10-Q 1 0001.txt QUARTERLY REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2000 Commission file number: 0 - 23644 INVESTMENT TECHNOLOGY GROUP, INC. (Exact Name of Registrant as Specified in Its Charter) DELAWARE 95 - 2848406 ------------------------------------------------------ ---------------------------------------------------- (State or Other Jurisdiction of Incorporation or (I.R.S. Employer Identification No.) Organization) 380 Madison Avenue, New York, New York (212) 588 - 4000 ------------------------------------------------------ ---------------------------------------------------- (Address of Principal Executive Offices) (Registrant's Telephone Number, Including Area Code) 10017 ------------------------------------------------------ (Zip Code)
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 [ ] As of August 11, 2000, the Registrant had 31,047,225 shares of common stock, $.01 par value, outstanding. QUARTERLY REPORT ON FORM 10-Q TABLE OF CONTENTS PART I. - FINANCIAL INFORMATION Page -------- Item 1. Financial Statements Consolidated Statements of Financial Condition: June 30, 2000 (unaudited) and December 31, 1999................. 4 Consolidated Statements of Income (unaudited): Six Months Ended June 30, 2000 and June 25, 1999................ 5 Three Months Ended June 30, 2000 and June 25, 1999.............. 6 Consolidated Statement of Changes in Stockholders' Equity (unaudited): Six Months Ended June 30, 2000.................................. 7 Consolidated Statements of Cash Flows (unaudited): Six Months Ended June 30, 2000 and June 25, 1999................ 8 Condensed Notes to Consolidated Financial Statements (unaudited).... 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................... 13 PART II. - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders................. 19 Item 5. Other Information................................................... 19 Item 6. Exhibits and Reports on Form 8-K.................................... 19 Signatures..........................................................20 QUANTEX IS A REGISTERED TRADEMARK OF INVESTMENT TECHNOLOGY GROUP, INC. POSIT IS A REGISTERED SERVICE MARK OF THE POSIT JOINT VENTURE. SMARTSERVER IS A SERVICE MARK OF INVESTMENT TECHNOLOGY GROUP, INC. TCA IS A TRADEMARK OF INVESTMENT TECHNOLOGY GROUP, INC. ACE IS A TRADEMARK OF INVESTMENT TECHNOLOGY GROUP, INC. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 2 of 20 FORWARD-LOOKING STATEMENTS In addition to the historical information contained throughout this Form 10-Q, there are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements regarding our expected future financial position, results of operations, cash flows, dividends, financing plans, business strategies, competitive positions, plans and objectives of management for future operations, and concerning securities markets and economic trends are forward-looking statements. Although we believe our expectations reflected in such forward-looking statements are based on reasonable assumptions, there can be no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements herein include, among others, the actions of both current and potential new competitors, rapid changes in technology, fluctuations in market trading volumes, market volatility, changes in the regulatory environment, risk of errors or malfunctions in our systems or technology, cash flows into or redemptions from equity funds, effects of inflation, customer trading patterns, as well as general economic and business conditions; securities, credit and financial market conditions; adverse changes or volatility in interest rates. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 3 of 20 PART I. - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (DOLLARS IN THOUSANDS)
------------------------- ------------------------- JUNE 30, DECEMBER 31, 2000 1999 ------------------------- ------------------------- ASSETS (UNAUDITED) Cash and cash equivalents................................. $ 92,195 $ 53,081 Securities owned, at fair value........................... 185,462 43,612 Receivables from brokers, dealers and other, net.......... 28,862 19,181 Investments in limited partnerships....................... 15,596 13,922 Securities, available-for-sale, at fair value............. 1,828 2,023 Due from affiliates....................................... 11,363 - Premises and equipment.................................... 22,463 20,229 Capitalized software...................................... 5,494 5,629 Goodwill.................................................. 549 824 Deferred taxes............................................ 7,792 13,324 Other assets.............................................. 10,109 7,663 ------------------------- ------------------------- Total assets.............................................. $ 381,713 $ 179,488 ========================= ========================= LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable and accrued expenses..................... $ 47,071 $ 33,459 Payable to brokers, dealers and other..................... 73,264 3,932 Software royalties payable................................ 5,650 4,874 Securities sold, not yet purchased, at fair value......... 78,513 5,861 Income taxes payable...................................... 9,883 15,710 ------------------------- ------------------------- Total liabilities......................................... 214,381 63,836 ------------------------- ------------------------- STOCKHOLDERS' EQUITY: Preferred stock, par value $0.01; shares authorized: 1,000,000; shares issued: none...................... - - Common stock, par value $0.01; shares authorized: 100,000,000; shares issued: 33,374,162 and 32,179,106 at June 30, 2000 and December 31, 1999................................... 334 322 Additional paid-in capital............................. 122,861 96,534 Retained earnings...................................... 109,311 75,727 Common stock held in treasury, at cost; shares: 2,453,921 and 2,213,721 at June 30, 2000 and December 31, 1999 (66,174) (58,052) Accumulated other comprehensive income (loss): Currency translation adjustment..................... (19) (7) Unrealized gain on securities, available-for-sale, net of tax.......................................... 1,019 1,128 ------------------------- ------------------------- Total stockholders' equity............................. 167,332 115,652 ------------------------ ------------------------- Total liabilities and stockholders' equity $ 381,713 $ 179,488 ========================= =========================
SEE ACCOMPANYING UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 4 of 20 CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SIX MONTHS ENDED ----------------------------------------- JUNE 30, JUNE 25, 2000 1999 ----------------------------------------- REVENUES: Commissions: POSIT.............................................. $ 82,533 $ 61,570 Electronic trading desk............................ 32,838 21,478 Client............................................. 38,047 24,769 Other................................................ 5,155 1,123 -------------------- ------------------ Total revenues................................... 158,573 108,940 -------------------- ------------------ EXPENSES: Compensation and employee benefits................... 38,759 25,915 Transaction processing............................... 21,654 15,357 Software royalties................................... 10,798 8,026 Occupancy and equipment.............................. 8,203 6,409 Telecommunications and data processing services...... 6,298 4,304 Net loss on long-term investments ................... 2,593 1,215 Spin-off costs ...................................... - 6,759 Other general and administrative..................... 10,340 7,416 -------------------- ------------------ Total expenses................................... 98,645 75,401 -------------------- ------------------ Income before income tax expense.......................... 59,928 33,539 Income tax expense........................................ 26,344 16,786 ----------------------------------------- Net income................................................ $ 33,584 $ 16,753 ========================================= Basic net earnings per share of common stock.............. $ 1.09 $ 0.55 ========================================= Diluted net earnings per share of common stock............ $ 1.07 $ 0.53 ========================================= Basic weighted average shares outstanding................. 30,712 30,191 ========================================= Diluted weighted average shares and common stock equivalents outstanding............................... 31,385 31,817 =========================================
SEE ACCOMPANYING UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 5 of 20 CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED ----------------------------------------- JUNE 30, JUNE 25, 2000 1999 ----------------------------------------- REVENUES: Commissions: POSIT.............................................. $ 44,431 $ 32,824 Electronic trading desk............................ 15,471 10,878 Client............................................. 19,471 12,080 Other................................................ 3,588 530 -------------------- ------------------ Total revenues................................... 82,961 56,312 -------------------- ------------------ EXPENSES: Compensation and employee benefits................... 20,319 13,667 Transaction processing............................... 10,945 7,821 Software royalties................................... 5,810 4,274 Occupancy and equipment.............................. 4,307 3,296 Telecommunications and data processing services...... 3,265 2,384 Net loss on long-term investments ................... 1,811 329 Spin-off costs ...................................... - 4,505 Other general and administrative..................... 5,182 3,734 -------------------- ------------------ Total expenses................................... 51,639 40,010 -------------------- ------------------ Income before income tax expense.......................... 31,322 16,302 Income tax expense........................................ 13,642 7,908 ----------------------------------------- Net income................................................ $ 17,680 $ 8,394 ========================================= Basic net earnings per share of common stock.............. $ 0.57 $ 0.27 ========================================= Diluted net earnings per share of common stock............ $ 0.56 $ 0.26 ========================================= Basic weighted average shares outstanding................. 30,930 30,670 ========================================= Diluted weighted average shares and common stock equivalents outstanding.............................. 31,526 32,040 =========================================
SEE ACCOMPANYING UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 6 of 20 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) SIX MONTHS ENDED JUNE 30, 2000 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Common Additional Stock Preferred Common Paid-in Retained Held in Stock Stock Capital Earnings Treasury ------------------------------------------------------------------------- Balance at December 31, 1999............... $ - $ 322 $ 96,534 $ 75,727 $ (58,052) Purchase of common stock for treasury (240,200 shares)........................ - - - - (8,122) Issuance of common stock in connection with the employee stock option plan (1,174,631 shares)...................... - 12 25,723 - - Issuance of common stock in connection with the employee stock purchase plan (20,429 shares)......................... - - 604 - - Comprehensive income: Net income.............................. - - - 33,584 - Other comprehensive income: Currency translation adjustment..... - - - - - Unrealized holding gain on securities available-for-sale, net of tax ($86). - - - - - Comprehensive income....................... ------------------------------------------------------------------------- Balance at June 30, 2000................... $ - $ 334 $ 122,861 $ 109,311 $ (66,174) =========================================================================
Accumulated Total Comprehensive Stockholders' Income Equity --------------------------------------- Balance at December 31, 1999............... $ 1,121 $ 115,652 Purchase of common stock for treasury (240,200 shares)........................ - (8,122) Issuance of common stock in connection with the employee stock option plan (1,174,631 shares)...................... - 25,735 Issuance of common stock in connection with the employee stock purchase plan (20,429 shares)......................... - 604 Comprehensive income: Net income.............................. - 33,584 Other comprehensive income: Currency translation adjustment..... (12) (12) Unrealized holding gain on securities available-for-sale, net of tax ($86). (109) (109) --------------- Comprehensive income....................... 33,463 --------------------------------------- Balance at June 30, 2000................... $ 1,000 $ 167,332 =======================================
SEE ACCOMPANYING UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 7 of 20 CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (DOLLARS IN THOUSANDS)
SIX MONTHS ENDED --------------------------------------------- JUNE 30, 2000 JUNE 25, 1999 --------------------------------------------- Cash flows from operating activities: Net income...................................................................... $ 33,584 $ 16,753 Adjustments to reconcile net income to net cash provided by operating activities: Deferred income tax expense .............................................. 5,618 362 Depreciation and amortization.............................................. 6,429 6,574 Undistributed loss of affiliates........................................... 2,793 1,165 Provision for doubtful receivables......................................... 140 60 Loss on sale of Premises and equipment..................................... 5 - Decrease (increase) in operating assets: Securities owned, at fair value............................................. (141,850) 11,858 Receivables from brokers, dealers and other, net............................ (9,822) 6,254 Tax receivable.............................................................. - (10,298) Due from affiliates......................................................... (11,363) 722 Investments in limited partnerships......................................... (923) (66) Other assets................................................................ (2,433) (970) Increase (decrease) in operating liabilities: Accounts payable and accrued expenses....................................... 13,613 17,786 Payable to brokers, dealers and other....................................... 69,332 2,902 Software royalties payable.................................................. 776 146 Securities sold, not yet purchased, at fair value........................... 72,652 (265) Due to affiliates........................................................... - (1,422) Income taxes payable to affiliate........................................... - (3,853) Income taxes payable........................................................ (5,828) - Securities available-for-sale gains............................................. (1,973) - ----------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES.................................. 30,750 47,708 ----------------------------------------------- Cash flows from investing activities: Purchase of premises and equipment.......................................... (6,911) (3,376) Proceeds from sales of securities, available-for-sale....................... 1,973 - Proceeds from sales of premises and equipment............................... 5 - Purchase of investment in limited partnership............................... (750) (5,000) Investment in joint venture................................................. (2,805) (964) Capitalization of software development costs................................ (1,353) (2,291) ----------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES...................................... (9,841) (11,631) ----------------------------------------------- Cash flows from financing activities: Dividends paid.............................................................. - (74,624) Retirement of common stock held in treasury at cost......................... - 12,760 Purchase of common stock for treasury....................................... (8,122) - Issuance of common stock under employee stock plan.......................... 26,339 29,265 ----------------------------------------------- NET CASH PROVIDED BY/(USED IN) FINANCING ACTIVITIES........................ 18,217 (32,599) ----------------------------------------------- Effect of foreign currency translation on cash and cash equivalents......... (12) 153 Net increase in cash and cash equivalents.................................. 39,114 3,631 Cash and cash equivalents - beginning of period................................. 53,081 77,324 ----------------------------------------------- Cash and cash equivalents - end of period....................................... $ 92,195 $ 80,955 =============================================== Supplemental cash flow information: Interest paid............................................................... $ 86 $ 19 =============================================== Income taxes paid .......................................................... $ 13,539 $ - =============================================== Income taxes paid to affiliate.............................................. $ - $ 6,538 ===============================================
SEE ACCOMPANYING UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 8 of 20 CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) ORGANIZATION AND BASIS OF PRESENTATION The Consolidated Financial Statements include the accounts of Investment Technology Group, Inc. and its wholly-owned subsidiaries ("ITG"), which principally include: (1) ITG Inc., a broker-dealer in equity securities, (2) Investment Technology Group International Limited, which is a 50% partner in the ITG Europe joint venture, (3) ITG Australia Holdings Pty Limited, which is a 50% partner in ITG Pacific Holdings Pty Limited, (4) ITG Canada Corp., an institutional broker-dealer in Canada, and (5) Inference Group LLC, an internal asset management subsidiary. Our investments in the ITG Europe joint venture and ITG Pacific Holdings Pty Limited are accounted for using the equity method. We are a leading financial technology firm that provides a fully integrated set of value-added electronic equity analysis and trade execution tools. We provide services that help our clients optimize their portfolio construction and trading strategies, efficiently access liquidity in multiple markets and achieve superior, low-cost trade execution. Our clients are major institutional investors and broker/dealers. Our products and services include: POSIT, an electronic stock crossing system; QuantEX, a Unix-based design-support, trade management and order routing system; ITG Platform, a PC-based order routing and trade management system; Electronic Trading Desk, an agency-only trading desk offering clients the ability to efficiently access multiple sources of liquidity; SmartServers, which offer server-based implementation of trading strategies; ACE and TCA, a set of pre- and post-trade tools for systematically analyzing and lowering transaction costs; ITG/OPT, a computer-based equity portfolio selection system; and research, development, sales and consulting services to our clients. SPIN-OFF FROM JEFFERIES GROUP On April 27, 1999, we were effectively spun off from Jefferies Group, Inc ("Jefferies Group"). The spin-off was effected through a series of transactions including our merger with and into Jefferies Group, with Jefferies Group surviving the merger and being renamed Investment Technology Group, Inc. The merger occurred following the transfer by Jefferies Group of substantially all of its assets and liabilities to its wholly-owned subsidiary ("New Jefferies"), and the pro rata distribution by Jefferies Group to its stockholders of all of the New Jefferies common stock. After these transactions, New Jefferies owned all of the assets of Jefferies Group other than Jefferies Group's equity interest in ITG, and Jefferies Group's existing stockholders owned all of the equity interest in New Jefferies. Following the merger, New Jefferies was renamed Jefferies Group, Inc., and, through its subsidiaries, carries on the businesses of Jefferies Group prior to the transactions (other than the businesses of our company). The merger and related transactions resulted in the stockholders of Jefferies Group becoming direct stockholders of our company and Jefferies Group ceasing to be our parent company. The merger was accounted for as a "merger of entities under common control" in accordance with generally accepted accounting principles and accordingly, reflected the historical cost basis of assets and liabilities of ITG. The consolidated financial statements reflect all adjustments, which are in the opinion of management, necessary for the fair presentation of the results for the interim periods and should be read in conjunction with our 1999 annual report on Form 10-K. FAIR VALUE OF FINANCIAL INSTRUMENTS Substantially all of our financial instruments are carried at fair value or amounts approximating fair value. Cash and cash equivalents, securities owned and certain receivables, are carried at fair value or contracted amounts which approximate fair value due to the short period to maturity and repricing characteristics. Similarly, liabilities are carried at amounts approximating fair value. Securities sold, not yet purchased are valued at quoted market prices. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 9 of 20 USE OF ESTIMATES ITG's management has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets, liabilities, revenues and expenses to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. RECLASSIFICATIONS Certain reclassifications have been made to the prior year's amounts to conform to the current year's presentation. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses at June 30, 2000 and December 31, 1999 consisted of the following;
JUNE 30, DECEMBER 31, 2000 1999 -------------------------------- (DOLLARS IN THOUSANDS) Accounts payable and accrued expenses......................... $ 13,737 $ 11,754 Accrued compensation ......................................... 10,276 580 Deferred compensation ........................................ 11,206 9,424 Deferred options.............................................. - 2,280 Accrued soft dollars payable.................................. 9,255 6,688 Accrued rent expense.......................................... 2,597 2,733 -------------------------------- Total ........................................................ $ 47,071 $ 33,459 ================================
OTHER COMPREHENSIVE INCOME (LOSS) The following summarizes other comprehensive income (loss) as of June 30, 2000 (Dollars in thousands):
UNREALIZED CURRENCY HOLDING GAIN ON OTHER TRANSLATION SECURITIES, COMPREHENSIVE ADJUSTMENT AVAILABLE FOR SALE INCOME/(LOSS) -------------------------------------------------------- Pre-tax amount..................................... $ (12) $ (195) $ (207) Tax benefit........................................ - 86 86 -------------------------------------------------------- Net of tax amount.................................. $ (12) $ (109) $ (121) ======================================================== UNREALIZED HOLDING GAIN ON ACCUMULATED CURRENCY SECURITIES, OTHER TRANSLATION AVAILABLE FOR SALE, COMPREHENSIVE ADJUSTMENT NET OF TAX INCOME/(LOSS) -------------------------------------------------------- Balance at December 31,1999....................... $ (7) $ 1,128 $ 1,121 Change during period ended June 30, 2000.......... (12) (109) (121) -------------------------------------------------------- Balance at June 30, 2000.......................... $ (19) $ 1,019 $ 1,000 ========================================================
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 10 of 20 EARNINGS PER SHARE Net earnings per share of common stock, is based upon an adjusted weighted average number of shares of common stock outstanding. The diluted weighted average number of outstanding shares for the six months ended June 30, 2000 and June 25, 1999 was 31.4 million and 31.8 million, respectively. The diluted weighted average number of outstanding shares for the three months ended June 30, 2000 and June 25, 1999 was 31.5 million and 32.0 million, respectively. The following is a reconciliation of the basic and diluted earnings per share computations for the six months ended June 30, 2000 and June 25, 1999.
SIX MONTHS ENDED ----------------------------------- JUNE 30, JUNE 25, 2000 1999 --------------- ---------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ----------------------------------- Net income......................................................... $ 33,584 $ 16,753 =============== ============= Shares of common stock and common stock equivalents: Average number of common shares used in basic computation... 30,712 30,191 Effect of dilutive securities - options....................... 673 1,626 --------------- ------------- Average number of common shares used in diluted computation. 31,385 31,817 =============== ============= Earnings per share: Basic......................................................... $ 1.09 $ 0.55 =============== ============= Diluted....................................................... $ 1.07 $ 0.53 =============== ============= The following is a reconciliation of the basic and diluted earnings per share computations for the three months ended June 30, 2000 and June 25, 1999. THREE MONTHS ENDED ----------------------------------- JUNE 30, JUNE 25, 2000 1999 --------------- ---------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ----------------------------------- Net income......................................................... $ 17,680 $ 8,394 =============== ============= Shares of common stock and common stock equivalents: Average number of common shares used in basic computation... 30,930 30,670 Effect of dilutive securities - options....................... 596 1,370 --------------- ------------- Average number of common shares used in diluted computation. 31,526 32,040 =============== ============= Earnings per share: Basic......................................................... $ 0.57 $ 0.27 =============== ============= Diluted....................................................... $ 0.56 $ 0.26 =============== =============
NET CAPITAL REQUIREMENT ITG Inc. is subject to the Uniform Net Capital Rule (Rule 15c3-1) under the Securities Exchange Act of 1934, which requires the maintenance of minimum net capital. ITG Inc. has elected to use the alternative method permitted by Rule 15c3-1, which requires that ITG Inc. maintain minimum net capital equal to the greater of $250,000 or 2% of aggregate debit balances arising from customer transactions, as defined. At June 30, 2000, ITG Inc. had net capital of $33.8 million, which was $33.5 million in excess of required minimum net capital. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 11 of 20 CONTINGENCIES In 1998, we received a "30-day letter" from the IRS proposing certain adjustments which, if sustained, would result in a tax deficiency of approximately $9.6 million plus interest. The adjustments proposed relate to (i) the disallowance of deductions taken in connection with the termination of certain compensation plans at the time of our initial public offering in 1994 and (ii) the disallowance of tax credits taken in connection with certain research and development expenditures. We believe that the tax benefits in question were taken properly and intend to vigorously contest the proposed adjustments. Based on the facts and circumstances known at this time, we are unable to predict when this matter will be resolved or the costs associated with its resolution. Our company may continue to be liable for certain liabilities of its former parent, Jefferies Group, despite the express assignment of such liabilities to, and the express assumption of such liabilities by, New Jefferies. Pursuant to the distribution agreement, benefits agreement and tax sharing and indemnification agreement executed in connection with the spin-off, New Jefferies will be obligated to indemnify ITG for liabilities related to ITG's former parent and its subsidiaries, but not for liabilities related to the company. Under those agreements, ITG will be obligated to indemnify New Jefferies for liabilities related to our company. ITG's ability to recover any costs under such indemnity will depend upon the future financial strength of New Jefferies. At June 30, 2000 and December 31, 1999, we had outstanding capital contribution commitments to a limited partnership in the amount of $750,000 and $1,500,000, respectfully. DIVIDENDS Any future payments of dividends will be at the discretion of our Board of Directors and will depend on our financial condition, results of operations, capital requirements and other factors deemed relevant. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 12 of 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL REVENUES: We generate substantially all of our revenues from the following four products and services, each contributing to our single line of business: o POSIT: a confidential electronic stock crossing system; o Electronic Trading Desk: an agency-only trading desk; o Front End Software; o QuantEX: a Unix-based front-end software system providing market analysis, trade management and electronic connectivity to POSIT and multiple trade execution destinations; and o ITG Platform: a PC-based front-end software system providing market analysis, trade management and electronic connectivity to POSIT and multiple trade execution destinations. Revenues primarily consist of commissions from customers' use of our trade execution and analytical services. Because these commissions are paid on a per-transaction basis, revenues fluctuate from period to period depending on the volume of securities traded through our services. We record as POSIT revenue any order that is executed on the POSIT system regardless of the manner in which the order was submitted to POSIT. ITG collects a commission from each side of a trade matched on POSIT. We record as Electronic Trading Desk revenue any order that is handled by our trading desk personnel and executed at any trade execution destination other than POSIT. We record as Client revenue any order that is sent by our clients, through ITG's front-end systems but without assistance from the Electronic Trading Desk, to any third party trade execution destination. Other revenue includes interest and dividend income/expense, market gains/losses, financing costs resulting from temporary positions in securities assumed in the normal course of our agency trading business and fee income from the development of European software products. EXPENSES: Expenses consist of compensation and employee benefits, transaction processing, software royalties, occupancy and equipment, telecommunications and data processing services, net loss on long-term investments, spin-off costs and other general and administrative expenses. Compensation and employee benefits expenses include base salaries, bonuses, employment agency fees, part-time employee compensation, fringe benefits, including employer contributions for medical insurance, life insurance, retirement plans and payroll taxes, offset by capitalized software. Transaction processing expenses consist of floor brokerage and clearing fees and connection fees for use of certain third party execution services. Software royalties are payments to our POSIT joint venture partner, BARRA. Occupancy and equipment expenses include rent, depreciation, amortization of leasehold improvements, maintenance, utilities, occupancy taxes and property insurance. Telecommunications and data processing services include costs for computer hardware, office automation and workstations, data center equipment, market data services and voice, data, telex and network communications. Net loss on long-term investments includes amortization of goodwill and equity gain/loss on our ITG Europe, ITG Australia and Vostock (our joint venture with WIT Capital Corporation to market an online auction system for secondary and follow-on equity offerings). Spin-off costs include legal, accounting, consulting and various other expenses in connection with the spin-off from Jefferies Group and related transactions. Other general and administrative expenses include amortization of capitalized software and goodwill, legal, audit, tax, consulting and promotional expenses. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 13 of 20 RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 25, 1999 The table below sets forth, certain items in the statement of operations expressed as a percentage of revenues for the periods indicated:
SIX MONTHS ENDED ------------------------------- JUNE 30, JUNE 25, ------------------------------- 2000 1999 ------------------------------- 100.0% 100.0% Revenues: Commissions POSIT............................................ 52.0 56.5 Electronic trading desk.......................... 20.7 19.7 Client........................................... 24.0 22.7 Other................................................ 3.3 1.1 Expenses: Compensation and employee benefits................... 24.4 23.8 Transaction processing............................... 13.7 14.1 Software royalties................................... 6.8 7.4 Occupancy and equipment.............................. 5.2 5.9 Telecommunications and data processing services...... 4.0 4.0 Net loss on long-term investments ................... 1.6 1.1 Spin-off costs ...................................... 0.0 6.2 Other general and administrative..................... 6.5 6.8 --------------- --------------- Total expenses................................... 62.2 69.3 --------------- --------------- Income before income tax expense.......................... 37.8 30.8 Income tax expense........................................ 16.6 15.4 --------------- --------------- Net income................................................ 21.2 15.4 =============== ===============
EARNINGS PER SHARE: Basic net earnings per share for the six months ended June 30, 2000 ("First Half 2000") increased $0.54, or 98%, to $1.09 from $0.55 for the six months ended June 25, 1999 ("First Half 1999"). Diluted net earnings per share increased $0.54, or 102%, from $0.53 to $1.07. Diluted net earnings per share for First Half 1999, excluding non-recurring charges of $6.8 million incurred in connection with our spin-off from Jefferies Group, were $0.69. There were no such spin-off charges in First Half 2000. REVENUES: Total revenues increased $49.7 million, or 46%, from $108.9 million to $158.6 million. There were 121 trading days in the First Half 1999 and 126 trading days in the First Half 2000. Revenues per trading day increased by $359,000, or 40%, from $900,000 to $1,259,000. Revenues per employee increased $79,000, or 22%, from $364,000 to $443,000. POSIT, Client and Electronic Trading Desk revenues increased 42% over the First Half 1999 as a result of providing our clients with broadened access to liquidity sources, such as linking to electronic communications networks ("ECN's"), and tools for understanding and minimizing trading costs. In addition, there were increases in trading volume from existing clients as well as an increase in the number of our customers. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 14 of 20 The number of shares crossed on the POSIT system increased 1.2 billion, or 40%, from 3.0 billion in the First Half 1999 to 4.2 billion. The number of shares crossed on the POSIT system per day increased 8.4 million, or 34%, from 25.1 million to 33.5 million. POSIT's quarterly volume hit a record 2.3 billion shares during the second quarter of 2000 and a single day record of over 80 million shares crossed on June 27th. Of Client revenues, our QuantEx and Platform products increased 39% representing 66% of the increase in Client revenues. Electronic Trading Desk revenues increased 53%, in part due to the impact of our Company becoming the clearing and execution broker for two large introducing brokers. Other revenues increased primarily from a gain recorded on the partial sale of our investment in Versus Technologies, Inc. and increases in investment income, larger average interest-earning balances and improved rates of return. EXPENSES: Total expenses excluding income tax expense for First Half 2000 increased $23.2 million, or 31%, from $75.4 million in First Half 1999 to $98.6 million. COMPENSATION AND EMPLOYEE BENEFITS: Salaries, bonuses and related employee benefits increased as a result of increases in headcount, financial performance based compensation and additional compensation necessary to attract and retain quality personnel. As of the end of the First Half 2000 we had 358 employees, representing an increase of 20% or 59 over First Half 1999. Approximately 78% of the increase in employees were staffed in technology, product development and production infrastructure. This is consistent with our ongoing effort to respond to continuous changes in the securities industry and demand for increased efficiencies by enhancing existing software and developing new software and services. Average compensation and employee benefits expenses per person increased $21,000, or 24%, from $87,000 to $108,000. TRANSACTION PROCESSING: Transaction processing as a percentage of revenues decreased from 14.1% to 13.7% of revenues. Reductions in clearing and execution costs resulted from a decrease in floor brokerage costs, as we are no longer charged by NYSE Specialists for trades executed within five minutes. These savings were offset by increases in ECN related costs as we continue to expand our clients' access to new liquidity sources. SOFTWARE ROYALTIES: Because software royalties are contractually fixed at 13% of POSIT revenues, the increase is wholly attributable to an increase in POSIT revenues. OCCUPANCY AND EQUIPMENT: We continue to enhance our infrastructure and add to our employee base. Depreciation/amortization, rent and maintenance contracts represented 90% of the increase as we expanded our research and development facility in Culver City, California in December 1999, our New York headquarters in January 2000 and we added a new office in Waltham, Massachusetts for our new internal asset management subsidiary, Inference Group LLC. TELECOMMUNICATIONS AND DATA PROCESSING SERVICES: The increase in telecommunications and data processing services stems primarily from fees for additional client data services, including market data line connections, increases in communication charges for linking clients to ITG in New York and Boston, and increases in the costs associated with infrastructure improvements. NET LOSS ON LONG-TERM INVESTMENTS: The increase in loss on long-term investments primarily resulted from the start-up costs of Vostock combined with losses on our ITG Europe joint venture during its second full year of operations. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 15 of 20 SPIN-OFF COSTS: The spin-off expenses in the First Half 1999 were attributable to our legal, accounting, consulting and other expenses incurred for the spin-off and merger transactions, as discussed in "Condensed Notes to Consolidated Financial Statements - Spin-Off from Jefferies Group." The Spin-off was concluded in 1999 and as a result there are no associated costs in First Half 2000. OTHER GENERAL AND ADMINISTRATIVE: The increase in other general and administrative expenses primarily related to consulting and marketing costs geared towards developing new business opportunities. Additionally, subsequent to our spin-off, specified administrative services previously provided to us for a fixed monthly fee by Jefferies Group were performed by ITG. This change resulted in reduced administrative service fees offset by higher legal, audit and accounting fees. INCOME TAX EXPENSE: The decrease in the effective tax rate from 50.0% to 44.0% resulted primarily from non-deductible spin-off expenses which were incurred in First Half 1999. RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE MONTHS ENDED JUNE 25, 1999 The table below sets forth, certain items in the statement of operations expressed as a percentage of revenues for the periods indicated:
THREE MONTHS ENDED ------------------------------- JUNE 30, JUNE 25, ------------------------------- 2000 1999 ------------------------------- 100.0% 100.0% Revenues: Commissions POSIT............................................ 53.6 58.3 Electronic trading desk.......................... 18.6 19.3 Client........................................... 23.5 21.5 Other................................................ 4.3 0.9 Expenses: Compensation and employee benefits................... 24.5 24.3 Transaction processing............................... 13.2 13.9 Software royalties................................... 7.0 7.6 Occupancy and equipment.............................. 5.2 5.9 Telecommunications and data processing services...... 3.9 4.2 Net loss on long-term investments ................... 2.2 0.6 Spin-off costs ...................................... 0.0 8.0 Other general and administrative..................... 6.2 6.6 --------------- --------------- Total expenses................................... 62.2 71.2 --------------- --------------- Income before income tax expense.......................... 37.8 28.9 Income tax expense........................................ 16.4 14.0 --------------- --------------- Net income................................................ 21.4 14.9 =============== ===============
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 16 of 20 EARNINGS PER SHARE: Basic net earnings per share for the three months ended June 30, 2000 ("Second Quarter 2000") increased $0.30, or 111%, to $0.57 from $0.27 for the three months ended June 25, 1999 ("Second Quarter 1999"). Diluted net earnings per share increased $0.30, or 115%, to $0.56 from $0.26. Diluted net earnings per share for Second Quarter 1999, excluding non-recurring charges of $4.5 million incurred in connection with our spin-off from Jefferies Group, were $0.36. There were no such spin-off charges in Second Quarter 2000. REVENUES: Total revenues increased $26.7 million, or 47%, from $56.3 million to $83.0 million. There were 63 trading days in both Second Quarter 1999 and Second Quarter 2000. Revenues per trading day increased by $423,000, or 47%, from $894,000 to $1,317,000. Revenues per employee increased $44,000, or 23%, from $188,000 to $232,000. POSIT, Electronic Trading Desk and Client revenues increased 42% over the Second Quarter 1999 as a result of providing our clients with broadened access to liquidity sources, such as ECN's, and tools for understanding and managing trading costs. In addition, there were increases in trading volume from existing clients as well as an increase in the number of our customers. The number of shares crossed on the POSIT system increased 0.7 billion, or 44%, from 1.6 billion in Second Quarter 1999 to 2.3 billion. The number of shares crossed on the POSIT system per day increased 11.1 million, or 43%, from 25.7 million to 36.8 million. POSIT's volume hit a record 2.3 billion shares for the Second Quarter 2000 and a single day record of over 80 million shares crossed on June 27th. Of Client revenues, our QuantEx and Platform product revenues increased 47% representing 70% of the increase in Client revenues. Electronic Trading Desk revenues increased 42%, in part due to the impact of our Company becoming the clearing and execution broker for two large introducing brokers. Other revenues increased primarily from a gain recorded on the partial sale of our investment in Versus Technologies, Inc. and increases in investment income, larger average interest-earning balances and improved rates of return. EXPENSES: Total expenses excluding income tax expense for Second Quarter 2000 increased $11.6 million, or 29%, from $40.0 million in Second Quarter 1999 to $51.6 million. COMPENSATION AND EMPLOYEE BENEFITS: Salaries, bonuses and related employee benefits increased primarily due to growth in our employee base of 59 or 20% from 299 to 358. Further contributing to the increase was the additional compensation necessary to attract and retain quality personnel and the increase in our financial performance upon which we model our bonus compensation. Average compensation and employee benefits expenses per person increased $11,000, or 24%, from $46,000 to $57,000 on a quarter to quarter basis. TRANSACTION PROCESSING: Transaction processing as a percentage of revenues decreased from 13.9% to 13.2% of revenues. Reductions in clearing and execution costs resulted from a decrease in floor brokerage costs, as we are no longer charged by NYSE Specialists for trades executed within five minutes. These savings were offset by increases in ECN related costs as we continue to expand our clients' access to new liquidity sources. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 17 of 20 SOFTWARE ROYALTIES: Because software royalties are contractually fixed at 13% of POSIT revenues, the increase is wholly attributable to an increase in POSIT revenues. OCCUPANCY AND EQUIPMENT: We continue to enhance our infrastructure and add to our employee base. Depreciation/amortization, rent and maintenance contracts represented 80% of the increase as we expanded our research and development facility in Culver City, California in December 1999, our New York headquarters in January 2000 and we established a new office in Waltham, Massachusetts for our new internal asset management subsidiary, Inference Group LLC. TELECOMMUNICATIONS AND DATA PROCESSING SERVICES: The increase in telecommunications and data processing services stems primarily from fees for additional client data services, including market data line connections, increases in communication charges for linking clients to ITG in New York and Boston, and increases in the costs associated with infrastructure improvements. NET LOSS ON LONG-TERM INVESTMENTS: The increase in loss on long-term investments primarily resulted from the start-up costs of Vostock combined with losses on our ITG Europe joint during its second full year of operations. SPIN-OFF COSTS: The spin-off expenses in the Second Quarter 1999 were attributable to our legal, accounting, consulting and other expenses incurred for the spin-off and merger transactions, as discussed in "Condensed Notes to Consolidated Financial Statements - Spin-Off from Jefferies Group." The Spin-off was concluded in 1999 and as a result there are no associated costs in Second Quarter 2000. OTHER GENERAL AND ADMINISTRATIVE: The increase in other general and administrative expenses primarily related to consulting and marketing costs geared towards developing new business opportunities. Additionally, subsequent to our spin-off, specified administrative services previously provided to us at a fixed monthly fee by Jefferies Group were performed by ITG. This change resulted in reduced administrative service fees offset by higher legal, audit and accounting fees. INCOME TAX EXPENSE The decrease in the effective tax rate from 48.5% to 43.6% resulted primarily from non-deductible spin-off expenses which were incurred in the Second Quarter 1999. LIQUIDITY AND CAPITAL RESOURCES Our liquidity and capital resource requirements result from our working capital needs, primarily consisting of compensation and benefits, transaction processing fees and software royalty fees. Historically, cash from operations has met all working capital requirements. A substantial portion of our assets are liquid, consisting of cash and cash equivalents or assets readily convertible into cash. We believe that our cash flow from operations and existing cash balances will be sufficient to meet our cash requirements. We generally invest our excess cash in money market funds and other short-term investments that generally mature within 90 days or less. Additionally, securities owned at fair value include highly liquid, common stock, variable rate municipal securities and auction rate preferred stock. At June 30, 2000, such cash equivalents amounted to $277.7 million and net receivables from brokers, dealers and other, of $27.9 million were due within 30 days. Historically, all regulatory capital needs of ITG Inc. have been provided by cash from operations. We believe that cash flows from operations will provide ITG Inc. with sufficient regulatory capital. As of June 30, 2000, we had net excess regulatory capital of $33.5 million. Although we believe that the combination of our existing net regulatory capital and operating cash flows will be sufficient to meet regulatory capital requirements, a shortfall in net regulatory capital would have a material adverse effect on us. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 18 of 20 PART II. - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None. ITEM 5. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 27 - Financial Data Schedule. INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 19 of 20 SIGNATURE --------- 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. INVESTMENT TECHNOLOGY GROUP, INC. --------------------------------- (Registrant) Date: August 11, 2000 By: /s/ Howard C. Naphtali --------------------- ----------------------- Howard C. Naphtali Chief Financial Officer and Duly Authorized Signatory of Registrant INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES Page 20 of 20