<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 31, 1997
REGISTRATION NO. 333-31841
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
AMENDMENT NO.1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
E*TRADE GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 6211 94-2844166
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
</TABLE>
FOUR EMBARCADERO PLACE
2400 GENG ROAD
PALO ALTO, CA 94303
(415) 842-2500
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
----------------
CHRISTOS M. COTSAKOS
PRESIDENT AND CHIEF EXECUTIVE OFFICER
E*TRADE GROUP, INC.
FOUR EMBARCADERO PLACE
2400 GENG ROAD
PALO ALTO, CA 94303
(415) 842-2500
(NAME AND ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA
CODE, OF AGENT FOR SERVICE)
----------------
COPIES TO:
THOMAS A. BEVILACQUA KENNETH L. GUERNSEY
BROBECK, PHLEGER & HARRISON LLP KARYN R. SMITH
TWO EMBARCADERO PLACE MONA CHANDRA
2200 GENG ROAD COOLEY GODWARD LLP
PALO ALTO, CA 94303 ONE MARITIME PLAZA, 20TH FLOOR
(415) 424-0160 SAN FRANCISCO, CA 94111
(415) 693-2000
----------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
----------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933 check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
----------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS
REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES
AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
===============================================================================
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED JULY 31, 1997
[LOGO OF E*TRADE]
7,000,000 SHARES
COMMON STOCK
Of the 7,000,000 shares of Common Stock offered hereby, 5,000,000 shares are
being sold by E*TRADE Group, Inc. ("E*TRADE" or the "Company") and 2,000,000
shares are being sold by the Selling Stockholders. See "Principal and Selling
Stockholders." The Company will not receive any of the proceeds from the sale
of shares by the Selling Stockholders. The Company's Common Stock is traded on
the Nasdaq National Market under the symbol "EGRP." On July 29, 1997, the last
reported sale price of the Common Stock on the Nasdaq National Market was
$28.13 per share. See "Price Range of Common Stock."
-----------
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" BEGINNING ON PAGE 6.
-----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
================================================================================
<TABLE>
<CAPTION>
UNDERWRITING PROCEEDS TO
PRICE TO DISCOUNTS AND PROCEEDS TO SELLING
PUBLIC COMMISSIONS COMPANY(1) STOCKHOLDERS
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share...................... $ $ $ $
- --------------------------------------------------------------------------------
Total(2)....................... $ $ $ $
</TABLE>
================================================================================
(1) Before deducting expenses payable by the Company, estimated at $1,200,000.
(2) The Company and certain of the Selling Stockholders have granted to the
Underwriters a 30-day option to purchase up to an additional 1,050,000
shares of Common Stock solely to cover over-allotments, if any. See
"Underwriting." If such option is exercised in full, the total Price to
Public, Underwriting Discounts and Commissions, Proceeds to Company and
Proceeds to Selling Stockholders will be $ , $ , $ and $ ,
respectively.
-----------
The Common Stock is offered by the Underwriters as stated herein, subject to
receipt and acceptance by them and subject to their right to reject any order
in whole or in part. It is expected that delivery of such shares will be made
through the offices of Robertson, Stephens & Company LLC ("Robertson Stephens &
Company"), San Francisco, California, on or about , 1997.
-----------
ROBERTSON, STEPHENS & COMPANY
HAMBRECHT & QUIST
DEUTSCHE MORGAN GRENFELL
MONTGOMERY SECURITIES
E*TRADE SECURITIES
The date of this Prospectus is , 1997
<PAGE>
[TWO GATEFOLD PAGES]
INFORMATION CONTAINED IN THE COMPANY'S WEB SITE SHALL NOT BE DEEMED TO BE PART
OF THIS PROSPECTUS.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK OF THE
COMPANY, INCLUDING STABILIZING BIDS, SYNDICATE COVERING TRANSACTIONS AND THE
IMPOSITION OF PENALTY BIDS. FOR A DISCUSSION OF THESE ACTIVITIES, SEE
"UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK
ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE
"UNDERWRITING."
2
<PAGE>
INSIDE GATEFOLD
---------------
(headline)
SOMEDAY, WE'LL ALL INVEST THIS WAY
(Body Copy)
E*TRADE IS A LEADING PROVIDER OF ONLINE INVESTING SERVICES, offering its
customers a combination of innovation, technology, service and value.
Its services feature an easy-to-use graphical user interface, the
ability to create personalized environments reflecting users' individual needs
and interests and unbundled services for cost-effective pricing.
Customers can access E*TRADE through the Internet, direct modem link,
online service providers America Online, AT&T WorldNet, CompuServe, Microsoft
Network and Prodigy, and touch-tone telephone. Automated order placement,
portfolio tracking, related market information and news are available 24 hours a
day, seven days a week.
WWW.etrade.com
- --------------
Call 1-800-STOCKS-3
................................................................................
THE INTERNET
INNOVATIVE BUSINESS
OPPORTUNITIES
JUST AS THE MICROPROCESSOR CHANGED COMPUTING, the emergence of the Internet as
a tool for communication and commerce is driving a revolution in online
transactions and information services, providing organizations and individuals
around the world with new ways of conducting business.
................................................................................
ELECTRONIC COMMERCE:
FASTER, LESS
EXPENSIVE, MORE
CONVENIENT
WITH THE PROLIFERATION of PERSONAL COMPUTERS AND MODEMS and the rise of the
Internet, companies that have traditionally conducted business in person,
through the mail or by telephone are utilizing electronic commerce. Consumers
are recognizing that self-directed online transactions can be faster, less
expensive and more convenient than transactions conducted through a human
intermediary.
................................................................................
E*TRADE's MISSION:
TO BE A RECOGNIZED
LEADER IN ELECTRONIC
COMMERCE
E*TRADE OFFERS ELECTRONIC ACCESS VIRTUALLY ANYWHERE, ANY TIME, thereby
shifting the financial services paradigm from a business hours only,
intermediary-based model to one in which consumers have ultimate control over
when and where they initiate transactions. The Company's technology can be
adapted to other aspects of electronic commerce. Leveraging this technology
and its position as a leading provider of online investing services, E*TRADE's
mission is to be a recognized leader in electronic commerce.
................................................................................
E*TRADE: EMPOWERING
CONSUMERS THROUGH
TECHNOLOGY
E*TRADE USES INFORMATION TECHNOLOGY to provide value-added electronic
commerce. In 1992, the Company formed E*TRADE Securities and began offering
consumers online investing services available 24 hours a day, seven days a
week. E*TRADE empowers its customers to take control of their own financial
transactions.
(E*Trade logo and tagline)
Someday, we'll all invest this way
<PAGE>
NO DEALER, SALES REPRESENTATIVE OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS
OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY, ANY SELLING STOCKHOLDER OR ANY OF THE UNDERWRITERS.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY ANY SECURITIES OTHER THAN THE SHARES OF COMMON STOCK TO WHICH IT
RELATES OR AN OFFER TO, OR A SOLICITATION OF, ANY PERSON IN ANY JURISDICTION
WHERE SUCH AN OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF
THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES,
CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE
COMPANY OR THAT INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary................................................................... 4
Risk Factors.............................................................. 6
Use of Proceeds........................................................... 18
Price Range of Common Stock............................................... 18
Dividend Policy........................................................... 18
Capitalization............................................................ 19
Selected Consolidated Financial Data...................................... 20
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 21
Business.................................................................. 30
Management................................................................ 49
Certain Transactions...................................................... 60
Principal and Selling Stockholders........................................ 61
Description of Capital Stock.............................................. 63
Shares Eligible for Future Sale........................................... 66
Underwriting.............................................................. 67
Legal Matters............................................................. 69
Experts................................................................... 69
Interests of Counsel...................................................... 69
Additional Information.................................................... 69
Available Information..................................................... 70
Index to Consolidated Financial Statements................................ F-1
</TABLE>
----------------
E*TRADE(R) is a registered trademark of the Company. TELE*MASTER(TM), among
other marks, is a common law trademark of the Company. This Prospectus also
includes trademarks of entities other than the Company.
3
<PAGE>
SUMMARY
The following summary is qualified in its entirety by the more detailed
information, including "Risk Factors," and the consolidated financial
statements and notes thereto, appearing elsewhere in this Prospectus. Investors
should consider carefully the information discussed under the heading "Risk
Factors."
THE COMPANY
E*TRADE Group, Inc. ("E*TRADE" or the "Company") is a leading provider of
online investing services and has established a popular, branded destination
Web site for self-directed investors. The Company offers automated order
placement and execution, along with a suite of products and services that can
be personalized, including portfolio tracking, Java-based charting and quote
applications, real-time market commentary and analysis, news and other
information services. The Company provides these services 24 hours a day, seven
days a week by means of the Internet, touch-tone telephone, online service
providers (America Online, AT&T WorldNet, CompuServe, Microsoft Network and
Prodigy) and direct modem access. E*TRADE's proprietary transaction-enabling
technology supports highly automated, easy-to-use and cost-effective services
that empower its customers to take greater control of their investment
decisions and financial transactions. Further, the Company believes that its
technology can be adapted to provide transaction-enabling services related to
other aspects of electronic commerce.
As of June 30, 1997, the Company had over 182,000 accounts (with assets under
management in excess of $5.5 billion) representing a compounded annual growth
rate in new accounts of 127% since October 1, 1994. Average daily transaction
volumes were approximately 17,800 in June 1997, as compared to approximately
8,000 transactions per day in June 1996. For the month ended June 30, 1997, the
Company opened an average of 680 new accounts per day with average daily
deposits of $13.5 million. The Company began offering online investing services
through the Internet in February 1996 and it is the Company's most rapidly
growing channel. Transactions over the Internet represented 60% of the
Company's June 1997 transaction volume.
E*TRADE's objective is to be a leading, branded provider of online investing
services through automation, innovation, technology, service and value. The
Company's strategy to accomplish this objective includes continued aggressive
marketing of its online investing services to further establish E*TRADE's brand
name recognition and increase its share of the online investing market and
continued broadening of its suite of value-added services that personalize and
enhance its customers' online investing experience. In addition, the Company
plans to leverage its E*TRADE brand equity and large customer base to pursue
additional related revenue opportunities, including advertising and
subscription-based revenue streams.
The Company was incorporated in California in 1982 and was reincorporated in
Delaware in July 1996. Its principal corporate offices are located at Four
Embarcadero Place, 2400 Geng Road, Palo Alto, California 94303, and its
telephone number is (415) 842-2500. Unless otherwise indicated, all references
in this Prospectus to "E*TRADE" or the "Company" refer to E*TRADE Group, Inc.,
a Delaware corporation, E*TRADE Securities, Inc., its principal broker-dealer
subsidiary ("E*TRADE Securities"), its other subsidiaries and its predecessor
California corporation. The Company's World Wide Web site is located at
www.etrade.com. Information contained in the Company's Web site shall not be
deemed to be part of this Prospectus.
4
<PAGE>
THE OFFERING
<TABLE>
<C> <S>
Common Stock offered by the Company.......... 5,000,000 shares
Common Stock offered by the Selling 2,000,000 shares
Stockholders................................
Common Stock to be outstanding after the 35,958,147 shares(1)
Offering....................................
Use of Proceeds.............................. For working capital and other
general corporate purposes. See
"Use of Proceeds."
Nasdaq National Market symbol................ EGRP
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
(in thousands, except per share and operating data)
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED SEPTEMBER 30, ENDED JUNE 30,
-------------------------------------- ----------------
1992 1993 1994 1995 1996 1996 1997
------ ------ ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Net revenues............ $ 848 $2,974 $10,905 $23,340 $51,595 $34,423 $94,260
Pre-tax income (loss)... (283) 103 244 4,309 (1,383) (2,224) 14,110
Net income (loss)....... (285) 99 785 2,581 (828) (1,334) 8,382
Net income (loss) per
common share........... $(0.01) -- $ 0.03 $ 0.10 $ (0.03) $ (0.05) $ 0.24
Weighted average number
of common and common
equivalent shares...... 24,828 26,677 26,186 26,481 28,564 28,477 34,719
OPERATING DATA:
Average customer
transactions per day... 12 194 869 2,335 6,148 5,667 13,769
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1997
-----------------------
ACTUAL AS ADJUSTED(2)
-------- --------------
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and equivalents.................................... $ 18,116 $150,510
Total assets............................................ 719,845 852,239
Stockholders' equity.................................... 83,057 215,451
</TABLE>
- --------
(1) Based on 30,958,147 shares of Common Stock outstanding as of June 30, 1997.
Excludes 5,250,120 shares of Common Stock issuable upon the exercise of
outstanding options to purchase Common Stock as of June 30, 1997. See
"Management--Associate Benefit Plans" and Note 7 of Notes to Consolidated
Financial Statements.
(2) Adjusted to give effect to the sale of 5,000,000 shares of Common Stock
offered by the Company hereby at an assumed public offering price per share
of $28.13 and the application of the estimated net proceeds therefrom. See
"Use of Proceeds" and "Capitalization."
----------------
Except as otherwise indicated, all information in this Prospectus assumes no
exercise of the Underwriters' over-allotment option. This Prospectus contains
forward-looking statements which involve risks and uncertainties. The Company's
actual results may differ materially from the results discussed in the forward-
looking statements. Factors that might cause such a difference include, but are
not limited to, those discussed in "Risk Factors" and elsewhere in this
Prospectus.
5
<PAGE>
RISK FACTORS
In addition to the other information contained in this Prospectus, the
following risk factors should be considered in evaluating the Company and its
business before purchasing shares of the Common Stock offered hereby. This
Prospectus contains forward-looking statements which involve risks and
uncertainties. The Company's actual results may differ materially from the
results discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to, those discussed in "Risk
Factors" and elsewhere in this Prospectus.
RISKS ASSOCIATED WITH MANAGEMENT OF A CHANGING BUSINESS
The Company has experienced substantial changes in and expansion of its
business and operations since it began offering electronic investing services
in 1992 and Internet investing services in February 1996 and expects to
continue to experience periods of rapid change. The Company's past expansion
has placed, and any future expansion would place, significant demands on the
Company's administrative, operational, financial and other resources. In
particular, in fiscal 1997 the Company failed to comply with applicable
advertising restrictions in one international jurisdiction and, due to a
clerical oversight, failed to timely renew its registration as a broker-dealer
in two states, Nebraska and Ohio. For the nine months ended June 30, 1997, the
Company recorded a $4.3 million pre-tax charge against earnings in connection
with the failure to renew its registration in Ohio. The Company expects
operating expenses and staffing levels to increase substantially in the
future. In particular, the Company has hired and intends to hire a significant
number of additional skilled personnel, including persons with experience in
both the computer and brokerage industries, and, in particular, persons with
Series 7 or other broker-dealer licenses. Competition for such personnel is
intense, and there can be no assurance that the Company will be able to
attract, assimilate or retain additional highly qualified senior managers and
technical persons in the future. The Company also expects to expend resources
with respect to future expansion of its accounting and internal management
systems and the implementation of a variety of new systems and procedures. In
addition, the Company expects that future expansion will continue to challenge
the Company's ability to hire, train, motivate and manage its associates. If
the Company's revenues do not increase in proportion to its operating
expenses, the Company's management systems do not expand to meet increasing
demands, the Company fails to attract, assimilate and retain qualified
personnel, or the Company's management otherwise fails to manage the Company's
expansion effectively, there would be a material adverse effect on the
Company's business, financial condition and operating results. See "--
Government Regulation," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Business--Government Regulation; Net
Capital Requirements" and " --Associates" and "Management."
The rapid growth in the use of the Company's services has strained its
ability to adequately expand technologically. The haste required in acquiring
new equipment and applications may result in less rigorous testing and
validation of hardware and software, which could lead to performance problems.
In addition, the Company relies on a number of third parties to process its
transactions, including online and Internet service providers, back office
processing organizations, services providers and market makers, all of which
will need to expand the scope of the operations they perform for the Company.
Any backlog caused by a third party's inability to expand at the rate
necessary to meet the Company's needs could have a material adverse effect on
the Company's business, financial condition and operating results. As trading
volume increases, the Company may have difficulty hiring, training and
integrating qualified personnel at the necessary pace, and the shortage of
licensed personnel could cause a backlog in the processing of orders requiring
review, exposing the Company not only to unsatisfied customers, but also to
liability for transactions that were ordered but not executed on a timely
basis.
RISKS OF SYSTEMS FAILURE
The Company receives and processes trade orders principally through the
Internet, online service providers and touch-tone telephone. This method of
trading is heavily dependent on the integrity of the electronic systems
supporting it. Orders placed from the close of the stock markets one day until
the opening
6
<PAGE>
the next business day must be processed through the Company's system in a
short period of time prior to the opening of the stock markets. Heavy stress
placed on the Company's systems during peak trading times could cause the
Company's systems to operate at unacceptably low speeds or fail altogether.
Any significant degradation or failure of the Company's systems or any other
systems in the trading process (e.g., online and Internet service providers,
record keeping and data processing functions performed by third parties and
third-party software such as Internet browsers), even for a short time, could
cause customers to suffer delays in trading. Such delays could cause
substantial losses for customers and could subject the Company to claims from
customers for losses, including litigation claiming fraud or negligence. The
Company has experienced such systems failures and degradation in the past,
including two such failures in May 1996, and could experience future system
failures and degradations. In order to promote customer satisfaction and
protect the E*TRADE brand name, the Company has compensated customers for
verifiable losses arising in connection with such failures. The Company
recorded a pre-tax charge against earnings in excess of $1.7 million in
connection with such systems failures in May 1996. Since May 1996, the Company
has experienced occasional system interruptions. During a systems failure, the
Company may be able to take orders by telephone. However, under applicable
regulations, all Company associates accepting telephone orders must have
securities brokers' licenses. An adequate number of personnel with securities
brokers' licenses may not be available to take customer calls in the event of
a systems failure. There can be no assurance that the Company's network
structure will operate appropriately in the event of a subsystem, component or
software failure or that, in the event of an earthquake, fire or any other
natural disaster, power or telecommunications failure, act of God or act of
war, the Company will be able to prevent an extended systems failure. Any
systems failure that causes interruptions in the Company's operations could
have a material adverse effect on the Company's business, financial condition
and operating results. In addition, the Company has, in the past, received
adverse publicity in the financial press and in online discussion forums
primarily relating to systems failures. See "Business--E*TRADE Transaction-
Enabling Technology."
RISKS ASSOCIATED WITH THE SECURITIES BUSINESS; CONCENTRATION OF SERVICES
Substantially all of the Company's revenues in recent years have been from
electronic brokerage services, and the Company expects its electronic
brokerage services to continue to account for substantially all of its
revenues for the foreseeable future. E*TRADE, like other securities firms, is
directly affected by national and international economic and political
conditions, broad trends in business and finance and substantial fluctuations
in volume and price levels of securities and futures transactions. In recent
months, the U.S. securities markets have established record levels of trading
which, the Company believes, has favorably impacted its business.
Correspondingly, a downturn in these markets could adversely affect the
Company's operating results. In October 1987 and October 1989, the stock
market suffered two of the largest declines in history. As a result of these
declines, many firms in the industry suffered financial losses, and the level
of individual investor trading activity decreased. Reduced trading volume and
prices have historically resulted in reduced transaction revenues. In periods
of low volume, the Company's profitability would be adversely affected because
certain expenses, consisting primarily of salaries and benefits, computer
hardware and software costs and occupancy expenses, remain relatively fixed.
Severe market fluctuations in the future could have a material adverse effect
on the Company's business, financial condition and operating results. Certain
of the Company's competitors with more diverse product and service offerings
may be better positioned to withstand such a downturn in the securities
industry. See "--Substantial Competition."
E*TRADE's brokerage business, by its nature, is subject to various other
risks, including customer default and employees' misconduct and errors. In
addition, to the extent E*TRADE permits customers to purchase securities on
margin, the Company is subject to risks inherent in extending credit,
especially during periods of rapidly declining markets in which the value of
the collateral held by the Company could fall below the amount of a customer's
indebtedness. Under specific regulatory guidelines, the borrowing and lending
of securities by E*TRADE are accompanied, respectively, by the disbursement
and receipt of cash deposits. Failure to maintain cash deposit levels at all
times at least equal to the value of the related securities would subject
E*TRADE to risk of loss, should there be sharp changes in market values of
substantial amounts of
7
<PAGE>
securities and should parties to the borrowing and lending transactions fail
to honor their commitments. Any such losses could have a material adverse
effect on the Company's business, financial condition and operating results.
See "Business--Operations."
SIGNIFICANT FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company expects to experience significant fluctuations in future
quarterly operating results that may be caused by many factors, including the
following: the timing of introductions or enhancements of online investing
services and products by the Company or its competitors; market acceptance of
online investing services and products; the pace of development of the market
for online commerce; changes in trading volume in the securities markets;
trends in the securities markets; changes in pricing policies by the Company
or its competitors; changes in strategy; the success of or costs associated
with acquisitions or other strategic relationships; changes in key personnel;
seasonal trends; the extent of international expansion; the mix of
international and domestic sales; changes in the level of operating expenses
to support projected growth; and general economic conditions. In addition, the
Company has experienced fluctuations in the average number of customer
transactions per day and expects that its rate of growth in customer
transactions at any given time is not necessarily indicative of future
transaction activity. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Quarterly Results."
Due to the foregoing factors, quarterly revenues and operating results are
difficult to forecast, and the Company believes that period-to-period
comparisons of its operating results will not necessarily be meaningful and
should not be relied upon as any indication of future performance. It is
likely that the Company's future quarterly operating results from time to time
will not meet the expectations of securities analysts or investors, which may
have an adverse effect on the market price of the Company's Common Stock.
RISKS ASSOCIATED WITH ENTERING NEW MARKETS
One element of the Company's strategy is to leverage the E*TRADE brand and
technology to enter new markets. No assurance can be given that the Company
will be able to successfully adapt its proprietary processing technology to
provide information and transaction processing services in other markets or
that, if any such adaptation is successful, the Company will compete
successfully in any such new markets. E*TRADE Securities plans, subject to
regulatory approval, to establish investment banking operations, raising
public and private equity capital for companies over the Internet and other
electronic media. In addition, the Company plans to pursue additional related
revenue opportunities, including advertising and subscription-based revenue
streams. There can be no assurance that the Company will be successful in its
pursuit of any of these opportunities or that such pursuit will not divert
management attention or inefficiently utilize Company resources. See
"Business--Strategic Relationships."
POTENTIAL REDUCTION IN ORDER FLOW REBATES
The Company has arrangements with various Nasdaq market makers and third
market firms to receive cash payments in exchange for routing trade orders to
these firms for execution. This practice of receiving payments for order flow
is widespread in the securities industry. Under applicable SEC regulations,
receipt of these payments requires disclosure of such payments by the Company
to its customers. The revenues received by the Company under these
arrangements for fiscal 1996 and the nine months ended June 30, 1997 amounted
to 22% and 22% of net revenues, respectively. However, the amount received per
transaction declined over these periods, and the Company expects this trend to
continue. In addition, there can be no assurance that payments for order flow
will continue to be permitted by the Securities and Exchange Commission (the
"SEC"), the National Association of Securities Dealers (the "NASD") or other
regulatory agencies, courts or governmental units. Loss of any or all of these
revenues could have a material adverse effect on the Company's business,
financial condition and operating results. See "Business--Operations."
RISKS ASSOCIATED WITH SELF-CLEARING OPERATIONS
The Company implemented equity self-clearing operations in July 1996 and
options self-clearing operations in April 1997. Clearing services include the
confirmation, receipt, settlement and delivery functions
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involved in securities transactions. Prior to its conversion to self-clearing
operations, the Company cleared all of its customer trades as a fully-
disclosed correspondent of Herzog, Heine, Geduld, Inc. ("Herzog"), a broker-
dealer that provides clearing services. Self-clearing securities firms are
subject to substantially more regulatory control and examination than the
Company has experienced in the past. Errors in performing clearing functions
or reporting could lead to civil penalties imposed by the SEC or the NASD.
Self-clearing operations involve substantial risks of losses due to clerical
errors related to the handling of customer funds and securities. Errors in the
clearing process also may lead to civil liability for actions in negligence
brought by parties who are financially harmed as a result of such errors. Any
liability that arises as a result of self-clearing operations could have a
material adverse effect on the Company's business, financial condition and
operating results. Clearing operations have accounted for a significant
portion of the Company's cost of services, and there can be no assurance that
clearing for itself will not result in significantly higher clearing costs in
the future. The failure of the Company to perform self-clearing operations
accurately and cost-effectively could have a material adverse effect on the
Company's business, financial condition and operating results.
As a self-clearing firm, the Company assumes direct responsibility for the
possession and control of customer securities and other assets and the
clearance of customer securities transactions. Having this responsibility
requires the Company to record on its balance sheet the customer receivables
and customer payables to the Company that are a result of customer margin
loans (i.e., loans made to customers that are collateralized by securities in
the customers' margin accounts at the Company) and customer free credit
balances (i.e., customer cash balances maintained by the Company),
respectively. In addition, to the extent that the Company's customer debit
balances from margin loans and other transactions exceed customer free credit
balances, the Company must obtain financing for any excess debit balance. As a
self-clearing firm, the Company contracts with a third-party service bureau,
Beta Systems, Inc., a subsidiary of Thomson Information Services, Inc. ("Beta
Systems"), for its customer record keeping and data processing services. Beta
Systems is currently the Company's sole provider of these services. There can
be no assurance that Beta Systems will be able to provide these services in an
efficient, cost-effective manner or will be able to adequately expand its
services to meet the Company's needs. A loss in the availability of these
services from Beta Systems and the inability of the Company to make
alternative arrangements in a timely manner, if at all, would have a material
adverse effect on the Company's business, financial condition and operating
results. See "Business--Operations."
DEPENDENCE ON IMPROVED CUSTOMER SERVICE OPERATIONS
The Company believes that providing an effective customer service team to
handle customer needs is critical to its success. The Company's customer
service capacity has been and may continue to be severely strained at times.
During the nine months ended June 30, 1997, the Company's customer service
department serviced approximately 73% of its inquiries through telephone calls
and approximately 27% through e-mail. This department handles only non-revenue
interactions, with customers needing extra assistance, and generally is not
involved in order processing. In the past, the Company has fallen short of its
target response time for customer service calls. Sub-optimal customer service
could damage the E*TRADE name and lead some customers to transfer their
business to other, less congested online brokers, limit their trading activity
or refrain from electronic trading entirely. Even if the Company is able to
remedy any capacity problems that have arisen, on any given day a surge of
activity could cause the Company to fail to provide adequate customer service.
There can be no assurance that the Company will not face customer service
capacity constraints, and the failure to remedy such constraints could have a
material adverse effect on the Company's business, financial condition and
operating results. See "Business--Customer Service."
SUBSTANTIAL COMPETITION
The market for electronic brokerage services, particularly over the
Internet, is new, rapidly evolving and intensely competitive, and the Company
expects competition to continue and intensify in the future. E*TRADE
encounters direct competition from discount brokerage firms providing either
touch-tone
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telephone or online brokerage services, or both. Discount brokerage firms
generally effect transactions for their customers on an "execution only"
basis, without offering other services such as portfolio valuation, investment
recommendations and research. These competitors include such discount
brokerage firms as Charles Schwab & Co., Inc., Fidelity Brokerage Services,
Inc., Waterhouse Securities, Inc., Quick & Reilly, Inc., National Discount
Brokers (a subsidiary of Sherwood Securities Corp.), Discover Brokerage, Inc.
(a subsidiary of Morgan Stanley Dean Witter Discover & Company), firms owned
by Ameritrade, Inc. (including All-American Brokers, also known as eBroker)
and DLJ Direct (a division of Donaldson, Lufkin & Jenrette Securities
Corporation), among others. The Company also encounters competition from
established full-commission brokerage firms such as PaineWebber Incorporated,
Merrill Lynch, Pierce, Fenner & Smith Incorporated and Smith Barney, Inc.,
among others. In addition, the Company competes with financial institutions,
mutual fund sponsors and other organizations, some of which provide electronic
brokerage services.
Many of the Company's competitors have longer operating histories and
significantly greater financial, technical, marketing and other resources than
the Company. In addition, many of these competitors offer a wider range of
services and financial products than the Company, and thus may be able to
respond more quickly to new or changing opportunities, technologies and
customer requirements. Many current and potential competitors also have
greater name recognition and more extensive customer bases that could be
leveraged, thereby gaining market share to the Company's detriment. Such
competitors may be able to undertake more extensive promotional activities,
offer more attractive terms to customers than the Company and adopt more
aggressive pricing policies, possibly even sparking a price war in the
electronic brokerage business. Moreover, current and potential competitors
have established or may establish cooperative relationships among themselves
or with third parties to enhance their services and products. For example,
Charles Schwab's One-Source mutual fund service and similar, more complete
services may discourage potential customers from using the Company's brokerage
services. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share.
The general financial success of companies within the securities industry
over the past several years has strengthened existing competitors. Management
believes that such success will continue to attract new competitors to the
industry, such as banks, software development companies, insurance companies,
providers of online financial and information services and others, as such
companies expand their services and product lines. Commercial banks and other
financial institutions have become a competitive factor in the securities
industry by offering their customers certain corporate and individual
financial services traditionally provided by securities firms. The current
trend toward consolidation in the commercial banking industry could further
increase competition in all aspects of the Company's business. Commercial
banks generally are expanding their securities activities, as well as their
activities relating to the provision of financial services. While it is not
possible to predict the type and extent of competitive services that
commercial banks and other financial institutions ultimately may offer or
whether administrative or legislative barriers will be repealed or modified,
brokerage firms such as the Company may be adversely affected by such
competition or legislation. Particularly as financial services and products
proliferate, to the extent the Company's competitors are able to attract and
retain customers on the basis of the convenience of one-stop shopping, the
Company's business or its ability to grow could be adversely affected. In many
instances, the Company competes with such organizations for the same
customers. In addition, competition among financial services firms exists for
experienced technical and other personnel.
There can be no assurance that the Company will be able to compete
effectively with current or future competitors or that the competitive
pressures faced by the Company will not have a material adverse effect on the
Company's business, financial condition and operating results. See "Business--
Competition."
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EARLY STAGE OF MARKET DEVELOPMENT; DEPENDENCE ON ONLINE COMMERCE AND THE
INTERNET
The market for electronic brokerage services, particularly over the
Internet, is at an early stage of development and is rapidly evolving. As is
typical for new and rapidly evolving industries, demand and market acceptance
for recently introduced services and products are subject to a high level of
uncertainty. With respect to the Company, this uncertainty is compounded by
the risks that consumers will not adopt online commerce and that an
appropriate infrastructure necessary to support increased commerce on the
Internet will fail to develop, in each case, to a sufficient extent and within
an adequate time frame to permit the Company to succeed.
Sales of many of the Company's services and products will depend upon the
adoption of the Internet by consumers as a widely used medium for commerce and
communication. The Internet may not prove to be a viable commercial
marketplace because of inadequate development of the necessary infrastructure,
such as a reliable network backbone, or timely development of complementary
services and products, such as high speed modems and high speed communication
lines. The Internet has experienced, and is expected to continue to
experience, significant growth in the number of users and amount of traffic.
There can be no assurance that the Internet infrastructure will continue to be
able to support the demands placed on it by this continued growth. In
addition, the Internet could lose its viability due to delays in the
development or adoption of new standards and protocols to handle increased
levels of Internet activity or due to increased governmental regulation.
Moreover, critical issues concerning the commercial use of the Internet
(including security, reliability, cost, ease of use, accessibility and quality
of service) remain unresolved and may negatively affect the growth of Internet
use or the attractiveness of commerce and communication on the Internet.
Because global commerce and online exchange of information on the Internet and
other similar open wide area networks are new and evolving, there can be no
assurance that the Internet will prove to be a viable commercial marketplace.
If critical issues concerning the commercial use of the Internet are not
favorably resolved, if the necessary infrastructure is not developed, or if
the Internet does not become a viable commercial marketplace, the Company's
business, financial condition and operating results will be materially
adversely affected.
Adoption of online commerce, particularly by those individuals that have
historically relied upon traditional means of commerce, will require a broad
acceptance by such individuals of new and substantially different methods of
conducting business. Moreover, the Company's brokerage services over the
Internet involve a new approach to securities trading and, as a result,
intensive marketing and sales efforts may be necessary to educate prospective
customers regarding the uses and benefits of the Company's brokerage services
and products. For example, consumers who already obtain brokerage services
from more traditional full-commission brokerage firms, or even discount
brokers, may be reluctant or slow to change to obtaining brokerage services
over the Internet. Moreover, the security and privacy concerns of existing and
potential users of the Company's services may inhibit the growth of online
commerce generally, and online brokerage trading in particular, which could
have a material adverse effect on the Company's business, financial condition
and operating results. See "Business--Background."
RAPID TECHNOLOGICAL CHANGE; DELAYS IN INTRODUCTION OF NEW SERVICES AND
PRODUCTS
The information and financial services and communications industries are
characterized by rapid technological change, changes in customer requirements,
frequent new service and product introductions and enhancements, and emerging
industry standards. The introduction of services or products embodying new
technologies and the emergence of new industry standards and practices can
render existing services or products obsolete and unmarketable. The Company's
future success will depend, in part, on its ability to develop leading
technologies, enhance its existing services and products, develop new services
and products that address the increasingly sophisticated and varied needs of
its prospective customers, and respond to technological advances and emerging
industry standards and practices on a timely and cost-effective basis. The
development of new services and products or enhanced versions of existing
services and products entails significant technical risks. There can be no
assurance that the Company will be successful in effectively using
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new technologies, adapting its services and products to emerging industry
standards, developing, introducing and marketing service and product
enhancements, or new services and products, or that it will not experience
difficulties that could delay or prevent the successful development,
introduction or marketing of these services and products, or that its new
service and product enhancements will adequately meet the requirements of the
marketplace and achieve market acceptance. If the Company is unable to develop
and introduce new services and products or enhancements of existing services
and products in a timely manner in response to changing market conditions or
customer requirements, or if new services and products do not achieve market
acceptance, the Company's business, financial condition and operating results
will be materially adversely affected. See "Business--Strategy," "--Services
and Products" and "--E*TRADE Transaction-Enabling Technology."
RISKS ASSOCIATED WITH ENCRYPTION TECHNOLOGY
A significant barrier to online commerce and communication is the secure
transmission of confidential information over public networks. The Company
relies on encryption and authentication technology, including public key
cryptography technology licensed from RSA Data Security, Inc. ("RSA"), to
provide the security and authentication necessary to effect secure
transmission of confidential information. There can be no assurance that
advances in computer capabilities, new discoveries in the field of
cryptography or other events or developments will not result in a compromise
or breach of the RSA or other algorithms used by the Company to protect
customer transaction data. If any such compromise of the Company's security
were to occur, it could have a material adverse effect on the Company's
business, financial condition and operating results. See "Business--Services
and Products."
DEPENDENCE ON INTELLECTUAL PROPERTY RIGHTS
The Company's success and ability to compete are dependent to a significant
degree on its proprietary technology. The Company relies primarily on
copyright, trade secret and trademark law to protect its technology. The
Company has no patents. Effective trademark protection may not be available
for the Company's trademarks. Although the Company has registered the
trademark "E*TRADE" in the United States and certain other countries, and has
certain other registered trademarks, there can be no assurance that the
Company will be able to secure significant protection for these trademarks. It
is possible that competitors of the Company or others will adopt product or
service names similar to "E*TRADE," thereby impeding the Company's ability to
build brand identity and possibly leading to customer confusion. The inability
of the Company to adequately protect the name "E*TRADE" would have a material
adverse effect on the Company's business, financial condition and operating
results. Notwithstanding the precautions taken by the Company, it may be
possible for a third party to copy or otherwise obtain and use the Company's
software or other proprietary information without authorization or to develop
similar software independently. Policing unauthorized use of the Company's
technology is difficult, particularly because the global nature of the
Internet makes it difficult to control the ultimate destination or security of
software or other data transmitted. The laws of other countries may afford the
Company little or no effective protection of its intellectual property. There
can be no assurance that the steps taken by the Company will prevent
misappropriation of its technology or that agreements entered into for that
purpose will be enforceable. In addition, litigation may be necessary in the
future to enforce the Company's intellectual property rights, to protect the
Company's trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or
invalidity. Such litigation, whether successful or unsuccessful, could result
in substantial costs and diversions of resources, either of which could have a
material adverse effect on the Company's business, financial condition and
operating results. See "Business--Intellectual Property and Other Proprietary
Rights."
RISK OF INFRINGEMENT
The Company may in the future receive notices of claims of infringement of
other parties' proprietary rights. There can be no assurance that claims for
infringement or invalidity (or claims for indemnification resulting from
infringement claims) will not be asserted or prosecuted against the Company.
Any such claims,
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with or without merit, could be time consuming to defend, result in costly
litigation, divert management's attention and resources or require the Company
to enter into royalty or licensing agreements. There can be no assurance that
such licenses would be available on reasonable terms, if at all, and the
assertion or prosecution of any such claims could have a material adverse
effect on the Company's business, financial condition and operating results.
See "Business--Intellectual Property and Other Proprietary Rights."
DEPENDENCE ON KEY PERSONNEL
The Company's success has been, and will be, dependent to a large degree on
its ability to retain the services of its existing executive officers and to
attract and retain qualified additional senior and middle managers and key
personnel in the future. The Company does not have "key person" life insurance
policies on any of its officers or associates. The loss of the services of any
of the key personnel or the inability to identify, hire, train and retain
other highly qualified technical and managerial personnel, including qualified
customer service personnel, in the future could have a material adverse effect
on the Company's business, financial condition and operating results.
Competition for such personnel is intense. There can be no assurance that the
Company will be able to attract, assimilate or retain qualified technical and
managerial personnel in the future, and the failure of the Company to do so
would have a material adverse effect on the Company's business, financial
condition and operating results. See "Business--Associates" and "Management."
GOVERNMENT REGULATION
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. Broker-dealers are subject to
regulations covering all aspects of the securities business, including sales
methods, trade practices among broker-dealers, use and safekeeping of
customers' funds and securities, capital structure, record keeping and the
conduct of directors, officers and employees. The Company is required to
comply with many complex laws and rules to which it previously has not been
subject as a fully-disclosed broker-dealer, including rules relating to
possession and control of customer funds and securities, margin lending and
execution and settlement of transactions. The Company's ability to so comply
is dependent in large part upon the establishment and maintenance of a
qualified compliance system. The Company is aware of several instances of its
non-compliance with applicable regulations. In particular, in fiscal 1997 the
Company failed to comply with applicable advertising restrictions in one
international jurisdiction, and due to a clerical oversight failed to timely
renew its registration as a broker-dealer in two states, Nebraska and Ohio.
One of the states, Ohio, as a condition of renewing the Company's license as a
broker-dealer in that state, required the Company to offer customers resident
in that state the ability to rescind (for up to 30 days) certain securities
transactions effected through the Company during the period January 1, 1997
through April 15, 1997, the date the Company's license was renewed. For the
nine months ended June 30, 1997, the Company recorded a $4.3 million pre-tax
charge against earnings in connection with this matter.
Additional legislation, changes in rules promulgated by the SEC, the NASD,
the Board of Governors of the Federal Reserve System, the various stock
exchanges and other self-regulatory organizations, or changes in the
interpretation or enforcement of existing laws and rules, may directly affect
the mode of operation and profitability of broker-dealers. The SEC, the NASD
or other self-regulatory organizations and state securities commissions may
conduct administrative proceedings, which can result in censure, fine, the
issuance of cease-and-desist orders or the suspension or expulsion of a
broker-dealer or any of its officers or employees. The Company's ability to
comply with all applicable laws and rules is dependent in large part upon the
establishment and maintenance of a compliance system reasonably designed to
ensure such compliance, as well as the Company's ability to attract and retain
qualified compliance personnel. The Company's growth has placed considerable
strain on its ability to ensure such compliance, and it has, in the past,
experienced turnover in its compliance personnel. The principal purpose of
regulation and discipline of broker-dealers is the protection of customers and
the securities markets, rather than protection of creditors and stockholders
of broker-dealers. The Company could in the future be subject to disciplinary
or other actions due to claimed noncompliance, which could have a material
adverse effect on the Company's business, financial condition and operating
results.
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The Company has initiated an aggressive marketing campaign designed to bring
brand name recognition to E*TRADE. All marketing activities by E*TRADE
Securities are regulated by the NASD, and all such marketing materials are
required by the NASD to be reviewed by E*TRADE Securities' compliance officer
prior to release. The Company has in the past been requested by the NASD to
discontinue the use of certain marketing materials. The NASD can impose
certain penalties, including censure, fine, suspension of all advertising, the
issuance of cease-and-desist orders or the suspension or expulsion of a
broker-dealer or any of its officers or employees for violations of the NASD's
advertising regulations. The Company does not currently solicit orders from
its customers or make investment recommendations. However, if the Company were
to engage in such activities, it would become subject to additional rules and
regulations governing, among other things, the suitability of recommendations
to customers and sales practices.
It is the Company's intent to expand its business in United States
securities to other countries and to broaden its customer's opportunities to
trade securities of companies listed outside the United States through the
Internet and other gateways. At June 30, 1997, over 2,500 of the Company's
accounts were for customers with addresses in over 60 foreign countries. In
order to expand its services globally, E*TRADE Securities must comply with the
regulatory controls of each specific country in which it conducts business.
The varying compliance requirements of other national regulatory jurisdictions
will impose a limit to the Company's rate of international expansion. The
Company intends to rely primarily on local third parties for regulatory
compliance in international jurisdictions. See "--Risks Associated with
International Strategy."
There can be no assurance that other federal, state or foreign agencies will
not attempt to regulate the Company's online and other electronic activities.
The Company anticipates that it may be required to comply with record keeping,
data processing and other regulatory requirements as a result of proposed
federal legislation or otherwise, and the Company may be subject to additional
regulation as the market for online commerce evolves. Because of the growth in
the electronic commerce market, Congress has held hearings on whether to
regulate providers of services and transactions in the electronic commerce
market, and federal or state authorities could enact laws, rules or
regulations affecting the Company's business or operations. The Company also
may be subject to federal, state and foreign money transmitter laws and state
and foreign sales and use tax laws. If enacted or deemed applicable to the
Company, such laws, rules or regulations could be imposed on the Company's
activities or its business, thereby rendering the Company's business or
operations more costly or burdensome, less efficient or even impossible, any
of which could have a material adverse effect on the Company's business,
financial condition and operating results.
Due to the increasing popularity of the Internet, it is possible that laws
and regulations may be enacted with respect to the Internet, covering issues
such as user privacy, pricing, content and quality of products and services.
The Telecommunications Act of 1996 prohibits the transmission over the
Internet of certain types of information and content. Although certain of
these prohibitions have been held unconstitutional, the increased attention
focused upon these liability issues as a result of the Telecommunications Act
could adversely affect the growth of Internet and private network use. In
addition, the adoption of other laws or regulations may reduce the rate of
growth of the Internet, which could in turn decrease the demand for the
Company's services or could otherwise have a material adverse effect on the
Company's business, financial condition and operating results. See "Business--
Government Regulation; Net Capital Requirements."
EFFECT OF NET CAPITAL REQUIREMENTS
The SEC, the NASD and various other regulatory agencies have stringent rules
with respect to the maintenance of specific levels of net capital by
securities brokers, including the SEC's Uniform Net Capital Rule (the "Net
Capital Rule"), which governs both E*TRADE Securities and E*TRADE Capital,
Inc. (formerly ET Execution Services), a non-operational broker-dealer
subsidiary of E*TRADE Group, Inc. ("E*TRADE Capital"). Net capital is the net
worth of a broker or dealer (assets minus liabilities), less certain
deductions that result from excluding assets that are not readily convertible
into cash and from conservatively valuing certain other assets. Failure to
maintain the required net capital may subject a firm to suspension or
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revocation of registration by the SEC and suspension or expulsion by the NASD
and other regulatory bodies and ultimately could require the firm's
liquidation. In addition, a change in the net capital rules, the imposition of
new rules or any unusually large charge against net capital could limit those
operations of the Company that require the intensive use of capital, such as
trading activities and the financing of customer account balances, and also
could restrict the Company's ability to withdraw capital from its brokerage
subsidiaries, which in turn could limit the Company's ability to pay
dividends, repay debt and redeem or purchase shares of its outstanding stock.
A significant operating loss or any unusually large charge against net capital
could adversely affect the ability of the Company to expand or even maintain
its present levels of business, which could have a material adverse effect on
the Company's business, financial condition and operating results. See
"Business--Government Regulation; Net Capital Requirements."
As of June 30, 1997, E*TRADE Securities was required to maintain minimum net
capital of $8.4 million and had total net capital of approximately $22.9
million, or approximately $14.5 million in excess of the minimum amount
required. In February 1996, E*TRADE Capital, then doing business as ET
Execution Services, undertook to act as guarantor pursuant to an agreement
between the Company and Merrill Lynch Business Financial Services, Inc. This
undertaking caused E*TRADE Capital to fall short of its minimum net capital
requirement and thus be in violation of the Net Capital Rule through May 30,
1996, when E*TRADE Capital was released from the guarantee. The Company has
reported the violation of E*TRADE Capital to the SEC and the NASD and is
awaiting their decisions. There can be no assurance that either or both the
SEC or the NASD will not impose a penalty upon E*TRADE Capital, including
fines, restrictions on business activities or suspension of trading
activities, or that the imposition of any such penalty will not have a
material adverse effect on the Company's business, financial condition and
operating results. In addition, there can be no assurance that a violation of
the Net Capital Rule will not occur in the future. See "Business--Government
Regulation; Net Capital Requirements."
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING
The Company currently anticipates that its available cash resources and
credit facilities, combined with the net proceeds to the Company from this
offering, will be sufficient to meet its presently anticipated working capital
and capital expenditure requirements for at least the next 12 months. However,
the Company may need to raise additional funds in order to support more rapid
expansion, develop new or enhanced services and products, respond to
competitive pressures, acquire complementary businesses or technologies or
take advantage of unanticipated opportunities. The Company's future liquidity
and capital requirements will depend upon numerous factors, including the
costs and timing of expansion of research and development efforts and the
success of such efforts, the success of the Company's existing and new service
offerings and competing technological and market developments. The Company's
forecast of the period of time through which its financial resources will be
adequate to support is operations is a forward-looking statement that involves
risks and uncertainties, and actual results could vary. The factors described
earlier in this paragraph will impact the Company's future capital
requirements and the adequacy of its available funds. The Company may be
required to raise additional funds through public or private financing,
strategic relationships or other arrangements. There can be no assurance that
such additional funding, if needed, will be available on terms attractive to
the Company, or at all. Furthermore, any additional equity financing may be
dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants. Strategic arrangements, if necessary to raise
additional funds, may require the Company to relinquish its rights to certain
of its technologies. If additional funds are raised through the issuance of
equity securities, the percentage ownership of the stockholders of the Company
will be reduced, stockholders may experience additional dilution in net book
value per share, or such equity securities may have rights, preferences or
privileges senior to those of the holders of the Company's Common Stock. There
can be no assurance that additional financing will be available when needed on
terms favorable to the Company, if at all. If adequate funds are not available
on acceptable terms, the Company may be unable to develop or enhance its
services and products, take advantage of future opportunities or respond to
competitive pressures, any of which could have a material adverse effect on
the Company's business, financial condition and operating results. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
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RISKS ASSOCIATED WITH ACQUISITIONS AND STRATEGIC RELATIONSHIPS
While the Company has no current agreements or negotiations underway with
respect to any potential acquisitions, the Company may make acquisitions of
other companies or technologies in the future, and the Company regularly
evaluates such opportunities. Acquisitions entail numerous risks, including
difficulties in the assimilation of acquired operations and products,
diversion of management's attention from other business concerns, amortization
of acquired intangible assets and potential loss of key employees of acquired
companies. The Company has no experience in assimilating acquired
organizations into the Company's operations. No assurance can be given as to
the ability of the Company to integrate successfully any operations,
personnel, services or products that might be acquired in the future, and the
failure of the Company to do so could have a material adverse effect on the
Company's business, financial condition and operating results.
The Company has established a number of strategic relationships with online
and Internet service providers and software and information service providers.
A significant number of such relationships have only recently been entered
into. There can be no assurance that any such relationships will be
maintained, that if such relationships are maintained, they will be successful
or profitable, or that the Company will develop any new such relationships.
See "Business--Strategic Relationships."
RISKS ASSOCIATED WITH INTERNATIONAL STRATEGY
A component of the Company's strategy is its planned increase in efforts to
attract more international customers. To date, the Company has limited
experience in providing brokerage services internationally. There can be no
assurance that the Company will be able to market successfully its services
and products in international markets. In addition, there are certain risks
inherent in doing business in international markets, particularly in the
heavily regulated brokerage industry, such as unexpected changes in regulatory
requirements, tariffs and other trade barriers, difficulties in staffing and
managing foreign operations, political instability, fluctuations in currency
exchange rates, reduced protection for intellectual property rights in some
countries, seasonal reductions in business activity during the summer months
in Europe and certain other parts of the world, and potentially adverse tax
consequences, any of which could adversely impact the success of the Company's
international operations. The Company has recently entered into agreements to
provide online trading services in Canada, Australia and New Zealand under the
E*TRADE name. In connection with these agreements, the Company relies upon
third parties for a variety of business and regulatory compliance matters.
There can be no assurance that one or more of the factors described above will
not have a material adverse effect on the Company's future international
operations, if any, and, consequently, on the Company's business, financial
condition and operating results. See "Business--Strategy" and "--Strategic
Relationships."
MANAGEMENT'S DISCRETION AS TO USE OF UNALLOCATED NET PROCEEDS
The Company has designated only limited specific use for the net proceeds
from the sale of Common Stock described in this Prospectus. The Company
expects to use the net proceeds for working capital and other general
corporate purposes. Consequently, the Board of Directors and management of the
Company will have broad discretion in allocating the net proceeds of this
offering. See "Use of Proceeds."
CONCENTRATION OF STOCK OWNERSHIP
Upon the completion of this offering, the Company's present directors and
executive officers and their respective affiliates will beneficially own
approximately 23.9% of the outstanding Common Stock. As a result, these
stockholders, if they act together, will be able to exercise significant
influence over all matters requiring stockholder approval, including the
election of directors and approval of significant corporate transactions. Such
concentration of ownership also may have the effect of delaying, preventing or
deterring a change in control of the Company. See "Principal and Selling
Stockholders" and "Description of Capital Stock--Certain Provisions Affecting
Stockholders."
16
<PAGE>
VOLATILITY OF STOCK PRICE
The market price of the Company's Common Stock has been and is likely to
continue to be highly volatile and subject to wide fluctuations in response to
quarterly variations in operating results, announcements of technological
innovations or new software, services or products by the Company or its
competitors, changes in financial estimates by securities analysts or other
events or factors, many of which are beyond the Company's control. In
addition, the stock market has experienced significant price and volume
fluctuations that have particularly affected the market prices of equity
securities of many technology and services companies and that often have been
unrelated to the operating performance of such companies. These broad market
fluctuations may adversely affect the market price of the Company's Common
Stock. In the past, following periods of volatility in the market price for a
company's securities, securities class action litigation often has been
instituted. Such litigation could result in substantial costs and a diversion
of management attention and resources, which could have a material adverse
effect on the Company's business, financial condition and operating results.
SHARES ELIGIBLE FOR FUTURE SALE
No prediction can be made as to the effect, if any, that future sales of
shares of Common Stock, or the availability of shares of Common Stock for
future sale, will have on the market price for the Common Stock prevailing
from time to time. Sales of substantial amounts of Common Stock, or the
perception that such sales could occur, could adversely affect prevailing
market prices for shares of the Common Stock. Upon completion of the offering,
based on shares outstanding on June 30, 1997, the Company will have
outstanding 35,958,147 shares of Common Stock. Approximately 26,762,184 shares
will be tradeable without restriction or further registration under the
Securities Act of 1933 (the "Securities Act") by persons other than
"affiliates" of the Company, including shares which will be eligible for
immediate sale in the public market without restriction pursuant to Rule
144(k) under the Securities Act. As of the closing of this offering, the
remaining approximately 9,195,963 shares of Common Stock will be "restricted
securities" (as defined in Rule 144 under the Securities Act), and may be sold
under Rule 144 subject to the holding period, volume limitations and other
restrictions under Rule 144. Approximately 8,570,103 of such shares of Common
Stock are subject to lock-up agreements under which the holders of such shares
have agreed with the representatives of the Underwriters not to sell or
otherwise dispose of any of such shares for a period of 60 days following the
date of this Prospectus, subject to certain limited exceptions. See "Shares
Eligible for Future Sale."
EFFECTS OF CERTAIN CHARTER AND BYLAW PROVISIONS
The Company's Board of Directors has the authority to issue up to an
additional 1,000,000 shares of Preferred Stock and to determine the price,
rights, preferences and privileges of those shares without any further vote or
action by the Company's stockholders. The rights of the holders of Common
Stock will be subject to, and may be adversely affected by, the rights of the
holders of Preferred Stock. While the Company has no present intention to
issue shares of Preferred Stock, such issuance, while providing desirable
flexibility in connection with the possible acquisitions and other corporate
purposes, could have the effect of delaying, deferring or preventing a change
in control of the Company and entrenching existing management. In addition,
such Preferred Stock may have other rights, including economic rights, senior
to the Common Stock, and, as a result, the issuance thereof could have a
material adverse effect on the market value of the Common Stock. The Company
is also subject to the anti-takeover provisions of Section 203 of the Delaware
General Corporation Law, which restricts certain "business combinations" with
"interested stockholders" for three years following the date the person
becomes an interested stockholder, unless the Board of Directors approves the
business combination. By delaying and deterring unsolicited takeover attempts,
these provisions could adversely affect prevailing market prices for the
Company's Common Stock. Certain other provisions of the Company's Restated
Certificate of Incorporation or Restated Bylaws, including elimination of the
ability of stockholders to act by written consent, a staggered Board of
Directors and advance notice for stockholder proposals and director
nominations, may have the effect of delaying or preventing changes of control
or management of the Company, which could adversely affect the market price of
the Company's Common Stock. See "Description of Capital Stock."
17
<PAGE>
USE OF PROCEEDS
The net proceeds from the sale of the 5,000,000 shares of Common Stock
offered by the Company hereby are estimated to be approximately $132.4 million
($144.3 million if the Underwriters' over-allotment option is exercised in
full), assuming a public offering price of $28.13 per share, after deducting
estimated underwriting discounts and commissions and offering expenses payable
by the Company. The Company will not receive any proceeds from the sale of
shares of Common Stock by the Selling Stockholders. See "Principal and Selling
Stockholders."
The net proceeds will be used for working capital and other general
corporate purposes, which will include meeting the Company's regulatory net
capital requirements, capital expenditures, increasing capacity, international
expansion, the development and marketing of new products and services and
funding potential acquisitions. The Company continues to evaluate potential
acquisition opportunities; however, none are presently under active
consideration. Pending such uses, the Company will invest the net proceeds of
this offering in short-term, investment-grade, interest-bearing securities.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock has been traded on the Nasdaq National Market
under the symbol EGRP since the Company's initial public offering on August
16, 1996. The following table sets forth the high and low sale prices of the
Company's Common Stock as reported by the Nasdaq National Market for the
periods indicated.
<TABLE>
<CAPTION>
HIGH LOW
---- ----
<S> <C> <C>
FISCAL 1996
Fourth Quarter (from August 16, 1996)..............$13.3/16 $ 8 3/8
FISCAL 1997
First Quarter..................................... 12 1/2 9
Second Quarter.................................... 25 1/4 11 1/8
Third Quarter..................................... 21 14 3/4
Fourth Quarter (through July 29, 1997)............ 28 1/8 17 31/32
</TABLE>
The last reported sale price of the Common Stock on July 29, 1997, was
$28.13 per share. As of July 18, 1997, there were approximately 236 holders of
record of the Company's Common Stock.
DIVIDEND POLICY
The Company has never declared or paid cash dividends on its capital stock.
The Company currently intends to retain all of its earnings, if any, for use
in its business and does not anticipate paying any cash dividends in the
foreseeable future. The payment of any future dividends will be at the
discretion of the Company's Board of Directors and will depend upon a number
of factors, including future earnings, the success of the Company's business
activities, regulatory capital requirements, the general financial condition
and future prospects of the Company, general business conditions and such
other factors as the Board of Directors may deem relevant.
18
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of June
30, 1997 (i) on an actual basis and (ii) as adjusted to reflect the sale by
the Company of 5,000,000 shares of Common Stock offered hereby at an assumed
public offering price of $28.13 per share, after deducting estimated
underwriting discounts and commissions and offering expenses payable by the
Company, and the receipt of the estimated net proceeds therefrom. This table
should be read in conjunction with the Consolidated Financial Statements and
Notes thereto and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1997
-------------------
ACTUAL AS ADJUSTED
------- -----------
(in thousands)
<S> <C> <C>
Preferred Stock, $.01 par value, 1,000,000 shares
authorized, none outstanding........................... $ -- $ --
Common Stock, $.01 par value, 50,000,000 shares
authorized, 30,958,147 shares outstanding, actual; and
35,958,147 shares outstanding, as adjusted(1).......... 309 359
Additional paid-in capital.............................. 74,095 206,439
Retained earnings....................................... 8,653 8,653
------- --------
Stockholders' equity.................................. 83,057 215,451
------- --------
Total capitalization................................ $83,057 $215,451
======= ========
</TABLE>
- --------
(1) Excludes as of June 30, 1997: (i) 4,000,000 shares of Common Stock
reserved for issuance under the Company's 1996 Stock Incentive Plan,
options to purchase 1,702,700 of which were outstanding, (ii) 3,547,420
shares of Common Stock reserved for issuance pursuant to the exercise of
outstanding options granted under the Company's 1993 Stock Option Plan and
1983 Employee Incentive Stock Option Plan, and (iii) 615,380 shares of
Common Stock available for issuance under the Company's 1996 Stock
Purchase Plan. Of the options outstanding at June 30, 1997, options to
purchase 687,119 shares of Common Stock were then exercisable. See
"Management--Associate Benefit Plans" and Note 7 of Notes to Consolidated
Financial Statements.
19
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth for the periods indicated selected
consolidated financial data for the Company. The following selected
consolidated financial data are qualified by the more detailed consolidated
financial statements of the Company and the notes thereto included elsewhere
in this Prospectus and should be read in conjunction with such consolidated
financial statements and notes and the discussion under "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Prospectus. The consolidated statement of
operations data for the years ended September 30, 1994, 1995 and 1996 and the
consolidated balance sheet data at September 30, 1995 and 1996 have been
derived from the Company's consolidated financial statements included
elsewhere in this Prospectus. The consolidated statement of operations data
for the years ended September 30, 1992 and 1993 and the consolidated balance
sheet data at September 30, 1992, 1993 and 1994 have been derived from audited
financial statements not included in this Prospectus. The consolidated
statement of operations data for the nine months ended June 30, 1996 and 1997
and the consolidated balance sheet data at June 30, 1997 are derived from
unaudited consolidated financial statements which, in the opinion of
management, have been prepared on the same basis as the audited consolidated
financial statements and contain all adjustments, consisting only of normal
recurring accruals, necessary for a fair presentation of the results of
operations for such periods. The results of operations for the nine months
ended June 30, 1997 are not necessarily indicative of results to be expected
for the full year.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
-------------------------------------- ----------------
1992 1993 1994 1995 1996 1996 1997
------ ------ ------ ------- ------- ------- -------
CONSOLIDATED STATEMENT OF
OPERATIONS DATA: (in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Transaction revenues.. $ 327 $2,158 $9,548 $20,835 $44,178 $30,208 $72,329
Interest, net of
interest expense..... -- 17 302 1,004 4,813 2,213 15,646
International......... -- -- -- -- -- -- 4,000
Computer services and
other................ 521 799 1,055 1,501 2,604 2,002 2,285
------ ------ ------ ------- ------- ------- -------
Net revenues........ 848 2,974 10,905 23,340 51,595 34,423 94,260
------ ------ ------ ------- ------- ------- -------
Cost of services:
Cost of services...... 579 1,973 7,646 13,340 34,268 24,030 45,364
Registration charge... -- -- -- -- -- -- 4,334
Self-clearing start-up
costs................ -- -- -- 141 2,240 1,844 --
------ ------ ------ ------- ------- ------- -------
Total cost of
services........... 579 1,973 7,646 13,481 36,508 25,874 49,698
------ ------ ------ ------- ------- ------- -------
Operating expenses:
Selling and marketing. 116 282 998 2,466 7,600 5,749 16,232
Technology
development.......... 176 216 335 943 2,792 1,323 4,435
General and
administrative....... 260 400 1,682 2,141 6,078 3,701 9,785
------ ------ ------ ------- ------- ------- -------
Total operating
expenses........... 552 898 3,015 5,550 16,470 10,773 30,452
------ ------ ------ ------- ------- ------- -------
Total cost of
services and
operating expenses. 1,131 2,871 10,661 19,031 52,978 36,647 80,150
------ ------ ------ ------- ------- ------- -------
Pre-tax income (loss)... (283) 103 244 4,309 (1,383) (2,224) 14,110
Income tax expense
(benefit).............. 2 4 (541) 1,728 (555) (890) 5,728
------ ------ ------ ------- ------- ------- -------
Net income (loss)....... $ (285) $ 99 $ 785 $ 2,581 $ (828) $(1,334) $ 8,382
====== ====== ====== ======= ======= ======= =======
Net income (loss) per
share.................. $(0.01) $ -- $ 0.03 $ 0.10 $ (0.03) $ (0.05) $ 0.24
====== ====== ====== ======= ======= ======= =======
Weighted average number
of common and common
equivalent shares
outstanding............ 24,828 26,677 26,186 26,481 28,564 28,477 34,719
====== ====== ====== ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------------------------------- JUNE 30,
1992 1993 1994 1995 1996 1997
-------- -------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE
SHEET DATA:
Cash and equivalents.... $ 48 $ 36 $ 692 $ 9,624 $ 14,641 $ 18,116
Total assets............ 226 728 2,163 14,164 294,881 719,845
Long-term obligations... 1,165 1,310 64 45 22 6
Stockholders' equity
(deficiency)........... (1,107) (788) (92) 11,148 69,304 83,057
</TABLE>
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the consolidated
financial statements and notes thereto included elsewhere in this Prospectus.
This discussion contains forward-looking statements which involve risks and
uncertainties. The Company's actual results may differ materially from those
anticipated in these forward-looking statements as a result of certain
factors, including, but not limited to, those set forth under "Risk Factors"
and elsewhere in this Prospectus.
OVERVIEW
E*TRADE is a leading provider of online investing services and has
established a popular, branded destination Web site for self-directed
investors. Founded in 1982, the Company operated initially as a service
bureau, providing automated online securities transaction services to various
brokerage firms, including Fidelity Brokerage Services, Inc., Quick & Reilly
and, through an agreement with Bank of America, Charles Schwab. In 1992, the
Company formed E*TRADE Securities and began to offer retail investing services
and account information 24 hours a day, seven days a week.
The Company's revenues consist principally of transaction revenues, which
include securities brokerage commissions and payments based on order flow
(described below), interest and certain other fees related to the Company's
product offerings. The Company has experienced substantial growth in its
revenues since the inception of E*TRADE Securities. At the end of fiscal 1992,
the Company was processing slightly over 100 transactions per day. For June
1997, the Company's average daily transaction volume had grown to 17,800.
Although increases in the overall activity in the securities markets have
contributed to the Company's growth, the Company believes that its growth has
also been due to the success of its advertising campaigns in bringing brand
name recognition to the E*TRADE name, the launch of Internet access to E*TRADE
and the continuing successful integration of new product developments.
The Company uses other broker-dealers to execute its customers' orders and,
in recent years, has derived a significant portion of its revenues from these
broker-dealers for such order flow. This practice of receiving payments for
order flow is widespread in the securities industry. Under applicable SEC
regulations, receipt of these payments requires disclosure of such payments by
the Company to its customers. The revenues received by the Company under these
arrangements for fiscal 1995 and 1996 and the first nine months of fiscal 1997
amounted to 20%, 22% and 22% of net revenues, respectively. However, the
amount received per transaction has declined over these periods, and the
Company expects this trend to continue. There can be no assurance that these
revenues will continue at their present levels or that the Company will be
able to continue its present relationships and terms for such payments for
order flow. In addition, there can be no assurance that payments for order
flow will continue to be permitted by the SEC, the NASD or other regulatory
agencies, courts or governmental units. Loss of any or all of these revenues
could have a material adverse effect on the Company's business, financial
condition and operating results.
The Company is making significant investments in systems technology and
established a second data center in Rancho Cordova, California, in July 1996.
This facility supports systems, network services, trading, customer service,
transaction redundancy and backup between the Company's Palo Alto and Rancho
Cordova locations, thereby providing an operational system in the event of a
service interruption at either facility. The Company's customer service
capacity has been strained at times. Through significant investments in
technology and personnel, the Company continues to address its growing
customer service needs.
The Company implemented equity self-clearing operations in July 1996 and
options self-clearing operations in April 1997. Prior to July 1996, the
Company cleared all of its customer transactions as a fully-disclosed
correspondent of Herzog. Clearing services include the confirmation, receipt,
settlement, custody and delivery functions involved in securities
transactions. In the first quarter of fiscal 1996, the Company
21
<PAGE>
began hiring associates to perform these functions. As a consequence, the
Company incurred significant non-recurring costs associated with the hiring
and training of its associates, as well as systems integration costs. The
Company continued to incur expenses for clearing operations performed by
Herzog through June 1996. The conversion to self-clearing has allowed the
Company to realize significant cost savings.
The Company now assumes direct responsibility for the possession and control
of customer securities and other customer assets and the clearance of
customers' securities transactions. Having this responsibility requires the
Company to record on its balance sheet the customer receivables and customer
payables to the Company that are a result of customer margin loans (i.e.,
loans made to customers that are collateralized by securities held in the
customers' margin accounts at the Company) and customer free credit balances
(i.e., customer cash balances maintained by the Company), respectively. In
addition, to the extent that the Company's customer debit balances exceed
customer free credit balances, the Company must obtain financing for any
excess debit balance. The Company recorded receivables from customers,
brokers, dealers and clearing organizations of $460 million and payables to
customers, brokers, dealers and clearing organizations of $572 million as of
June 30, 1997. The Company contracts with a third-party service bureau, Beta
Systems, for its customer record keeping and data processing services, having
previously relied on Herzog for these services.
The Company's transaction revenues increased from $9.5 million in fiscal
1994 to $44.2 million in fiscal 1996 and $72.3 million for the nine months
ended June 30, 1997. Transaction revenues include securities brokerage
transactions and, since late fiscal 1994, payments for order flow. The Company
recognized $2.0 million in international revenue in the three months ended
March 31, 1997 representing licensing fees attributable to the Company's
agreement with VERSUS Technologies, Inc. ("VERSUS"). This licensing agreement
grants VERSUS, through its subsidiary VERSUS Brokerage Services, Inc., the
exclusive right to offer online investing services under the E*TRADE name to
customers with addresses in Canada. The Company recognized $2.0 million in
international revenues for the three months ended June 30, 1997 representing
licensing fees attributable to the Company's agreement with Nova Pacific
Capital Ltd. ("Nova Pacific"). This licensing agreement grants Nova Pacific
the exclusive right to offer online investing services under the E*TRADE name
to customers with addresses in Australia and New Zealand. Under these
agreements, the Company will receive ongoing royalties from VERSUS and Nova
Pacific based upon their transaction revenues. The Company may, from time to
time, seek to enter into similar licensing agreements with others as part of
its international expansion strategy. There can be no assurance that any such
future agreements will be consummated or that the terms thereof will be
comparable to those of the aforementioned agreements or that the recognition
of any licensing fees will occur during the period in which an arrangement is
consummated. Prior to the three months ended March 31, 1997, the Company did
not recognize any international revenues. See "Business--Strategic
Relationships."
Interest revenues, net of interest expense, increased from $302,000 in
fiscal 1994 to $4.8 million in fiscal 1996 and to $15.6 million for the nine
months ended June 30, 1997. The Company previously participated in the
interest spread on its customer debit and credit balances through its clearing
agreement with Herzog but is no longer subject to that agreement as a result
of its conversion to self-clearing operations. Consequently, the Company now
has greater control over interest rates charged to customers for debit
balances and interest rates paid for credit balances. The Company began
receiving fees on its customers' assets invested in money market funds in
September 1994, which fees were shared with Herzog until the Company's change
to self-clearing operations in July 1996. Computer services and other revenues
increased from $1.1 million in fiscal 1994 to $2.6 million in fiscal 1996 and
to $2.3 million for the nine months ended June 30, 1997. Computer services
revenues consist primarily of fees for the time customers are connected to the
Company online. Other revenues represent the Company's return on its
investment in Roundtable Partners LLC, a consortium of broker-dealers that
provides the Company with alternative broker-dealers through which to route
its customers' orders for execution. The Company also participates in the
operating results of Roundtable Partners LLC as an equity owner.
22
<PAGE>
The Company's total cost of services increased from $7.6 million in fiscal
1994 to $36.5 million in fiscal 1996 and to $49.7 million for the nine months
ended June 30, 1997. Cost of services includes clearing fees paid to the
Company's former clearing broker, system maintenance and communication
expenses and expenses related to the Company's clearing operations and
customer service activities.
Selling and marketing expenses increased from $1.0 million in fiscal 1994 to
$7.6 million in fiscal 1996 and $16.2 million for the nine months ended June
30, 1997 and consist primarily of the costs associated with the actual
advertising placement expenses as well as the creative development of
advertising.
Technology development expenses increased from $335,000 in fiscal 1994 to
$2.8 million in fiscal 1996 and $4.4 million for the nine months ended June
30, 1997. General and administrative expenses consist of payroll and
consulting costs associated with the development and enhancement of the
Company's product offerings. In addition to such amounts, the Company
capitalized costs of $114,000 in fiscal 1996 and $2.3 million for the nine
months ended June 30, 1997 for internally developed software.
General and administrative expenses increased from $1.7 million in fiscal
1994 to $6.1 million in fiscal 1996 and to $9.8 million for the nine months
ended June 30, 1997 and consist primarily of facilities costs, equipment and
maintenance expenses, as well as corporate management costs, including
accounting, human resources, compliance and other administrative expenses.
The Company has experienced substantial changes in and expansion of its
business and operations since it began offering online investing services in
1992 and Internet investing services in February 1996 and expects to continue
to experience periods of rapid change. The Company's past expansion has
placed, and any future expansion would place, significant demands on the
Company's administrative, operational, financial and other resources.
Competition for highly qualified senior managers and technical personnel is
intense. If the Company fails to attract, assimilate and retain such
personnel, there would be a material adverse effect on the Company's business,
financial condition and operating results.
The securities industry is subject to extensive regulation under federal,
state and applicable international laws. As a result, the Company is required
to comply with many complex laws and rules and its ability to so comply is
dependent in large part upon the establishment and maintenance of a qualified
compliance system. The Company is aware of several instances of its non-
compliance with applicable regulations. In particular, the Company failed to
comply with applicable advertising restrictions in one international
jurisdiction and, due to a clerical oversight, failed to timely renew its
registration as a broker-dealer in two states, Nebraska and Ohio. One of the
states, Ohio, as a condition of renewing the Company's license as a broker-
dealer in that state, required the Company to offer customers resident in that
state the ability to rescind (for up to 30 days) certain securities
transactions effected through the Company during the period January 1, 1997
through April 15, 1997, the date the Company's license was renewed. For the
nine months ended June 30, 1997, the Company recorded a one-time, $4.3 million
pre-tax charge against earnings in connection with this matter.
23
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the percentage of net revenues represented by
certain items on the Company's consolidated statements of operations for the
periods indicated:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, JUNE 30,
------------------- -------------
1994 1995 1996 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Revenues:
Transaction revenues.................... 87.6% 89.3% 85.6% 87.8% 76.7%
Interest, net of interest expense....... 2.7 4.2 9.4 6.4 16.6
International........................... -- -- -- -- 4.3
Computer services and other............. 9.7 6.5 5.0 5.8 2.4
----- ----- ----- ----- -----
Net revenues.......................... 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- -----
Cost of services:
Cost of services........................ 70.1 57.2 66.4 69.8 48.1
Registration charge..................... -- -- -- -- 4.6
Self-clearing start-up costs............ -- 0.6 4.3 5.4 --
----- ----- ----- ----- -----
Total cost of services................ 70.1 57.8 70.7 75.2 52.7
----- ----- ----- ----- -----
Operating expenses:
Selling and marketing................... 9.2 10.6 14.7 16.7 17.2
Technology development.................. 3.1 4.0 5.4 3.8 4.7
General and administrative.............. 15.4 9.1 11.8 10.8 10.4
----- ----- ----- ----- -----
Total operating expenses.............. 27.7 23.7 31.9 31.3 32.3
----- ----- ----- ----- -----
Total cost of services and operating
expenses............................. 97.8 81.5 102.6 106.5 85.0
----- ----- ----- ----- -----
Pre-tax income (loss)..................... 2.2 18.5 (2.6) (6.5) 15.0
Income tax expense (benefit).............. (5.0) 7.4 (1.0) (2.6) 6.1
----- ----- ----- ----- -----
Net income (loss)......................... 7.2% 11.1% (1.6)% (3.9)% 8.9%
===== ===== ===== ===== =====
</TABLE>
Nine Months Ended June 30, 1997 and 1996
Revenues
Transaction revenues increased 139% to $72.3 million for the nine months
ended June 30, 1997, up from $30.2 million for the same period in fiscal 1996.
Of these amounts, commission revenues increased 129% to $52.0 million, up from
$22.7 million for the same period in fiscal 1996. Average commissions per
transaction declined from $21.19 for the nine months ended June 30, 1996 to
$19.97 for the same period in fiscal 1997, due to the planned lowering of
commissions on listed market orders from $19.95 to $14.95 in February 1996.
Payments for order flow increased 171% to $20.3 million for the nine months
ended June 30, 1997, up from $7.5 million for the same period in the prior
year. The growth in payments for order flow was greater than the growth in
average daily transactions because the conversion to self-clearing operations
completed in July 1996 has provided significant opportunities to improve order
flow revenues. The average transaction revenues per securities transaction was
$27.79 for the nine months ended June 30, 1997 and $28.20 for the same period
in fiscal 1996. The increase in transaction revenues resulted primarily from
an increase in the number of transactions processed by the Company.
Transactions for the nine months ended June 30, 1997 totaled 2,602,000, for an
average of 13,769 per day, representing an increase of 143% over the average
daily transaction volume of 5,667 for the same period in fiscal 1996.
Net interest revenues for the nine months ended June 30, 1997 increased 607%
to $15.6 million, up from $2.2 million for the same period in fiscal 1996.
This increase was primarily a result of average customer margin debit balances
increasing 168% to $286.0 million, average customer interest-earning credit
balances increasing
24
<PAGE>
516% to $213.0 million and average customer money market fund balances
increasing 133% to $606.0 million during the period, compared to the average
balances during the nine months ended June 30, 1996. Additionally, the growth
in interest revenues was due to the conversion to self-clearing operations
completed in July 1996, which has provided significant opportunities to manage
funds in customer accounts.
International revenues were $4.0 million for the nine months ended June 30,
1997, due to the recognition of licensing fees attributable to the Company's
agreements with VERSUS, in the second quarter of fiscal 1997, and Nova
Pacific, in the third quarter of fiscal 1997, each for $2.0 million. There
were no international revenues for the nine months ended June 30, 1996.
Computer services and other revenues increased 14% to $2.3 million for the
nine months ended June 30, 1997 up from $2.0 million for the comparable period
in fiscal 1996. These revenues increased as a result of an increase in the
profits from the investment in Roundtable Partners LLC, partially offset by a
decrease in customer connect time charges.
Cost of Services
Total cost of services increased 92% to $49.7 million for the nine months
ended June 30, 1997 from $25.9 million for the comparable period in fiscal
1996. Included in cost of services in the nine months ended June 30, 1997 was
a charge of $4.3 million, which resulted from a clerical oversight connected
with the Company's failure to timely renew its registration as a broker-dealer
in the state of Ohio. Included in cost of services in the nine months ended
June 30, 1996 were self-clearing start-up costs of $1.8 million. Cost of
services, exclusive of the registration charge and self-clearing start-up
costs, increased 89%, which increase reflects the overall increase in customer
transactions processed by the Company, a related increase in customer service
inquiries, and operations and maintenance costs associated with the second
data center in Rancho Cordova, California.
Operating Expenses
Selling and marketing expenses increased 182% to $16.2 million for the nine
months ended June 30, 1997, up from $5.7 million for the comparable period in
fiscal 1996. The increase reflects expenditures for advertising placements,
creative development and collateral materials resulting from a variety of
advertising campaigns directed at building brand name recognition, growing
customer base and market share, and maintaining customer retention rates. In
addition, the increase reflects the Company's national television advertising
campaign launched during the second quarter of fiscal 1997.
Technology development costs increased 235% to $4.4 million for the nine
months ended June 30, 1997, up from $1.3 million for the comparable period in
fiscal 1996. The fiscal 1997 level of expenses was incurred to enhance the
Company's existing product offerings, including maintenance of the Company's
Web site, which was launched in February 1996.
General and administrative expenses increased 164% to $9.8 million for the
nine months ended June 30, 1997, up from $3.7 million for the comparable
period in fiscal 1996. The increase was the result of increased costs
associated with personnel additions, relocation to larger facilities, and an
increased use of consultants by the Company in comparison to the same period
in the prior year.
Income Tax Expense (Benefit)
Income tax expense (benefit) represents the provision for federal and state
income taxes at an effective rate of 40.6% for the nine months ended June 30,
1997 and 40.0% for the comparable period in fiscal 1996.
25
<PAGE>
Fiscal Years ended September 30, 1996, 1995 and 1994
Revenues
Transaction revenues increased 112% to $44.2 million in fiscal 1996, up from
$20.8 million in fiscal 1995. Transaction revenues were $9.5 million in fiscal
1994. Of these amounts, payments for order flow were $11.4 million in fiscal
1996, an increase of 148% compared to $4.6 million in fiscal 1995. The
increases in transaction revenues were primarily the result of higher
securities transaction volumes over both periods and the initiation of order
flow rebates in late fiscal 1994, offset in part by reductions in the
commission rates charged for certain transactions. The average transaction
revenues per securities transaction were $27.81 in fiscal 1996, $31.61 in
fiscal 1995 and $29.68 in fiscal 1994.
Net interest revenues increased 379% to $4.8 million in fiscal 1996, up from
$1.0 million in fiscal 1995. This increase was primarily due to average
customer margin debt of $124.4 million in fiscal 1996, an increase of 164%
compared to $47.1 million in fiscal 1995. Average customer interest earning
credit balances were $85.2 million in fiscal 1996, an increase of 492%
compared to $14.4 million in fiscal 1995; and average customer money market
fund balances were $290.7 million in fiscal 1996, an increase of 100% compared
to $145.0 million in fiscal 1995. In fiscal 1994, net interest revenues were
$302,000, average customer debit balances were $25.3 million, average customer
interest earning credit balances were $10.1 million and average customer money
market fund balances were $290.7 million.
Computer services and other revenues increased 73% to $2.6 million in fiscal
1996, up from $1.5 million in fiscal 1995. Computer services and other
revenues were $1.1 million in fiscal 1994. These increases in computer
services and other revenues were primarily due to the increase in the amount
of connect time used by customers over both periods.
Cost of Services
Total cost of services increased 171% to $36.5 million in fiscal 1996, up
from $13.5 million in fiscal 1995. Cost of services was $7.6 million in fiscal
1994. These increases were largely attributable to the increase in the number
of transactions processed by the Company, an increase in customer service
inquiries and a $3.1 million increase in customer claims and bad debt
reserves.
Self-clearing start-up costs were $2.2 million in fiscal 1996, compared to
$141,000 in fiscal 1995. The Company incurred these expenses as it continued
to hire associates and utilize consultants in preparation for the conversion
to self-clearing operations, which occurred in July 1996. The Company does not
anticipate incurring additional conversion costs in fiscal 1997.
Operating Expenses
Selling and marketing expenses increased 208% to $7.6 million in fiscal
1996, up from $2.5 million in fiscal 1995. Selling and marketing expenses were
$1.0 million in fiscal 1994. These increases reflect the increased
expenditures for advertising placements, creative development and collateral
materials. In fiscal 1996, there were additional costs attributed to the
launch of the Company's Web site and associated advertising campaign.
Technology development expenses increased 196% to $2.8 million in fiscal
1996, up from $943,000 in fiscal 1995. Technology development expenses were
$335,000 in fiscal 1994. These increases were attributable to the costs
associated with enhancing the Company's existing product offerings. In fiscal
1996, there were additional costs associated with the Company's development
efforts for the launch of its Web site and the design and implementation of
the Company's second data center in Rancho Cordova, California.
General and administrative expenses increased 184% to $6.1 million in fiscal
1996, up from $2.1 million in fiscal 1995. General and administrative expenses
were $1.7 million in fiscal 1994. The increase in fiscal 1996 was the result
of increased costs associated with personnel additions, a relocation to
larger facilities and an increased use of consultants by the Company.
Income Tax Expense (Benefit)
Income tax expense (benefit) represents federal and state income taxes at an
effective rate of 40.1% for both fiscal 1996 and 1995. In fiscal 1994,
although the Company had pre-tax net income, it recorded a net income tax
benefit of $541,000 due to full recognition of net operating loss
carryforwards generated in prior years.
26
<PAGE>
QUARTERLY RESULTS
The following table sets forth certain unaudited quarterly financial data
for the seven quarters ended June 30, 1997. In the opinion of the Company's
management, this unaudited information has been prepared on the same basis as
the audited consolidated financial statements contained herein and includes
all adjustments (consisting of normal recurring adjustments) necessary to
present fairly the information set forth therein when read in conjunction with
the Consolidated Financial Statements and Notes thereto. The operating results
for any quarter are not necessarily indicative of results for any future
period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------------------
DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30,
1995 1996 1996 1996 1996 1997 1997
-------- -------- -------- --------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Transaction revenues... $7,329 $ 9,160 $13,719 $13,970 $20,372 $24,419 $27,538
Interest, net of
interest expense...... 593 579 1,040 2,601 3,854 5,017 6,775
International.......... -- -- -- -- -- 2,000 2,000
Computer services and
other................. 506 710 787 601 797 765 723
------ ------- ------- ------- ------- ------- -------
Net revenues........... 8,428 10,449 15,546 17,172 25,023 32,201 37,036
------ ------- ------- ------- ------- ------- -------
Cost of services:
Cost of services....... 4,523 6,043 13,463 10,239 13,278 14,049 18,037
Registration charge.... -- -- -- -- -- -- 4,334
Self-clearing start-up
costs................. 166 469 1,209 396 -- -- --
------ ------- ------- ------- ------- ------- -------
Total cost of services. 4,689 6,512 14,672 10,635 13,278 14,049 22,371
------ ------- ------- ------- ------- ------- -------
Operating expenses:
Selling and marketing.. 1,127 2,391 2,231 1,851 3,128 7,805 5,299
Technology development. 253 359 711 1,469 1,567 1,438 1,430
General and
administrative........ 892 869 1,941 2,376 3,162 3,809 2,814
------ ------- ------- ------- ------- ------- -------
Total operating
expenses.............. 2,272 3,619 4,883 5,696 7,857 13,052 9,543
------ ------- ------- ------- ------- ------- -------
Total cost of services
and operating
expenses.............. 6,961 10,131 19,555 16,331 21,135 27,101 31,914
------ ------- ------- ------- ------- ------- -------
Pre-tax income (loss)... 1,467 318 (4,009) 841 3,888 5,100 5,122
Income tax expense
(benefit).............. 589 133 (1,612) 335 1,628 2,046 2,054
------ ------- ------- ------- ------- ------- -------
Net income (loss)....... $ 878 $ 185 $(2,397) $ 506 $ 2,260 $ 3,054 $ 3,068
====== ======= ======= ======= ======= ======= =======
<CAPTION>
AS A PERCENTAGE OF NET REVENUES
--------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Transaction revenues... 87.0% 87.7% 88.2% 81.4% 81.4% 75.8% 74.3%
Interest, net of
interest expense...... 7.0 5.5 6.7 15.1 15.4 15.6 18.3
International.......... -- -- -- -- -- 6.2 5.4
Computer services and
other................. 6.0 6.8 5.1 3.5 3.2 2.4 2.0
------ ------- ------- ------- ------- ------- -------
Net revenues........... 100.0 100.0 100.0 100.0 100.0 100.0 100.0
------ ------- ------- ------- ------- ------- -------
Cost of services:
Cost of services....... 53.6 57.8 86.6 59.6 53.1 43.6 48.7
Registration charge.... -- -- -- -- -- -- 11.7
Self-clearing start-up
costs................. 2.0 4.5 7.8 2.3 -- -- --
------ ------- ------- ------- ------- ------- -------
Total cost of services. 55.6 62.3 94.4 61.9 53.1 43.6 60.4
------ ------- ------- ------- ------- ------- -------
Operating expenses:
Selling and marketing.. 13.4 22.9 14.3 10.8 12.5 24.2 14.3
Technology development. 3.0 3.4 4.6 8.5 6.3 4.5 3.9
General and
administrative........ 10.6 8.3 12.5 13.9 12.6 11.8 7.6
------ ------- ------- ------- ------- ------- -------
Total operating
expenses.............. 27.0 34.6 31.4 33.2 31.4 40.5 25.8
------ ------- ------- ------- ------- ------- -------
Total cost of services
and operating
expenses.............. 82.6 96.9 125.8 95.1 84.5 84.1 86.2
------ ------- ------- ------- ------- ------- -------
Pre-tax income (loss)... 17.4 3.1 (25.8) 4.9 15.5 15.9 13.8
Income tax expense
(benefit).............. 7.0 1.3 (10.4) 2.0 6.5 6.4 5.5
------ ------- ------- ------- ------- ------- -------
Net income (loss)....... 10.4% 1.8% (15.4)% 2.9% 9.0% 9.5% 8.3%
====== ======= ======= ======= ======= ======= =======
</TABLE>
27
<PAGE>
The Company expects to experience significant fluctuations in future
quarterly operating results that may be caused by many factors, including the
following: the timing of introductions of enhancements to online financial
services and products by the Company or its competitors; market acceptance of
online financial services and products; the pace of development of the market
for online commerce; changes in transaction volume on the securities markets;
trends in the securities markets; domestic and international regulation of the
brokerage industry; changes in pricing policies by the Company or its
competitors; changes in strategy; the success of or costs associated with
acquisitions or other strategic relationships; changes in key personnel;
seasonal trends; the extent of international expansion; the mix of
international and domestic sales; changes in the level of operating expenses
to support projected growth; and general economic conditions. Due to the
foregoing factors, quarterly revenues and operating results are difficult to
forecast, and the Company believes that period-to-period comparisons of its
operating results will not necessarily be meaningful and should not be relied
upon as an indication of future performance. It is likely that the Company's
future quarterly operating results from time to time will not meet the
expectations of securities analysts or investors, which may have an adverse
effect on the market price of the Company's Common Stock. See "Risk Factors--
Significant Fluctuations in Quarterly Operating Results."
The securities industry is subject to extensive regulation under federal,
state and applicable international laws. As a result, the Company is required
to comply with many complex laws and rules and its ability to so comply is
dependent in large part upon the establishment and maintenance of a qualified
compliance system. The Company is aware of several instances of its non-
compliance with applicable regulations. See "Risk Factors--Government
Regulation."
LIQUIDITY AND CAPITAL RESOURCES
In August 1996, the Company completed an initial public offering of its
Common Stock, resulting in net proceeds to the Company of approximately $46.4
million. The Company also has financed its activities through cash provided by
operations, the private placement of Preferred Stock and, to a lesser extent,
equipment financing. In September 1995, the Company privately placed $12.3
million of convertible Preferred Stock, of which $3.8 million was used to
repurchase and retire outstanding Common Stock. In April and June 1996, the
Company sold convertible Preferred Stock for an aggregate of $11.8 million.
All of the Company's Preferred Stock converted to Common Stock upon the
completion of the Company's initial public offering.
In July 1996, the Company obtained $100 million in authorized financing, to
be collateralized by customer securities. At June 30, 1997, $51.9 million was
outstanding under these lines. In addition, the Company has entered into
numerous agreements with other broker-dealers to provide financing for the
Company's stock loan activities.
The Company currently anticipates that its available cash resources and
credit facilities will be sufficient to meet its presently anticipated working
capital and capital expenditure requirements for at least the next 12 months.
However, the Company may need to raise additional funds in order to support
more rapid expansion, develop new or enhanced services and products, respond
to competitive pressures, acquire complementary businesses or technologies or
take advantage of unanticipated opportunities. If additional funds are raised
through the issuance of equity securities, the percentage ownership of the
stockholders of the Company will be reduced, stockholders may experience
additional dilution in net book value per share or such equity securities may
have rights, preferences or privileges senior to those of the holders of the
Company's Common Stock. There can be no assurance that additional financing
will be available when needed on terms favorable to the Company, if at all. If
adequate funds are not available on acceptable terms, the Company may be
unable to develop or enhance its services and products, take advantage of
future opportunities or respond to competitive pressures, any of which could
have a material adverse effect on the Company's business, financial condition
and operating results.
Cash used in operating activities was $44.8 million for the nine months
ended June 30, 1997, compared to $4.1 million in the comparable period for
fiscal 1996. The increase in cash used in the fiscal 1997 period
28
<PAGE>
was primarily a result of increases in brokerage-related assets in excess of
related liabilities of $61.1 million arising from the self-clearing operations
begun subsequent to June 30, 1996, offset in part by net income during the
period. Cash provided by (used in) operating activities in fiscal 1996, 1995
and 1994 was ($7.8) million, $3.4 million and $891,000, respectively. Such
amounts reflect net income (loss) for the respective periods and, in fiscal
1996, the impact of self-clearing operations in the fourth quarter resulting
in an increase in brokerage-related assets in excess of related liabilities of
$7.3 million.
Cash used in investing activities was $4.8 million and $2.1 million for the
nine months ended June 30, 1997 and 1996, respectively, primarily as a result
of cash used for purchases of property and equipment and, in the fiscal 1997
period, a relocation loan to the Company's Chief Executive Officer (see Note 4
of Notes to Consolidated Financial Statements), partially offset by the net
sales and maturities of investment securities. Cash used in investing
activities was $45.8 million for fiscal 1996, primarily as a result of the
investment of the proceeds from the Company's initial public offering and the
Company's continued investment in technological infrastructure and the second
data center in Rancho Cordova. Cash used for investing activities in fiscal
1995 and 1994 of $1.7 million and $124,000 represent primarily equipment
purchases.
Cash provided by financing activities was $53.0 million for the nine months
ended June 30, 1997, primarily due to bank loans and proceeds from the
exercise of stock options, compared with $12.0 million for the comparable
period in fiscal 1996, arising principally from the sale of preferred stock.
Cash provided by financing activities was $58.6 million for fiscal 1996 due to
proceeds from the Company's initial public offering and private sales of
securities, offset by the repayment of long-term debt. Cash provided by (used
in) financing activities in fiscal 1995 and 1994 of $7.3 million and
($111,000) reflects net proceeds from the sale of securities, offset by
repurchases of common stock and repayment of obligations.
The Company expects that it will incur approximately $25.0 million of
capital expenditures for the 12 months ended June 30, 1998.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, whose effective date was delayed by SFAS No. 127. This new
standard provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities beginning in
fiscal 1998. The Company does not expect this standard to have a material
effect on its consolidated financial statements.
In February 1997, the FASB issued SFAS No. 128, Earnings per Share. The
Company is required to adopt SFAS No. 128 in the first quarter of fiscal 1998
and will restate at that time earnings per share ("EPS") data for prior
periods to conform with SFAS No. 128. Earlier application is not permitted.
SFAS No. 128 replaces current EPS reporting requirements and requires a dual
presentation of basic and diluted EPS. Basic EPS excludes dilution and is
computed by dividing net income by the weighted average number of common
shares outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. If SFAS No. 128 had been in effect
during the current and prior periods, basic EPS would have been $.28 and
$(.09) for the nine months ended June 30, 1997 and 1996, respectively. Diluted
EPS under SFAS No. 128 would not have been significantly different from fully
diluted EPS currently reported for the periods.
29
<PAGE>
BUSINESS
The following discussion of the Company's business contains forward-looking
statements which involve risks and uncertainties. The Company's actual results
may differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including, but not limited to,
those set forth under "Risk Factors" and elsewhere in this Prospectus.
OVERVIEW
E*TRADE Group, Inc. ("E*TRADE" or the "Company") is a leading provider of
online investing services and has established a popular, branded destination
Web site for self-directed investors. The Company offers automated order
placement and execution, along with a suite of products and services that can
be personalized, including portfolio tracking, Java-based charting and quote
applications, real-time market commentary and analysis, news and other
information services. The Company provides these services 24 hours a day,
seven days a week by means of the Internet, touch-tone telephone, online
service providers (America Online, AT&T WorldNet, CompuServe, Microsoft
Network and Prodigy) and direct modem access. E*TRADE's proprietary
transaction-enabling technology supports highly automated, easy-to-use and
cost-effective services that empower its customers to take greater control of
their investment decisions and financial transactions. Further, the Company
believes that its technology can be adapted to provide transaction-enabling
services related to other aspects of electronic commerce. See "--Strategic
Relationships."
As of June 30, 1997, the Company had over 182,000 accounts (with assets
under management in excess of $5.5 billion) representing a compounded annual
growth rate in new accounts of 127% since October 1, 1994. Average daily
transaction volumes were approximately 17,800 in June 1997, as compared to
approximately 8,000 transactions per day in June 1996. For the month ended
June 30, 1997, the Company opened an average of 680 new accounts per day with
average daily deposits of $13.5 million. The Company began offering online
investing services through the Internet in February 1996 and it is the
Company's most rapidly growing channel. Transactions over the Internet
represented 60% of the Company's June 1997 transaction volume.
E*TRADE's objective is to be a leading, branded provider of online investing
services through automation, innovation, technology, service and value. The
Company's strategy to accomplish this objective includes continued aggressive
marketing of its online investing services to further establish E*TRADE's
brand name recognition and increase its share of the online investing market
and continued broadening of its suite of value-added services that personalize
and enhance its customers' online investing experience. In addition, the
Company plans to leverage its E*TRADE brand equity and large customer base to
pursue additional related revenue opportunities, including advertising and
subscription-based revenue streams.
BACKGROUND
Advances in telecommunications and information technology have fundamentally
altered the way individuals conduct business. For example, the development of
the microprocessor and the personal computer revolutionized the way
individuals use computers by providing inexpensive and powerful capabilities
to them. Consumers have embraced the personal computer and expressed strong
preferences for the convenience and control it provides. In a similar fashion,
consumers also have begun using a variety of other electronic devices such as
the automatic teller machine ("ATM") and the facsimile machine, which are now
seen as valuable tools for expediting and controlling transactions and
eliminating human intermediaries.
Just as the microprocessor changed the use of computers, the emergence of
the Internet as a tool for communications and commerce is driving a revolution
in the world of financial transactions and information services. Consumers are
rapidly embracing the Internet because it is simple to access, makes vast
amounts of information available instantaneously, and allows individuals to
communicate with one another regardless of
30
<PAGE>
location. With the proliferation of personal computers and modems and the
development of easy-to-use Web browsers, use of the Internet grew to 49
million users worldwide by the end of 1996, according to International Data
Corporation, which estimates that the number will reach approximately 193
million by the end of 2000.
The Emergence of Electronic Commerce
The Internet and online services have provided organizations and individuals
with innovative ways of conducting business. With the emergence of the
Internet as a globally accessible, fully interactive and individually
addressable communications and computing medium, companies that have
traditionally conducted business in person, through the mail or over the
telephone are increasingly utilizing electronic commerce. Increased use of
credit cards, ATMs, the incidence of electronic funds transfers and online
banking and online bill payment has automated, simplified and reduced the
costs of financial transactions for consumers, businesses and financial
institutions. Consumers are showing strong preferences for transacting certain
types of business--such as paying bills, booking airline tickets, trading
securities, and purchasing consumer products such as personal computers, books
and cars--electronically, rather than in person or over the telephone. These
transactions are being streamlined through online commerce and can now be
performed directly by individuals virtually anywhere at any time. Consumers
have accepted and even welcomed self-directed online transactions because such
transactions can be faster, less expensive and more convenient than
transactions conducted through a human intermediary.
Development of Online Investing and Information Services
In the past, the individual investor could access the financial markets only
through a full-commission broker, who would give investment advice and place
trades. With the deregulation of brokerage commissions in 1975 and the
resulting unbundling of brokerage services, investors began to realize that
they could separate financial advisory services from securities trading. This
brought about the advent of the discount brokerage firm, which provided an
alternative investment approach by completing trades at a reduced cost.
With the emergence of electronic investing services, investors can further
unbundle the costs associated with the human interaction required by full-
commission and traditional discount brokerage firms. By requiring personnel to
handle each transaction, most traditional brokerage firms restrict their
customers' access to trading and information to the availability of the person
processing the transaction. In addition, although full-commission and discount
brokerage firms are able to offer electronic trading services, their continued
reliance on personnel, branch offices and the associated infrastructure for a
major part of their business prevents them from reducing their cost structure
to the lower level achievable through an all electronic model. As a result of
these factors, online investing accounts are gaining popularity and the
aggregate value of these accounts is expected to grow to $524 billion by the
year 2001, according to Forrester Research, Inc.
The Company believes that the ubiquity of ATMs, the presence of banks in
supermarkets, the proliferation of do-it-yourself financial transaction
software, the growth of discount brokerage firms and a variety of other
indicators evidence a shift in societal norms that is fundamentally altering
the way consumers manage their personal financial assets. The Company also
believes, based on customer feedback and the rapid acceptance by consumers of
online transactions, that consumers are increasingly taking direct control
over their personal financial affairs, not simply because they are able to do
so, but because they find it more convenient and less expensive than relying
on financial intermediaries. Investors want the flexibility to transact
business at times and places that are convenient for them. In addition, the
broad availability of financial information online has dramatically narrowed
the gap between the resources available to the individual investor and the
institutional investor. Individual investors have become increasingly
sophisticated and knowledgeable about investing, having experienced greater
access to stock quotes, company financial information, investment advice and
other investment information on the Web or through other online services. As
investors obtain even more access to investment information, the Company
believes they will desire greater control over their financial decisions and
seek alternative ways to invest more conveniently and
31
<PAGE>
cost-effectively and with less interaction with brokers and other financial
services professionals. The Company believes that this trend has created a
growing opportunity to provide online investing services that are easy to
access, easy to use, cost-effective and secure.
THE E*TRADE SOLUTION
E*TRADE uses its proprietary transaction-enabling technology to provide
consumers with easy-to-use and cost-effective online investing services,
including value-added financial information. E*TRADE's service is accessible
through multiple gateways: the Internet, touch-tone telephone, online service
providers and direct modem access. The Company offers order placement and
execution services 24 hours a day, seven days a week, thereby shifting the
financial transactions paradigm from a business hours only, intermediary-based
model to one in which consumers have the ultimate control over where and when
they initiate transactions.
The Company's services are highly automated, with most customer orders being
entered, processed and confirmed electronically and without human
intervention. By avoiding the inefficiencies and personnel requirements and
associated costs of non-automated order entry and processing, the Company is
able to provide its services at a lower cost than traditional full-commission
or discount brokerage firms. The Company's technology is based on a modular
architecture which is scalable to handle increasing transaction volumes and
allows for application programs to be quickly modified in response to changing
business requirements.
E*TRADE empowers its customers to take greater control of their investment
decisions and financial transactions through the following features:
. User-Friendly Trading Interfaces. Through its easy-to-use graphical
online and touch-tone telephone trading interfaces, E*TRADE has made
online investing simple, fast and fun. Consumers accessing E*TRADE for
the first time are able to understand quickly the wide variety of
services available and how to access those services, a feature the
Company believes has allowed it to broaden its customer base.
. Personalized Environments. Investors can customize their user interfaces
to select the market indicators, portfolio views and value-added
information services, including personalized watch lists, news, charts
and market analysis, that are most valuable to them based on their
individual investment objectives. The Company believes that offering
such services enables the investor to make more informed investment
decisions in a more timely and convenient manner.
. Broad Range of Internet Services. The Company continually strives to
increase the functionality of its services, as well as to offer new
services that enhance its customers' online experience. Through a series
of strategic alliances, the Company has begun offering electronic cash
management capabilities, including electronic funds transfer via the
Internet, market commentary and analysis, online investing services in
select international markets and Java-based charting and quote
applications.
. Anywhere, Any Time Access. By maintaining multiple gateways through
which customers may access E*TRADE virtually anywhere at any time, the
Company can increase the number of customers served and transactions
processed. Customers are able to trade securities through the Internet,
touch-tone telephone, online service providers (America Online, AT&T
WorldNet, CompuServe, Microsoft Network and Prodigy), and direct modem
access.
. Cost-effective Services. By unbundling the services that many full-
commission and discount brokerage firms include in their high
transaction costs, the Company, through its proprietary transaction-
enabling technology, is able to charge a lower price, yet provide value-
added products and services.
. Secure Operations. The Company believes that account security is one of
the key factors for success in the online brokerage industry. By
offering highly secure services through the use of encryption and
authentication technology, the Company has achieved a leadership
position in the secure provision of online brokerage services.
32
<PAGE>
STRATEGY
The Company's objective is to be a leading, branded provider of online
investing services. The key elements of the Company's strategy to accomplish
this objective include the following:
. Enhance E*TRADE Brand Awareness. The Company intends to further
establish E*TRADE's brand name recognition through aggressive public
relations and mass market advertising.
. Expand Customer Base. Through aggressive mass market advertising and
targeted direct response programs, the Company intends to raise consumer
awareness and generate new accounts to increase its share of the online
investing market. As of June 30, 1997, the Company had over 182,000
accounts representing a compounded annual growth rate of 187% since
October 1, 1994. Average daily transaction volumes were approximately
17,800 in June 1997, as compared to approximately 8,000 transactions per
day in June 1996. For the month ended June 30, 1997, the Company opened
an average of 680 new accounts per day with average daily deposits of
$13.5 million.
. Continue to Broaden Service Offerings. The Company continually strives
to increase the functionality of its services, as well as to offer new
services that enhance its customers' online experience and generate new
sources of revenue for the Company. For example, the Company currently
provides portfolio tracking and records management, market data and
access to delayed quotes through the Internet at no additional cost,
while real-time quotes can be obtained online for a small fee. In
addition, the Company has expanded its services to include immediate
access to news, market commentary and analysis, company financial
information and electronic funds transfer via the Internet. In addition,
the Company will be providing multi-lingual programs to reach specially
targeted communities. The Company also plans to adapt its proprietary
transaction-enabling technology to provide additional online investing
services, such as mutual fund trading and fixed income securities
trading. In addition, subject to regulatory approval, E*TRADE Securities
intends to raise public and private equity capital for companies over
the Internet and other electronic media.
. Develop New Revenue Streams. The Company plans to leverage its E*TRADE
brand equity and large customer base to pursue additional revenue
opportunities including advertising and subscription-based revenue
streams. Such services may include paid sponsorship opportunities on the
E*TRADE Web site and value-added financial products and services related
to portfolio management and asset allocation.
. Leverage Benefits of Highly Automated Operations. The Company's services
are highly automated, with most customer orders being entered, processed
and confirmed electronically and without human intervention. By avoiding
the inefficiencies, personnel requirements and associated costs of
non-automated order entry and processing, the Company is able to provide
its services at a lower cost than traditional full-commission and
discount brokerage firms. The Company continually seeks ways to automate
other aspects of its business, such as the customer new account
application, lead fulfillment cashiering and customer service functions.
In addition, the Company implemented self-clearing operations, which
further reduced the cost of providing its services to customers.
. Develop and Maintain Strategic Relationships. In order to enhance
accessibility of its services and provide new service offerings, the
Company has established strategic relationships with online service
providers (America Online, AT&T WorldNet, CompuServe, Microsoft Network
and Prodigy), whose subscribers are potential consumers for online
investing services, as well as a number of software and information
service providers. The Company believes that these relationships help
build E*TRADE's brand name recognition and customer base.
. Penetrate International Customer Base. E*TRADE recently entered into
licensing agreements with VERSUS in Canada and with Nova Pacific in
Australia and New Zealand to provide online investing services under the
E*TRADE name. In addition, the Company plans to create "localized" user
interfaces using local languages and offering services tailored to
regional regulatory requirements and customs.
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The Company's strategy involves substantial risks and uncertainties. There
can be no assurance that the Company will be successful in implementing its
strategy or that its strategy, even if implemented, will lead to successful
achievement of the Company's objectives. If the Company is unable to implement
its strategy effectively, the Company's business, financial condition and
operating results would be materially adversely affected. For a description of
certain risks relating to the Company's business strategy, see "Risk Factors."
SERVICES AND PRODUCTS
The Company's services are based on proprietary transaction-enabling
technology and are designed to serve the needs of self-directed investors. The
Company's services include fully automated stock and option order processing
via personal computer or touch-tone telephone, online investment portfolio
tracking and financial market news and information. The Company offers its
services to consumers through a broad range of electronic gateways, including
the Internet, touch-tone telephone, online service providers (America Online,
AT&T WorldNet, CompuServe, Microsoft Network and Prodigy), and direct modem
access. All records are maintained on one centralized system, so that
customers have access to current account information regardless of which
gateways they are using.
The Company continually strives to increase the functionality of its
services, as well as to offer new services that enhance customers' online
investing experiences. The Company's services give consumers increased control
of their personal investments by providing a direct link to the financial
markets and to financial information through a customized user interface. The
Company's existing services and product offerings are described below:
Stock and Options Trading
Customers can directly place orders to buy and sell Nasdaq and exchange-
listed securities, as well as equity and index options, through the E*TRADE
automated order processing system. E*TRADE supports a range of order types,
including market orders, limit orders (good-till-cancelled or day), stop
orders and short sales. System intelligence automatically checks the
parameters of an order, together with the customer's buying power and
positions held, prior to executing an order. All listed market orders (subject
to certain size limitations) are executed at the National Best Bid/Offer
("NBBO") or better at the time of receipt by the third market firm or
exchange. The NBBO is a dynamically updated representation of the combined
highest bid and lowest offer quoted across all United States stock exchanges
and market makers registered in a specific stock. Eligible orders are exposed
to the marketplace for possible price improvement, but in no case are orders
executed at a price inferior to the NBBO. Limit orders are executed based on
an indicated price and time priority. All Nasdaq market orders (subject to
certain size limitations) are executed at the Best Bid/Offer (Inside Market)
or better at the time of receipt by the market-maker. All transaction and
portfolio records are automatically updated to reflect trading activity. Buy
and sell orders placed when the markets are closed are automatically submitted
prior to the next day's market opening. Account holders receive electronic
notification of order executions, printed trade confirmations and detailed
monthly statements. The Company also arranges for the transmittal of proxy,
annual report and tender offer materials to customers.
Market Data and Financial Information
During trading hours, E*TRADE continually receives a direct feed of detailed
quote data, market information and news. Customers can create their own
personal lists of stocks and options for quick access to current pricing
information. E*TRADE provides its customers free access 20-minute delayed
quotes, including stocks, options, major market indices, most active issues,
and largest gainers and losers for the major exchanges. Users are alerted when
there is current news on an identified stock or when a stock has reached a
user-defined price threshold. Through its alliances, the Company has expanded
its services to include immediate access to breaking news, charts, market
commentary and analysis and company financial information.
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Upon placing an order, the customer is provided with a real-time bid and ask
quote, at no extra charge. For $30 per month, individual investors can obtain
unlimited real-time quotes and market data. The Company's Web site provides
links to other business and financial Web sites, including the CNN Financial
Network and the EDGAR database, which provides access to SEC filings of public
companies.
Portfolio Tracking and Records Management
Customers have online access to a listing of all their portfolio assets held
at E*TRADE, including data on the date of purchase, cost basis, current price
and current market value. The system automatically calculates unrealized
profits and losses for each asset held. Detailed account balance and
transaction information includes cash and money fund balances, buying power,
net market portfolio value, dividends paid, interest earned, deposits and
withdrawals. Brokerage history includes all orders, changes and cancellations.
Tax records include total short-term or long-term gain/loss and commissions
paid. Customers can also create "shadow" portfolios to include any number of
financial instruments a customer is interested in tracking--for example,
assets held at another brokerage firm. These shadow portfolios can include
stocks, options, bonds and mutual funds.
Cash Management Services
Customer payments are received through the mail or federal wire system and
are credited to customer accounts upon receipt. The Company also provides
other cash management services to its customers. For example, uninvested funds
earn interest in a credit interest program or can be invested in one of five
money market funds. In addition, the Company provides free checking services
through a commercial bank and is exploring the expansion of these services.
The Company, through its strategic relationship with National Processing
Company, has expanded its cash management offerings to include electronic
funds transfer via the Internet and an automatic deposit program to allow
scheduled periodic transfers of funds into customers' accounts.
Account Security
The Company uses a combination of proprietary and industry standard security
measures to protect customers' assets. Customers are assigned unique account
numbers, user identifications and passwords that must be used each time they
log on to the system. The Company relies on encryption and authentication
technology, including public key cryptography technology licensed from RSA
Data Security, Inc. ("RSA"), to provide the security and authentication
necessary to effect the secure exchange of information. In addition the
Company uses Secure Socket Layers ("SSL") technology for data encryption.
Telephone transactions are secured through a personal identification number
(PIN)--the same technology used in ATMs. A second level of password protection
is used prior to order placement. In addition, the Company has an agreement to
provide digital certification and authentication services for electronic
commerce through its alliance with VeriSign, Inc.
Access and Delivery of Services
The Company's services are widely accessible through multiple gateways, with
automated order placement available 24 hours a day, seven days a week by
personal computer. In addition, customers can access E*TRADE by touch-tone
telephone and, in a limited number of markets, through interactive television.
Personal Computer. Customers using personal computers can access the
E*TRADE system through the Internet, online service providers (America
Online, AT&T WorldNet, CompuServe, Microsoft Network and Prodigy), or
direct modem access. The Company's Web site combines an easy-to-use
graphical user interface with the trading capabilities that experienced
investors demand. The Web-based system also includes direct links to many
investment-related resources on the Web. Alternatively, accessing E*TRADE
by dialing directly through a modem offers a method for connecting to the
trading system independent of either the Internet or a proprietary online
service.
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Touch-tone Telephone. TELE*MASTER, E*TRADE's interactive voice response
system, provides a convenient way for customers to access quote
information, place stock and option orders, review account balances and
check messages from any touch-tone telephone.
Interactive Television. GTE MainStreet, an interactive television system
operated by GTE Corporation, is available as a gateway to the Company's
investing services. Revenues and transaction volume through GTE MainStreet
represent an immaterial portion of the Company's business.
Substantially all of the Company's revenues in recent years have been from
online investing services, and the Company expects its online investing
services to continue to account for substantially all of its revenues for the
foreseeable future. E*TRADE, like other securities firms, is directly affected
by national and international economic and political conditions, broad trends
in business and finance and substantial fluctuations in volume and price
levels of securities and futures transactions. Severe market fluctuations in
the future could have a material adverse effect on the Company's business,
financial condition and operating results. Certain of the Company's
competitors with more diverse product and service offerings may be better
positioned to withstand such a downturn in the securities industry.
The market for online investing services, particularly over the Internet, is
at an early stage of development and is rapidly evolving. As is typical for
new and rapidly evolving industries, demand and market acceptance for recently
introduced services and products are subject to a high level of uncertainty.
Sales of many of the Company's services and products will depend upon the
adoption of the Internet by consumers as a widely used medium for commerce and
communication. The Internet may not prove to be a viable commercial
marketplace because of inadequate development of the necessary infrastructure.
Moreover, the security and privacy concerns of existing and potential users of
the Company's services may inhibit the growth of online commerce. If the
necessary infrastructure is not developed, if security and privacy concerns
inhibit the growth of online commerce, or if the Internet does not otherwise
become a viable commercial marketplace, there would be a material adverse
effect on the Company's business, financial condition and operating results.
E*TRADE TRANSACTION-ENABLING TECHNOLOGY
The E*TRADE engine is a proprietary transaction-enabling technology that
automates traditionally labor-intensive transactions. Because it was custom-
tailored for electronic marketplace use, the E*TRADE engine provides customers
with efficient service and has the added advantage of being scalable and
adaptable as usage increases and service offerings are expanded. Beyond these
features, the multi-tiered design of the E*TRADE engine and related software
allows for rapid expansion of network and computing capacity without
interrupting service or requiring replacement of existing hardware or
software.
The E*TRADE Engine
The E*TRADE transaction-enabling technology engine includes a wide variety
of functions and services that allow customers to open and monitor investment
accounts and to place orders for equity and options transactions. E*TRADE's
core technology allows for standardized processing across multiple gateways.
The primary components include a graphical user interface, the interface
server that connects the customer to the processor, and the automated
transaction processor.
Graphical User Interface ("GUI"). E*TRADE's GUI environment is based on
Netscape's Secure Enterprise Server and today can be accessed by
individuals utilizing Netscape Navigator or Microsoft Internet Explorer.
E*TRADE's GUI connects to the interface server through a bank of Sun
servers. These "gateway servers" provide for load balancing and offer
immediate scalability. Access is restricted through the use of secured
network servers and routers.
The Interface Server. The interface server's primary function is to provide
access to an efficient, standard transaction processor from all gateways.
The server technology enables communications through
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multiple platforms and allows different platforms to communicate with each
other. Beyond these features, the interface server also has been designed
to be scalable and portable and runs in an environment that is both
redundant and secure.
The Automated Processor. The core of the E*TRADE engine is the automated
processor, designed to provide the highest degree of automation for all
E*TRADE transactions. The automated processor was designed to rapidly read
data, process transactions and transmit information to multiple locations.
Because of this, the Company processes over 85% of its transactions without
any manual intervention. Dual facilities that run independently share load
balancing and provide redundancy and backup, as well as scalability. The
proprietary nature of the system, along with user ID and password
protection at the application level, provide security for the automated
processor. Internet access to the processor is through the Company's Web
site, which restricts access through the use of secured network servers and
routers.
The Company maintains an internal development staff to continually enhance
its software and develop new services and transactions. The Company's software
is designed to be versatile and adaptable, so that the E*TRADE engine can be
configured to meet the differing demands of strategic relationships or
customer requests.
The Company established a second data center in Rancho Cordova, California
in July 1996. This facility supports systems, network, trading, customer
service and transaction redundancy and backup between the Company's Palo Alto
and Rancho Cordova data centers, thereby providing business resumption
capability in the event of a service interruption at either facility. To
provide for system continuity during short outages, the Company also has
equipped its computer facilities with uninterruptible power supply units as
well as back-up generators.
The information and financial services and communications industries are
characterized by rapid technological change, changes in customer requirements,
frequent new service and product introductions and enhancements, and emerging
industry standards. The introduction of services or products embodying new
technologies and the emergence of new industry standards and practices can
render existing services or products obsolete and unmarketable. The Company's
future success will depend, in part, on its ability to develop leading
technologies, enhance its existing services and products, develop new services
and products that address the increasingly sophisticated and varied needs of
its prospective customers, and respond to technological advances and emerging
industry standards and practices on a timely and cost-effective basis. There
can be no assurance that the Company will be able, for technical or other
reasons, to develop and introduce new services and products or enhance
existing services and products in a timely manner in response to changing
market conditions or customer requirements, or that new services and products
will achieve market acceptance, the failure of any of which could result in a
material adverse effect on the Company's business, financial condition and
operating results.
A significant risk to online commerce and communication is the insecure
transmission of confidential information over public networks. The Company
relies on encryption and authentication technology, including public key
cryptography technology licensed from RSA, to provide the security and
authentication necessary to effect secure transmission of confidential
information. There can be no assurance that advances in computer capabilities,
new discoveries in the field of cryptography or other events or developments
will not result in a compromise or breach of the RSA or other algorithms used
by the Company to protect customer transaction data. If any such compromise of
the Company's security were to occur, it could have a material adverse effect
on the Company's business, financial condition and operating results.
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STRATEGIC RELATIONSHIPS
The Company pursues strategic relationships to increase its access to online
consumers, to build brand name recognition and to expand the products and
services the Company can provide to its online customers.
Core Business Expansion
E*TRADE has secured or is actively pursuing alliances with (i) Internet
access and service providers, (ii) Internet content providers, (iii) providers
of home and online banking services, and (iv) electronic commerce companies.
These alliances are intended to increase the Company's core customer base,
transaction volume and operational efficiency and to further enhance its brand
name recognition.
To date, the Company has concentrated principally on securing alliances with
online service providers. While a majority of the Company's customers access
its services directly through the Internet, direct modem access or touch-tone
telephone, many use online service providers (America Online, AT&T WorldNet
CompuServe, Microsoft Network and Prodigy). Strategic relationships with such
service providers allow the Company to access a greater number of potential
customers and allow the online service providers to offer their subscribers a
broader range of service options.
New Account Development and Distribution
The Company has developed alliances with key channels in the online medium
to increase account development and expand distribution. These channels
include proprietary online services, internet service providers and popular
destination Web sites such as search engines or financial content providers.
These channels attract significant numbers of users, and the Company's
relationships provide access to expanded market opportunities. Set forth below
are descriptions of certain of the Company's key alliances:
America Online. America Online, Inc. and the Company have had a
business relationship for over seven years. In October 1996, the
Company signed a non-exclusive agreement with America Online to place
E*TRADE in America Online's new online Brokerage Area, giving America
Online's approximately 8 million subscribers access to E*TRADE's Web
site.
AT&T Corp.. The Company entered into an agreement with AT&T Corp. which
allows E*TRADE's customers to link directly to the AT&T WorldNetSM
Service download site to sign up for the AT&T WorldNetSM Service
((C)1997 AT&T Corp. all rights reserved). AT&T WorldNetSM is a service
mark of AT&T Corp.
CompuServe. CompuServe Incorporated and the Company have had a non-
exclusive contractual relationship for over ten years. Initially,
CompuServe served as an access point for the Company's service bureau
business. The Company's current agreement with CompuServe permits the
approximately 5.3 million CompuServe customers to open online investing
accounts with E*TRADE and access those accounts either through
CompuServe or via the Company's TELE*MASTER service. The Company pays
CompuServe a fee for these transactions.
Erol's Internet Services. The Company has signed a letter of intent for
a strategic alliance with Erol's Internet Services which will offer
Erol's approximately 300,000 customers direct access to E*TRADE's
products and services.
Intuit. The Company has signed a letter of intent for a strategic
relationship with Quicken Investment Services, Inc., a subsidiary of
Intuit, Inc., to develop a means by which users of Intuit's Quicken
financial management software will be able to download information from
E*TRADE to the Quicken software resident on the user's personal
computer using the Open Financial Exchange ("OFX") standard format. In
addition, it is intended that these same users will be able to link to
E*TRADE for the purpose of entering orders via their E*TRADE accounts.
There can be no assurance that the Company will reach a definitive
agreement with Intuit on terms favorable to the Company, or at all.
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Microsoft. The Company has entered into an alliance with Microsoft
Corporation to integrate E*TRADE's online investing services into the
Microsoft Investor online trading area of Microsoft Network. E*TRADE
will support the OFX standard allowing customers to download
information from their E*TRADE account into Microsoft Money and
Microsoft Investor.
Prodigy Services Corporation. Prodigy Services Corporation, a
subsidiary of Prodigy, Inc., and the Company announced a non-exclusive
agreement in July 1997 to offer Prodigy's members direct access to
E*TRADE's products and services.
USA Today. The Company has entered into an agreement with USA Today
Information Network to provide direct access to E*TRADE's services
through USA Today Online's Web site, a commercial area that includes
personal finance services and products.
Yahoo! The Company has entered into an agreement with Yahoo! that
provides direct access for Web visitors between Yahoo! Finance and
E*TRADE's Web site.
In addition, the Company has established relationships with the following:
The Fourth Communication Network, Inc. (a provider of high-speed Internet
access and video services in hotels), Data Broadcasting Corporation (a
provider of financial information to individual investors) and Windows on
Wallstreet.
Content
Content such as news, quotes, charts and fundamental data help provide
investors with the information necessary to make investment decisions. The
Company believes that real-time information services facilitate new ideas and
increase transaction volume. The Company's partnerships with leading content
providers fulfill customers' information needs and help drive transaction
volume.
BASELINE Financial Services. BASELINE Financial Services provides
customers with access to a wide array of investment fundamentals, First
Call earnings estimates and historical prices on over 6,500 stocks.
Available to customers free of charge from the "Investor Resources"
area of the E*TRADE Web site, BASELINE information can be used to
examine a company's statistics prior to making investment decisions.
Briefing.com. Briefing.com, a service of Charter Media, Inc. provides
free of charge market commentary and analysis to E*TRADE customers.
Updates are posted throughout the day to keep investors informed of
important developments affecting the markets.
CyberCash. The Company has a strategic relationship with CyberCash,
Inc. ("CyberCash"), which provides E*TRADE customers access to a
library of current news and investment publications, as well as the
latest technology for making purchases on the Internet. In addition,
E*TRADE's customers will be able to download a personal CyberCash
wallet from E*TRADE's Web site.
INVESTools. The Company has entered into a revenue sharing agreement
with INVESTools which provides E*TRADE customers with direct access to
25 brand-name research reports and newsletters plus stock screening
tools on a pay-per-use basis.
Quote.com. Quote.com, Inc. provides current news and charting
capabilities that are directly linked to E*TRADE customers' stock watch
and quote lookup features. News provided includes Reuters News, PR
Newswire and BusinessWire. Charts provided include intra-day, daily and
weekly price graphs. These services were integrated into E*TRADE's Web
site and are free to E*TRADE customers. Quote.com also has entered into
an agreement with the Company to provide a direct link to E*TRADE's
services from its trading menu on its own Internet Web site.
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International
The Company's expansion into new markets is being enhanced by alliances with
companies in key international markets. These alliances enable the Company to
capitalize on these relationships, by providing market knowledge, contacts and
local understanding. The Company believes that these alliances can accelerate
worldwide acceptance of the Company's online investing services.
Nova Pacific Capital. The Company has formed an alliance with Nova
Pacific Capital Limited, a Sydney, Australia-based financial and
technology development company, to provide online investing to
customers with addresses in Australia and New Zealand under the E*TRADE
name.
VERSUS Technologies, Inc. The Company has entered into an alliance with
VERSUS Technologies, Inc., a Canadian supplier of electronic trading,
to provide online investing services to Canadian residents.
Product Enhancement
The Company believes that technology is a key component in maintaining
market leadership in the Internet arena. Partnerships with leading technology
providers support the Company's products and services with up-to-date features
and offer the best solutions for customers.
National Processing Company. The Company has an agreement with National
Processing Company to provide E*TRADE's customers the ability to
initiate funds transfers from checking accounts at third-party
institutions into their E*TRADE accounts over the Internet. This
service is available to E*TRADE customers free of charge.
Neural. In February 1997, the Company entered into an exclusive
agreement with Neural Applications Corporation ("Neural") that allows
Neural's Java-based intelligent process optimization solutions and data
management systems to be incorporated into the Company's Java-based
chating and quote applications.
Telesphere. The Company has an agreement with Telesphere Corporation, a
leading global securities information firm, by which Telesphere
provides the Company with real-time market data on international
securities, in addition to data on United States securities.
VeriSign. The Company has entered into an alliance with VeriSign Inc.,
a leading provider of digital certification services for electronic
commerce. VeriSign's Digital IDs enhance electronic commerce by
authenticating the individuals, organizations and content involved in
an electronic transaction. Through this alliance, the Company believes
that it will provide its customers with the most technologically
advanced level of security for Internet investing and highly simplified
Web site access.
MARKETING
The Company's marketing strategy is based on an integrated marketing model
which employs a mix of communications media. The goals of the Company's
marketing programs are to increase E*TRADE's brand name recognition and to
attract new customers. The Company pursues these goals through advertising,
marketing on its own Web site and other online opportunities, direct one-on-
one marketing, aggressive public relations, and co-marketing programs. All
communications by E*TRADE Securities with the public are regulated by the
NASD. See "--Government Regulation; Net Capital Requirements."
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Direct Response Advertising; Web Site Marketing
The Company's advertising focuses on building awareness of E*TRADE's brand,
products and services and on marketing online investing as a better way of
handling their securities transactions, accessing financial and market data,
and managing portfolios. Advertising is increasingly directing interested
prospects to the Company's Web site for additional information, as opposed to
generating primarily telephone-based inquiries. Print advertisements are
placed in a broad range of business, technology and financial publications,
including Barron's, Forbes, Forbes ASAP, Investor's Business Daily, Money,
Smart Money, the Wall Street Journal and Wired. E*TRADE also advertises
regularly on financial cable networks, national television networks and on
national business radio networks. Through the Web site, prospective customers
can get detailed information on the Company's services, use an interactive
demonstration system, request additional information and complete an account
application online. Since May 1, 1996, a majority of the Company's new
accounts have been generated through the Internet. E*TRADE's increasing
Internet focus is resulting in decreased customer acquisition costs, since
providing information through its Web site can substitute for paper-based
information packages.
Public Relations Program
The Company aggressively pursues public relations opportunities to build
brand awareness. This campaign has resulted in appearances on CNBC, CNN and
The Today Show, in addition to profiles in Barron's, Business Week, the
Financial Times, Investor's Business Daily, Money, Smart Money, Time and the
Wall Street Journal among others. There are links to E*TRADE's Web site from
approximately 1,200 sites on the Web, which the Company believes is a
significant factor in increasing brand awareness and generating leads, as
consumers increasingly look to the Internet as a key source of information and
commercial activity. The Company also actively seeks speaking opportunities at
industry conferences and events.
Co-marketing/Promotion
The Company has established a number of significant co-marketing
relationships to promote its products. These include participation in
Netscape's in-box promotional offer for the Netscape Navigator browser
available through retail outlets, distribution of new account kits with Window
on Wallstreet's Investor software products, inclusion in Apple Computer's in-
store interactive demonstrations and links with a number of Web-based
information providers. The Company intends to enter into additional co-
marketing relationships as a component of its marketing strategy.
E*TRADE is also developing a virtual shopping mall of software, services and
products that will help individuals make informed investment decisions.
Through E*TRADE's Web site, customers would be able to purchase or subscribe
to products available from this mall at special discount prices. Goods and
services offered would be reviewed and selected for inclusion by E*TRADE based
on overall perceived "best value" within specified product categories.
Companies selected for inclusion in return would promote E*TRADE's services
through their Web sites and/or marketing materials. There can be no assurance
that the Company will succeed in developing a virtual shopping mall or that,
if developed, it will be successful or profitable.
CUSTOMER SERVICE
The Company believes that providing an effective customer service team to
handle customer needs is critical to its success. The Company's customer
service organization helps customers get online, handles product and service
inquiries and addresses all brokerage and technical questions. The customer
service team also makes welcome calls to verify the satisfaction of its
customers. The Company's customers have access to a toll-free number from 5:00
a.m. to 9:00 p.m. Pacific time, Monday through Friday. The Company's current
policy specifies that customer service associates have or obtain a securities
broker's license.
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The Company's customer service capacity has been and may continue to be
strained at times. The Company has been making and is continuing to make
significant investments in technology and personnel to improve response times.
The Company's continued focus on customer independence and technology has
successfully resulted in fewer inquiries to E*TRADE personnel per transaction.
However, there can be no assurance that the Company will be able to
consistently provide enough service capacity, and the failure to do so could
have a material adverse effect on the Company's business, financial condition
and operating results.
OPERATIONS
Clearing
The Company implemented equity self-clearing operations in July 1996 and
options self-clearing operations in April 1997. Clearing operations include
the confirmation, receipt, settlement, custody and delivery functions involved
in securities transactions. Performing its own clearing operations allows
E*TRADE Securities to retain customer free credit balances and securities for
use in margin lending activities subject to SEC and NASD rules. The Company
has entered into a seven-year agreement with Beta Systems for the provision of
computer services by Beta Systems to support order entry, order routing,
securities processing, customer statements, tax reporting, regulatory
reporting, and other services necessary to the management of a brokerage
clearing business.
Since the Company's conversion to self-clearing, customers' securities
typically are held by the Company in nominee name on deposit at one or more of
the recognized securities industry depository trust companies, to facilitate
ready transferability. The Company collects dividends and interest on
securities held in nominee name and makes the appropriate credits to customer
accounts. The Company also facilitates exercise of subscription rights on
securities held for its customers. The Company arranges for the transmittal of
proxy, annual report and tender offer materials to customers. E*TRADE
Securities relies upon certificate counts and microfilming procedures as
deterrents to theft of securities and, as required by the NASD and certain
other regulatory authorities, carries fidelity bonds covering loss or theft.
Self-clearing, especially where conducted by firms such as the Company,
without significant prior experience, involves substantial risks. The failure
of the Company to perform self-clearing accurately and cost-effectively could
have a material adverse effect on the Company's business, financial condition
and operating results.
Lending and Borrowing Activities
Margin Lending. The Company makes loans to customers collateralized by
customer securities. Margin lending by the Company is subject to the margin
rules of the Board of Governors of the Federal Reserve System, NASD margin
requirements and the Company's internal policies, which are more stringent
than the Federal Reserve and NASD requirements. In permitting customers to
purchase securities on margin, the Company takes the risk of a market decline
that could reduce the value of the collateral held by the Company to below the
customers' indebtedness before the collateral can be sold, which could result
in losses to the Company. Under applicable NASD rules, in the event of a
decline in the market value of the securities in a margin account, the Company
is obligated to require the customer to deposit additional securities or cash
in the account so that at all times the customer's equity in the account is at
least 25% of the value of the securities in the account. E*TRADE's current
internal requirement, however, is that the customer's equity not fall below
30%. If it does, the customer will be required to increase the account's
equity to 40%. Margin lending to customers constitutes the major portion of
the basis on which net capital requirements of the Company are determined
under the SEC's Net Capital Rule. To the extent these activities expand, the
Company's net capital requirements will increase.
Securities Lending and Borrowing. The Company borrows securities both to
cover short sales and to complete customer transactions in the event a
customer fails to deliver securities by the required settlement date. The
Company collateralizes such borrowings by depositing cash or securities with
the lender and
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receives a rebate (in the case of cash collateral) or pays a fee calculated to
yield a negotiated rate of return. When lending securities, the Company
receives cash or securities and generally pays a rebate (in the case of cash
collateral) to the other party in the transaction. Securities lending and
borrowing transactions are executed pursuant to written agreements with
counterparties that require that the securities borrowed be "marked to market"
on a daily basis and that excess collateral be refunded or that additional
collateral be furnished in the event of changes in the market value of the
securities. The securities usually are "marked to market" on a daily basis
through the facilities of the various national clearing organizations.
Order Processing
All listed market orders other than those with special qualifiers (subject
to certain size limitations based on the size in the primary market) are
executed at the National Best Bid/Offer ("NBBO") or better at the time of
receipt by the third market firm or exchange. Eligible orders are exposed to
the marketplace for possible price improvement, but in no case are orders
executed at a price inferior to the NBBO. Limit orders are executed based on
an indicated price and time priority. All Nasdaq market orders (subject to
certain size limitations based on the trading characteristics of the
particular security) are executed at the Best Bid/Offer (Inside Market), or
better at the time of receipt by the market-maker. Eligible orders are subject
to possible price improvement in the marketplace.
The Company receives orders principally through the Internet, online
services and touch-tone telephone. This method of trading is heavily dependent
on the integrity of the electronic systems supporting it. Heavy stress placed
on the Company's systems during peak trading times could cause the Company's
systems to operate at an unacceptably low speed or fail. Any significant
degradation or failure of the Company's systems or any other systems in the
trading process (e.g., online service providers, record keeping and data
processing functions performed by third parties and third-party software such
as Internet browsers), even for a short time, could cause customers to suffer
delays in trading. Such delays could cause substantial losses for customers
and could subject the Company to claims from customers for such losses,
including litigation claiming fraud or negligence.
The Company has experienced such system failures and degradation in the past
and could experience future system failures and degradations. In order to
promote customer satisfaction and protect the E*TRADE brand name, the Company
compensated customers for verifiable losses arising in connection with such
systems failures. The Company recorded a pre-tax charge against earnings in
excess of $1.7 million in connection with two such systems failures in May
1996. Since May 1996, the Company has experienced occasional system
interruptions. Any systems failure that causes interruptions in the Company's
operations could have a material adverse effect on the Company's business,
financial condition and operating results.
The Company relies on a number of third parties to process its transactions,
including online and Internet service providers, back office processing
organizations, service providers and market makers, all of which may need to
expand the scope of the operations they perform for the Company. Any backlog
caused by a third party's inability to expand at the rate necessary to meet
the Company's needs or a loss in the availability of these services and the
inability of the Company to make alternative arrangements in a timely manner,
if at all, could have a material adverse effect on the Company's business,
financial condition and operating results.
COMPETITION
The market for online investing services, particularly over the Internet, is
new, rapidly evolving and intensely competitive, and the Company expects
competition to continue to intensify in the future. E*TRADE encounters direct
competition from discount brokerage firms providing either touch-tone
telephone or online investing services, or both. These competitors include
Charles Schwab & Co., Inc. and Fidelity Brokerage Services, Inc., among
others. The Company also encounters competition from established full-
commission brokerage firms, such as Merrill Lynch, Pierce, Fenner & Smith
Incorporated and PaineWebber Incorporated, among others. In addition, the
Company competes with financial institutions, mutual fund sponsors and other
organizations, some of which provide online investing services.
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The Company believes that the principal competitive factors affecting the
market for its transaction-enabling services are cost, service, quality,
execution, delivery platform capabilities, ease of use, graphical user
interface look and feel, depth and breadth of services and content, financial
strength and innovation. Based on research conducted with both customer and
non-customer focus groups and the success the Company has enjoyed, the Company
believes that it presently competes favorably with respect to each of these
factors.
Many of the Company's competitors have longer operating histories and
significantly greater financial, technical, marketing and other resources than
the Company. Many current and potential competitors also have greater name
recognition and more extensive customer bases that could be leveraged, thereby
gaining market share to the Company's detriment. Additionally, it is possible
that new competitors or alliances among competitors may emerge and rapidly
acquire significant market share.
The general financial success of companies within the securities industry
over the past several years has strengthened existing competitors. Management
believes that such success will continue to attract new competitors to the
securities industry such as banks, software development companies, insurance
companies, providers of online financial and information services and others,
as such companies expand their product lines. The current trend toward
consolidation in the commercial banking industry could further increase
competition in all aspects of the Company's business. While it is not possible
to predict the type and extent of competitive services that commercial banks
and other financial institutions ultimately may offer or whether
administrative or legislative barriers will be repealed or modified, firms
such as the Company may be adversely affected by such competition or
legislation. In addition, competition among financial services firms exists
for experienced technical and other personnel.
There can be no assurance that the Company will be able to compete
effectively with current or future competitors or that the competitive
pressures faced by the Company will not have a material adverse effect on the
Company's business, financial condition and operating results. See "Risk
Factors--Substantial Competition."
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company's success and ability to compete are dependent to a significant
degree on its proprietary technology. The Company relies primarily on
copyright, trade secret and trademark law to protect its technology. The
Company has no patents. Effective trademark protection may not be available
for the Company's trademarks. The Company has registered the trademark
"E*TRADE" in the United States and certain other countries, and has certain
other registered trademarks. The inability of the Company to adequately
protect the name "E*TRADE" would have a material adverse effect on the
Company's business, financial condition and operating results.
The source code for the Company's proprietary software is protected both as
a trade secret and as a copyrighted work. The Company's policy is to enter
into confidentiality and assignment agreements with its associates,
consultants and vendors and generally to control access to, and distribution
of, its software, documentation and other proprietary information.
Notwithstanding the precautions taken by the Company, it may be possible for a
third party to copy or otherwise obtain and use the Company's software or
other proprietary information without authorization or to develop similar
software independently. The laws of other countries may afford the Company
little or no effective protection of its intellectual property. The inability
of the Company to protect its intellectual property rights could have a
material adverse effect on the Company's business, financial condition and
operating results.
The Company may in the future receive notices of claims of infringement of
other parties' proprietary rights. Any such claims, with or without merit,
could be time consuming to defend, result in costly litigation, divert
management's attention and resources or require the Company to enter into
royalty or licensing agreements. There can be no assurance that such licenses
would be available on reasonable terms, if at all, and the assertion or
prosecution of any such claims could have a material adverse effect on the
Company's business, financial condition and operating results.
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GOVERNMENT REGULATION; NET CAPITAL REQUIREMENTS
Securities Industry
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. The SEC is the federal agency
responsible for the administration of the federal securities laws. E*TRADE
Securities is registered as a broker-dealer with the SEC. Much of the
regulation of broker-dealers has been delegated to self-regulatory
organizations, principally the NASD, which has been designated by the SEC as
E*TRADE Securities' primary regulator. These self-regulatory organizations
adopt rules (subject to approval by the SEC) that govern the industry and
conduct periodic examinations of E*TRADE Securities' operations. Securities
firms are also subject to regulation by state securities administrators in
those states in which they conduct business. E*TRADE Securities is registered
as a broker-dealer in all 50 states and the District of Columbia.
The Company is aware of several instances of its non-compliance with
applicable regulations. In particular, the Company failed to comply with
applicable advertising restrictions in one international jurisdiction, and due
to a clerical oversight failed to renew its registration as a broker-dealer in
two states, Nebraska and Ohio. One of the states, Ohio, as a condition of
renewing the Company's license as a broker-dealer in that state, required the
Company to offer customers resident in that state the ability to rescind (for
up to 30 days) certain securities transactions effected through the Company
during the period January 1, 1997 through April 15, 1997, the date the
Company's license was renewed. For the nine months ended June 30, 1997, the
Company recorded a $4.3 million pre-tax charge against earnings in connection
with this matter.
Broker-dealers are subject to regulations covering all aspects of the
securities business, including sales methods, trade practices among broker-
dealers, use and safekeeping of customers' funds and securities, capital
structure, record keeping and the conduct of directors, officers and
employees. The Company is required to comply with many complex laws and rules,
including rules relating to possession and control of customer funds and
securities, margin lending and execution and settlement of transactions.
Additional legislation, changes in rules promulgated by the SEC, the NASD, the
Board of Governors of the Federal Reserve System, the various stock exchanges,
and other self-regulatory organizations, or changes in the interpretation or
enforcement of existing laws and rules, may directly affect the mode of
operation and profitability of broker-dealers. The SEC, the NASD or other
self-regulatory organizations and state securities commissions may conduct
administrative proceedings, which can result in censure, fine, the issuance of
cease-and-desist orders or the suspension or expulsion of a broker-dealer or
any of its officers or employees. The Company's ability to comply with all
applicable laws and rules is dependent in large part upon the maintenance of a
compliance system reasonably designed to ensure such compliance. The principal
purpose of regulation and discipline of broker-dealers is the protection of
customers and the securities markets, rather than protection of creditors and
shareholders of broker-dealers. In addition, because the use of the Internet
to provide online investing services is relatively new, regulatory standards
are evolving. As a result, the Company may, in the future, become subject to
additional regulation in the United States and in international jurisdictions.
E*TRADE Securities is a member of Securities Investor Protection Corporation
("SIPC"), which provides, in the event of the liquidation of a broker-dealer,
protection for customers' accounts held by E*TRADE Securities of up to
$500,000 for each customer account, subject to a limitation of $100,000 for
claims for cash balances. In addition, E*TRADE Securities has obtained
protection, in excess of SIPC coverage, of $9.5 million for each account in
the form of an excess securities bond from National Union Fire Insurance
Company of Pittsburgh, Pennsylvania, a member company of American
International Group.
The Company has initiated an aggressive marketing campaign designed to bring
brand name recognition to E*TRADE. All marketing activities by E*TRADE
Securities are regulated by the NASD, and all such marketing materials are
required by the NASD to be reviewed by E*TRADE Securities' compliance officer
prior to release. The Company does not currently solicit orders from its
customers or make investment
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recommendations. However, if the Company were to engage in such activities, it
would become subject to additional rules and regulations governing, among
other things, the suitability of recommendations to customers and sales
practices.
It is the Company's intent to expand its business in United States
securities to other countries through the Internet and other gateways. In
order to expand its services globally, E*TRADE Securities must comply with the
regulatory controls of each specific country in which it conducts business.
E*TRADE Securities is regulated in the United States primarily by the NASD and
the SEC. The varying compliance requirements of other national regulatory
jurisdictions may impose a limit to the Company's rate of international
expansion.
Net Capital Requirements
As registered broker-dealers and members of the NASD, E*TRADE Securities and
E*TRADE Capital (a non-operational broker-dealer subsidiary of the Company)
are subject to the Net Capital Rule. The Net Capital Rule, which specifies
minimum net capital requirements for registered broker-dealers, is designed to
measure the general financial integrity and liquidity of a broker-dealer and
requires that at least a minimum part of its assets be kept in relatively
liquid form.
E*TRADE Securities has elected to compute net capital under the alternative
method of calculation permitted by the Net Capital Rule. Under the alternative
method, E*TRADE Securities is required to maintain minimum net capital, as
defined in the Net Capital Rule, equal to the greater of $250,000 or 2% of the
amount of its "aggregate debit items" computed in accordance with the Formula
for Determination of Reserve Requirements for Brokers and Dealers. The
"aggregate debit items" are assets that have, as their source, transactions
with customers, primarily margin loans. Failure to maintain the required net
capital may subject a firm to suspension or revocation of registration by the
SEC and suspension or expulsion by the NASD and other regulatory bodies and
ultimately could require a firm's liquidation. The Net Capital Rule prohibits
payments of dividends, redemption of stock, the prepayment of subordinated
indebtedness, and the making of any unsecured advance or loan to a
shareholder, employee or affiliate, if aggregate debit items rise beyond 5% of
net capital. The Net Capital Rule also provides that the SEC may restrict, for
up to 20 business days, any withdrawal of equity capital, or unsecured loans
or advances to shareholders, employees or affiliates ("capital withdrawal") if
such capital withdrawal, together with all other net capital withdrawals
during a 30-day period, exceeds 30% of excess net capital and the SEC
concludes that the capital withdrawal may be detrimental to the financial
integrity of the broker-dealer.
Net capital is essentially defined as net worth (assets minus liabilities),
plus qualifying subordinated borrowings and certain discretionary liabilities,
less certain mandatory deductions that result from excluding assets that are
not readily convertible into cash and from valuing conservatively certain
other assets. Among these deductions are adjustments (called "haircuts") which
reflect the possibility of a decline in the market value of an asset prior to
its disposition.
A change in the Net Capital Rule, the imposition of new rules or any
unusually large charge against net capital could limit those operations of the
Company that require the intensive use of capital, such as trading activities
and the financing of customer account balances, and also could restrict the
Company's ability to withdraw capital from its brokerage subsidiaries, which
in turn could limit the Company's ability to pay dividends, repay debt and
redeem or purchase shares of its outstanding stock.
As of June 30, 1997, E*TRADE Securities was required to maintain minimum net
capital of $8.4 million and had total net capital of approximately $22.9
million, or approximately $14.5 million in excess of the minimum amount
required. In February 1996, E*TRADE Capital, then doing business as ET
Execution Services, undertook to act as guarantor pursuant to an agreement
between the Company and Merrill Lynch Business Financial Services, Inc. As a
result of a breakdown of internal controls for the monitoring of such proposed
contracts, this undertaking inadvertently caused E*TRADE Capital to fall short
of its minimum net capital requirement and thus be in violation of the Net
Capital Rule through May 30, 1996 when E*TRADE
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Capital was released from the guarantee. The Company has reported the
violation of E*TRADE Capital to the SEC and the NASD. The Company has
implemented internal controls intended to prevent such violations in the
future, including the review of proposed contracts by finance personnel of the
Company. There can be no assurance that a violation of the Net Capital Rule
will not occur in the future.
Electronic Commerce
The Company anticipates that it may be required to comply with record
keeping, data processing and other regulatory requirements as a result of
proposed federal legislation or otherwise, and the Company may be subject to
additional regulation as the market for online commerce evolves. Because of
the growth in the electronic commerce market, Congress has held hearings on
whether to regulate providers of services and transactions in the electronic
commerce market, and federal or state authorities could enact laws, rules or
regulations affecting the Company's business or operations. The Company also
may be subject to federal, state and foreign money transmitter laws and state
and foreign sales and use tax laws. If enacted or deemed applicable to the
Company, such laws, rules or regulations could be imposed on the Company's
activities or its business.
Due to the increasing popularity of the Internet, it is possible that laws
and regulations may be enacted with respect to the Internet, covering issues
such as user privacy, pricing, content and quality of products and services.
The Telecommunications Act of 1996 prohibits the transmission over the
Internet of certain types of information and content. Although certain of
these prohibitions have been held unconstitutional, the increased attention
focused upon these liability issues as a result of the Telecommunications Act
could adversely affect the growth of Internet and private network use.
ASSOCIATES
At June 30, 1997, the Company had 484 full-time associates. The Company's
success has been, and will be, dependent to a large degree on its ability to
retain the services of its existing executive officers and to attract and
retain qualified additional senior and middle managers and key personnel in
the future. There can be no assurance that the Company will be able to
attract, assimilate or retain qualified technical and managerial personnel in
the future, and the failure of the Company to do so would have a material
adverse effect on the Company's business, financial condition and operating
results. None of the Company's associates is subject to collective bargaining
agreements or is represented by a union. The Company considers its relations
with its associates to be good.
PROPERTIES
The Company currently leases three spaces for its corporate offices in Palo
Alto, California. The leases comprise an aggregate of 74,000 square feet and
expire beginning in June 2000. The Company established a second data center in
Rancho Cordova, California in July 1996. The Company leases an aggregate
72,000 square feet at the Rancho Cordova facility. The lease expires in June
2006. The Company believes that it has adequate space for its current needs.
LEGAL AND ADMINISTRATIVE PROCEEDINGS
The Company is not currently a party to any litigation that it believes
could have a material adverse effect on the Company's business, financial
condition or operating results. However, from time to time the Company has
been threatened with, or named as a defendant in, lawsuits and administrative
claims. Compliance and trading problems that are reported to the NASD or the
SEC by dissatisfied customers are investigated by the NASD or the SEC, and, if
pursued by such customers, may rise to the level of arbitration or
disciplinary action. One or more of such lawsuits, claims or disciplinary
actions decided adversely to the Company could have a material adverse effect
on the Company's business, financial condition and results of operations. The
Company is also subject to periodic regulatory audits and inspections.
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The securities industry is subject to extensive regulation under federal,
state and applicable international laws. As a result, the Company is required
to comply with many complex laws and rules and its ability to so comply is
dependent in large part upon the establishment and maintenance of a qualified
compliance system. The Company is aware of several instances of its non-
compliance with applicable regulations. In particular, the Company failed to
comply with applicable advertising restrictions in one international
jurisdiction, and due to a clerical oversight failed to renew its registration
as a broker-dealer in two states, Nebraska and Ohio. One of the state
jurisdictions, Ohio, as a condition of renewing the Company's license as a
broker-dealer in that jurisdiction, required the Company to offer customers
resident in that state the ability to rescind (for up to 30 days) certain
securities transactions effected through the Company during the period January
1, 1997 through April 15, 1997, the date the Company's license was renewed.
For the nine months ended June 30, 1997, the Company recorded a $4.3 million
pre-tax charge against earnings in connection with this matter.
The Company maintains insurance in such amounts and with such coverages,
deductibles and policy limits as management believes are reasonable and
prudent. The principal risks that the Company insures against are
comprehensive general liability, commercial property, hardware/software
damage, and directors and officers liability. The Company believes that such
insurance coverages are adequate for the purpose of its business.
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MANAGEMENT
DIRECTORS, OFFICERS AND KEY PERSONNEL
The directors, officers and key personnel of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
William A. Porter(3)............. 68 Chairman of the Board
Christos M. Cotsakos(3).......... 49 President, Chief Executive Officer and
Director
Kathy Levinson................... 42 Executive Vice President, Customer
Operations; President and Chief
Operating Officer of E*TRADE
Securities, Inc.
Judy Balint...................... 44 Senior Vice President, Global
Marketing and Strategic Business
Development
Debra Chrapaty................... 36 Senior Vice President, E*TRADE
Technologies and Chief Information
Officer
Rebecca L. Patton................ 42 Senior Vice President, Advanced
Products Group
Stephen C. Richards.............. 43 Chief Financial Officer and Treasurer,
Senior Vice President, Finance and
Administration; Chief Financial
Officer of E*TRADE Securities, Inc.
Thomas A. Bevilacqua............. 41 Secretary
Richard S. Braddock(2)........... 55 Director
William E. Ford(1)(2)............ 36 Director
George Hayter(1)................. 58 Director
Keith Petty(2)................... 77 Director
Lewis E. Randall(3).............. 55 Director
Lester C. Thurow(1).............. 59 Director
</TABLE>
- --------
(1)Member of the Audit Committee
(2)Member of the Compensation Committee
(3)Member of the Nominating Committee
William A. Porter is the Chairman and Founder of the Company. He founded the
Company in 1982 and served as President until October 1993 and Chief Executive
Officer, Chief Financial Officer, Treasurer and Secretary, until April 1996.
He founded E*TRADE Securities, Inc. in 1992. Mr. Porter received a BA in
Mathematics from Adams State College, an MA in Physics from Kansas State
College, and an MBA in Management from the Massachusetts Institute of
Technology. In May 1996, Mr. Porter was named Silicon Valley's Emerging
Company Entrepreneur of the Year by the San Jose Business Journal.
Christos M. Cotsakos joined E*TRADE Group, Inc. in March 1996 as President,
Chief Executive Officer and a director. Prior to joining E*TRADE, he served as
President, Co-Chief Executive Officer, Chief Operating Officer and a director
of A.C. Nielsen, Inc. from March 1995 to January 1996, as President and Chief
Executive Officer of Nielsen International from September 1993 to March 1995,
and as President and Chief Operating Officer of Nielsen Europe, Middle East
and Africa from March 1992 to September 1993. Mr. Cotsakos joined Nielsen
after 19 years with the Federal Express Corporation from 1973 to 1992, where
he held a number of senior executive positions both in the United States and
Europe. Mr. Cotsakos serves as
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a director of National Processing Company, consultants in transaction
technology, Forte Software, Inc., a provider of high-end client/server
application and development products and services and The Fourth Network
Communications Network, Inc., a provider of high bandwidth, high speed
Internet access and Internet Services to the hotel industry. A decorated
Vietnam Veteran, he received a BA from William Paterson College, an MBA from
Pepperdine University and is currently pursuing a PhD in economics at the
Management School, University of London.
Kathy Levinson has served as Executive Vice President of the Company since
November 1996 and President and Chief Operating Officer of E*TRADE Securities,
Inc., since January 1996, and a director of E*TRADE Securities, Inc. since
June 1996. From January 1995 to December 1995, Ms. Levinson worked as a
consultant for the Company. Prior to that, Ms. Levinson worked for Charles
Schwab from 1981 to October 1994, most recently serving as Senior Vice
President of Custody Services and prior to that was Senior Vice President of
Credit Service from 1989 to October 1994. She received a BA in Economics from
Stanford University.
Judy Balint is Senior Vice President, Global Marketing and Strategic
Business Development of the Company. Prior to joining E*TRADE in March 1997,
Ms. Balint was Senior Vice President and corporate director of marketing for
National Processing Company, consultants in transaction technology, from
February 1996 to March 1997. Ms. Balint served as CEO Paris and Managing
Director of CME--KHBB Transactional Advertising, a global advertising network
of the former Saatchi & Saatchi Group, from 1992 to April 1995. Ms. Balint
held a variety of positions with Federal Express Corporation from 1987 to 1992
and with DHL Worldwide Express from 1979 to 1987. Ms. Balint received a B.A.
in journalism from the University of Wisconsin, Madison and an MBA in
international business from the Monterey Institute of International Studies.
Debra Chrapaty is Senior Vice President, E*TRADE Technologies, and Chief
Information Officer of the Company. Prior to joining the Company in July 1997,
Ms. Chrapaty served as vice president and chief technology officer for the
National Basketball Association ("NBA") from 1994 through June 1997. Before
joining the NBA, from 1992 through 1994 Ms. Chrapaty was director, internal
systems consulting, at Bertelsmann C.I.S. in New York. From 1990 through 1992,
she was with EMI Records Group in New York. Her previous experience with
financial organizations includes stints with the Federal Reserve Bank of New
York from 1985 to 1990 and Chase Econometrics/IDC in Philadelphia. Ms.
Chrapaty received a BBA in economics from Temple University and an MBA in
information systems from New York University.
Rebecca L. Patton has served as Senior Vice President, Advanced Products
Group since July 1997. Ms. Patton joined the Company in September 1995 as Vice
President, Marketing and served as Senior Vice President, Marketing and
Communications from August 1996 to July 1997. From 1988 to September 1995, Ms.
Patton served in a variety of management positions at Apple Computer,
including Worldwide Marketing Manager of the Personal Interactive Electronics
Division and Manager of Apple's PowerBook marketing group. Ms. Patton received
a BA in Economics, summa cum laude, from Duke University and an MBA from
Stanford University.
Stephen C. Richards joined the Company in April 1996 as Chief Financial
Officer and Treasurer and has served as Senior Vice President, Finance and
Administration and Chief Financial Officer of E*TRADE Securities, Inc. since
June 1996. From 1984 to April 1996, Mr. Richards served in various positions
at Bear Stearns & Co., Inc., an investment bank, including Managing Director
and Chief Financial Officer of Correspondent Clearing. Prior to 1984, Mr.
Richards served as Vice President/Deputy Controller of Becker Paribas and
First Vice President/Controller of Jefferies & Company, Inc. He received a BA
in Statistics and Economics from the University of California at Davis and an
MBA in Finance from the University of California at Los Angeles. Mr. Richards
is a certified public accountant.
Thomas A. Bevilacqua has served as the Secretary of E*TRADE Group, Inc.
since May 1996 and also serves as a director of E*TRADE Online Ventures. Mr.
Bevilacqua has been a partner at the law firm of Brobeck, Phleger & Harrison
LLP since 1991. He received a BA and a JD from the University of California.
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Richard S. Braddock has been a director of the Company since April 1996.
From June 1994 to September 1995, he served as a partner in Clayton, Dubilier
& Rice, a leveraged buy-out firm. From January 1993 to July 1993, he served as
Chief Executive Officer of Medco Containment, a mail-order pharmaceutical
company. From 1974 to October 1992, Mr. Braddock served in various capacities
with a division of Citibank, including as President and Chief Executive
Officer from 1990 to October 1992 and as a director from 1985. Mr. Braddock
serves on the board of directors of Eastman Kodak Company, True North
Communications, an advertising company, ION Laser Technology, the Lincoln
Center for the Performing Arts, DFS Group Limited, and IBN Limited. He
received a BA in History from Dartmouth and an MBA from Harvard University.
William E. Ford has been a director of the Company since September 1995. Mr.
Ford is a managing member of General Atlantic Partners, LLC ("GAP LLC") and
has been with GAP LLC since July 1991. From August 1987 to July 1991, Mr. Ford
was an associate with Morgan Stanley & Co., Incorporated. Mr. Ford is also a
director of LHS Group Inc., a publicly-traded software company, Envoy
Corporation, a publicly traded health insurance claims processing company, GT
Interactive Software, a publicly traded software company, Marcam Corporation,
a publicly traded software company, SS&C Technologies, Inc., a publicly traded
software company, and several private software companies in which GAP LLC or
one of its affiliates is an investor. Mr. Ford received a BA in Economics from
Amherst College and an MBA from Stanford University.
George Hayter has been a director of the Company since December 1995 and
currently provides consulting services to the Company. Mr. Hayter has served
as a partner of George Hayter Associates, a consulting firm, from 1990 to the
present. From 1976 to December 1990, he served with the London Stock Exchange,
serving in his final position as the Managing Director of Trading Markets
Division. Mr. Hayter serves on the boards of directors of Critchley Group PLC,
an electrical accessories company listed on the London Stock Exchange, Linea
Directa Aseguradora SA, a car insurance company in Spain, Pegasus Group PLC,
an accounting software company listed on the London Stock Exchange, and Active
Imaging PLC, a digital image processing manufacturer traded on the London AIM
Market. He received an MA in Natural Sciences from Queens' College, Cambridge,
England.
Keith Petty has been a director of the Company since 1982. Mr. Petty was a
founding partner of the law firm of Jackson Tufts Cole & Black, LLP (formerly
Petty, Andrews, Tufts & Jackson) and retired from that firm in 1986. Mr. Petty
currently provides business and legal consulting to start-up companies and
serves as a Director for four privately held for-profit companies and two
nonprofit companies. He received a BS in Business (major in accounting) from
the University of Idaho and a JD from Stanford Law School, is a certified
public accountant and has been admitted to the bar in California and Idaho.
Lewis E. Randall has been a director of the Company since 1983. Mr. Randall
served at both Apple Computer and Intel during their formative years, largely
in the capacity of software and hardware engineering management. Mr. Randall
has served as the owner and president of Lone Tree, Inc. a privately-held loan
factor, since August 1994, and served as its Vice President of Finance and co-
owner from September 1989 to August 1994. Mr. Randall received a BA in
Philosophy from Harvard University.
Lester C. Thurow has been a director of the Company since April 1996. Mr.
Thurow has been a Professor of Economics at Massachusetts Institute of
Technology ("MIT") since 1968. From 1987 to 1993, he served as Dean of MIT's
Sloan School of Management. Mr. Thurow has served as a director of Analog
Devices, Inc., a publicly traded semiconductor and software company, since
1991, and as a director of Grupo Casa Autry, a publicly traded wholesale
distributor of pharmaceuticals since 1993. Mr. Thurow received a BA in
economics from Williams College, an MA from Oxford University and a PhD from
Harvard University.
Messrs. Braddock, Ford, Hayter, Petty, Randall and Thurow are independent
directors. Failure to maintain two independent directors could result in a
delisting of the Company's Common Stock from the Nasdaq National Market.
51
<PAGE>
The members of the Board of Directors of the Company are classified into
three classes, one of which is elected at each Annual Meeting of Stockholders
to hold office for a three-year term and until successors of such class have
been elected and qualified. See "Description of Capital Stock--Certain
Provisions Affecting Stockholders." There are no family relationships among
any of the directors or officers of the Company.
BOARD COMMITTEES
In May 1996, the Board of Directors created an Audit Committee, a
Compensation Committee and a Nominating Committee of the Board. The Audit
Committee which is composed of William E. Ford (Chair), Lester C. Thurow and
George Hayter,is charged with reviewing the Company's annual audit and meeting
with the Company's independent accountants to review the Company's internal
controls and financial management practices. The Compensation Committee, which
is composed of Richard S. Braddock (Chair), William E. Ford and Keith Petty,
recommends to the Board of Directors compensation for the Company's key
associates and administers the 1996 Stock Incentive Plan, the 1993 Stock
Option Plan, the 1983 Employee Incentive Stock Option Plan and the 1996 Stock
Purchase Plan with respect to officers and directors of the Company. The
Nominating Committee, which is composed of Christos M. Cotsakos (Chair),
William A. Porter and Lewis E. Randall, nominates for stockholder approval
persons to membership on the Board of Directors. In November 1996, the Board
of Directors created the Secondary Committee, which is composed of Christos M.
Cotsakos, to administer the stock option plans of the Company with respect to
all individuals other than officers and directors of the Company. See "--
Associate Benefit Plans."
DIRECTOR COMPENSATION
Non-employee directors receive $5,000 per year, in addition to $800 for each
meeting of the Board attended (and $400 per committee meeting attended). In
addition, each non-employee director receives stock options pursuant to the
automatic option grant provisions of the Company's 1996 Stock Incentive Plan.
See "--Associate Benefit Plans." All directors receive reimbursement of
reasonable out-of-pocket expenses incurred in connection with meetings of the
Board. In December 1995, the Company entered into a consulting arrangement
with Mr. Hayter, a director of the Company, to provide international business
consulting at a base rate of $1,500 for each day of consulting plus expenses,
with the exception of attendance at Board meetings. Mr. Hayter's fees were
payable in the form of $750 in cash and $750 in Common Stock (issued at fair
market value on the dates of services rendered). During the six months ended
March 31, 1996, Mr. Hayter was paid $23,520 and accrued 6,096 shares of Common
Stock pursuant to this arrangement. He also accrued 1,421 shares of Common
Stock pursuant to this arrangement from April 1, 1996 through June 6, 1996.
The Company and Mr. Hayter restated the consulting arrangement on June 7,
1996, at which time the Common Stock component of the arrangement terminated.
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
The Company reincorporated in Delaware in July 1996, in part to take
advantage of certain provisions in Delaware's corporate law relating to
limitations on liability of corporate officers and directors. The Company
believes that the reincorporation into Delaware, the provisions of its
Restated Certificate of Incorporation and Restated Bylaws and the separate
indemnification agreements outlined below are necessary to attract and retain
qualified persons as directors and officers. The Company's Restated
Certificate of Incorporation limits the liability of directors to the maximum
extent permitted by Delaware law. This provision is intended to allow the
Company's directors the benefit of Delaware General Corporation Law which
provides that directors of Delaware corporations may be relieved of monetary
liabilities for breach of their fiduciary duties as directors, except under
certain circumstances, including breach of their duty of loyalty, acts or
omissions not in good faith or involving intentional misconduct or a knowing
violation of law, unlawful payments or dividends or unlawful stock repurchases
or redemptions or any transaction from which the director derived an improper
personal benefit. The Company's Restated Bylaws provide that the Company shall
indemnify its officers and directors to the fullest extent provided by
Delaware law. The Restated Bylaws authorize the use of indemnification
agreements and the Company has entered or intends to enter into such
agreements with each of its directors and executive officers.
52
<PAGE>
The Company has obtained officer and director liability insurance with
respect to liabilities arising out of certain matters, including matters
arising under the Securities Act.
There is no pending litigation or proceeding involving a director, officer,
associate or other agent of the Company as to which indemnification is being
sought, nor is the Company aware of any threatened litigation that may result
in claims for indemnification by any director, officer, associate or other
agent.
EXECUTIVE COMPENSATION
Summary of Cash and Other Compensation
The following table sets forth the compensation earned by the Company's
current and former Chief Executive Officers and the Company's four other
highest-paid executive officers ("Named Executive Officers") for services
rendered in all capacities to the Company and its subsidiaries for the fiscal
years ended September 30, 1996 and 1995, respectively.
SUMMARY COMPENSATION TABLE(/1/)
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------------------------------- ------------
SECURITIES
NAME AND OTHER ANNUAL UNDERLYING ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS/SARS COMPENSATION
-------------------- ---- -------- -------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Christos M. Cotsakos .. 1996 $126,134(2) $ 437 $53,804(3) 1,080,000 --
President, Chief
Executive Officer and
Director 1995 -- -- -- -- --
William A. Porter(4) .. 1996 206,667(5) 21,982 -- -- $2,013(6)
Chairman of the Board 1995 140,713(5) 22,395 -- -- 1,315(6)
Kathy Levinson ........ 1996 163,309(7) 546 -- 144,000 --
Executive Vice
President Customer
Operations 1995 113,941(7) -- -- 600,000(8) --
Stephen C. Richards(9)
....................... 1996 59,187 102,659(10) 69,000(11) 240,000 --
Senior Vice President
of Finance and
Administration, Chief
Financial Officer and
Treasurer 1995 -- -- -- -- --
David R. Ewing(12) .... 1996 135,292 10,949 -- -- --
Former Senior Vice
President of E*TRADE
Technologies 1995 10,417 -- -- 240,000 --
Wayne H. Heldt(13) .... 1996 146,333(14) 19,252 -- -- 2,483(6)
Former Vice President
and Managing Director
of International
Affairs 1995 127,500(14) 21,664 -- -- 629(6)
</TABLE>
- --------
(1) In accordance with the rules of the SEC, the compensation described in
this table does not include medical, group life insurance or other
benefits received by the Named Executive Officers that are available
generally to all salaried employees of the Company, and certain
perquisites and other personal benefits received by the Named Executive
Officers that do not exceed the lesser of $50,000 or 10% of any such
officer's salary and bonus disclosed in this table.
(2) Mr. Cotsakos joined the Company as President, Chief Executive Officer and
a director in March 1996. Includes $2,000 paid to Mr. Cotsakos in his
capacity as a director.
(3) Includes $50,000 as reimbursement of relocation and moving expenses.
53
<PAGE>
(4) Mr. Porter served as Chief Executive Officer until April 1996.
(5) Includes $4,000 and $5,000 paid to Mr. Porter in his capacity as a
director in fiscal 1996 and 1995, respectively.
(6) Represents employer contributions to the Company's 401(k) Plan.
(7) Includes $52,059 in fiscal 1996 and $113,941 in fiscal 1995 paid to Ms.
Levinson in her capacity as a consultant from January 1995 to December
1995.
(8) Includes 300,000 shares of Common Stock pursuant to a warrant issued to
Ms. Levinson in her capacity as a consultant, which warrant was fully
exercised by January 1996.
(9) Mr. Richards joined the Company as Chief Financial Officer and Treasurer
in April 1996.
(10) Includes a one-time signing bonus of $102,441.
(11) Represents reimbursement of relocation and moving expenses.
(12) In July 1997, Mr. Ewing announced his resignation, effective October
1997, as an executive officer of the Company. Mr. Ewing will continue
with the Company in a consulting capacity.
(13) Mr. Heldt resigned as an executive officer of the Company in June 1997.
(14) Includes $3,000 and $5,000 paid to Mr. Heldt in his capacity as a
director in fiscal 1996 and 1995, respectively.
Stock Option Grants
The following table contains information concerning the grant of stock
options under the Company's 1993 Stock Option Plan for the 1996 fiscal year to
the Named Executive Officers. The table also lists potential realizable values
of such options on the basis of assumed annual compounded stock appreciation
rates of 5% and 10% over the life of the options which are set at a maximum of
10 years.
<TABLE>
<CAPTION>
OPTION/SAR GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
-----------------------------------------
% OF TOTAL POTENTIAL REALIZABLE
NUMBER OF OPTIONS/ VALUE AT ASSUMED
SECURITIES SARS EXERCISE ANNUAL RATES OF STOCK
UNDERLYING GRANTED TO OR BASE PRICE APPRECIATION FOR
OPTIONS/ EMPLOYEES PRICE OPTION TERM
SARS IN FISCAL PER EXPIRATION -----------------------
NAME GRANTED(1) YEAR SHARE(2) DATE 5%(3) 10%(3)
---- ---------- ---------- -------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Christos M. Cotsakos.... 600,000 14.8% $2.33 3/28/06 $ 879,195 $2,228,052
480,000 11.9% 7.00 5/14/06 2,113,086 5,354,975
William A. Porter....... -- -- -- -- -- --
Kathy Levinson.......... 144,000 3.6% 2.05 1/1/06 185,650 470,154
Stephen C. Richards..... 210,000 5.2% 2.33 3/28/06 307,718 779,818
30,000 0.7% 7.00 5/14/06 132,068 334,686
David R. Ewing(4)....... -- -- -- -- -- --
Wayne H. Heldt(5)....... -- -- -- -- -- --
</TABLE>
--------
(1) Each option, with the exception of options granted to Christos M.
Cotsakos, will become exercisable for 20% of the option shares after 12
months of continued service from the date of grant. The balance of the
option shares will become exercisable in a series of 4 successive equal
annual installments upon the optionee's completion of each additional year
of service measured from the first anniversary of the date of grant. The
options for Mr. Cotsakos became exercisable for 20% of the shares on
September 1, 1996 and will become exercisable for 80% of the shares in a
series of 48 equal monthly installments upon the completion of each
additional month of service thereafter.
Upon a merger or consolidation in which the Company is not the surviving
corporation, options issued under the Company's 1993 Stock Option Plan and
1996 Stock Incentive Plan will accelerate unless assumed by the acquiring
entity. Pursuant to his employment agreement, options held by Mr. Cotsakos
become immediately exercisable upon a change in control.
54
<PAGE>
(2) The exercise price of each option may be paid in cash, in shares of Common
Stock valued at fair market value on the exercise date or through a
cashless exercise procedure involving a same-day sale of the purchased
shares. The Company may also finance the option exercise by loaning the
optionee sufficient funds to pay the exercise price for the purchased
shares and the federal and state tax liability incurred in connection with
such exercise. The Compensation Committee has the authority to reprice
outstanding options through the cancellation of those options and the
grant of replacement options with an exercise price equal to the lower
fair market value of the option shares on the regrant date.
(3) The potential realizable value is reported net of the option price, but
before income taxes associated with exercise. These amounts represent
assumed annual compounded rates of appreciation at 5% and 10% only from
the date of grant to the expiration date of the option. There is no
assurance provided to any executive officer or any other holder of the
Company's securities that the actual stock price appreciation over the 10-
year option term will be at the assumed 5% and 10% levels or at any other
defined level. Unless the market price of the Common Stock does in fact
appreciate over the option term, no value will be realized from the option
grants made to the executive officers.
(4) In July 1997, Mr. Ewing announced his resignation, effective October 1997,
as an executive officer of the Company. Mr. Ewing will continue with the
Company in a consulting capacity.
(5) Mr. Heldt resigned as an executive officer of the Company in June 1997.
Option Exercises and Holdings
The following table provides information with respect to the Named Executive
Officers concerning the exercise of options during the last fiscal year and
unexercised options held as of the end of the last fiscal year.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR
VALUES
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
IN-THE-MONEY
OPTIONS/SARS AT
VALUE FY-END ($)
REALIZED ($) NUMBER OF SECURITIES (MARKET PRICE OF
(MARKET UNDERLYING UNEXERCISED SHARES AT
NUMBER OF PRICE AT OPTIONS/SARS FY-END ($13.1875)
SHARES EXERCISE, LESS AT FY-END LESS EXERCISE PRICE)
ACQUIRED EXERCISE ------------------------- -------------------------
NAME ON EXERCISE PRICE) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- -------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Christos M. Cotsakos.... -- -- 216,000 864,000 $1,896,500 $7,586,000
William A. Porter....... -- -- -- -- -- --
Kathy Levinson.......... -- -- 60,000 84,000 766,300 4,668,800
Stephen C. Richards..... -- -- -- 240,000 -- 2,465,000
David R. Ewing(1)....... -- -- 96,000 144,000 1,218,000 1,827,000
Wayne H. Heldt(2)....... 316,020 $1,464,000 420,000 16,000 5,419,800 2,787,300
</TABLE>
- --------
(1) In July 1997, Mr. Ewing announced his resignation, effective October 1997,
as an executive officer of the Company. Mr. Ewing will continue with the
Company in a consulting capacity.
(2) Mr. Heldt resigned as an executive officer of the Company in June 1997.
ASSOCIATE BENEFIT PLANS
Stock Incentive Plan and Option Plans
The Company's 1996 Stock Incentive Plan (the "1996 Plan") serves as the
successor equity incentive program to the Company's 1993 Stock Option Plan
(the "1993 Plan"), which is the successor to the Company's 1983 Employee
Incentive Stock Option Plan (the "1983 Plan"). The 1996 Plan became effective
on May 31, 1996 upon adoption by the Board of Directors.
55
<PAGE>
The authorized reserves under the 1996 Plan consist of all of the
outstanding options under the 1993 Plan and 1983 Plan, which are incorporated
into the 1996 Plan, and an additional 4,000,000 shares, which have been
authorized for issuance under the 1996 Plan. No further option grants will be
made under the 1993 Plan and the 1983 Plan. The incorporated options will
continue to be governed by their existing terms, unless the Plan Administrator
elects to extend one or more features of the 1996 Plan to those options.
However, except as otherwise noted below, the outstanding options under the
1993 Plan and the 1983 Plan contain substantially the same terms and
conditions summarized below for the Discretionary Option Grant Program in
effect under the 1996 Plan.
The 1996 Plan is divided into three separate components: (i) the
Discretionary Option Grant Program under which eligible individuals in the
Company's employ or service (including officers, non-employee Board members
and consultants) may, at the discretion of the Plan Administrator, be granted
options to purchase shares of Common Stock at an exercise price not less than
the fair market value of those shares on the grant date, (ii) the Stock
Issuance Program under which such individuals may, in the Plan Administrator's
discretion, be issued shares of Common Stock directly, through the purchase of
such shares at a price not less than the fair market value of those shares at
the time of issuance or as a bonus tied to the performance of services, and
(iii) the Automatic Option Grant Program under which option grants will
automatically be made at periodic intervals to eligible non-employee Board
members to purchase shares of Common Stock at an exercise price equal to the
fair market value of those shares on the grant date.
The Discretionary Option Grant Program and the Stock Issuance Program are
administered by the Compensation Committee of the Board. The Compensation
Committee as Plan Administrator has complete discretion to determine which
eligible individuals are to receive option grants or stock issuances, the time
or times when such option grants or stock issuances are to be made, the number
of shares subject to each such grant or issuance, the status of any granted
option as either an incentive stock option or a non-statutory stock option
under the federal tax laws, the vesting schedule to be in effect for the
option grant or stock issuance and the maximum term for which any granted
option is to remain outstanding. The administration of the Automatic Option
Grant Program is self-executing in accordance with the express provisions of
such program.
The exercise price for the shares of Common Stock subject to option grants
made under the 1996 Plan may be paid in cash or in shares of Common Stock
valued at fair market value on the exercise date. The option also may be
exercised through a same-day sale program without any cash outlay by the
optionee. In addition, the Plan Administrator may provide financial assistance
to one or more optionees in the exercise of their outstanding options by
allowing such individuals to deliver a full-recourse, interest-bearing
promissory note in payment of the exercise price and any associated
withholding taxes incurred in connection with such exercise.
In the event that the Company is acquired by merger or asset sale, each
outstanding option under the Discretionary Option Grant Program which is not
to be assumed by the successor corporation, as well as the options granted
under the 1993 Plan and 1983 Plan which were incorporated into the 1996 Plan,
will automatically accelerate in full, and all unvested shares under the Stock
Issuance Program will immediately vest, except to the extent the Company's
repurchase rights with respect to those shares are to be assigned to the
successor corporation. The Plan Administrator will have the authority under
the Discretionary Option Grant and Stock Issuance Programs to grant options
and to structure repurchase rights so that the shares subject to those options
or repurchase rights will automatically vest in the event the individual's
service is terminated, whether involuntarily or through a resignation for good
reason, within a designated period not to exceed 18 months under certain
circumstances.
Stock appreciation rights are authorized for issuance under the
Discretionary Option Grant Program that provide the holders with the election
to surrender their outstanding options for an appreciation distribution from
the Company equal to the excess of (i) the fair market value of the vested
shares of Common Stock subject to the surrendered option over (ii) the
aggregate exercise price payable for such shares. Such
56
<PAGE>
appreciation distribution may be made in cash or in shares of Common Stock.
There are currently no outstanding stock appreciation rights under the 1993
Plan or the 1983 Plan.
The Plan Administrator has the authority to effect the cancellation of
outstanding options under the Discretionary Option Grant Program (including
options incorporated from the 1993 Plan and the 1983 Plan) in return for the
grant of new options for the same or different number of option shares with an
exercise price per share not less than the fair market value of the Common
Stock on the new grant date.
Each individual who first joins the Board after the effective date of the
Company's initial public offering as a non-employee Board member will also
receive an option grant for 20,000 shares of Common Stock at the time of his
or her commencement of Board service, provided such individual has not
otherwise been in the prior employ of the Company. In addition, at each annual
stockholders meeting, each individual who is to continue to serve as a non-
employee Board will receive an option grant to purchase 5,000 shares of Common
Stock, whether or not such individual has been in the prior employ of the
Company.
Each automatic grant will have an exercise price equal to the fair market
value per share of Common Stock on the grant date and will have a maximum term
of 10 years, subject to earlier termination following the optionee's cessation
of Board service. Each automatic option will be immediately exercisable;
however, any shares purchased upon exercise of the option will be subject to
repurchase, at the option exercise price paid per share, should the optionee's
service as a non-employee Board member cease prior to vesting in the shares.
The 20,000-share grant will vest in four equal and successive annual
installments over the optionee's period of Board service. Each additional
5,000-share grant will vest upon the optionee's completion of two years of
Board service measured from the grant date. However, each outstanding option
will immediately vest upon (i) certain changes in the ownership or control of
the Company or (ii) the death or disability of the optionee while serving as a
Board member.
The Board may amend or modify the 1996 Plan at any time. The 1996 Plan will
terminate on May 30, 2006, unless sooner terminated by the Board. Options to
purchase an aggregate of 5,250,120 shares were outstanding under the 1996
Plan, the 1993 Plan and the 1983 Plan as of June 30, 1997. In July 1997, the
Company granted options to purchase 240,000 shares of the Company's Common
Stock to Ms. Debra Chrapaty, the Company's Senior Vice President, E*TRADE
Technologies and Chief Information Officer.
1996 Stock Purchase Plan
The Company's 1996 Stock Purchase Plan (the "Purchase Plan") was adopted by
the Board of Directors on May 31, 1996. The Purchase Plan is designed to allow
eligible associates of the Company and participating subsidiaries to purchase
shares of Common Stock, at semi-annual intervals, through their periodic
payroll deductions under the Purchase Plan, and a reserve of 650,000 shares of
Common Stock has been established for this purpose.
The Purchase Plan will be implemented in a series of successive offering
periods, each with a maximum duration of 24 months. However, the initial
offering period began on August 16, 1996 and will end on the last business day
in July 1998. Since January 1997, the Company has sold 34,620 shares of Common
Stock under the Purchase Plan.
Individuals who are eligible associates on the start date of any offering
period may enter the Purchase Plan on that start date or on any subsequent
semi-annual entry date (February 1 or August 1 each year). Individuals who
become eligible associates after the start date of the offering period may
join the Purchase Plan on any subsequent semi-annual entry date within that
period.
Payroll deductions may not exceed 10% of the participant's base salary for
each semi-annual period of participation, and the accumulated payroll
deductions will be applied to the purchase of shares on the participant's
behalf on each semi-annual purchase date (the last business day in January and
July each year,
57
<PAGE>
with the first such purchase date occurring on January 31, 1997) at a purchase
price per share not less than 85% of the lower of (i) the fair market value of
the Common Stock on the participant's entry date into the offering period or
(ii) the fair market value on the semi-annual purchase date. Should the fair
market value of the Common Stock on any semi-annual purchase date be less than
the fair market value of the Common Stock on the first day of the offering
period, then the current offering period will automatically end and a new 24-
month offering period will begin, based on the lower fair market value.
The Board may amend or modify the Purchase Plan following any semi-annual
purchase date. The Purchase Plan will terminate on the last business day in
July 2006, unless sooner terminated by the Board.
401(k) Plan
Effective January 1, 1995, the Company adopted a 401(k) (the "401(k) Plan")
that covers all eligible associates of the Company. An associate is eligible
to participate in the plan upon hire, and may elect to defer, in the form of
contributions to the 401(k) Plan, up to the $9,500 limitation imposed by
Internal Revenue Code Section 402(g). Associates' contributions are invested
in specific assets, specific funds or other investments permitted under the
401(k) Plan according to the directions of each individual associate and the
directed investment procedure. The contributions are fully vested and
nonforfeitable at all times. Upon completion of one year of service, the
401(k) Plan provides for employer contributions to the 401(k) Plan of an
amount equal to 25% of the amount contributed by all eligible associates, up
to 2% for individual associates total compensation. The Company has made
contributions of $6,000 and $52,000 for the years ended September 30, 1995 and
1996, respectively.
EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AGREEMENTS AND CHANGE OF
CONTROL ARRANGEMENTS
In March 1996, Christos M. Cotsakos entered into an employment agreement
with the Company (the "Cotsakos Agreement"). The agreement currently provides
for annual base salary compensation of $390,000 (due to the Company achieving
certain annualized revenue targets). Mr. Cotsakos is also eligible to
participate in the Company's bonus plan and other benefit plans.
Pursuant to the Cotsakos Agreement, on March 29, 1996, Mr. Cotsakos was
granted options to purchase 600,000 shares at the Company's Common Stock at an
exercise price of $2.33 per share under the Company's 1993 Stock Option Plan.
These options are exercisable until March 28, 2006, subject to certain
exceptions. In addition, on May 15, 1996, Mr. Cotsakos was granted additional
options to purchase 480,000 shares of Common Stock at the then-current fair
market value. These options are exercisable until May 14, 2006, subject to
certain exceptions. The options vested with respect to 20% of the shares on
September 1, 1996, with the remaining 80% of the shares vesting in equal
installments for every month of employment thereafter over a period of four
years.
The Cotsakos Agreement terminates on December 31, 2001, but is renewable for
successive one-year periods, unless either party gives 180 days' notice. Upon
termination of Mr. Cotsakos' employment, he is entitled to severance payments
as follows: (i) payment equal to five full years of current total annual
compensation if termination within three years after a change in control of
the Company (as defined) or if he elects to terminate his employment for good
reason (as defined) within three years after any change in control, and (ii)
payment equal to four full years of (A) current total annual compensation if
he is terminated by the Company other than for cause (as defined) and such
termination is not described in (i) above and (B) he elects to terminate his
employment for good reason and such termination is not described in (i) above.
In addition, Mr. Cotsakos' options become immediately exercisable upon a
change in control or upon the termination of Mr. Cotsakos other than for cause
or at his election for good reason.
From January 1995 to December 1995, Kathy Levinson, the Executive Vice
President of Operations of E*TRADE Group and the President and Chief Operating
Officer of E*TRADE Securities was self-employed as a consultant. During this
period, Ms. Levinson, worked under contract with the Company, pursuant to
which she provided consulting services to assist with E*TRADE's transition to
self-clearing operations. During
58
<PAGE>
the term of this agreement, Ms. Levinson was paid $166,000 by the Company, and
received a warrant to purchase 300,000 shares of Common Stock, which warrant
was fully exercised by January 1996, and options to purchase 300,000 shares of
Common Stock which vest at a rate of 20% per year over a period of five years
and will terminate on January 2, 2005.
In January 1997, Ms. Levinson entered into an Management Continuity
Agreement with the Company (the "Levinson Agreement"). The Levinson Agreement
provides for an annual base salary of $194,000. Ms. Levinson is also eligible
to participate in the Company's bonus plan and other benefit plans. In the
event that: (i) Ms. Levinson's employment is involuntarily terminated (as
defined) less than 60 days before or within 18 months after a change in
control of the Company (as defined); or (ii) Ms. Levinson is terminated during
the first 18 months of the Levinson Agreement other than for cause (as
defined) or good business reasons (as defined), Ms. Levinson is entitled to
severance payments equal to 18 months base salary.
In connection with an acquisition of the Company by merger or asset sale,
any outstanding option held by the Named Executive Officers under the
Company's 1996 Stock Incentive Plan will automatically accelerate in full and
all unvested shares of Common Stock held by such individuals subject to direct
issuances made under such plans will immediately vest in full, except to the
extent such options are to be assumed by, and the Company's repurchase rights
with respect to these shares are to be assigned to, the successor corporation.
In addition, the Compensation Committee as Plan Administrator of the 1996 Plan
will have the authority to provide for the accelerated vesting of the shares
of Common Stock subject to outstanding options held by the Named Executive
Officers or the shares of Common Stock subject to direct issuances held by
such individuals under certain circumstances.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee consisted of Richard S. Braddock, William E. Ford
and Keith Petty at the end of the fiscal year ended September 30, 1996. During
fiscal 1996, William A. Porter and Lewis E. Randall served on the Compensation
Committee from October 1, 1995 to May 31, 1996. Mr Porter was an executive
officer of the Company during the fiscal year ended September 30, 1996.
59
<PAGE>
CERTAIN TRANSACTIONS
In September 1990, the Company entered into a restructuring agreement with
all of its long-term creditors, whereby certain obligations of the Company,
totaling $999,508, were converted to subordinated and unsecured promissory
notes bearing interest at a rate of seven percent per annum (the "7% Notes").
At the time, the Company's founders, William Porter, the Chairman of the
Board, and Bernard Newcomb, then a director and Vice President of Research and
Development, received the 7% Notes in principal amounts of $230,316 and
$152,490, respectively. The Company's indebtedness to Messrs. Porter and
Newcomb resulted from accrued but unpaid salaries owed to them. In September
1995, all outstanding principal and accrued interest on the 7% Notes was
repaid. Messrs. Porter and Newcomb received $318,276 and $210,741,
respectively, pursuant to the 7% Notes.
On September 28, 1995, the Company sold 100,000 shares of Series A Preferred
Stock for $123 per share. On April 10, 1996, the Company sold 20,336 shares of
Series B Preferred Stock for $140 per share. All Preferred Stock was sold in
private financings, pursuant to preferred stock purchase agreements and
investors' rights agreements. The terms of those agreements (with the
exception of amount and price) are substantially similar for the Series A and
Series B, under which the Company made the standard representations,
warranties and covenants, and which provided the purchasers thereunder with
rights of first offer, tag-along rights, preemptive rights, and demand and
piggyback registration rights. All of the material terms of the Series A and
Series B agreements, with the exception of the registration rights, terminated
upon the effective date of the Company's Registration Statement in connection
with its initial public offering. All shares of Preferred Stock converted into
Common Stock on a 60-for-1 basis automatically upon the completion of the
Company's initial public offering. The purchasers of the Preferred Stock
included, among other things, the following directors, entities associated
with directors, and holders of 5% or more of the Company's Common Stock:
<TABLE>
<CAPTION>
SHARES OF PREFERRED
STOCK PURCHASED
--------------------
SERIES SERIES
INVESTOR A B
-------- ---------- ---------
<S> <C> <C>
General Atlantic Partners II, L.P.(1).................. 87,742 6,267
GAP Coinvestment Partners, L.P.(1)..................... 12,258 876
Christos M. Cotsakos(2)................................ -- 6,050
Richard S. Braddock.................................... -- 7,143
</TABLE>
- -------
(1) The general partner of General Atlantic Partners II, L.P. ("GAP II") is
General Atlantic Partners, LLC ("GAP LLC"), a Delaware limited liability
company. William E. Ford, a director of the Company, is one of the
managing members of GAP LLC. The same managing members of GAP LLC are the
general partners of GAP Coinvestment Partners, L.P. ("GAP Coinvestors").
Mr. Ford disclaims beneficial ownership of shares owned by GAP II and GAP
Coinvestment except to the extent of his pecuniary interest.
(2) Includes shares held by the Cotsakos Revocable Trust under Agreement dated
September 3, 1987, shares held in an IRA account and shares held as a
custodian for his daughter. Mr. Cotsakos disclaims beneficial ownership of
shares held as a custodian and one-half of the shares held by the Cotsakos
Revocable Trust.
During the fourth calendar quarter of 1996, the Company made a relocation
loan to Mr. Cotsakos, its Chief Executive Officer and a Director, in the
aggregate principal amount of $3,147,188. The proceeds of this loan were used
to fund the purchase by Mr. Cotsakos of a personal residence in the Silicon
Valley area. In providing this relocation loan, the Compensation Committee of
the Board of Directors considered, among the other things, the rapid
escalation of residential housing costs in the Silicon Valley area as well as
the costs incurred by Mr. Cotsakos in relocating from Brussels, Belgium to
California. The relocation loan accrues interest at the rate of 7% per annum
which, together with the principal amount, is due and payable in November
1999. The loan is secured by a combination of assets, including the residence
purchased, having a fair market value of at least 140% of the amounts
outstanding. The due date of the relocation loan is subject to acceleration
upon the occurrence of certain events.
In June 1997, the Company invested $2,000,000 in KAP Group, LLC, a
California limited liability company ("KAP Group"), by means of a Promissory
Note in the principal amount of $1,805,951 and through purchase of a Warrant
for $194,049. Other investors in KAP Group include Mr. Porter, Chairman of the
Board of Directors of the Company, and members of his family, and Messrs.
Heldt, Petty and Randall. KAP Group intends to invest substantially all of its
assets in another entity which will be formed for the purpose of engaging in
securities trading. KAP Group has agreed not to engage in businesses
competitive with the Company.
60
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth information regarding the beneficial
ownership of the Company's Common Stock as of the date of the Prospectus and
as adjusted to reflect the sale of shares of Common Stock offered hereby by
(i) each person who is known to the Company to own beneficially more than 5%
of the outstanding shares of the Common Stock of the Company, (ii) each Named
Executive Officer, (iii) each director, (iv) each of the Selling Stockholders
and (v) all directors and executive officers as a group. Unless otherwise
indicated below, to the knowledge of the Company, all persons listed below
have sole voting and investment power with respect to their shares of Common
Stock, except to the extent authority is shared by spouses under applicable
law.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES TO BE
OWNED PRIOR TO BENEFICIALLY OWNED
NAME OFFERING NUMBER OF AFTER OFFERING
---- -------------------- SHARES TO --------------------
MANAGEMENT AND OTHER BE SOLD IN
SIGNIFICANT STOCKHOLDERS NUMBER PERCENT(1) THE OFFERING NUMBER PERCENT(1)
------------------------ --------- ---------- ------------ --------- ----------
<S> <C> <C> <C> <C> <C>
William A. Porter(2)(3).. 2,431,491 7.9% 100,000 2,331,491 6.5%
Christos M. Cotsakos(4).. 1,323,751 4.2 -- 1,323,751 3.6
Richard S. Braddock(5)... 357,830 1.2 100,000 257,830 *
William E. Ford(6)....... 12,001 * -- 12,001 *
George Hayter(7)......... 19,518 * 5,000 14,518 *
Keith Petty(8)........... 274,883 * 50,000 224,883 *
Lewis E. Randall(9)...... 467,001 1.5 20,000 447,001 1.2
Lester C. Thurow(10)..... 32,001 * -- 32,001 *
General Atlantic
Partners, LLC(11)....... 5,770,330 18.6 1,395,400 4,374,930 12.2
Kathy Levinson(12)....... 348,921 1.1 100,000 248,921 *
Rebecca Patton(13)....... 168,001 * 50,000 118,001 *
Stephen C. Richards(14).. 48,751 * 48,000 751 *
All directors and
executive officers as a
group (13 persons)(15).. 5,484,149 17.0% 457,555 5,026,594 13.5%
OTHER SELLING
STOCKHOLDERS
Marty Averbuch........... 90,000 * 15,000 75,000 *
Robert Clegg(16)......... 24,713 * 12,000 12,713 *
David Ewing(17).......... 56,001 * 20,000 36,001 *
Tom Goodrich............. 24,000 * 24,000 -- *
Pam Kramer(18)........... 3,600 * 3,600 -- *
Diane Maldaver(19)....... 16,700 * 5,000 11,700 *
Donna Pecorino(20)....... 24,513 * 2,000 22,513 *
William A. Porter, III... 165,480 * 25,000 140,480 *
Scott Porter............. 182,100 * 25,000 157,100 *
---------
Total.................. 2,000,000
=========
</TABLE>
- --------
* Less than 1%.
(1) Based on 30,958,147 shares outstanding on June 30, 1997 prior to the
offering and 35,958,147 shares outstanding after the offering. Shares of
Common Stock subject to options that are exercisable within 60 days of
July 31, 1997 are deemed beneficially owned by the person holding such
options for the purpose of computing the percentage of ownership of such
person but are not treated as outstanding for the purpose of computing the
percentage of any other person. Assumes no exercise of the Underwriters
over-allotment option.
(2) The address of Mr. Porter is c/o E*TRADE Group, Inc., Four Embarcadero
Place, 2400 Geng Road, Palo Alto, California 94303.
61
<PAGE>
(3) Includes 200,460 shares of Common Stock held by Mr. Porter's wife. Mr.
Porter disclaims beneficial ownership of such shares.
(4) Includes 198,000 shares held by the Cotsakos Revocable Trust under
Agreement dated September 3, 1987, 105,000 shares held in an IRA account
and 60,000 shares held as a custodian for his daughter. Mr. Cotsakos
disclaims beneficial ownership of shares held as a custodian and one-half
the shares held by the Cotsakos Revocable Trust. Also includes 910,000
shares of Common Stock which Mr. Cotsakos has the option to purchase. See
"Management--Employment Contract" for a description of the vesting of these
options to purchase Common Stock.
(5) Includes 12,000 shares of Common Stock issuable upon exercise of stock
options that are exercisable within 60 days of July 31, 1997.
(6) Excludes 5,058,220 shares held by General Atlantic Partners II, L.P. and
712,110 shares held by GAP Coinvestment Partners, L.P. See footnote 9
below.
(7) Includes 12,000 shares of Common Stock issuable upon exercise of stock
options that are exercisable within 60 days of July 31, 1997.
(8) Includes 262,883 shares held by Keith and Gail Wells Petty, as Trustees of
the Keith and Gail Wells Petty Trust. Includes 12,000 shares of Common
Stock issuable upon exercise of stock options that are exercisable within
60 days of July 31, 1997.
(9) Includes 294,000 shares held by Lewis or Martha Randall, as Trustees of the
Lewis E. and Martha E. Randall Living Trust dated August 16, 1984. Includes
96,000 shares held solely by Mr. Randall's wife. Mr. Randall disclaims
beneficial ownership of such shares held by his wife. Include 12,000 shares
of Common Stock which Mr. Randall has the option to purchase within 60 days
of July 31, 1997.
(10) Includes 12,000 shares of Common Stock issuable upon exercise of stock
options that are exercisable within 60 days of July 31, 1997.
(11) Includes 5,058,220 shares held by General Atlantic Partners II, L.P. ("GAP
II") and 712,110 shares held by GAP Coinvestment Partners, L.P. ("GAP
Coinvestment"). The general partner of GAP II is General Atlantic
Partners, LLC ("GAP LLC"), a Delaware limited liability company. Mr. Ford,
a director of the Company, is one of the managing members of GAP LLC. The
same managing members of GAP LLC are the general partners of GAP
Coinvestment. In connection with the Offering, GAP II is selling 1,223,195
shares of Common Stock and GAP LLC is selling 172,205 shares of Common
Stock. Mr. Ford disclaims beneficial ownership of shares owned by GAP II
and GAP Coinvestment except to the extent of his pecuniary interest
therein. The address for GAP II, GAP Coinvestment, GAP LLC and Mr. Ford
is: c/o General Atlantic Service Corporation, Three Pickwick Plaza,
Greenwich, CT 06830.
(12) Includes 50,000 shares of Common Stock issuable upon exercise of stock
options that are exercisable within 60 days of July 31, 1997.
(13) Includes 144,000 shares of Common Stock issuable upon exercise of stock
options that are exercisable within 60 days of July 31, 1997.
(14) Includes 48,000 shares of Common Stock issuable upon exercise of stock
options that are exercisable within 60 days of July 31, 1997.
(15) Includes the information in the notes above, as applicable.
(16) Includes 24,000 shares of Common Stock issuable upon exercise of stock
options that are exercisable within 60 days of July 31, 1997.
(17) Includes 56,000 shares of Common Stock issuable upon exercise of stock
options that are exercisable within 60 days of July 31, 1997.
(18) Includes 3,600 shares of Common Stock issuable upon exercise of stock
options that are exercisable within 60 days of July 31, 1997.
(19) Includes 16,700 shares of Common Stock issuable upon exercise of stock
options that are exercisable within 60 days of July 31, 1997.
(20) Includes 24,000 shares of Common Stock issuable upon exercise of stock
options that are exercisable within 60 days.
62
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the completion of this offering, the authorized capital stock of the
Company will consist of 50,000,000 shares of Common Stock, $.01 par value per
share ("Common Stock"), and 1,000,000 shares of Preferred Stock, $.01 par
value per share ("Preferred Stock").
COMMON STOCK
The holders of outstanding shares of Common Stock are entitled to share
ratably in dividends declared out of assets legally available therefor at such
time and in such amounts as the Board of Directors may from time to time
lawfully determine. Each holder of Common Stock is entitled to one vote for
each share held. The Common Stock is not entitled to conversion or preemptive
rights and is not subject to redemption or assessment. Upon liquidation,
dissolution or winding up of the Company, any assets legally available for
distribution to stockholders as such are to be distributed ratably among the
holders of the Common Stock at that time outstanding. As of June 30, 1997,
there were 30,958,147 shares of Common Stock outstanding and as of July 18,
1997 there were approximately 236 stockholders of record. The Common Stock
presently outstanding is, and the Common Stock issued in this offering will
be, fully paid and nonassessable. The Common Stock is currently traded on the
Nasdaq National Market under the trading symbol "EGRP"
PREFERRED STOCK
Preferred Stock may be issued in series from time to time with such
designations, relative rights, priorities, preferences, qualifications,
limitations and restrictions thereof, to the extent that such are not fixed in
the Company's Restated Certificate of Incorporation, as the Board of Directors
determines. The rights, preferences, limitations and restrictions of different
series of Preferred Stock may differ with respect to dividend rates, amounts
payable on liquidation, voting rights, conversion rights, redemption
provisions, sinking fund provisions and other matters. The Board of Directors
may authorize the issuance of Preferred Stock which ranks senior to the Common
Stock with respect to the payment of dividends and the distribution of assets
on liquidation. In addition, the Board of Directors is authorized to fix the
limitations and restrictions, if any, upon the payment of dividends on Common
Stock to be effective while any shares of Preferred Stock are outstanding. The
Board of Directors, without stockholder approval, can issue Preferred Stock
with voting and conversion rights which could adversely affect the voting
power of the holders of Common Stock. The issuance of Preferred Stock may have
the effect of delaying, deferring or preventing a change in control of the
Company. There are currently no shares of Preferred Stock outstanding and the
Company has no present intention to issue any shares of Preferred Stock. See
"Risk Factors--Effects of Certain Charter and Bylaw Provisions."
CERTAIN PROVISIONS AFFECTING STOCKHOLDERS
Delaware, like many other states, permits a corporation to adopt a number of
measures through amendment of the corporate charter or bylaws or otherwise,
which may have the effect of delaying or deterring any unsolicited takeover
attempts. The right of stockholders to cumulate votes in the election of
directors is eliminated. In addition, Section 203 of the Delaware General
Corporation Law restricts certain "business combinations" with "interested
stockholders" for three years following the date that person becomes an
interested stockholder, unless the Board of Directors approves the business
combination. By delaying or deterring unsolicited takeover attempts, these
provisions could adversely affect prevailing market prices for the Company's
Common Stock. See "Risk Factors--Effects of Certain Charter and Bylaw
Provisions."
The Company's Restated Certificate of Incorporation and Restated Bylaws
contain certain provisions that could discourage potential takeover attempts
and make more difficult attempts by stockholders to change management. The
Restated Certificate of Incorporation and the Restated Bylaws provide for a
classified Board
63
<PAGE>
of Directors and permit the Board to create new directorships and to elect new
directors to serve for the full term of the class of directors in which the
new directorship was created. The terms of the directors are staggered to
provide for the election of approximately one-third of the Board members each
year, with each director serving a three-year term. The Board (or its
remaining members, even though less than a quorum) is also empowered to fill
vacancies on the Board occurring for any reason for the remainder of the term
of the class of directors in which the vacancy occurred. Stockholders may
remove a director or the entire Board only for cause, and such removal
requires the affirmative vote of two-thirds of the outstanding voting stock.
The Company's Restated Certificate of Incorporation provides that stockholders
may not take action by written consent but only at a stockholders' meeting and
that special meetings of the stockholders of the Company may only be called by
the Chairman of the Board, the President, a majority of the directors or the
holders of not less than 10% of the outstanding voting stock. The Restated
Bylaws also establish procedures, including advance notice procedures with
regard to the nomination of candidates for election as directors, and
stockholder proposals.
The Company's Restated Certificate of Incorporation provides that, in
addition to the requirements of the Delaware General Corporation Law, any
"Business Combination" (as defined in the Certificate of Incorporation)
requires the affirmative vote of two-thirds of the votes entitled to be cast
by the holders of the Company's then outstanding capital stock, voting
together as a class, unless two-thirds of the directors approve the proposed
transaction.
A "Business Combination" includes (i) a merger or consolidation of the
Company or any of its subsidiaries with an "Interested Stockholder" (as
defined in the Restated Certificate of Incorporation) or any other corporation
which is, or after such transaction would be, an "Affiliate" or "Associate"
(as such terms are defined in the Securities Exchange Act of 1934, as amended)
of an Interested Stockholder, (ii) any sale, lease, exchange, mortgage,
pledge, transfer or other disposition to or with, or proposed by or on behalf
of, any Interested Stockholder or any Affiliate or Associate of any Interested
Stockholder involving any assets of the Company or any subsidiary that
constitute 5% or more of the total assets of the Company, (iii) the issuance
or transfer by the Company or any subsidiary of any securities of the Company
or any subsidiary to, or proposed by or on behalf of, an Interested
Stockholder or any Affiliate or Associate of an Interested Stockholder in
exchange for cash, securities or other property that constitute 5% or more of
the total assets of the Company, (iv) the adoption of any plan or proposal for
the liquidation or dissolution of the Company or any spin-off or split-up of
any kind of the Company or any subsidiary, proposed by or on behalf of an
Interested Stockholder or an Affiliate or Associate of an Interested
Stockholder, or (v) any reclassification, recapitalization, or merger or
consolidation of the Company with any of its subsidiaries or any other
transaction that has the effect, directly or indirectly, of increasing the
proportionate share of any class or series of capital stock of the Company or
any of its subsidiaries that is beneficially owned by any Interested
Stockholder or an Affiliate or Associate of any Interested Stockholder.
An "Interested Stockholder" generally is defined as (i) an individual,
corporation or other entity which is or was at any time within the two-year
period preceding the date of the transaction in question, the beneficial owner
of 10% or more of the outstanding voting securities of the Company, (ii) an
Associate or Affiliate of the Company who within the two-year period preceding
the date of the transaction in question was the beneficial owner of 10% or
more of the outstanding voting securities of the Company, or (iii) under
certain circumstances, an assignee of any of the foregoing persons. A person
is a "beneficial owner" of any capital stock of the Company (a) which such
person or any of its Affiliates or Associates beneficially owns, directly or
indirectly, (b) which such person or any of its Affiliates or Associates has,
directly or indirectly, (i) the right to acquire (whether such right is
exercisable immediately or subject only to the passage of time), pursuant to
any agreement, arrangement or understanding or upon the exercise of conversion
rights, exchange rights, warrants or options, or otherwise, or (ii) the right
to vote pursuant to any agreement, arrangement or understanding, or (c) which
are beneficially owned, directly or indirectly, by any other person with which
such person or any of its Affiliates or Associates has any agreement,
arrangement or understanding for the purpose of acquiring, holding, voting or
disposing of any shares of capital stock.
64
<PAGE>
The foregoing provisions of the Restated Certificate of Incorporation and
Restated Bylaws of the Company may deter any potential unfriendly offers or
other efforts to obtain control of the Company that are not approved by the
Board of Directors and could thereby deprive the stockholders of opportunities
to realize a premium on their Common Stock and could make removal of incumbent
directors more difficult. At the same time, these provisions may have the
effect of inducing any persons seeking control of the Company or a business
combination with the Company to negotiate terms acceptable to the Board of
Directors. Such provisions of the Company's Restated Certificate of
Incorporation and Restated Bylaws can be changed or amended only by the
affirmative vote of the holders of at least 66 2/3% of the Company's then
outstanding voting stock.
Following the completion of the offering, the Company's present directors
(including the director emeritus) and executive officers and their respective
affiliates will beneficially own approximately 23.9% of the outstanding Common
Stock, giving them veto power with respect to any stockholder action or
approval requiring a majority vote.
TRANSFER AGENT AND REGISTRAR
The Company has appointed American Stock Transfer & Trust Company as its
transfer agent and registrar of the Common Stock.
65
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
GENERAL
The Common Stock has only been publicly traded since the Company's initial
public offering on August 16, 1996, and there is no assurance that a
significant public market for the Common will be sustained after this
Offering. Future sales of substantial amounts of shares of Common Stock in the
public market could adversely affect prevailing market prices and could impair
the Company's future ability to raise capital through the sale of its equity
securities.
Upon completion of this Offering, the Company will have 35,958,147 shares of
Common Stock outstanding, approximately 26,762,184 of which will be
transferable without restriction or registration under the Securities Act,
including shares which will be eligible for immediate sale in the public
market without restriction pursuant to Rule 144(k) under the Securities Act,
except for any shares purchased by an existing "affiliate" of the Company, as
that term is defined in Rule 144 under the Securities Act (an "Affiliate").
The remaining approximately 9,195,963 shares of Common Stock outstanding will
be "restricted securities" as defined in Rule 144 (the "Restricted Shares"),
and may be sold subject to the holding period, volume limitations and other
restrictions of Rule 144.
Approximately 8,570,103 Restricted Shares (the "Lock-up Restricted Shares")
are subject to lock-up agreements between the holders thereof and the
representatives of the Underwriters, pursuant to which the holders of Lock-up
Restricted Shares have agreed not to offer, sell, contract to sell or grant
any option to purchase or otherwise dispose of Common Stock of the Company
until 60 days after the date of this Prospectus (the "Lock-up Period"),
subject to certain limited exceptions. Following the expiration of the Lock-up
Period, approximately 7,185,162 Lock-Up Restricted Shares will become
available for immediate resale in the public market, of which approximately
6,760,642 Lock-Up Restricted Shares are subject to the volume limitations and
other restrictions of Rule 144 under the Securities Act.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated under that Rule) who owns shares that were
purchased from the Company (or any Affiliate) at least one year previously,
including persons who may be deemed Affiliates of the Company, is entitled to
sell within any three-month period a number of shares that does not exceed the
greater of 1% of the then outstanding shares of the Company's Common Stock
(approximately 359,581 shares immediately after this offering) or the average
weekly trading volume of the Company's Common Stock in the over-the-counter
market during the four calendar weeks preceding the date on which notice of
the sale is filed with the Securities and Exchange Commission. Sales under
Rule 144 also are subject to certain manner-of-sale provisions, notice
requirements and the availability of current public information about the
Company. Any person (or persons whose shares are aggregated) who is not deemed
to have been an Affiliate of the Company at any time during the 90 days
preceding a sale, and who owns shares within the definition of "restricted
securities" under Rule 144 that were purchased from the Company (or any
Affiliate) at least two years previously, would be entitled to sell those
shares under Rule 144(k) without regard to the volume limitations, manner of
sale provisions, public requirements or notice requirements.
REGISTRATION RIGHTS
Pursuant to an agreement between the Company and the holders (or their
permitted transferees) of approximately 4,367,976 shares of Common Stock
("Holders"), the Holders are entitled to certain rights with respect to the
registration of such shares under the Securities Act. If the Company proposes
to register its Common Stock in any public offering subsequent to this
offering, subject to certain exceptions, under the Securities Act, the Holders
are entitled to notice of the registration and are entitled at the Company's
expense, subject to certain limitations, to include such shares therein,
provided that the managing underwriters have the right to limit the number of
such shares included in the registration. In addition, certain of the Holders
may require the Company, at its expense, subject to certain limitations, on no
more than on five occasions in the aggregate, to file a registration statement
under the Securities Act with respect to their shares of Common Stock. Such
rights may not be exercised until 90 days after the completion of a subsequent
offering.
66
<PAGE>
UNDERWRITING
The Underwriters named below, acting through their representatives,
Robertson, Stephens & Company LLC, Hambrecht & Quist LLC, Deutsche Morgan
Grenfell, Montgomery Securities and E*TRADE Securities, Inc. (the
"Representatives"), have severally agreed with the Company and the Selling
Stockholders, subject to the terms and conditions in the Underwriting
Agreement, to purchase the number of shares of Common Stock set forth opposite
their respective names below. The Underwriters are committed to purchase and
pay for all such shares if any are purchased.
<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
----------- ---------
<S> <C>
Robertson, Stephens & Company LLC.................................
Hambrecht & Quist LLC.............................................
Deutsche Morgan Grenfell..........................................
Montgomery Securities.............................................
E*TRADE Securities, Inc...........................................
---------
Total........................................................... 7,000,000
=========
</TABLE>
The Representatives have advised the Company and the Selling Stockholders
that the Underwriters initially propose to offer shares of the Common Stock to
the public at the public offering price set forth on the cover page of this
Prospectus and to certain dealers at such price less a concession of not more
than $ per share, of which $ may be reallowed to other dealers. After the
public offering, the public offering price, concession and reallowance to
dealers may be reduced by the Representatives. No such reduction shall change
the amount of proceeds to be received by the Company as set forth on the cover
page of this Prospectus.
The Company and certain Selling Stockholders have granted to the
Underwriters an option, exercisable during the 30-day period after the date of
this Prospectus, to purchase up to 1,050,000 additional shares of Common
Stock, respectively, at the same price per share as will be paid for the
7,000,000 shares that the Underwriters have agreed to purchase. To the extent
that the Underwriters exercise such option, each of the Underwriters will have
a firm commitment to purchase approximately the same percentage of such
additional shares that the number of shares of Common Stock to be purchased by
it shown in the above table represents as a percentage of the 7,000,000 shares
offered hereby. If purchased, such additional shares will be sold by the
Underwriters on the same terms as those on which the 7,000,000 shares are
being sold.
The Underwriting Agreement contains covenants of indemnity among the
Underwriters, the Company and the Selling Stockholders against certain civil
liabilities, including liabilities under the Securities Act and liabilities
arising from breaches of representations and warranties contained in the
Underwriting Agreement. The Company has been advised by the SEC that, in the
SEC's view, indemnification for liabilities arising under the Securities Act
is contrary to the federal securities laws and, therefore, unenforceable.
Each officer and director who holds shares of the Company and the Selling
Stockholders have agreed with the Representatives, for the Lock-Up Period,
subject to certain exceptions, not to offer to sell, contract to sell, or
otherwise sell, dispose of, or grant any rights with respect to any shares of
Common Stock, any options or warrants to purchase any shares of Common Stock,
or any securities convertible into or exchangeable for shares of Common Stock
owned as of the date of this Prospectus or thereafter acquired directly by
such holders or with respect to which they have or hereafter acquire the power
of disposition, without the prior written consent of Robertson, Stephens &
Company LLC. However, Robertson, Stephens & Company LLC may, in its sole
discretion and at any time without notice, release all or any portion of the
securities subject to lock-up agreements. There are no agreements between the
Representatives and any of the Company's stockholders providing consent by the
Representatives to the sale of shares prior to the expiration of the Lock-Up
Period. In addition, the Company has agreed that, during the Lock-Up Period,
the
67
<PAGE>
Company will not, subject to certain exceptions, without the prior written
consent of Robertson, Stephens & Company LLC, issue, sell, contract to sell,
or otherwise dispose of, any shares of Common Stock, any options or warrants
to purchase any shares of Common Stock or any securities convertible into,
exercisable for or exchangeable for shares of Common Stock, other than the
Company's sale of shares in this offering, the issuance of Common Stock upon
the exercise of outstanding options, and the Company's issuance of options and
shares under existing stock option and stock purchase plans. See "Shares
Eligible for Future Sale."
Under the Rules of the NASD, when an NASD member such as E*TRADE Securities
participates in the distribution of its securities, the public offering price
can be no higher than that recommended by a "qualified independent
underwriter" meeting certain standards. In accordance with this requirement,
Robertson Stephens & Company LLC has agreed to serve in such role and
recommend a price in compliance with the Rules.
The Representatives of the Underwriters have advised the Company that,
pursuant to Regulation M under the Securities Act, certain persons
participating in the Offering may engage in transactions, including
stabilizing bids, syndicate covering transactions or the imposition of penalty
bids, which may have the effect of stabilizing or maintaining the market price
of the Common Stock at a level above that which might otherwise prevail in the
open market. A "stabilizing bid" is a bid for or the purchase of the Common
Stock on behalf of the Underwriters for the purpose of fixing or maintaining
the price of the Common Stock. A "syndicate covering transaction" is the bid
for or the purchase of the Common Stock on behalf of the Underwriters to
reduce a short position incurred by the Underwriters in connection with the
Offering. A "penalty bid" is an arrangement permitting the Representatives to
reclaim the selling concession otherwise accruing to an Underwriter or
syndicate member in connection with the Offering if the Common Stock
originally sold by such Underwriter or syndicate member is purchased by the
Representatives in a syndicate covering transaction and has therefore not been
effectively placed by such Underwriter or syndicate member. The
Representatives have advised the Company that such transactions may be
effected on the Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.
As permitted by Rule 103 under the Exchange Act, Underwriters or prospective
Underwriters that are market makers ("passive market makers") in the Common
Stock may make bids for or purchases of Common Stock on the Nasdaq National
Market until such time, if any, when a stabilizing bid for such securities has
been made. Rule 103 generally provides that: (i) a passive market maker's net
daily purchases of the Common Stock may not exceed 30% of its average daily
trading volume in such securities for the two full consecutive calendar months
(or any 60 consecutive days ending within the 10 days) immediately preceding
the filing date of the registration statement of which this Prospectus forms a
part; (ii) a passive market maker may not effect transactions or display bids
for the Common Stock at a price that exceeds the highest independent bid for
the Common Stock by persons who are not passive market makers; and (iii) bids
made by passive market makers must be identified as such.
SUBSEQUENT RESTRICTIONS
Securities industry regulations prohibit an NASD member firm, after the
completion of a distribution of securities of its parent to the public, from
effecting any transaction (except on an unsolicited basis) for the account of
any customer in, or making any recommendation with respect to, any such
security. Thus, following this offering, E*TRADE Securities and the Company's
other subsidiaries will not be permitted to make recommendations regarding the
purchase or sale of the Company's Common Stock.
68
<PAGE>
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Brobeck, Phleger & Harrison LLP, Palo Alto, California. Certain
legal matters in connection with this offering will be passed upon for the
Underwriters by Cooley Godward LLP, San Francisco, California. Thomas A.
Bevilacqua, a partner at Brobeck, Phleger & Harrison LLP, holds options to
purchase certain shares of Common Stock. See "Interests of Counsel."
EXPERTS
The consolidated financial statements as of September 30, 1996 and 1995 and
for each of the three years in the period ended September 30, 1996, included
in this Prospectus, have been audited by Deloitte & Touche LLP, independent
auditors, as stated in their report appearing herein. Such consolidated
financial statements have been included herein in reliance upon the report of
such firm given upon their authority as experts in accounting and auditing.
INTERESTS OF COUNSEL
Thomas A. Bevilacqua, in his capacity as a director of E*TRADE Online
Ventures, received in May 1996 an option to purchase 30,000 shares of Common
Stock of the Company with an exercise price of $9.50 per share. In February
1997, Mr. Bevilacqua received an additional option to purchase 2,500 shares of
Common Stock. The number of option shares so granted represents one-half the
number of option shares granted to each non-employee director of the Company
pursuant to the 1996 Plan. See "Management--Director Compensation" and "Legal
Matters."
ADDITIONAL INFORMATION
The Company has filed with the SEC a registration statement (together with
all amendments and exhibits thereto, the "Registration Statement") under the
Act with respect to the Common Stock offered hereby. This Prospectus does not
contain all of the information set forth in the Registration Statement,
certain parts of which are omitted in accordance with the Rules and
Regulations of the SEC. For further information with respect to the Company
and the Common Stock offered hereby, reference is made to the Registration
Statement and to the exhibits and schedules filed therewith. Statements
contained in this Prospectus as to the contents of any contract or other
document are not necessarily complete, and in each instance reference is made
to the copy of such contract or other document filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference. Copies of the Registration Statement and the exhibits and
schedules thereto may be inspected, without charge, at the offices of the SEC,
or obtained at prescribed rates from the Public Reference Section of the SEC
at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549,
and at the SEC's regional offices located at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 and at Seven World Trade Center
(13th Floor), New York, New York 10019. The SEC also makes electronic filings
publicly available on the Internet within 24 hours of acceptance. The SEC's
Internet address is www.sec.gov. The SEC Web site also contains reports, proxy
and information statements, and other information regarding registrants that
file electronically with the SEC.
69
<PAGE>
AVAILABLE INFORMATION
The Company is subject to the information requirements of the Exchange Act,
and in accordance therewith files reports and other information with the
Commission. Reports, proxy statements and other information filed by the
Company can be inspected and copied (at prescribed rates) at the offices of
the Commission set forth under "Additional Information" above. In addition,
the Commission maintains a World Wide Web site on the Internet at www.sec.gov
that contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission. Quotations
relating to the Company's Common Stock appear on the Nasdaq National Market
and such reports, proxy statements and other information concerning the
Company can also be inspected at the offices of The Nasdaq Stock Market, Inc.,
1735 K Street, N.W., Washington, D.C. 20006.
70
<PAGE>
E*TRADE GROUP, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report............................................. F-2
Consolidated Balance Sheets as of September 30, 1995 and 1996 and June
30, 1997 (Unaudited).................................................... F-3
Consolidated Statements of Operations for the Years Ended September 30,
1994, 1995 and 1996 and for the Nine Months Ended June 30, 1996 and 1997
(Unaudited)............................................................. F-4
Consolidated Statements of Stockholders' Equity for the Years Ended
September 30, 1994, 1995 and 1996 and for the Nine Months Ended June 30,
1997 (Unaudited)........................................................ F-5
Consolidated Statements of Cash Flows for the Years Ended September 30,
1994, 1995 and 1996 and for the Nine Months Ended June 30, 1996 and 1997
(Unaudited)............................................................. F-6
Notes to Consolidated Financial Statements............................... F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of E*TRADE Group, Inc.:
We have audited the accompanying consolidated balance sheets of E*TRADE
Group, Inc. and subsidiaries (the "Company") as of September 30, 1995 and
1996, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended
September 30, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of E*TRADE Group, Inc. and
subsidiaries at September 30, 1995 and 1996, and the results of their
operations and their cash flows for each of the three years in the period
ended September 30, 1996 in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
San Jose, California
November 22, 1996
F-2
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------ JUNE 30,
1995 1996 1997
----------- ------------ ------------
(Unaudited)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and equivalents.................... $ 9,624,000 $ 14,641,000 $ 18,116,000
Cash and investments required to be
segregated under Federal or other
regulations............................ -- 35,500,000 183,500,000
Investment securities................... -- 35,003,000 25,214,000
Brokerage receivables--net.............. 1,936,000 193,228,000 459,653,000
Other assets............................ 470,000 2,203,000 4,593,000
----------- ------------ ------------
Total current assets................... 12,030,000 280,575,000 691,076,000
Property and equipment--net.............. 1,458,000 9,228,000 16,270,000
Equity investment........................ 676,000 2,860,000 3,105,000
Relocation loan receivable............... -- -- 3,147,000
Other assets............................. -- 2,218,000 6,247,000
----------- ------------ ------------
TOTAL ASSETS............................. $14,164,000 $294,881,000 $719,845,000
=========== ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Brokerage payables...................... $ -- $219,483,000 $572,490,000
Bank loan payable....................... -- -- 51,900,000
Accounts payable, accrued liabilities
and other.............................. 2,971,000 6,072,000 12,392,000
----------- ------------ ------------
Total current liabilities.............. 2,971,000 225,555,000 636,782,000
Long-term portion of capital leases...... 45,000 22,000 6,000
----------- ------------ ------------
Total liabilities...................... 3,016,000 225,577,000 636,788,000
----------- ------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 9
and 10)
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par: shares
authorized, 1,000,000; Series A: 800,000
shares designated; shares issued and
outstanding: 1995, 100,000; 1996, none;
1997, none.............................. 1,000 -- --
Common stock, $.01 par: shares
authorized, 50,000,000; shares issued
and outstanding: September 1995,
14,890,980; September 1996, 29,539,147;
June 1997, 30,958,147................... 149,000 295,000 309,000
Additional paid-in capital............... 9,899,000 68,738,000 74,095,000
Retained earnings........................ 1,099,000 271,000 8,653,000
----------- ------------ ------------
Total Stockholders' equity............. 11,148,000 69,304,000 83,057,000
----------- ------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY.................................. $14,164,000 $294,881,000 $719,845,000
=========== ============ ============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
SEPTEMBER 30, JUNE 30,
------------------------------------ ------------------------
1994 1995 1996 1996 1997
----------- ----------- ----------- ----------- -----------
(Unaudited)
<S> <C> <C> <C> <C> <C>
REVENUES:
Transaction revenues... $ 9,548,000 $20,835,000 $44,178,000 $30,208,000 $72,329,000
Interest--net of
interest expense (A).. 302,000 1,004,000 4,813,000 2,213,000 15,646,000
International.......... -- -- -- -- 4,000,000
Computer services and
other................. 1,055,000 1,501,000 2,604,000 2,002,000 2,285,000
----------- ----------- ----------- ----------- -----------
Net revenues........ 10,905,000 23,340,000 51,595,000 34,423,000 94,260,000
----------- ----------- ----------- ----------- -----------
COST OF SERVICES:
Cost of services....... 7,646,000 13,340,000 34,268,000 24,030,000 45,364,000
Registration charge.... -- -- -- -- 4,334,000
Self-clearing start-up
costs................. -- 141,000 2,240,000 1,844,000 --
----------- ----------- ----------- ----------- -----------
Total cost of
services........... 7,646,000 13,481,000 36,508,000 25,874,000 49,698,000
----------- ----------- ----------- ----------- -----------
OPERATING EXPENSES:
Selling and marketing.. 998,000 2,466,000 7,600,000 5,749,000 16,232,000
Technology development. 335,000 943,000 2,792,000 1,323,000 4,435,000
General and
administrative........ 1,682,000 2,141,000 6,078,000 3,701,000 9,785,000
----------- ----------- ----------- ----------- -----------
Total operating
expenses........... 3,015,000 5,550,000 16,470,000 10,773,000 30,452,000
----------- ----------- ----------- ----------- -----------
Total cost of
services and
operating expenses. 10,661,000 19,031,000 52,978,000 36,647,000 80,150,000
----------- ----------- ----------- ----------- -----------
PRE-TAX INCOME (LOSS)... 244,000 4,309,000 (1,383,000) (2,224,000) 14,110,000
INCOME TAX EXPENSE
(BENEFIT)............... (541,000) 1,728,000 (555,000) (890,000) 5,728,000
----------- ----------- ----------- ----------- -----------
NET INCOME (LOSS)....... $ 785,000 $ 2,581,000 $ (828,000) $(1,334,000) $ 8,382,000
=========== =========== =========== =========== ===========
NET INCOME (LOSS) PER
SHARE................... $ 0.03 $ 0.10 $ (0.03) $ (0.05) $ 0.24
=========== =========== =========== =========== ===========
Weighted average number
of common and common
equivalent shares
outstanding 26,186,000 26,481,000 28,564,000 28,477,000 34,719,000
</TABLE>
- -------
(A) Interest is presented net of interest expense. Interest expense for the
years ended 1994, 1995, and 1996 was $106,000, $83,000, and $2,224,000,
respectively. Interest expense for the nine months ended June 30, 1996 and
1997 was $60,000 and $8,103,000, respectively (unaudited).
See notes to consolidated financial statements.
F-4
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
TOTAL
PREFERRED STOCK COMMON STOCK ADDITIONAL RETAINED STOCKHOLDERS'
----------------- -------------------- PAID-IN EARNINGS EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL (DEFICIT) (DEFICIENCY)
-------- ------- ---------- -------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, OCTOBER 1,
1993................... 15,498,180 $155,000 $ 1,325,000 $(2,267,000) $ (787,000)
Net income............. 785,000 785,000
Issuance of common
stock................. 380,520 4,000 159,000 163,000
Exercise of stock
warrants.............. 1,235,940 12,000 (12,000) --
Repurchase of common
stock................. (2,160,240) (22,000) (231,000) (253,000)
---------- -------- ----------- ----------- -----------
BALANCE, SEPTEMBER 30,
1994................... 14,954,400 149,000 1,241,000 (1,482,000) (92,000)
Net income............. 2,581,000 2,581,000
Issuance of Series A
preferred stock....... 100,000 $ 1,000 12,299,000 12,300,000
Exercise of stock
warrants.............. 1,293,120 13,000 13,000
Exercise of stock
options............... 497,100 5,000 141,000 146,000
Repurchase of common
stock................. (1,853,640) (18,000) (3,782,000) (3,800,000)
-------- ------- ---------- -------- ----------- ----------- -----------
BALANCE, SEPTEMBER 30,
1995................... 100,000 1,000 14,890,980 149,000 9,899,000 1,099,000 11,148,000
Net loss............... (828,000) (828,000)
Issuance of Series B
preferred stock, net
of issuance costs..... 20,336 2,837,000 2,837,000
Issuance of Series C
preferred stock, net
of issuance costs..... 11,180 8,950,000 8,950,000
Initial public
offering.............. 5,026,550 50,000 46,352,000 46,402,000
Conversion of preferred
stock................. (131,516) (1,000) 7,890,960 79,000 (78,000) --
Exercise of stock
warrants, including
tax benefit........... 403,080 4,000 286,000 290,000
Exercise of stock
options, including tax
benefit............... 1,320,060 13,000 472,000 485,000
Issuance of common
stock for services.... 7,517 20,000 20,000
-------- ------- ---------- -------- ----------- ----------- -----------
BALANCE, SEPTEMBER 30,
1996................... -- -- 29,539,147 295,000 68,738,000 271,000 69,304,000
Net income*............ 8,382,000 8,382,000
Exercise of stock
options, including tax
benefit*.............. 1,384,380 14,000 5,150,000 5,164.000
Initial public offering
costs*................ (102,000) (102,000)
Employee Stock Purchase
Plan*................. 34,620 309,000 309,000
-------- ------- ---------- -------- ----------- ----------- -----------
BALANCE JUNE 30, 1997*.. -- $ -- 30,958,147 $309,000 $74,095,000 $ 8,653,000 $83,057,000
======== ======= ========== ======== =========== =========== ===========
</TABLE>
- --------
* Unaudited
See notes to consolidated financial statements.
F-5
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED
SEPTEMBER 30, JUNE 30,
------------------------------------ --------------------------
1994 1995 1996 1996 1997
--------- ----------- ------------ ----------- -------------
(Unaudited)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM
OPERATING ACTIVITIES:
Net income (loss)..... $ 785,000 $ 2,581,000 $ (828,000) $(1,334,000) $ 8,382,000
Noncash items included
in net income (loss):
Deferred income taxes. (589,000) 303,000 (487,000) (848,000) 790,000
Depreciation and
amortization......... 65,000 230,000 876,000 478,000 2,179,000
Equity income from
investment........... (353,000) (228,000) (542,000) (654,000)
Other................. 87,000 67,000 107,000 20,000
Net effect of changes
in brokerage related
assets and
liabilities:
Brokerage
receivables......... (203,000) (1,437,000) (191,292,000) (1,156,000) (266,098,000)
Cash and investments
required to be
segregated under
Federal or other
regulations......... (35,500,000) (148,000,000)
Brokerage payables... 219,483,000 353,007,000
Other changes, net:
Other assets......... 97,000 (113,000) (2,998,000) (2,722,000) (683,000)
Accounts payable,
accrued liabilities
and other........... 649,000 2,095,000 3,101,000 1,973,000 6,320,000
--------- ----------- ------------ ----------- -------------
Net cash provided by
(used in) operating
activities......... 891,000 3,373,000 (7,766,000) (4,131,000) (44,757,000)
--------- ----------- ------------ ----------- -------------
CASH FLOWS FROM
INVESTING ACTIVITIES:
Purchase of property
and equipment........ (124,000) (1,375,000) (8,733,000) (2,502,000) (9,221,000)
Internally developed
software............. (114,000) (2,302,000)
Purchase of equity
investment........... (2,000,000)
Purchase of investment
securities........... (504,000) (337,073,000) (445,765,000)
Sale/maturity of
investment
securities........... 302,070,000 455,544,000
Relocation loan....... (3,147,000)
Reinvestment of equity
investment earnings.. (566,000)
Distributions received
from equity
investment........... 181,000 44,000 408,000 658,000
--------- ----------- ------------ ----------- -------------
Net cash used in
investing
activities......... (124,000) (1,698,000) (45,806,000) (2,094,000) (4,799,000)
--------- ----------- ------------ ----------- -------------
CASH FLOWS FROM
FINANCING ACTIVITIES:
Proceeds from issuance
of common stock, net
of issue costs....... 163,000 46,402,000 (102,000)
Proceeds from issuance
of preferred stock... 12,300,000 11,787,000 11,787,000
Proceeds from exercise
of stock options..... 146,000 310,000 294,000 940,000
Proceeds from exercise
of stock warrants.... 13,000 113,000 113,000
Proceeds from Employee
Stock Purchase Plan.. 309,000
Repurchase of common
stock................ (253,000) (3,800,000)
Increase in bank loan
payable.............. 51,900,000
Proceeds from long-
term note payable.... 2,500,000
Repayment of long-term
note payable......... (1,381,000) (2,500,000) (167,000)
Repayment of capital
leases............... (21,000) (21,000) (23,000) (17,000) (16,000)
--------- ----------- ------------ ----------- -------------
Net cash provided by
(used in) financing
activities......... (111,000) 7,257,000 58,589,000 12,010,000 53,031,000
--------- ----------- ------------ ----------- -------------
INCREASE IN CASH AND
EQUIVALENTS............ 656,000 8,932,000 5,017,000 5,785,000 3,475,000
CASH AND EQUIVALENTS--
Beginning of period.... 36,000 692,000 9,624,000 9,624,000 14,641,000
--------- ----------- ------------ ----------- -------------
CASH AND EQUIVALENTS--
End of period.......... $ 692,000 $ 9,624,000 $ 14,641,000 $15,409,000 $ 18,116,000
========= =========== ============ =========== =============
SUPPLEMENTAL
DISCLOSURES:
Cash paid for
interest............. $ 18,000 $ 399,000 $ 2,013,000 $ 60,000 $ 7,153,000
========= =========== ============ =========== =============
Cash paid for income
taxes................ $ 41,000 $ 830,000 $ 1,025,000 $ 1,025,000 $ 1,205,000
========= =========== ============ =========== =============
Non-cash investing and
financing activities:
Capital expenditures
financed with note
payable/capital
leases............... $ 26,000 $ 2,500,000 $
Tax benefit on
exercise of stock
options and warrants. $ 352,000 $ 352,000 $ 4,224,000
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AT JUNE 30, 1997 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1996 AND 1997 IS UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation--The consolidated financial statements include E*TRADE
Group, Inc. and its subsidiaries (collectively, the "Company"), E*TRADE
Securities, Inc. ("E*TRADE Securities") and E*TRADE Capital, Inc. (formerly,
ET Execution Services, Inc.), securities broker-dealers. The Company has four
offices in California, and as of September 30, 1996 and June 30, 1997,
approximately 25% and 24%, respectively of E*TRADE Securities' customer
accounts were located in California. All intercompany balances and
transactions have been eliminated.
Transaction Revenues--The Company derives revenues from commissions and to a
lesser extent payments from other broker-dealers for order flow related to
customer transactions in equity and debt securities and options. Securities
transactions are recorded on a trade date basis and are executed by
independent broker-dealers. Through June 1996 the Company did not receive or
hold customers' securities or funds. The Company implemented self-clearing
operations and took custody of securities and funds in customer accounts in
July 1996.
Interest, Net of Interest Expense--Prior to July 1996, these amounts
represent the Company's participation in the interest differential on its
customer debit and credit balances through a contractual agreement with its
former clearing broker, and fees on its customer assets invested in money
market accounts. Subsequent to the implementation of self-clearing in July
1996, these amounts primarily represent interest earned by the Company on
credit extended to its customers to finance their purchases of securities on
margin, fees on its customer assets invested in money market accounts and
interest earned on investment securities, offset by interest paid to customers
on certain credit balances and interest paid to other broker/dealers through
the Company's stock loan program.
International Revenue--International revenue represents fees from the
licensing of rights which allow the licensees to offer on-line investing
services under the E*TRADE name in their foreign countries. Under the
agreements the Company will receive ongoing royalties.
Computer Services Revenue--Computer services revenue represents connect time
charges for direct modem access and touch-tone telephone customers. Such
revenues are recorded as earned.
Depreciation and Amortization--Furniture, fixtures and equipment are stated
at cost and are depreciated on a straight-line basis over their estimated
useful lives, generally three to seven years. Leasehold improvements are
amortized over the lesser of their useful lives or the life of the lease.
Technology Development Costs--Technology development costs are charged to
operations as incurred. Technology development costs include costs incurred in
the development and enhancement of software used in connection with services
provided by the Company that do not otherwise qualify as internally developed
software costs. The cost of internally developed software is capitalized and
included in other assets. The costs to develop such software are capitalized
when management authorizes and commits to funding a project it believes will
be completed and used to perform the functions intended and the conceptual
formulation, design and testing of possible software project alternatives have
been completed. Pilot projects and projects where expected future economic
benefits are less than probable are not eligible for capitalization.
Internally developed software costs include payroll and consulting costs, and
are amortized on a straight line basis over
F-7
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(INFORMATION AT JUNE 30, 1997 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1996 AND 1997 IS UNAUDITED)
their estimated useful lives, generally two to three years. No such costs were
capitalized in fiscal 1994 or 1995, $114,000 was capitalized in fiscal 1996
and $2,302,000 was capitalized in the nine months ended June 30, 1997.
Cash Equivalents--For purposes of reporting cash flows, the Company
considers all highly liquid investments with original maturities of three
months or less (except for amounts required to be segregated under Federal or
other regulations or amounts designated as trading securities) to be cash
equivalents.
Cash and Investments Required to be Segregated under Federal or Other
Regulations--Cash and investments required to be segregated under Federal or
other regulations consist primarily of securities purchased under agreements
to resell ("Resale Agreements"). Resale Agreements are accounted for as
collateralized financing transactions and are recorded at their contractual
amounts.
Investments--Investment securities represent a portfolio of commercial
paper, cash and money market funds. The cost of these investments approximates
fair market value, and management has designated them as trading securities.
Equity investment represents the Company's investment in a limited liability
company, Roundtable Partners LLC ("Roundtable"), which is accounted for using
the equity method. The Company's return on its investment in Roundtable is
included in other revenues. Roundtable is a consortium of broker-dealers.
Estimated Fair-Value of Financial Instruments--The Company believes the
amounts presented for financial instruments on the consolidated balance sheet
consisting of cash equivalents, money market funds, commercial paper, and
brokerage receivables and payables to be reasonable estimates of fair-value.
The Company uses available market information as of the balance sheet date and
appropriate valuation methodologies in deriving amounts reported for financial
instruments.
Use of Estimates--The preparation of the Company's consolidated financial
statements in conformity with generally accepted accounting principles
necessarily requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the consolidated balance sheet dates and the
reported amounts of revenues and expenses for the periods presented.
Stock-Based Compensation--As permitted by Statement of Financial Accounting
Standards ("SFAS") No. 123, the Company accounts for its stock-based
compensation on the intrinsic-value method in accordance with Accounting
Principles Board Opinion No. 25.
Advertising Costs--Advertising costs are expensed when the initial
advertisement is run.
Income Taxes--The Company accounts for income taxes in accordance with SFAS
No. 109, Accounting for Income Taxes which requires the recognition of
deferred tax liabilities and assets at tax rates expected to be in effect when
these balances reverse. Future tax benefits attributable to temporary
differences are recognized to the extent that realization of such benefits is
more likely than not.
Long-lived Assets--The Company adopted SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of
effective October 1, 1996. The adoption did not have a material impact on the
financial statements.
F-8
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(INFORMATION AT JUNE 30, 1997 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1996 AND 1997 IS UNAUDITED)
Earnings per Share--Earnings per share is based on the fully diluted
weighted average number of common and common equivalent shares outstanding
during the period. Pursuant to rules of the Securities and Exchange
Commission, all common and common equivalent shares issued and options,
warrants and other rights to acquire shares of common stock at a price less
than the initial public offering price granted by the Company during the 12
months preceding the offering date (using the treasury stock method until
shares are issued) have been included in the computation of common and common
equivalent shares outstanding for all periods prior to the initial public
offering (see Note 7).
Unaudited Interim Information--The consolidated financial information as of
June 30, 1997 and for the nine months ended June 30, 1997 and 1996 is
unaudited. In the opinion of management, such information contains all
adjustments, consisting only of normal recurring accruals, necessary for a
fair presentation of the results of such period.
Recently Issued Accounting Standards--On June 28, 1996, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, effective for transfers of financial assets made after December
31, 1996 except for certain financial assets for which the effective date has
been delayed until 1998 by SFAS No. 127, Deferral of the Effective Date of
Certain Provisions of SFAS No. 125. This new statement provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities. The Company does not expect SFAS No. 125 to
have a material effect on its consolidated financial statements.
In February 1997, the FASB issued SFAS No. 128, Earnings per Share. The
Company is required to adopt SFAS No. 128 in the first quarter of fiscal 1998
and will restate at that time earnings per share ("EPS") data for prior
periods to conform with SFAS No. 128. Earlier application is not permitted.
SFAS No. 128 replaces current EPS reporting requirements and requires a dual
presentation of basic and diluted EPS. Basic EPS excludes dilution and is
computed by dividing net income by the weighted average number of common
shares outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. If SFAS No. 128 had been in effect
during the periods presented, basic EPS would have been $.05, $.16 and ($.05)
for the years ended September 30, 1994, 1995 and 1996, respectively, and
($.09) and $.28 for the nine months ended June 30, 1996 and 1997,
respectively. The method used to calculate diluted EPS under SFAS No. 128 is
the same as the method used to calculate the EPS reported herein.
Reclassifications--Certain items in these financial statements have been
reclassified to conform to the current period presentation.
F-9
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(INFORMATION AT JUNE 30, 1997 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1996 AND 1997 IS UNAUDITED)
2. BROKERAGE RECEIVABLES AND PAYABLES--NET
Brokerage receivables and payables--net consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------- JUNE 30,
1995 1996 1997
---------- ------------ ------------
<S> <C> <C> <C>
Receivable from customers (less allowance
for doubtful accounts of $0, $129,000 and
$236,000 in 1995, 1996 and 1997
respectively)............................ $ -- $168,777,000 $399,332,000
Receivable from brokers, dealers and
clearing organizations:
Net settlement and deposits with clearing
organizations........................... -- 16,018,000 23,741,000
Deposits paid for securities borrowed.... -- 5,804,000 23,575,000
Securities failed to deliver............. -- 214,000 365,000
Other.................................... 1,936,000 2,415,000 12,640,000
---------- ------------ ------------
Total brokerage receivables--net........ $1,936,000 $193,228,000 $459,653,000
========== ============ ============
Payable to customers...................... $ -- $183,561,000 $278,558,000
Payable to brokers, dealers and clearing
organizations:
Deposits received for securities loaned.. -- 33,576,000 288,630,000
Securities failed to receive............. -- 494,000 1,760,000
Other.................................... -- 1,852,000 3,542,000
---------- ------------ ------------
Total brokerage payables................ $ -- $219,483,000 $572,490,000
========== ============ ============
</TABLE>
Receivable from and payable to brokers, dealers and clearing organizations
result from the Company's brokerage activities. Receivable from customers
represents credit extended to customers to finance their purchases of
securities on margin. At September 30, 1996 and June 30, 1997 credit extended
to customers with respect to margin accounts was $171 million and $400 million
respectively. Securities owned by customers are held as collateral for amounts
due on margin balances (the value of which is not reflected on the
accompanying balance sheets). Payable to customers represents free credit
balances and other customer funds pending completion of security transactions.
The Company pays interest on certain customer credit balances (see Note 5).
3. PROPERTY AND EQUIPMENT--NET
Property and equipment--net consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------- JUNE 30,
1995 1996 1997
---------- ---------- -----------
<S> <C> <C> <C>
Furniture and fixtures.................... $ 206,000 $ 706,000 $ 770,000
Equipment................................. 2,199,000 6,221,000 13,940,000
Leasehold improvements.................... 52,000 4,164,000 5,635,000
---------- ---------- -----------
2,457,000 11,091,000 20,345,000
Less: Accumulated depreciation and
amortization............................. 999,000 1,863,000 4,075,000
---------- ---------- -----------
Total..................................... $1,458,000 $9,228,000 $16,270,000
========== ========== ===========
</TABLE>
F-10
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(INFORMATION AT JUNE 30, 1997 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1996 AND 1997 IS UNAUDITED)
4. RELOCATION LOAN RECEIVABLE
During the fourth calendar quarter of 1996, the Company made a relocation
loan to Mr. Christos Cotsakos, its Chief Executive Officer and a Director, in
the aggregate principal amount of $3,147,000. The proceeds of this loan were
used to fund the purchase by Mr. Cotsakos of a personal residence in the
Silicon Valley area. The relocation loan accrues interest at the rate of 7%
per annum which, together with the principal amount, is due and payable in
November 1999. The loan is required to be collateralized by a combination of
assets, including the residence purchased. The due date of the relocation loan
is subject to acceleration upon the occurrence of certain events including the
voluntary cessation of employment with the Company by Mr. Cotsakos.
5. LONG-TERM NOTES PAYABLE AND SHORT-TERM FUNDING
During 1996, the Company used $2.5 million of the proceeds from its initial
public offering (see Note 7) to repay a term loan originally obtained in
February 1996 to finance the purchase of equipment and leasehold improvements.
Interest was accrued at the per annum rate equal to the sum of 2.70% over the
30-Day Commercial Paper Rate as defined. There was no prepayment penalty.
The principal source of financing for E*TRADE Securities' margin lending is
cash balances in customers' accounts and financing obtained from other
broker/dealers through the Company's stock loan program.
For use in its brokerage operations, E*TRADE Securities maintains committed
lines of financing totaling $100 million to provide collateral financing of
customer securities. There were no borrowings outstanding under these lines at
September 30, 1996; at June 30, 1997, $59.1 million was outstanding, which was
repaid on July 3, 1997.
6. INCOME TAXES
The components of income tax expense (benefit) for the years ended September
30 are as follows:
<TABLE>
<CAPTION>
1994 1995 1996
--------- ---------- ---------
<S> <C> <C> <C>
Current:
Federal.................................. $ 11,000 $1,030,000 $ (66,000)
State.................................... 37,000 395,000 (2,000)
--------- ---------- ---------
Total current.......................... 48,000 1,425,000 (68,000)
--------- ---------- ---------
Deferred:
Federal.................................. (563,000) 302,000 (441,000)
State.................................... (26,000) 1,000 (46,000)
--------- ---------- ---------
Total deferred......................... (589,000) 303,000 (487,000)
--------- ---------- ---------
Total tax expense (benefit)................ $(541,000) $1,728,000 $(555,000)
========= ========== =========
</TABLE>
F-11
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(INFORMATION AT JUNE 30, 1997 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1996 AND 1997 IS UNAUDITED)
Deferred income taxes are recorded when revenues and expenses are recognized
in different periods for financial statement and tax return purposes. The
temporary differences and tax carryforwards that created deferred tax assets
at September 30 are as follows:
<TABLE>
<CAPTION>
1994 1995 1996
-------- -------- ---------
<S> <C> <C> <C>
Deferred tax assets:
Reserves and allowances................... $ 26,000 $156,000 $ 215,000
Net operating loss carryforwards.......... 558,000 -- 804,000
Other..................................... 5,000 141,000 226,000
-------- -------- ---------
Total deferred tax assets............... 589,000 297,000 1,245,000
-------- -------- ---------
Deferred tax liabilities:
Depreciation and amortization............. -- 3,000 284,000
Equity investment......................... -- -- 180,000
Other..................................... -- 8,000 8,000
-------- -------- ---------
Total deferred tax liabilities.......... -- 11,000 472,000
-------- -------- ---------
Net deferred tax asset...................... $589,000 $286,000 $ 773,000
======== ======== =========
There were no valuation allowances associated with the deferred tax assets at
September 30, 1994, 1995 and 1996.
The effective tax rates differed from the federal statutory rates as follows
for the years ended September 30:
<CAPTION>
1994 1995 1996
-------- -------- ---------
<S> <C> <C> <C>
Tax expense at federal statutory rate....... 34.0% 35.0% 35.0%
State income taxes, net of federal tax
benefit.................................... 2.8 6.1 2.3
Decrease in federal income tax asset
valuation allowance........................ (260.4) -- --
Other....................................... 1.5 (1.0) 2.8
-------- -------- ---------
Effective tax rate.......................... (222.1)% 40.1% 40.1%
======== ======== =========
</TABLE>
7. STOCKHOLDERS' EQUITY
In September 1995, the Company sold 100,000 shares of Series A Preferred
Stock ("Series A") to General Atlantic Partners for $12,300,000. In April
1996, the Company sold 20,336 shares of Series B Preferred Stock ("Series B")
to Christos Cotsakos, Chief Executive Officer and a Director, and affiliates,
Richard Braddock, and General Atlantic Partners and affiliates for $2,847,000
and incurred issuance costs of $10,000. In June 1996, the Company sold 11,180
shares of Series C Preferred Stock ("Series C") to SOFTBANK Holdings Inc. for
$9,000,000 and incurred issuance costs of $50,000.
The Company executed an initial public offering under the Securities Act of
1933 resulting in the issuance by the Company of 5,026,550 shares of common
stock on August 16, 1996, at a price to the public of $52.8 million. In
connection with this offering, the Company incurred issuance costs of $6.4
million, including underwriting discounts and commissions. Each share of
Series A, Series B and Series C Preferred Stock was automatically converted
into 60 shares of common stock upon the closing of the initial public
offering.
F-12
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(INFORMATION AT JUNE 30, 1997 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1996 AND 1997 IS UNAUDITED)
The Company's stock option plans provide for the granting of nonqualified or
incentive stock options to officers, directors, key employees and consultants
for the purchase of shares of the Company's common stock at a price determined
by the Board of Directors at the date the option is granted. The options are
generally exercisable ratably over a five-year period from the date the option
is granted and expire within ten years from the date of grant.
In April 1993, the stockholders of the Company approved the 1993 Stock
Option Plan (the "1993 Plan"), which authorized 1,800,000 shares of the
Company's common stock as available for the granting of options. Through April
1996, the authorized number of shares was increased to 5,400,000.
In July 1996, the stockholders of the Company approved the 1996 Stock
Incentive Plan (the "1996 Plan") and reserved 4,000,000 shares of common stock
for future grants. Following adoption, no additional grants may be made under
the 1993 Plan. The 1996 Plan is divided into three components: the
Discretionary Option Grant Program, the Stock Issuance Program and the
Automatic Option Grant Program. Under the Discretionary Option Grant Program,
options may be granted to purchase shares of common stock at an exercise price
not less than the fair market value of those shares on the grant date to
eligible employees. The Stock Issuance Program allows for individuals to be
issued shares of common stock directly through the purchase of such shares at
a price not less than the fair market value of those shares at the time of
issuance or as a bonus tied to the performance of services. Under the
Automatic Option Grant Program, options are automatically granted at periodic
intervals to eligible non-employee members of the Board of Directors to
purchase shares of common stock at an exercise price equal to the fair market
value of those shares on the grant date.
In July 1996, the stockholders of the Company approved the 1996 Stock
Purchase Plan ("Stock Purchase Plan") and reserved 650,000 shares of common
stock for sale to employees at a price no less than 85% of the lower of the
fair market value at the beginning of the two-year offering period or the end
of each of the six-month purchase periods. The first purchase date under the
Stock Purchase Plan was January 31, 1997.
During 1994 and 1995, warrants that had been issued to the Company's
creditors in June 1990 in connection with a restructuring agreement (the
"Restructuring Warrants") to purchase 1,235,940 and 1,263,240 shares of common
stock, respectively, were exercised for $210 and $206, respectively. The
remaining Restructuring Warrants expired in June 1995. In January 1995, a
consultant was granted a warrant to purchase 300,000 shares of the Company's
common stock at $.42 per share, of which 29,880 were exercised in fiscal 1995
and the remainder in fiscal 1996.
F-13
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(INFORMATION AT JUNE 30, 1997 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1996 AND 1997 IS UNAUDITED)
A summary of stock option activity follows:
<TABLE>
<CAPTION>
NUMBER OPTION PRICE
OF SHARES PER SHARE
---------- ------------
<S> <C> <C>
Outstanding at September 30, 1993................... 3,210,000 $.13-$.28
Granted........................................... 90,000 $0.28
---------- ------------
Outstanding at September 30, 1994................... 3,300,000 $.13-$.28
Granted........................................... 1,776,000 $.28-$.50
Canceled.......................................... (876,000) $.28-$.42
Exercised......................................... (497,100) $.13-$.50
---------- ------------
Outstanding at September 30, 1995................... 3,702,900 $.13-$.50
Granted........................................... 4,045,000 $2.05-$13.42
Canceled.......................................... (157,200) $.28-$10.50
Exercised......................................... (1,320,060) $.13-$.50
---------- ------------
Outstanding at September 30, 1996................... 6,270,640 $.13-$13.42
Granted........................................... 1,094,000 $9.00-$24.69
Canceled.......................................... (634,200) $.28-$24.63
Exercised......................................... (1,480,320) $.13-$9.50
---------- ------------
Outstanding at June 30, 1997........................ 5,250,120 $.28-$24.69
========== ============
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------------- JUNE 30,
1994 1995 1996 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Options available for grant.......... 1,800,000 900,000 3,184,100 2,297,300
Options exercisable.................. 1,230,000 1,490,000 959,040 687,119
</TABLE>
The Company has a 401(k) salary deferral program, which became effective on
January 1, 1995, for eligible employees who have met certain service
requirements. The Company matches certain employee contributions; additional
contributions to this plan are at the discretion of the Company. Total Company
contribution expense for the years ended September 30, 1994, 1995 and 1996 was
$0, $6,000 and $52,000 respectively.
F-14
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(INFORMATION AT JUNE 30, 1997 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1996 AND 1997 IS UNAUDITED)
8. REGULATORY REQUIREMENTS
E*TRADE Securities is subject to the Uniform Net Capital Rule (the "Rule")
under the Securities Exchange Act of 1934 administered by the Securities and
Exchange Commission and the National Association of Securities Dealers, Inc.,
which requires the maintenance of minimum net capital. E*TRADE Securities has
elected to use the alternative method permitted by the Rule, which requires
that the Company maintain minimum net capital equal to the greater of $250,000
or 2 percent of aggregate debit balances arising from customer transactions,
as defined. E*TRADE Securities had amounts in relation to the Uniform Net
Capital Rule as follows as of September 30, 1996 and June 30, 1997:
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1996 1997
------------- -----------
<S> <C> <C>
Net capital....................................... $17,117,000 $22,906,000
Percentage of aggregate debit balances............ 9.2% 5.4%
Required net capital.............................. $ 3,703,000 $ 8,412,000
Excess net capital................................ $13,414,000 $14,494,000
</TABLE>
Under the alternative method, a broker-dealer may not repay subordinated
borrowings, pay cash dividends or make any unsecured advances or loans to its
parent or employees if such payment would result in net capital of less than
5% of aggregate debit balances or less than 120% of its minimum dollar amount
requirement.
9. LEASE ARRANGEMENTS
The Company leases equipment under capital leases expiring through fiscal
1999. Future minimum lease payments under capital leases as of September 30,
1996, are as follows:
<TABLE>
<S> <C>
Year ending September 30:
1997.............................................................. $27,000
1998.............................................................. 20,000
1999.............................................................. 2,000
-------
Total minimum lease payments........................................ 49,000
Less: Amount representing interest.................................. (5,000)
-------
Present value of minimum lease payments............................. $44,000
=======
</TABLE>
The Company has three non-cancelable operating leases for office facilities
through 2006 and operating leases for equipment through 2001. Future minimum
rental commitments under these leases at September 30, 1996, are as follows:
<TABLE>
<S> <C>
Year ending September 30:
1997........................................................... $6,462,000
1998........................................................... 6,534,000
1999........................................................... 5,502,000
2000........................................................... 2,158,000
2001........................................................... 2,043,000
Thereafter..................................................... 2,912,000
</TABLE>
F-15
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(INFORMATION AT JUNE 30, 1997 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1996 AND 1997 IS UNAUDITED)
Certain leases contain provisions for renewal options and rent escalations
based on increases in certain costs incurred by the lessor. Rent expense for
the years ended September 30, 1994, 1995 and 1996 was approximately $169,000,
$344,000 and $2,441,000, respectively.
10. COMMITMENTS, CONTINGENCIES AND REGULATORY MATTERS
The Company is a defendant in civil actions arising from the normal course
of business. In the opinion of management, these actions are expected to be
resolved with no material effect on the Company's consolidated financial
position or results of operations. During the year ended September 30, 1996,
the Company settled claims made by its former clearing broker. The total
amount of this settlement was $850,000 and is included in general and
administrative expenses. In connection with the settlement agreement, the
Company repurchased all shares of its common stock owned by its former
clearing broker at the date of the settlement for $253,000, which represented
their estimated fair market value.
During the quarter ended March 31, 1997, the Company became aware of several
instances of its non-compliance with applicable broker-dealer regulations. In
particular, the Company failed to comply with applicable advertising
restrictions in one international jurisdiction, and due to a clerical
oversight failed to renew its registration as a broker-dealer in two states.
One of the state jurisdictions, as a condition of renewing the Company's
license as a broker-dealer in that jurisdiction, required the Company to offer
resident customers of that state the ability to rescind (for up to 30 days)
certain securities transactions affected through the Company during the period
January 1, 1997, through April 15, 1997, the date the Company's license was
renewed. The ultimate cost of this action, recorded in the quarter ended June
30, 1997, was $4.3 million.
In March 1996, the Company entered into a five-year employment agreement
with a key executive officer. The employment agreement provides for, among
other things, an annual base salary which is subject to adjustment based on
the Company's performance and a severance payment up to $1,250,000 in the
event of termination of employment under certain defined circumstances.
11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET CREDIT RISK AND
CONCENTRATIONS OF CREDIT RISK
The Company's customer securities activities are transacted on either a cash
or margin basis. In margin transactions, the Company extends credit to the
customer, subject to various regulatory and internal margin requirements,
collateralized by cash and securities in the customer's account. As customers
write option contracts or sell securities short, the Company may incur losses
if the customers do not fulfill their obligations and the collateral in
customer accounts is not sufficient to fully cover losses which customers may
incur from these strategies. To control this risk, the Company monitors
required margin levels daily, and customers are required to deposit additional
collateral, or reduce positions, when necessary.
Through its broker-dealer subsidiaries, the Company loans securities
temporarily to other brokers in connection with its securities lending
activities. The Company receives cash as collateral for the securities loaned.
Increases in security prices may cause the market value of the securities
loaned to exceed the amount of cash received as collateral. In the event the
counterparty to these transactions does not return the loaned securities, the
Company may be exposed to the risk of acquiring the securities at prevailing
market prices in order to satisfy its customer obligations. The Company
controls this risk by requiring credit approvals for counterparties, by
monitoring the market value of securities loaned on a daily basis and by
requiring deposits of additional cash as collateral when necessary.
F-16
<PAGE>
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONCLUDED)
(INFORMATION AT JUNE 30, 1997 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1996 AND 1997 IS UNAUDITED)
The Company is obligated to settle transactions with brokers and/or other
financial institutions even if its customers fail to meet their obligations to
the Company. Customers are required to complete their transactions on
settlement date, generally three business days after trade date. If customers
do not fulfill their contractual obligations, the Company may incur losses.
The Company has established procedures to reduce this risk by requiring that
customers deposit cash and/or securities into their account prior to placing
an order.
The Company may at times maintain inventories in equity securities on both a
long and short basis. While long inventory positions represent the Company's
ownership of securities, short inventory positions represent obligations of
the Company to deliver specified securities at a contracted price, which may
differ from market prices prevailing at the time of completion of the
transaction. Accordingly, both long and short inventory positions may result
in losses or gains to the Company as market values of securities fluctuate. To
mitigate the risk of losses, long and short positions are marked to market
daily and are continuously monitored by the Company.
F-17
<PAGE>
[INSIDE BACK COVER PAGE]
[PICTURES/ARTWORK]
<PAGE>
[OUTSIDE BACK COVER PAGE]
[COMPANY LOGO]
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses payable by the
Registrant in connection with the sale of Common Stock being registered. All
amounts are estimates except the registration fee, the NASD fee and the Nasdaq
National Market.
<TABLE>
<CAPTION>
AMOUNT
TO BE PAID
----------
<S> <C>
Registration fee............................................... $ 64,815
NASD fee....................................................... 21,889
Nasdaq National Market fee..................................... 17,500
Printing and engraving......................................... 100,000
Legal fees and expenses........................................ 400,000
Accounting fees and expenses................................... 250,000
Blue sky fees and expenses..................................... 10,000
Transfer agent fees............................................ 10,000
Miscellaneous.................................................. 325,796
----------
Total........................................................ $1,200,000
==========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the General Corporation Law of the state of Delaware (the
"Delaware Law") empowers a Delaware corporation to indemnify any persons who
are, or are threatened to be made, parties to any threatened, pending or
completed legal action, suit or proceedings, whether civil, criminal,
administrative or investigative (other than action by or in the right of such
corporation), by reason of the fact that such person was an officer or
director of such corporation, or is or was serving at the request of such
corporation as a director, officer, employee or agent of another corporation
or enterprise. The indemnity may include expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually and reasonably
incurred by such person in connection with such action, suit or proceeding,
provided that such officer or director acted in good faith and in a manner he
reasonably believed to be in or not opposed to the corporation's best
interests, and, for criminal proceedings, had no reasonable cause to believe
his conduct was illegal. A Delaware corporation may indemnify officers and
directors in an action by or in the right of the corporation under the same
conditions, except that no indemnification is permitted without judicial
approval if the officer or director is adjudged to be liable to the
corporation in the performance of his duty. Where an officer or director is
successful on the merits or otherwise in the defense of any action referred to
above, the corporation must indemnify him against the expenses which such
officer or director actually and reasonably incurred.
In accordance with the Delaware Law, the Restated Certificate of
Incorporation of the Company contains a provision to limit the personal
liability of the directors of the Registrant for violations of their fiduciary
duty. This provision eliminates each director's liability to the Registrant or
its stockholders for monetary damages except (i) for any breach of the
director's duty of loyalty to the Registrant or its stockholders, (ii) for
acts or omissions not in good faith or which involve intentional misconduct or
a knowing violation of law, (iii) under Section 174 of the Delaware Law
providing for liability of directors for unlawful payment of dividends or
unlawful stock purchases or redemptions, or (iv) for any transaction from
which a director derived an improper personal benefit. The effect of this
provision is to eliminate the personal liability of directors for monetary
damages for actions involving a breach of their fiduciary duty of care,
including any such actions involving gross negligence.
Article 5 of the Restated Bylaws of the Registrant provide for
indemnification of the officers and directors of the Registrant to the fullest
extent permitted by applicable law.
II-1
<PAGE>
In connection with the incorporation of the Registrant into the State of
Delaware, the Registrant entered into indemnification agreements with each
director and certain officers, a form of which is attached as Exhibit 10.1
hereto and incorporated herein by reference. The Indemnification Agreements
provide indemnification to such directors and officers under certain
circumstances for acts or omissions which may not be covered by directors' and
officers' liability insurance. Reference is also made to Section 8 of the
Underwriting Agreement contained in Exhibit 1.1 hereto, indemnifying officers
and directors of the Registrant against certain liabilities.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Since June 30, 1994, the Registrant has sold and issued the following
unregistered securities:
(1) During the period June 30, 1994 through June 30, 1997, the Registrant
granted stock options to employees, directors and consultants under its
1993 Stock Option Plan and 1996 Stock Incentive Plan, covering an aggregate
of 6,895,100 shares of the Company's Common Stock at an average exercise
price of $5.39 per share. Of these, options covering an aggregate of
755,400 shares were cancelled without being exercised. During the same
period, the Registrant sold an aggregate of 2,997,480 shares of its Common
Stock to employees, directors and consultants for cash consideration in the
aggregate amount of $1,317,055 upon the exercise of outstanding stock
options.
(2) On March 30, 1994, the Registrant sold 220,860 shares of Common Stock
to Robert Graham, Roberta Colin, Tracy Henderson and Steve Herrick for
$110,430 in cash.
(3) On May 17, 1994, the Registrant sold 44,116 shares of Common Stock to
17 early stockholders of the Registrant, including co-founders William A.
Porter and Bernard A. Newcomb, for an aggregate price of $441.16 pursuant
to the exercise of warrants.
(4) On September 28, 1995, the Registrant sold 100,000 shares of Series A
Preferred Stock to General Atlantic Partners II, L.P. and GAP Coinvestment
Partners, L.P. for $12,300,000 in cash.
(5) On September 28, 1995, the Registrant sold 29,880 shares of its
Common Stock to a consultant who is now an employee for $12,450 in cash
upon the exercise of a warrant granted on January 3, 1995 to purchase
300,000 shares at $0.416 per share, and on January 31, 1996 sold the
remaining 270,120 shares exercisable under the warrant for $112,550 in
cash.
(6) On April 10, 1996, the Registrant sold 20,336 shares of Series B
Preferred Stock to Christos M. Cotsakos and affiliates, Richard S.
Braddock, General Atlantic Partners II, L.P. and GAP Coinvestment Partners,
L.P. for $2,847,040 in cash.
(7) On March 31, 1996 and June 7, 1996, the Registrant issued 6,096 and
1,421 shares of Common Stock, respectively, to George Hayter, a director of
the Company, for consulting services.
(8) On June 6, 1996, the Registrant sold 11,180 shares of Series C
Preferred Stock to SOFTBANK Holdings Inc. for $9.0 million in cash.
The sales and issuances of securities in the transactions described in
paragraph (1) above were deemed to be exempt from registration under the
Securities Act by virtue of Rule 701 promulgated thereunder in that they were
offered and sold either pursuant to a written compensatory benefit plan or
pursuant to a written contract relating to compensation, as provided by Rule
701, or were deemed to be exempt from registration under the Securities Act by
virtue of Section 4(2) as transactions not involving any public offering.
The sale and issuance of securities in the transactions described in
paragraphs (2) through (8) were deemed to be exempt from registration under
the Securities Act by virtue of Section 4(2) and/or Regulation D promulgated
thereunder as transactions not involving any public offering. The purchasers
in each case represented their intention to acquire the securities for
investment only and not with a view to the distribution thereof. Appropriate
legends are affixed to the stock certificates issued in such transactions. All
recipients either received adequate information about the Registrant or had
access, through employment or other relationships, to such information.
II-2
<PAGE>
In May 1996, E*TRADE Group, Inc., a Delaware corporation ("E*TRADE
Delaware"), was formed and 100 shares of Common Stock were issued to E*TRADE
Group, Inc., a California corporation ("E*TRADE California") for a de minimis
dollar amount. The sale and issuance were deemed to be exempt from
registration under the Securities Act by virtue of Section 4(2) as a
transaction not involving any public offering.
In July 1996, E*TRADE California merged with and into E*TRADE Delaware. In
connection with the merger, E*TRADE Delaware issued an aggregate of 16,501,637
shares of Common Stock to the holders of common stock of E*TRADE California,
such that holders of common stock of E*TRADE California received a
proportionate interest in E*TRADE Delaware Common Stock, without giving effect
to the offering. Likewise, E*TRADE Delaware issued 100,000 shares of Series A
Preferred Stock, 20,336 shares of Series B Preferred Stock, and 11,180 shares
of Series C Preferred Stock to the holders of Series A Preferred Stock, Series
B Preferred Stock, and Series C Preferred Stock, respectively. The issues of
securities were not registered under the Securities Act due to the exemption
from registration thereunder provided by Section 3(a)(9) thereof.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
------- --------------------
<C> <S>
*1.1 Form of Underwriting Agreement.
3.1 Restated Certificate of Incorporation. (Incorporated by reference to
Exhibit 3.3 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
3.2 Restated Bylaws of the Registrant. (Incorporated by reference to
Exhibit 3.4 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
4.1 Specimen of Common Stock Certificate. (Incorporated by reference to
Exhibit 4.1 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
4.2 Reference is hereby made to Exhibits 3.1 and 3.2.
**5.1 Opinion of Brobeck, Phleger & Harrison LLP (as amended).
10.1 Underwriting Agreement dated August 15, 1996, by and among the
Company, Robertson, Stephens & Company LLC, Hambrecht & Quist LLC,
Deutsche Morgan Grenfell/C. J. Lawrence Inc., and the Selling
Stockholders named therein. (Incorporated by reference to Exhibit
10.1 of the Company's Annual Report on form 10-K.)
10.2 Form of Indemnification Agreement entered into between the
Registrant and its directors and certain officers. (Incorporated by
reference to Exhibit 10.1 of the Company's Registration Statement on
Form S-1, Registration Statement No. 333-05525.)
10.3 1983 Employee Incentive Stock Option Plan. (Incorporated by
reference to Exhibit 10.2 of the Company's Registration Statement on
Form S-1, Registration Statement No. 333-05525.)
10.4 1993 Stock Option Plan. (Incorporated by reference to Exhibit 10.3
of the Company's Registration Statement on Form S-1, Registration
Statement No. 333-05525.)
10.5 1996 Stock Incentive Plan. (Incorporated by reference to Exhibit
99.1 of the Company's Registration Statement on Form S-8,
Registration Statement No. 333-12503.)
10.6 401(k) Plan. (Incorporated by reference to Exhibit 10.8 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-05525.)
10.7 1996 Stock Purchase Plan. (Incorporated by reference to Exhibit
99.13 of the Company's Registration Statement on Form S-8,
Registration Statement No. 333-12503.)
10.8 Employee Bonus Plan. (Incorporated by reference to Exhibit 10.10 of
the Company's Registration Statement on Form S-1, Registration
Statement No. 333-05525.)
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
------- --------------------
<C> <S>
10.9 Lease of premises at Four Embarcadero Place, 2400 Geng Road, Palo
Alto, California. (Incorporated by reference to Exhibit 10.11 of
the Company's Registration Statement on Form S-1, Registration
Statement No. 333-05525.)
10.10 Lease of premises at 10951 White Rock Road, Rancho Cordova,
California. (Incorporated by reference to Exhibit 10.12 of the
Company's Registration Statement on Form S-1, Registration
Statement No. 333-05525.)
10.11 Employment Agreement dated March 15, 1996, by and between Christos
M. Cotsakos and the Registrant. (Incorporated by reference to
Exhibit 10.13 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
10.12 Clearing Agreement between E*TRADE Securities, Inc. and Herzog,
Heine, Geduld, Inc. dated May 11, 1994. (Incorporated by reference
to Exhibit 10.14 of the Company's Registration Statement on Form S-
1, Registration Statement No. 333-05525.)
10.13 Guarantee by the Registrant to Herzog, Heine, Geduld, Inc.
(Incorporated by reference to Exhibit 10.15 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
05525.)
+10.14 BETAHOST Master Subscription Agreement between E*TRADE Securities,
Inc. and BETA Systems Inc. dated June 27, 1996. (Incorporated by
reference to Exhibit 10.13 of the Company's Registration Statement
on Form S-1, Registration Statement No. 333-05525.)
10.15 Stock Purchase Agreement among the Registrant, General Atlantic
Partners II, L.P. and GAP Coinvestment Partners, L.P. dated
September 28, 1995. (Incorporated by reference to Exhibit 10.17 of
the Company's Registration Statement on Form S-1, Registration
Statement No. 333-05525.)
10.16 Stock Purchase Agreement among the Registrant, General Atlantic
Partners II, L.P., and GAP Coinvestment Partners, L.P., Richard S.
Braddock and the Cotsakos Group dated April 10, 1996. (Incorporated
by reference to Exhibit 10.18 of the Company's Registration
Statement on Form S-1, Registration Statement No. 333-05525.)
10.17 Stock Purchase Agreement between the Registrant and SOFTBANK
Holdings Inc. dated June 6, 1996. (Incorporated by reference to
Exhibit 10.19 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
10.18 Stockholders Agreement among the Registrant, General Atlantic
Partners II, L.P., GAP Coinvestment Partners, L.P. and the
Stockholders named therein dated September 28, 1995 (the
"Stockholders Agreement"). (Incorporated by reference to Exhibit
10.20 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
10.19 Supplement No. 1 to Stockholders Agreement dated as of April 10,
1996 (Incorporated by reference to Exhibit 10.21 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
05525.)
10.20 Stockholders Agreement Supplement and Amendment dated as of June 6,
(Incorporated by reference to Exhibit 10.22 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
05525.)
10.21 Consulting Agreement between the Registrant and George Hayter dated
as of June 7, 1996. (Incorporated by reference to Exhibit 10.23 of
the Company's Registration Statement on Form S-1, Registration
Statement No. 333-05525.)
**+10.22 License and Service Agreement between the Registrant and VERSUS
Technologies Inc. dated as of January 21, 1997.
*10.23 Form of Loan Agreement between Christos M. Cotsakos and the
Registrant.
*10.24 Management Continuity Agreement dated as of January 1, 1997 between
the Registrant and Kathy Levinson.
*11.1 Statement regarding computation of per share earnings.
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
------- --------------------
<C> <S>
21.1 Subsidiaries of the Registrant. (Incorporated by reference to
Exhibit 21.1 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-05525.)
**23.1 Consent of Independent Auditors.
**23.2 Consent of Counsel (included in Exhibit 5.1).
*24.1 Power of Attorney (see page II-6).
*27.1 Financial Data Schedule as of and for the nine months ended June 30,
1997.
</TABLE>
- --------
+ Confidential treatment has been requested with respect to certain portions
of this exhibit.
* Previously filed.
** Filed herewith.
(b) FINANCIAL STATEMENT SCHEDULES
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
financial statements or notes thereto.
ITEM 17. UNDERTAKINGS
The undersigned Registrant hereby undertakes to provide to the Underwriters
at the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the Delaware General Corporation Law, the Restated
Certificate of Incorporation or the Restated Bylaws of Registrant,
Indemnification Agreements entered into between the Registrant and its
directors and certain of its officers, Underwriting Agreement, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Securities Act, and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a director, officer, or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered hereunder, the
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form
of Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of Prospectus shall
be deemed to be a new Registration Statement relating to the securities
offered therein, and the offering of such securities at that time shall he
deemed to be the initial bona fide offering thereof.
II-5
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS DULY CAUSED THIS AMENDMENT NO. 1 TO THE REGISTRATION STATEMENT TO BE
SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE
CITY OF PALO ALTO, STATE OF CALIFORNIA ON THIS 29TH DAY OF JULY 1997.
E*TRADE Group, Inc.
/s/ Christos M. Cotsakos
By __________________________________
Christos M. Cotsakos
President and Chief Executive
Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
NO 1 TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN
THE CAPACITIES AND ON THE DATES INDICATED:
SIGNATURE TITLE DATE
* Chairman of the
- ------------------------------------- Board July 29, 1997
William A. Porter
* President and Chief
- ------------------------------------- Executive Officer July 29, 1997
Christos M. Cotsakos (principal
executive officer)
/s/ Stephen C. Richards Chief Financial
- ------------------------------------- Officer (principal July 29, 1997
Stephen C. Richards financial and
accounting officer)
*
- ------------------------------------- Director July 29, 1997
Richard S. Braddock
II-6
<PAGE>
SIGNATURE TITLE DATE
* Director July 29, 1997
- -------------------------------------
William E. Ford
* Director July 29, 1997
- -------------------------------------
George Hayter
* Director July 29, 1997
- -------------------------------------
Keith Petty
* Director July 29, 1997
- -------------------------------------
Lewis E. Randall
* Director July 29, 1997
- -------------------------------------
Lester C. Thurow
* By /s/ Stephen C. Richards
----------------------------------
Attorney-in-Fact
II-7
<PAGE>
EXHIBIT 5.1
[LETTERHEAD OF BROBECK, PHLEGER & HARRISON LLP]
July 29, 1997
E*TRADE Group, Inc.
Four Embarcadero Place
2400 Geng Road
Palo Alto, CA 94303
Ladies and Gentlemen:
We have acted as counsel to E*TRADE Group, Inc., a Delaware corporation
(the "Company"), in connection with the registration of up to 8,050,000 shares
of the Company's Common Stock (the "Shares"), as described in the Company's
Registration Statement on FormS-1 filed with the Securities and Exchange
Commission on July 23, 1997 under the Securities Act of 1933, as amended (the
"Registration Statement").
We have examined originals or copies of (i) the Restated Certificate of
Incorporation of the Company; (ii) the Restated Bylaws of the Company; (iii)
certain resolutions of the Board of Directors of the Company; and (iv) such
other documents and records as we have deemed necessary and relevant for the
purposes hereof. In addition, we have relied on certificates of officers of the
Company and certificates of public officials as to certain matters of fact
relating to this opinion and have made such investigations of law as we have
deemed necessary and relevant as a basis hereof.
We have assumed the genuineness of all signatures, the authenticity of
all documents, certificates and records submitted to us as originals, the
conformity to authentic original documents, certificates and records of all such
documentation submitted to us as copies and the truthfulness of all statements
of facts contained therein. Based on the foregoing and subject to the
limitations set forth herein and having due regard for such legal considerations
as we deem relevant, we are of the opinion that the Shares, when issued and sold
in the manner described in the Registration Statement, will be validly issued,
fully paid and nonassessable shares of the Common Stock.
The foregoing opinion is based on and limited to the General Corporation
Law of the State of Delaware and the relevant federal laws of the United States,
and we express no opinion with respect to the laws of any other jurisdiction.
<PAGE>
E*TRADE Group, Inc. July 29, 1997
Page 2
We consent to the use of this opinion as an exhibit to the Registration
Statement, and further consent to the use of our name wherever appearing in the
Registration Statement, including the prospectus constituting a part thereof,
and in any amendment or supplement thereto.
Very truly yours,
BROBECK, PHLEGER & HARRISON LLP
<PAGE>
EXHIBIT 10.22
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL
TREATMENT HAS BEEN REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL
HAS BEEN FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE
COMMISSION PURSUANT TO RULE 24b-2.]
LICENSE AND SERVICES AGREEMENT
This License and Services Agreement ("Agreement") is entered into as
of January 21, 1997 ("Effective Date") among VERSUS Technologies Inc., a
corporation organized under the laws of Canada, located at 181 Bay Street, Suite
3810, Toronto, Ontario M5J 2T3 ("VTI") and VERSUS Brokerage Services Inc., a
corporation organized under the laws of Ontario and a wholly-owned subsidiary of
VTI, located at 181 Bay Street, Suite 3810, Toronto, Ontario M5J 2T3 ("VBSI")
(VTI and VBSI collectively referred to herein as "VERSUS"); and E*TRADE Group,
Inc., a Delaware corporation located at Four Embarcadero Place, 2400 Geng Road,
Palo Alto, CA 94303 ("E*TRADE").
1. Certain Definitions.
-------------------
1.1 "Affiliate" of a party shall mean an entity directly or
indirectly controlling, controlled by or under common control with that party
where control means the ownership or control, directly or indirectly, of more
than fifty percent (50%) of all of the voting power of the shares (or other
securities or rights) entitled to vote for the election of directors or other
governing authority; provided that such entity shall be considered an Affiliate
only for the time during which such control exists.
1.2 "Applicable VERSUS Entity" shall mean VTI or VBSI (depending on
which such entity is then primarily responsible for performing the Services in
Canada or both of such entities if they are both primarily responsible for
performing the Services in Canada).
1.3 "Business Day" shall mean any day in both the United States and
Canada which is not a Saturday, Sunday or official government holiday in either
country.
1.4 "Canadian" shall mean, with reference to a Customer, a Customer
that has, in the case of an individual, a valid Canadian social insurance number
(SIN) and a valid mailing address in Canada (which is not a post office box
number unless there is another valid mailing address in Canada) and, in the case
of any other person or entity that is a Customer, a valid tax identification
number and a valid mailing address in Canada;
<PAGE>
1.5 "Customer" means a Canadian person who receives Services provided
by VERSUS in association with the Licensed Marks.
1.6 "Disclosing Party" shall mean a party hereto that discloses its
Proprietary Information to the other party.
1.7 "E*TRADE Services" shall mean those Services which are provided,
directly or indirectly, solely by E*TRADE pursuant to this Agreement.
1.8 "Improvements" shall mean any updates, upgrades, improvements,
new versions and releases, enhancements or replacements of the Technology or the
VERSUS Retail Core System, as applicable.
1.9 "Licensed Marks" shall mean solely the E*TRADE trademarks, trade
names, logos, and marks specified in Attachment A hereto or which may in the
future be adopted for use by E*TRADE or its Affiliates in connection with
Services offered by E*TRADE or its Affiliates; provided, however, that the
appearance and/or style of the Licensed Marks may change from time to time in
E*TRADE's sole discretion; provided, further, that such changes are made by
E*TRADE to the Licensed Marks for use by E*TRADE, its Affiliates and all other
E*TRADE licensees except to the extent E*TRADE determines that applicable laws,
regulations, local customs, or local usage of other trademarks, tradenames or
logos might prohibit or impede the adoption of such changes by any licensee.
1.10 "Listed Person" shall mean an entity listed in Attachment J, as
amended from time to time pursuant to the provisions of this Agreement.
1.11 "Listed Person Acquisition" shall mean a change of control of VTI
or VBSI by reason of a Listed Person, or a group of persons (including a Listed
Person) acting jointly, becoming a beneficial owner of *** percent (***%) or
more of the then outstanding voting and equity securities of VTI or VBSI, on a
fully diluted basis.
1.12 "Marketing Expenses" shall mean all costs and expenses (other
than costs and expenses arising from data management, printing, distribution and
similar costs that are excluded by E*TRADE from its customary calculation of its
marketing expenses) arising from marketing, promotional and advertising
activities, including advertisement placement, advertisement creation and
employee salaries for employees at least * * * of whose employment
responsibilities involve marketing the Services in association with the Licensed
Marks.
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
2
<PAGE>
1.13 "Net Revenue" shall mean all gross revenue received from third
parties and recognized by the Applicable VERSUS Entity less the provision for
bad debts, all as determined in accordance with Canadian generally accepted
accounting principles.
1.14 "Proprietary Information" of a Disclosing Party shall mean the
following, to the extent previously, currently or subsequently disclosed to the
other party hereunder or otherwise: information relating to products or
technology of the Disclosing Party or the properties, composition, structure,
use or processing thereof, or systems therefor, or to the Disclosing Party's
business (including, without limitation, computer programs, code, algorithms,
schematics, data, know-how, processes, ideas, inventions (whether patentable or
not), names and expertise of employees and consultants, all information relating
to customers and customer transactions and other technical, business, financial,
customer and product development plans, forecasts, strategies and information).
In particular, but without limitation, Technology and Improvements thereto by
whomever made shall be considered Proprietary Information of E*TRADE and the
VERSUS Retail Core System and Improvements thereto by whomever made shall be
considered Proprietary Information of VERSUS.
1.15 "Proprietary Rights" shall mean patent rights, copyrights, trade
secret rights and similar proprietary intellectual property rights.
1.16 "Receiving Party" shall mean a party hereto that receives
Proprietary Information of the other party.
1.17 "Revenues" shall mean all Net Revenue from providing Services to
Customers, in the currency in which such revenue is earned by VERSUS, provided
however, that Revenues do not include trailer fees, interest income, spread
income on client balances, account services and registration fees or fees
derived from the provision of data or other information.
1.18 "Services" shall mean the provision of financial and market
information and data and electronic retail brokerage services to retail
customers using the Technology, Licensed Marks and, in the case of VERSUS, using
the VERSUS Retail Core System, via any and all electronic gateways and
electronic distribution channels including telephone (interactive voice
response).
1.19 "Technology" shall mean software (in object code form), related
technology, content, information, inventions (whether or not patentable), ideas
and know-how owned or controlled by E*TRADE and used by it or its Affiliates as
of the date of this Agreement, and any Improvements thereto made by or for
E*TRADE during the term of this Agreement which are owned or controlled by
E*TRADE or its Affiliates, in connection with the Services offered by E*TRADE or
its Affiliates
3
<PAGE>
(including without limitation the technology and information provided by E*TRADE
as described in Attachment D hereto).
1.20 "Territory" shall mean Canada.
1.21 "United States" shall mean the United States of America.
1.22 "VERSUS Retail Core System" has the meaning set forth in
Attachment C.
2. Technology License.
------------------
2.1 License Grant. Subject to all the terms and limitations of this
-------------
Agreement, E*TRADE hereby grants VTI, with the right to sublicense to VBSI, a
sole and exclusive, perpetual, non-transferable, non-sublicensable (except to
VBSI) license to use the Technology and the associated Proprietary Rights
therein solely for the purpose of using, marketing and providing the Services in
the Territory and only so long as the Applicable VERSUS Entity uses the Licensed
Marks in connection with the provision of all such Services. The foregoing
license is exclusive only in the Territory and no rights to use the Technology
or any associated Proprietary Rights therein are granted by E*TRADE outside of
the Territory (provided the foregoing shall not prevent the use of the E*TRADE
web site). No Services provided under the license will be marketed or provided
directly or indirectly by or under the authority of VERSUS for any direct or
indirect customers who are not Canadian. Any marketing by VERSUS to Customers
outside the Territory shall be done solely in cooperation with E*TRADE (and with
E*TRADE's prior written consent in each instance) and shall be in compliance
with all applicable laws.
2.2 VERSUS agrees not to (i) disassemble, decompile or otherwise
reverse engineer the Technology or otherwise attempt to derive the source code
or algorithms underlying the Technology, or, except as contemplated by this
Agreement, copy or modify the Technology, or allow others to do any of the
foregoing.
2.3 As between the parties, except for the license herein, E*TRADE
and its licensors shall retain and own all right, title and interest in and to
the Technology and all Proprietary Rights thereto.
3. Trademark License.
-----------------
3.1 License to Licensed Marks. Subject to all the terms and
-------------------------
limitations of this Agreement, E*TRADE hereby grants VTI, with the right to
sublicense to VBSI, a sole and exclusive, perpetual, non-transferable, non-
sublicensable (except to VBSI) license to use the Licensed Marks in the
Territory solely in connection with the marketing, promotion and supply of the
Services. The foregoing license is exclusive only
4
<PAGE>
in the Territory and, subject to Section 2.1, no rights to use the Licensed
Marks are granted by E*TRADE outside of the Territory (provided the foregoing
shall not prevent the use of the E*TRADE web site).
3.2 VERSUS acknowledges that the Licensed Marks are owned solely and
exclusively by E*TRADE. VERSUS hereby acknowledges and agrees that, except as
set forth herein, VERSUS has no rights, title or interest in or to the Licensed
Marks and that all use of the Licensed Marks by VERSUS shall inure to the
benefit of E*TRADE. VERSUS agrees not to apply for registration of the Licensed
Marks (or any mark confusingly similar thereto) anywhere in the Territory.
E*TRADE shall apply for and diligently pursue registration of the Licensed Marks
within the Territory at its expense, and, in such event and if applicable,
VERSUS agrees to reasonably assist and cooperate with E*TRADE in connection
therewith at E*TRADE's expense.
3.3 VERSUS acknowledges that, notwithstanding the registration by
E*TRADE of the Licensed Marks and the diligent pursuit by E*TRADE of the
protection of E*TRADE's right, title and interest in the Licensed Marks, E*TRADE
cannot guarantee that no third party anywhere in the world has a legitimate
claim or interest in the Licensed Marks. Notwithstanding the foregoing, VERSUS
requires, and E*TRADE agrees, that, subject to Section 13.1, financial
responsibility and liability for the use by VERSUS of the Licensed Marks solely
within the scope of this Agreement is borne by E*TRADE, and E*TRADE's
responsibility in respect of infringement shall be as set out in Section 13.1.
3.4 E*TRADE shall not itself, and shall not permit any other person
except VERSUS (and its Affiliates which are permitted assignees under Section
23)(or, in respect of the Licensed Marks, without limiting its obligations under
Sections 13.1 and 13.2, shall use reasonable efforts so that any other person
except VERSUS (and its Affiliates which are permitted assignees under Section
23) is not permitted), directly or indirectly to (i) use the Licensed Marks or
Technology in or, in respect of, the Territory, or (ii) use or license any part
of the Technology or E*TRADE Services in or in respect of the Territory, whether
or not in association with the Licensed Marks, for the benefit of any person
other than VERSUS (or its Affiliates which are permitted assignees under Section
23), except in each case to the extent of (A) uses or licenses of the Licensed
Marks or the Technology that do not conflict with E*TRADE's licenses to VERSUS
hereunder and that are unrelated to the provision of the Services, and (B)
marketing or promotional activities engaged in by E*TRADE, its Affiliates or its
licensees that are not primarily directed to the Canadian market for the
Services, subject to Section 9. VERSUS shall not itself nor shall it permit any
other person (other than E*TRADE, its Affiliates and its licensees) to directly
or indirectly provide Services to customers who are not Customers.
3.5 VERSUS shall have the right to continue using the VERSUS
trademarks in association with all aspects of its business and, when promoting
or
5
<PAGE>
identifying Services to Customers, VERSUS may use the VERSUS trademarks in
conjunction with the Licensed Marks. VERSUS shall not use any trademarks, trade
names or logos in connection with the promotion of Services save and except for
the Licensed Marks and the VERSUS trademarks as contemplated by this Section
3.5, third party trademarks used in association with services and products not
offered by E*TRADE (within the scope of agreements with such third parties), and
except as required by law. VERSUS and E*TRADE shall work co-operatively to
determine a suitable means for the use of the Licensed Marks and the VERSUS
trademarks in combination, provided that VERSUS must obtain the prior written
consent of E*TRADE to any use of the Licensed Marks in combination with any
VERSUS trademarks, tradenames or logos other than uses set forth on Attachment A
which are approved by E*TRADE as of the date hereof.
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
3.6 If any product or services, including financial services but
excluding the Services (the "New Services"), are to be offered to Customers
directly or indirectly by E*TRADE or its Affiliates using the Technology or the
Licensed Marks, E*TRADE shall first offer to VERSUS, by written notice delivered
to VERSUS, the sole and exclusive right to offer the New Services to Customers
using the Technology and the Licensed Marks. Such first offer shall be subject
to the terms and conditions of a commercially reasonable license between E*TRADE
and VERSUS, as stipulated by E*TRADE, subject to such modifications as may be
agreed to by the parties. VERSUS shall have * * * from the date of
receipt of E*TRADE's written notice to review the terms of the proposed license
and exercise its right of first offer in respect of such license by delivering a
written notice to E*TRADE that it agrees to offer the New Services to Customers
on the proposed terms of the license. If VERSUS exercises its right of first
offer, the license shall include the grant of a right of sublicense to
sublicensees reasonably acceptable to E*TRADE (provided VERSUS shall remain
involved in the offering of the New Services) and, if the license is in respect
of New Services which are financial services, no upfront license fee will be
payable by VERSUS. If VERSUS does not exercise its right of first offer in
respect of such license within such * * * E*TRADE shall be entitled,
directly or indirectly, to offer the New Services to Customers, provided that if
the opportunity to offer such New Services using the Technology or Licensed
Marks under license is to be offered to a third party, (i) such license shall be
on principal terms substantively no more favorable to such third party than the
license terms offered to VERSUS; (ii) the Marketing Expenses per annum required
of such third party, expressed as a dollar amount, shall not be less than the
dollar amount of Marketing Expenses per annum required of VERSUS under this
Agreement; and (iii) in the case of a license in respect of financial services,
VERSUS
6
<PAGE>
shall be entitled to a mutually determined percentage of the royalties payable
to E*TRADE under such license.
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
4. Up-Front Payments; Royalties; Records; Audit.
--------------------------------------------
4.1 As partial consideration for this Agreement, the Applicable
VERSUS Entity will pay E*TRADE fees aggregating * * * , which shall be
payable
* * * after the Effective Date of this Agreement, as set forth in
Attachment E hereto. The parties agree that the aggregate fees shall be
comprised of separate fees of * * * payable for use of the Licensed
Marks and * * * for use of the Technology and E*TRADE Services.
4.2 The Applicable VERSUS Entity will also pay ongoing aggregate
royalties ("Royalties") equal to * * * percent ( * * * %) of
its Revenues from any Services provided by or under the authority of VERSUS.
The parties agree that these aggregate Royalties shall be comprised of separate
royalties of * * * percent ( * * * %) of Revenues from Services
payable for use of the Licensed Marks and * * * percent ( * * *
%) of Revenues from Services for use of the Technology and E*TRADE Services.
4.3 Royalties shall be paid within * * * Business Days after
the end of each * * * with respect to Revenues recorded in that
quarter. Notwithstanding anything to the contrary in Section 4.2, Royalties
with respect to Revenues will be paid by the Applicable VERSUS Entity in the
currency in which such Revenues were received and will be subject to any local
applicable laws or regulations. Any overdue amounts with respect to Royalties
or other payments hereunder shall bear interest at the rate of eighteen (18%)
per cent per annum (based on a year of 360 days) or the maximum rate permitted
under applicable law, whichever is less. Each of VERSUS and E*TRADE shall be
responsible for the payment of any and all applicable taxes and duties in
respect of any payments made under this Agreement by it to the other (other than
taxes based on income). Each of VERSUS and E*TRADE shall be entitled to deduct
and remit withholding taxes on amounts payable under this Agreement to the other
as may be required by applicable law. In the event that either VERSUS or
E*TRADE becomes liable to pay any taxes or related interest and penalties as a
result of its not withholding any taxes required to be withheld by it under
applicable law, the other party shall indemnify and hold such party harmless in
respect thereof.
7
<PAGE>
4.4 VERSUS shall keep and maintain detailed and accurate books and
records with regard to Revenues, Royalties and the calculation thereof at such
address(es) as it shall notify E*TRADE of in writing from time to time. E*TRADE
or its representatives (who shall be reasonably acceptable to VERSUS) shall be
entitled to
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
review and audit such books and records and/or compliance with the terms of this
Agreement from time to time during normal business hours upon reasonable notice
to VERSUS and copy pertinent materials from such books and records relating to
the audit, all at E*TRADE's expense; provided that VERSUS will bear any such
expense if the review or audit shows an underpayment of more than * * *
percent (* * * %) for the period audited. All deficiencies in payments
shown by any such audit shall be immediately paid by VBSI along with interest
calculated as provided in Section 4.3. All overpayments of Royalties made by
VBSI shall be repaid by E*TRADE to VBSI within ten (10) Business Days of the
date when E*TRADE receives written notice of its receipt of such overpayment
together with reasonably detailed supporting documentation in connection
therewith.
5. VERSUS Obligations. Subject to the provisions hereof, each
------------------
Applicable VERSUS Entity shall use best efforts to provide and market the
Services under the licenses provided hereunder. In connection with its
obligations hereunder, each Applicable VERSUS Entity shall (and as to Sections
5(i) through 5(iii) subject to applicable law and VERSUS' ability to obtain the
necessary regulatory approvals):
(i) subject to Section 3.5, use its best efforts to market and promote
the Services in Canada using the Licensed Marks exclusively, but in any case
shall spend no less than the minimum amounts per each calendar year for
Marketing Expenses as specified in Attachment E hereto with respect to the
provision of Services to Customers; provided that it may reduce or suspend its
marketing, advertising and promotional activities below such amounts specified
in Attachment E (with E*TRADE's prior written consent, which shall not be
unreasonably withheld) if it is encountering difficulties in properly servicing
current demand for Services, or expects to encounter difficulties in properly
servicing additional demand for the Services;
(ii) meet minimum standards for marketing, customer service,
operational reliability, performance and technological development of the
Services as specified in Attachment F hereto. Attachment F is for the mutual
benefit of the parties and may be amended as agreed to from time to time by the
parties. Such minimum
8
<PAGE>
standards also include the standards, functional and performance requirements as
set forth in the Product/Service Requirements document in Attachment B and the
System Architecture document in Attachment C (and any subsequent versions agreed
upon by the parties);
(iii) provide regulatory and operational compliance and customer
service reasonably necessary for it to provide the Services in the jurisdictions
in Canada in which the Services are offered by VERSUS. Prior to providing any
Services to Customers, each Applicable VERSUS Entity shall ensure that the
Services meet all applicable Canadian securities and other regulatory standards
and requirements in the jurisdictions in which the Services are provided by it);
and
(iv) diligently pursue the necessary regulatory approvals for the
provision of the Services to Customers in all Canadian provinces.
6. Quality Standards.
-----------------
6.1 Subject to Section 5(ii) and applicable law (including applicable
regulatory requirements), E*TRADE shall establish reasonable quality standards
for the Services provided under the Licensed Marks for the purpose of protecting
the Licensed Marks as provided herein. The Applicable VERSUS Entity shall
provide E*TRADE with access, at no expense to E*TRADE, to samples of the
Services in the form that it intends to provide them under the Licensed Marks to
allow E*TRADE to review the quality of the Services, and, if the samples meet
E*TRADE's quality control requirements, E*TRADE shall approve the level of
quality of such samples. Thereafter, upon the request of E*TRADE, the
Applicable VERSUS Entity shall furnish, at no expense to E*TRADE, production
samples of the Services it intends to sell under the Licensed Marks to allow
E*TRADE to monitor the quality of the Services.
6.2 The Applicable VERSUS Entity agrees to adopt the level of quality
as set forth in Section 6.1 hereof for the Services provided under the Licensed
Marks as the minimum standard of quality for the Services.
6.3 E*TRADE shall have the right to request the Applicable VERSUS
Entity to make any changes and/or corrections to the Services provided by it
under the Licensed Marks as may be required to prevent an erosion of the
goodwill associated with the Licensed Marks, and to maintain the quality
standard prescribed in Section 6.1 above, and, subject to applicable law and
Section 8.6, the Applicable VERSUS Entity agrees to make and incorporate said
changes or corrections at its sole cost and expense.
6.4 The Applicable VERSUS Entity shall have the right to create and
distribute promotional and marketing literature and materials for the Services
using the Licensed Marks and materials and content provided by E*TRADE
hereunder. The Applicable VERSUS Entity shall furnish to E*TRADE, at no expense
to E*TRADE,
9
<PAGE>
samples of all literature and materials containing the Licensed Marks that it
distributes or intends to distribute prior to any distribution thereof. E*TRADE
shall control the quality (but not the Canadian content) of all promotional and
marketing literature and materials bearing the Licensed Marks and the Applicable
VERSUS Entity's use of the Licensed Marks. Such quality control must be
necessary, in E*TRADE's reasonable determination, to the preservation of
E*TRADE's interest in the Licensed Marks, the "look and feel" and value
propositions associated with the Licensed Marks, and other similar quality
related standards. If E*TRADE believes that the Licensed Marks are being used
by the Applicable VERSUS Entity in a manner likely to diminish E*TRADE's rights
in or protection of the Licensed Marks (other than uses which are approved as of
the date hereof by E*TRADE and are set forth on Attachment A and uses which are
governed by applicable Canadian law with which VERSUS must comply), the
Applicable VERSUS Entity agrees, at its sole cost and expense, to make whatever
changes and/or corrections E*TRADE deems necessary to protect the Licensed
Marks.
6.5 VERSUS agrees that it shall not engage, participate or otherwise
become involved in any activity or course of action that diminishes and/or
tarnishes the image and/or reputation of any Licensed Mark.
6.6 E*TRADE shall have the right to inspect VERSUS' operations and
facilities during normal business hours upon reasonable prior notice, to the
extent reasonably necessary to ensure that E*TRADE's quality standards have been
and are being met by VERSUS. VERSUS shall provide E*TRADE with monthly reports
(no later than ten (10) days after the end of each calendar month) no more
detailed than VERSUS' internal reports, taking into account E*TRADE's advice
when formulating VERSUS' internal format, for E*TRADE to evaluate VERSUS'
operational efficiency and controls with respect to the Services as outlined in
the Measures of Operational Efficiency and Controls document in Attachment G
hereto which may be amended from time to time upon mutual agreement by the
parties hereto) and to obtain reasonably detailed information on the amount of
Royalties to be paid for each such month in the form of the report set out in
Attachment G. From and after six (6) months following the date of this
Agreement, VERSUS will use reasonable efforts to deliver to E*TRADE reports in
the form set forth in Attachment G, which reports shall contain information
collected for each calendar week and are to be delivered promptly after the end
of each such week.
6.7 VERSUS agrees to comply with all applicable laws in the Territory
and, at all times, to conduct its activities under this Agreement in a lawful
manner.
6.8 VERSUS agrees to use the Licensed Marks in accordance with this
Agreement and only in connection with the Services.
6.9 E*TRADE shall use reasonable efforts to inform VERSUS of all of
its marketing initiatives and advertising campaigns that would be reasonably
likely to
10
<PAGE>
significantly affect the Canadian market for the Services prior to use. Upon
request by VERSUS and subject to availability, E*TRADE shall provide a
reasonable number of copies of its advertising and promotional materials to
assist VERSUS in the development of its own such materials for the Canadian
market. E*TRADE and VERSUS shall work together cooperatively to determine the
circumstances in which a reference to the availability of the Services to
Customers through VERSUS should be made in E*TRADE's advertising and promotional
materials, provided that the final determination shall be within E*TRADE's sole
discretion. Notwithstanding the foregoing, E*TRADE shall include an appropriate
reference approved by VERSUS on its World Wide Web home page (as well as certain
of its advertising and promotional materials as determined in E*TRADE's sole
discretion) that Services are available to Customers through the Applicable
VERSUS Entity in the jurisdictions within Canada in which VERSUS is offering
such Services.
6.10 With respect to approvals required under Sections 3.5, 6.1 and
6.4, if E*TRADE does not respond within ten (10) Business Days after receipt of
the request for approval, either approving or disapproving the proposed action
or materials, E*TRADE shall be deemed to have given its approval to such action
or materials.
7. Use and Display of Licensed Marks.
---------------------------------
7.1 The Applicable VERSUS Entity acknowledges and agrees that the
presentation and image of the Licensed Marks should be of a uniform and
consistent quality with respect to all services, activities and products
associated with the Licensed Marks. Accordingly, subject to Section 3.5 and
applicable law, the Applicable VERSUS Entity acknowledges and agrees to use the
Licensed Marks in accordance with E*TRADE's reasonable standards for the
Licensed Marks, including the standards referred to in Section 7.2 provided that
E*TRADE's judgment as to the reasonableness of any such standards shall be
determinative.
7.2 All usage by the Applicable VERSUS Entity of the Licensed Marks
shall include the registered trademark symbol and shall be in the following
form, as appropriate: [Licensed Mark](TM), until the applicable trademark has
been registered, or [Licensed Mark](R), after the applicable trademark has been
registered, except for such non-compliance as is consistent with E*TRADE's then
current usage. All literature and materials printed, distributed or
electronically transmitted by the Applicable VERSUS Entity and containing the
Licensed Marks shall include the following notice (except for such non-
compliance as is consistent with E*TRADE's then current usage) in close
proximity to the Licensed Marks:
[Licensed Mark] is a trademark of E*Trade Group, Inc. used under
license.
11
<PAGE>
8. E*TRADE Technology and Services and VERSUS Technology.
-----------------------------------------------------
8.1 To carry on the physical transfer of Technology from E*TRADE to
the Applicable VERSUS Entity, E*TRADE shall provide to the Applicable VERSUS
Entity, as soon as reasonably practicable after the Effective Date of this
Agreement, Technology in tangible form (including but not limited to those items
described in Attachment D) as would be reasonably necessary for it to provide
the Services. E*TRADE agrees to undertake and provide services related to the
Technology and Services as specified in Attachment D. Notwithstanding anything
to the contrary herein, all Improvements to the Technology will only be required
to be provided by E*TRADE to the Applicable VERSUS Entity within a reasonable
time after E*TRADE makes the same available for distribution to its customers
and the Applicable VERSUS Entity shall have no less priority in this regard than
other licensees with similar licenses. The parties shall use their best efforts
to work together to implement the Technology so that the Applicable VERSUS
Entity may launch the Services by February 1, 1997. Any Improvements to that
portion of the Technology indicated as being owned by E*TRADE in the System
Architecture document set forth in Attachment C and in Attachment D (whether or
not patentable or copyrightable) that are developed by either party shall be
owned solely by E*TRADE (provided that if the Applicable VERSUS Entity creates
such an Improvement it shall retain perpetual license rights in respect
thereof). E*TRADE shall have the right, at its own expense, and solely in its
own name, to apply for, prosecute and defend its Proprietary Rights with respect
thereto. VERSUS agrees to and hereby makes any assignments necessary to
accomplish the foregoing ownership, will otherwise cooperate with E*TRADE to
achieve such ownership and will aid in any application for registration and
protection of such Proprietary Rights at E*TRADE's expense.
8.2 The VERSUS Retail Core System, and all specific Improvements to
that portion of such system indicated as being owned by VERSUS in the System
Architecture document set forth in Attachment C (whether or not patentable or
copyrightable) that are developed by either party shall be owned solely by
VERSUS (provided that if E*TRADE creates such an Improvement it shall retain
perpetual license rights in respect thereof). VERSUS shall have the right, at
its own expense, and solely in its own name, to apply for, prosecute and defend
its Proprietary Rights with respect thereto. E*TRADE agrees to and hereby makes
any assignments necessary to accomplish the foregoing ownership, will otherwise
reasonably cooperate with VERSUS to achieve such ownership and will aid in any
application for registration and protection of such Proprietary Rights at
VERSUS' expense.
8.3 E*TRADE shall perform or provide all of the E*TRADE Services
reasonably necessary to support the provision of the Services to Customers by
the Applicable VERSUS Entity. The E*TRADE Services shall include the services
described in Attachments B and D. The E*TRADE Services shall also include
integration services to be performed by E*TRADE with the assistance of the
Applicable
12
<PAGE>
VERSUS Entity in order to adapt and Canadianize the Technology and the Services
to facilitate the provision of Services to Customers in accordance with the
milestone dates contemplated by Attachment H hereto and on an ongoing basis. As
part of the E*TRADE Services, E*TRADE shall provide in a timely manner such
changes to the Technology and the Services as VERSUS may reasonably require in
order to comply with Canadian regulatory and market requirements, provided,
however, that any extraordinary costs incurred by E*TRADE in connection
therewith shall not be deemed to be covered by the fees payable to E*TRADE
hereunder and shall be promptly reimbursed by VERSUS. E*TRADE agrees to provide
the Applicable VERSUS Entity with prior written notice of any such extraordinary
costs prior to incurring any such costs and that such costs must be agreed to by
VERSUS before they are incurred. In the absence of such notice and agreement,
such costs shall not be reimbursable by VERSUS and E*TRADE shall have no
obligation to provide the changes that would have given rise to the
extraordinary costs which have not been approved. In connection with the
foregoing, the parties shall use their best efforts to have their mutual
technologies and systems fully integrated, tested and available to provide the
Services to Customers on or before February 15, 1997.
8.4 E*TRADE will provide a reasonable amount of training in respect
of the Technology and Services for the Applicable VERSUS Entity's personnel,
including customer service, account opening and operations, at the E*TRADE's
facilities and at mutually agreeable times. During the initial
development/launch period, E*TRADE will provide additional reasonable support
(whether by phone or fax or occasionally in person in Palo Alto or Toronto) in
connection with the initial launch of the Services. The parties agree that in-
person support will be provided primarily in Palo Alto and only occasionally in
Toronto. Each party will pay its own travel, room and board and other out-of-
pocket expenses incurred in connection with any activity under this Section 8.4
although extraordinary costs incurred by E*TRADE in fulfilling its obligations
in the preceding sentence shall be reimbursed by VERSUS promptly and shall not
be costs that are deemed to be included in fees that are otherwise payable by
VERSUS to E*TRADE hereunder. E*TRADE agrees to provide the Applicable VERSUS
Entity with prior written notice of any such extraordinary costs prior to
incurring any such costs and that such costs must be agreed to by VERSUS before
they are incurred. In the absence of such notice and agreement, such costs
shall not be reimbursable by VERSUS and E*TRADE shall have no obligation to
provide the changes that would have given rise to the extraordinary costs which
have not been approved.
8.5 Subject to Section 8.6, E*TRADE shall use reasonable efforts to
remain competitive and to continually improve and upgrade its Technology,
systems, facilities, and E*TRADE Services to facilitate the marketing of the
Services by the Applicable VERSUS Entity to Customers.
8.6 E*TRADE and VERSUS shall work to ensure the continuing
compatibility of the Technology with the VERSUS Retail Core System for the
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<PAGE>
performance of Services to Customers by the Applicable VERSUS Entity including
necessary compliance with Canadian legal and market requirements. No change or
Improvement shall be made by any party hereto to the Technology, the VERSUS
Retail Core System or the Services which would reasonably be expected to result
in incompatibility in respect of the parties' respective systems, or non-
compliance with Canadian legal requirements, or restrictions on VERSUS' or its
Customers' ability to use the Services in accordance with this Agreement,
without the prior written approval of the party that has not made such change or
Improvement, which approval shall not be unreasonably withheld. E*TRADE and
VERSUS shall create and maintain a change management process to ensure
compliance with this Section 8.6 and such process will involve the nomination of
two (2) representatives by each of E*TRADE and VERSUS to establish a change
management committee to review, coordinate, manage and approve technology and
service changes.
8.7 E*TRADE and VERSUS shall use reasonable efforts to use their
respective buying power to help the other to receive, participate in, or benefit
from the services negotiated by it in the course of operating, and promoting
Services around the world so long as, with respect to VERSUS, such services are
used to provide Services in accordance with this Agreement and, with respect to
E*TRADE, that E*TRADE's use of its reasonable efforts shall extend without
limitation to providing VERSUS with the services provided to E*TRADE and its
Affiliates by Quote.com, PR Newswire, First Call, Baseline, CompuServe, America
Online, Microsoft, Intuit and Quicken. The parties agree that the third party
services listed and to the extent described in Attachment I hereto are available
as of the Effective Date, subject to any rights of such third party service
providers to cease providing such services to any party hereunder.
9. Transfer of Customer Accounts; Services to E*TRADE Customers.
------------------------------------------------------------
The Applicable VERSUS Entity shall not open any accounts for customers who are
not Customers. E*TRADE shall not open any accounts for Canadian customers of
the Services unless they have a valid mailing address in the United States.
Each party shall refer such Customers for whom they may not open accounts in
accordance with the prior sentence to the other party. The parties shall work
together to transfer to the Applicable VERSUS Entity any existing E*TRADE
accounts for Customers.
10. Representations and Warranties.
------------------------------
10.1 Representations and Warranties of E*TRADE. E*TRADE represents,
-----------------------------------------
warrants and agrees that:
(i) it is a corporation duly organized, validly existing and in good
standing under the laws of the State of Delaware and it has the corporate power
and is authorized under its Certificate of Incorporation and its Bylaws to carry
on its business as now conducted;
14
<PAGE>
(ii) it has performed all corporate actions and received all corporate
authorizations necessary to execute and deliver this Agreement and to perform
its obligations hereunder;
(iii) it has and shall maintain the power and authority and all
material governmental licenses, authorizations, consents and approvals to be
obtained within the United States to own its assets, carry on its business and
to execute, deliver, and perform its obligations under this Agreement;
(iv) there are no (A) non-governmental third parties and (B)
governmental or regulatory entities in the United States who are entitled to any
notice of the transaction, licenses and services contemplated hereunder or whose
consent is required to be obtained by E*TRADE for the consummation of the
transaction contemplated hereunder;
(v) to the best of its knowledge (without limiting its liability under
Section 13.1), it and its licensors are the sole and rightful owners of all
right, title and interest in and to the Technology and the Licensed Marks and
all related Proprietary Rights therein and it has the unrestricted right to
market, license and exploit the Technology and the Licensed Marks;
(vi) to the best of its knowledge (without limiting its liability
under Section 13.1), no claims have been made in respect of the Technology or
Licensed Marks and no demands of any third party have been made pertaining to
them, and no proceedings have been instituted or are pending or threatened that
challenge the rights of E*TRADE in respect thereof;
(vii) all E*TRADE Services, will be provided by E*TRADE in a
professional, diligent and timely manner using staff knowledgeable and suitably
qualified for the performance of the respective tasks for which they are
responsible and it will use reasonable efforts, subject to Section 8.7, to
ensure that the quality and reliability of the E*TRADE Services are no less
favorable to VERSUS than the equivalent services provided by it for its own
purposes or for its licensees;
(viii) E*TRADE has filed for Canadian trademark registration with
the Canadian Trademarks Office for the Licensed Marks noted on Attachment A and
the examiner has indicated prior to the date hereof that he does not anticipate
any attempt by third parties to block such registration;
(ix) E*TRADE shall not directly or indirectly apply for registration
as a broker or dealer or operate as a broker or dealer in any jurisdiction in
Canada under Canadian securities laws except (A) to the extent it is required by
law to register for purposes of this Agreement or (B) pursuant to its exercise
of its remedies upon the occurrence of any event giving it the right to
terminate this Agreement,
15
<PAGE>
following its giving notice of the termination of this Agreement and provided,
further, that in the event E*TRADE is required to register pursuant to the
operation of clause (ix)(A), it shall not operate the registered entity as a
broker or dealer or otherwise use such registration to intentionally, in either
case, divert business involving the Technology or the Licensed Marks from the
business(es) of the Applicable VERSUS Entity; and
(x) OTHER THAN THOSE SET FORTH ABOVE, E*TRADE MAKES NO WARRANTIES TO
ANY PERSON OR ENTITY WITH RESPECT TO ANY TECHNOLOGY, LICENSED MARKS, GOODS,
SERVICES, RIGHTS OR OTHER SUBJECT MATTER OF THIS AGREEMENT ALL OF WHICH ARE
PROVIDED "AS IS," AND HEREBY DISCLAIMS ALL IMPLIED WARRANTIES, INCLUDING WITHOUT
LIMITATION WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE
AND (WITHOUT LIMITING ITS LIABILITY UNDER SECTION 13.1) NONINFRINGEMENT.
10.2 Representations and Warranties of VTI and VBSI. VTI and VBSI
----------------------------------------------
each represents, warrants and agrees that:
(i) it is a corporation duly organized, validly existing and in good
standing under the laws of the jurisdiction of its incorporation; and it has the
corporate power and is authorized under its Articles of Incorporation and its
Bylaws to carry on its business as now conducted;
(ii) it has performed all corporate actions and received all corporate
authorizations necessary to execute and deliver this Agreement and to perform
its obligations hereunder;
(iii) it has and shall maintain the power and authority and all
material governmental licenses, authorizations, consents and approvals to be
obtained in Canada to own its assets, carry on its business and to execute,
deliver, and perform its obligations under this Agreement;
(iv) it is in compliance with all requirements of any Canadian, or to
the best of its knowledge, any other law (statutory or common), treaty, rule or
regulation or determination of an arbitrator or of a governmental authority, in
each case applicable to or binding upon it or any of its property or to which
the Services or any of its business related to the Services is subject, except
where failure to be in compliance could not reasonably be expected to have a
material adverse change in, or a material adverse effect upon, the operations,
business, properties, condition (financial or otherwise) or prospects of VERSUS
and its Affiliates taken as a whole;
(v) there are no (A) non-governmental third parties or (B)
governmental or regulatory entities in Canada who are entitled to any notice of
the
16
<PAGE>
transaction contemplated hereunder or whose consent is required to be obtained
by VERSUS for the consummation of the transaction contemplated hereunder;
(vi) the overall fees for Services provided by the Applicable VERSUS
Entity shall be at levels that are competitive with its major competitors in the
Canadian market;
(vii) the Applicable VERSUS Entity shall use its best efforts
during the term of this Agreement to develop, market and distribute the Services
and that all Services distributed under the Licensed Marks will be subject to
the quality control measures as contemplated by this Agreement;
(viii) if E*TRADE is required to directly or indirectly register as
a broker or dealer in any Canadian jurisdiction for purposes of this Agreement,
the Applicable VERSUS Entity shall provide E*TRADE with office space within its
facilities at a reasonable cost, subject to applicable law, the terms of
VERSUS's lease, and availability, provided VERSUS shall make reasonable efforts
to accommodate E*TRADE in this regard; and
(ix) it does not currently, and will not during the term of this
Agreement, represent or promote any services or products that intentionally
divert business away from the business(es) operated by the Applicable VERSUS
Entity that use the Technology or the Licensed Marks. The Applicable VERSUS
Entity will conduct its business in a manner that reflects favorably on the
Technology and the Licensed Marks.
11. Intentionally Omitted.
---------------------
12. Confidentiality. Each party recognizes the importance to the
---------------
other of the other's Proprietary Information. In particular each party
recognizes that the technology and Proprietary Information of the other party
(and the confidential nature thereof) are critical to the business of the other
party and that it would not enter into this Agreement without assurance that
such technology and information and the value thereof will be protected as
provided in this Section 12 and elsewhere in this Agreement. Accordingly, each
party agrees as follows:
12.1 The Receiving Party agrees (i) to hold the Disclosing Party's
Proprietary Information in confidence and to take all reasonable precautions to
protect such Proprietary Information (including, without limitation, all
precautions the Receiving Party employs with respect to its confidential
materials), (ii) not to divulge any such Proprietary Information or any
information derived therefrom to any third person, (iii) not to make any use
whatsoever at any time of such Proprietary Information except as expressly
authorized in this Agreement, and (iv) not to remove or export from the United
States or reexport any such Proprietary Information or any direct product
thereof (e.g., Technology by whomever made) to Afghanistan, the Peoples'
----
Republic of China or
17
<PAGE>
any Group Q, S, W, Y or Z country (as specified in Supplement No. 1 to Section
770 of the U.S. Export Administration Regulations, or a successor thereto) or
otherwise except in compliance with and with all licenses and approvals required
under applicable export laws and regulations, including without limitation,
those of the U.S. Department of Commerce. Any employee or contractor given
access to any such Proprietary Information must have a legitimate "need to know"
and shall be similarly bound in writing. Without granting any right or license,
the Disclosing Party agrees that the foregoing clauses (i), (ii) and (iii) shall
not apply with respect to information the Receiving Party can document (A) is in
or (through no improper action or inaction by the Receiving Party or any
Affiliate, agent or employee) enters the public domain (and is readily available
without substantial effort), (B) was rightfully in its possession or known by it
prior to receipt from the Disclosing Party, (C) was rightfully disclosed to it
by another person without restriction, (D) was independently developed by it by
persons without access to such information and without use of any Proprietary
Information of the Disclosing Party or (E) was required to be disclosed in
accordance with applicable law provided that reasonable efforts are undertaken
by the Receiving Party to minimize the extent of any required disclosure and to
obtain an undertaking from the recipient to maintain the confidentiality
thereof. The Receiving Party must promptly notify the Disclosing Party of any
information it believes comes within any circumstance listed in the immediately
preceding sentence and will bear the burden of proving the existence of any such
circumstance by clear and convincing evidence. Each party's obligations under
this Section 12.1 (except under clause (iv) of the first sentence) shall
terminate, with respect to any particular information, ten (10) years after the
date of disclosure of such information.
12.2 The Receiving Party acknowledges and agrees that due to the
unique nature of the Disclosing Party's Proprietary Information, there can be no
adequate remedy at law for any breach of its obligations hereunder, that any
such breach may allow the Receiving Party or third parties to unfairly compete
with the Disclosing Party resulting in irreparable harm to the Disclosing Party,
and therefore, that upon any such breach or any threat thereof, the Disclosing
Party shall be entitled to appropriate equitable relief in addition to whatever
remedies it might have at law and to be indemnified by the Receiving Party from
any loss or harm, including, without limitation, lost profits and attorney's
fees, in connection with any breach or enforcement of the Receiving Party's
obligations hereunder or the unauthorized use or release of any such Proprietary
Information. The Receiving Party will notify the Disclosing Party in writing
immediately upon the occurrence of any such unauthorized release or other
breach. Any breach of this Section 12 will constitute a material breach of this
Agreement.
13. Indemnification; Proprietary Rights.
-----------------------------------
13.1 E*TRADE shall indemnify and hold harmless VERSUS and its
Customers from and against any damages, costs, and attorneys' fees, if any,
finally awarded in any suit or the amount of the settlement thereof resulting
from a claim by a
18
<PAGE>
third party that the Technology, Licensed Marks or E*TRADE Services infringe any
United States or Canadian Proprietary Rights, and all costs and damages arising
in connection therewith, provided that (i) E*TRADE is promptly notified of any
and all threats, claims and proceedings related thereto, (ii) E*TRADE shall have
sole control of the defense and/or settlement thereof, (iii) VERSUS furnishes to
E*TRADE, upon request, information available to VERSUS for such defense, and
(iv) VERSUS provides E*TRADE with reasonable assistance at E*TRADE's expense.
THE FOREGOING IS IN LIEU OF ANY WARRANTIES OF NONINFRINGEMENT, WHICH ARE HEREBY
DISCLAIMED (WITHOUT LIMITING THE LIABILITY OF E*TRADE HEREUNDER). The foregoing
obligation of E*TRADE does not apply with respect to Technology, E*TRADE
Services or Licensed Marks or portions or components thereof (A) not supplied by
or on behalf of E*TRADE or its licensors, (B) made in whole or in part in
accordance to VERSUS specifications to the extent that the alleged infringement
is caused by VERSUS' specifications, (C) that are modified by or on behalf of
VERSUS (other than by E*TRADE or its Affiliates) after delivery from E*TRADE to
the extent that the alleged infringement relates to such modification, (D)
combined by or on behalf of VERSUS (other than by E*TRADE or its Affiliates)
with other products, processes or materials to the extent the alleged
infringement relates to such combination, (E) where VERSUS continues allegedly
infringing activity after being supplied with modifications (as provided below)
that would have avoided the alleged infringement, to the extent that the alleged
infringement is caused by such continuing activity or (F) to the extent the
claim arises by reason of VERSUS' use of the Technology, E*TRADE Services or
Licensed Marks not being in accordance with this Agreement. VERSUS will
indemnify E*TRADE and its officers, directors, agents and employees from all
damages, settlements, attorneys' fees and expenses related to a claim of
infringement or misappropriation excluded from E*TRADE's indemnity obligation by
the immediately preceding sentence. Notwithstanding the foregoing, neither
party shall be obligated to indemnify or hold harmless the other party for any
claim of any third party for infringement of United States or Canadian
Proprietary Rights, or any costs or damages arising in connection therewith,
that relate solely to the combination of any of the E*TRADE Services, Licensed
Marks, or Technology with any of the VERSUS Retail Core System or related
trademarks, services, software and technology of VERSUS. In the event the
Technology, Licensed Marks, or E*TRADE Services are held or are reasonably
believed by E*TRADE to infringe, as provided in the first sentence of this
Section 13.1, E*TRADE shall, use commercially reasonable efforts, at its sole
expense, (i) in the case of Technology and E*TRADE Services, replace the
infringing portions of the Technology or E*TRADE Services or modify them to be
non-infringing provided that any such replacements or modifications do not
materially adversely affect VERSUS' right or ability to continue using the
E*TRADE Services or Technology as contemplated by this Agreement, including
without limitation, materially adversely affecting the functionality, usefulness
or compatibility thereof, or, (ii) procure for VERSUS the right to continue
using the E*TRADE Services, Technology and Licensed Marks in substantially the
same manner as contemplated by this Agreement.
19
<PAGE>
If the foregoing alternatives are not available on commercially
reasonable terms, E*TRADE may terminate this Agreement on thirty (30) days prior
written notice, and in the event of such termination, E*TRADE shall refund to
VERSUS all amounts paid by VERSUS to E*TRADE pursuant to Section 4.1, and shall
be liable to pay to VERSUS all costs, expenses and damages incurred by VERSUS as
a result of such termination as determined by arbitration, a court of competent
jurisdiction or as agreed to by the parties, including without limitation the
costs of developing or migrating to a replacement system and technology, but
subject to an overall limit of * * * .
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
This Section 13.1 is intended to state the entire liability of E*TRADE
with respect to infringement claims notwithstanding the representations in
Sections 10.1(v), (vi) and (x).
13.2 If VERSUS becomes aware of any product or activity of any third
party that involves infringement or violation of any E*TRADE Proprietary Right
in the Territory, then VERSUS shall promptly notify E*TRADE in writing of such
infringe ment or violation. E*TRADE shall do all such acts or things as are
reasonably necessary to maintain the validity of the Licensed Marks including
promptly taking action to enforce its rights in respect of the Licensed Marks in
Canada and including taking such steps as may be reasonably necessary to enjoin
and terminate any infringement or passing off in respect of the Licensed Marks
which comes to its attention. Only if E*TRADE does not take the aforesaid
action within ninety (90) days of having written notice from VERSUS of such
infringement or passing off, VERSUS shall have the right, at its own expense, to
undertake such proceedings and take such action as it reasonably shall deem
appropriate.
13.3 E*TRADE and VERSUS agree to work cooperatively regarding issues
concerning Proprietary Rights and similar matters and to exercise reasonable
business judgment in carrying out the objects of this Agreement to avoid
exposing either party to liability under patent, copyright, trademark or similar
laws in the Territory.
13.4 Each party hereto (the "Indemnitor") agrees to defend, indemnify
and hold the other parties hereto harmless from and against any and all costs
and expenses (including reasonable attorneys' fees), liabilities, damages or
other loss arising out of the Indemnitor's actions or omissions to act under
this Agreement, any breach of the Indemnitor's covenants, representations or
warranties hereunder.
20
<PAGE>
14. Term and Termination.
--------------------
14.1 Subject to the provisions of this Agreement, it is the parties
intention and agreement that this Agreement and the licenses herein shall be
perpetual. It is intended that, in the event of a breach of the Agreement,
diligent effort will be made by all parties to resolve and cure the breach, or
cease the offending activity, and that all differences will be addressed
promptly and in good faith with a view to quick resolution pursuant to Section
24.6. This Agreement will remain in effect unless terminated pursuant to this
Section 14.
14.2 This Agreement may be terminated by a party for cause immediately
by written notice upon the occurrence of any of the following events:
(i) If the other ceases to do business or otherwise terminates its
business operations for a period of sixty (60) days; or
(ii) If the other shall fail to promptly secure or renew any license,
registration, permit, authorization or approval necessary for the conduct of its
business in the manner contemplated by this Agreement or if any such license,
registration, permit, authorization or approval is revoked or suspended and not
reinstated within sixty (60) days; or
(iii) If, subject to the operation of Section 24.6, the other
breaches any material provision of this Agreement and fails to cure such breach
within thirty (30) days of the managements' decision, or failure to reach a
decision, pursuant to Section 24.6.
14.3 This Agreement shall automatically be terminated without any
requirement of notice to any other person if the other becomes insolvent or
seeks protection under any bankruptcy, receivership, trust deed, creditors
arrangement, composition or comparable proceeding, or if any such proceeding is
instituted against the other (and not dismissed within sixty (60) days).
14.4 E*TRADE may terminate this Agreement immediately upon written
notice if:
(i) VERSUS fails to pay any of the amounts payable hereunder to
E*TRADE as provided in Sections 4.1 and 4.2 above within thirty (30) days after
receipt of written notice from E*TRADE that any such amount is due and payable
pursuant to such provisions and remains unpaid under such provisions, provided
that, any such breach that is cured prior to delivery of a notice of termination
pursuant to this Section 14.4(i) shall not be deemed to have caused an event of
termination hereunder.
21
<PAGE>
(ii) there occurs a Listed Person Acquisition; provided the right of
termination with respect to any particular Listed Person Acquisition, under this
Section 14.4(ii) must be exercised within ten (10) days after the date that VTI
or VBSI, as applicable, notifies E*TRADE in writing that such Listed Person
Acquisition has occurred.
14.5 Upon any termination of this Agreement by either party (except as
provided in clause (iv) below and as otherwise provided herein), (i) all rights
and licenses granted VERSUS under this Agreement and all other rights and
obligations hereunder shall terminate, (ii) VERSUS will immediately cease using
and return to E*TRADE all E*TRADE Proprietary Information, Technology, marketing
materials and literature in its possession, custody or control in whichever form
held (including without limitation all documents or media containing any of the
foregoing and all copies, extracts or embodiments thereof), (iii) VERSUS will
cease using the Licensed Marks and any other trademarks, service marks and other
designations of E*TRADE, and (iv) Sections 4, 8.1, 8.2, 12, 13, 14, 17, 18, 19,
22, 23 and 24 of this Agreement will continue in accordance with their terms.
Notwithstanding anything to the contrary in this Section 14.5, in the event any
party (the "Party in Willful Breach") willfully, intentionally and deliberately
commits an act or omission in material breach of this Agreement, with the
intent, desire or objective of causing the other party (the "Offended Party") to
exercise its right of termination under this Agreement, without there being at
the same time a material breach by the Offended Party, then on termination of
this Agreement by the Offended Party in response to such material breach,
neither the Party in Willful Breach nor any of its Affiliates will, for a period
of one (1) year after the effective date of termination directly or indirectly
engage in the business of providing the Services in or in respect of the
Territory that intentionally diverts business away from the provision of
Services by the Offended Party or its Affiliates. In such circumstances, the
Party in Willful Breach shall be required to permit the Offended Party to
continue to benefit from the provisions of this Agreement for a period of up to
one (1) year (at the option of the Offended Party) following termination of the
Agreement, and in such event the Agreement shall continue in effect for such
period.
14.6 (i) The list of Listed Persons in Attachment J may include up to
eight (8) named entities each of which is a direct competitor of E*TRADE or its
Affiliates (with each named entity automatically being interpreted to include
such named entity's affiliates and subsidiaries). E*TRADE may amend Attachment
J from time to time, by delivering to VERSUS an amended Attachment J in writing
to supersede and replace the preceding Attachment J, provided that, prior to VTI
or VBSI entering into any solicitation or negotiation process in respect of any
proposed change in control transaction (where such transaction is intended to
result in a change involving a person or a group of persons acting jointly,
becoming a beneficial owner of fifty percent or more of the then outstanding
voting and equity securities of VTI or VBSI, on a fully diluted basis) relating
to VTI or VBSI, and subject to Section 12, VERSUS will give E*TRADE written
notice that it proposes to engage in such a solicitation or negotiation process,
and
22
<PAGE>
upon the date commencing five (5) days after E*TRADE's receipt of any such
notice, E*TRADE shall be prohibited from amending Attachment J during the course
of any such solicitation or negotiation process until such time as either (A)
VTI or VBSI has given E*TRADE notice that it has terminated such solicitation or
negotiation process or (B) such solicitation or negotiation process has been
terminated.
(ii) If a Listed Person Acquisition is proposed by VERSUS, E*TRADE
shall have a right of first offer in respect of such proposed Listed Person
Acquisition. VERSUS shall promptly deliver written notice to E*TRADE of the
terms of the proposed Listed Person Acquisition, the number and class of shares
that are the subject of the proposed Listed Person Acquisition, and the price of
such shares. E*TRADE shall have thirty (30) Business Days to review the
proposed terms of the Listed Person Acquisition and exercise its right of first
offer by delivery of a written notice to VERSUS that it agrees to acquire the
shares on the terms of the proposed Listed Person Acquisition. If E* TRADE does
not exercise its right of first offer within such thirty (30) Business Day
period, VERSUS may proceed with the Listed Person Acquisition on principal terms
substantively no more favorable to the Listed Person than the terms offered to
E*TRADE. On completion of the Listed Person Acquisition, E*TRADE's rights under
Section 14.4(ii) shall arise.
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
(iii) If a Listed Person Acquisition occurs and E*TRADE does not
exercise its rights of termination under Section 14.4(ii), this Agreement shall
continue in full force and effect provided that the royalties payable hereunder
per annum shall be the greater of the amount determined pursuant to Section 4.2
and an amount equal to * * * % of the aggregate amount of Royalties paid
pursuant to Section 4.2 during the calendar year immediately preceding the
effective date of the Listed Person Acquisition.
(iv) If a Listed Person Acquisition occurs and E*TRADE exercises its
right of termination under Section 14.4(ii) and VERSUS determines that it
desires to wind down its use of the licenses in an orderly manner, the effective
date of termination of the Agreement shall be up to one (1) year, at VERSUS's
option, from the date of E*TRADE's exercise of its termination right to the
extent such period is reasonably necessary to permit VERSUS to wind down its use
of the licenses granted hereunder in such orderly manner.
14.7 Each party understands that the rights of termination hereunder
are absolute. Neither party shall incur any liability whatsoever for any
damage, loss or expenses of any kind suffered or incurred by the other (or for
any compensation to the
23
<PAGE>
other) arising from or incident to any termination of this Agreement by such
party which complies with the terms of the Agreement whether or not such party
is aware of any such damage, loss or expenses.
14.8 Termination is not the sole remedy under this Agreement and,
whether or not termination is effected, all other remedies will remain
available, except in respect of Section 14.4(ii), in which case termination, if
effected, is the sole remedy under this Agreement.
15. Intentionally Omitted.
---------------------
16. Request to Convert Royalties to Equity. Subject to board,
--------------------------------------
shareholder, and regulatory approvals and subject to compliance with the terms
of a shareholders' agreement between VTI and its major shareholders (the "VTI
Shareholders' Agreement"), E*TRADE may request, at any time prior to the initial
public offering of participating equity shares (which, for greater certainty,
shall not mean preferred shares) of VTI pursuant to a prospectus filed and
receipted in accordance with applicable regulatory requirements (the "IPO"), to
purchase shares of VTI in consideration and in lieu of any payments due and
payable by the Applicable VERSUS Entity under Sections 4.1 and 4.2. Within
thirty (30) Business Days after receipt of written notice from E*TRADE to
exercise its option to convert such amounts due and payable by VTI into shares,
VTI shall use reasonable efforts to solicit the consent of its then current
shareholders of VTI and any relevant third parties to transfer VTI shares
beneficially owned by VTI shareholders to E*TRADE up to a maximum of ***% of the
outstanding shares of VTI in the aggregate. Subject to the approval of the VTI
shareholders, such shares shall be valued at fair market value determined in
accordance with the provisions of the VTI Shareholders' Agreement in the form of
Attachment K hereto, and E*TRADE shall become a party to the VTI Shareholders'
Agreement if required to do so by VTI. On termination of this Agreement in
accordance with its provisions, VTI shall have the right, exercisable for a
period of one (1) year following the effective date of the termination, to
purchase from E*TRADE all shares of VTI purchased by E*TRADE in accordance with
this Section 16 and beneficially owned by it, prior to the IPO, at the fair
market value determined in accordance with the provisions of the VTI
Shareholders' Agreement in the form of Attachment K and, after the IPO, at the
market price for such shares. In the event VTI exercises its call option,
E*TRADE agrees to pay all amounts and make all necessary filings required of a
foreign person selling taxable Canadian property. No representation is made
herein by VTI that shareholders of VTI will agree to the sale of their shares or
to the valuation price.
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
17. Nonsolicitation. During the term of, and for two (2) years after
---------------
the termination of this Agreement, neither party will, directly or indirectly,
solicit the employment or services of any employee or consultant of the other
party with whom such party has had contact or who became known to it in
connection with this Agreement, or encourage such employees or consultants to
leave the other party; provided, however,
24
<PAGE>
that the foregoing does not prevent a party from employing such persons who
contact a party on their own initiative without prior solicitation from such
party or to general advertisements or other general solicitations of employment
not directed to the other party's employees or consultants.
18. INCIDENTAL AND CONSEQUENTIAL DAMAGES. NEITHER PARTY WILL BE
------------------------------------
LIABLE UNDER ANY CONTRACT, NEGLIGENCE, STRICT LIABILITY OR OTHER THEORY FOR ANY
INDIRECT, INCIDENTAL OR CONSEQUENTIAL DAMAGES (INCLUDING WITHOUT LIMITATION LOST
PROFITS) WITH RESPECT TO ANY SUBJECT MATTER OF THIS AGREEMENT SAVE AND EXCEPT
THE FOREGOING SHALL NOT APPLY IN THE CASE OF A BREACH OF SECTION 12.
19. LIMITATION OF OBLIGATIONS AND LIABILITY. NEITHER PARTY WILL BE
---------------------------------------
LIABLE WITH RESPECT TO ANY SUBJECT MATTER OF THIS AGREEMENT UNDER ANY CONTRACT,
NEGLIGENCE, STRICT LIABIL ITY OR OTHER THEORY FOR LOST DATA, COST OF PROCUREMENT
OF SUBSTITUTE GOODS, SERVICES, TECHNOLOGY OR RIGHTS OR FOR ANY AMOUNTS
AGGREGATING IN EXCESS OF * * * SAVE AND EXCEPT THE FOREGOING SHALL NOT
APPLY IN THE CASE OF WILLFUL MISCONDUCT OF SUCH PARTY OR, SUBJECT TO SECTION
13.1, IN THE CASE OF INFRINGEMENT.
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
20. Board Observer. E*TRADE shall have the right to designate one
--------------
(1) employee of E*TRADE to become a non-voting observer of VTI's Board of
Directors meetings. Such observer shall be subject to the same obligations as
members of the board in respect of confidentiality, conflict of interest, and
diversion of corporate opportunities and shall enter into an agreement with VTI
to this effect prior to attending such meetings. E*TRADE shall have the right
to change any observer designated by it at any time effective upon notice to
VTI. Any and all travel costs incurred for the attendance by representatives of
E*TRADE at meetings of the VTI Board of Directors shall be borne by E*TRADE.
21. Financial Statements and Accounting Records. Subject to Section
-------------------------------------------
12, consolidated financial statements for VTI, including without limitation, a
consolidated balance sheet of VTI, VBSI and their Affiliates and the related
consolidated statements of income, cash flow and shareholders' equity shall be
submitted by VERSUS to E*TRADE within thirty (30) days after the end of each
fiscal quarter of VERSUS for such fiscal quarter and within sixty (60) days
after the end of each fiscal
25
<PAGE>
year for such year (such annual financial statements to be audited by an
nationally recognized accounting firm in Canada). The Applicable VERSUS Entity
shall also provide E*TRADE with copies of monthly and annual regulatory
financial filings made with Canadian regulatory or self regulatory authorities
and stock exchanges promptly after such filings are made. Such monthly and
quarterly financial statements shall be prepared in accordance with Canadian
generally accepted accounting principles and/or applicable regulatory
requirements.
22. Independent Contractors. The parties are independent contractors
-----------------------
and not partners, joint venturers or otherwise affiliated and neither has any
right or authority to bind the other in any way.
23. Assignment. Except as otherwise provided herein, the rights and
----------
obligations of each party under this Agreement are personal and may not be
assigned, directly or indirectly, either voluntarily or by operation of law,
without the prior written consent of the non-assigning party, such consent not
to be unreasonably withheld. For greater certainty, it shall be deemed
reasonable for either party to withhold its consent to any assignment by the
other party to a direct competitor of the party whose consent has been
requested. Notwithstanding the foregoing, either party may assign this
Agreement or delegate any of its rights or obligations to an Affiliate. The
assigning party must advise the other party in writing no less than thirty (30)
days prior to the effective date of any proposed assignment. No consent by a
party to an assignment shall have the effect of releasing the assigning party.
24. Miscellaneous.
-------------
24.1 Amendment and Waiver. Except as otherwise expressly provided
--------------------
herein, any provision of this Agreement may be amended and the observance of any
provision of this Agreement may be waived (either generally or any particular
instance and either retroactively or prospectively) only with the written
consent of the parties.
24.2 Governing Law and Legal Actions. This Agreement shall be
-------------------------------
governed by and construed under the laws of the State of California and the
United States without regard to conflicts of laws provisions thereof and without
regard to the United Nations Convention on Contracts for the International Sale
of Goods. The foregoing choice of governing law shall not apply in such a
manner as to cause (i) VTI or VBSI to do or omit to do any act or
thing in conflict with any laws or regulations of Canada (including the laws,
regulations, rules, policies, by-laws or similar requirements of the provinces,
territories, regulatory and self-regulatory organizations in Canada) nor to
cause VTI or VBSI to violate a standard applicable to it that is required of
either of them under such laws or regulations, or (ii) E*TRADE to do or omit to
do any act or thing in conflict with any laws or regulations of the State of
California or the United States (including the laws, regulations, rules,
policies, by-laws or similar requirements of other states and regulatory and
self-regulatory organizations in the
26
<PAGE>
United States) nor to cause E*TRADE to violate a standard applicable to it that
is required of it under such laws or regulations. Both parties consent to the
jurisdiction of courts in the Northern District of California and agree that
process may be served in the manner provided herein for giving of notices or
otherwise as allowed by California or U.S. federal law. In any action or
proceeding to enforce rights under this Agreement, the prevailing party shall be
entitled to recover costs and attorneys' fees.
24.3 Headings. Headings and captions are for convenience only and are
--------
not to be used in the interpretation of this Agreement.
24.4 Notices. Notices under this Agreement shall be sufficient only
-------
if personally delivered, delivered by a major commercial rapid delivery or
courier service with tracking capabilities or mailed by certified or registered
mail, return receipt requested to a party at its addresses set forth on the
first page of this Agreement or as amended by notice pursuant to this
subsection. If not received sooner, notice by mail shall be deemed received
five (5) days after deposit in the U.S. or Canadian mails.
24.5 Entire Agreement. This Agreement, and all Attachments, schedules
----------------
and exhibits hereto, supersedes all proposals, oral or written, all
negotiations, conversations, or discussions between or among the parties
relating to the subject matter of this Agreement and all past dealing or
industry custom.
24.6 Arbitration. Except that either party may seek equitable or
-----------
similar relief from a court, any dispute, controversy or claim arising out of or
in relation to this Agreement or at law, or the breach, termination or
invalidity thereof, that cannot be settled amicably by agreement of the parties
hereto, shall be finally settled by arbitration in accordance with the
arbitration rules of the American Arbitration Association ("AAA"), then in force
by one or more qualified, independent arbitrators appointed in accordance with
said rules; provided, however, that arbitration proceedings may not be
instituted until the party alleging breach of this Agreement by the other party
has given the other party not less than sixty (60) days to remedy any alleged
breach and the other party has failed to do so. The place of arbitration shall
be Palo Alto, California. All documents and agreements relative to any such
dispute shall be read, interpreted, and construed from the English versions
thereof. The award rendered shall be final and binding upon both parties.
Judgment upon the award may be entered in any court having jurisdiction, or
application may be made to such court for judicial acceptance of the award
and/or an order of enforcement as the case may be. Prior to any party providing
to the other a notice of termination or a notice of an event which, if left
uncured, would lead to a right of termination, and prior to seeking to use
arbitration pursuant to this Section 24.6 with respect to an event of
termination occurring under Section 14.2(iii), the parties shall each designate
an appropriate senior officer to undertake the review and resolution of the
dispute. Such representatives shall promptly proceed in good faith to
expeditiously resolve the dispute for a period of thirty (30) days prior to
using the arbitration process. If a resolution cannot be achieved within such
27
<PAGE>
thirty (30) day period, either party may refer the matter to arbitration in
accordance with this provision.
24.7 Force Majeure. Neither party hereto shall be responsible for any
-------------
failure to perform its obligations under this Agreement (other than obligations
to pay money or obligations under Section 12) if such failure is caused by acts
of God, war, strikes, revolutions, lack or failure of transportation facilities,
laws or governmental regulations or other causes which are beyond the reasonable
control of such party. Obligations hereunder, however, shall in no event be
excused but shall be suspended only until the cessation of any cause of such
failure, and the corresponding obligations of the other party (including,
notwithstanding the above, payment obligations) shall be similarly suspended.
In the event that such force majeure should obstruct performance of this
Agreement for more than thirty (30) days, the parties hereto shall consult with
each other to determine whether this Agreement should be terminated. The party
facing an event of force majeure shall use its best endeavors in order to remedy
that situation as well as to minimize its effects. The party facing such event
of force majeure shall notify the other party by telex or telefax immediately
after its occurrence, to be promptly confirmed by written notice pursuant to
Section 24.4.
24.8 Severability. If any provision of this Agreement is held
------------
illegal, invalid or unenforceable by a court of competent jurisdiction or the
parties otherwise mutually agree that a provision is or becomes illegal or
invalid, that provision will be limited or eliminated to the minimum extent
necessary so that this Agreement shall otherwise remain in full force and effect
and enforceable.
24.9 Further Assurances. The parties agree to co-operate with and
------------------
assist each other and take such other action as may be reasonably necessary to
implement and carry into effect this Agreement to its full extent.
24.10 Counterparts. This Agreement may be executed in counterparts,
------------
each of which shall be deemed an original, but all of which together shall
constitute one and the same instrument.
24.11 Currency Reference. All references to dollars and payments to
------------------
be made herein shall be references to U.S. dollars unless expressly stated
otherwise in the applicable provision.
24.12 Joint and Several Obligations. All VERSUS payment obligations
-----------------------------
shall be made on the basis of joint and several liability for such obligations.
Each of the VERSUS entities agrees that it has received adequate consideration
in connection with its respective obligations hereunder.
28
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
Effective Date. All signed copies of this Agreement shall be deemed originals.
E*TRADE GROUP, INC:
By:
-----------------------------------------------
Name:
---------------------------------------------
Title:
-------------------------------------------
VERSUS TECHNOLOGIES INC.
By:
-----------------------------------------------
Name:
---------------------------------------------
Title:
-------------------------------------------
VERSUS BROKERAGE SERVICES INC.
By:
-----------------------------------------------
Name:
---------------------------------------------
Title:
-------------------------------------------
29
<PAGE>
Attachment A
1. Licensed Marks
[LOGO OF E*TRADE]
[LOGO OF E*TRADE CANADA]
2. Permitted Combination of Licensed Marks with VERSUS Marks
. NONE in combination with the VERSUS Logo.
. With the text "A Service of VERSUS Brokerage Services Inc." such as in the
examples below, to identify the broker as VERSUS as required by regulatory
bodies.
Font sizes for the text that adjoins the marks are to remain proportional
with the logo size used, as co-operatively determined by E*TRADE and VERSUS,
provided that the text is not reduced to a font size considered as "fine
print" by applicable regulatory bodies. (The examples, below, are not meant
---
to be the definitive guidelines for these proportions).
[LOGO OF E*TRADE CANADA]
A service of VERSUS Brokerage Services Inc.
[LOGO OF E*TRADE CANADA]
A Service of
VERSUS Brokerage Services Inc.
181 Bay Street, Ste. 3810 Toronto, Ontario M5J 2T3
1 of 2
<PAGE>
[LOGO OF E TRADE CANADA]
A service of VERSUS Brokerage Services Inc.
181 Bay Street, Ste. 3810
Toronto, Ontario M5J 2T3
[LOGO OF E TRADE CANADA]
A Service of
VERSUS Brokerage Services Inc.
[LOGO OF E TRADE CANADA]
A Service of
VERSUS Brokerage Services Inc.
181 Bay Street, Ste. 3810
Toronto, Ontario M5J 2T3
2 of 2
<PAGE>
ATTACHMENT B
PRODUCT/SERVICE REQUIREMENTS - BUSINESS MODEL
1. ELECTRONIC RETAIL BROKER BUSINESS MODEL
The business model under which VERSUS (as defined in the license agreement for
the services referred herein) and E*TRADE will operate is based on the E*TRADE
international model. This business model is providing electronic retail
brokerage services to users, both prospective clients and private clients, via
two primary electronic access points -- telephones and personal-computers. Both
access points will use international telecommunications networks, both public
(Internet) and private (e.g., America On-line), to provide to the retail client
----
a range of services for financial securities transactions in various regulatory
jurisdictions around the world.
The governing principal for this comprehensive global securities trading
service, is providing clients with a consistent user interface and substantially
-------------------------
comparable features from any and all domestic access points. In this business
- -------------------
model there are three classes of service: access services, prospect marketing
services and brokerage services.
Generally speaking, the front-end access services and marketing services are to
be performed either by E*TRADE or VERSUS or jointly, while the back-end, or
client, brokerage services and functions are provided exclusively by VERSUS
(see Attachment C for detailed descriptions or roles and responsibilities).
Consequently, as a service offered by VERSUS, this venture will operate under
the Canadian regulatory environment, where executions, clearing and settlement
must occur and customer accounts will be opened and maintained.
The "E*TRADE Canada" value proposition for the retail client is one of providing
transactional tools available to institutional investors -- i.e., "that level
----
the playing field" --while providing high-quality service. This is achieved
through automation and direct access to exchanges and, eventually, other Over-
The-Counter markets. To ensure that the same value proposition is experienced by
users of the E*TRADE service world-wide will require a consistency of
information and service standards.
2. BUSINESS SERVICES LOGICAL SCHEMATIC
1 of 3
<PAGE>
ELECTRONIC BROKER SERVICE LOGICAL SCHEMATIC
Prospect
Access Marketing Brokerage
Services Services Services
Trade
* Internet Services:
[GRAPHICS [World Wide * Promotion
Web] * Pre-trade
* Trade
APPEAR * Telephone * Prospect * Post-trade
(ACD) support
Support
Services:
HERE] * Mail * Account
management
* Request & * Cash
* Broadcast media enrollment management
fulfillment
* Securities
management
* Technical support * Information
archiving & * Customer
research service
2 of 3
<PAGE>
The schematic diagram illustrates the conceptual business system and services,
which VERSUS and E*TRADE will offer under the name E*TRADE Canada.
ACCESS SERVICES will provide communication links to marketing and/or brokerage
functions for prospective clients and customers, via four major channels:
* Internet (WWW),
* Telephone,
* Mail, and
* Broadcast media (TV, radio, print).
In addition, clients will be able to access technical support which is
considered an access service as well.
The MARKETING SERVICES function is to make prospective clients and existing
clients aware of E*TRADE Canada services, stimulate trial use, and convert users
to initiate or increase their use of brokerage or trading services. This will be
done by promoting the E*TRADE Canada service and products, providing information
to prospective clients through automated electronic or manual means, and by
mailing information and enrollment kits.
BROKERAGE SERVICES consist of value-added Trade Services (see schematic diagram)
and Support Services (see schematic diagram) associated with managing accounts.
Specifically, the trade services encompass pre-trade (e.g., market research),
----
trade (e.g., order entry and execution) and post-trade services (e.g., trade
---- ----
Confirmations and account information). Support services include account
management, cash management, securities management and customer service.
34
<PAGE>
ATTACHMENT C:
SYSTEMS ARCHITECTURE DOCUMENT
INTRODUCTION
The purpose of this attachment to the Agreement is to define the E*TRADE Canada
system components, their systematic relationships, and the respective roles and
responsibilities of both parties in designing, developing, operating, and
maintaining the system. Ownership of each party's component contributions to
the E*TRADE Canada system is also assigned.
This attachment is comprised of three sections:
1. System Architecture Diagram.
* This diagram identifies all the major technical components which will be
used to launch E*TRADE Canada, including the components provided by E*TRADE
(the "Technology") and the components provided by VERSUS (the "VERSUS
Retail Core System"). It is expected that the system architecture will
evolve over time as provided for in the Agreement. The "Technology"
supplied by E*TRADE is shaded in gray. The other components (unshaded)
constitute the "VERSUS Retail Core System."
2. System Component Responsibilities and Ownership.
* This table documents the responsibilities of each party for the design,
implementation and operation of the system components, and defines
ownership.
3. VERSUS Retail Server Core
* This VERSUS component is central to implementing the E*TRADE Canada system
and provides the basis for gross commission revenue calculations (see
Attachment G2 for calculations).
1 of 1
<PAGE>
E*TRADE Canada System Architecture Diagram
ATTACHMENT C 1 (a) January 17, 1997
*See next page for legend Version 1.0 Rev 9
[ARCHITECTURE DIAGRAM APPEARS HERE]
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
<PAGE>
E*TRADE Canada System Architecture Diagram - Legend
ATTACHMENT C 1 (b) January 16, 1997
Version 1.0 Rev 9
Legend
[LEGEND E*TRADE Technology or System Component
APPEARS HERE]
[LEGEND E*TRADE Manual Process/Live Support
APPEARS HERE]
[LEGEND VERSUS Technology or System Component
APPEARS HERE]
[LEGEND VERSUS Manual Process/Live Support
APPEARS HERE]
[LEGEND Telephony of Computer Link
APPEARS HERE]
[LEGEND Periodic File Transfer
APPEARS HERE]
[LEGEND Paper Mail
APPEARS HERE]
<PAGE>
ATTACHMENT c:
SYSTEMS ARCHITECTURE DOCUMENT (CONTINUED)
2. SYSTEM COMPONENT RESPONSIBILITIES AND OWNERSHIP
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
* See section 3 of this attachment for a detailed description of the VERSUS
Retail Server Core.
<PAGE>
Attachment C
Systems Architecture Document (continued)
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
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<PAGE>
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
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<PAGE>
Attachment D.
Technology and Services Provided by E*TRADE
A. TECHNOLOGY
1. E*TRADE Canada Customer Service ACD
***
2. E*TRADE Canada Web Server
***
3. E*TRADE Canada Customer Web Site
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
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<PAGE>
***
4. E*TRADE Canada Marketing Site Development
***
5. E*TRADE Internet Customer Service Toolkit
***
6. Specification and set-up of E*TRADE-VERSUS data connectively (U.S.
side).
B. SERVICES
INFORMATION (CONTENT)
1. Customer Service
***
2. E*TRADE standards and measures
***
3. E*TRADE Canada Customer Web Site Content
E*TRADE (or its Third Party Service Providers, to the extent they
agree to co-operate) will provide the following data content for the
E*TRADE Canada Customer Web Site:
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
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<PAGE>
***
4. E*TRADE Canada Marketing Web Site Content
***
5. E*TRADE Knowledge Base
Sharing of E*TRADE's knowledge base for VERSUS to leverage in their
own training programs and development of policies and procedures
***
OTHER SERVICES
6. E*TRADE Technical Support
***
7. Marketing, Advertising, and Promotion
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
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<PAGE>
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
<PAGE>
Attachment E
------------
PAYMENTS; MARKETING EXPENSE MINIMUMS
------------------------------------
Initial Payment Schedule
- ------------------------
Payments for the aggregate fees payable pursuant to Section 4.1 are payable on
the following schedule:
1. * * * * * * * * * * * * * * * * * * * * * * * * * *
* * * * * *
2. * * * * * * * * * * * * * * * * * * * * * * * * * *
* * * * * *
3. * * * * * * * * * * * * * * * * * * * * * * * * * *
* * * * * *
* * * * * * * * * * * * * * * * * * * * * * * * * * *
* * * * *
* * * * * * * * * * * * * * * * * * * * * * * * * * *
* * * * *
* * * * * * * * * * * * * * * * * * * * * * * * * * *
* * * * *
* * * * * * * * * * * * * * * * * * * * * * * * * * *
* * * * *
Yearly Marketing Expense Minimums
- ---------------------------------
1. In * * * , a minimum marketing expenditure of * * * .
- -- ----------------------------------------------------------------------
2. In * * * and beyond, a minimum marketing expenditure equal to *
* * % of Revenues (as defined in the Agreement) is required, to be based on
rolling yearly budget projections and adjusted on a quarterly basis.
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
31
<PAGE>
Attachment F
MINIMUM SERVICE LEVELS
Introduction
This Appendix consists of the minimum service levels which VERSUS will
diligently strive to achieve for prudent business reasons and to ensure that
E*TRADE brand's public standing is maintained. VERSUS will strive to meet these
performance levels no later than 1 month after launch date.
E*TRADE (U.S.) Performance Standards, set for itself and expected of E*TRADE
branded services, may be higher than the levels currently reflected in this
document and include additional items. A goal of the E*TRADE Canada Service is
to meet or exceed all applicable E*TRADE standards within a reasonable period of
time. To that end, minimum service levels will be jointly reviewed and revised
on a regular basis by VERSUS and E*TRADE.
Minimum Service Levels
1. Provide information and enrollment packages
***
2. Open and maintain client trading account
***
3. Trading Services
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
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<PAGE>
4. Provide client support
***
Monitoring
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
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<PAGE>
Attachment G
1. Measures of Operational Efficiency and Controls
Introduction
This Attachment consists of measures, procedures, and other information
associated with the goal to continually promote, progress and preserve
excellence in service to E*TRADE Canada customers. Trends in these measures are
an important VERSUS management tool for identifying potential problem areas, to
correct them early, and to track progress.
Providing these metrics to E*TRADE on a regular basis, services a two-fold
purpose:
. VERSUS can optimally leverage E*TRADE experience in the evaluation of the
trends reflected, the provision of possible solutions to problematic ones, and
the identification opportunities in others.
. E*TRADE can continually evaluate the success of its licensing agreement and
the consistency of its brand image.
The measures tracked continually evolve with the needs of the business, changes
in technology and processes, and as information becomes more readily accessible.
Included in these measures are those to which minimum service standards were
assigned in Attachment F.
The Measures
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
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<PAGE>
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
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<PAGE>
***
Monitoring
In order to evaluate the on-going operational efficiency associated with the
E*TRADE brand, VERSUS shall make the following reports available to E*TRADE
(subject to the operation of Section 6.6 of the License Agreement):
1. All the statistics listed above.
2. Accompanying explanations of any significant trends or variations from
trend.
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
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<PAGE>
Attachment G (continued)
- ------------
2. Monthly Royalty Calculation
Gross Commission Revenues
Less Bad Debt Provision Recorded
=Net Commission Revenues
* * * % Royalty = * * * x Net Commission Revenues
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
32
<PAGE>
Attachment H.
Summary Milestones
<TABLE>
<S> <C>
Buy Media Thursday, January 2
E*TRADE-VERSUS Agreement Press Release Wednesday, January 22
Marketing Services Complete Wednesday, January 22
Account Opening Testing Complete Wednesday, January 22
Broker Services Testing Complete Thursday, January 23
Third Party Agreements Complete Friday, January 24
Regulatory Briefings Complete (Ontario) Friday, January 24
Access Services Testing Complete Monday, January 27
Broadcast Media Launch Monday, January 27
Systems Integration Testing Complete Monday, February 3
Official Electronic Retail Trading Launch Wednesday, February 5
</TABLE>
1 of 1
<PAGE>
Attachment I
List of Third-Party Vendors Utilized By E*Trade
Third-Party vendors utilized by E*TRADE on an on-going basis in its provision of
services for E*TRADE Canada.
Telecommunications
. AT&T
. Pacific Bell
Market Data and News
. * * *
. Reuters (on U.S. and Canadian markets)--via QuoteCom
. PR News Wire (on U.S. markets only)--via QuoteCom
. Business Wire (on U.S. markets only)--via QuoteCom
. Briefing Com (on U.S. markets only)
. Baseline (on U.S. markets only)
. * * *
Customer Service
. SOFTBANK
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
1 of 1
<PAGE>
Attachment J
Listed Persons
***
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
1 of 1
<PAGE>
ATTACHMENT K
3.08 Fair Market Value
-----------------
(1) "Fair Market Value" for the purposes of Sections 3.07, 3.08, 3.09,
3.11, 3.13 and 3.14 shall be determined on the basis of $0.01 per Class A Share
for Class A Shares (and $0.01 per Class C Share for Class C Shares) included in
the Offered Shares (as such term is defined in Sections 3.07, 3.09(1), 3.11(1),
3.13(1) and 3.14(3) and the en bloc fair market value of the Class B Shares for
Class B Shares included in the Offered Shares (as such term is defined in
Sections 3.07, 3.09(1), 3.11(1), 3.13(1) and 3.14(3)) on the date of the Event
(as such term is defined in Sections 3.07, 3.09(1), 3.11(1), 3.13(1) and
3.14(3)) defined as the highest price, expressed in terms of money or money's
worth, available in an open and unrestricted market between informed and willing
parties acting at arm's length and under no compulsion to act and without any
downward adjustment to reflect the fact that the Class B Shares included in the
Offered Shares may constitute a minority interest. The process of determining
Fair Market Value shall be as follows:
(i) Such price as the Offeror and the Offerees (as such terms
are defined in Sections 3.07, 3.09, and 3.11, 3.13, and
3.14) may agree in writing within 20 Business Days of the
Event triggering the sale;
(ii) If no such agreement is reached, the Offerees shall, after
consulting the Offeror, prepare a list of three qualified
and independent business valuers, each having experience
valuing companies in the software and financial services
industries, within 24 Business Days of the Event. Each such
business valuer shall be asked to submit a written proposal
to prepare a valuation of the Corporation and to make a
presentation to the Offerees and the Offeror within 31
Business Days of the Event. Within 35 Business Days of the
Event, the Offerees, acting on the basis of a majority vote
based on the number of Class B Shares held by each of them,
shall select a valuer from the list of business valuers
after consultation with the Offeror and the Offeror shall
have the right to veto such selection. If the Offeror
vetoes such selection the Offerees shall select one of the
remaining candidates (hereinafter in this Section 3.08
referred to as the "Valuer"). If the Offerees or the
Offeror fail to comply with the proceedings and timing of
this Section 3.08(1)(ii) then the other of the Offerees or
the Offeror, as the case may be, provided they are in
compliance with this Section 3.08(1)(ii), shall select the
Valuer;
<PAGE>
(iii) The Valuer shall prepare a written valuation report on
the Fair Market Value of the Offered Shares. Fair Market
Value will be calculated such that (i) the valuation is
based on all the Shares and not just the Offered Shares;
(ii) the value of any insurance on the life of any
Shareholder or employee and the proceeds of such
insurance shall be excluded; and (iii) the value of all
intangible and unrecorded assets shall be considered.
The valuation report shall contain disclosure consistent
with that required under the Ontario Securities
Commission's Policy 9.1 and Appendix A to Standard #91-1
"Valuation Report Standards and Recommendations" of the
Canadian Institute of Chartered Business Valuators if
such Appendix A exists or, if it does not, as it was in
March, 1994, a copy of which is annexed hereto as
Schedule D. The Corporation will cooperate fully in
providing information and access to management to the
Valuer. The Valuer shall provide a draft of its report
to the Offerees and the Offeror within 60 Business Days
of the Event. The draft may omit value conclusions but
should set out major assumptions, judgments, pertinent
empirical evidence and a detailed framework for
valuation calculations. The Offerees and the Offeror
shall provide written comments on the draft to the
Valuer within 70 Business Days of the Event. The Valuer
shall provide its final valuation report to the Offerees
and the Offeror within 80 Business Days of the Event;
(iv) The Offeror shall have the right to engage a separate
business valuer (hereinafter in this Section 3.08
referred to as the "Offeror's Valuer") to prepare a
valuation report (with disclosure as set out in Section
3.08(l)(iii)) on the Fair Market Value of the Offered
Shares. The Corporation will provide the Offeror's
Valuer the same cooperation, information and access as
provided to the Valuer. The Offeror's Valuer shall
adhere to the same valuation report timetable,
disclosure and process as that described in Section
3.08(1)(iii) above. The Offerees shall be entitled to
provide to the Valuer the draft valuation report of the
Offeror's Valuer and the Offeror shall be entitled to
provide to the Offeror's Valuer the draft valuation
report of the Valuer;
(v) The price of the Offered Shares shall be the Fair Market
Value set out in the Valuer's valuation report subject
to (vi) below. For this purpose, in the event Fair
Market Value is expressed in a range, the mid-point of
the range shall be the price of the Offered Shares;
<PAGE>
(vi) If the Offeror notifies the Offerees by notice in
writing within 85 Business Days of the Event that it is
not satisfied with the price as described in Section
3.08(l)(v) above and if, and only if, the Offeror's
Valuer has prepared a report as set out in Section
3.08(l)(iv) then the final Valuer's report and the final
Offeror's Valuer's report shall be submitted to an
independent arbitrator (hereinafter in this Section 3.08
referred to as the "Arbitrator") to be selected as set
out in Section 3.08(l)(vii) below who shall determine
the price of the Offered Shares as set out in Section
3.08(l)(viii) below;
(vii) If an Offeror's Valuer has been appointed, then within
90 Business Days of the Event each of the Offerees and
the Offeror shall submit in writing to each other and to
the Secretary of the Corporation the names of up to two
individuals that they have determined would be willing
to serve as Arbitrator on an hourly or per diem rate
basis and that they consider to be qualified and
independent and the resumes of such individuals. The
Offerees and the Offeror may, at their option, within 95
Business Days of the Event interview such individuals
and, following any such interviews, within 95 Business
Days of the Event, the names shall be placed in a
container and drawn one at a time by the Secretary of
the Corporation until a selection is not vetoed, with
each of the Offeror and the Offerees having the right to
veto one selection. The first name drawn and not vetoed
shall be the Arbitrator; and
(viii) The Arbitrator shall not be requested to prepare a third
valuation but shall be asked to review the two valuation
reports and the written comments thereon provided
pursuant to Section 3.08(l)(iii) above, and to interview
the Offeror, the Offerees, representatives of the
Corporation, the Valuer and the Offeror's Valuer and on
the basis of this review to determine the price of the
Offered Shares. In conducting his or her review, the
Arbitrator should give particular emphasis to the
qualifications and independence of the Valuer and the
Offeror's Valuer, the scope of their work and analysis
and the fullness and clarity of the disclosure of
assumptions, judgments, pertinent empirical evidence and
calculations in the valuation reports. The Arbitrator
shall submit his or her written report within 140
Business Days of the Event setting out his or her
determination of the price of the Offered Shares and
brief reasons therefor. The decision of the Arbitrator
shall be binding on all parties.
<PAGE>
(2) The cost of the Valuer shall be paid by * * * unless the Fair Market
Value is being determined in connection with a sale pursuant to Section 3.09, or
in connection with a sale in the case of termination for Cause, pursuant to
Section 3.12(3) in which case the cost of the Valuer shall be paid * * *, the
cost of the Offeror's Valuer shall be paid * * *, and the cost of the Arbitrator
shall be paid * * *.
(3) The parties hereto expressly agree that none of the provisions of the
Arbitration Act (Ontario), as now enacted or as the same may from time to time
be amended, re-enacted or replaced shall apply to this Agreement except those
mandatory
provisions set out in Section 3 of such Act.
[* INDICATES THAT MATERIAL HAS BEEN OMITTED AND CONFIDENTIAL TREATMENT HAS BEEN
REQUESTED THEREFOR. ALL SUCH OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2.]
<PAGE>
SCHEDULE D
[LOGO OF THE CANADIAN INSTITUTE OF CHARTERED BUSINESS VALUATORS]
- --------------------------------------------------------------------------------
March 18, 1994
Subject: Valuation Standard - "Appendix A" to Standard #91-1
Enclosed for your review and comment is a prepared Valuation Standard.
"Appendix A", in addition to Standard #91-1 "Valuation Report Standards and
Recommendations".
The objective of Appendix A is to clarify the CICBV's view of disclosure
standards pertaining to valuation reports and fairness opinions that are
prepared in connection with ??-arm length transactions and other transactions
subject to securities regulation.
All proposed standards are circulated in exposure draft form to members for
comments and we encourage your participation in this process.
To be considered, we would ask that you send your comments to the Institute's
office by April 18, 1994 in the enclosed self-addressed envelope.
Norman ?? CBV
Tom P. ?? CBV
Practice Standards Committee
<PAGE>
APPENDIX A TO STANDARD #91-1
Introduction
The objective of Appendix A is to clarify the CICBV's view of disclosure
standards pertaining to valuation reports and fairness opinions ("Valuation
Reports") that are prepared in connection with non-arm's length transactions
and other transactions subject to securities regulation.
Securities regulation concerning non-arm's length transactions has been
designed, in part, to address actual or perceived informational imbalance that
might exist between a controlling shareholder and minority shareholders in the
context of significant non-arm's length transactions. The requirement for a
valuation or fairness opinion in these situations is expected to provide
adequate information concerning the financial perspective of the transaction to
allow shareholders to make informed decisions.
The CICBV interprets the disclosure standards for valuation and fairness
opinions in securities regulation to be disclosure sufficient to allow a
shareholder to understand the basis of the valuation or fairness opinion and to
form a reasoned view on the opinion conclusion.
While it is not required that sufficient information be provided to enable
the reader to perform his or her own independent valuation, a Valuation Report
should contain sufficient narrative and schedules to support the opinion and
calculations for the purposes at hand. The source of any fact which is material
to the formal valuation must be clearly stated, including sufficient details
so that the significance of the fact can be reasonably received by a user of the
report. Adequate disclosure will usually include a comparison of valuation
calculations and conclusions arrived at through different methods, a discussion
of the schedules for accepting or rejecting each methodology and the relative
importance or weighing of relevant methodologies in arriving at a final
valuation conclusion. If materials are prepared by the valuer to present
valuation conclusions to the special committee or board of directors then this
information should usually be incorporated into and form a part of the Valuation
Report. A summary of a full Valuation Report will be sufficient only if it
provides security holders with a sufficiently detailed review of all material
factors contained in the report so that the reader can understand the valuer's
thought process, key assumptions and calculations made in arriving at its
conclusion.
A greater level of disclosure is generally required in valuations prepared
for the above described purposes than in other circumstances and/or for other
purposes. Accordingly, while Standard #91-1 applies to all Valuation Reports,
Appendix A applies only to Valuation Reports prepared for securities regulatory
purposes.
<PAGE>
-2-
I. General
The following is the test of overall disclosure adequacy that should be
applied to Valuation Reports to which this Appendix applies:
Disclosures should be sufficient to allow a shareholder to understand
the basis of the valuation or fairness opinion and to form a reasoned
view on the opinion conclusions.
This Appendix A should not be viewed as an all inclusive list of
required disclosure but rather as a guideline for minimum acceptable disclosure.
Where sub-lists of information are provided, they should be viewed as examples
of the type and level of information that should be disclosed. There will be
situations where certain items listed are not applicable or where other items
that are not listed should be disclosed. The valuer should consider the level of
disclosure described herein when considering the appropriate level of disclosure
in a Valuation Report concerning matters or valuation methodologies not
addressed herein but that are important in reaching a valuation conclusion.
The disclosure requirements set out in Sections II and III should be
applied to each segment of a business that the valuer considers and values
separately in arriving at an overall valuation result.
In some circumstances, disclosure of certain information required to be
furnished may be viewed as potentially detrimental to the issuer or the
security holders of the issuer, overweighing the benefit of disclosure
of information to prospective recipients. As non-disclosure of the
information may require securities regulatory approval, valuers should
consult their legal adviser in such circumstances before publication or
filing of the Valuation Report.
<PAGE>
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II. Fundamental Financial Information
The Valuation Report should contain the following fundamental financial
information:
1. Historical Financial Information: historical financial information
--------------------------------
including:
i) Annual Financial Information: comparative summaries for the most
----------------------------
recent five years, if available, of:
- income statements (setting out at least: sales, gross profit, major
expense items, operating profit or earnings before interest and
taxes, interest/financing expenses, earnings before income taxes,
income taxes and net income);
- statements of changes in financial position (setting out at least:
earnings from operations, depreciation, amortization and depletion,
deferred taxes, other major deferred charges, major deferred
revenues, debt borrowings and repayments, equity issues, other
capital transactions and dividends);
- balance sheets (setting out at least: cash and marketable
securities, other current assets, fixed assets including
accumulated depreciation, intangible assets, short-term debt,
current portion of long-term debt, other current liabilities, long-
term debt, deferred taxes, preferred equity and common equity);
- key financial statement notices and statistics; and
- key operational statistics such as those commonly provided in
Annual Reports for public companies in the relevant industries;
The historical summaries should be lengthened if the business cycle
warrants; and
ii) Interim Financial Information: comparative summaries on as similar a
-----------------------------
basis as possible to that set out in (i) above of operating results
and the financial position for and as at the end of the most recent
interim period for which information is available; this information
should be provided on a comparative basis to the same interim period
for the prior year.
2. Future-Oriented Financial Information: future oriented financial
---------------------------------------
information including:
i) Budget: a summary of the management prepared budget for the current
------
year, to the extent such information is available, on as similar a
basis as possible to that set out in 1.(i) above unless the valuer
has not used such forecast or projection in preparing the valuation
in which case a statement to this effect, and the valuers reasons for
this, should be included in the Valuation Report; and
ii) Forecast/Projection: a summary of the most recent management prepared
-------------------
forecast or projection prepared in the course of management's
business
<PAGE>
-4-
planning process or in contemplation of the transaction to which the
valuation or fairness opinion pertains, to the extent such information is
available, on as similar a basis as possible to that set out in 1.(i)
above unless the valuer has not used such forecast or projection in
preparing the valuation in which case a statement to this effect, and the
valuer's reasons for this, should be included in the Valuation Report.
3. Empirical Evidence: empirical evidence underlying and supporting key
------------------
financial assumptions, judgments, and calculations such as:
i) Market Statistics: a discussion of and market trading statistics
-----------------
for companies the valuer considers to be relevant and that the
valuer uses in arriving at the valuation conclusion; where market
trading statistics are used, disclosure should include at least the
following:
- date(s) of the actual market price data; and
- the particular statistics used (such as earnings/cash flow/
book value multiples, yields, etc.).
ii) Transactional Statistics: a discussion of and valuation statistics
------------------------
from transactions involving businesses the valuer considers to be
relevant and uses in arriving at the valuation conclusion; the
disclosure on such transactions should be on as similar a basis as
possible to that set out in 3.(i) above;
iii) Discount Rates, Multiples and Capitalization Rates: a discussion of
--------------------------------------------------
and all relevant quantitative data used to calculate discount rates,
multiples and/or capitalization rates; where comparable companies
and transactions have been used this would include information
described in 3.(i) and (ii) above; where the Capital Asset Pricing
Model has been used, disclosure should include the risk-free rate,
market risk premium, xxxx growth rates and debt-equity structure
xxxxxxxx as well market benchmark rates of return, bases of
comparable companies and debt-equity ratios of comparable companies
the valuer considered in arriving at the inputs used in the
valuation;
iv) Commodity Prices: the sources and details of commodity pricing
----------------
assumptions used in forecasts and projections (e.g. metal prices,
timber prices, oil and gas prices, etc.) with reference to actual
current prices and third-party commodity price forecasts the valuer
considered in arriving at the inputs used in the valuation; and
v) Economic Assumptions: key economic assumptions used by the valuer as
--------------------
inputs into the valuation (such as GDP growth, interest rates,
exchange rates, etc.).
<PAGE>
-5-
III. Valuation Calculations
The Valuation Report should clearly set out the basis of the valuation
computation for each of the valuation methodologies adopted by the valuator and
separately disclose other factors (such as redundancies) in sufficient detail to
assess the impact on the overall valuation conclusion. In this regard, the
following disclosure guidelines should be followed by the valuators in preparing
the valuation report:
4. Capitalized Earnings/Cash Flow
------------------------------
i) Unadjusted Earnings/Cash Flow: the reported historical and
-----------------------------
future-oriented earnings/cash flow for each of the years reviewed
by the valuer;
ii) Normalization Adjustments: all significant normalization
-------------------------
adjustments, on a year-by-year basis, made by the valuer;
normalization adjustments may include, but not be limited to:
* non-recurring revenue and expense items (such as start-up costs);
* restructuring charges or special revenues;
* earnings/losses from discontinued operations;
* adjustments related to changing interest rates or exchange rates;
* expenses that are not expected to continue in the future or,
conversely, that would be required in the future; and
* adjustments relating to redundant assets that the valuer
considered separately;
iii) Tax Calculations: income tax calculations including:
----------------
* the determination of the tax rate applied to the business;
* the impact of tax credits and other deductions; and
* the calculation of tax shield where appropriate;
iv) Financing Costs: interest expense and other financing costs,
---------------
including the calculation thereof (e.g. rates, amounts, etc.) if
not actual reported amounts;
v) Sustaining Capital Reinvestments: sustaining capital reinvestment
--------------------------------
and the valuer's underlying supportingcalculations and rationale;
vi) Cash Flow Income: significant cash flow income such as
----------------
depreciation, amortization, depletion and deferred taxes;
vii) Capitalization Rates: calculations and rationale underlying the
--------------------
capitalization rates selected by the valuer, where market trading
or comparable transaction statistics are used, those companies or
transactions considered most relevant by the valuer should be
specifically identified and information supporting their
comparability disclosed (such as their financial size,
profitability relative
<PAGE>
- 6 -
growth prospects, financial leverage, nature of operations,
etc.); if the Capital Asset Pricing Model is used the
calculations should be disclosed as described in 3.(iii) above.
viii) Sustainable Earnings/Cash Flow: calculations (such as
------------------------------
averaging, selected average or weighted averaging) used by the
valuer in determining sustainable earnings/cash flow to be
capitalized and the rationale supporting the calculations; and
ix) Summary Calculations: a summary of the overall valuation
--------------------
calculations that sets out at least the sustainable
earnings/cash flow to be capitalized, capitalization rates,
capitalized values, the tax shield where appropriate, the
addition of redundant asset value where applicable and the value
result.
5. Discounted Cash Flow Approach
-----------------------------
When the discounted cash flow approach is used, in addition to
applicable items being disclosed as set out elsewhere herein, the
Valuation Report should contain the following valuation calculation
information:
l) Forecast Assumptions: key financial assumptions (such as sales
--------------------
growth rates, major expense reductions/growth, interest rates,
tax rates, depreciation rates, etc.) and supporting rationale;
major differences from assumptions used by management in
preparing its forecast or projection should be highlighted and
discussed;
n) Forecast Cash Flow: for each forecast year, the following type
------------------
of information, for each major segment of the business, as
applicable:
- revenues;
- operating profile;
- income expenses;
- depreciation, amortization and depletion;
- current income taxes;
- capital expenditures (reinvestment and, separately,
expediency);
- changes in working capital;
- cash flow;
- additional borrowings and/or other financings;
- loan repayments, if discounting leveraged cash flows; and
- loan payment, if discounting leveraged cash flows;
<PAGE>
-7-
iii) Terminal/Residual Value: the rationale for determination of the
-----------------------
terminal/residual value along with all calculations and underlying key
assumptions. If alternative methods were considered, their calculations should
be disclosed and the results compared. Where capitalization of earnings or cash
flow was used, the amount to be capitalized should be separately disclosed in
the forecast and the rationale and underlying empirical support for the
capitalization rate (including the assumed growth rate) should be fully
disclosed as described in 3.(iii) above.
iv) Sensitivity Analysis: A summary of the discounted cash flow results from
--------------------
varying key assumptions (such as the discount rate, commodity pricing and/or
major operating assumptions); and
v) Summary Calculations: A summary of the overall valuation calculations
--------------------
that sets out at least the discount rate(1), net present value of cash flows
discounted, net present value of the terminal value and the value of redundant
assets where applicable and the value result.
6. Asset Based Approaches
----------------------
When asset based approaches are used, in addition to applicable items being
disclosed as set out elsewhere herein, the Valuation Report should contain the
following:
i) Fair Market Value of Assets and Liabilities: the fair market value,
-------------------------------------------
method of valuation and valuation calculations for each significant assets and
liability (tangible, intangible and off-balance sheet) together with comparisons
to their net book values;
ii) Liquidation Costs: all significant liquidation costs and all relevant
-----------------
assumptions and supporting data (e.g., selling or auction commissions, legal
fees, administrative costs and operating losses, severance and vacation pay, tax
costs of realization of assets, tax costs to the corporation of distribution of
net assets to shareholders, time value of money, etc.);
iii) Summary: a summary of the overall valuation calculations.
-------
7. Redundant Assets
----------------
Each significant redundant asset should be separately identified with the
rationale in support of its indemnification. Both the method of valuing the
redundant asset as well as the valuation calculations should be disclosed as set
out elsewhere herein. The financial impact, if any, on historical and projected
income and cash flow statements should be disclosed. As relevant, the following
type of information supporting the calculation of value should be disclosed:
<PAGE>
-6-
- appraisal values, appraisal dates, and names of appraisers;
- estimated costs of disposition, if any;
- tax, calculations (e.g. tax rates, capital gains, tax shield, etc.);
- interest rates; and
- financial ratios (such as current ratio; debt equity ratios, etc.)
used to determine excess or redundant leverage.
8. Other Approaches
----------------
Where other valuation methodologies are used, the Valuation Report
should set out the rationale for using the methodologies and should contain a
level of financial disclosure of such methodologies, including supporting
empirical evidence, consistent with the level of financial disclosure set out
herein.
9. Valuation Conclusions
---------------------
The valuation ranges developed by the different methodologies used
should be compared and discussed. The valuer may choose to arrive at the overall
conclusion of value based on a single valuation method, or some synthesis of the
value conclusions determined under different methodologies. The valuer should
reconcile the results of different methodologies and discuss the reconciling in
support of the final valuation conclusion.
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
We consent to the use in this Amendment No. 1 to the Registration Statement
of E*TRADE Group, Inc. on Form S-1 of our report dated November 22, 1996
appearing in the Prospectus, which is part of this Registration Statement.
We also consent to the reference to us under the heading "Experts" in such
Prospectus.
Deloitte & Touche LLP
San Jose, California
July 31, 1997
