transactions does not return the loaned securities, the Company may be exposed to the risk of acquiring the securities at prevailing market prices in order to satisfy its client obligations. The Company controls this risk by requiring credit approvals for counterparties, by monitoring the market value of securities loaned on a daily basis, and by requiring additional cash as collateral or returning collateral when necessary.
The Company also borrows securities temporarily from other brokers in connection with customer settlement activities. The Company deposits cash as collateral for the securities borrowed. Decreases in security prices may cause the market value of the securities borrowed to fall below the amount of cash deposited as collateral. In the event the counterparty to these transactions does not return collateral, the Company may be exposed to the risk of selling the securities at prevailing market prices. The Company controls this risk by requiring credit approvals for counterparties, by monitoring the collateral values on a daily basis, and by depositing additional collateral with counterparties or receiving cash when deemed necessary.
The Company may at times maintain inventories in equity securities on both a long and short basis. Whereas long inventory positions represent the Company’s ownership of securities, short inventory positions represent obligations of the Company to deliver specified securities at a contracted price, which may differ from market prices prevailing at the time of completion of the transaction. Accordingly, both long and short inventory positions may result in losses or gains to the Company as market values of securities fluctuate. To mitigate the risk of losses, long and short positions are marked to market daily and are continuously monitored by the Company.
(17) Contingencies – Legal Matters
On January 12, 2017, the Company reached a final settlement with the SEC to resolve the SEC’s inquiry into ITG Inc.’s activity with respect to pre-released American Depositary Receipts (“ADRs”),
substantially all of which related to ITG Inc.’s matched-book operations. ITG Inc.’s activity in pre-released ADRs was discontinued in the fourth quarter of 2014, with all outstanding transactions completely wound down by the end of 2014.
According to the terms of the settlement, the Company paid an aggregate amount of $24.5 million in January 2017, which includes disgorgement of $15.1 million, prejudgment interest of $1.9 million and a civil monetary penalty of $7.5 million.
The Company had fully reserved the $24.5 million as of December 31, 2016.
The Company is not a party to any pending legal proceedings other than claims and lawsuits arising in the ordinary course of business, except a putative class action lawsuit and a derivative action have been filed with respect to the Company and certain of its current and former directors and/or executives in connection with the Company’s announcement of the SEC matter described in the following paragraph (and other related actions could be filed).
On August 12, 2015, the Company reached a final settlement with the SEC in connection with the SEC’s investigation into a proprietary trading pilot operated within AlterNet for sixteen months in 2010 through mid-2011. The investigation was focused on customer disclosures, Form ATS regulatory filings and customer information controls relating to the pilot’s trading activity, which included (a) crossing against sell-side clients in POSIT and (b) violations of Company policy and procedures by a former employee. These violations principally involved information breaches for a period of several months in 2010 regarding sell-side parent orders flowing into ITG’s algorithms and executions by all customers in non-POSIT markets that were not otherwise available to ITG clients. According to the terms of the settlement, the Company paid an aggregate amount of $20.3 million, representing a civil penalty of $18 million, disgorgement of approximately $2.1 million in trading revenues and prejudgment interest of approximately $0.25 million.
In connection with the announcement of the SEC investigation regarding AlterNet, two putative class action lawsuits were filed with respect to the Company and certain of its current and former executives and have since been consolidated into a single action captioned
In re Investment Technology Group, Inc.
Securities Litigation
before the U.S. District Court for the Southern District of New York. The complaint alleges, among other things, that the defendants made material misrepresentations or omitted to disclose material facts concerning, among other subjects, the matters that were the subject of the SEC settlement regarding AlterNet and the SEC investigation that led to the SEC settlement. The complaint seeks an unspecified amount of damages under the federal securities laws. On April 26, 2017, the court granted in part and denied in part the Company’s motion to dismiss the complaint
and granted the plaintiff leave to file a motion to amend its complaint within 30 days from the date of the court’s opinion
.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements, including the notes thereto.
Overview
ITG is a global financial technology
company that helps leading brokers and asset managers improve returns for investors. ITG empowers traders to reduce the end-to-end cost of implementing investments via technology-enabled liquidity, execution, analytics and workflow technology solutions. ITG has offices in Asia Pacific, Europe and North America and offers execution services in more than 50 countries.
Our business is organized into four reportable operating segments: U.S. Operations, Canadian Operations, European Operations and Asia Pacific Operations (see Note 14,
Segment Reporting
, to the condensed consolidated financial statements). These four operating segments provide the following categories of products and services:
|
·
|
|
Execution Services — includes (a) liquidity matching through POSIT, (b) self-directed trading using algorithms (including single stocks and portfolio lists) and smart routing, (c) portfolio trading and high-touch trading desks providing execution expertise and (d) futures and options trading
|
|
·
|
|
Workflow Technology — includes trade order and execution management software applications in addition to network connectivity
|
|
·
|
|
Analytics — includes (a) tools enabling portfolio managers and traders to improve pre-trade, real-time and post-trade execution performance, (b) portfolio construction and optimization decisions and (c) securities valuation
|
Regional segment results exclude the impact of Corporate activity, which is presented separately and includes investment income from treasury activity, certain non-operating revenues and other gains as well as costs not associated with operating the businesses within the Company’s regional segments. These costs include, among others, (a) the costs of being a public company, such as certain staff costs, a portion of external audit fees, and reporting, filing and listing costs, (b) intangible asset amortization, (c) interest expense, (d) professional fees associated with our global transfer pricing structure, (e) foreign exchange gains or losses and (f) certain non-operating expenses.
Sources of Revenues
Revenues from our products and services are generated from commissions and fees, recurring (subscriptions) and other sources.
Commissions and fees are derived primarily from (i) commissions charged for trade execution services, (ii) income generated on net executions, whereby equity orders are filled at different prices within or at the National Best Bid and Offer (“NBBO”) and (iii) commission sharing arrangements between ITG Net (our private value‑added FIX‑based financial electronic communications network) and third‑party brokers and alternative trading systems whose trading products are made available to our clients on our order management system (“OMS”) and execution management system (“EMS”) applications in addition to commission sharing arrangements for our Single Ticket Clearing service and our RFQ‑hub request‑for‑quote service. Because commissions are earned on a per‑transaction basis, such revenues fluctuate from period to period depending on (a) the volume of securities traded through our services in the U.S. and Canada, (b) the contract value of securities traded in Europe and the Asia Pacific region and (c) our commission rates. Certain factors that affect our volumes and contract values traded include: (i) macro trends in the global equities markets that affect overall institutional equity trading activity, (ii) competitive pressure, including pricing, created by the existence of electronic execution competitors and (iii) potential changes in market structure in the U.S. and other regions. In addition to share volume, revenues from net executions are also impacted by the width of spreads within the NBBO. Trade orders are delivered to us from our OMS and EMS products and other vendors’ products, direct computer‑to‑computer links to customers through ITG Net and third‑party networks and phone orders from our customers.
Recurring revenues are derived from the following primary sources: (i) connectivity fees generated through ITG Net for the ability of the sell‑side to receive orders from, and send indications of interest to, the buy‑side and for the sell‑side to receive requests‑for‑quotes through RFQ‑hub, (ii) software and analytical products and services and (iii) maintenance and customer technical support for our OMS. Prior to the divestiture of our remaining investment research operations in May 2016, recurring revenues included subscriptions from these operations.
Other revenues include: (1)
for historical periods up until April 2016,
income from principal trading in Canada,
including within our arbitrage trading desk,
(2) the net spread on foreign exchange transactions executed on a principal basis to facilitate equity trades by clients in different currencies, as well as on other foreign exchange transactions unrelated to equity trades, (3) for historical periods up until June 2016, the net interest spread earned on matched-book securities borrowed and loaned transactions, (4) non-recurring consulting services, such as one-time implementation and customer training related activities, (5) investment income from treasury activity, (6) interest income on securities borrowed in connection with customers’ settlement activities, (7) market gains/losses resulting from temporary positions in securities assumed in the normal course of agency trading (including trade errors and client trade accommodations) and (8) non‑recurring gains and losses such as divestitures.
Expenses
Compensation and employee benefits, our largest expense, consist of salaries and wages, incentive compensation, employee benefits and taxes. Incentive compensation fluctuates based on revenues, profitability and other measures, taking into account the landscape for key talent. Incentive compensation includes a combination of cash and deferred share‑based awards. Only the cash portion of incentive compensation is a variable expense in the current period. As a result, our ratio of compensation expense to revenues may fluctuate from period‑to‑period based on revenue levels.
Transaction processing expense consists of costs to access various third‑party execution destinations and to process, clear and settle transactions. These costs tend to fluctuate with share and trade volumes, the mix of trade execution services used by clients and the rates charged by third parties.
Occupancy and equipment expense consists primarily of rent and utilities related to leased premises, office equipment and depreciation and amortization of fixed assets and leasehold improvements.
Telecommunications and data processing expenses primarily consist of costs for obtaining market data, telecommunications services and systems maintenance.
Other general and administrative expenses primarily include software amortization, professional (including legal) fees, consulting, business development and intangible asset amortization.
Interest expense consists primarily of costs associated with outstanding debt and credit facilities.
Non‑GAAP Financial Measures
To supplement our financial information presented in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”), management uses certain “non‑GAAP financial measures” as such term is defined in Regulation G promulgated by the SEC. Generally, a non‑GAAP financial measure is a numerical measure of a company’s operating performance, financial position or cash flows that excludes or includes amounts that are included in, or excluded from, the most directly comparable measure calculated and presented in accordance with U.S. GAAP. Management believes the presentation of these measures provides investors with greater transparency and supplemental data relating to our financial condition and results of operations, and therefore a more complete understanding of factors affecting our business than U.S. GAAP measures alone. In addition, management believes the presentation of these measures is useful to investors for period‑to‑period comparison of results as the items described below reflect certain unique and/or non‑operating items such as acquisitions, divestitures, restructuring charges, write‑offs and impairments, charges associated with litigation or regulatory matters together with related expenses or items outside of management’s control.
Adjusted expenses, adjusted income (loss) before income tax expense (benefit), adjusted income tax expense (benefit) and adjusted net income (loss),
together with related per share amounts, are non‑GAAP performance measures
that we believe are useful to assist investors in gaining an understanding of the trends and operating results for our core business. These measures should be viewed in addition to, and not in lieu of, results reported under U.S. GAAP.
Reconciliations of adjusted expenses, adjusted income before income tax expense, adjusted income tax expense and adjusted net income to expenses, loss before income tax benefit, income tax benefit and net loss and related per share amounts as determined in accordance with U.S. GAAP for the three months ended March 31, 2016 are provided below (dollars in thousands except per share amounts). There were no such adjustments during the three months ended March 31, 2017.
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 31, 2016
|
|
|
Total expenses
|
|
$
|
128,306
|
|
|
Less:
|
|
|
|
|
|
Compensation awards for current CEO
(1)
|
|
|
(2,797)
|
|
|
Arbitration case with former CEO and associated costs
(2)
|
|
|
(2,812)
|
|
|
Adjusted expenses
|
|
$
|
122,697
|
|
|
|
|
|
|
|
|
Loss before income tax benefit
|
|
$
|
(3,638)
|
|
|
Effect of adjustments
|
|
|
5,609
|
|
|
Adjusted income before income tax expense
|
|
$
|
1,971
|
|
|
|
|
|
|
|
|
Income tax benefit
|
|
$
|
(1,132)
|
|
|
Tax effect of adjustments
(1) (2)
|
|
|
1,262
|
|
|
Adjusted income tax expense
|
|
$
|
130
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(2,506)
|
|
|
Net effect of adjustments
|
|
|
4,347
|
|
|
Adjusted net income
|
|
$
|
1,841
|
|
|
|
|
|
|
|
|
Diluted loss per share
|
|
$
|
(0.08)
|
|
|
Net effect of adjustments
|
|
|
0.13
|
|
|
Adjusted diluted income per share
|
|
$
|
0.05
|
|
|
|
(1)
|
|
During the three months ended March 31, 2016, we expensed $2.8 million for cash and stock awards granted to our current Chief Executive Officer upon the commencement of his employment in January 2016, a significant portion of which replaced awards he forfeited at his former employer. Due to U.S. tax regulations, only a small portion of the amount expensed for these awards was eligible for a tax deduction
.
|
|
(2)
|
|
During the three months ended March 31, 2016, we established a reserve of $2.5 million in accordance with ASC 450,
Contingencies
, for the pending arbitration case with our former Chief Executive Officer and incurred legal fees related to this matter of $0.3 million.
|
Executive Summary for the Quarter Ended March 31, 2017
Consolidated Overview
We posted our second consecutive quarter of global profitability in the first quarter of 2017 due to record profitability in Europe and Asia Pacific, driven in part by the growth in block trading through POSIT Alert. In North America we posted continued solid results in Canada and saw a reduction in revenues in the U.S. following the very active fourth quarter of 2016 post the U.S. election. We did, however, continue to grow market share in the U.S. and we took further actions to reduce our cost base through reductions in headcount and office space as we focus on restoring profitability in the U.S. and funding investments in targeted growth initiatives.
On a U.S. GAAP basis, we generated revenues of $120.8 million and net income of $5.3 million, or $0.16 per diluted share in the first quarter of 2017 compared to revenues of $124.7 million and a net loss of $2.5 million, or $0.08 per diluted share in the first quarter of 2016. On an adjusted basis, we generated net income of $1.8 million, or $0.05 per share (see
Non-GAAP Financial Measures
) in the first quarter of 2016. Expenses of $117.0 million in the first quarter of 2017 were down 9% from expenses of $128.3 million and 5% from adjusted expenses of $122.7 million (see
Non-GAAP
Financial Measures
) in the first quarter of 2016, primarily reflecting the divestiture of our remaining investment research operations as well as lower legal costs.
We are continuing our focus on growth through the execution of our Strategic Operating Plan, which aims to enhance our global capabilities in liquidity, execution, analytics and workflow technology solutions. We have sharpened our focus around these four key service offerings following the divestitures and closings of non-core operations. As part of this plan we are pursuing significant investments in technology and people to bolster these key service offerings and sharpen our brand with the expectation that we will meaningfully grow market share, revenues and profitability on a global basis.
Segment Discussions
Our U.S. average daily volume (“ADV”) for the first quarter of 2017 was 150.9 million shares, up 4% from the fourth quarter of 2016 and down 7% from the very active first quarter of 2016. While we saw a second consecutive quarter with market share gains in the U.S., there were significant movements within the mix of our volume amongst our client segments that resulted in lower trading revenues and higher execution costs. The reduced trading margin, together with $3.3 million of employee separation and lease abandonment costs, increased our reported pre-tax loss in the U.S. to $6.6 million in the first quarter of 2017 from $1.8 million in the fourth quarter of 2016.
Canadian revenues were higher than the first quarter of 2016 despite the closure of the arbitrage trading desk in April 2016. Trading commissions were 11% higher than the first quarter of 2016 while market volumes were down 7% year-over-year. The stronger results were due to a second consecutive record quarter in MATCHNow as well as growth in POSIT Alert and electronic trading from sell-side clients.
In Europe we had record levels of revenue, market share and pre-tax profitability in the first quarter of 2017. The growth in trading from buy-side clients, particularly in POSIT Alert where we saw record activity, more than offset the impact of reduced activity from sell-side clients. The improved mix of business has raised our average commission rate and significantly improved our margins.
Our
Asia Pacific business achieved its most profitable quarter on record. Our pre-tax profit was $1.8 million, compared with a $0.6 million pre-tax loss in the prior year quarter. Asia Pacific commissions and fees increased 33% over the prior year quarter, significantly outpacing the 10% growth in overall market-wide activity, driven by record activity in POSIT Alert for the fourth consecutive quarter and strong growth in algorithmic trading.
Corporate activity in the first quarter of 2017 reduced pre-tax income by $6.1 million compared to a pre-tax reduction of $14.2 million in the first quarter of 2016. The reduction in the pre-tax loss reflects the impact of costs incurred during the prior year period related to the arbitration with ITG’s former CEO and the expensing of upfront cash and stock awards granted to our current CEO, a significant portion of which replaced compensation he forfeited at his former employer. We also saw reductions in legal fees and intangible amortization.
Capital Resource Allocation
During the first quarter of 2017, we repurchased 161,708 shares under our authorized stock repurchase program for $3.2 million, or an average cost of $19.85 per share, and we maintained our $0.07 quarterly dividend program, paying out $2.3 million in cash.
Going forward we expect to use our share repurchase program to offset dilution from the issuance of stock under employee compensation plans. We may repurchase additional shares opportunistically depending on various factors including, among others, market conditions and competing needs for the use of our capital.
Results of Operations — Three Months Ended March 31, 2017 Compared to Three Months Ended March 31, 2016
U.S. Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
40,561
|
|
$
|
49,453
|
|
$
|
(8,892)
|
|
(18)
|
%
|
Recurring
|
|
|
11,921
|
|
|
15,522
|
|
|
(3,601)
|
|
(23)
|
%
|
Other
|
|
|
911
|
|
|
1,354
|
|
|
(443)
|
|
(33)
|
%
|
Total revenues
|
|
|
53,393
|
|
|
66,329
|
|
|
(12,936)
|
|
(20)
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
26,801
|
|
|
29,399
|
|
|
(2,598)
|
|
(9)
|
%
|
Transaction processing
|
|
|
10,948
|
|
|
10,239
|
|
|
709
|
|
7
|
%
|
Other expenses
|
|
|
22,248
|
|
|
24,586
|
|
|
(2,338)
|
|
(10)
|
%
|
Total expenses
|
|
|
59,997
|
|
|
64,224
|
|
|
(4,227)
|
|
(7)
|
%
|
(Loss) income before income tax (benefit) expense
|
|
$
|
(6,604)
|
|
$
|
2,105
|
|
$
|
(8,709)
|
|
N/A
|
|
Commissions and fees declined 18% compared to the prior year quarter resulting from a 7% reduction in our ADV, which compared favorably to the 20% decrease in total daily U.S. market volumes. Commissions and fees were also negatively impacted by a 14% decline in our overall revenue per share from $0.0043 to $0.0037 driven by
significant movements within the mix of our volume amongst our client segments
as well as reduced high-touch trading for equities due to the reduction in our high-touch trading organization following the sale of our remaining investment research operations in May 2016. ADV from sell-side accounts represented 56% of our overall ADV compared with 52% in the first quarter of 2016. In addition, lower-rate index rebalance trading made up a greater proportion of our buy-side activity in the first quarter of 2017.
As compared to the preceding fourth quarter of 2016, our ADV grew 4% while total daily U.S. market volumes declined 3%. This resulted in a second consecutive quarter with market share growth, to 2.20%, up from 2.05% in the fourth quarter of 2016 and 1.75% in the third quarter of 2016.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
|
|
|
U.S. Operations: Key Indicators*
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
|
Total trading volume (in billions of shares)
|
|
|
9.4
|
|
|
9.9
|
|
|
(0.5)
|
|
(5)
|
%
|
Average trading volume per day (in millions of shares)
|
|
|
150.9
|
|
|
161.8
|
|
|
(10.9)
|
|
(7)
|
%
|
Average revenue per share
|
|
$
|
0.0037
|
|
$
|
0.0043
|
|
$
|
(0.0006)
|
|
(14)
|
%
|
U.S. market trading days
|
|
|
62
|
|
|
61
|
|
|
1
|
|
2
|
|
* Excludes activity from ITG Net commission share arrangements.
Recurring revenues decreased 23% from the first quarter of 2016 primarily from the loss of billed investment research revenue following the divestiture of our remaining investment research operations in May 2016 and the amendment to terminate the initial energy research distribution agreement at the end of 2016. We also experienced lower OMS subscriptions and connectivity revenue due to client attrition, slightly offset by higher billed revenue for our analytics products.
Other revenues decreased 33% from the prior year period due to the closing of our matched-book securities lending operations in the second quarter 2016, partially offset by higher market data tape rebate revenue.
Compensation and employee benefits decreased 9% from the first quarter of 2016 due to the impact of divesting our remaining investment research operations in May 2016, cost savings measures implemented during the second half of 2016 and the impact of the increased use of deferred stock awards in our incentive compensation program to better align employees with the Strategic Operating Plan. These declines were offset in part by $2.5 million of employee separation costs during the first quarter of 2017 associated with headcount reductions and discontinuing our corporate access service.
Transaction processing costs increased 7% from the prior year period, despite the 7% reduction in ADV, due to the growth in market-on-close index rebalance trading from passive accounts and increased routing for sell-side clients where we saw an increase in liquidity taking. As a percentage of commission and fees, transaction processing costs increased to 27.0% in the first quarter of 2017, up from 20.7% in the first quarter of 2016, due to the factors noted above and the impact of the reduction in the average rate per share.
Other expenses decreased 10% from the first quarter of 2016 due to the impact of divesting our remaining investment research operations in May 2016 and reduced energy research costs from the amendment to terminate the initial energy research distribution agreement. We also saw lower travel and entertainment, marketing, and recruiting costs. These reductions were partially offset by $0.8 million of lease abandonment costs related to the reduction of our office space in Bo
ston.
Canadian Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
14,232
|
|
$
|
12,855
|
|
$
|
1,377
|
|
11
|
%
|
Recurring
|
|
|
1,303
|
|
|
1,283
|
|
|
20
|
|
2
|
%
|
Other
|
|
|
947
|
|
|
1,958
|
|
|
(1,011)
|
|
(52)
|
%
|
Total revenues
|
|
|
16,482
|
|
|
16,096
|
|
|
386
|
|
2
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
4,402
|
|
|
4,718
|
|
|
(316)
|
|
(7)
|
%
|
Transaction processing
|
|
|
2,931
|
|
|
2,544
|
|
$
|
387
|
|
15
|
%
|
Other expenses
|
|
|
5,651
|
|
|
5,496
|
|
|
155
|
|
3
|
%
|
Total expenses
|
|
|
12,984
|
|
|
12,758
|
|
|
226
|
|
2
|
%
|
Income before income tax expense
|
|
$
|
3,498
|
|
$
|
3,338
|
|
|
160
|
|
5
|
%
|
Currency translation from a stronger Canadian Dollar increased total Canadian revenues and expenses by $0.5 million and $0.3 million, respectively, resulting in an increase of $0.2 million to pre-tax income.
Commissions and fees increased 11% compared to the first quarter of 2016, despite a 7% decline in daily market-wide volumes due to strong growth in MATCHNow, which had a second consecutive record quarter, as well as growth in POSIT Alert and electronic trading by sell-side clients.
Recurring revenues were comparable to the prior year period and other revenues declined 52% largely from the closure of our arbitrage trading desk in April 2016.
Compensation and employee benefits costs decreased 7% compared to the first quarter of 2016 due to the increased use of deferred stock awards in our incentive compensation program to better align employees with the Strategic Operating Plan and cost savings measures implemented during the second half of 2016.
Transaction processing costs increased 15% over the prior year period, which was higher than the growth in commission and fees, as a result of an increase in the proportion of our routing activity where we took liquidity and an increase in the trading of lower-priced stocks on the trading desk where we charge a lower commission rate. The impact of these increases was partially offset by the closing of our arbitrage trading desk in April 2016.
Other expenses increased 3% from the first quarter of 2016 due to increased costs related to our resiliency efforts, offset in part by reductions in general and administrative expenses, where we saw lower travel and entertainment costs and the discontinuation of research distribution fees.
European Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
32,781
|
|
$
|
27,396
|
|
$
|
5,385
|
|
20
|
%
|
Recurring
|
|
|
3,982
|
|
|
3,886
|
|
|
96
|
|
2
|
%
|
Other
|
|
|
(51)
|
|
|
(143)
|
|
|
92
|
|
(64)
|
%
|
Total revenues
|
|
|
36,712
|
|
|
31,139
|
|
|
5,573
|
|
18
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
9,010
|
|
|
9,610
|
|
|
(600)
|
|
(6)
|
%
|
Transaction processing
|
|
|
8,146
|
|
|
7,626
|
|
|
520
|
|
7
|
%
|
Other expenses
|
|
|
8,355
|
|
|
8,224
|
|
|
131
|
|
2
|
%
|
Total expenses
|
|
|
25,511
|
|
|
25,460
|
|
|
51
|
|
0
|
%
|
Income before income tax expense
|
|
$
|
11,201
|
|
$
|
5,679
|
|
$
|
5,522
|
|
97
|
%
|
Overall currency rate changes in the European region reduced revenues and expenses by $2.2 million and $1.7 million, respectively, reducing profitability by $0.5 million. This decrease in profitability was primarily driven by a reduction in the euro exchange rate, as revenues and expenses that originate in British pounds largely offset each other.
Commissions and fees were 20% higher than the first quarter of 2016 due primarily to record revenue in POSIT Alert from institutional and hedge fund clients, which more than offset the impact of reduced trading from sell-side clients and the weaker British pound. Sell-side accounts made up 53% of our European value traded in the first quarter of 2017 compared to 66% in the prior year quarter. This favorable change in business mix together with the higher concentration of business in POSIT Alert pushed our overall commission rate 22% higher than the first quarter of 2016.
Recurring revenues increased 2% from the prior year period due to higher billed revenue for analytics products and higher connectivity fees, partially offset by currency translation. Other revenues were favorable to the prior year period due to
a lower impact of trade errors and client trade accommodations
.
Compensation and employee benefits decreased 6% from the first quarter of 2016 due to the favorable impact of currency translation on costs for employees based in the U.K., the increased use of deferred stock awards in our incentive compensation program to better align employees with the Strategic Operating Plan, and cost savings measures implemented during the second half of 2016.
Transaction processing costs increased 7% from the prior year period due to an 8% growth in daily value traded in British pound terms, offset in part by the impact of currency translation. As a percentage of commissions and fees, transaction processing costs declined to 24.8%, compared to 27.8% in the prior year quarter reflecting the increase in our average commission rate noted above.
Other expenses increased 2% from the first quarter of 2016 due to higher charges for global research and development costs, client connectivity and market data fees, offset in part by the favorable impact of currency translation on U.K.-based expenses.
Asia Pacific Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
12,306
|
|
$
|
9,256
|
|
$
|
3,050
|
|
33
|
%
|
Recurring
|
|
|
1,744
|
|
|
1,504
|
|
|
240
|
|
16
|
%
|
Other
|
|
|
(107)
|
|
|
(3)
|
|
|
(104)
|
|
nm
|
|
Total revenues
|
|
|
13,943
|
|
|
10,757
|
|
|
3,186
|
|
30
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
4,667
|
|
|
4,503
|
|
|
164
|
|
4
|
%
|
Transaction processing
|
|
|
2,831
|
|
|
2,425
|
|
|
406
|
|
17
|
%
|
Other expenses
|
|
|
4,600
|
|
|
4,429
|
|
|
171
|
|
4
|
%
|
Total expenses
|
|
|
12,098
|
|
|
11,357
|
|
|
741
|
|
7
|
%
|
Income (loss) before income tax expense (benefit)
|
|
$
|
1,845
|
|
$
|
(600)
|
|
$
|
2,445
|
|
nm
|
|
nm – not meaningful
Currency translation from a stronger Australian Dollar increased total Asia Pacific revenues and expenses by $0.5 million and $0.2 million, respectively, resulting in an increase of $0.3 million to pre-tax income.
Commissions and fees increased 33% over the first quarter of 2016 due to the growth in higher-rate institutional order flow into POSIT Alert and increased algorithmic trading by clients. The growth in POSIT Alert resulted in a fourth consecutive record quarter for the product in the Asia Pacific region in terms of both daily value traded and commissions.
Recurring revenues increased 16% over the prior year quarter due to the growth in connectivity revenue, while other revenues decreased due to
a larger impact of trade errors and client trade accommodations.
Compensation and employee benefits increased 4% over the first quarter of 2016 due to additional headcount and currency translation. These increases were partially offset by the increased use of deferred stock awards in our incentive compensation program to better align employees with the Strategic Operating Plan and cost savings measures implemented during the second half of 2016.
Transaction processing costs increased 17% from the prior year period, exceeding the 12% growth in value executed, due to higher clearing costs in Hong Kong as well as a larger proportion of our trading in markets where costs are higher. As a percentage of commissions and fees, transaction processing costs decreased to 23.0% from 26.2% last year reflecting the impact of a higher average commission rate.
Oth
er expenses increased 4% compared to the first quarter of 2016 due to the increase in market data and connectivity to support client growth and higher depreciation expenses associated with investments we are making to enhance redundancy and business recovery capabilities, partially offset by lower travel and entertainment expenses.
Corporate
Corporate a
ctivity includes investment income from treasury activity, certain non-operating revenues and other gains as well as costs not associated with operating the businesses within our regional segments. These costs include, among others, (a) the costs of being a public company, such as certain staff costs, a portion of external audit fees, and reporting, filing and listing costs, (b) intangible asset amortization, (c) interest expense, (d) professional fees associated with our global transfer pricing structure, (e) foreign exchange gains or losses and (f) certain non‑operating expenses.
In the first quarter of 2017, we incurred a pre-tax loss from Corporate activities of $6.1 million, reflecting $0.3 million of investment income and $6.4 million of costs, compared to a pre-tax loss of $14.2 million in the prior year period, reflecting $0.3 million of investment income and $14.5 million of costs. The decline in costs compared to the first quarter of 2016 primarily reflects the impact of $2.8 million of costs incurred during the prior year period related to the arbitration with ITG’s former CEO and $2.8 million for the amount expensed for upfront cash and stock awards granted to our current CEO, a significant portion of which replaced compensation he forfeited at his former employer. We also saw reductions in legal fees and intangible amortization
.
Corporate costs can vary from period to period as we work through litigation, regulatory and other corporate matters.
Consolidated income tax expense
Our effective tax rate was a benefit of 39.1% on our pre-tax income in the first quarter of 2017 compared to a benefit of 31.1% on our pre-tax loss in the first quarter of 2016. The significant benefit, despite the pre-tax income in the first quarter of 2017, reflected the impact of the new accounting pronouncement resulting in the recognition of excess tax benefits on employee stock vestings (see Note 2,
Recently Adopted Accounting Standards
, to the condensed consolidated financial statements) , which increased our recorded tax benefit by $1.1 million, together with the combined impact of a higher benefit rate on losses in the U.S., a lower expense rate on earnings in Europe and the lack of tax costs on earnings in Asia Pacific due to the existence of net operating losses that are fully reserved. Our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings. In addition, our ability to continue to recognize tax benefits in the U.S. is dependent on our ongoing assessment of future profitability.
Liquidity and Capital Resources
Liquidity
Our primary source of liquidity is cash provided by operations. Our liquidity requirements result from our working capital needs, which include clearing and settlement activities, as well as our regulatory capital needs. A substantial portion of our assets is liquid, consisting of cash and cash equivalents or assets readily convertible into cash. Cash is principally invested in money market mutual funds. At March 31, 2017, unrestricted cash and cash equivalents totaled $245.4 million. Included in this amount is $116.5 million of cash and cash equivalents held by subsidiaries outside the United States. Due to the December 2015 amendment to the capital structure of our operations outside of North America, which included a deemed dividend on all cumulative undistributed earnings at that time, we currently do not foresee a need to repatriate funds from certain foreign subsidiaries to the U.S. by way of additional dividends. Should we need to do so in the future, our effective tax rate may increase.
As a self‑clearing broker‑dealer in the U.S., we are subject to cash deposit requirements with clearing organizations that may be large in relation to total liquid assets and may fluctuate significantly based upon the nature and size of customers’ trading activity and market volatility. At March 31, 2017, we had interest‑bearing security deposits totaling $17.8 million with clearing organizations in the U.S. for the settlement of equity trades. In the normal course of our U.S. settlement activities, we may also need to temporarily finance customer securities positions from short settlements or delivery failures. These financings may be funded from existing cash resources, borrowings under stock loan transactions or short‑term bank loans under our committed facility. On January 27, 2017, we entered into a new $150 million 364‑day revolving credit agreement (the “Credit Agreement”) in the U.S. with a syndicate of banks and JPMorgan Chase Bank, N.A., as Administrative Agent (see Note 10,
Borrowings
, to the condensed consolidated financial statements).
We also self‑clear equity trades in Australia, maintaining a deposit with clearing organizations of $2.3 million at March 31, 2017. We continue to maintain a $1.6 million clearing deposit in Hong Kong, which is expected to be released in the coming months now that we have migrated to a third-party clearing provider (see discussion in
Regulatory Capital
below). In Europe, we maintained $1.4 million in restricted cash related to protected client funds and we had deposits with our clearing and settlement agents of $35.7 million at March 31, 2017.
Capital Resources
Capital resource requirements relate to capital purchases, as well as business investments, and are generally funded from operations. When required, as in the case of a major acquisition, our strong cash generating ability has historically allowed us to access U.S. capital markets.
Operating Activities
The table below summarizes the effect of the major components of operating cash flow.
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
(in thousands)
|
|
2017
|
|
2016
|
|
Net income (loss)
|
|
$
|
5,302
|
|
$
|
(2,506)
|
|
Non-cash items included in net income (loss)
|
|
|
12,694
|
|
|
26,846
|
|
Effect of changes in receivables/payables from/to customers and brokers
|
|
|
(71,085)
|
|
|
(11,605)
|
|
Effect of changes in other working capital and operating assets and liabilities
|
|
|
(9,052)
|
|
|
(45,344)
|
|
Net cash used in operating activities
|
|
$
|
(62,141)
|
|
$
|
(32,609)
|
|
Our operating activities typically result in the use of cash in the first quarter of an annual period due to the impact of paying the cash portion of the prior year’s incentive compensation and for increased settlement receivables. The net cash used in operating activities during the three months ended March 31, 2017 was higher than the amount used in the prior year period due to an increase in cash used in settlement activities, which was largely offset by a $57.6 million increase in short-term bank loans reflected in financing activities. The decrease in cash used for other working capital changes as compared to the prior year quarter reflects in part the reduction in restricted cash required in Hong Kong following the migration to a third-party clearing solution (see discussion in
Regulatory Capital
below) and an increase in accrued research payables under client commission arrangements, partially offset by the payment to the SEC in January 2017 for the settlement of the inquiry into ITG Inc.’s discontinued activity with respect to pre-released American Depository Receipts.
In the normal course of our clearing and settlement activities worldwide, cash is typically used to fund restricted or segregated cash accounts (under regulations and otherwise), broker and customer fails to deliver/receive, securities borrowed, deposits with clearing organizations and net activity related to receivables/payables from/to customers and brokers. The cash requirements vary from day to day depending on value transacted and customer trading patterns.
Investing Activities
Net cash used in investing activities of $10.2 million during the three months ended 2017 includes investments in software development projects, computer hardware and office space.
Financing Activities
Net cash provided by financing activities of $40.1 million primarily reflects proceeds from short‑term bank borrowings that are used to support our settlement activities partially offset by repurchases of ITG common stock, our dividend program, shares withheld for net settlements of share‑based awards and repayments of long‑term debt.
During the first three months of 2017, we repurchased approximately 0.6 million shares of our common stock at a cost of $13.1 million, which was funded from our available cash resources. Of these shares, nearly 0.2 million were purchased under our Board of Directors’ authorization for a total cost of $3.2 million (average cost of $19.85 per share). In addition, nearly 0.5 million shares were repurchased for $9.9 million pertaining solely to the satisfaction of minimum statutory withholding tax upon the net settlement of equity awards. As of March 31, 2017, the total remaining number of shares currently available for repurchase under ITG’s stock repurchase program was 1.3 million. The specific timing and amount of repurchases will vary depending on various factors, including, among others, market conditions and competing needs for the use of our capital. We may elect to conduct future share repurchases through open market purchases, private transactions or automatic share repurchase programs under SEC Rule 10b5-1.
Regulatory Capital
ITG Inc., AlterNet and ITG Derivatives are subject to the SEC’s Uniform Net Capital Rule (Rule 15c3‑1), which requires the maintenance of minimum net capital. ITG Inc. has elected to use the alternative method permitted by Rule 15c3‑1, which requires that ITG Inc. maintain minimum net capital equal to the greater of $1.0 million or 2% of aggregate debit balances arising from customer transactions, as defined. AlterNet and ITG Derivatives have elected to use the basic method permitted by Rule 15c3‑1, which requires that they each maintain minimum net capital equal to the greater of 6
2
/
3
% of aggregate indebtedness or $100,000. Dividends or withdrawals of capital cannot be made if capital is needed to comply with regulatory requirements.
Net capital balances and the amounts in excess of required net capital at March 31, 2017 for the U.S. Operations are as follows (dollars in thousands):
|
|
|
|
|
|
|
|
U.S. Operations
|
|
Net Capital
|
|
Excess
|
|
ITG Inc.
|
|
$
|
79,820
|
|
$
|
78,820
|
|
AlterNet
|
|
|
3,239
|
|
|
3,077
|
|
ITG Derivatives
|
|
|
860
|
|
|
760
|
|
As of March 31, 2017, ITG Inc. had $8.9 million of cash in a special reserve bank account for the benefit of customers under the Customer Protection Rule pursuant to SEC Rule 15c3-3 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and $2.5 million under proprietary accounts of broker dealers.
In addition, our Canadian, European and Asia Pacific Operations have subsidiaries with regulatory capital requirements. The regulatory net capital balances and amount of regulatory capital in excess of the minimum requirements applicable to each business at March 31, 2017, is summarized in the following table (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
Net Capital
|
|
Excess
|
|
Canadian Operations
|
|
|
|
|
|
|
|
Canada
|
|
$
|
24,984
|
|
$
|
24,610
|
|
European Operations
|
|
|
|
|
|
|
|
Ireland
|
|
|
70,313
|
|
|
33,333
|
|
U.K.
|
|
|
1,955
|
|
|
1,173
|
|
Asia Pacific Operations
|
|
|
|
|
|
|
|
Australia
|
|
|
22,990
|
|
|
12,466
|
|
Hong Kong
|
|
|
2,840
|
|
|
2,403
|
|
Singapore
|
|
|
1,025
|
|
|
954
|
|
During the three months ended March 31, 2017, we migrated from self-clearing in Hong Kong to the use of a third-party clearer which settles trades executed in Hong Kong on behalf of ITG Australia Limited. Since capital requirements with respect to unsettled trades are generally lower in Australia than Hong Kong, we expect this migration to reduce our overall peak capital requirements in the Asia Pacific region by at least $10 million.
Liquidity and Capital Resource Outlook
Historically, our working capital, stock repurchase, dividend program and investment activity requirements have been funded from cash from operations and short‑term loans, with the exception of strategic acquisitions, which at times have required long‑term financing. We believe that our cash flow from operations, existing cash balances and our available credit facilities will be sufficient to meet our ongoing operating cash and regulatory capital needs, while also complying with the terms of the Credit Agreement. However, our ability to borrow additional funds may be impacted by financial lending institutions’ ability or willingness to lend to us on commercially acceptable terms.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
We are a member of various U.S. and non-U.S. exchanges and clearing houses that trade and clear, respectively, equities and/or derivative contracts. Associated with our membership, we may be required to pay a proportionate share of financial obligations of another member who may default on its obligations to the exchanges or the clearing house. While the rules governing different exchange or clearinghouse memberships vary, in general, our
guarantee obligations would arise only if the exchange had previously exhausted its resources. The maximum potential payout under these memberships cannot be estimated. We have not recorded any contingent liability in the condensed consolidated financial statements for these agreements and believe that any potential requirement to make payments under these agreements is remote.
As of March 31, 2017, our other contractual obligations and commercial commitments consisted principally of fixed charges, including minimum future rentals under non-cancelable operating leases, minimum future purchases under non-cancelable purchase agreements and compensation under employment agreements.
There has been no significant change to such arrangements and obligations since December 31, 2016.
New Accounting Pronouncements
In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017‑04,
Intangibles – Goodwill and other (Topic 350): Simplifying the test for goodwill impairment.
The amendments in this ASU
address concerns over the cost and complexity of the two-step goodwill impairment test and removes the second step of the test. An entity will apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment.
ASU 2017‑04 is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. We are currently evaluating the new guidance and have not yet determined the impact of adoption on our financial statements.
In November 2016, the FASB issued ASU 2016‑18,
Statement of Cash Flows (Topic 230): Restricted Cash.
The amendments in this ASU
require that the statement of cash flows explain the change during the period in the total of cash, cash equivalents and restricted cash. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016‑18 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the new guidance and have not yet determined the impact of adoption on our financial statements.
In August 2016, the FASB issued ASU 2016-15,
Statement of Cash Flows (Topic 230): Classification of certain cash receipts and cash payments
. The amendments in this ASU provide specific guidance for eight specific cash flow classification issues, with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230,
Statement of Cash Flows
. These amendments are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the new guidance and have not yet determined the impact of adoption on our financial statements.
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842)
, which requires lessees to recognize leases on the balance sheet and disclose key information about leasing arrangements. The new standard requires a lessee to recognize an asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as finance or operating, with classification affecting the pattern of expense recognition in the income statement. Classification will be based on criteria that are largely similar to those applied in current lease accounting, but more significant management judgment will be required. The new standard is effective for us on January 1, 2019, with early adoption permitted. A modified retrospective transition approach is required for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently evaluating the effect of adoption of the new standard and expect that it will have a material effect on our financial statements. We currently believe the most significant changes relate to real estate and office and equipment operating leases. We do not expect a significant change in our leasing activity between now and adoption.
In May 2014, the FASB issued ASU 2014‑09,
Revenue from Contracts with Customers
. The standard provides companies with a single five step revenue recognition model for use in accounting for revenue arising from contracts with customers and supersedes current revenue recognition guidance, including industry‑specific revenue guidance. The core principle of the model is to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or
services. ASU 2014‑09 applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification. The standard will also require significant additional qualitative and quantitative disclosures describing the nature, amount, timing, and uncertainty of revenues. Entities have the option of using either a full retrospective or modified approach to adopt ASU 2014‑09. The original standard was effective for fiscal years beginning after December 15, 2016, however, in April 2015, the FASB proposed a one‑year deferral of this standard, with a new effective date for fiscal years beginning after December 15, 2017. We are currently in the assessment phase of our evaluation of this guidance, where we are identifying and documenting the in-scope revenue streams, facilitating scoping interviews to identify complexity of arrangements and reviewing written customer contracts. We have not yet selected a transition method, nor will we determine the impact of adoption on our financial statements, until we complete the assessment phase.
Critical Accounting Estimates
There has been no significant change to our critical accounting estimates, which are more fully described in Item 7,
Management’s Discussion and Analysis of Financial Condition and Results of Operations
, in our Annual Report on Form 10-K for the year ended December 31, 2016.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Please see our Annual Report on Form 10-K (Item 7A) for the year ended December 31, 2016. There has been no material change in this information.
Item 4. Controls and Procedures
|
a)
|
|
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.
|
|
b)
|
|
Changes in Internal Control over Financial Reporting.
There were no changes in our internal control over financial reporting during the quarter ended March 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
|