<PAGE>
Internet Financial Services Inc.
2,000,000 Shares of Common Stock
$7.00 per Share
Internet Financial Services Inc. is offering 2,000,000 shares of its
common stock. This is our initial public offering and there currently is no
public market for our common stock.
---------------------
Investing in the common stock involves risks. See "Risk Factors"
beginning on page 5.
---------------------
================================================================================
Public Underwriting Proceeds
Offering Discounts and to
Price Commissions Company
- --------------------------------------------------------------------------------
Per Share ......... $7.00 $.65 $6.35
- --------------------------------------------------------------------------------
Total ............. $14,000,000 $1,300,000 $12,700,000
================================================================================
---------------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is a
criminal offense.
We have granted the underwriter a 45-day option to purchase up to an
additional 300,000 shares of common stock to cover over-allotments. The
underwriter is offering the shares on a firm commitment basis. Whale Securities
Co., L.P. expects to deliver the shares of common stock to purchasers on April
23, 1999.
---------------------
Whale Securities Co., L.P.
April 20, 1999
<PAGE>
[LOGO AND DIAGRAM]
<PAGE>
PROSPECTUS SUMMARY
The Offering
Common stock offered..... 2,000,000 shares
Common stock to be
outstanding after this
offering................ 7,631,745 shares. Our outstanding shares do not
include:
o 200,000 shares reserved for issuance upon
exercise of the underwriter's warrants;
o 1,049,900 shares reserved for issuance upon
exercise of options granted under our stock option
plans;
o 150,100 shares reserved for issuance upon the
exercise of options available for future grant
under our stock option plans;
o 351,250 shares reserved for issuance upon
exercise of non plan options and warrants; and
o 300,000 shares reserved for issuance in this
offering to cover over-allotments, if any, by the
underwriter.
Use of proceeds.......... We intend to use the net proceeds of this offering
for;
o sales and marketing;
o expanding and upgrading our network;
o expanding client services;
o repaying indebtedness; and
o working capital and general corporate purposes.
Nasdaq SmallCap Market
symbol.................. IFSX
Boston Stock Exchange
symbol.................. IFI
----------------------
Notice to California investors: Each purchaser of our common stock in
California must be an accredited investor as that term is defined in Rule 501(a)
of Regulation D promulgated under the Securities Act of 1933, or satisfy one of
the following suitability standards:
o minimum gross income of $65,000 and a net worth, exclusive of home, home
furnishings and automobiles, of $250,000; or
o minimum net worth, exclusive of home, home furnishings and automobiles,
of $500,000.
Notice to Ohio, South Carolina and Washington investors: Each purchaser of
our common stock in Ohio, South Carolina and Washington must be an accredited
investor as that term is defined in Rule 501(a) of Regulation D promulgated
under the Securities Act.
3
<PAGE>
Summary Financial Information
The following summary financial data as of September 30, 1998 and 1997, and
for the years ended September 30, 1998 and 1997, are derived from our audited
consolidated financial statements. The summary financial data as of December 31,
1998 and for the three months ended December 31, 1998 and 1997 are derived from
our unaudited consolidated financial statements.
Statement of Operations Data:
<TABLE>
<CAPTION>
Three Months Ended
Year Ended September 30, December 31,
------------------------------- -----------------------------
1997 1998 1997 1998
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Revenues .................................... $ 4,532,532 $9,119,268 $1,457,560 $3,180,033
Net revenues ................................ 4,320,173 8,859,946 1,437,950 3,071,530
Commissions, floor brokerage and clearing
charges ................................... 1,844,927 3,425,725 597,070 1,369,610
Employee compensation and related costs ..... 1,297,575 2,247,963 380,041 852,342
Other expenses .............................. 2,234,868 3,805,903 823,427 1,074,854
Net loss .................................... (1,059,973) (632,410) (365,779) (229,426)
Net loss per share .......................... (.30) (.12) (.07) (.04)
Weighted average number of shares
outstanding ............................... 3,508,560 5,171,182 5,120,771 5,291,080
</TABLE>
Balance Sheet Data:
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1998
-------------------- --------------------------------------------------
Actual Pro Forma As Adjusted
---------------- -------------- --------------
<S> <C> <C> <C> <C>
Working capital (deficit) ......... $ (691,258) $ (1,777,898) $ (352,898) $10,710,269
Total assets ...................... 5,539,457 6,363,494 7,813,494 18,430,676
Total liabilities ................. 3,785,038 4,575,371 4,975,371 3,988,538
Stockholders' equity .............. 1,754,419 1,788,123 2,838,123 14,442,138
</TABLE>
The pro forma information presented above gives effect to the receipt of
approximately $1,050,000 of net proceeds in January 1999 upon the issuance of
221,500 shares of common stock, and the receipt of $375,000 of net proceeds in
January 1999 upon the issuance of a $400,000 principal amount promissory note
and warrants to purchase 140,000 shares of common stock.
The as adjusted information presented above gives effect to:
o the sale of the shares of common stock offered by this prospectus, the
anticipated application of a portion of the estimated net proceeds for
the repayment of $750,000 principal amount of indebtedness, a $5,000
prepayment fee and $32,000 of accrued and unpaid interest;
o the reclassification of approximately $246,000 of deferred offering costs
as a reduction to equity;
o the write-off of non-cash deferred option and warrant costs related to
the issuance of options and warrants in connection with indebtedness
being repaid with a portion of the proceeds of this offering; and
o the recognition of approximately $16,000 of professional fee expenses
related to the issuance of options to non-employees effective on the date
of this prospectus.
We have not categorized our consolidated financial statements between
current and non-current assets and liabilities. For purposes of calculating
working capital, we consider our cash and cash equivalents, securities owned,
receivables from clearing brokers and a portion of other assets to be current
assets, and securities sold, not yet purchased, the current portion of notes
payable and accounts payable and accrued liabilities to be current liabilities.
4
<PAGE>
RISK FACTORS
The shares offered by this prospectus are speculative and involve a high
degree of risk. Each prospective investor should carefully consider the
following risk factors before making an investment decision.
Because we have experienced losses and expect our expenses to increase, we may
not be able to achieve profitability.
Since our inception, we have incurred losses. As of December 31, 1998 we
had an accumulated deficit of $2,133,187. We expect to continue to incur losses
until we are able to significantly increase our client base and revenues. Our
operating expenses are expected to continue to increase significantly in
connection with our proposed expanded activities. Accordingly, our future
profitability will depend on our ability to increase our client base and our
revenues while controlling costs.
The evolving nature of the online brokerage market makes the ultimate demand for
our services uncertain.
The level of demand for online brokerage services is uncertain because the
market is rapidly evolving. Our offering of brokerage services over the Internet
involves a relatively new approach to securities trading. Customers of
traditional full-commission brokerage firms or discount brokers may be reluctant
or slow to convert to Internet brokerage services. Moreover, security and
privacy concerns of existing and potential users of our services may deter
potential clients from using our trading systems. If the market for online
brokerage services does not develop as we expect, our business, financial
condition and operating results will be materially adversely affected.
Client attrition results in the loss of clients which may adversely impact our
business and the value of your investment.
Any significant increase in our client attrition rate could have a material
adverse effect on our business and operations. Historically, we have experienced
a client attrition rate of 7% per month. Client attrition results in the erosion
of our client base. We must attract new clients to maintain our client base.
Declines in the securities markets could reduce client use of our online
brokerage services.
A general decrease in trading activity in the securities markets could
adversely affect the level of trading by our clients. Historically, when the
stock market suffers large declines, known as a bear market, the level of
individual investor activity declines. We will likely be adversely affected
during any long-term bear market. As a result, our business, financial condition
and operating results would be adversely affected because expenses such as
salaries and benefits, computer and networking costs and rent remain relatively
fixed. Moreover, our operating results may fluctuate dramatically from period to
period as a result of these factors.
We may not be able to compete successfully for clients because the number of
competitors is increasing and some of our competitors are better known and have
greater resources.
The market for electronic brokerage services is intensely competitive and
rapidly changing. We compete directly with other firms which focus on active
trading clients as well as other discount brokerage firms offering online or
telephone brokerage services. We also face competition for clients from full
commission brokerage firms, financial institutions and mutual funds. Many of our
competitors have well-established reputations for providing brokerage and
financial services and have longer operating histories and significantly greater
financial, technical, marketing, personnel and other resources than we have.
Many of our clients also maintain accounts with one or more of our competitors.
The general financial success of companies in the securities industry over
the past several years has strengthened existing competition. We believe that
this success will continue to attract new competitors to the industry which
could adversely affect our ability to gain or even maintain market share. These
potential competitors include depository institutions, insurance companies and
providers of online financial and information services. We cannot assure you
that we will be able to compete successfully. Competitive factors could
materially adversely affect our business, financial condition and operating
results.
5
<PAGE>
We need to expand our network infrastructure and client support capabilities or
we will not be able to service our growing client base.
We will need to expand our network infrastructure and client support
capabilities in anticipation of an expanded client base. Expansion will require
us to make significant up front expenditures for servers, routers and computer
equipment, to increase bandwidth for internet connectivity and to hire and train
additional client service personnel. Expansion must be completed without system
disruptions. Failure to expand our network infrastructure or client service
capabilities would materially adverse affect our business and operations.
System failures or service interruptions could be caused by high levels of
client usage, failures of third-party systems or other acts beyond our control.
System failures or service interruptions could result in:
o substantial losses for our clients
o client inability to satisfy margin obligations
o decreased commission revenues
o loss of client accounts
o harm to our reputation.
System failures or service interruptions could cause substantial losses for
our clients and result in decreased commission revenues from client trading
activities and in loss of client accounts, client inability to satisfy margin
obligations and harm to our reputation and the perception of our trading
system's reliability. Any significant degradation or failure of our trading
systems or any other systems in the trading process could cause clients to
suffer delays in trading. During a systems failure, we may not be able to
process the volume of telephone orders placed by our clients.
Our online trading systems are heavily dependent on the integrity of the
electronic systems supporting it. Heavy stress placed on our trading systems
during peak trading times could cause our systems to operate at unacceptably low
speed or fail. Failure of our trading systems could also be caused by online
service providers, record keeping and data processing functions performed by
third parties and third-party software such as Internet browsers and trading
engines. Additionally, a natural disaster, power or telecommunications failure
or act of war, may cause an extended systems failure. Computer viruses or
unauthorized access to or sabotage of our network by a third party could also
result in system failures or service interruptions.
If we are unable to prevent unauthorized access to our clients' transactions and
other data we could be harmed.
Advances in computer capabilities, new discoveries in the field of
cryptography or other events or developments could result in a compromise of the
technology or other software used by us to protect client transaction and other
data. The secure transmission of confidential information over public networks
is a critical element of our operations. Any significant compromise of our
trading systems' security could materially adversely affect our business,
financial condition and operating results.
Our operations would be interrupted if the services of our clearing brokers are
terminated.
Watley is dependent on the operational capacity and the ability of its
clearing brokers for the orderly processing of transactions. Watley's clearing
agreements may be terminated by either party, upon 60 days written notice for
Penson Financial Services, Inc., and 30 days prior written notice for Weiss,
Peck & Greer, L.L.C. Termination or material interruptions of services provided
by our clearing brokers would have a material adverse effect on our operations.
Watley's agreements with its clearing brokers provide that the clearing brokers
process all securities transactions for Watley's account and the accounts of
Watley's clients. Services of the clearing brokers include billing and credit
extension, control and receipt, custody and delivery of securities.
Our client lending activities subject us to the risks of loss resulting from
clients not satisfying their obligations and our being required to cover our
clients' obligations.
We are subject to the risks inherent in extending credit to the extent that
we permit our clients to purchase securities on a margin basis. In the event
that margin requirements are not sufficient to cover losses, Watley may be
required to sell or buy securities at prevailing market prices and incur losses
to satisfy client
6
<PAGE>
obligations. A portion of Watley's clients' securities activities are transacted
on a margin basis through the clearing broker which Watley has agreed to
indemnify. Credit is extended to the client and secured by cash and securities
in the client's account or short sales, i.e., sales of securities not yet
purchased. Margin risk is exacerbated during periods of rapidly declining
markets in which the value of the collateral held by Watley could fall below the
amount borrowed by the client.
We may seek to expand through acquisitions which are not currently identified
and which therefore may entail risks which you will not have a basis to
evaluate.
We may seek to expand our operations by acquiring companies in businesses
which we believe will complement or enhance our business. We cannot assure you
that we will be able to ultimately effect any acquisition, successfully
integrate any acquired business in our operations or otherwise successfully
expand our operations. We are not currently involved in negotiations with
respect to any material acquisitions, and are not a party to any agreement,
commitment, arrangement or understanding relating to any acquisitions. We have
not established any minimum criteria for any acquisition and our management may
have complete discretion in determining the terms of any acquisition.
Consequently, there is no basis for you to evaluate the specific merits or risks
of any potential acquisition that we may undertake.
Converting to a self-clearing broker will subject us to many risks which could
adversely affect our business and the value of your investment.
We may not receive regulatory approval to engage in self-clearing
operations.
The NASD must agree to amend Watley's membership agreement before Watley
will be able to engage in self-clearing operations. We cannot assure you that
the NASD will agree to so amend Watley's membership agreement.
Self-clearing brokers are subject to more regulatory control and
examination than we are currently subject which could lead to civil liabilities
or penalties for errors or violations of regulations.
Self-clearing securities firms are subject to substantially more regulatory
control and examination than we are currently subject. Errors in performing
clearing functions or reporting could lead to civil penalties imposed by the SEC
or the NASD. Self-clearing operations, especially where conducted by firms such
as Watley, without significant prior experience, involve substantial risks of
losses due to clerical errors relating to the handling of client funds and
securities. We cannot assure you that Watley will be able to perform these
operations as accurately and efficiently as these operations are being performed
by Watley's clearing brokers. Clearing process errors also may lead to civil
liability for actions in negligence brought by parties who are financially
harmed as a result. Any liability that arises as a result of self-clearing
operations could have a material adverse effect on our business, financial
condition and operating results. Watley's failure to perform self-clearing
operations accurately and cost-effectively could have a material adverse effect
on our business, financial condition and operating results.
Converting to self-clearing operations will increase our capital
requirements and impose additional responsibilities for controlling client
securities and clearing transactions.
If we convert to a self-clearing firm, we will have to pay for a portion of
the securities purchased by our clients, to the extent the purchases are made on
margin, which will increase our capital requirements substantially. We will also
have direct responsibility for the possession and control of client securities
and other assets and the clearance of client securities transactions. This will
require us to record on our balance sheet the client receivables and client
payables to Watley that are a result of client margin loans and client free
credit balances maintained by Watley which could have a significant effect on
our total assets and total liabilities.
Our inability to obtain accurate information could cause service interruptions
and loss of clients and could subject us to claims by clients or third parties.
We depend upon information suppliers to accurately provide and, in some
cases, format the data, on a real-time basis. Failure by any service provider to
supply information according to our requirements could result in service
interruptions, adverse client perception of our trading system and loss of
clients. In addition,
7
<PAGE>
we could be sued by clients who download inaccurate information from our trading
system for losses resulting from the client's use of information. We may also be
subject to claims, including claims for negligence, copyright or trademark
infringement based on the nature and content of information downloaded by
clients from our trading systems and subsequently distributed to others. We do
not maintain insurance to cover most of these types of liabilities. Any
liability imposed on us or costs incurred in defending claims that are not
covered by insurance or are in excess of our insurance coverage could materially
adversely affect our business, financial condition and operating results.
If the Internet infrastructure is not developed or issues concerning the
commercial use of the Internet are not favorably resolved, use of our trading
systems may be adversely affected.
Our business, financial condition and operating results will be materially
adversely affected if critical issues concerning the commercial use of the
Internet are not favorably resolved, the necessary infrastructure is not
developed, or the Internet does not become a viable commercial marketplace.
Widespread acceptance of UltimateTrader and WatleyTrader will depend upon the
adoption of the Internet as a widely used medium for commerce. The Internet may
not continue to develop as a commercial marketplace because of inadequate
development of the necessary infrastructure, such as a reliable network
backbone, or timely development of complementary services and products, such as
high speed modems and high speed communication lines. In addition, use of the
Internet could be adversely affected by delays in the development or adoption of
new standards and protocols to handle increased levels of Internet activity or
due to increased governmental regulation. Critical issues concerning the
commercial use of the Internet, including security, reliability, cost, ease of
use, accessibility and quality of service, remain unresolved. These issues may
negatively affect the growth of Internet use or the attractiveness of commerce
and communications on the Internet and, therefore impede our ability to grow.
Failure by third-party information vendors, telecommunication suppliers or
clearing brokers to be year 2000 complaint could adversely affect our network
operations.
We would be harmed if there are any systems failures or interruptions in
service resulting from the inability of our computing system or any
third-party's systems to recognize the year 2000. We are highly dependent upon
third-party financial information vendors, telecommunications suppliers and our
clearing brokers. We have sent letters to a number of our vendors requesting
assurances of their compliance. These third parties have generally advised us
that their review of their operating systems indicate that their operating
systems are or will be year 2000 compliant. Since our evaluation of these issues
is continuing, we cannot assure you that additional issues will not be
discovered which could present a material risk of disruption to our operations.
Rapid technological change could cause our trading system to become less
attractive to potential clients.
Electronic stock trading is characterized by rapidly changing technology,
changing client requirements, frequent new services and trading system
introductions and enhancements and evolving industry standards in computer
hardware, operating systems, database technology and information delivery
systems. If we are unable to respond to these changes, our trading systems may
become less attractive to potential clients. Our success will depend upon our
ability to maintain and develop competitive technologies to continue to enhance
our trading system and to develop and introduce new services in a timely and
cost-effective manner. Developing these technologies, trading systems and
services may require substantial time and expense. We cannot assure you that we
will be able to respond quickly, cost-effectively or sufficiently to these
developments. Our business, financial condition and operating results may be
adversely affected if we are unable to anticipate or respond quickly to any
developments.
Third parties could obtain access to our proprietary information or
independently develop similar technologies because of the limited protection for
our intellectual property.
Third parties may copy or obtain and use our proprietary technologies,
ideas, know-how and other proprietary information without authorization or
independently develop technologies similar or superior to our technologies. In
addition, the confidentiality and non-competition agreements between us and our
key employees, distributors and clients may not provide meaningful protection of
our proprietary technologies or
8
<PAGE>
other intellectual property if unauthorized use or disclosure occurs. Policing
unauthorized use of our technologies and other intellectual property is
difficult, particularly because the global nature of the Internet makes it
difficult to control the ultimate destination or security of software or other
data transmitted. Furthermore, the laws of other jurisdictions may afford little
or no effective protection of our intellectual property rights. Our business,
financial condition and operating results could be adversely affected if we are
unable to protect our intellectual property rights.
Your investment will be subject to immediate and substantial dilution.
Purchasers of the shares of common stock in this offering will experience
immediate and substantial dilution of $5.12 per share, or 73.1%, between the net
tangible book value per share of common stock after this offering and the
initial public offering price per share.
Our management has significant control over stockholder matters which may impact
the ability of minority stockholders to have a say in our activities.
Our officers and directors and their families control the outcome of all
matters submitted to a vote of the holders of common stock, including the
election of directors, amendments to our certificate of incorporation and
approval of significant corporate transactions. After the closing of this
offering, these persons will beneficially own, in the aggregate, approximately
42.7% of our outstanding common stock. This consolidation of voting power could
also have the effect of delaying, deterring or preventing a change in control of
Internet Financial Services that might be beneficial to other stockholders.
We will use a portion of the proceeds of this offering to repay debt, some of
which is owed to affiliated parties.
We have allocated approximately $787,000, or 6.7%, of the net proceeds of
this offering to repay outstanding indebtedness, including $100,000 to repay
amounts owed to Mel Steinberg, the father of Eric Steinberg, our Executive Vice
President, and approximately $500,000 will be used to repay a loan which is
guaranteed by six persons who are our officers, directors and/or principal
stockholders. These persons will receive a benefit as a result of the release of
their guarantees. Accordingly, these proceeds will not be available for other
corporate purposes.
Our management's broad discretion in the use of the proceeds of this offering
may increase the risk that they will not be used effectively.
We have allocated approximately $1,163,000, or 10.0%, of the estimated net
proceeds of this offering to working capital and general corporate purposes. Our
management will have broad discretion as to the application of these proceeds
without having to seek your approval.
FORWARD-LOOKING STATEMENTS
Some of the statements in this prospectus discuss future expectations or
state other forward-looking information. Those statements are subject to known
and unknown risks, uncertainties and other factors that could cause our actual
results to differ materially from those contemplated by the statements. Factors
that might cause a difference include, but are not limited to, those discussed
in "Risk Factors" and elsewhere in this prospectus.
9
<PAGE>
USE OF PROCEEDS
The net proceeds from the sale of the 2,000,000 shares of common stock
being offered by this prospectus, after deducting underwriting discounts and
other expenses of this offering, are estimated to be $11,650,000.
We expect to use these net proceeds during the twelve months following the
consummation of this offering approximately as follows:
<TABLE>
<CAPTION>
Approximate
Approximate Percentage of
Application of Net Proceeds Dollar Amount Net Proceeds
- --------------------------- --------------- --------------
<S> <C> <C>
Sales and marketing .................................... $ 3,600,000 30.9%
Expand and upgrade network ............................. 3,400,000 29.2
Expand client services ................................. 2,700,000 23.2
Repay indebtedness ..................................... 787,000 6.7
Working capital and general corporate purposes ......... 1,163,000 10.0
----------- -----
Total ................................................ $11,650,000 100.0%
=========== =====
</TABLE>
Sales and Marketing. We intend to produce, create and place television
advertising, Internet and print commercials. We also expect to hire additional
personnel to engage in these activities.
Expand and Upgrade Network. We intend to expand our network infrastructure
to support an increasing client base and to purchase additional computer and
telephone communications equipment to create an off-site back-up communications
center or hot site.
Expand Client Services. We expect to hire additional personnel and
purchase additional systems and equipment to:
o convert to self-clearing;
o engage in operations with international financial institutions and
clients;
o provide additional client support;
o continue to develop software and programming; and
o expand our third-market institutional sales desk to increase the number
of securities we cover for this market.
Repayment of Indebtedness. We intend to repay:
o the $500,000 principal amount promissory note, plus a $5,000 prepayment
fee, to New York Small Business Venture Fund LLC; and
o $250,000 principal amount of promissory notes, bearing interest at an
annual rate of 8%, including approximately $100,000 principal amount of
promissory notes held by Mel Steinberg, the father of Eric Steinberg, our
Executive Vice President.
o approximately $32,000 of accrued interest due on the promissory notes
The $500,000 principal amount promissory note bears interest at an annual
rate of 12% and is due October 2003, subject to prepayment. We used the proceeds
of these loans for working capital and general corporate purposes.
Working Capital and General Corporate Purposes. We may use a portion of the
proceeds allocated to working capital and general corporate purposes to pay a
portion of trade payables incurred from time to time and the salaries of our
officers, if cash flow from operations is insufficient for these purposes.
Over-allotment Option. If the underwriter exercises its over-allotment
option in full, we will realize additional net proceeds of $1,842,000, all of
which will be allocated to working capital and general corporate purposes.
The foregoing represents our best estimate of the allocation of the net
proceeds of this offering based upon the current status of our business. We
based this estimate on assumptions, including continued expansion
10
<PAGE>
of our client base and corresponding increases in revenues and that our proposed
network expansion can be completed and new services can be introduced without
unanticipated delays or costs. If any of these factors change, we may find it
necessary to reallocate a portion of the proceeds within the above-described
categories or use portions of the proceeds for other purposes. Our estimates may
prove to be inaccurate, new programs or activities may be undertaken which will
require considerable additional expenditures or unforeseen expenses may occur.
Based upon our current plans and assumptions relating to our business plan,
we anticipate that the net proceeds of this offering will satisfy our capital
requirements for at least twelve months following the closing of this offering.
If our plans change or our assumptions prove to be inaccurate, we may need to
seek additional financing sooner than currently anticipated or curtail our
operations. We cannot assure you that the proceeds of this offering will be
sufficient to fund our proposed expansion or that additional financing will
become available if needed.
We will invest proceeds not immediately required for the purposes described
above principally in United States government securities, short term
certificates of deposit, money market funds or other short-term interest bearing
investments.
DILUTION
The difference between the initial public offering price per share and the
net tangible book value per share of common stock after this offering
constitutes the dilution to investors in this offering. Net tangible book value
per share is determined by dividing total tangible assets less total liabilities
by the number of outstanding shares of common stock.
At December 31, 1998, we had a net tangible book value of $1,462,522 or
$.28 per share. After giving effect to the sale of the 2,000,000 shares of
common stock being offered, after deducting estimated underwriting discounts and
expenses of this offering, our adjusted net tangible book value at December 31,
1998 would have been $14,362,740 or $1.88 per share, representing an immediate
increase in net tangible book value of $1.60 per share to the existing
stockholders and an immediate dilution of $5.12, or 73.1%, per share to new
investors.
The following table illustrates the above information with respect to
dilution to new investors on a per share basis:
<TABLE>
<CAPTION>
<S> <C> <C>
Initial public offering price ........................... $ 7.00
Net tangible book value before offering ................ $ .28
Increase attributable to new investors and pro forma
adjustments ........................................... 1.60
-----
Adjusted net tangible book value after offering ......... 1.88
------
Dilution to new investors ............................... $ 5.12
======
</TABLE>
The following table sets forth as of the date of this prospectus, with
respect to our existing stockholders and new investors, a comparison of the
number of shares of common stock we issued, the percentage ownership of those
shares, the total consideration paid, the percentage of total consideration paid
and the average price per share. The number of shares purchased by existing
stockholders includes 295,271 shares issued after December 31, 1998 and 35,714
shares to be issued upon the closing of this offering.
<TABLE>
<CAPTION>
Average Price
Shares Purchased Total Consideration per Share
----------------------- -------------------------- --------------
Number Percent Amount Percent
----------- --------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Existing stockholders ......... 5,631,745 73.8% $ 4,664,933 25.0% $ .83
New investors ................. 2,000,000 26.2 14,000,000 75.0 7.00
--------- ----- ----------- -----
Total ....................... 7,631,745 100.0% $18,664,933 100.0%
========= ===== =========== =====
</TABLE>
The above table assumes no exercise of the underwriter's over-allotment
option. If the underwriter exercises the over-allotment option in full, we
estimate that the new investors will have paid $16,100,000 for the 2,300,000
shares of common stock being offered, representing approximately 77.5% of the
total consideration for 29.0% of the total number of shares of common stock
outstanding. In addition, the above table does not give effect to the shares
issuable upon exercise of outstanding options and warrants.
11
<PAGE>
DIVIDENDS
We have never declared or paid any dividends to the holders of our common
stock and we do not anticipate paying cash dividends in the foreseeable future.
We currently intend to retain all earnings for use in connection with the
expansion of our business and for general corporate purposes. Our board of
directors will have the sole discretion in determining whether to declare and
pay dividends in the future. The declaration of dividends will depend on our
profitability, financial condition, cash requirements, future prospects and
other factors deemed relevant by our board of directors. Our ability to pay cash
dividends in the future could be limited or prohibited by regulatory
requirements and the terms of financing agreements that we may enter into or by
the terms of any preferred stock that we may authorize and issue.
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 1998
on an actual basis, adjusted to give effect to pro forma information and
adjusted to give effect to our sale of 2,000,000 shares of the common stock
being offered and the anticipated application of the estimated net proceeds. The
pro forma and as adjusted number of shares issued and outstanding include 70,771
shares issuable upon the closing of this offering and 35,714 shares which will
be issued upon exercise of options upon the closing of this offering. The share
numbers presented in the following table do not include:
o the 200,000 shares reserved for issuance upon exercise of the
underwriter's warrants;
o the 1,049,900 shares reserved for issuance upon exercise of options
granted under our stock option plans;
o the 150,100 shares reserved for issuance upon the exercise of options
available for future grant under our stock option plans;
o the 351,250 shares reserved for issuance upon exercise of non plan
options and warrants; and
o the 300,000 shares reserved for issuance in this offering to cover
over-allotments, if any, by the underwriter.
<TABLE>
<CAPTION>
December 31, 1998
--------------------------------------------------
Actual Pro Forma As Adjusted
--------------- --------------- --------------
<S> <C> <C> <C>
Short-term debt ........................................ $ 740,587 $ 740,587 $ 490,587
============ ============ ============
Long-term debt ......................................... $ 695,000 $ 1,095,000 $ 595,000
------------ ------------ ------------
Stockholders' equity:
Preferred stock, par value $.01 per share, 1,000,000
shares authorized; no shares issued or outstanding,
actual, pro forma or as adjusted .................... -- -- --
Common stock, par value $.001 per share, 10,000,000
shares authorized; 5,300,760 shares issued and
outstanding, actual; 5,631,745 shares issued and
outstanding, pro forma; 7,631,745 shares issued
and outstanding, as adjusted ........................ 5,301 5,632 7,632
Additional paid-in capital ............................ 4,135,568 5,325,237 16,989,622
Option costs .......................................... (219,559) (359,559) (140,000)
Accumulated deficit ................................... (2,133,187) (2,133,187) (2,415,116)
------------ ------------ ------------
Total stockholders' equity .......................... $ 1,788,123 $ 2,838,123 $ 14,442,138
------------ ------------ ------------
Total capitalization ............................. $ 2,483,123 $ 3,933,123 $ 15,037,138
============ ============ ============
</TABLE>
In January 1999, our authorized common stock was increased to 20,000,000
shares.
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
We are a financial services company which owns A.B. Watley, Inc., a
registered securities broker-dealer and member of the National Association of
Securities Dealers, Inc. We acquired all of the capital stock of Watley in
January 1997. Our financial statements consolidate the historical results of
Watley. Watley has accounted for all of our revenues for each period presented.
We have experienced substantial changes to, and expansion of, our business
and operations since we began offering Internet brokerage services in March
1997. We expect to continue to expand our business and client base which will
require us to increase our personnel, purchase additional equipment and expand
our network and client service capabilities which will result in increasing
expenses.
Results of Operations
Three months ended December 31, 1998 compared to the three months ended
December 31, 1997
Revenues for the three months ended December 31, 1998 were $3,180,033, an
increase of 118.2% as compared to revenues of $1,457,560 for the three months
ended December 31, 1997. Revenues from commissions increased by $1,288,174, or
108.5% from $1,187,487, for the December 1997 period to $2,475,661 for the
December 1998 period due to the significantly increased number of online orders,
as well as the growth in our third-market institutional sales desk operations.
The number of online trading accounts grew from 455 at December 31, 1997 to 988
at December 31, 1998. Data Service revenues also increased by $151,592, or
122.2% from $124,012 for the December 1997 period to $275,604 for the December
1998 period due to the increase in the number of online accounts. Revenues from
principal transactions increased by $264,801, or 232.6% from $113,858 for the
December 1997 period to $378,659 for the December 1998 period, mainly as a
function of the significantly higher volumes of business conducted by the
third-market institutional sales desk. Interest and other income increased from
$32,203 for the December 1997 period to $50,109 for the December 1998 period.
Interest expense increased from $19,610 for the December 1997 period to
$108,503 for the December 1998 period as result of increased borrowings.
As a result of the above, net revenues increased by $1,633,580, or 113.6%,
from $1,437,950 for the December 1997 period to $3,071,530 for the December 1998
period. Nearly all of our revenues were generated by clients in the United
States and no single client or group of related clients accounted for 10% or
more of our revenues.
Total expenses increased by $1,496,268, or 83.1%, from $1,800,538 for the
December 1997 period to $3,296,806 for the December 1998 period. Commissions,
floor brokerage and clearing charges represent payments to our clearing and
floor brokers and to employees who facilitate our clients' transactions and
other expenses related to market data services. As a result of the large
increase in the volume of business conducted by our clients, these expenses
increased by $772,540, or 129.4%, from $597,070 for the December 1997 period to
$1,369,610 for the December 1998 period. Employment compensation and related
costs increased by $472,301, or 124.3%, from $380,041 for the December 1997
period to $852,342 for the December 1998 period, largely due to the hiring of 21
new employees to service the growth in our client base. Communications expense
increased by $58,616, or 40.5%, from $144,732 for the December 1997 period to
$203,348 for the December 1998 period as a function of the growth in our online
client base. We expect that these expenses will continue to increase as we try
to further expand our client base.
Business development costs consist of advertising costs to obtain new
clients, which costs have mostly been for print and media advertising. These
expenses decreased by $164,407, or 44.7%, from $368,102 for the December 1997
period to $203,695 for the December 1998 period as a result of significantly
increased effectiveness of our marketing efforts and the resulting lower costs
of client acquisition.
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<PAGE>
Professional service expenses increased from $104,816 for the December 1997
period to $198,571 for the December 1998 period, primarily due to increased
audit fees and consulting fees relating to the general growth of our business.
Occupancy and equipment costs increased by $144,433, or 204.2%, from $70,716 for
the December 1997 period to $215,149 for the December 1998 period, primarily due
to the relocation of our offices to a new, larger space and the purchase of
additional equipment to provide additional capacity and to facilitate the
relocation efforts. Depreciation and amortization expense increased by $45,633,
or 65.9%, from $69,278 for the December 1997 period to $114,911 for the December
1998 period for similar reasons. Other expenses increased by $73,397 or 111.6%,
from $65,783 for the December 1997 period to $139,180 for the December 1998
period for the same reasons.
The income tax provision increased from $3,191 for the December 1997 period
to $4,150 for the December 1998 period.
Our operating results improved from a net loss of $365,779 for the three
months ended December 1997 to a net loss of $229,426 for the three months ended
December 31, 1998.
The results of operations for the three months ended December 31, 1998 are
not necessarily indicative of the results for any future interim period or for
the year ending September 30, 1999.
Fiscal year ended September 30, 1998 compared to fiscal year ended September 30,
1997.
Revenues for fiscal 1998 were $9,119,268, an increase of 101.2%, as
compared to revenues of $4,532,532 for fiscal 1997. Revenues from commissions
increased by $3,385,272, or 84.3% from $4,017,787 for fiscal 1997 to $7,403,059
for fiscal 1998 due to the substantially increased volume of orders transacted
by our online brokerage clients, as well as through our third-market
institutional sales desk. We experienced an increase in the number of online
trading clients from approximately 300 at September 30, 1997 to approximately
900 at September 30, 1998. Data service revenues also increased by $512,883, or
345.7% from $148,353 for fiscal 1997 to $661,236 for fiscal 1998 due to the
increased number of online trading accounts. Revenues from principal
transactions increased by $671,592, or 291.6%, from $230,297 for fiscal 1997 to
$901,889 for fiscal 1998, largely as a result of the increased volume of
business conducted by our third-market institutional sales desk. Interest and
other income increased from $130,095 for fiscal 1997 to $146,704 for fiscal
1998.
Interest expense increased from $212,359 for fiscal 1997 to $259,322 for
fiscal 1998 as a result of increased borrowings.
As a result of the above, our net revenues increased by $4,539,773, or
105.1%, from $4,320,173 for fiscal 1997 to $8,859,946 for fiscal 1998.
Substantially all of our revenues were generated by clients in the United
States. No client or group of related clients accounted for 10% or more of our
revenues.
Total expenses increased by $4,102,221 or 76.3%, from $5,377,370 for fiscal
1997 to $9,479,591 for fiscal 1998. Commissions, floor brokerage and clearing
charges represent payments to our clearing brokers and to employees who
facilitate our clients' transactions and expenses related to market data
services. As a result of the significant increase in the volume of transactions
by our clients, these expenses increased by $1,580,798, or 85.7%, from
$1,844,927 for fiscal 1997 to $3,425,725 for fiscal 1998. Employment
compensation and related costs increased by $950,388, or 73.2% from $1,297,575
for fiscal 1997 to $2,247,963 for fiscal 1998 due to our hiring of 25 additional
personnel to service our increased client base. Communications expense increased
by $419,807, or 124.4%, from $337,584 for fiscal 1997 to $757,391 for fiscal
1998 as a result of our substantially increased base of online clients. We
expect that these expenses will continue to increase as we seek to expand our
client base.
Business development expenses increased by $539,227, or 122.2%, from
$441,424 for fiscal 1997 to $980,651 for fiscal 1998 as a result of our expanded
marketing efforts. We expect aggregate expenses to continue to increase as we
expand our marketing efforts. However, our new client acquisition costs
decreased on a per client basis.
Professional service expenses increased from $894,920 for fiscal 1997 to
$971,494 for fiscal 1998. Occupancy and equipment costs increased by $294,589,
or 196.9%, from $149,580 for fiscal 1997 to $444,169
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<PAGE>
for fiscal 1998, primarily due to the relocation of our offices to larger space
and the purchase of additional equipment in anticipation of our proposed
expansion. Depreciation and amortization expense increased by $164,227, or
82.5%, from $198,980 for fiscal 1997 to $363,207 for fiscal 1998 for the same
reasons. Other expenses increased by $76,611, or 36.1%, from $212,380 for fiscal
1997 to $288,991 for fiscal 1998 for the same reasons.
The income tax provision increased from $2,776 for fiscal 1997 to $12,765
for fiscal 1998.
As a result of the foregoing, our operating results improved from a net
loss of $1,059,973 for fiscal 1997 to a net loss of $632,410 for fiscal 1998.
Liquidity and Capital Resources
Our capital requirements have exceeded our cash flow from operations as we
have been building our business. At December 31, 1998, we had a working capital
deficit of $1,777,898. As a result, we have depended upon sales of our common
stock and borrowings from officers, directors and stockholders and third parties
to finance our working capital requirements.
Watley has outstanding an aggregate of $530,000 in the form of subordinated
loans, under agreements approved by the NASD. These loans are included by Watley
for purposes of computing its net capital under the SEC's net capital rules.
These borrowings by Watley consist of:
o a $55,000 principal amount non-interest bearing loan, and a $125,000
principal amount loan, bearing interest at an annual rate of 12%, from
Steve Malin, our Chairman of the Board and Chief Executive Officer; and
o a $200,000 principal amount loan, bearing interest at an annual rate of
15% and a $150,000 principal amount loan bearing interest at an annual
rate of 13% from Mel Steinberg, father of Eric Steinberg, our Executive
Vice President.
The loans mature in October 2000, except for the $125,000 loan which matures in
April 2000. During our fiscal year ended September 30, 1997, we paid an
aggregate of $47,788 of interest on these loans and during our fiscal year ended
September 30, 1998, we paid an aggregate of $49,500 of interest on these loans.
Watley is currently required to maintain net capital of $100,000 and a
ratio of aggregate indebtedness to net capital of 15 to 1 under the SEC's net
capital rule. Such rule also prohibits "equity capital" including the
subordinated loans, from being withdrawn or cash dividends from being paid if
Watley's net capital ratio would exceed 10 to 1 or if Watley would have less
than its minimum required net capital. Accordingly, Watley's ability to repay
the subordinated loans may be restricted under the net capital rule. At December
31, 1998, Watley had net capital of $187,875, which was $87,875 in excess of its
minimum required net capital, and Watley's net capital ratio was 3.3 to 1.
We received net proceeds of $2,045,000 from a private placement of equity
securities during our fiscal year ended September 30, 1997. We used
approximately $1,180,000 of these proceeds to acquire the systems and equipment
utilized to test and launch our online trading systems during that period. We
used the balance of these proceeds for advertising and working capital.
During our fiscal year ended September 30, 1998, we received net proceeds
of $990,000 from a private placement of equity securities and $250,000 from the
issuance of $250,000 principal amount notes and options to purchase an aggregate
of 35,714 shares of common stock for nominal consideration, of which $100,000
was furnished by Mel Steinberg. We used these proceeds to develop software and
to purchase a portion of the equipment required to expand our online network.
In October 1998, we obtained a $500,000 loan from New York Small Business
Venture Fund LLC, bearing interest at an annual rate of 12%, payable monthly. In
connection with this loan, we issued to the lender a $500,000 principal amount
promissory note and warrants to purchase 191,250 shares of our common stock at
an exercise price equal to the initial public offering price of our common
stock. We granted the lender a security interest in substantially all of our
assets to secure our obligations under the loan, and six persons who are our
officers, directors and/or principal stockholders guaranteed our obligations
under this loan. We used these funds for the purchase of additional equipment,
marketing expenses, software development and working capital. We intend to repay
the loan, plus a 1% prepayment fee, from the proceeds of this offering.
15
<PAGE>
In December 1998, we obtained a $500,000 line of financing from General
Electric Capital Corporation which is to be used from time to time primarily for
the purchase or leasing of additional equipment and software. We are required to
deliver to the lender a letter of credit in the amount of 50% of any amount
borrowed under this financing. As of December 31, 1998, we borrowed
approximately $311,208 under this line of financing, which we used to purchase
equipment. In connection with our borrowing under this financing, we have
granted the lender a security interest in existing equipment as well as in all
equipment purchased using funds obtained under this financing.
We had cash and cash equivalents of $970,308 as of September 30, 1998. Our
operating activities provided $582,325 of net cash. We had a net loss of
$632,410 and a decrease in receivables from clearing brokers of $239,479, which
was more than offset by depreciation and amortization of $363,207, non-cash
amortization of option costs of $226,227, a non-cash compensation charge of
$115,000 and an increase in accounts payable and accrued liabilities of
$660,605. We used $1,440,345 of net cash in investing activities, consisting of
$2,244,313 of property and equipment purchases, which was partially offset by
deferred rent incentives of $803,968. Financing activities provided $1,125,635
of net cash, consisting of $990,870 of proceeds from sales of common stock and
$250,000 of proceeds from the issuance of notes payable, which were partially
offset by a $40,000 repayment of a loan to Bank of New York and $75,235 of
payments made for deferred offering costs.
As of December 31, 1998, we had cash and cash equivalents of $250,797.
Operating activities during the three months ended December 31, 1998 created a
net use of cash of $31,946. We incurred a net loss during the December 1998
period of $229,426 and $406,861 of cash was restricted to secure letters of
credit. These uses of cash were partially offset by depreciation and
amortization of $114,911, non-cash amortization of option costs of $71,983, a
decrease in securities owned of $89,548 and an increase in accounts payable and
accrued liabilities of $362,344. During the December 1998 period, we used
$984,097 of net cash in investing activities, consisting entirely of property
and equipment purchases. Financing activities provided $296,532 of cash,
consisting of $500,000 of proceeds from the issuance of notes payable and $2,500
of proceeds from exercised stock options, which were partially offset by
$195,968 of payments made for deferred offering costs and a $10,000 repayment of
a loan to Bank of New York. We issued 38,260 shares of our common stock to
acquire Computer Strategies, Inc. during the three months ended December 31,
1998. Computer Strategies provided software support, research and development to
us and we were Computer Strategies' primary customer. The acquisition was
accounted for as a purchase. We recorded approximately $60,000 in goodwill from
the acquisition which is being amortized over three years, and approximately
$59,000 in capitalized software attributable to costs incurred in the
application development stage of our software development.
In January 1999, we obtained a $400,000 loan from New York Community
Investment Company L.L.C., bearing interest at an annual rate of 12%, payable
monthly. In connection with this loan, we issued to the lender a $400,000
principal amount promissory note and warrants to purchase 140,000 shares of our
common stock at an exercise price equal to the initial public offering price of
our common stock. We granted the lender a security interest in substantially all
of our assets to secure our obligations under the loan. We are using these funds
for marketing expenses and working capital.
In January 1999, we sold an aggregate of 221,500 shares of common stock to
12 investors in a private placement at a price of $4.80 per share for which we
received aggregate net proceeds of approximately $1,050,000. In connection with
this private placement:
o Anthony Huston, our Executive Vice President purchased 50,000 shares at a
price of $240,000;
o Leon Ferguson, Senior Vice President, purchased 52,000 shares at a price
of $249,600; and
o Mark Chambre, who has agreed to serve as a director upon the closing of
this offering, purchased 15,000 shares at a price of $72,000.
All of the purchasers of these shares agreed not to sell or otherwise dispose of
any of these shares for a period of twelve months from the date of this
prospectus.
We expect to make capital expenditures of approximately $3,300,000 during
the twelve months following the closing of this offering. These capital
expenditures are expected to be made to expand our network
16
<PAGE>
infrastructure, create an off-site back-up communications center or hot-site,
purchase additional systems to convert to self-clearing operations, provide
additional client support, expand our third-market institutional sales desk and
continue software and programming development.
We need the proceeds of this offering to expand our operations and finance
our future working capital requirements. Based upon our current plans and
assumptions relating to our business plan, we anticipate that the net proceeds
of this offering will satisfy our capital requirements for at least twelve
months following the closing of this offering. If our plans change or our
assumptions prove to be inaccurate, we may need to seek additional financing
sooner than currently anticipated or curtail our operations. We may seek
additional debt or equity financing to fund the cost of continued expansion. If
we incur debt, we will become subject to the risks that interest rates may
fluctuate and cash flow may be insufficient to make payments on the debt.
Net Operating Loss Carryforwards
Our net operating loss carryforwards expire beginning in the year 2012. The
issuance of additional equity securities, together with our recent financings
and this offering, could result in an ownership change and, thus, could limit
our use of our prior net operating losses. If we achieve profitable operations,
any significant limitation on the utilization of our net operating losses would
have the effect of increasing our tax liability and reducing net income and
available cash reserves. We are unable to determine the availability of these
net operating losses since this availability is dependent upon profitable
operations, which we have not achieved in prior periods.
Relevant Accounting Standards
We generally grant stock options to employees and consultants with an
exercise price not less than the fair market value at the date of grant. We
account for stock option grants to employees in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
and, accordingly, recognize no compensation expense related to option grants. In
cases where we grant options below the fair market value of the stock at the
date of grant, the difference between the strike price and the fair market value
is treated as compensation expense and amortized over the vesting period of the
option, if any. Stock options granted to consultants and others instead of cash
compensation are recorded based upon management's estimate of the fair value of
the options or the related services provided and expensed over the vesting
period, if any.
Pro forma information regarding net income (loss) is required under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," and has been determined as if we had accounted for all the 1998
and 1997 stock option grants on the fair value method.
We account for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes." We recognize the current and deferred tax
consequences of all transactions that have been recognized in the financial
statements, using the provisions of enacted tax laws. Deferred tax assets are
recognized for temporary differences that will result in deductible amounts in
future years and for tax loss carryforwards, if in the opinion of our
management, it is more likely than not that the deferred tax asset will be
realized. SFAS No. 109 requires companies to set up a valuation allowance for
the component of net deferred tax assets which does not meet the more likely
than not criteria for realization. We have established this valuation allowance
for our deferred tax assets.
In 1997, the Financial Accounting Standards Board issued SFAS No. 128,
"Earnings per Share." The new rules are effective for both interim and annual
financial statements for the periods ending after December 15, 1997. SFAS No.
128 supersedes APB No. 15 to conform earnings per share with international
standards as well as to simplify the complexity of the computation under APB No.
15. The previous primary earnings per share calculation is replaced with a basic
earnings per share calculation. The basic earnings per share differs from the
primary earnings per share calculation in that the basic earnings per share does
not include any potentially dilutive securities. Fully dilutive earnings per
share is replaced with diluted earnings per share and should be disclosed
regardless of dilutive impact to basic earnings per share. Accordingly, we have
adopted SFAS No. 128 effective September 30, 1998.
Year 2000 Issues
We have devised a plan and have substantially completed a review and
assessment of all hardware and software and believe that our hardware and
software are substantially year 2000 compliant so that the
17
<PAGE>
computer programs do not cease functioning because of an inability to process on
a date occurring from and after January 1, 2000. Our review has not revealed any
year 2000 issues that cannot be remediated in a timely manner. We do not believe
that any remediation costs will be material.
We are highly dependent upon third-party financial information vendors,
telecommunications suppliers and our clearing brokers. We have sent letters to a
number of our vendors requesting assurances of their compliance. Such third
parties have generally advised us that their review of their operating systems
indicate that their operating systems are year 2000 compliant or will be year
2000 compliant in a timely manner. We are currently developing a contingency
plan if any third parties with which we do business have any material year 2000
compliance problems.
We would be materially adversely affected if there are any failures or
interruptions in service resulting from the inability of our computing systems
or any third-party's systems to recognize the year 2000. Moreover, since our
evaluation of these issues is continuing, we may discover additional issues
which could present a material risk of disruption to our operations.
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<PAGE>
BUSINESS
We are a financial services company which owns A.B. Watley, Inc., a
registered securities broker-dealer and member of the National Association of
Securities Dealers, Inc. We provide real-time online financial brokerage
services and comprehensive information about the securities markets through our
proprietary trading systems, UltimateTrader(R) and WatleyTrader(TM). Watley has
received favorable industry recognition, ranking second in Dow Jones Business
Directory's recent survey of Internet brokers and sixth in Gomez Advisors Spring
1999 ranking of Internet brokers. In addition, UltimateTrader and WatleyTrader
were ranked seventh and sixteenth in Barron's annual ranking of online brokers
published in March 1999.
Internet Financial Services was incorporated in May 1996 under the laws of
the State of Delaware. Watley was organized in December 1958 under the laws of
the State of New York. In January 1997, we acquired all of the outstanding
capital stock of Watley.
Industry Overview
Our industry has recently experienced a series of changes, led by
electronic and online commerce, which has created market opportunities for us
and other similarly situated brokerage firms. These favorable market trends
include:
The Emergence of Electronic and Online Commerce.
Internet and online services have provided organizations and individuals
with innovative ways of conducting business. With the emergence of the Internet
as a globally accessible, fully interactive and individually addressable
communications and computing medium, companies that have traditionally conducted
business in person, through the mail or over the telephone are increasingly
utilizing electronic commerce. Increased use of credit cards, automated teller
machines, the incidence of electronic funds transfers and online banking and
bill paying has automated, simplified and reduced the costs of financial
transactions for consumers, businesses and financial institutions.
Consumers have shown a strong preference for transacting various types of
business electronically, such as paying bills, buying insurance, booking airline
tickets and trading securities, rather than in person or over the telephone.
These transactions are being streamlined through online commerce and can now be
performed directly by individuals virtually anywhere at any time. Consumers have
accepted and even welcomed self-directed online transactions because these
transactions can be faster, less expensive and more convenient than transactions
conducted through a human intermediary.
The Development of Online Brokerage Services.
In the past, individual investors could access the financial markets only
through a full-commission broker, who would offer investment advice and place
trades. With the deregulation of brokerage commissions in 1975 and the resulting
unbundling of brokerage services, investors began to realize that they could
separate financial advisory services from securities trading. This brought about
the advent of discount brokerage firms, which provide an alternative investment
approach by completing trades at a reduced cost.
With the emergence of electronic brokerage services, investors are being
given the ability to further unbundle the costs associated with the human
interaction required by full-commission and traditional discount brokerage
firms. By requiring personnel to handle each transaction, most traditional
brokerage firms restrict their clients' access to trading and information to the
availability of the person processing the transaction. In addition, although
full-commission and discount brokerage firms are able to offer electronic
trading services, their continued reliance on personnel, branch offices and the
associated infrastructure for a major part of their business prevents them from
reducing their cost structure to the lower price points achievable through
electronic trading.
We believe that the increased presence of automated teller machines, the
growth of discount brokerage firms and a variety of other indicators evidence a
shift in demographics that is fundamentally altering the way consumers manage
their personal financial assets. Based on consumer feedback and the rapid
acceptance by consumers of online transactions, we also believe that consumers
are increasingly taking direct control over their personal financial affairs,
not only because they are now able to do so, but also because they find it more
convenient and less expensive than relying on financial intermediaries.
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As investors obtain even more access to investment information, we believe,
based upon our experience in the industry, they will desire greater control over
their financial decisions and seek alternative ways to invest more conveniently
and cost-effectively and with less interaction with brokers and other financial
services professionals. Based upon our experience in the industry, we believe
that this trend has created a growing opportunity to provide online trading
services, such as UltimateTrader, that are easy to access, easy to use,
cost-effective and secure.
The Growing Market for Active Traders, Active Investors and Online Brokerage
Services.
Active trading is dependent upon liquidity, i.e., the ability to buy or
sell stock at any given time. Until recently, liquidity was primarily provided
by Nasdaq, the New York Stock Exchange and an alternative trading system called
Instinet. However, the liquidity on Instinet is available only to institutional
clients and certain brokerage firms.
In 1996, the SEC adopted rules which brought about sweeping changes in the
structure of the over-the-counter market and were very beneficial for us and our
clients, as well as to public companies and their shareholders. These rules,
known as the order handling rules, permitted the creation and operation of
electronic communication networks, open broadcasting systems that allow anyone
with a connection to the network to see all the bids and offers posted into the
system for any Nasdaq traded security. The order handling rules require market
makers to display certain limit orders in their quotations or to send those
orders to an electronic communication network for display. The increased
regulatory emphasis on enforcing compliance with the duty of brokers to obtain
the best execution for their clients has fostered the growing importance of
electronic communication networks, which provide an ever-increasing source of
liquidity in the over-the-counter market.
Based upon our experience in the industry, we believe that this regulatory
environment and the increased availability of information to individual
investors on a real-time basis, together with advances in Internet, networking
and communications technologies, has created investing opportunities for active
traders and active investors and market opportunities for online brokerage
services.
Online trading is the fastest growing segment of the brokerage industry and
is expected to grow significantly. Forrester Research, Inc. projects that the
online trading industry grew from approximately 1.5 million accounts at the end
of 1996 to approximately 5 million accounts at the end of 1998, and that the
market will grow to 8.4 million accounts at the end of 1999 and 14.4 million
accounts in 2002. Another industry report indicates that the volume of
securities trades placed over the Internet increased by 34% during the fourth
calendar quarter of 1998, compared to the third quarter of 1998, and that the
number of online trades accounts for 25% to 30% of all individual investor stock
transactions and 14% of all equity transactions. Industry experts also project
that retail commissions generated by the online trading market will grow from
approximately $268 million, or 15% of the commissions generated by discount
brokerages in 1996, to as much as $2.2 billion, or 60% of total discount
brokerage commissions by 2001.
Strategy
Our strategy is to capitalize on perceived opportunities arising from the
expanding online trading market by:
o Targeting active traders and other active investors. We believe that the
market for these clients is currently underserviced and that
UltimateTrader is positioned to satisfy their requirements.
o Expanding our marketing efforts for our online brokerage service. We
intend to aggressively market UltimateTrader by targeting active traders
through print, online and other advertisements. Our advertising efforts
are expected to include advertisements in financial publications and
various other regional and national publications that have a demographic
similar to our target market. We also intend to advertise and promote
UltimateTrader through Internet website and banner advertisements and
television commercials.
o Expanding our network infrastructure and client support capabilities. We
intend to expand our network infrastructure and client support
capabilities to better service an expected increasing client
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base. Our internal computing needs will require additional networking
equipment. We also intend to establish an off-site back-up communications
center or hot site, in a different region of the country, to mirror the
primary location to ensure continued operations in the event of a systems
failure at our primary location.
o Improving our third-market institutional sales desk. We are continuously
seeking to improve our technical expertise and apply new technologies to
more effectively provide these services. Additionally, after this
offering, we intend to hire additional associates to expand the number of
securities we cover for this market.
In addition, we intend to expand our operations by:
o Converting to self-clearing operations. Based upon an internal
cost/benefit analysis we believe that performing these operations
internally will reduce our operating costs and provide us the opportunity
to receive expanded revenues from margin transactions with our clients.
We expect to accomplish this expansion by acquiring an existing clearing
firm or hiring the appropriate staff to build and manage our own clearing
department. We intend to develop and/or obtain the requisite software
systems and to acquire computer hardware, as well as the necessary
personnel, to convert to self-clearing operations during the year 2000.
o Offering online services in foreign markets. We are currently evaluating
opportunities to provide electronic execution services for foreign
institutions and their clients for transactions in the U.S. securities
markets and to arrange for foreign institutions to provide for these
services for our clients in foreign markets.
o Offering fee-based asset management services. We are evaluating the
possibility of offering a comprehensive range of financial advisory
services online, including assessing risk profiles, asset allocation and
fund placement.
UltimateTrader
We designed UltimateTrader by uniquely integrating third-party market data
and order entry software with our proprietary networking systems to create a
proprietary trading system.
Since UltimateTrader is a client-server application, it is not restricted
by the limitation of HTML, the primary programming language of the worldwide
web. With trading systems which use HTML, displayed data remains static until a
query is repeated. In contrast, UltimateTrader delivers and automatically
updates a continuous, dynamic stream of live market data to the client's screen.
UltimateTrader provides our clients access to comprehensive information on
stocks, markets, indices, mutual funds, news and options. UltimateTrader clients
are able to access bid and ask prices, charts, research and over 170 other types
of information for any listed or Nasdaq traded stock, as well as the ability to
establish and track their securities, cash and margin positions on a real-time
basis. Our clients can arrange the display and configuration of data on their
computer screens using a menu and tool bar, which are generally utilized in the
Windows(TM) operating system. Different computer screen arrays or pages can be
built to suit the user's personal requirements.
UltimateTrader clients can execute trades with a few simple mouse clicks or
keystrokes. UltimateTrader clients can route trades directly to the exchanges,
the Nasdaq Market Maker System, a specific market maker or an electronic
communication network. As a result, we believe trades can be executed more
quickly than if the trade is routed through a third market firm or an online
brokerage firm's trading desk, as within any other trading systems. The order
entry section can be preset for size and type of order. The client can use a
mouse to click the bid or ask price of a security and either close out an open
position or add to an existing one. If the user clicks the bid or ask price of
the security, the order entry screen will appear pre-configured to buy or sell.
Once an order is entered, UltimateTrader sends the order to the exchange
selected in less than two seconds from virtually anywhere in the world. These
significant savings in time have tremendous value to a client who is trying to
trade in markets characterized by rapidly changing prices.
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Speed of order execution is also affected by how an order is routed.
UltimateTrader clients are able to route their orders directly to the exchanges,
such as the New York Stock Exchange, American Stock Exchange, Nasdaq Stock
Market, Inc. and Chicago Board Options Exchange. Most other retail online
trading systems route orders to a third-market firm or to the online broker's
trading desk or trading subsidiary, which in turn routes the orders to the
market. The Company believes that most internal trading systems and those of
third-market firms cannot match the order execution speed and capacity of the
exchanges.
Clients can also elect to route trades to our Watley trading desk for
efficient execution. Our Watley trading desk consists of registered
representatives who are available to assist our clients. There is no additional
cost for executing orders via the Watley trading desk button.
UltimateTrader clients may place bids or offers onto an electronic
communication network which will also appear in the Nasdaq Market Maker Level 2
screen with the corresponding price and size of the order. This gives our
clients an advantage in attempting to execute orders in between the current bid
and asked prices of Nasdaq securities.
To direct an order to a specific market maker or electronic communication
network, our clients double click on the market maker or ECN and mark their
order entry screen with this preference. The SelectNet preference button is
useful when our clients wish to execute orders for more than 1,000 shares of a
security. Orders sent through SelectNet are only shown to the market makers
trading that particular security.
UltimateTrader Service Levels. UltimateTrader clients can select among four
different service levels, depending on the information desired and the cost and
fees which a client is willing to pay for information and service.
The following table sets forth the features offered for each
UltimateTrader Service Level
<TABLE>
<CAPTION>
Ultimate Trader Service Level Service Level Service Level Service Level
Features I II III IV
- ------------------------------------------ --------------- --------------- --------------- --------------
<S> <C> <C> <C> <C>
Dynamic Updating Quotations .............. - - - -
Unlimited Customized Pages ............... - - - -
Electronic Execution ..................... - - - -
Board View Portfolio Minder .............. - - -
Position Minder .......................... - - -
Scrolling Tickers ........................ - - -
Alarms ................................... - - -
Snap Quotes .............................. - - -
Market Minder ............................ - - -
Hot Keys ................................. - - -
MultiQuotes .............................. - - -
Charts with Technical Studies ............ - -
Nasdaq Level II Data ..................... -
Color Coded Market Maker Screens ......... -
Time and Sales ........................... -
</TABLE>
Following is a description of each of the UltimateTrader features we offer:
o Dynamic Updating Quotations -- displays real time changes in prices and
markets as they occur.
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o Unlimited Customized Pages -- allows clients to create computer screen
layouts to their preference with their data and to scroll freely among
these pages.
o Electronic Execution -- provides direct electronic access to various
exchanges and markets for rapid routing of execution of trades.
o Board View Portfolio Minder -- used to create computer windows with
comprehensive price and other data relating to a number of different
securities.
o Position Minder -- serves as a portfolio monitor and displays existing
open positions as well as the status of pending orders.
o Scrolling Tickers -- displays price and trading volume information for
the symbols that a client chooses on a live basis. The quotes will move
through the ticker window as the server receives them.
o Alarms -- alerts clients by an audio or visual pop-up when target
criteria have been met for a specified security.
o Snap Quotes -- displays detailed information about individual symbols.
o Market Minder -- a fully configurable quote screen that can display
virtually any information about the security selected by the client.
o Hot Keys -- the ability to execute/cancel trades with a simple keystroke.
o MultiQuotes -- displays prices and fundamentals for any symbol.
o Charts with Technical Studies -- allows clients to view live, dynamically
updating, real-time intraday chart data and historical information for
stocks, options or indices.
o Nasdaq Level II Data -- continuously updated display of market maker and
electronic communication network current prices and changes.
o Color Coded Nasdaq Market Maker Screens -- designed to visually display,
by a special color on the screen, upward and downward trends in recent
trades in a security.
o Time and Sales -- reflects last and cumulative trades, prices and
aggregate daily volume in a security.
Our fee schedule for clients subscribing to Service Level I is as follows:
<TABLE>
<CAPTION>
Number of Trades Per Month Transaction Charges Monthly Fee for Real Time Data
- ---------------------------- --------------------- -------------------------------
<S> <C> <C>
1-19 trades per month $ 16.95 $50 per month
20 or more per month $ 16.95 free
</TABLE>
Our fee schedule for clients subscribing to Service Levels II, III and IV
is as follows:
<TABLE>
<CAPTION>
Monthly Fee for Real Time Data*
----------------------------------------------
Number of Trades Per Month Transaction Charges Level II Level III Level IV
- -------------------------- --------------------- -------------- --------------- -----------
<S> <C> <C> <C> <C>
1-9 trades per month $ 23.95 $ 75 $ 150 $ 300
10-24 trades per month $ 22.95 $ 50 $ 125 $ 250
25-49 trades per month $ 20.95 free $ 75 $ 200
50-99 trades per month $ 19.95 free free free
100-199 trades per month $ 18.95 free free free
200 or more trades per month $ 17.95 free free free
</TABLE>
Dow Jones News Service is an optional service priced at $95.00 per month.
Watley's for an exchange listed security in excess of 2,000 shares or a
Nasdaq listed security in excess of 10,000 shares incur a surcharge of $.01 per
share and a commission of $.01 per share on the entire order. We also charge an
additional fee for executing on an electronic communication network or
SelectNet, substantially all of which is forwarded to the owner or operator of
that system.
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Optional Services. We offer a vast array of optional services to
UltimateTrader clients. Among these are the Dow Jones News Service and various
charting and market trading services. The Dow Jones News Screen provides
continuously updating real-time news in a scrolling format, including:
breaking news;
corporate announcements;
interviews;
industry news;
market reports;
economic and political developments;
hot stock alerts; and
international events.
With Dow Jones News and a number of other services, we invoice the client
directly as part of their monthly bill and remit the special charges to the
vendor supplying these services, while retaining approximately 15% of the charge
as our fee.
Virtual Private Network Access. Watley has created a virtual private
network solution called the Dedicated Port Service for those clients who require
reliable non-Internet access to the equity markets. This service offers local
dial access from nearly anywhere in the country via modem, as well as ISDN
access in selected metropolitan areas. We charge users a fixed monthly fee for
unlimited usage.
UltimateTrader has accounted for most of our retail customer account
revenues in the past year and we anticipate this to continue in the future.
During our fiscal year ended September 30, 1998 and three months ended December
31, 1998, we derived approximately 67.4% and 70.3% of our total revenues from
UltimateTrader clients.
WatleyTrader
WatleyTrader is our web-based Internet brokerage service which we designed
for active investors who execute trades online and use online services to gather
information about the securities markets. WatleyTrader provides comprehensive
information on stocks, markets, indices, mutual funds, news and options in a
live format for free. WatleyTrader clients can place trades, obtain quotes,
order research and check account balances and portfolio valuations online or
through our automated touch-tone phone system, 24 hours a day. The electronic
order system for the WatleyTrader directs orders to the Watley Desk for
execution. WatleyTrader client orders are entered, processed and confirmed
electronically.
WatleyTrader targets price sensitive investors and competes directly with
E*Trade, Charles Schwab and other online brokerages. The basic fee schedule for
the WatleyTrader is a transaction charge of $9.95 per order with an additional
$15.00 fee for trades made by telephone. Orders of more than 5,000 shares bear a
commission of $.01 per share for the entire order
During our fiscal year ended September 30, 1998 and three months ended
December 31, 1998, approximately 1.4% and .8% of our revenues originated from
WatleyTrader clients.
Third-Market Institutional Sales Desk
Watley's third-market institutional sales desk specializes in facilitating
and/or executing large-block transactions in approximately 500 thinly-traded
equity securities. These services are provided to clients who often require that
their purchases or sales of large positions remain anonymous. We match buyers
and sellers to execute off-exchange transactions, to minimize the impact on the
market and prevent our client's positions from being disclosed to competing
firms. Our third-market institutional sales clients include mutual and
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pension funds, insurance companies, banks, corporations and independent fund
managers. Approximately 30.7% and 28.9% of our revenues for our fiscal year
ended September 30, 1998 and three months ended December 31, 1998 were derived
from the institutional trading desk.
Client Services
Client services for all levels of online service, including trading,
administrative, and technical support, are among our highest priorities. Based
on our experience in the industry and client feedback, we believe that providing
an effective client service team to handle client needs is critical to our
success. Our client service organization helps clients get online, handles
product and service inquiries and addresses all brokerage and technical
questions. The client service team also makes welcome calls to verify the
satisfaction of our clients.
Live client support is available 10 hours a day from 8:00 AM to 6:00 PM EST
Monday through Friday. Our client services department operates on a one-stop
shopping basis, meaning that clients do not have to be transferred between
departments to receive answers to their inquiries. We currently employ ten
client services associates, all of whom are registered representatives and are
available to accept and execute client orders, research past trades, discuss
account information, and provide detailed technical support. A separate
technical team helps clients with particularly serious or persistent technical
issues.
In order to provide professional and efficient client support, we have
purchased and implemented client management software. Databases are updated with
each client contact to track client service calls, trading patterns and
compliance issues, and to generate periodic reports for management. Client
services associates access the latest client account information through their
own searchable client services manual and solutions database.
We recently launched online support and chat services for our clients. This
service currently offers an online, indexed UltimateTrader user manual and chat
area. The chat area offers clients the ability to query and chat with client
services associates in real-time. Our goal with respect to the provision of
online support and chat services is to create a sense of virtual community among
prospective and existing clients and between our company and our clients.
We plan to create a VIP client services team to service our most active
online clients. In addition to providing client support for all issues on an
account manager basis, we intend for the VIP team to offer face-to-face contact,
individualized service and customized incentive packages. We believe that
providing highly personalized and professional client support, especially for
our niche market high volume clients, will further differentiate our products
and services from those of our competitors.
Operations
Clearing and Order Processing
Watley does not hold any funds or securities of its clients nor does Watley
directly execute and process either its own or its clients' securities
transactions. Since October 1996, Watley has cleared all transactions for its
clients, on a fully disclosed basis, with Penson Financial Services, Inc. for
retail accounts and Weiss, Peck & Greer, L.L.C. for institutional accounts.
Watley's agreements with its clearing brokers provide that the clearing
brokers process all securities transactions for Watley's account and the
accounts of Watley's clients for a fee. Services of the clearing brokers include
billing and credit control and receipt, custody and delivery of securities, for
which we pay a per ticket charge. Watley has agreed to indemnify and hold the
clearing brokers harmless from certain liabilities or claims, including claims
arising from the transactions of its clients, which could be material in amount.
Watley's clearing agreements may be terminated by either party, upon 60 days'
written notice for Penson Financial Services, Inc., and 30 day's prior written
notice for Weiss, Peck & Greer, L.L.C. Watley depends on the operational
capacity and the ability of the clearing brokers for the orderly processing of
transactions. By engaging the processing services of clearing brokers, however,
Watley is exempt from certain capital reserve requirements imposed by federal
securities laws.
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Clients' securities transactions are effected on either a cash or margin
basis. In connection with margin transactions, credit is extended to a client,
collateralized by securities and cash in the client's account, for a portion of
the purchase price. The client is charged for margin financing at interest rates
based on the brokers' call rate plus an additional amount of up to 1.75%. The
brokers' call rate is the prevailing interest rate charged by banks on secured
loans to broker-dealers.
Margin lending is subject to the margin rules of the Board of Governors of
the Federal Reserve system. Margin lending subjects us to the risk of a market
decline that would reduce the value of our collateral below the client's
indebtedness before the collateral can be sold. Under applicable rules, in the
event of a decline in the market value of the securities in a margin account,
the client is required to deposit additional securities or cash in the account
so that the loan is at all times no greater than 65% of the market value of
securities in the margin account.
Network Infrastructure
Our network consists of a series of servers, routing and
Internet-networking equipment, workstations, software support clusters, and
firewall management systems. This creates a global connection to our intranet,
so that any computer that can connect to the Internet can connect to our system.
Any individual with a personal computer who has a connection to the
Internet and has Windows compatible software can subscribe to UltimateTrader.
Once an account is opened, the client downloads UltimateTrader software and is
given a unique user name and password. The client then logs onto the
UltimateTrader system and is connected to one of our order servers.
Our network is accessed by electronic messaging. A message is sent to
Watley's intranet via the client's Internet service provider. In order to access
Watley's network, this message first passes through a firewall and web shield.
The firewall allows appropriate Internet traffic into the network. The web
shield prevents virus infected files or messages from reaching the network. Once
the message has passed through the firewall and web shield, a permission server
qualifies the information. Once the client establishes a connection to the
UltimateTrader system, the connection between the client and server is
maintained until the client requests it be terminated.
Our technology is supported by an internal staff of programmers, developers
and operators 24 hours a day, seven days a week. The programming staff is
supplemented by a team of quality control analysts, web page developers,
technical writers and design specialists who ensure the final product is
user-friendly and dependable. In addition to supporting the systems, the staff
continually enhances software and hardware and develops new services. Software
is designed to be versatile and easily adaptable to new and emerging
technologies.
The order server accepts buy/sell or sell short messages from the client
application and qualifies the order for appropriate review. Once an order is
qualified, it is sent to the exchange of the client's choice and messages are
sent to update our data base. This update offers the client real-time account
positions, equity and profit and loss calculations. All transactions for the day
are processed for delivery to the clearing firm.
Account Security
We use a combination of proprietary and industry standard security measures
to protect our clients' assets. Clients are assigned unique account numbers,
user identifications and passwords that must be used each time they log on to
the system. In accordance with standard industry practices, telephone orders
require authentication via personal identification number/password and/or other
personal information. In addition, our trade processing system is designed to
compare the Watley accounts database with the clearing firm's account
information on a daily basis to detect any discrepancies.
We rely on encryption and authentication technology, including public key
cryptography technology licensed from other parties, to provide the security and
authentication necessary to effect the secure exchange of information.
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Firewalls and other software limit not only system access to the authorized
users, but also limit the authorized users to specifically approved
applications. This filter-software prevents unauthorized access to critical
areas of the system such as account information. Furthermore, public access
servers, such as e-mail, chat services and the file transfer protocol, are in a
network entirely separate from the rest of our systems.
We have implemented special policies relating to the transfer or withdrawal
of funds by clients to prevent unauthorized withdrawals. All requests for fund
withdrawal or transfer require a signed letter from the account holder. Checks
will only be made out in the account holder's name and wire transfers will only
be sent to a bank account in the account holder's name.
Proposed Self-clearing Operations
We currently intend to convert to self-clearing operations. If we were to
implement self-clearing operations, our client's securities typically will be
held by us in nominee name on deposit at one or more of the recognized
securities industry depository trust companies, to facilitate ready
transferability. We will collect dividends and interest on securities held in
nominee name and make the appropriate credits to our client's account. We will
also facilitate exercise of subscription rights on securities held for our
clients. We will arrange for the transmittal of proxy and tender offer materials
and issuer reports to our clients.
Self-clearing operations, especially where conducted by firms such as our
company, without significant prior experience, involve substantial risks of
losses due to clerical errors related to the handling of client funds and
securities. Errors in the clearing process also may lead to civil liability for
actions in negligence brought by parties who are financially harmed as a result
of these errors. Clearing operations have accounted for a significant portion of
our cost of services. Our failure to perform self-clearing operations accurately
and cost-effectively could have a material adverse effect on our business,
financial condition and operating results.
Suppliers
We obtain financial information from a number of third-party suppliers of
software and information services, including PC Quote, Inc., Townsend Analytics,
Ltd., Ethos Corporation and S&P ComStock, Inc. We have a number of alternative
sources of supply of these items of software and information services available
to us at comparable cost, on a timely basis to provide adequate replacements, if
arrangements with any of our current suppliers are abrogated.
Marketing and Advertising
We intend to market UltimateTrader by targeting active traders through
print, online and other advertisements. To date, we have engaged in limited
marketing and advertising efforts, consisting primarily of print advertising in
Investors Business Daily, a daily trade publication. We have also conducted
surveys of our existing client base to understand their media consuming habits
and demographic profiles to effectively target our advertising campaign. We are
developing a comprehensive marketing plan to attract potential clients, as well
as build market awareness, educate the investing public and develop brand name
recognition and loyalty within the most active trading segment of the market.
Our advertising efforts are expected to include advertisements in financial
publications and various other regional and national publications that have
demographics similar to our target markets. We also intend to advertise and
promote UltimateTrader through Internet website and banner advertisements and
television commercials.
Our initial marketing efforts will be concentrated in the United States.
However, as part of our long-term goals, we plan to market our services to
trading communities interested in U.S. equities in Western Europe, Latin
America, and Asia.
Competition
The market for electronic brokerage services is highly competitive and
rapidly changing. We believe that we compete on the basis of speed and accuracy
of order execution, processing and confirmation, quality of
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client service, ease of use, amount and timeliness of information provided,
price and reliability of our trading systems. We expect that our ability to
compete will also be affected by our ability to introduce new services and
enhancements to existing services into the market on a timely basis.
We believe our competition consists of large and small brokerage firms,
utilizing the Internet to transact retail brokerage business. Among these
competitors are E*Trade Group, Inc., Charles Schwab & Co., Inc., Quick & Reilly,
Inc., Waterhouse Securities, Inc., Fidelity Brokerage Services, Inc. and Datek
Securities Corp. We also face competition for clients from full commission
brokerage firms, including Morgan Stanley Dean Witter & Co., PaineWebber
Incorporated and Salomon Smith Barney, as well as financial institutions and
mutual funds.
Securities Regulation
Watley is a broker-dealer registered with the SEC and NASD and is licensed
as a broker-dealer in 49 states.
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. In addition, the SEC, NASD, other
self regulatory organizations, such as the various stock exchanges, and other
regulatory bodies, such as state securities commissions, require strict
compliance with their rules and regulations. As a matter of public policy,
regulatory bodies are charged with safeguarding the integrity of the securities
and other financial markets and with protecting the interests of clients
participating in those markets, and not with protecting the interests of our
stockholders.
Broker-dealers are subject to regulations covering all aspects of the
securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of clients' funds and securities, capital
structure, record keeping and the conduct of directors, officers and employees.
Because of the recent increase in the number of complaints by online traders,
the SEC, NASD and other regulatory organizations may adopt more stringent
regulations for online firms and their practices. If we fail to comply with any
laws, rules or regulations we could be censured, fined, issued a
cease-and-desist order or Watley or our officers and employees could be
suspended or expelled.
In addition, significant changes in Watley's current business or practices,
including converting to self-clearing operations, require NASD and other
regulatory approval.
To expand our services internationally, we would have to comply with
regulatory controls of each specific country in which we conduct business. The
brokerage industry in many foreign countries is heavily regulated. The varying
compliance requirements of these different regulatory jurisdictions and other
factors may limit our ability to expand internationally.
Following the closing of this offering, we intend to initiate a
comprehensive marketing campaign to bring greater brand name recognition to our
products and services. All marketing activities by Watley are regulated by the
NASD. The NASD can impose penalties, including censure, fine, suspension of all
advertising, the issuance of cease-and-desist orders or the suspension or
expulsion of a broker-dealer and its officers or employees for violations of the
NASD's advertising regulations.
Net Capital Requirements
The SEC, NASD and various other regulatory agencies have stringent rules
requiring the maintenance of specific levels of net capital by securities
brokers, including the SEC's uniform net capital rule which governs Watley. Net
capital is defined as assets minus liabilities, plus other allowable credits and
qualifying subordinated borrowings less mandatory deductions that result from
excluding assets that are not readily convertible into cash and from valuing
other assets, such as a firm's positions in securities, conservatively. Among
these deductions are adjustments in the market value of securities to reflect
the possibility of a market decline prior to disposition.
As of December 31, 1998, Watley was required to maintain minimum net
capital, in accordance with SEC rules, of approximately $100,000 and had total
net capital of $187,875 or approximately $87,875 in excess of minimum net
capital requirements.
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If Watley fails to maintain the required net capital Watley may be subject
to suspension or revocation of registration by the SEC and suspension or
expulsion by the NASD and other regulatory bodies, which ultimately could
require Watley's liquidation. In addition, a change in the net capital rules,
the imposition of new rules, a specific operating loss, or any unusually large
charge against net capital could limit those operations of Watley that require
the intensive use of capital and could limit our ability to expand our business.
The net capital rules also could restrict our ability to withdraw capital from
Watley, which could limit our ability to pay dividends, repay debt and
repurchase shares of our outstanding stock.
Intellectual Property Rights
We rely on a combination of copyright, trademark and trade secrets laws and
non-disclosure agreements to protect our proprietary technologies, ideas,
know-how and other proprietary information. We hold a United States trademark
registration for the UltimateTrader name. We have no patents or registered
copyrights. Third parties may copy or otherwise obtain and use our proprietary
technologies, ideas, know-how and other proprietary information without
authorization or independently develop technologies similar or superior to our
technologies. In addition, the confidentiality and non-competition agreements
between us and our key employees, distributors and clients may not provide
meaningful protection of our proprietary technologies or other intellectual
property in the event of unauthorized use or disclosure. Policing unauthorized
use of our technologies and other intellectual property is difficult,
particularly because the global nature of the Internet makes it difficult to
control the ultimate destination or security of software or other data
transmitted.
There has been substantial litigation in the software industry involving
intellectual property rights. We believe that our technologies and trading
systems have been developed independent of others. Third parties may assert
infringement claims against us and our technologies and trading systems may be
determined to infringe on the intellectual property rights of others.
Research and Development
During the years ended September 30, 1997 and 1998, we spent approximately
$62,000 and $703,000 for software development. During the three months ended
December 31, 1998, we spent approximately $760,000 for software development.
These software development efforts were related to enhancing the operational
capabilities of our trading systems.
Computer Strategies, Inc. Acquisition
Effective October 2, 1998, we acquired all of the capital stock of Computer
Strategies, Inc. for 38,260 shares of common stock valued at $183,648. Computer
Strategies provided computer software consulting services. Leon Ferguson was the
founder and sole stockholder of Computer Strategies and became our Senior Vice
President and Chief Information Officer upon closing of the acquisition.
Personnel
As of March 22, 1998, we employed a total of 59 persons, of whom 10 are
engaged in executive management, 16 in trading activities, 10 in client service,
5 in sales and marketing, 9 clerical and back office personnel, as well as 9
other employees. All but one of our employees are employed on a full-time basis.
In addition, we retain a computer development and consulting firm on an
exclusive basis. We believe our relations with our employees are generally good
and we have no collective bargaining agreements with any labor unions.
Our registered representatives are required to take examinations
administered by the NASD and state authorities to be qualified to transact
business, and are required to enter into agreements with Watley obligating them
to adhere to Watley's supervisory procedures and not to solicit customers in the
event of termination of employment. Watley's agreements with registered
representatives do not obligate these representatives to be associated with
Watley for any length of time.
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Our success will depend on our ability to hire and retain additional
qualified marketing, industry, technical and financial personnel. Qualified
personnel are in high demand. We face considerable competition from other
brokerage and financial service firms and other Internet and online service
companies for these personnel, many of which have significantly greater
resources than we have.
Properties
Our principal offices are located at 40 Wall Street, New York, New York,
where we occupy approximately 15,000 square feet at an annual cost of
approximately $480,000, or $40,000 per month, plus escalations. Although the
lease began in January 1998, monthly rental payments will not commence until
June 1999. The initial term of the lease for the new office space expires in
June 2009.
Legal Proceedings
Our business involves substantial risks of liability, including exposure to
liability under federal and state securities laws in connection with the
underwriting or distribution of securities and claims by dissatisfied clients
for fraud, unauthorized trading, churning, mismanagement and breach of fiduciary
duty. In recent years, there has been an increasing incidence of litigation
involving the securities industry, including class actions which generally seek
rescission and substantial damages.
In the ordinary course of business, we and our principals are, and may
become a party to legal or regulatory proceedings or arbitrations. We are not
currently involved in any legal or regulatory proceedings or, arbitrations, the
outcome of which is expected to have a material adverse effect on our business.
How to Contact Internet Financial Services
Our principal executive offices are located at 40 Wall Street, New York,
New York 10005, and our telephone number is (212) 422-1664. We maintain a
website at www.abwatley.com. Information contained in our website is not part of
this prospectus.
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MANAGEMENT
Executive Officers and Directors
Our executive officers and directors are as follows:
<TABLE>
<CAPTION>
Name Age Positions
- ---- ----- ---------
<S> <C> <C>
Steven Malin ................ 41 Chairman of the Board, Chief Executive Officer and Director
Harry Simpson ............... 32 President, Chief Operating Officer and Director
Robert Malin ................ 34 President of A.B. Watley, Inc. and Director
Anthony G. Huston ........... 36 Executive Vice President -- Strategic Planning
Eric Steinberg .............. 33 Executive Vice President -- Administration
Leon Ferguson ............... 36 Senior Vice President and Chief Information Officer
Jonathan Priddle ............ 37 Senior Vice President -- Sales
Brett Vernick ............... 31 Senior Vice President -- Management Information Services
Michael Fielman ............. 48 Vice President -- Finance
William Brawer .............. 42 Director
Elizabeth Chambers .......... 36 Director
Mark Chambre ................ 38 Director
Stanley Weinstein ........... 73 Director
</TABLE>
Steven Malin co-founded Internet Financial Services in May 1996 and has
been our Chairman of the Board and Chief Executive Officer since inception. From
August 1993 to December 1996, Mr. Malin served as a consultant to Watley. From
1987 to 1993, he was a Senior Foreign Exchange Options Broker for Tullett and
Tokyo Forex, Inc., a global inter-bank money brokering firm with its primary
offices located in London, New York and Tokyo. Mr. Malin attended The Fletcher
School of Law and Diplomacy from 1982 to 1984. He received a bachelor of arts
degree from Vassar College in 1980.
Harry Simpson has been our President and Chief Operating Officer since
March 1998 and was our Executive Vice President of Online Brokerage Services
from May 1996 until March 1998. From January 1993 to September 1995, he served
as Vice President of Tullett and Tokyo Forex, Inc., and Manager of its Foreign
Exchange Options Desk in New York. From January 1988 to December 1992, Mr.
Simpson worked as a Senior Foreign Exchange Options Broker for Exco
International, Inc., an international money broker in Hong Kong and Tokyo. Mr.
Simpson received a bachelor of science degree in finance from Indiana University
in 1987.
Robert Malin is a co-founder of Internet Financial Services. He has been
associated with Watley since August 1993, initially as General Securities
Principal and director of day-to-day operations and, most recently, serving as
President. His earlier experience includes managing equity-trading, client
services and brokerage operations. Mr. Malin and Steven Malin are brothers.
Anthony G. Huston. Mr. Huston has been our Executive Vice President since
May 1996. From September 1995 to May 1996, Mr. Huston served as a consultant to
Watley. From August 1988 to May 1995, he served as Vice President and Manager
in the Foreign Exchange Options Department in the New York, Tokyo, and London
offices of Tullett and Tokyo Forex, Inc. Mr. Huston received a bachelor of arts
degree in asian studies and international relations from the University of
Michigan in 1985. He attended New York University as a post graduate student in
economics.
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<PAGE>
Eric Steinberg. Mr. Steinberg has been our Executive Vice President of
Administration since March 1998. His responsibilities include management of our
offices and negotiating our purchase and leasing arrangements. From May 1996 to
February 1998, Mr. Steinberg served as an administrative consultant to Internet
Financial Services. From August 1993 to May 1996 he served as a consultant to
Watley. From 1991 to 1993, he was a manager at Primary Financial Services, Inc.,
a financial consulting and leasing company. From September 1986 to May 1991, Mr.
Steinberg was employed as an account manager by Manhattan Leasing, Inc., a New
York based leasing company.
Leon Ferguson. Mr. Ferguson joined us in October 1998 as Senior Vice
President and Chief Information Officer in connection with our acquisition of
Computer Strategies, Inc., a software consulting firm he formed in 1996 and
served as its President and Chief Executive Officer since inception. From May
1994 to January 1996, Mr. Ferguson served as Director of Information Technology
Strategies at Williams Telecommunications Group, a long-distance
telecommunications company that was acquired by WorldCom, Inc. in 1995. From
May 1990 to May 1994, Mr. Ferguson served as Chairman of Digital Communications
Associates, Inc. a software development company he founded which specializes in
high speed transaction solutions for the long distance telecommunications
industry. Mr. Ferguson received a bachelor of computer science degree from the
University of Oklahoma in 1988.
Jonathan Priddle. Mr. Priddle has served as our Senior Vice President of
Sales since December 1998. From April 1997 to November 1998, he provided
consulting services to Watley. From August 1995 to March 1997, he served as a
senior broker at Eurobrokers, Inc., a global interbank money brokering firm in
New York. From January 1995 to August 1995, Mr. Priddle served as a Senior
Currency Broker in the New York office of Tullett and Tokyo Forex, Inc. From
April 1994 to January 1995, Mr. Priddle was the Manager of the Currency/FRA
Department at Cantor Fitzgerald Associates, a foreign exchange brokerage firm.
From March 1992 to April 1994 Mr. Priddle was a broker in the Currency
Arbitrage Department of Garvin Guybutler Corporation, a global interbank money
brokering firm. Mr. Priddle began his career with Tullett and Tokyo, Inc. in
June 1985 and served in the London, Tokyo and New York offices until March
1992. Mr. Priddle attended Yeovil Tertiary College from September 1978 to March
1981 and Bristol Polytechnic from March 1981 to March 1986. Both institutions
are located in the United Kingdom.
Brett Vernick. Mr. Vernick has served as our Senior Vice President for
Management Information Services since May 1996. From March 1995 to April 1996,
Mr. Vernick served as the Eastern U.S. Region Network Specialist for PC Quote,
Inc., an international data feed corporation. From August 1992 to February
1995, he served as Director of Management Information Systems for Soil
Mechanics Environmental Services, Inc. Mr. Vernick received a bachelor of
science degree in political science and international relations from Stonybrook
in 1993.
Michael Fielman. Mr. Fielman has been our Vice President -- Finance since
April 1998. From January 1996 to March 1998, he was Controller of Cord
Contracting Co., Inc., a hydrogeologic consulting drywall contractor. From 1991
to January 1996, he was Chief Financial Officer of Artkraft Strauss Sign
Corporation, a provider of advertising signs. He received a bachelor of science
degree from New York Institute of Technology in 1973.
William Brawer has agreed to serve as a director of Internet Financial
Services upon the closing of this offering. Since February 1996, he has served
as Chairman and Chief Executive Officer of Brawer Brothers, a producer of nylon
and polyester bi-products. Mr. Brawer served in various other senior management
capacities with Brawer Brothers. Mr. Brawer received a bachelor of science
degree from Colorado University in 1978.
Elizabeth Chambers has agreed to serve as a director of Internet Financial
Services upon the closing of this offering. Since August 1998, she has been Vice
President of Business Design and a member of the executive committee at the
Reader's Digest Association. Ms. Chambers is also a member of the Board of
Directors of the Reader's Digest Foundation. From September 1989 to August 1998,
Ms. Chambers was with McKinsey & Company, where she was elected to partnership
in June 1995. Ms. Chambers graduated from Stanford University with degrees in
political science and economics, and holds an MBA from Harvard University.
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<PAGE>
Mark Chambre has agreed to serve as a director of Internet Financial
Services upon the closing of this offering. Since June 1993, he has served as
Senior Broker in the Yen Swaps Division of the Tokyo Forex Co., Inc., in Tokyo,
Japan. From April 1988 to May 1993, Mr. Chambre served as Manager of the Tokyo
Forex Co.'s Financial Futures Division. Mr. Chambre joined its parent company,
Tullett and Tokyo, Inc., in New York in 1983. Mr. Chambre received a bachelor
of arts degree from Drew University in 1982.
Stanley Weinstein has agreed to serve as a director of Internet Financial
Services upon the closing of this offering. He has been an independent corporate
financial consultant since 1991. From 1960 to 1991 he served as a partner with
Deloitte & Touche, LLP, an international accounting firm. Mr. Weinstein served
for fifteen years as adjunct Associate Professor of Accounting at Pace
University and co-authored the widely recognized SEC Compliance -- Financial
Reporting and Forms handbook. He received a bachelor of business administration
degree in accounting from City College of New York in 1949. Since May 1995, he
has served as a director of York Research Corp., a company engaged in the
production and marketing of energy related projects.
Directors are elected at each annual meeting of stockholders and hold
office until the next annual meeting of stockholders and the election and
qualification of their successors. Executive officers are elected by and serve
at the discretion of the board of directors.
We have agreed, for a period of five years from the date of this
prospectus, if so requested by the underwriter, to nominate and use our best
efforts to elect a designee of the underwriter as a director of our company or,
at the underwriter's option, as a non-voting adviser to our board of directors.
Our officers, directors and principal stockholders have agreed to vote their
shares of common stock in favor of a designee. The underwriter has not yet
exercised its right to designate a person.
Special Advisory Board
We have established a special advisory board to the board of directors
which will initially consist of Anthony G. Huston and Eric Steinberg. The
special advisory board will advise and assist the board of directors in
executive planning and decision making. Members of our special advisory board
will be invited to attend, observe and participate in all meetings of the board
of directors but will not have the right to cast a vote.
Board Committees
The board of directors has established a Compensation Committee which, upon
the closing of this offering, will be comprised of Mark Chambre and William
Brawer. The Compensation Committee will review and determine the compensation
for all officers and directors of our company and will review general policy
matters relating to the compensation and benefits of all employees. The
Compensation Committee will also administer each of the stock option plans.
The board of directors has established an Audit Committee which, upon the
closing of this offering, will be comprised of Elizabeth Chambers and Stanley
Weinstein. The Audit Committee will recommend to the board of directors the
annual engagement of a firm of independent accountants and will review with the
independent accountants the scope and results of audits, our internal accounting
controls and audit practices and professional services rendered to us by our
independent accountants.
Directors' Compensation
All directors are reimbursed for their reasonable expenses incurred in
attending meetings of the board of directors and its committees. Directors who
are employees receive no additional compensation for service as members of the
board of directors or committees. Following this offering, all of our
non-employee directors will be compensated annually for their services at $2,000
and non-qualified options to acquire 1,500 shares of our common stock at the end
of each year of service.
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<PAGE>
Executive Compensation
During the fiscal year ended September 30, 1998, the salary of Mr. Steven
Malin, our Chief Executive Officer was $70,000. Mr. Malin forgave his salary for
fiscal 1998 and no other compensation, including "long-term compensation"
payments, were made to him in any form. No executive officer received salary and
bonus compensation which exceeded $100,000 in this fiscal year.
There were no stock option grants to Mr. Malin, during the fiscal year
ended September 30, 1998.
Employment Agreements
We have entered into a four-year employment agreement with Steven Malin and
three-year employment agreements with Harry Simpson, Robert Malin, Anthony G.
Huston and Eric Steinberg all of which are automatically renewable for
additional one-year terms and provide for annual base compensation of $90,000
until the effectiveness of this offering, and increasing to $110,000 after this
offering. Each agreement provides for a bonus equal to 20% of their salaries,
payable semi-annually, based upon certain revenue levels achieved by us, as may
be approved by the board of directors or a committee of the board.
Each of the employment agreements requires the officer to devote his full
time and efforts to our business and contains non-competition and non-disclosure
covenants of the officer for the term of his employment and for a period of two
years thereafter. Each employment agreement provides that we may terminate the
agreement for cause. In addition, each employment agreement provides for
termination by either party without cause upon at least 180 days written notice
prior to the end of the original term or any renewal term.
Key-man Life Insurance
We have obtained "key-man" life insurance on each of the lives of Steven
Malin and Harry Simpson in excess of $2,000,000 and on the life of Robert Malin
in the amount of $1,000,000.
Stock Option Plans
On January 27, 1997, the board of directors and stockholders adopted our
1997 stock option plan and on March 16, 1998, our board of directors and
stockholders adopted our 1998 stock option plan. We have reserved 400,000 shares
of common stock for issuance upon exercise of options granted from time to time
under the 1997 stock option plan and 800,000 shares of common stock for issuance
upon exercise of options granted from time to time under the 1998 stock option
plan. The 1997 and 1998 stock option plans are intended to assist us in securing
and retaining key employees, directors and consultants by allowing them to
participate in our ownership and growth through the grant of incentive and
non-qualified options.
Under each of the stock option plans we may grant incentive stock options
only to key employees and employee directors, or we may grant non-qualified
options to our employees, officers, directors and consultants. The 1997 stock
option plan shall be administered by a committee, appointed by our board of
directors, consisting of from one to three directors. The 1998 stock option plan
shall be administered directly by our board of directors.
Subject to the provisions of each of the stock option plans, either the
board or the committee will determine who shall receive options, the number of
shares of common stock that may be purchased under the options, the time and
manner of exercise of options and exercise prices. The term of options granted
under each of the stock option plans may not exceed ten years or five years for
an incentive stock option granted to an optionee owning more than 10% of our
voting stock. The exercise price for incentive stock options shall be equal to
or greater than 100% of the fair market value of the shares of the common stock
at the time granted; provided that incentive stock options granted to a 10%
holder of our voting stock shall be exercisable at a price equal to or greater
than 110% of the fair market value of the common stock on the date of the grant.
The exercise price for non-qualified options will be set by the board or the
committee, in its discretion, but in no event shall the exercise price be less
than the fair market value of the shares of common
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<PAGE>
stock on the date of grant. The exercise price may be payable in cash or, with
the approval of the board or the committee, by delivery of shares or by a
combination of cash and shares. Shares of common stock received upon exercise of
options granted under each of the plans will be subject to restrictions on sale
or transfer.
As of the date of this prospectus, we have granted options to purchase
1,049,900 shares of common stock under our stock options plans at an exercise
price ranging from $2.00 to $7.00 per share. Of these options, options to
purchase 620,000 shares have been granted to our officers and directors. All of
the options granted to such officers and directors terminate on the ten year
anniversary of their vesting date.
For one year from the closing of the offering we will not grant options or
warrants to our existing officers, directors, employees or stockholders
beneficially owning 5% or more of the outstanding voting securities or their
affiliates, except for those options reserved for issuance under our 1998 stock
option plan.
Limitation on Liability and Indemnification Matters
As authorized by the Delaware General Corporation Law, our certificate of
incorporation provides that none of our directors shall be personally liable to
us or our stockholders for monetary damages for breach of fiduciary duty as a
director, except for liability for:
o any breach of the director's duty of loyalty to our company or its
stockholders;
o acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law
o unlawful payments of dividends or unlawful stock redemptions or
repurchases; or
o any transaction from which the director derived an improper personal
benefit.
This provision limits our rights and the rights of our stockholders to recover
monetary damages against a director for breach of the fiduciary duty of care
except in the situations described above. This provision does not limit our
rights or the rights of any stockholder to seek injunctive relief or rescission
if a director breaches his duty of care. In addition, our certificate of
incorporation provides that if the Delaware General Corporation Law is amended
to further limit the liability of a director, then the liability of the
directors shall be eliminated or limited to the fullest extent permitted by such
amendment. These provisions will not alter the liability of directors under
federal securities laws.
Our certificate of incorporation further provides for the indemnification
of any and all persons who serve as our director, officer, employee or agent to
the fullest extent permitted under the Delaware General Corporation Law.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to our directors, officers and controlling persons pursuant to
the foregoing provisions, or otherwise, we have been advised that in the opinion
of the SEC such indemnification is against public policy as expressed in the
Securities Act, and is, therefore, unenforceable.
Before the closing of this offering, we will obtain and maintain a policy
of insurance under which our directors and officers will be insured, subject to
the limits of the policy, against certain losses arising from claims made
against our directors and officers by reason of any acts or omissions covered
under this policy in their capacities as directors or officers, including
liabilities under the Securities Act.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information known to Internet Financial
Services, as of the date of this prospectus and as adjusted to reflect the sale
by us of the 2,000,000 shares of common stock offered under this prospectus,
relating to the beneficial ownership of shares of common stock by: each person
who is known by us to be the beneficial owner of more than five percent of the
outstanding shares of common stock; each director or person who has agreed to
become a director; and all executive officers and directors as a group.
Unless otherwise indicated, the address of each beneficial owner in the
table set forth below is care of Internet Financial Services, 40 Wall Street,
New York, New York 10005.
We believe that all persons named in the table have sole voting and
investment power with respect to all shares of common stock beneficially owned
by them.
A person is deemed to be the beneficial owner of securities that can be
acquired by him within 60 days from the date of this prospectus upon the
exercise of options, warrants or convertible securities. Each beneficial owner's
percentage ownership is determined by assuming that options, warrants or
convertible securities that are held by him, but not those held by any other
person, and which are exercisable within 60 days of the date of this prospectus
have been exercised and converted.
<TABLE>
<CAPTION>
Percentage of Shares Beneficially Owned
Number of Shares ----------------------------------------
Name and Address of Beneficial Owner Beneficially Owned Before Offering After Offering
- ----------------------------------------- -------------------- ----------------- ---------------
<S> <C> <C> <C>
Steven Malin ............................ 1,875,000 33.3% 24.6%
Linda Malin ............................. 1,000,000 17.8 13.1
Robert Malin ............................ 850,000 15.1 11.1
Anthony G. Huston ....................... 325,000 5.8 4.3
Eric Steinberg .......................... 300,000 5.3 3.9
Harry Simpson ........................... 216,667 3.8 2.8
Mark Chambre ............................ 52,500 .9 .7
William Brawer .......................... 0 0 0
Elizabeth Chambers ...................... 0 0 0
Stanley Weinstein ....................... 0 0 0
All directors and executive officers as a
group consisting of 13 persons ......... 3,350,834 57.3% 42.7%
</TABLE>
The number of shares beneficially owned by Steven, Linda and Robert Malin
include shares held in irrevocable family and charitable trusts for which they
are trustees. In addition, the number of shares held by Steven Malin includes
shares held by a family partnership for which Steven Malin is the general
partner.
The number of shares beneficially owned by Anthony Huston does not include
175,000 shares held by an irrevocable family trust of which Anthony Huston is a
beneficiary.
The number of shares beneficially owned by Eric Steinberg does not include
125,000 shares held by an irrevocable family trust of which Eric Steinberg is a
beneficiary.
The number of shares beneficially owned by Harry Simpson includes 66,667
shares of common stock issuable upon exercise of currently exercisable options,
but does not include 133,333 shares of common stock issuable upon exercise of
options which are not currently exercisable or 350,000 shares held in trusts of
which Harry Simpson is a beneficiary.
The number of shares beneficially owned by all of our officers and
directors as a group includes 208,334 shares of common stock issuable upon
exercise of currently exercisable options, but does not include 411,666 shares
of common stock issuable upon exercise of options which are not currently
exercisable.
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<PAGE>
CERTAIN TRANSACTIONS
In October 1994, Steven Malin, Chairman of the Board and Chief Executive
Officer and a principal stockholder of Internet Financial Services, loaned
Watley $55,000 on an interest free basis. The maturity date for this loan is
October 31, 2000. Additionally, in April 1995, Mr. Malin loaned Watley $125,000
at an annual interest rate of 12%. The maturity date for this loan is April 30,
2000. Each of these loans are subordinate to the prior payment by Watley in full
of all other present and future creditors.
In October 1995, Mel Steinberg, the father of Eric Steinberg, an executive
officer and principal stockholder of Internet Financial Services, loaned Watley
$200,000 at an annual interest rate of 15%. Additionally, effective October 30,
1996, Mr. Steinberg loaned Watley $150,000 at an annual interest rate of 13%.
The maturity date for each of the loans is October 31, 2000. Each of these loans
are subordinate to the prior payment by Watley in full of all other present and
future creditors.
On September 4, 1996, we loaned $100,000 to Robert Malin, President of
Watley and a director and principal stockholder of Internet Financial Services.
The loan bears interest at an annual rate of 6% and is due upon demand. Mr.
Malin has agreed to repay the loan within six months of the effective date of
the offering.
In January 1997, we acquired all of the issued and outstanding shares of
Watley which were held by Steven Malin and Robert Malin. As consideration for
the acquisition, we issued 425,000 shares of common stock to Robert Malin and
6,538 shares of common stock to Steven Malin. The aggregate value of the shares
issued by us was $80,000.
In April 1997, we completed a private placement of 1,050,000 shares of our
common stock for which we received net proceeds of $2,045,000. In connection
with this private placement, Jonathan Priddle, an executive officer of Internet
Financial Services, purchased 25,000 shares at a price of $50,000 and Mark
Chambre, who has agreed to serve as a director of Internet Financial Services
upon the closing of this offering, purchased 37,500 shares at a price of
$75,000. In addition, relatives of Anthony Huston and Eric Steinberg, each an
executive officer and principal stockholder of Internet Financial Services,
purchased an aggregate of 62,500 shares at an aggregate price of $125,000. All
of these purchases were on the same terms and at the same price as the purchases
made by the other investors in this private placement.
In May 1997, we sold computer hardware and related assets to Centennial
Ventures, Inc., a broker-dealer of which Linda Malin, a principal stockholder of
Internet Financial Services and the sister of Steven and Robert Malin, is an
executive officer. As consideration for this sale, Centennial Ventures, Inc.
delivered a promissory note in the principal amount of $39,860.75. The note is
due on May 1, 1999, bears interest at an annual rate of 8% and is secured by all
of the assets we sold to Centennial Ventures, Inc.
In February 1998, Mel Steinberg loaned to Internet Financial Services
$100,000 at an interest rate of 8%. The loan is due in February 2001. As
additional consideration for the loan, we granted Mr. Steinberg an option to
purchase 14,286 shares of common stock for nominal consideration. Mr. Steinberg
has notified us that he intends to exercise the option upon the completion of
this offering. We have agreed to repay the loan, including accrued interest
through the date of this prospectus, from the proceeds of this offering.
On October 2, 1998, we entered into a loan agreement with New York Small
Business Venture Fund LLC under which we borrowed $500,000 at an annual interest
rate of 12%, repayable over 35 months, with payments of interest only in the
first two years. We granted the lender a security interest in substantially all
of our assets to secure our obligations under the loan, and six persons who are
officers, directors and/or principal stockholders of Internet Financial Services
guaranteed our obligations under this loan. We intend to repay this loan out of
the proceeds of this offering, which will discharge the liability of the
guarantors. Stanley Weinstein, who has agreed to serve as a director of Internet
Financial Services on the date of this prospectus, received a $25,000 consulting
fee from us in connection with the loan.
Effective October 2, 1998, we acquired all of the shares of capital stock
of Computer Strategies, Inc., for 38,260 shares of our common stock valued at
$183,648. Leon Ferguson was the founder and sole stockholder of Computer
Strategies, Inc., and became our Senior Vice President and Chief Information
Officer upon the closing of the acquisition.
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In January 1999, we completed a private placement of 221,500 shares of
common stock to 12 investors for which we received net proceeds of approximately
$1,050,000. In connection with this private placement:
o Anthony Huston purchased 50,000 shares at a price of $240,000;
o a trust naming Leon Ferguson and his wife as beneficiaries for which Mr.
Ferguson is sole trustee purchased 52,000 shares at a price of $249,600;
and
o Mark Chambre purchased 15,000 shares at a price of $72,000.
All of the purchasers of these shares agreed not to sell or otherwise dispose of
these shares for a period of twelve months from the date of this prospectus. All
of these purchases were made on the same terms and at the same price per share
as the purchases made by the other investors in this private placement.
We believe that prior transaction with our officers, directors and
principal stockholders were on terms that were no less favorable than we could
have obtained from unaffiliated third parties. All future transactions,
including loans and advances, between us and our officers, directors and
stockholders beneficially owning 5% or more of our outstanding voting
securities, or their affiliates, will be for bona fide business purposes and on
terms not less favorable to us than we could have obtained in arm's length
transactions from unaffiliated third parties.
DESCRIPTION OF SECURITIES
Our authorized capital stock consists of 20,000,000 shares of common stock,
$.001 par value per share and 1,000,000 shares of preferred stock $.01 par value
per share. As of the date of this prospectus, there are 5,631,745 shares of
common stock issued and outstanding, which are held of record by 66 holders. As
of the date of this prospectus, there are no shares of preferred stock
outstanding. Upon closing of this offering there will be 7,631,745 shares of
common stock outstanding and no shares of preferred stock outstanding.
Common Stock
Holders of common stock are entitled to one vote for each share on all
matters submitted to a stockholder vote. Holders of common stock do not have
cumulative voting rights. Therefore, holders of a majority of the shares of
common stock voting for the election of directors can elect all of the
directors. Holders of common stock are entitled to share in all dividends that
the board of directors, in its discretion, declares from legally available
funds. In any liquidation, dissolution or winding up of Internet Financial
Services, each outstanding share entitles its holder to participate pro rata in
all assets that remain after payment of liabilities and after providing for each
class of stock, if any, having preference over the common stock.
Holders of common stock have no conversion, preemptive or other
subscription rights, and there are no redemption provisions applicable to the
common stock. The rights of the holders of common stock are subject to any
rights that may be fixed for holders of preferred stock, when and if any
preferred stock is issued. All outstanding shares of common stock are, and the
shares underlying all options and warrants will be, duly authorized, validly
issued, fully paid and non-assessable upon our issuance of these shares.
Preferred Stock
Our board of directors is authorized, without further action by the
stockholders, to issue 1,000,000 shares of preferred stock from time to time in
one or more series and to fix the rights, preferences, privileges and
restrictions of these shares, including: the rights and terms relating to any
new series of preferred stock could adversely affect the voting power or other
rights of the holders of common stock. Additionally, preferred stock may be used
to discourage, delay or prevent a change in control.
Registration Rights
The holders of 405,224 shares of common stock, including 331,250 shares of
common stock issuable upon exercise of currently exercisable warrants, are
entitled to registration rights under the Securities Act for these shares.
Whenever we propose to register any of our securities under the Securities Act
for our own account or for the account of other security holders, we shall be
required to promptly notify the holders of each of the registerable shares of a
proposed registration. We may be required to include all registerable
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<PAGE>
shares which these holders may request to be included in a registration. These
holders have waived their registration rights in connection with this offering.
Additionally, holders of the registerable shares have agreed not to request
registration or sell or otherwise dispose of the registerable shares for a
period of 12 months following the date of this prospectus.
In connection with this offering, we have agreed to grant to the
underwriter registration rights in connection with the 200,000 shares of common
stock issuable upon exercise of the underwriter's warrants.
Delaware Anti-Takeover Law
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law. That section provides, with exceptions, that a Delaware
corporation may not engage in any of a broad range of business combinations with
a person or his affiliate or associate who is an owner of 15% or more of the
outstanding voting stock of the corporation for a period of three years from the
date that this person became an interested stockholder.
Transfer Agent and Warrant Agent
The transfer agent for our common stock is American Stock Transfer & Trust
Company, 40 Wall Street, New York, New York 10005.
SHARES ELIGIBLE FOR FUTURE SALE
Upon the closing of this offering, we will have 7,631,745 shares of common
stock issued and outstanding of which the 2,000,000 shares offered by this
prospectus will be freely tradeable without restriction or further registration
under the Securities Act, except for any shares purchased by an affiliate of
Internet Financial Services. An affiliate of Internet Financial Services, a
person who has a controlling position with regard to Internet Financial
Services, will be subject to the resale limitations under the Securities Act.
All of the remaining 5,631,745 shares of common stock currently outstanding
are restricted securities. Of these restricted shares, 4,000,000 shares will be
immediately eligible for sale, subject to the contractual restrictions described
below. The remaining restricted shares will become eligible for sale at various
times beginning 90 days following the date of this prospectus, subject to the
contractual provisions described below. We have also issued options and warrants
to purchase 1,601,150 shares of common stock, including the 200,000 shares of
common stock issuable upon exercise of the underwriter's warrants.
We have granted registration rights to holders of 405,224 restricted
shares, including 331,250 shares of common stock issuable upon exercise of
currently exercisable warrants, as well as registration rights to the
underwriter for the shares of common stock issuable upon exercise of the
underwriter's warrants.
The holders of approximately 5,500,000 of the restricted shares of common
stock have agreed not to sell or otherwise dispose of any of those shares of
common stock or exercise any registration rights for a period of twelve months
following the date of this prospectus without the underwriter's prior written
consent.
We can not predict the effect, if any, that market sales of common stock or
the availability of these shares for sale will have on the market price
prevailing from time to time. Nevertheless, the possibility that substantial
amounts of common stock may be sold in the public market may adversely affect
prevailing market prices for the common stock and could impair our ability to
raise capital through the sale of our equity securities.
39
<PAGE>
UNDERWRITING
Whale Securities Co., L.P., as underwriter, has agreed, subject to the
terms and conditions contained in the underwriting agreement relating to this
offering, to purchase the 2,000,000 shares of common stock offered by us.
The underwriting agreement provides that the obligations of the underwriter
are subject to the delivery of an opinion of our counsel and to various other
conditions. The underwriter is committed to purchase and pay for all of the
shares of common stock if any are purchased.
The underwriter has advised us that it proposes to offer the shares of
common stock to the public at the public offering price set forth on the cover
page of this prospectus. The underwriter may allow certain dealers who are
members of the NASD concessions, not in excess of $.26 per share, of which not
in excess of $.13 per share may be reallowed to other dealers who are members of
the NASD. Watley, our subsidiary, will not participate in this offering.
We have granted to the underwriter an option, exercisable not later than 45
days after the date of this prospectus, to purchase up to 300,000 shares at the
public offering price set forth on the cover page of this prospectus, less
underwriting discounts and commissions. The underwriter may exercise this option
only to cover over-allotments, if any, made in connection with the sale of the
shares of common stock offered by this prospectus. If the underwriter exercises
its over-allotment in full, the total price to public would be $16,100,000, the
total underwriting discounts and commissions would be $1,495,000 and the total
proceeds, before payment of the expenses of this offering, to us would be
$14,605,000
We have agreed to pay to the underwriter a non-accountable expense
allowance equal to 3% of the gross proceeds derived from the sale of the shares
offered by this prospectus, including any securities sold prior to the
underwriter's over-allotment option, $50,000 of which has been paid as of the
date of this prospectus. We have also agreed to pay all expenses in connection
with qualifying the shares offered under the laws of states that the underwriter
may designate, including expenses of counsel retained for this purpose by the
underwriter. We estimate the expenses of this offering to be $1,050,000, or
$1,113,000 if the underwriter's over-allotment option is completely exercised.
At the closing of this offering, we will sell to the underwriter and its
designees, for an aggregate of $100, underwriter's warrants to purchase up to
200,000 shares of common stock. The underwriter's warrants are exercisable at
any time, in whole or in part, during the four-year period commencing one year
from the date of this prospectus, at an exercise price of $11.55 per share (165%
of the public offering price per share). The underwriter's warrants are only
assignable or transferable to the officers and partners of the underwriter and
members of the selling group for one year following the date of this prospectus.
During the exercise period, the holders of the underwriter's warrants will have
the opportunity to profit from a rise in the market price of the common stock,
which will dilute the interests of our stockholders. We expect that the
underwriter's warrants will be exercised when we would, in all likelihood, be
able to obtain any capital it needs on terms more favorable. Any profit realized
by the underwriter on the sale of the underwriter's warrants, the underlying
shares of common stock or the underlying warrants may be deemed additional
underwriting compensation. The underwriter's warrants contain a cashless
exercise provision. We have agreed that, upon the request of the holders of the
majority of the underwriter's warrants, we will at our own expense, on one
occasion during the exercise period, register the underwriter's warrants and the
shares of common stock underlying the underwriter's warrants under the
Securities Act. We have also agreed to include the underwriter's warrants and
all the underlying shares of common stock in any appropriate registration
statement which is filed by us under the Securities Act during the seven years
following the date of this prospectus.
We have agreed, for a period of five years from the date of this
prospectus, if so requested by the underwriter, to recommend and use our best
efforts to elect a designee of the underwriter as a director of Internet
Financial Services. Our officers, directors and principal stockholders have
agreed to vote their shares of common stock in favor of this designee. The
underwriter has not yet exercised and does not intend to exercise its right to
designate this person in the near future.
40
<PAGE>
The holders of approximately 5,500,000 shares of common stock have agreed
not to sell or otherwise dispose any of those securities in the public markets
for a period of twelve months from the date of this prospectus without the
underwriter's prior written consent.
The underwriter has informed us that it does not expect sales of the
securities offered to discretionary accounts to exceed 1% of the shares offered
by this prospectus.
We have agreed to indemnify the underwriter against certain civil
liabilities, including liabilities under the Securities Act.
Before this offering there has been no public market for the common stock.
Accordingly, the initial public offering price of the common stock has been
determined by negotiation between us and the underwriter and may not necessarily
be related to our asset value, net worth or other established criteria of value.
Factors to be considered in determining the public offering price include our
financial condition and prospects, an assessment of our management, market
prices of similar securities of comparable publicly-traded companies, financial
and operating information of companies engaged in activities similar to our
business and the general condition of the securities market.
In connection with this offering, the underwriter may engage in passive
market making transactions in the shares on Nasdaq in accordance with Rule 103
of Regulation M promulgated under the Exchange Act.
In connection with this offering, the underwriter may engage in
transactions that stabilize, maintain or otherwise affect the price of the
common stock. These transactions may include stabilization transactions
permitted by Rule 104 of Regulation M, under which persons may bid for or
purchase shares to stabilize the market price. Specifically, the underwriter may
over-allot in connection with the offering, creating a short position in the
common stock for its own account. In addition, to cover over-allotments or to
stabilize the price of the common stock, the underwriter may bid for, and
purchase, shares of common stock in the open market. The underwriter may also
reclaim selling concessions allowed to a dealer for distributing the common
stock in the offering, if the underwriter repurchases previously distributed
common stock in transactions to cover short positions, in stabilization
transactions or otherwise. Any of these activities may stabilize or maintain the
market price of the common stock above independent market levels. The
underwriter is not required to engage in these activities, and may end any of
these activities at any time.
LEGAL MATTERS
The validity of the securities offered by this prospectus will be passed
upon for Internet Financial Services by Hartman & Craven LLP, New York, New
York. Edward I. Tishelman, a member of the firm of Hartman & Craven LLP, is the
owner of 112,500 shares of common stock. Tenzer Greenblatt LLP has served as
counsel to the underwriter in connection with this offering.
EXPERTS
The consolidated financial statements as of September 30, 1997 and
September 30, 1998, and for each of the two years in the period ended September
30, 1998, appearing in this prospectus and registration statement have been
audited by Ernst & Young, LLP, independent auditors, as set forth in their
report thereon appearing elsewhere in this prospectus, and are included in
reliance upon this report given on the authority of Ernst & Young, LLP as
experts in auditing and accounting.
ADDITIONAL INFORMATION
We have filed with the SEC the registration statement on form SB-2 under
the Securities Act with respect to the common stock offered by this prospectus.
This prospectus, which constitutes a part of the registration statement, does
not contain all of the information set forth in the registration statement and
the exhibits filed with it, portions of which have been omitted as permitted by
the rules and regulations of the SEC. For further information with respect to
Internet Financial Services and the securities offered by this prospectus,
reference is made to the registration statement and to the exhibits filed with
it. Statements contained in this prospectus regarding the content of any
contract or other document referred to are not necessarily complete. In each
41
<PAGE>
instance, we refer you to the copy of the contracts and or other documents filed
as exhibits to the registration statement, and these statements are hereby
qualified in their entirety by reference to the contract or document. The
registration statement, including all exhibits, may be inspected without charge
at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C.
20549, and at the SEC's regional offices located at Seven World Trade Center,
Suite 1300, New York, New York 10048 and Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. Copies of these materials may also
be obtained from the SEC's Public Reference at 450 Fifth Street, N.W., Room
1024, Washington, D.C. 20549, upon the payment of prescribed fees. You may
obtain information on the operation of the Public Reference Room by calling the
SEC at 1-800-SEC-0330. In addition, registration statements and other filings
made with the commission through its Electronic Data Gathering, Analysis and
Retrieval systems are publicly available through the SEC's site on the World
Wide Web located at http://www.sec.gov. The registration statement, including
all exhibits and schedules and amendments, has been filed with the commission
through the Electronic Data Gathering, Analysis and Retrieval system.
Upon the closing of this offering, we will become subject to the reporting
requirements of the Exchange Act and in accordance with these requirements, will
file reports, proxy statements and other information with the SEC. We intend to
furnish our stockholders with annual reports containing audited financial
statements and other periodic reports as we deem appropriate or as may be
required by law.
42
<PAGE>
Internet Financial Services Inc.
Consolidated Financial Statements
Years Ended September 30, 1997 and 1998 and Three Months Ended
December 31, 1997 and 1998 (unaudited)
Contents
<TABLE>
<S> <C>
Report of Independent Auditors ........................................................... F-2
Consolidated Statements of Financial Condition as of September 30, 1997 and September 30,
1998 and December 31, 1998 (unaudited) .................................................. F-3
Consolidated Statements of Operations for the Years Ended September 30, 1997 and 1998 and
for the Three Months Ended December 31, 1997 and December 31, 1998 (unaudited) .......... F-4
Consolidated Statements of Changes in Stockholder's Equity for the Years Ended September
30, 1997 and September 30, 1998 and for the Three Months Ended December 31, 1998
(unaudited) ............................................................................. F-5
Consolidated Statements of Cash Flows for the Years Ended September 30, 1997 and 1998 and
for the Three Months Ended December 31, 1997 and December 31, 1998 (unaudited) .......... F-6
Notes to Consolidated Financial Statements ............................................... F-7
</TABLE>
F-1
<PAGE>
Report of Independent Auditors
To the Board of Directors and Stockholders of
Internet Financial Services Inc.
We have audited the accompanying consolidated statements of financial
condition of Internet Financial Services Inc. (the "Company") as of September
30, 1997 and 1998, and the related consolidated statements of operations,
changes in stockholders' equity and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Internet
Financial Services Inc. as of September 30, 1997 and 1998, and the consolidated
results of its operations and its cash flows for the years then ended in
conformity with generally accepted accounting principles.
Ernst & Young LLP
New York, New York
November 13, 1998
F-2
<PAGE>
Internet Financial Services Inc.
Consolidated Statements of Financial Condition
<TABLE>
<CAPTION>
September 30, September 30, December 31,
1997 1998 1998
--------------- --------------- ---------------
Assets (unaudited)
<S> <C> <C> <C>
Cash and cash equivalents .............................................. $ 702,693 $ 970,308 $ 250,797
Restricted cash ........................................................ 113,569 -- 406,861
Securities owned, at market value ...................................... 24,206 104,518 14,970
Receivables from clearing broker ....................................... 292,356 531,835 474,648
Property and equipment at cost, net of accumulated depreciation of
$167,774, $530,892 and $645,803 at September 30, 1997, September
30, 1998 and December 31, 1998, respectively .......................... 1,010,208 3,650,743 4,591,868
Loans receivable from related party .................................... 123,697 115,711 117,256
Deferred offering costs ................................................ -- 75,235 271,203
Other assets ........................................................... 119,902 91,107 235,891
------------ ------------ ------------
Total assets ........................................................... $ 2,386,631 $ 5,539,457 $ 6,363,494
============ ============ ============
Liabilities and stockholders' equity Liabilities:
Subordinated borrowings ............................................... 350,000 $ 350,000 $ 350,000
Subordinated borrowings from related party ............................ 180,000 180,000 180,000
Securities sold, not yet purchased, at market value ................... -- 19,137 5,826
Notes payable ......................................................... -- 250,000 750,000
Notes payable to related party ........................................ -- -- 85,587
Bank loan ............................................................. 120,000 80,000 70,000
Deferred rent incentives .............................................. -- 803,968 803,968
Accounts payable and accrued liabilities .............................. 681,899 2,101,933 2,329,990
------------ ------------ ------------
Total liabilities ...................................................... 1,331,899 3,785,038 4,575,371
Stockholders' equity:
Common stock, $.001 par value, 10,000,000 shares authorized, 5,050,000,
5,137,500 and 5,300,760 shares issued and outstanding at September
30, 1997, September 30, 1998 and December 31, 1998, respectively .... 5,050 5,138 5,301
Additional paid-in capital ............................................ 2,441,902 3,758,333 4,135,568
Option costs, net ..................................................... -- (100,292) (219,559)
Subscriptions receivable .............................................. (120,869) (4,999) --
Accumulated deficit ................................................... (1,271,351) (1,903,761) (2,133,187)
------------ ------------ ------------
Total stockholders' equity ............................................. 1,054,732 1,754,419 1,788,123
------------ ------------ ------------
Total liabilities and stockholders' equity ............................. $ 2,386,631 $ 5,539,457 $ 6,363,494
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
Internet Financial Services Inc.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Year ended Three months ended
-------------------------------- -------------------------------
September 30, September 30, December 31, December 31,
1997 1998 1997 1998
--------------- --------------- -------------- ---------------
Revenues: (unaudited) (unaudited)
<S> <C> <C> <C> <C>
Commissions ................................................ $ 4,017,787 $7,403,059 $ 1,187,487 $ 2,475,661
Data service revenues ...................................... 148,353 661,236 124,012 275,604
Principal transactions ..................................... 230,297 901,889 113,858 378,659
Interest and other income .................................. 130,095 146,704 31,058 48,564
Interest income -- related party ........................... 6,000 6,380 1,145 1,545
------------ ---------- ----------- -----------
Total revenues .............................................. 4,532,532 9,119,268 1,457,560 3,180,033
Interest expense ........................................... 197,359 244,322 15,860 104,753
Interest expense -- related party .......................... 15,000 15,000 3,750 3,750
------------ ---------- ----------- -----------
Net revenues ................................................ 4,320,173 8,859,946 1,437,950 3,071,530
------------ ---------- ----------- -----------
Expenses:
Commissions, floor brokerage, and clearing charges ......... 1,844,927 3,425,725 597,070 1,369,610
Employee compensation and related costs .................... 1,297,575 2,247,963 380,041 852,342
Communications ............................................. 337,584 757,391 144,732 203,348
Business development ....................................... 441,424 980,651 368,102 203,695
Professional services ...................................... 894,920 971,494 104,816 198,571
Occupancy and equipment costs .............................. 149,580 444,169 70,716 215,149
Depreciation and amortization .............................. 198,980 363,207 69,278 114,911
Other ...................................................... 212,380 288,991 65,783 139,180
------------ ---------- ----------- -----------
Total expenses .............................................. 5,377,370 9,479,591 1,800,538 3,296,806
------------ ---------- ----------- -----------
Loss before income taxes .................................... (1,057,197) (619,645) (362,588) (225,276)
Income tax provision ........................................ 2,776 12,765 3,191 4,150
------------ ---------- ----------- -----------
Net loss .................................................... $ (1,059,973) $ (632,410) $ (365,779) $ (229,426)
============ ========== =========== ===========
Net loss per common share ................................... $ (.30) $ (.12) $ (.07) $ (.04)
============ ========== =========== ===========
Weighted average common shares outstanding .................. 3,508,560 5,171,182 5,120,771 5,291,080
============ ========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
Internet Financial Services Inc.
Consolidated Statements of Changes in Stockholders' Equity
<TABLE>
<CAPTION>
Common Stock Issued Additional Unamortized
------------------------- Paid-in Option
Shares Par Value Capital Costs
------------ ----------- ------------ --------------
<S> <C> <C> <C> <C>
Balance at October 1, 1996 ....... 431,538 $ 432 $ 259,568 $ --
Issuance of common stock, net ... 4,618,462 4,618 2,160,967 --
Issuance of non-employee stock
options (Note 12) .............. -- -- 21,367 --
Net loss ........................ -- -- -- --
--------- ------ ---------- ----------
Balance at September 30, 1997 .... 5,050,000 5,050 2,441,902 --
Issuance of common stock, net ... 87,500 88 874,912 --
Issuance of non-employee stock
options (Note 12) .............. -- -- 76,832 --
Other contributions (Note 9) .... -- -- 115,000 --
Option costs, net ............... -- -- 249,687 (100,292)
Net loss ........................ -- -- -- --
--------- ------ ---------- ----------
Balance at September 30, 1998 .... 5,137,500 5,138 3,758,333 (100,292)
Issuance of common stock, net.... 163,260 163 185,985 --
Option costs, net ............... -- -- 191,250 (119,267)
Net loss ........................ -- -- -- --
--------- ------ ---------- ----------
Balance at December 31, 1998
(unaudited) ..................... 5,300,760 $5,301 $4,135,568 $ (219,559)
========= ====== ========== ==========
Subscriptions Receivable
------------------------------ Accumulated
Shares Amount Deficit Total
--------------- ------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Balance at October 1, 1996 ....... -- $ -- $ (211,378) $ 48,622
Issuance of common stock, net ... (3,568,462) (120,869) -- 2,044,716
Issuance of non-employee stock
options (Note 12) .............. -- -- -- 21,367
Net loss ........................ -- -- (1,059,973) (1,059,973)
---------- ----------- ------------ -------------
Balance at September 30, 1997 .... (3,568,462) (120,869) (1,271,351) 1,054,732
Issuance of common stock, net ... 3,318,451 115,870 -- 990,870
Issuance of non-employee stock
options (Note 12) .............. -- -- -- 76,832
Other contributions (Note 9) .... -- -- -- 115,000
Option costs, net ............... -- -- -- 149,395
Net loss ........................ -- -- (632,410) (632,410)
---------- ----------- ------------ -------------
Balance at September 30, 1998 .... (250,011) (4,999) (1,903,761) 1,754,419
Issuance of common stock, net.... 250,011 4,999 -- 191,147
Option costs, net ............... -- -- -- 71,983
Net loss ........................ -- -- (229,426) (229,426)
---------- ----------- ------------ -------------
Balance at December 31, 1998
(unaudited) ..................... -- $ -- $ (2,133,187) $ 1,788,123
========== =========== ============ =============
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
Internet Financial Services Inc.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Year ended Three months ended
----------------------------------- ------------------------------
September 30, September 30, December 31, December 31,
1997 1998 1997 1998
----------------- --------------- -------------- -------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Cash flows from operating activities
Net loss $ (1,059,973) $ (632,410) $ (365,779) $ (229,426)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Other contributions -- 115,000 -- --
Depreciation and amortization 198,980 363,207 69,188 114,911
Amortization of option costs 21,367 226,227 26,353 71,983
Loss on disposal of fixed assets 46,411 -- -- --
Subscriptions receivable -- -- -- 4,999
Changes in assets and liabilities:
(Increase) decrease in operating assets:
Restricted cash (113,569) 113,569 -- (406,861)
Securities owned 144,473 (80,312) (48,187) 89,548
Receivables from clearing brokers (219,122) (239,479) 60,295 57,187
Loans from related party (23,697) 7,986 (1,145) (1,545)
Other assets (57,184) 28,795 48,764 (81,775)
Increase (decrease) in operating liabilities:
Securities sold, not yet purchased (41,262) 19,137 -- (13,311)
Accounts payable and accrued liabilities 409,516 660,605 651,222 362,344
------------- ------------ ---------- ----------
Net cash provided by (used in) operating
activities (694,060) 582,325 440,711 (31,946)
------------- ------------ ---------- ----------
Cash flows used in investing activities
Purchases of property and equipment, net (1,177,982) (2,244,313) (422,907) (984,097)
------------- ------------ ---------- ----------
Deferred rent incentives -- 803,968 -- --
------------- ------------ ---------- ----------
Net cash used in investing activities (1,177,982) (1,440,345) (422,907) (984,097)
------------- ------------ ---------- ----------
Cash flows from financing activities
Proceeds from sale of common stock, net 2,044,716 990,870 -- --
Proceeds from exercised stock options -- -- -- 2,500
Proceeds from issuance of subordinated
borrowings 150,000 -- -- --
Proceeds from notes payable 120,000 250,000 -- 500,000
Deferred offering costs -- (75,235) -- (195,968)
Repayment of bank loan (125,000) (40,000) (10,000) (10,000)
------------- ------------ ---------- ----------
Net cash provided by (used in) financing
activities 2,189,716 1,125,635 (10,000) 296,532
------------- ------------ ---------- ----------
Net increase (decrease) in cash and cash
equivalents 317,674 267,615 7,804 (719,511)
Cash and cash equivalents at beginning of period 385,019 702,693 702,693 970,308
------------- ------------ ---------- ----------
Cash and cash equivalents at end of period $ 702,693 $ 970,308 $ 710,497 $ 250,797
============= ============ ========== ==========
Supplemental non-cash financing activities
and disclosure of cash flow information
Note receivable from sale of property and
equipment $ 39,951 $ -- $ -- $ --
Accounts payable for purchases of property and
equipment -- 759,429 -- --
Other contributions -- 115,000 -- --
Cash paid for:
Interest $ 193,733 $ 90,802 $ 15,860 $ 41,600
Taxes 53,633 2,776 -- --
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
Internet Financial Services Inc.
Notes to Consolidated Financial Statements
Years ended September 30, 1997 and 1998 (unaudited with
respect to data as of December 31, 1998 and for the three-month periods
ended December 31, 1997 and December 31, 1998)
1. Organization and Basis of Presentation
Internet Financial Services Inc. ("IFSI" or the "Company") conducts
business primarily through its principal subsidiary, A.B. Watley, Inc. ("A.B.
Watley"). A.B Watley is a registered broker-dealer under the Securities
Exchange Act of 1934 and is a member of the National Association of Securities
Dealers, Inc.
A.B. Watley is an introducing broker-dealer which conducts business in
electronic trading, information and brokerage services, as well as
institutional block trading. A.B. Watley clears all transactions through two
clearing brokers on a fully disclosed basis. Accordingly, A.B. Watley is exempt
from the Securities and Exchange Commission's ("SEC") Rule 15c3-3.
IFSI is a Delaware corporation organized on May 15, 1996. During its fiscal
year ended September 30, 1997, all of the shares of capital stock of A.B. Watley
were acquired by IFSI. Since IFSI and A.B. Watley were under common control, the
acquisition has been accounted for under Accounting Interpretations of the
Accounting Principles Board Opinion No. 16, "Transfers and Exchanges Between
Companies Under Common Control," which requires the assets and liabilities so
transferred to be accounted for at historical cost in a manner similar to that
used in pooling of interests accounting. IFSI issued 431,538 shares of its
common stock in consideration for the 99 shares of A.B. Watley; additionally,
the operating results of IFSI reflect the operating results of A.B. Watley for
the years presented.
The consolidated financial statements include the accounts of IFSI and its
wholly-owned subsidiary, A.B. Watley. All significant intercompany balances and
transactions have been eliminated. Certain prior year amounts reflect
reclassifications to conform to current year's presentations.
The unaudited consolidated financial statements as of December 31, 1998 and
for the three months ended December 31, 1997 and December 31, 1998 have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three-month period ended December 31,
1998 are not necessarily indicative of the results that may be expected for the
year ending September 30, 1999.
2. Summary of Significant Accounting Policies
Restricted Cash:
Restricted cash consists of cash on deposit at a financial institution
securing letters of credit and lines of credit.
Securities Transactions, Revenues, and Related Expenses:
Securities transactions and related revenues and expenses, including
commissions revenues and expenses, are recorded on a trade date basis. Data
service revenues represent fees charged to customers for real-time access to
various financial data. These fees are recorded as earned.
Securities Owned and Sold, Not Yet Purchased:
Securities owned and securities sold, not yet purchased are stated at
market or fair values, with resulting unrealized gains and losses reflected in
the consolidated statements of operations. Market value is generally based on
listed market prices. If listed market prices are unattainable, fair value is
determined based on other relevant factors including broker or dealer price
quotes.
F-7
<PAGE>
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1997 and 1998 (unaudited with
respect to data as of December 31, 1998 and for the three-month periods
ended December 31, 1997 and December 31, 1998)
2. Summary of Significant Accounting Policies -- (Continued)
Property and Equipment:
Computer equipment, furniture and fixtures, and leasehold improvements are
carried at cost and depreciated on the straight-line basis over their estimated
useful lives, generally three to five years.
Construction-in-progress, upon occupancy, will be amortized on a
straight-line basis over the shorter of the useful life of the leasehold
improvement or the term of the lease, generally ten years upon occupancy.
Deferred rent incentives, which represent construction costs reimbursed by the
lessor of the Company's office space, will be amortized on a straight-line basis
over the term of the lease, which is ten years.
Computer software is amortized on the straight-line basis over a period of
three years. The cost of internally developed computer software is capitalized
when management commits to funding a project it believes will be completed and
used to perform the functions intended. The capitalized software is not
amortized until the projects are complete. Pilot projects and projects where
expected future economic benefits are less than probable are not eligible for
capitalization.
Use of Estimates:
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities in
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Stock Options:
The Company accounts for stock option grants to employees in accordance
with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock
Issued to Employees," and, accordingly, recognizes no compensation expense
related to such grants. In cases where the Company grants options below the fair
market value of the stock at the date of grant, the difference between the
strike price and the fair market value is treated as compensation expense and
amortized over the vesting period of the option. Stock options granted to
consultants and others in lieu of cash compensation are recorded based upon
management's estimate of fair value of the options or the related services
provided and expensed over the vesting period, if any.
Fair Value of Financial Instruments:
Substantially all of the Company's financial instruments are carried at
fair value or amounts approximating fair value.
Business Development:
The Company expenses all promotional costs as incurred and advertising
costs upon first exhibition of the advertisement.
Income Taxes:
Income taxes have been provided using the liability method under Statement
of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income
Taxes."
Earnings Per Share:
Per share data is determined based on the weighted average number of common
shares outstanding each year.
F-8
<PAGE>
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1997 and 1998 (unaudited with
respect to data as of December 31, 1998 and for the three-month periods
ended December 31, 1997 and December 31, 1998)
2. Summary of Significant Accounting Policies -- (Continued)
Statement of Cash Flows:
The Company defines cash equivalents as highly liquid investments with
original maturities of three months or less, other than those held for sale in
the ordinary course of business.
3. Net Capital Requirement
A.B. Watley is subject to the SEC's Uniform Net Capital Rule 15c3-1 (the
"Net Capital Rule") which requires A.B. Watley to maintain minimum net capital
such that the ratio of aggregate indebtedness to net capital, both as defined,
shall not exceed 15 to 1. The Net Capital Rule also requires that equity capital
may not be withdrawn or cash dividends paid if A.B. Watley's resulting net
capital ratio would exceed 10 to 1. At September 30, 1998, A.B. Watley had net
capital, as defined, of $161,128 which was $61,128 in excess of its required net
capital of $100,000. The aggregate indebtedness to net capital ratio was 7.4 to
1. At December 31, 1998, A.B. Watley had net capital, as defined, of $187,875
which was $87,875 in excess of its required net capital of $100,000. The
aggregate indebtedness to net capital ratio was 3.3 to 1.
4. Financial Instruments with Off-Balance Sheet Risk or Concentrations of
Credit Risk
Pursuant to clearing agreements, the clearing and depository operations for
A.B. Watley's and customers' securities transactions are provided by two
clearing broker-dealers. A.B. Watley has agreed to indemnify its clearing
brokers for losses that the clearing brokers may sustain from the customer
accounts introduced by A.B. Watley. A.B. Watley, through its clearing brokers,
seeks to control the risks associated with these activities by requiring
customers to maintain margin collateral in compliance with various regulatory
and internal guidelines. The clearing brokers monitor required margin levels
daily and, pursuant to such guidelines, request customers to deposit additional
collateral or reduce securities positions when necessary. All customer
transactions pending as of September 30, 1998 settled without material adverse
effect to the Company.
Also, in the normal course of business, customers may sell securities
short. Subsequent market fluctuations may require the clearing firms to obtain
additional collateral from A.B. Watley's customers. It is the policy of the
clearing firms to value the short positions and to obtain additional deposits
where deemed appropriate.
The Company may at times maintain inventories in equity securities on both
a long and short basis. While long positions represent the Company's ownership
of securities, short positions represent obligations of the Company.
Accordingly, both long and short positions may result in gains or losses to the
Company as market values of securities fluctuate. To manage the risk of losses,
the Company marks long and short positions to market daily and continuously
monitors the market fluctuations.
F-9
<PAGE>
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1997 and 1998 (unaudited with
respect to data as of December 31, 1998 and for the three-month periods
ended December 31, 1997 and December 31, 1998)
5. Property and Equipment
Property and equipment consist of the following:
<TABLE>
<CAPTION>
September 30
------------------------------
1997 1998
------------- --------------
<S> <C> <C>
Computer equipment ...................................... $1,115,626 $ 1,961,113
Software ................................................ 62,356 697,377
Construction-in-progress ................................ -- 1,503,338
Furniture, fixtures, and leasehold improvements ......... -- 19,807
---------- -----------
1,177,982 4,181,635
Less accumulated depreciation and amortization .......... 167,774 530,892
---------- -----------
$1,010,208 $ 3,650,743
========== ===========
</TABLE>
At September 30, 1998, software includes $602,363 of software under
development. (See Note 2). Construction-in-progress represents amounts related
to leasehold improvements being made on the Company's office space. The Company
expects to occupy such space in early fiscal 1999. (See Note 2).
6. Subordinated Borrowings
Borrowings of $530,000 at September 30, 1997 and 1998 are subordinated to
the claims of general creditors, and mature in the amounts of $200,000, $150,000
and $55,000 on October 31, 1999 and $125,000 on April 30, 2000. The subordinated
borrowings bear interest at annual rates of 15%, 13%, 0% and 12%, respectively.
The loans are covered by agreements approved by the National Association of
Securities Dealers, Inc. and are included by A.B. Watley for purposes of
computing net capital under the Net Capital Rule. To the extent that such
borrowings are required for A.B. Watley's continued compliance with minimum net
capital requirements, they may not be repaid. Of the total subordinated
borrowings, $180,000 is from an officer and shareholder of the Company. For the
years ended September 30, 1997 and 1998, interest expense on the subordinated
loans amounted to $62,000 and $64,500, respectively.
7. Notes Payable
Effective February 13, 1998 and April 16, 1998, the Company issued
promissory notes in the amount of $200,000 and $50,000, respectively, to three
individuals, two of whom are minority stockholders of the Company. The notes
bear interest at 8% per annum. The principal plus accrued interest on the notes
is payable on the earlier of (a) the consummation of an initial public offering
("IPO") of the Company's equity securities, or (b) if such IPO does not occur on
or before the first anniversary of the issue date of the notes, the principal
plus accrued interest shall be payable in twelve equal monthly installments,
unless the holders agree to extend such maturity date. For the year ended
September 30, 1998, interest expense on the notes amounted to $11,833.
Upon execution of these promissory notes, the holders were granted options
on the common stock of the Company for a total price of $250. Pursuant to the
Option Agreements, the options become exerciseable upon consummation of an IPO,
and the number of shares to be issued will be determined by dividing the initial
principal amount of the promissory notes by the IPO price. The fair value of the
options is accounted for as a debt servicing fee, and is being amortized over a
one year period. The unamortized amount of the debt service fee is included as
"Option costs, net" in Stockholders' Equity. Amortization expense related to the
debt servicing fee for the year ended September 30, 1998 amounted to $149,395.
F-10
<PAGE>
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1997 and 1998 (unaudited with
respect to data as of December 31, 1998 and for the three-month periods
ended December 31, 1997 and December 31, 1998)
7. Notes Payable -- (Continued)
Effective October 2, 1998, the Company borrowed $500,000 from New York
Small Business Venture Fund, LLC ("NYSB") under the condition that the proceeds
of the loan be used as working capital to further the corporate purposes of the
Company and not to repay any debt or redeem any equity interests. The loan
accrues interest at 12% per annum which is payable first in 24 monthly
installments of $5,000 beginning December 1, 1998. Commencing December 1, 2000,
the principal amount of the loan is payable in 35 monthly installments of $8,333
plus interest on the unpaid balance, except for the last installment which shall
be in the amount of $208,345 plus interest on the unpaid balance.
As collateral for the loan, NYSB received a security interest in the
Company's assets, and certain officers and directors of the Company have
personally guaranteed all amounts due. Under the terms and conditions of the
loan agreement, NYSB received warrants expiring October 2, 2003 to acquire
191,250 shares of the Company's common stock at an exercise price equal to the
IPO price. In the event there has been no IPO within five years from the closing
of the loan, the number of shares to be acquired under the terms of the warrant
are reduced to 100,000 and NYSB shall have the right to put its ownership
interest at a price as defined in the warrant agreement and cause the Company to
repurchase all or part of such interest at any time thereafter. The fair value
of the warrants (approximately $191,250) has been accounted for as a debt
servicing fee and is being amortized over the life of the loan. The unamortized
amount of the debt servicing fee is included as "Option costs, net" in
Stockholders' Equity.
8. Bank Loan
The bank loans at September 30, 1997 and 1998 consist of an unsecured term
loan, with the full principal amount due September 29, 2000, and an interest
rate of 8.5% per annum.
9. Related Party Transactions
Included in loans receivable from related party at September 30, 1998 on
the consolidated statement of financial condition are notes of $103,000, plus
accrued interest of $12,711, due from a shareholder and officer of the Company.
The notes generally bear interest at an annual rate of 6% and are payable on
demand.
Other contributions of $115,000 on the consolidated statement of changes in
stockholders' equity represent compensation forgiven by two significant
stockholders and officers of the Company. For consolidated financial statement
purposes, the unpaid compensation is considered an expense and a contribution of
capital.
10. Commitments and Contingencies
The Company has entered into two lease agreements for office space which
expire on June 23, 2009 and September 15, 1999, respectively. Both lease
agreements are noncancellable and contain escalation provisions. As of September
30, 1998, the aggregate minimum future rental payments required were as follows:
Year Ended September 30
----------------------------
1999 ..................................... $ 158,538
2000 ..................................... 454,279
2001 ..................................... 463,947
2002 ..................................... 492,940
2003 ..................................... 492,940
Thereafter ............................... 2,235,945
-----------
$ 4,298,589
===========
F-11
<PAGE>
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1997 and 1998 (unaudited with
respect to data as of December 31, 1998 and for the three-month periods
ended December 31, 1997 and December 31, 1998)
10. Commitments and Contingencies -- (Continued)
Rent expense for the years ended September 30, 1997 and 1998 was $98,934
and $170,101, respectively.
In December 1998, the Company obtained a $500,000 line of financing from
General Electric Capital Corporation ("GECC") which is to be used for the
purchase or leasing of additional equipment and software. The Company is
required to deliver to GECC a letter of credit in the amount of 50% of any
amount borrowed under this financing. In addition, the Company has granted the
lender a security interest in certain of the Company's existing equipment as
well as in all equipment purchased using funds under this financing.
In the ordinary course of business, the Company is party to several legal
proceedings, the outcome of which, either singularly or in the aggregate, is not
expected to have a material impact on the Company's financial position.
11. Acquisitions
Effective October 2, 1998, and as subsequently modified, the Board of
Directors approved the issuance of 38,260 shares of the Company's common stock
for all the shares of capital stock of Computer Strategies, Inc. ("CSI"). CSI
provided software support, research and development to the Company with the
Company serving as CSI's primary customer. The acquisition was accounted for as
a purchase. The Company recorded approximately $60,000 in goodwill from the
acquisition which is being amortized over 3 years, and approximately $59,000 in
capitalized software attributable to costs incurred in the application
development stage of the Company's software development. At the date of
acquisition, CSI owed $85,580 to the sole shareholder of CSI, who became an
officer of the Company. This amount is included in notes payable to related
party and was paid to Mr. Ferguson in January and February 1999.
12. Stock Options
Under the Company's 1997 and 1998 Stock Option Plans (the "Plans"),
employees, non-employee directors and officers, and consultants are generally
granted options (both incentive stock options and nonqualified stock options) to
purchase shares of common stock at prices not less than the estimated fair
market value of the common stock on the date the option is granted. The options
are exercisable at either the date of grant, in ratable installments or
otherwise, generally over a period of one to three years from the date of grant.
The options generally expire within ten years after the date of grant. The
number of shares delivered in the aggregate under the 1997 and 1998 Plans cannot
exceed 400,000 and 600,000 shares, respectively, (1,000,000 shares in total). No
option shall be granted under the 1997 Plan after January 26, 2007 or under the
1998 Plan after March 16, 2008.
A summary of the Company's stock option activity (exclusive of the options
discussed in Note 7 and the information discussed in Note 16) and related
information for the years ended September 30, 1997 and 1998 is as follows:
F-12
<PAGE>
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1997 and 1998 (unaudited with
respect to data as of December 31, 1998 and for the three-month periods
ended December 31, 1997 and December 31, 1998)
12. Stock Options -- (Continued)
<TABLE>
<CAPTION>
Number Weighted Average
of Shares Exercise Price
----------- -----------------
<S> <C> <C>
Outstanding at October 1, 1996 .................. -- $ --
Granted, year ended September 30, 1997 ......... 375,000 1.90
------- -------
Outstanding at September 30, 1997 ............... 375,000 1.90
Granted, year ended September 30, 1998 ......... 45,100 8.89
------- -------
Outstanding at September 30, 1998 ............... 420,100 $ 2.34
======= =======
Exercisable at September 30, 1997 ............... 50,000 $ 2.00
======= =======
Exercisable at September 30, 1998 ............... 312,500 $ 1.88
======= =======
</TABLE>
Included in the table above are non-employee option grants of 85,000 and
20,000 shares, respectively, for the years ended September 30, 1997 and 1998.
The estimated fair values of the grants to non-employees are amortized over the
vesting period of the grants, if any. For the years ended September 30, 1997 and
1998 the amount charged to expense for non-employee options was $21,367 and
$76,832, respectively, and is included in professional services.
The weighted average fair value of options granted during the years ended
September 30, 1997 and 1998 was $0.57 and $1.13, respectively. The fair value of
each option grant was estimated at the date of grant using the Black-Scholes
option valuation model. The Black-Scholes option valuation model was developed
for use in estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. Because the Company's stock options
have characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its stock
options. In calculating the fair values of the stock options, the following
weighted average assumptions were used:
1997 Grants 1998 Grants
------------- ------------
Dividend yield ................... 0% 0%
Average expected life:
Employees ....................... 5.4 years 5.4 years
Non-employees ................... 5.5 years 0.5 years
Risk-free interest rate .......... 6.6% 5.4%
Expected volatility .............. 0% 0%
Pro forma information regarding net income is required under Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," and has been determined as if the Company had accounted for all
the 1997 and 1998 stock option grants on the fair value method. For purposes of
the pro forma information, the fair values of the 1997 and 1998 option grants to
employees are amortized over the vesting period. The pro forma information for
the years ended September 30, 1997 and 1998 is as follows:
F-13
<PAGE>
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1997 and 1998 (unaudited with
respect to data as of December 31, 1998 and for the three-month periods
ended December 31, 1997 and December 31, 1998)
12. Stock Options -- (Continued)
Year ended September 30
---------------------------------
1997 1998
---------------- --------------
Net loss as reported ................... $ (1,059,973) $ (632,410)
Net loss pro forma ..................... (1,082,707) $ (674,499)
Net loss per share as reported ......... $ (.30) $ (.12)
Net loss per share pro forma ........... $ (.31) $ (.13)
Additional information regarding options outstanding as of September 30,
1998 (exclusive of the options discussed in Note 7 and the information discussed
in Note 16) is as follows:
Weighted Average
Remaining
Exercise Number Number Contractual Life
Price Outstanding Exercisable (Years)
---------- ------------- ------------- -----------------
$ .02 125,000 125,000 8.33
2.00 180,500 130,500 9.52
5.00 69,500 19,500 10.93
8.00 25,100 17,500 9.99
10.00 20,000 20,000 0.58
------- -------
Total 420,100 312,500
======= =======
During October and November 1998, three employees exercised stock options
which were granted during 1997 at a strike price of two cents per share, and
were issued 125,000 shares of the Company's common stock.
Effective November 19, 1998, the Board of Directors agreed to: (1) grant
for no additional consideration 16,200 additional options at a strike price of
$5.00 per share to two employees who were granted $5.00 options in September
1997; and (2) amend the option grants to all option holders who were granted
$8.00 options in November 1997 to reflect a strike price of $6.00 per share.
Effective November 20, 1998, the Board of Directors agreed to amend the
option grants to all option holders who were granted $10.00 options in April
1998 to reflect a strike price of $6.00 per share.
13. Income Taxes
The Company files a consolidated federal income tax return with A.B.
Watley. For all periods presented, the Company provides for income taxes as
required under SFAS No. 109. The Company records income taxes using a liability
approach for financial accounting and reporting which results in the recognition
and measurement of deferred tax assets based upon the likelihood of realization
of tax benefits in future years.
The provision for income taxes for the years ending September 30, 1997 and
1998 is comprised of New York State and New York City taxes in the amount of
$2,776 and $12,765, respectively. No benefit has been provided for the Company's
net operating losses.
The difference between the U.S. federal tax rate and the Company's
effective tax rate for the years ending September 30, 1997 and 1998 follows:
F-14
<PAGE>
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1997 and 1998 (unaudited with
respect to data as of December 31, 1998 and for the three-month periods
ended December 31, 1997 and December 31, 1998)
13. Income Taxes -- (Continued)
Year ended September 30
---------------------------
1997 1998
------------ ------------
Tax benefit at federal statutory rate .......... (34.0%) (34.0%)
State taxes, net of federal tax effect ......... 0.3% 2.9%
Valuation allowance ............................ 34.8% 33.9%
Other .......................................... (0.8%) (0.3%)
----- -----
Effective tax rate ............................. 0.3% 2.5%
===== =====
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Components of the
Company's deferred tax assets and liabilities as of September 30, 1997 and 1998
are as follows:
Year ended September 30
----------------------------
1997 1998
------------- ------------
Net operating loss ....................... $ 369,197 $ 638,238
Mark-to-market loss on inventory ......... 10,931 10,932
Depreciation ............................. (33,441) (82,221)
Other .................................... 9,867 6,927
---------- ----------
Total deferred tax assets ................ 356,554 573,876
Valuation reserve ........................ (356,554) (573,876)
---------- ----------
Net deferred tax asset ................... $ -- $ --
========== ==========
At September 30, 1998, the Company has a net operating loss carryforwards
for federal tax purposes of $1,382,065 that will expire no sooner than September
30, 2013.
14. Capital Stock
Effective January 24, 1997, the Company's certificate of incorporation was
amended to reflect the total number of shares authorized to issue as 10,000,000
shares with a par value of $.001 per share.
On October 1, 1998, and as subsequently modified, the Company's Board of
Directors authorized the sale of up to 2,000,000 shares of common stock (subject
to increase at the discretion of the Company's executive officers), plus a 15%
over-allotment option to the underwriter, in an IPO at an estimated gross
offering price of not less than $7.00 per share. The Board of Directors approved
the following, conditional on the effectiveness of the IPO: (1) the issuance of
3,000 shares of common stock with a three year restriction provision for nominal
consideration to certain employees of the Company, and (2) grants of 519,350 and
14,500 stock options with an exercise price of $7.00 per share to certain
employees and non-employees, respectively, of the Company. These options vest
over a period of up to three years. The estimated fair value of non-employee
options and the 3,000 shares issued to certain employees will be expensed upon
the effectiveness of the IPO.
15. Earnings Per Share
The weighted average number of shares outstanding for the years ended
September 30, 1997 and 1998 reflect the 70,771 shares discussed in Note 16 below
as though the shares were outstanding as of the beginning of each year. Since
the Company recognized a net loss in both years, diluted earnings per common
share is the same as earnings per common share for both years.
F-15
<PAGE>
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1997 and 1998 (unaudited with
respect to data as of December 31, 1998 and for the three-month periods
ended December 31, 1997 and December 31, 1998)
16. Subsequent Events (Unaudited)
On January 14, 1999, the Board of Directors agreed to amend the Company's
certificate of incorporation to increase the authorized number of shares of
common stock to 20,000,000, and to authorize and delineate the terms under which
preferred stock may be issued. In addition, the Board agreed to issue, subject
to the effectiveness of the IPO, 70,771 additional shares of common stock for
nominal additional consideration to certain stockholders who purchased private
placement shares during the year ended September 30, 1998.
During January 1999, the Board of Directors approved the issuance of
221,500 shares of the Company's common stock in a private placement offering.
The common stock was issued at a price of $4.80 per share (total gross proceeds
of $1,063,200) and was restricted with regard to sale or disposition for a
period of one year. Two employees of the Company purchased an aggregate of
102,000 shares as part of this offering.
Effective January 28, 1999, the Company borrowed $400,000 from New York
Community Investment Company, L.L.C. ("NYCIC"), an affiliate of NYSB, under the
conditions that the proceeds of the loan be used as working capital to further
the corporate purposes of the Company and not to repay any debt or redeem any
equity interests. The loan accrues interest at 12% per annum which is payable
first in 24 monthly installments of $4,000 beginning March 1, 1999. Commencing
March 1, 2001, the principal amount of the loan is payable in 35 monthly
installments of $6,667 plus interest on the unpaid balance, except for the last
installment which shall be in the amount of $166,665 plus interest on the unpaid
balance.
As collateral for the loan, NYCIC received a security interest in the
Company's assets. Under the terms and conditions of the loan agreement, NYCIC
received warrants expiring January 28, 2004 to acquire 140,000 shares of the
Company's common stock at an exercise price equal to the IPO price. In the event
there has been no IPO within five years from the closing of the loan, the number
of shares to be acquired under the terms of the warrant are reduced to 80,000
and NYCIC shall have the right to put its ownership interest at a price defined
in the warrant agreement and cause the Company to repurchase all or part of such
interest at any time thereafter. The fair value of the warrants (approximately
$140,000) will be accounted for as a debt servicing fee and amortized over the
life of the loan. The unamortized amount of the debt servicing fee will be
included as "Option costs, net" in Stockholders' Equity.
On January 31, 1999, the subordinated borrowings maturing on October 31,
1999 were amended to extend the maturity date to October 31, 2000.
On March 24, 1999 the Company amended its 1998 Stock Option Plan to
increase the number of shares covered thereunder to 800,000 shares. In addition
the Company agreed to issue as of the effective date of its IPO options covering
an aggregate of 224,750 shares to certain employees at an exercise price of
$7.00 per share.
F-16
<PAGE>
[LOGO AND DIAGRAM]
<PAGE>
================================================================================
We have not authorized any dealer, salesperson or any other person to
give any information or to represent anything not contained in this prospectus.
You must not rely on any unauthorized information. This prospectus does not
offer to sell or buy any shares in any jurisdiction where it is unlawful.
-----------------------------------
TABLE OF CONTENTS
Page
Prospectus Summary ....................... 3
Risk Factors ............................. 5
Forward-Looking Statements ............... 9
Use of Proceeds .......................... 10
Dilution ................................. 11
Dividends ................................ 12
Capitalization ........................... 12
Management's Discussion and Analysis
of Financial Condition and Results
of Operations ......................... 13
Business ................................. 19
Management ............................... 31
Principal Stockholders ................... 36
Certain Transactions ..................... 37
Description of Securities ................ 38
Shares Eligible for Future Sale .......... 39
Underwriting ............................. 40
Legal Matters ............................ 41
Experts .................................. 41
Additional Information ................... 41
Index to Financial Statements ............ F-1
-----------------------------------
Until May 15, 1999, all dealers effecting transactions in the registered
securities, whether or not participating in this offering, may be required to
deliver a prospectus. This is in addition to the dealers' obligation to deliver
a prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
================================================================================
<PAGE>
================================================================================
2,000,000 Shares
INTERNET FINANCIAL
SERVICES INC.
Common Stock
-------------
PROSPECTUS
-------------
Whale Securities Co., L.P.
April 20, 1999
================================================================================
