================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
|X| SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD
ENDED SEPTEMBER 30, 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 November 14, 2007.
FIRST MONTAUK FINANCIAL CORP.
FORM 10-Q
SEPTEMBER 30, 2007
INDEX
Page
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Condensed Consolidated Statements of Financial Condition
as of September 30, 2007 (unaudited) and December 31, 2006 .. F-1
Condensed Consolidated Statements of Operations for the Nine Months
and Three Months Ended September 30, 2007 (unaudited)
and 2006 (unaudited) ........................................ F-2
Condensed Consolidated Statements of Changes in Stockholders'
Equity for the period from January 1, 2006
to September 30, 2007 (unaudited) ...........................F-3-F-4
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended September 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 ................. 20-28
Item 3. Risk Management ........................................ 28-30
Item 4. Controls and Procedures ................................ 31
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings ...................................... 32
Item 1A. Risk Factors ........................................... 32
Item 2. Unregistered Sales of Equity Securities................. 32
Item 3. Defaults Upon Senior Securities ........................ 32
Item 4. Submission of Matters to a Vote of
Securities Holders .................................... 32
Item 5. Other Information ..................................... 33-34
Item 6. Exhibits ............................................... 35
Signatures ...................................................... 36
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, December 31,
2007 2006
(unaudited) (restated)
ASSETS
Cash and cash equivalents $ 1,326,390 $ 1,145,751
Due from clearing firm 2,512,741 4,988,747
Securities owned, at market value 168,941 198,447
Prepaid expenses 464,637 285,480
Employee and broker receivables - net of reserve for bad debt
of $783,122 and $807,536 respectively 273,858 343,491
Property and equipment - net 195,431 239,033
Other assets 1,091,323 597,968
--------- ----------
Total assets 6,033,321 7,798,917
========= ==========
LIABILITIES
Accounts payable 929,241 313,427
Accrued expenses 960,197 1,195,426
Income taxes payable 11,358 4,167
Commissions payable 2,233,920 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 47,670 67,156
--------- ----------
Total liabilities 4,207,397 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 9,628,630 11,646,620
Additional paid-in capital 4,035,064 950,592
Accumulated deficit (11,839,998) (9,814,258)
------------ -----------
Total stockholders' equity 1,825,924 2,813,491
------------ -----------
Total liabilities and stockholders' equity $ 6,033,321 $ 7,798,917
============ ===========
See notes to condensed consolidated financial statements.
F-1
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Nine Months Ended September 30, Three Months Ended September 30,
2007 2006 2007 2006
(unaudited) (unaudited) (unaudited) (unaudited)
Revenues:
Commissions $ 24,941,439 $29,509,203 $7,708,284 $ 9,081,813
Principal transactions 1,261,458 3,318,729 306,482 833,929
Investment banking 3,440,269 2,914,197 960,849 596,963
Interest and other income 2,068,309 2,449,776 546,178 761,470
---------- ---------- --------- -----------
Total revenue 31,711,475 38,191,905 9,521,793 11,274,175
---------- ---------- --------- -----------
Expenses:
Commissions, employee compensation and benefits 27,491,131 31,712,982 8,264,249 9,592,676
Executive separation - 951,266 - -
Clearing and floor brokerage 1,134,419 1,111,675 334,866 415,896
Communications and occupancy 1,262,127 1,369,832 427,583 486,539
Legal matters and related costs 1,221,588 772,193 237,337 159,642
Other operating expenses 2,471,582 2,296,864 1,048,368 762,089
Interest 17,875 74,803 5,032 8,057
---------- ---------- ---------- -----------
Total expenses 33,598,722 38,289,615 10,317,435 11,424,899
---------- ---------- ---------- -----------
Loss before income taxes (1,887,247) (97,710) (795,642) (150,724)
Provision (benefit) for income taxes 16,199 14,331 600 (30,730)
----------- ----------- ---------- -----------
Net loss (1,903,446) (112,041) (796,242) (119,994)
Preferred stock dividends (122,294) (126,204) (36,490) (42,866)
----------- ------------ ----------- -----------
Net loss applicable to common stockholders $ (2,025,740) $ (238,245) $ (832,732) $ (162,860)
=========== ============ =========== ===========
Loss per share:
Basic $ (0.12) $ (0.01) $ (0.06) $ (0.01)
Diluted $ (0.12) $ (0.01) $ (0.06) $ (0.01)
Weighted average number of shares of stock outstanding:
Basic 16,439,992 16,531,580 13,245,477 18,382,826
Diluted 16,439,992 16,531,580 13,245,477 18,382,826
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 PERIOD FROM JANUARY 1, 2006 TO SEPEMBER 30, 2007 (UNAUDITED)
Series B Convertible
Series A Convertible Preferred Stock
Preferred Stock (Restated) Common Stock
-------------------------------------------- ------------------------- Additional
Shares Amount Shares Amount Shares Amount Paid-in 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 38,173
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 September 30, 2007 22,282 $2,228 - $ - 13,254,248 $9,628,630 $4,035,064
====================== ===================== ========================= =============
See notes to consolidated financial statements.
F-3
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE PERIOD FROM JANUARY 1, 2006 TO SEPEMBER 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 38,173
Payment of preferred stock dividends (122,294) (122,294)
Cancellation of preferred A stock
Cancellation of preferred B stock 1,000,000
Cancellation of common stock
Net loss for the period (1,903,446) (1,903,446)
------------ ---------- -----------
Balances at September 30, 2007 $(11,839,998) $ - $1,825,924
============ ========== ===========
See notes to condensed consolidated financial statements.
F-4
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
2007 2006
(unaudited) (unaudited)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,903,446) $ (112,041)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation of property and equipment 89,195 202,413
Amortization of stock compensation and deferred costs 38,173 351,752
Increase (decrease) in cash attributable to changes in assets
and liabilities:
Payment on note payable - (200,000)
Due from clearing firm 2,476,006 (505,741)
Securities owned 29,505 10,999
Prepaid expenses (179,156) (257,264)
Employee and broker receivables 69,632 (107,632)
Other assets (493,355) 23,301
Accounts payable 615,814 (75,213)
Accrued expenses (235,229) (629,401)
Income taxes payable 7,191 500
Commissions payable (145,015) 281,961
Securities sold, not yet purchased (484) 1,186
Other liabilities (19,486) 22,575
---------- ---------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 349,345 (992,605)
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (45,593) (13,232)
---------- ---------
NET CASH USED IN INVESTING ACTIVITIES (45,593) (13,232)
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of capital lease (819) (6,925)
Proceeds from exercise of incentive stock option - 22,034
Payment of preferred stock dividends (122,294) (126,204)
---------- ----------
NET CASH USED IN FINANCING ACTIVITIES (123,113) (111,095)
---------- ----------
Net increase (decrease) in cash and cash equivalents 180,639 (1,116,932)
Cash and cash equivalents at beginning of period 1,145,751 1,990,815
---------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,326,390 $ 873,883
========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 17,500 $ 33,891
========== ===========
Income taxes $ 10,823 $ 118,018
========== ===========
Noncash 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 $ 2,056,163 $ -
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 September 30, 2007 and
for the nine-month and three-month periods ended September 30,
2007 and 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 ("MDA") 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 September 30, 2007, and
results of operations for the nine months and three months
ended September 30, 2007 and 2006, cash flows for the nine
months ended September 30, 2007 and 2006 and changes in
stockholders' equity for the nine months ended September 30,
2007, as applicable, have been made. The results of operations
for the nine and three months ended September 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.
During the 2007 quarter, we cut costs by approximately $1.4
million on an annualized basis. This was accomplished through
reductions in our work force, subletting a portion of our
office space and the renegotiation of our outsourced mailroom
contract. 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 continued 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 July 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 have adopted FIN 48
effective January 1, 2007 and there is no impact of adopting
FIN 48 on our consolidated financial statements to date.
Statement of Financial Accounting Standard 159, Fair Value
Option for Financial Assets and Financial Liabilities
("FAS 159")
In February 2007, the FASB issued SFAS No. 159, "The Fair
Value Option for Financial Assets and Financial Liabilities"
("SFAS No. 159"). SFAS No. 159 permits entities to choose to
measure, on an item-by-item basis, specified financial
instruments and certain other items at fair value. Unrealized
gains and losses on items for which the fair value option has
been elected are required to be reported in earnings at each
reporting date. SFAS No. 159 is effective for fiscal years
beginning after November 15, 2007, the provisions of which are
required to be applied prospectively. The Company expects to
adopt SFAS No. 159 in the first quarter of Fiscal 2008 and is
still evaluating the effect, if any, on its financial position
or results of operations.
NOTE 3 - STOCK-BASED COMPENSATION
The Company periodically issues common stock to employees,
non-employee consultants and non-employee independent
registered representatives in accordance with the provisions
of the following shareholder approved equity compensation
plans ("the Plans"):
2002 Stock Incentive Plan
The 2002 Incentive Stock Option Plan, which replaced the 1992
Incentive Stock Option Plan that expired in September 2002,
has reserved up to 5,000,000 shares of common stock for
issuance to employees, non-employee consultants and
non-employee registered representatives of the Company. Only
options issued to employees qualify for incentive stock option
treatment ("ISOs"). The Board of Directors determines the
terms and provisions of each award granted under the 2002
Plan, including the exercise price, term and vesting schedule.
In the case of ISO's, the per share exercise price must be
equal to at least 100% of the fair market value of a share of
common stock on the date of grant, and no individual will be
granted ISOs corresponding to shares with an aggregate fair
value in excess of $100,000 in any calendar year. The 2002
Incentive Stock Plan will terminate in 2012.
2002 Non-Executive Director Stock Option Plan
Under the 2002 Director Plan, which replaced the 1992
Non-Executive Director Stock Option Plan that expired in
September 2002, each non-executive director will automatically
be granted an option to purchase 20,000 shares, pro rata, on
September 1st of each year or partial year of service. The
2002 Director Plan does not contain a reserve for a specific
number of shares available for grant. Each option issued under
the 2002 Director Plan will be immediately vested
non-qualified stock options, and will have a five-year term
and an exercise price equal to 100% of the fair market value
of the shares subject to such option on the date of grant. The
2002 Director Plan will terminate in 2012.
7
1996 Senior Management Plan
In June 2000, the Company's stockholders approved an amendment
to the 1996 Senior Management Plan (the "1996 Plan") to
increase the number of shares reserved for issuance to key
management employees from 2,000,000 to 4,000,000 shares.
Awards can be granted through the issuance of incentive stock
rights, stock options, stock appreciation rights, limited
stock appreciation rights, and shares of restricted common
stock. The exercise price of an option designated as an ISO
may in no event be less than 100% of the then fair market
price of the stock (110% with respect to ten percent
stockholders), and not less than 85% of the fair market price
in the case of other options. The 1996 Plan terminated in June
2006.
The Plans provide for accelerated vesting if there is a change
in control as defined in the plans.
Accounting for Employee Awards:
Effective January 1, 2006, the Plans are accounted for in
accordance with the recognition and measurement provisions of
Statement of Financial Accounting Standards No. 123 (revised
2004), Share-Based Payment ("FAS 123(R)"), which replaces SFAS
No. 123, Accounting for Stock-Based Compensation ("FAS 123"),
and supersedes Accounting Principles Board Opinion No. 25
("APB 25"), Accounting for Stock Issued to Employees, and
related interpretations. FAS 123(R) requires compensation
costs related to share-based payment transactions, including
employee stock options, to be recognized in the financial
statements. In addition, the Company adheres to the guidance
set forth within Securities and Exchange Commission ("SEC")
Staff Accounting Bulletin No. 107, which provides the Staff's
views regarding the interaction between FAS 123(R) and certain
SEC rules and regulations and provides interpretations with
respect to the valuation of share-based payments for public
companies.
Prior to January 1, 2006, the Company accounted for similar
employee transactions in accordance with APB 25, which
employed the intrinsic value method of measuring compensation
cost. Accordingly, compensation expense was not recognized for
employee fixed stock options if the exercise price of the
option equaled or exceeded the fair value of the underlying
stock at the grant date. While FAS 123, for employee options,
encouraged recognition of the fair value of all stock-based
awards on the date of grant as expense over the vesting
period, companies were permitted to continue to apply the
intrinsic value-based method of accounting prescribed by APB
25 and disclose certain pro-forma amounts as if the fair value
approach of FAS 123 had been applied. In December 2002, FAS
No. 148, Accounting for Stock-Based Compensation-Transition
and Disclosure, an amendment of FAS 123, was issued, which, in
addition to providing alternative methods of transition for a
voluntary change to the fair value method of accounting for
stock-based employee compensation, required more prominent
pro-forma disclosures in both the annual and interim financial
statements. The Company complied with these disclosure
requirements for all applicable periods prior to January 1,
2006.
In adopting FAS 123(R), the Company applied the modified
prospective approach to the transition. Under the modified
prospective approach, the provisions of FAS 123(R) are to be
applied to new employee awards and to employee awards
modified, repurchased, or cancelled after the required
effective date. Additionally, compensation cost for the
portion of employee awards for which the requisite service has
not been rendered that are outstanding as of the required
effective date shall be recognized as the requisite service is
rendered on or after the required effective date. The
compensation cost for that portion of employee awards shall be
based on the grant-date fair value of those awards as
calculated for either recognition or pro-forma disclosures
under FAS 123.
8
As a result of the adoption of FAS 123(R), the Company's
results for the nine and three month periods ended September
30, 2007 include share-based compensation expense for employee
options and shares totaling approximately $6,200 and $937,
respectively. . The Company's results for the nine and three
month periods ended September 30, 2006 includes share-based
compensation expense for employee options and shares totaling
approximately $235,000 and $22,000, 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 and 2006 is
the estimated fair value of options granted amortized on a
straight-line basis over the requisite service period for the
entire portion of the award. The Company has not adjusted the
expense by estimated forfeitures, as required by FAS 123(R)
for employee options, since the forfeiture rate based upon
historical data was determined to be immaterial.
Accounting for Non-employee Awards:
The Company previously accounted for options granted to its
non-employee consultants and non-employee registered
representatives using the fair value cost in accordance with
FAS 123 and EITF No. 96-18. The adoption of FAS 123(R) and SAB
107 as of January 1, 2006, had no material impact on the
accounting for non-employee awards. The Company continues to
consider the additional guidance set forth in EITF Issue No.
96-18 ("EITF 96-18"), "Accounting for Equity Instruments That
Are Issued to Other Than Employees".
Stock compensation expense related to non-employee options was
approximately $32,000 and $590 for the nine month and three
month periods ended September 30, 2007 compared to
approximately $48,000 for the nine months ended September 30,
2006. For the three months ended September 30, 2006, the
Company had a $2,000 reversal due to the reduction in the
market price of the stock. 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:
------------------------- ------------------------------------------- -------------------------------------------
Nine Months Ended Three Months Ended
------------------------- ------------------------------------------- -------------------------------------------
------------------------- --------------------- --------------------- --------------------- ---------------------
September 30, 2007 September 30, 2006 September 30, 2007 September 30, 2006
---- ---- ---- ----
------------------------- --------------------- --------------------- --------------------- ---------------------
------------------------- --------------------- --------------------- --------------------- ---------------------
Expected volatility 66% 66% 66% 66%
------------------------- --------------------- --------------------- --------------------- ---------------------
------------------------- --------------------- --------------------- --------------------- ---------------------
Expected dividend yield 0% 0% 0% 0%
------------------------- --------------------- --------------------- --------------------- ---------------------
------------------------- --------------------- --------------------- --------------------- ---------------------
Risk-free interest rate 3.71%-4.54% 3.71%-5.10% 3.71%-4.54% 3.71%-4.59%
------------------------- --------------------- --------------------- --------------------- ---------------------
------------------------- --------------------- --------------------- --------------------- ---------------------
Expected term (in years) 1-5 years 0-5 years 1-5 years 0-4.5 years
------------------------- --------------------- --------------------- --------------------- ---------------------
The following table represents all of our stock options
granted, exercised and forfeited/expired during the first nine
months of 2007.
----------------------------- -------------- ------------------- -------------------- ------------------
Weighted
Weighted Average
Average Remaining Aggregate
Number Exercise Price Contractual Intrinsic
Stock Options of Shares per Share Term Value
----------------------------- -------------- ------------------- -------------------- ------------------
----------------------------- -------------- ------------------- -------------------- ------------------
Outstanding at
January 1, 2007 2,137,402 $0.79 2.5 92,954
----------------------------- -------------- ------------------- -------------------- ------------------
----------------------------- -------------- ------------------- -------------------- ------------------
Granted 412,000 $0.54
----------------------------- -------------- ------------------- -------------------- ------------------
----------------------------- -------------- ------------------- -------------------- ------------------
Exercised -- --
----------------------------- -------------- ------------------- -------------------- ------------------
----------------------------- -------------- ------------------- -------------------- ------------------
Forfeited/expired (607,602) $0.80
----------------------------- -------------- ------------------- -------------------- ------------------
----------------------------- -------------- ------------------- -------------------- ------------------
Outstanding at 1,941,800 $0.74 2.4 4,284
September 30, 2007
----------------------------- -------------- ------------------- -------------------- ------------------
----------------------------- -------------- ------------------- -------------------- ------------------
Exercisable at
September 30, 2007 1,556,240 $0.74 2.1 4,212
----------------------------- -------------- ------------------- -------------------- ------------------
The weighted average estimated fair value of all stock options
granted during the nine months ended September 30, 2007 and
2006 was $.54 and $0.59, respectively. The intrinsic value of
options exercised during the first nine months of 2007 and
2006 was $0 and $49,000, respectively. Cash received from the
exercise of all stock options in the first nine months of 2007
and 2006 was $0 and $22,000, 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 nine
months ended September 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 September 30, 2007 -- --
----------------------------------- -------------------------------- -----------------------------
The total fair value of shares vested during the nine months
ended September 30, 2007 and 2006, was $51,000 and $773,500,
respectively.
NOTE 4 - PREPAID EXPENSES
Prepaid expenses at September 30, 2007 include a payment for
errors and omissions insurance coverage. The unamortized
amount at September 30, 2007 is $249,000, which will be
written off over the next four months.
NOTE 5 - OTHER ASSETS
Other assets at September 30, 2007 include commissions
receivable due from vendors for insurance, mutual funds and
fees of $615,000 and deposits of $474,000.
NOTE 6 - ACCOUNTS PAYABLE
Accounts payable at September 30, 2007 includes an insurance
premium financing agreement with a current balance of
$148,000, payable in two remaining monthly installments of
$75,000 each, including interest at the rate of 5.87% per
annum and legal fees of $413,000.
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 2011.
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 $ 245,925
2008 853,911
2009 672,805
2010 61,407
2011 and beyond 18,627
---------
$1,852,675
=========
12
Master Services Agreement:
Effective November 2006, the Company entered into a master
services agreement with an outside vendor 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 per month thereafter. On October 12, 2007, the Company
received a letter from the vendor acknowledging delays in the
implementation of the development project and agreeing to
suspend billing to the Company beginning with the September
2007 payment. A resumption of payments would not begin until
mutually agreeable specific milestones and deliverables as
contained in a revised project plan are met. As of the filing
of this report, the revised project plan has not been
finalized. To date, the Company has paid $400,000 to the
vendor, which is included in other assets on the Condensed
Consolidated Statements of Financial Condition.
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. He
resigned on August 31, 2007, effective September 28, 2007. As
part of the negotiation of his existing employment contract he
received his 2007 bonus of $100,000.
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 (see below). 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 as CEO 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
remains employed in the capacity of President and Chief
Executive Officer of both the Company and FMSC.
Mr. Kurylak's employment contract has been renewed for one
year under the terms of the Amended Employment Agreement
previously filed.
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.
13
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.
SEC Proposed Settlement
The Company has recently resolved a regulatory investigation
by the SEC concerning FMSC's, and a former employee's failure
to reasonably supervise the securities trading and research
activities of a former institutional analyst. The
investigation covered the time period from March through
December 2003. It is anticipated that the SEC will issue an
Order Instituting Public Administrative and Cease-And-Desist
Proceedings and Impose Remedial Sanctions. The settlement will
result in the imposition of a censure and $100,000 fine
against FMSC, and a six month supervisory suspension and fine
of $50,000 against the Company's former president and CEO. The
settlement should be concluded in the fourth quarter of 2007
or the first quarter of 2008. The fine against the Company has
been accrued for in the third quarter of 2007.
NASD AWC
On September 14, 2007 FMSC entered into a Letter of
Acceptance, Waiver and Consent ("AWC") with the Financial
Industry Regulatory Authority ("FINRA", formerly the National
Association of Securities Dealers "NASD"). The AWC resolved an
investigation by the FINRA Staff into sales practice
activities of certain individuals who were formerly registered
representatives of FMSC, as well as the supervision of those
activities by FMSC. Without admitting or denying the
allegations set forth in the AWC, FMSC accepted FINRA's
findings and consented to a censure, paid a $175,000 and
agreed to an undertaking requiring a written certification by
a senior officer of the firm, reviewing the firm's systems and
procedures regarding its supervisory procedures, and training
and monitoring of supervisors.
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
14
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.
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 beneficially owned 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 a
new 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"), which
expired on August 14, 2007, without the Company exercising its
option. The June Settlement Agreement also provided that the
lease between an Okun affiliated entity and the Company shall
be deemed void ab initio.
15
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 September 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 September 30, 2007, it was not
possible to predict the outcome of these legal matters pending
against the Company.
NOTE 9 - LOSS PER SHARE
Basic loss per share for the nine and three months
ended September 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:
Nine months ended Three months ended
September 30 September 30
----------------- ------------------
2007 2006 2007 2006
---- ---- ---- ----
Numerator - basic:
Net loss $ (1,903,446) $ (112,041) $ (796,242) $ (119,994)
Deduct: preferred stock dividends ( 122,294) (126,204) ( 36,490) (42,866)
------------ --------- ----------- -----------
Numerator for basic loss $ (2,025,740) $ (238,245) $ (832,732) $ (162,860)
per share ============ =========== =========== ===========
Numerator - diluted:
Net loss $ (1,903,446) $ (112,041) $ (796,242) $ (119,994)
Add: preferred stock dividends (122,294) (126,204) ( 36,490) ( 42,866)
Add: convertible debenture
interest, net of tax ( 1,125) ( 34,902) ( 750) ( 375)
------------ ----------- ----------- -----------
Numerator for diluted $ (2,026,865) $ (273,147) $ (833,482) $ (163,235)
loss per share ============ =========== =========== ===========
Denominator:
Weighted average common
shares outstanding 16,439,992 16,531,580 13,245,477 18,382,826
Effect of dilutive securities:
Stock options and warrants -- -- -- --
Convertible preferred stock -- -- -- --
Nonvested employee stock -- -- -- --
Convertible debentures -- -- -- --
------------ ----------- ---------- ----------
Denominator for basic and
diluted loss per share 16,439,992 16,531,580 13,245,477 18,382,826
============ =========== ========== ==========
16
The following securities have been excluded from the dilutive
per share computation, as they are antidilutive:
------------------ ------------------------------- -----------------------------------------
Nine months ended Three months ended
September 30, September 30,
2007 2006 2007 2006
---- ---- ---- ----
------------------ --------------- --------------- -------------------- --------------------
------------------ --------------- --------------- -------------------- --------------------
Stock options 1,941,800 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 50,000
------------------ --------------- --------------- -------------------- --------------------
------------------ --------------- --------------- -------------------- --------------------
Convertible
preferred stock 44,564 2,588,978 44,564 2,588,978
------------------ --------------- --------------- -------------------- --------------------
------------------ --------------- --------------- -------------------- --------------------
Nonvested
employee stock -- 58,153 - 59,375
------------------ --------------- --------------- -------------------- --------------------
As required by FAS 128, "Earnings per Share", cumulative
preferred stock dividends for the nine months and three months
ended September 30, 2007 and 2006 were deducted from net loss
to arrive at the numerator for basic and diluted loss per
share.
NOTE 10 - TERMINATIONS
On August 31, 2007, Mr. Phillip P. D'Ambrisi resigned his
positions as Chief Operating Officer of the Company and
its wholly owned subsidiary, First Montauk Securities Corp.
("FMSC"). Mr. D'Ambrisi also resigned effective August 31,
2007 as a member of the board of directors of the Company and
FMSC.
Effective September 1, 2007, the Company and Mr. D'Ambrisi
entered into a consulting agreement ("Consulting Agreement")
pursuant to which Mr. D'Ambrisi will provide certain services
to the Company during the term of such Agreement. A copy of
the Consulting Agreement was filed as Exhibit 10.1 to the
Company's Report on Form 8-K on September 7, 2007.
On August 31, 2007, Mr. Jeffrey J. Fahs, resigned as Executive
Vice President, General Counsel and Secretary of the Company
and its subsidiaries effective as of September 28, 2007. As
part of the negotiation of his existing employment contract he
received his 2007 bonus of $100,000.
NOTE 11 - 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 September 30, 2007, FMSC had net capital of
$592,691, which was $342,691 in excess of its required net
capital of $250,000. FMSC's ratio of aggregate indebtedness to
net capital was 5.89 to 1.
NOTE 12 - 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:
17
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 (collective, 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.
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
18
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 214 registered
representatives and services approximately 48,000 retail and institutional
customers, which comprise approximately $3 billion in customer assets. All of
our 90 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, Financial Industry Regulatory Authority
(formerly 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 September 30, 2007 Compared to Three Months Ended
September 30, 2006
Revenues by Source
The following provides a breakdown of total revenues by source for the
three-month periods ended September 30, 2007 and 2006 (in thousands of dollars).
Three Months Ended
-----------------------------------------------------------------
------------------------------ --- ------------------------------
September 30, 2007 September 30, 2006
------------------------------ ------------------------------
% of Total % of Total
Commissions Amount Revenues Amount Revenues
Equities $ 2,932 31% $ 3,905 34%
Mutual Funds 1,437 15% 1,320 12%
Insurance 1,268 13% 1,584 14%
Alternative Products 965 10% 1,264 11%
Asset Management Fees 1,010 11% 980 9%
Fixed Income 96 1% 29 1%
-------------- --------------- -------------- ---------------
Total 7,708 81% 9,082 81%
Principal Transactions 307 3% 834 7%
Investment Banking 961 10% 597 5%
Interest and Other
Interest 456 5% 588 5%
Other 90 1% 173 2%
-------------- --------------- -------------- ---------------
Total 546 6% 761 7%
-------------- --------------- -------------- ---------------
Total revenues $ 9,522 100% $ 11,274 100%
============== =============== ============== ===============
Overview
Total revenues decreased $1.75 million, or 16%, for the three months
ended September 30, 2007 (the "2007 quarter"), to $9.52 million from $11.27
million for the three months ended September 20, 2006 (the "2006 quarter"). The
decrease in revenues is primarily attributable to a decline in the number of
producing registered representatives. There were decreases in several categories
of revenues, the largest coming from equity commissions and principal
transactions of $1.5 million. On the other hand, investment banking revenues
increased $364,000 in 2007 when compared to the comparable period in 2006.
Expenses decreased in the 2007 quarter by $1.1 million, or 10%,
compared to the 2006 quarter. Commission, employee compensation and benefits
decreased by $1.3 million, from $9.6 million in the 2006 quarter to $8.3 million
in the 2007 quarter.
The net loss applicable to common stockholders for the 2007 quarter was
$833,000, or ($0.06) per basic and diluted share compared to a net loss
applicable to common stockholders for the 2006 quarter of $163,000, or ($0.01)
per basic and diluted share.
21
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 $7.7 million compared to $9.1
million for the 2006 quarter, a decrease of approximately $1.4 million.
Decreases in commissions from the sale of equities of $1.0 million accounted for
the majority of the reduction in commission revenues. This decrease highlights
the result of the reduction in producing registered representatives' from the
2006 quarter to the 2007 quarter.
Principal Transactions
Principal transactions, which include mark-ups/mark-downs on customer
transactions in which we act as principal, proprietary trading, and the sale of
fixed income securities, decreased $528,000, or 63%, from $834,000 for the 2006
quarter to $306,000 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, rather than on a principal
basis.
Investment Banking
Investment banking revenues for the 2007 quarter increased $364,000
from $597,000 in the 2006 quarter, to $961,000 in the 2007 quarter, an increase
of approximately 61%. Investment banking revenue includes fees from private
offerings of securities for public companies, which is a function of the number
of the Company's corporate clientele needing financing for capital expansion. In
addition, the Company is constantly looking to expand the number of banking
clients. This category also includes 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 decreased by approximately $215,000 during
the 2007 period when compared to the 2006 period. Of the total decrease,
$132,000 was from the reduction in interest income. This decrease was directly
related to the amount of margin debit carried by customers.
Revenues received from vendors for marketing fees decreased by
approximately $99,000, due in large part to the reduction in alternative
investment products sold during the 2007 period.
Commissions, Employee Compensation and Benefits
Commission expense, consistently the largest expense category and
directly related to commission revenue, decreased 16%, or $1.34 million, from
$8.21 million for the 2006 quarter, to $6.87 million for the 2007 quarter.
Compensation and benefits expense for management, operations and clerical
personnel, which include salaries, severance payments, payroll taxes, stock and
option compensation, health insurance premiums, and bonus accruals, remained
constant during the 2007 quarter, at approximately $1.4 million.
Clearing and Floor Brokerage
Clearing and floor brokerage costs, which are greatly affected by
volume and type of transactions, decreased $81,000, to $335,000 in the 2007
quarter from $416,000 during the 2006 quarter. As a percentage of
transaction-based commissions, clearing costs remained relatively constant at
approximately 6.1%. Clearing costs, as a percentage of gross revenues, can
fluctuate depending upon the product mix.
22
Communications and Occupancy
Communications and occupancy costs decreased $59,000, from $486,000 in
the 2006 quarter to $427,000 in the 2007 period. In September 2006, we
terminated the lease on our NYC office, and therefore eliminated all of the
costs associated with that office including rent, market data services,
telephone and other office related expenses.
Legal matters and related costs
Legal matters and related settlement costs increased $77,000, from
$160,000 during the 2006 quarter to $237,000 for the 2007 quarter, most of which
was related to an increase in legal settlement costs of $63,000. In 2006, we
recorded a note due from two of our brokers who were named in a case we settled
in the same period. The estimated cost of this settlement was accrued for
earlier in 2006. As a result of recording the receivable due from the brokers,
the net legal settlement costs for the 2006 quarter was a credit of $45,000.
This compares to settlement costs of $9,000 in the 2007 period.
Other Operating Expenses
Other operating expenses increased $286,000 for the 2007 quarter.
During this quarter, the Company settled two ongoing investigations; one with
the SEC and the other with FINRA (see Note 8 -Commitments and Contingencies -
Legal Matters). The total fines and censures related to these two investigations
is $275,000 and were accrued for by the Company in August and September 2007.
Nine Months Ended September 30, 2007 Compared to Nine Months Ended
September 30, 2006
Revenues by Source
The following provides a breakdown of total revenues by source for the
nine-month periods ended September 30, 2007 and 2006 (in thousands of dollars).
Nine Months Ended
-----------------------------------------------------------------
------------------------------ --- ------------------------------
September 30, 2007 September 30, 2006
------------------------------ ------------------------------
% of
Total % of Total
Commissions Amount Revenues Amount Revenues
----------- ------ -------- ------ --------
Equities $ 9,801 31% $ 14,987 39%
Mutual Funds 4,729 15% 4,531 12%
Insurance 3,582 11% 3,774 10%
Alternative Products 3,579 11% 3,201 8%
Asset Management Fees 3,080 10% 2,884 8%
Fixed Income 171 1% 132 <1%
-------------- --------------- -------------- ---------------
Total 24,942 79% 29,509 77%
Principal Transactions 1,261 4% 3,319 9%
Investment Banking 3,440 11% 2,914 8%
Interest and Other
Interest 1,631 5% 1,915 5%
Other 437 1% 535 1%
-------------- --------------- -------------- ---------------
Total 2,068 6% 2,450 6%
-------------- --------------- -------------- ---------------
Total revenues $ 31,711 100% $ 38,192 100%
============== =============== ============== ===============
23
Overview
Overall, revenues decreased $6.4 million for the nine months ended
September 30, 2007 (the "2007 period"), to $31.7 million, compared to $38.1
million, for the nine months ended September 30, 2006 (the "2006 period").
Commission revenues decreased by $4.6 million while revenues from principal
transactions decreased by $2.1 million. The decrease in revenues is primarily
attributable to a decline in the number of producing registered 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. This was a result of an amendment of Exhibit A of the
clearing agreement signed by our wholly owned subsidiary, First Montauk
Securities Corp. ("FMSC") on June 29, 2006.
Expenses in the 2007 period decreased by approximately $4.69 million, a
decrease of 12% over the 2006 period. The 2006 period includes an $820,000
credit due to a partial allocation of the $1.0 million received from NFS in June
2006 and $951,000 of executive separation costs. Included in the 2007 decrease
are a reduction in commission, employee compensation and benefits of $4.2
million, from $31.7 million in the 2006 period to $27.5 million in the 2007
period and executive separation costs of $951,000.
Net loss applicable to shareholders in the 2007 period was $2,026,000,
or ($0.12) per basic and diluted share compared to a net loss applicable to
shareholders of $238,000, or ($0.01) per basic and diluted share for the same
period in 2006.
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 $4.6 million to $24.9 from
$29.5 million in the same period in 2006, 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
and principal transactions of $5.2 million, offset by increases in commissions
from alternative products, which include commissions on REIT's, 1031 exchanges
and oil & gas programs of $378,000, mutual funds of $198,000 and fees from
managed accounts of $196,000.
Principal Transactions
Principal transactions decreased $2.0 million, from $3.3 million for
the 2006 period to $1.3 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 $526,000 for the 2007 period,
from $2.9 million in the 2006 period, to $3.4 million in the 2007 period.
Investment banking revenue includes fees from private offerings of securities
for public companies, which is a function of the number of the Company's
corporate clientele needing financing for capital expansion. The Company is
constantly looking to expand the number of banking clients. This category also
includes 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 period decreased by $381,000
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. Of the total decrease, $299,000 was from the reduction in
interest income. Taking into consideration the $180,000 received from NFS, the
actual decrease would have been approximately $119,000. This decrease was
directly related to the amount of margin debit carried by customers.
Commissions, Employee Compensation and Benefits
Commission expense, consistently the largest expense category and
directly related to commission revenue, decreased 17%, or $4.6 million, from
$27.3 million for the 2006 period, to $22.7 million for the 2007 period.
Compensation and benefits expense for management, operations and clerical
personnel, which include salaries, severance payments, payroll taxes, stock and
option compensation, health insurance premiums, and bonus accruals, increased
for the 2007 period, to $4.8 million from $4.4 million, an increase of
approximately $400,000 over the 2006 period. Included in the 2007 period was
approximately $251,000 of severance costs for various personnel and bonus
accruals associated with employment contracts of $200,000.
24
Executive Separation
Executive separation costs decreased $951,266 for the 2007 period when
compared with the 2006 period. In February 2006, we 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 slightly from $1.11 million in the 2006
period to $1.13 in the 2007 period. 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 $1.66
million. Based on this adjustment, clearing and floor brokerage costs for 2007
would have decreased approximately $520,000 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 approximately $110,000,
from $1.37 million in the 2006 period to $1.26 million 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 $245,000. 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.
Legal matters and related costs
Legal matters and related settlement costs increased approximately
$450,000, from $772,000 during the 2006 period to $1.2 million for the 2007
period, most of which was related to legal fees. Legal fees during the first
nine months of 2007 were $1.15 million compared to $710,000 during the first
nine months of 2006. In 2006, we incurred $271,000 in legal fees in connection
with the anticipated acquisition of the Company by a private investor. In 2007,
we incurred $407,000, for legal fees related to various lawsuits involving the
termination of the proposed merger in December 2006 (See Note 8 - Commitments
and Contingencies - Legal Matters). The amount for the 2007 period was net of a
$600,000 reimbursement from our insurance carrier which was received in August
2007. Other legal fees include costs associated with the SEC investigation and
the resolution of the settlement with both the SEC and FINRA, as well as fees
associated with customer claims.
Other Operating Expenses
Other operating expenses increased approximately $175,000 for the 2007
period, from $2.3 million in the 2006 period to $2.5 million in the 2007 period.
During the 2007 quarter, the Company settled two regulatory inquiries; one with
the SEC and the other with FINRA (see Note 8 -Commitments and Contingencies -
Legal Matters).The total fines related to these two investigations is $275,000
and were accrued for by the Company in August and September 2007.
25
Liquidity and Capital Resources
Approximately 66% 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 increased during the nine months
ended September 30, 2007 by $181,000. Net cash provided by operating activities
during the 2007 period was $349,000, which consists of a net loss of $1,903,000,
increased by non-cash charges including depreciation of $89,000, amortization of
stock compensation and deferred costs of $38,000. Cash was increased by
decreases in the amount due from clearing firm, securities owned, and broker
receivables of $2.5 million, $30,000 and $70,000, respectively, and increases in
accounts payable of $616,000. Cash was decreased by an increase in prepaid
expenses, deposits and commissions receivable from outside vendors of $179,000,
$320,000 and $190,000, respectively and decreases in accrued expenses,
commissions payable and other liabilities of $235,000, $145,000 and $19,000,
respectively.
Additions to property and equipment of $46,000 accounted for the use of
cash from investing activities during the nine months ended September 30, 2007.
Financing activities used net cash of $123,000 due to the payment of
preferred stock dividends of $122,000 and capital leases of $820 during the
first nine months of 2007.
The financing agreement with AICCO Inc. for the renewal of our errors
and omissions insurance policy had a balance at September 30, 2007 of
approximately $148,000, payable in two remaining monthly installments of $74,781
each, including interest at the rate of 5.87% per annum.
During the 2007 quarter, we cut costs by approximately $1.4 million on
an annualized basis. This was accomplished through reductions in our work force,
subletting a portion of our office space and the renegotiation of our outsourced
mailroom contract. 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 continued 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.
Contractual Obligations
The Company has contractual obligations to make future payments in
connection with its short-term debt, severance payments and non-cancelable lease
and service 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) $ 25,296 $0 $0 $0 $25,296
Severance
payments (2) 50,000 16,668 0 0 66,668
Operating
leases 245,924 853,911 672,805 61,407 1,834,047
-------- -------- -------- ------- ----------
Total $321,220 $870,579 $672,805 $61,407 $1,926,011
======== ======== ======== ======= ==========
26
(1) Short-term debt in 2007 includes a convertible debenture in the amount of
$25,000 with accrued interest of $296, maturing on 12/11/07.
(2) Severance payments of $66,668 are due and owing to our former general
counsel. Payments are made semi-monthly at the rate of $16,667 per month
with the final payment due in January 2008.
Effective November 2006, we entered into a master services agreement
with an outside vendor 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. Under the agreement, we will pay $480,000 over an
initial 12 month period and then $20,000 a month thereafter. On October 12,
2007, the Company received a letter from the vendor acknowledging delays in the
implementation of the development project and agreeing to suspend billing to us
beginning with the September 2007 payment. A resumption of payments would not
begin until mutually agreeable specific milestones and deliverables as contained
in a revised project plan are met. As of the filing of this report, the revised
project plan has not been finalized.
Net Capital
At September 30, 2007, Montauk Financial Group had net capital of
$592,691, which was $342,691 in excess of its required net capital of $250,000,
and the ratio of aggregate indebtedness to net capital was 5.89 to 1.
Common Stock
On June 15, 2007, we 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. On June 15, 2007, the Okun affiliated entities surrendered
5,272,305 of their common share holdings. (See Note 8 - COMMITMENTS AND
CONTINGENCIES - 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-COMMITMENTS AND CONTINGENCIES- 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.
As of September 30, 2007, we have 22,282 Series A preferred shares
issued and outstanding. Quarterly dividends of $19,601 and $23,532 were paid
during the three months ended September 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 $16,889 and $20,000 were paid during the three months
ended September 30, 2007 and 2006, respectively.
27
Mr. Okun purchased all the shares of Series B in a private transaction
on February 23, 2007 at a price of $10.00 per share of Series B. On June 15,
2007, as part of the settlement with Mr. Okun and the Okun Defendants (See Note
8-COMMITMENTS AND CONTINGENCIES- Legal Matters-Termination of Merger Agreement;
Litigation and Settlement) an agreement was reached which required the parties
to surrender all shares of Series B previously owned by the Okun Defendants. On
June 15, 2007, 197,824 shares of Series B were surrendered and cancelled. There
are currently no shares of Series B 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.
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. During the quarter, the Company reduced expenses by
approximately $1.5 million annually. This included a reduction in the workforce,
subletting of office space, and renegotiating of outsourced office functions. 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
continued 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.
28
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.
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.
September 30, 2007 December 31, 2006
----------------------------------- ----------------------------------------
Securities Sold
Securities but not yet Securities Securities Sold but
Owned Purchased Owned not yet Purchased
--------------- ------------------- ------------------ ---------------------
Marketable:
Government $ 6,825 $ 0 $ 2,015 $ 0
Corporate 0 0 0 0
Municipal 0 0 0 0
Certificates of deposit 0 0 0
0
--------------- ------------------- ------------------ ---------------------
Total debt securities 6,825 0 2,015 0
Equity securities 91,863 0 97,941 495
Mutual funds 11 6,008 0
96
Options 425 0 0 0
Warrants 69,732 0 92,483 0
--------------- ------------------- ------------------ ---------------------
Total $168,941 $ 11 $198,447 $495
=============== =================== ================== =====================
29
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.
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.
30
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure based closely on the definition of "disclosure controls and
procedures" in Rule 13a-15(e). In designing and evaluating the disclosure
controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives, and management necessarily was
required to apply its judgment in designing and evaluating the controls and
procedures.
Based on their evaluation, as of September 30, 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 September 30, 2007, that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting.
31
PART II
OTHER INFORMATION
Item 1. Legal proceedings
SEC Proposed Settlement
The Company has recently resolved a regulatory investigation
by the SEC concerning FMSC's, and a former employee's failure to reasonably to
supervise the securities trading and research activities of a former
institutional analyst. The investigation covered the time period from March
through December 2003. It is anticipated that the SEC will issue an Order
Instituting Public Administrative and Cease-And-Desist Proceedings and Imposing
Remedial Sanctions. The settlement will result in the imposition of a censure
and $100,000 fine against FMSC, and a six month supervisory suspension and fine
of $50,000 against the Company's former president and C.E.O. The settlement
should be concluded in the fourth quarter of 2007 or the first quarter of 2008.
The fine against the Company has been accrued for in the third quarter of 2007.
NASD AWC
On September 14, 2007 FMSC entered into a Letter of Acceptance, Waiver
and Consent ("AWC") with the Financial Industry Regulatory Authority ("FINRA",
formerly the National Association of Securities Dealers "NASD"). The AWC
resolved an investigation by the FINRA Staff into sales practice activities of
certain individuals who were formerly registered representatives of FMSC, as
well as the supervision of those activities by FMSC. Without admitting or
denying the allegations set forth in the AWC, FMSC accepted FINRA's findings and
consented to a censure, paid a $175,000 and agreed to an undertaking requiring a
written certification by a senior officer of the firm, reviewing the firm's
systems and procedures regarding its supervisory procedures, and training and
monitoring of supervisors.
Termination of Merger Agreement, Litigation and Settlement
See Note 8 - COMMITMENTS AND CONTINGENCIES - 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.
32
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 with the Okun defendants. 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 remains employed in the capacity of President and Chief Executive
Officer of both the Company and FMSC. Mr. Kurylak's employment contract has been
renewed for one year under the terms of the Amended Employment Agreement
previously filed. 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 was filed as Exhibit 10.2 to the Company's Report on
Form 8-K filed on May 11, 2007, and Amendment No. 1 to the Amended Employment
Agreement, which was filed as Exhibit 10.3 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2007, filed on August 14, 2007.
33
Senior Employee Resignations
On August 31, 2007, Mr. Phillip P. D'Ambrisi resigned his positions as Chief
Operating Officer of the Company and its wholly owned subsidiary, First
Montauk Securities Corp. ("FMSC"). Mr. D'Ambrisi also resigned effective
August 31, 2007 as a member of the board of directors of the Company and FMSC.
Effective September 1, 2007, the Company and Mr. D'Ambrisi entered into a
consulting agreement ("Consulting Agreement") pursuant to which Mr. D'Ambrisi
will provide certain services to the Company during the term of such Agreement.
A copy of the Consulting Agreement was filed as Exhibit 10.1 to the Company's
Report on Form 8-K filed on September 7, 2007.
On August 31, 2007, Mr. Jeffrey J. Fahs, resigned as Executive Vice President,
General Counsel and Secretary of the Company and its subsidiaries effective as
of September 28, 2007. As part of the negotiation of his existing employment
contract he received his 2007 bonus of $100,000.
34
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 dated as of June 15, 2007 to the Amended and Restated Employment Agreement,
dated as of May 9, 2007 , between Victor K. Kurylak and First Montauk Financial Corp. (Filed as
Exhibit 10.3 to Form 10-Q for the Quarter ended June 30, 2007, dated August 14, 2007)
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
*10.4 Consulting Agreement, dated as of September 1, 2007, between
Philip D'Ambrisi and First Montauk Financial Corp. (Filed as
Exhibit 10.1 to Form 8-K dated September 6, 2007).
- ----------------- ----------------------------------------------------------------------------------------------------
- ----------------- ----------------------------------------------------------------------------------------------------
*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
- ----------------- ----------------------------------------------------------------------------------------------------
35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FIRST MONTAUK FINANCIAL CORP.
(Registrant)
Dated: November 14, 2007 /s/ Mindy A. Horowitz
---------------------------------------
Mindy A. Horowitz
Acting Chief Financial Officer
/s/ Victor K. Kurylak
---------------------------------------
Victor K. Kurylak
President and Chief Executive Officer
36