10-Q 1 form10q331.txt FORM 10-Q FOR QUARTER ENDED MARCH 31, 2007 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 MARCH 31, 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: 18,526,553 shares of Common Stock were outstanding at May 15, 2007. FIRST MONTAUK FINANCIAL CORP. FORM 10-Q MARCH 31, 2007 INDEX Page PART I. FINANCIAL INFORMATION: Item 1. Financial Statements Condensed Consolidated Statements of Financial Condition as of March 31, 2007 (unaudited) and December 31, 2006 ............................................. F-1 Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2007 (unaudited) and 2006 (unaudited).................................. F-2 Condensed Consolidated Statements of Changes in Stockholders' Equity for the period from January 1, 2006 to March 31, 2007 (unaudited)............................. F-3-F-4 Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2007 (unaudited) and 2006 (unaudited) .............................................. F-5 Notes to Condensed Consolidated Financial Statements ........................................... 6-14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .................................................... 15-19 Item 3. Risk Management .......................................................................... 20 Item 4. Controls and Procedures .................................................................. 21 PART II. OTHER INFORMATION: Item 1. Legal Proceedings ....................................................................... 22 Item 1A. Risk Factors ............................................................................. 22 Item 2. Unregistered Sales of Equity Securities .................................................. 22 Item 3. Defaults Upon Senior Securities .......................................................... 22 Item 4. Submission of Matters to a Vote of Security Holders ...................................... 22 Item 5. Other Information ........................................................................ 22-23 Item 6. Exhibits ................................................................................. 24 Signatures ........................................................................................ 24
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION March 31, December 31, 2007 2006 (unaudited) ASSETS Cash and cash equivalents $ 218,159 $1,145,751 Due from clearing firm 4,456,874 4,988,747 Securities owned, at market value 278,782 198,447 Prepaid expenses 820,815 285,480 Employee and broker receivables - net of reserve for bad debt of $792,036 and $807,536 respectively 331,627 343,491 Property and equipment - net 206,399 239,033 Other assets 1,266,170 597,968 ----------- --------- Total assets $ 7,578,826 $7,798,917 =========== ========= LIABILITIES Accounts payable 851,300 313,427 Accrued expenses 783,284 1,195,426 Income taxes payable 14,167 4,167 Commissions payable 2,449,494 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 164,952 67,156 ----------- --------- Total liabilities 4,288,208 3,985,426 ----------- --------- Commitments and contingencies (See notes) STOCKHOLDERS' EQUITY Preferred stock, 3,929,898 shares authorized, $.10 par value, no shares issued and outstanding - - Series A convertible preferred stock, 625,000 shares authorized, $.10 par value 305,369 shares issued and outstanding; liquidation preference $1,526,845 30,537 30,537 Series B convertible redeemable preferred stock, 445,102 shares authorized, $.10 par value, 197,824 shares issued and outstanding, liquidation preference: $1,000,000 19,782 19,782 Common stock, no par value, 60,000,000 shares authorized, 18,526,553 shares issued and outstanding 11,684,198 11,646,620 Additional paid-in capital 1,930,810 1,930,810 Accumulated deficit (10,374,709) (9,814,258) ----------- ----------- Total stockholders' equity 3,290,618 3,813,491 ----------- ----------- Total liabilities and stockholders' equity $ 7,578,826 $7,798,917 =========== =========== 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, 2007 2006 (unaudited) (unaudited) Revenues: Commissions $ 8,826,996 $10,522,765 Principal transactions 594,416 1,364,554 Investment banking 2,010,488 745,561 Interest and other income 812,717 679,142 ----------- ------------ Total revenue 12,244,617 13,312,022 ----------- ------------ Expenses: Commissions, employee compensation and benefits 10,748,070 11,138,524 Executive separation - 951,366 Clearing and floor brokerage 407,560 639,914 Communications and occupancy 423,766 544,708 Legal matters and related costs 430,544 198,503 Other operating expenses 737,522 827,989 Interest 4,082 33,951 ----------- ------------ Total expenses 12,751,544 14,334,955 ----------- ------------ Loss before income taxes (506,927) (1,022,933) Provision for income taxes 10,621 20,861 ----------- ------------ Net loss (517,548) (1,043,794) Preferred stock dividends (42,903) (42,776) ----------- ------------ Net loss applicable to common stockholders $ (560,451) $ (1,086,570) =========== ============ Loss per share: Basic $ (0.03) $ (0.07) Diluted $ (0.03) $ (0.07) Weighted average number of shares of stock outstanding: Basic 18,483,338 15,335,937 Diluted 18,483,338 15,335,937 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 MARCH 31, 2007 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, 2006 305,369 $30,537 197,824 $19,782 15,937,407 $10,444,110 $1,930,810 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 30,537 197,824 19,782 18,526,553 11,646,620 1,930,810 Amortization of deferred compensation 37,578 Payment of preferred stock dividends Net loss for the period -------- ------- -------- ------- ----------- ----------- ----------- Balances at March 31, 2007 305,369 $30,537 197,824 $19,782 18,526,553 $11,684,198 $ 1,930,810 ======== ======= ======== ======= =========== =========== =========== 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, 2006 TO MARCH 31, 2007 Retained Earnings (Accumulated Deferred Stockholders' Deficit) Compensation Equity Balances at January 1, 2006 $(8,809,203) $(388,185) $ 3,227,851 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) - 3,813,491 Amortization of deferred compensation 37,578 Payment of preferred stock dividends (42,903) (42,903) Net loss for the period (517,548) (517,548) -------------- ---------- ------------- Balances at March 31, 2007 $ (10,374,709) $ - $ 3,290,618 ============== ========== ============= 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, 2007 2006 (unaudited) (unaudited) DECREASE IN CASH AND CASH EQUIVALENTS CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (517,548) $ (1,043,794) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization of property and equipment 37,783 78,536 Amortization of stock compensation and deferred costs 37,578 142,351 Note payable issued in connection with separation agreement - 327,234 Increase (decrease) in cash attributable to changes in assets and liabilities: Due from clearing firm 531,873 (784,688) Securities owned (80,334) (344,583) Prepaid expenses (535,336) (789,040) Employee and broker receivables 11,864 41,557 Income taxes receivable - - Other assets (668,202) (9,396) Securities sold, not yet purchased (484) 3,242 Commissions payable 70,559 411,139 Accounts payable 537,873 759,285 Accrued expenses (412,143) (241,819) Income taxes payable 10,000 (32,000) Other liabilities 97,796 63,855 ---------- ----------- NET CASH USED IN OPERATING ACTIVITIES (878,721) (1,418,121) ---------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (5,148) (5,307) ---------- ----------- NET CASH USED IN INVESTING ACTIVITIES (5,148) (5,307) ---------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Payment of capital lease (820) (2,235) Proceeds from exercise of incentive stock option - 8,604 Payment of preferred stock dividends (42,903) (42,776) ---------- ----------- NET CASH USED IN FINANCING ACTIVITIES (43,723) (36,407) ---------- ----------- Net decrease in cash and cash equivalents (927,592) (1,459,835) Cash and cash equivalents at beginning of period 1,145,751 1,990,815 ---------- ----------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 218,159 $ 530,980 ========== =========== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 4,082 $ 27,060 ========= =========== Income taxes $ 2,306 $ 61,308 ========= =========== Noncash financing activity: 6% convertible debentures converted into common stock $ - $ 30,000 Valuation of stock option grants $31,574 $ 39,546 See notes to condensed consolidated financial statements. F-5
6 FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION The interim financial information as of March 31, 2007 and for the three months ended March 31, 2007 and March 31, 2006 has been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although management believes that the disclosures made are adequate to provide for fair presentation. These condensed consolidated financial statements should be read in conjunction with the condensed consolidated financial statements and the notes thereto, included in the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 2006, previously filed with the SEC. In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of financial position as of March 31, 2007, and results of operations, cash flows and changes in stockholders' equity for the three months ended March 31, 2007 and 2006, as applicable, have been made. The results of operations for the three months ended March 31, 2007 are not necessarily indicative of the operating results for the full fiscal year or any future periods. NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENTS Financial Accounting Standards Board (FASB) No. 48, ---------------------------------------------------- Accounting for Uncertainty in Income Taxes ("FIN 48") ----------------------------------------------------- In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes--an interpretation of FASB Statement No. 109 (FIN 48), which provides clarification related to the process associated with accounting for uncertain tax positions recognized in consolidated financial statements. FIN 48 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. FIN 48 also provides guidance related to, among other things, classification, accounting for interest and penalties associated with tax positions, and disclosure requirements. We are required to, and have adopted FIN 48 effective January 1, 2007 and there is no impact of adopting FIN 48 on our condensed consolidated financial statements. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities", which permits entities to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. An entity would report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The decision about whether to elect the fair value option is applied instrument by instrument, with a few exceptions; the decision is irrevocable; and it is applied only to entire instruments and not to portions of instruments. SFAS No. 159 requires disclosures that facilitate comparisons (a) between entities that choose different measurement attributes for similar assets and liabilities and (b) between assets and liabilities in the financial statements of an entity that selects different measurement attributes for similar assets and liabilities. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Upon implementations, an entity shall report the effect of the first remeasurement to fair value as a cumulative effect adjustment to the opening balance of retained earnings. Since the provisions of SFAS No. 159 are applied prospectively, any potential impact will depend on the instruments selected for fair value measurement at the time of implementation. The Company is currently evaluating the impact of adopting this pronouncement on our condensed consolidated financial statements. 7 NOTE 3 - STOCK-BASED COMPENSATION The Company periodically issues common stock to employees, non-employee consultants and non-employee independent registered representatives in accordance with the provisions of the following shareholder approved equity compensation plans ("the Plans"): 2002 Stock Incentive Plan The 2002 Incentive Stock Option Plan, which replaced the 1992 Incentive Stock Option Plan that expired in September 2002, has reserved up to 5,000,000 shares of common stock for issuance to employees, non-employee consultants and non-employee registered representatives of the Company. Only options issued to employees qualify for incentive stock option treatment ("ISOs"). The Board of Directors determines the terms and provisions of each award granted under the 2002 Plan, including the exercise price, term and vesting schedule. In the case of ISO's, the per share exercise price must be equal to at least 100% of the fair market value of a share of common stock on the date of grant, and no individual will be granted ISOs corresponding to shares with an aggregate fair value in excess of $100,000 in any calendar year. The 2002 Incentive Stock Plan will terminate in 2012. 2002 Non-Executive Director Stock Option Plan Under the 2002 Director Plan, which replaced the 1992 Non-Executive Director Stock Option Plan that expired in September 2002, each non-executive director will automatically be granted an option to purchase 20,000 shares, pro rata, on September 1st of each year or partial year of service. The 2002 Director Plan does not contain a reserve for a specific number of shares available for grant. Each option issued under the 2002 Director Plan will be immediately vested non-qualified stock options, and will have a five-year term and an exercise price equal to 100% of the fair market value of the shares subject to such option on the date of grant. The 2002 Director Plan will terminate in 2012. 1996 Senior Management Plan In June 2000, the Company's stockholders approved an amendment to the 1996 Senior Management Plan (the "1996 Plan") to increase the number of shares reserved for issuance to key management employees from 2,000,000 to 4,000,000 shares. Awards can be granted through the issuance of incentive stock rights, stock options, stock appreciation rights, limited stock appreciation rights, and shares of restricted common stock. The exercise price of an option designated as an ISO may in no event be less than 100% of the then fair market price of the stock (110% with respect to ten percent stockholders), and not less than 85% of the fair market price in the case of other options. The 1996 Plan terminated in June 2006. The Plans provide for accelerated vesting if there is a change in control as defined in the plans. Accounting for Employee Awards: Effective January 1, 2006, the Plans are accounted for in accordance with the recognition and measurement provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment ("FAS 123(R)"), which replaces SFAS No. 123, Accounting for Stock-Based Compensation ("FAS 123"), and supersedes Accounting Principles Board Opinion No. 25 ("APB 25"), Accounting for Stock Issued to Employees, and related interpretations. FAS 123(R) requires compensation costs related to share-based payment transactions, including employee stock options, to be recognized in the financial statements. In addition, the Company adheres to the guidance set forth within Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 107, which provides the Staff's views regarding the interaction between FAS 123(R) and certain SEC rules and regulations and provides interpretations with respect to the valuation of share-based payments for public companies. 8 Prior to January 1, 2006, the Company accounted for similar employee transactions in accordance with APB 25, which employed the intrinsic value method of measuring compensation cost. Accordingly, compensation expense was not recognized for employee fixed stock options if the exercise price of the option equaled or exceeded the fair value of the underlying stock at the grant date. While FAS 123, for employee options, encouraged recognition of the fair value of all stock-based awards on the date of grant as expense over the vesting period, companies were permitted to continue to apply the intrinsic value-based method of accounting prescribed by APB 25 and disclose certain pro-forma amounts as if the fair value approach of FAS 123 had been applied. In December 2002, FAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FAS 123, was issued, which, in addition to providing alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation, required more prominent pro-forma disclosures in both the annual and interim financial statements. The Company complied with these disclosure requirements for all applicable periods prior to January 1, 2006. In adopting FAS 123(R), the Company applied the modified prospective approach to the transition. Under the modified prospective approach, the provisions of FAS 123(R) are to be applied to new employee awards and to employee awards modified, repurchased, or cancelled after the required effective date. Additionally, compensation cost for the portion of employee awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is rendered on or after the required effective date. The compensation cost for that portion of employee awards shall be based on the grant-date fair value of those awards as calculated for either recognition or pro-forma disclosures under FAS 123. As a result of the adoption of FAS 123(R), the Company's results for the three month periods ended March 31, 2007 and March 31, 2006 includes share-based compensation expense for employee options and shares totaling approximately $4,400 and $48,000, respectively. Such amounts have been included in the condensed consolidated statements of operations within commissions, employee compensation and benefits. No income tax benefit has been recognized in the income statement for share-based compensation arrangements as the Company has provided for a 100% valuation allowance on net deferred tax assets. Employee stock option compensation expense in 2007 is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for the entire portion of the award. The Company has not adjusted the expense by estimated forfeitures, as required by FAS 123(R) for employee options, since the forfeiture rate based upon historical data was determined to be immaterial. Accounting for Non-employee Awards: The Company previously accounted for options granted to its non-employee consultants and non-employee registered representatives using the fair value cost in accordance with FAS 123 and EITF No. 96-18. The adoption of FAS 123(R) and SAB 107, as of January 1, 2006, had no material impact on the accounting for non-employee awards. The Company continues to consider the additional guidance set forth in EITF Issue No. 96-18 ("EITF 96-18"), "Accounting for Equity Instruments That Are Issued to Other Than Employees". Stock compensation expense related to non-employee options was approximately $33,000 for the three months ended March 31, 2007 compared to approximately $37,000 for the three months ended March 31, 2006. These amounts are included in the condensed consolidated statements of operations within commissions, employee compensation and benefits. 9 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. The assumptions made in calculating the fair values of all options are as follows: ------------------------------------ ------------------------------------------------------------- ------------------------------------------------------------ Three Months Ended ------------------------------------ ------------------------------------------------------------- ------------------------------------ -------------------------------- ---------------------------- March 31, 2007 March 31, 2006 -------------- -------------- ------------------------------------ -------------------------------- ---------------------------- ------------------------------------ -------------------------------- ---------------------------- Expected volatility 70% 68% ------------------------------------ -------------------------------- ---------------------------- ------------------------------------ -------------------------------- ---------------------------- Expected dividend yield 0% 0% ------------------------------------ -------------------------------- ---------------------------- ------------------------------------ -------------------------------- ---------------------------- Risk-free interest rate 4.18%-4.54% 3.71%-4.82% ------------------------------------ -------------------------------- ---------------------------- ------------------------------------ -------------------------------- ---------------------------- 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 2007. ----------------------------- ------------- ------------------- -------------------- ------------------- Number Weighted Average Weighted Average of Exercise Price Remaining Aggregate Stock Options Shares per Share Contractual Term Intrinsic Value ----------------------------- ------------- ------------------- -------------------- ------------------- ----------------------------- ------------- ------------------- -------------------- ------------------- Outstanding at January 1, 2007 2,137,402 $0.79 2.5 92,954 ----------------------------- ------------- ------------------- -------------------- ------------------- ----------------------------- ------------- ------------------- -------------------- ------------------- Granted 243,000 $0.60 ----------------------------- ------------- ------------------- -------------------- ------------------- ----------------------------- ------------- ------------------- -------------------- ------------------- Exercised - - ----------------------------- ------------- ------------------- -------------------- ------------------- ----------------------------- ------------- ------------------- -------------------- ------------------- Forfeited/expired (259,000) $0.84 ----------------------------- ------------- ------------------- -------------------- ------------------- ----------------------------- ------------- ------------------- -------------------- ------------------- Outstanding at 2,121,402 $0.77 2.7 25,058 March 31, 2007 ----------------------------- ------------- ------------------- -------------------- ------------------- ----------------------------- ------------- ------------------- -------------------- ------------------- Exercisable at March 31, 2007 1,754,602 $0.75 2.5 24,780 ----------------------------- ------------- ------------------- -------------------- -------------------
The weighted-average grant date fair value of all share options granted during the three months ended March 31, 2007 and 2006 was $0.27 and $0.59, respectively. The intrinsic value of all stock options exercised during the first quarters of 2007 and 2006 was $0 and $56,000, respectively. Cash received from the exercise of all stock options in the first three months of 2007 and 2006 was $0 and $8,604, 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 three months ended March 31, 2007: ----------------------------------- -------------------------------- ----------------------------- Nonvested Shares Shares Weighted-Average Grant-Date Fair Value ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Nonvested January 1, 2007 100,000 $0.57 ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Granted -- -- ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Vested (100,000) $0.57 ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Forfeited -- -- ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Nonvested March 31, 2007 -- -- ----------------------------------- -------------------------------- -----------------------------
The total fair value of shares vested during the three months ended March 31, 2007 and 2006, was $51,000 and $430,000, respectively. NOTE 4 - PREPAID EXPENSES Prepaid expenses at March 31, 2007 include a payment for errors and omissions insurance coverage. The unamortized amount at March 31, 2007 is $622,000, which will be written off over the next ten months. NOTE 5 - OTHER ASSETS Other assets include receivables for underwriting fees of $977,000 and security deposits of $289,000. NOTE 6 - ACCOUNTS PAYABLE Accounts payable at March 31, 2007 includes an insurance premium financing agreement with a current balance of $585,000, payable in eight remaining monthly installments of $74,781 each, including interest at the rate of 5.87% per annum. 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). 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). 11 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 - 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 Investigation The SEC is investigating whether FMSC, and/or certain former employees failed reasonably to supervise the securities trading and research activities of a former analyst. The investigation covered the time period from approximately March 2000 until January 2004 when the analyst resigned. The SEC has recently advised us that it intends to recommend bringing an enforcement proceeding against FMSC, one of its former principals and another former employee for failing to supervise reasonably. The SEC will be seeking a monetary penalty and an order suspending the former principal from acting in a supervisory capacity for a period of time. FMSC is entitled to make a Wells submission to the SEC staff and intends to make such a submission or otherwise attempt to negotiate a resolution with the SEC. It is believed that any resolution will include a monetary penalty which will not have a materially adverse effect on our financial statements. NASD Enforcement Sales Practice Investigation The NASD Department of Enforcement is conducting an investigation of the sales practice activities of certain individuals who were formerly registered representatives of FMSC, as well as the supervision of those activities by FMSC. On April 9, 2007, NASD notified FMSC through a "Wells call" that it intends to file an administrative action against it in connection with an alleged failure to reasonably supervise the activities of three former registered representatives of FMSC. NASD has indicated that it will be seeking a monetary penalty and certain undertakings by FMSC. FMSC is entitled to make a Wells submission to the NASD Staff and currently intends to make such a submission or otherwise attempt to negotiate a resolution with NASD. It is believed that any resolution will include a monetary penalty which will not have a materially adverse effect on our financial statements. 12 Termination of Merger Agreement, Litigation; and Settlement ----------------------------------------------------------- On December 29, 2006, the Company received notification from representatives of the Okun Purchasers that they were terminating the merger agreement and not proceeding with the merger. They alleged the Company's failure to satisfy conditions and the Company's alleged breach of various representations, warranties, covenants and agreements in the merger agreement. On January 8, 2007, the Company filed a lawsuit in the Supreme Court of New Jersey, Monmouth County, Chancery Division against the Okun Purchasers, Mr. Okun, IPofA and several other affiliated entities which Mr. Okun controls (collectively, the "Okun Defendants"). The purpose of this lawsuit was to enforce the terms of the merger pursuant to the merger agreement executed on May 5, 2006. Pursuant to the merger agreement shareholders of the Company's common stock would have received $1.00 in cash for each share of common stock. The lawsuit alleged, among other things, that the Okun Purchasers breached the merger agreement by terminating the agreement on December 29, 2006 without cause or justification. The Company's complaint demands 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 now beneficially own 52.8% of the Company's voting securities. According to the amended Schedule 13D, additional shares of the Company's common stock were purchased in privately negotiated transactions for $1.00 per share and the 197,824 shares of Series B Redeemable Convertible Preferred Stock ("Series B Preferred Stock") outstanding were purchased for $10.00 per share. Each share of Series B Preferred Stock is convertible into 10 shares of common stock. The Series B Preferred Stock and certain of the shares of common stock were purchased from two of the Company's former officers and directors. (See Note 7- 13 On May 9, 2007, the Company announced that it had reached an agreement with Mr. Okun and the Okun Defendants ("Settlement Agreement") to settle the three separate lawsuits arising out of the termination of the merger agreement. Under the Settlement Agreement, Louis J. Rogers, formerly of Triple Net Properties LLC, will become the Chief Executive Officer and a director of the Company. Victor K. Kurylak, the Company's current Chief Executive Officer, will remain as President of the Company and also as President and Chief Executive Officer of First Montauk Securities Corp., the broker-dealer subsidiary of the Company. In addition, Mr. Okun, through affiliates, has agreed to invest an additional $2,000,000 in the Company through the purchase of preferred stock or convertible debt directly from the Company within 90 days after approval of the Settlement Agreement by the Federal District Court, District of New Jersey. According to the terms of the Settlement Agreement, a Put Option will be issued to all Company shareholders other than the Okun affiliates. The Put Option is designed to allow the remaining minority shareholders of the Company to sell their shares to an Okun affiliate for $1.00 per common share of the Company, the original purchase price under the merger agreement, in 18 months. However, if the market price of the Company's common shares exceeds $1.25 per share for 45 days in any 60 trading day period during the 18 months with daily volume greater than 75,000 shares, and certain other conditions are satisfied, the Put Options will terminate. The Put Options are nontransferable and subject to various other terms and conditions. The Put Options will be issued on a record date to be determined by the parties to the settlement. Upon Mr. Okun's investment of the $2,000,000 within 90 days, the Company's board of directors will increase the number of directors on the board by three members and fill these newly created directorships with three additional persons to be nominated by Mr. Okun. The existing independent directors of the Company will continue to serve until the next annual meeting but will not stand for reelection. The next annual meeting will be rescheduled from the previously announced date of June 22, 2007 to a date to be determined later in the year. On May 11, 2007, the Company filed with the SEC a Form 8-K relating to the settlement, the Put Option, the investment of $2 million by Mr. Okun, and the appointment of Mr. Rogers as Chief Executive Officer and a director of the Company. The foregoing description of the 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. As of March 31, 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 March 31, 2007, it was not possible to predict the outcome of these legal matters pending against the Company. 14 NOTE 9 - LOSS PER SHARE Basic loss per share for the three months ended March 31, 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 loss per share: ------------------------------------------------- ------------------------------------------------- Three months ended March 31, ------------------------------------------------- ------------------------------------------------- ------------------------------------------------- ----------------------- ------------------------- 2007 2006 ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- (unaudited) (unaudited) ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- Numerator - basic and diluted: ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- Net loss $(517,548) $(1,043,794) ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- Deduct: Preferred stock dividends (42,903) (42,776) ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- Numerator for basic and diluted loss per share $(560,451) $(1,086,570) ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- ------------------------------------------------- ----------------------- ------------------------- Denominator for basic and diluted loss per 18,483,338 15,335,937 share (weighted average) ------------------------------------------------- ----------------------- ------------------------- The following securities have been excluded from the dilutive per share computation, as they are antidilutive: ------------------------------------------- ------------------------------------------------------- Three months ended ------------------------------------------- ------------------------------------------------------- ------------------------------------------- ------------------------------------------------------- March 31, ------------------------------------------- ------------------------------------------------------- ------------------------------------------- --------------------------- --------------------------- 2007 2006 ---- ---- ------------------------------------------- --------------------------- --------------------------- ------------------------------------------- --------------------------- --------------------------- ------------------------------------------- --------------------------- --------------------------- ------------------------------------------- --------------------------- --------------------------- Stock options 2,121,402 2,323,402 ------------------------------------------- --------------------------- --------------------------- ------------------------------------------- --------------------------- --------------------------- Warrants 407,518 464,724 ------------------------------------------- --------------------------- --------------------------- ------------------------------------------- --------------------------- --------------------------- Convertible debentures 25,000 2,440,000 ------------------------------------------- --------------------------- --------------------------- ------------------------------------------- --------------------------- --------------------------- Convertible preferred stock 2,588,978 2,588,978 ------------------------------------------- --------------------------- --------------------------- ------------------------------------------- --------------------------- --------------------------- Nonvested employee stock -- 516,669 ------------------------------------------- --------------------------- ---------------------------
As required by FAS 128, "Earnings per Share", cumulative preferred stock dividends for the three months ended March 31, 2007 and 2006 were deducted from net loss to arrive at the numerator for basic and diluted loss per share. 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Factors Affecting "Forward-Looking Statements" From time to time, we may publish "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, or make oral statements that constitute forward-looking statements. These forward-looking statements may relate to such matters as anticipated financial performance, future revenues or earnings, business prospects, projected ventures, new products, anticipated market performance, and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, we caution readers that a variety of factors could cause our actual results to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. These risks and uncertainties, many of which are beyond our control, include, but are not limited to: (i) transaction volume in the securities markets, (ii) the volatility of the securities markets, (iii) fluctuations in interest rates, (iv) changes in regulatory requirements which could affect the cost of doing business, (v) fluctuations in currency rates, (vi) general economic conditions, both domestic and international, (vii) changes in the rate of inflation and related impact on securities markets, (viii) competition from existing financial institutions and other new participants in the securities markets, (ix) legal developments affecting the litigation experience of the securities industry, (x) the timely completion of the acquisition of the Company by a private investor, and (xi) changes in federal and state tax laws which could affect the popularity of products sold by us. We do not undertake any obligation to publicly update or revise any forward-looking statements. The reader is referred to our previous filings with the Commission, including our Form 10-K/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 237 registered representatives and services approximately 48,000 retail and institutional customers, which comprise over $3 billion in customer assets. All of our 102 branch office and satellite locations in 24 states are owned and operated by affiliates; who are independent representatives who maintain all appropriate licenses and are responsible for all office overhead and expenses. Montauk Financial Group also employs registered representatives directly at its corporate headquarters. Montauk Financial Group is registered as a broker-dealer with the Securities and Exchange Commission, the National Association of Securities Dealers, the Municipal Securities Rule Making Board, the National Futures Association, and the Securities Investor Protection Corporation and is licensed to conduct its brokerage activities in all 50 states, the District of Columbia, and the Commonwealth of Puerto Rico, and registered as an International broker-dealer to conduct business with institutional clients in the province of Ontario, Canada. Securities transactions are cleared through National Financial Services LLC ("NFS") of Boston, MA, and Penson Financial Services Inc of Dallas, TX, with various floor brokerage and specialist firms also providing execution services. These arrangements provide Montauk Financial Group with back office support and transaction processing services on all principal, national and international securities exchanges, and access to many other financial services and products which allows Montauk Financial Group to offer products and services comparable to larger brokerage firms. 16 RESULTS OF OPERATIONS Three Months Ended March 31, 2007 Compared to Three Months Ended March 31, 2006 Revenues by Source The following provides a breakdown of total revenues by source for the three-month periods ended March 31, 2007 and 2006 (in thousands of dollars). Three Months Ended ----------------------------------------------------------------- ------------------------------ --- ------------------------------ March 31, 2007 March 31, 2006 ------------------------------ ------------------------------ Amount % of Total Amount % of Total Revenues Revenues Commissions Equities $ 3,431 28% $ 6,335 48% Mutual Funds 1,699 14% 1,601 12% Insurance 1,085 9% 1,110 8% Alternative Products 1,545 13% 564 4% Asset Management Fees 1,044 9% 895 7% Fixed Income 23 <1% 18 <1% ---------- -------- --------- -------- Total 8,827 73% 10,523 79% Principal Transactions 594 5% 1,364 10% Investment Banking 2,011 16% 746 6% Interest and Other Interest 582 5% 576 4% Other 231 1% 103 1% ----------- -------- --------- -------- Total 813 6% 679 5% ----------- -------- --------- -------- Total revenues $ 12,245 100% $ 13,312 100% =========== ========= ========= =========
Overview Total revenues decreased $1.07 million, or 8%, for the three months ended March 31, 2007 (the "2007 quarter"), to $12.24 million from $13.31 million for the three months ended March 31, 2006 (the "2006 quarter"). The decrease in revenues is primarily attributable to a decline in the number of registered representatives from 285 at March 31, 2006 to 237 at March 31, 2007, a decrease of approximately 50 reps. Decreases in commissions from equity and principal transactions of $2.5 million, were partially offset by increases in investment banking revenue of $1.3 million and other income of $128,000. Expenses decreased in the 2007 quarter by $1.58 million, or 11%, compared to the 2006 quarter. There were reductions in most expenses categories, most notably communications and occupancy costs of $121,000 and commission expense of $457,000 in the 2007 quarter when compared to the 2006 quarter. The net loss attributable to common stockholders for the 2007 quarter decreased approximately $526,000 from a loss of $1.09 million, or ($.07) per basic and diluted share for the 2006 quarter to a loss of $560,000, or ($.03) per basic and diluted share for the 2007 quarter. Commission Revenue Commissions are comprised of revenues from the sale of equities, fixed income, mutual funds, insurance, asset management fees and alternative products. Commission revenue for the 2007 quarter was $8.8 million compared to $10.5 million for the 2006 quarter, a decrease of approximately $1.7 million. Decreases in commissions from the sale of equities of $2.9 million were partially offset by increases in the sale of alternative products and mutual funds of $980,000 and $84,000, respectively and fees from managed accounts of $150,000. This decrease highlights the change in our business mix over the last several years, moving primarily from transaction based to more fee based in nature. 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 $770,000, or 56%, from $1.4 million for the 2006 quarter to $594,000 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. 17 Investment Banking Investment banking revenues for the 2007 quarter increased $1.26 million from $746,000 in the 2006 quarter, to $2.01 million in the 2007 quarter, an increase of approximately 170%. The increase in investment banking revenues is attributable to the Company having completed a greater number of investment banking transactions in the first quarter of 2007. This category includes private offerings of securities in which we act as placement agent and new issues of equity and preferred stock offerings in which we participate as a selling group or syndicate member. Interest and Other Income Interest and other income for the 2007 quarter remained relatively unchanged for the 2007 quarter. Other income, which includes marketing and operations fees, increased by $128,000 when compared to the 2006 quarter. Commissions, Employee Compensation and Benefits Commission expense, consistently the largest expense category and directly related to commission revenue, decreased 8%, or $718,000, from $9.6 million for the 2006 quarter, to $8.8 million for the 2007 quarter. Compensation and benefits expense for management, operations and clerical personnel, which include salaries and payroll taxes, stock and option compensation, health insurance premiums, and bonus accruals, increased for the 2007 quarter, to $1.91 million (16% of total revenues) from $1.59 million (12% of total revenues), an increase of approximately $320,000 over the 2006 quarter. Included in the 2007 quarter was approximately $198,000 of severance costs for various personnel and additional bonus accruals of $105,000. Executive Separation Executive separation costs decreased $951,266 for the 2007 quarter when compared with the 2006 quarter. In February 2006, the Company entered into a separation agreement with our Chairman of the Board, which provided for the termination of his employment as of that date. In the 2007 quarter, 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, decreased $232,000 in the 2007 quarter when compared to the 2006 quarter. As a percentage of transaction-based commissions, clearing costs remained relatively constant at approximately 7%. Clearing costs, as a percentage of gross revenues, fluctuate depending upon the product mix. Communications and Occupancy Communications and occupancy costs decreased $121,000, from $545,000 in the 2006 quarter to $424,000 in the 2007 quarter 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 $232,000, from $199,000 during the 2006 quarter to $431,000 for the 2007 quarter, most of which was related to legal fees. During the first quarter of 2006, we expensed $61,000 for legal fees in connection with the anticipated sale of our stock to a private investor. During the 2007 quarter, we expensed $190,000 related to various lawsuits involving the proposed merger that was terminated in December 2006 (See Note 8-Legal Matters). Other Operating Expenses Other operating costs decreased approximately $90,000, to $738,000 in the 2007 quarter from $828,000 during the 2006 quarter. The largest decrease in other operating expenses during the 2007 quarter were for the categories of depreciation, errors & omissions insurance, and professional fees of $41,000, $32,000 and $50,000, respectively. 18 Liquidity and Capital Resources We maintain a highly liquid balance sheet with approximately 78% of our assets consisting of cash, securities owned, and receivables from our clearing firm and other broker-dealers and insurance companies. The balances in these accounts can and do fluctuate significantly from day to day, depending on general economic and market conditions, volume of activity, and investment opportunities. These accounts are monitored on a daily basis in order to ensure compliance with regulatory capital requirements and to preserve liquidity. Overall, cash and cash equivalents decreased during the three months ended March 31, 2007 by $928,000. Net cash used in operating activities during the 2007 quarter was $879,000, which consists of a net loss of $518,000, increased by non-cash charges including depreciation of $38,000, amortization of stock compensation and deferred costs of $38,000. Cash was reduced by increases in securities owned, prepaid expenses and broker receivables of $80,000, $535,000 and $551,000, respectively, and decreases in accrued expenses of $412,000. Cash was increased by a decrease in the amount due from clearing firm of $532,000 and increases in accounts payable of $538,000. Additions to property and equipment of $5,100 accounted for the use of cash from investing activities during the three months ended March 31, 2007. Financing activities used net cash of $44,000 due to the payment of preferred stock dividends of $43,000 and capital leases of $1,000 during the first three months of 2007. The financing agreement with AICCO Inc. for the renewal of our errors and omissions insurance policy had a balance at March 31, 2007 of approximately $585,000, payable in eight remaining monthly installments of $74,781 each, including interest at the rate of 5.87% per annum. Consolidated Contractual Obligations and Lease Commitments The table below provides information about our commitments related to debt obligations, leases, guarantees and investments as of March 31, 2007. This table does not include any projected payment amounts related to our potential exposure to arbitrations and other legal matters. As of March 31, 2007 Expected Maturity Date -------------------------- --------------- ---------------- ---------------- -------------- --------------- --------- -------------- After Category 2007 2008 2009 2010 2011 2011 Total -------------------------- --------------- ---------------- ---------------- -------------- --------------- --------- -------------- -------------------------- --------------- ---------------- ---------------- -------------- --------------- --------- -------------- Debt Obligations $25,000 0 0 0 0 0 $25,000 -------------------------- --------------- ---------------- ---------------- -------------- --------------- --------- -------------- -------------------------- --------------- ---------------- ---------------- -------------- --------------- --------- -------------- Capital Lease Obligations 0 0 0 0 0 0 $0 -------------------------- --------------- ---------------- ---------------- -------------- --------------- --------- -------------- -------------------------- --------------- ---------------- ---------------- -------------- --------------- --------- -------------- Operating Lease Obligations $1,012,782 $890,496 $648,337 $50,762 0 0 $2,602,377 -------------------------- --------------- ---------------- ---------------- -------------- --------------- --------- -------------- -------------------------- --------------- ---------------- ---------------- -------------- --------------- --------- -------------- Total $1,037,782 $890,496 $648,337 $50,762 $0 $0 $2,627,377 -------------------------- --------------- ---------------- ---------------- -------------- --------------- --------- --------------
19 Net Capital At March 31, 2007, Montauk Financial Group had net capital of $1,461,330, which was $1,211,330 in excess of its required net capital of $250,000, and the ratio of aggregate indebtedness to net capital was 2.38 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, 2007, we have 305,369 Series A preferred shares issued and outstanding. Quarterly dividends of $22,903 and $22,776 were paid during the three months ended March 31, 2007 and 2006, respectively. Mr. Okun beneficially owns 283,087 shares of Series A Preferred Stock. Series B Convertible Redeemable Preferred Stock In connection with a Separation Agreement we entered into with Mr. William J. Kurinsky in 2005, we issued an aggregate of 197,824 shares of a newly created class of Series B Convertible Redeemable Preferred Stock ("Series B"), par value $0.10 per share, which will have a deemed issue price of $1,000,000, and is convertible into common stock on the basis of ten shares of common stock for each share of Series B. The Series B also provides that the preferred shares have voting rights based upon the number of shares of common stock into which it would be converted. The Series B also includes a cumulative dividend of 8% per year. The shares are restricted securities under the Securities Act of 1933 and the regulations of the SEC and we relied upon the exemption from registration under Section 4(2) of the Securities Act of 1933 to issue the shares of Series B. A quarterly dividend of $20,000 was paid during the three months ended March 31, 2007 and 2006. Mr. Okun beneficially owns all shares of Series B Preferred Stock which were purchased in a private transaction on February 23, 2007 at a price of $10.00 per share of Series B Preferred Stock. 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. 20 Item 3. Risk Management Risk is an inherent part of our business and activities. The extent to which we properly and effectively identify, assess, monitor and manage the various types of risk involved in our activities is critical to our soundness and profitability. We seek to identify, assess, monitor and manage the following principal risks involved in its business activities: market, credit, operational and legal. Senior management takes an active role in the risk management process and requires specific administrative and business functions to assist in the identification, assessment and control of various risks. Our risk management policies and procedures are subject to ongoing review and modification. Market Risk. Certain of our business activities expose us to market risk. This market risk represents the potential for loss that may result from a change in value of a financial instrument as a result of fluctuations in interest rates, equity prices or changes in credit rating of issuers of debt securities. This risk relates to financial instruments we hold as investment and for trading. Securities inventories are exposed to risk of loss in the event of unfavorable price movements. Securities positions are marked to market on a daily basis. Market-making activities are client-driven, with the objective of meeting clients' needs while earning a positive spread. At March 31, 2007 and December 31, 2006, the balances of our securities positions owned, and sold not yet purchased, were approximately $279,000 and $198,000, and $11 and $495, respectively. In our view, the potential exposure to market risk, trading volatility and the liquidity of securities held in the firm's inventory accounts could potentially have a material effect on its financial position. Credit Risk. Credit risk represents the loss that we would incur if a client, counterparty or issuer of securities or other instruments that we hold fails to perform its contractual obligations. Client activities involve the execution, settlement, and financial of various transactions on behalf of its clients. Client activities are transacted on either a cash or margin basis. Client activities may expose us to off-balance sheet credit risk. We may have to purchase or sell financial instruments at the prevailing market price in the event of the failure of a client to settle a trade on its original terms or in the event that cash and securities in the client margin accounts are not sufficient to fully cover the client losses. We seek to control the risks associated with client activities by requiring clients to maintain collateral in compliance with various regulations and company policies. Operational Risk. Operational risk generally refers to the risk of loss resulting from our operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our operating systems, business disruptions and inadequacies or breaches in our internal control processes. We operate in diverse markets and rely on the ability of our employees and systems to process high numbers of transactions often within short time frames. In the event of a breakdown or improper operation of systems, human error or improper action by employees, we could suffer financial loss, regulatory sanctions or damage to our reputation. In order to mitigate and control operational risk, we have developed and continue to enhance policies and procedures that are designed to identify and manage operational risk at appropriate levels. Included in our operational risk management practice is disaster recovery for our critical systems. We believe that our disaster recovery program, including off-site back-up technology and operational facilities, is adequate to handle a reasonable business disruption. However, there can be no assurances that a disaster directly affecting our headquarters or operations center would not have a material adverse impact. Insurance and other safeguards might only partially reimburse us for our losses. Legal Risk. Legal risk includes the risk of non-compliance with applicable legal and regulatory requirements. We are subject to extensive regulation in the different jurisdictions in which we conduct our business. We have various procedures addressing issues such as regulatory capital requirements, sales and trading practices, use of and safekeeping of customer funds, credit granting, collection activities, anti money-laundering and record keeping. 21 Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Acting Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 13a-15(e). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in designing and evaluating the controls and procedures. Based on their evaluation, as of March 31, 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 March 31, 2007, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 22 PART II OTHER INFORMATION Item 1. Legal proceedings SEC Investigation The SEC is investigating whether FMSC, and/or certain former employees failed reasonably to supervise the securities trading and research activities of a former analyst. The investigation covered the time period from approximately March 2000 until January 2004 when the Capital Markets Group was dissolved and the analyst resigned. The SEC has recently advised us that it intends to recommend bringing an enforcement proceeding against FMSC, one of its former principals and another former employee for failing to supervise reasonably. The SEC will be seeking a monetary penalty and an order suspending the former principal from acting in a supervisory capacity for a period of time. FMSC is entitled to make a Wells submission to the SEC staff and intends to make such a submission or otherwise attempt to negotiate a resolution with the SEC. It is believed that any resolution will include a monetary penalty which will not have a materially adverse effect on our financial statements. NASD Enforcement Sales Practice Investigation The NASD Department of Enforcement is conducting an investigation of the sales practice activities of certain individuals who were formerly registered representatives of FMSC, as well as the supervision of those activities by FMSC. On April 9, 2007, NASD notified FMSC through a "Wells call" that it intends to file an administrative action against it in connection with an alleged failure to reasonably supervise the activities of three former registered representatives of FMSC. NASD has indicated that it will be seeking a monetary penalty and certain undertakings by FMSC. FMSC is entitled to make a Wells submission to the NASD Staff and currently intends to make such a submission or otherwise attempt to negotiate a resolution with NASD. It is believed that any resolution will include a monetary penalty which will not have a materially adverse effect on our financial statements. Termination of Merger Agreement, Litigation and Settlement See Note 8 - Legal Matters - Termination of Merger Agreement; Litigation and Settlement. Item 1A. Risk Factors Refer to December 31, 2006 Form 10-K/A. Item 2. Unregistered Sales of Equity Securities (a) Not applicable. (b) Not applicable. (c) Not applicable. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. 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 Settlement Agreement. Pursuant to the Amended Employment Agreement, Mr. Kurylak will continue his employment by the Company as President of the Company and also President and Chief Executive Officer of First Montauk Securities Corp., the Company's broker-dealer subsidiary. Mr. Kurylak will resign, however, from the position of Chief Executive Officer of the Company. In this modified capacity, Mr. Kurylak will report to the Chief Executive Officer of the Company and the Company's board of directors. In addition, Mr. Kurylak will continue to serve as a member of the board of directors of the Company. 23 The Amended Employment Agreement will expire on December 31, 2007 ("Term"), subject to renewal for one additional period of one year unless the Company provides written notice of its intention not to renew the Amended Employment Agreement at least 120 days prior to December 31, 2007. During the term of the Amended Employment Agreement, Mr. Kurylak will be compensated at the rate of $300,000 on an annualized basis. He is eligible for customary fringe benefits and to participate in the Company's executive bonus pool. In the event of the termination of Mr. Kurylak's employment by the Company without "cause" or by Mr. Kurylak for "good reason" as these terms are defined in the Amended Employment Agreement, he would be entitled to: (a) all compensation accrued but not paid as of the termination date; (b) base salary for the remainder of the Term; (c) a severance payment equal to $300,000 payable in a lump sum payment; (d) continued participation in the Company's benefit plans (or comparable plans); and (e) any applicable bonus. If Mr. Kurylak's employment is terminated by the Company for "cause" or by him without "good reason", he will be entitled only to accrued compensation. If termination of the Amended Employment Agreement occurs as a result of the expiration of such agreement without renewal by the Company at the end of the Term, Mr. Kurylak will be entitled to the accrued compensation, any applicable bonus and the severance payment. In the event Mr. Kurylak is a member of the board of directors of the Company on the termination date, the payment of any and all compensation due under the Amended Employment Agreement, except the accrued compensation, is expressly conditioned on Mr. Kurylak's resignation from the board of directors of the Company within five (5) business of the termination date. The Amended Employment Agreement contains confidentiality obligations that survive indefinitely and non-solicitation and non-competition obligations that end on the first anniversary of the date of cessation of Mr. Kurylak's employment. The foregoing description of Mr. Kurylak's Amended Employment Agreement is qualified in its entirety by reference to the full text of the Amended Employment Agreement, which is filed as Exhibit 10.2 to the Company's Report on Form 8-K filed on May 11, 2007. Appointment of Louis Rogers as Chief Executive Officer of the Company Pursuant to the Settlement Agreement, Mr. Louis Rogers is being appointed Chief Executive Officer and a director of the Company. The Company and Mr. Rogers shall enter into an employment agreement on mutually agreeable terms. 24 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) ----------------- ---------------------------------------------------------------------------------------------------- ----------------- ---------------------------------------------------------------------------------------------------- *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 ----------------- ---------------------------------------------------------------------------------------------------- ----------------- ---------------------------------------------------------------------------------------------------- 99.1 Press Release dated May 9, 2007 ----------------- ----------------------------------------------------------------------------------------------------
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, 2007 /s/ Mindy A. Horowitz --------------------------------------------- Mindy A. Horowitz Acting Chief Financial Officer /s/ Victor K. Kurylak --------------------------------------------- Victor K. Kurylak President and Chief Executive Officer