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 around the world. ITG empowers traders to reduce the end-to-end cost of implementing investments via 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 15,
Segment Reporting
, to the condensed consolidated financial statements). These four operating segments provide the following categories of products and services:
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·
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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 single stock sales trading desks providing execution expertise and (d) futures and options trading
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|
·
|
|
Workflow Technology — includes trade order and execution management software applications in addition to network connectivity
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|
·
|
|
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
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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.
As a result of the new revenue recognition standard (see discussion in
New Accounting Pronouncements
below), which we intend to adopt on January 1, 2018, we have identified two key accounting changes that will affect the timing of revenue recognition as it relates to bundled commission arrangements and fees for licenses of functional intellectual property. We are currently assessing the financial impact of these accounting changes but expect (1) a deferral of revenues generated in the first half of the year for commissions attributable to analytics products under bundled arrangements that will be recognized over the course of the year as the performance obligations for those analytics products are satisfied and (2) an acceleration of license fee revenues to the delivery date for software provided for a specified period. These changes only relate to the timing of when revenue is recognized and have no effect on the underlying transaction price of the products and services we perform. For more information on our evaluation of the revenue recognition standard and its impact on our financial statements, refer to
New Accounting Pronouncements
below.
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 competitive environment 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 revenues, adjusted expenses, adjusted pre-tax (loss) income, adjusted income tax expense (benefit) and adjusted net (loss) income, 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 revenues, adjusted expenses, adjusted pre-tax (loss) income, adjusted income tax expense (benefit) and adjusted net (loss) income to revenues, expenses, (loss) income before income tax expense (benefit), income tax expense (benefit) and net loss and related per share amounts as determined in accordance with U.S.
GAAP for the three and nine months ended September 30, 2017 and September 30, 2016, respectively, are provided below (dollars in thousands except per share amounts).
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|
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|
|
|
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|
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|
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|
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Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
September 30
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Total revenues
|
|
$
|
114,531
|
|
$
|
104,185
|
|
$
|
356,947
|
|
$
|
349,463
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
Other revenues - gains
(1)
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|
|
—
|
|
|
—
|
|
|
—
|
|
|
(2,438)
|
Adjusted revenues
|
|
$
|
114,531
|
|
$
|
104,185
|
|
$
|
356,947
|
|
$
|
347,025
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses
|
|
$
|
116,486
|
|
$
|
131,983
|
|
$
|
350,004
|
|
$
|
390,557
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment of customer intangible asset
(2)
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|
|
(325)
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|
|
—
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|
|
(325)
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|
|
—
|
Legal costs related to the planned formation of the derivatives venture
(2)
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|
|
(750)
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|
|
—
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|
(750)
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|
|
—
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Reserve for settlement related to ADRs and associated costs
(3)
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|
|
—
|
|
|
(23,743)
|
|
|
—
|
|
|
(23,743)
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Restructuring
(4)
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(4,355)
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Upfront compensation awards for current CEO
(5)
|
|
|
—
|
|
|
(541)
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|
|
—
|
|
|
(3,857)
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Arbitration case with former CEO and associated costs
(6)
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|
|
—
|
|
|
941
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|
|
—
|
|
|
(6,580)
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Gain from currency translation adjustment
(7)
|
|
|
—
|
|
|
1,066
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|
|
—
|
|
|
1,066
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Adjusted expenses
|
|
$
|
115,411
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|
$
|
109,706
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|
$
|
348,929
|
|
$
|
353,088
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before income tax expense (benefit)
|
|
$
|
(1,955)
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|
$
|
(27,798)
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|
$
|
6,943
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|
$
|
(41,094)
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Effect of adjustments
|
|
|
1,075
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|
|
22,277
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|
|
1,075
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|
|
35,031
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Adjusted pre-tax (loss) income
|
|
$
|
(880)
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|
$
|
(5,521)
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|
$
|
8,018
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|
$
|
(6,063)
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|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense (benefit)
|
|
$
|
45,012
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|
$
|
(3,887)
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|
$
|
43,965
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|
$
|
(9,460)
|
Tax effect of adjustments
(1) (3) (4) (5) (6)
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|
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—
|
|
|
1,125
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|
|
—
|
|
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5,101
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Valuation allowance for U.S. deferred tax assets arising in periods prior to the third quarter of 2017
(8)
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|
|
(42,262)
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|
|
—
|
|
|
(42,262)
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|
|
—
|
Adjusted income tax expense (benefit)
|
|
$
|
2,750
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|
$
|
(2,762)
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|
$
|
1,703
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|
$
|
(4,359)
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|
|
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|
|
|
|
|
|
|
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|
Net loss
|
|
$
|
(46,967)
|
|
$
|
(23,911)
|
|
$
|
(37,022)
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|
$
|
(31,634)
|
Net effect of adjustments
|
|
|
43,337
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|
|
21,152
|
|
|
43,337
|
|
|
29,930
|
Adjusted net (loss) income
|
|
$
|
(3,630)
|
|
$
|
(2,759)
|
|
$
|
6,315
|
|
$
|
(1,704)
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|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted loss per share
|
|
$
|
(1.42)
|
|
$
|
(0.73)
|
|
$
|
(1.12)
|
|
$
|
(0.96)
|
Net effect of adjustments
|
|
|
1.31
|
|
|
0.65
|
|
|
1.30
|
|
|
0.91
|
Adjusted diluted (loss) income per share
|
|
$
|
(0.11)
|
|
$
|
(0.08)
|
|
$
|
0.18
|
|
$
|
(0.05)
|
|
(1)
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|
In the second quarter of 2016, we received insurance proceeds of $2.4 million from our corporate insurance carrier to settle a claim for lost profits arising from an August 2015 outage in our outsourced primary data center in the U.S. Additionally, we generated a nominal gain on the completion of the sale of our investment research operations in May 2016.
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|
(2)
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|
In the third quarter of 2017, we deemed the remaining value of a customer intangible asset recorded in ITG Derivatives of $0.3 million fully impaired and incurred legal fees related to the planned formation of the Matrix venture of $0.8 million (Note: the venture is expected to launch by the first quarter of 2018 subject to the receipt of required regulatory approvals and satisfaction of other customary closing conditions).
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|
(3)
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|
In the third quarter of 2016, we accrued $22.1 million for a settlement with the SEC with respect to an inquiry involving discontinued activity in pre-released ADRs and incurred legal fees related to this matter of $1.6 million.
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(4)
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During the first half of 2016, we incurred restructuring charges of $4.4 million related to (a) the reduction in our high-touch trading and sales organizations and (b) the closing of our U.S. matched-book securities lending operations and our Canadian arbitrage trading desk.
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|
(5)
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Our current Chief Executive Officer was granted cash and stock awards 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.
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|
(6)
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|
In the first half of 2016, we incurred a charge of $4.8 million, net of an insurance recovery of $0.5 million, to settle an arbitration case with our former CEO and incurred legal fees of $2.7 million. In the third quarter of 2016, we recorded a reimbursement of $0.9 million of these legal fees from our insurance carrier.
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|
(7)
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|
In the third quarter of 2016, we substantially completed the liquidation of our investment in our Israel entity that ceased operations in December 2013. During our period of ownership and through December 2013, we had accumulated foreign exchange translation gains as a component of equity, which have been reclassified as a gain that reduced other general and administrative expenses in the Consolidated Statement of Operations.
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|
(8)
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|
In the third quarter of 2017, we determined that it was appropriate to establish a full valuation allowance on our U.S. deferred tax assets, of which $42.3 million related to periods prior to the third quarter of 2017.
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Executive Summary for the Quarter Ended September 30, 2017
Consolidated Overview
Our results for the third quarter were mixed. While we continued to achieve strong results in our international operations, including record levels of revenue and profits in Asia Pacific, weak market-wide volumes in the U.S. weighed on our consolidated performance. The challenging quarter in the U.S. resulted in a cumulative pre-tax loss in the U.S. tax jurisdiction over the previous three years, leading to a full valuation allowance on our U.S. deferred tax assets. Prevailing accounting guidance limits our ability to consider other subjective evidence to support deferred tax assets, such as forecasts of future profits, when objective verifiable evidence such as a cumulative loss exists. The establishment of this valuation allowance does not limit our ability to utilize the underlying deferred tax assets against future profits in the U.S. jurisdiction.
Our revenues during the third quarter of 2017 were $114.5 million, 10% higher than the third quarter of 2016 due largely to the growth in global block crossing through POSIT Alert. On a U.S. GAAP basis, we incurred a net loss of $47.0 million, or $1.42 per diluted share in the third quarter of 2017, compared to a net loss of $23.9 million, or $0.73 per diluted share in the third quarter of 2016. Our GAAP loss in the third quarter of 2017 included a non-cash charge of $42.3 million, or $1.28 per diluted share, to establish the full valuation allowance on U.S deferred tax assets that arose in prior periods mentioned above and charges of $1.1 million, or $0.03 per diluted share, related to the planned formation of the Matrix venture. On an adjusted basis excluding those items, we generated a loss of $3.6 million, or $0.11 per diluted share in the third quarter of 2017 compared to an adjusted loss of $2.8 million, or $0.08 per diluted share, in the third quarter of 2016. Unlike the prior-year period, the adjusted loss in the third quarter of 2017 does not include the impact of deferred tax benefits on the adjusted pre-tax loss in the U.S. jurisdiction during the quarter totaling $5.5 million, or $0.16 per diluted share.
During the third quarter, we continued to implement cost efficiencies with staff reductions that are expected to save nearly $3 million in annual costs. This action resulted in a charge for employee termination costs of $1.7 million, or $0.05 per share. The cost reduction measures we have implemented since the third quarter of 2016 are now approaching annual savings of $20 million and are fully funding investments we are making in growth initiatives under the Strategic Operating Plan (“SOP”) and in strategic hires for our U.S. sales and coverage teams. We also expect to take additional steps to further improve our operating efficiency, including the consolidation of office space at our New York headquarters in the fourth quarter, and the streamlining of our derivatives offering upon the closing of the Matrix venture, which is expected to occur by the first quarter of 2018.
We are continuing our focus on growth through the execution of our SOP, 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 with the expectation that we will meaningfully grow market share, revenues and profitability on a global basis. As of September 30, 2017, we have identified 58 employees that are or will be fully dedicated to executing the plan and our total investment under the plan since its inception in late July 2016 is more than $15 million.
Segment Discussions
In the U.S., we are working to narrow the profitability gap in the face of weaker market volumes where average daily trading in U.S. equities fell to a three-year low of 6.1 billion shares in the third quarter of 2017, down 8% from the
third quarter of 2016. Our U.S. average daily volume (“ADV”) was 8% higher than the third quarter of 2016, outperforming market-wide volumes driven in part by increased trading in POSIT Alert, where our ADV was up 30% from the third quarter of 2016.
Trading activity in Canada held up well during the quarter despite lower market-wide volumes. Commissions and fees were 11% higher than the third quarter of 2016 while market-wide volumes were down 14% versus the prior year quarter. This outperformance reflected growth in activity from buy-side clients.
In Europe, our executed daily value was 11% higher in British pound terms than the third quarter of 2016, slightly outperforming the 9% increase in market-wide trading activity. This outperformance reflected increased activity from buy-side clients that was partially offset by reduced activity from sell-side clients. The growth in buy-side activity was largely driven by increased block crossing in POSIT Alert.
In Asia Pacific, we achieved record revenues and profitability. Asia Pacific commissions and fees increased 22% over the prior-year quarter, significantly outpacing the 12% growth in overall market-wide trading activity, driven by another record quarter for value traded in POSIT Alert and increased algorithmic and portfolio trading by clients. Our pre-tax profit in Asia Pacific increased to $2.9 million with a margin of 19%, compared with a pre-tax profit of $0.9 million and a margin of 7% in the prior-year quarter.
Corporate activity in the third quarter of 2017 reduced pre-tax income by $6.2 million compared to a pre-tax reduction of $26.4 million in the third quarter of 2016. The lower pre-tax loss reflects the impact of costs incurred during the prior-year period related to a reserve for a settlement with the SEC related to an inquiry involving discontinued activity in pre-released ADRs and related legal fees, as well as costs for the continued expensing of upfront awards to our current CEO, a significant portion of which replaced awards he forfeited at his former employer.
Capital Resource Allocation
During the third quarter of 2017, we repurchased 119,727 shares under our authorized repurchase program for $2.4 million, or an average cost of $20.22 per share, and we maintained our $0.07 quarterly dividend program, paying out $2.3 million in cash. On a year-to-date basis, we have repurchased 371,704 shares under our authorized repurchase program for $7.4 million, or an average cost of $19.92 per share and we have paid cash dividends of $6.9 million.
Our goal over the long term is to use our share repurchase program to offset dilution from the issuance of stock under employee compensation plans, although the number of shares repurchased may vary from period to period. 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 September 30, 2017 Compared to Three Months Ended September 30, 2016
U.S. Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
34,618
|
|
$
|
35,739
|
|
$
|
(1,121)
|
|
(3)
|
%
|
Recurring
|
|
|
11,855
|
|
|
12,430
|
|
|
(575)
|
|
(5)
|
%
|
Other
|
|
|
930
|
|
|
605
|
|
|
325
|
|
54
|
%
|
Total revenues
|
|
|
47,403
|
|
|
48,774
|
|
|
(1,371)
|
|
(3)
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
26,423
|
|
|
25,527
|
|
|
896
|
|
4
|
%
|
Transaction processing
|
|
|
8,711
|
|
|
8,797
|
|
|
(86)
|
|
(1)
|
%
|
Other expenses
|
|
|
21,263
|
|
|
22,978
|
|
|
(1,715)
|
|
(7)
|
%
|
Total expenses
|
|
|
56,397
|
|
|
57,302
|
|
|
(905)
|
|
(2)
|
%
|
Loss before income tax benefit
|
|
$
|
(8,994)
|
|
$
|
(8,528)
|
|
$
|
(466)
|
|
(5)
|
%
|
Commissions and fees declined 3% compared to the prior-year period due primarily to a decline in our overall revenue per share. Our ADV increased 8% over the third quarter of 2016, despite an 8% decrease in total daily U.S. market volumes. This outperformance pushed our market share for the quarter to 2.06%, well above our market share of 1.75% in the third quarter of 2016. Our revenue per share declined from $0.0041 to $0.0036, driven by a lower average revenue per share earned on net executions with sell-side clients and movements within the mix of our volume amongst our buy-side clients. ADV from sell-side clients comprised 52% of our overall ADV, consistent with the prior-year period.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
U.S. Operations: Key Indicators*
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
|
Total trading volume (in billions of shares)
|
|
|
7.9
|
|
|
7.4
|
|
|
0.5
|
|
7
|
%
|
Average trading volume per day (in millions of shares)
|
|
|
125.0
|
|
|
115.5
|
|
|
9.5
|
|
8
|
%
|
Average revenue per share
|
|
$
|
0.0036
|
|
$
|
0.0041
|
|
$
|
(0.0005)
|
|
(12)
|
%
|
U.S. market trading days
|
|
|
63
|
|
|
64
|
|
|
(1)
|
|
(2)
|
%
|
* Excludes activity from ITG Net commission share arrangements.
Recurring revenues were down 5% from the third quarter of 2016 primarily reflecting lower OMS subscriptions and connectivity revenue due to client attrition.
Other revenues increased $0.3 million from the third quarter of 2016 due to higher market data tape rebates and higher commission aggregation revenue, as well as lower client trade accommodations.
Compensation and employee benefits increased 4% from the third quarter of 2016 due to the impact of $1.7 million of employee separation costs, increased headcount dedicated to the SOP and strategic hires for our sales and coverage teams. These increases were partially offset by cost savings measures implemented during the second half of 2016 and throughout 2017.
Transaction processing costs decreased 1% from the prior-year period, despite the 8% increase in our ADV, due in part to the impact of a higher crossing rate in POSIT, lower execution costs from a shifting mix in client business and a reduction in fixed clearing costs. As a percentage of commission and fees, transaction processing costs increased to 25.2% in the third quarter of 2017 from 24.6% in the third quarter of 2016 due primarily to the impact of the reduction in the average revenue per share.
Other expenses decreased 7% from the third quarter of 2016 due to reduced energy research costs from the amendment to terminate the original energy research distribution agreement. We also saw lower travel and entertainment costs and an increase in the amount of global research and development costs charged out to other regions.
Canadian Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
12,902
|
|
$
|
11,607
|
|
$
|
1,295
|
|
11
|
%
|
Recurring
|
|
|
1,307
|
|
|
1,255
|
|
|
52
|
|
4
|
%
|
Other
|
|
|
846
|
|
|
857
|
|
|
(11)
|
|
(1)
|
%
|
Total revenues
|
|
|
15,055
|
|
|
13,719
|
|
|
1,336
|
|
10
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
4,674
|
|
|
4,466
|
|
|
208
|
|
5
|
%
|
Transaction processing
|
|
|
2,916
|
|
|
2,055
|
|
|
861
|
|
42
|
%
|
Other expenses
|
|
|
6,060
|
|
|
5,702
|
|
|
358
|
|
6
|
%
|
Total expenses
|
|
|
13,650
|
|
|
12,223
|
|
|
1,427
|
|
12
|
%
|
Income before income tax expense
|
|
$
|
1,405
|
|
$
|
1,496
|
|
$
|
(91)
|
|
(6)
|
%
|
Currency translation from a stronger Canadian Dollar increased total Canadian revenues and expenses by $0.5 million and $0.4 million, respectively, resulting in an increase of $0.1 million to pre-tax income.
Commissions and fees were 11% higher than the third quarter of 2016, despite a 14% decline in market-wide volumes for the same period due to growth in activity from buy-side clients and favorable currency translation.
Recurring revenues and other revenues were comparable to the prior-year period.
Compensation and employee benefits costs increased 5% compared to the third quarter of 2016 due primarily to currency translation.
Transaction processing costs increased 42% over the prior-year period, significantly exceeding the growth in commission and fees, due primarily to an increase in the proportion of our execution activity where we took liquidity, an increase in third-party order routing costs and an increase in the number of settlement tickets processed. As a percentage of commissions and fees, transaction processing increased to 22.6% from 17.7% in the prior-year period.
Other expenses increased 6% from the third quarter of 2016 due to higher charges for global research and development costs and increases in hardware depreciation and consulting costs.
European Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
32,393
|
|
$
|
25,062
|
|
$
|
7,331
|
|
29
|
%
|
Recurring
|
|
|
3,946
|
|
|
4,013
|
|
|
(67)
|
|
(2)
|
%
|
Other
|
|
|
(83)
|
|
|
(181)
|
|
|
98
|
|
54
|
%
|
Total revenues
|
|
|
36,256
|
|
|
28,894
|
|
|
7,362
|
|
25
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
9,631
|
|
|
8,698
|
|
|
933
|
|
11
|
%
|
Transaction processing
|
|
|
8,675
|
|
|
7,284
|
|
|
1,391
|
|
19
|
%
|
Other expenses
|
|
|
9,028
|
|
|
8,203
|
|
|
825
|
|
10
|
%
|
Total expenses
|
|
|
27,334
|
|
|
24,185
|
|
|
3,149
|
|
13
|
%
|
Income before income tax expense
|
|
$
|
8,922
|
|
$
|
4,709
|
|
$
|
4,213
|
|
89
|
%
|
Overall currency rate changes in the European region increased revenues and expenses by $0.9 million and $0.4 million, respectively, resulting in an increase of $0.5 million to pre-tax income.
Commissions and fees were 29% higher than the third quarter of 2016 due primarily to a significant increase in block crossing in POSIT Alert, higher algorithmic trading and single stock sales trading from institutional and hedge
fund clients and favorable currency translation.
This growth more than offset the impact of reduced trading from sell-side clients. Sell-side clients made up 42% of our European value traded in the third quarter of 2017 compared to 60% in the prior-year quarter. This favorable change in business mix pushed our overall commission rate 20% higher than the third quarter of 2016.
Recurring revenue declined 2% from the prior-year period due to lower OMS connectivity and RFQ-hub maintenance fees while other revenues were favorable to the prior-year period due to a lower impact from client trade accommodations.
Compensation and employee benefits increased 11% from the third quarter of 2016 due to higher headcount associated with our continued investment in technology and operational staff to invest in our growth initiatives and prepare for MiFID II, along with the impact of currency translation.
Transaction processing costs increased 19% from the prior-year period, reflecting a 9% growth in daily value traded and increases in rebates paid to introducing brokers, third-party order routing costs, and ETF execution costs. We also incurred higher settlement financing costs and had an increase from currency translation. As a percentage of commissions and fees, transaction processing costs fell to 26.8%, compared to 29.1% in the prior-year period due primarily to the impact of the increased overall commission rate.
Other expenses increased 10% from the third quarter of 2016 due to higher charges for global research and development costs, new exchange distribution fees and higher connectivity, as well as higher consulting, software maintenance, licensing and hardware depreciation costs as we continue to invest in our growth initiatives and prepare for MiFID II.
Asia Pacific Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
13,562
|
|
$
|
11,075
|
|
$
|
2,487
|
|
22
|
%
|
Recurring
|
|
|
1,822
|
|
|
1,516
|
|
|
306
|
|
20
|
%
|
Other
|
|
|
(57)
|
|
|
(89)
|
|
|
32
|
|
36
|
%
|
Total revenues
|
|
|
15,327
|
|
|
12,502
|
|
|
2,825
|
|
23
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
4,411
|
|
|
4,450
|
|
|
(39)
|
|
(1)
|
%
|
Transaction processing
|
|
|
3,126
|
|
|
2,663
|
|
|
463
|
|
17
|
%
|
Other expenses
|
|
|
4,852
|
|
|
4,488
|
|
|
364
|
|
8
|
%
|
Total expenses
|
|
|
12,389
|
|
|
11,601
|
|
|
788
|
|
7
|
%
|
Income before income tax expense
|
|
$
|
2,938
|
|
$
|
901
|
|
$
|
2,037
|
|
226
|
%
|
Overall currency rate changes decreased revenues by $0.2 million, due to a weaker Japanese Yen, with virtually no impact on expenses, due to a stronger Australian dollar, resulting in a $0.2 million unfavorable impact on pretax income.
Commissions and fees increased 22% over the prior-year period primarily due to strong order flows into the Hong Kong, Japan and Korea markets and the increased use of our trading algorithms and our POSIT Alert block crossing system where we had another record quarter for value traded. We also had higher commission sharing revenues from trades executed through our Triton EMS and for trading technology outsourced to regional broker-dealers.
Recurring revenues increased 20% from the third quarter of 2016 due to the increase in connectivity revenue, while other revenues increased due to lower client trading accommodations.
Compensation and employee benefits costs decreased 1% from the prior-year period due to the impact of stock award forfeitures and lower cash bonus accruals from the increased use of deferred stock awards in our incentive compensation program to better align employees with the SOP.
Transaction processing costs increased 17% from the third quarter of 2016, higher than the 10% growth in daily value executed, due primarily to the impact of 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 24.0% due to the impact of a higher average commission rate.
Other expenses increased 8% from the prior-year period due to higher depreciation expenses associated with investments we are making to enhance redundancy and business recovery capabilities and higher charges for global research and development costs.
Corporate
Corporate activity 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 third quarter of 2017, we incurred a pre-tax loss from Corporate activities of $6.2 million, reflecting $0.5 million of revenues and $6.7 million of costs, compared to a pre-tax loss of $26.4 million in the prior-year period, reflecting $0.3 million of revenues and $26.7 million of costs. The increase in revenues reflects higher investment income. The decline in costs compared to the third quarter of 2016 reflects costs incurred in the prior-year period for the reserve for a settlement with the SEC related to an inquiry involving discontinued activity in pre-released ADRs and related legal fees, as well as costs for the continued expensing of upfront cash and stock awards granted to our current CEO, a significant portion of which replaced awards he forfeited at his former employer. These costs were reduced by a gain of $1.1 million to recognize into earnings foreign translation gains that were previously recorded directly to equity following the substantial liquidation of our Israel entity and a recovery of $0.9 million from our insurance carrier for legal fees related to the arbitration case with our former CEO. Corporate costs in the third quarter of 2017 included $0.3 million of asset impairment costs and $0.8 million in legal fees associated with the planned formation of the Matrix venture. Corporate costs, including legal expenses, can vary from period to period as we work through litigation, regulatory and other corporate matters.
Consolidated income tax expense
In the third quarter of 2017, we reported a tax expense of $45.0 million on a pre-tax loss of $2.0 million. The significant tax expense in the current quarter reflected the impact of a full valuation allowance on U.S. deferred tax assets, giving rise to an additional non-cash charge of $48.1 million, of which $42.3 million related to assets that arose in prior periods. We made our assessment after applying the appropriate weighting to both positive and negative evidence related to whether it is more-likely than not that some or all of our deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we considered our cumulative pre-tax loss in the U.S. jurisdiction over the previous three years as a significant piece of negative evidence. Prevailing accounting guidance limits our ability to consider other subjective evidence to support deferred tax assets, such as projections of future profits, when objective verifiable evidence such as a cumulative loss exists. In the third quarter of 2016, we reported a tax benefit of $3.9 million, on our pre-tax loss of $27.8 million, resulting in an effective rate of 14.0%. The low effective rate in the prior-year period reflects the impact of the non-deductibility of a substantial portion of the $22.1 million reserve for the ADR matter. This was partially offset by a higher tax benefit recorded on the pre-tax losses in our U.S. Operations and from our other Corporate activities (most of which was incurred in the U.S.), the lower expense rate incurred on our pre-tax earnings in Europe and the benefit of pre-tax income in Asia Pacific, where we do not currently incur tax expense due to cumulative losses.
Our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings.
Results of Operations — Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016
U.S. Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
115,268
|
|
$
|
128,806
|
|
$
|
(13,538)
|
|
(11)
|
%
|
Recurring
|
|
|
35,658
|
|
|
42,728
|
|
|
(7,070)
|
|
(17)
|
%
|
Other
|
|
|
2,633
|
|
|
2,143
|
|
|
490
|
|
23
|
%
|
Total revenues
|
|
|
153,559
|
|
|
173,677
|
|
|
(20,118)
|
|
(12)
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
79,264
|
|
|
82,378
|
|
|
(3,114)
|
|
(4)
|
%
|
Transaction processing
|
|
|
29,706
|
|
|
28,918
|
|
|
788
|
|
3
|
%
|
Other expenses
|
|
|
65,217
|
|
|
71,678
|
|
|
(6,461)
|
|
(9)
|
%
|
Total expenses
|
|
|
174,187
|
|
|
182,974
|
|
|
(8,787)
|
|
(5)
|
%
|
Loss before income tax benefit
|
|
$
|
(20,628)
|
|
$
|
(9,297)
|
|
$
|
(11,331)
|
|
nm
|
|
nm – not meaningful
Commissions and fees declined 11% compared to the prior-year period due primarily to a decline in our overall revenue per share. Our ADV increased 4% over the prior year period despite a nearly 17% decrease in average daily U.S. market volumes. This outperformance pushed our market share for the first nine months of 2017 to 2.14%, well above our market share of 1.82% in the first nine months of 2016. Our overall revenue per share declined 14% from $0.0042 to $0.0036 driven by significant movements within the mix of our volume amongst our client segments as well as decreased single stock sales trading from headcount reductions to that team following the sale of our remaining investment research operations in May 2016. ADV from our lower priced sell-side accounts increased to 55% of our overall ADV compared with 52% for the prior-year period.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
U.S. Operations: Key Indicators*
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Total trading volume (in billions of shares)
|
|
|
26.5
|
|
|
25.7
|
|
|
0.8
|
|
3
|
%
|
Average trading volume per day (in millions of shares)
|
|
|
141.2
|
|
|
135.9
|
|
|
5.3
|
|
4
|
%
|
Average revenue per share
|
|
$
|
0.0036
|
|
$
|
0.0042
|
|
$
|
(0.0006)
|
|
(14)
|
%
|
U.S. market trading days
|
|
|
188
|
|
|
189
|
|
|
(1)
|
|
(1)
|
%
|
* Excludes activity from ITG Net commission share arrangements.
Recurring revenues decreased 17% from the prior-year period following the divestiture of our remaining investment research operations in May 2016 and the amendment to terminate the original energy research distribution agreement at the end of 2016. We also experienced lower OMS subscriptions and connectivity revenue due to client attrition.
Other revenues increased $0.5 million from the first nine months of 2016 due to the impact from lower client trade accommodations, which reduced other revenues by $1.1 million during the prior-year period versus $0.3 million in the current-year period, as well as higher market data tape rebate revenue in the current period. These increases were offset by the loss of revenue from the impact of the closing of our matched-book securities lending operations in the second quarter 2016.
Compensation and employee benefits decreased 4% from the prior-year period 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 throughout 2017, and the impact of the increased use of deferred stock awards in our incentive compensation program to better align employees with the SOP. These declines were offset in part by an increase in employee separation costs of $5.1 million, headcount dedicated to executing the SOP and strategic hires for our sales and coverage teams.
Transaction processing costs increased 3% from the prior-year period, slightly lower than the growth in our ADV. As a percentage of commissions and fees, transaction processing costs increased to 25.8% from 22.5% during the prior year period due to the impact of the reduction in the average revenue per share.
Other expenses declined 9% from the comparable period in 2016 due to the impact of divesting our remaining investment research operation in May 2016, a reduction in travel and entertainment costs and reduced energy research costs from the amendment to terminate the original energy research distribution agreement.
Canadian Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
40,738
|
|
$
|
37,531
|
|
$
|
3,207
|
|
9
|
%
|
Recurring
|
|
|
3,894
|
|
|
3,834
|
|
|
60
|
|
2
|
%
|
Other
|
|
|
2,889
|
|
|
4,240
|
|
|
(1,351)
|
|
(32)
|
%
|
Total revenues
|
|
|
47,521
|
|
|
45,605
|
|
|
1,916
|
|
4
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
13,519
|
|
|
13,881
|
|
|
(362)
|
|
(3)
|
%
|
Transaction processing
|
|
|
8,627
|
|
|
6,837
|
|
|
1,790
|
|
26
|
%
|
Other expenses
|
|
|
17,341
|
|
|
17,271
|
|
|
70
|
|
—
|
%
|
Total expenses
|
|
|
39,487
|
|
|
37,989
|
|
|
1,498
|
|
4
|
%
|
Income before income tax expense
|
|
$
|
8,034
|
|
$
|
7,616
|
|
$
|
418
|
|
5
|
%
|
Currency translation from a stronger Canadian Dollar increased total Canadian revenues and expenses by $0.4 million and $0.3 million, respectively, resulting in an increase of $0.1 million to pre-tax income.
Commissions and fees grew 9% compared to the prior-year period despite a 10% decline in market-wide volumes due to growth in block crossing in POSIT Alert and other buy-side trading activity, as well as higher sell-side trading activity and favorable currency translation.
Recurring revenues were comparable to the prior-year period and other revenues declined 32% largely from the closure of our arbitrage trading desk in April 2016.
Compensation and employee benefits costs decreased 3% from the comparable period in 2016 due to lower headcount and the impact of the increased use of deferred stock awards in our incentive compensation program to better align employees with the SOP.
Transaction processing costs increased 26% over the prior-year period, significantly exceeding the growth in commission and fees, due primarily to an increase in the proportion of our execution activity where we took liquidity, an increase in third-party order routing costs and an increase in the number of settlement tickets processed. As a percentage of commissions and fees, transaction processing costs increased to 21.2% from 18.2% in the prior-year period.
Other expenses were flat with the prior-year period due to reductions in consulting, travel and entertainment, and software amortization costs and the discontinuation of research distribution fees which largely offset higher charges for global research and development costs.
European Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
100,033
|
|
$
|
80,629
|
|
$
|
19,404
|
|
24
|
%
|
Recurring
|
|
|
11,976
|
|
|
12,173
|
|
|
(197)
|
|
(2)
|
%
|
Other
|
|
|
(302)
|
|
|
(566)
|
|
|
264
|
|
47
|
%
|
Total revenues
|
|
|
111,707
|
|
|
92,236
|
|
|
19,471
|
|
21
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
27,832
|
|
|
27,949
|
|
|
(117)
|
|
—
|
%
|
Transaction processing
|
|
|
26,642
|
|
|
22,449
|
|
|
4,193
|
|
19
|
%
|
Other expenses
|
|
|
26,283
|
|
|
25,166
|
|
|
1,117
|
|
4
|
%
|
Total expenses
|
|
|
80,757
|
|
|
75,564
|
|
|
5,193
|
|
7
|
%
|
Income before income tax expense
|
|
$
|
30,950
|
|
$
|
16,672
|
|
$
|
14,278
|
|
86
|
%
|
Overall currency rate changes in the European region, primarily from the British pound, reduced revenues and expenses by $3.1 million and $2.8 million, respectively, reducing pre-tax income by $0.3 million. This decrease in pre-tax income was comparatively small as revenues and expenses that originate in British pounds largely offset each other.
Commissions and fees were 24% higher than the prior-year period due to strong growth in block crossing in POSIT Alert, as well as growth in, single stock sales trading and algorithmic trading from institutional and hedge fund clients and higher commission sharing revenues from trades executed through our Triton EMS. This growth more than offset the impact of reduced trading from sell-side clients and currency translation. Sell-side clients made up 47% of our European value traded in the current period compared to 63% in the prior-year period. This favorable change in business mix pushed our overall commission rate 21% higher than the first nine months of 2016.
Recurring revenue declined 2% from the comparable period on 2016 due to lower OMS connectivity and RFQ-hub maintenance fees while other revenues were favorable to the prior-year period due to a lower impact from client trade accommodations.
Compensation and employee benefits were flat to the prior-year period as higher headcount was offset by the favorable impact of currency translation, an accelerated charge for deferred stock awards in the prior-year period related to a termination and the increased use of deferred stock awards in our incentive compensation program to better align employees with the SOP.
Transaction processing costs increased 19% from the prior-year period reflecting a 3% growth in daily value traded, increased trading in more costly emerging markets, higher costs to execute ETF trades and higher settlement financing costs. These increases were offset in part by the impact of currency translation. As a percentage of commissions and fees, transaction processing costs declined to 26.6%, compared to 27.8% in the prior-year period reflecting the increase in our average commission rate noted above.
Other expenses increased 4% from the prior-year period due to higher charges for global research and development costs, new exchange distribution fees and higher connectivity, as well as higher consulting, software amortization, software maintenance, licensing and recruiting costs as we continue to invest in our growth initiatives and prepare for MiFID II, partially offset in part by the favorable impact of currency translation.
Asia Pacific Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
$ in thousands
|
|
2017
|
|
2016
|
|
Change
|
|
% Change
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
37,880
|
|
$
|
30,175
|
|
$
|
7,705
|
|
26
|
%
|
Recurring
|
|
|
5,285
|
|
|
4,485
|
|
|
800
|
|
18
|
%
|
Other
|
|
|
(175)
|
|
|
(121)
|
|
|
(54)
|
|
(45)
|
%
|
Total revenues
|
|
|
42,990
|
|
|
34,539
|
|
|
8,451
|
|
24
|
%
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
13,742
|
|
|
13,466
|
|
|
276
|
|
2
|
%
|
Transaction processing
|
|
|
8,791
|
|
|
7,527
|
|
|
1,264
|
|
17
|
%
|
Other expenses
|
|
|
14,139
|
|
|
13,338
|
|
|
801
|
|
6
|
%
|
Total expenses
|
|
|
36,672
|
|
|
34,331
|
|
|
2,341
|
|
7
|
%
|
Income before income tax expense
|
|
$
|
6,318
|
|
$
|
208
|
|
$
|
6,110
|
|
nm
|
|
nm – not meaningful
Currency translation increased total Asia Pacific revenues and expenses by $0.1 million and $0.2 million, respectively, resulting in a decrease of $0.1 million to pre-tax income.
Commissions and fees increased 26% over the prior-year period primarily due to strong order flows into the Australia, Hong Kong and Korea markets and the increased use of our trading algorithms and our POSIT Alert block crossing system. We also had higher commission sharing revenues from trades executed through our Triton EMS and for trading technology outsourced to regional broker-dealers.
Recurring revenues increased 18% from the comparable period in 2016 due to higher billed revenue from analytics products and recurring connectivity, while other revenues decreased due to a higher impact from client trade accommodations.
Compensation and employee benefits increased 2% over the prior-year period due to a slight increase in headcount, partially offset by the increased use of deferred stock awards in our incentive compensation program to better align employees with the SOP and cost savings measures implemented during the second half of 2016.
Transaction processing costs increased 17% from the prior-year period, which was higher than the 10% growth in daily value executed due primarily to the impact of a larger proportion of our trading in markets where costs are higher. As a percentage of commissions and fees, transaction processing costs decreased to 23.2% from 24.9% due to the impact of a higher average commission rate.
Other expenses increased 6% from the comparable period in 2016 due to higher depreciation expenses associated with investments we are making to enhance redundancy and business recovery capabilities, as well as higher charges for global research and development costs, partially offset by lower travel and entertainment expenses.
Corporate
For the first nine months of 2017, we incurred a pre-tax loss from Corporate activities of $17.7 million, reflecting $1.2 million of revenues and $18.9 million of costs, compared to a pre-tax loss of $56.3 million in the prior-year period, reflecting $3.4 million of revenues and $59.7 million of costs. The reduction in revenues reflect the recognition of $2.4 million of insurance proceeds received in the second quarter 2016, net of related expenses, under our business interruption insurance policy for the impact of an outage at our primary outsourced data center incurred in August 2015. The decline in costs reflects costs incurred in the prior-year period for a reserve for a settlement with the SEC related to an inquiry involving discontinued activity in pre-released ADRs and related legal fees, the expensing of upfront cash and stock awards granted to our current CEO, a significant portion of which replaced awards he forfeited at his former employer, the settlement of the arbitration claim by our former CEO, net of insurance recoveries, together with related legal fees, and restructuring costs related to (a) the reduction in high-touch sales trading headcount that was previously focused on our research products and (b) the closing of our U.S. matched-book securities lending operations and our Canadian arbitrage trading desk. Costs during the 2016 period were reduced by the reclassification of an accumulated foreign translation gain after we substantially liquidated our Israel entity. Corporate costs in the current period included $0.3 million of asset impairment costs and $0.8 million in legal fees associated with the planned formation of the Matrix venture, which were more than offset by reductions in legal fees and intangible amortization as compared to the comparable period in 2016. Corporate costs, including legal expenses, can vary from period to period as we work through litigation, regulatory and other corporate matters.
Consolidated income tax expense
In the first nine months of 2017, we reported a tax expense of $44.0 million on pre-tax income of $6.9 million. The significant tax expense in the current period reflected the impact of a full valuation allowance on U.S. deferred tax assets, giving rise to an additional non-cash charge of $48.1 million, of which $42.3 million related to assets that arose in periods prior to the third quarter of 2017. We made our assessment after applying the appropriate weighting to both positive and negative evidence related to whether it is more-likely than not that some or all of our deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we considered our cumulative pre-tax loss in the U.S. jurisdiction over the previous three years as a significant piece of negative evidence. Prevailing accounting guidance limits our ability to consider other subjective evidence, such as projections of future profits, when objective verifiable evidence such as a cumulative loss exists. In the first nine months of 2016, we reported a tax benefit of $9.5 million on a pre-tax loss of $41.1 million, resulting in an effective rate of 23.0%. The low effective rate in the prior-year period reflects the impact of the non-deductibility of a substantial portion of the $22.1 million reserve for the ADR matter, offset in part by a higher tax benefit recorded on the pre-tax losses in our U.S. Operations and from our other Corporate activities (most of which was incurred in the U.S.), and the lower expense rate incurred on our pre-tax earnings in Europe.
Our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings.
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 September 30, 2017, unrestricted cash and cash equivalents totaled $238.8 million. Included in this amount is $123.8 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 or reduce the amount of any valuation allowance required.
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 September 30, 2017, we had interest‑bearing security deposits totaling $39.5 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 non-standard 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 11,
Borrowings
, to the condensed consolidated financial statements).
We also self‑clear equity trades in Australia, maintaining a deposit with clearing organizations of $3.3 million at September 30, 2017. We no longer maintain a clearing deposit in Hong Kong since migrating to a third-party clearing provider (see discussion in
Regulatory Capital
below). In Europe, we maintained $1.5 million in restricted cash related to protected client funds and we had deposits with our clearing and settlement agents of $38.3 million at September 30, 2017. As part of our European settlement activities, we may need to temporarily finance customer securities positions from non-standard settlements or delivery failures. These financings may be funded from existing cash resources, borrowings under stock loan transactions or short-term bank loans under uncommitted overdraft facilities with our clearing agent and a commercial bank.
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 obtain debt financing.
Operating Activities
The table below summarizes the effect of the major components of operating cash flow.
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
(in thousands)
|
|
2017
|
|
2016
|
|
Net loss
|
|
$
|
(37,022)
|
|
$
|
(31,634)
|
|
Gain on sale of investment research operations
|
|
|
—
|
|
|
(21)
|
|
Non-cash items included in net loss
(1)
|
|
|
85,375
|
|
|
39,541
|
|
Effect of changes in receivables/payables from/to customers and brokers
|
|
|
(46,594)
|
|
|
(63,890)
|
|
Effect of changes in other working capital and operating assets and liabilities
|
|
|
(9,726)
|
|
|
(18,682)
|
|
Net cash used in operating activities
|
|
$
|
(7,967)
|
|
$
|
(74,686)
|
|
|
(1)
|
|
Includes the impact of establishing a full valuation allowance for U.S. deferred tax assets of $48.3 million.
|
Our operating activities resulted in net cash being used during the nine months ended September 30, 2017. However, the use of cash was less than the prior-year period largely due to higher cash earnings, as the net loss for the nine months ended September 30, 2017 included the large non-cash charge to establish the valuation allowance for U.S. deferred tax assets, while the net loss for the nine months ended September 30, 2016 included significant cash charges. While we also saw a significant reduction in operating activities from settlement receivables, that impact was more than offset by a decrease in the amount of short-term debt financing from our European settlement agent reflected in financing activities. Other working capital changes had less of a negative impact to cash used in operating activities due to the positive effects of liquidating our restricted cash and clearing deposits in Hong Kong and an increase to accrued research payments under client commission arrangements. These positive impacts were offset during the current period 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 ADRs and the payment of 2016 incentive compensation in the first quarter of 2017.
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 $31.2 million during the nine months ended September 30, 2017 includes investments in software development projects, computer hardware and office space.
Financing Activities
Net cash provided by financing activities of $1.1 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 nine months of 2017, we repurchased approximately 0.9 million shares of our common stock at a cost of $17.9 million, which was funded from our available cash resources. Of these shares, nearly 0.4 million were purchased under our Board of Directors’ authorization for a total cost of $7.4 million (average cost of $19.92 per share). In addition, nearly 0.5 million shares were repurchased for $10.5 million pertaining solely to the satisfaction of minimum statutory withholding tax upon the net settlement of equity awards. As of September 30, 2017, the total remaining number of shares currently available for repurchase under ITG’s stock repurchase program was 1.1 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 September 30, 2017 for the U.S. Operations are as follows (dollars in thousands):
|
|
|
|
|
|
|
|
U.S. Operations
|
|
Net Capital
|
|
Excess
|
|
ITG Inc.
|
|
$
|
84,131
|
|
$
|
83,131
|
|
AlterNet
|
|
|
4,550
|
|
|
4,450
|
|
ITG Derivatives
|
|
|
723
|
|
|
623
|
|
As of September 30, 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 September 30, 2017, is summarized in the following table (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
Net Capital
|
|
Excess
|
|
Canadian Operations
|
|
|
|
|
|
|
|
Canada
|
|
$
|
25,878
|
|
$
|
25,478
|
|
European Operations
|
|
|
|
|
|
|
|
Ireland
|
|
|
75,352
|
|
|
41,882
|
|
U.K.
|
|
|
2,019
|
|
|
1,156
|
|
Asia Pacific Operations
|
|
|
|
|
|
|
|
Australia
|
|
|
25,082
|
|
|
8,560
|
|
Hong Kong
|
|
|
6,212
|
|
|
5,723
|
|
Singapore
|
|
|
1,075
|
|
|
1,001
|
|
In 2017, we migrated from self-clearing in Hong Kong to the use of a third-party clearer that 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, this migration has reduced our overall peak capital requirements in the Asia Pacific region by more than $10 million.
During the second quarter of 2017, we received regulatory approval for a change in the method used to determine our capital requirements in Europe following an extensive review we initiated with our local regulator. This change has lowered peak capital requirements in the region by nearly $20 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 September 30, 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 have completed a detailed review of a representative sample of customer contracts from each in-scope revenue stream and have identified two key accounting changes related to bundled commission arrangements and fees for licenses of functional intellectual property, that will impact the financial statements. We are currently assessing the financial impact of these accounting changes but expect (1) a deferral of revenues generated in the first half of the year for commissions attributable to analytics products under bundled arrangements that will be recognized over the course of the year as the performance obligations for those analytics products are satisfied, and (2) an acceleration of license fee revenues to the delivery date for software provided for a specified period. These changes only relate to the timing of when revenue is recognized and have no effect on the underlying transaction price of the products and services we perform. We are currently in the design and implementation phase of this project which, in addition to quantifying the financial impact of the accounting changes identified, also involves: finalizing accounting policies in accordance with the new revenue standard; designing process changes and internal controls; finalizing the selection of a transition method of adoption; and drafting the required disclosures under the new standard.
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 September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
|