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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-28191
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eSPEED, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 13-4063515
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(State or Other Jurisdiction of Incorporation) (I.R.S. Employer
Identification No.)
299 PARK AVENUE, NEW YORK, NEW YORK 10171
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(Address of Principal Executive Offices) (Zip Code)
(212) 821-3000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
CLASS A COMMON STOCK, $. 01 PAR VALUE
(Title of Class)
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Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
The aggregate market value of voting common equity held by
non-affiliates of the registrant, based upon the closing price of the Class A
common stock on March 15, 2002 as reported on the Nasdaq National Market, was
approximately $308,686,582.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
Class Outstanding at March 15, 2002
- ----- -----------------------------
Class A Common Stock, Par Value $.01 Per Share 28,290,779 Shares
Class B Common Stock, Par Value $.01 Per Share 26,688,814 Shares
DOCUMENTS INCORPORATED BY REFERENCE.
NONE.
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eSPEED, INC.
2001 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS...........................................................1
ITEM 2. PROPERTIES.........................................................29
ITEM 3. LEGAL PROCEEDINGS..................................................29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................31
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS................................................33
ITEM 6. SELECTED FINANCIAL DATA............................................35
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS..........................................36
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.........49
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................50
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE................................74
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................75
ITEM 11. EXECUTIVE COMPENSATION.............................................77
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.........................................................79
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................81
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K........................................................87
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PART I
ITEM 1. BUSINESS
The information in this report contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Such statements are
based upon current expectations that involve risks and uncertainties. Any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. For example, words such as "may,"
"will," "should," "estimates," "predicts," "potential," "continue," "strategy,"
"believes," "anticipates," "plans," "expects," "intends" and similar expressions
are intended to identify forward-looking statements. Our actual results and the
timing of certain events may differ significantly from the results discussed in
the forward-looking statements. Factors that might cause or contribute to such a
discrepancy include, but are not limited to, those discussed elsewhere in this
report in the sections entitled "Risk Factors" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations".
OVERVIEW OF OUR BUSINESS
We are a leading provider of electronic marketplace and related trading
technology solutions and operate multiple buyer, multiple seller real-time
electronic marketplaces. Our suite of marketplace tools provides end-to-end
transaction solutions for the purchase and sale of financial and non-financial
products via the Internet or over our global private network. Our products
enable market participants to transact business instantaneously, more
effectively and at lower cost. In 2001, we processed over 3.5 million electronic
transactions, totaling more than $37 trillion of transactional volume. We have
over 700 clients, including most of the largest fixed income trading firms and
leading natural gas and electricity trading firms in the world. We have offices
in the U.S., Europe and Asia that can transact trading 24 hours a day, around
the world. As a result of the terrorist attacks of September 11, 2001, our
offices in the World Trade Center were destroyed and we lost 180 of our
employees, including many members of our senior management. The loss of these
assets and employees and the need to relocate our surviving employees have
negatively impacted our business. See "Risk Factors".
We believe we offer one of the most robust, large-scale, instantaneous and
reliable transaction processing systems. Our global private network permits
market participants to view information and execute transactions in a fraction
of a second. Our proprietary software provides an end-to-end solution, including
front-end applications, transaction processing engines, credit and risk
management tools and back-office and clearance modules, enabling
straight-through processing.
Our revenues consist primarily of transaction fees and software solution fees.
We do not risk our own capital in transactions or extend credit to market
participants.
Our eSpeed(R) system is accessible to our clients through (1) our proprietary
front-end trading software, (2) our application programming interface (API), a
dedicated software application linking our clients networks to our system, (3)
the Web, via a browser interface or Java application and (4) software developed
in alliances with independent software vendors. Our system runs on large-scale
hardware located in two data centers in the U.S. and Europe and is distributed
either over our multiple path global network or via the Internet through links
to multiple global Internet service providers.
Additionally, we have an agreement whereby the New York Board of Trade, through
its subsidiaries, will provide clearing and regulatory services and we will
provide electronic execution and related services for the U.S. futures exchange,
currently known as the Cantor Exchange(SM), the first fully electronic futures
exchange in the U.S. While we are in the process of evaluating our business plan
with respect to our operation of the Cantor Exchange(SM), we are confident that
our eSpeed(R) system will continue to provide us with major opportunities for
the electronic
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trading of a broad range of futures contracts globally. Currently, the Cantor
Exchange(SM) has obtained regulatory authority to operate in the United Kingdom,
Denmark, Finland, France, Hong Kong, Ireland, Italy, Japan, Norway, Portugal and
in eight German states.
We market our services through the following three basic products: eSpeed
Markets(SM), eSpeed Software Solutions(SM) and eSpeed Online(SM).
o eSpeed Markets(SM) is a full service solution combining all of our
proprietary software and our global high-speed private network. eSpeed
Markets(SM) currently operates in some of the largest and most complex
marketplaces in the world, including the global government bond market and
the energy market, and is designed to be extendible to any multiple buyer,
multiple seller marketplace. eSpeed Markets(SM) is also available through a
complete Internet-only distribution channel.
o eSpeed Software Solutions(SM) provides a complete outsourced solution to
our clients to enable them to distribute their branded products to their
customers through online offerings and auctions, including private and
reverse auctions.
o eSpeed Online(SM) provides retail-based e-commerce businesses with online
access to wholesale market participants. It enables them to offer their
customers access to a variety of markets that are traditionally available
only to institutional investors and wholesalers.
Our objective is to be the world's leading provider of trading technology and
interactive electronic marketplaces for products that trade. We believe that the
scalability and extendibility of our eSpeed(R) suite of products enable us to
introduce new markets and distribute products and services more quickly, cost
effectively and seamlessly than our competitors.
We commenced operations in March 1999 as a division of Cantor Fitzgerald
Securities, a subsidiary of Cantor Fitzgerald, L.P. Our initial focus was the
global fixed income, foreign exchange and futures and options trading markets.
Our relationship with Cantor, a leading global inter-dealer broker in the fixed
income markets, has enabled us to become the leader in this electronic
marketplace. In the last two years, we have significantly expanded the types of
products capable of being traded electronically through our eSpeed(R) system.
Our goal is to offer the full range of financial products currently traded in
today's global markets. In 2000, we entered the North American energy market
with a group of leading energy industry partners. In 2001, we entered the
Canadian fixed income market through our investment in and technology agreement
with Freedom International Brokerage, the leading Canadian inter-dealer broker
of fixed-income products and other capital products, and we entered the German
and United Kingdom energy markets. We plan to reintroduce most of our North
American fixed income products during 2002. We also plan to leverage our
electronic marketplace expertise and reputation to sell software products and
services directly to participants in these marketplaces.
OUR INDUSTRY
Historically, the trading of financial and nonfinancial products has been an
inefficient process. Buying, selling or trading activity is traditionally
effected through either (1) a central physical location, like a trading pit or
auction house, where market participants have to access the market through this
central location or its members, (2) a bilateral arrangement with a buyer or
seller or (3) several layers of middlemen and salespersons who assist in
handling orders. Each of these approaches is people and time intensive, which
adds to the direct and indirect cost of the product bought or sold.
Additional inefficiencies with transaction execution include lack of real-time
price information, small disparate groups of interested buyers and sellers,
limited liquidity and problems associated with executing trades as market
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prices change. As more transactions occur and participants extend credit to each
other, there are added risks to both buyers and sellers because of the lack of
sophisticated risk management tools. Also, after a buy or sell order is
executed, there are the additional tasks of recording, accounting, tracking,
delivering and financially settling the transaction. Each of these tasks, if
done manually, can add potential cost and error to the process as additional
participants or systems enter the transaction cycle.
Electronic marketplaces have emerged as effective means of conducting
transactions. In an electronic marketplace, substantially all of the
participants' actions are facilitated through an electronic medium, such as a
private electronic network or over the Internet, which effectively eliminates
the need for actual face-to-face or voice-to-voice participant interaction,
reducing the inefficiencies inherent in a physical market. Additionally, as
adoption of the Internet has become more widespread, businesses are recognizing
online channels as an efficient means of distribution of their products to their
customers.
Many financial exchanges worldwide, including certain exchanges in France,
Germany, Japan, Sweden, Switzerland and the United Kingdom, are now partially or
completely electronic. Various electronic marketplaces have been implemented to
address the varied needs of the broad business-to-business initiatives,
including marketplaces aimed at the procurement of finished goods or services,
as well as neutral marketplaces for the trading of commodity or commodity-like
goods. We believe the trading of commodity-like products will require
capabilities found in the financial markets, including real-time pricing,
futures and other hedging capabilities and robust interactive trading.
Additionally, we believe companies will seek to outsource online solutions for
the electronic distribution of their products to avoid the difficulty and cost
of developing and maintaining their own online solutions.
OUR SOLUTION
Our electronic marketplace end-to-end solution includes real-time and auction-
based transaction processing, credit and risk management tools and back-end
processing and billing systems, all accessible through our global privately
managed high-speed data network and over the Internet. Because of the scale and
adaptability of our system, our eSpeed(R) products have applications across a
broad range of companies, industries and vertical marketplaces, including any
business-to-business marketplace involving multiple buyers and multiple sellers.
In addition, we license our software to provide a complete outsourced solution
to our clients, enabling them to distribute their branded products to their
customers through online offerings and auctions, including private and reverse
auctions, and request-for-quote capabilities. Our products enable market
participants to transact business instantaneously, more effectively and at lower
cost.
OUR TECHNOLOGY PLATFORM
Our electronic marketplace solutions operate on our technology platform that
emphasizes scalability, performance, adaptability and reliability. Our
technology platform consists of:
o our proprietary, internally developed real-time global network distribution
system;
o our proprietary transaction processing software, which includes interactive
matching auction engines, fully integrated credit and risk management
systems, pricing engines and associated middle and back-office operations
systems;
o client interfaces ranging from Windows, Java, UNIX, our proprietary API and
proprietary vendor access; and
o customized inventory distribution and auction protocols designed to be used
by our clients and partners in their distribution and trading systems.
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Together, these components enable our clients to effect transactions in real-
time, with straight-through processing.
Network distribution system
Our eSpeed(R) system contains a proprietary hub- and-spoke digital network. This
network uses Cisco Systems' network architecture and is operated by
Cisco-certified engineers. Our network's high-speed points of presence comprise
the major business centers of the world, including New York, London, Tokyo,
Milan, Chicago, Los Angeles and Toronto. Altogether, we manage 22 hubs linked
by over 50,000 miles of cable, over 700 Cisco network devices and more than 350
high capacity Sun servers and Compaq Alpha servers located in two data centers
in London and Rochelle Park, New Jersey. The redundant structure of our system
provides multiple backup paths and re-routing of data transmission if one spoke
of a hub fails. We believe we operate one of the largest and most robust
interactive trading network distribution systems currently in operation.
Our distribution system accepts orders and postings instantaneously and
distributes responses, generally in under 300 milliseconds. We estimate that our
network is currently running at approximately 15% of capacity.
In addition to our own network system, we also receive and distribute secure
trading information from clients using the services of multiple, major Internet
service providers throughout the world. These connections enable us to offer our
products and services via the Internet to our global clients.
Transaction processing software
Most of our software applications have been developed internally and are central
to the success of our eSpeed(R) system. Our auction and trading engines operate
in real time, facilitating efficient interaction between buyers and sellers. Our
credit and risk management systems monitor and regulate these buyers and
sellers. Our pricing engines provide prices for illiquid financial products
derived from multiple trades in other related financial instruments. These
critical applications work together seamlessly and are supported by middle and
back office software that verifies, confirms, reports, stores, tracks and, if
applicable, enables the settlement of each transaction. Our transaction
processing software includes verification mechanisms at various stages of the
execution process, which result in significantly reduced manual intervention,
decreased probability of erroneous trades and more accurate execution for
clients.
eSpeed(R) transaction engines
Our auction and transaction engines use Interactive Matching(SM), our
proprietary rules-based method, to process in excess of 150 transactions per
second per auction, instrument or product. These engines were developed to
support trading in the largest capital markets in the world, such as government
bonds and futures contracts, and the more diverse, fragmented and database
intensive markets, such as U.S. municipal bonds (with over 1.7 million different
issues), corporate bonds and Eurobonds. These transaction engines are designed
to be modular and flexible to allow modification in order to apply them to other
markets and auction types. In Europe, for example, we have added a component
that allows us to process transactions and auctions in multiple currencies
simultaneously. Our transaction engines have embedded security features and an
added messaging layer to provide security from unauthorized use. In addition, we
use encryption to protect our clients that transact business over the Internet.
We believe our marketplace expertise and rules-based systems provide incentives
for clients to actively participate in our marketplaces. For example,
Interactive Matching(SM) provides incentives to participate in our marketplaces
by encouraging participants to expose their orders to the market. In standard
auctions, the incentive is for participants to wait until the last moment to
make a bid or offer. Our priority rules encourage trading activity by giving the
last successful active participant a time-based right of first refusal on the
next sale or purchase. In addition, in many
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markets we have structured our pricing policy to provide incentives. The party
that provides auction products for the market or creates liquidity (by inputting
a price to buy or sell) pays less commission (or no commission) than the
participant that consummates the trade by acting on that price. With our pricing
policies and proprietary priority rules, our system is designed to increase
activity and to draw participants into the market. This proprietary rules-based
system is adaptable and, as part of our business strategy, we intend to apply it
across other non-financial markets for multiple products and services.
eSpeed Credit Master(SM) - credit and risk management systems
Our credit and risk management systems have been an important part of the
operation of our electronic marketplaces and were damaged as a result of the
terrorist attacks on September 11, 2001. We plan to re-implement them as soon as
possible. These systems (1) continuously monitor trades of our clients to help
prevent them from exceeding their credit limits, (2) automatically prevent
further trading once a client has reached a pre-determined credit limit and (3)
evaluate transactions and calculate both individual positions and risk exposure
across various products and credit limits. Once re-implemented, our proprietary
credit and risk management systems will also be made available to our global
clients to enable them to monitor the position of their traders and will be
integrated with our software solution systems so our global clients can monitor
the credit of their customers who transact directly with them online. These
systems will store client data relevant to credit and risk management, such as
financial statements, credit documents, contacts and internal analyses. These
systems will also enable our clients to make our electronic marketplaces
available to their customers while maintaining control of their customers'
trading activity and risk.
eSpeed Name Give-Up Matrix(SM) - credit monitoring
Through the use of our name give-up matrix, we enable our market participants to
create counterparty credit exposure limits to manage the counterparties with
which they transact in non-central counterparty markets. In these markets,
participants settle transactions directly with other participants. Using this
module, the participants can pre-select the counterparties that they are willing
to transact with in that market. The module displays all prices to market
participants, and highlights and enables execution on prices that are from
approved counterparties. Additionally, the module has features that permit each
participant to manage the activities of its traders on a real-time basis.
eSpeed(SM) pricing engines and analytics
We have developed a number of analytical software tools that permit us to price
products that trade in less liquid markets and for which current pricing
information is not readily available. For example, our MOLE(SM) system (Multiple
Order Link Engine) is a computer application that enables us to link multiple
markets, offer prices and create and enhance marketplaces for products that have
limited liquidity. In the Financial Vertical, MOLE(SM) currently uses data from
existing cash and futures markets to calculate pricing for transactions where no
market prices currently exist, thereby facilitating liquidity. These
multi-variable trades are extremely difficult to execute in voice-based markets
due to their complexity and the slow speed of manual execution.
eSpeed(SM) middle and back-office applications
Our middle and back-office applications support clearance, settlement, tracking
and reporting of trades and provide links to outside clearing entities. For
example, in the financial markets, we outsource our fulfillment services to
Cantor and Freedom (for Canadian markets), where both parties to a trade send
either cash or securities to Cantor or Freedom and Cantor or Freedom settles
the trade and sends each party the cash or securities due. Our reporting and
accounting systems are designed to track and record all charges and commissions
for a trade. Our eSpeed(R) system and products automate previously paper and
telephone-based transaction processing, confirmation
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and other functions, substantially improving and reducing the cost of many of
our clients' back offices, and enabling straight-through processing.
Client interfaces
Our system can be accessed by our clients in four ways:
o using our eSpeed(R)proprietary front-end trading software;
o using our application programming interface (API) for clients to write
their own software linking their networks and software applications
directly to our systems. Our application programming interface enables
clients to conduct computer price updating, program trading and
straight-through processing;
o through the Web via a browser, or using a downloaded Java application or
dedicated proprietary software application via the Internet, both for
wholesale clients and for retail clients who participate in our
marketplaces; and
o through software developed in alliances with independent software vendors.
ESPEED(R) PRODUCTS
We market our services through the following three products: eSpeed Markets
(SM), eSpeed Software Solutions(SM) and eSpeed Online(SM).
ESPEED MARKETS(SM)
eSpeed Markets(SM) is a full service solution combining all of our proprietary
software and our global high-speed private network. eSpeed Markets(SM) currently
operates in some of the largest and most complex marketplaces, and is designed
to be extendible to any multiple buyer, multiple seller marketplace. eSpeed
Markets(SM) is also available over the Internet. Currently, most of our revenues
are derived from transactions in the global fixed income market powered by our
eSpeed Markets(SM) product.
eSpeed Markets(SM) enables us to operate what we believe is the only integrated
network engaged in electronic trading in multiple products and marketplaces on a
global basis. We believe that the time and expense required to develop and
install electronic trading networks will serve as significant barriers to entry.
FINANCIAL VERTICAL
WHOLESALE FIXED INCOME. The global fixed income market is the largest financial
market in the world. The Bond Market Association estimates that, in the U.S.
alone, as of 2001, there were over $18 trillion of fixed income securities
outstanding with over $520 billion of volume traded daily. In the U.S. Treasury
securities market, there is reported to be over $290 billion a day in trading
just among the primary dealers and their clients. The global market for interest
rate swaps, interest rate options and currency swaps had over $60 trillion in
notional value outstanding as of June 2000.
Foreign exchange. The trading of currencies in all monetary pairs represents the
largest trading volume market in the world. The Bank for International
Settlements has estimated the daily volume traded in the foreign exchange
markets to have been $1.97 trillion.
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Futures and options. Futures and options trading is a leading financial activity
throughout the world, with contracts traded on a wide variety of financial
instruments, commodities and indexes. According to the Futures Industry
Association, Inc., in 2001, over 3.1 billion futures and options contracts were
traded in the world's futures and options markets. Currently, a significant
volume of futures trading is still being done on open outcry exchanges, but
there has been a significant movement towards the conversion of these markets to
electronic trading. To date, we believe the most successful initiatives have
been made in Europe. We believe that there is significant opportunity in the
continued conversion of these markets to electronic networks, such as our own.
Limitations of the traditional financial market
While the traditional financial market facilitates trading, it has the following
significant shortcomings:
o limited direct access and, therefore, inefficient pricing;
o high transaction costs and slow execution due to the number of people
involved in a voice transaction;
o difficulty in implementing program trading, especially programs designed to
automatically and simultaneously execute multiple trades in different, but
related products;
o significant expense incurred in processing, confirming and clearing manual
processes; and
o compliance and regulatory risk associated with voice transactions and non-
automated audit trails.
Our Financial Vertical solution
The Financial Vertical contains U.S. Treasury and agency securities, European,
Japanese, Canadian and emerging market sovereign bonds, U.S. and global
corporate bonds, mortgage-backed securities, municipal bonds, interest rate
swaps and options, futures, options, repos and basis trades. Cantor has been a
major facilitator and, in some cases, provider of liquidity in numerous
financial products through its offices in the U.S., Canada, Europe and Asia. Our
eSpeed Markets(SM) product provides the only way to electronically access
Cantor's marketplaces. Through our alliance with Freedom, Cantor and six leading
Canadian financial institutions, our eSpeed Markets(SM) product also powers the
electronic platform of Freedom International Brokerage, the leading inter-dealer
broker of Canadian fixed income and other capital markets products.
Our private electronic network for wholesale financial markets is connected to
most of the largest financial institutions worldwide. We have installed in the
offices of our existing client base the technology infrastructure necessary to
provide price information and trade execution on an instantaneous basis in a
broad range of securities and financial instruments. We believe our eSpeed(R)
suite of products enables us to introduce and distribute a broad mix of
financial products and services quickly, efficiently and at lower cost.
In our electronic marketplaces, participants may either electronically execute
trades themselves or call brokers, who then input trade orders into the market
for them. In our fully electronic trades, all stages of the trade occur
electronically. The participant inputs its buy or sell order instructions
directly into our electronic trading system using our software, a web-browser,
or electronically through an application programming interface or other
software. Our system provides to the participant, normally within 300
milliseconds, an on-screen confirmation that the participant's order has been
accepted. Simultaneously, an electronic confirmation can be sent to the
participant's back office and risk system, enabling risk management capabilities
and straight-through processing for the participant. A broker assisted trade is
executed in substantially the same manner as an electronic trade, except that
the participant telephones a broker, who then inputs the participant's order
into our electronic marketplace system. Our U.S. Government Securities
marketplace is now a fully electronic marketplace.
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We also see opportunities to expand our business by licensing our technology to
other voice brokers in addition to Cantor.
ENERGY VERTICAL
In September 2000, we, together with Coral Energy Holding (an affiliate of
Shell), Dominion Energy, Dynegy, Koch Energy Trading, TXU Energy Trading,
Williams Energy Marketing & Trading and Cantor, announced the formation of
TradeSpark, a new comprehensive energy marketplace. TradeSpark was created as a
wholesale marketplace for energy-related products and services in North America
with both electronic trading systems and voice brokers. As part of our
arrangement with TradeSpark, we have implemented electronic marketplaces for
natural gas, electricity, coal, weather derivatives and emission allowances. It
is the intention of TradeSpark to provide the full spectrum of energy-related
tradable instruments, including cash, spot, forward, futures, indices and data
sales.
TradeSpark unites our technology platform, accessed over both a private global
network and the Internet, and our partners' in-depth energy market knowledge and
liquidity to bring speed, neutrality, efficiency and technological leadership to
the energy trading market. In 2001, Dynegy became a partner in TradeSpark and,
in conjunction with this expanded relationship, Dynegy established an underlying
electronic link between its proprietary e-commerce portal, Dynegydirect, and the
TradeSpark platform.
Since inception, over 200 companies, including most of the major energy trading
firms in North America, have traded using TradeSpark. We effected over 75,000
transactions comprising approximately $150 billion of transaction volume since
TradeSpark's inception. Gas Daily reports that the TradeSpark partners, together
with Entergy, traded approximately 32.8 billion cubic feet of natural gas per
day, and Power Markets Week reports that these companies traded 403 million
megawatt hours of electricity during 2000. These companies estimate they traded
roughly 20% of all gas and power traded in North America during the last quarter
of 2000.
Limitations affecting the traditional energy market
The traditional voice-brokered energy marketplace has been fraught with
inefficiencies, including the lack of real-time price information, small pools
of liquidity, high transaction costs and problems associated with executing
trades in a fast moving market. More recently, credit has become a major issue
to the market participants because of massive price fluctuations caused by
various states' approaches to deregulation, the lack of a liquid hedging market,
limited risk management tools and the bankruptcy of certain major industry
participants. While there have been a handful of electronic systems and single
dealer platforms initiated over the past three years, we believe that none have
unbiased information about prices and enough products or liquidity to give
companies exchange-like execution in the energy marketplace.
Our Energy Vertical solution
Powered by our full trading platform encompassed in eSpeed Markets(SM),
TradeSpark offers an end-to-end marketplace and trading solution that includes
real-time and auction-based transaction processing, risk management tools and
back-end processing systems, as well as access to a fully registered futures
exchange, allowing for the creation of futures and options products for this
marketplace.
Designed to bring marketplace efficiency to the energy markets, TradeSpark is
fully operational and, as of December 31, 2001, employed 39 brokerage personnel
with access to our electronic trading platform. TradeSpark offers three possible
points of access to one pool of liquidity: over the Internet, through our
private network and through TradeSpark voice brokers.
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ESPEED SOFTWARE SOLUTIONS(SM)
eSpeed Software Solutions(SM) provides a complete outsourced solution to our
clients, enabling them to distribute their branded products to their customers
through online offerings and auctions, including private and reverse auctions,
and request-for-quote capabilities. Our eSpeed Software Solutions(SM) product
takes advantage of the scalability, flexibility and functionality of our
eSpeed(R) system to allow our clients to quickly create online connectivity to
their customers.
We have signed software solution agreements with Refco Securities, Sanwa
Securities and the Federal Home Loan Bank. Refco Securities operates a global
securities futures brokerage business. eSpeed Software Solutions(SM) has
developed a front end trading system for Refco Securities that enables it to
communicate its prices for securities products to its customers. Sanwa
Securities is the securities subsidiary of Sanwa Bank, one of the largest
financial institutions in Japan. Sanwa transacts with its customers through our
real-time technology platform to supplement its Japanese government bond
business. The Federal Home Loan Bank is a U.S. Government sponsored enterprise
and one of the largest issuers in the global short-term securities market. Our
electronic auction-based technology is expected to begin powering the Federal
Home Loan Bank's primary discount note auctions in 2002.
ESPEED ONLINE(SM)
eSpeed Online(SM) provides retail-based e-commerce businesses with online access
to wholesale market participants. It enables these online businesses to offer
their customers access to a variety of markets that are traditionally available
only to institutional investors and wholesalers. eSpeed Online(SM) also links to
middle and back-office systems, providing a complete end-to-end retail solution
for trade execution, risk management, processing and billing. To date, we have
signed agreements with several online brokers, including AB Watley,
Bondpage.com, Charles Schwab, Firstrade Securities, MostActives.com, Mr. Stock,
Muriel Siebert, myTrack, Scot Trade, Sutton Online, The Net Investor, Tradescape
and WebStreet Securities. In January 2001, Charles Schwab & Co. introduced U.S.
Treasuries to its customer base through eSpeed Online(SM).
Technological advances have created new and inexpensive means for individual
investors to directly access markets online and participate in the securities
markets. Despite the growth in online accounts and access to public equity
markets, there has been very limited access for retail Internet trading in fixed
income securities, futures, options and other wholesale financial instruments at
cost-effective pricing and spreads. We believe that the emergence of electronic
marketplaces that promote greater liquidity, enhanced access and more efficient
pricing will increase trading among retail investors in financial and other
products other than equities. We believe that companies will increasingly seek
an outsourced solution to distribute their products electronically.
OUR GROWTH STRATEGY
Our objective is to be the world's leading provider of interactive electronic
marketplaces and related software solutions to a broad range of industries and
vertical marketplaces. We believe we can extend our expertise in the creation of
instantaneous electronic marketplaces to a broad range of products and services.
Our growth strategy to achieve this objective includes the following key
elements:
EXPAND SYSTEM FUNCTIONALITY AND DEVELOP NEW PRODUCTS, SOFTWARE AND SERVICES FOR
OUR EXISTING FINANCIAL AND ENERGY MARKETS
We plan to continue to expand the types of financial, energy and other products
traded in our marketplaces both in the United States and abroad. We also plan to
reintroduce most of our North American fixed income products during 2002. Our
goal is to include in our electronic marketplaces the full range of products
that are currently
9
traded in today's markets worldwide. In addition, we plan to develop software
and services to add new methods to effect transactions in these products. We
expect that our traditional client base will begin to trade new products as we
develop electronic marketplaces for them, and we intend to continue to convert
our existing global clients to our fully electronic platform.
LEVERAGE OUR ESPEED(R)SYSTEM FOR USE IN A WIDE RANGE OF ADDITIONAL
BUSINESS-TO-BUSINESS MARKETS AND INDUSTRIES
Because of the scale of our system and its ease of adaptability, we believe our
eSpeed(R) system has applications across a broad range of products, including
Internet-based marketplaces for a wide array of goods and services, particularly
those involving multiple buyers and sellers. As evidenced by the formation of
TradeSpark, we are well positioned to leverage the significant costs and efforts
that have been incurred developing our eSpeed(R) system to quickly create
electronic markets in a wide range of products. We plan, over time, to serve
additional marketplaces, including global energy, bandwidth, telecommunications,
chemicals, electronic components, metals and other markets that can benefit from
more efficient, centralized, electronic trading facilities. We plan to continue
to expand our eSpeed(R) system across the financial markets and their products.
LICENSE OUR SOFTWARE TO PROVIDE A BROAD RANGE OF MARKET PARTICIPANTS WITH AN
OUTSOURCED SOLUTION FOR ONLINE DISTRIBUTION OF THEIR PRODUCTS
We provide a complete outsourced solution to our clients to enable them to
distribute their branded products to their customers through online offerings,
auctions, including private and reverse auctions, and request-for-quote
capabilities. We are rebuilding our dedicated sales force that will focus on
licensing our software solutions to existing and new clients.
PURSUE STRATEGIC ALLIANCES AND ACQUISITIONS
We are continually exploring opportunities to maximize our growth, including
acquisitions, strategic alliances, joint ventures, private placements,
recapitalizations or any combination of the foregoing, to expand our vertical
markets and generate future growth. We are seeking to enter into joint ventures
and other strategic alliances to create liquidity in new and existing product
markets, to utilize our patents in such ventures and strategic alliances and to
attract new participants to trade products in those markets. We have employed
this strategy in our formation of TradeSpark and our alliance with Freedom, as
well as in our market making relationship with Deutsche Bank.
OUR CLIENTS
Our clients in the Financial Vertical include banks, dealers, brokers and other
wholesale market participants, over 500 of which currently participate in our
electronic marketplaces, including most of the largest bond trading firms in the
world, as identified by Euromoney Magazine. Our clients in the Energy Vertical
include energy trading companies, utilities and other wholesale market
participants, over 200 of which currently participate in our electronic
marketplace, including leading North American energy trading companies.
We are providing wholesale and retail investors access to the electronic
marketplaces and brokerage-related services supported by our eSpeed(R) system.
We expect that a significant portion of our clients who use brokers will migrate
to fully electronic access over the coming years. We also expect to add clients
for our eSpeed Software Solutions(SM) product from a wide variety of industries.
In addition, due to the loss of virtually all of Cantor's U.S. non-equity voice
brokerage business in connection with the terrorist attacks of September 11,
2001, we intend to build relationships with new clients, including traditional
competitors of Cantor. We further intend to provide third parties with the
infrastructure, including systems administration, internal network support and
operations and disaster recovery
10
services, that is critical to providing fully electronic marketplaces in a wide
variety of products. Other than Cantor, no client of ours accounts for more than
10% of our revenues.
SALES, MARKETING AND CORPORATE DEVELOPMENT
We promote our electronic marketplaces and services to our existing and
prospective clients through a combination of sales, marketing and co-marketing
campaigns. We leverage our client relationships through a variety of direct
marketing and sales initiatives and build and enhance our brand image through
marketing campaigns targeted at a diverse audience, including traders, potential
partners and the investor and press communities. We may market to our existing
and prospective retail clients through a variety of co-marketing/co-branding
initiatives with our online partners. We have designed our sales and marketing
efforts to promote brand awareness and educate our audience regarding the nature
of our electronic marketplaces, products and services and the advantages
associated with the automation of trading activities, as well as our association
with Cantor.
Additionally, our senior management staff actively works to establish strategic
relationships, develop new markets for our technology and structure and execute
investments and acquisitions. Our staff promotes eSpeed at conferences,
conventions, events and speaking engagements that advance both our technology
and our brand name. In many cases, these engagements are focused within specific
vertical markets that we intend to develop in the future. All of these efforts
are intended to enhance our image, profile and profitability.
SOFTWARE DEVELOPMENT
We devote substantial efforts to the development and improvement of our
electronic marketplaces and licensed software products. We work with our clients
to identify their specific requirements and make modifications to our software,
network distribution systems and technologies that are responsive to those
needs. Our research and development efforts focus on internal development,
strategic partnering, acquisitions and licensing. Although we lost many
technology professionals and software developers on September 11, 2001, we
continue to employ over 250 technology professionals, a majority of which are
software developers. Our technology team's objective is to develop new products
and services in order to provide superior electronic marketplace solutions to
our clients. We also focus our efforts on enhancing our Internet interfaces to
facilitate real-time markets and comply with the standard Internet security
protocol and future security protocols in order to capitalize on the development
of new commercial marketplaces. We are continuing to develop new marketplaces
and products using our internally developed application software. In addition,
we have forged strategic alliances with third-party independent software vendors
through which we will work to develop sophisticated, industry specific,
front-end applications and products.
COMPETITION
The development and operation of electronic marketplaces are evolving. As a
result, competition in these marketplaces is currently fragmented. We expect to
face competition from a number of different sources varying in size, business
objectives and strategy.
Our current and prospective competitors are numerous and include inter-dealer
brokerage firms, market data and information vendors, securities and futures
exchanges, electronic communications networks, crossing systems, consortia,
business-to-business marketplace infrastructure and software companies and niche
energy market and other commodity business-to-business Internet-based trading
systems.
The electronic marketplace solutions we provide to our clients enable them to
expand the range of services they provide to their ultimate customers, which are
also potential participants in our electronic marketplaces. We intend to
structure our relationships with our clients and conduct our operations to
mitigate the potential for this
11
competition. We do not intend to use the access to the customer base of our
clients that we obtain in providing our electronic marketplace solutions to
compete with these clients in other product transactions.
We believe our electronic marketplaces compete primarily on the basis of speed,
functionality, efficiency, price, system stability and ability to provide market
participants with access to liquidity.
OUR INTELLECTUAL PROPERTY
We have adopted a comprehensive intellectual property program to protect our
proprietary technology. We currently have licenses covering four of Cantor's
patents in the U.S. One patent relates to a data processing system and method
for electronically trading select items such as fixed income instruments. Two
patents relate to a fixed income portfolio index processor. One patent relates
to a system for shared remote access of multiple application programs by one or
more computers. Foreign counterpart applications for some of these U.S. patents
have been filed. The licenses are exclusive, except in the event that we do not
seek to or are unable to provide to Cantor any requested services covered by the
patents and Cantor elects not to require us to do so.
In April 2001, we purchased the Wagner patent, which addresses automated futures
trading and provides for bids and offers to be placed and matched
electronically. In August 2001, we received a preliminary ruling from the United
States District Court in Dallas, Texas upholding our position regarding the
scope of the Wagner patent. See "Item 3. Legal Proceedings".
In July 2001, we purchased a patent, the Lawrence patent, which relates to the
electronic trading of municipal bonds and electronic auctions of fixed income
securities and interest rate products. Auction based trading allows
broker-dealers and their customers to send our "bid-wanted" forms listing the
available securities, then to accept bids with a final auction time. The
Lawrence patent brings additional efficiencies to the auctioned markets by,
among other things, enabling potential buyers to electronically place bids
securely and anonymously.
We also have an agreement to license several pending U.S. patent applications
relating to various other aspects of our electronic trading systems, including
both functional and design aspects. We have filed a number of patent
applications to further protect our proprietary technology and innovations in
the past year.
We cannot at this time determine the significance of any of the foregoing
patents, or future patents, if issued, to our business. We can give no assurance
that any of the foregoing patents is valid and enforceable, or that any of these
patents would not be infringed by a third party competing or seeking to compete
with our business. Our business strategy may include licensing such patents for
royalties, joint venturing with other marketplaces or exchanges, or exclusively
using the patents in our marketplaces.
EMPLOYEES
As of December 31, 2001, we had 312 employees, four of whom are our executive
officers. None of these employees is represented by a union. We believe that we
have good relations with our employees.
12
RISK FACTORS
In addition to the other information in this Report, the following risk factors
should be considered carefully in evaluating us and our business.
RISKS RELATED TO OUR BUSINESS
THE EVENTS OF SEPTEMBER 11, 2001 HAVE HAD AND WILL CONTINUE TO HAVE AN ADVERSE
EFFECT ON OUR BUSINESS.
Our losses
Our previous headquarters were in the World Trade Center. As a result of the
terrorist attacks of September 11, 2001 (the September 11 Events), our offices
in the World Trade Center were destroyed and we lost approximately 180 of our
employees, including many members of our senior management. The destruction of
our assets, the loss of all those employees, including product development
personnel, and the need to relocate the surviving employees has negatively
impacted our business. In addition, although we still have redundancy of our
system, we now have two data centers instead of the three that we had prior to
the September 11 Events.
Cantor's losses
Cantor and TradeSpark lost an aggregate of 478 employees and equipment and
systems as a result of the September 11 Events. Cantor also lost its
headquarters. Such losses have negatively impacted our revenues and will
continue to adversely impact our revenues in the future since, among other
things, Cantor is not currently trading many of the financial products its voice
brokers historically traded using our eSpeed(R) system. In addition, the loss of
Cantor's assets and brokers will negatively affect our strategy to convert the
products that those brokers were trading in voice-assisted transactions to
products that are traded fully electronically over our eSpeed(R) system.
Insurance
As a result of the September 11 Events, fixed assets with a book value of
$17,690,289 were destroyed. As of December 31, 2001, we had received $20.5
million of insurance proceeds to cover the net book value of the fixed assets
that were destroyed, plus the actual additional cost of the assets we replaced.
Although we expect to recover any further costs we incur if we decide to replace
any additional destroyed fixed assets through our property and casualty
insurance coverage of $40 million, we cannot guarantee or currently estimate the
amount or timing of such recovery. In addition, we have incurred and will
continue to incur business interruption losses due to the September 11 Events.
Although we expect to recover or reduce these losses through our $25 million of
business interruption insurance, we cannot guarantee or currently estimate the
amount or timing of receipt of any such insurance proceeds.
WE MAY INCUR LOSSES IN THE FUTURE.
From our inception through December 31, 2001, we have sustained a cumulative net
loss of approximately $91.3 million. While we currently expect to generate
operating profits in the year 2002, as we continue to develop our systems and
infrastructure and expand our brand recognition and client base through
increased marketing efforts, we may actually incur additional losses.
IF WE DO NOT EXPAND THE USE OF OUR ELECTRONIC SYSTEMS, OR IF OUR CLIENTS DO NOT
USE OUR MARKETPLACES OR SERVICES, OUR REVENUES AND PROFITABILITY WILL BE
ADVERSELY AFFECTED.
The use of electronic marketplaces is relatively new. The success of our
business plan depends, in part, on our ability to maintain and expand the
network of trading firms, dealers, banks and other financial institutions that
use
13
our interactive electronic marketplaces. We cannot assure you that we will be
able to continue to expand our marketplaces, or that we will be able to retain
the current participants in our marketplaces. Although some of our agreements
with market participants require certain minimum payments, none of our
agreements with market participants require them to use our electronic
marketplaces.
IF WE ARE UNABLE TO ENTER INTO ADDITIONAL MARKETING AND STRATEGIC ALLIANCES OR
OUR CURRENT STRATEGIC ALLIANCES ARE NOT SUCCESSFUL, WE MAY NOT GENERATE
INCREASED TRADING IN OUR ELECTRONIC MARKETPLACES.
We expect to continue to enter into strategic alliances with other market
participants, such as retail brokers, exchanges, energy companies, market
makers, consortia, clearinghouses, major market participants and technology
companies, in order to increase client access to and use of our electronic
marketplaces. We cannot assure you that we will be able to continue to enter
into these strategic alliances on terms that are favorable to us, or at all. In
addition, we cannot assure you that our current strategic alliances will be
successful. The success of our current and future relationships will depend on
the amount of increased trading in our electronic marketplaces and the liquidity
generated therein. These arrangements may not generate the expected number of
new clients or increased trading volume we are seeking.
TO INCREASE AWARENESS OF OUR ELECTRONIC MARKETPLACES, WE MAY NEED TO INCUR
SIGNIFICANT MARKETING EXPENSES.
To successfully execute our business plan, we must build awareness and
understanding of our electronic marketplace services, software products, brand
and the adaptability of our electronic marketplaces for non-financial vertical
markets. In order to build this awareness, our marketing efforts must succeed
and we must provide high quality services. These efforts may require us to incur
significant expenses. We cannot assure you that our marketing efforts will be
successful or that the allocation of funds to these marketing efforts will be
the most effective use of those funds.
IF WE EXPERIENCE COMPUTER SYSTEMS FAILURES OR CAPACITY CONSTRAINTS, OUR ABILITY
TO CONDUCT OUR OPERATIONS COULD BE HARMED.
We internally support and maintain many of our computer systems and networks.
Our failure to monitor or maintain these systems and networks or, if necessary,
to find a replacement for this technology in a timely and cost-effective manner
would have a material adverse effect on our ability to conduct our operations.
We also rely and expect to rely on third parties for various computer and
communications systems, such as telephone companies, online service providers,
data processors, clearance organizations and software and hardware vendors. Our
systems, or those of our third-party providers, may fail or operate slowly,
causing one or more of the following:
o unanticipated disruptions in service to our clients;
o slower response times;
o delays in our clients' trade execution;
o failed settlement of trades;
o incomplete or inaccurate accounting, recording or processing of trades;
o financial losses;
14
o litigation or other client claims; and
o regulatory sanctions.
We experienced systems and telecommunications failures in connection with the
terrorist attacks of September 11, 2001. We cannot assure you that we will not
experience additional systems failures in the future from power or
telecommunications failure, acts of God or war, terrorist attacks, human error,
natural disasters, fire, power loss, sabotage, hardware or software malfunctions
or defects, computer viruses, intentional acts of vandalism and similar events.
Any system failure that causes an interruption in service or decreases the
responsiveness of our service, including failures caused by client error or
misuse of our systems, could damage our reputation, business and brand name.
IF WE DO NOT EFFECTIVELY MANAGE OUR GROWTH, OUR EXISTING PERSONNEL AND SYSTEMS
MAY BE STRAINED AND OUR BUSINESS MAY NOT OPERATE EFFICIENTLY.
In order to execute our business plan, we must grow significantly. This growth
will place significant strain on our personnel, management systems and
resources. We expect that the number of our employees, including technical and
management-level employees, will increase for the foreseeable future. We must
continue to improve our operational and financial systems and managerial
controls and procedures, and we will need to continue to expand, train and
manage our technical workforce. We must also maintain close coordination among
our technical, compliance, accounting, finance, marketing and sales
organizations. We cannot assure you that we will manage our growth effectively,
and failure to do so could result in our business operating inefficiently.
WE OPERATE IN A RAPIDLY EVOLVING BUSINESS ENVIRONMENT. IF WE ARE UNABLE TO ADAPT
OUR BUSINESS EFFECTIVELY TO KEEP PACE WITH THESE CHANGES, OUR OPERATIONS WILL BE
ADVERSELY AFFECTED.
The pace of change in our market is extremely rapid. Operating in such a
rapidly-changing business environment involves a high degree of risk. Our
success will depend on our ability to adapt effectively to these changing market
conditions.
IF WE ARE UNABLE TO KEEP UP WITH RAPID TECHNOLOGICAL CHANGES, WE MAY NOT BE ABLE
TO COMPETE EFFECTIVELY.
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality, accessibility and features of our proprietary
software, network distribution systems and technologies. The financial services
and e-commerce industries are characterized by rapid technological changes,
changes in use and client requirements and preferences, frequent product and
service introductions embodying new technologies and the emergence of new
industry standards and practices that could render our existing proprietary
technology and systems obsolete. Our success will depend, in part, on our
ability to:
o develop and license leading technologies useful in our business;
o enhance our existing services;
o develop new services and technologies that address the increasingly
sophisticated and varied needs of our existing and prospective clients; and
o respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis.
15
The development of proprietary electronic trading technology entails significant
technical, financial and business risks. Further, the adoption of new Internet,
networking or telecommunications technologies may require us to devote
substantial resources to modify and adapt our services. We cannot assure you
that we will successfully implement new technologies or adapt our proprietary
technology and transaction-processing systems to client requirements or emerging
industry standards. We cannot assure you that we will be able to respond in a
timely manner to changing market conditions or client requirements.
IF WE WERE TO LOSE THE SERVICES OF MEMBERS OF MANAGEMENT AND EMPLOYEES WHO
POSSESS SPECIALIZED MARKET KNOWLEDGE AND TECHNOLOGY SKILLS, WE MAY NOT BE ABLE
TO MANAGE OUR OPERATIONS EFFECTIVELY OR DEVELOP NEW ELECTRONIC MARKETPLACES.
Our future success depends, in significant part, on the continued service of
Howard Lutnick, our Chairman, Chief Executive Officer and President, and our
other executive officers and managers and sales and technical personnel who
possess extensive knowledge and technology skills in our markets. We cannot
assure you that we would be able to find an appropriate replacement for Mr.
Lutnick if the need should arise. Any loss or interruption of Mr. Lutnick's
services could result in our inability to manage our operations effectively
and/or develop new electronic marketplaces. We have not entered into employment
agreements with any of our executive officers or other personnel, and while we
intend to acquire reasonable amounts of "key person" life insurance, we do not
as of yet have "key person" life insurance policies on any of our executive
officers or personnel. All of the members of our senior management team are also
officers, partners or key employees of Cantor. As a result, they dedicate only a
portion of their professional efforts to our business and operations. We cannot
assure you that the time these persons devote to our business and operations in
the future will be adequate and that we will not experience an adverse effect on
our operations due to the demands placed on our management team by their other
professional obligations. We intend to strive to provide high quality services
that will allow us to establish and maintain long-term relationships with our
clients. Our ability to do so will depend, in large part, upon the individual
employees who represent us in our dealings with clients. The market for
qualified programmers, technicians and sales persons is extremely competitive
and has grown more so in recent periods as electronic commerce has experienced
growth. We cannot assure you that we will be successful in our efforts to
recruit and retain the required personnel.
IF CANTOR OR WE ARE UNABLE TO PROTECT THE INTELLECTUAL PROPERTY RIGHTS WE
LICENSE FROM CANTOR OR OWN, OUR ABILITY TO OPERATE ELECTRONIC MARKETPLACES MAY
BE MATERIALLY ADVERSELY AFFECTED.
Our business is dependent on proprietary technology and other intellectual
property rights. We license most of our patented technology from Cantor. The
license arrangement is exclusive, except in the event that (1) we are unwilling
to provide to Cantor any requested services covered by the patents with respect
to a marketplace and Cantor elects not to require us to do so, or we are unable
to provide such services or (2) we do not exercise our right of first refusal to
provide to Cantor electronic brokerage services with respect to a marketplace,
in which case Cantor retains a limited right to use the patents and patent
applications solely in connection with the operation of that marketplace. We
cannot guarantee that the concepts which are the subject of the patents and
patent applications covered by the license from Cantor or that we own are
patentable or that issued patents are or will be valid and enforceable. Where
patents are granted in the U.S., we can give no assurance that equivalent
patents will be granted in Europe or elsewhere, as a result of differences in
local laws affecting patentability and validity. Moreover, we cannot guarantee
that Cantor's issued patents or our issued patents are valid and enforceable, or
that third parties competing or intending to compete with us will not infringe
any of these patents. Despite precautions we or Cantor has taken or may take to
protect our intellectual property rights, it is possible that third parties may
copy or otherwise obtain and use our proprietary technology without
authorization. It is also possible that third parties may independently develop
technologies similar to ours. It may be difficult for us to monitor unauthorized
use of our proprietary technology and intellectual property rights. We cannot
assure you that the steps we have taken will prevent misappropriation of our
technology or intellectual property rights.
16
We use our eSpeed(R) registered service mark for the services described herein
and have registered that service mark in a number of jurisdictions around the
world. Although several existing third-party registrations and applications for
trademarks and servicemarks consisting of designations similar to ours in
certain countries have come to light, they are for goods and services that are
of a different type from those being offered under our eSpeed(R) registered
service mark. Although we are not presently aware of any third-party objections
to our use or registration of our eSpeed(R) registered service mark in these
countries, and believe we could defend against any third-party claims asserted
in these countries, such registrations and applications could potentially affect
the registration, and/or limit our use, of our eSpeed(R) registered service mark
in these countries, thereby requiring us to adopt and use another service mark
for our services in such countries.
IF IT BECOMES NECESSARY TO PROTECT OR DEFEND OUR INTELLECTUAL PROPERTY RIGHTS,
WE MAY HAVE TO RESORT TO COSTLY LITIGATION.
We may have to resort to litigation to enforce our intellectual property rights,
protect our trade secrets, determine the validity and scope of the proprietary
rights of others or defend ourselves from claims of infringement, invalidity or
unenforceability. We may incur substantial costs and diversion of resources as a
result of litigation, even if we win. In the event we do not win, we may have to
enter into royalty or licensing agreements. We cannot assure you that an
agreement would be available to us on reasonable terms, if at all.
IF OUR SOFTWARE LICENSES FROM THIRD PARTIES ARE TERMINATED, OUR ABILITY TO
OPERATE OUR BUSINESS MAY BE MATERIALLY ADVERSELY AFFECTED.
We license software from third parties, such as database software, much of which
is integral to our systems and our business. The licenses are terminable if we
breach our obligations under the license agreements. If any of these
relationships were terminated or if any of these third parties were to cease
doing business, we may be forced to spend significant time and money to replace
the licensed software. However, we cannot assure you that the necessary
replacements will be available on reasonable terms, if at all.
IF THE STRENGTH OF OUR DOMAIN NAMES IS DILUTED, THE VALUE OF OUR PROPRIETARY
RIGHTS MAY DECREASE.
We own many Internet domain names, including "www.espeed.com." The regulation of
domain names in the U.S. and in foreign countries may change and the strength of
our names could be diluted. We may not be able to prevent third parties from
acquiring domain names that infringe or otherwise decrease the value of our
trademarks and other proprietary rights.
IF WE INFRINGE ON PATENT RIGHTS OR COPYRIGHTS OF OTHERS, WE COULD BECOME
INVOLVED IN COSTLY LITIGATION.
Patents or copyrights of third parties may have an important bearing on our
ability to offer certain of our products and services. We cannot assure you that
we are or will be aware of all patents or copyrights containing claims that may
pose a risk of infringement by our products and services. In addition, patent
applications in the U.S. are generally confidential until a patent is issued. As
a result, we cannot evaluate the extent to which our products and services may
be covered or asserted to be covered by claims contained in pending patent
applications. In general, if one or more of our products or services were to
infringe patents held by others, we may be required to stop developing or
marketing the products or services, to obtain licenses to develop and market the
services from the holders of the patents or to redesign the products or services
in such a way as to avoid infringing on the patent claims, which could limit the
manner in which we conduct our operations.
17
DUE TO INTENSE COMPETITION, OUR MARKET SHARE AND FINANCIAL PERFORMANCE COULD
SUFFER.
The electronic trading and Internet-based financial and non-financial services
markets are highly competitive and many of our competitors are more established
and have greater financial resources than us. We expect that competition will
intensify in the future. Many of our competitors also have greater market
presence, engineering and marketing capabilities and technological and personnel
resources than we do. As a result, as compared to us, our competitors may:
o develop and expand their network infrastructures and service offerings more
efficiently or more quickly;
o adapt more swiftly to new or emerging technologies and changes in client
requirements;
o take advantage of acquisitions and other opportunities more effectively;
o devote greater resources to the marketing and sale of their products and
services; and
o leverage existing relationships with clients and strategic partners more
effectively or exploit more recognized brand names to market and sell their
services.
Our current and prospective competitors are numerous and include interdealer
brokerage firms, technology companies and market data and information vendors,
securities and futures exchanges, electronic communications networks, crossing
systems, software companies, consortia, business-to-business marketplace
infrastructure companies and niche market energy and other commodity business-
to-business Internet-based trading systems.
We believe that we may also face competition from large computer software
companies, media and technology companies and some securities brokerage firms
that are currently our clients.
The number of businesses providing Internet-based financial and non-financial
services is rapidly growing, and other companies, in addition to those named
above, have entered into or are forming joint ventures or consortia to provide
services similar to those provided by us. Others may acquire the capabilities
necessary to compete with us through acquisitions.
In the event we extend the application of our Interactive Matching(SM)
technology to conducting or facilitating auctions of consumer goods and services
over the Internet, we expect to compete with both online and traditional sellers
of these products and services. The market for selling products and services
over the Internet is new, rapidly evolving and intensely competitive. Current
and new competitors can launch new sites at a relatively low cost. We expect we
will potentially compete with a variety of companies with respect to each
product or service we offer. We may face competition from a number of other
large Internet companies that have expertise in developing online commerce and
in facilitating Internet traffic, which could choose to compete with us either
directly or indirectly through affiliations with other e-commerce companies. We
cannot assure you that we will be able to compete effectively with such
companies.
BECAUSE SOME OF OUR CLIENTS HAVE INVESTED IN CONSORTIA THAT HAVE DEVELOPED
ELECTRONIC TRADING NETWORKS, WE COMPETE WITH THEM IN CERTAIN ASPECTS OF OUR
BUSINESS.
Consortia owned by some of our clients have developed electronic trading
networks. Such consortia compete with us and our electronic marketplaces in some
areas of our business and may compete with us in other areas in the future.
18
IF WE EXPERIENCE LOW TRADING VOLUME IN PRODUCTS, OUR PROFITABILITY COULD SUFFER.
We have experienced significant fluctuations in the aggregate trading volume of
products being traded in our marketplaces. We expect that fluctuations in the
trading volume of products traded in our marketplaces will occur in the future
from time to time and have a direct impact on our future operating results. This
may cause significant fluctuations in our profitability when the trading volumes
are low.
IF ADVERSE ECONOMIC AND POLITICAL CONDITIONS OCCUR, SUBSTANTIAL DECLINES IN THE
U.S. AND GLOBAL FINANCIAL SERVICES MARKETS MAY RESULT AND OUR PROFITABILITY
COULD SUFFER.
The global financial services business is, by its nature, risky and volatile and
is directly affected by many national and international factors that are beyond
our control. Any one of these factors may cause a substantial decline in the
U.S. and global financial services markets, resulting in reduced trading volume
and turnover. These events could have a material adverse effect on our
profitability. These factors include:
o economic and political conditions in the U.S. and elsewhere in the world;
o terrorist attacks or war;
o concerns over inflation and wavering institutional/consumer confidence
levels;
o the availability of cash for investment by mutual funds and other wholesale
and retail investors;
o fluctuating interest and exchange rates;
o legislative and regulatory changes; and
o currency values.
BECAUSE THERE IS LESS U.S. TREASURY DEBT OUTSTANDING, TRADING IN OUR
MARKETPLACES MAY DECLINE.
Our business is highly dependent upon the volume of bonds being traded through
our eSpeed(R) system. If the U.S. reduces its outstanding Treasury debt, there
may be a decline in the volume of U.S. Treasury securities traded through our
eSpeed(R) system.
BECAUSE WE EXPECT TO CONTINUE TO EXPAND OUR OPERATIONS OUTSIDE NORTH AMERICA, WE
MAY FACE SPECIAL ECONOMIC AND REGULATORY CHALLENGES THAT WE MAY NOT BE ABLE TO
MEET.
We operate electronic marketplaces throughout Europe and Asia and we plan to
further expand our operations throughout these regions and other regions in the
future. There are certain risks inherent in doing business in international
markets, particularly in the regulated brokerage industry. These risks include:
o less developed automation in exchanges, depositories and national clearing
systems;
o unexpected changes in regulatory requirements, tariffs and other trade
barriers;
o difficulties in staffing and managing foreign operations;
o fluctuations in exchange rates;
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o reduced protection for intellectual property rights;
o seasonal reductions in business activity during the summer months; and
o potentially adverse tax consequences.
We are required to comply with the laws and regulations of foreign governmental
and regulatory authorities of each country in which we conduct business. These
may include laws, rules and regulations relating to any aspect of the securities
business, including sales methods, capital structure, record-keeping,
broker-dealer and employee registration requirements and the conduct of
directors, officers and employees. Any failure to develop effective compliance
and reporting systems could result in regulatory penalties in the applicable
jurisdiction.
The growth of the Internet as a means of conducting international business has
also raised many legal issues regarding, among other things, the circumstances
in which countries or other jurisdictions have the right to regulate Internet
services that may be available to their citizens from service providers located
elsewhere. In many cases, there are no laws, regulations, judicial decisions or
governmental interpretations that clearly resolve these issues. This uncertainty
may adversely affect our ability to use the Internet to expand our international
operations, and creates the risk that we could be subject to disciplinary
sanctions or other penalties for failure to comply with applicable laws or
regulations.
AS WE ENTER NEW MARKETS, WE MAY NOT BE ABLE TO SUCCESSFULLY ADAPT OUR TECHNOLOGY
AND MARKETING STRATEGY FOR USE IN THOSE MARKETS.
We are leveraging our eSpeed(R) system to enter new markets. We cannot assure
you that we will be able to successfully adapt our proprietary software,
electronic distribution networks and technology for use in other markets. Even
if we do adapt our software, networks and technology, we cannot assure you that
we will be able to attract clients and compete successfully in any such new
markets. We cannot assure you that our marketing efforts or our pursuit of any
of these opportunities will be successful. If these efforts are not successful,
we may realize less than expected earnings, which in turn could result in a
decrease in the market value of our Class A common stock. Furthermore, these
efforts may divert management attention or inefficiently utilize our resources.
We intend to create electronic marketplaces for many vertical markets and extend
into others, but there is no guarantee that we will be able to do so.
IF WE ACQUIRE OTHER COMPANIES, WE MAY NOT BE ABLE TO INTEGRATE THEIR OPERATIONS
EFFECTIVELY.
Our business strategy contemplates expansion through the acquisition of
exchanges and other companies providing services or having technologies and
operations that are complementary to ours. Acquisitions entail numerous risks,
including:
o difficulties in the assimilation of acquired operations and products;
o diversion of management's attention from other business concerns;
o assumption of unknown material liabilities of acquired companies;
o amortization of acquired intangible assets, which would reduce future
reported earnings; and
o potential loss of clients or key employees of acquired companies.
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We cannot assure you that we will be able to integrate successfully any
operations, personnel, services or products that might be acquired in the
future, and our failure to do so could adversely affect our profitability and
the value of our Class A common stock.
BECAUSE OUR BUSINESS IS SUBJECT TO EXTENSIVE GOVERNMENT AND OTHER REGULATION, WE
MAY FACE RESTRICTIONS WITH RESPECT TO THE WAY WE CONDUCT OUR OPERATIONS.
The Securities and Exchange Commission, NASD Regulation, Inc., Commodity Futures
Trading Commission and other agencies extensively regulate the U.S. financial
industry. Our international operations may become subject to similar regulations
in specific jurisdictions. In addition, our activities in the Energy Vertical
may be subject to regulation by the Federal Energy Regulatory Commission under
the Federal Power Act. Certain of our U.S. subsidiaries are required to comply
strictly with the rules and regulations of these agencies. As a matter of public
policy, these regulatory bodies are responsible for safeguarding the integrity
of the securities and other financial markets and protecting the interests of
investors in those markets. Most aspects of our U.S. broker-dealer subsidiaries
are highly regulated, including:
o the way we deal with our clients;
o our capital requirements;
o our financial and Securities and Exchange Commission reporting practices;
o required record keeping and record retention procedures;
o the licensing of our employees; and
o the conduct of our directors, officers, employees and affiliates.
If we fail to comply with any of these laws, rules or regulations, we may be
subject to censure, fines, cease-and-desist orders, suspension of our business,
suspensions of personnel or other sanctions, including revocation of
registration as a broker-dealer. Changes in laws or regulations or in
governmental policies could have a material adverse effect on the conduct of our
business. These agencies have broad powers to investigate and enforce compliance
and punish non-compliance with their rules and regulations. We cannot assure you
that we and/or our directors, officers and employees will be able to fully
comply with, and will not be subject to, claims or actions by these agencies.
The products and services we offer through our electronic marketplaces are
likely to be regulated by federal, state and foreign governments. Our ability to
provide such services will be affected by these regulations. In addition, as we
expand our business to other vertical markets, it is likely that we will be
subject to additional federal, state and foreign regulations. The implementation
of unfavorable regulations or unfavorable interpretations of existing
regulations by courts or regulatory bodies could require us to incur significant
compliance costs or cause the development of affected markets to become
impractical.
BECAUSE WE ARE SUBJECT TO RISKS ASSOCIATED WITH NET CAPITAL REQUIREMENTS, WE MAY
NOT BE ABLE TO ENGAGE IN OPERATIONS THAT REQUIRE SIGNIFICANT CAPITAL.
The Securities and Exchange Commission, Commodity Futures Trading Commission and
various other regulatory agencies have stringent rules and regulations with
respect to the maintenance of specific levels of net capital by regulated
companies. Net capital is the net worth of a broker or dealer, less deductions
for certain types of assets. If a firm fails to maintain the required net
capital, it may be subject to suspension or revocation of registration by the
21
Securities and Exchange Commission or Commodity Futures Trading Commission, and
suspension or expulsion by these regulators could ultimately lead to the firm's
liquidation. If these net capital rules are changed or expanded, or if there is
an unusually large charge against net capital, operations that require the
intensive use of capital would be limited. Also, our ability to withdraw capital
from broker-dealer subsidiaries could be restricted, which in turn could limit
our ability to pay dividends, repay debt and redeem or purchase shares of our
outstanding stock. A large operating loss or charge against net capital could
adversely affect our ability to expand or even maintain our present levels of
business, which could have a material adverse effect on our business. In
addition, we may become subject to net capital requirements in foreign
jurisdictions.
BECAUSE WE OFFER ACCESS TO SOME OF OUR MARKETPLACES TO ONLINE RETAIL BROKERS AND
OTHERS, WE ARE SUBJECT TO RISKS RELATING TO UNCERTAINTY IN THE REGULATION OF THE
INTERNET.
There are currently few laws or regulations that specifically regulate
communications or commerce on the Internet. However, laws and regulations may be
adopted in the future that address issues such as user privacy, pricing,
taxation and the characteristics and quality of products and services. For
example, the Telecommunications Act sought to prohibit transmitting various
types of information and content over the Internet. Several telecommunications
companies have petitioned the Federal Communications Commission to regulate
Internet service providers and other online service providers in a manner
similar to long distance telephone carriers and to impose access fees on those
companies. This could increase the cost of transmitting data over the Internet.
Moreover, it may take years to determine the extent to which existing laws
relating to issues such as property ownership, libel and personal privacy are
applicable to the Internet. Any new laws or regulations relating to the Internet
could adversely affect our business.
BECAUSE BROKERAGE SERVICES INVOLVE SUBSTANTIAL RISKS OF LIABILITY, WE MAY BECOME
SUBJECT TO RISKS OF LITIGATION.
Many aspects of our business, and the businesses of our clients, involve
substantial risks of liability. Dissatisfied clients frequently make claims
regarding quality of trade execution, improperly settled trades, mismanagement
or even fraud against their service providers. We and our clients may become
subject to these claims as the result of failures or malfunctions of systems and
services provided by us and third parties may seek recourse against us. We could
incur significant legal expenses defending claims, even those without merit. An
adverse resolution of any lawsuits or claims against us could result in our
obligation to pay substantial damages.
In addition, we are subject to legal proceedings and claims against Cantor and
its affiliates as a result of the transactions surrounding our formation.
Although Cantor has agreed to indemnify us against claims or liabilities arising
from our assets or operations prior to the formation transactions, we cannot
assure you that such claims or litigation will not harm our business.
IF WE CANNOT DETER EMPLOYEE MISCONDUCT, WE MAY BE HARMED.
There have been a number of highly publicized cases involving fraud or other
misconduct by employees in the financial services industry in recent years, and
we run the risk that employee misconduct could occur. Misconduct by employees
could include hiding unauthorized or unsuccessful activities from us. In either
case, this type of conduct could result in unknown and unmanaged risks or
losses. Employee misconduct could also involve the improper use of confidential
information, which could result in regulatory sanctions and serious reputational
harm. It is not always possible to deter employee misconduct, and the
precautions we take to prevent and detect this activity may not be effective in
all cases.
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BECAUSE OUR BUSINESS IS DEVELOPING, WE CANNOT PREDICT OUR FUTURE CAPITAL NEEDS
OR OUR ABILITY TO SECURE ADDITIONAL FINANCING.
We anticipate, based on management's experience and current industry trends,
that our existing cash resources will be sufficient to meet our anticipated
working capital and capital expenditure requirements for at least the next 12
months. However, we believe that there are a significant number of capital
intensive opportunities for us to maximize our growth and strategic position,
including, among other things, acquisitions, joint ventures, strategic alliances
or other investments. As a result, we may need to raise additional funds to:
o increase the regulatory net capital necessary to support our operations;
o support more rapid growth in our business;
o develop new or enhanced services and products;
o respond to competitive pressures;
o acquire complementary technologies;
o enter into strategic alliances;
o acquire companies with marketplace or other specific domain expertise; and
o respond to unanticipated requirements.
We cannot assure you that we will be able to obtain additional financing when
needed on terms that are acceptable, if at all.
THE MARKET PRICE OF OUR CLASS A COMMON STOCK HAS FLUCTUATED AND MAY FLUCTUATE IN
THE FUTURE, AND FUTURE SALES OF OUR SHARES COULD ADVERSELY AFFECT THE MARKET
PRICE OF OUR CLASS A COMMON STOCK.
The market price of our Class A common stock has fluctuated widely since our
initial public offering and may continue to fluctuate widely, depending upon
many factors, including our perceived prospects and the prospects of the
financial and other business-to-business marketplaces in general, differences
between our actual financial and operating results and those expected by
investors and analysts, changes in analysts' recommendations or projections,
seasonality, changes in general valuations for Internet and e-commerce-related
companies, changes in general economic or market conditions and broad market
fluctuations.
Future sales of our shares also could adversely affect the market price of our
Class A common stock. If our existing stockholders sell a large number of
shares, or if we issue a large number of shares of our common stock in
connection with future acquisitions, strategic alliances or otherwise, the
market price of our Class A common stock could decline significantly. Moreover,
the perception in the public market that these stockholders might sell shares of
Class A common stock could depress the market price of our Class A common stock.
We have registered under the Securities Act 10,630,000 shares of our Class A
common stock, which are reserved for issuance upon exercise of options granted
under our stock option plan. Since our stock option plan has been amended to
increase the amount of shares available for issuance under our stock option
plan, we will likely register additional shares. In addition, if we increase our
total outstanding shares of common stock, we will register additional shares of
Class A common stock so that the stock available for issuance under our stock
option plan will be registered. Once registered, these shares can be sold in the
public market upon issuance, subject to restrictions
23
under the securities laws applicable to resales by affiliates. In addition, we
have registered under the Securities Act 425,000 shares of our Class A common
stock issuable under our stock purchase plan. We also will be issuing new shares
of our Class A common stock in connection with our matching program for our
401(k) plan. The maximum number of new shares we will be issuing in connection
with our 401(k) plan is $3,000 worth per employee per year.
Since June 9, 2001, approximately 5.9 million shares of our Class A common stock
that have been distributed to partners of Cantor as part of a deferred stock
distribution by Cantor have been eligible for resale in the public market
subject to Rule 144 under the Securities Act. On June 9, 2002, approximately
4,160,000 of these shares may be resold in the public market pursuant to Rule
144(k) under the Securities Act. The availability for sale of such number of
shares may have an adverse effect on the market price of our Class A common
stock.
In addition, we have issued shares of our Class A common stock, warrants and
convertible preferred stock and have granted registration rights in connection
with certain of our strategic alliances. See "Item 13. Certain Relationships and
Related Transactions."
RISKS RELATED TO OUR RELATIONSHIP WITH CANTOR
BECAUSE WE CONTINUE TO DEPEND ON CANTOR'S BUSINESS, EVENTS WHICH ADVERSELY
AFFECT CANTOR'S BUSINESS, INCLUDING A SALE, DISSOLUTION, LIQUIDATION OR
WINDING-UP OF CANTOR, MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR REVENUES.
Since inception, we have recognized a significant portion of our revenues in
connection with our relationship with Cantor. Consequently, our business has
been adversely affected by the effect of the September 11 Events on Cantor's
business. See "-- The events of September 11, 2001 have had and will continue to
have an adverse effect on our business." It is possible that, because of the
September 11 Events, Cantor may not continue to satisfy the governmental
regulatory requirements necessary for it to continue to provide clearance and
settlement for the trades made over our eSpeed(R) system. If Cantor cannot
provide clearance and settlement services for us, we will have to find a third
party to provide such services or provide such services ourselves. There is no
guarantee we will be able to find an alternative provider of clearance and
settlement services and, even if we do, we are likely to encounter difficulties
in transitioning to any such provider. Moreover, such alternative provider may
charge more or less than Cantor did for such services, which may negatively
affect our results of operations. In addition, any other future events which
adversely affect Cantor's business or operating results, including a sale,
dissolution, liquidation or winding-up of all or a material portion of Cantor's
business, could have a material adverse effect on our most significant source of
revenues. We also are a general creditor of Cantor to the extent that there are
transaction revenues and software solutions fees owing to us from Cantor. Events
that adversely affect Cantor's financial position and its ability to remit to us
our share of transaction revenues and software solutions fees could have a
material adverse effect on our revenues.
CONFLICTS OF INTEREST AND COMPETITION WITH CANTOR MAY ARISE.
Various conflicts of interest between us and Cantor may arise in the future in a
number of areas relating to our past and ongoing relationships, including
competitive business activities, potential acquisitions of businesses or
properties, the election of new directors, payment of dividends, incurrence of
indebtedness, tax matters, financial commitments, marketing functions, indemnity
arrangements, service arrangements, issuances of our capital stock, sales or
distributions by Cantor of its shares of our common stock and the exercise by
Cantor of control over our management and affairs. Our Amended and Restated
Joint Services Agreement, as currently in effect (the "Joint Services
Agreement"), with Cantor provides that, in some circumstances, Cantor can
unilaterally determine the
24
commissions that will be charged to clients for effecting trades in marketplaces
in which we collaborate with Cantor. The determination of the nature of
commissions charged to clients does not affect the allocation of revenues that
Cantor and we share with respect to those transactions. However, in
circumstances in which Cantor determines to charge clients lower commissions,
the amount that we receive in respect of our share of the commissions will be
correspondingly decreased. Pursuant to our Administrative Services Agreement
with Cantor, Cantor is required to obtain for us, among other things, property
and casualty insurance of not less than $40 million and business interruption
insurance of $25 million. Cantor has procured insurance coverage for us in these
respective amounts; however, we are listed on this insurance policy as one of
several insured parties, together with Cantor and several of its affiliates.
This insurance policy is for aggregate amounts in excess of the amounts set
forth above. The Administrative Services Agreement does not provide for the
allocation of the proceeds among the named insureds. Because Cantor controls us
and the allocation of the proceeds received from insurance, Cantor may allocate
the proceeds among the insured parties in a manner with which we disagree and
that may have an adverse effect on our financial condition.
Three of our directors and a majority of our officers also serve as directors
and/or officers of Cantor. Simultaneous service as an eSpeed director or officer
and service as a director or officer, or status as a partner, of Cantor could
create, or appear to create, potential conflicts of interest when such
directors, officers and/or partners are faced with decisions that could have
different implications for us and for Cantor. Mr. Lutnick, our Chairman,
President and Chief Executive Officer, is the sole stockholder of the managing
general partner of Cantor. As a result, Mr. Lutnick controls Cantor. As of March
15, 2002, Mr. Lutnick controlled approximately 90.9% of the combined voting
power of all classes of our voting stock. Mr. Lutnick's simultaneous service as
our Chairman, President and Chief Executive Officer and his control of Cantor
could create or appear to create potential conflicts of interest when Mr.
Lutnick is faced with decisions that could have different implications for us
and for Cantor.
BECAUSE OUR JOINT SERVICES AGREEMENT WITH CANTOR HAS A PERPETUAL TERM AND
CONTAINS NON-COMPETITION PROVISIONS AND RESTRICTIONS ON OUR ABILITY TO PURSUE
STRATEGIC TRANSACTIONS, THIS AGREEMENT MAY BECOME BURDENSOME TO OUR BUSINESS.
Although Cantor has agreed, subject to certain conditions, not to compete with
us in providing electronic brokerage services, Cantor is currently engaged in
securities transaction and other financial instruments execution and processing
operations and other activities that are related to the electronic trading
services we provide. Our Joint Services Agreement obligates us to perform
technology support and other services for Cantor at cost, whether or not related
to our electronic brokerage services, sets forth the ongoing revenue sharing
arrangements between Cantor and us and subjects us and Cantor to non-competition
obligations. The Joint Services Agreement precludes us from entering into lines
of business in which Cantor now or in the future may engage, or providing, or
assisting any third party in providing, voice-assisted brokerage services,
clearance, settlement and fulfillment services and related services, except
under limited circumstances. Although we believe Cantor has no plans to form,
acquire or commence any other operations similar to ours, the Joint Services
Agreement permits Cantor to perform, in limited circumstances, electronic
brokerage operations. In addition, the Joint Services Agreement imposes
limitations on our ability to pursue strategic alliances, joint ventures,
partnerships, business combinations, acquisitions and similar transactions.
Because the Joint Services Agreement has a perpetual term, even in the event of
a breach by one of the parties, and does not provide for modification under its
terms, this agreement may become burdensome for us, may distract us from
focusing on our internal operations, may deter or discourage a takeover of our
company and may limit our ability to expand our operations.
25
BECAUSE AGREEMENTS BETWEEN US AND CANTOR ARE NOT THE RESULT OF ARM'S-LENGTH
NEGOTIATIONS, WE MAY RECEIVE LOWER COMMISSIONS FROM, AND PAY HIGHER SERVICE FEES
TO, CANTOR THAN WE WOULD WITH RESPECT TO THIRD PARTY SERVICE PROVIDERS.
In connection with the formation transactions, we entered into Assignment and
Assumption Agreements, an Administrative Services Agreement, a Joint Services
Agreement and several other agreements with Cantor relating to the provision of
services to each other and third parties. These agreements are not the result of
arm's-length negotiations because Cantor owns and controls us. As a result, the
prices charged to us or by us for services provided under the agreements may be
higher or lower than prices that may be charged by third parties and the terms
of these agreements may be generally less favorable to us than those that we
could have negotiated with third parties.
BECAUSE WE DEPEND ON SERVICES AND ACCESS TO OPERATING ASSETS PROVIDED BY THIRD
PARTIES TO CANTOR, WE MAY NOT HAVE RECOURSE AGAINST THOSE THIRD PARTIES.
Many of the assets and services provided by Cantor under the terms of the
Administrative Services Agreement are leased or provided to Cantor by
third-party vendors. As a result, in the event of a dispute between Cantor and a
third-party vendor, we could lose access to, or the right to use, as applicable,
office space, personnel, corporate services and operating assets. In such a
case, we would have no recourse with respect to the third-party vendor. Our
inability to use these services and operating assets for any reason, including
any termination of the Administrative Services Agreement between us and Cantor
or the agreements between Cantor and third-party vendors, could result in
serious interruptions of our operations.
OUR REPUTATION MAY BE AFFECTED BY ACTIONS TAKEN BY CANTOR AND ENTITIES THAT ARE
RELATED TO CANTOR.
Cantor currently is our most significant client. Cantor holds direct and
indirect ownership and management interests in numerous other entities that
engage in a broad range of financial services and securities-related activities.
Actions taken by, and events involving, Cantor or these related companies which
are perceived negatively by the securities markets, or the public generally,
could have a material adverse effect on us and could affect the price of our
Class A common stock. In addition, events which negatively affect the financial
condition of Cantor may negatively affect us. These events could cause Cantor to
lose clients that may trade in our marketplaces, could impair Cantor's ability
to perform its obligations under the Joint Services Agreement, the
Administrative Services Agreement and other agreements Cantor enters into with
us and could cause Cantor to liquidate investments, including by selling or
otherwise transferring shares of our common stock.
IF WE BECOME SUBJECT TO LITIGATION AND OTHER LEGAL PROCEEDINGS, WE MAY BE
HARMED.
From time to time, we and Cantor may become involved in litigation and other
legal proceedings relating to claims arising from our and their operations in
the normal course of business. Cantor is currently subject to a number of legal
proceedings that could affect us. We cannot assure you that these or other
litigation or legal proceedings will not materially affect our ability to
conduct our business in the manner that we expect or otherwise adversely affect
us. See "Item 3. Legal Proceedings".
RISKS RELATED TO E-COMMERCE AND THE INTERNET
IF ELECTRONIC MARKETPLACES DO NOT CONTINUE TO GROW, WE WILL NOT BE ABLE TO
ACHIEVE OUR BUSINESS OBJECTIVES.
The success of our business plan depends on our ability to create interactive
electronic marketplaces for a wide range of products. Historically, securities
and commodities markets operated through open outcry formats which have recently
begun to be supplanted by new systems that match buyers and sellers
electronically. The energy
26
markets in which we participate through TradeSpark operate through phone-based
and bulletin-board formats and have recently begun to transact electronically.
The utilization of our products and services depends on the continued
acceptance, adoption and growth of electronic markets. We cannot assure you that
the growth and acceptance of the use of electronic markets will continue.
IF E-COMMERCE AND INTERNET USAGE DOES NOT CONTINUE TO GROW, WE WILL NOT BE ABLE
TO ACHIEVE OUR BUSINESS OBJECTIVES.
Our strategic and financial objectives would be adversely impacted if e-commerce
adoption and usage does not continue to grow. Business-to-business use of the
Internet as a medium of commerce is a recent phenomenon and is subject to a high
level of uncertainty. Internet usage may be inhibited for a number of reasons,
including:
o access costs;
o inadequate network infrastructure;
o security concerns;
o uncertainty of legal, regulatory and tax issues concerning the use of the
Internet;
o concerns regarding ease of use, accessibility and reliability;
o inconsistent quality of service; and
o lack of availability of cost-effective, high-speed service.
If Internet usage grows, the Internet infrastructure may not be able to support
the demands placed on it, or the Internet's performance and reliability may
decline. Similarly, Web sites have experienced interruptions in their service as
a result of outages and other delays occurring throughout the Internet network
infrastructure. If these outages or delays occur frequently, use of the Internet
as a commercial or business medium could grow more slowly or decline. Even if
Internet usage continues to grow, online trading in the wholesale securities
markets, and in particular the fixed income securities and futures markets, may
not be accepted by our clients. This could negatively affect the growth of our
business.
OUR NETWORKS AND THOSE OF OUR THIRD-PARTY SERVICE PROVIDERS MAY BE VULNERABLE TO
SECURITY RISKS, WHICH COULD MAKE OUR CLIENTS HESITANT TO USE OUR ELECTRONIC
MARKETPLACES.
We expect the secure transmission of confidential information over public
networks to be a critical element of our operations. Our networks and those of
our third-party service providers, including Cantor and associated clearing
corporations, and our clients may be vulnerable to unauthorized access, computer
viruses and other security problems. Persons who circumvent security measures
could wrongfully use our information or cause interruptions or malfunctions in
our operations, which could make our clients hesitant to use our electronic
marketplaces. We may be required to expend significant resources to protect
against the threat of security breaches or to alleviate problems, including
reputational harm and litigation, caused by any breaches. Although we intend to
continue to implement industry-standard security measures, we cannot assure you
that those measures will be sufficient.
27
RISKS RELATED TO OUR CAPITAL STRUCTURE
BECAUSE THE VOTING CONTROL OF OUR COMMON STOCK IS CONCENTRATED AMONG THE HOLDERS
OF OUR CLASS B COMMON STOCK, THE MARKET PRICE OF OUR CLASS A COMMON STOCK MAY BE
ADVERSELY AFFECTED BY DISPARATE VOTING RIGHTS.
As of March 15, 2002, Cantor beneficially owned approximately 90.4% of the
combined voting power of all classes of our voting stock. As long as Cantor
beneficially owns a majority of the combined voting power of our common stock,
it will have the ability, without the consent of the public stockholders, to
elect all of the members of our board of directors and to control our management
and affairs. In addition, it will be able to determine the outcome of matters
submitted to a vote of our stockholders for approval and will be able to cause
or prevent a change in control of our company. In certain circumstances, the
shares of our Class B common stock issued to Cantor upon consummation of the
formation transactions may be transferred without conversion to our Class A
common stock.
The holders of our Class A common stock and Class B common stock have
substantially identical rights, except that holders of our Class A common stock
are entitled to one vote per share, while holders of our Class B common stock
are entitled to 10 votes per share on all matters to be voted on by stockholders
in general. This differential in the voting rights and our ability to issue
additional Class B common stock could adversely affect the market price of our
Class A common stock.
DELAWARE LAW AND OUR CHARTER MAY MAKE A TAKEOVER OF OUR COMPANY MORE DIFFICULT
AND DILUTE YOUR PERCENTAGE OF OWNERSHIP OF OUR COMMON STOCK.
Provisions of Delaware law, such as its business combination statute, may have
the effect of delaying, deferring or preventing a change in control of our
company. In addition, our Amended and Restated Certificate of Incorporation
authorizes the issuance of preferred stock, which our board of directors can
create and issue without prior stockholder approval and with rights senior to
those of our common stock, as well as additional shares of our Class B common
stock and warrants to purchase our common stock. Any such issuances would make a
takeover of our company more difficult and may dilute your percentage ownership
of our common stock. Our Amended and Restated Certificate of Incorporation and
our Second Amended and Restated By-Laws include provisions which restrict the
ability of our stockholders to take action by written consent and provide for
advance notice for stockholder proposals and director nominations. These
provisions may have the effect of delaying or preventing changes of control or
management of our company, even if such transactions would have significant
benefits to our stockholders. As a result, these provisions could limit the
price some investors might be willing to pay in the future for shares of our
Class A common stock.
DELAWARE LAW MAY PROTECT DECISIONS OF OUR BOARD OF DIRECTORS THAT HAVE A
DIFFERENT EFFECT ON HOLDERS OF OUR CLASS A AND CLASS B COMMON STOCK.
Stockholders may not be able to challenge decisions that have an adverse effect
upon holders of our Class A common stock if our board of directors acts in a
disinterested, informed manner with respect to these decisions, in good faith
and in the belief that it is acting in the best interests of our stockholders.
Delaware law generally provides that a board of directors owes an equal duty to
all stockholders, regardless of class or series, and does not have separate or
additional duties to either group of stockholders, subject to applicable
provisions set forth in a company's charter.
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ITEM 2. PROPERTIES
We have offices in the U.S., Europe and Asia. Our principal executive offices
are temporarily located at 299 Park Avenue, New York, New York. We do not have a
written agreement to sublease this space from Cantor and the amount, if any, we
are going to pay Cantor for the use of this space has not been determined at
this time. The space we occupy at 299 Park is inadequate for our needs, but we
anticipate subleasing from Cantor adequate space for our short-term needs at 135
East 57th Street, New York, New York, for which Cantor has entered into a
two-year sublease for five floors. We are looking for permanent headquarters
space in the New York metropolitan area to occupy following the end of our
expected sublease from Cantor. Our largest presence outside of the New York
metropolitan area is in London, where we have the right to use approximately
15,000 square feet of Cantor's existing office space. Our right to use this
space expires at the earlier of (1) the time that Cantor's lease expires in 2016
or (2) when Cantor ceases to be an affiliate of ours and Cantor asks us to
vacate. We will pay Cantor approximately $2.6 million annually for use of this
space. Additionally, we occupy approximately 18,750 square feet of space in our
Concurrent Computing Center in Rochelle Park, New Jersey and temporary space in
Weehawken, New Jersey. We pay Cantor approximately $717,000 annually for the use
of the Rochelle Park space.
ITEM 3. LEGAL PROCEEDINGS
eSpeed patent related legal proceedings
After we acquired the Wagner patent in April 2001, we joined ETS, the prior
patent owner, as a plaintiff in litigation pending in the United States District
Court for the Northern District of Texas against the Board of Trade of the City
of Chicago and the Chicago Mercantile Exchange, and in the Southern District of
New York against the New York Mercantile Exchange. The plaintiffs allege that
the defendants in each case infringed the Wagner patent. The complaints seek
injunctive relief, a reasonable royalty, treble damages pursuant to 37 U.S.C.
ss.284, attorneys' fee, interest and costs. On October 12, 2001, the Judge in
the Texas case entered an order, following a hearing (usually referred to as a
Markman hearing) construing the claims of the patent. We believe the ruling was
generally consistent with our interpretation of the scope of the patent.
Discovery in both the New York and Texas actions is ongoing. The New York
Markman hearing is currently scheduled for April 15, 2002. The New York case is
set to be trial ready on July 29, 2002, but that date will be postponed if
dispositive motions are filed, which seems likely. The Texas action is scheduled
for trial on August 12, 2002. There are pretrial orders in both cases with other
intermediate deadlines for completion of certain litigation tasks. There can be
no assurance these orders will not be further amended.
Although the ultimate outcome of these actions cannot be ascertained at this
time and the results of legal proceedings cannot be predicted with certainty, it
is the opinion of management that the resolution of these matters will not have
a material adverse effect on our financial condition or results of operations.
Cantor related legal proceedings
In February 1998, Market Data Corporation contracted with Chicago Board
Brokerage (a company controlled by the Chicago Board of Trade and Prebon Yamane)
to provide the technology for an electronic trading system to compete with
Cantor's United States Treasury brokerage business. Market Data Corporation is
controlled by Iris Cantor and Rodney Fisher, her nephew-in-law. Iris Cantor, a
company under the control of Iris Cantor referred to herein as Cantor Fitzgerald
Incorporated (CFI) and Rodney Fisher are limited partners of CFLP.
In April 1998, CFLP filed a complaint in the Delaware Court of Chancery against
Market Data Corporation, Iris Cantor, CFI, Rodney Fisher and Chicago Board
Brokerage seeking an injunction and other remedies. The
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complaint alleges that Iris Cantor, CFI and Rodney Fisher violated certain
duties, including fiduciary duties under Cantor's partnership agreement, due to
their competition with CFLP with respect to the electronic trading system
mentioned above. CFLP believes Market Data Corporation's technology for
electronic trading systems would be of substantial assistance to competitors in
the wholesale market if provided to them. The complaint further alleges that
Market Data Corporation and Chicago Board Brokerage tortiously interfered with
CFLP's partnership agreement and aided and abetted Iris Cantor's, CFI's and
Rodney Fisher's breaches of fiduciary duty. Iris Cantor, CFI and Rodney Fisher
counterclaimed seeking, among other things, (1) to reform agreements they have
with CFLP and (2) a declaration that CFLP breached the implied covenant of good
faith and fair dealing.
CFLP settled its dispute with Chicago Board Brokerage in April 1999, and Chicago
Board Brokerage subsequently announced it was disbanding its operations.
On March 13, 2000, the Delaware Court of Chancery ruled in favor of CFLP,
finding that Iris Cantor, CFI and Rodney Fisher had breached the Partnership
Agreement of CFLP, and that Market Data Corporation had aided and abetted that
breach. The court awarded CFLP declaratory judgment relief and court costs and
attorneys' fees. The defendants moved for re-argument with respect to the award
of fees and costs. Justice Steele adhered to his previous decision that CFLP is
entitled to recover court costs and attorneys' fees.
On November 5, 2001, Justice Steele entered an Order of Declaratory Judgment,
which provides that if Iris Cantor, CFI and/or Rod Fisher, through MDC or
otherwise, wish to compete with CFLP or its affiliates in a manner that could
reasonably be expected to harm a core business of CFLP, they must obtain the
written consent of CFLP's Managing General Partner. On December 4, 2001, the
defendants filed notices of appeal. The Delaware Supreme Court dismissed the
appeals as interlocutory. The Court has yet to enter a final order regarding
fees and costs.
Two related actions are pending in New York. In a case pending in the Supreme
Court of New York, plaintiff CFLP alleges, among other things, that defendants
Market Data Corporation, CFI, Iris Cantor and Rodney Fisher misused confidential
information of CFLP in connection with the above-mentioned provision of
technology to Chicago Board Brokerage. In a case filed in the United States
District Court for the Southern District of New York, CFI and Iris Cantor
allege, among other things, that certain senior officers of CFLP breached
fiduciary duties they owed to CFI. The allegations in this lawsuit relate to
several of the same events underlying the court proceedings in Delaware.
Neither of these two cases had been pursued prior to the March 13, 2000 decision
in the court proceedings in Delaware. On May 15, 2000, the senior officers of
CFLP who are defendants in the federal action in New York moved to dismiss the
complaint against them on several grounds, including, among other things, that
matters that were adjudicated against them in Delaware. Iris Cantor and CFI
filed papers opposing the motion to dismiss on June 5, 2000, and the defendants
filed a reply on June 15, 2000.
On February 7, 2001, the court granted the motion to dismiss CFI's complaint.
CFI and Iris Cantor appealed. In November 2001, the United States Court of
Appeals for the Second Circuit heard oral arguments. It has yet to render a
decision.
On May 16, 2000, CFI filed an action in Delaware Superior Court, New Castle
County, against CFLP and CF Group Management, Inc. (CFGM) seeking payment of $40
million allegedly due pursuant to a settlement agreement in an earlier
litigation between the parties. The complaint alleges that CFI is entitled to a
one-time $40 million payment upon "an initial public offering of CFLP or of a
successor to a material portion of the assets and business of CFLP..." CFI
alleges that our initial public offering on December 10, 1999 triggered the
payment obligation under the settlement agreement. On September 26, 2000, CFLP
and CFGM filed an answer denying liability. Following the events of September
11, 2001, the action was stayed.
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On June 12, 2000, CFLP and CFGM filed a lawsuit in the Delaware Court of
Chancery against Iris Cantor, CFI and Rodney Fisher, seeking a declaratory
judgment that an Offer to Exchange, dated May 8, 2000 (the Exchange Offer),
pursuant to which certain partnership units in CFLP could be exchanged for
"e-units" that are entitled to receive distributions of our stock from CFLP on
certain future dates subject to certain conditions, did not breach any fiduciary
duty or otherwise violate Delaware law. On July 18, 2000, CFI, Iris Cantor and
Rodney Fisher filed the