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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
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 0-28191
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eSpeed, Inc.
(Exact name of Registrant as Specified in Its Charter)
Delaware 13-4063515
(State or Other Jurisdiction of (I.R.S. Employer Identification
Incorporation) No.)
One World Trade Center, 103rd Floor, New York, NY 10048
(Address of Principal Executive Offices) (Zip Code)
(212) 938-3773
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on which Registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, $. 01 par value
(Title of Class)
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
The aggregate market value of voting common equity held by non-affiliates
of the registrant, based upon the closing price of the Class A common stock on
March 15, 2000 as reported on the Nasdaq National Market, was approximately
$719,372,500.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
Class Outstanding at March 15, 2000
Class A Common Stock, par value $.01 per share 10,350,000 shares
Class B Common Stock, par value $.01 per share 40,650,000 shares
DOCUMENTS INCORPORATED BY REFERENCE.
None.
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eSPEED, INC.
1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
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PART I
ITEM 1 BUSINESS.............................................................1
ITEM 2 PROPERTIES..........................................................38
ITEM 3 LEGAL PROCEEDINGS...................................................38
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................41
PART II
ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS....................................42
ITEM 6 SELECTED FINANCIAL DATA.............................................45
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.................................46
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK................................................53
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.........................54
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.................................71
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................72
ITEM 11 EXECUTIVE COMPENSATION.............................................76
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.......................................................82
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................84
PART IV
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K...........................................95
PART I
ITEM 1. BUSINESS
The information in this report contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Such statements
are based upon current expectations that involve risks and uncertainties. Any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. For example, words such as "may,"
"will," "should," "estimates," "predicts," "potential," "continue," "strategy,"
"believes," "anticipates," "plans," "expects," "intends" and similar expressions
are intended to identify forward-looking statements. Our actual results and the
timing of certain events may differ significantly from the results discussed in
the forward-looking statements. Factors that might cause or contribute to such a
discrepancy include, but are not limited to, those discussed elsewhere in this
report in the section entitled "Risk Factors."
Overview of Our Business
eSpeed, Inc. is a leading provider of business-to-business electronic
marketplace solutions for the trading of products via the Internet or over our
global privately managed private network. Our eSpeed(((Service Mark))) system is
an end-to-end marketplace and trading community solution, which includes
real-time and auction-based transaction processing, risk management tools and
back-end processing and billing systems available to our clients. Our system is
designed to enable market participants to transact business instantaneously,
more effectively and at lower cost than traditional trading methods. Our
revenues are driven by trading activity and volumes in the marketplaces we
operate.
Our eSpeed((((Service Mark)))) system employs our international high speed
private electronic network and proprietary transaction processing software,
enabling significant capacity for fully electronic trading by our clients. We
believe these components form one of the most robust large scale, instantaneous,
mission critical trading systems in the world. Our network is internationally
distributed and permits market participants to view information and execute
trades in a fraction of a second from locations around the globe. Our system
operates and accesses a fully regulated U.S. futures exchange currently known as
the Cantor Exchange((((Service Mark)))). This exchange is the first fully
electronic futures exchange in the U.S. and will serve as our platform for the
electronic trading of a broad range of futures contracts globally.
Our eSpeed((((Service Mark)))) system includes our proprietary trading
application engine, which currently processes 150 transactions per second per
tradable instrument, our proprietary credit and risk module, which provides
real-time credit analysis and oversight, and our back-office and clearance
modules, which provide straight-through processing. Our eSpeed((((Service
Mark)))) system is accessible to our clients in four ways: through our
proprietary application programming interface (or API), through a dedicated
software application, via the Internet through a browser interface or Java
applet, or through front-end trading systems developed by third-party software
companies.
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Our objective is to create the leading business-to-business marketplace
trading solution. Our strategy is to leverage the scale and extendibility of our
system, our leading marketplace development expertise and our proprietary
futures exchange across markets.
Recent Events
We commenced operations in March 1999 as a division of Cantor Fitzgerald
(Cantor). Cantor currently operates with us the largest wholesale marketplace
for U.S. Treasury securities and leading marketplaces for many other global
fixed-income securities and financial instruments. Cantor also operates in other
non-financial markets, such as energy, commodities and acid rain emissions. Over
the past 25 years, Cantor has been a leading intermediary for the fixed income
markets. In 1972, Cantor developed the world's first screen-based marketplace
for the trading of U.S. government securities. Since the early 1990s, Cantor has
developed systems to promote fully electronic marketplaces. Since 1996, Cantor
has invested more than $200 million in information technology, including the
development of proprietary electronic transaction processing software, network
distribution systems and related contractual rights that comprise our
eSpeed((((Service Mark)))) system. In connection with the initial public
offering of our Class A common stock in December 1999, Cantor contributed to us
this proprietary software, network distribution systems, technologies and
related contractual rights.
We began marketing our eSpeed((((Service Mark)))) system throughout 1999
and, through our relationship with Cantor, we focused primarily on the financial
services industry and, in particular, fixed income products (which we refer to
as the Interest Rate Vertical). We now operate the largest global electronic
marketplace for U.S. Treasury securities, transacting billions of dollars daily,
and we operate leading global electronic marketplaces for other fixed income
securities and financial instruments. Most of the largest financial institutions
currently use our marketplaces to trade a wide range of global fixed income
securities, futures, options and other financial instruments. These financial
instruments include government securities denominated in U.S. dollars, Euros,
Yen, British Pounds Sterling, Canadian dollars and currencies of emerging market
countries, as the well as securities of U.S. agencies, municipal securities,
Eurobonds, corporate bonds and other global fixed income securities and U.S.
Treasury futures.
Within the Interest Rate Vertical, we believe we operate the only
electronic marketplaces used for trading multiple securities in multiple
currencies, and on a global basis provide a fully registered futures exchange.
Over 500 institutions worldwide participate in the Interest Rate Vertical,
including the 25 largest bond trading firms in the world, as identified by
Euromoney Magazine. Most of these institutions use our proprietary eSpeed screen
displays and/or trading platforms, which allow us to deliver information and
execute transactions instantaneously through the computer security barriers that
permit or exclude entry into the internal networks of these institutions. We
have devoted significant resources to developing client arrangements, providing
point-to-point communication links and creating proprietary software to
establish connectivity through these security barriers in order to deliver data
and execute transactions for our clients on a secure basis.
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Industry Background
Growth of the Internet and Business-to-Business Electronic Commerce. The
Internet has emerged as the fastest growing communications medium in history.
With over 165 million users at the end of 1998, growing to 623 million users by
2002, as estimated by IDC, the Internet is dramatically changing how businesses
and individuals communicate and share information. The Internet has created new
opportunities for conducting commerce, such as business-to-consumer and
person-to-person electronic commerce. Recently, the widespread adoption of
intranets and the acceptance of the Internet as a business communications
platform has created a foundation for business-to-business electronic commerce
that will enable organizations to streamline complex processes, lower costs and
improve productivity. With this foundation, Internet-based business-to-business
electronic commerce is poised for rapid growth and is expected to represent a
significantly larger opportunity than business-to-consumer or person-to-person
electronic commerce. According to Forrester Research, business-to-business
electronic commerce is expected to grow from $43 billion in 1998 to $1.3
trillion in 2003, accounting for more than 90% of the dollar value of electronic
commerce in the United States. This market is expected to create a substantial
demand for Internet-based electronic commerce applications.
Electronic Marketplaces. Electronic marketplaces have emerged as major
interactive mediums for business-to-business transactions, including auctions
and exchange-like trading mechanisms. In an electronic marketplace,
substantially all of the participants' actions are facilitated through an
electronic medium, such as a private electronic network or the Internet, which
effectively eliminates the need for actual face-to-face or voice-to-voice
participant interaction and saves time and money thereby creating enormous
efficiencies.
Our Trading Services and Technology Platform
In our electronic marketplaces, participants may either electronically
execute trades themselves or call brokers/terminal operators who then input
trade orders into the eSpeed system for them. In a fully electronic trade, all
stages of the trade occur electronically. The participant inputs its buy or sell
order instructions directly into our electronic trading system, using a
web-browser, a keyboard, an application programming interface or other software.
The system provides to the participant, normally within 300 milliseconds, an
on-screen confirmation that the participant's order has been accepted.
Instantaneously, once a trade is executed, the participant receives an on-screen
trade confirmation. Simultaneously, an electronic confirmation can be sent to
the participant's back office and risk system, enabling risk management
capabilities and straight-through processing for the participant. A
broker/terminal operator assisted trade is executed in substantially the same
manner as an electronic trade, except that the participant telephones a
broker/terminal operator who then inputs the participant's order into our
electronic marketplace system.
Over time, we expect fully electronic trading to become the predominant
trading method in our marketplaces. However, through our affiliation with
Cantor, we have the ability to offer to our clients broker/terminal operator
trading capabilities, thereby providing instantaneous back-up and marketplace
access. Unlike most traditional exchanges that have created side-by-side
competitive markets for voice and electronic access and, as a result, have
created separate pools
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of liquidity, our markets permit access to fully electronic and broker/terminal
operator orders to be all transacted within our eSpeed system in one liquidity
pool, seamlessly.
Our electronic marketplaces operate on our proven technology platform that
emphasizes scalability, performance and reliability. Our technology platform
consists of:
o our proprietary, internally developed real-time global network
distribution system;
o our proprietary transaction processing software, which includes order
matching auction engines, fully integrated credit and risk management
systems, pricing engines and associated middle and back office operations
systems;
o client interfaces ranging from Windows, Java, UNIX, our proprietary static
library API and proprietary vendor access; and
o customized inventory distribution and auction protocols designed to be
used by our clients in their distribution and trading systems.
Together, these components enable participants in our marketplaces to
trade almost every commodity in real-time efficiently, with straight-through
processing capabilities and certainty of execution.
Network Distribution System. Our eSpeed((((Service Mark)))) system
contains a proprietary hub and spoke digital network. This network uses Cisco
Systems network architecture and is operated by certified Cisco engineers. Our
network's high speed points of presence comprise the major financial hubs of the
world, including New York, London, Tokyo, Frankfurt, Paris, Milan, Chicago, Los
Angeles and Toronto. Altogether, we manage 22 hubs linked by over 50,000 miles
of cable, over 800 Cisco routers and switches and over an aggregate of 550 high
capacity Sun servers, Compaq Alpha super servers and Windows NT servers. The
redundant structure of the system provides multiple backup paths and re-routing
of data transmission if one spoke of a hub fails. This instantaneous backup is
critical to maintaining our clients' connectivity. We believe we operate one of
the largest and most robust interactive trading network distribution systems
currently in operation.
Our distribution system accepts orders and postings instantaneously and
distributes responses, generally in 300 milliseconds. The network can transport
150 million bits of information per second around the world and is currently
running at approximately 12% of capacity.
In addition to our own network system, we also distribute encrypted data
and receive trading information from clients using the services of multiple,
major Internet service providers throughout the world. These connections enable
us to offer Internet-based trading to our global clients which is completely
integrated with our private network.
Transaction Processing Software. Most of our software applications have
been developed internally and are central to the success of our
eSpeed((((Service Mark)))) system. Our order-matching auction and trading
engines operate in real-time, facilitating efficient interaction between buyers
and sellers. Our credit and risk management systems monitor and regulate these
buyers and
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sellers, limiting market and credit risk. Our pricing engines provide prices for
illiquid financial products through multiple trades in other related financial
instruments. These critical applications work together seamlessly and are
supported by middle and back office software that verifies, confirms, reports,
stores, tracks and, if applicable, clears each trade.
o eSpeed Trading Engines. Our auction and trading engines use
Interactive Matching((Service Mark)), our proprietary rules-based
method, to process in excess of 150 transactions per second per
auction, instrument or product. These engines were developed to
support trading of the largest capital markets in the world, such as
government bonds and futures contracts, and the more diverse,
fragmented and database intensive markets, such as U.S. municipal
bonds (with over 1.7 million different issues), corporate bonds and
Eurobonds. These trading engines are designed to be modular and
flexible to allow modification in order to apply them to other
markets and auction types. In Europe, for example, we have added a
component that allows us to process trading and auctions in multiple
currencies simultaneously. Our trading engines have embedded
security features and an added messaging layer to provide security
from unauthorized use. In addition, we use encryption to protect our
clients that trade over the Internet. When used together, our
trading engines can trade a wide range of instruments and products
and facilitate trade in auctions and markets. Our systems have
handled trades ranging in size from $100 to billions of dollars.
We believe our marketplace expertise and rules based systems provide
incentives for clients to actively participate in our marketplaces.
For example, Interactive Matching provides incentives to participate
in our marketplaces by encouraging participants to expose their
orders to the market by providing them priority in an interactive
marketplace. In standard auctions, the incentive is for participants
to wait until the last moment to make a bid or offer. Our priority
rules encourage trading activity by giving the last successful
active participant a time-based right of first refusal on the next
sale/purchase. In addition, in many markets we have structured our
pricing policy to provide that the party that provides auction
products for the market or creates liquidity by inputting a price to
buy or sell pays less commission (or no commission) than the
participant that consummates the trade by acting on that price. With
our pricing policies and proprietary priority rules, our system is
designed to increase activity and to draw participants into the
market. This proprietary rules-based system is easily adaptable and,
as part of our business strategy, we intend to apply it across other
non-financial markets for a multiple of products and services.
o eSpeed Credit Master - Credit and Risk Management Systems. Our
credit and risk management systems are critical to the operation of
our electronic marketplaces. Our proprietary credit and risk
management systems (1) continuously monitor trades of our clients to
ensure that they have not exceeded their credit limits, (2)
automatically prevent further trading once a client has reached a
pre-determined credit limit, and (3) evaluate trade transactions and
calculate both individual positions and risk exposure across various
products and credit limits. These systems can also be made available
to our global clients to enable them to monitor the position of
their traders and integrated with our private label systems so they
can monitor the credit of their clients who participate in our
marketplaces. These systems store client data relevant to credit
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and risk management, such as financial statements, credit documents,
contacts and internal analyses. These systems also enable our
clients to make our electronic marketplaces available to their
clients while maintaining control of their trading activity and
risk.
o eSpeed Pricing Engines and Analytics. We have internally developed a
number of sophisticated, analytical software tools that permit us to
price products that trade in less liquid markets and for which
current pricing information is not readily available. For example,
our MOLE((Service Mark)) system (Multiple Order Link Engine) is a
computer application that enables us to link multiple markets, offer
prices and create and enhance marketplaces for products that have
limited liquidity. For example, in the Interest Rate Vertical, MOLE
currently uses data from existing cash and futures markets to
calculate pricing for transactions where no market prices currently
exist, thereby enabling liquidity.
o eSpeed Back-Office - Middle and Back-Office Applications. Our middle
and back office applications support clearance, settlement, tracking
and reporting of trades and provide links to outside clearing
entities. In the financial markets, we outsource our fulfillment
services to Cantor, where both parties to a trade send either cash
or a security to Cantor and Cantor settles the trade and sends each
party the cash or security due. Our reporting and accounting systems
are designed to ensure that all charges and commissions for a trade
are tracked and recorded. Our accounting systems are designed to
ensure that books and records are kept in accordance with regulatory
guidelines and accounting standards.
o Client Interfaces. Our systems can be accessed by our clients in
four ways:
o using our eSpeed((Service Mark)) proprietary front end trading
software;
o using our application programming interface to write their own
software linking their networks and software applications
directly to our systems;
o through the Web via a browser, or using a downloaded java
application or dedicated proprietary software application via
the Internet, both for wholesale clients and for retail
clients who participate in our marketplaces; and
o through software developed in alliances with third-party
vendors such as QV Trading and SunGard/ASC. Our application
programming interface enables clients to conduct computer
price updating, program trading and straight-through
processing.
o eSpeed Private Label Products. We enable our clients to serve their
customers more effectively be supplying them with a private label
version of our eSpeed((Service Mark)) system, which incorporates the
functionality of our eSpeed((Service Mark)) system but allows them
to place their branding on the system for distribution to their
customers, whether via the Web or via a private network. These
products encompass our strategy to enable our clients to better
serve their institutional clients, as well as allowing us to enable
online and
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traditional retail brokers to provide their clients with
instantaneous access to a broad range of financial instruments:
o our Private Label products for the institutional market will
enable our clients to create their own customized versions of
our eSpeed((Service Mark)) system to enable them to transact
with their customers in an efficient manner utilizing a
co-branded version of our eSpeed((Service Mark)) system. Our
customers will use the system to allow more efficient
distribution of a wide variety of instruments that these
dealers will support, enabling them to transact more cost
effectively with their clients, and ensuring that they have a
turnkey e-commerce solution for their own marketing efforts.
We will enable these clients to deliver a customized
e-commerce solution to their customers, quickly, efficiently
and cost effectively.
o our Private Label products for the retail marketplace will
enable online and traditional retail brokers to provide their
clients with instantaneous access to previously unavailable
wholesale marketplaces for the retail trading of fixed income
instruments, futures, options and other financial instruments.
While retail investors generally have been able to buy and
sell equity securities at the same prices and spreads as
wholesale market participants and institutional investors,
this has not been the case with fixed income securities,
futures, options and other financial instruments. We believe
our eSpeed((Service Mark)) system will expand marketplaces
and/or retail volume and enhance execution for individual
retail investors.
Benefits of Our eSpeed((Service Mark)) System
The benefits of our eSpeed((Service Mark)) system include the following:
Instantaneous Price Dissemination and Auction and Trade Execution. Our
eSpeed((Service Mark)) system provides our clients with the ability to access
pricing and other information, operate auctions and execute trades
instantaneously, as opposed to traditional trading methods which provide less
timely information, non-real-time auctions and less efficient trade execution.
Lower Transaction Costs. Our eSpeed((Service Mark)) system streamlines the
entire trading process by eliminating the significant layers of manual
intervention that currently exist at both the front-end of the process,
including order entry, matching and postings functions, as well as at the middle
and back-end of the process (clearance, settlement, tracking and reporting
functions), resulting in significantly lower transaction costs for our clients.
Multiple Product Program Trading. Our eSpeed((Service Mark)) system
provides our clients with the ability to execute sophisticated and complex
transactions and trading strategies, including the trading of multiple products
across multiple markets simultaneously.
Greater Accuracy and Decreased Probability of Erroneous Trades. Our
eSpeed((Service Mark)) system includes verification mechanisms at various stages
of the execution process, which result in significantly reduced manual
intervention, decreased probability of erroneous trades and more accurate
execution for clients.
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Integrated Compliance and Credit Risk Functions. Our eSpeed((Service
Mark)) system includes a comprehensive range of compliance and credit risk
management components that perform several critical functions, including: (1)
continuously monitoring trading activity to ensure that clients are staying
within credit limits; (2) automatically preventing further trades once credit
limits have been exceeded; and (3) evaluating and calculating positions and risk
exposure across various products and credit limits. These risk, credit and
compliance tools are highly sophisticated and can be customized for our clients
and integrated into their information technology platforms.
Highly Efficient Pricing on Illiquid Securities. Our MOLE((Service Mark))
system enables us to provide prices for illiquid products through multiple
trades in other related products. These multi-variable trades are extremely
difficult to execute in traditional markets due to their complexity and the slow
speed of manual execution.
Ability to Automate Back-Office Functions. Our eSpeed((Service Mark))
system automates previously paper and telephone-based transaction processing,
confirmation and other functions, substantially improving and reducing the cost
of client back-offices, and enabling straight-through processing.
Private Label Products. Our private label initiative will allow our
clients to better serve their customers by enabling them to deliver an
e-commerce solution quickly, efficiently and cost effectively. We believe we not
only enhance the overall liquidity and efficiency of the market but also
maintain a stronger client relationship.
Leveraging Our eSpeed((Service Mark)) System Horizontally to Expand to
Additional Non-Financial Marketplaces (Vertical Markets).
Because of the scale of our system and its ease of adaptability, we
believe our eSpeed((Service Mark)) system and Interactive Matching((Service
Mark)) have applications across a broad range of products, including any
business-to-business marketplace involving multiple buyers and sellers. We are
well positioned to leverage the significant costs and efforts that have been
incurred developing our eSpeed((Service Mark)) system to quickly create
electronic markets in a wide range of products.
We expect to extend our marketplaces to include additional financial and
non-financial products, including energy, telecommunications products, including
bandwidth and telephone minutes, and bulk commodity chemicals, electronic
components and other decentralized or illiquid markets, through a variety of
approaches, together with Cantor as well as with other strategic partners.
Initially, we will focus our expansion efforts on the securities and
financial instruments traded by Cantor that have not yet been converted to
electronic trading. We plan to significantly expand the types of securities and
financial products traded in the Interest Rate Vertical marketplaces. Our goal
is to include in our electronic marketplaces the full range of fixed income
securities, futures, options and other securities and financial products that
are currently traded in today's markets worldwide.
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The Interest Rate Vertical
Wholesale Fixed Income Securities Trading. The global fixed income
securities market is the largest financial market in the world. In the United
States alone, there are over $13 trillion of fixed income securities
outstanding, and in the U.S. Government Securities market alone, there is
reported to be approximately $200 billion a day in trading just among the
primary dealers and their clients. Other fixed income instruments are traded
widely, and in Europe, Asia and the emerging markets, there is another
approximately $13 trillion of fixed income securities outstanding, with an
average daily trading volume of approximately $300 billion. In Europe, the
creation of the Euro has manifested a market second only to the United States in
breadth. We expect continued significant growth in these fixed income markets as
the issue of currency translation is removed as an obstacle to the development
of a large unified Pan-European market for securities.
Futures and Options Trading. Futures and options trading is a leading
financial activity throughout the world, with contracts traded on a wide variety
of financial instruments, commodities and indexes. In 1998, over 1.5 billion
futures contracts were traded in the world's futures markets, and over 750
million options contracts were traded on a variety of exchanges. Futures and
options provide several important economic benefits, including the ability to
shift or otherwise manage market risk. In part because these markets provide the
opportunity for leveraged investments, they attract large pools of risk capital.
Currently, most futures trading is still being done on open outcry exchanges,
but there has been a significant movement towards the conversion of these
markets to electronic trading. To date, we believe the most successful
initiatives have been made in Europe. We believe that there is significant
opportunity in the continued conversion of these markets to electronic networks,
such as our own.
Interest Rate Vertical. The Interest Rate Vertical includes many of the
largest Cantor marketplaces, including U.S. Treasury and European government
securities, global fixed income securities, futures, options and other financial
products. We intend to convert most of Cantor's remaining marketplaces to our
electronic trading platform by the end of 2000. Today, together with Cantor, our
systems execute in excess of $45 trillion in transaction volume annually and are
major facilitators and, in some cases, providers, of liquidity in numerous
financial products through our offices in the United States, Canada, Europe and
Asia. We share with Cantor a portion of the transaction-based revenues paid by
financial market participants for trades using our electronic marketplaces.
Cantor and most of the largest financial institutions in the world are currently
our primary clients. Our eSpeed((Service Mark)) system provides the only way to
electronically access Cantor's marketplaces. Consequently, we believe that
clients will be strongly motivated to use our interactive electronic
marketplaces.
Traditional Trading Methods for Financial Marketplaces. In both the fixed
income and futures markets, trading practices historically have centered on a
method of trading known as open outcry, where all trading activity is focused on
a central physical location, or pit. This method of trading can create
significant value for the market participants in the pit, who often have access
to better and more timely market information than other market participants. All
other market participants have to access the market through this central
location. Additionally, in order to access the pit, individuals and
institutional traders must send their orders through several layers of
middlemen, who assist in handling such orders. This process is inefficient. In
today's
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heavily regulated open outcry U.S. futures markets, for example, an
order can be routed through multiple people during its execution, adding
significant costs to the transaction. Virtually all U.S. futures exchanges are
controlled by their members and floor traders. Professional broker-dealers,
traders, institutional traders and individuals currently must trade with these
floor members, who are the market makers. These factors result in higher direct
and indirect costs of trade execution.
Traditional Order Execution
Limitation of Traditional Trading Methods. While traditional financial
markets facilitate large volume trading, they have significant shortcomings such
as the following:
o limited direct access and, therefore, many investors may not receive
efficient pricing;
o high transaction costs due to the number of people involved in an
open outcry system;
o slow execution;
o program trading, especially programs designed to automatically and
simultaneously execute multiple trades in different, but related,
financial products, is difficult to implement because of the current
manual nature of these markets;
o significant expense is also incurred in processing, confirming,
clearing and implementing compliance programs designed to monitor
and manage the exposure of individual professionals, as well as the
entire enterprise;
o paper and telephone-based trading produces delayed information and
results in compliance programs that are expensive to manage and can
be circumvented.
Therefore, institutions bear increased risk. These factors impede trading by
limiting volume and liquidity.
Emergence of Electronic Exchanges. Many financial exchanges worldwide,
including certain exchanges in France, Germany, Japan, Sweden, Switzerland and
the United Kingdom, are now partially or completely electronic. In the United
States, however, trading in many types of financial instruments continues to be
conducted primarily on open outcry exchanges. Recently, many exchanges have
introduced side-by-side markets for voice and electronic access and, as a
result, have created separate pools of liquidity. Moreover, substantially all of
the electronic trading systems introduced internationally and in the United
States have been implemented on a regional basis. Most of these systems provide
limited market liquidity and are designed to accommodate trading in one or a
limited number of securities and financial products, typically equity
securities. We believe that wholesale market participants and institutions will
ultimately look for a limited number of marketplaces to meet most of their
trading needs. This is because market participants will not want to work with
multiple trading platforms and connect their information technology platforms
and compliance programs to a large number of disparate systems. We believe the
trend toward electronic trading will continue and will ultimately result in a
majority of markets worldwide becoming fully electronic.
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In addition, recently there has been considerable discussion regarding the
move toward the demutualization of exchanges. Exchanges have historically been
operated on a not-for-profit basis for the benefit of their respective members,
and this governance structure has limited their ability to adopt new
technologies and respond quickly to market changes. In response to technological
advances in trading systems, many exchanges are contemplating the reorganization
of their ownership and management structures and are seeking to form alliances
with strategic partners. These developments have created, and are expected to
continue to create, opportunities for strategic acquisitions and alliances.
Online Trading. Favorable investing environments and advances in
technology have led to the rapid development of online and traditional retail
brokerage businesses. Technological advances have created new and inexpensive
means for individual investors to directly access markets online and participate
in the securities markets. According to International Data Corporation, the
number of online brokerage accounts grew from approximately 1.5 million at the
end of 1996 to over 6.4 million at the end of 1998, representing $324.0 billion
in assets and over 300,000 trades per day, primarily in equity securities.
International Data Corporation also estimates that, by 2002, 30% of investors
will trade online, and there will be over 24 million online accounts, a 275%
increase from 1998. Despite the growth in online accounts and access to public
equity markets, there has been very limited access for retail Internet trading
in fixed income securities, futures, options and other wholesale financial
instruments at cost-effective pricing and spreads. We believe that the emergence
of electronic marketplaces which promote greater liquidity, enhanced access and
more efficient pricing will increase trading among retail investors.
Our Interest Rate Vertical Marketplace Solution
Our private electronic network for wholesale financial markets is
connected to most of the largest financial institutions worldwide. We have
installed in the offices of our existing client base, comprising more than 500
leading dealers, banks and other financial institutions, the technology
infrastructure necessary to provide price information and trade execution on an
instantaneous basis in a broad range of securities and financial instruments. We
believe our eSpeed((Service Mark)) system enables us to introduce and distribute
a broad mix of financial products and services more quickly, cost effectively
and seamlessly than competitors.
Our eSpeed((Service Mark)) system:
o has a flexible design which allows us to quickly and easily add new
financial instruments in multiple currencies and trading models;
o uses a network distribution system, which we believe is one of the
most robust systems in operation, and which enables us to provide
access to a broad mix of accurate, instantaneous market data and
fast and highly reliable trade execution;
o is designed to minimize the need for human intermediaries in the
trading process by providing clients with multiple methods of
accessing our marketplaces and executing trades directly; and
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o uses Interactive Matching((Service Mark)), our proprietary,
rules-based trading method that interactively executes buy and sell
orders from multiple market participants.
These system features enable us to operate what we believe is the only
integrated trading network engaged in electronic trading in multiple products
and marketplaces on a global basis.
We believe our eSpeed((Service Mark)) system provides us with significant
competitive advantages over existing electronic trading systems and new entrants
seeking to develop and introduce limited electronic trading systems to the
global securities and financial instruments marketplaces. We also believe that
the time and expense required to develop and install electronic trading networks
will serve as a significant barrier to entry to many other potential
competitors.
Our Growth Strategy
Our objective is to be the leading provider of interactive electronic
marketplaces in the world. We believe we can extend our expertise in the
creation of instantaneous electronic marketplaces to a broad range of financial
and non-financial products and services. Our growth strategy to achieve this
objective includes the following key elements:
Focus Exclusively on Developing and Operating Interactive Electronic
Marketplaces. We intend to capitalize on the trend toward the increased use of
electronic trading platforms by focusing our business exclusively on the
development and operation of interactive electronic marketplaces worldwide. We
believe this operational focus provides us with a significant advantage over
competitors that have multiple and sometimes conflicting business objectives,
rigid business practices and cumbersome ownership structures that may impede
their ability to efficiently develop and implement electronic trading platforms
of their own.
Leverage Our eSpeed((Service Mark)) System for Use in Other
Business-to-Business and Consumer Markets. Because of the scale of our system
and its ease of adaptability, we believe our eSpeed((Service Mark)) system and
Interactive Matching((Service Mark)) have applications across a broad range of
products, including Internet-based marketplaces for a wide array of goods and
services, particularly those involving multiple buyers and sellers. We are well
positioned to leverage the significant costs and efforts that have been incurred
developing our eSpeed((Service Mark)) system to quickly create electronic
markets in a wide range of products.
Expand the Number of Financial and Non-Financial Products in Our
Electronic Marketplaces. Our electronic marketplaces currently handle the
trading of financial products which have among the highest average annual
trading volumes of all financial products, including U.S. government securities,
U.S. Treasury futures, non-U.S. G-7 government bonds, Eurobonds, corporate
bonds, agency securities, U.K. gilts, emerging markets securities, U.S.,
European and other repurchase agreements and municipal bonds. We plan to
significantly expand the types of securities and financial products traded in
our marketplaces. Our goal is to include in our electronic marketplaces the full
range of fixed income securities, futures, options and other securities and
financial products that are currently traded in today's markets worldwide.
Initially, we will focus our expansion efforts on the securities and financial
instruments traded by Cantor that have not yet been converted to electronic
trading. We expect to further extend our marketplaces to include additional
financial and non-financial products, including energy,
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communications, including bandwidth and telephone minutes and other
decentralized or illiquid markets, through a variety of approaches together with
Cantor or other strategic partners.
Convert Existing Clients to Fully Electronic Trading. Currently, less than
4% of the trades executed daily in our marketplaces, representing more than $6
billion in volume, are executed on a fully electronic basis without the
assistance of a broker. We intend to continue to convert substantially all of
Cantor's clients to a fully electronic trading environment. We believe the ease
of use, low price and efficient execution that our electronic marketplaces
afford will encourage clients to convert their trading to fully electronic
trading. We have a team of over 30 persons dedicated to enhancing client
awareness of the advantages of electronic trading and providing client support
in converting trading activity to a fully electronic trading format, and we
intend to increase that number. We also expect to leverage Cantor's historical
client relationships in connection with these efforts.
Leverage Existing eSpeed((Service Mark)) System Connectivity to Deploy New
Products and Services. Our eSpeed((Service Mark)) system provides connectivity
to, and the opportunity to electronically interact with, a global client base
that includes dealers, banks and financial institutions at hundreds of sites
around the globe. As a result, a significant number of our major clients
currently have installed the hardware necessary to trade on a fully electronic
basis. Utilizing the existing infrastructure and flexible architecture of this
system, we will be able to install with relative ease and at marginal
incremental cost, the components that will enable a client to electronically
trade in additional types of securities and financial products. We expect access
to this existing global private trading network to enable us to introduce and
distribute a broad mix of electronic trading products and services, more
quickly, cost effectively and seamlessly than competitors without access to such
a network.
Creating Online Retail Broker Access to Wholesale Markets for Fixed Income
Securities and Other Financial Products. We intend to create retail
marketplaces, where appropriate, to enable online and traditional retail brokers
to provide their clients with instantaneous access to previously unavailable
wholesale marketplaces for retail trading of fixed income securities, futures,
options and other financial instruments. While retail investors generally have
been able to buy and sell equity securities at the same prices and spreads as
wholesale market participants and institutional investors, this has not been the
case with fixed income securities, futures, options and other financial
instruments. We believe our eSpeed((Service Mark)) system will expand
marketplaces and/or retail volume and enhance execution for individual retail
investors.
Pursue Acquisitions and Strategic Alliances. We intend to capitalize on
the highly fragmented nature of the financial marketplaces and the trends toward
exchange demutualization and consolidation among regional and global market
participants. We expect to pursue an acquisition-based growth program that will
enable us (1) to acquire complementary technologies and service capabilities in
a cost-effective manner and (2) to broaden our product base and the securities
markets in which we provide our electronic trading services. We will seek to
enter into joint ventures and other strategic alliances to create additional
liquidity in the global financial products markets and to attract new trading
participants to those markets. We believe the flexibility afforded by our
corporate governance structure will enable us to implement these strategies, as
well as to anticipate and respond to developments and trends in the global
financial markets, more efficiently than competitors, such as exchanges, which
have broadly dispersed
13
memberships and cumbersome management structures. Additionally, in connection
with our strategy for non-financial marketplaces, we may pursue acquisitions and
strategic alliances to allow us to enter these markets quickly. We also may
pursue acquisitions which may add functionality to our technology offerings.
Sales and Marketing
We expect to promote our electronic marketplaces and brokerage-related
services to Cantor's existing clients and new clients through a combination of
sales, advertising, marketing and co-marketing campaigns. We also expect to
leverage the historical client relationships of Cantor's employees under our
Joint Services Agreement with Cantor. We intend to build and enhance the eSpeed
brand name recognition through a sales, advertising and marketing campaign. We
expect to market to retail clients through a variety of campaigns, including
co-marketing campaigns with our online and traditional retail brokers. We intend
to design our sales, marketing and advertising campaigns to promote brand
awareness and educate the marketplace regarding the nature of our electronic
marketplaces, products and services and the advantages associated with the
automation of trading activities, such as enhanced instantaneous information
flow, price transparency and more direct and cost-effective market access, tight
spreads and instantaneous trade execution.
Our Clients
Clients in our marketplaces include banks, dealers, brokers and other
wholesale market participants, over 500 of which currently participate in our
electronic marketplaces, including the 25 largest bond trading firms in the
world, as identified by Euromoney Magazine. Through our eSpeed((Service Mark))
system, we expect to enable retail brokerage firms to expand their businesses by
providing them with the ability to offer their individual clients the option of
trading bonds and futures electronically in the same way they trade equity
securities, and we expect to include other marketplaces previously unavailable
to retail investors, or not available to them at reasonable spreads or
commissions. We intend to provide to wholesale and retail investors and to
Cantor access to our electronic marketplaces and brokerage-related services
supported by our eSpeed((Service Mark)) system. We expect that a significant
portion of our clients who use brokers will migrate to fully electronic access
over the coming years. We also intend to provide to third parties and to Cantor
the infrastructure, including systems administration, internal network support
and operations and disaster recovery services, that is critical to providing
fully electronic marketplaces for trading in a wide range of financial products.
Other than Cantor, no client of ours accounts for more than 10% of our revenues.
Strategic Alliances
In 1997, Cantor entered into an agreement with the New York Cotton
Exchange, which, upon merging with the Coffee, Sugar & Cocoa Exchange, became
known as the New York Board of Trade. The agreement sets forth the terms and
conditions pursuant to which Cantor operates an electronic marketplace, called
the Cantor Exchange, for futures contracts cleared by and under the regulatory
supervision of the New York Board of Trade. Cantor has assigned to us all of its
rights and obligations under its agreement with a subsidiary of the New York
Board of Trade to jointly operate the Cantor Exchange. Under the agreement, the
New York Board of
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Trade, through its subsidiaries, provides clearing and regulatory services and
we provide electronic execution and related services for the Cantor Exchange.
Pursuant to the agreement, neither we nor our affiliates will during the
term of the agreement establish in the United States an electronic market for
trading futures contracts or options on futures contracts on cotton, cheese,
coffee, sugar, cocoa, milk or frozen orange juice. We have agreed that within
the United States we will exclusively operate for the Cantor Exchange markets
for U.S. Treasury futures and other products so designated by the Cantor
Exchange. We and our affiliates may establish any electronic market that is
located physically outside the United States for such products if the New York
Board of Trade is not capable of providing regulatory or clearing services with
respect to such products.
Software Development
We devote substantial efforts to the development and improvement of our
electronic marketplaces. We will work with our clients to identify their
specific needs and make modifications to our software, network distribution
systems and technologies which are responsive to those needs. We are pursuing a
four-pronged approach to our research and development efforts: (1) internal
development; (2) strategic partnering; (3) acquisitions; and (4) licensing. We
have approximately 200 persons involved in our internal software development
efforts. Our technology team's objective will be to develop new products and
services that employ proven technology designed to provide superior electronic
trade execution and marketplace services to our clients. We will also focus our
efforts on enhancing our Web site and Internet screen interface to facilitate
real-time markets, comply with the standard Internet security protocol and
future security protocols and migrate transactions to the public networks in
order to capitalize on the development of new commercial marketplaces. We are
continuing to develop new marketplaces and products using our internally
developed application software having open architecture and standards. In
addition, we have forged strategic alliances with organizations such as
Sungard/ASC and QV Trading through which we will work to develop sophisticated,
front-end trading applications and products. We expect to license products from
and to companies when it is cost effective or profitable to do so.
Competition
The development and operation of electronic trading marketplaces are
evolving. As a result, competition in these marketplaces is currently very
fragmented. We expect to face competition from a number of different sources
varying in size, business objectives and strategy.
In the Interest Rate Vertical, our eSpeed((Service Mark)) system currently
competes, and we expect it to compete, directly and indirectly, with:
o traditional trading methods, including manual buy/sell order input
by registered brokers in response to telephone originated requests
and execution of trades in open outcry trading pits on exchange
floors, such as the Chicago Board of Trade, the Chicago Mercantile
Exchange and other exchanges and over-the-counter markets;
15
o products developed and used by exchanges and financial services
firms, such as Liberty Brokerage Investment Corporation and
Garban-Intercapital plc, seeking to act as market intermediaries;
o automated trade execution services developed by third party vendors
for commercialization in a wide range of financial products markets;
o products and services of market data, information and communication
vendors, such as Reuters Group plc, Bloomberg L.P. and Bridge
Information Systems Inc., that have created electronic networks
which link them to most major financial institutions and that have
attempted, in some cases, to expand their networks to include
trading platforms; and
o consortia comprised of leading financial institutions and service
providers, such as BrokerTec Global LLC, which has announced its
intention to explore the development of electronic trading networks,
and EuroMTS.
In the business-to-business sector in general, we compete, directly and
indirectly, with:
o business-to-business marketplace infrastructure companies like Ariba
and CommerceOne, as well as with other Internet-based marketplace
trading and infrastructure platforms; and
o Niche market Internet-based trading systems, including AltraEnergy
Trading and HoustonStreet.
The electronic trading services we provide our wholesale clients enable
them to expand the range of services they provide to their ultimate customers,
which are also potential participants in our electronic marketplaces. We intend
to structure our relationships with our clients and conduct our operations to
mitigate the potential for this competition. We do not intend to use the access
to the customer base of our wholesale clients that we obtain in providing our
electronic trading services to compete with these wholesale clients in other
securities and financial instrument transactions.
We believe our electronic marketplaces will compete primarily on the basis
of speed, efficiency, price and ability to provide access to liquidity to market
participants.
Our Intellectual Property
We have adopted a comprehensive intellectual property protection program
to protect our proprietary technology. We currently have licenses covering four
of Cantor's patents in the United States. One patent relates to a data
processing system and method for electronically trading select items such as
fixed income instruments. Two patents relate to a fixed income portfolio index
processor. One patent relates to a system for shared remote access of multiple
application programs by one or more computers. Foreign counterpart applications
for some of these U.S. patents have been filed. The licenses are exclusive,
except in the event that we do not
16
seek to or are unable to provide to Cantor any requested services covered by the
patents and Cantor elects not to require us to do so.
We also have an agreement to license several pending U.S. patent
applications relating to various other aspects of our electronic trading
systems, including both functional and design aspects. Additional patent
applications likely will be filed in the near future to further protect our
proprietary technology.
We cannot at this time determine the significance of any of the foregoing
patents, or future patents, if issued, to our business. We can give no assurance
that any of the foregoing patents is valid and enforceable, or that any of these
patents would not be infringed by a third party competing or seeking to compete
with our business.
Regulation
The securities industry and financial markets in the United States and
elsewhere are subject to extensive regulation. As a service provider to the
securities industry and financial markets, and as a registered broker-dealer,
our business activities fall within the scope of these regulations.
Regulation of the U.S. Securities Industry and Broker-Dealers.
As a matter of public policy, regulatory bodies in the United States and
the rest of the world are charged with safeguarding the integrity of the
securities and other financial markets and with protecting the interests of
investors participating in those markets. In the United States, the Securities
and Exchange Commission is the federal agency responsible for the administration
of the federal securities laws. Our regulated U.S. subsidiaries, eSpeed
Securities, Inc. and eSpeed Government Securities, Inc., are registered with the
Securities and Exchange Commission as broker-dealers. They are also members of
the National Association of Securities Dealers, Inc., a self regulatory body to
which most broker-dealers belong. Certain self-regulatory organizations, such as
the National Association of Securities Dealers, Inc., adopt rules and examine
broker-dealers and require strict compliance with their rules and regulations.
The Securities and Exchange Commission and self-regulatory organization rules
cover many aspects of a broker-dealer's business, including capital structure
and withdrawals, sales methods, trade practices among broker-dealers, use and
safekeeping of customer's funds and securities, record-keeping, the financing of
clients' purchases, broker-dealer and employee registration and the conduct of
directors, officers and employees. In connection with a violation of these
rules, the Securities and Exchange Commission, self-regulatory organizations and
state securities commissions may conduct administrative proceedings which can
result in censure, fine, the issuance of cease-and-desist orders or the
suspension or expulsion of a broker-dealer, its officers or employees.
Effect of Net Capital Requirements. The Securities and Exchange Commission
and the National Association of Securities Dealers, Inc. impose rules that
require notification when net capital falls below certain predefined criteria,
dictate the ratio of debt to equity in the regulatory capital composition of a
broker-dealer and constrain the ability of a broker-dealer to expand its
business under certain circumstances. Additionally, the Uniform Net Capital Rule
and the National Association of Securities Dealers, Inc. rules impose certain
requirements that may have
17
the effect of prohibiting a broker-dealer from distributing or withdrawing
capital and requiring prior notice to the Securities and Exchange Commission and
the National Association of Securities Dealers, Inc. for certain withdrawals of
capital.
Through our broker-dealer subsidiary, eSpeed Government Securities, Inc.,
we are subject to SEC broker-dealer regulation under Section 15C of the
Securities Exchange Act of 1934, which requires the maintenance of minimum
liquid capital, as defined. At December 31, 1999, eSpeed Government Securities,
Inc.'s liquid capital of $1,536,699 was in excess of minimum requirements by
$1,511,699. Additionally, our other broker-dealer subsidiary, eSpeed Securities,
Inc., is subject to SEC broker-dealer regulation under Rule 17a-5 of the
Securities Exchange Act of 1934, which requires the maintenance of minimum net
capital and requires that the ratio of aggregate indebtedness to net capital,
both as defined, shall not exceed 8 to 1. At December 31, 1999, eSpeed
Securities, Inc. had net capital of $1,048,849, which was $572,325 in excess of
its required capital of $476,524. eSpeed Securities, Inc.'s net capital ratio
was 3.63 to 1.
Application of Exchange Act to Internet Business. The Securities Exchange
Act of 1934 governs, among other things, the operation of the financial products
markets and broker-dealers. When enacted, the Securities Exchange Act of 1934
did not contemplate the conduct of a securities business throughout the
Internet. Although the Securities and Exchange Commission, in releases and
no-actions letters, has provided guidance on various issues related to the
conduct of a securities business through the Internet, the application of the
laws to the conduct of a securities business through the Internet continues to
evolve. Uncertainty regarding these issues may adversely affect the viability
and profitability of our business.
Financial Futures and Options. Financial futures and options in financial
futures are subject to regulation by the Commodity Futures Trading Commission
under the Commodity Exchange Act, and exchanges that provide facilities for the
trading of those products are also subject to Commodity Futures Trading
Commission regulation. As a service provider to the Cantor Exchange((Service
Mark)), a futures exchange that is a designated contract market under the
Commodity Exchange Act, we could be adversely affected by changes in laws or
regulations governing the products or clients of the Cantor Exchange((Service
Mark)).
Exchange Regulation. Securities exchanges must register with the
Securities and Exchange Commission and comply with various requirements of the
Securities Exchange Act of 1934. Effective April 1999, new rules expanded the
scope of exchange regulation to include many brokerage matching and execution
systems, such as the matching systems that we support. The new rules impose
various requirements relating to fair access, capacity, security, record-keeping
and reporting. Our subsidiaries expect to comply with these requirements.
Although we do not expect the compliance costs to be significant, our
subsidiaries could encounter unforeseen expenses associated with operation of
these rules.
Regulation of the Non-U.S. Securities Industries and Investment Service
Providers.
The securities industry and financial markets in the European Union and
elsewhere are subject to extensive regulation. As the owner and operator of
electronic marketplaces for the securities industry and financial markets, our
business activities may fall within the scope of
18
those regulations depending upon the extent to which we are characterized as
providing a regulated investment service.
The securities industry in the member states of the European Union is
extensively regulated by agencies in each member state. European Union measures
provide for the mutual recognition of regulatory agencies and of prudential
supervision making possible the grant of a single authorization for the provider
of investment services which, broadly, is valid throughout the European Union.
As an investment service provider in the United Kingdom, our principal regulator
would be the Securities and Futures Authority. The conduct of an investment
business is also regulated by agencies in each of the other member states in
which we may provide investment services. The provision of investment services
is also regulated by other agencies in other jurisdictions in which we operate
such as the Securities and Futures Commission in Hong Kong and the local
government agency delegated by the Japanese Financial Supervisory Agency in
Japan.
As a matter of public policy, regulatory bodies in the European Union and
the rest of the world are charged with safeguarding the integrity of the
securities and other financial markets and with protecting the interests of
investors participating in those markets. We are seeking authorization from the
Securities and Futures Authority to provide investment services in the United
Kingdom and we intend to exercise our rights under the European Union Investment
Services Directive to provide such investment services throughout the European
Union. Similar authorization applications will be made in other jurisdictions,
such as Hong Kong and Japan, where such authorization is necessary to operate an
electronic marketplace.
The Securities and Futures Authority and other regulatory agencies in the
European Union may conduct administrative proceedings which can result in
censure, fine, the prevention of activities or the suspension or expulsion of an
investment services provider. The applicable investment service regulations
cover minimum financial resource requirements and conduct of business rules for
all authorized investment businesses.
Investment exchanges may be operated and authorized as investment
businesses in the European Union, subject to the provision of the Investment
Services Directive. Alternatively, investment exchanges can obtain authorization
as an investment exchange from each member state in the European Union in
accordance with the applicable regulations of that member state.
Changes in Existing Laws and Rules. Additional legislation or regulation,
changes in existing laws and rules or changes in the interpretation or
enforcement of existing laws and rules, either in the United States or
elsewhere, may directly affect our mode of operation and our profitability.
Employees
As of December 31, 1999, we had 370 employees, five of whom are our
executive officers. None of these employees is represented by a union. We
believe that we have good relations with our employees.
19
RISK FACTORS
An investment in our company involves a high degree of risk. You should
carefully consider the risks below, together with the other information
contained in this report, before you decide to invest in our company. If any of
the following risks occur, our business, results of operations and financial
condition could be harmed, the trading price of our Class A common stock could
decline, and you could lose all or part of your investment.
RISKS RELATED TO OUR COMPANY AND OUR BUSINESS
Because we have a limited operating history, you may not be able to accurately
evaluate eSpeed.
We are a recently formed company. We have had limited operations to date
and, as a result, we have a limited operating history upon which to evaluate the
merits of investing in our Class A common stock. As an early stage company, we
are subject to risks, expenses and difficulties associated with implementing our
business plan that are not typically encountered by more mature companies. In
particular, our prospects are subject to risks, expenses and uncertainties
encountered by companies in the new and rapidly evolving market for electronic
commerce products and services. These risks include our failure or inability to:
o provide services to our clients that are reliable and cost-effective;
o expand our sales structure and marketing programs;
o increase awareness of our brand or market positioning; and
o respond to technological developments or service offerings by competitors.
We may not be able to implement our business plan successfully, or at all.
Because we have a history of losses, we expect to continue to incur losses and
generate negative cash flow from operations for the foreseeable future.
Since our inception, we have incurred substantial costs to develop our
technology and infrastructure. As a result, from our inception through December
31, 1999, we have sustained cumulative net losses of approximately $12.6
million. We expect that we will continue to incur losses and generate negative
cash flow from operations for the foreseeable future as we continue to develop
our systems and infrastructure and expand our brand recognition and client base
through increased marketing efforts.
If we do not expand the use of our electronic systems, or if our and Cantor's
clients do not use our marketplaces or services, our revenues and profitability
will be adversely affected.
The use of electronic marketplaces is relatively new. The success of our
business plan depends, in part, on our ability to maintain and expand the
network of brokers, dealers, banks and other financial institutions that will
use our interactive electronic marketplaces. We cannot assure you that we will
be able to continue to expand our marketplaces, or that we will be able to
20
retain the current participants in our marketplaces. None of our agreements with
market participants require them to use our electronic marketplaces.
If we are unable to enter into marketing and strategic alliances, we may not
generate increased trading in our electronic marketplaces.
We expect to enter into strategic alliances with other market
participants, such as retail brokers, exchanges, market makers, clearinghouses
and technology companies, in order to increase client access to and use of our
electronic marketplaces. We cannot assure you that we will be able to enter into
these strategic alliances on terms that are favorable to us, or at all. The
success of these relationships will depend on the amount of increased trading in
our electronic marketplaces by the clients of these strategic alliance partners.
These arrangements may not generate the expected number of new clients or
increased trading volume we are seeking.
To increase awareness of our electronic marketplaces, we may need to incur
significant marketing expenses.
To successfully execute our business plan, we must build awareness and
understanding of our electronic marketplace services, brand and the adaptability
of our electronic marketplaces for non-financial products. In order to build
this awareness, our marketing efforts must succeed and we must provide
high-quality services. These efforts will require us to incur significant
expenses. We cannot assure you that our marketing efforts will be successful or
that the allocation of funds to these marketing efforts will be the most
effective use of those funds.
If we experience computer systems failures or capacity constraints, our ability
to conduct our operations could be harmed.
We internally support and maintain many of our computer systems and
networks. Our failure to monitor or maintain these systems and networks or, if
necessary, to find a replacement for this technology in a timely and
cost-effective manner, would have a material adverse effect on our ability to
conduct our operations.
We also rely and expect to rely on third parties for various computer and
communications systems, such as telephone companies, online service providers,
data processors, clearance organizations and software and hardware vendors. Our
systems, or those of our third party providers, may fail or operate slowly,
causing one or more of the following:
o unanticipated disruptions in service to our clients;
o slower response times;
o delays in our clients' trade execution;
o failed settlement by clients to whom we provide services to
facilitate settlement operations;
o decreased client service satisfaction;
21
o incomplete or inaccurate accounting, recording or processing of
trades;
o financial losses;
o litigation or other client claims; and
o regulatory sanctions.
We cannot assure you that we will not experience systems failures from
power or telecommunications failure, acts of God or war, human error, natural
disasters, fire, power loss, sabotage, hardware or software malfunctions or
defects, computer viruses, intentional acts of vandalism and similar events. The
assets acquired by us from Cantor in the formation transactions have been
acquired by us "as is." Although Cantor used in its business the systems and
technology it transferred to us in connection with the formation transactions,
there can be no assurance that such systems and technology were or are entirely
free from defects. To the extent any defects are discovered, we will not have
any recourse against Cantor. Any system failure that causes an interruption in
service or decreases the responsiveness of our service, including failures
caused by client error or misuse of our systems, could damage our reputation,
business and brand name.
If we do not effectively manage our growth, our existing personnel and systems
may be strained and our business may not operate efficiently.
In order to execute our business plan, we must grow significantly. This
growth will place significant strain on our personnel, management systems and
resources. We expect that the number of our employees, including technical and
management-level employees, will continue to increase for the foreseeable
future. We must continue to improve our operational and financial systems and
managerial controls and procedures, and we will need to continue to expand,
train and manage our technical workforce. We must also maintain close
coordination among our technical, compliance, accounting, finance and marketing
and sales organizations. We cannot assure you that we will manage our growth
effectively, and failure to do so could result in our business operating
inefficiently.
If we are unable to keep up with rapid technological changes, we may not be able
to compete effectively.
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality, accessibility and features of our proprietary
software, network distribution systems and technologies. The financial services
and e-commerce industries are characterized by rapid technological change,
changes in use and client requirements and preferences, frequent product and
service introductions embodying new technologies and the emergence of new
industry standards and practices that could render our existing proprietary
technology and systems obsolete. Our success will depend, in part, on our
ability to:
o develop and license leading technologies useful in our business;
o enhance our existing services;
22
o develop new services and technologies that address the increasingly
sophisticated and varied needs of our existing and prospective
clients; and
o respond to technological advances and emerging industry standards
and practices on a cost-effective and timely basis.
The development of proprietary electronic trading technology entails
significant technical, financial and business risks. Further, the adoption of
new Internet, networking or telecommunications technologies may require us to
devote substantial resources to modify and adapt our services. We cannot assure
you that we will successfully implement new technologies or adapt our
proprietary technology and transaction-processing systems to client requirements
or emerging industry standards. We cannot assure you that we will be able to
respond in a timely manner to changing market conditions or client requirements.
If we were to lose the services of members of management and employees who
possess specialized market knowledge and technology skills, we may not be able
to manage our operations effectively or develop new electronic marketplaces.
Our future success depends, in significant part, on the continued service
of Howard Lutnick, our Chairman and Chief Executive Officer, Frederick Varacchi,
our President and Chief Operating Officer, and our other executive officers and
managers and sales and technical personnel who possess extensive financial
markets knowledge and technology skills. We cannot assure you that we would be
able to find an appropriate replacement for Mr. Lutnick or Mr. Varacchi if the
need should arise. Any loss or interruption of Mr. Lutnick's or Mr. Varacchi's
services could result in our inability to manage our operations effectively
and/or develop new electronic marketplaces. We have not entered into employment
agreements with and we do not have "key person" life insurance policies on any
of our officers or other personnel. All of the members of our senior management
team are also officers, partners or key employees of Cantor. As a result, they
dedicate only a portion of their professional efforts to our business and
operations. We cannot assure you that the time these persons devote to our
business and operations in the future will be adequate and that we will not
experience an adverse effect on our operations due to the demands placed on our
management team by their other professional obligations. We intend to strive to
provide high quality services that will allow us to establish and maintain
long-term relationships with our clients. Our ability to do so will depend, in
large part, upon the individual employees who represent us in our dealings with
clients. The market for qualified programmers, technicians and sales persons is
extremely competitive and has grown more so in recent periods as electronic
commerce has experienced growth. We cannot assure you that we will be successful
in our efforts to recruit and retain the required personnel.
If Cantor or we are unable to protect the intellectual property rights we
license from Cantor or own, our ability to operate electronic trading
marketplaces may be materially adversely affected.
Our business is dependent on proprietary technology and other intellectual
property rights. We license our patented technology from Cantor. The license
arrangement is exclusive, except in the event that (1) we are unwilling to
provide to Cantor any requested services covered by the patents with respect to
a marketplace and Cantor elects not to require us to do so, or we
23
are unable to provide such services or (2) we do not exercise our right of first
refusal to provide to Cantor electronic brokerage services with respect to a
marketplace, in which case Cantor retains a limited right to use the patents and
patent applications solely in connection with the operation of that marketplace.
We cannot guarantee that the concepts which are the subject of the patents and
patent applications covered by the license from Cantor are patentable or that
issued patents are or will be valid and enforceable. Where patents are granted
in the U.S., we can give no assurance that equivalent patents will be granted in
Europe or elsewhere, as a result of differences in local laws affecting
patentability and validity. Moreover, we cannot guarantee that Cantor's issued
patents are valid and enforceable, or that third parties competing or intending
to compete with us will not infringe any of these patents. Despite precautions
we or Cantor has taken or may take to protect our intellectual property rights,
it is possible that third parties may copy or otherwise obtain and use our
proprietary technology without authorization. It is also possible that third
parties may independently develop technologies similar to ours. It may be
difficult for us to monitor unauthorized use of our proprietary technology and
intellectual property rights. We cannot assure you that the steps we have taken
will prevent misappropriation of our technology or intellectual property rights.
We intend to use our eSpeed service mark for the services described herein
and have applied to register that service mark in a number of jurisdictions
around the world. Although several existing third party registrations and
applications for trademarks consisting of designations similar to ours in
certain European countries have recently come to light, they are for goods and
services that are different from those being offered under our eSpeed service
mark. Although we are not presently aware of any third party objections to our
use or registration of our eSpeed service mark in these countries, and believe
we could defend against any third party claims asserted in these countries, such
registrations and applications could potentially affect the registration, and/or
limit our use, of our eSpeed service mark in these European countries, thereby
requiring us to adopt and use another service mark for our services in such
countries.
If it becomes necessary to protect or defend our intellectual property rights,
we may have to resort to costly litigation.
We may have to resort to litigation to enforce our intellectual property
rights, protect our trade secrets, determine the validity and scope of the
proprietary rights of others or defend ourselves from claims of infringement,
invalidity or unenforceability. We may incur substantial costs and diversion of
resources as a result of litigation, even if we win. In the event we do not win,
we may have to enter into royalty or licensing agreements. We cannot assure you
that an agreement would be available to us on reasonable terms, if at all.
One of the patents we license from Cantor and which relates to Interactive
Matching((Service Mark)) is currently the subject of litigation involving
Liberty Brokerage Investment Corporation and Liberty Brokerage Inc. This patent
is exclusively licensed to us subject to certain conditions. We have assumed
responsibility for defending this suit on behalf of Cantor and its affiliates.
We have also agreed to indemnify Cantor with respect to all costs arising in
connection with or relating to this lawsuit, including any damages or judgments.
We cannot assure you that any of the patents owned or licensed by us will be
upheld by a court as valid and/or enforceable.
24
If our software licenses from third parties are terminated, our ability to
operate our business may be materially adversely affected.
We license software from third parties, much of which is integral to our
systems and our business. The licenses are terminable if we breach our
obligations under the license agreements. If any of these relationships were
terminated or if any of these third parties were to cease doing business, we may
be forced to spend significant time and money to replace the licensed software.
However, we cannot assure you that the necessary replacements will be available
on reasonable terms, if at all.
If the strength of our domain names is diluted, the value of our proprietary
rights may decrease.
We own many Internet domain names including "www.espeed.com." The
regulation of domain names in the United States and in foreign countries may
change and the strength of our names could be diluted. We may not be able to
prevent third parties from acquiring domain names that infringe or otherwise
decrease the value of our trademarks and other proprietary rights.
If we infringe on patent rights or copyrights of others, we could become
involved in costly litigation.
Patents or copyrights of third parties may have an important bearing on
our ability to offer certain of our products and services. We cannot assure you
that we are or will be aware of all patents or copyrights containing claims that
may pose a risk of infringement by our products and services. In addition,
patent applications in the United States are generally confidential until a
patent is issued. As a result, we cannot evaluate the extent to which our
products and services may be covered or asserted to be covered by claims
contained in pending patent applications. In general, if one or more of our
products or services were to infringe patents held by others, we may be required
to stop developing or marketing the products or services, to obtain licenses to
develop and market the services from the holders of the patents or to redesign
the products or services in such a way as to avoid infringing on the patent
claims, which could limit the manner in which we conduct our operations.
Due to intense competition in our industry, our market share and financial
performance could suffer.
The electronic trading and Internet-based financial services markets are
highly competitive and many of our competitors are more established and have
greater financial resources than us. We expect that competition will intensify
in the future. Many of our competitors also have greater market presence,
engineering and marketing capabilities and technological and personnel resources
than we do. As a result, as compared to us, our competitors may:
o develop and expand their network infrastructures and service
offerings more efficiently or more quickly;
25
o adapt more swiftly to new or emerging technologies and changes in
client requirements;
o take advantage of acquisitions and other opportunities more
effectively;
o devote greater resources to the marketing and sale of their products
and services; and
o more effectively leverage existing relationships with clients and
strategic partners or exploit more recognized brand names to market
and sell their services.
Our current and prospective competitors are numerous and include:
o Interdealer brokerage firms, including Liberty Brokerage Investment
Corporation and Garban-Intercapital plc.
o Technology companies and market data and information vendors,
including Reuters Group plc, Bloomberg L.P. and Bridge Information
Systems, Inc.;
o Securities or futures exchanges or similar entities, including the
Chicago Board of Trade, the Chicago Mercantile Exchange, the Chicago
Board of Options Exchange, Eurex, the New York Stock Exchange and
the Nasdaq National Market;
o Electronic communications networks, crossing systems and similar
entities such as Investment Technology Group and Optimark
Technologies Inc.; and
o Consortia such as BrokerTec Global LLC and EuroMTS.
We believe that we may also face competition from large computer software
companies, media and technology companies and some securities brokerage firms
that are currently our clients. In addition, Market Data Corporation, which is
controlled by Iris Cantor and Rodney Fisher, has technology for electronic
trading systems that, if provided to our competitors in the wholesale market,
will be of substantial assistance to them in competing with us. Iris Cantor and
Rod Fisher are limited partners of Cantor.
The number of businesses providing Internet-based financial services is
rapidly growing, and other companies, in addition to those named above, have
entered into or are forming joint ventures or consortia to provide services
similar to those provided by us. Others may acquire the capabilities necessary
to compete with us through acquisitions.
In the event we extend the application of our Interactive
Matching((Service Mark)) technology to conducting or facilitating auctions of
consumer goods and services over the Internet, we expect to compete with both
online and traditional sellers of these products and services. The market for
selling products and services over the Internet is new, rapidly evolving and
intensely competitive. Current and new competitors can launch new sites at a
relatively low cost. We expect we will potentially compete with a variety of
companies with respect to each product or service we offer. We may face
competition from e-Bay, priceline.com, Amazon.com and a number of other large
Internet companies that have expertise in developing online commerce and in
facilitating Internet
26
traffic, including America Online, Microsoft and Yahoo!, which could choose to
compete with us either directly or indirectly through affiliations with other
e-commerce companies. We cannot assure you that we will be able to compete
effectively with such companies.
Because some of our clients may develop electronic trading networks, we could
compete with them in aspects of our business.
Consortia owned by some of our clients have announced their intention to
explore the development of electronic trading networks. BrokerTec Global LLC, a
proposed electronic inter-dealer fixed income broker whose members include
Citigroup, Credit Suisse First Boston, Deutsche Bank AG, Goldman Sachs Group,
Lehman Brothers, Merrill Lynch & Co., Dresdner Kleinwort Benson, ABN-AMRO and
Morgan Stanley Dean Witter, has announced its intention to develop or acquire a
facility for electronic trading of U.S. Treasury securities, Euro-denominated
sovereign debt and other fixed income securities and futures-related products.
All of the members of BrokerTec Global LLC are currently clients of Cantor and
ours. Consortia such as BrokerTec Global LLC may compete with us and our
electronic marketplaces in the future. We currently compete with a similar
consortium called EuroMTS in Europe. The members of EuroMTS include the leading
fixed income dealers in European government securities, as well as clients of
Cantor and ours. Additionally, in the non-financial business-to-business
marketplaces, we compete with Ariba, CommerceOne, AltraEnergy Trading and
HoustonStreet, as well as with other Internet-based trading and infrastructure
platforms.
If we experience low trading volume in securities and financial products, our
profitability could suffer.
We have experienced significant fluctuations in the aggregate trading
volume of securities and financial products being traded in our marketplaces. We
expect that fluctuations in the trading volume of securities and financial
products traded in our marketplaces will occur in the future from time to time
and have a direct impact on our future operating results. This may cause
significant fluctuations in our profitability when the trading volumes are low.
If adverse economic and political conditions occur, substantial declines in the
U.S. and global financial services markets may result and our profitability
could suffer.
The global financial services business is, by its nature, risky and
volatile and is directly affected by many national and international factors
that are beyond our control. Any one of these factors may cause a substantial
decline in the U.S. and global financial services markets, resulting in reduced
trading volume and turnover. These events could materially adversely affect our
profitability. These factors include:
o economic and political conditions in the United States and elsewhere
in the world;
o concerns over inflation and wavering institutional/consumer
confidence levels;
o the availability of cash for investment by mutual funds and other
wholesale and retail investors;
o rising interest rates;
27
o fluctuating exchange rates;
o legislative and regulatory changes; and
o currency values.
In the past several years, the U.S. financial markets have achieved
historic highs. We do not believe these strong markets can continue
indefinitely. Our revenues and profitability are likely to decline significantly
during periods of stagnant economic conditions or low trading volume in the U.S.
and global financial markets.
Because we expect to continue to expand our operations outside North America, we
may face special economic and regulatory challenges that we may not be able to
meet.
We operate electronic marketplaces throughout Europe and Asia and we plan
to further expand our operations throughout these regions in the future. There
are certain risks inherent in doing business in international markets,
particularly in the regulated brokerage industry. These risks include:
o less developed automation in exchanges, depositories and national
clearing systems;
o unexpected changes in regulatory requirements, tariffs and other
trade barriers;
o difficulties in staffing and managing foreign operations;
o fluctuations in currency exchange rates;
o reduced protection for intellectual property rights;
o seasonal reductions in business activity during the summer months;
and
o potentially adverse tax consequences.
We are required to comply with the laws and regulations of foreign
governmental and regulatory authorities of each country in which we conduct
business. These may include laws, rules and regulations relating to any aspect
of the securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of clients' funds and securities, capital
structure, record-keeping, the financing of clients' purchases, broker-dealer
and employee registration requirements and the conduct of directors, officers
and employees. Any failure to develop effective compliance and reporting systems
could result in regulatory penalties in the applicable jurisdiction.
The growth of the Internet as a means of conducting international business
has also raised many legal issues regarding, among other things, the
circumstances in which countries or other jurisdictions have the right to
regulate Internet services that may be available to their citizens from service
providers located elsewhere. In many cases, there are no laws, regulations,
judicial decisions or governmental interpretations that clearly resolve these
issues. This uncertainty may adversely affect our ability to use the Internet to
expand our international operations, and creates
28
the risk that we could be subject to disciplinary sanctions or other penalties
for failure to comply with applicable laws or regulations.
If we enter new markets, we may not be able to successfully adapt our technology
and marketing strategy for use in those markets.
We intend to leverage our eSpeed((Service Mark)) system and Cantor's
relationships to enter new markets. We cannot assure you that we will be able to
successfully adapt our proprietary software, electronic distribution networks
and technology for use in other markets. Even if we do adapt our software,
networks and technology, we cannot assure you that we will be able to attract
clients and compete successfully in any such new markets. We cannot assure you
that our marketing efforts or our pursuit of any of these opportunities will be
successful. If these efforts are not successful, we could suffer losses while
developing new marketplaces or realize less than expected earnings, which in
turn could result in a decrease in the market value of our Class A common stock.
Furthermore, these efforts may divert management attention or inefficiently
utilize our resources. We intend to create electronic marketplaces for many
financial products by the end of 2000, but there is no guarantee that we will be
able to do so.
If we acquire other companies, we may not be able to integrate their operations
effectively.
Our business strategy contemplates expansion through the acquisition of
exchanges and other companies providing services or having technologies and
operations that are complementary to ours. Acquisitions entail numerous risks,
including:
o difficulties in the assimilation of acquired operations and
products;
o diversion of management's attention from other business concerns;
o assumption of unknown material liabilities of acquired companies;
o amortization of acquired intangible assets, which would reduce
future reported earnings; and
o potential loss of clients or key employees of acquired companies.
We cannot assure you that we will be able to integrate successfully any
operations, personnel, services or products that might be acquired in the
future, and our failure to do so could adversely affect our profitability and
the value of our Class A common stock.
Because our business is subject to extensive government and other regulation, we
may face restrictions with respect to the way we conduct our operations.
The Securities and Exchange Commission, National Association of Securities
Dealers, Inc., Commodity Futures Trading Commission and other agencies
extensively regulate the U.S. securities industry. Our international operations
may be subject to similar regulations in specific jurisdictions. Our U.S.
subsidiaries are required to comply strictly with the rules and regulations of
these agencies. As a matter of public policy, these regulatory bodies are
responsible for safeguarding the integrity of the securities and other financial
markets and protecting the
29
interests of investors in those markets. Most aspects of our U.S. broker-dealer
subsidiaries are highly regulated, including:
o the way we deal with our clients;
o our capital requirements;
o our financial and Securities and Exchange Commission reporting
practices;
o required record keeping and record retention procedures;
o the licensing of our employees; and
o the conduct of our directors, officers, employees and affiliates.
If we fail to comply with any of these laws, rules or regulations, we may
be subject to censure, fines, cease-and-desist orders, suspension of our
business, suspensions of personnel or other sanctions, including revocation of
registration as a broker-dealer. Changes in laws or regulations or in
governmental policies could have a material adverse effect on the conduct of our
business. These agencies have broad powers to investigate and enforce compliance
and punish non-compliance with their rules and regulations. We cannot assure you
that we and/or our directors, officers and employees will be able to fully
comply with, and will not be subject to, claims or actions by these agencies.
The consumer products and services we anticipate offering through our
electronic marketplaces are likely to be regulated by federal and state
governments. Our ability to provide such services will be affected by these
regulations. The implementation of unfavorable regulations or unfavorable
interpretations of existing regulations by courts or regulatory bodies could
require us to incur significant compliance costs or cause the development of
affected markets to become impractical.
Because we are subject to risks associated with net capital requirements, we may
not be able to engage in operations that require significant capital.
The Securities and Exchange Commission, Commodity Futures Trading
Commission and various other regulatory agencies have stringent rules and
regulations with respect to the maintenance of specific levels of net capital by
broker-dealers. Net capital, which is assets minus liabilities, is the net worth
of a broker or dealer, less deductions for certain types of assets. If a firm
fails to maintain the required net capital, it may be subject to suspension or
revocation of registration by the Securities and Exchange Commission or
Commodity Futures Trading Commission, and suspension or expulsion by these
regulators could ultimately lead to the firm's liquidation. If these net capital
rules are changed or expanded, or if there is an unusually large charge against
net capital, operations that require the intensive use of capital would be
limited. Also, our ability to withdraw capital from broker-dealer subsidiaries
could be restricted, which in turn could limit our ability to pay dividends,
repay debt and redeem or purchase shares of our outstanding stock. A large
operating loss or charge against net capital could adversely affect our
30
ability to expand or even maintain our present levels of business, which could
have a material adverse effect on our business.
Because we intend to offer access to some of our marketplaces to online retail
brokers, we are subject to risks relating to uncertainty in the regulation of
the Internet.
There are currently few laws or regulations that specifically regulate
communications or commerce on the Internet. However, laws and regulations may be
adopted in the future that address issues such as user privacy, pricing,
taxation and the characteristics and quality of products and services. For
example, the Telecommunications Act sought to prohibit transmitting various
types of information and content over the Internet. Several telecommunications
companies have petitioned the Federal Communications Commission to regulate
Internet service providers and online service providers in a manner similar to
long distance telephone carriers and to impose access fees on those companies.
This could increase the cost of transmitting data over the Internet. Moreover,
it may take years to determine the extent to which existing laws relating to
issues such as property ownership, libel and personal privacy are applicable to
the Internet. Any new laws or regulations relating to the Internet could
adversely affect our business.
Because brokerage services involve substantial risks of liability, we may become
subject to risks of litigation.
Many aspects of our business, and the businesses of our clients, involve
substantial risks of liability. Dissatisfied clients frequently make claims
regarding quality of trade execution, improperly settled trades, mismanagement
or even fraud against their service providers. We and our clients may become
subject to these claims as the result of failures or malfunctions of systems and
services provided by us and may seek recourse against us. We could incur
significant legal expenses defending claims, even those without merit. An
adverse resolution of any lawsuits or claims against us could result in our
obligation to pay substantial damages.
In addition, we may also become subject to legal proceedings and claims
against Cantor and its affiliates as a result of the formation transactions.
Although Cantor has agreed to indemnify us against claims or liabilities arising
from our assets or operations prior to the formation transactions, we cannot
assure you that such claims or litigation will not harm our business.
If we cannot deter employee misconduct, we may be harmed.
There have been a number of highly publicized cases involving fraud or
other misconduct by employees in the financial services industry in recent
years, and we run the risk that employee misconduct could occur. Misconduct by
employees could include hiding unauthorized or unsuccessful activities from us.
In either case, this type of conduct could result in unknown and unmanaged risks
or losses. Employee misconduct could also involve the improper use of
confidential information, which could result in regulatory sanctions and serious
reputational harm. It is not always possible to deter employee misconduct, and
the precautions we take to prevent and detect this activity may not be effective
in all cases.
31
Because our business is developing, we cannot predict our future capital needs
or our ability to secure additional financing.
We anticipate, based on management's experience and current industry
trends, that our existing cash resources, combined with the net proceeds we
received from our initial public offering, will be sufficient to meet our
anticipated working capital and capital expenditure requirements for at least
the next 12 months. However, we believe that there are a significant number of
capital intensive opportunities for us to maximize our growth and strategic
position, including, among other things, acquisitions, joint ventures, strategic
alliances or other investments. We are currently considering such options and
their effect on our capital requirements. We may need to raise additional funds
to:
o increase the regulatory net capital necessary to support our
operations;
o support more rapid growth in our business;
o develop new or enhanced services and products;
o respond to competitive pressures;
o acquire complementary technologies;
o enter into strategic alliances;
o acquire companies with marketplace or other specific domain
expertise; and
o respond to unanticipated requirements.
We cannot assure you that we will be able to obtain additional financing
when needed on terms that are acceptable, if at all.
The market price of our Class A common stock may fluctuate.
The price of our Class A common stock may fluctuate widely, depending upon
many factors, including our perceived prospects, and the prospects of the
financial industries in general, differences between our actual financial and
operating results and those expected by investors and analysts, changes in
analysts' recommendations or projections, changes in general valuations for
Internet and e-commerce-related companies, changes in general economic or market
conditions and broad market fluctuations.
Future sales of our shares could adversely affect the market price of our
Class A common stock.
If our existing stockholders sell a large number of shares, or if we issue
a large number of shares of our common stock in connection with future
acquisitions, strategic alliances or otherwise, the market price of our Class A
common stock could decline significantly. Moreover, the perception in the public
market that these stockholders might sell shares of Class A common stock could
depress the market price of our Class A common stock.
32
Although we and our directors, executive officers and holders of common
stock and securities convertible into or exercisable or exchangeable for common
stock issued prior to our initial public offering in December 1999 have agreed
pursuant to certain "lock-up" agreements with the underwriters that we and they
will not offer, sell, contract to sell, pledge, grant any option to sell, or
otherwise dispose of, directly or indirectly, any shares of common stock or
securities convertible into or exercisable or exchangeable for common stock,
subject to certain exceptions, before June 7, 2000 without the prior written
consent of Warburg Dillon Read LLC, we and these persons may be released of this
obligation by Warburg Dillon Read LLC in its sole discretion in whole or in part
at any time with or without notice.
We may decide to register an additional 5,000,000 shares of our Class A
common stock under the Securities Act of 1933 for use by us as consideration for
future acquisitions. Upon such registration, these shares generally will be
freely tradable after issuance, unless the resale thereof is contractually
restricted or unless the holders thereof are subject to the restrictions on
resale provided in Rule 145 under the Securities Act. In any event, any
registered shares so issued will be subject to contractual restrictions and,
thus, will not be freely tradable before June 7, 2000.
We intend to initially register 20%, or approximately 10,000,000 shares of
Class A common stock, of the total outstanding shares of our common stock, which
are reserved for issuance upon exercise of options granted under our stock
option plan. If we increase our total outstanding shares of common stock, we
will register additional shares of Class A common stock so that the stock
available for issuance under our stock option plan will be registered. Once we
register these shares, they can be sold in the public market upon issuance,
subject to restrictions under the securities laws applicable to resales by
affiliates. We also plan to register the shares of Class A common stock issuable
under our stock purchase plan.
RISKS RELATED TO OUR RELATIONSHIP WITH CANTOR
Because we depend on Cantor's business, events which impact Cantor's operating
results may have a material adverse effect on our revenues.
We recognized over 66% of our revenues for the period from March 10, 1999
to December 31, 1999 from transactions in which we received amounts based on
fixed percentages of commissions paid to Cantor. Consequently, any reductions in
the amount of commissions paid to Cantor, including events which impact Cantor's
business or operating results, could have a material adverse effect on our most
significant source of revenues.
In addition, fees paid to us by Cantor for system services represented
32.6% of our revenues for the period from March 10, 1999 to December 31, 1999.
These fee revenues are remitted to us on a monthly basis.
We are a general creditor of Cantor to the extent that there are
transaction revenues and system service fees owing to us from Cantor. Events
that negatively impact Cantor's financial position and ability to remit our
share of transaction revenues and system service fees could have a material
adverse effect on our revenues.
33
Conflicts of interest and competition with Cantor may arise.
Various conflicts of interest between us and Cantor may arise in the
future in a number of areas relating to our past and ongoing relationships,
including competitive business activities, potential acquisitions of businesses
or properties, the election of new directors, payment of dividends, incurrence
of indebtedness, tax matters, financial commitments, marketing functions,
indemnity arrangements, service arrangements, issuances of our capital stock,
sales or distributions by Cantor of its shares of our common stock and the
exercise by Cantor of control over our management and affairs. Our Joint
Services Agreement with Cantor provides that in some circumstances Cantor can
unilaterally determine the commissions that will be charged to clients for
effecting trades in marketplaces in which we collaborate with Cantor. The
determination of the nature of commissions charged to clients does not affect
the allocation of revenues that Cantor and we share with respect to those
transactions. However, in circumstances in which Cantor determines to charge
clients lower commissions, the amount that we receive in respect of our share of
the commissions will correspondingly be decreased. A majority of our directors
and officers also serve as directors and/or officers of Cantor. Simultaneous
service as an eSpeed director or officer and service as a director or officer,
or status as a partner, of Cantor could create, or appear to create, potential
conflicts of interest when such directors, officers and/or partners are faced
with decisions that could have different implications for us and for Cantor. Mr.
Lutnick, our Chairman and Chief Executive Officer, is the sole stockholder of
the managing general partner of Cantor. As a result, Mr. Lutnick controls
Cantor. Cantor owns all of the outstanding shares of our Class B common stock,
representing approximately 98% of the combined voting power of all classes of
our voting stock. Mr. Lutnick's simultaneous service as our Chairman and Chief
Executive Officer and his control of Cantor could create or appear to create
potential conflicts of interest when Mr. Lutnick is faced with decisions that
could have different implications for us and for Cantor.
Because our Joint Services Agreement with Cantor has a perpetual term and
contains non-competition provisions and restrictions on our ability to pursue
strategic transactions, this agreement may become burdensome to our business.
As part of the formation transactions, Cantor contributed substantially
all of our assets to us. Although Cantor has agreed, subject to certain
conditions, not to compete with us in providing electronic brokerage services,
Cantor is currently engaged in securities transaction and other financial
instruments execution and processing operations and other activities that are
related to the electronic trading services we provide. Our Joint Services
Agreement obligates us to perform technology support and other services for
Cantor at cost, whether or not related to our electronic brokerage services,
sets forth the ongoing revenue sharing arrangements between Cantor and us and
subjects us and Cantor to non-competition obligations. The Joint Services
Agreement precludes us from entering into lines of business in which Cantor now
or in the future may engage, or providing, or assisting any third party in
providing, voice-assisted brokerage services, clearance, settlement and
fulfillment services and related services, except under the limited
circumstances described in Item 13 under "Joint Services
Agreement--Non-competition and Market Opportunity Provisions." Although we
believe Cantor has no plans to form, acquire or commence any other operations
similar to ours, the Joint Services Agreement permits Cantor to perform, in
limited circumstances, electronic brokerage operations. In addition, the Joint
Services Agreement imposes limitations on our ability to pursue strategic
alliances, joint
34
ventures, partnerships, business combinations, acquisitions and similar
transactions. Because the Joint Services Agreement has a perpetual term, even in
the event of a breach by one of the parties, and does not provide for
modification under its terms, this agreement may become burdensome for us, may
distract us from focusing on our internal operations, may deter or discourage a
takeover of our company and may limit our ability to expand our operations.
Because agreements between us and Cantor are not the result of arm's-length
negotiations, we may receive lower commissions from, and pay higher service fees
to, Cantor than we would with respect to third party service providers.
In connection with the formation transactions, we entered into Assignment
and Assumption Agreements, an Administrative Services Agreement, a Joint
Services Agreement and several other agreements with Cantor relating to the
provision of services to each other and third parties. These agreements are not
the result of arm's length negotiations because Cantor owns and controls us. As
a result, the prices charged to us or by us for services provided under the
agreements may be higher or lower than prices that may be charged by third
parties and the terms of these agreements may be generally less favorable to us
than those that we could have negotiated with third parties.
Because we depend on services and access to operating assets provided by third
parties to Cantor, we may not have recourse against those third parties.
Many of the assets and services provided by Cantor under the terms of the
Administrative Services Agreement are leased or provided to Cantor by third
party vendors. As a result, in the event of a dispute between Cantor and a
third-party vendor, we could lose access to, or the right to use, as applicable,
office space, personnel, corporate services and operating assets. In such a
case, we would have no recourse with respect to the third party vendor. Our
inability to use these services and operating assets for any reason, including
any termination of the Administrative Services Agreement between us and Cantor
or the agreements between Cantor and third party vendors, could result in
serious interruptions of our operations.
Our reputation may be affected by actions taken by Cantor and entities that are
related to Cantor.
Cantor currently is our most significant client. Cantor holds direct and
indirect ownership and management interests in numerous other entities that
engage in a broad range of financial services and securities-related activities.
Actions taken by, and events involving, Cantor or these related companies which
are perceived negatively by the securities markets, or the public generally,
could have a material adverse effect on us and could affect the price of our
Class A common stock. In addition, events which negatively affect the financial
condition of Cantor may negatively affect us. These events could cause Cantor to
lose clients that may trade in our marketplaces, could impair Cantor's ability
to perform its obligations under the Joint Services Agreement and other
agreements Cantor enters into with us and could cause Cantor to liquidate
investments, including by selling or otherwise transferring shares of our common
stock.
35
If we become subject to litigation and other legal proceedings, we may be
harmed.
From time to time, we and Cantor may become involved in litigation and
other legal proceedings relating to claims arising from our and their operations
in the normal course of business. Cantor is currently subject to a number of
legal proceedings that could affect us. We cannot assure you that these or other
litigation or legal proceedings will not materially affect our ability to
conduct our business in the manner that we expect or otherwise adversely affect
us.
RISKS RELATED TO E-COMMERCE AND THE INTERNET
If electronic marketplaces for securities and financial products do not continue
to grow, we will not be able to achieve our business objectives.
The success of our business plan depends on our ability to create
interactive electronic marketplaces in a wide range of securities and financial
products. Historically, securities and commodities markets operated through an
open outcry format in which buyers and sellers traded securities in pits through
verbal communication. These open outcry markets have recently begun to be
supplanted with new systems that match buyers and sellers electronically. The
utilization of our interactive electronic marketplaces depends on the continued
acceptance and utilization of these electronic securities and commodities
markets. We cannot assure you that the growth and acceptance of the use of
electronic markets will continue.
If e-commerce and Internet usage does not continue to grow, we will not be able
to achieve our business objectives.
As part of our business strategy, we expect to do business with online and
traditional retail brokers. We expect to enable these firms to provide to their
clients access, where appropriate, to trading in fixed income securities and
futures and other wholesale financial products markets through the Internet.
Our strategic and financial objectives would be adversely impacted if
Internet usage does not continue to grow. Consumer use of the Internet as a
medium of commerce is a recent phenomenon and is subject to a high level of
uncertainty. Internet usage may be inhibited for a number of reasons, including:
o access costs;
o inadequate network infrastructure;
o security concerns;
o uncertainty of legal, regulatory and tax issues concerning the use
of the Internet;
o concerns regarding ease of use, accessibility and reliability;
o inconsistent quality of service; and
o lack of availability of cost-effective, high-speed service.
36
If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it, or the Internet's performance and reliability
may decline. Similarly, Web sites have experienced interruptions in their
service as a result of outages and other delays occurring throughout the
Internet network infrastructure. If these outages or delays occur frequently,
use of the Internet as a commercial or business medium could grow more slowly or
decline. Even if Internet usage continues to grow, online trading in the
wholesale securities markets, and in particular the fixed income securities and
futures markets, may not be accepted by retail customers. This could negatively
affect the growth of our business.
Our networks and those of our third-party service providers may be vulnerable to
security risks, which could make our clients hesitant to use our electronic
marketplaces.
We expect the secure transmission of confidential information over public
networks to be a critical element of our operations. Our networks and those of
our third party-service providers, including Cantor and associated clearing
corporations, and our clients may be vulnerable to unauthorized access, computer
viruses and other security problems. Persons who circumvent security measures
could wrongfully use our information or cause interruptions or malfunctions in
our operations, which could make our clients hesitant to use our electronic
marketplaces. We may be required to expend significant resources to protect
against the threat of security breaches or to alleviate problems, including
reputational harm and litigation, caused by any breaches. Although we intend to
continue to implement industry-standard security measures, we cannot assure you
that those measures will be sufficient.
RISKS RELATED TO OUR CAPITAL STRUCTURE
Because the voting control of our common stock is concentrated among the holders
of our Class B common stock, the market price of our Class A common stock may be
adversely affected by disparate voting rights.
Cantor beneficially owns all of our outstanding Class B common stock,
representing approximately 98% of the combined voting power of all classes of
our voting stock. As long as Cantor beneficially owns a majority of the combined
voting power of our common stock, it will have the ability, without the consent
of the public stockholders, to elect all of the members of our board of
directors and to control our management and affairs. In addition, it will be
able to determine the outcome of matters submitted to a vote of our stockholders
for approval and will be able to cause or prevent a change in control of our
company. In certain circumstances, the Class B common stock issued to Cantor
upon consummation of the formation transactions may be transferred without
conversion to Class A common stock.
The holders of our Class A common stock and Class B common stock have
substantially identical rights, except that holders of our Class A common stock
are entitled to one vote per share, while holders of our Class B common stock
are entitled to 10 votes per share on all matters to be voted on by stockholders
in general. This differential in the voting rights and our ability to issue
additional Class B common stock could adversely affect the market price of our
Class A common stock.
37
Delaware law and our charter may make a takeover of our company more difficult.
Provisions of Delaware law, such as its business combination statute, may
have the effect of delaying, deferring or preventing a change in control of our
company. In addition, our Amended and Restated Certificate of Incorporation
authorizes the issuance of preferred stock, which our board of directors can
create and issue without prior stockholder approval and with rights senior to
those of our common stock, as well as additional shares of our Class B common
stock. Our Amended and Restated Certificate of Incorporation and our Amended and
Restated By-Laws include provisions which restrict the ability of our
stockholders to take action by written consent and provide for advance notice
for stockholder proposals and director nominations. These provisions may have
the effect of delaying or preventing changes of control or management of our
company, even if such transactions would have significant benefits to our
stockholders. As a result, these provisions could limit the price some investors
might be willing to pay in the future for shares of our Class A common stock.
Delaware law may protect decisions of our board of directors that have a
different effect on holders of our Class A and Class B common stock.
Stockholders may not be able to challenge decisions that have an adverse
effect upon holders of the Class A common stock if our board of directors acts
in a disinterested, informed manner with respect to these decisions, in good
faith and in the belief that it is acting in the best interests of our
stockholders. Delaware law generally provides that a board of directors owes an
equal duty to all stockholders, regardless of class or series, and does not have
separate or additional duties to either group of stockholders, subject to
applicable provisions set forth in a company's charter.
Item 2. Properties
Our principal executive offices are located at One World Trade Center, New
York, New York. Our principal executive offices occupy approximately 50,000
square feet of leased space, which we occupy pursuant to the Administrative
Services Agreement with Cantor. Our right to use this space expires at the time
that Cantor's lease expires in 2012. We will pay Cantor approximately $1.25
million annually for use of this space. Our largest presence outside of New York
is in London, where we have the right to use approximately 15,000 square feet of
Cantor's existing office space. Our right to use this space expires at the
earlier of (1) the time that Cantor's lease expires in 2016 or (2) when Cantor
ceases to be an affiliate of ours and Cantor asks us to vacate. We will pay
Cantor approximately $900,000 annually for use of this space. We believe our
facilities are adequate for our reasonably foreseeable future needs.
ITEM 3. LEGAL PROCEEDINGS
On June 21, 1999, Cantor and its affiliate CFPH, LLC, brought suit against
Liberty Brokerage Investment Corporation and Liberty Brokerage Inc. in the
United States District Court for the District of Delaware for infringement of
the Fraser et al. U.S. patent 5,905,974, entitled "Automated Auction Protocol
Processor." Cantor alleged in the complaint that Liberty was infringing the `974
patent by making, using, selling and/or offering for sale systems and methods
that embody or use the inventions claimed in the `974 patent. On August 10,
1999, Cantor and
38
CFPH, L.L.C. voluntarily dismissed the suit without prejudice. Subsequently,
on August 10, 1999, Liberty filed an action for declaratory judgment in the
United States District Court for the District of Delaware against Cantor and two
of its affiliates, Cantor Fitzgerald Securities and CFPH, LLC, claiming that the
`974 patent was invalid, unenforceable and not infringed by Liberty. On October
12, 1999, Cantor, Cantor Fitzgerald Securities and CFPH, LLC moved (1) to
dismiss all claims against Cantor Fitzgerald Securities for failure to state a
claim upon which relief can be granted and (2) to dismiss the action as against
Cantor, Cantor Fitzgerald Securities and CFPH, LLC for lack of an actual case or
controversy within the meaning of 28 U.S.C. Section 2201. On November 22, 1999,
the Court granted the motion to dismiss the action as against Cantor Fitzgerald
Securities, and denied the motion to dismiss the action as against Cantor and
its affiliate CFPH, LLC. On January 5, 2000, Liberty filed an Amended Complaint
naming us as a defendant. On January 19, 2000, Cantor and CFPH, LLC filed a
Second Renewed Motion to Dismiss the action. On March 8, 2000, oral arguments
took place on the Second Renewed Motion to Dismiss. No decision has been
rendered. We have assumed responsibility for defending this suit on behalf of
Cantor and its affiliates and the risk of loss associated with it.
In February 1998, Market Data Corporation contracted with Chicago Board
Brokerage (a company controlled by the Chicago Board of Trade and Prebon Yamane)
to provide the technology for an electronic trading system to compete with
Cantor's United States Treasury brokerage business. Market Data Corporation is
controlled by Iris Cantor and Rodney Fisher, her nephew-in-law. Iris Cantor, a
company under the control of Iris Cantor referred to herein as CFI, and Rodney
Fisher are limited partners of Cantor Fitzgerald, L.P.
In April 1998, Cantor Fitzgerald, L.P. filed a complaint in the Delaware
Court of Chancery against Market Data Corporation, Iris Cantor, CFI, Rodney
Fisher and Chicago Board Brokerage seeking an injunction and other remedies. The
complaint alleges that Iris Cantor, CFI and Rodney Fisher violated certain
duties, including fiduciary duties under Cantor's partnership agreement due to
their competition with Cantor Fitzgerald, L.P. with respect to the electronic
trading system mentioned above. The complaint further alleges that Market Data
Corporation and Chicago Board Brokerage tortiously interfered with Cantor's
partnership agreement and aided and abetted Iris Cantor's, CFI's and Rodney
Fisher's breaches of fiduciary duty. Iris Cantor, CFI and Rodney Fisher
counterclaimed seeking, among other things, (1) to reform agreements they have
with Cantor Fitzgerald, L.P. and (2) a declaration that Cantor Fitzgerald, L.P.
breached the implied covenant of good faith and fair dealing. Cantor has agreed
to indemnify us for any liabilities that we incur with respect to any current or
future litigation involving (1) Market Data Corporation, (2) Iris Cantor, (3)
CFI or (4) Rodney Fisher.
Cantor Fitzgerald, L.P. settled its dispute with Chicago Board Brokerage
in April 1999, and Chicago Board Brokerage subsequently announced it was
disbanding its operations. On March 17, 2000, the Delaware Court of Chancery
ruled in favor of Cantor Fitzgerald, L.P., finding that Iris Cantor, CFI and
Rodney Fisher had breached the Partnership Agreement of Cantor Fitzgerald, L.P.,
and that Market Data Corporation had aided and abetted that breach. The court
awarded Cantor Fitzgerald, L.P. declaratory judgment relief and court costs and
attorneys' fees. Counsel for the defendants have expressed their intentions to
appeal this result. We believe Market Data Corporation's technology for
electronic trading systems would be of substantial assistance to competitors in
the wholesale market if provided to them.
39
Two related actions are pending in New York. In a case pending in the
Supreme Court of New York, New York County, plaintiff Cantor Fitzgerald, L.P.
alleges, among other things, that defendants Market Data Corporation, CFI, Iris
Cantor and Rodney Fisher misused confidential information of Cantor Fitzgerald,
L.P. in connection with the above mentioned provision of technology to Chicago
Board Brokerage. In a case pending in the United States District Court for the
Southern District of New York, CFI and Iris Cantor allege, among other things,
that certain senior officers of Cantor Fitzgerald, L.P. breached fiduciary
duties they owed to CFI. The allegations in this lawsuit relate to several of
the same events underlying the court proceedings in Delaware. Neither of these
two cases has been pursued during the pendency of the court proceedings in
Delaware.
In addition to the allegations set forth in the pending lawsuits, Cantor
has received correspondence from the attorneys representing Iris Cantor, CFI,
Market Data Corporation and Rodney Fisher in the proceedings in Delaware,
expressing a purported concern that Cantor and/or certain of its partners may be
in breach of Cantor's partnership agreement (including, among other things, the
partnership agreement's provisions relating to competition with the partnership)
and the general partnership agreement of Cantor Fitzgerald Securities with
respect to our initial public offering. Generally, these attorneys have alleged
that various purported conflicts of interest will exist arising from the fact
that certain of our directors and officers will simultaneously hold positions
with Cantor Fitzgerald, L.P. Moreover, these attorneys have asserted that our
business plan may not be consistent with certain purported rights of Market Data
Corporation (including purported intellectual property rights) and other parties
and they requested more information regarding our initial public offering.
Although we do not expect to incur any losses with respect to the pending
lawsuits or supplemental allegations surrounding Cantor's partnership agreement,
Cantor has agreed to indemnify us with respect to any liabilities we incur as a
result of such lawsuits or allegations.
Cantor and Reuters were parties to a confidential arbitration under the
auspices of the American Arbitration Association in New York, New York, which
began in June 1995 with respect to a January 1993 agreement among Reuters,
Cantor and Market Data Corporation. The agreement executed in 1993 involved,
among other things, the delivery by Cantor of certain market data arising out of
non-United States government bond and U.S. municipal bond interdealer brokerage
transactions for transmittal over Reuters' network. The agreement also
contemplated the joint development by Cantor and Reuters of an electronic
trading system for certain transactions in non-United States government bonds.
Cantor and Reuters did not develop this electronic trading system. In the
arbitration, Reuters alleged that Cantor materially breached the agreement
primarily by failing to provide non-screen, voice brokerage data concerning
non-United States government bonds and U.S. municipal bonds that Reuters
contends are subject to the agreement and fraud. Reuters sought to recover from
Cantor amounts representing past payments for market data, the reimbursement of
attorneys' fees and other damages. Cantor denied Reuters' allegations that there
had been any material breach of this agreement or fraud, and asserted a breach
of contract claim and various other counterclaims against Reuters, including
claims for Reuters' failure since February 1997 to pay any of the money due
Cantor for data under this agreement. In February 1997, Reuters unilaterally
ceased making such payments to Cantor in connection with the dispute and in
November 1999 stopped distributing Cantor's market data that was provided to
Reuters.
40
On December 30, 1999, Cantor entered into a new agreement with Reuters
pursuant to which Cantor and Reuters settled outstanding disputes and terminated
the 1993 agreement. We cannot assure you that Market Data Corporation will not
seek to assert claims against us or Cantor relating to our activities with
respect to the 1993 agreement or the arbitration. Cantor has agreed to indemnify
us with respect to any claims that may be asserted by Market Data Corporation or
Reuters relating to the 1993 agreement or arising out of the arbitration.
On May 5, 1999, Cantor Fitzgerald, L.P., The Board of Trade of the City of
Chicago, The New York Mercantile Exchange and The Chicago Mercantile Exchange
were sued by Electronic Trading Systems Corporation in the United States
District Court for the Northern District of Texas (Dallas Division) for alleged
infringement of Wagner United States patent 4,903,201, entitled "Automated
Futures Trade Exchange." The patent relates to a system and method for
implementing an electronic, computer-automated futures exchange. On July 1,
1999, Cantor answered the complaint, asserting, among other things, that the
`201 patent was invalid and not infringed by Cantor and that Cantor was not the
real party in interest. Although not identified by the complaint, Cantor
believes that the system being charged with infringement is a version of the
electronic trading system used by the Cantor Exchange((Service Mark)), which
Cantor contributed to us in December 1999. Electronic Trading Systems
Corporation executed a Covenant Not to Sue, Release and Settlement Agreement,
dated February 18, 2000, pursuant to which it agreed not to sue Cantor
Fitzgerald, L.P. or any of its affiliates or successors, including us, or any
customers, for infringement of the `201 patent by the Cantor Exchange((Service
Mark)). On March 22, 2000, counsel to the parties filed with the court a Joint
Stipulation and (proposed) Order of Dismissal requesting that Cantor Fitzgerald,
L.P. be dismissed from the case without prejudice by Electronic Trading Systems
Corporation. On March 23, 2000, the Court signed an Agreed Order of Dismissal
and on March 24, 2000 Cantor Fitzgerald, L.P. was dismissed from the case.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
41
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Price Range of Class A Common Stock
Our Class A common stock, $.01 par value, began trading on the Nasdaq
National Market under the symbol "ESPD" on December 10, 1999. There is no public
trading market for the Company's Class B common stock, $.01 par value. The
following table sets forth the high and low sales price of our Class A common
stock for the fourth quarter of 1999 from December 10, 1999.
Year Ended December 31, 1999 High Low
- ---------------------------- ---- ---
Fourth Quarter (from December 10, 1999) $63.75 $30.00
The number of stockholders of record of our Class A common stock as of
March 15, 2000 was 24, although we believe that there is a larger number of
beneficial owners. As of March 15, 2000, there were two stockholders of record
of our Class B common stock. On March 15, 2000, the last reported sale price of
our Class A common stock on the Nasdaq National Market was $70.00.
Rights of Common Stock
Holders of Class A common stock generally have the same rights as holders
of Class B common stock, except that holders of Class A common stock have one
vote per share and holders of Class B common stock have 10 votes per share on
all matters submitted to a vote of stockholders. Generally, all matters to be
voted on by stockholders must be approved by a majority or, in the case of
election of directors, by a plurality of the votes entitled to be cast by
holders of all shares of Class A common stock and Class B common stock present
in person or represented by proxy, voting together as a single class, subject to
any voting rights granted to holders of any preferred stock, except that (i)
amendments to our Amended and Restated Certificate of Incorporation that would
change the powers, preferences or special rights of the Class A common stock or
the Class B common stock so as to affect them adversely also must be approved by
a majority of the votes entitled to be cast by the holders of the shares
affected by the amendment, voting as a separate class, and (ii) any amendment to
our Amended and Restated Certificate of Incorporation to increase the authorized
shares of Class B common stock. Each share of Class B common stock is
convertible at any time, at the option of the holder, into one share of Class A
common stock. Each share of Class B common stock will automatically convert into
a share of Class A common stock upon any transfer, with limited exceptions.
Dividend Policy
We intend to retain our future earnings, if any, to help finance the
growth and development of our business. We have never paid a cash dividend, and
we do not expect to pay any cash dividends on our common stock in the
foreseeable future.
42
In the event we decide to declare dividends on our common stock in the
future, such declaration will be subject to the discretion of our board of
directors. Our board of directors may take into account such matters as general
business conditions, our financial results, capital requirements, contractual,
legal and regulatory restrictions on the payment of dividends by us to our
stockholders or by our subsidiaries to us and any such other factors as our
board of directors may deem relevant.
Recent Sale of Unregistered Securities
In exchange for assets contributed to us pursuant to the Assignment and
Assumption Agreement, on December 9, 1999, we issued 43,999,900 shares of Class
B common stock to Cantor Fitzgerald, L.P. and certain of its affiliates. The
sale of these securities was deemed to be exempt from registration under the
Securities Act of 1933 in reliance on Section 4(2) of the Securities Act of
1933, as a transaction by an issuer not involving a public offering.
Use of Proceeds of Initial Public Offering
The effective date of our registration statement (Registration No.
333-87475) filed on Form S-1 relating to our initial public offering of Class A
common stock was December 9, 1999. In our initial public offering, we sold
7,000,000 shares of Class A common stock at a price of $22.00 per share and
Cantor Fitzgerald Securities, the selling stockholder, sold 3,350,000 shares of
Class A common stock at a price of $22.00 per share. Our initial public offering
was managed on behalf of the underwriters by Warburg Dillon Read LLC, Hambrecht
& Quist, Thomas Weisel Partners LLC and Cantor Fitzgerald & Co. The offering
commenced on December 10, 1999 and closed on December 15, 1999. Proceeds to us
from our initial public offering, after deduction of the underwriting discounts
and commissions of approximately $10.0 million and offering costs of $4.4
million, totaled approximately $139.6 million. None of the expenses incurred in
our initial public offering were direct or indirect payments to our directors,
officers, general partners or their associates, to persons owning 10% or more of
any class of our equity securities or to our affiliates. Of the $139.6 million
raised, approximately $5.0 million has been used for working capital purposes
and the balance of $134.6 million has been invested in reverse repurchase
agreements which are fully collateralized by U.S. Government Securities held in
a custodial account at a third-party bank. We intend to use the amount invested
in the reverse repurchase agreements as follows:
o Approximately $25 million will be invested in hardware and software
for entry into new product segments, expansion of our current
markets and an increase in communication links to our clients;
o Approximately $25 million will be for hiring of technology and other
professionals to develop new markets in both financial and
non-financial sectors;
o Approximately $25 million will be for marketing to current and new
institutional clients and to promote general awareness and
acceptance of the retail trading of fixed income securities and
other financial instruments; and
43
o The balance of the net proceeds will be used for working capital and
general corporate purposes, including possible acquisitions and
strategic alliances.
Of the amount of proceeds spent through December 31, 1999, approximately
$5.0 million has been paid to Cantor under the Administrative Services Agreement
between us and Cantor.
The occurrence of unforeseen events, opportunities or changed business
conditions, however, could cause us to use the net proceeds of our initial
public offering in a manner other than as described above.
44
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data for eSpeed should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and with our audited financial statements, related
notes and other financial information beginning on page 54.
For the period from
March 10, 1999
(date of commencement
of operations) to
December 31, 1999
----------------------
Statement of Operations Data:
Total revenues........................................ $ 38,188,925
Expenses:
Compensation and employee benefits................. 21,502,326
Occupancy and equipment............................ 10,292,349
Professional and consulting fees................... 5,148,796
Communications and client networks................. 3,355,070
Fulfillment services fees paid to affiliates....... 3,527,945
Administrative fees paid to affiliates............. 1,662,058
Options granted to Cantor employees(1)............. 2,850,073
Other.............................................. 2,649,110
---------------
Total expenses..................................... 50,987,727
---------------
Loss before benefit for income taxes.................. (12,798,802)
Income tax benefit.................................... 211,889
---------------
Net loss.............................................. $ (12,586,913)
===============
Per Share Data:
Net loss........................................... $ (12,586,913)
Basic and diluted net loss per share............... $ (0.28)
Weighted average shares of common stock outstanding 44,495,000
Statement of Financial Condition: December 31, 1999
-----------------
Cash and cash equivalents............................. $ 201,001
Total assets.......................................... 144,327,089
Total liabilities..................................... 8,815,276
Total stockholders' equity............................ 135,511,813
- ---------------------
(1) Options granted to Cantor employees represent a one-time, non-cash charge
due to option grants we made to Cantor employees exercisable at the initial
public offering price of $22 per share.
45
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS:
The following discussion contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors.
The following discussion is qualified in its entirety by, and should be read in
conjunction with, the more detailed information and our financial statements and
the notes thereto appearing elsewhere in this filing.
Overview
eSpeed, Inc. was incorporated on June 3, 1999 as a Delaware corporation.
Our wholly-owned subsidiaries are eSpeed Securities, Inc., eSpeed Government
Securities, Inc., eSpeed Markets, Inc. and eSpeed Securities International
Limited. Prior to our initial public offering, we were a wholly-owned subsidiary
of, and we conducted our operations as a division of, Cantor Fitzgerald
Securities, which in turn is a 99.5%-owned subsidiary of Cantor Fitzgerald, L.P.
We commenced operations as a division of Cantor on March 10, 1999, the date the
first fully electronic transaction using our eSpeed((Service Mark)) system was
executed. Cantor has been developing systems to promote fully electronic
marketplaces since the early 1990s. Since January 1996, Cantor has used our
eSpeed((Service Mark)) system internally to conduct electronic trading.
Concurrent with our initial public offering in December 1999, Cantor
contributed to us, and we acquired from Cantor, certain of our assets. These
assets primarily consist of proprietary software, network distribution systems,
technologies and other related contractual rights that comprise our
eSpeed((Service Mark)) system.
As of December 31, 1999, we had an accumulated net loss of $12,586,913.
This loss primarily resulted from expenditures on our technology and
infrastructure incurred in building our revenue base. We expect that we will
continue to incur losses and generate negative cash flow from operations for the
foreseeable future as we continue to develop our systems and infrastructure and
expand our brand recognition and client base through increased marketing
efforts. In light of the rapidly changing nature of our business and our limited
operating history, we believe that period-to-period comparisons of our operating
results will not necessarily be meaningful and should not be relied upon as an
indication of future performance.
In September 1999, our board of directors changed our fiscal year from the
last Friday of March to December 31.
46
Results of Operations
The following table sets forth statement of operations data for the period
from March 10, 1999 (date of commencement of operations) to December 31, 1999.
Period from March 10, 1999 (date of commencement
of operations) to December 31, 1999
- --------------------------------------------------------------------------------
Revenues:
Transaction Revenues:
Fully electronic transactions.................................. $ 10,079,842
Voice-assisted brokerage transactions.......................... 11,777,306
Screen assisted open outcry transactions....................... 3,524,399
-------------
Total transaction revenues............................... 25,381,547
Interest income................................................... 347,804
System services fees.............................................. 12,459,574
-------------
Total revenues........................................... 38,188,925
-------------
Expenses:
Compensation and employee benefits............................. 21,502,326
Occupancy and equipment........................................ 10,292,349
Professional and consulting fees............................... 5,148,796
Communications and client networks............................. 3,355,070
Fulfillment services fees...................................... 3,527,945
Administrative fees............................................ 1,662,058
Options granted to Cantor employees............................ 2,850,073
Other.......................................................... 2,649,110
-------------
Total expenses........................................... 50,987,727
-------------
Loss before benefit for income taxes.............................. $(12,798,802)
=============
Revenues
Transaction Revenues
We operate interactive electronic marketplaces. We have entered into a
Joint Services Agreement with Cantor under which we and Cantor agreed to
collaborate to provide brokerage and related services to clients in multiple
electronic markets for transactions in securities and other financial products.
In addition, we may, in our discretion, collaborate on operating markets for
non-financial products. Under the Joint Services Agreement, we own and operate
the electronic trading systems and are responsible for providing electronic
brokerage services, and Cantor provides voice-assisted brokerage services,
fulfillment services such as clearance and settlement, and related services such
as credit and risk management services, oversight of client suitability and
regulatory compliance, sales positioning of products and other services
customary to marketplace intermediary operations. Under this agreement, we and
Cantor have agreed to share revenues derived from transactions effected in the
marketplaces in which we collaborate and other specified markets.
47
Generally, if the transactions:
o are effected in a marketplace in which we collaborate with Cantor,
are fully electronic transactions and relate to financial products,
such as fixed income securities, futures contracts, derivatives and
commodities, that are not traded on the Cantor Exchange((Service
Mark)), or products that are traded on the Cantor Exchange((Service
Mark)), then we receive the aggregate transaction revenues and pay
to Cantor service fees equal to 35% and 20% of the transaction
revenues, respectively.
o are effected in a marketplace in which we collaborate with Cantor,
involve voice-assisted brokerage services that Cantor provides and
the transactions relate to (1) financial products that are not
traded on the Cantor Exchange((Service Mark)), or (2) products that
are traded on the Cantor Exchange((Service Mark)), then, in the case
of a transaction described in (1), Cantor receives the aggregate
transaction revenues and pays to us a service fee equal to 7% of the
transaction revenues, and, in the case of a transaction described in
(2), we receive the aggregate transaction revenues and pay to Cantor
a service fee equal to 55% of the transaction revenues.
o are effected in a marketplace in which we do not collaborate with
Cantor, but in which we do provide electronic brokerage services,
and (1) the transaction relates to a financial product, then we will
receive the aggregate transaction revenues and pay to Cantor a
fulfillment service fee equal to 20% of the transaction and data
revenues paid to or received by us or (2) the transaction relates to
a non-financial product, then we will receive all of the transaction
revenues.
o are not effected through an electronic marketplace, but are
electronically assisted, such as screen-assisted open outcry
transactions, then Cantor receives the aggregate transaction
revenues and pays to us a service fee equal to 2.5% of the
transaction revenues.
We are pursuing an aggressive strategy to convert most of Cantor's
financial marketplace products to our eSpeed((Service Mark)) system and, with
the assistance of Cantor, to continue to create new markets and convert new
clients to our eSpeed((Service Mark)) system. Other than Cantor, no client of
ours accounted for more than 10% of our transaction revenues from our date of
inception through December 31, 1999.
The process of converting these marketplaces includes modifying existing
Cantor trading systems to allow for transactions to be entered directly from a
client location, signing an agreement with the client, installing the hardware
and software at the client location and establishing communication lines between
us and the client.
From March 10, 1999 to December 31, 1999, we earned $25,381,547 in
transaction revenues from the U.S. fixed income marketplaces, as these
marketplaces were the first converted to our eSpeed((Service Mark)) system. It
is anticipated that as more marketplaces are converted to our eSpeed((Service
Mark)) system and more clients are added to our eSpeed((Service Mark)) system,
more of our income will be generated from marketplaces around the world. Our
revenues are currently highly dependent on transaction volume in the fixed
income markets globally. Accordingly, revenues are
48
dependent on the volume of transactions in marketplaces that we operate,
which can be affected by, among other things, economic and political conditions
in the United States and elsewhere in the world, concerns over inflation and
wavering institutional/consumer confidence levels, the availability of cash for
investment by mutual funds and other wholesale and retail investors, rising
interest rates, fluctuating exchange rates, legislative and regulatory changes
and currency values.
Interest Income
The proceeds of our initial public offering have been invested by us in
reverse repurchase agreements which are fully collateralized by U.S. Government
securities held in a custodial account at The Chase Manhattan Bank. From
December 15, 1999 to December 31, 1999, these investments generated interest
income of $347,804 at an average interest rate of 5.2%.
System Services Fees
We have agreed to provide to Cantor technology support services at cost,
including (1) systems administration, (2) internal network support, (3) support
and procurement for desktops of end-user equipment, (4) operations and disaster
recovery services, (5) voice and data communications, (6) support and
development of systems for clearance and settlement services, (7) systems
support for Cantor brokers, (8) electronic applications systems and network
support for Cantor's unrelated dealer businesses with respect to which we will
not collaborate with Cantor and (9) provision and/or implementation of existing
electronic applications systems, including improvements and upgrades thereto,
and use of the related intellectual property rights, having potential
application in a gaming business. System service fees revenues from Cantor from
March 10, 1999 to December 31, 1999 were $12,459,574 and represented 32.6% of
total revenues for that period.
Expenses
Compensation and employee benefits
At December 31, 1999, we had approximately 370 professionals,
substantially all of whom are full time employees located predominantly in New
York and London. Compensation costs include salary, bonus accruals, payroll
taxes and costs of employer-provided medical benefits for our employees. We
intend to hire additional technical, sales and marketing, product development
and administrative personnel, including personnel from Cantor, in order to
expand our business. As a result, we anticipate that compensation expense may
increase significantly in subsequent periods. We have granted 292,005 stock
options to certain employees of Cantor and a consultant at an exercise price per
share of $22, resulting in a one-time, non-cash charge to us of $2,850,073 for
the fourth quarter of 1999.
Occupancy and equipment
Occupancy and equipment costs of $10,292,349 for the period from March 10,
1999 to December 31, 1999 included depreciation on computer and communications
equipment and amortization of software owned by us, lease costs of other fixed
assets leased by us from Cantor and a charge for premises costs from Cantor.
Fixed assets are reflected as if they were
49
contributed to us by Cantor in a non-cash transaction effective March 10, 1999
at their then current net book value (cost less accumulated depreciation) of
$7,370,560. Cantor leases from third parties under operating lease arrangements
certain computer related fixed assets that we have the right to use at rates
intended to equal costs incurred by Cantor. Our equipment expenses should
increase as we continue to invest in technology and related equipment. Occupancy
expenditures are comprised of our rent and facilities costs of our New York and
London offices.
Professional and consulting fees
Professional and consulting fees of $5,148,796 for the period from March
10, 1999 to December 31, 1999 consisted primarily of consultant costs paid to
outside computer professionals who perform specialized enhancement activities
for us. We currently have approximately 20 contracted consultants and additional
outside service providers working under short-term contracts costing
approximately $500,000 per month in the aggregate. The costs of professional
legal counsel engaged to defend the patents used in our business amounted to
approximately $482,000 for the period from March 10, 1999 to December 31, 1999.
Our professional and consulting expenses will likely increase over the
foreseeable future.
Communications and client networks
Communications costs of $3,355,070 for the period from March 10, 1999 to
December 31, 1999 included the costs of local and wide area network
infrastructure, the cost of establishing the client network linking clients to
us, data and telephone lines, data and telephone usage and other related costs.
We expect such costs to increase as we continue to expand into new marketplaces
and geographic locations and establish additional communication links with
clients. However, certain communications costs are decreasing globally due to
increased competition in the communications industry. This may or may not result
in a decrease in our communications costs.
Fulfillment services fees
Under the Joint Services Agreement, we are required to pay to Cantor a
fulfillment services fee of 20%, 35% or 55%, depending on the type of
transaction, of commissions paid by clients related to fully electronic
transactions. As we continue to sign up new clients, in conjunction with Cantor,
and the volume of business processed in the fully electronic brokerage channel
increases, this expense will likely increase commensurately with our revenues.
Administrative fees
Under an Administrative Services Agreement with Cantor, Cantor agreed to
provide various administrative services to us, including, but not limited to,
accounting, tax, legal and human resources, and we agreed to provide sales and
marketing services at cost to Cantor. We are required to reimburse Cantor for
its costs of providing these services plus an allocation of overhead. We have
provided for the cost of such services in our financial statements under the
terms set forth in the Administrative Services Agreement as if it was effective
for the period from March 10, 1999 to December 31, 1999. This amount was
$1,662,058 for the period from March 10, 1999 to December 31, 1999. As we expand
our business, the services provided by
50
Cantor, and accordingly the expense, will likely also increase. As circumstances
warrant, we will consider adding employees to take over these services from
Cantor.
Other expenses
Other expenses of $2,649,110 for the period from March 10, 1999 to
December 31, 1999 consisted primarily of travel, promotional and entertainment
expenditures. We expect that these expenses will also continue to increase over
the foreseeable future as we seek to expand our business. While we have no
obligation under the Joint Services Agreement to do so, we intend to use
approximately $25 million of the proceeds received by us from our initial public
offering for sales, marketing and advertising expenses related to our
marketplaces.
Quarterly Results of Operations
The following table sets forth, by quarter, statement of operations data
for the period from March 10, 1999 (date of commencement of operations) to
December 31, 1999. Results of any period are not necessarily indicative of
results for a full year.
March 10 to March Quarter Ended Quarter Ended Quarter Ended
26, 1999 June 25, 1999 September 24, 1999 December 31, 1999
----------------- ------------- ------------------ -----------------
Revenues:
Transaction Revenues:
Fully electronic transactions.................... $ 76,621 $ 1,153,471 $ 2,590,715 $ 6,259,035
Voice-assisted brokerage transactions............ 664,597 3,900,345 3,817,144 3,395,220
Screen assisted open outcry transactions......... 379,316 1,376,962 1,075,426 692,695
----------- ------------ ------------ ------------
Total transaction revenues............ 1,120,534 6,430,778 7,483,285 10,346,950
Interest income....................................... 347,804
System services fees.................................. 827,716 4,138,578 4,138,578 3,354,702
----------- ------------ ------------ ------------
Total revenues........................ 1,948,250 10,569,356 11,621,863 14,049,456
----------- ------------ ------------ ------------
Expenses:
Compensation and employee benefits.............. 1,267,838 6,403,446 7,033,656 6,797,386
Occupancy and equipment......................... 676,023 2,854,350 3,102,063 3,659,913
Professional and consulting fees................ 185,985 1,596,097 1,833,266 1,533,448
Communications and client networks.............. 221,159 1,103,081 1,121,552 909,278
Fulfillment services fees....................... 26,817 403,715 906,750 2,190,663
Administrative fees............................. 93,701 461,266 512,233 594,858
Options granted to Cantor employees............. 2,850,073
Other........................................... 15,235 500,034 606,850 1,526,991
----------- ------------ ------------ ------------
Total expenses........................ 2,486,758 13,321,989 15,116,370 20,062,610
----------- ------------ ------------ ------------
Loss before benefit for income taxes.................. $ (538,508) $ (2,752,633) $ (3,494,507) $ (6,013,154)
----------- ------------ ------------ ------------
Liquidity and Capital Resources
Before our initial public offering, we relied on Cantor to provide
financing and cash flow for our operations. Proceeds to us from our initial
public offering were approximately
51
$139.6 million. Since our initial public offering, we have relied on our cash
flow from operations and the proceeds from our initial public offering to
provide for our cash needs.
Our cash flow is comprised of transaction revenues and system services
fees from Cantor, charges from Cantor of various fees, occupancy costs and other
expenses paid by Cantor on our behalf and investment income. In acting in its
capacity as a fulfillment services provider, Cantor processes and settles the
transaction and, as such, collects and pays the funds necessary to clear the
transaction with the counterparty. In doing so, Cantor receives our portion of
the transaction fee and, in accordance with the Joint Services Agreement, remits
the gross amount owed to us. Under the Administrative Services Agreement and the
Joint Services Agreement, any net receivable or payable will be settled monthly
at the discretion of the parties.
Our ability to withdraw capital from our regulated broker-dealer
subsidiaries could be restricted, which in turn could limit our ability to pay
dividends, repay debt and redeem or purchase shares of our outstanding stock.
Although we have no material commitments for capital expenditures, we
anticipate that we will experience a substantial increase in our capital
expenditures and lease commitments consistent with our anticipated growth in
operations, infrastructure and personnel. We currently anticipate that we will
continue to experience significant growth in our operating expenses for the
foreseeable future and that our operating expenses will be a material use of our
cash resources.
Under the current operating structure, our cash flow from operations and
the net proceeds from our initial public offering should be sufficient to fund
our current working capital and current capital expenditure requirements for at
least the next 12 months. However, we believe that there are a significant
number of capital intensive opportunities for us to maximize our growth and
strategic position, including, among other things, acquisitions, joint ventures,
strategic alliances or other investments. We are currently considering such
options and their effect on our capital requirements.
Impact of the Year 2000
The year 2000 computer problem refers to the potential for system and
processing failures of date related data as a result of computer controlled
systems using two digits rather than four to define the applicable year. For
example, computer programs that have time sensitive software may recognize a
date represented as 00 as the year 1900 rather than the year 2000. This could
result in a system failure or miscalculations causing disruptions in operations,
including, among other things, a temporary inability to process transactions,
send transmissions to clearing agents or engage in similar normal business
activities.
As a result of the work performed by us and Cantor, we experienced no
adverse impact from a Year 2000 problem. Our and Cantor's combined costs
associated with upgrades to hardware and software, testing and remediating our
systems were approximately $9.2 million through December 31, 1999.
52
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have invested $134,644,521 of our excess cash in securities purchased
under reverse repurchase agreements which are fully collateralized by U.S.
Government securities held in a custodial account at The Chase Manhattan Bank.
These reverse repurchase agreements have an overnight maturity and, as such, are
highly liquid. We do not use derivative financial instruments, derivative
commodity instruments or other market risk sensitive instruments, positions or
transactions. Accordingly, we believe that we are not subject to any material
risks arising from changes in interest rates, foreign currency exchange rates,
commodity prices, equity prices or other market changes that affect market risk
sensitive instruments. Our policy is to invest our excess cash in a manner to
provide us with the appropriate level of liquidity to enable us to meet our
current obligations, primarily accounts payable, capital expenditures and
payroll, recognizing that we do not currently have outside bank funding.
53
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
eSpeed, Inc. and Subsidiaries
CONSOLIDATED FINANCIAL STATEMENTS
Page No.
--------
Independent Auditors' Report.......................................... 55
Consolidated Statement of Financial Condition......................... 56
Consolidated Statement of Operations.................................. 57
Consolidated Statement of Cash Flow................................... 58
Consolidated Statement of Changes in Stockholders' Equity............. 59
Notes to Consolidated Financial Statements............................ 60
54
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of eSpeed, Inc.:
We have audited the accompanying consolidated statement of financial condition
of eSpeed, Inc. and Subsidiaries (the "Company") as of December 31, 1999, and
the related statements of operations, cash flows and changes in stockholders'
equity for the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company at December 31, 1999,
and the results of their operations and their cash flows for the period from
March 10, 1999 (date of commencement of operations) to December 31, 1999, in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
New York, New York
March 24, 2000
55
eSpeed, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
December 31, 1999
Assets
Cash...................................................................................... $ 201,001
Securities purchased under agreements to resell........................................... 134,644,521
---------------
Fixed assets, at cost..................................................................... 12,556,627
Less accumulated depreciation and amortization............................................ (3,086,555)
---------------
Fixed assets, net......................................................................... 9,470,072
Prepaid expenses, principally computer maintenance agreements............................. 11,495
---------------
Total assets.............................................................................. $ 144,327,089
===============
Liabilities and Stockholders' Equity
Liabilities
Payable to affiliates, net................................................................ $ 6,743,929
Accounts payable and accrued liabilities.................................................. 2,071,347
---------------
Total liabilities......................................................................... 8,815,276
---------------
Stockholders' Equity
Preferred stock, par value $.01 per share; 50,000,000 shares authorized, no
shares issued or outstanding.
- - Class A common stock, par value $.01 per share; 200,000,000 shares
authorized; 10,350,000 shares issued and outstanding................................... 103,500
Class B common stock, par value $.01 per share; 100,000,000 shares
authorized; 40,650,000 shares issued and outstanding................................... 406,500
Additional paid in capital................................................................ 147,588,726
Accumulated deficit....................................................................... (12,586,913)
---------------
Total stockholders' equity................................................................ 135,511,813
---------------
Total liabilities and stockholders' equity................................................ $ 144,327,089
===============
See notes to consolidated financial statements
56
eSpeed, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF OPERATIONS
December 31, 1999
Revenues:
Transaction revenues......................................... $ 25,381,547
Interest income.............................................. 347,804
System service fees from affiliates.......................... 12,459,574
--------------
Total revenues............................................... 38,188,925
--------------
Expenses:
Compensation and employee benefits........................... 21,502,326
Occupancy and equipment...................................... 10,292,349
Professional and consulting fees............................. 5,148,796
Communications and client networks........................... 3,355,070
Fulfillment fees paid to affiliates.......................... 3,527,945
Administrative fees paid to affiliates....................... 1,662,058
Options granted to Cantor employees.......................... 2,850,073
Other........................................................ 2,649,110
--------------
Total expenses............................................... 50,987,727
--------------
Loss before benefit for income taxes......................... (12,798,802)
---------------
Income Taxes:
Federal...................................................... --
State and local.............................................. 211,889
Total taxes.................................................. 211,889
--------------
Net loss..................................................... $ (12,586,913)
===============
Per Share Data:
Basic and diluted net loss per share......................... $ (0.28)
Weighted average shares of common stock outstanding.......... 44,495,000
See notes to consolidated financial statements
57
eSpeed, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CASH FLOW
December 31, 1999
Cash flows from operating activities:
Net loss .................................................................. $ (12,586,913)
Non-cash item included in net loss:
Depreciation and amortization .......................................... 3,086,555
Issuance of stock options .............................................. 2,850,073
Decrease in operating assets:
Prepaid expenses ....................................................... 1,190,728
Increase (decrease) in operating liabilities:
Payable to affiliates, net ............................................. 6,743,929
Accrued compensation and benefits ...................................... (1,490,836)
Accounts payable and accrued liabilities ............................... 444,699
-------------
Cash provided by operating activities ............................... 238,235
-------------
Cash flows from investing activities:
Acquisitions of fixed assets .............................................. (2,717,462)
Capitalization of software development costs .............................. (2,468,605)
Increase in securities purchased under agreements to resell................ (134,644,521)
-------------
Cash used in investing activities ................................... (139,830,588)
-------------
Cash flows from financing activities:
Capital contribution ...................................................... 200,000
Proceeds from initial public offering, net ................................ 143,990,000
Payment of offering costs ................................................. (4,396,646)
-------------
Cash provided by financing activities ............................... 139,793,354
-------------
Net increase in cash ......................................................... 201,001
Cash balance, beginning of period ............................................ --
-------------
Cash balance, end of period .................................................. $ 201,001
-------------
Supplemental disclosure of non-cash financing activities:
Effective March 10, 1999, the Company received an initial capital contribution
as follows:
Fixed assets .............................................................. $ 7,370,560
Prepaid expenses .......................................................... 1,202,223
Accrued compensation and benefits ......................................... (1,490,836)
Accounts payable and accrued expenses ..................................... (1,626,648)
-------------
Total non-cash capital contributed $ 5,455,299
=============
See notes to consolidated financial statements
58
Total
Common Stock Common Stock Additional Paid in Accumulated Stockholders'
Class A Class B Capital Deficit Equity
Balance, March 10, 1999 ......................... $ -- $ -- $ -- $ -- $ --
Cash capital contribution (100 Shares) .......... 1 199,999 200,000
Non-cash capital contribution (43,999,900 Shares) 439,999 5,015,300 5,455,299
Conversion of Class B common stock to Class A
common stock (3,350,000 Shares) .............. 33,500 (33,500) --
Initial public offering of Class A common
stock (7,000,000 Shares) ..................... 70,000 143,920,000 143,990,000
Costs of initial public offering ................ (5,749,481) (5,749,481)
Issuance of options ............................. 2,850,073 2,850,073
Issuance of warrant ............................. 1,352,835 1,352,835
Net loss ........................................ (12,586,913) (12,586,913)
--------- --------- ------------- ------------- ------------
Balance, December 31, 1999 ...................... $ 103,500 $ 406,500 $ 147,588,726 $ (12,586,913) $135,511,813
========= ========= ============= ============= ============
See notes to consolidated financial statements
59
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999
1. Organization and Formation Transaction
eSpeed, Inc. (eSpeed or, together with its wholly owned subsidiaries, the
Company) is a majority owned subsidiary of Cantor Fitzgerald Securities (CFS),
which in turn is a 99.5% owned subsidiary of Cantor Fitzgerald, L.P. (CFLP, or
together with its subsidiaries, Cantor). eSpeed commenced operations on March
10, 1999 as a division of CFS. eSpeed is a Delaware corporation that was
incorporated on June 3, 1999. The Company engages in the business of operating
interactive business-to-business vertical electronic marketplaces designed to
enable market participants to trade financial and non-financial products more
efficiently and at a lower cost that traditional trading environments permit.
In December 1999, the Company completed its initial public offering (the
Offering) of 10,350,000 shares of Class A common stock at $22 per share, of
which 7 million shares were sold by the Company, raising approximately $144
million in proceeds before Offering expenses. The remaining shares were sold by
CFS.
The accompanying financial statements include activities of the Company
while operating as a division of CFS from March 10, 1999 to the Offering. The
formation transactions include the initial capital contribution of net assets of
$5,455,299. This contribution includes fixed assets with a net book value of
$7,370,560 and prepaid expenses of $1,202,223, and the assumption of liabilities
consisting of accrued compensation, accounts payable and other liabilities of
$3,117,484. In exchange for the contribution of net assets, the Company issued
Cantor 43,999,900 shares of Class B common stock. Immediately thereafter, Cantor
converted 3,350,000 shares of Class B common stock to Class A common stock and
sold them in the Offering.
2. Summary of Significant Accounting Policies
Use of Estimates: The preparation of the consolidated financial statements
in conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts of the assets
and liabilities, revenues and expenses, and the disclosure of contingent assets
and liabilities in the consolidated financial statements. Estimates, by their
nature, are based on judgment and available information. As such, actual results
could differ from the estimates included in these consolidated financial
statements.
Transaction Revenues: Securities transactions and the related transaction
revenues are recorded on a trade date basis.
Fixed Assets: Fixed assets, which comprise computer and communication
equipment and software, are depreciated over their estimated economic useful
lives of three to five years using an accelerated method. Internal and external
direct costs of application development and of obtaining software for internal
use are capitalized and amortized over their estimated economic useful life of
three years on a straight-line basis.
Securities Purchased under Agreements to Resell: Securities purchased
under agreements to resell (Resale, or Reverse Repurchase, Agreements) are
accounted for as
60
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999
collateralized investment transactions. It is the policy of the Company to
obtain possession of the collateral with a market value equal to or in excess of
the principal amount loaned. Collateral is valued daily and the Company may
require counter-parties to deposit additional collateral or return amounts
loaned when appropriate. The Company generally does not report assets received
as collateral in Resale Agreements because the debtor typically has the right to
substitute or redeem the collateral on short notice.
Stock Options: Awards to employees of options to purchase the Class A
common stock of the Company are accounted for under Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees". No expense is
recognized for awards under non-compensatory plans. Options granted to
non-employees are accounted for under the Financial Accounting Standards Board's
Statement of Financial Accounting Standard (SFAS) No. 123, "Accounting for
Stock-Based Compensation", where the options granted are recognized based on the
fair value of the options at the time of the grant.
New Accounting Pronouncements: In June 1998, the Financial Accounting
Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. The statement, as amended, is
effective for fiscal years beginning after June 15, 2000. The Company has
evaluated the impact of adopting SFAS No. 133 and believes it will not have a
material effect on its financial statements.
3. Fixed Assets
Fixed assets consist of the following: December 31, 1999
----------------
Computer and communication equipment....................... $ 9,544,265
Software, including software development costs............. 3,012,362
---------------
12,556,627
Less accumulated depreciation and amortization............. (3,086,555)
---------------
Fixed assets, net.......................................... $ 9,470,072
===============
4. Income Taxes
Through December 9, 1999, the Company operated as a division of CFS, which
is a New York partnership. Under applicable federal and state income tax laws,
the taxable income or loss of a partnership is allocated to each partner based
upon their ownership interest. CFS is, however, subject to the Unincorporated
Business Tax (UBT) of the City of New York, and the benefit for income taxes
represents a reduction in UBT. The loss generated by the Company while it
operated as a division of CFS will be used as a reduction of the taxable income
of CFS and, as such, the Company will be reimbursed for such tax and has
recognized the tax benefit as an offset to payable to affiliates.
61
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999
Since the commencement date of the Offering, December 10, 1999, the
Company has been subject to income tax as a corporation. The net operating
losses from that date, in the amount of $4,409,883 will be available on a carry
forward basis through 2014 to offset future operating income of the Company.
5. Commitments and Contingencies
Leases: Under an administrative services agreement, eSpeed is obligated
for minimum rental payments under various non-cancelable leases with third
parties, principally for office space and computer equipment, expiring at
various dates through 2014 as follows:
For the Period Ending December 31:
- ---------------------------------
2000....................................................... $ 4,435,118
2001....................................................... 4,273,899
2002....................................................... 4,193,291
2003....................................................... 4,152,367
2004....................................................... 4,115,995
Thereafter................................................. 20,352,341
---------------
Total...................................................... $ 41,523,011
===============
Rental expense under the above and under all other operating leases
amounted to $3,738,303 for the period ended December 31, 1999.
Legal Matters: On June 21, 1999, Cantor and its affiliate CFPH, LLC,
brought suit against Liberty Brokerage Investment Corporation and Liberty
Brokerage Inc. in the United States District Court for the District of Delaware
for infringement of the Fraser et al. U.S. patent 5,905,974, entitled "Automated
Auction Protocol Processor." Cantor alleged in the complaint that Liberty was
infringing the `974 patent by making, using, selling and/or offering for sale
systems and methods that embody or use the inventions claimed in the `974
patent. On August 10, 1999, Cantor and CFPH, L.L.C. voluntarily dismissed the
suit without prejudice. Subsequently, on August 10, 1999, Liberty filed an
action for declaratory judgment in the United States District Court for the
District of Delaware against Cantor and two of its affiliates, Cantor Fitzgerald
Securities and CFPH, LLC, claiming that the `974 patent was invalid,
unenforceable and not infringed by Liberty. On October 12, 1999, Cantor, Cantor
Fitzgerald Securities and CFPH, LLC moved (1) to dismiss all claims against
Cantor Fitzgerald Securities for failure to state a claim upon which relief can
be granted and (2) to dismiss the action as against Cantor, Cantor Fitzgerald
Securities and CFPH, LLC for lack of an actual case or controversy within the
meaning of 28 U.S.C. Section 2201. On November 22, 1999, the Court granted the
motion to dismiss the action as against Cantor Fitzgerald Securities, and denied
the motion to dismiss the action as against Cantor and its affiliate CFPH, LLC.
On January 5, 2000, Liberty filed an Amended Complaint naming the Company as a
defendant. On January 19, 2000, Cantor and CFPH, LLC filed a Second Renewed
Motion to Dismiss the action. On March 8, 2000, oral
62
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999
arguments took place on the Second Renewed Motion to Dismiss. No decision has
been rendered. The Company has assumed responsibility for defending this suit on
behalf of Cantor and its affiliates and the risk of loss associated with it.
In February 1998, Market Data Corporation contracted with Chicago Board
Brokerage (a company controlled by the Chicago Board of Trade and Prebon Yamane)
to provide the technology for an electronic trading system to compete with
Cantor's United States Treasury brokerage business. Market Data Corporation is
controlled by Iris Cantor and Rodney Fisher, her nephew-in-law. Iris Cantor, a
company under the control of Iris Cantor referred to herein as CFI, and Rodney
Fisher are limited partners of Cantor Fitzgerald, L.P.
In April 1998, Cantor Fitzgerald, L.P. filed a complaint in the Delaware
Court of Chancery against Market Data Corporation, Iris Cantor, CFI, Rodney
Fisher and Chicago Board Brokerage seeking an injunction and other remedies. The
complaint alleges that Iris Cantor, CFI and Rodney Fisher violated certain
duties, including fiduciary duties under Cantor's partnership agreement due to
their competition with Cantor Fitzgerald, L.P. with respect to the electronic
trading system mentioned above. The complaint further alleges that Market Data
Corporation and Chicago Board Brokerage tortuously interfered with Cantor's
partnership agreement and aided and abetted Iris Cantor's, CFI's and Rodney
Fisher's breaches of fiduciary duty. Iris Cantor, CFI and Rodney Fisher
counterclaimed seeking, among other things, (1) to reform agreements they have
with Cantor Fitzgerald, L.P. and (2) a declaration that Cantor Fitzgerald, L.P.
breached the implied covenant of good faith and fair dealing. Cantor has agreed
to indemnify the Company for any liabilities that the Company incurs with
respect to any current or future litigation involving (1) Market Data
Corporation, (2) Iris Cantor, (3) CFI or (4) Rodney Fisher.
Cantor Fitzgerald, L.P. settled its dispute with Chicago Board Brokerage
in April 1999 and Chicago Board Brokerage subsequently announced it was
disbanding its operations. On March 17, 2000, the Delaware Court of Chancery
ruled in favor of Cantor Fitzgerald, L.P., finding that Iris Cantor, CFI and
Rodney Fisher had breached the Partnership Agreement of Cantor Fitzgerald, L.P.,
and that Market Data Corporation had aided and abetted that breach. The court
awarded Cantor Fitzgerald, L.P. declaratory judgment relief and court costs and
attorneys' fees. Counsel for the defendants have expressed their intentions to
appeal this result. The Company believes Market Data Corporation's technology
for electronic trading systems will be of substantial assistance to competitors
in the wholesale market if provided to them.
Two related actions are pending in New York. In a case pending in the
Supreme Court of New York, New York County, plaintiff Cantor Fitzgerald, L.P.
alleges, among other things, that defendants Market Data Corporation, CFI, Iris
Cantor and Rodney Fisher misused confidential information of Cantor Fitzgerald,
L.P. in connection with the above mentioned provision of technology to Chicago
Board Brokerage. In a case pending in the United States District Court for the
Southern District of New York, CFI and Iris Cantor allege, among other things,
that certain senior officers of Cantor Fitzgerald, L.P. breached fiduciary
duties they owed to CFI. The allegations in this lawsuit relate to several of
the same events underlying the court proceedings in
63
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999
Delaware. Neither of these two cases has been pursued during the pending of the
court proceedings in Delaware.
In addition to the allegations set forth in the pending lawsuits, Cantor
has received correspondence from the attorneys representing Iris Cantor, CFI,
Market Data Corporation and Rodney Fisher in the proceedings in Delaware,
expressing a purported concern that Cantor and/or certain of its partners may be
in breach of Cantor's partnership agreement (including, among other things, the
partnership agreement's provisions relating to competition with the partnership)
and the general partnership agreement of Cantor Fitzgerald Securities with
respect to the Company's initial public offering. Generally, these attorneys
have alleged that various purported conflicts of interest will exist arising
from the fact that certain of the Company's directors and officers will
simultaneously hold positions with Cantor Fitzgerald, L.P. Moreover, these
attorneys have asserted that the Company's business plan may not be consistent
with certain purported rights of Market Data Corporation (including purported
intellectual property rights) and other parties and they requested more
information regarding the Company's initial public offering.
Although the Company does not expect to incur any losses with respect to
the pending lawsuits or supplemental allegations surrounding Cantor's
partnership agreement, Cantor has agreed to indemnify the Company with respect
to any liabilities the Company incurs as a result of such lawsuits or
allegations.
Cantor and Reuters were parties to a confidential arbitration under the
auspices of the American Arbitration Association in New York, New York, which
began in June 1995 with respect to a January 1993 agreement among Reuters,
Cantor and Market Data Corporation. The agreement executed in 1993 involved,
among other things, the delivery by Cantor of certain market data arising out of
non-United States government bond and U.S. municipal bond interdealer brokerage
transactions for transmittal over Reuters' network. The agreement also
contemplated the joint development by Cantor and Reuters of an electronic
trading system for certain transactions in non-United States government bonds.
Cantor and Reuters did not develop this electronic trading system. In the
arbitration, Reuters alleged that Cantor materially breached the agreement
primarily by failing to provide non-screen, voice brokerage data concerning
non-United States government bonds and U.S. municipal bonds that Reuters
contends are subject to the agreement and fraud. Reuters sought to recover from
Cantor amounts representing past payments for market data, the reimbursement of
attorneys' fees and other damages. Cantor denied Reuters' allegations that there
had been any material breach of this agreement or fraud, and asserted a breach
of contract claim and various other counterclaims against Reuters, including
claims for Reuters' failure since February 1997 to pay any of the money due
Cantor for data under this agreement. In February 1997, Reuters unilaterally
ceased making such payments to Cantor in connection with the dispute and in
November 1999 stopped distributing Cantor's market data that was provided to
Reuters.
On December 30, 1999, Cantor entered into a new agreement with Reuters
pursuant to which Cantor and Reuters settled outstanding disputes and terminated
the 1993 agreement. The Company cannot assure you that Market Data Corporation
will not seek to assert claims against
64
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999
the Company or Cantor relating to our activities with respect to the 1993
agreement or the arbitration. Cantor has agreed to indemnify the Company with
respect to any claims that may be asserted by Market Data Corporation or Reuters
relating to the 1993 agreement or arising out of the arbitration.
On May 5, 1999, Cantor, The Board of Trade of the City of Chicago, The New
York Mercantile Exchange and The Chicago Mercantile Exchange, were sued by
Electronic Trading Systems, Inc. in the United States District Court for the
Northern District of Texas (Dallas Division) for alleged infringement of Wagner
United States patent 4,903,201, entitled "Automated Futures Trade Exchange". The
patent relates to a system and method for implementing an electronic,
computer-automated futures exchange. On July 1, 1999, Cantor answered the
complaint, asserting, among other things, that the `201 patent was invalid and
not infringed by Cantor and that Cantor was not the real party in interest.
Although not identified by the complaint, Cantor believes that the system being
charged with infringement is a version of the electronic trading system used by
the Cantor Exchange((Service Mark)), which Cantor contributed to the Company in
December 1999. Electronic Trading Systems Corporation executed a Covenant Not to
Sue, Release and Settlement Agreement, dated February 18, 2000, pursuant to
which it agreed not to sue Cantor Fitzgerald, L.P. or any of its affiliates or
successors, including the Company, or any customers, for infringement of the
`201 patent by the Cantor Exchange((Service Mark)). On March 22, 2000, counsel
to the parties filed with the court a Joint Stipulation and (proposed) Order of
Dismissal requesting that Cantor Fitzgerald, L.P. be dismissed from the case
without prejudice by Electronic Trading Systems Corporation. On March 23, 2000,
the Court signed an Agreed Order of Dismissal and on March 24, 2000 Cantor
Fitzgerald, L.P. was dismissed from the case.
Although the ultimate outcome of these actions cannot be ascertained at
this time and the results of legal proceedings cannot be predicted with
certainty, it is the opinion of management that the resolution of these matters
will not have a material adverse effect on the financial condition or results of
operations of the Company.
Risks and Uncertainties: The majority of the Company's revenues consist of
fees earned from Cantor in connection with its interactive electronic
business-to-business vertical marketplaces. Revenues for these services are
transaction based. As a result, the Company's revenues could vary based on the
transaction volume of financial markets around the world.
6. Related Party Transactions
At December 31, 1999, the Company had overnight Resale Agreements with CFS
totaling $134,644,521, including accrued interest. Under the terms of the
agreement, the securities collateralizing the Resale Agreements are held under a
custodial arrangement with a third party bank.
Under a Joint Services Agreement among the Company and Cantor, the Company
earns transaction revenue equal to a percentage of Cantor's commission revenue
on customer transactions for services provided by the Company. The percentage of
the transaction revenues range from 2.5% to 100%, depending on the type of
electronic services provided for the
65
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999
transaction. Revenues from such transactions during the period ended December
31, 1999 totaled $25,381,547.
On certain transactions (those where the Company receives 100% of the
commission revenue share), Cantor provides the Company with fulfillment services
for which Cantor is paid a fee of 20% or 35% of the transaction revenue earned
on the transaction. Charges to the Company from Cantor for such fulfillment
services during the period ended December 31, 1999 totaled $3,527,945.
Under the Administrative Services Agreement, the Company provides network,
data center and server administration support and other technology services to
Cantor. The Company charges Cantor for these services commensurate with its
costs of providing these services. System services fees received from Cantor
during the period ended December 31, 1999 totaled $12,459,574.
Under an Administrative Services Agreement, Cantor provides various
administrative services to the Company, including accounting, tax, sales and
marketing, legal and facilities management. The Company is required to reimburse
Cantor for the cost of providing such services. The costs represent the direct
and indirect costs of providing such services and are determined based upon the
time incurred by the individual performing such services. Management believes
that this allocation methodology is reasonable. The Administrative Service
Agreement has a three-year term which will renew automatically for successive
one-year terms unless cancelled upon six month's prior notice by either the
Company or Cantor. The Company incurred administrative fees for such services
during the period ended December 31, 1999 totaling $1,662,058.
7. Capitalization
The rights of holders of shares of Class A and Class B common stock are
substantially identical, except that holders of Class B common stock are
entitled to 10 votes per share, while holders of Class A common stock are
entitled to one vote per share. Additionally, each share of Class B common stock
is convertible at any time, at the option of the holder, into one share of Class
A common stock.
8. Regulatory Capital Requirements
Through its subsidiary, eSpeed Government Securities, Inc., the Company is
subject to Securities and Exchange Commission (SEC) broker-dealer regulation
under Section 15C of the Securities Exchange Act of 1934, which requires the
maintenance of minimum liquid capital, as defined. At December 31, 1999, eSpeed
Government Securities, Inc.'s liquid capital of $1,536,699 was in excess of
minimum requirements by $1,511,699.
Additionally, the Company's subsidiary, eSpeed Securities, Inc., is
subject to SEC broker-dealer regulation under Rule 17a-5 of the Securities
Exchange Act of 1934 which requires the maintenance of minimum net capital and
requires that the ratio of aggregate
66
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999
indebtedness to net capital, both as defined, shall not exceed 8 to 1. At
December 31, 1999, eSpeed Securities, Inc. had net capital of $1,048,849, which
was $572,325 in excess of its required net capital of $476,524, and eSpeed
Securities, Inc.'s net capital ratio was 3.63 to 1.
9. Deferred Compensation Plan
Employees of the Company are eligible to participate in the Cantor
Fitzgerald Deferral Plan (the Plan), which is a deferred-salary plan sponsored
by CFLP, whereby an eligible employee may elect to defer a portion of his salary
by directing the Company to contribute to the Plan. The Plan is available to all
employees of the Company meeting certain eligibility requirements and is subject
to the provisions of the Employee Retirement Income Security Act of 1974. While
the Company has the option to contribute to the Plan on behalf of its
participants, no such contribution was made during the period ended December 31,
1999. The administration of the Plan is performed by CFLP. The Company pays its
proportionate share of such administrative costs under the Administrative
Services Agreement.
10. Long-Term Incentive Plan
The Company has adopted a Long-Term Incentive Plan (the LT Plan) which
will provide for awards in the form of 1) either incentive stock options or
non-qualified stock options (NQSOs); 2) stock appreciation rights; 3) restricted
or deferred stock; 4) dividend equivalents; 5) bonus shares and awards in lieu
of obligations to pay cash compensation; and 6) other awards, the value of which
is based in whole or in part upon the value of eSpeed's common stock.
The Compensation Committee of the Board of Directors administers the LT
Plan and is generally empowered to select the individuals who will receive the
awards and the terms and conditions of those awards.
The LT Plan also authorizes the automatic grant of NQSOs to non-employee
directors upon initial election as a director and additional grants at each
annual meeting thereafter. These options will have an exercise price equal to
the fair market value of the Class A common stock on the date of grant.
11. Stock Purchase Plan
The Company has adopted a Stock Purchase Plan to permit eligible,
including employees of Cantor, employees to purchase shares of eSpeed common
stock at a discount. At the end of each purchase period, as defined, accumulated
payroll deductions will be used to purchase stock at a price determined by a
Stock Purchase Plan Administrative Committee, which will generally not be less
than 85% of the lowest market price at various defined dates during the purchase
period. The Company has reserved 425,000 shares of Class A common stock for
issuance under the Stock Purchase Plan.
67
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999
12. Options and Warrants
In connection and concurrent with the Offering, the Company issued options
under the LT Plan to employees of Cantor, outside directors of the Company, and
employees of the Company. In addition, the Company issued a warrant to a
consultant. The options and warrants have contractual expiration dates of either
five or ten years from the grant date, and give the holder the right to purchase
shares of the Company's Class A common stock at the initial public offering
price of $22. No options or warrants were exercised or expired and 24,900
options were forfeited during the period ended December 31, 1999.
The fair value of the options and warrants was estimated using a modified
Black-Scholes option pricing model and the following assumptions: risk-free
interest rate of 6%, no expected dividends, expected stock price volatility of
55%, and expected lives ranging from three to eight years from the grant date.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its stock options or warrants.
The Company issued 135,000 warrants to a consultant in connection with the
Offering. The grant date estimated fair value of $1,352,835 has been recorded as
an increase to additional paid in capital and as an increase in Offering costs
which have been charged against additional paid in capital. Accordingly, the
issuance of the warrants resulted in no net change in additional paid in
capital. The warrants are exercisable commencing on the one-year anniversary of
the Offering.
The Company issued 282,005 vested options to Cantor employees that are
exercisable on the first anniversary of the Offering and issued 10,000
immediately exercisable options to a consultant. The estimated fair value of the
options at the time of the Offering resulted in a one-time non-cash charge to
the Company of $2,850,073.
The Company also issued 6,227,445 options to employees and outside
directors of the Company, of which 500,000 are immediately exercisable. The
remaining options vest as follows: 3,915,000 spread ratably over the five
successive anniversaries of the Offering, 1,752,445 spread ratably over the four
successive anniversaries of the Offering, and 60,000 spread ratably over the
three successive six month anniversaries of the Offering. The options had an
estimated fair value of $82,758,567 as of the grant date. Had the Company
accounted for these options in its stock based compensation plan based on the
fair value of awards at grant date in a manner consistent with the methodology
of SFAS 123, the Company's net loss and loss per common share would have
increased by $6,642,591 and $0.15, respectively.
68
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999
As of December 31, 1999, the weighted average remaining contractual life
of options and warrants outstanding was approximately 9-1/4 years; and options
for 510,000 shares were currently exercisable.
13. Segment and Geographic Data
Segment Information: The Company currently operates its business in one
segment, that of operating interactive electronic business-to-business vertical
marketplaces for the trading of financial and non-financial products. This
segment comprised approximately 66% of revenues for the period ended December
31, 1999. The remainder of the Company's revenues was derived from system
services fees received from Cantor and interest income.
Geographic Information: The Company operates in the Americas, Europe, and
Asia. Revenue attribution for purposes of preparing geographic data is
principally based upon the marketplace where the financial product is traded,
which, as a result of regulatory jurisdiction constraints in most circumstances,
is also representative of the location of the client generating the transaction
resulting in commissionable revenue. The information that follows, in
management's judgement, provides a reasonable representation of the activities
of each region as of and for the period ended December 31, 1999:
TRANSACTION REVENUES
Europe................................................... $ 5,392,923
Asia..................................................... 450,457
-----------------
Total Non-Americas....................................... 5,843,380
Americas................................................. 19,538,167
-----------------
TOTAL.................................................... 25,381,547
=================
AVERAGE LONG-LIVED ASSETS
Europe................................................... $ 2,257,914
Asia..................................................... 925,790
-----------------
Total Non-Americas....................................... 3,183,704
Americas................................................. 5,236,613
-----------------
TOTAL.................................................... $ 8,420,317
=================
69
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the period from March 10, 1999 (date of commencement of operations)
to December 31, 1999
Quarterly Information (Unaudited)
The unaudited quarterly results of operations of the Company for 1999 are
prepared in accordance with generally accepted accounting principles. The
information presented reflects all adjustments (which consist of normal
recurring accruals) that are, in management's opinion, necessary for the fair
presentation of results of operations for the periods presented. Results of any
period are not necessarily indicative of results for a full year.
Quarter Ended
March 10 ------------------------------------------------------
through June 25, September December 31,
26, 1999 1999 24, 1999 1999
------------ ------------ ------------ ------------
Total revenues ......................... $ 1,948,250 $ 10,569,356 $ 11,621,863 $ 14,049,456
Total expenses ......................... 2,486,758 13,321,989 15,116,370 20,062,610
------------ ------------ ------------ ------------
Loss before provision for income taxes.. (538,508) (2,752,633) (3,494,507) (6,013,154)
Income tax benefit ..................... 13,470 68,849 89,488 40,082
------------ ------------ ------------ ------------
Net loss ............................... $ (525,038) $ (2,683,784) $ (3,405,019) $ (5,973,072)
============ ============ ============ ============
Net loss per share ..................... $ (0.01) $ (0.06) $ (0.08) $ (0.13)
============ ============ ============ ============
70
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
71
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table provides information regarding our directors and executive
officers:
Name Age Title
- ---- --- -----
Howard W. Lutnick................... 38 Chairman of the Board and
Chief Executive Officer
Frederick T. Varacchi............... 34 President and Chief
Operating Officer;
Director
Douglas B. Gardner.................. 38 Vice Chairman; Director
Kevin C. Piccoli.................... 42 Senior Vice President and
Chief Financial Officer
Stephen M. Merkel................... 41 Senior Vice President,
General Counsel and
Secretary
Richard C. Breeden.................. 50 Director(1)
Larry R. Carter..................... 56 Director(1)
William J. Moran.................... 58 Director(1)
Joseph P. Shea...................... 45 Director
- -----------
(1) Non-employee director.
Howard W. Lutnick. Mr. Lutnick has been our Chairman of the Board of
Directors and Chief Executive Officer since June 1999. Mr. Lutnick joined Cantor
in 1983 and has served as President and Chief Executive Officer of Cantor since
1991. He directs all facets of eSpeed's and Cantor's worldwide operations. Mr.
Lutnick's company, CF Group Management, Inc., is the managing general partner of
Cantor. Mr. Lutnick serves as co-chairman of the Cantor Exchange((Service
Mark)). Mr. Lutnick is a member of the Executive Committee of the Intrepid
Museum Foundation's Board of Trustees, the Zachary and Elizabeth M. Fisher
Center for Alzheimer's Disease Research at Rockefeller University, the Board of
Managers of Haverford College, the Board of Directors of City Harvest and the
Board of Directors of New York City Public/Private Initiatives, Inc.
Frederick T. Varacchi. Mr. Varacchi has been our President and Chief
Operating Officer since June 1999. Mr. Varacchi has been an Executive Managing
Director and the Chief Operating Officer of Cantor since October 1999. From
March 1998 to October 1999, he served as Senior Managing Director and Chief
Information Officer of Cantor. Before joining Cantor, Mr. Varacchi was Senior
Vice President and Chief Technology Officer of Greenwich/Natwest Capital
Markets, overseeing information technology for the company from January 1995 to
February 1998. From March 1990 to January 1995, Mr. Varacchi worked for Chase
Manhattan Bank, where he held a variety of senior technology positions,
including Head of Global Network Systems for Private Banking. From January 1989
to March 1990, Mr. Varacchi served in a variety of positions with Salomon Smith
Barney, including as Head of Front Office Systems. Mr.
72
Varacchi is a member of the Board of Directors of Expert Ease Software and QV
Trading Systems Inc.
Douglas B. Gardner. Mr. Gardner has been our Vice Chairman since June
1999. Mr. Gardner has been an Executive Managing Director of Cantor since
October 1999. He previously served as Senior Managing Director and Chief
Administrative Officer of Cantor from January 1994 to October 1999, where he was
responsible for overseeing all worldwide finance and support related functions.
Mr. Gardner serves as a director and is on the executive and finance committees
of the Cantor Exchange((Service Mark)). Prior to joining Cantor, Mr. Gardner was
a partner of DG Equities, a commercial and residential real estate developer and
owner. From 1983 to 1985, Mr. Gardner was associated with Lehman Brothers in the
High-Technology Division of its Corporate Finance Department.
Kevin C. Piccoli. Mr. Piccoli has been our Senior Vice President and Chief
Financial Officer since September 1999. He has been a Managing Director of
Cantor since October 1999 and Senior Vice President and Chief Financial Officer
of Cantor, responsible for its global accounting, regulatory, management
reporting and treasury functions, since July 1999. Prior to joining Cantor, he
was a Managing Director and Chief Financial Officer at Greenwich Capital
Holdings, Inc., a subsidiary of National Westminster Bank, from April 1992 to
July 1999. Mr. Piccoli's responsibilities at Greenwich included global
accounting, tax and regulatory reporting. Prior to joining Greenwich in April
1992, Mr. Piccoli was an audit partner at Coopers & Lybrand.
Stephen M. Merkel. Mr. Merkel has been our Senior Vice President, General
Counsel and Secretary since June 1999. Mr. Merkel has also been Senior Vice
President, General Counsel and Secretary of Cantor since 1993, where he is
responsible for Cantor's legal, compliance, tax, risk and credit departments.
Mr. Merkel serves as a director and Secretary of the Cantor Exchange((Service
Mark)). Prior to joining Cantor, Mr. Merkel was Vice President and Assistant
General Counsel of Goldman Sachs & Co. from February 1990 to May 1993. From
September 1985 to January 1990, Mr. Merkel was associated with the law firm of
Paul, Weiss, Rifkind, Wharton & Garrison.
Richard C. Breeden. Mr. Breeden has been our director since December 1999.
Mr. Breeden has been Chairman of the Board and Chief Executive Officer of
Equivest Finance, Inc., a publicly traded vacation ownership company, since
October 1997 and President since October 1998. Mr. Breeden has served as Trustee
for the Bennett Funding Group, Inc. since 1996. Mr. Breeden also has served as
President of Richard C. Breeden & Co., a consulting firm, since 1996. From 1993
to 1996, Mr. Breeden served as Chairman of the worldwide financial services
practice of Coopers & Lybrand and, from 1989 to 1993, Mr. Breeden was Chairman
of the U.S. Securities and Exchange Commission. Mr. Breeden was a director of
The Philadelphia Stock Exchange, Inc.
Larry R. Carter. Mr. Carter has been our director since December 1999. Mr.
Carter joined Cisco Systems in January 1995 as Vice President, Finance and
Administration and as Chief Financial Officer and Secretary. In July 1997, he
was promoted to Senior Vice President, Finance and Administration, Chief
Financial Officer and Secretary. From 1992 to January 1995, Mr. Carter was Vice
President and Corporate Controller at Advanced Micro Devices. His career
73
also includes four years with V.L.S.I. Technology Inc. as Vice President,
Finance and Chief Financial Officer and two years at S.G.S. Thompson
Microelectronics Inc. as Vice President, Finance, Administration and Chief
Financial Officer. He also spent 19 years at Motorola, Inc., where he held a
variety of financial positions, the last being Vice President and Controller,
M.O.S. Group. Mr. Carter is on the Board of Directors of Network Appliance,
Inc., Ultratech Stepper, Inc. and QLogic Corporation.
William J. Moran. Mr. Moran has been our director since December 1999. Mr.
Moran joined the Chase Manhattan Corporation and the Chase Manhattan Bank in
1975 as Internal Control Executive. After several promotions, Mr. Moran was
named General Auditor in 1992, Executive Vice President in 1997 and a member of
the Management Committee in 1999. Before joining Chase, Mr. Moran was with the
accounting firm of Peat, Marwick, Mitchell & Co. for nine years.
Joseph P. Shea. Mr. Shea has been our director since December 1999. Mr.
Shea has been with Cantor since 1989. He has been Executive Managing Director
since October 1999, was Senior Managing Director in charge of U.S. taxable fixed
income securities from 1997 to 1999, was Managing Director of the corporate bond
and U.S. government agency securities departments from 1995 to 1997 and was
Managing Director of the corporate bond department from 1989 to 1995.
Committees of the Board
The members of the Audit Committee are Messrs. Breeden, Carter and Moran,
all of whom are non-employee directors. The Audit Committee is responsible for
recommending to the board of directors the engagement of our independent
auditors and reviewing with our independent auditors the conduct and results of
the audits, our internal accounting controls, audit practices and the
professional services furnished by our independent auditors.
The members of the Compensation Committee are Messrs. Breeden, Carter and
Moran, all of whom are non-employee directors. The Compensation Committee is
responsible for reviewing and approving all compensation agreements for our
officers and for administering our stock option plan and our stock purchase
plan.
The Audit Committee and the Compensation Committee were each formed upon
the closing of the initial public offering in December 1999. Neither committee
met during the year ended December 31, 1999.
Compensation of Directors
Directors who are also our employees do not receive additional
compensation for serving as directors. We have granted our initial non-employee
directors options to purchase 20,000 shares of our common stock at an exercise
price per share equal to $22.00, which was the initial public offering price of
our Class A common stock on December 10, 1999. Any other options to be granted
to non-employee directors will be in amounts to be determined by our board of
directors. Non-employee directors are also reimbursed for out-of-pocket expenses
incurred in attending meetings of our board of directors or committees of our
board of directors.
74
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Under the securities laws of the United States, our directors, executive
officers and any person holding more than 10% of our Class A common stock are
required to file initial forms of ownership of our Class A common stock and
reports of changes in that ownership at the Securities and Exchange Commission.
Specific due dates for these forms have been established, and we are required to
disclose in this report any failure to file by these dates.
Based solely on our review of the copies of such forms received by it with
respect to fiscal 1999, or written representations from certain reporting
persons, to the best of our knowledge, all reports were filed on a timely basis,
except for Mr. Moran's Form 3, which was amended to report inadvertently omitted
information, and Mr. Merkel's Form 4, which was filed late.
75
ITEM 11. EXECUTIVE COMPENSATION
The following table provides certain summary information concerning all
compensation earned by our Chief Executive Officer and each of the other four
most highly compensated executive officers (collectively, the "Named Executive
Officers") whose annual salary and bonus for the year ended December 31, 1999
exceeded $100,000 in the aggregate.
Summary Compensation Table
March 10, 1999 Long-Term
through December Compensation Awards
31, 1999 Securities Underlying
Name and Principal Position Year Compensation-Salary Options (#)
- --------------------------- ---- ------------------- ---------------------
Howard W. Lutnick......... 1999 $280,000 2,500,000
Chairman and Chief
Executive Officer
Frederick T. Varacchi..... 1999 400,000 800,000
President and Chief
Operating Officer
Douglas B. Gardner........ 1999 200,000 375,000
Vice Chairman
Kevin C. Piccoli.......... 1999 100,000 65,000
Senior Vice President
and Chief Financial
Officer
Stephen M. Merkel......... 1999 120,000 100,000
Senior Vice President
and General Counsel
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The following table sets forth the options granted during 1999 and the value of
the options held on December 31, 1999 by our Named Executive Officers:
OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
--------------------------------------------------------------------------------------------------------------------------------
Number of
Shares Percent of Total
Underlying Options Granted Exercise or Base Grant Date Present
Options to Employees in Price Expiration Value ($)(3)
Name Granted 1999 ($/share) Date
-------------------------- ----------- ---------------- ---------------- ---------- ------------------
Howard W. Lutnick.......... 2,000,000(1) 34.9% $22.00 12/09/09 $ 29,089,173
Howard W. Lutnick.......... 500,000(2) 8.7% $22.00 12/09/04 $ 5,344,797
Frederick T. Varacchi...... 800,000(1) 13.9% $22.00 12/09/09 $ 11,635,669
Douglas B. Gardner......... 375,000(1) 6.5% $22,00 12/09/09 $ 5,454,220
Kevin C. Piccoli........... 65,000(1) 1.1% $22.00 12/09/09 $ 945,398
Stephen M. Merkel.......... 100,000(1) 1.7% $22.00 12/09/09 $ 1,454,459
- ------------
(1) The options vest and become exercisable in five annual installments
beginning December 10, 2000.
(2) These options are immediately vested and exercisable.
(3) The fair value of the options was estimated using a modified Black-Scholes
option pricing model and the following assumptions: risk-free interest
rate of 6%, no expected dividends, expected stock price volatility of 55
and assumed to be exercised at 80% of their original life.
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The following table provides information, with respect to the Named
Executive Officers, concerning options held as of December 31, 1999.
Aggregated Option/Exercises In Last Fiscal Year
and Fiscal Year-End Option/Values
Number of Securities Underlying Value of Unexercised In-the-Money
Unexercised Options/SARs at Fiscal Options/ SARs at Fiscal
Shares Acquired Value Realized Year-End (#) Year-End($)(1)
Name on Exercise (#) on Exercise ($) Exercisable Unexercisable Exercisable Unexercisable
- ----------------------- ---------------- ---------------- ----------- ------------- ----------- -------------
Howard W. Lutnick............. 0 -- 500,000 2,000,000 $6,781,250 $27,125,000
Frederick T. Varacchi......... 0 -- 0 800,000 0 10,850,000
Douglas B. Gardner............ 0 -- 0 375,000 0 5,085,938
Kevin C. Piccoli.............. 0 -- 0 65,000 0 881,563
Stephen M. Merkel............. 0 -- 0 100,000 0 1,356,250
- ----------
(1) Based on the last reported price of $35.5625 for the Class A common stock on
December 31, 1999.
Compensation Committee Interlock and Insider Participation
The Compensation Committee of the board of directors consists of Messrs.
Breeden, Carter and Moran. All of the members of the Compensation Committee are
non-employee directors and are not former officers. During 1999, none of our
executive officers served as a member of the board of directors or on the
compensation committee of a corporation where any of its executive officers
served on our Compensation Committee or on our board of directors.
1999 Long-Term Incentive Plan
In December 1999, our board of directors and stockholder approved the
adoption of our 1999 Long-Term Incentive Plan. The purpose of the plan is to
allow us to attract, retain and award present and prospective officers,
employees, directors, consultants and certain other individuals (including
employees of Cantor) and to compensate them in a way that provides additional
incentives and enables such individuals to increase their ownership interests in
our Class A common stock. Individual awards under the plan may take the form of:
o either incentive stock options or non-qualified stock options;
o stock appreciation rights;
o restricted or deferred stock;
o dividend equivalents;
o bonus shares and awards in lieu of our obligations to pay cash
compensation; and
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o other awards, the value of which is based in whole or in part upon
the value of our Class A common stock.
The plan is generally administered by the Compensation Committee, except
that our board will perform the committee's functions under the plan for
purposes of grants of awards to non-employee directors, and may perform any
other function of the committee as well. The Compensation Committee generally is
empowered to select the individuals who will receive awards and the terms and
conditions of those awards, including the number of shares subject to the award
exercise prices for options and other exercisable awards, vesting and forfeiture
conditions (if any), performance conditions, the extent to which awards may be
transferable and periods during which awards will remain outstanding. Awards may
be settled in cash, shares, other awards or other property, as determined by the
Compensation Committee. In January 2000, our board delegated its authority to
grant awards under the plan, other than grants to executive officers and
directors, to a combination of either (i) Mr. Lutnick and Mr. Varacchi or (ii)
Mr. Lutnick and Mr. Gardner, provided that the Compensation Committee will
review such grants on a quarterly basis.
The maximum number of shares of our Class A common stock that may be
subject to outstanding awards under the plan will not exceed 20% of the
aggregate number of shares of all classes of common stock outstanding determined
immediately after each award is granted. The number of shares deliverable upon
exercise of incentive stock options is limited to 10,000,000 shares of Class A
common stock.
In connection with our initial public offering on December 10, 1999,
options in the form of non-qualified stock options to purchase a total of
6,227,445 shares of Class A common stock had been granted to our directors,
executive officers and other employees as follows: 20,000 shares to each of our
three initial non-employee directors, 250,000 shares to Joseph Shea, 2,500,000
shares to Howard Lutnick, 800,000 shares to Frederick Varacchi, 375,000 shares
to Douglas Gardner, 100,000 shares to Stephen Merkel, 65,000 shares to Kevin
Piccoli, 2,077,445 shares to our other employees and other persons eligible to
receive options under our plan. In addition, options to purchase 282,005 shares
to employees of Cantor and 10,000 shares to a consultant were also issued in
connection with our initial public offering. Each of the above options has an
exercise price per share equal to the initial public offering price. Except as
to Mr. Lutnick, all options are non-transferable. As to Mr. Lutnick, the options
to purchase 500,000 shares are immediately exercisable and are transferable to
members of his family (or a trust established for the benefit of his family) in
order to facilitate his estate planning. In addition, the options issued to the
consultant are exercisable immediately. The options granted to our executive
officers vest over a period of five years and the options granted to all other
employees vest over a period of four years. All options and expire on the
earlier of 10 years after the date of grant or in connection with a termination
of employment. However, Mr. Lutnick's immediately exercisable options and the
options granted to Cantor employees expire five years after the date of grant
and generally do not terminate in connection with a termination of employment.
All options generally shall vest and become exercisable upon a change in control
of eSpeed, except that as to Messrs. Varacchi, Gardner, Merkel, Piccoli, Shea
and Lee Amaitis (the "Covered Employees"), their options shall vest but continue
to become exercisable in accordance with their original vesting schedule
(regardless of whether their employment with eSpeed continues).
79
However, if, following the change in control of eSpeed, Mr. Lutnick at any time
ceases to be eSpeed's chairman and chief executive officer (other than by reason
of his death or disability), all then-unexercisable options held by the Covered
Employees shall become fully exercisable as of such date.
The plan will remain in effect until terminated by our board. The plan may
be amended by our board without the consent of our stockholders, except that any
amendment, although effective when made, will be subject to stockholder approval
if required by any Federal or state law or regulation or by the rules of any
stock exchange or automated quotation system on which our common stock may then
be listed or quoted.
The number of shares reserved or deliverable under the plan and the number
of shares subject to outstanding awards are subject to adjustment in the event
of stock splits, stock dividends and other extraordinary corporate events.
We generally will be entitled to a tax deduction equal to the amount of
compensation realized by a participant through awards under the plan, except (1)
no deduction is permitted in connection with incentive stock options if the
participant holds the shares acquired upon exercise for the required holding
periods; and (2) deductions for some awards could be limited under the $1.0
million deductibility cap of Section 162(m) of the Internal Revenue Code. This
limitation, however, should not apply to awards granted under the plan during a
grace period of approximately three years following our initial public offering
in December 1999 , and should not apply to certain options, stock appreciation
rights and performance-based awards granted thereafter if we comply with certain
requirements under Section 162(m).
Stock Purchase Plan
In November 1999, our board of directors and stockholder approved the
adoption of our Stock Purchase Plan. The Stock Purchase Plan will permit our
eligible employees to purchase shares of our common stock at a discount.
Employees who elect to participate will have amounts withheld through payroll
deductions during purchase periods. At the end of each purchase period,
accumulated payroll deductions will be used to purchase stock at a price
determined by the administrative committee that administers the Stock Purchase
Plan, but which will not be less than 85% of the lower of the market price at
the beginning of the purchase period or the end of the purchase period,
including interim dates, as may be determined by the administrative committee.
Our Class A common stock that is purchased under the Stock Purchase Plan may be
subject to a holding period. We have reserved 425,000 shares of our Class A
common stock for issuance under the Stock Purchase Plan.
The Stock Purchase Plan will remain in effect until terminated by our
board or until no shares of our Class A common stock are available for issuance
under the Stock Purchase Plan. The Stock Purchase Plan may be amended by our
board without the consent of our stockholders, except that any amendment,
although effective when made, will be subject to stockholder approval if
required by any federal or state law or regulation or by the rules of any stock
exchange or automated quotation system on which our common stock may then be
listed or quoted.
80
The Stock Purchase Plan is intended to qualify under Section 423 of the
Internal Revenue Code, and as such, we will not be entitled to any tax deduction
where a participant holds the purchased shares for the longer of two years from
the beginning of the purchase period, or one year from the end of the purchase
period.
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
By Management. The following table sets forth certain information, as of
March 15, 2000, with respect to the beneficial ownership of our common equity
by: (i) each director; (ii) each of the Named Executive Officers; and (iii) all
executive officers and directors as a group. Each person listed below can be
reached at our headquarters located at One World Trade Center, 103rd Floor, New
York, NY 10048. Shares of Class B common stock are convertible into shares of
Class A common stock at any time in the discretion of the holder on a
one-for-one basis. Accordingly, a holder of Class B common stock is deemed to be
the beneficial owner of an equal amount of number of shares of Class A common
stock for purposes of this table.
Beneficial Ownership(1)
-------------------------------------------------------------
Class A Common Stock Class B Common Stock
--------------------------- -------------------------
Name Shares % Shares %
- ---------------------------------------- ------------- -------- -------------- -----
Howard W. Lutnick....................... 41,150,000(2) 79.9% 40,650,000(3) 100%
Frederick T. Varacchi................... -- -- -- --
Douglas B. Gardner...................... -- -- -- --
Kevin C. Piccoli........................ -- -- -- --
Stephen M. Merkel(4).................... 2,250 * -- --
Richard C. Breeden...................... 22,500 * -- --
Larry R. Carter(5)...................... 45,500 * -- --
William J. Moran........................ 3,000 * -- --
Joseph P. Shea.......................... -- -- -- --
All executive officers and
directors as a group (9 persons)....... 41,223,250 80.0% 40,650,000 100%
- -------------------
* Less than 1 %
(1) Based upon information supplied by officers and directors, and filings
under Sections 13 and 16 of the Securities Exchange Act of 1934, as
amended (the "Exchange Act").
(2) Consists of (1) 500,000 immediately exercisable options, (2) 8,800,000
shares of Class B common stock held by Cantor Fitzgerald, L.P., which
shares are immediately convertible into shares of Class A common stock,
and (3) 31,850,000 shares of Class B common stock held by Cantor
Fitzgerald Securities, which shares are immediately convertible into Class
A common stock. Cantor Fitzgerald, L.P. is the managing partner of Cantor
Fitzgerald Securities. CF Group Management, Inc. is the Managing General
Partner of Cantor Fitzgerald, L.P. and Mr. Lutnick is the President and
sole stockholder of CF Group Management, Inc.
(3) Consists of (1) 8,800,000 shares of Class B common stock held by Cantor
Fitzgerald, L.P., which shares are immediately convertible into shares of
Class A common stock, and (2) 31,850,000 shares of Class B common stock
held by Cantor Fitzgerald Securities, which shares are immediately
convertible into Class A common stock. Cantor Fitzgerald, L.P. is the
managing partner of Cantor Fitzgerald Securities. CF Group Management,
Inc. is the Managing General Partner of Cantor Fitzgerald, L.P. and Mr.
Lutnick is the President and sole stockholder of CF Group Management, Inc.
(4) These shares are beneficially owned by Mr. Merkel's spouse.
82
(5) The shares are owned by Cavallino Ventures LLC, of which Mr. Carter is the
President.
By Others. The following table sets forth certain information, as of March
15, 2000, with respect to the beneficial ownership of our common equity by each
person or entity known to us to beneficially own more than 5% of our Class A
common stock and Class B common stock, other than our officers and directors.
Unless indicated otherwise, the address of each entity listed is One World Trade
Center, New York, NY 10048, and each entity listed has sole voting and
investment powers over the shares beneficially owned. Shares of Class B common
stock are convertible into shares of Class A common stock at any time in the
discretion of the holder on a one-for-one basis. Accordingly, a holder of Class
B common stock is deemed to be the beneficial owner of an equal amount of number
of shares of Class A common stock for purposes of this table.
Beneficial Ownership(1)
-----------------------------------------------------------
Class A Common Stock Class B Common Stock
--------------------------- ------------------------
Name Shares % Shares %(2)
- ------------------------------------------------------------- ------------ ------- ------------ -----
Cantor Fitzgerald Securities................................. 31,850,000(3) 75.5%(4) 31,850,000 78.35%
Cantor Fitzgerald, L.P....................................... 40,650,000(5) 79.7%(6) 40,650,000(5) 100%
CF Group Management, Inc..................................... 40,650,000(7) 79.7%(6) 40,650,000(7) 100%
Fred Alger(8)................................................ 874,200 8.5%(9) -- --
Essex Investment Management Company(10)...................... 1,291,405 12.5%(9) -- --
Nicholas Applegate Capital Management(11).................... 703,011 6.8%(9) -- --
- -------------------
(1) Based upon filings under Section 13 of the Exchange Act.
(2) Based on 40,650,000 shares of Class B common stock outstanding on March
15, 2000.
(3) Consists of 31,850,000 shares of Class B common stock which are
immediately convertible into shares of Class A common stock.
(4) Percentage based on 10,350,000 shares of Class A common stock outstanding
on March 15, 2000 and 31,850,000 shares of Class B common stock
immediately convertible into Class A common stock.
(5) Consists of 8,800,000 shares of Class B common stock owned by Cantor
Fitzgerald, L.P. and 31,850,000 shares of Class B common stock owned by
Cantor Fitzgerald Securities, which shares are immediately convertible
into Class A common stock. Cantor Fitzgerald, L.P. is the managing partner
of Cantor Fitzgerald Securities.
(6) Percentage based on 10,350,000 shares of Class A common stock outstanding
on March 15, 2000 and 40,650,000 shares of Class B common stock
immediately convertible into Class A common stock.
(7) Includes 31,850,000 shares of Class B common stock held by Cantor
Fitzgerald Securities and 8,800,000 shares of Class B common stock held by
Cantor Fitzgerald L.P., which shares are immediately convertible into
Class A common stock. CF Group Management, Inc. is the Managing General
Partner of Cantor Fitzgerald, L.P.
(8) Fred Alger Management, Inc. and Fred M. Alger III beneficially own the
874,200 shares of Class A common stock as a group. They have shared voting
and sole dispositive power with respect to the shares. The address of Fred
Alger Management Inc. and Fred M. Alger III is One World Trade Center,
Suite 9333, New York, NY 10048.
83
(9) Percentage based on 10,350,000 shares of Class A common stock outstanding
on March 15, 2000.
(10) The address of Essex Investment Management Company is 125 High Street,
Boston, MA 02110. Essex Investment Management Company has sole voting
power with respect to only 943,485 shares of Class A common stock.
(11) The address of Nicholas Applegate Capital Management is 600 West Broadway,
29th Floor, San Diego, CA 92101. Nicholas Applegate Capital Management has
sole voting power with respect to only 550,917 shares of Class A common
stock.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Formation Transactions
Concurrently with our initial public offering, Cantor contributed to us
substantially all of our assets. These assets primarily consist of proprietary
software, network distribution systems, technologies and related contractual
rights that comprise our eSpeed((Service Mark)) system. In exchange for these
assets, we issued to Cantor 43,999,900 shares of our Class B common stock,
representing approximately 98% of the voting power of our outstanding capital
stock. Cantor converted 3,350,000 of these shares into shares of the Class A
common stock which it sold in our initial public offering.
Cantor conceived of and has been developing systems to promote fully
electronic marketplaces since the early 1990's. Since 1996, Cantor has invested
more than $200 million in information technology, which culminated in the
development of our eSpeed((Service Mark)) system. Cantor's technology
initiatives during this period included software development, infrastructure and
maintenance associated with operating Cantor's entire global securities
business. The evolutionary process which led to the development of our
eSpeed((Service Mark)) system was a combination of the development of Cantor's
brokerage, trading, clearance, settlement, analytical pricing and related
systems and was impacted by the continual improvement in computer processing and
the changing trading environment. Accordingly, it is difficult to separately
quantify development or other systems costs associated with the ultimate
development of our eSpeed((Service Mark)) system as it emanated in part from all
of the information technology initiatives of Cantor.
Since January 1996, Cantor has used our eSpeed((Service Mark)) system
internally to conduct electronic trading. In March 1999, the first fully
electronic transaction using our eSpeed((Service Mark)) system was executed by a
client.
Cantor has previously entered into contractual agreements or other
arrangements with many of the participants that trade in our electronic
marketplaces. These agreements and arrangements provide the general terms and
conditions, including those relating to warranties and allocations of liability,
under which those participants may electronically execute trades in our
marketplaces; none of these participants are obligated to use our marketplaces
under these agreements. We have the rights and obligations under many of these
arrangements as they relate to operating our eSpeed((Service Mark)) system.
Certain of our subsidiaries have been registered as broker-dealers with the
National Association of Securities Dealers, Inc. We also intend to obtain any
foreign regulatory approvals for our foreign subsidiaries that are necessary or
advisable. As we receive the regulatory approvals and licenses necessary to
operate our electronic marketplaces
84
globally and increase client awareness of our electronic marketplaces, we intend
to enter directly into tri-party agreements and other arrangements with clients
and Cantor. We assist market participants, including Cantor, in participating in
the electronic marketplaces that are created and supported by our
eSpeed((Service Mark)) system. We share with Cantor a portion of the
transaction-based revenues paid by market participants for transactions effected
through our electronic marketplaces or which are otherwise electronically
assisted. Cantor and many of the largest financial institutions in the world are
currently our primary clients.
Cantor operates its equity dealing business, money market and securities
lending business, matched book repurchase agreement business, investment
advisory business and other specified businesses, including those in which
Cantor acts as a dealer. These businesses are carried out in over 10 locations
around the world. We do not share in any revenues generated by these businesses,
other than service fees we may become entitled to receive in connection with
hardware maintenance and other systems support development services we may
provide to Cantor. Cantor also provides voice brokerage services, clearance,
settlement and fulfillment services and other related services in connection
with our electronic marketplaces. Accordingly, upon conversion of Cantor's
marketplaces to our eSpeed((Service Mark)) platform, orders for financial
instruments will continue to be received and executed by Cantor brokers over the
telephone, and this method of order entry by Cantor into our electronic trading
platform is contemplated to continue for the foreseeable future. It is
anticipated that a significant percentage of orders and revenues will continue
to be recorded by Cantor, and a sharing of commissions (as described below under
"Joint Services Agreement") with us will occur. Since it is not possible to
predict the level of acceptance by clients, and individual traders located
within each client, of fully electronic order entry processing, we anticipate
that each marketplace product will experience widely varying direct electronic
usage rates by clients and their trading personnel.
We entered into the agreements described below in connection with the
formation transactions and to help define the terms of our relationship with
Cantor in the future. In an effort to mitigate conflicts of interest between us
and Cantor, we and Cantor have agreed that none of these agreements may be
amended without the approval of a majority of our disinterested directors.
Assignment and Assumption Agreements
In December 1999, we entered into Assignment and Assumption Agreements
with Cantor pursuant to which Cantor contributed to us rights and interests in
the assets and contractual and other arrangements which comprise our
eSpeed((Service Mark)) system. In consideration for the contribution of these
assets, rights and interests, we issued to Cantor shares of our Class B common
stock representing approximately 100% of the outstanding shares of our capital
stock prior to our initial public offering and we assumed certain liabilities
relating to the assets which Cantor contributed to us. These liabilities include
accrued compensation and benefits and other accrued liabilities. Under the terms
of the Assignment and Assumption Agreements, Cantor has agreed to indemnify us
with respect to liabilities and losses we suffer which result from the operation
of, and events relating to, the assets transferred to us prior to and in
connection with their transfer, except that we will assume the defense of and
indemnify Cantor with respect to any liabilities arising out of the patent
litigation involving Liberty Brokerage. We have agreed to indemnify
85
Cantor with respect to liabilities and losses which they suffer which result
from our ownership and operation of these assets.
Joint Services Agreement
We have entered into a Joint Services Agreement with Cantor under which we
and Cantor have agreed to collaborate to provide brokerage and related services
to clients in multiple electronic markets for transactions in securities and
other financial products. In addition, we may in our discretion collaborate on
non-financial products. This agreement provides for a perpetual term. Under the
agreement, we own and operate the electronic trading systems and are responsible
for providing electronic brokerage services, and Cantor will provide
voice-assisted brokerage services, clearance, settlement and fulfillment
services and related services, such as credit and risk management services,
oversight of client suitability and regulatory compliance, sales positioning of
products and other services customary to brokerage operations.
All information and data (other than information relating to bids, offers
or trades or other information that is input into, created by or otherwise
resides on an electronic trading system for financial products) created,
developed, used in connection with or relating to the operation of and effecting
of transactions in any marketplace are the sole property of Cantor or us, as
applicable, on the following basis: (1) if the data relate to financial
products, the data belong solely to Cantor, (2) if the data relate to a
collaborative marketplace in which only products that are non-financial products
are traded, the ownership of the data will be determined by Cantor and us on a
case-by-case basis through good faith negotiations, (3) if the data relate to a
marketplace in which we do not collaborate with Cantor but in which we provide
electronic brokerage services and only non-financial products are traded, the
data belong solely to us and (4) if the data relate to a non-collaborative
marketplace that is not a marketplace in which we provide electronic brokerage
services and in which financial products are traded, the data belong solely to
Cantor. All right, title and interest in the data relating to bids, offers or
trades or other information that is input into, created by or otherwise resides
on an electronic trading system for financial products belong to Cantor. We have
the right to use such data only in connection with the execution of transactions
in such markets.
Commission Sharing Arrangement
Under this agreement, we and Cantor share revenues derived from
transactions effected in the marketplaces in which we collaborate and other
specified markets. We have agreed to collaborate with Cantor to determine the
amount of commissions to be charged to clients that effect transactions in these
marketplaces; however, in the event we are unable to agree with Cantor with
respect to a transaction pricing decision, Cantor is entitled to make the final
pricing decision with respect to transactions for which Cantor provides
voice-assisted brokerage services and we are entitled to make the final pricing
decision with respect to transactions that are fully electronic. We may not make
a final transaction pricing decision that results in the share of transaction
revenues received by Cantor being less than Cantor's actual cost of providing
clearance, settlement and fulfillment services and other transaction services.
In some cases, we receive the aggregate transaction revenues and pay a service
fee to Cantor. In other cases, Cantor receives the aggregate transaction
revenues and pays a service fee to us. The amount of the
86
service fee and the portion of the transaction revenues that we and Cantor
receive is based on several factors, including whether: (1) the marketplace is
one in which we collaborate with Cantor; (2) the transaction is fully electronic
or Cantor provides voice-assisted brokerage services; (3) the product traded is
a financial product; and (4) the product is traded on the Cantor
Exchange((Service Mark)). Generally, we share revenues as follows:
Fully Electronic Transactions in Collaborative Marketplaces. If a
transaction is fully electronic and is effected in a marketplace in which
we collaborate with Cantor, we receive the aggregate transaction revenues
and pay to Cantor a service fee equal to:
o 35% of the transaction revenues, if the product is a financial
product that is not traded on the Cantor Exchange((Service Mark));
o 20% of the transaction revenues, if the product is traded on the
Cantor Exchange((Service Mark));
o an amount determined on a case-by-case basis, if the product is not
a financial product and is not traded on the Cantor
Exchange((Service Mark)).
Voice-Assisted Transactions in Collaborative Marketplaces.
Generally, if Cantor provides voice-assisted brokerage services with
respect to a transaction that is effected in a marketplace in which we
collaborate with Cantor:
o Cantor receives the aggregate transaction revenues and pays to us a
service fee equal to 7% of the transaction revenues, if the product
is a financial product that is not traded on the Cantor
Exchange((Service Mark)) other than in certain instances in which we
receive the aggregate transaction revenues and Cantor receiving a
35% service fee;
o we receive the aggregate transaction revenues and pay to Cantor a
service fee equal to 55% of the transaction revenues, if the product
is traded on the Cantor Exchange((Service Mark)); and
o we receive an amount determined on a case-by-case basis, if the
product is not a financial product and is not traded on the Cantor
Exchange((Service Mark)).
Non-Collaborative Marketplaces Involving Electronic Brokerage
Services. If a transaction is effected in a marketplace in which we do not
collaborate with Cantor:
o Cantor receives the aggregate transaction revenues and pays to us a
service fee equal to 30% of the portion of the transaction revenues
we would have received had we collaborated with Cantor, if Cantor
either itself or through a third party provides electronic brokerage
services in that marketplace;
87
o we receive the aggregate transaction revenues and pay to Cantor a
service fee equal to 20% of the transaction revenues, if the product
is a financial product and we provide electronic brokerage services;
and
o we receive 100% of the transaction revenues and do not pay Cantor a
service fee, if the product is not a financial product and we
provide electronic brokerage service.
Electronically Assisted Transactions in Non-Electronic Marketplaces.
If a transaction is not effected in an electronic marketplace, but is
electronically assisted, such as a screen assisted open outcry
transaction, we receive 2.5% of the transaction revenues.
In the event that Cantor's direct costs payable to third parties for
providing clearance, settlement and fulfillment services with respect to a
transaction in a collaborative marketplace with respect to any financial product
for any month exceed the direct costs incurred by Cantor to clear and settle a
cash transaction in United States Treasury securities for such month, the cost
of the excess is borne pro rata by Cantor and us in the same proportion as the
transaction revenues and service fees for such transaction are to be shared.
In the event that a client does not pay, or pays only a portion of, the
transaction revenues relating to a transaction, then we and Cantor each bear our
respective share of the loss based on the percentage of the transaction revenues
we would otherwise have been entitled to receive with respect to such
transaction.
System Services
We also provide to Cantor technology support services, including (1)
systems administration, (2) internal network support, (3) support and
procurement for desktops of end-user equipment, (4) operations and disaster
recovery services, (5) voice and data communications, (6) support and
development of systems for clearance, settlement and fulfillment services, (7)
systems support for Cantor brokers, (8) electronic applications systems and
network support and development for the unrelated dealer businesses with respect
to which we do not collaborate with Cantor and (9) provision and/or
implementation of existing electronic applications systems, including
improvements and upgrades thereto, and use of the related intellectual property
rights, having potential application in a gaming business. Cantor pays to us an
amount equal to the direct and indirect costs, including overhead, that we incur
in performing these services. We do not receive service fees or are otherwise
entitled to share in transaction revenues relating to the system services that
we provide to Cantor for unrelated dealer businesses. We have agreed not to use
confidential information, including business plans and software, obtained from
or used by Cantor in connection with the provision of these services to parties
other than Cantor. For the purposes of the Joint Services Agreement, an
unrelated dealer business means (1) Cantor's equity businesses as they exist
from time to time, (2) Cantor's money market instruments and securities lending
division, as they exist from time to time, (3) any business or portion thereof
or activity in which Cantor acts as a dealer or otherwise takes market risk or
positions, including in the process of executing matched principal transactions,
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providing the services of a specialist or market maker or providing trading or
arbitrage operations, (4) activities wherever located that would, if conducted
in the United Kingdom, be subject to the United Kingdom Gaming Act of 1963 or
activities wherever located currently or in the future involving betting,
gambling, odds making, lotteries, gaming, wagering, staking, drawing or casting
losts and similar or related activities and (5) any business not involving
operating a marketplace.
Intellectual Property
Cantor has granted to us a license covering Cantor's patents and patent
applications that relate to the eSpeed((Service Mark)) system. The license is
perpetual, irrevocable, world-wide and royalty free and is exclusive, except in
the event that (1) we are unwilling to provide to Cantor any requested services
covered by the patents with respect to a marketplace and Cantor elects not to
require us to do so, or we are unable to provide such services or (2) we do not
exercise our right of first refusal to provide to Cantor electronic brokerage
services with respect to a marketplace, in which events Cantor will have a
limited right to use the patents and patent applications solely in connection
with the operation of that marketplace. Cantor will cooperate with us, at our
expense, in any attempt by us to prevent any third party infringement of our
patent rights under the license.
Cantor has also granted to us a non-exclusive, perpetual, irrevocable
worldwide, royalty-free right and license to use the trademarks "Cantor
Exchange," "Interactive Matching" and "CX".
Non-competition and Market Opportunity Provisions
The Joint Services Agreement imposes the following performance obligations
on us and restricts our ability to compete with Cantor and Cantor's ability to
compete with us in the following circumstances:
o If Cantor wishes to create a new financial product marketplace, Cantor may
require us to provide electronic brokerage services with respect to that
marketplace. We must use our commercially reasonable efforts to develop an
electronic trading system for that marketplace within a specified time
period. If, after diligent effort, we are unable to do so, we have no
liability to Cantor for our failure and Cantor may create and operate the
marketplace in any manner that Cantor deems to be acceptable. Cantor's
proposal to create a new marketplace must be commercially reasonable and
Cantor must diligently pursue the development of the marketplace and cause
the new marketplace to become operational within a specified time period.
o If Cantor wishes to create a new financial product marketplace and Cantor
does not require us to develop an electronic trading system for that
marketplace as described in the preceding paragraph, Cantor must, in any
event, notify us of its intention to create the new marketplace. We will
have a right of first refusal to provide electronic brokerage services
with respect to that marketplace. We must use commercially reasonable
efforts to develop and put into operation an electronic trading system for
the marketplace within a specified time period. If
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we are able to do so, transactions in the marketplace will be subject to
the revenue sharing arrangements described above. If we are unable to do
so, or we elect not to provide electronic brokerage services with respect
to the new marketplace, Cantor may provide or otherwise obtain electronic
brokerage services for that marketplace in any manner that Cantor deems to
be acceptable. Cantor's proposal to create a new marketplace must be
commercially reasonable and Cantor must diligently pursue the development
of the marketplace and cause the new marketplace to become operational
within a specified time period.
o If Cantor wishes to create a new electronic marketplace for a product that
is not a financial product, Cantor must notify us of its intention to do
so. We will have the opportunity to offer to provide the electronic
brokerage services with respect to the new marketplace. If Cantor rejects
our offer, Cantor may operate the marketplace in any manner that Cantor
deems to be acceptable.
o If we wish to create a new electronic marketplace for a financial product,
we must notify Cantor of our intention to do so. Cantor will have a right
of first refusal to provide the applicable voice-assisted brokerage
services, clearance, settlement and fulfillment services and/or related
services for that marketplace. If Cantor (1) elects not to provide such
services or (2) fails to notify us within a specified time period that it
will provide such services, we may provide or otherwise obtain those
services for that marketplace in any manner that we deem to be acceptable.
o If we wish to create a new electronic marketplace for a product that is
not a financial product, we must notify Cantor of our intention to do so.
Cantor will have the opportunity to offer to provide the applicable
voice-assisted brokerage services, clearance, settlement and fulfillment
services and/or related services for that marketplace. If we reject
Cantor's offer, we may create and operate the marketplace in any manner
that we deem to be acceptable.
o Subject to the exceptions described below, we may not directly or
indirectly: (1) engage in any activities competitive with a business
activity conducted by Cantor now or in the future; or (2) provide or
assist any other person in providing voice-assisted brokerage services,
clearance, settlement and fulfillment services and/or related services. We
are permitted to engage in these activities:
o in collaboration with Cantor;
o with respect to a new marketplace involving a financial product,
after Cantor has indicated that it is unable or unwilling to provide
such voice-assisted brokerage services, clearance, settlement and
fulfillment services and/or related services with respect to that
marketplace;
o with respect to a new marketplace involving a product that is not a
financial product, after having considered in good faith any
proposal submitted by Cantor relating to the provision of those
services; or
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o with respect to an unrelated dealer business in which we develop and
operate a fully electronic marketplace.
o Subject to the exceptions described below, Cantor may not directly
or indirectly provide or assist any other person in providing
electronic brokerage services. Cantor is permitted to engage in
these activities:
o in collaboration with us; or
o with respect to a new marketplace, after (1) we have indicated that
we are unable to develop an electronic trading system for that new
marketplace within a specified time period or (2) we have declined
to exercise our right of first refusal or have exercised our right
of first refusal but are unable to develop an electronic trading
system within a specified time period.
o The unrelated dealer businesses retained by Cantor are expressly excluded
from our rights of first refusal and the restrictions on Cantor's ability
to compete with us. However, we may create fully electronic marketplaces
in unrelated dealer businesses.
We and Cantor are entitled to pursue and may enter into alliance opportunities,
including strategic alliances, joint ventures, partnerships or similar
arrangements, with third parties and consummate business combinations with third
parties on the following basis only. If an alliance opportunity (1) relates to a
person that directly or indirectly provides voice-assisted brokerage services
and engages in business operations that do not involve electronic brokerage
services, then Cantor is entitled to pursue and consummate a transaction with
respect to that alliance opportunity, (2) relates to a person that directly or
indirectly provides electronic brokerage services and engages in business
operations that do not involve any voice-assisted brokerage service, then we are
entitled to pursue and consummate a transaction with respect to that alliance
opportunity or (3) is an alliance opportunity with respect to a person other
than those described in clauses (1) and (2) above, then we and Cantor will
cooperate to jointly pursue and consummate a transaction with respect to such
alliance opportunity on mutually agreeable terms. A business combination
includes a transaction initiated by and in which either we or Cantor is/are the
acquirer involving (A) a merger, consolidation, amalgamation or combination, (B)
any sale, dividend, split or other disposition of any capital stock or other
equity interests (or securities convertible into or exchangeable for or options
or warrants to purchase any capital stock or other equity equivalents) of the
person, (C) any tender offer (including without limitation of a self-tender),
exchange offer, recapitalization, dissolution or similar transaction, (D) any
sale, dividend or other disposition of a significant portion of the assets and
properties of the person (even if less than all or substantially all of such
assets or properties), and (E) entering into any agreement or understanding, or
the granting of any rights or options, with respect to any of the foregoing.
Administrative Services Agreement
We have entered into an Administrative Services Agreement with Cantor that
states the terms under which Cantor provides certain administrative and
management services to us. Cantor
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makes available to us some of its administrative and other staff, including its
internal audit, treasury, legal, tax, human resources, corporate development and
accounting staffs. Members of these staffs arrange for our insurance coverage
and provide a wide array of services, including administration of our personnel
and payroll operations, benefits administration, internal audits, facilities
management, promotional sales and marketing, legal, risk management, accounting
and tax preparation and other services. We reimburse Cantor for the actual costs
incurred by Cantor, plus other reasonable costs, including reasonably allocated
overhead and any applicable taxes. We have also entered into arrangements with
Cantor under which we have the right to use certain assets, principally computer
equipment, from Cantor relating to the operation of our eSpeed((Service Mark))
system. These assets are subject to operating leases with third party leasing
companies. Under this provision of the Administrative Services Agreement, we
have agreed to be bound by the general terms and conditions of the operating
leases relating to the assets used by us. Under the Administrative Services
Agreement, we provide sales, marketing and public relations services to Cantor.
Cantor reimburses us for the actual costs incurred by us, plus other reasonable
costs, including reasonably allocated overhead. The Administrative Services
Agreement has a three-year term which will renew automatically for successive
one-year terms unless canceled by either us or Cantor upon six months' prior
notice; provided, however, that our right to use our New York space expires at
the time that Cantor's lease expires in 2006 and our right to use our London
office space expires at the earlier of (1) the time Cantor's lease expires in
2016 or (2) until Cantor ceases to be an affiliate of ours and Cantor asks us to
vacate.
Registration Rights Agreement
Pursuant to the Registration Rights Agreement entered into by Cantor and
us, Cantor has received piggyback and demand registration rights.
The piggyback registration rights allow Cantor to register the shares of
Class A common stock issued or issuable to it in connection with the conversion
of its Class B common stock whenever we propose to register any shares of Class
A common stock for our own or another's account under the Securities Act for a
public offering, other than:
o any shelf registration of shares of Class A common stock to be used
as consideration for acquisitions of additional businesses; and
o registrations relating to employee benefit plans.
Cantor also has the right, on three occasions, to require that we register
under the Securities Act any or all of the shares of Class A common stock issued
or issuable to it in connection with the conversion of its Class B common stock.
No more than one of these registrations may be demanded within the first year
after the closing of our initial public offering. The demand and piggyback
registration rights apply to Cantor and to any transferee of shares held by
Cantor who agrees to be bound by the terms of the Registration Rights Agreement.
We have agreed to pay all costs of one demand and all piggyback
registrations, other than underwriting discounts and commissions. All of these
registration rights are subject to conditions and limitations, including (1) the
right of underwriters of an offering to limit the number of
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shares included in that registration; (2) our right not to effect any demand
registration within six months of a public offering of our securities; and (3)
that Cantor agrees to refrain from selling its shares during the period from 15
days prior to and 90 days after the effective date of any registration statement
for the offering of our securities.
Potential Conflicts of Interest and Competition with Cantor
Various conflicts of interest between us and Cantor may arise in the
future in a number of areas relating to our past and ongoing relationships,
including potential acquisitions of businesses or properties, the election of
new directors, payment of dividends, incurrence of indebtedness, tax matters,
financial commitments, marketing functions, indemnity arrangements, service
arrangements, issuances of our capital stock, sales or distributions by Cantor
of its shares of our common stock and the exercise by Cantor of control over our
management and affairs. A majority of our directors and officers also serve as
directors and/or officers of Cantor. Simultaneous service as an eSpeed director
or officer and service as a director or officer, or status as a partner, of
Cantor could create or appear to create potential conflicts of interest when
such directors, officers and/or partners are faced with decisions that could
have different implications for us and for Cantor. Mr. Lutnick, our Chairman and
Chief Executive Officer, is the sole stockholder of the managing general partner
of Cantor. As a result, Mr. Lutnick controls Cantor. Cantor owns all of the
outstanding shares of our Class B common stock, representing approximately 98%
of the combined voting power of all classes of our voting stock. Mr. Lutnick's
simultaneous service as our Chairman and Chief Executive Officer and his control
of Cantor could create or appear to create potential conflicts of interest when
Mr. Lutnick is faced with decisions that could have different implications for
us and for Cantor.
Our relationship with Cantor may result in agreements that are not the
result of arm's-length negotiations. As a result, the prices charged to us or by
us for services provided under agreements with Cantor may be higher or lower
than prices that may be charged by third parties and the terms of these
agreements may be more or less favorable to us than those that we could have
negotiated with third parties. However, we intend that transactions between us
and Cantor and/or its other affiliates will be subject to the approval of a
majority of our independent directors.
In addition, Cantor can compete with us under certain circumstances.
Consulting Services
For consulting services provided to us and Cantor by Martin J. Wygod in
connection with our initial public offering, we have issued to Martin J. Wygod
or his designees warrants to purchase 135,000 shares of our Class A common
stock. The warrants have a five-year term and are exercisable commencing on the
first anniversary of the date of issuance at a price per share equal to the
initial public offering price. The warrants are not transferable, other than to
charities and trusts established for the benefit of Mr. Wygod's children and
grandchildren.
We granted Mr. Wygod piggyback and demand registration rights in
connection with the warrants. The piggyback registration rights allow Mr. Wygod
to have registered the shares of
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Class A common stock issued or issuable upon exercise of the warrants and will
be substantially similar to the piggyback registration rights to be granted to
Cantor. Mr. Wygod also has the right, on one occasion, to require that we
register under the Securities Act of 1933, a minimum of 75% of the aggregate
number of shares of Class A common stock underlying the warrants. The demand
registration right is only available when we are eligible to use Form S-3 to
register the shares.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K:
(a)(1) Financial Statements. See index to Financial Statements on page 54.
(a)(2) All other schedules are omitted because they are not applicable, not
required or the required information is in the Financial Statements or the Notes
thereto.
(a)(3) The following Exhibits are filed as part of this Report as required by
Regulation S-K. The Exhibits designated by an asterisk (*) are management
contracts and compensation plans and arrangements required to be filed as
Exhibits to this Report.
Exhibit Number Description
- -------------- -----------
2.1 -- Assignment and Assumption Agreement, dated as of December 9, 1999, by and among Cantor
Fitzgerald, L.P., Cantor Fitzgerald Securities, CFFE, LLC, Cantor Fitzgerald L.L.C., CFPH,
LLC Cantor Fitzgerald & Co. and eSpeed, Inc.
2.2 -- Assignment and Assumption Agreement, dated as of, December 9, 1999 by and among Cantor Fitzgerald
International, eSpeed Securities International Limited and Cantor Fitzgerald International Holdings, L.P.
3.1 -- Amended and Restated Certificate of Incorporation of eSpeed, Inc. (Incorporated by reference
to Exhibit 3.1 to the Registrant's Registration Statement on Form S-1 (Reg. No. 333-87475).
3.2 -- Amended and Restated By-Laws of eSpeed, Inc. (Incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-1 (Reg. No. 333-87475)).
4.1 -- Specimen Class A Common Stock Certificate. (Incorporated by reference to Exhibit 4.1 to the
Registrant's Registration Statement on Form S-1 (Reg. No. 333-87475)).
10.1* -- Long-Term Incentive Plan of eSpeed, Inc. (Incorporated by reference to Exhibit 10.1 to the
Registrant's Registration Statement on Form S-1 (Reg. No. 333-87475)).
10.2* -- eSpeed, Inc. Stock Purchase Plan. (Incorporated by reference to Exhibit 10.2 to the
Registrant's Registration Statement on Form S-1 (Reg. No. 333-87475)).
10.3 -- Joint Services Agreement, dated as of December 15, 1999, by and among Cantor Fitzgerald,
L.P., Cantor Fitzgerald International, Cantor Fitzgerald Gilts, Cantor Fitzgerald Securities,
Cantor Fitzgerald & Co., Cantor Fitzgerald Partners, eSpeed, Inc., eSpeed Securities, Inc.,
eSpeed Government Securities, Inc., eSpeed Securities International Limited and eSpeed
Markets, Inc.
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10.4 -- Amendment No. 1 to Joint Services Agreement, dated as of January 1, 2000, by and among Cantor
Fitzgerald L.P., Cantor Fitzgerald International, Cantor Fitzgerald Gilts, Cantor Fitzgerald
Securities, Cantor Fitzgerald & Co., Cantor Fitzgerald Partners, eSpeed Inc., eSpeed
Securities, Inc., eSpeed Government Securities, eSpeed Securities International Limited and
eSpeed Markets, Inc.
10.5 -- Administrative Services Agreement, dated as of December 15, 1999, by and among Cantor
Fitzgerald, L.P., Cantor Fitzgerald International, Cantor Fitzgerald Gilts, Cantor Fitzgerald
Securities, Cantor Fitzgerald & Co., Cantor Fitzgerald Partners, eSpeed, Inc., eSpeed
Securities, Inc., eSpeed Government Securities, Inc., eSpeed Securities International Limited
and eSpeed Markets, Inc.
10.6 -- Registration Rights Agreement, dated as of December 9, 1999, by and among eSpeed and the
Investors named therein.
10.7 -- Sublease Agreement, dated as of December 15, 1999, between Cantor Fitzgerald Securities and
eSpeed, Inc.
10.8 -- Warrants issued to Martin J. Wygod and a related trust.
21 -- List of subsidiaries of eSpeed, Inc. (Incorporated by reference to Exhibit 21 to the
Registrant's Registration Statement on Form S-1 (Reg. No. 333-87475)).
27 -- Financial Data Schedule.
(b) Reports on Form 8-K.
We did not file any Form 8-K Current Reports during the last
quarter of the fiscal year ended December 31, 1999.
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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 report to be signed on
its behalf by the undersigned, thereunto duly authorized.
eSPEED, INC.
/s/ Howard W. Lutnick
----------------------
Howard W. Lutnick
Chairman of the Board and
Chief Executive Officer
Dated: March 27, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
Signature Title Date
--------- ----- ----
Chairman of the Board and Chief Executive Officer
/s/ Howard W. Lutnick (Principal Executive Officer) March 27, 2000
- ---------------------------------------
Howard W. Lutnick
/s/ Frederick T. Varacchi President and Chief Operating Officer March 28, 2000
- ---------------------------------------
Frederick T. Varacchi
/s/ Douglas B. Gardner Vice Chairman March 28, 2000
- ---------------------------------------
Douglas B. Gardner
Senior Vice President and Chief Financial Officer
/s/ Kevin C. Piccoli (Principal Financial and Accounting Officer) March 27, 2000
- ---------------------------------------
Kevin C. Piccoli
/s/ Richard C. Breeden Director March 28, 2000
- ---------------------------------------
Richard C. Breeden
/s/ Larry R. Carter Director March 28, 2000
- ---------------------------------------
Larry R. Carter
/s/ William J. Moran Director March 27, 2000
- ---------------------------------------
William J. Moran
/s/ Joseph P. Shea Director March 28, 2000
- ---------------------------------------
Joseph P. Shea