment agreement with the Company. However, since the
May Settlement Agreement was vacated and set aside, Mr. Kurylak's resignation
was not accepted and thus cancelled. On June 15, 2007, the Company and Mr.
Kurylak executed an Amendment Number One to the Amended and Restated Employment
Agreement ("Amendment to Amended Employment Agreement") to correctly state that
Mr. Kurylak is employed in the capacity of President and Chief Executive Officer
of both the Company and FMSC. The Amended Employment Agreement will expire on
December 31, 2007 ("Term"), subject to renewal for one additional period of one
year unless the Company provides written notice of its intention not to renew
the Amended Employment Agreement at least 120 days prior to December 31, 2007.
During the term of the Amended Employment Agreement, Mr. Kurylak will be
compensated at the rate of $300,000 on an annualized basis. He is eligible for
customary fringe benefits and to participate in the Company's executive bonus
pool.
In the event of the termination of Mr. Kurylak's employment by the Company
without "cause" or by Mr. Kurylak for "good reason" as these terms are defined
in the Amended Employment Agreement, he would be entitled to: (a) all
compensation accrued but not paid as of the termination date; (b) base salary
for the remainder of the Term; (c) a severance payment equal to $300,000 payable
in a lump sum payment; (d) continued participation in the Company's benefit
plans (or comparable plans); and (e) any applicable bonus. If Mr. Kurylak's
employment is terminated by the Company for "cause" or by him without "good
reason", he will be entitled only to accrued compensation. If termination of the
Amended Employment Agreement occurs as a result of the expiration of such
agreement without renewal by the Company at the end of the Term, Mr. Kurylak
will be entitled to the accrued compensation, any applicable bonus and the
severance payment.
In the event Mr. Kurylak is a member of the board of directors of the Company on
the termination date, the payment of any and all compensation due under the
Amended Employment Agreement, except the accrued compensation, is expressly
conditioned on Mr. Kurylak's resignation from the board of directors of the
Company within five (5) business of the termination date.
The Amended Employment Agreement contains confidentiality obligations that
survive indefinitely and non-solicitation and non-competition obligations that
end on the first anniversary of the date of cessation of Mr. Kurylak's
employment.
The foregoing description of Mr. Kurylak's Amended Employment Agreement is
qualified in its entirety by reference to the full text of the Amended
Employment Agreement, which is filed as Exhibit 10.2 to the Company's Report on
Form 8-K filed on May 11, 2007, and the Amendment to the Amended Employment
Agreement, which is filed herewith as Exhibit 10.3.
32
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 Settlement Agreement dated as of May 8, 2007 among First Montauk Financial Corp., Edward H. Okun,
Investment Properties of America, LLC, IPofA Water View, LLC, FMFG Acquisition Co. Inc., FMFG
Ownership I, FMFG Ownership II, Victor K. Kurylak, Ward R. Jones, Jr., Barry Shapiro, David
Portman and Mindy Horowitz (Filed as Exhibit 10.1 to the Form 8-K dated May 11, 2007)
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
10.2 Amended and Restated Agreement, dated as of May 9, 2007 between Victor K. Kurylak and First
Montauk Financial Corp. (Filed as Exhibit 10.2 to the Form 8-K dated May 11, 2007)
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
*10.3 Amendment Number One to the Amended and Restated Employment Agreement, dated as of June 15, 2007,
between Victor K. Kurylak and First Montauk Financial Corp.
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
*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
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FIRST MONTAUK FINANCIAL CORP.
(Registrant)
Dated: August 14, 2007 /s/ Mindy A. Horowitz
--------------------------------------------
Mindy A. Horowitz
Acting Chief Financial Officer
/s/ Victor K. Kurylak
--------------------------------------------
Victor K. Kurylak
President and Chief Executive Officer
34