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 Commission file number: 0 - 23644
March 26, 1999
INVESTMENT TECHNOLOGY GROUP, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 95 - 2848406
- ------------------------------------- ---------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or 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 May 10, 1999, the Registrant had 30,874,196 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:
March 26, 1999 (unaudited) and December 31, 1998 ....... 4
Consolidated Statements of Operations (unaudited):
Three Months Ended March 26, 1999 and March 27, 1998 ... 5
Consolidated Statement of Changes in Stockholders' Equity
(unaudited): Three Months Ended March 26, 1999 ......... 6
Consolidated Statements of Cash Flows (unaudited):
Three Months Ended March 26, 1999 and March 27, 1998 ... 7
Condensed Notes to Consolidated Financial Statements
(unaudited) ............................................ 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................... 12
PART II OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders ......... 18
Item 6. Exhibits and Reports on Form 8-K ............................ 19
Signatures ..................................................... 20
QUANTEX -Registered Trademark- ("QUANTEX") IS A REGISTERED TRADEMARK OF
INVESTMENT TECHNOLOGY GROUP, INC.
POSIT -Registered Trademark- ("POSIT") IS A REGISTERED SERVICE MARK OF THE POSIT
JOINT VENTURE.
SMARTSERVER IS A SERVICE MARK 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, securities industry participants'
responses to Year 2000 issues, as well as general economic and business
conditions; securities, credit and financial and 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)
MARCH 26, DECEMBER 31,
1999 1998
------------------------ ------------------------
ASSETS (UNAUDITED)
Cash and cash equivalents.................................... $ 113,175 $ 77,324
Securities owned, at fair value.............................. 31,765 39,615
Receivables from brokers, dealers and other, net............. 16,172 24,127
Due from affiliates.......................................... 467 722
Investments.................................................. 1,029 1,000
Premises and equipment....................................... 19,595 19,662
Capitalized software......................................... 6,263 6,450
Goodwill..................................................... 1,236 1,373
Deferred taxes............................................... 2,732 2,784
Other assets................................................. 7,261 7,455
------------------------ ------------------------
Total assets................................................. $ 199,695 $ 180,512
------------------------ ------------------------
------------------------ ------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses........................ $ 32,666 $ 24,154
Payable to brokers, dealers and other........................ 2,283 1,881
Software royalties payable................................... 3,456 4,070
Securities sold, not yet purchased, at fair value............ 148 288
Due to affiliates............................................ 2,117 2,557
Income taxes payable to affiliate............................ 3,860 3,853
------------------------ ------------------------
Total liabilities............................................ 44,530 36,803
------------------------ ------------------------
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: 31,026,579 and
30,961,253 at March 26, 1999 and December 31,
1998..................................................... 310 309
Additional paid-in capital................................. 54,419 51,396
Retained earnings.......................................... 113,284 104,925
Common stock held in treasury, at cost; shares:
1,300,332 at March 26, 1999 and at December 31,
1998..................................................... (12,760) (12,760)
Accumulated other comprehensive loss:
Currency translation adjustment.......................... (88) (161)
------------------------ ------------------------
Total stockholders' equity................................. 155,165 143,709
------------------------ ------------------------
Total liabilities and stockholders' equity $ 199,695 $ 180,512
------------------------ ------------------------
------------------------ ------------------------
SEE ACCOMPANYING UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
Page 4 of 20
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
MARCH 26, MARCH 27,
1999 1998
---------------------------------------
REVENUES:
Commissions............................................ $ 50,665 $ 40,282
Interest and dividends................................. 1,101 801
Other.................................................. 862 304
---------------------------------------
Total revenues..................................... 52,628 41,387
---------------------------------------
EXPENSES:
Compensation and employee benefits..................... 12,248 10,585
Transaction processing................................. 7,536 5,654
Software royalties..................................... 3,752 2,985
Occupancy and equipment................................ 3,113 2,797
Telecommunications and data processing services........ 1,920 1,781
Net loss on long-term investments ..................... 886 1,002
Spin-off costs ........................................ 2,254 251
Other general and administrative....................... 3,682 3,282
---------------------------------------
Total expenses..................................... 35,391 28,337
---------------------------------------
Income before income tax expense........................... 17,237 13,050
Income tax expense......................................... 8,878 5,688
---------------------------------------
Net income................................................. $ 8,359 $ 7,362
---------------------------------------
---------------------------------------
Basic net earnings per share of common stock .............. $ 0.28 $ 0.25
---------------------------------------
---------------------------------------
Diluted net earnings per share of common stock ............ $ 0.27 $ 0.24
---------------------------------------
---------------------------------------
Basic weighted average shares outstanding ................. 29,708 29,091
---------------------------------------
---------------------------------------
Diluted weighted average shares and common stock
equivalents outstanding................................ 31,513 30,560
---------------------------------------
---------------------------------------
SEE ACCOMPANYING UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
Page 5 of 20
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 26, 1999
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Common
Additional Stock Accumulated Total
Preferred Common Paid-in Retained Held in Comprehensive Stockholders'
Stock Stock Capital Earnings Treasury Income/(loss) Equity
--------------------------------------------------------------------------------------
Balance at December 31, 1998.............. $ - $ 309 $ 51,396 $ 104,925 $ (12,760) $ (161) $ 143,709
Issuance of common stock in connection
with the employee stock option plan
(44,876 shares)........................ - 1 2,712 - - - 2,713
Issuance of common stock in connection
with the employee stock purchase plan
(20,449 shares)......................... - - 311 - - - 311
Comprehensive income/(loss):
Net income.............................. - - - 8,359 - - 8,359
Other comprehensive income, net of tax:
Currency translation adjustment.... - - - - - 73 73
------------
Comprehensive income...................... - - - - - - 8,432
--------------------------------------------------------------------------------------
Balance at March 26, 1999................. $ - $ 310 $ 54,419 $ 113,284 $ (12,760) $ (88) $ 155,165
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
SEE ACCOMPANYING UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
Page 6 of 20
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED
----------------------------
MARCH 26, MARCH 27,
1999 1998
----------------------------
Cash flows from operating activities:
Net earnings..................................... $ 8,359 $ 7,362
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Deferred income tax expense.................... 52 283
Depreciation and amortization.................. 3,238 1,983
Undistributed loss (income) of affiliates...... 863 (39)
Provision for doubtful accounts receivable..... 30 24
Decrease (increase) in operating assets:
Securities owned, at fair value................ 7,850 (1,142)
Receivables from brokers, dealers and other.... 7,925 (1,348)
Due from affiliates............................ 255 195
Investments.................................... (29) (218)
Other assets................................... (57) 684
Increase (decrease) in operating liabilities:
Accounts payable and accrued expenses.......... 8,535 5,380
Payable to brokers, dealers and other.......... 402 892
Software royalties payable..................... (614) 354
Securities sold, not yet purchased, at
fair value................................... (139) (3)
Due to affiliates.............................. (440) (1,381)
Income taxes payable to affiliate.............. 7 (359)
----------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES.... 36,237 12,667
----------------------------
Cash flows from investing activities:
Purchase of premises and equipment............. (1,778) (802)
Investment in joint venture.................... (637) -
Capitalization of software development costs... (1,068) (1,247)
----------------------------
NET CASH USED IN INVESTING ACTIVITIES........ (3,483) (2,049)
----------------------------
Cash flows from financing activities:
Issuance of common stock....................... 3,024 1,166
----------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES.... 3,024 1,166
----------------------------
Effect of foreign currency translation on cash
and cash equivalents........................... 73 (87)
Net increase in cash and cash equivalents.... 35,851 11,697
Cash and cash equivalents - beginning of period.. 77,324 14,263
----------------------------
Cash and cash equivalents - end of period........ $ 113,175 $ 25,960
----------------------------
----------------------------
Supplemental cash flow information:
Interest paid.................................. $ 28 $ 13
----------------------------
----------------------------
Income taxes paid to affiliate................. $ 7,074 $ 5,263
----------------------------
----------------------------
SEE ACCOMPANYING UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
Page 7 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 securities registered
under the Exchange Act, (2) Investment Technology Group International Limited,
which is a 50% partner in the ITG Europe joint venture, and (3) ITG Australia
Holdings Pty Limited, which is a 50% partner in ITG Pacific Holdings Pty
Limited. Investments in companies of fifty percent or less are accounted for
using the equity method. Jefferies Group, Inc. ("Jefferies Group") owned over
80% of our common stock at March 26, 1999. See Note - Spin-Off from Jefferies
Group.
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 include: POSIT, the
world's largest intra-day electronic equity matching system; QuantEX, a
fully-integrated trade routing, analysis and management system; ITG Platform,
a tool that provides connection to POSIT, ITG's electronic trading desk and
SuperDOT; pre- and post-trade analysis, a set of analytical tools for
systematically lowering the costs of trading; SmartServers, which offer
server based implementation of trading strategies; ITG/OPT, a computer-based
equity portfolio selection system; and research, development, sales and
consulting services to clients.
All material intercompany balances and transactions are eliminated in
consolidation. 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
1998 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.
USE OF ESTIMATES
Management of ITG have 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.
INCOME TAXES
Until to April 27, 1999, we were a member of the Jefferies affiliated group
("Group") for purposes of filing a Federal income tax return (i.e., Jefferies
Group owned more than 80% of ITG). With respect to tax periods ending prior to
April 28, 1999, our tax liability is determined on a "separate return" basis.
That is, we are required to pay to Jefferies Group its proportionate share of
the consolidated tax liability plus any excess of its "separate" tax liability
(assuming a separate tax return were to be filed by the us) over its
proportionate amount of the consolidated Group tax liability. Alternatively,
Jefferies Group is required to pay us an "additional amount" for the amount by
which the consolidated tax liability of the Group is decreased by reason of
inclusion of ITG in the Group.
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
Page 8 of 20
Income taxes are accounted for on the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the Consolidated Statement of Operations in
the period that includes the enactment date.
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at March 26, 1999 and December 31,
1998 consisted of the following;
MARCH 26, DECEMBER 31,
1999 1998
---------------------------
(DOLLARS IN THOUSANDS)
Accounts payable and accrued expenses........... $ 10,325 $ 6,581
Deferred compensation plan...................... 3,924 3,801
Deferred options................................ 2,797 2,778
Accrued soft dollars expenses................... 7,482 6,692
Accrued bonus expense........................... 5,677 1,757
Accrued rent expense............................ 2,386 2,445
Deferred revenues............................... 75 100
---------------------------
Total .......................................... $ 32,666 $ 24,154
---------------------------
---------------------------
OTHER COMPREHENSIVE LOSS
The following summarizes other comprehensive income (loss) for the quarter
ended March 26, 1999
(Dollars in thousands):
TAX NET
PRE-TAX (EXPENSE) OF TAX
AMOUNT OR BENEFIT AMOUNT
-------------------------------------
Currency translation adjustment......... $ 73 $ - $ 73
-------------------------------------
Other Comprehensive loss................ $ 73 $ - $ 73
-------------------------------------
-------------------------------------
ACCUMULATED
CURRENCY OTHER
TRANSLATION COMPREHENSIVE
ADJUSTMENT INCOME/(LOSS)
---------------------------
Balance at December 31,1998............. $ (161) $ (161)
Change during quarter ended
March 26, 1999........................ 73 73
---------------------------
Balance at March 26, 1999............... $ ( 88) $ ( 88)
---------------------------
---------------------------
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 adjusted average
number of outstanding shares for the three months ended March 26, 1999 and
March 27, 1998 was 29.7 million and 29.1 million, respectively.
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
Page 9 of 20
The following is a reconciliation of the basic and diluted earnings per
share computations for the three months ended March 26, 1999 and March 27, 1998.
MARCH 26, MARCH 27,
1999 1998
------------- -------------
(AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
Net earnings..................................................... $ 8,359 $ 7,362
------------- -------------
------------- -------------
Shares of common stock and common stock equivalents:
Average number of common shares used in basic computation..... 29,708 29,091
Effect of dilutive securities -- options...................... 1,805 1,469
------------- -------------
Average number of common shares used in diluted computation... 31,513 30,560
------------- -------------
------------- -------------
Earnings per share:
Basic......................................................... $ 0.28 $ 0.25
------------- -------------
------------- -------------
Diluted....................................................... $ 0.27 $ 0.24
------------- -------------
------------- -------------
The following is a reconciliation of the basic and diluted earnings per
share computations for the three months ended March 26, 1999 and March 27, 1998
on a pre spin-off basis. In calculating the per share data, the historical
numbers of shares outstanding, stated below, have been adjusted to reflect the
spin-off and merger transactions effective on April 27, 1999 and discussed in
"-- Spin-Off from Jefferies Group."
MARCH 26, MARCH 27,
PRE SPIN-OFF BASIS 1999 1998
------------- -------------
(AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
Net earnings..................................................... $ 8,359 $ 7,362
------------- -------------
------------- -------------
Shares of common stock and common stock equivalents:
Average number of common shares used in basic computation...... 18,620 18,233
Effect of dilutive securities -- options....................... 1,131 921
------------- -------------
Average number of common shares used in diluted computation.... 19,751 19,154
------------- -------------
------------- -------------
Earnings per share:
Basic.......................................................... $ 0.45 $ 0.40
------------- -------------
------------- -------------
Diluted........................................................ $ 0.42 $ 0.38
------------- -------------
------------- -------------
SPIN-OFF FROM JEFFERIES GROUP
On April 27, 1999, we were effectively spun off from 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. ("New ITG"). 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).
In connection with these transactions, on April 21, 1999, we paid a special
cash dividend of $4.00 per share, payable pro rata to all of our stockholders of
record as of April 20, 1999, including Jefferies Group. The aggregate
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
Page 10 of 20
amount of the special cash dividend was $74.6 million, of which we paid $60.0
million to Jefferies Group. As a result of the merger and based upon the
number of shares of Jefferies Group common stock outstanding on the date of
the merger (23,931,814) and the number of shares of the ITG's common stock
held by Jefferies Group (15,000,000), ITG's stockholders other than
Jefferies Group received 1.5955 shares of common stock of New ITG for each
share of the of ITG common stock held by them. Through March 26, 1999, we
had incurred spin-off costs of approximately $4.2 million consisting of
approximately $1.9 million through December 31, 1998 and approximately $2.3
million in First Quarter 1999. 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.
CONTINGENCIES
In 1998, we received a "30-day letter" 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, Inc. 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, New Jefferies will be obligated to indemnify ITG for
liabilities related to its former parent and its subsidiaries, but not for
liabilities related to our 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.
DIVIDENDS
Any future payments of dividends will be at the discretion of our Board
of Directors and will depend on the our financial condition, results of
operations, capital requirements and other factors deemed relevant. Our
revolving credit facility substantially limits our ability to pay dividends.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations - Liquidity and Capital Resources."
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
Page 11 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
services through our single line of business:
- POSIT: a confidential electronic stock crossing system;
- Electronic Trading Desk: an agency-only trading desk ;
- Front End Software;
- QuantEX: a Unix-based front-end software system providing
market analysis, trade management and electronic
connectivity to POSIT and multiple trade execution
destinations ; and
- 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 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 income and market losses resulting from
temporary positions in securities assumed in the normal course of our agency
trading business.
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, commissions paid to employees of Jefferies Group,
fringe benefits, including employer contributions for medical insurance, life
insurance, retirement plans and payroll taxes, reduced by the employee
portion of 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 at the contractually fixed rate of 13% of POSIT
Revenues. 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 gains on the sale
of equity investments, as offset by amortization of goodwill, equity
gain/loss pickup and initial start-up costs. 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 goodwill, legal, audit, tax,
consulting and promotional expenses.
SPIN-OFF FROM JEFFERIES GROUP
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
Page 12 of 20
On April 27, 1999, we were effectively spun off from 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. ("New ITG"). 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 our company,
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).
In connection with these transactions, on April 21, 1999, we paid a
special cash dividend of $4.00 per share, payable pro rata to all of our
stockholders of record as of April 20, 1999, including Jefferies Group. The
aggregate amount of the special cash dividend was $74.6 million, of which we
paid $60.0 million to Jefferies Group. As a result of the merger and based
upon the number of shares of Jefferies Group common stock outstanding on the
date of the merger (23,931,814) and the number of shares of ITG's common
stock held by Jefferies Group (15,000,000), ITG's stockholders other than
Jefferies Group received 1.5955 shares of common stock of the surviving
corporation for each share of ITG's common stock held by them. Through March
26, 1999, we had incurred spin-off costs of approximately $4.2 million,
consisting of approximately $1.9 million through December 31, 1998 and
approximately $2.3 million in First Quarter 1999. 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.
RESULTS OF OPERATIONS
The table below sets forth, certain items in the statement of income
expressed as a percentage of revenues for the periods indicated:
-------------------------
THREE MONTHS ENDED
-------------------------
March 26, March 27,
-------------------------
1999 1998
-------------------------
Revenues: 100.0% 100.0%
Commissions...................................... 96.3 97.3
Interest and dividends and other................. 3.7 2.7
Expenses:
Compensation and employee benefits............... 23.3 25.6
Transaction processing........................... 14.3 13.7
Software royalties............................... 7.1 7.2
Occupancy and equipment.......................... 5.9 6.8
Telecommunications and data processing services.. 3.6 4.3
Net loss on long-term investments................ 1.7 2.4
Spin-off costs................................... 4.3 0.6
Other general and administrative................. 7.0 7.9
-------------------------
Total expenses................................ 67.2 68.5
-------------------------
Operating income................................... 32.8 31.5
Income tax expense................................. 16.9 13.7
-------------------------
Net income......................................... 15.9 17.8
-------------------------
-------------------------
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
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QUARTER ENDED MARCH 26, 1999 COMPARED TO QUARTER ENDED MARCH 27, 1998
EARNINGS PER SHARE:
Basic net earnings per share increased $0.03, or 12.0%, from $0.25 for the
three months ended March 27, 1998 ("First Quarter 1998") to $0.28 for the three
months ended March 26, 1999 ("First Quarter 1999"). Diluted net earnings per
share increased $0.03, or 12.5%, from $0.24 to $0.27. Diluted net earnings per
share for First Quarter 1999, excluding non-recurring charges of $2.3 million
incurred in connection with our spin-off from Jefferies Group, were $0.34, or a
42% increase over $0.24 per share for First Quarter 1998. In calculating the
per share data, the historical numbers of shares outstanding have been adjusted
to reflect the spin-off and merger transactions effective on April 27, 1999 and
discussed in "-- Spin-Off from Jefferies Group."
REVENUES:
Total revenues increased $11.2 million, or 27%, from $41.4 million to
$52.6 million. There were 59 trading days in First Quarter 1998 compared to
58 in First Quarter 1999. Revenues per trading day increased by $206,000, or
29%, from $701,000 to $907,000. Revenues per employee increased $9,000, or
5%, from $185,000 to $194,000.
The following table itemizes revenues by category (in thousands):
THREE MONTHS ENDED,
-------------------------
MARCH 26, MARCH 27,
1999 1998 CHANGE % CHANGE
---------------------------------------------
POSIT............................ $28,746 $22,800 $5,946 26.1%
Desk............................. 10,572 9,682 890 9.2
Client........................... 12,718 8,109 4,609 56.8
Other............................ 592 796 (204) (25.6)
The increases in POSIT, Desk and Client revenues were attributable to an
increase in trading volume by existing customers and an increase in the number
of customers. The number of shares crossed on the POSIT system increased 287
million, or 25%, from 1.1 billion to 1.4 billion. The number of shares crossed
on the POSIT system per day increased 5.2 million, or 27%, from 19.2 million to
24.4 million. Of Client revenues, ITG Platform increased 341% representing 11.5%
of all Client revenues.
Other revenues decreased primarily as a result of an increase in trading
losses of $0.9 million over First Quarter 1998, reflecting market losses from
temporary positions in securities assumed in the normal course of our agency
trading business. This was essentially offset by development fee income charged
to ITG Europe of $0.3 million and reimbursement from our joint venture partner
of $0.4 million for POSIT development work.
EXPENSES:
Total expenses increased $7.1 million, or 25%, from $28.3 million to $35.4
million.
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
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The following table itemizes expenses by category (in thousands):
THREE MONTHS ENDED,
-------------------
MARCH 26, MARCH 27,
1999 1998 CHANGE % CHANGE
-----------------------------------------------------------
Compensation and employee benefits...................... $12,248 $10,585 $1,663 15.7%
Transaction processing.................................. 7,536 5,654 1,882 33.3
Software royalties...................................... 3,752 2,985 767 25.7
Occupancy and equipment................................. 3,113 2,797 316 11.3
Telecommunications and data processing services......... 1,920 1,781 139 7.8
Net loss on long-term investments....................... 886 1,002 (116) (11.6)
Spin-off costs.......................................... 2,254 251 2,003 798.0
Other general and administrative........................ 3,682 3,282 400 12.2
Income taxes............................................ 8,878 5,688 3,190 56.1
COMPENSATION AND EMPLOYEE BENEFITS: Salaries, bonuses and related
employee benefits increased primarily due to growth in our employee base of
21% from 226 to 272, and additional compensation necessary to attract and
retain quality personnel. Over 50% of the increase in new 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 decreased $9,000, or
4%, from $189,000 to $180,000 on an annualized basis.
TRANSACTION PROCESSING: Transaction processing as a percentage of
revenues increased from 13.7% to 14.3% of revenues. Clearing costs as a
percentage of revenues increased 0.6% due to an increase in ticket volume and
0.2% due to an increase in international ticket charges. This was partially
offset (0.6%) due to clearing volume discounts. Execution and other costs
increased 0.4% as a percentage of revenues.
SOFTWARE ROYALTIES: As software royalties are contractually fixed at 13% of
POSIT revenues, the increase is wholly attributable to an increase in POSIT
revenues.
OCCUPANCY AND EQUIPMENT: The increase in occupancy and equipment expense is
primarily attributed to purchase of equipment and software and related
maintenance contracts associated with the expansion of our research and
development facility in Culver City, California.
TELECOMMUNICATIONS AND DATA PROCESSING SERVICES: The increase in
telecommunications and data processing services stems primarily from the data
feed upgrades for clients, including market data line connections, totaling $0.6
million. This increase was offset in part by a decrease in spending on
contingency-related planning and implementation.
NET LOSS ON LONG-TERM INVESTMENTS: The net loss on long-term investments in
First Quarter 1999 primarily reflects losses incurred by ITG Europe, which is
now fully operational. In August 1998, we sold our equity ownership in the
LongView Group, Inc., however, the investment in LongView Group had incurred a
loss in First Quarter 1998.
SPIN-OFF COSTS: The spin-off expenses are attributable to our legal,
accounting, consulting and other expenses incurred for the spin-off and merger
transactions, as discussed in "Spin-Off from Jefferies Group."
OTHER GENERAL AND ADMINISTRATIVE: The increase reflects software
amortization for certain products that were released in late 1998, offset by a
decline in consulting for projects such as network migration and strategic
market studies.
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
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INCOME TAX EXPENSE: The increase was the result of an increase in pretax
income and an increase in the effective tax rate from 43.6% in First Quarter
1998 to 51.5% in First Quarter 1999. The effective tax rate increased due to
certain non-deductible expenses, such as spin-off costs and the inability to
offset the larger First Quarter 1999 international losses with United States
profits in calculating income tax expense.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity and capital resource requirements are the result of the
funding of working capital needs, primarily consisting of compensation, benefits
and 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, variable rate municipal securities, auction
rate preferred stock and common stock. At March 26, 1999, such cash equivalents
amounted to $113.2 million and receivables from brokers, dealers and other, net
of $16.2 million were due within 30 days. A special cash dividend of $74.6
million was paid on April 21, 1999 in connection with the spin-off from
Jefferies Group. See "Spin-Off from Jefferies Group."
Historically, all regulatory capital needs of ITG Inc. have been provided
by cash from operations. We believe that cash flows from operations and the
receipt of the exercise price for the exercise of options which were scheduled
to expire on April 30, 1999 in the amount of approximately $8.7 million will
provide ITG Inc. with sufficient regulatory capital. We have an agreement with
a bank to borrow up to $20 million on a revolving basis to enable ITG Inc. to
satisfy its regulatory net capital requirements. This commitment will expire on
March 14, 2000. Any amounts drawn may be prepaid at any time, but no later than
March 15, 2001. We incur a fee at a rate per annum equal to 0.35% on the daily
amount of the unused commitment to March 13, 2000. The interest rate on any
amounts drawn will be prime; if such amounts are not repaid within two weeks,
the interest rate will increase to prime plus 2%. The credit facility is
secured by a pledge of the stock of ITG Inc., ITG Ventures, Inc. and ITG Global
Trading Incorporated. This agreement limits our ability to pay cash dividends
or incur indebtedness and requires us to comply with certain financial
covenants. On March 26, 1999, assuming that the spin-off from Jefferies Group
had been consummated on that date, ITG Inc. would have had pro forma excess net
regulatory capital of approximately $16.5 million (not including the $20 million
available under the new revolving credit facility). Although we believe that
the combination of our existing net regulatory capital, operating cash flows and
the revolving credit facility will be sufficient to meet regulatory capital
requirements, a shortfall in net regulatory capital would have a material
adverse effect on us.
THE YEAR 2000 ISSUE
Some computer systems and software products were originally designed to
accept only two digit entries in the data code field. As a result, certain
computer systems and software packages will not be able to interpret dates
beyond December 31, 1999 and thus will interpret dates beginning January 1, 2000
incorrectly. This could potentially result in
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
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computer failure or miscalculations, causing operating disruptions, including an
inability to process transactions, send invoices or engage in normal business
operations. Therefore, companies may have to upgrade or replace computer and
software systems in order to comply with the "Year 2000" requirements.
STRATEGY
We are well aware of and are actively addressing the Year 2000 issue and
the potential problems that can arise in any computer and software system.
Planning and evaluation work began in 1997 including the identification of those
systems affected. We established a "Year 2000 working group" to address the Year
2000 issue. We have targeted our efforts into three major areas: (1) vendors;
(2) company proprietary products; and (3) clients.
VENDORS. Our ability to successfully meet the Year 2000 challenge is in part
dependent on our vendors. We have contacted our vendors to determine the status
of their Year 2000 programs and have created a database recording each vendor's
readiness status. Over 95% of our vendors have responded that their systems are
currently Year 2000 compliant, and substantially all of our vendors have
indicated that they expect their systems to be Year 2000 compliant by
September 30, 1999. Based upon the results of our testing to date, we are
satisfied with the representations we have received from our vendors. We are in
the process of integrating Year 2000 compliant versions of our vendors' software
and hardware with our proprietary products.
COMPANY PROPRIETARY PRODUCTS. We have evaluated our trading systems and have
endeavored to examine all code contained in our internally produced software.
We have completed regression testing of all mission critical systems and
released Year 2000 compliant versions of all such systems other than QuantEX. We
plan to complete date-forward testing of all mission critical systems and
release a Year 2000 compliant version of QuantEX by the end of June 1999. We
also participated in the Securities Industry Association's industry-wide testing
program in March and April 1999.
CLIENTS. We sent a letter explaining our Year 2000 strategy to all clients in
July 1998. In addition, we contacted clients on a project-by-project basis to
ascertain compatibility between our systems and changes made to the clients'
systems. We started to provide point-to-point testing opportunities for our
clients in April 1999.
YEAR 2000 CONTINGENCY PLANNING
We are preparing a Year 2000 contingency plan to deal with both internal
and external failures of critical systems. The Year 2000 issue can affect all
businesses that rely heavily on automated systems. Our Year 2000 contingency
plan is therefore intended to address failures of internal systems, client
connections and connections to trading destinations, as well as failures of
major infrastructure components. We intend to have our contingency plan in place
by July 1999 and to update and refine such plan as needed on a continuing basis.
We believe, however, that such contingency plan will not provide satisfactory
solutions for our worst-case scenario. The general failure of computer and
communication systems relied upon by the securities industry, such as the
systems provided by long distance telephone companies, the stock exchanges,
Nasdaq, The Depository Trust Company and ADP Brokerage Services, and the failure
of our securities clearing and execution firms to provide services under
agreements with us. Such failure would prevent us from operating in whole or in
part until such systems or services have been restored and could have a material
adverse effect on us.
In the event any of our internally developed systems fails, we will
undertake to remediate such system on an emergency basis at the time of such
failure. To ensure that adequate staff will be available to handle any such
emergencies in January of 2000, we have imposed a moratorium on employee
vacations during the first two weeks of January 2000, and have made arrangements
to have a number of software development personnel (normally based in our Culver
City office) at our New York headquarters during the final week of December 1999
and the first week of January 2000. Our inability to remediate a failure of any
of our internally developed mission critical systems would prevent us from
operating in whole or in part until such systems have been restored and could
have a material adverse effect on us.
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
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COSTS
We do not believe that the costs incurred to ready our systems for the Year
2000 will have a material effect on our financial condition. Total costs for the
whole project are estimated to be between $2.5 and $3.0 million, which includes
the cost of personnel, consultants and software and hardware costs. Costs
incurred for the Year 2000 project were approximately $0.6 million for the First
Quarter 1999 and totaled $2.1 million to date.
PART II. - OTHER INFORMATION
Item 4. Submission of Matters to a vote of Security Holders
(a) Date of the Meeting - April 20, 1999
Type of Meeting - Annual Meeting of Stockholders
(b) At the meeting, the following directors were elected by the
stockholders to hold office until the next annual meeting of
stockholders or until their successors have been duly elected and
qualified:
Frank E. Baxter
Neal S. Garonzik
William I Jacobs
Raymond L. Killian, Jr.
Robert L. King
Mark A. Wolfson
(c) At the meeting, with respect to the election of the directors,
ratification of the appointment of KPMG LLP as our independent
auditors for the 1999 fiscal year, and approval and adoption of the
Agreement and Plan of Merger between our company and Jefferies
Group, the following votes were cast in the following manner:
Election of Directors:
NAME FOR WITHHELD
------------------------------------------------------------------
Frank E. Baxter 18,161,646 526
Neal S. Garonzik 18,161,646 526
William I Jacobs 18,161,646 526
Raymond L. Killian, Jr. 18,161,646 526
Robert L. King 18,161,646 526
Mark A. Wolfson 18,161,646 526
Ratification of the appointment of KPMG LLP as our independent auditors for
the 1999 fiscal year:
NUMBER OF SHARES
----------------
For 18,160,592
Against 1,025
Abstain 555
Approval and adoption the Agreement and Plan of Merger between ITG and
Jefferies Group:
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
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NUMBER OF SHARES
----------------
For 17,441,413
Against 20,621
Abstain 630
Delivered Not-Voted 699,508
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 3.2 - Amended and Restated Bylaws of the Company.
Exhibit 10.1 - Amendment No.1, dated as of April 20, 1999, to the
Credit Agreement between the Company and The Bank of
New York.
Exhibit 10.2 - Assumption Agreement, dated as of April 27, 1999,
between the Company and The Bank of New York.
Exhibit 27 - Financial Data Schedule.
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
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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: MAY 10, 1999 By: /s/ John R. MacDonald
----------------- ---------------------
John R. MacDonald
Chief Financial Officer and
Duly Authorized Signatory of Registrant
INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
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