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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
COMMISSION FILE NUMBER 0-21324
------------------------
NYFIX, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 06-1344888
(State or other jurisdiction of (I.R.S. Employer identification number)
incorporation or organization)
333 LUDLOW STREET
STAMFORD, CONNECTICUT 06902
(203) 425-8000
(Address of principal executive offices)
-----------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
There were 32,394,380 shares of Common Stock issued and outstanding as of
October 31, 2004.
NYFIX, INC.
FORM 10-Q
For the quarter ended September 30, 2004
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of 3
September 30, 2004 and December 31, 2003
Condensed Consolidated Statements of Operations for the 4
three and nine months ended September 30, 2004 and 2003
Condensed Consolidated Statements of Cash Flows for the 5
nine months ended September 30, 2004 and 2003
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 20
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 43
ITEM 4. Controls and Procedures 44
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 47
ITEM 2. Changes in Securities and Use of Proceeds 47
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 47
SIGNATURES 49
2
NYFIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
SEPTEMBER 30, DECEMBER 31,
2004 2003
--------- -----------
Assets
Current assets:
Cash and cash equivalents $ 14,800 $ 21,006
Short-term investments 6,764 3,448
Accounts receivable, less allowances of $1,449 and $1,839 12,820 10,371
Brokerage receivables 188,463 1,945
Deferred income taxes -- 976
Prepaid expenses and other current assets 5,046 3,929
--------- -----------
Total current assets 227,893 41,675
Property and equipment, less accumulated depreciation of $29,924 and $24,476 14,763 16,592
Goodwill 57,892 55,966
Acquired intangible assets, net 9,267 10,235
Investments in unconsolidated affiliates -- 3,088
Notes receivable and other amounts due from unconsolidated affiliates -- 814
Deferred income taxes -- 16,424
Other assets, net 10,419 7,378
--------- -----------
Total assets $ 320,234 $ 152,172
========= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 9,022 $ 6,664
Accrued expenses 6,089 4,807
Brokerage payables 188,967 1,700
Current portion of capital lease obligations 247 531
Current portion of long-term debt and other liabilities 2,516 1,894
Deferred revenue 2,669 2,732
--------- -----------
Total current liabilities 209,510 18,328
Long-term portion of capital lease obligations -- 135
Long-term debt and other liabilities 1,772 1,137
--------- -----------
Total liabilities 211,282 19,600
Commitments and contingencies (see notes)
Stockholders' equity:
Preferred stock, $1.00 par value; 5,000,000 shares authorized; none issued -- --
Common stock, $0.001 par value; 60,000,000 shares authorized; 34 33
33,719,943 and 33,222,475 issued
Additional paid-in capital 185,187 182,863
Accumulated deficit (56,855) (30,770)
Treasury stock, 1,348,030 and 1,361,300 shares, at cost (19,290) (19,480)
Notes receivable issued for common stock (71) (74)
Accumulated other comprehensive loss (53) --
--------- -----------
Total stockholders' equity 108,952 132,572
--------- -----------
Total liabilities and stockholders' equity $ 320,234 $ 152,172
========= ===========
The accompanying notes to condensed consolidated financial statements are an integral part of these statements.
3
NYFIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2004 2003 2004 2003
-------- -------- -------- --------
Revenue:
Subscription $ 11,039 $ 9,115 $ 30,320 $ 25,765
Capital sale 2,547 2,117 6,590 6,800
Service contract 2,447 2,327 7,631 7,094
Transaction 3,457 2,836 10,314 9,715
-------- -------- -------- --------
Total revenue 19,490 16,395 54,855 49,374
-------- -------- -------- --------
COST OF REVENUE:
Subscription 5,877 5,448 17,283 14,833
Capital sale 828 791 2,385 2,279
Service contract 1,046 745 2,853 2,087
Transaction 2,721 1,961 7,192 6,260
-------- -------- -------- --------
Total cost of revenue 10,472 8,945 29,713 25,459
-------- -------- -------- --------
GROSS PROFIT:
Subscription 5,162 3,667 13,037 10,932
Capital sale 1,719 1,326 4,205 4,521
Service contract 1,401 1,582 4,778 5,007
Transaction 736 875 3,122 3,455
-------- -------- -------- --------
Total gross profit 9,018 7,450 25,142 23,915
-------- -------- -------- --------
OPERATING EXPENSE:
Selling, general and administrative 10,067 8,502 28,216 24,626
Restructuring charge -- -- 2,527 --
Research and development 257 381 895 943
Depreciation and amortization 540 721 1,709 2,076
-------- -------- -------- --------
Total operating expense 10,864 9,604 33,347 27,645
-------- -------- -------- --------
Loss from operations (1,846) (2,154) (8,205) (3,730)
Interest expense (24) (16) (282) (74)
Investment income 28 304 91 557
Other expense, net -- (62) (70) (649)
-------- -------- -------- --------
Loss before income tax (1,842) (1,928) (8,466) (3,896)
Income tax provision (benefit) 20,251 (871) 17,619 (1,858)
-------- -------- -------- --------
Net loss $(22,093) $ (1,057) $(26,085) $ (2,038)
======== =======- ======== ========
Basic and diluted loss per common share $ (0.68) $ (0.03) $ (0.81) $ (0.06)
======== =======- ======== ========
Basic and diluted weighted average common
shares outstanding 32,338 31,791 32,152 31,367
======== =======- ======== ========
The accompanying notes to condensed consolidated financial statements are an integral part of these statements.
4
NYFIX, INC.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2004 2003
--------- ---------
Cash flows from operating activities:
Net loss $ (26,085) $ (2,038)
Adjustments to reconcile net loss to net cash provided by operating
activities:
Depreciation and amortization 10,696 9,505
Restructuring charge 2,527 --
Deferred income taxes 17,619 (560)
Provision for doubtful accounts 336 589
Equity in loss of unconsolidated affiliates 74 725
Loss (gain) on sale of investments 17 (235)
Other, net 176 (107)
Changes in assets and liabilities (net of business
acquisitions):
Accounts receivable (2,785) (2,372)
Prepaid expenses and other assets (1,402) (45)
Brokerage receivables (186,518) --
Deferred revenue (63) 184
Accounts payable, accrued expenses and other liabilities 2,855 (578)
Brokerage payables 187,267 --
--------- ---------
Net cash provided by operating activities 4,714 5,068
--------- ---------
Cash flows from investing activities:
Purchases of short-term investments (10,038) (4,129)
Sales of short-term investments 6,705 9,986
Capital expenditures for property and equipment (4,322) (4,098)
Capitalization of product enhancement costs (5,344) (3,857)
Cash acquired from acquisitions, net of payments 1,381 18
Loans and advances to unconsolidated affiliates, net of repayments (205) (2,211)
--------- ---------
Net cash used in investing activities (11,823) (4,291)
--------- ---------
Cash flows from financing activities:
Proceeds from borrowings 1,100 --
Principal payments under capital lease obligations (419) (852)
Net proceeds from issuance of common stock 275 434
--------- ---------
Net cash provided by (used in) financing activities 956 (418)
--------- ---------
Effect of exchange rate changes on cash (53) --
--------- ---------
Net (decrease) increase in cash and cash equivalents (6,206) 359
Cash and cash equivalents, beginning of period 21,006 11,213
--------- ---------
Cash and cash equivalents, end of period $ 14,800 $ 11,572
========= =========
The accompanying notes to condensed consolidated financial statements are an integral part of these statements.
5
NYFIX, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
NYFIX, Inc. (together with its subsidiaries, the "Company"), founded in
1991 through the acquisition of a New York corporation, is headquartered in
Stamford, Connecticut. In December 2003, the Company reincorporated as a
Delaware corporation. The Company is an established provider to the domestic and
international financial markets of trading workstations, middle office trade
automation technologies and trade communication technologies. The Company's
NYFIX Network connects broker-dealers, institutions and exchanges. In addition
to its headquarters in Stamford, the Company has offices on Wall Street in New
York City, in London's Financial District, in Chicago, and in San Francisco. The
Company operates three data centers in the northeastern United States and has
established additional data center hubs in London, Amsterdam, Hong Kong and
Tokyo. The Company has two business segments: its Technology Services segment
and its Transaction Services segment. The Company provides trading technology,
industry network connectivity and execution services, offering certain
underlying, universally applicable network inter-connectivity products, systems,
facilities, and supporting operations to its segments. The Company's Technology
Services segment is a technology provider, focusing on offering trade-management
systems, a centralized industry order-routing network, order-routing software,
exchange-floor automation systems, exchange and market access technology and
post-trade processing systems. The Company's Technology Services segment
customers consist primarily of United States securities brokerage firms and
international derivatives brokerage firms. The Company's Transaction Services
segment is primarily comprised of its broker-dealer subsidiaries registered with
the National Association of Securities Dealers ("NASD"), which in addition to
the technology provided by the Company's Technology Services segment, provides
an electronic execution venue for trading in United States equities and direct
market access and execution links. NYFIX Clearing Corporation ("NYFIX Clearing")
was established by the Company to provide clearing brokerage operations for the
Company's broker-dealer operations, NYFIX Millennium, L.L.C. ("NYFIX
Millennium") and NYFIX Transaction Services, Inc. ("NYFIX Transaction
Services"). NYFIX Clearing, in addition to its clearing operations, will borrow
securities, as necessary to complete the settlement process, and may borrow and
lend securities to earn incremental interest income (see Note 2).
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of the Securities and Exchange
Commission's ("SEC") Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. The Company
believes that the disclosures contained herein are adequate to make the
information presented not misleading. The accompanying condensed consolidated
financial statements include the accounts of the Company and reflect all
adjustments, consisting of normal recurring adjustments, considered necessary by
management for a fair presentation of the Company's financial condition and
results of operations. All significant intercompany balances and transactions
have been eliminated in consolidation.
The operating results for the three and nine months ended September 30,
2004 and 2003 are not necessarily indicative of the results to be expected for
any future interim period or any future year. These condensed consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and footnotes thereto in the Company's Annual Report on
Form 10-K for the year ended December 31, 2003 ("2003 Form 10-K"). The Company's
significant accounting policies are the same as those listed in Note 1 to the
2003 Form 10-K.
6
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
Prior to July 1, 2003, the Company's 18% ownership interest in Renaissance
Trading Technologies, Inc. ("Renaissance") was accounted for under the equity
method since the Company had the ability to exercise significant influence over
the operating and financial policies of Renaissance. Effective July 1, 2003, the
Company acquired the remaining 82% of Renaissance, which the Company did not
already own. As of that date, the Company consolidated Renaissance. Prior to
March 29, 2004, the Company's 40% ownership interest in EuroLink Network, Inc.
("EuroLink") was accounted for under the equity method. Effective March 29,
2004, the Company acquired the remaining 60% of EuroLink, which the Company did
not already own. As of that date, the Company consolidated EuroLink (see Note
3).
On February 1, 2002, the Company acquired an additional 30% ownership
interest in NYFIX Millennium, resulting in a total ownership interest of 80% and
regained control of the NYFIX Millennium Board of Directors. Effective on that
date, the Company consolidated NYFIX Millennium and recognized 100% of NYFIX
Millennium's operating losses. If and when NYFIX Millennium achieves
profitability, 24% of its profits will be allocated to the other partners in
accordance with the contractual agreement among the parties.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the dates of the condensed consolidated financial statements and the reported
amounts of revenue and expense during the reporting periods in the condensed
consolidated financial statements and accompanying notes. The estimates include
the collectibility of accounts receivable, the use and recoverability of
inventory, the useful lives of tangible and intangible assets, recoverability of
goodwill and the realization of deferred tax assets, among others. The markets
for the Company's products are characterized by intense competition, rapid
technological development and pricing pressures, all of which could affect the
future realizability of the Company's assets. Estimates and assumptions are
reviewed periodically and the effects of revisions are reflected in the
condensed consolidated financial statements in the period they are determined to
be necessary. Actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made in the prior period's condensed
consolidated financial statements to conform to the current period's
presentation. In connection therewith, amortization expense of intangible assets
of $0.6 million and $1.6 million was reclassified from depreciation and
amortization expense to cost of revenue for the three and nine months ended
September 30, 2003, respectively.
Stock-based Employee Compensation
The Company accounts for its stock-based employee compensation plans under
the recognition and measurement provisions of the Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees and related
interpretations and has elected the disclosure-only alternative under Statement
of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based
Compensation. The Company does not recognize stock-based compensation expense in
its reported results of operations as all stock options granted had an exercise
price equal to the fair value of the underlying common stock on the date of
grant. The following table illustrates the effect on net loss and loss per share
if the Company had applied the fair value recognition provisions of SFAS No.
123, as required by SFAS No. 148, Accounting for Stock-based Compensation -
Transition and Disclosure, to stock-based employee compensation:
7
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------------------
2004 2003 2004 2003
-------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net loss, as reported $(22,093) $ (1,057) $(26,085) $ (2,038)
Compensation expense based on the fair
value method, net of tax (665) (1,200) (2,019) (4,220)
-------- -------- -------- ---------
Pro forma net loss $(22,758) $ (2,257) $(28,104) $ (6,258)
======== ======== ======== =========
Basic and diluted loss per common share:
As reported $ (0.68) $ (0.03) $ (0.81) $ (0.06)
======== ======== ======== =========
Pro forma $ (0.70) $ (0.07) $ (0.87) $ (0.20)
======== ======== ======== =========
2. BROKER-DEALER OPERATIONS
Broker-dealer Net Capital Requirements
The SEC, the NASD and the Financial Services Authority ("FSA"), as well as
other regulatory agencies and securities exchanges within and outside the United
States, have stringent rules with respect to the maintenance of specific levels
of net capital by regulated broker-dealers. These rules include the NASD's and
the FSA's net capital rules, to which the Company's broker-dealer subsidiaries
are subject. The failure by one of these subsidiaries to maintain its required
net capital may lead to suspension or revocation of its registration by the SEC
and its suspension or expulsion by the NASD, the FSA and other United States or
international regulatory bodies, and ultimately could require its liquidation.
In addition, a change in the net capital rules, the imposition of new rules or
any unusually large charge against the net capital of one of the Company's
broker-dealer subsidiaries could limit that subsidiary's operations,
particularly those that are capital intensive. A large charge to the net capital
of one of these subsidiaries could result from an error or other operational
failure or a failure of a customer to complete one or more transactions,
including as a result of that customer's insolvency or other credit
difficulties, and the Company cannot assure that it would be able to furnish the
affected subsidiary with the requisite additional capital to offset that charge.
The net capital rules could also restrict the Company's ability to withdraw
capital from its broker-dealer subsidiaries, which could limit the Company's
ability to pay cash dividends, repay debt or repurchase shares of its
outstanding stock. A significant operating loss or any unusually large charge
against net capital could adversely affect the Company's financial condition,
results of operations or cash flows.
NYFIX Clearing, NYFIX Transaction Services, and NYFIX Millennium, as
registered broker-dealers, are subject to the minimum net capital requirements
of the NASD. During the year ended December 31, 2003, the Company funded $10.8
million to NYFIX Clearing to enable it to maintain its minimum excess net
capital requirement of $10.0 million as a condition of its approval by the
Depository Trust and Clearing Corporation ("DTCC"). NYFIX International, Ltd.
("NYFIX International"), as a broker dealer registered with the FSA in the
United Kingdom, is also subject to minimum net capital requirements. These
broker-dealers have consistently operated in excess of their minimum and minimum
excess net capital requirements. During the three months ended September 30,
2004, the Company funded $1.3 million to NYFIX International as a condition of
NYFIX International's approval by the FSA. During the nine months ended
September 30, 2004, the Company provided an aggregate additional capital of $1.3
million in the form of capital contributions and subordinated loans to enable
its United States-based broker-dealer subsidiaries to individually and
8
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
collectively exceed their net capital requirements. At September 30, 2004, the
Company's broker-dealer subsidiaries had aggregate net capital of $12.8 million,
which exceeded the aggregate minimum net capital required by $2.4 million. The
Company's broker-dealer subsidiaries may require the Company to fund or commit
more of its consolidated cash, cash-equivalents and short-term investments in
the future to maintain their individual minimum and minimum excess net capital
requirements. If any or all of these broker-dealer subsidiaries were to fall
below their minimum or minimum excess net capital requirements, their operations
may be restricted.
Brokerage Receivables and Payables
In connection with its brokerage clearing operations, NYFIX Clearing
borrows securities either to complete transactions for which the securities have
not been received by the required settlement date, or lends securities as part
of its strategy in which the same underlying securities are borrowed and loaned
for the same period of time, reducing exposure to market risk. The amount of
collateral required to be deposited for securities borrowed, or received for
securities loaned, is an amount generally in excess of the market value of the
applicable securities borrowed or loaned. The Company monitors the market value
of the securities borrowed and loaned, with additional collateral obtained or
excess collateral returned, when deemed appropriate.
NYFIX Clearing earns interest revenue from the cash collateral it provides
to the lender of securities and pays interest on the cash collateral received
from the borrower of the securities. Net revenue related to these stock loan
transactions, which commenced in December 2003, was $25,000 and $47,000 for the
three and nine months ended September 30, 2004, respectively, and is included in
"transaction revenue" in the accompanying condensed consolidated statement of
operations.
Securities borrowed and loaned are recorded based on the amounts of cash
collateral advanced or received. In the accompanying condensed consolidated
balance sheets, securities borrowed is reflected in "brokerage receivables," and
securities loaned is reflected in "brokerage payables."
Brokerage receivables consisted of the following:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
(IN THOUSANDS)
Stock receivable (matched and reserved) $188,401 $ 1,466
Other 62 479
------------- ------------
Total brokerage receivables $188,463 $ 1,945
============= ============
Brokerage payables consisted of the following:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
(IN THOUSANDS)
Stock payable $188,953 $ 1,385
Other 14 315
------------- ------------
Total brokerage payables $188,967 $ 1,700
============= ============
9
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
3. ACQUISITIONS, GOODWILL AND OTHER ACQUIRED INTANGIBLE ASSETS
ACQUISITIONS
EuroLink
On March 6, 2002, the Company acquired a convertible preferred stock
interest in EuroLink, with its operations based in Madrid, Spain, for $4.0
million in cash. EuroLink offers the European securities industry direct
electronic access to the United States equity markets from Europe. EuroLink
offers the Company's equity products and services to the European marketplace,
primarily on a transaction fee basis. The preferred stock automatically
converted into a 40% common stock interest on March 6, 2004. Since its initial
investment and through March 29, 2004, the Company had recorded its equity in
the losses of EuroLink aggregating $1.0 million, including $0.1 million for the
three months ended March 31, 2004. During the three and nine months ended
September 30, 2003, the Company recorded its equity in the losses of EuroLink of
$0.1 million and $0.3 million, respectively. Such losses were included in "other
expense, net" in the accompanying condensed consolidated statements of
operations. In addition, the Company had notes receivable from EuroLink at March
29, 2004 and December 31, 2003 of $0.6 million, bearing an interest rate of
6.0%. The Company also advanced to EuroLink $0.2 million during the first
quarter of 2004 and $0.2 million during the year ended December 31, 2003 to fund
certain operating costs. Such notes and advances were reflected as "notes
receivable and other amounts due from unconsolidated affiliates" in the
accompanying condensed consolidated balance sheet at December 31, 2003.
Effective March 29, 2004, the Company acquired the remaining 60% of
EuroLink that it did not already own for $24,000 in cash and promissory notes
issued and payable in the Company's common stock or cash, at the Company's
option, having a fair value of $0.5 million. The fair value of the notes, which
mature on April 28, 2005, was included in "current portion of long-term debt and
other liabilities" in the accompanying condensed consolidated balance sheet at
September 30, 2004. In connection with the acquisition, the Company contributed
to EuroLink's capital certain obligations that EuroLink owed to the Company,
including the aforementioned notes receivable and advances, aggregating $1.0
million. The Company's key consideration for the acquisition of EuroLink was the
expected synergy to be achieved by consolidating EuroLink with NYFIX
International, the Company's newly formed London-based subsidiary through which
it plans to capture electronic order flow to and from the United States and
within Europe.
The total purchase price for 100% of EuroLink, consisting of the Company's
pre-acquisition equity investment basis of $3.0 million, the notes receivable
and advances of $1.0 million, the promissory notes of $0.5 million and
acquisition-related expenses of $0.1 million, was $4.6 million. The excess of
the purchase price over the fair value of the net assets acquired was $3.2
million and has been recorded as goodwill. Preliminary allocations have been
made to the tangible and intangible assets. While it is anticipated that a
substantial portion of the purchase price will be classified as goodwill, the
Company has not completed its final allocation of the purchase price to the
tangible and intangible assets of EuroLink. Asset valuations will be performed
by an independent third-party, and are expected to be completed by December 31,
2004.
Renaissance
On October 2, 2002, the Company acquired an 18% interest in the membership
units of Renaissance. Renaissance was formed to commercialize a Nasdaq trading
10
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
platform (the "Platform"). The Company acquired its interest in return for
300,000 shares of the Company's common stock with a fair value of $3.74 per
share, totaling $1.1 million. In addition, the Company received an option to
purchase, between October 2004 and October 2006, a minimum of 20% to a maximum
of 40% of the total outstanding membership units of Renaissance at a price to be
determined based upon a formula. The intellectual property rights and source
code to the Platform were developed over the previous several years by a major
bank and brokerage firm. In connection with its investment, the Company
acquired, for $1.0 million, the intellectual property rights and source code to
the Platform from the major bank and brokerage firm, and contributed such
intellectual property rights and source code to Renaissance. In consideration
for the intellectual property rights contributed and advanced funding of the
operating costs and capital expenditures, the Company was to share in 50% of
Renaissance's revenue for, at a minimum, three years.
In October 2002, the Company loaned $1.5 million to Renaissance in exchange
for a convertible secured promissory note. The note bore an interest rate of
5.5%, was due in October 2007, or was convertible into 6,400,000 membership
units (or 32% of the total outstanding membership units, subject to dilution) of
Renaissance, at the Company's option. In February 2003, the Company loaned an
additional $1.0 million to Renaissance in exchange for a secured promissory
note. The note bore an interest rate of 5.5% and was due in February 2008. In
addition, the Company funded to Renaissance $2.2 million, in the aggregate
through June 30, 2003 to fund certain operating costs and capital expenditures
of Renaissance. The Company sublet approximately 8,000 square feet of office
space to Renaissance at an annual cost of $0.2 million. Prior to July 1, 2003,
the Company's investment in Renaissance was accounted for under the equity
method. During the six months ended June 30, 2003, the Company recorded its
equity in the losses of Renaissance of $0.4 million, which was included in
expense, net" in the accompanying condensed consolidated statement of operations
for the nine months ended September 30, 2003.
Effective July 1, 2003, the Company acquired the remaining 82% of the
membership units of Renaissance, which it did not already own. The Company's key
considerations for the acquisition of Renaissance included the ability to sell
its products into the over the counter ("OTC") market, or by integrating
Renaissance features into existing NYFIX products to enable customers to have a
single view and access to the OTC and listed marketplaces from one workstation.
The Company financed the July 2003 Renaissance acquisition by (i)
exercising its option to convert the outstanding $1.5 million promissory note,
plus accrued interest of $0.1 million, for an additional 32% of the outstanding
membership units in Renaissance; and (ii) acquiring from the unitholders the
remaining 50% of the membership units in Renaissance, for a total value of $5.7
million, by issuing (a) 462,286 shares of its common stock into an irrevocable
trust for the benefit of certain unitholders of Renaissance, having a fair value
of $2.7 million; (b) promissory notes payable, at the Company's option, in its
common stock or cash to certain unitholders of Renaissance, maturing in December
2004, having a fair value of $1.3 million; (c) promissory notes payable, at the
Company's option, in its common stock or cash to certain unitholders of
Renaissance with annual maturity dates ranging between July 2004 and July 2007,
having a fair value of $1.3 million; and (d) 59,653 shares of the Company's
common stock with selling restrictions to certain unitholders of Renaissance,
having a fair value of $0.3 million. On July 2, 2004, the Company issued 51,828
shares of its common stock as the first principal payment under the promissory
notes, valued at $0.2 million. On April 7, 2004, pursuant to notice from certain
payees after default on the promissory notes, the Company issued 375,346 shares
of its common stock as payment in full for $2.0 million in principal amount of
such notes. On September 23, 2004, the Company entered into amended promissory
notes and settlement agreements with certain unitholders of Renaissance (the
"Amended Notes"). Pursuant to the Amended Notes, on September 27, 2004 and
October 27, 2004, the Company issued an additional 13,270 shares and 20,800
shares of its common stock to such unitholders from its treasury stock.
11
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
In connection with the acquisition, the Company contributed to
Renaissance's capital certain obligations that Renaissance owed to the Company,
including the aforementioned promissory note and advances aggregating $3.2
million. In addition, the Company acquired 60,000 shares of its common stock,
valued at $0.4 million, that it had issued in connection with its original
investment in Renaissance, and which Renaissance had acquired. The Company has
classified these 60,000 shares as "treasury stock" in the accompanying condensed
consolidated balance sheets.
The total purchase price for 100% of Renaissance, consisting of the
Company's pre-acquisition equity investment basis of $1.3 million, was $11.8
million. The excess of the purchase price over the fair value of the net assets
acquired was $8.2 million and has been recorded as goodwill.
GOODWILL AND ACQUIRED INTANGIBLE ASSETS
Goodwill and acquired intangible assets primarily relate to the Company's
2004 acquisition of EuroLink, 2003 acquisition of Renaissance, and 2002
acquisitions of an additional 30% ownership interest in NYFIX Millennium and the
acquisition of Javelin Technologies, Inc. ("Javelin"). In the absence of
circumstances requiring impairment testing on a quarterly or other more frequent
basis, the Company has set October 1 as its annual testing date for goodwill
impairment. Effective October 1, 2003, the Company performed its annual test for
impairment using the discounted cash flow valuation method. Since there was an
indication of impairment to the value of goodwill as a result of the Company
establishing a valuation allowance on its deferred tax assets (see Note 6 -
Income Taxes), the Company undertook an internal goodwill impairment review as
of September 30, 2004. Based upon the results of this internal review, the
Company does not believe its goodwill was impaired as of September 30, 2004. The
Company expects to complete its annual test for impairment during the fourth
quarter of 2004.
In connection with the Company's March 31, 2002 acquisition of Javelin,
$1.0 million in cash and 270,945 shares of common stock, having a fair value of
$4.0 million at March 31, 2002, were being held in escrow by an unrelated party,
subject to a final working capital adjustment. On March 15, 2004, a
representative of the former shareholders of Javelin executed a settlement
agreement with the Company that, among other things, paid the Company $1.3
million and distributed the Company's common stock held in the escrow fund to
the former Javelin shareholders. The Company recorded the $1.3 million of net
proceeds received in the first quarter of 2004 as a reduction in goodwill.
The changes in the carrying amount of goodwill by segment for the nine
months ended September 30, 2004, were as follows:
TECHNOLOGY TRANSACTION
SERVICES SERVICES TOTAL
--------- --------- ---------
(IN THOUSANDS)
Balance as of January 1, 2004 $ 50,164 $ 5,802 $ 55,966
Goodwill acquired or (adjusted) during the
period
EuroLink (preliminary estimate) -- 3,176 3,176
Javelin (1,250) -- (1,250)
--------- --------- ---------
Balance as of September 30, 2004 $ 48,914 $ 8,978 $ 57,892
========= ========= =========
12
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
Acquired intangible assets consisted of the following:
SEPTEMBER 30, DECEMBER 31, USEFUL LIVES
2004 2003 (YEARS)
------------ ------------ ------------
(IN THOUSANDS)
Existing technology $10,600 $10,600 5 - 7
Customer related intangibles 3,700 2,700 5
Trademarks and other 800 800 6 - 14
------------ ------------
Total intangible assets, gross 15,100 14,100
Less: Accumulated amortization 5,833 3,865
------------ ------------
Total intangible assets, net $ 9,267 $10,235
============ ============
The Company completed the asset valuations for the Renaissance acquisition
during the fourth quarter of 2003 and expects to complete the asset valuations
for EuroLink during the fourth quarter of 2004. Amortization expense of acquired
intangible assets was $0.7 million and $2.0 million for the three and nine
months ended September 30, 2004, and $0.6 million and $1.6 million for the three
and nine months ended September 30, 2003, respectively, and was included in
"cost of revenue" in the accompanying condensed consolidated statement of
operations.
Based on identified intangible assets recorded at September 30, 2004, the
future amortization expense is expected to be as follows:
AMOUNT
------
(IN THOUSANDS)
Remainder of 2004 $ 672
2005 2,691
2006 2,691
2007 1,566
2008 726
Thereafter 921
-------
Future amortization expense $ 9,267
=======
4. RESTRUCTURING CHARGE
Effective February 1, 2004, the Company entered into an agreement to lease
additional space at its New York City offices at 100 Wall Street. In connection
with this agreement, the Company ceased use, in the second quarter of 2004, of
one of its other offices on Wall Street and commenced consolidating its
operations into the new space and eliminated 14 staff positions. In accordance
with SFAS No. 146, Accounting for Exit or Disposal Activities, the Company
recorded a charge to operations of $2.5 million in the three months ended June
30, 2004. This charge included the fair value of the remaining rent payments,
net of estimated sub-lease income, severance and write-offs of fixed assets and
leasehold improvements.
The Company has included the restructuring charge liabilities with "current
portion of long-term debt and other liabilities" and "long-term debt and other
liabilities" in the accompanying condensed consolidated balance sheet at
September 30, 2004, and has classified the expense as "restructuring charge" in
the accompanying condensed consolidated statement of operations for the nine
months ended September 30, 2004. The restructuring charge established by the
Company, and activities related thereto, are summarized as follows:
13
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
BALANCE AT NON-CASH BALANCE AT
JANUARY 1, CASH USES AND SEPTEMBER 30,
2004 CHARGES USES OTHER 2004
------------- -------- ------- --------- -------------
(in thousands)
Lease costs, net of
sublease income $ -- $2,097 $ (309) $ 13 $1,801
Fixed asset dispositions -- 319 -- (319) --
Severance -- 111 (96) -- 15
------------- -------- ------- --------- -------------
Total $ -- $2,527 $ (405) $ (306) 1,816
============= ======== ======= =========
Less: current portion 549
-------------
Long-term portion $1,267
=============
5. DEBT OBLIGATIONS
The Company borrowed $1.1 million in August 2004 from a financial
institution with which it has an investment portfolio. The loan is
collateralized by the investment portfolio, which principally consists of
auction rate certificates. The loan is payable at any time, at the Company's
discretion, and accrues interest at a rate of LIBOR plus 1.5%. The average
interest rate for the period was 3.21%. The Company has classified the loan as
"current portion of long-term debt and other liabilities" in the accompanying
condensed consolidated balance sheet at September 30, 2004, as it intends to
repay it within twelve months.
6. INCOME TAXES
The Company established a deferred tax asset valuation allowance of $21.0
million at September 30, 2004, in accordance with SFAS No. 109, Accounting for
Income Taxes ("SFAS No. 109"). Where there are cumulative operating losses in
recent years, SFAS No. 109 requires, except in very limited circumstances, that
a valuation allowance be established. The Company had operating income in 2001,
but did not in 2002 and 2003. The Company previously estimated that its deferred
tax assets, consisting primarily of tax credit carryforwards and net operating
loss carryforwards, would be realized and no valuation allowance was required,
based on revenue and operating expense assumptions. During the third quarter of
2004, the Company's general and administrative expenses related to compliance
with Section 404 of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") and legal
expenses increased more than forecasted and the Company expects these costs to
remain at this higher level in the near term. These cost increases, together
with revenues from its Transaction Services segment being impacted by much lower
than expected volumes in the equity markets, particularly during the month of
September, were the primary reasons the Company did not achieve profitability
for the quarter and thus reduced its forecast for the near-term. The Company
expects to return to profitability, but until it can achieve and sustain an
appropriate level of profitability, it plans to record a full valuation
allowance on its deferred tax assets. The Company recorded a tax provision of
$20.3 million and $17.6 million for the three and nine months ended September
30, 2004, respectively, compared to tax benefits of $0.9 million and $1.9
million for the three and nine months ended September 30, 2003.
The Company's effective tax rate was 1,099% and 208% for the three and nine
months ended September 30, 2004, respectively, and 45% and 48% for the three and
nine months ended September 30, 2003, respectively. The Company's effective tax
rate for the three and nine months ended September 30, 2004 is higher than the
Federal statutory rate primarily due to the establishment of the aforementioned
deferred tax asset valuation allowance. The Company's effective tax rate for the
three and nine months ended September 30, 2003 is higher than the Federal
statutory rate primarily due to the effects of recognition of certain research
and development tax credits and state income taxes.
14
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
7. PER SHARE INFORMATION
The Company's basic loss per common share ("EPS") was calculated based on
the net loss available to common stockholders and the weighted-average number of
shares outstanding during the reporting period. Diluted EPS normally includes
additional dilution from common stock equivalents, such as stock issuable
pursuant to the exercise of outstanding stock options. Stock options
representing 857,287 and 978,408 shares for the three and nine months ended
September 30, 2004, respectively, and 1,208,916 and 1,038,184 shares for the
three and nine months ended September 30, 2003, respectively, were excluded from
the loss per share calculations since the amounts would be anti-dilutive.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ---------------------------
2004 2003 2004 2003
-------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net loss $(22,093) $ (1,057) $(26,085) $ (2,038)
======== ======= ======== ========
Loss per common share - basic and diluted $ (0.68) $ (0.03) $ (0.81) $ (0.06)
======== ======= ======== ========
Weighted average shares outstanding 32,338 31,791 32,152 31,367
======== ======= ======== ========
8. BUSINESS SEGMENT INFORMATION
The Company has adopted the disclosure requirements of SFAS No. 131,
Disclosures About Segments of an Enterprise and Related Information, which
establishes standards for additional disclosure about operating segments for
interim and annual financial statements. This standard requires financial and
descriptive information be disclosed for segments whose operating results are
reviewed by the Company for decisions on resource allocation. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers.
The Company operates as a financial services technology company in two
industry segments, Technology Services and Transaction Services.
The Company's Technology Services segment is comprised of four of its
subsidiaries, which work together as technology providers, focusing on offering
trade-management systems, a centralized industry order-routing network,
order-routing software, exchange-floor automation systems, exchange and market
access technology and post-trade processing systems. The Technology Services
segment customers consist primarily of United States securities brokerage firms
and international derivatives brokerage firms. The Company's Technology Services
segment primarily generates subscription, capital sale and service revenue.
The Company's Transaction Services segment is comprised of six of its
subsidiaries. Three are NASD registered broker-dealers; one is an introducing
broker-dealer for derivatives and was granted its broker-dealer license in 2002
by the National Futures Association; one was incorporated in the United Kingdom
on March 29, 2004 and on September 29, 2004 received its FSA broker-dealer
license in anticipation of the Company's expansion into Europe and other
international markets; and EuroLink, of which we acquired the remaining 60% we
did not already own effective March 29, 2004 and which represented the Company's
initial transaction efforts in the European markets. Currently, the customers of
the NASD registered broker-dealers consist primarily of United States securities
brokerage firms and United States buy-side institutions, including banks, mutual
funds and other professional money managers. The Company's Transaction Services
segment primarily generates revenue from the application of commissions charged
on executed trades.
15
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
The accounting policies of the reportable segments are the same as those
described in the summary of significant accounting policies contained in Note 1
to the 2003 Form 10-K. The operating segments reported below are the segments of
the Company for which separate financial information is available and for which
operating results are evaluated regularly by senior management in deciding how
to allocate resources and in assessing performance.
Summarized financial information by business segment was as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- ------------------------------
2004 2003 2004 2003
-------- -------- -------- ---------
Revenue: (IN THOUSANDS)
Technology Services $ 15,941 $ 13,695 $ 44,717 $ 40,378
Transaction Services 4,194 3,313 12,217 10,827
Eliminations (645) (613) (2,079) (1,831)
-------- -------- -------- ---------
Total revenue $ 19,490 $ 16,395 $ 54,855 $ 49,374
======== ======== ======== =========
Gross Profit:
Technology Services $ 8,159 $ 6,660 $ 22,103 $ 21,273
Transaction Services 859 790 3,039 2,642
-------- -------- -------- ---------
Total gross profit $ 9,018 $ 7,450 $ 25,142 $ 23,915
======== ======== ======== =========
Reconciling information between business segments and the loss before
income tax benefit was as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ------------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
(IN THOUSANDS)
Gross profit for reportable segments $ 9,018 $ 7,450 $ 25,142 $ 23,915
Operating expenses (10,864) (9,604) (33,347) (27,645)
Interest expense (24) (16) (282) (74)
Investment income 28 304 91 557
Other expense, net -- (62) (70) (649)
--------- --------- --------- ---------
Loss before income tax $ (1,842) $ (1,928) $ (8,466) $ (3,896)
========= ========= ========= =========
9. COMPREHENSIVE LOSS
The components of comprehensive loss, net of tax, were as follows:
16
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ------------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
(IN THOUSANDS)
Net loss $(22,093) $ (1,057) $(26,085) $ (2,038)
Foreign currency translation adjustment (53) -- (53) --
Changes in net unrealized gain on -- (207) -- (103)
available-for-sale securities
--------- --------- --------- ---------
Total comprehensive loss $(22,146) $ (1,264) $(26,138) $ (2,141)
========= ========= ========= =========
10. COMMITMENTS AND CONTINGENCIES
Litigation
On May 13, 2004, an action entitled FULLER & THALER ASSET MANAGEMENT V.
NYFIX, INC., ET AL. was filed in the United States District Court for the
District of Connecticut. The complaint named the Company, its Chairman and CEO,
its former CFO, its current CFO and certain of its directors as defendants. The
complaint was filed as a purported class action claim on behalf of all buyers of
the Company's stock between March 30, 2000 and March 30, 2004 and seeks an
unspecified amount of damages. The complaint alleged violations of Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 ("Exchange Act"), based
on the issuance of a series of allegedly false and misleading financial
statements and press releases concerning, among other things, the Company's
investment in NYFIX Millennium. On July 20, 2004, the court appointed three
different plaintiffs to be the lead plaintiffs, as Fuller & Thaler Asset
Management withdrew as the named plaintiff. The action became styled JOHNSON, ET
AL. V. NYFIX, INC., ET AL. On August 19, 2004, the newly named plaintiffs filed
a first amended class action complaint, which added, among other things,
allegations of violations of Sections 11 and 15 of the Securities Act of 1933,
as amended. The new allegations are based fundamentally on the same allegations
as the plaintiffs asserted in the original complaint. The defendants have filed
a motion to dismiss the amended complaint with prejudice. The Company believes
that this amended complaint, like the original complaint, is without merit.
Although it is not possible to forecast the outcome of this matter at this time,
the Company intends to vigorously defend the lawsuit.
SEC Matters
In connection with the Company's restatement of its 1999 through 2002
consolidated financial statements in May 2004, the Division of Enforcement of
the SEC informed the Company by letter dated July 14, 2004, that it was
conducting an informal inquiry. By letter dated October 28, 2004, the Division
of Enforcement of the SEC informed the Company that it was conducting a second
informal inquiry, which appears from the SEC's request for documents to relate
to the Company's granting of stock options to its senior management and
directors. The Company is cooperating with the SEC with respect to both matters.
The Company is unable to predict the outcome of either matter at this time.
11. CASH FLOW SUPPLEMENTAL INFORMATION
Information about the cash flow activities related to the 2004 EuroLink
acquisition and Javelin goodwill adjustment and the 2003 Renaissance acquisition
was as follows:
17
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2004 2003
------- --------
(IN THOUSANDS)
Fair value of assets acquired, including cash of $155 and $28 $ (4,566) $(12,649)
Fair value of liabilities assumed 207 1,016
Promissory note converted to equity -- 1,560
Fair value of capital contributed 1,026 3,181
Fair value of notes issued 450 2,703
Common stock issued -- 2,997
Treasury stock acquired -- (380)
Pre-acquisition investment basis 3,014 1,590
Javelin working capital adjustment settlement 1,250 --
------- --------
Cash acquired from acquisitions $ 1,381 $ 18
======= ========
The preceding fair values of net assets and liabilities for the nine months
ended September 30, 2003 and 2004 were based on the preliminary values. The
final allocation of assets acquired in 2004 may differ from the fair values
presented.
Information about other cash flow activities was as follows:
NINE MONTHS ENDED
SEPTEMBER 30,
-------------
2004 2003
------- ------
Supplemental disclosures of cash flow information: (IN THOUSANDS)
Cash paid for interest $ 91 $ 74
Cash paid (refunds received) for income taxes, net 48 (1,084)
Supplemental schedule of noncash investing and
financing information:
Common stock issued for promissory note payments 2,237 --
Treasury stock issued for promissory note payments 190 --
Unrealized gain on available-for-sale securities -- 103
12. RELATED PARTY TRANSACTIONS
At December 31, 2003, the Company had a note receivable of $70,000, plus
accrued interest, from a former officer of the Company, in connection with his
exercise of options for the Company's common stock, with an annual interest rate
of 5.5%, and a maturity date of May 13, 2004. Such note was included in "notes
receivable issued for common stock" within stockholders' equity at December 31,
2003 on the accompanying condensed consolidated balance sheet. In addition, at
December 31, 2003, the Company had a note receivable of $300,000, plus accrued
interest from the same former officer, with an annual interest rate of 5.5%, and
a maturity date of July 2, 2004. Such note was included in "prepaid expense and
other current assets" at December 31, 2003 on the accompanying condensed
consolidated balance sheet.
18
NYFIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(Unaudited)
On July 27, 2004, the Company received notes from the former officer for
$70,000 and $300,000 to replace the notes that matured on May 13, 2004 and July
2, 2004, respectively. Both new notes mature on July 27, 2006, accrue interest
annually at 4.0%, may be prepaid at any time without penalty and are
collateralized by assets in a brokerage account of the former officer, which
primarily consist of shares of the Company's stock. Such notes were included in
"notes receivable issued for common stock" within stockholders' equity and
"other assets," respectively, at September 30, 2004 on the accompanying
condensed consolidated balance sheet. A director of the Company, in a separate
transaction, made an unsecured loan to the former officer. The proceeds from the
loan were used to exercise stock options to purchase the Company's common stock,
which is included in the collateral, and to pay accrued interest of $23,000 due
on the original notes.
13. NASDAQ DELISTING PROCEEDING
On April 1, 2004 and May 19, 2004, Nasdaq notified the Company that it was
not in compliance with Nasdaq's listing requirements because the Company had not
timely filed its 2003 Form 10-K and its Quarterly Report on Form 10-Q ("Form
10-Q") for the quarter ended March 31, 2004. On April 29, 2004, the Company
requested from the Nasdaq Listing Qualifications Panel (the "Panel"), and was
granted, an extension to May 31, 2004 to meet Nasdaq's listing requirements. On
May 28, 2004, the Company filed its 2003 Form 10-K and its Form 10-Q for the
quarter ended March 31, 2004 and requested that Nasdaq dismiss the pending
delisting action against it. On June 8, 2004, Nasdaq advised the Company that
the Panel had closed its hearing file regarding the delisting of the Company and
had determined that monitoring of the Company by the Panel over the longer term
was not necessary.
19
NYFIX, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The purpose of management's discussion and analysis of financial condition
and results of operations ("MD&A") is to provide an overview of NYFIX, Inc. to
help facilitate an understanding of the significant factors influencing our
financial statements and also to convey our expectations of the potential impact
of known trends, events, or uncertainties that may impact our future financial
statements. Our MD&A includes forward-looking statements, including, without
limitations, our expectations. Our actual results may differ materially from
those expressed or implied in the forward-looking statements as a result of
various factors including, but not limited to, those discussed in the "Risk
Factors" section of our 2003 Form 10-K, and below. We assume no obligation to
update the forward-looking statements or such risk factors. You should read this
discussion in conjunction with our condensed consolidated financial statements
and related notes included in this Report on Form 10-Q and our consolidated
financial statements and related notes, "Selected Consolidated Financial Data"
and "Risk Factors" included in our 2003 Form 10-K.
OVERVIEW
NYFIX, founded in 1991 through the acquisition of a New York corporation,
is headquartered in Stamford, Connecticut. In December 2003, we reincorporated
as a Delaware corporation.
We are an established provider to the domestic and international financial
markets of trading workstations, middle-office trade automation technologies and
trade communication technologies. Our NYFIX Network is one of the industry's
largest networks, connecting broker-dealers, institutions and exchanges. In
addition to our headquarters in Stamford, we have offices on Wall Street in New
York City, in London's Financial District, in Chicago, and in San Francisco. We
operate three data centers in the northeastern United States and have
established additional data center hubs in London, Amsterdam, Hong Kong and
Tokyo.
We are a provider of trading technology, industry network connectivity and
execution services, offering certain underlying, universally applicable network
inter-connectivity products, systems, facilities, and supporting operations to
our two business segments: our Technology Services segment and our Transaction
Services segment. These segments, in turn, package these products and services
and add others to address the needs of their specific markets. We also provide
to our segments products specifically developed to support the marketing
strategy of that segment. We provide product development, systems development,
data center and network operations support to our segments.
Our Technology Services segment is comprised of four of our subsidiaries:
NYFIX USA, NYFIX Overseas, Javelin, and Renaissance. These businesses work
together as technology providers, focusing on offering trade-management systems,
a centralized industry order-routing network, order-routing software,
exchange-floor automation systems, exchange and market access technology and
post-trade processing systems. Our Technology Services segment customers consist
primarily of United States securities brokerage firms and international
derivatives brokerage firms. Our Technology Services segment generates
subscription, capital sale and service revenue.
Our Transaction Services segment is comprised of six of our subsidiaries:
NYFIX Millennium, NYFIX Transaction Services, and NYFIX Clearing, which are NASD
registered broker-dealers; NYFIX Partners, which is our introducing
broker-dealer for derivatives and was granted its broker-dealer license in 2002
by the National Futures Association; NYFIX International, which we incorporated
in the United Kingdom on March 29, 2004 and which received its FSA broker-dealer
license on September 29, 2004, in anticipation of our expansion into European
and other international markets; and EuroLink, of which we acquired the
remaining 60% we did not already own effective March 29, 2004 and which
represented our initial transaction efforts in the European markets. NYFIX
Millennium provides a modernized electronic execution venue under Regulation ATS
20
NYFIX, INC.
for trading in United States stocks. NYFIX Transaction Services provides
technology and direct market access and execution links. NYFIX Clearing, a
member of the DTCC, settles and clears transactions on behalf of NYFIX
Millennium and NYFIX Transaction Services. While NYFIX Partners has not
initiated any active business, we are discussing opportunities with sponsoring
broker-dealers and potential customers for the derivatives markets to augment
our future business plans. Our Transaction Services segment generates
subscription and transaction revenue.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
This MD&A reviews our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. These principles require us to make estimates,
based on assumptions, which if not accurate, could materially affect our
financial statements, including the assets, liabilities, revenue and expense and
the disclosure of contingent assets and liabilities at the date of the financial
statements and future reporting periods. The markets for our products are
characterized by intense competition, rapid technological development and
pricing pressures, all of which could affect the future realization of our
assets.
Estimates, including assumptions related to: the collectibility of accounts
receivable; the useful lives of tangible and intangible assets; the
recoverability of goodwill; the realization of deferred tax assets; revenue
recognition; product enhancement costs; income taxes; and contingencies are
reviewed periodically and the effects of revisions are reflected in the
condensed consolidated financial statements in the period they are determined to
be necessary. We base our estimates on historical experience and on various
other factors and assumptions that we believe to be reasonable, the results of
which form the bases for making estimates and assumptions about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ materially from these estimates under
different assumptions.
For our accounting policies that, among others, are critical to the
understanding of our results of operations due to the assumptions we must make
in their application, refer to Item 7, Management's Discussion and Analysis of
our Financial Condition and Results of Operations ("MD&A"), in our 2003 Form
10-K. We have reviewed the development and selection of these accounting
policies, estimates, including the underlying assumptions, and the related
disclosures in the financial statements and this MD&A with our Audit Committee.
Refer to Note 1 in the Notes to the Consolidated Financial Statements in Item 15
of our 2003 Form 10-K for our significant accounting policies. In the first nine
months of 2004, there have been no material changes to our significant
accounting policies.
OVERVIEW OF FINANCIAL RESULTS
The tables provided below present additional views of our revenue and gross
profit. The following table presents our revenue, gross profit and gross profit
as a percentage of revenue, by reportable segment for the periods indicated:
21
NYFIX, INC.
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- ---------------------------
2004 2003 2004 2003
--------- -------- -------- ---------
($ in thousands)
Segment revenue:
Technology Services $ 15,941 $ 13,696 $ 44,717 $ 40,379
Transaction Services 4,194 3,312 12,217 10,826
Eliminations (645) (613) (2,079) (1,831)
--------- -------- -------- ---------
Total revenue $ 19,490 $ 16,395 $ 54,855 $ 49,374
========= ======== ======== =========
Segment revenue, as a percentage of total
revenue:
Technology Services 82 % 84 % 82 % 82 %
Transaction Services 21 % 20 % 22 % 22 %
Eliminations (3)% (4)% (4)% (4)%
--------- -------- -------- ---------
Total 100 % 100 % 100 % 100 %
========= ======== ======== =========
Segment gross profit:
Technology Services $ 8,159 $ 6,660 $ 22,103 $ 21,273
Transaction Services 859 790 3,039 2,642
--------- -------- -------- ---------
Total gross profit $ 9,018 $ 7,450 $ 25,142 $ 23,915
========= ======== ======== =========
Segment gross profit, as a percentage of
revenue:
Technology Services 51 % 49 % 49 % 53 %
Transaction Services 20 % 24 % 25 % 24 %
Total 46 % 45 % 46 % 48 %
The following table shows our revenue, cost of revenue, gross profit and
operating expense expressed as percentages of revenue for the periods indicated:
22
NYFIX, INC.
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ----------------------
2004 2003 2004 2003
---- ---- ---- ----
Revenue:
Subscription 57% 56% 55% 52%
Capital sale 13% 13% 12% 14%
Service contract 12% 14% 14% 14%
Transaction 18% 17% 19% 20%
---- ---- ---- ----
Total revenue 100% 100% 100% 100%
---- ---- ---- ----
Cost of Revenue:
Subscription 53% 60% 57% 58%
Capital sale 33% 37% 36% 34%
Service contract 43% 32% 37% 29%
Transaction 79% 69% 70% 64%
Total cost of revenue 54% 55% 54% 52%
Gross Profit:
Subscription 47% 40% 43% 42%
Capital sale 67% 63% 64% 66%
Service contract 57% 68% 63% 71%
Transaction 21% 31% 30% 36%
Total gross profit 46% 45% 46% 48%
Operating Expense:
Selling, general and administrative 52% 52% 51% 50%
Restructuring charge 0% 0% 5% 0%
Research and development 1% 2% 2% 2%
Depreciation and amortization 3% 4% 3% 4%
---- ---- ---- ----
Total operating expense 56% 58% 61% 56%
---- ---- ---- ----
We recognize revenue in accordance with the SEC's Staff Accounting Bulletin
("SAB") No. 101, Revenue Recognition in Financial Statements, as amended by SAB
101A and 101B ("SAB 101") and SAB 104, Revenue Recognition. SAB 101 requires
that four basic criteria must be met before revenue can be recognized: (1)
persuasive evidence of an arrangement exists; (2) delivery has occurred or
services have been rendered; (3) the fee is fixed and determinable; and (4)
collectibility is reasonably assured. Determination of criteria (3) and (4) are
based on our judgment regarding the fixed nature of the fee charged for products
delivered and the collectibility of those fees. Should changes in conditions
cause us to determine these criteria are not met for certain future
transactions, revenue recognized for any reporting period could be adversely
impacted.
We recognize revenue from software arrangements in accordance with
Statement of Position ("SOP") 97-2, Software Revenue Recognition as amended by
SOP 98-9, Modification of SOP 97-2 with Respect to Certain Transactions. Revenue
is recognized when persuasive evidence of an arrangement exists and delivery has
occurred, provided the fee is fixed or determinable, collectibility is probable
and the arrangement does not require significant customization or modification
of the software.
23
NYFIX, INC.
We recognize revenue for contracts with multiple deliverables, which are
not covered under SOP 97-2, in accordance with the Financial Accounting
Standards Board's ("FASB") Emerging Issues Task Force 00-21, Accounting for
Revenue Arrangements with Multiple Deliverables ("EITF No. 00-21"). EITF No.
00-21 applies to certain contractually binding arrangements under which a
company performs multiple revenue generating activities and requires that all
companies account for each element within an arrangement with multiple
deliverables as separate units of accounting if (a) the delivered item has value
on a stand-alone basis, (b) there is objective and reliable evidence of fair
value and (c) the amount of the total arrangement consideration is fixed.
Our revenue is comprised of subscription, capital sale, service contract
and transaction components, described as follows:
Subscription revenue contracts are primarily with brokerage firms,
international banks and global exchanges trading in equities and/or derivatives.
Subscription revenue contracts are for providing equipment and services and for
use of our NYFIX Network, with an initial term of generally one to three years
with automatic renewal periods unless we receive prior written notice of
cancellation. Additional services, provided under schedules, or addendums to the
contract, are either co-terminus with the original contract or have provisions
similar to the original contract. Under the terms of the subscription contracts
and addendums, customers typically contract for a flat periodic charge after
initial installation and acceptance. The revenue related to these contracts is
recognized over the term of the contract, or addendum, on a straight-line basis.
We also include within our subscription revenue, telecommunication and other
charges, which we provide to the customer at cost plus a normal profit. Such
revenue is recognized as the services are provided. As we have no history of
significant cancellations, we do not record a reserve for cancellations.
Capital sale revenue, which is comprised of software and capital equipment
sales and project management fees, is generated primarily by sales to customers
in the futures, options and currencies trading market or to those customers who
typically acquire licenses in perpetuity, and is recognized upon shipment of the
product and acceptance by the customer. Capital sale revenue is recognized in
accordance with SOP 97-2, described above. As we have no history of significant
sales returns or allowances, we do not record a reserve for sales returns and
allowances.
Service contract revenue, which is comprised of maintenance contracts for
subscription equipment and software and capital equipment, is recognized over
the contract period on a straight-line basis. Service contracts for subscription
equipment are generally co-terminus with the subscription contract. Service
contracts for software and capital equipment, typically characterized as a
percentage of the original capital sale contract, are generally for an initial
term of one to three years with automatic renewal periods unless we receive
prior written notice of cancellation. Certain service contracts provide for
invoicing in advance of the service being performed, generally quarterly.
Transaction revenue primarily consists of per-share commissions charged to
customers who send and receive a match and execution in our ATS order matching
system, customers to whom we provide execution and smart order routing
technology and gateways to access markets in: (1) their own name, (2) a third
party "give up" name, or (3) our name. Transaction revenue is generally invoiced
monthly in arrears or is extracted from the clearing process within three days
of the trade date and recognized in the period in which it is earned. Also,
included in transaction revenue is the net revenue from our stock loan business
where we lend securities as part of our strategy in which both a securities
borrowed and a securities loaned agreement are transacted with the same
underlying securities for the same period of time. Certain transaction revenue
contracts, which include multiple deliverables, or other types of our revenue
are accounted for in accordance with EITF 00-21, described above. Some of these
contracts have minimum volume commitments or are invoiced at a minimum
transaction-based fee. The arrangement consideration is allocated to each
element based on the relative fair values of each element. We account for each
24
NYFIX, INC.
element of an arrangement with multiple deliverables separately.Vendor specific
objective evidence for fair value of services is primarily determined by
reference to renewal pricing.
Revenue on contracts invoiced in advance of the services being performed is
deferred and recognized as revenue over the period earned and is included in
"deferred revenue" in our condensed consolidated balance sheets. Shipping,
handling and installation charges, if any, are generally invoiced to a customer
and are included in revenue upon completion of the installation.
Cost of revenue principally consists of costs associated with our data
center operations where we maintain equipment and infrastructure to support our
operations, amortization of capitalized product enhancement costs, depreciation
of subscription equipment, amortization of intangible assets and other direct
costs, including customer-specific telecommunication costs, execution, clearing
fees and market data feeds. Certain data center costs, such as labor, equipment
maintenance, software support and depreciation and amortization, are allocated
to our segments based on usage estimates.
Operating expense is comprised of selling, general and administrative
("SG&A"), research and development ("R&D") and depreciation and amortization.
SG&A expense consists of salaries and benefits, office rent and other office
expense, provision for doubtful accounts, and marketing expense. Corporate SG&A
expense is allocated to our segments based on usage estimates. R&D expense
relates to our cost of developing new products and technologies to meet the
current and future needs of our customers, up to the point of technical
feasibility at which point we capitalize such costs to bring our products to
market. R&D expense consists primarily of salaries and related costs for our
technical and development staff. Depreciation and amortization expense consists
of such expense for our corporate equipment and software.
MD&A related to segment revenue, cost of revenue and gross profit includes
intercompany revenue and cost of revenue, which have been eliminated in
consolidation.
HISTORICAL RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2003
Revenue
The following table presents an overview of our revenue:
25
NYFIX, INC.
-----------------------------------------------
2004 2003
$ % $ %
-------- ------- -------- -------
($ in thousands)
Technology Services:
Subscription $ 10,947 69 % $ 9,251 68 %
Capital sale 2,547 16 % 2,117 15 %
Service contract 2,447 15 % 2,327 17 %
-------- --------
Sub-total 15,941 82 % 13,695 84 %
-------- --------
Transaction Services:
Subscription 737 18 % 477 14 %
Transaction 3,457 82 % 2,836 86 %
-------- --------
Sub-total 4,194 22 % 3,313 20 %
-------- --------
Eliminations:
Subscription (645) n/a (613) n/a
-------- --------
Sub-total (645) n/a (613) n/a
-------- --------
Total revenue
Subscription 11,039 57 % 9,115 56 %
Capital sale 2,547 13 % 2,117 13 %
Service contract 2,447 12 % 2,327 14 %
Transaction 3,457 18 % 2,836 17 %
-------- ------- -------- -------
Consolidated revenue $ 19,490 100 % $ 16,395 100 %
======== ======- ======== =======
Segment subtotals are presented as a percentage of consolidated revenue
Consolidated revenue increased $3.1 million, or 19%, to $19.5 million for
the three months ended September 30, 2004 as compared to $16.4 million for the
three months ended September 30, 2003.
Our Technology Services segment revenue increased $2.2 million, or 16%, to
$15.9 million for the three months ended September 30, 2004 as compared to $13.7
million for the three months ended September 30, 2003.
Subscription revenue for our Technology Services segment increased to $10.9
million for the three months ended September 30, 2004 from $9.2 million for the
three months ended September 30, 2003. This $1.7 million increase was primarily
attributable to an increase in our buy-side initiative of $1.1 million and a net
increase in subscription revenue from our traditional technology customers of
$0.4 million. In August 2002, we began an initiative to sell circuits to
buy-side institutions in order to leverage our expansive NYFIX Network. As of
September 30, 2004, we had in excess of 1,800 connections as a result of this
initiative. Our traditional technology average annualized revenue per customer
was $129,000 for the three months ended September 30, 2004, as compared to
$111,000 for the three months ended September 30, 2003. We had a net increase of
four customers to 295 customers at September 30, 2004 from 291 customers at
September 30, 2003. We expect our buy-side related revenue to increase in the
next several quarters as we continue to add and implement services for buy-side
customers. In addition, with the integration of the Renaissance Nasdaq trading
platform product into our product offering, we expect to continue to experience
quarterly net increases in customers.
Capital sale revenue for our Technology Services segment was $2.5 million
for the three months ended September 30, 2004 as compared to $2.1 million for
the three months ended September 30, 2003, respectively, which was primarily
26
NYFIX, INC.
attributable to increased consulting services for our derivatives products.
Capital sale revenue continues to vary considerably from period to period. We do
not expect that this increase in capital sale revenue constitutes a trend
towards higher capital sale revenue in the future.
Service revenue for our Technology Services segment increased to $2.4
million for the three months ended September 30, 2004 from $2.3 million for the
three months ended September 30, 2003, which was primarily attributable to an
increase in service revenue for our subscription business which was slightly
offset by a decrease in maintenance revenue, which is based on prior capital
sale revenue.
As a percentage of total revenue, our Technology Services segment decreased
to 82% for the three months ended September 30, 2004 from 84% for the three
months ended September 30, 2003.
Our Transaction Services segment revenue increased $0.9 million, or 27%, to
$4.2 million for the three months ended September 30, 2004 as compared to $3.3
million for the three months ended September 30, 2003. Our Transaction Services
customer base increased in the three months ended September 30, 2004 to 167 from
90 at September 30, 2003, with average revenue per customer of $25,000 in the
current year's quarter compared to average revenue per customer of $37,000 in
the prior year's quarter. The decrease in average revenue per customer was
attributed to a decrease in revenue from several large customers from whom we
generate transaction revenue from orderflow executed enroute to the NYSE. The
revenue attributed to these customers' orderflow was lower during the three
months ended September 30, 2004 than in the three months ended September 30,
2003 as a result of lower volume of orderflow executed and competitive pricing
for such customers. For our Transaction Services segment, we expect to continue
to add customers during the fourth quarter with the emphasis on the buy-side. We
expect this segment of our business to grow as a percentage of the overall
Transaction Services segment. As a percentage of total revenue, our Transaction
Services segment increased to 22% for the three months ended September 30, 2004
from 20% for the three months ended September 30, 2003. We expect our
Transaction Services segment revenue to be a larger percentage of our
consolidated revenue in future periods.
Cost of Revenue
The following table presents an overview of our cost of revenue:
27
NYFIX, INC.
Three Months Ended September 30,
--------------------------------------------------------------
2004 2003
$ % $ %
--------------------------- ---------------------------
($ in thousands)
Technology Services:
Subscription $ 5,908 76% $ 5,500 78%
Capital sale 828 11% 791 11%
Service contract 1,046 13% 745 11%
-------- -------
Sub-total 7,782 49% 7,036 51%
-------- -------
Transaction Services:
Subscription 582 17% 454 18%
Transaction 2,753 83% 2,068 82%
-------- -------
Sub-total 3,335 80% 2,522 76%
-------- -------
Corporate and Eliminations:
Corporate:
Data center and telecommunications 3,005 3,182
Fixed asset depreciation and amortization 1,362 1,313
Amortization of product enhancement costs 1,031 678
Allocated to:
Technology Services (4,419) (4,346)
Transaction Services (979) (827)
-------- -------
Sub-total -- --
-------- -------
Eliminations:
Subscription (613) n/a (506) n/a
Transaction (32) n/a (107) n/a
-------- -------
Sub-total (645) n/a (613) n/a
-------- -------
Consolidated cost of revenue $ 10,472 54% $ 8,945 55%
======== =======
Segment subtotals are presented as a percentage of segment revenue.
Consolidated cost of revenue increased $1.6 million, or 18%, to $10.5
million for the three months ended September 30, 2004 as compared to $8.9
million for the three months ended September 30, 2003. The primary factors for
the increase in 2004 were transaction related costs of $0.6 million, including
execution and clearing fees, labor costs of $0.5 million, product enhancement
cost amortization of $0.4 million, which was primarily due to product
enhancements costs to support our Technology Services products, amortization of
EuroLink and Renaissance intangible assets of $0.1 million, market data feed
costs of $0.1 million, depreciation expense of $0.1 million and cross connection
fees of $0.1 million. Slightly offsetting these increases was a decrease of $0.2
million, due to reduced data center maintenance and facility costs and other
miscellaneous expenses. As a percentage of revenue, cost of revenue decreased to
54% for the three months ended September 30, 2004, from 55% for the three months
ended September 30, 2003, as the increase in the Technology Services and
Transaction Services revenue was greater than the increase in Technology
Services and Transaction Services costs.
Our Technology Services segment cost of revenue increased $0.8 million, or
11%, to $7.8 million for the three months ended September 30, 2004 compared to
$7.0 million for the three months ended September 30, 2003. This increase was
primarily attributable to higher labor costs of $0.4 million, network connection
fees of $0.1 million, market data feed costs of $0.1 million, and the
aforementioned increases in allocated corporate expenses, such as
telecommunications expenses, depreciation and amortization of fixed assets and
amortization of product enhancement costs, of $0.1 million. Included in the
increase was additional service contract cost of revenue of $0.3 million, or
43%, which increased to $1.0 million for the three months ended September 30,
2004, from $0.7 million for the three months ended June 30, 2003. This increase
was primarily due to increased labor costs to support our products. As a
28
NYFIX, INC.
percentage of revenue, cost of revenue decreased to 49% in 2004, from 51% in
2003, as the increase in the revenue grew at a faster rate than increase in the
aforementioned costs. We expect to see a slight decrease in our cost of revenue
as a percentage of revenue for the next several quarters as many of the
investments in property and equipment in our data center and network
infrastructure made in 2002 and 2003 should yield lower costs as a percentage of
revenue.
Our Transaction Services segment cost of revenue increased $0.8 million, or
32%, to $3.3 million for the three months ended September 30, 2004 compared to
$2.5 million for the three months ended September 30, 2003. In addition to the
aforementioned increase in transaction related costs of $0.6 million, including
execution and clearing fees, cost of revenue decreased by $0.1 million related
to intercompany charges from the Technology Services segment, which are passed
through to Transaction Services customers. These intercompany costs were
eliminated in our consolidated cost of revenue. As a percentage of revenue, cost
of revenue increased to 80% for the three months ended September 30, 2004, from
76% for the three months ended September 30, 2003, as the increased transaction
related costs grew at a faster pace than the increased segment revenue. We
expect our cost of revenue to decline as a percentage of Transaction Services
segment revenue for the next several quarters. This is attributable to the
expected increases in revenue and the change in customer mix as described above,
which should enable us to spread our fixed costs over a greater revenue base,
and reduced clearing expenses as a result of self-clearing our trades through
NYFIX Clearing.
Gross Profit and Gross Profit Margin (as a Percentage of Revenue)
The following table presents an overview of our gross profit and gross
profit margin:
Three Months Ended September 30,
------------------------------------------------------------------
2004 2003
$ % $ %
---------------------------- ----------------------------
($ in thousands)
Technology Services:
Subscription $ 5,039 46% $ 3,752 41%
Capital sale 1,719 67% 1,326 63%
Service contract 1,401 57% 1,582 68%
------- -------
Sub-total 8,159 51% 6,660 49%
------- -------
Transaction Services:
Subscription 155 21% 22 5%
Transaction 704 20% 768 27%
------- -------
Sub-total 859 20% 790 24%
------- -------
Eliminations:
Subscription (32) n/a (107) n/a
Transaction 32 n/a 107 n/a
------- -------
Sub-total -- --
------- -------
Total gross profit:
Subscription 5,162 47% 3,667 40%
Capital sale 1,719 67% 1,326 63%
Service contract 1,401 57% 1,582 68%
Transaction 736 21% 875 31%
------- -------
Consolidated gross profit $ 9,018 46% $ 7,450 45%
======= =======
Percentages are presented as a percentage of segment revenue, except for
consolidated gross profit percentages, which are presented as a percentage of
consolidated revenue.
Consolidated gross profit increased $1.5 million to $9.0 million for the
29
NYFIX, INC.
three months ended September 30, 2004 from $7.5 million for the three months
ended September 30, 2003. The aforementioned increase in revenue offset the
increase in cost of revenue. Accordingly, our gross profit margin increased to
46% for the three months ended September 30, 2004, as compared to 45% for the
three months ended September 30, 2003.
Our Technology Services segment gross profit increased $1.5 million to $8.2
million for the three months ended September 30, 2004 from $6.7 million for the
three months ended September 30, 2003. As a percentage of segment revenue, gross
profit margin increased to 51% for the three months ended September 30, 2004
from 49% for the three months ended September 30, 2003. The increase in gross
profit margin is primarily attributable to growth in our traditional equity
products subscription and service contract revenue, which outpaced the
aforementioned increases in our costs, and gross profit contributed by our
buy-side initiative. We expect to see slight improvements in our Technology
Services segment gross profit margin for the next several quarters, as many of
the improvements to our data center and network infrastructure made in 2002 and
2003 should yield lower costs as a percentage of revenue.
Our Transaction Services segment gross profit increased $0.1 million to
$0.9 million for the three months ended September 30, 2004 from $0.8 million for
the three months ended September 30, 2003. Transaction Services segment gross
profit margin decreased to 20% for the three months ended September 30, 2004, as
compared to 24% for the three months ended September 30, 2003. The decrease in
gross profit was primarily attributable to the aforementioned increase in
transaction cost of revenue, which grew at a faster rate than the increase in
transaction revenue. We expect our Transaction Services segment gross margin to
continue to improve as a percentage of Transaction Services segment revenue in
the fourth quarter of 2004. This is attributable to the expected increases in
revenue and change in customer mix as described above, which should enable us to
spread our fixed costs over a greater revenue base, as well as reduced clearing
expenses as a result of self-clearing our trades through NYFIX Clearing.
SG&A
The following table presents an overview of our SG&A expense:
Three Months Ended September 30,
-----------------------------------------------------------
2004 2003
$ % $ %
----------------------- -------------------------
($ in thousands)
Salaries and benefits $ 5,775 58 % $ 5,134 59 %
Provision for doubtful accounts 255 3 % 292 3 %
Occupancy and related 902 9 % 966 11 %
Marketing, travel and entertainment 871 9 % 530 6 %
General and other 2,264 22 % 1,580 19 %
------- -------
Total SG&A $10,067 52 % $ 8,502 52 %
======= =======
The total SG&A is presented as a percentage of consolidated revenue.
SG&A expense increased $1.6 million, or 19%, to $10.1 million for the three
months ended September 30, 2004, as compared to $8.5 million for the three
months ended September 30, 2003. The increase was primarily attributable to
increased professional and consulting fees of $0.7 million due principally to
legal and audit fees incurred in connection with the class action lawsuit filed
against us and SEC matters and consulting fees related to Sarbanes-Oxley
compliance; increased salaries and benefits of $0.6 million primarily due to
company-wide salary increases effective January 1, 2004, staff dedicated to our
NYFIX International start-up and increased health care costs; and increased
30
NYFIX, INC.
marketing, travel and entertainment expenses of $0.3 million. As a percentage of
total revenue, SG&A expense remained constant at 52% for the three months ended
September 30, 2004 and 2003, as the increase in SG&A expense increase was offset
by the increase in consolidated revenue. We expect that our general and
administrative expenses, particularly related to our legal, audit and consulting
fees incurred in connection with the class action lawsuit filed against us, SEC
matters and Sarbanes-Oxley compliance will increase to higher levels in the near
term. In addition, we expect our employee benefits to increase in 2005 as our
primary health insurance policies, which we expect to see increase 10% to 20%,
renew on January 1, 2005.
R&D
R&D expense decreased $0.1 million, or 25%, to $0.3 million for the three
months ended September 30, 2004, from $0.4 million for the three months ended
September 30, 2003, as our developers' efforts were concentrated on enhancing
our products. As a percentage of total revenue, research and development expense
remained decreased to 1% for the three months ended September 30, 2004, from 2%
for the three months ended September 30, 2003. We expect a similar amount of R&D
expense for the next several quarters.
Depreciation and Amortization
Depreciation and amortization expense decreased $0.2 million, or 29%, to
$0.5 million for the three months ended September 30, 2004, from $0.7 million
for the three months ended September 30, 2003, due to a slight decrease in net
property and equipment. As a percentage of total revenue, depreciation and
amortization expense decreased to 3% for the three months ended September 30,
2004 from 4% for the three months ended September 30, 2003. The decrease as a
percentage of total revenue was primarily attributable to the decreased
amortization expense. We expect to see similar trending of depreciation and
amortization expense in the near term.
Loss from Operations
Loss from operations was $1.8 million for the three months ended September
30, 2004, as compared to a loss of $2.2 million for the three months ended
September 30, 2003. The decrease in operating loss was primarily due to the
increase in gross profit, as revenue increased at a greater pace than cost of
revenue. This decrease was offset by higher SG&A expense, primarily due to legal
and audit fees incurred in connection with the class action lawsuit filed
against us and SEC matters and consulting fees related to Sarbanes-Oxley
compliance. As a percentage of total revenue, loss from operations was a deficit
of 9% for the three months ended September 30, 2004 as compared to a deficit of
13% for the three months ended September 30, 2003. The decrease in the deficit
as a percentage of total revenue was primarily attributable to the increase in
revenue.
Investment Income
Investment income decreased $0.3 million for the three months ended
September 30, 2004 as compared to the three months ended September 30, 2003, due
primarily to realized gains on investments of $0.2 million in the prior year's
three month period.
Other Income (Expense), net
We accounted for EuroLink, our previously unconsolidated affiliate, under
the equity method through March 28, 2004. For the three months ended September
30, 2003, we recognized equity in the losses of EuroLink of $0.1 million.
Income Tax Provision (Benefit)
We recorded an income tax provision of $20.3 million for the three months
ended September 30, 2004, compared to a tax benefit of $0.9 million for the
31
NYFIX, INC.
three months ended September 30, 2003. We established a deferred tax asset
valuation allowance of $21.0 million at September 30, 2004, in accordance with
SFAS No. 109. Where there are cumulative operating losses in recent years, SFAS
No. 109 requires, except in very limited circumstances, that a deferred tax
asset valuation allowance be established. We had operating income in 2001, but
did not in 2002 and 2003. We had previously estimated that our deferred tax
assets, consisting primarily of tax credit carryforwards and net operating loss
carryforwards, would be realized and no valuation allowance was required, based
on revenue and operating expense assumptions. During the third quarter of 2004,
our general and administrative expenses related to Sarbanes-Oxley compliance and
legal expenses increased more than forecasted and we expect these costs to
remain at this higher level in the near term. These cost increases, together
with revenues from our Transaction Services segment being impacted by much lower
than expected volumes in the equity markets, particularly during the month of
September, were the primary reasons we did not achieve profitability for the
quarter and thus reduced our forecast for the near-term. We expect to return to
profitability, but until we can achieve and sustain an appropriate level of
profitability, we plan to record a full valuation allowance on our deferred tax
assets.
Our effective tax rate was 1,099% for the three months ended September 30,
2004, and 45% for the three months ended September 30, 2003. Our effective tax
rate for the three months ended September 30, 2004 is higher than the Federal
statutory rate primarily due to the aforementioned deferred tax asset valuation
allowance. Our effective tax rate for the three months ended September 30, 2003
is higher than the Federal statutory rate primarily due to the effects of
recognition of certain research and development tax credits and state income
taxes.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2003
Revenue
The following table presents an overview of our revenue:
32
NYFIX, INC.
Nine Months Ended September 30,
--------------------------------------------------------------------
2004 2003
$ % $ %
-------- -------- ------- --------
($ in thousands)
Technology Services:
Subscription $ 30,496 68 % $ 26,484 66 %
Capital sale 6,590 15 % 6,800 17 %
Service contract 7,631 17 % 7,094 18 %
-------- -------
Sub-total 44,717 82 % 40,378 82 %
-------- -------
Transaction Services:
Subscription 1,903 16 % 1,112 10 %
Transaction 10,314 84 % 9,715 90 %
-------- -------
Sub-total 12,217 22 % 10,827 22 %
-------- -------
Eliminations:
Subscription (2,079) n/a (1,831) n/a
-------- -------
Sub-total (2,079) n/a (1,831) n/a
-------- -------
Total revenue
Subscription 30,320 55 % 25,765 52 %
Capital sale 6,590 12 % 6,800 14 %
Service contract 7,631 14 % 7,094 14 %
Transaction 10,314 19 % 9,715 20 %
-------- -------- ------- --------
Consolidated revenue $ 54,855 100 % $ 49,374 100 %
======== ======== ======= ========
Segment subtotals are presented as a percentage of consolidated revenue.
Consolidated revenue increased $5.5 million, or 11%, to $54.9 million for
the nine months ended September 30, 2004 as compared to $49.4 million for the
nine months ended September 30, 2003.
Our Technology Services segment revenue increased $4.3 million, or 11%, to
$44.7 million for the nine months ended September 30, 2004 as compared to $40.4
million for the nine months ended September 30, 2003.
Subscription revenue for our Technology Services segment increased to $30.5
million for the nine months ended September 30, 2004 from $26.5 million for the
nine months ended September 30, 2003. This $4.0 million increase was primarily
attributable to our buy-side initiative of $3.1 million, a net increase in
subscription revenue from our traditional technology customers of $0.2 million
and from others of $0.7 million. In August 2002, we began an initiative to sell
circuits to buy-side institutions in order to leverage our expansive NYFIX
Network. We had a net increase of four customers to 295 customers at September
30, 2004 from 291 customers at September 30, 2003. Our traditional technology
average annualized revenue per customer was $119,000 for the nine months ended
September 30, 2004, as compared to $105,000 for the nine months ended September
30, 2003.
Capital sale revenue for our Technology Services segment slightly decreased
to $6.6 million for the nine months ended September 30, 2004 as compared to $6.8
million for the nine months ended September 30, 2003.
Service revenue for our Technology Services segment increased to $7.6
million for the nine months ended September 30, 2004 from $7.1 million for the
nine months ended September 30, 2003, which was primarily attributable to an
33
NYFIX, INC.
increase in service revenue for our subscription business and slightly offset by
a decrease in maintenance revenue, which is based on prior capital sale revenue.
As a percentage of total revenue, our Technology Services segment remained
constant at 82% for both the nine months ended September 30, 2004 and September
30, 2003.
Our Transaction Services segment revenue increased $1.4 million, or 13%, to
$12.2 million for the nine months ended September 30, 2004 as compared to $10.8
million for the nine months ended September 30, 2003. Our Transaction Services
customer base increased in the nine months ended September 30, 2004 to 167 from
90 at September 30, 2003, with average revenue per customer of $73,000 in the
current year's nine month period compared to average revenue per customer of
$120,000 in the prior year's nine month period. The decrease in average revenue
per customer was attributed to a decrease in revenue from several large
customers from whom we generate transaction revenue from orderflow executed
enroute to the NYSE. The revenue attributed to these customers' orderflow was
lower during the nine months ended September 30, 2004 than in the nine months
ended September 30, 2003 as a result of lower volume of orderflow executed and
competitive pricing for such customers. As a percentage of total revenue, our
Transaction Services segment remained constant at 22% for both the nine months
ended September 30, 2004 and the nine months ended September 30, 2003.
Cost of Revenue
The following table presents an overview of our cost of revenue:
34
NYFIX, INC.
Nine Months Ended September 30,
-------------------------------------------------------------
2004 2003
$ % $ %
--------------------------- -----------------------------
($ in thousands)
Technology Services:
Subscription $ 17,376 77% $ 14,740 77%
Capital sale 2,385 11% 2,279 12%
Service contract 2,853 13% 2,087 11%
-------- --------
Sub-total 22,614 51% 19,106 47%
-------- --------
Transaction Services:
Subscription 1,736 19% 948 12%
Transaction 7,442 81% 7,236 88%
-------- --------
Sub-total 9,178 75% 8,184 76%
-------- --------
Corporate and Eliminations:
Corporate:
Data center and telecommunications 9,061 8,973
Fixed asset depreciation and amortization 4,235 3,881
Amortization of product enhancement costs 2,737 1,881
Allocated to:
Technology Services (13,511) (12,350)
Transaction Services (2,522) (2,385)
-------- --------
Sub-total -- --
-------- --------
Eliminations:
Subscription (1,829) n/a (855) n/a
Transaction (250) n/a (976) n/a
-------- --------
Sub-total (2,079) n/a (1,831) n/a
-------- --------
Consolidated cost of revenue $ 29,713 54% $ 25,459 52%
=======- ========
Segment subtotals are presented as a percentage of segment revenue.
Consolidated cost of revenue increased $4.3 million, or 17%, to $29.7
million for the nine months ended September 30, 2004 as compared to $25.5
million for the nine months ended September 30, 2003. Included in the $4.3
million increase were $1.7 million of costs associated with Renaissance, which
we acquired on July 1, 2003. The primary factors for the increase in 2004 were
labor costs of $1.7 million, product enhancement cost amortization of $0.9
million, which was primarily due product enhancements costs to support our
Technology Services products, transaction related costs of $0.7 million,
telecommunication expense of $0.4 million, depreciation expense of $0.4 million,
market data feed costs of $0.4 million, cross connection fees of $0.3 million
and amortization of EuroLink and Renaissance intangible assets of $0.3 million.
Slightly offsetting these increases was a decrease of $0.4 million, due to
reduced data center maintenance and facility costs and other miscellaneous
expenses. As a percentage of revenue, cost of revenue increased to 54% for the
nine months ended September 30, 2004, from 52% for the nine months ended
September 30, 2003, as the increase in the aforementioned Technology Services
costs and Transaction Services costs as mentioned below exceeded the increases
in our Transaction and Transaction Services revenue.
Our Technology Services segment cost of revenue increased $3.5 million, or
18%, to $22.6 million for the nine months ended September 30, 2004 compared to
$19.1 million for the nine months ended September 30, 2003. This increase was
primarily attributable to higher labor costs of $1.8 million, amortization of
acquired intangible assets of $0.2 million due to the Renaissance acquisition,
market data feed costs of $0.3 million, network connection fees of $0.3 million
and the aforementioned increases in allocated corporate expenses, such as
telecommunications expenses, depreciation and amortization of fixed assets and
amortization of product enhancement costs, of $1.2 million. Included in the
increase was additional service contract cost of revenue of $0.8 million, or
35
NYFIX, INC.
38%, to $2.9 million for the nine months ended September 30, 2004, from $2.1
million for the nine months ended September 30, 2003. This increase was
primarily due to increased labor costs to support our products. As a percentage
of revenue, cost of revenue increased to 51% in 2004, from 47% in 2003, as the
increase in the aforementioned costs grew at a faster rate than our revenue
Our Transaction Services segment cost of revenue increased $1.0 million, or
12%, to $9.2 million for the nine months ended September 30, 2004 compared to
$8.2 million for the nine months ended September 30, 2003. In addition to the
aforementioned increase of $0.7 million in transaction related expenses, cost of
revenue decreased by $0.7 million, to $0.3 million, related to intercompany
charges from the Technology Services segment, which are passed through to
Transaction Services customers. These intercompany costs were eliminated in our
consolidated cost of revenue. As a percentage of revenue, cost of revenue
decreased to 75% for the nine months ended September 30, 2004, from 76% for the
nine months ended September 30, 2003, as the increase in the aforementioned
costs grew at a slower rate than our revenue.
Gross Profit and Gross Profit Margin (as a Percentage of Revenue)
The following table presents an overview of our gross profit and gross
profit margin:
Nine Months Ended September 30,
----------------------------------------------
2004 2003
$ % $ %
---------------------- ----------------------
($ in thousands)
Technology Services:
Subscription $ 13,120 43% $ 11,745 44%
Capital sale 4,205 64% 4,521 66%
Service contract 4,778 63% 5,007 71%
-------- --------
Sub-total 22,103 49% 21,273 53%
-------- --------
Transaction Services:
Subscription 167 9% 163 15%
Transaction 2,872 28% 2,479 26%
-------- --------
Sub-total 3,039 25% 2,642 24%
-------- --------
Eliminations:
Subscription (250) n/a (976) n/a
Transaction 250 n/a 976 n/a
-------- --------
Sub-total -- --
-------- --------
Total gross profit:
Subscription 13,037 43% 10,932 42%
Capital sale 4,205 64% 4,521 66%
Service contract 4,778 63% 5,007 71%
Transaction 3,122 30% 3,455 36%
-------- --------
Consolidated gross profit $ 25,142 46% $ 23,915 48%
======== ========
Percentages are presented as a percentage of segment revenue, except for
consolidated gross profit percentages, which are presented as a percentage of
consolidated revenue.
Consolidated gross profit increased $1.2 million to $25.1 million for the
nine months ended September 30, 2004 from $23.9 million for the nine months
ended September 30, 2003. The aforementioned increase in cost of revenue offset
the increase in revenue. Accordingly, our gross profit margin decreased to 46%
for the nine months ended September 30, 2004, as compared to 48% for the nine
months ended September 30, 2003.
Our Technology Services segment gross profit increased $0.8 million to
$22.1 million for the nine months ended September 30, 2004 from $21.3 million
36
NYFIX, INC.
for the nine months ended September 30, 2003. As a percentage of segment
revenue, gross profit margin decreased to 49% for the nine months ended
September 30, 2004 from 53% for the nine months ended September 30, 2003. The
decrease in gross profit margin is primarily attributable to the aforementioned
increases in our costs, which grew faster than revenue, as we were generally
unable to pass increased costs to our customers due to competitive pricing
pressures.
Our Transaction Services segment gross profit increased $0.4 million to
$3.0 million for the nine months ended September 30, 2004 from $2.6 million for
the nine months ended September 30, 2003. Transaction Services segment gross
profit margin increased to 25% for the nine months ended September 30, 2004, as
compared to 24% for the nine months ended September 30, 2003. The increase in
gross profit was primarily attributable to the aforementioned increase in
transaction revenue.
SG&A
The following table presents an overview of our SG&A expense:
Nine Months Ended September 30,
---------------------------------------------------------
2004 2003
$ % $ %
----------------------- ------------------------
($ in thousands)
Salaries and benefits $16,783 60 % $15,182 61 %
Provision for doubtful accounts 336 1 % 590 2 %
Occupancy and related 2,883 10 % 2,846 12 %
Marketing, travel and entertainment 2,187 8 % 1,841 7 %
General and other 6,027 21 % 4,167 17 %
------ ------
Total SG&A $28,216 51 % $24,626 50 %
====== ======
The total SG&A is presented as a percentage of consolidated revenue.
SG&A expense increased $3.6 million, or 15%, to $28.2 million for the nine
months ended September 30, 2004, as compared to $24.6 million for the nine
months ended September 30, 2003. The increase was primarily attributable to
increased professional and consulting fees of $1.8 million due principally to
legal and audit fees incurred in connection with the restatement of our 1999
through 2002 financial statements, the class action lawsuit filed against us and
SEC matters and consulting fees related to Sarbanes-Oxley compliance; increased
salaries and benefits of $1.6 million primarily due to increased staffing
related to our July 2003 Renaissance acquisition, annual merit increases
effective January 1, 2004 and increased health care costs; and increased
marketing, travel and entertainment expenses of $0.3 million, primarily related
to NYFIX International. As a percentage of total revenue, SG&A expense increased
to 51% for the nine months ended September 30, 2004 from 50% for the nine months
ended September 30, 2003, as the increase in SG&A expense outpaced the increase
in consolidated revenue.
Restructuring Charge
Effective February 1, 2004, we entered into an agreement to lease
additional space at our New York City offices at 100 Wall Street. In connection
with this agreement, we ceased use, in the second quarter 2004, of one of our
other offices on Wall Street and commenced consolidating our operations into the
new space and eliminated 14 staff positions. In accordance with SFAS No. 146,
Accounting for Exit or Disposal Activities, we recorded a charge to operations
of $2.5 million. This charge included the fair value of the remaining rent
payments, net of estimated sub-lease income, severance and write-offs of and
fixed assets and leasehold improvements. Effective January 1, 2005, we will
maintain one office on Wall Street comprising 35,800 square feet, which is a 23%
reduction from the 46,500 square feet previously leased. In addition to
operational efficiencies, we believe that we can realize an annual lease savings
of approximately 20%.
37
NYFIX, INC.
R&D
R&D expense remained constant at $0.9 million for both the nine months
ended September 30, 2004 and the nine months ended September 30, 2003. As a
percentage of total revenue, research and development expense remained at 2% for
both the nine months ended September 30, 2004 and the nine months ended
September 30, 2003.
Depreciation and Amortization
Depreciation and amortization expense decreased $0.4 million, or 19%, to
$1.7 million for the nine months ended September 30, 2004, from $2.1 million for
the nine months ended September 30, 2003 due to a slight decrease in net
property and equipment. As a percentage of total revenue, depreciation and
amortization expense decreased to 3% for the nine months ended September 30,
2004 from 4% for the nine months ended September 30, 2003. The decrease as a
percentage of total revenue was primarily attributable to the decreased
amortization expense.
Loss from Operations
Loss from operations was $8.2 million for the nine months ended September
30, 2004, as compared to a loss from operations of $3.7 million for the nine
months ended September 30, 2003. The operating loss was primarily due to the
restructuring charge of $2.5 million; higher SG&A expense, primarily due to
legal and audit fees related to the restatement of our 1999 through 2002
consolidated financial statements, the class action lawsuit filed against us and
SEC matters and consulting fees related to Sarbanes-Oxley compliance; and
subscription cost of revenue, primarily due to costs associated with
Renaissance, which we acquired in July 2003, and transaction general and
administrative costs, primarily due to costs associated with NYFIX
International. The cost increases were partially offset by increased revenue as
described above. As a percentage of total revenue, loss from operations was a
deficit of 15% for the nine months ended September 30, 2004 as compared to a
deficit of 8% for the nine months ended September 30, 2003. The increased loss
as a percentage of total revenue was attributable primarily to the increase in
operating expenses, including the restructuring charge.
Interest Expense
Interest expense increased $0.2 million, primarily due to accelerated
interest expense on the notes to Renaissance unitholders for which we were in
default. We expect to see higher interest expense in the future as we intend to
obtain a credit facility during the fourth quarter of 2004.
Investment Income
Investment income decreased $0.5 million, principally due to reduced
realized gains and interest on investments and reduced interest on loans to
unconsolidated affiliates, as well as lower overall invested balances.
Other Income (Expense), net
We recognized equity in the loss of EuroLink of $0.1 million for the three
months ended March 31, 2004. We accounted for our previously unconsolidated
affiliates, Renaissance and EuroLink, under the equity method through June 30,
2003 and March 28, 2004, respectively. For the nine months ended September 30,
2003, we recognized equity in the losses of EuroLink of $0.3 million and equity
in the losses of Renaissance through June 30, 2003 of $0.4 million. Slightly
offsetting these losses is settlement income of $75,000, which we recognized
during the nine months ended September 30, 2003.
Income Tax Provision (Benefit)
38
NYFIX, INC.
We recorded an income tax provision of $17.6 million for the nine months
ended September 30, 2004, compared to a tax benefit of $1.9 million for the nine
months ended September 30, 2003. We established a deferred tax asset valuation
allowance of $21.0 million at September 30, 2004, in accordance with SFAS No.
109. Where there are cumulative operating losses in recent years, SFAS No. 109
requires, except in very limited circumstances, that a deferred tax asset
valuation allowance be established. We had operating income in 2001, but did not
in 2002 and 2003. We had previously estimated that our deferred tax assets,
consisting primarily of tax credit carryforwards and net operating loss
carryforwards, would be realized and no valuation allowance was required, based
on revenue and operating expense assumptions. During the third quarter of 2004,
our general and administrative expenses related to Sarbanes-Oxley compliance and
legal expenses increased more than forecasted and we expect these costs to
remain at this higher level in the near term. These cost increases, together
with revenues from our Transaction Services segment being impacted by much lower
than expected volumes in the equity markets, particularly during the month of
September, were the primary reasons we did not achieve profitability for the
quarter and we reduced our forecast for the near-term. We expect to return to
profitability, but until we can achieve and sustain an appropriate level of
profitability, we plan to record a full valuation allowance on our deferred tax
assets.
Our effective tax rate was 208% for the nine months ended September 30,
2004, and 48% for the nine months ended September 30, 2003. Our effective tax
rate for the nine months ended September 30, 2004 is higher than the Federal
statutory rate primarily due to the deferred tax asset valuation allowance. Our
effective tax rate for the nine months ended September 30, 2003 is higher than
the Federal statutory rate primarily due to the effects of recognition of
certain research and development tax credits and state income taxes.
LIQUIDITY AND CAPITAL RESOURCES
Historically, a significant source of our funding has been the sale of
equity securities. Between 1997 and 1999 we raised a total of $9.5 million in
net proceeds through several private placements where we issued an aggregate of
3,431,000 shares of our common stock. In 2001, we raised $57.3 million, net of
expenses, from a follow-on public offering of three million shares of our common
stock. We used a portion of the net proceeds from the follow-on public offering
to repurchase 1.3 million shares of our common stock at an aggregate cost of
$19.1 million. We also have historically received funding from the exercise of
stock options by employees, which aggregated $3.8 million from 2001 through
September 30, 2004. We funded our acquisitions of Javelin, NYFIX Millennium,
Renaissance and EuroLink primarily through the issuance of our common stock or
promissory notes payable in our common stock, or at our option, cash. Refer to
Item 1 Acquisitions and Investments in our 2003 Form 10-K.
Another significant source of funding for us is cash generated from
operations, which was $4.7 million for the nine months ended September 30, 2004
and $15.4 million, $3.7 million and $10.6 million in the years ended December
31, 2003, 2002 and 2001, respectively, aggregating $34.4 million. Excluding the
impact of changes in assets and liabilities, net of business acquisitions, which
tend to be subject to short-term fluctuations, the comparable amount of cash
generated from operations was $36.1 million in the aggregate. Our primary source
of cash from operations is from revenue received from our customers. Our primary
uses of cash for operations include data center expenses, including its
operations and telecommunication costs, and selling, general and administrative
expenses, including legal and Sarbanes-Oxley compliance.
We have invested $4.3 million for the nine months ended September 30, 2004
and $5.3 million, $4.6 million and $7.1 million in the years ended December 31,
2003, 2002 and 2001, respectively, aggregating $21.3 million, in our data center
infrastructure and other property and equipment to keep current with technology
trends. We expect to invest at a similar level in the fourth quarter of 2004 and
throughout 2005.
We had capitalized product enhancements of $5.3 million for the nine months
ended September 30, 2004 and $5.3 million, $2.8 million and $2.7 million, in the
years ended December 31, 2003, 2002 and 2001, respectively, to keep our products
39
NYFIX, INC.
competitive. The increase in capitalized product enhancement costs since 2003 is
primarily attributable to our Javelin and Renaissance product lines. We have
many projects in development, some of which are described in Item 1 of our 2003
Form 10-K, which we have released or expect to release into production over the
next several quarters.
We acquired net cash of $1.4 million in the nine months ended September 30,
2004, and have invested $2.5 million, $12.1 million and $17.2 million of cash in
the years ended December 31, 2003, 2002 and 2001, respectively, aggregating a
net $30.4 million, for our acquisitions of Javelin, Renaissance, NYFIX
Millennium, NYFIX Transaction Services and EuroLink. Included in our 2004 amount
were net proceeds of $1.3 million received primarily as a return of funds held
in escrow pursuant to a settlement agreement with a representative of the former
shareholders of Javelin. In connection with our Renaissance acquisition we
issued notes payable over the next several years, aggregating $3.0 million,
payable, at our option, in cash or our common stock. On April 7, 2004, pursuant
to notice from certain payees after default on the notes, we issued shares of
our common stock as payment in full of $2.0 million in principal amount of such
notes. On July 2, 2004 we issued shares of our common stock in payment of $0.2
million of such notes that came due on July 1, 2004. We intend to pay the
remainder of this debt with our common stock, thus not requiring cash. On March
29, 2004, we acquired the remaining 60% of EuroLink's common stock that we did
not already own. We paid for the EuroLink acquisition with $24,000 in cash and
one-year promissory notes payable in our common stock or cash, at our option,
valued at $0.5 million. We intend to integrate EuroLink with NYFIX
International. We have no current plans for any other acquisitions. We plan to
continue to focus on the synergies arising from our previous acquisitions.
Our long-term capital needs depend on numerous factors, including the rate
at which we obtain new customers and expand our staff and infrastructure, as
needed, to accommodate such growth, and the rate at which we choose to invest in
new technologies to modify our NYFIX Network and infrastructure. We have ongoing
needs for capital, including working capital for operations and capital
expenditures to maintain and expand our operations.
At September 30, 2004, our principal sources of liquidity were cash, cash
equivalents and short-term investments in the aggregate of $21.6 million and
accounts receivable of $12.8 million. At September 30, 2004, we had accounts
payable and accrued expenses aggregating $15.1 million. We do not expect to make
any significant income tax payments through 2005 due to available net operating
loss carryforwards and research and development tax credits.
NYFIX Clearing, NYFIX Transaction Services and NYFIX Millennium, as
registered broker-dealers, are subject to the minimum net capital requirements
of the NASD. During the year ended December 31, 2003, we funded $10.8 million to
our broker-dealer subsidiary, NYFIX Clearing, to enable it to maintain its
minimum excess net capital requirement of $10.0 million as a condition of its
approval by the DTCC. NYFIX International, as an FSA-registered broker dealer,
is also subject to minimum net capital requirements. Our broker-dealers have
consistently operated in excess of their minimum net capital requirements.
During the three months ended September 30, 2004, we funded $1.3 million to
NYFIX International as a condition of its approval by the FSA. During the nine
months ended September 30, 2004, we provided an aggregate additional capital of
$1.3 million in the form of capital contributions and subordinated loans to
enable our United States broker-dealer subsidiaries to individually and
collectively exceed their net capital requirements. At September 30, 2004, our
broker-dealer subsidiaries had aggregate net capital of $12.8 million, which
exceeded the aggregate minimum net capital required by $2.4 million. At
September 30, 2004, we had an aggregate of $13.0 million of our consolidated
cash, cash-equivalents and short-term investments committed to maintain our
broker-dealer subsidiaries' minimum and minimum excess net capital requirements
of $10.4 million. Our broker-dealer subsidiaries may require us to fund or
commit more of our consolidated cash, cash-equivalents and short-term
investments in the future to maintain their individual minimum and minimum
excess net capital requirements. If any or all of these broker-dealer
subsidiaries were to fall below their minimum or minimum excess net capital
requirements, their operations may be restricted by certain regulatory agencies.
40
NYFIX, INC.
As a result of our continued operating losses and decline in available
working capital, we are pursuing a credit facility to provide incremental
availability of working capital to further support our operating and investment
strategy. We believe that our cash and short-term investments of $21.6 million
at September 30, 2004, together with anticipated cash to be generated from
operations and a credit facility that we expect to be in place by December 2004,
will be sufficient to support our capital and operating needs and our net
capital requirements of our broker-dealer operations for at least the next
twelve months.
Working Capital
We had working capital of $18.4 million at September 30, 2004, down from
$23.3 million at December 31, 2003. Items affecting working capital in the nine
months ended September 30, 2004 were principally cash used to acquire property,
equipment and leasehold improvements, enhance our products, fund pre-acquisition
working capital advances to EuroLink and current liabilities recognized in
conjunction with the restructuring charge. These items were partially offset by
cash flows provided by operating activities and net cash acquired from the
Javelin escrow settlement.
Cash Provided by Operating Activities
Net cash provided by operating activities in the nine months ended
September 30, 2004 was $4.7 million, as our net loss of $26.1 million, adjusted
for non-cash items, such as depreciation, amortization, deferred taxes,
provision for doubtful accounts and equity in loss of unconsolidated affiliates,
provided $5.4 million. Unfavorable working capital changes of $0.7 million,
including accounts receivable of $2.8 million, prepaid expenses and other assets
of $1.4 million and deferred revenue of $0.1 million were partially offset by
increases in accounts payable and other liabilities of $2.9 million and in
brokerage payables (net of brokerage receivables) of $0.8 million. For the next
several quarters, we expect to generate positive cash flows from operating
activities.
Net cash provided by operating activities in the nine months ended
September 30, 2003 was $5.1 million, as our net loss of $2.0 million, adjusted
for non-cash items, such as depreciation, amortization, deferred taxes,
provision for doubtful accounts and equity in loss of unconsolidated affiliates,
provided $8.0 million. Unfavorable working capital changes of $3.3 million,
including an increase in accounts receivable of $2.4 million, a decrease in
accounts payable and other liabilities of $0.6 million and an increase in
prepaid expenses and other assets of $0.3 million were partially offset by
favorable net changes in other working capital items of $0.4 million, resulting
in a net cash decrease from working capital of $2.9 million.
Cash Used in Investing Activities
For the nine months ended September 30, 2004, net cash used in investing
activities was $11.8 million. This consisted primarily of product enhancement
costs of $5.4 million, capital expenditures, primarily for data center equipment
and software, of $4.3 million, the net purchase of short-term investments of
$3.3 million, and loans and advances to EuroLink of $0.2 million. These amounts
were partially offset by cash acquired from acquisitions of $1.4 million, which
included cash of $1.3 million received primarily as a return of funds held in
escrow pursuant to a settlement agreement with a representative of the former
shareholders of Javelin. For the next several quarters, we expect to invest a
similarly proportionate amount of cash for capital expenditures for property and
equipment as well as product enhancement costs.
For the nine months ended September 30, 2003, net cash used in investing
activities was $4.3 million. This consisted primarily of capital expenditures of
$4.1 million, primarily for data center equipment and software, product
enhancement costs of $3.9 million and loans and advances to unconsolidated
affiliates of $2.2 million. These amounts were partially offset by proceeds from
the net sales of short-term investments of $5.9 million.
41
NYFIX, INC.
Cash Provided by (Used in) Financing Activities
For the nine months ended September 30, 2004, our net cash provided by
financing activities was $1.0 million, consisting of proceeds from borrowings of
$1.1 million and net proceeds from the issuance of common stock resulting from
the exercise of stock options by employees of $0.3 million, partially offset by
principal payments under capital lease obligations of $0.4 million. For the nine
months ended September 30, 2003, our net cash used in financing activities was
$0.4 million, consisting of principal payments under capital lease obligations
of $0.8 million, partially offset by net proceeds from the issuance of common
stock resulting from the exercise of stock options by employees of $0.4 million.
We expect to have a new credit facility in place by December 2004.
SEASONALITY AND INFLATION
We believe that our operations have not been significantly affected by
seasonality or inflation.
RISK FACTORS: FORWARD LOOKING STATEMENTS
This document contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, which are intended to be
covered by the safe harbors created thereby. Investors are cautioned that all
forward-looking statements involve risks and uncertainty, including without
limitation, our ability to market and develop our products. Although we believe
that the assumptions underlying the forward-looking statements contained herein
are reasonable, any of the assumptions could be inaccurate, and therefore, there
can be no assurance that the forward-looking statements included in this
document will prove to be accurate. In light of the significant uncertainties
inherent in the forward-looking statements included herein, the inclusion of
such information should not be regarded as a representation by us or any other
person that our objectives and plans will be achieved.
ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rates
Market risk generally represents the risk of loss that may be expected to
result from the potential change in value of a financial instrument as a result
of fluctuations in credit ratings of the issuer, equity prices, interest rates
or foreign currency exchange rates. We do not use derivative financial
instruments for any purpose.
We are exposed to market risk principally through changes in interest rates
and equity prices. Our short-term investment portfolio of $6.8 million and $3.4
million at September 30, 2004 and December 31, 2003, respectively, consisted of
$2.5 million and $2.4 million, respectively, of auction rate certificates. We
also had $4.3 million and $1.0 million of treasury bills at September 30, 2004
and December 31, 2003, respectively. Risk is limited on the auction rate
certificates portfolio due to the fact that it is invested in insured municipal
bonds. The potential decrease in fair value resulting from a hypothetical 10%
change in interest rates for the auction rate certificates would not be material
to operations, cash flows or fair value.
42
NYFIX, INC.
We are subject to interest rate risk on our $4.3 million and $1.0 million
of treasury bills at September 30, 2004 and December 31, 2003, respectively, and
our $1.1 million in borrowings collateralized by $2.1 million of our auction
rate certificates at September 30, 2004. A hypothetical 10% change in interest
rates would not result in a material change in their fair values.
We were also subject to interest rate risk on our $0.6 million of notes
receivable from unconsolidated affiliates at December 31, 2003. A hypothetical
10% change in interest rates would not have resulted in a material change in
their fair value.
Foreign currency risk
Our earnings are affected by fluctuations in the value of the United States
dollar as compared with foreign currencies, predominately the British pound and
the euro, due to our operations in the United Kingdom and continental Europe.
We manage foreign currency risk through the structure of our business. In
the substantial majority of our transactions, we receive payments denominated in
the United States dollar or British pounds sterling. Therefore, we do not rely
on international currency markets to obtain and pay illiquid currencies. The
foreign currency exposure that does exist is limited by the fact that the
majority of transactions are paid according to our standard payment terms, which
are generally short-term in nature. The foreign exchange translation gain for
the nine months ended September 30, 2004 was not material.
Securities Market and Credit Risk
NYFIX Clearing is subject to market risk when a counterparty does not
deliver cash or securities to it as expected and NYFIX Clearing holds cash (in
lieu of securities) or securities (in lieu of cash) at any point in time. This
risk arises from the potential inability of the counterparty's clearing agent to
meet its settlement obligation by delivering cash or securities, as required,
which is a credit risk. NYFIX Clearing is a member of several highly rated
clearing organizations, which have margin requirements and other mechanisms that
are designed to substantially mitigate this risk.
When necessary, NYFIX Clearing can liquidate or purchase securities in the
market to close out the position at the prevailing market price. NYFIX
Clearing's stock lending practice is to maintain collateral in excess of the
contract value and to request additional collateral whenever necessary. NYFIX
Clearing seeks high-quality, creditworthy counterparties and has controls in
place that are designed to monitor and limit this exposure.
ITEM 4. CONTROLS AND PROCEDURES
Section 404 of Sarbanes-Oxley requires management's annual review and
evaluation of the design and effectiveness of our internal control systems, and
an attestation of management's assessment of the design and effectiveness of
these systems by our independent registered public accounting firm. We are
currently documenting and testing our internal control systems and procedures
and are considering improvements that we believe may be necessary under Section
404. This process has required us to hire additional personnel and outside
advisory services, and has resulted in additional accounting and consulting
expenses. Further, the evaluation and attestation processes required by
Sarbanes-Oxley are new, and neither companies nor independent registered public
accounting firms have significant experience in testing or complying with these
requirements. Accordingly, we may encounter problems or delays in completing our
review and evaluation, the implementation of improvements, and the receipt of an
attestation report by our independent registered public accounting firm.
On May 27, 2004, we restated our consolidated financial statements that
appeared in our Form 10-K/A for the year ended December 31, 2002 and the
condensed consolidated financial statements that appeared in our Forms 10-Q/A
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NYFIX, INC.
for each of the interim periods ended March 31, 2003, June 30, 2003 and
September 30, 2003 to change our accounting for our 1999 and 2001 investments in
and 2002 acquisition of an additional 30% interest in NYFIX Millennium. In light
of our determination to restate our 1999 through 2002 consolidated financial
statements, our management directed that steps be taken to review the operation
and effectiveness of our internal controls and procedures with respect to our
accounting for investment and acquisition transactions. That review is in
progress, in conjunction with our testing and evaluation of our internal control
procedures, as required by Sarbanes-Oxley.
By letter dated October 14, 2004, Deloitte & Touche LLP, our independent
registered public accounting firm, advised us that it believes we may not be
able to complete, on a timely basis, our assessment of compliance with
Sarbanes-Oxley and that Deloitte & Touche LLP may not be able to complete its
work in order to report on management's assessment of internal control at year
end. In addition, in October 2004, we became aware that we had issued our 2003
annual report to stockholders without a complete review by our internal and
external reporting and disclosure processes. In response, we have taken steps to
improve the quality of our internal and external reporting and disclosure
processes to ensure that we obtain all required internal and external reviews
before financial information is included in any public filing or other general
public or investor communication. We believe that these steps will improve our
disclosure controls and procedures.
With the reporting process enhancement noted above, our Chief Executive
Officer and our Chief Financial Officer believe that we maintain a system of
disclosure controls and procedures to provide reasonable assurance that we are
able to record, process, summarize and report the information required in our
quarterly and annual reports by the Exchange Act. However, we can give no
assurance as to the timing of completion of our evaluation, testing and
remediation actions required under Sarbanes-Oxley or their impact on our
operations. Moreover, the Chief Executive Officer, Chief Financial Officer or
independent registered public accounting firm could determine that our controls
over financial reporting are not effective as defined under Sarbanes-Oxley and
contain significant deficiencies and/or material weaknesses that affect the
accuracy of the reporting on our results of operations.
As required by Sarbanes-Oxley, we continue to test and evaluate our
internal control procedures to determine whether our controls are designed and
operating effectively. As a result of our testing and evaluation performed to
date, we have noted that improvements should be made in the design or operation
of our internal control structure. We believe adequate compensating controls
exist in these areas; however, we are developing plans to implement improvements
or additional control procedures. We have disclosed these matters to the audit
committee of our board of directors and to our independent registered public
accounting firm. Other than as discussed above, there were no significant
changes to our internal controls during our most recent quarter that have
materially affected, or are reasonably likely to materially affect, our internal
controls over financial reporting.
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NYFIX, INC.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Litigation
On May 13, 2004, an action entitled FULLER & THALER ASSET MANAGEMENT V.
NYFIX, INC., ET AL. was filed in the United States District Court for the
District of Connecticut. The complaint named us, our Chairman and CEO, our
former CFO, our current CFO and certain of our directors as defendants. The
complaint was filed as a purported class action claim on behalf of all buyers of
our stock between March 30, 2000 and March 30, 2004 and seeks an unspecified
amount of damages. The complaint alleged violations of Sections 10(b) and 20(a)
of the Securities Exchange Act of 1934, based on the issuance of a series of
allegedly false and misleading financial statements and press releases
concerning, among other things, our investment in NYFIX Millennium. On July 20,
2004, the court appointed three different plaintiffs to be the lead plaintiffs,
as Fuller & Thaler Asset Management withdrew as the named plaintiff. The action
became styled JOHNSON, ET AL. V. NYFIX, INC., ET AL. On August 19, 2004, the
newly named plaintiffs filed a first amended class action complaint, which
added, among other things, allegations of violations of Sections 11 and 15 of
the Securities Act of 1933, as amended. The new allegations are based
fundamentally on the same allegations as the plaintiffs asserted in the original
complaint. The defendants have filed a motion to dismiss the amended complaint
with prejudice. We believe that this amended complaint, like the original
complaint, is without merit. Although it is not possible to forecast the outcome
of this matter, we intend to vigorously defend the lawsuit.
SEC Matters
In connection with our restatement of our 1999 through 2002 consolidated
financial statements in May 2004, the Division of Enforcement of the SEC
informed us by letter dated July 14, 2004, that it was conducting an informal
inquiry. By letter dated October 28, 2004, the Division of Enforcement of the
SEC informed us that it was conducting a second informal inquiry, which appears
from the SEC's request for documents to relate to our grant of stock options to
our senior management and directors. We are cooperating with the SEC with
respect to both matters. We are unable to predict the outcome of either matter
at this time.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On July 2, 2004, we issued an aggregate of 51,828 shares of our common
stock to fourteen unitholders, most of whom are current employees of Renaissance
Trading Technologies, LLC as payment in full for the first installment of $0.2
million of unsecured promissory notes that we issued in connection with our July
1, 2003 acquisition of the remaining 82% of the membership interests of
Renaissance, which we previously did not own. The notes are payable in our
common stock or cash, at our discretion.
In connection with the issuance of our shares to the above individuals, we
relied on the exemption from registration provided by Section 4(2) of the
Securities Act of 1933.
On September 27, 2004, we issued an aggregate of 13,270 shares of our
common stock to two unitholders of Renaissance pursuant to amended promissory
note and settlement agreements with those unitholders dated September 23, 2004,
as an adjustment to the shares issued to such unitholders on April 7, 2004 as
payment in full for $2.0 million in principal amount of unsecured promissory
notes.
In connection with the issuance of our shares to the above individuals, we
relied on the exemption from registration provided by Section 4(2) of the
Securities Act of 1933. In addition, since all of the recipients of our shares
45
NYFIX, INC.
were "accredited investors" as defined in Rule 501 promulgated under the
Securities Act, we believe that the transaction falls within the safe harbor
provided by Regulation D, thereunder.
ITEM 6. EXHIBITS
10.1 Amendment No.1, to the Employment Agreement dated November 4, 2004
between Peter K. Hansen and the Company.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
Omitted from this Part II are items which are inapplicable or to which the
answer is negative for the period presented.
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NYFIX, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NYFIX, INC.
By: s/ Mark R. Hahn
-----------------------------------
Mark R. Hahn
Chief Financial Officer
(Principal Financial and Accounting
Officer)
Dated: November 9, 2004
47
Exhibits Index
Exhibit
10.1 Amendment No.1, to the Employment Agreement dated November 4, 2004
between Peter K. Hansen and the Company.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.