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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-28191
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ESPEED, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 13-4063515
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation) Identification No.)
135 EAST 57TH, NEW YORK, NEW YORK 10022
(Address of Principal Executive Offices) (Zip Code)
(212) 938-5000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
CLASS A COMMON STOCK, $. 01 PAR VALUE
(Title of Class)
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of voting common equity held by non-affiliates
of the registrant, based upon the closing price of the Class A common stock on
June 28, 2002 as reported on the Nasdaq National Market, was approximately
$288,986,197.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Class Outstanding at March 17, 2003
- ----- -----------------------------
CLASS A COMMON STOCK, PAR VALUE $.01 PER SHARE 29,855,446 SHARES
CLASS B COMMON STOCK, PAR VALUE $.01 PER SHARE 25,362,809 SHARES
DOCUMENTS INCORPORATED BY REFERENCE.
NONE.
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ESPEED, INC.
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I ....................................................................1
ITEM 1. BUSINESS............................................................1
ITEM 2. PROPERTIES.........................................................23
ITEM 3. LEGAL PROCEEDINGS..................................................23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS............................................................24
PART II ...................................................................26
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS........................................26
ITEM 6. SELECTED FINANCIAL DATA............................................28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS:.....................29
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK........................................................38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE.............................62
PART III ...................................................................63
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT.........................................................63
ITEM 11. EXECUTIVE COMPENSATION.............................................64
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT.....................................................66
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................69
ITEM 14. CONTROLS AND PROCEDURES............................................74
PART IV ...................................................................74
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K................................................74
1
PART I
ITEM 1. BUSINESS
The information in this report contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Such statements are
based upon current expectations that involve risks and uncertainties. Any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. For example, words such as "may,"
"will," "should," "estimates," "predicts," "potential," "continue," "strategy,"
"believes," "anticipates," "plans," "expects," "intends" and similar expressions
are intended to identify forward-looking statements. Our actual results and the
timing of certain events may differ significantly from the results discussed in
the forward-looking statements. Factors that might cause or contribute to such a
discrepancy include, but are not limited to, the effect of the September 11
Events (as defined below) on our operations, including in particular the loss of
hundreds of eSpeed, Cantor Fitzgerald, L.P. and TradeSpark employees, our
limited operating history, the possibility of future losses and negative cash
flow from operations, the effect of market conditions, including volume and
volatility, and the current global recession on our business, our ability to
enter into marketing and strategic alliances, to hire new personnel, to expand
the use of our electronic system, to induce clients to use our marketplaces and
services and to effectively manage any growth we achieve, and other factors that
are discussed under "Risk Factors" in this Annual Report on Form 10-K. The
following discussion is qualified in its entirety by, and should be read in
conjunction with, the more detailed information set forth in our financial
statements and the notes thereto appearing elsewhere in this filing.
OVERVIEW OF OUR BUSINESS
We are a leader in developing and deploying electronic marketplaces and related
trading technology that offers traders access to the most liquid, efficient and
neutral financial markets in the world. We operate multiple buyer, multiple
seller real-time electronic marketplaces for the global non-equity capital
markets, including the world's largest government bond markets and other fixed
income marketplaces. Our suite of marketplace tools provides end-to-end
transaction solutions for the purchase and sale of financial and non-financial
products over our global private network or via the Internet.
Our products enable market participants to transact business instantaneously,
more effectively and at lower cost than in traditional voice-based brokerage
markets. Our systems were built to support multiple buyers and sellers in
interactive marketplaces, in a completely neutral, efficient and real-time
environment. In 2002, we processed over 4.5 million electronic transactions,
totaling more than $35 trillion of transactional volume. Our clients include
most of the largest fixed income and foreign exchange trading firms, major
exchanges and leading natural gas and electricity trading firms in the world. We
have offices in the U.S., U.K. and Asia that can transact trading 24 hours a
day, around the world. We believe we offer one of the most robust, large-scale,
instantaneous and reliable transaction processing systems in the world. Our
global private network permits market participants to view information and
execute transactions in a fraction of a second. Our proprietary software
provides an end-to-end solution, including front-end applications, transaction
processing engines, credit and risk management tools and back-office and
clearance modules, enabling straight-through processing.
As a result of the terrorist attacks of September 11, 2001, our offices in the
World Trade Center were destroyed and we lost 180 of our employees, including
many members of our senior management (the September 11 Events). The loss of
these assets and employees and the need to relocate our surviving employees have
negatively impacted our business. See "Risk Factors".
We commenced operations in March 1999 as a division of Cantor Fitzgerald
Securities, a subsidiary of Cantor Fitzgerald, L.P. (Cantor). Our initial focus
was the global government bond markets of the world, specifically, U.S., Europe,
Canada and Japan. Our relationship with Cantor, a leading global inter-dealer
broker in the fixed income markets and the former leader in the U.S. government
bond voice-brokerage business, enabled us to become the leader in what today we
consider our core electronic marketplaces, the government bond markets of the
world. Our goal is to offer the full range of financial products currently
traded in today's global non-equity capital markets, which includes wholesale
fixed income, foreign exchange and futures and options.
In 2000, we entered the North American energy market with a group of leading
energy industry partners. In 2001, we entered the Canadian fixed income market
through our investment in and technology agreement with Freedom International
Brokerage (Freedom), the leading Canadian inter-dealer broker of fixed income
products and other capital products. During 2003, we plan to move beyond the
world's government bond and energy markets by focusing our efforts on several
other non-equity capital markets, including U.S. agencies, treasury spreads,
foreign exchange and interest rate swaps. We also plan to leverage our
electronic marketplace expertise and reputation to sell software products and
services directly to participants in these marketplaces.
Our revenues consist primarily of transaction fees and software solutions fees,
and we market our services to clients, partners and prospects. We do not risk
our own capital in transactions or extend credit to market participants.
1
We have organized our business in four categories, across multiple liquid and
commoditized industries in the financial services and energy markets. These four
categories are core products, new product rollouts, product enhancement software
and eSpeed Software Solutions(SM) sales. We offer our products and services to
participants in the financial and energy markets.
Our objective is to be the leading provider of trading technology and
interactive marketplaces for the non-equity capital markets, where we believe
the opportunity for electronic trading to be substantial. Specifically, we
believe we are well-positioned to take advantage of the large opportunities
throughout the fixed income, foreign exchange, futures and energy markets of the
world. We believe that the scalability and extendibility of our eSpeed(R) suite
of products enable us to introduce new markets and distribute products and
services more quickly, cost effectively and seamlessly than our competitors.
THE INDUSTRY
Historically, the trading of financial and nonfinancial products has been an
inefficient process. Buying, selling or trading activity is traditionally
effected through either (1) a central physical location, like a trading pit or
auction house, where market participants have to access the market through this
central location or its members, (2) a bilateral arrangement with a buyer or
seller or (3) several layers of middlemen and salespersons who assist in
handling orders. Each of these approaches is people and time intensive, which
adds to the direct and indirect cost of the product bought or sold.
Additional inefficiencies with transaction execution include lack of real-time
price information, small disparate groups of interested buyers and sellers,
limited liquidity and problems associated with executing trades as market prices
change. As more transactions occur and participants extend credit to each other,
there are added risks to both buyers and sellers because of the lack of
sophisticated risk management tools. Also, after a buy or sell order is
executed, there are the additional tasks of recording, accounting, tracking,
delivering and financially settling the transaction. Each of these tasks, if
done manually, can add potential cost and error to the process as additional
participants or systems enter the transaction cycle.
Electronic marketplaces have emerged as effective means of conducting
transactions and creating markets. In an electronic marketplace, substantially
all of the participants' actions are facilitated through an electronic medium,
such as a private electronic network or over the Internet, which effectively
eliminates the need for actual face-to-face or voice-to-voice participant
interaction, reducing the inefficiencies inherent in a physical market.
Additionally, as adoption of the Internet has become more widespread, businesses
are recognizing online channels as an efficient means of distribution of their
products to their customers.
Many financial exchanges worldwide, including certain exchanges in France,
Germany, Japan, Sweden, Switzerland and the United Kingdom, are now partially or
completely electronic. Various electronic marketplaces have been implemented to
address the varied needs of the broad business-to-business initiatives,
including marketplaces aimed at the procurement of finished goods or services,
as well as neutral marketplaces for the trading of commodity or commodity-like
goods. We believe the trading of commodity-like products will require
capabilities found in the financial markets, including real-time pricing,
futures and other hedging capabilities and robust interactive trading.
Additionally, we believe companies will seek to outsource online solutions for
the electronic distribution of their products to avoid the difficulty and cost
of developing and maintaining their own online solutions.
OUR SOLUTION
Our electronic marketplace end-to-end solution includes real-time and
auction-based transaction processing, credit and risk management tools and
back-end processing and billing systems, all accessible through our privately
managed global high-speed data network and over the Internet. Because of the
scale and adaptability of our system, our products have applications across a
broad range of companies, industries and vertical marketplaces, including any
global non-equity capital marketplace involving multiple buyers and multiple
sellers. In addition, we license our software to provide a complete outsourced
solution to our clients, enabling them to distribute their branded products to
their customers through online offerings and auctions, including private and
reverse auctions, and request-for-quote capabilities. Our products enable market
participants to transact business instantaneously, more effectively and at lower
cost.
OUR MARKET FOCUS
FINANCIAL MARKETS
WHOLESALE FIXED INCOME. The global fixed income market is the largest financial
market in the world. The Bond Market Association estimates that, in the U.S.
alone, as of 2002, there were over $20.2 trillion of fixed income securities
outstanding with over $632 billion of volume traded daily. In the U.S. Treasury
securities market, there is reported to be over $366 billion a day in trading
just among the primary dealers and their clients. According to the International
Swaps and Derivatives Association, the global market for interest rate swaps,
interest rate options and currency swaps had over $82.7 trillion in notional
value outstanding as of June 2002.
2
FOREIGN EXCHANGE. The trading of currencies in all monetary pairs represents the
largest trading volume market in the world. The Bank for International
Settlements has estimated the daily volume traded in the foreign exchange
markets to have been $1.2 trillion as of April 2001.
FUTURES AND OPTIONS. Futures and options trading is a leading financial activity
throughout the world, with contracts traded on a wide variety of financial
instruments, commodities and indexes. According to the Futures Industry
Association, Inc., in 2002, over 5.99 billion futures and options contracts were
traded in the world's futures and options markets. Currently, a significant
volume of futures trading is still being done on open outcry exchanges, but
there has been a significant movement towards the conversion of these markets to
electronic trading. To date, we believe the most successful initiatives have
been made in Europe. We believe that there is significant opportunity in the
continued conversion of these markets to electronic networks, such as our own.
Limitations of the traditional financial market
While the traditional financial market facilitates trading, it has the following
significant shortcomings:
o limited direct access and, therefore, inefficient pricing;
o high transaction costs and slow execution due to the number of people
involved in a voice transaction;
o difficulty in implementing program trading, especially programs designed to
automatically and simultaneously execute multiple trades in different, but
related products;
o significant expense incurred in processing, confirming and clearing manual
processes; and
o compliance and regulatory risk associated with voice transactions and
non-automated audit trails.
Our Financial Markets Solution
Our products in the financial markets include U.S. Treasury and agency
securities, European, Japanese, Canadian and emerging market sovereign bonds,
U.S. and global corporate bonds, mortgage-backed securities, municipal bonds,
interest rate swaps and options, futures, options, foreign exchange, repos and
basis trades. Cantor has been a major facilitator and, in some cases, provider
of liquidity in numerous financial products through its offices in the U.S.,
Canada, Europe and Asia. Our eSpeed(R) system provides the only way to
electronically access Cantor's marketplaces. Through our alliance with Freedom,
Cantor and six leading Canadian financial institutions, eSpeed also powers the
electronic platform of Freedom International Brokerage, the leading inter-dealer
broker of Canadian fixed income and other capital markets products.
Our private electronic network for wholesale financial markets is connected to
most of the largest financial institutions worldwide. We have installed in the
offices of our existing client base the technology infrastructure necessary to
provide price information and trade execution on an instantaneous basis in a
broad range of securities and financial instruments. We believe our eSpeed(R)
portfolio of products enables us to introduce and distribute a broad mix of
financial products and services quickly, efficiently and at lower cost.
In our electronic marketplaces, participants may either electronically execute
trades themselves or call brokers, who then input trade orders into the market
for them. In our fully electronic trades, all stages of the trade occur
electronically. The participant inputs its buy or sell order instructions
directly into our electronic trading system using our software, a web-browser or
electronically through an application programming interface or other software.
Our system provides to the participant, normally within 300 milliseconds, an
on-screen confirmation that the participant's order has been accepted.
Simultaneously, an electronic confirmation can be sent to the participant's back
office and risk system, enabling risk management capabilities and
straight-through processing for the participant. A broker-assisted trade is
executed in substantially the same manner as an electronic trade, except that
the participant telephones a broker, who then inputs the participant's order
into our electronic marketplace system. Our U.S. Government Securities
marketplace is now a fully electronic marketplace.
We also see opportunities to expand our business by licensing our technology to
other voice brokers in addition to Cantor.
3
ENERGY MARKETS
In September 2000, we, together with Coral Energy Holding (an affiliate of
Shell), Dominion Energy, Dynegy, Koch Energy Trading, TXU Energy Trading,
Williams Energy Marketing & Trading and Cantor, announced the formation of
TradeSpark, a new comprehensive energy marketplace. TradeSpark was created as a
wholesale marketplace for energy-related products and services in North America
with both electronic trading systems and voice brokers. As part of our
arrangement with TradeSpark, we have implemented electronic marketplaces for
natural gas, electricity, coal, weather derivatives and emission allowances.
TradeSpark combines our technology platform, accessed over both a private global
network and the Internet, and our partners' in-depth energy market knowledge and
liquidity to bring speed, neutrality, efficiency and technological leadership to
the energy trading market.
The traditional voice-brokered energy marketplace has been fraught with
inefficiencies, including the lack of real-time price information, small pools
of liquidity, high transaction costs and problems associated with executing
trades in a fast moving market. More recently, credit has become a major issue
to the market participants because of significant price fluctuations caused by
various states' approaches to deregulation, the lack of a liquid hedging market,
limited risk management tools and the bankruptcy of certain major industry
participants. While there have been a handful of electronic systems and single
dealer platforms initiated over the past three years, we believe that none have
unbiased information about prices and enough products or liquidity to give
companies exchange-like execution in the energy marketplace.
Powered by our full trading platform encompassed in eSpeed, TradeSpark offers an
end-to-end marketplace and trading solution that includes real-time and
auction-based transaction processing, risk management tools and back-end
processing systems, as well as access to a fully registered futures exchange,
allowing for the creation of futures and options products for this marketplace.
TradeSpark offers three possible points of access to one pool of liquidity: over
the Internet, through our private network and through TradeSpark voice brokers.
TradeSpark began the year with strong results, however the exit of major energy
companies from the wholesale energy trading markets along with significant
credit deterioration and liquidity issues in the marketplace led to a severe
downturn in the energy market overall as well as in the performance of
TradeSpark, and caused a negative impact on its net revenues recorded, which
caused us to write down our investment in TradeSpark to its net realizable value
in the fourth quarter of 2002.
ESPEED(R) PRODUCTS
Our products are organized in the following four categories:
CORE PRODUCTS
Currently, most of our revenues are derived from transactions in our core
products. These include various United States, European, Canadian and Japanese
government securities. Our full-service eSpeed(R) system, combining all of our
proprietary software and our global high-speed private network, currently
operates in some of the largest and most complex government bond marketplaces in
the world. It is designed to be extendible to any multiple-buyer,
multiple-seller marketplace and can support massive liquidity and fluctuation in
many markets. Our customers in these core products are the largest financial
institutions in the world. These customers access our eSpeed(R) system primarily
through our global high-speed private network. In addition, the system for these
products is also available over the Internet. Our core products enable us to
operate what we believe is the only integrated network engaged in electronic
trading in multiple products and marketplaces on a global basis. We believe that
the time and expense required to develop and install electronic marketplaces
will serve as significant barriers to entry for our competitors.
NEW PRODUCT ROLLOUTS
We have identified major opportunities to leverage our position in our core
global government bond markets into a variety of key non-equity capital markets.
For example, in 2003 we will roll out products in U.S. agencies, off-the-run
U.S. Treasury securities, spreads, and basis trading of U.S. Treasuries,
municipal bonds, interest rate swaps and foreign exchange.
In December 2002, we entered into an agreement with the Chicago Board of Trade
(CBOT) to distribute futures products through the eSpeed(R) system, providing
customers the ability to trade both cash and futures in one neutral,
fully-electronic marketplace. By routing CBOT futures trades over the existing
eSpeed(R) network and providing front-end integration to our clients, our cash
traders and the CBOT's futures traders will have direct, instantaneous access to
both markets. This product will be available through the eSpeed(R) SuperQuads
software.
Also in December 2002, we acquired the technology to route equities order flow
directly to listed exchanges and ECNs, either as directed by the client or via
automatic order routing, through the acquisition of the business and technology
of TSI Holdings, Inc., known as TradeAnywhere. In 2002, we became a recognized
service bureau for the New York Stock Exchange and American Stock Exchange. We
intend to capitalize on this recognized service bureau status by leasing
telecommunications capacity to other firms which will use it to transmit orders
to the exchanges.
4
PRODUCT ENHANCEMENT SOFTWARE
We recently introduced the following three significant software enhancements --
SuperQuads, Price Improvement and Direct Dealing -- that will enable our clients
to engage in the electronic trading of our core products and future product
rollouts.
o SuperQuads is a new screen configuration that allows for the introduction
of additional markets and products on the eSpeed(R) system. For example,
through our agreement with the Chicago Board of Trade, SuperQuads will
enable us to route CBOT's treasury futures traders over its existing
network and will offer front end integration to clients. Customers will
have the ability to trade both cash and futures in one neutral,
fully-electronic marketplace. It will allow for network distribution and
seamless front office integration, as well as positioning ourselves in this
new market segment. We expect to release this product in the second quarter
of 2003.
o Price Improvement is an enhancement for trading products on our
eSpeed(R) system that gives users the opportunity to trade past a bid or
offer, from bid/ask state, and advance their position by slightly improving
on the quoted market. The enhancement was designed to make trading more
efficient, bringing buyers and sellers closer to the desired trading state,
and positions us to share in the revenues generated by the improved trades.
o Direct Dealing allows users to put in a request for a quote for specific
products, providing the trader with the ability to reach market
participants with an electronic request for interest in specific securities
for which the trader has defined sizes. Direct Dealing maintains the
trader's anonymity, allows the trader to determine a set amount of time for
the request to be filled and treats all participants equally. Direct
Dealing is especially useful for trading in large blocks, helping to
eliminate unwanted market movement and bringing with it electronic
efficiency to less liquid markets.
ESPEED SOFTWARE SOLUTIONS(SM)
eSpeed Software Solutions(SM) leverages our global infrastructure, portfolio of
intellectual property and electronic trading expertise to allow customers to
build electronic marketplaces and exchanges, enable real-time auctions, enhance
debt issuance and customize trading interfaces. eSpeed Software Solutions(SM)
takes advantage of the scalability, flexibility and functionality of our
eSpeed(R) system to enable our clients to distribute their branded products to
their customers through online offerings and auctions, including private and
reverse auctions, via our trading platform and global network. Using
eSpeed Software Solutions(SM), customers are able to develop a marketplace,
trade with its customers, issue debt, trade odd lots, access program trading
interfaces, and access our network and our intellectual property.
We have signed software solution agreements with Refco Securities and the
Federal Home Loan Bank. Refco Securities operates a global securities futures
brokerage business. eSpeed Software Solutions(SM) has developed a front end
trading system for Refco Securities that enables it to communicate its prices
for securities products to its customers. The Federal Home Loan Bank is a U.S.
Government sponsored enterprise and one of the largest issuers in the global
short-term securities market. Our electronic auction-based technology began
powering the Federal Home Loan Bank's primary discount note auctions in August
2002.
We have also entered into long-term licensing agreements with respect to our
patents and other intellectual property, including a license agreement with
InterContinentalExchange Inc. and as well as licenses to the Chicago Mercantile
Exchange Inc. and the Board of Trade of the City of Chicago.
Additionally, we have an agreement whereby the New York Board of Trade, through
its subsidiaries, will provide clearing and regulatory services and we will
provide electronic execution and related services for the U.S. futures exchange,
currently known as the Cantor Exchange(SM), the first fully electronic futures
exchange in the U.S. Currently, the Cantor Exchange(SM) has obtained regulatory
authority to operate in the United Kingdom, Denmark, Finland, France, Hong Kong,
Ireland, Italy, Japan, Norway, Portugal and in eight German states. This
business was suspended after the September 11 Events. While we are in the
process of evaluating our business plan with respect to our operation of the
Cantor Exchange(SM), we are confident that our eSpeed(R) system will continue to
provide us with major opportunities for the electronic trading of a broad range
of futures contracts globally, including opportunities like our futures
agreement with CBOT.
5
OUR TECHNOLOGY
Our eSpeed(R) system is accessible to our clients through (1) our proprietary
front-end trading software, (2) our application programming interface (API),
which is a dedicated software application linking our clients' networks to our
system, (3) the Web, via a browser interface or Java application, and (4)
software developed in alliances with independent software vendors. Our system
runs on large-scale hardware located in data centers in the U.S. and the U.K.
and is distributed either over our multiple path global network or via the
Internet through links to multiple global Internet service providers.
Our electronic marketplaces operate on a technology platform and network that
emphasize scalability, performance, adaptability and reliability. Our technology
platform consists of:
o our proprietary, internally developed real-time installed global network
distribution system;
o our proprietary transaction processing software, which includes interactive
matching auction engines, fully integrated credit and risk management
systems, pricing engines and associated middle and back-office operations
systems;
o client interfaces ranging from Windows, Java, UNIX, our proprietary API and
proprietary vendor access; and
o customized inventory distribution and auction protocols designed to be used
by our clients and partners in their distribution and trading systems.
Together, these components enable our clients to effect transactions in
real-time, with straight-through processing.
Network distribution system
Our eSpeed(R) system contains a proprietary hub-and-spoke digital network. This
network uses Cisco Systems' network architecture and is operated by
Cisco-certified engineers. Our network's high-speed points of presence comprise
the major business centers of the world, including New York, London, Tokyo,
Milan, Chicago, Los Angeles and Toronto. Altogether, we manage 24 hubs linked by
over 50,000 miles of cable, over 500 Cisco network devices and more than 700
high capacity Sun servers and Compaq Alpha servers located in data centers in
London and Rochelle Park, New Jersey that are able to process over 150
transactions per second, per instrument or product. The redundant structure of
our system provides multiple backup paths and re-routing of data transmission if
one spoke of a hub fails. We believe we operate one of the largest and most
robust interactive trading network distribution systems currently in operation.
Our distribution system accepts orders and postings instantaneously and
distributes responses, generally in under 300 milliseconds. We estimate that our
network is currently running at approximately 15% of capacity.
In addition to our own network system, we also receive and distribute secure
trading information from clients using the services of multiple, major Internet
service providers throughout the world. These connections enable us to offer our
products and services via the Internet to our global clients.
Transaction processing software
Most of our software applications have been developed internally and are central
to the success of our eSpeed(R) system. Our auction and trading engines operate
in real time, facilitating efficient interaction between buyers and sellers. Our
credit and risk management systems monitor and regulate these buyers and
sellers. Our pricing engines provide prices for illiquid financial products
derived from multiple trades in other related financial instruments. These
critical applications work together seamlessly and are supported by middle and
back office software that verifies, confirms, reports, stores, tracks and, if
applicable, enables the settlement of each transaction. Our transaction
processing software includes verification mechanisms at various stages of the
execution process, which result in significantly reduced manual intervention,
decreased probability of erroneous trades and more accurate execution for
clients.
eSpeed(R) transaction engines
Our auction and transaction engines use Interactive Matching(SM), our
proprietary rules-based method, to process in excess of 150 transactions per
second per auction, instrument or product. These engines were developed to
support trading in the largest capital markets in the world, such as government
bonds and futures contracts, and the more diverse, fragmented and database
intensive markets, such as U.S. municipal bonds (with over 1.7 million different
issues), corporate bonds and Eurobonds. These transaction engines are designed
to be modular and flexible to allow modification in order to apply them to other
markets and auction types. In Europe, for example, we have added a component
that allows us to process transactions and auctions in multiple currencies
6
simultaneously. Our transaction engines have embedded security features and an
added messaging layer to provide security from unauthorized use. In addition, we
use encryption to protect our clients that transact business over the Internet.
We believe our marketplace expertise and rules-based systems provide incentives
for clients to actively participate in our marketplaces. For example,
Interactive Matching(SM) provides incentives to participate in our marketplaces
by encouraging participants to expose their orders to the market. In standard
auctions, the incentive is for participants to wait until the last moment to
make a bid or offer. Our priority rules encourage trading activity by giving the
last successful active participant a time-based right of first refusal on the
next sale or purchase. In addition, in many markets we have structured our
pricing policy to provide incentives. The party that provides auction products
for the market or creates liquidity (by inputting a price to buy or sell) pays
less commission (or no commission) than the participant that consummates the
trade by acting on that price. With our pricing policies and proprietary
priority rules, our system is designed to increase activity and to draw
participants into the market. This proprietary rules-based system is adaptable
and, as part of our business strategy, we intend to apply it across other
non-financial markets for multiple products and services.
eSpeed Credit Master(SM) - credit and risk management systems
Our credit and risk management systems have been an important part of the
operation of our electronic marketplaces and were withdrawn from the market as a
result of the terrorist attacks on September 11, 2001. We plan to reintroduce
them throughout 2003. These systems (1) continuously monitor trades of our
clients to help prevent them from exceeding their credit limits, (2)
automatically prevent further trading once a client has reached a pre-determined
credit limit and (3) evaluate transactions and calculate both individual
positions and risk exposure across various products and credit limits. Once
re-implemented, our proprietary credit and risk management systems will also be
made available to our global clients to enable them to monitor the position of
their traders and will be integrated with our software solution systems so our
global clients can monitor the credit of their customers who transact directly
with them online. These systems will store client data relevant to credit and
risk management, such as financial statements, credit documents, contacts and
internal analyses. These systems will also enable our clients to make our
electronic marketplaces available to their customers while maintaining control
of their customers' trading activity and risk.
eSpeed Name Give-Up Matrix(SM) - credit monitoring
Through the use of our name give-up matrix, we enable our market participants to
create counterparty credit exposure limits to manage the counterparties with
which they transact in non-central counterparty markets. In these markets,
participants settle transactions directly with other participants. Using this
module, the participants can pre-select the counterparties that they are willing
to transact with in that market. The module displays all prices to market
participants, and highlights and enables execution on prices that are from
approved counterparties. Additionally, the module has features that permit each
participant to manage the activities of its traders on a real-time basis.
eSpeed(R) pricing engines and analytics
We have developed a number of analytical software tools that permit us to price
products that trade in less liquid markets and for which current pricing
information is not readily available. For example, our MOLE(SM) system (Multiple
Order Link Engine) is a computer application that enables us to link multiple
markets, offer prices and create and enhance marketplaces for products that have
limited liquidity. In our financial markets, MOLE(SM) currently uses data from
existing cash and futures markets to calculate pricing for transactions where no
market prices currently exist, thereby facilitating liquidity. These
multi-variable trades are extremely difficult to execute in voice-based markets
due to their complexity and the slow speed of manual execution.
eSpeed(R) middle and back-office applications
Our middle and back-office applications support clearance, settlement, tracking
and reporting of trades and provide links to outside clearing entities. For
example, in the financial markets, we outsource our fulfillment services to
Cantor and Freedom (for Canadian markets), where both parties to a trade send
either cash or securities to Cantor or Freedom and Cantor or Freedom settles the
trade and sends each party the cash or securities due. Our reporting and
accounting systems are designed to track and record all charges and commissions
for a trade. Our eSpeed(R) system and products automate previously paper and
telephone-based transaction processing, confirmation and other functions,
substantially improving and reducing the cost of many of our clients' back
offices, and enabling straight-through processing.
OUR GROWTH STRATEGY
Our objective is to be the world's leading provider of interactive electronic
marketplaces and related software solutions to a broad range of industries and
marketplaces. We believe we can extend our expertise in the creation of
instantaneous electronic marketplaces to a broad range of products and services.
Our growth strategy to achieve this objective includes the following key
elements:
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EXPAND SYSTEM FUNCTIONALITY AND DEVELOP NEW PRODUCTS, SOFTWARE AND SERVICES FOR
OUR EXISTING FINANCIAL MARKETS
We plan to continue to expand the types of financial and other products traded
in our marketplaces, both in the United States and abroad. In 2003 we will roll
out products in U.S. agencies, off-the-run U.S. Treasury securities, spreads,
and basis trading of U.S. Treasuries, municipal bonds, interest rate swaps and
foreign exchange. Our goal is to include in our electronic marketplaces the full
range of financial products that are currently traded in today's non-equity
capital markets worldwide. In addition, we plan to develop software and
services to add new methods to effect transactions in these products, including
our SuperQuads, Price Improvement and Direct Dealing software enhancements. We
expect that our traditional client base will begin to trade new products as we
develop electronic marketplaces for them, and we intend to continue to convert
our existing global clients to our fully electronic platform.
LEVERAGE OUR ESPEED(R) SYSTEM FOR USE IN A WIDE RANGE OF ADDITIONAL NON-EQUITY
CAPITAL MARKETS AND OTHER INDUSTRIES
Because of the scale of our system and infrastructure and its ease of
adaptability, we believe our eSpeed(R) system has applications across a broad
range of products, including Internet-based marketplaces for a wide array of
goods and services, particularly those involving multiple buyers and sellers. We
believe we are well positioned to leverage the significant costs and efforts
that have been incurred developing our eSpeed(R) system to quickly create
electronic markets in a wide range of products. We plan, over time, to serve
additional marketplaces that can benefit from more efficient, centralized,
electronic trading facilities. We plan to continue to expand our eSpeed(R)
system across the financial markets and their products.
LICENSE OUR SOFTWARE TO PROVIDE A BROAD RANGE OF MARKET PARTICIPANTS WITH AN
OUTSOURCED SOLUTION FOR ONLINE DISTRIBUTION OF THEIR PRODUCTS
We provide a complete outsourced solution to our clients to enable them to
distribute their branded products to their customers through online offerings,
auctions, including private and reverse auctions, and direct dealing
capabilities. We are rebuilding our dedicated sales force that will focus on
licensing our software solutions to existing and new clients.
PURSUE STRATEGIC ALLIANCES AND ACQUISITIONS
We are continually exploring opportunities to maximize our growth, including
acquisitions, strategic alliances, joint ventures, private placements,
recapitalizations or any combination of the foregoing, to expand our vertical
markets and generate future growth. We are seeking to enter into joint ventures
and other strategic alliances to create liquidity in new and existing product
markets, to utilize our patents in such ventures and strategic alliances and to
attract new participants to trade products in those markets. We have employed
this strategy in our alliance with Freedom and in our other ventures.
OUR CLIENTS
Our clients in our financial markets include banks, dealers, brokers and other
wholesale market participants, over 700 of which currently participate in our
electronic marketplaces, including most of the largest bond trading firms in the
world, as identified by Euromoney Magazine. Our clients in our energy markets
include energy trading companies, utilities and other wholesale market
participants.
We are providing wholesale and retail investors access to the electronic
marketplaces and brokerage-related services supported by our eSpeed(R) system.
We expect that a significant portion of our clients who use brokers will migrate
to fully electronic access over the coming years. We also expect to add clients
for eSpeed Software Solutions(SM) from a wide variety of industries. In
addition, due to the loss of virtually all of Cantor's U.S. non-equity voice
brokerage business in connection with the terrorist attacks of September 11,
2001, we intend to build relationships with new clients, including traditional
competitors of Cantor. We further intend to provide third parties with the
infrastructure, including systems administration, internal network support and
operations and disaster recovery services, that is critical to providing fully
electronic marketplaces in a wide variety of products. Other than Cantor, no
client of ours accounts for more than 10% of our revenues.
SALES, MARKETING AND CORPORATE DEVELOPMENT
We promote our electronic marketplaces and services to our existing and
prospective clients through a combination of sales, marketing and co-marketing
campaigns. We leverage our client relationships through a variety of direct
marketing and sales initiatives and build and enhance our brand image through
marketing and communications campaigns targeted at a diverse audience, including
traders, potential partners and the investor and press communities. We may
market to our existing and prospective retail clients through a
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variety of co-marketing/co-branding initiatives with our online partners. We
have designed our sales and marketing efforts to promote brand awareness and
educate our audience regarding the nature of our electronic marketplaces,
products and services and the advantages associated with the automation of
trading activities, as well as our association with Cantor.
Additionally, our senior management staff actively works to establish strategic
relationships, develop new markets for our technology and structure and execute
investments and acquisitions. Our staff promotes eSpeed at conferences,
conventions, events and speaking engagements that advance both our technology
and our brand name. In many cases, these engagements are focused within specific
vertical markets that we intend to develop in the future. All of these efforts
are intended to enhance our image, awareness and profitability.
SOFTWARE DEVELOPMENT
We devote substantial efforts to the development and improvement of our
electronic marketplaces and licensed software products. We work with our clients
to identify their specific requirements and make modifications to our software,
network distribution systems and technologies that are responsive to those
needs. Our research and development efforts focus on internal development,
strategic partnering, acquisitions and licensing. Although we lost many
technology professionals and software developers on September 11, 2001, we
continue to employ over 266 technology professionals. Our technology team's
objective is to develop new products and services in order to provide superior
electronic marketplace solutions to our clients. We also focus our efforts on
enhancing our Internet interfaces to facilitate real-time markets and comply
with the standard Internet security protocol and future security protocols in
order to capitalize on the development of new commercial marketplaces. We are
continuing to develop new marketplaces and products using our internally
developed application software. In addition, we have forged strategic alliances
with third-party independent software vendors through which we will work to
develop sophisticated, industry specific, front-end applications and products.
COMPETITION
The development and operation of electronic marketplaces are evolving. As a
result, competition in these marketplaces is currently fragmented. We expect to
face competition from a number of different sources varying in size, business
objectives and strategy, some of which competitors are larger than we are and
have greater financial resources.
Our current and prospective competitors are numerous and include inter-dealer
brokerage firms, market data and information vendors, securities and futures
exchanges, electronic communications networks, crossing systems, consortia,
business-to-business marketplace infrastructure and software companies and niche
energy market and other commodity business-to-business Internet-based trading
systems. In January 2003, ICAP and BrokerTec Global, two of our largest
competitors, entered into an agreement by which ICAP would acquire certain
businesses of BrokerTec Global involving electronic trading of government
securities. The acquisition is conditional upon regulatory approval in the
United States and, if approved, could have a significant impact on our
competitive position.
The electronic marketplace solutions we provide to our clients enable them to
expand the range of services they provide to their ultimate customers, which are
also potential participants in our electronic marketplaces. We intend to
structure our relationships with our clients and conduct our operations to
mitigate the potential for this competition. We do not intend to use the access
to the customer base of our clients that we obtain in providing our electronic
marketplace solutions to compete with these clients in other product
transactions.
We believe our electronic marketplaces compete primarily on the basis of speed,
functionality, efficiency, price, system stability and ability to provide market
participants with access to liquidity.
OUR INTELLECTUAL PROPERTY
We have adopted a comprehensive intellectual property program to protect our
proprietary technology. We currently have licenses covering four of Cantor's
patents in the U.S. One patent relates to a data processing system and method
for electronically trading select items such as fixed income instruments. Two
patents relate to a fixed income portfolio index processor. One patent relates
to a system for shared remote access of multiple application programs by one or
more computers. Foreign counterpart applications for some of these U.S. patents
have been filed. The licenses are exclusive, except in the event that we do not
seek to or are unable to provide to Cantor any requested services covered by the
patents and Cantor elects not to require us to do so.
In April 2001, we purchased the Wagner Patent, which addresses automated futures
trading and provides for bids and offers to be placed and matched
electronically. In August 2002, we entered into a Settlement Agreement with
Electronic Trading Systems Corporation, the Chicago Mercantile Exchange Inc. and
the CBOT to resolve the litigation related to the Wagner Patent.
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See "Item 3. Legal Proceedings". On March 29, 2002, we entered into a long term
licensing agreement with IntercontinentalExchange, Inc. (ICE) granting use of
our Wagner Patent to ICE. Under the terms of the agreement, ICE will pay an
annual royalty of $2 million per year. ICE will also pay to us $0.10 for each
contract that participants submit to the electronic futures exchange for
trading, or $0.20 for each contract contained in matched trades on the
electronic futures exchange. To date, we have not received any per contract
revenue from this arrangement. The agreement will remain in effect until
February 7, 2007, or for the duration of the life of the patent, unless certain
conditions are not met. In December 2002, we entered into an agreement with the
Chicago Board of Trade to distribute futures products over our eSpeed(R) system.
In July 2001, we purchased a patent, the Lawrence Patent, which relates to the
electronic trading of municipal bonds and electronic auctions of fixed income
securities and interest rate products. Auction-based trading allows
broker-dealers and their customers to send our "bid-wanted" forms listing the
available securities, then to accept bids with a final auction time. The
Lawrence Patent brings additional efficiencies to the auctioned markets by,
among other things, enabling potential buyers to electronically place bids
securely and anonymously.
We also have an agreement to license several pending U.S. patent applications
relating to various other aspects of our electronic trading systems, including
both functional and design aspects. We have filed a number of patent
applications to further protect our proprietary technology and innovations.
We cannot at this time determine the significance of any of the foregoing
patents, or future patents, if issued, to our business. We can give no assurance
that any of the foregoing patents will be found by a court to be valid and
enforceable, or that any of these patents would not be infringed by a third
party competing or seeking to compete with our business. Our business strategy
may include licensing such patents for royalties, joint venturing with other
marketplaces or exchanges, or exclusively using the patents in our marketplaces.
EMPLOYEES
As of December 31, 2002, we had 319 employees, five of whom are our executive
officers. None of these employees is represented by a union. We believe that we
have good relations with our employees.
WEBSITE ACCESS TO REPORTS
Our Internet website address is www.espeed.com. Through our Internet website, we
make available, free of charge, the following reports as soon as reasonably
practicable after electronically filing them with, or furnishing them to, the
SEC: our annual report on Form 10-K; our quarterly reports on Form 10-Q; our
current reports on Form 8-K; and amendments to those reports filed or furnished
pursuant to Section 13(a) of the Securities Exchange Act of 1934. Our Proxy
Statements for our Annual Meetings are also available through our Internet
website. Our Internet website and the information contained therein or connected
thereto are not intended to be incorporated into this Annual Report on Form
10-K.
RISK FACTORS
In addition to the other information in this Report, the following risk factors
should be considered carefully in evaluating us and our business.
RISKS RELATED TO OUR BUSINESS
THE EVENTS OF SEPTEMBER 11, 2001 HAVE HAD AND MAY CONTINUE TO HAVE AN ADVERSE
EFFECT ON OUR BUSINESS.
Our losses
Our previous headquarters were in the World Trade Center. As a result of the
September 11 Events, our offices in the World Trade Center were destroyed and we
lost approximately 180 of our employees, including many members of our senior
management. The destruction of our assets, the loss of all those employees,
including product development personnel, and the need to relocate the surviving
employees has negatively impacted our business. In addition, although we still
have redundancy of our system, we now have two data centers instead of the three
that we had prior to the September 11 Events.
Cantor's losses
Cantor and TradeSpark lost an aggregate of 478 employees and equipment and
systems as a result of the September 11 Events. Cantor also lost its
headquarters. Such losses have negatively impacted our revenues and may continue
to adversely impact our revenues in the future since, among other things, Cantor
is not currently trading many of the financial products its voice brokers
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historically traded using our eSpeed(R) system. In addition, the loss of
Cantor's assets and brokers will negatively affect our strategy to convert the
products that those brokers were trading in voice-assisted transactions to
products that are traded fully electronically over our eSpeed(R) system.
WE MAY INCUR LOSSES IN THE FUTURE.
From our inception through December 31, 2002, we have sustained a cumulative net
loss of approximately $49.4 million. While we currently expect to generate
operating profits in the year 2003, as we continue to develop our systems and
infrastructure and expand our brand recognition and client base through
increased marketing efforts, we may incur additional losses.
IF WE DO NOT EXPAND THE USE OF OUR ELECTRONIC SYSTEMS, OR IF OUR CLIENTS DO NOT
USE OUR MARKETPLACES OR SERVICES, OUR REVENUES AND PROFITABILITY WILL BE
ADVERSELY AFFECTED.
The use of electronic marketplaces is relatively new. The success of our
business plan depends, in part, on our ability to maintain and expand the
network of trading firms, dealers, banks and other financial institutions that
use our interactive electronic marketplaces. We cannot assure you that we will
be able to continue to expand our marketplaces, or that we will be able to
retain the current participants in our marketplaces. Although some of our
agreements with market participants require certain minimum payments, none of
our agreements with market participants require them to use our electronic
marketplaces.
IF WE ARE UNABLE TO ENTER INTO ADDITIONAL MARKETING AND STRATEGIC ALLIANCES OR
OUR CURRENT OR FUTURE STRATEGIC ALLIANCES ARE NOT SUCCESSFUL, WE MAY NOT
GENERATE INCREASED TRADING IN OUR ELECTRONIC MARKETPLACES.
We expect to continue to enter into strategic alliances with other market
participants, such as retail brokers, exchanges, energy companies, market
makers, consortia, clearinghouses, major market participants and technology
companies, in order to increase client access to and use of our electronic
marketplaces. We cannot assure you that we will be able to continue to enter
into these strategic alliances on terms that are favorable to us, or at all. In
addition, we cannot assure you that our current or future strategic alliances
will be successful. The success of our current and future relationships will
depend on the amount of increased trading in our electronic marketplaces and the
liquidity generated therein. These arrangements may not generate the expected
number of new clients or increased trading volume we are seeking.
As a result of the downturn of the energy market and the performance of
TradeSpark, our investment in TradeSpark has become impaired and has been
written down to its net realizable value.
TO INCREASE AWARENESS OF OUR ELECTRONIC MARKETPLACES, WE MAY NEED TO INCUR
SIGNIFICANT MARKETING EXPENSES.
To successfully execute our business plan, we must build awareness and
understanding of our electronic marketplace services, software products, brand
and the adaptability of our electronic marketplaces for non-financial vertical
markets. In order to build this awareness, our marketing efforts must succeed
and we must provide high quality services. These efforts may require us to incur
significant expenses. We cannot assure you that our marketing efforts will be
successful or that the allocation of funds to these marketing efforts will be
the most effective use of those funds.
IF WE EXPERIENCE COMPUTER SYSTEMS FAILURES OR CAPACITY CONSTRAINTS, OUR ABILITY
TO CONDUCT OUR OPERATIONS COULD BE HARMED.
We internally support and maintain many of our computer systems and networks.
Our failure to monitor or maintain these systems and networks or, if necessary,
to find a replacement for this technology in a timely and cost-effective manner
would have a material adverse effect on our ability to conduct our operations.
We also rely and expect to rely on third parties for various computer and
communications systems, such as telephone companies, online service providers,
data processors, clearance organizations and software and hardware vendors. Our
systems, or those of our third-party providers, may fail or operate slowly,
causing one or more of the following:
o unanticipated disruptions in service to our clients;
o slower response times;
o delays in our clients' trade execution;
o failed settlement of trades;
o incomplete or inaccurate accounting, recording or processing of trades;
11
o financial losses;
o litigation or other client claims; and
o regulatory sanctions.
We experienced systems and telecommunications failures in connection with the
terrorist attacks of September 11, 2001. We cannot assure you that we will not
experience additional systems failures in the future from power or
telecommunications failure, acts of God or war, terrorist attacks, human error,
natural disasters, fire, power loss, sabotage, hardware or software malfunctions
or defects, computer viruses, intentional acts of vandalism and similar events.
Any system failure that causes an interruption in service or decreases the
responsiveness of our service, including failures caused by client error or
misuse of our systems, could damage our reputation, business and brand name.
IF WE DO NOT EFFECTIVELY MANAGE OUR GROWTH, OUR EXISTING PERSONNEL AND SYSTEMS
MAY BE STRAINED AND OUR BUSINESS MAY NOT OPERATE EFFICIENTLY.
In order to execute our business plan, we must grow significantly. This growth
will place significant strain on our personnel, management systems and
resources. We expect that the number of our employees, including technical and
management-level employees, will increase for the foreseeable future. We must
continue to improve our operational and financial systems and managerial
controls and procedures, and we will need to continue to expand, train and
manage our technical workforce. We must also maintain close coordination among
our technical, compliance, accounting, finance, marketing and sales
organizations. We cannot assure you that we will manage our growth effectively,
and failure to do so could result in our business operating inefficiently.
WE OPERATE IN A RAPIDLY EVOLVING BUSINESS ENVIRONMENT. IF WE ARE UNABLE TO ADAPT
OUR BUSINESS EFFECTIVELY TO KEEP PACE WITH THESE CHANGES, OUR OPERATIONS WILL BE
ADVERSELY AFFECTED.
The pace of change in our market is extremely rapid. Operating in such a
rapidly-changing business environment involves a high degree of risk. Our
success will depend on our ability to adapt effectively to these changing market
conditions.
IF WE ARE UNABLE TO KEEP UP WITH RAPID TECHNOLOGICAL CHANGES, WE MAY NOT BE ABLE
TO COMPETE EFFECTIVELY.
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality, accessibility and features of our proprietary
software, network distribution systems and technologies. The financial services
and e-commerce industries are characterized by rapid technological changes,
changes in use and client requirements and preferences, frequent product and
service introductions embodying new technologies and the emergence of new
industry standards and practices that could render our existing proprietary
technology and systems obsolete. Our success will depend, in part, on our
ability to:
o develop and license leading technologies useful in our business;
o enhance our existing services;
o develop new services and technologies that address the increasingly
sophisticated and varied needs of our existing and prospective clients; and
o respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis.
The development of proprietary electronic trading technology entails significant
technical, financial and business risks. Further, the adoption of new Internet,
networking or telecommunications technologies may require us to devote
substantial resources to modify and adapt our services. We cannot assure you
that we will successfully implement new technologies or adapt our proprietary
technology and transaction-processing systems to client requirements or emerging
industry standards. We cannot assure you that we will be able to respond in a
timely manner to changing market conditions or client requirements.
IF WE WERE TO LOSE THE SERVICES OF MEMBERS OF MANAGEMENT AND EMPLOYEES WHO
POSSESS SPECIALIZED MARKET KNOWLEDGE AND TECHNOLOGY SKILLS, WE MAY NOT BE ABLE
TO MANAGE OUR OPERATIONS EFFECTIVELY OR DEVELOP NEW ELECTRONIC MARKETPLACES.
Our future success depends, in significant part, on the continued service of
Howard Lutnick, our Chairman, Chief Executive Officer and President, and our
other executive officers and managers and sales and technical personnel who
possess extensive knowledge and technology skills in our markets. We cannot
assure you that we would be able to find an appropriate replacement
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for Mr. Lutnick if the need should arise. Any loss or interruption of Mr.
Lutnick's services could result in our inability to manage our operations
effectively and/or develop new electronic marketplaces. We have not entered into
employment agreements with any of our executive officers or other personnel.
Although we have obtained $15 million in "key person" life insurance on the life
of Mr. Lutnick, we do not have "key person" life insurance policies on any of
our other executive officers or personnel. All of the members of our senior
management team are also officers, partners or key employees of Cantor. As a
result, they dedicate only a portion of their professional efforts to our
business and operations. We cannot assure you that the time these persons devote
to our business and operations in the future will be adequate and that we will
not experience an adverse effect on our operations due to the demands placed on
our management team by their other professional obligations. We intend to strive
to provide high quality services that will allow us to establish and maintain
long-term relationships with our clients. Our ability to do so will depend, in
large part, upon the individual employees who represent us in our dealings with
clients. The market for qualified programmers, technicians and sales persons is
extremely competitive and has grown more so in recent periods as electronic
commerce has experienced growth. We cannot assure you that we will be successful
in our efforts to recruit and retain the required personnel.
IF CANTOR OR WE ARE UNABLE TO PROTECT THE INTELLECTUAL PROPERTY RIGHTS WE
LICENSE FROM CANTOR OR OWN, OUR ABILITY TO OPERATE ELECTRONIC MARKETPLACES MAY
BE MATERIALLY ADVERSELY AFFECTED.
Our business is dependent on proprietary technology and other intellectual
property rights. We license some of our patented technology from Cantor. The
license arrangement is exclusive, except in the event that (1) we are unwilling
to provide to Cantor any requested services covered by the patents with respect
to a marketplace and Cantor elects not to require us to do so, or we are unable
to provide such services or (2) we do not exercise our right of first refusal to
provide to Cantor electronic brokerage services with respect to a marketplace,
in which case Cantor retains a limited right to use the patents and patent
applications solely in connection with the operation of that marketplace. We
cannot guarantee that the concepts which are the subject of the patents and
patent applications covered by the license from Cantor or that we own are
patentable or that issued patents are or will be valid and enforceable. Where
patents are granted in the U.S., we can give no assurance that equivalent
patents will be granted in Europe or elsewhere, as a result of differences in
local laws affecting patentability and validity. Moreover, we cannot guarantee
that Cantor's issued patents or our issued patents are valid and enforceable, or
that third parties competing or intending to compete with us will not infringe
any of these patents. Despite precautions we or Cantor has taken or may take to
protect our intellectual property rights, it is possible that third parties may
copy or otherwise obtain and use our proprietary technology without
authorization. It is also possible that third parties may independently develop
technologies similar to ours. It may be difficult for us to monitor unauthorized
use of our proprietary technology and intellectual property rights. We cannot
assure you that the steps we have taken will prevent misappropriation of our
technology or intellectual property rights.
We use our eSpeed(R) registered service mark for the services described herein
and have registered that service mark in a number of jurisdictions around the
world. Although several existing third-party registrations and applications for
trademarks and servicemarks consisting of designations similar to ours in
certain countries have come to light, they are for goods and services that are
of a different type from those being offered under our eSpeed(R) registered
service mark. Although we are not presently aware of any third-party objections
to our use or registration of our eSpeed(R) registered service mark in these
countries, and believe we could defend against any third-party claims asserted
in these countries, such registrations and applications could potentially affect
the registration, and/or limit our use, of our eSpeed(R) registered service mark
in these countries, thereby requiring us to adopt and use another service mark
for our services in such countries.
WE HAVE HAD TO RESORT TO COSTLY LITIGATION TO PROTECT AND DEFEND CERTAIN OF OUR
INTELLECTUAL PROPERTY RIGHTS, AND MAY CONTINUE TO HAVE TO DO SO.
We have had to resort to costly litigation to enforce certain of our
intellectual property rights. We may have to continue to resort to litigation to
protect our trade secrets, determine the validity and scope of the proprietary
rights of others or defend ourselves from claims of infringement, invalidity or
unenforceability. We may incur substantial costs and diversion of resources as a
result of litigation, even if we win. In the event we do not win, we may have to
enter into royalty or licensing agreements. We cannot assure you that an
agreement would be available to us on reasonable terms, if at all.
IF OUR SOFTWARE LICENSES FROM THIRD PARTIES ARE TERMINATED, OUR ABILITY TO
OPERATE OUR BUSINESS MAY BE MATERIALLY ADVERSELY AFFECTED.
We license database and other software from third parties, much of which is
integral to our systems and our business. The licenses are terminable if we
breach our obligations under the license agreements. If any of these
relationships were terminated or if any of these third parties were to cease
doing business, we may be forced to spend significant time and money to replace
the licensed software. However, we cannot assure you that the necessary
replacements will be available on reasonable terms, if at all.
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IF THE STRENGTH OF OUR DOMAIN NAMES IS DILUTED, THE VALUE OF OUR PROPRIETARY
RIGHTS MAY DECREASE.
We own many Internet domain names, including "www.espeed.com." The regulation of
domain names in the U.S. and in foreign countries may change and the strength of
our names could be diluted. We may not be able to prevent third parties from
acquiring domain names that infringe or otherwise decrease the value of our
trademarks and other proprietary rights.
IF WE INFRINGE ON PATENT RIGHTS OR COPYRIGHTS OF OTHERS, WE COULD BECOME
INVOLVED IN COSTLY LITIGATION.
Patents or copyrights of third parties may have an important bearing on our
ability to offer certain of our products and services. We cannot assure you that
we are or will be aware of all patents or copyrights containing claims that may
pose a risk of infringement by our products and services. In addition, patent
applications in the U.S. are generally confidential until a patent is issued. As
a result, we cannot evaluate the extent to which our products and services may
be covered or asserted to be covered by claims contained in pending patent
applications. In general, if one or more of our products or services were to
infringe patents held by others, we may be required to stop developing or
marketing the products or services, to obtain licenses to develop and market the
services from the holders of the patents or to redesign the products or services
in such a way as to avoid infringing on the patent claims, which could limit the
manner in which we conduct our operations.
DUE TO INTENSE COMPETITION, OUR MARKET SHARE AND FINANCIAL PERFORMANCE COULD
SUFFER.
The electronic trading and Internet-based financial and non-financial services
markets are highly competitive and many of our competitors are more established
and have greater financial resources than us. We expect that competition will
intensify in the future. Many of our competitors also have greater market
presence, engineering and marketing capabilities and technological and personnel
resources than we do. As a result, as compared to us, our competitors may:
o develop and expand their network infrastructures and service offerings more
efficiently or more quickly;
o adapt more swiftly to new or emerging technologies and changes in client
requirements;
o take advantage of acquisitions and other opportunities more effectively;
o devote greater resources to the marketing and sale of their products and
services; and
o leverage existing relationships with clients and strategic partners more
effectively or exploit more recognized brand names to market and sell their
services.
Our current and prospective competitors are numerous and include interdealer
brokerage firms, technology companies and market data and information vendors,
securities and futures exchanges, electronic communications networks, crossing
systems, software companies, consortia, business-to-business marketplace
infrastructure companies and niche market energy and other commodity
business-to-business Internet-based trading systems. In January 2003, ICAP and
BrokerTec Global, two of our largest competitors, entered into an agreement by
which ICAP would acquire certain businesses of BrokerTec Global involving
electronic trading of government securities. The acquisition is conditional upon
regulatory approval in the United States and, if approved, could have a
significant impact on our competitive position.
We believe that we may also face competition from large computer software
companies, media and technology companies and some securities brokerage firms
that are currently our clients.
The number of businesses providing Internet-based financial and non-financial
services is rapidly growing, and other companies, in addition to those named
above, have entered into or are forming joint ventures or consortia to provide
services similar to those provided by us. Others may acquire the capabilities
necessary to compete with us through acquisitions.
In the event we extend the application of our Interactive Matching(SM)
technology to conducting or facilitating auctions of consumer goods and services
over the Internet, we expect to compete with both online and traditional sellers
of these products and services. The market for selling products and services
over the Internet is new, rapidly evolving and intensely competitive. Current
and new competitors can launch new sites at a relatively low cost. We expect we
will potentially compete with a variety of companies with respect to each
product or service we offer. We may face competition from a number of other
large Internet companies that have expertise in developing online commerce and
in facilitating Internet traffic, which could choose to compete with us either
directly or indirectly through affiliations with other e-commerce companies. We
cannot assure you that we will be able to compete effectively with such
companies.
14
IF WE EXPERIENCE LOW TRADING VOLUME IN PRODUCTS, OUR PROFITABILITY COULD SUFFER.
We have experienced significant fluctuations in the aggregate trading volume of
products being traded in our marketplaces. We expect that fluctuations in the
trading volume of products traded in our marketplaces will occur in the future
from time to time and have a direct impact on our future operating results. This
may cause significant fluctuations in our profitability when the trading volumes
are low.
IF ADVERSE ECONOMIC AND POLITICAL CONDITIONS OCCUR, SUBSTANTIAL DECLINES IN THE
U.S. AND GLOBAL FINANCIAL SERVICES MARKETS MAY RESULT AND OUR PROFITABILITY
COULD SUFFER.
The global financial services business is, by its nature, risky and volatile and
is directly affected by many national and international factors that are beyond
our control. Any one of these factors may cause a substantial decline in the
U.S. and global financial services markets, resulting in reduced trading volume
and turnover. These events could have a material adverse effect on our
profitability. These factors include:
o economic and political conditions in the U.S. and elsewhere in the world;
o terrorist attacks or war;
o concerns over inflation and wavering institutional/consumer confidence
levels;
o the availability of cash for investment by mutual funds and other wholesale
and retail investors;
o fluctuating interest and exchange rates;
o legislative and regulatory changes; and
o currency values.
IF THERE IS LESS U.S. TREASURY DEBT OUTSTANDING, OR IF OUR SHARE OF THE U.S.
TREASURY MARKET DECLINES, OUR REVENUES MAY BE ADVERSELY AFFECTED.
Our business is highly dependent upon the volume of bonds being traded through
our eSpeed(R) system. We believe that we have historically led the U.S. Treasury
benchmark market, and our revenues are increasingly concentrated in this
business. If the U.S. reduces its outstanding Treasury debt, or if there is
contraction in the U.S. Treasury market, there may be a decline in the volume of
U.S. Treasury securities traded through our eSpeed(R) system. Similarly, if we
were to lose market share in the U.S. Treasury market, our revenues would be
adversely affected.
BECAUSE WE EXPECT TO CONTINUE TO EXPAND OUR OPERATIONS OUTSIDE NORTH AMERICA, WE
MAY FACE SPECIAL ECONOMIC AND REGULATORY CHALLENGES THAT WE MAY NOT BE ABLE TO
MEET.
We operate electronic marketplaces throughout Europe and Asia and we plan to
further expand our operations throughout these regions and other regions in the
future. There are certain risks inherent in doing business in international
markets, particularly in the regulated brokerage industry. These risks include:
o less developed automation in exchanges, depositories and national clearing
systems;
o unexpected changes in regulatory requirements, tariffs and other trade
barriers;
o difficulties in staffing and managing foreign operations;
o fluctuations in exchange rates;
o reduced protection for intellectual property rights;
o seasonal reductions in business activity during the summer months; and
o potentially adverse tax consequences.
15
We are required to comply with the laws and regulations of foreign governmental
and regulatory authorities of each country in which we conduct business. These
may include laws, rules and regulations relating to any aspect of the securities
business, including sales methods, capital structure, record-keeping,
broker-dealer and employee registration requirements and the conduct of
directors, officers and employees. Any failure to develop effective compliance
and reporting systems could result in regulatory penalties in the applicable
jurisdiction.
The growth of the Internet as a means of conducting international business has
also raised many legal issues regarding, among other things, the circumstances
in which countries or other jurisdictions have the right to regulate Internet
services that may be available to their citizens from service providers located
elsewhere. In many cases, there are no laws, regulations, judicial decisions or
governmental interpretations that clearly resolve these issues. This uncertainty
may adversely affect our ability to use the Internet to expand our international
operations, and creates the risk that we could be subject to disciplinary
sanctions or other penalties for failure to comply with applicable laws or
regulations.
AS WE ENTER NEW MARKETS, WE MAY NOT BE ABLE TO SUCCESSFULLY ADAPT OUR TECHNOLOGY
AND MARKETING STRATEGY FOR USE IN THOSE MARKETS.
We are leveraging our eSpeed(R) system to enter new markets. WE cannot assure
you that we will be able to successfully adapt our proprietary software,
electronic distribution networks and technology for use in other markets. Even
if we do adapt our software, networks and technology, we cannot assure you that
we will be able to attract clients and compete successfully in any such new
markets. We cannot assure you that our marketing efforts or our pursuit of any
of these opportunities will be successful. If these efforts are not successful,
we may realize less than expected earnings, which in turn could result in a
decrease in the market value of our Class A common stock. Furthermore, these
efforts may divert management attention or inefficiently utilize our resources.
We intend to create electronic marketplaces for many vertical markets and extend
into others, but there is no guarantee that we will be able to do so.
IF WE ACQUIRE OTHER COMPANIES, WE MAY NOT BE ABLE TO INTEGRATE THEIR OPERATIONS
EFFECTIVELY.
Our business strategy contemplates expansion through the acquisition of
exchanges and other companies providing services or having technologies and
operations that are complementary to ours. Acquisitions entail numerous risks,
including:
o difficulties in the assimilation of acquired operations and products;
o diversion of management's attention from other business concerns;
o assumption of unknown material liabilities of acquired companies;
o amortization of acquired intangible assets, which would reduce future
reported earnings; and
o potential loss of clients or key employees of acquired companies.
We cannot assure you that we will be able to integrate successfully any
operations, personnel, services or products that might be acquired in the
future, and our failure to do so could adversely affect our profitability and
the value of our Class A common stock.
BECAUSE OUR BUSINESS IS SUBJECT TO EXTENSIVE GOVERNMENT AND OTHER REGULATION, WE
MAY FACE RESTRICTIONS WITH RESPECT TO THE WAY WE CONDUCT OUR OPERATIONS.
The Securities and Exchange Commission, NASD Regulation, Inc., Commodity Futures
Trading Commission and other agencies extensively regulate the U.S. financial
industry. Our international operations may become subject to similar regulations
in specific jurisdictions. Certain of our U.S. subsidiaries are required to
comply strictly with the rules and regulations of these agencies. As a matter of
public policy, these regulatory bodies are responsible for safeguarding the
integrity of the securities and other financial markets and protecting the
interests of investors in those markets. Most aspects of our U.S. broker-dealer
subsidiaries are highly regulated, including:
o the way we deal with our clients;
o our capital requirements;
o our financial and Securities and Exchange Commission reporting practices;
o required record keeping and record retention procedures;
16
o the licensing of our employees; and
o the conduct of our directors, officers, employees and affiliates.
If we fail to comply with any of these laws, rules or regulations, we may be
subject to censure, fines, cease-and-desist orders, suspension of our business,
suspensions of personnel or other sanctions, including revocation of
registration as a broker-dealer. Changes in laws or regulations or in
governmental policies could have a material adverse effect on the conduct of our
business. These agencies have broad powers to investigate and enforce compliance
and punish non-compliance with their rules and regulations. We cannot assure you
that we and/or our directors, officers and employees will be able to fully
comply with, and will not be subject to, claims or actions by these agencies.
The products and services we offer through our electronic marketplaces are
likely to be regulated by federal, state and foreign governments. Our ability to
provide such services will be affected by these regulations. In addition, as we
expand our business to other vertical markets, it is likely that we will be
subject to additional federal, state and foreign regulations. The implementation
of unfavorable regulations or unfavorable interpretations of existing
regulations by courts or regulatory bodies could require us to incur significant
compliance costs or cause the development of affected markets to become
impractical.
BECAUSE WE ARE SUBJECT TO RISKS ASSOCIATED WITH NET CAPITAL REQUIREMENTS, WE MAY
NOT BE ABLE TO ENGAGE IN OPERATIONS THAT REQUIRE SIGNIFICANT CAPITAL.
The Securities and Exchange Commission, Commodity Futures Trading Commission and
various other regulatory agencies have stringent rules and regulations with
respect to the maintenance of specific levels of net capital by regulated
companies. Net capital is the net worth of a broker or dealer, less deductions
for certain types of assets. If a firm fails to maintain the required net
capital, it may be subject to suspension or revocation of registration by the
Securities and Exchange Commission or Commodity Futures Trading Commission, and
suspension or expulsion by these regulators could ultimately lead to the firm's
liquidation. If these net capital rules are changed or expanded, or if there is
an unusually large charge against net capital, operations that require the
intensive use of capital would be limited. Also, our ability to withdraw capital
from broker-dealer subsidiaries could be restricted, which in turn could limit
our ability to pay dividends, repay debt and redeem or purchase shares of our
outstanding stock. A large operating loss or charge against net capital could
adversely affect our ability to expand or even maintain our present levels of
business, which could have a material adverse effect on our business. In
addition, we may become subject to net capital requirements in foreign
jurisdictions.
BECAUSE WE OFFER ACCESS TO SOME OF OUR MARKETPLACES TO ONLINE RETAIL BROKERS AND
OTHERS, WE ARE SUBJECT TO RISKS RELATING TO UNCERTAINTY IN THE REGULATION OF THE
INTERNET.
There are currently few laws or regulations that specifically regulate
communications or commerce on the Internet. However, laws and regulations may be
adopted in the future that address issues such as user privacy, pricing,
taxation and the characteristics and quality of products and services. For
example, the Telecommunications Act sought to prohibit transmitting various
types of information and content over the Internet. Several telecommunications
companies have petitioned the Federal Communications Commission to regulate
Internet service providers and other online service providers in a manner
similar to long distance telephone carriers and to impose access fees on those
companies. This could increase the cost of transmitting data over the Internet.
Moreover, it may take years to determine the extent to which existing laws
relating to issues such as property ownership, libel and personal privacy are
applicable to the Internet. Any new laws or regulations relating to the Internet
could adversely affect our business.
BECAUSE BROKERAGE SERVICES INVOLVE SUBSTANTIAL RISKS OF LIABILITY, WE MAY BECOME
SUBJECT TO RISKS OF LITIGATION.
Many aspects of our business, and the businesses of our clients, involve
substantial risks of liability. Dissatisfied clients frequently make claims
regarding quality of trade execution, improperly settled trades, mismanagement
or even fraud against their service providers. We and our clients may become
subject to these claims as the result of failures or malfunctions of systems and
services provided by us and third parties may seek recourse against us. We could
incur significant legal expenses defending claims, even those without merit. An
adverse resolution of any lawsuits or claims against us could result in our
obligation to pay substantial damages.
In addition, we are subject to legal proceedings and claims against Cantor and
its affiliates as a result of the transactions surrounding our formation.
Although Cantor has agreed to indemnify us against claims or liabilities arising
from our assets or operations prior to the formation transactions, we cannot
assure you that such claims or litigation will not harm our business.
17
IF WE CANNOT DETER EMPLOYEE MISCONDUCT, WE MAY BE HARMED.
There have been a number of highly publicized cases involving fraud or other
misconduct by employees in the financial services industry in recent years, and
we run the risk that employee misconduct could occur. Misconduct by employees
could include hiding unauthorized or unsuccessful activities from us. In either
case, this type of conduct could result in unknown and unmanaged risks or
losses. Employee misconduct could also involve the improper use of confidential
information, which could result in regulatory sanctions and serious reputational
harm. It is not always possible to deter employee misconduct, and the
precautions we take to prevent and detect this activity may not be effective in
all cases.
BECAUSE OUR BUSINESS IS DEVELOPING, WE CANNOT PREDICT OUR FUTURE CAPITAL NEEDS
OR OUR ABILITY TO SECURE ADDITIONAL FINANCING.
We anticipate, based on management's experience and current industry trends,
that our existing cash resources will be sufficient to meet our anticipated
working capital and capital expenditure requirements for at least the next 12
months. However, we believe that there are a significant number of capital
intensive opportunities for us to maximize our growth and strategic position,
including, among other things, acquisitions, joint ventures, strategic alliances
or other investments. As a result, we may need to raise additional funds to:
o increase the regulatory net capital necessary to support our operations;
o support more rapid growth in our business;
o develop new or enhanced services and products;
o respond to competitive pressures;
o acquire complementary technologies;
o enter into strategic alliances;
o acquire companies with marketplace or other specific domain expertise; and
o respond to unanticipated requirements.
We cannot assure you that we will be able to obtain additional financing when
needed on terms that are acceptable, if at all.
THE MARKET PRICE OF OUR CLASS A COMMON STOCK HAS FLUCTUATED AND MAY FLUCTUATE IN
THE FUTURE, AND FUTURE SALES OF OUR SHARES COULD ADVERSELY AFFECT THE MARKET
PRICE OF OUR CLASS A COMMON STOCK.
The market price of our Class A common stock has fluctuated widely since our
initial public offering and may continue to fluctuate widely, depending upon
many factors, including our perceived prospects and the prospects of the
financial and other business-to-business marketplaces in general, differences
between our actual financial and operating results and those expected by
investors and analysts, changes in analysts' recommendations or projections,
seasonality, changes in general valuations for Internet and e-commerce-related
companies, changes in general economic or market conditions and broad market
fluctuations.
Future sales of our shares also could adversely affect the market price of our
Class A common stock. If our existing stockholders sell a large number of
shares, or if we issue a large number of shares of our common stock in
connection with future acquisitions, strategic alliances or otherwise, the
market price of our Class A common stock could decline significantly. Moreover,
the perception in the public market that these stockholders might sell shares of
Class A common stock could depress the market price of our Class A common stock.
We have registered under the Securities Act 10,630,000 shares of our Class A
common stock, which are reserved for issuance upon exercise of options granted
under our stock option plan. Since our stock option plan has been amended to
increase the amount of shares available for issuance under our stock option
plan, we will likely register additional shares. In addition, if we increase our
total outstanding shares of common stock, we will register additional shares of
Class A common stock so that the stock available for issuance under our stock
option plan will be registered. Once registered, these shares can be sold in the
public market upon issuance, subject to restrictions under the securities laws
applicable to resales by affiliates. In addition, we have registered under the
Securities Act 425,000 shares of our Class A common stock issuable under our
stock purchase plan. We also will be issuing new shares of our Class A common
stock in connection with our matching program for our 401(k) plan. The maximum
number of new shares we will be issuing in connection with our 401(k) plan is
$3,000 worth per employee per year.
18
Since June 9, 2002, approximately 5.9 million shares of our Class A common stock
that have been distributed to partners of Cantor as part of a deferred stock
distribution by Cantor have been eligible for resale in the public market
subject to Rule 144(k) under the Securities Act. The availability for sale of
such number of shares may have an adverse effect on the market price of our
Class A common stock.
In addition, we have issued shares of our Class A common stock, warrants and
convertible preferred stock and have granted registration rights in connection
with certain of our strategic alliances. See "Item 13. Certain Relationships and
Related Transactions."
Our board has authorized the repurchase of up to $40 million of our outstanding
Class A common stock. As of December 31, 2002, we had repurchased 24,600 shares
of our Class A common stock for a total of $221,892 under the repurchase plan
authorized by our board of directors. During the first quarter of 2003, we
purchased an additional 161,799 shares for a total purchase price of $1,872,112,
bringing the total number of treasury shares owned to 186,399 at a book value of
$2,094,004. We anticipate making additional stock repurchases in 2003.
RISKS RELATED TO OUR RELATIONSHIP WITH CANTOR
BECAUSE WE CONTINUE TO DEPEND ON CANTOR'S BUSINESS, EVENTS WHICH ADVERSELY
AFFECT CANTOR'S BUSINESS, INCLUDING A SALE, DISSOLUTION, LIQUIDATION OR
WINDING-UP OF CANTOR, MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR REVENUES.
Since inception, we have recognized a significant portion of our revenues in
connection with our relationship with Cantor. Consequently, our business was
adversely affected by the effect of the September 11 Events on Cantor's
business. See "-- The events of September 11, 2001 have had and may continue to
have an adverse effect on our business." In addition, any other future events
which adversely affect Cantor's business or operating results, including a sale,
dissolution, liquidation or winding-up of all or a material portion of Cantor's
business, could have a material adverse effect on our most significant source of
revenues. We also are a general creditor of Cantor to the extent that there are
transaction revenues and software solutions fees owing to us from Cantor. Events
that adversely affect Cantor's financial position and its ability to remit to us
our share of transaction revenues and software solutions fees could have a
material adverse effect on our revenues.
CONFLICTS OF INTEREST AND COMPETITION WITH CANTOR MAY ARISE.
Various conflicts of interest between us and Cantor may arise in the future in a
number of areas relating to our past and ongoing relationships, including
competitive business activities, potential acquisitions of businesses or
properties, the election of new directors, payment of dividends, incurrence of
indebtedness, tax matters, financial commitments, marketing functions, indemnity
arrangements, service arrangements, issuances of our capital stock, sales or
distributions by Cantor of its shares of our common stock and the exercise by
Cantor of control over our management and affairs. Our Amended and Restated
Joint Services Agreement, as currently in effect (the Joint Services Agreement),
with Cantor provides that, in some circumstances, Cantor can unilaterally
determine the commissions that will be charged to clients for effecting trades
in marketplaces in which we collaborate with Cantor. The determination of the
nature of commissions charged to clients does not affect the allocation of
revenues that Cantor and we share with respect to those transactions. However,
in circumstances in which Cantor determines to charge clients lower commissions,
the amount that we receive in respect of our share of the commissions will be
correspondingly decreased. Pursuant to our Administrative Services Agreement
with Cantor, Cantor is required to obtain for us, among other things, property
and casualty insurance of not less than $40 million and business interruption
insurance of $25 million. Cantor has procured property insurance coverage for us
covering our fixed assets and business interruption insurance in the amount of
$25 million. However, in the case of business interruption insurance, we are
listed on this insurance policy as one of several insured parties, together with
Cantor and several of its affiliates. This insurance policy is for aggregate
amounts in excess of the amounts set forth above. The Administrative Services
Agreement does not provide for the allocation of the proceeds among the named
insureds. Because Cantor controls us and the allocation of the proceeds received
from insurance, Cantor may allocate the proceeds among the insured parties in a
manner with which we disagree and that may have an adverse effect on our
financial condition.
Four of our directors and our executive officers are either partners and/or
officers of Cantor. Simultaneous service as an eSpeed director or officer and
service as an officer, or status as a partner, of Cantor could create, or appear
to create, potential conflicts of interest when such directors, officers and/or
partners are faced with decisions that could have different implications for us
and for Cantor. Mr. Lutnick, our Chairman, President and Chief Executive
Officer, is the sole stockholder of the managing general partner of Cantor. As a
result, Mr. Lutnick controls Cantor. As of March 1, 2003, Mr. Lutnick controlled
approximately 89.8% of the combined voting power of all classes of our voting
stock. Mr. Lutnick's simultaneous service as our Chairman, President and Chief
Executive Officer and his control of Cantor could create or appear to create
potential conflicts of interest when Mr. Lutnick is faced with decisions that
could have different implications for us and for Cantor.
19
BECAUSE OUR JOINT SERVICES AGREEMENT WITH CANTOR HAS A PERPETUAL TERM AND
CONTAINS NON-COMPETITION PROVISIONS AND RESTRICTIONS ON OUR ABILITY TO PURSUE
STRATEGIC TRANSACTIONS, THIS AGREEMENT MAY BECOME BURDENSOME TO OUR BUSINESS.
Although Cantor has agreed, subject to certain conditions, not to compete with
us in providing electronic brokerage services, Cantor is currently engaged in
securities transaction and other financial instruments execution and processing
operations and other activities that are related to the electronic trading
services we provide. Our Joint Services Agreement obligates us to perform
technology support and other services for Cantor at cost, whether or not related
to our electronic brokerage services, sets forth the ongoing revenue sharing
arrangements between Cantor and us and subjects us and Cantor to non-competition
obligations. The Joint Services Agreement precludes us from entering into lines
of business in which Cantor now or in the future may engage, or providing, or
assisting any third party in providing, voice-assisted brokerage services,
clearance, settlement and fulfillment services and related services, except
under limited circumstances. Although we believe Cantor has no plans to form,
acquire or commence any other operations similar to ours, the Joint Services
Agreement permits Cantor to perform, in limited circumstances, electronic
brokerage operations. In addition, the Joint Services Agreement imposes
limitations on our ability to pursue strategic alliances, joint ventures,
partnerships, business combinations, acquisitions and similar transactions.
Because the Joint Services Agreement has a perpetual term, even in the event of
a breach by one of the parties, and does not provide for modification under its
terms, this agreement may become burdensome for us, may distract us from
focusing on our internal operations, may deter or discourage a takeover of our
company and may limit our ability to expand our operations.
BECAUSE AGREEMENTS BETWEEN US AND CANTOR ARE NOT THE RESULT OF ARM'S-LENGTH
NEGOTIATIONS, WE MAY RECEIVE LOWER SERVICE FEES FROM, AND PAY HIGHER SERVICE
FEES TO, CANTOR THAN WE WOULD WITH RESPECT TO THIRD PARTY SERVICE PROVIDERS.
In connection with the formation transactions, we entered into Assignment and
Assumption Agreements, an Administrative Services Agreement, a Joint Services
Agreement and several other agreements with Cantor relating to the provision of
services to each other and third parties. These agreements are not the result of
arm's-length negotiations because Cantor owns and controls us. As a result, the
prices charged to us or by us for services provided under the agreements may be
higher or lower than prices that may be charged by third parties and the terms
of these agreements may be generally less favorable to us than those that we
could have negotiated with third parties.
BECAUSE WE DEPEND ON SERVICES AND ACCESS TO OPERATING ASSETS PROVIDED BY THIRD
PARTIES TO CANTOR, WE MAY NOT HAVE RECOURSE AGAINST THOSE THIRD PARTIES.
Many of the assets and services provided by Cantor under the terms of the
Administrative Services Agreement are leased or provided to Cantor by
third-party vendors. As a result, in the event of a dispute between Cantor and a
third-party vendor, we could lose access to, or the right to use, as applicable,
office space, personnel, corporate services and operating assets. In such a
case, we would have no recourse with respect to the third-party vendor. Our
inability to use these services and operating assets for any reason, including
any termination of the Administrative Services Agreement between us and Cantor
or the agreements between Cantor and third-party vendors, could result in
serious interruptions of our operations.
OUR REPUTATION MAY BE AFFECTED BY ACTIONS TAKEN BY CANTOR AND ENTITIES THAT ARE
RELATED TO CANTOR.
Cantor currently is our most significant client. Cantor holds direct and
indirect ownership and management interests in numerous other entities that
engage in a broad range of financial services and securities-related activities.
Actions taken by, and events involving, Cantor or these related companies which
are perceived negatively by the securities markets, or the public generally,
could have a material adverse effect on us and could affect the price of our
Class A common stock. In addition, events which negatively affect the financial
condition of Cantor may negatively affect us. These events could cause Cantor to
lose clients that may trade in our marketplaces, could impair Cantor's ability
to perform its obligations under the Joint Services Agreement, the
Administrative Services Agreement and other agreements Cantor enters into with
us and could cause Cantor to liquidate investments, including by selling or
otherwise transferring shares of our common stock.
IF WE BECOME SUBJECT TO LITIGATION AND OTHER LEGAL PROCEEDINGS, WE MAY BE
HARMED.
From time to time, we and Cantor may become involved in litigation and other
legal proceedings relating to claims arising from our and their operations in
the normal course of business. Cantor is currently subject to a number of legal
proceedings that could affect us. We cannot assure you that these or other
litigation or legal proceedings will not materially affect our ability to
conduct our business in the manner that we expect or otherwise adversely affect
us. See "Item 3. Legal Proceedings".
20
RISKS RELATED TO E-COMMERCE AND THE INTERNET
IF ELECTRONIC MARKETPLACES DO NOT CONTINUE TO GROW, WE WILL NOT BE ABLE TO
ACHIEVE OUR BUSINESS OBJECTIVES.
The success of our business plan depends on our ability to create interactive
electronic marketplaces for a wide range of products. Historically, securities
and commodities markets operated through open outcry formats which have recently
begun to be supplanted by new systems that match buyers and sellers
electronically. The energy markets in which we participate through TradeSpark
operate through phone-based and bulletin-board formats and have recently begun
to transact electronically. The utilization of our products and services depends
on the continued acceptance, adoption and growth of electronic markets. We
cannot assure you that the growth and acceptance of the use of electronic
markets will continue.
IF E-COMMERCE AND INTERNET USAGE DOES NOT CONTINUE TO GROW, WE WILL NOT BE ABLE
TO ACHIEVE OUR BUSINESS OBJECTIVES.
Our strategic and financial objectives would be adversely impacted if e-commerce
adoption and usage does not continue to grow. Business-to-business use of the
Internet as a medium of commerce is a recent phenomenon and is subject to a high
level of uncertainty. Internet usage may be inhibited for a number of reasons,
including:
o access costs;
o inadequate network infrastructure;
o security concerns;
o uncertainty of legal, regulatory and tax issues concerning the use of the
Internet;
o concerns regarding ease of use, accessibility and reliability;
o inconsistent quality of service; and
o lack of availability of cost-effective, high-speed service.
If Internet usage grows, the Internet infrastructure may not be able to support
the demands placed on it, or the Internet's performance and reliability may
decline. Similarly, Web sites have experienced interruptions in their service as
a result of outages and other delays occurring throughout the Internet network
infrastructure. If these outages or delays occur frequently, use of the Internet
as a commercial or business medium could grow more slowly or decline. Even if
Internet usage continues to grow, online trading in the wholesale securities
markets, and in particular the fixed income securities and futures markets, may
not be accepted by our clients. This could negatively affect the growth of our
business.
OUR NETWORKS AND THOSE OF OUR THIRD-PARTY SERVICE PROVIDERS MAY BE VULNERABLE TO
SECURITY RISKS, WHICH COULD MAKE OUR CLIENTS HESITANT TO USE OUR ELECTRONIC
MARKETPLACES.
We expect the secure transmission of confidential information over public
networks to be a critical element of our operations. Our networks and those of
our third-party service providers, including Cantor and associated clearing
corporations, and our clients may be vulnerable to unauthorized access, computer
viruses and other security problems. Persons who circumvent security measures
could wrongfully use our information or cause interruptions or malfunctions in
our operations, which could make our clients hesitant to use our electronic
marketplaces. We may be required to expend significant resources to protect
against the threat of security breaches or to alleviate problems, including
reputational harm and litigation, caused by any breaches. Although we intend to
continue to implement industry-standard security measures, we cannot assure you
that those measures will be sufficient.
RISKS RELATED TO OUR CAPITAL STRUCTURE
BECAUSE THE VOTING CONTROL OF OUR COMMON STOCK IS CONCENTRATED AMONG THE HOLDERS
OF OUR CLASS B COMMON STOCK, THE MARKET PRICE OF OUR CLASS A COMMON STOCK MAY BE
ADVERSELY AFFECTED BY DISPARATE VOTING RIGHTS.
As of March 1, 2003, Cantor beneficially owned approximately 89.8% of the
combined voting power of all classes of our voting stock. As long as Cantor
beneficially owns a majority of the combined voting power of our common stock,
it will have the ability, without the consent of the public stockholders, to
elect all of the members of our board of directors and to control our management
and affairs. In addition, it will be able to determine the outcome of matters
submitted to a vote of our stockholders for approval and will be able to cause
or prevent a change in control of our company. In certain circumstances, the
shares of our Class B common stock issued to Cantor upon consummation of the
formation transactions may be transferred without conversion to our Class A
common stock.
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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., U.K. and Asia. Our principal executive offices are
located at 135 East 57th Street, New York, New York. We currently occupy space
subleased by Cantor. Our largest presence outside of the New York metropolitan
area is in London, where we have the right to use approximately 15,000 square
feet of Cantor's existing office space. Our right to use this space expires at
the earlier of (1) the time that Cantor's lease expires in 2016 or (2) when
Cantor ceases to be an affiliate of ours and Cantor asks us to vacate. We will
pay Cantor approximately $2.6 million annually for use of this space.
Additionally, we occupy approximately 18,750 square feet of space in our
concurrent computing center in Rochelle Park, New Jersey. We pay Cantor
approximately $717,000 annually for the use of the Rochelle Park space.
ITEM 3. LEGAL PROCEEDINGS
By Statement of Claim dated October 8, 2002, Municipal Partners, LLC (MPLLC)
commenced an arbitration before the NASD against Cantor Fitzgerald Partners and
Howard Lutnick (the Arbitration). Although MPLLC did not name eSpeed as a
respondent in the Arbitration, MPLLC seeks, among other things, (i) a
declaration that the License and Service Agreement dated January 30, 2002,
between MPLLC and eSpeed is null and void and (ii) an order directing eSpeed to
reimburse MPLLC for certain costs. By Order to Show Cause signed on October 30,
2002, eSpeed, Cantor Fitzgerald Partners and Howard Lutnick moved for an order
staying the Arbitration in its entirety or, alternatively, staying the
Arbitration insofar as it seeks relief directly or indirectly against eSpeed.
The motion has been fully briefed and is currently sub judice. The parties have
agreed to participate in court sponsored non-binding mediation.
By Summons and Complaint dated October 30, 2002, eSpeed commenced an action
against MPLLC seeking, among other things, payment for services rendered
pursuant to the License and Service Agreement and payment for eSpeed's share of
certain electronic revenues of MPLLC. In the interim, the parties have agreed to
submit to non-binding mediation.
eSpeed patent related legal proceedings
On August 26, 2002, we entered into a Settlement Agreement (the Agreement) with
Electronic Trading Systems Corporation (ETS), the Chicago Mercantile Exchange
Inc. (CME) and CBOT to resolve the litigation related to the Wagner Patent
(United States Patent No. 4,903,201). The Wagner Patent deals with automated
futures trading systems in which transactions are completed by a computerized
matching of bids and offers of futures contracts on an electronic platform.
Under the terms of the Agreement, CME and CBOT will each pay $15 million to us
as a fully paid up license. Each $15 million payment will include $5 million,
which was received in the three months ended September 30, 2002, and $2 million
per year until 2007. We will recognize these payments, over the remaining life
of the Wagner Patent, under the caption "Software Solutions and licensing fees
from unrelated parties" in our consolidated statements of operations. The Wagner
Patent expires in February 2007. As part of the Agreement, all parties will be
released from the legal claims brought against each other without admitting
liability on the part of any party. We may be paying ETS up to $5,750,000 over
time out of the amounts we receive under the Agreement in connection with the
settlement of the litigation relating to the Wagner Patent. For the year ended
December 31, 2002, $2,750,000 was paid to ETS. The net settlement proceeds of
$24,250,000 is to be recognized as revenue ratably over the remaining useful
life of the patent. For the year ended December 31, 2002, we have recorded
revenue of $1,796,074 related to the Settlement Agreement.
After we acquired the Wagner Patent in April 2001, we joined ETS, the prior
patent owner, as a plaintiff in litigation pending in the Southern District of
New York against the New York Mercantile Exchange. The plaintiffs allege that
the defendants in each case infringed the Wagner Patent. The complaints seek
injunctive relief, a reasonable royalty, treble damages pursuant to 37 U.S.C.
ss.284, attorneys' fees, interest and costs. The defendants have asserted
counterclaims by which they contend they are entitled to the their attorneys'
fees should they prevail. On June 26, 2002, the Judge in the New York case
entered an order following a Markman hearing construing the claims of the
patent. We believe that both of those Markman rulings were generally consistent
with out interpretation of the scope of the patent.
Expert discovery is ongoing in the New York case, and a limited amount of fact
discovery remains, with any trial likely in 2003.
Although the ultimate outcome of these actions cannot be ascertained at this
time (although the parties from time to time are actively pursuing settlement
discussions) and the results of legal proceedings cannot be predicted with
certainty, it is the opinion of management that the resolution of these matters
will not have a material adverse effect on our financial condition or results of
operations.
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Cantor related legal proceedings
In February 1998, Market Data Corporation (MDC) contracted to provide the
technology for an electronic trading system to compete with Cantor's United
States Treasury brokerage business. MDC is controlled by Iris Cantor and Rodney
Fisher