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================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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: June 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
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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
August 7, 2000 was 25,787,911.
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WEB STREET, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED JUNE 30, 2000
INDEX
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2000
(unaudited) and December 31, 1999................................ 3
Condensed Consolidated Statements of Operations (unaudited) for
the three months and six months ended June 30, 2000 and 1999..... 4
Condensed Consolidated Statements of Cash Flows (unaudited) for
the six months ended June 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............................................ 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk.........18
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds..........................19
Item 4. Submission of Matters to a Vote of Security Holders................19
Item 6. Exhibits and Reports on Form 8-K...................................20
SIGNATURES ..................................................................21
2
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
WEB STREET, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
------------ ------------
(Unaudited)
ASSETS
<S> <C> <C>
Cash and cash equivalents ......................................... $ 27,103,091 $ 39,189,362
Receivable from clearing broker ................................... 1,128,414 2,395,679
Other receivables ................................................. 827,119 359,917
Securities owned, at market ....................................... 145,289 --
Property and equipment, net ....................................... 6,007,560 3,994,411
Prepaid expenses and other ........................................ 2,236,046 1,851,534
------------ ------------
Total assets ...................................................... $ 37,447,519 $ 47,790,903
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable ................................................ $ 2,372,704 $ 2,705,228
Accrued compensation and benefits ............................... 925,349 1,202,561
Other accrued expenses .......................................... 950,388 774,072
Securities sold, not yet purchased, at market ................... 250,323 --
Deferred rent ................................................... 179,898 146,082
------------ ------------
Total liabilities ................................................. 4,678,662 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;
25,767,652 shares issued and outstanding at June 30, 2000 and
25,660,402 shares issued and outstanding at December 31, 1999) 257,677 256,604
Additional paid-in capital ...................................... 65,802,643 65,317,651
Accumulated deficit ............................................. (33,291,463) (22,611,295)
------------ ------------
Total stockholders' equity ........................................ 32,768,857 42,962,960
------------ ------------
Total liabilities and stockholders' equity ........................ $ 37,447,519 $ 47,790,903
============ ============
</TABLE>
See notes to condensed consolidated financial statements.
3
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WEB STREET, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
2000 1999 2000 1999
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
Revenues:
Transaction revenue ............. $ 6,281,117 $ 5,608,487 $ 18,359,057 $ 9,879,755
Interest income ................. 672,371 167,034 1,406,920 314,834
Other revenue ................... 371,152 260,043 613,879 477,570
---------------------------- ----------------------------
Total revenues ..................... 7,324,640 6,035,564 20,379,856 10,672,159
Cost of services:
Clearance and execution ......... 4,553,101 2,658,950 9,906,680 4,376,646
Employee compensation and
benefits ...................... 1,048,105 707,692 2,015,040 1,257,813
Communication and data processing 791,959 331,611 1,449,671 619,810
---------------------------- ----------------------------
Total cost of services ............. 6,393,165 3,698,253 13,371,391 6,254,269
Operating expenses:
Marketing and advertising ....... 2,880,899 1,610,821 8,472,768 2,243,969
Technology development .......... 682,994 598,282 1,392,234 912,502
General and administrative ...... 4,255,786 1,370,403 7,823,631 2,489,023
---------------------------- ----------------------------
Total operating expenses ........... 7,819,679 3,579,506 17,688,633 5,645,494
---------------------------- ----------------------------
Net loss ........................... $ (6,888,204) $ (1,242,195) $(10,680,168) $ (1,227,604)
============================ ============================
Basic and diluted net loss per
common share .................... $ (0.27) $ (0.06) $ (0.42) $ (0.06)
============================ ============================
Weighted-average common shares used
in computation of basic and
diluted net loss per common share 25,727,076 20,404,466 25,715,280 20,404,466
============================ ============================
</TABLE>
See notes to condensed consolidated financial statements.
4
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WEB STREET, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six months ended June 30,
----------------------------
2000 1999
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss .................................................... $(10,680,168) $ (1,227,604)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ........................... 973,685 268,840
Compensation and other expenses incurred through
issuance of stock options and warrants ................ 479,425 171,359
Net deferred rent accretion (amortization) .............. 33,816 (2,148)
Changes in operating assets and liabilities:
Receivable from clearing broker ....................... 1,267,265 157,159
Other receivables ..................................... (467,202) 531,597
Prepaid expenses and other assets ..................... (475,603) (759,196)
Securities owned and securities sold, not yet purchased 105,034 --
Accounts payable ...................................... (332,524) 239,279
Accrued compensation and benefits ..................... (277,212) 66,005
Other accrued expenses ................................ 176,317 269,873
------------ ------------
Net cash used in operating activities .......................... (9,197,167) (284,836)
Cash flows from investing activities:
Purchases of property, equipment and software ............... (2,895,744) (2,441,891)
Cash flows from financing activities:
Proceeds from issuance of common stock, net of issuance costs -- 5,005,740
Redemption of preferred stock ............................... -- (650,000)
Payment from related party .................................. -- 190,000
Proceeds from the exercise of stock options ................. 6,640 --
------------ ------------
Net cash provided by financing activities ...................... 6,640 4,545,740
------------ ------------
Increase (decrease) in cash and cash equivalents ............... (12,086,271) 1,819,013
Cash and cash equivalents at beginning of period ............... 39,189,362 1,579,639
------------ ------------
Cash and cash equivalents at end of period ..................... $ 27,103,091 $ 3,398,652
============ ============
Supplemental disclosures of cash flow information:
Interest paid ............................................... $ 4,462 $ 948
Income taxes paid ........................................... -- --
Eliminate common stock put rights ........................... -- 624,375
</TABLE>
See notes to condensed consolidated financial statements.
5
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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, they 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 six months ended June 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 Web Street, Inc. annual report on Form
10-K for the year ended December 31, 1999.
2. Receivable from Clearing Broker
Receivable from clearing broker represents the net settlement due to
the Company for customer trading activity payable by its clearing broker.
Receivable from clearing broker at June 30, 2000 and December 31, 1999 consisted
of the following:
June 30, December 31,
2000 1999
---------- ----------
Rebates receivable from payments for order flow .... $ 488,141 $1,566,091
Commissions receivable ............................. 640,273 829,588
---------- ----------
$1,128,414 $2,395,679
========== ==========
3. Property and Equipment
Property and equipment, net at June 30, 2000 and December 31, 1999,
consisted of the following:
December 31,
June 30, 2000 1999
----------- -----------
Hardware and equipment ....................... $ 3,937,114 $ 2,813,417
Furniture and fixtures ....................... 593,599 438,576
Software ..................................... 1,626,614 872,458
Buildings and leasehold improvements ......... 1,994,082 1,151,101
Land and improvements ........................ 44,886 25,000
----------- -----------
Total cost ................................... 8,196,295 5,300,552
Accumulated depreciation ..................... (2,188,735) (1,306,141)
----------- -----------
$ 6,007,560 $ 3,994,411
=========== ===========
6
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4. Securities Owned and Securities Sold, Not Yet Purchased
Securities owned and securities sold, not yet purchased arise in the
ordinary course of business as a result of non-proprietary trading activities
related to customer trade execution. These positions are liquidated as soon as
reasonably possible. Securities owned and securities sold, not yet purchased are
carried at market value and are recorded on a trade date basis. Changes in the
market value of securities owned and securities sold, not yet purchased are
reported as a component of net loss in the statements of operations.
Securities sold, not yet purchased represent obligations to purchase
such securities at a future date. The Company may incur a loss in excess of
amounts reported in the balance sheet if the market value of the securities
subsequently increases.
5. Commitments and Contingencies
During the six months ended June 30, 2000, the Company entered into
various operating leases principally for office facilities. The Company's
aggregate future minimum lease payments on various leases expiring through 2010
were approximately $16,612,000 at June 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.
6. Related Party Transactions
Other assets at June 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 March 16, 2001.
7. Stock Options
During the six months ended June 30, 2000, the Company granted
employees options to purchase 2,182,810 shares of its common stock. The
weighted-average exercise price of options granted was $8.14 per share. During
the same period, options previously granted to employees on 71,070 shares of the
Company's common stock were forfeited or terminated. The weighted-average
exercise price of options forfeited or terminated was $7.62 per share.
8. 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, which requires that it maintain minimum net capital, as defined, of 6
2/3% of aggregate indebtedness or $100,000, whichever is greater. At June 30,
2000, Web Street Securities had net capital of $5,699,581, which exceeded the
minimum net capital requirements by $5,499,944, and a ratio of aggregate
indebtedness to net capital of 0.53 to 1.
7
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Through July 2, 2000, Web Street Securities, Inc. was exempt from the
customer protection rule, Rule 15c3-3 under the Securities Exchange Act of 1934,
under paragraph (k)(2)(ii) of that rule, because it introduced customers to a
clearing broker on a fully-disclosed basis and did not hold customer funds or
securities.
On July 3, 2000, the Company completed its 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, the Company is
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 $77,510,000 and other
clearing-related balances were transferred onto the Company's balance sheet.
8
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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 April 30, 2000, our initial clearing agreement with U.S Clearing
Corp. expired. From May 1, 2000 through the end of the second quarter, U.S.
Clearing provided clearing and execution services for our customers' accounts
under an interim clearing agreement. Our initial agreement with U.S. Clearing
Corp. provided us with payments for order flow that were above the then-current
market rates. While operating under the interim agreement with U. S. Clearing,
we received lower payments for order flow than we had historically received, as
the payments were based on the current-market rebates received from the market
makers that were counter party to our customers' orders. Additionally, we
experienced a $1.25 increase in clearing costs per trade compared to what we had
been charged by U.S. Clearing under the terms of the initial agreement. Our
results from operations were also adversely impacted by external market factors
in the second quarter of 2000. Principally, towards the end of the first quarter
and into the beginning of the second quarter of 2000, the U.S. equity markets
experienced an increase in price volatility followed by a decrease in the volume
of shares transacted on the major exchanges. These combined factors contributed
to our lower trade volumes and transaction revenues in the second quarter
compared to our recent quarterly results. However, we carefully managed
discretionary spending, including marketing, during the second quarter and
thereby lessened the impact of these factors on our results from operations.
On July 3, 2000, we completed our conversion to become a self-clearing
broker-dealer. Since July 3, 2000, we have been performing clearing 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. We expect the conversion to self-clearing operations to result in
increased interest income from carrying our customers' accounts, as well as
lower clearance and execution costs per trade. Beyond the second quarter, we
anticipate this conversion will contribute to important positive customer
benefits, renewed revenue growth and improved operating results for the firm.
However, anticipated positive effects of self-clearing operations will not be
fully realized immediately because of residual conversion costs expected to be
incurred in the third quarter of 2000 and the time we expect it will take to
optimize our self-clearing operations.
Above-market order flow payments received under our initial agreement
with U.S. Clearing allowed us to offer our customers commission-free trades on
over-the-counter market and limit orders of 1,000 or more shares priced at more
than $2.00 per share. Because the decrease in order flow payments we experienced
upon the expiration of our initial agreement with U.S. Clearing will continue
after our conversion to self-clearing operations, we now only offer these
commission-free trades on market orders. We have attempted to (1) offset any
competitive advantage we may lose from charging customers a
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commission for all limits orders, (2) attract higher customer margin balances
and (3) generate additional interest income for the Company by charging
customers who carry margin loan balances lower margin interest rates than we had
under our agreements with U.S. Clearing Corp.
During the second quarter of 2000, we announced the following new
product offerings and strategic alliances aimed at increasing customer reliance
on us as their one-stop online financial services provider:
o A redesigned web site that includes the Web Street Global Asset
Manager(SM), a tool designed to enable cash and investment management
through a single on-line account;
o The industry's lowest published margin rates for margin balances in
excess of $2,500,000;
o An alliance with InsWeb, a leading on-line insurance services provider,
to provide our customers with access to low-cost home, auto, life and
health insurance; and
o An alliance with Lending Tree, a nationally-recognized loan marketplace
for consumers and lenders, that offers our customers access to
affordable mortgages and other consumer loans.
During the second quarter of 2000, we increased our capital investments
with the addition of $892,000 in property and equipment. 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 September 2000. We expect to execute equipment lease agreements
in the third quarter that require aggregate lease payments of approximately
$2,250,000 over the next three years to make the mirror data center operational.
During the second quarter of 2000, we also began construction of
storefront improvements in our three planned state-of-the-art financial service
centers in the financial districts of San Francisco, Boston and Denver. These
street-level locations will enable us to provide customers with in-person
educational seminars, access to information on various financial markets, and
demonstrations detailing our product services and 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. Expenditures on these
facilities were not significant in the second quarter of 2000. However, we
expect to invest a total of between $1,500,000 and $2,000,000 in these
facilities in the third and fourth quarters of 2000, a substantial portion of
which may be financed through leases. We intend to open additional financial
service centers in other select locations in the United States and
internationally.
We intend to increase expenditures in all 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 also plan to continue enhancing
financial, operational and management controls and reporting systems and
procedures in support of the continued expansion of our operations. However, we
also intend to continue scaling back planned increases in our direct consumer
marketing efforts in the near term as we increase our focus on domestic and
international business-to-business partnerships as a key driver of our growth.
10
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Results of Operations
In the discussion below, we compare our results of operations for the
three month and six month periods ended June 30, 2000 and 1999.
The following table shows for the periods presented (a) the percentage
of total 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 Total Revenues Percentage Change
------------------------------------------- ------------------
Three months Six months Three Six
ended June 30, ended June 30, month month
2000 1999 2000 1999 periods periods
------------------- ------------------- ------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Transaction revenue ............................... 86 % 93 % 90 % 93 % 12% 86%
Interest income ................................... 9 3 7 3 303 347
Other revenue ..................................... 5 4 3 4 43 29
------------------- -------------------
Total revenues ....................................... 100 100 100 100 21 91
Cost of services:
Clearance and execution ........................... 62 44 48 41 71 126
Employee compensation and benefits ................ 14 12 10 12 48 60
Communication and data processing ................. 11 5 7 6 139 134
------------------- -------------------
Total costs of services .............................. 87 61 65 59 73 114
Operating expenses:
Marketing and advertising ......................... 40 26 42 21 79 278
Technology development ............................ 9 10 7 9 14 53
General and administrative ........................ 58 23 38 23 211 214
------------------- -------------------
Total operating expenses ............................. 107 59 87 53 118 213
------------------- -------------------
Net loss ............................................. (94)% (21)% (52)% (12)% 455 770
=================== ===================
Other Data:
Total trades (thousands of trades) ................... 342.4 253.4 811.4 440.6 35 84
Average trades per day ............................... 5,435 4,022 6,440 3,600 35 79
Total customer accounts (thousands of accounts) (1)(2) 123.0 66.4 123.0 66.4 85 85
Total customer assets (millions of dollars) (1) ...... $ 895 $ 471 $ 895 $ 471 90 90
Total employees (1) .................................. 174 112 174 112 55 55
</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.
Three Months Ended June 30, 2000 Compared to Three Months Ended June 30, 1999
Revenues
Total revenues increased to $7,325,000 in the second quarter of 2000,
up 21% from $6,036,000 in the second quarter of 1999. Our transaction volumes,
total customer accounts and customer asset balances grew rapidly during the last
half of 1999 and through the first half of 2000. However, in the second quarter
of 2000 much of this growth was offset by reductions in our transaction revenues
related to industry-wide declines in the volume of shares traded on the major
exchanges. We executed on average 5,435 trades per day in the three months ended
June 30, 2000 compared to an average of 4,022 trades per day during the same
period of 1999, a 35% increase. Total customer accounts increased 85%
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from 66,400 at June 30, 1999 to 123,000 at June 30, 2000. Customer asset
balances increased 90% from $471,175,000 at June 30, 1999 to $894,844,000 at
June 30, 2000.
Transaction revenue increased to $6,281,000 in the second quarter of
2000, up 12% from $5,608,000 in the second quarter of 1999. Transaction revenue
represented 86% of total revenue in the second quarter of 2000, compared to 93%
in the same period in 1999. Brokerage commissions increased to 62% of total
revenues in the second quarter of 2000 from 56% in the second quarter of 1999,
while order flow-related rebates declined to 24% of total revenue in the second
quarter of 2000 from 36% in the corresponding period in 1999. The decrease in
the contribution to total revenue by transaction revenue and the change in
transaction revenue mix was due to the April 30, 2000 expiration of our initial
clearing agreement with U.S. Clearing, which provided above-market payments for
order flow. For the three months ended June 30, 2000, equity transactions
represented 91% and option transactions represented 9% of our total transaction
volumes. This compares to 88% for equity transactions and 12% for option
transactions for the three months ended June 30, 1999. Average transaction
revenue decreased to $18.34 per trade in the second quarter of 2000 from $22.13
in the second quarter of 1999 due to a decrease in order flow payments resulting
from the expiration of our initial clearing agreement with U.S. Clearing.
Transaction revenue from our international partnerships, principally our
agreement with ConSors Discount-Broker (ConSors), represented approximately 37%
of our total revenues in the second quarter of 2000 compared with 9% in the
second quarter of 1999. We expect revenues from our international relationships
to continue to increase as a percentage of our total revenues in the future.
Interest income increased to $672,000, or 9% of total revenue, in the
second quarter of 2000, up 303% from $167,000, or 3% of total revenue, in the
second quarter of 1999 due primarily to increases in our average cash balances.
Our average cash balances increased from approximately $4.4 million during the
second quarter of 1999 to approximately $29.6 million during the second quarter
2000 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. Also contributing
to the increase in interest income were the increases in our customer money
market and margin debit balances. We expect interest income to increase as a
percentage of total revenue in the future as a result of our conversion to self-
clearing operations because we will retain the full interest spread that we
previously shared with U.S. Clearing, and we expect additional growth in
customer credit and debit balances.
Other revenue increased to $371,000 in the second quarter of 2000, up
43% from $260,000 in the second quarter of 1999. The increase was due to a
comparable increase in the number of subscribers to our automatically updating
real-time quote services at prices ranging from $19.95 to $79.95 per month.
Other revenue increased slightly to 5% of total revenue in the second quarter of
2000 from 4% in the same period in 1999.
Cost of Services
Total cost of services increased to $6,393,000 in the second quarter of
2000, up 73% from $3,698,000 in the comparable quarter of 1999. This increase
was due to the increase in the clearing cost per trade under the interim
clearing agreement with U.S. Clearing, greater margin-sharing payments to our
international partners and the increases discussed above in the number of
securities transactions we executed during the second quarter of 2000. Clearance
and execution costs increased to $4,553,000 in the second quarter of 2000, up
71% from $2,659,000 in the same period in 1999. Average clearance and execution
costs per trade increased to $13.30 in the second quarter of 2000 from $10.49 in
the same period in 1999. The transaction-based fees paid to U.S. Clearing for
trade execution, as well as to various market data vendors, increased throughout
1999 and into the first quarter of 2000 as transaction volumes increased.
Additionally, beginning in April 2000 we experienced a $1.25 increase in
clearing costs per trade compared to what we had been charged under the terms of
our initial clearing agreement with U.S.
12
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Clearing. In April 1999, we began making margin-sharing payments for trades
directed to us under agreements with our international partners that we also
recorded as clearance and execution costs. These margin-sharing payments caused
the average clearance and execution cost per trade to increase by $1.63 in the
second quarter of 2000 from its level in the second quarter of 1999. As a result
of growth in these margin-sharing payments and the higher transaction-based fees
paid to U.S. Clearing, clearance and execution costs increased to 62% of total
revenues in the second quarter of 2000 from 44% in the second quarter of 1999.
Employee compensation and benefits increased to $1,048,000 in the
second quarter of 2000, up 48% from $708,000 in the second quarter of 1999.
Communication and data processing costs increased to $792,000 in the second
quarter of 2000, up 139% from $332,000 in the second quarter of 1999. These
increases resulted from our addition of licensed brokers and other customer
service personnel, as well as third party market data services, communication
lines and equipment to accommodate the increased number of customer accounts and
associated traffic to our web site and to our customer service call center.
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. These enhancements to our operations resulted in greater
personnel, occupancy and communication costs in the second quarter of 2000
compared to the same period in 1999. Total employees involved in brokerage,
customer service and technical support activities increased to 116 at June 30,
2000 from 79 at June 30, 1999. As a percentage of total revenues, employee
compensation and benefit costs increased to 14% in the three months ended June
30, 2000, from 12% in the same three-month period of 1999. Communication and
data processing costs as a percentage of total revenues increased to 11% at June
30, 2000 from 5% at June 30, 1999.
Operating Expenses
Total operating expenses increased to $7,820,000 during the three
months ended June 30, 2000, up 118% from $3,580,000 during the three months
ended June 30, 1999. The majority of this increase was due to increased general
and administrative expenses, as described in further detail below.
Marketing and advertising expenses increased to $2,881,000 in the
second quarter of 2000, up 79% from $1,611,000 in the second quarter of 1999,
but down significantly from its first quarter 2000 level of $5,592,000. During
the fourth quarter of 1999, we began production of a new national advertising
campaign, employing the tagline "Invest with Ambition," that launched in
February 2000. We began airing these advertisements in the first quarter of 2000
and had committed to approximately $2,470,000 in broadcast and print advertising
for the second quarter. Because of the delay in our conversion to self-clearing
operations and the adverse impact we anticipated the delay would have on our
revenues and gross margins in the second quarter, we elected to curtail planned
marketing activities for the second quarter of 2000 and we were able to
negotiate the deferral of roughly $152,000 of our committed advertising until
the third quarter of 2000. We intend to continue to carefully manage marketing
expenditures throughout the remainder of the year.
Technology development expenses increased to $683,000 in the second
quarter of 2000, up 14% from $598,000 in the same period in 1999. The increased
spending was due to an increase in the number of technology department employees
and consultants, and an increase in the expenses related to software development
to enhance our web site, prepare for self-clearing operations and expand our
product and service offerings. However, in the second quarter of 2000,
technology development expenses decreased slightly to 9% of total revenues, from
10% in the second quarter of 1999 as certain fixed expenses in this category
were spread over a larger revenue base. We expect that technology development
expenditures will continue to increase in the future, but may fluctuate as a
percentage of revenues over time depending on the timing of future development
projects.
13
<PAGE>
General and administrative expenses increased to $4,256,000 in the
second quarter of 2000, up 211% from $1,370,000 in the second quarter of 1999.
This increase was 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 benefit levels to attract and retain qualified employees, (2)
increased consulting expenses related to the conversion of our operations to
self-clearing, (3) expenses associated with being a public company and (4)
increased occupancy costs related to opening our new brokerage operation
facilities in Chicago, Illinois in December 1999. Additionally, we recorded
higher non-cash charges for stock options and warrants, granted at or above
then-current market values, to vendors and an international partner in the
second half of 1999. The values associated with these grants are amortized over
the period over which services are rendered. This non-cash expense also includes
charges related to stock options granted to employees below the current market
value of our stock at the time of the grants. The non-cash expense associated
with vendor and employee-related grants was $64,000 in the second quarter of
1999 and $246,000 for the second quarter of 2000. We have not granted any
options with exercise prices below the current market value of our stock to
employees since September 1, 1998, nor do we expect to make any such grants in
the future. As a result, the charges against income associated with the employee
grants will decline in future periods. However, we have granted and may continue
to grant options and warrants to third parties, for services rendered and on
which we will be required to recognize future charges against income. We
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. We incurred approximately $1,171,000 of
start-up costs related to our self-clearing conversion during the quarter ended
June 30, 2000. Excluding these costs, general and administrative expenses for
the three months ended June 30, 2000 were 42% of total revenues. We expect to
incur a lesser amount of conversion-related costs in the third quarter of 2000
as we complete the full conversion and start-up to self-clearing operations.
Six Months Ended June 30, 2000 Compared to Six Months Ended June 30, 1999
Revenues
Total revenues increased to $20,380,000 in the first half of 2000, up
91% from $10,672,000 in the first half of 1999. We executed on average 6,440
trades per day in the six months ended June 30, 2000 compared to an average of
3,600 trades per day during the same period of 1999, an increase of 79%.
Transaction revenue increased to $18,359,000 in the first half of 2000,
up 86% from $9,880,000 in the first half of 1999. Transaction revenue
represented 90% of total revenue in the first six months of 2000, compared to
93% in the same period in 1999. Brokerage commissions decreased slightly to 59%
of total revenues in the first half of 2000 from 60% in the first half of 1999,
while order flow-related rebates grew slightly to 41% of total revenue in the
first half of 2000 from 40% in the corresponding period in 1999. For the six
months ended June 30, 2000, equity transactions represented 91% and option
transactions represented 9% of our total transaction volumes. This compares to
86% for equity transactions and 14% for option transactions for the six months
ended June 30, 1999. Average transaction revenue increased slightly to $22.63
per trade in the first half of 2000 from $22.42 in the first half of 1999. The
slight increase in average transaction revenue per trade is a result of the
increase in average order flow-related payments per trade, particularly in the
first three months of 2000, largely offset by the shift in trade mix away from
higher commission option trades, and lower order flow payments in May and June
of 2000 as a result of the expiration of our initial clearing agreement with
U.S. Clearing. Transaction revenue from our international partnerships,
principally our agreement with ConSors Discount-Broker (ConSors), represented
approximately 28% of our total revenues in the first half of 2000. Our
relationship with ConSors became operational at the end of the first quarter of
1999.
14
<PAGE>
Interest income increased to $1,407,000, or 7% of total revenue, in the
first half of 2000, up 347% from $315,000, or 3% of total revenue, in the first
half of 1999 due primarily to increases in our average cash balances. Our
average cash balances increased from approximately $3.5 million during the first
half of 1999 to approximately $32.8 million during the first half of 2000 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. Also contributing to
the increase in interest income were the increases in our customer money market
and margin debit balances.
Other revenue increased to $614,000 in the first half of 2000, up 29%
from $478,000 in the first half of 1999. The increase was due to a comparable
increase in the number of subscribers to our automatically updating real-time
quote services at prices ranging from $19.95 to $79.95 per month. Other revenue
decreased to 3% of total revenue in the second three months of 2000 from 4% in
the same period in 1999, as transaction revenues and interest income grew at a
more rapid rate through the first six months of 2000.
Cost of Services
Total cost of services increased to $13,371,000 in the first half of
2000, up 114% from $6,254,000 in the first half of 1999. This increase was due
primarily to the increase discussed above in the number of securities
transactions we executed during the first six months of 2000. Clearance and
execution costs increased to $9,907,000 in the first six months of 2000, up 126%
from $4,377,000 in the same period in 1999. Average clearance and execution
costs per trade increased to $12.21 in the first six months of 2000 from $9.93
in the same period in 1999. The transaction-based fees paid to U.S. Clearing for
trade execution, as well as to various market data vendors, increased throughout
1999 and into the first six months of 2000 as transaction volumes increased.
Additionally, beginning in April 2000 we experienced a $1.25 increase in
clearing costs per trade compared to what we had been charged under the terms of
our initial clearing agreement with U.S. Clearing. In April 1999, we began
making margin-sharing payments for trades directed to us under agreements with
our international partners that we also recorded as clearance and execution
costs. These margin-sharing payments caused the average clearance and execution
cost per trade to increase by $1.79 in the first half of 2000 from its level in
the first half of 1999. As a result of initiating these margin-sharing payments
and the higher transaction-based fees paid to U.S. Clearing, clearance and
execution costs increased to 48% of total revenues in the first half of 2000
from 41% in the first half of 1999.
Employee compensation and benefits increased to $2,015,000 in the first
half of 2000, up 60% from $1,258,000 in the first half of 1999. Communication
and data processing costs increased to $1,450,000 in the first half of 2000, up
134% from $620,000 in the first half of 1999. These increases resulted from our
addition of licensed brokers and other customer service personnel, as well as
third party market data services, communication lines and equipment to
accommodate the increased number of customer accounts and associated traffic to
our web site and to our customer service call center. 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. These enhancements to our operations resulted in greater personnel,
occupancy and communication costs in the first half of 2000 compared to the same
period in 1999. As a percentage of total revenues, employee compensation and
benefit costs decreased to 10% in the six months ended June 30, 2000, from 12%
in the same six-month period of 1999. Communication and data processing costs as
a percentage of total revenues increased to 7% for the six months ended June 30,
2000 from 6% for the six months ended June 30, 1999.
15
<PAGE>
Operating Expenses
Total operating expenses increased to $17,689,000 during the six months
ended June 30, 2000, up 213% from $5,645,000 during the six months ended June
30, 1999. The majority of this increase was due to increased costs associated
with marketing and advertising to develop brand awareness for our web site and
an increase in general and administrative expenses, as described in further
detail below.
Marketing and advertising expenses increased to $8,473,000 in the first
half of 2000, up 278% from $2,244,000 in the first half of 1999. During the
fourth quarter of 1999, we began production of a new national advertising
campaign launched in February 2000. As of December 31, 1999, approximately
$684,000 of production costs related to this campaign were deferred and included
in prepaid expenses and other assets in our consolidated balance sheet. These
costs were charged to expense in the first half of 2000 upon the first airing of
these advertisements.
Technology development expenses increased to $1,392,000 in the first
half of 2000, up 53% from $913,000 in the same period in 1999. The increased
spending was due to an increase in the number of technology department employees
and consultants, and an increase in the expenses related to software development
to enhance our web site, prepare for self-clearing operations and expand our
product and service offerings. However, in the first half of 2000, technology
development expenses decreased to 7% of total revenues, from 9% in the first
half of 1999 as certain fixed expenses in this category were spread over a
larger revenue base.
General and administrative expenses increased to $7,824,000 in the
first half of 2000, up 214% from $2,489,000 in the first half of 1999. This
increase was 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 benefit levels to attract and retain qualified employees, (2) increased
consulting expenses related to the conversion of our operations to
self-clearing, (3) expenses associated with being a public company and (4)
increased occupancy costs related to opening our new brokerage operation
facilities in Chicago, Illinois in December 1999. Additionally, we recorded
higher non-cash charges for stock options and warrants, granted at or above
then-current market values, to vendors and an international partner in the
second half of 1999. The values associated with these grants are amortized over
the period over which services are rendered. This non-cash expense also includes
charges related to stock options granted to employees below the current market
value of our stock at the time of the grants. The non-cash expense associated
with vendor and employee-related grants was $171,000 in the first six months of
1999 and $479,000 in the first six months of 2000. We incurred approximately
$1,923,000 of start-up and redundant costs related to our self-clearing
conversion during the six months ended June 30, 2000. Excluding to these costs,
general and administrative expenses for the six months ended June 30, 2000 were
29% of total revenues.
Liquidity and Capital Resources
As of June 30, 2000, we had cash and cash equivalents of $27,103,000
and no bank debt. Our cash used in operating activities was $9,197,000 in the
first six months of 2000, compared to $285,000 used in operating activities
during the first six months of 1999. Our operating cash inflows consist
principally of brokerage commissions and order flow-related payments collected,
and other revenue and interest received. Our operating cash outflows consist
principally of clearing and execution costs, employee compensation and benefit
costs, marketing and advertising costs, and general and administrative costs
paid. The increase in operating cash outflows for the first six months of 2000
compared to the same period in 1999 is attributable to greater amounts paid for
marketing and advertising, and non-recurring and redundant costs associated with
our conversion to self-clearing operations. We paid $8,212,000 in marketing and
advertising costs and $1,418,000 in non-recurring and redundant costs associated
with our conversion to self-clearing operations in the first half of 2000.
16
<PAGE>
Cash used in investing activities, all of which has represented capital
expenditures, increased to $2,896,000 for the six months ended June 30, 2000,
compared to $2,442,000 for the six months ended June 30, 1999. We continued to
acquire, build or develop facilities, fixed assets and software for cash and
under operating leases during the first six months of 2000 to support the
continued rapid growth of the business. During the six months ended June 30,
2000, we signed leases increasing our aggregate commitments under non-cancelable
operating leases for facilities and equipment to $16,612,000 at June 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 $77,510,000, and other clearing-related
balances were transferred onto our balance sheet. 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.
Additionally, as a self-clearing broker-dealer we will be required to
maintain significantly higher minimum net capital. See note 8 to the Condensed
Consolidated Financial Statements. During April 2000, we contributed $6 million
in capital to our wholly-owned subsidiary, Web Street Securities. Management
expects that this contribution will initially provide us with net capital of
approximately $4 million in excess of the minimum net capital that will be
required of us as a self-clearing broker-dealer.
In the future, we expect to incur higher costs, particularly technology
development, payroll and occupancy costs, to grow our business. We anticipate
increased levels of capital expenditures in the remainder of 2000 to complete
our mirror data center, to complete storefront improvements in our planned
financial service centers in San Francisco, Boston and Denver, and to continue
to expand our existing systems and network of online financial service centers
over the next year. It is our intention to finance certain of these capital
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 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 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.
17
<PAGE>
Cautionary Note Regarding Forward-Looking Statements
Because we want to provide you with more 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," "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
self-clearing operations, our ability to establish and maintain domestic and
international relationships 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 by our
international customers and our international partners, and we do not hold any
assets or incur any liabilities denominated in foreign currencies.
At June 30, 2000, we owned $145,000 of publicly-traded equity
securities and had an obligation to buy $250,000 of previously-sold
publicly-traded equity securities. We are exposed to equity price risk as a
result of these securities positions. Equity price risk results from changes in
the level or volatility of equity prices in general that affect the value of our
securities owned and securities sold, not yet purchased. Equity price risk was
measured assuming an instantaneous 10% decrease in value of the securities in
our portfolios as of June 30, 2000, with all other variables held constant. If
the market price of securities owned and securities sold, not yet purchased were
to decrease by 10%, the fair value of the portfolio would increase by $11,000
due to the offset of losses on securities owned with gains on securities sold,
not yet purchased. The magnitude of change in equity prices chosen reflects our
view of changes that are reasonably possible over a one-year period. The
selection of the magnitude of change in equity prices should not be construed as
our prediction of future market events, but rather an illustration of the impact
of such events.
18
<PAGE>
PART II - OTHER INFORMATION
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. We have used approximately $9.7
million to market our online brokerage services and other financial services and
products, approximately $2.9 million for the acquisition, construction or
development of property, equipment and software, and approximately $2.9 million
for working capital and general corporate purposes. The above-mentioned uses of
the offering proceeds are before consideration of cumulative cash flow from
operating activities exclusive of these uses since the IPO of approximately
$936,000. We have invested the remaining net proceeds, pending their use, in
short-term, investment grade, interest-bearing obligations.
Item 4. Submission of Matters to a Vote of Security Holders
a) Our 2000 Annual Meeting of Stockholders was held on May 9,
2000.
b) The stockholders voted to re-elect two Class I directors to
our Board of Directors. Results of the voting were as follows:
<TABLE>
<CAPTION>
Authority Broker
Director For Withheld Abstentions Non-Votes
<S> <C> <C> <C> <C>
D. Jonathan Rosenberg... 21,376,718 37,298 - -
Frederic J. Graber...... 21,376,718 37,298 - -
</TABLE>
Joseph J. Fox, Avi Fox and Robert F. Bernard continued their
terms of office as our directors after the 2000 Annual Meeting
of Stockholders.
c) The stockholders also voted to ratify the appointment by our
Board of Directors of Arthur Andersen LLP as the independent
auditors of our financial statements for the year ending
December 31, 2000. Results of the voting were as follows:
For Against Abstentions Broker Non-Votes
21,403,647 - 10,369 -
19
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
a) We have filed the following exhibits with this quarterly
report.
Exhibit
Number Exhibit
10.1 Sublease agreement dated October 31, 1999 between Web
Street, Inc. and ContiGroup Companies, Inc. for
premises at 222 Riverside Plaza, Chicago, Illinois
10.2 + Dealers' Omnibus Options Clearing Agreement dated
April 12, 2000 between Web Street Securities, Inc.
and ABN-AMRO, Incorporated (Firm Transactions)
10.3 + Dealers' Omnibus Options Clearing Agreement dated
April 12, 2000 between Web Street Securities, Inc.
and ABN-AMRO, Incorporated (Customer Transactions)
27 Financial Data Schedule
+ A portion of the exhibit has been omitted pursuant to a
request for confidential treatment.
b) Reports on Form 8-K.
We did not file any Current Reports on Form 8-K during the second
quarter of 2000.
20
<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: August 14, 2000 By: /s/ JOSEPH J. FOX
-----------------
Joseph J. Fox
Co-Chief Executive Officer (principal
executive officer) and Co-Chairman of
the Board
Date: August 14, 2000 By: /s/ JOSEPH A. BARR
------------------
Joseph A. Barr
President, Chief Financial Officer
(principal financial and accounting
officer) and Treasurer
21
<PAGE>
EXHIBIT INDEX
-------------
Exhibit Number Exhibit
-------------- -----------------------------------------------------------------
10.1 Sublease agreement dated October 31, 1999 between Web Street, Inc
and. ContiGroup Companies, Inc. for premises at 222 Riverside
Plaza, Chicago, Illinois
10.2 + Dealers' Omnibus Options Clearing Agreement dated April 12, 2000
between Web Street Securities, Inc. and ABN-AMRO, Incorporated
(Firm Transactions)
10.3 + Dealers' Omnibus Options Clearing Agreement dated April 12, 2000
between Web Street Securities, Inc. and ABN-AMRO, Incorporated
(Customer Transactions)
27 Financial Data Schedule
+ A portion of the exhibit has been omitted pursuant to a request for
confidential treatment.
