10-Q 1 form10q93007.txt FORM 10-Q FOR QUARTER ENDED SEPTEMBER 30, 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 SEPTEMBER 30, 2007 |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO Commission File Number: 0-6729 FIRST MONTAUK FINANCIAL CORP. -------------------------------------------------------------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) New Jersey 22-1737915 ---------------------- ---------------------------------- (State of Incorporation) (I.R.S. Employer Identification No.) Parkway 109 Office Center, 328 Newman Springs Road, Red Bank, New Jersey 07701 -------------------------------------------------------------------------------- (Address of principal executive offices)(Zip Code) (732) 842-4700 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). |_| Yes |X| No APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d)of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. |_| Yes |_| No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 13,254,248 shares of Common Stock were outstanding at November 14, 2007. FIRST MONTAUK FINANCIAL CORP. FORM 10-Q SEPTEMBER 30, 2007 INDEX Page PART I. FINANCIAL INFORMATION: Item 1. Financial Statements Condensed Consolidated Statements of Financial Condition as of September 30, 2007 (unaudited) and December 31, 2006 .. F-1 Condensed Consolidated Statements of Operations for the Nine Months and Three Months Ended September 30, 2007 (unaudited) and 2006 (unaudited) ........................................ F-2 Condensed Consolidated Statements of Changes in Stockholders' Equity for the period from January 1, 2006 to September 30, 2007 (unaudited) ...........................F-3-F-4 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 (unaudited) and 2006 (unaudited) ... F-5 Notes to Condensed Consolidated Financial Statements ........... 6-19 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................. 20-28 Item 3. Risk Management ........................................ 28-30 Item 4. Controls and Procedures ................................ 31 PART II. OTHER INFORMATION: Item 1. Legal Proceedings ...................................... 32 Item 1A. Risk Factors ........................................... 32 Item 2. Unregistered Sales of Equity Securities................. 32 Item 3. Defaults Upon Senior Securities ........................ 32 Item 4. Submission of Matters to a Vote of Securities Holders .................................... 32 Item 5. Other Information ..................................... 33-34 Item 6. Exhibits ............................................... 35 Signatures ...................................................... 36 FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION September 30, December 31, 2007 2006 (unaudited) (restated) ASSETS Cash and cash equivalents $ 1,326,390 $ 1,145,751 Due from clearing firm 2,512,741 4,988,747 Securities owned, at market value 168,941 198,447 Prepaid expenses 464,637 285,480 Employee and broker receivables - net of reserve for bad debt of $783,122 and $807,536 respectively 273,858 343,491 Property and equipment - net 195,431 239,033 Other assets 1,091,323 597,968 --------- ---------- Total assets 6,033,321 7,798,917 ========= ========== LIABILITIES Accounts payable 929,241 313,427 Accrued expenses 960,197 1,195,426 Income taxes payable 11,358 4,167 Commissions payable 2,233,920 2,378,935 Securities sold, not yet purchased, at market value 11 495 6% convertible debentures 25,000 25,000 Capital leases payable - 820 Other liabilities 47,670 67,156 --------- ---------- Total liabilities 4,207,397 3,985,426 --------- ---------- Commitments and contingencies Series B convertible redeemable preferred stock, 445,102 shares authorized, $.10 par value, 0 and 197,824 shares issued and outstanding, respectively liquidation preference: $0 and $1,000,000, respectively - 1,000,000 STOCKHOLDERS' EQUITY Preferred stock, 3,929,898 shares authorized, $.10 par value, no shares issued and outstanding - - Series A convertible preferred stock, 625,000 shares authorized, $.10 par value 22,282 and 305,369 shares issued and outstanding, respectively; liquidation preference: $111,410 and $1,526,845, respectively 2,228 30,537 Common stock, no par value, 60,000,000 shares authorized, 13,254,248 and 18,526,553 shares issued and outstanding, respectively 9,628,630 11,646,620 Additional paid-in capital 4,035,064 950,592 Accumulated deficit (11,839,998) (9,814,258) ------------ ----------- Total stockholders' equity 1,825,924 2,813,491 ------------ ----------- Total liabilities and stockholders' equity $ 6,033,321 $ 7,798,917 ============ =========== See notes to condensed consolidated financial statements. F-1
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS Nine Months Ended September 30, Three Months Ended September 30, 2007 2006 2007 2006 (unaudited) (unaudited) (unaudited) (unaudited) Revenues: Commissions $ 24,941,439 $29,509,203 $7,708,284 $ 9,081,813 Principal transactions 1,261,458 3,318,729 306,482 833,929 Investment banking 3,440,269 2,914,197 960,849 596,963 Interest and other income 2,068,309 2,449,776 546,178 761,470 ---------- ---------- --------- ----------- Total revenue 31,711,475 38,191,905 9,521,793 11,274,175 ---------- ---------- --------- ----------- Expenses: Commissions, employee compensation and benefits 27,491,131 31,712,982 8,264,249 9,592,676 Executive separation - 951,266 - - Clearing and floor brokerage 1,134,419 1,111,675 334,866 415,896 Communications and occupancy 1,262,127 1,369,832 427,583 486,539 Legal matters and related costs 1,221,588 772,193 237,337 159,642 Other operating expenses 2,471,582 2,296,864 1,048,368 762,089 Interest 17,875 74,803 5,032 8,057 ---------- ---------- ---------- ----------- Total expenses 33,598,722 38,289,615 10,317,435 11,424,899 ---------- ---------- ---------- ----------- Loss before income taxes (1,887,247) (97,710) (795,642) (150,724) Provision (benefit) for income taxes 16,199 14,331 600 (30,730) ----------- ----------- ---------- ----------- Net loss (1,903,446) (112,041) (796,242) (119,994) Preferred stock dividends (122,294) (126,204) (36,490) (42,866) ----------- ------------ ----------- ----------- Net loss applicable to common stockholders $ (2,025,740) $ (238,245) $ (832,732) $ (162,860) =========== ============ =========== =========== Loss per share: Basic $ (0.12) $ (0.01) $ (0.06) $ (0.01) Diluted $ (0.12) $ (0.01) $ (0.06) $ (0.01) Weighted average number of shares of stock outstanding: Basic 16,439,992 16,531,580 13,245,477 18,382,826 Diluted 16,439,992 16,531,580 13,245,477 18,382,826 See notes to condensed consolidated financial statements. F-2
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE PERIOD FROM JANUARY 1, 2006 TO SEPEMBER 30, 2007 (UNAUDITED) Series B Convertible Series A Convertible Preferred Stock Preferred Stock (Restated) Common Stock -------------------------------------------- ------------------------- Additional Shares Amount Shares Amount Shares Amount Paid-in Capital -------------------------------------------- ------------------------- ---------------- Balances at January 1, 2006, as previously reported 305,369 $ 30,537 197,824 $ 19,782 15,937,407 $10,444,110 $ 1,930,810 Restatement to reclassify Series B stock as temporary equity (197,824) (19,782) (980,218) --------- --------- ----------- -------- ---------- ---------- ----------- Balances at January 1, 2006, as restated 305,369 30,537 - - 15,937,407 10,444,110 950,592 Increase in deferred compensation (76,266) Amortization of deferred compensation Reclass to common stock (39,546) Exercise of incentive stock options 68,800 33,504 Cashless exercise of incentive stock options 27,586 Cashless exercise of warrants 42,760 22,211 Expired warrant obligation - 37,607 Conversion of bonds into common stock 2,450,000 1,225,000 Payment of preferred stock dividends Net loss for the period ---------------------- --------------------- ------------------------- ------------- Balances at December 31, 2006 305,369 30,537 - - 18,526,553 11,646,620 950,592 Amortization of deferred compensation 38,173 Payment of preferred stock dividends Redemption of Preferred A stock (1,629,549) 1,629,549 Cancellation of Preferred A stock (283,087) 1,601,240 (1,601,240) Cancellation of Preferred B stock 1,000,000 Cancellation of common stock (5,272,305) (2,056,163) 2,056,163 Net loss for the period ---------------------- --------------------- ------------------------- ------------- Balances at September 30, 2007 22,282 $2,228 - $ - 13,254,248 $9,628,630 $4,035,064 ====================== ===================== ========================= ============= See notes to consolidated financial statements. F-3
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE PERIOD FROM JANUARY 1, 2006 TO SEPEMBER 30, 2007 (UNAUDITED) (Accumulated Deferred Stockholders' Deficit) Compensation Equity Balances at January 1, 2006, as previously reported $ (8,809,203) $ (388,185) $3,227,851 Restatement to reclassify Series B stock as temporary equity (1,000,000) ------------ ---------- ----------- Balances at January 1, 2006, as restated (8,809,203) (388,185) 2,227,851 Increase in deferred compensation 76,266 - Amortization of deferred compensation 272,373 272,373 Reclass to common stock 39,546 - Exercise of incentive stock options 33,504 Cashless exercise of incentive stock options - Cashless exercise of warrants 22,211 Expired warrant obligation 37,607 Conversion of bonds into common stock 1,225,000 Payment of preferred stock dividends (168,506) (168,506) Net loss for the period (836,549) (836,549) ------------ ---------- ----------- Balances at December 31, 2006 (9,814,258) - 2,813,491 Amortization of deferred compensation 38,173 Payment of preferred stock dividends (122,294) (122,294) Cancellation of preferred A stock Cancellation of preferred B stock 1,000,000 Cancellation of common stock Net loss for the period (1,903,446) (1,903,446) ------------ ---------- ----------- Balances at September 30, 2007 $(11,839,998) $ - $1,825,924 ============ ========== =========== See notes to condensed consolidated financial statements. F-4
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended September 30, 2007 2006 (unaudited) (unaudited) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH FLOWS FROM OPERATING ACTIVITIES Net loss $(1,903,446) $ (112,041) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation of property and equipment 89,195 202,413 Amortization of stock compensation and deferred costs 38,173 351,752 Increase (decrease) in cash attributable to changes in assets and liabilities: Payment on note payable - (200,000) Due from clearing firm 2,476,006 (505,741) Securities owned 29,505 10,999 Prepaid expenses (179,156) (257,264) Employee and broker receivables 69,632 (107,632) Other assets (493,355) 23,301 Accounts payable 615,814 (75,213) Accrued expenses (235,229) (629,401) Income taxes payable 7,191 500 Commissions payable (145,015) 281,961 Securities sold, not yet purchased (484) 1,186 Other liabilities (19,486) 22,575 ---------- --------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 349,345 (992,605) ---------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (45,593) (13,232) ---------- --------- NET CASH USED IN INVESTING ACTIVITIES (45,593) (13,232) ---------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Payment of capital lease (819) (6,925) Proceeds from exercise of incentive stock option - 22,034 Payment of preferred stock dividends (122,294) (126,204) ---------- ---------- NET CASH USED IN FINANCING ACTIVITIES (123,113) (111,095) ---------- ---------- Net increase (decrease) in cash and cash equivalents 180,639 (1,116,932) Cash and cash equivalents at beginning of period 1,145,751 1,990,815 ---------- ----------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,326,390 $ 873,883 ========== =========== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 17,500 $ 33,891 ========== =========== Income taxes $ 10,823 $ 118,018 ========== =========== Noncash financing activities: Proceeds from exercise of warrants $ - $ 22,211 6% convertible debentures converted into common stock $ - $1,225,000 Cancellation and Redemption of Preferred A stock $ 28,309 $ - Cancellation of Preferred B stock $ 1,000,000 $ - Cancellation of Common stock $ 2,056,163 $ - See notes to condensed consolidated financial statements. F-5
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION The interim financial information as of September 30, 2007 and for the nine-month and three-month periods ended September 30, 2007 and 2006 has been prepared without audit, in accordance with accounting principles generally accepted in the United States of America and pursuant to the interim financial statements rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted pursuant to such rules and regulations, although management believes that the disclosures made are adequate to provide for fair presentation. These condensed consolidated financial statements should be read in conjunction with management's discussion and analysis of financial condition and results of operations ("MDA") included elsewhere in this report on Form 10-Q and the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 2006, previously filed with the SEC on May 4, 2007. In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of financial position as of September 30, 2007, and results of operations for the nine months and three months ended September 30, 2007 and 2006, cash flows for the nine months ended September 30, 2007 and 2006 and changes in stockholders' equity for the nine months ended September 30, 2007, as applicable, have been made. The results of operations for the nine and three months ended September 30, 2007 are not necessarily indicative of the operating results for the full fiscal year or any future periods. The condensed consolidated statement of financial condition for December 31, 2006 has been restated. The restatement reflects a change in the accounting for the Series B redeemable preferred stock from stockholder's equity to temporary equity resulting from a redemption feature in the Series B that was not in the control of the Company. The result of the restatement was the reduction of stockholders' equity at December 31, 2006 by $1 million and an increase in temporary equity of $1 million. In June 2007, the Series B preferred stock was surrendered by its owner and cancelled by the Company resulting in an increase in paid-in capital by the $1 million temporary equity. During the 2007 quarter, we cut costs by approximately $1.4 million on an annualized basis. This was accomplished through reductions in our work force, subletting a portion of our office space and the renegotiation of our outsourced mailroom contract. We believe that our cash resources will be sufficient to meet our minimum planned operating needs for the next 6 months. Beyond that period, management has other plans for increasing cash flow, including pursuing additional financing and continued reductions in overhead costs. Although we have plans to pursue additional financing, there can be no assurance that we will be able to secure financing when needed or obtain such financing on terms satisfactory to us, if at all, or that any additional funding we do obtain will be sufficient to meet our needs in the long term. If additional funding cannot be obtained, we will review alternative courses of action to conserve our cash flow. 6 NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENTS Financial Accounting Standards Board (FASB) No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48") In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes--an interpretation of FASB Statement No. 109 (FIN 48), which provides clarification related to the process associated with accounting for uncertain tax positions recognized in consolidated financial statements. FIN 48 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. FIN 48 also provides guidance related to, among other things, classification, accounting for interest and penalties associated with tax positions, and disclosure requirements. We have adopted FIN 48 effective January 1, 2007 and there is no impact of adopting FIN 48 on our consolidated financial statements to date. Statement of Financial Accounting Standard 159, Fair Value Option for Financial Assets and Financial Liabilities ("FAS 159") In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS No. 159"). SFAS No. 159 permits entities to choose to measure, on an item-by-item basis, specified financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected are required to be reported in earnings at each reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007, the provisions of which are required to be applied prospectively. The Company expects to adopt SFAS No. 159 in the first quarter of Fiscal 2008 and is still evaluating the effect, if any, on its financial position or results of operations. NOTE 3 - STOCK-BASED COMPENSATION The Company periodically issues common stock to employees, non-employee consultants and non-employee independent registered representatives in accordance with the provisions of the following shareholder approved equity compensation plans ("the Plans"): 2002 Stock Incentive Plan The 2002 Incentive Stock Option Plan, which replaced the 1992 Incentive Stock Option Plan that expired in September 2002, has reserved up to 5,000,000 shares of common stock for issuance to employees, non-employee consultants and non-employee registered representatives of the Company. Only options issued to employees qualify for incentive stock option treatment ("ISOs"). The Board of Directors determines the terms and provisions of each award granted under the 2002 Plan, including the exercise price, term and vesting schedule. In the case of ISO's, the per share exercise price must be equal to at least 100% of the fair market value of a share of common stock on the date of grant, and no individual will be granted ISOs corresponding to shares with an aggregate fair value in excess of $100,000 in any calendar year. The 2002 Incentive Stock Plan will terminate in 2012. 2002 Non-Executive Director Stock Option Plan Under the 2002 Director Plan, which replaced the 1992 Non-Executive Director Stock Option Plan that expired in September 2002, each non-executive director will automatically be granted an option to purchase 20,000 shares, pro rata, on September 1st of each year or partial year of service. The 2002 Director Plan does not contain a reserve for a specific number of shares available for grant. Each option issued under the 2002 Director Plan will be immediately vested non-qualified stock options, and will have a five-year term and an exercise price equal to 100% of the fair market value of the shares subject to such option on the date of grant. The 2002 Director Plan will terminate in 2012. 7 1996 Senior Management Plan In June 2000, the Company's stockholders approved an amendment to the 1996 Senior Management Plan (the "1996 Plan") to increase the number of shares reserved for issuance to key management employees from 2,000,000 to 4,000,000 shares. Awards can be granted through the issuance of incentive stock rights, stock options, stock appreciation rights, limited stock appreciation rights, and shares of restricted common stock. The exercise price of an option designated as an ISO may in no event be less than 100% of the then fair market price of the stock (110% with respect to ten percent stockholders), and not less than 85% of the fair market price in the case of other options. The 1996 Plan terminated in June 2006. The Plans provide for accelerated vesting if there is a change in control as defined in the plans. Accounting for Employee Awards: Effective January 1, 2006, the Plans are accounted for in accordance with the recognition and measurement provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment ("FAS 123(R)"), which replaces SFAS No. 123, Accounting for Stock-Based Compensation ("FAS 123"), and supersedes Accounting Principles Board Opinion No. 25 ("APB 25"), Accounting for Stock Issued to Employees, and related interpretations. FAS 123(R) requires compensation costs related to share-based payment transactions, including employee stock options, to be recognized in the financial statements. In addition, the Company adheres to the guidance set forth within Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 107, which provides the Staff's views regarding the interaction between FAS 123(R) and certain SEC rules and regulations and provides interpretations with respect to the valuation of share-based payments for public companies. Prior to January 1, 2006, the Company accounted for similar employee transactions in accordance with APB 25, which employed the intrinsic value method of measuring compensation cost. Accordingly, compensation expense was not recognized for employee fixed stock options if the exercise price of the option equaled or exceeded the fair value of the underlying stock at the grant date. While FAS 123, for employee options, encouraged recognition of the fair value of all stock-based awards on the date of grant as expense over the vesting period, companies were permitted to continue to apply the intrinsic value-based method of accounting prescribed by APB 25 and disclose certain pro-forma amounts as if the fair value approach of FAS 123 had been applied. In December 2002, FAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FAS 123, was issued, which, in addition to providing alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation, required more prominent pro-forma disclosures in both the annual and interim financial statements. The Company complied with these disclosure requirements for all applicable periods prior to January 1, 2006. In adopting FAS 123(R), the Company applied the modified prospective approach to the transition. Under the modified prospective approach, the provisions of FAS 123(R) are to be applied to new employee awards and to employee awards modified, repurchased, or cancelled after the required effective date. Additionally, compensation cost for the portion of employee awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is rendered on or after the required effective date. The compensation cost for that portion of employee awards shall be based on the grant-date fair value of those awards as calculated for either recognition or pro-forma disclosures under FAS 123. 8 As a result of the adoption of FAS 123(R), the Company's results for the nine and three month periods ended September 30, 2007 include share-based compensation expense for employee options and shares totaling approximately $6,200 and $937, respectively. . The Company's results for the nine and three month periods ended September 30, 2006 includes share-based compensation expense for employee options and shares totaling approximately $235,000 and $22,000, respectively. Such amounts have been included in the condensed consolidated statements of operations within commissions, employee compensation and benefits. No income tax benefit has been recognized in the income statement for share-based compensation arrangements as the Company has provided for a 100% valuation allowance on net deferred tax assets. Employee stock option compensation expense in 2007 and 2006 is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for the entire portion of the award. The Company has not adjusted the expense by estimated forfeitures, as required by FAS 123(R) for employee options, since the forfeiture rate based upon historical data was determined to be immaterial. Accounting for Non-employee Awards: The Company previously accounted for options granted to its non-employee consultants and non-employee registered representatives using the fair value cost in accordance with FAS 123 and EITF No. 96-18. The adoption of FAS 123(R) and SAB 107 as of January 1, 2006, had no material impact on the accounting for non-employee awards. The Company continues to consider the additional guidance set forth in EITF Issue No. 96-18 ("EITF 96-18"), "Accounting for Equity Instruments That Are Issued to Other Than Employees". Stock compensation expense related to non-employee options was approximately $32,000 and $590 for the nine month and three month periods ended September 30, 2007 compared to approximately $48,000 for the nine months ended September 30, 2006. For the three months ended September 30, 2006, the Company had a $2,000 reversal due to the reduction in the market price of the stock. These amounts are included in the condensed consolidated statements of operations within commissions, employee compensation and benefits. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. During 2007, the Company took into consideration guidance under FAS 123(R) and SEC Staff Accounting Bulletin No. 107 ("SAB 107") when reviewing and updating assumptions. The expected volatility is based upon historical volatility of our stock and other contributing factors. The expected term is based upon observation of actual time elapsed between date of grant and exercise of options for all employees. Previously such assumptions were determined based on historical data. 9 The assumptions made in calculating the fair values of all options are as follows: ------------------------- ------------------------------------------- ------------------------------------------- Nine Months Ended Three Months Ended ------------------------- ------------------------------------------- ------------------------------------------- ------------------------- --------------------- --------------------- --------------------- --------------------- September 30, 2007 September 30, 2006 September 30, 2007 September 30, 2006 ---- ---- ---- ---- ------------------------- --------------------- --------------------- --------------------- --------------------- ------------------------- --------------------- --------------------- --------------------- --------------------- Expected volatility 66% 66% 66% 66% ------------------------- --------------------- --------------------- --------------------- --------------------- ------------------------- --------------------- --------------------- --------------------- --------------------- Expected dividend yield 0% 0% 0% 0% ------------------------- --------------------- --------------------- --------------------- --------------------- ------------------------- --------------------- --------------------- --------------------- --------------------- Risk-free interest rate 3.71%-4.54% 3.71%-5.10% 3.71%-4.54% 3.71%-4.59% ------------------------- --------------------- --------------------- --------------------- --------------------- ------------------------- --------------------- --------------------- --------------------- --------------------- Expected term (in years) 1-5 years 0-5 years 1-5 years 0-4.5 years ------------------------- --------------------- --------------------- --------------------- --------------------- The following table represents all of our stock options granted, exercised and forfeited/expired during the first nine months of 2007. ----------------------------- -------------- ------------------- -------------------- ------------------ Weighted Weighted Average Average Remaining Aggregate Number Exercise Price Contractual Intrinsic Stock Options of Shares per Share Term Value ----------------------------- -------------- ------------------- -------------------- ------------------ ----------------------------- -------------- ------------------- -------------------- ------------------ Outstanding at January 1, 2007 2,137,402 $0.79 2.5 92,954 ----------------------------- -------------- ------------------- -------------------- ------------------ ----------------------------- -------------- ------------------- -------------------- ------------------ Granted 412,000 $0.54 ----------------------------- -------------- ------------------- -------------------- ------------------ ----------------------------- -------------- ------------------- -------------------- ------------------ Exercised -- -- ----------------------------- -------------- ------------------- -------------------- ------------------ ----------------------------- -------------- ------------------- -------------------- ------------------ Forfeited/expired (607,602) $0.80 ----------------------------- -------------- ------------------- -------------------- ------------------ ----------------------------- -------------- ------------------- -------------------- ------------------ Outstanding at 1,941,800 $0.74 2.4 4,284 September 30, 2007 ----------------------------- -------------- ------------------- -------------------- ------------------ ----------------------------- -------------- ------------------- -------------------- ------------------ Exercisable at September 30, 2007 1,556,240 $0.74 2.1 4,212 ----------------------------- -------------- ------------------- -------------------- ------------------
The weighted average estimated fair value of all stock options granted during the nine months ended September 30, 2007 and 2006 was $.54 and $0.59, respectively. The intrinsic value of options exercised during the first nine months of 2007 and 2006 was $0 and $49,000, respectively. Cash received from the exercise of all stock options in the first nine months of 2007 and 2006 was $0 and $22,000, respectively. 10 The Company has issued shares that vest over time (as the term is defined in FAS 123(R)) to its senior officers. The following table summarizes the activity during the nine months ended September 30, 2007: ----------------------------------- -------------------------------- ----------------------------- Weighted-Average Grant-Date Nonvested Shares Shares Fair Value ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Nonvested January 1, 2007 100,000 $0.57 ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Granted -- -- ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Vested (100,000) $0.57 ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Forfeited -- -- ----------------------------------- -------------------------------- ----------------------------- ----------------------------------- -------------------------------- ----------------------------- Nonvested September 30, 2007 -- -- ----------------------------------- -------------------------------- -----------------------------
The total fair value of shares vested during the nine months ended September 30, 2007 and 2006, was $51,000 and $773,500, respectively. NOTE 4 - PREPAID EXPENSES Prepaid expenses at September 30, 2007 include a payment for errors and omissions insurance coverage. The unamortized amount at September 30, 2007 is $249,000, which will be written off over the next four months. NOTE 5 - OTHER ASSETS Other assets at September 30, 2007 include commissions receivable due from vendors for insurance, mutual funds and fees of $615,000 and deposits of $474,000. NOTE 6 - ACCOUNTS PAYABLE Accounts payable at September 30, 2007 includes an insurance premium financing agreement with a current balance of $148,000, payable in two remaining monthly installments of $75,000 each, including interest at the rate of 5.87% per annum and legal fees of $413,000. NOTE 7 - DEFINITIVE MERGER AGREEMENT On May 5, 2006, the Company entered into a definitive merger agreement with FMFG Ownership, Inc. and FMFG AcquisitionCo, Inc. (collectively referred to as the "Okun Purchasers") which are wholly-owned by Mr. Edward H. Okun. Mr. Okun is the controlling person of Investment Properties of America, LLC ("IPofA"), a privately owned, diversified real estate investment and management company. Pursuant to the merger agreement, the Okun Purchasers were to purchase all of the Company's outstanding securities for an aggregate purchase price of $23 million, or $1.00 in cash per common share, $2.00 in cash per Series A Preferred Stock (convertible into two shares of common stock), and $10.00 in cash per share of Series B Preferred Stock (convertible into ten shares of common stock). 11 In June 2006, the Okun Purchasers purchased in the open market and privately negotiated transactions, 2,159,348 shares of the Company's common stock, and in privately negotiated transactions, 283,087 shares of Series A Preferred Stock at a price of $4.00 per share (convertible into 566,174 shares of the Company's common stock) and $1,190,000 principal amount of the Company's convertible debentures (convertible into 2,380,000 shares of the Company's common stock). On June 20 and 23, 2006, the Okun Purchasers converted the $1,190,000 principal amount of the convertible debentures into 2,380,000 shares of the Company's common stock. As a result of these purchases and conversions, the Okun Purchasers beneficially owned 24.6% of the Company's common stock (assuming none of the shares of Series A Preferred Stock were converted into common stock). On August 17, 2006, the Company's shareholders (including the Okun Purchasers) voted at a special meeting of shareholders to approve the merger agreement and the merger. At the meeting, the Okun Purchasers voted all of the Company's shares beneficially owned by them in favor of the merger agreement and the merger. Subsequently, the deadline for completing the merger was extended from October 31, 2006 to December 31, 2006 in order to allow the parties to fulfill certain conditions to the merger, including obtaining the necessary consent of the NASD. On December 29, 2006, the Company received notification from representatives of the Okun Purchasers that they were terminating the merger agreement and not proceeding with the merger. They alleged the Company's failure to satisfy conditions and the Company's alleged breach of various representations, warranties, covenants and agreements in the merger agreement (See Note 8-Legal Matters-Termination of Merger Agreement; Litigation and Settlement). NOTE 8 - COMMITMENTS AND CONTINGENCIES Operating Leases: The Company leases office facilities and equipment under operating leases expiring at various dates through 2011. Certain leases require the Company to pay increases in real estate taxes, operating costs and repairs over certain base year amounts. Future minimum rental commitments under all non-cancelable leases with terms greater than one year are as follows: Year ending December 31, 2007 $ 245,925 2008 853,911 2009 672,805 2010 61,407 2011 and beyond 18,627 --------- $1,852,675 ========= 12 Master Services Agreement: Effective November 2006, the Company entered into a master services agreement with an outside vendor for development of certain software, data integration and business processing improvement consulting services. The term of the agreement is for a minimum of 3 years and under the agreement the Company will pay $480,000 over an initial 12 month period and then $20,000 per month thereafter. On October 12, 2007, the Company received a letter from the vendor acknowledging delays in the implementation of the development project and agreeing to suspend billing to the Company beginning with the September 2007 payment. A resumption of payments would not begin until mutually agreeable specific milestones and deliverables as contained in a revised project plan are met. As of the filing of this report, the revised project plan has not been finalized. To date, the Company has paid $400,000 to the vendor, which is included in other assets on the Condensed Consolidated Statements of Financial Condition. Employment Agreements: In January 2007, First Montauk Securities Corp. ("FMSC"), the Company's broker-dealer subsidiary, entered into an employment agreement with a new Executive Vice President, Secretary and General Counsel which provides him with a base salary of $200,000 per year through December 31, 2008 and bonuses of $100,000 per year through December 31, 2008, provided he is still employed by the Company at the end of each year. He resigned on August 31, 2007, effective September 28, 2007. As part of the negotiation of his existing employment contract he received his 2007 bonus of $100,000. As of May 9, 2007, the Company and Victor K. Kurylak, President and Chief Executive Officer of the Company, executed an Amended and Restated Employment Agreement ("Amended Employment Agreement"). The Amended Employment Agreement was executed in connection with the execution of the May Settlement Agreement (see below). Pursuant to the Amended Employment Agreement, Mr. Kurylak was to continue his employment with the Company as President. Mr. Kurylak was to resign, however, from the position of Chief Executive Officer of the Company in connection with the May Settlement Agreement upon appointment of his successor and execution by his successor of an employment agreement with the Company. However, since the May Settlement Agreement was vacated and set aside, Mr. Kurylak's resignation as CEO was not accepted and thus cancelled. On June 15, 2007, the Company and Mr. Kurylak executed an Amendment Number One to the Amended and Restated Employment Agreement ("Amendment to Amended Employment Agreement") to correctly state that Mr. Kurylak remains employed in the capacity of President and Chief Executive Officer of both the Company and FMSC. Mr. Kurylak's employment contract has been renewed for one year under the terms of the Amended Employment Agreement previously filed. In the event of the termination of Mr. Kurylak's employment by the Company without "cause" or by Mr. Kurylak for "good reason" as these terms are defined in the Amended Employment Agreement, he would be entitled to: (a) all compensation accrued but not paid as of the termination date; (b) base salary for the remainder of the Term; (c) a severance payment equal to $300,000 payable in a lump sum payment; (d) continued participation in the Company's benefit plans (or comparable plans); and (e) any applicable bonus. If Mr. Kurylak's employment is terminated by the Company for "cause" or by him without "good reason", he will be entitled only to accrued compensation. If termination of the Amended Employment Agreement occurs as a result of the expiration of such agreement without renewal by the Company at the end of the Term, Mr. Kurylak will be entitled to the accrued compensation, any applicable bonus and the severance payment. In the event Mr. Kurylak is a member of the board of directors of the Company on the termination date, the payment of any and all compensation due under the Amended Employment Agreement, except the accrued compensation, is expressly conditioned on Mr. Kurylak's resignation from the board of directors of the Company within five (5) business of the termination date. 13 The Amended Employment Agreement contains confidentiality obligations that survive indefinitely and non-solicitation and non-competition obligations that end on the first anniversary of the date of cessation of Mr. Kurylak's employment. Legal Matters: The Company is a respondent or co-respondent in various legal proceedings, including customer arbitrations and regulatory investigations. Management is contesting these claims and believes that there are meritorious defenses in each case. However, litigation is subject to many uncertainties, and some of these actions and proceedings may result in an adverse judgment. Further, the availability of insurance coverage is determined on a case-by-case basis by the insurance carrier, and is limited to the coverage limits within the policy for any individual claim and in the aggregate. After considering all relevant facts, available insurance coverage and consultation with litigation counsel, management believes that significant judgments or other unfavorable outcomes from pending litigation could have a material adverse impact on the Company's condensed consolidated financial condition, results of operations, and cash flows in any particular quarterly or annual period, or in the aggregate, and could impair the Company's ability to meet the statutory net capital requirements of its securities business. SEC Proposed Settlement The Company has recently resolved a regulatory investigation by the SEC concerning FMSC's, and a former employee's failure to reasonably supervise the securities trading and research activities of a former institutional analyst. The investigation covered the time period from March through December 2003. It is anticipated that the SEC will issue an Order Instituting Public Administrative and Cease-And-Desist Proceedings and Impose Remedial Sanctions. The settlement will result in the imposition of a censure and $100,000 fine against FMSC, and a six month supervisory suspension and fine of $50,000 against the Company's former president and CEO. The settlement should be concluded in the fourth quarter of 2007 or the first quarter of 2008. The fine against the Company has been accrued for in the third quarter of 2007. NASD AWC On September 14, 2007 FMSC entered into a Letter of Acceptance, Waiver and Consent ("AWC") with the Financial Industry Regulatory Authority ("FINRA", formerly the National Association of Securities Dealers "NASD"). The AWC resolved an investigation by the FINRA Staff into sales practice activities of certain individuals who were formerly registered representatives of FMSC, as well as the supervision of those activities by FMSC. Without admitting or denying the allegations set forth in the AWC, FMSC accepted FINRA's findings and consented to a censure, paid a $175,000 and agreed to an undertaking requiring a written certification by a senior officer of the firm, reviewing the firm's systems and procedures regarding its supervisory procedures, and training and monitoring of supervisors. Termination of Merger Agreement; Litigation and Settlement On December 29, 2006, the Company received notification from representatives of the Okun Purchasers that they were terminating the merger agreement and not proceeding with the merger. They alleged the Company's failure to satisfy conditions and the Company's alleged breach of various representations, warranties, covenants and agreements in the merger agreement. On January 8, 2007, the Company filed a lawsuit in the Supreme Court of New Jersey, Monmouth County, Chancery Division against the Okun Purchasers, Mr. Okun, IPofA and several other affiliated entities which Mr. Okun controls (collectively, the "Okun Defendants"). The purpose of this lawsuit was to enforce the terms of the merger pursuant to the merger agreement 14 executed on May 5, 2006. Pursuant to the merger agreement shareholders of the Company's common stock would have received $1.00 in cash for each share of common stock. The lawsuit alleged, among other things, that the Okun Purchasers breached the merger agreement by terminating the agreement on December 29, 2006 without cause or justification. The Company's complaint demanded specific performance of the merger agreement and completion of the merger. In the alternative, the Company sought compensatory damages for breach of contract and breach of the covenant of good faith and fair dealing as well as payment of $2 million held in escrow to secure the performance of the Okun Purchasers under the merger agreement. The lawsuit also sought to void the lease agreement that the Company entered into with another Okun affiliate to relocate the Company's corporate offices to a building purchased by that Okun affiliate in Red Bank, NJ. The Company claimed that the Okun Defendants fraudulently induced the Company to execute this new lease by falsely representing that the Okun Purchasers would consummate the merger. On February 12, 2007, the Company received the Okun Purchasers' answer to the lawsuit which contained several counterclaims against it. In their counterclaims, the Okun Purchasers alleged that the Company breached the merger agreement and failed to disclose certain material facts about the Company, and sought the return of $2 million held in escrow as well as compensatory damages, interest and costs. The Okun Purchasers filed two additional actions; one on February 2, 2007, in the Circuit Court of the State of Florida against the Company's President and Chief Executive Officer, and the other, a shareholder derivative action in the Federal District Court for the District of New Jersey against the Company and certain of its directors and officers, filed on February 16, 2007. The Company believes these actions are based on the same facts and circumstances as the previous action that the Company filed against the Okun Purchasers, Mr. Okun and the other Okun Defendants for their breach of the merger agreement, and are part of their response to the original lawsuit the Company filed in the New Jersey Superior Court. The Company and the individual defendants believe that they acted properly on behalf of the Company's shareholders and have meritorious defenses against all of these claims. On February 26, 2007, Mr. Okun and certain of his affiliates filed an amendment to their Schedule 13D with the SEC disclosing that they beneficially owned 52.8% of the Company's voting securities. According to the amended Schedule 13D, additional shares of the Company's common stock were purchased in privately negotiated transactions for $1.00 per share and the 197,824 shares of Series B Redeemable Convertible Preferred Stock ("Series B Preferred Stock") outstanding were purchased for $10.00 per share. Each share of Series B Preferred Stock is convertible into 10 shares of common stock. The Series B Preferred Stock and certain of the shares of common stock were purchased from two of the Company's former officers and directors (See Note 7- Definitive Merger Agreement). On May 9, 2007, the Company announced that it had reached an agreement with Mr. Okun and the Okun Defendants ("May Settlement Agreement") to settle the three separate lawsuits arising out of the termination of the merger agreement. However, on May 23, 2007 the Company announced that it and the Okun Defendants had agreed to consent to the entry of a Court Order to vacate and set aside the May Settlement Agreement. The Company filed with the SEC Forms 8-K relating to the May Settlement Agreement and its subsequent setting aside on May 11 and 23, 2007, respectively. On June 15, 2007, the Company announced that it had reached a new agreement with Mr. Okun and the Okun Defendants ("June Settlement Agreement") to settle the three separate lawsuits arising out of the termination of the merger agreement. The June Settlement Agreement provided that Okun's affiliated entities would surrender all of their First Montauk preferred stock holdings and 5,272,305 of their common share holdings, such that the Okun's affiliates would hold less than 25% of the outstanding common shares of stock in First Montauk. These shares have since been surrendered and cancelled. The Company also obtained an exclusive 60 day option (the "Option Period") to purchase the balance of the shares held by the Okun affiliated entities (the "Option Securities") for the aggregate purchase price of $2,500,000 (the "Option"), which expired on August 14, 2007, without the Company exercising its option. The June Settlement Agreement also provided that the lease between an Okun affiliated entity and the Company shall be deemed void ab initio. 15 In return, the Company agreed to direct the escrow agent, Signature Bank New York, to pay to an Okun affiliated entity the $2 million on deposit by Mr. Okun and the Okun Defendants under the Escrow Agreement executed and delivered pursuant to the May 5, 2006 Merger Agreement. The foregoing description of the June Settlement Agreement is qualified in its entirety by reference to the full text of the Settlement Agreement which is filed as Exhibit 10.1 to the Report on Form 8-K filed with the SEC on June 15, 2007. As of September 30, 2007, the Company has accrued for potential legal liabilities that are probable and can be reasonably estimated based on a review of existing claims and arbitrations. Management cannot give assurance that this amount will be adequate to cover actual costs that may be subsequently incurred. As of September 30, 2007, it was not possible to predict the outcome of these legal matters pending against the Company. NOTE 9 - LOSS PER SHARE Basic loss per share for the nine and three months ended September 30, 2007 and 2006 is based on the weighted average number of shares of common stock outstanding. The following table sets forth the weighted average number of shares of common stock and dilutive securities outstanding used in the computation of basic and diluted earnings (loss) per share: Nine months ended Three months ended September 30 September 30 ----------------- ------------------ 2007 2006 2007 2006 ---- ---- ---- ---- Numerator - basic: Net loss $ (1,903,446) $ (112,041) $ (796,242) $ (119,994) Deduct: preferred stock dividends ( 122,294) (126,204) ( 36,490) (42,866) ------------ --------- ----------- ----------- Numerator for basic loss $ (2,025,740) $ (238,245) $ (832,732) $ (162,860) per share ============ =========== =========== =========== Numerator - diluted: Net loss $ (1,903,446) $ (112,041) $ (796,242) $ (119,994) Add: preferred stock dividends (122,294) (126,204) ( 36,490) ( 42,866) Add: convertible debenture interest, net of tax ( 1,125) ( 34,902) ( 750) ( 375) ------------ ----------- ----------- ----------- Numerator for diluted $ (2,026,865) $ (273,147) $ (833,482) $ (163,235) loss per share ============ =========== =========== =========== Denominator: Weighted average common shares outstanding 16,439,992 16,531,580 13,245,477 18,382,826 Effect of dilutive securities: Stock options and warrants -- -- -- -- Convertible preferred stock -- -- -- -- Nonvested employee stock -- -- -- -- Convertible debentures -- -- -- -- ------------ ----------- ---------- ---------- Denominator for basic and diluted loss per share 16,439,992 16,531,580 13,245,477 18,382,826 ============ =========== ========== ==========
16 The following securities have been excluded from the dilutive per share computation, as they are antidilutive: ------------------ ------------------------------- ----------------------------------------- Nine months ended Three months ended September 30, September 30, 2007 2006 2007 2006 ---- ---- ---- ---- ------------------ --------------- --------------- -------------------- -------------------- ------------------ --------------- --------------- -------------------- -------------------- Stock options 1,941,800 1,655,300 1,730,400 1,685,552 ------------------ --------------- --------------- -------------------- -------------------- ------------------ --------------- --------------- -------------------- -------------------- Warrants 407,518 149,133 407,518 157,092 ------------------ --------------- --------------- -------------------- -------------------- ------------------ --------------- --------------- -------------------- -------------------- Convertible debentures 50,000 50,000 50,000 50,000 ------------------ --------------- --------------- -------------------- -------------------- ------------------ --------------- --------------- -------------------- -------------------- Convertible preferred stock 44,564 2,588,978 44,564 2,588,978 ------------------ --------------- --------------- -------------------- -------------------- ------------------ --------------- --------------- -------------------- -------------------- Nonvested employee stock -- 58,153 - 59,375 ------------------ --------------- --------------- -------------------- --------------------
As required by FAS 128, "Earnings per Share", cumulative preferred stock dividends for the nine months and three months ended September 30, 2007 and 2006 were deducted from net loss to arrive at the numerator for basic and diluted loss per share. NOTE 10 - TERMINATIONS On August 31, 2007, Mr. Phillip P. D'Ambrisi resigned his positions as Chief Operating Officer of the Company and its wholly owned subsidiary, First Montauk Securities Corp. ("FMSC"). Mr. D'Ambrisi also resigned effective August 31, 2007 as a member of the board of directors of the Company and FMSC. Effective September 1, 2007, the Company and Mr. D'Ambrisi entered into a consulting agreement ("Consulting Agreement") pursuant to which Mr. D'Ambrisi will provide certain services to the Company during the term of such Agreement. A copy of the Consulting Agreement was filed as Exhibit 10.1 to the Company's Report on Form 8-K on September 7, 2007. On August 31, 2007, Mr. Jeffrey J. Fahs, resigned as Executive Vice President, General Counsel and Secretary of the Company and its subsidiaries effective as of September 28, 2007. As part of the negotiation of his existing employment contract he received his 2007 bonus of $100,000. NOTE 11 - NET CAPITAL REQUIREMENTS FMSC is subject to the SEC Uniform Net Capital Rule (Rule 15c3-1), which requires FMSC to maintain minimum net capital, as defined. At September 30, 2007, FMSC had net capital of $592,691, which was $342,691 in excess of its required net capital of $250,000. FMSC's ratio of aggregate indebtedness to net capital was 5.89 to 1. NOTE 12 - SHAREHOLDER RIGHTS PLAN The Board of Directors of First Montauk declared a dividend of one preferred share purchase right for each outstanding share of First Montauk's common stock pursuant to a Rights Agreement dated as of August 8, 2007, between First Montauk and Continental Stock Transfer & Trust Company, as Rights Agent (the "Rights Agreement"). The dividend was paid on August 8, 2007 to the Company's shareholders of record on that date ("Record Date"). In addition, the Board of Directors authorized the issuance of one preferred share purchase right for each additional share of common stock that becomes outstanding between August 8, 2007 and the earliest of: 17 o the "distribution date", which is the earlier of: (1) the close of business on the tenth (10th) business day (unless further extended by a resolution adopted by a majority of the Continuing Directors of the Board of Directors of the Company as of the close of business on August 9, 2007 (the date of the Company's 2007 Annual Meeting)) after a public announcement that (i) a person has acquired beneficial ownership of 10% or more of the outstanding shares of common stock (the "Requisite Percentage") or (ii) in the case of Edward H. Okun, FMFG Ownership Inc., FMFG Ownership II, Inc. and any of their respective Affiliates and Associates (collective, the "Okun Parties") and their respective successors and assigns acquired additional shares of the common stock and beneficially own more than an aggregate of 3,300,308 shares of common stock after the Record Date (each person specified in (i) and (ii) hereafter referred to as an "Acquiring Person); and (2) a date that the Board of Directors designates following the commencement of, or first public disclosure of an intent to commence, a tender or exchange offer for outstanding shares of common stock that could result in the offeror becoming an Acquiring person; o the date on which the rights expire, which is August 8, 2017; and o the date, if any, on which the Board of Directors redeems the preferred share purchase rights. Each preferred share purchase right entitles its registered holder to purchase from the Company one one-hundredth of a share of a new Series C Participating Cumulative Preferred Stock, at a price of $2.00 per one one-hundredth of a preferred share, subject to adjustment as described below. If an Acquiring Person acquires beneficial ownership of the Requisite Percentage or more of the outstanding shares of common stock after August 8, 2007, after the distribution date the preferred share purchase rights will entitle each right holder, other than the Acquiring Person or any affiliate or associate of the Acquiring Person (whose preferred share purchase rights shall be null and void and nontransferable), to purchase, for the purchase price, the number of shares of common stock which at the time of the transaction would have a market value of twice the purchase price. After an Acquiring Person becomes the beneficial owner of the Requisite Percentage or more of the outstanding shares of common stock but before the Acquiring Person becomes the beneficial owner of more than 50% of the common shares, the Board of Directors may elect to exchange each preferred share purchase right, other than those that have become null and void and nontransferable as described above, for shares of common stock, without payment of the purchase price. The exchange rate in this situation would be one-half of the number of shares of common stock that would otherwise be issuable at that time upon the exercise of one preferred share purchase right. At any time prior to an Acquiring Person acquiring beneficial ownership of the Requisite Percentage or more of the outstanding shares of common stock , the Board of Directors may redeem the preferred share purchase rights in whole, but not in part. The redemption price of $0.0001 per preferred share purchase right, subject to adjustment as provided in the Rights Agreement, may be paid in cash, shares of common stock or other First Montauk securities deemed by the Board of Directors to be at least equivalent in value. The Board of Directors may also supplement or amend any provision of the Rights Agreement, including the date on which the distribution date or expiration date would occur, the time during which the preferred share purchase rights may be redeemed and the terms of the preferred shares. In the case of a redemption, the preferred share purchase rights are designed to ensure that the Board of Directors has adequate time to consider any proposed acquisition transaction involving First Montauk and to protect First Montauk and its shareholders against any proposed acquisition transaction in which all shareholders are not treated equitably and do not receive fair value for their shares of common stock. The preferred share 18 purchase rights have certain antitakeover effects and will cause substantial dilution to a person that attempts to acquire First Montauk on terms not approved by the Board of Directors. The preferred share purchase rights should not affect any prospective offeror willing to make an all-cash offer at a full and fair price, or willing to negotiate with the Board of Directors. Similarly, the preferred share purchase rights will not interfere with any merger or other business combination approved by the Board of Directors since the Board of Directors may, at its option, redeem all, but not less than all, of the then outstanding preferred share purchase rights at the redemption price. The foregoing description of the Shareholder Rights Plan is qualified in its entirety by reference to the full text of the Rights Agreement, which is filed as Exhibit 4.1 to the Company's Report on Form 8-K filed on August 8, 2007. 19 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Factors Affecting "Forward-Looking Statements" From time to time, we may publish "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, or make oral statements that constitute forward-looking statements. These forward-looking statements may relate to such matters as anticipated financial performance, future revenues or earnings, business prospects, projected ventures, new products, anticipated market performance, and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, we caution readers that a variety of factors could cause our actual results to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. These risks and uncertainties, many of which are beyond our control, include, but are not limited to: (i) transaction volume in the securities markets, (ii) the volatility of the securities markets, (iii) fluctuations in interest rates, (iv) changes in regulatory requirements which could affect the cost of doing business, (v) fluctuations in currency rates, (vi) general economic conditions, both domestic and international, (vii) changes in the rate of inflation and related impact on securities markets, (viii) competition from existing financial institutions and other new participants in the securities markets, (ix) legal developments affecting the litigation experience of the securities industry, (x) the timely completion of the acquisition of the Company by a private investor, and (xi) changes in federal and state tax laws which could affect the popularity of products sold by us. We do not undertake any obligation to publicly update or revise any forward-looking statements. The reader is referred to our previous filings with the Commission, including our Form 10-K/A for the year ended December 31, 2006. Overview We are a New Jersey-based financial services holding company whose wholly owned subsidiary, First Montauk Securities Corp., ("FMSC") has operated as a full service retail and institutional securities brokerage firm since 1987. Since July 2000, FMSC has operated under the trade name "Montauk Financial Group" and provides a broad range of securities brokerage and investment services to a diverse retail and institutional clientele, as well as corporate finance and investment banking services to corporations and businesses. We also sell insurance products through our subsidiary, Montauk Insurance Services, Inc. Montauk Financial Group has approximately 214 registered representatives and services approximately 48,000 retail and institutional customers, which comprise approximately $3 billion in customer assets. All of our 90 branch office and satellite locations in 24 states are owned and operated by affiliates; who are independent representatives who maintain all appropriate licenses and are responsible for all office overhead and expenses. Montauk Financial Group also employs registered representatives directly at its corporate headquarters. Montauk Financial Group is registered as a broker-dealer with the Securities and Exchange Commission, Financial Industry Regulatory Authority (formerly the National Association of Securities Dealers), the Municipal Securities Rule Making Board, the National Futures Association, and the Securities Investor Protection Corporation and is licensed to conduct its brokerage activities in all 50 states, the District of Columbia, and the Commonwealth of Puerto Rico, and registered as an International broker-dealer to conduct business with institutional clients in the province of Ontario, Canada. Securities transactions are cleared through National Financial Services LLC ("NFS") of Boston, MA, and Penson Financial Services Inc of Dallas, TX, with various floor brokerage and specialist firms also providing execution services. These arrangements provide Montauk Financial Group with back office support and transaction processing services on all principal, national and international securities exchanges, and access to many other financial services and products which allows Montauk Financial Group to offer products and services comparable to larger brokerage firms. 20 RESULTS OF OPERATIONS Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006 Revenues by Source The following provides a breakdown of total revenues by source for the three-month periods ended September 30, 2007 and 2006 (in thousands of dollars). Three Months Ended ----------------------------------------------------------------- ------------------------------ --- ------------------------------ September 30, 2007 September 30, 2006 ------------------------------ ------------------------------ % of Total % of Total Commissions Amount Revenues Amount Revenues Equities $ 2,932 31% $ 3,905 34% Mutual Funds 1,437 15% 1,320 12% Insurance 1,268 13% 1,584 14% Alternative Products 965 10% 1,264 11% Asset Management Fees 1,010 11% 980 9% Fixed Income 96 1% 29 1% -------------- --------------- -------------- --------------- Total 7,708 81% 9,082 81% Principal Transactions 307 3% 834 7% Investment Banking 961 10% 597 5% Interest and Other Interest 456 5% 588 5% Other 90 1% 173 2% -------------- --------------- -------------- --------------- Total 546 6% 761 7% -------------- --------------- -------------- --------------- Total revenues $ 9,522 100% $ 11,274 100% ============== =============== ============== ===============
Overview Total revenues decreased $1.75 million, or 16%, for the three months ended September 30, 2007 (the "2007 quarter"), to $9.52 million from $11.27 million for the three months ended September 20, 2006 (the "2006 quarter"). The decrease in revenues is primarily attributable to a decline in the number of producing registered representatives. There were decreases in several categories of revenues, the largest coming from equity commissions and principal transactions of $1.5 million. On the other hand, investment banking revenues increased $364,000 in 2007 when compared to the comparable period in 2006. Expenses decreased in the 2007 quarter by $1.1 million, or 10%, compared to the 2006 quarter. Commission, employee compensation and benefits decreased by $1.3 million, from $9.6 million in the 2006 quarter to $8.3 million in the 2007 quarter. The net loss applicable to common stockholders for the 2007 quarter was $833,000, or ($0.06) per basic and diluted share compared to a net loss applicable to common stockholders for the 2006 quarter of $163,000, or ($0.01) per basic and diluted share. 21 Commission Revenue Commissions are comprised of revenues from the sale of equities, fixed income, mutual funds, insurance, asset management fees and alternative products. Commission revenue for the 2007 quarter was $7.7 million compared to $9.1 million for the 2006 quarter, a decrease of approximately $1.4 million. Decreases in commissions from the sale of equities of $1.0 million accounted for the majority of the reduction in commission revenues. This decrease highlights the result of the reduction in producing registered representatives' from the 2006 quarter to the 2007 quarter. Principal Transactions Principal transactions, which include mark-ups/mark-downs on customer transactions in which we act as principal, proprietary trading, and the sale of fixed income securities, decreased $528,000, or 63%, from $834,000 for the 2006 quarter to $306,000 for the 2007 quarter. The decrease is primarily due to the reduction in the number of registered representatives who engaged in these types of transactions and the use of our clearing firm to handle more of our fixed income securities transactions on an agency basis, rather than on a principal basis. Investment Banking Investment banking revenues for the 2007 quarter increased $364,000 from $597,000 in the 2006 quarter, to $961,000 in the 2007 quarter, an increase of approximately 61%. Investment banking revenue includes fees from private offerings of securities for public companies, which is a function of the number of the Company's corporate clientele needing financing for capital expansion. In addition, the Company is constantly looking to expand the number of banking clients. This category also includes new issues of equity and preferred stock offerings in which we participate as a selling group or syndicate member. Interest and Other Income Interest and other income decreased by approximately $215,000 during the 2007 period when compared to the 2006 period. Of the total decrease, $132,000 was from the reduction in interest income. This decrease was directly related to the amount of margin debit carried by customers. Revenues received from vendors for marketing fees decreased by approximately $99,000, due in large part to the reduction in alternative investment products sold during the 2007 period. Commissions, Employee Compensation and Benefits Commission expense, consistently the largest expense category and directly related to commission revenue, decreased 16%, or $1.34 million, from $8.21 million for the 2006 quarter, to $6.87 million for the 2007 quarter. Compensation and benefits expense for management, operations and clerical personnel, which include salaries, severance payments, payroll taxes, stock and option compensation, health insurance premiums, and bonus accruals, remained constant during the 2007 quarter, at approximately $1.4 million. Clearing and Floor Brokerage Clearing and floor brokerage costs, which are greatly affected by volume and type of transactions, decreased $81,000, to $335,000 in the 2007 quarter from $416,000 during the 2006 quarter. As a percentage of transaction-based commissions, clearing costs remained relatively constant at approximately 6.1%. Clearing costs, as a percentage of gross revenues, can fluctuate depending upon the product mix. 22 Communications and Occupancy Communications and occupancy costs decreased $59,000, from $486,000 in the 2006 quarter to $427,000 in the 2007 period. In September 2006, we terminated the lease on our NYC office, and therefore eliminated all of the costs associated with that office including rent, market data services, telephone and other office related expenses. Legal matters and related costs Legal matters and related settlement costs increased $77,000, from $160,000 during the 2006 quarter to $237,000 for the 2007 quarter, most of which was related to an increase in legal settlement costs of $63,000. In 2006, we recorded a note due from two of our brokers who were named in a case we settled in the same period. The estimated cost of this settlement was accrued for earlier in 2006. As a result of recording the receivable due from the brokers, the net legal settlement costs for the 2006 quarter was a credit of $45,000. This compares to settlement costs of $9,000 in the 2007 period. Other Operating Expenses Other operating expenses increased $286,000 for the 2007 quarter. During this quarter, the Company settled two ongoing investigations; one with the SEC and the other with FINRA (see Note 8 -Commitments and Contingencies - Legal Matters). The total fines and censures related to these two investigations is $275,000 and were accrued for by the Company in August and September 2007. Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006 Revenues by Source The following provides a breakdown of total revenues by source for the nine-month periods ended September 30, 2007 and 2006 (in thousands of dollars). Nine Months Ended ----------------------------------------------------------------- ------------------------------ --- ------------------------------ September 30, 2007 September 30, 2006 ------------------------------ ------------------------------ % of Total % of Total Commissions Amount Revenues Amount Revenues ----------- ------ -------- ------ -------- Equities $ 9,801 31% $ 14,987 39% Mutual Funds 4,729 15% 4,531 12% Insurance 3,582 11% 3,774 10% Alternative Products 3,579 11% 3,201 8% Asset Management Fees 3,080 10% 2,884 8% Fixed Income 171 1% 132 <1% -------------- --------------- -------------- --------------- Total 24,942 79% 29,509 77% Principal Transactions 1,261 4% 3,319 9% Investment Banking 3,440 11% 2,914 8% Interest and Other Interest 1,631 5% 1,915 5% Other 437 1% 535 1% -------------- --------------- -------------- --------------- Total 2,068 6% 2,450 6% -------------- --------------- -------------- --------------- Total revenues $ 31,711 100% $ 38,192 100% ============== =============== ============== ===============
23 Overview Overall, revenues decreased $6.4 million for the nine months ended September 30, 2007 (the "2007 period"), to $31.7 million, compared to $38.1 million, for the nine months ended September 30, 2006 (the "2006 period"). Commission revenues decreased by $4.6 million while revenues from principal transactions decreased by $2.1 million. The decrease in revenues is primarily attributable to a decline in the number of producing registered representatives. Included in interest and other income for the 2006 period is an additional $180,000 of margin interest, a partial allocation of the $1.0 million received from NFS in June 2006. This was a result of an amendment of Exhibit A of the clearing agreement signed by our wholly owned subsidiary, First Montauk Securities Corp. ("FMSC") on June 29, 2006. Expenses in the 2007 period decreased by approximately $4.69 million, a decrease of 12% over the 2006 period. The 2006 period includes an $820,000 credit due to a partial allocation of the $1.0 million received from NFS in June 2006 and $951,000 of executive separation costs. Included in the 2007 decrease are a reduction in commission, employee compensation and benefits of $4.2 million, from $31.7 million in the 2006 period to $27.5 million in the 2007 period and executive separation costs of $951,000. Net loss applicable to shareholders in the 2007 period was $2,026,000, or ($0.12) per basic and diluted share compared to a net loss applicable to shareholders of $238,000, or ($0.01) per basic and diluted share for the same period in 2006. Commission Revenue Commissions are comprised of revenues from the sale of equities, fixed income, mutual funds, insurance, asset management fees and alternative products. Commission revenue for the 2007 period decreased $4.6 million to $24.9 from $29.5 million in the same period in 2006, related to the reduction in the number of registered representatives from the 2006 period to the 2007 period. The decrease was primarily attributable to a reduction in revenue from agency equity and principal transactions of $5.2 million, offset by increases in commissions from alternative products, which include commissions on REIT's, 1031 exchanges and oil & gas programs of $378,000, mutual funds of $198,000 and fees from managed accounts of $196,000. Principal Transactions Principal transactions decreased $2.0 million, from $3.3 million for the 2006 period to $1.3 for the 2007 period. The decrease is primarily due to the reduction in the number of registered representatives who engaged in these types of transactions and the use of our clearing firm to handle more of our fixed income securities transactions. Investment Banking Investment banking revenues increased by $526,000 for the 2007 period, from $2.9 million in the 2006 period, to $3.4 million in the 2007 period. Investment banking revenue includes fees from private offerings of securities for public companies, which is a function of the number of the Company's corporate clientele needing financing for capital expansion. The Company is constantly looking to expand the number of banking clients. This category also includes new issues of equity and preferred stock offerings in which we participate as a selling group or syndicate member. Interest and Other Income Interest and other income for the 2007 period decreased by $381,000 when compared to the 2006 period, which period included an additional $180,000 of margin interest rebate, a partial allocation of the $1.0 million received from NFS in June 2006. Of the total decrease, $299,000 was from the reduction in interest income. Taking into consideration the $180,000 received from NFS, the actual decrease would have been approximately $119,000. This decrease was directly related to the amount of margin debit carried by customers. Commissions, Employee Compensation and Benefits Commission expense, consistently the largest expense category and directly related to commission revenue, decreased 17%, or $4.6 million, from $27.3 million for the 2006 period, to $22.7 million for the 2007 period. Compensation and benefits expense for management, operations and clerical personnel, which include salaries, severance payments, payroll taxes, stock and option compensation, health insurance premiums, and bonus accruals, increased for the 2007 period, to $4.8 million from $4.4 million, an increase of approximately $400,000 over the 2006 period. Included in the 2007 period was approximately $251,000 of severance costs for various personnel and bonus accruals associated with employment contracts of $200,000. 24 Executive Separation Executive separation costs decreased $951,266 for the 2007 period when compared with the 2006 period. In February 2006, we entered into a separation agreement with our then Chairman of the Board, which provided for the termination of his employment as of that date. In the 2007 period, there was no separation agreements entered into with any executives. Clearing and Floor Brokerage Clearing and floor brokerage costs which are greatly affected by volume and type of transactions, increased slightly from $1.11 million in the 2006 period to $1.13 in the 2007 period. In June 2006, we allocated approximately $544,000 of the $1 million received in the settlement from NFS to clearing fees for costs incurred in prior periods. Actual clearing costs for the 2006 period, excluding the settlement amount from NFS of $544,000, would have been $1.66 million. Based on this adjustment, clearing and floor brokerage costs for 2007 would have decreased approximately $520,000 for the 2007 period. As a percentage of transaction-based commissions, clearing costs remained relatively constant at approximately 7%. Clearing costs, as a percentage of gross revenues, fluctuate depending upon the product mix. Communications and Occupancy Communications and occupancy costs decreased approximately $110,000, from $1.37 million in the 2006 period to $1.26 million in the 2007 period. In the 2006 period there was a $135,000 reduction in costs incurred in prior periods related to data aggregation as part of the $1 million received from NFS in June 2006. Excluding this reduction, communications and occupancy costs would have decreased by approximately $245,000. This decrease is primarily due to the termination of our New York City branch office lease in September 2006 and costs related to the operating of that office. Legal matters and related costs Legal matters and related settlement costs increased approximately $450,000, from $772,000 during the 2006 period to $1.2 million for the 2007 period, most of which was related to legal fees. Legal fees during the first nine months of 2007 were $1.15 million compared to $710,000 during the first nine months of 2006. In 2006, we incurred $271,000 in legal fees in connection with the anticipated acquisition of the Company by a private investor. In 2007, we incurred $407,000, for legal fees related to various lawsuits involving the termination of the proposed merger in December 2006 (See Note 8 - Commitments and Contingencies - Legal Matters). The amount for the 2007 period was net of a $600,000 reimbursement from our insurance carrier which was received in August 2007. Other legal fees include costs associated with the SEC investigation and the resolution of the settlement with both the SEC and FINRA, as well as fees associated with customer claims. Other Operating Expenses Other operating expenses increased approximately $175,000 for the 2007 period, from $2.3 million in the 2006 period to $2.5 million in the 2007 period. During the 2007 quarter, the Company settled two regulatory inquiries; one with the SEC and the other with FINRA (see Note 8 -Commitments and Contingencies - Legal Matters).The total fines related to these two investigations is $275,000 and were accrued for by the Company in August and September 2007. 25 Liquidity and Capital Resources Approximately 66% of our assets consist of cash, securities owned, and receivables from our clearing firm and other broker-dealers and insurance companies. The balances in these accounts can and do fluctuate significantly from day to day, depending on general economic and market conditions, volume of activity, and investment opportunities. These accounts are monitored on a daily basis in order to ensure compliance with regulatory capital requirements and to preserve liquidity. Overall, cash and cash equivalents increased during the nine months ended September 30, 2007 by $181,000. Net cash provided by operating activities during the 2007 period was $349,000, which consists of a net loss of $1,903,000, increased by non-cash charges including depreciation of $89,000, amortization of stock compensation and deferred costs of $38,000. Cash was increased by decreases in the amount due from clearing firm, securities owned, and broker receivables of $2.5 million, $30,000 and $70,000, respectively, and increases in accounts payable of $616,000. Cash was decreased by an increase in prepaid expenses, deposits and commissions receivable from outside vendors of $179,000, $320,000 and $190,000, respectively and decreases in accrued expenses, commissions payable and other liabilities of $235,000, $145,000 and $19,000, respectively. Additions to property and equipment of $46,000 accounted for the use of cash from investing activities during the nine months ended September 30, 2007. Financing activities used net cash of $123,000 due to the payment of preferred stock dividends of $122,000 and capital leases of $820 during the first nine months of 2007. The financing agreement with AICCO Inc. for the renewal of our errors and omissions insurance policy had a balance at September 30, 2007 of approximately $148,000, payable in two remaining monthly installments of $74,781 each, including interest at the rate of 5.87% per annum. During the 2007 quarter, we cut costs by approximately $1.4 million on an annualized basis. This was accomplished through reductions in our work force, subletting a portion of our office space and the renegotiation of our outsourced mailroom contract. We believe that our cash resources will be sufficient to meet our minimum planned operating needs for the next 6 months. Beyond that period, management has other plans for increasing cash flow, including pursuing additional financing and continued reductions in overhead costs. Although we have plans to pursue additional financing, there can be no assurance that we will be able to secure financing when needed or obtain such financing on terms satisfactory to us, if at all, or that any additional funding we do obtain will be sufficient to meet our needs in the long term. If additional funding cannot be obtained, we will review alternative courses of action to conserve our cash flow. Contractual Obligations The Company has contractual obligations to make future payments in connection with its short-term debt, severance payments and non-cancelable lease and service agreements. The following table sets forth these contractual obligations by year. This table does not include any projected payment amounts related to our potential exposure to arbitrations and other legal matters. Expected Maturity Date Category 2007 2008 2009 2010 Total -------------- -------- ------- -------- ------- ---------- -------------- -------- ------- -------- ------- ---------- Short-term debt (1) $ 25,296 $0 $0 $0 $25,296 Severance payments (2) 50,000 16,668 0 0 66,668 Operating leases 245,924 853,911 672,805 61,407 1,834,047 -------- -------- -------- ------- ---------- Total $321,220 $870,579 $672,805 $61,407 $1,926,011 ======== ======== ======== ======= ========== 26 (1) Short-term debt in 2007 includes a convertible debenture in the amount of $25,000 with accrued interest of $296, maturing on 12/11/07. (2) Severance payments of $66,668 are due and owing to our former general counsel. Payments are made semi-monthly at the rate of $16,667 per month with the final payment due in January 2008. Effective November 2006, we entered into a master services agreement with an outside vendor for development of certain software, data integration and business processing improvement consulting services. The term of the agreement is for a minimum of 3 years. Under the agreement, we will pay $480,000 over an initial 12 month period and then $20,000 a month thereafter. On October 12, 2007, the Company received a letter from the vendor acknowledging delays in the implementation of the development project and agreeing to suspend billing to us beginning with the September 2007 payment. A resumption of payments would not begin until mutually agreeable specific milestones and deliverables as contained in a revised project plan are met. As of the filing of this report, the revised project plan has not been finalized. Net Capital At September 30, 2007, Montauk Financial Group had net capital of $592,691, which was $342,691 in excess of its required net capital of $250,000, and the ratio of aggregate indebtedness to net capital was 5.89 to 1. Common Stock On June 15, 2007, we reached an agreement with Mr. Okun and the Okun Defendants ("June Settlement Agreement") to settle the three separate lawsuits arising out of the termination of the merger agreement between the Company and the Okun Purchasers. On June 15, 2007, the Okun affiliated entities surrendered 5,272,305 of their common share holdings. (See Note 8 - COMMITMENTS AND CONTINGENCIES - Legal Matters - Termination of Merger Agreement; Litigation and Settlement). Series A Convertible Preferred Stock In 1999, we issued 349,511 shares of Series A Convertible Preferred Stock in an exchange offering related to a settlement with holders of certain leases. Each share of the Preferred Stock is convertible into two shares of Common Stock and pays a quarterly dividend of 6%. On June 15, 2007, as part of the settlement with Mr. Okun and the Okun Defendants (See Note 8-COMMITMENTS AND CONTINGENCIES- Legal Matters-Termination of Merger Agreement; Litigation and Settlement) an agreement was reached which required the parties to surrender all shares of Series A Preferred Stock previously owned by the Okun Defendants. On June 15, 2007, 283,087 shares of Series A Preferred Stock were surrendered and cancelled. As of September 30, 2007, we have 22,282 Series A preferred shares issued and outstanding. Quarterly dividends of $19,601 and $23,532 were paid during the three months ended September 30, 2007 and 2006, respectively. Series B Convertible Redeemable Preferred Stock In connection with a Separation Agreement we entered into with Mr. William J. Kurinsky in 2005, we issued an aggregate of 197,824 shares of a newly created class of Series B Convertible Redeemable Preferred Stock ("Series B"), par value $0.10 per share, which had a deemed issue price of $1,000,000, and was convertible into common stock on the basis of ten shares of common stock for each share of Series B. The Series B also provided that the preferred shares have voting rights based upon the number of shares of common stock into which it would be converted. The Series B also included a cumulative dividend of 8% per year. The shares are restricted securities under the Securities Act of 1933 and the regulations of the SEC and we relied upon the exemption from registration under Section 4(2) of the Securities Act of 1933 to issue the shares of Series B. A quarterly dividend of $16,889 and $20,000 were paid during the three months ended September 30, 2007 and 2006, respectively. 27 Mr. Okun purchased all the shares of Series B in a private transaction on February 23, 2007 at a price of $10.00 per share of Series B. On June 15, 2007, as part of the settlement with Mr. Okun and the Okun Defendants (See Note 8-COMMITMENTS AND CONTINGENCIES- Legal Matters-Termination of Merger Agreement; Litigation and Settlement) an agreement was reached which required the parties to surrender all shares of Series B previously owned by the Okun Defendants. On June 15, 2007, 197,824 shares of Series B were surrendered and cancelled. There are currently no shares of Series B outstanding. Application of Critical Accounting Policies Generally accepted accounting principles are complex and require management to apply significant judgments to various accounting, reporting and disclosure matters. Our management must use assumptions and estimates to apply these principles where actual measurement is not possible or practical. For a complete discussion of our significant accounting policies, see "Management Discussion and Analysis" and "Notes to the Consolidated Financial Statements" in our 2006 Annual Report filed on Form 10-K/A. Certain policies are considered critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements. Off-Balance Sheet Arrangements We execute securities transactions on behalf of our customers. If either the customer or counter-party fails to perform, we, by agreement with our clearing broker may be required to discharge the obligations of the non-performing party. In such circumstances, we may sustain a loss if the market value of the security is different from the contract value of the transaction. We seek to control off-balance-sheet risk by monitoring the market value of securities held or given as collateral in compliance with regulatory and internal guidelines. Pursuant to such guidelines, our clearing firm requires additional collateral or reduction of positions, when necessary. We also complete credit evaluations where there is thought to be credit risk. Item 3. Risk Management Business Risk. Our business is subject to significant risk from a decline in revenues due to the loss of registered representatives, expenses related to legal matters associated with our terminated merger plans and regulatory exposure. We may incur further losses in the future and such losses would necessarily affect the nature, scope and level of our future business. Our ability to continue as a going concern is dependent on our ability to maintain and increase operating revenues, reduce operating expenses, and raise additional capital. During the quarter, the Company reduced expenses by approximately $1.5 million annually. This included a reduction in the workforce, subletting of office space, and renegotiating of outsourced office functions. We believe that our cash resources will be sufficient to meet our minimum planned operating needs for the next 6 months. Beyond that period, management has other plans for increasing cash flow, including pursuing additional financing and continued reductions in overhead costs. We cannot make any assurances that we will be successful in these activities, which would therefore have a materially adverse affect on our financial condition. Our ability to obtain additional financing from other sources depends on many factors, some of which are beyond our control, including the state of the capital markets and the uncertainties that are common in the securities industry. The necessary additional financing may not be available to us or may be available only on terms that would result in dilution to the current owners of our common stock. If additional funding cannot be obtained, we will review alternative courses of action to conserve our cash flow. 28 As a securities broker-dealer, we are subject to uncertainties that are common in the securities industry. These uncertainties include: o the volatility of capital markets; o governmental regulation; o litigation; o intense competition; o substantial fluctuations in the volume and price level of securities; and o dependence on third parties. As a result, revenues and earnings may vary significantly from period to period. In periods of low volume, profitability is impaired because certain expenses remain relatively fixed. In the event of a substantial change in market conditions or a loss of a substantial number of registered representatives from whom our revenues are derived, our financial condition and results of operations would be adversely affected. Market Risk. Market risk is the risk of loss to the Company resulting from changes in interest rates and equity prices. The Company has exposure to market risk primarily through its broker-dealer. The Company's broker-dealer, First Montauk Securities Corp., carries debt obligations on behalf of its customers and acts as a market maker in approximately 15 over-the-counter equity securities. In connection with these activities, the Company maintains inventories to facilitate client transactions. Occasionally, the Company invests for its own proprietary equity investment accounts. The following table represents the fair value of trading inventories associated with the Company's broker-dealer client facilitation, market-making activities and proprietary trading activities. September 30, 2007 December 31, 2006 ----------------------------------- ---------------------------------------- Securities Sold Securities but not yet Securities Securities Sold but Owned Purchased Owned not yet Purchased --------------- ------------------- ------------------ --------------------- Marketable: Government $ 6,825 $ 0 $ 2,015 $ 0 Corporate 0 0 0 0 Municipal 0 0 0 0 Certificates of deposit 0 0 0 0 --------------- ------------------- ------------------ --------------------- Total debt securities 6,825 0 2,015 0 Equity securities 91,863 0 97,941 495 Mutual funds 11 6,008 0 96 Options 425 0 0 0 Warrants 69,732 0 92,483 0 --------------- ------------------- ------------------ --------------------- Total $168,941 $ 11 $198,447 $495 =============== =================== ================== =====================
29 Changes in value of the Company's inventory may result from fluctuations in interest rates, credit ratings of the issuer, equity prices and the correlation among these factors. The Company's primary method of controlling risk is through the establishment and monitoring of limits on the dollar amount of securities positions that can be entered into. Position limits in inventory accounts are monitored on a daily basis. Management also monitors inventory levels and trading results, as well as inventory aging, pricing, concentration and securities ratings. Since the inventory accounts are used primarily to facilitate customer transactions the number of positions and absolute dollar amounts are maintained well within Company limits and therefore represents minimal market risk to the Company. Our policy is to hold securities pending customer transactions and therefore we generally do not maintain positions longer than one year. Credit Risk. Credit risk represents the loss that we would incur if a client, counterparty or issuer of securities or other instruments that we hold fails to perform its contractual obligations. Client activities involve the execution, settlement, and financial of various transactions on behalf of its clients. Client activities are transacted on either a cash or margin basis. Client activities may expose us to off-balance sheet credit risk. We may have to purchase or sell financial instruments at the prevailing market price in the event of the failure of a client to settle a trade on its original terms or in the event that cash and securities in the client margin accounts are not sufficient to fully cover the client losses. We seek to control the risks associated with client activities by requiring clients to maintain collateral in compliance with various regulations and company policies. Operational Risk. Operational risk generally refers to the risk of loss resulting from our operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our operating systems, business disruptions and inadequacies or breaches in our internal control processes. We operate in diverse markets and rely on the ability of our employees and systems to process high numbers of transactions often within short time frames. In the event of a breakdown or improper operation of systems, human error or improper action by employees, we could suffer financial loss, regulatory sanctions or damage to our reputation. In order to mitigate and control operational risk, we have developed and continue to enhance policies and procedures that are designed to identify and manage operational risk at appropriate levels. Included in our operational risk management practice is disaster recovery for our critical systems. We believe that our disaster recovery program, including off-site back-up technology and operational facilities, is adequate to handle a reasonable business disruption. However, there can be no assurances that a disaster directly affecting our headquarters or operations center would not have a material adverse impact. Insurance and other safeguards might only partially reimburse us for our losses. Legal Risk. Legal risk includes the risk of non-compliance with applicable legal and regulatory requirements. We are subject to extensive regulation in the different jurisdictions in which we conduct our business. We have various procedures addressing issues such as regulatory capital requirements, sales and trading practices, use of and safekeeping of customer funds, credit granting, collection activities, anti money-laundering and record keeping. 30 Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 13a-15(e). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in designing and evaluating the controls and procedures. Based on their evaluation, as of September 30, 2007, our Chief Executive Officer and our Acting Chief Financial Officer concluded that our disclosure controls and procedures were effective. Changes in Internal Controls There have not been any changes in our internal control over financial reporting (as defined in Rules 13a-15(f) under the Exchange Act) that occurred during the quarter ended September 30, 2007, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 31 PART II OTHER INFORMATION Item 1. Legal proceedings SEC Proposed Settlement The Company has recently resolved a regulatory investigation by the SEC concerning FMSC's, and a former employee's failure to reasonably to supervise the securities trading and research activities of a former institutional analyst. The investigation covered the time period from March through December 2003. It is anticipated that the SEC will issue an Order Instituting Public Administrative and Cease-And-Desist Proceedings and Imposing Remedial Sanctions. The settlement will result in the imposition of a censure and $100,000 fine against FMSC, and a six month supervisory suspension and fine of $50,000 against the Company's former president and C.E.O. The settlement should be concluded in the fourth quarter of 2007 or the first quarter of 2008. The fine against the Company has been accrued for in the third quarter of 2007. NASD AWC On September 14, 2007 FMSC entered into a Letter of Acceptance, Waiver and Consent ("AWC") with the Financial Industry Regulatory Authority ("FINRA", formerly the National Association of Securities Dealers "NASD"). The AWC resolved an investigation by the FINRA Staff into sales practice activities of certain individuals who were formerly registered representatives of FMSC, as well as the supervision of those activities by FMSC. Without admitting or denying the allegations set forth in the AWC, FMSC accepted FINRA's findings and consented to a censure, paid a $175,000 and agreed to an undertaking requiring a written certification by a senior officer of the firm, reviewing the firm's systems and procedures regarding its supervisory procedures, and training and monitoring of supervisors. Termination of Merger Agreement, Litigation and Settlement See Note 8 - COMMITMENTS AND CONTINGENCIES - Legal Matters - Termination of Merger Agreement; Litigation and Settlement. Item 1A. Risk Factors Refer to December 31, 2006 Form 10-K/A. Item 2. Unregistered Sales of Equity Securities (a) Not applicable. (b) Not applicable. (c) Not applicable. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. 32 Item 5. Other Information Amended and Restated Employment Agreement with Victor Kurylak As of May 9, 2007, the Company and Victor K. Kurylak, President and Chief Executive Officer of the Company, executed an Amended and Restated Employment Agreement ("Amended Employment Agreement"). The Amended Employment Agreement was executed in connection with the execution of the May Settlement Agreement. Pursuant to the Amended Employment Agreement, Mr. Kurylak was to continue his employment with the Company as President . Mr. Kurylak was to resign, however, from the position of Chief Executive Officer of the Company in connection with the May Settlement Agreement with the Okun defendants. However, since the May Settlement Agreement was vacated and set aside, Mr. Kurylak's resignation was not accepted and thus cancelled. On June 15, 2007, the Company and Mr. Kurylak executed an Amendment Number One to the Amended and Restated Employment Agreement ("Amendment to Amended Employment Agreement") to correctly state that Mr. Kurylak remains employed in the capacity of President and Chief Executive Officer of both the Company and FMSC. Mr. Kurylak's employment contract has been renewed for one year under the terms of the Amended Employment Agreement previously filed. During the term of the Amended Employment Agreement, Mr. Kurylak will be compensated at the rate of $300,000 on an annualized basis. He is eligible for customary fringe benefits and to participate in the Company's executive bonus pool. In the event of the termination of Mr. Kurylak's employment by the Company without "cause" or by Mr. Kurylak for "good reason" as these terms are defined in the Amended Employment Agreement, he would be entitled to: (a) all compensation accrued but not paid as of the termination date; (b) base salary for the remainder of the Term; (c) a severance payment equal to $300,000 payable in a lump sum payment; (d) continued participation in the Company's benefit plans (or comparable plans); and (e) any applicable bonus. If Mr. Kurylak's employment is terminated by the Company for "cause" or by him without "good reason", he will be entitled only to accrued compensation. If termination of the Amended Employment Agreement occurs as a result of the expiration of such agreement without renewal by the Company at the end of the Term, Mr. Kurylak will be entitled to the accrued compensation, any applicable bonus and the severance payment. In the event Mr. Kurylak is a member of the board of directors of the Company on the termination date, the payment of any and all compensation due under the Amended Employment Agreement, except the accrued compensation, is expressly conditioned on Mr. Kurylak's resignation from the board of directors of the Company within five (5) business of the termination date. The Amended Employment Agreement contains confidentiality obligations that survive indefinitely and non-solicitation and non-competition obligations that end on the first anniversary of the date of cessation of Mr. Kurylak's employment. The foregoing description of Mr. Kurylak's Amended Employment Agreement is qualified in its entirety by reference to the full text of the Amended Employment Agreement, which was filed as Exhibit 10.2 to the Company's Report on Form 8-K filed on May 11, 2007, and Amendment No. 1 to the Amended Employment Agreement, which was filed as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007, filed on August 14, 2007. 33 Senior Employee Resignations On August 31, 2007, Mr. Phillip P. D'Ambrisi resigned his positions as Chief Operating Officer of the Company and its wholly owned subsidiary, First Montauk Securities Corp. ("FMSC"). Mr. D'Ambrisi also resigned effective August 31, 2007 as a member of the board of directors of the Company and FMSC. Effective September 1, 2007, the Company and Mr. D'Ambrisi entered into a consulting agreement ("Consulting Agreement") pursuant to which Mr. D'Ambrisi will provide certain services to the Company during the term of such Agreement. A copy of the Consulting Agreement was filed as Exhibit 10.1 to the Company's Report on Form 8-K filed on September 7, 2007. On August 31, 2007, Mr. Jeffrey J. Fahs, resigned as Executive Vice President, General Counsel and Secretary of the Company and its subsidiaries effective as of September 28, 2007. As part of the negotiation of his existing employment contract he received his 2007 bonus of $100,000. 34 Item 6. Exhibits The exhibits designated with an asterisk (*) are filed herewith. All other exhibits have been previously filed with the Commission and, pursuant to 17 C.F.R. ss. 230.411, are incorporated by reference to the document referenced in brackets following the description of such exhibits. ----------------- ---------------------------------------------------------------------------------------------------- 10.1 Settlement Agreement dated as of May 8, 2007 among First Montauk Financial Corp., Edward H. Okun, Investment Properties of America, LLC, IPofA Water View, LLC, FMFG Acquisition Co. Inc., FMFG Ownership I, FMFG Ownership II, Victor K. Kurylak, Ward R. Jones, Jr., Barry Shapiro, David Portman and Mindy Horowitz (Filed as Exhibit 10.1 to the Form 8-K dated May 11, 2007) ----------------- ---------------------------------------------------------------------------------------------------- ----------------- ---------------------------------------------------------------------------------------------------- 10.2 Amended and Restated Agreement, dated as of May 9, 2007 between Victor K. Kurylak and First Montauk Financial Corp. (Filed as Exhibit 10.2 to the Form 8-K dated May 11, 2007) ----------------- ---------------------------------------------------------------------------------------------------- ----------------- ---------------------------------------------------------------------------------------------------- 10.3 Amendment Number One dated as of June 15, 2007 to the Amended and Restated Employment Agreement, dated as of May 9, 2007 , between Victor K. Kurylak and First Montauk Financial Corp. (Filed as Exhibit 10.3 to Form 10-Q for the Quarter ended June 30, 2007, dated August 14, 2007) ----------------- ---------------------------------------------------------------------------------------------------- ----------------- ---------------------------------------------------------------------------------------------------- *10.4 Consulting Agreement, dated as of September 1, 2007, between Philip D'Ambrisi and First Montauk Financial Corp. (Filed as Exhibit 10.1 to Form 8-K dated September 6, 2007). ----------------- ---------------------------------------------------------------------------------------------------- ----------------- ---------------------------------------------------------------------------------------------------- *31.1 Certification of President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 ----------------- ---------------------------------------------------------------------------------------------------- ----------------- ---------------------------------------------------------------------------------------------------- *31.2 Certification of Acting Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 ----------------- ---------------------------------------------------------------------------------------------------- ----------------- ---------------------------------------------------------------------------------------------------- *32.1 Certification of President and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ----------------- ---------------------------------------------------------------------------------------------------- ----------------- ---------------------------------------------------------------------------------------------------- *32.2 Certification of Acting Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ----------------- ----------------------------------------------------------------------------------------------------
35 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST MONTAUK FINANCIAL CORP. (Registrant) Dated: November 14, 2007 /s/ Mindy A. Horowitz --------------------------------------- Mindy A. Horowitz Acting Chief Financial Officer /s/ Victor K. Kurylak --------------------------------------- Victor K. Kurylak President and Chief Executive Officer 36