<PAGE>
==============================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: September 30, 2000
Commission File Number: 0-27705
WEB STREET, INC.
(Exact name of registrant as specified in its charter)
Delaware 36-4212401
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
510 Lake Cook Road, Deerfield, Illinois 60015
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (847) 444-4700
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [_]
The number of shares of the registrant's Common Stock outstanding as of
November 8, 2000 was 25,832,274.
==============================================================
<PAGE>
WEB STREET, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000
INDEX
<TABLE>
<CAPTION>
<S> <C>
PART I - FINANCIAL INFORMATION Page
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 2000 (unaudited) and December 31,
1999............................................................ 3
Condensed Consolidated Statements of Operations
(unaudited) for the three months and nine months ended
September 30, 2000 and 1999..................................... 4
Condensed Consolidated Statements of Cash Flows
(unaudited) for the nine months ended September 30, 2000
and 1999........................................................ 5
Notes to Condensed Consolidated Financial Statements.............. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................... 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk........ 17
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................... 18
Item 2. Changes in Securities and Use of Proceeds....................... 18
Item 6. Exhibits and Reports on Form 8-K................................ 18
SIGNATURES.................................................................. 19
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
WEB STREET, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------ -----------------
(Unaudited)
ASSETS
<S> <C> <C>
Cash and cash equivalents.................................................. $ 20,671,449 $ 39,189,362
Brokerage receivables, net................................................. 100,993,205 2,395,679
Property and equipment, net................................................ 8,060,135 3,994,411
Deposits with clearing organizations....................................... 1,873,933 105,999
Prepaid expenses and other................................................. 2,213,953 2,105,452
----------------- -----------------
Total assets............................................................... $133,812,675 $ 47,790,903
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Brokerage payables........................................................ $ 98,243,666 $ 350,376
Accounts payable.......................................................... 4,508,895 2,354,852
Accrued expenses.......................................................... 1,806,295 1,976,633
Deferred rent............................................................. 201,487 146,082
----------------- -----------------
Total liabilities.......................................................... 104,760,343 4,827,943
Commitments and contingencies
Stockholders' equity:
Preferred stock ($.01 par value; 2,000,000 shares authorized; no shares
issued and outstanding).................................................. - -
Common stock ($.01 par value, 100,000,000 shares authorized; 25,797,286
shares issued and outstanding at September 30, 2000 and 25,660,402
shares issued and outstanding at December 31, 1999)...................... 257,973 256,604
Additional paid-in capital................................................ 65,872,228 65,317,651
Accumulated deficit....................................................... (37,077,869) (22,611,295)
----------------- -----------------
Total stockholders' equity................................................. 29,052,332 42,962,960
----------------- -----------------
Total liabilities and stockholders' equity................................. $133,812,675 $ 47,790,903
================= =================
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
WEB STREET, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
2000 1999 2000 1999
------------------------------- --------------------------------
<S> <C> <C> <C> <C>
Revenues:
Transaction revenue..................... $ 4,185,170 $ 6,060,978 $ 22,544,227 $15,940,733
Interest income......................... 2,303,651 162,969 3,715,033 478,751
Other revenue........................... 117,278 268,333 731,157 745,903
------------------------------- --------------------------------
6,606,099 6,492,280 26,990,417 17,165,387
Interest expense........................ (989,589) (1,214) (994,051) (2,162)
------------------------------- --------------------------------
Net revenues............................. 5,616,510 6,491,066 25,996,366 17,163,225
Cost of services:
Clearance and execution................. 2,758,615 2,802,187 12,665,295 7,178,833
Employee compensation and benefits...... 1,437,414 639,682 3,452,454 1,897,495
Communication and data processing....... 822,773 417,990 2,272,444 1,037,800
------------------------------- --------------------------------
Total cost of services................... 5,018,802 3,859,859 18,390,193 10,114,128
Operating expenses:
Marketing and advertising............... 971,300 3,289,569 9,444,068 5,533,538
Technology development.................. 1,195,099 488,677 2,587,333 1,401,179
General and administrative.............. 3,142,978 1,617,669 10,966,609 4,106,692
------------------------------- --------------------------------
Total operating expenses................. 5,309,377 5,395,915 22,998,010 11,041,409
------------------------------- --------------------------------
Loss from operations..................... (4,711,669) (2,764,708) (15,391,837) (3,992,312)
Gain from settlement of litigation....... 925,263 - 925,263 -
------------------------------- --------------------------------
Net loss................................. $(3,786,406) $(2,764,708) $(14,466,574) $(3,992,312)
=============================== ================================
Basic and diluted net loss per common
share................................... $ (0.15) $ (0.13) $ (0.56) $ (0.19)
=============================== ================================
Weighted-average common shares used in
computation of basic and diluted net
loss per common share................... 25,783,938 20,841,324 25,731,112 20,550,308
=============================== ================================
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
WEB STREET, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine months ended September 30,
-------------------------------
2000 1999
------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss........................................................................ $(14,466,574) $(3,992,312)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization............................................... 1,460,326 543,430
Compensation and other expenses incurred through issuance of stock
options and warrants...................................................... 525,759 226,430
Provision for uncollectible accounts........................................ 534,325 165,559
Net deferred rent accretion (amortization).................................. 55,405 (3,222)
Changes in operating assets and liabilities:
Brokerage receivables..................................................... (23,085,492) (350,044)
Deposits with clearing organizations...................................... (1,767,934) (11,423)
Prepaid expenses and other assets......................................... (339,712) (441,153)
Brokerage payables........................................................ 22,068,392 157,050
Accounts payable.......................................................... 2,154,043 (132,659)
Accrued expenses.......................................................... (170,338) 274,387
------------ -----------
Net cash used in operating activities............................................. (13,031,800) (3,563,957)
Cash flows from investing activities:
Purchases of property, equipment and software................................... (5,516,300) (2,913,030)
Cash flows from financing activities:
Proceeds from issuance of common stock, net of issuance costs................... 22,550 7,087,743
Redemption of preferred stock................................................... - (650,000)
Payment from related party...................................................... - 190,000
Proceeds from the exercise of stock options..................................... 7,637 800
------------ -----------
Net cash provided by financing activities......................................... 30,187 6,628,543
------------ -----------
Increase (decrease) in cash and cash equivalents.................................. (18,517,913) 151,556
Cash and cash equivalents at beginning of period.................................. 39,189,362 1,579,639
------------ -----------
Cash and cash equivalents at end of period........................................ $ 20,671,449 $ 1,731,195
============ ===========
Supplemental disclosures of cash flow information:
Interest paid................................................................... $ 881,551 $ 2,162
Income taxes paid............................................................... - -
Significant non-cash transactions:
Eliminate common stock put rights............................................... $ - $ 624,375
Gain on settlement of litigation................................................ 500,263 -
Balances transferred from clearing broker upon conversion of operations:
Brokerage receivables, net.................................................... 75,824,898 -
Brokerage payables............................................................ 75,824,898 -
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
WEB STREET, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include the accounts of Web Street, Inc. and its wholly-owned subsidiary, Web
Street Securities, Inc. (collectively, the Company), and have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, these statements do not include all of the information
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the nine months ended September 30, 2000 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2000.
The balance sheet at December 31, 1999 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's annual report on Form 10-K for the
year ended December 31, 1999.
Certain amounts from prior periods have been reclassified to conform with
the current period's presentation.
2. Brokerage Receivables and Payables
Brokerage receivables and payables include amounts due on customer cash and
margin transactions. Securities owned by customers are held as collateral for
receivables. Such collateral is not recorded in the financial statements.
Brokerage receivables at September 30, 2000 and December 31, 1999 consisted
of the following:
September 30, December 31,
2000 1999
------------- ------------
Receivables from customers.................... $ 98,930,119 $ -
Fees and commissions receivable............... 963,010 2,536,673
Receivable from clearing organizations........ 1,667,689 -
Deposits for securities borrowed.............. 240,500 -
Other......................................... 158,035 -
Allowance for uncollectible accounts.......... (966,148) (140,994)
------------ ----------
$100,993,205 $2,395,679
============ ==========
6
<PAGE>
Brokerage payables at September 30, 2000 and December 31, 1999 consisted of
the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Customer payables................................................... $72,505,689 $ -
Fees, commissions and margin-sharing payments payable............... 894,119 350,376
Deposits for securities loaned...................................... 24,843,858 -
----------- --------
$98,243,666 $350,376
=========== ========
</TABLE>
3. Property and Equipment
Property and equipment, net at September 30, 2000 and December 31, 1999,
consisted of the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Hardware and equipment.............................................. $ 5,072,761 $ 2,813,417
Furniture and fixtures.............................................. 568,981 438,576
Software............................................................ 2,774,505 872,458
Buildings and leasehold improvements................................ 2,355,719 1,151,101
Land and improvements............................................... 44,886 25,000
----------- -----------
Total cost......................................................... 10,816,852 5,300,552
Accumulated depreciation............................................ (2,756,717) (1,306,141)
----------- -----------
$ 8,060,135 $ 3,994,411
=========== ===========
</TABLE>
4. Commitments and Contingencies
The Company has entered into various operating leases, principally for
office facilities and computer hardware. The Company's aggregate future minimum
lease payments on various leases expiring through 2010 were approximately
$16,925,000 at September 30, 2000.
The Company has entered into employment agreements with several of its key
executive officers. These employment agreements provide for annual base salary
compensation, annual incentive compensation and severance payments in the event
of termination of employment under defined circumstances, including changes in
the Company's control.
The Company is, from time to time, a party to certain pending and
threatened legal actions arising in the ordinary course of business. Management
does not believe that any such current matters, either individually or in the
aggregate, will have a material adverse effect on the Company's results of
operations, financial condition or cash flows.
5. Related Party Transactions
Other assets at September 30, 2000 included $315,000 of amounts due from
officers of the Company under unsecured promissory notes. These notes bear
interest at 5% and are due in 2001.
6. Stock Options
During the nine months ended September 30, 2000, the Company granted
employees options to purchase 2,427,000 shares of its common stock. The
weighted-average exercise price of options granted was $7.52 per share. During
the same period, options previously granted to employees on 239,400 shares
7
<PAGE>
of the Company's common stock were forfeited or terminated. The weighted-average
exercise price of options forfeited or terminated was $6.66 per share.
7. Regulatory Requirements
As a registered broker-dealer, Web Street Securities, Inc. is subject to
the Uniform Net Capital Rule, Rule 15c3-1 under the Securities Exchange Act of
1934 (the Rule), which requires broker-dealers to maintain certain minimum net
capital. Web Street Securities, Inc. has elected to use the alternative method
permitted by the Rule, which requires that it maintain minimum net capital, as
defined, of 2% of aggregate debit balances arising from customer transactions,
or $250,000, whichever is greater. At September 30, 2000, Web Street Securities
had net capital of $7,163,573, which represented 7.2% of aggregate debit
balances and which exceeded the minimum net capital requirements by $5,160,498.
The Rule provides that equity capital may not be withdrawn or profit
distributions may not be made if the resulting net capital would be less than 5%
of aggregate debit balances.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
You should read the following discussion along with our condensed
consolidated financial statements and the related notes included in this
quarterly report. The following discussion contains forward-looking statements
that are subject to risks, uncertainties and assumptions. Our actual results,
performance and achievements in 2000 and beyond may differ materially from those
expressed in, or implied by, these forward-looking statements. See "--Cautionary
Note Regarding Forward-Looking Statements."
Overview
We provide online brokerage services to individual investors, primarily in
the United States, Europe, Asia and Latin America, through our wholly owned
subsidiary, Web Street Securities, Inc., a registered broker-dealer. Through our
web site, located at www.webstreet.com, our customers can quickly execute
equity, option and mutual fund trades at a low cost, and conveniently access
real-time trading, financial market and account information.
On July 3, 2000, we completed our conversion to become a self-clearing
broker-dealer. Since July 3, 2000, we have been performing clearance and
execution services for all equity securities and mutual fund transactions in our
customers' accounts. We have established a correspondent relationship with
ABN.AMRO, Incorporated to provide clearing services for options trading in our
customers' accounts on an omnibus basis. In connection with the conversion, we
have discontinued our correspondent clearing relationship with our former
clearing broker. Prior to May 1, 2000, our initial clearing agreement provided
us above-market payments for order flow on customer transactions. From May 1,
2000 through July 2, 2000, we operated under an interim agreement with our
former clearing broker and since May 1, 2000 we have received payments for order
flow, either through our former clearing broker or as a self-clearing firm, at
current market rates. The conversion to self-clearing operations has resulted in
increased net interest income from carrying our customers' accounts, as well as
lower clearance and execution costs per trade. Beyond the third quarter of 2000,
we anticipate that our operating as a self-clearing organization will contribute
to important customer benefits, renewed revenue growth and improved gross
margins for the firm compared to the results of this quarter. These anticipated
positive effects of self-clearing operations were not fully realized during the
third quarter of 2000 because of residual conversion costs incurred in the
quarter and because our new self-clearing operations are not yet fully
optimized.
8
<PAGE>
Also, at the end of June, 2000, we launched a redesigned website featuring
a series of new product offerings aimed at increasing customer reliance on us as
their one-stop on-line financial services provider, including:
. Enhanced cash management services featuring the Web Street Global Asset
Manager(SM), a new product designed to enable customers to conduct cash and
investment management through a single online account;
. The industry's lowest published margin rates for margin balances in excess
of $2,500,000;
. An alliance with InsWeb, a leading online insurance services provider,
providing access to low-cost home, auto, life and health insurance; and
. An alliance with Lending Tree, a nationally recognized online loan
marketplace for consumers and lenders, that offers access to home mortgages
and other consumer loans.
Additionally, in the third quarter of 2000 we filed with the National
Association of Securities Dealers for approval to provide securities clearing
services for other broker-dealers. We believe clearing services has the
potential to provide a good source of revenue in the future.
We opened our new financial services center in downtown Boston on October
23, 2000. We expect to open two other new state-of-the-art financial services
centers in the financial districts of San Francisco and Denver by the end of the
fourth quarter of 2000. These street-level locations, along with our financial
services center in Beverly Hills, will enable us to provide customers with
in-person educational seminars, including an introduction to online investing as
well as other financial topics, access to information on various financial
markets, and demonstrations of our product and service offerings. Because of the
inherently impersonal nature of business conducted via the Internet, we believe
that our existing and potential new customers will benefit from, and favor, the
opportunity for face-to-face interaction with us. As of the end of the third
quarter of 2000, we had invested $1,128,000 in these three new facilities. We
expect to invest a total of between $1,500,000 and $2,000,000 in these three new
financial services centers, a portion of which may be financed through leases.
We intend to open additional financial services centers in other select
locations in the United States and internationally.
Additionally, we completed construction on our mirror data center and
leased the equipment necessary to make it operational. We expect the mirror data
center to become operational in the fourth quarter of 2000.
We intend to prudently increase expenditures in most operating areas,
including expansion of our customer base, continued development and delivery of
state-of-the-art online financial products and services, and an increase in the
number of our financial services centers. We plan to continue enhancing
financial, operational and management controls and reporting systems and
procedures in support of the continued expansion of our operations. We
anticipate only modest increases in our direct consumer marketing efforts in the
near term as we increase our focus on entering into domestic and international
business-to-business partnerships as a key driver of our growth.
9
<PAGE>
Results of Operations
In the discussion below, we compare our results of operations for the three
month and nine month periods ended September 30, 2000 and 1999.
The following table shows for the periods presented (a) the percentage of
net revenues represented by items on our condensed consolidated statements of
operations and other operating data, and (b) the percentage change in each item
from the prior corresponding period.
<TABLE>
<CAPTION>
Period-to-Period
Percentage of Net Revenues Percentage Change
------------------------------------------ -------------------
Three months ended Nine months ended Three Nine
September 30, September 30, month month
2000 1999 2000 1999 periods periods
------------------ ----------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Transaction revenue........................... 75 % 93 % 87 % 93 % (31)% 41 %
Interest income............................... 41 3 14 3 n/m n/m
Other revenue................................. 2 4 3 4 (56) (2)
------------------ -----------------
118 100 104 100 2 57
Interest expense.............................. (18) - (4) - n/m n/m
------------------ -----------------
Net revenues................................... 100 100 100 100 (13) 51
Cost of services:
Clearance and execution....................... 49 43 49 42 (2) 76
Employee compensation and benefits............ 25 10 13 11 125 82
Communication and data processing............. 15 6 9 6 97 119
------------------ -----------------
Total costs of services........................ 89 59 71 59 30 82
Operating expenses:
Marketing and advertising..................... 17 51 36 32 (70) 71
Technology development........................ 21 8 10 8 144 85
General and administrative.................... 56 25 42 24 94 167
------------------ -----------------
Total operating expenses....................... 94 84 88 64 (2) 108
------------------ -----------------
Loss from operations........................... (83)% (43)% (59)% (23)% 70 286
================== =================
Other Data:
Total trades (thousands of trades)............. 328.1 264.0 1,139.5 704.6 24 62
Average trades per day......................... 5,208 4,124 6,029 3,700 26 63
Total customer accounts (thousands of
accounts)/(1)(2)/............................. 126.8 73.0 126.8 73.0 74 74
Total customer assets (millions of dollars)
/(1)/......................................... $866.7 $519.0 $866.7 $519.0 67 67
Total employees/(1)/........................... 177 119 177 119 49 49
</TABLE>
(1) As of the end of each period presented.
(2) Represents open accounts, regardless of whether there have ever been any
funds or securities in the account.
n/m Not meaningful
Revenues
Net revenues decreased 13% to $5,617,000 in the third quarter of 2000 from
$6,491,000 in the third quarter of 1999. However, total net revenues increased
51% to $25,996,000 for the nine months
10
<PAGE>
ended September 30, 2000, from $17,163,000 in the comparable period of 1999. Our
transaction volumes, total customer accounts and customer asset balances grew
rapidly during the last quarter of 1999 and the first quarter of 2000. This
growth was offset in the second and third quarters of 2000 by industry-wide
declines in the volume of shares traded on the major securities exchanges and
markets. This decline in trading volume adversely impacted our operating results
in both the three and nine months ended September 30, 2000. We executed an
average of 5,208 trades per day in the three months ended September 30, 2000
compared to an average of 4,124 trades per day during the same period of 1999, a
26% increase. During the nine months ended September 30, 2000, we executed an
average of 6,029 trades per day, an increase of 63% from an average of 3,700
trades per day during the corresponding period in 1999. However, these increases
in the volume of trades executed did not increase at the same rate as the rates
of increase in total customer accounts and customer asset balances. Total
customer accounts increased 74% from 73,000 at September 30, 1999 to 126,800 at
September 30, 2000. Customer asset balances increased 67% from $519,029,000 at
September 30, 1999 to $866,697,000 at September 30, 2000. Our revenue mix
shifted in the third quarter of 2000 from being almost entirely comprised of
transaction revenue to a mix in which transaction revenue remains the
predominant revenue stream, but net interest income contributes a significant
percentage to our total revenues. This shift in revenue mix is expected to
continue into the future and is primarily due to our conversion to self-clearing
operations on July 3, 2000.
Transaction Revenue
Transaction revenue decreased 31% to $4,185,000 in the third quarter of
2000, from $6,061,000 in the third quarter of 1999. Transaction revenue
represented 75% of net revenues in the third quarter of 2000, compared to 93% in
the same period in 1999. For the nine months ended September 30, transaction
revenue increased 41% to $22,544,000, or 87% of net revenues, in 2000, from
$15,941,000, or 93% of net revenues, in 1999. Brokerage commissions increased to
66% of net revenues in the third quarter of 2000 from 52% in the third quarter
of 1999, while order flow-related rebates declined to 8% of net revenues in the
third quarter of 2000 from 42% in the corresponding period in 1999. For the nine
months ended September 30, brokerage commissions were 56% of net revenues in
2000 compared to 54% in 1999, while order flow-related rebates were 31% of net
revenues in 2000 versus 39% in 1999. The decrease in the contribution to net
revenues by transaction revenue and the change in transaction revenue mix
between the three month periods ended September 30, 2000 and 1999 were due
principally to two factors: (1) the April 30, 2000 expiration of our initial
clearing agreement with U.S. Clearing, which provided us with above-market
payments for order flow, and (2) the July 3, 2000 conversion of our operations
from fully-disclosed to self-clearing, which resulted in greater net interest
income per account. These factors also led to a decrease in average transaction
revenue per trade, which declined to $12.76 in the third quarter of 2000 from
22.96 in the third quarter of 1999 and to $19.78 for the nine months ended
September 30, 2000 from $22.62 in the same period of 1999. Approximately $8.86
and $2.40 of the decreases in average transaction revenue per trade for the
three month and nine month periods ended September 30, 2000, compared to their
corresponding periods in 1999, respectively, was due to the decline in payments
for order flow that we have experienced. The remaining decline in transaction
revenue per trade between the three-month periods ended September 30, 2000 and
1999 was predominantly due to free and discounted trade commissions offered to
customers to help ensure customer satisfaction during the launch of our
redesigned web site and conversion to self-clearing operations. We do not
anticipate the need to offer such discounts beyond the third quarter of 2000.
For both the three-month periods ended September 30, 2000 and 1999, equity
transactions represented 90% and option transactions represented 10% of our
total transaction volumes. Revenue from our international partnerships,
principally our agreement with ConSors Discount-Broker (ConSors), represented
approximately 34% of our net revenues in the third quarter of 2000 compared with
20% in the third quarter of 1999, and approximately 29% of our net revenues in
the first three quarters of 2000 compared with 11% in the same period of 1999.
We expect revenues from our international and domestic relationships to increase
as a percentage of our net revenues in the future.
11
<PAGE>
Interest Income and Interest Expense
Interest income for the nine months ended September 30, 2000 and 1999 is
comprised of interest earned on customer margin balances, our share of net
interest income on customer margin loans made by the Company's former
clearing broker, fee income related to the sweep of excess customer funds into
money market instruments and interest earned on cash balances. Interest expense
consists principally of interest on customer cash accounts and stock loans to
finance customer margin balances. Interest income increased substantially to
$2,304,000, or 41% of net revenues, in the third quarter of 2000, from $163,000,
or 3% of net revenues, in the third quarter of 1999. For the nine months ended
September 30, interest income increased to $3,715,000, or 14% of net revenues,
in 2000, from $479,000, or 3% of net revenues, in 1999. Interest expense also
increased substantially to $990,000, or 18% of net revenues, in the third
quarter of 2000, from $1,000, or less than 1% of net revenues, in the third
quarter of 1999. For the nine months ended September 30, interest expense
increased to $994,000, or 4% of net revenues, in 2000, from $2,000, or less than
1% of net revenues, in 1999. The increases in both dollar and percentage-of-net-
revenues terms are due to our conversion to self-clearing operations and, to a
lesser extent, increases in our average cash balances. Prior to July 3, 2000, we
were paid a portion of the net interest earned on customer margin loans made by
our former clearing broker. Upon our conversion to self-clearing operations we
began receiving the full amount of interest charged on customer margin balances
and we also began incurring the costs of financing those balances. During the
third quarter of 2000, our customer margin balances, which are included in
brokerage receivables on our Condensed Consolidated Balance Sheets, yielded an
average of 8.5%. Our average cash balances increased from approximately $2.6
million and $3.0 million during the three and nine months ended September 30,
1999, respectively, to approximately $23.9 million and $29.7 million during the
three and nine months ended September 30, 2000, respectively, as a result of our
receipt of approximately $41 million from our offering of 4,192,500 shares of
our common stock to the public during the fourth quarter of 1999, less the uses
of those proceeds since the offering. Interest expense arises principally from
two sources: (1) interest paid on customer free credit balances and (2) interest
paid on collateral received from lending our customers' securities to other
broker-dealers. To the extent possible we have financed our customers' margin
balances from other customers' credit balances. Customer credit balances are
included in brokerage payables on our Condensed Consolidated Balance Sheets.
Where customer funds are not sufficient to fund customer margin balances, we
have financed these margin balances from either our own cash or from securities
transactions in which we have loaned customers' securities to other broker-
dealers for a cash collateral deposit. The obligation to return the collateral
deposited by broker-dealers that have borrowed our customers' securities is also
included in brokerage payables on our Condensed Consolidated Balance Sheets. The
blended cost of funds from paying our customers interest and paying interest on
stock loans was approximately 4.1% in the third quarter of 2000. We expect net
interest income to remain a significant percentage of net revenues in the future
as a result of our conversion to self-clearing operations.
Other Revenue
Other revenue decreased 56% to $117,000 in the third quarter of 2000 from
$268,000 in the third quarter of 1999. For the nine months ended September 30,
other revenue decreased 2% to $731,000 in 2000, from $746,000 in 1999. The
decrease was due primarily to free or discounted premium subscriptions services
offered to customers in the third quarter of 2000 to help ensure customer
satisfaction during the launch of our redesigned web site and conversion to
self-clearing operations. In addition, we lowered the pricing on our Level II
premium dynamic quote services as of September 1, 2000. We have further lowered
our pricing on subscription services effective November 1, 2000 due to recent
decreases in the cost of providing these services. Therefore, we anticipate
other revenue from these services will grow at a lower rate than transaction
revenue and interest income in the future.
12
<PAGE>
Cost of Services
Total cost of services increased 30% to $5,019,000, or 89% of net revenues,
in the third quarter of 2000 from $3,860,000 or 59% of net revenue in the
comparable quarter of 1999. For the nine months ended September 30, total costs
of services increased 82% to $18,390,000 or 71% of net revenue in 2000, from
$10,114,000 000 or 59% of net revenue in 1999. All components of our costs of
services increased as a percentage of net revenue with the largest increases
occurring in employee compensation and benefits and communication and data
processing, which also increased in dollar terms. These increases were primarily
due to the addition of staff and greater depreciation charges, as more fully
discussed below. Clearance and execution costs declined in the third quarter of
2000 compared to the third quarter of 1999, but increased as a percentage of net
revenue because of a larger decrease in net revenues. As we continue to operate
as a self-clearing broker-dealer, diversify our revenue mix to be less dependent
on transaction revenue, and optimize our new trade clearance and execution
processes, we expect cost of services to steadily decline as a percent of net
revenues.
Clearance and Execution
Clearance and execution costs per trade decreased 21% from $10.61 per trade
in the third quarter of 1999 to $8.41 per trade in the third quarter of 2000.
However, clearance and execution costs per trade rose 9% on a year-to-date
basis, from $10.19 for the nine months ended September 30, 1999 to $11.11 for
the nine months ended September 30, 2000. Average clearance and execution costs
per trade in both the three and nine months ended September 30, 2000 compared to
their corresponding periods in 1999 were impacted to varying degrees by (1)
decreases in per trade direct clearance and execution costs subsequent to our
conversion to self-clearing operations as of July 3, 2000, (2) increases in
margin sharing payments to our international partners and (3) non-recurring
costs incurred related to the self-clearing conversion and new web site launched
on June 28, 2000. Both the three and nine month periods ended September 30, 2000
experienced decreases in average direct clearance and execution costs per trade
when compared to the same periods in 1999 because of our conversion to self-
clearing operations and the resultant elimination of per-trade charges assessed
by our former clearing broker. These reductions in direct clearance and
execution costs from the elimination of ticket charges by our former clearing
broker were partially offset by other clearance and execution costs directly
associated with our conversion to self-clearing operations. The net reduction in
average direct clearance and execution costs per trade related to the combined
effect of eliminating per trade fees paid to our former clearing broker and new
costs directly related to self-clearing operations was approximately $4.77 and
$1.09 for the three and nine-month periods ended September 30, 2000,
respectively. The decline in the nine months ended September 30, 2000 was not as
great as that in the third quarter of 2000 because there were only three months
of self-clearing operations during the nine-month period, and from May 1, 2000
through July 2, 2000, we experienced a $1.25 increase in clearing costs per
trade charged to us by our former clearing broker compared to what we had been
charged under the terms of our initial clearing agreement, which expired on
April 30, 2000. Average clearance and execution costs per trade in both the
three and nine month periods ended September 30, 2000 were also impacted by
higher average margin-sharing payments per trade made to our international
partners. These margin-sharing payments commenced in April 1999 and have grown
as business directed through our international partners has grown. Margin-
sharing payments caused the average clearance and execution costs per trade to
increase by $0.88 in the third quarter of 2000 from its level in the third
quarter of 1999, and by $1.46 in the nine months ended September 30, 2000 from
the same period in 1999. Additionally, the average clearance and execution costs
per trade increased in both the three and nine-month periods ended September 30,
2000 compared to the corresponding periods in 1999 because of non-recurring
costs incurred in 2000 related to the self-clearing conversion and related
launch of our redesigned web site. These costs principally related to our
efforts to ensure customer satisfaction through our conversion and caused
average clearance and execution costs per trade to increase by $1.20 and $0.77
in the three and nine-month period ended September 30, 2000, respectively, over
their corresponding
13
<PAGE>
periods in 1999. Management does not expect to incur similar conversion-related
costs beyond the third quarter of 2000.
Employee Compensation and Benefits
Employee compensation and benefits increased 125% to $1,437,000 in the
third quarter of 2000, from $640,000 in the third quarter of 1999. For the nine
months ended September 30, employee compensation and benefits increased 82% to
$3,452,000 in 2000 from $1,897,000 in 1999. As a percentage of net revenues,
employee compensation and benefits costs increased to 25% and 13% in the three
and nine months ended September 30, 2000, respectively, from 10% and 11% in the
same respective periods of 1999. These increases resulted principally from our
addition of licensed brokers and other customer service personnel to accommodate
the increased number of customer accounts and associated traffic to our web site
and to our customer service call center, and the addition of all the back office
personnel needed to operate as a self-clearing broker-dealer. Furthermore, the
personnel we have added to support the growth in our business and conversion to
self-clearing operations have tended to be at higher compensation levels than we
have historically experienced. Total employees directly involved in brokerage,
customer service and technical support activities increased to 108 at September
30, 2000 from 67 at September 30, 1999.
Communication and Data Processing
Communication and data processing costs increased 97% to $823,000 in the
third quarter of 2000 from $418,000 in the third quarter of 1999. For the nine
months ended September 30, communication and data processing expense increased
119% to $2,272,000 in the 2000 from $1,038,000 in 1999. Communication and data
processing costs as a percentage of net revenues increased to 15% and 9% in the
three and nine months ended September 30, 2000, respectively, from 6% in both of
the same respective periods of 1999. Throughout 2000 we have incurred higher
costs for market data services, communication lines and equipment to support our
higher levels of staffing, and accommodate the increased number of customer
accounts and associated traffic to our web site. Additionally, in December
1999, we moved the brokerage operations of Web Street Securities into 33,000
square feet of newly leased space in downtown Chicago, Illinois and
significantly upgraded the telecommunications systems and equipment in our call
center.
Operating Expenses
Total operating expenses decreased 2% to $5,309,000 during the three months
ended September 30, 2000 from $5,396,000 during the three months ended September
30, 1999. For the nine months ended September 30, operating expenses increased
108% to $22,998,000 in 2000 from $11,041,000 in 1999. Fluctuations in marketing
and advertising expenses, and increases in technology development and general
and administrative expenses, as described in further detail below, impacted
operating expenses.
Marketing and Advertising
Marketing and advertising expenses decreased 70% to $971,000 in the third
quarter of 2000 from $3,290,000 in the third quarter of 1999 as a result of our
evolution from reliance on direct marketing to consumers, to pursuit of
customers via domestic, as well as international, business-to-business
relationships with financial services providers during the third quarter of
2000. Marketing and advertising expenses were impacted in the third quarter of
2000 by $152,000 in committed advertising costs from the first quarter of 2000
that we were able to defer until the third quarter of 2000. Marketing and
advertising expenses for the nine-month period ended September 30, 2000
increased 71% to $9,444,000 in 2000 from $5,534,000 in the corresponding period
of 1999. During the fourth quarter of 1999, we began production of a new
national advertising campaign, employing the tagline "Invest with
14
<PAGE>
Ambition," that launched in February 2000 and ran through June 2000, at which
time we began to curtail national consumer advertising in favor of more targeted
marketing initiatives. Substantially all marketing aimed at directing customers
to Web Street via our international partners continues to be paid for by our
partners. As we grow through partnerships in the future, we expect that our
partners will continue to be responsible for most customer acquisition costs. We
intend to continue to carefully manage our marketing expenditures throughout the
remainder of the year.
Technology Development
Technology development expenses increased 144% to $1,195,000 in the third
quarter of 2000 from $489,000 in the same period in 1999. For the nine months
ended September 30, technology development expenses increased 85% to $2,587,000
in 2000 from $1,401,000 in 1999. These increases were principally due to
greater charges for depreciation of computer hardware and software, and rental
of computer hardware, which collectively added $322,000 and $657,000 to
technology development costs in the three and nine months ended September 30,
2000, respectively, from their respective levels in 1999. Additionally, we have
increased the number of technology employees and consultants, and incurred
greater expenses related to software development to enhance our web site,
prepare for self-clearing operations and expand our product and service
offerings, and are incurring greater support and maintenance costs. We expect
that technology development expenditures will continue to increase in the
future, but may fluctuate as a percent of net revenues over time depending on
the timing of future development projects.
General and Administrative
General and administrative expenses increased 94% to $3,143,000 in the
third quarter of 2000 from $1,618,000 in the third quarter of 1999. For the
nine months ended September 30, general and administrative expenses increased
167% to $10,967,000 in 2000 from $4,107,000 in 1999. These increases were due
to a variety of factors, all related to the significant growth of our business
that we experienced during the intervening period. These factors include (1) an
increase in the number of employees, and improved compensation and benefits
levels to attract and retain qualified employees, (2) increased consulting
expenses primarily related to the conversion of our operations to self-clearing,
(3) increased occupancy costs principally related to opening our new brokerage
operation facilities in Chicago, Illinois in December 1999, but also related to
the leasing of facilities for our new financial services centers in San
Francisco, Boston and Denver, and (4) expenses associated with being a public
company. We incurred approximately $2,400,000 of start-up and redundant costs
related to our self-clearing conversion during the nine months ended September
30, 2000. We do not anticipate additional start-up or redundant costs related
to our self-clearing conversion during the fourth quarter of 2000. We do
anticipate hiring additional personnel and continuing to incur increased
administrative costs related to being a public company and to support the
expected future growth of our business. However, we expect the rate of growth
in general and administrative expenses as a percent of total net revenue to
decline in future quarters.
Liquidity and Capital Resources
As of September 30, 2000, we had cash and cash equivalents of $20,671,000
and no bank debt. Our cash used in operating activities was $13,032,000 in the
first nine months of 2000, compared to $3,564,000 used in operating activities
during the first nine months of 1999. Our operating cash inflows consist
principally of brokerage commissions and order flow-related payments collected,
interest collected on customers' margin balances and on our cash balances, and
other revenue received. Our operating cash outflows consist principally of
clearing and execution costs, interest paid on customer free credit balances and
stock loans, employee compensation and benefit costs, marketing and advertising
costs, and general and administrative costs paid. Additionally, cash
transactions affecting brokerage
15
<PAGE>
receivables and payables, and the payment and recovery of deposits with clearing
organizations are also included in net operating cash flows. The increase in
operating cash outflows for the first nine months of 2000 compared to the same
period in 1999 is principally attributable to (1) an increase in the amount paid
for marketing and advertising of roughly $3.3 million, (2) an increase in the
amount paid for general and administrative expenses of approximately $4.6
million, and (3) amounts deposited with clearing organizations of $1.8 million
during the third quarter of 2000.
Cash used in investing activities, all of which has represented capital
expenditures, increased to $5,516,000 for the nine months ended September 30,
2000, compared to $2,913,000 for the nine months ended September 30, 1999. We
continued to increase our capital investments with the addition of $2,621,000 in
property and equipment in the third quarter of 2000, which brought our total
capital investments in infrastructure for the year to $5,516,000. We invested
significantly in the software necessary to operate as a self-clearing broker-
dealer, and in the computer hardware and facilities needed to support our web
site, including a newly constructed mirror data center that we expect to become
operational in the fourth quarter of 2000. We are also making investments in
software development related to web site content that we intend to launch in the
coming months. During the nine months ended September 30, 2000, we entered into
new leases increasing our aggregate commitments under non-cancelable operating
leases for facilities and equipment to $16,925,000 at September 30, 2000. Cash
flows related to operating leases are included in net cash used in operating
activities.
On July 3, 2000, we completed our conversion to become a self-clearing
broker-dealer. Clearing services include the confirmation, receipt, settlement,
custody and delivery functions involved in the execution of securities
transactions. As a self-clearing broker-dealer we are responsible for the
possession and control of customers' securities and other assets and the
clearance of customers' securities transactions. Accordingly, on July 3, 2000,
customer receivables related to margin loans of $75,825,000, payables related to
customers' free credit balances of $71,527,000, and other clearing-related
payables totaling $4,298,000 were transferred onto our balance sheet. To the
extent possible, we have financed our customers' margin balances from other
customers' free credit balances. Where customer funds are not sufficient to
fund customer margin balances, we have financed these margin balances from
either our own cash or from securities transactions in which we have loaned
customers' securities to other broker-dealers for cash collateral deposit.
Additionally, on April 27, 2000, we secured an $8 million line of credit with
Harris Trust and Savings Bank. Borrowings on this line will be secured by
customers' margin account securities and will bear interest at the federal funds
rate plus 1.25%. Either party can cancel this borrowing arrangement with 60
days' prior notice. As of September 30, 2000 we had no outstanding borrowings
under this credit line.
Additionally, as a self-clearing broker-dealer we are required to maintain
significantly higher minimum net capital than we did as a fully-disclosed
broker-dealer prior to June 2000. In the third quarter of 2000, we contributed
an additional $3 million in capital to our wholly-owned subsidiary, Web Street
Securities, Inc. The net capital rule provides that equity capital may not be
withdrawn or profit distributions may not be made if the resulting net capital
would be less than specified amounts. See Note 7 to the Condensed Consolidated
Financial Statements.
In the future, we expect to incur higher costs, particularly technology
development, payroll and occupancy costs, to grow our business. We anticipate
slightly lower levels of capital expenditures in the fourth quarter as compared
to the third quarter of 2000 to complete our mirror data center, to complete our
planned financial services centers in San Francisco and Denver, and to continue
to expand our existing systems. It is our intention to finance certain of these
expenditures with additional lease financing that we expect to be available to
us.
We believe that our current cash and cash equivalents, supplemented with
lease financing that we expect to be available, will be sufficient to meet our
anticipated cash needs for working capital, regulatory
16
<PAGE>
capital and capital expenditures for at least the next 12 months. However,
during this period, we may need to seek additional capital in the private and/or
public equity markets in order to support more rapid growth, to respond to
competitive pressures, to develop new products and services and/or to acquire
complimentary businesses. After that 12-month period, if cash generated from
operations is insufficient to satisfy our liquidity requirements, we may need to
raise additional funds through public or private financing, strategic
relationships or other arrangements. If we receive additional funds through the
issuance of equity securities, our existing stockholders may experience
significant dilution and these equity securities may have rights, preferences or
privileges senior to those of our common stock. Further, we may not be able to
obtain additional financing when needed or on terms favorable to us or our
stockholders. If we are unable to obtain additional financing when needed, or to
do so on acceptable terms, we may be unable to develop or enhance our products
or services, take advantage of business opportunities or respond to competitive
pressures.
Cautionary Note Regarding Forward-Looking Statements
Because we want to provide you with meaningful and useful information, this
quarterly report includes forward-looking statements that reflect our current
expectations and projections about our future results, performance, prospects
and opportunities. You can find many of these statements by looking for words
such as "may," "will," "expect," "anticipate," "believe," "intend," "estimate,"
"potential," "foresee" and similar expressions. These forward-looking
statements are based on information currently available to us and are subject to
a number of risks, uncertainties and other factors that could cause our actual
results, performance, prospects or opportunities in the remainder of 2000 and
beyond to differ materially from those expressed in, or implied by, these
forward-looking statements. These risks, uncertainties and other factors
include, without limitation, our ability to successfully manage our new self-
clearing operations, our ability to establish and maintain domestic and
international relationships with strategic partners and relationships with
content providers, intense price and other competition among companies providing
online financial services, our need to maintain and increase our customer
accounts, volatility in the securities markets, our ability to develop and
enhance our services and products, risk of system failures, and existing and
future regulations affecting the online brokerage industry or the Internet
generally. We caution you not to place undue reliance on any forward-looking
statements. For further information about these and other risks, uncertainties
and factors that could affect Web Street's future results, performance,
prospects and opportunities, please review the disclosure included under the
caption "Business-Risk Factors" in our annual report on Form 10-K for the year
ended December 31, 1999, as filed with the Securities and Exchange Commission.
Except as otherwise required by federal securities laws, we undertake no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events, changed circumstances or any
other reason after the date of this quarterly report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our primary financial instruments are cash in banks, money market
instruments and short-term certificates of deposit. We do not believe that
these instruments are subject to material potential near-term losses in future
earnings from reasonably possible near-term changes in market rates or prices.
We do not have derivative financial instruments for speculative or trading
purposes. In the normal course of business, our customers enter into
transactions where the risk of potential loss due to market fluctuations or
failure to perform exceeds the amounts reported for the transaction. We have
established policies, procedures and internal processes governing our management
of market risks in the normal course of our business operations. We
continuously monitor our exposure to market and counterparty risk through the
use of a variety of financial, position and credit exposure reporting and
control procedures. In addition, we review the credit-worthiness of each
customer and/or other counterparty with which we conduct business. We are not
currently exposed to any material currency exchange risks because the risk is
borne
17
<PAGE>
by our international customers and our international partners, and we do not
hold any assets or incur any liabilities denominated in foreign currencies.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
As previously disclosed in our Annual Report on Form 10-K for the year
ended December 31, 1999, on October 7, 1998, we filed a complaint against
Yahoo!, Inc. in the United States District Court for the Northern District of
Illinois. Also as previously disclosed, Yahoo! filed a counterclaim on November
12, 1998. On September 1, 2000 we entered into an agreement with Yahoo! to
settle all claims and counterclaims pursuant to which, Yahoo! has agreed to pay
to us $425,000 in cash and to provide to us advertising services valued at
$500,263.
Item 2. Changes in Securities and Use of Proceeds
On November 16, 1999, our registration statements on Form S-1 (File No.
333-85849 and File No. 333-91087) relating to the initial public offering (IPO)
of our common stock was declared effective by the SEC. After payment of the
underwriting discount of $3,228,225 and expenses of $1,911,082, we received net
proceeds of $40,978,193 from the offering. To date, we have used approximately
$10.9 million to market our online brokerage services and other financial
services and products, approximately $5.5 million for the acquisition,
construction or development of property, equipment and software, and
approximately $4.6 million for working capital and general corporate purposes.
We have invested the remaining net proceeds, pending their use, in short-term,
investment grade interest-bearing obligations.
Item 6. Exhibits and Reports on Form 8-K.
a) We have filed the following exhibits with this quarterly report.
Exhibit
Number Exhibit
10 Web Street, Inc. 2000 Stock Plan
27 Financial Data Schedule
b) Reports on Form 8-K.
We did not file any Current Reports on Form 8-K during the third quarter of
2000.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 2000 By: /s/ JOSEPH J. FOX
-------------------------------------
Joseph J. Fox
Co-Chief Executive Officer (principal
executive officer) and Co-Chairman of
the Board
Date: November 14, 2000 By: /s/ JOSEPH A. BARR
-------------------------------------
Joseph A. Barr
President, Chief Financial Officer
(principal financial and accounting
officer) and Treasurer
19
<PAGE>
EXHIBIT INDEX
-------------
<TABLE>
<CAPTION>
<S> <C>
Exhibit Number Exhibit
-------------- ------------------------------------------------------------
10 Web Street, Inc. 2000 Stock Plan
27 Financial Data Schedule
</TABLE>
