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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, 2001
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
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(State or Other Jurisdiction of Incorporation) (I.R.S. Employer
Identification No.)
299 PARK AVENUE, NEW YORK, NEW YORK 10171
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(Address of Principal Executive Offices) (Zip Code)
(212) 821-3000
(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. |X|
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, 2002 as reported on the Nasdaq National Market, was
approximately $308,686,582.
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, 2002
- ----- -----------------------------
Class A Common Stock, Par Value $.01 Per Share 28,290,779 Shares
Class B Common Stock, Par Value $.01 Per Share 26,688,814 Shares
DOCUMENTS INCORPORATED BY REFERENCE.
NONE.
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eSPEED, INC.
2001 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS...........................................................1
ITEM 2. PROPERTIES.........................................................29
ITEM 3. LEGAL PROCEEDINGS..................................................29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................31
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS................................................33
ITEM 6. SELECTED FINANCIAL DATA............................................35
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS..........................................36
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.........49
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................50
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE................................74
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................75
ITEM 11. EXECUTIVE COMPENSATION.............................................77
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.........................................................79
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................81
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K........................................................87
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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 sections entitled "Risk Factors" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations".
OVERVIEW OF OUR BUSINESS
We are a leading provider of electronic marketplace and related trading
technology solutions and operate multiple buyer, multiple seller real-time
electronic marketplaces. Our suite of marketplace tools provides end-to-end
transaction solutions for the purchase and sale of financial and non-financial
products via the Internet or over our global private network. Our products
enable market participants to transact business instantaneously, more
effectively and at lower cost. In 2001, we processed over 3.5 million electronic
transactions, totaling more than $37 trillion of transactional volume. We have
over 700 clients, including most of the largest fixed income trading firms and
leading natural gas and electricity trading firms in the world. We have offices
in the U.S., Europe and Asia that can transact trading 24 hours a day, around
the world. As a result of the terrorist attacks of September 11, 2001, our
offices in the World Trade Center were destroyed and we lost 180 of our
employees, including many members of our senior management. The loss of these
assets and employees and the need to relocate our surviving employees have
negatively impacted our business. See "Risk Factors".
We believe we offer one of the most robust, large-scale, instantaneous and
reliable transaction processing systems. Our global private network permits
market participants to view information and execute transactions in a fraction
of a second. Our proprietary software provides an end-to-end solution, including
front-end applications, transaction processing engines, credit and risk
management tools and back-office and clearance modules, enabling
straight-through processing.
Our revenues consist primarily of transaction fees and software solution fees.
We do not risk our own capital in transactions or extend credit to market
participants.
Our eSpeed(R) system is accessible to our clients through (1) our proprietary
front-end trading software, (2) our application programming interface (API), a
dedicated software application linking our clients networks to our system, (3)
the Web, via a browser interface or Java application and (4) software developed
in alliances with independent software vendors. Our system runs on large-scale
hardware located in two data centers in the U.S. and Europe and is distributed
either over our multiple path global network or via the Internet through links
to multiple global Internet service providers.
Additionally, we have an agreement whereby the New York Board of Trade, through
its subsidiaries, will provide clearing and regulatory services and we will
provide electronic execution and related services for the U.S. futures exchange,
currently known as the Cantor Exchange(SM), the first fully electronic futures
exchange in the U.S. While we are in the process of evaluating our business plan
with respect to our operation of the Cantor Exchange(SM), we are confident that
our eSpeed(R) system will continue to provide us with major opportunities for
the electronic
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trading of a broad range of futures contracts globally. Currently, the Cantor
Exchange(SM) has obtained regulatory authority to operate in the United Kingdom,
Denmark, Finland, France, Hong Kong, Ireland, Italy, Japan, Norway, Portugal and
in eight German states.
We market our services through the following three basic products: eSpeed
Markets(SM), eSpeed Software Solutions(SM) and eSpeed Online(SM).
o eSpeed Markets(SM) is a full service solution combining all of our
proprietary software and our global high-speed private network. eSpeed
Markets(SM) currently operates in some of the largest and most complex
marketplaces in the world, including the global government bond market and
the energy market, and is designed to be extendible to any multiple buyer,
multiple seller marketplace. eSpeed Markets(SM) is also available through a
complete Internet-only distribution channel.
o eSpeed Software Solutions(SM) provides a complete outsourced solution to
our clients to enable them to distribute their branded products to their
customers through online offerings and auctions, including private and
reverse auctions.
o eSpeed Online(SM) provides retail-based e-commerce businesses with online
access to wholesale market participants. It enables them to offer their
customers access to a variety of markets that are traditionally available
only to institutional investors and wholesalers.
Our objective is to be the world's leading provider of trading technology and
interactive electronic marketplaces for products that trade. We believe that the
scalability and extendibility of our eSpeed(R) suite of products enable us to
introduce new markets and distribute products and services more quickly, cost
effectively and seamlessly than our competitors.
We commenced operations in March 1999 as a division of Cantor Fitzgerald
Securities, a subsidiary of Cantor Fitzgerald, L.P. Our initial focus was the
global fixed income, foreign exchange and futures and options trading markets.
Our relationship with Cantor, a leading global inter-dealer broker in the fixed
income markets, has enabled us to become the leader in this electronic
marketplace. In the last two years, we have significantly expanded the types of
products capable of being traded electronically through our eSpeed(R) system.
Our goal is to offer the full range of financial products currently traded in
today's global markets. In 2000, we entered the North American energy market
with a group of leading energy industry partners. In 2001, we entered the
Canadian fixed income market through our investment in and technology agreement
with Freedom International Brokerage, the leading Canadian inter-dealer broker
of fixed-income products and other capital products, and we entered the German
and United Kingdom energy markets. We plan to reintroduce most of our North
American fixed income products during 2002. We also plan to leverage our
electronic marketplace expertise and reputation to sell software products and
services directly to participants in these marketplaces.
OUR INDUSTRY
Historically, the trading of financial and nonfinancial products has been an
inefficient process. Buying, selling or trading activity is traditionally
effected through either (1) a central physical location, like a trading pit or
auction house, where market participants have to access the market through this
central location or its members, (2) a bilateral arrangement with a buyer or
seller or (3) several layers of middlemen and salespersons who assist in
handling orders. Each of these approaches is people and time intensive, which
adds to the direct and indirect cost of the product bought or sold.
Additional inefficiencies with transaction execution include lack of real-time
price information, small disparate groups of interested buyers and sellers,
limited liquidity and problems associated with executing trades as market
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prices change. As more transactions occur and participants extend credit to each
other, there are added risks to both buyers and sellers because of the lack of
sophisticated risk management tools. Also, after a buy or sell order is
executed, there are the additional tasks of recording, accounting, tracking,
delivering and financially settling the transaction. Each of these tasks, if
done manually, can add potential cost and error to the process as additional
participants or systems enter the transaction cycle.
Electronic marketplaces have emerged as effective means of conducting
transactions. In an electronic marketplace, substantially all of the
participants' actions are facilitated through an electronic medium, such as a
private electronic network or over the Internet, which effectively eliminates
the need for actual face-to-face or voice-to-voice participant interaction,
reducing the inefficiencies inherent in a physical market. Additionally, as
adoption of the Internet has become more widespread, businesses are recognizing
online channels as an efficient means of distribution of their products to their
customers.
Many financial exchanges worldwide, including certain exchanges in France,
Germany, Japan, Sweden, Switzerland and the United Kingdom, are now partially or
completely electronic. Various electronic marketplaces have been implemented to
address the varied needs of the broad business-to-business initiatives,
including marketplaces aimed at the procurement of finished goods or services,
as well as neutral marketplaces for the trading of commodity or commodity-like
goods. We believe the trading of commodity-like products will require
capabilities found in the financial markets, including real-time pricing,
futures and other hedging capabilities and robust interactive trading.
Additionally, we believe companies will seek to outsource online solutions for
the electronic distribution of their products to avoid the difficulty and cost
of developing and maintaining their own online solutions.
OUR SOLUTION
Our electronic marketplace end-to-end solution includes real-time and auction-
based transaction processing, credit and risk management tools and back-end
processing and billing systems, all accessible through our global privately
managed high-speed data network and over the Internet. Because of the scale and
adaptability of our system, our eSpeed(R) products have applications across a
broad range of companies, industries and vertical marketplaces, including any
business-to-business marketplace involving multiple buyers and multiple sellers.
In addition, we license our software to provide a complete outsourced solution
to our clients, enabling them to distribute their branded products to their
customers through online offerings and auctions, including private and reverse
auctions, and request-for-quote capabilities. Our products enable market
participants to transact business instantaneously, more effectively and at lower
cost.
OUR TECHNOLOGY PLATFORM
Our electronic marketplace solutions operate on our technology platform that
emphasizes scalability, performance, adaptability 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 interactive
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 API and
proprietary vendor access; and
o customized inventory distribution and auction protocols designed to be used
by our clients and partners in their distribution and trading systems.
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Together, these components enable our clients to effect transactions in real-
time, with straight-through processing.
Network distribution system
Our eSpeed(R) system contains a proprietary hub- and-spoke digital network. This
network uses Cisco Systems' network architecture and is operated by
Cisco-certified engineers. Our network's high-speed points of presence comprise
the major business centers of the world, including New York, London, Tokyo,
Milan, Chicago, Los Angeles and Toronto. Altogether, we manage 22 hubs linked
by over 50,000 miles of cable, over 700 Cisco network devices and more than 350
high capacity Sun servers and Compaq Alpha servers located in two data centers
in London and Rochelle Park, New Jersey. The redundant structure of our system
provides multiple backup paths and re-routing of data transmission if one spoke
of a hub fails. 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 under 300 milliseconds. We estimate that our
network is currently running at approximately 15% of capacity.
In addition to our own network system, we also receive and distribute secure
trading information from clients using the services of multiple, major Internet
service providers throughout the world. These connections enable us to offer our
products and services via the Internet to our global clients.
Transaction processing software
Most of our software applications have been developed internally and are central
to the success of our eSpeed(R) system. Our 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
sellers. Our pricing engines provide prices for illiquid financial products
derived from 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, enables the settlement of each transaction. Our transaction
processing software 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.
eSpeed(R) transaction engines
Our auction and transaction engines use Interactive Matching(SM), 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 in 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 transaction 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 transactions and auctions in multiple currencies
simultaneously. Our transaction 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 transact business over the Internet.
We believe our marketplace expertise and rules-based systems provide incentives
for clients to actively participate in our marketplaces. For example,
Interactive Matching(SM) provides incentives to participate in our marketplaces
by encouraging participants to expose their orders to the market. 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 or purchase. In addition, in many
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markets we have structured our pricing policy to provide incentives. 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 adaptable and, as part of our business strategy, we intend to apply it
across other non-financial markets for multiple products and services.
eSpeed Credit Master(SM) - credit and risk management systems
Our credit and risk management systems have been an important part of the
operation of our electronic marketplaces and were damaged as a result of the
terrorist attacks on September 11, 2001. We plan to re-implement them as soon as
possible. These systems (1) continuously monitor trades of our clients to help
prevent them from exceeding their credit limits, (2) automatically prevent
further trading once a client has reached a pre-determined credit limit and (3)
evaluate transactions and calculate both individual positions and risk exposure
across various products and credit limits. Once re-implemented, our proprietary
credit and risk management systems will also be made available to our global
clients to enable them to monitor the position of their traders and will be
integrated with our software solution systems so our global clients can monitor
the credit of their customers who transact directly with them online. These
systems will store client data relevant to credit and risk management, such as
financial statements, credit documents, contacts and internal analyses. These
systems will also enable our clients to make our electronic marketplaces
available to their customers while maintaining control of their customers'
trading activity and risk.
eSpeed Name Give-Up Matrix(SM) - credit monitoring
Through the use of our name give-up matrix, we enable our market participants to
create counterparty credit exposure limits to manage the counterparties with
which they transact in non-central counterparty markets. In these markets,
participants settle transactions directly with other participants. Using this
module, the participants can pre-select the counterparties that they are willing
to transact with in that market. The module displays all prices to market
participants, and highlights and enables execution on prices that are from
approved counterparties. Additionally, the module has features that permit each
participant to manage the activities of its traders on a real-time basis.
eSpeed(SM) pricing engines and analytics
We have developed a number of 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(SM) 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. In the Financial Vertical, MOLE(SM) currently uses data from
existing cash and futures markets to calculate pricing for transactions where no
market prices currently exist, thereby facilitating liquidity. These
multi-variable trades are extremely difficult to execute in voice-based markets
due to their complexity and the slow speed of manual execution.
eSpeed(SM) 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. For
example, in the financial markets, we outsource our fulfillment services to
Cantor and Freedom (for Canadian markets), where both parties to a trade send
either cash or securities to Cantor or Freedom and Cantor or Freedom settles
the trade and sends each party the cash or securities due. Our reporting and
accounting systems are designed to track and record all charges and commissions
for a trade. Our eSpeed(R) system and products automate previously paper and
telephone-based transaction processing, confirmation
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and other functions, substantially improving and reducing the cost of many of
our clients' back offices, and enabling straight-through processing.
Client interfaces
Our system can be accessed by our clients in four ways:
o using our eSpeed(R)proprietary front-end trading software;
o using our application programming interface (API) for clients to write
their own software linking their networks and software applications
directly to our systems. Our application programming interface enables
clients to conduct computer price updating, program trading and
straight-through processing;
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 independent software vendors.
ESPEED(R) PRODUCTS
We market our services through the following three products: eSpeed Markets
(SM), eSpeed Software Solutions(SM) and eSpeed Online(SM).
ESPEED MARKETS(SM)
eSpeed Markets(SM) is a full service solution combining all of our proprietary
software and our global high-speed private network. eSpeed Markets(SM) currently
operates in some of the largest and most complex marketplaces, and is designed
to be extendible to any multiple buyer, multiple seller marketplace. eSpeed
Markets(SM) is also available over the Internet. Currently, most of our revenues
are derived from transactions in the global fixed income market powered by our
eSpeed Markets(SM) product.
eSpeed Markets(SM) enables us to operate what we believe is the only integrated
network engaged in electronic trading in multiple products and marketplaces on a
global basis. We believe that the time and expense required to develop and
install electronic trading networks will serve as significant barriers to entry.
FINANCIAL VERTICAL
WHOLESALE FIXED INCOME. The global fixed income market is the largest financial
market in the world. The Bond Market Association estimates that, in the U.S.
alone, as of 2001, there were over $18 trillion of fixed income securities
outstanding with over $520 billion of volume traded daily. In the U.S. Treasury
securities market, there is reported to be over $290 billion a day in trading
just among the primary dealers and their clients. The global market for interest
rate swaps, interest rate options and currency swaps had over $60 trillion in
notional value outstanding as of June 2000.
Foreign exchange. The trading of currencies in all monetary pairs represents the
largest trading volume market in the world. The Bank for International
Settlements has estimated the daily volume traded in the foreign exchange
markets to have been $1.97 trillion.
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Futures and options. 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. According to the Futures Industry
Association, Inc., in 2001, over 3.1 billion futures and options contracts were
traded in the world's futures and options markets. Currently, a significant
volume of 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.
Limitations of the traditional financial market
While the traditional financial market facilitates trading, it has the following
significant shortcomings:
o limited direct access and, therefore, inefficient pricing;
o high transaction costs and slow execution due to the number of people
involved in a voice transaction;
o difficulty in implementing program trading, especially programs designed to
automatically and simultaneously execute multiple trades in different, but
related products;
o significant expense incurred in processing, confirming and clearing manual
processes; and
o compliance and regulatory risk associated with voice transactions and non-
automated audit trails.
Our Financial Vertical solution
The Financial Vertical contains U.S. Treasury and agency securities, European,
Japanese, Canadian and emerging market sovereign bonds, U.S. and global
corporate bonds, mortgage-backed securities, municipal bonds, interest rate
swaps and options, futures, options, repos and basis trades. Cantor has been a
major facilitator and, in some cases, provider of liquidity in numerous
financial products through its offices in the U.S., Canada, Europe and Asia. Our
eSpeed Markets(SM) product provides the only way to electronically access
Cantor's marketplaces. Through our alliance with Freedom, Cantor and six leading
Canadian financial institutions, our eSpeed Markets(SM) product also powers the
electronic platform of Freedom International Brokerage, the leading inter-dealer
broker of Canadian fixed income and other capital markets products.
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 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(R)
suite of products enables us to introduce and distribute a broad mix of
financial products and services quickly, efficiently and at lower cost.
In our electronic marketplaces, participants may either electronically execute
trades themselves or call brokers, who then input trade orders into the market
for them. In our fully electronic trades, all stages of the trade occur
electronically. The participant inputs its buy or sell order instructions
directly into our electronic trading system using our software, a web-browser,
or electronically through an application programming interface or other
software. Our system provides to the participant, normally within 300
milliseconds, an on-screen confirmation that the participant's order has been
accepted. 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 assisted trade is
executed in substantially the same manner as an electronic trade, except that
the participant telephones a broker, who then inputs the participant's order
into our electronic marketplace system. Our U.S. Government Securities
marketplace is now a fully electronic marketplace.
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We also see opportunities to expand our business by licensing our technology to
other voice brokers in addition to Cantor.
ENERGY VERTICAL
In September 2000, we, together with Coral Energy Holding (an affiliate of
Shell), Dominion Energy, Dynegy, Koch Energy Trading, TXU Energy Trading,
Williams Energy Marketing & Trading and Cantor, announced the formation of
TradeSpark, a new comprehensive energy marketplace. TradeSpark was created as a
wholesale marketplace for energy-related products and services in North America
with both electronic trading systems and voice brokers. As part of our
arrangement with TradeSpark, we have implemented electronic marketplaces for
natural gas, electricity, coal, weather derivatives and emission allowances. It
is the intention of TradeSpark to provide the full spectrum of energy-related
tradable instruments, including cash, spot, forward, futures, indices and data
sales.
TradeSpark unites our technology platform, accessed over both a private global
network and the Internet, and our partners' in-depth energy market knowledge and
liquidity to bring speed, neutrality, efficiency and technological leadership to
the energy trading market. In 2001, Dynegy became a partner in TradeSpark and,
in conjunction with this expanded relationship, Dynegy established an underlying
electronic link between its proprietary e-commerce portal, Dynegydirect, and the
TradeSpark platform.
Since inception, over 200 companies, including most of the major energy trading
firms in North America, have traded using TradeSpark. We effected over 75,000
transactions comprising approximately $150 billion of transaction volume since
TradeSpark's inception. Gas Daily reports that the TradeSpark partners, together
with Entergy, traded approximately 32.8 billion cubic feet of natural gas per
day, and Power Markets Week reports that these companies traded 403 million
megawatt hours of electricity during 2000. These companies estimate they traded
roughly 20% of all gas and power traded in North America during the last quarter
of 2000.
Limitations affecting the traditional energy market
The traditional voice-brokered energy marketplace has been fraught with
inefficiencies, including the lack of real-time price information, small pools
of liquidity, high transaction costs and problems associated with executing
trades in a fast moving market. More recently, credit has become a major issue
to the market participants because of massive price fluctuations caused by
various states' approaches to deregulation, the lack of a liquid hedging market,
limited risk management tools and the bankruptcy of certain major industry
participants. While there have been a handful of electronic systems and single
dealer platforms initiated over the past three years, we believe that none have
unbiased information about prices and enough products or liquidity to give
companies exchange-like execution in the energy marketplace.
Our Energy Vertical solution
Powered by our full trading platform encompassed in eSpeed Markets(SM),
TradeSpark offers an end-to-end marketplace and trading solution that includes
real-time and auction-based transaction processing, risk management tools and
back-end processing systems, as well as access to a fully registered futures
exchange, allowing for the creation of futures and options products for this
marketplace.
Designed to bring marketplace efficiency to the energy markets, TradeSpark is
fully operational and, as of December 31, 2001, employed 39 brokerage personnel
with access to our electronic trading platform. TradeSpark offers three possible
points of access to one pool of liquidity: over the Internet, through our
private network and through TradeSpark voice brokers.
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ESPEED SOFTWARE SOLUTIONS(SM)
eSpeed Software Solutions(SM) provides a complete outsourced solution to our
clients, enabling them to distribute their branded products to their customers
through online offerings and auctions, including private and reverse auctions,
and request-for-quote capabilities. Our eSpeed Software Solutions(SM) product
takes advantage of the scalability, flexibility and functionality of our
eSpeed(R) system to allow our clients to quickly create online connectivity to
their customers.
We have signed software solution agreements with Refco Securities, Sanwa
Securities and the Federal Home Loan Bank. Refco Securities operates a global
securities futures brokerage business. eSpeed Software Solutions(SM) has
developed a front end trading system for Refco Securities that enables it to
communicate its prices for securities products to its customers. Sanwa
Securities is the securities subsidiary of Sanwa Bank, one of the largest
financial institutions in Japan. Sanwa transacts with its customers through our
real-time technology platform to supplement its Japanese government bond
business. The Federal Home Loan Bank is a U.S. Government sponsored enterprise
and one of the largest issuers in the global short-term securities market. Our
electronic auction-based technology is expected to begin powering the Federal
Home Loan Bank's primary discount note auctions in 2002.
ESPEED ONLINE(SM)
eSpeed Online(SM) provides retail-based e-commerce businesses with online access
to wholesale market participants. It enables these online businesses to offer
their customers access to a variety of markets that are traditionally available
only to institutional investors and wholesalers. eSpeed Online(SM) also links to
middle and back-office systems, providing a complete end-to-end retail solution
for trade execution, risk management, processing and billing. To date, we have
signed agreements with several online brokers, including AB Watley,
Bondpage.com, Charles Schwab, Firstrade Securities, MostActives.com, Mr. Stock,
Muriel Siebert, myTrack, Scot Trade, Sutton Online, The Net Investor, Tradescape
and WebStreet Securities. In January 2001, Charles Schwab & Co. introduced U.S.
Treasuries to its customer base through eSpeed Online(SM).
Technological advances have created new and inexpensive means for individual
investors to directly access markets online and participate in the securities
markets. 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 that promote greater liquidity, enhanced access and more efficient
pricing will increase trading among retail investors in financial and other
products other than equities. We believe that companies will increasingly seek
an outsourced solution to distribute their products electronically.
OUR GROWTH STRATEGY
Our objective is to be the world's leading provider of interactive electronic
marketplaces and related software solutions to a broad range of industries and
vertical marketplaces. We believe we can extend our expertise in the creation of
instantaneous electronic marketplaces to a broad range of products and services.
Our growth strategy to achieve this objective includes the following key
elements:
EXPAND SYSTEM FUNCTIONALITY AND DEVELOP NEW PRODUCTS, SOFTWARE AND SERVICES FOR
OUR EXISTING FINANCIAL AND ENERGY MARKETS
We plan to continue to expand the types of financial, energy and other products
traded in our marketplaces both in the United States and abroad. We also plan to
reintroduce most of our North American fixed income products during 2002. Our
goal is to include in our electronic marketplaces the full range of products
that are currently
9
traded in today's markets worldwide. In addition, we plan to develop software
and services to add new methods to effect transactions in these products. We
expect that our traditional client base will begin to trade new products as we
develop electronic marketplaces for them, and we intend to continue to convert
our existing global clients to our fully electronic platform.
LEVERAGE OUR ESPEED(R)SYSTEM FOR USE IN A WIDE RANGE OF ADDITIONAL
BUSINESS-TO-BUSINESS MARKETS AND INDUSTRIES
Because of the scale of our system and its ease of adaptability, we believe our
eSpeed(R) system has 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. As evidenced by the formation of
TradeSpark, we are well positioned to leverage the significant costs and efforts
that have been incurred developing our eSpeed(R) system to quickly create
electronic markets in a wide range of products. We plan, over time, to serve
additional marketplaces, including global energy, bandwidth, telecommunications,
chemicals, electronic components, metals and other markets that can benefit from
more efficient, centralized, electronic trading facilities. We plan to continue
to expand our eSpeed(R) system across the financial markets and their products.
LICENSE OUR SOFTWARE TO PROVIDE A BROAD RANGE OF MARKET PARTICIPANTS WITH AN
OUTSOURCED SOLUTION FOR ONLINE DISTRIBUTION OF THEIR PRODUCTS
We provide a complete outsourced solution to our clients to enable them to
distribute their branded products to their customers through online offerings,
auctions, including private and reverse auctions, and request-for-quote
capabilities. We are rebuilding our dedicated sales force that will focus on
licensing our software solutions to existing and new clients.
PURSUE STRATEGIC ALLIANCES AND ACQUISITIONS
We are continually exploring opportunities to maximize our growth, including
acquisitions, strategic alliances, joint ventures, private placements,
recapitalizations or any combination of the foregoing, to expand our vertical
markets and generate future growth. We are seeking to enter into joint ventures
and other strategic alliances to create liquidity in new and existing product
markets, to utilize our patents in such ventures and strategic alliances and to
attract new participants to trade products in those markets. We have employed
this strategy in our formation of TradeSpark and our alliance with Freedom, as
well as in our market making relationship with Deutsche Bank.
OUR CLIENTS
Our clients in the Financial Vertical include banks, dealers, brokers and other
wholesale market participants, over 500 of which currently participate in our
electronic marketplaces, including most of the largest bond trading firms in the
world, as identified by Euromoney Magazine. Our clients in the Energy Vertical
include energy trading companies, utilities and other wholesale market
participants, over 200 of which currently participate in our electronic
marketplace, including leading North American energy trading companies.
We are providing wholesale and retail investors access to the electronic
marketplaces and brokerage-related services supported by our eSpeed(R) 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 expect to add clients
for our eSpeed Software Solutions(SM) product from a wide variety of industries.
In addition, due to the loss of virtually all of Cantor's U.S. non-equity voice
brokerage business in connection with the terrorist attacks of September 11,
2001, we intend to build relationships with new clients, including traditional
competitors of Cantor. We further intend to provide third parties with the
infrastructure, including systems administration, internal network support and
operations and disaster recovery
10
services, that is critical to providing fully electronic marketplaces in a wide
variety of products. Other than Cantor, no client of ours accounts for more than
10% of our revenues.
SALES, MARKETING AND CORPORATE DEVELOPMENT
We promote our electronic marketplaces and services to our existing and
prospective clients through a combination of sales, marketing and co-marketing
campaigns. We leverage our client relationships through a variety of direct
marketing and sales initiatives and build and enhance our brand image through
marketing campaigns targeted at a diverse audience, including traders, potential
partners and the investor and press communities. We may market to our existing
and prospective retail clients through a variety of co-marketing/co-branding
initiatives with our online partners. We have designed our sales and marketing
efforts to promote brand awareness and educate our audience regarding the nature
of our electronic marketplaces, products and services and the advantages
associated with the automation of trading activities, as well as our association
with Cantor.
Additionally, our senior management staff actively works to establish strategic
relationships, develop new markets for our technology and structure and execute
investments and acquisitions. Our staff promotes eSpeed at conferences,
conventions, events and speaking engagements that advance both our technology
and our brand name. In many cases, these engagements are focused within specific
vertical markets that we intend to develop in the future. All of these efforts
are intended to enhance our image, profile and profitability.
SOFTWARE DEVELOPMENT
We devote substantial efforts to the development and improvement of our
electronic marketplaces and licensed software products. We work with our clients
to identify their specific requirements and make modifications to our software,
network distribution systems and technologies that are responsive to those
needs. Our research and development efforts focus on internal development,
strategic partnering, acquisitions and licensing. Although we lost many
technology professionals and software developers on September 11, 2001, we
continue to employ over 250 technology professionals, a majority of which are
software developers. Our technology team's objective is to develop new products
and services in order to provide superior electronic marketplace solutions to
our clients. We also focus our efforts on enhancing our Internet interfaces to
facilitate real-time markets and comply with the standard Internet security
protocol and future security protocols 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. In addition,
we have forged strategic alliances with third-party independent software vendors
through which we will work to develop sophisticated, industry specific,
front-end applications and products.
COMPETITION
The development and operation of electronic marketplaces are evolving. As a
result, competition in these marketplaces is currently fragmented. We expect to
face competition from a number of different sources varying in size, business
objectives and strategy.
Our current and prospective competitors are numerous and include inter-dealer
brokerage firms, market data and information vendors, securities and futures
exchanges, electronic communications networks, crossing systems, consortia,
business-to-business marketplace infrastructure and software companies and niche
energy market and other commodity business-to-business Internet-based trading
systems.
The electronic marketplace solutions we provide to our 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
11
competition. We do not intend to use the access to the customer base of our
clients that we obtain in providing our electronic marketplace solutions to
compete with these clients in other product transactions.
We believe our electronic marketplaces compete primarily on the basis of speed,
functionality, efficiency, price, system stability and ability to provide market
participants with access to liquidity.
OUR INTELLECTUAL PROPERTY
We have adopted a comprehensive intellectual property program to protect our
proprietary technology. We currently have licenses covering four of Cantor's
patents in the U.S. 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
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.
In April 2001, we purchased the Wagner patent, which addresses automated futures
trading and provides for bids and offers to be placed and matched
electronically. In August 2001, we received a preliminary ruling from the United
States District Court in Dallas, Texas upholding our position regarding the
scope of the Wagner patent. See "Item 3. Legal Proceedings".
In July 2001, we purchased a patent, the Lawrence patent, which relates to the
electronic trading of municipal bonds and electronic auctions of fixed income
securities and interest rate products. Auction based trading allows
broker-dealers and their customers to send our "bid-wanted" forms listing the
available securities, then to accept bids with a final auction time. The
Lawrence patent brings additional efficiencies to the auctioned markets by,
among other things, enabling potential buyers to electronically place bids
securely and anonymously.
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. We have filed a number of patent
applications to further protect our proprietary technology and innovations in
the past year.
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. Our business strategy may include licensing such patents for
royalties, joint venturing with other marketplaces or exchanges, or exclusively
using the patents in our marketplaces.
EMPLOYEES
As of December 31, 2001, we had 312 employees, four 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.
12
RISK FACTORS
In addition to the other information in this Report, the following risk factors
should be considered carefully in evaluating us and our business.
RISKS RELATED TO OUR BUSINESS
THE EVENTS OF SEPTEMBER 11, 2001 HAVE HAD AND WILL CONTINUE TO HAVE AN ADVERSE
EFFECT ON OUR BUSINESS.
Our losses
Our previous headquarters were in the World Trade Center. As a result of the
terrorist attacks of September 11, 2001 (the September 11 Events), our offices
in the World Trade Center were destroyed and we lost approximately 180 of our
employees, including many members of our senior management. The destruction of
our assets, the loss of all those employees, including product development
personnel, and the need to relocate the surviving employees has negatively
impacted our business. In addition, although we still have redundancy of our
system, we now have two data centers instead of the three that we had prior to
the September 11 Events.
Cantor's losses
Cantor and TradeSpark lost an aggregate of 478 employees and equipment and
systems as a result of the September 11 Events. Cantor also lost its
headquarters. Such losses have negatively impacted our revenues and will
continue to adversely impact our revenues in the future since, among other
things, Cantor is not currently trading many of the financial products its voice
brokers historically traded using our eSpeed(R) system. In addition, the loss of
Cantor's assets and brokers will negatively affect our strategy to convert the
products that those brokers were trading in voice-assisted transactions to
products that are traded fully electronically over our eSpeed(R) system.
Insurance
As a result of the September 11 Events, fixed assets with a book value of
$17,690,289 were destroyed. As of December 31, 2001, we had received $20.5
million of insurance proceeds to cover the net book value of the fixed assets
that were destroyed, plus the actual additional cost of the assets we replaced.
Although we expect to recover any further costs we incur if we decide to replace
any additional destroyed fixed assets through our property and casualty
insurance coverage of $40 million, we cannot guarantee or currently estimate the
amount or timing of such recovery. In addition, we have incurred and will
continue to incur business interruption losses due to the September 11 Events.
Although we expect to recover or reduce these losses through our $25 million of
business interruption insurance, we cannot guarantee or currently estimate the
amount or timing of receipt of any such insurance proceeds.
WE MAY INCUR LOSSES IN THE FUTURE.
From our inception through December 31, 2001, we have sustained a cumulative net
loss of approximately $91.3 million. While we currently expect to generate
operating profits in the year 2002, as we continue to develop our systems and
infrastructure and expand our brand recognition and client base through
increased marketing efforts, we may actually incur additional losses.
IF WE DO NOT EXPAND THE USE OF OUR ELECTRONIC SYSTEMS, OR IF OUR 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 trading firms, dealers, banks and other financial institutions that
use
13
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 retain
the current participants in our marketplaces. Although some of our agreements
with market participants require certain minimum payments, none of our
agreements with market participants require them to use our electronic
marketplaces.
IF WE ARE UNABLE TO ENTER INTO ADDITIONAL MARKETING AND STRATEGIC ALLIANCES OR
OUR CURRENT STRATEGIC ALLIANCES ARE NOT SUCCESSFUL, WE MAY NOT GENERATE
INCREASED TRADING IN OUR ELECTRONIC MARKETPLACES.
We expect to continue to enter into strategic alliances with other market
participants, such as retail brokers, exchanges, energy companies, market
makers, consortia, clearinghouses, major market participants 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 continue to enter
into these strategic alliances on terms that are favorable to us, or at all. In
addition, we cannot assure you that our current strategic alliances will be
successful. The success of our current and future relationships will depend on
the amount of increased trading in our electronic marketplaces and the liquidity
generated therein. 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, software products, brand
and the adaptability of our electronic marketplaces for non-financial vertical
markets. In order to build this awareness, our marketing efforts must succeed
and we must provide high quality services. These efforts may 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 of trades;
o incomplete or inaccurate accounting, recording or processing of trades;
o financial losses;
14
o litigation or other client claims; and
o regulatory sanctions.
We experienced systems and telecommunications failures in connection with the
terrorist attacks of September 11, 2001. We cannot assure you that we will not
experience additional systems failures in the future from power or
telecommunications failure, acts of God or war, terrorist attacks, human error,
natural disasters, fire, power loss, sabotage, hardware or software malfunctions
or defects, computer viruses, intentional acts of vandalism and similar events.
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 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, 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.
WE OPERATE IN A RAPIDLY EVOLVING BUSINESS ENVIRONMENT. IF WE ARE UNABLE TO ADAPT
OUR BUSINESS EFFECTIVELY TO KEEP PACE WITH THESE CHANGES, OUR OPERATIONS WILL BE
ADVERSELY AFFECTED.
The pace of change in our market is extremely rapid. Operating in such a
rapidly-changing business environment involves a high degree of risk. Our
success will depend on our ability to adapt effectively to these changing market
conditions.
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 changes,
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;
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.
15
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, Chief Executive Officer and President, and our
other executive officers and managers and sales and technical personnel who
possess extensive knowledge and technology skills in our markets. We cannot
assure you that we would be able to find an appropriate replacement for Mr.
Lutnick if the need should arise. Any loss or interruption of Mr. Lutnick'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 any of our executive officers or other personnel, and while we
intend to acquire reasonable amounts of "key person" life insurance, we do not
as of yet have "key person" life insurance policies on any of our executive
officers or 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 MARKETPLACES MAY
BE MATERIALLY ADVERSELY AFFECTED.
Our business is dependent on proprietary technology and other intellectual
property rights. We license most of 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 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 or that we own 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 or our 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.
16
We use our eSpeed(R) registered service mark for the services described herein
and have registered that service mark in a number of jurisdictions around the
world. Although several existing third-party registrations and applications for
trademarks and servicemarks consisting of designations similar to ours in
certain countries have come to light, they are for goods and services that are
of a different type from those being offered under our eSpeed(R) registered
service mark. Although we are not presently aware of any third-party objections
to our use or registration of our eSpeed(R) registered 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(R) registered service mark
in these 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.
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, such as database software, 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 U.S. 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 U.S. 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.
17
DUE TO INTENSE COMPETITION, OUR MARKET SHARE AND FINANCIAL PERFORMANCE COULD
SUFFER.
The electronic trading and Internet-based financial and non-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;
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 leverage existing relationships with clients and strategic partners more
effectively or exploit more recognized brand names to market and sell their
services.
Our current and prospective competitors are numerous and include interdealer
brokerage firms, technology companies and market data and information vendors,
securities and futures exchanges, electronic communications networks, crossing
systems, software companies, consortia, business-to-business marketplace
infrastructure companies and niche market energy and other commodity business-
to-business Internet-based trading systems.
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.
The number of businesses providing Internet-based financial and non-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(SM)
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 a number of other
large Internet companies that have expertise in developing online commerce and
in facilitating Internet traffic, 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 HAVE INVESTED IN CONSORTIA THAT HAVE DEVELOPED
ELECTRONIC TRADING NETWORKS, WE COMPETE WITH THEM IN CERTAIN ASPECTS OF OUR
BUSINESS.
Consortia owned by some of our clients have developed electronic trading
networks. Such consortia compete with us and our electronic marketplaces in some
areas of our business and may compete with us in other areas in the future.
18
IF WE EXPERIENCE LOW TRADING VOLUME IN PRODUCTS, OUR PROFITABILITY COULD SUFFER.
We have experienced significant fluctuations in the aggregate trading volume of
products being traded in our marketplaces. We expect that fluctuations in the
trading volume of 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 have a material adverse effect on our
profitability. These factors include:
o economic and political conditions in the U.S. and elsewhere in the world;
o terrorist attacks or war;
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 fluctuating interest and exchange rates;
o legislative and regulatory changes; and
o currency values.
BECAUSE THERE IS LESS U.S. TREASURY DEBT OUTSTANDING, TRADING IN OUR
MARKETPLACES MAY DECLINE.
Our business is highly dependent upon the volume of bonds being traded through
our eSpeed(R) system. If the U.S. reduces its outstanding Treasury debt, there
may be a decline in the volume of U.S. Treasury securities traded through our
eSpeed(R) system.
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 and other 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 exchange rates;
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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, capital structure, record-keeping,
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 the risk that we could be subject to disciplinary
sanctions or other penalties for failure to comply with applicable laws or
regulations.
AS WE ENTER NEW MARKETS, WE MAY NOT BE ABLE TO SUCCESSFULLY ADAPT OUR TECHNOLOGY
AND MARKETING STRATEGY FOR USE IN THOSE MARKETS.
We are leveraging our eSpeed(R) system 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 may 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 vertical markets and extend
into others, 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.
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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, NASD Regulation, Inc., Commodity Futures
Trading Commission and other agencies extensively regulate the U.S. financial
industry. Our international operations may become subject to similar regulations
in specific jurisdictions. In addition, our activities in the Energy Vertical
may be subject to regulation by the Federal Energy Regulatory Commission under
the Federal Power Act. Certain of 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 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 products and services we offer through our electronic marketplaces are
likely to be regulated by federal, state and foreign governments. Our ability to
provide such services will be affected by these regulations. In addition, as we
expand our business to other vertical markets, it is likely that we will be
subject to additional federal, state and foreign 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 regulated
companies. Net capital 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
21
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 ability to expand or even maintain our present levels of
business, which could have a material adverse effect on our business. In
addition, we may become subject to net capital requirements in foreign
jurisdictions.
BECAUSE WE OFFER ACCESS TO SOME OF OUR MARKETPLACES TO ONLINE RETAIL BROKERS AND
OTHERS, 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 other 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 third parties 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 are subject to legal proceedings and claims against Cantor and
its affiliates as a result of the transactions surrounding our formation.
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.
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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 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. As a result, 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 HAS FLUCTUATED AND MAY FLUCTUATE IN
THE FUTURE, AND FUTURE SALES OF OUR SHARES COULD ADVERSELY AFFECT THE MARKET
PRICE OF OUR CLASS A COMMON STOCK.
The market price of our Class A common stock has fluctuated widely since our
initial public offering and may continue to fluctuate widely, depending upon
many factors, including our perceived prospects and the prospects of the
financial and other business-to-business marketplaces in general, differences
between our actual financial and operating results and those expected by
investors and analysts, changes in analysts' recommendations or projections,
seasonality, 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 also 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.
We have registered under the Securities Act 10,630,000 shares of our Class A
common stock, which are reserved for issuance upon exercise of options granted
under our stock option plan. Since our stock option plan has been amended to
increase the amount of shares available for issuance under our stock option
plan, we will likely register additional shares. In addition, 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 registered, these shares can be sold in the
public market upon issuance, subject to restrictions
23
under the securities laws applicable to resales by affiliates. In addition, we
have registered under the Securities Act 425,000 shares of our Class A common
stock issuable under our stock purchase plan. We also will be issuing new shares
of our Class A common stock in connection with our matching program for our
401(k) plan. The maximum number of new shares we will be issuing in connection
with our 401(k) plan is $3,000 worth per employee per year.
Since June 9, 2001, approximately 5.9 million shares of our Class A common stock
that have been distributed to partners of Cantor as part of a deferred stock
distribution by Cantor have been eligible for resale in the public market
subject to Rule 144 under the Securities Act. On June 9, 2002, approximately
4,160,000 of these shares may be resold in the public market pursuant to Rule
144(k) under the Securities Act. The availability for sale of such number of
shares may have an adverse effect on the market price of our Class A common
stock.
In addition, we have issued shares of our Class A common stock, warrants and
convertible preferred stock and have granted registration rights in connection
with certain of our strategic alliances. See "Item 13. Certain Relationships and
Related Transactions."
RISKS RELATED TO OUR RELATIONSHIP WITH CANTOR
BECAUSE WE CONTINUE TO DEPEND ON CANTOR'S BUSINESS, EVENTS WHICH ADVERSELY
AFFECT CANTOR'S BUSINESS, INCLUDING A SALE, DISSOLUTION, LIQUIDATION OR
WINDING-UP OF CANTOR, MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR REVENUES.
Since inception, we have recognized a significant portion of our revenues in
connection with our relationship with Cantor. Consequently, our business has
been adversely affected by the effect of the September 11 Events on Cantor's
business. See "-- The events of September 11, 2001 have had and will continue to
have an adverse effect on our business." It is possible that, because of the
September 11 Events, Cantor may not continue to satisfy the governmental
regulatory requirements necessary for it to continue to provide clearance and
settlement for the trades made over our eSpeed(R) system. If Cantor cannot
provide clearance and settlement services for us, we will have to find a third
party to provide such services or provide such services ourselves. There is no
guarantee we will be able to find an alternative provider of clearance and
settlement services and, even if we do, we are likely to encounter difficulties
in transitioning to any such provider. Moreover, such alternative provider may
charge more or less than Cantor did for such services, which may negatively
affect our results of operations. In addition, any other future events which
adversely affect Cantor's business or operating results, including a sale,
dissolution, liquidation or winding-up of all or a material portion of Cantor's
business, could have a material adverse effect on our most significant source of
revenues. We also are a general creditor of Cantor to the extent that there are
transaction revenues and software solutions fees owing to us from Cantor. Events
that adversely affect Cantor's financial position and its ability to remit to us
our share of transaction revenues and software solutions fees could have a
material adverse effect on our revenues.
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 Amended and Restated
Joint Services Agreement, as currently in effect (the "Joint Services
Agreement"), with Cantor provides that, in some circumstances, Cantor can
unilaterally determine the
24
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 be
correspondingly decreased. Pursuant to our Administrative Services Agreement
with Cantor, Cantor is required to obtain for us, among other things, property
and casualty insurance of not less than $40 million and business interruption
insurance of $25 million. Cantor has procured insurance coverage for us in these
respective amounts; however, we are listed on this insurance policy as one of
several insured parties, together with Cantor and several of its affiliates.
This insurance policy is for aggregate amounts in excess of the amounts set
forth above. The Administrative Services Agreement does not provide for the
allocation of the proceeds among the named insureds. Because Cantor controls us
and the allocation of the proceeds received from insurance, Cantor may allocate
the proceeds among the insured parties in a manner with which we disagree and
that may have an adverse effect on our financial condition.
Three of our directors and a majority of our 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,
President and Chief Executive Officer, is the sole stockholder of the managing
general partner of Cantor. As a result, Mr. Lutnick controls Cantor. As of March
15, 2002, Mr. Lutnick controlled approximately 90.9% of the combined voting
power of all classes of our voting stock. Mr. Lutnick's simultaneous service as
our Chairman, President 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.
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 limited circumstances. 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 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.
25
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, the
Administrative 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.
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. See "Item 3. Legal Proceedings".
RISKS RELATED TO E-COMMERCE AND THE INTERNET
IF ELECTRONIC MARKETPLACES 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 for a wide range of products. Historically, securities
and commodities markets operated through open outcry formats which have recently
begun to be supplanted by new systems that match buyers and sellers
electronically. The energy
26
markets in which we participate through TradeSpark operate through phone-based
and bulletin-board formats and have recently begun to transact electronically.
The utilization of our products and services depends on the continued
acceptance, adoption and growth of electronic 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.
Our strategic and financial objectives would be adversely impacted if e-commerce
adoption and usage does not continue to grow. Business-to-business 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.
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 our clients. 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.
27
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.
As of March 15, 2002, Cantor beneficially owned approximately 90.4% 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
shares of our Class B common stock issued to Cantor upon consummation of the
formation transactions may be transferred without conversion to our 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.
DELAWARE LAW AND OUR CHARTER MAY MAKE A TAKEOVER OF OUR COMPANY MORE DIFFICULT
AND DILUTE YOUR PERCENTAGE OF OWNERSHIP OF OUR COMMON STOCK.
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 and warrants to purchase our common stock. Any such issuances would make a
takeover of our company more difficult and may dilute your percentage ownership
of our common stock. Our Amended and Restated Certificate of Incorporation and
our Second 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 our 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.
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ITEM 2. PROPERTIES
We have offices in the U.S., Europe and Asia. Our principal executive offices
are temporarily located at 299 Park Avenue, New York, New York. We do not have a
written agreement to sublease this space from Cantor and the amount, if any, we
are going to pay Cantor for the use of this space has not been determined at
this time. The space we occupy at 299 Park is inadequate for our needs, but we
anticipate subleasing from Cantor adequate space for our short-term needs at 135
East 57th Street, New York, New York, for which Cantor has entered into a
two-year sublease for five floors. We are looking for permanent headquarters
space in the New York metropolitan area to occupy following the end of our
expected sublease from Cantor. Our largest presence outside of the New York
metropolitan area 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 $2.6 million annually for use of this
space. Additionally, we occupy approximately 18,750 square feet of space in our
Concurrent Computing Center in Rochelle Park, New Jersey and temporary space in
Weehawken, New Jersey. We pay Cantor approximately $717,000 annually for the use
of the Rochelle Park space.
ITEM 3. LEGAL PROCEEDINGS
eSpeed patent related legal proceedings
After we acquired the Wagner patent in April 2001, we joined ETS, the prior
patent owner, as a plaintiff in litigation pending in the United States District
Court for the Northern District of Texas against the Board of Trade of the City
of Chicago and the Chicago Mercantile Exchange, and in the Southern District of
New York against the New York Mercantile Exchange. The plaintiffs allege that
the defendants in each case infringed the Wagner patent. The complaints seek
injunctive relief, a reasonable royalty, treble damages pursuant to 37 U.S.C.
ss.284, attorneys' fee, interest and costs. On October 12, 2001, the Judge in
the Texas case entered an order, following a hearing (usually referred to as a
Markman hearing) construing the claims of the patent. We believe the ruling was
generally consistent with our interpretation of the scope of the patent.
Discovery in both the New York and Texas actions is ongoing. The New York
Markman hearing is currently scheduled for April 15, 2002. The New York case is
set to be trial ready on July 29, 2002, but that date will be postponed if
dispositive motions are filed, which seems likely. The Texas action is scheduled
for trial on August 12, 2002. There are pretrial orders in both cases with other
intermediate deadlines for completion of certain litigation tasks. There can be
no assurance these orders will not be further amended.
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 our financial condition or results of operations.
Cantor related legal proceedings
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 Cantor Fitzgerald
Incorporated (CFI) and Rodney Fisher are limited partners of CFLP.
In April 1998, CFLP 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
29
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 CFLP with respect to the electronic trading system
mentioned above. CFLP believes Market Data Corporation's technology for
electronic trading systems would be of substantial assistance to competitors in
the wholesale market if provided to them. The complaint further alleges that
Market Data Corporation and Chicago Board Brokerage tortiously interfered with
CFLP'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 CFLP and (2) a declaration that CFLP breached the implied covenant of good
faith and fair dealing.
CFLP settled its dispute with Chicago Board Brokerage in April 1999, and Chicago
Board Brokerage subsequently announced it was disbanding its operations.
On March 13, 2000, the Delaware Court of Chancery ruled in favor of CFLP,
finding that Iris Cantor, CFI and Rodney Fisher had breached the Partnership
Agreement of CFLP, and that Market Data Corporation had aided and abetted that
breach. The court awarded CFLP declaratory judgment relief and court costs and
attorneys' fees. The defendants moved for re-argument with respect to the award
of fees and costs. Justice Steele adhered to his previous decision that CFLP is
entitled to recover court costs and attorneys' fees.
On November 5, 2001, Justice Steele entered an Order of Declaratory Judgment,
which provides that if Iris Cantor, CFI and/or Rod Fisher, through MDC or
otherwise, wish to compete with CFLP or its affiliates in a manner that could
reasonably be expected to harm a core business of CFLP, they must obtain the
written consent of CFLP's Managing General Partner. On December 4, 2001, the
defendants filed notices of appeal. The Delaware Supreme Court dismissed the
appeals as interlocutory. The Court has yet to enter a final order regarding
fees and costs.
Two related actions are pending in New York. In a case pending in the Supreme
Court of New York, plaintiff CFLP alleges, among other things, that defendants
Market Data Corporation, CFI, Iris Cantor and Rodney Fisher misused confidential
information of CFLP in connection with the above-mentioned provision of
technology to Chicago Board Brokerage. In a case filed 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 CFLP 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 had been pursued prior to the March 13, 2000 decision
in the court proceedings in Delaware. On May 15, 2000, the senior officers of
CFLP who are defendants in the federal action in New York moved to dismiss the
complaint against them on several grounds, including, among other things, that
matters that were adjudicated against them in Delaware. Iris Cantor and CFI
filed papers opposing the motion to dismiss on June 5, 2000, and the defendants
filed a reply on June 15, 2000.
On February 7, 2001, the court granted the motion to dismiss CFI's complaint.
CFI and Iris Cantor appealed. In November 2001, the United States Court of
Appeals for the Second Circuit heard oral arguments. It has yet to render a
decision.
On May 16, 2000, CFI filed an action in Delaware Superior Court, New Castle
County, against CFLP and CF Group Management, Inc. (CFGM) seeking payment of $40
million allegedly due pursuant to a settlement agreement in an earlier
litigation between the parties. The complaint alleges that CFI is entitled to a
one-time $40 million payment upon "an initial public offering of CFLP or of a
successor to a material portion of the assets and business of CFLP..." CFI
alleges that our initial public offering on December 10, 1999 triggered the
payment obligation under the settlement agreement. On September 26, 2000, CFLP
and CFGM filed an answer denying liability. Following the events of September
11, 2001, the action was stayed.
30
On June 12, 2000, CFLP and CFGM filed a lawsuit in the Delaware Court of
Chancery against Iris Cantor, CFI and Rodney Fisher, seeking a declaratory
judgment that an Offer to Exchange, dated May 8, 2000 (the Exchange Offer),
pursuant to which certain partnership units in CFLP could be exchanged for
"e-units" that are entitled to receive distributions of our stock from CFLP on
certain future dates subject to certain conditions, did not breach any fiduciary
duty or otherwise violate Delaware law. On July 18, 2000, CFI, Iris Cantor and
Rodney Fisher filed their respective answers, affirmative defenses,
counterclaims and third-party claims, in which they claimed that certain special
conditions imposed upon them in connection with the Exchange Offer and not upon
other partners effectively precluded their participation in the Exchange Offer,
violated the Partnership Agreement of CFLP and constituted a breach of fiduciary
duty, and that accepting those conditions would conflict with their fiduciary
duties to Market Data Corporation. CFI, Iris Cantor and Rodney Fisher claimed
that CFGM and Howard Lutnick, the Chairman, Chief Executive Officer and sole
shareholder of CFGM, the Managing General Partner of CFLP, breached their
fiduciary duties and engaged in self-dealing in allegedly structuring our
formation, the transfer of assets to us, the receipt of stock options, salaries
and other compensation by Howard Lutnick and our other executives, and our
initial public offering. They further alleged that CFGM and Howard Lutnick
converted Partnership assets (CFLP's technology assets) and intended to migrate
CFLP's brokerage business to us without sharing our value with CFI, Iris Cantor
and Rodney Fisher. Rodney Fisher also contends that we, which he has named as a
third-party defendant, aided and abetted these alleged breaches of fiduciary
duties. Among other things, CFI, Iris Cantor and Rodney Fisher requested the
removal of CFGM as the managing general partner of CFLP, a declaration that CFGM
and Howard Lutnick have breached their fiduciary duties to CFI, Iris Cantor and
Rodney Fisher and have breached the settlement agreement in an earlier
litigation and the partnership agreement of CFLP, a declaration that the
Exchange Offer and all or certain of the amendments to the partnership agreement
are null and void, unspecified damages and a constructive trust on any proceeds
derived from the challenged conduct. On September 15, 2000, CFLP, CFGM, Howard
Lutnick and we responded to the counterclaims by answering certain counterclaims
and moving for dismissal and for judgment on the pleadings with respect to the
counterclaims. Argument on the motions took place on March 15, 2001. On November
5, 2001, the Court issued its opinion, granting the motion for judgment on the
pleadings and finding that the Exchange Offer and amendments to the Partnership
Agreement are facially valid as to their terms and methods of enactment. In an
Order of Declaratory Judgment entered on the same day, the Court declared, among
other things, that the Exchange Offer and Partnership Agreement amendments
related thereto are valid and do not result from either a breach of the
Partnership Agreement or the fiduciary duties of the CFLP Parties. It further
declared that the defendants are entitled to participate in the Exchange Offer
on the same terms as the other Limited Partners. On December 4, 2001, the
defendants filed notices of appeal. The Delaware Supreme Court dismissed the
appeals as interlocutory.
Although we do not expect to incur any losses with respect to the pending
lawsuits or supplemental allegations relating to Cantor and Cantor's partnership
agreement, Cantor has agreed to indemnify us with respect to any liabilities we
incur as a result of any breach by Cantor of any covenant or obligation
contained in Cantor's partnership agreement and for any liabilities that are
incurred with respect to the litigation involving Market Data Corporation, Iris
Cantor, CFI and Rodney Fisher.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company held its 2001 Annual Meeting of Stockholders (the Annual
Meeting) on December 6, 2001.
(b) The following directors were elected at the Annual Meeting and they are our
only directors: Howard W. Lutnick, Lee M. Amaitis, Joseph C. Noviello, Stephen
M. Merkel, Richard C. Breeden, Larry R. Carter and William J. Moran. John H.
Dalton was elected to our Board by the directors in February 2002.
(c) Set forth below is a description of the matters voted upon at the Annual
Meeting, including the number of votes cast for, as well as the number of votes
withheld and broker non-votes, as to each nominee for election as a director and
as to the approval of our 1999 Long-Term Incentive Plan, as amended and
restated.
31
1. Election of seven directors, each to serve until the next Annual Meeting of
Stockholders and until his successor is duly elected and qualified.
Name of WITHHOLD BROKER
Candidate FOR AUTHORITY NON-VOTES
- --------- --- --------- ---------
Howard W. Lutnick 298,288,647 2,205,307 0
Lee M. Amaitis 298,288,647 2,205,307 0
Joseph C. Noviello 298,288,647 2,205,307 0
Stephen M. Merkel 298,288,647 2,205,307 0
Richard C. Breeden 300,352,875 141,079 0
Larry R. Carter 300,352,875 141,079 0
William J. Moran 300,352,875 141,079 0
2. Approval of our 1999 Long-Term Incentive Plan, as amended and restated.
FOR AGAINST ABSTENTIONS BROKER NON-VOTES
--- ------- ----------- ----------------
289,637,993 5,246,364 32,049 5,557,000
32
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 was initially offered to the public on December 10,
1999 at $22.00 per share. It has traded since that date on the Nasdaq National
Market under the symbol "ESPD." Through March 15, 2002, the high and low sales
prices for our Class A common stock, as reported by Nasdaq, were as follows:
High Low
---- ---
2000
First Quarter.............................................. $89.88 $36.50
Second Quarter............................................. 61.48 22.00
Third Quarter.............................................. 49.25 20.00
Fourth Quarter............................................. 30.00 13.25
2001
First Quarter ............................................. 34.75 13.63
Second Quarter............................................. 28.23 16.25
Third Quarter.............................................. 19.94 7.44
Fourth Quarter............................................. 9.00 4.60
2002 First Quarter (through March 15, 2002)................ 12.21 7.91
On March 15, 2002, the last reported closing price of our Class A common stock
on the Nasdaq National Market was $11.55 and there were 819 holders of record of
our Class A common stock and two holders of record of our Class B common stock.
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 on our common
stock and we do not expect to pay any cash dividends on our common stock in the
foreseeable future.
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.
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
33
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. Of the
$139.6 million raised, approximately $8.9 million has been used to fund
investments in various entities, approximately $45.5 million has been used to
acquire fixed assets and to pay for the development of capitalized software,
approximately $8.9 million has been used to purchase intangible assets and pay
for the defense of patents, and approximately $8.2 million has been used for
other working capital purposes. The remaining $68.1 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.
Of the amount of proceeds spent through December 31, 2001, approximately $18.0
million has been paid to Cantor under the Administrative Services Agreement
between Cantor and us.
34
ITEM 6. SELECTED FINANCIAL DATA
In the table below, we provide you with our selected historical financial data.
We have prepared this statement of operations and statement of financial
condition data using our consolidated financial statements for the years ended
December 31, 2001 and December 31, 2000 and for the period from March 10, 1999
(date of commencement of operations) to December 31, 1999. The consolidated
financial statements for these periods were audited by Deloitte & Touche LLP,
independent auditors. The following selected financial data should be read in
conjunction with "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" beginning on page 36 of this Report and
with our consolidated financial statements and the notes thereto beginning on
page 50 of this Report.
For the period from March 10,
1999 (date of commencement of
For the year ended For the year ended operations) to December 31,
December 31, 2001 December 31, 2000 1999
----------------- ----------------- -----------------------------
Statement of operations data (in thousands,
except per share data):
Total revenues.................................. $124,969 $91,027 $34,661
-------- ------- -------
Expenses:
Compensation and employee benefits.............. 53,437 53,963 21,502
Occupancy and equipment......................... 29,549 21,561 10,293
Professional and consulting fees................ 10,568 13,036 5,149
Communications and client networks.............. 8,109 4,589 3,355
Marketing....................................... 4,356 8,285 --
Administrative fees paid to related parties..... 9,798 6,524 1,662
Non-cash business partner securities(1)......... 1,223 32,041 --
Options granted to Cantor employees(2).......... -- -- 2,850
Loss on unconsolidated investments(3)........... 3,833 -- --
Provision for September 11 Events, net(4)....... 13,323 -- --
Other........................................... 8,569 9,684 2,649
------- ------- ------
Total expenses.................................. 142,765 149,683 47,460
------- ------- ------
Loss before (benefit) provision for
income taxes................................ (17,796) (58,656) (12,799)
Income tax (benefit) provision.................. 531 406 (212)
------- ------- ------
Net loss........................................ $(18,327) $(59,062) $(12,587)
========= ========= =========
Basic and diluted net loss per
share........................................... ($0.34) ($1.15) ($0.28)
======= ======= =======
Weighted average shares of common
stock outstanding............................... 54,297 51,483 44,495
35
December 31, 2001 December 31, 2000 December 31, 1999
----------------- ----------------- -----------------
Statement of financial condition (in thousands):
Cash and cash equivalents....................... $159,899 $122,164 $134,846
Total assets.................................... 203,099 155,122 144,327
Total liabilities............................... 29,917 22,864 8,815
Total stockholders' equity...................... 173,182 132,258 135,512
- --------------------
(1) See "Item 8. Financial Statements and Supplementary Data, Note 7".
(2) See "Item 8. Financial Statements and Supplementary Date, Note 11".
(3) See "Item 8. Financial Statements and Supplementary Data, Note 7".
(4) See "Item 8. Financial Statements and Supplementary Data, Note 2".
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 Report.
OVERVIEW
We were incorporated on June 3, 1999 as a Delaware corporation. 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(R) 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(R) system internally to conduct
electronic trading. In September 1999, our board of directors changed our fiscal
year end from the last Friday of March to December 31.
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(R)
system.
On September 11, 2001, our principal place of business at One World Trade Center
was destroyed and, as a result, we lost 180 employees and Cantor and TradeSpark
lost 478 employees. Through implementation of our business recovery plan, we
immediately relocated our surviving employees to various locations in the New
York metropolitan area. Our operating proprietary software was unharmed.
As of December 31, 2001, we had an accumulated deficit of $91.3 million. This
deficit primarily resulted from expenditures on our technology and
infrastructure incurred in building our revenue base, from non-cash charges
incurred in connection with the issuance of business partner securities and from
provisions for the September 11 Events. In spite of the September 11 Events, for
the quarter ended December 31, 2001, we recorded net income
36
for the first time. We expect that we will continue to generate net income from
operations. However, in light of the rapidly changing nature of our business,
the fact that our 1999 operations began on March 10, 1999 and the September 11
Events, 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.
We operate interactive electronic marketplaces and license customized real-time
software solutions to our clients. In general, we receive transaction fees based
on a percentage of the face value of products traded through our system.
Products may be traded on a fully electronic basis, electronically through a
voice broker or via open outcry with prices displayed on data screens. We
receive different fees for these different system utilizations. Additionally, we
receive revenues from licensing software and providing technology support.
We have entered into an Amended and Restated 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 products. Under the Amended and Restated Joint Services
Agreement, as currently in effect, we 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 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 share revenues derived from transactions effected in the marketplaces in
which we collaborate and other specified markets. The portion of the transaction
revenues that we and Cantor receive are 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 or other product; and (4) the
product is traded on the Cantor Exchange(SM). The percentage of the transaction
revenues we receive ranges from 2.5% to 65%. However, in general, for fully
electronic transactions, we receive 65% of the transaction revenues and Cantor
receives 35% of the transaction revenues; for voice-assisted brokerage
transactions, Cantor receives 93% of the transaction revenues and we receive 7%
of the transaction revenues. In addition, if the transactions relate to a gaming
business, we receive 25% of the net trading revenues. We have agreed to provide
to Cantor technology support services at cost.
We have also entered into services agreements with TradeSpark and Freedom
pursuant to which we provide the technology infrastructure for the transactional
and technology related elements of the TradeSpark and Freedom marketplaces, as
well as certain other services, in exchange for specified percentages of
transaction revenues from the marketplaces. If a transaction is fully
electronic, we receive 65% of the aggregate transaction revenues and TradeSpark
or Freedom receives 35% of the transaction revenues. In general, if TradeSpark
or Freedom provides voice-assisted brokerage services with respect to a
transaction, then we receive 35% of the revenues and TradeSpark or Freedom
receives 65% of the revenues.
We have pursued an aggressive strategy to convert most of Cantor's financial
marketplace products to our eSpeed(R) system and, with the assistance of Cantor,
to continue to create new markets and convert new clients to our eSpeed(R)
system. The process of converting these marketplaces includes modifying existing
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. Other than Cantor, no client of ours accounted for more than 10%
of our transaction revenues from our date of inception through December 31,
2001. As a result of the September 11 Events and the resulting loss of voice
brokers, Cantor's U.S. operations were reduced, including the trading by it of
certain U.S. financial products. Cantor also sold the assets of its municipal
bond business in the first quarter of 2002 after that business ceased operations
on September 11, 2001, but acquired a 25% special interest in Municipal Partners
LLC, the newly formed entity that owns the assets. We have entered into a
services agreement with Municipal Partners pursuant to which we receive a
percentage of the revenues for all electronic transactions made by Municipal
Partners over our eSpeed(R) system. Cantor has not yet fully determined which
financial product marketplaces it will re-enter. In
37
addition, Cantor's business product development activity has been greatly
reduced due to the September 11 Events. If Cantor determines not to re-enter its
affected businesses, exits additional businesses or does not continue to develop
new products or enter into new businesses, we will likely be adversely affected.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments which affect the reported amounts of assets,
liabilities, revenues and expenses and the related disclosures of contingents
assets and liabilities. Actual results may differ from our estimates as a result
of the occurrence of future events or changes in conditions which affected our
judgments or estimates.
We believe that the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Provision for September 11 Events
We have recorded an expense in the year ended December 31, 2001 for the costs
which we have incurred, are committed to incur, or reasonably expect to incur,
and for assets which were destroyed or impaired as a result of the September 11
Events. In our judgment, such costs are properly recorded in the same period as
the September 11 Events, even if disbursement will not occur until future
periods.
Due to the extent of the loss of life and the destruction of assets, the effect
of the September 11 Events required us to make estimates and judgments in an
uncertain environment. In addition to any changes in our business strategy which
resulted from the destruction, factors which ultimately determine the costs
directly related to September 11th include the degree and speed with which we,
Cantor and TradeSpark rebuild our damaged businesses.
The provision includes estimates of the costs of external professionals who are
performing the duties of employees who were lost on September 11th. These costs
will ultimately depend on the length of time such external professionals are
utilized.
We have also estimated the direct costs of hiring new employees to perform the
duties of those lost. Such costs may include both recruitment fees and up-front
payment of bonuses as an inducement to attract qualified employees to critical
positions. The payment of such inducements can vary significantly depending on
the timing of the recruitment and the qualifications of the new employee.
As a direct result of the loss of certain Cantor employees on September 11th,
certain Cantor businesses which formerly used the functionality our eSpeed(R)
system have ceased operations. We had internally developed, and were internally
developing, enhancements to our electronic trading systems to facilitate the use
of our eSpeed(R) system for many products. In some instances, we had purchased
functionality developed and owned by third parties. As a result of the September
11 Events, the future usage of some of our internally developed or externally
purchased software is uncertain. We have included a charge for the carrying
value of those assets related to functionality which we do not believe will be
used in the future. The charge for such write-offs is dependent on the accuracy
of our assumptions as to which businesses will not be revived.
We will also incur costs related to our departure from certain businesses or
physical locations, directly as a result of the September 11 Events. Such costs
include our estimates of our share of the expenses of closing two offices in
Europe, severance payments to employees and other costs.
38
Insurance Coverage
We have insurance coverage for both property and casualty losses and for
business interruption through our Administrative Services Agreement with Cantor.
Under the property and casualty coverage, we expect to be reimbursed through
Cantor for the greater of fair value or replacement costs for assets lost as a
result of the September 11 Events. For assets not replaced, we have estimated
that fair value will approximate carrying value and, as such, the reimbursement
will have no effect on our net income. Although a final settlement with the
insurance company for the claim has not occurred, we have used our judgment in
determining the amount by which replacement costs have exceeded fair value, and
such excess has been recognized as a gain on replacement of fixed assets.
The business interruption claim has also not been settled. We have not recorded
any revenue which might be realized as a result of such insurance since the
recovery is not readily determinable at this time.
Related Party Transactions
As described in the notes to our consolidated financial statements, we share
revenues with Cantor, TradeSpark and Freedom. In addition, we provide technology
support services to Cantor, TradeSpark and Freedom, and Cantor provides
administrative services to us.
Since Cantor holds a controlling interest in us, and holds a significant
interest in TradeSpark and Freedom, such transactions among and between us and
Cantor, TradeSpark and Freedom are on a basis which might not be replicated if
such service or revenue sharing arrangements were between, or among, unrelated
parties.
We recognize software solution fees from related parties based on the allocated
portion of our costs of providing services to our related parties. Such
allocation of costs requires us to make judgments as to the equitable
distribution of such costs. In addition, we receive administrative services from
Cantor, for which we pay a fee based on Cantor's good faith determination of an
equitable allocation of the costs of providing such services. There is no
assurance that we could realize such revenues, or obtain services at such costs,
if we had to replicate such arrangements with unrelated parties.
Patents
During the year ended December 31, 2001, we acquired two patents that we believe
play critical roles in the electronic trading of certain financial instruments.
The original cost has been reflected as an asset in our Statement of Financial
Condition. In order to perfect and defend our rights under the patents, we have
incurred substantial legal costs. We have capitalized such legal costs, thereby
increasing the carrying value of the patents.
In our judgment, the patents are enforceable and provide competitive advantages
in the relevant electronic marketplaces. We believe the inherent value of the
patents exceeds their carrying value. However, if the rights afforded us under
the patents are not enforced or if the patents do not provide the competitive
advantages which we anticipated at the time of purchase, we may have to
write-down the patents, and such charges could be substantial.
Capitalized Software Costs
We capitalize the direct costs of employees who are engaged in creating software
for internal use. This treatment requires us to estimate the portion of the
employees' efforts which directly produce new software or provide additional
functionality to existing software.
39
In our judgment, these employee-related costs represent valuable software.
However, if the costs incurred to produce the software are deemed to exceed the
benefit which the software provides, we may have to write-down the capitalized
software costs, and such charge could be substantial.
Equity Instruments
We enter into transactions in which we issue certain equity instruments whose
value, in part, is dependent on the value of our publicly traded Class A common
stock. Such instruments include options and warrants to purchase shares of our
Class A common stock as well as convertible preferred shares. The preferred
shares are convertible into either shares of our Class A common stock or
warrants to purchase shares of our Class A common stock.
The value of equity instruments issued establishes either the basis of assets
acquired in exchange for the instruments, or an expense which is, or will be,
recognized in conjunction with the issuance.
We utilize judgment in establishing the fair value of these equity instruments
in the absence of a ready market for such instruments. Options and warrants are
valued using an option pricing model which requires us to make assumptions as to
future interest rates, price volatility of our Class A common stock, future
dividends and expected life of the option or warrant being valued. We believe
that our assumptions used in the valuation of the instruments are reasonable.
However, changes in the assumptions could result in differing valuation of the
options, warrants or preferred shares which, in turn, would change the basis of
assets acquired or expense recognized.
RESULTS OF OPERATIONS - FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
REVENUES
Year Ended December Percentage of Year Ended December Percentage of
31, 2001 Total revenues 31, 2000 Total revenues
-------- -------------- -------- --------------
(in thousands) (in thousands)
Transaction revenues with related parties:
Fully electronic transactions.................. $75,430 60.4% $52,693 57.9%
Voice-assisted brokerage transactions.......... 22,553 18.1 15,144 16.6
Screen assisted open outcry transactions....... 385 0.3 2,450 2.7
--- --- ----- ---
Total transaction revenues with related parties..... 98,368 78.8 70,287 77.2
Software solution fees from related parties......... 16,283 13.0 12,333 13.5
Software solution fees from unrelated parties....... 1,962 1.6 66 0.1
Gain on replacement of assets....................... 2,680 2.1 - 0.0
Interest income from related parties................ 5,676 4.5 8,341 9.2
-------- ------ ------- ------
Total revenues ................. $124,969 100.0% $91,027 100.0%
======== ====== ======= ======
TRANSACTION REVENUES WITH RELATED PARTIES
Under the Amended and Restated Joint Services Agreement between us and Cantor
and services agreements between us and TradeSpark and between us and Freedom, we
own and operate the electronic trading system and are responsible for providing
electronic brokerage services, and Cantor, TradeSpark or Freedom provides
voice-assisted brokerage services, fulfillment services, such as clearance and
settlement, and related services, such as credit risk management services,
oversight of client suitability and regulatory compliance, sales positioning of
products and other services customary to marketplace intermediary operations. In
general, for fully electronic transactions, we receive 65% of the transaction
revenues and Cantor, TradeSpark or Freedom receives 35% of the transaction
revenues. In general, for voice-assisted brokerage transactions, we receive 7%
of the transaction
40
revenues in the case of Cantor transactions, and 35% of the transaction revenues
in the case of TradeSpark and Freedom transactions. In addition, we receive 25%
of the net revenues from Cantor's gaming businesses.
For the year ended December 31, 2001, we earned $98.4 million in transaction
revenues with related parties, a 40% increase over transaction revenues with
related parties of $70.3 million for the year ended December 31, 2000. The
growth in these revenues was attributable to the roll out of electronic
marketplaces and an increase in the number of clients electronically trading
through our eSpeed(R) system.
As a result of the September 11 Events, the United States government bond
markets were closed on September 11th and September 12th. By the time the United
States government bond markets reopened on September 13th, we had re-established
global connectivity of our electronic trading system. Our transaction revenues
for the three months after the September 11 Events represented 23% of our total
transaction revenues for the 2001 calendar year. In addition, our transaction
revenues from fully electronic transactions as a percent of total transaction
revenues remained almost unchanged when comparing the three months after
September 11th (77%) to the nine months ended September 30, 2001 (75%).
Our revenues are currently highly dependent on transaction volumes in the fixed
income markets globally. Accordingly, among other things, equity market
volatility, economic and political conditions in the United States and elsewhere
in the world, concerns over inflation, institutional and consumer confidence
levels, the availability of cash for investment by mutual funds and other
wholesale and retail investors, fluctuating interest and exchange rates and
legislative and regulatory changes may have an impact on our volume of
transactions. In addition, a significant amount of our revenues is currently
received in connection with our relationship with Cantor. Consequently, our
revenues have been negatively affected by the effect of the September 11 Events
on Cantor and may be negatively affected in the future if Cantor's business
continues to suffer due to the September 11 Events or otherwise.
SOFTWARE SOLUTION FEES FROM RELATED PARTIES
Under various services agreements, we provide Cantor, TradeSpark and Freedom
technology support services, including systems administration, internal network
support, support and procurement for desktops of end-user equipment, operations
and disaster recovery services, voice and data communications, support and
development of systems for clearance and settlement services, systems support
for brokers, electronic applications systems and network support, and provision
and/or implementation of existing electronic applications systems, including
improvements and upgrades thereto, and use of the related intellectual property
rights. In general, we charge Cantor, TradeSpark and Freedom the actual direct
and indirect costs, including overhead, of providing such services and receive
payment on a monthly basis; provided, however, in exchange for a 25% share of
the net revenues from Cantor's gaming businesses, we are obligated to spend, and
do not otherwise get reimbursed for, the first $750,000 of costs for providing
technology support and development services in connection with such gaming
businesses.
Software solution fees from related parties for the year ended December 31, 2001
were $16.3 million as compared to software solution fees from related parties
for the year ended December 31, 2000 of $12.3 million, an increase of 32%.
Software solution fees from related parties increased primarily as a result of
an increase in support provided to Cantor as well as support provided to
TradeSpark and Freedom through September 11th. However, as a result of the
September 11 Events, there has been and will continue to be a reduction in
demand for our support services from Cantor and TradeSpark due to the loss of
their voice brokers and therefore a decrease in our software solution fees from
related parties.
41
SOFTWARE SOLUTION FEES FROM UNRELATED PARTIES
We receive fees from certain of our clients for providing online access to their
customers through the use of our electronic trading platform. Such fees are
deferred and recognized as revenues ratably over the term of the licensing
agreement. We also receive software solution fees from unrelated parties by
charging our clients for additional connections to our system to help protect
them from possible business interruptions.
Software solution fees from unrelated parties for the year ended December 31,
2001 were $2.0 million as compared with $0.1 million for the year ended
December 31, 2000. We anticipate that as we license our software to additional
market participants, our revenues from software solution fees from unrelated
parties will grow.
GAIN ON REPLACEMENT OF ASSETS
Our assets in the World Trade Center were destroyed as a result of the September
11 Events. We believe most, if not all, of such assets were covered by insurance
policies which provide for reimbursement for replacement cost if such destroyed
assets are replaced. To the extent that replacement cost exceeds the carrying
value of such replaced equipment, the excess results in gains. For the year
ended December 31, 2001, we recognized $2.7 million of such gains. We expect to
recognize additional gains as we continue to replace destroyed equipment,
however, the amount of such additional gains cannot be readily determined at
this time but is limited to the remaining amount of our insurance coverage.
INTEREST INCOME FROM RELATED PARTIES
For the year ended December 31, 2001, we generated interest income from
overnight reverse repurchase agreements with a related party of $5.7 million as
compared to interest income of $8.3 million for the year ended December 31,
2000. The reduction in interest income was principally as a result of a
reduction in weighted average interest rates on overnight reverse repurchase
agreements from 6.3% in 2000 to 3.9% in 2001, offset in part by interest on the
proceeds of our follow-on public offering in March 2001.
EXPENSES
Year Ended Percentage of Year Ended Percentage of
December 31, 2001 Total expenses December 31, 2000 Total expenses
----------------- -------------- ----------------- --------------
(in thousands) (in thousands)
Compensation and employee benefits................... $53,437 37.4% $53,963 36.1%
Occupancy and equipment.............................. 29,549 20.7 21,561 14.4
Professional and consulting fees..................... 10,568 7.4 13,036 8.7
Communications and client networks................... 8,109 5.7 4,589 3.1
Marketing............................................ 4,356 3.1 8,285 5.5
Administrative fees paid to related parties.......... 9,798 6.9 6,524 4.4
Non-cash business partner securities................. 1,223 0.9 32,041 21.4
Loss on unconsolidated investments................... 3,833 2.7 -- --
Provision for September 11 Events, net............... 13,323 9.3 -- --
Other................................................ 8,569 5.9 9,684 6.4
-------- ------ -------- -------
Total expenses..................... $142,765 100.0% $149,683 100.0%
======== ====== ======== ======
COMPENSATION AND EMPLOYEE BENEFITS
At December 31, 2001, we had 312 professionals. Immediately prior to the
September 11 Events, we had 492 professionals as compared to 493 at December
31, 2000. For the year ended December 31, 2001, our
42
compensation costs were $53.4 million as compared to compensation costs of $54.0
million for the year ended December 31, 2000. Our quarterly compensation costs
after the September 11 Events reflected a 50% reduction as compared to the three
months ended September 30, 2001. We expect our compensation costs to rise as we
reorganize our remaining staff.
Substantially all of our employees are full time employees located predominately
in the New York metropolitan area and London. Compensation costs include
salaries, bonus accruals, payroll taxes and costs of employer-provided benefits
for our employees. Cantor intends to distribute 25% of its distributable profits
for five years on behalf of the families of those employees lost on September
11th. From such distributions, Cantor will provide 10 years of health care
benefits to those families. We will not be charged for such payments on behalf
of the families as Cantor is assuming such costs. Our future compensation costs
are uncertain and are dependent upon the degree and speed with which we and
Cantor replace our lost employees and businesses.
OCCUPANCY AND EQUIPMENT
Occupancy and equipment costs were $29.5 million for the year ended December 31,
2001, an increase of 37% as compared to occupancy and equipment costs of $21.6
million for the year ended December 31, 2000. The net increase in occupancy and
equipment costs was due to the expansion of space needed to accommodate our
additional operations and an increase in the number of our locations, including
our new concurrent computing center in New Jersey, offset in part by reduced
rent expense following the destruction of our One World Trade Center
headquarters. Occupancy and equipment costs do not reflect the write-off of
destroyed assets as we anticipate that our insurance coverage will fully
compensate us for such write-offs.
Occupancy expenditures primarily consist of the rent and facilities costs of our
offices in the New York metropolitan area and our offices in London and Tokyo.
While the September 11 Events resulted in a decline in occupancy and equipment
costs due to a decrease in both space and equipment, we anticipate that such
costs will increase in the future in connection with a new lease for our
corporate headquarters. Although we also believe that equipment costs will
increase in the future as we replace lost equipment, we anticipate that such
equipment costs will remain below those incurred prior to the September 11
Events.
PROFESSIONAL AND CONSULTING FEES
Professional and consulting fees were $10.6 million for the year ended December
31, 2001 as compared to professional and consulting fees of $13.0 million for
the year ended December 31, 2000, a decrease of 19%, primarily related to a
decrease in contract personnel costs prior to September 11th.
The costs of professionals and consultants utilized to temporarily replace
employees lost as a result of the September 11 Events are included in "Provision
for September 11 Events" and, as a result, do not affect this expense caption.
COMMUNICATIONS AND CLIENT NETWORKS
Communications costs were $8.1 million for the year ended December 31, 2001 as
compared to $4.6 million for the year ended December 31, 2000, a 77% increase.
Communication costs include 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.
The increase in costs was attributable to the expansion of our globally managed
digital network. While such costs decreased in the quarter following the
September 11 Events as a result of the destruction of our One World Trade Center
headquarters, we anticipate that expenditures for communications and client
networks will increase in the future.
43
MARKETING
We incurred marketing expenses of $4.3 million for the year ended December 31,
2001, a 47% decrease as compared to marketing expenses of $8.3 million for the
year ended December 31, 2000. Marketing expenses were higher in 2000 due to the
implementation of our marketing program in that year. In addition, marketing
expenditures sharply declined in the quarter following the September 11 Events.
We expect that non-advertising marketing expenses in 2002 will remain at the
same level as in 2001. We are considering whether to advertise, and any
advertising may increase these expenses significantly.
ADMINISTRATIVE FEES PAID TO RELATED PARTIES
Under an Administrative Services Agreement, Cantor provides various
administrative services to us, including accounting, tax, legal and facilities
management, for which we reimburse Cantor for the direct and indirect costs of
providing such services. Administrative fees paid to related parties amounted to
$9.8 million for the year ended December 31, 2001, a 50% increase over the $6.5
million of such fees for the year ended December 31, 2000. Overall,
administrative fees increased as we expanded our business, however such fees
declined in the three months following the September 11 Events as compared to
the three months ended September 30, 2001.
Administrative fees paid to related parties are dependent upon both the costs
incurred by Cantor, and the portion of Cantor's administrative services which
are utilized by us. Due to the effect of the September 11 Events on both us and
Cantor, the level of administrative fees in the future cannot be reasonably
determined at this time.
NON-CASH BUSINESS PARTNER SECURITIES
We enter into strategic alliances with other industry participants in order to
expand our business and to enter into new marketplaces. As part of these
strategic alliances, we have issued warrants and convertible preferred stock.
These securities do not require cash outlays and do not represent a use of our
assets. The expense related to these issuances is based on the value of the
securities being issued and the structure of the transaction. We believe period
to period comparisons are not meaningful as these transactions do not recur on a
regular basis. Note 7 of our consolidated financial statements in this Report on
Form 10-K contains further details regarding the issuance by us of non-cash
business partner securities.
LOSS ON UNCONSOLIDATED INVESTMENTS
In the third quarter of 2001, we wrote off our investments in QV Trading Systems
and Visible Markets, each of which ceased operations during that period. We
recognized a loss of $3.8 million related to such write-offs.
PROVISION FOR SEPTEMBER 11 EVENTS
As described in note 2 of our consolidated financial statements, we have
recorded an expense of $13.3 million in the year ended December 31, 2001 to
reflect our estimate of the costs incurred as a direct result of the September
11 Events. Of these costs, $6.2 million represent write-offs of software
development costs and goodwill and, as such, do not require cash outlays. We
anticipate that our business interruption insurance may result in a recovery of
these costs in future periods; however, the amount of such recovery is not
readily determinable at this time.
OTHER
Other expenses consist primarily of recruitment fees, travel, promotional and
entertainment expenditures. For the year ended December 31, 2001, other expenses
were $8.6 million, a decrease of 12% as compared to other expenses of $9.7
million for the year ended December 31, 2000. The decrease resulted primarily
from the decrease
44
in recruitment fees. We anticipate that other expenses will not increase
because, although we expect to incur additional recruitment fees due to the
September 11 Events, such costs were estimated and included in the "Provision
for September 11 Events".
NET LOSS
Excluding non-cash charges for business partner securities, losses on
unconsolidated investments and the Provision for September 11 Events, our net
loss was $0.05 million for the year ended December 31, 2001 as compared to a net
loss of $27.0 million for the year ended December 31, 2000. Including the above
non-cash charges, we incurred a net loss of $18.3 million for the year ended
December 31, 2001 as compared to net losses of $59.1 million for the year ended
December 31, 2000. Other than the non-cash charges, the losses primarily
resulted from expenditures on our technology and infrastructure incurred in
building our revenue base. In light of the rapidly changing nature of our
business and the September 11 Events, 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.
RESULTS OF OPERATIONS - FOR THE YEAR ENDED DECEMBER 31, 2000 AND THE PERIOD FROM
MARCH 10, 1999 THROUGH DECEMBER 31, 1999
REVENUES
Period from March 10, 1999
(date of commencement of
Year ended Percentage of operations) to Percentage of
December 31, 2000 Total revenues December 31, 1999 Total revenues
----------------- -------------- ----------------- --------------
(in thousands) (in thousands)
Transaction revenues with related parties:
Fully electronic transactions................ $52,693 57.9% $6,552 18.9%
Voice-assisted brokerage transactions........ 15,144 16.6 11,777 34.0
Screen assisted open outcry transactions..... 2,450 2.7 3,525 10.2
----- --- ----- ----
Total transaction revenues with related parties. 70,287 77.2 21,854 63.1
Software solution fees from related parties...... 12,333 13.6 12,459 35.9
Software solution fees from unrelated parties.... 66 -- -- --
Interest income from related parties............. 8,341 9.2 348 1.0
----- --- --- ---
Total revenues................. $91,027 100.0% $34,661 100.0%
======= ====== ======= ======
TRANSACTION REVENUES WITH RELATED PARTIES
For the year ended December 31, 2000, we earned $70.3 million in transaction
revenues with related parties, a 222% increase over transaction revenues of
$21.9 million for the period from March 10, 1999 to December 31, 1999. The
growth in these revenues was attributable to the continued roll out of
electronic marketplaces and an increase in the number of clients electronically
trading through our eSpeed(SM) system, as well as the fact that we operated for
a full 12-month period in 2000.
SOFTWARE SOLUTION FEES FROM RELATED PARTIES
Software solution fees from related parties for the year ended December 31, 2000
were $12.3 million. This compares with software solution fees from related
parties for the period from March 10, 1999 to December 31, 1999 of $12.5
million. For the year ended December 31, 2000, such fees decreased as a result
of a decrease in traditional brokerage support and the migration to fully
electronic transactions. As a percentage of revenues,
45
software solution fees from related parties decreased from 35.9% for the period
from March 10, 1999 to December 31, 1999 to 13.6% for the year ended December
31, 2000 as a result of our increased transaction revenues.
SOFTWARE SOLUTION FEES FROM UNRELATED PARTIES
Software solution fees from unrelated parties for the year ended December 31,
2000 were $0.1 million. We had no such fees for the period from March 10, 1999
to December 31, 1999.
INTEREST INCOME FROM RELATED PARTIES
For the year ended December 31, 2000, we generated interest income from
overnight reverse repurchase agreements with a related party of $8.3 million, at
a weighted average interest rate of 6.3%, as compared to interest income of $0.3
million for the period from March 10, 1999 to December 31, 1999. This increase
primarily reflects the fact that we received the net proceeds from our initial
public offering on December 15, 1999.
EXPENSES
Period from March 10, 1999
(date of commencement of
Year ended Percentage of operations) Percentage of
December 31, 2000 Total expenses to December 31, 1999 Total expenses
----------------- -------------- ----------------- --------------
(in thousands) (in thousands)
Compensation and employee benefits........... $53,963 36.1% $21,502 45.3%
Occupancy and equipment...................... 21,561 14.4 10,293 21.7
Professional and consulting fees............. 13,036 8.7 5,149 10.8
Communications and client networks........... 4,589 3.1 3,355 7.1
Marketing.................................... 8,285 5.5 -- --
Administrative fees paid to related parties.. 6,524 4.4 1,662 3.5
Options granted to Cantor employees.......... -- -- 2,850 6.0
Non-cash business partner securities......... 32,041 21.4 -- --
Other........................................ 9,684 6.4 2,649 5.6
----- --- ----- ---
Total expenses............. $149,683 100% $47,460 100%
======== ==== ======= ====
COMPENSATION AND EMPLOYEE BENEFITS
At December 31, 2000, we had 493 professionals as compared to 331 professionals
at December 31, 1999. For the year ended December 31, 2000, our compensation
costs were $54.0 million as compared to compensation costs of $21.5 million for
the period from March 10, 1999 to December 31, 1999, a 151.0% increase,
principally due to our increased number of employees.
OCCUPANCY AND EQUIPMENT
Occupancy and equipment costs were $21.6 million for the year ended December 31,
2000 as compared to occupancy and equipment costs of $10.3 million for the
period from March 10, 1999 to December 31, 1999, an increase of 109.5%. The
increase in occupancy and equipment costs was due to the expansion of space
needed to accommodate our additional personnel and an increase in the number of
our international locations. Occupancy expenditures are comprised principally of
the rent and facilities costs of our New York and London offices.
PROFESSIONAL AND CONSULTING FEES
Professional and consulting fees were $13.0 million for the year ended December
31, 2000 as compared to professional and consulting fees of $5.1 million for the
period from March 10, 1999 to December 31, 1999, an
46
increase of 153.2%, due to an increase in our strategic investment activities
and expenses incurred in connection with technology development.
COMMUNICATIONS AND CLIENT NETWORKS
Communications costs were $4.6 million for the year ended December 31, 2000 as
compared to $3.4 million for the period from March 10, 1999 to December 31,
1999, an increase of 36.8%. Communications costs increased in 2000, primarily
due to the longer period of operations of our business in 2000.
MARKETING
We incurred marketing expenses of $8.3 million for the year ended December 31,
2000 as compared to nominal marketing expenses during the period from March 10,
1999 to December 31, 1999. The increase in marketing expenses was due to the
implementation of our marketing program in 2000.
ADMINISTRATIVE FEES PAID TO RELATED PARTIES
Administrative fees paid to related parties amounted to $6.5 million for the
year ended December 31, 2000 as compared to administrative fees of $1.7 million
for the period from March 10, 1999 to December 31, 1999, an increase of 292.5%.
Administrative fees increased as we expanded our business.
NON-CASH BUSINESS PARTNER SECURITIES
We enter into strategic alliances with other industry participants in order to
expand our business and to enter into new marketplaces. As part of these
strategic alliances, we have issued warrants and convertible preferred stock.
These securities do not require cash outlays and do not represent a use of our
assets. The expense related to these issuances is based on the value of the
securities being issued and the structure of the transaction. We believe
period-to-period comparisons are not meaningful as these transactions do not
recur on a regular basis. Note 7 of our consolidated financial statements in
this Report on Form 10-K contains further details regarding the issuance by us
of non-cash business partner securities.
OTHER
Other expenses consist primarily of recruitment fees, travel, promotional and
entertainment expenditures. For the year ended December 31, 2000, other expenses
were $9.7 million as compared to other expenses of $2.6 million for the period
from March 10, 1999 to December 31, 1999, an increase of 265.5%, primarily due
to an increase in recruitment fees.
NET LOSS
Excluding non-cash charges for business partner securities, our net loss was
$27.0 million for the year ended December 31, 2000 as compared to a net loss of
$12.6 million for the period from March 10, 1999 to December 31, 1999. Including
the non-cash charges, we incurred a net loss of $59.1 million for the year ended
December 31, 2000 as compared to a net loss of $12.6 million for the period from
March 10, 1999 to December 31, 1999. Other than the non-cash charges, the losses
primarily resulted from expenditures on our technology and infrastructure
incurred in building our revenue base.
47
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) through December
31, 2001. Results of any period are not necessarily indicative of results for a
full year.
2001 Quarter Ended
---------------------------------------------------------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
Total revenues................ $31,887,574 $34,079,474 $28,191,333 $30,810,433
Total expenses................ 34,080,038 34,892,678 50,912,728 22,879,322
---------- ---------- ---------- ----------
Income (loss) before provision for
income taxes.............. (2,192,464) (813,204) (22,721,395) 7,931,111
Income tax provision.......... 99,999 158,001 129,000 144,000
------ ------- ------- -------
Net income (loss)............. $(2,292,463) $(971,205) $(22,850,395) $7,787,111
============ ========== ============= ==========
Net income (loss) per share... $(0.04) $(0.02) $(0.42) $0.14
======= ======= ======= =====
2000 Quarter Ended
---------------------------------------------------------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
Total revenues................ $19,174,426 $22,501,762 $22,491,596 $26,859,257
Total expenses................ 24,007,842 61,421,404 32,340,267 31,913,388
---------- ---------- ---------- ----------
Loss before provision for
income taxes.............. (4,833,416) (38,919,642) (9,848,671) (5,054,131)
Income tax provision.......... 92,500 107,500 88,125 118,000
------ ------- ------ -------
Net loss...................... $(4,925,916) $(39,027,142) $(9,936,796) $(5,172,131)
============ ============= ============ ============
Net loss per share............ $(0.10) $(0.76) $(0.19) $(0.10)
======= ======= ======= =======
1999 Quarter Ended
---------------------------------------------------------------------------------------
March 10 through 26 June 25 September 24 December 31
------------------- ------- ------------ -----------
Total revenues................ $1,921,433 $10,165,641 $10,715,113 $11,858,793
Total expenses................ 2,459,941 12,918,274 14,209,620 17,871,947
--------- ---------- ---------- ----------
Loss before benefit 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)
======= ======= ======= =======
SEASONALITY
The financial markets in which we operate are generally affected by seasonality.
Traditionally, the financial markets around the world experience lower volume
during the summer and at the end of the year due to a general slowdown in the
business environment and, therefore, transaction volume levels may decrease
during those periods. However, because of volatility in global markets caused by
global unrest, the September 11 Events and
48
general global economic problems, as well as policy changes from the Federal
Reserve Bank of the United States, the anticipated year-end slowdown did not
occur as dramatically in 2001.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2001, we had cash and cash equivalents of $159.9 million. We
generated cash of $3.4 million in our operating activities, consisting of net
income after non-cash items of $5.2 million offset in part by a $1.8 million
increase in net operating liabilities. We also used net cash of $11.8 million
resulting from $32.3 million of purchases of fixed assets and intangible assets,
capitalization of software developments costs and patent defense costs, and
purchases of investments offset by $20.5 million of insurance proceeds resulting
from destruction of our fixed assets at One World Trade Center. As of December
31, 2001, we had repurchased 24,600 shares of our Class A common stock for a
total of $221,892 under the repurchase plan authorized by our board of
directors. Our board has authorized the repurchase of up to $40 million of our
outstanding Class A common stock. In addition, we generated net cash proceeds of
$46.2 million from issuances of our Class A common stock.
Our operating cash flows consist of transaction revenues from related parties
and software solution fees from related and unrelated parties, various fees paid
to or costs reimbursed to Cantor, other costs paid directly by us and interest
income from related parties. In its capacity as a fulfillment service provider,
Cantor processes and settles transactions and, as such, collects and pays the
funds necessary to clear transactions with the counterparty. In doing so, Cantor
receives our portion of the transaction fee and, in accordance with the Amended
and Restated Joint Services Agreement, remits the gross amount owed to us. In
addition, we have entered into a similar services agreements with TradeSpark and
Freedom. Under the Administrative Services Agreement, the Amended and Restated
Joint Services Agreement and the services agreements with TradeSpark and
Freedom, any net receivable or payable is settled at the discretion of the
parties.
We anticipate that we will experience an 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 growth in our operating expenses for the foreseeable future and that
our operating expenses will be a material use of our cash resources. Our
insurance proceeds should mitigate our capital expenditures for the near term.
Under the current operating structure, our cash flows from operations and our
other cash resources 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, strategic alliances and joint ventures potentially involving
all types and combinations of equity, debt, acquisition, recapitalization and
reorganization alternatives. We are continually considering such options and
their effect on our liquidity and capital resources.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At December 31, 2001, we had invested $157.3 million of our 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 generally 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 cash
in a manner that provides 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.
49
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ESPEED, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Report............................................. 51
Consolidated Statements of Financial Condition........................... 52
Consolidated Statements of Operations.................................... 53
Consolidated Statements of Cash Flows.................................... 54
Consolidated Statements of Stockholders' Equity.......................... 56
Notes to Consolidated Financial Statements............................... 59
50
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of eSpeed, Inc.:
We have audited the accompanying consolidated statements of financial condition
of eSpeed, Inc. and subsidiaries (the Company) as of December 31, 2001 and 2000,
and the related statements of operations, cash flows and stockholders' equity
for the years ended December 31, 2001 and 2000, and for the period from March
10, 1999 (date of commencement of operations) to December 31, 1999. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of the Company at
December 31, 2001 and 2000, and the consolidated results of its operations and
its cash flows for the years ended December 31, 2001 and 2000, and for the
period from March 10, 1999 (date of commencement of operations) to December 31,
1999, in conformity with accounting principles generally accepted in the United
States of America.
/s/ Deloitte & Touche LLP
March 20, 2002
New York, New York
51
eSpeed, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF
FINANCIAL CONDITION
As of December 31, 2001 and December 31, 2000
ASSETS
December 31, 2001 December 31, 2000
----------------- -----------------
Cash................................................................... $ 2,567,932 $ 161,463
Reverse repurchase agreements with related parties..................... 157,330,676 122,002,249
------------- -------------
Total cash and cash equivalents....................................... 159,898,608 122,163,712
Fixed assets, net...................................................... 19,137,269 23,441,365
Investments............................................................ 11,732,863 5,833,679
Intangible assets, net................................................. 9,122,491 --
Other assets........................................................... 3,207,832 3,683,507
------------- -------------
Total assets................................................... $ 203,099,063 $ 155,122,263
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Payable to related parties, net.......................................... $ 6,822,163 $ 11,370,248
Accounts payable and accrued liabilities................................. 23,095,092 11,494,262
------------- -------------
Total liabilities.................................................. 29,917,255 22,864,510
------------- -------------
Stockholders' Equity:
Preferred stock, par value $.01 per share; 50,000,000 shares authorized,
8,000,750 and 8,000,000 shares issued
and outstanding.......................................................... 80,008 80,000
Class A common stock, par value $.01 per share; 200,000,000 shares
authorized; 26,590,668 and 16,342,202 shares issued...................... 265,906 163,422
Class B common stock, par value $.01 per share; 100,000,000 shares
authorized; 28,354,737 and 35,520,480 shares issued and outstanding...... 283,547 355,205
Additional paid-in capital............................................... 266,791,989 205,908,024
Subscription receivable.................................................. -- (1,250,000)
Unamortized expense of business partner securities....................... (2,691,900) --
Treasury stock, 24,600 shares of Class A common stock at cost............ (221,892) --
Accumulated deficit...................................................... (91,325,850) (72,998,898)
------------- -------------
Total stockholders' equity.......................................... 173,181,808 132,257,753
------------- -------------
Total liabilities and stockholders' equity.......................... $ 203,099,063 $ 155,122,263
============= =============
See notes to consolidated financial statements
52
eSpeed, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2001 and 2000 and for the period from
March 10, 1999 (date of commencement of operations) to December 31, 1999
For the year For the year For the period
ended December ended December ended December
31, 2001 31, 2000 31, 1999
----------------- ------------------ -----------------
Revenues:
Transaction revenues with related parties
Fully electronic transactions............................... $ 75,429,874 $ 52,692,703 $6,551,897
Voice-assisted brokerage transactions....................... 22,553,037 15,144,343 11,777,306
Screen assisted open outcry transactions.................... 385,115 2,450,333 3,524,399
----------------- ------------------ -----------------
Total transaction revenues with related parties.................. 98,368,026 70,287,379 21,853,602
Software solution fees from related parties...................... 16,283,305 12,333,222 12,459,574
Software solution fees from unrelated parties.................... 1,961,589 65,625 --
Gain on replacement of fixed assets ............................. 2,680,000 --- --
Interest income from related parties............................. 5,675,894 8,340,815 347,804
----------------- ------------------ -----------------
Total revenues................................................... 124,968,814 91,027,041 34,660,980
Expenses:
Compensation and employee benefits............................... 53,437,250 53,963,239 21,502,326
Occupancy and equipment.......................................... 29,549,068 21,560,535 10,292,349
Professional and consulting fees................................. 10,568,007 13,036,494 5,148,796
Communications and client networks............................... 8,108,618 4,588,626 3,355,070
Marketing ....................................................... 4,355,661 8,285,385 ---
Administrative fees paid to related parties ..................... 9,797,996 6,524,341 1,662,058
Non-cash business partner securities............................. 1,222,631 32,040,505 ---
Options granted to Cantor employees.............................. --- --- 2,850,073
Loss on unconsolidated investments............................... 3,833,679 --- ---
Provision for September 11 Events, net .......................... 13,323,189 --- ---
Other............................................................ 8,568,667 9,683,776 2,649,110
----------------- ------------------ -----------------
Total expenses................................................... 142,764,766 149,682,901 47,459,782
Loss before provision (benefit) for income taxes................. (17,795,952) (58,655,860) (12,798,802)
----------------- ------------------ -----------------
Provision (benefit) for income taxes:
Federal.......................................................... --- --- ---
State and local.................................................. 531,000 406,125 (211,889)
----------------- ------------------ -----------------
Total tax provision (benefit).................................... 531,000 406,125 (211,889)
----------------- ------------------ -----------------
Net loss......................................................... $(18,326,952) $(59,061,985) $(12,586,913)
================= ================== =================
Share and per share data
Basic and diluted net loss per share............................. $ (.34) $ (1.15) $ (.28)
Weighted average shares of common stock outstanding.............. 54,296,811 51,482,505 44,495,000
See notes to consolidated financial statements
53
eSpeed, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2001 and 2000 and for the period from
March 10, 1999 (date of commencement of operations) to December 31, 1999
For the year For the year For the period
ended December ended December ended December
31, 2001 31, 2000 31, 1999
------------------ ------------------- -------------------
Cash flows from operating activities:
Net loss...................................................... $ (18,326,952) $ (59,061,985) $ (12,586,913)
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization.............................. 5,975,471 6,098,754 3,086,555
Issuance of non-cash business partner securities........... 1,222,631 32,040,505 ---
Issuance of stock options.................................. --- --- 2,850,073
Equity in net (gains) losses of certain unconsolidated
investments........................................... 147,838 --- ---
Loss on unconsolidated investments......................... 3,833,679 --- ---
Non-cash issuance of securities under employee
benefit plans........................................ 440,679 --- ---
Gain on replacement of fixed assets........................ (2,680,000) --- ---
Provision for September 11 Events, net..................... 13,323,189 --- ---
(Increase) decrease in operating assets:
Other assets......................................... 475,675 (3,672,012) 1,190,728
Increase (decrease) in operating liabilities:
Payable to related parties, net....................... (4,548,085) 4,626,319 6,743,929
Accounts payable and accrued liabilities.............. 3,762,327 9,422,915 (1,046,137)
------------------ ------------------- -------------------
Net cash provided by (used in) operating
activities........................................... 3,626,452 (10,545,504) 238,235
------------------ ------------------- -------------------
Cash flows from investing activities:
Purchases of fixed assets..................................... (12,901,831) (11,043,479) (2,717,462)
Capitalization of software development costs.................. (7,358,226) (9,026,568) (2,468,605)
Purchase of patents........................................... (2,650,000) --- ---
Capitalization of patent defense costs........................ (6,283,142) --- ---
Insurance claim proceeds resulting from destruction
of fixed assets........................................ 20,476,420 --- ---
Purchases of investments...................................... (2,909,786) (5,833,679) ---
Cash payment for TreasuryConnect LLC.......................... (170,781) -- --
------------------ ------------------- -------------------
Net cash used in investing activities................. (11,797,346) (25,903,726) (5,186,067)
------------------ ------------------- -------------------
Cash flows from financing activities:
Proceeds from issuances of securities......................... 47,750,000 50,000,000 143,990,000
Purchase of issued securities from a related party............ --- (25,000,000) ---
Treasury stock repurchase..................................... (221,892) --- ---
Proceeds from issuance of securities under the ESPP........... 589,120 371,448 ---
Proceeds from exercises of options............................ 414,298 ---
Payments for issuance related expenses........................ (2,625,736) (1,604,028) (4,396,646)
Proceeds from capital contributions........................... --- --- 200,000
------------------ ------------------- -------------------
Cash provided by financing activities.................... 45,905,790 23,767,420 139,793,354
------------------ ------------------- -------------------
54
For the year For the year For the period
ended December ended December ended December
31, 2001 31, 2000 31, 1999
------------------ ------------------- -------------------
Net increase (decrease) in cash and cash equivalents.......... 37,734,896 (12,681,810) 134,845,522
------------------ ------------------- -------------------
Cash and cash equivalents, beginning of period................ 122,163,712 134,845,522 ---
------------------ ------------------- -------------------
Cash and cash equivalents, end of period...................... $159,898,608 $122,163,712 $134,845,522
================== =================== ===================
Supplemental disclosure of non-cash activities:
Issuance of Class A common stock in exchange for investment... $ 6,970,907
Issuance of Class A common stock in exchange for intangible
asset....................................................... $ 500,000
Issuance of warrants in exchange for intangible asset......... $ 197,000
Cancellation of subscription receivable....................... $ 1,250,000
Acquisition of TreasuryConnect:
Fixed assets............................................. $ 1,000,000
Goodwill................................................. 3,184,773
------------------
Total fair value of assets............................... 4,184,773
Less issuance of Class A common stock.................... (4,013,992)
------------------
Cash paid................................................ $ 170,781
==================
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
55
eSpeed, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31, 2001 and 2000 and for the period from
March 10, 1999 (date of commencement of operations) to December 31, 1999
Additional
Common Stock Common Stock Paid- in Subscription
Preferred Stock Class A Class B Capital receivable
------------------------------------------------------------------------------
Balance March 10, 1999...... $--- $--- $--- $--- $---
Capital contribution (100
shares)..................... 1 199,999
Non-cash capital
contribution (43,990,900
shares)..................... 439,999 5,015,300
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
Costs of initial public
offering.................... (5,749,481)
Issuance of options......... 2,850,073
Issuance of warrant......... 1,352,835
Net loss....................
------------------------------------------------------------------------------
Balance, December 31, 1999.. 103,500 406,500 147,588,726
Conversions of Class B
common stock to Class A
common stock
(5,129,520 shares).......... 51,295 (51,295)
Issuance of Preferred Stock
(8,000,000 shares).......... 80,000 2,155,000
Issuance of Class A common
stock
(56,748 shares)............. 567 2,599,433 (1,250,000)
Purchase of Class A common
stock from related party
(789,071 shares)............
Sale of Class A common
stock (Issuance and sale of
789,071 new shares and sale of
789,071 shares from treasury
stock) ..................... 7,891 24,992,109
Unamortized
expense of
business Total
partner Accumulated Stockholders'
securities Treasury Stock Deficit Equity
----------------------------------------------------------------
Balance March 10, 1999...... $--- $--- $--- $---
Capital contribution (100
shares)..................... 200,000
Non-cash capital
contribution (43,990,900
shares)..................... 5,455,299
Conversion of Class B common
stock to Class A common
stock (3,350,000 shares)....
Initial public offering of
Class A common stock
(7,000,000 shares).......... 143,990,000
Costs of initial public
offering.................... (5,749,481)
Issuance of options......... 2,850,073
Issuance of warrant......... 1,352,835
Net loss.................... (12,586,913) (12,586,913)
----------------------------------------------------------------
Balance, December 31, 1999.. (12,586,913) 135,511,813
Conversions of Class B
common stock to Class A
common stock
(5,129,520 shares)..........
Issuance of Preferred Stock
(8,000,000 shares).......... 2,235,200
Issuance of Class A common
stock
(56,748 shares)............. (1,350,000)
Purchase of Class A common
stock from related party
(789,071 shares)............ (25,000,000) (25,000,000)
Sale of Class A common
stock (Issuance and sale of
789,071 new shares and sale of
789,071 shares from treasury
stock) ..................... 25,000,000 50,000,000
56
Additional
Common Stock Common Stock Paid- in Subscription
Preferred Stock Class A Class B Capital receivable
-----------------------------------------------------------------------------
Issuance of warrants........ 29,805,305
Costs of issuance of
securities.................. (1,604,028)
Issuance of Class A common
stock under the ESPP
(16,863 shares)............. 169 371,279
Net loss.................... ------- -------- -------- ------------ ----------
Balance, December 31, 2000.. $80,000 $163,422 $355,205 $205,908,024 ($1,250,000)
Conversions of Class B ======= ======== ======== ============ ==========
common stock to Class A
common stock (7,165,743
shares)..................... 71,658 (71,658)
Secondary public offering of
Class A common stock
(2,500,000 shares).......... 25,000 47,725,000
Issuance of Class A common
stock (548,096 shares)...... 5,480 11,920,106
Issuance of warrants........ 3,786,000
Issuance of preferred stock
(750 shares)................ 8 110,917
Amortization of and charges
for warrants................ 214,606
Issuance of Class A common
stock under the ESPP (44,168
shares)..................... 442 588,678
Issuance of Class A common
stock from exercises of
options (18,833 shares)..... 188 414,110
Cancellation of subscription
receivable (28,374 shares).. (284) (1,249,716) 1,250,000
Treasury stock repurchase
(24,600 shares), at cost....
Unamortized
expense of
business Total
partner Accumulated Stockholders'
securities Treasury Stock Deficit Equity
---------------------------------------------------------------
Issuance of warrants........ 29,805,305
Costs of issuance of
securities.................. (1,604,028)
Issuance of Class A common
stock under the ESPP
(16,863 shares)............. 371,448
Net loss.................... (59,061,985) (59,061,985)
-------- -------- ---------- ----------
Balance, December 31, 2000.. $--- $--- ($72,998,898) $132,257,753
Conversions of Class B ======== ======== =========== ===========
common stock to Class A
common stock (7,165,743
shares)..................... -
Secondary public offering of
Class A common stock
(2,500,000 shares).......... 47,750,000
Issuance of Class A common
stock (548,096 shares)...... 11,925,586
Issuance of warrants........ (3,589,000) 197,000
Issuance of preferred stock
(750 shares)................ 110,925
Amortization of and charges
for warrants................ 897,100 1,111,706
Issuance of Class A common
stock under the ESPP (44,168
shares)..................... 589,120
Issuance of Class A common
stock from exercises of
options (18,833 shares)..... 414,298
Cancellation of subscription
receivable (28,374 shares)..
Treasury stock repurchase
(24,600 shares), at cost.... (221,892) (221,892)
57
Additional
Common Stock Common Stock Paid- in Subscription
Preferred Stock Class A Class B Capital receivable
------------------------------------------------------------------------------
Costs of issuance of
securities.................. (2,625,736)
Net loss....................
---------------- ----------- ---------- -------------- ----------
Balance, December 31, 2001.. $80,008 $265,906 $283,547 $266,791,989 $---
================ =========== ========== ============= ==========
Unamortized
expense of
business Total
partner Accumulated Stockholders'
securities Treasury Stock Deficit Equity
---------------------------------------------------------------
Costs of issuance of
securities.................. (2,625,736)
Net loss.................... (18,326,952) (18,326,952)
------------ --------- ----------- -----------
Balance, December 31, 2001.. $(2,691,900) $(221,892) $(91,325,850) $173,181,808
============ ========= =========== ===========
See notes to consolidated financial statements
58
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: eSpeed, Inc. (eSpeed or, together with its wholly owned
subsidiaries, the Company) primarily engages in the business of operating
interactive vertical electronic marketplaces designed to enable market
participants to trade financial and non-financial products more efficiently and
at a lower cost than traditional trading environments permit. All significant
intercompany balances and transactions have been eliminated in consolidation.
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. In December 1999, the Company completed its
initial public offering (the Offering) (see Note 9).
The accompanying financial statements include activities of the Company while
operating as a division of CFS from March 10, 1999 to the Offering.
Use of Estimates: The preparation of the consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of the assets and liabilities, revenues and expenses, and the
disclosure of contingent assets and liabilities in the consolidated financial
statements. Management believes that the estimates utilized in preparing the
consolidated financial statements are reasonable and prudent. 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.
Software solution fees: Pursuant to various services agreements, the Company
recognizes fees from related parties in amounts generally equal to its actual
direct and indirect costs, including overhead, of providing such services at the
time when such services are performed. For specific technology support functions
that are both utilized by the Company and provided to related parties, the
Company allocates the actual costs of providing such support functions based on
the relative usage of such support services by each party. In addition, certain
clients of the Company provide online access to their customers through use of
the Company's electronic trading platform. The Company receives up-front and/or
periodic fees from unrelated parties for the use of its platform. Such fees are
deferred and recognized as revenue ratably over the term of the licensing
agreement.
Cash and Cash Equivalents: The Company considers all highly liquid investments
with original maturity dates of 90 days or less at the date of acquisition to be
cash equivalents. Cash equivalents consist of securities purchased under
agreements to resell (Reverse Repurchase Agreements). 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 deposited. Collateral is valued daily and the
Company may require counter-parties to deposit additional collateral or return
amounts deposited when appropriate.
Fixed Assets: Fixed assets, principally computer and communication equipment and
software, are depreciated over their estimated economic useful lives (generally
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. Leasehold improvements are amortized over their
estimated economic useful lives, or the remaining lease term, whichever is
shorter.
59
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Investments: Investments include debt and equity instruments. The Company has
both the ability and the intent to hold its debt investments to maturity and, as
such, carries such investments at cost. The Company accounts for its equity
investments in entities at historical cost when the Company does not have
significant influence in the investee. Investments in which the Company does
have significant influence are accounted for using the equity method. The
Company does not maintain trading inventory of marketable equity securities.
Intangible assets: Intangible assets consist primarily of purchased patents. The
costs incurred in filing and defending patents are capitalized when management
believes such costs serve to enhance the value of the patent. Capitalized costs
related to issued patents are amortized over a period not to exceed 17 years or
the remaining life of the patent, whichever is shorter, using the straight-line
method.
Net loss per share: The Company computes net loss per common share by dividing
net loss for the year by the weighted-average number of common shares
outstanding for the period.
Stock Based Compensation: Awards to employees of options to purchase the common
stock of the Company are accounted for under Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees", and related interpretations.
No expense is recognized for awards under non-compensatory plans. Options and
warrants granted to non-employees are accounted for under the Financial
Accounting Standards Board's Statement of Financial Accounting Standards (SFAS)
No. 123, "Accounting for Stock-Based Compensation", where the options or
warrants granted are recognized based on the fair value of the options or
warrants at the time of the grant.
New Accounting Pronouncements: On July 20, 2001, the Financial Accounting
Standards Board (FASB) issued Statement of Accounting Standards No. 141,
"Business Combinations" (SFAS 141), and SFAS No. 142, "Goodwill and Other
Intangible Assets" (SFAS 142). SFAS 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001.
As a result, the pooling-of-interests method will be prohibited. SFAS 142
changes the accounting for goodwill from the amortization method to an
impairment-only approach. Thus, amortization of goodwill, including goodwill
recorded in past business combinations, will cease upon adoption of this
Statement, which for the Company will be January 1, 2002. The adoption of SFAS
141 and 142 will not have a material impact on the business, results of
operations or financial condition of the Company.
Reclassifications: Certain reclassifications have been made to prior year
balances in order to conform to the current year presentation.
2. SEPTEMBER 11 EVENTS
On September 11, 2001, the Company's principal place of business at One World
Trade Center was destroyed and, in connection therewith, the Company lost 180
employees and Cantor and TradeSpark lost an aggregate of 478 employees (the
September 11 Events).
Through the implementation of its business recovery plan, the Company
immediately relocated its surviving employees to various locations in the New
York metropolitan area. The United States government bond markets were closed on
September 11, 2001 and September 12, 2001. By the time the United States
government bond markets reopened on September 13, 2001, the Company had
re-established global connectivity of its eSpeed(R) system. The Company's
operating proprietary software was unharmed.
60
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As a result of the September 11 Events, fixed assets with a net book value of
$17,796,420 were destroyed. The Company has recovered these losses through its
$40,000,000 of property insurance and, as such, has not recorded a net loss
related to the destruction of its fixed assets. The Company's property insurance
also covers full replacement cost of the assets actually replaced. As a result,
the Company has recorded a gain on replacement of fixed assets through December
31, 2001 of $2,680,000, representing the excess of replacement cost over the
book value of fixed assets destroyed. As of December 31, 2001, the Company had
received $20,476,420 of insurance proceeds to cover the net book value of the
fixed assets that were destroyed plus the actual cost of the assets replaced.
The Company has recognized a net provision of $13,323,189 for non-property
damage related to the September 11 Events. Such provision includes the
incremental costs associated with substituting external professionals for
deceased employees, write-off of software development costs, write-off of
goodwill and costs associated with the Company's restructuring, including costs
associated with the closing of two offices, as a result of the September 11
Events, less refunds received for marketing campaigns which were cancelled after
the September 11 Events. The write-off related to software development consists
of costs that previously were capitalized but have now been written off because
the software being developed related to aspects of the Company's business that
were adversely affected by the September 11 Events. The write-off of goodwill
relates to goodwill associated with the acquisition of TreasuryConnect LLC. The
Company hopes to recover a significant portion or all of these costs through its
$25,000,000 of business interruption insurance coverage. However, the Company
cannot currently estimate the amount or timing of any such recovery and,
accordingly, no business interruption insurance recoveries have been recorded at
this time.
The following table summarizes the provision related to the September 11 Events:
Description Amount
----------- ------
Accruals
--------
Professional and consulting fees..................... $2,227,000
Recruitment.......................................... 2,961,563
Restructuring........................................ 2,315,778
Other................................................ 1,550,308
---------
9,054,649
---------
Asset Write Offs
----------------
Software development costs........................... 2,299,913
Goodwill............................................. 3,184,773
-----------
5,484,686
-----------
Less: Receipt for cancelled
marketing campaign................................... (1,216,146)
-----------
Provision for September 11 Events, net............... $13,323,189
===========
At December 31, 2001, the accrual balance relating to September 11 Events was
$7,362,672. These amounts are expected to be paid within the next 12 months.
61
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company has undertaken an assessment of losses and costs other than those
described above that it expects to incur in relation to the September 11 Events,
including loss of business. After such losses and costs are estimable, the
Company intends to submit insurance claims for such losses and costs pursuant to
its business interruption insurance coverage. The Company expects that a
significant portion or all of these losses and costs will be recovered by
insurance proceeds.
The Company paid a full year discretionary bonus to the estates of its deceased
employees, and has included such amount in compensation expense in the
consolidated statement of operations for the year ended December 31, 2001. The
families of the Company's deceased employees will also receive a share of
Cantor's partnership profits for the next five years to pay for, among other
things, 10 years of healthcare coverage. These costs will be borne by Cantor and
not by the Company.
3. FIXED ASSETS
December 31, December 31,
Fixed assets consist of the following: 2001 2000
- -------------------------------------- ------------ -----------
Computer and communication equipment............... $10,021,646 $19,920,077
Software, including software development costs..... 18,870,472 12,038,930
Leasehold improvements and other fixed assets...... 474,525 422,396
------- -------
29,366,645 32,381,403
Less accumulated depreciation and amortization..... (10,229,376) (8,940,038)
------------ -----------
Fixed assets, net.................................. $19,137,269 $23,441,365
=========== ===========
As a result of the September 11 Events, fixed assets with a net book value of
$17,796,420 were destroyed and $2,299,913 of software development costs were
written off.
4. INTANGIBLE ASSETS
On April 3, 2001, the Company purchased the exclusive rights to United States
Patent No. 4,903,201 (the Wagner Patent) dealing with the process and operation
of electronic futures trading systems that include, but are not limited to,
energy futures, interest rate futures, single stock futures and equity index
futures. The Company purchased the Wagner Patent from Electronic Trading Systems
Corporation for an initial payment of $1,750,000 in cash and 24,334 shares of
the Company's Class A common stock valued at $500,000. The patent expires in
2007. Additional payments are contingent upon the generation of patent-related
revenues. The Company has capitalized approximately $6,300,000 of legal costs
associated with acquisition and defense of the Wagner Patent.
On August 7, 2001, the Company purchased the exclusive rights to United States
Patent No. 5,915,209 (the Lawrence Patent) covering electronic auctions of fixed
income securities. The patent expires in 2014. The Company purchased the
Lawrence Patent for $900,000 payable over three years, and 15,000 warrants to
purchase the Company's Class A common stock at an exercise price of $16.08,
which were valued at $197,000. The warrants expire on August 6, 2011. Additional
payments are contingent upon the generation of patent-related revenues.
5. 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
such partner's 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
62
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company while it operated as a division of CFS was used as a reduction of the
taxable income of CFS and, as such, the Company was reimbursed for such tax
benefit.
Since the commencement date of the Offering, December 10, 1999, the Company has
been subject to income tax as a corporation. Net operating losses (NOLs) from
that date, approximating $51,200,000, will be available on a carry forward basis
to offset future operating income of the Company. However, a valuation allowance
has been recorded at December 31, 2001 to offset the full amount of the NOLs as
realization of this deferred tax benefit is dependent upon generating sufficient
taxable income prior to the expiration of the NOLs.
6. COMMITMENTS AND CONTINGENCIES
Leases: Under an administrative services agreement, eSpeed is obligated to
Cantor for minimum rental payments under Cantor's various non-cancelable leases
with third parties, principally for office space and computer equipment,
expiring at various dates through 2016 as follows:
For the Year Ending December 31:
2002......................................................... $1,212,488
2003......................................................... 1,212,488
2004......................................................... 1,212,488
2005......................................................... 1,240,339
2006......................................................... 1,240,339
Thereafter................................................... 10,978,045
----------
Total........................................................ $17,096,187
===========
In 2002, Cantor obtained office space in New York in which Cantor and the
Company will conduct operations. The commitments listed above do not include
payments for such office space as the Company's allocation of such office space
had not been fully determined.
Rental expense under the above and under all other operating leases for the
years ended December 31, 2001 and 2000 and the period from March 10, 1999 to
December 31, 1999 was $10,988,614, $7,341,614 and $3,783,303, respectively.
Legal Matters: In the ordinary course of business, the Company and Cantor are
defendants or co-defendants in various litigation matters. For certain pending
litigation matters or supplemental allegations surrounding Cantor's limited
partnership agreement, Cantor has agreed to indemnify the Company with respect
to any liabilities the Company may incur as a result of such lawsuits or
allegations. Although there can be no assurances, the Company believes, based on
information currently available and consultation with counsel, that the ultimate
resolution of these legal proceedings will not have a material adverse effect on
its financial condition or results of operations.
Risk and Uncertainties: The majority of the Company's revenues consist of
transaction fees earned from Cantor based on fixed percentages of certain
commissions paid to Cantor. Consequently, any reductions in the amounts of such
commissions paid to Cantor could have a material adverse effect on the Company's
most significant source of revenues. In addition, the Company's and Cantor's
revenues could vary based on the transaction volumes of financial markets around
the world.
63
7. ACQUISITIONS, INVESTMENTS, AND BUSINESS PARTNER TRANSACTIONS
Williams and Dynegy
In June 2000, the Company sold to The Williams Companies, Inc. (Williams) and
Dynegy, Inc. (Dynegy) one Unit each consisting of (i) 789,071 shares (the
Shares) of the Company's Class A common stock and (ii) warrants (the Warrants)
exercisable for the purchase of up to 666,666 shares of Class A common stock,
for an aggregate purchase price for each Unit of $25,000,000. The Warrants have
a per share exercise price of $35.20, a ten year term and are exercisable during
the last 4 1/2 years of the term, subject to acceleration under certain
prescribed circumstances intended to provide incentives to Williams and Dynegy
to invest in four Qualified Verticals as described below. The Shares were not
transferable prior to the first anniversary of the Closing. The Company recorded
a non-cash charge of $29,805,305 at the time of the Closing to reflect the value
of the Warrants.
Each of Williams and Dynegy agreed that, subject to the satisfaction of certain
conditions, it would invest $2,500,000 in at least four entities (the Qualified
Verticals) formed by the Company and Cantor within 12 months of the Closing. In
June 2001, the initial agreed upon period was extended by the parties to a
period not to exceed two years. Investment by Williams and Dynegy was contingent
upon the Company and Cantor offering seven qualified verticals for investment.
If the Company and Cantor fail to provide seven qualified vertical markets for
Williams and Dynegy to invest in, there will be no additional investment by
Williams and Dynegy and they will continue to hold fully vested warrants. To the
extent that either Williams or Dynegy does not invest in at least four Qualified
Verticals, such entity will be required to make a $2,500,000 payment to the
Company for each investment not made. TradeSpark, the first Qualified Vertical,
was established in September 2000. Williams and, subject to certain limitations,
Dynegy, will be entitled to invest $25,000,000 in shares of the Company's Class
A common stock (the Additional Investment Right) if they invest in the Qualified
Verticals. Such right provides for investment at a 10% discount to the average
trading price for the 10 trading days preceding the date of such party's
investment in such new Qualified Vertical, or, under certain circumstances, the
public announcement of the formation of such Qualified Vertical. The Additional
Investment Right was approved by stockholders at the Company's 2000 Annual
Meeting of Stockholders on October 26, 2000.
The Company entered into an agreement with Cantor providing that, if and when an
Additional Investment Right is exercised by Williams or Dynegy, the Company
will purchase from Cantor half the number of shares purchased by Williams or
Dynegy. The purchase price to be paid to Cantor by the Company will be the same
purchase price per share as is paid by Williams and Dynegy at the time.
Accordingly, the purchase of any shares by the Company from Cantor will be
simultaneous with the sale of an equal number of shares by the Company to
Williams or Dynegy, and this part of the transaction will have no resulting
effect on the Company's results of operations or total outstanding common stock.
TradeSpark
On September 25, 2000, the Company and Cantor, in conjunction with Williams and
other participants in the energy market, formed TradeSpark to operate a
wholesale electronic and telephonic marketplace in North America for natural
gas, electricity, coal, emissions allowances, and weather financial products.
64
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company invested $2,000,000 for a 5% interest in TradeSpark and Cantor
invested $4,250,000 and contributed certain assets in exchange for a 28.33%
interest. The remaining 66.67% interest was purchased by energy industry market
participants (EIPs). The Company has also entered into a technology services
agreement with TradeSpark pursuant to which the Company provides the technology
infrastructure for the transactional and technology related elements of the
TradeSpark marketplace as well as certain other services in exchange for
specified percentages of transaction revenues from the marketplace.
In order to provide incentives to the EIPs to trade on the TradeSpark electronic
marketplace, the Company issued 5,500,000 shares of Series A Redeemable
Convertible Preferred Stock (Series A Preferred Stock) and 2,500,000 shares of
Series B Redeemable Convertible Preferred Stock (Series B Preferred Stock) to a
limited liability company newly-formed by the EIPs. Upon the satisfaction of
certain revenue thresholds and other conditions, principally related to the
volume of transactions executed through the TradeSpark marketplace, the Series A
Preferred Stock and Series B Preferred Stock are convertible into Series A and B
Warrants, respectively, to collectively purchase up to 8,000,000 shares of the
Company's Class A common stock at an exercise price of $27.94 per share. To the
extent that the conditions to full conversion are not satisfied, each share of
unconverted Series A and B Preferred Stock may be redeemed at the Company's
option, or may be converted into 1/100th of a share of the Company's Class A
common stock. In 2000, the Company recognized a non-cash charge of $2,235,200,
equal to the fair value of the 80,000 shares of Class A common stock issuable
upon conversion of the preferred stock, if none of the conditions are met. The
Company will recognize additional non-cash charges related to the issuance of
these shares of preferred stock if and when they are converted over the six-year
period from date of issuance, which non-cash charges could aggregate $53,644,800
if all conditions (including but not limited to TradeSpark total transaction
revenues of at least $250,000,000) are met and all shares of preferred stock are
converted. No such additional non-cash charges were recognized during the years
ended December 31, 2001 and 2000. The fair value of the Preferred Stock was
estimated based on the value of the warrants into which the Preferred Stock
would be converted (assuming full conversion), discounted for liquidity,
hedging, and dilution issues. The warrants were valued using a modified
Black-Scholes pricing model and assumptions as to risk-free interest rate,
expected life and range of expected volatility of 6.3%, 10 years, and 32% to
55%, respectively.
For the year ended December 31, 2001, the Company's share of TradeSpark's losses
was $211,706.
Freedom
The Company and Cantor formed a limited partnership (the LP) to acquire an
interest in Freedom International Brokerage (Freedom), a Canadian government
securities broker-dealer and Nova Scotia unlimited liability company. On April
4, 2001, the Company contributed 310,769 shares of its Class A common stock,
valued at $6,970,907, to the LP as a limited partner, which entitles the Company
to 75% of the LP's capital interest in Freedom. The Company shares in 15% of the
LP's cumulative profits but not in cumulative losses. Cantor contributed 103,588
shares of the Company's Class A common stock as the general partner. Cantor will
be allocated all of the LP's cumulative losses or 85% of the cumulative profits.
The LP exchanged the 414,357 shares for a 66.7% interest in Freedom. In
addition, the Company issued fully vested, non-forfeitable warrants to purchase
400,000 shares of its Class A common stock at an exercise price per share of
$21.31 to provide incentives over the three year period ending April 2004 to the
other Freedom owner participants to migrate to the Company's fully electronic
platform. The warrants were valued using a modified Black-Scholes pricing model
and assumptions as to risk-free interest rate, expected life and expected
volatility of 6%, five years and 50%, respectively. The Company recorded
additional paid-in capital of $3,589,000, representing the value of the
warrants, and $897,100 as a non-cash charge for the twelve months ended December
31, 2001. The remaining unamortized balance of $2,691,900 will be recognized as
an expense ratably through April 2004. To the extent necessary to protect the
65
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company from any allocation of losses, Cantor is required to provide future
capital contributions to the LP up to an amount that would make Cantor's total
contribution equal to the Company's initial investment in the LP. The Company
receives 65% of all electronic transaction services revenues and Freedom
receives 35% of such revenues. The Company also receives 35% of revenues derived
from Freedom's voice-assisted transactions, other miscellaneous transactions and
the sale of market data or other information.
The Company entered into this transaction principally to expand its business in
Canadian fixed-income, foreign exchange and other capital markets products and
to leverage its opportunities to transact business with the six leading Canadian
financial institutions that are participants in Freedom. The Company believes
that Freedom may experience significant short-term losses as the voice brokerage
business of Freedom is converted to a fully electronic marketplace. Accordingly,
the Company was willing to accept a reduced profits interest in order to avoid
recognizing potentially significant short-term losses prior to the anticipated
achievement by Freedom of profitability. The Company determined the appropriate
number of shares and warrants to be issued in this transaction based on the
anticipated benefits to be realized and the structure of the profit and loss
arrangement.
For the year ended December 31, 2001, the net income of the LP was $425,787. The
Company's share of that income was $63,868.
TreasuryConnect
On May 25, 2001, the Company acquired all the interests in TreasuryConnect LLC,
a company that operated an electronic trade communication and execution platform
for OTC derivatives, in exchange for 188,009 shares of the Company's Class A
common stock, valued at $4,013,992 and cash of $170,781. The net assets acquired
consisted of $1,000,000 of fixed assets, primarily related to software. The
remaining portion of the purchase price was allocated to goodwill. The Company's
consolidated financial statements include the operating results, which were
immaterial during 2001, of TreasuryConnect LLC from the date of acquisition. As
a result of the September 11 Events, the Company wrote off the goodwill
associated with the acquisition.
Loss on unconsolidated investments
On September 7, 2001, the Company wrote off its investments in QV Trading
Systems and Visible Markets, each of which ceased operations in the third
quarter of 2001. The Company recognized a loss of $3,833,679 related to the
write-offs.
Deutsche Bank
On July 30, 2001, the Company entered into an agreement to form a business
partner relationship with Deutsche Bank, AG (Deutsche Bank), whereby Deutsche
Bank will channel its electronic market-making engines and liquidity for
specified European fixed income products using the Company's electronic trading
platform. In connection with the agreement, Deutsche Bank purchased 750 shares
of Series C Redeemable Convertible Preferred Stock (Series C Preferred) of the
Company at its par value of $0.01 per share. Each share of the Series C
Preferred is convertible at the option of Deutsche Bank into 10 shares of the
Company's Class A common stock at any time during the five years ending July 31,
2006. The Company has recognized a non-cash charge of $110,925, representing the
fair value of such Class A common stock into which the Series C Preferred may be
converted, if none of the future conditions are met. Such value in excess of the
cash proceeds was given as an inducement to Deutsche Bank to enter into the
agreement.
At the end of each year of the five year agreement in which Deutsche Bank
fulfills its liquidity and market-making
66
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
obligations for specified products, 150 shares of Series C Preferred will
automatically convert into warrants to purchase 150,000 shares of the Company's
Class A common stock at an exercise price of $14.79 per share. If all conditions
are met and all of the shares of preferred stock are converted, the total
non-cash charge could aggregate $3,330,000 over the next five years. The Company
will recognize the contingent non-cash charges on a straight-line basis over the
five year period as conditions are satisfied. For the year ended December 31,
2001, the Company has recognized a non-cash charge of $214,606 for the
conditions that had been satisfied to date.
At the end of the five year period, to the extent that Deutsche Bank does not
fulfill its obligations under the agreement and Series C Preferred shares remain
outstanding, the Company has the option to redeem each share of the Series C
Preferred outstanding in exchange for 10 shares of the Company's Class A common
stock.
8. RELATED PARTY TRANSACTIONS
All of the Company's Reverse Repurchase Agreements are transacted on an
overnight basis with CFS. Under the terms of these agreements, the securities
collateralizing the Reverse Repurchase Agreements are held under a custodial
arrangement with a third party bank and are permitted to be sold or repledged.
The fair value of such collateral at December 31, 2001 and 2000 totaled
$159,941,811 and $122,620,469, respectively.
Investments in TradeSpark and the limited partnership that invested in Freedom
are accounted for using the equity method. The carrying value of such related
party investments approximated $8,800,000 and $2,800,000 at December 31, 2001
and December 31, 2000, respectively, and is included in Investments in the
Consolidated Statements of Financial Condition.
Under the Amended and Restated Joint Services Agreement between the Company and
Cantor and services agreements between the Company and TradeSpark and the
Company and Freedom, the Company owns and operates the electronic trading system
and is responsible for providing electronic brokerage services, and Cantor,
TradeSpark or Freedom provides voice-assisted brokerage services, fulfillment
services, such as clearance and settlement, and related services, such as credit
risk management services, oversight of client suitability and regulatory
compliance, sales positioning of products and other services customary to
marketplace intermediary operations. In general, for fully electronic
transactions, the Company receives 65% of the transaction revenues and Cantor,
TradeSpark or Freedom receives 35% of the transaction revenues. In general, for
voice-assisted brokerage transactions, the Company receives 7% of the
transaction revenues, in the case of Cantor transactions, and 35% of the
transaction revenues, in the case of TradeSpark or Freedom transactions. In
addition, the Company receives 25% of the net revenues from Cantor's gaming
businesses.
Under those services agreements, the Company has agreed to provide Cantor,
TradeSpark and Freedom technology support services, including systems
administration, internal network support, support and procurement for desktops
of end-user equipment, operations and disaster recovery services, voice and data
communications, support and development of systems for clearance and settlement
services, systems support for brokers, electronic applications systems and
network support, and provision and/or implementation of existing electronic
applications systems, including improvements and upgrades thereto, and use of
the related intellectual property rights. In general, the Company charges
Cantor, TradeSpark and Freedom the actual direct and indirect costs, including
overhead, of providing such services and receives payment on a monthly basis. In
exchange for a 25% share of the net revenues from Cantor's gaming businesses,
the Company is obligated to spend and does not get reimbursed for the first
$750,000 each quarter of the costs of providing support and development services
for such gaming businesses.
Under an Administrative Services Agreement, Cantor provides various
administrative services to the Company, including accounting, tax, 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 Services Agreement has a
three-year term which will renew automatically for successive one-year terms
unless cancelled upon six months' prior notice by either the Company or Cantor.
The Company incurred administrative fees for such services during the years
ended December 31, 2001, December 31, 2000 and for the period ended December 31,
1999 totaling $9,797,996, $6,524,341 and $1,662,058, respectively.
The services provided under both the Amended and Restated Joint Services
Agreement and the Administrative Services Agreement are not the result of
arm's-length negotiations because Cantor controls the Company. As a result,
the amounts
67
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
charged for services under these agreements may be higher or lower than
amounts that would be charged by third parties if the Company did not obtain
such services from Cantor.
9. 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. The Company initially issued 100 shares of Class B common stock
to Cantor in exchange for a cash contribution of $200,000.
Prior to the Offering, Cantor contributed net assets of $5,455,299. This
contribution included 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 to Cantor
43,999,900 shares of Class B common stock. Immediately thereafter, Cantor
converted 3,350,000 shares of Class B common stock into Class A common stock and
sold them in the Offering.
In the Offering, 10,350,000 shares of Class A common stock were sold at $22 per
share, of which 7,000,000 shares were sold by the Company, raising approximately
$144,000,000 in proceeds before Offering expenses of $4,396,646, net of
underwriting discounts. The remaining shares were sold by CFS.
In June 2000, the Company sold 1,578,142 shares of Class A common stock to
minority investors for consideration of $50,000,000, as discussed in Note 7. In
connection with this transaction, one half of the shares sold by the Company
were purchased from Cantor for $25,000,000.
In July 2000, in conjunction with the acquisition by Cantor of a municipal bond
brokerage business, the Company issued 28,374 shares of Class A common stock to
the shareholders of the acquired business. This stock issuance has been treated
as an issuance on behalf of Cantor, and the value of the stock issued has been
reflected as a direct charge to accumulated deficit in the Company's statement
of financial condition. The Company also issued an additional 28,374 shares of
Class A common stock to certain employees of the acquired business in exchange
for promissory notes, which was recorded as a subscription receivable. The
promissory notes and the related issued shares were terminated and cancelled
effective December 1, 2001.
In September 2000, the Company issued 8,000,000 shares of Redeemable Convertible
Preferred Stock (the Preferred Stock) to business partners in conjunction with
an investment in the TradeSpark Qualified Vertical. As more fully described in
Note 7, if certain conditions are met, the Preferred Stock is convertible at the
option of the holder into warrants to purchase the Company's Class A common
stock. To the extent the conditions are not met, the Company may either redeem
the Preferred Stock or convert the Preferred Stock into 1/100th of a share of
the Company's Class A common stock.
During the years ended December 31, 2001 and 2000, the Company sold 44,168 and
16,863 shares of Class A common stock, respectively, pursuant to the Company's
Employee Stock Purchase Plan as discussed in Note 12.
During the year ended December 31, 2001, the Company issued 18,833 shares of
Class A common stock related to the exercise of employee options which are more
fully discussed in Note 11.
On March 13, 2001, the Company and selling stockholders, including CFS,
completed a secondary offering of 7,135,000 shares of the Company's Class A
common stock to the public at $20 per share. Of the Class A common
68
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
stock offered, 2,500,000 shares were sold by the Company, and 4,635,000 shares
were sold by the selling stockholders, principally CFS. Proceeds to the Company,
net of underwriting discounts, but before offering expenses of $1,940,127,
totaled $47,750,000. On April 11, 2001, CFS sold an additional 250,000 shares of
Class A common stock in connection with the exercise of the underwriters'
over-allotment option.
As more fully discussed in Note 7, in 2001 the Company issued shares of its
Class A common stock in an acquisition and in business partner transactions. The
Company issued 310,769 shares of its Class A common stock in the formation of a
limited partnership and 188,009 shares of its Class A common stock in the
acquisition of all of the interests in TreasuryConnect LLC. Additionally, the
Company issued 750 shares of Redeemable Convertible Preferred Stock as part of
an agreement with Deutsche Bank, AG.
On August 7, 2001, the Company issued 24,334 shares as part of its acquisition
of the Wagner Patent, which is more fully discussed in Note 4.
On September 10, 2001, the Company's board of directors authorized the
repurchase of $40,000,000 of outstanding Class A common stock. As of December
31, 2001, the Company has purchased 24,600 shares for a total of $221,892 under
this repurchase plan.
10. LONG-TERM INCENTIVE PLAN
The Company has adopted the eSpeed, Inc. 1999 Long-Term Incentive Plan, as
amended and restated (the LT Plan) which provides for awards in the form of 1)
either incentive stock options or non-qualified stock options; 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 Class A common stock.
The Compensation Committee of the Board of Directors administers the LT Plan and
is generally empowered to determine award recipients, and the terms and
conditions of those awards. Awards may be granted to directors, officers,
employees, consultants and service providers of the Company and its affiliates.
During 2001, the Company issued 10,934 shares of restricted Class A common stock
valued at $220,247 to certain employees under the LT Plan. The Company
recognized the entire value of $220,247 of compensation expense in the current
year as the Company elected to fully vest the shares after the September 11
Events.
11. OPTIONS AND WARRANTS
Issued in connection with the Long-Term Incentive Plan
During the years ended December 31, 2001 and 2000, respectively, the Company
issued 3,653,816 and 3,770,312 options to employees pursuant to the LT Plan. The
exercise prices for the options equaled or exceeded the value of the Company's
Class A common stock on the date of each award. The options generally vest
ratably over four or five years from the grant date.
Concurrent with the Offering, the Company issued 6,227,445 options to employees
and outside directors of the Company, of which 500,000 were immediately
exercisable. At the time of the grant, the remaining options were originally
scheduled to 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.
Concurrent with the Offering, the Company also issued 290,320 options to Cantor
employees and 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 in the period ended December 31, 1999. The business purpose for
issuing the options was to compensate the individuals who assisted the Company
in its formation and the completion of the Offering.
69
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
both as an increase to additional paid-in capital and as an increase in Offering
expenses which have been charged against additional paid-in capital.
On October 19, 2000, the option terms were amended so that, effective on the
first anniversary of the Offering, future vesting occurs ratably on a quarterly
basis. This amendment had no financial impact as the market value of the
Company's Class A common stock was below the exercise price of all outstanding
options at that date.
As a result of the September 11 Events, the Company fully vested all options for
deceased employees of the Company, Cantor and TradeSpark. In addition, the
expiration date of options was extended to the fifth anniversary of the option
grant date. The extension of the expiration date did not result in additional
compensation expense for the year ended December 31, 2001 as the original grant
price of the options was higher than the Company's stock price on the date of
modification.
Pursuant to guidelines contained in APB 25, the Company records no expense for
options issued to employees. The weighted average grant date fair values of
employee stock options granted were $3.23, $16.90 and $13.29 for the years ended
December 31, 2001 and 2000 and the period ended December 31, 1999, respectively.
The following table represents the effect of the Company's net loss and net loss
per common share had the Company accounted for the 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:
Increase in net loss per
Year Increase in net loss common share
---- -------------------- ------------
2001 $11,807,858 $0.21
2000 28,738,843 0.56
1999 6,642,591 0.15
The fair value of the above options and warrants was estimated using a modified
Black-Scholes option pricing model. 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 the stock options or warrants. The following
table presents the assumptions that were used in the Black-Scholes model for the
years ended December 31, 2001 and 2000 and for the period ended December 31,
1999:
Risk-free interest
Year rate Expected life Expected volatility Dividends
- ---- ---- ------------- ------------------- ---------
2001 3.25% 3 to 8 years 80% None
2000 5.25% 2 to 8 years 80% None
1999 6.00% 3 to 8 years 55% None
Issued in connection with acquisitions, investments and business partner
securities
In June 2000, the Company issued 1,333,332 warrants to purchase Class A common
stock to business partners as discussed in Note 7. The warrants expire in June
2010 and are generally exercisable beginning December 2004. The estimated fair
value of the warrants at the time of issuance resulted in a one-time non-cash
charge to the
70
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company of $29,805,305. The fair value of the warrants was estimated using a
modified Black-Scholes pricing model and assumptions as to risk-free interest
rate, expected life and expected volatility of 7.4%, 10 years and 48%,
respectively.
As discussed in Note 4, on August 7, 2001, the Company issued 15,000 warrants to
purchase the Company's Class A common stock as part of its purchase of a patent.
The warrants expire on August 6, 2011 and the estimated fair value of the
warrants issued was $197,000.
As discussed in Note 7, the Company issued 400,000 warrants to purchase the
Company's Class A common stock as part of the formation of the limited
partnership to acquire Freedom.
The following table summarizes changes in all of the Company's stock options and
warrants from March 10, 1999 (date of commencement of operations) to December
31, 2001.
Options and Warrants
eSpeed and Weighted
Cantor employee Warrants and Average
options Other Options Total Exercise Price Expiration Dates
------- ------------- ----- -------------- ----------------
Granted............................ 6,517,765 135,000 6,652,765 $22.00 12/2004 - 12/2009
Exercised.......................... - - - -
Canceled........................... (24,900) (24,900) 22.00
-----------------------------------------------------
Balance, December 31, 1999......... 6,492,865 135,000 6,627,865 22.00 12/2004 - 12/2009
Granted............................ 3,770,312 1,333,332 5,103,644 25.76 2/2010 - 12/2010
Exercised.......................... - - - -
Canceled........................... (292,460) (292,460) 24.38
-----------------------------------------------------
Balance, December 31, 2000......... 9,970,717 1,468,332 11,439,049 23.62 12/2004-12/2010
Granted............................ 3,653,816 415,000 4,068,816 6.45 1/2010 - 10/2011
Exercised.......................... (18,833) - (18,833) 22.00
Canceled / Expired................. (378,371) (281,310) 18.25
-----------------------------------------------------
Balance, December 31, 2001......... 13,227,329 1,883,332 15,110,661 $19.76 12/2004-10/2011
=====================================================
The following table provides further details relating to all of the Company's
stock options and warrants outstanding as of December 31, 2001.
Weighted
Weighted Average
average Remaining
Range of Number exercise Contractual Number Weighted Average
Exercise Prices Outstanding price Life (in years) Exercisable Exercise Price
--------------- ----------- ----- --------------- ----------- --------------
$5.10 to $8.97 3,358,557 $5.11 9.8 - -
13.88 to 20.50 2,238,115 16.39 7.0 1,148,737 $16.30
21.00 to 31.19 8,773,113 23.76 6.3 4,754,473 22.32
31.63 to 47.25 689,366 40.35 6.6 364,965 38.41
50.38 to 77.00 51,510 57.24 6.1 34,110 56.41
---------- ---------
15,110,661 $19.76 7.2 6,302,285 $22.34
========== =========
71
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. STOCK PURCHASE PLAN
The Company has adopted a qualified Employee Stock Purchase Plan to permit
eligible employees to purchase shares of eSpeed common stock at a discount. At
the end of each quarterly purchase period, as defined, accumulated payroll
deductions are 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. During the year ended December 31, 2001, the Company
issued 44,168 shares to employees at an average price of $13.33 per share.
During the year ended December 31, 2000, the Company issued 16,863 shares to
employees at an average price of $21.99 per share. In October 2001, the Company
suspended the ESPP.
13. DEFERRED COMPENSATION PLAN
Employees of the Company are eligible to participate in the eSpeed Inc. Deferral
Plan for Employees of Cantor Fitzgerald, L.P. and its Affiliates (the Plan),
whereby eligible employees may elect to defer a portion of their salaries 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. Employee contributions are directed to
one or more investment funds, one of which, beginning in 2000, invests in the
Company's Class A common stock (the eSpeed Stock Fund). The Company will match
contributions to the eSpeed Stock Fund annually with up to $3,000 of the
Company's Class A common stock per participant. In 2002 and 2001, the Company
contributed 28,241 and 14,050 shares of its Class A common stock relating to
employee contributions to the eSpeed Stock Fund for the year ended December 31,
2001 and 2000, respectively. The administration of the Plan is performed by
CFLP. The Company pays its proportionate share of such administrative costs
under the Administrative Services Agreement.
14. 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, 2001, eSpeed
Government Securities, Inc.'s liquid capital of $65,789,445 was in excess of
minimum requirements by $65,764,445.
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 indebtedness to net capital, both as defined, shall not
exceed 15 to 1. At December 31, 2001, eSpeed Securities, Inc. had net capital of
$6,922,754, which was $6,607,062 in excess of its required net capital, and
eSpeed Securities, Inc.'s net capital ratio was 0.68 to 1.
15. SEGMENT AND GEOGRAPHIC DATA TABLES
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, licensing
software, and providing technology support services to Cantor and other related
parties.
Product information: The Company currently markets its services through three
products; eSpeed Markets(SM), an integrated electronic trading marketplace;
eSpeed Software Solutions(SM), in which the Company recognizes fees
72
eSpeed, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
from technology support services and licensing fees; and eSpeed Online(SM),
which provides e-commerce businesses with online access to wholesale market
participants. Revenues from eSpeed Markets(SM) and eSpeed Online(SM) are
included in transaction revenues and eSpeed Markets(SM) comprises the majority
of those revenues.
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 judgment, provides a reasonable representation of the activities of
each region as of and for the periods indicated.
- ----------------------------------------------------------------------------------------------------------
For the year For the year For the period from
ended ended March 10, 1999 to
Transaction Revenues: December, 31, 2001 December 31, 2000 December 31, 1999
- ----------------------------------------------------------------------------------------------------------
Europe........................... $20,657,534 $13,214,668 $5,392,923
Asia............................. 2,653,378 1,397,154 450,457
----------- ----------- -----------
Total Non-Americas............... 23,310,912 14,611,822 5,843,380
Americas......................... 75,057,114 55,675,557 16,010,222
----------- ----------- -----------
Total............................ $98,368,026 $70,287,379 $21,853,602
=========== =========== ===========
Average long-lived assets December 31, 2001 December 31, 2000 December 31, 1999
----------------- ----------------- -----------------
Europe........................... $3,737,700 $2,225,886 $2,257,914
Asia............................. 434,809 791,570 925,790
----------- ----------- -----------
Total Non-Americas............... 4,172,509 3,017,456 3,183,704
Americas......................... 19,031,755 13,736,827 5,236,613
----------- ----------- -----------
Total............................ $23,204,264 $16,754,283 $8,420,317
=========== =========== ==========
73
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
74
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table provides information as of March 15, 2002 regarding our
directors and executive officers.
Name Age Title
--- -----
Howard W. Lutnick....... 40 Chairman of the Board, Chief Executive
Officer and President
Lee M. Amaitis.......... 52 Global Chief Operating Officer; Director
Joseph C. Noviello...... 36 Executive Vice President and Chief Information
Officer; Director
Stephen M. Merkel....... 43 Executive Vice President, General Counsel and
Secretary; Director
Richard C. Breeden...... 52 Director(1)(2)
Larry R. Carter......... 58 Director(1)(2)
John H. Dalton.......... 60 Director (1)
William J. Moran........ 60 Director(1)(2)
(1) Non-employee director
(2) Member of the Audit and Compensation Committees
Howard W. Lutnick. Mr. Lutnick has been our Chairman of the Board of Directors
and Chief Executive Officer since June 1999. Mr. Lutnick has been our President
since June 1999. Mr. Lutnick joined Cantor in 1983 and has served as President
and Chief Executive Officer of Cantor since 1991. 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(SM). Mr. Lutnick is a member of the
Executive Committee of the Intrepid Museum Foundation's Board of Trustees, the
Board of Managers of Haverford College and the Board of Directors of the Zachary
and Elizabeth M. Fisher Center for Alzheimer's Disease Research at Rockefeller
University, City Harvest and the Tate Gallery Projects Center.
Lee M. Amaitis. Mr. Amaitis has been our Global Chief Operating Officer and
director since September 2001. Mr. Amaitis has been Executive Managing Director
of eSpeed International Limited from December 1999. Mr. Amaitis has also been
President and Chief Executive Officer of Cantor Fitzgerald International and
Cantor Fitzgerald Europe since March 1995. Prior to joining Cantor, Mr. Amaitis
was Managing Partner and Senior Managing Director of Cowen Government Brokers
from April 1991 to February 1995 and was Manager MBS and Limited Partner of
Cowen & Co. from February 1989 to April 1991.
Joseph C. Noviello. Mr. Noviello has been our Executive Vice President and Chief
Information Officer and director since September 2001. Mr. Noviello served as
our Senior Vice President and Chief Technology Officer from December 1999 to
September 2001. From December 1995 to December 1999, Mr. Noviello served as
Managing Director of Cantor.
Stephen M. Merkel. Mr. Merkel has been our Executive Vice President, General
Counsel and Secretary since September 2001 and was our Senior Vice President,
General Counsel and Secretary from June 1999 to September 2001. Mr. Merkel has
been our director since September 2001. Mr. Merkel has been Executive Managing
Director, General Counsel and Secretary of Cantor since December 2000 and was
Senior Vice President, General Counsel and Secretary of Cantor from 1993 to
December 2000. Mr. Merkel is responsible for Cantor's legal, compliance, tax,
risk and credit departments. Mr. Merkel serves as a director and Secretary of
the Cantor
75
Exchange(SM). 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. Mr. Merkel is on the Board of
Directors of Freedom International Brokerage Company and is on the Management
Committee of TradeSpark, L.P.
Richard C. Breeden. Mr. Breeden has been our director since December 1999. Since
1996, Mr. Breeden has been Chairman and Chief Executive Officer of Richard C.
Breeden & Co., a consulting firm. Mr. Breeden was Chairman of the Board and
Chief Executive Officer of Equivest Finance, Inc., a publicly traded vacation
ownership company, from October 1997 to February, 2002 and was President of
Equivest from October 1998 to February, 2002. Mr. Breeden has served as Trustee
for the Bennett Funding Group, Inc. 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 is a member of the Board of Directors of
W.P. Stewart & Co., Ltd.
Larry R. Carter. Mr. Carter has been our director since December 1999. Mr.
Carter joined Cisco Systems, a computer technology company, 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 and served as a director
of Cisco Systems since July 2000. From 1992 to January 1995, Mr. Carter was Vice
President and Corporate Controller at Advanced Micro Devices. His career 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 a member of the Board of Trustees at Loyola Marymount University. Mr.
Carter is also on the Board of Directors of Transmeta Corp. and QLogic
Corporation.
John H. Dalton. Mr. Dalton has been our director since February 2002. Mr. Dalton
has been President of IPG Photonics Corp., a company that designs, develops and
manufactures a range of advanced amplifiers and lasers for the telecom and
industrial markets, since September 2000. From May 1999 to June 2000, Mr. Dalton
was Chairman and Chief Executive Officer of EPCAD Systems, a company that
researches and develops electroplasma technology for the metals industry. Mr.
Dalton served as Secretary of the Navy from July 1993 to November 1998. Mr.
Dalton serves on the Board of Directors of TransTechnology Corp. and Fresh Del
Monte Produce Inc.
William J. Moran. Mr. Moran has been our director since December 1999. Mr. Moran
is Executive Vice President and General Auditor of J.P. Morgan Chase & Co. 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.
COMMITTEES OF THE BOARD
Our board of directors has an Audit Committee and a Compensation Committee. The
members of our Audit Committee are Messrs. Breeden, Carter and Moran, all of
whom are independent directors. Our Audit Committee selects the independent
auditors, reviews such auditors' independent status, consults with such auditors
and with management with regard to the adequacy of our internal accounting
controls and considers any non-audit functions to be performed by the
independent auditors.
The members of our Compensation Committee are Messrs. Breeden, Carter and Moran.
The Compensation Committee is responsible for reviewing and approving all
compensation arrangements for our executive officers and for overseeing our
stock option and stock purchase plans.
76
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 with 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 us with
respect to fiscal 2001, or written representations from certain reporting
persons, to the best of our knowledge, all reports were filed on a timely basis.
ITEM 11. EXECUTIVE COMPENSATION
The following table provides certain summary information concerning all
compensation earned for the year ended December 31, 2001, the year ended
December 31, 2000 and the period from March 10, 1999 through December 31, 1999
by our Chief Executive Officer and each of our other executive officers required
to be included in the table (collectively, the Named Executive Officers).
Summary Compensation Table
Long-Term
-------------------
Compensation
Awards
Underlying Name
and Principal Position Year Salary Bonus Options (#)
---------------------- ---- ------ ----- -----------
Howard W. Lutnick............................. 2001 $400,000 $600,000 1,500,000
Chairman, Chief Executive Officer 2000 350,000 650,000 625,000
and President 1999 280,000 -- 2,500,000
Frederick T. Varacchi*........................ 2001 354,167 500,000 --
2000 500,000 500,000 200,000
1999 400,000 -- 800,000
Douglas B. Gardner*........................... 2001 177,083 350,000 --
2000 250,000 350,000 75,000
1999 200,000 -- 375,000
Lee M. Amaitis................................ 2001 107,418 300,000 375,000
Global Chief Operating Officer 2000 107,418 333,333 50,000
1999 -- -- 325,000
Joseph C. Noviello............................ 2001 275,000 400,000 200,000
Chief Information Officer 2000 250,000 350,500 65,000
1999 175,000 250,000 85,000
Stephen M. Merkel............................. 2001 150,000 400,000 200,000
Executive Vice President, Secretary 2000 150,000 300,000 100,000
and General Counsel 1999 120,000 -- 100,000
- ----------------
*Messrs. Varacchi and Gardner were lost as a result of the terrorist attacks on
September 11, 2001.
77
The following table sets forth the options granted during 2001 to, and the value
of the options held on December 31, 2001 by, our Named Executive Officers.
Messrs. Varacchi and Gardner were not granted any options during 2001:
OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
Percent of Total
Number of Shares Options Granted
Underlying Options to Employees Exercise or base Grant Date
Name Granted in 2001 Price ($/Share) Expiration Date Present Value ($)
---- ------- ------- --------------- --------------- -----------------
Howard W. Lutnick........... 1,500,000(1) 42.2% $5.10 10/19/11 4,068,150(2)
Lee M. Amaitis.............. 375,000(1) 10.5 5.10 10/19/11 1,017,038(2)
Joseph C. Noviello.......... 200,000(1) 5.6 5.10 10/19/11 542,420(2)
Stephen M. Merkel........... 200,000(1) 5.6 5.10 10/19/11 542,420(2)
- -------------------
(1) The options vest quarterly over a four year period from the date of grant,
October 19, 2001.
(2) The fair value of the options was estimated using a modified Black-Scholes
option pricing model and the following assumptions: risk-free interest rate
of 3.25%, no expected dividends, expected stock price volatility of 80% and
assumed to be exercised at 80% of their original life.
The following table provides information, with respect to the Named Executive
Officers, concerning options and SARs held as of December 31, 2001.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION/SAR VALUES
Number of Securities Underlying Value of Unexercised In-Money
Shares Unexercised Options/SARS at Options/SARs at Fiscal Year
Acquired on Value Realized Fiscal Year End (#) End($)(1)
Exercise on Exercise -------------------------------- -------------------------------
Name (#) ($) Exercisable Unexercisable Exercisable Unexercisable
- ---------------------------------------------------------------------------------------------------------------------------------
Howard W. Lutnick........... 0 -- 1,425,000 3,200,000 11,799,000 26,496,000
Frederick T. Varacchi*...... 0 -- 1,000,000 -- 8,280,000 --
Douglas B. Gardner*......... 0 -- 450,000 -- 3,726,000 --
Lee M. Amaitis.............. 0 -- 140,000 610,000 1,159,200 5,050,800
Joseph C. Noviello.......... 0 -- 58,750 291,250 486,450 2,411,550
Stephen M. Merkel........... 0 -- 60,000 340,000 496,800 2,815,200
- ----------------------
(1) Based on the last reported price of $8.28 for our Class A common stock on
December 31, 2001.
* Messrs. Varacchi and Gardner were lost as a result of the terrorist attacks on
September 11, 2001.
COMPENSATION OF DIRECTORS
Directors who are also our employees do not receive additional compensation for
serving as directors. On October 19, 2001, we granted each of our three
non-employee directors at the time options to purchase 30,000 shares of our
Class A common stock at an exercise price per share equal to $5.10, which was
the price of our Class A common stock on October 18, 2001. These options vest in
three equal installments beginning on the first of three semi-
78
anniversaries of the date of grant. Effective February 11, 2002, Mr. Dalton was
granted an option to purchase 30,000 shares of our Class A common stock at an
exercise price per share of $8.95 in connection with his election to our board.
Our non-employee directors receive annual compensation of $25,000. They also
receive compensation for each quarterly meeting of the board of directors
attended of $2,000 and options to purchase 1,500 shares of our Class A common
stock, which options vest in three equal installments beginning on the first of
three semi-anniversaries of the date of grant, and they receive $1,000 for each
additional meeting of our board of directors or committee of our board of
directors actually attended, whether by telephone or otherwise. If both a
meeting of our board of directors and of a committee of our board of directors
are held on the same date, an aggregate of $1,000 will be paid for attendance at
both meetings. Non-employee directors also are reimbursed for all out-of-pocket
expenses incurred in attending meetings of our board of directors or committees
of our board of directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of our board of directors consists of Messrs.
Breeden, Carter and Moran. All of the members of our Compensation Committee are
non-employee directors and are not former officers. During 2001, 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.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
BY MANAGEMENT. The following table sets forth certain information, as of March
15, 2002, 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 299 Park Avenue, New York, NY 10171.
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 number of shares of Class A common stock for purposes of this
table.
Beneficial Ownership(1)
---------------------------------------------------------------------------
Class A common Class B common
stock stock
--------------------------------- ---------------------------------
Name Shares % Shares %
- ----------------------------------------------------------------------------------------------------------------------------------
Howard W. Lutnick................................ 29,780,697 (2) 52.5%(3) 26,688,814(4) 100%
Lee M. Amaitis................................... 309,136 1.1(5) -- --
Joseph C. Noviello............................... 95,224 * -- --
Stephen M. Merkel................................ 133,703 (6) * -- --
Richard C. Breeden............................... 64,499 * -- --
Larry R. Carter.................................. 85,499 (7) * -- --
John H. Dalton................................... -- * -- --
William J. Moran................................. 44,999 * -- --
All executive officers and directors as a
group (8 persons) ............................... 30,513,466 53.3%(8) 26,688,814 100%
- -------------
* 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).
79
(2) Consists of (1) 1,743,750 shares of Class A common stock subject to options
currently exercisable or exercisable within 60 days of March 15, 2002, (2)
2,667,475 shares of Class B common stock held by Cantor Fitzgerald, L.P.,
which shares are immediately convertible into shares of Class A common
stock, (3) 24,021,339 shares of Class B common stock held by Cantor
Fitzgerald Securities, which shares are immediately convertible into Class
A common stock, (4) 387,469 shares of Class A common stock held by CF Group
Management, Inc. and (5) 960,664 shares of Class A common stock held
directly by Mr. Lutnick. 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) Percentage based on (1) 28,290,779 shares of Class A common stock
outstanding on March 15, 2002, (2) 26,688,814 shares of Class B common
stock immediately convertible into Class A common stock and (3) 1,743,750
shares of Class A common stock subject to options currently exercisable or
exercisable within 60 days of March 15, 2002.
(4) Consists of (1) 2,667,475 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) 24,021,339 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.
(5) Percentage based on (1) 28,290,779 shares of Class A common stock
outstanding on March 15, 2002 and (2) 205,624 shares of Class A common
stock subject to options currently exercisable or exercisable within 60
days of March 15, 2002.
(6) Includes 2,250 shares of Class A common stock beneficially owned by Mr.
Merkel's spouse.
(7) Includes 45,500 shares of Class A common stock owned by Cavallino Ventures
LLC, of which Mr. Carter is the President.
(8) Percentage based on (1) 28,290,779 shares of Class A common stock
outstanding on March 15, 2002, (2) 26,688,814 shares of Class B common
stock immediately convertible into Class A common stock and (3) 2,261,495
shares of Class A common stock subject to options currently exercisable or
exercisable within 60 days of March 15, 2002.
BY OTHERS. The following table sets forth certain information, as of March 15,
2002, 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 299 Park
Avenue, New York, NY 10171, and each entity listed has sole voting and
investment power 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.............................. 24,021,339(3) 45.9%(4) 24,021,339 90.0%
Cantor Fitzgerald, L.P.................................... 26,688,814(5) 48.5%(6) 26,688,814(7) 100.0%
CF Group Management, Inc.................................. 27,076,283(8) 49.2%(6) 26,688,814(7) 100.0%
J.P. Morgan Chase & Co. (9)............................... 1,637,364 5.8%(10) -- --
- ------------
(1) Based upon filings under Section 13 of the Exchange Act.
(2) Based on 26,688,614 shares of Class B common stock outstanding on March 15,
2002.
(3) Consists of shares of Class B common stock.
(4) Percentage based on 28,290,779 shares of Class A common stock outstanding
on March 15, 2002 and 24,021,339 shares of Class B common stock immediately
convertible into Class A common stock.
80
(5) Consists of (1) 2,667,475 shares of Class B common stock owned by Cantor
Fitzgerald, L.P. and (2) 24,021,339 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 28,290,779 shares of Class A common stock outstanding
on March 15, 2002 and 26,688,614 shares of Class B common stock immediately
convertible into Class B common stock.
(7) Consists of 2,667,475 shares of Class B common stock owned by Cantor
Fitzgerald, L.P. and 24,021,339 shares of Class B common stock owned by
Cantor Fitzgerald Securities. 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.
(8) Consists of (1) 387,469 shares of Class A common stock held by CF Group
Management, Inc., (2) 24,021,339 shares of Class B common stock held by
Cantor Fitzgerald Securities, which shares are immediately convertible into
Class A common stock and (3) 2,667,475 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.
(9) The address of J.P. Morgan Chase & Co. is 270 Park Avenue, New York, NY
10017. J.P. Morgan Chase & Co. has sole voting power with respect to
1,302,897 shares, sole dispositive power with respect to 1,632,784 shares
and shared dispositive power with respect to 4,580 shares of Class A common
stock.
(10) Percentage based on 28,290,779 shares of Class A common stock outstanding
on March 15, 2002.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
THE FORMATION TRANSACTIONS
Concurrently with our initial public offering, Cantor contributed to us certain
of our assets. These assets primarily consist of the proprietary software,
network distribution systems, technologies and related contractual rights that
comprise our eSpeed(R) 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 capital stock outstanding at the time. Cantor
converted 3,350,000 of these shares into the shares of our Class A common stock
which it sold in our initial public offering in December 1999.
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.
JOINT SERVICES AGREEMENT
Under our Joint Services Agreement with Cantor, we own and operate the
electronic trading systems and are responsible for providing electronic
brokerage services, and Cantor provides voice-assisted brokerage services,
clearance, settlement and other fulfillment 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. This agreement provides for a perpetual term.
REVENUE SHARING ARRANGEMENT
Under the Joint Services Agreement, we and Cantor share commissions 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 affect transactions in these
marketplaces; however, in the event we are unable to agree with Cantor with
respect to a transaction pricing decision, Cantor is
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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 commissions received by Cantor being less than Cantor's
actual cost of providing clearance, settlement and fulfillment services and
other transaction services. We and Cantor share revenues derived from
transactions effected in the marketplaces in which we collaborate and other
specified markets. The portion of the transaction revenues that we and Cantor
receive are 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 or other product; and (4) the product is traded on the Cantor
Exchange(SM). The percentage of the transaction revenues we receive ranges from
2.5% to 65%. However, in general, we receive 65% of the transaction revenues for
fully electronic transactions and Cantor receives 35% of the transaction
revenues. Cantor receives 93% of the transaction revenues for voice-assisted
brokerage transactions and we receive 7% of the transaction revenues. In
addition, if the transactions relate to a gaming business, we receive 25% of the
net trading revenues.
SOFTWARE SOLUTION 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 other 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 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. In
exchange for a 25% share of the net revenue from Cantor's gaming businesses, we
are obligated to spend and do not get reimbursed for the first $750,000 each
quarter of costs of providing support and development services for such gaming
businesses.
INTELLECTUAL PROPERTY
Cantor has granted to us a license covering Cantor's patents and patent
applications that relate to our eSpeed(R) system. The license is perpetual,
irrevocable, worldwide 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 servicemarks
"Cantor Exchange(SM)," "Interactive Matching(SM)," "MOLE(SM)" and "CX(SM)".
NON-COMPETITION AND MARKET OPPORTUNITY PROVISIONS
The Joint Services Agreement imposes performance obligations on us and restricts
our ability to compete with Cantor and Cantor's ability to compete with us in
markets that we and Cantor traditionally operate. We and Cantor have agreed to
exclude the TradeSpark and Freedom marketplaces from the provisions of the Joint
Services Agreement in order to enable us to enter into separate agreements in
connection with the new marketplaces.
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ADMINISTRATIVE SERVICES AGREEMENT
Under our Administrative Services Agreement with Cantor, Cantor provides certain
administrative and management services to us. Cantor makes available to us some
of its administrative and other staff, including its internal audit, treasury,
legal, tax, insurance, human resources, facilities, 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. These assets are subject to operating leases with third
party leasing companies. 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 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.
Pursuant to the Administrative Services Agreement, Cantor is required to obtain
for us, among other things, property and casualty insurance of not less than $40
million and business interruption insurance of $25 million. Cantor has procured
insurance coverage for us in these respective amounts; however, we are listed on
this insurance policy as one of several insured parties, together with Cantor
and several of its affiliates. This insurance policy is for aggregate amounts in
excess of the amounts set forth above. The Administrative Services Agreement
does not provide for the allocation of the proceeds among the named insureds.
Insurance proceeds paid to date have been paid to Cantor on behalf of all
parties named on the policy, and Cantor has allocated these proceeds among the
insured parties.
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 our
Class A common stock issued or issuable to it in connection with the conversion
of its shares of our Class B common stock whenever we propose to register any
shares of our Class A common stock for our own or another's account under the
Securities Act for a public offering, other than any shelf registration of
shares of our Class A common stock to be used as consideration for acquisitions
of additional businesses and 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 our Class A common stock issued
or issuable to it in connection with the conversion of its shares of our Class B
common stock. 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. We have also agreed to
indemnify Cantor and any transferee for certain liabilities they may incur in
connection with the exercise of their registration rights. 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 shares included in
that registration; (2) our right not to effect any demand registration within
six months of a public
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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,
President and Chief Executive Officer, is the sole stockholder of the managing
general partner of Cantor. As a result, Mr. Lutnick controls Cantor. Cantor owns
shares of our Class A common stock and Class B common stock representing
approximately 90.4% of the total voting power of our capital stock. Mr.
Lutnick's simultaneous service as our Chairman, President 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, transactions between us and Cantor and/or its other
affiliates are subject to the approval of a majority of our independent
directors. In addition, Cantor can compete with us under certain circumstances.
WILLIAMS AND DYNEGY
On June 5, 2000, each of Williams Energy Marketing & Trading and Dynegy
purchased a unit consisting of (a) 789,071 shares of our Class A common stock
and (b) warrants exercisable for the purchase of up to 666,666 shares of our
Class A common stock, for an aggregate purchase price for the unit of $25.0
million. The warrants have a per share exercise price of $35.20, a 10-year term
and are exercisable commencing on December 5, 2005, subject to acceleration
under certain prescribed circumstances. Acceleration results from the investment
by Williams and/or Dynegy, along with at least two additional participants, in
four new electronic and telephonic verticals to be formed by us and Cantor,
which we refer to as Qualified Verticals, by an agreed upon date. The initial
agreed upon date of June 2001 has been extended by the parties for a period not
to exceed two years. We refer to such period as the Presentment Period. The
Presentment Period operates in three month increments, and is subject to the
right of Dynegy and Williams to refuse to grant an additional three month
extension on not less than 30 days' prior notice to us. In connection with the
four Qualified Verticals, Williams and, subject to certain limitations, Dynegy,
will be entitled to invest $25.0 million in shares of our Class A common stock
at a 10% discount to the trading price of our Class A common stock determined at
the time of the investment in the Qualified Vertical. If we present Qualified
Vertical opportunities in accordance with the terms of the agreements, and
either Williams or Dynegy does not invest in at least four Qualified Verticals,
the non-investing entity will be required to make a $2,500,000 payment to us for
each investment not made, up to a maximum of $10 million. Williams and Dynegy
have already invested in the first Qualified Vertical presented to it,
Tradespark.
At such time as Williams and Dynegy (or their permitted affiliate assignees)
have made an aggregate equity investment in us of an amount equal to at least
$100.0 million, valued on a cost basis (and for so long as such
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parties maintain ownership of equity securities having such cost basis), Cantor
will use its best efforts to cause one designee jointly selected by Williams and
Dynegy to be nominated to our board of directors and to vote its shares of
common equity in favor of such designee.
In connection with the Williams and Dynegy transactions, we purchased from
Cantor 789,071 shares of our Class A common stock, representing half of the
number of shares of our Class A common stock sold by us to Williams and Dynegy,
for a purchase price of $25.0 million. In addition, Cantor has agreed to sell
half of the number of shares to be purchased by Williams and Dynegy, in the
aggregate, each time an additional investment right is exercised in connection
with a new Qualified Vertical for the same purchase price per share as is paid
by Williams and Dynegy at the time.
TRADESPARK
On September 22, 2000, we made a cash investment in TradeSpark of $2.0 million
in exchange for a 5% interest in TradeSpark, and Cantor made a cash investment
of $4.25 million in TradeSpark and agreed to contribute to TradeSpark certain
assets relating to its voice brokerage business in certain energy products in
exchange for a 28.33% interest in TradeSpark. We and Cantor also executed an
amendment to the Joint Services Agreement in order to enable each of us to
engage in this business transaction. The remaining 66.67% interest in TradeSpark
was purchased by energy industry market participants (EIPs). In connection with
such investment, we entered into a perpetual technology services agreement with
TradeSpark pursuant to which we provide the technology infrastructure for the
transactional and technology related elements of the TradeSpark marketplace as
well as certain other services to TradeSpark in exchange for specified
percentages of transaction revenues from the marketplace. If a transaction is
fully electronic, we receive 65% of the aggregate transaction revenues and
TradeSpark receives 35% of the transaction revenues. In general, if TradeSpark
provides voice-assisted brokerage services with respect to a transaction, then
we receive 35% of the revenues and TradeSpark receives 65% of the revenues.
Cantor also entered into an administrative services agreement with TradeSpark
pursuant to which it will provide administrative services to TradeSpark at cost.
We and Cantor each received representation rights on the management committee of
TradeSpark in proportion to our ownership interests in TradeSpark.
In order to provide incentives to the EIPs to trade on the TradeSpark electronic
marketplace, which will result in commissions to us under the TradeSpark
technology services agreement, we issued 5,500,000 shares of our Series A
preferred stock and 2,500,000 shares of our Series B preferred stock to a
limited liability company newly-formed by the EIPs to hold their investments in
TradeSpark and the Series A and B preferred stock.
MUNICIPAL PARTNERS
In January 2002, Cantor sold the assets of the business known as Municipal
Partners, Inc., a municipal bond broker, to Brian Kelly, a former employee of
Cantor, in exchange for a 25% special interest in a newly formed limited
liability company organized by Mr. Kelley, Municipal Partners, LLC. Cantor had
purchased substantially all of the assets of Municipal Partners, Inc. in July
2000. Cantor also loaned $1,000,000 to Newco and is entitled to distributions
equal to 5% of the gross revenues of the business less the amount of our revenue
share for electronic transactions. In connection with the sale, we (1) granted
Municipal Partners, LLC a non-exclusive license to use our software and
technology to operate a municipal bond brokerage business; (2) will maintain our
municipal bond trading platform and provide the software capabilities that were
in place in Cantor's municipal bond business (we are to be compensated for
upgrading the trading platform at cost plus a reasonable profit or at prevailing
rates, at our election); (3) will provide web-hosting, technical and customer
support at cost plus a reasonable fee to Municipal Partners, LLC; (4) will
receive 50% of gross revenues of Municipal Partners, LLC with respect to
electronic transactions; and (5) terminated existing arrangements with former
brokers in the business (some of whom are deceased) pursuant to which we had
given them shares of our Class A common stock valued at $1,250,000 in exchange
for promissory notes in the same
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amount and we and they agreed to termination of the notes and cancellation of
the shares in certain circumstances, which have since occurred.
FREEDOM INTERNATIONAL BROKERAGE
On January 29, 2001, we and Cantor formed a limited partnership to acquire 66.7%
of Freedom International Brokerage. On April 4, 2001, we contributed 310,770
shares of our Class A common stock to the limited partnership, which entitles us
to 75% of the limited partnership's interest in Freedom. We share in 15% of the
limited partnership's cumulative profits but not in its cumulative losses.
Cantor contributed 103,589 shares of our Class A common stock as the general
partner. Cantor will be allocated all of the limited partnership's cumulative
losses and 85% of the cumulative profits. The limited partnership exchanged the
414,359 shares for its 66.7% interest in Freedom. In addition, we issued
warrants to purchase 400,000 shares of our Class A common stock to provide
incentives to the Freedom owner-participants other than us and Cantor to migrate
to our fully electronic platform. To the extent necessary to protect us from any
allocation of losses, Cantor is required to provide future capital contributions
to the limited partnership up to an amount that would make Cantor's total
contribution equal to our investment in the limited partnership.
Upon the closing of the transaction, we entered into a services agreement with
Freedom to provide for electronic trading technology and services and
infrastructure/back-offices services. Under this agreement, we are entitled to
65% of the electronic transaction services revenues and Freedom is entitled to
35% of the revenues. We also receive 35% of revenues derived from all
voice-assisted transactions, other miscellaneous transactions and the sale of
market data or other information that is not incidental to the above services.
INDEMNIFICATION BY CANTOR
Although we do not expect to incur any losses with respect to pending lawsuits
or supplemental allegations relating to Cantor and Cantor's limited partnership
agreement, Cantor has agreed to indemnify us with respect to any liabilities we
incur as a result of such lawsuits or allegations.
REVERSE REPURCHASE AGREEMENTS
We enter into overnight reverse repurchase agreements with Cantor. At December
31, 2001, the reverse repurchase agreements totaled $157.3 million, including
accrued interest. The securities collateralizing the reverse repurchase
agreements are held under a custodial arrangement with a third party bank.
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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 50.
(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. We have requested confidential treatment as to certain
portions of the Exhibits designated by a cross (+), which portions have been
omitted and filed separately with the Securities and Exchange Commission.
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. (Incorporated by
reference by Exhibit 2.1 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1999).
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. (Incorporated by reference to
Exhibit 2.2 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1999).
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 Second Amended and Restated By-Laws of eSpeed, Inc.
(Incorporated by reference to Exhibit 3.2 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2000).
3.3 Certificate of Designations, Preferences and Rights of Series
A Redeemable Convertible Preferred Stock of eSpeed, Inc.
(Incorporated by reference to Exhibit 3.3 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September
30, 2000).
3.4 Certificate of Designations, Preferences and Rights of Series
B Redeemable Convertible Preferred Stock of eSpeed, Inc.
(Incorporated by reference to Exhibit 3.4 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September
30, 2000).
3.5 Certificate of Designations, Preferences and Rights of Series
C Redeemable Convertible Preferred Stock of eSpeed, Inc.
(Incorporated by reference to Exhibit 3.5 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2001).
4 Specimen Class A Common Stock Certificate. (Incorporated by
reference to Exhibit 4 to the Registrant's Registration
Statement on Form S-1 (Reg. No. 333-87475)).
10.1* Long-Term Incentive Plan of eSpeed, Inc., as amended and
restated.
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10.2* Amended and Restated eSpeed, Inc. Employee Stock Purchase
Plan (Incorporated by reference to Exhibit 10.2 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2000).
10.3 Amended and Restated Joint Services Agreement, dated as of
April 1, 2001, by and among Canter Fitzgerald, L.P., a
Delaware limited partnership, on behalf of itself and its
direct and indirect, current and future, subsidiaries, other
than eSpeed, Inc. and its direct and indirect, current and
future, subsidiaries, and eSpeed, Inc., a Delaware
corporation, on behalf of itself and its direct and indirect,
current and future, subsidiaries. (Incorporated by reference
to Exhibit 10.20 to the Registrant's Quarterly Report for the
quarter ended June 30, 2001).
10.4 Amendment No. 1 to Amended and Restated Joint Services
Agreement, dated as of January 30, 2002.
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. (Incorporated by reference
to Exhibit 10.5 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1999).
10.6 Registration Rights Agreement, dated as of December 9, 1999,
by and among eSpeed and the Investors named therein.
(Incorporated by reference to Exhibit 10.6 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1999).
10.7 Sublease Agreement, dated as of December 15, 1999, between
Cantor Fitzgerald Securities and eSpeed, Inc. (Incorporated
by reference to Exhibit 10.7 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1999).
10.8 Warrants issued to Martin J. Wygod and a related trust.
(Incorporated by reference to Exhibit 10.8 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1999).
10.9 Registration Rights Agreement, dated as of June 5, 2000 among
eSpeed, Inc., Williams Energy Marketing & Trading Company and
Dynegy, Inc. (Incorporated by reference to Exhibit 10.9 to
the Registrant's Quarterly Report for the quarter ended June
30, 2000).
10.10 Stock Purchase Agreement, dated April 26, 2000, between
eSpeed, Inc. and Cantor Fitzgerald Securities (Incorporated
by reference to Exhibit 10.10 to the Registrant's Quarterly
Report for the quarter ended June 30, 2000).
10.11 Amendment to Stock Purchase Agreement, dated June 2, 2000,
among eSpeed, Inc., Cantor Fitzgerald Securities and Cantor
Fitzgerald, L.P. (Incorporated by reference to Exhibit 10.11
to the Registrant's Quarterly Report for the quarter ended
June 30, 2000).
10.12 Warrant issued to Dynegy, Inc. (Incorporated by reference to
Exhibit 10.12 to the Registrant's Quarterly Report for the
quarter ended June 30, 2000).
10.13 Warrant issued to Williams Energy Marketing & Trading Company
(Incorporated by reference to Exhibit 10.13 to the
Registrant's Quarterly Report for the quarter ended June 30,
2000).
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10.14+ Subscription Agreement, dated April 26, 2000, among Dynegy,
Inc., eSpeed, Inc. and Cantor Fitzgerald, L.P. (Incorporated
by reference to Exhibit 10.14 to the Registrant's Quarterly
Report for the quarter ended June 30, 2000).
10.15+ Subscription Agreement, dated April 26, 2000, among The
Williams Companies, Inc., eSpeed, Inc. and Cantor Fitzgerald,
L.P. (Incorporated by reference to Exhibit 10.15 to the
Registrant's Quarterly Report for the quarter ended June 30,
2000).
10.16 Registration Rights Agreement, dated as of September 22, 2000
among eSpeed, Inc., EIP Holdings, LLC, Williams Energy
Marketing & Trading Company and Coral Energy Holding, LP,
Koch Energy Trading, Inc. TXU Energy Trading Company and
Dominion Energy Exchange, Inc. (Incorporated by reference to
Exhibit 10.16 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 2000).
10.17 Registration Rights Agreement, dated as of July 30, 2001,
among eSpeed, Inc. and the Investors named therein
(Incorporated by reference to Exhibit 10.19 to the
Registrant's Quarterly Report for the quarter ended June 30,
2001).
10.18 Warrant Agreement, dated as of April 4, 2001, among eSpeed,
Inc. and the Freedom participants named therein (Incorporated
by reference to Exhibit 10.21 to the Registrant's Quarterly
Report for the quarter ended June 30, 2001).
21 List of subsidiaries of eSpeed, Inc.
23 Consent of Deloitte & Touche LLP, independent auditors.
24 Powers of Attorney (included on signature page).
(b) Reports on Form 8-K.
We filed a Current Report on Form 8-K on October 11, 2001 that included
press releases issued by us with respect to the impact on our business of
the attacks on the World Trade Center on September 11, 2001.
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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 Annual Report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized, on the
28th day of March, 2002.
eSPEED, INC.
By: /s/ Howard W. Lutnick
-------------------------------------
Name: Howard W. Lutnick
Title: Chairman of the Board, Chief
Executive Officer and President
POWERS OF ATTORNEY
Each person whose signature appears below hereby authorizes and constitutes
Howard W. Lutnick and Stephen M. Merkel, and each of them singly, his true and
lawful attorney-in-fact, with full power of substitution and resubstitution, for
him and in his name, place and stead, in any and all capacities, to sign and
file any and all amendments to this Report, with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
and he hereby ratifies and confirms all that said attorney-in-fact or either of
them, or his or their substitutes, may lawfully do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report has been signed below by the following persons on behalf of the
Registrant, eSpeed, Inc., in the capacities and on the date or dates indicated.
SIGNATURE CAPACITY IN WHICH SIGNED DATE
/s/ Howard W. Lutnick Chairman of the Board, March 28, 2002
- -------------------------- Chief Executive Officer
Howard W. Lutnick and President
(Principal Executive Officer)
/s/John Martinez Controller (Principal Financial March 28, 2002
- -------------------------- and Accounting Officer)
John Martinez
/s/ Lee Amaitis Director March 28, 2002
- --------------------------
Lee Amaitis
/s/ Richard C. Breeden Director March 28, 2002
- --------------------------
Richard C. Breeden
/s/ Larry R. Carter Director March 28, 2002
- --------------------------
Larry R. Carter
/s/ John H. Dalton Director March 28, 2002
- --------------------------
Hon. John H. Dalton
/s/ Stephen M. Merkel Director March 28, 2002
- --------------------------
Stephen M. Merkel
/s/ William J. Moran Director March 28, 2002
- --------------------------
William J. Moran
/s/ Joseph Noviello Director March 28, 2002
- --------------------------
Joseph Noviello
90
EXHIBIT INDEX
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. (Incorporated by
reference by Exhibit 2.1 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1999).
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. (Incorporated by reference to
Exhibit 2.2 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1999).
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 Second Amended and Restated By-Laws of eSpeed, Inc.
(Incorporated by reference to Exhibit 3.2 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2000).
3.3 Certificate of Designations, Preferences and Rights of Series
A Redeemable Convertible Preferred Stock of eSpeed, Inc.
(Incorporated by reference to Exhibit 3.3 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September
30, 2000).
3.4 Certificate of Designations, Preferences and Rights of Series
B Redeemable Convertible Preferred Stock of eSpeed, Inc.
(Incorporated by reference to Exhibit 3.4 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September
30, 2000).
3.5 Certificate of Designations, Preferences and Rights of Series
C Redeemable Convertible Preferred Stock of eSpeed, Inc.
(Incorporated by reference to Exhibit 3.5 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2001).
4 Specimen Class A Common Stock Certificate. (Incorporated by
reference to Exhibit 4 to the Registrant's Registration
Statement on Form S-1 (Reg. No. 333-87475)).
10.1* Long-Term Incentive Plan of eSpeed, Inc., as amended and
restated.
10.2* Amended and Restated eSpeed, Inc. Employee Stock Purchase
Plan (Incorporated by reference to Exhibit 10.2 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2000).
10.3 Amended and Restated Joint Services Agreement, dated as of
April 1, 2001, by and among Canter Fitzgerald, L.P., a
Delaware limited partnership, on behalf of itself and its
direct and indirect, current and future, subsidiaries, other
than eSpeed, Inc. and its direct and indirect, current and
future, subsidiaries, and eSpeed, Inc., a Delaware
corporation, on behalf of itself and its direct and indirect,
current and future, subsidiaries. (Incorporated by reference
to Exhibit 10.20 to the Registrant's Quarterly Report for the
quarter ended June 30, 2001).
10.4 Amendment No. 1 to Amended and Restated Joint Services
Agreement, dated as of January 30, 2002.
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. (Incorporated by reference
to Exhibit 10.5 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1999).
10.6 Registration Rights Agreement, dated as of December 9, 1999,
by and among eSpeed and the Investors named therein.
(Incorporated by reference to Exhibit 10.6 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1999).
10.7 Sublease Agreement, dated as of December 15, 1999, between
Cantor Fitzgerald Securities and eSpeed, Inc. (Incorporated
by reference to Exhibit 10.7 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1999).
10.8 Warrants issued to Martin J. Wygod and a related trust.
(Incorporated by reference to Exhibit 10.8 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1999).
10.9 Registration Rights Agreement, dated as of June 5, 2000 among
eSpeed, Inc., Williams Energy Marketing & Trading Company and
Dynegy, Inc. (Incorporated by reference to Exhibit 10.9 to
the Registrant's Quarterly Report for the quarter ended June
30, 2000).
10.10 Stock Purchase Agreement, dated April 26, 2000, between
eSpeed, Inc. and Cantor Fitzgerald Securities (Incorporated
by reference to Exhibit 10.10 to the Registrant's Quarterly
Report for the quarter ended June 30, 2000).
10.11 Amendment to Stock Purchase Agreement, dated June 2, 2000,
among eSpeed, Inc., Cantor Fitzgerald Securities and Cantor
Fitzgerald, L.P. (Incorporated by reference to Exhibit 10.11
to the Registrant's Quarterly Report for the quarter ended
June 30, 2000).
10.12 Warrant issued to Dynegy, Inc. (Incorporated by reference to
Exhibit 10.12 to the Registrant's Quarterly Report for the
quarter ended June 30, 2000).
10.13 Warrant issued to Williams Energy Marketing & Trading Company
(Incorporated by reference to Exhibit 10.13 to the
Registrant's Quarterly Report for the quarter ended June 30,
2000).
10.14+ Subscription Agreement, dated April 26, 2000, among Dynegy,
Inc., eSpeed, Inc. and Cantor Fitzgerald, L.P. (Incorporated
by reference to Exhibit 10.14 to the Registrant's Quarterly
Report for the quarter ended June 30, 2000).
10.15+ Subscription Agreement, dated April 26, 2000, among The
Williams Companies, Inc., eSpeed, Inc. and Cantor Fitzgerald,
L.P. (Incorporated by reference to Exhibit 10.15 to the
Registrant's Quarterly Report for the quarter ended June 30,
2000).
10.16 Registration Rights Agreement, dated as of September 22, 2000
among eSpeed, Inc., EIP Holdings, LLC, Williams Energy
Marketing & Trading Company and Coral Energy Holding, LP,
Koch Energy Trading, Inc. TXU Energy Trading Company and
Dominion Energy Exchange, Inc. (Incorporated by reference to
Exhibit 10.16 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 2000).
10.17 Registration Rights Agreement, dated as of July 30, 2001,
among eSpeed, Inc. and the Investors named therein
(Incorporated by reference to Exhibit 10.19 to the
Registrant's Quarterly Report for the quarter ended June 30,
2001).
10.18 Warrant Agreement, dated as of April 4, 2001, among eSpeed,
Inc. and the Freedom participants named therein (Incorporated
by reference to Exhibit 10.21 to the Registrant's Quarterly
Report for the quarter ended June 30, 2001).
21 List of subsidiaries of eSpeed, Inc.
23 Consent of Deloitte & Touche LLP, independent auditors.
24 Powers of Attorney (included on signature page).