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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q/A
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
Commission file number 1-11921
----------------
E*TRADE Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware 94-2844166
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
4500 Bohannon Drive, Menlo Park, CA 94025
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (650) 331-6000
----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
As of August 10, 2000, the number of shares outstanding of the registrant's
common stock was 299,908,164.
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E*TRADE Group, Inc.
Form 10-Q/A Quarterly Report
For the Quarter Ended June 30, 2000
Table of Contents
Page
----
Part I--Financial Information
Item 1. Financial Statements
Consolidated Statements of Operations.......................... 3
Consolidated Balance Sheets.................................... 4
Condensed Consolidated Statements of Cash Flows................ 5
Notes to Condensed Consolidated Financial Statements........... 6
Management's Discussion and Analysis of Financial Condition and
Item 2. Results of Operations.......................................... 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk..... 42
Part II--Other Information
Item 1. Legal and Administrative Proceedings........................... 44
Item 2. Changes in Securities and Use of Proceeds...................... 45
Item 3. Defaults Upon Senior Securities................................ 45
Item 4. Submission of Matters to a Vote of Security Holders............ 45
Item 5. Other Information.............................................. 45
Item 6. Exhibits and Reports on Form 8-K............................... 46
Signatures.............................................................. 48
UNLESS OTHERWISE INDICATED, REFERENCES TO "COMPANY" MEAN E*TRADE GROUP,
INC. AND ITS SUBSIDIARIES.
This Form 10-Q/A is being filed to amend Part II Item 6 to include the
Company's Amended and Restated Strategic Alliance Agreement dated as of
September 26, 2000, between the Company and Wit SoundView Group, Inc. Other
than the inclusion of that additional exhibit and updates to the Exhibits list
in Part II Item 6, this Form 10-Q/A has not been updated to give effect to any
items addressed in documents filed with the SEC subsequent to June 30, 2000.
E*TRADE(R) and the E*TRADE logo are registered trademarks of E*TRADE
Securities, Inc. All other products, trademarks or service marks mentioned in
this document or any document incorporated by reference herein are trademarks
or service marks of E*TRADE Group, Inc., its subsidiaries, or other companies
with which they are associated or with which they have a business
relationship.
FORWARD-LOOKING STATEMENTS
Certain statements in this report, including statements regarding the
Company's strategy, financial performance and revenue sources, are forward-
looking statements based on current expectations and entail various 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 report. Readers are urged to carefully review and
consider the various disclosures made by the Company in this report and in the
Company's other reports filed with the SEC, including the Company's Annual
Report on Form 10-K/A as filed with the SEC on April 17, 2000, that attempt to
advise interested parties of certain risks and factors that may affect the
Company's business. Readers are cautioned not to place undue reliance on these
forward-looking statements to reflect events or circumstances occurring after
the date hereof. The following should be read in conjunction with the
Company's consolidated financial statements and notes thereto contained in
that filing.
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
E*TRADE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
June 30, June 30,
------------------- --------------------
2000 1999 2000 1999
--------- -------- --------- ---------
Revenue:
Transaction revenues.............. $ 180,194 $106,067 $ 587,102 $ 256,911
Interest income................... 257,193 104,129 657,065 245,696
Global and institutional.......... 33,906 26,937 108,989 84,351
Other............................. 24,863 8,606 60,786 27,245
--------- -------- --------- ---------
Gross revenues.................. 496,156 245,739 1,413,942 614,203
Interest expense.................. (164,841) (58,652) (405,762) (145,154)
Provision for loan losses......... (974) (665) (2,767) (1,435)
--------- -------- --------- ---------
Net revenues.................... 330,341 186,422 1,005,413 467,614
--------- -------- --------- ---------
Cost of services.................... 124,489 82,237 366,470 198,967
--------- -------- --------- ---------
Operating expenses:
Selling and marketing............. 115,081 99,784 422,245 235,667
Technology development............ 32,526 20,659 111,033 50,481
General and administrative........ 50,179 24,574 142,482 69,654
Amortization of goodwill and other
intangibles...................... 6,716 565 13,900 1,934
Merger-related expenses........... 1,133 3,652 31,519 3,652
--------- -------- --------- ---------
Total operating expenses........ 205,635 149,234 721,179 361,388
--------- -------- --------- ---------
Total cost of services and
operating expenses............. 330,124 231,471 1,087,649 560,355
--------- -------- --------- ---------
Operating income (loss)............. 217 (45,049) (82,236) (92,741)
--------- -------- --------- ---------
Non-operating income (expense):
Gain on sale of investments....... 24,416 8,439 66,647 41,806
Unrealized gain (loss) on venture
fund............................. (3,462) -- 7,363 --
Corporate interest--net and
other............................ (8,178) 3,158 (15,478) 13,291
--------- -------- --------- ---------
Total non-operating income...... 12,776 11,597 58,532 55,097
--------- -------- --------- ---------
Pre-tax income (loss)............... 12,993 (33,452) (23,704) (37,644)
Income tax expense (benefit)........ 7,888 (12,230) (1,732) (15,659)
Minority interest in subsidiary..... (585) 539 318 1,671
--------- -------- --------- ---------
Income (loss) before cumulative
effect of accounting change and
extraordinary loss................. 5,690 (21,761) (22,290) (23,656)
Cumulative effect of accounting
change, net of tax................. -- -- -- (469)
Extraordinary loss on early
extinguishment of subordinated
debt, net of tax................... -- (1,985) -- (1,985)
--------- -------- --------- ---------
Net income (loss)................... 5,690 (23,746) (22,290) (26,110)
Preferred stock dividends........... -- 60 -- 180
--------- -------- --------- ---------
Income (loss) applicable to common
stock.............................. $ 5,690 $(23,806) $ (22,290) $ (26,290)
========= ======== ========= =========
Income (loss) per share before
cumulative effect of accounting
change and extraordinary loss:
Basic............................. $ 0.02 $ (0.08) $ (0.08) $ (0.09)
========= ======== ========= =========
Diluted........................... $ 0.02 $ (0.08) $ (0.08) $ (0.09)
========= ======== ========= =========
Income (loss) per share:
Basic............................. $ 0.02 $ (0.09) $ (0.08) $ (0.10)
========= ======== ========= =========
Diluted........................... $ 0.02 $ (0.09) $ (0.08) $ (0.10)
========= ======== ========= =========
Shares used in computation of income
(loss) per share before cumulative
effect of accounting change and
extraordinary loss and income
(loss) per share:
Basic............................. 294,015 271,276 275,337 265,434
Diluted........................... 309,346 271,276 275,337 265,434
See notes to condensed consolidated financial statements.
3
E*TRADE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
June 30, September 30,
2000 1999
----------- -------------
(Unaudited)
ASSETS
------
Cash and equivalents................................ $ 178,894 $ 124,801
Cash and investments required to be segregated under
Federal or other regulations....................... 86,414 104,500
Brokerage receivables--net.......................... 5,657,869 2,912,581
Mortgage-backed securities.......................... 3,345,760 1,426,053
Loans receivable--net............................... 3,535,825 2,154,509
Investments......................................... 966,646 830,329
Property and equipment--net......................... 263,692 178,854
Goodwill and other intangibles...................... 471,895 17,211
Other assets........................................ 385,602 159,386
----------- ----------
Total assets.................................... $14,892,597 $7,908,224
=========== ==========
LIABILITIES AND SHAREOWNERS' EQUITY
-----------------------------------
Liabilities:
Brokerage payables................................ $ 5,044,173 $2,824,212
Banking deposits.................................. 3,987,954 2,162,682
Borrowings by bank subsidiary..................... 2,858,000 1,267,474
Accounts payable, accrued and other liabilities... 462,253 203,971
Convertible subordinated notes.................... 650,000 --
----------- ----------
Total liabilities............................... 13,002,380 6,458,339
----------- ----------
Company-obligated mandatorily redeemable preferred
capital securities of E*TRADE Financial Corporation
subsidiary trusts holding solely junior
subordinated debentures of and other mandatorily
redeemable preferred securities.................... 30,631 30,584
----------- ----------
Shareowners' equity:
Common stock, $.01 par: shares authorized,
600,000,000; shares issued and outstanding: June
30, 2000, 298,283,829; September 30, 1999,
275,145,791...................................... 2,983 2,751
Additional paid-in capital........................ 1,746,753 1,269,167
Unearned ESOP shares.............................. (1,697) (2,122)
Shareowners' notes receivable..................... (18,743) --
Accumulated deficit............................... (30,654) (8,364)
Accumulated other comprehensive income............ 160,944 157,869
----------- ----------
Total shareowners' equity....................... 1,859,586 1,419,301
----------- ----------
Total liabilities and shareowners' equity....... $14,892,597 $7,908,224
=========== ==========
See notes to condensed consolidated financial statements.
4
E*TRADE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Nine Months Ended
June 30,
------------------------
2000 1999
----------- -----------
Net cash used in operating activities, net of effects
from acquisitions................................... $ (374,834) $ (34,677)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of available-for-sale securities.......... (6,754,919) (4,749,045)
Proceeds from sales, maturities of and principal
payments on available-for-sale securities......... 4,704,934 4,419,793
Net increase in loans held for investment.......... (1,394,055) (733,742)
Increase in restricted deposits.................... (71,445) --
Cash used in business acquisitions, net of cash
acquired.......................................... (31,770) --
Purchases of property and equipment, net of capital
lease and property and equipment acquired......... (134,342) (82,893)
Other.............................................. 15,714 15,667
----------- -----------
Net cash used in investing activities.......... (3,665,883) (1,130,220)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in banking deposits................... 1,825,273 566,849
Advances from the Federal Home Loan Bank of
Atlanta........................................... 2,168,000 1,989,510
Payments on advances from the Federal Home Loan
Bank of Atlanta................................... (1,295,000) (1,777,510)
Net increase in securities sold under agreements to
repurchase........................................ 717,526 104,626
Net proceeds from convertible subordinated notes... 631,312 --
Proceeds from issuance of common stock............. 17,921 401,827
Proceeds from associate stock transactions......... 28,594 15,805
Proceeds from bank loans and lines of credit, net
of transaction costs.............................. 177,455 --
Payments on bank loans and lines of credit......... (151,843) --
Issuance of shareowners' notes receivable.......... (18,607) --
Net decrease in other borrowed funds............... -- (29,792)
Other.............................................. (5,821) (5,711)
----------- -----------
Net cash provided by financing activities...... 4,094,810 1,265,604
----------- -----------
INCREASE IN CASH AND EQUIVALENTS..................... 54,093 100,707
CASH AND EQUIVALENTS--Beginning of period............ 124,801 71,317
----------- -----------
CASH AND EQUIVALENTS--End of period.................. $ 178,894 $ 172,024
=========== ===========
SUPPLEMENTAL DISCLOSURES:
Non-cash investing and financing activities:
Unrealized gain on available-for-sale securities... $ 8,029 $ 404,502
=========== ===========
Tax benefit on exercise of stock options........... $ 27,498 $ 39,436
=========== ===========
Assets acquired under capital lease obligations.... $ 32,752 $ --
=========== ===========
Purchase acquisitions, net of cash acquired:
Common stock issued and stock options assumed.... $ 411,411 $ --
Cash paid, less acquired (including acquisition
costs).......................................... $ 31,770 $ --
Liabilities assumed.............................. $ 19,586 $ --
Carrying value of joint-venture investment....... $ 5,343 $ --
----------- -----------
Fair value of assets recorded (including goodwill
of $447,691).................................... $ 468,110 $ --
=========== ===========
See notes to condensed consolidated financial statements.
5
E*TRADE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial
statements include E*TRADE Group, Inc., a financial services holding company,
and its subsidiaries (collectively, the "Company"), including E*TRADE
Securities, Inc. ("E*TRADE Securities"), a securities broker-dealer, E*TRADE
Financial Corporation ("ETFC"), formerly Telebanc Financial Corporation, a
provider of banking and related financial services, and TIR (Holdings) Limited
("TIR"), a provider of global securities brokerage and other related services
to institutional clients. The primary business of ETFC consists of the
activities conducted by E*TRADE Bank, Inc. (the "Bank" or "E*TRADE Bank"),
formerly known as Telebank, and E*TRADE Capital Markets, Inc. ("ETCM"),
formerly Telebanc Capital Markets. E*TRADE Bank is a federally chartered
savings bank that provides deposit accounts insured by the Federal Deposit
Insurance Corporation ("FDIC") to customers nationwide. ETCM is a funds
manager and registered broker-dealer.
These interim condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC") and, in the opinion of management, reflect all normal
recurring adjustments necessary to present fairly the financial position,
results of operations and cash flows for the periods presented in conformity
with accounting principles generally accepted in the United States of America.
All significant intercompany accounts and transactions have been eliminated.
These interim condensed consolidated financial statements should be read in
conjunction with the audited annual consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K/A for the
fiscal year ended September 30, 1999.
The condensed consolidated financial statements of the Company have been
prepared to give retroactive effect to the acquisition of ETFC on January 12,
2000, which was accounted for as a pooling of interests (see Note 23 to the
Company's Annual Report on Form 10-K/A for the fiscal year ended September 30,
1999).
NOTE 2. BROKERAGE RECEIVABLES--NET AND PAYABLES
Brokerage receivables--net and payables consist of the following (in
thousands):
June 30, September 30,
2000 1999
---------- -------------
Receivable from customers and non-customers (less
allowance for doubtful accounts of $6,440 at June
30, 2000 and $975 at September 30, 1999).......... $4,791,836 $2,559,283
Receivable from brokers, dealers and clearing
organizations:
Net settlement and deposits with clearing
organizations................................... 116,662 20,066
Deposits paid for securities borrowed............ 730,245 306,326
Securities failed to deliver..................... 4,950 7,508
Other............................................ 14,176 19,398
---------- ----------
Total brokerage receivables--net............... $5,657,869 $2,912,581
========== ==========
Payable to customers and non-customers............. $1,483,961 $ 946,760
Payable to brokers, dealers and clearing
organizations:
Deposits received for securities loaned.......... 3,505,736 1,806,590
Securities failed to receive..................... 5,398 7,235
Other............................................ 49,078 63,627
---------- ----------
Total brokerage payables....................... $5,044,173 $2,824,212
========== ==========
6
Receivable from and payable to brokers, dealers and clearing organizations
result from the Company's brokerage activities. Receivable from customers and
non-customers represents credit extended to customers to finance their
purchases of securities on margin. At June 30, 2000 and September 30, 1999,
credit extended to customers and non-customers with respect to margin accounts
was $4,752.5 million and $2,452.1 million, respectively. Securities owned by
customers and non-customers are held as collateral for amounts due on margin
balances, the value of which is not reflected in the accompanying consolidated
balance sheets. Payable to customers and non-customers represents free credit
balances and other customer and non-customer funds pending completion of
securities transactions. The Company pays interest on certain customer and
non-customer credit balances.
NOTE 3. INVESTMENTS
Investments are comprised of trading and available-for-sale debt and equity
securities, as defined under the provisions of SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Also included in
investments are investments in entities in which the Company owns between 20%
and 50%, which are accounted for under the equity method.
The carrying amounts of investments are shown below (in thousands):
June 30, September 30,
2000 1999
-------- -------------
Trading securities.................................... $ 5,090 $ 38,269
Available-for-sale investment securities.............. 825,384 685,555
Equity method investments:
Venture capital funds............................... 66,697 36,270
Other equity method investments..................... 54,370 57,402
Other investments..................................... 15,105 12,833
-------- --------
Total investments................................. $966,646 $830,329
======== ========
E*OFFERING
Included in other equity method investments is a 23.6% investment in
E*OFFERING Corp. ("E*OFFERING"), a full service, Internet-based investment
bank. On May 15, 2000, Wit Capital Group, Inc., renamed Wit SoundView Group,
Inc. ("Wit"), entered into a definitive agreement to acquire E*OFFERING. Under
the terms of the agreement, E*TRADE shareholders will receive approximately
10,532,000 shares of Wit. Concurrently with this agreement, E*TRADE and Wit
entered into a strategic alliance pursuant to which Wit will be the exclusive
source of IPOs, follow-on offerings, and other investment banking products to
E*TRADE for a three year term, and E*TRADE will acquire Wit's retail brokerage
business. As part of the consideration for the exclusivity rights, Wit has
agreed to issue to E*TRADE approximately 4,026,000 shares of common stock
which are subject to a three-year prohibition on transfer. In addition, Wit
has agreed to issue to E*TRADE a warrant to purchase up to 2,000,000 shares of
Wit common stock for $10.25 per share, contingent upon maintaining the
exclusivity rights for years four and five of the strategic alliance. In
connection with the strategic alliance, E*TRADE also agreed to purchase
2,000,000 shares of Wit common stock for $10.25 per share. The transactions
contemplated by the strategic alliance are contingent upon each other and on
the closing of the merger of E*OFFERING into Wit, which is subject to approval
by Wit's shareholders. The agreement is expected to close at the end of the
current calendar year.
Publicly-Traded Equity Securities
Included in available-for-sale securities are investments in several
companies that are publicly-traded and carried at fair value. During the nine
months ended June 30, 2000, the Company sold shares of its publicly-traded
investments generating proceeds of $66.0 million, resulting in a pre-tax gain
of $65.4 million. Unrealized gains
7
related to these investments were $314.1 million and $282.3 million at June
30, 2000 and September 30, 1999, respectively. There were no unrealized losses
related to these investments at June 30, 2000 and September 30, 1999.
Venture Capital Funds
The Company made a $50.3 million capital commitment to the E*TRADE
eCommerce Fund II, L.P. ("Fund II") as of June 16, 2000. It is anticipated
that Fund II will have total committed capital of between $200-$250 million,
with all capital in excess of the E*TRADE contributions being raised from
third parties. Fund II invests in early to mid-stage companies offering e-
commerce related services, products or infrastructure. Through Fund II, the
Company is able to leverage its own investment capital, expand the scope of
its strategic investments (beyond financial services) and keep it in a
position to capitalize on leading-edge technologies. Fund II is managed by its
General Partner, E*TRADE Ventures II, LLC ("General Partner II"). Christos M.
Cotsakos, the Chairman of the Board of Directors and Chief Executive Officer
of the Company, and Thomas Bevilacqua, the Company's Chief Strategic
Investment Officer, are the managing members of General Partner II. The
Company is a non-managing member of General Partner II. General Partner II
receives an annual management fee of approximately 1.75% of the total
committed capital. The management fee is used to offset the costs and expenses
of the Company's corporate development/strategic group. In addition, to the
extent that Fund II generates profits, 25% are allocated to General Partner II
as a carried interest. As a member of General Partner II, the Company is
entitled to receive 32% of such amount provided that up to one-fifth of the
Company's interest can be allocated by the managing members to Company
personnel.
The Company made a $25 million contribution to the E*TRADE eCommerce Fund,
L.P. (the "Fund") on October 1, 1999. The Fund has committed capital of
approximately $100 million, $75 million of which was raised from third party
investors. The Fund invests in early to mid-stage Internet companies focused
on e-commerce, infrastructure tools, communication and services. The Company
received a general and limited partnership interest of approximately 28% in
the Fund. Through the Fund, the Company is able to leverage its own investment
capital, expand the scope of its strategic investments (beyond financial
services) and keep it in a position to capitalize on leading-edge
technologies. The Fund is managed by its General Partner, E*TRADE Ventures I,
LLC (the "General Partner"). Christos M. Cotsakos, the Chairman of the Board
of Directors and Chief Executive Officer of the Company, and Thomas
Bevilacqua, the Company's Chief Strategic Investment Officer, are the managing
members of the General Partner. The Company is a non-managing member of the
General Partner. The General Partner receives an annual management fee of
approximately 1.75% of the total committed capital. The management fee is paid
in its entirety to the Company and is used to offset the costs and expenses of
its corporate development/strategic group. In addition, to the extent that the
Fund generates profits, 20% are allocated to the General Partner as a carried
interest. As a member of the General Partner, the Company is entitled to
receive 50% of such amount provided that up to one-fifth of the Company's
interest can be allocated by the managing members to Company personnel. The
Company also has limited partnership interests in two other unrelated venture
capital funds.
NOTE 4. RELATED PARTY TRANSACTIONS
During the second and third quarters of fiscal year 2000, the Company made
relocation loans to three executive officers in the aggregate principal amount
of $9.8 million. The relocation loans accrue interest at the rates of between
6.2% and 6.8% per annum, and are collateralized by residential properties. The
principal amounts of $1.6 million, $4.0 million, and $4.2 million are due in
March 2002, March 2005, and May 2005, respectively. Interest on the $4.0
million and $4.2 million loans begins to accrue in March 2003 and May 2003,
respectively, and interest on the $1.6 million loan begins to accrue
immediately. Accrued interest on the loans is due upon loan maturity. Related
party loans receivable are recorded in other assets.
NOTE 5. SUBORDINATED NOTES AND OTHER BORROWINGS
On February 7, 2000, the Company completed a Rule 144A offering of $500
million convertible subordinated notes due February 2007. On March 17, 2000,
the initial purchasers exercised an option to purchase
8
an additional $150 million of notes. The notes are convertible, at the option
of the holder, into a total of 27,542,373 shares of the Company's common stock
at a conversion price of $23.60 per share. The notes bear interest at 6%,
payable semiannually, and are non-callable for three years and may then be
called by the Company at a premium, which declines over time. The holders have
the right to require redemption at a premium in the event of a change in
control or other defined redemption event. The Company used $145.0 million of
the net proceeds to repay the outstanding balance on a line of credit in
February 2000. Debt issuance costs of $19.1 million are included in other
assets and are being amortized to corporate interest expense over the term of
the notes. Had these securities been issued at the beginning of the fiscal
year and the proceeds used to reduce the borrowings under the line of credit,
income per share would have been reduced to loss per share of $0.01 for the
three months ended June 30, 2000 and loss per share would have been increased
to $0.17 per share for the nine months ended June 30, 2000, compared to income
per share of $0.02 and loss per share of $0.08 recorded in the three and nine
months ended June 30, 2000, respectively, due to the additional interest
expense and amortization of issuance costs associated with the notes.
In December 1999, the Company obtained a $150 million line of credit
agreement with a syndicate of banks. The line of credit, which had an
expiration date of March 31, 2000, was dissolved by the Company in February
2000 following the Company's issuance of convertible subordinated notes and
repayment of the $145.0 million outstanding balance.
In November 1999, the Company obtained a $50 million line of credit under
an agreement with a bank that expires in November 2000. The line of credit is
collateralized by investment securities that are owned by the Company.
Borrowings under the line of credit bear interest at 0.35% above LIBOR. The
agreement requires the Company to meet certain financial covenants. As of June
30, 2000, the Company was in compliance with all such covenants and had $30.8
million outstanding under this line of credit.
NOTE 6. SHAREOWNERS' NOTES RECEIVABLE
During the third quarter of fiscal year 2000, the Company made full
recourse loans to several of its executive officers in the aggregate principal
and interest amount of $18.7 million. The proceeds of these loans were used to
fund the purchase of shares of E*TRADE common stock through the exercise and
hold of stock options. The loans accrue interest at the rate of 7.75% per
annum. The principal amount and accrued interest on the shareowners' notes
receivable are due through July 2001.
NOTE 7. COMPREHENSIVE INCOME
On October 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income, which requires that an enterprise report, by major
components and as a single total, the change in net assets during the period
from non-owner sources. The reconciliation of net income (loss) to
comprehensive income (loss) is as follows (in thousands):
Three Months Ended Nine Months Ended
June 30, June 30,
------------------- ------------------
2000 1999 2000 1999
--------- -------- -------- --------
Net income (loss)................. $ 5,690 $(23,746) $(22,290) $(26,110)
Changes in other comprehensive
income (loss):
Unrealized gain (loss) on
available-for-sale securities,
net of tax..................... (109,696) 25,234 1,616 239,246
Cumulative translation
adjustments.................... 3,004 (880) 1,459 (265)
--------- -------- -------- --------
Total comprehensive income
(loss)....................... $(101,002) $ 608 $(19,215) $212,871
========= ======== ======== ========
9
NOTE 8. INCOME (LOSS) PER SHARE
The following table sets forth the computation of the numerator and
denominator used in the computation of basic and diluted income (loss) per
share (in thousands):
Nine Months Ended
Three Months ended June 30, June 30,
-------------------------------- ----------------------
2000 1999 2000 1999
------------------- ------------ ------------ ---------
Basic and
Basic Diluted Basic and Basic and diluted
income income diluted loss diluted loss loss per
per share per share per share per share share
--------- --------- ------------ ------------ ---------
Numerator:
Income (loss) before
cumulative effect of
accounting change and
extraordinary loss... $ 5,690 $ 5,690 $(21,761) $(22,290) $ (23,656)
Premium on redemption
of trust preferred
securities (a)....... -- -- (381) -- --
-------- -------- -------- -------- ---------
Adjusted income (loss)
before cumulative
effect of accounting
change and
extraordinary loss... 5,690 5,690 (22,142) (22,290) (23,656)
Cumulative effect of
accounting change,
net of tax........... -- -- -- -- (469)
Extraordinary loss on
early extinguishment
of subordinated debt,
net of tax........... -- -- (1,985) -- (1,985)
-------- -------- -------- -------- ---------
Adjusted net income
(loss)............... 5,690 5,690 (24,127) (22,290) (26, 110)
Less: preferred stock
dividends............ -- -- 60 -- 180
-------- -------- -------- -------- ---------
Adjusted income (loss)
applicable to common
stock................ $ 5,690 $ 5,690 $(24,187) $(22,290) $(26, 290)
======== ======== ======== ======== =========
Denominator:
Weighted average
shares outstanding... 294,015 294,015 271,276 275,337 265,434
Dilutive effect of
options issued to
associates........... -- 14,502 -- -- --
Dilutive effect of
warrants
outstanding.......... -- 829 -- -- --
-------- -------- -------- -------- ---------
294,015 309,346 271,276 275,337 265,434
======== ======== ======== ======== =========
- --------
(a) This charge represents costs incurred to purchase certain of the Company's
trust preferred securities on the open market. The costs were charged
against additional paid-in capital but increase the net loss for earnings
per share purposes (see Note 15 to the Company's Annual Report on Form 10-
K/A).
Because the Company reported a net loss in the nine months ended June 30,
2000 and in the three and nine months ended June 30, 1999, the calculation of
diluted loss per share for these periods does not include common stock
equivalents as they are anti-dilutive and would result in a reduction of loss
per share. If the Company had reported net income in the nine months ended
June 30, 2000 and in the three and nine months ended June 30, 1999, there
would have been approximately 17,263,000, 21,029,000 and 19,003,000 additional
shares for options outstanding, respectively, and approximately 875,000,
1,129,000, and 1,278,000 additional shares for warrants outstanding,
respectively, in the calculation of diluted loss per share. Excluded from the
calculation of diluted income (loss) per share for all periods presented are
approximately 27,542,000 shares of common stock issuable under convertible
subordinated notes as the effect of applying the treasury stock method on an
as-if-converted basis would be anti-dilutive in the calculation of diluted
income (loss) per share.
10
The following options to purchase shares of common stock have not been
included in the computation of diluted income (loss) per share because the
options' exercise price was greater than the average market price of the
Company's common stock for the periods stated; therefore, the effect would be
anti-dilutive (in thousands, except exercise price data):
Three Months Nine Months
Ended June Ended June
30, 30,
------------- -------------
2000 1999 2000 1999
------ ------ ------ ------
Options excluded from computation of diluted
income (loss) per share...................... 13,303 145 8,451 182
Exercise price ranges:
High......................................... $58.75 $58.75 $58.75 $58.75
Low.......................................... $19.72 $48.25 $24.63 $25.56
NOTE 9. 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 ("SEC") and the National Association of Securities Dealers
Regulation, Inc. ("NASDR"), 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 two percent of aggregate debit
balances arising from customer transactions, as defined. E*TRADE Securities
had amounts in relation to the Rule as follows (in thousands, except
percentage data):
June 30, September 30,
2000 1999
-------- -------------
Net capital.......................................... $451,153 $162,729
Percentage of aggregate debit balances............... 9.1% 6.2%
Required net capital................................. $ 99,155 $ 52,206
Excess net capital................................... $351,998 $110,523
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.
TIR's brokerage subsidiary companies and the Company's international
affiliates are also subject to net capital requirements. These companies are
located in the United States, Australia, Hong Kong, the Philippines and
Europe. The companies outside the United States have various and differing
capital requirements, all of which were met at June 30, 2000 and September 30,
1999.
ETFC's registered broker-dealer subsidiary, ETCM, is also subject to the
Rule and is required to maintain net capital equal to the greater of $100,000
or 6.67% of aggregate indebtedness, as defined. The Rule also requires that
the ratio of aggregate indebtedness to net capital shall not exceed 15 to 1.
The table below summarizes the minimum and excess net capital requirements
for the Company's United States based broker subsidiaries (in thousands):
June 30, 2000 September 30, 1999
------------------------ ------------------------
Required Excess Required Excess
Net Net Net Net Net Net
Capital Capital Capital Capital Capital Capital
-------- ------- ------- -------- ------- -------
TIR Securities, Inc......... $250 $ 1,714 $ 1,464 $ 82 $ 2,289 $ 2,207
TIR Investor Select, Inc.... $ 5 $ 423 $ 418 $ 5 $ 254 $ 249
Marquette Securities, Inc... $250 $ 502 $ 252 $250 $ 445 $ 195
E*TRADE Capital Markets,
Inc........................ $252 $20,086 $19,834 $190 $17,310 $17,120
11
The Bank is also subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary--actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, E*TRADE
Bank must meet specific capital guidelines that involve quantitative measures
of the Bank's assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. E*TRADE Bank's capital
amounts and classification are also subject to qualitative judgments by the
regulators about the strength of components of capital, risk weightings of
assets and off-balance-sheet transactions, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require E*TRADE Bank to maintain minimum amounts and ratios of total and Tier
I capital to risk-weighted assets and of Tier I capital to average assets.
Management believes, as of June 30, 2000, that the Bank meets all capital
adequacy requirements to which it is subject. As of June 30, 2000 and
September 30, 1999, E*TRADE Bank qualified as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, E*TRADE Bank must maintain minimum total risk-based, Tier I risk-
based, and Tier I leverage ratios as set forth in the following table. There
are no conditions or events since June 30, 2000 that management believes have
changed the institution's category.
E*TRADE Bank's required and actual capital amounts and ratios are presented
in the table below (dollars in thousands):
Required To Be
Well
Capitalized
Required For Under Prompt
Capital Corrective
Adequacy Action
Actual Purposes Provisions
-------------- --------------- ---------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- --------- ----- --------- -----
As of June 30, 2000:
Core capital (to adjusted
tangible assets)........... $475,258 6.42% >$296,024 >4.0% >$370,030 > 5.0%
Tangible capital (to
tangible assets)........... $475,258 6.42% >$111,248 >1.5% N/A N/A
Tier I capital (to risk
weighted assets)........... $475,258 16.17% N/A N/A >$178,747 > 6.0%
Total capital (to risk
weighted assets)........... $484,598 16.48% >$238,329 >8.0% >$297,911 >10.0%
As of September 30, 1999:
Core capital (to adjusted
tangible assets)........... $440,469 11.20% >$157,320 >4.0% >$196,651 > 5.0%
Tangible capital (to
tangible assets)........... $440,469 11.20% >$ 58,995 >1.5% N/A N/A
Tier I capital (to risk
weighted assets)........... $440,469 25.97% N/A N/A >$101,768 > 6.0%
Total capital (to risk
weighted assets)........... $447,170 26.36% >$135,691 >8.0% >$169,614 >10.0%
NOTE 10. COMMITMENTS, CONTINGENCIES AND OTHER REGULATORY MATTERS
As of June 30, 2000, the Bank had commitments to purchase $26.9 million in
fixed rate and $632.9 million in variable rate loans and certificates of
deposit scheduled to mature in less than one year approximating
$2,112.5 million. In the normal course of business, the Bank makes various
commitments to extend credit and incur contingent liabilities that are not
reflected in the balance sheets.
The Company is a defendant in civil actions arising in the normal course of
business, including several putative class action filings. The matters alleged
by the plaintiffs include:
. False and deceptive advertising and other communications regarding the
Company's commission rates and ability to timely execute and confirm
online transactions;
. Damages arising from alleged problems in accessing brokerage accounts and
placing orders;
. Damages arising from system interruptions; and
12
. Unfair business practices regarding the extent to which initial public
offering shares are made available to the Company's customers.
These proceedings are at early stages, and the Company is unable to predict
their ultimate outcome; however, the Company believes that all of these claims
are without merit and intends to defend against them vigorously. An
unfavorable outcome in any of these matters, if they are not covered by
insurance, could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, even if the
ultimate outcomes are resolved in favor of the Company, the defense of such
litigation could entail considerable cost and the diversion of efforts of
management, either of which could have a material adverse effect on the
Company's results of operation.
From time to time, the Company has been threatened with, or named as a
defendant in, lawsuits, arbitrations and administrative claims. Compliance and
trading problems that are reported to the NASDR or the SEC by dissatisfied
customers are investigated by the NASDR or the SEC, and, if pursued by such
customers, may rise to the level of arbitration or disciplinary action. One or
more of such claims or disciplinary actions decided adversely against the
Company could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company is also subject to
periodic regulatory audits and inspections.
The securities and banking industries are 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 noncompliance with applicable regulations.
NOTE 11. ACQUISITIONS
On June 14, 2000, the Company entered into a definitive agreement to
acquire VERSUS Technologies, Inc. ("VERSUS"), a Canadian-based provider of
electronic securities trading services for institutional and retail investors
and owner of the E*TRADE Canada license, in which the Company has an existing
$1.5 million investment at June 30, 2000. Through the acquisition of VERSUS,
the Company will increase its retail and institutional client base and be able
to incorporate the technology underlying the VERSUS Network, a scalable
proprietary electronic trading platform, into its global cross border trading
platform, enabling institutions and investment dealers worldwide to route
orders globally through its trading networks. In connection with this
transaction, the Company agreed to acquire all of the outstanding shares of
VERSUS stock in exchange for E*TRADE common stock valued at approximately
$174.0 million, with VERSUS to become a wholly-owned subsidiary of the
Company. The acquisition of VERSUS is subject to the satisfaction of certain
conditions and is expected to close by the end of fiscal year 2000. The
acquisition is expected to be accounted for as a pooling of interests.
13
On January 12, 2000, the Company completed the acquisition of ETFC. ETFC is
the holding company for E*TRADE Bank, an Internet-based bank. Under the terms
of the agreement, ETFC shareowners received 1.05 shares of E*TRADE common
stock for each share of ETFC common stock representing a total of
approximately 35,600,000 shares of the Company's common stock. The Company
also assumed all outstanding ETFC options, which were converted to options to
purchase approximately 5,494,000 shares of the Company's common stock. The
acquisition was accounted for as a pooling of interests and, accordingly, all
prior financial data of the Company has been restated to include the
historical operations of ETFC. There were no significant intercompany
transactions requiring elimination for any prior periods presented. The
Company has incurred $0.2 million and $27.1 million of merger-related expenses
in the three and nine months ended June 30, 2000, respectively, related to the
acquisition of ETFC. The information below reflects the operations of E*TRADE
and ETFC through the date of acquisition (in thousands):
Income (Loss)
Before
Cumulative
Effect of
Accounting
Change and Net
Net Extraordinary Income
Revenues Loss (Loss)
---------- ------------- --------
Nine months ended June 30, 2000
E*TRADE Group............................. $ 981,990 $(22,713) $(22,713)
ETFC through December 31, 1999............ 23,423 423 423
---------- -------- --------
Combined.................................. $1,005,413 $(22,290) (22,290)
========== ======== ========
Nine months ended June 30, 1999
E*TRADE Group............................. $ 432,365 $(27,719) $(27,719)
ETFC...................................... 35,249 4,063 1,609
---------- -------- --------
Combined.................................. $ 467,614 $(23,656) $(26,110)
========== ======== ========
On May 5, 2000, the Company completed the acquisition of Card Capture
Services, Inc. ("CCS"), the largest independent network of centrally-managed
automated teller machines in the United States, for an aggregate purchase
price of $94.0 million. The aggregate purchase price is comprised of:
approximately 4,247,000 shares of common stock valued at $87.4 million issued
in exchange for 100% of the outstanding shares of CCS, the assumption of
employee stock options, and incentive payments to management; cash paid of
$5.1 million; and acquisition costs of $1.5 million. The acquisition was
accounted for using the purchase method of accounting, and the results of
CCS's operations have been combined with those of the Company since the date
of acquisition. The purchase price allocation at June 30, 2000 is preliminary
and has been allocated based on the estimated fair value of net tangible and
intangible assets acquired. At June 30, 2000, the Company allocated $17.3
million to acquired assets and assumed liabilities of $13.6 million. The
purchase price exceeded the fair value of the assets acquired by $90.3
million, which was primarily recorded as goodwill to be amortized over fifteen
years, pending the completion of an independent valuation of CCS net assets.
Merger-related expenses related to the acquisition of CCS were not significant
through June 30, 2000. Additional costs associated with the CCS merger are
expected to be incurred throughout fiscal 2000.
During the quarter ended December 31, 1999, the Company acquired 100%
ownership of three of its foreign affiliates, E*TRADE Nordic AB, a Swedish
company, E*TRADE @ Net Bourse S.A., a French company, and the remaining
portion of its E*TRADE UK joint venture, for an aggregate purchase price of
$362.0 million. The purchase price was comprised of 11.7 million shares of the
Company's common stock, cash of $26.7 million and the assumption of options of
the affiliates. The purchase price exceeded the fair value of the assets
acquired by $357.4 million, which was recorded as goodwill to be amortized
over 20 years. Merger-related expenses related to foreign acquisitions were
not significant.
14
The pro forma information below assumes that the acquisitions of the
Company's foreign affiliates and CCS occurred at the beginning of fiscal 1999
and includes the effect of amortization of goodwill from that date (in
thousands, except per share amounts):
Nine Months ended
June 30,
--------------------
2000 1999
---------- --------
Net revenues.......................................... $1,026,320 $512,205
Net loss.............................................. $ (29,960) $(46,710)
Basic and diluted loss per share...................... $ (0.10) $ (0.17)
The pro forma information is for informational purposes only and is not
necessarily indicative of the results of future operations nor results that
would have been achieved had the acquisitions taken place at the beginning of
fiscal 1999.
15
NOTE 12. SEGMENT INFORMATION
The Company provides securities brokerage and related investment and
financial services. Following the acquisitions of TIR in fiscal 1999 and ETFC
in fiscal 2000 (see Note 11), the Company classified the operations of
E*TRADE's historical business, TIR and ETFC as separate reportable segments
due to the relatively short operating history of the combined operations of
E*TRADE's historical business with TIR and ETFC and due to ETFC's online
banking services which represent a new line of business. With the acquisition
of three foreign affiliates in the quarter ended December 31, 1999, their
results have been combined with TIR to constitute the International segment.
With the acquisition of CCS in the quarter ended June 30, 2000, the operations
of CCS have been combined with ETFC to comprise the Banking segment. This is
the manner in which management currently evaluates the Company's operating
performance. Financial information for the Company's reportable segments is
presented in the table below and the totals are equal to the Company's
consolidated amounts as reported in the condensed consolidated financial
statements.
E*TRADE
Group International Banking Total
---------- ------------- ---------- -----------
(in thousands)
Three months ended June 30,
2000:
Interest income--net of
interest expense......... $ 59,192 $ 765 $ 32,395 $ 92,352
Non-interest revenue--net
of provision for loan
losses................... 195,753 36,043 6,193 237,989
---------- -------- ---------- -----------
Net revenues.............. $ 254,945 $ 36,808 $ 38,588 $ 330,341
========== ======== ========== ===========
Operating income (loss)... $ 1,419 $ (4,567) $ 3,365 $ 217
Pre-tax income (loss)..... $ 14,699 $ (4,518) $ 2,812 $ 12,993
Three months ended June 30,
1999:
Interest income--net of
interest expense......... $ 30,001 $ 273 $ 15,203 $ 45,477
Non-interest revenue--net
of provision for loan
losses................... 117,181 24,997 (1,233) 140,945
---------- -------- ---------- -----------
Net revenues.............. $ 147,182 $ 25,270 $ 13,970 $ 186,422
========== ======== ========== ===========
Operating income (loss)... $ (47,259) $ 1,563 $ 647 $ (45,049)
Pre-tax income (loss)..... $ (39,247) $ 1,037 $ 4,758 $ (33,452)
Nine months ended June 30,
2000:
Interest income--net of
interest expense......... $ 166,976 $ 1,296 $ 83,031 $ 251,303
Non-interest revenue--net
of provision for loan
losses................... 634,799 111,599 7,712 754,110
---------- -------- ---------- -----------
Net revenues.............. $ 801,775 $112,895 $ 90,743 $ 1,005,413
========== ======== ========== ===========
Operating loss............ $ (78,945) $ (384) $ (2,907) $ (82,236)
Pre-tax loss.............. $ (19,286) $ (970) $ (3,448) $ (23,704)
Nine months ended June 30,
1999:
Interest income--net of
interest expense......... $ 68,718 $ 670 $ 31,154 $ 100,542
Non-interest revenue--net
of provision for loan
losses................... 282,254 80,723 4,095 367,072
---------- -------- ---------- -----------
Net revenues.............. $ 350,972 $ 81,393 $ 35,249 $ 467,614
========== ======== ========== ===========
Operating income (loss)... $ (104,653) $ 5,939 $ 5,973 $ (92,741)
Pre-tax income (loss)..... $ (53,309) $ 5,386 $ 10,279 $ (37,644)
As of June 30, 2000:
Segment assets............ $7,185,102 $274,902 $7,432,593 $14,892,597
As of September 30, 1999:
Segment assets............ $3,771,370 $155,610 $3,981,244 $ 7,908,224
No one single customer accounted for greater than 10% of total revenues in
the three or nine months ended June 30, 2000 or 1999.
16
NOTE 13. Recent Accounting Pronouncements
In December 1999, the Securities and Exchange Commission ("SEC") staff
issued Staff Accounting Bulletin No. 101 Revenue Recognition in Financial
Statements ("SAB 101"). SAB 101 states that all registrants are expected to
apply the accounting and disclosures described in it. The SEC staff, however,
will not object if registrants that have not applied SAB 101 do not restate
prior financial statements provided they report a change in accounting
principle in accordance with Accounting Principles Board Opinion No. 20
Accounting Changes, by cumulative catch-up adjustment no later than the second
quarter of the fiscal year beginning after December 15, 1999. The Company is
currently evaluating the impact, if any, of SAB 101 on its revenue recognition
policy and its consolidated financial statements.
17
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Forward-Looking Statements
The following discussion of the financial condition and results of
operations of E*TRADE Group, Inc. should be read in conjunction with the
condensed consolidated financial statements and notes thereto included
elsewhere in this Form 10-Q. This discussion contains forward-looking
statements, including statements regarding our Company's strategy, financial
performance and revenue sources, which involve risks and uncertainties. Actual
results may differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including, but not limited to,
those set forth in the section entitled "Risk Factors" and elsewhere in this
Form 10-Q.
Results of Operations
Revenue Detail (in millions, except percentage data)
The following table sets forth the components of revenue and the percentage
change for the three and nine months ended June 30, 2000 and 1999:
Three Months Nine Months
Ended Ended
June 30, June 30,
--------------- -----------------
Percentage Percent
2000 1999 Change 2000 1999 Change
------- ------- ---------- --------- ------- -------
Transaction revenues:
Commission.............. $ 161.5 $ 95.0 70% $ 524.0 $ 227.9 130%
Order Flow.............. 18.7 11.1 68% 63.1 29.0 118%
------- ------- --------- -------
Total transaction
revenues............. 180.2 106.1 70% 587.1 256.9 129%
======= ======= ========= =======
Interest income:
Brokerage-related
activities............. 121.6 54.1 125% 329.1 119.0 177%
Banking-related
activities............. 135.6 50.0 171% 328.0 126.7 159%
------- ------- --------- -------
Total interest
income............... 257.2 104.1 147% 657.1 245.7 167%
------- ------- --------- -------
Global and institutional.. 33.9 26.9 26% 109.0 84.4 29%
Other..................... 24.9 8.6 189% 60.8 27.2 123%
------- ------- --------- -------
Gross revenues........ 496.2 245.7 102% 1,414.0 614.2 130%
======= ======= ========= =======
Interest expense:
Brokerage-related
activities............. 61.6 24.1 156% 160.8 49.6 224%
Banking-related
activities............. 103.2 34.6 198% 245.0 95.6 156%
------- ------- --------- -------
Total interest
expense.............. 164.8 58.7 181% 405.8 145.2 180%
Provision for loan
losses................... 1.0 0.7 46% 2.8 1.4 93%
------- ------- --------- -------
Net revenues.......... $ 330.3 $ 186.4 77% $ 1,005.4 $ 467.6 115%
======= ======= ========= =======
(Percentages may not recalculate and balances may not add due to rounding.)
Net Revenues
Net revenues increased to $330.3 million in the third quarter of fiscal
2000, up 77% from $186.4 million in the equivalent period of fiscal 1999. Net
revenues increased to $1,005.4 million for the nine months ended June 30,
2000, up 115% from $467.6 million in the equivalent period of fiscal 1999. The
increase in net revenue is mainly due to the growth in our diversified and
global revenue streams, improvements in our cross-selling ability across
business lines, and sustained growth in customer trading volumes, net new
active bank and brokerage customer accounts and customer assets.
18
Transaction Revenues
Transaction revenues increased to $180.2 million in the third quarter of
fiscal 2000, up 70% from $106.1 million in the equivalent period in fiscal
1999. Transaction revenues increased to $587.1 million for the nine months
ended June 30, 2000, up 129% from $256.9 million for the equivalent period in
fiscal 1999. Transaction revenues consist of commission revenues and payments
for order flow. Growth in transaction revenues reflects the overall high level
of trading volume in U.S. financial markets for the nine months ended June 30,
2000. Further, sustained growth in new customer accounts coupled with our
Power E*TRADE program, which extends special initiatives to participating,
highly active customers who remained active this quarter, despite declining
volumes in the market, and the implementation of our Customer Relationship
Management ("CRM") technology, which has enabled us to identify and attract
higher quality accounts, contributed to the growth in transaction revenues
during the third quarter in fiscal 2000 despite a historic decline in overall
market trading volumes during that quarter.
Commission revenues for the third quarter of fiscal 2000 increased to
$161.5 million, up 70% from $95.0 million in the same period a year ago.
Commission revenues for the nine months ended June 30, 2000 increased to
$524.0 million, up 130% from $227.9 million in the same period a year ago.
Domestic brokerage transactions for the third quarter of fiscal 2000 totaled
10.5 million, or an average of 166,528 transactions per day. This is an
increase of 107% over the average daily domestic brokerage transaction volume
of 80,635 for the same period in the prior year. Domestic brokerage
transactions for the nine months ended June 30, 2000 totaled 33.2 million, or
an average of 174,757 transactions per day. This is an increase of 171% over
the average daily domestic brokerage transaction volume of 64,444 for the same
period in the prior year. Commissions per trade decreased from $18.51 and
$18.59 in the three and nine months ended June 30, 1999, respectively, to
$17.33 and $17.70 for the three and nine months ended June 30, 2000,
respectively. The decline in commissions per trade was a result of promotional
activities, changes in the mix of revenue generating transactions and the
August 1999 implementation of the Power E*TRADE program, a component of which
provides reduced commissions for active traders. Further, market conditions in
the third quarter of fiscal 2000 coupled with our efforts to diversify revenue
streams during this period have resulted in a reduction in transaction
revenues as a percentage of gross revenues to 36% from 43% in the third
quarter of fiscal 1999. Commission revenues as a percentage of gross revenues
are expected to decrease as we continue to execute on cross-selling
initiatives across business lines, leveraging our diversified business model.
Payments for order flow increased to $18.7 million for the third quarter of
fiscal 2000, up 68% from $11.1 million for the same period a year ago. Order
flow revenue increased to $63.1 million for the nine months ended June 30,
2000, up 118% from $29.0 million for the same period in the prior year. As a
percentage of transaction revenues, payments for order flow were 10% for the
three months ended June 30, 2000 and 1999. As a percentage of transaction
revenues, payments for order flow were 11% for the nine months ended June 30,
2000 and 1999. Payments for order flow did not increase at the same rate as
transactions due to changes in the order flow mix, a decrease in the average
shares per equity transaction and the continued impact of the SEC's order
handling rules.
Interest Income and Expense
Interest income from brokerage-related activities is comprised of interest
earned by our brokerage subsidiary on credit extended to customers to finance
their purchases of securities on margin and fees on customer assets invested
in money market accounts. Interest expense from brokerage-related activities
is comprised of interest paid to customers on certain credit balances,
interest paid to banks and interest paid to other broker-dealers through our
brokerage subsidiary's stock loan program. Interest income from banking-
related activities reflects interest earned on assets, consisting primarily of
loans receivable and mortgage-backed securities. Interest expense from
banking-related activities is comprised of interest-bearing liabilities which
include customer deposits, advances from the Federal Home Loan Bank of Atlanta
and other borrowings.
Brokerage interest income increased to $121.6 million in the third quarter
of fiscal 2000, up 125% from $54.1 million in the same period a year ago.
Brokerage interest income increased to $329.1 million for the nine months
ended June 30, 2000, up 177% from $119.0 million in the same period in fiscal
1999. These increases
19
primarily reflect the overall increase in average customer margin balances,
which increased 119% to $5,048.4 million in the third quarter of fiscal 2000,
from $2,306.9 million in the same period a year ago, and average customer
money market fund balances, which increased 133% to $7,224.1 million in the
third quarter of fiscal 2000, from $3,098.3 million in the same period a year
ago. Brokerage interest expense increased to $61.6 million in the third
quarter of fiscal 2000, up 156% from $24.1 million in the comparable prior
year period. Brokerage interest expense increased to $160.8 million for the
nine months ended June 30, 2000, up 224% from $49.6 million in the comparable
prior year period. This increase is due to an overall increase in average
customer credit balances, which increased 113% to $1,426.0 million in the
third quarter of fiscal 2000, from $670.7 million in the same period a year
ago, and average stock loan balances, which increased 95% to $3,715.1 million
in the third quarter of fiscal 2000, from $1,910.0 million in the same period
a year ago.
Banking interest income increased to $135.6 million in the third quarter of
fiscal 2000, up 171% from $50.0 million for the same period a year ago.
Banking interest income increased to $328.0 million for the nine months ended
June 30, 2000, up 159% from $126.7 million for the same period a year ago.
These increases reflect an increase in the average interest-earning asset
balances coupled with an increase in the average interest yield. Average
interest-earning assets increased 140% to $6,907.2 million during the third
quarter of fiscal 2000, from $2,875.0 million in the same period a year ago.
The average yield increased to 7.86% in the third quarter of fiscal 2000 from
6.93% in the same period a year ago. Average interest-earning assets increased
135% to $5,702.9 million during the nine months ended June 30, 2000, from
$2,429.3 million in the same period a year ago. The average yield increased to
7.67% in the nine months ended June 30, 2000 from 7.00% in the same period a
year ago. Interest expense from banking activities increased to $103.2 million
in the third quarter of fiscal 2000, up 198% from $34.6 million for the same
period a year ago. Interest expense from banking activities increased to
$245.0 million in the nine months ended June 30, 2000, up 156% from $95.6
million for the same period a year ago. These increases reflect an increase in
the average interest-bearing liabilities coupled with an increase in the
average cost of the borrowings. Average interest-bearing liabilities increased
165% to $6,552.8 million during the third quarter of fiscal 2000, from
$2,470.6 million in the same period a year ago. The average cost increased to
6.33% in the third quarter of fiscal 2000 from 5.62% in the same period a year
ago. Average interest-bearing liabilities increased 140% to $5,357.0 million
during the nine months ended June 30, 2000, from $2,229.0 million in the same
period a year ago. The average cost increased to 6.11% in the nine months
ended June 30, 2000 from 5.73% in the same period a year ago.
20
The following tables present average balance data and income and expense
data for our banking subsidiary's operations and the related interest yields
and rates for the three and nine months ended June 30, 2000 and 1999. The
tables also present information for the periods indicated with respect to net
interest margin, an indicator of an institution's profitability, which is
calculated by dividing net interest income by interest-earning banking assets.
Another indicator of profitability is net interest spread, which is the
difference between the weighted average yield earned on interest-earning
assets and weighted average rate paid on interest-bearing liabilities.
Interest includes the incremental tax benefit of tax exempt income.
Three Months Ended June 30, Three Months Ended June 30,
2000 1999
------------------------------- -------------------------------
Interest Average Interest Average
Average Income/ Annualized Average Income/ Annualized
Balance Expense Yield/Cost Balance Expense Yield/Cost
----------- -------- ---------- ----------- -------- ----------
(Dollars in thousands)
(unaudited)
Interest-earning banking
assets:
Loans receivable,
net.................. $ 3,374,777 $ 68,620 8.13% $ 1,306,819 $ 24,755 7.58%
Interest-bearing
deposits............. 45,721 737 6.48 31,339 370 4.73
Mortgage-backed and
related available-
for-sale securities.. 3,187,770 60,992 7.65 1,277,246 20,578 6.44
Available-for-sale
investment
securities........... 223,459 3,873 7.13 213,934 3,285 6.35
Investment in FHLB
stock................ 69,414 1,341 7.77 24,403 456 7.50
Trading securities.... 6,077 78 5.11 21,257 388 7.31
----------- -------- ------ ----------- -------- ------
Total interest-
earning banking
assets............. 6,907,218 $135,641 7.86% 2,874,998 $ 49,832 6.93%
Non-interest-earning
banking assets......... 288,330 109,208
----------- -----------
Total banking
assets............. $ 7,195,548 $ 2,984,206
=========== ===========
Interest-bearing banking
liabilities:
Retail deposits....... $ 3,491,184 $ 53,547 6.12% $ 1,416,953 $ 19,909 5.64%
Brokered callable
certificates of
deposit.............. 91,730 1,478 6.46 67,093 1,110 6.63
FHLB advances......... 1,354,077 21,694 6.34 467,434 6,351 5.38
Other borrowings...... 1,615,762 26,472 6.48 499,026 6,668 5.29
Subordinated debt,
net.................. -- -- -- 20,062 591 11.77
----------- -------- ----------- --------
Total interest-
bearing banking
liabilities........ 6,552,753 $103,191 6.33% 2,470,568 $ 34,629 5.62%
Non-interest bearing
banking liabilities.... 161,966 61,426
----------- -----------
Total banking
liabilities........ 6,714,719 2,531,994
Total banking
shareowner's
equity............. 480,829 452,212
----------- -----------
Total banking
liabilities and
shareowner's equity.... $ 7,195,548 $ 2,984,206
=========== ===========
Excess of interest-
earning banking assets
over interest-bearing
banking liabilities/net
interest income........ $ 354,465 $ 32,450 $ 404,430 $ 15,203
=========== ======== =========== ========
Net interest spread..... 1.53% 1.31%
====== ======
Net interest margin (net
yield on interest-
earning banking
assets)................ 1.88% 2.12%
====== ======
Ratio of interest-
earning banking assets
to
interest-bearing
banking liabilities.... 105.41% 116.37%
====== ======
Return on average total
banking assets......... 0.07%* 0.17%
====== ======
Return on average net
banking assets......... 0.07%* 0.25%
====== ======
Equity to total banking
assets................. 6.68%* 15.15%
====== ======
- --------
* Ratios calculated by excluding ESOP and merger related costs of $0.2
million and $0.5 million, respectively in the three months ended June 30,
2000 and 1999, respectively.
21
Nine Months Ended June 30,
Nine Months Ended June 30, 2000 1999
------------------------------- ------------------------------
Interest Average Interest Average
Average Income/ Annualized Average Income/ Annualized
Balance Expense Yield/Cost Balance Expense Yield/Cost
---------- --------- ---------- ---------- -------- ----------
(Dollars in thousands)
(unaudited)
Interest-earning banking assets:
Loans receivable, net................... $2,828,210 $ 168,439 7.94% $1,054,103 $ 60,636 7.67%
Interest-bearing deposits............... 65,540 2,768 5.64 26,673 891 4.46
Mortgage-backed and related
available- for-sale securities......... 2,535,820 142,366 7.49 1,083,575 53,108 6.54
Available-for-sale investment
securities............................. 201,858 10,391 6.94 219,044 10,163 6.31
Investment in FHLB stock................ 53,502 3,109 7.76 21,913 1,229 7.49
Trading securities...................... 17,956 926 6.88 23,945 1,299 7.24
---------- --------- ------ ---------- -------- ------
Total interest-earning banking
assets............................... 5,702,886 $ 327,999 7.67% 2,429,253 $127,326 7.00%
Non-interest-earning banking assets....... 231,192 97,265
---------- ----------
Total banking assets.................. $5,934,078 $2,526,518
========== ==========
Interest-bearing banking liabilities:
Retail deposits......................... $2,900,118 $ 130,101 5.98 $1,234,211 $ 52,869 5.98%
Brokered callable certificates of
deposit................................ 87,551 4,266 6.49 67,070 3,330 6.61
FHLB advances........................... 1,048,832 48,913 6.13 406,848 16,542 5.34
Other borrowings........................ 1,286,937 61,633 6.29 498,098 20,448 5.39
Subordinated debt, net.................. 33,536 -- -- 22,732 2,358 13.83
---------- --------- ---------- --------
Total interest-bearing banking
liabilities.......................... 5,356,974 $ 244,913 6.11% 2,228,959 $ 95,547 5.73%
Non-interest bearing banking
liabilities:............................. 81,843 67,727
---------- ----------
Total banking liabilities............... 5,438,817 2,296,686
Total banking shareowner's equity....... 495,261 229,832
---------- ----------
Total banking liabilities and shareowner's
equity................................... $5,934,078 $2,526,518
========== ==========
Excess of interest-earning banking assets
over interest-bearing banking
liabilities/net interest income.......... $ 345,912 $ 83,086 $ 200,294 $ 31,779
========== ========= ========== ========
Net interest spread....................... 1.56% 1.27%
====== ======
Net interest margin (net yield on
interest-earning banking assets)......... 1.94% 1.74%
====== ======
Ratio of interest-earning banking assets
to interest-bearing banking liabilities.. 106.46% 108.99%
====== ======
Return on average total banking assets.... 0.16%* 0.14%
====== ======
Return on average net banking assets...... 0.17%* 0.15%
====== ======
Equity to total banking assets............ 8.35%* 9.10%
====== ======
- --------
* Ratios calculated by excluding ESOP and merger related costs of $17.1
million and $1.1 million, respectively, in the nine months ended June 30,
2000 and 1999, respectively.
22
Global and Institutional
Global and institutional revenues increased to $33.9 million in the third
quarter of fiscal 2000, up 26% from $26.9 million in the same period a year
ago. For the nine months ended June 30, 2000, global and institutional
revenues increased to $109.0 million from $84.4 million, up 29% from the same
period in fiscal 1999. Global and institutional revenues are comprised of
revenues from TIR's operations, as well as licensing fees, royalties and
brokerage-related transaction revenue from our international affiliates. TIR's
net revenues increased to $33.3 million in the third quarter of fiscal 2000,
up 32% from $25.3 million for the same period a year ago. These increases are
primarily attributable to strong market conditions in Asia and Europe during
the nine months ended June 30, 2000, partially offset by historic market
volatility during the three months ended June 30, 2000, which resulted in an
18% decline in global and institutional revenues from $41.4 million in the
second quarter of fiscal 2000. TIR's revenues are largely comprised of
commissions from institutional trade executions; for the third quarter of
fiscal 2000, approximately 69.5% of TIR's transactions were from outside the
U.S., and approximately 72.4% were from cross-border transactions.
Other Revenues
Other revenues increased to $24.9 million in the third quarter of fiscal
2000, up 189% from $8.6 million for the comparable period in fiscal 1999.
Other revenues increased to $60.8 million for the nine months ended June 30,
2000, up 123% from $27.2 million for the comparable period in fiscal 1999.
Other revenues increased primarily due to growth in E*TRADE Business Solutions
revenue, mutual funds revenue, revenues from fees charged for advertising on
our Web site, investment banking revenue, and brokerage and banking-related
fees for services. Further, with the acquisition of CCS on May 5, 2000,
accounted for under the purchase method, other revenues in the three and nine
month periods ended June 30, 2000 include both net ATM transaction fees and
the gross proceeds from the sale of ATM machines.
Provision for Loan Losses
The Company recorded a provision for loan losses of $1.0 million in the
third quarter of fiscal 2000, up 46% from $0.7 million for the comparable
period in fiscal 1999. For the nine months ended June 30, 2000, the provision
for loan losses increased to $2.8 million from $1.4 million, up 93% from the
same period in fiscal 1999. The provision for loan losses recorded reflects
increases in our allowance for loan losses based upon management's review and
assessment of the risk in our loan portfolio, as well as the level of charge-
offs as a portion of our allowance for loan losses. The increase in the
provision for loan losses in the third quarter of fiscal 2000 primarily
reflects the growth in the Company's loan portfolio. As of June 30, 2000, the
total loan loss allowance was $9.7 million, or 0.27% of total loans
outstanding. The total loan loss allowance as of September 30, 1999 was $7.1
million, or 0.33% of total loans outstanding. As of June 30, 2000, the general
loan loss allowance was $9.3 million, or 93% of total non-performing assets of
$10.0 million. As of September 30, 1999, the general loan loss allowance was
$6.7 million, or 79% of total non-performing assets of $8.5 million.
Cost of Services
Total cost of services increased to $124.5 million for the third quarter of
fiscal 2000, up 51% from $82.2 million in the comparable period in fiscal
1999. Total cost of services increased to $366.5 million for the nine months
ended June 30, 2000, up 84% from $199.0 million in the comparable period in
fiscal 1999. Cost of services includes expenses related to our brokerage
clearing operations, customer service activities, Web site content costs,
system maintenance, communication expenses and depreciation. These increases
reflect the overall increase in customer transactions processed by our
brokerage and banking subsidiaries, a related increase in customer service
inquiries, and operations and maintenance costs associated with our technology
centers in Rancho Cordova, California and Alpharetta, Georgia. Cost of
services as a percentage of net revenues was 38% in the third quarter of
fiscal 2000 and 44% in the comparable period in fiscal 1999. Cost of services
as a percentage of net revenues was 36% for the nine months ended June 30,
2000, compared to 43% in the comparable period in fiscal 1999. The improvement
in cost of services as a percentage of net revenue is reflective of increased
trading volumes and the diversification of revenue streams.
23
Operating Expenses
Selling and marketing expenses increased to $115.1 million in the third
quarter of fiscal 2000, up 15% from $99.8 million in the comparable period in
fiscal 1999. Selling and marketing expenses increased to $422.2 million for
the nine months ended June 30, 2000, up 79% from $235.7 million in the
comparable period in fiscal 1999. The increases reflect expenditures for
advertising placements, creative development and collateral materials
resulting from a variety of advertising campaigns directed at building brand
name recognition, growing the customer base and market share, and maintaining
customer retention rates. Selling and marketing expenditures in the three and
nine months ended June 30, 2000 reflect expenditures which resulted from our
sponsorship of Super Bowl XXXIV. International marketing and banking
expenditures are expected to increase as we expand our advertising efforts for
these segments; however, overall marketing expenditure levels are not expected
to continue to grow at the same rate in the fourth quarter of fiscal 2000 as
in the first two quarters of the year.
Technology development expenses increased to $32.5 million in the third
quarter of fiscal 2000, up 57% from $20.7 million in the comparable period in
fiscal 1999. Technology development expenses increased to $111.0 million for
the nine months ended June 30, 2000, up 120% from $50.5 million in the
comparable period in fiscal 1999. The increased level of expense was incurred
to enhance our existing product offerings, including maintenance of our Web
site and development of our CRM technology prior to achievement of
technological feasibility, reflecting our continuing commitment to invest in
new products and technologies. Technology development expenses in the third
quarter of fiscal 2000 decreased by $9.6 million or 23% from the second
quarter of fiscal 2000 primarily due to an increase in capitalizable
development costs for certain internally developed software which reached
technological feasibility at the end of the second quarter of fiscal 2000, as
well as a reduction in the use of outside consultants as we refocused our
efforts on fewer, but more beneficial projects. Capitalized costs will be
amortized to technology development expense over the expected life of the
developed applications.
General and administrative expenses increased to $50.2 million in the third
quarter of fiscal 2000, up 104% from $24.6 million in the comparable period in
fiscal 1999. General and administrative expenses increased to $142.5 million
for the nine months ended June 30, 2000, up 105% from $69.7 million in the
comparable period in fiscal 1999. These increases were the result of personnel
additions and the development of administrative functions resulting from our
overall growth.
Amortization of goodwill and other intangibles was $6.7 million in the
third quarter of fiscal 2000, an increase of $6.2 million from $0.6 million in
the comparable period in fiscal 1999. Amortization of goodwill and other
intangibles increased to $13.9 million for the nine months ended June 30,
2000, an increase of $12.0 million from $1.9 million in the comparable period
in fiscal 1999. These increases primarily consist of amortization of goodwill
related to the acquisition of three of our foreign affiliates and CCS during
fiscal 2000. Goodwill is amortized over 15 to 20 years.
Merger-related expenses of $1.1 million were recognized in the third
quarter of fiscal 2000, compared to $3.7 million of merger-related expenses
recognized in the third quarter of fiscal 1999. Merger-related expenses of
$31.5 million were recognized in the nine months ended June 30, 2000, compared
to $3.7 million of merger-related expenses recognized in the comparable period
of fiscal 1999. Merger-related expenses primarily relate to transaction costs
associated with the E*TRADE Financial Corporation acquisition. Additional
costs associated with mergers and acquisitions are expected to be incurred
throughout fiscal 2000.
Non-operating Income (Expense)
Corporate interest expense-net was $6.0 million for the quarter ended June
30, 2000, compared with $4.2 million in corporate interest income-net in the
comparable period in fiscal 1999. Corporate interest expense-net was $8.4
million for the nine month period ended June 30, 2000, compared with $14.8
million in corporate interest income-net in the comparable period in fiscal
1999. Corporate interest expense-net increased primarily as a result of a
decrease in average corporate investment balances coupled with an increase in
interest
24
expense resulting from the issuance of $650 million in convertible
subordinated notes during the three months ended March 31, 2000.
In the third quarter of fiscal 2000, we continued to liquidate portions of
our investment portfolio and recognized realized gains of $24.4 million,
compared with $8.4 million in recognized realized gains in the third quarter
of fiscal 1999. The gain on sale of investments for the nine month period
ended June 30, 2000 was $66.6 million, compared with $41.8 million in
recognized realized gains for the equivalent period in fiscal 1999.
We recorded an unrealized loss of $3.5 million during the third quarter of
fiscal 2000 on our participation in the E*TRADE eCommerce Fund L.P.,
representing market declines on public investments held by the fund. We
recorded an unrealized gain of $7.4 million in the nine months ended June 30,
2000. This fund was formed in the first quarter of fiscal 2000.
Equity in losses of investments included in other non-operating income
(expense) was $1.4 million in the third quarter of fiscal 2000, which resulted
from our minority ownership in investments which are accounted for under the
equity method, compared to $0.9 million in the comparable period in fiscal
1999. Equity in losses of investments was $6.0 million for the nine month
period ended June 30, 2000, compared to $1.9 million in the equivalent period
in fiscal 1999. These investments include E*TRADE Japan and Archipelago. We
expect that these companies will continue to invest in the development of
their products and services and will incur operating losses throughout fiscal
2000, which will result in future charges to reflect our proportionate share
of those losses. Included in equity in losses of investments is our
proportionate share of the operating losses in E*OFFERING. The pending
acquisition of E*OFFERING by Wit Capital Group, Inc., renamed Wit Soundview
Group, Inc., announced May 15, 2000, is not expected to have a material effect
on equity in losses of investments.
Income Tax Expense (Benefit)
Income tax expense (benefit) represents the expense for federal and state
income taxes at an effective tax rate of 61% for the third quarter of fiscal
2000 and the benefit for federal and state income taxes at an effective tax
rate of 37% for the comparable period in fiscal 1999. Income tax benefit
represents the benefit for federal and state income taxes at an effective tax
rate of 7% for the nine months ended June 30, 2000 and 42% for the comparable
period in fiscal 1999. The rate for the three and nine months ended June 30,
2000 reflects the impact of non-deductible merger-related expenses and
amortization of goodwill arising from acquisitions.
Minority Interest in Subsidiaries
Minority interest in the net loss of subsidiaries was $0.6 million in the
third quarter of fiscal 2000 compared to $0.5 million in minority interest in
the net income of subsidiaries in the third quarter of fiscal 1999. Minority
interest in the net income of subsidiaries was $0.3 million and $1.7 million
in the nine months ended June 30, 2000 and 1999, respectively. Minority
interest in the net loss of subsidiaries results primarily from ETFC's
interest payments to subsidiary trusts which have issued Company-obligated
mandatorily redeemable capital securities and which hold junior subordinated
debentures of ETFC. Also included in minority interest in subsidiaries for the
three months ended June 30, 2000 is the net income (loss) attributed to
minority interests in E*TRADE Nordic and E*TRADE Germany.
Cumulative Effect of Change in Accounting Principle
The cumulative effect of change in accounting principle was $0.5 million in
the nine months ended June 30, 1999, resulting from the implementation by ETFC
of Statement of Position 98-5, Reporting on the Cost of Start-Up Activities,
which requires that the cost of start-up activities be expensed as incurred
rather than capitalized, with initial application reported as the cumulative
effect of a change in accounting principle.
Extraordinary Loss on Early Extinguishment of Debt
In June 1999, ETFC redeemed all of its outstanding debt. ETFC wrote off
both the related premium and the remaining discount as an extraordinary loss
on the early extinguishment of debt, totaling approximately $2.0 million, net
of tax.
25
Liquidity and Capital Resources
We have financing facilities totaling $425.0 million to meet the needs of
E*TRADE Securities. These facilities, if used, would be collateralized by
customer securities. There were no borrowings outstanding under these lines on
June 30, 2000. We also have a short term line of credit for up to $50 million,
collateralized by marketable securities owned by us, of which $30.8 million
was outstanding as of June 30, 2000. In addition, we have entered into
numerous agreements with other broker-dealers to provide financing under our
stock loan program.
On February 7, 2000, we completed a Rule 144A offering of $500 million
convertible subordinated notes due February 2007. The notes are convertible,
at the option of the holder, into a total of 21,186,441 shares of our common
stock at a conversion price of $23.60 per share. The notes bear interest at
6%, payable semiannually, and are non-callable for three years and may then be
called by us at a premium, which declines over time. The holders have the
right to require redemption at a premium in the event of a change in control
or other defined redemption event. On March 17, 2000, the initial purchasers
exercised an option to purchase an additional $150 million of notes, which are
convertible into 6,355,932 shares of common stock. We used $145.0 million of
the $631.3 million in net proceeds to pay the outstanding balance on a $150
million line of credit, which was subsequently dissolved, in February 2000. We
expect to use the remaining net proceeds for general corporate purposes,
including the future growth of the business. Debt issuance costs of $19.1
million are included in other assets and are being amortized to corporate
interest expense over the term of the notes. Had these securities been issued
at the beginning of the fiscal year, and the proceeds used to repay the
outstanding balance on the $150 million line of credit agreement, income per
share would have decreased to loss per share of $0.01 for the three months
ended June 30, 2000 and loss per share would have increased to $0.17 for the
nine months ended June 30, 2000, respectively, compared to income per share of
$0.02 and loss per share of $0.08 recorded in the three and nine months ended
June 30, 2000, respectively, due to the additional net interest expense and
issuance costs associated with the securities.
We currently anticipate that our available cash resources, credit
facilities, and liquid portfolio of equity securities, along with the
convertible subordinated debt offering described above, will be sufficient to
meet our presently anticipated working capital and capital expenditure
requirements for at least the next 12 months. However, we 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. Our future liquidity and capital requirements will depend upon
numerous factors, including costs and timing of expansion of technology
development efforts and the success of such efforts, the success of our
existing and new service offerings and competing technological and market
developments. Our forecast of the period of time through which our financial
resources will be adequate to support our 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 our future
capital requirements and the adequacy of our available funds. If additional
funds are raised through the issuance of equity securities, the percentage
ownership of the shareowners in our company will be reduced, shareowners 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 our common stock. There can be no assurance that additional
financing will be available when needed on terms favorable to our company, if
at all.
If adequate funds are not available on acceptable terms, we may be unable
to develop or enhance our services and products, take advantage of future
opportunities or respond to competitive pressures, any of which could have a
material adverse effect on our business, financial condition and operating
results.
Cash used in operating activities, net of effects from acquisitions, was
$374.8 million for the nine months ended June 30, 2000 compared to $34.7
million in the equivalent period in fiscal 1999. Cash used in operating
activities, net of effects from acquisitions, primarily reflects the increase
in brokerage-related assets in excess of liabilities of $570.2 million and an
increase in other assets and intangibles of $170.8 million offset by a
decrease in segregated cash balances of $67.3 million and an increase in
accounts payable, accrued and other liabilities of
26
$255.0 million. Cash used in operating activities in the prior year period
primarily reflects an increase in brokerage-related assets in excess of
liabilities of $112.8 million offset by proceeds from the sales and maturities
of loans, net of purchases, of $46.7 million, proceeds from the sales and
maturities of trading assets, net of purchases, of $23.5 million, and an
increase in interest credited to customer deposits of $45.0 million.
Cash used in investing activities was $3,665.9 million for the nine months
ended June 30, 2000 and $1,130.2 million in the equivalent period in fiscal
1999. For the nine months ended June 30, 2000, cash used in investing
activities was the result of the excess of purchases of investments over the
net sale/maturity of investments of $2,050.0 million, purchases of $134.3
million of property and equipment, a decrease in loans held for investment of
$1,394.1 million, an increase in restricted deposits of $71.4 million, and
$31.8 million paid for the acquisition of three foreign affiliates and CCS.
This compares to cash used in investing activities in the equivalent period of
fiscal 1999 where the Company had an excess of purchases of investments over
the net sale/maturity of investments of $329.3 million, purchases of $82.9
million of property and equipment, and an increase in loans held for
investment of $733.7 million.
Cash provided by financing activities was $4,094.8 million for the nine
months ended June 30, 2000, compared with $1,265.6 million in the equivalent
period in fiscal 1999. Cash provided by financing activities for the nine
months ended June 30, 2000 primarily resulted from $3,415.8 million in
increased banking deposits, net advances from the Federal Home Loan Bank of
Atlanta, and increases in securities sold under agreements to repurchase and
the issuance of $631.3 million in convertible subordinated debt, net of
issuance costs. Cash provided by financing activities in the comparable period
of fiscal 1999 primarily resulted from $883.5 million in increased banking
deposits, net advances from the Federal Home Loan Bank of Atlanta and
increases in securities sold under agreements to repurchase and proceeds from
issuance of common stock and associate stock transactions of $417.6 million.
Recent Accounting Pronouncements
In December 1999, the Securities and Exchange Commission ("SEC") staff
issued Staff Accounting Bulletin No. 101 Revenue Recognition in Financial
Statements ("SAB 101"). SAB 101 states that all registrants are expected to
apply the accounting and disclosures described in it. The SEC staff, however,
will not object if registrants that have not applied SAB 101 do not restate
prior financial statements provided they report a change in accounting
principle in accordance with Accounting Principles Board Opinion No. 20
Accounting Changes, by cumulative catch-up adjustment no later than the second
quarter of the fiscal year beginning after December 15, 1999. We are currently
evaluating the impact, if any, of SAB 101 on our revenue recognition policy
and our consolidated financial statements.
27
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision in our company. The risks and uncertainties described
below are not the only ones facing us and there may be additional risks that
we do not presently know of or that we currently deem immaterial. All of these
risks may impair our business operations. This document also contains forward-
looking statements that involve risks and uncertainties, and actual results
may differ materially as a result of certain factors, including those set
forth below and elsewhere in this filing. If any of the following risks
actually occur, our business, financial condition or results of operations
could be materially adversely affected. In such case, the trading price of our
common stock could decline, and you may lose all or part of your investment.
In accordance with "plain English" guidelines provided by the Securities
and Exchange Commission, the risk factors have been written in the first
person.
We could suffer substantial losses and be subject to customer litigation if
our systems fail or our transaction processing is slow
We receive and process transactions mostly through the Internet, online
service providers and touch-tone telephone. Thus, we depend heavily on the
integrity of the electronic systems supporting these types of transactions,
including our internal software programs and computer systems. Our systems or
any other systems in the transaction process could slow down significantly or
fail for a variety of reasons including:
. undetected errors in our internal software programs or computer systems;
. our inability to effectively resolve any errors in our internal software
programs or computer systems once they are detected; or
. heavy stress placed on our system during certain peak trading times.
If our systems or any other systems in the transaction process slow down
significantly or fail even for a short time, our customers could suffer delays
in transaction processing, which could cause substantial losses and possibly
subject us to claims for such losses or to litigation claiming fraud or
negligence. We have experienced such systems failures and degradation in the
past, including failures on February 3, 4, and 5, 1999, March 19, 1999, July
19, 1999, August 10, 1999, September 27, 1999, January 25, 2000, March 2, 2000
and May 3, 2000. We could experience future system failures and degradations,
including instances in foreign markets where we must implement new transaction
processing infrastructures. To promote customer satisfaction and protect our
brand name, we have, on certain occasions, compensated customers for
verifiable losses from such failures. To date, during our systems failures, we
were able to take orders by telephone; however, with respect to our brokerage
transactions, only associates with securities brokers' licenses can accept
telephone orders. An adequate number of such associates may not be available
to take customer calls in the event of a future systems failure. We may not be
able to increase our customer service personnel and capabilities in a timely
and cost-effective manner. We could experience a number of adverse
consequences as a result of these systems failures, including the loss of
existing customers and the inability to attract or retain new customers. There
can be no assurance that our network structure will operate appropriately in
any of the following events:
. a subsystem, component or software failure;
. a power or telecommunications failure;
. human error;
. an earthquake, fire or other natural disaster; or
. an act of God or war.
28
There can be no assurance that, in any such event, we will be able to
prevent an extended systems failure. Any such systems failure that interrupts
our operations could have a material adverse effect on our business, financial
condition and operating results and we have adverse publicity in the past in
the financial press and elsewhere relating to systems failures.
Our security could be breached, which could damage our reputation and deter
customers from using our services
We must protect our computer systems and network from physical break-ins,
security breaches and other disruptions caused by unauthorized access. The
open nature of the Internet makes protecting against these threats more
difficult. Computer break-ins could jeopardize the security of information
stored in and transmitted through our computer systems and network, which
could adversely affect our ability to retain or attract customers, damage our
reputation and subject us to litigation. We have in the past, and could in the
future, be subject to denial of service, vandalism and other attacks on our
systems by Internet hackers. In addition, we must guard against damage by
insiders with access to the system. Although we intend to continue to
implement security technology and establish operational procedures to prevent
break-ins, damage and failures, these security measures may or may be unable
to prevent future attacks from disrupting operations. Our insurance coverage
in certain circumstances may be insufficient to cover losses that may result
from such events.
Our business could suffer if we cannot protect the confidentiality of customer
information transmitted over public networks
A significant barrier to online commerce is the need for secure
transmission of confidential information over public networks. We rely on
encryption and authentication technology, including cryptography technology
licensed from RSA Data Security, Inc., to provide secure transmission of
confidential information. There can be no assurance that advances in computer
and cryptography capabilities or other developments will not result in a
compromise of the RSA or other algorithms we use to protect customer
transaction data. If any such compromise of our security were to occur, it
could have a material adverse effect on our business, financial condition and
operating results.
Our quarterly results fluctuate and do not reliably indicate future operating
results
We do not believe that our historical operating results should be relied
upon as an indication of our future operating results. We expect to experience
large fluctuations in future quarterly operating results that may be caused by
many factors, including the following:
. fluctuations in the fair market value of our equity investments in other
companies, including through existing or future private investment funds
managed by us;
. fluctuations in interest rates, which will impact our investment and loan
portfolios;
. increased levels of advertising, sales and marketing expenditures for
customer acquisition, which may be affected by competitive conditions in
the marketplace;
. the timing of introductions or enhancements to online financial services
and products by us or our competitors;
. market acceptance of online financial services and products;
. the pace of development of the market for online commerce;
. changes in trading volume in securities markets;
. trends in securities and banking markets;
. domestic and international regulation of the brokerage, banking and
internet industries;
29
. implementation of new accounting pronouncements, such as Statement of
Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities;
. changes in domestic or international tax rates;
. changes in pricing policies by us or our competitors;
. changes in strategy;
. the success of, or costs associated with, acquisitions, joint ventures or
other strategic relationships;
. changes in key personnel;
. seasonal trends;
. the extent of international expansion;
. the mix of international and domestic revenues;
. fluctuation in foreign exchange rates;
. changes in the level of operating expenses to support projected growth;
and
. general economic conditions.
We have also experienced fluctuations in the average number of customer
transactions per day. Thus, the rate of growth in customer transactions at any
given time is not necessarily indicative of future transaction activity.
Our business will suffer if we cannot effectively compete
The market for financial services over the Internet is new, rapidly
evolving and intensely competitive. We expect competition to continue and
intensify in the future. We face direct competition from financial
institutions, brokerage firms, banks, mutual fund companies, Internet portals
and other organizations. These competitors include, among others:
. American Express;
. America Online, Inc.;
. Ameritrade, Inc.;
. Bank of America;
. Charles Schwab & Co., Inc.;
. Citigroup, Inc.;
. Datek Online Holdings Corporation;
. DLJdirect;
. Fidelity Brokerage Services, Inc.;
. Fleet Boston Financial;
. Intuit Inc.;
. Merrill Lynch, Pierce, Fenner & Smith Incorporated;
. Microsoft Money;
. National Discount Brokers;
. Net.B@nk, Inc.;
30
. PaineWebber Incorporated;
. Salomon Smith Barney, Inc.;
. TD Waterhouse Securities, Inc.;
. Wells Fargo & Company;
. WingspanBank.com; and
. X.com; and
. Yahoo! Inc.
Many of our competitors have longer operating histories and significantly
greater financial, technical, marketing and other resources than we do. In
addition, many of our competitors offer a wider range of services and
financial products than we do, and thus may be able to respond more quickly to
new or changing opportunities, technologies and customer requirements. Many of
our competitors also have greater name recognition and larger customer bases
that could be leveraged, thereby gaining market share from us. Such
competitors may conduct more extensive promotional activities and offer better
terms and lower prices to customers than we do, possibly even sparking a price
war in the online financial services industry. Moreover, certain competitors
have established cooperative relationships among themselves or with third
parties to enhance their services and products. For example, Charles Schwab's
One-Source mutual fund service and similar services may discourage potential
customers from using our brokerage services. Accordingly, it is possible that
new competitors or alliances among existing competitors may significantly
reduce our market share.
General financial success within the financial services industry over the
past several years has strengthened existing competitors. We believe that such
success will continue to attract new competitors, such as software development
companies, insurance companies and others, as such companies expand their
product lines. Commercial banks and other financial institutions have become
more competitive with our brokerage operations by offering their customers
certain corporate and individual financial services traditionally provided by
securities firms. The current trend toward consolidation in the commercial
banking industry could further increase competition in all aspects of our
business. Commercial banks generally are expanding their securities and
financial services activities. While we cannot predict the type and extent of
competitive services that commercial banks and other financial institutions
ultimately may offer, we may be adversely affected by such competition. To the
extent our competitors are able to attract and retain customers, our business
or ability to grow could be adversely affected. In many instances, we are
competing with such organizations for the same customers. In addition,
competition among financial services firms exists for experienced technical
and other personnel.
There can be no assurance that we will be able to compete effectively with
current or future competitors or that such competition will not have a
material adverse effect on our business, financial condition and operating
results.
Our success depends on our ability to effectively adapt to changing business
conditions
We have grown rapidly and our business and operations have changed
substantially since we began offering electronic investing services in 1992,
and Internet investing services in February 1996, and we expect this trend to
continue. Such rapid change and expansion places significant demands on our
administrative, operational, financial, and technical management and other
resources.
We expect operating expenses and staffing levels to increase substantially
in the future. In particular, we have hired and intend to hire a significant
number of additional skilled personnel, including persons with experience in
the computer, brokerage and banking industries, and, specifically, persons
with Series 7 or other broker-dealer licenses. Competition for such personnel
is intense, and there can be no assurance that we will be
31
able to find or keep additional suitable senior managers or technical persons
or licensed representatives in the future. In particular, we depend heavily on
our chief executive officer and other members of senior management, the loss
of any of whom could seriously harm our business. We also expect to expend
resources for future expansion of our accounting and internal information
management systems and for a number of other new systems and procedures. In
addition, we expect that future expansion will continue to challenge our
ability to successfully hire and retain associates. If our revenues do not
keep up with expenses, our information management systems do not expand to
meet increasing demands, we fail to attract, assimilate and retain qualified
personnel, or we fail to manage our expansion effectively, there could be a
material adverse effect on our business, financial condition and operating
results.
The rapid growth in the use of our services has strained our ability to
adequately expand technologically. As we acquire new equipment and
applications quickly, we have less time to test and validate hardware and
software, which could lead to performance problems. We also rely on a number
of third parties to process our transactions, including online and Internet
service providers, back office processing organizations, service providers and
market-makers, all of which will need to expand the scope of the operations
they perform for us. Any backlog caused by a third party's inability to expand
sufficiently to meet our needs could have a material adverse effect on our
business, financial condition and operating results. As transaction volume
increases, we may have difficulty hiring and training qualified personnel at
the necessary pace, and the shortage of licensed personnel could cause a
backlog in the processing of brokerage orders that need review, which could
not only lead to unsatisfied customers, but also to liability for brokerage
orders that were not executed on a timely basis.
Through our Digital Financial Media initiative, we plan to deliver
interactive multimedia content and commerce through a variety of broadband
communications channels and electronic platforms. We believe that achieving
success in this strategy is essential to our ability to compete in the rapidly
evolving electronic marketplaces in which we operate. We have limited
experience in these media and our failure to execute this strategy
successfully may limit our future growth.
Due to our status as a savings and loan holding company, our ability to
engage in some media activities may be restricted. See "Risk Factors--Due to
our recent merger with Telebanc (now E*TRADE Financial Corporation), we may be
restricted in expanding our activities, and our inexperience with being
regulated as a savings and loan holding company could negatively affect both
us and E*TRADE Financial Corporation."
If we lose the services of key members of our management, in particular, our
Chief Executive Officer and our Chief Financial Officer and President, we may
not be able to effectively execute our business plan and our trading price may
suffer
Our future success depends to a significant degree on the skills,
experience and efforts of our Chief Executive Officer, Chief Financial
Officer, President and other key personnel. The loss of the services of any of
these individuals could compromise our ability to effectively operate our
business.
Our ability to attract customers and our profitability may suffer if changes
in government regulation favor our competition or restrict our business
practices
The securities and banking industries in the United States are each 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;
. execution of customers' orders;
. use and safekeeping of customers' funds and securities;
. capital structure;
32
. record keeping;
. advertising;
. conduct of directors, officers and employees; and
. supervision.
Because we are a self-clearing broker-dealer, we have to comply with many
complex laws and rules. These include rules relating to possession and control
of customer funds and securities, margin lending, and execution and settlement
of transactions. Our ability to so comply with these rules depends largely on
the establishment and maintenance of a qualified compliance system.
Similarly, E*TRADE and ETFC, as savings and loan holding companies, and
E*TRADE Bank, as a federally chartered savings bank and subsidiary of ETFC,
are subject to extensive regulation, supervision and examination by the Office
of Thrift Supervision ("OTS") and, in the case of E*TRADE Bank, the Federal
Deposit Insurance Corporation. Such regulation covers all aspects of the
banking business, including lending practices, safeguarding deposits, capital
structure, record keeping, and conduct and qualifications of personnel.
In November 1999, the Gramm-Leach-Bliley Act was enacted into law. This act
reduces the legal barriers between banking, securities and insurance
companies, and will make it easier for bank holding companies to compete
directly with our securities business, as well as for our competitors in the
securities business to diversify their revenues and attract additional
customers through entry into the banking and insurance businesses. The Gramm-
Leach-Bliley Act may have a material impact on the competitive landscape that
we face.
Additionally our mode of operation and profitability may be directly
affected by:
. additional legislation;
. changes in rules promulgated by the SEC, the National Association of
Securities Dealers Regulation, Inc., ("NASDR"), the Board of Governors of
the Federal Reserve System, the OTS, the various stock exchanges and
other self-regulatory organizations; or
. changes in the interpretation or enforcement of existing laws and rules.
The SEC, the NASDR or other self-regulatory organizations and state
securities commissions can censure, fine, issue cease-and-desist orders or
suspend or expel a broker-dealer or any of its officers or employees. The OTS
may take similar action with respect to our banking activities. Our ability to
comply with all applicable laws and rules is largely dependent on our
establishment and maintenance of a system to ensure such compliance, as well
as our ability to attract and retain qualified compliance personnel. Our
growth has placed considerable strain on our ability to ensure such
compliance. We could be subject to disciplinary or other actions due to
claimed noncompliance in the future, which could have a material adverse
effect on our business, financial condition and operating results.
We have initiated an aggressive marketing campaign designed to bring brand
name recognition to E*TRADE and E*TRADE Bank. All marketing activities by
E*TRADE Securities are regulated by the NASDR, and all marketing materials
must be reviewed by an E*TRADE Securities Series 24 licensed principal prior
to release. The NASDR has in the past asked us to revise certain marketing
materials. We are currently the subject of formal NASDR and SEC investigations
into our advertising practices. At the same time, we have voluntarily agreed
to prefile all advertising ten (10) days prior to first use for the NASDR's
review and comment. This prefiling requirement began June 12, 2000 and will
expire on September 12, 2000. The NASDR can impose certain penalties for
violations of its advertising regulations, including:
. censures or fines;
33
. suspension of all advertising;
. the issuance of cease-and-desist orders; or
. the suspension or expulsion of a broker-dealer or any of its officers or
employees.
We do not currently solicit orders from our customers or make investment
recommendations. However, if we were to engage in such activities, we would
become subject to additional rules and regulations governing, among other
things, sales practices and the suitability of recommendations to customers.
We have entered into a letter of intent with Ernst & Young LLP to jointly
establish a new company that will provide financial advice for on-line
investors.
We intend to continue expanding our business to other countries and to
broaden our customers' abilities to trade securities of non-U.S. companies and
execute other transactions through the Internet and other gateways. In order
to expand our services globally, we must comply with the regulatory controls
of each specific country in which we conduct business. Our international
expansion could be limited by the compliance requirements of other national
regulatory jurisdictions. We intend to rely primarily on local third parties
and our subsidiaries for regulatory compliance in international jurisdictions.
See "Risk Factors--We face numerous risks associated with doing business in
international markets."
There can be no assurance that other federal, state or foreign agencies
will not attempt to regulate our online and other activities. We anticipate
that we may be required to comply with record keeping, data processing and
other regulatory requirements as a result of proposed federal legislation or
otherwise. We may also be subject to additional regulation as the market for
online commerce evolves. Because of the growth in the electronic commerce
market, Congress has held hearings on whether to regulate providers of
services and transactions in the electronic commerce market. As a result,
federal or state authorities could enact laws, rules or regulations affecting
our business or operations. We may also be subject to federal, state or
foreign money transmitter laws and state and foreign sales or use tax laws. If
such laws are enacted or deemed applicable to us, our business or operations
would be rendered more costly or burdensome, less efficient or even
impossible. Any of the foregoing could have a material adverse effect on our
business, financial condition and operating results.
Due to the increasing popularity of the Internet, laws and regulations may be
passed dealing with issues such as user privacy, pricing, content and quality
of products and services.
As required by the Gramm-Leach-Bliley Act, the SEC and OTS have recently
adopted regulations on financial privacy, to take effect in July 2000, that
will require E*TRADE Securities and E*TRADE Bank to notify consumers about the
circumstances in which they may share consumers' personal information with
unaffiliated third parties and to give consumers the right to prohibit such
information sharing in specified circumstances. Although E*TRADE Securities
and E*TRADE Bank already provide such opt-out rights in our privacy policies,
the regulations will require us to modify the text and the form of
presentation of our privacy policies and to incur additional expense to ensure
ongoing compliance with the regulations.
In addition, several recent reports have focused attention on the online
brokerage industry. For example, the New York Attorney General carried out an
investigation of the online brokerage industry and issued a report in November
1999, citing consumer complaints about delays and technical difficulties
conducting online stock trading. SEC Commissioner Laura Unger also issued a
report in November 1999 on issues raised by online brokerage, including
suitability and marketing issues. Most recently, the United States General
Accounting Office issued a report to certain Congressional Requestors citing a
need for better investor protection information on brokers' Web sites.
Increased attention focused upon these issues could adversely affect the
growth of the online financial services industry, which could, in turn,
decrease the demand for our services or could otherwise have a material
adverse effect on our business, financial condition and operating results.
34
We may be fined or forced out of business if we do not maintain the net
capital levels required by regulators
The SEC, NASDR, OTS and various other regulatory agencies have stringent
rules with respect to the maintenance of specific levels of net capital by
securities broker-dealers and regulatory capital by banks. Net capital is the
net worth of a broker or dealer (assets minus liabilities), less deductions
for certain types of assets. If a firm fails to maintain the required net
capital it may be subject to suspension or revocation of registration by the
SEC and suspension or expulsion by the NASDR, and could ultimately lead to the
firm's liquidation. In the past, our broker-dealer subsidiaries have depended
largely on capital contributions by us in order to comply with net capital
requirements. If such net capital rules are changed or expanded, or if there
is an unusually large charge against net capital, operations that require the
intensive use of capital would be limited. Such operations may include
investing activities, marketing and the financing of customer account
balances. Also, our ability to withdraw capital from brokerage subsidiaries
could be restricted, which in turn could limit our ability to pay dividends,
repay debt and redeem or purchase shares of our outstanding stock. A large
operating loss or charge against net capital could adversely affect our
ability to expand or even maintain our present levels of business, which could
have a material adverse effect on our business, financial condition and
operating results.
The table below summarizes the minimum net capital requirements for our
domestic broker-dealer subsidiaries as of June 30, 2000 (in thousands):
Required Excess
Net Net Net
Capital Capital Capital
-------- -------- --------
E*TRADE Securities, Inc.......................... $99,155 $451,153 $351,998
TIR Securities, Inc.............................. $ 250 $ 1,714 $ 1,464
TIR Investor Select, Inc......................... $ 5 $ 423 $ 418
Marquette Securities, Inc........................ $ 250 $ 502 $ 252
E*TRADE Capital Markets, Inc..................... $ 252 $ 20,086 $ 19,834
Similarly, banks, such as E*TRADE Bank are subject to various regulatory
capital requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could
have a direct material effect on a bank's operations and financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, a bank must meet specific capital guidelines that involve
quantitative measures of a bank's assets, liabilities, and certain off-
balance-sheet items as calculated under regulatory accounting practices. A
bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about the strength of components of the bank's
capital, risk weightings of assets and off balance sheet transactions, and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require a bank to maintain minimum amounts and ratios of total and Tier 1
capital to risk-weighted assets and of Tier 1 capital to average assets. To be
categorized as well capitalized, a bank must maintain minimum total risk-
based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the
following table.
The table below summarizes the capital adequacy requirements for E*TRADE
Bank as of June 30, 2000 (dollars in thousands):
Required To Be
Well
Capitalized
Under Prompt
Corrective
Action
Actual Provisions
-------------- --------------
Amount Ratio Amount Ratio
-------- ----- -------- -----
Core Capital (to adjusted tangible
assets................................... $475,258 6.42% $370,030 > 5.0%
Tier 1 Capital (to risk weighted assets).. $475,258 16.17% $178,747 > 6.0%
Total Capital (to risk weighted assets)... $484,598 16.48% $297,911 >10.0%
35
As a significant portion of our revenues come from online investing services,
any downturn in the securities industry could significantly harm our business
A significant portion of our revenues in recent years has been from online
investing services, and we expect this business to continue to account for a
significant portion of our revenues in the foreseeable future. We, like other
financial services firms, are directly affected by economic and political
conditions, broad trends in business and finance and changes in volume and
price levels of securities and futures transactions. The U.S. securities
markets are characterized by considerable fluctuation and a downturn in these
markets could adversely affect our operating results. Significant downturns in
the U.S. Securities markets occurred in October 1987 and October 1989. A
significant downturn in the U.S. securities markets most recently began in
March of 2000, as a result of which the volume of trading has decreased
industry-wide and many broker-dealers, including E*TRADE, have suffered
financial losses. When trading volume is low, our operating results may be
adversely affected because overhead remains relatively fixed. Severe market
fluctuations in the future could have a material adverse effect on our
business, financial condition and operating results. Some of our competitors
with more diverse product and service offerings might withstand such a
downturn in the securities industry better than we would. See "Risk Factors--
Our business will suffer if we cannot effectively compete."
Our brokerage business, by its nature, is subject to various other risks,
including customer default and employee misconduct and errors. We sometimes
allow customers to purchase securities on margin, therefore we are affected
because we are subject to risks inherent in extending credit. This risk is
especially great when the market is rapidly declining and the value of the
collateral we hold could fall below the amount of a customer's indebtedness.
Under specific regulatory guidelines, any time we borrow or lend securities,
we must correspondingly disburse or receive cash deposits. If we fail to
maintain adequate cash deposit levels at all times, we run the risk of loss if
there are sharp changes in market values of many securities and parties to the
borrowing and lending transactions fail to honor their commitments. Any such
losses could have a material adverse effect on our business, financial
condition and operating results.
Changes in interest rates may reduce E*TRADE Financial Corporation's
profitability
The results of operations for ETFC depend in large part upon the level of
its net interest income, that is, the difference between interest income from
interest-earning assets, such as loans and mortgage-backed securities, and
interest expense on interest-bearing liabilities, such as deposits and
borrowings. Many factors cause changes in interest rates, including
governmental monetary policies and domestic and international economic and
political conditions. If ETFC is unsuccessful in managing the effects of
changes in interest rates, its financial condition and results of operations
could suffer.
Changes in market interest rates could reduce the value of ETFC's financial
assets. Fixed-rate investments, mortgage-backed and related securities and
mortgage loans generally decline in value as interest rates rise.
We could lose customers and have difficulty attracting new customers if we are
unable to quickly introduce new products and services that satisfy changing
customer needs
Our future success depends, in part, on our ability to develop and enhance
our services and products. There are significant technical risks in the
development of new services and products or enhanced versions of existing
services and products. There can be no assurance that we will be successful in
achieving any of the following:
. effectively using new technologies;
. adapting our services and products to meet emerging industry standards;
. developing, introducing and marketing service and product enhancements;
or
. developing, introducing and marketing new services and products.
We may also experience difficulties that could delay or prevent the
development, introduction or marketing of these services and products. Our
status as a regulated savings and loan holding company resulting from the
36
acquisition of Telebanc Financial Corporation (now ETFC) could also lead to
delays in or prevent the development, introduction and marketing of new
services and products. Additionally, these new services and products may not
adequately meet the requirements of the marketplace or achieve market
acceptance. If we are unable to develop and introduce enhanced or new services
and products quickly enough to respond to market or customer requirements, or
if they do not achieve market acceptance, our business, financial condition
and operating results will be materially adversely affected.
Our success depends upon the growth of the Internet as a commercial
marketplace
The market for financial services, particularly over the Internet, is
rapidly evolving. Consequently, demand and market acceptance for newly
introduced services and products are subject to a high level of uncertainty.
For us, this uncertainty is compounded by the risks that consumers will not
continue to adopt online commerce and that commerce on the Internet will not
adequately develop or flourish to permit us to continue to grow.
Sales of many of our services and products will depend on consumers
continuing to adopt the Internet as a method of doing business. 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 be adversely affected by slow development or adoption of
standards and protocols to handle increased Internet activity, or due to
increased governmental regulation. Moreover, critical issues including
security, reliability, cost, ease of use, accessibility and quality of service
remain unresolved and may negatively affect the growth of Internet use or
commerce on the Internet.
Adoption of online commerce by individuals who have relied upon traditional
means of commerce in the past will require such individuals to accept new and
very different methods of conducting business. Moreover, our brokerage and
banking services over the Internet involve a new approach to securities
trading and banking which require extensive marketing and sales efforts to
educate prospective customers regarding their uses and benefits. For example,
consumers who trade with traditional brokerage firms, or even discount
brokers, may be reluctant or slow to change to obtaining brokerage services
over the Internet. Also, concerns about security and privacy on the Internet
may hinder the growth of online investing and banking, which could have a
material adverse effect on our business, financial condition and operating
results.
The market price of our common stock, like other technology stocks, may be
highly volatile and any significant decrease in our stock price may make it
difficult for our shareowners to sell their stock
The market price of our common stock has been, and is likely to continue to
be, highly volatile and subject to wide fluctuations due to various factors,
many of which may be beyond our control, including:
. quarterly variations in operating results;
. volatility in the stock market;
. volatility in the general economy;
. changes in interest rates;
. announcements of acquisitions, technological innovations or new software,
services or products by us or our competitors; and
. changes in financial estimates and recommendations by securities
analysts.
In addition, there have been large price and volume fluctuations in the
stock market which have affected the market prices of securities of many
technology, Internet and financial services companies, often unrelated to the
operating performance of such companies. These broad market fluctuations may
adversely affect the market price of our common stock. In the past, volatility
in the market price of a company's securities has often led to securities
class action litigation. Such litigation could result in substantial costs and
a diversion of our attention and resources, which could have a material
adverse effect on our business, financial condition and operating results.
37
Our success depends on our ability to protect our intellectual property and
any failure to do so could substantially harm our business
Our success and ability to compete are dependent to a significant degree on
our proprietary technology. We rely primarily on copyright, trade secret and
trademark law to protect our technology and our brand. Effective trademark
protection may not be available for our trademarks. Although we have
registered the trademark "E*TRADE" in the United States and certain other
countries, and have certain other registered trademarks, there can be no
assurance that we will be able to secure significant protection for these
trademarks. Our competitors or others may adopt product or service names
similar to "E*TRADE," thereby impeding our ability to build brand identity and
possibly leading to customer confusion. Our inability to adequately protect
the name "E*TRADE" could have a material adverse effect on our business,
financial condition and operating results. Despite any precautions we take, a
third party may be able to copy or otherwise obtain and use our software or
other proprietary information without authorization or to develop similar
software independently. Policing unauthorized use of our technology is made
especially difficult by the global nature of the Internet and difficulty in
controlling the ultimate destination or security of software or other data
transmitted on it. The laws of other countries may afford us little or no
effective protection for our intellectual property. There can be no assurance
that the steps we take will prevent misappropriation of our technology or that
agreements entered into for that purpose will be enforceable. In addition,
litigation may be necessary in the future to:
. enforce our intellectual property rights;
. protect our trade secrets;
. determine the validity and scope of the proprietary rights of others; or
. defend against claims of infringement or invalidity.
Such litigation, whether successful or unsuccessful, could result in
substantial costs and diversion of resources, either of which could have a
material adverse effect on our business, financial condition and operating
results.
We may face claims for infringement of third parties' proprietary rights and
it could be costly and time-consuming to defend against such claims, even
those without merit
We have received in the past, and may receive in the future, notices of
claims of infringement of other parties' proprietary rights. There can be no
assurance that claims for infringement or invalidity--or any indemnification
claims based on such claims--will not be asserted or prosecuted against us.
Any such claims, with or without merit, could be time consuming and costly to
defend or litigate, divert our attention and resources or require us to enter
into royalty or licensing agreements. There can be no assurance that such
licenses would be available on reasonable terms, if at all, and the assertion
or prosecution of any such claims could have a material adverse effect on our
business, financial condition and operating results.
Our attempts to enter new markets may be unsuccessful, which could decrease
our earnings and consequently decrease the market value of our common stock
One element of our strategy is to leverage the E*TRADE brand and technology
to enter new markets. No assurance can be given that we will be able to
successfully adapt our proprietary processing technology for use in other
markets. Even if we do adapt our technology, no assurance can be given that we
will be able to compete successfully in any such new markets. There can be no
assurance that our pursuit of any of these opportunities will be successful.
If these efforts are not successful, we could realize less than expected
earnings, which in turn could result in a decrease in the market value of our
common stock. Furthermore, such efforts may divert management attention or
inefficiently utilize our resources.
38
As a result of our recent merger with Telebanc (now E*TRADE Financial
Corporation), we face numerous new risks, including possible failure to
successfully integrate and assimilate E*TRADE Financial Corporation's
operations with our own
On January 12, 2000, we acquired Telebanc Financial Corporation (now ETFC).
ETFC is an online provider of Internet banking services. This represents a new
line of business for us. No assurance can be given that we will be successful
in this market. We may experience difficulty in assimilating ETFC products and
services with our own and we may not be able to integrate successfully the
employees of ETFC into our organization. These difficulties may be exacerbated
by the geographical distance between our various locations and ETFC's Virginia
location. If we fail to successfully integrate ETFC's operations with our own,
our operating results and business could be adversely affected.
E*TRADE Bank holds a loan portfolio consisting primarily of one- to four-
family residential loans. A critical component of the banking industry is the
ability to accurately assess credit risk and establish corresponding loan loss
reserves. This is a new industry for us and accordingly, we are dependent upon
ETFC's management and employees to advise us in this area. Our status as a
regulated savings and loan holding company resulting from the acquisition of
ETFC could also lead to delays or prevent the development, introduction and
marketing of new services and products.
Due to our recent merger with Telebanc (now E*TRADE Financial Corporation), we
may be restricted in expanding our activities, and our inexperience with being
regulated as a savings and loan holding company could negatively affect both
us and E*TRADE Financial Corporation.
Upon the completion of our acquisition of Telebanc (now ETFC) and its
subsidiary, Telebank (subsequently renamed E*TRADE Bank), on January 12, 2000,
we became subject to regulation as a savings and loan holding company. As a
result, we are required to register with the OTS and file periodic reports,
and are subject to examination by the OTS. Under financial modernization
legislation recently enacted into law, our activities are restricted to
activities that are financial in nature and certain real estate-related
activities. We may also make merchant banking investments in companies whose
activities are not financial in nature, if those investments are engaged in
for the purpose of appreciation and ultimate resale of the investment, and we
do not manage or operate the company. Such merchant banking investments may be
subject to maximum holding periods and special capital requirements.
We believe that all of our existing activities and investments are
permissible under the new legislation, but the OTS has not yet issued
regulations or otherwise interpreted the new statute. Even if all of our
existing activities and investments are permissible, under the new legislation
we will be constrained in pursuing future new activities that are not
financial in nature. We are also limited in our ability to invest in other
savings and loan holding companies, and all transactions between us and
E*TRADE Bank must be conducted on an arms' length basis.
In addition to regulation of us and ETFC as savings and loan holding
companies, federal savings banks such as E*TRADE Bank are subject to extensive
regulation of their activities and investments, their capitalization, their
risk management policies and procedures, and their relationship with
affiliated companies. In addition, as a condition to approving our acquisition
of ETFC, the OTS imposed various notice and other requirements, primarily a
requirement that E*TRADE Bank obtain prior approval from the OTS of any future
material changes to E*TRADE Bank's business plan. These regulations and
conditions, and our inexperience with them, could affect our ability to
realize synergies from the merger, and could negatively affect both us and
E*TRADE Bank following the merger.
We face numerous risks associated with doing business in international markets
One component of our strategy is a planned increase in efforts to attract
more international customers. To date, we have limited experience in providing
brokerage services internationally, and ETFC has had only limited
39
experience providing banking services to customers outside the United States.
There can be no assurance that our international licensees or subsidiaries
will be able to market our branded services and products successfully in
international markets. In addition, there are certain risks inherent in doing
business in international markets, particularly in the heavily regulated
brokerage and banking industries, such as:
. unexpected changes in regulatory requirements, tariffs and other trade
barriers;
. difficulties in staffing and managing foreign operations;
. the level of investor interest in cross-border trading;
. authentication of on-line customers;
. increased regulation of the use of customer data;
. 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;
. the level of adoption of the Internet in international markets; and
. potentially adverse tax consequences.
Any of the foregoing could adversely impact the success of our
international operations. In addition, because some of these international
markets are served through license arrangements with others, we rely upon
these third parties for a variety of business and regulatory compliance
matters. We have limited control over the management and direction of these
third parties. We run the risk that their action or inaction could harm our
operations and/or the goodwill associated with our brand name. Additionally,
certain of our international licensees have the right to sell sub-licenses.
Generally, we have less control over sub-licensees than we do over licensees.
As a result, the risk to our operations and goodwill is higher. There can be
no assurance that one or more of the factors described above will not have a
material adverse effect on our future international operations, if any, and,
consequently, on our business, financial condition and operating results.
Any failure to successfully integrate the companies that we acquire into our
existing operations or failure to maintain our relationships with strategic
partners could harm our business
We recently acquired Telebanc (now ETFC), TIR, Card Capture Services,
Electronic Investing Corporation, and several of our European licensees.
Additionally, we signed a definitive agreement to acquire our Canadian
licensee. We may also acquire other companies or technologies in the future,
and we regularly evaluate such opportunities. Acquisitions and mergers entail
numerous risks, including:
. difficulties in the assimilation of acquired operations and products;
. diversion of management's attention from other business concerns;
. amortization of acquired intangible assets; and
. potential loss of key employees of acquired companies.
We have limited experience in assimilating acquired organizations into our
operations. No assurance can be given as to our ability to integrate
successfully any operations, technology, personnel, services or new businesses
or products that might be acquired in the future. Failure to successfully
assimilate acquired organizations could have a material adverse effect on our
business, financial condition and operating results.
We have established a number of strategic relationships with online and
Internet service providers, as well as software and information service
providers. There can be no assurance that any such relationships will be
40
maintained, or that if they are maintained, they will be successful or
profitable. Additionally, we may not be able to develop any new relationships
of this type in the future. We also make investments, either directly or
through affiliated private investment funds, in equity securities of other
companies without acquiring control of those companies. There may be no public
market for the securities of the companies we invest in. In order for us to
realize a return on our investment, such companies must be sold or
successfully complete a public offering of their securities. There can be no
assurance that such companies will be acquired or complete a public offering
or that such an acquisition or public offering will allow us to sell our
securities at a profit, or at all.
Due to the foregoing factors, quarterly revenues and operating results are
difficult to forecast. We believe that period-to-period comparisons of our
operating results will not necessarily be meaningful and you should not rely
on them as any indication of future performance. Our future quarterly
operating results may not consistently meet the expectations of securities
analysts or investors, which in turn may have an adverse effect on the market
price of our common stock.
We have substantially increased our indebtedness, which may make it more
difficult to make payments on our debts or to obtain financing
As a result of our sale of 6% convertible subordinated notes in February
2000, we have incurred $650 million of additional indebtedness, increasing our
ratio of debt to equity (expressed as a percentage) to approximately 38% as of
June 30, 2000. We may incur substantial additional indebtedness in the future.
The level of our indebtedness, among other things, could:
. make it difficult for us to make payments on our debt;
. make it difficult for us to obtain any necessary financing in the future
for working capital, capital expenditures, debt service requirements or
other purposes;
. limit our flexibility in planning for, or reacting to, changes in our
business; and
. make us more vulnerable in the event of a downturn in our business.
There can be no assurance that we will be able to meet our debt service
obligations, including obligations under the notes.
Loss or reductions in revenue from order flow rebates could harm our business
Order flow revenue as a percentage of revenue has decreased over the past
three years. There can be no assurance that payments for order flow will
continue to be permitted by the SEC, the NASDR or other regulatory agencies,
courts or governmental units. Loss of any or all of these revenues could have
a material adverse effect on our business, financial condition and operating
results.
We may incur costs to avoid investment company status and may suffer adverse
consequences if we are deemed to be an investment company
We may incur significant costs to avoid investment company status and may
suffer other adverse consequences if we are deemed to be an investment company
under the Investment Company Act of 1940, which is commonly referred to as the
"1940 Act".
A company may be deemed to be an investment company if it owns investment
securities with a value exceeding 40% of its total assets, subject to certain
exclusions. After giving effect to the sale of 6% convertible subordinated
notes, we will have substantial short-term investments until the net proceeds
from the sale can be deployed. In addition, we and our subsidiaries have made
minority equity investments in other companies that may constitute investment
securities under the 1940 Act. In particular, many of our publicly-traded
equity investments, which are owned directly by us or through related venture
funds, are deemed to be investment securities. Although our investment
securities currently comprise less than 40% of our total assets, the value of
41
these minority investments has fluctuated in the past, and substantial
appreciation in some of these investments may, from time to time, cause the
value of our investment securities to exceed 40% of our total assets. These
factors may result in us being treated as an "investment company" under the
1940 Act.
We believe we are primarily engaged in a business other than investing,
reinvesting, owning, holding, or trading securities for our account and,
therefore, are not an investment company within the meaning of the 1940 Act.
However, in the event that such exemption is not available and the 40% limit
were to be exceeded (including through fluctuations in the value of our
investment securities), we may need to reduce our investment securities as a
percentage of our total assets. This reduction can be attempted in a number of
ways, including the sale of investment securities and the acquisition of non-
investment security assets, such as cash, cash equivalents and government
securities. If we sell investment securities, we may sell them sooner than we
intended. These sales may be at depressed prices and we may never realize
anticipated benefits from, or may incur losses on, these investments. Some
investments may not be sold due to normal contractual or legal restrictions or
the inability to locate a suitable buyer. Moreover, we may incur tax
liabilities if we sell these assets. We may also be unable to purchase
additional investment securities that may be important to our operating
strategy. If we decide to acquire non-investment security assets, we may not
be able to identify and acquire suitable assets, and will likely realize a
lower return on any such investments.
If we were deemed to be an investment company, we could become subject to
substantial regulation under the 1940 Act with respect to our capital
structure, management, operations, affiliate transactions and other matters.
As a consequence, we could be barred from engaging in business or issuing our
securities as we have in the past and might be subject to civil and criminal
penalties for noncompliance. In addition, some of our contracts might be
voidable, and a court-appointed receiver could take control of us and
liquidate our business in certain circumstances.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
For quantitative and qualitative disclosures about market risk, we have
evaluated such risk for our brokerage, international, corporate and banking
related operations separately. The following discussion about our market risk
disclosures includes forward-looking statements. Actual results could differ
materially from those projected in the forward-looking statements as a result
of certain factors, including those set forth in the section entitled "Risk
Factors" and elsewhere in this filing. Reference is made to Part II, Item 7A,
Quantitative and Qualitative Disclosures About Market Risk, in our Annual
Report on Form 10-K/A for the year ended September 30, 1999.
Brokerage, International, and Corporate Operations
Our brokerage, international and corporate operations are exposed to market
risk related to changes in interest rates, foreign currency exchange rates and
equity security price risk. However, we do not believe any such exposures are
material. To reduce certain risks, we utilize derivative financial
instruments; however, we do not hold derivative financial instruments for
speculative or trading purposes
Interest Rate Sensitivity
During the quarter ended June 30, 2000, we had a variable rate bank line of
credit. As of June 30, 2000, we had $30.8 million outstanding under this line.
The line of credit and the monthly interest payment are subject to interest
rate risk. If market interest rates were to increase immediately and uniformly
by one percent at June 30, 2000, the interest payments would increase by an
immaterial amount.
Foreign Currency Exchange Risk
A portion of our operations consist of brokerage and investment services
outside of the United States. As a result, our results of operations could be
adversely affected by factors such as changes in foreign currency
42
exchange rates or economic conditions in the foreign markets in which we
provide our services. We are primarily exposed to changes in exchange rates on
the Japanese yen, the British pound and the Euro. When the U.S. dollar
strengthens against these currencies, the U.S. dollar value of non-U.S.
dollar-based revenues decreases. When the U.S. dollar weakens against these
currencies, the U.S. dollar value of non-U.S. dollar-based revenues increases.
Correspondingly, the U.S. dollar value of non-U.S. dollar-based costs
increases when the U.S. dollar weakens and decreases when the U.S. dollar
strengthens. We are a net payer of British pounds and, as such, benefit from a
stronger dollar, and are adversely affected by a weaker dollar relative to the
British pound. However, we are a net receiver of currencies other than British
pounds, and as such, benefit from a weaker dollar, and are adversely affected
by a stronger dollar relative to these currencies. Accordingly, changes in
exchange rates may adversely affect our consolidated sales and operating
margins as expressed in U.S. dollars.
To mitigate the short-term effect of changes in currency exchange rates on
our non-U.S. dollar-based revenues and operating expenses, we routinely hedge
our material net non-U.S. dollar-based exposures by entering into foreign
exchange forward and option contracts. Currently, hedges of transactions do
not extend beyond twelve months. Given the short term nature of our foreign
exchange forward and option contracts, our exposure to risk associated with
currency market movement on the instruments is not material.
Equity Price Risk
We have investments in publicly-traded equity securities which, in
conjunction with cash provided from operations and financing arrangements, are
utilized to meet forecasted liquidity needs. The fair value of these
securities at June 30, 2000 was $350.7 million. As a result of significant
market volatility during the three months ended June 30, 2000, the fair value
of our equity portfolio was subjected to significant fluctuations. As the
Company accounts for these securities as available-for-sale, unrealized gains
and losses resulting from changes in the fair value of these securities are
reflected as a change in shareowners' equity, and not reflected in the
determination of operating results until the securities are sold. Depreciation
in the market value of our portfolio impacts our financing strategies which
could result in higher interest expense if alternative financing strategies
are used. At June 30, 2000, unrealized gains on these securities were $314.1
million.
Financial Instruments
For our working capital and reserves, which are required to be segregated
under Federal or other regulations, we invest in money market funds, resale
agreements, certificates of deposit, and commercial paper. Money market funds
do not have maturity dates and do not present a material market risk. The
other financial instruments are fixed rate investments with short maturities
and do not present a material interest rate risk.
Banking Operations
We manage our banking related interest rate risk through the use of
financial derivatives such as interest rate cap, swap and floor agreements. We
use these instruments to ensure that the market value of equity and net
interest income are protected from the impact of changes in interest rates. We
have experienced no material changes in market risk pertaining to our banking
operations during the quarter ended June 30, 2000.
43
PART II. OTHER INFORMATION
Item 1. Legal and Administrative Proceedings
On November 21, 1997, a putative class action was filed in the Superior
Court of California, County of Santa Clara, by Larry R. Cooper on behalf of
himself and other similarly situated individuals. The action alleges, among
other things, that our advertising, other communications and business
practices regarding our commission rates and our ability to timely execute and
confirm transactions through our online brokerage services were false and
deceptive. The action seeks injunctive relief enjoining the purported
deceptive and unfair practices alleged in the action and also seeks
unspecified compensatory and punitive damages, as well as attorney fees. On
June 1, 1999, the Court entered an order denying plaintiffs' motion for class
certification. On January 25, 2000, the court ordered plaintiffs to submit all
claims seeking monetary relief to arbitration and stayed all other claims
pending the outcome of arbitration. A motion to modify that order was denied
on July 13, 2000. We are unable to predict the ultimate outcome of this
proceeding.
On February 11, 1999, a putative class action was filed in the Supreme
Court of New York, County of New York, by Evan Berger, on behalf of himself
and other similarly situated individuals. The action alleges, among other
things, that our advertising, other communications and business practices
regarding our ability to timely execute and confirm transactions through our
online brokerage services were false and deceptive. Plaintiff seeks damages
based on causes of action for breach of contract and violation of New York
consumer protection statutes. By a Decision and Order, entered March 28, 2000,
the Court ordered plaintiff to proceed to arbitration on her breach of
contract claim and granted our motion to dismiss plaintiff's consumer
protection claims. Although plaintiff has not filed for arbitration to date,
we are unable to predict the ultimate outcome of this proceeding.
On March 1, 1999, a putative class action was filed in the Court of Common
Pleas, Cuyahoga County, Ohio, by Truc Q. Hoang. The Hoang complaint seeks
damages and injunctive relief arising out of, among other things, plaintiff's
alleged problems accessing her account and placing orders. Plaintiff alleges
causes of action for breach of contract, breach of fiduciary duty, unjust
enrichment, fraud, unfair and deceptive trade practices,
negligence/intentional tort and injunctive relief. On September 1, 1999, the
Court of Common Pleas denied our motion to compel arbitration and we appealed.
By a Journal Entry and Opinion, dated March 16, 2000, the Court of Appeals
reversed the Court of Common Pleas' decision and remanded this case to the
Court of Common Pleas on the grounds that the Court of Common Pleas'
resolution of our motion to compel arbitration could not be determined until
it first determined whether this case should be certified as a class action.
On June 16, 2000, we filed a "Motion to Dismiss for Lack of Subject Matter
Jurisdiction" to which we anticipate plaintiff will be responding in the near
future. We are unable to predict, however, the ultimate outcome of this
proceeding.
On March 10, 1999, a putative class action was filed in the Superior Court
of California, County of Santa Clara, by Raj Chadha. The Chadha complaint
seeks damages and injunctive relief arising out of, among other things,
February 3, 4, and 5, 1999, system interruptions. Plaintiff brings causes of
action for breach of fiduciary duty, violations of the Consumer Legal Remedies
Act, and violations of the California Unfair Business Practices Act. On July
29, 1999, the Court granted our petition to compel arbitration and stayed all
further proceedings. At this time, we are unable to predict the ultimate
outcome of this proceeding.
On March 11, 1999, a putative class action was filed in the Superior Court
of California, County of Santa Clara, by Elie Wurtman. The Wurtman complaint
seeks damages and injunctive relief arising out of, among other things,
plaintiff's alleged problems accessing her account and placing orders. The
complaint also makes allegations regarding access problems relating to our
customers residing or traveling outside of the United States. Plaintiff brings
causes of action for negligence and violations of the Consumer Legal Remedies
Act and California Unfair Business Practices Act. On September 23, 1999 the
Superior Court denied our motion to compel arbitration. We filed an appeal in
October 1999, and all briefing on that appeal has now been completed. At this
time, we are unable to predict the ultimate outcome of this proceeding.
44
On April 14, 1999, a putative class action was filed in the Superior Court
of California, County of Los Angeles, by Matthew J. Rosenberg. Plaintiff seeks
injunctive relief based on alleged violations of the California Unfair
Business Practices Act regarding the extent to which shares in IPOs were made
available to our customers. On October 6, 1999, the Superior Court dismissed
plaintiff's class action claims with prejudice but granted plaintiff leave to
amend his claim for injunctive relief. Plaintiff filed an amended complaint on
October 26, 1999, and we subsequently filed a petition to compel arbitration
that was granted on December 29, 1999. On February 29, 2000, plaintiff filed a
notice of appeal, and the Court of Appeal for the State of California, Second
Appellate District, dismissed plaintiff's appeal on July 20, 2000. At this
time, we are unable to predict the ultimate outcome of this proceeding.
We believe the foregoing claims are without merit and intend to defend
against them vigorously. An unfavorable outcome in any matters which are not
covered by insurance could have a material adverse effect on our business,
financial condition and results of operations. In addition, even if the
ultimate outcomes are resolved in our favor, the defense of such litigation
could entail considerable cost and the diversion of efforts of management,
either of which could have a material adverse effect on our results of
operation.
From time to time, we have been threatened with, or named as a defendant
in, lawsuits, securities arbitrations before the NASDR, and administrative
claims. Compliance and trading problems that are reported to the NASDR or the
SEC by dissatisfied customers are investigated by the NASDR or the SEC and, if
pursued by such customers, may rise to the level of arbitration or
disciplinary action. One or more of such claims or disciplinary actions
decided against us could have a material adverse effect on our business,
financial condition and results of operations. We are also subject to periodic
regulatory audits and inspections.
The securities industry is subject to extensive regulation under federal,
state and applicable international laws. As a result, we are required to
comply with many complex laws and rules and our ability to so comply is
dependent in large part upon the establishment and maintenance of a qualified
compliance system. We are aware of several instances of our noncompliance with
applicable regulations. In particular, in fiscal 1997, our failure to timely
renew our broker dealer registration in Ohio resulted in a $4.3 million pre-
tax charge against earnings.
In March 2000, we paid a fine of $20,000 to the NASDR for failing to
promptly respond to NASDR requests for information related to customer
complaints on twelve instances between April 1999 and June 1999.
In April 2000, we paid a fine of $20,000 to the NASDR for failure to report
our short interest positions to the NASDR for the months of June 1996 through
September 1998.
We maintain insurance in such amounts and with such coverages, deductibles
and policy limits as management believes are reasonable and prudent. The
principal risks that we insure against are comprehensive general liability,
commercial property, residential property, hardware/software damage, directors
and officers, and errors and omissions liability. We believe that such
insurance coverages are adequate for the purpose of our business but cannot
guarantee that we will be able to, or elect to, purchase or maintain such
coverages in the future.
Item 2. Changes in Securities and Use of Proceeds--Not applicable.
Item 3. Defaults Upon Senior Securities--Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders--None.
Item 5. Other Information--None.
45
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
*4.1 Indenture, dated February 1, 2000, by and between the Company and
The Bank of New York.
*10.1 Employment agreement, dated June 1, 1999, by and between the
Company and Christos M. Cotsakos.
*10.2 Employment agreement, dated June 1, 1999, by and between the
Company and Kathy Levinson.
*10.3 Purchase Agreement, dated February 1, 2000, by and among the
Company, FleetBoston Robertson Stephens Inc., Hambrecht & Quist
LLC and Goldman, Sachs & Co.
*10.4 Registration Rights Agreement, dated February 1, 2000, by and
among the Company, FleetBoston Robertson Stephens Inc., Hambrecht
& Quist LLC and Goldman, Sachs & Co.
*10.5 E*TRADE Ventures I, LLC, Limited Liability Company Operating
Agreement.
*10.6 E*TRADE eCommerce Fund, L.P., Amended and Restated Limited
Partnership Agreement.
*10.7 E*TRADE eCommerce Fund II, L.P., Limited Partnership Agreement.
*10.8 E*TRADE Group, Inc. Note Secured by Deed of Trust dated March 17,
2000, by and between the Company and Theodore J. Theophilos.
*10.9 E*TRADE Group, Inc. Amendment to Note Secured by Deed of Trust,
dated May 5, 1999, by and between the Company and Theodore J.
Theophilos.
*10.10 Employment agreement, dated May 24, 2000, by and between the
Company and Jerry Gramaglia.
*10.11 Form of Note Secured by Stock Pledge Agreement by and between the
Company and Christos M. Cotsakos, Jerry Gramaglia, Connie M.
Dotson, Pamela Kramer, Michael Sievert and Leonard C. Purkis.
*10.12 Form of Stock Pledge Agreement by and between the Company and
Christos M. Cotsakos, Jerry Gramaglia, Connie M. Dotson, Pamela
Kramer, Michael Sievert and Leonard C. Purkis.
*10.13 E*TRADE Group, Inc. Note Secured by Deed of Trust dated May, 2000,
by and between the Company and Chuck W. Thomson.
**10.14 Amended and Restated Strategic Alliance Agreement dated September
26, 2000, by and between E*Trade Group, Inc. and Wit SoundView
Group, Inc.
*27.1 Financial Data Schedule.
*99.1 Press release, dated January 25, 2000, relating to the 6%
convertible subordinated notes due 2007.
*99.2 Press release, dated February 2, 2000, relating to the 6%
convertible subordinated notes due 2007.
--------
* Previously filed.
** Confidential treatment has been requested as to certain portions of this
agreement. Such omitted confidential information has been designated by
an asterisk and has been filed separately with the Securities and
Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange
Act of 1934, as amended, pursuant to an application for confidential
treatment.
(b) Reports on Form 8-K
On July 18, 2000, the Company filed a Current Report on Form 8-K to report
the announcement of an agreement to acquire VERSUS Technologies, Inc., a
Canadian based provider of electronic securities. In connection with this
transaction, the Company agreed to acquire all of the outstanding ordinary
shares of
46
VERSUS in exchange for an aggregate of $174 million worth of the Company's
common stock, with VERSUS to become a wholly-owned subsidiary of the Company.
The acquisition is subject to the satisfaction of certain conditions and is
intended to be accounted for as a pooling of interests.
On June 20, 2000, the company filed a Current Report on Form 8-K to report
the strategic alliance between E*TRADE Group, Inc. and Wit Capital Group,
Inc., now known as Wit Soundview Group, Inc., ("Wit"). In connection with the
strategic alliance, E*TRADE Securities, Inc. agreed to acquire from Wit
substantially all of the retail brokerage accounts maintained by Wit's
subsidiary, Wit Capital Corporation. The transactions contemplated by the
strategic alliance are contingent on the closing of the merger of E*OFFERING
Corp. into Wit's subsidiary, Wit Soundview Corporation.
On April 17, 2000, the Company filed a Current Report on Form 8-K to report
the first period of consolidated results of E*TRADE and E*TRADE Financial
Corporation ("ETFC"). The acquisition of ETFC was completed on January 12,
2000 and was accounted for as a pooling of interests.
On January 27, 2000, the Company filed a Current Report on Form 8-K to
report the final closing of its merger with E*TRADE Financial Corporation.
47
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
E*TRADE Group, Inc.
(Registrant)
Dated: October 25, 2000
/s/ Christos M. Cotsakos
-----------------------------
Christos M. Cotsakos
Chairman of the Board and Chief
Executive Officer
(Principal Executive Officer)
/s/ Leonard C. Purkis
-----------------------------
Leonard C. Purkis
Chief Financial Officer
(Principal Financial and Accounting
Officer)
48