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U.S. Securities and Exchange Commission
Washington, D.C. 20549
Form 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2000
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to ______
Commission file number: 1-14897
A.B. Watley Group Inc.
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(Name of small business issuer in its charter)
Delaware 13-3911867
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
40 Wall Street, New York, New York 10005
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (212) 422-1100
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Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $.001 par value
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(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes /X/ No //.
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. / /
The issuer's revenues for the fiscal year ended September 30, 2000 were
$42,752,654.
The aggregate market value of the voting stock held by nonaffiliates of the
registrant on December 27, 2000 (computed by reference to the closing price of
such stock on such date) was approximately $41,869,132. The number of shares of
common stock, par value $.001 per share, outstanding as of December 18, 2000 was
8,823,090 shares.
DOCUMENTS INCORPORATED BY REFERENCE
None
Transitional Small Business Disclosure Format (check one):
Yes / / No /X/
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Forward Looking Statements: This Report contains certain statements that may be
deemed "forward-looking statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act. All statements, other than
statements of historical facts, that address activities, events or developments
that the company intends, expects, projects, believes or anticipates will or may
occur in the future are forward-looking statements. Such statements are based on
certain assumptions and assessments made by management of the company in light
of its experience and its perception of historical trends, current conditions,
expected future developments and other factors it believes to be appropriate.
The forward-looking statements included in this Report are also subject to a
number of material risks and uncertainties, including but not limited to
economic, competitive, governmental and technological factors affecting the
company's operations, markets, services and prices, and other factors discussed
in the company's filings under the Securities Act and the Exchange Act.
Stockholders and prospective investors are cautioned that such forward-looking
statements are not guarantees of future performance and that actual results,
developments and business decisions may differ from those envisaged by such
forward-looking statements.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
A.B. Watley Group Inc. provides direct-access trading capabilities and related
software to both retail as well as corporate customers. As of September 30, 2000
we had approximately 11,000 retail customers. In August 2000 we began marketing
our proprietary technology, which we call a Direct-access Vertical Exchange
(DAVE), to the brokerage and banking industries. These initiatives resulted in
our recently announced licensing agreement with E*TRADE Group, Inc.
Historically, revenues have been generated primarily from retail customer
transactional fees. In the future, we anticipate augmenting that revenue with
licensing and related fees from our corporate clients.
Direct-access trading technology provides customers with the opportunity to
trade securities directly into various market centers, including exchanges and
Electronic Communication Networks (ECNs) without the intervention of a broker.
The absence of broker intervention is a key feature that differentiates us from
most online brokers. Other features of our service include:
o Integrated Product: real-time market data delivery and trade execution
software
o Speed: Average trade execution is less than 5 five seconds
o Market Transparency: Ability to view all market participants and
market centers in real-time
Generally, direct-access results in better trade execution as well as lower
transactional costs for the user.
Our services are delivered through DAVE, which is a combination of our
proprietary: (a) order entry and trade processing and (b) data delivery engines.
Today, customers can access DAVE through (i) UltimateTrader(R) II, our
proprietary client-server direct-access software application and (ii)
WatleyTrader, our proprietary web-based direct-access platform. In fiscal year
2001, we will add a voice recognition platform and a wireless application.
We believe our subsidiary, A.B. Watley, Inc., is one of the largest
direct-access brokerage firms in the U.S. A.B. Watley, Inc. is a registered
securities broker-dealer and member of the National Association of Securities
Dealers, Inc. Through this unit we provide real-time online financial brokerage
products and services to retail customers.
In September 2000 we began distributing our proprietary direct-access software
product to our retail customers. Prior to this, we had licensed enabling
software from third-party vendors. We anticipate that by January 2001, all of
our retail customers will have migrated to our proprietary software. This change
provides us with meaningful operating and financial benefits. For example,
direct-access software licensing fees paid to third party vendors totaled
approximately $14.4 million in fiscal 2000, representing approximately 27% of
total operating expenses. We anticipate eliminating most of this expense by the
second quarter of fiscal year 2001. Due to the implementation of our proprietary
software, we will recognize additional expenses including the amortization of
capitalized software of approximately $277,000 per month, and the recognition of
software developers salaries as an expense, previously capitalized, of
approximately $200,000 per month or $5,724,000 annually.
Of equal significance, we are leveraging our proprietary software development
experience and products. We are fully prepared to provide these same large-scale
technology solutions to corporate clients, primarily banks and brokerage firms.
We recently launched the B-2-B Solutions Group. This group is responsible for
marketing our technology and services to corporate clients. In this regard, on
November 22, 2000 we signed a license agreement with E*TRADE Group, Inc. (See
"Corporate Client Segment" for a further discussion of the E*TRADE license
agreement). We are actively seeking additional B-2-B clients. In accordance with
generally accepted accounting principles, software developed for internal use
and subsequently marketed and licensed is accounted for as follows: the net
proceeds received from such license are applied against the carrying amount of
that software and no profit is recognized until the aggregate net proceeds from
licenses and amortization have reduced the carrying amount of the software to
zero. Subsequent proceeds are recognized in revenue as earned.
Industry Overview
Our industry has recently experienced a series of changes led by electronic and
online commerce. These changes have created significant market opportunities for
us along with other similar brokerage firms. Favorable market trends have
resulted from (i) growing market acceptance of online brokerage services; (ii)
pronounced market segmentation; (iii) a complementary regulatory environment;
and (iv) disparity in the scalability and quality of competing trading
technologies.
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Growing Market Acceptance of Online Brokerage Services
Online trading is the fastest growing segment of the brokerage industry and is
expected to continue to grow significantly. The evolution of the Internet has
fundamentally changed the way in which many investors manage their financial
affairs. The speed, convenience, choice, cost savings and information offered by
the Internet as an investment tool has increasingly driven investor assets
online. Forrester Research and IDC project that total U.S. assets managed online
will increase from $325 billion at the end of 1998 to $3.1 trillion in 2003, a
compound annual growth rate of 57%. During this five-year period, the number of
online accounts is expected to grow to over 20 million, up from 5 million in
1998. Forrester and IDC also estimate that by 2003, 30% of all investors will
invest online, up significantly from approximately 10% today. According to The
Industry Standard, total online trades as a percent of total trading volume has
grown from less than 1% to 14% within the last four years, and currently
represents approximately 30% of total total average trading volume on NASDAQ and
the NYSE.
Historically, individual investors accessed the financial markets through
full-commission brokers, who offered investment advice and placed trades. With
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 and subsequent proliferation of discount brokerage firms, which provided
an alternative investment approach by completing trades at a reduced cost.
The emergence of electronic brokerage services has provided investors with the
ability to further unbundle services and costs typically charged by
full-commission and traditional discount brokerage firms. By requiring personnel
to handle each transaction, most traditional brokerage firms restrict client
access to trading and information. Further, while full-commission and discount
brokerage firms are able to offer electronic trading services, their continued
reliance on personnel, branch offices and associated infrastructure prevents
them from capturing the same operating efficiencies that are achievable by
electronic trading.
The growth of discount brokerage firms and the increasing utilization of the
Internet to access a wide range of financial services underscore a fundamental
shift in market demographics. This shift has altered the way consumers manage
their personal financial assets. Based on industry research reports and the
rapid consumer acceptance of online transactions, we believe 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.
Pronounced Market Segmentation
As the brokerage industry has matured, market segmentation has become more
pronounced. Segments within the industry are defined and identified based on a
variety of demographic factors. One of these factors is customer trading
activity. In July 2000, Robertson Stephens, Inc. stated in its Active Trading
report that active traders (all accounts trading 30-plus times a quarter),
represent approximately 54% of the 1.68 million average online daily trades yet
only 6.3%, or 800,100 of approximately 12.7 million total online accounts. This
translates into 910,000 trades per day from 800,100 accounts, or an average of
68 trades per account per quarter, versus the overall online industry average of
7 trades per quarter.
Since inception, we have targeted and served the most active 6.3% of trading
clients in the U.S. It is our belief that this group also happens to be among
the most profitable and historically under-served segment within the brokerage
community. This active trading segment is our primary target market.
There has been an active trader segment in the U.S. for many years. Active
trading is dependent upon the following core characteristics: (i) software
quality; (ii) software reliability; and (iii) access to efficient liquid market
centers. Until recently, access to that efficiency and liquidity was primarily
limited to institutions. Direct-access broadens the availability to all
investors. Moreover, this capability fuels the expansion of the active trader
segment.
We are positioned to provide this market segment with some of the most
sophisticated trading systems available. As recently as five years ago, a
website that offered online trading technology was considered state-of-the-art.
Today, our direct-access technology, featuring smart-order routing and
split-second trade execution empowers all investors. Through our leadership and
adherence to the direct-access model of speed and market transparency, we
believe our business model is defining a new paradigm. While many of our
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competitors in the brokerage industry decide whether to adopt this leading edge
technology or not, we have created and grown our business model based on three
core elements that together represent the foundation of our trading platforms.
These core elements are maximum liquidity, transparency and speed.
A Complementary Regulatory Environment
In 1996, the SEC adopted rules that brought sweeping changes to the structure of
the over-the-counter market. These rule changes also brought potential benefits
to our business and to our competitors. They also brought significant benefits
to active trading clients. Known as "order handling rules", they allowed for the
creation and operation of ECN's. ECN's are 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 ECN 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 ECN's, which provide an
ever-increasing source of liquidity in the over-the-counter market.
Additional and more recent rule changes have facilitated the emergence of
direct-access trading technology and business models offering such technology.
The Securities and Exchange Commission is adopting two rules to improve public
disclosure of order execution and routing practices. Under Rule 11Ac1-5, market
centers that trade Nasdaq National Market System securities will be required to
make available to the public monthly electronic reports that include uniform
statistical measures of execution quality. Under Rule 11Ac1-6, broker-dealers
that route customer orders in equity and option securities to certain
destinations for execution will be required to make available on a quarterly
basis reports that, among other things, identify the venues to which customer
orders are routed for execution. In addition, broker-dealers will be required to
disclose to customers, on request, the venues to which their individual orders
were routed. By reporting execution activity, many expect that the brokerage
industry, in particular order-handing, will become more transparent to the
public. These rules are also intended to spur more vigorous competition among
market participants to provide the best possible prices for investor orders.
In light of the new disclosure rules being adopted, many industry analysts feel
that demand for direct-access execution capabilities and real-time market
information will continue to grow and potentially grow at an increasing rate. We
believe that these recent regulatory developments, coupled with the increased
availability of real-time information, advances in the Internet and networking
and communications technologies, have created significant investing
opportunities for active traders and investors. These recent changes also
represent significant market opportunities for online brokerage services.
Disparity in the Scalability and Quality of Competing Trading Technologies
The expansion of the online brokerage market has significantly impacted the
financial markets. The development of direct-access and our DAVE technology
represent the next wave of change. While the established online brokers have
used the Internet to make more efficient the communication with investors, our
proprietary direct-access technology allows investors to interact directly with
markets. In our opinion, this interactive capability represents a fundamental
change and will become the accepted standard in the financial markets.
Our direct-access platform is not only technologically advanced, but is also
highly scalable (see "Technology Summary"). The combination of technology and
scalability provides us with a competitive advantage versus the established
online brokers as well as the smaller PC-based direct-access competitors. Many
of the largest online brokers presently possess the scale to accommodate
increased customer adoption; however, few currently own and/or offer a
direct-access service. In addition, the PC-based direct-access brokers are at a
competitive disadvantage because their existing capabilities lack the
much-needed scalability. Our current technological architecture allows us to
deliver a direct-access product efficiently to thousands, and potentially,
hundreds of thousands of simultaneous highly active retail and institutional
clients.
The Future of Direct-Access Trading Technology and DAVE
Our services are delivered through DAVE, which is a combination of our
proprietary: (a) order entry and trade processing and (b) data delivery engines.
Today, customers can access DAVE through (i) UltimateTrader(R) II, our
proprietary client-server direct-access
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software application; and (ii) WatleyTrader, our proprietary web-based
direct-access platform. In fiscal year 2001, we will add a voice recognition
platform and a wireless application.
Benefits of our proprietary technology platform to us include significantly
increased scalability, reliability and manageability. We also expect our
technology platform to substantially increase operating margins by eliminating
almost all third-party software licensing and data services fees and
streamlining internal information management support.
State-of-the-Art Technology
In the latter part of 1998, we commenced a strategic upgrade of our entire
technology platform in order to support an anticipated increase in demand for
our direct-access online brokerage services. Since that time, we have developed
and launched DAVE, our state-of-the-art trading and market data system. Our
system is designed to accommodate substantial increases in both client demand
and the regulatory requirements expected to result from decimalization,
regulatory reporting changes and T+1 settlement. Our current implementation of
leading-edge order entry and trade processing and data delivery technology
ensures scalability, flexibility, reliability and manageability to accommodate
the "next wave of change in the financial markets."
Features
Our technology model provides a number of significant and value-added benefits
to active investors:
<TABLE>
<CAPTION>
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A.B. Watley Technology Benefits for the retail market
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System Feature Client Benefits
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<S> <C>
o Direct Access to Exchanges & ECNs o Allows investors to execute independently of third party
market makers for more efficient executions. Provides
ability to act as "market maker" on par with institutional
traders.
o Superior Speed of Execution o Client-server order execution model substantially
reduces time elapsed between investor order entry and
receipt of order by exchange/ECN. Average order
execution time for an OTC market order is 2-7 seconds.
o Order Routing Discretion o Enables investors to actively determine venue for order
execution among variety of alternatives (Island, Instinet,
other ECNs, NASDAQ, specific market makers, NYSE DOT, our
company block trade desk). Provides critical added ability
to trade at the best price.
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o NASDAQ Level II Data o Enables access to complete range of bid/ask, volume and
market depth for variety of execution markets.
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o Realtime Data Analytics o Provides best available retail package of realtime,
streaming market data, charts and technical analysis. This
suite of content includes intraday charting, a variety of
analytical studies (e.g., relative strength indicators, moving
averages, moving average convergence divergence), time and sales,
option quote chains, regional exchange quotes and news.
------------------------------------------ ---------------------------------------------------------------------------
o High Utilization Capacity o Affords access to our company's technology platform by
entire client base on simultaneous basis. Critical given
consistent high level of concurrent utilization and spikes
in utilization due to highly volatile market movements and
shifts in market liquidity.
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</TABLE>
Technology Summary
The DAVE system architecture incorporates a Sun Solaris UNIX server platform
with BEA System's Tuxedo middleware. The database system runs on an Oracle
Parallel Server in conjunction with Objectivity software for database object
management. Through a combination of these components and proprietary business
logic, the OETP (Order Entry and Trade Processing) component system provides a
leading-edge platform to handle vast numbers of users engaged in high-volume
direct-access trading. The DD (Data
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Delivery) component system also utilizes a Sun Solaris UNIX platform together
with Vitria Communicator middleware. For database management, the DD system
utilizes an Oracle database system for relational data and Objectivity software
for database object management.
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The DAVE: Open/Distributed Enterprise Architecture
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<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Ultimate Trader Internet B2B Partner
Client Intranet
3rd Party
Web Client Multiple Application
Oracle OAS Redundant
Connections
DATA DELIVERY SYSTEM Oracle
Oracle ORDER ENTRY AND TRADE PROCESSING Database
Database Tuxedo Transaction Monitor Middleware
Tuxedo Transaction Monitor Middleware Vitria Publish/Subscribe Middleware Objectivity
Objectivity Vitria Publish/Subscribe Middleware Database
Database Multiple Sun E4500 Servers
Multiple Sum E4500 Servers
Internet Co-location Facilities
A.B. Watley Data Centers (UUNet, Globix)
(New York, Dallas)
Service Bureau Exchange Interfaces Market Data
Back Office NYSE, NASDAQ, PC Quote, NASDAQ,
ECN, Order Desk NYSE, OPRA
</TABLE>
Highly Scalable and Cost Efficient UNIX-based trading system
Our newly upgraded platform has been developed to run on UNIX computing
platforms, offering the benefit of unparalleled expansion and scalability. This
in turn allows for the ready "cloning" of the technology platform with minimum
modification and cost to accommodate a substantial increase in customer demand.
UNIX also contributes significantly to the efficiency of the platform by
providing superior processing capacity and thereby requiring fewer servers to
process trading activity. Fewer UNIX servers also imply lower server-related
maintenance costs relative to NT servers.
System scalability has also been enhanced by the utilization of a massive
parallel processing (MPP) architecture design. By managing transaction
processing on a "stateless" basis, our system enables increased processing power
in proportion to the addition of hardware. This increased processing power
becomes vital as securities regulations drive the move to decimalization
(expected to increase market data volume by two to three times) and T+1
settlement (necessitating realtime order entries to back-end or service bureau
mainframes).
Open/Distributed Enterprise Architecture Highly Flexible
Both the OETP and DD systems utilize the C++/Java programming paradigm in
connection with object oriented application development and iterative
development cycles. As a result, the primary software components utilized in
both systems can be readily modified for future upgrades and projects. By
adopting an open architecture approach, moreover, our system may integrate
different
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protocols, application programming interfaces, third party
applications, operating systems and hardware without disrupting the enterprise
infrastructure.
The open architecture approach will also enable us to more easily integrate the
trading system with third party software developer applications, thereby
providing built-in potential scalability to alternative distribution channels
controlled by third parties. Discussions with one technical analysis software
vendor to this effect have already been initiated.
Middle and Back-office Architecture Highly Fault Tolerant
The middle office platform provides superior reliability by employing
transaction process monitoring that incorporates a "handshake" confirmation for
each piece of data sent to an end user or between servers, databases and
applications. In addition, effective recovery ability is provided through the
storage of information in the database prior to the transmission of any message,
data or transaction coupled with the ability to recall this data and restart
transactions.
The back-office database platform reinforces the tolerance of the system by
incorporating four Objectivity databases (one primary and one hot standby in
each data center) and an Oracle Parallel Server utilizing data replication, thus
providing complete remote backup of all database services. In this way, the
architecture can switch to the hot standby system and the alternative data
center in the event of any failure of the primary system.
System Reduces Cost of Market Data Delivery
We believe we are well positioned to capture a significant share of the market
for these services and benefit in several ways. First, we expect to capture
operating efficiencies that were unavailable to us in the past. With a
proprietary platform, we will lower or eliminate costs that we historically
associated with data and software vendors. At present, every client using vendor
supplied software costs us approximately $227.50 in data and software costs per
month. When we complete the migration of our client base to our proprietary
platform, we expect such costs to be reduced to approximately $13 per client per
month. The proprietary software and associated scale economies will allow us to
be one of the lowest cost providers of integrated real-time streaming market
data. We expect significant business-to-business (B-2-B) opportunities,
primarily through licensing agreements, to emerge from this capability. In
addition, we are presently developing an in-house clearing business that is
expected to assist greatly in the transition of our business model from one that
is largely variable in its cost structure to one that is largely fixed in its
cost structure.
The enhanced technology platform eliminates much of the effective cost of
large-scale data delivery by employing a "publish and subscribe" delivery method
that makes all market data available to all investors on an "as needed" basis.
Unlike request-reply processing, publish-subscribe is "decoupled", allowing for
asynchronous, anonymous and immediate communication without complicated
administrative overhead. In conjunction with our proprietary compression
methodology, this approach (i) ensures our ability to cope with surges in
real-time market data demand as the industry moves towards decimalization; and
(ii) significantly reduces both the complexity of application code and the
bandwidth and hardware required for market data delivery. The enhanced
scalability of the Sun server platform further reduces the cost of data delivery
by markedly reducing the number of servers required to support a large number of
investors simultaneously receiving realtime information.
Furthermore, the new platform is capable of employing IP Multicasting and thus
can generate additional savings as the major Internet carriers deploy multicast
enabled networks. By employing IP Multicasting, the system can "broadcast" all
quotes while users subscribe to these quotes as needed - enabling information
delivery to be scaled to a nearly unlimited number of subscribers. This in turn
leads to another significant decrease in the bandwidth and in the number of
servers required to distribute market data to our clients.
Architecture Allows for Efficient Administration
Our system incorporates a highly effective system administration function that
provides a complete window on the entire Information Technology (IT) platform,
thereby allowing system administrators to work proactively to solve system
problems before service may be affected. This feature, in conjunction with the
enhanced scalability of the Sun server platform, improves managerial control and
efficiency by reducing systems administration staff requirements. Importantly,
the remote administrative capabilities of the software enable us to utilize any
variety of co-location facilities for further efficiencies and reliability.
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Leading Technology Team
We presently maintain a dedicated in-house IT team with the expertise and
resources necessary to fully develop, test, modify, maintain and administer a
state-of-the-art online brokerage technology platform. Our technology team has
been completely integrated into our business model from inception, and consists
of 41 full-time IT professionals grouped into a development unit and a system
administration unit. Our team is led by the former Director of IT Strategies for
WorldCom. Also, several of our team members have gained experience with the U.S.
Navy, Morgan Stanley Dean Witter, Goldman Sachs, American Airlines
Sabre/Travelocity, EDS and State Farm Insurance.
Importantly, the IT group engages in the full-time development of technology
designed to serve the active investor. As a result of its extensive experience,
the technology team enjoys the accumulated expertise needed to customize and
integrate requisite "best-of-class" components into a seamless and superior
trading platform.
The technology group applies our accumulated expertise through a uniform object
oriented analysis and design methodology called Rational Unified Process
(RUP). When working in a RUP environment, detailed documentation is written
for all iterations of the software development process. By strictly adhering to
the RUP methodology for software development, we beliieve our investment in
proprietary technology development is protected from poor requirements
gathering, "feature creep" and employee turnover. In addition, we usually
benefit from faster development cycles and lower maintenance costs.
Targeted Marketing Strategy for Both Retail and Business-to-Business Clients
Our marketing strategy is to simultaneously target the active trading segment of
the retail customer universe and corporate clients within the banking and
brokerage communities.
Active Trading Segment
In July 2000, Robertson Stephens stated in their Active Trading report that the
active trader market (all accounts trading 30-plus times a quarter), represents
54% of the 1.68 million average online daily trades but only 6.3%, or 800,100,
of the 12.7 million total online accounts. This translates into 910,000 trades
per day from 800,100 accounts. Based on these findings, we presently have a
market share of less than 1% of the active trader segment.
Because very few firms have the technology and products to address this target
market, we feel that customer procurement in this market segment is still at a
very early stage. In short, we are confident that highly targeted advertising
will help increase our market share. Our cost per new account has consistently
averaged approximately $890, while revenue per client has averaged $2,900 per
year. We are committed to not only keeping our yield per new account above
industry averages, but believe the opportunity exists for margin expansion and
increasing yields. We intend to continue our targeted marketing efforts in three
selected mediums: (i) newspaper (Investors Business Daily); (ii) television
(CNBC); and (iii) industry tradeshows.
We fully intend to continue to target active retail traders and other active
investors. It is our contention that our direct-access product offering is well
positioned to satisfy this "premium" market segment. We have established a very
good reputation as a market leader for direct-access trading platforms and
believe we are well positioned to benefit from both increased market demand and
by owning a superior product and service offering.
Corporate Client Segment
Presently there are approximately 800,100 online trading retail customers making
an average of 910,000 trades per day. These 800,100 active traders represent
about 6.3% of the entire market population. These active traders currently
reside at approximately 150 different competing brokerage firms. Besides
marketing directly to these customers, we expect to acquire clients through
strategic B-2-B alliances. Through these alliances we anticipate licensing our
products and services on a private-label or co-branded basis. Our alliance
partners will be responsible for marketing our products to their customers. We
believe we possess significant advantages over competitors. These advantages
include:
o Scalable and cost-efficient UNIX based architecture
o Highly flexible and adaptable system, allowing ease of client integration
o Proven software development support team, allowing for customized and
differentiated products
o Cost-efficient product delivery
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Based upon our experience to date, the development of an effective, scalable
direct access trading system is not only time consuming, but also expensive.
This is further evidenced by a competitor's recent experience. Charles Schwab &
Co., Inc. recently acquired a PC-based direct access provider. Soon after the
acquisition was completed, Schwab stated that it would require 12-18 months to
fully integrate the systems. We believe our enterprise architecture and
end-to-end solution provision strategy is fully capable of delivering a private
label or co-branded product to larger brokerage firms more efficiently.
Consistent with these competitive advantages, we recently entered into a license
agreement with E*TRADE Group Inc. Under the terms of this agreement, we will
provide a portion of our technology to E*TRADE who will in turn offer it to its
customers under the E*TRADE brand name. Based upon E*TRADE successfully
marketing and migrating their customers to our product, this agreement
represents the potential for us to earn up to $3 million per month in additional
revenue over a three-year period depending upon the number of customers E*TRADE
places into service. We believe there are other companies like E*TRADE who will
be drawn to our products and technology.
In addition to large brokerage firms and banks, we intend to market our products
and services to the broader day-trading small order execution system (SOES)
industry. This universe of potential clients is continuously and actively
seeking to reduce costs and provide better service to their customers.
A four-person B-2-B team spearheads our B-2-B strategy. This team has been
soliciting interest from the broad brokerage market and promoting our integrated
direct-access platform technology. In addition, we have recently commenced
servicing foreign institutions by providing them and their clients with
electronic execution services for transactions in the U.S. securities markets.
At this time, we are actively pursuing a number of additional licensing
relationships that may provide us with a global presence.
Retail Product and Feature Set Matrix
We currently offer clients and business partners access to DAVE through two
primary access points: (i) software (UltimateTrader(R) II ("UT II")); and (ii)
web-based (WatleyTrader ("WT")). In fiscal year 2001, we will add (i) a wireless
application ("WAP"); and (ii) a voice recognition platform ("IVR"). The
following table illustrates the feature sets of each access point:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Product Access Points: ............................................UT II WT WAP IVR
FREE Realtime Level II Data .......................................X X X
Quick buy and sell buttons with auto routing.......................X X X X
Detailed status report on each order entered.......................X X X X
Compatibility with MAC OS X........................................X X
All activity and account information...............................X X X X
Links to historical P&L............................................X X X X
Dynamic Updating Quotations........................................X X X
Unlimited Customized Pages.........................................X X
Realtime Purchasing Power..........................................X X X X
Minder View Portfolio Minder.......................................X X X
Position Minder....................................................X X X
Scrolling Tickers..................................................X X X
Alarms.............................................................X X X X
Quick Quotes.......................................................X X X X
Hot Keys...........................................................X X X
Charts with Technical Studies......................................X X
Color Coded Market Maker Screens...................................X X X
Time and Sales.....................................................X X X
Pre-Market Open and Post-Market Close Trading......................X X X X
</TABLE>
Flagship Direct-access Product: UltimateTrader II
UltimateTrader II is our flagship and premium-level direct-access product. It
provides the user with the following feature set:
> FREE Realtime Level II Data - continuously updated display of market maker
and electronic communication network current prices and changes.
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> Color Coded NASDAQ Market Maker Screens - designed to visually display, by
a special color in the screen, upward and downward trends in recent trades
in a security.
> Charts with Technical Studies - allows clients to view live, dynamically
updating, realtime intraday chart data and historical information for
stocks, option or indices.
> Time and Sales - reflects last and cumulative trades, prices and aggregate
daily volume in a security.
> Pre-Market Open and Post-Market Close Trading - access to trading during
both pre-market open (8:00 AM EST to 9:30 AM EST), and post-market close
(4:00 PM EST to 5:00 PM EST) hours.
> Auto routing - Quick buy and sell buttons with the ability to execute/
cancel trades with a simple keystroke.
> Detailed status report on each order entered - extensive review and order
notification including date stamp, quantity, average price, market
participant and user ID.
> Compatibility with MAC OS X - proprietary data delivery and execution
platform deliverable through the Macintosh OS X operating system.
> All activity and account information - a detailed breakdown of order
status, historical trade information and real time positions, buying power
and realized P&L.
> Links to historical P&L - the ability to see all realized profit and
losses.
> Dynamic Updating Quotations - displays real time changes in prices and
markets as they occur.
> Unlimited Customized Pages and screen real estate - allows clients to
create computer screen layouts to their preference with their data and to
scroll freely among these pages.
> Realtime Purchasing Power - allows clients to view current buying power,
the value of the account as of the trading day's business morning.
> Portfolio Minder - used to create computer windows with comprehensive price
and other data relating to a number of different securities.
> Position Screen - displays existing open positions.
> 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.
> Alarms - alerts clients by an audio or visual pop-up when target criteria
have been met for a specified security.
> Minder View- a fully configurable quote screen that can display virtually
any information about the security selected.
> Hot Keys - the ability to execute/cancel trades with a simple keystroke.
Additional Brokerage Services
In addition to the features listed above, we offer our clients a full range of
services through third-party relationships. These include: Managed Asset Plan,
Unlimited Checkwriting, Visa Gold Card Services, and Automatic MAP Deposit.
Customers also have access to over 5,000 mutual funds. We also offer a full
suite of research tools including access to Briefing.com, Zacks earnings
estimates and EO enabled vertical portals that gives a professional single point
of access to industry-focused content on the web.
Client Services
Client services for all levels of our online service, including trading,
administrative, and technical support, are among our highest priorities. Based
on our experience in the industry and based on client feedback, providing an
effective client service team to handle client needs is critical to our success.
Our Client Service department helps clients get online, handles product and
services inquiries and addresses all brokerage and technical questions. The
Client Service department also conducts various surveys to verify the
satisfaction of our clients and to learn more about client preferences and
requirements.
We provide live client support from Monday through Friday between the hours of
8:00 AM and 8:00 PM EST. Our client services department operates on a one-stop
shopping basis, meaning that clients do not typically have to be transferred
between departments to receive answers to their inquiries. We currently employ
45 Client Services personnel (inclusive of management), 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 support 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 relationship management (CRM) and computer telephony
integration (CTI) software. CRM databases are updated with each client contact
to track client service
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calls. A separate internal database tracks trading patterns, changes in customer
balances and compliance issues. Both databases are used to generate periodic
reports for management. Client services associates access the latest product and
account information through CRM and customer account databases.
During the second quarter of fiscal year 1999, we launched online support and
chat services for our clients. This service currently offers an online, indexed
UltimateTrader(R) user manual and chat area. The chat area offers clients the
ability to query and chat with Client Services associates in realtime. 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 are planning to upgrade our online support
capabilities through a recently acquired online chat support software package.
We have created a VIP client services team to service our most active online
clients. By providing client support for all issues on an account manager basis,
we intend for the VIP team to offer much more individualized service on a
prioritized basis. By providing highly prioritized, personalized and
professional client support, especially for our niche market high volume
clients, we will further differentiate our products and services from those of
our competitors.
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.
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.
Operations, Clearing and Order Processing
We do not hold client funds or securities, nor do we generally execute and
process directly either our own or our clients' securities transactions. Since
October 1996, we have cleared all transactions for clients, on a fully disclosed
basis, with Penson Financial Services, Inc. for retail accounts and Weiss, Peck
& Greer, L.L.C. for institutional accounts.
Our agreement with such clearing brokers provide that the clearing brokers
process all securities transactions for our account and the accounts of our
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. We have agreed to indemnify and hold the clearing brokers
harmless from certain liabilities or claims, including claims arising from the
transactions of our clients, which could be material in amount. Our 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. We depend 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, we are exempt from certain
reserve requirements imposed by federal laws.
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.
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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.
Third-Market Institutional Sales Desk
Our third-market institutional sales and trading desk specializes in
facilitating and/or executing large-block transactions in approximating 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 pension funds, insurance companies, banks, corporations and independent fund
managers. Approximately 19% of our revenues for our fiscal year ended September
30, 2000 were derived from the institutional trading desk. We hope to
significantly leverage our institutional market presence in the future when we
begin to create electronic, complementary products and services for this market
place.
Investment Considerations and Risk Factors
Although we are optimistic that we will be able to continue our substantial
growth and strengthen our position in the online and electronic trading of
securities, we also acknowledge that our business and this industry in general
are subject to a number of risks and uncertainties which could adversely affect
future results. Among these are:
1. Competition In The Online And Electronic Brokerage Business Is Increasing.
Not only are we faced with competing with the traditional electronic trading
firms, such as E*Trade and E-Schwab, as well as smaller sized competitors, but
we are also faced with the entry of new firms, including traditional brokerage
firms such as Merrill Lynch, and the emergence of giants, such as Goldman Sachs
& Co., as a sponsor or joint venturer of e-commerce brokerage firms and
electronic communications networks. We will continue to compete based upon what
we perceive as the excellence of our trading systems, the skills of our customer
service personnel, the breadth of information and other services provided,
attractive pricing of our services and maintenance and upgrade of our
technology. Although added competition has also served to increase the overall
market for this type of brokerage service, the increased competition also places
more pressure on us in our competitive efforts, including a need to increase our
marketing efforts, which is already underway.
2. We Are Expanding Rapidly And Need to Properly Manage Our Increased
Infrastructure. The expansion of our business has led us to increase our systems
and personnel. These must be managed efficiently and places additional burdens
upon executive management.
3. We Must Maintain Our Access To The Most Improved Technology. Technological
changes continue in the electronic commerce field generally and in our segment
of online brokerage. We must keep pace with these technological developments by
a combination of licensing and developing software, to be able to continue to
provide what we regard as highly efficient and attractive services and systems
for our accounts.
4. Our Industry Faces Substantial Regulatory Supervision. We, as well as all
members of the U.S. securities brokerage industry, are regulated by the NASD and
SEC. These supervisory bodies have tended to increase the intensity of their
regulatory efforts, particularly with respect to the online trading industry.
Additional regulations have been proposed, from time to time, dealing with the
suitability of online trading and broker supervision of accounts. All these
place a greater burden on the conduct of our electronic and online brokerage
business.
5. Our Proposed Conversion to Self-Clearing Operations Subjects Us to Additional
Risks. Although self-clearing will allow us to theoretically increase the
profitability of our operations, it will also place additional burdens upon
managing our business. 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 ours,
without significant prior experience, involve substantial risk of losses due to
clerical errors related to the handling of client funds and securities. We have
attempted to mitigate this risk by
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hiring, from a large competitor, as a senior officer someone who has extensive
experience in the senior management of self-clearing operations and conversions
to self-clearing. 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.
6. Downturns in the Securities Industry Could Adversely Affect Our Business. A
significant portion of our revenues in recent years has been from online
brokerage commissions and related services. Downturns in the securities
industry and markets could adversely affect 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 are marketing UltimateTrader by targeting active traders through print,
online, television, radio and other modes. We have also conducted surveys of our
existing client base to understand their media consuming habits and demographics
profiles to effectively target our advertising campaign. We have implemented 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 include advertisements in financial publications and
various other regional and national publications that have demographics similar
to our target market. In the last ten months, we have emphasized advertising and
promoting UltimateTrader through television commercials, primarily on CNBC and
have therefore significantly increased our marketing expense. We may seek to
advertise and promote UtimateTrader through Internet website and banner
advertisements and television commercials. We also plan to broaden our presence
on the Internet through various partnerships, sponsorships and co-branding
efforts such as our agreement with U-Cool, an Internet community site that has
over 150,000 subscribers and 10 million unique monthly visitors. Our strong
rankings in various industry surveys have provided us with extremely valuable
publicity. We will continue to make investments in our online services and
offerings to maintain and even strengthen these rankings.
Competition
The market for electronic brokerage services is highly competitive and rapidly
changing. We believe that we compete on the basis of speed of order execution,
processing and confirmation, quality of 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 Merrill Lynch & Co., Inc.; Morgan Stanley Dean Witter
& Co.; PaineWebber Incorporated; and Salomon Smith Barney, as well as financial
institutions and mutual funds.
Securities Regulation
Our Watley subsidiary 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 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.
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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.
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 September 30, 2000, Watley was required to maintain minimum net capital,
in accordance with SEC rules, of approximately $314,169 and had total net
capital of $1,627,920 or approximately $1,313,751 in excess of minimum net
capital requirements.
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, 2000 and 1999, we spent approximately
$5,000,000 and $6,000,000, respectively, for software development. These
software development efforts are related to enhancing the operational
capabilities of our trading systems.
We completed a major project in August 2000. These software development efforts
are related to the creation of proprietary direct access online trading and
market information software. The software development efforts will allow us to
transition our UltimateTrader and WatleyTrader customers from vendor software to
our proprietary software. This is expected to reduce our
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operating costs by approximately $1,200,000 per month beginning in the second
quarter of fiscal 2001. As of December 14, 2000, we have transitioned
approximately 3,400 UltimateTrader customers on to our proprietary software
reducing our costs to outside vendors by approximately $816,000 per month.
Effective September 2000, we began amortizing approximately $10 million of
capitalized software development costs over a three year period or approximately
$277,000 per month.
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 December 1, 2000, we employed a total of 144 persons, of whom 8 are
engaged in executive management, 24 in trading activities, 41 in information
technology, 28 in client service, 6 in sales and marketing, 19 clerical and back
office personnel, as well as 14 other employees. 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.
Our success will depend, in part, 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 that we have.
ITEM 2. DESCRIPTION OF PROPERTY.
Our principal offices are located at 40 Wall Street, New York, New York, where
we occupy approximately 43,000 square feet at an annual cost of approximately
$1,400,000, or $116,000 per month, plus escalations. The initial term of the
lease for such office space expires in June 2009. We also occupy approximately
16,000 square feet at an annual cost of $204,000 in Allen, Texas. The initial
term of the lease for such space expires in June 2004.
ITEM 3. 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 arbitration. We are not currently
involved in any legal or regulatory proceedings or arbitration, the outcome of
which is expected to have a material adverse effect on our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended September 30, 2000.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) Trading in our company's shares of common stock presently takes place
on the NASDAQ National Market under the symbol ABWG.
The following table sets forth the range of high and low sales prices for
our company's common stock since April 20, 1999, the date we completed our
initial public offering:
Fiscal 1999: High Low
------------ ---- ---
4/20/99 - 6/30/99 $23.25 $10.375
7/01/99 - 9/30/99 $15.62 $8.375
Fiscal 2000: High Low
------------ ---- ---
10/1/99 - 12/31/99 $14.25 $9.4375
1/01/00 - 3/31/00 $28.25 $9.75
4/01/00 - 6/30/00 $27.50 $15.25
7/01/00 - 9/30/00 $26.9375 $9.00
(b) The number of holders of our company's common stock was approximately
109 on December 1, 2000, computed by the number of record holders,
inclusive of holders for whom shares are being held in the name of
brokerage houses and clearing agencies.
(c) Our company has not paid a cash dividend since inception.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The following discussion of the financial condition and results of operations of
our company should be read in conjunction with the consolidated financial
statements and notes thereto appearing elsewhere herein.
Results of Operations
Fiscal year ended September 30, 2000 compared to fiscal year ended September 30,
1999
Total revenues for fiscal 2000 were $42,752,654, an increase of 103.7%, as
compared to revenues of $20,987,613 for fiscal 1999. Revenues from commissions
increased by $16,769,335, or 103.5%, from $16,198,858 for fiscal 1999 to
$32,968,193 for fiscal 2000 due primarily to the significantly increased number
of online trades executed as well as due to the growth in our third-market
institutional sales division. During fiscal 2000, our company's online brokerage
division had total billed transactions of 1,509,448 and average billed
transactions of 5,966 per day, an increase of 129.1% compared to an average
daily billed transaction rate of 2,604 per day during fiscal 1999 totaling
656,217 billed transactions. Data service revenues increased by $375,273, or
22.9%, from $1,640,123 for fiscal 1999 to $2,015,396 for fiscal 2000 due to the
increase in the number of online accounts. We experienced an increase in the
number of online brokerage accounts from approximately 3,500 at September 30,
1999 to approximately 11,800 at September 30, 2000. We expect the number of
accounts and corresponding revenue to increase during fiscal 2001 but the extent
of these increases is dependent on market conditions and the relative success of
our sales and marketing efforts. Revenues from principal transactions increased
by $3,232,821, or 131.6%, from $2,456,874 for fiscal 1999 to $5,689,695 for
fiscal 2000, mainly as a function of the significantly higher volumes of
business conducted by both the online brokerage division's trading desk and the
third-market institutional sales division. Interest and other income increased
from $685,578 for fiscal 1999 to $2,073,190 for fiscal 2000 due to the overall
growth of our business.
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As a result of the foregoing, net revenues increased by $21,668,727, or 105.0%,
from $20,639,156 for fiscal 1999 to $42,307,883 for fiscal 2000. Nearly all of
our revenues were generated by clients in the United States and no single group
of related clients accounted for 10% or more of our revenues.
Interest expense increased from $333,457 for fiscal 1999 to $373,354 for fiscal
2000 as a result of increased borrowings.
Interest expense - related party increased by $56,417 as a result of additional
borrowings of $3,500,000. These amounts were borrowed at various dates during
fiscal 2000.
Total expenses increased by $30,613,336, or 144.2%, from $21,231,139 for fiscal
1999 to $51,844,475 for fiscal 2000. Commissions, floor brokerage and clearing
charges represent payments to our clearing and floor brokers who facilitate our
clients' transactions. As a result of the large increase in the volume of
business conducted by our online trading accounts, such expenses increased by
$12,637,811, or 158.6%, from $7,967,765 for fiscal 1999 to $20,605,576 for
fiscal 2000. Employment compensation and related costs increased by $6,495,541,
or 122.4%, from $5,306,590 for fiscal 1999 to $11,802,131 for fiscal 2000,
largely due to the hiring of 95 new employees in the last quarter of fiscal year
1999, and an additional 50 employees throughout fiscal 2000. In addition, we
added four senior managers and provided current employees raises and bonuses to
stay competitive in the marketplace and retain key employees. Our company does
not expect to increase our head count other than in our technology group.
Communications expense increased by $641,260, or 51.9%, from $1,236,449 for
fiscal 1999 to $1,877,709 for fiscal 2000 as a function of the growth in our
online trading accounts. We expect that the foregoing expenses will continue to
increase as we expand our client base.
Business development costs consist primarily of advertising costs to obtain new
accounts, which have mostly been for online print and media advertising. These
expenses increased by $6,552,828, or 325.0%, from $2,016,372 for fiscal 1999 to
$8,569,200 for fiscal 2000 as we increased our planned advertising and
promotional efforts. We do not anticipate these costs increasing but instead
intend to reallocate our resources to those activities which have demonstrated
the best results.
Professional services increased from $1,532,994 for fiscal 1999 to $1,726,598
for fiscal 2000 due to the general growth in our business. Occupancy and
equipment costs increased by $2,764,785, or 145.0%, from $1,907,080 for fiscal
1999 to $4,671,865 for fiscal 2000, primarily due to the expansion of our
offices by an additional 40,000 square feet in New York and Texas and the
leasing of additional equipment to increase our capacity and to facilitate the
relocation efforts. Depreciation and amortization increased by $962,766, or
154.9%, from $621,188 for fiscal 1999 to $1,583,954 for fiscal 2000 due to our
overall growth. Other expenses increased by $364,741, or 56.8%, from $642,701
for fiscal 1999 to $1,007,442 for fiscal 2000 due to our overall growth.
The income tax provision increased from $32,494 for fiscal 1999 to $53,913 for
fiscal 2000.
A loss of $256,386 was recorded as a result of our investments in an Israeli
online broker/dealer, Insider Financial Services Online Ltd., and a technology
company, Gale Technologies, Inc.
As a consequence of the foregoing, our operating loss increased from $591,983
for fiscal 1999, to a loss of $9,536,592 for fiscal 2000.
Fiscal year ended September 30, 1999 compared to fiscal year ended September 30,
1998
Total revenues for fiscal 1999 were $20,987,613, an increase of 130.1%, as
compared to revenues of $9,119,268 for fiscal 1998. Revenues from commissions
increased by $8,795,799, or 118.8%, from $7,403,059 for fiscal 1998 to
$16,198,858 for fiscal 1999 due primarily to the significantly increased number
of online trades executed as well as due to the growth in our third-market
institutional sales division. During fiscal 1999, the Company's online brokerage
division had total billed transactions of 656,217 and average billed
transactions of 2,604 per day, an increase of 310.7% compared to an average
daily billed transaction rate of 634 per day during fiscal 1998 totaling 159,789
billed transactions. Data service revenues increased by $978,887, or 148.0%,
from $661,236 for fiscal 1998 to $1,640,123 for fiscal 1999 due to the increase
in the number of online accounts. We experienced an increase in the number of
online brokerage accounts from approximately 900 at September 30, 1998 to
approximately 3,500 at September 30, 1999. We expect the number of accounts and
corresponding revenue to increase during fiscal 2000 but the extent of these
increases is dependent on market conditions and the relative success of our
sales and marketing efforts. Revenues from principal transactions increased by
$1,554,985, or 172.4%, from $901,889 for fiscal 1998 to $2,456,874 for fiscal
1999, mainly as a function of the significantly higher volumes of business
conducted by both the online brokerage division's trading desk and the
third-market institutional sales division. Interest and other income increased
from $146,704 for fiscal 1998 to $685,578 for fiscal 1999.
As a result of the foregoing, net revenues increased by $11,779,210, or 132.9%,
from $8,859,946 for fiscal 1998 to $20,639,156 for fiscal 1999. Nearly all of
our revenues were generated by clients in the United States and no single group
of related clients accounted for 10% or more of our revenues.
18
<PAGE>
Interest expense increased from $244,322 for fiscal 1998 to $333,457 for fiscal
1999 as a result of increased borrowings.
Total expenses increased by $11,751,548, or 124.0%, from $9,479,591 for fiscal
1998 to $21,231,139 for fiscal 1999. Commissions, floor brokerage and clearing
charges represent payments to our clearing and floor brokers and to software
vendors who facilitate our clients' transactions. As a result of the large
increase in the volume of business conducted by our online trading accounts,
such expenses increased by $4,542,040, or 132.6%, from $3,425,725 for fiscal
1998 to $7,967,765 for fiscal 1999. Employment compensation and related costs
increased by $3,058,627, or 136.1%, from $2,247,963 for fiscal 1998 to
$5,306,590 for fiscal 1999, largely due to the hiring of 95 new employees to
service the growth in our client base. Communications expense increased by
$479,058, or 63.3%, from $757,391 for fiscal 1998 to $1,236,449 for fiscal 1999
as a function of the growth in our online trading accounts. We expect that the
foregoing expenses will continue to increase as we expand our client base.
Business development costs consist primarily of advertising costs to obtain new
accounts, which have mostly been for print and media advertising. These expenses
increased by $1,035,721, or 105.6%, from $980,651 for fiscal 1998 to $2,016,372
for fiscal 1999 as our company increased our planned advertising and promotional
efforts. We anticipate that this percentage increase will accelerate and
increase substantially in light of our plans to more aggressively market our
services in an attempt to obtain additional accounts.
Professional services increased from $971,494 for fiscal 1998 to $1,532,994 for
fiscal 1999 due to the general growth in our business. Occupancy and equipment
costs increased by $1,462,911, or 329.3%, from $444,169 for fiscal 1998 to
$1,907,080 for fiscal 1999, primarily due to the relocation of our offices to a
new, 19,000 square foot facility and the leasing of additional equipment to
increase our capacity and to facilitate the relocation efforts. Depreciation and
amortization increased by $257,981, or 71%, from $363,207 for fiscal 1998 to
$621,188 for fiscal 1999 for similar reasons. Other expenses increased by
$353,710, or 122.4%, from $288,991 for fiscal 1998 to $642,701 for fiscal 1999
due to our overall growth.
The income tax provision increased from $12,765 for fiscal 1998 to $32,494 for
fiscal 1999.
An extraordinary loss of $177,125 was recorded as a result of an early
retirement of $500,000 of debt. The extraordinary loss was comprised of a $5,000
prepayment penalty and unamortized option costs of $172,125.
As a consequence of the foregoing, our operating results before extraordinary
loss were essentially unchanged on a substantially higher volume of business
after significant investments in infrastructure in fiscal 1999. We suffered a
loss of $632,410 for fiscal 1998 as compared to a loss before extraordinary loss
on early extinguishment of debt of $624,477 and a net loss of $801,602 for
fiscal 1999.
Liquidity and Capital Resources
Prior to our initial public offering (IPO), our capital requirements exceeded
our cash flow from operations as we built our business. Since the IPO, the
proceeds from the IPO, the exercise of stock options and warrants of $3,241,993,
the sale of $3,000,000 of stock through our equity line facility, loans from
officers of our company of $3,500,000 and cash flow from operations have been
able to satisfy our cash needs as we continued to build our business.
In January 1999, we obtained a $400,000 loan from New York Community Investment
Company L.L.C. (NYCIC), 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.
On April 23, 1999, we consummated our initial public offering of common stock.
Our company sold 2,300,000 shares of common stock at a gross offering price of
$7 per share, receiving net proceeds of approximately $13,250,000. We utilized
approximately $776,800 for the repayment of outstanding notes payable of
$500,000 to New York Small Business Venture Fund LLC and a
19
<PAGE>
$250,000 promissory note, including any accrued interest on these same notes
payable. We are using the proceeds of the IPO to expand our operations and
finance our future working capital requirements.
Effective August 8, 2000, we entered into an agreement with an investment group
providing us with an eighteen-month equity line of up to $48,000,000. The
agreement allows us to draw down funds in exchange for equity. We are not
obligated to take down any of the funds and pricing is based upon ninety four
percent of the volume weighted average price of our common stock for the 22 days
prior to each takedown. We have registered the securities to be sold to the
investment group pursuant to the equity line facility for resale under the
Securities Act of 1933. On September 6, 2000, we drew down $3,000,000 of the
equity line, and issued 333,333 shares to the investment group and received net
proceeds of $2,850,000.
During fiscal 2000 our company borrowed $3,500,000 from officers of our company
at rates ranging from 7% to 10%, which loans mature in the next two years.
During the twelve months ended September 30, 2000, we spent approximately
$5,000,000 for software development. We completed a major project in August
2000. These software development efforts are related to the creation of
proprietary direct access online trading and market information software. The
software development efforts will allow us to transition our UltimateTrader and
WatleyTrader customers from vendor software to our proprietary software system
which is expected to reduce our operating costs by approximately $1,200,000 per
month beginning in the second quarter of fiscal 2001. Due to the implementation
of our proprietary software, we will recognize additional expenses including the
amortization of capitalized software of approximately $277,000 per month, and
the recognition of software developers salaries as an expense, previously
capitalized, of approximately $200,000 per month or $5,724,000 annually. As of
December 14, 2000, we have transitioned approximately 3,400 UltimateTrader
customers on to our proprietary software reducing our costs to outside vendors
by approximately $816,000 per month.
Throughout fiscal 1999 and 2000, we have entered into various operating leases
which are used to obtain computer equipment. In certain leases, we were required
to deliver to the lender a letter of credit or cash deposits. In connection with
such leases, we have granted the lender a security interest in all the equipment
purchased. In addition, during fiscal 2000, our company purchased equipment and
incurred capital lease obligations of $2,047,410.
As of September 30, 2000 and 1999, our company has notes payable of $1,455,794
and $2,035,445, respectively, to two vendors for the purchase of software
licenses. The current value of the notes includes imputed interest totaling
$221,697 and $127,533, respectively. The average effective interest rate on the
notes approximates 8%. The notes are payable in installments over the next two
years.
Cash used by operating activities during fiscal 2000 was $6,107,588. We had a
net loss of $9,846,891 and an increase from other assets of $1,037,957,
restricted cash of $17,679, securities owned of $176,780 and receivables from
clearing brokers of $493,621, which was offset by an increase in accounts
payable and accrued liabilities of $2,876,407, and other liabilities of
$535,275, and non-cash items such as depreciation and amortization of
$1,583,954, loss on investments of $256,386, and non-cash compensation/service
costs of $94,697.
Cash used in investing activities was $8,960,548 during fiscal 2000. Uses of
cash in fiscal 2000 related to purchases of equipment, software and leasehold
improvements made in our new facility at 40 Wall Street as well as investments
in Insider Financial Services Online Ltd. and Gale Technologies, Inc., offset by
deferred rent incentives of $647,042. In addition to the cash used in investing
activities during the year 2000, we accrued accounts payable relating to
purchases of property and equipment of $625,870 during this period.
Cash provided by financing activities was $10,859,397 during fiscal 2000. Cash
provided by financing activities during fiscal 2000 consisted primarily of
proceeds from the sale of common stock in a private equity offering of 333,333
shares at an offering price of $9.00, employee exercised stock options of
approximately $1,282,000, exercised warrants of approximately $1,960,000 and
loans from officers of approximately $3,500,000 and proceeds from obligations
under capital leases of approximately $2,047,000. We used a portion of these
proceeds to pay approximately $485,487 in notes payable, and $257,852 to pay
obligations on capital leases.
We had cash and cash equivalents of $9,298,822 as of September 30, 1999. Our
operating activities used $25,189 of net cash. We had a net loss of $801,602 and
an increase in other assets of $1,350,857, restricted cash of $513,753,
securities owned of $109,863, and receivables from clearing brokers of $94,453,
which was more than offset by depreciation and amortization of $626,187,
non-cash amortization of option costs of $210,683, and an increase in accounts
payable and accrued liabilities and other liabilities of $1,800,469. We used
$6,123,595 of net cash in investing activities, consisting of property and
equipment purchases and an investment in Gale Technologies, Inc. Financing
activities provided $14,477,298 of net cash, consisting of approximately
$14,364,000 from proceeds of our IPO and a private placement, and approximately
$150,000 in notes payable.
Watley has outstanding an aggregate of $405,000 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:
<PAGE>
o a $55,000 principal amount non-interest bearing loan; and
o a $200,000 principal amount loan, bearing interest at an annual
20
<PAGE>
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.
For each of the years ended September 30, 2000 and 1999, interest expense on
these loans amounted to $42,000.
Watley is currently required to maintain minimum net capital such that the ratio
of aggregate indebtedness to net capital both as defined shall not exceed 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
September 30, 2000, Watley had net capital of $1,627,920, which was $1,313,751
in excess of its minimum required net capital, and Watley's aggregate
indebtedness to net capital ratio was 2.9 to 1.
Net Operating Loss Carryforwards
Our net operating loss carryforwards expire beginning in the year 2013. The
issuance of additional equity securities, together with our recent financings
and the IPO, 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 issued at or above
the fair market value of the stock. 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 1999,
1998 and 1997 stock option grants on the fair value method.
In fiscal 1999, we adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise." Under the new
standard, our company is required to use the management approach to reporting
its segments. The management approach designates that the internal organization
that is used by management for making operating decisions and assessing
performance as the source of our company's segments. Based on this approach, we
have determined that we operate in one reporting segment.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new standard requires companies to
record derivatives on the balance sheet as assets or liabilities, measured at
fair value. Gains or losses resulting from changes in the values of those
derivatives will be reported in the statement of operations or as a deferred
item, depending on the use of the derivatives and whether they qualify for hedge
accounting. The key criterion for hedge accounting is that the derivative must
be highly effective in achieving offsetting changes in fair value or cash flows
of the hedged items during the term of the hedge. The new standard is not
expected to impact our company's financial position or statement of operations.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 140
replaces SFAS No. 125, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities." It revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures, but it carries over most of SFAS
No. 125's provisions without reconsideration. SFAS No. 140 is effective for
transactions after March 31, 2001. This standard is not expected to impact our
company's financial position or statement of operations.
21
<PAGE>
Year 2000 Issues
The financial markets were essentially unaffected by the issues regarding Y2K,
reporting only a few minor technical problems. Our company and its
counterparties were not adversely affected. However, we will continue monitoring
our systems and those of our vendors to ensure that there is no material
disruption to our operations due to Y2K issues.
ITEM 7. FINANCIAL STATEMENTS.
The financial statements required by this Item are enumerated in Item 13 and
are found following page 30 of this Report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.
Our executive officers and directors are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Steven Malin 43 Chairman of the Board, Chief Executive Officer and Director
Robert Malin 35 Vice Chairman, President of A.B. Watley, Inc. and Director
Anthony G. Huston 37 President and Director
Eric Steinberg 35 Executive Vice President - Administration
Leon Ferguson 38 Executive Vice President and Chief Information Officer
Peter A. Wigger 54 Executive Vice President and Director of Operations
Joseph M. Ramos, Jr. 42 Executive Vice President and Chief Financial Officer
Elizabeth Chambers 38 Director
Mark Chambre 39 Director
Michael B. Kraines 37 Director
Stanley Weinstein 74 Director
</TABLE>
Steven Malin. Steven Malin co-founded our company 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.
Robert Malin. Robert Malin is a co-founder of our company and has served as a
director since inception. 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 President since September 2000 and
has served as a director of our company since March 2000. From May 1996 to
September 2000, he was Executive Vice President. 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.
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 our
company. 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.
22
<PAGE>
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.
Peter A. Wigger. Mr. Wigger has been our Executive Vice President and Director
of Operations since September 1999. From January 1997 to January 1999, he was
Chairman and Chief Executive Officer of National Investor Services Corp., the
clearing subsidiary of TD Waterhouse Securities Inc., an international
broker-dealer. From October 1987 to December 1997, he was Executive Vice
President and a member of the Waterhouse Securities Board of Directors. From
July 1986 to October 1987, he was Senior Vice President and Director of
Operations for Scotia Mcleod. From January 1970 to July 1986, Mr. Wigger was
Vice President and Director of Operations for Richardson Greenfields Securities
Inc.
Joseph M. Ramos, Jr. Mr. Ramos has been our Executive Vice President and Chief
Financial Officer since October 2000. From June 1999 to October 2000 he was
Senior Vice President and Chief Financial Officer. From March 1998 to June 1999,
he was Chief Financial Officer of Nikko Securities Co., International, an
international broker-dealer. He was also Controller with Nikko Securities Co.,
International from November 1997 to March 1998. From April 1997 to November
1997, he was Chief Financial Officer of Brunswick Securities Inc., an
international broker-dealer. From September 1987 to February 1996, he served in
various management positions at Cantor Fitzgerald Securities, a broker-dealer.
His most recent position was Chief Financial Officer of their broker-dealer
operations based in Los Angeles, California. From October 1982 to September
1987, he was on the audit staff of Deloitte & Touche, LLP, an international
accounting firm. Mr. Ramos is a Certified Public Accountant, licensed in New
York State. He received a bachelor of science degree in accounting from St.
John's University in 1982.
Elizabeth Chambers. Ms. Chambers has served as director of our company since
April 1999. Since October 1999, she has been Senior Vice President of Strategy
and Business Development at the Reader's Digest Association. From August 1998 to
October 1999, she was 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.
Mark Chambre. Mr. Chambre has served as a director of our company since April
1999. 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 Mary 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.
Michael B. Kraines. Mr. Kraines has served as a director of our company since
March 2000. Since January 1999, he has been a director with the Financial
Institutions Group of Wasserstein Perella & Co., Inc., an international
investment bank. From Febuary 1995 to January 1999 he served as Vice President
of Wasserstein Perella. In connection with this practice, he has advised
companies in banking, finance, asset management and brokerage and mergers and
acquisitions, among other things. Mr. Kraines graduated from Cornell University
with a major in government in 1985 with distinction and Phi Beta Kappa. In 1988,
he received a J.D. from Harvard Law School, graduating cum laude and serving as
Notes Editor on the Harvard Journal on Legislation. Mr. Kraines also received an
M.B.A. with a concentration in finance from The University of Chicago in 1992.
Stanley Weinstein. Mr. Weinstein has served as a director of our company since
April 1999. 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
products.
Directors are elected at each annual meeting of stockholders and hold office
until the next annual meeting of stockholders and the election and
qualifications of their successors. Executive officers are elected by and serve
at the discretion of the board of directors.
23
<PAGE>
Compliance with Section 16(a) of the Exchange Act.
During the fiscal year ended September 30, 2000, based upon an examination of
the public filings, all of our company's officers and directors timely filed
reports on Forms 3 and 4, except for Mr. Ferguson who was late in reporting the
acquisition of 175 shares for his individual retirement account.
Item 10. Executive Compensation.
The following table sets forth for the fiscal year indicated the compensation
paid by our company to our Chief Executive Officer and other executive officers
with annual compensation exceeding $100,000:
Summary Compensation Table
<TABLE>
<CAPTION>
Long Term
Annual Compensation Compensation
------------------- ------------
Awards
Name and Underlying
Principal Position Fiscal Year Salary Bonus Options/SARs(#)
------------------ ----------- ------ ----- ---------------
<S> <C> <C> <C> <C>
Steven Malin, 2000 $110,000 $22,000 0
Chairman and Chief 1999 93,075 18,615 0
Executive Officer
Anthony G. Huston 2000 110,000 22,000 0
President 1999 72,887 14,577 0
Peter A. Wigger, 2000 175,000 50,000 0
Executive Vice President and 1999 6,731 0 150,000
Director of Operations
Harry Simpson, 2000 71,923 16,500 0
President and Chief 1999 99,736 19,947 200,000
Operating Officer (1)
Leon Ferguson, 2000 100,000 20,000 0
Executive Vice President 1999 86,769 17,353 150,000
and Chief Information
Officer
Joseph M. Ramos, Jr. 2000 150,000 30,000 50,000
Executive Vice President and 1999 37,500 0 10,000
Chief Financial Officer
Brett Vernick, Senior 2000 96,200 7,500 0
Vice President, 1999 90,426 18,085 0
Management Information
Services (2)
</TABLE>
Employment Agreements
We have entered into a four-year employment agreement with Steven Malin and
three-year employment agreements with Robert Malin, Anthony G. Huston, Eric
Steinberg, Leon Ferguson and Joseph M. Ramos all of which are automatically
renewable for additional one-year terms. The employment agreements provide for
annual base compensation of $110,000, except for Mr. Ferguson ($100,000), Mr.
Ramos ($150,000) and Mr. Wigger ($175,000). Each agreement provides for a bonus
equal to 20% of their salaries, payable semi-annually except for Mr. Wigger
($50,000 paid annually), based upon certain revenue levels achieved by us, as
may be approved by the board of directors or a committee of the board.
---------------
(1) Mr. Simpson ceased serving as President and Chief Operating Officer on
May 15, 2000.
(2) Mr. Vernick ceased serving as Vice President, Management Information
Services on September 15, 2000.
24
<PAGE>
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.
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. All of our non-employee directors are compensated
annually for their services at $2,000 and granted non-qualified options to
acquire 1,500 shares of our common stock at the end of each year of service.
Option Grants in Last Fiscal Year
The following table contains information concerning options granted to executive
officers named in the Summary Compensation Table during the fiscal year ended
September 30, 2000:
<TABLE>
<CAPTION>
Individual Grants
Number of Securities % of Total Options
Underlying Options Granted to Employees
Name Granted (#) in Fiscal Year Exercise Price ($/sh) Expiration Date
---- ----------- -------------- --------------------- ---------------
<S> <C> <C> <C> <C>
Steven Malin 0 n/a 0 n/a
Joseph M. Ramos, Jr. 10,000 14% 10.00 October 27, 2009
40,000 10.1875 February 1, 2010
Anthony G. Huston 0 n/a 0 n/a
Harry Simpson 0 n/a 0 n/a
Leon Ferguson 0 n/a 0 n/a
Peter A. Wigger 0 n/a 0 n/a
Brett Vernick 0 n/a 0 n/a
</TABLE>
Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values
The following table contains information concerning (i) options exercised by
executive officers named in the Summary Compensation Table during the fiscal
year ended September 30, 2000 and (ii) the number and value, at September 30,
2000, of unexercised options held by executive officers named in the Summary
Compensation Table:
<TABLE>
<CAPTION>
Number of Securities Underlying Value of Unexercised In-the-Money
Shares Acquired Unexercised Options at FY-End (#) Options at FY-End ($)
Name on Exercise (#) Value Realized ($) (Excisable/Unexercisable) (Exercisable/Unexercisable)(1)
---- --------------- ------------------ --------------------------------- ---------------------------------
<S> <C> <C> <C> <C>
Steven Malin 0 n/a 0/0 0/0
Harry Simpson 133,333 1,599,996 0/0 0/0
Leon Ferguson 0 n/a 50,000/100,000 137,500/275,000
Brett Vernick 1,000 17,453 149,000/0 1,004,750/0
Anthony G. Huston 0 n/a 0/0 0/0
Joseph M. Ramos, Jr. 0 n/a 2,500/57,500 0/0
Peter A. Wigger 0 n/a 0/150,000 0/9,000
</TABLE>
(1) Fair market value of underlying securities (the closing price of the
Company's common stock on the National Association of Securities Dealers
Quotation System) at fiscal year end (September 30, 2000) minus the exercise
price.
25
<PAGE>
Stock Option Plans
On January 27, 1997, the board of directors and stockholders adopted our 1997
stock option plan, on March 16, 1998, our board of directors and stockholders
adopted our 1998 stock option plan and on November 1, 1999 and March 14, 2000,
the board of directors and stockholders, respectively, adopted our 1999 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 each of the 1998 and 1999 stock option plans. The 1997,
1998 and 1999 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 is administered by a committee, appointed by our board of directors,
consisting of from one to three directors. The 1998 and 1999 stock option plans
are 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 of
options granted under the 1997 or 1998 stock option plans be less than the fair
market value of the shares of common 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 September 30, 2000, we have granted options to purchase 1,385,350 shares
of common stock under our stock options plans at an exercise price ranging from
$2.00 to $23.50 per share. Of these options, options to purchase 524,000 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 grant
date.
On October 24, 2000, the board of directors, subject to stockholder approval to
be sought at our annual meeting of stockholders to be held in March 2001,
adopted our 2000 stock option plan. We have reserved 800,000 shares of common
stock for issuance upon exercise of options granted from time to time under the
2000 stock option plan. The 2000 stock option plan is 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 the 2000 stock option plan 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 2000 stock option plan
will be administered directly by our board of directors.
Subject to the provisions of the 2000 stock option plan, the board 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 the 2000 stock option
plan 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, in its discretion. The
exercise price may be payable in cash or, with the approval of the board, by
delivery of shares or by a combination of cash and shares. Shares of common
stock received upon exercise of options granted under the 2000 stock option plan
will be subject to restrictions on sale or transfer.
As of December 1, 2000 and subject to stockholder approval as described above,
we have granted options to purchase 133,000 shares of common stock under the
2000 stock option plan at an exercise price of $8.00 per share. All of the
options granted terminate on the ten year anniversary of their grant date.
26
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth information known to us, as of December 1, 2000,
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; each of the executive
officers named in the summary compensation table; 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 A.B. Watley Group Inc., 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 December 1, 2000 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 December 1, 2000 have been exercised and
converted.
<TABLE>
<CAPTION>
Number of Shares Percentage of Shares
Name and Address of Beneficial Owner Beneficially Owned Beneficially Owned
------------------------------------ ------------------ --------------------
<S> <C> <C>
Steven Malin 1,888,194 21.4%
Linda Malin 1,001,200 11.3
Robert Malin 850,000 9.6
Anthony G. Huston 325,000 3.7
Leon Ferguson 143,685 1.6
Peter A. Wigger 0 0
Joseph M. Ramos, Jr. 2,500 0
Harry Simpson 0 0
Brett Vernick 170,500 1.9
Mark Chambre 56,500 .6
Elizabeth Chambers 9,550 0
Michael B. Kraines 1,500 0
Stanley Weinstein 2,000 0
All directors and executive officers as a
group (13 persons) 4,450,629 49.2%
</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 G. Huston does not include
175,000 shares of common stock held by an irrevocable family trust of which
Anthony G. Huston is a beneficiary.
The number of shares beneficially owned by Leon Ferguson includes 50,000 shares
of common stock issuable upon exercise of currently exercisable options, 52,000
shares of common stock held by a trust of which Leon Ferguson is a trustee and a
beneficiary and 175 shares of common stock held in an individual retirement
account.
The number of shares beneficially owned by Peter A. Wigger does not include
150,000 shares of common stock issuable upon exercise of options which are not
currently exercisable.
The number of shares beneficially owned by Brett Vernick includes 149,000 shares
of common stock issuable upon exercise of currently exercisable options.
The number of shares beneficially owned by Joseph M. Ramos, Jr. includes 2,500
shares of common stock issuable upon exercise of currently exercisable options,
but does not include 57,500 shares of common stock issuable upon exercise of
options which are not currently exercisable.
27
<PAGE>
The number of shares beneficially owned by Harry Simpson does not include
350,000 shares of common stock held in trusts of which Harry Simpson is the
beneficiary.
The number of shares beneficially owned by Mark Chambre does not include 2,000
shares of common stock owned by his wife, as to which he disclaims beneficial
ownership.
The number of shares beneficially owned by Michael B. Kraines includes 1,500
shares of common stock issuable upon exercise of currently exercisable options.
The number of shares beneficially owned by all of our officers and directors as
a group includes 203,000 shares of common stock issuable upon exercise of
currently exercisable options, but does not include 307,500 shares of common
stock issuable upon exercise of options which are not currently exercisable.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
In October 1994, Steven Malin, Chairman of the Board and Chief Executive Officer
and a principal stockholder of our company, loaned Watley $55,000 on an interest
free basis. The maturity date for this loan is October 31, 2000. The loan is
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 our company, 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 our company. The loan bears interest
at an annual rate of 6% and is due upon demand.
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 6,535
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 the private placement, Jonathan Priddle, a former officer of our company,
purchased 25,000 shares at a price of $50,000 and Mark Chambre, a director of
our company, purchased 37,500 shares at a price of $75,000. In addition,
relatives of Anthony G. Huston and Eric Steinberg, each an executive officer and
principal stockholder of our company, 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
our company 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 payable on demand, 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 us $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 exercised the option in April 1999. We
repaid the loan, including accrued interest, from the proceeds of the IPO.
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 our company guaranteed our
obligations under this loan. We repaid this loan out of the proceeds of the IPO,
which discharged the liability of the guarantors. Stanley Weinstein, a director
of our company, 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.
28
<PAGE>
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 G. 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.
During fiscal year 2000, we borrowed $3,500,000 from officers and major
stockholders. Such loans were comprised of (i) a $3,200,000 loan from Steven
Malin; (ii) a $150,000 loan from a corporation controlled by Steven Malin; (iii)
a $75,000 loan from a corporation controlled by Linda Malin; and (iv) a $75,000
loan from a corporation controlled by Eric Steinberg. The notes bear interest
ranging from 7% to 10% maturing in two years from the effective date. On April
30, 2000, a subordinated borrowing of $125,000 from Steven Malin matured,
however Mr. Malin continued to loan our company $125,000 at an interest rate of
12% with no stated maturity date.
We believe that prior transactions 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.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report:
1. Financial Statements:
Consolidated Financial Statements of A.B. Watley Group Inc. and
subsidiaries
Report of Independent Auditors
Consolidated Statement of Financial Condition--Year ended September
30, 2000, Consolidated Statements of Operations--Years ended September
30, 2000 and 1999, Consolidated Statements of Changes in Stockholders'
Equity--Years ended
September 30, 2000 and 1999, Consolidated Statements of Cash
Flows--Years ended September 30, 2000 and 1999, Notes to Consolidated
Financial Statements
2. Financial Statement Schedules:
Financial Statement schedules have been omitted because the required
information is inapplicable or because the information is presented
in the financial statements or related notes.
29
<PAGE>
3. Exhibits and Index:
Exhibit
No. Description
------- -----------
3.1 Restated Certificate of Incorporation of the Company and form of
amendment thereto.*
3.2 By-Laws of the Company, as amended.*
4.1 Specimen Common Stock Certificate.*
4.2 Form of Underwriter's Warrant Agreement, including Form of Warrant
Certificate.*
10.1 1997 Stock Option Plan.*
10.2 Second Amended and Restated 1998 Stock Option Plan.*
10.3 Employment Agreement dated as of May 1, 1997 between the Company
and Steven Malin and Amendment to Employment Agreement dated as of
October 1, 1998 between the Company and Steven Malin.*
10.4 Employment Agreement dated as of June 1, 1997 between the Company
and Harry Simpson and Amendment to Employment Agreement dated
October 1, 1998 between the Company and Harry Simpson.*
10.5 Employment Agreement dated as of January 1, 1999 between the
Company and Robert Malin.*
10.6 Employment Agreement dated as of June 1, 1997 between the Company
and Anthony G. Huston and Amendment to Employment Agreement dated
as of October 1, 1998 between the Company and Anthony G. Huston.*
10.7 Employment Agreement dated as of March 1, 1998 between the
Company and Eric Steinberg.*
10.8 Office lease dated as of June 20, 1997 between 40 Wall Development
Associates, LLC, as Landlord and the Company as Tenant for premises
located at 40 Wall Street, New York, New York.*
10.9 [Intentionally omitted.]
10.10 [Intentionally omitted.]
10.11 Co-Branding Agreement dated October 11, 1996 between PC Quote,
Inc. and A.B. Watley, Inc., as amended.*
10.12 Computer Software License Agreement dated December 8, 1996
between Townsend Analytics, Ltd. and A.B. Watley, Inc., as
amended.*
10.13 Fully Disclosed Clearing Agreement dated October 3, 1996 and
Amendment dated June 8, 1998 between Penson Financial Services,
Inc. and A.B. Watley, Inc.*
10.14 Fully Disclosed Correspondent Agreement dated November 18, 1996
between Weiss, Peck & Greer, L.L.C. and A.B. Watley, Inc.*
10.15 License Agreement dated as of October 1, 1998 between Ethos
Corporation and A.B. Watley, Inc.*
10.16 Service Marketing Representative Agreement dated as of January
29, 1998 between S&P ComStock, Inc. and A.B. Watley, Inc.*
10.17 Master Lease Agreement dated December 17, 1998 between General
Electric Capital Corporation and the Company.*
10.18 Security Agreement dated December 17, 1998 between General
Electric Capital Corporation and the Company.*
10.19 Letter of Credit Agreement dated December 17, 1998 between
General Electric Capital Corporation and the Company.*
10.20 Loan Agreement dated January 28, 1999 between New York
CommunityInvestment Company L.L.C., the Company and A.B. Watley,
Inc.*
10.21 Promissory Note of the Company and A.B. Watley, Inc. dated
January 28, 1999 issued to the New York Community Investment
Company L.L.C.*
10.22 Security Agreement dated January 28, 1999 between New York
Community Investment Company L.L.C. and A.B. Watley, Inc.*
10.23 Security Agreement dated January 28, 1999 between New York
Community Investment Company L.L.C. and the Company.*
10.24 Objectivity Master License and Support Agreement dated September
30, 1999 between Objectivity, Inc. and A.B. Watley Group Inc. **
10.25 Reseller Network License Order Form dated May 26, 1999 between
Database Consultants Inc. and A.B. Watley Group Inc. **
10.26 1999 Stock Option Plan***
10.27 Employment Agreement dated as of June 18, 1999 between the
Company and Joseph Ramos.
10.28 Employment Agreement dated as of September 1, 1999 between the
Company and Peter Wigger.
23.2 Consent of Ernst & Young LLP, independent auditors.
99.27 Financial Data Schedule
* Filed as an exhibit to the Company's Registration Statement on
Form SB-2 (File No. 333-71783) and hereby incorporated by
reference herein.
** Filed as an exhibit to the Company's Annual Report on Form 10-KSB
for the year ended September 30, 1999 and hereby incorporated by
reference herein.
*** Filed as an exhibit to the Company's Registration Statement on
Form S-8 (File No. 333-35340) and hereby incorporated by
reference herein.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the quarter ended September 30, 2000.
30
<PAGE>
A.B. Watley Group Inc.
Consolidated Financial Statements
Years Ended September 30, 2000 and 1999
Contents
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Auditors F-2
Consolidated Statement of Financial Condition as of September 30, 2000 F-3
Consolidated Statements of Operations for the Years Ended September 30, 2000 and 1999 F-4
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended
September 30, 2000 and 1999 F-5
Consolidated Statements of Cash Flows for the Years Ended September 30, 2000 and 1999 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 A.B. Watley Group Inc.
We have audited the accompanying consolidated statement of financial condition
of A.B. Watley Group Inc. (the "Company") as of September 30, 2000, and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows for the years ended September 30, 2000 and 1999. 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 auditing standards generally accepted
in the United States. 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 A.B. Watley Group
Inc. as of September 30, 2000, and the consolidated results of its operations
and its cash flows for the years ended September 30, 2000 and 1999 in conformity
with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
New York, New York
November 22, 2000
F-2
<PAGE>
A.B. Watley Group Inc.
Consolidated Statement of Financial Condition
<TABLE>
<CAPTION>
September 30, 2000
-----------------
<S> <C>
ASSETS
Cash and cash equivalents $5,090,083
Restricted cash 531,432
Securities owned, at market value 391,161
Receivables from clearing brokers 1,119,909
Property and equipment, at cost, net of accumulated depreciation and amortization
of $2,929,737 18,523,320
Investments 728,614
Loan receivable from related party 128,071
Other assets 2,520,054
-----------
Total assets $29,032,644
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Subordinated borrowings $350,000
Subordinated borrowings from officer 55,000
Securities sold, not yet purchased, at market value 180,993
Notes payable to officers 3,625,000
Notes payable, net of unamortized discount of $127,533 1,728,261
Bank loan 3,333
Deferred rent incentives 1,399,554
Accounts payable and accrued liabilities 7,063,840
Other liabilities 2,448,877
-----------
Total liabilities 16,854,858
-----------
Stockholders' equity:
Common stock, $.001 par value, 20,000,000
authorized, 8,798,090 issued and outstanding 8,798
Additional paid-in capital 24,814,573
Option costs, net (93,331)
Accumulated deficit (12,552,254)
------------
Total stockholders' equity 12,177,786
-----------
Total liabilities and stockholders' equity $29,032,644
===========
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
A.B. Watley Group Inc.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Years ended
-----------
September 30, September 30,
2000 1999
---- ----
<S> <C> <C>
Revenues:
Commissions $32,968,193 $16,198,858
Data service revenues 2,015,396 1,640,123
Principal transactions 5,689,695 2,456,874
Interest and other income 2,073,190 685,578
Interest income - related party 6,180 6,180
----------- -----------
Total revenues 42,752,654 20,987,613
Interest expense 373,354 333,457
Interest expense - related party 71,417 15,000
----------- -----------
Net revenues 42,307,883 20,639,156
----------- -----------
Expenses:
Commissions, floor brokerage and clearing charges 20,605,576 7,967,765
Employee compensation and related costs 11,802,131 5,306,590
Business development 8,569,200 2,016,372
Occupancy and equipment 4,671,865 1,907,080
Communications 1,877,709 1,236,449
Professional fees 1,726,598 1,532,994
Depreciation and amortization 1,583,954 621,188
Other expenses 1,007,442 642,701
----------- -----------
Total expenses 51,844,475 21,231,139
----------- -----------
Loss from operations (9,536,592) (591,983)
Loss on investments 256,386 --
----------- -----------
Loss before income tax and extraordinary loss on early
extinguishment of debt (9,792,978) (591,983)
Income tax provision 53,913 32,494
----------- -----------
Loss before extraordinary loss on early extinguishment
of debt (9,846,891) (624,477)
Extraordinary loss on early extinguishment of debt -- (177,125)
------------ ----------
Net loss $(9,846,891) $(801,602)
============ ==========
Basic and diluted earnings before extraordinary item per
common share ($1.21) ($0.09)
======= =======
Basic and diluted earnings per common share ($1.21) ($0.11)
======= =======
Weighted average shares outstanding - basic and diluted
8,122,393 7,136,434
========= =========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
A.B. Watley Group Inc.
Consolidated Statements of Changes in Stockholders' Equity
<TABLE>
<CAPTION>
Common Stock Issued Additional Subscriptions Receivable
------------------- Paid-in Option ------------------------
Shares Par Value Capital Costs, net Shares Amount
------ --------- ------- ---------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
Balance at October 1, 1998 5,137,500 $5,138 $3,758,333 $(100,292) (250,011) $(4,999)
Issuance of common stock, net 2,794,245 2,794 14,548,137 -- 250,111 4,999
Issuance of non-employee stock
options -- -- 24,029 -- -- --
Option costs, net -- -- 331,250 (21,039) -- --
Net loss -- -- -- -- -- --
--------- ------ ----------- --------- --------- --------
Balance at September 30, 1999 7,931,745 $7,932 $18,661,749 $(121,331) -- $--
Issuance of common stock, net 866,345 866 6,091,127 -- -- --
Options costs, net -- -- -- 28,000 -- --
Net loss -- -- -- -- -- --
Other -- -- 61,697 -- -- --
--------- ------ ----------- --------- --------- --------
Balance at September 30, 2000 8,798,090 $8,798 $24,814,573 $(93,331) -- $--
========= ====== =========== ========= == ===
</TABLE>
<TABLE>
<CAPTION>
Accumulated
Deficit Total
------- -----
<S> <C> <C>
Balance at October 1, 1998 $(1,903,761) $1,754,419
Issuance of common stock, net 14,555,930
Issuance of non-employee stock
options -- 24,029
Option costs, net -- 310,211
Net loss (801,602) (801,602)
------------ -----------
Balance at September 30, 1999 $(2,705,363) $15,842,987
------------ -----------
Issuance of common stock, net -- 6,091,993
Options costs, net -- 28,000
Net loss (9,846,891) (9,846,891)
Other -- 61,697
------------ -----------
Balance at September 30, 2000 $(12,552,254) $12,177,786
============= ===========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
A.B. Watley Group Inc.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years ended
-----------
September 30, September 30,
2000 1999
---- ----
<S> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES
Net loss $(9,846,891) $(801,602)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,583,954 626,187
Non-cash compensation/service costs 94,697 210,683
Loss on early extinguishment of debt -- 177,125
Loss on investments 256,386
Changes in assets and liabilities:
Increase in operating assets:
Restricted cash (17,679) (513,753)
Securities owned (176,780) (109,863)
Receivables from clearing brokers (493,621) (94,453)
Loans receivable from related party (6,180) (6,180)
Other assets (1,037,957) (1,350,857)
Increase in operating liabilities:
Securities sold, not yet purchased 124,801 37,055
Accounts payable and accrued liabilities 2,876,407 1,552,517
Other liabilities 535,275 247,952
----------- ----------
Net cash used in operating activities (6,107,588) (25,189)
----------- ----------
CASH FLOWS USED IN INVESTING ACTIVITIES
Purchases of property and equipment, net (8,732,590) (6,013,595)
Investments (875,000) (110,000)
Deferred rent incentives 647,042 --
----------- ----------
Net cash used in investing activities (8,960,548) (6,123,595)
----------- ----------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Proceeds from sale of common stock, net 2,850,000 14,364,798
Proceeds from exercised stock options 1,281,993 2,500
Proceeds from exercised stock warrants 1,960,000 --
Proceeds from notes payable to officers 3,500,000 --
Proceeds from (repayment of) notes payable (485,487) 150,000
Payment of lease obligations under capital leases (257,852) --
Proceeds from obligations under capital leases 2,047,410 --
Repayment of bank loan (36,667) (40,000)
----------- ----------
Net cash provided by financing activities 10,859,397 14,477,298
----------- ----------
Net (decrease) increase in cash and cash equivalents (4,208,739) 8,328,514
Cash and cash equivalents at beginning of year 9,298,822 970,308
----------- ----------
Cash and cash equivalents at end of year $5,090,083 $9,298,822
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Accounts payable for purchases of property and equipment $625,870 $715,242
Notes payable for purchases of property and equipment -- 1,813,748
Cash paid for:
Interest $316,800 $184,371
Taxes 40,425 5,858
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
A.B. Watley Group Inc.
Notes to Consolidated Financial Statements
Years ended September 30, 2000 and 1999
1. Organization and Basis of Presentation
A.B. Watley Group Inc. ("ABWG" or the "Company"), which was formerly known as
Internet Financial Services Inc., 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.
The consolidated financial statements include the accounts of ABWG 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.
2. Summary of Significant Accounting Policies
Cash and Cash Equivalents:
Cash and cash equivalents include highly liquid instruments with original
maturities of less than three months held by one global financial institution.
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 rea1-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>
A.B. Watley Group Inc.
Notes to Consolidated Financial Statements - (Continued)
Years ended September 30, 2000 and 1999
2. Summary of Significant Accounting Policies - (Continued)
Property and Equipment:
Computer equipment and furniture and fixtures are carried at cost and
depreciated/amortized 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 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.
Investments
The Company accounts for its investments using the equity method in accordance
with generally accepted accounting principles.
Use of Estimates:
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States 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". 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 in the same period(s) and in the same manner as if the Company had paid
cash for the services instead of paying with or using the stock options.
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. Advertising production
costs are expensed when the initial advertisement is run. Costs of communicating
advertising are expensed as the services are received. Substantially all
business development costs relate to advertising.
Income Taxes:
Income taxes have been provided using the liability method under Statement of
Financial Accounting Standards ("SFAS") No.109, "Accounting for Income Taxes."
F-8
<PAGE>
A.B. Watley Group Inc.
Notes to Consolidated Financial Statements - (Continued)
Years ended September 30, 2000 and 1999
Segment Reporting:
In fiscal 1999, the Company adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information". SFAS No. 131 supersedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise". Under the new
standard, the Company is required to use the management approach to reporting
its segments. The management approach designates the internal organization that
is used by management for making operating decisions and assessing performance
as the source of the Company's segments. Based on this approach, the Company has
determined that it operates in one reporting segment.
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, 2000, A.B. Watley had net capital,
as defined, of $1,627,920 which was $1,313,751 in excess of its required net
capital of $314,169. The aggregate indebtedness to net capital ratio was 2.9 to
1.
4. Financial Instruments with Off-Balance Sheet Risk or Concentration 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, 2000 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>
A.B. Watley Group Inc.
Notes to Consolidated Financial Statements - (Continued)
Years ended September 30, 2000 and 1999
5. Property and Equipment September 30,
2000
----
Computer equipment $5,167,001
Software 10,867,859
Construction-in-progress 273,770
Furniture, fixtures and leasehold improvements 5,144,427
-----------
21,453,057
Less accumulated depreciation and amortization 2,929,737
-----------
$18,523,320
===========
At September 30, 2000, substantially all software represents software developed
for internal use. Effective September 2000, the Company began amortizing
approximately $10 million of capitalized software developed for internal use
over a three year period or approximately $277,000 per month (See Note 2).
Construction-in-progress represents amounts related to leasehold improvements
being made on the Company's office space. (See Note 2).
Included in computer equipment as of September 30, 2000 is equipment purchased
under capital leases of $2,047,410. There were no capital leases as of September
30, 1999. These assets secure the related obligations under capital leases of
$1,789,558 as of September 30, 2000 which are included in other liabilities in
the statement of financial condition.
6. Subordinated Borrowings
Borrowings of $405,000 at September 30, 2000 are subordinated to the claims of
general creditors, and mature on October 31, 2001, as amended on October 15,
2000. The subordinated borrowings of $200,000, $150,000 and $55,000 bear
interest at annual rates of 15%, 13% and 0%, 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, $55,000 is from an officer and stockholder of the Company. For the
year ended September 30, 2000 and 1999, interest expense on the subordinated
loans amounted to $58,250 and $64,500, respectively.
7. Notes Payable
Effective January 28, 1999, the Company borrowed $400,000 from New York
Community Investment Company, L.L.C. ("NYCIC") 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. At
September 30, 2000, the principal balance on this loan is $400,000.
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 Company's initial public offering
("IPO") price. The fair value of the warrants (approximately $140,000) is being
accounted for as a debt servicing fee and amortized over the life of the loan.
The unamortized amount of the debt servicing fee is included as "Option costs,
net" in Stockholders' Equity. Amortization expense relating to the debt
servicing fee for the years ended September 30, 2000 and 1999 amounted to
$28,000 and $18,669, respectively.
F-10
<PAGE>
A.B. Watley Group Inc.
Notes to Consolidated Financial Statements - (Continued)
Years ended September 30, 2000 and 1999
As of September 30, 2000, the Company has notes payable of $1,455,794 to two
vendors for the purchase of software licenses. The current value of the notes
includes imputed interest totaling $127,533. The average effective interest rate
on the notes approximates 8%. The notes are payable in installments.
Installments equaling $984,548 and $471,246 are payable during the years ended
September 30, 2001 and 2002, respectively.
8. Bank Loan
The bank loan, an unsecured term loan carrying an interest rate of 8.5%, was
fully paid on October 1, 2000.
9. Loans Receivable from Related Party
Included in loans receivable from related party in the consolidated statement of
financial condition are notes of $103,000, plus accrued interest of $25,071, to
an officer and stockholder of the Company. The notes generally bear interest at
an annual rate of 6% and are payable on demand.
10. Notes Payable to Officers
The Company issued the following promissory notes to officers and major
stockholders of the Company:
Effective Maturity Principal Interest
Date Date Amount Rate
---- ---- ------ ----
April 30, 2000 -- $ 125,000 12%
March 23, 2000 March 22, 2002 75,000 10%
March 23, 2000 March 22, 2002 150,000 10%
March 23, 2000 March 22, 2002 75,000 10%
May 31, 2000 May 30, 2002 500,000 7%
June 30, 2000 May 31, 2002 1,200,000 7%
August 20, 2000 July 31, 2002 1,000,000 7%
September 24, 2000 September 23, 2002 500,000 7%
---------
$3,625,000
==========
As of September 30, 2000, accrued interest on notes payable to officers was
$71,417.
11. Commitments and Contingencies
The Company has entered into certain leases for office space under
noncancellable operating lease agreements that expire on June 23, 2009 and
contain escalation provisions. The Company has also entered into various
operating leases which are used to obtain computer equipment and software. As of
September 30, 2000, the aggregate minimum future rental payments required under
operating leases were as follows:
Year ended September 30,
------------------------
2001 $4,470,283
2002 3,709,475
2003 2,638,674
2004 1,574,880
F-11
<PAGE>
A.B. Watley Group Inc.
Notes to Consolidated Financial Statements - (Continued)
Years ended September 30, 2000 and 1999
2005 1,552,507
Thereafter 6,098,121
-----------
$20,043,940
===========
During the year ended September 30, 2000, the Company purchased $2,047,410
of computer equipment under various capital leases and incurred capital lease
obligations of the same amount. The required future minimum payments under the
capital leases are $882,160 in 2001 and 2002, and $513,900 in 2003.
Rent expense for the years ended September 30, 2000 and 1999 was $3,334,740 and
$1,476,623, respectively.
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.
12. Stock Options
Under the Company's 1999, 1998 and 1997 Stock Option Plans (collectively, the
"Plans"), employees, non-employee directors, 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 1999, 1998
and 1997 Plans cannot exceed 800,000, 800,000 and 400,000 shares, respectively,
(2,000,000 shares in total). No option shall be granted under the 1999 Plan
after November 1, 2009, under the 1998 Plan after March 16, 2008 or under the
1997 Plan after January 26, 2007.
A summary of the Company's stock option activity (exclusive of the warrants
discussed in Notes 7 and 14) and related information for the years ended
September 30, 2000 and 1999 is as follows:
Number of Weighted Average
Shares Exercise Price
--------- ----------------
Outstanding at October 1, 1998 420,100 $2.34
Granted, year ended September 30, 1999 1,068,850 7.89
Exercised, year ended September 30, 1999 125,000 0.02
Forfeited, year ended September 30, 1999 1,500 9.40
Outstanding at September 30, 1999 1,362,450 5.94
Granted, year ended September 30, 2000 356,775 13.11
Exercised, year ended September 30, 2000 193,183 6.68
Forfeited, year ended September 30, 2000 140,692 8.45
Outstanding at September 30, 2000 1,385,350 9.90
Exercisable at September 30, 1999 342,955 4.49
Exercisable at September 30, 2000 533,829 6.24
Included in the table above are non-employee option grants of 44,750 shares for
the year ended September 30, 1999.
During the year ended September 30, 2000 certain employees were granted stock
options below fair market value. Compensation expense related to these options
amounted to $61,697 for the year ended September 30, 2000.
F-12
<PAGE>
A.B. Watley Group Inc.
Notes to Consolidated Financial Statements - (Continued)
Years ended September 30, 2000 and 1999
The weighted average fair value of options granted during the years ended
September 30, 2000 and 1999 was $8.88 and $3.05, 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 estimate of its
stock options. In calculating the fair values of the stock options, the
following weighted average assumptions were used:
2000 Grants 1999 Grants 1999 Grants
----------- ----------- -----------
Subsequent Prior
to IPO To IPO
----------- -----------
Dividend yield 0% 0% 0%
Weighted average expected life:
Employees 4.5 years 4.8 years 4.8 years
Non-employees 0.1 Years 0.2 years 0.2 years
Weighted average risk-free interest rate 6.1% 5.1% 5.1%
Expected volatility 79% 77% 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 2000 and 1999 stock option grants on the fair value method. For purposes of
the pro forma information, the fair values of the 2000 and 1999 option grants to
employees are amortized over the vesting period. The effects of applying SFAS
No. 123 for providing pro-forma disclosures are not likely to be representative
of the effects on reported pro-forma net income for future years. The pro forma
information for the years ended September 30, 2000 and 1999 is as follows:
Years ended September 30,
-------------------------
2000 1999
---- ----
Net loss as reported............. $ (9,846,891) $ (801,602)
Net loss pro forma............... $(11,704,931) $(1,228,531)
Net loss per share as reported... $(1.21) $(.11)
Net loss per share pro forma..... $(1.44) $(.17)
Additional information regarding options outstanding as of September 30, 2000
(exclusive of the warrants discussed in Notes 7 and 14) is as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------- --------------------
Weighted Average
Number Remaining Number
Range of Exercisable Outstanding as Contractual Life Weighted Average Exercisable as Weighted Average
Prices of 9/30/00 (years) Exercise Price of 9/30/00 Exercise Price
-------------------- -------------- ----------------- ---------------- -------------- ----------------
<S> <C> <C> <C> <C> <C>
$2.00 156,500 7.52 $2.00 156,500 $2.00
$5.00 85,700 8.78 $5.00 43,550 $5.00
$7.00 560,775 8.46 $7.00 216,104 $7.00
$9.81-$13.25 438,800 9.09 $10.26 108,800 $10.12
$15.25-$23.50 143,575 9.64 $17.20 8,875 $20.94
--------- -------
1,385,350 533,829
========= =======
</TABLE>
F-13
<PAGE>
A.B. Watley Group Inc.
Notes to Consolidated Financial Statements - (Continued)
Years ended September 30, 2000 and 1999
For financial reporting purposes, the Company is required to recognize
compensation expense on the options issued under the 1999 stock option plan
equal to the instrinsic value of the options, defined as the positive difference
between the fair value of the Company's common stock at September 30, 1999 and
the strike prices of options, amortized over the vesting period of the options.
For the year ended September 30, 1999, the compensation expense incurred related
to the 1999 stock option plan was immaterial.
13. Income Taxes
The Company files consolidated federal, state and local income tax returns 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, 2000 and 1999
is comprised of New York State and New York City taxes in the amount of $53,913
and $32,494, respectively. No benefit has been provided for the Company's net
operating losses.
Years ended September 30,
-------------------------
2000 1999
---- ----
Tax benefit at federal statutory rate (34.0%) (34.0%)
State taxes, net of federal tax effect 0.4 2.7
Valuation allowance 33.7 32.0
Other (0.6) 3.4
----- ----
Effective tax rate (0.5%) 4.1%
===== ====
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, 2000 and 1999 are as
follows:
Years ended September 30,
-------------------------
2000 1999
---- ----
Net operating loss $5,985,460 $1,276,868
Depreciation (657,860) (291,171)
Other 12,261 1,201
---------- ----------
Total deferred tax assets 5,339,861 986,898
Valuation reserve (5,339,861) (986,898)
---------- ----------
Net deferred tax asset $ -- $ --
========== ==========
F-14
<PAGE>
A.B. Watley Group Inc.
Notes to Consolidated Financial Statements - (Continued)
Years ended September 30, 2000 and 1999
At September 30, 2000, the Company had a net operating loss carryforward for
federal tax purposes of approximately $12,823,000 that will expire no sooner
than September 30, 2013.
14. Capital Stock
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 and was restricted with regard to
sale or disposition for a period of one year. This private placement offering
generated total gross proceeds of $1,063,200 and after related legal and filing
expenses of $13,200, the net proceeds were $1,050,000. Two employees of the
Company purchased an aggregate of 102,000 shares as part of this offering.
On April 23, 1999, 2,300,000 shares of the Company's common stock (including
300,000 shares to cover over-allotments) were sold in the IPO. The net proceeds
from the offering of approximately $13,250,000 have been used primarily to
reduce outstanding indebtedness, expand sales and marketing, expand and upgrade
the Company's computing, physical, and personnel infrastructure and for working
capital and general corporate matters.
Upon effectiveness of the IPO, the Company issued 3,000 shares of common stock
with a three year restriction provision for nominal consideration to certain
employees of the Company. In addition, the Company issued 70,771 shares of
common stock for nominal additional consideration to certain stockholders who
purchased private placement shares during the year ended September 30, 1998.
During the quarter ending June 30, 2000, Whale Securities Co., L.P. ("Whale")
exercised 124,784 underwriter's warrants, on a cashless basis, and received
59,829 shares. The warrants were issued as a result of underwriting the
Company's IPO. The warrants were exercised at the price of $11.55 per share.
Whale continues to hold warrants to purchase an additional 75,216 shares with an
exercise price of $11.55, which expire April 23, 2004.
Effective October 2, 1998, the Company borrowed $500,000 from New York Small
Business Venture Fund, LLC ("NYSB"). 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. The loan was subsequently repaid with the proceeds of the IPO. On January
3, 2000, July 6, 2000 and July 17, 2000, NYSB exercised 50,000, 85,000 and
56,250 warrants, respectively, equal to an aggregate of 191,250 shares. The
warrants were exercised at the IPO price of $7.00 per share.
On July 17, 2000 and August 18, 2000, NYCIC exercised 28,750 and 60,000
warrants, respectively, equal to 88,750 shares. The warrants were exercised at
the IPO price of $7.00 per share. NYCIC continues to hold warrants to purchase
an additional 51,250 shares, which expire January 28, 2004.
Effective August 8, 2000, the Company entered into an agreement with an
investment group providing the Company with an eighteen-month equity line of up
to $48 million. The agreement allows the Company to draw down funds in exchange
for equity. The Company is not obligated to take down any of the funds and
pricing is based upon ninety four percent of the volume weighted average price
(VWAP) of the Company's stock for the 22 days prior to each takedown. The
Company will pay the placement agent a fee of 5% of any amount drawn down. In
addition, the Company provided 70,893 warrants each to the investment group and
placement agent at a strike price of $19.47, expiring August 9, 2003. The
Company has registered the stock for resale under the Securities Act of 1933. On
September 6, 2000, the Company drew down $3,000,000 of the equity line, issued
333,333 shares to the investment group, and received net proceeds of $2,850,000.
F-15
<PAGE>
A.B. Watley Group Inc.
Notes to Consolidated Financial Statements - (Continued)
Years ended September 30, 2000 and 1999
For the fiscal year ended September 30, 2000, stock options aggregating 193,183
shares were exercised resulting in proceeds of $1,281,993.
15. Earnings Per Share
Per share data is determined based on the weighted average number of common
shares outstanding each year.
The weighted average number of shares outstanding for the year ended September
30, 1999 reflects the 70,771 shares (discussed in Note 14) as though the shares
were outstanding as of the beginning of the fiscal year. Since the Company
recognized a net loss in each of the years ended September 30, 2000 and 1999,
diluted earnings per common share is the same as basic earnings per common
share.
16. Extraordinary Item
On April 29, 1999, the Company prepaid a $500,000 loan from NYSB bearing an
interest rate of 12% from the proceeds of the IPO. Accordingly, the Company
recorded an extraordinary loss of $177,125 ($0.02 per share) related to the
early retirement of debt. The extraordinary loss was comprised of a $5,000
prepayment penalty and unamortized option costs of $172,125. There was no tax
benefit recognized for the extraordinary item because of the Company's net
operating losses.
F-16
<PAGE>
SIGNATURES
----------
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
A.B. WATLEY GROUP INC.
By: /s/ Steven Malin
--------------------
Steven Malin
Chairman of the Board
Date: December 28, 2000
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated:
<TABLE>
<CAPTION>
Signatures Title Date
---------- ----- ----
<S> <C> <C>
/s/ Steven Malin Chairman of the Board, Chief Executive Officer and December 28, 2000
---------------- Director (Principal Executive Officer and Principal
Steven Malin Financial Officer)
/s/ Anthony G. Huston President and Director December 28, 2000
----------------------
Anthony G. Huston
/s/ Joseph M. Ramos, Jr. Executive Vice President and Chief Financial Officer December 28, 2000
------------------------ (Principal Accounting Officer)
Joseph M. Ramos, Jr.
/s/ Robert Malin Director December 28, 2000
----------------
Robert Malin
/s/ Elizabeth Chambers Director December 28, 2000
----------------------
Elizabeth Chambers
/s/ Mark Chambre Director December 28, 2000
----------------
Mark Chambre
/s/ Michael Kraines Director December 28, 2000
-------------------
Michael Kraines
/s/ Stanley Weinstein Director December 28, 2000
---------------------
Stanley Weinstein
</TABLE>
<PAGE>
EXHIBIT INDEX
-------------
Exhibit
No. Description
------- -----------
10.27 Employment Agreement dated as of June 18, 1999 between the
Company and Joseph Ramos.
10.28 Employment Agreement dated as of September 1, 1999 between the
Company and Peter Wigger.
23.2 Consent of Ernst & Young LLP, independent auditors.
99.27 Financial Data Schedule
