Back to GetFilings.com
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
----------------
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-11921
E*TRADE GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-2844166
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
FOUR EMBARCADERO PLACE, 2400 GENG RD., PALO ALTO, CA 94303
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (650) 842-2500
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
TITLE OF EACH CLASS
COMMON STOCK--$0.01 PAR VALUE
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. [_]
As of December 22, 1998, the aggregate market value of voting stock held by
nonaffiliates of the registrant was approximately $1,292,200,000 (based upon
the closing price for shares of the Registrant's Common Stock as reported by
the National Market System of the National Association of Securities Dealers
Automated Quotation System on that date). Shares of Common Stock held by each
officer, director, and holder of 5% or more of the outstanding Common Stock
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive
determination for other purposes.
The number of shares of Common Stock outstanding as of December 22, 1998 was
56,764,300 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Definitive Proxy Statement relating to the Company's 1999 Annual Meeting to be
filed hereafter (incorporated into Part III hereof).
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
E*TRADE GROUP, INC.
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
PART I Page
----
Item 1. Business...................................................... 3
Item 2. Properties.................................................... 26
Item 3. Legal and Administrative Proceedings.......................... 26
Item 4. Submission of Matters to a Vote of Security Holders........... 27
PART II
Market for Registrant's Common Equity and Related Stockholder
Item 5. Matters....................................................... 27
Item 6. Selected Financial Data....................................... 29
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 30
Item 7a. Quantitative and Qualitative Disclosures About Market Risk.... 39
Item 8. Financial Statements and Supplementary Data................... 40
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..................................... 60
PART III
Item 10. Directors and Executive Officers of the Registrant ........... 60
Item 11. Executive Compensation........................................ 60
Security Ownership of Certain Beneficial Owners and
Item 12. Management.................................................... 60
Item 13. Certain Relationships and Related Transactions ............... 60
PART IV
Exhibits, Financial Statement Schedules and Reports on Form 8-
Item 14. K............................................................. 61
Exhibit Index........................................................... 61
Signatures.............................................................. 64
The page numbers in this Table of Contents reflect actual page numbers, not
EDGAR page tag numbers.
----------------
UNLESS OTHERWISE INDICATED, REFERENCES TO "COMPANY" MEAN E*TRADE GROUP, INC.
AND ITS SUBSIDIARIES, AND REFERENCES TO "FISCAL" MEAN THE COMPANY'S YEAR ENDED
SEPTEMBER 30 (E.G. "FISCAL 1998" REPRESENTS THE PERIOD OCTOBER 1, 1997 TO
SEPTEMBER 30, 1998).
2
PART I
ITEM 1. BUSINESS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the consolidated
financial statements and notes thereto included elsewhere in this Form 10-K.
This document contains forward-looking statements, including statements
regarding the Company's strategy, financial performance and revenue sources
which involve risks and uncertainties. The Company's actual results may differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including, but not limited to, those set forth in
the risk factors section and elsewhere in this Form 10-K.
E*TRADE Group, Inc. ("E*TRADE" or the "Company"), through its wholly-owned
subsidiary, E*TRADE Securities, Inc., is a leading provider of online
investing services and has established a popular, branded destination Web site
for self-directed investors. The Company offers automated order placement and
execution, along with a suite of products and services that can be
personalized, including portfolio tracking, Java-based charting and quote
applications, real-time market commentary and analysis, news and other
information services. The Company provides these services 24 hours a day,
seven days a week by means of the Internet, touch-tone telephone, including
interactive voice recognition, online service providers (America Online, AT&T
WorldNet, CompuServe, Microsoft Network and Prodigy) and direct modem access.
E*TRADE's proprietary transaction-enabling technology supports highly
automated, easy-to-use and cost-effective services that empower its customers
to take greater control of their investment decisions and financial
transactions. Further, the Company believes that its technology can be adapted
to provide transaction-enabling services related to other aspects of
electronic commerce.
Free resources available to the public on E*TRADE's Web site include
breaking financial news, real-time stock and option price quotes, company
financial information and news announcements, live market commentary,
personalized investment portfolios, investor community areas, and search and
filtering tools for mutual fund and fixed income products. E*TRADE's Web site
services three levels of investors--visitors, members, and customers, with
each successive group gaining access to additional value-added products and
services. Visitors can view market information, headline news, stock quotes
and charts, mutual fund information, and much more. By registering but not
opening an account, a visitor becomes a member and receives free access to
many advanced, customizable investment research tools, including free real-
time quotes and secure email. Customers, those investors with E*TRADE
accounts, have complete access to E*TRADE's trading engine and to all the
investment research and management features, including Smart Alerts, and many
sophisticated analytical and record keeping tools. Customers may also
subscribe to E*TRADE's Professional Edge service and receive access to IPOs,
institutional quality research reports, and other premium services.
As of September 30, 1998, the Company had over 544,000 accounts (with assets
under management in excess of $11.2 billion) representing a compounded annual
growth rate in new accounts since October 1, 1994, of 131%. The Company's
average daily transaction volume was 30,500 for the quarter ended September
30, 1998, a 27% increase over the average daily transaction volume of 24,100
in the equivalent period in fiscal 1997. For the quarter ended September 30,
1998, the Company opened an average of 1,410 new accounts per day with average
daily deposits of $20 million. The Company began offering online investing
services through the Internet in February 1996 and it has been the Company's
most rapidly growing channel. Transactions over the Internet and through
online service providers represented 77% of the Company's fourth quarter 1998
transaction volume.
The Company operates in a single industry segment: securities brokerage and
related investment services. No material part of the Company's consolidated
revenue is received from a single customer or group of customers, or from a
foreign corporation.
The Company was incorporated in California in 1982 and was reincorporated in
Delaware in July 1996. The Company's principal corporate offices are located
at Four Embarcadero Place, 2400 Geng Road, Palo Alto, CA 94303, and its
telephone number is (650)842-2500.
3
SERVICES AND PRODUCTS
The Company's services are based on proprietary transaction-enabling
technology and are designed to serve the needs of self-directed investors. The
Company's services include fully automated stock, option, fixed income and
mutual fund order processing via personal computer or touch-tone telephone,
including interactive voice recognition, online investment portfolio tracking
and financial market news and information. The Company offers its services to
consumers through a broad range of electronic gateways, including the
Internet, touch-tone telephone, including interactive voice recognition,
online service providers (America Online, AT&T WorldNet, CompuServe, Microsoft
Network and Prodigy), interactive television and direct modem access. All
records are maintained on one centralized system, so that customers have
access to current account information regardless of which gateways they are
using.
The Company continually strives to increase the functionality of its
services, as well as to offer new services that enhance customers' online
investing experiences. The Company's services give consumers increased control
of their personal investments by providing a link to the financial markets and
to financial information through a customizable and personalized user
interface. The Company's existing services and product offerings are described
below:
Stock, Option and Mutual Fund Trading
Customers can directly place orders to buy and sell Nasdaq and exchange-
listed securities, as well as equity and index options, and mutual funds
through E*TRADE's automated order processing system. E*TRADE supports a range
of order types, including market orders, limit orders (good-till-canceled or
day), stop orders and short sales. System intelligence automatically checks
the parameters of an order, together with the customer's available cash
balance and positions held, prior to executing an order. All listed market
orders (subject to certain size limitations) are executed at the National Best
Bid/Offer ("NBBO") or better at the time of receipt by the third market firm
or exchange. The NBBO is a dynamically updated representation of the combined
highest bid and lowest offer quoted across all United States stock exchanges
and market makers registered in a specific stock. Eligible orders are exposed
to the marketplace for possible price improvement, but in no case are orders
executed at a price inferior to the NBBO. Limit orders are executed based on
an indicated price and time priority. All Nasdaq market orders (subject to
certain size limitations) are executed at the Best Bid/Offer (Inside Market)
or better at the time of receipt by the market-maker. All transaction and
portfolio records are automatically updated to reflect trading activity. Buy
and sell orders placed when the markets are closed are automatically submitted
prior to the next day's market opening. Account holders receive electronic
notification of order executions, printed trade confirmations and detailed
statements. The Company also arranges for the transmittal of proxy, annual
report and tender offer materials to customers.
In November 1997, E*TRADE established a Mutual Fund Center (the "Center"),
which features more than 4,300 mutual funds, 850 of which are available
without transaction fees. The Center also offers several services free of
charge, such as, Power Search, a state-of-the-art proprietary screening tool,
and a wide spectrum of research including risk measures, portfolio
information, historical charts, and online prospectuses. Mutual fund orders
received by 4:00 p.m. Eastern time are purchased at the net asset value of the
fund as of the day of purchase.
Market Data and Financial Information
During trading hours, E*TRADE continuously receives a direct feed of
detailed quote data, market information and news. Customers can create their
own personal lists of stocks and options for quick access to current pricing
information. E*TRADE provides its customers and members free real-time quotes,
including stocks, options, major market indices, most active issues, and
largest gainers and losers for the major exchanges. Users are alerted when
there is current news on an identified stock or when a stock has reached a
user-defined price threshold. Through its alliances, the Company also provides
immediate access to breaking news, charts, market commentary and analysis and
company financial information. The Company's Web site
4
provides links to other business and financial Web sites, including the CNN
Financial Network and the EDGAR database, which provides access to SEC filings
of public companies.
Portfolio Tracking and Records Management
Customers have online access to a listing of all their portfolio assets held
at E*TRADE, including data on the date of purchase, cost basis, current price
and current market value. The system automatically calculates unrealized
profits and losses for each asset held. Detailed account balance and
transaction information includes cash and money fund balances, buying power,
net market portfolio value, dividends received, interest earned, deposits and
withdrawals. Brokerage history includes all orders, executions, changes and
cancellations. Tax records include total short-term or long-term gain/loss and
commissions paid. Customers can also create "shadow" portfolios to include
most financial instruments a customer is interested in tracking--for example,
assets held at another brokerage firm. These shadow portfolios can include
stocks, options, bonds and most mutual funds.
Cash Management Services
Customer payments are received through the mail, federal wire system or the
Internet and are credited to customer accounts upon receipt. The Company also
provides other cash management services to its customers. For example,
uninvested funds earn interest in a credit interest program or can be invested
in one of nine money market funds. In addition, the Company provides free
checking services with no minimum balance requirement through a commercial
bank and is exploring the expansion of these services. The Company, through
its strategic relationship with National Processing Company, has expanded its
cash management offerings to include electronic funds transfer via the
Internet and an automatic deposit program to allow scheduled periodic
transfers of funds into customers' E*TRADE accounts.
Account Security
The Company uses a combination of proprietary and industry standard security
measures to protect customers' accounts. Customers are assigned unique account
numbers, user identifications and trading passwords that must be used each
time they log on to the system. The Company relies on encryption and
authentication technology, including public key cryptography technology
licensed from RSA Data Security, Inc. ("RSA"), to provide the security and
authentication necessary to effect the secure exchange of information. In
addition the Company uses Secure Socket Layers technology for data encryption.
Touch-tone telephone transactions are secured through a personal
identification number, the same technology used in ATMs. A second level of
password protection is used prior to order placement. In addition, the Company
has an agreement to provide digital certification and authentication services
for electronic commerce through its alliance with VeriSign, Inc.
Access and Delivery of Services
The Company's services are widely accessible through multiple gateways, with
automated order placement available 24 hours a day, seven days a week by
personal computer. In addition, customers can access E*TRADE by touch-tone
telephone and, in a limited number of markets, through interactive television.
. Personal Computer. Customers using personal computers can access the
E*TRADE system through the Internet, online service providers (America
Online, AT&T WorldNet, CompuServe, Microsoft Network and Prodigy), or
direct modem access. The Company's Web site combines an easy-to-use
graphical user interface with the trading capabilities that experienced
investors demand. The Web-based system also includes direct links to
many investment-related resources on the Web. Alternatively, accessing
E*TRADE by dialing directly through a modem offers a method for
connecting to the trading system independent of either the Internet or a
proprietary online service.
5
. Touch-tone Telephone. TELE*MASTER, E*TRADE's interactive investing
system, provides customers with a convenient way to access quotes, place
orders and access portfolio information using their voice or touch-tone
telephone keypad.
. Interactive Television. WebTV Networks, an interactive television
system, is available as a gateway to the Company's investing services.
Revenues and transaction volume through WebTV Networks represent an
immaterial portion of the Company's business.
Substantially all of the Company's revenues come from online investing
services, and the Company expects its online investing services to continue to
account for substantially all of its revenues for the foreseeable future.
E*TRADE, like other investing services firms, is directly affected by national
and international economic and political conditions, broad trends in business
and finance and substantial fluctuations in volume and price levels of
securities and futures transactions. Severe market fluctuations in the future
could have a material adverse effect on the Company's business, financial
condition and operating results. Certain of the Company's competitors with
more diverse product and service offerings may be better positioned to
withstand such a downturn in the securities industry. See "Risk Factors--Risks
Associated with the Securities Industry; Concentration of Services" and "Risk
Factors--Risks Associated with Substantial Competition."
The market for online investing services, particularly over the Internet, is
at an early stage of development and is rapidly evolving. As is typical for
new and rapidly evolving industries, demand and market acceptance for recently
introduced services and products are subject to a high level of uncertainty.
See "Risk Factors--Risks Associated with Early Stage of Market Development;
Dependence on Online Commerce and the Internet."
E*TRADE TRANSACTION-ENABLING TECHNOLOGY
The E*TRADE engine is a proprietary transaction-enabling technology that
automates traditionally labor-intensive transactions. Because it was custom-
tailored for electronic marketplace use, the E*TRADE engine provides customers
with efficient service and has the added advantage of being scalable and
adaptable as usage increases and service offerings are expanded. Beyond these
features, the multi-tiered design of the E*TRADE engine and related software
allows for rapid expansion of network and computing capacity without
interrupting service or requiring replacement of existing hardware or
software.
The E*TRADE Engine
The E*TRADE transaction-enabling technology engine includes a wide variety
of functions and services that allow customers to open and monitor investment
accounts and to place orders for equity, option, mutual fund and fixed income
transactions. E*TRADE's core technology is based on E*TRADE's new proprietary
Stateless Architecture (SM) currently in the patent process. The architecture
provides the key drivers of our techno-business strategy (i.e. reliability,
scalability, reusability and security). The primary components include a
graphical user interface, the session manager, the transaction process
monitor, the data manager and the trade processor. See "Risk Factors--Risks
Associated with Systems Failure" and "Risk Factors--Risks Associated with
Intellectual Property Rights."
. Graphical User Interface ("GUI"). E*TRADE's GUI environment is based on
Netscape's Secure Enterprise Server and currently can be accessed by
individuals utilizing Netscape Navigator or Microsoft Internet Explorer.
E*TRADE's GUI connects to the session manager server through a group of
Sun E4000 servers. These "web servers" provide for load balancing using
Resonate software and offer immediate scalability. Access is restricted
through the use of secured network servers and routers.
. The Session Manager. The session manager's primary function is to
maintain session and state and provide a consistent, reliable user
experience. The session manager is based on the Netscape Application
Server product and runs on a uniquely configured group of Sun E4000
servers. The servers are redundant and configured dynamically so that
even if a server has a problem, it does not
6
impact the user. By deploying dynamic load balancing capabilities, the
servers dynamically re-allocate load if a server is lost. If a server is
added for a heavy trading day, it will also dynamically allocate load,
so additional capacity may be added without scheduling a system outage.
. The Transaction Process Monitor. The transaction process monitor
provides transaction delivery and establishes the business logic by
which a transaction is or is not executed. Based on BEA's Tuxedo
product, the monitor accepts a transaction from the session manager and
evaluates it using business logic written in Java reusable code objects,
stored at the Tuxedo services layer. The transaction is tagged,
monitored and accepted or rejected at this layer. If accepted, it is
then passed along to the data manager and, if appropriate, the automated
trade processing layer.
. The Data Manager. Storing and retrieving content and information for the
Web and IVR interfaces is the role of the data manager. Based on Oracle
data technology, content is received from E*TRADE's content provider
partners, stored in uniquely designed databases and caching servers and
passed on to E*TRADE users. User information such as trade transaction
and balances and positions are also received from our customers and
stored on data management servers. E*TRADE data servers are based on Sun
technology and are secure and redundant, providing rapid, reliable, safe
information access and retrieval.
. The Trade Processor. The core of the E*TRADE trading engine is the
automated processor, designed to provide the highest degree of
automation for all E*TRADE transactions. The automated processor is
designed to rapidly read data, process transactions and transmit
information to multiple locations. Because of this, the Company
processes over 90% of its transactions without any manual intervention.
Dual facilities that run independently share load balancing and provide
redundancy and backup, as well as scalability. The proprietary nature of
the system, along with user ID and password protection at the
application level, provide security for the automated processor.
Internet access to the processor is through the Company's Web site,
which restricts access through the use of secured network servers and
routers.
The Company maintains an internal development staff to continually enhance
its software and develop new products and services. The Company's software is
designed using Java code objects so it is versatile and reusable, allowing
E*TRADE products to be configured to meet the differing demands of strategic
relationships or customer requests.
The Company is making significant investments in systems technology and has
established technology centers in both Palo Alto and Rancho Cordova,
California. These facilities support systems, network services, trading,
customer service, transaction redundancy and backup between the two locations,
thereby providing an operational system in the event of a service interruption
at either facility. To provide for system continuity during potential outages,
the Company also has equipped its computer facilities with uninterruptible
power supply units, as well as back-up generators. In fiscal 1998, the Company
opened a new facility in Alpharetta, Georgia which will also support systems,
network services, trading and customer service. The technology center in the
Alpharetta facility is scheduled to be operational during the second quarter of
fiscal 1999.
The information and financial services and communications industries are
characterized by rapid technological change, changes in customer requirements,
frequent new service and product introductions and enhancements, and emerging
industry standards. See "Risk Factors--Risks Associated with Delays in
Introduction of New Services and Products."
A significant risk to online commerce and communication is the insecure
transmission of confidential information over public networks. The Company
relies on encryption and authentication technology, including public key
cryptography technology licensed from RSA, to provide the security and
authentication necessary to effect secure transmission of confidential
information. See "Risk Factors--Risks Associated with Encryption Technology."
7
STRATEGIC RELATIONSHIPS
The Company pursues strategic relationships to increase its access to online
consumers, to build brand name recognition and to expand the products and
services the Company can provide to its online customers.
Core Business Expansion
E*TRADE has secured or is actively pursuing alliances with (i) Internet
access and service providers, (ii) Internet content providers, (iii) providers
of home and online banking services, and (iv) electronic commerce companies.
These alliances are intended to increase the Company's core customer base,
transaction volume and operational efficiency and to further enhance its brand
name recognition.
The Company has concentrated principally on securing alliances with Internet
access, online service and content providers. While a majority of the
Company's customers access its services directly through the Internet, direct
modem access or touch-tone telephone, many use online service providers
(America Online, AT&T WorldNet, CompuServe, Microsoft Network and Prodigy).
Strategic relationships with such service providers allow the Company to
access a greater number of potential customers and allow the online service
providers to offer their subscribers a broader range of service options. The
Company's partnerships with leading content providers fulfill customers'
information needs and help drive transaction volume. See "Risk Factors--Risks
Associated with Acquisitions, Strategic Relationships."
New Account Development and Distribution
The Company has developed alliances with key channels in the online medium
to increase account development and expand distribution. These channels
include proprietary online services, internet service providers and popular
destination Web sites such as search engines or financial content providers.
These channels attract significant numbers of users, and the Company's
relationships provide access to expanded market opportunities. Set forth below
are descriptions of certain of the Company's key alliances:
. America Online. In July 1998, the Company entered into a two year
agreement with America Online ("AOL"), a provider of internet access and
content that allows direct access to E*TRADE's Web site from the AOL
Brokerage Center. E*TRADE is one of four exclusive sponsors of that
area. The agreement provides for extensive marketing and promotional
programs across AOL properties.
. Yahoo! The Company has entered into an agreement with Yahoo!, a search
engine portal, that provides direct access from the Quotes area of
Yahoo! Finance to E*TRADE's Web site. In August 1998, the agreement was
expanded to include extensive advertising, sponsorship, and promotional
programs throughout Yahoo! Finance and related areas of the Yahoo!
Network of properties as well as a number of unique targeted marketing
and promotional programs created for E*TRADE to directly reach the
millions of Yahoo! Finance registered users. The Company is also
sponsoring two highly popular areas of Yahoo!, Financial News and
Insider Trading, as well as renewing its position as one of the premier
merchants in Yahoo! Finance.
. E-Loan. In January 1998, the Company entered into a three year agreement
with E-Loan, Inc., a privately held multi-lender Internet mortgage
company, to prominently feature links to the Company's Online investment
services from the E-Loan Web site. In addition, E-Loan is to be the
exclusive multi-lender partner providing home loans through E*TRADE's
Web site.
. InsWeb. The Company has entered into an agreement with InsWeb, a leading
Internet insurance marketplace, that allows consumers to comparison shop
for insurance. InsWeb provides a co-branded area on the E*TRADE Web site
that extends E*TRADE's reach into additional financial products and
services.
. GeoCities. The Company has entered into an agreement with GeoCities, one
of the largest providers of personal Web sites and communities on the
Internet. GeoCities will provide extensive marketing,
8
promotional, and branding programs for E*TRADE throughout the GeoCities
Wall Street community.
. ZDNet. The Company has entered into an agreement with ZDNet, Ziff-Davis'
Internet site and a leading site in news, information and entertainment
category. The agreement calls for the Company to be the exclusive
provider of online investment tools, including a portfolio manager and
E*TRADE's stock market game to ZDNet's customer base.
. CBS SportsLine. In May 1998, the Company entered into a comprehensive
co-marketing agreement which makes the Company the exclusive category
sponsor of the CBS SportsLine/MarketWatch Business & Financial Arena.
This co-marketing agreement also includes the Company's branded banners
running throughout special promotions on CBS SportsLine and GolfWeb and
the exchange of branded content, tools and technology, ensuring that the
best offerings of each site are available to the Company's customers.
. SinaNet. The Company has an exclusive agreement to promote its Internet-
based investing services to Chinese-speaking investors in the United
States through SinaNet, Inc., a media company which has created a
popular Chinese-language Web site in North America.
. WebTV Networks. The Company has an agreement whereby E*TRADE has an
entrance page available to WebTV Network subscribers from the Investing
and Brokerage section of the WebTV Network where it is prominently
featured.
. CUSO Financial Service. In May 1998, the Company entered into an
agreement with CUSO Financial Services ("CFS"), a San Diego-based
securities broker-dealer, to provide credit union customers the option
of self directing their own investments or utilizing a CFS licensed
broker for traditional services.
. Bridgeway Capital Management, Inc. In June 1998, the Company formed an
alliance with Bridgeway Capital Management, Inc. ("Bridgeway"), a
Houston-based money management firm, whereby the Company became the
exclusive no transaction fee outlet for the Bridgeway family of mutual
funds. As a result, no other brokerage will be allowed to offer
Bridgeway funds without charging transaction fees. The Company also
began a subscription offering for the newest, actively-managed portfolio
in the Bridgeway family of domestic equity funds, Bridgeway Micro-Cap
Limited Portofolio.
. Scudder Kemper Investments, Inc. In June 1998, the Company formed an
agreement with Scudder Kemper Investments, Inc., a global leader in
investment management, whereby select Scudder Mutual Funds are available
without transaction fees through the Company's Mutual Fund Center.
In addition, the Company has established relationships with the following:
The Fourth Communication Network, Inc. (a provider of high-speed Internet
access and video services in hotels), Data Broadcasting Corporation (a
provider of financial information to individual investors), Windows on
WallStreet (maker of technical analysis software) and Stockpoint (a provider
of financial information to individual investors).
Content
Content such as news, quotes, charts and fundamental data help provide
investors with the information necessary to make investment decisions. The
Company believes that these information services facilitate new ideas and
increase transaction volume. The Company's partnerships with leading content
providers fulfill customers' information needs and help drive transaction
volume.
. Reuters Reality Online. The Company has an agreement with Reuters
Reality Online to provide Reuters news, quotes, and company news on
E*TRADE's Web site. This provides E*TRADE customers with up to the
minute world class news and information services.
9
. BASELINE Financial Services. BASELINE Financial Services provides
customers with access to a wide array of investment fundamentals, First
Call earnings estimates and historical prices on over 6,500 stocks.
Available to customers free of charge from the "Investor Tools" area of
the E*TRADE Web site, BASELINE information can be used to examine a
company's statistics prior to making investment decisions.
. Briefing.com. Briefing.com, a service of Charter Media, Inc., provides
market commentary and analysis to E*TRADE customers free of charge.
Updates are posted throughout the day to keep investors informed of
important developments affecting the markets.
. INVESTools. The Company has entered into a revenue sharing agreement
with INVESTools which provides E*TRADE customers with direct access to
25 brand-name research reports and newsletters plus stock screening
tools on a pay-per-use basis.
. QUOTE.com. Quote.com provides current news and charts that are directly
linked to E*TRADE customers' stock watch portfolio and quote lookup
features. News provided includes Reuters News, PR Newswire and
BusinessWire. Charts provided include intra-day, daily and weekly price
graphs.
. IDD Enterprises. IDD provides E*TRADE customers with access to mutual
fund profiles and two types of screening tools (Quick Fund Search and
Advanced Fund Search) within the E*TRADE Mutual Fund Center.
. InUnity Corporation. InUnity Corporation provides customers with access
to electronic prospectuses for funds offered within the E*TRADE Mutual
Fund Center.
. Morningstar, Inc. Morningstar, Inc. provides performance information and
proprietary "star" ratings on mutual funds within the E*TRADE Mutual
Fund Center.
. MSNBC Business Video. The Company has entered into a revenue sharing
agreement with MSNBC Business Video which provides E*TRADE customers
with direct access to exclusive audio and video coverage of news events
worldwide, as well as an archive of more than 8,000 audio and video
segments at a preferred customer discount.
International
The Company's expansion into new markets is being enhanced by alliances with
companies in key international markets. These alliances enable the Company to
capitalize on these relationships, by providing market knowledge, contacts and
local understanding. The Company believes that these alliances can accelerate
worldwide acceptance of the Company's online investing services. See "Risk
Factors"--"Risks Associated with International Strategy."
. Nova Pacific Capital. The Company has formed an alliance with Nova
Pacific Capital Limited, a Sydney, Australia-based financial and
technology development company, to provide online investing to
individual investors in Australia and New Zealand under the E*TRADE
brand name.
. VERSUS Technologies, Inc. The Company has entered into an alliance with
VERSUS Technologies, Inc., a Canadian supplier of electronic trading, to
provide online investing services to individual investors in Canada
under the E*TRADE brand name.
. Jerusalem Global Ltd. The Company has formed an alliance with Jerusalem
Global Limited, an Israeli-based high tech investment banking boutique,
to provide online investing services to individual investors in Israel
under the E*TRADE brand name.
. Electronic Share Information Ltd. The Company has formed a joint venture
company under the name E*TRADE UK with Electronic Share Information
Limited ("ESI"), a leading provider of internet-based financial services
in the UK. The joint venture company will provide the Company with
access to ESI's customer base of more than 170,000 investors.
10
. SOFTBANK CORP. In June 1998, the Company formed a joint venture company
with SOFTBANK CORP., a Japanese software distributor. The joint venture
company, E*TRADE Japan K.K., is intended to provide the Japanese market
with access to a premier destination for online securities trading
services and investing products.
. E*TRADE Nordic. In September 1998, the Company entered into an agreement
with a start-up Swedish company backed by local entrepreneurs to form
E*TRADE Nordic, to provide online investing services to individual
investors in Sweden, Norway, Denmark, Finland, and Iceland under the
E*TRADE brand name.
. CPR E*TRADE. In December 1998, the Company's licensee in France, E*TRADE
@ Net Bourse, entered into a sublicensing agreement with CPR, a premier
French investment and asset management bank in France, to form CPR
E*TRADE to provide online investing services to individual investors in
France under the E*TRADE brand name.
. E*TRADE Korea. In July 1998, the Company entered into a master licensing
agreement with Tokyo-based SOFTBANK CORP. to form E*TRADE Korea, to
provide online investing services to individual investors in Korea under
the E*TRADE brand name.
. E*TRADE Germany. In April 1998, the Company formed an alliance with two
leading financial services firms in Germany, the New York Broker Group,
headquartered in Dusseldorf and the Berliner Freiverkehr Group,
headquartered in Berlin, with the eventual formation of E*TRADE Germany
and E*TRADE Central Europe, Inc. Online investing services will be
provided to individual investors in Germany, Poland, Hungary, the Czech
Republic, and Croatia under the E*TRADE brand name through this
alliance.
Product Enhancement
The Company believes that technology is a key component in maintaining
market leadership in the Internet arena. Partnerships with leading technology
providers support the Company's products and services with up-to-date features
and offer the best solutions for customers.
. Critical Path. The Company has an agreement with Critical Path, a
leading provider of outsourced email services and infrastructure for Web
portals, Internet service providers, Web hosting companies and
corporations. Critical Path provides E*TRADE with email and other
services for its customers.
. National Processing Company. The Company has an agreement with National
Processing Company to provide E*TRADE's customers the ability to
initiate funds transfers from checking accounts at third-party
institutions into their E*TRADE accounts over the Internet. This service
is available to E*TRADE customers free of charge.
. Neural. In February 1997, the Company entered into an agreement with
Neural Applications Corporation ("Neural") that allows Neural's Java-
based intelligent process optimization solutions and data management
systems to be incorporated into the Company's Java-based charting and
quote applications.
. Telesphere. The Company has an agreement with Telesphere Corporation, a
leading global securities information firm, by which Telesphere provides
the Company with real-time market data on some internationally traded
securities, in addition to data on domestically traded securities.
. VeriSign. The Company has entered into an alliance with VeriSign Inc., a
leading provider of digital certification services for electronic
commerce. VeriSign's Digital IDs enhance electronic commerce by
authenticating the individuals, organizations and content involved in an
electronic transaction. Through this alliance, the Company believes that
it will provide its customers with the most technologically advanced
level of security for Internet investing and highly simplified Web site
access.
The Company has established a number of strategic relationships, both
domestic and international, with online and Internet service providers and
software and information service providers. A significant number of
11
such relationships have only recently been entered into. There can be no
assurance that any such relationships will be maintained, that if such
relationships are maintained, they will be successful or profitable, or that
the Company will develop any new such relationships. See "Risk Factors--Risks
Associated with Acquisitions, Strategic Relationships."
MARKETING
The Company's marketing strategy is based on an integrated marketing model
which employs a mix of communications media. The goals of the Company's
marketing programs are to increase E*TRADE's brand name recognition, to
attract new customers and to increase the retention and value of existing
customers. The Company pursues these goals through advertising, marketing on
its own Web site and other online opportunities, direct one-on-one marketing,
public relations, and co-marketing programs. All communications by E*TRADE
Securities, Inc. with the public are regulated by the National Association of
Securities Dealers, Inc. (the "NASD").
Advertising and Marketing
The Company's advertising focuses on building awareness of E*TRADE's brand,
products and services and positions E*TRADE as a better way of handling
securities transactions, accessing financial and market data, and managing
portfolios for the individual investor. Advertising is increasingly directing
interested prospects to the Company's Web site for additional information, as
opposed to generating primarily telephone-based inquiries. Print
advertisements are placed in a broad range of business, technology and
financial publications, including Barron's, Forbes, Forbes ASAP, Investor's
Business Daily, Money, Smart Money, the Wall Street Journal, Fortune and
Wired. E*TRADE also advertises regularly on national cable and television
networks and on national radio networks. Through the Web site, prospective
customers can get detailed information on the Company's services, use an
interactive demonstration system, play the E*TRADE game, request additional
information and complete an account application online.
Public Relations Program
The Company pursues public relations opportunities to build brand awareness.
This campaign has resulted in appearances on CNBC, CNN and The Today Show, in
addition to profiles in Barron's, Business Week, the Financial Times,
Investor's Business Daily, Money, Smart Money, Time and the Wall Street
Journal among others. There are links to E*TRADE's Web site from over 1,000
sites on the Web, which the Company believes is a significant factor in
increasing brand awareness and generating leads, as consumers increasingly
look to the Internet as a key source of information and commercial activity.
The Company also actively participates in speaking opportunities at industry
conferences and events.
CUSTOMER SERVICE
The Company believes that providing an effective customer service team to
handle customer needs is critical to its success. The Company's customer
service organization helps customers get online, handles product and service
inquiries and addresses all brokerage and technical questions. The Company's
customers have access to a toll-free number from 5:00 a.m. to 6:00 p.m.
Pacific time, Monday through Friday. The Company's current policy specifies
that customer service associates have or obtain a securities broker's license.
See "Risk Factors--Risk Associated with Management of a Changing Business."
OPERATIONS
Clearing
The Company implemented self-clearing operations for equities in July 1996
and self-clearing operations for options in April 1997. Clearing operations
include the confirmation, receipt, settlement, custody and
12
delivery functions involved in securities transactions. Performing its own
clearing operations allows E*TRADE Securities to retain customer free credit
balances and securities for use in margin lending activities subject to
Securities and Exchange Commission ("SEC") and NASD rules. In July 1996, the
Company signed a seven-year agreement with BETA Systems for the provision of
computer services to support order entry, order routing, securities
processing, customer statement preparation, tax reporting, regulatory
reporting, and other services necessary to manage a brokerage clearing
business.
Since the Company's conversion to self-clearing, customers' securities
typically are held by the Company in nominee name on deposit at one or more of
the recognized securities industry depository trust companies, to facilitate
ready transferability. The Company collects dividends and interest on
securities held in nominee name and makes the appropriate credits to customer
accounts. The Company also facilitates exercise of subscription rights on
securities held for its customers. The Company arranges for the transmittal of
proxy, annual report and tender offer materials to customers. E*TRADE
Securities relies upon certificate counts and microfilming procedures as
deterrents to theft of securities and, as required by the NASD and certain
other regulatory authorities, carries fidelity bonds covering loss or theft.
Self-clearing operations performed by firms without significant prior
experience, such as the Company, involve substantial risks.
Lending and Borrowing Activities
Margin Lending. The Company makes loans to customers collateralized by
customer securities. Margin lending by the Company is subject to the margin
rules of the Board of Governors of the Federal Reserve System, NASD margin
requirements and the Company's internal policies, which are more stringent
than the Federal Reserve and NASD requirements. In permitting customers to
purchase securities on margin, the Company takes the risk of a market decline
that could reduce the value of the collateral held by the Company to below the
customers' indebtedness before the collateral can be sold, which could result
in losses to the Company. Under applicable NASD rules, in the event of a
decline in the market value of the securities in a margin account, the Company
is obligated to require the customer to deposit additional securities or cash
in the account so that at all times the customer's equity in the account is at
least 25% of the value of the securities in the account. E*TRADE's current
internal requirement, however, is that the customer's equity not fall below
30%. In the event a customer's equity falls below 30%, the customer will be
required to increase the account's equity to 35%. Margin lending to customers
constitutes the major portion of the basis on which net capital requirements
of the Company are determined under the SEC's Net Capital Rule. To the extent
these activities expand, the Company's net capital requirements will increase.
See "Risk Factors--Risks Associated with Net Capital Requirements" and "Risk
Factors--Risks Associated with the Securities Industry; Concentration of
Services."
Securities Lending and Borrowing. The Company borrows securities both to
cover short sales and to complete customer transactions in the event a
customer fails to deliver securities by the required settlement date. The
Company collateralizes such borrowings by depositing cash or securities with
the lender and receives a rebate (in the case of cash collateral) or pays a
fee calculated to yield a negotiated rate of return. When lending securities,
the Company receives cash or securities and generally pays a rebate (in the
case of cash collateral) to the other party in the transaction. Securities
lending and borrowing transactions are executed pursuant to written agreements
with counterparties that require that the securities borrowed be "marked-to-
market" on a daily basis and that excess collateral be refunded or that
additional collateral be furnished in the event of changes in the market value
of the securities. The securities usually are "marked-to-market" on a daily
basis through the facilities of the various national clearing organizations.
Order Processing
All listed market orders other than those with special qualifiers (subject
to certain size limitations based on the size in the primary market) are
executed at the NBBO or better at the time of receipt by the third market firm
or exchange. Eligible orders are exposed to the marketplace for possible price
improvement, but in no case are orders executed at a price inferior to the
NBBO. Limit orders are executed based on an
13
indicated price and time priority. All Nasdaq market orders (subject to
certain size limitations based on the trading characteristics of the
particular security) are executed at the Best Bid/Offer (Inside Market), or
better at the time of receipt by the market-maker. Eligible orders are subject
to possible price improvement in the marketplace. See "Risk Factors--Risks
Associated with Systems Failure."
The market for online investing services, particularly over the Internet, is
new, rapidly evolving and intensely competitive, and the Company expects
competition to continue to intensify in the future. See "Risk Factors--Risks
Associated with Substantial Competition."
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. See "Risk Factors--Risks
Associated with Government Regulation" and "Risk Factors--Risks Associated
with Net Capital Requirements."
ASSOCIATES
At September 30, 1998, the Company had 833 associates. The Company's success
has been, and will be, dependent to a large degree on its ability to retain
the services of its existing executive officers and to attract and retain
qualified additional senior and middle managers and key personnel in the
future. There can be no assurance that the Company will be able to attract,
assimilate or retain qualified technical and managerial personnel in the
future, and the failure of the Company to do so would have a material adverse
effect on the Company's business, financial condition and operating results.
None of the Company's associates is subject to collective bargaining
agreements or is represented by a union. The Company considers its relations
with its associates to be good.
EXECUTIVE OFFICERS OF THE REGISTRANT
In addition to the executive officers who are also directors of the Company,
the following executive officers are not directors and are elected by and
serve at the discretion of the Board of Directors:
NAME AGE POSITION
---- --- --------
Kathy Levinson............................. 43 President and Chief Operating
Officer of E*TRADE
Securities, Inc.
Leonard C. Purkis.......................... 50 Chief Financial Officer and
Executive Vice President,
Finance and Administration
Judy Balint................................ 45 President and Chief Operating
Officer, E*TRADE
International
Debra Chrapaty............................. 37 President and Chief Operating
Officer, E*TRADE
Technologies
Jerry D. Gramaglia......................... 43 Senior Vice President, Sales,
Marketing and Communications
Rebecca L. Patton.......................... 43 Senior Vice President,
Advanced Products Group
Stephen C. Richards........................ 44 Senior Vice President,
Corporate Development and
New Ventures
Connie M. Dotson........................... 49 Senior Vice President,
Service Quality
Kathy Levinson is President and Chief Operating Officer. She joined the
company in January 1996 after serving as a consultant to E*TRADE during 1995.
Prior to that, Ms. Levinson held a variety of senior level positions at
Charles Schwab, most recently a senior vice president of custody services. Ms.
Levinson received a BA in economics from Stanford and completed the Program
for Management Development at Harvard University.
14
Leonard C. Purkis is Chief Financial Officer and Executive Vice President of
Finance and Administration. Mr. Purkis previously served as chief financial
officer for Iomega Corporation from 1995 to 1998. Prior to joining Iomega, he
served in numerous senior level domestic and international finance positions
for General Electric Co. and its subsidiaries, culminating his career there as
senior vice president, finance, for GE Capital Fleet Services. A native of
Cardiff, Wales, he is a graduate of the Institute of Chartered Accountants in
England and Wales, and began his career as an audit manager at Coopers &
Lybrand.
Judy Balint is President and Chief Operating Officer of E*TRADE's
international division. From March 1997 to June 1998, she served as senior
vice president, global marketing and strategic business development. Prior to
joining E*TRADE, Ms. Balint was senior vice president and corporate director
of marketing for National Processing, Inc., consultants in transaction
technology. Ms. Balint has held a variety of senior executive positions for
DHL, Federal Express, and CME-KHBB, a global advertising network of the former
Saatchi & Saatchi Group. She earned a BA in journalism from the University of
Wisconsin, Madison and an MBA in international business from the Monterey
Institute of International Studies in Monterey, California.
Debra Chrapaty is President and Chief Operating Officer of E*TRADE
Technologies. Prior to joining E*TRADE in July 1997 as senior vice president
technologies and chief information officer, Ms. Chrapaty served as chief
information officer and chief technology officer of the National Basketball
Association. Ms. Chrapaty has also served as director, internal systems
consulting, at Bertelsmann C.I.S., and with EMI Records Group. Her prior
experience with financial organizations includes the Federal Reserve Bank of
New York and Chase Econometric/IDC. Ms. Chrapaty earned her BBA in economics
at Temple University and her MBA in information systems at New York
University.
Jerry D. Gramaglia is Senior Vice President, Sales, Marketing, and
Communications. Prior to joining E*TRADE in June 1998, Mr. Gramaglia was vice
president of marketing for Sprint Corporation's $3 billion consumer division,
including Internet channel marketing. He also served for more than 20 years in
a variety of senior executive positions for major global consumer companies,
including Pepsico, Procter & Gamble, and Nestle Corporation. Mr. Gramaglia
earned a BA in economics from Denison University.
Rebecca L. Patton has served as Senior Vice President, Advanced Products
Group since July 1997. Ms. Patton joined the Company in September 1995 as vice
president, marketing and served as senior vice president, marketing and
communications from August 1996 to July 1997. From 1988 to September 1995,
Ms. Patton served in a variety of management positions at Apple Computer,
including worldwide marketing manager of the Personal Interactive Electronics
Division and manager of Apple's PowerBook marketing group. Ms. Patton received
a BA in Economics from Duke University and an MBA from Stanford University. In
December 1998, Ms. Patton left the Company in order to pursue a position as
President and Chief Executive Officer of Della & James, a start-up e-commerce
venture company for wedding registry of major retailers.
Stephen C. Richards is Senior Vice President, Corporate Development and New
Ventures. From 1996 to 1998, Mr. Richards served as E*TRADE's senior vice
president of finance, chief financial officer and treasurer. Prior to joining
E*TRADE in April 1996, Mr. Richards was managing director and chief financial
officer of correspondent clearing at Bear Stearns & Company. He is also a
former vice president/deputy controller of Becker Paribas, and former first
vice president/controller of Jefferies and Company, Inc. He received a BA in
statistics and economics from the University of California at Davis and an MBA
in finance from the University of California at Los Angeles. Mr. Richards is a
Certified Public Accountant.
Connie M. Dotson is Senior Vice President, Service Quality. Ms. Dotson
joined E*TRADE in 1996 as customer service manager. She was named vice
president in 1997. Prior to joining E*TRADE, Ms. Dotson served as senior vice
president of operations for U.S. Computer Services/CableData, Inc., where she
was responsible for planning, organization, and control of all CableData
operational and support departments, including customer service, systems
support, new business, training, and field services.
The Company's present directors and executive officers and their respective
affiliates beneficially own approximately 40.8% of the Company's outstanding
Common Stock. As a result, these stockholders, if they
15
act together, will be able to exercise significant influence over all matters
requiring stockholder approval, including the election of directors and
approval of significant corporate transactions. Such concentration of
ownership also may have the effect of delaying, preventing or deterring a
change in control of the Company.
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision in our company. The risks and uncertainties described
below are not the only ones facing our company and there may be additional
risks that we do not presently know of or that we currently deem immaterial.
All of these risks may impair our business operations. This document also
contains forward-looking statements that involve risks and uncertainties and
actual results may differ materially from the results we discuss in the
forward-looking statements. If any of the following risks actually occur, our
business, financial condition or results of operations could be materially
adversely affected. In such case, the trading price of our Common Stock could
decline, and you may lose all or part of your investment.
In accordance with "plain English" guidelines provided by the Securities and
Exchange Commission, the risk factors have been written in the first person.
Risks Associated with Management of a Changing Business
We have grown rapidly and our business and operations have changed
substantially since we began offering electronic investing services in 1992
and Internet investing services in February 1996, and we expect this trend to
continue. Such rapid change and expansion places significant demands on our
administrative, operational, financial and other resources.
We expect operating expenses and staffing levels to increase substantially
in the future. In particular, we have hired and intend to hire a significant
number of additional skilled personnel, including persons with experience in
both the computer and brokerage industries, and, specifically, persons with
Series 7 or other broker-dealer licenses. Competition for such personnel is
intense, and there can be no assurance that we will be able to find or keep
additional suitable senior managers or technical persons in the future. We
also expect to expend resources for future expansion of our accounting and
internal information management systems and for a number of other new systems
and procedures. In addition, we expect that future expansion will continue to
challenge our ability to successfully hire and retain associates. If our
revenues do not keep up with operating expenses, our information management
systems do not expand to meet increasing demands, we fail to attract,
assimilate and retain qualified personnel, or we fail to manage our expansion
effectively, there would be a material adverse effect on our business,
financial condition and operating results. See "Government Regulation," Item
7--"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business--Associates."
The rapid growth in the use of our services has strained our ability to
adequately expand technologically. As we acquire new equipment and
applications quickly, we have less time and ability to test and validate
hardware and software, which could lead to performance problems. We also rely
on a number of third parties to process our transactions, including online and
Internet service providers, back office processing organizations, service
providers and market-makers, all of which will need to expand the scope of the
operations they perform for us. Any backlog caused by a third party's
inability to expand sufficiently to meet our needs could have a material
adverse effect on our business, financial condition and operating results. As
trading volume increases, we may have difficulty hiring and training qualified
personnel at the necessary pace, and the shortage of licensed personnel could
cause a backlog in the processing of orders that need review, which could lead
to not only unsatisfied customers, but also to liability for orders that were
not executed on a timely basis.
Risks Associated with Early Stage of Market Development; Dependence on Online
Commerce and the Internet
The market for electronic brokerage services, particularly over the
Internet, is at an early stage of development and is rapidly evolving.
Consequently, demand and market acceptance for recently introduced
16
services and products are subject to a high level of uncertainty. For us, this
uncertainty is compounded by the risks that consumers will not adopt online
commerce and that commerce on the Internet will not adequately develop or
flourish to permit us to succeed.
Sales of many of our services and products will depend on consumers adopting
the Internet as a method of doing business. This may not occur because of
inadequate development of the necessary infrastructure, such as a reliable
network infrastructure, or complementary services and products such as high
speed modems and communication lines. The Internet has grown and is expected
to grow both in number of users and amount of traffic. There can be no
assurance that the Internet infrastructure will continue to be able to support
the demands placed on it by this continued growth. In addition, the Internet
could lose its viability due to slow development or adoption of standards and
protocols to handle increased Internet activity, or due to increased
governmental regulation. Moreover, critical issues including security,
reliability, cost, ease of use, accessibility and quality of service remain
unresolved and may negatively affect the growth of Internet use or commerce on
the Internet. Because use of the Internet for commerce is new and evolving,
there can be no assurance that the Internet will prove to be a viable
commercial marketplace. If these critical issues are not resolved, if the
necessary infrastructure is not developed, or if the Internet does not become
a viable commercial marketplace, our business, financial condition and
operating results will be materially adversely affected.
Adoption of online commerce by individuals that have relied upon traditional
means of commerce in the past will require such individuals to accept new and
very different methods of conducting business. Moreover, our brokerage
services over the Internet involve a new approach to securities trading which
will require intensive marketing and sales efforts to educate prospective
customers regarding its uses and benefits. For example, consumers who trade
with more traditional brokerage firms, or even discount brokers, may be
reluctant or slow to change to obtaining brokerage services over the Internet.
Also, concerns about security and privacy on the Internet may hinder the
growth of online brokerage trading, which could have a material adverse effect
our business, financial condition and operating results.
Risks Associated with the Securities Industry; Concentration of Services
Almost all of our revenues in recent years have been from electronic
brokerage services, and we expect this business to continue to account for
almost all of our revenues in the foreseeable future. We, like other
securities firms, are directly affected by economic and political conditions,
broad trends in business and finance and changes in volume and price levels of
securities and futures transactions. In recent months, the U.S. securities
markets have fluctuated considerably and a downturn in these markets could
adversely affect our operating results. In October 1987 and October 1989, the
stock market suffered major declines, as a result of which many firms in the
industry suffered financial losses, and the level of individual investor
trading activity decreased after these events. Reduced trading volume and
prices have historically resulted in reduced transaction revenues. When
trading volume is low, our profitability may be adversely affected because our
overhead remains relatively fixed. Severe market fluctuations in the future
could have a material adverse effect on our business, financial condition and
operating results. Some of our competitors with more diverse product and
service offerings might withstand such a downturn in the securities industry
better than we would. See "Risks Associated with Substantial Competition."
Our brokerage business, by its nature, is subject to various other risks,
including customer default and employees' misconduct and errors. We sometimes
allow customers to purchase securities on margin, therefore we are subject to
risks inherent in extending credit. This risk is especially great when the
market is rapidly declining and the value of the collateral we hold could fall
below the amount of a customer's indebtedness. Under specific regulatory
guidelines, any time we borrow or lend securities, we must correspondingly
disburse or receive cash deposits. If we fail to maintain adequate cash
deposit levels at all times, we run the risk of loss if there are sharp
changes in market values of many securities and parties to the borrowing and
lending transactions fail to honor their commitments. Any such losses could
have a material adverse effect on our business, financial condition and
operating results. See "Business--Operations."
17
Risks Associated with Delays In Introduction of New Services and Products
Our future success depends in part on our ability to develop and enhance our
services and products. There are significant technical risks in the
development of new services and products or enhanced versions of existing
services and products. There can be no assurance that we will be successful in
achieving any of the following:
. effectively using new technologies;
. adapting our services and products to emerging industry standards;
. developing, introducing and marketing service and product enhancements;
or
. developing, introducing and marketing new services and products.
We may also experience difficulties that could delay or prevent the
development, introduction or marketing of these services and products.
Additionally, these new services and products may not adequately meet the
requirements of the marketplace or achieve market acceptance. If we are unable
to develop and introduce enhanced or new services and products quickly enough
to respond to market or customer requirements, or if they do not achieve
market acceptance, our business, financial condition and operating results
will be materially adversely affected. See "Business--Services and Products"
and "Business--E*TRADE Transaction-Enabling Technology."
Risks Associated with Substantial Competition
The market for electronic brokerage services over the Internet is new,
rapidly evolving and intensely competitive. We expect competition to continue
and intensify in the future. We face direct competition from discount
brokerage firms providing either touch-tone telephone or online brokerage
services, or both. These firms generally only execute transactions for their
customers, without offering other services such as portfolio valuation,
investment recommendations and research. This limitation on service offerings
may result in other firms having a lower cost structure. These competitors
include, among others, such discount brokerage firms as:
. Charles Schwab & Co., Inc.;
. Fidelity Brokerage Services, Inc.;
. Waterhouse Securities, Inc.;
. Quick & Reilly, Inc. (a subsidiary of Fleet Financial Group, Inc.);
. National Discount Brokers (a subsidiary of National Discount Brokers
Group);
. Discover Brokerage Direct, Inc. (a subsidiary of Morgan Stanley Dean
Witter Discover & Company);
. Ameritrade, Inc. (a subsidiary of Ameritrade Holding Corporation);
. DLJdirect (a subsidiary of Donaldson, Lufkin & Jenrette Securities
Corporation);
. Datek Online Holdings Corporation (Datek Online); and
. SURETRADE, Inc.
We also encounter competition from established full commission brokerage
firms such as PaineWebber Incorporated, Merrill Lynch, Pierce, Fenner & Smith
Incorporated and Smith Barney, Inc., among others. In addition, we compete
with financial institutions, mutual fund sponsors and other organizations,
some of which provide electronic brokerage services.
Many of our competitors have longer operating histories and significantly
greater financial, technical, marketing and other resources than we do. In
addition, many of our competitors offer a wider range of
18
services and financial products than we do, and thus may be able to respond
more quickly to new or changing opportunities, technologies and customer
requirements. Many of our competitors also have greater name recognition and
larger customer bases that could be leveraged, thereby gaining market share
from us. Such competitors may conduct more extensive promotional activities
and offer better terms and lower prices to customers than we do, possibly even
sparking a price war in the electronic brokerage business. Moreover, certain
competitors have established cooperative relationships among themselves or
with third parties to enhance their services and products. For example,
Charles Schwab's One-Source mutual fund service and similar, more complete
services may discourage potential customers from using our brokerage services.
Accordingly, it is possible that new competitors or alliances among existing
competitors may significantly reduce our market share.
General financial success within the securities industry over the past
several years has strengthened existing competitors. We believe that such
success will continue to attract new competitors to the industry, such as
banks, software development companies, insurance companies, providers of
online financial and information services and others, as such companies expand
their product lines. Commercial banks and other financial institutions have
become more competitive with us by offering their customers certain corporate
and individual financial services traditionally provided by securities firms.
The current trend toward consolidation in the commercial banking industry
could further increase competition in all aspects of our business. Commercial
banks generally are expanding their securities and financial services
activities. While we cannot predict the type and extent of competitive
services that commercial banks and other financial institutions ultimately may
offer, or whether legislative barriers will be modified, we may be adversely
affected by such competition or legislation. To the extent our competitors are
able to attract and retain customers based on the convenience of one-stop
shopping, our business or ability to grow could be adversely affected. In many
instances, we are competing with such organizations for the same customers. In
addition, competition among financial services firms exists for experienced
technical and other personnel.
There can be no assurance that we will be able to compete effectively with
current or future competitors or that such competition will not have a
material adverse effect on our business, financial condition and operating
results.
Risks Associated with Dependence on Intellectual Property Rights
Our success and ability to compete are dependent to a significant degree on
our proprietary technology. We rely primarily on copyright, trade secret and
trademark law to protect our technology. Effective trademark protection may
not be available for our trademarks. Although we have registered the trademark
"E*TRADE" in the United States and certain other countries, and have certain
other registered trademarks, there can be no assurance that we will be able to
secure significant protection for these trademarks. Our competitors or others
may adopt product or service names similar to "E*TRADE," thereby impeding our
ability to build brand identity and possibly leading to customer confusion.
Our inability to adequately protect the name "E*TRADE" would have a material
adverse effect on our business, financial condition and operating results.
Despite any precautions we take, a third party may be able to copy or
otherwise obtain and use our software or other proprietary information without
authorization or to develop similar software independently. Policing
unauthorized use of our technology is made especially difficult by the global
nature of the Internet and difficulty in controlling the ultimate destination
or security of software or other data transmitted on it. The laws of other
countries may afford us little or no effective protection for our intellectual
property. There can be no assurance that the steps we take will prevent
misappropriation of our technology or that agreements entered into for that
purpose will be enforceable. In addition, litigation may be necessary in the
future to:
. enforce our intellectual property rights;
. protect our trade secrets;
. determine the validity and scope of the proprietary rights of others; or
. defend against claims of infringement or invalidity.
19
Such litigation, whether successful or unsuccessful, could result in
substantial costs and diversions of resources, either of which could have a
material adverse effect our business, financial condition and operating
results. We currently have several ongoing trademark infringement litigation
actions that we have filed in an effort to protect our trademarks.
Risks Associated with Infringement
We may in the future receive notices of claims of infringement of other
parties' proprietary rights. There can be no assurance that claims for
infringement or invalidity (or any indemnification claims based on such
claims) will not be asserted or prosecuted against us. Any such claims, with
or without merit, could be time consuming and costly to defend or litigate,
divert our attention and resources or require us to enter into royalty or
licensing agreements. There can be no assurance that such licenses would be
available on reasonable terms, if at all, and the assertion or prosecution of
any such claims could have a material adverse effect on our business,
financial condition and operating results.
Risks Associated with Entering New Markets
One element of our strategy is to leverage the E*TRADE brand and technology
to enter new markets. No assurance can be given that we will be able to
successfully adapt our proprietary processing technology for use in other
markets. Even if we do adapt our technology, no assurance can be given that we
will be able to compete successfully in any such new markets. E*TRADE
Securities plans, subject to regulatory approval, to establish investment
banking operations, raising public and private equity capital for companies
over the Internet and other electronic media. We are currently in the process
of investing approximately $100 million in a new marketing campaign centered
on our new Internet Web site, Destination E*TRADE. We also plan to pursue
additional related revenue opportunities, such as revenue from correspondent
clearing, advertising and subscriptions. There can be no assurance that our
new marketing efforts or our pursuit of any of these opportunities will be
successful. If these efforts are not successful, we could realize less than
expected earnings, which in turn could result in a decrease in the market
value of our Common Stock. Furthermore, such efforts may divert management
attention or inefficiently utilize our resources. See "Business--Strategic
Relationships."
Risks Associated with International Strategy
One component of our strategy is a planned increase in efforts to attract
more international customers. To date, we have limited experience in providing
brokerage services internationally. There can be no assurance that our
international licensees will be able to market our branded services and
products successfully in international markets. In addition, there are certain
risks inherent in doing business in international markets, particularly in the
heavily regulated brokerage industry, such as:
. unexpected changes in regulatory requirements, tariffs and other trade
barriers;
. difficulties in staffing and managing foreign operations;
. political instability;
. fluctuations in currency exchange rates;
. reduced protection for intellectual property rights in some countries;
. seasonal reductions in business activity during the summer months in
Europe and certain other parts of the world; and
. potentially adverse tax consequences.
Any of the foregoing could adversely impact the success of our international
operations. Under these agreements, we rely upon third parties for a variety
of business and regulatory compliance matters. We have
20
limited control over the management and direction of these third parties. We
run the risk that their action or inaction could harm our operations and/or
the goodwill associated with our brand name. Additionally, our international
licensees have the right to sell sublicenses. Generally, we have less control
over sublicensees than we do over licensees. As a result, the risk to our
operations and goodwill is higher. There can be no assurance that one or more
of the factors described above will not have a material adverse effect on our
future international operations, if any, and, consequently, on our business,
financial condition and operating results. See "Business--Strategic
Relationships."
Risks Associated with Acquisitions, Strategic Relationships
We may acquire other companies or technologies in the future, and we
regularly evaluate such opportunities. Acquisitions entail numerous risks,
including:
. difficulties in the assimilation of acquired operations and products;
. diversion of management's attention from other business concerns;
. amortization of acquired intangible assets; and
. potential loss of key employees of acquired companies.
We have limited experience in assimilating acquired organizations into our
operations. No assurance can be given as to our ability to integrate
successfully any operations, personnel, services or products that might be
acquired in the future. Failure to successfully assimilate acquired
organizations could have a material adverse effect on our business, financial
condition and operating results.
We have established a number of strategic relationships with online and
Internet service providers and software and information service providers. A
majority of such relationships have only recently been entered into. There can
be no assurance that any such relationships will be maintained, or that if
they are maintained, they will be successful or profitable. Additionally, we
may not develop any new such relationships in the future. See "Business--
Strategic Relationships."
Risks Associated with Significant Fluctuations In Quarterly Operating Results
We expect to experience large fluctuations in future quarterly operating
results that may be caused by many factors, including the following:
. the timing of introductions or enhancements to online investing services
and products by us or our competitors;
. market acceptance of online investing services and products;
. the pace of development of the market for online commerce;
. changes in trading volume in securities markets;
. trends in securities markets;
. domestic and international regulation of the brokerage industry;
. changes in pricing policies by us or our competitors;
. changes in strategy;
. the success of or costs associated with acquisitions, joint ventures or
other strategic relationships;
. changes in key personnel;
. seasonal trends;
. the extent of international expansion;
21
. the mix of international and domestic revenues;
. changes in the level of operating expenses to support projected growth;
and
. general economic conditions.
We have also experienced fluctuations in the average number of customer
transactions per day. Thus, the rate of growth in customer transactions at any
given time is not necessarily indicative of future transaction activity.
Due to the foregoing factors, quarterly revenues and operating results are
difficult to forecast. We believe that period-to-period comparisons of our
operating results will not necessarily be meaningful and you should not rely
on them as any indication of future performance. Our future quarterly
operating results may not consistently meet the expectations of securities
analysts or investors, which in turn may have an adverse effect on the market
price of our Common Stock.
Risks Associated with Potential Reduction In Order Flow Rebates
We have arrangements with various Nasdaq market-makers and third market
firms to receive cash payments in exchange for routing trade orders to these
firms for execution. This practice of receiving payments for order flow is
widespread in the securities industry. Under applicable SEC regulations, we
have to disclose the receipt of these payments to our customers. Payments for
order flow decreased to $25.8 million in fiscal 1998, down 4% from $26.8
million in fiscal 1997, which had increased 135% from $11.4 million in fiscal
1996. The decrease in payments for order flow is reflective of a trend that we
expect to continue as a result of the implementation by the SEC of new order
handling rules in January 1997, the outcome of which was that the bid/ask
spread was reduced thereby reducing market maker margins and limiting their
ability to pay for order flow, and the loss of Roundtable Partners, LLC
("Roundtable") earnings, which ended when Roundtable was reorganized as
Knight/Trimark, Inc. and went public in July 1998 (see Note 5 of the
Consolidated Financial Statements). In addition, there can be no assurance
that payments for order flow will continue to be permitted by the SEC, the
NASD or other regulatory agencies, courts or governmental units. Loss of any
or all of these revenues could have a material adverse effect on our business,
financial condition and operating results.
Risks Associated with Government Regulation
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. Broker-dealers are subject to
regulations covering all aspects of the securities business, including:
. sales methods;
. trade practices among broker-dealers;
. use and safekeeping of customers' funds and securities;
. capital structure;
. record keeping;
. conduct of directors, officers and employees; and
. supervision.
Because we are a self-clearing broker-dealer, we have to comply with many
complex laws and rules. These include rules relating to possession and control
of customer funds and securities, margin lending and execution and settlement
of transactions. Our ability to so comply depends largely on the establishment
and maintenance of a qualified compliance system. We know of several instances
of our non-compliance with applicable regulations. For example, in fiscal 1997
we failed to comply with applicable advertising restrictions
22
in one international jurisdiction. Also, due to a clerical oversight we failed
to renew our registration as a broker-dealer on time in Nebraska and Ohio.
Ohio, as a condition of renewing our broker-dealer license, required us to
offer customers resident in that state the ability to rescind (for up to 30
days) certain securities transactions effected through us during the period
January 1, 1997 through April 15, 1997. In fiscal year 1997 we recorded a $4.3
million pre-tax charge against earnings in connection with this matter.
Our mode of operation and profitability may be directly affected by:
. additional legislation;
. changes in rules promulgated by the SEC, the NASD, the Board of
Governors of the Federal Reserve System, the various stock exchanges and
other self-regulatory organizations; or
. changes in the interpretation or enforcement of existing laws and rules.
The SEC, the NASD or other self-regulatory organizations and state
securities commissions can censure, fine, issue cease-and-desist orders or
suspend or expel a broker-dealer or any of its officers or employees. Our
ability to comply with all applicable laws and rules is largely dependent on
our establishment and maintenance of a compliance system to ensure such
compliance, as well as our ability to attract and retain qualified compliance
personnel. Our growth has placed considerable strain on our ability to ensure
such compliance, and we have experienced turnover of compliance personnel in
the past. The principal purpose of regulation and discipline of broker-dealers
is the protection of customers and the securities markets, rather than
protection of creditors and stockholders of broker-dealers. We could be
subject to disciplinary or other actions due to claimed noncompliance in the
future, which could have a material adverse effect on our business, financial
condition and operating results.
We have initiated an aggressive marketing campaign designed to bring brand
name recognition to E*TRADE. All marketing activities by E*TRADE Securities
are regulated by the NASD, and E*TRADE Securities' compliance officers must
review all marketing materials prior to release. The NASD has in the past
asked us to discontinue the use of certain marketing materials. The NASD can
impose certain penalties for violations of its advertising regulations,
including:
. censures or fines;
. suspension of all advertising;
. the issuance of cease-and-desist orders; or
. the suspension or expulsion of a broker-dealer or any of its officers or
employees.
We do not currently solicit orders from our customers or make investment
recommendations. However, if we were to engage in such activities, we would
become subject to additional rules and regulations governing, among other
things, sales practices and the suitability of recommendations to customers.
We intend to expand our business in United States securities to other
countries and to broaden our customers' abilities to trade securities of non-
U.S. companies through the Internet and other gateways. International
alliances signed during this fiscal year cover a number of countries in Europe
and Asia. These agreements grant the licensees the exclusive right to offer
online investing services under the E*TRADE name. In addition, the Company has
established joint ventures with strategic partners in Japan and the U.K.
E*TRADE's global network will extend to 32 countries and territories when
fully implemented. These agreements provide that the Company will receive
royalties based upon their transaction revenues. In order to expand its
services globally, E*TRADE Securities must comply with the regulatory controls
of each specific country in which it conducts business. Our international
expansion will be limited by the compliance requirements of other national
regulatory jurisdictions. We intend to rely primarily on local third parties
for regulatory compliance in international jurisdictions. See "Risks
Associated with International Strategy."
23
There can be no assurance that other federal, state or foreign agencies will
not attempt to regulate our online and other electronic activities. We
anticipate that we may be required to comply with record keeping, data
processing and other regulatory requirements as a result of proposed federal
legislation or otherwise. We may also be subject to additional regulation as
the market for online commerce evolves. Because of the growth in the
electronic commerce market, Congress has held hearings on whether to regulate
providers of services and transactions in the electronic commerce market. As a
result, federal or state authorities could enact laws, rules or regulations
affecting our business or operations. We may also be subject to federal, state
and foreign money transmitter laws and state and foreign sales and use tax
laws. If such laws are enacted or deemed applicable to us, our business or
operations would be rendered more costly or burdensome, less efficient or even
impossible. Any of the foregoing could have a material adverse effect on our
business, financial condition and operating results.
Due to the increasing popularity of the Internet, laws and regulations may
be passed dealing with issues such as user privacy, pricing, content and
quality of products and services. Increased attention focused upon these
liability issues could adversely affect the growth of the Internet, which
could in turn decrease the demand for our services or could otherwise have a
material adverse effect on our business, financial condition and operating
results.
Risks Associated with Net Capital Requirements
The SEC, the NASD and various other regulatory agencies have stringent rules
with respect to the maintenance of specific levels of net capital by
securities broker-dealers. Net capital is the net worth of a broker or dealer
(assets minus liabilities), 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 SEC and suspension or
expulsion by the NASD, and could ultimately lead to the firm's liquidation. If
such 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. Such operations may include trading activities and
the financing of customer account balances. Also, our ability to withdraw
capital from brokerage 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, financial condition and operating results.
As of September 30, 1998, E*TRADE Securities was required to maintain
minimum net capital of $20.4 million and had total net capital of
approximately $97.3 million, or approximately $76.9 million in excess of the
minimum amount required.
Risks Associated with Systems Failure
We receive and process trade orders mostly through the Internet, online
service providers and touch-tone telephone. Thus, we depend heavily on the
integrity of the electronic systems supporting this type of trading. We have a
short period of time to process orders placed from the close of the stock
markets one day until the opening the next business day. Heavy stress placed
on our systems during peak trading times could cause our systems to operate at
unacceptably low speed or fail. If our systems or any other systems in the
trading process slow down significantly or fail even for a short time, our
customers would suffer delays in trading, causing substantial losses and
possibly subjecting us to claims for such losses or to litigation claiming
fraud or negligence. We have experienced such systems failures and degradation
in the past, including two such failures in May 1996, and we could experience
future system failures and degradations. To promote customer satisfaction and
protect our brand name, we have on certain occasions compensated customers for
verifiable losses from such failures. We recorded a pre-tax charge against
earnings of over $1.7 million due to such systems failures in May 1996. Since
then, we have experienced occasional system interruptions. During a systems
failure, we may be able to take orders by telephone, however, only associates
with securities broker's
24
licenses can accept telephone orders. An adequate number of such associates
may not be available to take customer calls in the event of a systems failure.
There can be no assurance that our network structure will operate
appropriately in any of the following events:
. subsystem, component or software failure;
. a power or telecommunications failure;
. an earthquake, fire or other natural disaster; or
. an act of God or war.
There can be no assurance that in any such event, we will be able to prevent
an extended systems failure. Any such systems failure that interrupts our
operations could have a material adverse effect on our business, financial
condition and operating results. We have received, in the past, adverse
publicity in the financial press and in online discussion forums primarily
relating to systems failures. See "Business--E*TRADE Transaction- Enabling
Technology."
Risks Associated with Encryption Technology
A significant barrier to online commerce is the secure transmission of
confidential information over public networks. We rely on encryption and
authentication technology, including cryptography technology licensed from RSA
Data Security, Inc. ("RSA"), to provide secure transmission of confidential
information. There can be no assurance that advances in computer and
cryptography capabilities or other developments will not result in a
compromise of the RSA or other algorithms we use to protect customer
transaction data. If any such compromise of our security were to occur, it
could have a material adverse effect on our business, financial condition and
operating results. See "Business--Services and Products."
Risks Associated with the Year 2000
Because many computer systems were not designed to handle dates beyond the
year 1999, computer hardware and software may need to be modified prior to the
year 2000 in order to remain functional. This may affect us in numerous ways:
. We are still assessing the impact of the year 2000 issue on our
products, services and internal information systems. We do not expect
our financial results to be materially affected by the need to address
year 2000 issues, but if the costs associated with addressing these
issues are greater than planned, our earnings and results of operations
could be affected. Furthermore, if corrective actions are not completed
before year 2000 problems occur, demand for our products and services
could drop;
. We must rely on outside vendors to address year 2000 issues for their
hardware and software. We are still assessing the effect that year 2000
issues will have on our outside vendors and, at this time, cannot
determine the impact on our products, services and operations.
Contingency plans are being developed in the event that we or our key
vendors will not be year 2000 capable, but any such noncompliance may
have a negative effect on our financial results;
. The method of trading we employ depends heavily on the integrity of
electronic systems outside of our control, such as online and Internet
service providers, and third-party software such as Internet browsers. A
failure of any of these systems due to year 2000 issues would interfere
with the trading process and, in turn, may have a material adverse
effect on our business, financial condition and operating results.
Due to our dependence on computer technology to conduct our business, the
nature and impact of year 2000 processing failures on our business, financial
condition and operating results could be material. See Item 7--"Management's
Discussion and Analysis of Financial Condition and Results of Operations--Year
2000 Compatibility."
25
ITEM 2. PROPERTIES
During fiscal 1998 the Company entered into agreements to lease facilities
in Menlo Park, California, where it will consolidate its existing Silicon
Valley locations. In addition, the Company has operations in Rancho Cordova,
California and Alpharetta, Georgia. The leases comprise an aggregate of
373,496 square feet and expire at various dates through June 2009. The Company
believes that it has adequate space for its current needs.
ITEM 3. LEGAL AND ADMINISTRATIVE PROCEEDINGS
On November 21, 1997, a putative class action was filed in the Superior
Court of California, County of Santa Clara, by Larry R. Cooper on behalf of
himself and other similarly situated individuals. The action alleges, among
other things, that the Company's advertising, other communications and
business practices regarding the Company's commission rates and its ability to
timely execute and confirm transactions through its online brokerage services
were false and deceptive. The action seeks injunctive relief enjoining the
purported deceptive and unfair practices alleged in the action and also seeks
unspecified compensatory and punitive damages, as well as attorney fees.
This proceeding is currently in the discovery phase and the Company is
unable to speculate as to its ultimate outcome. However, the Company believes
that the claims are without merit and intends to defend against them
rigorously. An unfavorable outcome in any matters which are not covered by
insurance could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, even if the
ultimate outcomes are resolved in favor of the Company, the defense of such
litigation could entail considerable cost and the diversion of efforts of
management, either of which could have a material adverse effect on the
Company's results of operation.
From time to time the Company has been threatened with, or named as a
defendant in, lawsuits and administrative claims. Compliance and trading
problems that are reported to the NASD or the SEC by dissatisfied customers
are investigated by the NASD or the SEC, and, if pursued by such customers,
may rise to the level of arbitration or disciplinary action. One or more of
such claims or disciplinary actions decided adversely against the Company
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company is also subject to periodic
regulatory audits and inspections.
The securities industry is subject to extensive regulation under federal,
state and applicable international laws. As a result, the Company is required
to comply with many complex laws and rules and its ability to so comply is
dependent in large part upon the establishment and maintenance of a qualified
compliance system. The Company is aware of several instances of its non-
compliance with applicable regulations. In particular, in fiscal 1997, the
Company failed to comply with applicable advertising restrictions in one
international jurisdiction, and due to a clerical oversight, failed to timely
renew its registration as a broker-dealer in two states, Nebraska and Ohio.
One of the state jurisdictions, Ohio, as a condition of renewing the Company's
license as a broker-dealer in that jurisdiction, required the Company to offer
customers resident in that state the ability to rescind (for up to 30 days)
certain securities transactions effected through the Company during the period
January 1, 1997 through April 15, 1997, the date the Company's license was
renewed. For fiscal 1997, the Company recorded a one-time $4.3 million pre-tax
charge against earnings in connection with this matter.
The Company maintains insurance in such amounts and with such coverages,
deductibles and policy limits as management believes are reasonable and
prudent. The principal risks that the Company insures against are
comprehensive general liability, commercial property, hardware/software
damage, directors and officers, and errors and omissions liability. The
Company believes that such insurance coverages are adequate for the purpose of
its business.
26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock has been traded on the Nasdaq National Market
under the symbol EGRP since the Company's initial public offering on August
16, 1996. The following table shows the high and low sale prices of the
Company's Common Stock as reported by the Nasdaq National Market for the
periods indicated.
HIGH LOW
------ ------
FISCAL 1996
Fourth Quarter (from August 16, 1996).......................... $13.19 $ 8.38
FISCAL 1997
First Quarter.................................................. $12.50 $ 9.00
Second Quarter................................................. $25.25 $11.13
Third Quarter.................................................. $21.00 $14.75
Fourth Quarter................................................. $47.00 $17.97
FISCAL 1998
First Quarter.................................................. $46.88 $18.59
Second Quarter................................................. $27.75 $19.91
Third Quarter.................................................. $27.19 $20.13
Fourth Quarter................................................. $34.50 $16.63
The closing sale price of the Company's Common Stock as reported on the
Nasdaq National Market on December 22, 1998 was $38.44 per share. As of that
date there were 409 holders of record of the Company's Common Stock.
The market price of the Company's Common Stock is likely to be highly
volatile and could be subject to wide fluctuations in response to quarterly
variations in operating results, announcements of technological innovations or
new software, services or products by the Company or its competitors, changes
in financial estimates by securities analysts or other events or factors, many
of which are beyond the Company's control. In addition, the stock market has
experienced significant price and volume fluctuations that have particularly
affected the market prices of equity securities of many technology, internet
and services companies and that often have been unrelated to the operating
performance of such companies. These broad market fluctuations may adversely
affect the market price of the Company's Common Stock. In the past, following
periods of volatility in the market price for a company's securities,
securities class action litigation sometimes has been instituted. Such
litigation could result in substantial costs and a diversion of management
attention and resources, which could have a material adverse effect on the
Company's business, financial condition and operating results.
DIVIDENDS
The Company has never declared or paid cash dividends on its capital stock.
ShareData, which the Company acquired in July 1998 and accounted for as a
pooling of interest, was a Subchapter S corporation and did pay dividends to
its shareholders prior to its acquisition. The Company currently intends to
retain all
27
of its earnings, if any, for use in its business and does not anticipate
paying any cash dividends in the foreseeable future. The payment of any future
dividends will be at the discretion of the Company's Board of Directors and
will depend upon a number of factors, including future earnings, the success
of the Company's business activities, regulatory capital requirements, the
general financial condition and future prospects of the Company, general
business conditions and such other factors as the Board of Directors may deem
relevant.
RECENT SALES OF UNREGISTERED SECURITIES
On July 9, 1998, the Company entered into an agreement to issue and sell
15,650,000 shares of its common stock to SOFTBANK CORP., for an aggregate
purchase price of $400 million. No underwriters were involved and there were
no underwriting discounts or commissions. The securities were sold in reliance
upon the exemption from registration provided under Section 4(2) of the
Securities Act based on the fact that the common stock was sold by the issuer
in a sale not involving a public offering.
On July 6, 1998, the Company entered into an agreement whereby the Company
issued 1,313,000 shares of its common stock in connection with the merger of
ShareData, Inc., a California corporation ("ShareData"), with and into a
wholly owned subsidiary of the Company. The consideration for such issuance
consisted of all the issued and outstanding capital stock of ShareData. No
underwriters were involved and there were no underwriting discounts or
commissions. The securities were issued in reliance upon the exemption from
registration provided under Section 4(2) of the Securities Act based on the
fact that the common stock was sold by the issuer in a sale not involving a
public offering.
USE OF PROCEEDS
On August 16, 1996, a Registration Statement on Form S-1 (No. 333-05525) was
declared effective by the SEC, pursuant to which 5,026,550 shares of the
Company's Common Stock were offered and sold for the account of the Company at
a price of $10.50 per share, generating gross offering proceeds of $52,779,000
for the account of the Company. A further 675,450 shares of the Company's
Common Stock were offered and sold for the account of selling stockholders at
a price of $10.50 per share, generating gross offering proceeds of $7,092,000
for the account of selling stockholders. Each share of Series A. Series B and
Series C Preferred Stock was automatically converted into 60 shares of Common
Stock upon the closing of the initial public offering. The managing
underwriters were BancAmerica Robertson Stephens, Hambrecht & Quist LLC, and
Deutsche Morgan Grenfell/C.J. Lawrence, Inc.
In connection with the offering, the Company incurred $3,695,000 in
underwriting discounts and commissions, and $2,682,000 in other related
expenses. The net proceeds of the offering, after deducting the foregoing
expenses, were $46,402,000.
On August 20, 1997, a Registration Statement on Form S-1 (No. 333-31841) was
declared effective by the SEC, pursuant to which 7,305,000 shares of the
Company's Common Stock were offered and sold for the account of the Company at
a price of $27.50 per share, generating gross offering proceeds of
$200,888,000 for the account of the Company. A further 2,010,000 shares of the
Company's Common Stock were offered and sold for the account of selling
stockholders at a price of $27.50 per share, generating gross offering
proceeds of $55,275,000 for the account of selling stockholders. The managing
underwriters were BancAmerica Robertson Stephens, Hambrecht & Quist LLC,
Deutsche Morgan Grenfell/C.J. Lawrence, Inc., NationsBanc Montgomery
Securities, and E*TRADE Securities, Inc.
In connection with the offering, the Company incurred $10,044,000 in
underwriting discounts and commissions, and $2,019,000 in other related
expenses. The net proceeds of the offering, after deducting the foregoing
expenses, were $188,825,000.
28
The Company has used a portion of the net proceeds of the two offerings as
follows: (i) $26,636,000 for the purchase and installation of software,
machinery and equipment, (ii) $10,783,000 for the construction of plant,
building and facilities, (iii) $2,250,000 for the repayment of indebtedness,
(iv) $3,147,000 for a relocation loan to an officer, (v) $8,152,000 for the
joint venture investments, (vi) $25,043,000 for the purchase of equity
investments, (vii) $2,000,000 for investment in KAP Group, LLC, (viii)
$3,500,000 for the acquisition of OptionsLink, (ix) $13,156,000 for investment
in new projects, technology and products to expand and complement the
business, and (x) $140,560,000 for investment in short-term, investment grade,
interest bearing securities.
ITEM 6. SELECTED FINANCIAL DATA
YEARS ENDED SEPTEMBER 30,
----------------------------------------------
1998 1997 1996 1995 1994
---------- -------- -------- ------- -------
(in thousands, except per share amounts)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA*:
Revenues:
Transaction revenues......... $ 162,097 $109,659 $ 44,178 $20,835 $ 9,548
Interest, net of interest
expense..................... 56,019 25,265 4,813 1,004 302
International................ 7,031 4,000 -- -- --
Other........................ 20,135 17,471 13,529 6,947 5,558
---------- -------- -------- ------- -------
Net revenues................ 245,282 156,395 62,520 28,786 15,408
---------- -------- -------- ------- -------
Cost of services.............. 111,832 73,381 38,027 14,683 8,485
---------- -------- -------- ------- -------
Operating expenses:
Selling and marketing........ 71,293 28,160 10,944 4,204 2,372
Technology development....... 32,916 13,547 4,699 2,265 1,181
General and administrative... 30,906 16,847 8,238 3,022 2,724
---------- -------- -------- ------- -------
Total operating expenses.... 135,115 58,554 23,881 9,491 6,277
---------- -------- -------- ------- -------
Total cost of services and
operating expenses......... 246,947 131,935 61,908 24,174 14,762
---------- -------- -------- ------- -------
Pre-tax income (loss)......... (1,665) 24,460 612 4,612 646
Income tax expense (benefit).. (953) 9,425 (555) 1,728 (541)
---------- -------- -------- ------- -------
Net income (loss)............. $ (712) $ 15,035 $ 1,167 $ 2,884 $ 1,187
========== ======== ======== ======= =======
Net income (loss) per share:
Basic........................ $ (0.02) $ 0.46 $ 0.06 $ 0.17 $ 0.07
========== ======== ======== ======= =======
Diluted...................... $ (0.02) $ 0.42 $ 0.04 $ 0.10 $ 0.04
========== ======== ======== ======= =======
Shares used in computation of
net income (loss) per share:
Basic........................ 42,285 32,352 19,641 17,017 16,486
Diluted...................... 42,285 35,874 29,932 27,757 27,446
SEPTEMBER 30,
----------------------------------------------
1998 1997 1996 1995 1994
---------- -------- -------- ------- -------
(in thousands)
CONSOLIDATED BALANCE SHEET
DATA*:
Cash and equivalents.......... $ 21,834 $ 23,234 $ 15,856 $10,985 $ 2,000
Investment securities......... 502,534 191,958 35,563 560 560
Brokerage receivables--net.... 1,310,235 724,365 193,228 1,936 499
Total assets.................. 1,968,918 995,422 302,171 18,146 5,386
Stockholders' equity.......... 710,236 283,374 71,976 12,348 919
- --------
* All prior year amounts presented have been restated to reflect the
acquisition of ShareData, Inc. in July 1998, which was accounted for as a
pooling of interest (see Note 15 of the Consolidated Financial Statements).
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the consolidated
financial statements and notes thereto included elsewhere in this Form 10-K.
This discussion contains forward-looking statements, including statements
regarding the Company's strategy, financial performance and revenue sources
which involve risks and uncertainties. The Company's actual results may differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including, but not limited to, those set forth
elsewhere in this Form 10-K.
OVERVIEW
A leading branded provider of online investing services, E*TRADE has
established a popular destination Web site for self-directed investors.
Founded in 1982, the Company operated initially as a service bureau, providing
automated online securities transaction services to various brokerage firms,
including Fidelity Brokerage Services, Inc., Quick and Reilly, Inc. and,
through an agreement with Bank of America, Charles Schwab. In 1992, the
Company formed E*TRADE Securities and began to offer retail investing services
and account information 24 hours a day, seven days a week. The Company offers
independent investors the convenience and control of automated stock, option,
fixed income and mutual fund order placement at lower commission rates than
traditional brokerage firms. In addition, E*TRADE has a suite of value-added
products and services that can be customized and personalized, including
portfolio tracking, Java-based charting and quote applications, real-time
stock quotes, Smart Alerts, market commentary and analysis, news, investor
community areas and other information services.
Free resources available to the public on E*TRADE's Web site include
breaking financial news, real-time stock and option price quotes, company
financial information and news announcements, live market commentary,
personalized investment portfolios, investor community areas, and search and
filtering tools for mutual fund and fixed income products. E*TRADE's Web site
services three levels of investors--visitors, members, and customers, with
each successive group gaining access to additional value-added products and
services. Visitors can view market information, headline news, stock quotes
and charts, mutual fund information, and much more. By registering but not
opening an account, a visitor becomes a member and receives free access to
many advanced, customizable investment research tools, including free real-
times quotes and secure email. Customers, those investors with E*TRADE
accounts, have complete access to E*TRADE's trading engine and to all the
investment research and management features, including Smart Alerts, and many
sophisticated analytical and record keeping tools. Customers may also
subscribe to E*TRADE's Professional Edge service and receive access to IPOs,
institutional quality research reports, and other premium services.
The Company's revenues consist principally of transaction revenues, which
include securities brokerage commissions and payments based on order flow,
interest and certain other fees related to the Company's product offerings.
The Company has experienced substantial growth in its revenues since E*TRADE
Securities was formed. At the end of fiscal 1992, the Company was processing
slightly over 100 transactions per day. For the quarter ended September 30,
1998, the Company's average daily transaction volume was 30,500, a 27%
increase over the average daily transaction volume of 24,100 in the equivalent
period in fiscal 1997. Although increases in the overall activity in the
securities markets have contributed to the Company's growth, the Company
believes that its growth has also been due to the success of its advertising
campaigns in bringing brand name recognition to the E*TRADE name, the launch
of Internet access to E*TRADE in February 1996, and the continuing successful
integration of new product developments.
In December 1997, the Company acquired OptionsLink, a division of Hambrecht
& Quist LLC. OptionsLink is an all-electronic Web-based and interactive voice
response inquiry and order entry system for employee stock option and stock
purchase plan services for corporate stock plan participants. The acquisition
30
of OptionsLink demonstrates the Company's commitment to expand its products
and services into the corporate financial services market.
In July 1998, the Company acquired ShareData, Inc., a supplier of stock plan
knowledge-based software for pre-IPO and public companies. This acquisition
will enable the Company to extend its corporate services strategy, which began
when the Company purchased OptionsLink. Corporate financial services
represents a potential growth segment for the Company and provides an
opportunity to diversify its revenue stream. The Company intends to provide an
automated solution for stock plan management and company stock transaction
capabilities to plan sponsors and their employees through combining the
OptionsLink and ShareData, Inc. product offerings.
The Company uses other broker-dealers to execute its customers' orders and,
in recent years, has derived a significant portion of its revenues from these
broker-dealers for such order flow. This practice of receiving payments for
order flow is widespread in the securities industry. Under applicable SEC
regulations, receipt of these payments requires disclosure of such payments by
the Company to its customers. The revenues received by the Company under these
arrangements for fiscal 1998, 1997 and 1996 amounted to 16%, 19%, and 22% of
total transaction revenues, respectively. There can be no assurance that the
Company will be able to continue its present relationships and terms for such
payments for order flow. In addition, there can be no assurance that payments
for order flow will continue to be permitted by the SEC, the NASD or other
regulatory agencies, courts or governmental units. Loss of any or all of these
revenues could have a material adverse effect on the Company's business,
financial condition and operating results.
The Company is making significant investments in systems technology and has
established technology centers in both Palo Alto and Rancho Cordova,
California. These facilities support systems, network services, trading,
customer service, transaction redundancy and backup between the two locations,
thereby providing an operational system in the event of a service interruption
at either facility. In fiscal 1998, the Company opened a new facility in
Alpharetta, Georgia which will also support systems, network services,
trading, and customer service.
The Company implemented self-clearing operations for equity securities in
July 1996 and self-clearing operations for options in April 1997. Prior to
July 1996, the Company cleared all of its customer transactions as a fully
disclosed correspondent of Herzog, Heine, Geduld, Inc. ("Herzog"). Clearing
services include the confirmation, receipt, settlement, custody and delivery
functions involved in securities transactions. In the first quarter of fiscal
1996, the Company began hiring associates to perform these functions. As a
consequence, the Company incurred significant costs associated with the hiring
and training of its associates, and systems integration costs, while
continuing to incur expenses for clearing operations performed by Herzog
through June 1996. The conversion to self-clearing has allowed the Company to
realize significant cost savings and revenue enhancement.
The Company assumes direct responsibility for the possession and control of
customer securities and other customer assets and the clearing of customers'
securities transactions. This responsibility requires the Company to record on
its balance sheet the receivables and payables to the Company that are a
result of customer margin loans (i.e., loans made to customers that are
collateralized by securities held in the customers' accounts at the Company)
and customer free credit balances (i.e., customer cash balances maintained by
the Company), respectively. In addition, to the extent that the Company's
customer debit balances exceed customer free credit balances, the Company may
be required to obtain financing for any excess debit balance. The Company had
receivables from customers, brokers, dealers and clearing organizations of
$1.3 billion and payables to customers, brokers, dealers and clearing
organizations of $1.2 billion as of September 30, 1998. The Company contracts
with a third-party service bureau, BETA Systems, for its customer record
keeping and data processing services.
The Company has experienced substantial changes in, and expansion of, its
business and operations since it began offering online investing services in
1992 and Internet investing services in February 1996, and expects to continue
to experience periods of rapid growth. The Company's past expansion has
placed, and any
31
future expansion would place, significant demands on the Company's
administrative, operational, financial and other resources. Competition for
highly qualified senior managers and technical personnel is intense. If the
Company fails to attract, assimilate and retain such personnel, there could be
a material adverse effect on the Company's business, financial condition and
operating results.
The securities industry is subject to extensive regulation under federal,
state and applicable international laws. As a result, the Company is required
to comply with many complex laws and rules and its ability to so comply is
dependent in large part upon the establishment and maintenance of a qualified
compliance system. The Company is aware of several instances of its non-
compliance with applicable regulations. In particular, in fiscal 1997, the
Company failed to comply with applicable advertising restrictions in one
international jurisdiction and, due to a clerical oversight, failed to timely
renew its registration as a broker-dealer in two states, Nebraska and Ohio.
One of the states, Ohio, as a condition of renewing the Company's license as a
broker-dealer in that state, required the Company to offer customers resident
in that state the ability to rescind (for up to 30 days) certain securities
transactions effected through the Company during the period January 1, 1997
through April 15, 1997, the date the Company's license was renewed. For fiscal
1997, the Company recorded a $4.3 million pre-tax charge against earnings in
connection with this matter.
RESULTS OF OPERATIONS
The following table sets forth the percentage of net revenues represented by
certain items on the Company's consolidated statements of operations for the
periods indicated:
YEARS ENDED SEPTEMBER 30,
-----------------------------
1998 1997 1996
-------- -------- --------
Revenues:
Transaction revenues..... 66.1% 70.1% 70.7%
Interest, net of interest
expense................. 22.8 16.2 7.7
International............ 2.9 2.5 --
Other.................... 8.2 11.2 21.6
-------- -------- --------
Net revenues............ 100.0 100.0 100.0
-------- -------- --------
Cost of services.......... 45.6 46.9 60.8
-------- -------- --------
Operating expenses:
Selling and marketing.... 29.1 18.0 17.5
Technology development... 13.4 8.7 7.5
General and
administrative.......... 12.6 10.8 13.2
-------- -------- --------
Total operating
expenses............... 55.1 37.5 38.2
-------- -------- --------
Total cost of services
and operating
expenses............... 100.7 84.4 99.0
-------- -------- --------
Pre-tax income (loss)..... (0.7) 15.6 1.0
Income tax expense
(benefit)................ (0.4) 6.0 (0.9)
-------- -------- --------
Net income (loss)......... (0.3)% 9.6% 1.9%
======== ======== ========
FISCAL YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
Revenues
The Company's revenues increased to $245.3 million in fiscal 1998, up 57%
from $156.4 million in fiscal 1997, which was up from 150% from $62.5 million
in fiscal 1996. Transaction revenues increased to $162.1 million in fiscal
1998, up 48% from $109.7 million in fiscal 1997, which was up 148% from $44.2
million in fiscal 1996. Transaction revenues consist of commission revenues
and payments based on order flow. Commission revenues increased to $136.3
million, up 64% from $82.9 million in fiscal 1997, which was up
32
153% from $32.8 million in fiscal 1996. Transactions for fiscal 1998 totaled
7.0 million or an average of 27,600 transactions per day. This is an increase
of 68% over the average daily transaction volume of 16,400 in fiscal 1997,
which was up 169% from 6,100 in fiscal 1996. Average commissions per
transaction declined to $19.58 in fiscal 1998 from $20.00 in fiscal 1997 and
$20.82 in fiscal 1996, due primarily to a change in product mix and the
lowering of commissions on listed market orders from $19.95 to $14.95 in
February 1996. Payments for order flow decreased to $25.8 million in fiscal
1998, down 4% from $26.8 million in fiscal 1997, which had increased 135% from
$11.4 million in fiscal 1996. The decrease in payments for order flow is
reflective of a trend that the Company expects to continue as a result of the
implementation by the SEC of new order handling rules in January 1997, the
outcome of which was that the bid/ask spread was reduced thereby reducing
market maker margins and limiting their ability to pay for order flow, and the
loss of Roundtable earnings, which ended when Roundtable was reorganized as
Knight/Trimark, Inc. and went public in July 1998 (see Note 5 of the
Consolidated Financial Statements). Until its initial public offering,
Knight/Trimark would allocate a portion of its earnings to its owners,
including the Company, based on what percentage its owners contributed to
Knight/Trimark's total order flow. The Company previously recorded the amounts
it received under this allocation as payment for order flow revenue.
Net interest revenues primarily represent interest earned by the Company on
credit extended to its customers to finance their purchases of securities on
margin, fees on its customer assets invested in money market accounts and
interest earned on investment securities, offset by interest paid to customers
on certain credit balances, interest paid to banks and interest paid to other
broker-dealers through the Company's stock loan program. Net interest revenues
increased to $56.0 million in fiscal 1998, up 121% from $25.3 million in
fiscal 1997, which was up 427% from $4.8 million in fiscal 1996. This increase
was due primarily to growth in customer accounts and the opportunity that
being self-clearing has given the Company to manage interest rates. This
increase was also a result of average customer margin debit balances
increasing 70% to $925 million, average customer credit balances increasing
12% to $244 million, average money market fund balances increasing 95% to $1.4
billion, and an increase in investment securities from fiscal 1997 to fiscal
1998.
International revenues of $7.0 million represent international licensing
fees and ongoing royalties from agreements signed as part of E*TRADE's
continued international expansion effort. International alliances signed
during this fiscal year cover a number of countries in Europe and Asia. These
agreements grant the licensees the exclusive right to use E*TRADE's technology
and offer online investing services under the E*TRADE name. In addition, the
Company has established joint ventures with strategic partners in Japan and
the U.K. E*TRADE's global network will extend to 32 countries and territories
when fully implemented. These agreements provide that the Company will receive
royalties based upon their transaction revenues. International revenues were
$4.0 million in fiscal 1997, from licensing fees attributable to the Company's
agreements with VERSUS in Canada and Nova Pacific in Australia. Prior to
fiscal 1997, there were no international revenues. The Company may, from time
to time, seek to enter into similar licensing agreements with others as part
of its international expansion strategy. There can be no assurance that any
such future agreements will be consummated or that the terms thereof will be
comparable to those of the aforementioned agreements or that the recognition
of any licensing fees will occur during the period in which an arrangement is
consummated.
Other revenues increased to $20.1 million in fiscal 1998, up 15% from $17.5
million in fiscal 1997, which was up 30% from $13.5 million in fiscal 1996.
Other revenues increased primarily due to equity earnings from the Company's
investment in Roundtable, broker-related fees for services, new revenue
streams from OptionsLink, growth in ShareData, Inc. licensing revenue, and
increased revenues from mutual funds and advertising on the Company's Web
site. As a result of the Knight/Trimark initial public offering, the Company
will no longer recognize any equity income from the Company's investment in
Roundtable in future quarters (see Note 5 of the Consolidated Financial
Statements).
Cost of Services
Total cost of services increased to $111.8 million in fiscal 1998, up 52%
from $73.4 million in fiscal 1997, which was up 93% from $38.0 million in
fiscal 1996. Cost of services includes expenses related to the
33
Company's clearing operations and customer service activities, system
maintenance and communication expenses, and clearing fees paid to the
Company's former clearing broker. Cost of services as a percentage of total
transaction revenues was 69% in fiscal 1998 compared to 67% in fiscal 1997 and
86% in fiscal 1996. Included in total cost of services for fiscal 1997 was a
charge of $4.3 million, which resulted from a clerical oversight connected
with the Company's failure to timely renew its registration as a broker-dealer
in the state of Ohio. Included in total cost of services in fiscal 1996 were
self-clearing start-up costs of $2.2 million. Cost of services, exclusive of
the registration charge and self-clearing start-up costs, increased to $111.8
million in fiscal 1998, up 62% from $69.0 million in fiscal 1997, which was up
93% from $35.8 million in fiscal 1996. These increases reflect the overall
increase in customer transactions processed by the Company, a related increase
in customer service inquiries, and operations and maintenance costs associated
with the technology centers in Palo Alto and Rancho Cordova, California.
Operating Expenses
Selling and marketing expenses increased to $71.3 million in fiscal 1998, up
153% from $28.2 million in fiscal 1997, which was up 159% from $10.9 million
in fiscal 1996. This increase reflects expenditures for advertising
placements, creative development and collateral materials resulting from a
variety of advertising campaigns directed at building brand name recognition,
growing the customer base and market share, and maintaining customer retention
rates. Beginning in the fourth quarter of fiscal 1998, the Company
significantly expanded its marketing efforts including the launch of
Destination E*TRADE, expanded national television advertising and new
strategic marketing alliances with key business partners, such as AOL and
Yahoo!. These increased expenditure levels are expected to continue in fiscal
1999.
Technology development expenses increased to $32.9 million in fiscal 1998,
up 144% from $13.5 million in fiscal 1997, which was up 187% from $4.7 million
in fiscal 1996. The increased level of expenses was incurred to enhance the
Company's existing product offerings, including maintenance of the Company's
Web site, development efforts related to the launch of Destination E*TRADE and
proprietary Stateless Architecture SM, and reflects the Company's continuing
commitment to invest in new products and technologies.
General and administrative expenses increased to $30.9 million in fiscal
1998, up 84% from $16.8 million in fiscal 1997, which was up 105% from $8.2
million in fiscal 1996. This increase is the result of personnel additions,
the development of administrative functions resulting from the overall growth
in the Company, acquisition costs and the costs associated with the opening of
a new facility in Alpharetta, Georgia.
Income Tax Expense (Benefit)
Income tax expense (benefit) represents the provision for federal and state
income taxes at an effective rate of (57.2%), 38.5% and (90.7%) for fiscal
1998, 1997 and 1996, respectively. Prior to its merger with the Company,
ShareData, Inc. was a Subchapter S corporation and was not subject to federal
and state corporate income taxes. Additionally, the fiscal 1998 rate reflects
expected tax benefits from tax-exempt interest income and certain
nondeductible acquisition costs.
YEAR 2000 COMPATIBILITY
Many computer systems use only two digits to identify a specific year and
therefore may not accurately recognize and handle dates beyond the year 1999.
If not corrected, these computer applications could fail or create erroneous
results by or at the year 2000. The Company utilizes, and is dependent upon,
data processing systems and software to conduct its business. The data
processing systems and software include those developed and maintained by the
Company's third-party data processing vendors and software which is run on in-
house computer networks.
Due to the Company's dependence on computer technology to conduct its
business, and the dependence of the financial services industry on computer
technology, the nature and impact of year 2000 processing
34
failures on the Company's business, financial position, results of operations
or cash flows could be material. During the first quarter of fiscal 1998, the
Company initiated a review and assessment of all hardware and software to
evaluate whether it will function properly in the year 2000 without material
errors or interruptions.
The Company believes that all year 2000 issues revealed as a result of that
evaluation to date can be remedied in a timely manner, and therefore are not
expected to create a material risk of disruption of operations. With respect
to outside vendors, those vendors that have been contacted have indicated that
their hardware or software is or will be year 2000 compatible in time frames
that meet regulatory requirements. Evaluation of these issues is continuing
and there is a risk that other problems, not presently known to the Company,
will be discovered which could present a material risk of disruption to the
Company's operations and result in material adverse consequences to the
Company. Furthermore, there can be no assurance that the Company will not
experience unexpected delays in remediation of any year 2000 issues that may
be discovered. Any inability to remediate such issues in a timely manner could
cause a material disruption of the Company's business. In addition, the method
of trading employed by the Company is heavily dependent on the integrity of
electronic systems outside of the Company's control, such as online and
Internet service providers, and third-party software such as Internet
browsers. A failure of any such system in the trading process, even for a
short time, could cause interruption to the Company's business. The year 2000
issue could lower demand for the Company's services while increasing the
Company's costs. These combining factors, while not quantified, could have a
material adverse impact on the Company's financial results.
Because systems critical to the Company's functioning other than its
computer systems may be affected by the century change, the Company's year
2000 efforts also encompass facilities and equipment which rely on date-
dependent technology, such as, building equipment that contains embedded
technology and the Company's third party providers.
At this time, it does not appear that the costs of addressing year 2000
issues will have a material adverse impact on the Company's financial
position. However, in the event that the Company and third parties upon which
it relies are unable to address these issues in a timely manner, it could
result in a material financial risk to the Company.
Status of Year 2000 Efforts
The Company's year 2000 efforts address all computer systems, equipment and
business partner relationships considered essential to the Company's ability
to conduct its business. The objective of the Company's year 2000 project is
to identify the core business processes and associated computer systems and
equipment that may be at risk due to the use of two-digit year dates. Once
identified, the systems and equipment are rated for risk and are prioritized
for conversion or replacement according to their impact on core business
operations. The Company's year 2000 project follows a structured approach in
analyzing and mitigating year 2000 issues. This approach consists of six
phases awareness, assessment, remediation, validation, implementation and
industry-wide testing. The work associated with each phase may be performed
simultaneously with other phases of the project, depending on the nature of
the work to be performed and the technology and business requirements of the
specific business unit. For example, awareness is an ongoing effort and occurs
in each phase. As part of this project, the Company reviews its vendor
relationships (suppliers, alliances and third party providers) in an attempt
to assess their ability to meet the year 2000 challenge. In addition, this
plan seeks to ensure that all of the Company's business partners and service
providers are also year 2000 ready. In addition, written contingency plans are
being developed for all mission critical systems and many non-critical systems
to address any unexpected year 2000 failures.
Currently, the Company's primary focus is the completion of remediation and
testing, and on-going contingency planning and vendor management efforts.
However, the Company is continuing to assess the impact of year 2000 issues on
its products, internal information systems and third party vendor relations.
The Company has begun, and in many cases completed, corrective efforts in
these areas. The Company does not anticipate that addressing year 2000 issues
for its internal information systems and current and future products
35
will have a material impact on its operations or financial results. However,
there can be no assurance that these costs will not be greater than
anticipated, or that corrective actions undertaken will be completed before
year 2000 issues may arise.
The Company anticipates that remediation, testing and implementation of all
systems will be completed by March 1999. The Company will be participating in
an industry-wide test sponsored by the Securities Industry Association in the
first half of 1999 and is implementing plans to be prepared to participate in
the test. These activities will also include joint testing with selected
critical vendors, joint contingency planning with selected critical vendors,
and addressing year 2000 concerns with new vendors. The Company anticipates
that work on the awareness, contingency planning, and vendor management phases
of the project will continue through the century change.
The success of the Company's year 2000 efforts depends in part on the
adequacy of compliance by vendors with their representations concerning their
systems, and on parallel efforts being undertaken by vendors and other third
parties with which the Company's systems interact and therefore, the Company
is taking steps to determine the status of critical third parties' year 2000
compatibility. The Company has implemented a vendor management program.
Activities include creating an inventory of vendors, inquiring directly as to
the status of vendors' year 2000 efforts, and continuing contacts with vendors
to monitor the progress of vendors who may not yet be year 2000 capable. If
these suppliers fail to adequately address year 2000 issues for the products
and services they provide to the Company, this could have a material adverse
impact on the Company's operations and financial results. The Company is still
assessing the effect year 2000 issues will have on its suppliers and at this
time, cannot determine the impact it will have. There can be no assurance that
all third parties will provide accurate and complete information or that all
their systems will be fully year 2000 capable. Third parties' year 2000
processing failures may have a material adverse impact on the Company's
systems and operations.
As the year 2000 project continues, the Company may discover additional year
2000 issues, may not be able to develop, implement, or test remediation or
contingency plans, or may find that the costs of these activities exceed
current expectations and become material. In many cases, the Company is
relying on assurances from suppliers that new and upgraded information systems
and other products will be year 2000 capable. The Company plans to test such
third-party products, but cannot be sure that its tests will be adequate or
that, if problems are identified, they will be addressed by the supplier in a
timely and satisfactory way.
Because the Company uses a variety of information systems and has additional
systems embedded in its operations and infrastructure, the Company cannot be
sure that all of its systems will work together in a year 2000-capable
fashion. Furthermore, the Company cannot be sure that it will not suffer
business interruptions, either because of its own year 2000 issues or those of
its customers or suppliers whose year 2000 issues may make it difficult or
impossible for them to fulfill their commitments to the Company. If the
Company fails to satisfactorily resolve year 2000 issues related to its
products in a timely manner, it could be exposed to liability to third
parties.
The Company is continuing to evaluate year 2000-related risks and corrective
actions. However, the risks associated with the year 2000 may be pervasive and
complex; they can be difficult to identify and to address, and can result in
material adverse consequences to the Company. Even if the Company, in a timely
manner, completes all of its assessments, identifies and tests remediation
plans believed to be adequate, and develops contingency plans believed to be
adequate, some issues may not be identified or corrected in time to prevent
material adverse consequences to the Company.
The Company's plan may also be affected by regulatory changes, changes in
industry customs and practices, and significant systems modifications
unrelated to the year 2000 project including upgrades and additions to
capacity, and the cost and continued availability of qualified personnel and
other resources.
36
The Company has spent approximately $1.8 million since the first quarter of
fiscal 1998 and currently estimates that it will cost approximately an
additional $5 million to ascertain that its core computer systems and those of
our vendors are year 2000 capable. These expenditures will consist primarily
of compensation for information technology employees and contractors dedicated
to this project and related hardware and software costs. This estimate
excludes the time that may be spent by management and administrative staff in
guiding and assisting the information technology effort described above or for
making systems other than core brokerage computer systems year 2000 capable.
The Company expects to fund all year 2000 related costs through operating cash
flows. These costs are not expected to result in increased information
technology expenditures because they will be funded through a reallocation of
the Company's overall development spending. In accordance with generally
accepted accounting principles, such expenditures will be expensed as
incurred.
VARIABILITY OF RESULTS
The Company expects to experience significant fluctuations in future
quarterly operating results that may be caused by many factors, including the
following: the timing of introductions or enhancements to online investing
services and products by the Company or its competitors; market acceptance of
online investing services and products; the pace of development of the market
for online commerce; changes in trading volume in securities markets; trends
in securities markets; domestic and international regulation of the brokerage
industry; changes in pricing policies by the Company or its competitors;
changes in strategy; the success of or costs associated with acquisitions,
joint ventures or other strategic relationships; changes in key personnel;
seasonal trends; the extent of international expansion; the mix of
international and domestic revenues; changes in the level of operating
expenses to support projected growth; and general economic conditions.
Because of the foregoing factors, in addition to other factors that affect
the Company's operating results and financial position, investors should not
consider past financial performance or management's expectations a reliable
indicator of future performance, and not use historical trends to anticipate
results or trends in future periods. In that regard, results of operations and
financial condition could be adversely affected by a number of factors in
addition to those discussed above, including overall economic conditions and
lower than expected demand. Further, the Company's stock price is subject to
volatility. Any of the factors discussed above could have an adverse effect on
the Company's stock price. In addition, the Company's stock price could be
adversely affected if the Company's revenues or earnings in any quarter fail
to meet the investment community's expectations, or if there are broader,
negative market trends. The Company does not undertake an obligation to update
its forward-looking statements or risk factors to reflect future events or
circumstances.
LIQUIDITY AND CAPITAL RESOURCES
In August 1996, the Company completed an initial public offering of its
Common Stock, resulting in net proceeds to the Company of approximately $46.4
million.
In August 1997, the Company completed a secondary public offering of
7,305,000 shares of the Company's Common Stock at a price of $27.50 per share.
The proceeds to the Company from the offering, net of underwriting discounts
and offering expenses of $14.8 million, were $188.8 million. The Company also
has financed its activities through the private placement of Preferred Stock
and, to a lesser extent, equipment financing.
In July 1998, the Company entered into an agreement to issue and sell
15,650,000 shares of its common stock to SOFTBANK CORP., a Japanese
corporation, for an aggregate purchase price of $400 million. This investment
represents a minority interest ownership of approximately 27.6% in the Company
as of September 30, 1998.
In July 1996, the Company obtained financing facilities totaling $100
million, to be collateralized by customer securities. There were no borrowings
outstanding under these lines at September 30, 1998. At September 30, 1997,
$9.4 million was outstanding under these lines, which was repaid on October 1,
1997. In
37
addition, the Company has entered into numerous agreements with other broker-
dealers to provide financing under the Company's stock loan program.
The Company currently anticipates that its available cash resources and
credit facilities will be sufficient to meet its presently anticipated working
capital and capital expenditure requirements for at least the next 12 months.
However, the Company may need to raise additional funds in order to support
more rapid expansion, develop new or enhanced services and products, respond
to competitive pressures, acquire complementary businesses or technologies or
take advantage of unanticipated opportunities. The Company's future liquidity
and capital requirements will depend upon numerous factors, including costs
and timing of expansion of research and development efforts and the success of
such efforts, the success of the Company's existing and new service offerings
and competing technological and market developments. The Company's forecast of
the period of time through which its financial resources will be adequate to
support its operations is a forward-looking statement that involves risks and
uncertainties, and actual results could vary. The factors described earlier in
this paragraph will impact the Company's future capital requirements and the
adequacy of its available funds. If additional funds are raised through the
issuance of equity securities, the percentage ownership of the stockholders of
the Company will be reduced, stockholders may experience additional dilution
in net book value per share or such equity securities may have rights,
preferences or privileges senior to those of the holders of the Company's
Common Stock. There can be no assurance that additional financing will be
available when needed on terms favorable to the Company, if at all.
If adequate funds are not available on acceptable terms, the Company may be
unable to develop or enhance its services and products, take advantage of
future opportunities or respond to competitive pressures, any of which could
have a material adverse effect on the Company's business, financial condition
and operating results.
Cash used in operating activities was $30.2 million in fiscal 1998,
primarily as a result of increases in brokerage-related assets in excess of
related liabilities of $81.5 million, offset in part by depreciation and
amortization of $12.5 million and increases in accounts payable, accrued and
other liabilities in excess of other assets of $40.3 million. Cash used in
operating activities in fiscal 1997 and 1996 was $8.1 million and
$6.8 million, respectively. Such amounts primarily reflect net income for the
respective periods, increases in brokerage-related assets in excess of related
liabilities, and in fiscal 1997, the impact of depreciation and amortization
and increases in accounts payable, accrued and other liabilities in excess of
other assets.
Cash used in investing activities was $380.6 million in fiscal 1998, $174.6
million in fiscal 1997 and $46.4 million in fiscal 1996. In fiscal 1998, cash
used in investing activities reflects the investment of proceeds from the
common stock issuance to SOFTBANK CORP., investments in several companies and
joint ventures, and property and equipment purchases. Cash used in investing
activities in fiscal 1997 and 1996 primarily represent the investment of the
proceeds from the Company's secondary public offering of Common Stock in
August 1997 and initial public offering of Common Stock in August 1996.
Additionally, the Company made ongoing investments in its technological
infrastructure and the second technology center in Rancho Cordova, and in
fiscal 1997, a relocation loan to the Company's Chief Executive Officer (see
Note 6 of the Consolidated Financial Statements).
Cash provided by financing activities was $409.3 million in fiscal 1998,
compared with $190.2 million in fiscal 1997. In fiscal 1998, cash provided by
financing activities primarily consisted of $400 million in proceeds from the
common stock issuance to SOFTBANK CORP. and in fiscal 1997 the net proceeds
from the Company's secondary public offering. Cash provided by financing
activities in fiscal 1996 of $58.1 million reflects net proceeds from the
Company's initial public offering of Common Stock in August 1996 and private
sales of Preferred Stock.
The Company expects that it will incur approximately $25 million of capital
expenditures for the 12 months ended September 30, 1999.
38
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Disclosures
The following discussion about the Company's market risk disclosures
involves forward-looking statements. Actual results could differ materially
from those projected in the forward-looking statements . The Company is
exposed to market risk related to changes in interest rates, foreign currency
exchange rates and equity security price risk. The Company does not have
derivative financial instruments for speculative or trading purposes.
Interest Rate Sensitivity
The Company maintains a short-term investment portfolio consisting of mainly
income securities with an average maturity of less than two years. These
available-for-sale securities are subject to interest rate risk and will fall
in value if market interest rates increase. If market interest rates were to
increase immediately and uniformly by 10 percent in levels at September 30,
1998, the fair value of the portfolio would decline by an immaterial amount.
The Company has the ability to hold its fixed income investments until
maturity, and therefore the Company would not expect its operating results or
cash flows to be affected to any significant degree by the effect of a sudden
change in market interest rates on its securities portfolio.
Equity Price Risk
The Company holds a small portfolio of marketable-equity traded securities
that are subject to market price volatility. Equity price fluctuations of plus
or minus 15 percent would not have a material impact on the Company.
Financial Instruments
For its working capital and reserves which are required to be segregated
under Federal or other regulations, the Company invests in money market funds,
resale agreements, certificates of deposit, and commercial paper. Money market
funds do not have maturity dates and do not present a material market risk.
The other financial instruments are fixed rate investments with short
maturities and do not present a material interest rate risk.
39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Report.......................................... 41
Consolidated Balance Sheets as of September 30, 1998 and 1997......... 42
Consolidated Statements of Operations for the Years Ended September
30, 1998, 1997 and 1996.............................................. 43
Consolidated Statements of Stockholders' Equity for the Years Ended
September 30, 1998, 1997 and 1996.................................... 44
Consolidated Statements of Cash Flows for the Years Ended September
30, 1998, 1997 and 1996.............................................. 45
Notes to Consolidated Financial Statements............................ 46
40
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
E*TRADE Group, Inc.:
We have audited the accompanying consolidated balance sheets of E*TRADE
Group, Inc. and subsidiaries (the "Company") as of September 30, 1998 and
1997, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended
September 30, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of E*TRADE Group, Inc. and
subsidiaries at September 30, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period
ended September 30, 1998 in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
San Jose, California
November 23, 1998
41
E*TRADE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
SEPTEMBER 30,
-------------------
1998 1997
---------- --------
ASSETS
Current assets:
Cash and equivalents...................................... $ 21,834 $ 23,234
Cash and investments required to be segregated under
Federal or other regulations............................. 5,000 15,001
Investment securities..................................... 502,534 191,958
Brokerage receivables--net................................ 1,310,235 724,365
Other assets.............................................. 11,635 6,970
---------- --------
Total current assets..................................... 1,851,238 961,528
Property and equipment--net................................ 48,128 19,995
Investments................................................ 58,342 5,519
Related party receivables.................................. 3,719 3,259
Other assets............................................... 7,491 5,121
---------- --------
Total assets........................................... $1,968,918 $995,422
========== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Brokerage payables........................................ $1,184,917 $681,106
Bank loan payable......................................... -- 9,400
Accounts payable, accrued liabilities and other........... 73,765 21,542
---------- --------
Total liabilities........................................ 1,258,682 712,048
---------- --------
Commitments and contingencies (Notes 12 and 13)
Stockholders' equity:
Common stock, $.01 par: shares authorized, 150,000,000;
shares issued and outstanding: 1998, 56,603,291; 1997,
39,949,768................................................ 566 399
Additional paid-in capital................................. 681,624 266,953
Retained earnings.......................................... 15,310 16,022
Cumulative translation adjustment.......................... 210 --
Unrealized gain on available-for-sale securities, net of
tax....................................................... 12,526 --
---------- --------
Total stockholders' equity............................... 710,236 283,374
---------- --------
Total liabilities and stockholders' equity............. $1,968,918 $995,422
========== ========
See notes to consolidated financial statements.
42
E*TRADE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
YEARS ENDED SEPTEMBER 30,
--------------------------
1998 1997 1996
-------- -------- -------
Revenues:
Transaction revenues............................. $162,097 $109,659 $44,178
Interest--net of interest expense (A)............ 56,019 25,265 4,813
International.................................... 7,031 4,000 --
Other............................................ 20,135 17,471 13,529
-------- -------- -------
Net revenues.................................... 245,282 156,395 62,520
-------- -------- -------
Cost of services.................................. 111,832 73,381 38,027
-------- -------- -------
Operating expenses:
Selling and marketing............................ 71,293 28,160 10,944
Technology development........................... 32,916 13,547 4,699
General and administrative....................... 30,906 16,847 8,238
-------- -------- -------
Total operating expenses........................ 135,115 58,554 23,881
-------- -------- -------
Total cost of services and operating expenses... 246,947 131,935 61,908
-------- -------- -------
Pre-tax income (loss)............................. (1,665) 24,460 612
Income tax expense (benefit)...................... (953) 9,425 (555)
-------- -------- -------
Net income (loss)................................. $ (712) $ 15,035 $ 1,167
======== ======== =======
Net income (loss) per share:
Basic............................................ $ (0.02) $ 0.46 $ 0.06
======== ======== =======
Diluted.......................................... $ (0.02) $ 0.42 $ 0.04
======== ======== =======
Shares used in computation of net income (loss)
per share:
Basic............................................ 42,285 32,352 19,641
Diluted.......................................... 42,285 35,874 29,932
(A) Interest is presented net of interest expense of $39,714, $14,909 and
$2,224 for fiscal years ended September 30, 1998, 1997 and 1996,
respectively.
See notes to consolidated financial statements.
43
E*TRADE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
UNREALIZED
GAIN ON
PREFERRED AVAILABLE-
STOCK COMMON STOCK ADDITIONAL CUMULATIVE FOR-SALE TOTAL
------------- -------------- PAID-IN RETAINED TRANSLATION SECURITIES, STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS ADJUSTMENT NET OF TAX EQUITY
------ ------ ------ ------ ---------- -------- ----------- ----------- -------------
BALANCE, OCTOBER 1,
1995................... 100 $ 1 16,185 $162 $ 9,942 $ 2,243 $ -- $ -- $ 12,348
Net income.............. 1,167 1,167
Issuance of Series B
preferred stock, net of
issuance costs......... 20 2,837 2,837
Issuance of Series C
preferred stock, net of
issuance costs......... 11 8,950 8,950
Initial public
offering............... 5,027 50 46,352 46,402
Conversion of preferred
stock.................. (131) (1) 7,891 79 (78) --
Exercise of stock
warrants, including tax
benefit................ 403 4 286 290
Exercise of stock
options, including tax
benefit................ 1,351 13 506 519
Issuance of common stock
for services........... 7 20 20
Cash dividends--
ShareData.............. (518) (518)
Other employee stock
transactions........... (17) (39) (39)
---- --- ------ ---- -------- ------- ---- ------- --------
BALANCE, SEPTEMBER 30,
1996................... -- -- 30,847 308 68,776 2,892 -- -- 71,976
Net income.............. 15,035 15,035
Adjustment for ShareData
earnings............... (746) (746)
Issuance of common
stock, net of issuance
costs.................. 7,305 73 188,752 188,825
Exercise of stock
options, including tax
benefit................ 1,767 18 8,574 8,592
Employee Stock Purchase
Plan................... 74 1 687 688
Cash dividends--
ShareData.............. (1,159) (1,159)
Other employee stock
transactions........... (43) (1) 164 163
---- --- ------ ---- -------- ------- ---- ------- --------
BALANCE, SEPTEMBER 30,
1997................... -- -- 39,950 399 266,953 16,022 -- -- 283,374
Net loss................ (712) (712)
Issuance of common
stock, net of issuance
costs.................. 15,650 156 398,902 399,058
Exercise of stock
options, including tax
benefit................ 887 9 14,418 14,427
Employee Stock Purchase
Plan................... 104 1 1,193 1,194
Foreign currency
translation............ 210 210
Unrealized gain on
available-for-sale
securities, net of
tax.................... 12,526 12,526
Other employee stock
transactions........... 12 1 158 159
---- --- ------ ---- -------- ------- ---- ------- --------
BALANCE, SEPTEMBER 30,
1998................... -- $-- 56,603 $566 $681,624 $15,310 $210 $12,526 $710,236
==== === ====== ==== ======== ======= ==== ======= ========
See notes to consolidated financial statements.
44
E*TRADE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEARS ENDED SEPTEMBER 30,
---------------------------------
1998 1997 1996
----------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).......................... $ (712) $ 15,035 $ 1,167
Non-cash items included in net income
(loss):
Deferred income taxes..................... 573 1,704 (487)
Depreciation and amortization............. 12,513 3,793 901
Income from equity investment............. (1,198) (1,785) (228)
Other..................................... (219) (179) 107
Net effect of changes in brokerage related
assets and liabilities:
Cash and investments required to be
segregated under Federal or other
regulations.............................. 10,001 20,499 (35,500)
Brokerage receivables..................... (585,870) (531,137) (191,292)
Brokerage payables........................ 503,811 461,623 219,483
Bank loan payable......................... (9,400) 9,400 --
Other changes, net:
Other assets.............................. (8,194) (1,897) (5,850)
Accounts payable, accrued liabilities and
other.................................... 48,519 14,797 4,937
----------- --------- ---------
Net cash used in operating activities...... (30,176) (8,147) (6,762)
----------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment......... (35,329) (15,742) (9,474)
Purchase of investments.................... (32,278) -- (2,000)
Purchase of investment securities.......... (3,237,731) (993,282) (337,073)
Sale/maturity of investment securities..... 2,924,167 836,877 302,070
Related party transactions................. -- (3,147) --
Acquisition of OptionsLink................. (3,500) -- --
Distributions received from equity
investment................................ 4,108 658 44
----------- --------- ---------
Net cash used in investing activities...... (380,563) (174,636) (46,433)
----------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net
of issuance costs......................... 399,058 188,825 46,402
Proceeds from issuance of preferred stock,
net of issuance costs..................... -- -- 11,787
Proceeds from exercise of stock options.... 4,917 1,627 310
Proceeds from exercise of stock warrants... -- -- 113
Proceeds from Employee Stock Purchase
Plan...................................... 1,194 688 --
Proceeds from long-term note payable....... -- -- 2,500
Repayment of long-term note payable........ -- -- (2,500)
Cash dividends--ShareData.................. -- (1,159) (518)
Other...................................... 4,170 180 (28)
----------- --------- ---------
Net cash provided financing activities..... 409,339 190,161 58,066
----------- --------- ---------
INCREASE (DECREASE) IN CASH AND
EQUIVALENTS............................... (1,400) 7,378 4,871
CASH AND EQUIVALENTS--Beginning of period.. 23,234 15,856 10,985
----------- --------- ---------
CASH AND EQUIVALENTS--End of period........ $ 21,834 $ 23,234 $ 15,856
=========== ========= =========
SUPPLEMENTAL DISCLOSURES:
Cash paid for interest..................... $ 37,714 $ 13,440 $ 2,013
=========== ========= =========
Cash paid for income taxes................. $ -- $ 1,235 $ 1,025
=========== ========= =========
Non-cash financing activities:
Tax benefit on exercise of stock options
and warrants............................. $ 9,430 $ 6,926 $ 352
=========== ========= =========
Unrealized gain on investment securities
and investments.......................... $ 21,156 $ -- $ --
=========== ========= =========
See notes to consolidated financial statements.
45
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation--The consolidated financial statements include E*TRADE
Group, Inc. and its subsidiaries (collectively, the "Company"), including
E*TRADE Securities, Inc. ("E*TRADE Securities"), a securities broker-dealer.
The consolidated financial statements of the Company have been prepared to
give retroactive effect to the acquisition of ShareData, Inc. ("ShareData") in
July 1998 (see Note 15). All significant intercompany accounts and
transactions have been eliminated.
Transaction Revenues--The Company derives revenues from commissions related
to customer transactions in equity and debt securities, options and, to a
lesser extent, payments from other broker-dealers for order flow. Securities
transactions are recorded on a trade date basis and are executed by
independent broker-dealers. Through June 1996, the Company did not receive or
hold customers' securities or funds. The Company implemented self-clearing
operations and took custody of securities and funds in customer accounts in
July 1996.
Interest, Net of Interest Expense--Prior to July 1996, these amounts
represent the Company's participation in the interest differential on its
customer debit and credit balances through a contractual agreement with its
former clearing broker, and fees on its customer assets invested in money
market accounts. Subsequent to the implementation of self-clearing operations
in July 1996, these amounts primarily represent interest earned by the Company
on credit extended to its customers to finance their purchases of securities
on margin, fees on its customer assets invested in money market accounts and
interest earned on investment securities, offset by interest paid to customers
on certain credit balances, interest paid to banks and interest paid to other
broker-dealers through the Company's stock loan program.
International Revenue--International revenue represents fees from the
licensing of rights which allow foreign licensees to offer on-line investing
services using the E*TRADE brand name in their respective countries and
ongoing royalty payments based on transaction volume.
Other Revenue--Other revenue primarily represents ShareData software
licensing and maintenance fee revenue, broker-related fees for services,
revenues from advertising on the Company's Web site, equity earnings from the
Company's investment in Roundtable until its public offering in July 1998 (see
Note 5), and mutual fund fees.
Foreign Currency Translation--Assets and liabilities of operations outside
of the United States are translated into U.S. dollars using the exchange rate
in effect at each period end. Revenues and expenses are translated at the
average exchange rate during the period. The effects of foreign currency
translation adjustments arising from differences in exchange rates from period
to period are deferred and included as a separate component of stockholders'
equity.
Property and Equipment--Property and equipment are carried at cost and are
depreciated on a straight-line basis over their estimated useful lives,
generally three to seven years. Leasehold improvements are stated at cost and
are amortized over the lesser of their estimated useful lives or the life of
the lease.
Technology Development Costs--Technology development costs are charged to
operations as incurred. Technology development costs include costs incurred in
the development and enhancement of software used in connection with services
provided by the Company that do not otherwise qualify as internally developed
software costs. The cost of internally developed software is capitalized and
included in property and equipment. The costs to develop such software are
capitalized in accordance with Statement of Position 98-1, Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use, and begin
when management authorizes and commits to funding a project it believes will
be completed and used to perform
46
the functions intended and the conceptual formulation, design and testing of
possible software project alternatives have been completed. Pilot projects and
projects where expected future economic benefits are less than probable are
not capitalized. Internally developed software costs include the cost of
software tools and licenses used in the development of the Company's systems,
as well as payroll and consulting costs. Capitalized costs totaled
$10,210,000, $2,832,000 and $114,000 for the years ended September 30, 1998,
1997 and 1996, respectively.
Completed projects are transferred to property and equipment and are
reported at the lower of unamortized cost less any provision for impairment.
Amortization is based on the straight-line method over the estimated useful
life, generally two to three years. Amortization expense for the years ended
September 30, 1998 and 1997 was $1,715,000 and $69,000, respectively. There
was no amortization expense for the year ended September 30, 1996.
Cash Equivalents--For purposes of reporting cash flows, the Company
considers all highly liquid investments with original maturities of three
months or less (except for amounts required to be segregated under Federal or
other regulations or investment securities designated as available for sale)
to be cash equivalents.
Cash and Investments Required to be Segregated Under Federal or Other
Regulations--Cash and investments required to be segregated under Federal or
other regulations consist primarily of government backed securities purchased
under agreements to resell ("Resale Agreements"). Resale Agreements are
accounted for as collateralized financing transactions and are recorded at
their contractual amounts, which approximate fair value.
Investments--Investment securities represent a portfolio of commercial
paper, municipal bonds, corporate bonds, U.S. Government obligations,
preferred stocks and money market funds. The cost of these investments
approximates fair market value, and management has designated them as
available-for-sale. Unrealized gains and losses, net of tax, are computed on
the basis of average cost and are included as a separate component of
stockholders' equity. Realized gains and losses and declines in fair-value,
judged to be other than temporary, are included in other revenues. The cost of
securities sold is based on the average cost method and interest earned is
included in interest revenue.
Investments in entities of which the Company owns between 20% and 50% and on
which the Company has the ability to exercise significant influence are
accounted for under the equity method. Other investments are accounted for
using the cost method.
Impairment of Long-Lived Assets--In the event that facts and circumstances
indicate that the carrying value of a long-lived asset, including associated
intangibles, may be impaired, an evaluation of recoverability is performed by
comparing the estimated future undiscounted cash flows associated with the
asset to the asset's carrying amount to determine if a write-down to market
value or discounted cash flow is required.
Estimated Fair-Value of Financial Instruments--The Company believes the
amounts presented for financial instruments on the consolidated balance sheets
consisting of cash equivalents, commercial paper, municipal bonds, corporate
bonds, U.S. Government obligations, preferred stocks, money market funds, and
brokerage receivables and payables to be reasonable estimates of fair-value.
The Company uses available market information as of the balance sheet dates
and appropriate valuation methodologies in deriving amounts reported for
financial instruments.
Stock-Based Compensation--The Company accounts for employee stock-based
compensation using the intrinsic value method of accounting prescribed in
Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock
Issued to Employees. The Company provides pro forma disclosures of net income
and earnings per share as required under SFAS No. 123, Accounting for Stock-
Based Compensation. SFAS No. 123 encourages, but does not require companies to
recognize compensation expense for grants of stock, stock options, and other
equity instruments based on the fair-value method of accounting.
47
Advertising Costs--Advertising production costs are expensed when the
initial advertisement is run. Costs of communicating advertising are expensed
as the services are received.
Income Taxes--The Company accounts for income taxes in accordance with SFAS
No. 109, Accounting for Income Taxes, which requires the recognition of
deferred tax liabilities and assets at tax rates expected to be in effect when
these balances reverse. Future tax benefits attributable to temporary
differences are recognized to the extent that realization of such benefits is
more likely than not.
Earnings Per Share--The Company has adopted and retroactively applied the
provisions of SFAS No. 128, Earnings per Share, for all periods presented.
SFAS No. 128 requires a dual presentation of basic and diluted EPS. Basic EPS
excludes dilution and is computed by dividing net income by the weighted
average common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock.
New Accounting Standards-- In June 1997, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 130, Reporting Comprehensive Income. SFAS No.
130 establishes standards for the reporting and display of comprehensive
income and its components in a financial statement that is displayed with the
same prominence as other financial statements. Comprehensive income as defined
includes all changes in equity (net assets) during a period from nonowner
sources. The disclosures prescribed by SFAS No. 130 will be made beginning
with the first quarter of fiscal 1999.
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. This statement establishes standards for
reporting information about operating segments in annual financial statements.
It also establishes standards for related disclosures about products and
services, geographic areas, and major customers. The Company is in the process
of reassessing its current business segment reporting to determine if changes
in reporting will be required in adopting this new standard. The disclosures
prescribed by SFAS No. 131 will be adopted in the Company's fiscal 1999 annual
report.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. The new standard requires companies to
record derivatives on the balance sheet as assets or liabilities, measured at
fair value. Gains or losses resulting from changes in the values of those
derivatives will be reported in the statement of operations or as a deferred
item, depending on the use of the derivatives and whether they qualify for
hedge accounting. The key criterion for hedge accounting is that the
derivative must be highly effective in achieving offsetting changes in fair
value or cash flows of the hedged items during the term of the hedge. The
Company plans to adopt SFAS No. 133 in the first quarter of fiscal 2000 and
has not yet determined the effect, if any, of adopting the new standard.
Use of Estimates--The preparation of the Company's consolidated financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and related notes for the
periods presented. Actual results could differ from management's estimates.
Reclassifications--Certain items in these financial statements have been
reclassified to conform to the current period presentation.
2. INVESTMENT SECURITIES
The Company invests in high quality, short-term investments, which it
classifies as available-for-sale. As such, there were no significant
differences between amortized cost and estimated fair value at September 30,
1998 or 1997. Additionally, because investments are short-term and are
generally allowed to mature or contain
48
provisions which provide for resale at par to the issuer within 12 months,
realized gains and losses for the years ended September 30, 1998, 1997 and
1996 were minimal and there were no significant changes in net unrealized
gains and losses.
The following table presents the estimated fair value breakdown of
investment securities by category (in thousands):
SEPTEMBER 30,
-----------------
1998 1997
-------- --------
Municipal bonds......................................... $358,535 $ 43,904
Commercial paper........................................ 54,925 67,062
U.S. Government obligations............................. 47,102 560
Money market funds...................................... 37,967 61,879
Corporate bonds......................................... 4,005 10,927
Preferred stocks........................................ -- 7,626
-------- --------
Total investment securities........................... $502,534 $191,958
======== ========
3. BROKERAGE RECEIVABLES AND PAYABLES--NET
Brokerage receivables and payables--net consists of the following (in
thousands):
SEPTEMBER 30,
-------------------
1998 1997
---------- --------
Receivable from customers and non-customers (less
allowance for doubtful accounts of $862 and $435 in
1998 and 1997, respectively)......................... $ 961,305 $655,981
Receivable from brokers, dealers and clearing
organizations:
Net settlement and deposits with clearing
organizations....................................... 14,854 37,198
Deposits paid for securities borrowed................ 328,989 25,584
Securities failed to deliver......................... 728 1,011
Other................................................ 4,359 4,591
---------- --------
Total brokerage receivables--net.................... $1,310,235 $724,365
========== ========
Payable to customers and non-customers................ $ 340,044 $279,348
Payable to brokers, dealers and clearing
organizations:
Deposits received for securities loaned.............. 839,422 398,007
Securities failed to receive......................... 1,222 1,304
Other................................................ 4,229 2,447
---------- --------
Total brokerage payables............................ $1,184,917 $681,106
========== ========
Receivable from and payable to brokers, dealers and clearing organizations
result from the Company's brokerage activities. Receivable from customers
represents credit extended to customers to finance their purchases of
securities on margin. At September 30, 1998 and 1997, credit extended to
customers with respect to margin accounts was $956 million and $678 million,
respectively. Securities owned by customers are held as collateral for amounts
due on margin balances (the value of which is not reflected on the
accompanying consolidated balance sheets). Payable to customers represents
free credit balances and other customer funds pending completion of securities
transactions. The Company pays interest on certain customer credit balances.
49
4. PROPERTY AND EQUIPMENT--NET
Property and equipment--net consists of the following (in thousands):
SEPTEMBER 30,
---------------
1998 1997
------- -------
Equipment................................................. $23,117 $12,737
Leasehold improvements.................................... 14,699 6,525
Software.................................................. 25,451 5,664
Furniture and fixtures.................................... 3,556 1,251
------- -------
66,823 26,177
Less accumulated depreciation and amortization............ 18,695 6,182
------- -------
Total property and equipment-net........................ $48,128 $19,995
======= =======
5. INVESTMENTS
Investments consist of the following (in thousands):
SEPTEMBER 30,
--------------
1998 1997
------- ------
Knight/Trimark.............................................. $21,173 $3,509
Joint ventures.............................................. 10,153 --
KAP Group................................................... 2,000 2,000
Critical Path............................................... 15,250 --
Other investments........................................... 9,766 10
------- ------
Total investments......................................... $58,342 $5,519
======= ======
Through July 7, 1998, the Company owned a 4.47% interest in Roundtable
Partners LLC ("Roundtable"), a company formed to hold equity interests in
securities trading and market making companies and which made distributions to
its owners of a significant portion of its earnings. The Company had accounted
for its investment in Roundtable under the equity method since its inception.
On July 8, 1998, Roundtable was reorganized into a corporation known as
Knight/Trimark Group, Inc. ("Knight/Trimark") coincident with an initial
public offering of Knight/Trimark common stock. Knight/Trimark does not
currently intend to pay dividends. As a result of this reorganization, all of
the Company's ownership interest in Roundtable was converted into 2,566,432
shares of common stock of Knight/Trimark, which represents 4.99% of the issued
and outstanding shares of common stock of Knight/Trimark. Effective July 8,
1998, the Company accounts for its investment in Knight/Trimark as a long-term
marketable equity security held available-for-sale under the provisions of
SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities. Accordingly, this investment is carried at fair value at September
30, 1998, with unrealized gains of $12,340,000, net of tax of $8,505,000,
reported as a separate component of stockholders' equity. The Company's
investment in Knight/Trimark is subject to a sale restriction agreement with
the underwriters of the initial public offering, which expires in January
1999.
In June 1998, the Company entered into a joint venture agreement with
SOFTBANK CORP. to form E*TRADE Japan to provide online securities trading
services to residents of Japan. As part of the transaction, the Company
invested approximately $8 million in exchange for a 42% ownership position in
the joint venture. Additionally, the Company entered into a joint venture
agreement with Electronic Share Information Ltd. ("ESI") to form E*TRADE UK.
ESI is a leading provider of Internet financial services in the UK. The
Company accounts for its investments in the joint ventures under the equity
method.
In June 1997, the Company invested $2,000,000 in KAP Group, LLC ("KAP
Group"), by means of a promissory note in the principal amount of $1,806,000
and through the purchase of a warrant for $194,000.
50
The note bears interest at 7% per annum which, together with the principal
amount, is due and payable in July 2002. The warrant gives the Company the
right to purchase shares of KAP Group. KAP Group has invested substantially
all of its assets in another entity, which was formed for the purpose of
engaging in electronic options trading. KAP Group investors include the
Company's Chairman of the Board of Directors and others.
The Company has also made investments in non-public, venture capital-backed
high technology companies with which it does business and which provide
Internet-based services. These investments include: Critical Path, a leading
provider of outsourced email services and infrastructure for Web portals,
Internet service providers, Web hosting companies, and corporations; Digital
Island, a global IP applications network for the digital economy; and Third
Age Media, producers of ThirdAge.com, a comprehensive source of content,
community and commerce on the Web for active older adults. These investments
each represent less than 20% of the outstanding shares of these companies and
are accounted for under the cost method. At September 30, 1998, the Company
believes that the fair value of these investments approximates their carrying
basis.
6. RELATED-PARTY RECEIVABLES
During fiscal 1997, the Company made a relocation loan to Mr. Christos
Cotsakos, its Chief Executive Officer and a Director, in the aggregate
principal amount of $3,147,000. The proceeds of this loan were used to fund
the purchase by Mr. Cotsakos of a personal residence in the Silicon Valley
area. The relocation loan accrues interest at the rate of 7% per annum which,
together with the principal amount, is due and payable in November 1999.
Accrued interest totaled $420,000 and $200,000 as of September 30, 1998 and
1997, respectively. The loan is required to be collateralized by a combination
of assets, including the residence purchased. The due date of the relocation
loan is subject to acceleration upon the occurrence of certain events
including the voluntary cessation of employment with the Company by Mr.
Cotsakos.
7. LONG-TERM NOTES PAYABLE AND SHORT-TERM FUNDING
The principal source of financing for E*TRADE Securities' margin lending is
cash balances in customers' accounts and financing obtained from other broker-
dealers through E*TRADE Securities' stock loan program. E*TRADE Securities
also maintains committed lines of financing with banks totaling $100 million
to finance margin lending. There were no borrowings outstanding under these
lines at September 30, 1998. At September 30, 1997, $9,400,000 was outstanding
under these lines, bearing interest at 6.875% per annum, which was repaid on
October 1, 1997; such amount is recorded as bank loan payable in the
consolidated balance sheet.
8. INCOME TAXES
The components of income tax expense (benefit) are as follows (in
thousands):
YEARS ENDED SEPTEMBER 30,
-----------------------------
1998 1997 1996
--------- -------- --------
Current:
Federal.................................... $ (1,173) $ 5,499 $ (66)
State...................................... (353) 2,222 (2)
--------- -------- -------
Total current............................. (1,526) 7,721 (68)
--------- -------- -------
Deferred:
Federal.................................... (33) 1,727 (441)
State...................................... 606 (23) (46)
--------- -------- -------
Total deferred............................ 573 1,704 (487)
--------- -------- -------
Total tax expense (benefit)................. $ (953) $ 9,425 $ (555)
========= ======== =======
51
Deferred income taxes are recorded when revenues and expenses are recognized
in different periods for financial statement and tax return purposes. The
temporary differences and tax carryforwards that created deferred tax assets
(liabilities) are as follows (in thousands):
SEPTEMBER 30,
--------------
1998 1997
------- -----
Deferred tax assets:
Reserves and allowances................................. $ 599 $ 412
Net operating loss carryforwards........................ 1,804 487
Depreciation and amortization........................... 828 --
Deferred compensation................................... 999 533
Other................................................... 685 164
------- -----
Total deferred tax assets.............................. 4,915 1,596
------- -----
Deferred tax liabilities:
Depreciation and amortization........................... -- 2,292
Internally developed software........................... 5,783 --
Other................................................... 636 235
------- -----
Total deferred tax liabilities......................... 6,419 2,527
------- -----
Net deferred tax liability included in other
liabilities............................................. $(1,504) $(931)
======= =====
No valuation allowance has been provided for the deferred tax assets at
September 30, 1998 and 1997 as full realization of these assets is expected.
The effective tax rates differed from the federal statutory rates as
follows:
YEARS ENDED SEPTEMBER 30,
------------------------------
1998 1997 1996
--------- -------- ---------
Tax expense (benefit) at federal
statutory rate........................ (35.0)% 35.0% 35.0%
State income taxes, net of federal tax
benefit............................... 10.2 6.2 2.3
Income of Subchapter S corporation..... 65.6 (1.9) (130.8)
Nondeductible acquisition costs........ 24.5 -- --
Tax-exempt interest.................... (137.4) -- --
Other.................................. 14.9 (0.8) 2.8
--------- ------- ---------
Effective tax rate..................... (57.2)% 38.5% (90.7)%
========= ======= =========
Prior to being acquired by the Company, ShareData was a Subchapter S
corporation and was not subject to federal and state corporate income taxes.
9. STOCKHOLDERS' EQUITY
Stock Issuances
In April 1996, the Company sold 20,336 shares of Series B Preferred Stock
("Series B") to Christos Cotsakos, Chief Executive Officer and a Director, and
affiliates, Richard Braddock, and General Atlantic Partners and affiliates for
$2,847,000 and incurred issuance costs of $10,000. The Company used the
proceeds to provide additional working capital.
In June 1996, the Company sold 11,180 shares of Series C Preferred Stock
("Series C") to SOFTBANK Holdings Inc. for $9,000,000 and incurred issuance
costs of $50,000. The Company used the proceeds to provide additional
regulatory net capital to E*TRADE Securities.
52
In August 1996, the Company completed an initial public offering of
5,026,550 shares of the Company's common stock at a price of $10.50 per share.
Each outstanding share of Series A, Series B and Series C Preferred Stock was
automatically converted into 60 shares of common stock upon the closing of the
initial public offering. The proceeds to the Company from the offering, net of
underwriting discounts and offering expenses of $6.4 million, were $46.4
million.
In August 1997, the Company completed a secondary public offering of
7,305,000 shares of the Company's common stock at a price of $27.50 per share.
The proceeds to the Company from the offering, net of underwriting discounts
and offering expenses of $14.8 million, were $188.8 million.
In July 1998, the Company entered into an agreement to issue and sell
15,650,000 shares of common stock to SOFTBANK CORP., a Japanese corporation,
for an aggregate purchase price of $400 million.
Stock Option Plans
The Company's stock option plans provide for the granting of nonqualified or
incentive stock options to officers, directors, key employees and consultants
for the purchase of shares of the Company's common stock at a price determined
by the Board of Directors at the date the option is granted. The options are
generally exercisable ratably over a five-year period from the date the option
is granted and expire within ten years from the date of grant.
In July 1996, the stockholders of the Company approved the 1996 Stock
Incentive Plan (the "1996 Plan") and reserved 4,000,000 shares of common stock
for future grants. Following adoption, no additional grants may be made under
any prior plans. The 1996 Plan is divided into three components: the
Discretionary Option Grant Program, the Stock Issuance Program and the
Automatic Option Grant Program. Under the Discretionary Option Grant Program,
options may be granted to purchase shares of common stock at an exercise price
not less than the fair market value of those shares on the grant date to
eligible employees. The Stock Issuance Program allows for individuals to be
issued shares of common stock directly through the purchase of such shares at
a price not less than the fair market value of those shares at the time of
issuance or as a bonus tied to the performance of services. Under the
Automatic Option Grant Program, options are automatically granted at periodic
intervals to eligible non-employee members of the Board of Directors to
purchase shares of common stock at an exercise price equal to the fair market
value of those shares on the grant date.
A summary of stock option activity follows (in thousands):
WEIGHTED
NUMBER AVERAGE
OF EXERCISE
SHARES PRICE
------ --------
Outstanding at September 30, 1995......................... 4,023 $ .43
Granted.................................................. 4,092 $ 5.18
Exercised................................................ (1,351) $ .21
Canceled................................................. (179) $ 6.29
------ ------
Outstanding at September 30, 1996......................... 6,585 $ 3.29
Granted.................................................. 2,710 $21.06
Exercised................................................ (1,767) $ .91
Canceled................................................. (998) $ 6.96
------ ------
Outstanding at September 30, 1997......................... 6,530 $10.99
Granted.................................................. 3,677 $22.90
Exercised................................................ (887) $ 5.63
Canceled................................................. (712) $17.06
------ ------
Outstanding at September 30, 1998......................... 8,608 $16.17
====== ======
53
On October 22, 1998, the Company implemented an option cancellation /
regrant program pursuant to which employees who held outstanding stock options
with an exercise price in excess of $17.00 per share were able to cancel the
previously issued options and receive the same number of new options at an
exercise price of $17.00, the closing price of the Company's common stock on
October 22, 1998. Each new option has a maximum term of ten years, subject to
earlier termination upon the optionee's cessation of service, and will become
exercisable in a series of four successive equal annual installments over the
optionee's period of continued service with the Company measured from October
22, 1998, the regrant date. Options covering a total of 3,479,534 shares of
the Company's common stock were cancelled and regranted under the program.
SEPTEMBER 30,
-----------------
1998 1997 1996
----- ----- -----
Options available for grant............................ 152 1,213 2,870
Options exercisable (as adjusted for the October 22,
1998 transaction)..................................... 1,723 470 914
Options exercisable weighted average exercise price.... $9.13 $4.35 $1.17
The following table summarizes information on outstanding and exercisable
stock options as of September 30, 1998 (as adjusted for the October 22, 1998
transaction):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- -----------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
RANGE OF OUTSTANDING CONTRACTUAL AVERAGE EXERCISABLE AVERAGE
EXERCISABLE AS OF 9/30/98 LIFE EXERCISE AS OF 9/30/98 EXERCISE
PRICES (IN THOUSANDS) (YEARS) PRICE (IN THOUSANDS) PRICE
- -------------- -------------- ----------- -------- -------------- --------
$ 0.28--$ 2.33 1,879 7.09 $ 1.76 560 $ 1.54
$ 3.69--$11.25 1,509 7.77 $ 8.79 608 $ 7.86
$11.63--$17.75 4,098 9.86 $16.90 67 $15.57
$18.06--$21.00 791 9.10 $19.01 471 $18.18
$21.03--$42.81 331 9.18 $25.69 17 $28.33
- -------------- ----- ---- ------ ----- ------
$ 0.28--$42.81 8,608 8.79 $12.67 1,723 $ 9.13
============== ===== ==== ====== ===== ======
Stock Purchase Plan
In July 1996, the stockholders of the Company approved the 1996 Stock
Purchase Plan (the "Purchase Plan"), and reserved 650,000 shares of common
stock for sale to employees at a price no less than 85% of the lower of the
fair market value of the common stock at the beginning of the two-year
offering period or the end of each of the six-month purchase periods.
54
Additional Stock Plan Information
In accordance with SFAS No. 123, Accounting for Stock-Based Compensation,
the Company applied APB Opinion 25 and related interpretations in accounting
for its stock option plans, and accordingly does not record compensation
costs. If the Company had elected, beginning in fiscal 1996, to recognize
compensation cost based on the fair value of the option granted at the grant
date as prescribed by SFAS No. 123, net income (loss) and net income (loss)
per share would have been reduced to the pro forma amounts shown below (in
thousands, except per share amounts):
YEARS ENDED SEPTEMBER
30,
------------------------
1998 1997 1996
-------- ------- ------
AS REPORTED
Net income (loss)................................ $ (712) $15,035 $1,167
Net income (loss) per share-basic................ $ (.02) $ 0.46 $ 0.06
Net income (loss) per share-diluted.............. $ (.02) $ 0.42 $ 0.04
PRO FORMA
Net income (loss)................................ $(24,273) $ 8,728 $ 501
Net income (loss) per share-basic................ $ (.57) $ .27 $ 0.03
Net income (loss) per share-diluted.............. $ (.57) $ .24 $ 0.02
The Company's calculations were made using the minimum value method and
Black-Scholes option pricing models with the following weighted average
assumptions:
YEARS ENDED SEPTEMBER 30,
------------------------------
1998 1997 1996
-------- -------- --------
Dividend yield.......................... -- -- --
Expected volatility..................... 75% 65% 65%
Risk-free interest rate................. 6% 6% 6%
Expected life of option following
vesting (in months).................... 12 12 12
Under SFAS No. 123, the fair value of stock-based awards to employees is
calculated using the minimum value method for fiscal 1996 prior to the initial
public offering, and subsequently through the use of option pricing models,
even though such models were developed to estimate the fair value of freely
tradable, fully transferable options without vesting restrictions, which
significantly differ from the Company's stock option awards. These models also
require subjective assumptions, including future stock price volatility and
expected time to exercise, which greatly affect the calculated values.
The Company's calculations are based on a multiple option valuation approach
and forfeitures are recognized as they occur. The valuations of the computed
weighted average fair values of option grants under SFAS No. 123 in fiscal
1998, 1997 and 1996 were $12.09, $11.09 and $1.64, respectively.
401(k) Salary Deferral Program
The Company has a 401(k) salary deferral program, which became effective on
January 1, 1995, for eligible employees who have met certain service
requirements. The Company matches certain employee contributions; additional
contributions to this plan are at the discretion of the Company. Total Company
contribution expense for the years ended September 30, 1998, 1997 and 1996 was
$312,000, $153,000 and $59,000, respectively.
55
10. NET INCOME (LOSS) PER SHARE
The following table sets forth the computation of shares used in the
computations of basic and diluted net income (loss) per share (in thousands):
YEARS ENDED SEPTEMBER 30,
--------------------------
1998 1997 1996
-------- -------- --------
Shares Used in Computation (in thousands):
Weighted average common shares outstanding
used in computation of basic net income
(loss) per share............................. 42,285 32,352 19,641
Dilutive effect of stock options.............. -- 3,522 10,291
-------- -------- --------
Shares used in computation of diluted net
income (loss) per share...................... 42,285 35,874 29,932
======== ======== ========
Because the Company reported a net loss in fiscal 1998, the calculation of
diluted earnings per share does not include common stock equivalents as they
are anti-dilutive and would result in a reduction of net loss per share. If
the Company had reported net income in fiscal year 1998, there would have been
2,823,000 additional shares in the calculation of diluted earnings per share.
Options to purchase 299,712 and 119,581 shares of common stock at prices
ranging from $19.38 to $46.00 and $9.69 to $13.19 were outstanding as of
September 30, 1997 and 1996, respectively, but not included in the computation
of diluted net income (loss) per share for the years ended September 30, 1997
and 1996, respectively. These options were excluded because the options'
exercise price was greater than the average market price of the Company's
common stock for the years ended September 30, 1997 and 1996, respectively,
and therefore would be anti-dilutive for purposes of this calculation.
11. REGULATORY REQUIREMENTS
E*TRADE Securities is subject to the Uniform Net Capital Rule (the "Rule")
under the Securities Exchange Act of 1934 administered by the Securities and
Exchange Commission and the National Association of Securities Dealers, Inc.,
which requires the maintenance of minimum net capital. E*TRADE Securities has
elected to use the alternative method permitted by the Rule, which requires
that the Company maintain minimum net capital equal to the greater of $250,000
or 2 percent of aggregate debit balances arising from customer transactions,
as defined. E*TRADE Securities had amounts in relation to the Rule as follows
(in thousands, except percentage data):
SEPTEMBER 30,
----------------
1998 1997
------- -------
Net capital.............................................. $97,355 $51,721
Percentage of aggregate debit balances................... 9.5% 7.5%
Required net capital..................................... $20,429 $13,771
Excess net capital....................................... $76,926 $37,950
Under the alternative method, a broker-dealer may not repay subordinated
borrowings, pay cash dividends or make any unsecured advances or loans to its
parent or employees if such payment would result in net capital of less than
5% of aggregate debit balances or less than 120% of its minimum dollar amount
requirement.
56
12. LEASE ARRANGEMENTS
During fiscal 1998 the Company entered into agreements to lease facilities
in Menlo Park, California, where it will consolidate its existing Silicon
Valley locations. The Company also entered into an agreement to lease a
facility in Alpharetta, Georgia, where it has expanded certain operations,
such as customer service, and, in fiscal 1999, will establish a new technology
center.
The Company has non-cancelable operating leases for office facilities
through 2009 and operating leases for equipment through 2003. Future minimum
rental commitments under these leases at September 30, 1998, are as follows
(in thousands):
Years ending September 30:
1999............................................................ $ 28,281
2000............................................................ 22,185
2001............................................................ 14,829
2002............................................................ 10,782
2003............................................................ 10,596
Thereafter...................................................... 50,672
--------
$137,345
========
Certain leases contain provisions for renewal options and rent escalations
based on increases in certain costs incurred by the lessor. Rent expense for
the years ended September 30, 1998, 1997 and 1996 was approximately
$20,516,000, $11,389,000 and $2,697,000, respectively.
13. COMMITMENTS, CONTINGENCIES AND REGULATORY MATTERS
The Company is a defendant in civil actions arising from the normal course
of business. In the opinion of management, these actions are expected to be
resolved with no material effect on the Company's consolidated financial
position or results of operations.
On November 21, 1997, a putative class action was filed in the Superior
Court of California, County of Santa Clara, by Larry R. Cooper on behalf of
himself and other similarly situated individuals. The action alleges, among
other things, that the Company's advertising, other communications and
business practices regarding the Company's commission rates and its ability to
timely execute transactions through its online brokerage services were false
and deceptive. The action seeks injunctive relief enjoining the purported
deceptive and unfair practices alleged in the action and also seeks
unspecified compensatory and punitive damages, as well as attorney fees.
This proceeding is at an early stage and the Company is unable to speculate
as to its ultimate outcome. However, the Company believes it has meritorious
defenses to the claims and intends to conduct vigorous defenses. An
unfavorable outcome in any matters which are not covered by insurance could
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, even if the ultimate outcomes are
resolved in favor of the Company, the defense of such litigation could entail
considerable cost and the diversion of efforts of management, either of which
could have a material adverse effect on the Company's results of operation.
From time to time the Company has been threatened with, or named as a
defendant in, lawsuits and administrative claims. Compliance and trading
problems that are reported to the NASD or the SEC by dissatisfied customers
are investigated by the NASD or the SEC, and, if pursued by such customers,
may rise to the level of arbitration or disciplinary action. One or more of
such claims or disciplinary actions decided adversely against the Company
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company is also subject to periodic
regulatory audits and inspections.
57
The securities industry is subject to extensive regulation under federal,
state and applicable international laws. As a result, the Company is required
to comply with many complex laws and rules and its ability to so comply is
dependent in large part upon the establishment and maintenance of a qualified
compliance system. The Company is aware of several instances of its non-
compliance with applicable regulations. In particular, in fiscal 1997, the
Company failed to comply with applicable advertising restrictions in one
international jurisdiction and due to a clerical oversight, failed to timely
renew its registration as a broker-dealer in two states, Nebraska and Ohio.
One of the state jurisdictions, Ohio, as a condition of renewing the Company's
license as a broker-dealer in that jurisdiction, required the Company to offer
customers resident in that state the ability to rescind (for up to 30 days)
certain securities transactions effected through the Company during the period
January 1, 1997 through April 15, 1997, the date the Company's license was
renewed. For fiscal 1997, the Company recorded a $4.3 million pre-tax charge
against earnings in connection with this matter.
The Company maintains insurance in such amounts and with such coverage,
deductibles and policy limits as management believes are reasonable and
prudent. The principal risks that the Company insures against are
comprehensive general liability, commercial property, hardware/software
damage, directors and officers, and errors and omissions liability. The
Company believes that such insurance coverage is adequate for the purpose of
its business.
In March 1996, the Company entered into a five-year employment agreement
with a key executive officer. The employment agreement provides for, among
other things, an annual base salary which is subject to adjustment based on
the Company's performance and a severance payment up to $1,250,000 in the
event of termination of employment under certain defined circumstances.
14. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET CREDIT RISK AND
CONCENTRATIONS OF CREDIT RISK
The Company's customer securities activities are transacted on either a cash
or margin basis. In margin transactions, the Company extends credit to the
customer, subject to various regulatory and internal margin requirements,
collateralized by cash and securities in the customer's account. As customers
write option contracts or sell securities short, the Company may incur losses
if the customers do not fulfill their obligations and the collateral in
customer accounts is not sufficient to fully cover losses which customers may
incur from these strategies. To control this risk, the Company monitors
required margin levels daily, and customers are required to deposit additional
collateral, or reduce positions, when necessary.
Through its broker-dealer subsidiaries, the Company loans securities
temporarily to other brokers in connection with its securities lending
activities. The Company receives cash as collateral for the securities loaned.
Increases in security prices may cause the market value of the securities
loaned to exceed the amount of cash received as collateral. In the event the
counterparty to these transactions does not return the loaned securities, the
Company may be exposed to the risk of acquiring the securities at prevailing
market prices in order to satisfy its customer obligations. The Company
controls this risk by requiring credit approvals for counterparties, by
monitoring the market value of securities loaned on a daily basis and by
requiring deposits of additional cash as collateral when necessary.
The Company is obligated to settle transactions with brokers and other
financial institutions even if its customers fail to meet their obligations to
the Company. Customers are required to complete their transactions on
settlement date, generally three business days after trade date. If customers
do not fulfill their contractual obligations, the Company may incur losses.
The Company has established procedures to reduce this risk by requiring that
customers deposit cash and/or securities into their account prior to placing
an order.
The Company may at times maintain inventories in equity securities on both a
long and short basis. While long inventory positions represent the Company's
ownership of securities, short inventory positions represent obligations of
the Company. Accordingly, both long and short inventory positions may result
in losses or gains to the Company as market values of securities fluctuate. To
mitigate the risk of losses, long and short positions are marked to market
daily and are continuously monitored by the Company.
58
15. ACQUISITIONS
OptionsLink
In first quarter of fiscal 1998 E*TRADE acquired the OptionsLink Division of
Hambrech & Quist for a purchase price of $3.5 million. The purchase price
exceeded the fair value of the assets acquired by $3.1 million, of which $2.9
million was capitalized as software and amortized over two years, in
accordance with the Company's existing policy.
ShareData
On July 30, 1998, the Company acquired ShareData, Inc., ("ShareData").
ShareData supplies stock plan knowledge-based software for pre-IPO and public
companies. The Company issued 1.3 million shares of its common stock in
exchange for all outstanding common stock of ShareData. The Company also
assumed all outstanding ShareData options, which were converted to options to
purchase approximately 186,000 shares of the Company's common stock. The
acquisition was accounted for as a pooling-of-interest, and accordingly, all
prior financial data of the Company has been restated to include the
historical operations of ShareData. As a result of the acquisition, the
combined Company incurred charges and direct transaction costs relating to the
business combination of $1.2 million. These non-recurring costs have been
charged to operations in the fourth quarter of fiscal 1998. Prior to the
acquisition, ShareData reported on a calendar year end. Fiscal 1998 and 1997
include the results of ShareData for the twelve months ended September 30,
1998 and 1997, respectively. Fiscal 1996 includes the results of ShareData for
the twelve months ended December 31, 1996. The results of operations for the
quarter ended December 31, 1996 (revenues of $4,637,000 and net income of
$746,000), included in both fiscal 1997 and 1996, is reflected as an
adjustment to retained earnings in fiscal 1997. No adjustments were required
to conform accounting policies of the entities. There were no significant
intercompany transactions requiring elimination for any periods presented.
The operating results of the separate Companies are as follows (in
thousands):
NET NET INCOME
REVENUES (LOSS)
-------- ----------
Nine months ended June 30, 1998
E*TRADE Group......................................... $166,755 $18,334
ShareData............................................. 9,865 (3,130)
-------- -------
Combined.............................................. $176,620 $15,204
======== =======
Year ended September 30, 1997
E*TRADE Group......................................... $142,737 $13,905
ShareData............................................. 13,658 1,130
-------- -------
Combined.............................................. $156,395 $15,035
======== =======
Year ended September 30, 1996
E*TRADE Group......................................... $ 51,595 $ (828)
ShareData............................................. 10,925 1,995
-------- -------
Combined.............................................. $ 62,520 $ 1,167
======== =======
59
16. QUARTERLY DATA (UNAUDITED)
The unaudited quarterly financial information presented below reflects all
adjustments which, in the opinion of management, are of a normal and recurring
nature necessary to present fairly the results of operations for the periods
presented (in thousands, except per share amounts).
On November 23, 1998, the American Institute of Certified Public Accountants
held the first meeting of a task force formed to prepare guidance for
companies that account for business acquisitions under the purchase method of
accounting which includes in-process research and development ("IPR&D"). At
this meeting, representatives of the Securities and Exchange Commission
("SEC") expressed their views on this matter, which represented a significant
departure from previous accepted practice. After considering the new views
taken by the SEC on IPR&D, the Company has reassessed its allocation of the
purchase price of the OptionsLink acquisition made in the first quarter of
fiscal 1998. Initially, $2.8 million of the purchase price had been allocated
to IPR&D. Based on the SEC's recent guidance, the Company has reallocated a
substantial part of the purchase price to capitalized software, to be
amortized over two years, in accordance with the Company's existing policy.
The net effect of these reallocations are to reduce reported net loss in
fiscal year 1998 by $573,000 or $.01 cent per share. The impact of this change
for the quarter ended September 30, 1998, due to increased amortization
expense, is an increase in reported net loss by $169,000, with no change to
earnings per share.
FISCAL 1998 FISCAL 1997
----------------------------------- --------------------------------
4TH 3RD 2ND 1ST 4TH 3RD 2ND 1ST
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
-------- ------- ------- ------- ------- ------- ------- -------
E*TRADE Group (as
previously reported):
Revenues............... $ 64,296 $62,316 $53,309 $51,130 $48,477 $37,036 $32,201 $25,023
Cost of services....... 31,991 28,722 24,280 22,747 23,384 21,834 13,198 12,425
Net income (loss)...... (15,923) 6,560 6,118 4,914 5,523 3,068 3,054 2,260
Net income (loss) per
share:
Basic.................. $ (0.33) $ 0.17 $ 0.16 $ 0.13 $ 0.16 $ 0.10 $ 0.10 $ 0.08
Diluted................ $ (0.33) $ 0.16 $ 0.15 $ 0.12 $ 0.14 $ 0.09 $ 0.09 $ 0.07
ShareData and software
adjustment:
Revenues............... $ 4,366 $ 4,167 $ 2,821 $ 2,877 $ 3,507 $ 2,541 $ 2,973 $ 4,637
Cost of services....... 1,246 1,049 974 823 916 677 633 314
Net income (loss)...... 7 (990) (1,610) 212 353 (158) 189 746
Combined:
Revenues............... $ 68,662 $66,483 $56,130 $54,007 $51,984 $39,577 $35,174 $29,660
Cost of services....... 33,237 29,771 25,254 23,570 24,300 22,511 13,831 12,739
Net income (loss)...... (15,916) 5,570 4,508 5,126 5,876 2,910 3,243 3,006
Net income (loss) per
share:
Basic.................. $ (0.33) $ 0.14 $ 0.11 $ 0.13 $ 0.17 $ 0.09 $ 0.10 $ 0.10
Diluted................ $ (0.33) $ 0.13 $ 0.10 $ 0.12 $ 0.15 $ 0.08 $ 0.09 $ 0.09
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
The Company's Proxy Statement for its 1999 Annual Meeting of Stockholders,
which, when filed pursuant to Regulation 14A under the Securities Exchange Act
of 1934, will be incorporated by reference in this Annual Report on Form 10-K
pursuant to General Instruction G(3) of Form 10-K, provides the information
required under Part III (Items 10, 11, 12 and 13), except for the information
with respect to the Company's executive officers who are not directors, which
is included in "Item 1. Business-Executive Officers of the Registrant."
60
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
Consolidated Financial Statements and Financial Statement Schedules
See "Item 8. Financial Statements and Supplementary Data"
(b) Reports on Form 8-K
During the three month period ended September 30, 1998, the Company
filed a report on Form 8-K with the Securities and Exchange
Commission on July 17, 1998 in connection with the formation of a
joint venture company in the United Kingdom, the licensing of
certain E*TRADE trademarks in Korea, the acquisition of ShareData,
Inc. and the agreement to sell 15,650,000 shares of the Company's
common stock to SOFTBANK CORP.
(c) Exhibits.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 Restated Certificate of Incorporation (Incorporated by reference to
Exhibit 3.3 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
3.2 Restated Bylaws of the Registrant (Incorporated by reference to
Exhibit 3.4 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
3.3 Second Amended and Restated Certificate of Incorporation (Incorporated
by reference to the Company's quarterly report on Form 10-Q for the
period ending March 31, 1998).
4.1 Specimen of Common Stock Certificate (Incorporated by reference to
Exhibit 4.1 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
4.2 Reference is hereby made to Exhibits 3.1 and 3.2.
10.2 Form of Indemnification Agreement entered into between the Registrant
and its directors and certain officers (Incorporated by reference to
Exhibit 10.1 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
10.3 1983 Employee Incentive Stock Option Plan (Incorporated by reference
to Exhibit 10.2 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
10.4 1993 Stock Option Plan (Incorporated by reference to Exhibit 10.3 of
the Company's Registration Statement on Form S-1, Registration
Statement No. 333-05525.)
10.5 1996 Stock Incentive Plan (Incorporated by reference to Exhibit 99.1
of the Company's Registration Statement on Form S-8, Registration
Statement No. 333-12503.)
10.6 401(k) Plan (Incorporated by reference to Exhibit 10.8 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-05525.)
10.7 1996 Stock Purchase Plan (Incorporated by reference to Exhibit 99.13
of the Company's Registration Statement on Form S-8, Registration
Statement No. 333-12503.)
10.8 Employee Bonus Plan (Incorporated by reference to Exhibit 10.10 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-05525.)
10.9 Lease of premises at Four Embarcadero Place, 2400 Geng Road, Palo
Alto, California (Incorporated by reference to Exhibit 10.11 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-05525.)
61
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.10 Lease of premises at 10951 White Rock Road, Rancho Cordova, California
(Incorporated by reference to Exhibit 10.12 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
05525.)
10.11 Employment Agreement dated March 15, 1996, by and between Christos M.
Cotsakos and the Registrant (Incorporated by reference to Exhibit
10.13 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
10.12 Clearing Agreement between E*TRADE Securities, Inc. and Herzog, Heine,
Geduld, Inc. dated May 11, 1994 (Incorporated by reference to Exhibit
10.14 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
10.13 Guarantee by the Registrant to Herzog, Heine, Geduld, Inc.
(Incorporated by reference to Exhibit 10.15 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
05525.)
10.14 BETAHOST Master Subscription Agreement between E*TRADE Securities,
Inc. and BETA Systems Inc. dated June 27, 1996 (Incorporated by
reference to Exhibit 10.13 of the Company's Registration Statement on
Form S-1, Registration Statement No. 333-05525.)
10.15 Stock Purchase Agreement among the Registrant, General Atlantic
Partners II, L.P. and GAP Coinvestment Partners, L.P. dated September
28, 1995 (Incorporated by reference to Exhibit 10.17 of the Company's
Registration Statement on Form S-1, Registration Statement
No. 333-05525.)
10.16 Stock Purchase Agreement among the Registrant, General Atlantic
Partners II, L.P., and GAP Coinvestment Partners, L.P., Richard S.
Braddock and the Cotsakos Group dated April 10, 1996 (Incorporated by
reference to Exhibit 10.18 of the Company's Registration Statement on
Form S-1, Registration Statement No. 333-05525.)
10.17 Stock Purchase Agreement between the Registrant and SOFTBANK Holdings
Inc. dated June 6, 1996 (Incorporated by reference to Exhibit 10.19 of
the Company's Registration Statement on Form S-1, Registration
Statement No. 333-05525.)
10.18 Stockholders Agreement among the Registrant, General Atlantic Partners
II, L.P., GAP Coinvestment Partners, L.P. and the Stockholders named
therein dated September 1995 (the "Stockholders Agreement")
(Incorporated by reference to Exhibit 10.20 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
05525.)
10.19 Supplement No. 1 to Stockholders Agreement dated as of April 10, 1996
(Incorporated by reference to Exhibit 10.21 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
05525.)
10.20 Stockholders Agreement Supplement and Amendment dated as of June 6,
1996 (Incorporated by reference to Exhibit 10.22 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
05525.)
10.21 Consulting Agreement between the Registrant and George Hayter dated as
of June 1996 (Incorporated by reference to Exhibit 10.23 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-05525.)
10.22 License and Service Agreement between the Registrant and VERSUS
Technologies Inc. dated as of January 21, 1997 (Incorporated by
reference to Amendment No. 1 of the Company's Form 8-K filed on July
25, 1997.)
62
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.23 Form of Loan Agreement between Christos M. Cotsakos and the
Registrant. (Incorporated by reference to quarterly report on Form 10-
Q for the quarterly period ended December 31, 1996.)
10.24 Management Continuity Agreement dated as of January 1, 1997 between
the Registrant and Kathy Levinson. (Incorporated by reference to
Exhibit 10.24 of the Company's Registration Statement on Form S-1
filed on July 24, 1997, Registration Statement No. 333-31841).
10.25 Joint Venture Agreement dated June 3, 1998 by and between E*TRADE
Group, Inc. and SOFTBANK CORP. (Incorporated by reference to Exhibit
10.1 of the Company's Form 8-K filed on June 12, 1998).
10.26 Promissory Note dated June 5, 1998 issued by E*TRADE Group, Inc. to
SOFTBANK CORP. (Incorporated by reference to Exhibit 10.2 of the
Company's Form 8-K filed on June 12, 1998).
10.27 Stock Purchase Agreement dated June 5, 1998 by and between E*TRADE
Group, Inc. and SOFTBANK Holdings, Inc. (Incorporated by reference to
Exhibit 10.3 of the Company's Form 8-K filed on June 12, 1998).
10.28 Stock Purchase Agreement dated July 9, 1998 by and between E*TRADE
Group, Inc. and SOFTBANK Holdings, Inc. (Incorporated by reference to
Exhibit 10.1 of the Company's Form 8-K filed on July 17, 1998).
21.1 Subsidiaries of the Registrant (Incorporated by reference to Exhibit
21.1 of the Company's Registration Statement on Form S-1, Registration
Statement No. 333-05525.)
*23.1 Consent of Independent Auditors.
*27.1 Financial Data Schedule for the fiscal year ended September 30, 1998.
- --------
* Filed herewith
63
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
E*TRADE GROUP, INC.
/s/ Christos M. Cotsakos
By: _________________________________
CHRISTOS M. COTSAKOS
PRESIDENT, CHIEF EXECUTIVE OFFICER
AND DIRECTOR
Dated: December 29, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Christos M. Cotsakos President, Chief Executive December 29, 1998
____________________________________ Officer and Director
(CHRISTOS M. COTSAKOS) (principle executive
officer)
/s/ Leonard C. Purkis Chief Financial Officer, December 29, 1998
____________________________________ Executive Vice President,
(LEONARD C. PURKIS) Finance and Administration
Chairman of the Board December 29, 1998
____________________________________
(WILLIAM A. PORTER)
/s/ Richard S. Braddock Director December 29, 1998
____________________________________
(RICHARD S. BRADDOCK)
/s/ William E. Ford Director December 29, 1998
____________________________________
(WILLIAM E. FORD)
/s/ George Hayter Director December 29, 1998
____________________________________
(GEORGE HAYTER)
/s/ Lester C. Thurow Director December 29, 1998
____________________________________
(LESTER C. THUROW)
Director December 29, 1998
____________________________________
(LEWIS E. RANDALL)
/s/ Masayoshi Son Director December 29, 1998
____________________________________
(MASAYOSHI SON)
64