UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 1-14897
A.B. Watley Group Inc.
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(Name of registrant as specified in its charter)
Delaware 13-3911867
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
40 Wall Street, New York, New York 10005
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(Address of principal executive offices) (Zip Code)
Registrant`s telephone number, including area code: (212) 422-1100
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes / / No /X/.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant`s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K / /
The issuer`s revenues for the fiscal year ended September 30, 2003 were
$15,248,882.
The aggregate market value of the voting stock held by non-affiliates of the
registrant on May 14, 2004 computed by reference to the closing price of $.25
on such stock on such date was approximately $3,259,284. The number of shares of
common stock, par value $.001 per share, outstanding as of May 14, 2004 was
13,037,138 shares.
DOCUMENTS INCORPORATED BY REFERENCE
None
Forward Looking Statements: This Report contains certain statements that may be
deemed "forward-looking statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act. All statements, other than
statements of historical facts, that address activities, events or developments
that the Company intends, expects, projects, believes or anticipates will or may
occur in the future are forward-looking statements. Such statements are based on
certain assumptions and assessments made by management of the Company in light
of its experience and its perception of historical trends, current conditions,
expected future developments and other factors it believes to be appropriate.
The forward-looking statements included in this Report are also subject to a
number of material risks and uncertainties, including but not limited to
economic, competitive, governmental and technological factors affecting the
Company`s operations, markets, services and prices, and other factors discussed
in the Company`s filings under the Securities Act and the Exchange Act.
Stockholders and prospective investors are cautioned that such forward-looking
statements are not guarantees of future performance and that actual results,
developments and business decisions may differ from those envisaged by such
forward-looking statements.
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PART I
Item 1. Business
General
A.B. Watley Group Inc. ("ABWG" or the "Company") is a publicly-held financial
services holding company incorporated in the state of Delaware on May 15, 1996.
We conduct our core business activities through our subsidiaries A.B. Watley,
Inc. ("A.B. Watley"), A.B. Watley Direct, Inc. ("Direct" and formerly Integrated
Clearing Solutions, Inc. ("Integrated") and A.B. Watley Futures Corp. (ABW
Futures"). A.B. Watley and Direct are U.S. registered broker-dealers that engage
in direct-access trading and proprietary trading of U.S. equities and
institutional sales. We provide direct-access trading capabilities and related
software to both individuals as well as institutional customers. A.B. Watley
ceased operations in January 2004. In February 2004, A.B. Watley withdrew its
registration as a broker/dealer. ABW Futures is an introducing broker/dealer
registered with the National Futures Association and conducts futures trading
activity for customers.
As of September 30, 2003, the brokerage firms had approximately 1,100
customers. We have historically devoted significant resources to the development
of proprietary software. However, in July 2002, our business activities were
reorganized and we sold our software programs know as Ultimate Trader and Watley
Trader, including all related intellectual property rights, to a subsidiary of
one of our clearing brokers. We no longer consider software licensing to be a
core revenue source. The sale of the software programs provided us with working
capital and reduced our expense base. Pursuant to the terms of the sale, we
maintain a perpetual, non-exclusive license to use and sublicense the software.
To respond to our liquidity and capital resource needs, we have instituted
various cost cutting initiatives and raised additional capital. Our cost cutting
initiatives include reductions in workforce, reductions in capital expenditures
and renegotiation of clearing corporation agreements at more favorable rates.
On-Site Acquisition
On November 2, 2001, the Company acquired certain assets of On-Site Trading,
Inc. ("On-Site") and assumed up to $1.8 million in liabilities. This acquisition
included On-Site`s client base including 1,700 accounts representing client
assets (account balances and securities) of $84 million, On-Site Trading LLC
(the "LLC"), two branches owned by On-Site, and agreements with 12 non-business
branch locations. LLC, a broker-dealer subsidiary (the proprietary trading
business) was subsequently renamed ABW TRADING, LLC. The Company acquired these
assets for 1.875 million shares of its Common Stock. In connection with the
acquisition of On-Site, the Company also assumed up to $1.8 million in
liabilities of On-Site owed to the Class B members of the LLC. The Company
reclaimed 175,000 shares of Common Stock in connection with the On-Site
acquisition and assumed additional obligations of $1,050,000 in excess of the
$1,800,000 that the Company had originally agreed to assume.
The LLC was formed as a means for registered professionals to engage in
proprietary trading utilizing the LLC`s funds. Such registered professionals are
Class B members of the LLC, while the Company is the Class A member. The LLC was
a registered broker-dealer and a member of the Philadelphia Stock Exchange,
operated in 12 states and engaged exclusively in proprietary trading and did not
conduct business with the public. An initial capital contribution was required
to become a Class B member. On May 9, 2002, the Company notified the Class B
members that it had elected to cease the proprietary trading business as a
result of declining revenues. The Company continued to operate the On-Site
retail business, however the customer base has deteriorated significantly since
its acquisition and revenues from operations have declined. Management believes
that the deterioration is attributable to many factors including weakening
market conditions, as well as the loss and closing of branch operations. On June
18, 2002, the LLC withdrew its broker dealer registration and ceased trading
activities.
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Online Brokerage Services
Our industry has experienced a series of changes led by electronic and online
commerce. These changes have created significant market opportunities for us
along with other similar brokerage firms. Favorable market trends have resulted
from the following:
o growing market acceptance of online brokerage services;
o pronounced market segmentation;
o a complementary regulatory environment; and
o disparity in the scalability and quality of competing trading
technologies.
Historically, individual investors accessed the financial markets through
full-commission brokers, who offered investment advice and placed trades. With
deregulation of brokerage commissions in 1975 and the resulting unbundling of
brokerage services, investors began to realize that they could separate
financial advisory services from securities trading. This brought about the
advent and subsequent proliferation of discount brokerage firms, which provided
an alternative investment approach by completing trades at a reduced cost.
The emergence of electronic brokerage services has provided investors with
further access to unbundled services and costs typically charged by
full-commission and traditional discount brokerage firms. Further, while
full-commission and discount brokerage firms are able to offer electronic
trading services, their continued reliance on personnel, branch offices and
associated infrastructure prevents them from capturing the same operating
efficiencies that are achievable by electronic trading.
We conduct our brokerage activities through a global communications network
and sophisticated computerized information systems over which we receive and
transmit current market information.
Our services are delivered to our customers through Ultimate Trader, a client
server direct access software application and (b) Watley Trader, a web-based
direct-access platform. Benefits of the products for the retail market include:
o Direct Access to Exchanges & ECNs o Allows investors to execute
independently of third party market
makers for more efficient executions.
Provides ability to act as "market
maker" on par with institutional traders.
o Order Routing Discretion o Enables investors to actively determine
venue for order execution among variety
of alternatives (Island, Instinet, other
ECNs, NASDAQ, specific market makers,
NYSE DOT, our Company block trade desk).
Provides critical added ability to trade
at the best price.
o NASDAQ Level II Data o Enables access to complete range of
bid/ask, volume and market depth for
variety of execution markets.
o Realtime Data Analytics o Provides best available retail package
of real time, streaming market data,
charts and technical analysis. This
suite of content includes intra-day
charting, a variety of analytical
studies (e.g., RSI, moving averages,
MACD), time and sales, option quote
chains, regional exchange quotes and
news.
o High Utilization Capacity o Affords access to technology platform by
entire client base on simultaneous
basis. Critical given consistent high
level of concurrent utilization and
spikes in utilization due to highly
volatile market movements and shifts in
market liquidity.
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Client Services
Client services for all levels of our online service, including trading,
administrative, and technical support, are among our highest priorities. Based
on our experience in the industry and based on client feedback, providing an
effective client service team to handle client needs is critical to our success.
Our Client Service department helps clients get online, handles product and
services inquiries and addresses all brokerage and technical questions. The
Client Service department also conducts various surveys to verify the
satisfaction of our clients and to learn more about client preferences and
requirements.
We provide live client support from Monday through Friday between the hours
of 7:00 AM and 6:30 PM EST. Our Client Services department operates on a
one-stop shopping basis, meaning that clients do not typically have to be
transferred between departments to receive answers to their various inquiries.
All of our Client Service personnel are registered representatives and are
available to accept and execute client orders, research past trades, discuss
account information, and provide detailed technical support. A separate
technical support team helps clients with potentially serious or persistent
technical issues.
Account Security
We use a combination of proprietary and industry standard security measures
to protect our clients` assets. Clients are assigned unique account numbers,
user identifications and passwords that must be used each time they log on to
the system. In accordance with standard industry practices, telephone orders
require authentication via personal identification number/password and/or other
personal information. In addition, the trade processing system A.B. Watley uses
is designed to compare the A.B. Watley accounts database with the clearing
firm`s account information on a daily basis to detect any discrepancies.
We rely on encryption and authentication technology, including public key
cryptography technology licensed from other parties, to provide the security and
authentication necessary to effect the secure exchange of information.
Proprietary Trading
The Company takes proprietary positions through the trading of U.S. equities
in an attempt to realize gains. Our proprietary trading activities require the
commitment of capital and create an opportunity for profits and risk of loss due
to trading strategies and market fluctuations. Buying power is available to
traders to the extent that the aggregation of all positions in all of the
Company`s accounts were within A.B. Watley`s Net Capital requirements.
Trading profits or losses depend upon, among other things, the skills of
traders, the capital allocated to securities positions, the financial condition
and business prospects of particular issuers and general trends in the
securities markets. The amount of capital allocated to a particular trader is
based on the trader`s experience and performance as well as our risk management
policies. Customer funds are not used to fund proprietary trading activities.
We believe that our trading capability is a key ingredient to our success.
While this business can earn attractive returns, there is also the possibility
of incurring significant trading losses in periods of market turbulence. We seek
to balance our ability to profit from trading positions with our exposure to
potential losses. Our risk management includes input from all levels of the
Company including our traders as well as management.
Institutional Sales
Our institutional sales and trading desk specializes in facilitating and/or
executing large-block transactions in equity securities and services
institutional clients. These services are provided to clients who often require
that their purchases or sales of
5
large positions remain anonymous, with average trades ranging in the 10,000 to
100,000 share size. We match institutional buyers and sellers to minimize the
impact on the market and to prevent our client`s positions from being disclosed
to competing firms. Our institutional sales clients include mutual and pension
funds, insurance companies, banks, corporations and independent fund and money
managers.
Operations, Clearing and Order Processing
We do not hold client funds or securities, nor do we generally execute and
directly process either our own or our clients` securities transactions. Since
October 1996, we have cleared all transactions for retail clients, on a fully
disclosed basis, with Penson Financial Services, Inc. ("Penson"). Institutional
accounts are cleared through ABN Amro Incorporated("ABN").
Our agreements with such clearing brokers provide that the clearing brokers
process all securities transactions for our account and the accounts of our
clients for a fee. Services of the clearing brokers include billing and credit
control and receipt, custody and delivery of securities, for which we pay a per
ticket charge. We have agreed to indemnify our clearing brokers for losses they
may sustain from customer accounts introduced by us, which could be material in
amount. Our clearing agreements may be terminated by either party, upon 60 days`
written notice for Penson, and 30 days written notice for ABN. We depend on the
operational capacity and the ability of the clearing brokers for the orderly
processing of transactions. As a result of engaging the processing services of
clearing brokers, we are exempt from certain reserve requirements imposed by
federal securities laws.
Clients` securities transactions are effected on either a cash or margin
basis. In connection with margin transactions, credit is extended by the
clearing broker to a client, collateralized by securities and cash in the
client`s account, for a portion of the purchase price. The client is charged
interest by the clearing broker for margin financing. We receive a portion of
such interest from the clearing brokers.
Margin lending is subject to the margin rules of the Board of Governors of
the Federal Reserve System. Margin lending subjects us to the risk of a market
decline that would reduce the value of the collateral below the client`s
indebtedness before the collateral can be sold. Under applicable rules, in the
event of a decline in the market value of the securities in a margin account,
the client is required to deposit additional securities or cash in the account.
Marketing and Advertising
In connection with our cost-cutting initiatives, we have significantly
reduced our marketing and advertising expenditures.
Competition
The market for electronic brokerage services is highly competitive and
rapidly changing. We believe that we compete on the basis of speed of order
execution, processing and confirmation, quality of client service, ease of use,
amount and timeliness of information provided, price and reliability of the
trading systems which we utilize. Our competitors may have greater financial,
technical and marketing resources than the Company. We expect that our ability
to compete will be affected by our ability to introduce new services and
enhancements to existing services into the market on a timely basis.
We believe our competition consists of large and small brokerage firms
utilizing the Internet to transact retail brokerage business. Among these
competitors are E*TRADE Securities LLC.; Charles Schwab & Co., Inc.; Quick &
Reilly, Inc.; TD Waterhouse Investor Services, Inc.; Fidelity Brokerage Services
LLC; and Ameritrade, Inc. We also face competition for clients from full
commission brokerage firms.
Securities Regulation
A.B. Watley and Direct (collectively, the "B-D Subsidiaries") are
broker-dealers registered with the Securities and Exchange Commission ("SEC")
and National Association of Securities Dealers ("NASD") and licensed in the
states in which they do business. ABW Futures is registered as a futures
commission merchant with the National Futures Association. A.B. Watley ceased
operations in January 2004. In February 2004, A.B . Watley withdrew its
registration as a broker/dealer.
6
The securities industry in the United States is subject to extensive
regulation under federal and state laws. In addition, the SEC, NASD, other
self-regulatory organizations, such as the various stock exchanges, and other
regulatory bodies, such as state securities commissions, require strict
compliance with their rules and regulations. As a matter of public policy,
regulatory bodies are charged with safeguarding the integrity of the securities
and other financial markets and with protecting the interests of clients
participating in those markets, and not with protecting the interests of our
stockholders.
Broker-dealers are subject to regulations covering all aspects of the
securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of clients funds and securities, capital
structure, record keeping and the conduct of directors, officers and employees.
Because of the number of complaints by online traders, the SEC, NASD and other
regulatory organizations may adopt more stringent regulations for online firms
and their practices. If we fail to comply with any laws, rules or regulations we
could be censured, fined, suspended, or expelled.
In addition, significant changes in the B-D Subsidiaries` current business or
practices, require NASD and other regulatory approval.
To expand our services internationally, we would have to comply with
regulatory controls of each specific country in which we conduct business. The
brokerage industry in many foreign countries is heavily regulated. The varying
compliance requirements of these different regulatory jurisdictions and other
factors may limit our ability to expand internationally. We presently do not
have any plans to expand internationally.
All marketing activities by the B-D Subsidiaries are regulated by the NASD.
The NASD can impose penalties, including censure, fine, suspension of all
advertising, the issuance of cease-and-desist orders or the suspension or
expulsion of a broker-dealer and its officers or employees for violations of the
NASD`s advertising regulations.
Net Capital Requirements
The SEC, NASD and various other regulatory agencies have stringent rules
requiring the maintenance of specific levels of net capital by securities
brokers, including the SEC`s Uniform Net Capital Rule which governs A.B. Watley
and Direct. Net capital is defined as assets minus liabilities, plus other
allowable credits and qualifying subordinated borrowings less mandatory
deductions that result from excluding assets that are not readily convertible
into cash and from valuing other assets, such as a firm`s positions in
securities, conservatively. Among these deductions are adjustments in the market
value of securities to reflect the possibility of adverse market movement prior
to disposition.
If either of the B-D Subsidiaries fails to maintain the required net capital,
such subsidiary may be subject to suspension or revocation of registration by
the SEC and suspension or expulsion by the NASD and other regulatory bodies,
which ultimately could require the Subsidiary`s liquidation. In addition, a
change in the net capital rules, the imposition of new rules, a significant
operating loss, or any unusually large charge against net capital could limit
our operations that require the intensive use of capital and could limit our
ability to expand our business. The net capital rules also could restrict our
ability to withdraw capital from the B-D Subsidiaries, which could limit our
ability to pay dividends, repay debt and repurchase shares of our outstanding
stock.
In January 2004, A.B. Watley, as a result of Net Capital deficiencies, ceased
operations. In February 2004, A.B. Watley withdrew its registration as a
broker/dealer.
Personnel
As of September 30, 2003, we employed a total of 46 persons, of whom 4 are
engaged in executive management, 20 in trading activities, 6 in information
technology, 6 in client service, 4 in sales and marketing, and 6 administration
and back office personnel. We believe our relations with our employees are
generally good and we have no collective bargaining agreements with any labor
unions. During the fiscal year ended September 30, 2003 the company completed a
reduction in force.
7
Our registered representatives are required to take examinations administered
by the NASD and state authorities to be qualified to transact business, and are
required to enter into agreements with A.B. Watley obligating them to adhere to
our supervisory procedures and not to solicit customers in the event of
termination of employment. Our agreements with registered representatives do not
obligate these representatives to be associated with the Company for any length
of time.
Some of the Company`s proprietary trading activities are performed by registered
representatives who receive a portion of their trading profits, after deductions
for trading expenses. They are outside contractors, not entitled to
participation in any benefits plans of the Company.
Investment Considerations and Risk Factors
The following factors and other information in this Form 10-K should
carefully be considered when evaluating the Company and its stock.
o If we are unable to continue cost cutting and revenue generation
initiatives, enter into a strategic business combination or obtain
additional funding sources at acceptable terms, our ability to operate our
business will be significantly diminished.
We are implementing cost cutting and revenue generation initiatives, and
exploring strategic business combinations. We also will need to find additional
funding sources at rates and terms acceptable to us to meet our capital and
liquidity needs for the remainder of the year. To the extent that capital is
raised through the sale of equity or convertible debt securities, the issuance
of these securities could result in dilution to our stockholders. If we are
unable to obtain such financing, make sufficient improvement in our operating
results or find a strategic partner our ability to operate our business will be
significantly diminished.
o Periods of declining securities prices, decreasing trade volumes, or
uncertainty in the public equity markets may adversely affect our
revenues.
Our future revenues are likely to be lower during periods of declining
securities prices or reduced securities market activity The public markets have
historically experienced significant volatility not only in the number and size
of share offerings, but also in the secondary market trading volume and prices
of newly issued securities. Activity in the private equity markets frequently
reflects the trends in the public markets. As a result, our revenues from
brokerage activities may also be adversely affected during periods of declining
prices or reduced activity in the public markets.
o We may not be able to adapt with rapid technological change in a cost
effective manner, which could materially adversely impact the Company`s
business, financial condition and operating results.
Traditional and online financial services industries are characterized by
rapid technological change, changes in customer requirements, frequent new
service and product introductions and enhancements and evolving industry
standards. Our future success will depend on our ability to enhance our existing
services and products. We must also develop new services and products that
address the increasingly sophisticated and varied needs of our customers and
prospective customers. We must respond to technological
8
advances and evolving industry standards and practices on a timely and
cost-effective basis. The development and enhancement of services and products
entails significant technical and financial risks. We may fail to
o use new technologies effectively;
o adapt services and products to evolving industry standards; or
o develop, introduce and market service and product enhancements or new
services and products.
In addition, we may experience difficulties that could delay or prevent the
successful development, introduction or marketing of our services and products,
and our new service and product enhancements may not achieve market acceptance.
If we encounter these problems, our business, financial condition and operating
results may be materially adversely affected.
o Operational risks may disrupt our business or limit our growth.
Like other securities and securities-related businesses, we are highly dependent
on information processing and telecommunications systems.
We face operational risks arising from potential mistakes made in the
confirmation or settlement of transactions or from the failure to properly
record, evaluate or account for transactions. Our business is highly dependent
on our ability, and the ability of our clearing firms, to process, on a daily
basis, a large and growing number of transactions across numerous and diverse
markets. Consequently, we and our clearing firms rely heavily on our respective
financial, accounting, telecommunications and other data processing systems. If
any of these systems fail to operate properly or become unavailable due to
problems with our physical infrastructure, we could suffer financial loss, a
disruption of our business, liability to clients, regulatory intervention or
reputational damage. In addition, we are aware that other companies in our
industry have had problems due to high volume of telephone and e-mail customer
inquiries that has at times strained the capacity of their telecommunications
systems and customer service staffs, and has also led to temporary disruptions
in website service. Thus, any inability of systems used to accommodate an
increasing volume of transactions and customer inquiries could also constrain
our ability to expand our businesses and could damage our reputation.
o Employee misconduct could harm us and is difficult to detect and
deter.
There have been a number of highly publicized cases involving fraud or other
misconduct by employees in the financial services industry in recent years, and
we run the risk that employee misconduct could occur. Misconduct by employees
could bind us to transactions that exceed authorized limits or present
unacceptable risks, or hide from us unauthorized or unsuccessful activities. In
either case, this type of conduct could result in unknown and unmanaged risks or
losses. Employee misconduct could also involve the improper use of confidential
information, which could result in regulatory sanctions and serious reputational
harm. It is not always possible to deter employee misconduct, and the
precautions we take to prevent and detect this activity may not be effective in
all cases.
o The securities industry in which we operate is heavily regulated by the
SEC, state regulators, and the NASD. If we fail to comply with applicable
laws and regulations, we may face penalties or other sanctions that may be
detrimental to our business.
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. Broker-dealers are subject to
regulations covering all aspects of the securities business, including:
o sales methods;
o trade practices among broker-dealers;
o use and safekeeping of customers` funds and securities;
o capital structure;
o record keeping;
o conduct of directors, officers, and employees; and
o supervision of employees, particularly those in branch offices.
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The principal purpose of regulation and discipline of broker-dealers is the
protection of customers and the securities markets, rather than protection of
creditors and stockholders of broker-dealers.
Uncertainty regarding the application of these laws and other regulations to
our business may adversely affect the viability and profitability of our
business. The SEC, the NASD, other self-regulatory organizations and state
securities commissions can censure, fine, issue cease-and-desist orders, or
suspend or expel a broker-dealer or any of its officers or employees. Our
ability to comply with all applicable laws and rules is largely dependent on our
establishment and maintenance of a compliance system to ensure such compliance,
as well as our ability to attract and retain qualified compliance personnel. We
could be subject to disciplinary or other actions due to claimed noncompliance
in the future, and the imposition of any material penalties or orders on us
could have a material adverse effect on our business, operating results and
financial condition. In addition, it is possible that noncompliance could
subject us to future civil lawsuits, the outcome of which could harm our
business.
In addition, our mode of operation and profitability may be directly
affected by:
o additional legislation;
o changes in rules promulgated by the SEC, state regulators, the NASD, and
other regulatory and self-regulatory organizations; and
o changes in the interpretation or enforcement of existing laws and rules.
o The failure to remain in compliance with the Net Capital Rule would
adversely affect our ability to continue to operate as a broker-dealer.
The SEC, the NASD and various other regulatory agencies have stringent rules
with respect to the maintenance of specific levels of net capital by securities
brokers, including the SEC`s Uniform Net Capital Rule (the "Net Capital Rule").
Net capital is the net worth of a broker or dealer (assets minus liabilities),
less certain deductions that result from excluding assets that are not readily
convertible into cash and from conservatively valuing certain other assets.
Failure to maintain the required net capital may subject a firm to suspension or
revocation of registration by the SEC and suspension or expulsion by the NASD
and other regulatory bodies and ultimately could require the firm`s liquidation.
In addition, a change in the net capital rules, the imposition of new rules
or any unusually large charge against net capital could limit those aspects of
our contemplated operations that require the intensive use of capital, such as
trading activities and the financing of customer account balances. A significant
operating loss or any unusually large charge against net capital could adversely
affect our ability to operate and/or expand, which could have a material adverse
effect on our business, financial condition and operating results.
In January 2004, A.B. Watley, as a result of Net Capital deficiencies, ceased
operations. In February 2004, A.B. Watley withdrew its registration as a
broker/dealer. Direct and ABW Futures are presently in compliance with net
capital requirements, there can be no assurance that we will not fall below
minimum net capital requirements in the future.
o The failure of brokerage customers to meet their margin requirements could
result in significant liabilities.
The brokerage business, by its nature, is subject to risks related to
defaults by our customers in paying for securities they have agreed to purchase
and delivering securities they have agreed to sell. Our clearing broker may make
margin loans to our customers in connection with their securities transactions.
We are required by contract to indemnify that broker for, among other things,
any loss or expense incurred due to defaults by our customers in failing to
repay margin loans or to maintain adequate collateral for those loans. We will
be subject to risks inherent in extending credit, especially during periods of
volatile markets or in connection with the purchase of highly volatile stocks
which could lead to a higher risk of customer defaults.
o We may be obligated to redeem our Series A Preferred Stock at a point in
the future, which would impair our ability to raise additional capital as
we would more than likely not be able to repay such redemption.
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The holders of our Series A Preferred Stock have the right to have their
shares redeemed for cash equal to the greater of (i) the price we received when
we sold them the stock ($10,000 per share) plus any accrued and unpaid dividend
payments or (ii) the aggregate value of the shares of Common Stock into which
such shares of Series A Preferred Stock are then convertible (based upon the
closing bid price), in any of the following situations:
o if our Common Stock is not eligible to trade on the NYSE, the AMEX, the
NASDAQ National Market or the NASDAQ SmallCap market for a period of five
consecutive days.
o if we fail to register with the Securities and Exchange Commission (or
maintain such registration of) the Common Stock into which the Series A
Preferred Stock converts.
o if we fail to honor requests for conversion, or if we notify any holder of
Series A Preferred Stock of our intention not to honor future requests for
conversion.
o if the holders of more than 30 percent of the outstanding shares of our
Common Stock sell or exchange their stock.
o if we commit a material breach under, or otherwise materially violate the
terms of, the transaction documents entered into in connection with the
issuance of the Series A Preferred Stock and the warrants.
In April of 2002, our Common Stock was delisted from the NASDAQ Stock Market.
In addition, we have not registered the Common Stock into which the Series A
Preferred Stock converts. We have not received a redemption notice from any of
the holders of our Series A Preferred Stock. Redemption of the Series A
Preferred Stock in any event described above would require us to expend a
significant amount of cash that likely will exceed our ability to make such
payment or raise additional capital.
o Our stockholders could experience substantial dilution as a result of the
issuance of and terms of our Series A Preferred Stock and the related
warrants.
The 630 shares of Series A Preferred Stock that were sold in the private
placement are initially convertible into approximately 2,135,700 shares of
Common Stock. The warrants granted in connection with the sale of Series A
Preferred Stock are initially exercisable for 1,629,069 shares of Common Stock,
at an exercise price of $2.95 per share.
Under the terms of the Series A Preferred Stock, we are also obligated to
issue additional shares of Common Stock every six months to the holders of the
Series A Preferred Stock as preferred stock dividends. Initially, these
dividends will be payable at the rate of six percent for the first 18 months
following issuance of the Series A Preferred Stock and fifteen percent after
that initial 18 month period. The number of shares of Common Stock will be
determined by dividing the dividend payment by the market price for our Common
Stock on the day before such dividend is payable. Because these shares are
issueable as a dividend, we will receive no additional consideration in
connection with their issuance.
o We may also be required to issue shares of Common Stock without additional
consideration in the event that we fail to redeem any shares of Series A
Preferred Stock when required.
All of the foregoing issuances of Common Stock are likely to be substantially
dilutive to the outstanding shares of Common Stock, especially where, as
described above, the shares of Common Stock are issued without additional
consideration. Moreover, any increase in the number of shares of Common Stock we
are required to issue resulting from anti-dilution protection, penalties or
other adjustments to the conversion or exercise prices of the Series A Preferred
Stock and/or the warrants described above will further increase the anticipated
dilution to the outstanding holders of our Common Stock. We cannot predict
whether or how many additional shares of our Common Stock will become issuable
due to these provisions.
Any such dilution, potential dilution, or increase in dilution or potential
dilution, may result in a decrease in the value of the outstanding shares of our
Common Stock. Such a decrease in value, the risk of dilution, any actual
dilution, or any increase in potential dilution may cause our stockholders to
sell their shares, which would contribute to a downward movement in the price of
our Common Stock. This could
11
prevent us from sustaining a per share price sufficient to enable us to maintain
an active trading market on the NASDAQ National Market or SmallCap Market if our
stock is re-listed. In addition, any downward pressure on the trading price of
our Common Stock could encourage investors to engage in short sales, which would
further contribute to a downward pricing of our Common Stock.
o We may be required to obtain the consent of the holders of Series A
Preferred Stock before taking corporate actions, which could harm our
business.
Our charter documents require us to obtain the consent of the holders of the
Series A Preferred Stock before we may issue securities that have senior or
equal rights as the Series A Preferred Stock or take other actions with respect
to the Series A Preferred Stock or securities that have fewer rights than the
Series A Preferred Stock. We are also required to obtain the consent of the
holders of the Series A Preferred Stock before we amend or modify our
certificate of incorporation or bylaws, whether by merger, consolidation or
otherwise to change any of the rights of the holders of Series A Preferred
Stock. While these obligations may deter a potential acquirer from completing a
transaction with us, they may also prevent us from taking corporate actions that
would be beneficial to the holders of our Common Stock and the Company, such as
raising capital to operate our business or maintain our capitalization or per
share price in attempts to maximize stockholder volume and liquidity.
In June 2003 the holders of the Preferred Stock executed an agreement which
waived their rights to penalties, dividends and stock issuances during the
period June 1, 2003 through May 31, 2004. For the years ended September 30, 2003
and 2002, dividends of $252,000 and $315,000, respectively, were accrued for the
Preferred Stock.
o We may be unable to obtain critical goods or services from our suppliers.
We obtain financial information from a number of third-party suppliers of
software and information services. We believe we have available to us at
comparable cost a number of alternative sources of supply of these items of
software and information services, to provide adequate replacements on a timely
basis, if arrangements with any of our current suppliers are abrogated. We have
established a number of relationships with third-party suppliers of software and
information services. There can be no assurance that such relationships will
continue or that timely replacement of such services will be available in the
future.
o The Company is currently delinquent with its reporting requirements under
the Securities and Exchange Act of 1934 (the "1934 Act")
The Company has failed to timely file its reports due under the 1934 Act. As a
result of the Company's failure to timely file its reports under the 1934 Act,
the Company has been delisted by the Over-The-Counter Bulletin Board ("OTCBB").
As a result of this delisting, there currently is no active trading market for
the Company's securities. There is, therefore, no assurance that a market for
our common stock will develop.
o Our Common Stock is Subject to the "Penny Stock" Rules of the SEC and the
Trading Market in Our Securities is Limited, Which Makes Transactions in
Our Stock Cumbersome and May Reduce the Value of an Investment in Our
Stock.
The Securities and Exchange Commission has adopted Rule 15g-9 which
establishes the definition of a "penny stock," for the purposes relevant to us,
as any equity security that has a market price of less than $5.00 per share or
with an exercise price of less than $5.00 per share, subject to certain
exceptions. For any transaction involving a penny stock, unless exempt, the
rules require:
o that a broker or dealer approve a person's account for transactions in
penny stocks; and
o the broker or dealer receive from the investor a written agreement to the
transaction, setting forth the identity and quantity of the penny stock to
be purchased.
In order to approve a person's account for transactions in penny stocks, the
broker or dealer must:
o obtain financial information and investment experience objectives of the
person; and
12
o make a reasonable determination that the transactions in penny stocks are
suitable for that person and the person has sufficient knowledge and
experience in financial matters to be capable of evaluating the risks of
transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny
stock, a disclosure schedule prescribed by the Commission relating to the penny
stock market, which, in highlight form:
o sets forth the basis on which the broker or dealer made the suitability
determination; and
o that the broker or dealer received a signed, written agreement from the
investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in securities
subject to the "penny stock" rules. This may make it more difficult for
investors to dispose of our common stock and cause a decline in the market value
of our stock.
Disclosure also has to be made about the risks of investing in penny stocks in
both public offerings and in secondary trading and about the commissions payable
to both the broker-dealer and the registered representative, current quotations
for the securities and the rights and remedies available to an investor in cases
of fraud in penny stock transactions. Finally, monthly statements have to be
sent disclosing recent price information for the penny stock held in the account
and information on the limited market in penny stocks.
Item 2. Properties
Our principal offices are located at 40 Wall Street, New York, NY, where we
occupy approximately 28,500 square feet at an annual cost of approximately
$920,000 per year , plus escalations. The initial term of the lease for such
office space expires in June 2009. On January 16, 2003, the Company entered into
an sixteen-month lease agreement for approximately 2,750 square feet in San
Francisco, California, at an annual cost of $114,000. This lease agreement was
terminated as of November 30, 2003. On December 15, 2002, the Company entered
into an eighteen-month lease agreement for approximately 2,568 square feet in
Melville, NY, at an annual cost of $68,078. The Company no longer occupies the
Melville property and the landlord, W.B. Wood & Co. Inc., has obtained a
judgment in the amount of $17,019 against the Company. Accordingly, the Melville
lease has been terminated.
Our landlord, 40 Wall Street, LLC, commenced two separate landlord/tenant
proceedings seeking money judgments and orders of eviction against the Company.
Both proceedings have been settled whereby the Company vacated a portion of the
premises in March 2004 and will vacate the remaining portion of the premises
prior to June 1, 2004. The landlord has reserved the right to seek a money
judgment for all rent arrears (a provision has been provided in financial
statements)after the Company has vacated the premises.
Item 3. Legal Proceedings
Our business involves substantial risks of liability, including exposure to
liability under federal and state securities laws in connection with claims by
dissatisfied clients for fraud, unauthorized trading, churning, mismanagement,
and breach of fiduciary duty, as well as in connection with the underwriting or
distribution of securities. In recent years, there has been an increasing
incidence of litigation involving the securities industry, including class
actions which generally seek rescission and substantial damages.
In the ordinary course of business, we are, and may become, a party to
legal proceedings or arbitration. Except as described below, we are not a party
to any material legal proceedings or arbitrations.
We are currently a party to various suits alleging breach of contract due
to non-payment for services or goods provided, and for amounts claimed by Class
B members of the LLC. We are defending these suits and have commenced settlement
negotiations as to certain of such suits.
In addition, a suit has been brought by Akro Investicni Spolecnost, A.S.
and Bozena Konvalinkova, as Czech Receiver of Private Investors, as against A.B.
Watley. The plaintiffs alleged violations of New York common law and federal
securities law by A.B. Watley arising from an agreement between Private
Investors, a Czech broker-dealer, and A.B. Watley. Plaintiffs were seeking
damages of $31,400,000 (of which approximately $950,000 was alleged to represent
the damages and the balance represented punitive damages.) On April 16, 2003,
Morslav Tichy, a plaintiff in the action, filed a Notice of Dismissal dismissing
his claims without prejudice. Furthermore, in July 2003, a Stipulation and Order
of Dismissal with Prejudice was filed with the United States District Court -
Southern District of New York whereby the above action was dismissed pursuant to
a Settlement Agreement and Release. Pursuant to the Settlement Agreement and
13
Release, the Company made a cash payment of $275,000, which was covered by the
Companys insurance, to the plaintiffs in consideration for the plaintiffs
agreeing to have the action dismissed.
We are a defendant in an action titled Michael Fielman v. A.B. Watley, Inc.
and A.B. Watley Group, Inc., that was filed in the Supreme Court of the State of
New York, County of Nassau, Index No. 012082/02. This is an action for unpaid
wages seeking $28,657, plus statutory damages, costs, and attorneys' fees. This
matter has been settled in the amount of $34,657.
We are a defendant in an action titled General Electric Capital Corp., as
Assignee of Sun Microsystems, Inc. v. A.B. Watley Group, Inc. f/k/a Internet
Financial Services, Inc., Supreme Court of the State of New York, County of New
York, Index No. 117675/02. This is a breach of contract action in connection
with the lease of equipment, which seeks compensatory damages of $195,355, plus
interest, costs and attorney's fees. The Company has denied liability in its
entirety and has indicated that it intends to vigorously defend this matter. The
parties have reached a settlement in principle for the payment of $50,000 in two
installments although an agreement has not been finalized.
Our former legal counsel, has filed a complaint against the Company. The
title of the action is Hartman & Craven LLP v. A.B. Watley, Inc. and A.B. Watley
Group, Inc., which was filed in the Supreme Court of the State of New York,
County of New York, Index No.: 109502/03. Plaintiff has filed a Complaint
against, amongst others, A.B. Watley Group, Inc. and A.B. Watley, Inc. for
damages in the amount of $352,573.73 (a provision has been provided in financial
statements) for unpaid legal fees. A.B. Watley Group, Inc. and A.B. Watley, Inc.
deny liability, in part, and have asserted a counterclaim for malpractice and
breach of contract for unspecified damages. At this point, it is difficult to
determine the amount, if any, that A.B. Watley Group Inc. and A.B. Watley Inc.
will be held liable for. Plaintiff has filed a motion for summary judgment,
which was opposed by A.B. Watley Group Inc. and A.B. Watley Inc. The oral
argument on this motion for summary judgment was heard on March 30, 2004. As of
May 19, 2004, the court has not made a decision with respect to the summary
judgment.
We are defendant in an action titled Hyperfeed Technologies, Inc. v. A.B.
Watley Group Inc., filed in the Supreme Court of the State of New York, County
of New York, Index No. 111538/03. Plaintiff has obtained a consent judgment
order against A.B. Watley Group Inc. in the amount of $180,503 (a provision has
been provided in financial statements). Currently, Plaintiff is conducting
post-judgment discovery.
We are respondent in an arbitration titled Sean MacDonald and Adam Silver v.
A.B. Watley, Inc., NASD Arbitration No. 03-02644. Claimants have alleged
mismanagement of Mr. MacDonald's margin account. A.B. Watley, Inc. denies all
wrongdoing in connection with this matter.
We are respondent in an arbitration titled John W. Donavan and Bettina H.
Wolff v. A.B. Watley, Inc. Claimants are seeking damanges of approximately
$94,800 relating to the suitability of Claimants' investments. The Company
denies all wrongdoing in connection with this matter asserting that it acted in
accordance with its customer agreement as well as applicable federal securities
law. The parties have agreed to a settlement in principle although a formal
settlement agreement has not been consummated.
We are respondent in an arbitration titled Steven Messina, Brian Kelly, and
Thomas Messina v. A.B. Watley, Inc., NASD Arbitration No. 02-04649. Claimants
filed this claim against A.B. Watley, Inc. in August 2002 seeking damages for
unpaid commissions of approximately $146,668 (a provision has been provided in
financial statements)plus legal fees and costs in the amount of $4,025 for
arbitration fees and disbursements. Claimants have also requested an order to
have their Form U-5s amended to remove all references to any alleged improper
conduct. A.B. Watley, Inc. denies all wrongdoing in connection with this matter,
and has counterclaimed for $608,000 against Claimants for breach of contract and
fiduciary duty. A.B. Watley, Inc. intends to vigorously defend this matter and
prosecute its counterclaim.
We are respondent in an arbitration titled Gary Miller v. A.B. Watley, Inc.,
NASD Arb. No.: 03-07144. Claimant is seeking damages of approximately $49,000
relating to a breach of contract. A.B. Watley, Inc. denies all liability in
connection with this matter.
We are defendant in an action titled Pentech Financial Services, Inc. v. A.B.
Watley Group Inc., Supreme Court of the State of New York, County of New York,
Index No. 02-126759. Plaintiff has filed a complaint against A.B. Watley Group
Inc. for an alleged breach of a lease agreement. On May 28, 2003, Plaintiff
obtained a judgment in the amount of $465,583(a provision has been provided in
financial statements). A.B. Watley Group Inc. executed a settlement agreement
with Plaintiff, but the Company has defaulted under such settlement agreement.
14
Our former landlord, W.B. Wood & Co. Inc. filed a Notice of Petition for
Non-Payment against us in the District Court of the County of Suffolk for
failure to pay amounts owed in connection with our lease of our Melville, New
York office space. We did not respond to the action and our former landlord
obtained a judgment against us in the amount of $17,019,(a provision has been
provided in financial statements) which is presently owed.
We are defendant in an action titled Scott Schwartz v. A.B. Watley Inc.,
Supreme Court of the State of New York, County of New York, Index No. 121644/03.
Plaintiff filed a complaint alleging owed commissions and breach of contract.
A.B. Watley Inc. has settled the action for $6,750 which has been paid in full.
We are defendant in an action titled Siemens Financial Services, Inc. v. A.B.
Watley Group, Inc., Supreme Court of the State of New York, County of New York,
Index No. 603769/2002. Plaintiff filed a complaint alleging breach of contract.
Plaintiff has a judgment against A.B. Watley Group, Inc. in the amount of
$179,882 (a provision has been provided in financial statements) with interest
from July 10, 2003.
We are respondent in an arbitration titled Jeffrey Spittel v. A.B. Watley,
Inc., NASD Arbitration No. 03-08076. Claimant has submitted this claim to
arbitration claiming breach of contract, respondeat superior, and
misappropriation and conversion, in the amount of $7,500 plus punitive damages,
costs, disbursements and reasonable attorneys' fees. A.B. Watley, Inc. filed an
answer on January 12, 2004. A.B. Watley, Inc. denies all wrongdoing in
connection with this matter and intends to vigorously defend this matter.
We are defendant in an action titled Sprint Communication v. A.B. Watley,
Inc., United States District Court, Southern District of New York, Index No. 03
CV 6926. Plaintiff has submitted this claim alleging breach of contract for
unpaid telephone bills in the amount of $20,000 (a provision has been provided
in financial statements) plus costs, disbursements, and attorneys' fees. A.B.
Watley, Inc. filed an answer on January 8, 2004. A.B. Watley, Inc. denies all
wrongdoing in connection with this matter and intends to vigorously defend this
matter.
We are defendant in an action titled Peter Wigger v. A.B. Watley Group Inc.,
Supreme Court of the State of New York, County of New York, Index No. 604124/02.
Plaintiff filed a complaint alleging breach of a commission agreement and seeks
damages in the amount of $398,750 (a provision has been provided in financial
statements) plus interest accrued thereon. A.B. Watley Group Inc. is currently
in settlement negotiations regarding this matter.
We are defendant in an action titled Lehr Construction Corp. v. A.B. Watley
Group Inc., Supreme Court of New York, County of New York, Index No. 600276/02.
This action is for damages arising out of the alleged breach of a construction
contract. Plaintiff sought damages of approximately $233,794. On March 6, 2003,
the parties reached a settlement in which the Company consented to a judgment in
the amount of $295,857, less any payments made by the Company, and the parties
simultaneously entered into a Forbearance Agreement, which set forth a payment
schedule for the Company. The Company has paid $65,000 pursuant to the
Forbearance Agreement. On December 17, 2003, Plaintiff issued the Company a
Notice of Default under the Forbearance Agreement, which the Company has failed
to cure. Under the Forbearance Agreement, Plaintiff may execute on the
outstanding balance of the judgment in the amount of $179,917 (a provision has
been provided in financial statements) without further notice to the Company.
We are defendant in an action titled A.B. Watley Group, Inc./John Martinez,
Case No. 2-4173-03-36 Section 806 Sarbanes-Oxley Act Complaint. On July 11,
2003, the U.S. Department of Labor ("DOL") gave the Company notice that John
Martinez, a former officer of the Company, had filed a complaint against the
Company under Section 806 of the Sarbanes-Oxley Act of 2002 (the "Act"). The
Complaint alleges that the Company terminated Mr. Martinez in violation of the
Act for raising net-capital issues with the National Association of Securities
Dealers, Inc. - a private self-regulatory organization. The Complaint seeks: (i)
Mr. Martinez' base pay (at the annual rate of $150,000 per annum) for the period
from March 14, 2003 through April 7, 2003; (ii) the difference between his
current base pay with his new employer ($130,000) and his base pay at the
Company for a reasonable period of time; (iii) relocation costs incurred in
obtaining new employment in Baltimore, Maryland; (iv) litigation costs; (v) his
commuting costs during the time period April 7, 2003 until the unspecified time
of his relocation in Baltimore, Maryland; (vi) interest on the monies due him;
and (vii) any additional
15
compensation deemed appropriate by the DOL. On July 30, 2003, the Company
responded to the complaint and submitted its response and evidentiary materials
to the DOL. The response denies all liability and raised several defenses to the
complaint. The Company intends to vigorously defend this matter. On March 9,
2004, the Department of Labor gave notice that it had completed its
investigation and dismissed the complaint. Complainant has appealed and the U.S
Department of Labor has scheduled a proceeding on June 7, 2004.
We are respondent in an arbitration titled MCI Worldcom Communications, Inc.
v. A.B. Watley Group, Inc., AAA Arbitration, Reference # 1410003356. On
September 16, 2003, claimant filed this arbitration against the Company
asserting a breach of contract claim in the amount of $135,644 (a provision has
been provided in financial statements). On January 26, 2004, the Company
submitted its answer denying all material allegations and asserting several
affirmative defenses. The Company intends to continue to vigorously defend this
matter.
In March 2003, the holder of the $5 million secured demand note (the
"Noteholder") demanded repayment of the note. On March 31, 2003, ABW filed a
NASD Arbitration Demand and a Statement of Claim with the NASD Dispute
Resolution office. The arbitration sought to enforce the provisions of the
secured demand note agreement and to prevent premature withdrawal by the lender.
In April 2004, the parties agreed to discontinue the arbitration without
prejudice pursuant to a settlement agreement that provided for the repayment of
approximately $2.9 million of the $5 million outstanding principal of the
secured demand note. The Noteholder agreed that as long as the Company is not in
default of any of its obligation under the settlement agreement, not to commence
any litigation with respect to the outstanding balance due on the $5 million
secured demand note prior to December 20, 2004.
We are plaintiff in an action titled A.B. Watley Group Inc. v. John J. Amore,
et al., Supreme Court of the State of New York, County of New York, Index No.
602993/03. We have sued our former CEO who has filed a counterclaim against our
company.
We are defendant in an action titled John J. Amore v. Steven Malin and A.B.
Watley, Inc., Supreme Court of the State of New York, County of New York, Index
No. 603833/03. Plaintiff filed a complaint alleging breach of a contract against
A.B. Watley, Inc. seeking damages in the amount of $500,000 and slander against
Steven Malin, our Chairman, seeking damages in the amount of $5,000,000. We have
filed an answer denying all wrongdoing. We deny all wrongdoing in connection
with this matter and intend to vigorously defend this matter.
We are respondent in an arbitration titled William Frymer v. A.B. Watley,
Inc., NASD Arbitration No. 03-05524. A former employee of the Company has
commenced this arbitration claiming breach of contract and violation of New York
labor laws. The Claimant is seeking unpaid salary and bonus, stock options,
liquidated damages and punitive damages. We deny all wrongdoing in connection
with this matter and intend to vigorously defend this matter.
We are respondent in an arbitration titled James B. Fellus v. A.B. Watley,
Inc., NASD Arbitration No. 03-05526. A former employee of the Company has
commenced this arbitration claiming breach of contract and violation of New York
labor laws. The Claimant is seeking unpaid salary and bonus, stock options, a
lump sum payment of the sum of the highest month's Retail Division and Fixed
Income Division pretax profit incentive multiplied by 48, liquidated damages and
punitive damages. We deny all wrongdoing in connection with this matter and
intend to vigorously defend this matter.
In addition to the foregoing, in the ordinary course of business, we and our
principals are, and may become, a party to legal or regulatory proceedings
commenced by the NASD, the SEC or state securities regulators relating to
compliance, trading and administrative problems that are detected during
periodic audits and inspections or reported by dissatisfied customers. Such
matters, if pursued by such entities, could rise to the level of disciplinary
action. We are not currently involved in any proceeding by a governmental agency
or self-regulatory organization, the outcome of which is expected to have a
material
16
adverse effect on our business. There can be no assurance that one or more
future disciplinary actions, if decided adversely us, would not have a material
adverse effect on our business, financial condition and results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
On September 25, 2003, pursuant to a written consent in lieu of a meeting, the
stockholders of the Company holding 6,905,527 shares of common stock, a majority
of the outstanding shares of common stock approved the following:
o Robert Malin and Steven Malin were elected to the Company's Board of
Directors;
o Certain financing transactions were ratified requiring potential stock
issuances in excess of currently authorized capital stock;
o to increase the authorized number of common stock from 20,000,000 shares
to 50,000,000 shares;
o to adopt the Company's 2003 Stock Option Plan; and
o approve the selection of Marcum & Kliegman LLP as the Company's
independent auditors.
17
PART II
Item 5. Market for Registrant`s Common Equity and Related Stockholder Matters
The Company currently has authorized capital stock consisting of 50,000,000
common shares, $.001 par value, of which 12,787,138 shares are issued and
outstanding and 1,000,000 preferred shares, of which none are issued and
outstanding. The Company has authorized 690 shares of Series A Redeemable
Convertible Preferred Stock, $.01 par value, of which 630 are issued and
outstanding.
(a) Trading in the Company`s shares of Common Stock presently takes place on
the pink sheets under the symbol ABWG.
The following table sets forth the range of high and low sales prices for the
Company`s Common Stock for the last two fiscal years:
Fiscal 2004: High Low
--------------- ------ -----
10/1/03 - 12/31/03 $0.35 $0.15
1/01/04 - 3/31/04 $0.37 $0.18
Fiscal 2003: High Low
--------------- ------ -----
10/1/02 - 12/31/02 $0.75 $0.10
1/01/03 - 3/31/03 $0.65 $0.35
4/01/03 - 6/30/03 $0.50 $0.25
7/01/03 - 9/30/03 $0.72 $0.35
Fiscal 2002: High Low
--------------- ------ -----
10/1/01 - 12/31/01 $4.85 $2.00
1/01/02 - 3/31/02 $2.25 $0.66
4/01/02 - 6/30/02 $1.15 $0.06
7/01/02 - 9/30/02 $0.45 $0.10
(b) The number of record holders, exclusive of holders for whom shares are
being held in the name of brokerage houses and clearing agencies, of the
Company`s Common Stock was 93 on April 1, 2004.
(c) We have never paid cash dividends on our Common Stock. We do not expect
to declare or pay any dividends on our Common Stock in the foreseeable
future, but instead intend to retain all earnings, if any, to invest in
our operations. The payment of future dividends is within the discretion
of our board of directors and will depend upon our future earnings, our
capital requirements, financial condition and other relevant factors.
(d) To date the Company has not made any dividend payments associated with
the Series A Preferred Stock.
18
Item 6. Selected Financial Data
Consolidated Income Statement Data
Years ended
- --------------------------------------------------------------------------------------------------------------------------
Sept. 30, 2003 Sept. 30, 2002 Sept. 30, 2001 Sept. 30, 2000 Sept. 30, 1999
- --------------------------------------------------------------------------------------------------------------------------
Revenues:
Commissions 5,690,227 15,900,261 18,887,752 32,968,193 16,198,858
Data service fees 101,821 462,469 1,297,117 2,015,396 1,640,123
Principal transactions 7,848,918 2,533,998 3,196,844 5,689,695 2,456,874
Sale of software -- 3,908,308 -- -- --
Interest and other income 1,607,916 3,378,252 2,084,009 2,073,190 685,578
Interest income-related party -- -- 6,180 6,180 6,180
------------- ------------- ------------- ------------- -------------
Total revenues 15,248,882 26,183,288 25,471,902 42,752,654 20,987,613
------------- ------------- ------------- ------------- -------------
Interest expense 834,184 2,678,712 852,967 373,354 333,457
Interest expense to officer -- 392,841 398,117 71,417 15,000
------------- ------------- ------------- ------------- -------------
Net revenues 14,414,698 23,111,735 24,220,818 42,307,883 20,639,156
------------- ------------- ------------- ------------- -------------
Expenses:
Commission, floor brokerage and clearing 5,793,530 12,048,982 10,572,220 20,605,576 7,967,765
charges
Employee compensation and related costs 8,570,003 10,674,346 12,686,615 11,802,131 5,306,590
Loss on impairment of intangibles -- 7,870,110 -- -- --
Minority interests (87,019) (899,869) -- -- --
Other expenses 7,033,617 22,210,767 21,253,846 19,436,768 7,956,784
Loss on investments 84,287 -- 703,614 256,386 --
------------- ------------- ------------- ------------- -------------
Total expenses 21,394,418 51,904,336 45,216,295 52,100,861 21,231,139
------------- ------------- ------------- ------------- -------------
Loss before income tax and extraordinary (6,979,720) (28,792,601) (20,995,477) (9,792,978) (591,983)
loss on early extinguishments of debt
Income tax provision -- (8,725) (28,697) (53,913) (32,494)
------------- ------------- ------------- ------------- -------------
Loss before extraordinary loss on early (6,979,720) (28,801,326) (21,024,174) (9,846,891) (624,477)
extinguishments of debt
Extraordinary loss on early -- (250,000) -- -- (177,125)
extinguishment of debt
------------- ------------- ------------- ------------- -------------
Net loss $ (6,979,720) $(29,051,326) $(21,024,174) $ (9,846,891) $ (801,602)
============= ============= ============= ============= =============
Basic and diluted loss per common share:
Loss before extraordinary item $ (6,979,720) $(28,801,326) $(21,024,174) $ (9,846,891) $ (801,602)
Deemed dividend to preferred shareholders
- beneficial conversion feature -- (1,639,797) -- -- --
Deemed dividend to preferred shareholders
- accretion of redemption feature -- (1,959,617) -- -- --
Preferred stock dividends (252,000) (315,000) -- -- --
------------- ------------- ------------- ------------- -------------
Loss before extraordinary item
attributable to common shareholders (7,231,720) (32,715,740) (21,024,174) (9,846,891) (801,602)
------------- ------------- ------------- ------------- -------------
Extraordinary loss on
extinguishment of debt -- (250,000) -- -- --
------------- ------------- ------------- ------------- -------------
Net loss attributable to common
shareholders $ (7,231,720) $(32,965,740) $(21,024,174) $ (9,846,891) $ (801,602)
============= ============= ============= ============= =============
Basic and diluted loss before $ (0.57) $ (2.62) $ (2.13) $ (1.21) $ (0.09)
extraordinary item per common share
Basic and diluted loss per common $ (0.57) $ (2.64) $ (2.13) $ (1.21) $ (0.11)
share
Weighted average shares outstanding - 12,578,995 12,508,852 9,888,597 8,122,393 7,136,434
basic and diluted
Balance Sheet and Other Operating Data:
Total Assets $ 6,941,680 $ 7,036,620 $ 21,532,676 $ 29,032,644 $ 23,244,954
Property and Equipment, net of $ 1,698,062 $ 2,889,711 $ 14,806,945 $ 18,523,320 $ 10,852,956
accumulated depreciation
Long term obligations and redeemable $ 6,867,001 $ 6,926,487 $ 5,664,775 $ 6,071,129 $ 2,261,593
preferred stock
Stockholders` (deficit) equity $(22,497,075) $(16,828,339) $ 2,945,432 $ 12,177,786 $ 15,842,987
------------- ------------- ------------- ------------- -------------
19
(In thousands except per share data)
Year Ended September 30, (unaudited) First Quarter Second Quarter Third Quarter Fourth Quarter Full Year
- ---------------------------------------------------------------------------------------------------------------------------------
2003
Revenues $4,179 $3,494 $4,742 $2,834 $15,249
Net revenues 4,032 3,217 4,440 2,726 14,415
Loss before extraordinary item (1,675) (3,321) (1,004) (979) (6,979)
Net (loss) (1,675) (3,321) (1,004) (979) (6,979)
Loss before extraordinary item per share (0.14) (0.27) (0.09) (0.07) (0.57)
Basic and diluted loss per share (0.14) (0.27) (0.09) (0.07) (0.57)
- --------------------------------------------------------------------------------------------------------------------------------
2002
Revenues $8,289 $6,598 $5,320 $5,976 $26,183
Net revenues 7,272 5,120 4,888 5,832 23,112
Loss before extraordinary item (6,158) (14,492) (6,636) (1,515) (28,801)
Net (loss) (6,408) (14,492) (6,636) (1,515) (29,051)
Loss before extraordinary item per share (0.63) (1.22) (0.59) (0.18) (2.62)
Basic and diluted loss per share (0.65) (1.22) (0.59) (0.18) (2.64)
- --------------------------------------------------------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the consolidated
financial statements and notes thereto appearing elsewhere herein.
Results of Operations
Fiscal year ended September 30, 2003 compared to fiscal year ended September 30,
2002
Total revenues for fiscal 2003 were $15,248,882, a decrease of $10,934,406,
or 41.76% as compared to revenues of $26,183,288 for fiscal 2002.
Revenues from commissions decreased by $10,210,034, or 64.21%, from
$15,900,261 for fiscal 2002 to $5,690,227 for fiscal 2003 due primarily to the
decrease in retail commissions from accounts obtained in the On-Site Acquisition
and increased competition and pricing pressure.
Data service revenues decreased by $360,648, or 77.98%, from $462,469 for
fiscal 2002 to $101,821 for fiscal 2003 due to the increasing number of accounts
migrating to Ultimate Trader from other licensed software providers available
through our services. We charge our customers a data service fee for using other
software providers and do not charge for Ultimate Trader.
Revenues from principal transactions increased by $5,314,920, or 209.74%,
from $2,533,998 for fiscal 2002 to $7,848,918 for fiscal 2003, This increase is
primarily due to favorable overall market conditions and an increase in the
value of securities owned. Included in principal transactions for fiscal year
2002 are losses incurred by the Class B minority interest members of the LLC in
the amount of $740,585.
Revenues from the sale of software income decreased by $3,908,308, or
100.00%. The sale of software was transacted in 3rd quarter of fiscal 2002.
Interest and other income decreased by $1,770,336 or 52.40%, from
$3,378,252 for fiscal 2002 to $1,607,916 for fiscal 2003. This decrease is
largely due to the decreased margin interest and interest earned on the accounts
acquired from the On-Site transaction and interest income earned in the LLC.
Also included in interest income and other income for fiscal 2002 are one-time
settlements with venders. Also included in interest and other income for fiscal
2002, is a World Trade Center Business Recovery Grant of $150,000.
Interest expense decreased by $1,844,528 or 68.86%, from $2,678,712 for
fiscal 2002 to $834,184 for fiscal 2003 as a result of decreased borrowings
during the year. For fiscal 2002 the Company issued warrants in connection with
the increased borrowings. The value of such warrants were amortized over the
term of the loan as a component of interest expense. Interest expense relating
to the amortization of the warrants issued in connection with the financing
during the year ended September 30, 2002 was approximately $1,600,000.
20
Interest expense to officer - There was no related party interest for
fiscal 2003 as the related notes payable were forgiven in exchange for warrants
issued to the officers and former officers during fiscal 2002.
During fiscal 2003 there were no deemed dividends. During fiscal 2002,
there was $3,599,414 of deemed dividends.
During fiscal 2003 we had preferred dividends of $252,000 compared to
$315,000 during fiscal 2002. As of May 31, 2003, the holders of the preferred
stock agreed to waive dividends until July 31, 2004.
As a result of the foregoing, net revenues decreased by $8,697,037,or
37.63%, from $23,111,735 for fiscal 2002 to $14,414,698 for fiscal 2003. Nearly
all of our revenues were generated by clients in the United States and no single
group of related clients accounted for 10% or more of our revenues.
Total expenses decreased by $30,509,918 or 58.78%, from $51,904,336 for
fiscal 2002 to $21,394,418 for fiscal 2003.
Commissions, floor brokerage and clearing charges represent payments to our
clearing and floor brokers who facilitate our clients` transactions, payments
for data and software from third party venders and payouts to our non-business
branch locations. These expenses decreased $6,255,452 or 51.92%, from
$12,048,982 for fiscal 2002 to $5,793,530 for fiscal 2003. This is largely due
to a decrease in trading activity and a decrease in online software fees.
Employment compensation and related costs decreased by $2,104,343 or
19.71%, from $10,674,346 for fiscal 2002 to $8,570,003 for fiscal 2003,
primarily due to headcount reductions in administrative and management
personnel. Employee compensation also decreased due to the lower trading profits
generated by the Proprietary trading sales division for fiscal year 2003.
Communications expense decreased by $1,714,535 or 59.47%, from $2,882,953
for fiscal 2002 to $1,168,418 for fiscal 2003. This decrease was due to
discontinuing use of our offsite back up site and canceling data lines related
to the software that we had in fiscal 2002 and renegotiated new rates with our
vendors. Also in June of 2002 we closed the business of Onsite LLC.
Business development costs consist of television, radio, on-line and print
advertising to obtain new clients. These expenses decreased by $194,125, or
39.94%, from $485,993 for fiscal 2002 to $291,868 for fiscal 2003 as we
decreased our advertising and promotional efforts due to the slowdown in overall
trading volumes.
Professional fees decreased by $2,850,045 or 77.46%, from $3,679,184 for
fiscal 2002 to $829,139 for fiscal 2003.This decrease was largely due to a
decrease in accounting fees and legal fees associated with the On-Site
acquisition, the sale of the software and the conversion of notes payable.
Occupancy and equipment costs decreased by $3,781,593 or 64.70%,from
$5,845,238 for fiscal 2002 to $2,063,645 for fiscal 2003. Rent for fiscal 2003
decreased due to renegotiating our lease with our landlord and surrendering the
25th and 28th floors we had previously occupied space, the settlement and
expiration of certain leases during fiscal year 2003. These leases were
terminated as part of our overall cost cutting initiatives. In addition, during
fiscal year 2003 many of the Company's software maintenance and support
contracts expired. The Company did not renew or replace these contracts.
Depreciation and amortization decreased by $4,637,734 or 78.68%, from
$5,894,333 for fiscal 2002 to $1,256,599 for fiscal 2003 primarily due to the
disposal or surrender of assets subject to such depreciation and amortization.
We had sold software to an affiliate of our clearing broker and had written off
intangible assets recognized as a result of the On-Site acquisition. In
addition, we had surrendered leasehold improvements on the 25th floor and 28th
floors at 40 Wall Street.
Other expenses decreased by $257,803 or 15.33%, from $1,681,751 for fiscal
2002 to $1,423,948 for fiscal 2003. This decrease is a reduction in general
operating expenses as part of our overall cost cutting initiatives.
For fiscal 2002 we had a loss on impairment of $7,870,110 which represents
the write-off of intangible assets (customer lists) obtained in the On-Site
acquisition. The acquired customer base deteriorated significantly which
resulted in decreases in On-site
21
revenues and operating cash flows. This deterioration is attributable to many
causes including weakening market conditions, as well as the loss and closing of
branch operations, which resulted in a permanent impairment in the value of the
customer base acquired. There was no loss on impairment in fiscal 2003.
Loss on investments of $84,287 for fiscal 2003 represents the loss of the
value of the stock acquired from E*Trade in April 2002.
For fiscal 2002 the abandonment of leasehold improvements of $1,741,315
primarily relates to the surrender and termination of the 25th and 28th floor
office leases at 40 Wall Street that occurred in August 2002. These leases were
terminated as part of our overall cost cutting initiatives. In addition, we
abandoned leaseholds in offices formerly used by On-Site. There was no
abandonment of leasehold improvements for fiscal 2003.
Fiscal 2002 minority interest of $899,869 represents the trading losses of
the Class B non-voting members of the LLC.
As a consequence of the foregoing, our operating loss before income taxes
and extraordinary items decreased from $28,792,601 for fiscal 2002, to a loss of
$6,979,720 for fiscal 2003.
For Fiscal 2002 we had an extraordinary loss on extinguishment of debt of
$250,000 relating to the early extinguishment of the $2.5 million Senior
Subordinate Demand Note that was exchanged for $2,750,000 of Preferred Stock in
accordance with the Senior Subordinated Demand Note agreement.
During the year ended September 30, 2002, we had a deemed dividend to
preferred stockholders for beneficial conversion and accretion of the redemption
feature of $1,639,797 and $1,959,617, respectively, as well as a preferred stock
dividend of $315,000. As a consequence of the foregoing, our net loss
attributable to common shareholders decreased from $32,965,740 in fiscal 2002 to
$7,231,720 in fiscal 2003.
22
Results of Operations
Fiscal year ended September 30, 2002 compared to fiscal year ended September 30,
2001
Total revenues for fiscal 2002 were $26,183,288, an increase by $711,386 of
02.79% as compared to revenues of $25,471,902 for fiscal 2001.
Revenues from commissions decreased by $2,987,491, or 15.82%, from
$18,887,752 for fiscal 2001 to $15,900,261 for fiscal 2002 due primarily to a
decrease of UltimateTrader accounts, as well as a significant decrease in
overall trading activity by on-line traders due to adverse market conditions,
increased competition and pricing pressure. The decrease in Ultimate Trader
commissions, net of rebates in listed equities, over the counter securities and
options was $9,749,019 as compared to fiscal 2001. This decrease was partially
offset by the retail accounts acquired in the On-Site acquisition and the
commissions collected from the Class B Members in the LLC of $6,761,528.
Data service revenues decreased by $834,648, or 64.35%, from $1,297,117 for
fiscal 2001 to $462,469 for fiscal 2002 due to the increasing number of accounts
migrating to Ultimate Trader II from other licensed software providers available
through our services. We charge our customers a data service fee for using other
software providers and do not charge for Ultimate Trader II.
Revenues from principal transactions decreased by $662,846, or 20.73%, from
$3,196,844 for fiscal 2001 to $2,533,998 for fiscal 2002, mainly as a function
of lower volume of business conducted by the institutional sales division due to
adverse market conditions and unusually high employee turnover in the
institutional sales division. As a result of these factors, revenue from our
institutional sales division decreased $1,577,372 from the previous year.
Included in principle transactions for fiscal year 2002 are losses incurred by
the Class B minority interest members of the LLC of $740,585. These decreases
were partially offset by an increase in trading profits from the proprietary
trading division of $1,655,111.
Interest and other income increased from $2,084,009 for fiscal 2001 to
$3,378,252 for fiscal 2002. This increase is largely due to the increased margin
interest and interest earned on the additional accounts acquired from the
On-Site retail accounts and interest income earned in the LLC. Also included in
interest income and other income for fiscal 2002 are one-time settlements with
venders of $507,472 and a World Trade Center Business Recovery Grant of
$150,000.
Interest expense increased from $852,967 for fiscal 2001 to $ 2,678,712 for
fiscal 2002 as a result of increased borrowings during the year. The Company
issued warrants in connection with the borrowings. The value of such warrants
were amortized over the term of the loan as a component of interest expense.
Interest expense relating to the amortization of the warrants issued in
connection of the financing during the year ended September 30, 2002 was
approximately $1,600,000.
Interest expense - related party decreased by $5,276 or 1.33% from $398,117
for fiscal 2001 to $392,841 for fiscal 2002.
As a result of the foregoing, net revenues decreased by $1,109,083, or
4.58%, from $24,220,818 for fiscal 2001 to $23,111,735 for fiscal 2002. Nearly
all of our revenues were generated by clients in the United States and no single
group of related clients accounted for 10% or more of our revenues.
23
Total expenses increased by $6,688,041 or 14.79%, from $45,216,295 for
fiscal 2001 to $51,904,336 for fiscal 2002.
Commissions, floor brokerage and clearing charges represent payments to our
clearing and floor brokers who facilitate our clients` transactions, payments
for data and software from third party venders and payouts to our non-business
branch locations. These expenses increased $1,467,762 or 13.97%, from
$10,572,220 for fiscal 2001 to $12,048,982 for fiscal 2002. This increase is
largely due to the acquisition of the On-Site accounts with a lower gross margin
than our historical online client business. This increase was partially offset
by our lower volumes in our institutional sales division. In addition, our
online software licenses fees and data services fees decreased.
Employment compensation and related costs decreased by $2,012,269 or
15.86%, from $12,686,615 for fiscal 2001 to $10,674,346 for fiscal 2002,
primarily due to headcount reductions in administrative and management
personnel. Employee compensation also decreased due to the lower trading profits
generated by the institutional sales division for fiscal year 2002.
Communications expense increased by $672,897 or 30.45%, from $2,210,056 for
fiscal 2001 to $2,882,953 for fiscal 2002. This increase was due to the adding
of a back up site as well as the increased data and communication costs relating
to the On-Site branch locations.
Business development costs consist of television, radio, on-line and print
advertising to obtain new clients. These expenses decreased by $1,859,703, or
79.28%, from $2,345,696 for fiscal 2001 to $485,993 for fiscal 2002 as we
decreased our planned advertising and promotional efforts.
Professional fees decreased from $3,698,724 for fiscal 2001 to $3,679,184
for fiscal 2002. Accounting and legal fees increased $2,194,569. The increase in
accounting fees relates to the due diligence and the additional work relating to
the On-Site acquisition. Legal fees increased largely due to the On-site
acquisition, the issuance of Series A Preferred Stock, the software licensing
agreement with E*Trade and the sale of the software to our clearing broker. In
addition, legal costs were incurred for the settling of vendor claims. This
increase in legal and accounting fees was offset by a decrease in consulting
fees of $2,214,109 from fiscal year 2001, primarily as a result of our sale of
software, as external software consultants were no longer utilized to develop
and maintain such software.
Occupancy and equipment costs decreased by $464,759 or 7.37%, from
$6,309,997 for fiscal 2001 to $5,845,238 for fiscal 2002. Rent for the year
increased $494,916 largely due to the acquisition of the On-Site offices in
Great Neck, New York and Boca Raton, Florida. The office rent increase was
largely offset by a $470,787 decrease relating to the settlement with certain
leasing companies and the expiration of some leases during fiscal year 2002. In
addition, during fiscal year 2002 many of the Company`s software maintenance and
support contracts expired resulting in a decrease of $488,888 from the previous
year.
Depreciation and amortization increased by $394,411 or 7.17%, from
$5,499,922 for fiscal 2001 to $5,894,333 for fiscal 2002. This increase is
largely due to the amortization of the intangibles relating the On-site
acquisition of $715,000 net of a decrease in amortization of capitalized
software due to the sale of the software of approximately $540,000. Other
expenses increased by $492,300 or 41.39%, from $1,189,451 for fiscal 2001 to
$1,681,751 for fiscal 2002 due to the 2% penalty of approximately $311,000 for
not filing a registration statement in accordance with the Preferred Stock
agreement.
Loss on impairment of $7,870,110 represents the write off of intangible
assets (customer lists) obtained in the On-Site acquisition. The acquired
customer base deteriorated significantly which resulted in decreases in On-site
revenues and operating cash flows. This deterioration is attributable to many
causes including weakening market conditions, as well as the loss and closing of
branch operations, which resulted in a permanent impairment in the value of the
customer base acquired.
The abandonment of leasehold improvements of $1,741,315 primarily relates
to the surrender and termination of the 25th and 28th floor office leases at 40
Wall Street that occurred in August 2002. These leases were terminated as part
of our overall cost cutting initiatives. In addition, we abandoned leaseholds in
offices formerly used by On-Site.
24
Minority interest of $899,869 represents the trading losses of the Class
Bnon-voting members of the LLC.
As a consequence of the foregoing, our operating loss before income taxes
and extraordinary items increased from $20,995,477 for fiscal 2001, to a loss of
$28,792,601 for fiscal 2002.
The income tax provision (for minimum taxes) decreased from $28,697 for
fiscal 2001 to $8,725 for fiscal 2002.
We had an extraordinary loss on extinguishment of debt of $250,000 relating
to the early extinguishment of the $2.5 million Senior Subordinate Demand Note
that was exchanged for $2,750,000 of Preferred Stock in accordance with the
Senior Subordinated Demand Note agreement.
During the year ended September 30, 2002, we had a deemed dividend to
preferred stockholders for beneficial conversion and accretion of the redemption
feature of $1,639,797 and $1,959,617 respectively as well as a preferred stock
dividend of $315,000. As a consequence of the foregoing, our net loss increased
from $21,024,174 in fiscal year ended 2001 to $32,965,740 in fiscal year ended
2002.
Liquidity and Capital Resources
For the year ended September 30, 2003, we incurred consolidated losses of
approximately $7.0 million and used cash in our operating activities of nearly
$1.5 million. These losses and use of cash are in addition to the approximately
$50.1 million of losses and $24.1 million of cash used in operating activities
during the two years ending September 30, 2002. The market conditions during
fiscal 2003 have been very challenging for brokerage firms such as ABWG as well
as for the brokerage industry in general. Trading volume has significantly
decreased, we have lost customers in our core direct access business and
increased competition has put pricing and margin pressures on the Company.
To respond to our liquidity and capital resource needs, the Company has
taken, and is taking, a variety of steps to offset the cash used in operating
activities. Such steps include cost cutting initiatives, the pursuit of
additional revenue producing activities, and the raising of funds or reduction
of operating liabilities through sale of assets and the issuance of debt and
equity securities.
Our cost cutting initiatives include reductions in workforce, reductions in
capital expenditures, and renegotiating clearing corporation agreements at more
favorable rates. We are pursuing more traditional lines of business including
attracting active traders and hedge funds. However, in order to expand our
business, respond to competitive pressures and expand into additional products
and services, we have needed to raise additional funds through the issuance of
debt. When funds are raised through the issuance of equity securities or
financial instruments that are convertible into equity securities, our existing
shareholders may experience dilution in their ownership percentage or book
value. In addition, such securities may have rights, preferences and privileges
senior to those of the holders of our Common Stock. There can be no assurances
that the additional financing will be available when needed and on terms
satisfactory to the Company.
The Company may not be able to receive distributions from its regulated
broker-dealer subsidiaries due to capital withdrawal restrictions placed on the
regulated entities by the SEC`s Uniform Net Capital rule.
Cash used in operating activities during fiscal 2003 was $1,500,482. The
Company had a net loss of $6,979,720, which was largely offset by decreases in
restricted cash of $292,565, receivables from clearing brokers of $805,032, and
securities owned of $836,327. Offsets to cash used in operating activities
include the increases in accounts payable and accrued liabilities of $855,573,
payable to clearing broker of $1,597,767 and securities sold not yet purchased
of $28,010. Other offsets include a decrease in leasehold obligations of
$1,019,148 and non-cash items including depreciation and amortization of
$1,256,599, forgiveness of penalties on preferred stock of $759,107, the
issuance of warrants of $136,862 and amortization of options costs of $18,667.
25
Cash used in investing activities was $64,950 during fiscal 2003. The most
significant uses of cash used in investing activities were purchases of property
and equipment.
Cash provided by financing activities was $1,392,962 during fiscal 2003.
Cash provided by financing activities during fiscal 2003 consisted primarily of
net proceeds from the secured demand note of $1,798,000 offset by net payments
of notes payable of $200,000 and distributions to the Class B members of the LLC
of $205,038.
In 2002, cash used by operating activities during fiscal 2002 was
$8,278,756. We had a net loss of $29,051,326 and a decrease in securities sold
not yet purchased of $3,731,128 which was largely offset by a decreases in
receivables from clearing brokers of $1,178,045, securities owned of $2,748,940
and securities deposits of $1,312,479. Other offsets include non-cash items
including depreciation and amortization of $5,894,333, loss on impairment of
intangibles of $7,870,110, loss on disposal of leasehold improvements of
$1,741,315 and the issuance of warrants of $1,390,569.
Cash provided by investing activities was $4,138,384 during fiscal 2002.
The most significant sources of cash provided by investing activities was the
proceeds from the sale of the software.
Cash provided by financing activities was $3,846,085 during fiscal 2002.
Cash provided by financing activities during fiscal 2002 consisted primarily of
proceeds from the sale of Preferred Stock of $3,324,291, loans from officers of
$900,000, and notes payable of $187,884. In addition, we had capital
contributions from and distributions to, the Class B members of the LLC of
$446,307 and $1,012,397, respectively.
Cash used by operating activities during fiscal 2001 was $15,818,426. We
had a net loss of $21,024,174 and an increase from other assets of $324,319,
receivables from clearing brokers of $1,174,624, loans receivable from related
party of $129,126 and a decrease in accounts payable and accrued liabilities of
$513,973 which was offset by an increase in other liabilities of $67,288, and
non-cash items such as depreciation and amortization of $5,499,922, loss on
investments of $703,614 and non-cash compensation/service costs of $779,162.
Cash used in investing activities was $1,759,660 during fiscal 2001. Uses
of cash in fiscal 2001 related to purchases of equipment, software and leasehold
improvements made in our facility at 40 Wall Street of $1,759,660. In addition
to the cash used in investing activities during the year 2001, we accrued
accounts payable relating to purchases of property and equipment of $198,348
during this period.
Cash provided by financing activities was $12,996,056 during fiscal 2001.
Cash provided by financing activities during fiscal 2001 consisted primarily of
proceeds from the sale of Common Stock in a private equity offering of 2,027,241
shares at an offering price of $5.50, employee exercised stock options of
$987,290, loans from officers of approximately $850,000, and a loan of
$2,500,000. We used a portion of these proceeds to pay $790,938 in notes
payable, and $559,090 to pay obligations on capital leases.
At September 30, 2003, A.B. Watley has $5,530,000 of outstanding
subordinated loans, under agreements approved by the NASD. These loans are
included by A.B. Watley for purposes of computing its net capital under the
SEC`s net capital rules. These borrowings by A.B. Watley consist of:
o a $5,000,000 secured demand note from a third party bearing interest
at an annual rate of 7% (see Legal Proceedings).
o a $55,000 non-interest bearing loan and a $125,000 loan bearing
interest at 12% from an officer and a stockholder.
o a $200,000 loan, bearing interest at an annual rate of 15% and a
$150,000 loan bearing interest at an annual rate of 13%, from a family
member of a former executive officer of the Company
A.B. Watley is currently required to maintain minimum net capital such that
the ratio of aggregate indebtedness to net capital both as defined shall not
exceed 15 to 1 under the SEC`s net capital rule. Such rule also prohibits
"equity capital", including the subordinated loans, from being withdrawn or cash
dividends from being paid if our net capital ratio would exceed 10 to 1 or if we
would have less than our minimum required net
26
capital. Accordingly, our ability to repay the subordinated loans may be
restricted under the net capital rule.
Recent Accounting Developments
In January 2003, as revised in December 2003, the FASB issued
Interpretation No. 46 ("FIN46"), "Consolidation of Variable Interest Entities,
an Interpretation of ARB No. 51." FIN 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if the
equity investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 is effective for all new variable interest entities
created or acquired after January 31, 2003. For variable entities created or
acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for
the first interim or annual period beginning after March 15, 2004. Management
does not believe that the adoption of this pronouncement will have a material
effect on the Company's financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities." This statement clarifies the accounting guidance on (1) derivative
instruments (including certain derivative instruments embedded in other
contracts) and (2) hedging activities that fall within the scope of the SFAS
133. SFAS 149 also amends certain other existing pronouncements, which will
result in more consistent reporting of contracts that are derivatives in their
entirety or that contain embedded derivatives that warrant separate accounting.
SFAS 149 is effective (1) for contracts entered into or modified after September
30, 2003, with certain exceptions, and (2) for hedging relationships designated
after September 30, 2003. The guidance is to be applied prospectively.
Management does not believe that the adoption of any of this pronouncement will
have a material effect on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 addresses certain financial instruments that, under previous guidance,
could be accounted for as equity, but now must be classified as liabilities in
statements of financial position. These financial instruments include: 1)
mandatorily redeemable financial instruments, 2) obligations to repurchase the
issuer's equity shares by transferring assets, and 3) obligations to issue a
variable number of shares. SFAS No. 150 is effective for all financial
instruments entered into or modified after May 31, 2003, and otherwise effective
at the beginning of the first interim period beginning after June 15, 2003. The
Company adopted the above pronouncement during the current year and there was no
material effect on the Company's consolidated financial statements.
Off Balance Sheet Arrangements
Leases
During the year ended September 30, 2003, the Company had off balance sheet
arrangements related to its lease obligations. The Company is obligated under
such lease arrangements for $5,544,898 through 2009.
Clearing Agreements
Pursuant to clearance arrangements, the clearing and depository operations
for the Company and its customers' securities transactions are provided by two
clearing broker-dealers. The Company earns commissions as an introducing broker
for the transactions of its customers. In the normal course of business, the
Company's customer activities involve the execution and settlement of various
customer securities transactions. These activities may expose the Company to
off-balance-sheet risk in the event the customer or other broker is unable to
fulfill its contracted obligations and the Company has to purchase or sell the
security underlying the contract at a loss.
The Company's customer securities are transacted on either a cash or margin
basis. In margin transactions, the clearing broker extends the credit to the
Company's customer, subject to various regulatory margin requirements,
collateralized by cash and securities in the customers' accounts. However, the
Company is required to contact the customer and to either obtain additional
collateral or to sell the customer's position if such
27
collateral is not forthcoming. The Company is responsible for any losses on such
margin loans, and has agreed to indemnify its clearing brokers for losses that
the clearing brokers may sustain from the customer account introduced by the
Company.
Critical Accounting Policies and Procedures
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires that we
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and the related disclosure of contingent
assets and liabilities (see Note 2 to the consolidated financial statements). We
believe that of our significant accounting policies (see Note 2 to the
consolidated financial statements), the following may involve a higher degree of
judgment on our part and complexity of reporting.
Accounts Receivable
Accounts receivable consist primarily of amounts due to us from our normal
business activities. We maintain an allowance for doubtful accounts to reflect
the expected uncollectibility of accounts receivable based on past collection
history and specific risks identified among uncollected accounts.
Securities Transactions, Revenue, and Related Expenses
Securities transactions and related revenue and expenses, including
commissions, revenues and expenses, are recorded on trade date basis. Data
service revenues are recorded as the services are provided.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our primary financial instruments subject to market risk at September 30,
2003 consist of equity securities. In the normal course of business we hold
significant investments in equity securities. These instruments are subject to
material potential near-term losses in future earnings from reasonably possible
near-term changes in market rates or prices. We do not own derivative financial
instruments for speculative or trading purposes. In the normal course of
business, our customers enter into transactions where the risk of potential loss
due to market fluctuations or failure to perform exceeds the amount reported for
the transaction. We have established policies, procedures and internal processes
governing our management of market risk in the normal course of our business
operations. We, along with our clearing brokers, continuously monitor our
exposure to market and counter-party risk through the use of a variety of
financial, position and credit exposure reporting and control procedures. In
addition, we review the creditworthiness of each customer and/or other
counter-party with which we conduct business. We are not currently exposed to
any material currency exchange risk because the risk is borne by international
customers and our international licensees, and we do not hold any assets or
incur any liabilities denominated in foreign currency.
Item 8. Financial Statements and Supplementary Data
The financial statements required by this item are attached to this
document immediately following the signature page.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On July 26, 2002, Ernst & Young LLP informed us that it would no longer
serve as our independent auditors, and submitted its letter of resignation to
us. The audit reports of Ernst & Young on our consolidated financial statements
as of and for the fiscal years ended September 30, 2001 and September 30, 2000,
respectively, did not contain any adverse opinion or disclaimer of opinion, nor
were they qualified or modified as to uncertainty, audit scope or accounting
principles.
During our two fiscal years ended September 30, 2001, and 2000,
respectively, and subsequent interim periods through the date of Ernst & Young`s
resignation described above, there were no disagreements between us and Ernst &
Young on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedures which, if not resolved to Ernst &
Young`s satisfaction, would have caused Ernst & Young to make reference to the
28
subject matter of the disagreement in connection with its reports on our
consolidated financial statements for such years.
In a letter to our Board of Directors, Ernst & Young stated: "We believe the
Company`s Finance and Accounting department has insufficient resources and
expertise to ensure timely and accurate filing of requisite financial and
regulatory information." We believe that we are addressing those concerns by
addressed these concerns by hiring a consultant as interim Chief Financial
Officer and are taking additional steps to ensure timely filings in the future.
On October 8, 2002, we filed an amendment to our Current Report on Form 8-K
relating to the resignation of Ernst & Young as our independent auditors for the
purpose of including a letter, dated August 5, 2002, from Ernst & Young to the
Securities Exchange Commission pursuant to Item 304(a) of Regulation S-K under
the Securities Act of 1933, as amended.
On August 28, 2002, we engaged Israeloff, Trattner & Co. P.C. ("Israeloff") as
our independent public accountants. On October 10, 2002, Israeloff resigned as
our independent public accountants.
Israeloff did not issue a report on the Company`s financial statements during
our two most recent fiscal years and any subsequent interim period and,
therefore, no report contained an adverse opinion or disclaimer of opinion, or
was modified as to uncertainty, audit scope, or accounting principle.
Furthermore, during the two most recent fiscal years and any subsequent interim
period, there were no disagreements with Israeloff within the meaning of
Instruction 4 to Item 304 of Regulation S-B under the Securities Exchange Act of
1934 on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure, which disagreements, if not resolved
to the satisfaction of Israeloff, would have caused them to make reference in
connection with their opinion to the subject matter of the disagreement in
connection with any report they might have issued.
On October 21, 2002, we engaged Marcum & Kliegman LLP as our independent
public accountants.
Item 9A. Controls & Procedures
During the year, an evaluation was performed under the supervision and with
the participation of the Company`s management, including the Principal Executive
Officer and the Principal Financial Officer, of the effectiveness of the design
and operation of the Company`s disclosure controls and procedures. Based on that
evaluation, the Company`s management, including the Principal Executive Officer
and the Principal Financial Officer, concluded that the Company`s disclosure
controls and procedures were effective as of September 30, 2003. There have been
no significant changes in the Company`s internal controls or in other factors
that could significantly affect internal controls subsequent to September 30,
2003.
PART III
Item 10. Directors and Executive Officers of the Registrant
Directors are elected at each meeting of stockholders and hold office until the
next annual meeting of stockholders and the election and qualifications of their
successors. Executive officers are elected by and serve at the discretion of the
board of directors.
Our executive officers and directors are as follows:
Name Age Position
------- ----- ----------
Steven Malin 46 Chairman of the Board and Director
Robert Malin 39 Vice Chairman and Director
29
Steven Malin. Mr. Malin co-founded the Company in May 1996 and has been its
Chairman of the Board since inception. Mr. Malin also served as Chief Executive
Officer from May 1996 to September 2002. From August 1993 to December 1996, Mr.
Malin served as a consultant to the Company. From 1987 to 1993, he was a Senior
Foreign Exchange Options Broker for Tullett and Tokyo Forex, Inc., a global
inter-bank money brokering firm with its primary offices located in London, New
York and Tokyo. Mr. Malin attended the Fletcher School of Law and Diplomacy from
1982 to 1984. He received a bachelor of arts degree from Vassar College in 1980.
Robert Malin. Mr. Malin is a co-founder of the Company and has served as a
director since inception. He has been associated with the Company since August
1993, initially as General Securities Principal and director of day-to-day
operations and, most recently, serving as President. His earlier experience
includes managing equity trading, client services and brokerage operations. Mr.
Malin and Steven Malin are brothers.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
During the fiscal year ended September 30, 2003, based upon an examination of
the public filings, all of our company's officers and directors timely filed
reports on Forms 3 and 4 except for Michael Picone(1 late report).
Item 11. Executive Compensation
The following table sets forth for the fiscal year indicated the compensation
paid by our company to our Chief Executive Officer and other executive officers
with annual compensation exceeding $100,000:
Summary Compensation Table