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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, 2002
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
-----------------------------
(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, 2002 were
$26,183,288.
The aggregate market value of the voting stock held by non-affiliates of
the registrant on December 31, 2002 computed by reference to the closing price
of such stock on such date was approximately $6,243,507. The number of shares of
common stock, par value $.001 per share, outstanding as of February 21, 2003 was
12,508,852 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
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 U.S. registered broker-dealer that engages
in direct-access trading, proprietary trading of U.S. equities and institutional
sales and Integrated Clearing Solutions, Inc. ("Integrated"), a U.S. registered
broker-dealer that engages in mutual fund sales to institutional customers. We
provide direct-access trading capabilities and related software to both
individual as well as institutional customers. As of September 30, 2002, the
brokerage firms had approximately 4,000 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 II,
Ultimate Trader III, 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. We
continue to evaluate acquisitions that might increase cash flow and enhance
economies of scale within our existing infrastructure.
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. On
March 19, 2002, the Company reclaimed 361,944 shares of Common Stock being held
in escrow 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 continues 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.
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
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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.
The growth of discount brokerage firms and the increasing utilization of
the Internet to access a wide range of financial services underscore a
fundamental shift in market demographics. This shift has altered the way
consumers manage their personal financial assets. Based on industry research
reports and the rapid consumer acceptance of online transactions, we believe
consumers are increasingly taking direct control over their personal financial
affairs, not only because they are now able to do so, but also because they find
it more convenient and less expensive than relying on traditional financial
intermediaries.
We conduct our brokerage activities through a global communications network
and sophisticated computerized information systems over which we receive and
transmit current market information.
The direct access platform used by the Company is technologically advanced
and highly scalable. Our services are delivered to our customers through (a)
Ultimate Trader II, 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 Superior Speed of Execution o Client-server order execution model
substantially reduces time elapsed
between investor order entry and receipt
of order by exchange/ECN.
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 8:00 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.
In order to provide professional and efficient client support we
implemented and use Client Relationship Management (CRM) and Computer Telephony
Integration (CTI) software. CRM databases are updated with each client contact
to track client service calls. A separate internal database tracks trading
patterns, changes in customer balances and compliance issues. Both databases are
used to generate periodic reports for management. Client Services associates
access the latest product and account information through CRM and customer
account databases.
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 are 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") and Bank of New
York ("BONY") for institutional accounts.
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 BONY. 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, including Merrill Lynch & Co., Inc.; Morgan Stanley
DW Inc.; UBS PaineWebber Inc.; and Smith Barney, as well as financial
institutions and mutual funds.
Securities Regulation
A.B. Watley, and Integrated (collectively, the "B-D Subsidiaries") are
broker-dealers registered with the SEC and NASD and licensed in the states in
which they do business.
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.
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 Integrated. 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.
During the year ended September 30, 2002, A.B. Watley had Net Capital
deficiencies which were subsequently cured.
Personnel
As of December 31, 2002, we employed a total of 48 persons, of whom 5 are
engaged in executive management, 16 in trading activities, 6 in information
technology, 8 in client service, 3 in sales and marketing, and 10 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, 2002 the company completed a
reduction in force.
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.
The Company`s proprietary trading activities are primarily 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
6
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 Securities and Exchange Commission ("SEC"), state regulators, and
the National Association of Securities Dealers ("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.
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.
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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.
As of February 28, 2002, March 31, 2002, and April 30, 2002, the Company
had a net capital deficit as defined, of $520,836, $1,487,966, and $637,141,
respectively, in violation of the Net Capital Rule. In addition, as of September
30, 2002, the Company had a net capital deficit of $301,523. These deficiencies
were cured through additional funding and through funds generated from
operations. While the Company is 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 firm may make
margin loans to our customers in connection with their securities transactions.
We are required by contract to indemnify that firm 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.
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 and (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 tradable 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.
8
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 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.
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.
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
9
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, including Merrill Lynch & Co., Inc.; Morgan Stanley
DW Inc.; UBS PaineWebber Inc.; and Smith Barney, as well as financial
institutions and mutual funds.
Securities Regulation
A.B. Watley, and Integrated (collectively, the "B-D Subsidiaries") are
broker-dealers registered with the SEC and NASD and licensed in the states in
which they do business.
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.
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 Integrated. 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.
During the year ended September 30, 2002, A.B. Watley had Net Capital
deficiencies which were subsequently cured.
Personnel
As of December 31, 2002, we employed a total of 48 persons, of whom 5 are
engaged in executive management, 16 in trading activities, 6 in information
technology, 8 in client service, 3 in sales and marketing, and 10 administration
and back office
10
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, 2002 the company completed a reduction in force.
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.
The Company`s proprietary trading activities are primarily 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
11
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 Securities and Exchange Commission ("SEC"), state regulators, and
the National Association of Securities Dealers ("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.
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.
12
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.
As of February 28, 2002, March 31, 2002, and April 30, 2002, the Company
had a net capital deficit as defined, of $520,836, $1,487,966, and $637,141,
respectively, in violation of the Net Capital Rule. In addition, as of September
30, 2002, the Company had a net capital deficit of $301,523. These deficiencies
were cured through additional funding and through funds generated from
operations. While the Company is 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 firm may make
margin loans to our customers in connection with their securities transactions.
We are required by contract to indemnify that firm 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.
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 and (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 tradable 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.
13
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 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.
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.
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
$963,000 per year , plus escalations. The initial term of the lease for such
office space expires in June 2009. On December 6, 2002, the Company entered into
a sixteen-month lease agreement for approximately 3,200 square feet in San
Francisco, CA, at an annual cost of $114,000. 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.
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, the Company is, and may become, a party
to legal proceedings or arbitration. Except as described below, the Company is
not a party to any material legal proceedings or arbitrations.
The Company is 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. The Company is defending these suits and has 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 allege 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 seek damages of
$31,400,000 (of which approximately $950,000 is alleged to represent the
damages, and the balance represents punitive damages.) The Company believes it
has a meritorious defense against this suit and intends to fight it vigorously.
We are a defendant in four actions relating to the lease of equipment in which
the plaintiffs have asserted breach of contract and damages in the aggregate
amount of approximately $683,000. Three of such actions are pending before the
Supreme Court of New York, NY, and the remaining action is pending before the
District Court, 4th Judicial District, Hennepin County, MN.
We are a defendant in an action pending before the American Arbitration
Association ("AAA") in which the plaintiffs have asserted breach of fiduciary
duties. The plaintiff in this action seeks an accounting and unspecified
damages.
We are a defendant in an action pending before the AAA in connection with
our failure to maintain a registration statement in which the plaintiffs have
asserted breach of contract and claimed damages approximating $84,000.
We are a defendant in a breach of contract action pending before the
Supreme Court, Nassau County, New York arising out of an employment dispute. The
plaintiff in this action is seeking compensatory damages of $93,000, as well as
liquidated damages, under New York`s Labor Law, in the amount of 25% of the
compensatory damages.
We are a defendant in an action pending before the Supreme Court of New
York, NY in connection with a construction contract in which the plaintiffs have
asserted breach of contract and damages in the aggregate amount of approximately
$234,000.
We are a defendant in an action pending before the Supreme Court of New
York, NY in connection with an advertising contract in which the plaintiffs have
asserted breach of contract and damages in the aggregate amount of approximately
$29,000.
We are a defendant in an action pending before the NASD in which the
claimants have asserted breach of contract and damages in the aggregate amount
of approximately $147,000.
14
There is one action that relates to collection of an existing account
payable in which a judgment has been entered against the Company totaling
approximately $24,000.
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. The Company is 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 to
the Company, would not have a material adverse effect on the Company`s business,
financial condition and results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of our security holders during the
fiscal year ended September 30, 2002.
15
PART II
Item 5. Market for Registrant`s Common Equity and Related Stockholder Matters
The Company currently has authorized capital stock consisting of 20,000,000
common shares, $.001 par value, of which 12,508,852 shares are issued and
outstanding and 1,000,000 preferred shares, $.001 par value, of which 630 Series
A Redeemable Convertible Preferred Stock are issued and outstanding.
Since March 2002, the Company issued warrants that may potentially require an
issuance of shares greater than the number of shares that the Company is
currently authorized to issue. By issuing these securities, the Company has
exhausted its 20,000,000 authorized shares of common stock and cannot meet any
equity-based obligations entered into after March 2002 without shareholder
approval for an increase in the number of authorized shares. The Company
intends to seek approval of the transactions that require the issuance of these
warrants that potentially may require an issuance of shares greater than the
number of shares that the Company is currently authorized to issue as well as
approval for an increase in the number of authorized shares of common stock of
the Company from 20,000,000 to 50,000,000.
(a) Trading in the Company`s shares of Common Stock presently takes place
on the Over-the-Counter Market 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 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
Fiscal 2001: High Low
--------------- ------ -----
10/1/00 - 12/31/00 $15.13 $4.56
1/01/01 - 3/31/01 $10.25 $5.25
4/01/01 - 6/30/01 $14.30 $4.94
7/01/01 - 9/30/01 $7.93 $2.80
(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 79 on December 12, 2002.
(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.
16
Item 6. Selected Financial Data
Income Statement Data
Years ended
- --------------------------------------------------------------------------------------------------------------------------
Sept. 30, 2002 Sept. 30, 2001 Sept. 30, 2000 Sept. 30, 1999 Sept. 30, 1998
- --------------------------------------------------------------------------------------------------------------------------
Revenues:
Commissions 15,900,261 18,887,752 32,968,193 16,198,858 7,403,059
Data service fees 462,469 1,297,117 2,015,396 1,640,123 661,236
Principal transactions 2,533,998 3,196,844 5,689,695 2,456,874 901,889
Sale of software 3,908,308
Interest and other income 3,378,252 2,084,009 2,073,190 685,578 146,704
Interest income-related party -- 6,180 6,180 6,180 6,380
------------- ------------- ------------ ------------ -------------
Total revenues 26,183,288 25,471,902 42,752,654 20,987,613 9,119,268
------------- ------------- ------------ ------------ -------------
Interest expense 2,678,712 852,967 373,354 333,457 244,322
Interest expense to officer 392,841 398,117 71,417 15,000 15,000
------------- ------------- ------------ ------------ -------------
Net revenues 23,111,735 24,220,818 42,307,883 20,639,156 8,859,946
------------- ------------- ------------ ------------ -------------
Expenses:
Commission, floor brokerage and clearing 11,639,652 10,572,220 20,605,576 7,967,765 3,425,725
charges
Employee compensation and related costs 10,674,346 12,686,615 11,802,131 5,306,590 2,247,963
Loss on impairment of intangibles 7,870,110
Minority interests (899,869)
Other expenses 22,620,097 21,253,846 19,436,768 7,956,784 3,805,903
Loss on investments -- 703,614 256,386 -- --
------------- ------------- ------------ ------------ -------------
Total expenses 51,904,336 45,216,295 52,100,861 21,231,139 9,479,591
------------- ------------- ------------ ------------ -------------
Loss before income tax and extraordinary (28,792,601) (20,995,477) (9,792,978) (591,983) (619,645)
loss on early extinguishments of debt
Income tax provision (8,725) (28,697) (53,913) (32,494) (12,765)
------------- ------------- ------------ ------------ -------------
Loss before extraordinary loss on early (28,801,326) (21,024,174) (9,846,891) (624,477) (632,410)
extinguishments of debt
Extraordinary loss on early (250,000) -- -- (177,125) --
extinguishment of debt
------------- ------------- ------------ ------------ -------------
Net loss $(29,051,326) $(21,024,174) $ (9,846,891) $ (801,602) $ (632,410)
============= ============= ============ ============ =============
Basic and diluted earnings before $ (2.62) $ (2.13) $ (1.21) $ (0.09) $ (0.12)
extraordinary item per common share
Basic and diluted earnings per common $ (2.64) $ (2.13) $ (1.21) $ (0.11) $ (0.12)
share
Weighted average shares outstanding - 12,508,852 9,888,597 8,122,393 7,136,434 5,171,182
basic and diluted
Balance Sheet and Other Operating Data:
Total Assets $ 7,036,620 $ 21,532,676 $ 29,032,644 $ 23,244,954 $ 5,539,457
Property and Equipment, net of $ 2,889,711 $ 14,806,945 $ 18,523,320 $ 10,852,956 $ 3,650,743
accumulated depreciation
Long term obligations and redeemable $ 6,926,487 $ 5,664,775 $ 6,071,129 $ 2,261,593 $ 530,000
preferred stock
Stockholders` (deficit) equity ($16,828,339) $ 2,945,432 $ 12,177,786 $ 15,842,987 $ 1,754,419
Basic and diluted earnings before $ (2.62) $ (2.13) $ (1.21) $ (0.09) $ (0.12)
extraordinary item per common share
- --------------------------------------------------------------------------------------------------------------------------
17
(In millions except per share data)
Year Ended September 30, First Quarter Second Quarter Third Quarter Fourth Quarter Full Year
- ---------------------------------------------------------------------------------------------------------------------------------
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 (0.63) (1.22) (0.59) (0.18) (2.62)
share
Basic and diluted earnings per share (0.65) (1.22) (0.59) (0.18) (2.64)
- ---------------------------------------------------------------------------------------------------------------------------------
2001
Revenues $8,222 $7,163 $5,506 $4,581 $25,472
Net revenue 8,025 6,923 5,212 4,061 24,221
Loss from operations (2,135) (4,575) (6,031) (7,551) (20,292)
Net (loss) (2,250) (4,609) (6,607) (7,558) (21,024)
Basic and diluted earnings per share (0.26) (0.52) (0.61) (0.74) (2.13)
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, 2002 compared to fiscal year ended September 30,
2001
Total revenues for fiscal 2002 were $26,183,288, an increase of 2.79% 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.
18
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.
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 increased from $20,995,477 for fiscal 2001, to a loss of
$28,792,601 for fiscal 2002.
The income tax provision decreased from $28,697 for fiscal 2001 to $8,725
for fiscal 2002.
19
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.
Fiscal year ended September 30, 2001 compared to fiscal year ended September 30,
2000
Total revenues for fiscal 2001 were $25,471,902, a decrease of 40.42%, as
compared to revenues of $42,752,654 for fiscal 2000.
Revenues from commissions decreased by $14,080,441, or 42.71%, from
$32,968,193 for fiscal 2000 to $18,887,752 for fiscal 2001 due primarily to a
decrease of 2,831 UltimateTrader accounts or 48.94% of such 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. During
fiscal 2001, the Company`s online brokerage division had total billed
transactions of 883,454 and average billed transactions of 3,577 per day, a
decrease of 40.00% compared to an average daily billed transaction rate of 5,966
per day during fiscal 2000 totaling 1,509,448 billed transactions.
Data service revenues decreased by $718,279, or 35.64%, from $2,015,396 for
fiscal 2000 to $1,297,117 for fiscal 2001 due to the increasing number of
accounts migrated to UltimateTrader 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 UltimateTrader II.
Revenues from principal transactions decreased by $2,492,851, or 43.81%,
from $5,689,695 for fiscal 2000 to $3,196,844 for fiscal 2001, mainly as a
function of lower volume of business conducted by both the online brokerage
division`s trading desk and the third-market institutional sales division due to
adverse market conditions.
Interest and other income increased from $2,079,370 for fiscal 2000 to
$2,090,189 due to the introduction of a minimum charge for all customers, which
was offset by lower interest income.
Interest expense increased from $373,354 for fiscal 2000 to $852,967 for
fiscal 2001 as a result of increased borrowings.
Interest expense - related party increased by $326,700 as a result of
additional borrowings from related parties during the year.
As a result of the foregoing, net revenues decreased by $18,087,065, or
42.75%, from $42,307,883 for fiscal 2000 to $24,220,818 for fiscal 2001. 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 $6,884,566 or 13.21%, from $52,100,861 for
fiscal 2000 to $45,216,295 for fiscal 2001.
Commissions, floor brokerage and clearing charges represent payments to our
clearing and floor brokers who facilitate our clients` transactions. As a result
of a significant decrease in the volume of business conducted by our online
trading accounts, such expenses decreased by $10,033,356, or 48.69%, from
$20,605,576 for fiscal 2000 to $10,572,220 for fiscal 2001.
Employment compensation and related costs increased by $884,484 or 7.49%,
from $11,802,131 for fiscal 2000 to $12,686,615 for fiscal 2001, due to expenses
for software developers that were working on capitalized software development
projects during fiscal 2000 but instead were working on the E*Trade integration
and product enhancements and accordingly, had their salaries expensed during
fiscal 2001.
Communications expense increased by $332,347, or 17.70%, from $1,877,709
for fiscal 2000 to $2,210,056 for fiscal 2001 as a function of adding a back-up
site.
Business development costs consist of television, radio, on-line and print
advertising to obtain new clients. These expenses decreased by $6,223,504, or
72.63%, from $8,569,200 for fiscal 2000 to $2,345,696 for fiscal 2001 as the
Company decreased its planned advertising and promotional efforts.
20
Professional fees increased from $1,726,598 for fiscal 2000 to $3,698,724
for fiscal 2001 due to an increase of $2,124,232 for software consultants, the
use of an investor relations firm totaling $230,000, and the use of management
consultants totaling $369,083, and was offset by decreases of $526,000 in legal
expenses and employee acquisition costs of approximately $427,000.
Occupancy and equipment costs increased by $1,638,132 or 35.06%, from
$4,671,865 for fiscal 2000 to $6,309,997 for fiscal 2001, primarily due to the
expansion of our offices by an additional 15,277 square feet in New York and the
leasing of additional equipment to increase our capacity.
Depreciation and amortization increased by $3,915,968, or 247.23%, from
$1,583,954 for fiscal 2000 to $5,499,922 for fiscal 2001 due to the
implementation of our direct access trading platform and the related
amortization of capitalized software, as well as the amortization of capitalized
lease obligations.
Other expenses increased by $182,009, or 18.07%, from $1,007,442 for fiscal
2000 to $1,189,451 for fiscal 2001, due to additional administrative costs.
A loss of $703,614 was recorded in fiscal year 2001 as a result of the
write off of our investments in a technology company, Gale Technologies, Inc.
and Insider Financial Services Online, Ltd.
As a consequence of the foregoing, our operating loss increased from
$9,792,978 for fiscal 2000, to a loss of $20,995,477 for fiscal 2001.
The income tax provision decreased from $53,913 for fiscal 2000 to $28,697
for fiscal 2001.
As a consequence of the foregoing, our net loss increased from $9,846,891
in fiscal year ended 2000 to $21,024,174 in fiscal year ended 2001.
Liquidity and Capital Resources
For the year ended September 30, 2002, we incurred consolidated losses of
approximately $33 million and used cash in our operating activities of nearly
$8.3 million. These losses and use of cash are in addition to the approximately
$31 million of losses and $21 million of cash used in operating activities
during the two years ending September 30, 2001. The market conditions during
fiscal 2002 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 such as
fixed income and equity capital markets as well as examining the feasibility of
expanding our existing business to attract 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 debt or equity offerings. When the 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 Net Capital rule.
The following is a summary of our significant financing activities:
Licensing agreements and the sale of assets
-------------------------------------------
In April 2002, we granted a non-perpetual license of our proprietary
software to E*Trade for a one time-time flat fee of $5,000,000, which was
payable in cash ($2.6 million) and E*Trade stock ($2.4 million). The E*Trade
Stock was subsequently sold for cash.
21
In July 2002, we sold our software programs known as Ultimate Trader II,
Ultimate Trader III, and Watley Trader, including all related intellectual
property, to a subsidiary of one of our clearing brokers. In consideration for
the software, our clearing broker agreed to forgive $2,716,720 (including
interest of $566,720) of indebtedness owed by the Company to the clearing
broker. In addition, the asset purchase agreement provides for a future
reduction of indebtedness to the clearing broker of approximately $2,150,000,
contingent upon the Company paying our clearing broker $5,000,000 in clearing
fees or raising at least $4,000,000 in new equity capital over a 36 month period
beginning after July 31, 2002.
Issuance of debt obligations for cash
-------------------------------------
On August 30, 2001, we borrowed $2,500,000 from SDS Merchant Fund, L.P. in
exchange for our issuance of a senior subordinated demand note (the "Note")
bearing interest at an annual rate of 6%, and the issuance of warrants to
purchase 67,824 shares of Common Stock at an exercise price of $3.686 per share.
Warrants to purchase 45,000 shares at an exercise price of $3.686 per share of
Common Stock were issued to a consultant in connection with his efforts in
arranging this loan. Under the terms of the Senior Subordinated Demand Note, we
were also committed to issue additional warrants to purchase our Common Stock at
the end of each month in which the Note was outstanding. A total of 243,673 of
such warrants were issued. The Note was redeemed in November 2001 in connection
with our issuance of Series A Preferred Stock.
During the year ended September 30, 2001, the Company borrowed $4,350,000
from officers of the Company at rates ranging from 7% to 10%. In September 2002,
we issued warrants to purchase 1,479,486 and 923,145 shares of our Common Stock,
exercisable at $0 and $1.80, respectively, in consideration for the forgiveness
of $2,400,000 of such borrowings. The balance of the borrowing was repaid during
the year ended September 30, 2002.
We borrowed $700,000 from a former officer of the Company during the year
ended September 30, 2002. The borrowings are due on demand and bear interest at
10%.
In March 2002, a group which included a holder of our Series A Preferred
Stock and one of our clearing brokers granted the Company a $2,500,000 line of
credit, increased in April 2002 and May 2002 to $2,700,000 and $4,350,000,
respectively. At September 30, 2002, our borrowings under the line amounted to
$3,082,826.
Issuance of equity instruments in satisfaction of debt obligation
-----------------------------------------------------------------
In September 2002, in consideration of the forgiveness of notes payable to
officers aggregating $2,400,000, we issued warrants to purchase 1,479,486 and
923,145 shares of Common Stock to officers, exercisable at $0.00 and $1.80 per
share, respectively.
Issuance of equity for cash
---------------------------
On September 6, 2000, pursuant to an equity line provided by an investment
group, we drew down $3,000,000 and issued 333,333 shares of our Common Stock and
received net proceeds of $2,850,000. The quantity of shares issued was based
upon 94% of the volume weighted average price of our Common Stock for the 22
days prior to the draw.
On April 2, 2001, we sold 2,027,241 shares of Common Stock in a private
placement offering. The Common Stock was issued at $5.50 per share. The private
placement offering generated total net proceeds of $10,012,127. In addition, we
issued warrants expiring April 1, 2004 to acquire 608,174 shares of our Common
Stock at an exercise price of $6.75 per share. We have registered the shares for
resale under the Securities Act of 1933, as amended.
On November 29, 2001, we issued 630 shares of our Series A Convertible
Preferred Stock, at a price of $10,000 per share. Each share is convertible at
any time into 3,390 shares of our Common Stock. Preferred dividends on the
Series A Preferred Stock are cumulative at a rate of 6% per annum for the first
eighteen months and 15% thereafter. The purchasers were also issued Series A
warrants to purchase 1,601,460 shares of Common Stock at an exercise price of
$2.95 per share. The aggregate purchase price of the Preferred Stock and
warrants was $6.3 million, of which $3.45 million was paid to us in cash, and
$2.75 million was paid by the forgiveness of $2.5 million face amount of the
Company`s Senior Subordinated Demand Note issued in August of 2001, plus a 10%
premium upon exchange of such note pursuant to its terms.
Cash Flows
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.
22
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 $790,935 in notes
payable, and $559,090 to pay obligations on capital leases.
At September 30, 2002, A.B. Watley has $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 $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 capital. Accordingly, our ability
to repay the subordinated loans may be restricted under the net capital rule.
Net Operating Loss Carryforwards
The Company has net operating loss carryforwards that represent accumulated
losses which may be utilized to reduce future taxable income, and thus our tax
liabilities for future periods. Our net operating loss carryforwards expire
beginning in the year 2013. The issuance of additional equity securities,
together with our recent financings and the IPO, could result in an ownership
change and, thus, could limit our use of net operating losses. If we achieve
profitable operations, any significant limitation on the utilization of our net
operating losses would have the effect of increasing our tax liability and
reducing net income and available cash reserves. The tax benefits related to the
net operating loss carryfowards have been fully reserved for on our consolidated
statements of financial condition.
Relevant Accounting Standards
We generally grant stock options to employees and consultants with an
exercise price not less than the fair market value at the date of grant. We
account for stock option grants to employees in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
and, accordingly, recognize no compensation expense related to option grants
issued to employees at or above the fair market value of the stock. In cases
where we grant options to employees below the fair market value of the stock at
the date of grant, the difference between the exercise price and the fair market
value is treated as compensation expense and amortized over the vesting period
of the option, if any. Stock options granted to consultants and others instead
of cash compensation are recorded based upon management`s estimate of the fair
value of the options or the related services provided and recognized as expense
over the vesting period, if any.
23
Pro forma information regarding net income (loss) is required under
Statement of Financial Accounting Standards ("SFAS") No.123, "Accounting for
Stock-Based Compensation," and has been determined as if we had accounted for
all stock option grants on the fair value method.
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS 141 requires all business combinations initiated after
June 30, 2001 to be accounted for using the purchase method. Under SFAS No. 142,
intangible assets with indefinite lives and goodwill will no longer be required
to be amortized. Instead, these assets will be evaluated annually for
impairment. We adopted the provisions of SFAS No. 142 at the beginning of fiscal
year 2002 in accounting for the acquisition of certain assets of On-Site.
After our development of the Ultimate Trader II software was completed, we
began to market the software to third parties. In accordance with AICPA
Statement of Position ("SOP") 98-1, proceeds received from the license of the
computer software, net of direct incremental costs of marketing, such as
commissions, software reproduction costs, warranty and service obligations, and
installation costs are to be applied against the carrying amount of that
software. No profit is to be recognized until aggregate net proceeds from
licenses and amortization have reduced the carrying amount of the software to
zero. Subsequent proceeds are to be recognized in revenue as earned.
Recent Accounting Developments
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of." This statement principally
addresses implementation issues of SFAS No. 121, including developing a single
accounting model for long-lived assets to be disposed of by sale. The provisions
of this Statement are effective for financial statements issued for fiscal years
beginning after December 15, 2001, and interim periods within those fiscal
years, with early application encouraged. The provisions of this Statement
generally are to be applied prospectively.
SFAS No. 145, "Rescission of FASB Statement Nos. 4, 44 and 64, Amendment of
FASB Statement No. 13, and Technical Corrections as of April 2002" primarily
provides guidance for reporting gains and losses from extinguishment of debt and
sale-leaseback transactions. The provisions of this Statement are effective for
financial statements issued for fiscal years beginning after May 15, 2002 with
early adoption encouraged.
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities". This standard required companies to recognize costs associates with
exit or disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. SFAS No. 146 replaces the existing
guidance provided by EITF Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs incurred in a Restructuring)." SFAS No. 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure - an amendment of FASB Statement No. 123" provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. The provisions of this
Statement are effective for fiscal years beginning after December 15, 2003.
Management does not believe that the adoption of any of these
pronouncements had, or will have, a material effect on the Company`s
consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our primary financial instruments subject to market risk at September 30,
2002 consist of equity securities obtained in exchange for our granting of a
software license. The securities were sold in October 2002. In the normal course
of business we do not hold significant investments in securities. We do not
believe that these instruments are subject to material potential near-term
losses in future earnings from reasonably possible near-term changes in market
rates or prices. We do not 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
24
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 enumerated in Item 14
and are found following page xxx of this Report.
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
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 new
independent public accountants.
25
PART III
Item 10. Directors and Executive Officers of the Registrant
Information concerning the directors and officers of the Company is
contained in the Company`s definitive Proxy Statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A no later than 120
days after the after the close of the fiscal year ended September 30, 2002. Such
information is hereby incorporated by reference.
Item 11. Executive Compensation
Information concerning the directors and officers of the Company is
contained in the Company`s definitive Proxy Statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A no later than 120
days after the after the close of the fiscal year ended September 30, 2002. Such
information is hereby incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information concerning the directors and officers of the Company is
contained in the Company`s definitive Proxy Statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A no later than 120
days after the after the close of the fiscal year ended September 30, 2002. Such
information is hereby incorporated by reference.
Item 13. Certain Relationships and Related Transactions
Information concerning the directors and officers of the Company is
contained in the Company`s definitive Proxy Statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A no later than 120
days after the after the close of the fiscal year ended September 30, 2002. Such
information is hereby incorporated by reference.
Item 14. Controls and 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, 2002. 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,
2002.
26
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents filed as part of this report:
1. Financial Statements:
Consolidated Financial Statements of A.B. Watley Group Inc. and
subsidiaries
Report of Independent Auditors
Consolidated Statements of Financial Condition--Years ended September 30,
2002 and 2001, Consolidated Statements of Operations--Years ended September
30, 2002, 2001 and 2000, Consolidated Statements of Changes in
Stockholders` Equity--Years ended September 30, 2002, 2001 and 2000,
Consolidated Statements of Cash Flows--Years ended September 30, 2002, 2001
and 2000, Notes to Consolidated Financial Statements
2. Financial Statement Schedules:
Financial Statement schedules have been omitted because the required
information is inapplicable or because the information is presented in
the financial statements or related notes.
(b) Reports on Form 8-K:
The Company filed a Form 8-K Current Report on August 2, 2002 reporting the
resignation of Ernst & Young LLP as the Company`s independent auditors. The
Company amended this report on August 8, 2002.
The Company filed a Form 8-K Current Report on August 29, 2002 reporting
the appointment of Israeloff, Trattner & Co., P.C. as the Company`s
independent auditors.
The Company filed a Form 8-K Current Report on October 16, 2002 reporting
the resignation of Israeloff, Trattner & Co., P.C. as the Company`s
independent auditors.
The Company filed a Form 8-K Current Report on October 25, 2002 reporting
the appointment of Marcum & Kliegman LLP as the Company`s independent
auditors.
(c). Exhibits.
-------------
Exhibit
No. Description
--- -----------
3.1 Restated Certificate of Incorporation of the Company and
form of amendment thereto.*
3.2 By-Laws of the Company, as amended.*
4.1 Specimen Common Stock Certificate.*
4.2 Form of Underwriter`s Warrant Agreement, including Form of
Warrant Certificate.*
10.1 1997 Stock Option Plan.*
10.2 Second Amended and Restated 1998 Stock Option Plan.*
10.3 Employment Agreement dated as of May 1, 1997 between the
Company and Steven Malin and Amendment to Employment
Agreement dated as of October 1, 1998 between the Company
and Steven Malin.*
10.4 Employment Agreement dated as of June 1, 1997 between the
Company and Harry Simpson and Amendment to Employment
Agreement dated October 1, 1998 between the Company and
Harry Simpson.*
10.5 Employment Agreement dated as of January 1, 1999 between the
Company and Robert Malin.*
10.6 Employment Agreement dated as of June 1, 1997 between the
Company and Anthony G. Huston and Amendment to Employment
Agreement dated as of October 1, 1998 between the Company
and Anthony G. Huston.*
27
10.7 Employment Agreement dated as of March 1, 1998 between the
Company and Eric Steinberg.*
10.8 Office lease dated as of June 20, 1997 between 40 Wall
Development Associates, LLC, as Landlord and the Company as
Tenant for premises located at 40 Wall Street, New York, New
York.*
10.9 [Intentionally omitted.]
10.10 [Intentionally omitted.]
10.11 Co-Branding Agreement dated October 11, 1996 between PC
Quote,Inc. and A.B. Watley, Inc., as amended.*
10.12 Computer Software License Agreement dated December 8, 1996
between Townsend Analytics, Ltd. and A.B. Watley, Inc., as
amended.*
10.13 Fully Disclosed Clearing Agreement dated October 3, 1996 and
Amendment dated June 8, 1998 between Penson Financial
Services,Inc. and A.B. Watley, Inc.*
10.14 Fully Disclosed Correspondent Agreement dated November 18,
1996 between Weiss, Peck & Greer, L.L.C. and A.B. Watley,
Inc.*
10.15 License Agreement dated as of October 1, 1998 between Ethos
Corporation and A.B. Watley, Inc.*
10.16 Service Marketing Representative Agreement dated as of
January 29, 1998 between S&P ComStock, Inc. and A.B. Watley,
Inc.*
10.17 Master Lease Agreement dated December 17, 1998 between
General Electric Capital Corporation and the Company.*
10.18 Security Agreement dated December 17, 1998 between General
Electric Capital Corporation and the Company.*
10.19 Letter of Credit Agreement dated December 17, 1998 between
General Electric Capital Corporation and the Company.*
10.20 Loan Agreement dated January 28, 1999 between New York
Community Investment Company L.L.C., the Company and A.B.
Watley, Inc.*
10.21 Promissory Note of the Company and A.B. Watley, Inc. dated
January 28, 1999 issued to the New York Community Investment
Company L.L.C.*
10.22 Security Agreement dated January 28, 1999 between New York
Community Investment Company L.L.C. and A.B. Watley, Inc.*
10.23 Security Agreement dated January 28, 1999 between New York
Community Investment Company L.L.C. and the Company.*
10.24 Objectivity Master License and Support Agreement dated
September 30, 1999 between Objectivity, Inc. and A.B. Watley
Group Inc. **
10.25 Reseller Network License Order Form dated May 26, 1999
between Database Consultants Inc. and A.B. Watley Group Inc.
**
10.26 1999 Stock Option Plan.***
10.27 Employment Agreement dated as of June 18, 1999 between the
Company and Joseph Ramos.
10.28 Employment Agreement dated as of September 1, 1999 between
the Company and Peter Wigger.
10.29 2000 Stock Option Plan.****
10.30 Agreement, dated November 1, 2001, by and among A.B. Watley
Group Inc. and On-Site Trading, Inc. *****
10.31 Employment Agreement, dated as of November 2, 2001, between
the Company and Gary Mednick.
10.32 Series A Convertible Preferred Stock Purchase Agreement dated
November 2001 for the sale of 630 shares of Series A Redeemable
Convertible Preferred Stock
10.33 Intentionally omitted.
10.34 Master Subordination, Waiver, Release and Indemnification
Agreement entered on March 27, 2002. ******
10.35 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. ******
10.36 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. ******
10.37 First Amendment to Promissory Note entered between A.B. Watley
Group LLC and Penson Financial Services Inc. dated April 2002.
******
10.38 Second Amendment to Promissory Note entered between A.B. Watley
Group LLC and Penson Financial Services Inc. dated May 2002.
******
10.39 Non-Exclusive Perpetual License of proprietary software between
E*Trade and the Company dated April 2002. ******
10.40 Asset Purchase Agreement entered into with Integrated Trading
Solutions, Inc. dated July 2002.
10.40A License Agreement entered into Integrated Trading Solutions,
Inc dated July 2002.
10.41 Senior Subordinated Demand Note entered into with SDS Merchant
Fund, L.P. whereby the Company borrowed $2,500,000 dated August
30, 2001
10.42 Equity line entered into with investment group dated September
6, 2000 in the amount of $3,000,000. *******
10.43 Employment Agreement entered with Steven Malin dated September
2002.
10.44 Employment Agreement entered with Robert Malin dated September
2002.
10.45 Employment Agreement entered with John Amore dated September
2002.
10.46 Amendment to the Fully Disclosed Clearing Agreement between
Penson Financial Services, Inc. and A.B. Watley, Inc.
10.47 Amended and Restated Promissory Note between A.B. Watley Group,
Inc. and Penson Financial Services, Inc. dated July 2002.
10.48 First Amendment to Master Agreement and First Amendment to
Software Security Agreement dated as of April 2002******
10.49 Second Amendment to the Master Subordination, Waiver,
Release and Indemnification Agreement, dated as of
May 2002. ******
10.50 Third Amendment to the Master Subordination, Waiver,
Release and Indemnification Agreement, dated as of
May 2002. ******
99.1 Certification by Steven Malin, Principal Executive Officer,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification by Robert Malin, Principal Financial Officer,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 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.
28
A.B. Watley Group Inc.
Consolidated Financial Statements
Years Ended September 30, 2002, 2001 and 2000
Contents
Report of Independent Auditors F-2
Report of Independent Auditors F-3
Consolidated Statements of Financial Condition as of September 30, 2002 and 2001 F-4
Consolidated Statements of Operations for the Years Ended September 30, 2002, 2001 and 2000 F-5
Consolidated Statements of Changes in Stockholders` Deficit for the Years Ended F-6
September 30, 2002, 2001 and 2000
Consolidated Statements of Cash Flows for the Years Ended September 30, 2002, 2001 and 2000 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 balance sheet of A.B. Watley Group Inc. as of
September 30, 2002, and the related consolidated statements of operations,
changes in stockholders` deficit, and cash flows for the year ended 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, 2002, and the results of its operations and its cash flows for the
year ended 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
January 15, 2003
F-2
Independent Auditors` Report
- ----------------------------
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
A.B. Watley Group Inc.
We have audited the accompanying consolidated statement of financial condition
of A.B. Watley Group Inc. (the "Company") as of September 30, 2001, and the
related consolidated statements of operations, changes in stockholders` equity
and cash flows for the years ended September 30, 2001 and 2000. 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 audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the 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 audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of A.B. Watley Group
Inc. as of September 30, 2001, and the consolidated results of its operations
and its cash flows for the years ended September 30, 2001 and 2000 in conformity
with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
New York, New York
January 11, 2002
F-3
A.B. Watley Group Inc.
Consolidated Statements of Financial Condition
September 30, September 30,
2002 2001
------------ ------------
Assets:
Cash and cash equivalents $ 213,766 $ 508,053
Restricted cash 292,565 500,334
Receivables from clearing brokers 1,028,588 2,294,533
Securities owned at market value 2,145,472 343,434
Property and equipment, net of accumulated depreciation
of $5,317,435 and $8,659,868 2,889,711 14,806,945
Loans receivable from related party 258,226 257,197
Security deposits 132,001 1,444,480
Other assets 76,291 1,377,700
------------ ------------
Total Assets $ 7,036,620 $ 21,532,676
============ ============
Liabilities and Stockholders` (Deficit) Equity:
Accounts payable and accrued liabilities 8,409,141 8,514,557
Accrued liabilities to LLC Class B Members 2,492,310 --
Securities sold not yet purchased -- 372,545
Notes payable to officers 700,000 4,350,000
Notes payable - other 3,282,826 3,437,323
Subordinated borrowings - other 350,000 350,000
Subordinated borrowings from officer 180,000 180,000
Lease obligations 1,524,195 1,396,060
------------ ------------
16,938,472 18,600,485
------------ ------------
Series A Redeemable Convertible Preferred Stock $0.01 par value, 690 shares authorized
and 630 and 0 issued and outstanding at September 30, 2002 and 2001, respectively and
accrued dividends (liquidation preference - $6,300,000) 6,926,487 --
------------ ------------
Stockholders` (Deficit) Equity:
Preferred Stock $0.01 par value, 1,000,000 shares authorized and none issued and
outstanding at September 30, 2002 and September 30, 2001 -- --
Common Stock, $0.001 par value, 20,000,000 shares authorized at September 30, 2002
and September 30, 2001, respectively, 12,508,852 and 10,995,796 issued
and outstanding at September 30, 2002 and September 30, 2001 12,509 10,996
Additional paid-in capital 45,819,569 37,224,984
Option costs (32,663) (267,798)
Deferred compensation costs -- (459,563)
Accumulated deficit (62,627,754) (33,576,428)
------------ ------------
Total Stockholders` (Deficit) Equity (16,828,339) 2,932,191
------------ ------------
Total Liabilities and Stockholders` (Deficit) Equity $ 7,036,620 $ 21,532,676
============ ============
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,
2002 2001 2000
------------ ------------ ------------
Revenues:
Commissions $15,900,261 $18,887,752 $32,968,193
Data service fees 462,469 1,297,117 2,015,396
Principal transactions 2,533,998 3,196,844 5,689,695
Sale of software income 3,908,308 -- --
Interest and other income 3,378,252 2,084,009 2,073,190
Interest income - related parties -- 6,180 6,180
------------ ------------ ------------
Total revenues 26,183,288 25,471,902 42,752,654
Interest expense 2,678,712 852,967 373,354
Interest expense - related parties 392,841 398,117 71,417
------------ ------------ ------------
Net revenues 23,111,735 24,220,818 42,307,883
Expenses and other charges:
Commissions, floor brokerage, and clearing charges 12,048,982 10,572,220 20,605,576
Employee compensation and related costs 10,674,346 12,686,615 11,802,131
Communications 2,882,953 2,210,056 1,877,709
Business development 485,993 2,345,696 8,569,200
Professional services 3,679,184 3,698,724 1,726,598
Occupancy and equipment costs 5,845,238 6,309,997 4,671,865
Depreciation and amortization 5,894,333 5,499,922 1,583,954
Other expenses 1,681,751 1,189,451 1,007,442
Loss on impairment of intangibles 7,870,110 -- --
Loss on investments -- 703,614 256,386
Abandonment of leasehold improvements 1,741,315 -- --
Minority interest applicable to LLC Class B members (899,869) -- --
------------ ------------ ------------
Total expenses 51,904,336 45,216,295 52,100,861
------------ ------------ ------------
Loss before income taxes and extraordinary item (28,792,601) (20,995,477) (9,792,978)
Income tax provision 8,725 28,697 53,913
------------ ------------ ------------
Loss before extraordinary item (28,801,326) (21,024,174) (9,846,891)
Extraordinary loss on extinguishment of debt (250,000) -- --
------------ ------------ ------------
Net loss (29,051,326) (21,024,174) (9,846,891)
============ ============ ============
Basic and diluted loss per common share:
Loss before extraordinary item $ (28,801,326) $ (21,024,174) $ (9,846,891)
Deemed dividend to preferred shareholders - beneficial conversion (1,639,797)
Deemed dividend to preferred shareholders - accretion of redemption (1,959,617)
Preferred stock dividends (315,000)
------------ ------------- ------------
Loss before extraordinary item attributable to common shareholders (32,715,740) (21,024,174) (9,846,891)
Extraordinary loss on extinguishment of debt (250,000)
------------ ------------- ------------
Net loss attributable to common shareholders $ (32,965,740) $ (21,024,174) $ (9,846,891)
============ ============= ============
Loss before extraordinary item $ (2.62) $ (2.13) $ (1.21)
Extraordinary item $ (0.02) $ - $ -
Basic and diluted loss per share $ (2.64) $ (2.13) $ (1.21)
Weighted average shares outstanding 12,508,852 9,888,597 8,122,393
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, 1999 7,931,745 $7,932 $18,661,749 ($121,331) -- ($2,705,363) $15,842,987
Issuance of common stock 866,345 866 6,091,127 -- -- -- 6,091,993
Option cost - net -- -- -- 28,000 -- -- 28,000
Net loss -- -- -- -- -- (9,846,891) (9,846,891)
Other -- -- 61,697 -- -- -- 61,697
------------ ------------ ------------ ------------ ------------ ------------ ------------
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
Warrants issued in exchange
for debt -- -- -- -- -- -- --
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)
============ ============ ============ ============ ============ ============ ============
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,
2002 2001 2000
------------ ------------ ------------
Cash flows used in operating activities:
Net loss $(29,051,326) $(21,024,174) $(9,846,891)
Adjustments to reconcile net loss to net
cash used in
Operating activities:
Non-cash compensation and service
costs 459,563 779,162 94,697
Options costs 235,135 -- --
Penalties-preferred stock 311,487 -- --
Issuance of warrants 1,390,569 -- --
Minority interest
applicable to LLC Class
B members (899,869) -- --
Loss on investments -- 703,614 256,386
Depreciation and amortization 5,894,333 5,499,922 1,583,954
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 207,769 31,098 (17,679)
Receivables from clearing
brokers 1,178,045 (1,174,624) (493,621)
Securities owned 2,748,940 47,727 (176,780)
Loans receivable from
related party (1,029) (129,126) (6,180)
Security deposits 1,312,479 27,427 --
Other assets 833,598 (324,319) (1,037,957)
Increase (decrease) in operating
liabilities:
Accounts payable and
accrued liabilities 843,118 (513,973) 3,523,449
Securities sold, not yet
purchased (3,731,128) 191,552 124,801
Leasehold
obligations 128,135 67,288 535,275
------------ ------------ ------------
Net cash used in operating activities (8,278,756) (15,818,426) (5,460,546)
------------ ------------ ------------
Cash flows provided by (used in)
investing activities:
Purchases of property and equipment (261,930) (1,759,660) (8,732,590)
Proceeds of sale of
software license 4,400,314 -- --
Purchase of investments -- -- (875,000)
------------ ------------ ------------
Net cash provided by (used in) investing
activities 4,138,384 (1,759,660) (9,607,590)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from sale of common stock -- 10,012,127 2,850,000
Proceeds from sale of preferred stock 3,324,291 -- --
Proceeds from exercised stock options -- 987,290 1,281,993
Proceeds from exercised stock warrants -- -- 1,960,000
Proceeds of notes payable 187,884 2,500,000 --
Payments of notes payable -- (790,938) (485,487)
Proceeds from notes payable to officer 900,000 850,000 3,500,000
Payment of capital lease obligations -- (559,090) (257,852)
Proceeds from obligations under capital
leases -- -- 2,047,410
Capital distribution to LLC Class B members (1,012,397) -- --
Capital contribution by LLC Class B members 446,307 -- --
Repayment of bank loan -- (3,333) (36,667)
------------ ------------ ------------
Net cash provided by financing activities 3,846,085 12,996,056 10,859,397
------------ ------------ ------------
Net decrease in cash and cash equivalents (294,287) (4,582,030) (4,208,739)
Cash and cash equivalents at beginning of
period 508,053 5,090,083 9,298,822
------------ ------------ ------------
Cash and cash equivalents at end of period $213,766 $508,053 $5,090,083
============ ============ ============
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,
2002 2001 2000
------------ ------------ --------
Supplemental non-cash financing activities
and disclosure of cash flow information:
Exchange of property and equipment in payment of
operating expenses $ -- $ 198,348 $625,870
============ ============ ========
Issuance of notes payable in payment of operating
expenses $ 225,714 $ -- $ --
============ ============ ========
Discharge of note payable in exchange for software $ 2,150,000 $ -- $ --
============ ============ ========
Accrual of Preferred stock dividends $ 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 $ -- $ --
============ ============ ========
Cash paid for:
Interest $ 366,841 $ 539,627 $316,800
============ ============ ========
Taxes $ -- $ 15,456 $ 40,425
============ ============ ========
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"), Integrated Clearing Solutions,
Inc. ("Integrated") 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 Integrated 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 is an introducing
broker-dealer, conducting business in electronic trading, information and
brokerage services, as well, as institutional block trading. Integrated is an
introducing broker-dealer conducting sales of mutual funds to institutional
customers. A.B. Watley and Integrated clear all transactions through clearing
brokers on a fully disclosed basis. Accordingly, A.B. Watley and Integrated are
exempt from Rule 15c3-3 of the Securities and Exchange Act of 1934.
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").
2. Liquidity and Capital Resources
The Company has continued to incur substantial 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.
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.
Property and Equipment:
-----------------------
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.
Use of Estimates:
-----------------
The preparation of the 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 financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Stock Options:
--------------
The Company accounts for stock option grants to employees in accordance
with Accounting Principles Board Opinion ("APB") No.25, "Accounting for Stock
Issued to Employees". In cases where the Company grants options below the fair
market value of the stock at the date of grant, the difference between the
strike price and the fair market value is treated as compensation expense and
amortized over the vesting period of the option. Stock options granted to
consultants and others in lieu of cash compensation are recorded based upon
management`s estimate of fair value of the options or the related services
provided and expensed in the same period and in the same manner as if the
Company had paid cash for the services instead of paying with or using the stock
options.
Fair Value of Financial Instruments:
------------------------------------
Substantially all of the Company`s financial instruments are carried at fair
value or 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.
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.
Interest and Other Income:
--------------------------
Included in interest and other income is for the year ended September 30, 2002
$507,472 for settlements with vendors for which the Company was the beneficiary.
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:
------------------------
The following pronouncements have been issued by the Financial Accounting
Standards Board ("FASB").
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of." This statement principally
addresses implementation issues of SFAS No. 121, including developing a single
accounting model for long-lived assets to be disposed of by sale. The provisions
of this Statement are effective for financial statements issued for fiscal years
beginning after December 15, 2001, and interim periods within those fiscal
years, with early application encouraged. The provisions of this Statement
generally are to be applied prospectively.
SFAS No. 145, "Rescission of FASB Statement Nos. 4, 44 and 64, Amendment of
FASB Statement No. 13, and Technical Corrections as of April 2002" primarily
provides guidance for reporting gains and losses from extinguishment of debt and
sale-leaseback transactions. The provisions of this Statement shall be applied
in fiscal years beginning after May 15, 2002 with early adoption encouraged.
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities". This standard required companies to recognize costs associates with
exit or disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. SFAS No. 146 replaces the existing
guidance provided by EITF Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs incurred in a Restructuring)." SFAS No. 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
Management does not believe that the adoption of any of these
pronouncements will have a material effect on the consolidated financial
statements.
4. Net Capital Requirement
A.B. Watley and Integrated 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. Integrated is required to maintain minimum
net capital of $5,000 or 6-2/3% of aggregate indebtedness as defined.
As of September 30, 2002, A.B. Watley had a net capital deficit of
$301,523. This deficiency was cured in October 2002.
Integrated had $27,757 of net capital in excess of its minimum requirements
at September 30, 2002,
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
clearing broker-dealers. The Company 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, through its clearing brokers,
seeks to control the risks associated with these activities by requiring
customers to maintain margin collateral in compliance with various regulatory
and internal 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. As
of September 30, 2002, the Company has provided a reserve for uncollectible
receivables from clearing brokers in the amount of $750,000.
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 Statement of Financial
Condition. Securities positions are monitored on a daily basis to minimize the
risk of loss.
6. Property and Equipment
September 30, September 30,
2002 2001
------------ ------------
Computer equipment $ 751,836 $ 5,654,754
Software 4,793,939 11,615,793
Furniture, fixtures and leasehold improvements 2,661,370 6,196,266
------------ ------------
8,207,145 23,466,813
Less: Accumulated depreciation and amortization (5,317,434) (8,659,868)
------------ ------------
Property and equipment, at cost, net $ 2,889,711 $ 14,806,945
============ ============
Depreciation and amortization expense for the years ended September 30,
2002, 2001, 2000 was $5,894,333, $5,499,922 and $1,583,954, respectively.
As of September 30, 2002, there is no equipment purchased under capital
lease included in computer equipment. Included in computer equipment as of
September 30, 2001, is equipment purchased under capital leases of $2,047,410,
which secured the capital lease obligations of $1,230,468.
At September 30, 2002 and 2001 substantially all software represents
software developed for internal use. For the years ended September 30, 2002 and
2001, the Company amortized $3,938,365 and $4,050,961 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. 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.
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 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, 2002, 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
===========
The following pro forma information for the year ended September 30, 2001,
gives effect to the Company`s acquisition of certain assets of On-Site,
primarily customer lists and its interest in the broker-dealer subsidiary; the
assumption of certain liabilities of the business; and the issuance of Common
Stock, as if it occurred on October 1, 2000. Pro forma information for the year
ended September 30, 2002 is not required since the Company became the
introducing broker for On-Site as of October 1, 2001 and as such, the
Consolidated Statement of Operations for the 2002 fiscal year reflect the
associated commission revenues and expenses related to the On-Site acquisition.
For the twelve
months ended
September 30,
2001
----------------
Net revenues $62,672,021
================
Net loss applicable to common stockholders ($29,411,546)
================
Weighted average number of shares outstanding 11,401,653
================
Per share:
Net loss applicable to common stockholders ($2.58)
================
This pro forma information does not purport to be indicative of what would
have occurred had the acquisition been completed as of October 1, 2000, or of
the results which may occur in the future.
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, 2002, was
approximately $2,492,310 and is included in the accompanying Consolidated
Statement of Financial Condition as "Accrued Liabilities to LLC Class B
Members".
The Intangibles associated with the acquisition were being amortized on a
straight-line basis over a period of thirty-six months. The Company recognized
three months of amortization expense approximating $715,000 during the year
ended September 30, 2002.
The Company continues to operate the retail business, however the customer
base deteriorated significantly since its acquisition and revenues from
operations have declined. Management believes that the deterioration is
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 acquired since the customer
list acquired from On-Site has been determined to have minimal future value.
Therefore, 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. For the
quarters ended December 31, 2001, March 31, 2002, June 30, 2002 and September
30, 2002 net commissions earned from the retail business were $925,000,
$901,000, $228,000 and $88,000, respectively.
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,
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.
The aggregate purchase price of the Preferred Stock and the warrants of
$6,300,000 was allocated to the Preferred Stock with a value of $4,340,383 and
the balance of $1,959,617 was attributed to the fair market 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. As of September 30, 2002, the discount has been amortized in the amount
of $1,959,617.
The Company recorded a deemed dividend of $1,639,797, in the first quarter
of 2002, relating to the beneficial conversion feature of the Preferred Stock,
after taking into account the value of the warrants issued. The deemed dividend
increases the loss applicable to common stockholders in the calculation of basic
and diluted net loss per common share and is included in stockholders` deficit
as offsetting charges and credits to additional paid-in capital. In recognition
of the redemption features of the Preferred Stock, the Company excluded the
Preferred Stock from stockholders` deficit in the accompanying consolidated
financial statements.
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 shares of Common Stock issueable upon the
conversion of the shares of Preferred Stock in the amount of 2,135,700 shares,
and the exercise of warrants to purchase shares of Common Stock in the amount of
1,629,069. 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. As of
September 30, 2002, liquidated damages of approximately $311,000 were accrued to
the preferred holders.
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. For the year ended September 30, 2002, dividends of $315,000 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. Since the holders of the Preferred Stock may require the
Company to redeem all of the Preferred Stock upon the occurrence of certain
events, the Company has excluded the Preferred Stock from Stockholders` Deficit
in the accompanying Consolidated Statement of Financial Condition. The holders
of the Preferred Stock have waived their Redemption Right and have agreed to
amend the Certificate to provide that the Company has until September 30, 2002
to (a) file the Registration Statement and (b) to be listed on any of the NASDAQ
National Market, the NASDAQ SmallCap Market, the OTC Bulletin Board, the New
York Stock Exchange, Inc. or the American Stock Exchange, Inc. Although, the
waiver has not been amended or extended, to date, no redemption notice has been
received by the Company from any of its Preferred Stockholders.
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.
10. Notes and Loans Payable
a) Notes Payable - Officers
------------------------
As of September 30, 2002 and 2001, notes payable to officers consisted of
the following:
2002
----
Principal Interest
Effective Date Maturity Date Amount Rate
-------------- ------------- ------ ----
10/01/01 10/01/02 500,000 10%
02/02/02 On demand 200,000 10%
-----------
$700,000
===========
2001
----
Principal Interest
Effective Date Maturity Date Amount Rate
-------------- ------------- ------ ----
11/30/00 11/29/02 $300,000 7%
02/25/01 02/25/02 950,000 10%
02/25/01 02/25/02 950,000 10%
02/25/01 02/25/02 950,000 10%
02/25/01 02/25/02 950,000 10%
03/16/01 03/16/02 125,000 10%
03/16/01 03/16/02 125,000 10%
-----------
$4,350,000
===========
The outstanding loans payable at September 30, 2002 were made to a person
who is no longer an officer of the Company.
As of September 30, 2002 and 2001, interest payable related to these notes
payable to officers was $70,000 and $283,679 respectively. The notes payable to
officers are subordinated to the lines of credit granted by the holders of the
Company`s Preferred Stock. The note payable scheduled to mature on October 1,
2002 has not been repaid and the maturity date has not been extended.
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 are immediately exercisable and will
expire in September 2007.
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,
2002 2001
---------- ----------
Line of Credit $3,082,826 $ --
Loans Payable - other 200,000 577,323
Senior Subordinated demand note -- 2,500,000
New York Community Investment Company -- 360,000
---------- ----------
$3,282,826 $3,437,323
========== ==========
In February 2002, the Company borrowed $200,000 from a third party with
interest payable at a rate of 10% per annum. The loan has a stated maturity of
October 26, 2002.
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 are 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, 2002, the Company has borrowed $3,082,826 under this commitment. As of
September 30, 2002 the Company has accrued interest payable of $205,000. The
loan is collateralized by the assets of the Company as defined in the loan
agreement.
In January 1999, the Company borrowed $400,000 from New York Community
Investment Company, L.L.C. ("NYCIC"). At September 30, 2002, the loan of
$360,000 was repaid in full.
In August 30, 2001, the Company obtained a $2,500,000 loan (the "Senior
Subordinated Demand Note") bearing interest at an annual rate of 6% due on
demand. The loan was redeemed and converted to Series A Convertible Preferred
Stock on November 29, 2001.
As of September 30, 2001, the Company had notes payable of $577,323 to two
vendors for the purchase of software licenses. The loans were repaid during
2002.
11. Subordinated Borrowings
Subordinated borrowings are covered by agreements approved by the NASD and
are included by A.B. Watley for purposes of computing net capital under the Net
Capital Rule. To the extent that such subordinated borrowings are required for
A.B. Watley`s continued compliance with minimum net capital requirements, they
may not be repaid. Of the total subordinated borrowings, $180,000 and $55,000
for the year ended September 30, 2002 and September 30, 2001, respectively, is
from an officer and stockholder of the Company. For the year ended September 30,
2002, 2001 and 2000, interest expense on the subordinated loans amounted to
$64,500, $62,825 and $58,250, respectively. Subordinated borrowings as of
September 30, 2002 and 2001 are as follows:
September 30, 2002 September 30, 2001 Interest Rate Maturity
- ------------------ ------------------ ------------- --------
$125,000 $125,000 12% October 31, 2002
$55,000 $55,000 0% October 31, 2002
$200,000 $200,000 15% October 31, 2003
$150,000 $150,000 13% October 31, 2003
- ------------------- -----------------
$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 , the quarter reports on Form 10-Q for the quarters ended March 31,
2002, June 30, 2002, and December 31, 2002 were filed in April of 2003. The
Company`s financial statements do not reflect a reserve for any potential fines
or penalties that may result from such late filings.
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
----------------- --------------- ------------------
2003 $1,466,075 1,524,195 2,990,270
2004 1,151,277 - 1,151,277
2005 925,694 - 925,694
2006 939,764 - 939,764
2007 938,272 - 938,272
Thereafter 1,641,974 - 1,641,974
----------------- --------------- ------------------
$7,063,056 $1,524,195 $8,587,251
========== ========== ==========
The Company is in default of making the minimum payments required under
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. During the year ended
September 30, 2002, $1,200,000 of security deposits held by a lessor was applied
to equipment rental payments in arrears. The total amount representing interest
under these capital leases as of September 30, 2002 was $50,000.
Employment Agreements
- ---------------------
The Company has entered into four employment agreements with certain key
executives. The terms of the agreements range from two to four years and provide
for annual compensation of $850,000. The agreements also provide for a
discretionary bonus based upon the performance of the Company.
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.
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 allege 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 seek damages of
$31,400,000 (of which approximately $950,000 is alleged to represent the damages
with the balance represents punitive damages). The Company believes it has a
meritorious defense against this suit and intends to fight it vigorously and
although there can be no assurance, the Company believes the majority of the
claims if successful, will be substantially less than the amount of the damage
claims and will be covered by insurance.
In the opinion of management, after consultation with independent counsel,
the Company is unable to predict the ultimate outcome of these matters;
accordingly, no adjustment has been made in the accompanying consolidated
financial statements for any potential losses.
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, 2002, 2001, and 2000 is as follows:
Number Weighted Avg.
of Shares Exercise Price
--------- --------------
Outstanding at September 30, 1999 1,362,450 5.94
Granted 356,775 13.11
Exercised (193,183) 6.68
Forfeited (140,692) 8.45
---------- -----
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
========== =====
Exercisable at September 30, 2000 533,829 6.24
========== =====
Exercisable at September 30, 2001 759,058 8.10
========== =====
Exercisable at September 30, 2002 2,614,913 0.39
========== =====
F-18
Included in the table above are non-employee option grants of 50,000 and
9,500 shares for the year ended September 2002 and September 30, 2001.
During the years ended September 30, 2001, certain employees were granted
stock options with strike prices below fair market value. The difference between
the fair value of the Common Stock and the strike price equaled $555,182 and was
recorded as deferred compensation on the consolidated statement of financial
condition and will be amortized into employee compensation expense over the
three year vesting period of the options. Compensation expense related to these
options amounted to $459,564, $95,619 and $61,697 for the years ended September
30, 2002, 2001 and 2000, respectively.
The weighted average fair value of options granted during the years ended
September 30, 2002, 2001, and 2000 was $0.08, $4.82 and $8.88 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
2002 Grants 2001 Grants 2000 Grants
----------- ----------- -----------
Dividend yield 0% 0% 0%
Weighted average expected life:
Employees 5.0 years 4.0 years 4.5 years
Non-employees -- 0.1 years 0.2 years
Weighted average risk-free interest rate 3.88 5.17 6.10
Expected volatility 50% 92% 79%
Pro forma information regarding net income or loss is required under
Statement of Financial Accounting Standards ("SFAS") No.123, "Accounting for
Stock-Based Compensation," and has been determined as if the Company had
accounted for all the 2001 and 2000 stock option grants on the fair value
method. For purposes of the pro forma information, the fair values of the 2001
and 2000 option grants to employees are amortized over the vesting period. The
effects of applying SFAS No. 123 for providing pro-forma disclosures are not
likely to be representative of the effects on reported pro-forma net income for
future years. The pro forma information for the Years ended September 30, 2002,
and 2001 is as follows:
Years Ended September 30,
-------------------------
2002 2001 2000
---- ---- ----
Net loss as reported $(29,051,326) $(21,024,174) $(9,846,891)
Net loss pro forma $(29,698,476) $(23,791,767) $(11,704,931)
Net loss per share as reported $(2.29) $(2.13) $(1.21)
Net loss per share pro forma $(2.34) $(2.41) $(1.44)
Additional information regarding options outstanding as of September 30,
2002 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 9/30/02 Exercise Price
9/30/02 Life in years
- ---------------------------------------------------------------------------------------------------------------------------------
$0.10 3,450,000 9.95 $.10 2,500,000 $.10
$2.90 -$6.13 45,000 8.71 $4.33 5,000 $6.13
$8.00 -$10.88 40,650 7.84 $8.66 35,858 $8.41
$16.00 -$21.50 43,737 7.66 $18.20 24,055 $18.20
---------- ----------
3,579,387 2,614,913
========== ==========
14. Stock Warrants
At September 30, 2002 and 2001, the Company had warrants outstanding of
6,500,036 and 1,126,738, respectively, with exercise prices ranging between $0
and $19 and expirations extending through February 2012.
15. Income taxes
The Company has no income tax liability for Federal, State, and Local
income tax purposes. Income tax expense for the year ended September 30, 2002,
2001, and 2000 consists solely of minimum taxes based on capital. The provision
for income taxes for the years ending September 20, 2002, 2001, and 2000
amounted to $8,725, $28,697, and $53,913, respectively.
Years Ended September 30,
2002 2001 2000
--------------- ------------- -------------
Tax benefit at federal statutory rate (34.0%) (34.0%) (34.0%)
State taxes, net of federal tax effect 0.1 0.1 0.4
Valuation allowance on deferred tax assets 33.9 33.9 34.1
Other 0.1 0.1 0
------ ------ ------
Effective tax rate 0.1% 0.1% 0.5%
====== ====== ======
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The effects of temporary
differences that give rise to deferred tax assets at September 30, 2002, are
principally the result of net operating carryforwards. At September 30, 2002,
the Company had a net operating loss carryforward for federal tax purposes of
approximately $60,343,000 that will 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 was established.
16. Earnings Per Share
Per share data is determined based on the weighted average number of common
shares outstanding each year. Since the Company recognized a net loss in each of
the years ended September 30, 2002, 2001, and 1999 diluted earnings per common
share is the same as basic earnings per common share.
17. Subsequent Events
On January 15, 2003, A.B. Watley entered into a secured demand note
agreement for $5,000,000 with a maturity date of June 30, 2004. The loan bears
an interest rate of 7% per annum, payable monthly. In connection with the
agreement, the Company issued warrants to purchase 500,000 shares of Common
Stock at $0.75 per share. The warrants are immediately exercisable and will
expire in January 2008. The loan has been approved by the NASD and is included
for the purposes of computing net capital under Rule 15c3-1. The holder of the
secured demand note has the option to convert all of the collateral into Common
Stock of the Company within five business days after February 15, 2004, at a
discount of 5% of the average price per share based on the 10-day period prior
to conversion. The holder may also elect to convert the collateral within five
business days after June 30, 2004 at $1.80. In no event shall the conversion
result in the holder of the secured demand note owning more than 15% of A.B.
Watley stock.
In January 2003, the Company entered into two leases for office space
requiring security deposits of approximately $21,000 and aggregate minimum rents
of $15,173, payable monthly. The leases expire in 2004.
SIGNATURES
Date: April 15, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signatures Title
Date
------------------- ------------------------------
/s/ STEVEN MALIN Chairman of the Board
April 15, 2003
Steven Malin
/s/ ROBERT MALIN Vice-Chairman, Principal Accounting Officer,
April 15, 2003 Principal Financial Officer and Director
Robert Malin
/s/ John Amore Chief Executive Officer
April 15, 2003
John Amore
F-22
CERTIFICATION
I, Steven Malin, certify that:
1. I have reviewed this annual report on form 10-K of A.B. Watley Group Inc.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report.
4. The registrant`s other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant`s disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant`s other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant`s auditors and the audit
committee of registrant`s board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant`s ability to record,
process, summarize and report financial data and have identified for the
registrant`s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant`s internal
controls; and
6. The registrant`s other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ STEVEN MALIN
----------------------------------
Principal Executive Officer
Date: April 15, 2003
F-23
CERTIFICATION
I, Robert Malin, certify that:
1. I have reviewed this annual report on Form 10-K of A.B. Watley Group Inc.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report.
4. The registrant`s other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant`s disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant`s other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant`s auditors and the audit
committee of registrant`s board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant`s ability to record,
process, summarize and report financial data and have identified for the
registrant`s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant`s internal
controls; and
6. The registrant`s other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ ROBERT MALIN
----------------------------------
Principal Financial Officer
Date: April 15, 2003
F-24
EXHIBIT INDEX
Exhibit Page Description
- ------------ -----------
Exhibit 99.1 Principal Executive Officer Certification 906
Exhibit 99.2 Principal Financial Officer Certification 906
F-25