As filed with the Securities and Exchange Commission on February 4, 1999
Registration No. 333-_______
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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INTERNET FINANCIAL SERVICES INC.
(Name of small business issuer in its charter)
Delaware 6211 13-3911867
(State or jurisdiction of (Primary Standard Industrial (I.R.S. Employer Identification No.)
incorporation or organization) Classification Code Number)
40 Wall Street
New York, New York 10005
(212) 422-1664
(Address and telephone number of principal executive offices and principal
place of business)
Steven Malin
Chairman and Chief Executive Officer
Internet Financial Services Inc.
40 Wall Street, New York, New York 10005
(212) 422-1664
(Name, address and telephone number of agent for service)
Copies to:
Edward I. Tishelman, Esq. Robert J. Mittman, Esq.
Hartman & Craven LLP Tenzer Greenblatt LLP
460 Park Avenue 405 Lexington Avenue
New York, New York 10022 New York, New York 10174
(212) 753-7500 (212) 885-5000
(212) 688-2870 (fax) (212) 885-5001 (fax)
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Approximate date of proposed sale to the public:
As soon as practicable after the Registration Statement becomes effective
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If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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CALCULATION OF REGISTRATION FEE
=================================================================================================================
Proposed
Maximum Proposed
Offering Price Maximum Amount of
Title of Each Class of Amount to Be Per Aggregate Registration
Securities to be Registered Registered Unit(1) Offering Price(1) Fee(1)
- ------------------------------------------------------------------------------------------------------------------
Common Stock, $.001 par value ("Common
Stock") ............................. 1,955,000(2) $ 6.00 $11,730,000 $ 3,260.94
- ------------------------------------------------------------------------------------------------------------------
Underwriter's Warrants(3) ............ 170,000 $ .001 $ 100 $ --(4)
- ------------------------------------------------------------------------------------------------------------------
Common Stock underlying Underwriter's
Warrants ............................ 170,000 $ 9.90 $ 1,683,000 $ 467.87
- ------------------------------------------------------------------------------------------------------------------
Total .................................................................. $13,413,100
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Total Registration Fee ...................................................................... $ 3,728.81
=================================================================================================================
(1) Estimated solely for the purpose of computing the amount of the registration
fee pursuant to Rule 457(o) of the Securities Act.
(2) Includes 255,000 shares which the Underwriter has the option to purchase to
cover over-allotments, if any.
(3) Represents warrants to be issued to the Underwriter. Pursuant to Rule 416,
there is also being registered hereby such additional indeterminate number
of shares of Common Stock as may become issuable by reason of the
anti-dilution provisions set forth in the Underwriter's Warrants.
(4) None pursuant to Section 457(g).
ii
Internet Financial Services Inc.
Cross Reference Sheet for Prospectus Under Form SB-2
Front of Registration Statement and Outside Front
Cover of Prospectus ..................................... Front of Registration Statement and Outside Front
Cover Page of Prospectus
Inside Front and Outside Back Cover Pages of
Prospectus .............................................. Inside Front and Outside Back Cover
Summary Information and Risk Factors .................... Prospectus Summary; Risk Factors
Use of Proceeds ......................................... Use of Proceeds
Determination of Offering Price ......................... Outside Front Cover Page of Prospectus;
Underwriting
Dilution ................................................ Dilution
Selling Security Holders ................................ Inapplicable
Plan of Distribution .................................... Outside Front Cover Page of Prospectus;
Underwriting
Legal Proceedings ....................................... Litigation
Directors, Executive Officers, Promoters and
Control Persons ........................................ Management
Security Ownership of Certain Beneficial Owners
and Management ......................................... Principal Stockholders
Description of Securities ............................... Outside Front Cover Page of Prospectus; Prospectus
Summary; Capitalization; Description of Securities
Interests of Named Experts and Counsel .................. Legal Matters; Experts
Disclosure of Commission Position on
Indemnification for Securities Act Liabilities ......... Management
Organization within Last Five Years ..................... Certain Transactions
Description of Business ................................. Business
Management's Discussion and Analysis or Plan of
Operation .............................................. Management's Discussion and Analysis of Financial
Condition and Results of Operation
Description of Property ................................. Business
Certain Relationships and Related Transactions .......... Certain Transactions
Market for Common Equity and Related
Stockholder Matters .................................... Outside Front Cover Page of Prospectus; Risk
Factors; Management; Description of Securities
Executive Compensation .................................. Management
Financial Statements .................................... Financial Statements
Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure .................... Inapplicable
iii
The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION
DATED FEBRUARY 4, 1999
Internet Financial Services Inc.
1,700,000 Shares of Common Stock
$6.00 per Share
Internet Financial Services Inc. is offering 1,700,000 shares of its
common stock. This is our initial public offering and there currently is no
public market for our common stock. The offering price may not reflect the
market price of our shares after the offering.
We anticipate that our common stock will be listed on the Nasdaq SmallCap
Market under the symbol "IFSX."
---------------------
Investing in the common stock involves risks. See "Risk Factors beginning on
page 7."
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================================================================================
Public Underwriting Proceeds
Offering Discounts and to
Price Commissions Company
- --------------------------------------------------------------------------------
Per Share ......... $ 6.00 $ .60 $ 5.40
- --------------------------------------------------------------------------------
Total ............. $10,200,000 $1,020,000 $9,180,000
================================================================================
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Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is
a criminal offense.
We have granted the underwriter a 45-day option to purchase up to an
additional 255,000 shares of common stock to cover over-allotments. Whale
Securities Co., L.P. expects to deliver the shares of common stock to purchasers
on _____________, 1999.
---------------------
Whale Securities Co., L.P.
, 1999
We provide real-time online financial brokerage services and comprehensive
information about the securities markets through our proprietary trading
systems, UltimateTrader and WatleyTrader.
[Picture of Watley home page]
Home page of A.B. Watley, Inc., our wholly-owned subsidiary and a registered
broker dealer and member of the NASD.
UltimateTrader
[Picture of UltimateTrader screen]
o UltimateTrader provides our clients comprehensive information on stocks,
markets, indices, mutual funds and options.
o UltimateTrader delivers and automatically updates a continuous, dynamic stream
of live market data to the client's screen.
o UltimateTrader clients are able to access bid and ask prices, charts, research
and over 170 other types of information for any listed or Nasdaq traded stock.
o UltimateTrader clients can track their portfolio of securities, cash and
margin positions on a real-time basis.
o UltimateTrader clients are able to route their orders directly to an exchange
(New York Stock Exchange, American Stock Exchange, Nasdaq Stock Market and
Chicago Board Options Exchange), the Nasdaq Market Maker System, a specified
market maker or an ECN.
UltimateTrader clients may arrange the display and configuration of the windows
on their computer screens, using a menu and tool bar, in order to suit their
personal requirements. Various windows are shown below.
The UltimateTrader order entry window offers multiple execution choices and
rapid on-screen confirmations. Nasdaq orders may be routed directly to the
Nasdaq Stock Market, a specific market maker or an ECN. Orders for exchange
listed securities go directly to the NYSE's DOT system or the American Stock
Exchange's electronic order system. Orders may also be placed through our Watley
trading desk.
[Picture of Order Entry window]
The Nasdaq Level II Market Maker window allows UltimateTrader clients to see the
market makers in a security, as well as the volume and price of their bid and
offer quotes in real-time. The Time and Sales window shows actual trades by
size, time of execution and exchange.
The Position Minder window acts as a portfolio monitor by showing all open
positions, pending order size and status.
[Picture of Level II Market Maker window]
The Charting feature allows UltimateTrader clients to view live, dynamically
updating, real-time intraday chart data and historical information. Charts may
be created for stocks, options or indices for virtually any time period and time
interval desired by the client.
The Dow Jones News window provides continuously updating real-time news in a
scrolling format, including breaking news, corporate announcements, interviews,
industry news, market reports, economic and political developments, "hot stock"
alerts, international events and other information that impacts the securities
markets.
[Picture of a Charts window]
2
PROSPECTUS SUMMARY
This summary highlights selected information contained elsewhere in this
prospectus. It is not complete and may not contain all of the information that
is important to you. To understand this offering fully, you should read the
entire prospectus, including the risk factors and financial statements. Except
as otherwise indicated, the information in this Prospectus assumes no exercise
of the underwriter's over-allotment option to purchase up to 255,000 additional
shares of common stock. See "Underwriting" and Note 15 to Notes to the
Consolidated Financial Statements.
Our Company
Internet Financial Services Inc. provides real-time online financial
brokerage services and comprehensive information about the securities markets
through its proprietary trading systems, UltimateTrader(TM) and
WatleyTrader(TM). We designed UltimateTrader for use by self-directed active
traders. Active traders execute more trades per day than any other category of
investors and require real-time information and quick order execution to
effectuate their trading strategies.
UltimateTrader is a uniquely integrated trading system because it provides
active traders with the comprehensive information they need on a real-time basis
and the ability to execute trades in seconds. Since UltimateTrader is a
client-server application, it is not restricted by the "query-response"
limitation of HTML, the primary programming language of the worldwide web. As a
result, UltimateTrader delivers and automatically updates a continuous, dynamic
stream of live market data to the client's screen. With most other
Internet-based trading systems, displayed data remains static until the query is
repeated.
UltimateTrader provides our clients access to comprehensive information on
stocks, markets, indices, mutual funds, news and options. UltimateTrader clients
are able to access bid and ask prices, charts, research and over 170 other types
of information for any listed or Nasdaq traded stock, as well as the ability to
establish and track their securities, cash and margin positions on a real-time
basis. UltimateTrader clients have the ability to customize the screen layouts
they wish to have displayed. Our clients also have the option to receive the Dow
Jones News Service feed on a real-time basis.
UltimateTrader clients can execute trades with a few simple mouse-clicks or
keystrokes. UltimateTrader clients can route trades directly to the exchanges
(New York Stock Exchange, American Stock Exchange, Nasdaq and Chicago Board
Options Exchange), the Nasdaq Market Maker System, a specific market maker or an
electronic communications network. As a result, we believe that trades can be
executed more quickly than if the trade is routed through a third market firm or
an online brokerage firm's trading desk, as is the case with many other trading
systems.
WatleyTrader is our web-based Internet broker service which we designed for
active investors who execute trades on a frequent basis and use online services
to gather information about the securities markets. WatleyTrader provides
clients comprehensive information on stocks, markets, indices, mutual funds,
news and options in a totally live format for a fee, or a partially time delayed
format for free. WatleyTrader clients can place trades, obtain quotes, order
research and check account balances and portfolio valuations online or through
our automated touch-tone phone system, 24 hours a day. We introduced
WatleyTrader as an alternative to UltimateTrader for potential clients who do
not trade as frequently as active traders and as a means to market our services.
We also operate a third-market institutional sales desk which specializes
in executing and facilitating large-block transactions in approximately 300
thinly-traded equity securities. These services are provided to clients which
require that their purchases or liquidations of large positions remain
anonymous. We match buyers and sellers to execute "off-exchange transactions,"
to minimize the impact on the market and prevent our clients' positions from
being disclosed to competing firms. Our third-market institutional sales clients
include mutual and pension funds, insurance companies, banks, corporations and
independent fund managers.
3
Online trading is the fastest growing segment of the brokerage industry and
is expected to continue to grow significantly. Forrester Research, Inc.
estimates that the online trading industry grew from approximately 1.5 million
accounts at the end of 1996 to approximately 5 million accounts at the end of
1998 and that the market will grow to 8.4 million accounts at the end of 1999
and 14.4 million accounts in 2002. In addition, industry experts project that
retail commissions generated by the online trading market will grow from
approximately $268 million, or 15% of the commissions generated by discount
brokerages in 1996, to as much as $2.2 billion, or 60% of total discount
brokerage commissions by 2001. We believe that UltimateTrader's features
uniquely position our company to satisfy the needs of this growing market.
Our strategy is to capitalize on perceived opportunities arising from this
expanding market by:
o Targeting active traders and other active investors. We believe that the
market for such clients is currently underserviced and that UltimateTrader
is positioned to satisfy their requirements.
o Expanding our marketing efforts for our online brokerage service. We intend
to aggressively market UltimateTrader by targeting active traders through
print, online and other advertisements.
o Expanding our network infrastructure and client support capabilities. We
intend to undertake such expansion to better service an expected increasing
client base.
o Converting to self-clearing operations. We believe that performing such
operations internally will reduce our operating costs and provide us the
opportunity to receive revenues from margin transactions with our clients.
o Improving our third-market institutional sales desk. We are continuously
seeking to improve our technical expertise and apply new technologies to
more effectively provide such services. Additionally, after this offering,
we intend to hire additional associates to expand the number of securities
we cover for this market. During the year ended September 30, 1998,
revenues generated by our third-market institutional sales desk accounted
for 30.6% of our revenues.
o Offering new services:
International Expansion. We are currently evaluating opportunities to
provide electronic execution services for foreign institutions and their
clients for transactions in the U.S. securities markets and to arrange for
foreign institutions to provide for such services for our clients in
foreign markets.
Fee-based asset management services. We are evaluating the possibility of
offering online a comprehensive range of financial advisory services,
including assessing risk profiles, asset allocation and fund placement.
Revenues from our UltimateTrader clients accounted for 67.4% of our
revenues during the year ended September 30, 1998, and are expected to account
for an increasing percentage of our revenues in the future as we focus our
efforts on increasing our UltimateTrader client base. We experienced an increase
in the number of online trading clients from approximately 300 at September 30,
1997 to approximately 900 at September 30, 1998. Our success will depend on our
ability to significantly increase our currently limited UltimateTrader client
base.
Our company was incorporated in May 1996 under the laws of the State of
Delaware. Our wholly-owned subsidiary, A.B. Watley, Inc. ("Watley"), was
organized in December 1958 under the laws of the state of New York to conduct
business as a licensed broker-dealer. In January 1997, we acquired all of the
outstanding capital stock of Watley. All references to "our company," "our" or
"we" in this prospectus include Watley.
Our principal executive offices are located at 40 Wall Street, New York,
New York 10005, and our telephone number is (212) 422-1664. We maintain a
website at www.abwatley.com. Information contained in our website does not
constitute a part of this prospectus.
4
The Offering
Common stock offered..... 1,700,000 shares
Common stock to be
outstanding after the
offering(1)............. 7,337,696 shares
Use of proceeds.......... We intend to use the net proceeds of this offering
for sales and marketing; network expansion and
upgrade; expansion of client services; repayment of
indebtedness; and working capital and general
corporate purposes. See "Use of Proceeds."
Risk factors............. An investment in the common stock is speculative
and involves a high degree of risk. You should
purchase the shares only if you can afford a
complete loss of your investment. See "Risk Factors"
beginning on page 7 and "Dilution."
Proposed Nasdaq SmallCap
Market symbol........... IFSX
- -------------
(1) Does not include (i) 170,000 shares reserved for issuance upon exercise of
the underwriter's warrants; (ii) 825,150 shares reserved for issuance upon
exercise of options granted under our stock option plans; (iii) 174,850
shares reserved for issuance upon the exercise of options available for
future grant under our stock option plans; (iv) 351,250 shares reserved for
issuance upon exercise of non plan options and warrants; and (v)
255,000 shares reserved for issuance in this offering to cover over-
allotments, if any, by the underwriter. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations,"
"Management--Employment Agreements," "--Stock Option Plans" and
"Underwriting."
Forward Looking Statements
Some of the statements in this prospectus discuss future expectations or
state other "forward- looking" information. Those statements are subject to
known and unknown risks, uncertainties and other factors that could cause our
actual results to differ materially from those contemplated by the statements.
Factors that might cause such a difference include, but are not limited to,
those discussed in "Risk Factors" and elsewhere in this prospectus.
5
Summary Financial Information
The following summary financial information for our company's fiscal years
ended September 30, 1997 and September 30, 1998 should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the financial statements, including the notes thereto, included
in this prospectus.
Statement of Operations Data:
Year Ended September 30,
-------------------------------
1997 1998
--------------- -------------
Revenues .................................................. $ 4,532,532 $9,119,268
Net revenues .............................................. 4,320,173 8,859,946
Commissions, floor brokerage and clearing charges ......... 1,844,927 3,425,725
Employee compensation and related costs ................... 1,297,575 2,247,963
Other expenses ............................................ 2,234,868 3,805,903
Net loss .................................................. (1,059,973) (632,410)
Net loss per share ........................................ (.30) (.12)
Weighted average number of shares outstanding ............. 3,508,560 5,171,182
Balance Sheet Data:
September 30, 1998
-------------------------------------------------
Actual Pro Forma(1) As Adjusted(2)
-------------- -------------- ---------------
Working capital (deficit)(3) ......... $ (691,258) $1,226,727 $ 8,724,727
Total assets ......................... 5,539,457 7,639,135 14,941,150
Total liabilities .................... 3,785,038 4,648,568 3,796,568
Stockholders' equity ................. 1,754,419 2,990,567 11,144,582
- -------------
(1) Gives effect to (i) the receipt of approximately $454,015 of net proceeds on
October 6, 1998 upon the issuance of a $500,000 principal amount promissory
note and warrants to purchase 191,250 shares of common stock, (ii) the
receipt of $2,500 upon the exercise of employee stock options to acquire
125,000 shares of common stock at $.02 per share, (iii) the issuance of
38,260 shares of common stock in connection with the acquisition of the
capital stock of Computer Strategies, Inc., (iv) the receipt of
approximately $1,050,000 of net proceeds in January 1999 upon the issuance
of 221,500 shares of common stock and (v) the receipt of $375,000 of net
proceeds in January 1999 upon the issuance of a $400,000 principal amount
promissory note and warrants to purchase 140,000 shares of common stock
(collectively the "Pro Forma Adjustments"). See "Management's Discussion and
Analysis of Financial Condition and Results of Operations,"
"Business--Computer Strategies, Inc. Acquisition" and "Certain
Transactions."
(2) Gives effect to the (i) sale of the shares of common stock offered hereby,
(ii) the anticipated application of a portion of the estimated net proceeds
therefrom for the repayment of $750,000 principal amount of indebtedness and
$27,000 accrued and unpaid interest thereon, (iii) the recognition of
approximately $75,000 of deferred offering costs, and (iv) the write-off of
non-cash deferred option and warrant costs related to the issuance of
options and warrants in connection with indebtedness being repaid with a
portion of the proceeds of this offering. See "Use of Proceeds" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(3) Our Consolidated Financial Statements are not categorized between current
and non-current assets and liabilities. For purposes of calculating working
capital, we consider our cash and cash equivalents, securities owned,
receivables from clearing brokers and a portion of other assets to be
current assets, and securities sold, not yet purchased, the current portion
of notes payable and accounts payable and accrued liabilities to be current
liabilities. See Consolidated Financial Statements.
6
RISK FACTORS
The shares offered hereby are speculative and involve a high degree of
risk. Each prospective investor should carefully consider the following risk
factors before making an investment decision.
Limited Relevant Operating History. Prior to our acquisition of Watley,
Watley was a retail securities brokerage firm. Since March 1997, our primary
business has been to operate as an Internet-based broker-dealer. In May 1997, we
discontinued our prior securities brokerage activities. Accordingly, we have a
limited relevant operating history upon which you can evaluate our prospects and
future performance. You should consider our prospects based on the risks,
expenses and difficulties frequently encountered in the operation of a new
business in a rapidly evolving industry characterized by intense competition.
See "Management's Discussion of Financial Condition and Results of Operations."
Losses. Since our inception, we have incurred losses, including losses of
$1,059,973 during the year ended September 30, 1997 and $632,410 during the year
ended September 30, 1998. We had an accumulated deficit of $1,903,761 at
September 30, 1998. Our operating expenses have increased and are expected to
continue to increase significantly in connection with our proposed expanded
activities. Accordingly, our future profitability will depend on our ability to
increase our client base and our revenues while controlling costs. We expect to
continue to incur losses until we are able to significantly increase our client
base and revenues. In addition, we will incur aggregate non-cash charges of
approximately $353,912 during the year ending September 30, 1999 relating to the
write-off of debt servicing fees relating to certain promissory notes being
repaid upon the closing of this offering and the issuance of 14,500 options to
certain non-employees conditional upon the effectiveness of this offering. We
may never achieve significantly increased revenues or profitable operations. See
"Management's Discussions and Analysis of Financial Condition and Results of
Operations" and Consolidated Financial Statements.
Early Stage and Rapidly Evolving Market. The market for electronic
brokerage services, particularly over the Internet, is rapidly evolving. As a
result, the level of demand for online brokerage services is uncertain. Our
offering of brokerage services over the Internet involves a relatively new
approach to securities trading. As a result, intensive marketing and sales
efforts may be necessary to educate prospective clients regarding the uses and
benefits of our brokerage services and products. For example, customers of
traditional full-commission brokerage firms or discount brokers may be reluctant
or slow to convert to Internet brokerage services. Moreover, security and
privacy concerns of existing and potential users of our services may deter
potential clients from using our trading systems. If the market for online
brokerage services does not develop as we expect, our business, financial
condition and operating results will be materially adversely affected. See
"Business -- Industry Overview."
Risks Relating to Our Focus on Active Traders. Our focus is to attract
active traders and active investors as clients. Approximately 67.4% of our
revenues during the year ended September 30, 1998 were derived from commissions
and other fees from the online trading activities of our clients. We expect that
a substantial portion of our revenues will continue to be derived from our
clients' active trading activities. Our business, financial condition and
results of operations would be materially adversely affected by any factor
resulting in reduced commissions or a decline in the demand for our online
services.
Potential Client Attrition; Limited Customer Base. Active traders can lose
a significant amount of money quickly and become unable to continue to actively
trade. Our company's client attrition rate has historically been 7% per month.
Our client base has expanded from approximately 300 online trading accounts at
September 30, 1997 to approximately 900 online trading accounts at September 30,
1998. However, we are still dependent on a limited customer base for a
substantial portion of our revenues. Any significant increase in our client
attrition rate could have a material adverse effect on our business and
operations.
Risks Relating to the Securities Business. The securities business is
subject to numerous risks including stringent regulation, litigation, client
inability to satisfy commitments (such as margin obligations), client fraud and
employee misconduct and errors. Our company, like other securities firms, is
directly affected by national and international economic and political
conditions, broad trends in business and finance, fluctuations in volume and
price levels of securities, the level and volatility of interest rates,
legislative and regulatory changes, tax law changes, inflation, and the
availability of credit. Historically, when the stock market suffers large
declines (i.e.,
7
a "bear market") the level of individual investor activity declines. Our company
will likely be adversely affected during any long-term bear market. A general
decrease in trading activity in these markets could adversely affect the level
of trading by our clients. As a result, our company's business, financial
condition and operating results would be adversely affected because certain
expenses, consisting primarily of salaries and benefits, computer and networking
costs and rent remain relatively fixed. Moreover, our operating results may
fluctuate dramatically from period to period as a result of these factors.
Intense Competition. The market for electronic brokerage services is
intensely competitive, rapidly changing and has few barriers to entry. We
believe that we compete on the basis of speed and accuracy of order execution,
processing and confirmation, quality of client service, ease of use, amount and
timeliness of information provided and price and reliability of our trading
systems. We expect that our ability to compete will also be affected by our
ability to introduce new services and enhancements to existing services into the
market on a timely basis.
We compete directly with other firms which focus on active trading clients
as well as other discount brokerage firms offering online or touch-tone
brokerage services. We also face competition for clients from full commission
brokerage firms, financial institutions and mutual funds. Many of our
competitors have well-established reputations for providing brokerage and
financial services and have longer operating histories and significantly greater
financial, technical, marketing, personnel and other resources than we have. In
addition, many of our competitors offer a wider range of services and financial
products than we do. Such competitors may be able to undertake more extensive
promotional campaigns, adopt more aggressive pricing policies and even create
and withstand a pricing war in the electronic brokerage business. Many of our
clients also maintain accounts with one or more of our competitors.
The general financial success of companies in the securities industry over
the past several years has strengthened existing competition. We believe that
such success will continue to attract new competitors to the industry which
could adversely affect our ability to gain or even maintain market share. Such
potential competitors include depository institutions, insurance companies,
providers of online financial and information services and software development
companies. We cannot assure you that we will be able to compete successfully.
Competitive factors could materially adversely affect our business, financial
condition and operating results. See "Business -- Competition."
Need to Expand Network Infrastructure and Client Support Capabilities. We
will need to expand our network infrastructure and client support capabilities
in anticipation of an expanded client base. Such expansion will require us to
make significant up front expenditures for servers, routers and computer
equipment, to increase bandwidth for internet connectivity and to hire and train
additional client service personnel. Such expansion must be completed without
system disruptions, slower response times or degradation in speed of order
fulfillment and levels of client service. Failure to expand our network
infrastructure or client service capabilities would materially adversely affect
our company's business and operations. See "Business -- Strategy."
Risks of System Failures and Service Interruptions. Our clients rely on the
quick and accurate execution, processing and confirmation of transactions
executed on our trading systems. Our company receives and processes client trade
orders principally through the Internet, online services and touch-tone
telephone. This method of trading is heavily dependent on the integrity of the
electronic systems supporting it. Heavy stress placed on our company's trading
systems during peak trading times could cause our systems to operate at
unacceptably low speed or fail. Any significant degradation or failure of our
company's trading systems or any other systems in the trading process (e.g.,
online service providers, record keeping and data processing functions performed
by third parties and third-party software such as Internet browsers and trading
engines) could cause clients to suffer delays in trading. Such delays could
cause substantial losses for our clients and could adversely affect our company.
During a systems failure, our company may be able to take orders by
telephone. However, under applicable regulations, all company associates
accepting telephone orders must have securities brokers' licenses.
In the event of a sub-system, component or software failure, our network
structure may not operate properly. In the event of a natural disaster, power or
telecommunications failure or act of war, we may not be able to prevent an
extended systems failure. Moreover, computer viruses or unauthorized access to
or sabotage of our
8
network by a third party could result in system failures or service
interruptions. Any system failures or service interruptions could result in
decreased commission revenues from client trading activities and could result
in loss of client accounts and harm to our reputation and the perception of our
trading system's reliability. See "Business -- Operations."
Possible Security Compromises. The secure transmission of confidential
information over public networks is a critical element of our company's
operations. Our trading systems rely on encryption, authentication and firewall
technology to provide the security and authentication necessary to effect secure
transmission of confidential information over the Internet. Our company has
never experienced any security breaches in the transmission of confidential
information. However, advances in computer capabilities, new discoveries in the
field of cryptography or other events or developments could result in a
compromise of the technology or other algorithms used by our company to protect
client transaction and other data. Any such compromise of our trading systems
security could materially adversely affect our business, financial condition and
operating results. See "Business -- Operations."
Significant Capital Requirements; Possible Need for Additional Financing.
Our business is capital intensive. Our cash requirements have exceeded our cash
flow from operations as we have been building our business. At September 30,
1998, we had a working capital deficit of $691,258. As a result, we have been
dependent upon sales of our common stock and borrowings from our officers,
directors and stockholders and third parties to finance our working capital
requirements. We need the proceeds of this offering to expand our operations and
finance our future working capital requirements. Based upon our current plans
and assumptions relating to our business plan, we anticipate that the net
proceeds of this offering will satisfy our capital requirements for at least
twelve months following the closing of this offering. If our plans change or our
assumptions prove to be inaccurate, we may need to seek additional financing
sooner than currently anticipated or curtail our operations. We cannot assure
you that the proceeds of this offering will be sufficient to fund our proposed
expansion or that additional financing will become available if needed. Our
company will be materially adversely affected if we do not obtain financing when
needed. We may seek additional debt or equity financing to fund the cost of
continued expansion. Any issuance of equity securities would dilute the interest
of our stockholders. Additionally, if we incur debt, our company will become
subject to risks that interest rates may fluctuate and cash flow may be
insufficient to pay the principal and interest on any such debt. See "Use of
Proceeds" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Dependence Upon Clearing Brokers. Pursuant to Watley's agreements with its
clearing brokers, the clearing brokers, on a fee basis, process all securities
transactions for Watley's account and the accounts of Watley's clients. Services
of the clearing brokers include billing and credit extension, control and
receipt, custody and delivery of securities, for which we pay a per ticket
charge. Watley has agreed to indemnify and hold the clearing brokers harmless
from certain liabilities or claims, including claims arising from the
transactions of its clients. Watley's clearing agreements may be terminated by
either party, upon 60 days written notice in the case of Penson Financial
Services, Inc., and 30 days prior written notice in the case of Weiss, Peck &
Greer, L.L.C. Watley is dependent on the operational capacity and the ability of
the clearing brokers for the orderly processing of transactions. By engaging the
processing services of clearing brokers, however, Watley is exempt from certain
capital reserve requirements imposed by federal securities laws. Termination or
material interruptions of services provided by either of the clearing brokers
would have a material adverse effect on our operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business -- Operations."
Risks Relating to Possible Expansion or Acquisitions. We intend to use a
portion of this offering to expand our operations through internal growth and
possible acquisitions. Our proposed expansion will depend on, among other
factors, widespread consumer acceptance of UltimateTrader and WatleyTrader and
our ability to attract and retain clients, hire and retain additional skilled
management, marketing, industry, client service and other personnel and
successfully manage growth. We may seek to expand our operations by acquiring
companies in businesses which we believe will complement or enhance our
business. However, we are not currently involved in negotiations with respect to
any material acquisitions, and are not a party to any agreement, commitment,
arrangement or understanding relating to any such acquisitions. We have not
established any minimum criteria for any acquisition and, under certain
circumstances, our management will have complete discretion in
9
determining the terms of any such acquisition. Consequently, there is no basis
for you to evaluate the specific merits or risks of any potential acquisitions
that our company may undertake. We cannot assure you that we will be able to
ultimately effect any acquisition, successfully integrate any acquired business
in our operations or otherwise successfully expand our operations. See "Use of
Proceeds" and "Business -- Strategy."
Proposed Conversion to Self-Clearing Broker. We intend to expand Watley's
operations to include self-clearing operations during the year 2000. Watley's
membership agreement with the NASD currently requires Watley to clear all
transactions through its clearing firms and prohibits Watley from safekeeping
client securities. The NASD must agree to amend Watley's membership agreement
before Watley will be able to engage in self-clearing operations. We can not
assure you that the NASD will agree to so amend Watley's membership agreement.
Self-clearing securities firms are subject to substantially more regulatory
control and examination than we are currently subject. Errors in performing
clearing functions or reporting could lead to civil penalties imposed by the SEC
or the NASD. Self-clearing operations, especially where conducted by firms such
as Watley, without significant prior experience, involve substantial risks of
losses due to clerical errors relating to the handling of client funds and
securities. We cannot assure you that Watley will be able to perform such
operations as accurately and efficiently as such operations are being performed
by Watley's clearing brokers. Clearing process errors also may lead to civil
liability for actions in negligence brought by parties who are financially
harmed as a result of such errors. Any liability that arises as a result of
self-clearing operations could have a material adverse effect on our company's
business, financial condition and operating results. Watley's failure to perform
self-clearing operations accurately and cost-effectively could have a material
adverse effect on our business, financial condition and operating results.
If we convert to a self-clearing firm, we will have to pay for a portion of
the securities purchased by our clients, to the extent such purchases are made
on margin, which will increase our capital requirements substantially. We will
also have direct responsibility for the possession and control of client
securities and other assets and the clearance of client securities transactions.
This will require our company to record on our balance sheet the client
receivables and client payables to Watley that are a result of client margin
loans and client free credit balances (i.e., client cash balances maintained by
Watley) which could have a significant effect on our company's total assets and
total liabilities. In addition, to the extent that our client receivable
balances exceed client free credit balances, we could be liable for such
shortfall. We may not have the cash available at a given time to perform our
services. See "Business -- Operations."
Dependence Upon Sources of Financial Information; Integrity of Financial
Information. We receive financial information which is used by our clients from
Dow Jones News Retrieval, StockPoint (from Ethos Corporation), PC Quote, Inc.
and S&P Comstock. We depend upon information suppliers to accurately provide
and, in some cases, format such data, on a real-time basis. Failure by any
service provider to supply such information according to our company's
requirements could result in service interruptions, adverse client perception of
our trading system and loss of clients. In addition, we could be liable to a
client who downloads inaccurate information from our trading system for losses
resulting from the client's use of such information. We may also be subject to
claims for negligence, copyright or trademark infringement or other theories
based on the nature and content of information downloaded by clients from our
trading systems and subsequently distributed to others. We do not maintain
insurance to cover most of these types of liabilities. Any liability imposed on
our company or costs incurred in defending claims that are not covered by
insurance or are in excess of our insurance coverage could materially adversely
affect our business, financial condition and operating results.
Dependence on Online Commerce and the Internet. Acceptance of
UltimateTrader and WatleyTrader will depend upon the adoption of the Internet as
a widely used medium for commerce and communication. The Internet may not prove
to be a viable commercial marketplace because of inadequate development of the
necessary infrastructure, such as a reliable network backbone, or timely
development of complementary services and products, such as high speed modems
and high speed communication lines. The Internet has experienced, and is
expected to continue to experience, significant growth in the number of users
and amount of traffic. However, the Internet infrastructure may not be able to
support the demands placed on it by this continued growth. In addition, the
Internet could lose its viability due to delays in the development or adoption
of new standards and protocols to handle increased levels of Internet activity
or due to increased governmental regulation. Moreover,
10
critical issues concerning the commercial use of the Internet, including
security, reliability, cost, ease of use, accessibility and quality of service,
remain unresolved. Such issues may negatively affect the growth of Internet use
or the attractiveness of commerce and communication on the Internet. Our
company's business, financial condition and operating results will be materially
adversely affected if critical issues concerning the commercial use of the
Internet are not favorably resolved, the necessary infrastructure is not
developed, or the Internet does not become a viable commercial marketplace. See
"Business -- Industry Overview."
Year 2000 Issues. Our review of our hardware and software has not revealed
any year 2000 issues that cannot be remediated in a timely manner. However, we
are highly dependent upon third-party financial information vendors,
telecommunications suppliers and our clearing brokers. We have sent letters to a
number of such vendors requesting assurances of their compliance. Such third
parties have generally advised us that their review of their operating systems
indicate that their operating systems are year 2000 compliant. We would be
materially adversely affected if there are any failures or interruptions in
service resulting from the inability of our computing system or any such
third-party's systems to recognize the year 2000. Moreover, since our evaluation
of these issues is continuing, we cannot assure you that additional issues will
not be discovered which could present a material risk of disruption to our
operations. See "Management's Discussion and Analysis of Financial Conditions
and Results of Operations -- Year 2000 Issues."
Rapid Technological Change. Electronic stock trading is characterized by
rapidly changing technology, changing client requirements, frequent new services
and trading system introductions and enhancements and evolving industry
standards in computer hardware, operating systems, database technology and
information delivery systems. Our company's success will depend upon our ability
to maintain and develop competitive technologies to continue to enhance our
trading system and to develop and introduce new services in a timely and
cost-effective manner. The development of these technologies, trading systems
and services may require substantial time and expense. We cannot assure you that
we will be able to respond quickly, cost-effectively or sufficiently to such
developments. Our company's business, financial condition and operating results
may be adversely affected if we are unable to anticipate or respond quickly to
such developments. See "Business -- Strategy."
Credit Risks. We are subject to the risks inherent in extending credit to
the extent that we permit our clients to purchase securities on a "margin"
basis. A portion of Watley's clients' securities activities are transacted on a
margin basis (through the clearing broker which Watley has agreed to indemnify),
pursuant to which credit is extended to the client and secured by cash and
securities in the client's account or "short sales" (i.e., the sale of
securities not yet purchased). Such risks are exacerbated during periods of
rapidly declining markets in which the value of the collateral held by Watley
could fall below the amount borrowed by the client. In the event that margin
requirements are not sufficient to cover losses, Watley may be required to sell
or buy securities at prevailing market prices and incur losses to satisfy client
obligations.
Securities Regulation. The securities industry in the United States is
subject to extensive regulation under both 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.
If we fail to comply with any of these laws, rules or regulations we could be
censured, fined, issued a cease-and-desist order or our company or our officers
and employees could be suspended or expelled, any of which could have a material
adverse effect on our business, financial condition and operating results.
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.
Following the closing of this offering, we intend to initiate a
comprehensive marketing campaign to bring greater brand name recognition to our
products and services. All marketing activities by Watley are regulated by
11
the NASD. The NASD can impose certain 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 certain of its officers or
employees for violations of the NASD's advertising regulations. See "Business
- -- Securities Regulation."
Effect of Net Capital Requirements. The SEC, 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 which governs Watley. If Watley fails to maintain the
required net capital Watley may be subject to suspension or revocation of
registration by the SEC and suspension or expulsion by the NASD and other
regulatory bodies and ultimately could require Watley'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 operations of
Watley that require the intensive use of capital. Such rules also could restrict
our ability to withdraw capital from Watley, which in turn could limit our
ability to pay dividends, repay debt and repurchase shares of our outstanding
stock. A significant operating loss or any unusually large charge against net
capital could adversely affect our ability to expand or even maintain our
current levels of business, which could have a material adverse effect on our
business, financial condition and operating results. See "Business -- Net
Capital Requirements."
Governmental Regulation of the Internet and Online Commerce. Due to the
increasing popularity and use of the Internet and other online services, it is
possible that a number of laws and regulations may be adopted with respect to
the Internet or other online services covering issues such as user privacy,
pricing, content copyrights, and quality of services. Furthermore, the growth
and development of the market for online commerce may prompt more stringent
consumer protection laws that may impose additional burdens on those companies
conducting business online. Moreover, the recent increase in the number of
complaints by online traders could lead to more stringent regulations of online
trading firms and their practices by the SEC, NASD and other regulatory
agencies. The adoption of any additional laws or regulations may decrease the
growth of the Internet or other online services, which could, in turn, decrease
the demand for our trading systems and services and increase our cost of doing
business. Moreover, the applicability to the Internet and other online services
of existing laws in various jurisdictions governing issues such as property
ownership, sales and other taxes and personal privacy is uncertain and may take
years to resolve. In addition, as our services are available over the Internet
in multiple states and foreign countries, and as we have numerous clients
residing in such states and foreign countries, such jurisdictions may claim that
our company is required to qualify to do business as a foreign corporation in
each such state and foreign country. While our company is registered as a
broker-dealer in 49 states, we are qualified to do business as a foreign
corporation in only a few states; failure by our company to qualify as a
broker-dealer in other jurisdictions or as an out-of-state or "foreign"
corporation in a jurisdiction where it is required to do so could subject our
company to taxes and penalties for the failure to qualify. Our business,
financial condition or operating results could be materially adversely affected
by any such new legislation or regulation, the application of laws and
regulations from jurisdictions whose laws do not currently apply to our business
or the applications of existing laws and regulations to the Internet and other
online services.
Risks Associated with International Expansion. Part of our strategy is to
expand into international markets. This strategy depends on our ability to
provide international clients access to U.S. financial market data and to enter
into arrangements with foreign institutions to offer electronic execution
services for foreign markets. To date, we have only provided access to U.S.
financial markets to a limited number of international clients. We cannot assure
you that we will be able to successfully market or deliver our services in
international markets. Additionally, international expansion will subject our
company to certain risks inherent in doing business internationally, including
international economic, political and regulatory developments and increasing
client support and other staffing requirements.
Limited Intellectual Property Protection. We rely on a combination of
copyright, trademark and trade secrets laws and non-disclosure agreements to
protect our proprietary technologies, ideas, know-how and other proprietary
information. We have no patents or registered copyrights. Notwithstanding the
precautions we take, third parties may copy or otherwise obtain and use our
proprietary technologies, ideas, know-how and other proprietary information
without authorization or independently develop technologies similar or superior
to our technologies. In addition, the confidentiality and non-competition
agreements between our company and certain of our employees, distributors and
clients may not provide meaningful protection of our proprietary technologies or
12
other intellectual property in the event of unauthorized use or disclosure.
Policing unauthorized use of our technologies and other intellectual property is
difficult, particularly because the global nature of the Internet makes it
difficult to control the ultimate destination or security of software or other
data transmitted. Furthermore, the laws of the other countries may afford little
or no effective protection of our intellectual property rights. Our business,
financial condition and operating results could be adversely affected if we are
unable to protect our intellectual property rights.
There has been substantial litigation in the software industry involving
intellectual property rights. We believe that our technologies and trading
systems have been developed independent of others. Third parties may assert
infringement claims against our company and our technologies and trading systems
may be determined to infringe on the intellectual property rights of others. We
could become liable for damages, be required to modify our technologies or
trading systems or obtain a license if our technologies or trading systems are
determined to infringe upon the intellectual property rights of third parties.
We cannot assure you that we will be able to modify our technologies or trading
systems or obtain a license in a timely manner, if required, or have the
financial or other resources necessary to defend an infringement action. We
would be materially adversely affected if we fail to do any of the foregoing.
See "Business -- Intellectual Property Rights."
Dependence Upon Key Personnel; Need for Qualified Personnel. Our success
will be largely dependent on the personal efforts of a few key officers, Steven
Malin, our Chairman of the Board and Chief Executive Officer, Robert Malin,
President of Watley, and Harry Simpson, our President. We have entered into
employment agreements with each of such officers. However, our business,
financial condition and operating results could be materially adversely affected
if the services of any of such officers becomes unavailable. The Company has
obtained "key-man" life insurance on the lives of Steven Malin and Harry Simpson
in excess of $2,000,000 and on the life of Robert Malin in the amount of
$1,000,000. Our success will also depend on our ability to hire and retain
additional qualified marketing, industry, technical and financial personnel.
Qualified personnel are in high demand. We face considerable competition from
other brokerage and financial service firms and other Internet and online
service companies for such personnel, many of which have significantly greater
resources than we have. We may not be able to attract and retain additional
qualified personnel. We will be materially adversely affected if we are unable
to attract such personnel. See "Management."
Control by Management. After the closing of this offering, officers and
directors (and their families), will beneficially own, in the aggregate,
approximately 51.7% of the outstanding common stock. Accordingly, such persons
will continue to control the outcome of all matters submitted to a vote of the
holders of common stock, including the election of directors, amendments to our
company's certificate of incorporation and approval of significant corporate
transactions. Such consolidation of voting power could also have the effect of
delaying, deterring or preventing a change in control of our company that might
be beneficial to other stockholders. See "Management" and "Principal
Stockholders."
Use of Proceeds to Repay Indebtedness; Benefits to Related Parties; Broad
Discretion in Application of Proceeds. We have allocated approximately $777,000
(9.5%) of the net proceeds of this offering to repay outstanding indebtedness,
including $100,000 to repay amounts owed to Mel Steinberg, the father of Eric
Steinberg, Executive Vice President of our company and approximately $500,000
will be used to repay a loan which is guaranteed by six persons who are
officers, directors and/or principal stockholders of our company. Such persons
will receive a benefit as a result of the release of their guarantees.
Accordingly, such proceeds will not be available for other corporate purposes.
In addition, we have allocated approximately $823,000 (10.0%) of the estimated
net proceeds of this offering to working capital and general corporate purposes.
We will have broad discretion as to the application of such proceeds. Moreover,
a portion of the proceeds allocated to working capital may be utilized to pay a
portion of the salary of our officers over the twelve months following the
closing of this offering if cash flow from operations is insufficient for such
purposes. See "Use of Proceeds" and "Certain Transactions."
Immediate and Substantial Dilution. Purchasers of the shares of common
stock in this offering will experience immediate and substantial dilution of
$4.49 per share (or 74.8%) between the net tangible book value per share of
common stock after this offering and the initial public offering price per
share. See "Dilution."
No Dividends. Our company has never declared or paid any dividends to our
holders of common stock and we do not anticipate paying cash dividends in the
foreseeable future. See "Dividend Policy" and "Description of Securities --
Common Stock."
13
Shares Eligible for Future Sale; Registration Rights. All of the 5,637,696
currently outstanding shares of common stock are "restricted securities", as
that term is defined in Rule 144 promulgated under the Securities Act of 1933,
as amended. An aggregate of 4,000,000 of the restricted shares will be
immediately eligible for sale, without registration, under Rule 144, subject to
the contractual restrictions described below. Of the remaining restricted
shares, 1,120,000 shares will become eligible for sale under Rule 144 beginning
90 days following the date of this prospectus, subject to the contractual
restrictions described below. In addition, we have granted certain registration
rights to holders of 411,175 of such restricted shares (including 331,250 shares
issuable upon exercise of currently exercisable warrants), as well as demand and
piggyback registration rights to the underwriter with respect to the shares of
common stock issuable upon exercise of the underwriter's warrants. The holders
of substantially all of the restricted shares of common stock have agreed not to
sell or otherwise dispose of any shares of common stock (including pursuant to
Rule 144) or exercise any registration rights for a period of twelve months
following the date of this prospectus without the underwriter's prior written
consent. The possibility that a substantial number of shares of common stock may
be sold in the public market may adversely affect prevailing market prices for
the common stock and could impair our ability to raise capital through the sale
of equity securities. We cannot predict the effect, if any, that sales of such
securities or the availability of such securities for sale will have on the
market prices prevailing from time to time. See "Shares Eligible for Future
Sale" and "Underwriting."
No Assurance of Public Market; Arbitrary Determination of Offering Price.
Before this offering, there has been no public trading market for the common
stock. We cannot assure you that a regular trading market for the common stock
will develop after this offering or that, if developed, it will be sustained.
The initial public offering price of the common stock has been determined
arbitrarily by negotiation between us and the underwriter and is not necessarily
related to the assets, book value or potential earnings of our company or any
other recognized criteria of value. Additionally, the initial public offering
price of the common stock may not be indicative of the prices that may prevail
in the public market. See "Underwriting."
Possible Volatility of Market Price of Common Stock. The market price for
the common stock following this offering may be highly volatile as has been the
case with the securities of other companies in emerging businesses. Factors such
as our operating results, announcements by us or our competitors, introduction
of new products or technologies by us or our competitors and various factors
affecting the securities industry generally may have a significant impact on the
market price of the common stock. Additionally, in recent years, the stock
market has experienced a high level of price and volume volatility. Market
prices for the stock of many companies, particularly of small and emerging
growth companies, have experienced wide price fluctuations which have not
necessarily been related to the operating performance of such companies.
Possible Delisting of Securities from Nasdaq System; Risks Relating to
Low-Priced Stocks. We intend to list our common stock on Nasdaq after this
offering. If, at any time, we are unable to maintain the requirements for
continued listing on Nasdaq, our common stock will no longer be traded on Nasdaq
and trading in our common stock would thereafter be conducted in the non-Nasdaq
over-the-counter market. If the common stock is not listed on Nasdaq and the
trading price of the common stock were to fall below $5.00 per share, trading in
the common stock would become subject to the SEC's "penny stock" rules. The
penny stock rules require additional disclosure by broker-dealers in connection
with any trades involving a penny stock. The additional burdens imposed upon
broker-dealers by such requirements could, in the event the common stock were
deemed to be a penny stock, discourage broker-dealers from effecting
transactions in the common stock which could severely limit the market liquidity
of the common stock and the ability of purchasers in this offering to sell the
common stock in the secondary market.
Adverse Effect of the Authorization of Preferred Stock. Our certificate of
incorporation authorizes our board of directors to issue 1,000,000 shares of
"blank check" preferred stock and to fix the rights, preferences, privileges and
restrictions, including voting rights, of these shares, without further
stockholder approval. The rights of the holders of common stock will be subject
to and may be adversely affected by the rights of holders of any preferred stock
that may be issued in the future. The ability to issue preferred stock without
stockholder approval could have the effect of making it more difficult for a
third party to acquire a majority of the voting stock of our company thereby
delaying, deferring or preventing a change in control of our company. See
"Description of Securities -- Preferred Stock."
14
Significant Outstanding Options and Warrants; Potential Adverse Effect on
Market Price of Common Stock. Upon the closing of this offering, there will be
outstanding options and warrants to purchase an aggregate of 1,346,400 shares of
common stock (including 170,000 shares of common stock issuable upon exercise of
the underwriter's warrants) at exercise prices ranging from $2.00 to $9.90 per
share. To the extent that outstanding options and warrants are exercised,
dilution to the percentage ownership of our stockholders will occur and any
sales in the public market of the common stock underlying such options and
warrants may adversely affect prevailing market prices for the common stock.
Moreover, the terms upon which we will be able to obtain additional equity
capital may be adversely effected since the holders of outstanding options and
warrants can be expected to exercise them at a time when we would, in all
likelihood, be able to obtain any needed capital on terms more favorable to our
company than those provided in the outstanding options and warrants. See
"Management -- Stock Option Plans" and "Underwriting."
Anti-Takeover Provisions Affecting Stockholders. After this offering is
completed, our company will be subject to the State of Delaware's "business
combination" statute, which prohibits a publicly-traded Delaware corporation
from engaging in various business combination transactions in which a person
becomes an "interested stockholder," unless certain approvals are obtained or
other events occur. This statute could prohibit or delay mergers or other
attempted takeovers or changes in control with respect to our company and,
accordingly, may discourage attempts to acquire our company. See "Description of
Securities."
Limitations on Liability of Directors and Officers. Our company's
certificate of incorporation includes provisions to eliminate the personal
liability of directors of our company for monetary damages arising from a breach
of their fiduciary duties as directors to the extent permitted by applicable
law. As a result, stockholders may be unable to recover damages against our
directors for actions taken by them which constitute negligence or a violation
of certain of their fiduciary duties. See "Management -- Limitation of Liability
and Indemnification Matters."
15
USE OF PROCEEDS
The net proceeds from the sale of the 1,700,000 shares of common stock
being offered hereby (after deducting underwriting discounts and other expenses
of this offering) are estimated to be $8,200,000 ($9,531,100 if the
underwriter's over-allotment option is exercised in full).
We expect to use the net proceeds (assuming no exercise of the
underwriter's over-allotment option) during the twelve months following the
consummation of this offering approximately as follows:
Approximate
Approximate Percentage of
Application of Net Proceeds Dollar Amount Net Proceeds
- ---------------------------- --------------- --------------
Sales and marketing(1) .................................... $ 2,500,000 30.5%
Network expansion and upgrade(2) .......................... 2,300,000 28.0
Expansion of client services(3) ........................... 1,800,000 22.0
Repayment of indebtedness(4) .............................. 777,000 9.5
Working capital and general corporate purposes(5) ......... 823,000 10.0
----------- -----
Total ................................................... $ 8,200,000 100.0%
=========== =====
- ------------
(1) Includes the costs to produce, create and place television advertising,
Internet and print commercials, as well as salaries of personnel engaged
in these activities. See "Business -- Marketing and Advertising."
(2) Represents expenses to expand our network infrastructure to support an
increasing client base and for additional computer and telephone
communications equipment to create an off-site back-up communications center
or "hot site." See "Business -- Operations."
(3) Represents a portion of the costs of additional personnel and systems to (i)
convert to self-clearing, (ii) engage in operations with international
financial institutions and clients, (iii) provide additional client support,
(iv) continue software and programming development, and (v) expand our
third-market institutional sales desk to increase the number of securities
we cover for this market. See "Business."
(4) Represents amounts to repay (i) the $500,000 principal amount promissory
note plus a $5,000 prepayment fee, to New York Small Business Venture Fund
LLC, and (ii) $250,000 principal amount of promissory notes (bearing
interest at the rate of 8% per annum), plus approximately $22,000 of accrued
interest thereon, including approximately $100,000 principal amount of
promissory notes held by Mel Steinberg, the father of Eric Steinberg,
Executive Vice President of our company. The $500,000 principal amount
promissory note bears interest at the rate of 12% and is due October 2003,
subject to prepayment. We used the proceeds of these loans for working
capital and general corporate purposes. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Certain
Transactions."
(5) Represents amounts which may be used (i) for the relocation of our principal
offices and (ii) to pay a portion of trade payables incurred from time to
time and the salaries of our officers, if cash flow from operations is
insufficient for such purposes. See "Business -- Properties" and
"Management."
If the underwriter's over-allotment option is exercised in full, we will
realize additional net proceeds of $1,331,000, all of which will be allocated to
working capital and general corporate purposes.
The foregoing represents our best estimate of the allocation of the net
proceeds of this offering based upon the current status of our business. This
estimate is based on certain assumptions, including continued expansion of our
client base and corresponding increases in revenues and that our proposed
network expansion can be completed and new services can be introduced without
unanticipated delays or costs. If any of these factors change, we may find it
necessary to reallocate a portion of the proceeds within the above-described
categories or use portions thereof for other purposes. Our estimates may prove
to be inaccurate, new programs or activities may be undertaken which will
require considerable additional expenditures or unforeseen expenses may occur.
Based upon our current plans and assumptions relating to our business plan,
we anticipate that the net proceeds of this offering will satisfy our capital
requirements for at least twelve months following the closing of
16
this offering. If our plans change or our assumptions prove to be inaccurate, we
may need to seek additional financing sooner than currently anticipated or
curtail our operations. We cannot assure you that the proceeds of this offering
will be sufficient to fund our proposed expansion or that additional financing
will become available if needed.
Proceeds not immediately required for the purposes described above will be
invested principally in United States government securities, short term
certificates of deposit, money market funds or other short-term interest bearing
investments.
DILUTION
The difference between the initial public offering price per share and the
net tangible book value per share of common stock after this offering
constitutes the dilution to investors in this offering. Net tangible book value
per share is determined by dividing the net tangible book value of our company
(total tangible assets less total liabilities) by the number of outstanding
shares of common stock.
At September 30, 1998, our company had a net tangible book value of
$1,679,419 or $.33 per share ($.49 per share on a pro forma basis, after giving
effect to the Pro Forma Adjustments (see footnote 1 of Prospectus Summary --
Summary Financial Information)). After giving effect to the sale of the
1,700,000 shares of common stock offered hereby (after deducting estimated
underwriting discounts and expenses of this offering), the adjusted net tangible
book value of our company at September 30, 1998 would have been $11,059,582 or
$1.51 per share, representing an immediate increase in net tangible book value
of $1.02 per share to the existing stockholders and an immediate dilution of
$4.49 (74.8%) per share to new investors.
The following table illustrates the foregoing information with respect to
dilution to new investors on a per share basis:
Initial public offering price .............................. $ 6.00
Pro forma net tangible book value before offering ......... $ .49
Increase attributable to new investors .................... 1.02
-----
Adjusted net tangible book value after offering ............ 1.51
------
Dilution to new investors .................................. $ 4.49
======
The following table sets forth as of the effective date of this offering,
with respect to our existing stockholders and new investors, a comparison of the
number of shares of common stock acquired from our company, the percentage
ownership of such shares, the total consideration paid, the percentage of total
consideration paid and the average price per share.
Average Price
Shares Purchased Total Consideration per Share
----------------------- -------------------------- --------------
Number Percent Amount Percent
----------- --------- ------------- ----------
Existing Stockholders(1) ......... 5,637,696 76.1% $ 4,664,933 31.4% $ .83
New Investors .................... 1,700,000 23.9 10,200,000 68.6 6.00
--------- ----- ----------- -----
Total .......................... 7,337,696 100.0% $14,864,933 100.0%
========= ===== =========== =====
- ------------
(1) Includes all shares of common stock issued and outstanding after giving
effect to (i) the Pro Forma Adjustments and (ii) the issuance of 115,436
shares of common stock for no or nominal consideration subsequent to
September 30, 1998 (including 41,665 shares estimated to be issued upon
exercise of certain options upon the closing of this offering).
The above table assumes no exercise of the underwriter's over-allotment
option. If such option is exercised in full, it is estimated that the new
investors will have paid $11,730,000 for the 1,955,000 shares of common stock
offered by our company, representing approximately 71.5% of the total
consideration for 25.7% of the total number of shares of common stock
outstanding. In addition, the above table does not give effect to the shares
issuable upon exercise of outstanding options and warrants. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Management -- Stock Option Plans" and "Underwriting."
17
DIVIDENDS
Our company has never declared or paid any dividends to the holders of our
common stock and we do not anticipate paying cash dividends in the foreseeable
future. We currently intend to retain all earnings for use in connection with
the expansion of our business and for general corporate purposes. The future
declaration and payment of dividends, if any, will be within the sole discretion
of our board of directors and will depend upon our profitability, financial
condition, cash requirements, future prospects and other factors deemed relevant
by our board of directors. In addition, the payment of cash dividends on our
common stock in the future could be limited or prohibited by applicable
regulatory requirements and the terms of financing agreements that we may enter
into or by the terms of any preferred stock that may be authorized and issued.
CAPITALIZATION
The following table sets forth the capitalization of our company as of
September 30, 1998 (i) on an actual basis, (ii) adjusted to give effect to the
Pro Forma Adjustments (see footnote 1 to Prospectus Summary -- Summary Financial
Information) and (iii) adjusted to give effect to the sale by our company of
1,700,000 shares of common stock offered hereby and the anticipated application
of the estimated net proceeds therefrom.
September 30, 1998
--------------------------------------------------
Actual Pro Forma As Adjusted
--------------- --------------- --------------
Short-term debt ....................................... $ 250,000 $ 335,587 $ 85,587
============ ============ ============
Long-term debt ........................................ $ 610,000 $ 1,510,000 $ 1,010,000
------------ ------------ ------------
Stockholders' equity:
Preferred stock, par value $.01 per share, 1,000,000
shares authorized; no shares issued or outstanding,
actual, pro forma or as adjusted .................. -- -- --
Common Stock, par value $.001 per share, 20,000,000
shares authorized; 5,137,500 shares issued and
outstanding, actual; 5,637,696 shares issued and
outstanding, pro forma; 7,337,696 shares issued
and outstanding, as adjusted(1) ................... 5,138 5,637 7,337
Additional paid-in capital ............................ 3,758,333 5,325,232 13,539,917
Subscriptions receivable .............................. (4,999) (4,999) (4,999)
Option costs .......................................... (100,292) (431,542) (140,000)
Accumulated deficit ................................... (1,903,761) (1,903,761) (2,257,673)
------------ ------------ ------------
Total stockholders' equity ......................... $ 1,754,419 $ 2,990,567 $ 11,144,582
------------ ------------ ------------
Total capitalization ............................ $ 2,364,419 $ 4,500,567 $ 12,154,582
============ ============ ============
- ------------
(1) Includes 115,436 shares of common stock (pro forma and as adjusted) issued
for no or nominal consideration subsequent to September 30, 1998 (including
41,665 shares estimated to be issued upon exercise of certain options upon
the closing of this offering). Does not include (i) 170,000 shares reserved
for issuance upon exercise of the underwriter's warrants; (ii) 825,150
shares reserved for issuance upon exercise of options granted under our
stock option plans; (iii) 174,850 shares reserved for issuance upon the
exercise of options available for future grant under our stock option plans;
and (iv) 351,250 shares reserved for issuance upon exercise of non plan
options and warrants; and (v) 255,000 shares reserved for issuance in this
offering to cover over-allotments, if any, by the underwriter. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Management -- Employment Agreements," "-- Stock Option Plans"
and "Underwriting."
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Our company is a financial services company which owns A.B. Watley, Inc.
("Watley"), a registered securities broker-dealer and member of the National
Association of Securities Dealers, Inc. Our company acquired all of the capital
stock of Watley in January 1997. Our financial statements consolidate the
historical results of Watley.
We provide real-time online financial brokerage services and comprehensive
information about the securities markets through our proprietary trading
systems, UltimateTrader and WatleyTrader. We also operate a "third-market
institutional sales" desk which specializes in executing and facilitating
large-block transactions in approximately 300 thinly-traded equity securities.
We have experienced substantial changes to, and expansion of, our business
and operations since we began offering Internet brokerage services in March
1997. We expect to continue to expand our business and client base which will
require our company to increase our personnel, purchase additional equipment and
expand our network and client service capabilities which will result in
increasing expenses.
Results of Operations
Year ended September 30, 1998 ("Fiscal 98") compared to year ended September 30,
1997 ("Fiscal 97").
Revenues for Fiscal 98 were $9,119,268, an increase of 101.2%, as compared
to revenues of $4,532,532 for Fiscal 97. Revenues from commissions increased by
$3,385,272, or 84.3% from $4,017,787 for Fiscal 97 to $7,403,059 for Fiscal 98
due to the substantially increased volume of orders transacted by our online
brokerage clients, as well as through our third-market institutional sales desk.
We experienced an increase in the number of online trading clients from
approximately 300 at September 30, 1997 to approximately 900 at September 30,
1998. Data service revenues also increased by $512,883, or 345.7% from $148,353
for Fiscal 97 to $661,236 for Fiscal 98 due to the increased number of online
trading accounts. Revenues from principal transactions increased by $671,592, or
291.6%, from $230,297 for Fiscal 97 to $901,889 for Fiscal 98, largely as a
result of the increased volume of business conducted by our third-market
institutional sales desk. Interest and other income increased from $130,095 for
Fiscal 97 to $146,704 for Fiscal 98.
Interest expense increased from $212,359 for Fiscal 97 to $259,322 for
Fiscal 98 as a result of increased borrowings.
As a result of the foregoing, our net revenues increased by $4,539,773, or
105.1%, from $4,320,173 for Fiscal 97 to $8,859,946 for Fiscal 98. Substantially
all of our revenues were generated by clients in the United States and no client
or group of related clients accounted for 10% or more of our revenues.
Total expenses increased by $4,102,221 or 76.3%, from $5,377,370 for Fiscal
97 to $9,479,591 for Fiscal 98. Commissions, floor brokerage and clearing
charges represent payments to our clearing brokers and to certain employees who
facilitate our clients' transactions. As a result of the significant increase in
the volume of transactions by our clients, such expenses increased by
$1,580,798, or 85.7%, from $1,844,927 for Fiscal 97 to $3,425,725 for Fiscal 98.
Employment compensation and related costs increased by $950,388, or 73.2% from
$1,297,575 for Fiscal 97 to $2,247,963 for Fiscal 98 due to our hiring of 25
additional personnel to service our increased client base. Communications
expense increased by $419,807, or 124.4%, from $337,584 for Fiscal 97 to
$757,391 for Fiscal 98 as a result of our substantially increased base of online
clients. We expect that the foregoing expenses will continue to increase as we
seek to expand our client base.
Business development expenses consist of advertising costs to obtain new
clients, which costs have primarily been for print and media advertising. Such
expenses increased by $539,227, or 122.2%, from $441,424 for Fiscal 97 to
$980,651 for Fiscal 98 as a result of our expanded marketing efforts. We expect
such aggregate expenses to continue to increase as we expand our marketing
efforts. However, our new client acquisition costs decreased on a per client
basis.
19
Professional services increased from $894,920 for Fiscal 97 to $971,494 for
Fiscal 98. Occupancy and equipment costs increased by $294,589, or 196.9%, from
$149,580 for Fiscal 97 to $444,169 for Fiscal 98, primarily due to the
relocation of our offices to larger space and the purchase of additional
equipment in anticipation of our proposed expansion. Depreciation and
amortization increased by $164,227, or 82.5%, from $198,980 for Fiscal 97 to
$363,207 for Fiscal 98 for the same reasons. Other expenses increased by
$76,611, or 36.1%, from $212,380 for Fiscal 97 to $288,991 for Fiscal 98 for the
same reasons.
The income tax provision increased from $2,776 for Fiscal 97 to $12,765 for
Fiscal 98.
As a result of the foregoing, our operating results improved from a net
loss of $1,059,973 for Fiscal 97 to a net loss of $632,410 for Fiscal 98.
Liquidity and Capital Resources
Our business is capital intensive. Our capital requirements have exceeded
our cash flow from operations as we have been building our business. At
September 30, 1998, we had a working capital deficit of $691,258. As a result,
we have been substantially dependent upon sales of our common stock and
borrowings from officers, directors and stockholders and third parties to
finance our working capital requirements.
Watley has borrowed an aggregate of $530,000 in the form of subordinated
loans, pursuant to agreements approved by the NASD. Such loans are included by
Watley for purposes of computing its net capital under the SEC's net capital
rules. Such borrowings by Watley consist of (i) a $55,000 principal amount
non-interest bearing loan, and a $125,000 principal amount loan, bearing
interest at the rate of 12% per annum, from Steve Malin, our Chairman of the
Board, Chief Executive Officer and a principal stockholder of our company, and
(ii) a $200,000 principal amount loan, bearing interest at the rate of 15% per
annum and a $150,000 principal amount loan bearing interest at the rate of 13%
per annum from Mel Steinberg, father of Eric Steinberg, Executive Vice President
of our company. The loans mature in October 2000, except for the $125,000 loan
which matures in April 2000. During Fiscal 97, we paid an aggregate of $47,788
of interest on such loans and during Fiscal 98, we paid an aggregate of $49,500
of interest on such loans. See "Certain Transactions."
Watley is currently required to maintain net capital of $100,000 and a
ratio of aggregate indebtedness to net capital (the "net capital ratio") of 15
to 1 pursuant to the SEC's net capital rule. Such rule also prohibits "equity
capital" (which, pursuant to the net capital rule includes the subordinated
loans) from being withdrawn or cash dividends from being paid if Watley's net
capital ratio would exceed 10 to 1 or if Watley would have less than its minimum
required net capital. Accordingly, Watley's ability to repay the subordinated
loans may be restricted pursuant to the net capital rule. At September 30, 1998,
Watley had net capital of $161,128, which was $61,128 in excess of its minimum
required net capital, and Watley's net capital ratio was 7.4 to 1.
We received net proceeds of $2,045,000 from a private placement of equity
securities in Fiscal 97. We used approximately $1,180,000 of such proceeds to
acquire the systems and equipment utilized to test and launch our online trading
systems during that period. The balance of such proceeds were used for
advertising and working capital.
In Fiscal 98, we received net proceeds of $990,000 from a private placement
of equity securities and $250,000 from the issuance of $250,000 principal amount
notes and options to purchase an aggregate of 41,665 shares of common stock for
nominal consideration, of which $100,000 was furnished by Mel Steinberg. Such
proceeds were utilized to purchase a portion of the equipment acquired to expand
our online network. See "Certain Transactions."
We had cash and cash equivalents of $970,308 as of September 30, 1998. Our
operating activities provided $507,090 of net cash. We had a net loss of
$632,410 and a decrease in receivables from clearing brokers of $239,479, which
was more than offset by depreciation and amortization of $363,207, non-cash
amortization of option costs of $226,227, a non-cash compensation charge of
$115,000 and an increase in accounts payable and accrued liabilities of
$660,605. We used $1,440,345 of net cash in investing activities, consisting of
$2,244,313 of property and equipment purchases, which was partially offset by
deferred rent incentives of $803,968. Financing activities provided $1,200,870
of net cash, consisting of $990,870 of proceeds from sales of common stock and
$250,000 of proceeds from the issuance of notes payable, which were partially
offset by a $40,000 repayment of a loan to Bank of New York.
20
In October 1998, we obtained a $500,000 loan from New York Small Business
Venture Fund LLC, bearing interest at an annual rate of 12%, payable monthly. In
connection with such loan, we issued to the lender a $500,000 principal amount
promissory note and warrants to purchase 191,250 shares of our common stock at
an exercise price equal to the initial public offering price of our common stock
($6.00 per share). We granted the lender a security interest in substantially
all of our assets to secure our obligations under the loan, and six persons who
are officers, directors and/or principal stockholders of our company guaranteed
our obligations under such loan. We used these funds for the purchase of
additional equipment, marketing expenses and working capital. We intend to repay
the loan, plus a 1% prepayment fee, from the proceeds of this offering. See
"Certain Transactions."
In December 1998, we obtained a $500,000 line of financing from General
Electric Capital Corporation which is to be used from time to time primarily for
the purchase or leasing of additional equipment and software. We are required to
deliver to the lender a letter of credit in the amount of 50% of any amount
borrowed under this financing. As of December 31, 1998, we borrowed
approximately $311,208 under this line of financing, which we used to purchase
equipment. In connection with our company's borrowing under this financing, we
have granted the lender a security interest in certain of our company's existing
equipment as well as in all equipment purchased using funds obtained under this
financing.
In January 1999, we obtained a $400,000 loan from New York Community
Investment Company L.L.C., bearing interest at an annual rate of 12%, payable
monthly. In connection with such loan, we issued to the lender a $400,000
principal amount promissory note and warrants to purchase 140,000 shares of our
common stock at an exercise price equal to the initial public offering price of
our common stock ($6.00 per share). We granted the lender a security interest in
substantially all of our assets (other than our intangible assets) to secure our
obligations under the loan. We are using these funds for marketing expenses and
working capital.
In January 1999, we sold an aggregate of 221,500 shares of common stock to
12 investors in a private placement at a price of $4.80 per share for which we
received aggregate net proceeds of approximately $1,050,000. In connection with
such private placement, Anthony Huston, Executive Vice President of our company,
purchased 50,000 shares at a price of $240,000; Leon Ferguson, Senior Vice
President of our company, purchased 52,000 shares at a price of $249,600; and
Mark Chambre, who has agreed to serve as a director of our company upon the
closing of this offering, purchased 15,000 shares at a price of $72,000. All of
the purchasers of such shares agreed not to sell or otherwise dispose of any of
such shares for a period of twelve months from the date of this prospectus. See
"Certain Transactions."
We estimate that our capital expenditures will be approximately $3,300,000
during the twelve months following the closing of this offering. Such capital
expenditures are expected to be made to expand our network infrastructure,
create an off-site back-up communications center or "hot-site", purchase
additional systems to convert to self-clearing operations, provide additional
client support, expand our third-market institutional sales desk and continue
software and programming development.
We need the proceeds of this offering to expand our operations and finance
our future working capital requirements. Based upon our current plans and
assumptions relating to our business plan, we anticipate that the net proceeds
of this offering will satisfy our capital requirements for at least twelve
months following the closing of this offering. If our plans change or our
assumptions prove to be inaccurate, we may need to seek additional financing
sooner than currently anticipated or curtail our operations. We cannot assure
you that the proceeds of this offering will be sufficient to fund our proposed
expansion or that additional financing will become available if needed. Our
company will be materially adversely affected if we do not obtain financing when
needed. We may seek additional debt or equity financing to fund the cost of
continued expansion.
Net Operating Loss Carryforwards
Our company's net operating loss carryforwards ("NOLs") expire beginning in
the year 2012. Under Section 382 of the Internal Revenue Code of 1986, as
amended, utilization of prior NOLs is limited after an ownership change, as
defined in Section 382, to an annual amount equal to the value of the
corporation's outstanding stock immediately before the date of the ownership
change multiplied by the long-term tax exempt rate. The additional equity
financing obtained by our company in connection with its recent financings
21
and this offering will result in an ownership change and, thus, will limit our
company's use of its prior NOLs. In the event we achieve profitable operations,
any significant limitation on the utilization of its NOLs would have the effect
of increasing our tax liability and reducing net income and available cash
reserves. We are unable to determine the availability of such NOLs since this
availability is dependent upon profitable operations, which our company has not
achieved in prior periods. See Note 12 to Notes to Consolidated Financial
Statements.
Relevant Accounting Standards
Our company generally grants stock options to certain 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 ("APB") No. 25, "Accounting for Stock
Issued to Employees," and, accordingly, recognize no compensation expense
related to such grants. In cases where we grant options below the fair market
value of the stock at the date of grant, the difference between the strike price
and the fair market value is treated as compensation expense and amortized over
the vesting period of the option, if any. Stock options granted to consultants
and others in lieu of cash compensation are recorded based upon management's
estimate of the fair value of the options or the related services provided and
expensed over the vesting period, if any.
Pro forma information regarding net income (loss) is required under
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation," and has been determined as if we had accounted for
all the 1998 and 1997 stock option grants on the fair value method. See Notes 2
and 11 to Notes to Consolidated Financial Statements.
Our company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
Our company recognizes the current and deferred tax consequences of all
transactions that have been recognized in the financial statements, using the
provisions of enacted tax laws. Deferred tax assets are recognized for temporary
differences that will result in deductible amounts in future years and for tax
loss carryforwards, if in the opinion of our management, it is more likely than
not that the deferred tax asset will be realized. SFAS No. 109 requires
companies to set up a valuation allowance for the component of net deferred tax
assets which does not meet the "more likely than not" criteria for realization.
The Company has established such valuation allowance for its deferred tax
assets.
In 1997, the Financial Accounting Standards board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share." The new rules are
effective for both interim and annual financial statements for the periods
ending after December 15, 1997. SFAS No. 128 supersedes APB No. 15 to conform
earnings per share with international standards as well as to simplify the
complexity of the computation under APB No. 15. The previous primary earnings
per share ("EPS") calculation is replaced with a basic EPS calculation. The
basic EPS differs from the primary EPS calculation in that the basic EPS does
not include any potentially dilutive securities. Fully dilutive EPS is replaced
with diluted EPS and should be disclosed regardless of dilutive impact to basic
EPS. Accordingly, our company has adopted SFAS 128 effective September 30, 1998.
Year 2000 Issues
We have devised a plan and have substantially completed a review and
assessment of all hardware and software and believe that such hardware and
software are substantially year 2000 compliant so that the computer programs do
not cease functioning because of an inability to process on a date occurring
from and after January 1, 2000. Our review has not revealed any year 2000 issues
that cannot be remediated in a timely manner. We do not believe that any such
remediation costs will be material.
We are highly dependent upon third-party financial information vendors,
telecommunications suppliers and our clearing brokers. We have sent letters to a
number of such vendors requesting assurances of their compliance. Such third
parties have generally advised us that their review of their operating systems
indicate that their operating systems are year 2000 compliant. We are currently
developing a contingency plan in the event that any third parties with which we
do business have any material year 2000 compliance problems.
We would be materially adversely affected if there are any failures or
interruptions in service resulting from the inability of our computing systems
or any such third-party's systems to recognize the year 2000. Moreover, since
our evaluation of these issues is continuing, we cannot assure you that
additional issues will not be discovered which could present a material risk of
disruption to our operations.
22
BUSINESS
General
Internet Financial Services Inc. provides real-time online financial
brokerage services and comprehensive information about the securities markets
through its proprietary trading systems, UltimateTrader and WatleyTrader.
UltimateTrader is a uniquely integrated trading system because it provides
active traders with the comprehensive information they need on a real-time basis
and the ability to execute trades in seconds. WatleyTrader is our web-based
Internet broker service which we designed for active investors who execute
trades on a frequent basis and use online services to gather information about
the securities market. We also operate a third-market institutional sales desk
which specializes in executing and facilitating large-block transactions in
approximately 300 thinly-traded equity securities.
Watley is a broker-dealer registered with the SEC and NASD and is licensed
as a broker-dealer in 49 states.
Industry Overview
Our industry has recently experienced a series of changes, led by
electronic and online commerce, which has created market opportunities for our
company and other similarly situated brokerage firms. These favorable market
trends include:
The Emergence of Electronic and Online Commerce.
Internet and online services have provided organizations and individuals
with innovative ways of conducting business. With the emergence of the Internet
as a globally accessible, fully interactive and individually addressable
communications and computing medium, companies that have traditionally conducted
business in person, through the mail or over the telephone are increasingly
utilizing electronic commerce. Increased use of credit cards, automated teller
machines, the incidence of electronic funds transfers and online banking and
bill paying has automated, simplified and reduced the costs of financial
transactions for consumers, businesses and financial institutions.
Consumers have shown a strong preference for transacting certain types of
business electronically, such as paying bills, buying insurance, booking airline
tickets and trading securities, rather than in person or over the telephone.
These transactions are being streamlined through online commerce and can now be
performed directly by individuals virtually anywhere at any time. Consumers have
accepted and even welcomed self-directed online transactions because such
transactions can be faster, less expensive and more convenient than transactions
conducted through a human intermediary.
The Development of Online Brokerage Services.
In the past, individual investors could access the financial markets only
through a full-commission broker, who would offer investment advice and place
trades. With the 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 of discount brokerage firms, which provide an alternative investment
approach by completing trades at a reduced cost.
With the emergence of electronic brokerage services, investors are being
given the ability to further unbundle the costs associated with the human
interaction required by full-commission and traditional discount brokerage
firms. By requiring personnel to handle each transaction, most traditional
brokerage firms restrict their clients' access to trading and information to the
availability of the person processing the transaction. In addition, although
full-commission and discount brokerage firms are able to offer electronic
trading services, their continued reliance on personnel, branch offices and the
associated infrastructure for a major part of their business prevents them from
reducing their cost structure to the lower price points achievable through
electronic trading.
We believe that the increased presence of automated teller machines, the
growth of discount brokerage firms and a variety of other indicators evidence a
shift in demographics that is fundamentally altering the way consumers manage
their personal financial assets. Based on consumer feedback and the rapid
acceptance by consumers of online transactions, we also believe that 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 financial intermediaries.
23
As investors obtain even more access to investment information, we believe
they will desire greater control over their financial decisions and seek
alternative ways to invest more conveniently and cost-effectively and with less
interaction with brokers and other financial services professionals. We believe
that this trend has created a growing opportunity to provide online trading
services, such as UltimateTrader, that are easy to access, easy to use,
cost-effective and secure.
The Growing Market for Active Traders, Active Investors and Online Brokerage
Services.
Active trading is dependent upon liquidity, i.e., the ability to buy or
sell stock at any given time. Until recently, liquidity was primarily provided
by Nasdaq and an alternative trading system called Instinet. Both systems
display quoted bid and ask prices for stock and have automatic execution
capacity. However, the liquidity on Instinet is available only to institutional
clients and certain brokerage firms.
In 1996, the SEC adopted rules which brought about sweeping changes in the
structure of the over-the-counter market and were very beneficial for our
company and our clients, as well as to public companies and their shareholders.
These rules, known as the Order Handling Rules, permitted the creation and
operation of electronic communication networks ("ECNs"), open broadcasting
systems that allow anyone with a connection to the network to see all the bids
and offers posted into the system for any Nasdaq traded security. The Order
Handling Rules require market makers to display certain limit orders in their
quotations or to send those orders to an ECN for display. The increased
regulatory emphasis on enforcing compliance with the duty of brokers to obtain
the best execution for their clients has fostered the growing importance of
ECNs, which provide an ever-increasing source of liquidity (having a ready
market to buy or sell stock) in the over-the-counter market.
We believe that this regulatory environment and the increased availability
of information to individual investors on a real-time basis, together with
advances in Internet, networking and communications technologies, has created
investing opportunities for active traders and active investors and market
opportunities for online brokerage services.
Online trading is the fastest growing segment of the brokerage industry and
is expected to grow significantly. Forrester Research, Inc. projects that the
online trading industry grew from approximately 1.5 million accounts at the end
of 1996 to approximately 5 million accounts at the end of 1998, and that the
market will grow to 8.4 million accounts at the end of 1999 and 14.4 million
accounts in 2002. Another industry report indicates that the volume of
securities trades placed over the Internet increased by 34% during the fourth
calendar quarter of 1998, compared to the third quarter of 1998, and that the
number of online trades accounts for 25% to 30% of all individual investor stock
transactions and 14% of all equity transactions. Industry experts also project
that retail commissions generated by online trading market will grow from
approximately $268 million, or 15% of the commissions generated by discount
brokerages in 1996, to as much as $2.2 billion, or 60% of total discount
brokerage commissions by 2001.
Strategy
The online trading sector is the fastest growing segment in the brokerage
industry. Our strategy is to capitalize on perceived opportunities arising from
this expanding market by:
o Targeting active traders and other active investors. We believe that the
market for such clients is currently underserviced and that UltimateTrader
is positioned to satisfy their requirements.
o Expanding our marketing efforts for our online brokerage service. We intend
to aggressively market UltimateTrader by targeting active traders through
print, online and other advertisements. Our advertising efforts are
expected to include advertisements in financial publications and various
other regional and national publications that have a demographic similar to
our target market. We also intend to advertise and promote UltimateTrader
through Internet website and banner advertisements and television
commercials.
o Expanding our network infrastructure and client support capabilities. We
intend to expand our network infrastructure and client support
capabilities to better service an expected increasing client base. Our
24
internal computing needs will require additional networking equipment. We
also intend to establish an off-site back-up communications center or "hot
site", in a different region of the country, to mirror the primary location
in order to ensure continued operations in the event of a systems failure
at our primary location.
o Converting to self-clearing operations. We believe that performing such
operations internally will reduce our operating costs and provide us the
opportunity to receive revenues from margin transactions with our clients.
We expect that such expansion will be accomplished by acquiring an existing
clearing firm or hiring the appropriate staff to build and manage our own
clearing department. We intend to develop and/or obtain the requisite
software systems and to acquire computer hardware, as well as the necessary
personnel, to convert to self-clearing operations during the year 2000.
o Improving our third-market institutional sales desk. We are continuously
seeking to improve our technical expertise and apply new technologies to
more effectively provide such services. Additionally, after this offering,
we intend to hire additional associates to expand the number of securities
we cover for this market.
o Offering new services.
International Expansion. We are currently evaluating opportunities to
provide electronic execution services for foreign institutions and their
clients for transactions in the U.S. securities markets and to arrange
for foreign institutions to provide for such services for our clients in
foreign markets.
Offer fee-based asset management services. We are evaluating the
possibility of offering a comprehensive range of financial advisory
services online, including assessing risk profiles, asset allocation and
fund placement.
UltimateTrader
UltimateTrader was designed for use by self-directed active traders. Active
traders execute more trades per day than any other category of investors and
require real-time information and quick order execution to effectuate their
trading strategies.
We designed UltimateTrader by uniquely integrating third-party market data
and order entry software with our proprietary networking systems to create a
proprietary trading system. UltimateTrader provides active traders with the
comprehensive information they need on a real-time basis and the ability to
execute trades in seconds.
Since UltimateTrader is a client-server application, it is not restricted
by the "query-response" limitation of HTML, the primary programming language of
the worldwide web. As a result, UltimateTrader delivers and automatically
updates a continuous, dynamic stream of live market data to the client's screen.
With most other trading systems, displayed data remains static until the query
is repeated.
UltimateTrader provides our clients access to comprehensive information on
stocks, markets, indices, mutual funds, news and options. UltimateTrader clients
are able to access bid and ask prices, charts, research and over 170 other types
of information for any listed or Nasdaq traded stock, as well as the ability to
establish and track their securities, cash and margin positions on a real-time
basis. Our clients can arrange the display and configuration of data on their
computer screens using a menu and tool bar, which are generally utilized in the
Windows(TM) operating system. Different computer screen arrays or pages can be
built to suit the user's personal requirements.
UltimateTrader clients can execute trades with a few simple mouse clicks or
keystrokes. UltimateTrader clients can route trades directly to the exchanges,
the Nasdaq Market Maker System, a specific market maker or an ECN. As a result,
we believe trades can be executed more quickly than if the trade is routed
through a third market firm or an online brokerage firm's trading desk, as is
the case within any other trading systems. The order entry section can be preset
for size and type of order. The client can use a mouse to click the bid or ask
price of a security and either close out an open position or add to an existing
one. If the user clicks the bid or ask price of the security, the order entry
screen will appear pre-configured to buy or sell.
25
Once an order is entered, UltimateTrader sends the order to the exchange
selected in less than two seconds from virtually anywhere in the world. Such
significant savings in time have tremendous value to a client who is trying to
trade in markets characterized by rapidly changing prices.
Speed of order execution is also affected by how an order is routed.
UltimateTrader clients are able to route their orders directly to the exchanges
(such as the New York Stock Exchange, American Stock Exchange, Nasdaq Stock
Market, Inc. and Chicago Board Options Exchange). Most other retail online
trading systems route orders to a third-market firm (i.e., Knight, Trimark,
etc.) or to the online broker's trading desk or trading subsidiary, which in
turn routes the orders to the market. The Company believes that most internal
trading systems and those of third-market firms cannot match the order execution
speed and capacity of the exchanges.
Clients can also elect to route trades to our Watley trading desk for
efficient execution. Our Watley trading desk consists of registered
representatives who are available to assist our clients. There is no additional
cost for executing orders via the Watley trading desk button.
UltimateTrader clients may place bids or offers onto an ECN which will also
appear in the Nasdaq Market Maker Level 2 screen with the corresponding price
and size of the order. This gives our clients an advantage in attempting to
execute orders in between the current bid and asked prices of Nasdaq securities.
To direct an order to a specific market maker or ECN, our clients double
click on the market maker or ECN and mark their order entry screen with this
preference. The SelectNet preference button is useful when our clients wish to
execute orders for more than 1,000 shares of a security. Orders sent through
SelectNet are only shown to the market makers trading that particular security.
UltimateTrader Service Levels. UltimateTrader clients can select among four
different service levels, depending on the information desired and the cost and
fees which a client is willing to pay for information and service:
Service Level I System features include:
o Dynamic Updating Quotations -- displays real time changes in prices and
markets as they occur.
o Unlimited Customized Pages -- allows clients to creates computer screen
layouts to their preference with their data and to scroll freely among
these pages.
o Electronic Execution -- provides direct electronic access to various
exchanges and markets for rapid routing of execution of trades.
Service Level II System features includes Service Level I features plus:
o Board View Portfolio Minder -- used to create computer windows with
comprehensive price and other data relating to a number of different
securities.
o Position Minder -- serves as a portfolio monitor and displays existing
open positions as well as the status of pending orders.
o Scrolling Tickers -- displays price and trading volume information for
the symbols that a client chooses on a live basis. The quotes will move
through the ticker window as the server receives them.
o Alarms -- alerts clients by an audio or visual "pop-up" when target
criteria have been met for a specified security.
o Snap Quotes -- displays detailed information about individual symbols.
o Market Minder -- a fully configurable quote screen that can display
virtually any information the secur-ity selected by the client.
o Hot Keys -- the ability to execute/cancel trades with a simple keystroke.
o MultiQuotes -- displays prices and fundamentals for any symbol.
26
Service Level III features includes Service Level II features plus:
o Charts with Technical Studies -- allows clients to view live, dynamically
updating, real-time intraday chart data and historical information for
stocks, options or indices.
Service Level IV features includes Service Level III features plus:
o Nasdaq Level II Data -- continuously updated display of market maker and
ECN current prices and changes.
o Color Coded Nasdaq Market Maker Screens -- designed to visually display
(by a special color on the screen) upward and downward trends in recent
trades in a security.
o Time and Sales -- reflects last and cumulative trades, prices and
aggregate daily volume in a security.
Our fee schedule for clients subscribing to Service Level I is as follows:
Number of Trades Per Month Transaction Charges Monthly Fee for Real Time Data
- -------------------------- --------------------- -------------------------------
1-19 trades per month $ 16.95 $50 per month
20 or more trades per month $ 16.95 free
Our fee schedule for clients subscribing to Service Levels II, III and IV
is as follows:
Monthly Fee for Real Time Data*
----------------------------------------------
Number of Trades Per Month Transaction Charges Level II Level III Level IV
- -------------------------- --------------------- -------------- --------------- -----------
1-9 trades per month $ 23.95 $ 75 $ 150 $ 300
10-24 trades per month $ 22.95 $ 50 $ 125 $ 250
25-49 trades per month $ 20.95 free $ 75 $ 200
50-99 trades per month $ 19.95 free free free
100-199 trades per month $ 18.95 free free free
200 or more trades per month $ 17.95 free free free
- ------------
*Dow Jones News Service is an optional service priced at $95.00 per month.
Orders for an exchange listed security in excess of 2,000 shares or a
Nasdaq listed security in excess of 10,000 shares incur a surcharge of $.01 per
share and a commission of $.01 per share on the entire order. We also charge an
additional fee for executing on an ECN or SelectNet, substantially all of which
is forwarded to the owner or operator of that system.
Optional Services. We offer a vast array of optional services to
UltimateTrader clients. Among these are the Dow Jones News Service and various
charting and market trading services. The Dow Jones News Screen provides
continuously updating real-time news in a scrolling format, including breaking
news, corporate announcements, interviews, industry news, market reports,
economic and political developments, "hot stock" alerts, international events
and other information that impacts the securities markets.
With Dow Jones News and a number of other services, we invoice the client
directly as part of their monthly bill and remit the special charges to the
vendor supplying these services, while retaining approximately 15% of the charge
as our fee.
Virtual Private Network Access. Watley has created a virtual private
network solution called the Dedicated Port Service for those clients who require
reliable non-Internet access to the equity markets. This service offers local
dial access from nearly anywhere in the country via modem, as well as ISDN
access in selected metropolitan areas. Users are charged a fixed monthly fee for
unlimited usage.
UltimateTrader has accounted for most of our retail customer account
revenues in the past year and we anticipate this to continue in the future.
During the year ended September 30, 1998, we derived approximately 67.4% of our
company's total revenues from UltimateTrader clients.
27
WatleyTrader
WatleyTrader is our web-based Internet brokerage service which we designed
for active investors who execute trades on a frequent basis and use online
services to gather information about the securities markets. WatleyTrader
provides comprehensive information on stocks, markets, indices, mutual funds,
news and options in a live format for free. WatleyTrader clients can place
trades, obtain quotes, order research and check account balances and portfolio
valuations online or through our automated touch-tone phone system, 24 hours a
day. The electronic order system for the WatleyTrader directs orders to the
Watley Desk for execution. WatleyTrader client orders are entered, processed and
confirmed electronically.
WatleyTrader targets price sensitive investors and competes directly with
E-Trade, E-Schwab and other online brokerages. The basic fee schedule for the
WatleyTrader is a transaction charge of $9.95 per order (orders of more than
5,000 shares bear a commission of $.01 per share for the entire order) with an
additional $15.00 fee for trades made by telephone.
During our year ended September 30, 1998, approximately 1.4% of our
revenues originated from WatleyTrader clients.
Third-Market Institutional Sales Desk
Our third market institutional sales desk specializes in facilitating
and/or executing large-block transactions in approximately 300 thinly-traded
equity securities. These services are provided to clients who often require that
their purchase or sales of large positions remain anonymous. We match buyers and
sellers to execute "off-exchange transactions", to minimize the impact on the
market and prevent our client's positions from being disclosed to competing
firms. Our third-market institutional sales clients include mutual and pension
funds, insurance companies, banks, corporations and independent fund managers.
Approximately 30.7% of our revenues for the year ended September 30, 1998 were
derived from the institutional trading desk.
Client Services
Client services (trading, administrative, and technical support) for all
levels of online service are among our highest priorities. We believe that
providing an effective client service team to handle client needs is critical to
our success. Our client service organization helps clients get online, handles
product and service inquiries and addresses all brokerage and technical
questions. The client service team also makes welcome calls to verify the
satisfaction of our clients.
Live client support is available 10 hours a day from 8:00 AM to 6:00 PM EST
Monday through Friday. Our client services department operates on a 'one-stop
shopping' basis, meaning that clients do not have to be transferred between
departments in order to receive answers to their inquiries. We currently employ
ten client services associates, all of whom 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 team helps clients with particularly serious or persistent technical
issues.
In order to provide professional and efficient client support, we have
purchased and implemented client management software. Databases are updated with
each client contact to track client service calls, trading patterns and
compliance issues, and to generate periodic (daily and weekly) reports for
management. Client services associates access the latest client account
information through their own searchable client services manual and solutions
database.
We recently launched online support and chat services for our clients. This
service currently offers an online, indexed UltimateTrader user manual and chat
area. The chat area offers clients the ability to query and 'chat' with client
services associates in real-time. Our goal with respect to the provision of
online support and chat services is to create a sense of 'virtual community'
among prospective and existing clients and between our company and our clients.
We plan to create a VIP client services team to service our most active
online clients. In addition to providing client support for all issues on an
account manager basis, we intend for the VIP team to offer face-to-face
28
contact, individualized service and customized incentive packages. We believe
that providing highly personalized and professional client support, especially
for our niche market high volume clients, will further differentiate our
products and services from those of our competitors.
Operations
Clearing and Order Processing.
Watley does not hold any funds or securities of its clients nor does Watley
directly execute and process either its own or its clients' securities
transactions. Since October 1996, Watley has cleared all transactions for its
clients, on a fully disclosed basis, with Penson Financial Services, Inc. for
retail accounts and Weiss, Peck & Greer, L.L.C. for institutional accounts.
Pursuant to Watley's agreements with its clearing brokers, the clearing
brokers, process all securities transactions for Watley's account and the
accounts of Watley's 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. Watley has agreed to indemnify and hold the
clearing brokers harmless from certain liabilities or claims, including claims
arising from the transactions of its clients. Watley's clearing agreements may
be terminated by either party, upon 60 days' written notice in the case of
Penson Financial Services, Inc., and 30 day's prior written notice in the case
of Weiss, Peck & Greer, L.L.C. Watley is dependent on the operational capacity
and the ability of the clearing brokers for the orderly processing of
transactions. By engaging the processing services of clearing brokers, however,
Watley is exempt from certain capital 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 to a client,
collateralized by securities and cash in the client's account, for a portion of
the purchase price. The client is charged for such margin financing at interest
rates based on the brokers call rate (the prevailing interest rate charged by
banks on secured loans to broker-dealers), plus an additional amount of up to
1.75%.
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 our 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
so that the loan is at all times no greater than 65% of the market value of
securities in the margin account.
We currently intend to convert to self-clearing operations since we believe
that performing such operations internally will reduce our operating costs and
provide us the opportunity to receive revenues from margin transactions with our
clients. If we were to implement self-clearing operations, our client's
securities typically will be held by our company in nominee name on deposit at
one or more of the recognized securities industry depository trust companies, to
facilitate ready transferability. We will collect dividends and interest on
securities held in nominee name and make the appropriate credits to our client's
account. We will also facilitate exercise of subscription rights on securities
held for our clients. We will arrange for the transmittal of proxy and tender
offer materials and issuer reports to our clients.
Self-clearing operations, especially where conducted by firms such as our
company, without significant prior experience, involve substantial risks of
losses due to clerical errors related to the handling of client funds and
securities. Errors in the clearing process also may lead to civil liability for
actions in negligence brought by parties who are financially harmed as a result
of such errors. Clearing operations have accounted for a significant portion of
our cost of services. The failure of our company to perform self-clearing
operations accurately and cost-effectively could have a material adverse effect
on our business, financial condition and operating results.
Network Infrastructure.
Our network consists of a series of servers, routing and Internet-
networking equipment, workstations, software support clusters, and firewall
management systems. This creates a global connection to our intranet, so that
any computer that can connect to the Internet can connect to our system.
29
Any individual with a personal computer who has a connection to the
Internet and has Windows(TM) compatible software can subscribe to
UltimateTrader. Once an account is opened, the client downloads UltimateTrader
software and is given a unique user name and password. The client then logs onto
the UltimateTrader system and is connected to one of our order servers.
Our network is accessed by electronic messaging. A message is sent to
Watley's intranet via the client's Internet service provider. In order to access
Watley's network, this message first passes through a firewall and web shield.
The firewall allows appropriate Internet traffic into the network. The web
shield prevents virus infected files or messages from reaching the network. Once
the message has passed through the firewall and web shield, a permission server
qualifies the information. Once the client establishes a connection to the
UltimateTrader system, the connection between the client and server is
maintained until the client requests it be terminated.
Our technology is supported by an internal staff of programmers, developers
and operators 24 hours a day, seven days a week. The programming staff is
supplemented by a team of quality control analysts, web page developers,
technical writers and design specialists who ensure the final product is
user-friendly and dependable. In addition to supporting the systems, the staff
continually enhances software and hardware and develops new services. Software
is designed to be versatile and easily adaptable to new and emerging
technologies.
The order server accepts buy/sell or sell short messages from the client
application and qualifies the order for appropriate review. Once an order is
qualified, it is sent to the exchange of the client's choice and messages are
sent to update our data base. This update offers the client real-time account
positions, equity and profit and loss calculations. All transactions for the day
are processed for delivery to the clearing firm.
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, our trade processing system is designed to
compare the Watley accounts database with the clearing firm's account
information on a daily basis in order 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.
Firewalls and other software limit not only system access to the authorized
user(s), but also limit the authorized users to specifically approved
applications. This filter-software prevents unauthorized access to critical
areas of the system such as account information. Furthermore, public access
servers such as e-mail, chat services and FTP are in a network entirely separate
from the rest of our company's systems.
We have implemented special policies relating to the transfer or withdrawal
of funds by clients to prevent unauthorized withdrawals. All requests for fund
withdrawal or transfer require a signed letter from the account holder(s).
Checks will only be made out in the account holder's name and wire transfers
will only be sent to a bank account in the account holder's name.
Marketing and Advertising
We intend to market UltimateTrader by targeting active traders through
print, online and other advertisements. To date, we have engaged in limited
marketing and advertising efforts, consisting primarily of print advertising in
Investors Business Daily, a daily trade publication. We have also conducted
surveys of our existing client base to understand their media consuming habits
and demographic profiles in order to effectively target our advertising
campaign. We are developing a comprehensive marketing plan to attract potential
clients, as well as build market awareness, educate the investing public and
develop brand name recognition and loyalty within the most active trading
segment of the market. Our advertising efforts are
30
expected to include advertisements in financial publications and various other
regional and national publications that have demographics similar to our target
markets. We also intend to advertise and promote UltimateTrader through Internet
website and banner advertisements and television commercials.
Our initial marketing efforts will be concentrated in the United States.
However, as part of our long-term goals, we plan to market our services to
trading communities interested in U.S. equities in Western Europe, Latin
America, and Asia.
Competition
The market for electronic brokerage services is intensely competitive,
rapidly changing and has few barriers to entry. We believe that we compete on
the basis of speed and accuracy of order execution, processing and confirmation,
quality of client service, ease of use, amount and timeliness of information
provided, price and reliability of our trading systems.
We believe our competition consists of large and small brokerage firms,
utilizing the Internet to transact retail brokerage business. Among such
competitors are E*Trade Group, Inc., Charles Schwab & Co., Inc., Quick & Reilly,
Inc., Waterhouse Securities, Inc., Fidelity Brokerage Services, Inc. and Datek
Securities Corp. We also face competition for clients from full commission
brokerage firms, including Morgan Stanley Dean Witter & Co., PaineWebber
Incorporated and Salomon Smith Barney, as well as financial institutions and
mutual funds.
Securities Regulation
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. In addition, the SEC, the 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. 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. Certain changes in Watley's current business
or practices, including converting to self-clearing operations, require NASD and
other regulatory approval.
Net Capital Requirements
The SEC, 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 which governs Watley. Net
capital is essentially defined as net worth (assets minus liabilities), plus
other allowable credits and qualifying subordinated borrowings less certain
mandatory deductions that result from excluding assets that are not readily
convertible into cash and from valuing certain other assets, such as a firm's
positions in securities, conservatively. Among these deductions are adjustments
(called "haircuts") in the market value of securities to reflect the possibility
of a market decline prior to disposition.
As of September 30, 1998, Watley was required to maintain minimum "net
capital," in accordance with SEC rules, of approximately $100,000 and had total
net capital (as so computed) of approximately $161,128 or approximately $61,128
in excess of minimum net capital requirements.
Intellectual Property Rights
We rely on a combination of copyright, trademark and trade secrets laws and
non-disclosure agreements to protect our proprietary technologies, ideas,
know-how and other proprietary information. We have no patents or registered
copyrights. Notwithstanding the precautions we take, third parties may copy or
otherwise obtain and use our proprietary technologies, ideas, know-how and other
proprietary information without authorization or independently develop
technologies similar or superior to our technologies. In addition, the
confidentiality and non-competition agreements between our company and certain
of our employees, distributors and clients may
31
not provide meaningful protection of our proprietary technologies or other
intellectual property in the event of unauthorized use or disclosure. Policing
unauthorized use of our technologies and other intellectual property is
difficult, particularly because the global nature of the Internet makes it
difficult to control the ultimate destination or security of software or other
data transmitted.
In November 1998, our company filed with the United States Patent and
Trademark Office for a trademark registration on the supplemental register for
the UltimateTrader name. Although we are not aware of any challenges to our
right to use this trademark, we cannot assure you that a trademark registration
will be granted or, if granted, that the use of this mark would be upheld if
challenged.
There has been substantial litigation in the software industry involving
intellectual property rights. We believe that our technologies and trading
systems have been developed independent of others. Third parties may assert
infringement claims against our company and our technologies and trading systems
may be determined to infringe on the intellectual property rights of others.
Computer Strategies, Inc. Acquisition
Effective October 2, 1998, our company acquired all of the capital stock of
Computer Strategies, Inc. for 38,260 shares of common stock valued at $183,648.
Computer Strategies is a recently formed company providing computer software
consulting services. Leon Ferguson was the founder and sole stockholder of
Computer Strategies and became our Senior Vice President and Chief Information
Officer upon closing of the acquisition. See "Management -- Executive Officers
and Directors" and "Certain Transactions."
Personnel
As of November 24, 1998, we employed a total of 45 persons, of whom 10 are
engaged in executive management, 10 in trading activities, 10 in client service,
3 in sales and marketing, 5 clerical and back office personnel as well as 7
other employees. In addition, we retain a computer development and consulting
firm on an exclusive basis. We believe our relations with our employees are
generally good and we have no collective bargaining agreements with any labor
unions.
Our registered representatives are required to take examinations
administered by the NASD and state authorities in order to be qualified to
transact business, and are required to enter into agreements with Watley
obligating them to adhere to Watley's supervisory procedures and not to solicit
customers in the event of termination of employment. Watley's agreements with
registered representatives do not obligate such representatives to be associated
with Watley for any length of time.
Properties
Our principal offices are located at 40 Wall Street, New York, New York,
where we occupy approximately 15,000 square feet at an annual cost of
approximately $480,000, or $40,000 per month, plus escalations. Although the
lease began in January 1998, monthly rental payments will not commence until
June 1999. The initial term of the lease for the new office space expires in
June 2009.
Watley's operations are currently located at our offices at 33 West 17th
Street, New York, New York, where we occupy 7,400 square feet at an annual rent
of $131,000. These operations will be moved to our 40 Wall Street location over
the next several months. In addition, we occupy an additional 2,600 square feet
of space in New York, at an annual rental of $94,884 for our institutional
division. The lease for such space expires in 2004.
Legal Proceedings
Our business involves substantial risks of liability, including exposure to
liability under federal and state securities laws in connection with the
underwriting or distribution of securities and claims by dissatisfied clients
for fraud, unauthorized trading, churning, mismanagement and breach of fiduciary
duty. In recent years, there has been an increasing incidence of litigation
involving the securities industry, including class actions which generally seek
rescission and substantial damages.
In the ordinary course of business, we and our principals are, and may
become a party to legal or regulatory proceedings or arbitrations. We are not
currently involved in any legal or regulatory proceedings or, arbitrations, the
outcome of which is expected to have a material adverse effect on our business.
Because of the nature of our business, we may become party to legal or
regulatory proceedings or arbitrations.
32
MANAGEMENT
Executive Officers and Directors
Our executive officers and directors are as follows:
Name Age Positions
- ---- --- ---------
Steven Malin ................ 41 Chairman of the Board, Chief Executive Officer and Director
Harry Simpson ............... 32 President, Chief Operating Officer and Director
Robert Malin ................ 33 President of A.B. Watley, Inc. and Director
Anthony G. Huston ........... 35 Executive Vice President -- Strategic Planning
Eric Steinberg .............. 33 Executive Vice President -- Administration
Leon Ferguson ............... 36 Senior Vice President and Chief Information Officer
Jonathan Priddle ............ 36 Senior Vice President -- Sales
Brett Vernick ............... 30 Senior Vice President -- Management Information Services
Michael Fielman ............. 48 Vice President -- Finance
William Brawer .............. 42 Director
Elizabeth Chambers .......... 36 Director
Mark Chambre ................ 38 Director
Stanley Weinstein ........... 72 Director
Steven Malin co-founded our company in May 1996 and has been our Chairman
of the Board and Chief Executive Officer since inception. From April 1993 to May
1996, Mr. Malin served as a consultant to Watley. From 1987 to 1993, he was a
Senior Foreign Exchange Options Broker for Tullett and Tokyo Forex, Inc., a
global inter-bank money brokering firm with its primary offices located in
London, New York and Tokyo. Mr. Malin attended The Fletcher School of Law and
Diplomacy from 1982 to 1984. He received a bachelor of arts degree from Vassar
College in 1980.
Harry Simpson has been our President and Chief Operating Officer since
March 1998 and was our Executive Vice President of Online Brokerage Services
from May 1996 until March 1998. From January 1993 to September 1995, he served
as Vice President of Tullett and Tokyo Forex, Inc., and Manager of its Foreign
Exchange Options Desk in New York. From January 1988 to December 1992, Mr.
Simpson worked as a Senior Foreign Exchange Options Broker for Exco
International, Inc., an international money broker in Hong Kong and Tokyo. Mr.
Simpson received a bachelor of science degree in finance from Indiana University
in 1987.
Robert Malin is a co-founder of our company. He has been associated with
Watley since August 1993, initially as General Securities Principal and director
of day-to-day operations and, most recently, serving as President. His prior
experience includes managing equity-trading, client services and brokerage
operations. Mr. Malin and Steven Malin are brothers.
Anthony G. Huston. Mr. Huston joined our company in May 1996 as Executive
Vice President. From September 1995 to May 1996, Mr. Huston served as a
consultant to Watley. From August 1988 to May 1995 he served as Vice President
and Manager in the Foreign Exchange Options Department in the New York, Tokyo,
and London offices of Tullett and Tokyo Forex, Inc. Mr. Huston received a
bachelor of arts degree in asian studies and international relations from the
University of Michigan in 1985. He attended New York University as a post
graduate student in economics.
Eric Steinberg. Mr. Steinberg has been Executive Vice President of
Administration of our company since March 1998. His responsibilities include
management of our company offices and negotiating all purchase and
33
leasing arrangements for our company. From May 1996 to March 1998, Mr. Steinberg
served as an administrative consultant to our company. Prior thereto, from
August 1993 to May 1996 he served as a consultant to Watley. From 1991 to 1993,
he was a manager at Primary Financial Services, Inc., a financial consulting and
leasing company. From September 1986 to May 1991, Mr. Steinberg was employed as
an account manager by Manhattan Leasing, Inc., a New York based leasing company.
Leon Ferguson. Mr. Ferguson joined our company in October 1998 as Senior
Vice President and Chief Information Officer in connection with our acquisition
of Computer Strategies, Inc., a software consulting firm he formed in 1996 and
served as its President and Chief Executive Officer since inception. From May
1994 to January 1996, Mr. Ferguson served as Director of Information Technology
Strategies at Williams Telecommunications Group, a long-distance
telecommunications company that was acquired by WorldCom, Inc. in 1995. From
May 1990 to May 1994, Mr. Ferguson served as Chairman of Digital Communications
Associates, Inc. a software development company he founded which specializes in
high speed transaction solutions for the long distance telecommunications
industry. Mr. Ferguson received a bachelor of computer science degree from the
University of Oklahoma in 1988.
Jonathan Priddle. Mr. Priddle has served as our company's Senior Vice
President of Sales since December 1998. From March 1997 to November 1998, he
provided consulting services to our company. From August 1995 to March 1997, he
served as a senior broker at Eurobrokers, Inc., a global interbank money
brokering firm in New York. From January 1995 to August 1995, Mr. Priddle
served as a Senior Currency Broker in the New York office of Tullett and Tokyo
Forex, Inc. From April 1994 to January 1995, Mr. Priddle was the Manager of the
Currency/FRA Department at Cantor Fitzgerald Associates, a foreign exchange
brokerage firm. From March 1992 to April 1994 Mr. Priddle was a broker in the
Currency Arbitrage Department of Garvin Guybutler Corporation, a global
interbank money brokering firm. Mr. Priddle began his career with Tullett and
Tokyo, Inc. in June 1985 and served in the London, Tokyo and New York offices
until March 1992. Mr. Priddle attended Yeovil Tertiary College from September
1978 to March 1981 and Bristol Polytechnic from March 1981 to March 1986. Both
institutions are located in the United Kingdom.
Brett Vernick. Mr. Vernick has served as our company's Senior Vice
President for Management Information Services since May 1996. From March 1995
to April 1996, Mr. Vernick served as the Eastern U.S. Region Network Specialist
for PC Quote, Inc., an international data feed corporation. From August 1992 to
February 1995, he served as Director of Management Information Systems for Soil
Mechanics Environmental Services, Inc. Mr. Vernick received a bachelor of
science degree in political science and international relations from Stonybrook
in 1993.
Michael Fielman. Mr. Fielman joined our company in April 1998 as Vice
President -- Finance. From January 1996 to March 1998, he was Controller of Cord
Contracting Co., Inc., a hydrogeologic consulting drywall contractor. From 1991
to January 1996, he was Chief Financial Officer of Artkraft Strauss Sign
Corporation, a provider of advertising signs. He received a bachelor of science
degree from New York Institute of Technology in 1973.
William Brawer has agreed to serve as a director of our company upon the
closing of this offering. Since February 1996, he has served as Chairman and
Chief Executive Officer of Brawer Brothers, a producer of nylon and polyester
bi-products. Prior thereto he served in various other senior management
capacities with Brawer Brothers. Mr. Brawer received a bachelor of science
degree from Colorado University in 1978.
Elizabeth Chambers has agreed to serve as a director of our company upon
the closing of this offering. Since September 1998, she has been Vice President
of Business Design at Readers Digest, Inc. From June 1988 to August 1998, Ms.
Chambers served in the New York office of the business consulting firm, McKinsey
& Company, where she became a partner in 1997. Ms. Chambers is a member of Phi
Beta Kappa and received a bachelor of arts degree in economics and political
science from Stanford University in 1985. She received a Masters of Business
Administration from Harvard School of Business in 1989.
Mark Chambre has agreed to serve as a director of our company upon the
closing of this offering. Since June 1993, he has served as Senior Broker in
the Yen Swaps Division of the Tokyo Forex Co., Inc., in Tokyo, Japan. From
April 1988 to May 1993, Mr. Chambre served as Manager of the Tokyo Forex Co.'s
Financial Futures Division. Mr. Chambre joined its parent company, Tullett and
Tokyo, Inc., in New York in 1983. Mr. Chambre received a bachelor of arts
degree from Drew University in 1982.
34
Stanley Weinstein has agreed to serve as a director of our company upon the
closing of this offering. He has been an independent corporate financial
consultant since 1991. From 1960 to 1991 he served as a partner with Deloitte &
Touche, LLP, an international accounting firm. Mr. Weinstein served for fifteen
years as adjunct Associate Professor of Accounting at Pace University and
co-authored the widely recognized SEC Compliance -- Financial Reporting and
Forms handbook. He received a bachelor of business administration degree in
accounting from City College of New York in 1949. Since May 1995, he has served
as a director of York Research Corp., a company engaged in the production and
marketing of energy related projects.
Directors are elected at each annual meeting of stockholders and hold
office until the next annual meeting of stockholders and the election and
qualification of their successors. Executive officers are elected by and serve
at the discretion of the board of directors.
We have agreed, for a period of five years from the date of this
prospectus, if so requested by the underwriter, to nominate and use our best
efforts to elect a designee of the underwriter as a director of our company or,
at the underwriter's option, as a non-voting adviser to our board of directors.
Our officers, directors and principal stockholders have agreed to vote their
shares of common stock in favor of such designee. The underwriter has not yet
exercised its right to designate such a person.
Special Advisory Board
Effective as of the date of this prospectus, we have established a special
advisory board to the board of directors which will initially consist of Anthony
G. Huston and Eric Steinberg. The special advisory board will advise and assist
the board of directors in executive planning and decision making. Members of our
special advisory board will be invited to attend, observe and participate in all
meetings of the board of directors but will not have the right to cast a vote.
Board Committees
The board of directors has established a Compensation Committee which, upon
the consummation of this offering, will be comprised of Mark Chambre and William
Brawer. The Compensation Committee will review and determine the compensation
for all officers and directors of our company and will review general policy
matters relating to the compensation and benefits of all employees. The
Compensation Committee will also administer each of the stock option plans.
The board of directors has established an Audit Committee which, upon the
consummation of this offering, will be comprised of Elizabeth Chambers and
Stanley Weinstein. The Audit Committee will recommend to the board of directors
the annual engagement of a firm of independent accountants and will review with
the independent accountants the scope and results of audits, the internal
accounting controls of our company and audit practices and professional services
rendered to our company by such independent accountants.
Directors' Compensation
All directors are reimbursed for their reasonable expenses incurred in
attending meetings of the board of directors and its committees. Directors who
are employees of our company receive no additional compensation for service as
members of the board of directors or committees. Following this offering, all
non-employee directors of our company will be compensated annually for their
services at $2,000 and non-qualified options to acquire 1,500 shares of common
stock at the end of each year of service.
35
Executive Compensation
The following table shows compensation paid by our company for services
rendered during the fiscal year ended September 30, 1998 to Mr. Steven Malin,
our Chief Executive Officer. No other executive officer of our company received
salary and bonus compensation which exceeded $100,000 in such fiscal year.
Summary Compensation Table
Annual Compensation
Name and --------------------------- Other Annual
Principal Position Salary($)(1) Bonus($) Compensation(2)
- ------------------ -------------- ---------- ----------------
Steven Malin ........... $70,000 $-- $ --
Chief Executive Officer
- ------------
(1) Steve Malin's compensation during the year ended September 30, 1998 was
forgiven by him.
(2) No such compensation was paid by our company and there were no "long-term
compensation" payments made in any form.
There were no stock option grants to the named executive officer, during
the fiscal year ended September 30, 1998.
Employment Agreements
Our company has entered into a four-year employment agreement with Steven
Malin and three-year employment agreements with Harry Simpson, Robert Malin,
Anthony G. Huston and Eric Steinberg all of which are automatically renewable
for additional one-year terms and provide for annual base compensation of
$90,000, respectively, until the effectiveness of this offering, whereupon
annual base compensation under each agreement will be increased to $110,000.
Each agreement provides for a bonus equal to 20% of their salaries, payable
semi-annually, based upon certain revenue levels achieved by our company, as may
be approved by the board of directors or a committee thereof.
Each of the employment agreements requires the officer to devote his full
time and efforts to our company and contains non-competition and non-disclosure
covenants of the officer for the term of his employment and for a period of two
years thereafter. Each employment agreement provides that we may terminate the
agreement for cause. In addition, each employment agreement provides for
termination by either party without cause upon at least 180 days written notice
prior to the end of the original term or any renewal term.
Stock Option Plans
On January 27, 1997, the board of directors and stockholders adopted our
1997 stock option plan and on March 16, 1998, our board of directors and
stockholders adopted our 1998 stock option plan (which was amended in January
1999). We have reserved 400,000 shares of common stock for issuance upon
exercise of options granted from time to time under the 1997 stock option plan
and 600,000 shares of common stock for issuance upon exercise of options granted
from time to time under the 1998 stock option plan, as amended. The 1997 and
1998 stock option plans are intended to assist us in securing and retaining key
employees, directors and consultants by allowing them to participate in the
ownership and growth of our company through the grant of incentive and
non-qualified options.
Under each of the stock option plans we may grant incentive stock options
only to key employees (including officers) and employee directors, or we may
grant non-qualified options to our employees, officers, directors and
consultants. Incentive stock options granted under either of the stock option
plans are intended to be "Incentive Stock Options" as defined by Section 422 of
the Internal Revenue Code of 1986, as amended. The 1997 stock option plan shall
be administered by a committee, appointed by our board of directors, consisting
of from one to three directors. The 1998 stock option plan shall be administered
directly by our board of directors.
Subject to the provisions of each of the stock option plans, either the
board or the committee will determine who shall receive options, the number of
shares of common stock that may be purchased under the options,
36
the time and manner of exercise of options and exercise prices. The term of
options granted under each of the stock option plans may not exceed ten years
(five years in the case of an incentive stock option granted to an optionee
owning more than 10% of our voting stock). The exercise price for incentive
stock options shall be equal to or greater than 100% of the "fair market value"
of the shares of the common stock at the time the incentive stock option is
granted; provided, however, that incentive stock options granted to a 10% holder
of our voting stock shall be exercisable only at a price that is equal to or
greater than 110% of the fair market value of the common stock on the date of
the grant of the incentive stock option. The exercise price for non-qualified
options will be set by the board or the committee, in its discretion, but in no
event shall such exercise price be less than the fair market value of the shares
of common stock on the date of grant. Such exercise price may be payable in cash
or, with the approval of the board or the committee, by delivery of shares or by
a combination of cash and shares. Shares of common stock received upon exercise
of options granted under each of the plans will be subject to certain
restrictions on sale or transfer.
Under the 1998 stock option plan, grants of options (including both
incentive and non-qualified stock options) to any one optionee who is an
employee of our company, shall be limited to options to purchase 150,000 shares
of common stock in any calendar year. In addition, the board or the committee
determines the schedule of the time or times when an option may be exercised,
provided, however, that the aggregate fair market value of the shares of common
stock as to which an optionee may exercise incentive stock options may not
exceed $100,000 in any calendar year.
Each of the 1997 and 1998 stock option plans provide that the number of
options, including both issued and unissued options, and their exercise prices,
are to be appropriately adjusted for mergers, consolidations, recapitalizations,
stock dividends, stock splits or other share combinations. Shares allocated to
options and stock appreciation rights which have terminated for reasons other
than the exercise thereof may be reallocated to other options and/or stock
appreciation rights.
Each of the 1997 and 1998 stock option plans provide that if an optionee
dies, his options may be exercised by his executors or administrators, or by any
person who acquired the right to exercise such options, to the extent that the
optionee would have been entitled to do so at the date of death, at any time, or
from time to time, within one year after the date of optionee's death, but not
later than the expiration of the option. If an optionee's employment is
terminated, whether for cause or otherwise, an optionee may exercise such
option, to the extent that he would have been entitled to do so at the date of
termination, at any time, or from time to time, within ninety days of the date
of termination but not later than the expiration of the option.
As of the date of this prospectus, we have granted options to purchase
825,150 shares of common stock under our stock options plans at an exercise
price ranging from $2.00 to $6.00 per share. Of such options, options to
purchase 545,000 shares have been granted to our officers and directors. All of
the options granted to such officers and directors terminate on the ten year
anniversary of their vesting date.
401(k) Plan
Watley maintains a standardized 401(k) Plan known as the "A.B. Watley, Inc.
401(k) Savings Plan", a defined contribution pension plan with a cash or
deferred arrangement as described in Section 401(k) of the Internal Revenue Code
of 1986, as amended. The 401(k) plan is intended to qualify under Section 401(a)
of the code, so that contributions, and income earned thereon, are not taxable
to employees until withdrawn. All regular full-time employees over the age of 21
are eligible to participate in the 401(k) plan. The 401(k) plan provides that
each participant may make elective pre-tax salary deferrals up to 10% of his or
her annual compensation, subject to statutory limits. Our company also may make
discretionary annual matching contributions in amounts determined by the
compensation committee of the board of directors, subject to statutory limits.
Our policy is to base contributions on profitability. The trustee of the 401(k)
plan invests each employee's account at the direction of the employee, who may
choose among several investment alternatives, which do not include shares of our
company's common stock. Our company did not make any contributions to the 401(k)
plan during the last two fiscal years.
Limitation on Liability and Indemnification Matters
As authorized by the Delaware General Corporation Law, our certificate of
incorporation provides that no director of our company shall be personally
liable to our company or its stockholders for monetary damages for
37
breach of fiduciary duty as a director, except for liability (i) for any breach
of the director's duty of loyalty to our company or its stockholders, (ii) for
acts or omissions not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) for unlawful payments of dividends or unlawful
stock redemptions or repurchases or (iv) for any transaction from which the
director derived an improper personal benefit. This provision eliminates the
rights of our company and its stockholders (through stockholders' derivative
suits on behalf of our company) to recover monetary damages against a director
for breach of the fiduciary duty of care (including breaches resulting from
negligent or grossly negligent behavior) except in the situations described in
clauses (i) through (iv) above. This provision does not limit or eliminate the
rights of our company or any stockholder to seek injunctive relief or rescission
in the event of a breach of a director's duty of care. In addition, our
certificate of incorporation provides that if the Delaware General Corporation
Law is amended to further eliminate or limit the liability of a director, then
the liability of the directors shall be eliminated or limited to the fullest
extent permitted by such amendment. These provisions will not alter the
liability of directors under federal securities laws.
Our certificate of incorporation further provides for the indemnification
of any and all persons who serve as a director, officer, employee or agent of
our company to the fullest extent permitted under the Delaware General
Corporation Law.
Insofar as indemnification for liabilities arising under the securities act
may be permitted to directors, officers and controlling persons of our company
pursuant to the foregoing provisions, or otherwise, we have been advised that in
the opinion of the SEC such indemnification is against public policy as
expressed in the Securities Act, and is, therefore, unenforceable.
Prior to the closing of this offering, we will obtain and maintain a policy
of insurance under which directors and officers of our company will be insured,
subject to the limits of the policy, against certain losses arising from claims
made against such directors and officers by reason of any acts or omissions
covered under such policy in their respective capacities as directors or
officers, including liabilities under the Securities Act.
38
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information known to our company, as
of the date of this prospectus and as adjusted to reflect the sale by our
company of the 1,700,000 shares of common stock offered hereby, relating to the
beneficial ownership of shares of common stock by: (i) each person who is known
by us to be the beneficial owner of more than five percent of the outstanding
shares of common stock; (ii) each director or person who has agreed to become a
director of our company; and (iii) all executive officers and directors of our
company as a group.
Percentage of Shares Beneficially
Owned(2)
Number of Shares -----------------------------------
Name and Address of Beneficial Owner(1) Beneficially Owned(2) Before Offering After Offering
- ----------------------------------------- ----------------------- ----------------- ---------------
Steven Malin(3) ......................... 1,600,000 29.5% 22.5%
Harry Simpson ........................... 541,667(4) 9.9 7.6
Anthony G. Huston ....................... 500,000 8.9 6.8
Robert Malin(3) ......................... 425,000 7.8 6.0
Linda Malin(3) .......................... 425,000 7.8 6.0
Eric Steinberg .......................... 425,000 7.8 6.0
Mark Chambre ........................... 52,500 * *
William Brawer .......................... 0 0 0
Elizabeth Chambers ...................... 0 0 0
Stanley Weinstein ....................... 0 0 0
All directors and executive officers as a
group (13 persons) ..................... 3,936,094(5) 66.6% 51.7%
- ------------
* Less than 1%.
(1) Unless otherwise indicated, the address of each beneficial owner is care of
our company, 40 Wall Street, New York, New York 10005.
(2) Unless otherwise indicated, our company believes that all persons named in
the table have sole voting and investment power with respect to all shares
of common stock beneficially owned by them. A person is deemed to be the
beneficial owner of securities that can be acquired by such person within 60
days from the date of this prospectus upon the exercise of options, warrants
or convertible securities. Each beneficial owner's percentage ownership is
determined by assuming that options, warrants or convertible securities that
are held by such person (but not those held by any other person) and which
are exercisable within 60 days of the date of this prospectus have been
exercised and converted. Assumes a base of 5,637,696 shares of common stock
outstanding prior to this offering and a base of 7,337,696 shares of common
stock outstanding immediately after this offering, before any consideration
is given to outstanding options, warrants or convertible securities.
(3) Steven Malin and Robert Malin are brothers and Linda Malin is their sister.
(4) Includes 41,667 shares of common stock issuable upon exercise of currently
exercisable options. Does not include 83,333 shares of common stock issuable
upon exercise of options which are not currently exercisable.
(5) Includes 268,334 shares of common stock issuable upon exercise of currently
exercisable options. Does not include 276,666 shares of common stock
issuable upon exercise of options which are not currently exercisable.
39
CERTAIN TRANSACTIONS
In October 1994, Steven Malin, Chief Executive Officer and principal
stockholder of our Company, loaned Watley $55,000 on an interest free basis. The
maturity date for this loan is October 31, 1999. Additionally, in April 1995,
Mr. Malin loaned Watley $125,000 at an interest rate of 12% per annum. The
maturity date for this loan is April 30, 2000. Each of such loans are
subordinate to the prior payment by Watley in full of all other present and
future creditors.
In October 1995, Mel Steinberg, the father of Eric Steinberg, an executive
officer and principal stockholder of our company, loaned Watley $200,000 at an
interest rate of 15% per annum. Additionally, effective October 30, 1996, Mr.
Steinberg loaned Watley $150,000 at an interest rate of 13% per annum. The
maturity date for each of the loans is October 31, 1999. Each of such loans are
subordinate to the prior payment by Watley in full of all other present and
future creditors.
On September 4, 1996, we loaned $100,000 to Robert Malin, President of
Watley and a director and principal stockholder of our company. The loan bears
interest at the rate of 6% per annum and is due upon demand.
In January 1997, we acquired all of the issued and outstanding shares of
Watley which were held by Steven Malin and Robert Malin. As consideration for
the acquisition, our company issued 425,000 shares of common stock to Robert
Malin and 6,538 shares of common stock to Steven Malin. The aggregate value of
the shares issued by our company was $80,000.
In April 1997, we completed a private placement of 1,050,000 shares of
common stock for which we received net proceeds of $2,045,000. In connection
with such private placement, Jonathan Priddle, an executive officer of our
company, purchased 25,000 shares at a price of $50,000 and Mark Chambre, who has
agreed to serve as a director of our company upon the closing of this offering,
purchased 37,500 shares at a price of $75,000. In addition, relatives of Anthony
Huston and Eric Steinberg, each an executive officer and principal stockholder
of our company, purchased an aggregate of 52,500 shares at an aggregate price of
$105,000. All of these purchases were on the same terms and at the same price as
the purchases made by the other investors in such private placement.
In May 1997, we sold certain computer hardware and related assets to
Centennial Ventures, Inc., a broker-dealer of which Linda Malin, a principal
stockholder of our company and the sister of Steven and Robert Malin, is an
executive officer. As consideration for such sale, Centennial Ventures, Inc.
delivered a promissory note in the principal amount of $39,860.75. The note is
due on May 1, 1999, bears interest at the rate of 8% per annum and is secured by
all of the assets sold to Centennial Ventures, Inc. by our company.
In February 1998, Mel Steinberg loaned our company $100,000 at an interest
rate of 8%. The loan is due in February 2001. As additional consideration for
the loan, we granted Mr. Steinberg an option to purchase 16,666 shares of common
stock for nominal consideration. Mr. Steinberg has notified our company that he
intends to exercise the option upon the completion of this offering. We have
agreed to repay the loan, including interest accrued thereon through the date of
this prospectus, from the proceeds of this offering.
On October 2, 1998, we entered into a loan agreement with New York Small
Business Venture Fund LLC pursuant to which we borrowed $500,000 at an interest
rate of 12% per annum, repayable over 36 months, with payments of interest only
in the first two years. We granted the lender a security interest in
substantially all of our assets to secure our obligations under the loan, and
six persons who are officers, directors and/or principal stockholders of our
company guaranteed our obligations under such loan. We intend to repay this loan
out of the proceeds of this offering, which will discharge the liability of such
guarantors. Stanley Weinstein, who has agreed to serve as a director of our
company on the date of this prospectus, received a $25,000 consulting fee from
our company in connection with the loan.
Effective October 2, 1998, we acquired all of the shares of capital stock
of Computer Strategies, Inc., for 38,260 shares of our company's common stock
valued at $183,660. Leon Ferguson was the founder and sole stockholder of
Computer Strategies, Inc., and became our Senior Vice President and Chief
Information Officer upon the closing of the acquisition.
In January 1999, we completed a private placement of 221,500 shares of
common stock to 12 investors for which we received net proceeds of approximately
$1,050,000. In connection with such private placement, Anthony Huston purchased
50,000 shares at a price of $240,000, a trust naming Leon Ferguson and his wife
as beneficiaries for which Mr. Ferguson is sole trustee purchased 52,000 shares
at a price of $249,600 and Mark Chambre purchased 15,000 shares at a price of
$72,000. All of the purchasers of such shares agreed not to sell or otherwise
dispose of such shares for a period of twelve months from the date of this
prospectus. All of these purchases were made on the same terms and at the same
price per share as the purchases made by the other investors in such private
placement.
40
DESCRIPTION OF SECURITIES
Our company's authorized capital stock consists of 20,000,000 shares of
common stock, $.001 par value per share and 1,000,000 shares of preferred stock
$.01 par value per share. As of the date of this prospectus, 5,637,696 shares of
common stock are currently issued and outstanding and no shares of preferred
stock are outstanding. Upon closing of this offering there will be 7,337,696
shares of common stock outstanding and no shares of preferred stock outstanding.
Common Stock
Holders of common stock are entitled to one vote for each share on all
matters submitted to a stockholder vote. Holders of common stock do not have
cumulative voting rights. Therefore, holders of a majority of the shares of
common stock voting for the election of directors can elect all of the
directors. Holders of common stock are entitled to share in all dividends that
the board of directors, in its discretion, declares from legally available
funds. In any liquidation, dissolution or winding up of our company, each
outstanding share entitles its holder to participate pro rata in all assets that
remain after payment of liabilities and after providing for each class of stock,
if any, having preference over the common stock.
Holders of common stock have no conversion, preemptive or other
subscription rights, and there are no redemption provisions applicable to the
common stock. The rights of the holders of common stock are subject to any
rights that may be fixed for holders of preferred stock, when and if any
preferred stock is issued. All outstanding shares of common stock are, and the
shares underlying all options and warrants will be, duly authorized, validly
issued, fully paid and non-assessable upon issuance of such shares by our
company.
Preferred Stock
Our board of directors is authorized, without further action by the
stockholders, to issue 1,000,000 shares of preferred stock from time to time in
one or more series and to fix the rights, preferences, privileges and
restrictions thereof, including: the rights and terms relating to any new series
of preferred stock could adversely affect the voting power or other rights of
the holders of common stock. Additionally, such preferred stock may be used,
under certain circumstances, to discourage, delay or prevent a change in control
of our company.
Registration Rights
The holders of 411,175 shares of common stock (including 331,250 shares of
common stock issuable upon exercise of currently exercisable warrants) are
entitled to certain piggyback registration rights, under the Securities Act,
with respect to such shares. Whenever we propose to register any of our
securities under the Securities Act for our own account or for the account of
other security holders, we shall be required to promptly notify the holders of
each of the registerable shares of such proposed registration. We will be
required to include all registerable shares which such holders may request to be
included in such registration, subject to certain limitations. Such holders have
waived their registration rights in connection with this offering. Additionally,
holders of the registerable shares have agreed not to request registration or
sell or otherwise dispose of the registerable shares for a period of 12 months
following the date of this prospectus.
In connection with this offering, we have agreed to grant to the
underwriter certain demand and piggyback registration rights in connection with
the 170,000 shares of common stock issuable upon exercise of the underwriter's
warrants. See "Underwriting."
Delaware Anti-Takeover Law
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law. That section provides, with certain exceptions, that a Delaware
corporation may not engage in any of a broad range of business combinations with
a person or affiliate or associate of such person who is an "interested
stockholder" for a period of three years from the date that such person became
an interested stockholder unless: (i) the transaction resulting in a person's
becoming an interested stockholder, or the business combination, is approved by
the board of directors of the corporation before the person becomes an
interested stockholder, (ii) the interested stockholder acquires 85% or more of
the outstanding voting stock of the corporation in the same transaction that
41
makes it an interested stockholder (excluding certain employee stock ownership
plans); or (iii) on or after the date the person becomes an interested
stockholder, the business combination is approved by the corporation's board of
directors and by the holders of at least 66 2/3% of the corporation's
outstanding voting stock at an annual or special meeting, excluding shares owned
by the interested stockholder. An "interested stockholder" is defined as any
person that is (i) the owner of 15% or more of the outstanding voting stock of
the corporation or (ii) an affiliate or associate of the corporation and was the
owner of 15% or more of the outstanding voting stock of the corporation at any
time within the three year period immediately prior to the date on which it is
sought to be determined whether such person is an interested stockholder.
Transfer Agent and Warrant Agent
The transfer agent for the common stock and the warrant agent for the
underwriter's warrants is American Stock Transfer & Trust Company, 40 Wall
Street, New York, New York 10005.
SHARES ELIGIBLE FOR FUTURE SALE
Upon consummation of this offering, our company will have 7,337,696 shares
of common stock issued and outstanding of which the 1,700,000 shares offered
hereby will be freely tradeable without restriction or further registration
under the Securities Act, except for any shares purchased by an "affiliate of
our company" (in general, a person who has a controlling position with regard to
the company), which will be subject to the resale limitations of Rule 144
promulgated under the Securities Act.
All of the remaining 5,637,696 shares of common stock currently outstanding
are "restricted securities," as that term is defined under Rule 144. Of such
restricted shares, an aggregate of 4,000,000 shares will be immediately eligible
for sale, subject to the contractual restrictions described below. Of the
remaining restricted shares, 1,120,000 restricted shares will become eligible
for sale under Rule 144 beginning 90 days following the date of this prospectus,
and the balance of the restricted shares will become eligible for sale pursuant
to Rule 144 at various times beginning May 1999, subject to the contractual
provisions described below. In addition, we have granted certain registration
rights to holders of 411,175 of such restricted shares (including 331,250 shares
of common stock issuable upon exercise of currently exercisable warrants), as
well as demand and piggyback registration rights to the underwriter with respect
to the shares of common stock issuable upon exercise of the underwriter's
warrants. The holders (including all officers and directors) of substantially
all of the restricted shares of common stock have agreed not to sell or
otherwise dispose of any shares of common stock (including pursuant to Rule 144)
or exercise any registration rights for a period of twelve months following the
date of this prospectus without the underwriter's prior written consent.
In general, under Rule 144, as currently in effect, beginning 90 days after
the date of this prospectus, a person (or persons whose shares are aggregated),
who has beneficially owned restricted shares for at least one year (including
the holding period of any prior owner except an affiliate of our company) would
be entitled to sell, within any three month period, such number of shares that
does not exceed the greater of: (i) 1% of the then outstanding shares of our
company's common stock; or (ii) the average weekly trading volume of our
company's common stock during the four calendar weeks preceding such sale,
provided, that, certain public information about our company as required by Rule
144 is then available and the seller complies with certain manner of sale
provisions and notice requirements. A person who is not an affiliate of our
company, has not been an affiliate within three months prior to sale and has
beneficially owned the restricted securities for at least two years is entitled
to sell such shares under Rule 144 without regard to any of the limitations
described above.
Prior to this offering, there has been no public market for the common
stock and no prediction can be made as to the effect, if any, that market sales
of common stock or the availability of such shares for sale will have on the
market price prevailing from time to time. Nevertheless, the possibility that
substantial amounts of common stock may be sold in the public market may
adversely affect prevailing market prices for the common stock and could impair
our company's ability to raise capital through the sale of its equity
securities.
42
UNDERWRITING
Whale Securities Co., L.P., as underwriter, has agreed, subject to the
terms and conditions contained in the underwriting agreement relating to this
offering, to purchase the 1,700,000 shares of common stock offered by our
company.
The underwriting agreement provides that the obligations of the underwriter
thereunder are subject to approval of certain legal matters by counsel and to
various other conditions. The nature of the underwriter's obligations is such
that they are committed to purchase and pay for all of the shares of common
stock if any are purchased.
The underwriter has advised us that it proposes to offer the shares of
common stock to the public at the public offering price set forth on the cover
page of this prospectus. The underwriter may allow certain dealers who are
members of the NASD concessions, not in excess of $. per share, of which not in
excess of $. per share may be reallowed to other dealers who are members of the
NASD.
We have granted to the underwriter an option, exercisable not later than 45
days after the date of this prospectus, to purchase up to 255,000 shares at the
public offering price set forth on the cover page of this prospectus, less
underwriting discounts and commissions. The underwriter may exercise this option
only to cover over-allotments, if any, made in connection with the sale of the
shares of common stock offered hereby. If the underwriter exercises its
over-allotment in full, the total price to public would be $11,730,000, the
total underwriting discounts and commissions would be $1,173,000 and the total
proceeds (before payment of the expenses of this offering) to our company would
be $10,557,000
We have agreed to pay to the underwriter a non-accountable expense
allowance equal to 3% of the gross proceeds derived from the sale of the shares
offered hereby, including any securities sold prior to the underwriter's
over-allotment option, $50,000 of which has been paid as of the date of this
prospectus. We have also agreed to pay all expenses in connection with
qualifying the shares offered under the laws of such states as the underwriter
may designate, including expenses of counsel retained for such purpose by the
underwriter. We estimated the expenses of this offering to be $930,000, or
$975,900 if the underwriter's over-allotment option is completely exercised.
At the closing of this offering, we will sell to the underwriter and its
designees, for an aggregate of $100, underwriter's warrants to purchase up to
170,000 shares of common stock. The underwriter's warrants are exercisable at
any time, in whole or in part, during the four-year period commencing one year
from the date of this prospectus, at an exercise price of $9.90 per share (165%
of the public offering price per share). The underwriter's warrants are only
assignable or transferable to the officers and partners of the underwriter and
members of the selling group for one year following the date of this prospectus.
During the exercise period, the holders of the underwriter's warrants will have
the opportunity to profit from a rise in the market price of the common stock,
which will dilute the interests of our stockholders. We expect that the
underwriter's warrants will be exercised when we would, in all likelihood, be
able to obtain any capital it needs on terms more favorable. Any profit realized
by the underwriter on the sale of the underwriter's warrants, the underlying
shares of common stock or the underlying warrants may be deemed additional
underwriting compensation. The underwriter's warrants contain a cashless
exercise provision. We have agreed that, upon the request of the holders of the
majority of the underwriter's warrants, we will (at our own expense), on one
occasion during the exercise period, register the underwriter's warrants and the
shares of common stock underlying the underwriter's warrants under the
Securities Act. We have also agreed to include the underwriter's warrants and
all such underlying shares of common stock in any appropriate registration
statement which is filed by us under the Securities Act during the seven years
following the date of this prospectus.
We will retain the underwriter as a financial consultant for a period of
two years following closing of the offering for a fee of $60,000, payable in
full in advance. The consulting agreement with the underwriter does not require
the underwriter to devote a specific amount of time to the performance of its
duties there-under. It is anticipated that these consulting services will be
provided by principals of the underwriter and/or members of the underwriter's
corporate department who, however, have not been designated as of the date
hereof. In the
43
event that the underwriter originates a financing or a merger, acquisition,
joint venture or other transaction to which we are a party, the underwriter will
be entitled to receive a finder's fee in consideration of the origination of
such transaction.
We have agreed, for a period of five years from the date of this
prospectus, if so requested by the underwriter, to recommend and use our best
efforts to elect a designee of the underwriter as a director of our company. Our
officers, directors and principal stockholders have agreed to vote their shares
of common stock in favor of such designee. The underwriter has not yet exercised
and currently does not intend to exercise its right to designate such a person.
All of our officers, directors and securityholders have agreed not to sell
or otherwise dispose any of their securities in the public markets for a period
of twelve months from the date of this prospectus without the underwriter's
prior written consent.
The underwriter has informed us that it does not expect sales of the
securities offered to discretionary accounts to exceed 1% of the shares offered
hereby.
We have agreed to indemnify the underwriter against certain civil
liabilities, including liabilities under the Securities Act.
Prior to this offering there has been no public market for the common
stock. Accordingly, the initial public offering price of the common stock will
be determined by negotiation between us and the underwriter and may not
necessarily be related to our asset value, net worth or other established
criteria of value. Factors to be considered in determining such price include
our financial condition and prospects, an assessment of our management, market
prices of similar securities of comparable publicly-traded companies, certain
financial and operating information of companies engaged in activities similar
to those of our company and the general condition of the securities market.
In connection with this offering, the underwriter may engage in passive
market making transactions in the shares on Nasdaq in accordance with Rule 103
of Regulation M promulgated under the Securities Act.
In connection with this offering, the underwriter may engage in
transactions that stabilize, maintain or otherwise affect the price of the
common stock. These transactions may include stabilization transactions
permitted by Rule 104 of Regulation M, under which persons may bid for or
purchase shares to stabilize the market price. Specifically, the underwriter may
over-allot in connection with the offering, creating a short position in the
common stock for its own account. In addition, to cover over-allotments or to
stabilize the price of the common stock, the underwriter may bid for, and
purchase, shares of common stock in the open market. The underwriter may also
reclaim selling con-cessions allowed to a dealer for distributing the common
stock in the offering, if the underwriter repurchases previously distributed
common stock in transactions to cover short positions, in stabilization
transactions or otherwise. Any of these activities may stabilize or maintain the
market price of the common stock above independent market levels. The
underwriter is not required to engage in these activities, and may end any of
these activities at any time.
LEGAL MATTERS
The validity of the securities offered hereby will be passed upon for our
company by Hartman & Craven LLP, New York, New York. Edward I. Tishelman, a
member of the firm of Hartman & Craven LLP, is the owner of 112,500 shares of
common stock. Certain legal matters in connection with this offering will be
passed upon for the underwriter by Tenzer Greenblatt LLP.
EXPERTS
The consolidated financial statements of our company as of September 30,
1997 and September 30, 1998, and for each of the two years in the period ended
September 30, 1998, appearing in this prospectus and registration statement have
been audited by Ernst & Young, LLP, independent auditors as set forth in their
report thereon appearing elsewhere herein, and are included in reliance upon
such report given upon the authority of said firm as experts in auditing and
accounting.
44
ADDITIONAL INFORMATION
We have filed with the SEC the registration statement on form SB-2 under
the Securities Act with respect to the common stock offered hereby. This
prospectus, which constitutes a part of the registration statement, does not
contain all of the information set forth in the registration statement and the
exhibits filed therewith, certain portions of which have been omitted as
permitted by the rules and regulations of the SEC. For further information with
respect to our company and the securities offered hereby, reference is hereby
made to the registration statement and to the exhibits filed as a part thereof.
Statements contained in this prospectus regarding the content of any contract or
other document referred to are not necessarily complete. In each instance, we
refer you to the copy of such contract or other document filed as an exhibit to
the registration statement, and each such statement is hereby qualified in its
entirety by such reference. The registration statement, including all exhibits
thereto, may be inspected without charge at the principal office of the SEC at
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
commission's regional offices located at Seven World Trade Center, Suite 1300,
New York, New York 10048 and Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661. Copies of such materials may also be obtained
from the Public Reference Section of the commission at 450 Fifth Street, N.W.,
Room 1024, Washington, D.C. 20549, upon the payment of prescribed fees. In
addition, registration statements and certain other filings made with the
commission through its Electronic Data Gathering, Analysis and Retrieval systems
are publicly available through the commission's site on the World Wide Web
located at http://www.sec.gov. The registration statement, including all
exhibits and schedules thereto and amendments thereof, has been filed with the
commission through the Electronic Data Gathering, Analysis and Retrieval system.
Upon consummation of this offering, we will become subject to the reporting
requirements of the Securities Exchange Act and in accordance therewith, will
file reports, proxy statements and other information with the commission. We
intend to furnish our stockholders with annual reports containing audited
financial statements and such other periodic reports as we deem appropriate or
as may be required by law.
45
Internet Financial Services Inc.
Consolidated Financial Statements
Years ended September 30, 1998 and 1997
Contents
Report of Independent Auditors ..................................... F-2
Consolidated Statements of Financial Condition ..................... F-3
Consolidated Statements of Operations .............................. F-4
Consolidated Statements of Changes in Stockholders' Equity ......... F-5
Consolidated Statements of Cash Flows .............................. F-6
Notes to Consolidated Financial Statements ......................... F-7
F-1
Report of Independent Auditors
To the Board of Directors and Stockholders of
Internet Financial Services Inc.
We have audited the accompanying consolidated statements of financial
condition of Internet Financial Services Inc. (the "Company") as of September
30, 1998 and 1997, and the related consolidated statements of operations,
changes in stockholders' equity and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Internet
Financial Services Inc. as of September 30, 1998 and 1997, and the consolidated
results of its operations and its cash flows for the years then ended in
conformity with generally accepted accounting principles.
New York, New York Ernst & Young LLP
November 13, 1998
F-2
Internet Financial Services Inc.
Consolidated Statements of Financial Condition
September 30
1998 1997
-------------- --------------
Assets
Cash and cash equivalents ............................................ $ 970,308 $ 702,693
Restricted cash ...................................................... -- 113,569
Securities owned, at market value .................................... 104,518 24,206
Receivables from clearing brokers .................................... 531,835 292,356
Property and equipment at cost, net of accumulated depreciation of
$530,892 and $167,774 in 1998 and 1997, respectively ................ 3,650,743 1,010,208
Loans receivable from related party .................................. 115,711 123,697
Deferred offering costs .............................................. 75,235 --
Other assets ......................................................... 91,107 119,902
------------ ------------
Total assets ......................................................... $ 5,539,457 $ 2,386,631
============ ============
Liabilities and stockholders' equity
Liabilities:
Subordinated borrowings ............................................. $ 350,000 $ 350,000
Subordinated borrowings from related party .......................... 180,000 180,000
Securities sold, not yet purchased, at market value ................. 19,137 --
Notes payable ....................................................... 250,000 --
Bank loan ........................................................... 80,000 120,000
Deferred rent incentives ............................................ 803,968 --
Accounts payable and accrued liabilities ............................ 2,101,933 681,899
------------ ------------
Total liabilities .................................................... 3,785,038 1,331,899
Stockholders' equity:
Common stock, $.001 par value, 10,000,000 shares authorized, 5,137,500
and 5,050,000 shares issued and outstanding in 1998 and
1997, respectively ................................................ 5,138 5,050
Additional paid-in capital .......................................... 3,758,333 2,441,902
Option costs, net ................................................... (100,292) -
Subscriptions receivable (250,011 and 3,568,462 shares in 1998 and
1997, respectively) ............................................... (4,999) (120,869)
Accumulated deficit ................................................. (1,903,761) (1,271,351)
------------ ------------
Total stockholders' equity ........................................... 1,754,419 1,054,732
------------ ------------
Total liabilities and stockholders' equity ........................... $ 5,539,457 $ 2,386,631
============ ============
See notes to consolidated financial statements.
F-3
Internet Financial Services Inc.
Consolidated Statements of Operations
Year ended September 30
1998 1997
-------------- -----------------
Revenues:
Commissions ................................................ $ 7,403,059 $ 4,017,787
Data service revenues ...................................... 661,236 148,353
Principal transactions ..................................... 901,889 230,297
Interest and other income .................................. 146,704 130,095
Interest income - related party ............................ 6,380 6,000
----------- -------------
Total revenues .............................................. 9,119,268 4,532,532
Interest expense ........................................... 244,322 197,359
Interest expense - related party ........................... 15,000 15,000
----------- -------------
Net revenues ................................................ 8,859,946 4,320,173
----------- -------------
Expenses:
Commissions, floor brokerage, and clearing charges ......... 3,425,725 1,844,927
Employee compensation and related costs .................... 2,247,963 1,297,575
Communications ............................................. 757,391 337,584
Business development ....................................... 980,651 441,424
Professional services ...................................... 971,494 894,920
Occupancy and equipment costs .............................. 444,169 149,580
Depreciation and amortization .............................. 363,207 198,980
Other ...................................................... 288,991 212,380
----------- -------------
Total expenses .............................................. 9,479,591 5,377,370
----------- -------------
Loss before income taxes .................................... (619,645) (1,057,197)
Income tax provision ........................................ 12,765 2,776
----------- -------------
Net loss .................................................... $ (632,410) $ (1,059,973)
=========== =============
Net loss per common share ................................... $ (.12) $ (.30)
=========== =============
Weighted average common shares outstanding .................. 5,171,182 3,508,560
=========== =============
See notes to consolidated financial statements.
F-4
Internet Financial Services Inc.
Consolidated Statements of Changes in Stockholders' Equity
Common Stock Issued Additional Unamortized
------------------------- Paid-in Option
Shares Par Value Capital Costs
------------ ----------- ------------ --------------
Balance at October 1, 1996 ......... 431,538 $ 432 $ 259,568 $ --
Issuance of common stock, net ..... 4,618,462 4,618 2,160,967 --
Issuance of non-employee stock
options (Note 11) ................ -- -- 21,367 --
Net loss .......................... -- -- -- --
--------- ------ ---------- ----------
Balance at September 30, 1997 ...... 5,050,000 5,050 2,441,902 --
Issuance of common stock, net ..... 87,500 88 874,912 --
Issuance of non-employee stock
options (Note 11) ................ -- -- 76,832 --
Other contributions (Note 9) ...... -- -- 115,000 --
Option costs, net ................. -- -- 249,687 (100,292)
Net loss .......................... -- -- -- --
--------- ------ ---------- ----------
Balance at September 30, 1998 ...... 5,137,500 $5,138 $3,758,333 $ (100,292)
========= ====== ========== ==========
Subscriptions Receivable
------------------------------ Accumulated
Shares Amount Deficit Total
--------------- ------------- ---------------- ---------------
Balance at October 1, 1996 ......... -- $ -- $ (211,378) $ 48,622
Issuance of common stock, net ..... (3,568,462) (120,869) -- 2,044,716
Issuance of non-employee stock
options (Note 11) ................ -- -- -- 21,367
Net loss .......................... -- -- (1,059,973) (1,059,973)
---------- ----------- ------------ -------------
Balance at September 30, 1997 ...... (3,568,462) (120,869) (1,271,351) 1,054,732
Issuance of common stock, net ..... 3,318,451 115,870 -- 990,870
Issuance of non-employee stock
options (Note 11) ................ -- -- -- 76,832
Other contributions (Note 9) ...... -- -- -- 115,000
Option costs, net ................. -- -- -- 149,395
Net loss .......................... -- -- (632,410) (632,410)
---------- ----------- ------------ -------------
Balance at September 30, 1998 ...... (250,011) $ (4,999) $ (1,903,761) $ 1,754,419
========== =========== ============ =============
See notes to consolidated financial statements.
F-5
Internet Financial Services Inc.
Consolidated Statements of Cash Flows
Year ended September 30
1998 1997
--------------- -----------------
Cash flows from operating activities
Net loss $ (632,410) $ (1,059,973)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Other contributions 115,000 --
Depreciation and amortization 363,207 198,980
Amortization of option costs 226,227 21,367
Loss on disposal of fixed assets -- 46,411
Changes in assets and liabilities:
(Increase) decrease in operating assets:
Restricted cash 113,569 (113,569)
Securities owned (80,312) 144,473
Receivables from clearing brokers (239,479) (219,122)
Loans from related party 7,986 (23,697)
Other assets (46,440) (57,184)
Increase (decrease) in operating liabilities:
Securities sold, not yet purchased 19,137 (41,262)
Accounts payable and accrued liabilities 660,605 409,516
------------ -------------
Net cash provided by (used in) operating activities 507,090 (694,060)
------------ -------------
Cash flows used in investing activities
Purchases of property and equipment, net (2,244,313) (1,177,982)
Deferred rent incentives 803,968 --
------------ -------------
Net cash used in investing activities (1,440,345) (1,177,982)
------------ -------------
Cash flows from financing activities
Proceeds from sale of common stock, net 990,870 2,044,716
Proceeds from issuance of subordinated notes -- 150,000
Proceeds from notes payable 250,000 120,000
Repayment of bank loan (40,000) (125,000)
------------ -------------
Net cash provided by financing activities 1,200,870 2,189,716
------------ -------------
Net increase in cash and cash equivalents 267,615 317,674
Cash and cash equivalents at beginning of year 702,693 385,019
------------ -------------
Cash and cash equivalents at end of year $ 970,308 $ 702,693
============ =============
Supplemental non-cash financing activities
and disclosure of cash flow information
Note receivable from sale of property and equipment $ -- $ 39,951
Accounts payable for purchases of property and equipment 759,429 --
Other contributions 115,000 --
Cash paid for:
Interest $ 90,802 $ 193,733
Taxes 2,776 53,633
See notes to consolidated financial statements.
F-6
Internet Financial Services Inc.
Notes to Consolidated Financial Statements
Years ended September 30, 1998 and 1997
1. Organization and Basis of Presentation
Internet Financial Services Inc. ("IFSI" or the "Company") conducts
business primarily through its principal subsidiary, A.B. Watley, Inc. ("A.B.
Watley"). A.B Watley is a registered broker-dealer under the Securities
Exchange Act of 1934 and is a member of the National Association of Securities
Dealers, Inc.
A.B. Watley is an introducing broker-dealer which conducts business in
electronic trading, information and brokerage services, as well as
institutional block trading. A.B. Watley clears all transactions through two
clearing brokers on a fully disclosed basis. Accordingly, A.B. Watley is exempt
from the Securities and Exchange Commission's ("SEC") Rule 15c3-3.
IFSI is a Delaware corporation organized on May 15, 1996. During its fiscal
year ended September 30, 1997, all of the shares of capital stock of A.B. Watley
were acquired by IFSI. Since IFSI and A.B. Watley were under common control, the
acquisition has been accounted for under Accounting Interpretations of the
Accounting Principles Board Opinion No. 16, "Transfers and Exchanges Between
Companies Under Common Control," which requires the assets and liabilities so
transferred to be accounted for at historical cost in a manner similar to that
used in pooling of interests accounting. IFSI issued 431,538 shares of its
common stock in consideration for the 99 shares of A.B. Watley; additionally,
the operating results of IFSI reflect the operating results of A.B. Watley for
the years presented.
2. Summary of Significant Accounting Policies
Basis of Presentation:
The consolidated financial statements include the accounts of IFSI and its
wholly-owned subsidiary, A.B. Watley. All significant intercompany balances and
transactions have been eliminated. Certain prior year amounts reflect
reclassifications to conform to current year's presentations.
Securities Transactions, Revenues, and Related Expenses:
Securities transactions and related revenues and expenses, including
commissions revenues and expenses, are recorded on a trade date basis. Data
service revenues represent fees charged to customers for real-time access to
various financial data. These fees are recorded as earned.
Securities Owned and Sold, Not Yet Purchased:
Securities owned and securities sold, not yet purchased are stated at
market or fair values, with resulting unrealized gains and losses reflected in
the consolidated statements of operations. Market value is generally based on
listed market prices. If listed market prices are unattainable, fair value is
determined based on other relevant factors including broker or dealer price
quotes.
Property and Equipment:
Computer equipment, furniture and fixtures, and leasehold improvements are
carried at cost and depreciated on the straight-line basis over their estimated
useful lives, generally three to five years.
Construction-in-progress, upon occupancy, will be amortized on a
straight-line basis over the shorter of the useful life of the leasehold
improvement or the term of the lease, generally ten years upon occupancy.
Deferred rent incentives, which represent construction costs reimbursed by the
lessor of the Company's office space, will be amortized on a straight-line basis
over the term of the lease, which is ten years.
Computer software is amortized on the straight-line basis over a period of
three years. The cost of internally developed computer software is capitalized
when management commits to funding a project it believes will be completed and
used to perform the functions intended. The capitalized software is not
amortized until the projects are complete. Pilot projects and projects where
expected future economic benefits are less than probable are not eligible for
capitalization.
F-7
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1998 and 1997
2. Summary of Significant Accounting Policies -- (Continued)
Use of Estimates:
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities in
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Stock Options:
The Company accounts for stock option grants to employees in accordance
with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock
Issued to Employees," and, accordingly, recognizes no compensation expense
related to such grants. In cases where the Company grants options below the fair
market value of the stock at the date of grant, the difference between the
strike price and the fair market value is treated as compensation expense and
amortized over the vesting period of the option. Stock options granted to
consultants and others in lieu of cash compensation are recorded based upon
management's estimate of fair value of the options or the related services
provided and expensed over the vesting period, if any.
Fair Value of Financial Instruments:
Substantially all of the Company's financial instruments are carried at
fair value or amounts approximating fair value.
Business Development:
The Company expenses all promotional costs as incurred and advertising
costs upon first exhibition of the advertisement.
Income Taxes:
Income taxes have been provided using the liability method under Statement
of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income
Taxes."
Earnings Per Share:
Per share data is determined based on the weighted average number of common
shares outstanding each year.
Statement of Cash Flows:
The Company defines cash equivalents as highly liquid investments with
original maturities of three months or less, other than those held for sale in
the ordinary course of business.
3. Net Capital Requirement
A.B. Watley is subject to the SEC's Uniform Net Capital Rule 15c3-1 (the
"Net Capital Rule") which requires A.B. Watley to maintain minimum net capital
such that the ratio of aggregate indebtedness to net capital, both as defined,
shall not exceed 15 to 1. The Net Capital Rule also requires that equity capital
may not be withdrawn or cash dividends paid if A.B. Watley's resulting net
capital ratio would exceed 10 to 1. At September 30, 1998, A.B. Watley had net
capital, as defined, of $161,128 which was $61,128 in excess of its required net
capital of $100,000. The aggregate indebtedness to net capital ratio was 7.4
to 1.
4. Financial Instruments with Off-Balance Sheet Risk or Concentrations of
Credit Risk
Pursuant to clearing agreements, the clearing and depository operations for
A.B. Watley's and customers' securities transactions are provided by two
clearing broker-dealers. A.B. Watley has agreed to indemnify its clearing
brokers for losses that the clearing brokers may sustain from the customer
accounts introduced by A.B.
F-8
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1998 and 1997
4. Financial Instruments with Off-Balance Sheet Risk or Concentrations of
Credit Risk -- (Continued)
Watley. A.B. Watley, through its clearing brokers, seeks to control the risks
associated with these activities by requiring customers to maintain margin
collateral in compliance with various regulatory and internal guidelines. The
clearing brokers monitor required margin levels daily and, pursuant to such
guidelines, request customers to deposit additional collateral or reduce
securities positions when necessary. All customer transactions pending as of
September 30, 1998 settled without material adverse effect to the Company.
Also, in the normal course of business, customers may sell securities
short. Subsequent market fluctuations may require the clearing firms to obtain
additional collateral from A.B. Watley's customers. It is the policy of the
clearing firms to value the short positions and to obtain additional deposits
where deemed appropriate.
The Company may at times maintain inventories in equity securities on both
a long and short basis. While long positions represent the Company's ownership
of securities, short positions represent obligations of the Company.
Accordingly, both long and short positions may result in gains or losses to the
Company as market values of securities fluctuate. To manage the risk of losses,
the Company marks long and short positions to market daily and continuously
monitors the market fluctuations.
5. Property and Equipment
Property and equipment consist of the following:
September 30
-------------------------------
1998 1997
-------------- --------------
Computer equipment ...................................... $ 1,961,113 $ 1,115,626
Software ................................................ 697,377 62,356
Construction-in-progress ................................ 1,503,338 --
Furniture, fixtures, and leasehold improvements ......... 19,807 --
----------- -----------
4,181,635 1,177,982
Less accumulated depreciation and amortization .......... 530,892 167,774
----------- -----------
$ 3,650,743 $ 1,010,208
=========== ===========
At September 30, 1998, software includes $602,363 of software under
development. (See Note 2). Construction-in-progress represents amounts related
to leasehold improvements being made on the Company's office space. The Company
expects to occupy such space in early fiscal 1999. (See Note 2).
6. Subordinated Borrowings
Borrowings of $530,000 at September 30, 1998 and 1997 are subordinated to
the claims of general creditors, and mature in the amounts of $200,000, $150,000
and $55,000 on October 31, 1999 and $125,000 on April 30, 2000. The subordinated
borrowings bear interest at annual rates of 15%, 13%, 0% and 12%, respectively.
The loans are covered by agreements approved by the National Association of
Securities Dealers, Inc. and are included by A.B. Watley for purposes of
computing net capital under the Net Capital Rule. To the extent that such
borrowings are required for A.B. Watley's continued compliance with minimum net
capital requirements, they may not be repaid. Of the total subordinated
borrowings, $180,000 is from an officer and shareholder of the Company. For the
years ended September 30, 1998 and 1997, interest expense on the subordinated
loans amounted to $64,500 and $62,000, respectively.
7. Notes Payable
Effective February 13, 1998 and April 16, 1998, the Company issued
promissory notes in the amount of $200,000 and $50,000, respectively, to three
individuals, two of whom are minority stockholders of the Company. The notes
bear interest at 8% per annum. The principal plus accrued interest on the notes
is payable on
F-9
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1998 and 1997
7. Notes Payable -- (Continued)
the earlier of (a) the consummation of an initial public offering ("IPO") of the
Company's equity securities, or (b) if such IPO does not occur on or before the
first anniversary of the issue date of the notes, the principal plus accrued
interest shall be payable in twelve equal monthly installments, unless the
holders agree to extend such maturity date. For the year ended September 30,
1998, interest expense on the notes amounted to $11,833.
Upon execution of these promissory notes, the holders were granted options
on the common stock of the Company for a total price of $250. Pursuant to the
Option Agreements, the options become exerciseable upon consummation of an IPO,
and the number of shares to be issued will be determined by dividing the initial
principal amount of the promissory notes by the IPO price. The fair value of the
options is accounted for as a debt servicing fee, and is being amortized over a
one year period. The unamortized amount of the debt service fee is included as
"Option costs, net" in Stockholders' Equity. Amortization expense related to the
debt servicing fee for the year ended September 30, 1998 amounted to $149,395.
8. Bank Loan
The bank loans at September 30, 1998 and 1997 consist of an unsecured term
loan, with the full principal amount due September 29, 2000, and an interest
rate of 8.5% per annum.
9. Related Party Transactions
Included in loans from related party on the consolidated statement of
financial condition are notes of $103,000, plus accrued interest of $12,711, due
from a shareholder and officer of the Company. The notes generally bear interest
at an annual rate of 6% and are payable on demand.
Other contributions of $115,000 on the consolidated statement of changes in
stockholders' equity represent compensation forgiven by two significant
stockholders and officers of the Company. For consolidated financial statement
purposes, the unpaid compensation is considered an expense and a contribution of
capital.
10. Commitments and Contingencies
The Company has entered into two lease agreements for office space which
expire on June 23, 2009 and September 15, 1999, respectively. Both lease
agreements are noncancellable and contain escalation provisions. As of September
30, 1998, the aggregate minimum future rental payments required were as follows:
Year Ended September 30
-----------------------
1999 ................................ $ 158,538
2000 ................................ 454,279
2001 ................................ 463,947
2002 ................................ 492,940
2003 ................................ 492,940
Thereafter .......................... 2,235,945
-----------
$ 4,298,589
===========
Rent expense for the years ended September 30, 1998 and 1997 was $170,101
and $98,934, respectively.
In the ordinary course of business, the Company is party to several legal
proceedings, the outcome of which, either singularly or in the aggregate, is not
expected to have a material impact on the Company's financial position.
11. Stock Options
Under the Company's 1998 and 1997 Stock Option Plans (the "Plans"),
employees, nonemployee directors and officers, and consultants are generally
granted options (both incentive stock options and nonqualified stock
F-10
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1998 and 1997
11. Stock Options -- (Continued)
options) to purchase shares of common stock at prices not less than the
estimated fair market value of the common stock on the date the option is
granted. The options are exercisable at either the date of grant, in ratable
installments or otherwise, generally over a period of one to three years from
the date of grant. The options generally expire within ten years after the date
of grant. The number of shares delivered in the aggregate under the 1998 and
1997 Plans cannot exceed 600,000 and 400,000 shares, respectively, (1,000,000
shares in total). No option shall be granted under the 1998 Plan after March 16,
2008 or under the 1997 Plan after January 26, 2007.
A summary of the Company's stock option activity (exclusive of the options
discussed in Note 7 and the information discussed in Note 15) and related
information for the years ended September 30, 1998 and 1997 is as follows:
Number Weighted Average
of Shares Exercise Price
----------- -----------------
Outstanding at October 1, 1996 .................. -- $ --
Granted, year ended September 30, 1997 ......... 375,000 1.90
------- -------
Outstanding at September 30, 1997 ............... 375,000 1.90
Granted, year ended September 30, 1998 ......... 45,100 8.89
------- -------
Outstanding at September 30, 1998 ............... 420,100 $ 2.34
======= =======
Exercisable at September 30, 1997 ............... 50,000 $ 2.00
======= =======
Exercisable at September 30, 1998 ............... 312,500 $ 1.88
======= =======
Included in the table above are non-employee option grants of 20,000 and
85,000 shares, respectively, for the years ended September 30, 1998 and 1997.
The estimated fair values of the grants to non-employees are amortized over the
vesting period of the grants, if any. For the years ended September 30, 1998 and
1997 the amount charged to expense for non-employee options was $76,832 and
$21,367, respectively, and is included in professional services.
The weighted average fair value of options granted during the years ended
September 30, 1998 and 1997 was $1.13 and $0.57, respectively. The fair value of
each option grant was estimated at the date of grant using the Black-Scholes
option valuation model. The Black-Scholes option valuation model was developed
for use in estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. Because the Company's stock options
have characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its stock
options. In calculating the fair values of the stock options, the following
weighted average assumptions were used:
1998 Grants 1997 Grants
------------- ------------
Dividend yield ................... 0% 0%
Average expected life:
Employees ....................... 5.4 years 5.4 years
Nonemployees .................... 0.5 years 5.5 years
Risk-free interest rate .......... 5.4% 6.6%
Expected volatility .............. 0% 0%
Pro forma information regarding net income is required under Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," and has been determined as if the Company
F-11
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1998 and 1997
11. Stock Options -- (Continued)
had accounted for all the 1998 and 1997 stock option grants on the fair value
method. For purposes of the pro forma information, the fair values of the 1998
and 1997 option grants to employees are amortized over the vesting period. The
pro forma information for the years ended September 30, 1998 and 1997 is as
follows:
Year ended September 30
---------------------------------
1998 1997
-------------- ----------------
Net loss as reported ................... $ (632,410) $ (1,059,973)
Net loss pro forma ..................... $ (674,499) (1,082,707)
Net loss per share as reported ......... $ (.12) $ (.30)
Net loss per share pro forma ........... $ (.13) $ (.31)
Additional information regarding options outstanding as of September 30,
1998 (exclusive of the options discussed in Note 7 and the information discussed
in Note 15) is as follows:
Weighted Average
Remaining
Exercise Number Number Contractual Life
Price Outstanding Exercisable (Years)
--------------- ------------- ------------- -----------------
$ .02 125,000 125,000 8.33
2.00 180,500 130,500 9.52
5.00 69,500 19,500 10.93
8.00 25,100 17,500 9.99
10.00 20,000 20,000 0.58
------- -------
Total 420,100 312,500
======= =======
12. Income Taxes
The Company files a consolidated federal income tax return with A.B.
Watley. For all periods presented, the Company provides for income taxes as
required under SFAS No. 109. The Company records income taxes using a liability
approach for financial accounting and reporting which results in the recognition
and measurement of deferred tax assets based upon the likelihood of realization
of tax benefits in future years.
The provision for income taxes for the years ending September 30, 1998 and
1997 is comprised of New York State and New York City taxes in the amount of
$12,765 and $2,776, respectively. No benefit has been provided for the Company's
net operating losses.
The difference between the U.S. federal tax rate and the Company's
effective tax rate for the years ending September 30, 1998 and 1997 follows:
Year ended September 30
---------------------------
1998 1997
------------ ------------
Tax benefit at federal statutory rate .......... (34.0%) (34.0%)
State taxes, net of federal tax effect ......... 2.9% 0.3%
Valuation allowance ............................ 33.9% 34.8%
Other .......................................... (0.3%) (0.8%)
----- -----
Effective tax rate ............................. 2.5% 0.3%
===== =====
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Components of the
Company's deferred tax assets and liabilities as of September 30, 1998 and 1997
are as follows:
F-12
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1998 and 1997
12. Income Taxes -- (Continued)
Year ended September 30
---------------------------
1998 1997
------------ ------------
Net operating loss ....................... $ 638,238 $ 369,197
Mark-to-market loss on inventory ......... 10,932 10,931
Depreciation ............................. (82,221) (33,441)
Other .................................... 6,927 9,867
---------- ----------
Total deferred tax assets ................ 573,876 356,554
Valuation reserve ........................ (573,876) (356,554)
---------- ----------
Net deferred tax asset ................... $ -- $ --
========== ==========
At September 30, 1998, the Company had a net operating loss carryforward
for federal tax purposes of $1,382,065 that will expire no sooner than September
30, 2013.
13. Capital Stock
Effective January 24, 1997, the Company's certificate of incorporation was
amended to reflect the total number of shares authorized to issue as 10,000,000
shares with a par value of $.001 per share.
14. Earnings Per Share
The weighted average number of shares outstanding for the years ended
September 30, 1998 and 1997 reflect the 70,771 shares discussed in Note 15 below
as though the shares were outstanding as of the beginning of each year. Since
the Company recognized a net loss in both years, diluted earnings per common
share is the same as earnings per common share for both years.
15. Subsequent Events (Unaudited)
On October 1, 1998 and as subsequently modified, the Company's Board of
Directors authorized the sale of up to 1,700,000 shares of common stock, plus a
15% over-allotment option to the underwriter, in an underwritten public offering
(the "IPO") of the Company's common stock at an estimated gross offering price
of $6.00 per share. The Board of Directors approved the following, conditional
on the effectiveness of the IPO: (1) the issuance of 3,000 shares of common
stock with a three year lock-up provision for no consideration to certain
employees of the Company, and (2) grants of 519,350 and 14,500 stock options
with an exercise price of $6.00 per share to certain employees and
non-employees, respectively, of the Company. The non-employee options have an
estimated fair value of approximately $16,000 which will be expensed upon the
effectiveness of the IPO.
Effective October 2, 1998, the Company borrowed $500,000 from New York
Small Business Venture Fund, LLC ("NYSB") under the condition that the proceeds
of the loan be used as working capital to further the corporate purposes of the
Company and not to repay any debt or redeem any equity interests. The loan
accrues interest at 12% per annum which is payable first in 24 monthly
installments of $5,000 beginning December 1, 1998. Commencing December 1, 2000,
the principal amount of the loan is payable in 35 monthly installments of $8,333
plus interest on the unpaid balance, except for the last installment which shall
be in the amount of $208,345 plus interest on the unpaid balance.
As collateral for the loan, NYSB received a security interest in the
Company's assets, and certain officers and directors of the Company have
personally guaranteed all amounts due. Under the terms and conditions of the
loan agreement, NYSB received warrants expiring October 2, 2003 to acquire
191,250 shares of the Company's common stock at an exercise price equal to the
IPO price. In the event there has been no IPO within five years from the closing
of the loan, the number of shares to be acquired under the terms of the warrant
are reduced to 100,000 and NYSB shall have the right to put its ownership
interest at a price as defined in the warrant agreement and cause the Company to
repurchase all or part of such interest at any time thereafter. The fair value
of the warrants (approximately $191,250) will be accounted for as a debt
servicing fee and amortized over the life of the loan. The unamortized amount of
the debt servicing fee will be included as "Option costs, net" in Stockholders'
Equity.
F-13
Internet Financial Services Inc.
Notes to Consolidated Financial Statements -- (Continued)
Years ended September 30, 1998 and 1997
15. Subsequent Events (Unaudited) -- (Continued)
Effective October 2, 1998 and as subsequently modified, the Board of
Directors approved the issuance of 38,260 shares of the Company's common stock
for all the shares of capital stock of Computer Strategies, Inc. ("CSI"). CSI
provided software support, research and development to the Company with the
Company serving as CSI's primary customer. The acquisition will be accounted for
as a purchase. The Company expects to record approximately $60,000 in goodwill
from the acquisition which will be amortized over 3 years, and approximately
$59,000 in capitalized software attributable to costs incurred in the
application development stage of the Company's software development.
During October and November 1998, three employees exercised stock options
which were granted during 1997 at a strike price of two cents per share, and
were issued 125,000 shares of the Company's common stock.
Effective November 19, 1998, the Board of Directors agreed to (1) grant
for no additional consideration 16,200 additional options at a strike price of
$5.00 per share to two employees who were granted $5.00 options in September
1997; and (2) amend the option grants to all option holders who were granted
$8.00 options in November 1997 to reflect a strike price of $6.00 per share.
Effective November 20, 1998, the Board of Directors agreed to amend the
option grants to all option holders who were granted $10.00 options in April
1998 to reflect a strike price of $6.00 per share.
In December 1998, the Company obtained a $500,000 line of financing from
General Electric Capital Corporation ("GECC") which is to be used for the
purchase or leasing of additional equipment and software. The Company is
required to deliver to GECC a letter of credit in the amount of 50% of any
amount borrowed under this financing. In addition, the Company has granted the
lender a security interest in certain of the Company's existing equipment as
well as in all equipment purchased using funds under this financing.
On January 14, 1999, the Board of Directors agreed to amend the Company's
certificate of incorporation to increase the authorized number of shares of
common stock to 20,000,000, and to authorize and delineate the terms under which
preferred stock may be issued. In addition, the Board agreed to issue, subject
to the effectiveness of the IPO, 70,771 additional shares of common stock for
nominal additional consideration to certain stockholders who purchased private
placement shares during the year ended September 30, 1998.
During January 1999, the Board of Directors approved the issuance of
221,500 shares of the Company's common stock in a private placement offering.
The common stock was issued at a price of $4.80 per share (total gross proceeds
of $1,063,200) and was restricted with regard to sale or disposition for a
period of one year. Two employees of the Company purchased an aggregate of
102,000 shares as part of this offering.
Effective January 28, 1999, the Company borrowed $400,000 from New York
Community Investment Company, L.L.C. ("NYCIC"), an affiliate of NYSB, under the
conditions that the proceeds of the loan be used as working capital to further
the corporate purposes of the Company and not to repay any debt or redeem any
equity interests. The loan accrues interest at 12% per annum which is payable
first in 24 monthly installments of $4,000 beginning March 1, 1999. Commencing
March 1, 2001, the principal amount of the loan is payable in 35 monthly
installments of $6,667 plus interest on the unpaid balance, except for the last
installment which shall be in the amount of $166,665 plus interest on the unpaid
balance.
As collateral for the loan, NYCIC received a security interest in the
Company's assets. Under the terms and conditions of the loan agreement, NYCIC
received warrants expiring January 28, 2004 to acquire 140,000 shares of the
Company's common stock at an exercise price equal to the IPO price. In the event
there has been no IPO within five years from the closing of the loan, the number
of shares to be acquired under the terms of the warrant are reduced to 80,000
and NYCIC shall have the right to put its ownership interest at a price defined
in the warrant agreement and cause the Company to repurchase all or part of such
interest at any time thereafter. The fair value of the warrants (approximately
$140,000) will be accounted for as a debt servicing fee and amortized over the
life of the loan. The unamortized amount of the debt servicing fee will be
included as "Option costs, net" in Stockholders' Equity.
F-14
IFS [LOGO]
Internet Financial Services Inc.
[Picture]
================================================================================
We have not authorized any dealer, salesperson or any other person to
give any information or to represent anything not contained in this prospectus.
You must not rely on any unauthorized information. This prospectus does not
offer to sell or buy any shares in any jurisdiction where it is unlawful.
-----------------------------------
TABLE OF CONTENTS
Page
Prospectus Summary ....................... 3
Risk Factors ............................. 7
Use of Proceeds .......................... 16
Dilution ................................. 17
Dividends ................................ 18
Capitalization ........................... 18
Management's Discussion and Analysis
of Financial Condition and Results
of Operations ......................... 19
Business ................................. 23
Management ............................... 33
Principal Stockholders ................... 39
Certain Transactions ..................... 40
Description of Securities ................ 41
Shares Eligible for Future Sale .......... 42
Underwriting ............................. 43
Legal Matters ............................ 44
Experts .................................. 44
Additional Information ................... 45
Index to Financial Statements ............ F-1
-----------------------------------
Until ___________, 1999, all dealers effecting transactions in the
registered securities, whether or not participating in this offering, may be
required to deliver a prospectus. This is in addition to the dealers' obligation
to deliver a prospectus when acting as underwriters and with respect to their
unsold allotments or subscriptions.
================================================================================
================================================================================
1,700,000 Shares
INTERNET FINANCIAL
SERVICES INC.
Common Stock
----------------
PROSPECTUS
----------------
Whale Securities Co., L.P.
_______________, 1999
================================================================================
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers.
Section 145 of the General Corporation Law of the State of Delaware
provides for the indemnification of officers and directors under certain
circumstances against expenses incurred in successfully defending against a
claim and authorizes Delaware corporation to indemnify their officers and
directors under certain circumstances against expenses and liabilities incurred
in legal proceedings involving such persons because of their being or having
been an officer or director.
Section 102(b) of the Delaware General Corporation Law permits a
corporation, by so providing in its certificate of incorporation, to eliminate
or limit a director's liability to the corporation and its stockholders for
monetary damages arising out of certain alleged breaches of their fiduciary
duty. Section 102(b)(7) provides that no such limitation of liability may affect
a director's liability with respect to any of the following: (i) breaches of the
director's duty of loyalty to the corporation or its stockholders; (ii) acts or
omissions not made in good faith or which involve intentional misconduct of
knowing violations of law; (iii) liability for dividends paid or stock
repurchased or redeemed in violation of the Delaware General Corporation law; or
(iv) any transaction from which the director derived an improper personal
benefit. Section 102(b)(7) does not authorize any limitation on the ability of
the company or its stockholders to obtain injunctive relief, specific
performance or other equitable relief against directors.
Article Eighth of the Registrant's Certificate of Incorporation provides
that the personal liability of the directors of the Registrant be eliminated to
the fullest extent permitted under Section 102(b) of the Delaware General
Corporation law.
Article Ninth of the Registrant's Certificate of Incorporation and the
Registrant's By-laws provides that all persons who the Registrant is empowered
to indemnify pursuant to the provisions of Section 145 of the Delaware General
Corporation Law (or any similar provision or provisions of applicable law at the
time in effect), shall be indemnified by the Registrant to the full extent
permitted thereby. The foregoing right of indemnification shall not be deemed to
be exclusive of any other rights to which those seeking indemnification may be
entitled under any by-law, agreement, vote of stockholders or disinterested
directors, or otherwise.
Insofar as indemnification for liabilities under the Securities Act of
1933, as amended (the "Securities Act") may be permitted to directors, officers
or persons controlling the Registrant pursuant to the foregoing provisions, the
Registrant has been informed that in the opinion of the Commission, such
indemnification is against public policy as expressed in the Securities Act and
is therefor unenforceable.
Reference is made to the Underwriting Agreement, the proposed form of which
is filed as Exhibit 1.1, pursuant to which the underwriter agrees to indemnify
the directors and certain officers of the Registrant and certain other persons
against certain civil liabilities.
Item 25. Other Expenses of Issuance and Distribution.
The following table sets forth the expenses (other than the underwriting
discounts and commissions and the Underwriter's Non-Accountable Expense
Allowance) expected to be incurred in connection with the issuance and
distribution of the securities being registered.
SEC Registration .................................................... $ 3,728.81
NASD Filing Fee ..................................................... $ 1,841.13
Legal Fees and Expenses* ............................................ $ 110,000.00
Printing and Engraving Costs* ....................................... $ 90,000.00
Accounting Fees* .................................................... $ 180,000.00
Blue Sky Expenses and Counsel Fees .................................. $ **
Boston Stock Exchange and NASDAQ Listing Fees and Related Expenses* . $ 40,000.00
Consulting Fee ...................................................... $ 60,000.00
Miscellaneous* ...................................................... $ **
------------
Total ............................................................. $ 674,000.00
============
- ------------
* Estimated
** To be provided by amendment.
II-1
Item 26. Recent Sales of Unregistered Securities.
Since January 1997, the Registrant has issued securities without
registration under the Securities Act in the following transactions:
1. In January 1997, the Registrant issued an aggregate of 431,538 shares of
Common Stock, $.001 par value ("Common Stock"), valued at $80,000, to two
persons in exchange for all of the issued and outstanding shares of A.B.
Watley, Inc.
2. In January 1997, the Registrant issued an aggregate of 3,568,462 shares
of Common Stock to nine investors for aggregate proceeds of $71,369.
3. In April 1997, the Registrant issued an aggregate of 1,050,000 shares of
Common Stock to forty-two investors for aggregate proceeds of $2,100,000.
4. In April 1997, the Registrant issued options to purchase an aggregate of
180,500 shares of Common Stock, exercisable at $2.00 per share, to ten employees
under the Registrant's stock option plans.
5. In September 1997, the Registrant issued options to purchase an
aggregate of 87,700 shares of Common Stock, exercisable at $5.00 per share, to
seven employees under the Registrant's stock option plans.
6. In November 1997, the Registrant issued options to purchase an aggregate
of 20,600 shares of Common Stock, exercisable at $6.00 per share, to six
employees under the Registrant's stock option plans.
7. In January 1998, the Registrant issued 50,000 shares of Common Stock to
one investor for $500,000.
8. In March 1998, the Registrant issued 20,000 shares of Common Stock and
warrants to purchase 20,000 shares of Common Stock to one investor for $200,000.
9. In May 1998, the Registrant issued 17,500 shares of Common Stock to one
investor for $175,000.
10. In October 1998, the Registrant issued 38,260 shares of Common Stock,
valued at $183,648, to one person in exchange for all the shares of a business.
11. In October 1998, the Registrant issued warrants to purchase 191,250
shares of Common Stock to one entity as partial consideration for making a loan
to the Registrant.
12. In October 1998, the Registrant issued 25,000 shares of Common Stock to
an executive officer upon exercise of options, for proceeds of $500.
13. In November 1998, the Registrant issued an aggregate of 100,000 shares
of Common Stock to two executive officers upon exercise of options, for
aggregate proceeds of $2,000.
14. In December 1998, the Registrant issued an aggregate of 3,000 shares of
Common Stock to five employees for aggregate proceeds of $1,500.
15. In January 1999, the Registrant issued an aggregate of 70,771 shares of
Common Stock to three stockholders for no or nominal consideration.
16. In January 1999, the Registrant issued an aggregate of 221,500 shares
of Common Stock to twelve investors for aggregate net proceeds of $1,050,000.
17. In January 1999, the Registrant issued warrants to purchase 140,000
shares of Common Stock to one entity as partial consideration for making a loan
to the Registrant.
The sales and issuances of the Common Stock, options and warrants described
above were deemed to be exempt from registration under the Securities Act in
reliance upon Section 4(2) and Regulation 506 thereof as transactions not
involving a public offering. The Registrant made a determination that each of
the purchasers was a sophisticated investor. The purchasers in such private
offerings represented their intention to acquire the
II-2
securities for investment only and not with a view to the distribution thereof.
Appropriate legends were affixed to the stock certificates and warrants issued
in such transactions. All purchasers had adequate access, through their
employment or other relationships, to sufficient information about the
Registrant to make an informed investment decision. None of the securities were
sold through an underwriter and, accordingly, there were no underwriting
discounts or commissions involved.
Item 27. Exhibits.
Exhibit
No. Description
- ---------- -----------
1.1 Form of Underwriting Agreement.
3.1 Restated Certificate of Incorporation of the Company and form of amendment thereto.
3.2 By-Laws of the Company.
4.1 Specimen Common Stock Certificate.*
4.2 Form of Underwriter's Warrant Agreement, including Form of Warrant Certificate.
5.1 Form of Opinion of Hartman & Craven LLP on legality of securities being registered.*
10.1 1997 Stock Option Plan.
10.2 Amended and Restated 1998 Stock Option Plan.
10.3 Employment Agreement dated as of May 1, 1997 between the Company and Steven Malin and
Amendment to Employment Agreement dated as of October 1, 1998 between the Company and
Steven Malin.
10.4 Employment Agreement dated as of June 1, 1997 between the Company and Harry Simpson and
Amendment to Employment Agreement dated October 1, 1998 between the Company and Harry
Simpson.
10.5 Employment Agreement dated as of January 1, 1999 between the Company and Robert Malin.
10.6 Employment Agreement dated as of June 1, 1997 between the Company and Anthony G. Huston
and Amendment to Employment Agreement dated as of October 1, 1998 between the Company
and Anthony G. Huston.
10.7 Employment Agreement dated as of March 1, 1998 between the Company and Eric Steinberg.
10.8 Office lease dated as of June 20, 1997 between 40 Wall Development Associates, LLC, as
Landlord and the Company as Tenant for premises located at 40 Wall Street, New York,
New York.*
10.9 Office lease dated as of October 1, 1996 between 800 Third Avenue Associates as
Landlord and the Company as Tenant for premises located at 800 Third Avenue, New York,
New York.*
10.10 Office Lease Agreement dated as of September 15, 1998 between Robert A. Diamond as
Landlord and the Company as Tenant for premises known as Suite 110 at 100 Allentown
Parkway, Allen, Texas.*
10.11 Co-Branding Agreement dated October 11, 1996 between PC Quote, Inc. and A.B. Watley, Inc., as
amended.**
10.12 Computer Software License Agreement dated December 8, 1996 between Townsend Analytics, Ltd.
and A.B. Watley, Inc., as amended.**
10.13 Fully Disclosed Clearing Agreement dated October 3, 1996 and Amendment dated June 8, 1998
between Penson Financial Services, Inc. and A.B. Watley, Inc.
10.14 Fully Disclosed Correspondent Agreement dated November 18, 1996 between Weiss, Peck &
Greer, L.L.C. and A.B. Watley, Inc.
10.15 License Agreement dated as of October 1, 1998 between Ethos Corporation and A.B.
Watley, Inc.**
10.16 Service Marketing Representative Agreement dated as of January 29, 1998 between S&P
Com-Stock, Inc. and A.B. Watley, Inc.**
10.17 Master Lease Agreement dated December 17, 1998 between General Electric Capital
Corporation and the Company.*
10.18 Security Agreement dated December 17, 1998 between General Electric Capital Corporation
and the Company.*
10.19 Letter of Credit Agreement dated December 17, 1998 between General Electric Capital
Corporation and the Company.*
10.20 Loan Agreement dated January 28, 1999 between New York Community Investment Company
L.L.C., the Company and A.B. Watley, Inc.
10.21 Promissory Note of the Company and A.B. Watley, Inc. dated January 28, 1999 issued to
the New York Community Investment Company L.L.C.
10.22 Security Agreement dated January 28, 1999 between New York Community Investment Company
L.L.C. and A.B. Watley, Inc.
II-3
Exhibit
No. Description
- ----------- -----------
10.23 Security Agreement dated January 28, 1999 between New York Community Investment Company
L.L.C. and the Company.
23.1 Consent of Hartman & Craven LLP (contained in, and incorporated herein by reference to
Exhibit 5.1 of this Registration Statement).*
23.2 Consent of Ernst & Young LLP, independent auditors.
23.3 Consent of William Brawer.
23.4 Consent of Elizabeth Chambers.
23.5 Consent of Mark Chambre.
23.6 Consent of Stanley Weinstein.
24.1 Power of Attorney (contained in, and incorporated herein by reference to the signature
pages of this Registration Statement).
27.1 Financial Data Schedule.
- ------------
* To be filed by amendment
** Filed in redacted form pursuant to Rule 406 promulgated under the Securities
Act. Filed separately in unredacted form subject to a request for
confidential treatment pursuant to Rule 406 under the Securities Act.
Item 28. Undertakings.
The undersigned Registrant hereby undertakes to:
(1) file, during any period in which it offers or sells securities, a
post-effective amendment to this registration statement to:
(i) include any prospectus required by section 10(a)(3) of the
Securities Act;
(ii) reflect in the prospectus any facts or events which, individually
or together, represent a fundamental change in the information set
forth in the Registration Statement;
(iii) include any additional or changed material information on the plan
of distribution;
(2) for determining liability under the Securities Act, treat each such
post-effective amendment as a new registration of the securities offered,
and the offering of such securities at that time to be initial bona fide
offering; and
(3) file a post-effective amendment to remove from registration any of the
securities that remain unsold at the termination of this offering.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned Registrant hereby undertakes (1) to provide to the
underwriters at the closing specified in the underwriting agreement certificates
in such denominations and registered in such names as required by the
underwriters to permit prompt delivery to each purchaser; (2) that for the
purpose of determining any liability under the Securities Act, treat the
information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act as part of this Registration Statement as of the time
the Securities and Exchange Commission declares it effective; and (3) that for
the purpose of determining any liability under the Securities Act, treat each
post-effective amendment that contains a form of prospectus as a new
registration statement for the securities offered in the registration statement
herein, and treat the offering of the securities at that time as the initial
bona fide offering of those securities.
II-4
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements of filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned in the City of New York,
State of New York, on January 31, 1999.
INTERNET FINANCIAL SERVICES INC.
By: /s/ Steven Malin
-------------------------------------
Steven Malin,
Chairman and Chief Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Steven
Malin, Harry Simpson and Robert Malin, and each of them, his or her true and
lawful attorney-in-fact and agent, acting alone, with full powers of
substitution and resubstitution, for his or her and in his or her name, place
and stead, in any and all capacities, this Registration Statement, and to file
the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, each acting alone, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he or she might
or could do in person, hereby ratifying and confirming all that said
attorney-in-fact and agent, acting alone, or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
In accordance with the requirements of the Securities Act of 1933, this
registration statement was signed by the following persons in the capacities and
on the dates stated.
Signature Title Date
--------- ----- ----
/s/ Steven Malin Chairman of the Board, Chief Executive January 31, 1999
- ---------------------------- Officer and Director (Principal Executive
Steven Malin Officer and Principal Financial Officer)
/s/ Michael Fielman Vice President -- Finance January 31, 1999
- ---------------------------- (Principal Accounting Officer)
Michael Fielman
/s/ Harry Simpson President, Chief Operating Officer January 31, 1999
- ---------------------------- and Director
Harry Simpson
/s/ Robert Malin Director January 31, 1999
- ----------------------------
Robert Malin
II-5
EXHIBIT INDEX
-------------
Exhibit
No. Description
- ---------- -----------
1.1 Form of Underwriting Agreement.
3.1 Restated Certificate of Incorporation of the Company and form of amendment thereto.
3.2 By-Laws of the Company.
4.1 Specimen Common Stock Certificate.*
4.2 Form of Underwriter's Warrant Agreement, including Form of Warrant Certificate.
5.1 Form of Opinion of Hartman & Craven LLP on legality of securities being registered.*
10.1 1997 Stock Option Plan.
10.2 Amended and Restated 1998 Stock Option Plan.
10.3 Employment Agreement dated as of May 1, 1997 between the Company and Steven Malin and
Amendment to Employment Agreement dated as of October 1, 1998 between the Company and
Steven Malin.
10.4 Employment Agreement dated as of June 1, 1997 between the Company and Harry Simpson and
Amendment to Employment Agreement dated October 1, 1998 between the Company and Harry
Simpson.
10.5 Employment Agreement dated as of January 1, 1999 between the Company and Robert Malin.
10.6 Employment Agreement dated as of June 1, 1997 between the Company and Anthony G. Huston
and Amendment to Employment Agreement dated as of October 1, 1998 between the Company
and Anthony G. Huston.
10.7 Employment Agreement dated as of March 1, 1998 between the Company and Eric Steinberg.
10.8 Office lease dated as of June 20, 1997 between 40 Wall Development Associates, LLC, as
Landlord and the Company as Tenant for premises located at 40 Wall Street, New York,
New York.*
10.9 Office lease dated as of October 1, 1996 between 800 Third Avenue Associates as
Landlord and the Company as Tenant for premises located at 800 Third Avenue, New York,
New York.*
10.10 Office Lease Agreement dated as of September 15, 1998 between Robert A. Diamond as
Landlord and the Company as Tenant for premises known as Suite 110 at 100 Allentown
Parkway, Allen, Texas.*
10.11 Co-Branding Agreement dated October 11, 1996 between PC Quote, Inc. and A.B. Watley, Inc., as
amended.**
10.12 Computer Software License Agreement dated December 8, 1996 between Townsend Analytics, Ltd.
and A.B. Watley, Inc., as amended.**
10.13 Fully Disclosed Clearing Agreement dated October 3, 1996 and Amendment dated June 8, 1998
between Penson Financial Services, Inc. and A.B. Watley, Inc.
10.14 Fully Disclosed Correspondent Agreement dated November 18, 1996 between Weiss, Peck &
Greer, L.L.C. and A.B. Watley, Inc.
10.15 License Agreement dated as of October 1, 1998 between Ethos Corporation and A.B.
Watley, Inc.**
10.16 Service Marketing Representative Agreement dated as of January 29, 1998 between S&P
Com-Stock, Inc. and A.B. Watley, Inc.**
10.17 Master Lease Agreement dated December 17, 1998 between General Electric Capital
Corporation and the Company.*
10.18 Security Agreement dated December 17, 1998 between General Electric Capital Corporation
and the Company.*
10.19 Letter of Credit Agreement dated December 17, 1998 between General Electric Capital
Corporation and the Company.*
10.20 Loan Agreement dated January 28, 1999 between New York Community Investment Company
L.L.C., the Company and A.B. Watley, Inc.
10.21 Promissory Note of the Company and A.B. Watley, Inc. dated January 28, 1999 issued to
the New York Community Investment Company L.L.C.
10.22 Security Agreement dated January 28, 1999 between New York Community Investment Company
L.L.C. and A.B. Watley, Inc.
10.23 Security Agreement dated January 28, 1999 between New York Community Investment Company
L.L.C. and the Company.
23.1 Consent of Hartman & Craven LLP (contained in, and incorporated herein by reference to
Exhibit 5.1 of this Registration Statement).*
23.2 Consent of Ernst & Young LLP, independent auditors.
23.3 Consent of William Brawer.
23.4 Consent of Elizabeth Chambers.
23.5 Consent of Mark Chambre.
23.6 Consent of Stanley Weinstein.
24.1 Power of Attorney (contained in, and incorporated herein by reference to the signature
pages of this Registration Statement).
27.1 Financial Data Schedule.
- ------------
* To be filed by amendment
** Filed in redacted form pursuant to Rule 406 promulgated under the Securities
Act. Filed separately in unredacted form subject to a request for
confidential treatment pursuant to Rule 406 under the Securities Act.