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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
SECURITIES EXCHANGE ACT OF 1934 FOR THE
|X| QUARTERLY PERIOD ENDED:
MARCH 31, 2008
|_| 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 a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company.
Large accelerated filer |_| Accelerated filer |_|
Non-accelerated filer |_| Smaller reporting company |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: 13,257,248 shares of common
stock were outstanding at May 15, 2008.
FIRST MONTAUK FINANCIAL CORP.
FORM 10-Q
MARCH 31, 2008
INDEX
Page
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Condensed Consolidated Statements of Financial Condition as of
March 31, 2008 (unaudited) and December 31, 2007 ............................................... F-1
Condensed Consolidated Statements of Operations for the Three
Months Ended March 31, 2008 (unaudited) and 2007 (unaudited).................................... F-2
Condensed Consolidated Statements of Changes in Stockholders' Equity
for the period from January 1, 2008 to March 31, 2008 (unaudited)................................ F-3 - F-4
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2008 (unaudited) and 2007 (unaudited) ................................................. F-5
Notes to Condensed Consolidated Financial Statements (unaudited................................... 6-15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ...................................................... 16-22
Item 3. Quantitative and Qualitative Disclosures About Market Risk ................................. 22-24
Item 4T. Controls and Procedures .................................................................... 24
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings .......................................................................... 25
Item 1A. Risk Factors ............................................................................... 25
Item 2. Unregistered Sales of Equity Securities .................................................... 25
Item 3. Defaults Upon Senior Securities ............................................................ 25
Item 4. Submission of Matters to a Vote of Security Holders ........................................ 25
Item 5. Other Information .......................................................................... 25
Item 6. Exhibits ................................................................................... 26
Signatures .......................................................................................... 27
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, December 31,
2008 2007
(unaudited)
ASSETS
Cash and cash equivalents $ 501,802 $ 868,836
Due from clearing firm 1,947,750 2,347,946
Securities owned, at market value 222,796 159,773
Prepaid expenses 841,798 250,948
Employee and broker receivables - net of reserve for bad debt
of $745,392 and $758,515 respectively 283,590 288,049
Property and equipment - net 157,131 175,463
Other assets 895,927 1,159,893
------------ -----------
Total assets $ 4,850,794 $ 5,250,908
============ ===========
LIABILITIES
10% convertible note 1,000,000 1,000,000
Securities sold, not yet purchased, at market value - 201
Commissions payable 1,402,120 1,739,713
Accounts payable 933,981 256,549
Accrued expenses 473,940 556,527
Income taxes payable 6,803 11,358
Other liabilities 53,096 51,528
------------- -----------
Total liabilities 3,869,940 3,615,876
------------- -----------
Commitments and contingencies
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 shares issued and outstanding; liquidation preference: $111,410 2,228 2,228
Series C Participating Cumulative Preferred Stock, 200,000 shares authorized,
$.10 par value, no shares issued and outstanding - -
Common stock, no par value, 60,000,000 shares authorized,
13,257,248 shares issued and outstanding 9,625,872 9,621,030
Additional paid-in capital 4,035,064 4,035,064
Accumulated deficit (12,682,310) (12,023,290)
----------- ------------
Total stockholders' equity 980,854 1,635,032
----------- -----------
Total liabilities and stockholders' equity $ 4,850,794 $ 5,250,908
=========== ===========
See notes to condensed consolidated financial statements.
F-1
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31,
2008 2007
(unaudited) (unaudited)
Commissions $ 6,086,004 $8,826,996
Principal transactions 455,072 594,416
Investment banking 436,620 2,010,488
Interest and other income 540,322 812,717
----------- ------------
Total revenues 7,518,018 12,244,617
----------- ------------
Expenses:
Commissions, employee compensation and benefits 6,244,348 10,748,070
Clearing and floor brokerage 323,057 407,560
Communications and occupancy 453,007 423,766
Legal matters and related costs 171,625 430,544
Other operating expenses 952,908 737,522
Interest 29,686 4,082
----------- -----------
Total expenses 8,174,631 12,751,544
----------- -----------
Loss before provision for income taxes (656,613) (506,927)
Provision for income taxes 736 10,621
------------ -----------
Net loss $ (657,349) $(517,548)
Preferred stock dividends (1,671) (42,903)
------------ -----------
Net loss applicable to common stockholders $ (659,020) $(560,451)
============ ===========
Loss per share:
Basic $ (0.05) $ (0.03)
Diluted $ (0.05) $ (0.03)
Weighted average number of shares of stock outstanding:
Basic 13,248,477 18,483,338
Diluted 13,248,477 18,483,338
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, 2008 TO MARCH 31, 2008
Series A Convertible Series B Convertible
Preferred Stock Preferred Stock Common Stock Additional
Shares Amount Shares Amount Shares Amount Paid-in Capital
Balances at January 1, 2008 22,282 $ 2,228 - $ - 13,257,248 $9,621,030 $ 4,035,064
Amortization of deferred compensation 4,842
Payment of preferred stock dividends
Net loss --------- ---------- ------------------- ---------- ----------- -------------
Balances at March 31, 2008 22,282 $ 2,228 - $ - 13,257,248 $9,625,872 $ 4,035,064
========= ========== ==================== ========== =========== =============
See notes to condensed consolidated financial statements.
F-3
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE PERIOD FROM JANUARY 1, 2008 TO MARCH 31, 2008
Retained
Earnings
(Accumulated Deferred Stockholders'
Deficit) Compensation Equity
Balances at January 1, 2008 $ (12,023,290) $ - $ 1,635,032
Amortization of deferred compensation 4,842
Payment of preferred stock dividends (1,671) (1,671)
Net loss (657,349) (657,349)
------------- -------------- -------------
Balances at March 31, 2008 $ (12,682,310) $ - $ 980,854
============= ============== ==============
See notes to condensed consolidated financial statements.
F-4
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31,
2008 2007
(unaudited) (unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (657,349) $(517,548)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization of property and equipment 18,332 37,783
Amortization of stock compensation and deferred costs 12,342 37,578
Increase (decrease) in cash attributable to changes in assets
and liabilities:
Due from clearing firm 400,196 531,873
Securities owned (63,023) (80,334)
Prepaid expenses (590,850) (535,336)
Employee and broker receivables 4,459 11,864
Other assets 256,466 (668,202)
Securities sold, not yet purchased (201) (484)
Commissions payable (337,593) 70,559
Accounts payable 677,432 537,873
Accrued expenses (82,587) (412,143)
Income taxes payable (4,555) 10,000
Other liabilities 1,568 97,796
--------------- -----------
NET CASH USED IN OPERATING ACTIVITIES (365,363) (878,721)
--------------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment - (5,148)
--------------- -----------
NET CASH USED IN INVESTING ACTIVITIES - (5,148)
--------------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of capital lease - (820)
Payment of preferred stock dividends (1,671) (42,903)
--------------- -----------
NET CASH USED IN FINANCING ACTIVITIES (1,671) (43,723)
--------------- -----------
Net decrease in cash and cash equivalents (367,034) (927,592)
Cash and cash equivalents at beginning of period 868,836 1,145,751
--------------- ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 501,802 $ 218,159
=============== ============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 27,768 $ 4,082
=============== ============
Income taxes $ 5,291 $ 2,306
=============== ============
See notes to condensed consolidated financial statements.
F-5
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - GOING CONCERN AND LIQUIDITY CONSIDERATIONS
The accompanying condensed consolidated financial
statements have been prepared assuming that the Company will
continue as a going concern, which contemplates, among
other things, the realization of assets and satisfaction of
liabilities in the normal course of business. As of March 31,
2008, the Company had an accumulated deficit, and working
capital of $935,000, which does not include the repayment of
the $1,000,000 convertible secured note (the "Note") due on
December 31, 2008. For the three months ended March 31, 2008,
the Company incurred a net loss of $657,349. Approximately
$338,000 of the current period loss is attributable to a
fraudulent activity loss due to a breach in our clearing
firm's Internet security (as described more fully in
Note 10-"Fradulent Activity Loss" in the Notes to Financial
Statements). The Company has filed a claim on its fidelity
bond and business insurance carrier, in an attempt to recoup
the loss sustained and other expenses related to this matter.
To date, the Company has been able to finance its operations
through cash generated from operations, issuance of common
shares and proceeds from its convertible secured note.
In order to meet its business objectives, the Company
will be required to raise additional financing and/or
renegotiate the repayment terms of its Note in order to fund
operational expenditures and repayment of the Note. There is
no assurance that the Company will be successful in obtaining
such funding or debt renegotiation on terms satisfactory to
the Company, if at all. If the Company cannot raise additional
financing and/or renegotiate the repayment terms of its Note,
the Company may not be able to continue as a going concern.
NOTE 2 - BASIS OF PRESENTATION
The interim financial information as of March 31, 2008 and for
the three months ended March 31, 2008 and March 31, 2007 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 for the
fiscal year ended December 31, 2007, previously filed with the
SEC on March 31, 2008.
In the opinion of management, all adjustments (which include
normal recurring adjustments) necessary for a fair
presentation of the financial position, have been made. The
results of operations for the three months ended March 31,
2008 are not necessarily indicative of the operating results
for the full fiscal year or any future periods.
NOTE 3 - RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements, which defines fair value, establishes a
framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair
value measurements. This statement does not require any new
fair value measurements, but provides guidance on how to
6
measure fair value by providing a fair value hierarchy used to
classify the source of the information. SFAS No. 157 is
effective for fiscal years beginning after November 15, 2007,
and all interim periods within those fiscal years. In February
2008, the FASB released FASB Staff Position (FSP FAS 157-2 -
Effective Date of FASB Statement No. 157) which delays the
effective date of SFAS No. 157 for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or
disclosed at fair value in the financial statements on a
recurring basis (at least annually), to fiscal years beginning
after November 15, 2008 and interim periods within those
fiscal years. The implementation of SFAS No. 157 for financial
assets and liabilities, effective January 1, 2008, did not
have an impact on the Company's financial position and results
of operations. The Company is currently evaluating the impact
of adoption of this statement on its non-financial assets and
liabilities in the first quarter of fiscal 2009.
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 adopted this
Statement as of January 1, 2008 and has elected not to apply
the fair value option to any of its financial instruments.
In December 2007, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 141 (revised 2007), Business Combinations, which
replaces SFAS No 141. The statement retains the purchase
method of accounting for acquisitions, but requires a number
of changes, including changes in the way assets and
liabilities are recognized in the purchase accounting. It also
changes the recognition of assets acquired and liabilities
assumed arising from contingencies, requires the
capitalization of in-process research and development at fair
value, and requires the expensing of acquisition-related costs
as incurred. SFAS No. 141R is effective for business
combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or
after December 15, 2008.
In December 2007, the FASB issued SFAS No. 160.
"Noncontrolling Interests in Consolidated Financial
Statements-and Amendment of ARB No. 51." SFAS 160 establishes
accounting and reporting standards pertaining to ownership
interests in subsidiaries held by parties other than the
parent, the amount of net income attributable to the parent
and to the noncontrolling interest, changes in a parent's
ownership interest, and the valuation of any retained
noncontrolling equity investment when a subsidiary is
deconsolidated. This statement also establishes disclosure
requirements that clearly identify and distinguish between the
interests of the parent and the interests of the
noncontrolling owners. SFAS 160 is effective for fiscal years
beginning on or after December 15, 2008. The adoption of SFAS
160 is not currently expected to have a material effect on the
Company's consolidated financial position, results of
operations, or cash flows.
In March 2008, the Financial Accounting Standards Board (FASB)
issued FASB Statement No. 161, Disclosures about Derivative
Instruments and Hedging Activities. The new standard is
intended to improve financial reporting about derivative
instruments and hedging activities by requiring enhanced
disclosures to enable investors to better understand their
effects on an entity's financial position, financial
performance, and cash flows. It is effective for financial
statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early application
encouraged. The company is currently evaluating the impact of
adopting SFAS. No. 161 on its financial statements.
7
NOTE 4 - 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 shareholder approved equity compensation plans.
The Company's results for the three month periods ended March
31, 2008 and March 31, 2007 includes share-based compensation
expense for employee options and shares totaling approximately
$1,680 and $4,400, 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 2008 and 2007 is
the estimated fair value of options granted amortized on a
straight-line basis over the requisite service period for the
entire portion of the award. The Company has not adjusted the
expense by estimated forfeitures, as required by FAS 123(R)
for employee options, since the forfeiture rate based upon
historical data was determined to be immaterial.
Accounting for Non-employee Awards:
The Company previously accounted for options granted to its
non-employee consultants and non-employee registered
representatives using the fair value cost in accordance with
FAS 123 and EITF No. 96-18. The adoption of FAS 123(R) and SAB
107, as of January 1, 2006, had no material impact on the
accounting for non-employee awards. The Company continues to
consider the additional guidance set forth in EITF Issue No.
96-18 ("EITF 96-18"), "Accounting for Equity Instruments That
Are Issued to Other Than Employees".
Stock compensation expense related to non-employee options was
approximately $3,160 for the three months ended March 31, 2008
compared to approximately $33,000 for the three months ended
March 31, 2007. 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 2008, the
Company took into consideration guidance under FAS 123(R) and
SEC Staff Accounting Bulletin No. 107 ("SAB 107") when
reviewing and updating assumptions. The expected volatility is
based upon historical volatility of our stock and other
contributing factors. The expected term is based upon
observation of actual time elapsed between date of grant and
exercise of options for all employees. Previously such
assumptions were determined based on historical data.
8
The assumptions made in calculating the fair values of all
options are as follows:
------------------------------------ -------------------------------------------------------------
------------------------------------------------------------
Three Months Ended
------------------------------------ -------------------------------------------------------------
------------------------------------ -------------------------------- ----------------------------
March 31, 2008 March 31, 2007
-------------- --------------
------------------------------------ -------------------------------- ----------------------------
------------------------------------ -------------------------------- ----------------------------
Expected volatility 64% 70%
------------------------------------ -------------------------------- ----------------------------
------------------------------------ -------------------------------- ----------------------------
Expected dividend yield 0% 0%
------------------------------------ -------------------------------- ----------------------------
------------------------------------ -------------------------------- ----------------------------
Risk-free interest rate 2.46%-4.54% 4.18%-4.54%
------------------------------------ -------------------------------- ----------------------------
------------------------------------ -------------------------------- ----------------------------
Expected term (in years) 1-5 years 1-5 years
------------------------------------ -------------------------------- ----------------------------
The following table represents all of our stock options
granted, exercised and forfeited/expired during the first
three months of 2008.
----------------------------- -------------- ------------------ --------------------- ------------------
Weighted Average Weighted Average
Number Exercise Price Remaining Aggregate
Stock Options of Shares per Share Contractual Term Intrinsic Value
------------- --------- --------- -------------------- ---------------
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Outstanding at
January 1, 2008 1,871,200 $0.73 2.2 0
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Granted 6,000 $0.50
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Exercised - -
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Forfeited/expired (106,000) $0.99
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Outstanding at 1,771,200 $0.72 1.9 0
March 31, 2008
----------------------------- -------------- ------------------ --------------------- ------------------
----------------------------- -------------- ------------------ --------------------- ------------------
Exercisable at
March 31, 2008 1,502,480 $0.71 1.6 0
----------------------------- -------------- ------------------ --------------------- ------------------
The weighted average estimated fair value of all share
options granted during the three months ended March 31, 2008
and 2007 was $0.04 and $0.27, respectively. There were no
stock options exercised during the first quarters of 2008 and
2007.
9
NOTE 5 - PREPAID EXPENSES
Prepaid expenses at March 31, 2008 include a payment for
errors and omissions insurance coverage. The unamortized
amount at March 31, 2008 is $622,000, which will be expensed
over the next ten months.
NOTE 6 - OTHER ASSETS
Other assets at March 31, 2008 is primarily comprised of
commissions' receivable due from vendors for insurance, mutual
funds and fees totaling approximately $399,000 and deposits
of approximately $418,000.
NOTE 7 - ACCOUNTS PAYABLE
Accounts payable at March 31, 2008 includes an insurance
premium financing agreement with a current balance of
$524,000, payable in seven remaining monthly installments of
approximately $75,000 each, including interest at the rate of
4.22% per annum and accounting and consulting fees of
$166,000.
NOTE 8 - CONVERTIBLE NOTE PURCHASE AGREEMENT
On December 7, 2007 the Company entered into a note purchase
agreement (the "Note Purchase Agreement") with AEFC-FMFK
Investment Corp. ("AEFC-IC") pursuant to which AEFC-IC was
issued a 10% Convertible Secured Note due on December 31, 2008
for an aggregate principal amount up to $2,000,000 (the
"AEFC-IC Note"). The AEFC-IC Note accrues interest on the
unpaid principal amount at the rate of 10% per annum, which
will be paid monthly in arrears on or before the 10th day of
the month following the interest accrual. The principal of the
AEFC-IC Note and all accrued and unpaid interest thereon will
be payable in full on December 31, 2008. The AEFC-IC Note is
convertible into shares of common stock at $0.35 per share, as
adjusted, beginning July 1, 2008 if the AEFC-IC Note is not
prepaid prior to such date. The AEFC-IC Note is prepayable at
any time prior to July 1, 2008 subject to an escalating
prepayment penalty based on the date of prepayment which is
payable by us in cash and the issuance of a warrant to
purchase shares of common stock at an exercise price of $0.35
per share, as adjusted. In the event the Company (i) does not
draw the full $2,000,000 principal amount available under the
AEFC-IC Note and (ii) the AEFC-IC Note has not been prepaid by
July 1, 2008, the Company will issue AEFC-IC a warrant to
purchase shares of common stock at an exercise price of $0.35
per share, as adjusted, for each one dollar of principal
amount available but not drawn upon under the AEFC-IC Note.
The parties also executed a registration rights agreement. At
March 31, 2008, the Company had $1,000,000 of outstanding
borrowings under the Note Purchase Agreement.
In connection with, and concurrent with, the execution of the
Note Purchase Agreement, the AEFC-IC Note and the related
documents, the Company entered into the First Amendment, dated
as of December 7, 2007 ("First Amendment to the Rights
Agreement"), of the Rights Agreement, dated August 1, 2007,
between us and Continental Stock Transfer & Trust Company, as
Rights Agent ("Rights Agreement") as more fully described
above. The First Amendment to the Rights Agreement provides
that AEFC-IC will not be deemed to be an "Acquiring Person"
under the Rights Agreement by reason of (i) the execution of
the AEFC-IC Note Purchase Agreement; (ii) the issuance of the
AEFC-IC Note; (iii) the issuance of shares of common stock
upon the conversion of the AEFC-IC Note into shares of our
common stock; (iv) the issuance of any warrants to AEFC-IC
pursuant to the Note Purchase Agreement or any shares of
common stock upon exercise of such warrants; (v) the purchase
by AEFC-IC of all or any of the 3,300,308 shares of common
stock owned by Mr. Okun or any affiliates of Mr. Okun
(collectively, the "Okun Parties"); (vi) the approval,
execution or delivery of any agreement with respect to the
purchase by AEFC-IC of all or any of the 3,300,308 shares of
common stock owned by the Okun Parties; (vii) the public or
other announcement of the Note Purchase Agreement or any of
the transactions contemplated thereby, or the purchase by
AEFC-IC of all or any of the 3,300,308 shares of common stock
owned by the Okun Parties; or (viii) the consummation of the
Note Purchase Agreement and any other transactions
contemplated by the Note Purchase Agreement or any agreement
to purchase all or any of the 3,300,308 shares of common stock
owned by the Okun Parties
10
The foregoing description of the First Amendment to the Rights
Agreement is qualified in its entirety by reference to the
full text of the First Amendment to the Rights Agreement which
is filed on Exhibit 10.2 to the Company's Report on Form 8-K
filed on December 13, 2007.
NOTE 9 - 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,
2008 $ 876,004
2009 890,552
2010 236,120
2011 35,091
2012 and beyond 7,983
-------------------
$ 2,045,750
===================
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. Under the terms of the
agreement, the Company made payments totaling $400,000 to the
vendor for software development, none of which has been
amortized or expensed and has been included as security
deposits in other assets on the Consolidated Statements of
Financial Condition (See also Note 14- Subsequent Event).
Legal Matters:
First Montauk Securities Corp. ("FMSC"), the Company's wholly
owned subsidiary 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.
As of March 31, 2008, the Company has accrued litigation costs
that are probable and can be reasonably estimated based on a
review of existing claims, arbitrations and unpaid
settlements. Management cannot give assurance that this amount
will be adequate to cover actual costs that may be
subsequently incurred. Further, it is not possible to predict
the outcome of other matters pending against us. All such
cases will continue to be vigorously defended.
11
SEC Order
The SEC issued a Cease-And-Desist Order ("Order") on April 24,
2008, which determined that the Company failed reasonably to
supervise the trading and research activities of a former
institutional analyst and that the Company failed to adopt
reasonable policies and procedures so as to prevent and detect
certain conduct, which led to the former institutional
trader's violations of federal securities laws. The order
involves conduct that occurred during the time period from
March through December 2003. The Order imposed a censure and
fine of $100,000 against the Company, and a six-month
supervisory suspension and fine of $50,000 against the
Company's former president and CEO. The Company's monetary
fine had been accrued for in 2007 and paid in April 2008.
NOTE 10 - FRAUDULENT ACTIVITY LOSS
On January 24, 2008, a series of fraudulent purchase order
transactions were executed over the order entry system of
National Financial Services ("NFS"), the Company's clearing
broker, through an Internet protocol ("IP") address over the
Internet, which reflected the user identification and password
information of one of FMSC's registered representatives. These
transactions were purchased without authorization in several
customer accounts of the registered representative.
After these transactions were executed, NFS contacted the
appropriate regulatory authorities to report the fraudulent
activities, which the regulatory authorities determined to let
stand. Thereafter, FMSC took market action to liquidate the
securities fraudulently purchased in order to mitigate the
loss to the Company. These transactions resulted in a net loss
to the Company of approximately $338,000, which is reflected
in other expenses in the Condensed Consolidated Statements of
Operation. The Company has filed a claim on its fidelity bond
and business insurance carrier, in an attempt to recoup the
loss sustained and other expenses related to this matter.
NOTE 11 - LOSS PER SHARE
Basic loss per share for the three months ended March 31, 2008
and 2007 is based on the weighted average number of shares of
common stock outstanding.
12
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 loss per share:
Three months ended March 31,
2008 2007
(unaudited) (unaudited)
Numerator - basic:
Net loss $(657,349) $(517,548)
Deduct: dividends paid during the year (1,671) (42,903)
----------------------- ----------------------
Numerator for basic loss per share $(659,020) $(560,451)
======================= ======================
Numerator - diluted:
Numerator for basic loss per share $(659,020) $(560,451)
Add: preferred stock dividends -- --
Add: convertible debenture interest -- --
----------------------- ----------------------
Numerator for diluted loss per share $(659,020) $(560,451)
======================= ======================
Denominator:
Weighted average common shares outstanding 13,248,477 18,483,338
Effect of dilutive securities:
Stock options and warrants -- --
Restricted shares -- --
Convertible preferred stock Series B -- --
Convertible debentures -- --
Denominator for diluted loss per share 13,248,477 18,483,338
The following securities have been excluded from the dilutive
per share computation, as they are antidilutive:
------------------------------------------- -------------------------------------------------------
Three months ended
------------------------------------------- -------------------------------------------------------
------------------------------------------- -------------------------------------------------------
March 31,
------------------------------------------- -------------------------------------------------------
------------------------------------------- --------------------------- ---------------------------
2008 2007
---- ----
------------------------------------------- --------------------------- ---------------------------
------------------------------------------- --------------------------- ---------------------------
------------------------------------------- --------------------------- ---------------------------
------------------------------------------- --------------------------- ---------------------------
Stock options 1,771,200 2,121,402
------------------------------------------- --------------------------- ---------------------------
------------------------------------------- --------------------------- ---------------------------
Warrants 283,518 407,518
------------------------------------------- --------------------------- ---------------------------
------------------------------------------- --------------------------- ---------------------------
Convertible debentures 2,857,143 25,000
------------------------------------------- --------------------------- ---------------------------
------------------------------------------- --------------------------- ---------------------------
Convertible preferred stock 44,564 2,588,978
------------------------------------------- --------------------------- ---------------------------
13
As required by FAS 128, "Earnings per Share", cumulative
preferred stock dividends for the three months ended March 31,
2008 and 2007 were deducted from net loss to arrive at the
numerator for basic and diluted loss per share.
NOTE 12 - 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 March 31, 2008, FMSC had net capital of
$713,778, which was $463,778 in excess of its required net
capital of $250,000. FMSC's ratio of aggregate indebtedness to
net capital was 3.00 to 1.
NOTE 13 - FAIR VALUE MEASUREMENTS
The Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 157, "Fair Value Measurements" ("SFAS
157") as of January 1, 2008. SFAS 157 defines fair value as
the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market
participants at the measurement date, not adjusted for
transaction costs. SFAS 157 also establishes a fair value
hierarchy that prioritizes the inputs to valuation techniques
used to measure fair value into three broad levels giving the
highest priority to quoted prices in active markets for
identical assets or liabilities (Level 1) and the lowest
priority to unobservable inputs (Level 3) as described below:
Level 1 Inputs -- Unadjusted quoted prices in active markets for
identical assets or liabilities that is
accessible by the Company;
Level 2 Inputs -- Quoted prices in markets that are not active
or financial instruments for which all
significant inputs are observable, either
directly or indirectly;
Level 3 Inputs -- Unobservable inputs for the asset or
liability including significant assumptions
of the Company and other market participants.
The Company determines fair values for the following assets
and liabilities:
Long-term investments, at fair value--The Company's long-term
investments, at fair value, consists of marketable equity
securities and investment securities--marked to market. The
Company's marketable equity securities are classified within
level 1 of the fair value hierarchy, as they are valued using
quoted market prices from an exchange. Investment securities,
marked to market consists of warrants and equity securities
received in connection with certain capital raising
transactions. Warrants are generally exercisable at the
respective offering price of the transaction. Such investments
are classified within level 3 of the fair value hierarchy as
the value is determined by management based on valuation
models and enterprise value, taking into consideration the
financial performance of the companies relative to
projections, trends within sectors, underlying business models
and expected exit timing and strategy.
Trading securities and trading account securities sold but not
yet purchased, at fair value--The Company's trading securities
and trading account securities sold but not yet purchased, at
fair value, are securities owned or sold by the Company's
broker-dealer subsidiaries and consist of marketable and
non-public equity and debt securities. The Company classifies
14
marketable equity and debt securities within level 1 of the
fair value hierarchy because quoted market prices are used to
value the securities. Non-public equity and debt securities
are classified within level 3 of the fair value hierarchy if
enterprise values are used to value the securities. In
determining the enterprise value, the Company analyzes various
financial, performance and market factors to estimate the
value, including where applicable market trading activity,
which may be reported by The PORTAL MarketSM, a subsidiary of
The NASDAQ Stock Market, Inc.
The following tables present our assets and liabilities that
are measured at fair value on a recurring basis and are
categorized using the fair value hierarchy. The fair value
hierarchy has three levels based on the reliability of the
inputs used to determine fair value.
Fair Value Measurements at Reporting Date Using
-----------------------------------------------------------
Quoted Prices in Significant
Active Markets for Significant Unobservable
Description March 31, Identical Assets Other Inputs
----------------------- --------------- ------------------------- -------------- ------------------
Assets: $-- $-- $-- $--
Securities Owned $222,796 $222,796
--------------- ------------------------- -------------- ------------------
Total Assets $222,796 $222,796 $-- $--
=============== ========================= ============== ==================
Liabilities $-- $-- $-- $--
--------------- ------------------------- -------------- ------------------
Total Liabilities $-- $-- $-- $--
=============== ========================= ============== ==================
NOTE 14 - SUBSEQUENT EVENT
On April 28, 2008, the Company signed a new agreement amending
the master services agreement with an outside vendor (See Note
9 - Commitments and Contingencies - Master Services Agreement)
in exchange for a reimbursement of a portion of the system
development costs paid by the Company. As part of this
Agreement, the vendor will provide a one-time electronic data
feed and commission collection services to the Company through
February 2010, which will be amortized over a twenty-three
(23) month period, beginning April 2008.
15
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Factors Affecting "Forward-Looking Statements"
From time to time, we may publish "forward-looking statements" within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities and Exchange Act of 1934, as amended, or make oral
statements that constitute forward-looking statements. These forward-looking
statements may relate to such matters as anticipated financial performance,
future revenues or earnings, business prospects, projected ventures, new
products, anticipated market performance, and similar matters. The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In order to comply with the terms of the safe
harbor, we caution readers that a variety of factors could cause our actual
results to differ materially from the anticipated results or other expectations
expressed in our forward-looking statements. These risks and uncertainties, many
of which are beyond our control, include, but are not limited to: (i)
transaction volume in the securities markets, (ii) the volatility of the
securities markets, (iii) fluctuations in interest rates, (iv) changes in
regulatory requirements which could affect the cost of doing business, (v)
fluctuations in currency rates, (vi) general economic conditions, both domestic
and international, (vii) changes in the rate of inflation and related impact on
securities markets, (viii) competition from existing financial institutions and
other new participants in the securities markets, (ix) legal developments
affecting the litigation experience of the securities industry, (x) the timely
completion of the acquisition of the Company by a private investor, and (xi)
changes in federal and state tax laws which could affect the popularity of
products sold by us. We do not undertake any obligation to publicly update or
revise any forward-looking statements. The reader is referred to our previous
filings with the SEC, including our Form 10-K for the year ended December 31,
2007.
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 180 registered
representatives and services over 45,000 retail and institutional customers,
which comprise approximately $3 billion in customer assets. All of our 93 branch
office and satellite locations in 24 states are owned and operated by
affiliates; who are independent representatives who maintain all appropriate
licenses and are responsible for all office overhead and expenses. Montauk
Financial Group also employs registered representatives directly at its
corporate headquarters.
Montauk Financial Group is registered as a broker-dealer with the SEC,
Financial Industry Regulatory Authority ("FINRA" and 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.
16
RESULTS OF OPERATIONS
Three Months Ended March 31, 2008 Compared to Three Months Ended March 31, 2007
Revenues by Source
The following provides a breakdown of total revenues by source for the
three-month periods ended March 31, 2008 and 2007 (in thousands of dollars).
Three Months Ended
-----------------------------------------------------------------
------------------------------ --- ------------------------------
March 31, 2008 March 31, 2007
------------------------------ ------------------------------
Amount % of Total Amount % of Total
Revenues Revenues
Commissions
Equities $ 2,502 34% $ 3,431 28%
Mutual Funds 1,082 14% 1,699 14%
Insurance 884 12% 1,085 9%
Alternative Products 475 6% 1,545 13%
Asset Management Fees 1,058 14% 1,044 9%
Fixed Income 85 1% 23 <1%
-------------- --------------- -------------- ---------------
Total 6,086 81% 8,827 73%
Principal Transactions 455 6% 594 5%
Investment Banking 437 6% 2,011 16%
Interest and Other
Interest 410 5% 582 5%
Other 130 2% 231 1%
-------------- --------------- -------------- ---------------
Total 540 7% 813 6%
-------------- --------------- -------------- ---------------
Total revenues $ 7,518 100% $ 12,245 100%
============== =============== ============== ===============
Overview
Total revenues decreased $4.72 million, or 39%, for the three months
ended March 31, 2008 (the "2008 quarter"), to $7.52 million from $12.24 million
for the three months ended March 31, 2007 (the "2007 quarter"). The decrease in
revenues is primarily attributable to a decline in the number of producing
registered representatives quarter over quarter, which resulted in decreases in
almost every category of revenue.
Expenses decreased in the 2008 quarter by $4.58 million, or 36%,
compared to the 2007 quarter. Commissions, employee compensation and benefits
decreased by $4.5 million, from $10.7 million in the 2007 quarter to $6.2
million in the 2008 quarter. Included in other operating expenses is a
fraudulent activity loss of approximately $338,000 that occurred in January 2008
(See Note 9 - Fraudulent Activity Loss in the Notes to the Condensed
Consolidated Financial Statements for more details).
The net loss attributable to common stockholders for the 2008 quarter
was $659,000, or ($0.05) per basic and diluted share compared to a net loss
applicable to common stockholders for the 2007 quarter of $560,000 or, ($0.03)
per basic and diluted share.
17
Commission Revenue
Commissions are comprised of revenues from transactions of equities,
fixed income, mutual funds, insurance, asset management fees and alternative
products. Commission revenue for the 2008 quarter was $6.1 million compared to
$8.8 million for the 2007 quarter, a decrease of approximately $2.7 million.
Decreases in commissions from equity transactions of $929,000, mutual funds of
$600,000 and alternative products of $1.1 million accounted for the majority of
the reduction in commission revenues when compared to the 2007 quarter. This
decrease highlights the result of the reduction in producing registered
representatives from the 2007 quarter to the 2008 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 approximately $140,000, from $594,000 for the
2007 quarter to $455,000 for the 2008 quarter, also as a result of the reduction
in registered representatives.
Investment Banking
Investment banking revenues for the 2008 quarter decreased $1.6 million
from $2 million in the 2007 quarter, to $437,000 in the 2008 quarter, a decrease
of 78%. The decrease in investment banking revenues is attributable to the
Company having completed a smaller number of investment banking transactions in
the first quarter of 2008 when compared to the same quarter in 2007. This
category 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 $273,000 during
the 2008 quarter when compared to the 2007 quarter. Of the total decrease,
$175,000 was from the reduction in interest income, directly related to margin
debit rebates and the reduction in interest rates.
Other income, which includes marketing and operations fees, decreased
by $185,000 when compared to the 2007 quarter. This was due in large part to the
reduction in alternative investment products sold during the 2008 quarter. This
reduction was partially offset by increases in rental income, due to the
subletting of part of our office space, settlement proceeds received from one of
our arbitration claims and revenue from consulting services provided during the
quarter.
Commissions, Employee Compensation and Benefits
Commission expense, consistently the largest expense category and
directly related to commission revenue, decreased 41%, or $3.6 million, from
$8.8 million for the 2007 quarter, to $5.2 million for the 2008 quarter.
Compensation and benefits expense for management, operations and clerical
personnel, which include salaries, severance payments, payroll taxes, health
insurance premiums, and bonus accruals, decreased for the 2008 quarter, from
$1.91 million (16% of total revenues) to $1.07 million (14% of total revenues),
a decrease of approximately $840,000 over the 2007 quarter. Included in the 2007
quarter were severance costs and bonus accruals of approximately $383,000,
compared to the same costs in the 2008 quarter of approximately $70,000, a
decrease of $313,000 in the 2008 quarter.
Clearing and Floor Brokerage
Clearing and floor brokerage costs which are greatly affected by volume
and type of transactions, decreased $85,000 in the 2008 quarter when compared to
the 2007 quarter. As a percentage of transaction-based commissions, clearing
costs remained relatively constant at approximately 7%. Clearing costs, as a
percentage of gross revenues, fluctuate depending upon the product mix.
Communications and Occupancy
Communications and occupancy costs increased slightly during the 2008
quarter, to $453,000, from $424,000 in the 2007 quarter.
18
Legal matters and related costs
Legal matters and related settlement costs decreased $259,000, from
$431,000 during the 2007 quarter to $172,000 for the 2008 quarter, most of which
was related to legal fees. During the 2007 quarter, we expensed $190,000 related
to various lawsuits involving a proposed merger that was terminated in December
2006. There were no legal fees related to this matter during the 2008 quarter.
Other Operating Expenses
Other operating costs increased approximately $215,000, to $953,000 in
the 2008 quarter from $738,000 during the 2007 quarter. Included in this
category for the 2008 quarter is approximately $338,000 of losses as a result of
fraudulent trading activity (See Note 9 - Fraudulent Activity Loss in the Notes
to the Condensed Consolidated Financial Statements for more details).
Liquidity and Capital Resources
Approximately 55% of our assets consist of cash, securities owned, and
receivables from our clearing firm and other broker-dealers and insurance
companies. The balances in these accounts can and do fluctuate significantly
from day to day, depending on general economic and market conditions, volume of
activity, and investment opportunities. These accounts are monitored on a daily
basis in order to ensure compliance with regulatory capital requirements and to
preserve liquidity.
Overall, cash and cash equivalents decreased during the three months
ended March 31, 2008 by $367,000. Net cash used in operating activities during
the 2008 quarter was $365,000, which consists of a net loss of $657,000,
increased by non-cash charges including depreciation of $18,000 and amortization
of stock compensation and deferred costs of $12,000. Cash was reduced by
increases in securities owned and prepaid expenses of $63,000 and $591,000,
respectively, and decreases in commissions payable and accrued expenses of
$338,000 and $82,000, respectively. Cash was increased by decreases in the
amount due from clearing firm of $400,000 and other assets of $255,000 and
increases in accounts payable of $677,000.
There were no additions to property and equipment during the three
months ended March 31, 2008.
Financing activities used net cash of $1,700 due to the payment of
preferred stock dividends during the first three months of 2008.
The financing agreement with AICCO Inc. for the renewal of our errors
and omissions insurance policy had a balance at March 31, 2008 of approximately
$524,000, payable in seven remaining monthly installments of approximately
$75,000 each, including interest at the rate of 4.22% per annum.
Future Cash Requirements and Uncertainties Regarding Our Liquidity
Future Cash Requirements
Our primary future cash requirements will be to repay the convertible
secured note payable and fund general operating costs of the Company, including
commissions and employee costs:
Other than funding our general operating costs, we specifically
expect our primary cash requirements for the remainder of 2008 to be impacted by
the following specific use of cash:
o Convertible secured note payments - In accordance with the terms
of the convertible note payable agreement with AEFC-FMFK
Investment Corporation ("AEFV-IC"), the Company will be
required to repay any outstanding principal balance and unpaid
interest on December 31, 2008. At anytime after July 1, 2008,
AEFC-IC has, at its discretion, the right to convert the
principal balance outstanding into shares of the Company's common
stock. At March 31, 2008, the convertible note had a $1,000,000
principal balance outstanding.
19
Uncertainties Regarding Our Liquidity
If we do not generate sufficient cash from operations, face unanticipated cash
needs or do not otherwise have sufficient cash and cash equivalents, we will
need to incur additional debt or issue equity. If we are unable to obtain
financing in the future and operations do not generate sufficient cash we
may be unable to continue as a going concern.
We believe the following uncertainties exist regarding our liquidity:
o Ability to Increase Revenue - Our ability to generate cash from
operating activities will be a primary source of our liquidity.
If our revenues were to decline, our ability to generate net cash
from operating activities in a sufficient amount to meet our cash
needs could be adversely affected. Our capacity to generate cash in
the future is subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond our
control.
o Legal Matters - The Company, in the normal course of business,
is subject to various legal proceedings. The costs associated with
legal defense services and possible unfavorable legal settlements
may negatively impact the Company's liquidity.
Recent Accounting Pronouncements
See Note 3 "Recent Accounting Pronouncements" in the Notes to Financial
Statements in Item 1 for a full description of recent accounting pronouncements,
including the expected dates of adoption and estimated effects on results of
operations and financial condition, which is incorporated herein.
Contractual Obligations
The Company has contractual obligations to make future payments in
connection with its short-term debt 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 2008 2009 2010 2011 Total
------------------------- --------------- -------------- ------------ ------------ ---------------
------------------------- --------------- -------------- ------------ ------------ ---------------
Short-term debt (1) $1,000,000
$0 $0 $0 $1,000,000
Operating leases 845,014 890,552 236,120 35,091 2,006,777
------------------------- --------------- -------------- ------------ ------------ ---------------
Total $1,845,014 $890,552 $236,120 $35,091 $3,006,777
========================= =============== ============== ============ ============ ===============
20
(1) Short-term debt includes a 10% convertible secured note in the amount
of $1,000,000 maturing on December 31, 2008.
Net Capital
At March 31, 2008, FMSC had net capital of $713,778, which was $463,778
in excess of its required net capital of $250,000. FMSC's ratio of aggregate
indebtedness to net capital was 3.00 to 1.
Series A Convertible Preferred Stock
In 1999, we issued 349,511 shares of Series A Convertible Preferred
Stock in an exchange offering related to a settlement with holders of certain
leases. Each share of the Preferred Stock is convertible into two shares of
common stock and pays a quarterly dividend of 6%.
As of March 31, 2008, we have 22,282 Series A preferred shares issued
and outstanding. Quarterly dividends of $1,671 and $22,903 were paid during the
three months ended March 31, 2008 and 2007, respectively.
Series C Participating Cumulative Preferred Stock
The Board of Directors of the Company adopted a shareholder rights plan
as of August 8, 2007 and in connection therewith designated a Series C
Participating Cumulative Preferred Stock, $.10 par value per share ("Series C
Stock"). The rights were declared as a dividend of one preferred share purchase
right for each outstanding share of the common stock of the Company. The
dividend distribution was payable on August 8, 2007 to shareholders of record on
that date. When exercisable, each right will entitle its holder to purchase from
the Company one one-hundredth of a share of the Company's new Series C Stock, at
a price of $2.00 per one one-hundredth of a share of Series C Stock, subject to
adjustment. The Company has created a series of 200,000 shares of authorized but
not issued preferred stock for the Series C Stock authorized in this shareholder
rights plan. No shares of Series C Stock are currently issued and outstanding.
The rights will become exercisable on the tenth business day (unless
further extended by a resolution adopted by a majority of the "continuing
directors" of our Board of Directors as of the close of business on August 9,
2007 (the date of our 2007 Annual Meeting) following public announcement that a
person or group of affiliated or associated persons has acquired or obtained the
right to acquire beneficial ownership of 10% or more of the common stock without
approval of a majority of the Board of Directors of the Company. The rights
expire on August 8, 2017 unless earlier redeemed or exchanged by the Company.
In the event the Company is acquired in a merger or other business
combination transaction after the rights become exercisable, each holder of a
right would be entitled to receive that number of shares of the acquiring
company's common stock equal to the result obtained by multiplying the then
current purchase price by the number one one-hundredths of a share of Series C
Stock for which a right is then exercisable and dividing that product by 50% of
the then current market price per share of the acquiring company.
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 2007 Annual Report filed on Form 10-K. Certain policies are
considered critical because they are highly dependent upon subjective or complex
judgments, assumptions and estimates. Changes in such estimates may have a
significant impact on the financial statements.
21
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. Quantitative and Qualitative Disclosures About Market Risk
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.
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, FMSC,
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.
22
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.
March 31, 2008 December 31, 2007
----------------------------------- ------------------------------------
Securities Securities
Sold but not Sold but not
Securities yet Securities yet
Owned Purchased Owned Purchased
------------------------------- ----------------- ----------------- ---------------- -------------------
Marketable:
Government $ 6,756 $ 0 $ 6,756 $ 0
Corporate 0 0 0 0
Municipal 0 0 0 0
Certificates of deposit 0 0 0 0
----------------- ----------------- ---------------- -------------------
Total debt securities 6,756 0 6,756 0
Equity securities 125,338 0 71,019 0
Mutual funds 9,849 0 9,463 201
Options 0 0 0 0
Warrants 80,853 0 72,535 0
----------------- ----------------- ---------------- -------------------
Total $ 222,796 $ 0 $ 159,773 $ 201
================= ================= ================ ===================
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.
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Legal Risk. Legal risk includes the risk of non-compliance with applicable legal
and regulatory requirements. We are subject to extensive regulation in the
different jurisdictions in which we conduct our business. We have various
procedures addressing issues such as regulatory capital requirements, sales and
trading practices, use of and safekeeping of customer funds, credit granting,
collection activities, anti money-laundering and record keeping.
Item 4T. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Acting
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure based closely on the definition of "disclosure controls and
procedures" in Rule 13a-15(e). In designing and evaluating the disclosure
controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives, and management necessarily was
required to apply its judgment in designing and evaluating the controls and
procedures.
Based on their evaluation, as of March 31, 2008, 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 March 31, 2008, that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
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PART II
OTHER INFORMATION
Item 1. Legal proceedings
SEC Order
The SEC issued a Cease-And-Desist Order ("Order") on April 24, 2008,
which determined that the Company failed reasonably to supervise the trading and
research activities of a former institutional analyst and that the Company
failed to adopt reasonable policies and procedures so as to prevent and detect
certain conduct, which led to the former institutional trader's violations of
federal securities laws. The order involves conduct that occurred during the
time period from March through December 2003. The Order imposed a censure and
fine of $100,000 against the Company, and a six-month supervisory suspension and
fine of $50,000 against the Company's former president and CEO. The Company's
monetary fine had been accrued for in 2007 and paid in April 2008.
Item 1A. Risk Factors
Not applicable
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Not applicable.
(b) Not applicable.
(c) Not applicable.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. Other Information
Not applicable.
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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.
- ----------------- ----------------------------------------------------------------------------------------------------
*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
- ----------------- ----------------------------------------------------------------------------------------------------
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FIRST MONTAUK FINANCIAL CORP.
(Registrant)
Dated: May 15, 2008 /s/ Mindy A. Horowitz
---------------------------------------------
Mindy A. Horowitz
Acting Chief Financial Officer
/s/ Victor K. Kurylak
---------------------------------------------
Victor K. Kurylak
President and Chief Executive Officer
27