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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ___________ to ___________
Commission File Number: 1-14897
A.B. WATLEY GROUP INC.
(Exact name of Registrant as specified in its charter)
Delaware 13-3911867
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
90 Park Avenue
New York, NY 10016
(Address of principal executive offices, including zip code)
(212) 500-6500
(Registrant's telephone number, including area code)
Check whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months, and (2) has been subject to such filing requirements for
the past 90 days. Yes |X| No |_|
The number of shares of the Registrant's common stock outstanding at May
17, 2005, was 29,115,228.
Transitional Small Business Disclosure Format:Yes |_| No |X|
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A.B. WATLEY GROUP INC.
MARCH 31, 2005 QUARTERLY REPORT ON FORM 10-QSB
TABLE OF CONTENTS
PAGE
----
Special Note Regarding Forward Looking Statements ....................3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements .................................................4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................20
Item 3. Controls and Procedures..............................................25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings....................................................25
Item 2. Unregistered Sale of Equity in Securities and Use of Proceeds........30
Item 3. Defaults Upon Senior Securities......................................31
Item 4. Submission of Matters to a Vote of Security Holders..................32
Item 5. Other Information....................................................32
Item 6. Exhibits and Reports on Form 8-K.....................................35
2
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
To the extent that the information presented in this Quarterly Report on
Form 10-QSB for the quarter ended March 31, 2005, discusses financial
projections, information or expectations about our products or markets, or
otherwise makes statements about future events, such statements are
forward-looking. We are making these forward-looking statements in reliance on
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Although we believe that the expectations reflected in these
forward-looking statements are based on reasonable assumptions, there are a
number of risks and uncertainties that could cause actual results to differ
materially from such forward-looking statements. These risks and uncertainties
are described, among other places in this Quarterly Report, in "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
In addition, we disclaim any obligations to update any forward-looking
statements to reflect events or circumstances after the date of this Quarterly
Report. When considering such forward-looking statements, you should keep in
mind the risks referenced above and the other cautionary statements in this
Quarterly Report.
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS PAGE
----
Condensed Consolidated Statements of Financial Condition 5
as at March 31, 2005 (unaudited) and September 30, 2004
Condensed Consolidated Statements of Operations for the
three and six months ended March 31, 2005 and 2004 6
(unaudited)
Condensed Consolidated Statements of Cash Flows for the
six months ended March 31, 2005 and 2004 (unaudited) 7
Notes to Condensed Consolidated Financial Statements 8-19
(unaudited)
4
A.B. WATLEY GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30,
March 31, 2005 2004
--------------- ---------------
(Unaudited)
ASSETS:
Cash and cash equivalents $ 148,880 $ 182,929
Receivables from clearing brokers 49,341 314,374
Loans receivable from related party 258,227 258,227
Other assets 59,005 22,600
--------------- ---------------
TOTAL ASSETS $ 515,453 $ 778,130
=============== ===============
LIABILITIES AND STOCKHOLDERS' DEFICIT:
Accounts payable and accrued liabilities 9,209,775 9,916,940
Accrued liabilities to LLC Class B Members 1,905,240 1,910,600
Payable to clearing broker 74,950 135,412
Notes payable to former officer 700,000 700,000
Notes payable - other 307,500 307,500
Subordinated borrowings 2,791,260 2,791,260
Subordinated borrowings from officer 180,000 180,000
--------------- ---------------
15,168,725 15,941,712
--------------- ---------------
STOCKHOLDERS' DEFICIT:
Series A Redeemable Convertible Preferred Stock, $0.001 par value, 1,000,000
shares authorized and none issued and outstanding -- --
Common stock, $0.001 par value, 50,000,000 shares authorized
and 28,615,228 and 19,062,138 issued and outstanding at March 31, 2005
and September 30, 2004, respectively 28,615 19,062
Additional paid-in capital 61,034,719 60,326,668
Subscription receivable (506,163) (1,264,109)
Deferred compensation (582,000) (101,620)
Accumulated deficit (74,628,443) (74,143,583)
--------------- ---------------
TOTAL STOCKHOLDERS' DEFICIT (14,653,272) (15,163,582)
--------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 515,453 $ 778,130
=============== ===============
See notes to condensed consolidated financial statements
5
A.B. WATLEY GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended March 31, Six Months Ended March 31,
-------------------------------- --------------------------------
2005 2004 2005 2004
---- ---- ---- ----
Revenues:
Commissions $ 876,140 $ 1,752,534 $ 2,230,009 $ 3,049,468
Data service fees 108,403 116,045 215,056 257,754
Principal transactions -- 891,421 -- 2,356,633
Interest and other income 117,238 208,305 295,766 397,238
-------------- -------------- -------------- --------------
Total revenues 1,101,781 2,968,305 2,740,831 6,061,093
Interest expense 71,104 327,792 168,398 600,273
-------------- -------------- -------------- --------------
Net revenues 1,030,677 2,640,513 2,572,433 5,460,820
-------------- -------------- -------------- --------------
Expenses and other charges:
Commissions, floor brokerage and clearing charges 423,445 1,304,732 1,131,493 2,478,419
Employee compensation and related costs 640,462 1,223,332 1,163,517 2,594,465
Communications 104,502 107,862 177,716 325,721
Business development 42,816 (22,560) 64,299 79,330
Professional services 495,844 33,237 844,238 273,571
Occupancy and equipment 113,294 308,983 365,981 666,980
Depreciation and amortization -- 97,868 -- 198,387
Other expenses (121,566) 159,710 (689,951) 374,414
Abandonment of leasehold improvements -- 1,023,522 -- 1,023,522
-------------- -------------- -------------- --------------
Total expenses 1,698,797 4,236,686 3,057,293 8,014,809
-------------- -------------- -------------- --------------
Net loss ($ 668,120) ($ 1,596,173) ($ 484,860) ($ 2,553,989)
============== ============== ============== ==============
Basic and diluted loss per common share ($ 0.03) ($ 0.12) ($ 0.02) ($ 0.20)
============== ============== ============== ==============
Weighted average shares outstanding 23,160,019 12,917,694 21,730,596 12,851,698
============== ============== ============== ==============
See notes to condensed consolidated financial statements
6
A.B. WATLEY GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended
March 31,
2005 2004
----------- -----------
Cash flows from operating activities:
Net Loss ($ 484,860) ($2,553,989)
Adjustments to reconcile net loss to net cash (used in)
operating activities:
Non-cash compensation and service costs
Options costs -- 9,334
Amortization of debt discount in connection with
issuance of warrants and subordinated debt -- 91,241
Amortization of finance charge in connection with
notes payable -- 37,500
Deferred compensation costs 119,620 --
Depreciation and amortization -- 198,386
Loss on abandonment of leasehold improvements -- 1,023,522
Changes in assets and liabilities:
(Increase) decrease in operating assets:
Receivables from clearing brokers 265,034 (18,547)
Securities owned -- 1,309,145
Loans receivable from related party -- 14,500
Security deposits -- 30,000
Other assets (36,405) 5,394
Increase (decrease) in operating liabilities:
Accounts payable and accrued liabilities (655,166) 458,798
Payable to clearing broker (60,462) (1,000,475)
Securities sold, not yet purchased -- (28,010)
----------- -----------
Net cash used in operating activities ($ 852,239) ($ 423,201)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of warrants $ 64,501 $ --
Exercise of stock options 1,103 --
Proceeds from notes payable - other -- 1,950,000
Repayment of notes payable - other -- (1,455,131)
Proceeds from subscription receivable 757,946 --
Capital distribution to LLC Class B members (5,360) (45,000)
----------- -----------
Net cash provided by financing activities $ 818,190 $ 449,869
----------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (34,049) 26,668
Cash and cash equivalents at beginning of period 182,929 41,296
----------- -----------
Cash and cash equivalents at end of period $ 148,880 $ 67,964
=========== ===========
SUPPLEMENTAL NON-CASH FINANCING ACTIVITIES AND DISCLOSURE
OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 17,500 $ 17,500
Taxes -- --
SUPPLEMENTAL NON-CASH FINANCING ACTIVITIES AND DISCLOSURE OF
CASH FLOW INFORMATION:
Issuance of stock in payment of liability $ 52,000 --
Issuance of common stock for financing charge in connection with notes payable -- $ 87,500
Issuance of common stock in connection with employment agreement $ 600,000 --
7
A.B. WATLEY GROUP INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND BUSINESS
A.B. Watley Group Inc. ("ABWG" or the "Company") is a U.S. public corporation
organized as a Delaware corporation on May 15, 1996 under the name Internet
Financial Services, Inc. On August 27, 1999 the Company changed its name to A.B.
Watley Group Inc. The Company presently conducts its business primarily through
its subsidiary A.B. Watley Direct, Inc. ("Direct"). Direct is a registered
broker-dealer with the Securities and Exchange Commission ("SEC"), and a member
of the National Association of Securities Dealers, Inc. Direct is an introducing
broker-dealer, conducting business in electronic trading, information and
brokerage services and execution services for institutional customers. Direct
clears all transactions through clearing brokers on a fully disclosed basis.
Accordingly, Direct is exempt from Rule 15c3-3 of the Securities and Exchange
Act of 1934.
Effective October 12, 2004, the Company was relisted on the OTC Bulletin Board
under the symbol "ABWG".
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America (GAAP) and reflect all normal recurring adjustments
which are, in the opinion of management, necessary for a fair presentation of
the results for the interim periods presented. Pursuant to the rules and
regulations of the SEC, certain footnote disclosures, which are normally
required under GAAP, have been omitted. It is recommended that these condensed
consolidated financial statements be read in conjunction with the audited
consolidated financial statements included in the Company's Annual Report on
Form 10-KSB for the year ended September 30, 2004. The results of operations for
any interim period are not necessarily indicative of results for the full year.
Certain prior period amounts have been reclassified to conform to the current
period presentation.
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities is comprised of the following:
-------------- -------------
March 31, 2005 September 30,
(Unaudited) 2004
-------------- -------------
Commissions, floor brokerage and clearing costs $ 956,516 $ 1,809,805
Compensation 1,590,625 1,089,776
Communications 1,342,898 1,533,294
Business development 136,582 87,690
Professional fees 821,181 978,933
Occupancy, equipment and leases 1,453,713 1,133,243
Information technology 1,371,846 1,236,425
Legal 437,334 600,000
Accrued interest 555,161 491,885
Other 543,919 955,889
------------- -------------
$ 9,209,775 $ 9,916,940
============= =============
USE OF ESTIMATES
The preparation of the unaudited condensed consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the condensed consolidated financial statements
and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
8
ACCOUNTS PAYABLE SETTLEMENTS
During the three and six month periods ended March 31, 2005, the Company settled
outstanding balances with certain vendors for less than the amount that had
previously been accrued by the Company. Such settlements, in addition to
adjustments to amounts owed to certain vendors, resulted in a net benefit in the
amount of approximately $165,000 and $862,000 for the three and six month
periods ended March 31, 2005, respectively, which is included in "Other
Expenses" in the accompanying Condensed Consolidated Statements of Operations.
EQUITY-BASED COMPENSATION
As permitted under Statement of Financial Accounting Standards ("SFAS") No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure", which
amended SFAS No. 123, "Accounting for Stock Based Compensation", the Company has
elected to continue to follow the intrinsic value method in accounting for its
stock-based compensation arrangements as defined in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees", and the related
interpretations including Financial Accounting Standards Board Interpretation
No. 44, "Accounting for Certain Transactions Involving Stock Compensation", an
interpretation of APB No. 25. No stock-based employee compensation cost is
reflected in operations, as all options granted to the Parent to employees of
the Company under those plans has an exercise price equal to or greater than the
market value of the underlying common stock at the date of grant.
The following table illustrates the effects on net income as if the Company had
applied the fair value recognition provisions of SFAS No. 123 to stock-based
employee compensation:
Three Months Ended March 31, Six Months Ended March 31,
-------------------------- --------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Net loss ($ 668,120) ($1,596,173) ($ 484,860) ($2,553,989)
Deduct: Total stock-based employee
compensation expense determined
under the fair value method (394,913) (139,256) (454,574) (157,579)
----------- ----------- ----------- -----------
Pro forma net loss ($1,063,033) ($1,735,429) ($ 939,434) ($2,711,568)
----------- ----------- ----------- -----------
Basic and diluted loss per
common share as reported ($ 0.03) ($ 0.12) ($ 0.02) ($ 0.20)
----------- ----------- ----------- -----------
Pro forma loss per
common share - basic and diluted ($ 0.05) ($ 0.13) ($ 0.04) ($ 0.21)
----------- ----------- ----------- -----------
The Company follows SFAS No. 128, Earnings Per Share, which provides for the
calculation of "basic" and "diluted" earnings per shares ("EPS"). Basic EPS
includes no dilution and is computed by dividing income or loss available to
common stockholders by the weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that could occur
through the effect of common shares issuable upon exercise of stock options and
warrants. Potential common shares amounted to 21,448,938 and 15,400,954,
respectively as of March 31, 2005 and 2004, respectively, and were not included
in the computation of diluted EPS since the effect would be anti-dilutive.
On March 15, 2005, the Company modified the terms of 6,845,000 existing options
by fully accelerating the vesting period for these options. All other terms and
the exercise prices of the options remain the same.
In January 2005 we issued 1,300,000 stock options to the then president of our
subsidiary, A.B. Watley Direct, Inc. Each option has an exercise price of $.20
per share (the fair value of each option was approximately $.12).
The fair value of each option grant was estimated at the date of grant using the
Black-Scholes option valuation model. The Black-Scholes option valuation model
was developed for use in estimating the fair value of traded options which have
no vesting restrictions and are fully transferable. Because the Company's stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value estimate of
its stock options. In calculating the fair values of the stock options, the
following assumptions were used:
9
Six Months Ended March 31,
------------------------
2005 2004
---------- ----------
Dividend yield 0% 0%
Weighted average expected life:
Employees: 10.0 years 10.0 years
Non-employees: 10.0 years --
Weighted average risk-free rate 4.52% 4.21%
Expected volatility 416% 109%
FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the Company's financial instruments are carried at fair
value or at amounts approximating fair value.
BUSINESS DEVELOPMENT
The Company expenses all promotional costs as incurred. Advertising production
costs are expensed when the initial advertisement is run. Costs of advertising
are expensed as the services are received. Substantially all business
development costs relate to trade show attendance and exhibits.
INCOME TAXES
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
RECENT ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board ("FASB") finalized
FAS No. 123R "Share-Based Payment" ("FAS 123R"), amending FAS No. 123, effective
beginning the first quarter of fiscal 2006. FAS 123R will require the Company to
expense stock options based on grant date fair value in the condensed
consolidated financial statements. Further, the adoption of FAS 123R will
require additional accounting related to the income tax effects and additional
disclosure regarding the cash flow effects resulting from share-based payment
arrangements. The effect of expensing stock options on the results of operations
using a Black-Scholes option pricing model is presented in Note 2. The adoption
of FAS 123R which is effective for annual periods beginning October 1, 2006, is
not expected to have a material effect on the Company's financial statements.
In December 2004, the FASB issued FAS No. 153, "Exchanges of Nonmonetary Assets
- - an amendment of APB Opinion No. 29 ("FAS 153"). This statement amends APB
Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary exchange
has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The provisions of FAS 153 are
effective for the Company's fiscal year ending September 30, 2006. The adoption
of FAS 153 is not expected to have a material impact on the Company's condensed
consolidated financial position, liquidity or results of operations.
10
GOING CONCERN
The Company has continued to incur consolidated net losses and negative cash
flows from operations. Additionally, the Company has significant deficits in
both working capital and stockholders` equity. These factors raise substantial
doubt about the Company`s ability to continue as a going concern. The condensed
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty. As a result, management of ABWG may
seek to raise additional capital from time to time to fund operations through
private placements of equity or debt instruments. There can be no assurance that
any of these alternatives will be successful.
3. NET CAPITAL REQUIREMENTS
Direct is subject to the SEC's Uniform Net Capital Rule ("Rule 15c3-1"). In
accordance with this rule, Direct is required to maintain defined minimum net
capital equal to the greater of $5,000 or 6-2/3% of aggregate indebtedness as
defined. As of March 31, 2005, Direct had net capital of $63,529 which was
$50,875 in excess of its minimum requirement.
4. FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK AND CONCENTRATIONS OF
CREDIT RISK
Pursuant to clearance agreements, the clearing and depository operations for the
Company and its customers' securities transactions are provided by clearing
broker-dealers. The Company earns commissions as an introducing broker for the
transactions of its customers. In the normal course of business, the Company's
customer activities involve the execution and settlement of various customer
securities transactions. These activities may expose the Company to
off-balance-sheet risk in the event the customer or other broker is unable to
fulfill its contracted obligations and the Company has to purchase or sell the
security underlying the contract at a loss.
The Company's customer securities are transacted on either a cash or margin
basis. In margin transactions, the clearing broker extends the credit to the
Company's customers, subject to various regulatory margin requirements,
collateralized by cash and securities in the customers' accounts. However, the
Company is required to contact the customer and to either obtain additional
collateral or to sell the customer's position if such collateral is not
forthcoming. The Company is responsible for any losses on such margin loans, and
has agreed to indemnify its clearing brokers for losses that the clearing
brokers may sustain from the customer accounts introduced by the Company.
The Company seeks to control the risks associated with these activities by
reviewing the credit standing of each customer and counterparty with which it
does business. Further, working with the clearing brokers, it requires customers
to maintain margin collateral in compliance with various regulatory and internal
company policy guidelines. The clearing brokers monitor required margin levels
daily and, pursuant to such guidelines, request customers to deposit additional
collateral or reduce securities positions when necessary. The Company's exposure
to these risks becomes magnified in volatile markets. As of March 31, 2005, the
Company has provided a reserve for uncollectible receivables from clearing
brokers in the amount of $1,166,777. There was no bad debt expense incurred by
the Company for the three and six month periods ended March 31, 2005.
The Company may at times maintain positions in equity securities on both a long
and short basis. While long positions represent the Company's ownership of
securities, short positions represent obligations of the Company. Accordingly,
both long and short positions may result in gains or losses to the Company as
market values of securities fluctuate. To manage the risk of losses, the Company
marks long and short positions to market daily and continuously monitors the
market fluctuations.
11
5. NOTES AND LOANS PAYABLE
The Company's outstanding obligation under notes and loans payable as of March
31, 2005 and September 30, 2004 was as follows:
NOTES PAYABLE - FORMER OFFICER
Principal Interest
Effective Date Maturity Date Amount rate
- -------------- ------------- --------- --------
October 1, 2001 On Demand $500,000 10%
February 2, 2002 On Demand 200,000 10%
--------
$700,000
========
The former officer has requested repayment of the notes payable. The Company
paid $75,829 of accrued interest in October 2004 and has not made any other
payments on the notes. As of March 31, 2005 and September 30, 2004, accrued
interest on these Notes Payable - Former Officer amounted to $177,643 and
$218,472, respectively, which is included in Accounts Payable and Accrued
Liabilities in the accompanying Condensed Consolidated Statements of Financial
Condition.
On December 23, 2003, the Company borrowed $1,800,000 from a third party at the
rate of 20% per annum. On January 16, 2004 the Company repaid the $1,800,000.
Subsequently, during January and February 2004, the Company borrowed an
additional $307,500 from the same third party at the rate of 20% per annum. The
note is due on demand. As of March 31, 2005 and September 30, 2004, $94,388 and
$40,619, respectively, of interest has accrued on this note and is included in
Accounts Payable and Accrued Liabilities in the accompanying Condensed
Consolidated Statements of Financial Condition.
6. SUBORDINATED BORROWINGS
At March 31, 2005 and September 30, 2004, subordinated borrowings consisted of
$2,971,260 of subordinated notes payable to general creditors as follows:
Amount Interest Rate Maturity
------------ ------------- ---------------
$ 2,441,260 7% Matured
125,000 12% October 31, 2006
55,000 0% October 31, 2006
200,000 15% October 31, 2006
150,000 13% October 31, 2006
------------
$ 2,971,260
============
In March 2003, the holder of the $5 million secured demand note (the
"Noteholder") demanded repayment of the note. On March 31, 2003, we filed a NASD
Arbitration Demand and a Statement of Claim with the NASD Dispute Resolution
office. The arbitration sought to enforce the provisions of the secured demand
note agreement and to prevent premature withdrawal by the lender. In April 2004,
the parties agreed to discontinue the arbitration without prejudice pursuant to
a settlement agreement that provided for the repayment of approximately $2.9
million (which was repaid in April 2004) of the $5 million original secured
demand note. On June 4, 2004 the Noteholder sent us a notice of default alleging
that we did not meet certain of our obligations under the terms of the
settlement agreement. In June 2004, the note matured and we have not paid the
remaining balance or received an extension of the maturity date. The remaining
principal and interest balances payable at March 31, 2005, as set forth in our
condensed consolidated financial statements, were $2,441,260 and $283,130
respectively.
7. STOCKHOLDERS' DEFICIT
Effective October 12, 2004, we retained Sichenzia to represent us in the action
titled Dover Limited and Wendy Sui Cheng Yap v. A.B. Watley Inc., Robert Malin,
Keith Sorrentino, John Coakley, Alain Assemi and John J. Amore (Case No.: 04 CV
7366) as filed in the United States District Court, Southern District of New
York. In connection therewith, we paid Sichenzia an initial retainer of $10,000
and issued an aggregate of 1,000,000 shares of our common stock to designated
partners of Sichenzia. In the event we pay all Sichenzia invoices related to
this matter within 30 days of issuance, the 1,000,000 shares will be returned to
us for cancellation. If we fail to do so, the shares will be retained and the
proceeds from sales thereof will be applied to all of the outstanding and
current balances due by us to them. Any excess will be applied to additional
fees incurred, if any. Any remaining proceeds after that will be retained by the
share recipients.
12
In October 2004, we issued an aggregate of 300,000 shares of our common stock to
three persons with respect to legal and other services rendered and 100,000
shares to an affiliate of our legal counsel in return for services provided in
connection with a debt conversion. The impact of these issuances was a reduction
in Accounts Payable and Accrued Liabilities in the amount of $52,000, a $400
credit to Common Stock and $51,600 credit to Additional Paid-in Capital.
On December 31, 2004, the holder of 2,050,000 common stock purchase warrants,
each exercisable for one share of our common stock at an exercise price of $.01
per share, exercised these warrants resulting in proceeds of $20,500. The same
holder entered into a Warrant Amendment Agreement with us on December 31, 2004
whereby the holder paid us $44,002, and agreed to terminate 311,497 warrants
held by it with exercise prices ranging from $2.9333 to $3.686 in exchange for
our revising the terms of the 4,400,158 remaining warrants held by the holder.
The revisions included a reduction in the exercise price of the warrants from
$.01 to $.001 and the addition of restrictions related to the timing and amount
of warrants that the holder could exercise.
On March 8, 2005, the Company entered into a 1 year Consulting Agreement with
Blue Marble Investments, Ltd. ("Blue Marble") pursuant to which Blue Marble will
provide the Company with public relations services, and sales, marketing and
general corporate advice. In consideration of the March 8, 2005 Consulting
Agreement with Blue Marble, the Company issued 3,000,000 common stock purchase
warrants to Blue Marble, each to purchase one share of the Company's common
stock at a price of $0.01 per share at any time during the 10 year period
commencing March 8, 2006. The Company will record a charge to operations for the
fair value of the warrants over the two year term of the consulting agreement.
Pursuant to the Company's March 21, 2005 Employment Agreement with John G.
Hewitt (see Note 8), the Company issued 5,000,000 shares of common stock on
March 21, 2005. In addition, the Company agreed to issue 7,500,000 common stock
purchase warrants to Mr. Hewitt, each to purchase one share of the Company's
common stock at any time during the 10 year period commencing March 21, 2005.
2,000,000 of the warrants have an exercise price of $0.05 per share and vest
when and if the Company achieves a cumulative net profit during the term of the
Employment Agreement of $1,500,000 or more. 2,000,000 of the warrants have an
exercise price of $0.20 per share and vest when and if the Company achieves a
cumulative net profit during the term of the Employment Agreement of $4,500,000
or more. 2,000,000 of the warrants have an exercise price of $0.40 per share and
vest when and if the Company achieves a cumulative net profit during the term of
the Employment Agreement of $7,500,000 or more. 1,500,000 of the warrants have
an exercise price of $0.40 per share and vest when and if the Company achieves a
cumulative net profit during the term of the Employment Agreement of $10,500,000
or more. Subject to earlier forfeiture, as provided in the Employment Agreement,
in the event the cumulative net profit target of $10,500,000 is not achieved on
or before March 31, 2009, all non-vested warrants will be forfeited.
On May 17, 2005, the Company notified Mr. Hewitt that the Employment Agreement
was being terminated for cause. This had the effect of terminating the 7,500,000
common stock purchase warrants issued under the Employment Agreement. The
Company intends to seek the return of the 5,000,000 compensation shares for
cancellation. The Company has yet to determine the effect of the forgoing on its
financial statements.
On March 29, 2005, the holder of 1,103,090 common stock purchase warrants, each
exercisable for one share of our common stock at an exercise price of $.001 per
share, exercised these warrants resulting in proceeds of $1,103.
In July 2004 we sold 5,000,000 shares in a private placement transaction for
$2,000,000. Payment for the shares was to be made in installments with the final
payment due April 1, 2005. To date, we have received an aggregate of $1,571,837
from the subscribers. The subscribers are in default of their payment
obligation. The Company expects to receive the balance due form the subscribers
prior to fiscal 2005 year end.
13
On April 7, 2005, the Board of Directors of the Company amended its Certificate
of Incorporation in order to increase the number of authorized $0.001 par value
shares of common shares from 50,000,000 common shares to 500,000,000 common
shares.
In May 2005, the Company issued 500,000 shares of common stock in connection
with a settlement agreement for prior legal services performed.
8. COMMITMENTS AND CONTINGENCIES
LATE FILINGS
The Company has not filed its tax returns for the years ended September 30,
2004, 2003, 2002 & 2001.
LEASE AGREEMENTS
Until June 2004, the Company's principal offices were located at 40 Wall Street,
New York, NY at an annual cost of approximately $920,000 per year, plus
escalations. The initial term of the lease for such office space expired in June
2009. The Company's previous landlord, 40 Wall Street, LLC, commenced two
separate landlord/tenant proceedings seeking money judgments and orders of
eviction against the Company. Both proceedings have been settled whereby the
Company vacated a portion of the premises in March 2004 and the remaining
portion in June 2004. The Company has signed a confession of judgment for
$609,441 and the landlord is seeking a money judgment for all rent arrears (a
provision has been provided in the condensed consolidated financial statements).
The Company is in default of making the minimum payments required under certain
of its capital lease agreements. The Company is in the process of negotiating
settlements with such vendors which is not expected to have a material effect on
the condensed consolidated financial statements.
The Company presently occupies approximately 8,900 square feet at 90 Park
Avenue, 26th Floor, New York, NY 10016 pursuant to an arrangement with the
lessee, a related party (principals) to the Company, of the space. The term of
the lease expires on May 31, 2014. AB Watley Direct, Inc. has guaranteed the
full and timely performance of all obligations of the lessee under the lease.
The lease provides for the payment of an annual base rental, together with
lessee's proportionate share of building operating expenses including taxes. As
the lease contains certain rent escalations provisions, in accordance with
generally accepted accounting standards, the Company has elected to
straight-line its monthly rent expense of $33,125 over the term of the lease and
has recorded a deferred rent liability in the amount of $37,082 as of March 31,
2005, which is included in Accounts Payable and Accrued Liabilities in the
accompanying Condensed Consolidated Statements of Financial Condition. Under the
arrangement, the Company occupies approximately 95% of the leased space and pays
a proportionate amount of the lease payments.
The aggregate minimum future rental payments are as follows:
Fiscal Year Ended
-----------------
2005 $ 205,613
2006 349,550
2007 348,057
2008 390,503
2009 390,503
Thereafter 2,156,257
----------
$3,840,484
==========
Rent expense for the three and six months ended March 31, 2005 was $107,360 and
$334,912, respectively.
14
EMPLOYMENT AGREEMENTS
Effective March 21, 2005, the Company entered into a two year employment
agreement (the "Employment Agreement") with John G. Hewitt pursuant to which Mr.
Hewitt is serving as the Company's Chief Executive Officer and is also serving
as the President and Chief Executive Officer for the Company's wholly owned
subsidiary, A.B. Watley Direct, Inc. The term of the agreement is extendable for
additional one year periods at the mutual discretion of the parties. The
Employment Agreement provides for the payment of a base annual salary of
$250,000 to Mr. Hewitt together with 5,000,000 shares of the Company's
restricted common stock (the "Compensation Shares") and 7,500,000 common stock
purchase warrants (the "Compensation Warrants"). The warrants are subject to
anti-dilution. Mr. Hewitt is further entitled to participate in our proposed
employee bonus pool which may be funded with up to 25% of our annual net profit,
if any, for the twelve month periods commencing April 1, 2005. In the event the
Employment Agreement is terminated by Mr. Hewitt for "good reason", as such term
is defined therein, or is terminated by us "without cause", as such term us
defined therein, we are obligated to pay Mr. Hewitt all of the base salary due
for the remainder of the term. Further, in the event of termination for "good
reason", "without cause" or as the result of the death or disability of Mr.
Hewitt, all of the Compensation Warrants will be given the opportunity to vest
for the remainder of the term, and at the end of the term all non-vested
Compensation Warrants will be cancelled. In the event that during the first year
of the term, Mr. Hewitt terminates the Employment Agreement for other than "good
reason" or we terminate the Employment Agreement "with cause" Mr. Hewitt will be
required to return the Compensation Shares to us for cancellation. Further, in
the event of a termination at any time by Mr. Hewitt for other than "good
reason" or by us "for cause" all of the Compensation Warrants shall become
immediately void and of no further effect.
During the year ended September 30, 2002, the Company entered into employment
agreements with two key executives. The total remaining compensation commitment
under these three agreements is as follows:
Fiscal Year Ended
September 30,
-----------------
2005 $ 275,000
2006 $ 250,000
2007 $ 125,000
----------
$ 650,000
==========
LITIGATION
The Company's business involves substantial risks of liability, including
exposure to liability under federal and state securities laws in connection with
claims by dissatisfied clients for fraud, unauthorized trading, churning,
mismanagement, and breach of fiduciary duty, as well as in connection with the
underwriting or distribution of securities. In recent years, there has been an
increasing incidence of litigation involving the securities industry, including
class actions which generally seek rescission and substantial damages.
In the ordinary course of business, the Company is, and may become, a party to
legal proceedings or arbitration. Except as described below, the Company is not
a party to any material legal proceedings or arbitrations.
In 2004, the Company learned that the Securities and Exchange Commission staff
was conducting a formal order investigation. While the exact scope of the SEC
investigation is uncertain, it appears that the Commission is investigating
trading activities that may have occurred on the Company's premises. The
Company, along with certain officers and our directors, has been subpoenaed and
provided testimony to the Commission in connection with the investigation. The
Company and its officers, directors and subsidiaries will continue to cooperate
with the Commission's investigation. At this time, the Company is unable to
determine the outcome of the investigation.
15
The NASD has advised us and certain of our officers and former employees that it
intends to recommend the commencement of a disciplinary enforcement proceeding
in connection with alleged violations of certain securities rules and
regulations. Specifically, the contemplated charges relate to Late Trading and
Market Timing with respect to the trading of mutual funds in violation of
Section 17(a) of the Securities Act of 1933, Section 10(b) of the Exchange Act
of 1934, and Rule 10b-5 thereunder, as well as NASD Conduct Rules 2110 and 2120.
As of the present time, the action has not been filed. If commenced, we intend
to vigorously defend the action.
The Company is a defendant in an action titled Michael Fielman v. A.B. Watley,
Inc. and A.B. Watley Group Inc., which was filed in the Supreme Court of the
State of New York, County of Nassau, Index No. 012082/02. This is an action for
unpaid wages seeking $28,657, plus statutory damages, costs, and attorneys'
fees. This matter had been settled in the amount of $34,658 payable on an
installment basis of eight (8) months (a provision has been provided for in the
condensed consolidated financial statements). The Company is in default of the
settlement agreement and is currently paying the full amount due including
liquidated damages of 25% and attorneys fees of $10,000, totaling $53,322, of
which $41,928 has been paid as of March 31, 2005.
The Company is a defendant in an action titled Hartman & Craven LLP v. A.B.
Watley, Inc. and A.B. Watley Group Inc., which was filed in the Supreme Court of
the State of New York, County of New York, Index No.: 109502/03. Plaintiff has
filed a Complaint against, amongst others, A.B. Watley Group Inc. and A.B.
Watley, Inc. for damages in the amount of $352,574, plus accrued interest
thereon, for unpaid legal fees (a provision has been provided for in the
condensed consolidated financial statements). A.B. Watley Group Inc. and A.B.
Watley, Inc. deny liability, in part, and have asserted a counterclaim for
malpractice and breach of contract for unspecified damages. At this point, it is
difficult to determine the amount, if any, that A.B. Watley Group Inc. and A.B.
Watley Inc. may be held liable for. Plaintiff has filed a motion for summary
judgment, which has been fully submitted and briefed before the Court. The Court
granted the motion in part and denied the motion in part. The parties are
awaiting an executed judgment and are conducting pre-trial discovery. The
parties are currently in settlement discussions, the outcome of which cannot be
determined.
The Company is defendant in an action titled Hyperfeed Technologies, Inc. v.
A.B. Watley Group Inc., filed in the Supreme Court of the State of New York,
County of New York, Index No. 111538/03. Plaintiff has domesticated an
out-of-state judgment against A.B. Watley Group Inc. in the amount of $180,503
(a provision has been provided for in the condensed consolidated financial
statements). The parties have reached an agreement whereby the Company will pay
a total $205,000 to be paid in installments of $5,000 a month. As of March 31,
2005 the Company has paid $15,000 towards the judgment.
The Company is respondent in an arbitration titled Steven Messina, Brian Kelly,
and Thomas Messina v. A.B. Watley, Inc., NASD Arbitration No. 02-04649.
Claimants filed this action against A.B. Watley, Inc. in August 2002 seeking
actual damages consisting of unpaid commissions of approximately $147,000 (a
provision has been provided for in the condensed consolidated financial
statements). A.B. Watley, Inc. denies all wrongdoing in connection with this
matter, and has asserted a counterclaimfor $608,000 against Claimants for
breaches of contract and fiduciary duties. A.B. Watley, Inc. intends to
vigorously defend this matter and prosecute its counterclaim.
The Company is defendant in an action titled Pentech Financial Services, Inc. v.
A.B. Watley Group Inc., Supreme Court of the State of New York, County of New
York, Index No. 02-126759. Plaintiff filed a complaint against A.B. Watley Group
Inc. for an alleged breach of a lease agreement. On May 28, 2003, Plaintiff
obtained a judgment in the amount of $465,584 plus interest accrued thereon (a
provision has been provided for in the condensed consolidated financial
statements). A.B. Watley Group Inc. executed a settlement agreement with
Plaintiff for a total settlement of $522,584 payable on an installment basis.
A.B. Watley Group Inc. is currently in default of the settlement agreement. The
parties are currently in settlement discussions, the outcome of which cannot be
determined.
The Company's principal offices were formerly located at 40 Wall Street, New
York, New York at an annual cost of approximately $920,000 per year, plus
escalations. The Company's previous landlord, 40 Wall Street, LLC, commenced two
separate landlord/tenant proceedings seeking money judgments and orders of
eviction against the Company. Both proceedings have been settled whereby the
Company vacated a portion of the premises in March 2004 and the remaining
portion in June 2004. The Company has signed a confession of judgment for
$609,441 (a provision has been provided for in the condensed consolidated
financial statements) and the landlord has entered that money judgment
representing rent arrears. In connection with landlord's attempted enforcement
of such money judgment, landlord's counsel has served a motion seeking to
conduct discovery, including a deposition and information subpoena. The Company
has complied with all necessary discovery requests by providing a copy of the
Company's Quarterly financial statement, but the Court will likely order that
additional discovery be provided.
16
The Company is defendant is an action titled W.B. Wood & Co., Inc. v. A.B.
Watley Group, Inc. and A.B. Watley, Inc. and A.B. Watley Direct, Inc., Index
No.: 10189-2004. Plaintiff has filed a Complaint against the Company and its
subsidiaries in the amount of $85,642 for breach of a residential and equipment
lease contract (a provision has been provided for in the condensed consolidated
financial statements). The Company did not respond to the Complaint and
Plaintiff filed a motion for a default judgment, which the firm is currently
opposing. The Company denies liability and intends to vigorously defend this
matter.
The Company is defendant in an action titled Siemens Financial Services, Inc.
f/k/a Siemens Credit Corporation v. A.B. Watley Group Inc., Supreme Court of the
State of New York, County of New York, Index No. 603769/2002. This action is for
damages arising out of the breach of a contract. Plaintiff seeks damages of
approximately $215,000 and has a judgment against A.B. Watley Group Inc. in the
amount of $179,883 with interest accrued thereon from July 10, 2003 (a provision
has been provided for in the condensed consolidated financial statements).
Plaintiff is presently conducting post-judgment discovery.
The Company is defendant in an action titled Peter Wigger v. A.B. Watley Group
Inc., Supreme Court of the State of New York, County of New York, Index No.
604124/02. Plaintiff filed a complaint alleging breach of a commission agreement
and unpaid wages due and owing. Plaintiff seeks damages in the amount of
$398,750 plus interest accrued thereon. Plaintiff has filed a motion for summary
judgment on his claims. In March 2005, the parties reached a settlement, which
contemplates a total payment of $322,927 to Plaintiff over the course of 16
months (a provision has been provided for in the condensed consolidated
financial statements). The Company has paid $84,000 of this amount.
The Company is defendant in an action titled Lehr Construction Corp. v. A.B.
Watley Group Inc., Supreme Court of New York, County of New York, Index No.
600276/02. This action is for damages arising out of the alleged breach of a
construction contract. Plaintiff sought damages of approximately $233,794. On
March 6, 2003, the parties reached a settlement in which the Company consented
to a judgment in the amount of $295,857, less any payments made by the Company,
and the parties simultaneously entered into a Forbearance Agreement (the
"Agreement"), which set forth a payment schedule for the Company. The Company
has defaulted under the payment schedule, and Plaintiff has entered a judgment
against the Company for the remaining balance due thereunder, $173,357 (a
provision has been provided for in the condensed consolidated financial
statements). Further, under the Agreement, Plaintiff is entitled to interest on
the amount outstanding and its reasonable attorney's fees for collecting upon
the Judgment. As of December 13, 2004, Plaintiff stated that the total judgment,
interest and attorney's fees due are $249,610. On or about December 14, 2004,
Plaintiff served a restraining notice upon the Company. As a result of the
Company's default under a payment schedule under a prior Forbearance Agreement,
on March 1, 2005, the Company entered into a Second Forbearance Agreement and
new repayment schedule under which the Company agreed to pay $205,000 in cash
and $10,000 in securities to Plaintiff. The Company has paid $145,000 under the
Agreement and satisfied the securities payment under the Agreement. Pursuant to
the payment schedule, the Company is obligated to pay the remaining $60,000
balance in six consecutive monthly installments of $10,000. If the Company makes
the agreed upon payments, Plaintiff will file a Satisfaction of Judgment for the
entire amount of the Judgment against the Company and agrees to waive any
potential claim for failure to comply with Restraining Notices served upon the
Company. However, if the Company defaults under the payment schedule, Plaintiff
may declare a default and enter a judgment for $275,957, together with interest
thereon at the rate of 9% per annum, less any payment made by the Company under
the Agreement. Further, Plaintiff may take immediate steps to enforce the
Judgment.
In March 2003, the holder of the $5 million secured demand note (the
"Noteholder") demanded repayment of the note. On March 31, 2003, the Company
filed a NASD Arbitration Demand and a Statement of Claim with the NASD Dispute
Resolution office. The arbitration sought to enforce the provisions of the
secured demand note agreement and to prevent premature withdrawal by the lender.
In April 2004, the parties agreed to discontinue the arbitration without
prejudice pursuant to a settlement agreement that provided for the repayment of
approximately $2.9 million (which was repaid in April 2004) of the $5 million
original secured demand note. The remaining principal balance payable in the
consolidated financial statements is $2,441,260. The Noteholder agreed that as
long as the Company was not in default of any of its obligations under the
settlement agreement, not to commence any litigation with respect to the
outstanding balance due on the secured demand note prior to December 20, 2004.
On June 4, 2004 the Noteholder sent the Company a notice of default alleging
that it did not meet certain of its obligations under the terms of the
settlement agreement. In June 2004, the note matured and the Company has not
paid the remaining balance or received an extension of the maturity date. At
March 31, 2005 the outstanding principal and interest balances due on the Note
were $2,441,260 and $283,130, respectively.
17
The Company is plaintiff in an action titled A.B. Watley Group Inc. v. John J.
Amore, et al., Supreme Court of the State of New York, County of New York, Index
No. 602993/03. The Company has sued its former CEO who has filed a counterclaim
against the Company. The Company is unable at this time to provide a opinion as
to the likely outcome, nor the potential expense to be incurred.
The Company is defendant in an action titled John J. Amore v. Steven Malin and
A.B. Watley, Inc., Supreme Court of the State of New York, County of New York,
Index No. 603833/03. Plaintiff filed a complaint alleging breach of a contract
against A.B. Watley, Inc. seeking damages in the amount of $500,000 and slander
against Steven Malin, the Company's Chairman, seeking damages in the amount of
$5,000,000. The Company has filed an answer denying all wrongdoing. The Company
denies all wrongdoing in connection with this matter and intends to vigorously
defend this matter.
On December 9, 2004, A.B. Watley, Inc. was notified of an award rendered by an
NASD arbitration panel against A.B. Watley, Inc. for compensatory damages in the
amount of $811,927 (a provision has been provided for in the condensed
consolidated financial statements) to claimant, James B. Fellus, in the case
encaptioned James B. Fellus vs. A.B. Watley, Inc. (NASD Arbitration No.:
03-05526). All other relief sought by claimant (including an award against A.B.
Watley Direct, Inc. and/or A.B. Watley Group, Inc., and for attorneys fees and
punitive damages) was expressly denied. The arbitration involved claims by a
former employee of A.B. Watley, Inc. for alleged breach of contract (all other
claims having been withdrawn by the former employee). The amount awarded
presumably represented damages for alleged non-payment of contractual salary.
A.B. Watley, Inc. intends to move to vacate the award by asserting, among other
things, that the panel manifestly disregarded the undisputed facts and
applicable, well-settled law.
The Company is the respondent in an action titled Dover Limited et al v. A.B.
Watley, Inc. et al., Index No.: 04 Civ. 7366. Plaintiffs filed this complaint
against, among others, the Company, its President, and two employees alleging
six causes of action sounding in securities fraud, common law fraud, conspiracy
to commit fraud, breach of contract and breach of implied covenant of good faith
and fair dealing, and negligent misrepresentation. Plaintiffs are seeking
compensatory damages of $2,994,598 plus punitive damages of $5,000,000,
including costs, interest and attorney's fees. Plaintiff has filed an amended
compliant adding additional claims and parties, including A.B. Watley Group Inc.
and A.B. Watley Direct, Inc. The Company has filed a motion to dismiss the
Amended Complaint and intends to vigorously defend this matter.
The Company is respondent in an arbitration titled Leonard v. A.B. Watley
Direct, Inc. et. al., NASD Arb. No. 05-00070. Claimant filed an NASD Arbitration
against the Company and the Compliance Officer of A.B. Watley Direct, Inc. for
improperly terminating him. Claimant seeks $162,500 in compensatory damages. The
Company denies the allegations in their entirety and submits that the
arbitration is a vindictive attempt at retribution.
The Company is the plaintiff in an action titled A.B. Watley Group, Inc. v.
Baron Investigation Inc., Supreme Court of the State of New York, County of
Nassau, Index No. 000791/05. In this case, the Company sued Baron for, among
other things, negligence with respect to its background investigation of John J.
Amore, the Company's former chief executive officer. The Company is seeking in
excess of $10,000,000 in damages. Baron filed its answer denying the Company's
substantive allegations. At this juncture, it is impossible to provide an
opinion as to the likely outcome, nor the potential expense to be incurred.
In February 2005, the Company received a demand notice for payment of notes
issued to a former officer. The demand notice requested payment of the $700,000
notes payable to former officer recorded on the statement of financial condition
and payments for two other notes notice totaling $436,845 (a provision has been
provided for in the consolidated financial statements).
18
In addition to the foregoing, in the ordinary course of business, the Company
and its principals are, and may become, a party to legal or regulatory
proceedings commenced by the NASD, the SEC or state securities regulators
relating to compliance, trading and administrative problems that are detected
during periodic audits and inspections or reported by dissatisfied customers.
Such matters, if pursued by such entities, could rise to the level of
disciplinary action. Except as set forth herein, the Company is not currently
involved in any proceeding by a governmental agency or self-regulatory
organization, the outcome of which could have a material adverse effect on our
business. There can be no assurance that one or more disciplinary actions, if
decided adversely against us, would not have a material adverse effect on our
business, financial condition and results of operations.
9. INCOME TAXES
Deferred income taxes reflect the tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. The effects of temporary
differences that give rise to deferred tax assets at March 31, 2005, are
principally the result of net operating carryforwards. At March 31, 2005, the
Company had a net operating loss carry forward for federal, state and local tax
purposes of approximately $74.6 million that will begin to expire no sooner than
September 30, 2013.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
reversal of deferred tax assets, projected future taxable income and tax
planning strategies in making this assessment. Based upon the level of
historical taxable income and projections for future taxable income over the
period for which the deferred tax assets are deductible, management believes it
is more likely than not that the Company will not realize the benefits of these
deductible differences, and thus a 100% valuation allowance of theses benefits
($29.4 million) was established. Certain of such net operating loss benefits may
be limited as a result of a change of control.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our financial condition and results of operations
should be read in conjunction with our condensed consolidated financial
statements and notes thereto included herein. Our results of operations for
interim periods are not necessarily indicative of the results for the entire
fiscal year.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2004
REVENUES. Total revenues for the three months ended March 31, 2005 were
$1,101,781 a decrease of $1,866,524 or 63%, as compared to revenues of
$2,968,305 for the three months ended March 31, 2004. This decrease in revenue
is attributable to the decrease in commission revenue and principal trading
revenue. We ceased principal trading in January 2004.
Commissions: For the three months ended March 31, 2005, we earned commission
revenues of $876,140 representing a 50% decrease as compared to commission
revenues of $1,752,534 for the three months ended March 31, 2004. This decrease
in commission revenues is due to a decrease in overall trading volume.
Data Service Fees: Revenues from data service fees for the three months ended
March 31, 2005 were $108,403 as compared to $116,045 for the three months ended
March 31, 2004 representing an decrease of $7,642 or 7%, primarily due to
reductions in the amounts charged to customers for data service fees.
Revenues from Principal Transactions: We ceased proprietary trading in January
2004. We earned revenue of $891,421 from such transactions during the six months
ended March 31, 2004.
Interest and Other Income: Interest and Other Income for the three months ended
March 31, 2005 was $117,238 representing a $91,067, or 44%, decrease as compared
to $208,305 for the three months ended March 31, 2004 primarily due to ECN
rebates received during the three months ended March 31, 2004.
Interest Expense: Interest expense for the three months ended March 31, 2005 and
2004, were $71,104 and $327,792, respectively. The decrease of $256,688, or 78%,
resulted from the decrease in subordinated loans from $5 million as of March 31,
2004 to $2.4 million as of March 31, 2005, and $45,621 of amortization of debt
discount related to the subordinated loan included in the three months ended
March 31, 2004.
Net Revenues: As a result of the foregoing, for the three months ended March 31,
2005 net revenues were $1,030,677 compared to $2,640,513 for the three months
ended March 31, 2004, a decrease of $1,609,836 or 61%. Excluding revenue from
proprietary trading, net revenues decreased $718,415 or 41%. No single customer
or group of customers accounted for 10% or more of our revenues.
20
EXPENSES. Total expenses for the three months ended March 31, 2005 were
$1,698,796, a $2,537,889 or 60% decrease compared to total expenses of
$4,236,686 for the three months ended March 31, 2004. The decrease is
attributable to the following:
Commissions, Floor Brokerage and Clearing Charges: For the three months ended
March 31, 2005 and 2004, we incurred $423,445 and $1,304,732 of Commissions,
Floor Brokerage and Clearing Charges, respectively. The $881,287, or 68%,
decrease in costs represents payments to our clearing and floor brokers who
facilitate security transactions. The reduction in charges is due to the
elimination of the proprietary trading business in January 2004 and the decrease
of commission revenue.
Employee Compensation and Related Costs: Employee Compensation and Related Costs
of $640,462 for the three months ended March 31, 2005 reflects a 48% decrease as
compared to $1,223,332 incurred for such costs during the three months ended
March 31, 2004. This $582,870 decrease is attributable to both the reduction in
the number of administrative personnel and the elimination of compensation paid
to the proprietary trading division.
Communications: Communications expense for the three months ended March 31, 2005
amounted to $104,502, as compared to $107,862 for the three months ended March
31, 2004. This $3,360, or 3% decrease is largely due to the consolidation of
various data lines and obtaining competitive pricing with new vendors.
Business Development: Business Development costs for the three months ended
March 31, 2005 amounted to $42,816, an increase of $65,376 as compared to
($22,560) for the three months ended March 31, 2004. This increase was due to
additional personnel participating in trade shows to solicit new retail
customers.
Professional Services: Professional Services primarily consists of legal,
accounting and consulting costs. For the three months ended March 31, 2005, our
professional services amounted to $495,844 as compared to $33,237 for the three
months ended March 31, 2004, representing an increase of $462,607. This increase
was primarily the result of increased legal fees due to litigation offset by
reduced audit and accounting fees.
Occupancy and Equipment: The costs for Occupancy and Equipment for the three
months ended March 31, 2005 were $113,294 a decrease of $195,689 or 63%,
compared to $308,983 for the three months ended March 31, 2004. The reduction in
Occupancy and Equipment costs is due primarily to the relocation of our offices
from 40 Wall Street to 90 Park Avenue, New York, NY.
Depreciation and Amortization: There was no Depreciation and Amortization
expense for the three months ended March 31, 2005 as we have no fixed assets.
Other Expenses: For the three months ended March 31, 2005, we incurred a
$121,566 benefit in Other Expenses as compared to a $159,710 expense for the
three months ended March 31, 2004. The $281,276 reduction in Other Expenses is
primarily due to a benefit recognized in connection with settlements with
vendors and adjustments in the amount owed to certain vendors in the amount of
approximately $165,000.
21
Net Loss: As a result of the fore-mentioned factors, we incurred a net loss of
$668,120 for the three months ended March 31, 2005 as compared to a loss of
$1,596,173 for the three months ended March 31, 2004.
SIX MONTHS ENDED MARCH 31, 2005 COMPARED TO THE SIX MONTHS ENDED MARCH 31, 2004
REVENUES. Total revenues for the six months ended March 31, 2005 were $2,740,831
a decrease of $3,320,262 or 55%, as compared to revenues of $6,061,093 for the
six months ended March 31, 2004. This decrease in revenue is attributable to the
decrease in commission revenue and principal trading revenue. We ceased
principal trading in January 2004.
Commissions: For the six months ended March 31, 2005, we earned commission
revenues of $2,230,009 representing a 27% decrease as compared to commission
revenues of $3,049,468 for the six months ended March 31, 2004. This decrease in
commission revenues is due to a decrease in overall trading volume.
Data Service Fees: Revenues from data service fees for the six months ended
March 31, 2005 were $215,056 as compared to $257,754 for the six months ended
March 31, 2004 representing an decrease of $42,698 or 17%, primarily due to
reductions in the amounts charged to customers for data service fees.
Revenues from Principal Transactions: We ceased proprietary trading in January
2004. We earned revenue of $2,356,633 from such transactions during the six
months ended March 31, 2004.
Interest and Other Income: Interest and Other Income for the six months ended
March 31, 2005 was $295,766 representing a $101,472, or 26%, decrease as
compared to $397,238 for the six months ended March 31, 2004 primarily due to
ECN rebates received during the six months ended March 31, 2004.
Interest Expense: Interest expense for the six months ended March 31, 2005 and
2004, were $168,398 and $600,273, respectively. The decrease of $431,875, or
72%, resulted from the decrease in subordinated loans from $5 million as of
March 31, 2004 to $2.4 million as of March 31, 2005, and $91,241 of amortization
of debt discount related to the subordinated loan included in the six months
ended March 31, 2004.
Net Revenues: As a result of the foregoing, for the six months ended March 31,
2005 total net revenues were $2,572,433 compared to $5,460,820 for the six
months ended March 31, 2004, a decrease of $2,888,387 or 53%. Excluding revenue
from proprietary trading, net revenues decreased $531,754 or 17%. No single
customer or group of customers accounted for 10% or more of our revenues.
EXPENSES. Total expenses for the six months ended March 31, 2005 were
$3,057,293, a $4,957,516 or 62% decrease compared to total expenses of
$8,014,809 for the six months ended March 31, 2004. The decrease is attributable
to the following:
Commissions, Floor Brokerage and Clearing Charges: For the six months ended
March 31, 2005 and March 31, 2004 we incurred $1,131,493 and $2,478,419 of
Commissions, Floor Brokerage and Clearing Charges, respectively. The $1,346,926,
or 54%, decrease in costs represents payments to our clearing and floor brokers
who facilitate security transactions. The reduction in charges is due to the
elimination of the proprietary trading business in January 2004 and an overall
decrease in trading volume.
22
Employee Compensation and Related Costs: Employee Compensation and Related Costs
of $1,163,517 for the six months ended March 31, 2005 reflects a 55% decrease as
compared to $2,594,465 incurred for such costs during the six months ended March
31, 2004. This $1,430,948 decrease is attributable to both the reduction in the
number of administrative personnel and the elimination of compensation paid to
the proprietary trading division.
Communications: Communications expense for the six months ended March 31, 2005
amounted to $177,716, as compared to $325,721 for the six months ended March 31,
2004. This $148,005, or 45% decrease is largely due to the consolidation of
various data lines and obtaining competitive pricing with new vendors.
Business Development: Business Development costs for the six months ended March
31, 2005 amounted to $64,299, a decrease of $15,031, or 19%, as compared to
$79,330 for the six months ended March 31, 2004. This decrease was due to the
reduction of the amount of advertising in trade publications.
Professional Services: Professional Services primarily consists of legal,
accounting and consulting costs. For the six months ended March 31, 2005, our
professional services amounted to $844,238 as compared to $273,571 for the six
months ended March 31, 2004, representing an increase of $570,667 or 209%. This
increase was primarily the result of increased legal fees due to litigation
offset by reduced audit and accounting fees.
Occupancy and Equipment: The costs for Occupancy and Equipment for the six
months ended March 31, 2005 were $365,981 a decrease of $300,999 or 45%,
compared to $666,980 for the six months ended March 31, 2004. The reduction in
Occupancy and Equipment costs is due primarily to the relocation of our offices
from 40 Wall Street to 90 Park Avenue, New York, NY.
Depreciation and Amortization: There was no Depreciation and Amortization
expense for the three months ended March 31, 2005 as we have no fixed assets.
Other Expenses: For the six months ended March 31, 2005, we incurred a $689,951
benefit in Other Expenses as compared to a $374,414 expense for the six months
ended March 31, 2004. The $1,064,365 reduction in Other Expenses is primarily
due to a benefit recognized in connection with settlements with vendors and
adjustments in the amount owed to certain vendors in the amount of approximately
$862,000.
Net Loss: As a result of the fore-mentioned factors, we incurred a net loss of
$484,860 for the six months ended March 31, 2005 as compared to a loss of
$2,553,989 for the six months ended March 31, 2004.
GOING CONCERN
As indicated by the accompanying unaudited condensed consolidated financial
statements, we have significant deficits in working capital and stockholders'
equity, as well as, negative cash flows from operations. These factors continue
to raise substantial doubt about our ability to continue as a going concern. Our
condensed consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
23
LIQUIDITY AND CAPITAL RESOURCES
To respond to our liquidity and capital resource needs, we have taken, and are
taking, a variety of steps to offset the cash used in operating activities. Such
steps include the sale of five million shares of ABWG common stock in July 2004
for $2 million over two years, cost cutting initiatives, the pursuit of
additional revenue producing activities, and efforts to raise additional funds
through the issuance of debt or equity securities.
Our cost cutting initiatives include reductions in workforce, office relocation
to less costly facilities, reductions in capital expenditures, and renegotiating
clearing corporation agreements at more favorable rates. We are pursuing more
traditional lines of business including attracting active traders and hedge
funds. However, in order to expand our business, respond to competitive
pressures and expand into additional products and services, we have needed to
raise additional funds through the issuance of debt or the sale of common stock.
When funds are raised through the issuance of equity securities or financial
instruments that are convertible into equity securities, our existing
shareholders may experience dilution in their ownership percentage or book
value. In addition, such securities may have rights, preferences and privileges
senior to those of the holders of our common stock. There can be no assurances
that the additional financing will be available when needed and on terms
satisfactory to us.
Direct is currently required to maintain minimum net capital such that the ratio
of aggregate indebtedness to net capital both as defined shall not exceed 15 to
1 under the SEC`s net capital rule. Such rule also prohibits "equity capital",
including the subordinated loans, from being withdrawn or cash dividends from
being paid if our net capital ratio would exceed 10 to 1 or if we would have
less than our minimum required net capital. Accordingly, our ability to repay
the subordinated loans may be restricted under the net capital rule.
NET OPERATING LOSS CARRYFORWARDS
Our net operating loss carryforwards are scheduled to expire beginning in the
year 2013. The issuance of additional equity securities, together with our
recent financing and public offering, could be deemed to result in an ownership
change and thus could limit our use of our net operating losses. If we achieve
profitable operations, any limitations on the utilization of our net operating
losses would have the effect of increasing our tax liability and reducing net
income and available cash reserves.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
reversal of deferred tax assets, projected future taxable income and tax
planning strategies in making this assessment. Based upon the level of
historical taxable income and projections for future taxable income over the
period for which the deferred tax assets are deductible, management believes it
is more likely than not that we will not realize the benefits of these
deductible differences.
24
RECENT ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board ("FASB") finalized
FAS No. 123R "Share-Based Payment" ("FAS 123R"), amending FAS No. 123, effective
beginning the first quarter of fiscal 2006. FAS 123R will require us to expense
stock options based on grant date fair value in the condensed consolidated
financial statements. Further, the adoption of FAS 123R will require additional
accounting related to the income tax effects and additional disclosure regarding
the cash flow effects resulting from share-based payment arrangements. The
effect of expensing stock options on the results of operations using a
Black-Scholes option pricing model is presented in Note 2. The adoption of FAS
123R, which is effective for annual periods beginning October 1, 2006, is not
expected to have a material effect on our financial statements.
In December 2004, the FASB issued FAS No. 153, "Exchanges of Nonmonetary Assets
- - an amendment of APB Opinion No. 29 ("FAS 153"). This statement amends APB
Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary exchange
has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The provisions of FAS 153 are
effective for our fiscal year ending September 30, 2006. The adoption of FAS 153
is not expected to have a material impact on our condensed consolidated
financial position, liquidity or results of operations.
ITEM 3. CONTROLS AND PROCEDURES
Our principal executive officer and principal financial officer evaluated the
effectiveness of our disclosure controls and procedures (as defined in Rule
13a-14(c) under the Securities Exchange Act of 1934) as of the end of the
quarter ended March 31, 2005. Based on this evaluation, our principal executive
officer and principal financial officer have concluded that our controls and
procedures are effective in providing reasonable assurance that the information
required to be disclosed in this report is accurate and complete and has been
recorded, processed, summarized and reported within the time period required for
the filing of this report. Subsequent to the date of this evaluation, there have
not been any significant changes in our internal controls or, to our knowledge,
in other factors that could significantly affect our internal controls.
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Our business involves substantial risks of liability, including exposure to
liability under federal and state securities laws in connection with claims by
dissatisfied clients for fraud, unauthorized trading, churning, mismanagement,
and breach of fiduciary duty, as well as in connection with the underwriting or
distribution of securities. In recent years, there has been an increasing
incidence of litigation involving the securities industry, including class
actions which generally seek rescission and substantial damages.
25
In the ordinary course of business, we are, and may become, a party to legal
proceedings or arbitration. Except as described below, we are not a party to any
material legal proceedings or arbitrations.
In 2004, we learned that the Securities and Exchange Commission staff was
conducting a formal order investigation. While the exact scope of the SEC
investigation is uncertain, it appears that the Commission is investigating
trading activities that may have occurred on our premises. We, along with
certain officers and our directors, have been subpoenaed and provided testimony
to the Commission in connection with the investigation. We and our officers,
directors and subsidiaries will continue to cooperate with the Commission's
investigation. At this time, we are unable to determine the outcome of the
investigation.
The NASD has advised us and certain of our officers and former employees that it
intends to recommend the commencement of a disciplinary enforcement proceeding
in connection with alleged violations of certain securities rules and
regulations. Specifically, the contemplated charges relate to Late Trading and
Market Timing with respect to the trading of mutual funds in violation of
Section 17(a) of the Securities Act of 1933, Section 10(b) of the Exchange Act
of 1934, and Rule 10b-5 thereunder, as well as NASD Conduct Rules 2110 and 2120.
As of the present time, the action has not been filed. If commenced, we intend
to vigorously defend the action.
We are a defendant in an action titled Michael Fielman v. A.B. Watley, Inc. and
A.B. Watley Group Inc., which was filed in the Supreme Court of the State of New
York, County of Nassau, Index No. 012082/02. This is an action for unpaid wages
seeking $28,657, plus statutory damages, costs, and attorneys' fees. This matter
had been settled in the amount of $34,658 payable on an installment basis of
eight (8) months. We are in default of the settlement agreement and are
currently paying the full amount due including liquidated damages of 25% and
attorneys fees of $10,000, totaling $53,322, of which $41,928 has been paid as
of March 31, 2005.
We are a defendant in an action titled Hartman & Craven LLP v. A.B. Watley, Inc.
and A.B. Watley Group Inc., which was filed in the Supreme Court of the State of
New York, County of New York, Index No.: 109502/03. Plaintiff has filed a
Complaint against, amongst others, A.B. Watley Group Inc. and A.B. Watley, Inc.
for damages in the amount of $352,574, plus accrued interest thereon, for unpaid
legal fees. A.B. Watley Group Inc. and A.B. Watley, Inc. deny liability, in
part, and have asserted a counterclaim for malpractice and breach of contract
for unspecified damages. At this point, it is difficult to determine the amount,
if any, that A.B. Watley Group Inc. and A.B. Watley Inc. may be held liable for.
Plaintiff has filed a motion for summary judgment, which has been fully
submitted and briefed before the Court. The Court granted the motion in part and
denied the motion in part. The parties are awaiting an executed judgment and are
conducting pre-trial discovery. The parties are currently in settlement
discussions, the outcome of which cannot be determined.
We are a defendant in an action titled Hyperfeed Technologies, Inc. v. A.B.
Watley Group Inc., filed in the Supreme Court of the State of New York, County
of New York, Index No. 111538/03. Plaintiff has domesticated an out-of-state
judgment against A.B. Watley Group Inc. in the amount of $180,503. The parties
have reached an agreement whereby the Company will pay a total $205,000 to be
paid in installments of $5,000 a month. As of March 31, 2005 we have paid
$15,000 towards the judgment.
26
We are a respondent in an arbitration titled Steven Messina, Brian Kelly, and
Thomas Messina v. A.B. Watley, Inc., NASD Arbitration No. 02-04649. Claimants
filed this action against A.B. Watley, Inc. in August 2002 seeking actual
damages consisting of unpaid commissions of approximately $147,000. A.B. Watley,
Inc. denies all wrongdoing in connection with this matter, and has asserted a
counterclaimfor $608,000 against Claimants for breaches of contract and
fiduciary duties. A.B. Watley, Inc. intends to vigorously defend this matter and
prosecute its counterclaim.
We are a defendant in an action titled Pentech Financial Services, Inc. v. A.B.
Watley Group Inc., Supreme Court of the State of New York, County of New York,
Index No. 02-126759. Plaintiff filed a complaint against A.B. Watley Group Inc.
for an alleged breach of a lease agreement. On May 28, 2003, Plaintiff obtained
a judgment in the amount of $465,584 plus interest accrued thereon. A.B. Watley
Group Inc. executed a settlement agreement with Plaintiff for a total settlement
of $522,584 payable on an installment basis. A.B. Watley Group Inc. is currently
in default of the settlement agreement. The parties are currently in settlement
discussions, the outcome of which cannot be determined.
Our principal offices were formerly located at 40 Wall Street, New York, New
York at an annual cost of approximately $920,000 per year, plus escalations. The
Company's previous landlord, 40 Wall Street, LLC, commenced two separate
landlord/tenant proceedings seeking money judgments and orders of eviction
against the Company. Both proceedings have been settled whereby we vacated a
portion of the premises in March 2004 and the remaining portion in June 2004. We
have signed a confession of judgment for $609,441 and the landlord has entered
that money judgment representing rent arrears. In connection with landlord's
attempted enforcement of such money judgment, landlord's counsel has served a
motion seeking to conduct discovery, including a deposition and information
subpoena. We have complied with all necessary discovery requests by providing a
copy of our quarterly financial statement, but the Court will likely order that
additional discovery be provided.
We are the defendant is an action titled W.B. Wood & Co., Inc. v. A.B. Watley
Group, Inc. and A.B. Watley, Inc. and A.B. Watley Direct, Inc., Index No.:
10189-2004. Plaintiff has filed a Complaint against us and our subsidiaries in
the amount of $85,642 for breach of a residential and equipment lease contract.
We did not respond to the Complaint and Plaintiff filed a motion for a default
judgment, which we are currently opposing. We deny liability and intend to
vigorously defend this matter.
We are a defendant in an action titled Siemens Financial Services, Inc. f/k/a
Siemens Credit Corporation v. A.B. Watley Group Inc., Supreme Court of the State
of New York, County of New York, Index No. 603769/2002. This action is for
damages arising out of the breach of a contract. Plaintiff seeks damages of
approximately $215,000 and has a judgment against A.B. Watley Group Inc. in the
amount of $179,883 with interest accrued thereon from July 10, 2003. Plaintiff
is presently conducting post-judgment discovery.
27
We are a defendant in an action titled Peter Wigger v. A.B. Watley Group Inc.,
Supreme Court of the State of New York, County of New York, Index No. 604124/02.
Plaintiff filed a complaint alleging breach of a commission agreement and unpaid
wages due and owing. Plaintiff seeks damages in the amount of $398,750 plus
interest accrued thereon. Plaintiff has filed a motion for summary judgment on
his claims. In March 2005, the parties reached a settlement, which contemplates
a total payment of $322,927 to Plaintiff over the course of 16 months. We have
paid $84,000 of this amount.
We are a defendant in an action titled Lehr Construction Corp. v. A.B. Watley
Group Inc., Supreme Court of New York, County of New York, Index No. 600276/02.
This action is for damages arising out of the alleged breach of a construction
contract. Plaintiff sought damages of approximately $233,794. On March 6, 2003,
the parties reached a settlement in which we consented to a judgment in the
amount of $295,857, less any payments made by us, and the parties simultaneously
entered into a Forbearance Agreement (the "Agreement"), which set forth a
payment schedule for us. We have defaulted under the payment schedule, and
Plaintiff has entered a judgment against us for the remaining balance due
thereunder, $173,357. Further, under the Agreement, Plaintiff is entitled to
interest on the amount outstanding and its reasonable attorney's fees for
collecting upon the Judgment. As of December 13, 2004, Plaintiff stated that the
total judgment, interest and attorney's fees due are $249,610. On or about
December 14, 2004, Plaintiff served a restraining notice upon us. As a result of
the our default under a payment schedule under a prior Forbearance Agreement, on
March 1, 2005, we entered into a Second Forbearance Agreement and new repayment
schedule under which we agreed to pay $205,000 in cash and $10,000 in securities
to Plaintiff. We have paid $145,000 under the Agreement and satisfied the
securities payment under the Agreement. Pursuant to the payment schedule, we are
obligated to pay the remaining $60,000 balance in six consecutive monthly
installments of $10,000. If we make the agreed upon payments, Plaintiff will
file a Satisfaction of Judgment for the entire amount of the Judgment against
the us and agree to waive any potential claim for failure to comply with
Restraining Notices served upon us. However, if we default under the payment
schedule, Plaintiff may declare a default and enter a judgment for $275,957,
together with interest thereon at the rate of 9% per annum, less any payment
made by us under the Agreement. Further, Plaintiff may take immediate steps to
enforce the Judgment.
In March 2003, the holder of our $5 million secured demand note (the
"Noteholder") demanded repayment of the note. On March 31, 2003, we filed a NASD
Arbitration Demand and a Statement of Claim with the NASD Dispute Resolution
office. The arbitration sought to enforce the provisions of the secured demand
note agreement and to prevent premature withdrawal by the lender. In April 2004,
the parties agreed to discontinue the arbitration without prejudice pursuant to
a settlement agreement that provided for the repayment of approximately $2.9
million (which was repaid in April 2004) of the $5 million original secured
demand note. The remaining principal balance payable in the consolidated
financial statements is $2,441,260. The Noteholder agreed that as long as we
were not in default of any of its obligations under the settlement agreement,
not to commence any litigation with respect to the outstanding balance due on
the secured demand note prior to December 20, 2004. On June 4, 2004 the
Noteholder sent us a notice of default alleging that it did not meet certain of
its obligations under the terms of the settlement agreement. In June 2004, the
note matured and we have not paid the remaining balance or received an extension
of the maturity date. At March 31, 2005 the outstanding principal and interest
balances due on the Note were $2,441,260 and $283,130, respectively.
28
We are a plaintiff in an action titled A.B. Watley Group Inc. v. John J. Amore,
et al., Supreme Court of the State of New York, County of New York, Index No.
602993/03. We have sued our former CEO who has filed a counterclaim against us.
We are unable at this time to provide a opinion as to the likely outcome, nor
the potential expense to be incurred.
We are a defendant in an action titled John J. Amore v. Steven Malin and A.B.
Watley, Inc., Supreme Court of the State of New York, County of New York, Index
No. 603833/03. Plaintiff filed a complaint alleging breach of a contract against
A.B. Watley, Inc. seeking damages in the amount of $500,000 and slander against
Steven Malin, our Chairman, seeking damages in the amount of $5,000,000. We have
filed an answer denying all wrongdoing. We deny all wrongdoing in connection
with this matter and intend to vigorously defend this matter.
On December 9, 2004, A.B. Watley, Inc. was notified of an award rendered by an
NASD arbitration panel against A.B. Watley, Inc. for compensatory damages in the
amount of $811,927 to claimant, James B. Fellus, in the case encaptioned James
B. Fellus vs. A.B. Watley, Inc. (NASD Arbitration No.: 03-05526). All other
relief sought by claimant (including an award against A.B. Watley Direct, Inc.
and/or A.B. Watley Group, Inc., and for attorneys fees and punitive damages) was
expressly denied. The arbitration involved claims by a former employee of A.B.
Watley, Inc. for alleged breach of contract (all other claims having been
withdrawn by the former employee). The amount awarded presumably represented
damages for alleged non-payment of contractual salary. A.B. Watley, Inc. intends
to move to vacate the award by asserting, among other things, that the panel
manifestly disregarded the undisputed facts and applicable, well-settled law.
We are the respondent in an action titled Dover Limited et al v. A.B. Watley,
Inc. et al., Index No.: 04 Civ. 7366. Plaintiffs filed this complaint against,
among others, the Company, its President, and two employees alleging six causes
of action sounding in securities fraud, common law fraud, conspiracy to commit
fraud, breach of contract and breach of implied covenant of good faith and fair
dealing, and negligent misrepresentation. Plaintiffs are seeking compensatory
damages of $2,994,598 plus punitive damages of $5,000,000, including costs,
interest and attorney's fees. Plaintiff has filed an amended compliant adding
additional claims and parties, including A.B. Watley Group Inc. and A.B. Watley
Direct, Inc. We have filed a motion to dismiss the Amended Complaint and intend
to vigorously defend this matter.
We are respondent in an arbitration titled Leonard v. A.B. Watley Direct, Inc.
et. al., NASD Arb. No. 05-00070. Claimant filed an NASD Arbitration against us
and the Compliance Officer of A.B. Watley Direct, Inc. for improperly
terminating him. Claimant seeks $162,500 in compensatory damages. We deny the
allegations in their entirety and submit that the arbitration is a vindictive
attempt at retribution.
We are plaintiff in an action titled A.B. Watley Group, Inc. v. Baron
Investigation Inc., Supreme Court of the State of New York, County of Nassau,
Index No. 000791/05. In this case, we sued Baron for, among other things,
negligence with respect to its background investigation of John J. Amore, our
former chief executive officer, on behalf of A.B. Watley. We are seeking in
excess of $10,000,000 in damages. Baron filed its answer denying our substantive
allegations. At this juncture, it is impossible to provide an opinion as to the
likely outcome, nor the potential expense to be incurred.
29
In February 2005, we received a demand notice for payment of notes issued to a
former officer. The demand notice requested payment of the $700,000 notes
payable to former officer recorded on our statement of financial condition and
payments for two other notes totaling $436,845. We have not made payment on any
of these notes.
In addition to the foregoing, in the ordinary course of business, we, and our
principals are, and may become, a party to legal or regulatory proceedings
commenced by the NASD, the SEC or state securities regulators relating to
compliance, trading and administrative problems that are detected during
periodic audits and inspections or reported by dissatisfied customers. Such
matters, if pursued by such entities, could rise to the level of disciplinary
action. Except as set forth herein, we are not currently involved in any
proceeding by a governmental agency or self-regulatory organization, the outcome
of which could have a material adverse effect on our business. There can be no
assurance that one or more disciplinary actions, if decided adversely against
us, would not have a material adverse effect on our business, financial
condition and results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In January 2005 we issued 1,300,000 stock options to the then president of our
subsidiary, A.B. Watley Direct, Inc. Each option has an exercise price of $.20
per share.
Effective February 9, 2005 we entered into a financial and public relations
consulting agreement for the period February 9, 2005 through June 30, 2005. In
consideration thereof, we issued 400,000 common stock purchase warrants to the
consultant, each exercisable to purchase one share of our common stock at a
price of $.01 per share for a period of five years commencing on April 15, 2005.
The warrants contain a cashless exercise provision.
Pursuant to our March 21, 2005 Employment Agreement with John G. Hewitt, we
issued 5,000,000 shares of common stock (the "Compensation Shares") and
7,500,000 common stock purchase warrants (the "Compensation Warrants") to Mr.
Hewitt, each to purchase one share of our common stock at any time during the 10
year period commencing March 21, 2005. 2,000,000 of the Compensation Warrants
had an exercise price of $.05 per share and were to vest when and if we achieve
a cumulative net profit during the term of the Employment Agreement of
$1,500,000 or more. 2,000,000 of the Compensation Warrants had an exercise price
of $.20 per share and were to vest when and if we achieved a cumulative net
profit during the term of the Employment Agreement of $4,500,000 or more.
2,000,000 of the Compensation Warrants had an exercise price of $.40 per share
and were to vest when and if we achieved a cumulative net profit during the term
of the Employment Agreement of $7,500,000 or more. 1,500,000 of the Compensation
Warrants had an exercise price of $.40 per share and were to vest when and if we
achieved a cumulative net profit during the term of the Employment Agreement of
$10,500,000 or more. Subject to earlier forfeiture, as provided in the
Employment Agreement, in the event the cumulative net profit target of
$10,500,000 was not achieved on or before March 31, 2009, all non-vested
warrants were to be forfeited. The Compensation Shares were issued in April
2005. On May 17, 2005 we notified Mr. Hewitt that we were terminating the
Employment Agreement for cause. This effectively terminated the Compensation
Warrants issued to Mr. Hewitt under the Employment Agreement. As the result of
the termination, we intend to seek the return of the Compensation Shares for
cancellation. In conjunction with Mr. Hewitt's termination, our Chairman was
appointed as our principal executive officer on an interim basis.
30
In March 2005, the holders of certain of our common stock purchase warrants
exercisable at a price of $.001 per share, exercised 1,103,090 warrants at an
aggregate exercise price of $1,103.09 resulting in our issuance of 1,103,090
shares of common stock.
In consideration of consulting services provided pursuant to a March 8, 2005
consulting agreement, in March 2005 we issued 3,000,000 common stock purchase
warrants to the consultant, each to purchase one share of our common stock at a
price of $.01 per share at any time during the ten year period commencing on
March 8, 2006.
In May 2005 we issued 500,000 common shares to one person pursuant to an April
28, 2005 Settlement Agreement and Release.
Each of the above transactions were exempt from registration under the
Securities Act by reason of Section 4(2) of the Securities Act, or Regulation D
promulgated thereunder, as transactions by an issuer not involving a public
offering.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
In March 2003, the holder of our $5 million secured demand note (the
"Noteholder") demanded repayment of the note. On March 31, 2003, we filed a NASD
Arbitration Demand and a Statement of Claim with the NASD Dispute Resolution
office. The arbitration sought to enforce the provisions of the secured demand
note agreement and to prevent premature withdrawal by the lender. In April 2004,
the parties agreed to discontinue the arbitration without prejudice pursuant to
a settlement agreement that provided for the repayment of approximately $2.9
million (which was repaid in April 2004) of the $5 million original secured
demand note. On June 4, 2004 the Noteholder sent us a notice of default alleging
that we did not meet certain of our obligations under the terms of the
settlement agreement. In June 2004, the note matured and we have not paid the
remaining balance or received an extension of the maturity date. The outstanding
principal and interest balances payable at March 31, 2005, as set forth in our
condensed consolidated financial statements, were $2,441,260 and $283,130,
respectively.
In February 2005, we received a demand notice for payment of notes issued to a
former officer. The demand notice requested payment of the $700,000 notes
payable to former officer recorded on our statement of financial condition and
payments for two other notes totaling $436,845. We have not made payment on any
of these notes.
31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Stockholders holding an aggregate of 11,772,069 shares (approximately 52.24%) of
our outstanding common stock on February 3, 2005 consented in writing to amend
our Certificate of Incorporation to increase our authorized capitalization from
51,000,000 shares, consisting of 50,000,000 shares of common stock, $.001 par
value, and 1,000,000 shares of preferred stock, $.001 par value, to 501,000,000
shares, consisting of 500,000,000 shares of common stock, $.001 par value and
1,000,000 shares of preferred stock, $.001 par value. The Certificate of
Amendment was filed on April 7, 2005.
ITEM 5. OTHER INFORMATION.
Effective March 15, 2005 our board authorized and approved certain changes to
our option plans and outstanding stock options. Pursuant thereto, all of our
issued and outstanding stock options at March 15, 2005 became fully vested
notwithstanding the vesting terms set forth in the respective option agreements.
Further, all outstanding options were revised to provide for exercise for a
period of five years following the holder's termination of employment,
consulting arrangement or other affiliation with us subject to the limitations
that (i) an option may not be exercised after the expiration of the existing
exercise period; and (ii) if the employment of an employee by or the services of
a non-employee Director for, or consultant or advisor to, us, or a subsidiary of
ours shall be terminated for cause the option shall expire and be forfeited on
the date of termination. We also revised all outstanding options to provide for
exercise by the holder's estate for a period of one year following the death of
the holder subject to the limitations that (i) an option may not be exercised
after the expiration of the existing exercise period; and (ii) if the employment
of an employee by or the services of a non-employee Director for, or consultant
or advisor to, us, or a subsidiary of ours shall be terminated for cause the
option shall expire and be forfeited on the date of termination.
We also amended Section 9 our 2004 Non-Statutory Stock Option Plan to read as
follows:
"9. Termination of Employment or Death"
(a) Except as otherwise provided in the Stock Option
Agreement, if the employment of an employee by, or the
services of a non-employee Director for, or consultant or
advisor to, the Company or a subsidiary corporation of the
Company, shall be terminated for any reason, other than
cause, including, but not limited to, voluntary termination,
or permanent disability, then, subject to subsections (b),
(c) and (d) of this Section 9, his or its Option may be
exercised anytime within five (5) years after such
termination. For purposes of this subsection (a), an
employee, non-employee Director, consultant or advisor who
leaves the employ or services of the Company to become an
employee or non-employee Director of, or a consultant or
advisor to, a subsidiary corporation of the Company or a
corporation (or subsidiary or parent corporation of the
corporation) which has assumed the Option of the Company as
a result of a corporate reorganization or the like shall not
be considered to have terminated his employment or services.
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(b) Subject to the terms of the Stock Option Agreement, if
the holder of an Option under the Plan dies (i) while
employed by, or while serving as a non-employee Director for
or a consultant or advisor to, the Company or a subsidiary
corporation of the Company, or (ii) within five (5) years
after the termination of his employment or services, other
than for cause, then such Option may, subject to the
provisions of subsection (d) of this Section 9, be exercised
by the estate of the employee or non-employee Director,
consultant or advisor, or by a person who acquired the right
to exercise such Option by bequest or inheritance or by
reason of the death of such employee or non-employee
Director, consultant or advisor at any time within one (1)
year after such death.
(c) If the employment of an employee by, or the services of
a non-employee Director for, or consultant or advisor to,
the Company or a subsidiary corporation of the Company,
shall be terminated for cause then his or its option shall
expire and be forfeited effective as at the date of
termination.
(d) An Option may not be exercised pursuant to this Section
9 except to the extent that the holder was entitled to
exercise the Option at the time of termination of
employment, termination of directorship, termination of
consulting or advisory services, or death, and in any event
may not be exercised after the expiration of the Option."
On March 3, 2005 we terminated the employment of Gary Mednick as president of
A.B. Watley Direct, Inc. In connection with the termination, we agreed to allow
Mr. Mednick to retain all stock options previously granted to him. We are still
negotiating additional terms of the termination arrangement.
Effective March 27, 2005 we appointed Diego Baez as our Chief Operating Officer
pursuant to an at will arrangement. The arrangement provided for the payment of
an annual base salary of $150,000 and the issuance of 1,000,000 shares of our
restricted common stock (the "Share Compensation"). On May 4, 2005 we notified
Mr. Baez that we were terminating his employment for cause. The Share
Compensation was never paid to Mr. Baez and we do not intend to pay it as the
arrangement provided for forfeiture of the Share Compensation in the case of
termination for cause.
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Effective March 21, 2005 we entered into a two year employment agreement (the
"Employment Agreement") with John G. Hewitt pursuant to which Mr. Hewitt was
serving as our Chief Executive Officer and was also serving as the President and
Chief Executive Officer for our wholly owned subsidiary, A.B. Watley Direct,
Inc. The term of the agreement was extendable for additional one year periods at
the mutual discretion of the parties. The Employment Agreement provided for the
payment of a base annual salary of $250,000 to Mr. Hewitt together with
5,000,000 shares of our restricted common stock (the "Compensation Shares") and
7,500,000 common stock purchase warrants (the "Compensation Warrants"). The
Compensation Warrants were subject to anti-dilution. Mr. Hewitt was further
entitled to participate in our proposed employee bonus pool which may be funded
with up to 25% of our annual net profit, if any, for the twelve month periods
commencing April 1, 2005. In the event the Employment Agreement was terminated
by Mr. Hewitt for "good reason", as such term was defined therein, or was
terminated by us "without cause", as such term us defined therein, we were
obligated to pay Mr. Hewitt all of the base salary due for the remainder of the
term. Further, in the event of termination for "good reason", "without cause" or
as the result of the death or disability of Mr. Hewitt, all of the Compensation
Warrants would be given the opportunity to vest for the remainder of the term,
and at the end of the term all non-vested Compensation Warrants would be
cancelled. In the event that during the first year of the term, Mr. Hewitt
terminated the Employment Agreement for other than "good reason" or we
terminated the Employment Agreement "with cause" Mr. Hewitt was required to
return the Compensation Shares to us for cancellation. Further, in the event of
a termination at any time by Mr. Hewitt for other than "good reason" or by us
"for cause" all of the Compensation Warrants were to become immediately void and
of no further effect. On May 17, 2005 we notified Mr. Hewitt that we were
terminating the Employment Agreement for cause. This effectively terminated the
Compensation Warrants issued to Mr. Hewitt under the Employment Agreement. As
the result of the termination, we intend to seek the return of the Compensation
Shares for cancellation. In conjunction with Mr. Hewitt's termination, our
Chairman was appointed as our principal executive officer on an interim basis.
On April 28, 2005 we entered into a Settlement Agreement and Release (the
"Settlement Agreement") with respect to our $80,668 obligation to Singer
Frumento LLP for legal services. Thereunder we entered into a payment plan
whereby we agreed to make aggregate payments of $56,000 (the "Settlement
Amount") by December 10, 2005. We also issued 500,000 shares of our common stock
to Bill Singer, a partner in Singer Frumento LLP (the "Singer Shares"). The
Singer Shares are subject to sale and transfer restrictions and are returnable
to us for cancellation in the event we make payment in full of the Settlement
Amount. However, if we default under the Settlement Agreement and such default
is held cured in accordance with the cure provisions thereof, the sale and
transfer restrictions will be lifted and the Singer Shares will no longer be
subject to return. We have agreed to file a registration statement registering
the resale of the Singer Shares by November 1, 2005. Failure to do so
constitutes a default under the Settlement Agreement.
Effective October 12, 2004 we retained Sichenzia Ross Friedman Ference LLP
("Sichenzia") to represent us in the action titled Dover Limited and Wendy Sui
Cheng Yap v. A.B. Watley Inc., Robert Malin, Keith Sorrentino, John Coakley,
Alain Assemi and John J. Amore (Case No.: 04 CV 7366) as filed in the United
States District Court, Southern District of New York. In connection therewith,
we paid Sichenzia an initial retainer of $10,000 and issued an aggregate of
1,000,000 shares of our common stock to Sichenzia. In the event we paid all
Sichenzia invoices related to this matter within 30 days of issuance, the
1,000,000 shares were returnable to us for cancellation. If we failed to do so,
the shares would be retained and the proceeds from sales thereof would be
applied to all of the outstanding and current balances due by us to them. Any
excess would be applied to additional fees incurred, if any. Any remaining
proceeds after that would be retained by the share recipients. We have defaulted
under the payment terms of this agreement.
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Effective August 9, 2004 we reached an agreement with legal counsel, Sichenzia
Ross Friedman Ference LLP ("Sichenzia") with respect to our outstanding invoice
to them of approximately $141,000 (the "Outstanding Balance"). The agreement
provides for the payment of the Outstanding Balance in installments, $90,000 of
which had been paid as at December 20, 2004. The remaining installments were due
on or before March 31, 2005 ($10,000) and on or before January 15, 2005
($29,364). As an alternative to the January 15, 2005 payment, we could have made
payment of an aggregate of $41,364 in installments over a period of four months
commencing January 15, 2005. In consideration of the foregoing, we also issued
an aggregate of 550,000 shares of our common stock to designated partners in
Sichenzia. Sichenzia agreed that 450,000 of such shares would be returned to us
for cancellation in the event that we paid the Outstanding Balance in full and
not any time prior thereto allowed the current balance due to them to exceed
$30,000 for a period of more than 45 days. In the event we did not satisfy these
conditions, Sichenzia could retain the 450,000 shares and apply the sale
proceeds against the Outstanding Balance and any other sums then due by us to
them. We did not make the scheduled payments stated above and, as such,
Sichenzia has sold 166,000 of the shares realizing proceeds of $14,929.68 which
have been applied to the outstanding balance payable.
In July 2004 we sold 5,000,000 shares in a private placement transaction for
$2,000,000. Payment for the shares was to be made in installments with the final
payment due April 1, 2005. To date, we have received an aggregate of $1,571,837
from the subscribers. The subscribers are in default of their payment
obligation. We expect to receive the balance due from the subscribers prior to
fiscal 2005 year end.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
The following exhibits are filed as a part of this report on Form 10-QSB:
Exhibit No. Description
10.1 Non-Statutory 2004 Stock Option Plan, as amended on March 15,
2005.
10.2 Settlement Agreement and Release dated April 28, 2005 between
Registrant and Singer Frumento LLP.
31.1 Rule 13(a)-14(a)/15(d)-14(a) Certification of Principal
Executive Officer
31.2 Rule 13(a)-14(a)/15(d)-14(a) Certification of Principal
Financial Officer
32.1 Rule 1350 Certification of Principal Executive Officer
32.2 Rule 1350 Certification of Principal Financial Officer
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(b) Reports on Form 8-K
On January 28, 2005, we filed a Form 8-K dated December 31, 2004. Under Item
3.02 thereof, "Unregistered Sales of Equity Securities", we disclosed two
separate issuances of unregistered securities.
On March 14, 2005 we filed a Form 8-K dated March 8, 2005. Under Item 3.02
"Unregistered Sale of Equity Securities" we disclosed an issuance of
unregistered securities and under Item 9.01(c) "Exhibits" we filed exhibits
related to the issuance.
On March 25, 2005 we filed a Form 8-K dated March 21, 2005. Under Item 1.01
"Entry into a Material Agreement" we disclosed an employment agreement with a
newly employed executive officer. Under Item 3.02 "Unregistered Sale of Equity
Securities" we disclosed securities issued under the employment agreement. Under
5.02 "Departure of Directors or Principal Officers; Election of Directors;
Appointment of Principal Officers" we discussed the engagement of the new
executive officers. Under Item 9.01(c) "Exhibits" we filed the employment
agreement.
No other reports on Form 8-K were filed by us during the quarter ended March 31,
2005.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Form 10-QSB to be
signed on its behalf by the undersigned, thereunto duly authorized.
Dated: May 20, 2005 A.B. Watley Group Inc.
By: /s/ Robert Malin
--------------------
Robert Malin
President, Principal Financial Officer
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