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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, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-28191
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ESPEED, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 13-4063515
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation) Identification No.)
135 EAST 57TH, NEW YORK, NEW YORK 10022
(Address of Principal Executive Offices) (Zip Code)
(212) 938-5000
(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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
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
June 28, 2002 as reported on the Nasdaq National Market, was approximately
$288,986,197.
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 17, 2003
- ----- -----------------------------
CLASS A COMMON STOCK, PAR VALUE $.01 PER SHARE 29,855,446 SHARES
CLASS B COMMON STOCK, PAR VALUE $.01 PER SHARE 25,362,809 SHARES
DOCUMENTS INCORPORATED BY REFERENCE.
NONE.
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ESPEED, INC.
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I ....................................................................1
ITEM 1. BUSINESS............................................................1
ITEM 2. PROPERTIES.........................................................23
ITEM 3. LEGAL PROCEEDINGS..................................................23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS............................................................24
PART II ...................................................................26
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS........................................26
ITEM 6. SELECTED FINANCIAL DATA............................................28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS:.....................29
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK........................................................38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE.............................62
PART III ...................................................................63
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT.........................................................63
ITEM 11. EXECUTIVE COMPENSATION.............................................64
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT.....................................................66
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................69
ITEM 14. CONTROLS AND PROCEDURES............................................74
PART IV ...................................................................74
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K................................................74
1
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, the effect of the September 11
Events (as defined below) on our operations, including in particular the loss of
hundreds of eSpeed, Cantor Fitzgerald, L.P. and TradeSpark employees, our
limited operating history, the possibility of future losses and negative cash
flow from operations, the effect of market conditions, including volume and
volatility, and the current global recession on our business, our ability to
enter into marketing and strategic alliances, to hire new personnel, to expand
the use of our electronic system, to induce clients to use our marketplaces and
services and to effectively manage any growth we achieve, and other factors that
are discussed under "Risk Factors" in this Annual Report on Form 10-K. The
following discussion is qualified in its entirety by, and should be read in
conjunction with, the more detailed information set forth in our financial
statements and the notes thereto appearing elsewhere in this filing.
OVERVIEW OF OUR BUSINESS
We are a leader in developing and deploying electronic marketplaces and related
trading technology that offers traders access to the most liquid, efficient and
neutral financial markets in the world. We operate multiple buyer, multiple
seller real-time electronic marketplaces for the global non-equity capital
markets, including the world's largest government bond markets and other fixed
income marketplaces. Our suite of marketplace tools provides end-to-end
transaction solutions for the purchase and sale of financial and non-financial
products over our global private network or via the Internet.
Our products enable market participants to transact business instantaneously,
more effectively and at lower cost than in traditional voice-based brokerage
markets. Our systems were built to support multiple buyers and sellers in
interactive marketplaces, in a completely neutral, efficient and real-time
environment. In 2002, we processed over 4.5 million electronic transactions,
totaling more than $35 trillion of transactional volume. Our clients include
most of the largest fixed income and foreign exchange trading firms, major
exchanges and leading natural gas and electricity trading firms in the world. We
have offices in the U.S., U.K. and Asia that can transact trading 24 hours a
day, around the world. We believe we offer one of the most robust, large-scale,
instantaneous and reliable transaction processing systems in the world. 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.
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 September 11 Events). The loss of
these assets and employees and the need to relocate our surviving employees have
negatively impacted our business. See "Risk Factors".
We commenced operations in March 1999 as a division of Cantor Fitzgerald
Securities, a subsidiary of Cantor Fitzgerald, L.P. (Cantor). Our initial focus
was the global government bond markets of the world, specifically, U.S., Europe,
Canada and Japan. Our relationship with Cantor, a leading global inter-dealer
broker in the fixed income markets and the former leader in the U.S. government
bond voice-brokerage business, enabled us to become the leader in what today we
consider our core electronic marketplaces, the government bond markets of the
world. Our goal is to offer the full range of financial products currently
traded in today's global non-equity capital markets, which includes wholesale
fixed income, foreign exchange and futures and options.
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 (Freedom), the leading Canadian inter-dealer broker of fixed income
products and other capital products. During 2003, we plan to move beyond the
world's government bond and energy markets by focusing our efforts on several
other non-equity capital markets, including U.S. agencies, treasury spreads,
foreign exchange and interest rate swaps. We also plan to leverage our
electronic marketplace expertise and reputation to sell software products and
services directly to participants in these marketplaces.
Our revenues consist primarily of transaction fees and software solutions fees,
and we market our services to clients, partners and prospects. We do not risk
our own capital in transactions or extend credit to market participants.
1
We have organized our business in four categories, across multiple liquid and
commoditized industries in the financial services and energy markets. These four
categories are core products, new product rollouts, product enhancement software
and eSpeed Software Solutions(SM) sales. We offer our products and services to
participants in the financial and energy markets.
Our objective is to be the leading provider of trading technology and
interactive marketplaces for the non-equity capital markets, where we believe
the opportunity for electronic trading to be substantial. Specifically, we
believe we are well-positioned to take advantage of the large opportunities
throughout the fixed income, foreign exchange, futures and energy markets of the
world. 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.
THE 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 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 and creating markets. 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 privately
managed global high-speed data network and over the Internet. Because of the
scale and adaptability of our system, our products have applications across a
broad range of companies, industries and vertical marketplaces, including any
global non-equity capital 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 MARKET FOCUS
FINANCIAL MARKETS
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 2002, there were over $20.2 trillion of fixed income securities
outstanding with over $632 billion of volume traded daily. In the U.S. Treasury
securities market, there is reported to be over $366 billion a day in trading
just among the primary dealers and their clients. According to the International
Swaps and Derivatives Association, the global market for interest rate swaps,
interest rate options and currency swaps had over $82.7 trillion in notional
value outstanding as of June 2002.
2
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 $1.2 trillion as of April 2001.
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 2002, over 5.99 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 Markets Solution
Our products in the financial markets include 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, foreign exchange, 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(R) system provides the only way to
electronically access Cantor's marketplaces. Through our alliance with Freedom,
Cantor and six leading Canadian financial institutions, eSpeed 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)
portfolio 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.
We also see opportunities to expand our business by licensing our technology to
other voice brokers in addition to Cantor.
3
ENERGY MARKETS
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.
TradeSpark combines 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.
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 significant 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.
Powered by our full trading platform encompassed in eSpeed, 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.
TradeSpark offers three possible points of access to one pool of liquidity: over
the Internet, through our private network and through TradeSpark voice brokers.
TradeSpark began the year with strong results, however the exit of major energy
companies from the wholesale energy trading markets along with significant
credit deterioration and liquidity issues in the marketplace led to a severe
downturn in the energy market overall as well as in the performance of
TradeSpark, and caused a negative impact on its net revenues recorded, which
caused us to write down our investment in TradeSpark to its net realizable value
in the fourth quarter of 2002.
ESPEED(R) PRODUCTS
Our products are organized in the following four categories:
CORE PRODUCTS
Currently, most of our revenues are derived from transactions in our core
products. These include various United States, European, Canadian and Japanese
government securities. Our full-service eSpeed(R) system, combining all of our
proprietary software and our global high-speed private network, currently
operates in some of the largest and most complex government bond marketplaces in
the world. It is designed to be extendible to any multiple-buyer,
multiple-seller marketplace and can support massive liquidity and fluctuation in
many markets. Our customers in these core products are the largest financial
institutions in the world. These customers access our eSpeed(R) system primarily
through our global high-speed private network. In addition, the system for these
products is also available over the Internet. Our core products enable 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 marketplaces
will serve as significant barriers to entry for our competitors.
NEW PRODUCT ROLLOUTS
We have identified major opportunities to leverage our position in our core
global government bond markets into a variety of key non-equity capital markets.
For example, in 2003 we will roll out products in U.S. agencies, off-the-run
U.S. Treasury securities, spreads, and basis trading of U.S. Treasuries,
municipal bonds, interest rate swaps and foreign exchange.
In December 2002, we entered into an agreement with the Chicago Board of Trade
(CBOT) to distribute futures products through the eSpeed(R) system, providing
customers the ability to trade both cash and futures in one neutral,
fully-electronic marketplace. By routing CBOT futures trades over the existing
eSpeed(R) network and providing front-end integration to our clients, our cash
traders and the CBOT's futures traders will have direct, instantaneous access to
both markets. This product will be available through the eSpeed(R) SuperQuads
software.
Also in December 2002, we acquired the technology to route equities order flow
directly to listed exchanges and ECNs, either as directed by the client or via
automatic order routing, through the acquisition of the business and technology
of TSI Holdings, Inc., known as TradeAnywhere. In 2002, we became a recognized
service bureau for the New York Stock Exchange and American Stock Exchange. We
intend to capitalize on this recognized service bureau status by leasing
telecommunications capacity to other firms which will use it to transmit orders
to the exchanges.
4
PRODUCT ENHANCEMENT SOFTWARE
We recently introduced the following three significant software enhancements --
SuperQuads, Price Improvement and Direct Dealing -- that will enable our clients
to engage in the electronic trading of our core products and future product
rollouts.
o SuperQuads is a new screen configuration that allows for the introduction
of additional markets and products on the eSpeed(R) system. For example,
through our agreement with the Chicago Board of Trade, SuperQuads will
enable us to route CBOT's treasury futures traders over its existing
network and will offer front end integration to clients. Customers will
have the ability to trade both cash and futures in one neutral,
fully-electronic marketplace. It will allow for network distribution and
seamless front office integration, as well as positioning ourselves in this
new market segment. We expect to release this product in the second quarter
of 2003.
o Price Improvement is an enhancement for trading products on our
eSpeed(R) system that gives users the opportunity to trade past a bid or
offer, from bid/ask state, and advance their position by slightly improving
on the quoted market. The enhancement was designed to make trading more
efficient, bringing buyers and sellers closer to the desired trading state,
and positions us to share in the revenues generated by the improved trades.
o Direct Dealing allows users to put in a request for a quote for specific
products, providing the trader with the ability to reach market
participants with an electronic request for interest in specific securities
for which the trader has defined sizes. Direct Dealing maintains the
trader's anonymity, allows the trader to determine a set amount of time for
the request to be filled and treats all participants equally. Direct
Dealing is especially useful for trading in large blocks, helping to
eliminate unwanted market movement and bringing with it electronic
efficiency to less liquid markets.
ESPEED SOFTWARE SOLUTIONS(SM)
eSpeed Software Solutions(SM) leverages our global infrastructure, portfolio of
intellectual property and electronic trading expertise to allow customers to
build electronic marketplaces and exchanges, enable real-time auctions, enhance
debt issuance and customize trading interfaces. eSpeed Software Solutions(SM)
takes advantage of the scalability, flexibility and functionality of our
eSpeed(R) system to enable our clients to distribute their branded products to
their customers through online offerings and auctions, including private and
reverse auctions, via our trading platform and global network. Using
eSpeed Software Solutions(SM), customers are able to develop a marketplace,
trade with its customers, issue debt, trade odd lots, access program trading
interfaces, and access our network and our intellectual property.
We have signed software solution agreements with Refco 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. 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 began
powering the Federal Home Loan Bank's primary discount note auctions in August
2002.
We have also entered into long-term licensing agreements with respect to our
patents and other intellectual property, including a license agreement with
InterContinentalExchange Inc. and as well as licenses to the Chicago Mercantile
Exchange Inc. and the Board of Trade of the City of Chicago.
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. 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. This
business was suspended after the September 11 Events. 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 trading of a broad range
of futures contracts globally, including opportunities like our futures
agreement with CBOT.
5
OUR TECHNOLOGY
Our eSpeed(R) system is accessible to our clients through (1) our proprietary
front-end trading software, (2) our application programming interface (API),
which is 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 data centers in the U.S. and the U.K.
and is distributed either over our multiple path global network or via the
Internet through links to multiple global Internet service providers.
Our electronic marketplaces operate on a technology platform and network that
emphasize scalability, performance, adaptability and reliability. Our technology
platform consists of:
o our proprietary, internally developed real-time installed 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.
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 24 hubs linked by
over 50,000 miles of cable, over 500 Cisco network devices and more than 700
high capacity Sun servers and Compaq Alpha servers located in data centers in
London and Rochelle Park, New Jersey that are able to process over 150
transactions per second, per instrument or product. 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
6
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 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 withdrawn from the market as a
result of the terrorist attacks on September 11, 2001. We plan to reintroduce
them throughout 2003. 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(R) 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 our financial markets, 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(R) 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 and other functions,
substantially improving and reducing the cost of many of our clients' back
offices, and enabling straight-through processing.
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
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:
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EXPAND SYSTEM FUNCTIONALITY AND DEVELOP NEW PRODUCTS, SOFTWARE AND SERVICES FOR
OUR EXISTING FINANCIAL MARKETS
We plan to continue to expand the types of financial and other products traded
in our marketplaces, both in the United States and abroad. In 2003 we will roll
out products in U.S. agencies, off-the-run U.S. Treasury securities, spreads,
and basis trading of U.S. Treasuries, municipal bonds, interest rate swaps and
foreign exchange. Our goal is to include in our electronic marketplaces the full
range of financial products that are currently traded in today's non-equity
capital markets worldwide. In addition, we plan to develop software and
services to add new methods to effect transactions in these products, including
our SuperQuads, Price Improvement and Direct Dealing software enhancements. 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 NON-EQUITY
CAPITAL MARKETS AND OTHER INDUSTRIES
Because of the scale of our system and infrastructure 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. We
believe 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 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 direct dealing
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 alliance with Freedom and in our other ventures.
OUR CLIENTS
Our clients in our financial markets include banks, dealers, brokers and other
wholesale market participants, over 700 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 our energy markets
include energy trading companies, utilities and other wholesale market
participants.
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 eSpeed Software Solutions(SM) 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 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 and communications 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
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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, awareness 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 266 technology professionals. 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, some of which competitors are larger than we are and
have greater financial resources.
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. In January 2003, ICAP and BrokerTec Global, two of our largest
competitors, entered into an agreement by which ICAP would acquire certain
businesses of BrokerTec Global involving electronic trading of government
securities. The acquisition is conditional upon regulatory approval in the
United States and, if approved, could have a significant impact on our
competitive position.
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 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 2002, we entered into a Settlement Agreement with
Electronic Trading Systems Corporation, the Chicago Mercantile Exchange Inc. and
the CBOT to resolve the litigation related to the Wagner Patent.
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See "Item 3. Legal Proceedings". On March 29, 2002, we entered into a long term
licensing agreement with IntercontinentalExchange, Inc. (ICE) granting use of
our Wagner Patent to ICE. Under the terms of the agreement, ICE will pay an
annual royalty of $2 million per year. ICE will also pay to us $0.10 for each
contract that participants submit to the electronic futures exchange for
trading, or $0.20 for each contract contained in matched trades on the
electronic futures exchange. To date, we have not received any per contract
revenue from this arrangement. The agreement will remain in effect until
February 7, 2007, or for the duration of the life of the patent, unless certain
conditions are not met. In December 2002, we entered into an agreement with the
Chicago Board of Trade to distribute futures products over our eSpeed(R) system.
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.
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 will be found by a court to be 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, 2002, we had 319 employees, five of whom are our executive
officers. None of these employees is represented by a union. We believe that we
have good relations with our employees.
WEBSITE ACCESS TO REPORTS
Our Internet website address is www.espeed.com. Through our Internet website, we
make available, free of charge, the following reports as soon as reasonably
practicable after electronically filing them with, or furnishing them to, the
SEC: our annual report on Form 10-K; our quarterly reports on Form 10-Q; our
current reports on Form 8-K; and amendments to those reports filed or furnished
pursuant to Section 13(a) of the Securities Exchange Act of 1934. Our Proxy
Statements for our Annual Meetings are also available through our Internet
website. Our Internet website and the information contained therein or connected
thereto are not intended to be incorporated into this Annual Report on Form
10-K.
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 MAY 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
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 may 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
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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.
WE MAY INCUR LOSSES IN THE FUTURE.
From our inception through December 31, 2002, we have sustained a cumulative net
loss of approximately $49.4 million. While we currently expect to generate
operating profits in the year 2003, as we continue to develop our systems and
infrastructure and expand our brand recognition and client base through
increased marketing efforts, we may 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 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 OR FUTURE 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 or future 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.
As a result of the downturn of the energy market and the performance of
TradeSpark, our investment in TradeSpark has become impaired and has been
written down to its net realizable value.
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;
11
o financial losses;
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.
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
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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.
Although we have obtained $15 million in "key person" life insurance on the life
of Mr. Lutnick, we do not have "key person" life insurance policies on any of
our other 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 some 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.
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.
WE HAVE HAD TO RESORT TO COSTLY LITIGATION TO PROTECT AND DEFEND CERTAIN OF OUR
INTELLECTUAL PROPERTY RIGHTS, AND MAY CONTINUE TO HAVE TO DO SO.
We have had to resort to costly litigation to enforce certain of our
intellectual property rights. We may have to continue to resort to litigation to
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 database and other software from third parties, much of which is
integral to our systems and our business. The licenses are terminable if we
breach our obligations under the license agreements. If any of these
relationships were terminated or if any of these third parties were to cease
doing business, we may be forced to spend significant time and money to replace
the licensed software. However, we cannot assure you that the necessary
replacements will be available on reasonable terms, if at all.
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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.
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. In January 2003, ICAP and
BrokerTec Global, two of our largest competitors, entered into an agreement by
which ICAP would acquire certain businesses of BrokerTec Global involving
electronic trading of government securities. The acquisition is conditional upon
regulatory approval in the United States and, if approved, could have a
significant impact on our competitive position.
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.
14
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.
IF THERE IS LESS U.S. TREASURY DEBT OUTSTANDING, OR IF OUR SHARE OF THE U.S.
TREASURY MARKET DECLINES, OUR REVENUES MAY BE ADVERSELY AFFECTED.
Our business is highly dependent upon the volume of bonds being traded through
our eSpeed(R) system. We believe that we have historically led the U.S. Treasury
benchmark market, and our revenues are increasingly concentrated in this
business. If the U.S. reduces its outstanding Treasury debt, or if there is
contraction in the U.S. Treasury market, there may be a decline in the volume of
U.S. Treasury securities traded through our eSpeed(R) system. Similarly, if we
were to lose market share in the U.S. Treasury market, our revenues would be
adversely affected.
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;
o reduced protection for intellectual property rights;
o seasonal reductions in business activity during the summer months; and
o potentially adverse tax consequences.
15
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.
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. 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;
16
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
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.
17
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.
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 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.
18
Since June 9, 2002, 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(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."
Our board has authorized the repurchase of up to $40 million of our outstanding
Class A common stock. As of December 31, 2002, 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. During the first quarter of 2003, we
purchased an additional 161,799 shares for a total purchase price of $1,872,112,
bringing the total number of treasury shares owned to 186,399 at a book value of
$2,094,004. We anticipate making additional stock repurchases in 2003.
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 was
adversely affected by the effect of the September 11 Events on Cantor's
business. See "-- The events of September 11, 2001 have had and may continue to
have an adverse effect on our business." 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 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 property insurance coverage for us
covering our fixed assets and business interruption insurance in the amount of
$25 million. However, in the case of business interruption insurance, 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.
Four of our directors and our executive officers are either partners and/or
officers of Cantor. Simultaneous service as an eSpeed director or officer and
service as an 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 1, 2003, Mr. Lutnick controlled
approximately 89.8% 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.
19
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.
BECAUSE AGREEMENTS BETWEEN US AND CANTOR ARE NOT THE RESULT OF ARM'S-LENGTH
NEGOTIATIONS, WE MAY RECEIVE LOWER SERVICE FEES 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".
20
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 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.
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 1, 2003, Cantor beneficially owned approximately 89.8% 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.
21
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.
22
ITEM 2. PROPERTIES
We have offices in the U.S., U.K. and Asia. Our principal executive offices are
located at 135 East 57th Street, New York, New York. We currently occupy space
subleased by 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. We pay Cantor
approximately $717,000 annually for the use of the Rochelle Park space.
ITEM 3. LEGAL PROCEEDINGS
By Statement of Claim dated October 8, 2002, Municipal Partners, LLC (MPLLC)
commenced an arbitration before the NASD against Cantor Fitzgerald Partners and
Howard Lutnick (the Arbitration). Although MPLLC did not name eSpeed as a
respondent in the Arbitration, MPLLC seeks, among other things, (i) a
declaration that the License and Service Agreement dated January 30, 2002,
between MPLLC and eSpeed is null and void and (ii) an order directing eSpeed to
reimburse MPLLC for certain costs. By Order to Show Cause signed on October 30,
2002, eSpeed, Cantor Fitzgerald Partners and Howard Lutnick moved for an order
staying the Arbitration in its entirety or, alternatively, staying the
Arbitration insofar as it seeks relief directly or indirectly against eSpeed.
The motion has been fully briefed and is currently sub judice. The parties have
agreed to participate in court sponsored non-binding mediation.
By Summons and Complaint dated October 30, 2002, eSpeed commenced an action
against MPLLC seeking, among other things, payment for services rendered
pursuant to the License and Service Agreement and payment for eSpeed's share of
certain electronic revenues of MPLLC. In the interim, the parties have agreed to
submit to non-binding mediation.
eSpeed patent related legal proceedings
On August 26, 2002, we entered into a Settlement Agreement (the Agreement) with
Electronic Trading Systems Corporation (ETS), the Chicago Mercantile Exchange
Inc. (CME) and CBOT to resolve the litigation related to the Wagner Patent
(United States Patent No. 4,903,201). The Wagner Patent deals with automated
futures trading systems in which transactions are completed by a computerized
matching of bids and offers of futures contracts on an electronic platform.
Under the terms of the Agreement, CME and CBOT will each pay $15 million to us
as a fully paid up license. Each $15 million payment will include $5 million,
which was received in the three months ended September 30, 2002, and $2 million
per year until 2007. We will recognize these payments, over the remaining life
of the Wagner Patent, under the caption "Software Solutions and licensing fees
from unrelated parties" in our consolidated statements of operations. The Wagner
Patent expires in February 2007. As part of the Agreement, all parties will be
released from the legal claims brought against each other without admitting
liability on the part of any party. We may be paying ETS up to $5,750,000 over
time out of the amounts we receive under the Agreement in connection with the
settlement of the litigation relating to the Wagner Patent. For the year ended
December 31, 2002, $2,750,000 was paid to ETS. The net settlement proceeds of
$24,250,000 is to be recognized as revenue ratably over the remaining useful
life of the patent. For the year ended December 31, 2002, we have recorded
revenue of $1,796,074 related to the Settlement Agreement.
After we acquired the Wagner Patent in April 2001, we joined ETS, the prior
patent owner, as a plaintiff in litigation pending 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' fees, interest and costs. The defendants have asserted
counterclaims by which they contend they are entitled to the their attorneys'
fees should they prevail. On June 26, 2002, the Judge in the New York case
entered an order following a Markman hearing construing the claims of the
patent. We believe that both of those Markman rulings were generally consistent
with out interpretation of the scope of the patent.
Expert discovery is ongoing in the New York case, and a limited amount of fact
discovery remains, with any trial likely in 2003.
Although the ultimate outcome of these actions cannot be ascertained at this
time (although the parties from time to time are actively pursuing settlement
discussions) 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.
23
Cantor related legal proceedings
In February 1998, Market Data Corporation (MDC) contracted to provide the
technology for an electronic trading system to compete with Cantor's United
States Treasury brokerage business. MDC 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 (collectively, the Iris Cantor Parties) are limited partners of Cantor.
In April 1998, Cantor filed a complaint in the Delaware Court of Chancery
against MDC and the Iris Cantor Parties with respect to these matters. Cantor
believes MDC's technology for electronic trading systems would be of substantial
assistance to competitors in the wholesale market if provided to them. On March
13, 2000, the Delaware Court of Chancery ruled in favor of Cantor, finding that
the Iris Cantor Parties had breached the Partnership Agreement of Cantor, aided
and abetted by MDC. The court awarded Cantor declaratory judgment relief and
court costs and attorneys' fees.
On November 5, 2001, the Court of Chancery entered an Order of Declaratory
Judgement, which provides that if any of the Iris Cantor Parties, through MDC or
otherwise, wish to compete with Cantor or its affiliates in a manner that could
reasonably be expected to harm a core business of Cantor, they must obtain the
written consent of Cantor's Managing General Partner. On December 4, 2001, the
defendants filed notices of appeal. The Delaware Supreme Court dismissed the
appeals as interlocutory. On June 21, 2002 (and revised July 8, 2002), the Court
rendered an opinion denying defendants' further reargument as to the damages
award and stated that the case is now ripe for appeal. The parties were asked to
submit a proposed form of order regarding the amount of damages. The Court has
yet to enter a final order. In a related proceeding, MDC alleged that Cantor has
violated the declaratory judgment order by withholding its consent for MDC to
engage in certain business transactions. MDC has withdrawn its petition seeking
relief in this related proceeding.
On May 16, 2000, CFI filed an action in Delaware Superior Court, New Castle
County, against Cantor 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 Cantor or of a
successor to a material portion of the assets and business of Cantor..." 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. The stay was lifted on September 1, 2002 and
the parties have resumed discovery.
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 MDC, Iris
Cantor, CFI and Rodney Fisher.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company held its 2002 Annual Meeting of Stockholders (the Annual
Meeting) on October 23, 2002.
(b) The following directors were elected at the Annual Meeting: Howard W.
Lutnick, Lee M. Amaitis, Joseph C. Noviello, Stephen M. Merkel, Larry R. Carter,
John H. Dalton, Frank R. Lautenberg, William J. Moran and Albert M. Weis.
(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.
24
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 280,765,510 6,150,441 0
Lee M. Amaitis 280,765,510 6,150,441 0
Joseph C. Noviello 280,765,510 6,150,441 0
Stephen M. Merkel 280,765,510 6,150,441 0
Larry R. Carter 286,756,055 159,896 0
John H. Dalton 286,722,840 193,111 0
Frank R. Lautenberg 286,792,605 123,346 0
William J. Moran 286,792,605 123,346 0
Albert M. Weis 286,792,605 123,346 0
Mr. Lautenberg resigned as director as of December 31, 2002 because he was
elected as a United States Senator for the State of New Jersey.
25
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 is traded on the Nasdaq National Market under the
symbol "ESPD". For each quarter of the prior two years and through March 17,
2003, the high and low sales prices for our Class A common stock, as reported by
Nasdaq, were as follows:
High Low
------ ------
2001
First Quarter...................................... $34.75 $13.62
Second Quarter..................................... $28.23 $16.25
Third Quarter...................................... $19.94 $ 7.44
Fourth Quarter..................................... $ 9.00 $ 4.60
2002
First Quarter...................................... $12.21 $ 7.91
Second Quarter..................................... $14.10 $ 8.27
Third Quarter...................................... $11.07 $ 7.42
Fourth Quarter..................................... $19.90 $ 9.63
2003
First Quarter (through March 17, 2003)............. $19.20 $ 9.15
On March 17, 2003, the last reported closing price of our Class A common stock
on the Nasdaq National Market was $11.25 and there were 682 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 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 $62.4 million has been used to acquire fixed assets and
to pay for the development of capitalized software, approximately $22.7 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 $37.4 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.
26
Of the amount of proceeds spent through December 31, 2002, approximately $27.1
million has been paid to Cantor under the Administrative Services Agreement
between Cantor and us.
STOCK REPURCHASE
In February 2003, in accordance with the stock repurchase plan authorized by our
board of directors on September 10, 2001 and reaffirmed in October 2001, we
repurchased an aggregate of 161,799 shares of our Class A common stock for an
aggregate purchase price of $1,872,112. The reacquired shares have been
designated treasury shares and will be used for general corporate purposes.
27
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, 2002, 2001, 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 29 of this Report and with our
consolidated financial statements and the notes thereto beginning on page 39 of
this Report.
For the period from
March 10, 1999 (date of
Years Ended December 31, commencement of
--------------------------------------------------- operations) to
STATEMENT OF OPERATIONS DATA 2002 2001 2000 December 31, 1999
-------- -------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA):
Total revenues............................... $139,238 $124,969 $91,027 $34,661
-------- -------- -------- --------
Expenses:
Compensation and employee benefits........... 36,499 53,437 53,963 21,502
Occupancy and equipment...................... 24,863 29,549 21,561 10,293
Professional and consulting fees............. 5,658 10,568 13,036 5,149
Communications and client networks........... 6,336 8,109 4,589 3,355
Marketing.................................... 4,778 4,356 8,285 -
Administrative fees paid to related parties.. 9,134 9,798 6,524 1,662
Non-cash business partner securities (1)..... 2,059 1,223 32,041 -
Options granted to Cantor employees (2)...... 2,850
Loss on unconsolidated investments (3)....... 950 3,833 -
Provision for September 11, 2001 events (4).. (1,201) 13,323
Other........................................ 7,717 8,569 9,684 2,649
-------- -------- -------- --------
Total expenses............................... 96,793 142,765 149,683 47,460
-------- -------- -------- --------
Income (loss) before
provision (benefit) for income taxes........ 42,445 (17,796) (58,656) (12,799)
-------- -------- -------- --------
Income tax provision (benefit)............... 479 531 406 (212)
-------- -------- -------- --------
Net income (loss)............................ $ 41,966 $(18,327) $(59,062) $(12,587)
======== ======== ======== ========
Basic net income (loss) per share............ $0.76 $(0.34) $(1.15) $(0.28)
======== ======== ======== ========
Fully diluted net income (loss) per share.... $0.74 $(0.34) $(1.15) $(0.28)
======== ======== ======== ========
Basic weighted average shares
of common stock outstanding.................. 54,991 54,297 51,483 44,495
Fully diluted weighted average
shares of common stock outstanding........... 56,784 54,297 51,483 44,495
December 31, 2002 December 31, 2001 December 31, 2000 December 31, 1999
----------------- ----------------- ----------------- -----------------
STATEMENT OF FINANCIAL CONDITION
DATA (IN THOUSANDS):
Cash and cash equivalents.................... $187,999 $159,899 $122,164 $134,846
Total assets................................. 252,711 210,741 157,034 188,672
Total liabilities............................ 34,256 37,559 24,776 53,160
Total stockholders' equity................... 218,455 173,182 132,258 135,512
(1) See "Item 8. Financial Statements and Supplementary Data, Note 7."
(2) Concurrent with the initial public offering, we 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 us
of $2,850.
(3) See "Item 8. Financial Statements and Supplementary Data, Note 7."
(4) See "Item 8. Financial Statements and Supplementary Data, Note 2."
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS:
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.
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 consisted 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, 2002, we had an accumulated deficit of $49.4 million. This
loss primarily resulted from expenditures on our technology and infrastructure
incurred in building our revenue base and from non-cash charges incurred in
connection with the issuance of business partner securities. In spite of the
September 11 Events, for the year ended December 31, 2002, we recorded annual
net income 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 and the impact of 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;and 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, Freedom,
Municipal Partners LLC (MPLLC) and CO2e.com (CO2e) pursuant to which we provide
the technology infrastructure for the transactional and technology related
elements of the TradeSpark, Freedom, MPLLC and CO2e marketplaces, as well as
certain other services, in exchange for specified percentages of transaction
revenues from the marketplaces. In general, if a transaction is fully
electronic, we receive 65% of the aggregate transaction revenues and TradeSpark
or Freedom receives 35% of the transaction revenues. 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 and MPLLC each receive 50% of the fully electronic revenues related
to municipal bonds. Our agreement with CO2e provides that we receive 50%
29
of CO2e's fully electronic revenues and 15% of CO2e's voice-assisted and open
outcry revenues until December 2003; thereafter we will receive 20% of
voice-assisted and open outcry 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,
2002. 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 MPLLC, the newly
formed entity that owns the assets. Cantor has not yet fully determined which
financial product marketplaces it will re-enter. In addition, Cantor's business
product development activity continues to be 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
The following discussion 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
contingent 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 recorded an expense of $13.3 million in the year ended December 31, 2001 for
the costs which we had incurred or expected to incur and for assets which were
destroyed or impaired as a result of the September 11 Events. 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 our judgment, such costs were properly recorded in the same
period as the September 11 Events, even if disbursement did not occur until
future periods. During the year ended December 31, 2002, actual costs incurred
were charged against the provision and the remaining unused amount was reversed
in the fourth quarter of 2002.
Insurance Coverage
We have insurance coverage for both property and casualty losses and for
business interruption through our Administrative Services Agreement with Cantor.
During 2002, we received and recognized as income $12,832,886 of the $40,000,000
business interruption insurance recovery received by Cantor. This allocation was
based on an analysis prepared by an independent consultant.
Under the property and casualty coverage of $40 million, 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. To the extent that the cost
of assets replaced exceeds the carrying value of the assets destroyed, we will
recognize a gain on replacement of assets resulting from potential additional
recoveries under our property and casualty coverage. However, we cannot
currently estimate the amount or timing of any such gain, if any, and
accordingly, no gains on replacement of fixed assets have been recorded during
the current year.
Related Party Transactions
As described above, we share revenues with Cantor, TradeSpark, Freedom, MPLLC
and CO2e. In addition, we provide technology support services to Cantor,
TradeSpark, Freedom, MPLLC and CO2e, 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 services or revenue sharing arrangements were between, or among, unrelated
parties.
30
We recognize Software Solutions 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
We capitalized the costs associated with the purchase of two patents acquired in
2001. 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. These capitalized costs, and the
original purchase price of the patents, are amortized over the remaining life of
the patent to which they relate, and are reflected net of accumulated
amortization as an asset in our statements of financial condition. 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, in accordance with Generally Accepted Accounting Principles
(GAAP), 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.
In our judgment, these employee-related costs serve to create or enhance
valuable software. Our current policy is to capitalize these costs and amortize
them over their estimated economic useful life of three years on a straight-line
basis. However, if the costs incurred to produce the software are ultimately
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.
Business Partner Securities
We enter into transactions with business partners 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 business partner securities 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 these business partner securities 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 business partner
securities 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 the 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
valuations of the options, warrants or preferred shares which, in turn, would
change the basis of assets acquired or expense recognized.
31
RESULTS OF OPERATIONS
REVENUES
Year Ended Percentage Year Ended Percentage Year Ended Percentage
December 31, of Total December 31, of Total December 31, of Total
2002 Revenues 2001 Revenues 2000 Revenues
---------------- ------------ -------------- ----------- -------------- ----------
(in thousands) (in thousands) (in thousands)
Transaction revenues with related parties
Fully electronic transactions.............. $88,039 63.3% $75,430 60.4% $52,693 57.9%
Voice-assisted brokerage transactions...... 17,552 12.6 22,553 18.1 15,144 16.6
Screen-assisted open outcry transactions... 190 0.1 385 0.3 2,450 2.7
---------------- ------------ -------------- ----------- -------------- ----------
Total transaction revenues with related parties. 105,781 76.0 98,368 78.8 70,287 77.2
Software Solutions fees from related parties.... 13,207 9.5 16,283 13.0 12,333 13.5
Software Solutions and licensing fees from
unrelated parties............................... 4,512 3.2 1,962 1.6 66 0.1
Business interruption insurance proceeds........ 12,833 9.2 - 0.0 - 0.0
Gain on replacement of assets................... - 0.0 2,680 2.1 - 0.0
Interest income from related parties............ 2,905 2.1 5,676 4.5 8,341 9.2
--------- ------ --------- ------ -------- ------
Total Revenues......................... $139,238 100.0% $124,969 100.0% $91,027 100.0%
========= ====== ========= ====== ======== ======
REVENUES - COMPARISON OF THE YEARS ENDED DECEMBER 31, 2002 AND 2001
TRANSACTION REVENUES WITH RELATED PARTIES
For the year ended December 31, 2002, we earned $105.8 million in transaction
revenues with related parties, an 8% increase over transaction revenues with
related parties of $98.4 million for the year ended December 31, 2001. For the
year ended December 31, 2002, 83% of our transaction revenues were generated
from fully electronic transactions.
Our revenues are currently highly dependent on transaction volume 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 continue to be negatively affected in the future if Cantor's
business continues to suffer due to the September 11 Events or otherwise.
SOFTWARE SOLUTIONS FEES FROM RELATED PARTIES
Software Solutions fees from related parties for the year ended December 31,
2002 were $13.2 million as compared to Software Solutions fees from related
parties for the year ended December 31, 2001 of $16.3 million, a decrease of
19%. Software Solutions fees from related parties decreased primarily as a
result of a decrease in support provided to Cantor and TradeSpark due to the
loss of their voice brokers as a result of the September 11 Events. This
decrease was offset in part by additional Software Solutions fees from MPLLC,
which began utilizing our systems in 2002.
SOFTWARE SOLUTIONS AND LICENSING FEES FROM UNRELATED PARTIES
Software Solutions and licensing fees from unrelated parties for the year ended
December 31, 2002 were $4.5 million as compared with $2.0 million for the year
ended December 31, 2001, an increase of 125%, due primarily to licensing fees
earned in 2002 from InterContinentalExchange for use of the Wagner Patent and
licensing fees earned as part of the Wagner Patent Settlement Agreement, as more
fully described in Note 4 of our consolidated financial statements. We
anticipate that as we license our software and patents to additional market
participants, our revenues from Software Solutions and licensing fees from
unrelated parties will continue to grow.
32
BUSINESS INTERRUPTION INSURANCE PROCEEDS
During the year ended December 31, 2002, we received and recognized as revenue
$12.8 million as our portion of the $40 million business interruption insurance
recovery received by Cantor. This allocation was based on an analysis prepared
by an independent consultant.
GAIN ON REPLACEMENT OF ASSETS
Our assets in the World Trade Center were destroyed as a result of the September
11 Events. 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 a gain. For the year ended December 31, 2001,
we recognized $2.7 million of such gains. No additional proceeds were received
in 2002 and, accordingly, no gains were recognized in 2002.
INTEREST INCOME FROM RELATED PARTIES
For the year ended December 31, 2002, we generated interest income from
overnight reverse repurchase agreements with a related party of $2.9 million as
compared to interest income of $5.7 million for the year ended December 31,
2001. The reduction in interest income was principally as a result of a
reduction in weighted average interest rates on overnight reverse repurchase
agreements from 3.9% in 2001 to 1.7% in 2002.
REVENUES - COMPARISON OF THE YEARS ENDED DECEMBER 31, 2001 AND 2000
TRANSACTION REVENUES WITH RELATED PARTIES
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%).
SOFTWARE SOLUTIONS FEES FROM RELATED PARTIES
Software Solutions fees from related parties for the year ended December 31,
2001 were $16.3 million as compared to Software Solutions fees from related
parties for the year ended December 31, 2000 of $12.3 million, an increase of
33%. Software Solutions 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 prior to the September 11 Events.
SOFTWARE SOLUTIONS FEES FROM UNRELATED PARTIES
Software Solutions 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. This increase resulted from the addition of new clients and a full
year of revenue for clients added during 2000.
GAIN ON REPLACEMENT OF ASSETS
For the year ended December 31, 2001, we recognized $2.7 million of such gains.
See further discussion in the 2002 to 2001 comparison.
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 a result
33
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 Year Ended Percentage Year Ended Percentage
December of Total December of Total December of Total
31, 2002 Expenses 31, 2001 Expenses 31, 2000 Expenses
-------- -------- -------- -------- -------- --------
(in thousands) (in thousands) (in thousands)
Compensation and employee benefits............. $36,499 37.7% $53,437 37.4% $53,963 36.1%
Occupancy and equipment........................ 24,863 25.7 29,549 20.7 21,561 14.4
Professional and consulting fees............... 5,658 5.9 10,568 7.4 13,036 8.7
Communications and client networks............. 6,336 6.6 8,109 5.7 4,589 3.1
Marketing...................................... 4,778 4.9 4,356 3.1 8,285 5.5
Administrative fees paid to related parties.... 9,134 9.4 9,798 6.9 6,524 4.4
Non-cash business partner securities........... 2,059 2.1 1,223 0.9 32,041 21.4
Loss on unconsolidated investments............. 950 0.9 3,834 2.7 0 0.0
Provision for September 11 Events.............. (1,201) (1.2) 13,323 9.3 0 0.0
Other.......................................... 7,717 8.0 8,569 5.9 9,684 6.4
------- ------ -------- ------ -------- ------
Total Expenses............................... $96,793 100.0% $142,766 100.0% $149,683 100.0%
======= ====== ======== ====== ======== ======
EXPENSES - COMPARISON OF THE YEARS ENDED DECEMBER 31, 2002 AND 2001
COMPENSATION AND EMPLOYEE BENEFITS
At December 31, 2002, we had 319 employees, which was a slight increase from the
312 employees we had at December 31, 2001. However, prior to the September 11
Events, we had 492 employees. For the year ended December 31, 2002, our
compensation costs were $36.5 million as compared to compensation costs of $53.4
million for the year ended December 31, 2001. This decrease in compensation
costs and in the number of employees was principally due to the September 11
Events.
Substantially all of our employees are full-time employees located predominately
in the New York metropolitan area and London. Compensation costs include
salaries, bonuses, payroll taxes and costs of employer-provided benefits for our
employees. We expect that our future compensation costs will increase depending,
in part, upon a variety of factors, including our incremental revenue growth.
OCCUPANCY AND EQUIPMENT
Occupancy and equipment costs were $24.9 million for the year ended December 31,
2002, a decrease of 16% as compared to occupancy and equipment costs of $29.5
million for the year ended December 31, 2001. The decrease was primarily caused
by our reduced need for office space as a result of the September 11 Events.
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.
We moved into our temporary corporate headquarters in New York City during the
second quarter of 2002. The lease for our temporary headquarters will expire in
February 2004, and at this time management is evaluating various location
alternatives. We anticipate that our occupancy costs will remain substantially
unchanged in 2003. 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. We
expect a portion of our capital expenditures to be covered by insurance proceeds
from our property and casualty insurance coverage.
PROFESSIONAL AND CONSULTING FEES
Professional and consulting fees were $5.7 million for the year ended December
31, 2002 as compared to professional and consulting fees of $10.6 million for
the year ended December 31, 2001, a decrease of 46%, primarily related to a
decrease in contract personnel costs. We expect that professional and consulting
fees will remain at a level consistent with the current full year amount.
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.
34
COMMUNICATIONS AND CLIENT NETWORKS
Communications costs were $6.3 million for the year ended December 31, 2002 as
compared to $8.1 million for the year ended December 31, 2001, a 22% decrease.
The decrease was principally due to decreased data and telephone costs
subsequent to the September 11 Events. 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. We anticipate expenditures for communications
and client networks will increase in the near future as we continue to connect
additional customers to our network.
MARKETING
We incurred marketing expenses of $4.8 million for the year ended December 31,
2002 as compared to marketing expenses during the year ended December 31, 2001
of $4.4 million, an increase of 9%, resulting from the development of a 2002
advertising campaign. We expect our future marketing expenses to decrease as we
reduce spending related to our advertising campaign.
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
$9.1 million for the year ended December 31, 2002, a 7% decrease over the $9.8
million of such fees for the year ended December 31, 2001. Overall,
administrative fees decreased in the months following the September 11 Events as
compared to the months prior to the September 11 Events. We expect that the
level of future administrative fees paid to related parties may increase in
2003.
Administrative fees paid to related parties are dependent upon both the costs
incurred by Cantor and the portion of Cantor's administrative services that are
utilized by us.
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. Generally, this
expense is amortized over the term of the related agreement. Non-cash business
partner securities charges were $2.1 million for the year ended December 31,
2002, an increase of 75% as compared to non-cash business partner securities
charges of $1.2 million for the year ended December 31, 2001. This increase
resulted from a full year of amortization on warrants that were issued under
agreements with two business partners during 2001. Amortization on warrants
issued under an agreement executed with a business partner in August of 2002
further contributed to this increase. 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
As discussed in Note 7 of our consolidated financial statements, we wrote down
our investment in Tradespark by $950,000 to its net realizable value in the
fourth quarter of 2002 based on the results of an annual assessment required
under GAAP.
PROVISION FOR SEPTEMBER 11 EVENTS
As described in Note 2 of our consolidated financial statements, we recorded an
expense of $13.3 million in the year ended December 31, 2001 to reflect our
estimate of the costs incurred or expected to be incurred and assets impaired as
a direct result of the September 11 Events. For the year ended December 31,
2002, the remaining accrual related to the September 11 Events of $1,200,507 was
reversed.
OTHER
Other expenses consist primarily of recruitment fees, travel, promotional and
entertainment expenditures. For the year ended December 31, 2002, other expenses
were $7.7 million, a decrease of 10% as compared to other expenses of $8.6
million for the year ended December 31, 2001. The decrease resulted primarily
from the decrease in recruitment fees. We anticipate that other expenses will
increase in the future, primarily due to an increase in business related
insurance expenses.
35
PROVISION FOR INCOME TAXES
Income taxes through 2002 have been minimal due to the benefit of the NOL carry
forward. We expect the remaining NOL carry forward will be fully utilized during
2003 and subsequent to that, we will begin to record income tax provisions at
an anticipated effective tax rate of less than 40%.
EXPENSES - COMPARISON OF THE YEARS ENDED DECEMBER 31, 2001 AND 2000
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 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.
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 One World Trade Center.
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 18%, primarily related to a
decrease in contract personnel costs prior to September 11th.
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 76% 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.
MARKETING
We incurred marketing expenses of $4.3 million for the year ended December 31,
2001, a 48% 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.
ADMINISTRATIVE FEES PAID TO RELATED PARTIES
Administrative fees paid to related parties are dependent upon both the costs
incurred by Cantor, and the portion of Cantor's administrative services which
is utilized by us.
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.
36
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 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 represented write-offs of software development costs
and goodwill and, as such, did not require cash outlays.
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 11% as compared to other expenses of $9.7
million for the year ended December 31, 2000. The decrease resulted primarily
from the decrease in recruitment fees.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth, by quarter, statement of operations data for the
period from January 1, 2001 to December 31, 2002. Results of any period are not
necessarily indicative of results for a full year.
2002 Quarter Ended
---------------------------------------------------------------------------
March 31 June 30 September 30 December 31
----------------- ----------------- ----------------- -----------------
Total revenues............................. $30,033,175 $43,449,094 $32,978,651 $32,777,091
Total expenses............................. 24,063,057 23,643,686 25,190,762 23,895,587
----------------- ----------------- ----------------- -----------------
Income before provision for
income taxes........................... 5,970,118 19,805,408 7,787,889 8,881,504
Income tax provision....................... 114,000 114,000 122,065 128,502
----------------- ----------------- ----------------- -----------------
Net income................................. $5,856,118 $19,691,408 $7,665,824 $8,753,002
================= ================= ================= =================
Fully diluted net income per share......... $0.10 $0.35 $0.14 $0.15
================= ================= ================= =================
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
================= ================= ================= =================
Fully diluted net income (loss) per share.. $(0.04) $(0.02) $(0.42) $0.14
================= ================= ================= =================
37
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. During the fourth quarter of 2002, the timing of the
holidays contributed to a slowdown in transaction volume. However, the
anticipated year-end slowdown did not occur as dramatically in 2001 because of
the volatility in the global markets.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2002, we had cash and cash equivalents of $188.0 million. We
generated cash in 2002 of $60.6 million from our operating activities,
consisting almost entirely of net income after non-cash items of $60.0 million.
We also used net cash for investing activities in 2002 of $33.7 million
resulting from purchases of fixed assets, capitalization of software development
costs and patent defense costs.
As of December 31, 2002, 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. During the first quarter of 2003, we
purchased an additional 161,799 shares for a total purchase price of $1,872,112,
bringing the total number of treasury shares owned to 186,399 at a book value of
$2,094,004. We anticipate making additional stock repurchases in 2003.
Our operating cash flows consist of transaction revenues from related parties
and Software Solutions 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 amount owed to us.
In addition, we have entered into similar services agreements with TradeSpark,
Freedom, MPLLC and CO2e. Under the Administrative Services Agreement, the
Amended and Restated Joint Services Agreement and the services agreements with
TradeSpark, Freedom, MPLLC and CO2e 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, personnel, and our anticipated move into a new headquarters. 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 property and casualty insurance coverage
may 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. We
do not currently have outside bank funding. 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, 2002, we had invested $186.7 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 JP Morgan Chase. 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.
38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ESPEED, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Report............................................... 40
Consolidated Statements of Financial Condition............................. 41
Consolidated Statements of Operations...................................... 42
Consolidated Statements of Cash Flows...................................... 43
Consolidated Statements of Stockholders' Equity............................ 45
Notes to Consolidated Financial Statements................................. 47
39
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, 2002 and
2001, and the related statements of operations, cash flows and stockholders'
equity for the three years in the period ended December 31, 2002. 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 financial position of the Company at December 31, 2002
and 2001, and the results of their operations and their cash flows for the three
years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
March 26, 2003
New York, New York
40
ESPEED, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF DECEMBER 31, 2002 AND 2001
DECEMBER 31, DECEMBER 31,
2002 2001
------------------------ -------------------------
ASSETS
Cash................................................................. $ 1,313,190 $ 2,567,932
Reverse repurchase agreements with related parties................... 186,685,709 157,330,676
------------------------ -------------------------
Total cash and cash equivalents................................... 187,998,899 159,898,608
Fixed assets, net.................................................... 26,383,590 19,137,269
Investments.......................................................... 11,174,718 11,732,863
Intangible assets, net............................................... 19,527,505 9,122,491
Receivable from related parties...................................... 5,266,445 7,641,441
Other assets......................................................... 2,359,718 3,207,832
------------------------ -------------------------
Total Assets................................................ $ 252,710,875 $ 210,740,504
======================== =========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Payable to related parties........................................... $ 18,857,071 $ 14,463,604
Accounts payable and accrued liabilities............................. 15,398,757 23,095,092
------------------------ -------------------------
Total Liabilities........................................... 34,255,828 37,558,696
------------------------ -------------------------
Stockholders' Equity:
Preferred stock, par value $0.01 per share; 50,000,000 shares
authorized, 8,000,750 shares issued and outstanding.................. 80,008 80,008
Class A common stock, par value $.01 per share; 200,000,000 shares
authorized; 29,783,682 and 26,590,668 shares issued.................. 297,837 265,906
Class B common stock, par value $.01 per share; 100,000,000 shares
authorized; 25,388,814 and 28,354,737 shares issued and outstanding.. 253,888 283,547
Additional paid-in capital........................................... 268,900,204 266,791,989
Unamortized expense of business partner securities................... (1,495,500) (2,691,900)
Treasury stock, 24,600 shares of Class A common stock at cost........ (221,892) (221,892)
Accumulated deficit.................................................. (49,359,498) (91,325,850)
------------------------ -------------------------
Total stockholders' equity.................................. 218,455,047 173,181,808
------------------------ -------------------------
Total liabilities and stockholders' equity........................... $ 252,710,875 $210,740,504
======================== =========================
See notes to the consolidated financial statements
41
ESPEED, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
For the year ended For the year ended For the year ended
December 31, 2002 December 31, 2001 December 31, 2000
------------------- ------------------- -------------------
Revenues:
Transaction revenues with related parties
Fully electronic transactions ............................. $ 88,039,301 $ 75,429,874 $ 52,692,703
Voice-assisted brokerage transactions ..................... 17,551,873 22,553,037 15,144,343
Screen-assisted open outcry transactions .................. 190,321 385,115 2,450,333
------------------- ------------------- -------------------
Total transaction revenues with related parties ............ 105,781,495 98,368,026 70,287,379
Software Solutions fees from related parties ................. 13,206,987 16,283,305 12,333,222
Software Solutions and licensing fees from unrelated parties.. 4,512,063 1,961,589 65,625
Business interruption insurance proceeds from parent ......... 12,832,886 -- --
Gain on replacement of fixed assets .......................... -- 2,680,000 --
Interest income from related parties ......................... 2,904,580 5,675,894 8,340,815
------------------- ------------------- -------------------
Total revenues .......................................... 139,238,011 124,968,814 91,027,041
------------------- ------------------- -------------------
Expenses:
Compensation and employee benefits ........................... 36,498,880 53,437,250 53,963,239
Occupancy and equipment ...................................... 24,862,758 29,549,068 21,560,535
Professional and consulting fees ............................. 5,657,752 10,568,007 13,036,494
Communications and client networks ........................... 6,335,606 8,108,618 4,588,626
Marketing .................................................... 4,778,092 4,355,661 8,285,385
Administrative fees paid to related parties .................. 9,134,016 9,797,996 6,524,341
Non-cash business partner securities ......................... 2,059,099 1,222,631 32,040,505
Loss on unconsolidated investments ........................... 950,000 3,833,679 --
Provision for September 11 Events ............................ (1,200,507) 13,323,189 --
Other ........................................................ 7,717,396 8,568,667 9,683,776
------------------- ------------------- -------------------
Total expenses .......................................... 96,793,092 142,764,766 149,682,901
------------------- ------------------- -------------------
Income (loss) before provision for income taxes .................. $ 42,444,919 $ (17,795,952) $ (58,655,860)
------------------- ------------------- -------------------
Provision for income taxes ....................................... 478,567 531,000 406,125
------------------- ------------------- -------------------
Net income (loss) ................................................ $ 41,966,352 $ (18,326,952) $ (59,061,985)
=================== =================== ===================
Per share data:
Basic net income (loss) per share ....................... $ 0.76 $ (0.34) $ (1.15)
=================== =================== ===================
Fully diluted net income (loss) per share ............... $ 0.74 $ (0.34) $ (1.15)
=================== =================== ===================
Basic weighted average shares of common stock
outstanding .......................................... 54,991,400 54,296,811 51,482,505
=================== =================== ===================
Fully diluted weighted average shares of common stock
outstanding ........................................ 56,784,436 54,296,811 51,482,505
=================== =================== ===================
See notes to the consolidated financial statements
42
ESPEED, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
For the year ended For the year ended For the year ended
December 31, 2002 December 31, 2001 December 31, 2000
------------------ ------------------ ------------------
Cash flows from operating activities:
Net income (loss)...................................................... $ 41,966,352 $ (18,326,952) $ (59,061,985)
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ...................................... 16,012,981 5,975,471 6,098,754
Issuance of non-cash business partner securities ................... 2,059,099 1,222,631 32,040,505
Equity in net losses of certain unconsolidated investments.......... 189,568 147,838 --
Loss on unconsolidated investments ................................. 950,000 3,833,679 --
Non-cash issuance of securities under employee benefit plans ....... 52,210 440,679 --
Gain on replacement of fixed assets ................................ -- (2,680,000) --
Provision for September 11 Events, net ............................. (1,200,507) 13,323,189 --
(Increase) decrease in operating assets:
Other assets ................................................. 266,686 475,675 (3,672,012)
Receivable from related parties, net ......................... 2,374,996 (5,729,738) 42,433,200
Increase (decrease) in operating liabilities:
Payable to related parties, net .............................. 4,393,467 1,181,653 (37,806,881)
Accounts payable and accrued liabilities ..................... (6,495,828) 3,762,327 9,422,915
------------------ ------------------ ------------------
Net cash provided by (used in) operating activities ................ 60,569,024 3,626,452 (10,545,504)
------------------ ------------------ ------------------
Cash flows from investing activities:
Purchases of fixed assets ............................................. (11,216,785) (12,901,831) (11,043,479)
Capitalization of software development costs .......................... (8,705,840) (7,358,226) (9,026,568)
Purchase of patents ................................................... -- (2,650,000) --
Capitalization of patent defense costs ................................ (13,741,691) (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 .............................. (33,664,316) (11,797,346) (25,903,726)
------------------ ------------------ ------------------
Cash flows from financing activities:
Proceeds from issuances of securities ................................. -- 47,750,000 50,000,000
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 .................................... 1,195,583 414,298 --
Payments for issuance related expenses ................................ -- (2,625,736) (1,604,028)
------------------ ------------------ ------------------
Net cash provided by financing activities .......................... 1,195,583 45,905,790 23,767,420
------------------ ------------------ ------------------
See notes to the consolidated financial statements
43
ESPEED, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
For the year ended For the year ended For the year ended
December 31, 2002 December 31, 2001 December 31, 2000
------------------- ------------------- -------------------
Net increase (decrease) in cash and cash equivalents............... 28,100,291 37,734,896 (12,681,810)
-------------------- ------------------- ------------------
Cash and cash equivalents, beginning of period..................... 159,898,608 122,163,712 134,845,522
-------------------- ------------------- ------------------
Cash and cash equivalents, end of period........................... $ 187,998,899 $ 159,898,608 $ 122,163,712
==================== =================== ==================
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
===================
See notes to the consolidated financial statements
44
ESPEED, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Common Additional
Preferred Stock Class Common Stock Paid-in Subscription
Stock A Class B Capital receivable
-------------------------------------------------------------------------
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 2,155,200
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
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 (534,046 shares)... 5,340 11,696,604
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 for Deferral Plan
match (14,050 shares)............................... 140 223,502
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..
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
----------------------------------------------------------------
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
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 (534,046 shares)...... 11,701,944
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 for Deferral Plan
match (14,050 shares).................................. 223,642
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)
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
45
ESPEED, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Common Additional
Preferred Stock Class Common Stock Paid- in Subscription
Stock A Class B Capital receivable
-------------------------------------------------------------------------
Conversions of Class B common stock to Class A
common stock (2,965,900 shares)..................... 29,659 (29,659)
Amortization of and charges for warrants............ 862,694
Issuance of Class A common stock from
exercises of options (221,277, net of retirement
of 2,733 shares).................................... 2,214 1,193,369
Issuance of Class A common stock for Deferral Plan
match (5,814 shares)................................ 58 52,152
Net Income..........................................
------- -------- -------- ------------ -------------
Balance, December 31, 2002.......................... $80,008 $297,837 $253,888 $268,900,204 $ -
=========================================================================
Unamortized
expense of
business Total
partner Accumulated Stockholders'
securities Treasury Stock Deficit Equity
----------------------------------------------------------------
Conversions of Class B common stock to Class A
common stock (2,965,900 shares)............................ -
Amortization of and charges for warrants................... 1,196,400 2,059,094
Issuance of Class A common stock from exercises of
options (221,277, net of retirement of 2,733 shares)....... 1,195,583
Issuance of Class A common stock for Deferral Plan
match (5,814 shares)....................................... 52,210
Net Income................................................. 41,966,352 41,966,352
----------- --------- ------------ ------------
Balance, December 31, 2002................................. $(1,495,500) $(221,892) $(49,359,498) $218,455,047
================================================================
See notes to consolidated financial statements
46
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.
USE OF ESTIMATES: The preparation of the consolidated financial statements in
conformity with generally accepted accounting principles (GAAP) 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 SOLUTIONS 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. The Company also receives patent license fees from unrelated parties.
Such fees are recognized as income ratably over the license period.
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 seven years) using the straight-line 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.
INVESTMENTS: The Company accounts for its 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.
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.
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
47
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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: In July 2002, the Financial Accounting Standards
Board (the FASB) issued Statement of Financial Accounting Standards (SFAS) No.
146, "Accounting for Costs Associated with Exit or Disposal Activities," (SFAS
146) which supersedes prior accounting guidance, Emerging Issues Task Force
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit and Activity (including Certain Costs Incurred in a
Restructuring)." SFAS 146 prescribes new guidelines for recognition of costs
associated with exit or disposal activities. The provisions of SFAS 146 are
effective for disposal activities initiated after December 31, 2002.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46)
"Consolidation of Variable Interest Entities - an interpretation of Accounts
Research Bulletin (ARB) No. 51." FIN 46 provides guidance on the consolidation
of entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective immediately for entities created
after January 31, 2003. The provisions of FIN 46 should be applied to entities
created before February 1, 2003 no later than the beginning of the first interim
or annual reporting period beginning after June 15, 2003. The Company will adopt
FIN 46 as required in 2003 and is currently evaluating its impact on its
consolidated financial statements.
On December 31, 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based
Compensation - Transition and Disclosure" (SFAS 148). SFAS 148 permits three
alternative methods of transition for a voluntary change to the fair value based
method of accounting for employee based stock compensation. SFAS No. 148
continues to permit prospective application for companies that adopt it prior to
the beginning of fiscal year 2004. SFAS 148 also allows for a modified
prospective application, which requires the fair value of all unvested awards to
be amortized over the remaining service period, as well as restatement of prior
year's expense. The transition guidance and annual disclosure provisions of SFAS
148 are effective for fiscal years ending after December 15, 2002, with earlier
application permitted in certain circumstances. Management does not currently
anticipate changing its method of accounting for stock compensation and,
accordingly, SFAS 148 is not expected to have any effect on the Company's
financial statements.
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.
As a result of the September 11 Events, fixed assets with a book value of
$17,796,420 were destroyed. The Company has recovered these losses through its
$40,000,000 of property insurance coverage and, as such, has not recorded a net
loss related to the destruction of its fixed assets.
In addition, the Company is in the process of replacing assets that were
destroyed in connection with the September 11 Events. The Company's property
insurance covers full replacement cost of the assets actually replaced. To the
extent that the cost of assets replaced exceeds the carrying value of the assets
destroyed, the Company would record a gain on replacement of assets resulting
from potential additional recoveries under the Company's property and casualty
coverage. As of December 31, 2002, the Company had recovered $20,476,420 of
proceeds, which resulted in a gain on replacement of fixed assets of $2,680,000
at December 31, 2001. However, the Company cannot
48
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
currently estimate the amount or timing of any additional recoveries under its
insurance coverage, and accordingly, no gains on replacement of fixed assets
have been recorded during the year ended December 31, 2002.
In 2001, the Company recognized a net provision of $13,323,189 for non-property
damage related to the September 11 Events. At December 31, 2001, the accrual
balance for the September 11 Events was $7,362,672 and, at December 31, 2002, no
provision remains as the remaining accrual related to the September 11 Events of
$1,200,507 was reversed.
The following table summarizes the September 11 provision activity for the year
ended December 31, 2002:
Accrual for Accrual utilized Accrual reversed
September 11 Events during the period during the period
as of December 31, ended December 31, ended December 31,
2001 2002 2002
----------------------- ----------------------- -----------------------
Professional and consulting fees..... $ 535,023 $ 535,023 $ -
Recruitment.......................... 2,961,563 2,195,005 766,558
Restructuring........................ 2,315,778 2,315,778 -
Other................................ 1,550,308 1,116,359 433,949
----------------------- ----------------------- -----------------------
Accrual for September 11 Events...... $7,362,672 $6,162,165 $1,200,507
----------------------- ----------------------- -----------------------
During the year ended December 31, 2002, CFLP received $40,000,000 of insurance
proceeds pursuant to business interruption insurance coverage, of which
$12,832,886 was allocated to the Company. Such amount was received from CFLP and
recognized as income as reflected in the accompanying consolidated statement of
operations. This allocation was based on an analysis prepared by an independent
consultant.
CFLP intends to continue to distribute 25% of its profits, that would otherwise
be distributable to its partners, for the benefit of the families of the
Company's employees who were lost on September 11, 2001. From such
distributions, CFLP will provide 10 years of healthcare benefits to the
families. These costs will be borne by CFLP and not by the Company.
3. FIXED ASSETS
Fixed assets consist of the following: December 31, 2002 December 31, 2001
- -------------------------------------- ----------------- -----------------
Computer and communication equipment........................ $20,050,177 $10,021,648
Software, including software development costs.............. 27,659,228 18,870,472
Leasehold improvements and other fixed assets............... 1,128,370 474,525
----------- -----------
48,837,775 29,366,645
Less accumulated depreciation & amortization................ (22,454,185) (10,229,376)
----------- -----------
Fixed assets, net........................................... $26,383,590 $19,137,269
=========== ===========
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
WAGNER PATENT: 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 (ETS) 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. Accordingly, the Company paid approximately $234,000
to ETS during the year ended December 31, 2002 in connection with a long-
49
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
term license agreement with InterContinentalExchange (See Note 7). In order to
perfect and defend the Company's rights under the patents, the Company has
incurred substantial legal costs. The Company capitalized $13,741,691 and
$6,283,142 of such legal costs for the years ended December 31, 2002 and 2001,
respectively. The carrying value of the Wagner Patent, including capitalized
patent defense costs, is presented net of accumulated amortization in the
accompanying statement of financial condition and was $18,550,050 and $8,025,491
at December 31, 2002 and 2001, respectively.
On August 6, 2002, the Company entered into a Settlement Agreement (the
Settlement Agreement) with ETS, the Chicago Mercantile Exchange Inc. (CME) and
the Board of Trade of the City of Chicago (CBOT) to resolve the litigation
related to the Wagner Patent. As part of the Settlement Agreement, all parties
will be released from the legal claims brought against each other without
admitting liability on the part of any party. Under the terms of the Settlement
Agreement, CME and CBOT will each pay $15 million to eSpeed as a fully paid up
license, for a total of $30 million. Each $15 million payment includes $5
million, which was received in the three months ended September 30, 2002, and $2
million per year until 2007. Of the $30 million to be received by the Company,
$5,750,000 may be paid to ETS in its capacity as the former owner of the Wagner
Patent, and $24,250,000 is to be recognized as revenue ratably over the
remaining useful life of the patent. For the year ended December 31, 2002,
$2,750,000 was paid to ETS and the Company has recorded revenue of $1,796,074
related to the Settlement Agreement, which is included in Software Solutions and
licensing fees from unrelated parties.
LAWRENCE 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. The carrying value of the Lawrence patent net of accumulated
amortization was $977,455 and $1,097,000 at December 31, 2002 and 2001,
respectively.
5. INCOME TAXES
The provision for income taxes consisted of:
Year Ended December 31,
---------------------------
2002 2001 2000
------- ------- -------
(in Thousands)
Current:
U.S. federal ................ $ -- $ -- $ --
U.S. state and local ........ 479 531 406
Non- U.S. ................... -- -- --
------- ------- -------
479 531 406
Deferred ......................... -- -- --
------- ------- -------
Provision for income taxes........ $ 479 $ 531 $ 406
------- ------- -------
50
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Differences between the Company's actual income tax expense (benefit) and the
amount calculated utilizing the U.S. federal statutory rate are as follows:
Year Ended December 31,
-------------------------------------------
2002 2001 2000
-------- -------- ---------
(in Thousands)
Federal income tax expense (benefit) at 35% statutory rate $ 14,857 $ (6,229) $ (20,529)
State taxes, net of federal benefit 1,816 (765) (2,522)
State and City capital taxes 479 531 406
Non-deductible business partner securities 150 114 782
Other non-deductible/(taxable) items (113) 564 430
Exercise of employee stock options (820) - -
Decrease in valuation allowance for deferred items currently recognized (15,890) - -
Tax benefit of net operating loss not currently recognized - 6,316 21,839
-------- -------- ---------
$ 479 $ 531 $ 406
======== ======== =========
Deferred income taxes reflect the net tax effects of temporary differences
between the financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when such
differences are expected to reverse. Significant components of the Company's
deferred tax assets and liabilities at December 31, 2002 and 2001 were as
follows:
Year Ended December 31,
---------------------------
2002 2001
---------- ----------
(in Thousands)
Deferred tax assets:
Non-deductible warrant expense $ 12,096 $ 11,922
Net operating loss carryfowards 6,489 19,209
Provision for September 11 Events - 2,945
Basis difference of investments 1,192 359
Non-employee stock options 1,137 1,137
Other deferred and accrued expenses 1,317 1,613
---------- ----------
Total deferred tax asset 22,231 37,185
---------- ----------
Deferred tax liabilities:
Software capitalization 3,396 2,725
Gain on replacement of assets 1,072 1,072
Depreciation of fixed assets 961 670
Other 76 102
---------- ----------
Total deferred tax liability 5,505 4,569
---------- ----------
Net deferred tax asset 16,726 32,616
Valuation allowance (16,726) (32,616)
---------- ----------
Net deferred income tax $ - $ -
========== ==========
At December 31, 2002 the Company had net operating loss carryforwards for income
tax purposes of approximately $16,222,000, which if not utilized, are scheduled
to expire in 2021.
As reflected in the above table, the Company established a valuation allowance
against the net deferred tax asset of approximately $16,726,000 and $32,616,000
at December 31, 2002 and 2001, respectively. The valuation allowance primarily
relates to non-deductible warrant expenses and net operating loss carryfowards
where there is significant uncertainty as to their ultimate realization.
Additionally, the tax benefits associated with the employee exercises on
incentive stock options would normally serve to reduce taxes currently payable.
However, at December 31, 2002, the valuation allowance has been increased by the
$820,000 tax benefit of such, which will be recorded to additional
paid-in-capital if and when realized.
51
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. COMMITMENTS AND CONTINGENCIES
Leases: Under an administrative services agreement, the Company 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 ended December 31:
2003.................................................. $2,580,589
2004.................................................. 1,917,092
2005.................................................. 1,807,113
2006.................................................. 1,912,753
2007.................................................. 2,100,892
Thereafter............................................ 17,635,233
------------------
Total................................................. $27,953,672
==================
Rental expense under the above and under all other operating leases for the
years ended December 31, 2002, 2001 and 2000 was $5,929,205, $10,988,614 and
$7,341,614, 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.
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%
52
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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, 2002 and 2001. 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, 2002 and 2001, the Company's share of
TradeSpark's losses was $240,893 and $211,706, respectively.
In accordance with the annual assessment required by Statement of Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142), at
December 31, 2002 the carrying value of the Company's investment in TradeSpark
was written down by $950,000 to its net realizable value.
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.
53
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 and unamortized expense of
business partner securities of $3,589,000 in 2001, representing the value of the
warrants. Non cash charges of $1,196,400 and $897,100 have been recognized for
the years ended December 31, 2002 and 2001, respectively. The remaining
unamortized balance of $1,495,500 will be recognized as an expense ratably
through April 2004. To the extent necessary to protect the 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.
The Company's share of the income of the LP for the years ended December 31,
2002 and 2001 was $51,325 and $63,868, respectively. The carrying value of the
Company's investment in the LP at December 31, 2002 and 2001 was $7,086,102 and
$7,034,777, respectively.
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. As a result
of the September 11 Events, the Company wrote off the goodwill of $3,184,773
associated with the acquisition, which was included in the provision For
September 11 Events in the accompanying consolidated statements of operations.
OTHER 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 of these unconsolidated investments.
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,
54
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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 years ended December 31, 2002 and 2001, the
Company has recognized non-cash charges of $429,212 and $214,606, respectively.
Deutsche Bank is deemed to have fulfilled its obligations under the agreement
for the 12 months ended July 30, 2002, and accordingly, is entitled to warrants
to purchase 150,000 shares of the Company's Class A common stock.
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.
EASYSCREEN PLC
In October 2001 the Company purchased a secured convertible bond (the "Bond") in
the principal amount of 2,000,000 British Pounds Sterling. issued by EasyScreen
PLC. The Bond matures on October 29, 2006, subject to earlier conversion or
repayment, accrues interest at a rate of 9% per year which accumulates and is
payable to the Company pro-rata on the date of repayment or conversion. As of
December 31, 2002 and 2001 the carrying value of the bond was $3,509,000 and
$2,966,068 respectively, which is included in investments in the accompanying
consolidated statement of financial condition.
INTERCONTINENTALEXCHANGE
On March 29, 2002, the Company entered into an agreement with
InterContinentalExchange ("ICE", or the "ICE Agreement") granting use of the
Wagner Patent to ICE. Under the terms of the ICE Agreement, ICE pays the Company
an annual royalty of $2,000,000 per year. Such annual payment is recognized as
income ratably throughout the year. The unearned portion of the annual royalty,
amounting to $500,000 at December 31, 2002, is included in accounts payable and
accrued liabilities. ICE will also pay to the Company $0.10 for each contract
that participants submit to the electronic futures exchange for trading, or
$0.20 for each contract contained in matched trades on the electronic futures
exchange. The ICE Agreement will remain in effect until February 7, 2007, unless
certain contingencies are not met.
UBS
On August 21, 2002, the Company entered into an agreement with UBS USA, Inc.
(UBS) and Cantor for UBS to execute trades electronically on the eSpeed(R)
system in U.S. Treasury Securities, Agency Securities, European Government
Bonds, UK Gilts, Japanese Government Bonds and swaps of these various securities
instruments. The agreement has an initial term of two and one-half years,
commencing as of January 1, 2002. In addition to quarterly participation fees
paid to Cantor, UBS pays transaction fees to Cantor for each executed
transaction, which are shared with the Company pursuant to the Joint Services
Agreement.
In addition, the Company issued to UBS a warrant to purchase 300,000 shares of
its Class A common stock. The warrant has a term of 10 years and has an exercise
price equal to $8.75, the market value of the underlying Class A common stock on
the date of issuance. The warrant is fully vested and nonforfeitable, and is
exercisable nine years and six months after issuance, subject to acceleration
upon the satisfaction by UBS of its yearly commitment condition. The Company
recorded additional paid in capital and unamortized expense of business partner
securities of $2,189,910, representing the value of the warrants. This amount
will be amortized over the term of the agreement. The Company agreed to issue an
additional warrant to purchase 200,000 shares of its Class A common stock at an
exercise price equal to the market value of the underlying Class A common stock
on the date of issuance if the agreement is renewed for another two and one-half
years. For the twelve months ended December 31, 2002, the Company has recognized
a non-cash charge of $433,487 related to the amortization of the UBS warrants.
TSI HOLDINGS,INC.
In December 2002 the Company purchased software from TSI Holdings, Inc. for
$825,000 which is included in fixed assets in the accompanying consolidated
statement of financial condition. The software is being amortized using the
straight line method over the estimated useful life of three years.
55
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 not permitted to be sold or
repledged. The fair value of such collateral at December 31, 2002 and 2001
totaled $189,588,910 and $159,941,811, respectively.
Under the Amended and Restated Joint Services Agreement between the Company and
Cantor and services agreements between the Company and TradeSpark, Freedom,
MPLLC and CO2e, the Company owns and operates the electronic trading system and
is responsible for providing electronic brokerage services, and Cantor,
TradeSpark, Freedom, MPLLC or CO2e 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, if a transaction
is fully electronic, the Company receives 65% of the aggregate transaction
revenues and TradeSpark or Freedom receives 35% of the transaction revenues. If
TradeSpark or Freedom provides voice-assisted brokerage services with respect to
a transaction, then the Company receives 35% of the revenues and TradeSpark or
Freedom receives 65% of the revenues. The Company and MPLLC each receive 50% of
the fully electronic revenues related to municipal bonds. The Company's
agreement with CO2e provides that it receives 50% of CO2e's fully electronic
revenues and 15% of CO2e's voice-assisted and open outcry revenues until
December 2003, and 20% of voice assisted and open outcry revenues thereafter. 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, Freedom, MPLLC and CO2e 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, Freedom and MPLLC the actual direct and indirect
costs, including overhead, of providing such services and receives payment on a
monthly basis. These services are provided to CO2e at no additional cost other
than the revenue sharing arrangement set forth above. 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, 2002, 2001 and 2000 totaling $9,134,016, $9,797,996 and
$6,524,341, 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 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.
56
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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. As a result of the
Employee Stock Purchase Plan's suspension in October 2001, there was no activity
in 2002.
During the years ended December 31, 2002 and 2001, the Company issued 224,010
and 18,833 shares, respectively, 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 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.
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, 2002 and 2001, the Company has purchased 24,600 shares for a total of
$221,892 under this repurchase plan. During the first quarter of 2003, the
Company purchased an additional 161,799 shares for a total purchase price of
$1,872,112, bringing the total number of treasury shares owned to 186,399 at a
book value of $2,094,004.
On August 21, 2002, the Company issued to UBS a warrant to purchase 300,000
shares of its Class A common stock as part of a business partner agreement,
which is more fully discussed in Note 7.
57
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 the Company'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.
There were no shares issued under the LT Plan during 2002. 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 2001 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, 2002, 2001 and 2000, respectively, the
Company issued 2,471,050, 3,653,816 and 3,770,312 options to employees pursuant
to the LT Plan. The exercise prices for the options equaled 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.
On October 19, 2000, the option terms were amended so that 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.
58
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 $6.31, $3.25 and $12.42 for the years ended
December 31, 2002, 2001 and 2000, respectively. The following table represents
the effect 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 and giving effect to the accelerated
vesting of certain options as a result of the September 11 Events:
Decrease in Net Decrease in Net
Income / Increase Income / Increase in
Year in Net Loss Net Loss Per Share
---- ----------- ------------------
2002 $17,061,751 $0.31
2001 $37,021,370 $0.68
2000 $37,467,455 $0.73
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, 2002, 2001, and 2000:
Risk Free Expected
Year Interest Rate Expected Life (Years) Volatility Dividends
---- ------------- --------------------- ---------- ---------
2002 2.43% 3.07 69.00% None
2001 3.26% 3.08 80.00% None
2000 5.87% 2.84 80.00% 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 2005. The estimated fair
value of the warrants at the time of issuance resulted in a one-time non-cash
charge to the 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.
As discussed in Note 7, on July 30, 2002, 150 shares of Series C Redeemable
Convertible Preferred Stock held by Deutsche Bank automatically converted into a
right to 150,000 warrants to purchase the Company's Class A common stock as a
result of Deutsche Bank being deemed to have fulfilled its obligations under the
agreement between it and the Company for the year ended July 30, 2002.
As discussed in Note 7, on August 21, 2002, the Company issued to UBS warrants
to purchase 300,000 shares of the Company's Class A common stock.
59
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OPTIONS AND WARRANTS
The following table summarizes changes in all of the Company's stock options and
warrants for the years ended December 31 2002, 2001, and 2000:
eSpeed and Cantor Warrants and Weighted Average
employee options Other Options Total Exercise Price Expiration Dates
---------------- ------------- ----- -------------- ----------------
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........................ (378,371) (378,371) $18.25
------------ ------------ -------------
Balance, December 31, 2001...... 13,227,329 1,883,332 15,110,661 $19.76 12/2004 - 10/2011
Granted......................... 2,471,050 450,000 2,921,050 $13.13 1/2012 - 12/2012
Exercised....................... (224,010) (224,010) $5.19
Canceled........................ (78,771) (78,771) $8.81
------------ ------------ -------------
Balance, December 31, 2002...... 15,395,598 2,333,332 17,728,930 $18.90 12/2004 - 12/2012
============ ============ =============
The following table provides further details relating to all of the Company's
stock options and warrants outstanding as of December 31, 2002.
Weighted Average
Weighted Remaining Weighted
Range of Number Average Exercise Contractual Life Number Average Exercise
Exercise Prices Outstanding Price (in years) Exercisable Price
- --------------- ----------- ----- ---------- ----------- -----
$5.10 to $11.03 3,841,946 $5.81 8.8 725,973 $5.43
$12.28 to $18.26 4,314,149 $15.25 7.8 1,605,827 $15.94
$18.99 to $28.44 7,449,614 $22.15 4.6 6,058,227 $22.16
$28.88 to $43.06 1,746,842 $33.37 6.6 351,598 $35.52
$43.38 to $77.00 376,379 $45.30 7.0 197,480 $46.32
------------- ------------
17,728,930 $18.90 6.5 8,939,105 $20.30
============= ============
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. Accordingly, no shares were purchased under this plan in
2002.
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),
60
ESPEED, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 2003, 2002 and 2001, the
Company contributed 7,439, 5,814 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, 2002, 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, 2002, eSpeed
Government Securities, Inc.'s liquid capital of $109,148,671 was in excess of
minimum requirements by $109,123,671.
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, 2002, eSpeed Securities, Inc. had net capital of
$6,998,089, which was $6,679,567 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
and unrelated parties.
Product information: The Company currently markets its services through the
following products: core products, including an integrated network engaged in
electronic trading in government securities in multiple marketplaces over the
eSpeed(R) system; new product rollouts, including introduction of products in
non-equity capital markets; products enhancement software, which enables clients
to engage in enhanced electronic trading of core products and future product
rollouts and eSpeed Software Solutions(SM), which allows customers to use the
Company's intellectual property and trading expertise to build electronic
marketplaces and exchanges, develop customized trading interfaces and enable
real-time auctions and debt issuance. Revenues from core products comprises the
majority of the Company's 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 ended For the year ended For the year ended
Transaction Revenues: December 31, 2002 December 31, 2001 December 31, 2000
----------------- ----------------- -----------------
Europe.......................... $24,317,324 $20,657,534 $13,214,668
Asia............................ 2,580,390 2,653,378 1,397,154
----------------- ----------------- -----------------
Total Non-Americas.............. 26,897,714 23,310,912 14,611,822
Americas........................ 78,883,781 75,057,114 55,675,557
----------------- ----------------- -----------------
Total........................... $105,781,495 $98,368,026 $70,287,379
================= ================= =================
Average Long Lived Assets....... December 31, 2002 December 31, 2001
----------------- -----------------
Europe.......................... $5,576,717 $3,737,700
Asia............................ 387,632 434,809
----------------- -----------------
Total Non-Americas.............. 5,964,349 4,172,509
Americas........................ 17,536,681 19,031,755
----------------- -----------------
Total........................... $23,501,030 $23,204,264
================= ================-
61
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
62
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table provides information as of March 1, 2003 regarding our
directors and executive officers.
Name Age Title
--- -----
Howard W. Lutnick.................... 41 Chairman of the Board, Chief
Executive Officer and President
Lee M. Amaitis....................... 53 Global Chief Operating Officer;
Director
Joseph C. Noviello................... 37 Executive Vice President and Chief
Information Officer; Director
Stephen M. Merkel.................... 44 Executive Vice President, General
Counsel and Secretary; Director
Jeffrey M. Chertoff.................. 48 Senior Vice President and Chief
Financial Officer
Larry R. Carter...................... 59 Director (1)(2)
John H. Dalton....................... 61 Director (1)(2)
William J. Moran..................... 61 Director (1)(2)
Albert M. Weis....................... 76 Director (1)(2)
(1) Non-employee director
(2) Member of the Audit and Compensation Committees
Each director shall serve until our next annual meeting of stockholders and each
executive officer shall serve at the pleasure of our board of directors.
Howard W. Lutnick. Mr. Lutnick has been our Chairman of the Board of Directors
and Chief Executive Officer since June 1999 and has been our President since
September 2001. Mr. Lutnick joined Cantor Fitzgerald, L.P. in 1983 and has
served as President and Chief Executive Officer of Cantor since 1992. Mr.
Lutnick's company, CF Group Management, Inc., is the managing general partner of
Cantor. Mr. Lutnick is a member of the Board of Managers of Haverford College,
the Board of Directors of the Zachary and Elizabeth M. Fisher Center for
Alzheimer's Disease Research at Rockefeller University, the Executive Committee
of the Intrepid Museum Foundation's Board of Trustees and the Board of Directors
of the Solomon Guggenheim Museum Foundation.
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. Mr. Noviello is a director of the Cantor
Exchange(SM).
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,
human resources, risk and credit departments. Mr. Merkel serves as a director
and Secretary of the Cantor 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.
Jeffrey M. Chertoff. Mr. Chertoff has been our Senior Vice President and Chief
Financial Officer since May 2002. As Chief Financial Officer, Mr. Chertoff is
responsible for managing our global financial and accounting operations. Mr.
Chertoff served as Executive Vice President and Chief Financial Officer of Daiwa
Securities America from August 1998 to May 2002. From May 1995 to August 1998,
Mr. Chertoff was Controller, Director and Senior Operating Officer of Salomon
Brothers, Inc. Mr. Chertoff also served as Assistant Controller and Managing
Director at Bear Stearns, where he was employed from 1981 to 1995. He began his
career with Coopers & Lybrand, now PricewaterhouseCoopers, LLP.
63
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. Mr. Dalton serves as a director of the
Cantor Exchange(SM). 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.
Albert M. Weis. Mr. Weis has been President of A.M. Weis & Co., Inc., a money
management company, since 1976. Mr. Weis was Chairman of the New York Cotton
Exchange from 1997 to 1998, 1981 to 1983 and 1977 to 1978. From 1998 to 2000,
Mr. Weis was Chairman of the New York Board of Trade. From 1996 to 1999, Mr.
Weis was a director and chairman of the audit committee of Synetic, Inc. and,
from 1999 to 2001, he was a director and chairman of the audit committee of
Medical Manager Corporation (successor to Synetic, Inc.).
COMMITTEES OF THE BOARD
Our board of directors has an Audit Committee and a Compensation Committee. The
members of our Audit Committee are Messrs. Carter, Dalton, Moran and Weis, 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. Carter, Dalton, Moran and
Weis. 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.
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 2002, or written representations from certain reporting
persons, to the best of our knowledge, all reports were filed on a timely basis
other than late filings on Form 4 by each of our executive officers in
connection with option grants to them on December 9, 2002. The Forms 4 were
filed on January 29, 2003.
ITEM 11. EXECUTIVE COMPENSATION
The following table provides certain summary information concerning all
compensation earned for the year ended December 31, 2002, the year ended
December 31, 2001 and the year ended December 31, 2000 by our Chief Executive
Officer and each of our other executive officers required to be included in the
table (collectively, the Named Executive Officers).
64
SUMMARY COMPENSATION TABLE
--------------------------
LONG-TERM
ANNUAL COMPENSATION
COMPENSATION AWARDS
-------------- ------------ OTHER
SALARY BONUS OPTIONS COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) (#) ($) (1)
--------------------------- ---- --- --- --- -------
Howard W. Lutnick.................................. 2002 400,000 600,000 1,000,000 3,000
Chairman, Chief Executive Officer 2001 400,000 600,000 1,500,000 3,000
and President 2000 350,000 650,000 625,000 3,000
Lee M. Amaitis..................................... 2002 400,000 500,000 200,000 --
Global Chief Operating Officer 2001 107,418 300,000 375,000 --
2000 107,418 333,333 50,000 --
Joseph C. Noviello................................. 2002 300,000 450,000 75,000 3,000
Executive Vice President, Chief 2001 275,000 1,000,000(2) 200,000 3,000
Information Officer and President 2000 250,000 350,500 65,000 --
Stephen M. Merkel.................................. 2002 250,000 450,000 100,000 3,000
Executive Vice President, General Counsel 2001 150,000 400,000 200,000 3,000
and Secretary 2000 150,000 300,000 100,000 3,000
Jeffrey M. Chertoff................................ 2002 81,971(3) 125,000 75,000 --
Senior Vice President and Chief 2001 -- -- -- --
Financial Officer 2000 -- -- -- --
- ----------------------
(1) Consists of matching contributions by us under our Deferral Plan.
(2) The after-tax portion of $600,000 of such bonus was used to purchase units
in Cantor Fitzgerald, L.P.
(3) Pro rata based upon Mr. Chertoff's hire date of May 6, 2002 and annual
salary of $125,000.
The following table sets forth the options granted during 2002 to, and the value
of the options held on December 31, 2002 by, our Named Executive Officers:
OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
-----------------
Percentage of Total
Number of Shares Options Granted
Underlying Options to Employees Exercise or Base Grant Date
Name Granted in 2002 (%) Price ($/Share) Expiration Date Present Value ($)(3)
---- ------- ----------- --------------- --------------- --------------------
Howard W. Lutnick.......... 1,000,000(1) 41 14.39 12/9/2012 6,726,900
Lee M. Amaitis............. 200,000(1) 8 14.39 12/9/2012 1,345,380
Joseph C. Noviello......... 75,000(1) 3 14.39 12/9/2012 504,518
Stephen M. Merkel.......... 100,000(1) 4 14.39 12/9/2012 672,690
Jeffrey M. Chertoff........ 25,000(1) 1 14.39 12/9/2012 168,173
50,000(2) 2 10.72 3/26/2012 257,980
- ----------------------
(1) The options vest quarterly over a four year period from the date of
grant, December 9, 2002.
(2) These options vest quarterly over a four year period from the date of
grant, March 26, 2002.
(3) The present value of the options was estimated using a modified
Black-Scholes option pricing model and the following assumptions:
risk-free interest rate of 2.30% (3.97% for the $10.72 grant), no
expected dividends, expected stock price volatility of 69% and assumed
to be exercised at 31% of their original life.
65
The following table provides information, with respect to the Named Executive
Officers, concerning options and SARs held as of December 31, 2002.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
Number of Securities Underlying
Shares Unexercised Options at Fiscal Value of Unexercised In-Money
Acquired on Value Realized Year End (#) Options at Fiscal Year End($)(1)
Exercise on Exercise --------------------------------------------------------------------
Name (#) ($) Exercisable Unexercisable Exercisable Unexercisable
- -----------------------------------------------------------------------------------------------------------------------------------
Howard W. Lutnick............ -- -- 2,325,000 3,300,000 4,456,875 15,896,875
Lee M. Amaitis............... 93,750 1,560,827 215,000 641,250 36,320 3,894,961
Joseph C. Noviello........... 25,000 392,940 121,250 278,750 355,045 2,026,495
Stephen M. Merkel............ 50,000 658,665 100,000 350,000 2,640 2,035,210
Jeffrey M. Chertoff.......... -- -- 9,375 65,625 58,322 316,503
(1) Based on the last reported price of $16.94 for our Class A common stock on
December 31, 2002.
- ----------------------
COMPENSATION OF DIRECTORS
Directors who are also our employees do not receive additional compensation for
serving as directors. On October 23, 2002, we granted the following: (i) options
to purchase 30,000 shares of our Class A common stock to Albert M. Weis upon his
initial election as a director and (ii) options to purchase 10,000 shares of
Class A common stock to each of Larry R. Carter, John H. Dalton and William J.
Moran as compensation for their service as a directors. All options were granted
at an exercise price per share equal to $12.28, which was the price of our Class
A common stock on October 23, 2002. These options vest in three equal
installments beginning on the first of three semi-anniversaries of the date of
grant. Under our current policy, each of our non-employee directors is granted
an option to purchase 30,000 shares of our Class A common stock in connection
with his initial election to our board and an option to purchase 10,000 shares
of our Class A common stock each year he serves as a director thereafter. In
addition, non-employee directors receive annual compensation of $25,000. They
also receive cash compensation of $2,000 for each meeting of our board of
directors and $1,000 for each meeting of a committee of our board of directors
actually attended, whether in person, by telephone or otherwise. However, none
of our non-employee directors will be paid more than $3,000 in the aggregate for
attendance at meetings held on the same date. Non-employee directors also are
reimbursed for 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. Carter,
Dalton, Moran and Weis. All of the members of our Compensation Committee are
non-employee directors and are not former officers. During 2002, 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
1, 2003, 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 135 East 57th Street, New York, NY 10022.
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.
66
Beneficial Ownership(1)
----------------------------------------------------
Class A common stock Class B common stock
-------------------------- ----------------------
Name Shares % Shares %
- ------------------------------------------------- -------------- ------ ------------- ---
Howard W. Lutnick................................ 30,736,619(2) 52.6(3) 25,362,809(4) 100
Lee M. Amaitis................................... 396,637(5) 1.3(6) -- --
Joseph C. Noviello............................... 162,460(7) * -- --
Stephen M. Merkel................................ 180,178(8) * -- --
Jeffrey M. Chertoff.............................. 14,062(9) * -- --
Larry R. Carter.................................. 108,833(10) * -- --
John H. Dalton................................... 23,333(11) * -- --
William J. Moran................................. 69,333(12) * -- --
Albert M. Weis................................... 24,000(13) * -- --
All executive officers and directors as a
group (9 persons) ............................... 31,715,455 53.6(14) 25,362,809 100
- -------------
* Less than 1%
(1) Based upon information supplied by officers and directors, and filings
under Sections 13 and 16 of the Securities Exchange Act of 1934, as
amended (the Exchange Act).
(2) Consists of (1) 2,706,250 shares of Class A common stock subject to
options currently exercisable or exercisable within 60 days of March 1,
2003, (2) 500,000 shares of Class A common stock subject to currently
exercisable options held by a grantor retained annuity trust and
payable to Mr. Lutnick and of which Mr. Lutnick is the sole trustee,
(3) 2,641,470 shares of Class B common stock held by Cantor Fitzgerald,
L.P., (4) 22,721,339 shares of Class B common stock held by Cantor
Fitzgerald Securities, (5) 643,288 shares of Class A common stock held
by Cantor Fitzgerald Securities, (6) 387,469 shares of Class A common
stock held by CF Group Management, Inc., (7) 960,073 shares of Class A
common stock held directly by Mr. Lutnick, (8) 1,141 shares of Class A
common stock held in Mr. Lutnick's 401(k) account and (9) 175,589
shares of Class A common stock held by a trust for the benefit of
descendants of Mr. Lutnick, of which Mr. Lutnick's wife is one of two
trustees and Mr. Lutnick has limited powers to remove and replace such
trustees. 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) 29,851,134 shares of Class A common stock
outstanding on March 1, 2003, (2) 25,362,809 shares of Class B common
stock outstanding on March 1, 2003 and (3) 3,206,250 shares of Class A
common stock subject to options outstanding on March 1, 2003 currently
exercisable or exercisable within 60 days of March 1, 2003.
(4) Consists of (1) 2,641,470 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) 22,721,339 shares of Class B common
stock held 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. and Mr. Lutnick is the President and sole stockholder of CF Group
Management, Inc.
(5) Consists of (1) 293,125 shares of Class A common stock subject to
options currently exercisable or exercisable within 60 days of March 1,
2003 and (2) 103,512 shares of Class A common stock held directly by
Mr. Amaitis.
(6) Percentage based on (1) 29,851,134 shares of Class A common stock
outstanding on March 1, 2003 and (2) 293,125 shares of Class A common
stock subject to options currently exercisable or exercisable within 60
days of March 1, 2003.
(7) Consists of (1) 160,311 shares of Class A common stock subject to
options currently exercisable or exercisable within 60 days of March 1,
2003, (2) 585 shares of Class A common stock held directly by Mr.
Noviello, (3) 344 shares of Class A common stock held in Mr. Noviello's
401(k) account and (4) 1,220 shares of Class A common stock purchased
by Mr. Noviello through our Employee Stock Purchase Plan.
(8) Consists of (1) 141,250 shares of Class A common stock subject to
options currently exercisable or exercisable within 60 days of March 1,
2003, (2) 35,537 shares of Class A common stock held directly by Mr.
Merkel, (3) 1,141 shares of Class A
67
common stock held in Mr. Merkel's 401(k) account and (4) 2,250 shares
of Class A common stock beneficially owned by Mr. Merkel's spouse.
(9) Consists of 14,062 shares of Class A common stock subject to options
currently exercisable or exercisable within 60 days of March 1, 2003.
(10) Consists of (1) 63,333 shares of Class A common stock subject to
options currently exercisable or exercisable within 60 days of March 1,
2003 and (2) 45,500 shares of Class A common stock owned by Cavallino
Ventures LLC, of which Mr. Carter is the President.
(11) Consists of 23,333 shares of Class A common stock subject to options
currently exercisable or exercisable within 60 days of March 1, 2003.
(12) Consists of (1) 66,333 shares of Class A common
stock subject to options currently exercisable or
exercisable within 60 days of March 1, 2003 and (2)
3,000 shares of Class A common stock held directly
by Mr. Moran.
(13) Consists of (1) 10,000 shares of Class A common stock subject to
options currently exercisable or exercisable within 60 days of March 1,
2003, (2) 7,000 shares of Class A common stock held directly by Mr.
Weis and (3) 7,000 shares of Class A common stock, of which 1,000
shares are beneficially owned by Mr. Weis' spouse, 4,000 shares are
held in trust for Mr. Weis' children and 2,000 shares are beneficially
owned by Mr. Weis' children.
(14) Percentage based on (1) 29,851,134 shares of Class A common stock
outstanding on March 1, 2003, (2) 25,362,809 shares of Class B common
stock outstanding on March 1, 2003 and (3) 3,974,997 shares of Class A
common stock subject to options currently exercisable or exercisable
within 60 days of March 1, 2003.
BY OTHERS. The following table sets forth certain information, as of March 1,
2003, 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 common
equity, other than our officers and directors. Unless indicated otherwise, the
address of each entity listed is 135 East 57th Street, New York, NY 10022, 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 %
- ---- ------ --- ------ ---
Cantor Fitzgerald Securities.............................. 23,364,627 (2) 42.3 (3) 22,721,339 89.6 (4)
Cantor Fitzgerald, L.P.................................... 26,006,097 (5) 47.1 (3) 25,362,809 (6) 100 (4)
CF Group Management, Inc.................................. 26,393,566 (7) 47.8 (3) 25,362,809 (6) 100 (4)
- ------------
(1) Based upon filings under Section 13 of the Exchange Act.
(2) Consists of (1) 22,721,339 shares of Class B common stock and (2)
643,288 shares of Class A common stock.
(3) Percentage based on 29,851,134 shares of Class A common stock
outstanding on March 1, 2003 and 25,362,809 shares of Class B common
stock outstanding on March 1, 2003.
(4) Based on 25,362,809 shares of Class B common stock outstanding on March
1, 2003.
(5) Consists of (1) 2,641,470 shares of Class B common stock owned by
Cantor Fitzgerald, L.P., (2) 22,721,339 shares of Class B common stock
owned by Cantor Fitzgerald Securities and (3) 643,288 shares of Class A
common stock held by Cantor Fitzgerald Securities. Cantor Fitzgerald,
L.P. is the managing partner of Cantor Fitzgerald Securities.
(6) Consists of (1) 2,641,470 shares of Class B common stock held by Cantor
Fitzgerald, L.P. and (2) 22,721,339 shares of Class B common stock held
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.
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(7) Consists of (1) 387,469 shares of Class A common stock held by CF Group
Management, Inc., (2) 22,721,339 shares of Class B common stock held by
Cantor Fitzgerald Securities, (3) 643,288 shares of Class A common
stock held by Cantor Fitzgerald Securities and (4) 2,641,470 shares of
Class B common stock held by Cantor Fitzgerald, L.P. CF Group
Management, Inc. is the managing general partner of Cantor Fitzgerald,
L.P.
EQUITY COMPENSATION PLAN INFORMATION AS OF DECEMBER 31, 2002
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO WEIGHTED AVERAGE FUTURE ISSUANCE UNDER EQUITY
BE ISSUED UPON EXERCISE EXERCISE PRICE OF COMPENSATION PLANS
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (A))
(A) (B) (C)
------------------- ------------------- ------------------------
1999 Long-Term Incentive Plan (approved by
security holders)................................... 15,395,598 $17.443 1,156,150
Equity compensation plans not approved by
security holders.................................... 0 0 0
------------------- ------------------- ------------------------
Total.................................... 15,395,598 $17.443 1,156,150
=================== =================== ========================
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 Amended and Restated Joint Services Agreement, as amended, with Cantor
and services agreements with TradeSpark, Freedom, Municipal Partners, LLC and
CO2e.com, LLC, we own and operate the electronic trading systems and are
responsible for providing electronic brokerage services, and Cantor, TradeSpark,
Freedom, Municipal Partners, LLC and CO2e.com, LLC provide 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. Our agreement with Cantor provides
for a perpetual term.
REVENUE SHARING ARRANGEMENTS
Under our Amended and Restated Joint Services Agreement, as amended, with Cantor
and services agreements with TradeSpark, Freedom, Municipal Partners, LLC and
CO2e.com, LLC, we own and operate the electronic trading system and are
responsible for providing electronic brokerage services, and Cantor, TradeSpark,
Freedom, Municipal Partners, LLC or CO2e.com, LLC 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. We and Municipal
Partners, LLC each receive 50% of the fully electronic revenues related to
municipal bonds and we and CO2e.com, L.L.C. each receive 50% of the fully
electronic revenues. In general, for voice-assisted brokerage transactions we
receive 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 the case of CO2e.com, LLC, we receive 50% of CO2e.com, L.L.C.
fully electronic revenues and 15% of the voice assisted and open outcry revenues
until December 31, 2003, and 20% of voice-assisted and open outcry revenues
thereafter. In addition, we receive 25% of the net revenues from Cantor's gaming
business.
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In February 2003, we agreed that with respect to (i) certain network access
facilities services agreements and (ii) in other circumstances in which Cantor
refers network access facility services business to us, 60% of net revenues
from such business would be paid to Cantor and 40% of such revenues would be
paid to us. This revenue sharing arrangement will be made after deduction of all
sales commissions and direct third-party costs, including circuits and
maintenance.
SOFTWARE SOLUTIONS SERVICES
We also provide to Cantor, TradeSpark, Freedom, Municipal Partners, LLC and
CO2e.com, LLC software solutions 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 broker; (8)
electronic applications systems and network support and development; and (9)
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, that we incur in performing these
services. We charge Municipal Partners, LLC an amount based on the actual direct
and indirect costs, including overhead, of providing such services. These
services are provided to CO2e.com, LLC at no additional cost other than the
revenue sharing arrangement set forth above. In exchange for a 25% share of the
net revenues 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.
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
property insurance coverage for us covering our fixed assets and business
interruption insurance in the amount of $25 million. However, in the case of
business interruption insurance, we are listed on this insurance policy as one
of several insured parties, together with Cantor and several of its affiliates.
70
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. Pursuant to this
allocation, as of December 31, 2002, we had received approximately $20.5 million
of property insurance proceeds with respect to fixed assets of ours that were
destroyed as a result of the September 11 Events and approximately $12.8 million
of business interruption insurance proceeds, representing payments for both lost
revenues and increased expenses.
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 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. Four 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.
Cantor owns shares of our Class A common stock and Class B common stock
representing approximately 89.8% 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
71
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 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 provideS 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. See Note 7 to our
consolidated financial statements.
MUNICIPAL PARTNERS
In January 2002, Cantor sold the assets of the business known as Municipal
Partners, Inc., a municipal bond broker, to a newly formed limited company,
Municipal Partners, LLC, formed by Brian Kelly, a former employee of Cantor, in
exchange for a 25% special interest in 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 Municipal Partners, LLC 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. Pending receipt of
applicable licenses by Municipal Partners, LLC, Cantor provided Municipal
Partners, LLC with interim services. 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 amount with the result that the notes were
terminated and the shares were cancelled. This agreement is currently subject to
litigation. See "Item 3. Legal Proceedings."
72
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 310,769
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 103,588 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
414,357 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.
CO2E.COM, LLC
On October 11, 2002, Mitsui & Co. (U.S.A.), Inc. and MB Emission Trading, Inc.
(Mitsui) invested $1,200,000 in CO2e, a Cantor subsidiary. CO2e's purpose is to
form and operate one or more electronic trading markets for products related to
the mitigation of greenhouse gasses and related activities and to provide
brokerage information and consulting services relating to the emission or
mitigation of greenhouse gasses and related issues. In connection therewith, we
and CO2e entered into a Services Agreement whereby we will receive 50% of CO2e's
fully electronic revenues and 15% of CO2e's voice-assisted and open outcry
revenues until December 2003, and 20% thereafter. The Services Agreement
supersedes the provisions of the Joint Services Agreement with respect to CO2e
transactions. Mitsui received 4% of the equity of CO2e and we agreed to transfer
certain intellectual property rights to CO2e.
UBS
On August 21, 2002, we entered into a Global Fixed Income Transaction Fee
Agreement (the UBS Agreement) with UBS AG and certain named affiliates
(collectively, UBS) and Cantor for UBS to execute trades electronically on our
eSpeed(R) system in U.S. Securities, Agency Securities, European Government
Bonds, UK Gilts, Japanese Government Bonds and swaps of these various securities
instruments. The UBS Agreement has an initial term of two and one-half years,
commencing as of January 1, 2002. In addition to quarterly participation fees to
be paid to Cantor, UBS will pay transaction fees to Cantor for each executed
transaction. These fees will then be shared with us in accordance with our Joint
Services Agreement with Cantor.
In connection with the Agreement, we issued to UBS a warrant to purchase 300,000
shares of our Class A common stock. The warrant has a term of 10 years and has
an exercise price equal to $8.75, the market value of the underlying Class A
common stock on the date of issuance. The warrant is fully vested and
nonforfeitable, and is exercisable nine years and six months after issuance,
subject to acceleration upon the satisfaction by UBS of its yearly commitment
conditions provided for in the Agreement. We will be incurring a non-cash charge
equal to the fair value of the warrant on the date of issuance, which will be
amortized over the term of the Agreement. We have also agreed to issue an
additional warrant to purchase 200,000 shares of our Class A common stock at an
exercise price equal to the market value of the underlying Class A common stock
on the date of issuance if the UBS Agreement is renewed for another two and
one-half year term.
In addition, we have provided UBS with piggyback registration rights for the
Class A common stock underlying the warrants.
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, 2002, the reverse repurchase agreements totaled $186.7 million, including
accrued interest. The securities collateralizing the reverse repurchase
agreements are held under a custodial arrangement at J.P. Morgan Chase.
73
CANTOR FITZGERALD RELIEF FUND
On September 12, 2002, we donated $500,000 to the Cantor Fitzgerald Relief Fund
(the Relief Fund) in connection with a charity day. The Relief Fund is a
tax-exempt organization established to aid the families of the victims who
perished as a result of the September 11 Events. Mr. Lutnick, our Chief
Executive Officer, is one of the directors of the Relief Fund. Edie Lutnick, Mr.
Lutnick's sister, and Stuart Fraser, Cantor's Vice Chairman, are the other
directors of the Relief Fund.
ITEM 14. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer have concluded, based on
their evaluation as of a date within 90 days prior to the date of the filing of
this Report, that our controls and procedures are effective to ensure that
information required to be disclosed by us in the reports filed by us under the
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms, and
include controls and procedures designed to ensure that information required to
be disclosed by us in such reports is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosure.
There were no significant changes in our internal controls or in other factors
that could significantly affect these controls subsequent to the date of such
evaluation.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements. See Index to Financial Statements on page 39.
(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).
74
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. (Incorporated by
reference to Exhibit 10.1 to the Registrant's Registration
Statement on Form S-1 (Reg. No. 333-87475)).
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).
75
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).
10.19 Warrant Agreement, dated as of August 21, 2002, between
eSpeed, Inc. and UBS USA, Inc. (Incorporated by reference
to Exhibit 10.19 to the Registrant's Quarterly Report for
the quarter ended September 30, 2002).
10.20 Registration Rights Agreement, dated as of August 21, 2002,
by and between eSpeed, Inc. and UBS USA Inc. (Incorporated
by reference to Exhibit 10.20 to the Registrant's Quarterly
Report for the quarter ended September 30, 2002).
10.21 Services Agreement, dated as of October 11, 2002, between
eSpeed and CO2e.com LLC. (Incorporated by reference to
Exhibit 10.21 to the Registrant's Quarterly Report for the
quarter ended September 30, 2002).
10.22 Amendment to the Joint Services Agreement, dated as of
October 11, 2002, by and among eSpeed, Inc., Cantor
Fitzgerald, L.P. and certain of their respective
affiliates. (Incorporated by reference to Exhibit 10.22 to
the Registrant's Quarterly Report for the quarter ended
September 30, 2002).
10.23 Intellectual Property Rights Further Assurances Agreement,
dated as of October 11, 2002, between eSpeed, Inc. and
CO2e.com LLC. (Incorporated by reference to Exhibit 10.23
to the Registrant's Quarterly Report for the quarter ended
September 30, 2002).
10.24 Warrant Agreement, dated as of September 13, 2001, between
eSpeed, Inc. and Exchange Brokerage Systems Corp.
(Incorporated by reference to Exhibit 10.24 to the
Registrant's Quarterly Report for the quarter ended
September 30, 2002).
21 List of subsidiaries of eSpeed, Inc.
23 Consent of Deloitte & Touche LLP, independent auditors.
24 Powers of Attorney (included on signature page).
99 Certification by the Chief Executive Officer and Chief
Financial Officer Relating to a Periodic Report Containing
Financial Statements.
(b) Reports on Form 8-K.
None.
76
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
31st day of March, 2003.
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 Annual 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 31, 2003
- ------------------------------------ Chief Executive Officer
Howard W. Lutnick and President
(Principal Executive Officer)
/s/Jeffrey M. Chertoff Senior Vice President and Chief Financial March 31, 2003
- ------------------------------------ Officer (Principal Financial and Accounting
Jeffrey M. Chertoff Officer)
/s/ Lee Amaitis Director March 31, 2003
- ------------------------------------
Lee Amaitis
/s/ Larry R. Carter Director March 31, 2003
- ------------------------------------
Larry R. Carter
/s/ John H. Dalton Director March 31, 2003
- ------------------------------------
Hon. John H. Dalton
/s/ Stephen M. Merkel Director March 31, 2003
- ------------------------------------
Stephen M. Merkel
/s/ William J. Moran Director March 31, 2003
- ------------------------------------
William J. Moran
/s/ Joseph C. Noviello Director March 31, 2003
- ------------------------------------
Joseph C. Noviello
/s/ Albert M. Weis Director March 31, 2003
- ------------------------------------
Albert M. Weis
77
I, Howard W. Lutnick, certify that:
1. I have reviewed this annual report on Form 10-K of eSpeed, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
78
6. The registrant's other certifying officer and I have indicated in
this annual report whether there were significant changes in internal
controls or in the other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 31, 2003
/s/ Howard W. Lutnick
Howard W. Lutnick
Chairman of the
Board, Chief Executive Officer and
President
79
I, Jeffrey M. Chertoff, certify that:
1. I have reviewed this annual report on Form 10-K of eSpeed,
Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for,
the periods presented in this annual report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b. evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90
days prior to the filing date of this annual report (the
"Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
functions):
a. all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and
80
6. The registrant's other certifying officer and I have indicated
in this annual report whether there were significant changes in
internal controls or in the other factors that could
significantly affect internal controls subsequent to the date of
our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
/s/ Jeffrey M. Chertoff
------------------------------------
Jeffrey M. Chertoff
Senior Vice President and Chief
Financial Officer
81
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. (Incorporated by
reference to Exhibit 10.1 to the Registrant's Registration
Statement on Form S-1 (Reg. No. 333-87475)).
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).
82
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).
10.19 Warrant Agreement, dated as of August 21, 2002, between
eSpeed, Inc. and UBS USA, Inc. (Incorporated by reference
to Exhibit 10.19 to the Registrant's Quarterly Report for
the quarter ended September 30, 2002).
10.20 Registration Rights Agreement, dated as of August 21,
2002, by and between eSpeed, Inc. and UBS USA Inc.
(Incorporated by reference to Exhibit 10.20 to the
Registrant's Quarterly Report for the quarter ended
September 30, 2002).
83
10.21 Services Agreement, dated as of October 11, 2002, between
eSpeed and CO2e.com LLC. (Incorporated by reference to
Exhibit 10.21 to the Registrant's Quarterly Report for the
quarter ended September 30, 2002).
10.22 Amendment to the Joint Services Agreement, dated as of
October 11, 2002, by and among eSpeed, Inc., Cantor
Fitzgerald, L.P. and certain of their respective
affiliates. (Incorporated by reference to Exhibit 10.22 to
the Registrant's Quarterly Report for the quarter ended
September 30, 2002).
10.23 Intellectual Property Rights Further Assurances Agreement,
dated as of October 11, 2002, between eSpeed, Inc. and
CO2e.com LLC. (Incorporated by reference to Exhibit 10.23
to the Registrant's Quarterly Report for the quarter ended
September 30, 2002).
10.24 Warrant Agreement, dated as of September 13, 2001, between
eSpeed, Inc. and Exchange Brokerage Systems Corp.
(Incorporated by reference to Exhibit 10.24 to the
Registrant's Quarterly Report for the quarter ended
September 30, 2002).
21 List of subsidiaries of eSpeed, Inc.
23 Consent of Deloitte & Touche LLP, independent auditors.
24 Powers of Attorney (included on signature page).
99 Certification by the Chief Executive Officer and Chief
Financial Officer Relating to a Periodic Report Containing
Financial Statements.
84