UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 1-14897
A.B. Watley Group Inc.
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(Name of registrant as specified in its charter)
Delaware 13-3911867
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
40 Wall Street, New York, New York 10005
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(Address of principal executive offices) (Zip Code)
Registrant`s telephone number, including area code: (212) 422-1100
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
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(Title of Class)
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 / / No /X/.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant`s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K / /
The issuer`s revenues for the fiscal year ended September 30, 2003 were
$15,248,882.
The aggregate market value of the voting stock held by non-affiliates of the
registrant on May 14, 2004 computed by reference to the closing price of $.25
on such stock on such date was approximately $3,259,284. The number of shares of
common stock, par value $.001 per share, outstanding as of May 14, 2004 was
13,037,138 shares.
DOCUMENTS INCORPORATED BY REFERENCE
None
Forward Looking Statements: This Report contains certain statements that may be
deemed "forward-looking statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act. All statements, other than
statements of historical facts, that address activities, events or developments
that the Company intends, expects, projects, believes or anticipates will or may
occur in the future are forward-looking statements. Such statements are based on
certain assumptions and assessments made by management of the Company in light
of its experience and its perception of historical trends, current conditions,
expected future developments and other factors it believes to be appropriate.
The forward-looking statements included in this Report are also subject to a
number of material risks and uncertainties, including but not limited to
economic, competitive, governmental and technological factors affecting the
Company`s operations, markets, services and prices, and other factors discussed
in the Company`s filings under the Securities Act and the Exchange Act.
Stockholders and prospective investors are cautioned that such forward-looking
statements are not guarantees of future performance and that actual results,
developments and business decisions may differ from those envisaged by such
forward-looking statements.
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PART I
Item 1. Business
General
A.B. Watley Group Inc. ("ABWG" or the "Company") is a publicly-held financial
services holding company incorporated in the state of Delaware on May 15, 1996.
We conduct our core business activities through our subsidiaries A.B. Watley,
Inc. ("A.B. Watley"), A.B. Watley Direct, Inc. ("Direct" and formerly Integrated
Clearing Solutions, Inc. ("Integrated") and A.B. Watley Futures Corp. (ABW
Futures"). A.B. Watley and Direct are U.S. registered broker-dealers that engage
in direct-access trading and proprietary trading of U.S. equities and
institutional sales. We provide direct-access trading capabilities and related
software to both individuals as well as institutional customers. A.B. Watley
ceased operations in January 2004. In February 2004, A.B. Watley withdrew its
registration as a broker/dealer. ABW Futures is an introducing broker/dealer
registered with the National Futures Association and conducts futures trading
activity for customers.
As of September 30, 2003, the brokerage firms had approximately 1,100
customers. We have historically devoted significant resources to the development
of proprietary software. However, in July 2002, our business activities were
reorganized and we sold our software programs know as Ultimate Trader and Watley
Trader, including all related intellectual property rights, to a subsidiary of
one of our clearing brokers. We no longer consider software licensing to be a
core revenue source. The sale of the software programs provided us with working
capital and reduced our expense base. Pursuant to the terms of the sale, we
maintain a perpetual, non-exclusive license to use and sublicense the software.
To respond to our liquidity and capital resource needs, we have instituted
various cost cutting initiatives and raised additional capital. Our cost cutting
initiatives include reductions in workforce, reductions in capital expenditures
and renegotiation of clearing corporation agreements at more favorable rates.
On-Site Acquisition
On November 2, 2001, the Company acquired certain assets of On-Site Trading,
Inc. ("On-Site") and assumed up to $1.8 million in liabilities. This acquisition
included On-Site`s client base including 1,700 accounts representing client
assets (account balances and securities) of $84 million, On-Site Trading LLC
(the "LLC"), two branches owned by On-Site, and agreements with 12 non-business
branch locations. LLC, a broker-dealer subsidiary (the proprietary trading
business) was subsequently renamed ABW TRADING, LLC. The Company acquired these
assets for 1.875 million shares of its Common Stock. In connection with the
acquisition of On-Site, the Company also assumed up to $1.8 million in
liabilities of On-Site owed to the Class B members of the LLC. The Company
reclaimed 175,000 shares of Common Stock in connection with the On-Site
acquisition and assumed additional obligations of $1,050,000 in excess of the
$1,800,000 that the Company had originally agreed to assume.
The LLC was formed as a means for registered professionals to engage in
proprietary trading utilizing the LLC`s funds. Such registered professionals are
Class B members of the LLC, while the Company is the Class A member. The LLC was
a registered broker-dealer and a member of the Philadelphia Stock Exchange,
operated in 12 states and engaged exclusively in proprietary trading and did not
conduct business with the public. An initial capital contribution was required
to become a Class B member. On May 9, 2002, the Company notified the Class B
members that it had elected to cease the proprietary trading business as a
result of declining revenues. The Company continued to operate the On-Site
retail business, however the customer base has deteriorated significantly since
its acquisition and revenues from operations have declined. Management believes
that the deterioration is attributable to many factors including weakening
market conditions, as well as the loss and closing of branch operations. On June
18, 2002, the LLC withdrew its broker dealer registration and ceased trading
activities.
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Online Brokerage Services
Our industry has experienced a series of changes led by electronic and online
commerce. These changes have created significant market opportunities for us
along with other similar brokerage firms. Favorable market trends have resulted
from the following:
o growing market acceptance of online brokerage services;
o pronounced market segmentation;
o a complementary regulatory environment; and
o disparity in the scalability and quality of competing trading
technologies.
Historically, individual investors accessed the financial markets through
full-commission brokers, who offered investment advice and placed trades. With
deregulation of brokerage commissions in 1975 and the resulting unbundling of
brokerage services, investors began to realize that they could separate
financial advisory services from securities trading. This brought about the
advent and subsequent proliferation of discount brokerage firms, which provided
an alternative investment approach by completing trades at a reduced cost.
The emergence of electronic brokerage services has provided investors with
further access to unbundled services and costs typically charged by
full-commission and traditional discount brokerage firms. Further, while
full-commission and discount brokerage firms are able to offer electronic
trading services, their continued reliance on personnel, branch offices and
associated infrastructure prevents them from capturing the same operating
efficiencies that are achievable by electronic trading.
We conduct our brokerage activities through a global communications network
and sophisticated computerized information systems over which we receive and
transmit current market information.
Our services are delivered to our customers through Ultimate Trader, a client
server direct access software application and (b) Watley Trader, a web-based
direct-access platform. Benefits of the products for the retail market include:
o Direct Access to Exchanges & ECNs o Allows investors to execute
independently of third party market
makers for more efficient executions.
Provides ability to act as "market
maker" on par with institutional traders.
o Order Routing Discretion o Enables investors to actively determine
venue for order execution among variety
of alternatives (Island, Instinet, other
ECNs, NASDAQ, specific market makers,
NYSE DOT, our Company block trade desk).
Provides critical added ability to trade
at the best price.
o NASDAQ Level II Data o Enables access to complete range of
bid/ask, volume and market depth for
variety of execution markets.
o Realtime Data Analytics o Provides best available retail package
of real time, streaming market data,
charts and technical analysis. This
suite of content includes intra-day
charting, a variety of analytical
studies (e.g., RSI, moving averages,
MACD), time and sales, option quote
chains, regional exchange quotes and
news.
o High Utilization Capacity o Affords access to technology platform by
entire client base on simultaneous
basis. Critical given consistent high
level of concurrent utilization and
spikes in utilization due to highly
volatile market movements and shifts in
market liquidity.
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Client Services
Client services for all levels of our online service, including trading,
administrative, and technical support, are among our highest priorities. Based
on our experience in the industry and based on client feedback, providing an
effective client service team to handle client needs is critical to our success.
Our Client Service department helps clients get online, handles product and
services inquiries and addresses all brokerage and technical questions. The
Client Service department also conducts various surveys to verify the
satisfaction of our clients and to learn more about client preferences and
requirements.
We provide live client support from Monday through Friday between the hours
of 7:00 AM and 6:30 PM EST. Our Client Services department operates on a
one-stop shopping basis, meaning that clients do not typically have to be
transferred between departments to receive answers to their various inquiries.
All of our Client Service personnel are registered representatives and are
available to accept and execute client orders, research past trades, discuss
account information, and provide detailed technical support. A separate
technical support team helps clients with potentially serious or persistent
technical issues.
Account Security
We use a combination of proprietary and industry standard security measures
to protect our clients` assets. Clients are assigned unique account numbers,
user identifications and passwords that must be used each time they log on to
the system. In accordance with standard industry practices, telephone orders
require authentication via personal identification number/password and/or other
personal information. In addition, the trade processing system A.B. Watley uses
is designed to compare the A.B. Watley accounts database with the clearing
firm`s account information on a daily basis to detect any discrepancies.
We rely on encryption and authentication technology, including public key
cryptography technology licensed from other parties, to provide the security and
authentication necessary to effect the secure exchange of information.
Proprietary Trading
The Company takes proprietary positions through the trading of U.S. equities
in an attempt to realize gains. Our proprietary trading activities require the
commitment of capital and create an opportunity for profits and risk of loss due
to trading strategies and market fluctuations. Buying power is available to
traders to the extent that the aggregation of all positions in all of the
Company`s accounts were within A.B. Watley`s Net Capital requirements.
Trading profits or losses depend upon, among other things, the skills of
traders, the capital allocated to securities positions, the financial condition
and business prospects of particular issuers and general trends in the
securities markets. The amount of capital allocated to a particular trader is
based on the trader`s experience and performance as well as our risk management
policies. Customer funds are not used to fund proprietary trading activities.
We believe that our trading capability is a key ingredient to our success.
While this business can earn attractive returns, there is also the possibility
of incurring significant trading losses in periods of market turbulence. We seek
to balance our ability to profit from trading positions with our exposure to
potential losses. Our risk management includes input from all levels of the
Company including our traders as well as management.
Institutional Sales
Our institutional sales and trading desk specializes in facilitating and/or
executing large-block transactions in equity securities and services
institutional clients. These services are provided to clients who often require
that their purchases or sales of
5
large positions remain anonymous, with average trades ranging in the 10,000 to
100,000 share size. We match institutional buyers and sellers to minimize the
impact on the market and to prevent our client`s positions from being disclosed
to competing firms. Our institutional sales clients include mutual and pension
funds, insurance companies, banks, corporations and independent fund and money
managers.
Operations, Clearing and Order Processing
We do not hold client funds or securities, nor do we generally execute and
directly process either our own or our clients` securities transactions. Since
October 1996, we have cleared all transactions for retail clients, on a fully
disclosed basis, with Penson Financial Services, Inc. ("Penson"). Institutional
accounts are cleared through ABN Amro Incorporated("ABN").
Our agreements with such clearing brokers provide that the clearing brokers
process all securities transactions for our account and the accounts of our
clients for a fee. Services of the clearing brokers include billing and credit
control and receipt, custody and delivery of securities, for which we pay a per
ticket charge. We have agreed to indemnify our clearing brokers for losses they
may sustain from customer accounts introduced by us, which could be material in
amount. Our clearing agreements may be terminated by either party, upon 60 days`
written notice for Penson, and 30 days written notice for ABN. We depend on the
operational capacity and the ability of the clearing brokers for the orderly
processing of transactions. As a result of engaging the processing services of
clearing brokers, we are exempt from certain reserve requirements imposed by
federal securities laws.
Clients` securities transactions are effected on either a cash or margin
basis. In connection with margin transactions, credit is extended by the
clearing broker to a client, collateralized by securities and cash in the
client`s account, for a portion of the purchase price. The client is charged
interest by the clearing broker for margin financing. We receive a portion of
such interest from the clearing brokers.
Margin lending is subject to the margin rules of the Board of Governors of
the Federal Reserve System. Margin lending subjects us to the risk of a market
decline that would reduce the value of the collateral below the client`s
indebtedness before the collateral can be sold. Under applicable rules, in the
event of a decline in the market value of the securities in a margin account,
the client is required to deposit additional securities or cash in the account.
Marketing and Advertising
In connection with our cost-cutting initiatives, we have significantly
reduced our marketing and advertising expenditures.
Competition
The market for electronic brokerage services is highly competitive and
rapidly changing. We believe that we compete on the basis of speed of order
execution, processing and confirmation, quality of client service, ease of use,
amount and timeliness of information provided, price and reliability of the
trading systems which we utilize. Our competitors may have greater financial,
technical and marketing resources than the Company. We expect that our ability
to compete will be affected by our ability to introduce new services and
enhancements to existing services into the market on a timely basis.
We believe our competition consists of large and small brokerage firms
utilizing the Internet to transact retail brokerage business. Among these
competitors are E*TRADE Securities LLC.; Charles Schwab & Co., Inc.; Quick &
Reilly, Inc.; TD Waterhouse Investor Services, Inc.; Fidelity Brokerage Services
LLC; and Ameritrade, Inc. We also face competition for clients from full
commission brokerage firms.
Securities Regulation
A.B. Watley and Direct (collectively, the "B-D Subsidiaries") are
broker-dealers registered with the Securities and Exchange Commission ("SEC")
and National Association of Securities Dealers ("NASD") and licensed in the
states in which they do business. ABW Futures is registered as a futures
commission merchant with the National Futures Association. A.B. Watley ceased
operations in January 2004. In February 2004, A.B . Watley withdrew its
registration as a broker/dealer.
6
The securities industry in the United States is subject to extensive
regulation under federal and state laws. In addition, the SEC, NASD, other
self-regulatory organizations, such as the various stock exchanges, and other
regulatory bodies, such as state securities commissions, require strict
compliance with their rules and regulations. As a matter of public policy,
regulatory bodies are charged with safeguarding the integrity of the securities
and other financial markets and with protecting the interests of clients
participating in those markets, and not with protecting the interests of our
stockholders.
Broker-dealers are subject to regulations covering all aspects of the
securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of clients funds and securities, capital
structure, record keeping and the conduct of directors, officers and employees.
Because of the number of complaints by online traders, the SEC, NASD and other
regulatory organizations may adopt more stringent regulations for online firms
and their practices. If we fail to comply with any laws, rules or regulations we
could be censured, fined, suspended, or expelled.
In addition, significant changes in the B-D Subsidiaries` current business or
practices, require NASD and other regulatory approval.
To expand our services internationally, we would have to comply with
regulatory controls of each specific country in which we conduct business. The
brokerage industry in many foreign countries is heavily regulated. The varying
compliance requirements of these different regulatory jurisdictions and other
factors may limit our ability to expand internationally. We presently do not
have any plans to expand internationally.
All marketing activities by the B-D Subsidiaries are regulated by the NASD.
The NASD can impose penalties, including censure, fine, suspension of all
advertising, the issuance of cease-and-desist orders or the suspension or
expulsion of a broker-dealer and its officers or employees for violations of the
NASD`s advertising regulations.
Net Capital Requirements
The SEC, NASD and various other regulatory agencies have stringent rules
requiring the maintenance of specific levels of net capital by securities
brokers, including the SEC`s Uniform Net Capital Rule which governs A.B. Watley
and Direct. Net capital is defined as assets minus liabilities, plus other
allowable credits and qualifying subordinated borrowings less mandatory
deductions that result from excluding assets that are not readily convertible
into cash and from valuing other assets, such as a firm`s positions in
securities, conservatively. Among these deductions are adjustments in the market
value of securities to reflect the possibility of adverse market movement prior
to disposition.
If either of the B-D Subsidiaries fails to maintain the required net capital,
such subsidiary may be subject to suspension or revocation of registration by
the SEC and suspension or expulsion by the NASD and other regulatory bodies,
which ultimately could require the Subsidiary`s liquidation. In addition, a
change in the net capital rules, the imposition of new rules, a significant
operating loss, or any unusually large charge against net capital could limit
our operations that require the intensive use of capital and could limit our
ability to expand our business. The net capital rules also could restrict our
ability to withdraw capital from the B-D Subsidiaries, which could limit our
ability to pay dividends, repay debt and repurchase shares of our outstanding
stock.
In January 2004, A.B. Watley, as a result of Net Capital deficiencies, ceased
operations. In February 2004, A.B. Watley withdrew its registration as a
broker/dealer.
Personnel
As of September 30, 2003, we employed a total of 46 persons, of whom 4 are
engaged in executive management, 20 in trading activities, 6 in information
technology, 6 in client service, 4 in sales and marketing, and 6 administration
and back office personnel. We believe our relations with our employees are
generally good and we have no collective bargaining agreements with any labor
unions. During the fiscal year ended September 30, 2003 the company completed a
reduction in force.
7
Our registered representatives are required to take examinations administered
by the NASD and state authorities to be qualified to transact business, and are
required to enter into agreements with A.B. Watley obligating them to adhere to
our supervisory procedures and not to solicit customers in the event of
termination of employment. Our agreements with registered representatives do not
obligate these representatives to be associated with the Company for any length
of time.
Some of the Company`s proprietary trading activities are performed by registered
representatives who receive a portion of their trading profits, after deductions
for trading expenses. They are outside contractors, not entitled to
participation in any benefits plans of the Company.
Investment Considerations and Risk Factors
The following factors and other information in this Form 10-K should
carefully be considered when evaluating the Company and its stock.
o If we are unable to continue cost cutting and revenue generation
initiatives, enter into a strategic business combination or obtain
additional funding sources at acceptable terms, our ability to operate our
business will be significantly diminished.
We are implementing cost cutting and revenue generation initiatives, and
exploring strategic business combinations. We also will need to find additional
funding sources at rates and terms acceptable to us to meet our capital and
liquidity needs for the remainder of the year. To the extent that capital is
raised through the sale of equity or convertible debt securities, the issuance
of these securities could result in dilution to our stockholders. If we are
unable to obtain such financing, make sufficient improvement in our operating
results or find a strategic partner our ability to operate our business will be
significantly diminished.
o Periods of declining securities prices, decreasing trade volumes, or
uncertainty in the public equity markets may adversely affect our
revenues.
Our future revenues are likely to be lower during periods of declining
securities prices or reduced securities market activity The public markets have
historically experienced significant volatility not only in the number and size
of share offerings, but also in the secondary market trading volume and prices
of newly issued securities. Activity in the private equity markets frequently
reflects the trends in the public markets. As a result, our revenues from
brokerage activities may also be adversely affected during periods of declining
prices or reduced activity in the public markets.
o We may not be able to adapt with rapid technological change in a cost
effective manner, which could materially adversely impact the Company`s
business, financial condition and operating results.
Traditional and online financial services industries are characterized by
rapid technological change, changes in customer requirements, frequent new
service and product introductions and enhancements and evolving industry
standards. Our future success will depend on our ability to enhance our existing
services and products. We must also develop new services and products that
address the increasingly sophisticated and varied needs of our customers and
prospective customers. We must respond to technological
8
advances and evolving industry standards and practices on a timely and
cost-effective basis. The development and enhancement of services and products
entails significant technical and financial risks. We may fail to
o use new technologies effectively;
o adapt services and products to evolving industry standards; or
o develop, introduce and market service and product enhancements or new
services and products.
In addition, we may experience difficulties that could delay or prevent the
successful development, introduction or marketing of our services and products,
and our new service and product enhancements may not achieve market acceptance.
If we encounter these problems, our business, financial condition and operating
results may be materially adversely affected.
o Operational risks may disrupt our business or limit our growth.
Like other securities and securities-related businesses, we are highly dependent
on information processing and telecommunications systems.
We face operational risks arising from potential mistakes made in the
confirmation or settlement of transactions or from the failure to properly
record, evaluate or account for transactions. Our business is highly dependent
on our ability, and the ability of our clearing firms, to process, on a daily
basis, a large and growing number of transactions across numerous and diverse
markets. Consequently, we and our clearing firms rely heavily on our respective
financial, accounting, telecommunications and other data processing systems. If
any of these systems fail to operate properly or become unavailable due to
problems with our physical infrastructure, we could suffer financial loss, a
disruption of our business, liability to clients, regulatory intervention or
reputational damage. In addition, we are aware that other companies in our
industry have had problems due to high volume of telephone and e-mail customer
inquiries that has at times strained the capacity of their telecommunications
systems and customer service staffs, and has also led to temporary disruptions
in website service. Thus, any inability of systems used to accommodate an
increasing volume of transactions and customer inquiries could also constrain
our ability to expand our businesses and could damage our reputation.
o Employee misconduct could harm us and is difficult to detect and
deter.
There have been a number of highly publicized cases involving fraud or other
misconduct by employees in the financial services industry in recent years, and
we run the risk that employee misconduct could occur. Misconduct by employees
could bind us to transactions that exceed authorized limits or present
unacceptable risks, or hide from us unauthorized or unsuccessful activities. In
either case, this type of conduct could result in unknown and unmanaged risks or
losses. Employee misconduct could also involve the improper use of confidential
information, which could result in regulatory sanctions and serious reputational
harm. It is not always possible to deter employee misconduct, and the
precautions we take to prevent and detect this activity may not be effective in
all cases.
o The securities industry in which we operate is heavily regulated by the
SEC, state regulators, and the NASD. If we fail to comply with applicable
laws and regulations, we may face penalties or other sanctions that may be
detrimental to our business.
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. Broker-dealers are subject to
regulations covering all aspects of the securities business, including:
o sales methods;
o trade practices among broker-dealers;
o use and safekeeping of customers` funds and securities;
o capital structure;
o record keeping;
o conduct of directors, officers, and employees; and
o supervision of employees, particularly those in branch offices.
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The principal purpose of regulation and discipline of broker-dealers is the
protection of customers and the securities markets, rather than protection of
creditors and stockholders of broker-dealers.
Uncertainty regarding the application of these laws and other regulations to
our business may adversely affect the viability and profitability of our
business. The SEC, the NASD, other self-regulatory organizations and state
securities commissions can censure, fine, issue cease-and-desist orders, or
suspend or expel a broker-dealer or any of its officers or employees. Our
ability to comply with all applicable laws and rules is largely dependent on our
establishment and maintenance of a compliance system to ensure such compliance,
as well as our ability to attract and retain qualified compliance personnel. We
could be subject to disciplinary or other actions due to claimed noncompliance
in the future, and the imposition of any material penalties or orders on us
could have a material adverse effect on our business, operating results and
financial condition. In addition, it is possible that noncompliance could
subject us to future civil lawsuits, the outcome of which could harm our
business.
In addition, our mode of operation and profitability may be directly
affected by:
o additional legislation;
o changes in rules promulgated by the SEC, state regulators, the NASD, and
other regulatory and self-regulatory organizations; and
o changes in the interpretation or enforcement of existing laws and rules.
o The failure to remain in compliance with the Net Capital Rule would
adversely affect our ability to continue to operate as a broker-dealer.
The SEC, the NASD and various other regulatory agencies have stringent rules
with respect to the maintenance of specific levels of net capital by securities
brokers, including the SEC`s Uniform Net Capital Rule (the "Net Capital Rule").
Net capital is the net worth of a broker or dealer (assets minus liabilities),
less certain deductions that result from excluding assets that are not readily
convertible into cash and from conservatively valuing certain other assets.
Failure to maintain the required net capital may subject a firm to suspension or
revocation of registration by the SEC and suspension or expulsion by the NASD
and other regulatory bodies and ultimately could require the firm`s liquidation.
In addition, a change in the net capital rules, the imposition of new rules
or any unusually large charge against net capital could limit those aspects of
our contemplated operations that require the intensive use of capital, such as
trading activities and the financing of customer account balances. A significant
operating loss or any unusually large charge against net capital could adversely
affect our ability to operate and/or expand, which could have a material adverse
effect on our business, financial condition and operating results.
In January 2004, A.B. Watley, as a result of Net Capital deficiencies, ceased
operations. In February 2004, A.B. Watley withdrew its registration as a
broker/dealer. Direct and ABW Futures are presently in compliance with net
capital requirements, there can be no assurance that we will not fall below
minimum net capital requirements in the future.
o The failure of brokerage customers to meet their margin requirements could
result in significant liabilities.
The brokerage business, by its nature, is subject to risks related to
defaults by our customers in paying for securities they have agreed to purchase
and delivering securities they have agreed to sell. Our clearing broker may make
margin loans to our customers in connection with their securities transactions.
We are required by contract to indemnify that broker for, among other things,
any loss or expense incurred due to defaults by our customers in failing to
repay margin loans or to maintain adequate collateral for those loans. We will
be subject to risks inherent in extending credit, especially during periods of
volatile markets or in connection with the purchase of highly volatile stocks
which could lead to a higher risk of customer defaults.
o We may be obligated to redeem our Series A Preferred Stock at a point in
the future, which would impair our ability to raise additional capital as
we would more than likely not be able to repay such redemption.
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The holders of our Series A Preferred Stock have the right to have their
shares redeemed for cash equal to the greater of (i) the price we received when
we sold them the stock ($10,000 per share) plus any accrued and unpaid dividend
payments or (ii) the aggregate value of the shares of Common Stock into which
such shares of Series A Preferred Stock are then convertible (based upon the
closing bid price), in any of the following situations:
o if our Common Stock is not eligible to trade on the NYSE, the AMEX, the
NASDAQ National Market or the NASDAQ SmallCap market for a period of five
consecutive days.
o if we fail to register with the Securities and Exchange Commission (or
maintain such registration of) the Common Stock into which the Series A
Preferred Stock converts.
o if we fail to honor requests for conversion, or if we notify any holder of
Series A Preferred Stock of our intention not to honor future requests for
conversion.
o if the holders of more than 30 percent of the outstanding shares of our
Common Stock sell or exchange their stock.
o if we commit a material breach under, or otherwise materially violate the
terms of, the transaction documents entered into in connection with the
issuance of the Series A Preferred Stock and the warrants.
In April of 2002, our Common Stock was delisted from the NASDAQ Stock Market.
In addition, we have not registered the Common Stock into which the Series A
Preferred Stock converts. We have not received a redemption notice from any of
the holders of our Series A Preferred Stock. Redemption of the Series A
Preferred Stock in any event described above would require us to expend a
significant amount of cash that likely will exceed our ability to make such
payment or raise additional capital.
o Our stockholders could experience substantial dilution as a result of the
issuance of and terms of our Series A Preferred Stock and the related
warrants.
The 630 shares of Series A Preferred Stock that were sold in the private
placement are initially convertible into approximately 2,135,700 shares of
Common Stock. The warrants granted in connection with the sale of Series A
Preferred Stock are initially exercisable for 1,629,069 shares of Common Stock,
at an exercise price of $2.95 per share.
Under the terms of the Series A Preferred Stock, we are also obligated to
issue additional shares of Common Stock every six months to the holders of the
Series A Preferred Stock as preferred stock dividends. Initially, these
dividends will be payable at the rate of six percent for the first 18 months
following issuance of the Series A Preferred Stock and fifteen percent after
that initial 18 month period. The number of shares of Common Stock will be
determined by dividing the dividend payment by the market price for our Common
Stock on the day before such dividend is payable. Because these shares are
issueable as a dividend, we will receive no additional consideration in
connection with their issuance.
o We may also be required to issue shares of Common Stock without additional
consideration in the event that we fail to redeem any shares of Series A
Preferred Stock when required.
All of the foregoing issuances of Common Stock are likely to be substantially
dilutive to the outstanding shares of Common Stock, especially where, as
described above, the shares of Common Stock are issued without additional
consideration. Moreover, any increase in the number of shares of Common Stock we
are required to issue resulting from anti-dilution protection, penalties or
other adjustments to the conversion or exercise prices of the Series A Preferred
Stock and/or the warrants described above will further increase the anticipated
dilution to the outstanding holders of our Common Stock. We cannot predict
whether or how many additional shares of our Common Stock will become issuable
due to these provisions.
Any such dilution, potential dilution, or increase in dilution or potential
dilution, may result in a decrease in the value of the outstanding shares of our
Common Stock. Such a decrease in value, the risk of dilution, any actual
dilution, or any increase in potential dilution may cause our stockholders to
sell their shares, which would contribute to a downward movement in the price of
our Common Stock. This could
11
prevent us from sustaining a per share price sufficient to enable us to maintain
an active trading market on the NASDAQ National Market or SmallCap Market if our
stock is re-listed. In addition, any downward pressure on the trading price of
our Common Stock could encourage investors to engage in short sales, which would
further contribute to a downward pricing of our Common Stock.
o We may be required to obtain the consent of the holders of Series A
Preferred Stock before taking corporate actions, which could harm our
business.
Our charter documents require us to obtain the consent of the holders of the
Series A Preferred Stock before we may issue securities that have senior or
equal rights as the Series A Preferred Stock or take other actions with respect
to the Series A Preferred Stock or securities that have fewer rights than the
Series A Preferred Stock. We are also required to obtain the consent of the
holders of the Series A Preferred Stock before we amend or modify our
certificate of incorporation or bylaws, whether by merger, consolidation or
otherwise to change any of the rights of the holders of Series A Preferred
Stock. While these obligations may deter a potential acquirer from completing a
transaction with us, they may also prevent us from taking corporate actions that
would be beneficial to the holders of our Common Stock and the Company, such as
raising capital to operate our business or maintain our capitalization or per
share price in attempts to maximize stockholder volume and liquidity.
In June 2003 the holders of the Preferred Stock executed an agreement which
waived their rights to penalties, dividends and stock issuances during the
period June 1, 2003 through May 31, 2004. For the years ended September 30, 2003
and 2002, dividends of $252,000 and $315,000, respectively, were accrued for the
Preferred Stock.
o We may be unable to obtain critical goods or services from our suppliers.
We obtain financial information from a number of third-party suppliers of
software and information services. We believe we have available to us at
comparable cost a number of alternative sources of supply of these items of
software and information services, to provide adequate replacements on a timely
basis, if arrangements with any of our current suppliers are abrogated. We have
established a number of relationships with third-party suppliers of software and
information services. There can be no assurance that such relationships will
continue or that timely replacement of such services will be available in the
future.
o The Company is currently delinquent with its reporting requirements under
the Securities and Exchange Act of 1934 (the "1934 Act")
The Company has failed to timely file its reports due under the 1934 Act. As a
result of the Company's failure to timely file its reports under the 1934 Act,
the Company has been delisted by the Over-The-Counter Bulletin Board ("OTCBB").
As a result of this delisting, there currently is no active trading market for
the Company's securities. There is, therefore, no assurance that a market for
our common stock will develop.
o Our Common Stock is Subject to the "Penny Stock" Rules of the SEC and the
Trading Market in Our Securities is Limited, Which Makes Transactions in
Our Stock Cumbersome and May Reduce the Value of an Investment in Our
Stock.
The Securities and Exchange Commission has adopted Rule 15g-9 which
establishes the definition of a "penny stock," for the purposes relevant to us,
as any equity security that has a market price of less than $5.00 per share or
with an exercise price of less than $5.00 per share, subject to certain
exceptions. For any transaction involving a penny stock, unless exempt, the
rules require:
o that a broker or dealer approve a person's account for transactions in
penny stocks; and
o the broker or dealer receive from the investor a written agreement to the
transaction, setting forth the identity and quantity of the penny stock to
be purchased.
In order to approve a person's account for transactions in penny stocks, the
broker or dealer must:
o obtain financial information and investment experience objectives of the
person; and
12
o make a reasonable determination that the transactions in penny stocks are
suitable for that person and the person has sufficient knowledge and
experience in financial matters to be capable of evaluating the risks of
transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny
stock, a disclosure schedule prescribed by the Commission relating to the penny
stock market, which, in highlight form:
o sets forth the basis on which the broker or dealer made the suitability
determination; and
o that the broker or dealer received a signed, written agreement from the
investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in securities
subject to the "penny stock" rules. This may make it more difficult for
investors to dispose of our common stock and cause a decline in the market value
of our stock.
Disclosure also has to be made about the risks of investing in penny stocks in
both public offerings and in secondary trading and about the commissions payable
to both the broker-dealer and the registered representative, current quotations
for the securities and the rights and remedies available to an investor in cases
of fraud in penny stock transactions. Finally, monthly statements have to be
sent disclosing recent price information for the penny stock held in the account
and information on the limited market in penny stocks.
Item 2. Properties
Our principal offices are located at 40 Wall Street, New York, NY, where we
occupy approximately 28,500 square feet at an annual cost of approximately
$920,000 per year , plus escalations. The initial term of the lease for such
office space expires in June 2009. On January 16, 2003, the Company entered into
an sixteen-month lease agreement for approximately 2,750 square feet in San
Francisco, California, at an annual cost of $114,000. This lease agreement was
terminated as of November 30, 2003. On December 15, 2002, the Company entered
into an eighteen-month lease agreement for approximately 2,568 square feet in
Melville, NY, at an annual cost of $68,078. The Company no longer occupies the
Melville property and the landlord, W.B. Wood & Co. Inc., has obtained a
judgment in the amount of $17,019 against the Company. Accordingly, the Melville
lease has been terminated.
Our landlord, 40 Wall Street, LLC, commenced two separate landlord/tenant
proceedings seeking money judgments and orders of eviction against the Company.
Both proceedings have been settled whereby the Company vacated a portion of the
premises in March 2004 and will vacate the remaining portion of the premises
prior to June 1, 2004. The landlord has reserved the right to seek a money
judgment for all rent arrears (a provision has been provided in financial
statements)after the Company has vacated the premises.
Item 3. Legal Proceedings
Our business involves substantial risks of liability, including exposure to
liability under federal and state securities laws in connection with claims by
dissatisfied clients for fraud, unauthorized trading, churning, mismanagement,
and breach of fiduciary duty, as well as in connection with the underwriting or
distribution of securities. In recent years, there has been an increasing
incidence of litigation involving the securities industry, including class
actions which generally seek rescission and substantial damages.
In the ordinary course of business, we are, and may become, a party to
legal proceedings or arbitration. Except as described below, we are not a party
to any material legal proceedings or arbitrations.
We are currently a party to various suits alleging breach of contract due
to non-payment for services or goods provided, and for amounts claimed by Class
B members of the LLC. We are defending these suits and have commenced settlement
negotiations as to certain of such suits.
In addition, a suit has been brought by Akro Investicni Spolecnost, A.S.
and Bozena Konvalinkova, as Czech Receiver of Private Investors, as against A.B.
Watley. The plaintiffs alleged violations of New York common law and federal
securities law by A.B. Watley arising from an agreement between Private
Investors, a Czech broker-dealer, and A.B. Watley. Plaintiffs were seeking
damages of $31,400,000 (of which approximately $950,000 was alleged to represent
the damages and the balance represented punitive damages.) On April 16, 2003,
Morslav Tichy, a plaintiff in the action, filed a Notice of Dismissal dismissing
his claims without prejudice. Furthermore, in July 2003, a Stipulation and Order
of Dismissal with Prejudice was filed with the United States District Court -
Southern District of New York whereby the above action was dismissed pursuant to
a Settlement Agreement and Release. Pursuant to the Settlement Agreement and
13
Release, the Company made a cash payment of $275,000, which was covered by the
Companys insurance, to the plaintiffs in consideration for the plaintiffs
agreeing to have the action dismissed.
We are a defendant in an action titled Michael Fielman v. A.B. Watley, Inc.
and A.B. Watley Group, Inc., that was filed in the Supreme Court of the State of
New York, County of Nassau, Index No. 012082/02. This is an action for unpaid
wages seeking $28,657, plus statutory damages, costs, and attorneys' fees. This
matter has been settled in the amount of $34,657.
We are a defendant in an action titled General Electric Capital Corp., as
Assignee of Sun Microsystems, Inc. v. A.B. Watley Group, Inc. f/k/a Internet
Financial Services, Inc., Supreme Court of the State of New York, County of New
York, Index No. 117675/02. This is a breach of contract action in connection
with the lease of equipment, which seeks compensatory damages of $195,355, plus
interest, costs and attorney's fees. The Company has denied liability in its
entirety and has indicated that it intends to vigorously defend this matter. The
parties have reached a settlement in principle for the payment of $50,000 in two
installments although an agreement has not been finalized.
Our former legal counsel, has filed a complaint against the Company. The
title of the action is Hartman & Craven LLP v. A.B. Watley, Inc. and A.B. Watley
Group, Inc., which was filed in the Supreme Court of the State of New York,
County of New York, Index No.: 109502/03. Plaintiff has filed a Complaint
against, amongst others, A.B. Watley Group, Inc. and A.B. Watley, Inc. for
damages in the amount of $352,573.73 (a provision has been provided in financial
statements) for unpaid legal fees. A.B. Watley Group, Inc. and A.B. Watley, Inc.
deny liability, in part, and have asserted a counterclaim for malpractice and
breach of contract for unspecified damages. At this point, it is difficult to
determine the amount, if any, that A.B. Watley Group Inc. and A.B. Watley Inc.
will be held liable for. Plaintiff has filed a motion for summary judgment,
which was opposed by A.B. Watley Group Inc. and A.B. Watley Inc. The oral
argument on this motion for summary judgment was heard on March 30, 2004. As of
May 19, 2004, the court has not made a decision with respect to the summary
judgment.
We are defendant in an action titled Hyperfeed Technologies, Inc. v. A.B.
Watley Group Inc., filed in the Supreme Court of the State of New York, County
of New York, Index No. 111538/03. Plaintiff has obtained a consent judgment
order against A.B. Watley Group Inc. in the amount of $180,503 (a provision has
been provided in financial statements). Currently, Plaintiff is conducting
post-judgment discovery.
We are respondent in an arbitration titled Sean MacDonald and Adam Silver v.
A.B. Watley, Inc., NASD Arbitration No. 03-02644. Claimants have alleged
mismanagement of Mr. MacDonald's margin account. A.B. Watley, Inc. denies all
wrongdoing in connection with this matter.
We are respondent in an arbitration titled John W. Donavan and Bettina H.
Wolff v. A.B. Watley, Inc. Claimants are seeking damanges of approximately
$94,800 relating to the suitability of Claimants' investments. The Company
denies all wrongdoing in connection with this matter asserting that it acted in
accordance with its customer agreement as well as applicable federal securities
law. The parties have agreed to a settlement in principle although a formal
settlement agreement has not been consummated.
We are respondent in an arbitration titled Steven Messina, Brian Kelly, and
Thomas Messina v. A.B. Watley, Inc., NASD Arbitration No. 02-04649. Claimants
filed this claim against A.B. Watley, Inc. in August 2002 seeking damages for
unpaid commissions of approximately $146,668 (a provision has been provided in
financial statements)plus legal fees and costs in the amount of $4,025 for
arbitration fees and disbursements. Claimants have also requested an order to
have their Form U-5s amended to remove all references to any alleged improper
conduct. A.B. Watley, Inc. denies all wrongdoing in connection with this matter,
and has counterclaimed for $608,000 against Claimants for breach of contract and
fiduciary duty. A.B. Watley, Inc. intends to vigorously defend this matter and
prosecute its counterclaim.
We are respondent in an arbitration titled Gary Miller v. A.B. Watley, Inc.,
NASD Arb. No.: 03-07144. Claimant is seeking damages of approximately $49,000
relating to a breach of contract. A.B. Watley, Inc. denies all liability in
connection with this matter.
We are defendant in an action titled Pentech Financial Services, Inc. v. A.B.
Watley Group Inc., Supreme Court of the State of New York, County of New York,
Index No. 02-126759. Plaintiff has filed a complaint against A.B. Watley Group
Inc. for an alleged breach of a lease agreement. On May 28, 2003, Plaintiff
obtained a judgment in the amount of $465,583(a provision has been provided in
financial statements). A.B. Watley Group Inc. executed a settlement agreement
with Plaintiff, but the Company has defaulted under such settlement agreement.
14
Our former landlord, W.B. Wood & Co. Inc. filed a Notice of Petition for
Non-Payment against us in the District Court of the County of Suffolk for
failure to pay amounts owed in connection with our lease of our Melville, New
York office space. We did not respond to the action and our former landlord
obtained a judgment against us in the amount of $17,019,(a provision has been
provided in financial statements) which is presently owed.
We are defendant in an action titled Scott Schwartz v. A.B. Watley Inc.,
Supreme Court of the State of New York, County of New York, Index No. 121644/03.
Plaintiff filed a complaint alleging owed commissions and breach of contract.
A.B. Watley Inc. has settled the action for $6,750 which has been paid in full.
We are defendant in an action titled Siemens Financial Services, Inc. v. A.B.
Watley Group, Inc., Supreme Court of the State of New York, County of New York,
Index No. 603769/2002. Plaintiff filed a complaint alleging breach of contract.
Plaintiff has a judgment against A.B. Watley Group, Inc. in the amount of
$179,882 (a provision has been provided in financial statements) with interest
from July 10, 2003.
We are respondent in an arbitration titled Jeffrey Spittel v. A.B. Watley,
Inc., NASD Arbitration No. 03-08076. Claimant has submitted this claim to
arbitration claiming breach of contract, respondeat superior, and
misappropriation and conversion, in the amount of $7,500 plus punitive damages,
costs, disbursements and reasonable attorneys' fees. A.B. Watley, Inc. filed an
answer on January 12, 2004. A.B. Watley, Inc. denies all wrongdoing in
connection with this matter and intends to vigorously defend this matter.
We are defendant in an action titled Sprint Communication v. A.B. Watley,
Inc., United States District Court, Southern District of New York, Index No. 03
CV 6926. Plaintiff has submitted this claim alleging breach of contract for
unpaid telephone bills in the amount of $20,000 (a provision has been provided
in financial statements) plus costs, disbursements, and attorneys' fees. A.B.
Watley, Inc. filed an answer on January 8, 2004. A.B. Watley, Inc. denies all
wrongdoing in connection with this matter and intends to vigorously defend this
matter.
We are defendant in an action titled Peter Wigger v. A.B. Watley Group Inc.,
Supreme Court of the State of New York, County of New York, Index No. 604124/02.
Plaintiff filed a complaint alleging breach of a commission agreement and seeks
damages in the amount of $398,750 (a provision has been provided in financial
statements) plus interest accrued thereon. A.B. Watley Group Inc. is currently
in settlement negotiations regarding this matter.
We are defendant in an action titled Lehr Construction Corp. v. A.B. Watley
Group Inc., Supreme Court of New York, County of New York, Index No. 600276/02.
This action is for damages arising out of the alleged breach of a construction
contract. Plaintiff sought damages of approximately $233,794. On March 6, 2003,
the parties reached a settlement in which the Company consented to a judgment in
the amount of $295,857, less any payments made by the Company, and the parties
simultaneously entered into a Forbearance Agreement, which set forth a payment
schedule for the Company. The Company has paid $65,000 pursuant to the
Forbearance Agreement. On December 17, 2003, Plaintiff issued the Company a
Notice of Default under the Forbearance Agreement, which the Company has failed
to cure. Under the Forbearance Agreement, Plaintiff may execute on the
outstanding balance of the judgment in the amount of $179,917 (a provision has
been provided in financial statements) without further notice to the Company.
We are defendant in an action titled A.B. Watley Group, Inc./John Martinez,
Case No. 2-4173-03-36 Section 806 Sarbanes-Oxley Act Complaint. On July 11,
2003, the U.S. Department of Labor ("DOL") gave the Company notice that John
Martinez, a former officer of the Company, had filed a complaint against the
Company under Section 806 of the Sarbanes-Oxley Act of 2002 (the "Act"). The
Complaint alleges that the Company terminated Mr. Martinez in violation of the
Act for raising net-capital issues with the National Association of Securities
Dealers, Inc. - a private self-regulatory organization. The Complaint seeks: (i)
Mr. Martinez' base pay (at the annual rate of $150,000 per annum) for the period
from March 14, 2003 through April 7, 2003; (ii) the difference between his
current base pay with his new employer ($130,000) and his base pay at the
Company for a reasonable period of time; (iii) relocation costs incurred in
obtaining new employment in Baltimore, Maryland; (iv) litigation costs; (v) his
commuting costs during the time period April 7, 2003 until the unspecified time
of his relocation in Baltimore, Maryland; (vi) interest on the monies due him;
and (vii) any additional
15
compensation deemed appropriate by the DOL. On July 30, 2003, the Company
responded to the complaint and submitted its response and evidentiary materials
to the DOL. The response denies all liability and raised several defenses to the
complaint. The Company intends to vigorously defend this matter. On March 9,
2004, the Department of Labor gave notice that it had completed its
investigation and dismissed the complaint. Complainant has appealed and the U.S
Department of Labor has scheduled a proceeding on June 7, 2004.
We are respondent in an arbitration titled MCI Worldcom Communications, Inc.
v. A.B. Watley Group, Inc., AAA Arbitration, Reference # 1410003356. On
September 16, 2003, claimant filed this arbitration against the Company
asserting a breach of contract claim in the amount of $135,644 (a provision has
been provided in financial statements). On January 26, 2004, the Company
submitted its answer denying all material allegations and asserting several
affirmative defenses. The Company intends to continue to vigorously defend this
matter.
In March 2003, the holder of the $5 million secured demand note (the
"Noteholder") demanded repayment of the note. On March 31, 2003, ABW filed a
NASD Arbitration Demand and a Statement of Claim with the NASD Dispute
Resolution office. The arbitration sought to enforce the provisions of the
secured demand note agreement and to prevent premature withdrawal by the lender.
In April 2004, the parties agreed to discontinue the arbitration without
prejudice pursuant to a settlement agreement that provided for the repayment of
approximately $2.9 million of the $5 million outstanding principal of the
secured demand note. The Noteholder agreed that as long as the Company is not in
default of any of its obligation under the settlement agreement, not to commence
any litigation with respect to the outstanding balance due on the $5 million
secured demand note prior to December 20, 2004.
We are plaintiff in an action titled A.B. Watley Group Inc. v. John J. Amore,
et al., Supreme Court of the State of New York, County of New York, Index No.
602993/03. We have sued our former CEO who has filed a counterclaim against our
company.
We are defendant in an action titled John J. Amore v. Steven Malin and A.B.
Watley, Inc., Supreme Court of the State of New York, County of New York, Index
No. 603833/03. Plaintiff filed a complaint alleging breach of a contract against
A.B. Watley, Inc. seeking damages in the amount of $500,000 and slander against
Steven Malin, our Chairman, seeking damages in the amount of $5,000,000. We have
filed an answer denying all wrongdoing. We deny all wrongdoing in connection
with this matter and intend to vigorously defend this matter.
We are respondent in an arbitration titled William Frymer v. A.B. Watley,
Inc., NASD Arbitration No. 03-05524. A former employee of the Company has
commenced this arbitration claiming breach of contract and violation of New York
labor laws. The Claimant is seeking unpaid salary and bonus, stock options,
liquidated damages and punitive damages. We deny all wrongdoing in connection
with this matter and intend to vigorously defend this matter.
We are respondent in an arbitration titled James B. Fellus v. A.B. Watley,
Inc., NASD Arbitration No. 03-05526. A former employee of the Company has
commenced this arbitration claiming breach of contract and violation of New York
labor laws. The Claimant is seeking unpaid salary and bonus, stock options, a
lump sum payment of the sum of the highest month's Retail Division and Fixed
Income Division pretax profit incentive multiplied by 48, liquidated damages and
punitive damages. We deny all wrongdoing in connection with this matter and
intend to vigorously defend this matter.
In addition to the foregoing, in the ordinary course of business, we and our
principals are, and may become, a party to legal or regulatory proceedings
commenced by the NASD, the SEC or state securities regulators relating to
compliance, trading and administrative problems that are detected during
periodic audits and inspections or reported by dissatisfied customers. Such
matters, if pursued by such entities, could rise to the level of disciplinary
action. We are not currently involved in any proceeding by a governmental agency
or self-regulatory organization, the outcome of which is expected to have a
material
16
adverse effect on our business. There can be no assurance that one or more
future disciplinary actions, if decided adversely us, would not have a material
adverse effect on our business, financial condition and results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
On September 25, 2003, pursuant to a written consent in lieu of a meeting, the
stockholders of the Company holding 6,905,527 shares of common stock, a majority
of the outstanding shares of common stock approved the following:
o Robert Malin and Steven Malin were elected to the Company's Board of
Directors;
o Certain financing transactions were ratified requiring potential stock
issuances in excess of currently authorized capital stock;
o to increase the authorized number of common stock from 20,000,000 shares
to 50,000,000 shares;
o to adopt the Company's 2003 Stock Option Plan; and
o approve the selection of Marcum & Kliegman LLP as the Company's
independent auditors.
17
PART II
Item 5. Market for Registrant`s Common Equity and Related Stockholder Matters
The Company currently has authorized capital stock consisting of 50,000,000
common shares, $.001 par value, of which 12,787,138 shares are issued and
outstanding and 1,000,000 preferred shares, of which none are issued and
outstanding. The Company has authorized 690 shares of Series A Redeemable
Convertible Preferred Stock, $.01 par value, of which 630 are issued and
outstanding.
(a) Trading in the Company`s shares of Common Stock presently takes place on
the pink sheets under the symbol ABWG.
The following table sets forth the range of high and low sales prices for the
Company`s Common Stock for the last two fiscal years:
Fiscal 2004: High Low
--------------- ------ -----
10/1/03 - 12/31/03 $0.35 $0.15
1/01/04 - 3/31/04 $0.37 $0.18
Fiscal 2003: High Low
--------------- ------ -----
10/1/02 - 12/31/02 $0.75 $0.10
1/01/03 - 3/31/03 $0.65 $0.35
4/01/03 - 6/30/03 $0.50 $0.25
7/01/03 - 9/30/03 $0.72 $0.35
Fiscal 2002: High Low
--------------- ------ -----
10/1/01 - 12/31/01 $4.85 $2.00
1/01/02 - 3/31/02 $2.25 $0.66
4/01/02 - 6/30/02 $1.15 $0.06
7/01/02 - 9/30/02 $0.45 $0.10
(b) The number of record holders, exclusive of holders for whom shares are
being held in the name of brokerage houses and clearing agencies, of the
Company`s Common Stock was 93 on April 1, 2004.
(c) We have never paid cash dividends on our Common Stock. We do not expect
to declare or pay any dividends on our Common Stock in the foreseeable
future, but instead intend to retain all earnings, if any, to invest in
our operations. The payment of future dividends is within the discretion
of our board of directors and will depend upon our future earnings, our
capital requirements, financial condition and other relevant factors.
(d) To date the Company has not made any dividend payments associated with
the Series A Preferred Stock.
18
Item 6. Selected Financial Data
Consolidated Income Statement Data
Years ended
- --------------------------------------------------------------------------------------------------------------------------
Sept. 30, 2003 Sept. 30, 2002 Sept. 30, 2001 Sept. 30, 2000 Sept. 30, 1999
- --------------------------------------------------------------------------------------------------------------------------
Revenues:
Commissions 5,690,227 15,900,261 18,887,752 32,968,193 16,198,858
Data service fees 101,821 462,469 1,297,117 2,015,396 1,640,123
Principal transactions 7,848,918 2,533,998 3,196,844 5,689,695 2,456,874
Sale of software -- 3,908,308 -- -- --
Interest and other income 1,607,916 3,378,252 2,084,009 2,073,190 685,578
Interest income-related party -- -- 6,180 6,180 6,180
------------- ------------- ------------- ------------- -------------
Total revenues 15,248,882 26,183,288 25,471,902 42,752,654 20,987,613
------------- ------------- ------------- ------------- -------------
Interest expense 834,184 2,678,712 852,967 373,354 333,457
Interest expense to officer -- 392,841 398,117 71,417 15,000
------------- ------------- ------------- ------------- -------------
Net revenues 14,414,698 23,111,735 24,220,818 42,307,883 20,639,156
------------- ------------- ------------- ------------- -------------
Expenses:
Commission, floor brokerage and clearing 5,793,530 12,048,982 10,572,220 20,605,576 7,967,765
charges
Employee compensation and related costs 8,570,003 10,674,346 12,686,615 11,802,131 5,306,590
Loss on impairment of intangibles -- 7,870,110 -- -- --
Minority interests (87,019) (899,869) -- -- --
Other expenses 7,033,617 22,210,767 21,253,846 19,436,768 7,956,784
Loss on investments 84,287 -- 703,614 256,386 --
------------- ------------- ------------- ------------- -------------
Total expenses 21,394,418 51,904,336 45,216,295 52,100,861 21,231,139
------------- ------------- ------------- ------------- -------------
Loss before income tax and extraordinary (6,979,720) (28,792,601) (20,995,477) (9,792,978) (591,983)
loss on early extinguishments of debt
Income tax provision -- (8,725) (28,697) (53,913) (32,494)
------------- ------------- ------------- ------------- -------------
Loss before extraordinary loss on early (6,979,720) (28,801,326) (21,024,174) (9,846,891) (624,477)
extinguishments of debt
Extraordinary loss on early -- (250,000) -- -- (177,125)
extinguishment of debt
------------- ------------- ------------- ------------- -------------
Net loss $ (6,979,720) $(29,051,326) $(21,024,174) $ (9,846,891) $ (801,602)
============= ============= ============= ============= =============
Basic and diluted loss per common share:
Loss before extraordinary item $ (6,979,720) $(28,801,326) $(21,024,174) $ (9,846,891) $ (801,602)
Deemed dividend to preferred shareholders
- beneficial conversion feature -- (1,639,797) -- -- --
Deemed dividend to preferred shareholders
- accretion of redemption feature -- (1,959,617) -- -- --
Preferred stock dividends (252,000) (315,000) -- -- --
------------- ------------- ------------- ------------- -------------
Loss before extraordinary item
attributable to common shareholders (7,231,720) (32,715,740) (21,024,174) (9,846,891) (801,602)
------------- ------------- ------------- ------------- -------------
Extraordinary loss on
extinguishment of debt -- (250,000) -- -- --
------------- ------------- ------------- ------------- -------------
Net loss attributable to common
shareholders $ (7,231,720) $(32,965,740) $(21,024,174) $ (9,846,891) $ (801,602)
============= ============= ============= ============= =============
Basic and diluted loss before $ (0.57) $ (2.62) $ (2.13) $ (1.21) $ (0.09)
extraordinary item per common share
Basic and diluted loss per common $ (0.57) $ (2.64) $ (2.13) $ (1.21) $ (0.11)
share
Weighted average shares outstanding - 12,578,995 12,508,852 9,888,597 8,122,393 7,136,434
basic and diluted
Balance Sheet and Other Operating Data:
Total Assets $ 6,941,680 $ 7,036,620 $ 21,532,676 $ 29,032,644 $ 23,244,954
Property and Equipment, net of $ 1,698,062 $ 2,889,711 $ 14,806,945 $ 18,523,320 $ 10,852,956
accumulated depreciation
Long term obligations and redeemable $ 6,867,001 $ 6,926,487 $ 5,664,775 $ 6,071,129 $ 2,261,593
preferred stock
Stockholders` (deficit) equity $(22,497,075) $(16,828,339) $ 2,945,432 $ 12,177,786 $ 15,842,987
------------- ------------- ------------- ------------- -------------
19
(In thousands except per share data)
Year Ended September 30, (unaudited) First Quarter Second Quarter Third Quarter Fourth Quarter Full Year
- ---------------------------------------------------------------------------------------------------------------------------------
2003
Revenues $4,179 $3,494 $4,742 $2,834 $15,249
Net revenues 4,032 3,217 4,440 2,726 14,415
Loss before extraordinary item (1,675) (3,321) (1,004) (979) (6,979)
Net (loss) (1,675) (3,321) (1,004) (979) (6,979)
Loss before extraordinary item per share (0.14) (0.27) (0.09) (0.07) (0.57)
Basic and diluted loss per share (0.14) (0.27) (0.09) (0.07) (0.57)
- --------------------------------------------------------------------------------------------------------------------------------
2002
Revenues $8,289 $6,598 $5,320 $5,976 $26,183
Net revenues 7,272 5,120 4,888 5,832 23,112
Loss before extraordinary item (6,158) (14,492) (6,636) (1,515) (28,801)
Net (loss) (6,408) (14,492) (6,636) (1,515) (29,051)
Loss before extraordinary item per share (0.63) (1.22) (0.59) (0.18) (2.62)
Basic and diluted loss per share (0.65) (1.22) (0.59) (0.18) (2.64)
- --------------------------------------------------------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the consolidated
financial statements and notes thereto appearing elsewhere herein.
Results of Operations
Fiscal year ended September 30, 2003 compared to fiscal year ended September 30,
2002
Total revenues for fiscal 2003 were $15,248,882, a decrease of $10,934,406,
or 41.76% as compared to revenues of $26,183,288 for fiscal 2002.
Revenues from commissions decreased by $10,210,034, or 64.21%, from
$15,900,261 for fiscal 2002 to $5,690,227 for fiscal 2003 due primarily to the
decrease in retail commissions from accounts obtained in the On-Site Acquisition
and increased competition and pricing pressure.
Data service revenues decreased by $360,648, or 77.98%, from $462,469 for
fiscal 2002 to $101,821 for fiscal 2003 due to the increasing number of accounts
migrating to Ultimate Trader from other licensed software providers available
through our services. We charge our customers a data service fee for using other
software providers and do not charge for Ultimate Trader.
Revenues from principal transactions increased by $5,314,920, or 209.74%,
from $2,533,998 for fiscal 2002 to $7,848,918 for fiscal 2003, This increase is
primarily due to favorable overall market conditions and an increase in the
value of securities owned. Included in principal transactions for fiscal year
2002 are losses incurred by the Class B minority interest members of the LLC in
the amount of $740,585.
Revenues from the sale of software income decreased by $3,908,308, or
100.00%. The sale of software was transacted in 3rd quarter of fiscal 2002.
Interest and other income decreased by $1,770,336 or 52.40%, from
$3,378,252 for fiscal 2002 to $1,607,916 for fiscal 2003. This decrease is
largely due to the decreased margin interest and interest earned on the accounts
acquired from the On-Site transaction and interest income earned in the LLC.
Also included in interest income and other income for fiscal 2002 are one-time
settlements with venders. Also included in interest and other income for fiscal
2002, is a World Trade Center Business Recovery Grant of $150,000.
Interest expense decreased by $1,844,528 or 68.86%, from $2,678,712 for
fiscal 2002 to $834,184 for fiscal 2003 as a result of decreased borrowings
during the year. For fiscal 2002 the Company issued warrants in connection with
the increased borrowings. The value of such warrants were amortized over the
term of the loan as a component of interest expense. Interest expense relating
to the amortization of the warrants issued in connection with the financing
during the year ended September 30, 2002 was approximately $1,600,000.
20
Interest expense to officer - There was no related party interest for
fiscal 2003 as the related notes payable were forgiven in exchange for warrants
issued to the officers and former officers during fiscal 2002.
During fiscal 2003 there were no deemed dividends. During fiscal 2002,
there was $3,599,414 of deemed dividends.
During fiscal 2003 we had preferred dividends of $252,000 compared to
$315,000 during fiscal 2002. As of May 31, 2003, the holders of the preferred
stock agreed to waive dividends until July 31, 2004.
As a result of the foregoing, net revenues decreased by $8,697,037,or
37.63%, from $23,111,735 for fiscal 2002 to $14,414,698 for fiscal 2003. Nearly
all of our revenues were generated by clients in the United States and no single
group of related clients accounted for 10% or more of our revenues.
Total expenses decreased by $30,509,918 or 58.78%, from $51,904,336 for
fiscal 2002 to $21,394,418 for fiscal 2003.
Commissions, floor brokerage and clearing charges represent payments to our
clearing and floor brokers who facilitate our clients` transactions, payments
for data and software from third party venders and payouts to our non-business
branch locations. These expenses decreased $6,255,452 or 51.92%, from
$12,048,982 for fiscal 2002 to $5,793,530 for fiscal 2003. This is largely due
to a decrease in trading activity and a decrease in online software fees.
Employment compensation and related costs decreased by $2,104,343 or
19.71%, from $10,674,346 for fiscal 2002 to $8,570,003 for fiscal 2003,
primarily due to headcount reductions in administrative and management
personnel. Employee compensation also decreased due to the lower trading profits
generated by the Proprietary trading sales division for fiscal year 2003.
Communications expense decreased by $1,714,535 or 59.47%, from $2,882,953
for fiscal 2002 to $1,168,418 for fiscal 2003. This decrease was due to
discontinuing use of our offsite back up site and canceling data lines related
to the software that we had in fiscal 2002 and renegotiated new rates with our
vendors. Also in June of 2002 we closed the business of Onsite LLC.
Business development costs consist of television, radio, on-line and print
advertising to obtain new clients. These expenses decreased by $194,125, or
39.94%, from $485,993 for fiscal 2002 to $291,868 for fiscal 2003 as we
decreased our advertising and promotional efforts due to the slowdown in overall
trading volumes.
Professional fees decreased by $2,850,045 or 77.46%, from $3,679,184 for
fiscal 2002 to $829,139 for fiscal 2003.This decrease was largely due to a
decrease in accounting fees and legal fees associated with the On-Site
acquisition, the sale of the software and the conversion of notes payable.
Occupancy and equipment costs decreased by $3,781,593 or 64.70%,from
$5,845,238 for fiscal 2002 to $2,063,645 for fiscal 2003. Rent for fiscal 2003
decreased due to renegotiating our lease with our landlord and surrendering the
25th and 28th floors we had previously occupied space, the settlement and
expiration of certain leases during fiscal year 2003. These leases were
terminated as part of our overall cost cutting initiatives. In addition, during
fiscal year 2003 many of the Company's software maintenance and support
contracts expired. The Company did not renew or replace these contracts.
Depreciation and amortization decreased by $4,637,734 or 78.68%, from
$5,894,333 for fiscal 2002 to $1,256,599 for fiscal 2003 primarily due to the
disposal or surrender of assets subject to such depreciation and amortization.
We had sold software to an affiliate of our clearing broker and had written off
intangible assets recognized as a result of the On-Site acquisition. In
addition, we had surrendered leasehold improvements on the 25th floor and 28th
floors at 40 Wall Street.
Other expenses decreased by $257,803 or 15.33%, from $1,681,751 for fiscal
2002 to $1,423,948 for fiscal 2003. This decrease is a reduction in general
operating expenses as part of our overall cost cutting initiatives.
For fiscal 2002 we had a loss on impairment of $7,870,110 which represents
the write-off of intangible assets (customer lists) obtained in the On-Site
acquisition. The acquired customer base deteriorated significantly which
resulted in decreases in On-site
21
revenues and operating cash flows. This deterioration is attributable to many
causes including weakening market conditions, as well as the loss and closing of
branch operations, which resulted in a permanent impairment in the value of the
customer base acquired. There was no loss on impairment in fiscal 2003.
Loss on investments of $84,287 for fiscal 2003 represents the loss of the
value of the stock acquired from E*Trade in April 2002.
For fiscal 2002 the abandonment of leasehold improvements of $1,741,315
primarily relates to the surrender and termination of the 25th and 28th floor
office leases at 40 Wall Street that occurred in August 2002. These leases were
terminated as part of our overall cost cutting initiatives. In addition, we
abandoned leaseholds in offices formerly used by On-Site. There was no
abandonment of leasehold improvements for fiscal 2003.
Fiscal 2002 minority interest of $899,869 represents the trading losses of
the Class B non-voting members of the LLC.
As a consequence of the foregoing, our operating loss before income taxes
and extraordinary items decreased from $28,792,601 for fiscal 2002, to a loss of
$6,979,720 for fiscal 2003.
For Fiscal 2002 we had an extraordinary loss on extinguishment of debt of
$250,000 relating to the early extinguishment of the $2.5 million Senior
Subordinate Demand Note that was exchanged for $2,750,000 of Preferred Stock in
accordance with the Senior Subordinated Demand Note agreement.
During the year ended September 30, 2002, we had a deemed dividend to
preferred stockholders for beneficial conversion and accretion of the redemption
feature of $1,639,797 and $1,959,617, respectively, as well as a preferred stock
dividend of $315,000. As a consequence of the foregoing, our net loss
attributable to common shareholders decreased from $32,965,740 in fiscal 2002 to
$7,231,720 in fiscal 2003.
22
Results of Operations
Fiscal year ended September 30, 2002 compared to fiscal year ended September 30,
2001
Total revenues for fiscal 2002 were $26,183,288, an increase by $711,386 of
02.79% as compared to revenues of $25,471,902 for fiscal 2001.
Revenues from commissions decreased by $2,987,491, or 15.82%, from
$18,887,752 for fiscal 2001 to $15,900,261 for fiscal 2002 due primarily to a
decrease of UltimateTrader accounts, as well as a significant decrease in
overall trading activity by on-line traders due to adverse market conditions,
increased competition and pricing pressure. The decrease in Ultimate Trader
commissions, net of rebates in listed equities, over the counter securities and
options was $9,749,019 as compared to fiscal 2001. This decrease was partially
offset by the retail accounts acquired in the On-Site acquisition and the
commissions collected from the Class B Members in the LLC of $6,761,528.
Data service revenues decreased by $834,648, or 64.35%, from $1,297,117 for
fiscal 2001 to $462,469 for fiscal 2002 due to the increasing number of accounts
migrating to Ultimate Trader II from other licensed software providers available
through our services. We charge our customers a data service fee for using other
software providers and do not charge for Ultimate Trader II.
Revenues from principal transactions decreased by $662,846, or 20.73%, from
$3,196,844 for fiscal 2001 to $2,533,998 for fiscal 2002, mainly as a function
of lower volume of business conducted by the institutional sales division due to
adverse market conditions and unusually high employee turnover in the
institutional sales division. As a result of these factors, revenue from our
institutional sales division decreased $1,577,372 from the previous year.
Included in principle transactions for fiscal year 2002 are losses incurred by
the Class B minority interest members of the LLC of $740,585. These decreases
were partially offset by an increase in trading profits from the proprietary
trading division of $1,655,111.
Interest and other income increased from $2,084,009 for fiscal 2001 to
$3,378,252 for fiscal 2002. This increase is largely due to the increased margin
interest and interest earned on the additional accounts acquired from the
On-Site retail accounts and interest income earned in the LLC. Also included in
interest income and other income for fiscal 2002 are one-time settlements with
venders of $507,472 and a World Trade Center Business Recovery Grant of
$150,000.
Interest expense increased from $852,967 for fiscal 2001 to $ 2,678,712 for
fiscal 2002 as a result of increased borrowings during the year. The Company
issued warrants in connection with the borrowings. The value of such warrants
were amortized over the term of the loan as a component of interest expense.
Interest expense relating to the amortization of the warrants issued in
connection of the financing during the year ended September 30, 2002 was
approximately $1,600,000.
Interest expense - related party decreased by $5,276 or 1.33% from $398,117
for fiscal 2001 to $392,841 for fiscal 2002.
As a result of the foregoing, net revenues decreased by $1,109,083, or
4.58%, from $24,220,818 for fiscal 2001 to $23,111,735 for fiscal 2002. Nearly
all of our revenues were generated by clients in the United States and no single
group of related clients accounted for 10% or more of our revenues.
23
Total expenses increased by $6,688,041 or 14.79%, from $45,216,295 for
fiscal 2001 to $51,904,336 for fiscal 2002.
Commissions, floor brokerage and clearing charges represent payments to our
clearing and floor brokers who facilitate our clients` transactions, payments
for data and software from third party venders and payouts to our non-business
branch locations. These expenses increased $1,467,762 or 13.97%, from
$10,572,220 for fiscal 2001 to $12,048,982 for fiscal 2002. This increase is
largely due to the acquisition of the On-Site accounts with a lower gross margin
than our historical online client business. This increase was partially offset
by our lower volumes in our institutional sales division. In addition, our
online software licenses fees and data services fees decreased.
Employment compensation and related costs decreased by $2,012,269 or
15.86%, from $12,686,615 for fiscal 2001 to $10,674,346 for fiscal 2002,
primarily due to headcount reductions in administrative and management
personnel. Employee compensation also decreased due to the lower trading profits
generated by the institutional sales division for fiscal year 2002.
Communications expense increased by $672,897 or 30.45%, from $2,210,056 for
fiscal 2001 to $2,882,953 for fiscal 2002. This increase was due to the adding
of a back up site as well as the increased data and communication costs relating
to the On-Site branch locations.
Business development costs consist of television, radio, on-line and print
advertising to obtain new clients. These expenses decreased by $1,859,703, or
79.28%, from $2,345,696 for fiscal 2001 to $485,993 for fiscal 2002 as we
decreased our planned advertising and promotional efforts.
Professional fees decreased from $3,698,724 for fiscal 2001 to $3,679,184
for fiscal 2002. Accounting and legal fees increased $2,194,569. The increase in
accounting fees relates to the due diligence and the additional work relating to
the On-Site acquisition. Legal fees increased largely due to the On-site
acquisition, the issuance of Series A Preferred Stock, the software licensing
agreement with E*Trade and the sale of the software to our clearing broker. In
addition, legal costs were incurred for the settling of vendor claims. This
increase in legal and accounting fees was offset by a decrease in consulting
fees of $2,214,109 from fiscal year 2001, primarily as a result of our sale of
software, as external software consultants were no longer utilized to develop
and maintain such software.
Occupancy and equipment costs decreased by $464,759 or 7.37%, from
$6,309,997 for fiscal 2001 to $5,845,238 for fiscal 2002. Rent for the year
increased $494,916 largely due to the acquisition of the On-Site offices in
Great Neck, New York and Boca Raton, Florida. The office rent increase was
largely offset by a $470,787 decrease relating to the settlement with certain
leasing companies and the expiration of some leases during fiscal year 2002. In
addition, during fiscal year 2002 many of the Company`s software maintenance and
support contracts expired resulting in a decrease of $488,888 from the previous
year.
Depreciation and amortization increased by $394,411 or 7.17%, from
$5,499,922 for fiscal 2001 to $5,894,333 for fiscal 2002. This increase is
largely due to the amortization of the intangibles relating the On-site
acquisition of $715,000 net of a decrease in amortization of capitalized
software due to the sale of the software of approximately $540,000. Other
expenses increased by $492,300 or 41.39%, from $1,189,451 for fiscal 2001 to
$1,681,751 for fiscal 2002 due to the 2% penalty of approximately $311,000 for
not filing a registration statement in accordance with the Preferred Stock
agreement.
Loss on impairment of $7,870,110 represents the write off of intangible
assets (customer lists) obtained in the On-Site acquisition. The acquired
customer base deteriorated significantly which resulted in decreases in On-site
revenues and operating cash flows. This deterioration is attributable to many
causes including weakening market conditions, as well as the loss and closing of
branch operations, which resulted in a permanent impairment in the value of the
customer base acquired.
The abandonment of leasehold improvements of $1,741,315 primarily relates
to the surrender and termination of the 25th and 28th floor office leases at 40
Wall Street that occurred in August 2002. These leases were terminated as part
of our overall cost cutting initiatives. In addition, we abandoned leaseholds in
offices formerly used by On-Site.
24
Minority interest of $899,869 represents the trading losses of the Class
Bnon-voting members of the LLC.
As a consequence of the foregoing, our operating loss before income taxes
and extraordinary items increased from $20,995,477 for fiscal 2001, to a loss of
$28,792,601 for fiscal 2002.
The income tax provision (for minimum taxes) decreased from $28,697 for
fiscal 2001 to $8,725 for fiscal 2002.
We had an extraordinary loss on extinguishment of debt of $250,000 relating
to the early extinguishment of the $2.5 million Senior Subordinate Demand Note
that was exchanged for $2,750,000 of Preferred Stock in accordance with the
Senior Subordinated Demand Note agreement.
During the year ended September 30, 2002, we had a deemed dividend to
preferred stockholders for beneficial conversion and accretion of the redemption
feature of $1,639,797 and $1,959,617 respectively as well as a preferred stock
dividend of $315,000. As a consequence of the foregoing, our net loss increased
from $21,024,174 in fiscal year ended 2001 to $32,965,740 in fiscal year ended
2002.
Liquidity and Capital Resources
For the year ended September 30, 2003, we incurred consolidated losses of
approximately $7.0 million and used cash in our operating activities of nearly
$1.5 million. These losses and use of cash are in addition to the approximately
$50.1 million of losses and $24.1 million of cash used in operating activities
during the two years ending September 30, 2002. The market conditions during
fiscal 2003 have been very challenging for brokerage firms such as ABWG as well
as for the brokerage industry in general. Trading volume has significantly
decreased, we have lost customers in our core direct access business and
increased competition has put pricing and margin pressures on the Company.
To respond to our liquidity and capital resource needs, the Company has
taken, and is taking, a variety of steps to offset the cash used in operating
activities. Such steps include cost cutting initiatives, the pursuit of
additional revenue producing activities, and the raising of funds or reduction
of operating liabilities through sale of assets and the issuance of debt and
equity securities.
Our cost cutting initiatives include reductions in workforce, reductions in
capital expenditures, and renegotiating clearing corporation agreements at more
favorable rates. We are pursuing more traditional lines of business including
attracting active traders and hedge funds. However, in order to expand our
business, respond to competitive pressures and expand into additional products
and services, we have needed to raise additional funds through the issuance of
debt. When funds are raised through the issuance of equity securities or
financial instruments that are convertible into equity securities, our existing
shareholders may experience dilution in their ownership percentage or book
value. In addition, such securities may have rights, preferences and privileges
senior to those of the holders of our Common Stock. There can be no assurances
that the additional financing will be available when needed and on terms
satisfactory to the Company.
The Company may not be able to receive distributions from its regulated
broker-dealer subsidiaries due to capital withdrawal restrictions placed on the
regulated entities by the SEC`s Uniform Net Capital rule.
Cash used in operating activities during fiscal 2003 was $1,500,482. The
Company had a net loss of $6,979,720, which was largely offset by decreases in
restricted cash of $292,565, receivables from clearing brokers of $805,032, and
securities owned of $836,327. Offsets to cash used in operating activities
include the increases in accounts payable and accrued liabilities of $855,573,
payable to clearing broker of $1,597,767 and securities sold not yet purchased
of $28,010. Other offsets include a decrease in leasehold obligations of
$1,019,148 and non-cash items including depreciation and amortization of
$1,256,599, forgiveness of penalties on preferred stock of $759,107, the
issuance of warrants of $136,862 and amortization of options costs of $18,667.
25
Cash used in investing activities was $64,950 during fiscal 2003. The most
significant uses of cash used in investing activities were purchases of property
and equipment.
Cash provided by financing activities was $1,392,962 during fiscal 2003.
Cash provided by financing activities during fiscal 2003 consisted primarily of
net proceeds from the secured demand note of $1,798,000 offset by net payments
of notes payable of $200,000 and distributions to the Class B members of the LLC
of $205,038.
In 2002, cash used by operating activities during fiscal 2002 was
$8,278,756. We had a net loss of $29,051,326 and a decrease in securities sold
not yet purchased of $3,731,128 which was largely offset by a decreases in
receivables from clearing brokers of $1,178,045, securities owned of $2,748,940
and securities deposits of $1,312,479. Other offsets include non-cash items
including depreciation and amortization of $5,894,333, loss on impairment of
intangibles of $7,870,110, loss on disposal of leasehold improvements of
$1,741,315 and the issuance of warrants of $1,390,569.
Cash provided by investing activities was $4,138,384 during fiscal 2002.
The most significant sources of cash provided by investing activities was the
proceeds from the sale of the software.
Cash provided by financing activities was $3,846,085 during fiscal 2002.
Cash provided by financing activities during fiscal 2002 consisted primarily of
proceeds from the sale of Preferred Stock of $3,324,291, loans from officers of
$900,000, and notes payable of $187,884. In addition, we had capital
contributions from and distributions to, the Class B members of the LLC of
$446,307 and $1,012,397, respectively.
Cash used by operating activities during fiscal 2001 was $15,818,426. We
had a net loss of $21,024,174 and an increase from other assets of $324,319,
receivables from clearing brokers of $1,174,624, loans receivable from related
party of $129,126 and a decrease in accounts payable and accrued liabilities of
$513,973 which was offset by an increase in other liabilities of $67,288, and
non-cash items such as depreciation and amortization of $5,499,922, loss on
investments of $703,614 and non-cash compensation/service costs of $779,162.
Cash used in investing activities was $1,759,660 during fiscal 2001. Uses
of cash in fiscal 2001 related to purchases of equipment, software and leasehold
improvements made in our facility at 40 Wall Street of $1,759,660. In addition
to the cash used in investing activities during the year 2001, we accrued
accounts payable relating to purchases of property and equipment of $198,348
during this period.
Cash provided by financing activities was $12,996,056 during fiscal 2001.
Cash provided by financing activities during fiscal 2001 consisted primarily of
proceeds from the sale of Common Stock in a private equity offering of 2,027,241
shares at an offering price of $5.50, employee exercised stock options of
$987,290, loans from officers of approximately $850,000, and a loan of
$2,500,000. We used a portion of these proceeds to pay $790,938 in notes
payable, and $559,090 to pay obligations on capital leases.
At September 30, 2003, A.B. Watley has $5,530,000 of outstanding
subordinated loans, under agreements approved by the NASD. These loans are
included by A.B. Watley for purposes of computing its net capital under the
SEC`s net capital rules. These borrowings by A.B. Watley consist of:
o a $5,000,000 secured demand note from a third party bearing interest
at an annual rate of 7% (see Legal Proceedings).
o a $55,000 non-interest bearing loan and a $125,000 loan bearing
interest at 12% from an officer and a stockholder.
o a $200,000 loan, bearing interest at an annual rate of 15% and a
$150,000 loan bearing interest at an annual rate of 13%, from a family
member of a former executive officer of the Company
A.B. Watley is currently required to maintain minimum net capital such that
the ratio of aggregate indebtedness to net capital both as defined shall not
exceed 15 to 1 under the SEC`s net capital rule. Such rule also prohibits
"equity capital", including the subordinated loans, from being withdrawn or cash
dividends from being paid if our net capital ratio would exceed 10 to 1 or if we
would have less than our minimum required net
26
capital. Accordingly, our ability to repay the subordinated loans may be
restricted under the net capital rule.
Recent Accounting Developments
In January 2003, as revised in December 2003, the FASB issued
Interpretation No. 46 ("FIN46"), "Consolidation of Variable Interest Entities,
an Interpretation of ARB No. 51." FIN 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if the
equity investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 is effective for all new variable interest entities
created or acquired after January 31, 2003. For variable entities created or
acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for
the first interim or annual period beginning after March 15, 2004. Management
does not believe that the adoption of this pronouncement will have a material
effect on the Company's financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities." This statement clarifies the accounting guidance on (1) derivative
instruments (including certain derivative instruments embedded in other
contracts) and (2) hedging activities that fall within the scope of the SFAS
133. SFAS 149 also amends certain other existing pronouncements, which will
result in more consistent reporting of contracts that are derivatives in their
entirety or that contain embedded derivatives that warrant separate accounting.
SFAS 149 is effective (1) for contracts entered into or modified after September
30, 2003, with certain exceptions, and (2) for hedging relationships designated
after September 30, 2003. The guidance is to be applied prospectively.
Management does not believe that the adoption of any of this pronouncement will
have a material effect on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 addresses certain financial instruments that, under previous guidance,
could be accounted for as equity, but now must be classified as liabilities in
statements of financial position. These financial instruments include: 1)
mandatorily redeemable financial instruments, 2) obligations to repurchase the
issuer's equity shares by transferring assets, and 3) obligations to issue a
variable number of shares. SFAS No. 150 is effective for all financial
instruments entered into or modified after May 31, 2003, and otherwise effective
at the beginning of the first interim period beginning after June 15, 2003. The
Company adopted the above pronouncement during the current year and there was no
material effect on the Company's consolidated financial statements.
Off Balance Sheet Arrangements
Leases
During the year ended September 30, 2003, the Company had off balance sheet
arrangements related to its lease obligations. The Company is obligated under
such lease arrangements for $5,544,898 through 2009.
Clearing Agreements
Pursuant to clearance arrangements, the clearing and depository operations
for the Company and its customers' securities transactions are provided by two
clearing broker-dealers. The Company earns commissions as an introducing broker
for the transactions of its customers. In the normal course of business, the
Company's customer activities involve the execution and settlement of various
customer securities transactions. These activities may expose the Company to
off-balance-sheet risk in the event the customer or other broker is unable to
fulfill its contracted obligations and the Company has to purchase or sell the
security underlying the contract at a loss.
The Company's customer securities are transacted on either a cash or margin
basis. In margin transactions, the clearing broker extends the credit to the
Company's customer, subject to various regulatory margin requirements,
collateralized by cash and securities in the customers' accounts. However, the
Company is required to contact the customer and to either obtain additional
collateral or to sell the customer's position if such
27
collateral is not forthcoming. The Company is responsible for any losses on such
margin loans, and has agreed to indemnify its clearing brokers for losses that
the clearing brokers may sustain from the customer account introduced by the
Company.
Critical Accounting Policies and Procedures
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires that we
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and the related disclosure of contingent
assets and liabilities (see Note 2 to the consolidated financial statements). We
believe that of our significant accounting policies (see Note 2 to the
consolidated financial statements), the following may involve a higher degree of
judgment on our part and complexity of reporting.
Accounts Receivable
Accounts receivable consist primarily of amounts due to us from our normal
business activities. We maintain an allowance for doubtful accounts to reflect
the expected uncollectibility of accounts receivable based on past collection
history and specific risks identified among uncollected accounts.
Securities Transactions, Revenue, and Related Expenses
Securities transactions and related revenue and expenses, including
commissions, revenues and expenses, are recorded on trade date basis. Data
service revenues are recorded as the services are provided.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our primary financial instruments subject to market risk at September 30,
2003 consist of equity securities. In the normal course of business we hold
significant investments in equity securities. 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 own 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 amount reported for
the transaction. We have established policies, procedures and internal processes
governing our management of market risk in the normal course of our business
operations. We, along with our clearing brokers, continuously monitor our
exposure to market and counter-party risk through the use of a variety of
financial, position and credit exposure reporting and control procedures. In
addition, we review the creditworthiness of each customer and/or other
counter-party with which we conduct business. We are not currently exposed to
any material currency exchange risk because the risk is borne by international
customers and our international licensees, and we do not hold any assets or
incur any liabilities denominated in foreign currency.
Item 8. Financial Statements and Supplementary Data
The financial statements required by this item are attached to this
document immediately following the signature page.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On July 26, 2002, Ernst & Young LLP informed us that it would no longer
serve as our independent auditors, and submitted its letter of resignation to
us. The audit reports of Ernst & Young on our consolidated financial statements
as of and for the fiscal years ended September 30, 2001 and September 30, 2000,
respectively, did not contain any adverse opinion or disclaimer of opinion, nor
were they qualified or modified as to uncertainty, audit scope or accounting
principles.
During our two fiscal years ended September 30, 2001, and 2000,
respectively, and subsequent interim periods through the date of Ernst & Young`s
resignation described above, there were no disagreements between us and Ernst &
Young on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedures which, if not resolved to Ernst &
Young`s satisfaction, would have caused Ernst & Young to make reference to the
28
subject matter of the disagreement in connection with its reports on our
consolidated financial statements for such years.
In a letter to our Board of Directors, Ernst & Young stated: "We believe the
Company`s Finance and Accounting department has insufficient resources and
expertise to ensure timely and accurate filing of requisite financial and
regulatory information." We believe that we are addressing those concerns by
addressed these concerns by hiring a consultant as interim Chief Financial
Officer and are taking additional steps to ensure timely filings in the future.
On October 8, 2002, we filed an amendment to our Current Report on Form 8-K
relating to the resignation of Ernst & Young as our independent auditors for the
purpose of including a letter, dated August 5, 2002, from Ernst & Young to the
Securities Exchange Commission pursuant to Item 304(a) of Regulation S-K under
the Securities Act of 1933, as amended.
On August 28, 2002, we engaged Israeloff, Trattner & Co. P.C. ("Israeloff") as
our independent public accountants. On October 10, 2002, Israeloff resigned as
our independent public accountants.
Israeloff did not issue a report on the Company`s financial statements during
our two most recent fiscal years and any subsequent interim period and,
therefore, no report contained an adverse opinion or disclaimer of opinion, or
was modified as to uncertainty, audit scope, or accounting principle.
Furthermore, during the two most recent fiscal years and any subsequent interim
period, there were no disagreements with Israeloff within the meaning of
Instruction 4 to Item 304 of Regulation S-B under the Securities Exchange Act of
1934 on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure, which disagreements, if not resolved
to the satisfaction of Israeloff, would have caused them to make reference in
connection with their opinion to the subject matter of the disagreement in
connection with any report they might have issued.
On October 21, 2002, we engaged Marcum & Kliegman LLP as our independent
public accountants.
Item 9A. Controls & Procedures
During the year, an evaluation was performed under the supervision and with
the participation of the Company`s management, including the Principal Executive
Officer and the Principal Financial Officer, of the effectiveness of the design
and operation of the Company`s disclosure controls and procedures. Based on that
evaluation, the Company`s management, including the Principal Executive Officer
and the Principal Financial Officer, concluded that the Company`s disclosure
controls and procedures were effective as of September 30, 2003. There have been
no significant changes in the Company`s internal controls or in other factors
that could significantly affect internal controls subsequent to September 30,
2003.
PART III
Item 10. Directors and Executive Officers of the Registrant
Directors are elected at each meeting of stockholders and hold office until the
next annual meeting of stockholders and the election and qualifications of their
successors. Executive officers are elected by and serve at the discretion of the
board of directors.
Our executive officers and directors are as follows:
Name Age Position
------- ----- ----------
Steven Malin 46 Chairman of the Board and Director
Robert Malin 39 Vice Chairman and Director
29
Steven Malin. Mr. Malin co-founded the Company in May 1996 and has been its
Chairman of the Board since inception. Mr. Malin also served as Chief Executive
Officer from May 1996 to September 2002. From August 1993 to December 1996, Mr.
Malin served as a consultant to the Company. From 1987 to 1993, he was a Senior
Foreign Exchange Options Broker for Tullett and Tokyo Forex, Inc., a global
inter-bank money brokering firm with its primary offices located in London, New
York and Tokyo. Mr. Malin attended the Fletcher School of Law and Diplomacy from
1982 to 1984. He received a bachelor of arts degree from Vassar College in 1980.
Robert Malin. Mr. Malin is a co-founder of the Company and has served as a
director since inception. He has been associated with the Company since August
1993, initially as General Securities Principal and director of day-to-day
operations and, most recently, serving as President. His earlier experience
includes managing equity trading, client services and brokerage operations. Mr.
Malin and Steven Malin are brothers.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
During the fiscal year ended September 30, 2003, based upon an examination of
the public filings, all of our company's officers and directors timely filed
reports on Forms 3 and 4 except for Michael Picone(1 late report).
Item 11. Executive Compensation
The following table sets forth for the fiscal year indicated the compensation
paid by our company to our Chief Executive Officer and other executive officers
with annual compensation exceeding $100,000:
Summary Compensation Table
Long-Term
Compensation
Annual Compensation ------------------
Name and Principal Position Fiscal Year Salary Bonus Awards Underlying
Options/SARs (#)
-------------------------- ------------- ----------------- ---------- ------------------
Steven Malin, 2003 $ 150,000 $ 0 0
Chairman 2002 $ 17,212 $ 0 800,000
A.B. Watley Group Inc. 2001 $ 110,000 $ 0 30,000
John J. Amore, 2003 $ 235,745 $ 75,000 N/A
Chief Executive Officer 2002 $ 155,766(1) $ 0 1,300,000
A.B. Watley Group Inc. 2001 $ 0 $ 0 0
Robert Malin, 2003 $ 198,539 $ 0 0
Vice Chairman and Director 2002 $ 88,846 $ 0 1,300,000
A.B. Watley Group Inc. 2001 $ 110,000 $ 0 0
Michael Picone, 2003 $ 157,579 (2) $ 0 500,000
Chief Operating Officer 2002 $ 0 $ 0 0
A.B. Watley Group Inc. 2001 $ 0 $ 0 0
Gary Mednick, 2003 $ 250,000 $ 0 0
President 2002 $ 250,000 $ 50,000 25,000
A.B. Watley Direct, Inc. 2001 $ 0 $ 0 0
(1) Mr. Amore was appointed as an officer of the Company in September 2002
and was terminated in September 2003. All consideration received by
Mr. Amore during the year ended September 2002, was received as a
consultant of the Company.
(2) On August 31, 2003, Mr. Picone resigned as the Chief Operating Officer
of the Company. Subsequent to his resignation, Mr. Picone entered into
a consulting agreement with the Company.
30
EMPLOYMENT AGREEMENTS
On September 9, 2002, the Company has entered into three-year employment
agreements with Steven Malin and Robert Malin, both of which are automatically
renewable for additional one-year terms. The employment agreements provide for
annual base compensation of $150,000 for Steven Malin and $200,000 Robert Malin.
Each agreement provides for a discretionary bonus based upon the performance of
the Company, payable semi-annually, as may be approved by the board of directors
or a committee of the board.
Each of the employment agreements requires the officer to devote his full time
and efforts to our business and contains non-competition and non-disclosure
covenants of the officer for the term of his employment and for a period of two
years thereafter. Each employment agreement provides that the Company may
terminate the agreement for cause. In addition, each employment agreement
provides for termination by either party without cause upon at least 180 days
written notice prior to the end of the original term or any renewal term. In the
event that either Steven Malin or Robert Malin terminate their employment
agreement for good reason or the Company terminates the employment agreement
without cause, then the applicable officer is entitled to the following:
o annual base salary accrued and a prorated annual bonus prior to the date of
termination;
o annual base salary multiplied by the greater of two (2) (the "Applicable
Factor") or the number of years remaining in the employee's employment
agreement;
o annual bonus multiplied by the greater of Applicable Factor or the number
of years remaining in the employee's employment agreement;
o continuing health benefits; and
o all outstanding options and other equity shall vest and become immediately
exercisable.
In the event that Steven Malin or Robert Malin is terminated within six (6)
months of a change of control within the Company, then the Applicable Factor
shall be three (3).
DIRECTORS' COMPENSATION
All directors are reimbursed for their reasonable expenses incurred in attending
meetings of the board of directors and its committees. Directors who are
employees receive no additional compensation for service as members of the board
of directors or committees. Non-employee directors are compensated annually for
their services at $1,000 and granted non-qualified options to acquire 1,500
shares of our common stock at the end of each year of service.
OPTION GRANTS IN LAST FISCAL YEAR
The following table contains information concerning options granted to executive
officers named in the Summary Compensation Table during the fiscal year ended
September 30, 2003:
Individual Grants
Number of % of Total Options
Securities Granted to
Name Underlying Employees in Fiscal
Options Granted Year Exercise Expiration Date
(#) Price ($/sh)
------------- --------------- ------------------- ------------- -----------------
Michael Picone 500,000 100.0% .35 August 31, 2013
OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
The following table contains information concerning the number and value, at
September 30, 2003, of unexercised options held by executive officers named in
the Summary Compensation Table:
Number of Securities Underlying Unexercised Options at Value of Unexercised In-the-Money
Name FY-End (#) (Exercisable/Unexercisable) Options at FY-End ($)
(Exercisable/Unexercisable) (1)
- ------------- ------------------------------------------------------ --------------------------------------------
Steven Malin 375,000 / 425,000 $ 93,750 / $106,250
Robert Malin 780,000 / 550,000 $187,500 / $137,500
Michael Picone 500,000 / 0 0 / 0
Gary Mednick 13,750 / 11,250 0 / 0
31
(1) Fair market value of underlying securities (the closing price of the
Company's common stock at fiscal year end (September 30, 2003) minus the
exercise price.
STOCK OPTION PLANS
1997, 1998 and 1999 Stock Option Plan
On January 27, 1997, the board of directors and stockholders adopted our 1997
stock option plan, on March 16, 1998, our board of directors and stockholders
adopted our 1998 stock option plan and on November 1, 1999 and March 14, 2000,
the board of directors and stockholders, respectively, adopted our 1999 stock
option plan. The Company reserved 400,000 shares of common stock for issuance
upon exercise of options granted from time to time under the 1997 stock option
plan and 800,000 shares of common stock for issuance upon exercise of options
granted from time to time under each of the 1998 and 1999 stock option plans.
The 1997, 1998 and 1999 stock option plans are intended to assist us in securing
and retaining key employees, directors and consultants by allowing them to
participate in our ownership and growth through the grant of incentive and
non-qualified options.
Under each of the stock option plans the Company may grant incentive stock
options only to key employees and employee directors, or the Company may grant
non-qualified options to our employees, officers, directors and consultants. The
1997 stock option plan is administered by a committee, appointed by our board of
directors, consisting of from one to three directors. The 1998 and 1999 stock
option plans are administered directly by our board of directors.
Subject to the provisions of each of the stock option plans, either the board or
the committee will determine who shall receive options, the number of shares of
common stock that may be purchased under the options, the time and manner of
exercise of options and exercise prices. The term of options granted under each
of the stock option plans may not exceed ten years or five years for an
incentive stock option granted to an optionee owning more than 10% of our voting
stock. The exercise price for incentive stock options shall be equal to or
greater than 100% of the fair market value of the shares of the common stock at
the time granted; provided that incentive stock options granted to a 10% holder
of our voting stock shall be exercisable at a price equal to or greater than
110% of the fair market value of the common stock on the date of the grant. The
exercise price for non-qualified options will be set by the board or the
committee, in its discretion, but in no event shall the exercise price of
options granted under the 1997 or 1998 stock option plans be less than the fair
market value of the shares of common stock on the date of grant. The exercise
price may be payable in cash or, with the approval of the board or the
committee, by delivery of shares or by a combination of cash and shares. Shares
of common stock received upon exercise of options granted under each of the
plans will be subject to restrictions on sale or transfer.
As of September 30, 2003, the Company has granted options to purchase
2,692,700 shares of common stock under our stock options plans at an exercise
price ranging from $.10 to $21.50 per share.
2000 Stock Option Plan
On October 24, 2000 and July 17, 2001, the board of directors, and
stockholders, respectively, adopted our 2000 stock option plan. The Company has
reserved 1,600,000 shares of common stock for issuance upon exercise of options
granted from time to time under the 2000 stock option plan. The 2000 stock
option plan is intended to assist us in securing and retaining key employees,
directors and consultants by allowing them to participate in our ownership and
growth through the grant of incentive and non-qualified options.
Under the 2000 stock option plan the Company may grant incentive stock
options only to key employees and employee directors, or the Company may grant
non-qualified options to our employees, officers, directors and consultants. The
2000 stock option plan will be administered directly by our board of directors.
Subject to the provisions of the 2000 stock option plan, the board will
determine who shall receive options, the number of shares of common stock that
may be purchased under the options, the time and manner of exercise of options
and exercise prices. The term of options granted under the 2000 stock option
plan may not exceed ten years or five years for an incentive stock option
granted to an optionee owning more than 10% of our voting stock. The exercise
price for incentive stock options shall be equal to or greater than 100% of the
fair market value of the shares of the common stock at the time granted;
provided that incentive stock options granted to a 10% holder of our voting
stock shall be exercisable at a price equal to or greater than 110% of the fair
market value of the common stock on the date of the grant. The exercise price
for non-qualified options will be set by the board, in its discretion. The
exercise price may be payable in cash or, with the approval of the board, by
delivery of shares or by a combination of cash and shares. Shares of common
stock received upon exercise of options granted under the 2000 stock option plan
will be subject to restrictions on sale or transfer.
32
2003 Stock Option Plan
The majority stockholders of the Company have approved the 2003 Employee
Stock Option Plan (the "2003 Option Plan") and have authorized 2,000,000 shares
of Common Stock for issuance thereunder on September 25, 2003. The following is
a summary of principal features of the 2003 Option Plan. The summary, however,
does not purport to be a complete description of all the provisions of the 2003
Option Plan.
General
The 2003 Option Plan was adopted by the Board of Directors. The Board of
Directors has initially reserved 2,000,000 shares of Common Stock for issuance
under the 2003 Option Plan. Under the Plan, options may be granted which are
intended to qualify as Incentive Stock Options ("ISOs") under Section 422 of the
Internal Revenue Code of 1986 (the "Code") or which are not ("Non-ISOs")
intended to qualify as Incentive Stock Options thereunder.
The 2003 Option Plan and the right of participants to make purchases
thereunder are intended to qualify as an "employee stock purchase plan" under
Section 423 of the Internal Revenue Code of 1986, as amended (the "Code"). The
2003 Option Plan is not a qualified deferred compensation plan under Section
401(a) of the Internal Revenue Code and is not subject to the provisions of the
Employee Retirement Income Security Act of 1974 ("ERISA").
Purpose
The primary purpose of the 2003 Option Plan is to attract and retain the
best available personnel for the Company in order to promote the success of the
Company's business and to facilitate the ownership of the Company's stock by
employees. In the event that the 2003 Option Plan is not adopted the Company may
have considerable difficulty in attracting and retaining qualified personnel,
officers, directors and consultants.
Administration
The 2003 Option Plan will be administered by the Company's Board of
Directors, as the Board of Directors may be composed from time to time. All
questions of interpretation of the 2003 Option Plan are determined by the Board,
and its decisions are final and binding upon all participants. Any determination
by a majority of the members of the Board of Directors at any meeting, or by
written consent in lieu of a meeting, shall be deemed to have been made by the
whole Board of Directors.
Notwithstanding the foregoing, the Board of Directors may at any time, or
from time to time, appoint a committee (the "Committee") of at least two members
of the Board of Directors, and delegate to the Committee the authority of the
Board of Directors to administer the Plan. Upon such appointment and delegation,
the Committee shall have all the powers, privileges and duties of the Board of
Directors, and shall be substituted for the Board of Directors, in the
administration of the Plan, subject to certain limitations.
Members of the Board of Directors who are eligible employees are permitted to
participate in the 2003 Option Plan, provided that any such eligible member may
not vote on any matter affecting the administration of the 2003 Option Plan or
the grant of any option pursuant to it, or serve on a committee appointed to
administer the 2003 Option Plan. In the event that any member of the Board of
Directors is at any time not a "disinterested person", as defined in Rule
16b-3(c)(3)(i) promulgated pursuant to the Securities Exchange Act of 1934, the
Plan shall not be administered by the Board of Directors, and may only by
administered by a Committee, all the members of which are disinterested persons,
as so defined.
Eligibility
Under the 2003 Option Plan, options may be granted to key employees,
officers, directors or consultants of the Company, as provided in the 2003
Option Plan.
Terms of Options
The term of each Option granted under the Plan shall be contained in a
stock option agreement between the Optionee and the Company and such terms shall
be determined by the Board of Directors consistent with the provisions of the
Plan, including the following:
(a) PURCHASE PRICE. The purchase price of the Common Shares subject to each
ISO shall not be less than the fair market value (as set forth in the 2003
Option Plan), or in the case of the grant of an ISO to a Principal Stockholder,
not less that 110% of fair market value of such Common Shares at the time such
Option is granted. The purchase price of the Common Shares subject to each
Non-ISO shall be determined at the time such Option is granted, but in no case
less than 85% of the fair market value of such Common Shares at the time such
Option is granted.
33
(b) VESTING. The dates on which each Option (or portion thereof) shall be
exercisable and the conditions precedent to such exercise, if any, shall be
fixed by the Board of Directors, in its discretion, at the time such Option is
granted.
(c) EXPIRATION. The expiration of each Option shall be fixed by the Board
of Directors, in its discretion, at the time such Option is granted; however,
unless otherwise determined by the Board of Directors at the time such Option is
granted, an Option shall be exercisable for ten (10) years after the date on
which it was granted (the "Grant Date"). Each Option shall be subject to earlier
termination as expressly provided in the 2003 Option Plan or as determined by
the Board of Directors, in its discretion, at the time such Option is granted.
(d) TRANSFERABILITY. No Option shall be transferable, except by will or the
laws of descent and distribution, and any Option may be exercised during the
lifetime of the Optionee only by him. No Option granted under the Plan shall be
subject to execution, attachment or other process.
(e) OPTION ADJUSTMENTS. The aggregate number and class of shares as to
which Options may be granted under the Plan, the number and class shares covered
by each outstanding Option and the exercise price per share thereof (but not the
total price), and all such Options, shall each be proportionately adjusted for
any increase decrease in the number of issued Common Shares resulting from
split-up spin-off or consolidation of shares or any like Capital adjustment or
the payment of any stock dividend.
Except as otherwise provided in the 2003 Option Plan, any Option granted
hereunder shall terminate in the event of a merger, consolidation, acquisition
of property or stock, separation, reorganization or liquidation of the Company.
However, the Optionee shall have the right immediately prior to any such
transaction to exercise his Option in whole or in part notwithstanding any
otherwise applicable vesting requirements.
(f) TERMINATION, MODIFICATION AND AMENDMENT. The 2003 Option Plan (but not
Options previously granted under the Plan) shall terminate ten (10) years from
the earlier of the date of its adoption by the Board of Directors or the date on
which the Plan is approved by the affirmative vote of the holders of a majority
of the outstanding shares of capital stock of the Company entitled to vote
thereon, and no Option shall be granted after termination of the Plan. Subject
to certain restrictions, the Plan may at any time be terminated and from time to
time be modified or amended by the affirmative vote of the holders of a majority
of the outstanding shares of the capital stock of the Company present, or
represented, and entitled to vote at a meeting duly held in accordance with the
applicable laws of the State of Delaware.
FEDERAL INCOME TAX ASPECTS OF THE 2003 OPTION PLAN
THE FOLLOWING IS A BRIEF SUMMARY OF THE EFFECT OF FEDERAL INCOME TAXATION
UPON THE PARTICIPANTS AND THE COMPANY WITH RESPECT TO THE PURCHASE OF SHARES
UNDER THE 2003 OPTON PLAN. THIS SUMMARY DOES NOT PURPORT TO BE COMPLETE AND DOES
NOT ADDRESS THE FEDERAL INCOME TAX CONSEQUENCES TO TAXPAYERS WITH SPECIAL TAX
STATUS. IN ADDITION, THIS SUMMARY DOES NOT DISCUSS THE PROVISIONS OF THE INCOME
TAX LAWS OF ANY MUNICIPALITY, STATE OR FOREIGN COUNTRY IN WHICH THE PARTICIPANT
MAY RESIDE, AND DOES NOT DISCUSS ESTATE, GIFT OR OTHER TAX CONSEQUENCES OTHER
THAN INCOME TAX CONSEQUENCES. THE COMPANY ADVISES EACH PARTICIPANT TO CONSULT
HIS OR HER OWN TAX ADVISOR REGARDING THE TAX CONSEQUENCES OF PARTICIPATION IN
THE 2003 OPTION PLAN AND FOR REFERENCE TO APPLICABLE PROVISIONS OF THE CODE.
The 2003 Option Plan and the right of participants to make purchases
thereunder are intended to qualify under the provisions of Sections 421, 422 and
423 of the Code. Under these provisions, no income will be recognized by a
participant prior to disposition of shares acquired under the 2003 Option Plan.
If the shares are sold or otherwise disposed of (including by way of gift)
more than two years after the first day of the offering period during which
shares were purchased (the "Offering Date"), a participant will recognize as
ordinary income at the time of such disposition the lesser of (a) the excess of
the fair market value of the shares at the time of such disposition over the
purchase price of the shares or (b) 15% of the fair market value of the shares
on the first day of the offering period. Any further gain or loss upon such
disposition will be treated as long-term capital gain or loss. If the shares are
sold for a sale price less than the purchase price, there is no ordinary income
and the participant has a capital loss for the difference.
If the shares are sold or otherwise disposed of (including by way of gift)
before the expiration of the two-year holding period described above, the excess
of the fair market value of the shares on the purchase date over the purchase
price will be treated as ordinary income to the participant. This excess will
constitute ordinary income in the year of sale or other disposition even if no
gain is realized on the sale or a gift of the shares is made. The balance of any
gain or loss will be treated as capital gain or loss and will be treated as
long-term capital gain or loss if the shares have been held more than one year.
34
In the case of a participant who is subject to Section 16(b) of the
Exchange Act, the purchase date for purposes of calculating such participant's
compensation income and beginning of the capital gain holding period may be
deferred for up to six months under certain circumstances. Such individuals
should consult with their personal tax advisors prior to buying or selling
shares under the 2003 Option Plan.
The ordinary income reported under the rules described above, added to the
actual purchase price of the shares, determines the tax basis of the shares for
the purpose of determining capital gain or loss on a sale or exchange of the
shares.
The Company is entitled to a deduction for amounts taxed as ordinary income
to a participant only to the extent that ordinary income must be reported upon
disposition of shares by the participant before the expiration of the two-year
holding period described above.
Restrictions on Resales
Certain officers and directors of the Company may be deemed to be
"affiliates" of the Company as that term is defined under the Securities Act.
The Common Stock acquired under the 2003 Option Plan by an affiliate may be
reoffered or resold only pursuant to an effective registration statement or
pursuant to Rule 144 under the Securities Act or another exemption from the
registration requirements of the Securities Act.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following tables sets forth, as of April 1, 2004, the number of and percent
of the Company's common stock beneficially owned by
o all directors and nominees, naming them,
o our executive officers,
o our directors and executive officers as a group, without naming them, and
o persons or groups known by us to own beneficially 5% or more of our common
stock:
Unless otherwise indicated, the address of each beneficial owner in the table
set forth below is care of A.B. Watley Group Inc., 40 Wall Street, New York, New
York 10005.
The Company believes that all persons named in the table have sole voting and
investment power with respect to all shares of common stock beneficially owned
by them.
A person is deemed to be the beneficial owner of securities that can be acquired
by him within 60 days from April 1, 2004 upon the exercise of options, warrants
or convertible securities. Each beneficial owner's percentage ownership is
determined by assuming that options, warrants or convertible securities that are
held by him, but not those held by any other person, and which are exercisable
within 60 days of April 1, 2004 have been exercised and converted.
NUMBER OF SHARES PERCENTAGE OF SHARES
BENEFICIALLY OWNED BENEFICIALLY
OWNED(8)
NAME AND ADDRESS OF BENEFICIAL OWNER
- ------------------------------------------------ ------------------------ -----------------
Steven Malin 3,027,369(1)(2) 23.0%
Penson Financial Services, Inc. 1,300,000(7) 9.4%
On-Site Trading, Inc. Liquidating Trust 1,700,000 13.3%
Franklin Mutual Advisers, LLC 867,354(3) 6.7%
DMG Legacy International Ltd. 1,394,020(4) 9.8%
DMG Legacy Institutional Fund 1,394,020(4) 9.8%
DMG Legacy Fund 1,394,020(4) 9.8%
SDS Merchant Fund, L.P. 1,481,047(5) 10.4%
Linda Malin 2,187,567(1) 16.0%
Robert Malin 1,789,000(1)(6) 13.2%
Eric Steinberg 1,525,415 11.0%
Gary Mednick 13,750 *
35
All directors and executive officers as a group (3 4,830,119 36.2%
persons)
* Less than 1%.
(1) The number of shares beneficially owned by Steven, Linda and Robert Malin
include shares held in irrevocable family and charitable trusts for which they
are trustees. In addition, the number of shares held by Steven Malin includes
shares held by a family partnership for which Steven Malin is the general
partner.
(2) The number of shares beneficially owned by Steven Malin includes 375,000
shares of common stock issuable upon exercise of options but does not include
425,000 shares of common stock issuable upon exercise of options which are not
currently exercisable.
(3) The number of shares beneficially owned by Franklin Mutual Advisers, LLC
includes 425,445 shares of common stock issuable upon exercise of currently
exercisable warrants.
(4) The number of shares beneficially owned by DMG Legacy International Ltd.,
DMG Legacy Institutional Fund LLC and DMG Legacy Fund LLC (collectively, the
"DMG Group") are aggregated since such entities are affiliates and includes (i)
796,650 shares of common stock issuable upon the conversion of shares of series
A convertible preferred stock owned by the DMG Group and (ii) 597,370 shares of
common stock issuable upon the exercise of currently exercisable warrants.
(5) The number of shares beneficially owned by SDS Merchant Fund, L.P. ("SDS")
includes (i) 1,169,550 shares of common stock issuable upon the conversion of
shares of series A convertible preferred stock owned by SDS and (ii) 311,497
shares of common stock issuable upon the exercise of currently exercisable
warrants. The number of shares beneficially owned by SDS does not include
1,169,550 shares of common stock issuable upon exercise of warrants which are
not currently exercisable. Under the terms of the convertible preferred stock
purchase agreement, SDS is not entitled to convert any portion of the series A
convertible preferred stock or exercise any portion of the warrants or to
dispose of any portion of the series A convertible preferred stock or warrants
to the extent that the right to effect the conversion, exercise or disposition
would result in SDS or any of its affiliates owning more than 4.95% of the
outstanding shares of common stock of our company.
(6) The number of shares beneficially owned by Robert Malin includes 780,000
shares of common stock issuable upon exercise of options but does not include
520,000 shares of common stock issuable upon exercise of options which are not
currently exercisable.
(7) The number of shares beneficially owned by Penson Financial Services, Inc.
includes 1,000,000 shares of common stock issuable upon exercise of currently
exercisable warrants.
(8) Based on 12,787,138 shares of common stock currently outstanding and
10,646,183 exercisable warrants and options.
The address of all of the foregoing parties is c/o our company at 40 Wall
Street, New York, NY 10005 except for On-Site Trading Inc. Liquidating Trust,
Inc. whose address is c/o Robinson Brog, 1345 Avenue of Americas, New York, NY
10105, Franklin Mutual Advisers, LLC whose address in c/o The Bank of New York,
PO Box 11203, New York, NY 10286, SDS Merchant Fund, L.P. whose address is c/o
SDS Capital Partners, One Sound Shore Drive, Greenwich, Connecticut 06830 and
each member of the DMG Group, whose address is c/o DMG Advisors LLC, One Sound
Shore Drive, Greenwich, Connecticut 06830.
Item 13. Certain Relationships and Related Transactions
During fiscal year 2001, the Company borrowed an additional $850,000 from
officers and major stockholders. Total borrowings from officers and stockholders
were: (i) aggregate loans of $1,375,000 from a corporation controlled by Steven
Malin; (ii) aggregate loans of $1,075,000 from a corporation controlled by
Robert Malin; (iii) a $950,000 loan from a corporation controlled by Linda
Malin; and (iv) a $950,000 loan from a corporation controlled by Eric Steinberg.
The notes bear interest ranging from 7% to 10% maturing in one or two years from
the effective date. In fiscal 2001, Steven Malin had subordinated loans to our
company of $125,000 and $55,000. The subordination agreement for the $125,000
loan was renewed and the $55,000 loan continued as a subordinated loan maturing
in October 2002. Our company had notes receivable of $103,000 and $131,059 from
officers. The notes receivable bear interest at 6% and are due on demand.
During the fiscal year 2002, in September 2002, in consideration of the
forgiveness of notes payable to officers aggregating $2,400,000, the Company
issued warrants to purchase 1,479,486 and 923,145 shares of common stock to
officers, exercisable at $0 and $1.80 per share, respectively. The warrants were
exercisable as of September 2002 and expire in September 2007. As of the year
ending September 30, 2002, the Company had notes payable to officers in the
amount of $700,000 that bear interest at the rate of 10%. In April 2002,
$2,150,000 of notes payable to officers were assigned to one of the Company's
clearing brokers. Interest in payable at the rate of 10%. The loans expire on
March 2003. In July 2002, this amount was subsequently forgiven as part of the
sale of the Company's software to the clearing broker.
36
In April 2002, $2,150,000 of notes payable to officers were assigned to
Penson Financial Services, Inc. ("Penson"), which owns approximately 11% of the
Company's outstanding common stock and is a clearing broker for the Company.
Interest was payable on these notes at a rate of 10% per annum and the notes
matured through March 2003. In July 2002, these amounts were subsequently
forgiven as part of the sale of the Company's proprietary software programs (the
"Software") and related intellectual property, to Integrated Trading Solutions,
Inc. ("Integrated"), an affiliate of Penson, pursuant to an Asset Purchase
Agreement dated July 31, 2002 (the "Agreement"). Pursuant to the Agreement, the
Company sold to Integrated, and Integrated purchased and assumed from the
Company all of the Software, certain related intellectual property and contract
rights and certain other assets in exchange for the following consideration:
(i) an immediate reduction of $3,418,015 of debt owed by the Company to Penson;
(ii) a contingent reduction of additional debt owed by the Company to Penson of
up to $2,150,994 on the earlier of: (a) the date that Penson receives no less
than $5,000,000 in revenues under its clearing agreement with the Company
(provided that such revenues are received during the thirty-six months after the
closing date of the Agreement), or (b) in the event that the Company raises at
least $4,000,000 in new equity capital, which may include forgiveness of various
types of debt;
(iii) the assumption of certain additional identified and to be identified
liabilities of the Company by Integrated;
(iv) the granting of a license by Integrated to the Company that allows the
Company to utilize the Software at favorable rates. The license also provides
for the Company to receive a percentage of future royalties from the licensing
of the Software; and
(v) an amendment to the Company's clearing agreement with Penson.
The amount of consideration received by the Company from Integrated was
determined through arms-length negotiations between the parties. In addition,
prior to consummating the transaction, the Company obtained fairness and
valuation opinions from Appleby Capital, Inc., which opinions stated that the
consideration received by the Company was fair from a financial point of view,
and that the fair market value of the assets being sold, immediately prior to
the sale, were not more than $3,400,000.
The Company believes that prior transactions with our officers, directors and
principal stockholders were on terms that were no less favorable than the
Company could have obtained from unaffiliated third parties. All future
transactions, including loans and advances, between us and our officers,
directors and stockholders beneficially owning 5% or more of our outstanding
voting securities, or their affiliates, will be for bona fide business purposes
and on terms not less favorable to us than the Company could have obtained in
arm's length transactions from unaffiliated third parties.
Item 14. Principal Accounting Fees and Services
AUDIT FEES. The aggregate fees billed for professional services rendered by
Marcum & Kliegman LLP for the audit of the Company's group and certain
stand-alone financial statements ("Audit Services") during the year ended
September 30, 2003 were $174,000. The aggregate fees billed by Marcum & Kliegman
LLP for services rendered to the Company, other than the services described
above under "Audit Fees", for the fiscal year ended September 30, 2003 were
$30,000. These fees were principally for review of the Company's Quarterly
Reports on Form 10-Q.
TAX FEES. Marcum & Kliegman LLP did not provide any tax related services for the
year ended September 30, 2003.
FINANCIAL INFORMATION SYSTEMS DESIGN AND IMPLEMENTATION FEES. Marcum & Kliegman
LLP did not render any consulting services for the year ended September 30,
2003.
ALL OTHER FEES. There were no other fees billed or services rendered to the
Company by Marcum & Kliegman LLP.
Item 15. Exhibits and Reports on Form 8-K.
(a) Exhibits.
36
Exhibit
No. Description
--- -----------
3.1 Restated Certificate of Incorporation of the Company and
form of amendment thereto.*
3.2 By-Laws of the Company, as amended.*
4.1 Specimen Common Stock Certificate.*
4.2 Form of Underwriter`s Warrant Agreement, including Form of
Warrant Certificate.*
10.1 1997 Stock Option Plan.*
10.2 Second Amended and Restated 1998 Stock Option Plan.*
10.3 Employment Agreement dated as of May 1, 1997 between the
Company and Steven Malin and Amendment to Employment
Agreement dated as of October 1, 1998 between the Company
and Steven Malin.*
10.4 Employment Agreement dated as of January 1, 1999 between the
Company and Robert Malin.*
10.5 Office lease dated as of June 20, 1997 between 40 Wall
Development Associates, LLC, as Landlord and the Company as
Tenant for premises located at 40 Wall Street, New York, New
York.*
10.6 Fully Disclosed Clearing Agreement dated October 3, 1996 and
Amendment dated June 8, 1998 between Penson Financial
Services, Inc. and A.B. Watley, Inc.*
10.7 Master Lease Agreement dated December 17, 1998 between
General Electric Capital Corporation and the Company.*
10.8 Security Agreement dated December 17, 1998 between General
Electric Capital Corporation and the Company.*
10.9 Letter of Credit Agreement dated December 17, 1998 between
General Electric Capital Corporation and the Company.*
10.10 1999 Stock Option Plan.***
10.11 2000 Stock Option Plan.****
10.12 Agreement, dated November 1, 2001, by and among A.B. Watley
Group Inc. and On-Site Trading, Inc. *****
10.13 Employment Agreement, dated as of November 2, 2001, between
the Company and Gary Mednick. ********
10.14 Series A Convertible Preferred Stock Purchase Agreement
dated November 2001 for the sale of 630 shares of Series
A Redeemable Convertible Preferred Stock********
10.15 Master Subordination, Waiver, Release and
Indemnification Agreement entered on March 27, 2002.
******
10.16 Promissory Note in the amount of $1,600,000 entered between
A.B. Watley Group Inc. and Penson Financial Services, Inc.
dated March 27, 2002. ******
10.17 Promissory Note in the amount of $900,000 entered between
A.B. Watley Group Inc. and DMG legacy Institutional Fund
LLC and DMG Legacy Fund LLC dated March 27, 2002.
******
10.18 First Amendment to Promissory Note entered between
A.B. Watley Group LLC and Penson Financial Services Inc.
dated April 2002. ******
10.19 Second Amendment to Promissory Note entered between A.B.
Watley Group LLC and Penson Financial Services Inc.
dated May 2002. ******
10.20 Non-Exclusive Perpetual License of proprietary software
between E*Trade and the Company dated April 2002.
******
10.21 Asset Purchase Agreement entered into with Integrated
Trading Solutions, Inc. dated July 2002. ********
37
10.22 License Agreement entered into Integrated Trading Solutions,
Inc dated July 2002. ********
10.23 Senior Subordinated Demand Note entered into with SDS
Merchant Fund, L.P. whereby the Company borrowed
$2,500,000 dated August 30, 2001. ********
10.24 Equity line entered into with investment group dated
September 6, 2000 in the amount of $3,000,000.
*******
10.25 Employment Agreement entered with Steven Malin dated
September 2002. ********
10.26 Employment Agreement entered with Robert Malin dated
September 2002. ********
10.27 Amendment to the Fully Disclosed Clearing Agreement between
Penson Financial Services, Inc. and A.B. Watley, Inc.
********
10.28 Amended and Restated Promissory Note between A.B. Watley
Group, Inc. and Penson Financial Services, Inc. dated
July 2002. ********
10.29 First Amendment to Master Agreement and First Amendment to
Software Security Agreement dated as of April 2002******
10.30 Second Amendment to the Master Subordination, Waiver,
Release and Indemnification Agreement, dated as of
May 2002. ******
10.31 Third Amendment to the Master Subordination, Waiver,
Release and Indemnification Agreement, dated as of
May 2002. ******
14.1 Code of Ethics of A.B. Watley Group Inc.
31.1 Certification by Steven Malin, Principal Executive Officer,
pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
31.2 Certification by Robert Malin, Principal Financial Officer,
pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.1 Certification by Steven Malin, Principal Executive Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.2 Certification by Robert Malin, Principal Financial Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
* Filed as an exhibit to the Company`s Registration Statement
on Form SB-2 (File No. 333-71783) and hereby incorporated by
reference herein.
** Filed as an exhibit to the Company`s Annual Report on Form
10-KSB for the year ended September 30, 1999 and hereby
incorporated by reference herein.
*** Filed as an exhibit to the Company`s Registration Statement
on Form S-8 (File No. 333-35340) and hereby incorporated by
reference herein.
**** Filed as an exhibit to the Company`s Registration Statement
on Form S-8 (File No. 333- 67014) and hereby incorporated by
reference herein.
***** Filed as an exhibit to the Company`s Current Report on Form
8-K filed on November 16, 2001.
****** Filed as an exhibit to the Company`s Quarterly Report on
Form 10-Q for the quarter ending March 31, 2002.
******* Filed as an exhibit to the Company`s Quarterly Report on
Form 10-Q for the quarter ending June 30, 2002.
******** Filed as an exhibit to the Company`s Annual Report on
Form 10-K for the year ending September 30, 2002.
(b) Reports on Form 8-K:
38
On September 24, 2003, the Company filed a Form 8-K Current Report reporting
under Item 4 that effective as of September 19, 2003, the Company terminated the
employment of John J. Amore, the former Chief Executive Officer of the Company.
39
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has caused this Report to be signed on its behalf by the undersigned
thereunto duly authorized.
Signatures Title
Date
/s/ Steven Malin Chairman of the Board and Principal Executive Officer
--------------
Steven Malin
May 19, 2004
/s/ Robert Malin Vice-Chairman,Principal Financial Officer and
------------ Director
Robert Malin
May 19, 2004
40
A.B. Watley Group Inc.
Consolidated Financial Statements
Years Ended September 30, 2003, 2002 and 2001
Contents
Independent Auditors' Report F-2
Independent Auditors' Report F-3
Consolidated Statements of Financial Condition as of September 30, 2003 and 2002 F-4
Consolidated Statements of Operations for the Years Ended September 30, 2003, 2002 and 2001 F-5
Consolidated Statements of Changes in Stockholders` Equity (Deficit) for the Years Ended F-6
September 30, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the Years Ended September 30, 2003, 2002 and 2001 F-7
Notes to Consolidated Financial Statements F-9
Independent Auditors` Report
----------------------------
The Board of Directors and Stockholders of A.B. Watley Group Inc.
We have audited the accompanying consolidated balance sheet of A.B. Watley Group
Inc. as of September 30, 2003 and September 30, 2002, and the related
consolidated statements of operations, changes in stockholders` deficit, and
cash flows for the years ended September 30, 2003 and September 30, 2002. These
consolidated financial statements are the responsibility of the Company`s
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of A.B. Watley Group Inc. as of
September 30, 2003 and September 30, 2002, and the results of its operations and
its cash flows for the year ended September 30, 2003 and September 30, 2002, in
conformity with accounting principles generally accepted in the United States of
America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has suffered recurring losses
from operations, has a net capital deficiency and has negative cash flows from
operations that raise substantial doubt about its ability to continue as a going
concern. Management`s plans in regard to these matters are also described in
Note 2. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
/s/ Marcum & Kliegman LLP
New York, New York
May 3, 2004
F-2
Independent Auditors` Report
- ----------------------------
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
A.B. Watley Group Inc.
We have audited the consolidated statements of operations, changes in
stockholders` equity and cash flows for the year ended September 30, 2001. These
consolidated financial statements are the responsibility of the Company`s
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of its operations and its cash
flows for the year ended September 30, 2001 in conformity with accounting
principles generally accepted in the United States.
/s/ Ernst & Young LLP
--------------------
Ernst & Young
New York, New York
January 11, 2002
F-3
A.B. Watley Group Inc.
Consolidated Statements of Financial Condition
September 30, September 30,
2003 2002
------------ ------------
Assets:
Cash and cash equivalents $ 41,296 $213,766
Restricted cash -- 292,565
Receivables from clearing brokers 223,556 1,028,588
Securities owned at market value 1,309,145 2,145,472
Equipment and leasehold improvements, net of accumulated depreciation
of $6,574,033 and $5,317,434 1,698,062 2,889,711
Loans receivable from related party 272,727 258,226
Secured demand note 3,202,000 --
Security deposits 175,000 132,001
Other assets 19,894 76,291
------------ ------------
Total Assets $ 6,941,680 $ 7,036,620
============ ============
Liabilities and Stockholders` Deficit:
Accounts payable and accrued liabilities 9,769,760 9,933,336
Accrued liabilities to LLC Class B Members 2,000,253 2,492,310
Payable to clearing broker 1,597,767 --
Securities sold not yet purchased 28,010 --
Notes payable to former officer 700,000 700,000
Notes payable - other 3,082,826 3,282,826
Subordinated borrowings 4,863,138 --
Subordinated borrowings - other 350,000 350,000
Subordinated borrowings from officer 180,000 180,000
------------ ----------
22,571,754 16,938,472
------------ ----------
Series A Redeemable Convertible Preferred Stock $0.01 par value, 690 shares authorized
and 630 and 630 issued and outstanding at September 30, 2003 and 2002, respectively and
accrued dividends (liquidation preference - $6,300,000) 6,867,001 6,926,487
------------ ----------
Stockholders` Deficit:
Preferred Stock $0.001 par value, 1,000,000 shares authorized and none issued and
outstanding at September 30, 2003 and September 30, 2002 -- --
Common Stock, $0.001 par value, 20,000,000 shares authorized at September 30, 2003
and September 30, 2002, respectively, 12,787,138 and 12,508,852 issued
and outstanding at September 30, 2003 and September 30, 2002 12,787 12,509
Additional paid-in capital 47,111,608 45,819,569
Option costs (13,996) (32,663)
Accumulated deficit (69,607,474) (62,627,754)
------------ ------------
Total Stockholders` Deficit (22,497,075) (16,828,339)
------------ ------------
Total Liabilities and Stockholders` Deficit $ 6,941,680 $ 7,036,620
============ ============
See notes to consolidated financial statements.
F-4
A.B. Watley Group Inc.
Consolidated Statements of Operations
Years Ended
--------------------------------------------------
September 30, September 30, September 30,
2003 2002 2001
------------ ------------ ------------
Revenues:
Commissions $ 5,690,227 $15,900,261 $18,887,752
Data service fees 101,821 462,469 1,297,117
Principal transactions 7,848,918 2,533,998 3,196,844
Sale of software income -- 3,908,308 --
Interest and other income 1,607,916 3,378,252 2,084,009
Interest income - related parties -- -- 6,180
------------ ------------ ------------
Total revenues 15,248,882 26,183,288 25,471,902
Interest expense 834,184 2,678,712 852,967
Interest expense - related parties -- 392,841 398,117
------------ ------------ ------------
Net revenues 14,414,698 23,111,735 24,220,818
Expenses and other charges:
Commissions, floor brokerage, and clearing charges 5,793,530 12,048,982 10,572,220
Employee compensation and related costs 8,570,003 10,674,346 12,686,615
Communications 1,168,418 2,882,953 2,210,056
Business development 291,868 485,993 2,345,696
Professional services 829,139 3,679,184 3,698,724
Occupancy and equipment costs 2,063,645 5,845,238 6,309,997
Depreciation and amortization 1,256,599 5,894,333 5,499,922
Other expenses 1,423,948 1,681,751 1,189,451
Loss on impairment of intangibles -- 7,870,110 --
Loss on investments 84,287 -- 703,614
Abandonment of leasehold improvements -- 1,741,315 --
Minority interest applicable to LLC Class B members (87,019) (899,869) --
------------ ------------ ------------
Total expenses 21,394,418 51,904,336 45,216,295
------------ ------------ ------------
Loss before income taxes and extraordinary item (6,979,720) (28,792,601) (20,995,477)
Income tax provision -- 8,725 28,697
------------ ------------ ------------
Loss before extraordinary item (6,979,720) (28,801,326) (21,024,174)
Extraordinary loss on extinguishment of debt -- (250,000) --
------------ ------------ ------------
Net loss $ (6,979,720) $(29,051,326) $(21,024,174)
============ ============ ============
Basic and diluted loss per common share:
Loss before extraordinary item $(6,979,720) $ (28,801,326) $ (21,024,174)
Deemed dividend to preferred shareholders - beneficial conversion -- (1,639,797) --
Deemed dividend to preferred shareholders - accretion of redemption -- (1,959,617) --
Preferred stock dividends (252,000) (315,000) --
------------ ------------- ------------
Loss before extraordinary item attributable to common shareholders (7,231,720) (32,715,740) (21,024,174)
Extraordinary loss on extinguishment of debt -- (250,000)
------------ ------------- ------------
Net loss attributable to common shareholders $ (7,231,720) $ (32,965,740) $ (21,024,174)
============ ============= ============
Loss before extraordinary item $ (0.57) $ (2.62) $ (2.13)
Extraordinary item $ - $ (0.02) $ -
Basic and diluted loss per share $ (0.57) $ (2.64) $ (2.13)
Weighted average shares outstanding 12,578,995 12,508,852 9,888,597
See notes to consolidated financial statements.
F-5
A.B. Watley Group Inc.
Statement of Changes in Stockholders` Equity (Deficit)
Common Stock Issued
-------------------
Shares Par Value Additional Unamortized Deferred Accumulated Total
Paid-in Option Costs Compensation Deficit
Capital
------------ ------------ ------------ ------------ ------------ ------------ -------------
Balance at September 30, 2000 8,798,090 $8,798 $24,814,573 ($93,331) -- ($12,552,254) $12,177,786
Issuance of common stock 2,197,706 2,198 10,997,219 -- -- -- 10,999,417
Deferred stock based
compensation -- -- 555,182 -- (555,182) -- --
Amortization deferred
compensation -- -- -- -- 95,619 -- 95,619
Warrants issued to -- -- 369,083 -- -- -- 369,083
non-employees
Option cost - net -- -- 488,927 ($174,467) -- -- 314,460
Net loss -- -- -- -- -- (21,024,174) (21,024,174)
------------ ------------ ------------ ------------ ------------ ------------ -------------
Balance at September 30, 2001 10,995,796 $10,996 $37,224,984 ($267,798) (459,563) ($33,576,428) $2,932,191
------------ ------------ ------------ ------------ ------------ ------------ -------------
Issuance of common stock
-On-Site 1,513,056 1,513 5,158,011 -- -- -- 5,159,524
Amortization deferred -- -- -- -- 459,563 -- 459,563
compensation
Deemed dividend preferred -- -- 1,959,617 -- -- -- 1,959,617
stock - redemption feature
Accretion of deemed dividend
preferred stock -- -- (1,959,617) -- -- -- (1,959,617)
Forgiveness of receivables to
related parties -- -- (39,000) -- -- -- (39,000)
Forgiveness of notes payable
to officers and related
parties -- -- 2,400,000 -- -- -- 2,400,000
Dividends accrued on preferred
stock -- -- (315,000) -- -- -- (315,000)
Warrants issued to consultants -- -- 184,894 -- -- -- 184,894
Warrants issued to preferred
stockholder in connection
with credit line provided -- -- 1,045,367 -- -- -- 1,045,367
Amortization of bridge loan
warrants -- -- 349,447 202,467 -- -- 551,914
Option cost-net -- -- -- 32,668 -- -- 32,668
Issuance costs related to
preferred stock -- -- (189,134) -- -- -- (189,134)
Net loss -- -- -- -- -- (29,051,326) (29,051,326)
------------ ------------ ------------ ------------ ------------ ------------ -------------
Balance at September 30, 2002 12,508,852 $12,509 $45,819,569 ($32,663) $ -- ($62,627,754) ($16,828,339)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Dividends accrued on preferred
Stock -- -- (252,000) -- -- -- (252,000)
Stock issued in On-Site
settlement 278,286 278 199,722 200,000
Amortization of warrants issued
in connection with subordinated
borrowings 273,724 273,724
Preferred stock penalties waived 1,070,593 1,070,593
Option cost - net 18,667 18,667
Net loss (6,979,720) (6,979,720)
------------ ------------ ------------ ------------ ------------ ------------ -------------
Balance at September 30, 2003 12,787,138 $12,787 $47,111,608 ($13,996) $ -- ($69,607,474) ($22,497,075)
============ ============ ============ ============ ============ ============ =============
See notes to consolidated financial statements.
F-6
A.B. Watley Group Inc.
Consolidated Statements of Cash Flows
Years Ended
------------------------------------------------
September 30, September 30, September 30,
2003 2002 2001
------------ ------------ ------------
Cash flows used in operating activities:
Net loss $(6,979,720) $(29,051,326) $(21,024,174)
Adjustments to reconcile net loss to net
cash used in
Operating activities:
Non-cash compensation and service
costs -- 459,563 779,162
Options costs 18,667 235,135 --
Penalties-preferred stock 759,107 311,487 --
Debt discount
in connection with issuance
of warrants 136,862 1,390,569 --
Settlement of liabilities
to LLC Class B members (87,019) (899,869) --
Loss on investments -- -- 703,614
Depreciation and amortization 1,256,599 5,894,333 5,499,922
Loss on impairment of intangibles -- 7,870,110 --
Loss on extinguishment of debt -- 250,000 --
Loss on disposal of leasehold
improvements -- 1,741,315 --
Changes in assets and liabilities:
(Increase) decrease in operating
assets:
Restricted cash 292,565 207,769 31,098
Receivables from clearing
brokers 805,032 1,178,045 (1,174,624)
Securities owned 836,327 2,748,940 47,727
Loans receivable from
related party (14,501) (1,029) (129,126)
Security deposits (42,999) 1,312,479 27,427
Other assets 56,397 833,598 (324,319)
Increase (decrease) in operating
liabilities:
Accounts payable and
accrued liabilities (163,576) 971,253 (446,685)
Securities sold not yet
purchased 28,010 (3,731,128) 191,552
Payable to clearing broker 1,597,767
------------ ------------ ------------
Net cash used in operating activities (1,500,482) (8,278,756) (15,818,426)
------------ ------------ ------------
Cash flows provided by (used in)
investing activities:
Purchases of property and equipment (64,950) (261,930) (1,759,660)
Proceeds of sale of
software license -- 4,400,314 --
------------- ------------- -------------
Net cash provided by (used in) investing
activities (64,950) 4,138,384 (1,759,660)
------------- ------------ -------------
Cash flows from financing activities:
Proceeds from sale of common stock -- -- 10,012,127
Proceeds from sale of preferred stock -- 3,324,291 --
Proceeds from exercised stock options -- -- 987,290
Proceeds from exercised stock warrants -- -- --
Proceeds from notes payable 250,000 187,884 2,500,000
Payments of notes payable (450,000) -- (790,938)
Proceeds from secured demand note recievable 1,798,000 -- --
Proceeds from notes payable to officer -- 900,000 850,000
Payment of capital lease obligations -- -- (559,090)
Proceeds from obligations under capita
leases -- -- --
Capital distribution to LLC Class B members (205,038) (1,012,397) --
Capital contribution by LLC Class B members -- 446,307 --
Repayment of bank loan -- -- (3,333)
------------ ------------ ------------
Net cash provided by financing activities 1,392,962 3,846,085 12,996,056
------------ ------------ ------------
Net decrease in cash and cash equivalents (172,470) (294,287) (4,582,030)
Cash and cash equivalents at beginning of
period 213,766 508,053 5,090,083
------------ ------------ ------------
Cash and cash equivalents at end of period $41,296 $213,766 $508,053
============ ============ ============
See notes to consolidated financial statements.
F-7
A.B. Watley Group Inc.
Consolidated Statements of Cash Flows
(continued)
Years Ended
----------------------------------------
September 30, September 30, September 30,
2003 2002 2001
------------ ------------ --------
Supplemental non-cash financing activities
and disclosure of cash flow information:
Forgiveness of penalties on
Preferred stock $ 1,070,593 $ -- $ --
============ ============ ========
Exchange of property and equipment in payment of
operating expenses $ -- $ -- $198,348
============ ============ ========
Issuance of notes payable in payment of operating
expenses $ -- $ 225,714 $ --
============ ============ ========
Discharge of note payable in exchange for software $ -- $ 2,150,000 $ --
============ ============ ========
Preferred stock dividends $ 252,000 $ 315,000 $ --
============ ============ ========
Exchange of subordinated debt for preferred stock $ -- $ 2,500,000 $ --
============ ============ ========
Deemed dividend to preferred shareholders -beneficial
conversion $ -- $ 1,639,797 $ --
============ ============ ========
Deemed dividend to preferred shareholders -accretion of
redemption feature $ -- $ 1,959,617 $ --
============ ============ ========
Net assets of On-Site acquired by the issuance of
common stock $ -- $ 5,703,000 $ --
============ ============ ========
Issuance of warrants in forgiveness of debt $ -- $ 2,400,000 $ --
============ ============ ========
Discharge of debt in exchange for software $ -- $ 1,268,015 $ --
============ ============ ========
Issuance of secured demand note $ 5,000,000 $ -- $ --
============ ============ ========
Issuance of subordinated borrowing $ 5,000,000 $ -- $ --
============ ============ ========
Debt discount related to the issuance of warrants
in connection with subordinated borrowing $ 273,724 $ -- $ --
============ ============ ========
Settlements of LLC Class B Member Liabilities $ 87,019 $ -- $ --
============ ============ ========
Issuance of stock in payment of liability to On-Site $ 200,000 $ -- $ --
============ ============ ========
Cash paid for:
Interest $ 303,385 $ 366,841 $539,627
============ ============ ========
Taxes $ -- $ -- $ 15,456
============ ============ ========
See notes to consolidated financial statements.
F-8
A.B. Watley Group Inc.
Notes to Consolidated Financial Statements
1. Organization and Business
A.B. Watley Group Inc. ("ABWG" or the "Company") is a U.S. public
corporation. The Company conducts business primarily through its principal
subsidiaries, A.B. Watley, Inc. ("A.B. Watley"), A.B. Watley Direct, Inc.
("Direct", formerly Integrated Clearing Solutions, Inc. ("Integrated")) A.B.
Watley Futures Corp. ("ABW Futures") and ABW TRADING, LLC ("LLC") operating as
one integrated business segment. LLC ceased operations on June 18, 2002. ABWG is
a Delaware corporation organized on May 15, 1996.
A.B. Watley and Direct are registered broker-dealers with the Securities
and Exchange Commissions ("SEC"), and are members of the National Association of
Securities Dealers, Inc. ("NASD"). A.B. Watley and Direct are introducing
broker-dealers, conducting business in electronic trading, information and
brokerage services, as well, as institutional block trading. A.B. Watley and
Direct clear all transactions through clearing brokers on a fully disclosed
basis. Accordingly, A.B. Watley and Direct are exempt from Rule 15c3-3 of the
Securities and Exchange Act of 1934.
ABW Futures is an introducing broker/dealer registered with the National
Futures Association and conducts futures trading activity for customers. ABW
Futures clears all of its business through two clearing brokers.
LLC was a registered broker-dealer and a member of the Philadelphia Stock
Exchange and was acquired by the Company in November 2001. ABWG is the Class A
managing member of LLC. LLC was formed as a means for registered professionals
to engage in proprietary trading utilizing the LLC`s funds. As the managing
member, ABWG managed the operations of LLC and received trading fees from the
Class B members, who are the registered professionals. LLC cleared all
transactions through a clearing broker. Accordingly, LLC was also exempt from
Rule 15c3-3 of the Securities Exchange Act of 1934. On May 9, 2002, the Company
notified the LLC Class B members that it had elected to cease the proprietary
trading business operations.
On April 3, 2002, the Company received a determination letter from the
NASD Listing Qualifications Panel that the Company`s request for continued
listing on the NASD National Market was denied. In accordance with such denial,
the Company`s Common Stock was delisted from the NASDAQ Stock Market effective
with the open of business, April 4, 2002 (the "Delisting Date").
In January 2004, A.B. Watley, as a result of net capital deficiencies,
ceased operations. In February 2004, A.B. Watley withdrew its registration as a
broker/dealer.
2. Liquidity and Capital Resources
The Company has continued to incur consolidated net losses and negative
cash flows from operations. Additionally, the Company has significant deficits
in both working capital and stockholders` equity. These factors raise
substantial doubt about the Company`s ability to continue as a going concern.
The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.
Trading volume has significantly decreased and the Company has lost
customers in its direct access business. To respond to its liquidity and capital
resource needs management has implemented various cost cutting initiatives
including renegotiating its clearing agreements at more favorable rates,
restructuring its software license with E*Trade Group, Inc. and the sale of its
software programs known as Ultimate Trader II, Ultimate Trader III, Watley
Trader and related intellectual property. The Company is also looking into more
traditional lines of business such as fixed income and equity capital markets,
as well as the feasibility of expanding its existing business to attract active
traders and hedge funds. As a further fund raising alternative, the management
of ABWG may seek to raise additional capital from time to time to fund
operations through private placements of equity or debt instruments. There can
be no assurance that any of these alternatives will be successful.
F-9
3. Basis of Presentation
The consolidated financial statements include the accounts of ABWG and its
wholly -owned subsidiaries. All significant inter-company balances and
transactions have been eliminated. Certain prior year amounts reflect
reclassifications to conform to the current year`s presentations.
Cash and Cash Equivalents:
--------------------------
Cash and cash equivalents include highly liquid instruments with original
maturities of less than three months held by one global financial institution.
Restricted Cash:
----------------
Restricted cash consists of cash on deposit at financial institutions
securing letters of credit and lines of credit.
Securities Transactions, Revenues, and Related Expenses:
--------------------------------------------------------
Securities transactions and related revenues and expenses, including
commissions, revenues and expenses, are recorded on a trade date basis. Data
service revenues are recorded as the services are provided.
Securities owned and Securities Sold, Not Yet Purchased:
--------------------------------------------------------
Securities owned and securities sold, not yet purchased are stated at
market or fair values, with resulting unrealized gains and losses reflected in
the statement of operations. Market value is generally based on listed market
prices. If listed market prices are unattainable, fair values are determined
based on other relevant factors including broker or dealer price quotes.
Equipment and Leasehold Improvements
------------------------------------
Computer equipment, software, and furniture and fixtures are carried at
cost and depreciated or amortized on a straight-line basis over their estimated
useful lives, generally three to five years. Leasehold improvements are carried
at cost and are amortized on a straight-line basis over the lesser of the life
of the improvement or the term of the lease.
Accounts Payable and Accrued Liabilities
----------------------------------------
Accounts payable and accrued liabilities is comprised of the following:
September 30, September 30,
2003 2002
---------- ----------
Commissions, floor brokerage and clearing costs $1,288,154 $ 631,159
Employee compensation and related costs 870,438 481,036
Communications 713,203 479,653
Business development 513,692 269,659
Professional fees 1,823,458 3,382,561
Occupancy, equipment and leases 3,186,054 3,367,319
Accrued interest 626,950 773,784
Other 747,811 548,165
---------- ----------
$9,769,760 $9,933,336
========== ==========
Use of Estimates:
-----------------
The preparation of the consolidated financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
F-10
Equity-Based Compensation
--------------
As permitted by FASB Statement No. 123, Accounting for Stock Based
Compensation ("FAS 123"), which establishes a fair value based method of
accounting for equity-based compensation plans, the Company has elected to
follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees ("APB 25") for recognizing equity-based compensation expense for
financial statement purposes. Under APB 25, no compensation expense is
recognized at the time of option grant if the exercise price of the employee
stock option is fixed and equals or exceeds the fair market value of the
underlying common stock on the day of grant and the number of shares to be
issued pursuant to the exercise of such options are known and fixed at the grant
date.
In December 2002, the FASB issued Statement No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure ("FAS 148"). This standard
amends the disclosure requirements of FAS 123 for fiscal years ending after
December 15, 2002 to require prominent disclosure in both annual and interim
financial statements about the method used and the impact on reported results.
The Company follows the disclosure-only provisions of FAS 123 which requires
disclosure of the pro forma effects on net income (loss) as if the fair value
method of accounting prescribed by FAS 123 had been adopted, as well as certain
other information.
The following table summarizes relevant information as to reported results
under the Company's intrinsic value method of accounting for stock awards, with
supplemental information as if the fair value recognition provisions of FAS 123
had been applied for the following years ended September 30, 2003 and 2002 as
follows:
YEAR ENDED SEPTEMBER 30,
-------------------------------
2003 2002
------------ ------------
Net loss $(6,979,720) $(29,051,326)
Stock-based employee
compensation cost, net
of tax effect, under
fair value accounting 313,811 647,150
----------- ------------
Pro forma net loss under
Fair Value Method $(7,293,531) $(29,698,476)
----------- ------------
Loss per share
basic and diluted $ (0.55) $ (2.64)
Per share stock-based
employee compensation
cost, net of tax effect,
under fair value
accounting 0.02 0.05
------------ ------------
Pro forma loss per
share - basic and diluted $ (0.57) $ (2.69)
------------- ------------
Loss Per Share
--------------
Basic loss per share was computed using the weighted average number of
outstanding common shares. Diluted per share amounts when applicable include the
effect of dilutive common stock equivalents from the assumed exercise of
options, warrants and the convertible preferred stock. Dilutive per share
amounts are computed excluding common stock equivalents since their inclusion
would be anti-dilutive. Total shares issuable upon the exercise of warrants and
the conversion of preferred stock for the years ended September 30, 2003 and
2002 were 13,494,505 and 13,580,766, respectively.
Fair Value of Financial Instruments:
------------------------------------
Substantially all of the Company`s financial instruments are carried at
fair value or at amounts approximating fair value.
Business Development:
---------------------
The Company expenses all promotional costs as incurred. Advertising
production costs are expensed when the initial advertisement is run. Costs of
advertising are expensed as the services are received. Substantially all
business development costs relate to advertising. Advertising expense for the
years ended September 30, 2003, 2002 and 2001 were $101,760, $74,755 and
$1,443,615, respectively.
F-11
Income Taxes:
-------------
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
F-12
Internally Developed Software:
------------------------------
The Company accounts for internally developed software in accordance with
the Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or obtained for Internal Use." Proceeds received from the license or
sale of the computer software, net of direct incremental costs of marketing,
such as commissions, software reproduction costs, warranty and service
obligations, and installation costs, will be applied against the carrying amount
of that software. No profit will be recognized until aggregate net proceeds and
amortization have reduced the carrying amount of the software to zero.
Subsequent proceeds will be recognized in revenue as earned.
Accounting Developments:
------------------------
In January 2003, as revised in December 2003, the FASB issued
Interpretation No. 46 ("FIN46"), "Consolidation of Variable Interest Entities,
an Interpretation of ARB No. 51." FIN 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if the
equity investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 is effective for all new variable interest entities
created or acquired after January 31, 2003. For variable entities created or
acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for
the first interim or annual period beginning after March 15, 2004. Management
does not believe that the adoption of this pronouncement will have a material
effect on the Company's financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." This Statement amends and
clarifies SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities." This statement clarifies the accounting guidance on (1) derivative
instruments (including certain derivative instruments embedded in other
contracts) and (2) hedging activities that fall within the scope of the SFAS
133. SFAS 149 also amends certain other existing pronouncements, which will
result in more consistent reporting of contracts that are derivatives in their
entirety or that contain embedded derivatives that warrant separate accounting.
SFAS 149 is effective (1) for contracts entered into or modified after September
30, 2003, with certain exceptions, and (2) for hedging relationships designated
after September 30, 2003. The guidance is to be applied prospectively.
Management does not believe that the adoption of any of this pronouncement will
have a material effect on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 addresses certain financial instruments that, under previous guidance,
could be accounted for as equity, but now must be classified as liabilities in
statements of financial position. These financial instruments include: 1)
mandatorily redeemable financial instruments, 2) obligations to repurchase the
issuer's equity shares by transferring assets, and 3) obligations to issue a
variable number of shares. SFAS No. 150 is effective for all financial
instruments entered into or modified after May 31, 2003, and otherwise effective
at the beginning of the first interim period beginning after June 15, 2003. The
Company adopted the above pronouncement during the current year and there was no
material effect on the Company's consolidated financial statements.
4. Net Capital Requirement
A.B. Watley and Direct are subject to the SEC`s Uniform Net Capital Rule
("Rule 15c3-1"). In accordance with this rule, A.B. Watley is required to
maintain defined minimum net capital to the greater of $100,000 or 6-2/3% of
aggregate indebtedness as defined. Direct is required to maintain minimum net
capital of $5,000 or 6-2/3% of aggregate indebtedness as defined.
F-13
As of September 30, 2003, A.B. Watley had net capital of $568,592 which
was $320,211 in excess of its minimum requirement at September 30, 2003. Direct
had $18,140 of net capital which was approximately $13,140 in excess of its
minimum requirement at September 30, 2003.
As of September 30, 2003, ABW Futures had a net capital deficit of
$12,988. This deficiency was cured in December 2003.
5. Financial Instruments with Off Balance Sheet Risk and Concentrations of
Credit Risk
Pursuant to clearance agreements, the clearing and depository operations
for the Company and its customers' securities transactions are provided by two
clearing broker-dealers. The Company earns commissions as an introducing broker
for the transactions of its customers. In the normal course of business, the
Company's customer activities involve the execution and settlement of various
customer securities transactions. These activities may expose the Company to
off-balance-sheet risk in the event the customer or other broker is unable to
fulfill its contracted obligations and the Company has to purchase or sell the
security underlying the contract at a loss.
The Company's customer securities are transacted on either a cash or
margin basis. In margin transactions, the clearing broker extends the credit to
the Company's customers, subject to various regulatory margin requirements,
collateralized by cash and securities in the customers' accounts. However, the
Company is required to contact the customer and to either obtain additional
collateral or to sell the customer's position if such collateral is not
forthcoming. The Company is responsible for any losses on such margin loans, and
has agreed to indemnify its clearing brokers for losses that the clearing
brokers may sustain from the customer accounts introduced by the Company.
The Company seeks to control the risks associated with these activities by
reviewing the credit standing of each customer and counterparty with which it
does business. Further, working with the clearing brokers, it requires customers
to maintain margin collateral in compliance with various regulatory and internal
company policy guidelines. The clearing brokers monitor required margin levels
daily and, pursuant to such guidelines, request customers to deposit additional
collateral or reduce securities positions when necessary. The Company's exposure
to these risks becomes magnified in volatile markets. As of September 30, 2003,
the Company has provided a reserve for uncollectible receivables from clearing
brokers in the amount of $909,051. Total bad debt expense incurred by the
Company which is included in commissions, floor brokerage, and clearing charges
in the Consolidated Statement of Operations amounted to approximately $343,000
during the year ended September 30, 2003.
The Company may at times maintain positions in equity securities on both a
long and short basis. While long positions represent the Company's ownership of
securities, short positions represent obligations of the Company. Accordingly,
both long and short positions may result in gains or losses to the Company as
market values of securities fluctuate. To manage the risk of losses, the Company
marks long and short positions to market daily and continuously monitors the
market fluctuations.
Securities sold, but not yet purchased represent obligations of the
Company to deliver the specified security at a contracted price and thereby
create a liability to repurchase the security in the market at prevailing
prices. Accordingly, these transactions result in off balance sheet risk, as the
Company's ultimate obligation to satisfy the sale of securities sold, but not
yet purchased may exceed the amount recognized in the Consolidated Statements of
Financial Condition.
F-14
6. Equipment and Leasehold Improvements
September 30, September 30,
2003 2002
------------ ------------
Computer equipment $ 751,836 $ 751,836
Software 4,793,939 4,793,939
Furniture, fixtures and leasehold improvements 2,726,320 2,661,370
------------ ------------
8,272,095 8,207,145
Less: Accumulated depreciation and amortization (6,574,033) (5,317,434)
------------ ------------
Equipment and leasehold improvements, at $ 1,698,062 $ 2,889,711
cost, net ============ ============
Upon the Company relocating its corporate offices in 2004, the Company
expects to record a charge for abandonment of equipment and leasehold
improvements in the amount of approximately $1,000,000.
Depreciation and amortization expense for the years ended September 30,
2003, 2002, 2001 was $1,256,599, $5,894,333 and $5,499,922, respectively.
At September 30, 2003 and 2002 substantially all software represents
software developed for internal use. For the years ended September 30, 2003 and
2002, the Company amortized $4,793,939 and $3,938,365 of capitalized software
developed for internal use. During 2001, the Company began marketing its
internally developed software to third parties. During 2002, the Company`s
proprietary trading software was sold.
7. Sale of Software
In April 2002, the Company granted to E*TRADE a non-exclusive perpetual
license of the Company`s proprietary software for a one-time flat fee of
$5,000,000, payable in cash ($2.6 million) and E*TRADE stock ($2.4 million, or
474,500 shares). All of the E*trade stock has been sold with the proceeds used
for working capital purposes. Of the total proceeds, $3,809,000 has been
recorded in the Consolidated Statement of Financial Condition, as a reduction of
property and equipment in accordance with Statement of Position 98-1, Accounting
for Costs of Computer Software Developed or Obtained for Internal Use. For the
year ended September 30, 2002 the remaining balance of proceeds of $1,191,000
has been recorded in the Consolidated Statement of Operations as Sale of
Software Income.
In July 2002, the Company sold its software programs known as Ultimate
Trader II, Ultimate Trader III, Watley Trader and related intellectual property,
to an affiliate of one of its clearing brokers. The sale included all
proprietary software that displays market quotation, news, and other information
analysis; order entry including the initiation and transmission of trading
orders and position management and any applications that provide real time and
historical market prices. In consideration for the trading technology software,
the Company`s clearing broker agreed to forgive $2,716,720 (including interest
of $566,720) of indebtedness owed by the Company to the clearing broker. As part
of the agreement, the Company obtained a perpetual nonexclusive, license to
continue to use the software, including the right to sublicense the software.
Under the terms of the agreement, the Company was granted the right to use the
software royalty free until July 31, 2005, and for a nominal per user per month
fee thereafter, as defined. The Company also received a more favorable clearing
agreement, which will remain in effect until July 31, 2007. The asset purchase
agreement also provides for a future reduction of indebtedness of approximately
$2,100,000 from its clearing broker provided that over a 36-month period
beginning after July 31, 2002, that the Company has paid its clearing broker
$5,000,000 in clearing fees or raised at least $4,000,000 in new equity capital.
In order for the new capital to be considered towards the reduction in
indebtedness, the agreement requires that there be no cash payments or mandatory
redemptions affecting the principal amount prior to 18-months after July 31,
2002. All of the proceeds from the sale of software have been recorded in the
Consolidated Statement of Operations as Sale of Software Income for the year
ended September 30, 2002.
8. Acquisition of On-Site Trading, Inc.
In an effort to increase its customer base and to achieve greater
economies of scale, the Company entered into an Asset Purchase Agreement (the
"Asset Purchase Agreement") with On-Site Trading, Inc. ("On-Site"). On October
F-15
1, 2001, the Company acquired the customer lists and certain other On-Site
assets and liabilities (the retail business), including its 100% voting interest
in On-Site Trading LLC, a broker-dealer subsidiary (the proprietary trading
business) which was subsequently renamed ABW TRADING, LLC. Since the
acquisition, the retail business and proprietary trading business have operated
as one reporting unit. The acquisition was accounted for under the purchase
method of accounting. Pursuant to the terms of the Asset Purchase Agreement, the
Company issued 1,875,000 shares (which was later reduced by 361,944) of its
Common Stock to On-Site. Of these shares, 937,500 shares were delivered at
closing and 106,806 shares ("Escrow Shares") are being held in escrow to be
released to the sellers of On-Site at a later date. The remaining 468,750 shares
are being held in escrow and are deliverable on a pro rata basis upon the
Company achieving certain post-acquisition levels of revenues as defined in the
agreement. As of September 30, 2003, approximately 205,000 of such shares have
been earned by On-Site.
The final purchase price reflects the issuance of 1,513,056 shares at a
purchase price of $3.41 per share. The $3.41 per share price was determined by
calculating the weighted average share price of the Company`s Common Stock for
the 3 days prior and 3 days subsequent to the date of the acquisition of
On-Site. The excess purchase price of $8,584,000 over the fair value of the net
liabilities acquired of $2,881,000 was allocated to "Intangibles" representing
the retail business customer lists acquired.
The purchase price of $5,703,000, including expenses of $543,000, was
allocated to the net assets acquired as follows:
Net Assets
Acquired
Securities owned, at market value ........................ $ 4,551,000
Intangibles .............................................. 8,584,000
Other assets ............................................. 265,000
-----------
Total assets ............................................. 13,400,000
Securities sold, but not yet purchased ................... 3,358,000
Other liabilities ........................................ 381,000
Minority interest ........................................ 3,958,000
-----------
Total liabilities ........................................ 7,697,000
-----------
Net assets acquired ...................................... $ 5,703,000
===========
On May 9, 2002, the Company notified the LLC Class B members that it had
elected to cease the proprietary trading business`s operations as a result of
declining revenues. On June 18, 2002, LLC withdrew its broker dealer
registration and therefore was unable to continue trading activities. The
remaining liability to the LLC Class B members as of September 30, 2003 and
September 30, 2002, was $2,000,253 and $2,492,310, respectively, and is included
in the accompanying Consolidated Statement of Financial Condition as "Accrued
Liabilities to LLC Class B Members". During the year ended September 30, 2003
the balance payable to Class B Members was reduced by approximately $492,000 in
payments including the issuance of 200,000 shares of common stock to On-Site as
part of a settlement agreement with a former LLC Class B Member.
The Intangibles associated with the acquisition were being amortized on a
straight -line basis over a period of 36 months. The Company recognized three
months of amortization expense approximating $715,000 during the year ended
September 30, 2002.
The customer base from the On-Site acquisition had deteriorated
significantly since its acquisition and revenues from operations have declined.
Management believes that the deterioration was attributable to many causes
including weakening market conditions, as well as the loss and closing of branch
operations that resulted in a permanent impairment in the value of the
intangibles assets. As of September 30, 2002, the Company recorded a charge to
operations of $7,870,110 to write off the remaining carrying value of
Intangibles.
9. Redeemable Convertible Preferred Stock
On November 29, 2001, the Company entered into the Series A Convertible
Preferred Stock Purchase Agreement (the "Purchase Agreement") to issue and sell,
F-16
in a private placement, an aggregate of 630 (690 shares authorized, par value
$.01) shares of Series A Redeemable Convertible Preferred Stock ("Preferred
Stock"). Each share is convertible into 3,390 shares of the Company`s Common
Stock at an exercise price of $2.95. The purchasers of the Preferred Stock were
issued warrants, expiring in 5 years from the date of issuance, to purchase an
additional 1,629,069 shares of Common Stock at an exercise price of $2.95.
Pursuant to the Purchase Agreement and the Registration Rights Agreement
(the "Registration Agreement"), the Company was required to file a registration
statement (the "Registration Statement") with the Securities and Exchange
Commission registering for resale the 2,135,700 shares of Common Stock issuable
upon the conversion of the shares of Preferred Stock, and the 1,629,069 shares
of Common Stock subject to purchase upon exercise of the warrants. The Company
has not yet filed a Registration Statement and will not be able to have the
Registration Statement filed and declared effective within the period required.
A penalty of 2% of the liquidation preference value of the Preferred Stock for
each thirty-day period accrues to each holder of Preferred Stock and is added to
the liquidation preference amount until cured. In June 2003 the holders of the
Preferred Stock executed an agreement which waived their rights to penalties,
dividends and stock issuances during the period June 1, 2003 through May 31,
2004. For the years ended September 30, 2003 and 2002, dividends of $252,000 and
$315,000, respectively, were accrued for the Preferred Stock. Penalties accrued
through June 30, 2003 in the amount of $1,070,593 have been reversed and
recorded as additional paid-in-capital.
The Preferred Stock includes a liquidation preference of $10,000 per share
and bears a cumulative dividend at an initial 6% annual rate, which increases to
a 15% annual rate after eighteen months, payable twice a year in shares of
Common Stock. In June 2003 the holders of the Preferred Stock executed an
agreement which waived their rights to penalties, dividends and stock issuances
during the period June 1, 2003 through May 31, 2004. For the years ended
September 30, 2003 and 2002, dividends of $252,000 and $315,000, respectively,
were accrued for the Preferred Stock.
The holders of Preferred Stock may elect to convert their shares into the
Company`s Common Stock at any time, just as they may choose to exercise their
related warrants at any time. The holders of Preferred Stock also have the right
to require the Company to redeem all of the Preferred Stock for cash equal to
the greater of the liquidation preference amount plus any accrued but unpaid
dividends and penalties or the aggregate of the market value of the shares of
the Common Stock into which such shares of the Preferred Stock are then
convertible, upon certain triggering events, as defined in the Agreement. Such
triggering events have occurred. The holders of the Preferred Stock waived their
Redemption Rights through July 31, 2004.
The $6,300,000 aggregate purchase price of the Preferred Stock and the
warrants was allocated $4,340,383 to the Preferred Stock and the balance of
$1,959,617 was attributed to the fair value of the warrants. In connection with
this transaction, the Company issued Preferred Stock and received cash proceeds
of $3,324,291 (net of issue costs) and exchanged a note payable in the amount of
$2,500,000 ("Senior Subordinated Demand Note") for $2,750,000 plus accrued
interest. The premium of $250,000 was recorded as an extraordinary loss on the
extinguishment of debt in December 2001. The discount associated with the value
of the warrants was accreted over a ten-month period through September 30, 2002,
the date the redemption waiver expired.
Since the holders of the Preferred Stock may require the Company to redeem
all of the Preferred Stock, the Company has excluded the Preferred Stock from
Stockholders` Deficit in the accompanying consolidated statement of financial
condition.
The holders are not subject to any limitations on the number of
conversions of Preferred Stock or subsequent sales of the corresponding Common
Stock that they can effect, other than a prohibition on any holder acquiring a
beneficial ownership of more than 4.95% of the outstanding shares of the
Company`s Common Stock.
As of September 30, 2003 and 2002, the dilutive effect of the conversion
of preferred stock would result in the issuance of 3,764,769 and 3,474,343
shares respectively.
10. Notes and Loans Payable
a) Notes Payable - Former Officers
-------------------------------
F-17
As of September 30, 2003 and 2002, notes payable to former officers
consisted of the following:
Principal Interest
Effective Date Maturity Date Amount Rate
-------------- ------------- ------ ----
10/01/01 On demand 500,000 10%
02/02/02 On demand 200,000 10%
-----------
$700,000
===========
As of September 30, 2003 and 2002, interest payable related to these notes
payable to former officers was $113,667 and $70,000 respectively. The notes
payable to former officers are subordinated to the lines of credit granted by
the holders of the Company`s Preferred Stock.
In September 2002 of notes payable to officers aggregating $2,400,000,
were forgiven.
In April 2002, $2,150,000 of notes payable to officers was assigned to one
of the Company`s clearing brokers. Interest is payable at a rate of 10% per
annum. The loans expire through March 2003. In July 2002, this amount was
subsequently forgiven as part of the sale of the Company`s software.
b) Loans Payable - Other
---------------------
September 30, September 30,
2003 2002
---------- ----------
Line of Credit $3,082,826 $3,082,826
Loans Payable - other -- 200,000
---------- ----------
$3,082,826 $3,282,826
========== ==========
In February 2002, the Company borrowed $200,000 from a third party with
interest payable at a rate of 10% per annum. During fiscal 2003 the loan was
repaid in full.
In March 2002, one of the holders of the Company`s Preferred Stock led a
group that granted a line of credit of $4,200,000 to the Company. Borrowings
under the line of credit were payable on demand after June 18, 2002, with
interest payable at 10%. The proceeds of the loans were used for working
capital. Additionally, one member of the group was granted warrants to purchase
1,000,000 shares of the Company`s Common Stock at an exercise price of $.918 a
share in connection with the loan facility and a consultant retained by a member
of the group was also granted warrants to purchase 50,000 shares of the
Company`s Common Stock at an exercise price of $.918 a share. The fair value of
the warrants were amortized and recorded as interest expense. As of September
30, 2003, the Company has borrowed $3,082,826 under this commitment. As of
September 30, 2003 the Company has accrued interest payable of $513,292. The
loan is collateralized by certain assets of the Company as defined in the loan
agreement.
11. Secured Demand Note and Subordinated Borrowings
Secured Demand Note
On January 15, 2003, the Company entered into a Secured Demand Note
Collateral Agreement (the "SDN"), whereby a subordinated lender agreed to
deposit $5,000,000 worth of collateral in accounts to be held by the Company to
secure a subordinated loan for the same amount. The loan has been approved by
the NASD and is included for the purposes of computing net capital under Rule
15c3-1.
During the year ended September 30, 2003, the Company liquidated
approximately $1,798,000 of the SDN Collateral. This cash was then used by the
Company to support its operations. This transaction is reflected in the
accompanying Statement of Financial Condition as a reduction of the principal
amount of the SDN.
F-18
Subordinated Borrowings
At September 30, 2003, subordinated borrowings consisted of $5,530,000 of
subordinated notes payable to general creditors, of which $5,000,000 bearing
interest at 7% is due on June 30, 2004, $200,000 bearing interest at 15%,
$150,000 bearing interest at 13%, and the balance of $180,000 bearing interest
at 12% are due on October 31, 2006. In connection with the issuance of the
$5,000,000 subordinated borrowing the Company issued warrants to the lender to
purchase 500,000 shares of ABWG common stock at $0.75. The Company recorded a
debt discount in the amount of $273,724 which is amortized to interest expense
over the life of the subordinated loan. Interest expense relating to the
warrants was $136,862 for the year ended September 30, 2003. A.B. Watley ceased
operations in January 2004. In February 2004, A.B. Watley withdrew its
registration as a broker/dealer. To the extent borrowings are required for the
Company's continued compliance with minimum net capital requirements, they may
not be repaid. Of the total subordinated borrowings, $180,000 is from an officer
and shareholder of ABWG. On September 29, 2003, subordinated borrowings of
$530,000 bearing interest rate at 12% - 15% were converted to equity
subordinations for Net Capital purposes. Interest expense of approximately
$316,000, $64,500 and $62,825 was incurred on subordinated borrowings during the
years ended September 30, 2003, 2002 and 2001, respectively.
Subordinated borrowings as of September 30, 2003 and 2002 are as follows:
September 30, 2003 September 30, 2002 Interest Rate Maturity
------------------ ------------------ ------------- --------
$ 5,000,000 -- 7% June 30, 2004
$125,000 $125,000 12% October 31, 2006
$55,000 $55,000 0% October 31, 2006
$200,000 $200,000 15% October 31, 2006
$150,000 $150,000 13% October 30, 2006
- ------------------- ------------------
$5,530,000 $530,000
=================== ==================
12. Commitments and Contingencies
Late Filings
- ------------
The Company did not file required reports with the SEC on a timely basis .
Specifically , this annual report on Form 10-K and the quarterly reports on
Form 10-Q for the quarter ended December 31, 2003. The Company`s financial
statements do not reflect a reserve for any potential fines or penalties that
may result from such late filings. In addition the Company has not filed its tax
returns for the years ended September 30, 2003, 2002 & 2001.
Lease Agreements
- ----------------
The Company has entered into certain lease agreements for office space
under non-cancelable operating lease agreements that expire through dates
extending to June 2009. The leases contain various rent escalation provisions.
In addition, the Company has operating leases and capital leases for furniture
and computer equipment that expire at various dates through October 2005.
The aggregate minimum future rental payments required are as follows:
Fiscal Year Ended Operating leases Capital leases Total
----------------- --------------- ------------------
2004 $1,025,357 72,416 $ 1,097,773
2005 895,528 31,584 927,112
2006 938,272 1,493 939,765
2007 938,272 - 938,272
2008 938,272 - 938,272
Thereafter 703,704 - 703,704
----------------- --------------- ------------------
$5,439,405 $105,493 $5,544,898
================= =============== ==================
The Company is in default of making the minimum payments required under
F-19
certain of its capital lease agreements. The Company is in the process of
negotiating settlements with such vendors which is not expected to have a
material effect on the consolidated financial statements.
Employment Agreements
- ---------------------
During the year ended September 30, 2002, the Company entered into four
employment agreements with certain key executives. The terms of the agreements
ranged from two to four years and provided for annual compensation of $850,000.
The agreements also provided for a discretionary bonuses based upon the
performance of the Company. During the year ended September 30, 2003, two of
these employment agreements were terminated. The termination of these employment
agreements is not expected to have a material effect on the consolidated
financial statements. Annual compensation under the two remaining employment
agreements totals $350,000.
Fiscal Year Ended Annual Compensation
----------------- -------------------
2004 $350,000
2005 350,000
2006 330,000
2007 --
2008 --
Thereafter --
------------------
$1,030,000
==================
Litigation
- ----------
The Company is a party to various suits alleging breach of contract due to
non-payment for services or goods provided, and for the minority interests of
the Class B members of the LLC. The Company is defending these suits and has
commenced settlement negotiations as to certain of such suits.
We are currently a party to various suits alleging breach of contract due
to non-payment for services or goods provided, and for amounts claimed by Class
B members of the LLC. We are defending these suits and have commenced settlement
negotiations as to certain of such suits.
In addition, a suit has been brought by Akro Investicni Spolecnost, A.S.
and Bozena Konvalinkova, as Czech Receiver of Private Investors, as against A.B.
Watley. The plaintiffs alleged violations of New York common law and federal
securities law by A.B. Watley arising from an agreement between Private
Investors, a Czech broker-dealer, and A.B. Watley. Plaintiffs were seeking
damages of $31,400,000 (of which approximately $950,000 was alleged to represent
the damages and the balance represented punitive damages.) On April 16, 2003,
Morslav Tichy, a plaintiff in the action, filed a Notice of Dismissal dismissing
his claims without prejudice. Furthermore, in July 2003, a Stipulation and Order
of Dismissal with Prejudice was filed with the United States District Court -
Southern District of New York whereby the above action was dismissed pursuant to
a Settlement Agreement and Release. Pursuant to the Settlement Agreement and
Release, the Company made a cash payment of $275,000, which was covered by the
Companys insurance, to the plaintiffs in consideration for the plaintiffs
agreeing to have the action dismissed.
We are a defendant in an action titled Michael Fielman v. A.B. Watley,
Inc. and A.B. Watley Group, Inc., that was filed in the Supreme Court of the
State of New York, County of Nassau, Index No. 012082/02. This is an action for
unpaid wages seeking $28,657, plus statutory damages, costs, and attorneys'
fees. This matter has been settled in the amount of $34,657.
We are defendant in an action titled General Electric Capital Corp., as
Assignee of Sun Microsystems, Inc. v. A.B. Watley Group, Inc. f/k/a Internet
Financial Services, Inc., Supreme Court of the State of New York, County of New
York, Index No. 117675/02. This is a breach of contract action in connection
with the lease of equipment, which seeks compensatory damages of $195,355, plus
interest, costs and attorney's fees. The Company has denied liability in
F-20
its entirety and has indicated that it intends to vigorously defend this matter.
The parties have reached a settlement in principle for the payment of $50,000 in
two installments although an agreement has not been finalized.
Our former legal counsel, has filed a complaint against the Company. The
title of the action is Hartman & Craven LLP v. A.B. Watley, Inc. and A.B. Watley
Group, Inc., which was filed in the Supreme Court of the State of New York,
County of New York, Index No.: 109502/03. Plaintiff has filed a Complaint
against, amongst others, A.B. Watley Group, Inc. and A.B. Watley, Inc. for
damages in the amount of $352,573.73 (a provision has been provided in financial
statements) for unpaid legal fees. A.B. Watley Group, Inc. and A.B. Watley, Inc.
deny liability, in part, and have asserted a counterclaim for malpractice and
breach of contract for unspecified damages. At this point, it is difficult to
determine the amount, if any, that A.B. Watley Group Inc. and A.B. Watley Inc.
will be held liable for. Plaintiff has filed a motion for summary judgment,
which was opposed by A.B. Watley Group Inc. and A.B. Watley Inc. The oral
argument on this motion for summary judgment was heard on March 30, 2004. As of
May 19, 2004, the court has not made a decision with respect to the summary
judgment.
We are defendant in an action titled Hyperfeed Technologies, Inc. v. A.B.
Watley Group Inc., filed in the Supreme Court of the State of New York, County
of New York, Index No. 111538/03. Plaintiff has obtained a consent judgment
order against A.B. Watley Group Inc. in the amount of $180,503 (a provision has
been provided in financial statements). Currently, Plaintiff is conducting
post-judgment discovery.
We are respondent in an arbitration titled Sean MacDonald and Adam Silver
v. A.B. Watley, Inc., NASD Arbitration No. 03-02644. Claimants have alleged
mismanagement of Mr. MacDonald's margin account. A.B. Watley, Inc. denies all
wrongdoing in connection with this matter.
We are respondent in an arbitration titled John W. Donavan and Bettina H.
Wolff v. A.B. Watley, Inc. Claimants are seeking damanges of approximately
$94,800 relating to the suitability of Claimants' investments. The Company
denies all wrongdoing in connection with this matter asserting that it acted in
accordance with its customer agreement as well as applicable federal securities
law. The parties have agreed to a settlement in principle although a formal
settlement agreement has not been consummated.
We are respondent in an arbitration titled Steven Messina, Brian Kelly,
and Thomas Messina v. A.B. Watley, Inc., NASD Arbitration No. 02-04649.
Claimants filed this claim against A.B. Watley, Inc. in August 2002 seeking
damages for unpaid commissions of approximately $146,668 (a provision has been
provided in financial statements)plus legal fees and costs in the amount of
$4,025 for arbitration fees and disbursements. Claimants have also requested an
order to have their Form U-5s amended to remove all references to any alleged
improper conduct. A.B. Watley, Inc. denies all wrongdoing in connection with
this matter, and has counterclaimed for $608,000 against Claimants for breach of
contract and fiduciary duty. A.B. Watley, Inc. intends to vigorously defend this
matter and prosecute its counterclaim.
We are respondent in an arbitration titled Gary Miller v. A.B. Watley,
Inc., NASD Arb. No.: 03-07144. Claimant is seeking damages of approximately
$49,000 relating to a breach of contract. A.B. Watley, Inc. denies all
liability in connection with this matter.
We are defendant in an action titled Pentech Financial Services, Inc. v.
A.B. Watley Group Inc., Supreme Court of the State of New York, County of New
York, Index No. 02-126759. Plaintiff has filed a complaint against A.B. Watley
Group Inc. for an alleged breach of a lease agreement. On May 28, 2003,
Plaintiff obtained a judgment in the amount of $465,583(a provision has been
provided in financial statements). A.B. Watley Group Inc. executed a settlement
agreement with Plaintiff, but the Company has defaulted under such settlement
agreement.
Our former landlord, W.B. Wood & Co. Inc. filed a Notice of Petition for
Non-Payment against us in the District Court of the County of Suffolk for
failure to pay amounts owed in connection with our lease of our Melville, New
York office space. We did not respond to the action and our former landlord
obtained a judgment against us in the amount of $17,019,(a provision has been
provided in financial statements) which is presently owed.
We are defendant in an action titled Scott Schwartz v. A.B. Watley Inc.,
Supreme Court of the State of New York, County of New York, Index No. 121644/03.
Plaintiff filed a complaint alleging owed commissions and breach of contract.
A.B. Watley Inc. has settled the action for $6,750 which has been paid in full.
We are defendant in an action titled Siemens Financial Services, Inc. v.
A.B. Watley Group, Inc., Supreme Court of the State of New York, County of New
York, Index No. 603769/2002. Plaintiff filed a complaint alleging breach of
contract. Plaintiff has a judgment against A.B. Watley Group, Inc. in the amount
of $179,882 (a provision has been provided in financial statements) with
interest from July 10, 2003.
F-21
We are respondent in an arbitration titled Jeffrey Spittel v. A.B. Watley,
Inc., NASD Arbitration No. 03-08076. Claimant has submitted this claim to
arbitration claiming breach of contract, respondeat superior, and
misappropriation and conversion, in the amount of $7,500 plus punitive damages,
costs, disbursements and reasonable attorneys' fees. A.B. Watley, Inc. filed an
answer on January 12, 2004. A.B. Watley, Inc. denies all wrongdoing in
connection with this matter and intends to vigorously defend this matter.
We are defendant in an action titled Sprint Communication v. A.B. Watley,
Inc., United States District Court, Southern District of New York, Index No. 03
CV 6926. Plaintiff has submitted this claim alleging breach of contract for
unpaid telephone bills in the amount of $20,000 (a provision has been provided
in financial statements) plus costs, disbursements, and attorneys' fees. A.B.
Watley, Inc. filed an answer on January 8, 2004. A.B. Watley, Inc. denies all
wrongdoing in connection with this matter and intends to vigorously defend this
matter.
We are defendant in an action titled Peter Wigger v. A.B. Watley Group
Inc., Supreme Court of the State of New York, County of New York, Index No.
604124/02. Plaintiff filed a complaint alleging breach of a commission agreement
and seeks damages in the amount of $398,750 (a provision has been provided in
financial statements) plus interest accrued thereon. A.B. Watley Group Inc. is
currently in settlement negotiations regarding this matter.
We are defendant in an action titled Lehr Construction Corp. v. A.B.
Watley Group Inc., Supreme Court of New York, County of New York, Index No.
600276/02. This action is for damages arising out of the alleged breach of a
construction contract. Plaintiff sought damages of approximately $233,794. On
March 6, 2003, the parties reached a settlement in which the Company consented
to a judgment in the amount of $295,857, less any payments made by the Company,
and the parties simultaneously entered into a Forbearance Agreement, which set
forth a payment schedule for the Company. The Company has paid $65,000 pursuant
to the Forbearance Agreement. On December 17, 2003, Plaintiff issued the Company
a Notice of Default under the Forbearance Agreement, which the Company has
failed to cure. Under the Forbearance Agreement, Plaintiff may execute on the
outstanding balance of the judgment in the amount of $179,917 (a provision has
been provided in financial statements) without further notice to the Company.
We are defendant in an action titled A.B. Watley Group, Inc./John
Martinez, Case No. 2-4173-03-36 Section 806 Sarbanes-Oxley Act Complaint. On
July 11, 2003, the U.S. Department of Labor ("DOL") gave the Company notice that
John Martinez, a former officer of the Company, had filed a complaint against
the Company under Section 806 of the Sarbanes-Oxley Act of 2002 (the "Act"). The
Complaint alleges that the Company terminated Mr. Martinez in violation of the
Act for raising net-capital issues with the National Association of Securities
Dealers, Inc. - a private self-regulatory organization. The Complaint seeks: (i)
Mr. Martinez' base pay (at the annual rate of $150,000 per annum) for the period
from March 14, 2003 through April 7, 2003; (ii) the difference between his
current base pay with his new employer ($130,000) and his base pay at the
Company for a reasonable period of time; (iii) relocation costs incurred in
obtaining new employment in Baltimore, Maryland; (iv) litigation costs; (v) his
commuting costs during the time period April 7, 2003 until the unspecified time
of his relocation in Baltimore, Maryland; (vi) interest on the monies due him;
and (vii) any additional compensation deemed appropriate by the DOL. On July 30,
2003, the Company responded to the complaint and submitted its response and
evidentiary materials to the DOL. The response denies all liability and raised
several defenses to the complaint. The Company intends to vigorously defend this
matter. On March 9, 2004, the Department of Labor gave notice that it had
completed its investigation and dismissed the complaint. Complainant has
appealed and the U.S Department of Labor has scheduled a proceeding on June 7,
2004.
We are respondent in an arbitration titled MCI Worldcom Communications,
Inc. v. A.B. Watley Group, Inc., AAA Arbitration, Reference # 1410003356. On
September 16, 2003, claimant filed this arbitration against the Company
asserting a breach of contract claim in the amount of $135,644 (a provision has
been provided in financial statements). On January 26, 2004, the Company
submitted its answer denying all material allegations and asserting several
affirmative defenses. The Company intends to continue to vigorously defend this
matter.
In March 2003, the holder of the $5 million secured demand note (the
"Noteholder") demanded repayment of the note. On March 31, 2003, ABW filed a
NASD Arbitration Demand and a Statement of Claim with the NASD Dispute
Resolution office. The arbitration sought to enforce the provisions of the
secured demand note agreement and to prevent premature withdrawal by the lender.
F-22
In April 2004, the parties agreed to discontinue the arbitration without
prejudice pursuant to a settlement agreement that provided for the repayment of
approximately $2.9 million of the $5 million outstanding principal of the
secured demand note. The Noteholder agreed that as long as the Company is not in
default of any of its obligation under the settlement agreement, not to commence
any litigation with respect to the outstanding balance due on the $5 million
secured demand note prior to December 20, 2004.
Our landlord, 40 Wall Street, LLC, commenced two separate landlord/tenant
proceedings seeking money judgments and orders of eviction against the Company.
Both proceedings have been settled whereby the Company vacated a portion of the
premises in March 2004 and will vacate the remaining portion of the premises
prior to June 1, 2004. The landlord has reserved the right to seek a money
judgment for all rent arrears (a provision has been provided in financial
statements)after the Company has vacated the premises.
We are plaintiff in an action titled A.B. Watley Group Inc. v. John J.
Amore, et al., Supreme Court of the State of New York, County of New York, Index
No. 602993/03. We have sued our former CEO who has filed a counterclaim against
our company.
We are defendant in an action titled John J. Amore v. Steven Malin and
A.B. Watley, Inc., Supreme Court of the State of New York, County of New York,
Index No. 603833/03. Plaintiff filed a complaint alleging breach of a contract
against A.B. Watley, Inc. seeking damages in the amount of $500,000 and slander
against Steven Malin, our Chairman, seeking damages in the amount of $5,000,000.
We have filed an answer denying all wrongdoing. We deny all wrongdoing in
connection with this matter and intend to vigorously defend this matter.
We are respondent in an arbitration titled William Frymer v. A.B. Watley,
Inc., NASD Arbitration No. 03-05524. A former employee of the Company has
commenced this arbitration claiming breach of contract and violation of New York
labor laws. The Claimant is seeking unpaid salary and bonus, stock options,
liquidated damages and punitive damages. We deny all wrongdoing in connection
with this matter and intend to vigorously defend this matter.
We are respondent in an arbitration titled James B. Fellus v. A.B. Watley,
Inc., NASD Arbitration No. 03-05526. A former employee of the Company has
commenced this arbitration claiming breach of contract and violation of New York
labor laws. The Claimant is seeking unpaid salary and bonus, stock options, a
lump sum payment of the sum of the highest month's Retail Division and Fixed
Income Division pretax profit incentive multiplied by 48, liquidated damages and
punitive damages. We deny all wrongdoing in connection with this matter and
intend to vigorously defend this matter.
In addition to the foregoing, in the ordinary course of business, we and
our principals are, and may become, a party to legal or regulatory proceedings
commenced by the NASD, the SEC or state securities regulators relating to
compliance, trading and administrative problems that are detected during
periodic audits and inspections or reported by dissatisfied customers. Such
matters, if pursued by such entities, could rise to the level of disciplinary
action. We are not currently involved in any proceeding by a governmental agency
or self-regulatory organization, the outcome of which is expected to have a
material adverse effect on our business. There can be no assurance that one or
more future disciplinary actions, if decided adversely us, would not have a
material adverse effect on our business, financial condition and results of
operations.
13. Stock Options
Under the Company`s Stock Option Plans (collectively, the "Plans"),
employees, non-employee directors, officers, and consultants are generally
granted options (both incentive stock options and nonqualified stock options) to
purchase shares of Common Stock at prices not less than the estimated fair
market value of the Common Stock on the date the option is granted. The options
are exercisable at either the date of grant, in ratable installments or
otherwise, generally over a period of one to three years from the date of grant.
The options generally expire within ten years after the date of grant. The
number of shares delivered in the aggregate under the 2000, 1999, 1998 and 1997
Plans cannot exceed 1,600,000, 800,000, 800,000 and 400,000 shares,
respectively, (3,600,000 shares in total).
A summary of the Company`s stock option activity and related information
for the years ended September 30, 2003, 2002, and 2001 is as follows:
F-23
Number Weighted Avg.
of Shares Exercise Price
--------- --------------
Outstanding at September 30, 2000 1,385,350 $ 9.90
Granted 1,072,100 $ 6.54
Exercised (170,590) $ 5.79
Forfeited (183,923) $ 10.21
---------- --------
Outstanding at September 20, 2001 2,102,937 $ 9.68
Granted 3,520,000 $ 7.59
Exercised -- $ --
Forfeited (2,043,550) $ .13
---------- -------
Outstanding at September 30, 2002 3,579,387 $ 2.12
Granted 500,000 $ 0.35
Exercised -- --
Forfeited (1,386,687) $ 15.23
---------- -------
Outstanding at September 30, 2003 2,692,700 $ 6.37
========== =======
Exercisable at September 30, 2001 759,058 $ 8.10
========== =======
Exercisable at September 30, 2002 2,614,913 $ 0.39
========== =======
Exercisable at September 30, 2003 1,699,430 $ 6.94
========== =======
Included in the table above are non-employee option grants of -0- and
50,000 shares for the years ended September 30, 2003 and September 30, 2002,
respectively.
Compensation expense related to stock options for the years ended
September 30, 2003, 2002 and 2001 was $0, $459,563, $779,162, respectively.
The weighted average fair value of options granted during the years ended
September 30, 2003, 2002, and 2001 was $0.35, $0.08 and $4.82 and respectively.
The fair value of each option grant was estimated at the date of grant using the
Black-Scholes option valuation model. The Black-Scholes option valuation model
was developed for use in estimating the fair value of traded options which have
no vesting restrictions and are fully transferable. Because the Company`s stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management`s opinion, the existing models do
not necessarily provide a reliable single measure of the fair value estimate of
its stock options. In calculating the fair values of the stock options, the
following assumptions were used:
Years Ended
2003 Grants 2002 Grants 2001 Grants
----------- ----------- -----------
Dividend yield 0% 0% 0%
Weighted average expected life:
Employees 10.0 years 5.0 years 4.0 years
Non-employees -- -- 0.1 years
Weighted average risk-free interest rate 4.21 3.88 5.17
Expected volatility 109% 50% 92%
F-24
Additional information regarding options outstanding as of September 30,
2003 is as follows:
Options Outstanding Options Exercisable
------------------------- -------------------------
Range of Number of Weighted Average Weighted Average Number Exercisable Weighted Average
Exercisable Prices Outstanding as of Remaining Contractual Exercise Price as of 9/30/03 Exercise Price
9/30/03 Life in years
- ---------------------------------------------------------------------------------------------------------------------------------
$0.10 - $.35 2,600,000 9.19 $0.21 1,625,000 $0.25
$2.90 - $ 6.13 45,000 7.71 $4.93 36,750 $5.21
$8.00 - $10.875 36,750 6.89 $8.63 26,730 $8.84
$16.00 -$17.50 10,950 6.62 $16.90 10,950 $16.90
---------- ----------
2,692,700 1,699,430
========== ==========
14. Stock Warrants
At September 30, 2003 and 2002, the Company had warrants outstanding of
7,037,036 and 6,500,036, respectively, with exercise prices ranging between $0
and $19.47 and expirations extending through March 2012.
15. Income taxes
The Company has no income tax liability for Federal, State, and Local
income tax purposes. The Company is subject only to minimum taxes based on
capital and the provision for income taxes for the years ending September 20,
2003, 2002, and 2001 amounted to $0, $8,725, and $28,697, respectively.
Years Ended September 30,
2003 2002 2001
--------------- ------------- -------------
Tax benefit at federal statutory rate (34.0%) (34.0%) (34.0%)
State taxes, net of federal tax effect 0.1 0.1 0.1
Increase in valuation allowance on deferred tax assets 33.9 33.9 33.9
Other 0.1 0.1 0.1
--------------- ------------- -------------
Effective tax rate 0.1% 0.1% 0.1%
=============== ============= =============
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The effects of temporary
differences that give rise to deferred tax assets at September 30, 2003, are
principally the result of net operating carryforwards. At September 30, 2003,
the Company had a net operating loss carry forward for federal, state and local
tax purposes of approximately $67,000,000 that will begin to expire no sooner
than September 30, 2013.
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the reversal of deferred tax assets, projected future taxable income
and tax planning strategies in making this assessment. Based upon the level of
historical taxable income and projections for future taxable income over the
period for which the deferred tax assets are deductible, management believes it
is more likely than not that the Company will not realize the benefits of these
deductible differences, and thus a 100% valuation allowance of theses benefits
($26,000,000) was established. Certain of such net operating loss benefits may
be limited as a result of a change of control.
F-25