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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 1-14897
A.B. Watley Group Inc.
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(Name of registrant as specified in its charter)
Delaware 13-3911867
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
40 Wall Street, New York, New York 10005
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(Address of principal executive offices) (Zip Code)
Registrant`s telephone number, including area code: (212) 422-1100
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
-----------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes / / No /X/.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant`s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K / /
The issuer`s revenues for the fiscal year ended September 30, 2002 were
$26,183,288.
The aggregate market value of the voting stock held by non-affiliates of
the registrant on December 31, 2002 computed by reference to the closing price
of such stock on such date was approximately $6,243,507. The number of shares of
common stock, par value $.001 per share, outstanding as of February 21, 2003 was
12,508,852 shares.
DOCUMENTS INCORPORATED BY REFERENCE
None
Forward Looking Statements: This Report contains certain statements that may be
deemed "forward-looking statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act. All statements, other than
statements of historical facts, that address activities, events or developments
that the Company intends, expects, projects, believes or anticipates will or may
occur in the future are forward-looking statements. Such statements are based on
certain assumptions and assessments made by management of the Company in light
of its experience and its perception of historical trends, current conditions,
expected future developments and other factors it believes to be appropriate.
The forward-looking statements included in this Report are also subject to a
number of material risks and uncertainties, including but not limited to
economic, competitive, governmental and technological factors affecting the
Company`s operations, markets, services and prices, and other factors discussed
in the Company`s filings under the Securities Act and the Exchange Act.
Stockholders and prospective investors are cautioned that such forward-looking
statements are not guarantees of future performance and that actual results,
developments and business decisions may differ from those envisaged by such
forward-looking statements.
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PART I
Item 1. Business
A.B. Watley Group Inc. ("ABWG" or the "Company") is a publicly-held
financial services holding company incorporated in the state of Delaware on May
15, 1996. We conduct our core business activities through our subsidiaries
A.B.Watley, Inc. ("A.B. Watley"), a U.S. registered broker-dealer that engages
in direct-access trading, proprietary trading of U.S. equities and institutional
sales and Integrated Clearing Solutions, Inc. ("Integrated"), a U.S. registered
broker-dealer that engages in mutual fund sales to institutional customers. We
provide direct-access trading capabilities and related software to both
individual as well as institutional customers. As of September 30, 2002, the
brokerage firms had approximately 4,000 customers.
We have historically devoted significant resources to the development of
proprietary software. However, in July 2002, our business activities were
reorganized and we sold our software programs know as Ultimate Trader II,
Ultimate Trader III, and Watley Trader, including all related intellectual
property rights, to a subsidiary of one of our clearing brokers. We no longer
consider software licensing to be a core revenue source. The sale of the
software programs provided us with working capital and reduced our expense base.
Pursuant to the terms of the sale, we maintain a perpetual, non-exclusive
license to use and sublicense the software.
To respond to our liquidity and capital resource needs, we have instituted
various cost cutting initiatives and raised additional capital. Our cost cutting
initiatives include reductions in workforce, reductions in capital expenditures
and renegotiation of clearing corporation agreements at more favorable rates. We
continue to evaluate acquisitions that might increase cash flow and enhance
economies of scale within our existing infrastructure.
On November 2, 2001, the Company acquired certain assets of On-Site
Trading, Inc. ("On-Site") and assumed up to $1.8 million in liabilities. This
acquisition included On-Site`s client base including 1,700 accounts representing
client assets (account balances and securities) of $84 million, On-Site Trading
LLC (the "LLC"), two branches owned by On-Site, and agreements with 12
non-business branch locations. LLC, a broker-dealer subsidiary (the proprietary
trading business) was subsequently renamed ABW TRADING, LLC. The Company
acquired these assets for 1.875 million shares of its Common Stock. In
connection with the acquisition of On-Site, the Company also assumed up to $1.8
million in liabilities of On-Site owed to the Class B members of the LLC. On
March 19, 2002, the Company reclaimed 361,944 shares of Common Stock being held
in escrow in connection with the On-Site acquisition and assumed additional
obligations of $1,050,000 in excess of the $1,800,000 that the Company had
originally agreed to assume.
The LLC was formed as a means for registered professionals to engage in
proprietary trading utilizing the LLC`s funds. Such registered professionals are
Class B members of the LLC, while the Company is the Class A member. The LLC was
a registered broker-dealer and a member of the Philadelphia Stock Exchange,
operated in 12 states and engaged exclusively in proprietary trading and did not
conduct business with the public. An initial capital contribution was required
to become a Class B member. On May 9, 2002, the Company notified the Class B
members that it had elected to cease the proprietary trading business as a
result of declining revenues. The Company continues to operate the On-Site
retail business, however the customer base has deteriorated significantly since
its acquisition and revenues from operations have declined. Management believes
that the deterioration is attributable to many factors including weakening
market conditions, as well as the loss and closing of branch operations. On June
18, 2002, the LLC withdrew its broker dealer registration and ceased trading
activities.
Online Brokerage Services
Our industry has experienced a series of changes led by electronic and
online commerce. These changes have created significant market opportunities for
us along with other similar brokerage firms. Favorable market trends have
resulted from the following:
o growing market acceptance of online brokerage services;
o pronounced market segmentation;
o a complementary regulatory environment; and
o disparity in the scalability and quality of competing trading
technologies.
Historically, individual investors accessed the financial markets through
full-commission brokers, who offered investment advice and placed trades. With
deregulation of brokerage commissions in 1975 and the resulting unbundling of
brokerage services, investors began to realize that they could separate
financial advisory services from securities trading. This brought about the
advent
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and subsequent proliferation of discount brokerage firms, which provided an
alternative investment approach by completing trades at a reduced cost.
The emergence of electronic brokerage services has provided investors with
further access to unbundled services and costs typically charged by
full-commission and traditional discount brokerage firms. Further, while
full-commission and discount brokerage firms are able to offer electronic
trading services, their continued reliance on personnel, branch offices and
associated infrastructure prevents them from capturing the same operating
efficiencies that are achievable by electronic trading.
The growth of discount brokerage firms and the increasing utilization of
the Internet to access a wide range of financial services underscore a
fundamental shift in market demographics. This shift has altered the way
consumers manage their personal financial assets. Based on industry research
reports and the rapid consumer acceptance of online transactions, we believe
consumers are increasingly taking direct control over their personal financial
affairs, not only because they are now able to do so, but also because they find
it more convenient and less expensive than relying on traditional financial
intermediaries.
We conduct our brokerage activities through a global communications network
and sophisticated computerized information systems over which we receive and
transmit current market information.
The direct access platform used by the Company is technologically advanced
and highly scalable. Our services are delivered to our customers through (a)
Ultimate Trader II, a client server direct access software application and (b)
Watley Trader, a web-based direct-access platform. Benefits of the products for
the retail market include:
o Direct Access to Exchanges & ECNs o Allows investors to execute
independently of third party market
makers for more efficient executions.
Provides ability to act as "market
maker" on par with institutional traders.
o Superior Speed of Execution o Client-server order execution model
substantially reduces time elapsed
between investor order entry and receipt
of order by exchange/ECN.
o Order Routing Discretion o Enables investors to actively determine
venue for order execution among variety
of alternatives (Island, Instinet, other
ECNs, NASDAQ, specific market makers,
NYSE DOT, our Company block trade desk).
Provides critical added ability to trade
at the best price.
o NASDAQ Level II Data o Enables access to complete range of
bid/ask, volume and market depth for
variety of execution markets.
o Realtime Data Analytics o Provides best available retail package
of real time, streaming market data,
charts and technical analysis. This
suite of content includes intra-day
charting, a variety of analytical
studies (e.g., RSI, moving averages,
MACD), time and sales, option quote
chains, regional exchange quotes and
news.
o High Utilization Capacity o Affords access to technology platform by
entire client base on simultaneous
basis. Critical given consistent high
level of concurrent utilization and
spikes in utilization due to highly
volatile market movements and shifts in
market liquidity.
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Client Services
Client services for all levels of our online service, including trading,
administrative, and technical support, are among our highest priorities. Based
on our experience in the industry and based on client feedback, providing an
effective client service team to handle client needs is critical to our success.
Our Client Service department helps clients get online, handles product and
services inquiries and addresses all brokerage and technical questions. The
Client Service department also conducts various surveys to verify the
satisfaction of our clients and to learn more about client preferences and
requirements.
We provide live client support from Monday through Friday between the hours
of 8:00 AM and 6:30 PM EST. Our Client Services department operates on a
one-stop shopping basis, meaning that clients do not typically have to be
transferred between departments to receive answers to their various inquiries.
All of our Client Service personnel are registered representatives and are
available to accept and execute client orders, research past trades, discuss
account information, and provide detailed technical support. A separate
technical support team helps clients with potentially serious or persistent
technical issues.
In order to provide professional and efficient client support we
implemented and use Client Relationship Management (CRM) and Computer Telephony
Integration (CTI) software. CRM databases are updated with each client contact
to track client service calls. A separate internal database tracks trading
patterns, changes in customer balances and compliance issues. Both databases are
used to generate periodic reports for management. Client Services associates
access the latest product and account information through CRM and customer
account databases.
Account Security
We use a combination of proprietary and industry standard security measures
to protect our clients` assets. Clients are assigned unique account numbers,
user identifications and passwords that must be used each time they log on to
the system. In accordance with standard industry practices, telephone orders
require authentication via personal identification number/password and/or other
personal information. In addition, the trade processing system A.B. Watley uses
is designed to compare the A.B. Watley accounts database with the clearing
firm`s account information on a daily basis to detect any discrepancies.
We rely on encryption and authentication technology, including public key
cryptography technology licensed from other parties, to provide the security and
authentication necessary to effect the secure exchange of information.
Proprietary Trading
The Company takes proprietary positions through the trading of U.S.
equities in an attempt to realize gains. Our proprietary trading activities
require the commitment of capital and create an opportunity for profits and risk
of loss due to trading strategies and market fluctuations. Buying power is
available to traders to the extent that the aggregation of all positions in all
of the Company`s accounts are within A.B. Watley`s Net Capital requirements.
Trading profits or losses depend upon, among other things, the skills of
traders, the capital allocated to securities positions, the financial condition
and business prospects of particular issuers and general trends in the
securities markets. The amount of capital allocated to a particular trader is
based on the trader`s experience and performance as well as our risk management
policies. Customer funds are not used to fund proprietary trading activities.
We believe that our trading capability is a key ingredient to our success.
While this business can earn attractive returns, there is also the possibility
of incurring significant trading losses in periods of market turbulence. We seek
to balance our ability to profit from trading positions with our exposure to
potential losses. Our risk management includes input from all levels of the
Company including our traders as well as management.
Institutional Sales
Our institutional sales and trading desk specializes in facilitating and/or
executing large-block transactions in equity securities, and services
institutional clients. These services are provided to clients who often require
that their purchases or sales of
5
large positions remain anonymous, with average trades ranging in the 10,000 to
100,000 share size. We match institutional buyers and sellers to minimize the
impact on the market and to prevent our client`s positions from being disclosed
to competing firms. Our institutional sales clients include mutual and pension
funds, insurance companies, banks, corporations and independent fund and money
managers.
Operations, Clearing and Order Processing
We do not hold client funds or securities, nor do we generally execute and
directly process either our own or our clients` securities transactions. Since
October 1996, we have cleared all transactions for retail clients, on a fully
disclosed basis, with Penson Financial Services, Inc. ("Penson") and Bank of New
York ("BONY") for institutional accounts.
Our agreements with such clearing brokers provide that the clearing brokers
process all securities transactions for our account and the accounts of our
clients for a fee. Services of the clearing brokers include billing and credit
control and receipt, custody and delivery of securities, for which we pay a per
ticket charge. We have agreed to indemnify our clearing brokers for losses they
may sustain from customer accounts introduced by us, which could be material in
amount. Our clearing agreements may be terminated by either party, upon 60 days`
written notice for Penson, and 30 days written notice for BONY. We depend on the
operational capacity and the ability of the clearing brokers for the orderly
processing of transactions. As a result of engaging the processing services of
clearing brokers, we are exempt from certain reserve requirements imposed by
federal securities laws.
Clients` securities transactions are effected on either a cash or margin
basis. In connection with margin transactions, credit is extended by the
clearing broker to a client, collateralized by securities and cash in the
client`s account, for a portion of the purchase price. The client is charged
interest by the clearing broker for margin financing. We receive a portion of
such interest from the clearing brokers.
Margin lending is subject to the margin rules of the Board of Governors of
the Federal Reserve System. Margin lending subjects us to the risk of a market
decline that would reduce the value of the collateral below the client`s
indebtedness before the collateral can be sold. Under applicable rules, in the
event of a decline in the market value of the securities in a margin account,
the client is required to deposit additional securities or cash in the account.
Marketing and Advertising
In connection with our cost-cutting initiatives, we have significantly
reduced our marketing and advertising expenditures.
Competition
The market for electronic brokerage services is highly competitive and
rapidly changing. We believe that we compete on the basis of speed of order
execution, processing and confirmation, quality of client service, ease of use,
amount and timeliness of information provided, price and reliability of the
trading systems which we utilize. Our competitors may have greater financial,
technical and marketing resources than the Company. We expect that our ability
to compete will be affected by our ability to introduce new services and
enhancements to existing services into the market on a timely basis.
We believe our competition consists of large and small brokerage firms
utilizing the Internet to transact retail brokerage business. Among these
competitors are E*TRADE Securities LLC.; Charles Schwab & Co., Inc.; Quick &
Reilly, Inc.; TD Waterhouse Investor Services, Inc.; Fidelity Brokerage Services
LLC; and Ameritrade, Inc.; We also face competition for clients from full
commission brokerage firms, including Merrill Lynch & Co., Inc.; Morgan Stanley
DW Inc.; UBS PaineWebber Inc.; and Smith Barney, as well as financial
institutions and mutual funds.
Securities Regulation
A.B. Watley, and Integrated (collectively, the "B-D Subsidiaries") are
broker-dealers registered with the SEC and NASD and licensed in the states in
which they do business.
The securities industry in the United States is subject to extensive
regulation under federal and state laws. In addition, the SEC, NASD, other
self-regulatory organizations, such as the various stock exchanges, and other
regulatory bodies, such as state securities commissions, require strict
compliance with their rules and regulations. As a matter of public policy,
regulatory bodies are charged with safeguarding the integrity of the securities
and other financial markets and with protecting the interests of clients
participating in those markets, and not with protecting the interests of our
stockholders.
Broker-dealers are subject to regulations covering all aspects of the
securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of clients funds and securities, capital
structure, record keeping and the conduct of directors, officers and employees.
Because of the number of complaints by online traders, the SEC, NASD and other
regulatory organizations may adopt more stringent regulations for online firms
and their practices. If we fail to comply with any laws, rules or regulations we
could be censured, fined, suspended, or expelled.
In addition, significant changes in the B-D Subsidiaries` current business
or practices, require NASD and other regulatory approval.
To expand our services internationally, we would have to comply with
regulatory controls of each specific country in which we conduct business. The
brokerage industry in many foreign countries is heavily regulated. The varying
compliance requirements of these different regulatory jurisdictions and other
factors may limit our ability to expand internationally.
All marketing activities by the B-D Subsidiaries are regulated by the NASD.
The NASD can impose penalties, including censure, fine, suspension of all
advertising, the issuance of cease-and-desist orders or the suspension or
expulsion of a broker-dealer and its officers or employees for violations of the
NASD`s advertising regulations.
Net Capital Requirements
The SEC, NASD and various other regulatory agencies have stringent rules
requiring the maintenance of specific levels of net capital by securities
brokers, including the SEC`s uniform net capital rule which governs A.B. Watley
and Integrated. Net capital is defined as assets minus liabilities, plus other
allowable credits and qualifying subordinated borrowings less mandatory
deductions that result from excluding assets that are not readily convertible
into cash and from valuing other assets, such as a firm`s positions in
securities, conservatively. Among these deductions are adjustments in the market
value of securities to reflect the possibility of adverse market movement prior
to disposition.
If either of the B-D Subsidiaries fails to maintain the required net
capital, such subsidiary may be subject to suspension or revocation of
registration by the SEC and suspension or expulsion by the NASD and other
regulatory bodies, which ultimately could require the Subsidiary`s liquidation.
In addition, a change in the net capital rules, the imposition of new rules, a
significant operating loss, or any unusually large charge against net capital
could limit our operations that require the intensive use of capital and could
limit our ability to expand our business. The net capital rules also could
restrict our ability to withdraw capital from the B-D Subsidiaries, which could
limit our ability to pay dividends, repay debt and repurchase shares of our
outstanding stock.
During the year ended September 30, 2002, A.B. Watley had Net Capital
deficiencies which were subsequently cured.
Personnel
As of December 31, 2002, we employed a total of 48 persons, of whom 5 are
engaged in executive management, 16 in trading activities, 6 in information
technology, 8 in client service, 3 in sales and marketing, and 10 administration
and back office personnel. We believe our relations with our employees are
generally good and we have no collective bargaining agreements with any labor
unions. During the fiscal year ended September 30, 2002 the company completed a
reduction in force.
Our registered representatives are required to take examinations
administered by the NASD and state authorities to be qualified to transact
business, and are required to enter into agreements with A.B. Watley obligating
them to adhere to our supervisory procedures and not to solicit customers in the
event of termination of employment. Our agreements with registered
representatives do not obligate these representatives to be associated with the
Company for any length of time.
The Company`s proprietary trading activities are primarily performed by
registered representatives who receive a portion of their trading profits, after
deductions for trading expenses. They are outside contractors, not entitled to
participation in any benefits plans of the Company.
Investment Considerations and Risk Factors
The following factors and other information in this Form 10-K should
carefully be considered when evaluating the Company and its stock.
o If we are unable to continue cost cutting and revenue generation
initiatives, enter into a strategic business combination or obtain
additional funding sources at acceptable terms, our ability to operate
our business will be significantly diminished.
We are implementing cost cutting and revenue generation initiatives, and
exploring strategic business combinations. We also will need to find additional
funding sources at rates and terms acceptable to us to meet our capital and
liquidity needs for the remainder of the year. To the extent that capital is
raised through the sale of equity or convertible debt securities, the issuance
of these securities could result in dilution to our stockholders. If we are
unable to obtain such financing, make sufficient improvement in our operating
results or find a strategic partner our ability to operate our business will be
significantly diminished.
o Periods of declining securities prices, decreasing trade volumes, or
uncertainty in the public equity markets may adversely affect our
revenues.
Our future revenues are likely to be lower during periods of declining
securities prices or reduced securities market activity The public markets have
historically experienced significant volatility not only in the number and size
of share offerings, but also in the secondary market trading volume and prices
of newly issued securities. Activity in the private equity markets frequently
reflects the trends in the public markets. As a result, our revenues from
brokerage activities may also be adversely affected during periods of declining
prices or reduced activity in the public markets.
o We may not be able to adapt with rapid technological change in a cost
effective manner, which could materially adversely impact the
Company`s business, financial condition and operating results.
Traditional and online financial services industries are characterized by
rapid technological change, changes in customer requirements, frequent new
service and product introductions and enhancements and evolving industry
standards. Our future success will depend on our ability to enhance our existing
services and products. We must also develop new services and products that
address the increasingly sophisticated and varied needs of our customers and
prospective customers. We must respond to technological
6
advances and evolving industry standards and practices on a timely and
cost-effective basis. The development and enhancement of services and products
entails significant technical and financial risks. We may fail to
o use new technologies effectively;
o adapt services and products to evolving industry standards; or
o develop, introduce and market service and product enhancements or new
services and products.
In addition, we may experience difficulties that could delay or prevent the
successful development, introduction or marketing of our services and products,
and our new service and product enhancements may not achieve market acceptance.
If we encounter these problems, our business, financial condition and operating
results may be materially adversely affected.
o Operational risks may disrupt our business or limit our growth.
Like other securities and securities-related businesses, we are highly
dependent on information processing and telecommunications systems. We face
operational risks arising from potential mistakes made in the confirmation or
settlement of transactions or from the failure to properly record, evaluate or
account for transactions. Our business is highly dependent on our ability, and
the ability of our clearing firms, to process, on a daily basis, a large and
growing number of transactions across numerous and diverse markets.
Consequently, we and our clearing firms rely heavily on our respective
financial, accounting, telecommunications and other data processing systems. If
any of these systems fail to operate properly or become unavailable due to
problems with our physical infrastructure, we could suffer financial loss, a
disruption of our business, liability to clients, regulatory intervention or
reputational damage. In addition, we are aware that other companies in our
industry have had problems due to high volume of telephone and e-mail customer
inquiries that has at times strained the capacity of their telecommunications
systems and customer service staffs, and has also led to temporary disruptions
in website service. Thus, any inability of systems used to accommodate an
increasing volume of transactions and customer inquiries could also constrain
our ability to expand our businesses and could damage our reputation.
o Employee misconduct could harm us and is difficult to detect and
deter.
There have been a number of highly publicized cases involving fraud or
other misconduct by employees in the financial services industry in recent
years, and we run the risk that employee misconduct could occur. Misconduct by
employees could bind us to transactions that exceed authorized limits or present
unacceptable risks, or hide from us unauthorized or unsuccessful activities. In
either case, this type of conduct could result in unknown and unmanaged risks or
losses. Employee misconduct could also involve the improper use of confidential
information, which could result in regulatory sanctions and serious reputational
harm. It is not always possible to deter employee misconduct, and the
precautions we take to prevent and detect this activity may not be effective in
all cases.
o The securities industry in which we operate is heavily regulated by
the Securities and Exchange Commission ("SEC"), state regulators, and
the National Association of Securities Dealers ("NASD"). If we fail to
comply with applicable laws and regulations, we may face penalties or
other sanctions that may be detrimental to our business.
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. Broker-dealers are subject to
regulations covering all aspects of the securities business, including:
o sales methods;
o trade practices among broker-dealers;
o use and safekeeping of customers` funds and securities;
o capital structure;
o record keeping;
o conduct of directors, officers, and employees; and
o supervision of employees, particularly those in branch offices.
The principal purpose of regulation and discipline of broker-dealers is the
protection of customers and the securities markets, rather than protection of
creditors and stockholders of broker-dealers.
Uncertainty regarding the application of these laws and other regulations
to our business may adversely affect the viability and profitability of our
business. The SEC, the NASD, other self-regulatory organizations and state
securities commissions can censure, fine, issue cease-and-desist orders, or
suspend or expel a broker-dealer or any of its officers or employees. Our
ability to comply with all applicable laws and rules is largely dependent on our
establishment and maintenance of a compliance system to ensure such compliance,
as well as our ability to attract and retain qualified compliance personnel. We
could be subject to disciplinary or other actions due to claimed noncompliance
in the future, and the imposition of any material penalties or orders on us
could have a material adverse effect on our business, operating results and
financial condition. In addition, it is possible that noncompliance could
subject us to future civil lawsuits, the outcome of which could harm our
business.
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In addition, our mode of operation and profitability may be directly
affected by:
o additional legislation;
o changes in rules promulgated by the SEC, state regulators, the NASD,
and other regulatory and self-regulatory organizations; and
o changes in the interpretation or enforcement of existing laws and
rules.
o The failure to remain in compliance with the Net Capital Rule would
adversely affect our ability to continue to operate as a
broker-dealer.
The SEC, the NASD and various other regulatory agencies have stringent
rules with respect to the maintenance of specific levels of net capital by
securities brokers, including the SEC`s Uniform Net Capital Rule (the "Net
Capital Rule"). Net capital is the net worth of a broker or dealer (assets minus
liabilities), less certain deductions that result from excluding assets that are
not readily convertible into cash and from conservatively valuing certain other
assets. Failure to maintain the required net capital may subject a firm to
suspension or revocation of registration by the SEC and suspension or expulsion
by the NASD and other regulatory bodies and ultimately could require the firm`s
liquidation.
In addition, a change in the net capital rules, the imposition of new rules
or any unusually large charge against net capital could limit those aspects of
our contemplated operations that require the intensive use of capital, such as
trading activities and the financing of customer account balances. A significant
operating loss or any unusually large charge against net capital could adversely
affect our ability to operate and/or expand, which could have a material adverse
effect on our business, financial condition and operating results.
As of February 28, 2002, March 31, 2002, and April 30, 2002, the Company
had a net capital deficit as defined, of $520,836, $1,487,966, and $637,141,
respectively, in violation of the Net Capital Rule. In addition, as of September
30, 2002, the Company had a net capital deficit of $301,523. These deficiencies
were cured through additional funding and through funds generated from
operations. While the Company is presently in compliance with net capital
requirements, there can be no assurance that we will not fall below minimum net
capital requirements in the future.
o The failure of brokerage customers to meet their margin requirements
could result in significant liabilities.
The brokerage business, by its nature, is subject to risks related to
defaults by our customers in paying for securities they have agreed to purchase
and delivering securities they have agreed to sell. Our clearing firm may make
margin loans to our customers in connection with their securities transactions.
We are required by contract to indemnify that firm for, among other things, any
loss or expense incurred due to defaults by our customers in failing to repay
margin loans or to maintain adequate collateral for those loans. We will be
subject to risks inherent in extending credit, especially during periods of
volatile markets or in connection with the purchase of highly volatile stocks
which could lead to a higher risk of customer defaults.
o We may be obligated to redeem our Series A Preferred Stock at a point
in the future, which would impair our ability to raise additional
capital as we would more than likely not be able to repay such
redemption.
The holders of our Series A Preferred Stock have the right to have their
shares redeemed for cash equal to the greater of (i) the price we received when
we sold them the stock ($10,000 per share) plus any accrued and unpaid dividend
payments and (ii) the aggregate value of the shares of Common Stock into which
such shares of Series A Preferred Stock are then convertible (based upon the
closing bid price), in any of the following situations:
o if our Common Stock is not tradable on the NYSE, the AMEX, the NASDAQ
National Market or the NASDAQ SmallCap market for a period of five
consecutive days.
o if we fail to register with the Securities and Exchange Commission (or
maintain such registration of) the Common Stock into which the Series
A Preferred Stock converts.
o if we fail to honor requests for conversion, or if we notify any
holder of Series A Preferred Stock of our intention not to honor
future requests for conversion.
o if the holders of more than 30 percent of the outstanding shares of
our Common Stock sell or exchange their stock.
o if we commit a material breach under, or otherwise materially violate
the terms of, the transaction documents entered into in connection
with the issuance of the Series A Preferred Stock and the warrants.
In April of 2002, our Common Stock was delisted from the NASDAQ Stock
Market. In addition, we have not registered the Common Stock into which the
Series A Preferred Stock converts. We have not received a redemption notice from
any of the holders of our Series A Preferred Stock. Redemption of the Series A
Preferred Stock in any event described above would require us to expend a
significant amount of cash that likely will exceed our ability to make such
payment or raise additional capital.
8
o Our stockholders could experience substantial dilution as a result of
the issuance of and terms of our Series A Preferred Stock and the
related warrants.
The 630 shares of Series A Preferred Stock that were sold in the private
placement are initially convertible into approximately 2,135,700 shares of
Common Stock. The warrants granted in connection with the sale of Series A
Preferred Stock are initially exercisable for 1,629,069 shares of Common Stock,
at an exercise price of $2.95 per share.
Under the terms of the Series A Preferred Stock, we are also obligated to
issue additional shares of Common Stock every six months to the holders of the
Series A Preferred Stock as preferred stock dividends. Initially, these
dividends will be payable at the rate of six percent for the first 18 months
following issuance of the Series A Preferred Stock and fifteen percent after
that initial 18 month period. The number of shares of Common Stock will be
determined by dividing the dividend payment by the market price for our Common
Stock on the day before such dividend is payable. Because these shares are
issueable as a dividend, we will receive no additional consideration in
connection with their issuance.
o We may also be required to issue shares of Common Stock without
additional consideration in the event that we fail to redeem any
shares of Series A Preferred Stock when required.
All of the foregoing issuances of Common Stock are likely to be
substantially dilutive to the outstanding shares of Common Stock, especially
where, as described above, the shares of Common Stock are issued without
additional consideration. Moreover, any increase in the number of shares of
Common Stock we are required to issue resulting from anti-dilution protection,
penalties or other adjustments to the conversion or exercise prices of the
Series A Preferred Stock and/or the warrants described above will further
increase the anticipated dilution to the outstanding holders of our Common
Stock. We cannot predict whether or how many additional shares of our Common
Stock will become issuable due to these provisions.
Any such dilution, potential dilution, or increase in dilution or potential
dilution, may result in a decrease in the value of the outstanding shares of our
Common Stock. Such a decrease in value, the risk of dilution, any actual
dilution, or any increase in potential dilution may cause our stockholders to
sell their shares, which would contribute to a downward movement in the price of
our Common Stock. This could prevent us from sustaining a per share price
sufficient to enable us to maintain an active trading market on the NASDAQ
National Market or SmallCap Market if our stock is re-listed. In addition, any
downward pressure on the trading price of our Common Stock could encourage
investors to engage in short sales, which would further contribute to a downward
pricing of our Common Stock.
o We may be required to obtain the consent of the holders of Series A
Preferred Stock before taking corporate actions, which could harm our
business.
Our charter documents require us to obtain the consent of the holders of
the Series A Preferred Stock before we may issue securities that have senior or
equal rights as the Series A Preferred Stock or take other actions with respect
to the Series A Preferred Stock or securities that have fewer rights than the
Series A Preferred Stock. We are also required to obtain the consent of the
holders of the Series A Preferred Stock before we amend or modify our
certificate of incorporation or bylaws, whether by merger, consolidation or
otherwise to change any of the rights of the holders of Series A Preferred
Stock. While these obligations may deter a potential acquirer from completing a
transaction with us, they may also prevent us from taking corporate actions that
would be beneficial to the holders of our Common Stock and the Company, such as
raising capital to operate our business or maintain our capitalization or per
share price in attempts to maximize stockholder volume and liquidity.
o We may be unable to obtain critical goods or services from our
suppliers
We obtain financial information from a number of third-party suppliers of
software and information services. We believe we have available to us at
comparable cost a number of alternative sources of supply of these items of
software and information services, to provide adequate replacements on a timely
basis, if arrangements with any of our current suppliers are abrogated. We have
established a number of relationships with third-party suppliers of software and
information services. There can be no assurance that such relationships will
continue or that timely replacement of such services will be available in the
future.
Marketing and Advertising
In connection with our cost-cutting initiatives, we have significantly
reduced our marketing and advertising expenditures.
Competition
The market for electronic brokerage services is highly competitive and
rapidly changing. We believe that we compete on the basis of speed of order
execution, processing and confirmation, quality of client service, ease of use,
amount and timeliness of
9
information provided, price and reliability of the trading systems which we
utilize. Our competitors may have greater financial, technical and marketing
resources than the Company. We expect that our ability to compete will be
affected by our ability to introduce new services and enhancements to existing
services into the market on a timely basis.
We believe our competition consists of large and small brokerage firms
utilizing the Internet to transact retail brokerage business. Among these
competitors are E*TRADE Securities LLC.; Charles Schwab & Co., Inc.; Quick &
Reilly, Inc.; TD Waterhouse Investor Services, Inc.; Fidelity Brokerage Services
LLC; and Ameritrade, Inc.; We also face competition for clients from full
commission brokerage firms, including Merrill Lynch & Co., Inc.; Morgan Stanley
DW Inc.; UBS PaineWebber Inc.; and Smith Barney, as well as financial
institutions and mutual funds.
Securities Regulation
A.B. Watley, and Integrated (collectively, the "B-D Subsidiaries") are
broker-dealers registered with the SEC and NASD and licensed in the states in
which they do business.
The securities industry in the United States is subject to extensive
regulation under federal and state laws. In addition, the SEC, NASD, other
self-regulatory organizations, such as the various stock exchanges, and other
regulatory bodies, such as state securities commissions, require strict
compliance with their rules and regulations. As a matter of public policy,
regulatory bodies are charged with safeguarding the integrity of the securities
and other financial markets and with protecting the interests of clients
participating in those markets, and not with protecting the interests of our
stockholders.
Broker-dealers are subject to regulations covering all aspects of the
securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of clients funds and securities, capital
structure, record keeping and the conduct of directors, officers and employees.
Because of the number of complaints by online traders, the SEC, NASD and other
regulatory organizations may adopt more stringent regulations for online firms
and their practices. If we fail to comply with any laws, rules or regulations we
could be censured, fined, suspended, or expelled.
In addition, significant changes in the B-D Subsidiaries` current business
or practices, require NASD and other regulatory approval.
To expand our services internationally, we would have to comply with
regulatory controls of each specific country in which we conduct business. The
brokerage industry in many foreign countries is heavily regulated. The varying
compliance requirements of these different regulatory jurisdictions and other
factors may limit our ability to expand internationally.
All marketing activities by the B-D Subsidiaries are regulated by the NASD.
The NASD can impose penalties, including censure, fine, suspension of all
advertising, the issuance of cease-and-desist orders or the suspension or
expulsion of a broker-dealer and its officers or employees for violations of the
NASD`s advertising regulations.
Net Capital Requirements
The SEC, NASD and various other regulatory agencies have stringent rules
requiring the maintenance of specific levels of net capital by securities
brokers, including the SEC`s uniform net capital rule which governs A.B. Watley
and Integrated. Net capital is defined as assets minus liabilities, plus other
allowable credits and qualifying subordinated borrowings less mandatory
deductions that result from excluding assets that are not readily convertible
into cash and from valuing other assets, such as a firm`s positions in
securities, conservatively. Among these deductions are adjustments in the market
value of securities to reflect the possibility of adverse market movement prior
to disposition.
If either of the B-D Subsidiaries fails to maintain the required net
capital, such subsidiary may be subject to suspension or revocation of
registration by the SEC and suspension or expulsion by the NASD and other
regulatory bodies, which ultimately could require the Subsidiary`s liquidation.
In addition, a change in the net capital rules, the imposition of new rules, a
significant operating loss, or any unusually large charge against net capital
could limit our operations that require the intensive use of capital and could
limit our ability to expand our business. The net capital rules also could
restrict our ability to withdraw capital from the B-D Subsidiaries, which could
limit our ability to pay dividends, repay debt and repurchase shares of our
outstanding stock.
During the year ended September 30, 2002, A.B. Watley had Net Capital
deficiencies which were subsequently cured.
Personnel
As of December 31, 2002, we employed a total of 48 persons, of whom 5 are
engaged in executive management, 16 in trading activities, 6 in information
technology, 8 in client service, 3 in sales and marketing, and 10 administration
and back office
10
personnel. We believe our relations with our employees are generally good and we
have no collective bargaining agreements with any labor unions. During the
fiscal year ended September 30, 2002 the company completed a reduction in force.
Our registered representatives are required to take examinations
administered by the NASD and state authorities to be qualified to transact
business, and are required to enter into agreements with A.B. Watley obligating
them to adhere to our supervisory procedures and not to solicit customers in the
event of termination of employment. Our agreements with registered
representatives do not obligate these representatives to be associated with the
Company for any length of time.
The Company`s proprietary trading activities are primarily performed by
registered representatives who receive a portion of their trading profits, after
deductions for trading expenses. They are outside contractors, not entitled to
participation in any benefits plans of the Company.
Investment Considerations and Risk Factors
The following factors and other information in this Form 10-K should
carefully be considered when evaluating the Company and its stock.
o If we are unable to continue cost cutting and revenue generation
initiatives, enter into a strategic business combination or obtain
additional funding sources at acceptable terms, our ability to operate
our business will be significantly diminished.
We are implementing cost cutting and revenue generation initiatives, and
exploring strategic business combinations. We also will need to find additional
funding sources at rates and terms acceptable to us to meet our capital and
liquidity needs for the remainder of the year. To the extent that capital is
raised through the sale of equity or convertible debt securities, the issuance
of these securities could result in dilution to our stockholders. If we are
unable to obtain such financing, make sufficient improvement in our operating
results or find a strategic partner our ability to operate our business will be
significantly diminished.
o Periods of declining securities prices, decreasing trade volumes, or
uncertainty in the public equity markets may adversely affect our
revenues.
Our future revenues are likely to be lower during periods of declining
securities prices or reduced securities market activity The public markets have
historically experienced significant volatility not only in the number and size
of share offerings, but also in the secondary market trading volume and prices
of newly issued securities. Activity in the private equity markets frequently
reflects the trends in the public markets. As a result, our revenues from
brokerage activities may also be adversely affected during periods of declining
prices or reduced activity in the public markets.
o We may not be able to adapt with rapid technological change in a cost
effective manner, which could materially adversely impact the
Company`s business, financial condition and operating results.
Traditional and online financial services industries are characterized by
rapid technological change, changes in customer requirements, frequent new
service and product introductions and enhancements and evolving industry
standards. Our future success will depend on our ability to enhance our existing
services and products. We must also develop new services and products that
address the increasingly sophisticated and varied needs of our customers and
prospective customers. We must respond to technological
11
advances and evolving industry standards and practices on a timely and
cost-effective basis. The development and enhancement of services and products
entails significant technical and financial risks. We may fail to
o use new technologies effectively;
o adapt services and products to evolving industry standards; or
o develop, introduce and market service and product enhancements or new
services and products.
In addition, we may experience difficulties that could delay or prevent the
successful development, introduction or marketing of our services and products,
and our new service and product enhancements may not achieve market acceptance.
If we encounter these problems, our business, financial condition and operating
results may be materially adversely affected.
o Operational risks may disrupt our business or limit our growth.
Like other securities and securities-related businesses, we are highly
dependent on information processing and telecommunications systems. We face
operational risks arising from potential mistakes made in the confirmation or
settlement of transactions or from the failure to properly record, evaluate or
account for transactions. Our business is highly dependent on our ability, and
the ability of our clearing firms, to process, on a daily basis, a large and
growing number of transactions across numerous and diverse markets.
Consequently, we and our clearing firms rely heavily on our respective
financial, accounting, telecommunications and other data processing systems. If
any of these systems fail to operate properly or become unavailable due to
problems with our physical infrastructure, we could suffer financial loss, a
disruption of our business, liability to clients, regulatory intervention or
reputational damage. In addition, we are aware that other companies in our
industry have had problems due to high volume of telephone and e-mail customer
inquiries that has at times strained the capacity of their telecommunications
systems and customer service staffs, and has also led to temporary disruptions
in website service. Thus, any inability of systems used to accommodate an
increasing volume of transactions and customer inquiries could also constrain
our ability to expand our businesses and could damage our reputation.
o Employee misconduct could harm us and is difficult to detect and
deter.
There have been a number of highly publicized cases involving fraud or
other misconduct by employees in the financial services industry in recent
years, and we run the risk that employee misconduct could occur. Misconduct by
employees could bind us to transactions that exceed authorized limits or present
unacceptable risks, or hide from us unauthorized or unsuccessful activities. In
either case, this type of conduct could result in unknown and unmanaged risks or
losses. Employee misconduct could also involve the improper use of confidential
information, which could result in regulatory sanctions and serious reputational
harm. It is not always possible to deter employee misconduct, and the
precautions we take to prevent and detect this activity may not be effective in
all cases.
o The securities industry in which we operate is heavily regulated by
the Securities and Exchange Commission ("SEC"), state regulators, and
the National Association of Securities Dealers ("NASD"). If we fail to
comply with applicable laws and regulations, we may face penalties or
other sanctions that may be detrimental to our business.
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. Broker-dealers are subject to
regulations covering all aspects of the securities business, including:
o sales methods;
o trade practices among broker-dealers;
o use and safekeeping of customers` funds and securities;
o capital structure;
o record keeping;
o conduct of directors, officers, and employees; and
o supervision of employees, particularly those in branch offices.
The principal purpose of regulation and discipline of broker-dealers is the
protection of customers and the securities markets, rather than protection of
creditors and stockholders of broker-dealers.
Uncertainty regarding the application of these laws and other regulations
to our business may adversely affect the viability and profitability of our
business. The SEC, the NASD, other self-regulatory organizations and state
securities commissions can censure, fine, issue cease-and-desist orders, or
suspend or expel a broker-dealer or any of its officers or employees. Our
ability to comply with all applicable laws and rules is largely dependent on our
establishment and maintenance of a compliance system to ensure such compliance,
as well as our ability to attract and retain qualified compliance personnel. We
could be subject to disciplinary or other actions due to claimed noncompliance
in the future, and the imposition of any material penalties or orders on us
could have a material adverse effect on our business, operating results and
financial condition. In addition, it is possible that noncompliance could
subject us to future civil lawsuits, the outcome of which could harm our
business.
12
In addition, our mode of operation and profitability may be directly
affected by:
o additional legislation;
o changes in rules promulgated by the SEC, state regulators, the NASD,
and other regulatory and self-regulatory organizations; and
o changes in the interpretation or enforcement of existing laws and
rules.
o The failure to remain in compliance with the Net Capital Rule would
adversely affect our ability to continue to operate as a
broker-dealer.
The SEC, the NASD and various other regulatory agencies have stringent
rules with respect to the maintenance of specific levels of net capital by
securities brokers, including the SEC`s Uniform Net Capital Rule (the "Net
Capital Rule"). Net capital is the net worth of a broker or dealer (assets minus
liabilities), less certain deductions that result from excluding assets that are
not readily convertible into cash and from conservatively valuing certain other
assets. Failure to maintain the required net capital may subject a firm to
suspension or revocation of registration by the SEC and suspension or expulsion
by the NASD and other regulatory bodies and ultimately could require the firm`s
liquidation.
In addition, a change in the net capital rules, the imposition of new rules
or any unusually large charge against net capital could limit those aspects of
our contemplated operations that require the intensive use of capital, such as
trading activities and the financing of customer account balances. A significant
operating loss or any unusually large charge against net capital could adversely
affect our ability to operate and/or expand, which could have a material adverse
effect on our business, financial condition and operating results.
As of February 28, 2002, March 31, 2002, and April 30, 2002, the Company
had a net capital deficit as defined, of $520,836, $1,487,966, and $637,141,
respectively, in violation of the Net Capital Rule. In addition, as of September
30, 2002, the Company had a net capital deficit of $301,523. These deficiencies
were cured through additional funding and through funds generated from
operations. While the Company is presently in compliance with net capital
requirements, there can be no assurance that we will not fall below minimum net
capital requirements in the future.
o The failure of brokerage customers to meet their margin requirements
could result in significant liabilities.
The brokerage business, by its nature, is subject to risks related to
defaults by our customers in paying for securities they have agreed to purchase
and delivering securities they have agreed to sell. Our clearing firm may make
margin loans to our customers in connection with their securities transactions.
We are required by contract to indemnify that firm for, among other things, any
loss or expense incurred due to defaults by our customers in failing to repay
margin loans or to maintain adequate collateral for those loans. We will be
subject to risks inherent in extending credit, especially during periods of
volatile markets or in connection with the purchase of highly volatile stocks
which could lead to a higher risk of customer defaults.
o We may be obligated to redeem our Series A Preferred Stock at a point
in the future, which would impair our ability to raise additional
capital as we would more than likely not be able to repay such
redemption.
The holders of our Series A Preferred Stock have the right to have their
shares redeemed for cash equal to the greater of (i) the price we received when
we sold them the stock ($10,000 per share) plus any accrued and unpaid dividend
payments and (ii) the aggregate value of the shares of Common Stock into which
such shares of Series A Preferred Stock are then convertible (based upon the
closing bid price), in any of the following situations:
o if our Common Stock is not tradable on the NYSE, the AMEX, the NASDAQ
National Market or the NASDAQ SmallCap market for a period of five
consecutive days.
o if we fail to register with the Securities and Exchange Commission (or
maintain such registration of) the Common Stock into which the Series
A Preferred Stock converts.
o if we fail to honor requests for conversion, or if we notify any
holder of Series A Preferred Stock of our intention not to honor
future requests for conversion.
o if the holders of more than 30 percent of the outstanding shares of
our Common Stock sell or exchange their stock.
o if we commit a material breach under, or otherwise materially violate
the terms of, the transaction documents entered into in connection
with the issuance of the Series A Preferred Stock and the warrants.
In April of 2002, our Common Stock was delisted from the NASDAQ Stock
Market. In addition, we have not registered the Common Stock into which the
Series A Preferred Stock converts. We have not received a redemption notice from
any of the holders of our Series A Preferred Stock. Redemption of the Series A
Preferred Stock in any event described above would require us to expend a
significant amount of cash that likely will exceed our ability to make such
payment or raise additional capital.
13
o Our stockholders could experience substantial dilution as a result of
the issuance of and terms of our Series A Preferred Stock and the
related warrants.
The 630 shares of Series A Preferred Stock that were sold in the private
placement are initially convertible into approximately 2,135,700 shares of
Common Stock. The warrants granted in connection with the sale of Series A
Preferred Stock are initially exercisable for 1,629,069 shares of Common Stock,
at an exercise price of $2.95 per share.
Under the terms of the Series A Preferred Stock, we are also obligated to
issue additional shares of Common Stock every six months to the holders of the
Series A Preferred Stock as preferred stock dividends. Initially, these
dividends will be payable at the rate of six percent for the first 18 months
following issuance of the Series A Preferred Stock and fifteen percent after
that initial 18 month period. The number of shares of Common Stock will be
determined by dividing the dividend payment by the market price for our Common
Stock on the day before such dividend is payable. Because these shares are
issueable as a dividend, we will receive no additional consideration in
connection with their issuance.
o We may also be required to issue shares of Common Stock without
additional consideration in the event that we fail to redeem any
shares of Series A Preferred Stock when required.
All of the foregoing issuances of Common Stock are likely to be
substantially dilutive to the outstanding shares of Common Stock, especially
where, as described above, the shares of Common Stock are issued without
additional consideration. Moreover, any increase in the number of shares of
Common Stock we are required to issue resulting from anti-dilution protection,
penalties or other adjustments to the conversion or exercise prices of the
Series A Preferred Stock and/or the warrants described above will further
increase the anticipated dilution to the outstanding holders of our Common
Stock. We cannot predict whether or how many additional shares of our Common
Stock will become issuable due to these provisions.
Any such dilution, potential dilution, or increase in dilution or potential
dilution, may result in a decrease in the value of the outstanding shares of our
Common Stock. Such a decrease in value, the risk of dilution, any actual
dilution, or any increase in potential dilution may cause our stockholders to
sell their shares, which would contribute to a downward movement in the price of
our Common Stock. This could prevent us from sustaining a per share price
sufficient to enable us to maintain an active trading market on the NASDAQ
National Market or SmallCap Market if our stock is re-listed. In addition, any
downward pressure on the trading price of our Common Stock could encourage
investors to engage in short sales, which would further contribute to a downward
pricing of our Common Stock.
o We may be required to obtain the consent of the holders of Series A
Preferred Stock before taking corporate actions, which could harm our
business.
Our charter documents require us to obtain the consent of the holders of
the Series A Preferred Stock before we may issue securities that have senior or
equal rights as the Series A Preferred Stock or take other actions with respect
to the Series A Preferred Stock or securities that have fewer rights than the
Series A Preferred Stock. We are also required to obtain the consent of the
holders of the Series A Preferred Stock before we amend or modify our
certificate of incorporation or bylaws, whether by merger, consolidation or
otherwise to change any of the rights of the holders of Series A Preferred
Stock. While these obligations may deter a potential acquirer from completing a
transaction with us, they may also prevent us from taking corporate actions that
would be beneficial to the holders of our Common Stock and the Company, such as
raising capital to operate our business or maintain our capitalization or per
share price in attempts to maximize stockholder volume and liquidity.
o We may be unable to obtain critical goods or services from our
suppliers
We obtain financial information from a number of third-party suppliers of
software and information services. We believe we have available to us at
comparable cost a number of alternative sources of supply of these items of
software and information services, to provide adequate replacements on a timely
basis, if arrangements with any of our current suppliers are abrogated. We have
established a number of relationships with third-party suppliers of software and
information services. There can be no assurance that such relationships will
continue or that timely replacement of such services will be available in the
future.
Item 2. Properties
Our principal offices are located at 40 Wall Street, New York, NY, where we
occupy approximately 28,500 square feet at an annual cost of approximately
$963,000 per year , plus escalations. The initial term of the lease for such
office space expires in June 2009. On December 6, 2002, the Company entered into
a sixteen-month lease agreement for approximately 3,200 square feet in San
Francisco, CA, at an annual cost of $114,000. On December 15, 2002, the Company
entered into an eighteen-month lease agreement for approximately 2,568 square
feet in Melville, NY, at an annual cost of $68,078.
Item 3. Legal Proceedings
Our business involves substantial risks of liability, including exposure to
liability under federal and state securities laws in connection with claims by
dissatisfied clients for fraud, unauthorized trading, churning, mismanagement,
and breach of fiduciary duty, as well as in connection with the underwriting or
distribution of securities. In recent years, there has been an increasing
incidence of litigation involving the securities industry, including class
actions which generally seek rescission and substantial damages.
In the ordinary course of business, the Company is, and may become, a party
to legal proceedings or arbitration. Except as described below, the Company is
not a party to any material legal proceedings or arbitrations.
The Company is a party to various suits alleging breach of contract due to
non-payment for services or goods provided, and for amounts claimed by Class B
members of the LLC. The Company is defending these suits and has commenced
settlement negotiations as to certain of such suits.
In addition, a suit has been brought by Akro Investicni Spolecnost, A.S.
and Bozena Konvalinkova, as Czech Receiver of Private Investors, as against A.B.
Watley. The plaintiffs allege violations of New York common law and federal
securities law by A.B. Watley arising from an agreement between Private
Investors, a Czech broker-dealer, and A.B. Watley. Plaintiffs seek damages of
$31,400,000 (of which approximately $950,000 is alleged to represent the
damages, and the balance represents punitive damages.) The Company believes it
has a meritorious defense against this suit and intends to fight it vigorously.
We are a defendant in four actions relating to the lease of equipment in which
the plaintiffs have asserted breach of contract and damages in the aggregate
amount of approximately $683,000. Three of such actions are pending before the
Supreme Court of New York, NY, and the remaining action is pending before the
District Court, 4th Judicial District, Hennepin County, MN.
We are a defendant in an action pending before the American Arbitration
Association ("AAA") in which the plaintiffs have asserted breach of fiduciary
duties. The plaintiff in this action seeks an accounting and unspecified
damages.
We are a defendant in an action pending before the AAA in connection with
our failure to maintain a registration statement in which the plaintiffs have
asserted breach of contract and claimed damages approximating $84,000.
We are a defendant in a breach of contract action pending before the
Supreme Court, Nassau County, New York arising out of an employment dispute. The
plaintiff in this action is seeking compensatory damages of $93,000, as well as
liquidated damages, under New York`s Labor Law, in the amount of 25% of the
compensatory damages.
We are a defendant in an action pending before the Supreme Court of New
York, NY in connection with a construction contract in which the plaintiffs have
asserted breach of contract and damages in the aggregate amount of approximately
$234,000.
We are a defendant in an action pending before the Supreme Court of New
York, NY in connection with an advertising contract in which the plaintiffs have
asserted breach of contract and damages in the aggregate amount of approximately
$29,000.
We are a defendant in an action pending before the NASD in which the
claimants have asserted breach of contract and damages in the aggregate amount
of approximately $147,000.
14
There is one action that relates to collection of an existing account
payable in which a judgment has been entered against the Company totaling
approximately $24,000.
In addition to the foregoing, in the ordinary course of business, we and
our principals are, and may become, a party to legal or regulatory proceedings
commenced by the NASD, the SEC or state securities regulators relating to
compliance, trading and administrative problems that are detected during
periodic audits and inspections or reported by dissatisfied customers. Such
matters, if pursued by such entities, could rise to the level of disciplinary
action. The Company is not currently involved in any proceeding by a
governmental agency or self-regulatory organization, the outcome of which is
expected to have a material adverse effect on our business. There can be no
assurance that one or more future disciplinary actions, if decided adversely to
the Company, would not have a material adverse effect on the Company`s business,
financial condition and results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of our security holders during the
fiscal year ended September 30, 2002.
15
PART II
Item 5. Market for Registrant`s Common Equity and Related Stockholder Matters
The Company currently has authorized capital stock consisting of 20,000,000
common shares, $.001 par value, of which 12,508,852 shares are issued and
outstanding and 1,000,000 preferred shares, $.001 par value, of which 630 Series
A Redeemable Convertible Preferred Stock are issued and outstanding.
Since March 2002, the Company issued warrants that may potentially require an
issuance of shares greater than the number of shares that the Company is
currently authorized to issue. By issuing these securities, the Company has
exhausted its 20,000,000 authorized shares of common stock and cannot meet any
equity-based obligations entered into after March 2002 without shareholder
approval for an increase in the number of authorized shares. The Company
intends to seek approval of the transactions that require the issuance of these
warrants that potentially may require an issuance of shares greater than the
number of shares that the Company is currently authorized to issue as well as
approval for an increase in the number of authorized shares of common stock of
the Company from 20,000,000 to 50,000,000.
(a) Trading in the Company`s shares of Common Stock presently takes place
on the Over-the-Counter Market under the symbol ABWG
The following table sets forth the range of high and low sales prices for
the Company`s Common Stock for the last two fiscal years:
Fiscal 2002: High Low
--------------- ------ -----
10/1/01 - 12/31/01 $4.85 $2.00
1/01/02 - 3/31/02 $2.25 $0.66
4/01/02 - 6/30/02 $1.15 $0.06
7/01/02 - 9/30/02 $0.45 $0.10
Fiscal 2001: High Low
--------------- ------ -----
10/1/00 - 12/31/00 $15.13 $4.56
1/01/01 - 3/31/01 $10.25 $5.25
4/01/01 - 6/30/01 $14.30 $4.94
7/01/01 - 9/30/01 $7.93 $2.80
(b) The number of record holders, exclusive of holders for whom shares are
being held in the name of brokerage houses and clearing agencies, of
the Company`s Common Stock was 79 on December 12, 2002.
(c) We have never paid cash dividends on our Common Stock. We do not
expect to declare or pay any dividends on our Common Stock in the
foreseeable future, but instead intend to retain all earnings, if any,
to invest in our operations. The payment of future dividends is within
the discretion of our board of directors and will depend upon our
future earnings, our capital requirements, financial condition and
other relevant factors.
16
Item 6. Selected Financial Data
Income Statement Data
Years ended
- --------------------------------------------------------------------------------------------------------------------------
Sept. 30, 2002 Sept. 30, 2001 Sept. 30, 2000 Sept. 30, 1999 Sept. 30, 1998
- --------------------------------------------------------------------------------------------------------------------------
Revenues:
Commissions 15,900,261 18,887,752 32,968,193 16,198,858 7,403,059
Data service fees 462,469 1,297,117 2,015,396 1,640,123 661,236
Principal transactions 2,533,998 3,196,844 5,689,695 2,456,874 901,889
Sale of software 3,908,308
Interest and other income 3,378,252 2,084,009 2,073,190 685,578 146,704
Interest income-related party -- 6,180 6,180 6,180 6,380
------------- ------------- ------------ ------------ -------------
Total revenues 26,183,288 25,471,902 42,752,654 20,987,613 9,119,268
------------- ------------- ------------ ------------ -------------
Interest expense 2,678,712 852,967 373,354 333,457 244,322
Interest expense to officer 392,841 398,117 71,417 15,000 15,000
------------- ------------- ------------ ------------ -------------
Net revenues 23,111,735 24,220,818 42,307,883 20,639,156 8,859,946
------------- ------------- ------------ ------------ -------------
Expenses:
Commission, floor brokerage and clearing 11,639,652 10,572,220 20,605,576 7,967,765 3,425,725
charges
Employee compensation and related costs 10,674,346 12,686,615 11,802,131 5,306,590 2,247,963
Loss on impairment of intangibles 7,870,110
Minority interests (899,869)
Other expenses 22,620,097 21,253,846 19,436,768 7,956,784 3,805,903
Loss on investments -- 703,614 256,386 -- --
------------- ------------- ------------ ------------ -------------
Total expenses 51,904,336 45,216,295 52,100,861 21,231,139 9,479,591
------------- ------------- ------------ ------------ -------------
Loss before income tax and extraordinary (28,792,601) (20,995,477) (9,792,978) (591,983) (619,645)
loss on early extinguishments of debt
Income tax provision (8,725) (28,697) (53,913) (32,494) (12,765)
------------- ------------- ------------ ------------ -------------
Loss before extraordinary loss on early (28,801,326) (21,024,174) (9,846,891) (624,477) (632,410)
extinguishments of debt
Extraordinary loss on early (250,000) -- -- (177,125) --
extinguishment of debt
------------- ------------- ------------ ------------ -------------
Net loss $(29,051,326) $(21,024,174) $ (9,846,891) $ (801,602) $ (632,410)
============= ============= ============ ============ =============
Basic and diluted earnings before $ (2.62) $ (2.13) $ (1.21) $ (0.09) $ (0.12)
extraordinary item per common share
Basic and diluted earnings per common $ (2.64) $ (2.13) $ (1.21) $ (0.11) $ (0.12)
share
Weighted average shares outstanding - 12,508,852 9,888,597 8,122,393 7,136,434 5,171,182
basic and diluted
Balance Sheet and Other Operating Data:
Total Assets $ 7,036,620 $ 21,532,676 $ 29,032,644 $ 23,244,954 $ 5,539,457
Property and Equipment, net of $ 2,889,711 $ 14,806,945 $ 18,523,320 $ 10,852,956 $ 3,650,743
accumulated depreciation
Long term obligations and redeemable $ 6,926,487 $ 5,664,775 $ 6,071,129 $ 2,261,593 $ 530,000
preferred stock
Stockholders` (deficit) equity ($16,828,339) $ 2,945,432 $ 12,177,786 $ 15,842,987 $ 1,754,419
Basic and diluted earnings before $ (2.62) $ (2.13) $ (1.21) $ (0.09) $ (0.12)
extraordinary item per common share
- --------------------------------------------------------------------------------------------------------------------------
17
(In millions except per share data)
Year Ended September 30, First Quarter Second Quarter Third Quarter Fourth Quarter Full Year
- ---------------------------------------------------------------------------------------------------------------------------------
2002
Revenues $8,289 $6,598 $5,320 $5,976 $26,183
Net revenues 7,272 5,120 4,888 5,832 23,112
Loss before extraordinary item (6,158) (14,492) (6,636) (1,515) (28,801)
Net (loss) (6,408) (14,492) (6,636) (1,515) (29,051)
Loss before extraordinary item per (0.63) (1.22) (0.59) (0.18) (2.62)
share
Basic and diluted earnings per share (0.65) (1.22) (0.59) (0.18) (2.64)
- ---------------------------------------------------------------------------------------------------------------------------------
2001
Revenues $8,222 $7,163 $5,506 $4,581 $25,472
Net revenue 8,025 6,923 5,212 4,061 24,221
Loss from operations (2,135) (4,575) (6,031) (7,551) (20,292)
Net (loss) (2,250) (4,609) (6,607) (7,558) (21,024)
Basic and diluted earnings per share (0.26) (0.52) (0.61) (0.74) (2.13)
Item 7. Management`s Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the consolidated
financial statements and notes thereto appearing elsewhere herein.
Results of Operations
Fiscal year ended September 30, 2002 compared to fiscal year ended September 30,
2001
Total revenues for fiscal 2002 were $26,183,288, an increase of 2.79% as
compared to revenues of $25,471,902 for fiscal 2001.
Revenues from commissions decreased by $2,987,491, or 15.82%, from
$18,887,752 for fiscal 2001 to $15,900,261 for fiscal 2002 due primarily to a
decrease of UltimateTrader accounts, as well as a significant decrease in
overall trading activity by on-line traders due to adverse market conditions,
increased competition and pricing pressure. The decrease in Ultimate Trader
commissions, net of rebates in listed equities, over the counter securities and
options was $9,749,019 as compared to fiscal 2001. This decrease was partially
offset by the retail accounts acquired in the On-Site acquisition and the
commissions collected from the Class B Members in the LLC of $6,761,528.
Data service revenues decreased by $834,648, or 64.35%, from $1,297,117 for
fiscal 2001 to $462,469 for fiscal 2002 due to the increasing number of accounts
migrating to Ultimate Trader II from other licensed software providers available
through our services. We charge our customers a data service fee for using other
software providers and do not charge for Ultimate Trader II.
Revenues from principal transactions decreased by $662,846, or 20.73%, from
$3,196,844 for fiscal 2001 to $2,533,998 for fiscal 2002, mainly as a function
of lower volume of business conducted by the institutional sales division due to
adverse market conditions and unusually high employee turnover in the
institutional sales division. As a result of these factors, revenue from our
institutional sales division decreased $1,577,372 from the previous year.
Included in principle transactions for fiscal year 2002 are losses incurred by
the Class B minority interest members of the LLC of $740,585. These decreases
were partially offset by an increase in trading profits from the proprietary
trading division of $1,655,111.
Interest and other income increased from $2,084,009 for fiscal 2001 to
$3,378,252 for fiscal 2002. This increase is largely due to the increased margin
interest and interest earned on the additional accounts acquired from the
On-Site retail accounts and interest income earned in the LLC. Also included in
interest income and other income for fiscal 2002 are one-time settlements with
venders of $507,472 and a World Trade Center Business Recovery Grant of
$150,000.
Interest expense increased from $852,967 for fiscal 2001 to $ 2,678,712 for
fiscal 2002 as a result of increased borrowings during the year. The Company
issued warrants in connection with the borrowings. The value of such warrants
were amortized over the term of the loan as a component of interest expense.
Interest expense relating to the amortization of the warrants issued in
connection of the financing during the year ended September 30, 2002 was
approximately $1,600,000.
Interest expense - related party decreased by $5,276 or 1.33% from $398,117
for fiscal 2001 to $392,841 for fiscal 2002.
As a result of the foregoing, net revenues decreased by $1,109,083, or
4.58%, from $24,220,818 for fiscal 2001 to $23,111,735 for fiscal 2002. Nearly
all of our revenues were generated by clients in the United States and no single
group of related clients accounted for 10% or more of our revenues.
18
Total expenses increased by $6,688,041 or 14.79%, from $45,216,295 for
fiscal 2001 to $51,904,336 for fiscal 2002.
Commissions, floor brokerage and clearing charges represent payments to our
clearing and floor brokers who facilitate our clients` transactions, payments
for data and software from third party venders and payouts to our non-business
branch locations. These expenses increased $1,467,762 or 13.97%, from
$10,572,220 for fiscal 2001 to $12,048,982 for fiscal 2002. This increase is
largely due to the acquisition of the On-Site accounts with a lower gross margin
than our historical online client business. This increase was partially offset
by our lower volumes in our institutional sales division. In addition, our
online software licenses fees and data services fees decreased.
Employment compensation and related costs decreased by $2,012,269 or
15.86%, from $12,686,615 for fiscal 2001 to $10,674,346 for fiscal 2002,
primarily due to headcount reductions in administrative and management
personnel. Employee compensation also decreased due to the lower trading profits
generated by the institutional sales division for fiscal year 2002.
Communications expense increased by $672,897 or 30.45%, from $2,210,056 for
fiscal 2001 to $2,882,953 for fiscal 2002. This increase was due to the adding
of a back up site as well as the increased data and communication costs relating
to the On-Site branch locations.
Business development costs consist of television, radio, on-line and print
advertising to obtain new clients. These expenses decreased by $1,859,703, or
79.28%, from $2,345,696 for fiscal 2001 to $485,993 for fiscal 2002 as we
decreased our planned advertising and promotional efforts.
Professional fees decreased from $3,698,724 for fiscal 2001 to $3,679,184
for fiscal 2002. Accounting and legal fees increased $2,194,569. The increase in
accounting fees relates to the due diligence and the additional work relating to
the On-Site acquisition. Legal fees increased largely due to the On-site
acquisition, the issuance of Series A Preferred Stock, the software licensing
agreement with E*Trade and the sale of the software to our clearing broker. In
addition, legal costs were incurred for the settling of vendor claims. This
increase in legal and accounting fees was offset by a decrease in consulting
fees of $2,214,109 from fiscal year 2001, primarily as a result of our sale of
software, as external software consultants were no longer utilized to develop
and maintain such software.
Occupancy and equipment costs decreased by $464,759 or 7.37%, from
$6,309,997 for fiscal 2001 to $5,845,238 for fiscal 2002. Rent for the year
increased $494,916 largely due to the acquisition of the On-Site offices in
Great Neck, New York and Boca Raton, Florida. The office rent increase was
largely offset by a $470,787 decrease relating to the settlement with certain
leasing companies and the expiration of some leases during fiscal year 2002. In
addition, during fiscal year 2002 many of the Company`s software maintenance and
support contracts expired resulting in a decrease of $488,888 from the previous
year.
Depreciation and amortization increased by $394,411 or 7.17%, from
$5,499,922 for fiscal 2001 to $5,894,333 for fiscal 2002. This increase is
largely due to the amortization of the intangibles relating the On-site
acquisition of $715,000 net of a decrease in amortization of capitalized
software due to the sale of the software of approximately $540,000.
Other expenses increased by $492,300 or 41.39%, from $1,189,451 for fiscal
2001 to $1,681,751 for fiscal 2002 due to the 2% penalty of approximately
$311,000 for not filing a registration statement in accordance with the
Preferred Stock agreement.
Loss on impairment of $7,870,110 represents the write off of intangible
assets (customer lists) obtained in the On-Site acquisition. The acquired
customer base deteriorated significantly which resulted in decreases in On-site
revenues and operating cash flows. This deterioration is attributable to many
causes including weakening market conditions, as well as the loss and closing of
branch operations, which resulted in a permanent impairment in the value of the
customer base acquired.
The abandonment of leasehold improvements of $1,741,315 primarily relates
to the surrender and termination of the 25th and 28th floor office leases at 40
Wall Street that occurred in August 2002. These leases were terminated as part
of our overall cost cutting initiatives. In addition, we abandoned leaseholds in
offices formerly used by On-Site.
Minority interest of $899,869 represents the trading losses of the Class B
non-voting members of the LLC.
As a consequence of the foregoing, our operating loss before income taxes
and extraordinary items increased from $20,995,477 for fiscal 2001, to a loss of
$28,792,601 for fiscal 2002.
The income tax provision decreased from $28,697 for fiscal 2001 to $8,725
for fiscal 2002.
19
We had an extraordinary loss on extinguishment of debt of $250,000 relating
to the early extinguishment of the $2.5 million Senior Subordinate Demand Note
that was exchanged for $2,750,000 of Preferred Stock in accordance with the
Senior Subordinated Demand Note agreement.
During the year ended September 30, 2002, we had a deemed dividend to
preferred stockholders for beneficial conversion and accretion of the redemption
feature of $1,639,797 and $1,959,617 respectively as well as a preferred stock
dividend of $315,000. As a consequence of the foregoing, our net loss increased
from $21,024,174 in fiscal year ended 2001 to $32,965,740 in fiscal year ended
2002.
Fiscal year ended September 30, 2001 compared to fiscal year ended September 30,
2000
Total revenues for fiscal 2001 were $25,471,902, a decrease of 40.42%, as
compared to revenues of $42,752,654 for fiscal 2000.
Revenues from commissions decreased by $14,080,441, or 42.71%, from
$32,968,193 for fiscal 2000 to $18,887,752 for fiscal 2001 due primarily to a
decrease of 2,831 UltimateTrader accounts or 48.94% of such accounts, as well as
a significant decrease in overall trading activity by on line traders due to
adverse market conditions, increased competition and pricing pressure. During
fiscal 2001, the Company`s online brokerage division had total billed
transactions of 883,454 and average billed transactions of 3,577 per day, a
decrease of 40.00% compared to an average daily billed transaction rate of 5,966
per day during fiscal 2000 totaling 1,509,448 billed transactions.
Data service revenues decreased by $718,279, or 35.64%, from $2,015,396 for
fiscal 2000 to $1,297,117 for fiscal 2001 due to the increasing number of
accounts migrated to UltimateTrader II from other licensed software providers
available through our services. We charge our customers a data service fee for
using other software providers and do not charge for UltimateTrader II.
Revenues from principal transactions decreased by $2,492,851, or 43.81%,
from $5,689,695 for fiscal 2000 to $3,196,844 for fiscal 2001, mainly as a
function of lower volume of business conducted by both the online brokerage
division`s trading desk and the third-market institutional sales division due to
adverse market conditions.
Interest and other income increased from $2,079,370 for fiscal 2000 to
$2,090,189 due to the introduction of a minimum charge for all customers, which
was offset by lower interest income.
Interest expense increased from $373,354 for fiscal 2000 to $852,967 for
fiscal 2001 as a result of increased borrowings.
Interest expense - related party increased by $326,700 as a result of
additional borrowings from related parties during the year.
As a result of the foregoing, net revenues decreased by $18,087,065, or
42.75%, from $42,307,883 for fiscal 2000 to $24,220,818 for fiscal 2001. Nearly
all of our revenues were generated by clients in the United States and no single
group of related clients accounted for 10% or more of our revenues.
Total expenses decreased by $6,884,566 or 13.21%, from $52,100,861 for
fiscal 2000 to $45,216,295 for fiscal 2001.
Commissions, floor brokerage and clearing charges represent payments to our
clearing and floor brokers who facilitate our clients` transactions. As a result
of a significant decrease in the volume of business conducted by our online
trading accounts, such expenses decreased by $10,033,356, or 48.69%, from
$20,605,576 for fiscal 2000 to $10,572,220 for fiscal 2001.
Employment compensation and related costs increased by $884,484 or 7.49%,
from $11,802,131 for fiscal 2000 to $12,686,615 for fiscal 2001, due to expenses
for software developers that were working on capitalized software development
projects during fiscal 2000 but instead were working on the E*Trade integration
and product enhancements and accordingly, had their salaries expensed during
fiscal 2001.
Communications expense increased by $332,347, or 17.70%, from $1,877,709
for fiscal 2000 to $2,210,056 for fiscal 2001 as a function of adding a back-up
site.
Business development costs consist of television, radio, on-line and print
advertising to obtain new clients. These expenses decreased by $6,223,504, or
72.63%, from $8,569,200 for fiscal 2000 to $2,345,696 for fiscal 2001 as the
Company decreased its planned advertising and promotional efforts.
20
Professional fees increased from $1,726,598 for fiscal 2000 to $3,698,724
for fiscal 2001 due to an increase of $2,124,232 for software consultants, the
use of an investor relations firm totaling $230,000, and the use of management
consultants totaling $369,083, and was offset by decreases of $526,000 in legal
expenses and employee acquisition costs of approximately $427,000.
Occupancy and equipment costs increased by $1,638,132 or 35.06%, from
$4,671,865 for fiscal 2000 to $6,309,997 for fiscal 2001, primarily due to the
expansion of our offices by an additional 15,277 square feet in New York and the
leasing of additional equipment to increase our capacity.
Depreciation and amortization increased by $3,915,968, or 247.23%, from
$1,583,954 for fiscal 2000 to $5,499,922 for fiscal 2001 due to the
implementation of our direct access trading platform and the related
amortization of capitalized software, as well as the amortization of capitalized
lease obligations.
Other expenses increased by $182,009, or 18.07%, from $1,007,442 for fiscal
2000 to $1,189,451 for fiscal 2001, due to additional administrative costs.
A loss of $703,614 was recorded in fiscal year 2001 as a result of the
write off of our investments in a technology company, Gale Technologies, Inc.
and Insider Financial Services Online, Ltd.
As a consequence of the foregoing, our operating loss increased from
$9,792,978 for fiscal 2000, to a loss of $20,995,477 for fiscal 2001.
The income tax provision decreased from $53,913 for fiscal 2000 to $28,697
for fiscal 2001.
As a consequence of the foregoing, our net loss increased from $9,846,891
in fiscal year ended 2000 to $21,024,174 in fiscal year ended 2001.
Liquidity and Capital Resources
For the year ended September 30, 2002, we incurred consolidated losses of
approximately $33 million and used cash in our operating activities of nearly
$8.3 million. These losses and use of cash are in addition to the approximately
$31 million of losses and $21 million of cash used in operating activities
during the two years ending September 30, 2001. The market conditions during
fiscal 2002 have been very challenging for brokerage firms such as ABWG as well
as for the brokerage industry in general. Trading volume has significantly
decreased, we have lost customers in our core direct access business and
increased competition has put pricing and margin pressures on the Company.
To respond to our liquidity and capital resource needs, the Company has
taken, and is taking, a variety of steps to offset the cash used in operating
activities. Such steps include cost cutting initiatives, the pursuit of
additional revenue producing activities, and the raising of funds or reduction
of operating liabilities through sale of assets and the issuance of debt and
equity securities.
Our cost cutting initiatives include reductions in workforce, reductions in
capital expenditures, and renegotiating clearing corporation agreements at more
favorable rates. We are pursuing more traditional lines of business such as
fixed income and equity capital markets as well as examining the feasibility of
expanding our existing business to attract active traders and hedge funds.
However, in order to expand our business, respond to competitive pressures and
expand into additional products and services, we have needed to raise additional
funds through debt or equity offerings. When the funds are raised through the
issuance of equity securities or financial instruments that are convertible into
equity securities, our existing shareholders may experience dilution in their
ownership percentage or book value. In addition, such securities may have
rights, preferences and privileges senior to those of the holders of our Common
Stock. There can be no assurances that the additional financing will be
available when needed and on terms satisfactory to the Company.
The Company may not be able to receive distributions from its regulated
broker-dealer subsidiaries due to capital withdrawal restrictions placed on the
regulated entities by the SEC`s Net Capital rule.
The following is a summary of our significant financing activities:
Licensing agreements and the sale of assets
-------------------------------------------
In April 2002, we granted a non-perpetual license of our proprietary
software to E*Trade for a one time-time flat fee of $5,000,000, which was
payable in cash ($2.6 million) and E*Trade stock ($2.4 million). The E*Trade
Stock was subsequently sold for cash.
21
In July 2002, we sold our software programs known as Ultimate Trader II,
Ultimate Trader III, and Watley Trader, including all related intellectual
property, to a subsidiary of one of our clearing brokers. In consideration for
the software, our clearing broker agreed to forgive $2,716,720 (including
interest of $566,720) of indebtedness owed by the Company to the clearing
broker. In addition, the asset purchase agreement provides for a future
reduction of indebtedness to the clearing broker of approximately $2,150,000,
contingent upon the Company paying our clearing broker $5,000,000 in clearing
fees or raising at least $4,000,000 in new equity capital over a 36 month period
beginning after July 31, 2002.
Issuance of debt obligations for cash
-------------------------------------
On August 30, 2001, we borrowed $2,500,000 from SDS Merchant Fund, L.P. in
exchange for our issuance of a senior subordinated demand note (the "Note")
bearing interest at an annual rate of 6%, and the issuance of warrants to
purchase 67,824 shares of Common Stock at an exercise price of $3.686 per share.
Warrants to purchase 45,000 shares at an exercise price of $3.686 per share of
Common Stock were issued to a consultant in connection with his efforts in
arranging this loan. Under the terms of the Senior Subordinated Demand Note, we
were also committed to issue additional warrants to purchase our Common Stock at
the end of each month in which the Note was outstanding. A total of 243,673 of
such warrants were issued. The Note was redeemed in November 2001 in connection
with our issuance of Series A Preferred Stock.
During the year ended September 30, 2001, the Company borrowed $4,350,000
from officers of the Company at rates ranging from 7% to 10%. In September 2002,
we issued warrants to purchase 1,479,486 and 923,145 shares of our Common Stock,
exercisable at $0 and $1.80, respectively, in consideration for the forgiveness
of $2,400,000 of such borrowings. The balance of the borrowing was repaid during
the year ended September 30, 2002.
We borrowed $700,000 from a former officer of the Company during the year
ended September 30, 2002. The borrowings are due on demand and bear interest at
10%.
In March 2002, a group which included a holder of our Series A Preferred
Stock and one of our clearing brokers granted the Company a $2,500,000 line of
credit, increased in April 2002 and May 2002 to $2,700,000 and $4,350,000,
respectively. At September 30, 2002, our borrowings under the line amounted to
$3,082,826.
Issuance of equity instruments in satisfaction of debt obligation
-----------------------------------------------------------------
In September 2002, in consideration of the forgiveness of notes payable to
officers aggregating $2,400,000, we issued warrants to purchase 1,479,486 and
923,145 shares of Common Stock to officers, exercisable at $0.00 and $1.80 per
share, respectively.
Issuance of equity for cash
---------------------------
On September 6, 2000, pursuant to an equity line provided by an investment
group, we drew down $3,000,000 and issued 333,333 shares of our Common Stock and
received net proceeds of $2,850,000. The quantity of shares issued was based
upon 94% of the volume weighted average price of our Common Stock for the 22
days prior to the draw.
On April 2, 2001, we sold 2,027,241 shares of Common Stock in a private
placement offering. The Common Stock was issued at $5.50 per share. The private
placement offering generated total net proceeds of $10,012,127. In addition, we
issued warrants expiring April 1, 2004 to acquire 608,174 shares of our Common
Stock at an exercise price of $6.75 per share. We have registered the shares for
resale under the Securities Act of 1933, as amended.
On November 29, 2001, we issued 630 shares of our Series A Convertible
Preferred Stock, at a price of $10,000 per share. Each share is convertible at
any time into 3,390 shares of our Common Stock. Preferred dividends on the
Series A Preferred Stock are cumulative at a rate of 6% per annum for the first
eighteen months and 15% thereafter. The purchasers were also issued Series A
warrants to purchase 1,601,460 shares of Common Stock at an exercise price of
$2.95 per share. The aggregate purchase price of the Preferred Stock and
warrants was $6.3 million, of which $3.45 million was paid to us in cash, and
$2.75 million was paid by the forgiveness of $2.5 million face amount of the
Company`s Senior Subordinated Demand Note issued in August of 2001, plus a 10%
premium upon exchange of such note pursuant to its terms.
Cash Flows
In 2002, cash used by operating activities during fiscal 2002 was
$8,278,756. We had a net loss of $29,051,326 and a decrease in securities sold
not yet purchased of $3,731,128 which was largely offset by a decreases in
receivables from clearing brokers of $1,178,045, securities owned of $2,748,940
and securities deposits of $1,312,479. Other offsets include non-cash items
including depreciation and amortization of $5,894,333, loss on impairment of
intangibles of $7,870,110, loss on disposal of leasehold improvements of
$1,741,315 and the issuance of warrants of $1,390,569.
22
Cash provided by investing activities was $4,138,384 during fiscal 2002.
The most significant sources of cash provided by investing activities was the
proceeds from the sale of the software.
Cash provided by financing activities was $3,846,085 during fiscal 2002.
Cash provided by financing activities during fiscal 2002 consisted primarily of
proceeds from the sale of Preferred Stock of $3,324,291, loans from officers of
$900,000, and notes payable of $187,884. In addition, we had capital
contributions from and distributions to, the Class B members of the LLC of
$446,307 and $1,012,397, respectively.
Cash used by operating activities during fiscal 2001 was $15,818,426 We had
a net loss of $21,024,174 and an increase from other assets of $324,319,
receivables from clearing brokers of $1,174,624, loans receivable from related
party of $129,126 and a decrease in accounts payable and accrued liabilities of
$513,973 which was offset by an increase in other liabilities of $67,288, and
non-cash items such as depreciation and amortization of $5,499,922, loss on
investments of $703,614 and non-cash compensation/service costs of $779,162.
Cash used in investing activities was $1,759,660 during fiscal 2001. Uses
of cash in fiscal 2001 related to purchases of equipment, software and leasehold
improvements made in our facility at 40 Wall Street of $1,759,660. In addition
to the cash used in investing activities during the year 2001, we accrued
accounts payable relating to purchases of property and equipment of $198,348
during this period.
Cash provided by financing activities was $12,996,056 during fiscal 2001.
Cash provided by financing activities during fiscal 2001 consisted primarily of
proceeds from the sale of Common Stock in a private equity offering of 2,027,241
shares at an offering price of $5.50, employee exercised stock options of
$987,290, loans from officers of approximately $850,000, and a loan of
$2,500,000. We used a portion of these proceeds to pay $790,935 in notes
payable, and $559,090 to pay obligations on capital leases.
At September 30, 2002, A.B. Watley has $530,000 of outstanding subordinated
loans, under agreements approved by the NASD. These loans are included by A.B.
Watley for purposes of computing its net capital under the SEC`s net capital
rules. These borrowings by A.B. Watley consist of:
o a $55,000 non-interest bearing loan and a $125,000 loan bearing
interest at 12% from an officer and a stockholder.
o a $200,000 loan, bearing interest at an annual rate of 15% and a
$150,000 loan bearing interest at an annual rate of 13%, from a family
member of a former executive officer of the Company
A.B. Watley is currently required to maintain minimum net capital such that
the ratio of aggregate indebtedness to net capital both as defined shall not
exceed 15 to 1 under the SEC`s net capital rule. Such rule also prohibits
"equity capital", including the subordinated loans, from being withdrawn or cash
dividends from being paid if our net capital ratio would exceed 10 to 1 or if we
would have less than our minimum required net capital. Accordingly, our ability
to repay the subordinated loans may be restricted under the net capital rule.
Net Operating Loss Carryforwards
The Company has net operating loss carryforwards that represent accumulated
losses which may be utilized to reduce future taxable income, and thus our tax
liabilities for future periods. Our net operating loss carryforwards expire
beginning in the year 2013. The issuance of additional equity securities,
together with our recent financings and the IPO, could result in an ownership
change and, thus, could limit our use of net operating losses. If we achieve
profitable operations, any significant limitation on the utilization of our net
operating losses would have the effect of increasing our tax liability and
reducing net income and available cash reserves. The tax benefits related to the
net operating loss carryfowards have been fully reserved for on our consolidated
statements of financial condition.
Relevant Accounting Standards
We generally grant stock options to employees and consultants with an
exercise price not less than the fair market value at the date of grant. We
account for stock option grants to employees in accordance with Accounting
Principles Board Opinion N