U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2005 Commission file number 0-28191 ESPEED, INC. ----------------------------------------------------------------------- (Exact Name of Registrant as Specified in Its Charter) Delaware 13-4063515 --------------------------------- -------------------------------- (State or Other Jurisdiction of (I.R.S. Employer Identification Incorporation or Organization) No.) 110 East 59th Street ----------------------------------------------------------------------- (Address of Principal Executive Offices) New York, New York 10022 ----------------------------------------------------------------------- (City, State, Zip Code) (212) 938-5000 ----------------------------------------------------------------------- (Registrant's Telephone Number, Including Area Code) 135 East 57th Street, New York, New York 10022 ----------------------------------------------------------------------- (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No _ As of October 26, 2005, the registrant had 27,836,983 shares of Class A common stock, $0.01 par value, and 22,139,270 shares of Class B common stock, $0.01 par value, outstanding. eSpeed, Inc. and Subsidiaries Quarterly Report on Form 10-Q TABLE OF CONTENTS PART I. - FINANCIAL INFORMATION ITEM 1. Financial Statements Page Condensed Consolidated Statements of Financial Condition (unaudited): September 30, 2005 and December 31, 2004 3 Condensed Consolidated Statements of Income (unaudited): Three and Nine Months Ended September 30, 2005 and September 30, 2004 4 Condensed Consolidated Statements of Cash Flows (unaudited): Nine Months Ended September 30, 2005 and September 30, 2004 5 Notes to Condensed Consolidated Financial Statements (unaudited) 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 18 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 28 ITEM 4. Controls and Procedures 29 PART II. - OTHER INFORMATION ITEM 1. Legal Proceedings 29 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 31 ITEM 6. Exhibits 32 SIGNATURES 33 2 PART I. - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ESPEED, INC AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (IN THOUSANDS, EXCEPT SHARE DATA) September 30, 2005 December 31, 2004 --------------------- --------------------- (Unaudited) ASSETS Cash and cash equivalents $ 12,291 $ 19,884 Reverse repurchase agreements with related parties 172,020 189,804 --------------------- --------------------- Total cash and cash equivalents 184,311 209,688 Fixed assets, net 60,469 50,605 Investments 7,747 12,709 Goodwill 11,968 11,949 Intangible assets, net 13,017 16,097 Receivable from related parties 7,817 1,630 Other assets 6,965 7,455 --------------------- --------------------- Total assets $ 292,294 $ 310,133 ===================== ===================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Payable to related parties $ 6,057 $ 7,113 Accounts payable and accrued liabilities 32,865 24,795 --------------------- --------------------- Total current liabilities 38,922 31,908 Deferred income 7,698 8,011 --------------------- --------------------- Total liabilities 46,620 39,919 --------------------- --------------------- Stockholders' Equity: Preferred stock, par value $0.01 per share; 50,000,000 shares authorized, none outstanding at September 30, 2005 and December 31, 2004 - - Class A common stock, par value $.01 per share; 200,000,000 shares authorized; 34,375,135 and 34,289,773 shares issued at September 30, 2005 and December 31, 2004, respectively 344 343 Class B common stock, par value $.01 per share; 100,000,000 shares authorized; 22,139,270 shares outstanding at September 30, 2005 and December 31, 2004 221 221 Additional paid-in capital 294,843 294,115 Unearned stock based compensation (1,162) (3,080) Treasury stock, at cost; 6,539,090 and 3,082,815 shares of Class A common stock at September 30, 2005 and December 31, 2004, respectively (62,913) (33,972) Retained earnings 14,341 12,587 Total stockholders' equity 245,674 270,214 --------------------- --------------------- Total liabilities and stockholders' equity $ 292,294 $ 310,133 ===================== ===================== See notes to condensed consolidated financial statements 3 ESPEED, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) Three Months Ended Nine Months Ended September 30, September 30, --------------------------- --------------------------- 2005 2004 2005 2004 ---------- ----------- -------------- ----------- Revenues: Transaction revenues with related parties Fully electronic transactions $ 18,933 $ 25,489 $ 58,174 $ 85,170 Voice-assisted brokerage transactions 6,190 5,233 19,128 16,449 Screen-assisted open outcry transactions 1,121 225 1,931 614 ---------- ----------- -------------- ----------- Total transaction revenues with related parties 26,244 30,947 79,233 102,233 Software Solutions fees from related parties 6,099 4,681 18,860 13,268 Software Solutions and licensing fees from unrelated parties 3,770 3,278 11,712 9,383 Gain on sale of investments 1,015 - 1,015 - Interest income 1,644 865 4,311 2,370 ---------- ----------- -------------- ----------- Total revenues 38,772 39,771 115,131 127,254 ---------- ----------- -------------- ----------- Expenses: Compensation and employee benefits 13,048 10,499 38,989 29,582 Amortization of software development costs and other intangibles 5,206 4,109 14,376 11,643 Occupancy and equipment 7,712 6,322 22,657 18,622 Professional and consulting fees 2,018 1,663 7,088 3,461 Communications and client networks 1,931 1,684 5,569 4,892 Marketing 390 319 1,252 1,084 Administrative fees to related parties 3,216 3,435 10,515 9,604 Amortization of business partner and non-employee securities 50 136 310 722 Acquisition related costs - - 4,124 - Other 2,491 2,186 7,845 5,819 ---------- ----------- -------------- ----------- Total operating expenses 36,062 30,353 112,725 85,429 ---------- ----------- -------------- ----------- Income before income taxes 2,710 9,418 2,406 41,825 Income tax provision 837 3,683 652 16,354 ---------- ----------- -------------- ----------- Net income $ 1,873 $ 5,735 $ 1,754 $ 25,471 Per share data: Basic GAAP earnings per share $ 0.04 $ 0.11 $ 0.03 $ 0.46 ========== =========== ============== ========== Diluted GAAP earnings per share $ 0.04 $ 0.10 $ 0.03 $ 0.45 ========== =========== ============== ========== Basic weighted average shares of common stock outstanding 50,998 54,398 51,805 55,538 ========== =========== ============== ========== Diluted weighted average shares of common stock outstanding 51,697 55,289 52,586 57,065 ========== =========== ============== ========== See notes to condensed consolidated financial statements 4 ESPEED, INC. & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS) Nine Months Ended ----------------------------------- September 30, ----------------------------------- 2005 2004 ------------------ --------------- Cash flows from operating activities: Net income $ 1,754 $ 25,471 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 22,050 17,271 Amortization of business partner and non-employee securities 310 722 Amortization of employee stock based compensation 1,608 - Equity in net loss of unconsolidated investments 5 42 Gain on sale of investments (1,015) - Deferred income tax expense 298 1,022 Tax benefit from employee stock options and warrant exercises 109 958 Issuance of securities under employee benefit plan 186 90 Changes in operating assets and liabilities: Receivable from related parties (6,187) 300 Other assets 490 (1,447) Payable to related parties (1,056) (2,907) Accounts payable and accrued expenses 7,469 9,632 Deferred income (313) - ------------------ --------------- Net cash provided by operating activities 25,708 51,154 ------------------ --------------- Cash flows from investing activities: Purchase of fixed assets (11,330) (11,271) Capitalization of software development costs (15,399) (13,647) Capitalization of patents and related defense costs (1,688) (4,441) Proceeds from sale of investments 5,840 - Purchase of investment - (360) ------------------ --------------- Net cash used in investing activities (22,577) (29,719) ------------------ --------------- Cash flows from financing activities: Purchase of Class A common stock (28,941) (29,752) Proceeds from exercises of stock options and warrants 433 1,811 Receivable from broker on stock option exercises - 1,073 ------------------ --------------- Net cash used in financing activities (28,508) (26,868) ------------------ --------------- Net decrease in cash and cash equivalents (25,377) (5,433) ------------------ --------------- Cash and cash equivalents at beginning of period 19,884 55,318 Reverse repurchase agreements with related parties at beginning of period 189,804 173,182 ------------------ --------------- Total cash and cash equivalents at beginning of period 209,688 228,500 ------------------ --------------- Cash and cash equivalents at end of period 12,291 37,116 Reverse repurchase agreements with related parties at end of period 172,020 185,951 ------------------ --------------- Total cash and cash equivalents at end of period $ 184,311 $ 223,067 ================== =============== Supplemental cash information: Cash paid for income taxes $ 67 $ 12,851 Cash paid for interest $ - $ - See notes to condensed consolidated financial statements 5 ESPEED, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. ORGANIZATION AND BASIS OF PRESENTATION eSpeed, Inc. (eSpeed or, together with its wholly owned subsidiaries, the Company) primarily engages in the business of operating interactive electronic marketplaces designed to enable market participants to trade financial and non-financial products more efficiently and at a lower cost than traditional trading environments permit. The Company is a subsidiary of Cantor Fitzgerald Securities (CFS), which in turn is a 99.75% owned subsidiary of Cantor Fitzgerald, L.P. (CFLP or, together with its subsidiaries, Cantor). eSpeed commenced operations on March 10, 1999 as a division of CFS. eSpeed is a Delaware corporation that was incorporated on June 3, 1999. In December 1999, the Company completed its initial public offering. The Company's financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). All significant intercompany balances and transactions have been eliminated in consolidation. The financial statements reflect all normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the results. Certain reclassifications and format changes have been made to prior year information to conform to the current year presentation. Pursuant to the rules and regulations of the Securities and Exchange Commission, certain information and footnote disclosures, which are normally required under U.S. GAAP, have been condensed or omitted. It is recommended that these condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2004. The consolidated statement of financial condition at December 31, 2004 was derived from the audited financial statements. The results of operations for any interim period are not necessarily indicative of results for the full year. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES: The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities in the financial statements. Management believes that the estimates utilized in preparing the financial statements are reasonable and prudent. Estimates, by their nature, are based on judgment and available information. As such, actual results could differ from the estimates included in these financial statements. TRANSACTION REVENUES WITH RELATED-PARTIES: Securities transactions and the related transaction revenues are recorded on a trade date basis. Transaction revenues with related parties are comprised of fully electronic, voice-assisted brokerage and screen-assisted open outcry transactions. See Note 8 of notes to condensed consolidated financial statements for further discussion. SOFTWARE SOLUTIONS FEES: Pursuant to various services agreements, the Company recognizes fees from related parties in amounts generally equal to its actual direct and indirect costs, including overhead, of providing such services at the time when such services are performed. For specific technology support functions that are both utilized by the Company and provided to related parties, the Company allocates the actual costs of providing such support functions based on the relative usage of such support services by each party. In addition, certain clients of the Company provide online access to their customers through use of the Company's electronic trading platform. The Company receives up-front and/or periodic fees from unrelated parties for the use of its platform. Such fees are deferred and recognized as revenue ratably over the term of the licensing agreement. The Company also receives patent license fees from unrelated parties. Such fees are recognized as income ratably over the license period. CASH AND CASH EQUIVALENTS: The Company considers all highly liquid investments with original maturity dates of 90 days or less at the date of acquisition to be cash equivalents. Cash equivalents consist of securities purchased under agreements to resell (reverse repurchase agreements) and a money market fund. Reverse repurchase agreements are overnight transactions accounted for as collateralized financing transactions and are recorded at the contractual amount for which the securities will be resold, including accrued interest. It is the policy of the Company to obtain possession of collateral with a market value equal to or in excess of the principal amount deposited. Collateral is valued daily, and the Company may require counterparties to deposit additional collateral or return amounts deposited when appropriate. FIXED ASSETS: Fixed assets are recorded at cost. Fixed assets, principally computer, communication equipment and software, are depreciated over their estimated economic useful lives (generally three to seven years) using the straight-line method. Internal and 6 external direct costs of application development and of obtaining software for internal use are capitalized and amortized over their estimated economic useful life of three years on a straight-line basis. Leasehold improvements are amortized over their estimated economic useful lives, or the remaining lease term, whichever is shorter. INVESTMENTS: The Company's investments are comprised of an investment accounted for using the cost method of accounting, as well as investments accounted for using the equity method of accounting. Investments are accounted for under the equity method where the Company has a significant influence. A judgmental aspect of accounting for investments involves determining whether an other-than-temporary decline in the value of the investment has been sustained. Such evaluation is dependent on the specific facts and circumstances. As none of our investments has a readily determinable market value, the primary factor considered by the Company in determining whether an other-than-temporary decline in value has occurred is the financial condition of the investee. Factors indicative of an other-than-temporary decline include recurring operating losses, credit defaults and subsequent rounds of financing at an amount below the cost basis of the investment. This list is not all-inclusive and management weighs all quantitative and qualitative factors in determining if an other-than-temporary decline in value of an investment has occurred. The Company's investment under the cost method was sold in 2005. The Company's consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The Company's policy is to consolidate all entities of which it owns more than 50% unless it does not have control over the entity. In accordance with Financial Accounting Standards Board Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46), and the revised interpretation (FIN 46(R)), the Company would also consolidate any variable interest entities (VIEs) of which it is the primary beneficiary. The Company is currently not the primary beneficiary of any such entities and therefore does not include any VIEs in its consolidated financial statements. PATENTS: Intangible assets consist of purchased patents, the costs to defend and enforce the Company's rights under patents and costs incurred in connection with the filing and registration of patents. Capitalized costs related to the filing of patents are generally amortized on a straight-line basis over a period not to exceed three years. The costs of acquired patents are amortized over a period not to exceed 17 years or the remaining life of the patent, whichever is shorter, using the straight-line method. The costs to defend and enforce the Company's rights under these patents consist primarily of external litigation costs related to the pursuit of patent infringement lawsuits by the Company, and consist of fees for outside attorneys, technology experts and litigation support services. These costs are capitalized when such costs serve to enhance the value of the related patent, and are amortized over the remaining life of such patent. Should it be determined that the capitalized costs no longer serve to enhance the value of the respective patent, such as a situation in which the Company's patent is held to be invalid, these capitalized costs would be expensed in the period in which such determination was made. EVALUATION OF GOODWILL, LONG-LIVED ASSETS AND AMORTIZABLE INTANGIBLES: The Company accounts for goodwill and identifiable assets under the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets." In accordance with this guidance, gooodwill is not amortized but is reviewed annually for impairment, or more frequently if impairment indicators arise. The Company periodically evaluates potential impairment of long-lived assets when a change in circumstances occurs, by applying the concepts of SFAS No. 144 "Accounting for the Impairment or Disposal of Long Lived Assets" (SFAS 144) and assessing whether the unamortized carrying amount can be recovered over the remaining life through undiscounted future expected cash flows generated by the underlying assets. If the undiscounted future cash flows were less than the carrying value of the asset, an impairment charge would be recorded. The impairment charge would be measured as the excess of the carrying value of the asset over the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved. Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations accounted for as a purchase. We will review goodwill for impairment on an annual basis during the fourth quarter of each fiscal year or whenever an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. Goodwill impairment is determined using a two-step approach. The first step of the goodwill test compares the fair value of a reporting unit with its carrying amount, including goodwill. The second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that difference. STOCK-BASED COMPENSATION: Pursuant to guidelines contained in APB Opinion No. 25, "Accounting for Stock Issued to Employees," (APB 25) and as permitted by SFAS No. 123, "Accounting for Stock Based Compensation" (SFAS 123), the Company records no expense for stock options issued to employees as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. The Company accounts for stock issued to non-employees and business partners in accordance with the provisions of SFAS 123 and the Emerging Issues Task Force (EITF) Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services" (EITF 96-18). SFAS 123 states that equity instruments 7 that are issued in exchange for the receipt of goods or services should be measured at the fair value of consideration received or the fair value of the equity instruments issued, whichever is more readily reliably measurable. Under the guidance in EITF 96-18, the measurement date occurs as of the earlier of (a) the date at which a performance commitment is reached or (b) absent a performance commitment, the date at which the performance necessary to earn the equity instruments is complete (that is, the vesting date). The following table represents the effect had the Company accounted for the options in its stock-based compensation plan based on the fair value of awards at grant date in a manner consistent with the methodology of SFAS 123: THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------- -------------------------------- 2005 2004 2005 2004 ------------- --------------- --------------- ------------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net income, as reported $ 1,873 $ 5,735 $ 1,754 $ 25,471 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards granted, net of taxes (125) (1,634) (8,841) (5,970) ------------- --------------- --------------- ------------- Net income (loss), pro forma $ 1,748 $ 4,101 $ (7,087) $ 19,501 ============= =============== =============== ============= Basic weighted average shares of common stock outstanding 50,998 54,398 51,805 55,538 Diluted weighted average shares of common stock outstanding 51,697 55,289 52,586 57,065 Earnings (loss) per share: Basic - as reported $ 0.04 $ 0.11 $ 0.03 $ 0.46 Basic - pro forma $ 0.03 $ 0.08 $ (0.14) $ 0.35 Diluted - as reported $ 0.04 $ 0.10 $ 0.03 $ 0.45 Diluted - pro forma $ 0.03 $ 0.07 $ (0.14) $ 0.34 In response to the changes in accounting rules pursuant to Financial Accounting Standards Board (FASB) 123R, "Share-Based Payments," (SFAS 123R) during the fourth quarter of 2004, the Company's Board of Directors accelerated the vesting of unvested "out-of-the-money" stock options previously awarded to employees and officers. Under the intrinsic value method, there was no compensation expense associated with this action as the strike prices related to the accelerated options were above the fair market value of the Company's common stock on the day the acceleration was affected. As a result, options to purchase approximately 3.3 million shares with a fair value of $8.9 million became exercisable. On March 8, 2005, our Board of Directors accelerated the vesting of an additional 3.0 million unvested "out-of-the-money" stock options previously awarded to officers and employees with a fair value of $8.7 million, net of tax, which are reflected in the above table. As a result of both accelerations, the Company will not recognize share based after-tax compensation expense of approximately $10.2 million in 2005, $5.0 million in 2006, $2.0 million in 2007 and $0.4 million in 2008. INCOME TAXES: Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded against deferred tax assets if it is more likely than not that such assets will not be realized. RECENT ACCOUNTING PRONOUNCEMENTS: In December 2004, the FASB issued SFAS 123R, which replaces SFAS No. 123, "Accounting for Stock-Based Compensation," (SFAS 123R) and supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. In April 2005, the Securities Exchange Commission ("SEC") postponed the effective date of SFAS 123R until the first fiscal year beginning after June 15, 2005. As a result, the new effective 8 adoption date for the Company is the first quarter of 2006. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include modified prospective and modified retroactive adoption options. Under the modified retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the modified retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. The Company is evaluating the requirements of SFAS 123R and expects that the adoption of SFAS 123R may have a material impact on the Company's consolidated results of operations and earnings per share. The Company has not yet determined the method of adoption or the effect of adopting SFAS 123R, and it has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123. In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets--An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions" (SFAS 153). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, "Accounting for Nonmonetary Transactions," and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for the fiscal periods beginning after June 15, 2005. The adoption of SFAS 153 did not have a material effect on the Company's consolidated results of operations and financial condition. In March 2005, the FASB issued Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143 " ("FIN 47"), which requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability's fair value can be reasonably estimated. FIN 47 is effective for fiscal years ending after December 15, 2005. The Company is currently evaluating the effect that the adoption of FIN 47 will have on its consolidated results of operations and financial condition but does not expect it to have a material impact. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections" ("SFAS 154") which replaces Accounting Principles Board Opinions No. 20 "Accounting Changes" and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements--An Amendment of APB Opinion No. 28." SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company will apply SFAS 154 in future periods when it becomes applicable. 3. FIXED ASSETS Fixed assets consisted of the following: September 30, 2005 December 31, 2004 ----------------------- ----------------------- (IN THOUSANDS) Computer equipment $ 43,872 $ 34,749 Software, including software development costs 78,974 63,137 Leasehold improvements and other fixed assets 3,055 2,607 ----------------------- ----------------------- 125,901 100,493 Less: Accumulated depreciation & amortization (65,432) (49,888) ----------------------- ----------------------- Fixed assets, net $ 60,469 $ 50,605 ======================= ======================= In accordance with the provisions of Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," the Company capitalizes qualifying computer software costs incurred during the application development stage. During the nine months ended September 30, 2005 and 2004, software development costs totaling $15.4 million and $13.6 million, respectively, were capitalized. For the nine months ended September 30, 2005 and 2004, the Company's consolidated statements of operations included $9.3 million and $7.2 million, respectively, in relation to the amortization of software development costs. 4. GOODWILL AND OTHER INTANGIBLE ASSETS 9 The change in the carrying value of goodwill during the nine months ended September 30, 2005 was as follows (in thousands): Balance at December 31, 2004 $ 11,949 Adjustments 19 --------------- Balance at September 30, 2005 $ 11,968 =============== Goodwill shown in the table above was in connection with the acquisition of ITSEcco Holdings Limited during October 2004 as more fully discussed in Note 5. The adjustment to goodwill relates to professional services rendered in connection with the fair value of acquired intangibles. OTHER INTANGIBLE ASSETS Intangible assets consist of the following: September 30, 2005 December 31, 2004 ---------------------------------------- ------------------------------------------ Accumulated Accumulated Gross Amortization Net Gross Amortization Net ------------ ------------- ------------ ------------ ------------- ------------ (IN THOUSANDS) Patents, including capitalized legal costs $ 29,705 $ (19,191) $ 10,514 $ 27,600 $ (14,586) $ 13,014 Acquired intangibles: Existing technology 2,832 (543) 2,289 2,832 (118) 2,714 Customer contracts 412 (197) 215 412 (43) 369 ------------ ------------- ------------ ------------ ------------- ------------ $ 32,949 $ (19,931) $ 13,018 $ 30,844 $ (14,747) $ 16,097 ============ ============= ============= ============ ============ ============ During the nine months ended September 30, 2005 and 2004, the Company recorded intangible amortization expense of $5.2 million and $4.5 million, respectively. The estimated aggregate amortization expense for each of the next five fiscal years is as follows: $7.0 million in 2006, $3.5 million in 2007, $1.0 million in 2008, $0.7 million in 2009 and $0.2 million in 2010. PATENTS WAGNER PATENT: In April 2001, the Company purchased the exclusive rights to United States Patent No. 4,903,201 (the Wagner Patent) dealing with the process and operation of electronic futures trading systems that include, but are not limited to, energy futures, interest rate futures, single stock futures and equity index futures. The Company purchased the Wagner Patent from Electronic Trading Systems Corporation (ETS) for an initial payment of $1,750,000 in cash and 24,334 shares of the Company's Class A common stock valued at $500,000. The Wagner Patent expires in 2007. Additional payments are contingent upon the generation of patent-related revenues. The company paid $0.2 million in connection with a long-term license agreement with Intercontinental Exchange. In order to perfect and defend the Company's rights under the Wagner Patent, the Company has incurred substantial legal costs. As of September 30, 2005, the Company had capitalized approximately $21.1 million of related legal costs. The carrying value of the Wagner Patent, including such legal costs, was $6.6 million and $10.2 million at September 30, 2005 and December 31, 2004, respectively. In August 2002, the Company entered into a Settlement Agreement (the Settlement Agreement) with ETS, the Chicago Mercantile Exchange Inc. (CME) and the Board of Trade of the City of Chicago (CBOT) to resolve the litigation related to the Wagner Patent. As part of the Settlement Agreement, all parties were released from the legal claims brought against each other without admitting liability on the part of any party. Under the terms of the Settlement Agreement, CME and CBOT will each pay $15.0 million to eSpeed as a fully paid up license, for a total of $30.0 million. Each $15.0 million payment includes a $5.0 million payment, which was received in 2002, and additional $2.0 million payments per year until 2007. Of the $30.0 million to be received by the Company, approximately $5.8 million may be paid to ETS in its capacity as the former owner of the Wagner Patent, and the $24.2 million balance is to be recognized as revenue ratably over the remaining useful life of the Wagner Patent. In connection with the Settlement Agreement, the Company has recognized revenue of $4.0 million during both nine month periods ended September 30, 2005 and 2004, which is included in Software Solutions and licensing fees from unrelated parties in the Company's consolidated statements of operations. In December 2003, eSpeed and the New York Mercantile Exchange (NYMEX) entered into a settlement agreement (the NYMEX Settlement Agreement) regarding the Wagner Patent. As a licensee of the Wagner Patent, NYMEX will pay to eSpeed $8.0 million over a three-year period. eSpeed has received payments of $2.0 million in each of 2004 and 2003. Of the $8.0 million to be received by eSpeed, $1.2 million was paid to ETS during 2004 in its capacity as the former owner of the Wagner Patent and the remaining $6.8 10 million balance is to be recognized as revenue ratably over the remaining useful life of the Wagner Patent. During each of the nine month periods ended September 30, 2005 and 2004, the Company recorded revenue of approximately $1.6 million related to the NYMEX Settlement Agreement. The Company does not believe that any of the proceeds from the CBOT, CME and NYMEX settlements are indicative of a reimbursement for past patent infringement as no objective evidence exists which would indicate a value to be ascribed to past patent infringement. Instead, it has been determined that all of the proceeds represent licensing fees, which are amortized into income over the life of the Wagner Patent. In July 2004, the Company and the Board of Trade of the City of New York (NYBOT) renegotiated an agreement (the Agreement) that originated between Cantor and the New York Cotton Exchange in 1997. As part of the Agreement, which expires in 2017, all previous agreements between NYBOT/New York Clearing Corporation companies and Cantor/eSpeed companies have been terminated. As a result of the Agreement, eSpeed is the sole owner of the Cantor Financial Futures Exchange and the Commodity Futures Clearing Corporation of New York. Additionally, NYBOT and eSpeed have agreed that NYBOT will provide processing services for futures contracts or options on futures contracts listed on the Cantor Financial Futures Exchange or other exchanges designated by eSpeed. Under the terms of the Agreement, NYBOT will pay $5.5 million to eSpeed; $2.5 million was paid in July 2004, with three annual installments of $1.0 million per year (or $3.0 million) payable until 2007. In December 2004, NYBOT and the Company amended the Agreement. As such, the Company received $3.0 million from NYBOT thereby satisfying all future installment payments. During the nine-month period ended September 30, 2005, the Company recorded revenue of $0.3 million related to the Agreement, and will recognize the $5.0 million balance as revenue ratably over the life of the Agreement. LAWRENCE PATENT: In August 2001, the Company purchased the exclusive rights to United States Patent No. 5,915,209 (the Lawrence Patent) covering electronic auctions of fixed income securities. The Lawrence Patent expires in 2014. The Company purchased the Lawrence Patent for $0.9 million payable over three years, and warrants to purchase 15,000 shares of the Company's Class A common stock at an exercise price of $16.08, which were valued at approximately $0.2 million. The warrants expire on August 6, 2011. During the second quarter of 2005, the Company entered into an Amendment Agreement to amend the Purchase Agreement related to the Lawrence Patent. Pursuant to the Amendment Agreement, the Company will be required to pay $0.5 million over 4 years. Additional payments are contingent upon the generation of related revenues. OTHER: The Company has incurred costs in connection with various patent applications. The Company capitalized $1.6 million and $1.1 million of such legal costs during the nine months ended September 30, 2005 and year ended December 31, 2004, respectively. The carrying value of the capitalized costs related to patent applications was $2.6 million and $2.0 million at September 30, 2005 and December 31, 2004, respectively. 5. ACQUISITION OF ITSECCO HOLDINGS LIMITED In October 2004, eSpeed acquired all of the outstanding stock of United Kingdom-based ITSEcco Holdings Limited and its subsidiaries (ECCO). ECCO is a highly specialized software developer focused on the financial markets. Under terms of the agreement, eSpeed acquired ECCO for approximately $13.6 million in cash and will issue up to approximately 358,000 shares of eSpeed's Class A common stock subject to compliance with the terms of the purchase agreement, including certain restrictive covenants. In addition, $2.1 million of additional consideration has been placed in an escrow account pending the resolution of a legal matter. The following table summarizes the components of the net assets acquired (in thousands): Accounts receivable $465 Other assets 291 Intangible assets: Customer contracts (estimated useful life of 2 years) 412 Existing technology (estimated useful life of 5 years) 2,832 Goodwill 11,968 ------------ Total assets acquired $ 15,968 ------------ Deferred revenue 658 Taxes payable 455 Accounts payable and accrued expenses 1,220 ------------ Total liabilities assumed 2,333 ------------ Net assets acquired $ 13,635 ============ 11 The acquisition was accounted for as a purchase transaction in accordance with SFAS No. 141, Business Combinations, and accordingly, the assets and liabilities acquired were recorded at their fair value at the date of acquisition. The results of operations of ECCO have been included in the Company's financial statements subsequent to the date of acquisition. Proforma results have not been presented because the effect of the acquisition was not material. The excess of the purchase price over the estimated fair values of the net assets acquired was recorded as goodwill. Goodwill will not be amortized but will be reviewed annually for impairment, or more frequently if impairment indicators arise, in accordance with SFAS No. 142, Goodwill and Other Intangibles. Goodwill associated with this acquisition is not expected to be deductible for tax purposes. In connection with the acquisition, eSpeed recorded approximately $12.0 million of goodwill and $3.2 million of purchased intangibles. The purchased intangibles consist of $2.8 million in existing technology and $0.4 million of customer contracts, which will be amortized straight-line over their estimated useful lives of 5 years and 2 years, respectively. 6. INCOME TAXES The provision (benefit) for income taxes consists of the following: Three Months Ended Nine Months Ended September 30, September 30, ------------------------------- ------------------------------- 2005 2004 2005 2004 -------------- -------------- -------------- -------------- (IN THOUSANDS) Current: U.S. Federal $ 157 $ 2,676 $ 157 $ 12,599 U.S. State and Local (47) 594 124 2,733 Foreign (21) - 73 - -------------- -------------- -------------- -------------- 89 3,270 354 15,332 Deferred: U.S. Federal 678 342 214 846 U.S. State and Local 70 71 84 176 Foreign - - - - -------------- -------------- -------------- -------------- 748 413 298 1,022 -------------- -------------- -------------- -------------- Provision for income taxes $ 837 $ 3,683 $ 652 $ 16,354 ============== ============== ============== ============== 7. INVESTMENTS Investments consisted of the following: September 30, 2005 December 31, 2004 ------------------------ ------------------------ (IN THOUSANDS) Easyscreen $ - $ 4,957 Tradespark 3 3 EIP 700 701 Freedom International Brokerage 7,044 7,048 ------------------------ ------------------------ Investments $ 7,747 $ 12,709 ======================== ======================== In August 2005, the Company redeemed the secured convertible bond issued by Easyscreen PLC with a carrying value of $4.8 million for $5.8 million in cash proceeds. As a result, the Company recorded a pre-tax gain of $1.0 million, which is included in the Consolidated Statements of Income. 8. RELATED-PARTY TRANSACTIONS Cash and cash equivalents at September 30, 2005 and December 31, 2004 included $172.0 million and $189.8 million, respectively, of reverse repurchase agreements, which are transacted on an overnight basis with Cantor. Under the terms of these agreements, the securities collateralizing the reverse repurchase agreements are held under a custodial arrangement with a third party bank and are not 12 permitted to be resold or repledged. The fair value of such collateral at September 30, 2005 and December 31, 2004 totaled $185.0 million and $200.6 million, respectively. Under our Amended and Restated Joint Services Agreement with Cantor (JSA) and services agreements with BGC, TradeSpark, Freedom, Municipal Partners, LLC, and CO2e.com, LLC, we own and operate the electronic trading systems and are responsible for providing electronic brokerage services, and BGC, TradeSpark, Freedom, Municipal Partners, LLC, and CO2e.com, LLC, provide voice-assisted brokerage services, fulfillment services, such as clearance and settlement, and related services, such as credit risk management services, oversight of client suitability and regulatory compliance, sales positioning of products and other services customary to marketplace intermediary operations. In general, for fully electronic transactions, we receive 65% of the transaction revenues and Cantor, TradeSpark or Freedom receives 35% of the transaction revenues. Additionally, we receive 25% of certain net revenues from Cantor's Gaming Business as defined in the JSA, and treat all such revenue as fully electronic. With respect to the eSpeed equity order routing business, conducted for Cantor, the Company and Cantor each receive 50% of the revenues, after deduction of specified marketing, sales and other costs and fees. In addition, any eSpeed equity order routing business that is not conducted for Cantor will also be treated as a fully electronic transaction, and the Company will receive 65% of the revenues of any such business and Cantor will receive 35% of such revenues. Further, we and Municipal Partners, LLC, each receive 50% of the fully electronic revenues related to municipal bonds and we and CO2e.com, LLC, each receive 50% of the fully electronic revenues. In general, for voice-assisted brokerage transactions, we receive 7% of the transaction revenues, in the case of BGC transactions, and 35% of the transaction revenues, in the case of TradeSpark or Freedom transactions. For CO2e.com, LLC we receive 20% of the transaction revenues. For screen assisted open outcry brokerage transactions, we receive 2.5% of the transaction revenues in the case of BGC transactions, and for CO2e.com, LLC, we receive 20% of the transaction revenues. Under those services agreements, the Company has agreed to provide Cantor, BGC, TradeSpark, Freedom, MPLLC and CO2e technology support services, including systems administration, internal network support, support and procurement for desktops of end-user equipment, operations and disaster recovery services, voice and data communications, support and development of systems for clearance and settlement services, systems support for brokers, electronic applications systems and network support, and provision and/or implementation of existing electronic applications systems, including improvements and upgrades thereto, and use of the related intellectual property rights. In general, the Company charges Cantor, BGC, TradeSpark, Freedom and MPLLC the actual direct and indirect costs, including overhead, of providing such services and receives payment on a monthly basis. These services are provided to CO2e at no additional cost other than the revenue sharing arrangement set forth above. In exchange for a 25% share of the net revenues from Cantor's Gaming Businesses, the Company is obligated to spend and does not get reimbursed for the first $750,000 each quarter of the costs of providing support and development services for such gaming businesses. In February 2003, we agreed with Cantor that with respect to (i) certain network access facilities services agreements and (ii) other circumstances in which Cantor refers network access facility services business to us, 60% of net revenues from such business would be paid to Cantor and 40% of such revenues would be paid to us. This revenue sharing arrangement will be made after deduction of all sales commissions, marketing, helpdesk, clearing and direct third-party costs, including circuits and maintenance. During 2005, our Audit Committee and Board of Directors authorized our management to enter into various amendments or modifications to the JSA as follows: In January 2005, we were authorized to divide revenue between us and Cantor with respect to all products other than benchmark U.S. treasury securities, spot foreign exchange or European government bonds (EGBs), which become electronically traded in the future. Although we have not entered into any such modifications to date, we may receive no less than 50% of the net revenues for such products for a period of four years from the date a customer enters an order on our eSpeed(R) system for such products, or four years from the date of the amendment in the case of products which are currently voice-assisted for BGC customers. At the end of such four year period, the revenue share shall revert to a payment to eSpeed of 65% of the net revenues for such products. Net revenues shall be calculated after deduction of all related broker payouts, commissions and other compensation expense. We are authorized to pay directly to BGC or Cantor brokers up to 10% of gross revenues on increased electronic trading on our eSpeed(R) system by customers of such brokers in certain products. These payments are intended to provide incentive to voice brokers to encourage additional electronic trading on our eSpeed(R) system by their customers and are solely in the discretion of our management. We have further entered into an arrangement with Cantor with respect to a revenue share regarding FX. The JSA was clarified to provide that the 65%/35% revenue share between eSpeed and Cantor shall be paid after the payment of any revenue share amount to certain participants on the FX platform and after payment of fees relating to clearance, settlement and fulfillment services provided by Cantor. Such clearing and settlement fees shall be shared 65%/35% in the event that the average cost of such services exceeds the average costs associated with clearing and settling cash transaction in U.S. Treasuries. 13 On May 20, 2005, BGC, acquired Maxcor Financial Group, Inc. (Maxcor), a domestic and international inter-dealer broker for a broad range of financial instruments. As a result, Maxcor's voice-assisted brokerage transactions are subject to the terms and conditions of the JSA, effective from the acquisition date. As such, eSpeed has assumed financial responsibility for certain technology development personnel of Eurobrokers consistent with our relationship with BGC. Beginning on July 1, 2005, we will divide revenue with Cantor with respect to EGBs traded electronically as follows: (i) the first $1,500,000 of gross revenues from EGBs traded electronically (the "Initial Allocation Threshold") shall be shared 65% to eSpeed and 35% to Cantor, (ii) from July 1, 2005 through June 30, 2009, net revenues for EGBs derived from gross revenues in excess of the Initial Allocation Threshold shall be shared 50% to eSpeed and 50% to Cantor, and (iii) after June 30, 2009, net revenues from EGBs derived from gross revenues in excess of the Initial Allocation Threshold shall then be shared 65% to eSpeed and 35% to Cantor. Net revenue shall be calculated by deducting from gross brokerage commissions all related broker payouts, commissions and other compensation expenses. Additionally, we are authorized to privately label the eSpeed system to the Debt Capital Markets division of Cantor and the net revenue between us and Cantor, with respect to such privately labeled businesses shall be shared 50% to eSpeed and 50% to Cantor for a period of four years from the date such customer begins trading. Thereafter, net revenues shall be shared 65% to eSpeed and 35% to Cantor. Net revenues shall be calculated by deducting from gross brokerage commissions all related broker payouts, commissions and other compensation expenses. Under an Administrative Services Agreement, Cantor provides various administrative services to the Company, including accounting, tax, legal, human resources and facilities management. The Company is required to reimburse Cantor for the cost of providing such services. The costs represent the direct and indirect costs of providing such services and are determined based upon the time incurred by the individual performing such services. Management believes that this allocation methodology is reasonable. The Administrative Services Agreement renews automatically for successive one-year terms unless cancelled upon six months' prior notice by either the Company or Cantor. The Company incurred administrative fees for such services during the nine months ended September 30, 2005 and 2004 totaling $10.5 million, $9.6 million, respectively. The services provided under both the Amended and Restated Joint Services Agreement and the Administrative Services Agreement are not the result of arm's-length negotiations because Cantor controls the Company. As a result, the amounts charged for services under these agreements may be higher or lower than amounts that would be charged by third parties if the Company did not obtain such services from Cantor. Amounts due to or from related parties pursuant to the transactions described above are non-interest bearing. Receivables from Tradespark, Freedom and MPLLC totaled approximately $1.2 million and $1.0 million as of September 30, 2005 and December 31, 2004 respectively. All amounts due from related parties are included in the receivable from related parties in the condensed consolidated statements of financial condition. 14 9. EARNINGS PER SHARE The following is a reconciliation of the basic and diluted earnings per share computations: Three Months Ended Nine Months Ended September 30, September 30, -------------------------------------------------------------- 2005 2004 2005 2004 ------------- ------------- ------------- -------------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net income for basic and diluted earnings per share $ 1,873 $ 5,735 $ 1,754 $ 25,471 ============= ============= ============= ============== Shares of common stock and common stock equivalents; Weighted average shares used in basic computation 50,998 54,398 51,805 55,538 Dilutive effect of: Stock options 558 872 629 1,466 Restricted stock grants 141 - 152 - Business partner securities - 19 - 61 ------------- ------------- ------------- -------------- Weighted average shares used in diluted computation 51,697 55,289 52,586 57,065 ============= ============= ============= ============== Earnings per share: Basic $ 0.04 $ 0.11 $ 0.03 $ 0.46 ============= ============= ============= ============== Diluted $ 0.04 $ 0.10 $ 0.03 $ 0.45 ============= ============= ============= ============== During the three months ended September 30, 2005 and 2004, approximately 15.2 million and 15.8 million, respectively, of securities were excluded from the computation of diluted earnings per share because the effect was anti-dilutive. Additionally, during the nine months ended September 30, 2005 and 2004, approximately 15.0 million and 12.8 million, respectively, of securities were excluded from the computation of diluted earnings per share because the effect was anti-dilutive. 10. REGULATORY CAPITAL REQUIREMENTS Through its subsidiary, eSpeed Government Securities, Inc., the Company is subject to SEC broker-dealer regulation under Section 15C of the Securities Exchange Act of 1934, which requires the maintenance of minimum liquid capital, as defined. At September 30, 2005, eSpeed Government Securities, Inc.'s liquid capital of $111,224,621 was in excess of minimum requirements by $111,199,621. Additionally, the Company's subsidiary, eSpeed Securities, Inc., is subject to SEC broker-dealer regulation under Rule 17a-3 of the Securities Exchange Act of 1934, which requires the maintenance of minimum net capital and requires that the ratio of aggregate indebtedness to net capital, both as defined, shall not exceed 15 to 1. At September 30, 2005, eSpeed Securities, Inc. had net capital of $54,753,083, which was $54,703,967 in excess of its required net capital, and eSpeed Securities, Inc.'s net capital ratio was 1.35 to 1. As of September 30, 2005, the Company's regulated subsidiaries have no third party restrictions on their ability to transfer net assets to their parent company, eSpeed, Inc., except for the minimum liquid capital and net capital requirements for eSpeed Government Securities, Inc. and eSpeed Securities, Inc., which were $25,000 and $49,116, respectively. Both of these amounts were deemed immaterial per the requirements of SEC Rule 5-04 of Regulation S-X under the Securities Exchange Act of 1934. The regulatory requirements referred to above may restrict the Company's ability to withdraw capital from its regulated subsidiaries. 11. COMMITMENTS AND CONTINGENCIES During 2005, Cantor and the Company have established new global headquarters at 110 East 59th Street in New York's midtown Manhattan. Under the Administrative Services Agreement, eSpeed is obligated to Cantor for its pro rata portion (based on square footage used) of rental payments during the 16 year term of the lease for the new headquarters. There have been no significant changes in commitments and contingencies from the matters described in the notes to the Company's consolidated financial statements for the year ended December 31, 2004. Legal reserves are established in accordance with SFAS No. 5, "Accounting for Contingencies." Once established, reserves are adjusted when there is more information available or when an event occurs requiring a change. 15 LEGAL MATTERS 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 sought, 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. On February 7, 2005, MPLLC was granted permission to amend its claims to seek damages arising from eSpeed's direction to third parties to shut off certain circuits used by MPLLC after notice to MPLLC. After a full hearing on the merits, the Panel issued an award dated July 26, 2005 in MPLLC's favor in the amount of $363,292, which included interest in the amount of $73,903 and awarded no relief against eSpeed. Cantor has paid the award and the matter is finally resolved. By Summons and Complaint dated October 30, 2002, eSpeed commenced an action in New York State Supreme Court against MPLLC seeking, among other things, damages as a result of MPLLC's breach of a License and Services Agreement, under which MPLLC failed to pay eSpeed for ancillary information technology services and products provided to eSpeed, and failed to pay eSpeed a percentage of certain revenues derived by MPLLC from electronic trading. On November 19, 2002, MPLLC answered the Complaint. On April 1, 2004, MPLLC filed an amended Answer and Counterclaim. On May 25, 2004, eSpeed filed its reply to MPLLC's Counterclaim. Shortly thereafter, the parties engaged in a limited amount of discovery, but discovery was stayed pending the decision in the above-mentioned NASD Arbitration. On September 13, 2005, the parties entered into a case management Order setting forth a new discovery schedule. The parties have served document requests and are preparing to take depositions. In June 2003, we filed a patent infringement suit against BrokerTec USA, LLC, BrokerTec Global, LLC, its parent, ICAP, PLC, Garban, LLC, its technology provider, OM Technology, and its parent company, OM AB (collectively, BrokerTec), in the United States District Court for the District of Delaware. The parties thereafter agreed to substitute the defendant OM AB Technology for defendant OM AB and dismiss claims against BrokerTec Global, L.L.C. By Order dated September 13, 2004, ICAP was dismissed as a defendant. The suit centers on BrokerTec's and Garban's alleged infringement of U.S. Patent No. 6,560,580 issued on May 6, 2003, which expires in 2016, with respect to which eSpeed is the exclusive licensee. The patent covers a system and methods for auction-based trading of specialized items such as fixed income instruments. A jury trial began on February 7, 2005. In a pre-trial ruling on February 7, 2005, the U.S. District Court in Delaware ruled that the BrokerTec ETN did not infringe our 580 Patent. On February 22, 2005, a jury found that the Garban GTN did infringe our 580 Patent but that there was a deficiency in the application which led to the 580 Patent, finding that we "failed to provide adequate written description of each and every element recited" in certain claims of the 580 Patent. We are currently awaiting entry of final judgment on the jury findings by the court following post-trial motions, as well as a judgment on an inequitable conduct claim against eSpeed. The Court's rulings could lead to a judgment of invalidity on a portion of the claims set forth in the patent and, in the event of an adverse judgment on inequitable conduct, a judgment of unenforceability with respect to some or all claims. We expect to appeal certain rulings to the U.S. Court of Appeals for the Federal Circuit. Briefing of post-trial motions and on issues including unenforceability was completed on June 27, 2005. Both parties requested attorneys' fees from the other party, which may be awarded by the court in exceptional cases. Oral argument was held on October 12, 2005. In August 2004, Trading Technologies International, Inc. (TT) commenced an action in the United States District Court, Northern District of Illinois, Eastern Division, against us. In its complaint, TT alleged that we infringed and continue to infringe U.S. Patent No. 6,766,304, which issued on July 20, 2004 and U.S. Patent 6,772,132, which issued on August 3, 2004. TT also filed a motion for preliminary injunction seeking to preclude us from making, selling, and offering to sell a product that allegedly infringes such patents. A hearing on TT's motion for preliminary injunction was held on December 2, 2004. On February 9, 2005, the Court denied TT's motion for a preliminary injunction. The Court determined that we had not raised a substantial question concerning the validity or infringement of the patents but that TT had not proved that it would suffer irreparable harm absent an injunction. A trial date for this case has not yet been set. On March 16, 2005, TT filed an amended Complaint against us and added infringement allegations against Ecco and ITSEcco. On April 6, 2005, eSpeed and Ecco answered the Complaint in which we denied the infringement allegations. At the same time, eSpeed and Ecco filed a Counterclaim seeking a declaration that the patents in a suit are invalid, we do not make, use or sell any product that infringes any claims of the patents in suit, and the patents in suit are unenforceable because of inequitable conduct before the U.S. Patent and Trademark Office during the prosecution of the patents. On April 18, 2005, ITSEcco filed a motion to dismiss TT's complaint against it for lack of personal jurisdiction. The Court has not ruled on this motion. If TT ultimately prevails in this litigation, we may be required to pay TT damages and/or certain costs and expenses, and we may be forced to modify or withdraw certain products from the market. Both parties requested attorneys' fees from the other party, which may be awarded by the court in exceptional cases. In the first quarter of 2005, we were named as a defendant in a number of purported class action complaints on behalf of all persons who purchased the securities of eSpeed from August 12, 2003, to July 1, 2004, alleging that we made "material false 16 positive statements during the class period" and violated certain provisions of the U.S. Securities Exchange Act of 1934 ("Exchange Act"), as amended, and certain rules and regulations thereunder. On April 8, 2005, the district court consolidated the purported class action complaints, and subsequently the court appointed lead plaintiffs and lead counsel. We received the consolidated and amended complaint ("Amended Complaint") on September 27, 2005. The Amended Complaint names as defendants the following: eSpeed; three officers, Howard Lutnick, Lee Amaitis, and Joseph Noviello; and one former officer, Jeffrey Chertoff. In the Amended Complaint, plaintiffs allege violations of Section 10(b) of the Exchange Act and Rule 10b-5 against all defendants, and allege violations of Section 20(a) against the individual defendants. We believe that the lawsuit is without merit. 12. SEGMENT AND GEOGRAPHIC DATA SEGMENT INFORMATION: The Company currently operates its business in one segment, that of operating interactive electronic marketplaces for the trading of financial and non-financial products, licensing software, and providing technology support services to Cantor and other related and unrelated parties. PRODUCT INFORMATION: The Company currently markets its services through the following products: core products, including an integrated network engaged in electronic trading in government securities in multiple marketplaces over the eSpeed(R) system; new product rollouts, including introduction of products in non-equity capital markets; products enhancement software, which enables clients to engage in enhanced electronic trading of core products and new product rollouts; and eSpeed Software SolutionsSM, which allows customers to use the Company's intellectual property and trading expertise to build electronic marketplaces and exchanges, develop customized trading interfaces and enable real-time auctions and debt issuance. Revenues from core products comprise the majority of the Company's revenues. GEOGRAPHIC INFORMATION: The Company operates in the Americas (primarily in the United States), Europe and Asia. Transaction Revenue attribution for purposes of preparing geographic data is principally based upon the marketplace where the financial product is traded, which, as a result of regulatory jurisdiction constraints in most circumstances, is also representative of the location of the client generating the transaction resulting in commissionable revenue. The information that follows, in management's judgment, provides a reasonable representation of the transaction revenue and long-lived assets of each region as of and for the periods indicated. Three Months Ended September 30, Nine Months Ended September 30, ----------------------------------------------- ------------------------------------------------ 2005 2004 2005 2004 ---------------------- ---------------------- ---------------------- ------------------------ (IN THOUSANDS) Transaction revenues with related parties: Europe $ 6,327 $ 6,942 $ 21,036 $ 23,013 Asia 326 471 1,543 1,498 ---------------------- ---------------------- ---------------------- ------------------------ Total Non-Americas 6,653 7,413 22,579 24,511 Americas 19,590 23,534 56,653 77,722 ---------------------- ---------------------- ---------------------- ------------------------ Total $ 26,243 $ 30,947 $ 79,232 $ 102,233 ====================== ====================== ====================== ======================== September 30, 2005 December 31, 2004 ---------------------- ---------------------- (IN THOUSANDS) Long-lived assets: (a) Europe $ 16,475 $ 15,765 Asia 515 387 ---------------------- ---------------------- Total Non-Americas 16,990 16,152 Americas 43,479 34,453 ---------------------- ---------------------- Total $ 60,469 $ 50,605 ====================== ====================== (a) Represents fixed assets, net 17 13. ACQUISITION RELATED COSTS On June 15, 2005, the Company announced that it had submitted a binding irrevocable offer to acquire 51% of the share capital of Societa per il Mercato dei Titoli di Stato -- Borsa Obbligazionaria Europea S.p.A (MTS) for a total subscription price equal to 51% of Euro 250 million through the issuance of new MTS shares. The Company offered to acquire, at the same price per share, up to an additional 20% of the share capital of MTS from current MTS shareholders following closing. On July 1, 2005, the Company announced that it had been informed by MTS that a majority of MTS shareholders had voted to accept an alternative offer to acquire a majority interest in MTS. As a result of the shareholder vote, the Company terminated its commitment letter with Cantor , in which Cantor agreed to provide the Company with an unsecured credit facility of $60 million. There are no termination penalties associated with the termination of the commitment letter. The Company incurred legal, accounting, advisory, financing and other related expenses incurred in connection with its offer. These costs, which include a $300,000 fee paid to Cantor for the unsecured credit facility commitment, amounted to $4.1 million and were recorded during the quarter ended June 30, 2005 as acquisition-related costs in the accompanying condensed consolidated statement of income for the nine months ended September 30, 2005. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 and TradeSpark employees, the costs and expenses of developing, maintaining and protecting our intellectual property, including judgments or settlements paid or received and their related costs, the possibility of future losses and negative cash flow from operations, the effect of market conditions, including trading volume and volatility, our pricing strategy and that of our competitors, our ability to develop new products and services, to enter new markets, to secure and maintain market share, to enter into strategic alliances, joint ventures and other transactions, 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 our Annual Report on Form 10-K for the year ended December 31, 2004. 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 We have experienced major changes to our U.S. Treasury business, expanded and strengthened our senior management team and grown our sales force. We consider the trading of U.S. Treasury securities to be both a foundation for our company and an area for growth. During 2004, we encountered a competitive pricing environment and experienced an erosion of our market position leading to lower than expected revenues. We addressed our pricing structure on a client-by-client basis by offering tailored and flexible pricing solutions that focused on lowering the customers' marginal cost of trading on our eSpeed system. These solutions included a combination of variable and fixed commissions. We offered many of our largest bank and investment bank customers larger fixed fee/less variable pricing components, which has resulted in increases to volumes traded on the eSpeed platform which has reduced our sensitivity to changes in market volumes and has helped to increase our market share over the last three quarters. We also improved our client service. In January 2005, we announced the strategic decision to remove Price Improvement (PI) from our technology platform. We expect to continue to experience a revenue reduction in the short-term; we believe the long-term expected benefit of increased market volumes should result in increased revenues. We augmented our focus on new product sales and product technology rollouts. New product sales include the early-stage development of our FX product. We offer a unique trading platform that provides FX spot traders what we believe is the only truly neutral, anonymous, multiple buyer/multiple seller wholesale electronic market. We offer immediacy, and provide an order driven 18 marketplace where participants can place bids and offers. To create and grow our FX business, we hired an experienced and dedicated sales team. We remain a leading innovator in the provision of financial technology. We devoted significant energy to the development of new and proprietary methods and technologies that we expect to incorporate in new products and product enhancements during 2005 and beyond. We target our innovation to create new opportunities for our clients to gain trading advantage and increase trading profits and to meet new client needs that are generated by the rapid pace of change in their businesses. We believe that such continued delivery of new technologies that add value to our clients will create for us additional trading volume, new revenue opportunities and barriers against competition. We continue to see the positive effects of the changes we implemented in 2004. Our U.S. Treasury business is positioned for growth, and we are optimistic that our foreign exchange business will expand and add value to us. In sales, we continued to expand our sales force to support our growth efforts in the U.S. Treasury and foreign exchange markets. We expect our expenses to increase as we see revenue growth and additional opportunities. Additionally, we may continue to repurchase our Class A common shares opportunistically. On May 20, 2005, BGC, acquired Maxcor Financial Group, Inc. (Maxcor), a domestic and international inter-dealer broker for a broad range of financial instruments. As a result, Maxcor's voice-assisted brokerage transactions are subject to the terms and conditions of the JSA, effective from the acquisition date. As such, eSpeed has assumed financial responsibility for certain technology development personnel of Eurobrokers consistent with our relationship with BGC. In June 2005, we announced that we had submitted a binding irrevocable offer to acquire 51% of the share capital of Societa per il Mercato dei Titoli di Stato -- Borsa Obbligazionaria Europea S.p.A ("MTS"). We also offered to acquire up to an additional 20% of the share capital of MTS from current MTS shareholders following closing. In July 2005, we announced that we had been informed by MTS that a majority of MTS shareholders had voted to accept an alternative offer to acquire a majority interest in MTS. See Note 13 of notes to condensed consolidated financial statements for further discussion. CRITICAL ACCOUNTING POLICIES The following discussion is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities in the financial statements. Management believes that the estimates utilized in preparing the financial statements are reasonable and prudent. Estimates, by their nature, are based on judgment and available information. As such, actual results could differ from the estimates included in these financial statements. We believe that the following critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements. INSURANCE COVERAGE ------------------ We have insurance coverage for both property and casualty losses and for business interruption through our Administrative Services Agreement with Cantor. On September 11, 2001, we were entitled to property and casualty insurance coverage of up to $40.0 million under the Administrative Services Agreement with Cantor. Cantor received property and casualty insurance payments related to the September 11 Events totaling $45.0 million in 2001. As a result of the September 11 Events, we had fixed assets with a book value of approximately $17.8 million that were destroyed. We have recovered these losses through $20.5 million of property insurance proceeds remitted from Cantor and, as such, we have not recorded a net loss related to the destruction of our fixed assets. The basis for this allocation was the book value of the assets destroyed ($17.8 million) plus the difference of the cost of assets replaced through December 31, 2001, over the depreciated value of assets destroyed. During the year ended December 31, 2002, Cantor received $40.0 million of insurance proceeds pursuant to business interruption insurance coverage, of which $12.8 million was allocated to us. Such amount was received from Cantor and recognized as income in our consolidated statement of operations. This allocation was based on an analysis prepared by an independent consultant. During the year ended December 31, 2003, Cantor received an additional $21.0 million of insurance proceeds in settlement for property damage related to the September 11 Events. Under the Administrative Services Agreement with Cantor, we will be entitled to up to an additional $19.5 million of these proceeds as replacement assets are purchased in the future and surpass the initial payment of $20.5 million, depending on the ultimate replacement cost of the assets destroyed. The basis of this additional $19.5 million of 19 proceeds is the property and casualty coverage of $40.0 million less the $20.5 million already received. As we have already received proceeds in excess of the book value of the destroyed assets, any future allocations will result in a gain. No gains on replacement of fixed assets were recorded during the year ended December 31, 2004 or during the nine months ended September 30, 2005. We expect to begin recording such gains in the fourth quarter of 2005. We estimate that we have replaced assets with an aggregate cost of approximately $20.3 million. We expect to incur significant costs in relation to the replacement of fixed assets lost on September 11, 2001 as we continue to build our permanent infrastructure. RELATED-PARTY TRANSACTIONS -------------------------- We share revenues with Cantor, BGC, TradeSpark, Freedom, MPLLC and CO2e. In addition, we provide technology support services to Cantor, BGC, TradeSpark, Freedom, MPLLC and CO2e, and Cantor provides administrative services to us. Since Cantor holds a controlling interest in us, and holds a significant interest in BGC and Freedom, such transactions among and between us and Cantor, BGC and Freedom are on a basis which might not be replicated if such services or revenue sharing arrangements were between, or among, unrelated parties. We recognize Software Solutions fees from related parties based on the allocated portion of our costs of providing services to our related parties. Such allocation of costs requires us to make estimates and judgments as to the equitable distribution of such costs. In addition, we receive administrative services from Cantor, for which we pay a fee based on Cantor's good faith determination of an equitable allocation of the costs of providing such services. There is no assurance that we could realize such revenues, or obtain services at such costs, if we had to replicate such arrangements with unrelated parties. PATENTS ------- Intangible assets consist of purchased patents, costs incurred in connection with the filing and registration of patents and the costs to defend and enforce our rights under patents. The costs of acquired patents are amortized over a period not to exceed 17 years or the remaining life of the patent, whichever is shorter, using the straight-line method. Capitalized costs related to the filing of patents are generally amortized on a straight-line basis over a period not to exceed three years. The costs to defend and enforce our rights under these patents consist primarily of external litigation costs related to the pursuit of patent infringement lawsuits by us, and consist of fees for outside attorneys, technology experts and litigation support services. These costs are capitalized when such costs serve to enhance the value of the related patent, and are amortized over the remaining life of such patent. Should it be determined that the capitalized costs no longer serve to enhance the value of the respective patent, such as a situation in which our patent is held to be invalid, these capitalized costs would be expensed in the period in which such determination was made. We believe the inherent value of the patents exceeds their carrying value. However, if the rights afforded us under the patents are not enforced or the patents do not provide the competitive advantages that we anticipated at the time of purchase, we may have to write-down the patents, and such charges could be substantial. See Notes 4,8 and 11 of notes to our condensed consolidated financial statements for further discussion. CAPITALIZED SOFTWARE COSTS -------------------------- We capitalize the direct costs of employees who are engaged in creating software for internal use. This treatment requires us to estimate the portion of employees' efforts, which directly produce new software, including design, coding, and installation and testing activities, or provide additional functionality to existing software. In our judgment, these employee-related costs serve to create or enhance valuable software. Our current policy is to capitalize these costs and amortize them over their estimated economic useful life of three years on a straight-line basis. We expense maintenance and other costs that we are unable to capitalize under Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The capitalized costs incurred to produce the software are ultimately deemed to exceed the benefit that the software provides, we may have to write-down the capitalized software costs, and such charges could be substantial. GOODWILL AND PURCHASED INTANGIBLE ASSETS ---------------------------------------- We review goodwill and purchased intangible assets for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets". Intangible assets, such as purchased technology, are generally recorded in connection with a business acquisition. The value assigned to intangible assets is usually based on estimates and judgments regarding expectations for the success and life cycle of the technology acquired. We may be required to record an impairment charge to write down an asset to its realizable value. The impairment charge would be measured as the excess of the carrying value of the asset over the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved. 20 Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations accounted for as a purchase. Goodwill is no longer amortized, but instead is subject to periodic testing for impairment. We will review goodwill for impairment on an annual basis during the fourth quarter of each fiscal year or whenever an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. Goodwill impairment is determined using a two-step approach. The first step of the goodwill test compares the fair value of a reporting unit with its carrying amount, including goodwill. The second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that difference. Determining the fair value of intangible assets is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, risk adjusted discount rates and, future economic and market conditions. We base our fair value estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates. INCOME TAXES ------------ SFAS No. 109, "Accounting for Income Taxes", establishes financial accounting and reporting standards for the effect of income taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity's financial statements or tax returns. Estimates and judgment are required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2004 THREE MONTHS ENDED SEPTEMBER 30, ------------------------ 2005 2004 ----------- --------- (IN THOUSANDS) Transaction revenues with related parties Fully electronic transactions $ 18,933 $ 25,489 Voice-assisted brokerage transactions 6,190 5,233 Screen-assisted open outcry transactions 1,121 225 ----------- --------- Total transaction revenues with related parties 26,244 30,947 Software Solutions fees from related parties 6,099 4,681 Software Solutions and licensing fees from unrelated parties 3,770 3,278 Gain on sale of investments 1,015 - Interest income 1,644 865 ----------- --------- Total revenues $ 38,772 $ 39,771 ----------- --------- REVENUES Transaction revenues with related parties Transaction revenues with related parties for the three months ended September 30, 2005 were $26.2 million compared to $30.9 million during the comparable period in 2004. There were 64 trading days in both three-month periods ended September 30, 2005 and 2004. Transaction revenues per trading day decreased by $74,000 or 15%, to $410,000 from $484,000 for the three months ended September 30, 2005 and 2004, respectively. Volumes transacted on our system increased by $6,578 billion (approximately $6.6 trillion), or 63%, from $10,388 billion (approximately $10.4 trillion) for the three months ended September 30, 2004 to $16,966 billion (approximately $17.0 trillion) for the three months ended September 30, 2005. During the three months ended September 30, 2005, fully electronic and voice-assisted transactions contributed 72% and 24% of our transaction revenues, respectively, compared to 82% and 17%, respectively, for the comparable period in 2004. Fully electronic revenues for the three months ended September 30, 2005 of $18.9 million decreased from $25.5 million during the comparable period in 2004. This decrease was primarily the result of a competitive pricing environment and our migration to a larger 21 fixed fee/less variable price commission model. This decrease was partially offset by an increase in the overall U.S. Treasury volume of 11%, or $3.5 trillion to $34.6 trillion, compared to $31.1 trillion for the comparable period in 2004. Voice-assisted revenues for the three months ended September 30, 2005 of $6.2 million increased 18% from $5.2 million during the comparable period in 2004. The increase was primarily due to BGC's investment and expansion in the voice brokerage business and BGC's acquisition of Maxcor. Screen-assisted open outcry revenues for the three months ended September 30, 2005 of $1.1 million increased 398% from $0.2 million during the comparable period in 2004. The increase was primarily due to BGC's investment and expansion in the voice brokerage business and BGC's acquisition of Maxcor. In addition to changes in our pricing strategy and market share, our revenues are highly dependent on transaction volume in the global financial product markets. Accordingly, among other things, equity market volatility, economic and political conditions in the United States and elsewhere in the world, concerns over inflation, institutional and consumer confidence levels, the availability of cash for investment by mutual funds and other wholesale and retail investors, fluctuating interest and exchange rates and legislative and regulatory changes and currency values may have an impact on our volume of transactions. In addition, a significant amount of our revenues is currently received in connection with our relationship with Cantor and BGC. Software Solutions fees from related parties Software Solutions fees from related parties for the three months ended September 30, 2005 were $6.1 million compared to $4.7 million during the comparable period in 2004, an increase of 30%. This increase resulted from an increase in demand for our support services from Cantor and the growth of BGC. Software Solutions and licensing fees from unrelated parties Software Solutions and licensing fees from unrelated parties for the three months ended September 30, 2005 were $3.8 million compared to $3.3 million during the comparable period in 2004, a 15% increase, due to revenues generated from our acquisition of ECCO and due to licensing fees earned as part of the Wagner Patent settlement agreement with CBOT, CME, NYMEX, and NYBOT and our licensing agreement with Intercontinental Exchange. We anticipate that as we license our software and patents to additional market participants, our revenues from Software Solutions and licensing fees from unrelated parties will continue to grow. See Note 4 of notes to our condensed consolidated financial statements for further discussion. Gain on sale of investments During the three months ended September 30, 2005, we redeemed the secured convertible bond issued by EasyScreen PLC. As a result, we recorded a pre-tax gain of $1.0 million. There were no gains on sale of investments in the comparable period in 2004. Interest income During the three months ended September 30, 2005, the blended weighted average interest rate that we earned on overnight reverse repurchase agreements and money market Treasury funds was 3.52% compared to 1.51% during the comparable period in 2004. As a result of the increase in the weighted average interest rate between periods, we generated interest income of $1.6 million for the three months ended September 30, 2005, an increase of 90% compared to $0.9 million for the comparable period in 2004. EXPENSES THREE MONTHS ENDED SEPTEMBER 30, ------------------------ 2005 2004 ----------- ---------- (IN THOUSANDS) Compensation and employee benefits $ 13,048 $ 10,499 Amortization of software development costs and other intangibles 5,206 4,109 Occupancy and equipment 7,712 6,322 Professional and consulting fees 2,018 1,663 Communications and client networks 1,931 1,684 Marketing 390 319 Administrative fees to related parties 3,216 3,435 Amortization of business partner and non-employee securities 50 136 Other 2,491 2,186 Total expense $ 36,062 $ 30,353 22 Compensation and employee benefits At September 30, 2005, we had 387 employees, which was an increase from the 376 employees we had at September 30, 2004. Compensation costs for the three months ended September 30, 2005 were $13.0 million compared to $10.5 million during the comparable period in 2004. The $2.5 million or 24%, increase, in compensation costs resulted mainly from the expansion and strengthening of our sales force, additional headcount from our acquisition of ECCO and a transition to more of a restricted stock based compensation model. Substantially all of our full-time employees are located in the New York metropolitan area and London. Amortization of software development costs and other intangibles In accordance with the provisions of Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," we capitalize qualifying computer software costs incurred during the application development stage, and amortize them over their estimated useful life of three years on a straight-line basis. Amortization of software development costs and other intangibles was $5.2 million for the three months ended September 30, 2005, an increase of $1.1 million, or 27%, compared to $4.1 million during the comparable period in 2004. This was primarily related to increased investment in software development activities and increases in the amortization of intangible assets as we continued to devote significant resources to the innovation and development of technology and protection of our intellectual property portfolio. In addition, amortization of purchased intangible assets from our ECCO acquisition contributed to the increase. Occupancy and equipment Occupancy and equipment costs were $7.7 million for the three months ended September 30, 2005, a $1.4 million or 22%, increase, compared to $6.3 million for the comparable period in 2004. The increase was primarily attributable to additional depreciation expense associated with IT equipment purchases and relocation to our permanent corporate headquarters in New York City. Professional and consulting fees Professional and consulting fees were $2.0 million for the three months ended September 30, 2005 compared to $1.7 million for the comparable period in 2004, an increase of 21%, primarily the result of legal expenses incurred in connection with litigation defense costs. Communications and client networks Communications costs were $1.9 million for the three months ended September 30, 2005 compared to $1.7 million for the comparable period in 2004, an increase of 15%. The increase was primarily due to upgraded communication costs incurred at our new permanent headquarters. Communication costs include the costs of local and wide area network infrastructure, the cost of establishing the client network linking clients to us, data and telephone lines, data and telephone usage, and other related costs. We anticipate expenditures for communications and client networks will increase in the near future as we continue to connect additional customers to our network. Marketing We incurred marketing expenses of $0.4 million for the three months ended September 30, 2005, which remained relatively flat compared to $0.3 million for the comparable period in 2004. Administrative fees to related parties Under an Administrative Services Agreement, Cantor provides various administrative services to us, including accounting, tax, legal, human resources and facilities management, for which we reimburse Cantor for the direct and indirect costs of providing such services. Administrative fees to related parties amounted to $3.2 million for the three months ended September 30, 2005, a decrease of $0.2 million, compared to $3.4 million for the comparable period in 2004. 23 Administrative fees to related parties are dependent upon both the costs incurred by Cantor and the portion of Cantor's administrative services that are utilized by us. Administrative fees to related parties are therefore partially correlated to our business growth. Amortization of business partner and non-employee securities We enter into strategic alliances with other industry participants in order to expand our business and to enter into new marketplaces. As part of these strategic alliances, we have issued warrants and convertible preferred stock. These securities do not require cash outlays and do not represent a use of our assets. The expense related to these issuances is based on the value of the securities being issued and the structure of the transaction. Generally, this expense is amortized over the term of the related agreement. Charges in relation to the amortization of business partner and non-employee securities were $0.1 million for the three months ended September 30, 2005, which were flat compared to $0.1 million during the comparable period in 2004. Other expenses Other expenses consist primarily of insurance costs, travel, promotional and entertainment expenditures. For the three months ended September 30, 2005, other expenses were $2.5 million, an increase of $0.3 million, or 14%, compared to other expenses of $2.2 million for the comparable period in 2004. The increase was principally due to travel and entertainment related expenses. Income taxes During the three months ended September 30, 2005, we recorded an income tax provision of $0.8 million compared to $3.7 million during the three months ended September 30, 2004. Our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings. RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2004 REVENUES NINE MONTHS ENDED SEPTEMBER 30, --------------------- 2005 2004 ---- ---- (IN THOUSANDS) Transaction revenues with related parties Fully electronic transactions $ 58,174 $ 85,170 Voice-assisted brokerage transactions 19,128 16,449 Screen-assisted open outcry transactions 1,931 614 ------------ ----------- Total transaction revenues with related parties 79,233 102,233 Software Solutions fees from related parties 18,860 13,268 Software Solutions and licensing fees from unrelated parties 11,712 9,383 Gain on sale of investments 1,015 - Interest income 4,311 2,370 ------------ ----------- Total revenues $115,131 $127,254 ============ ============ Transaction revenues with related parties Transaction revenues with related parties for the nine months ended September 30, 2005 were $79.2 million compared to $102.2 million during the comparable period in 2004. There were 189 and 188 trading days in the nine-month periods ended September 30, 2005 and 2004, respectively. Transaction revenues per trading day decreased by $125,000, or 23%, to $419,000 from $544,000 for the nine months ended September 30, 2005 and 2004, respectively. Volumes transacted on our system increased by $10,153 billion (approximately $10.2 trillion), or 30%, from $33,377 billion (approximately $33.4 trillion) for the nine months ended September 30, 2004 to $43,530 billion (approximately $43.5 trillion) for the nine months ended September 30, 2005. During the nine months ended September 30, 2005, fully electronic and voice-assisted transactions contributed 73% and 24% of our transaction revenues, respectively, compared to 83% and 16%, respectively, for the comparable period in 2004. 24 Fully electronic revenues for the nine months ended September 30, 2005 of $58.2 million decreased from $85.2 million during the comparable period in 2004. This decrease was primarily due to the competitive pricing environment in U.S Treasury trading that led to the erosion of our market position and declining revenues. This decline in market position during the nine months ended September 30, 2005 was partially offset by an increase in the overall U.S. Treasury volume of 13%, or $12.6 trillion to $105.9 trillion, compared to $93.3 trillion for the comparable period in 2004. Voice-assisted revenues for the nine months ended September 30, 2005 of $19.1 million increased 16% from $16.4 million during the comparable period in 2004. The increase was primarily due to BGC's investment and expansion in the voice brokerage business and BGC's acquisition of Maxcor. Screen-assisted open outcry revenues for the nine months ended September 30, 2005 of $1.9 million increased 215% from $0.6 million during the comparable period in 2004. The increase was primarily due to BGC's investment and expansion in the voice brokerage business and BGC's acquisition of Maxcor. In addition to changes in our pricing strategy and market share, our revenues are highly dependent on transaction volume in the global financial product markets. Accordingly, among other things, equity market volatility, economic and political conditions in the United States and elsewhere in the world, concerns over inflation, institutional and consumer confidence levels, the availability of cash for investment by mutual funds and other wholesale and retail investors, fluctuating interest and exchange rates and legislative and regulatory changes and currency values may have an impact on our volume of transactions. In addition, a significant amount of our revenues is currently received in connection with our relationship with Cantor and BGC. Software Solutions fees from related parties Software Solutions fees from related parties for the nine months ended September 30, 2005 were $18.9 million compared to $13.3 million during the comparable period in 2004, an increase of 42%. This increase resulted from an increase in demand for our support services from Cantor and the growth of BGC. Software Solutions and licensing fees from unrelated parties Software Solutions and licensing fees from unrelated parties for the nine months ended September 30, 2005 were $11.7 million compared to $9.4 million during the comparable period in 2004, a 25% increase, due to revenues generated from our acquisition of ECCO and due to licensing fees earned as part of the Wagner Patent settlement agreement with CBOT, CME, NYMEX, and NYBOT and our licensing agreement with Intercontinental Exchange. We anticipate that as we license our software and patents to additional market participants, our revenues from Software Solutions and licensing fees from unrelated parties will continue to grow. See Note 4 of the condensed consolidated financial statements for further discussion. Gain on sale of investments During the nine months ended September 30, 2005, we redeemed the secured convertible bond issued by EasyScreen PLC. As a result, we recorded a pre-tax gain of $1.0 million. There were no gains on sale of investments in the comparable period in 2004. Interest income During the nine months ended September 30, 2005, the blended weighted average interest rate that we earned on overnight reverse repurchase agreements and money market Treasury funds was 3.05% compared to 1.36% during the comparable period in 2004. As a result of the increase in the weighted average interest rate between periods, we generated interest income of $4.3 million for the nine months ended September 30, 2005, an increase of 82% compared to $2.4 million for the comparable period in 2004. 25 EXPENSES NINE MONTHS ENDED SEPTEMBER 30, ---------------------- 2005 2004 -------- --------- (IN THOUSANDS) Compensation and employee benefits $ 38,989 $ 29,582 Amortization of software development costs and other intangibles 14,376 11,643 Occupancy and equipment 22,657 18,622 Professional and consulting fees 7,088 3,461 Communications and client networks 5,569 4,892 Marketing 1,252 1,084 Administrative fees to related parties 10,515 9,604 Amortization of business partner and non-employee securities 310 722 Acquisition related costs 4,124 - Other 7,845 5,819 -------- --------- Total expense $ 112,725 $ 85,429 -------- --------- Compensation and employee benefits At September 30, 2005, we had 387 employees, which was an increase from the 376 employees we had at September 30, 2004. Compensation costs for the nine months ended September 30, 2005 were $39.0 million compared to $29.6 million during the comparable period in 2004. The $9.4 million or 32% increase, in compensation costs resulted mainly from the expansion and strengthening of our senior management team, senior sales personnel, additional headcount from our acquisition of ECCO and a transition to more of a restricted stock based compensation model. Substantially all of our full-time employees are located in the New York metropolitan area and London. Amortization of software development costs and other intangibles In accordance with the provisions of Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," we capitalize qualifying computer software costs incurred during the application development stage, and amortize them over their estimated useful life of three years on a straight-line basis. Amortization of software development costs and other intangibles was $14.4 million for the nine months ended September 30, 2005, an increase of $2.8 million, or 24%, compared to $11.6 million during the comparable period in 2004. This was primarily related to increased investment in software development activities and increases in the amortization of intangible assets as we continued to devote significant resources to the innovation and development of technology and protection of our intellectual property portfolio. In addition, amortization of purchased intangible assets from our ECCO acquisition contributed to the increase. Occupancy and equipment Occupancy and equipment costs were $22.7 million for the nine months ended September 30, 2005, a $4.1 million or 22% increase, compared to $18.6 million for the comparable period in 2004. The increase was primarily attributable to additional depreciation expense associated with IT equipment purchases and relocation to our permanent corporate headquarters in New York City. Professional and consulting fees Professional and consulting fees were $7.1 million for the nine months ended September 30, 2005 compared to $3.5 million for the comparable period in 2004, an increase of 105%, primarily the result of legal expenses incurred in connection with litigation defense costs. Communications and client networks Communications costs were $5.6 million for the nine months ended September 30, 2005 compared to $4.9 million for the comparable period in 2004, an increase of 14%. The increase was primarily due to duplicate communication costs incurred at our temporary and permanent headquarters, and upgraded communications costs at our permanent headquarters. 26 Communication costs include the costs of local and wide area network infrastructure, the cost of establishing the client network linking clients to us, data and telephone lines, data and telephone usage, and other related costs. We anticipate expenditures for communications and client networks will increase in the near future as we continue to connect additional customers to our network. Marketing We incurred marketing expenses of $1.3 million for the nine months ended September 30, 2005, an increase of 15%, compared to $1.1 million for the comparable period in 2004. Administrative fees to related parties Under an Administrative Services Agreement, Cantor provides various administrative services to us, including accounting, tax, legal, human resources and facilities management, for which we reimburse Cantor for the direct and indirect costs of providing such services. Administrative fees to related parties amounted to $10.5 million for the nine months ended September 30, 2005, an increase of $0.9 million or 9%, compared to $9.6 million for the comparable period in 2004. Administrative fees to related parties are dependent upon both the costs incurred by Cantor and the portion of Cantor's administrative services that are utilized by us. Administrative fees to related parties are therefore partially correlated to our business growth. Amortization of business partner and non-employee securities We enter into strategic alliances with other industry participants in order to expand our business and to enter into new marketplaces. As part of these strategic alliances, we have issued warrants and convertible preferred stock. These securities do not require cash outlays and do not represent a use of our assets. The expense related to these issuances is based on the value of the securities being issued and the structure of the transaction. Generally, this expense is amortized over the term of the related agreement. Charges in relation to the amortization of business partner and non-employee securities were $0.3 million for the nine months ended September 30, 2005 compared to $0.7 million during the comparable period in 2004. This $0.4 million, or 57%, decrease resulted primarily from the fact that the value of a warrant agreement became fully amortized at the end of the first quarter of 2004, and thus contributed no amortization for the remainder of 2004. The amendment of another warrant agreement that had the effect of extending the term over which the related warrant value is amortized further contributed to this decrease. Acquisition related costs During the nine months ended September 30, 2005, we recorded $4.1 million of acquisition related costs in connection with our MTS offer. These costs primarily included legal, accounting, advisory and other related expenses. See note 13 of notes to our condensed consolidated financial statements for further discussion. Other expenses Other expenses consist primarily of insurance costs, travel, promotional and entertainment expenditures. For the nine months ended September 30, 2005, other expenses were $7.8 million, an increase of $2.0 million, or 35%, compared to other expenses of $5.8 million for the comparable period in 2004. The increase was principally due to employee recruiting costs, moving expenses related to our new office and travel and entertainment related expenses. Income taxes During the nine months ended September 30, 2005, we recorded an income tax provision of $0.7 million compared to an income tax provision of $16.4 million during the nine months ended September 30, 2004. Our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings. LIQUIDITY AND CAPITAL RESOURCES Our principal source of liquidity is our operating cash flow. This cash-generating capability is one of our fundamental strengths and provides us with substantial financial flexibility in meeting operating, investing and financing needs. At September 30, 2005, we had cash and cash equivalents of $184.3 million, a decrease of $25.4 million compared to $209.7 million at December 31, 2004. OPERATING ACTIVITIES 27 During the nine months ended September 30, 2005, our operating activities provided cash of $25.7 million compared to $51.2 million during the comparable period in 2004. The decrease of $25.5 million, or 50%, was primarily attributable to a decrease in net income. Our operating cash flows consist of transaction revenues with related parties and Software Solutions fees from related and unrelated parties, various fees paid to or costs reimbursed to Cantor, other costs paid directly by us and interest income. In its capacity as a fulfillment service provider, Cantor processes and settles transactions and, as such, collects and pays the funds necessary to clear transactions with the counterparty. In doing so, Cantor receives our portion of the transaction fee and, in accordance with the Joint Services Agreement, remits the amount owed to us. In addition, we have entered into similar services agreements with BGC, Freedom, MPLLC and CO2e. Under the Administrative Services Agreement, the Joint Services Agreement and the services agreements with BGC, TradeSpark, Freedom, MPLLC and CO2e, any net receivable or payable is settled monthly. INVESTING ACTIVITIES During the nine months ended September 30, 2005, we used cash in investing activities of $22.6 million compared to $29.7 million during the comparable period in 2004. The decrease was primarily due to proceeds received from the sale of investments and reduction in capitalization of patent defense costs partially offset by increased capitalization of software development costs. FINANCING ACTIVITIES During the nine months ended September 30, 2005, we used cash in financing activities of $28.5 million compared to cash used in financing activities of $26.9 million in the comparable period in 2004. During 2005, we repurchased approximately 3.5 million shares of our Class A common stock for a total of $28.9 million under our repurchase plan which included approximately 0.3 million shares repurchased from partners of Cantor and approximately 0.9 million shares repurchased from the Cantor Relief Fund, which were at fair market value on date of purchase. Our Board of Directors has authorized the repurchase of up to an additional $100 million of our outstanding Class A common stock of which $58.7 million remained available for repurchase at September 30, 2005. At the price levels at which we have been repurchasing shares, we believe the eSpeed shares represent an attractive investment and therefore, we may continue to repurchase shares opportunistically. In addition, proceeds from exercises of employee stock options and business partner warrants were lower during the nine months ended September 30, 2005 mainly because of lower overall market prices as compared to the comparable period in 2004. We anticipate that we will experience an increase in our capital expenditures and lease commitments consistent with our anticipated growth in operations, infrastructure and personnel. Our property and casualty insurance coverage proceeds may mitigate our capital outlay for capital expenditures for the near term. During the year ended December 31, 2003, Cantor received an additional $21.0 million of insurance proceeds in settlement for property damage related to the September 11 Events. We will be entitled to up to $19.5 million of these proceeds as replacement assets are purchased in the future, depending on the ultimate replacement value of the assets destroyed. Under the current operating structure, our cash flows from operations and our existing cash resources should be sufficient to fund our current working capital and current capital expenditure requirements for at least the next 12 months. However, we believe that there are a significant number of capital intensive opportunities for us to maximize our growth and strategic position, including, among other things, strategic alliances, joint ventures and other transactions potentially involving all types and combinations of equity, debt, acquisitions, recapitalization and reorganization alternatives. We are continually considering such options, including the possibility of additional repurchases of our Class A common stock, and their effect on our liquidity and capital resources. AGGREGATE CONTRACTUAL OBLIGATIONS There have been no significant changes to our significant contractual obligations, as detailed in our Annual Report on Form 10-K for the year ended December 31, 2004. OFF-BALANCE SHEET ARRANGEMENTS As of September 30, 2005, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK At September 30, 2005, we had invested $172.0 million of our cash in securities purchased under reverse repurchase agreements, $55.8 million of which is fully collateralized by U.S. government securities and $116.2 million of which is fully collateralized by eligible equity securities, both of which are held in a third party custodial account. These reverse repurchase agreements have an overnight maturity and, as such, are highly liquid. Additionally, at September 30, 2005, we had invested $1.9 million in a money market fund held at overnight durations. This fund solely invests in short-term U.S. government fixed income securities. 28 We generally do not use derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions. Accordingly, we believe that we are not subject to any material risks arising from changes in interest rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments. Our policy is to invest our cash in a manner that provides us with an appropriate level of liquidity. We are a global business, have operations in North America, Europe and Asia, and are therefore exposed to currency exchange rate fluctuations between the U.S. Dollar and the Canadian Dollar, British Pound Sterling, Euro, Hong Kong Dollar and Japanese Yen. Significant downward movements in the U.S. Dollar against currencies in which we pay expenses may have an adverse impact on our financial results if we do not have an equivalent amount of revenue denominated in the same currency. Management has presently decided not to engage in derivative financial instruments as a means of hedging this risk. We estimate that a hypothetical 10% adverse change in foreign exchange rates would have resulted in an increase in net loss of our international operations of $0.6 million for the nine months ended September 30, 2005. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as of the end of the period covered by this report were designed and were functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. The Company believes that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. (b) Change in Internal Control over Financial Reporting No change in the Company's internal control over financial reporting occurred during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. - OTHER INFORMATION ITEM 1. 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 sought, 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. On February 7, 2005, MPLLC was granted permission to amend its claims to seek damages arising from eSpeed's direction to third parties to shut off certain circuits used by MPLLC after notice to MPLLC. After a full hearing on the merits, the Panel issued an award dated July 26, 2005 in MPLLC's favor in the amount of $363,292, which included interest in the amount of $73,903 and awarded no relief against eSpeed. Cantor has paid the award and the matter is finally resolved. By Summons and Complaint dated October 30, 2002, eSpeed commenced an action in New York State Supreme Court against MPLLC seeking, among other things, damages as a result of MPLLC's breach of a License and Services Agreement, under which MPLLC failed to pay eSpeed for ancillary information technology services and products provided to eSpeed, and failed to pay eSpeed a percentage of certain revenues derived by MPLLC from electronic trading. On November 19, 2002, MPLLC answered the Complaint. On April 1, 2004, MPLLC filed an amended Answer and Counterclaim. On May 25, 2004, eSpeed filed its reply to MPLLC's Counterclaim. Shortly thereafter, the parties engaged in a limited amount of discovery, but discovery was stayed pending the decision in the above-mentioned NASD Arbitration. On September 13, 2005, the parties entered into a case management Order setting forth a new discovery schedule. The parties have served document requests and are preparing to take depositions. In June 2003, we filed a patent infringement suit against BrokerTec USA, LLC, BrokerTec Global, LLC, its parent, ICAP, PLC, Garban, LLC, its technology provider, OM Technology, and its parent company, OM AB (collectively, BrokerTec), in the United States District Court for the District of Delaware. The parties thereafter agreed to substitute the defendant OM AB Technology for defendant OM AB and dismiss claims against BrokerTec Global, L.L.C. By Order dated September 13, 2004, ICAP was dismissed as 29 a defendant. The suit centers on BrokerTec's and Garban's alleged infringement of U.S. Patent No. 6,560,580 issued on May 6, 2003, which expires in 2016, with respect to which eSpeed is the exclusive licensee. The patent covers a system and methods for auction-based trading of specialized items such as fixed income instruments. A jury trial began on February 7, 2005. In a pre-trial ruling on February 7, 2005, the U.S. District Court in Delaware ruled that the BrokerTec ETN did not infringe our 580 Patent. On February 22, 2005, a jury found that the Garban GTN did infringe our 580 Patent but that there was a deficiency in the application which led to the 580 Patent, finding that we "failed to provide adequate written description of each and every element recited" in certain claims of the 580 Patent. We are currently awaiting entry of final judgment on the jury findings by the court following post-trial motions, as well as a judgment on an inequitable conduct claim against eSpeed. The Court's rulings could lead to a judgment of invalidity on a portion of the claims set forth in the patent and, in the event of an adverse judgment on inequitable conduct, a judgment of unenforceability with respect to some or all claims. We expect to appeal certain rulings to the U.S. Court of Appeals for the Federal Circuit. Briefing of post-trial motions and on issues including unenforceability was completed on June 27, 2005. Both parties requested attorneys' fees from the other party, which may be awarded by the court in exceptional cases. Oral argument was held on October 12, 2005. In August 2004, Trading Technologies International, Inc. (TT) commenced an action in the United States District Court, Northern District of Illinois, Eastern Division, against us. In its complaint, TT alleged that we infringed and continue to infringe U.S. Patent No. 6,766,304, which issued on July 20, 2004 and U.S. Patent 6,772,132, which issued on August 3, 2004. TT also filed a motion for preliminary injunction seeking to preclude us from making, selling, and offering to sell a product that allegedly infringes such patents. A hearing on TT's motion for preliminary injunction was held on December 2, 2004. On February 9, 2005, the Court denied TT's motion for a preliminary injunction. The Court determined that we had not raised a substantial question concerning the validity or infringement of the patents but that TT had not proved that it would suffer irreparable harm absent an injunction. A trial date for this case has not yet been set. On March 16, 2005, TT filed an amended Complaint against us and added infringement allegations against Ecco and ITSEcco. On April 6, 2005, eSpeed and Ecco answered the Complaint in which we denied the infringement allegations. At the same time, eSpeed and Ecco filed a Counterclaim seeking a declaration that the patents in a suit are invalid, we do not make, use or sell any product that infringes any claims of the patents in suit, and the patents in suit are unenforceable because of inequitable conduct before the U.S. Patent and Trademark Office during the prosecution of the patents. On April 18, 2005, ITSEcco filed a motion to dismiss TT's complaint against it for lack of personal jurisdiction. The Court has not ruled on this motion. If TT ultimately prevails in this litigation, we may be required to pay TT damages and/or certain costs and expenses, and we may be forced to modify or withdraw certain products from the market. Both parties requested attorneys' fees from the other party, which may be awarded by the court in exceptional cases. In the first quarter of 2005, we were named as a defendant in a number of purported class action complaints on behalf of all persons who purchased the securities of eSpeed from August 12, 2003, to July 1, 2004, alleging that we made "material false positive statements during the class period" and violated certain provisions of the U.S. Securities Exchange Act of 1934 ("Exchange Act"), as amended, and certain rules and regulations thereunder. On April 8, 2005, the district court consolidated the purported class action complaints, and subsequently the court appointed lead plaintiffs and lead counsel. We received the consolidated and amended complaint ("Amended Complaint") on September 27, 2005. The Amended Complaint names as defendants the following: eSpeed; three officers, Howard Lutnick, Lee Amaitis, and Joseph Noviello; and one former officer, Jeffrey Chertoff. In the Amended Complaint, plaintiffs allege violations of Section 10(b) of the Exchange Act and Rule 10b-5 against all defendants, and allege violations of Section 20(a) against the individual defendants. We believe that the lawsuit is without merit. 30 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS The following table details our share repurchase activity during the third quarter of 2005, including the total number of shares purchased, the average price paid per share, the number of shares repurchased as part of our publicly announced plans and the approximate dollar value that may yet be purchased under these plans. SHARES PURCHASED VALUE OF SHARES THAT TOTAL NUMBER OF AVERAGE PRICE AS PART OF PUBLICLY MAY YET BE PURCHASED PERIOD SHARES PURCHASED PAID PER SHARE ANNOUNCED PLANS UNDER THE PLANS -------------- ------------------ --------------------- ---------------------- ------------------------- July 1 to July 31, 2005 - $ - - $ 68.2 million August 1 to August 31, 2005 276,553 $ 7.85 276,553 $ 66.0 million September 1 to September 30, 2005 921,222 $ 7.96 921,222 $ 58.7 million On August 5, 2004, the Company's Board of Directors authorized the repurchase of up to $100 million of outstanding Class A common stock, to replace the remaining $20.5 million authorized from the prior plan. As of September 30, 2005, approximately $58.7 million from this plan was available for further share repurchases. In September 2005, the Company's Board of Directors authorized the repurchase from the Cantor Relief Fund of all shares of eSpeed common stock owned and donated to the Relief, as well as other shares owned by the Relief Fund from time to time, provided that such repurchases are made in connection with the Company's buyback authorization and provided that the price of such shares is the fair market value on the date of purchase, which amount shall be no less than the five day average of shares as reported on the NASDAQ stock market or the closing price on the date of purchase. As a result, in September 2005, the Company repurchased approximately 0.9 million shares from the Cantor Relief Fund as disclosed in the table above. For the nine months ended September 30, 2005, we had repurchased an aggregate of 3.5 million shares of our Class A common stock for a total of $ 28.9 million, of which approximately 0.3 million shares were repurchased from partners of Cantor at fair market value on the date of purchase. The reacquired shares have been designated as treasury shares and will be used for general corporate purposes. 31 ITEM 6. EXHIBITS Exhibit No. Description ----------- ----------- 31.1 Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report on Form 10-Q for the quarter ended September 30, 2005 to be signed on its behalf by the undersigned thereunto duly authorized. eSpeed, Inc. (Registrant) /s/ Howard W. Lutnick ------------------------------ Howard W. Lutnick Chairman of the Board and Chief Executive Officer /s/ Jay Ryan ------------------------------ Jay Ryan Senior Vice President and Chief Financial Officer Date: November 9, 2005 33 EXHIBIT INDEX Exhibit No. Description ----------- ----------- 31.1 Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 34