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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES AND EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 000-32717
---------
Instinet Group Incorporated
(Exact Name of Registrant as Specified in Its Charter)
Delaware
(State or Other Jurisdiction 13-4134098
of Incorporation or Organization) (IRS Employer
Identification No.)
3 Times Square, New York, NY 10036
(Address of Principal Executive Offices) (Zip Code)
(212) 310-9500
(Registrant's Telephone Number, Including Area 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 No X
-- --
Number of shares outstanding of each of the registrant's classes of Common Stock
at August 09, 2001.
Common Stock, $0.01 par value 243,719,280 shares
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INSTINET GROUP INCORPORATED
FORM 10-Q QUARTERLY REPORT
For the Quarter Ended June 30, 2001
Table of Contents Page
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income for the three months and six months
ended June 30, 2001 and 2000 3
Consolidated Statements of Financial Condition as of June 30, 2001 and
December 31, 2000 4
Consolidated Statements of Cash Flows for the six months ended June 30,
2001 and 2000 5
Notes To Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 21
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Changes in Securities and Use of Proceeds 22
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 25
On May 9, 2001, we converted our company from a Delaware limited liability
company (Instinet Group LLC) into a Delaware corporation (Instinet Group
Incorporated). In this report, "Instinet," "our company," "we" and "our" refer
to Instinet Group LLC and its combined operations prior to the conversion date,
and to Instinet Group Incorporated and its consolidated subsidiaries after that
date.
Forward-Looking Statements:
We have made forward-looking statements in this report on Form 10-Q that are
based on our management's beliefs and assumptions and on information currently
available to our management. From time to time, we may also include oral or
written forward-looking statements in other materials released to the public.
Forward-looking statements include information concerning our possible or
assumed future results of operations, business strategies, financing plans,
competitive position, potential growth opportunities and the effects of
competition and regulation. Forward-looking statements include all statements
that are not historical facts. You can identify these statements by the use of
forward-looking terminology, such as the words "believes," "expects,"
"anticipates," "intends," "plans," "estimates," "may" or "might" or other
similar expressions. The forward-looking statements contained in this report
speak only as of the date hereof, and we do not undertake any obligation to
update any of them publicly in light of new information or future events.
Forward-looking statements involve significant risks, uncertainties and
assumptions. Although we believe that the expectations reflected in the
forward-looking statements are reasonable, actual results may differ materially
from those expressed in these forward-looking statements. You should not put
undue reliance on any forward-looking statements. You should understand that
many important factors could cause our results to differ materially from those
expressed or suggested in forward-looking statements, including those discussed
below under "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Quantitative and Qualitative Disclosures About
Market Risk," and under the caption "Risk Factors" in our Prospectus dated May
17, 2001, as filed with the SEC pursuant to Rule 424(b) under the Securities Act
of 1933 (the "Prospectus"). We hereby incorporate by reference those risk
factors from our Prospectus (other than those under the headings "There Has Been
No Prior Market for Our Common Stock" and "Investors in this Offering Will
Experience Immediate and Substantial Dilution") into this report on Form 10-Q.
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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
INSTINET GROUP INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Amounts)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- --------------------
2001 2000 2001 2000
-------- ---------- -------- --------
REVENUES
Transaction fees................. $379,727 $336,059 $795,190 $676,884
Interest......................... 11,575 9,969 24,382 18,183
Investments...................... 3,689 1,571 6,094 1,060
-------- ---------- -------- --------
Total revenues......... 394,991 347,599 825,666 696,127
EXPENSES
Compensation and benefits........ 120,720 101,057 254,505 195,391
Communications and equipment..... 44,844 35,661 90,235 64,558
Soft dollar and commission
recapture...................... 54,228 46,349 110,281 82,974
Brokerage, clearing and exchange
fees........................... 36,224 35,845 72,958 69,735
Depreciation and amortization.... 20,505 18,002 40,007 36,379
Professional fees................ 9,275 20,824 24,959 46,484
Occupancy........................ 14,473 9,133 25,363 19,063
Marketing and business
development.................... 8,577 7,733 18,731 20,514
Other............................ 13,414 6,898 26,417 19,061
-------- ---------- -------- --------
Total expenses......... 322,260 281,502 663,456 554,159
-------- ---------- -------- --------
Income before income taxes....... 72,731 66,097 162,210 141,968
Provision for income taxes....... 32,001 29,083 71,372 62,466
-------- ---------- -------- --------
Net income............. $40,730 $37,014 $90,838 $79,502
======== ========== ======== ========
Basic and diluted earnings per
share....................... $ .18 $ .18 $ .42 $ .38
======== ========== ======== ========
Weighted average shares
outstanding - basic......... 222,675 206,900 214,831 206,900
======== ========== ======== ========
Weighted average shares
outstanding - diluted....... 223,122 206,900 215,060 206,900
======== ========== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
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INSTINET GROUP INCORPORATED
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In Thousands, Except Per Share Amounts)
(Unaudited)
JUNE 30, DECEMBER 31,
2001 2000
------------ ------------
ASSETS
Cash and cash equivalents............................. $ 633,970 $ 415,199
Securities segregated under federal regulations....... 113,049 70,000
Securities owned, at market value..................... 80,443 185,121
Securities borrowed................................... 637,977 245,833
Receivable from broker-dealers........................ 399,947 660,319
Receivable from customers............................. 74,668 149,080
Commissions and other receivables, net................ 152,921 123,609
Investments........................................... 89,082 83,801
Receivable from Parent................................ 10,372 --
Receivable from affiliates, net....................... -- 14,267
Fixed assets and leasehold improvements, net of
accumulated depreciation and amortization........... 234,794 195,636
Goodwill, net of accumulated amortization............. 77,808 81,830
Deferred tax assets, net.............................. 73,489 76,917
Other assets.......................................... 115,991 138,812
---------- ----------
Total assets................................ $2,694,511 $2,440,424
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Short-term borrowings................................. $ 130,747 $ 117,072
Payable to broker-dealers............................. 205,487 542,731
Securities loaned..................................... 285,928 --
Payable to customers.................................. 258,149 346,866
Taxes payable......................................... 41,074 50,516
Payable to Parent..................................... -- 22,488
Payable to affiliates, net............................ 25,878 --
Subordinated debt to affiliate........................ -- 50,417
Accrued compensation.................................. 170,538 202,767
Accounts payable, accrued expenses and other
liabilities......................................... 216,211 180,231
---------- ----------
Total liabilities........................... 1,334,012 1,513,088
---------- ----------
STOCKHOLDERS' EQUITY..................................
Historical combined equity ........................... 948,363
Common stock, $0.01 par value (950,000 shares
authorized, 243,712 issued and outstanding) ........ 2,437
Additional paid-in capital............................ 1,354,884
Retained earnings..................................... 20,187
Accumulated other comprehensive loss.................. (1,801) (2,029)
Unearned compensation................................. (15,208) (18,998)
---------- ----------
Total stockholders' equity.................. 1,360,499 927,336
---------- ----------
Total liabilities and stockholders' equity.. $2,694,511 $2,440,424
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
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INSTINET GROUP INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
SIX MONTHS ENDED
JUNE 30,
---------------------
2001 2000
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................ $ 90,838 $ 79,502
Adjustments to reconcile net income to cash (used in) /
provided by/ operating activities:
Depreciation and amortization....................... 40,007 36,379
Deferred taxes...................................... 3,428 (28,361)
Forfeitures and amortization of unearned
compensation....................................... 3,790 --
(Increases)/decreases in operating assets:
Securities segregated under federal regulations..... (43,049) --
Securities borrowed................................. (392,144) (33,026)
Receivable from broker-dealers...................... 260,372 (142,681)
Receivable from customers........................... 74,412 (76,001)
Commissions and other receivables, net.............. (29,312) (12,713)
Receivable from Parent.............................. (10,372) --
Receivable from affiliates, net..................... 14,267 --
Other assets........................................ 22,821 (20,990)
Increases/(decreases) in operating liabilities:
Short-term borrowings............................... 13,675 (40,761)
Securities loaned................................... 285,928 --
Payable to broker-dealers........................... (337,244) 175,333
Payable to customers................................ (88,717) 47,529
Taxes payable....................................... (9,442) 81,772
Payable to Parent................................... (22,488) 15,328
Payable to affiliates, net.......................... 25,878 5,938
Accrued compensation................................ (32,229) 3,683
Accounts payable, accrued expenses and other
liabilities....................................... 35,980 10,269
--------- ---------
Cash (used in) / provided by operating activities. (93,601) 101,200
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Securities owned, at market value................... 104,678 (238,675)
Investments......................................... (5,281) (31,624)
Proceeds from the sale of fixed assets to affiliate. -- 17,300
Purchase of fixed assets and leasehold improvements. (75,143) (50,578)
Acquisitions of businesses, net of assets acquired
and liabilities assumed........................... -- (48,500)
--------- ---------
Cash provided by / (used in) investing activities. 24,254 (352,077)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Subordinated debt from affiliate.................... -- 50,209
Repayment of subordinated debt from affiliate....... (50,417) --
Loan from Parent.................................... 150,000 --
Capital distribution to Parent...................... (150,000) --
Net proceeds from initial public offering .......... 488,097 --
Repayment of loan from Parent....................... (150,000) --
Proceeds from issuance of common stock.............. 210 --
--------- ---------
Cash provided by financing activities............. 287,890 50,209
--------- ---------
Effect of exchange rate differences in cash and cash
equivalents......................................... 228 5,103
--------- ---------
Increase/(decrease) in cash and cash equivalents...... 218,771 (195,565)
Cash and cash equivalents, beginning of period........ 415,199 349,522
--------- ---------
Cash and cash equivalents, end of period.............. $ 633,970 $153,957
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
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INSTINET GROUP INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
Instinet Group Incorporated (the "Company" or "Instinet") is a Delaware
corporation that, through its operating subsidiaries, provides agency and other
brokerage services to broker-dealers and institutional customers worldwide. As
of June 30, 2001, the Company was approximately 85% owned by Reuters Group PLC
("Reuters" or "Parent") indirectly through certain Reuters subsidiaries.
2. BASIS OF PRESENTATION
Reuters reorganized its ownership of Instinet's worldwide agency brokerage
operations so that they would be wholly owned by and consolidated into the
Company. Prior to September 30, 2000, Reuters ownership of the Company's global
agency brokerage operations was structured such that its U.S. operations were
owned through a U.S.-based holding company, and its European and Asian
operations were owned through European-based holding companies. The
reorganization was accounted for at historical cost in a manner similar to a
pooling of interests.
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant transactions and
balances between and among the Company and its subsidiaries have been eliminated
in consolidation. These 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 adjustments, consisting only of normal
recurring adjustments, necessary for a fair statement of the financial position,
results of operations and cash flows for the periods presented in conformity
with generally accepted accounting principles. These financial statements should
be read in conjunction with the Company's audited financial statements and notes
thereto included in the Company's Prospectus dated May 17, 2001, as filed with
the SEC pursuant to Rule 424(b) under the Securities Act of 1933.
3. INITIAL PUBLIC OFFERING
On May 23, 2001, the Company completed its initial public offering. In that
offering, the Company sold 36,800,000 shares of common stock and received net
proceeds of approximately $488 million after deducting offering expenses.
4. SECURITIES OWNED ($ IN THOUSANDS)
Securities owned are recorded on a trade date basis and primarily represent
U.S. and foreign government securities, as well as shares of the London and Hong
Kong stock exchanges, and are carried at their market value with unrealized
gains and losses reported in income. Marketable securities owned consisted of
the following:
JUNE 30, DECEMBER 31,
------------ ------------
2001 2000
------------ ------------
U.S. government and federal agency obligations.............. $50,520 $167,360
Foreign sovereign obligations and other..................... 29,923 17,761
------------ ------------
Total............................................. $80,443 $185,121
============ ============
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5. INVESTMENTS ($ IN THOUSANDS)
From time to time, the Company makes strategic investments in other
companies. The changes in the carrying values at the end of each period of
investments made in non-U.S. dollars may result from fluctuations in exchange
rates. A description of the Company's more significant investments are as
follows:
- WR Hambrecht + Co ("Hambrecht") -- In May 1999 and April 2000, the
Company made strategic investments totaling $27,500, now representing a
7.2% interest, in Hambrecht. Hambrecht underwrites initial public
offerings through its auction-based securities offering via the Internet,
performs research and analysis, places and invests in private equity
transactions, and offers mergers and acquisition advisory services. As of
June 30, 2001 and December 31, 2000, the Company carried its investment
at estimated fair value, which was unchanged from its original cost.
- TP Group LDC -- Beginning in May 1999, the Company made strategic
investments, and also sold certain portions of its investment, in TP
Group LDC. TP Group LDC is a consortium led by the Company that owns 54%
of Tradepoint Financial Networks plc, a U.K.-based electronic order
driven equities market for U.K. securities. In November 2000, the Company
made an additional investment and, as of June 30, 2001 and December 31,
2000, the Company carried its investment at estimated fair value of
$6,907, which was unchanged from the cost.
- Archipelago Holdings LLC ("Archipelago") -- In July 1999, the Company
made a strategic investment of 15,528 GBP, representing a 11.1% voting
interest, in Archipelago. Archipelago, through its subsidiary, provides
order entry and execution capabilities using proprietary systems while
providing customers access to liquidity, including access to other
electronic communication networks. As of June 30, 2001 and December 31,
2000, the Company carried its investment at estimated fair value of
$22,050 and $23,137, respectively, which was unchanged from its original
cost.
- Vencast, Inc. ("Vencast") -- In March 2000, the Company made a strategic
investment of 5,031 GBP, representing a 12.6% interest, in Vencast.
Vencast provides solutions by using the Internet to facilitate the
process of raising capital and investing for the private equity industry.
As of June 30, 2001 and December 31, 2000, the Company carried its
investment at estimated fair value of $7,144 and $7,496, respectively,
which was unchanged from its original cost.
- The Nasdaq Stock Market, Inc. -- In April 2000, the Company made a
strategic investment of $15,475 in The Nasdaq Stock Market, Inc. As of
June 30, 2001 and December 31, 2000, the Company carried its investment
at estimated fair value, which was unchanged from its original cost.
- Tradeware S.A. ("Tradeware") -- In July 2000, April 2001 and June 2001,
the Company made strategic investments of 4,000 euros, 66,925 Belgian
francs and 1,500 euros, respectively, now representing a 47.9% interest,
in Tradeware. Tradeware is a European based provider of integrated order
routing solutions to broker-dealers in Europe. As of June 30, 2001 and
December 31, 2000, the Company carried its investment at $6,469 and
$3,723, respectively, as determined under the equity method.
- Knight Roundtable Europe Ltd. ("Roundtable") -- In March 2001, the
Company made a strategic investment of $1,000 in Roundtable. Roundtable
is a pan-European broker consortium designed to compete for order flow
from small investors in the region. As of June 30, 2001, the Company
carried its investment at estimated fair value, which was unchanged from
its original cost.
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- JapanCross Securities Co. Ltd. ("JapanCross") -- In February 2001 and May
2001, the Company made strategic investments of $1,722 and $815,
respectively, representing a 50% interest in JapanCross, a joint venture
which was established to provide a crossing service for Japanese equity
securities. As of June 30, 2001, the Company carried its investment at
$2,537 as determined under the equity method.
6. COLLATERAL ARRANGEMENTS ($ IN THOUSANDS)
Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities," a replacement of Financial Accounting Standards Board ("FASB")
Statement No. 125, the Company is required to disclose the collateral received
under securities borrowing, customer and non-customer agreements that it has the
ability to sell or repledge, and the amount of collateral that has been pledged
or resold. As of June 30, 2001 and December 31, 2000, the fair value of
collateral held by the Company that can be sold or repledged totaled $689,076
and 307,424, respectively. Such collateral is generally obtained under resale
and securities borrowing agreements. Of this collateral, approximately $434,526
and $236,000 has been sold or repledged generally to cover short sales or effect
deliveries of securities as of June 30, 2001 and December 31, 2000,
respectively. In addition, securities in customer accounts with a fair value of
approximately $15,198 and $104,810 could be sold or repledged by the Company as
of June 30, 2001 and December 31, 2000, respectively.
7. NET CAPITAL REQUIREMENTS ($ IN THOUSANDS)
As registered broker-dealers, the Company's U.S. broker-dealer subsidiaries
are subject to the SEC's Uniform Net Capital Rule, which requires the
maintenance of minimum net capital. As of June 30, 2001 and December 31, 2000,
the U.S. broker-dealer subsidiaries were in compliance with their respective
capital requirements and had net capital of $483,976 and $371,583, which was
$479,318 and $363,429 in excess of their required net capital of $4,658 and
$8,154, respectively.
As of June 30, 2001 and December 31, 2000, the Company segregated $113,049
and $70,000 in the special reserve bank account for the exclusive benefit of
customers in accordance with Federal regulations.
The Company's international broker-dealer subsidiaries are subject to
capital adequacy requirements promulgated by authorities of the countries in
which they operate. As of June 30, 2001 and December 31, 2000, these
subsidiaries had met their local capital adequacy requirements.
8. COMMITMENTS AND CONTINGENCIES ($ IN THOUSANDS)
In the normal course of conducting its securities business, the Company has
been involved in various legal proceedings. In the opinion of management, after
consultation with legal counsel, the ultimate outcome of pending litigation
matters will not have a material adverse effect on the financial condition or
results of operations of the Company.
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9. SEGMENT/GEOGRAPHIC DATA ($ IN THOUSANDS)
The Company's activities as a provider of agency brokerage services
constitute a single business segment pursuant to SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." The accompanying table
summarizes select data about the Company's domestic and international
operations. Because of the highly integrated nature of the financial markets in
which the Company competes and the integration of the Company's worldwide
business activities, the Company believes that results by geographic region are
not necessarily meaningful in understanding its business.
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------- --------------------
2001 2000 2001 2000
-------- ---------- -------- --------
Total revenues:
Domestic......................... $300,390 $269,176 $640,636 $510,894
International.................... 94,601 78,423 185,030 185,233
-------- -------- -------- --------
Total....................... $394,991 $347,599 $825,666 $696,127
======== ======== ======== ========
Income before income taxes:
Domestic......................... $ 51,487 $ 51,667 $129,591 $107,693
International.................... 21,244 14,430 32,619 34,275
-------- -------- -------- --------
Total....................... $ 72,731 $ 66,097 $162,210 $141,968
======== ======== ======== ========
JUNE 30, DECEMBER 31,
2001 2000
----------- ----------
Identifiable assets:
Domestic............................................. $2,092,634 $1,579,761
International........................................ 601,877 860,663
---------- ----------
Total........................................... $2,694,511 $2,440,424
========== ==========
10. COMPREHENSIVE INCOME ($ IN THOUSANDS)
Comprehensive income includes net income and changes in equity except those
resulting from investments by, or distributions to, stockholders. Comprehensive
income is as follows:
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- ---------------------
2001 2000 2001 2000
-------- -------- -------- --------
Net income........................................ $ 40,730 $ 37,014 $ 90,838 $ 79,502
Changes in other comprehensive income/(loss):
Foreign currency translation adjustment......... 128 6,374 228 9,676
-------- -------- -------- --------
Total comprehensive income, net of tax............ $ 40,858 $ 43,388 $ 91,066 $ 89,178
======== ======== ======== ========
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11. EARNINGS PER SHARE ($ AND SHARES IN THOUSANDS)
Basic earnings per share ("EPS") excludes dilution and is computed by
dividing net income by the weighted average number of common shares outstanding
for the period. Diluted EPS reflects the potential reduction in EPS that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock.
The Company has authorized the issuance of a maximum of 34,118 shares of
common stock under the Company's stock option plan. Options to purchase 22,629
shares of common stock at a weighted average exercise price of $16.20 per share
were outstanding as of June 30, 2001. However, options to purchase 14,025 shares
of common stock were not included in the computation of diluted EPS because the
options were anti-dilutive. The options expire on dates ranging from August 2006
to November 2007.
Earnings per share under the basic and diluted computations are as
follows:
Three Months Six Months
Ended June 30, Ended June 30,
-------------------- ---------------------
2001 2000 2001 2000
-------- -------- -------- --------
Net income....................................... $ 40,730 $ 37,014 $ 90,838 $ 79,502
Weighted average number of common shares
outstanding -- basic......................... 222,675 206,900 214,831 206,900
Common stock equivalent shares related to stock
incentive plans.............................. 447 -- 229 --
Weighted average number of common shares
outstanding -- diluted....................... 223,122 206,900 215,060 206,900
Basic earnings per share......................... $ 0.18 $ 0.18 $ 0.42 $ 0.38
Diluted earnings per share....................... $ 0.18 $ 0.18 $ 0.42 $ 0.38
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
We are the world's largest electronic agency securities broker and have
been providing investors with electronic trading solutions for more than 30
years. We operate an e-financial marketplace where buyers and sellers worldwide
can trade securities directly and anonymously with each other, and have the
opportunity to lower their overall trading costs. Through our electronic
platforms, customers also can access 40 securities markets throughout the world,
including Nasdaq, the NYSE and stock exchanges in Frankfurt, Hong Kong, London,
Paris, Sydney, Tokyo, Toronto and Zurich. We also provide customers with access
to research generated by us and by third parties, various informational and
decision-making tools and other brokerage services.
On May 23, 2001, we completed an initial public offering of 36.8 million
shares at an offering price of $14.50 per share. We received net proceeds of
approximately $488 million in the offering after deducting our offering
expenses.
On July 23, 2001, we signed a binding agreement to acquire ProTrader
Group, LP ("ProTrader"), a provider of advanced trading technologies and
electronic brokerage services, subject to regulatory approval. The acquisition
excludes ProTrader's proprietary trading business. The $150 million purchase
price will consist of $50 million in cash and $100 million in shares of Instinet
common stock. The transaction is expected to be completed in the third quarter
of 2001, and we do not anticipate that it will be material to our 2001 financial
results. The shares issued in this transaction will generally be subject to
lock-up agreements similar to those described under "Underwriting" in our
Prospectus and will be eligible for resale thereafter, subject to applicable
limitations under the Securities Act of 1933. We have granted registration
rights following the lock-up period with respect to these shares. Consistent
with our strategy of providing a range of different product and services to
serve the needs of a variety of institutional and professional investors, we
believe that this acquisition, if completed, would enhance our customer
interface and order routing technology.
Total U.S. market share volume in the three months ended June 30, 2001
declined to 208.6 billion shares from 222.4 billion in the three months ended
March 31, 2001. Nasdaq and NYSE share volumes were 122.7 billion and 18.8
billion shares, respectively, in the three months ended June 30, 2001, down from
132.7 billion and 20.1 billion shares in the three months ended March 31, 2001.
Our percentage of market share, however, increased to 10.3% of total U.S. market
share volume and 15.3% of Nasdaq share volume, and remained steady at 3.0% of
NYSE share volume, in the three months ended June 30, 2001. We have experienced,
and may continue to experience, significant seasonality in our business. As a
result of this and other factors described under "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Quarterly Results"
in the Prospectus, period-to-period comparisons of our revenues and operating
results are not necessarily meaningful, and the results for any quarter are not
necessarily indicative of results for any future period.
In the second quarter of 2001, we continued to incur expenses related to
the development of our fixed income securities platform. We did not, however,
incur any additional expenses or restructuring charges related to the
redeployment of our retail brokerage capability to our existing wholesale
business.
The following table shows the impact of our new business development
efforts and our soft dollar and commission recapture businesses on our total
expenses as a percentage of revenues. The required accounting for our soft
dollar and commission recapture businesses has a dilutive effect on our
operating margins. The portion of our transaction fee revenue representing soft
dollar revenues and commission recapture is offset dollar-for-dollar by expenses
we incur in paying for research from independent third parties and in making
payments representing commission recapture to pension plan and other plan
sponsors. Although we will continue to incur costs for new business initiatives,
we expect that they will decline as a percentage of revenues in the future. If
our soft dollar business continues to increase at a faster rate than our other
revenues, it will also continue to have an increasingly dilutive effect on our
operating margins.
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THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- -------------------
2001 2000 2001 2000
-------- ---------- -------- --------
(IN THOUSANDS, EXCEPT PERCENTAGES)
Total revenues............................. $394,991 $347,599 $825,666 $696,127
Soft dollar revenues and commission
recapture programs....................... 54,228 46,349 110,281 82,974
-------- ---------- -------- --------
Total revenues less soft dollar revenues
and commission recapture programs........ 340,763 301,250 715,385 613,153
-------- ---------- -------- --------
Total expenses............................. 322,260 281,502 663,456 554,159
Development expenses for fixed income and
retail businesses........................ 12,053 22,182 30,354 54,636
Soft dollar and commission recapture
expenses................................. 54,228 46,349 110,281 82,974
-------- ---------- -------- --------
Total expenses less development expenses
and soft dollar and commission recapture
expenses................................. 255,979 212,971 522,821 416,549
-------- ---------- -------- --------
Total expenses less development expenses
and soft dollar and commission recapture
expenses, as a percentage of total
revenue less soft dollar revenues and
commission recapture programs............ 75.1% 70.7% 73.1% 67.9%
======== ========== ======== ========
The growth in the number of our employees has been the principal
contributor to the increase in our compensation and benefits expense and
occupancy expense. This increase in compensation expense, coupled with increased
soft dollar and commission recapture expense, has resulted in reduced margins
for the six months ended June 30, 2001 from the comparable period in 2000,
despite the decrease in development expense discussed above.
In order to address the decline in our margins, we have undertaken a
review of spending initiatives with the aim of reducing our underlying operating
cost structure by approximately $70 million annually compared to our total
expenses in the first half of 2001. In order to achieve these cost reductions,
we plan to reduce our employee headcount worldwide by approximately 240 from
2,244 employees as of June 30, 2001 (excluding the effect of the ProTrader
acquisition), further cut back on the use of contractors and consultants,
consolidate some working groups and offices, and curtail discretionary spending
such as advertising and travel costs. We initiated these cost reduction measures
in July 2001 and expect to substantially complete the targeted headcount
reductions by the end of the third quarter of 2001. Based on current estimates,
we anticipate incurring the full cost of these reductions in the third quarter
of 2001 with a one-time charge of approximately $25 million.
12
13
KEY STATISTICAL INFORMATION
The following table presents key transaction volume information, as well as
certain other operating information.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -------------------
2001 2000 2001 2000
-------- ------- -------- --------
Total U.S. market share volume (millions)(1).............. 208,587 173,683 430,976 369,796
Our total U.S. market share volume (millions)(1).......... 21,389 15,922 44,131 30,739
Our percentage of total U.S. market share volume(1)....... 10.3% 9.2% 10.2% 8.3%
- -------------------------------------------------------------------------------------------------------
Nasdaq share volume (millions)(2)......................... 122,656 100,656 255,363 214,522
Our Nasdaq share volume (millions)(2)..................... 18,776 13,645 38,829 26,499
Our percentage of Nasdaq share volume(2).................. 15.3% 13.6% 15.2% 12.4%
- -------------------------------------------------------------------------------------------------------
NYSE share volume (millions).............................. 85,931 73,027 175,613 155,274
Our NYSE share volume (millions).......................... 2,613 2,277 5,302 4,240
Our percentage of NYSE share volume....................... 3.0% 3.1% 3.0% 2.7%
- -------------------------------------------------------------------------------------------------------
Our U.S. equity transaction volume (thousands)............ 27,208 19,594 54,695 37,695
Our international equity transaction volume (thousands)... 1,622 1,203 3,388 2,496
------- ------- ------- -------
Our total equity transaction volume (thousands)........... 28,830 20,797 58,083 40,190
- -------------------------------------------------------------------------------------------------------
Our average U.S. equity transaction size (shares per
transaction) ........................................... 786 813 807 815
Our average equity transactions per day (thousands)....... 457 330 464 319
- ---------------
(1) U.S. shares consist of shares of NYSE-listed and Nasdaq-quoted stocks.
(2) For a description of how we calculate our Nasdaq share volumes, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Nasdaq Volume Calculations" in the Prospectus.
13
14
RESULTS OF OPERATIONS
The following table sets forth our consolidated statements of income data
for the periods presented as a percentage of total revenues:
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
--------------- ---------------
2001 2000 2001 2000
----- ----- ----- -----
REVENUES:
Transaction fees............................... 96.2% 96.7% 96.3% 97.2%
Interest....................................... 2.9 2.9 3.0 2.6
Investments.................................... 0.9 0.4 0.7 0.2
----- ----- ----- -----
Total revenues............................ 100.0 100.0 100.0 100.0
EXPENSES:(1)
Compensation and benefits...................... 30.6 29.1 30.8 28.1
Communications and equipment................... 11.3 10.3 10.9 9.3
Soft dollar and commission recapture........... 13.7 13.3 13.4 11.9
Brokerage, clearing and exchange fees.......... 9.2 10.3 8.9 10.0
Depreciation and amortization.................. 5.2 5.2 4.8 5.2
Professional fees.............................. 2.3 6.0 3.0 6.7
Occupancy...................................... 3.7 2.6 3.1 2.7
Marketing and business development............. 2.2 2.2 2.3 3.0
Other.......................................... 3.4 2.0 3.2 2.7
----- ----- ----- -----
Total expenses............................ 81.6 81.0 80.4 79.6
----- ----- ----- -----
Income before income taxes..................... 18.4 19.0 19.6 20.4
Provision for income taxes..................... 8.1 8.4 8.6 9.0
----- ----- ----- -----
Net income................................ 10.3% 10.6% 11.0% 11.4%
===== ===== ===== =====
- ---------------
(1) The expenses in various categories in this table include costs incurred by
us in developing our fixed income securities business and a retail brokerage
capability. See "-- Overview."
THREE MONTHS ENDED JUNE 30, 2001 VERSUS THREE MONTHS ENDED JUNE 30, 2000
Overview
Net income increased 10.0% from $37.0 million for the three months ended
June 30, 2000 to $40.7 million for the comparable period in 2001. Our revenues
grew 13.6% from $347.6 million for the three months ended June 30, 2000 to
$395.0 million for the comparable period in 2001 primarily as a result of
increased U.S. trading volumes.
This revenue growth was offset by the 14.5% increase in expenses from
$281.5 million for the three months ended June 30, 2000 to $322.3 million for
the comparable period in 2001. This increase in expenses was primarily due to
additional staffing as a result of our growth particularly in the United States,
increased communications and equipment expenses primarily as a result of the
significant increase in transaction volumes, and increased expenses related to
our soft dollar and commission recapture businesses primarily due to increased
customer demand for our soft dollar services and increased overall market
transaction volumes.
Expenses increased despite an overall decrease in our business development
costs in connection with our efforts to expand and diversify our activities, as
well as a reduction in our professional fee expense. Our expenses related to the
development of our fixed income securities platform, which we launched in March
2000, increased slightly from $11.0 million for the three months ended June 30,
2000 to $12.1 for the comparable period in 2001. We incurred no expenses related
to the creation of a retail brokerage capability in the three months ended June
30, 2001, compared to expenses of $11.2 million in the three months ended June
30, 2000.
14
15
Revenues
Transaction fee revenue increased 13.0% from $336.1 million for the three
months ended June 30, 2000 to $379.7 million for the comparable period in 2001.
This increase was due to higher trading volumes both domestically and
internationally, reflecting growth in trading volumes in the global securities
markets. Transaction fee revenue earned from our international operations
increased from $76.6 million for the three months ended June 30, 2000 to $90.8
million for the comparable period in 2001. This amount represented 22.8% of our
transaction fee revenue for the three months ended June 30, 2000, and 23.9% for
the comparable period in 2001. This growth represents our continued expansion in
the international marketplace. Our soft dollar revenues and our revenues that
are subject to commission recapture, which are offset dollar-for-dollar by our
soft dollar research payments and commission recapture expenses, increased 17.0%
from $46.3 million for the three months ended June 30, 2000 to $54.2 million for
the comparable period in 2001, primarily due to increased customer demand for
our soft dollar services.
Our trading volumes in Nasdaq-quoted and NYSE-listed stocks increased 37.6%
and 14.7% for the three months ended June 30, 2001, respectively, compared to
the comparable period in 2000. Our share of volume in Nasdaq-quoted stocks
increased from 13.6% for the three months ended June 30, 2000 to 15.3% for the
comparable period in 2001, and our share of volume in NYSE-listed stocks
decreased slightly from 3.1% for the three months ended June 30, 2000 to 3.0%
for the comparable period in 2001. Our average number of transactions in
Nasdaq-quoted and NYSE-listed stocks per day increased 38.9% from 311,016 for
the three months ended June 30, 2000 to 431,866 for the comparable period in
2001.
Interest revenue increased 16.1% from $10.0 million for the three months
ended June 30, 2000 to $11.6 million for the comparable period in 2001. This
increase was primarily due to revenue generated by our clearing services.
Investment income increased 134.8% from $1.6 million for the three months
ended June 30, 2000 to $3.7 million for the comparable period in 2001. This
increase was primarily due to mark-to-market and related gains on our shares of
the London Stock Exchange and Hong Kong Stock Exchange.
Expenses
Compensation and benefits expense increased 19.5% from $101.1 million for
the three months ended June 30, 2000 to $120.7 million for the comparable period
in 2001. This increase was primarily due to the addition of new employees to
support our rapid growth, particularly in the United States, severance costs
related to certain employee departures, and an increase in incentive
compensation due to growth in our revenues. Our headcount increased from 2,007
employees as of June 30, 2000 to 2,244 employees as of June 30, 2001. Severance
costs and growth in our headcount contributed to the increase in our
compensation and benefits expense as a percentage of revenues from 29.1% for the
three months ended June 30, 2000 to 30.6% for the comparable period in 2001.
Communications and equipment expense increased 25.8% from $35.7 million for
the three months ended June 30, 2000 to $44.8 million for the comparable period
in 2001. This increase was due in large part to higher costs related to our core
communications, which increased 41.1% from $13.2 million for the three months
ended June 30, 2000 to $18.6 million for the comparable period in 2001. Of this
amount, $10.2 million related to network communications services that Radianz
began providing to us in June 2000. We outsourced these services and transferred
employees to Radianz at that time. In addition, our equipment and software costs
for upgrading our existing systems to increase capacity and for other
enhancements to and maintenance of those systems increased 30.5% from $11.1
million for the three months ended June 30, 2000 to $14.5 million in the
comparable period in 2001. Primarily as a result of increased cost for our core
communications, communications and equipment expense increased as a percentage
of our revenues from 10.3% for the three months ended June 30, 2000 to 11.4% for
the comparable period in 2001.
15
16
Soft dollar and commission recapture expense increased 17.0% from $46.3
million for the three months ended June 30, 2000 to $54.2 million for the
comparable period in 2001. This expense is offset dollar-for-dollar by soft
dollar revenues and revenues that are subject to commission recapture. This
increase was primarily due to increased customer demand for our soft dollar
services and increased overall market transaction volumes. As a result, this
expense increased as a percentage of our revenues from 13.3% for the three
months ended June 30, 2000 to 13.7% for the comparable period in 2001.
Brokerage, clearing and exchange fees increased 1.1% from $35.8 million for
the three months ended June 30, 2000 to $36.2 million for the comparable period
in 2001. This increase resulted primarily from higher domestic clearing fees due
to increased volumes. Our international clearing fees decreased primarily as a
result of lower rates charged by our clearing banks. In addition, we incurred
lower brokerage fees internationally as our acquisition of memberships in
additional securities exchanges enabled us to reduce our use of floor brokers.
As a percentage of our revenues, brokerage, clearing and exchange fees decreased
from 10.3% for the three months ended June 30, 2000 to 9.2% for the comparable
period in 2001.
Depreciation and amortization expense increased 13.9% from $18.0 million
for the three months ended June 30, 2000 to $20.5 million for the comparable
period in 2001. This increase was primarily due to an increase in depreciation
as a result of our additional purchases of fixed assets and amortization of
leasehold improvements in connection with our move to our new corporate
headquarters in New York. As a percentage of our revenues, depreciation and
amortization expense was 5.2% for the three months ended June 30, 2000 and 2001.
Professional fees decreased 55.5% from $20.8 million for the three months
ended June 30, 2000 to $9.3 million for the comparable period in 2001. This
decrease was primarily due to reduced use of technical and management
consultants, as well as reduced legal expenses. These fees were higher in the
three months ended June 30, 2000 as we were preparing for our reorganization and
initial public offering. A total of $6.0 million of the decrease in professional
fees was attributable to reduced use of consultants for the creation of a retail
brokerage capability and for our fixed income business. As a result,
professional fees decreased as a percentage of our revenues, from 6.0% for the
three months ended June 30, 2000 to 2.3% for the comparable period in 2001.
Occupancy expense increased 58.5% from $9.1 million for the three months
ended June 30, 2000 to $14.5 million for the comparable period in 2001. This
increase was primarily due to higher lease payments and related expenses for our
new corporate headquarters in New York.
Marketing and business development increased 10.9% from $7.7 million for
the three months ended June 30, 2000 to $8.6 million for the comparable period
in 2000. This increase was due primarily to increased marketing costs related to
our overall business.
Other expenses increased 94.5% from $6.9 million for the three months ended
June 30, 2000 to $13.4 million for the comparable period in 2001. This increase
was primarily related to increased travel costs, allowance for doubtful
accounts, and interest costs associated with our clearing business.
Provision for Income Taxes
Our tax provision increased 10.0% from $29.1 million for the three months
ended June 30, 2000 to $32.0 million for the comparable period in 2001 as a
result of our increased income before income taxes. Our effective income tax
rate remained unchanged at 44.0% for the same periods.
16
17
Six Months Ended June 30, 2001 Versus Six Months Ended June 30, 2000
Financial Overview
Overview
Net income increased 14.3% from $79.5 million for the six months ended June
30, 2000 to $90.8 million for the comparable period in 2001. Our revenues grew
18.6% from $696.1 million for the six months ended June 30, 2000 to $825.7
million for the comparable period in 2001 primarily as a result of increased
U.S. trading volumes. This growth offset the 2.5% decline in transaction fee
revenue earned from our international operations primarily as a result of
declines in share prices in non-U.S. securities markets despite our increased
volumes in those markets. Our revenues from trading outside the United States
are determined on the basis of the value of transactions (rather than the number
of shares traded).
This revenue growth was offset by the 19.7% increase in expenses from
$554.2 million for the six months ended June 30, 2000 to $663.5 million for the
comparable period in 2001. This increase in expenses was primarily due to
additional staffing as a result of our growth particularly in the United States,
increased expenses related to our soft dollar and commission recapture
businesses primarily as a result of our acquisition of Lynch, Jones & Ryan in
February 2000, and increased communications and equipment expenses primarily as
a result of the significant increase in transaction volumes.
Expenses increased despite an overall decrease in our business development
costs in connection with our efforts to expand and diversify our activities, as
well as a reduction in our professional fees and marketing and business
development expenses. Our expenses related to the development of our fixed
income securities platform, which we launched in March 2000, decreased from
$31.0 million for the six months ended June 30, 2000 to $25.6 for the comparable
period in 2001. Our expenses related to the creation of a retail brokerage
capability decreased from $23.7 million for the six months ended June 30, 2000
to $4.7 million for the comparable period in 2001. Included in the 2001 amount
is a restructuring charge of $4.0 million. All charges related to our change in
strategy related to our retail brokerage capability were incurred as of March
31, 2001.
Revenues
Transaction fee revenue increased 17.5% from $676.9 million for the six
months ended June 30, 2000 to $795.2 million for the comparable period in 2001.
This increase was due to higher trading volumes both domestically and
internationally, reflecting growth in trading volumes in the global securities
markets. Offsetting this growth, however, was a 2.5% decline in transaction fee
revenue earned from our international operations from $181.8 million for the six
months ended June 30, 2000 to $177.3 million for the comparable period in 2001.
This amount represented 26.9% of our transaction fee revenue for the six months
ended June 30, 2000, and 22.3% for the comparable period in 2001. As previously
noted, this decrease was primarily due to declines in share prices in non-U.S.
securities markets despite our increased transaction volumes in those markets.
Our revenues from trading outside the United States are determined on the basis
of the value of transactions (rather than the number of shares traded). Our soft
dollar revenues and our revenues that are subject to commission recapture, which
are offset dollar-for-dollar by our soft dollar research payments and commission
recapture expenses, increased 32.9% from $83.0 million for the six months ended
June 30, 2000 to $110.3 million for the comparable period in 2001 primarily
because our results in 2001 reflect a full six months of results of Lynch, Jones
& Ryan, which we acquired in February 2000. This growth was also a result of
increased customer demand for our soft dollar services.
Our trading volumes in Nasdaq-quoted and NYSE-listed stocks increased 46.5%
and 25.0%, respectively, for the six months ended June 30, 2001, compared to the
comparable period in 2000. Our share of volume in Nasdaq-quoted stocks increased
from 12.4% for the six months ended June 30, 2000 to 15.2% for the comparable
period in 2001, and our share of volume in NYSE-listed stocks increased from
2.7% for the six months ended June 30, 2000 to 3.0% for the comparable period in
2001. Our average number of transactions in Nasdaq-quoted and NYSE-listed stocks
per day increased 46.3% from 299,163 for the six months ended June 30, 2000 to
437,562 for the comparable period in 2001.
17
18
Interest revenue increased 34.1% from $18.2 million for the six months
ended June 30, 2000 to $24.4 million for the comparable period in 2001. This
increase was primarily due to revenue generated by our clearing services.
Investment income increased from $1.1 million for the six months ended June
30, 2000 to $6.1 million for the comparable period in 2001. This increase was
primarily due to mark-to-market gains on our shares of the London Stock Exchange
and Hong Kong Stock Exchange.
Expenses
Compensation and benefits expense increased 30.3% from $195.4 million for
the six months ended June 30, 2000 to $254.5 million in 2001. This increase was
primarily due to the addition of new employees to support our rapid growth,
particularly in the United States, severance costs related to certain employee
departures and increased incentive
compensation due to the growth in our revenues. Our headcount increased from
2,007 employees as of June 30, 2000 to 2,244 employees as of June 30, 2001.
Severance costs and the growth in our headcount contributed to the increase in
our compensation and benefits expense as a percentage of revenues from 28.1% for
the six months ended June 30, 2000 to 30.8% for the comparable period in 2001.
Communications and equipment expense increased 39.8% from $64.6 million for
the six months ended June 30, 2000 to $90.2 million for the comparable period in
2001. This increase was due in large part to higher costs related to our core
communications, which increased 55.4% from $26.0 million for the six months
ended June 30, 2000 to $40.4 million for the comparable period in 2001. Of this
amount, $19.5 million related to network communications services that Radianz
began providing to us in June 2000. We outsourced these services and transferred
employees to Radianz at that time. In addition, our equipment and software costs
for upgrading our existing systems to increase capacity and for other
enhancements to and maintenance of those systems increased 19.7% from $19.4
million for the six months ended June 30, 2000 to $23.3 million in the
comparable period in 2001. Primarily due to increased core communication costs,
communications and equipment expense increased as a percentage of our revenues
from 9.3% for the six months ended June 30,2000 to 10.9% for the comparable
period in 2001.
Soft dollar and commission recapture expense increased 32.9% from $83.0
million for the six months ended June 30, 2000 to $110.3 million for the
comparable period in 2001. This expense is offset dollar-for-dollar by soft
dollar revenues and revenues that are subject to commission recapture. This
increase was primarily due to the acquisition of Lynch, Jones & Ryan in February
2000, as well as a increase in the overall use of our soft dollar services by
our customers and increased market transaction volumes. Primarily as a result of
our purchase of Lynch, Jones & Ryan, this expense increased as a percentage of
our revenues from 11.9% for the six months ended March 31, 2000 to 13.4% for the
comparable period in 2001.
Brokerage, clearing and exchange fees increased 4.6% from $69.7 million for
the six months ended June 30, 2000 to $73.0 million for the comparable period in
2001. This increase resulted primarily from higher domestic clearing fees due in
large part to our acquisition of Lynch, Jones & Ryan, as well as increased
volumes. Our international clearing fees decreased primarily as a result of
lower rates charged by our clearing banks. In addition, we incurred lower
brokerage fees internationally as our memberships in additional securities
exchanges enabled us to reduce our use of floor brokers. As a percentage of our
revenues, brokerage, clearing and exchange fees decreased from 10.0% for the six
months ended June 30, 2000 to 8.8% for the comparable period in 2001.
Depreciation and amortization expense increased 10.0% from $36.4 million
for the six months ended June 30, 2000 to $40.0 million for the comparable
period in 2001. This increase was primarily due to an increase in depreciation
as a result of our additional purchases of fixed assets and amortization of
leasehold improvements, as a result of our move to our new corporate
headquarters in New York.
18
19
As a percentage of our revenues, depreciation and amortization expense decreased
from 5.2% for the six months ended June 30, 2000 to 4.8% for the comparable
period in 2001.
Professional fees decreased 46.3% from $46.5 million for the six months
ended June 30, 2000 to $25.0 million for the comparable period in 2001. This
decrease was primarily due to reduced use of technical and management
consultants, as well as reduced legal expenses. These fees were higher in the
six months ended June 30, 2000 as we were preparing for our reorganization and
initial public offering. A total of $12.4 million of the decrease in
professional fees was attributable to reduced use of consultants for the
creation of a retail brokerage capability and for our fixed income business.
Professional fees decreased as a percentage of our revenues, from 6.7% for the
six months ended June 30, 2000 to 3.0% for the comparable period in 2001.
Occupancy expense increased 33.0% from $19.1 million for the six months
ended June 30, 2000 to $25.4 million for the comparable period in 2001. This
increase was primarily due to higher lease payments and related expenses for our
new corporate headquarters in New York.
Marketing and business development expense decreased 8.7% from $20.5
million for the six months ended June 30, 2000 to $18.8 million for the
comparable period in 2001. This decrease was due primarily to a decreased level
of advertising as a result of the change in strategy related to our retail
brokerage capability.
Other expenses increased 38.6% from $19.1 million for the six months ended
June 30, 2000 to $26.4 million for the comparable period in 2001. This increase
was primarily related to increased travel costs and interest expense associated
with our subordinated borrowings from Reuters for our purchase of Lynch, Jones &
Ryan. These borrowings were repaid in June 2001.
Provision for Income Taxes
Our tax provision increased 14.3% from $62.5 million for the six months
ended June 30, 2000 to $71.4 million for the comparable period in 2001 as a
result of our increased income before income taxes. Our effective income tax
rate remained unchanged at 44.0% for both periods.
Liquidity and Capital Resources
Cash and cash equivalents, together with assets readily convertible into
cash, accounted for 72.9% and 73.5% of our assets as of December 31, 2000 and
June 30, 2001, respectively. Cash and cash equivalents increased from $415.2
million as of December 31, 2000 to $634.0 million as of June 30, 2001. This
increase was primarily due to the $488.1 million of net proceeds we received
from our initial public offering in May 2001, as well as a decrease in our
securities owned. This increase was offset in part by our return of capital
payment to Reuters and negative cash flows from operating activities. The
decline in our cash flows from operating activities resulted primarily from an
increase in securities borrowed related to our growing clearing business and
reduced payables to broker-dealers and customers. These factors more than offset
the positive cash impact of securities loaned in our clearing business and
reduced receivables from broker-dealers and customers. Receivables from and
payables to broker-dealers and customers declined primarily as a result of a
lower amount of securities transactions that had not yet settled as of June 30,
2001.
Our initial public offering also caused an increase in our total assets and
stockholders' equity between December 31, 2000 and June 30, 2001. Higher
balances of securities borrowed and loaned related to our growing clearing
business also contributed to this increase. Offsetting these factors were the
decreases in our receivables to and payables from broker-dealers and customers.
These changes led to our negative cash flow from operating activities in the
first six months of 2001. Changes in our total assets and liabilities generally
lead to large fluctuations in our cash flows from operating activities from
period to period and within periods.
19
20
Capital expenditures in the six months ended June 30, 2001 related to the
purchase of data processing and communications equipment, leasehold improvements
and purchases of furniture for our new office facilities to support our growth.
Capital expenditures and investments in new technology were financed primarily
through income from operations. Capital expenditures related to the move to our
new corporate headquarters are expected to be approximately $67.0 million in
2001, of which approximately $56.0 million was made in the six months ended June
30, 2001. Our aggregate minimum lease commitment is approximately $12.0 million
for the remainder of 2001. We anticipate that we will meet our 2001 capital
expenditure needs out of operating cash flows.
Cash provided by financing activities totaled $50.2 million and $287.9
million in the six months ended June 30, 2000 and 2001, respectively. Reuters
loaned us $49.0 million to fund our acquisition of Lynch, Jones & Ryan in
February 2000. This loan bore interest at an annual rate based on six-month
LIBOR plus 1.25% and was repaid in June 2001. In May 2001, we also made a return
of capital of $150.0 million to Reuters. We funded that return of capital
through an intercompany advance from Reuters. We repaid that advance in May 2001
out of the net proceeds we received from our initial public offering.
As of June 30, 2001, we had access to $250 million of uncommitted credit
lines from commercial banking institutions to meet the funding needs of our U.S.
operations and had no borrowings outstanding under these lines. In addition, as
of June 30, 2001, we had access to $819.6 million of uncommitted credit lines
from commercial banking institutions to meet the funding needs of our European
and Asian subsidiaries, with $122.5 million outstanding under these lines.
As of June 30, 2001, our U.S. registered broker-dealer subsidiaries had net
capital on a consolidated basis of $484.0 million, which was $479.3 million in
excess of their required consolidated net capital of $4.7 million. Included in
these amounts are balances related to our clearing subsidiary, which is the
counterparty to each of our customer transactions and which had net capital of
$272.1 million, which was $268.2 million in excess of its required net capital
of $3.9 million.
In connection with our correspondent clearing business, we are required to
maintain segregated funds in a special reserve bank account for the exclusive
benefit of our customers. As of June 30, 2001, these funds amounted to $113.0
million.
We currently anticipate that the net proceeds from our initial public
offering, together with our cash resources and credit facilities, will be
sufficient to meet our anticipated working capital, capital expenditures and
regulatory capital requirements as well as other anticipated requirements for at
least the next twelve months. To the extent that we further develop our
correspondent clearing operations or provide financing of retail customers'
account balances, whether through our wholesale business or otherwise, we may
need to obtain additional financing.
Recently Issued Accounting Standards
SFAS No. 141, "Business Combinations," was issued in June 2001 and is
effective for all business combinations initiated after June 30, 2001, as well
as all business combinations accounted for using the purchase method for which
the date of acquisition is July 1, 2001 or later. SFAS No. 141 requires that all
business combinations be accounted for under the purchase method of accounting.
Use of the pooling-of-interests method is no longer permitted. At this time, we
do not believe that adoption of this statement will have a material impact on
our financial condition and results of operations.
SFAS No. 142, "Goodwill and Other Intangible Assets," was issued in June
2001 and is effective for fiscal years beginning after December 15, 2001. SFAS
No. 142 requires that goodwill no longer be amortized to earnings, but instead
be reviewed for impairment. The amortization of goodwill ceases upon adoption of
the statement. At this time, management is reviewing the potential impact of
this statement on our financial condition and results of operations.
20
21
Item 3. Quantitative and Qualitative Disclosures About Market Risk
For a more detailed discussion of our exposure to market risk, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Quantitative and Qualitative Disclosures About Market Risk" in the
Prospectus.
Interest Rate Risk
The aggregate fair market value of our short-term investment portfolio,
classified as securities owned on our statements of financial condition, was
$178.3 million and $80.4 million as of December 31, 2000 and June 30, 2001,
respectively. These securities are subject to interest rate risk and will
decrease in value if interest rates increase. If interest rates had increased
immediately and uniformly by 100 basis points as of December 31, 2000 and June
30, 2001, the fair value of the portfolio would decline by $2.3 million and
$891,000, respectively. We generally hold these securities until maturity and
therefore would not expect our operating results or cash flows to be affected to
any significant degree by a sudden change in interest rates.
In addition, our short-term interest earning assets (mainly cash and money
market instruments) totaled $415.2 million and $634.0 million as of December 31,
2000 and June 30, 2001, respectively. We also had short-term borrowings of
$117.1 million and $130.7 million as of December 31, 2000 and June 30, 2001,
respectively, on which we are generally charged rates that approximate the U.S.
Federal Funds rate or the local equivalent rate. As a result, we do not
anticipate that changes in interest rates will have a material impact on our
financial condition, revenues or cash flows.
Exchange Rate Risk
Approximately $17.8 million and $29.9 million of our securities owned were
denominated in foreign currencies as of December 31, 2000 and June 30, 2001,
respectively. Of this amount, $4.8 million and $4.7 million were denominated in
euros as of December 31, 2000 and June 30, 2001, respectively; $5.1 million and
$5.0 million were denominated in Canadian dollars as of December 31, 2000 and
June 30, 2001, respectively; $6.8 million and $10.4 million were denominated in
British pounds as of December 31, 2000 and June 30, 2001, respectively; $8.3
million was denominated in Japanese yen as of June 30, 2001; and $1.0 million
was denominated in the Hong Kong dollar as of June 30, 2001. Our resulting
exposure to exchange rate risk is estimated as the potential loss in fair value
resulting from a hypothetical 10% adverse change in foreign exchange rates due
to functional versus reporting currency exposure and was $1.6 million and $2.7
million as of December 31, 2000 and June 30, 2001, respectively.
Approximately 23.7% of our revenues and 25.3% of our expenses as of
December 31, 2000, and 22.4% of our revenues and 23.0% of our expenses as of
June 30, 2001 were denominated in non-U.S. dollar currencies. Our profits are
therefore exposed to foreign currency risk -- not of a loss of funds but rather
of a loss for financial reporting purposes. We estimate this risk as the
potential loss in revenue resulting from a hypothetical 10% adverse change in
foreign exchange rates on the mix in our profits between our functional currency
and the respective reporting currencies of our subsidiaries. On this basis, the
estimated risk was approximately $3.4 million for 2000, and $3.1 million for the
six months ended June 30, 2001.
Equity Price Risk
As an agency broker, we do not trade securities for our own account or
maintain inventories of securities for sale. However, included in securities
owned on our statements of financial condition are marketable securities of the
London and Hong Kong stock exchanges as a result of their demutualizations,
which exposes us to market price risk. This risk is estimated as the potential
loss in fair value resulting from a hypothetical 10% adverse change in quoted
market prices and
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amounted to approximately $680,000 and $1.1 million as of December 31, 2000 and
June 30, 2001, respectively.
CREDIT RISK ON UNSETTLED TRADES
In the six months ended June 30, 2001, our loss from transactions in which
a party refused or was unable to settle and other credit losses have been
immaterial.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
For a discussion of our legal and administrative proceedings, see
"Business-Legal and Administrative Proceedings" in the Prospectus. There have
been no material developments with respect to legal and administrative
proceedings.
Item 2. Changes in Securities and Use of Proceeds
The effective date of the Company's first registration statement, filed on
Form S-1 under the Securities Act of 1933 (File Nos. 333-55190 and 333-61186)
relating to the Company's initial public offering of its Common Stock, par value
$0.01, and the related Preferred Stock Purchase Rights, was May 17, 2001. The
effective date of Post-Effective Amendment No. 1, filed solely to add an exhibit
pursuant to Rule 462(d) under the Securities Act of 1933, was May 22, 2001. The
maximum aggregate offering price of the Common Stock registered was $533.6
million. A total of 36,800,000 shares of the Company's Common Stock (including
4,800,000 shares resulting from the underwriters' exercise of their
over-allotment option), together with the related Preferred Stock Purchase
Rights, were sold. The managing underwriters for the offering were Credit Suisse
First Boston Corporation; Deutsche Banc Alex. Brown Inc.; Bear, Stearns & Co.
Inc.; J.P. Morgan Securities Inc.; Merrill Lynch, Pierce, Fenner & Smith
Incorporated; Salomon Smith Barney Inc. and WR Hambrecht + Co.
The offering commenced on May 17, 2001 and was completed on May 23, 2001.
The aggregate offering price of the 36,800,000 shares of Common Stock sold
(together with the related Preferred Stock Purchase Rights and including the
underwriters' over-allotment shares) was $533.6 million. Net proceeds to the
Company were $488.1 million, after deduction of the underwriting discounts and
commissions of $33.5 million and other offering expenses of approximately $12.0
million.
From the proceeds of the offering, we used $150.0 million of the net
proceeds to repay our indebtedness to Reuters for an advance to us in May 2001.
We used this advance to fund a simultaneous return of capital to Reuters. We
intend to use $50 million of the proceeds for our acquisition of ProTrader and
the remaining proceeds for working capital and general corporate purposes.
Pending use, we have invested the remaining proceeds in short-term,
interest-bearing, money market investments.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
In the second quarter of 2001, John C. Bogle, John Kasich and Kay Koplovitz
were appointed to the Instinet Board of Directors as independent directors. With
these three appointments, the size of the Instinet Board increased to ten
members.
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Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed or incorporated by reference as part
of this quarterly report on Form 10-Q:
Exhibit
Number Description
--------- ------------------------------------------------------------
2.1 Contribution Agreement between Instinet Corporation and
Instinet Group LLC, dated July 25, 2000 (incorporated herein
by reference to Exhibit 2.1 to the Company's registration
statement on Form S-1 (No. 333-55190)).
2.2 Asset Contribution Agreement between Instinet Corporation
and Instinet Group LLC, dated July 31, 2000 (incorporated
herein by reference to Exhibit 2.2 to the Company's
registration statement on Form S-1 (No. 333-55190)).
2.3 Subscription Agreement between Reuters Holdings Switzerland
SA and Instinet Group LLC, dated July 31, 2000 (incorporated
herein by reference to Exhibit 2.3 to the Company's
registration statement on Form S-1 (No. 333-55190)).
2.4 Contribution Agreement between Reuters C Corporation and
Instinet Group LLC, dated September 29, 2000 (incorporated
herein by reference to Exhibit 2.4 to the Company's
registration statement on Form S-1 (No. 333-55190)).
2.5 Contribution Agreement between Reuters Holdings Switzerland
SA and Instinet Group LLC, dated September 29, 2000
(incorporated herein by reference to Exhibit 2.5 to the
Company's registration statement on Form S-1 (No.
333-55190)).
2.6 Contribution Agreement between Reuters Holdings Switzerland
SA and Instinet Group LLC, dated September 29, 2000
(incorporated herein by reference to Exhibit 2.6 to the
Company's registration statement on Form S-1 (No.
333-55190)).
3.1 Certificate of Incorporation of Instinet Group Incorporated,
dated May 9, 2001 (incorporated herein by reference to
Exhibit 4.2 to the Company's registration statement on Form
S-1 (No. 333-55190)).
3.2* Bylaws of Instinet Group Incorporated.
4.1 Form of Common Stock Certificate (incorporated herein by
reference to Exhibit 4.1 to the Company's registration
statement on Form S-1 (No. 333-55190)).
4.2* Corporate Agreement between Instinet Group Incorporated and
Reuters Limited, dated May 17, 2001.
4.3* Rights Agreement between Instinet Group Incorporated and
Mellon Investor Services LLC, dated May 15, 2001.
10.1 Instinet Group Annual Bonus Plan (incorporated herein by
reference to Exhibit 10.5 to the Company's registration
statement on Form S-1 (No. 333-55190)).
10.2 Instinet Earnings Participation Unit Plan effective January
1, 1993; form of 1998 Performance Award; Instinet 1999
Equity Super Plan Summary and Amendment; 1999 Super (EPU)
Plan for Fixed Income Group (incorporated herein by
reference to Exhibit 10.6 to the Company's registration
statement on Form S-1 (No. 333-55190)).
10.3 Instinet 2000 Stock Option Plan (incorporated herein by
reference to Exhibit 10.7 to the Company's registration
statement on Form S-1 (No. 333-55190)).
10.4 Employment Agreement between Instinet Group LLC and Douglas
M. Atkin, dated April 2, 2001 (incorporated herein by
reference to Exhibit 10.1 to the Company's registration
statement on Form S-1 (No. 333-55190)).
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24
10.5 Employment Agreement between Instinet Group LLC and Mark
Nienstedt, dated April 2, 2001 (incorporated herein by
reference to Exhibit 10.2 to the Company's registration
statement on Form S-1 (No. 333-55190)).
10.6 Employment Agreement between Instinet Group LLC and Kenneth
K. Marshall, dated April 2, 2001 (incorporated herein by
reference to Exhibit 10.3 to the Company's registration
statement on Form S-1 (No. 333-55190)).
10.7 Employment Agreement between Instinet Group LLC and Peter
Fenichel, dated April 2, 2001 (incorporated herein by
reference to Exhibit 10.4 to the Company's registration
statement on Form S-1 (No. 333-55190)).
10.8 Employment Agreement between Instinet Group LLC and
Andre-Francois Helier Villeneuve, dated April 30, 2001
(incorporated herein by reference to Exhibit 10.27 to the
Company's registration statement on Form S-1 (No.
333-55190)).
10.9 Fixed Income Data Agreement between Reuters Limited and
Instinet Corporation, dated October 1, 1999 (incorporated
herein by reference to Exhibit 10.8 to the Company's
registration statement on Form S-1 (No. 333-55190)).
10.10 Letter agreement between Reuters Limited and Instinet
Corporation, dated August 1, 2000, amending the Fixed Income
Data Agreement (incorporated herein by reference to Exhibit
10.10 to the Company's registration statement on Form S-1
(No. 333-55190)).
10.11 Global Reuters Services Contract between Reuters Limited and
Instinet Global Holdings, Inc., dated December 21, 2000
(incorporated herein by reference to Exhibit 10.9 to the
Company's registration statement on Form S-1 (No.
333-55190)).
10.12 Redistribution Addendum to Reuters Global Agreement between
Reuters Limited and Instinet Global Holding, Inc., dated
December 21, 2000, amending the Global Reuters Services
Contract (incorporated herein by reference to Exhibit 10.11
to the Company's registration statement on Form S-1 (No.
333-55190)).
10.13* Data Distribution Agreement between Instinet Global
Holdings, Inc. and Reuters America, Inc., dated May 17,
2001.
10.14* License Agreement between Instinet Global Services Limited
and Reuters Limited, dated May 17, 2001.
10.15* U.S. Tax Sharing Agreement by and among Reuters America
Holdings, Inc., Instinet Group Incorporated and Instinet
Global Holdings, Inc., dated May 17, 2001.
10.16* U.K. Tax Sharing Agreement between Reuters Group PLC,
Instinet Group Incorporated and Instinet Holdings Limited,
dated May 16, 2001.
10.17* Sublease between Reuters C Corp. and Instinet Global
Holdings, Inc., dated May 16, 2001.
10.18* Corporate Services Agreement between Reuters Limited and
Instinet Group Incorporated, dated May 16, 2001.
99.1* Information incorporated by reference into Form 10-Q (Risk
Factors from the Prospectus).
* Filed electronically herewith.
(b) The following reports on Form 8-K were filed for the last quarter
covered by this report, and subsequently through August 10, 2001:
Date of Report Item Number Financial Statements Required to be Filed
- --------------- ------------------ -----------------------------------------
July 24, 2001 Items 5 & 7 No
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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.
Dated: August 10, 2001
INSTINET GROUP INCORPORATED
By: /s/ MARK NIENSTEDT
---------------------------
Name: Mark Nienstedt
Title: Executive Vice President, Chief Financial Officer and Director
(Duly Authorized Officer and Principal Financial and Accounting Officer)
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EXHIBIT INDEX
Exhibit
Number Description
- --------- -----------------------------------------------------------------
2.1 Contribution Agreement between Instinet Corporation and Instinet
Group LLC, dated July 25, 2000 (incorporated herein by reference
to Exhibit 2.1 to the Company's registration statement on Form
S-1 (No. 333-55190)).
2.2 Asset Contribution Agreement between Instinet Corporation and
Instinet Group LLC, dated July 31, 2000 (incorporated herein by
reference to Exhibit 2.2 to the Company's registration statement
on Form S-1 (No. 333-55190)).
2.3 Subscription Agreement between Reuters Holdings Switzerland SA
and Instinet Group LLC, dated July 31, 2000 (incorporated herein
by reference to Exhibit 2.3 to the Company's registration
statement on Form S-1 (No. 333-55190)).
2.4 Contribution Agreement between Reuters C Corporation and Instinet
Group LLC, dated September 29, 2000 (incorporated herein by
reference to Exhibit 2.4 to the Company's registration statement
on Form S-1 (No. 333-55190)).
2.5 Contribution Agreement between Reuters Holdings Switzerland SA
and Instinet Group LLC, dated September 29, 2000 (incorporated
herein by reference to Exhibit 2.5 to the Company's registration
statement on Form S-1 (No. 333-55190)).
2.6 Contribution Agreement between Reuters Holdings Switzerland SA
and Instinet Group LLC, dated September 29, 2000 (incorporated
herein by reference to Exhibit 2.6 to the Company's registration
statement on Form S-1 (No. 333-55190)).
3.1 Certificate of Incorporation of Instinet Group Incorporated,
dated May 9, 2001 (incorporated herein by reference to Exhibit
4.2 to the Company's registration statement on Form S-1 (No.
333-55190)).
3.2* Bylaws of Instinet Group Incorporated.
4.1 Form of Common Stock Certificate (incorporated herein by
reference to Exhibit 4.1 to the Company's registration statement
on Form S-1 (No. 333-55190)).
4.2* Corporate Agreement between Instinet Group Incorporated and
Reuters Limited, dated May 17, 2001.
4.3* Rights Agreement between Instinet Group Incorporated and Mellon
Investor Services LLC, dated May 15, 2001.
10.1 Instinet Group Annual Bonus Plan (incorporated herein by
reference to Exhibit 10.5 to the Company's registration statement
on Form S-1 (No. 333-55190)).
10.2 Instinet Earnings Participation Unit Plan effective January 1,
1993; form of 1998 Performance Award; Instinet 1999 Equity Super
Plan Summary and Amendment; 1999 Super (EPU) Plan for Fixed
Income Group (incorporated herein by reference to Exhibit 10.6 to
the Company's registration statement on Form S-1 (No.
333-55190)).
10.3 Instinet 2000 Stock Option Plan (incorporated herein by reference
to Exhibit 10.7 to the Company's registration statement on Form
S-1 (No. 333-55190)).
10.4 Employment Agreement between Instinet Group LLC and Douglas M.
Atkin, dated April 2, 2001 (incorporated herein by reference to
Exhibit 10.1 to the Company's registration statement on Form S-1
(No. 333-55190)).
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10.5 Employment Agreement between Instinet Group LLC and Mark
Nienstedt, dated April 2, 2001 (incorporated herein by reference
to Exhibit 10.2 to the Company's registration statement on Form
S-1 (No. 333-55190)).
10.6 Employment Agreement between Instinet Group LLC and Kenneth K.
Marshall, dated April 2, 2001 (incorporated herein by reference
to Exhibit 10.3 to the Company's registration statement on Form
S-1 (No. 333-55190)).
10.7 Employment Agreement between Instinet Group LLC and Peter
Fenichel, dated April 2, 2001 (incorporated herein by reference
to Exhibit 10.4 to the Company's registration statement on Form
S-1 (No. 333-55190)).
10.8 Employment Agreement between Instinet Group LLC and
Andre-Francois Helier Villeneuve, dated April 30, 2001
(incorporated herein by reference to Exhibit 10.27 to the
Company's registration statement on Form S-1 (No. 333-55190)).
10.9 Fixed Income Data Agreement between Reuters Limited and Instinet
Corporation, dated October 1, 1999 (incorporated herein by
reference to Exhibit 10.8 to the Company's registration statement
on Form S-1 (No. 333-55190)).
10.10 Letter agreement between Reuters Limited and Instinet
Corporation, dated August 1, 2000, amending the Fixed Income Data
Agreement (incorporated herein by reference to Exhibit 10.10 to
the Company's registration statement on Form S-1 (No.
333-55190)).
10.11 Global Reuters Services Contract between Reuters Limited and
Instinet Global Holdings, Inc., dated December 21, 2000
(incorporated herein by reference to Exhibit 10.9 to the
Company's registration statement on Form S-1 (No. 333-55190)).
10.12 Redistribution Addendum to Reuters Global Agreement between
Reuters Limited and Instinet Global Holding, Inc., dated December
21, 2000, amending the Global Reuters Services Contract
(incorporated herein by reference to Exhibit 10.11 to the
Company's registration statement on Form S-1 (No. 333-55190)).
10.13* Data Distribution Agreement between Instinet Global Holdings,
Inc. and Reuters America, Inc., dated May 17, 2001.
10.14* License Agreement between Instinet Global Services Limited and
Reuters Limited, dated May 17, 2001.
10.15* U.S. Tax Sharing Agreement by and among Reuters America Holdings,
Inc., Instinet Group Incorporated and Instinet Global Holdings,
Inc., dated May 17, 2001.
10.16* U.K. Tax Sharing Agreement between Reuters Group PLC, Instinet
Group Incorporated and Instinet Holdings Limited, dated May 16,
2001.
10.17* Sublease between Reuters C Corp. and Instinet Global Holdings,
Inc., dated May 16, 2001.
10.18* Corporate Services Agreement between Reuters Limited and Instinet
Group Incorporated, dated May 16, 2001.
99.1* Information incorporated by reference into Form 10-Q (Risk
Factors from the Prospectus).
* Filed electronically herewith.
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