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UNITED STATES
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 MARCH 31, 2005
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 32,442,431 shares of Common Stock issued and outstanding as of May
31, 2005.
NYFIX, INC.
FORM 10-Q
For the quarter ended March 31, 2005
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of March 31, 2005
and December 31, 2004 3
Condensed Consolidated Statements of Operations for the
three months ended March 31, 2005 and 2004 (As Restated) 4
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 2005 and 2004 (As Restated) 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk 37
Item 4. Controls and Procedures 38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 41
Item 6. Exhibits and Reports on Form 8-K 41
Signatures 42
2
NYFIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
MARCH 31, DECEMBER 31,
2005 2004
---------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 21,711 $ 22,405
Short-term investments 1,895 4,466
Accounts receivable, less allowances of $2,042 and $2,107 15,952 13,405
Securities borrowed 69,367 138,456
Prepaid expenses and other current assets 3,965 3,941
--------- ---------
Total current assets 112,890 182,673
Property and equipment, less accumulated depreciation of $33,654 and $31,733 14,873 16,649
Goodwill 62,519 62,519
Acquired intangible assets, net 7,697 8,346
Other assets, net 11,565 10,904
--------- ---------
Total assets $ 209,544 $ 281,091
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,300 $ 10,639
Accrued expenses 7,265 7,579
Securities loaned 69,185 138,375
Current portion of capital lease obligations 406 510
Current portion of long-term debt and other liabilities 1,637 1,731
Deferred revenue 3,162 2,994
--------- ---------
Total current liabilities 89,955 161,828
Long-term portion of capital lease obligations 798 896
Long-term debt and other liabilities 12,199 11,625
--------- ---------
Total liabilities 102,952 174,349
--------- ---------
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;
33,752,860 shares issued in 2005 and 2004 34 34
Additional paid-in capital 201,679 201,635
Accumulated deficit (75,908) (75,773)
Treasury stock, 1,327,230 shares in 2005 and 2004, at cost (18,992) (18,992)
Notes receivable issued for common stock (67) (67)
Accumulated other comprehensive loss (154) (95)
--------- ---------
Total stockholders' equity 106,592 106,742
--------- ---------
Total liabilities and stockholders' equity $ 209,544 $ 281,091
========= =========
The accompanying notes to condensed consolidated financial statements are an integral part of these statements.
3
NYFIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
MARCH 31,
------------------------
2005 2004
--------- ---------
(AS RESTATED -
SEE NOTE 2)
REVENUE:
Subscription $ 12,333 $ 9,305
Capital sale 2,409 1,988
Service contract 2,978 2,480
Transaction 5,960 3,363
-------- --------
Total revenue 23,680 17,136
-------- --------
COST OF REVENUE:
Subscription 6,402 5,683
Capital sale 1,292 817
Service contract 1,192 917
Transaction 3,278 2,083
-------- --------
Total cost of revenue 12,164 9,500
-------- --------
GROSS PROFIT:
Subscription 5,931 3,622
Capital sale 1,117 1,171
Service contract 1,786 1,563
Transaction 2,682 1,280
-------- --------
Total gross profit 11,516 7,636
-------- --------
OPERATING EXPENSE:
Selling, general and administrative 10,904 8,602
Research and development 58 315
Equity in loss of unconsolidated affiliate -- 74
Depreciation and amortization 541 541
-------- --------
Total operating expense 11,503 9,532
-------- --------
Income (loss) from operations 13 (1,896)
Interest expense (190) (82)
Investment income 56 46
-------- --------
Loss before income tax provision (benefit) (121) (1,932)
Income tax provision (benefit) 14 (772)
-------- --------
Net loss $ (135) $ (1,160)
======== ========
Basic and diluted loss per common share $ (0.00) $ (0.04)
======== ========
Basic and diluted weighted average common shares outstanding 32,426 31,873
======== ========
The accompanying notes to condensed consolidated financial statements are an integral part of these statements.
4
NYFIX, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
--------------------------
2005 2004
---------- ------------
(AS RESTATED -
SEE NOTE 2)
Cash flows from operating activities:
Net loss $ (135) $ (1,160)
Adjustments to reconcile net loss to net cash (used in) provided
by operating activities:
Depreciation and amortization 3,748 3,451
Compensation expense related to stock option grants 44 93
Deferred income taxes 14 (18)
Provision for doubtful accounts 125 --
Equity in loss of unconsolidated affiliates -- 74
Other, net 16 (8)
Changes in assets and liabilities (net of business
acquisition):
Accounts receivable (2,672) (1,160)
Prepaid expenses and other assets (642) (1,328)
Securities borrowed 69,089 (23,179)
Deferred revenue 168 137
Accounts payable, accrued expenses and other liabilities (2,021) 1,386
Securities loaned (69,190) 23,602
-------- --------
Net cash (used in) provided by operating activities (1,456) 1,890
-------- --------
Cash flows from investing activities:
Net sales (purchases) of short-term investments 2,571 (2,727)
Capital expenditures for property and equipment (350) (1,418)
Capitalization of product enhancement costs (1,217) (1,833)
Cash acquired from acquisitions -- 1,405
Advances to unconsolidated affiliates -- (205)
-------- --------
Net cash provided by (used in) investing activities 1,004 (4,778)
-------- --------
Cash flows from financing activities:
Proceeds from borrowings 19 --
Principal payments under capital lease obligations (202) (200)
Net proceeds from issuance of common stock -- 103
-------- --------
Net cash used in financing activities (183) (97)
Effect of exchange rate changes on cash (59) --
-------- --------
Net decrease in cash and cash equivalents (694) (2,985)
Cash and cash equivalents, beginning of period 22,405 21,006
-------- --------
Cash and cash equivalents, end of period $ 21,711 $ 18,021
======== ========
The accompanying notes to condensed consolidated financial statements are an integral part of these statements.
5
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, is incorporated in Delaware and headquartered in Stamford, Connecticut.
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, in San Francisco and in
Madrid. The Company operates redundant data centers in the northeastern United
States and 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 broker-dealers registered with the National
Association of Securities Dealers ("NASD") or the Financial Services Authority
("FSA"), which in addition to the technology provided by the Company's
Technology Services segment, provides an electronic execution venue for trading
in United States stocks and direct market access and execution links.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
include the accounts of NYFIX, Inc. and its majority-owned and wholly-owned
subsidiaries, and 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 Regulation S-X. Accordingly, they do not
include all of the information and notes 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, which were comprised of normal and recurring
accruals, 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 months ended March 31, 2005 and 2004
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 accompanying notes in the Company's Annual Report on Form 10-K
for the year ended December 31, 2004 ("2004 Form 10-K"). The Company's
significant accounting policies are the same as those listed in Note 1 to the
Consolidated Financial Statements in Item 8 of the 2004 Form 10-K.
The Company has an 80% ownership interest in NYFIX Millennium L.L.C.
("NYFIX Millennium"). The Company consolidates the financial statements of NYFIX
Millennium and, since the Company is currently the only source of funding for
NYFIX Millennium, the Company has recognized 100% of NYFIX Millennium's
operating losses. If and when NYFIX Millennium achieves profitability, 24% of
its profits will be allocated to the minority partners in accordance with the
contractual agreement amongst the parties.
6
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
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 it did not already own. As of that date, the Company consolidated EuroLink
(see Note 4).
USE OF ESTIMATES
The preparation of condensed consolidated 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 useful lives of
tangible and intangible assets, the recoverability of goodwill and the
realization of deferred tax assets, among others. 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 materially from those estimates.
STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation under the
recognition and measurement provisions of the Accounting Principles Board
Opinion ("APB") 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 ("SFAS No. 123"). Stock-based compensation expense of $44,000 and
$93,000 was included in the operating results for the three months ended March
31, 2005 and 2004, respectively, for the intrinsic value of certain stock
options where the fair value of the Company's common stock on the measurement
date was in excess of the exercise price. The following table illustrates the
effect on net loss and loss per common 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 compensation:
THREE MONTHS ENDED
MARCH 31,
-----------------------
2005 2004
----------- ---------
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
Net loss, as reported $ (135) $ (1,160)
Add: Stock-based compensation expense included in reported
net loss, net of tax 44 78
Deduct: Stock-based compensation expense determined under the
fair value method, net of tax (718) $ (499)
-------- --------
Pro forma net loss $ (809) $ (1,581)
======== ========
Basic and diluted loss per common share:
As reported $ (0.00) $ (0.04)
======== ========
Pro forma $ (0.02) $ (0.05)
======== ========
7
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123(R), SHARE-BASED PAYMENTS
("SFAS No. 123(R)") SFAS No. 123(R) is a revision of SFAS No. 123 and supersedes
APB No. 25 and its related implementation guidance. SFAS 123(R) establishes
standards for the accounting for transactions in which an entity exchanges its
equity for goods or services. It also addresses transactions in which an entity
incurs liabilities in exchange for goods or services that are based on the fair
value of the entity's equity instruments or that may be settled by the issuance
of those equity instruments. SFAS No. 123(R) focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123(R) allows entities to apply a modified retrospective
application to periods before the required effective date. SFAS No. 123(R) is
effective for public entities that do not file as small business issuers as of
the beginning of the first annual reporting period that begins after June 15,
2005, or in the Company's case January 1, 2006. The Company is evaluating the
impact of SFAS No. 123(R), which could have a material impact on its
consolidated financial statements.
In December 2004, the FASB issued SFAS No. 153, EXCHANGES OF NONMONETARY
ASSETS ("SFAS No. 153"). SFAS No. 153 addresses the measurement of exchanges of
nonmonetary assets. SFAS No. 153 eliminates the exception from the fair value
measurement for nonmonetary exchanges of similar product assets in paragraph
21(b) of APB Opinion No. 29, ACCOUNTING FOR NONMONETARY TRANSACTIONS, and
replaces it with an exception for exchanges that do not have commercial
substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS No. 153 is effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005. The Company has not completed its analysis of the impact of SFAS No. 153
on the Company, but as the Company has not been involved in significant
nonmonetary exchanges in the past, it does not expect that the provisions of
SFAS No. 153 will have a material impact on its consolidated financial
statements.
In November 2004, the FASB issued SFAS No. 151, INVENTORY COSTS ("SFAS
No. 151"). SFAS No. 151 amends Accounting Research Bulleting ("ARB") No. 43
INVENTORY PRICING to clarify that abnormal amounts of idle facility expense,
freight, handling costs, and wasted materials (spoilage) should be recognized as
current-period charges. SFAS No. 151 also requires that allocation of fixed
production overheads to the cost of conversion be based on the normal capacity
of the production facilities. SFAS No. 151 is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The Company has not
completed its analysis of the impact of SFAS No. 151, but as inventory is not a
material component of its consolidated financial statements, the Company does
not expect that the provisions of SFAS No. 151 will have a material impact on
its consolidated financial statements.
In March 2005, the FASB issued Interpretation No. 47, ACCOUNTING FOR
CONDITIONAL ASSET RETIREMENT OBLIGATIONS ("FIN 47"). FIN 47 clarifies that the
term conditional asset retirement obligations as used in Statement of Financial
Accounting Standards No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS,
refers to a legal obligation to perform an asset retirement activity in which
the timing and/or method of settlement are conditional on a future event. FIN 47
requires that these obligations be recognized if their fair value is reasonably
estimable. FIN 47 is effective for fiscal years ending after December 15, 2005.
The Company does not expect the provisions of FIN 47 to have a material impact
on its consolidated financial statements.
2. RESTATEMENT OF PREVIOUSLY ISSUED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
Subsequent to the issuance of the condensed consolidated financial
statements as of and for the three months ended March 31, 2004, management of
the Company determined that it incorrectly accounted for compensation expense
attributable to stock options granted. As a result, the condensed consolidated
8
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
financial statements for the three months ended March 31, 2004, contained
herein, have been restated from the amounts previously reported.
The Company accounted for compensation expense attributable to stock
options granted to certain employees and directors between 1993 and 2004
incorrectly as the intrinsic value of these stock options was calculated as of a
date other than the measurement date. Correcting this error had the effect of
increasing the net loss by $83,000 for the three months ended March 31, 2004.
In addition, the Company reclassified its equity in loss of
unconsolidated affiliates of $74,000 for the three months ended March 31, 2004
to an operating expense.
The following table summarizes the significant effects of the
restatement on the Company's condensed consolidated statement of operations for
the three months ended March 31, 2004:
AS PREVIOUSLY
REPORTED AS RESTATED
------------- -----------
(IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
Condensed consolidated statements of
operations data:
Cost of revenue:
Subscription $ 5,675 $ 5,683
Capital sale 817 817
Service contract 917 917
Transaction 2,079 2,083
------- -------
Total cost of revenue 9,488 9,500
------- -------
Operating expense:
Selling, general and administrative 8,523 8,602
Research and development 313 315
Equity in loss of unconsolidated affiliate -- 74
Depreciation and amortization 541 541
------- -------
Total operating expense 9,377 9,532
------- -------
Loss from operations (1,729) (1,896)
Interest expense (74) (82)
Investment income 46 46
Equity in loss of unconsolidated affiliate (74) --
------- -------
Loss before income tax benefit (1,831) (1,932)
Income tax benefit (754) (772)
------- -------
Net loss $(1,077) $(1,160)
======= =======
Basic and diluted loss per common share $ (0.03) $ (0.04)
======= =======
3. BROKER-DEALER OPERATIONS
BROKER-DEALER NET CAPITAL REQUIREMENTS
The SEC, the NASD and the 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
9
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
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 Corp. ("NYFIX Clearing"), NYFIX Transaction Services Inc.
("NYFIX Transaction Services"), and NYFIX Millennium, as registered
broker-dealers, are subject to the minimum net capital requirements of the NASD.
NYFIX International, Ltd. ("NYFIX International"), as a broker-dealer registered
with the FSA in the United Kingdom, is also subject to the minimum net capital
requirements of the FSA. During the three months ended March 31, 2005, the
Company provided aggregate additional capital of $2.8 million in the form of
capital contributions to enable its broker-dealer subsidiaries to individually
and collectively exceed their net capital requirements. At March 31, 2005, the
Company's broker-dealer subsidiaries had aggregate net capital of $15.4 million,
which exceeded the aggregate minimum and minimum excess net capital required by
$4.0 million. The Company's broker-dealer subsidiaries may need 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, in the case
of NYFIX Clearing, its 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.
SECURITIES BORROWED AND SECURITIES LOANED
In the normal course of its brokerage clearing operations, NYFIX
Clearing settles customer securities transactions. This activity may expose
NYFIX Clearing to off-balance sheet risk arising from the potential that
customers or counterparties may fail to satisfy their obligations. In the event
customers and counterparties fail to satisfy their obligations, NYFIX Clearing
may be required to purchase or sell financial instruments, at unfavorable market
prices, to satisfy those obligations. NYFIX Clearing mitigates the risk of
customer non-performance by requiring introducing brokers to maintain cash
deposits. NYFIX Clearing believes that the settlement of these transactions will
not have a material effect on NYFIX Clearing's statement of financial condition.
Liabilities to brokers and dealers related to unsettled transactions
(i.e., securities failed-to-receive) are recorded at the amounts for which the
securities were acquired and are paid upon receipt of the securities from other
brokers or dealers. In the case of aged securities failed-to-receive, NYFIX
Clearing may, under industry regulations, purchase the underlying securities in
the market and seek reimbursement for any losses from the counterparty.
NYFIX Clearing's customer financing and securities settlement activities
require NYFIX Clearing to pledge customer securities in support of secured
financing sources such as securities loaned. In the event that the counterparty
is unable to meet its contractual obligation to return customer securities
10
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
pledged as collateral, NYFIX Clearing may be exposed to the risk of acquiring
the securities at prevailing market prices in order to satisfy customer
obligations. NYFIX Clearing controls this risk by monitoring the market value of
securities pledged on a daily basis and requiring adjustments of collateral
levels in the event of excess market exposure. Additionally, NYFIX Clearing
establishes credit limits for such activities and monitors compliance on a daily
basis. At March 31, 2005 and December 31, 2004, the market value of customer
securities pledged under these secured financing transactions approximated the
amounts due.
NYFIX Clearing may at times, because of processing errors, maintain
equity securities on both a long and short basis. Both long and short positions
may result in losses or gains to NYFIX Clearing as market values of securities
fluctuate. Long and short positions are marked to market daily and are
continuously monitored by NYFIX Clearing with the intent to liquidate the
positions. NYFIX Clearing is engaged in various trading activities in which
counterparties primarily include broker-dealers. In the event counterparties do
not fulfill their obligations, NYFIX Clearing may be exposed to credit risk. The
risk of default depends on the creditworthiness of the counterparty. It is NYFIX
Clearing's policy to review, as necessary, the credit standing of each
counterparty. NYFIX Clearing does not anticipate nonperformance by the
counterparties in the above situations.
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
securities loan transactions was $43,000 and $2,000 for the three months ended
March 31, 2005 and 2004, respectively, and was included in "transaction revenue"
in the accompanying condensed consolidated statements of operations. "Securities
borrowed" and "securities loaned" are recorded based on the amounts of cash
collateral advanced or received in the accompanying condensed consolidated
balance sheets.
Securities borrowed consisted of the following:
MARCH 31, DECEMBER 31,
2005 2004
--------- ------------
(IN THOUSANDS)
Stock receivable (matched and reserved) $ 62,258 $136,187
Other 7,109 2,269
-------- --------
Total securities borrowed $ 69,367 $138,456
======== ========
Securities loaned consisted of the following:
MARCH 31, DECEMBER 31,
2005 2004
--------- ------------
(IN THOUSANDS)
Stock payable $ 57,949 $136,229
Other 11,236 2,146
-------- --------
Total securities loaned $ 69,185 $138,375
======== ========
11
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
4. ACQUISITIONS, GOODWILL AND OTHER ACQUIRED INTANGIBLES
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. The preferred stock automatically converted into a 40% common
stock interest on March 6, 2004.
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, in the aggregate having a fair value of $0.5 million. The fair value of
the notes, which were payable on April 28, 2005, was included in "current
portion of long-term debt and other liabilities" in the accompanying condensed
consolidated balance sheets as of March 31, 2005 and December 31, 2004. The
Company intends to pay the notes using its common stock. Due to the delay in
issuing its 2004 consolidated financial statements, the Company was unable to
issue its common stock to satisfy this debt. The Company intends to settle this
obligation through the issuance of common stock as soon as practicable
subsequent to the filing of its 2004 Form 10-K and its Quarterly Report on Form
10-Q for the three months ended March 31, 2005.
In connection with the acquisition, the Company contributed to
EuroLink's capital certain obligations that EuroLink owed to the Company,
including notes receivable and advances outstanding as of March 29, 2004,
aggregating $1.0 million.
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. Such loss for
the three months ended March 31, 2004 was included in "equity in loss of
unconsolidated affiliate" in the accompanying condensed consolidated statement
of operations. In addition, the Company had notes receivable from EuroLink at
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 year ended December 31, 2004
to fund certain operating costs.
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 Company's key consideration for the acquisition of
EuroLink was the expected synergy to be achieved by combining EuroLink with
NYFIX International, the Company's London-based broker-dealer 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 in the aggregate
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 $2.9 million and has been recorded as goodwill.
GOODWILL AND ACQUIRED INTANGIBLE ASSETS
Goodwill and acquired intangibles primarily relate to the Company's
acquisitions. 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. As of October 1, 2004, the Company
performed its annual test for impairment using the discounted cash flow
valuation method. There was no indication of impairment to the value of goodwill
12
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
for the quarter ended March 31, 2005 or any other prior periods. The Company
completed the asset valuations for the EuroLink acquisition during the fourth
quarter of 2004.
The carrying amount of goodwill by reportable segment was as follows:
TECHNOLOGY TRANSACTION
SERVICES SERVICES TOTAL
--------- -------------- ---------
(IN THOUSANDS)
Balance as of March 31, 2005 and
December 31, 2004 $52,514 $10,005 $62,519
======= ======= =======
Acquired intangible assets consisted of the following:
MARCH 31, DECEMBER USEFUL LIVES
2005 31, 2004 (YEARS)
-------- -------- ------------
(IN THOUSANDS)
Existing technology $ 10,600 $ 10,600 5 - 7
Customer related intangibles 3,380 3,380 5
Trademarks and other 800 800 6 - 14
-------- --------
Total intangible assets, gross 14,780 14,780
Less: Accumulated amortization 7,083 6,434
-------- --------
Total intangible assets, net $ 7,697 $ 8,346
======== ========
Amortization expense of acquired intangible assets was $0.6 million for
each of the three month periods ended March 31, 2005 and 2004 and was included
in "cost of revenue" in the accompanying condensed consolidated statements of
operations.
Based on identified intangible assets recorded at March 31, 2005, the
future amortization expense is expected to be as follows:
AMOUNT
(IN THOUSANDS)
Remainder of 2005 $ 1,946
2006 2,595
2007 1,471
2008 631
2009 575
Thereafter 479
-------
Future amortization expense $ 7,697
=======
13
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
5. 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 as of 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 property and equipment.
The Company included the restructuring charge liabilities within
"current portion of long-term debt and other liabilities" and "long-term debt
and other liabilities" in the accompanying condensed consolidated balance sheets
as of March 31, 2005 and December 31, 2004. The accruals established by the
Company, and activities related thereto, consisted of the following:
BALANCE AT NON-CASH BALANCE AT
JANUARY 1, CASH USES AND MARCH 31,
2005 CHARGES USES OTHER 2005
------------- ------------ ---------- ---------- ----------
(IN THOUSANDS)
Lease costs, net of
estimated sublease income $ 1,740 $ -- $ (215) $ 13 $ 1,538
============ =========== ========== =========
Less: current portion 434
---------
Long-term portion $ 1,104
=========
6. CONVERTIBLE DEBT
On December 30, 2004, the Company issued a $7.5 million Convertible Note
with an interest rate of 5% due in December 2009 (the "Note") through a private
placement to a lender. The interest is payable in cash or, at the Company's
option as described below, by the issuance of shares of its common stock,
semi-annually in arrears on June 30 and December 30 of each year, beginning June
30, 2005.
The Note is subordinated to all existing and future secured indebtedness
of the Company. The lender has certain rights which require the Company to
register the common stock issuable upon conversion of the Note or for payment of
interest, under the Securities Act of 1933, as amended. Such registration
statement is to be effective by September 30, 2005 and if it is not, the Company
will be required to pay additional interest, in cash, for each month the
effectiveness is delayed. The additional interest varies by month and has an
aggregate cap of $500,000 for the duration of the Note.
The entire outstanding principal amount of the Note together with all
accrued but unpaid interest is due in cash on December 30, 2009; and except
under certain conditions, the Company has no right of early prepayment on the
Note.
At the option of the lender, the Note is convertible into the Company's
common stock at $6.94 per common share, which was a 20% premium over the average
of the Company's common stock closing price for the five trading days preceding
December 30, 2004. At the option of the Company, the Note is convertible into
its common stock according to a formula based on the market price of that stock
during the term of the Note which requires among other things for the Company's
common stock to exceed $10.41 per common share, which is 150% of the price at
which the lender can convert the Note. If the Company converts the Note prior to
December 30, 2007, the Company is required to pay an additional make-whole
interest payment in either cash or the Company's stock at the Company's
discretion. The Company determined that the conversion feature and a change in
control provision of the Note are embedded derivatives that require bifurcation,
in accordance with SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
14
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
HEDGING ACTIVITIES. However, the Company determined that these embedded
derivatives were not significant and therefore did not require separate
accounting treatment at December 31, 2004.
If the Company issues its common stock in lieu of cash to convert the
Note or to make interest payments, or any portion thereof, the Company is
required to have an effective registration statement covering the public resale
of such shares and pay a 5% premium based on an average of the closing price of
its common stock for the previous ten trading days.
As a result of the restatement of the Company's financial statements for
the year ended December 31, 2003, the Company was in breach of certain
representations and warranties relating to those financial statements that
constituted an event of default under the Note. On June 24, 2005, the lender
waived all defaults under the Note and extended the requirement to have a
registration statement be effective for the shares of the Company's common stock
that may be issued as payment of principal or interest under the Note to March
31, 2006. In exchange, the Company agreed to reduce the price at which the
lender can convert the Note into its common stock from $6.94 per share, as
described above, to $5.75 per share, which was a 16% premium over the average of
the Company's common stock closing price for the five trading days preceding
June 24, 2005. Accordingly, the Company's option to convert the Note into its
common stock is based on the market price of its stock during the term of the
Note which requires, among other things, the common stock to exceed 150% of the
price (or $8.63 per common share on a revised basis) at which the lender can
convert the Note.
In addition, at the option of the lender, the Company may issue to the
lender up to an additional $2.5 million note under terms substantially similar
to those of the Note. In March 2005, the Lender requested, and the Company
agreed to extend the termination date of the option to issue the additional $2.5
million note from March 30, 2005 to until ten days after the date the Company
filed its 2004 Form 10-K.
7. INCOME TAXES
The Company recorded an income tax provision of $14,000 and an income
tax benefit of $0.8 million for the three months ended March 31, 2005 and 2004,
respectively. The Company, which initially established a valuation allowance on
September 30, 2004, had a valuation allowance of $25.7 million as of March 31,
2005 and $25.6 million at December 31, 2004. Until the Company can achieve and
sustain an appropriate level of profitability, it plans to maintain a valuation
allowance on its deferred tax assets. The Company's effective tax rate was 12%
and 40% for the three months ended March 31, 2005 and 2004, respectively. The
Company's effective tax rate for the three months ended March 31, 2005 is lower
than the Federal statutory rate primarily due to the valuation allowance
recorded on the deferred tax assets. The Company's effective tax benefit rate
for the three months ended March 31, 2004 is higher than the Federal statutory
rate primarily due to the benefits of certain research and development tax
credits and state income taxes. The total deferred tax liabilities were included
in "long-term debt and other liabilities" in the accompanying condensed
consolidated balance sheets as of March 31, 2005 and December 31, 2004.
8. LOSS PER SHARE
The Company's basic and diluted 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. Stock
options representing 604,096 and 946,507 shares were excluded from the loss per
share calculations for the three months ended March 31, 2005 and 2004,
respectively, as their effect was anti-dilutive.
15
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
----------------------
2005 2004
--------- ---------
(IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
Net loss $ (135) $ (1,160)
======= ========
Loss per common share - basic and diluted $ (0.00) $ (0.04)
======= ========
Weighted average shares outstanding 32,426 31,873
======= ========
9. 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 presently 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 ("NFA"); one was incorporated in the United
Kingdom on March 29, 2004 and registered as a broker-dealer with the FSA in
connection with the Company's expansion into Europe and other international
markets; and EuroLink, which we acquired the remaining 60% we did not 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 revenues from the application of commissions charged
on executed trades.
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 Consolidated Financial Statements in Item 8 of the Company's 2004 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.
16
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
Summarized financial information by business segment was as follows:
THREE MONTHS ENDED
MARCH 31,
-------------------------------
2005 2004
----------- ---------
(IN THOUSANDS)
Revenue:
Technology Services $ 17,359 $ 13,870
Transaction Services 7,117 3,925
Eliminations (796) (659)
-------- --------
Total revenue $ 23,680 $ 17,136
======== ========
Gross Profit:
Technology Services $ 8,377 $ 6,423
Transaction Services 3,139 1,213
-------- --------
Total gross profit $ 11,516 $ 7,636
======== ========
Reconciling information between business segments and the loss before
income taxes was as follows:
THREE MONTHS ENDED
MARCH 31,
-------------------------------
2005 2004
----------- ---------
(IN THOUSANDS)
Gross profit for reportable segments $ 11,516 $ 7,636
Operating expense (11,503) (9,532)
Interest expense (190) (82)
Investment income 56 46
-------- --------
Loss before income taxes $ (121) $ (1,932)
======== ========
10. TOTAL COMPREHENSIVE LOSS
The components of total comprehensive loss, net of tax, were as follows:
THREE MONTHS ENDED
MARCH 31,
-------------------------------
2005 2004
----------- ---------
(IN THOUSANDS)
Net loss $ (135) $(1,160)
Foreign currency translation adjustment (59) --
------- -------
Total comprehensive loss $ (194) $(1,160)
======= =======
17
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
11. 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 against the complaint.
During the course of normal business, the Company becomes involved in
various routine legal proceedings. The Company believes that it is not presently
a party to any other material litigation the outcome of which could reasonably
be expected to have a material adverse effect on its consolidated financial
statements.
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. On January 25, 2005, the Company filed a current
report on Form 8-K, which indicated that the Company believed that the matter
was a formal 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 related to the Company's stock options granted. On
February 25, 2005, the Company filed a current report on Form 8-K, which
indicated that the Company believed that the matter was a formal inquiry. 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 and can give no
assurances that the outcome of either or both matters will not have a material
impact on the Company.
12. CASH FLOW SUPPLEMENTAL INFORMATION
Information about the cash flow activities related to the EuroLink
acquisition and Javelin Technologies, Inc. ("Javelin") adjustment was as
follows:
18
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
THREE MONTHS
ENDED MARCH 31,
2004
--------------
(IN THOUSANDS)
Fair value of assets acquired, including cash of $155 $(4,520)
Fair value of liabilities assumed 136
Fair value of capital contributed 1,026
Fair value of notes issued 499
Pre-acquisition investment basis 3,014
Javelin working capital adjustment settlement 1,250
-------
Cash acquired from acquisitions $ 1,405
=======
The preceding fair values of net assets and liabilities for the three
months ended March 31, 2004 were based on the preliminary estimates. The final
allocation of assets acquired at March 31, 2004 differed from the fair values
presented.
Information about other cash flow activities was as follows:
THREE MONTHS ENDED
MARCH 31,
----------------------
2005 2004
--------- ---------
Supplemental disclosures of cash flow information: (IN THOUSANDS)
Cash paid for interest $ 118 $ 74
Cash paid for income taxes, net -- 18
13. SUBSEQUENT EVENTS
NASDAQ DELISTING PROCEEDING
On April 5, 2005, Nasdaq notified the Company that the Company was not
in compliance with the requirements for listing on The Nasdaq National Market
because the Company had not timely filed its 2004 Form 10-K. At a May 12, 2005
hearing with the Nasdaq Listing Qualifications Panel, the Company requested an
extension of time to meet Nasdaq's listing requirements. In a decision dated
June 14, 2005, the NASDAQ Listing Qualification Panel determined to grant the
Company's request for continued listing on the Nasdaq National Market, subject
to the Company's filing its 2004 Form 10-K and its Quarterly Report on Form 10-Q
for the three months ended March 31, 2005 by June 30, 2005.
The Company has filed its 2004 Form 10-K and with this filing of the
Company's Quarterly Report on Form 10-Q for the three months ended March 31,
2005, the Company believes that it is in compliance with the requirements for
listing on The Nasdaq National Market. The Company will request that Nasdaq
dismiss the pending delisting action against it and permit its common stock to
resume trading on the Nasdaq National Market under the symbol NYFX.
If the Company's common stock is delisted from Nasdaq, stockholders may
find it more difficult to obtain timely and accurate quotes and execute trades
in our common stock. In addition, if our common stock is delisted from Nasdaq
19
Notes to Condensed Consolidated Financial Statements - continued
(Unaudited)
and the market price of our common stock is less than $5.00 per share, our
common stock could be considered a penny stock and become subject to the
regulations applicable to penny stocks.
20
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 condensed consolidated financial statements and also to convey our
expectations of the potential impact of known trends, events, or uncertainties
that may impact our future condensed consolidated 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 2004 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 2004 Form 10-K.
The following discussion and analysis gives effect to the restatement of
our condensed consolidated financial statements for the three months ended March
31, 2004, to correctly account for compensation expense attributable to stock
options granted to our employees and directors, as discussed in Note 2 to the
Condensed Consolidated Financial Statements.
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 a 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, in San Francisco and in Madrid. We
operate redundant data centers in the northeastern US 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 products to our segments 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
customers consist primarily of US 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 was approved for
membership in the National Futures Association in 2002, is our Introducing
Broker for derivative transactions; NYFIX International, which was incorporated
in the United Kingdom on March 29, 2004, is a broker-dealer registered with the
21
NYFIX, INC.
FSA broker-dealer license in connection with our expansion into European and
other international markets; and EuroLink. We acquired the remaining 60% of
EuroLink we did not own, effective March 29, 2004. We have integrated EuroLink's
operations, which represented our initial transaction efforts in the European
markets, into NYFIX International.
NYFIX Millennium provides a modernized electronic execution venue under
Regulation ATS for trading in US stocks. NYFIX Transaction Services provides
technology and direct market access and execution links. NYFIX Clearing, a
member of the Depository Trust and Clearing Corporation ("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.
In recent years, we have invested heavily in pursuing a growth-oriented
strategy and have organized those efforts largely through our acquired and
majority-owned subsidiaries. After the introduction of our NYFIX Network in
1998, although we experienced quarter over quarter revenue growth from 1999
through 2001, we also generated operating losses. Thereafter, as a result of the
impact of the tragic events of September 11, 2001 on our customer base, the
downturn in the financial markets, and the fixed-cost base of our acquired
companies we have not been able to generate sufficient revenue to offset our
operating costs and, thus, experienced operating losses through 2004. We believe
that our decision to continue to invest during the last three years is an
important factor to help us become better positioned to take advantage of future
opportunities. We have entered new customer market segments, launched new
products and continue to pursue other opportunities to support trading for a
variety of financial instruments in more markets while increasing our
international business opportunities.
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
condensed consolidated financial statements, including the assets, liabilities,
revenue and expense and the disclosure of contingent assets and liabilities at
the date of the condensed consolidated financial statements and future reporting
periods.
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 consider to be reasonable, the results of
which form the basis 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
understanding our condensed consolidated financial statements 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 2004 Form 10-K. Refer to Note 1 to the Consolidated Financial
Statements in Item 8 of our 2004 Form 10-K for our significant accounting
policies. In the three months ended March 31, 2005, there have been no material
changes to our significant accounting policies.
22
NYFIX, INC.
OVERVIEW OF FINANCIAL RESULTS
The tables provided below present 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:
THREE MONTHS ENDED
MARCH 31,
---------------------------
2005 2004
------------- ---------
($ IN THOUSANDS)
Segment revenue:
Technology Services $ 17,359 $ 13,870
Transaction Services 7,117 3,925
Eliminations (796) (659)
------------- ---------
Total revenue $ 23,680 $ 17,136
============= =========
Segment revenue, as a percentage of total revenue:
Technology Services 73% 81%
Transaction Services 30% 23%
Eliminations (3)% (4)%
------------- ---------
Total 100% 100%
============= =========
Segment gross profit:
Technology Services $ 8,377 $ 6,423
Transaction Services 3,139 1,213
------------- ---------
Total gross profit $ 11,516 $ 7,636
============= =========
Segment gross profit, as a percentage of
revenue:
Technology Services 48% 46%
Transaction Services 44% 31%
Total 49% 45%
Discussion of segment revenue, cost of revenue and gross profit within
MD&A includes intercompany revenue and cost of revenue, which are eliminated, as
shown above, in consolidation.
The following table presents our revenue, cost of revenue, gross profit
and operating expense expressed as percentages of revenue for the periods
indicated:
23
NYFIX, INC.
THREE MONTHS ENDED
MARCH 31,
------------------
2005 2004
-------- --------
REVENUE:
Subscription 52% 54%
Capital sale 10% 12%
Service contract 13% 14%
Transaction 25% 20%
------- ------
Total revenue 100% 100%
------- ------
COST OF REVENUE:
Subscription 52% 61%
Capital sale 54% 41%
Service contract 40% 37%
Transaction 55% 62%
------- ------
Total cost of revenue 51% 55%
------- ------
GROSS PROFIT:
Subscription 48% 39%
Capital sale 46% 59%
Service contract 60% 63%
Transaction 45% 38%
------- ------
Total gross profit 49% 45%
------- ------
OPERATING EXPENSE:
Selling, general and administrative 46% 50%
Research and development 0% 2%
Equity in loss of unconsolidated affiliate 0% 0%
Depreciation and amortization 2% 3%
------- ------
Total operating expense 48% 55%
------- ------
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.
24
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 professional services 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. Revenue on these contracts 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.
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 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.
25
NYFIX, INC.
Revenue on contracts invoiced in advance of the services being performed
is deferred and recognized as revenue in the period earned and until earned 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
centers where we maintain equipment and infrastructure to support our
operations, amortization of capitalized product enhancement costs and acquired
intangible assets, depreciation of subscription equipment 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
across our lines of business based on usage estimates.
Operating expense is comprised of selling, general and administrative
("SG&A"), research and development ("R&D"), equity in loss of unconsolidated
affiliate 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. 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. Equity in loss of
unconsolidated affiliate consists of 40% of EuroLinks's operating losses prior
to March 29, 2004. Depreciation and amortization expense consists of such
expense for our corporate equipment and software and amortization of certain
intangible assets.
Discussion of segment revenue, cost of revenue and gross profit within
MD&A includes intercompany revenue and cost of revenue, which are eliminated, as
shown above, in consolidation.
HISTORICAL RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THREE MONTHS ENDED MARCH 31, 2004
REVENUE
The following table presents an overview of our revenue:
26
NYFIX, INC.
THREE MONTHS ENDED MARCH 31,
--------------------------------------------
2005 2004
$ % $ %
------------------- --------------------
($ IN THOUSANDS)
Technology Services:
Subscription $ 11,982 69% $ 9,402 68%
Capital sale 2,409 14% 1,988 14%
Service contract 2,968 17% 2,480 18%
-------- --------
Sub-total 17,359 73% 13,870 81%
-------- --------
Transaction Services:
Subscription 1,147 16% 562 14%
Service contract 10 0% -- 0%
Transaction 5,960 84% 3,363 86%
-------- --------
Sub-total 7,117 30% 3,925 23%
-------- --------
Eliminations:
Subscription (796) n/a (659) n/a
-------- --------
Sub-total (796) n/a (659) n/a
-------- --------
Total revenue
Subscription 12,333 52% 9,305 54%
Capital sale 2,409 10% 1,988 12%
Service contract 2,978 13% 2,480 14%
Transaction 5,960 25% 3,363 20%
-------- --------
Consolidated revenue $ 23,680 100% $ 17,136 100%
======== ========
Segment subtotals are presented as a percentage of consolidated revenue
Consolidated revenue increased $6.6 million, or 39%, to $23.7 million
for the three months ended March 31, 2005 as compared to $17.1 million for the
three months ended March 31, 2004.
Our Technology Services segment revenue increased $3.5 million, or 25%,
to $17.4 million for the three-months ended March 31, 2005, as compared to $13.9
million for the three-months ended March 31, 2004.
Subscription revenue for our Technology Services segment increased to
$12.0 million for the three months ended March 31, 2005 from $9.4 million for
the three months ended March 31, 2004. This $2.6 million, or 28%, increase was
primarily attributable to an increase in subscription revenue as a result of an
increase in our buy-side initiative, as described below, of $2.5 million, from
$1.3 million for the three months ended March 31, 2004 to $3.8 million for the
three months ended March 31, 2005. In August 2002, we began a direct marketing
initiative to connect buy-side institutions to our expansive NYFIX Network. We
expect our buy-side related subscription revenue to continue to increase for the
remainder of 2005 as we continue to add buy-side customers.
Capital sale revenue for our Technology Services segment was $2.4
million for the three months ended March 31, 2005 as compared to $2.0 million
for the three months ended March 31, 2004, which was primarily attributable to
increased capital sales of our derivatives products partially offset by reduced
capital sales of our Javelin products. Capital sale revenue continues to vary
considerably from quarter to quarter. While we expect that capital sale revenue
will be comparable in 2005 to 2004, we cannot predict the timing and consistency
of such revenue.
27
NYFIX, INC.
Service revenue for our Technology Services segment increased to $3.0
million for the three months ended March 31, 2005 from $2.5 million for the
three months ended March 31, 2004, which was primarily attributable to an
increase in service revenue for the increase in our buy-side initiative,
discussed above, and a slight increase in maintenance revenue, which was based
on prior capital sale revenue.
As a percentage of total revenue, our Technology Services segment
revenue decreased to 72% (before eliminations) for the three months ended March
31, 2005 from 81% (before eliminations) for the three months ended March 31,
2004.
Our Transaction Services segment revenue increased $3.2 million, or 82%,
to $7.1 million for the three months ended March 31, 2005 as compared to $3.9
million for the three months ended March 31, 2004. Our Transaction Services
revenue attributable to domestic and international buy-side customers increased
$2.9 million to $3.6 million from $0.7 million, as our customer base and
transaction volume increased in the three months ended March 31, 2005 as
compared to the three months ended March 31, 2004. For our Transaction Services
segment, we expect to continue to add customers on a quarterly basis with the
emphasis on buy-side customers. We expect this component of our business to
continue to grow as a percentage of the overall Transaction Services segment. As
a percentage of total revenue, our Transaction Services segment increased to 30%
(before eliminations) for the three months ended March 31, 2005 from 23% (before
eliminations) for the three months ended March 31, 2004. 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:
28
NYFIX, INC.
THREE MONTHS ENDED MARCH 31,
----------------------------------------------------
2005 2004
$ % $ %
------------------------ ------------------------
($ in thousands)
Technology Services:
Subscription $ 6,498 72% $ 5,713 77%
Capital sale 1,292 14% 817 11%
Service contract 1,192 13% 917 12%
-------- ---------
Sub-total 8,982 52% 7,447 54%
-------- ---------
Transaction Services:
Subscription 692 17% 537 20%
Transaction 3,286 83% 2,175 80%
-------- ---------
Sub-total 3,978 56% 2,712 69%
-------- ---------
Corporate and Eliminations:
Corporate:
Data center and telecommunications 6,412 4,985
Fixed asset depreciation and amortization 1,401 1,468
Amortization of product enhancement costs 1,155 815
Allocated to:
Technology Services (7,548) (6,213)
Transaction Services (1,420) (1,055)
-------- ---------
Sub-total -- --
-------- ---------
Eliminations:
Subscription (788) n/a (567) n/a
Transaction (8) n/a (92) n/a
-------- ---------
Sub-total (796) n/a (659) n/a
-------- ---------
Consolidated cost of revenue $ 12,164 51% $ 9,500 55%
======== =========
Segment subtotals are presented as a percentage of segment revenue.
Consolidated cost of revenue increased $2.7 million, or 28%, to $12.2
million for the three months ended March 31, 2005 as compared to $9.5 million
for the three months ended March 31, 2004. The primary factors for the increase
in 2005 were labor costs of $0.8 million, transaction related costs of $0.7
million, including execution and clearing fees, product enhancement cost
amortization of $0.4 million, which was primarily due to increased amortization
on product enhancements capitalized to support our Technology Services products,
data center facility management expenses of $0.3 million, telecommunication
expense of $0.2 million and cross connection fees of $0.1 million. As a
percentage of revenue, cost of revenue decreased to 51% for the three months
ended March 31, 2005, from 55% for the three months ended March 31, 2004, as the
increase in the previously discussed Technology Services and Transaction
Services revenue exceeded the increases in our Technology Services and
Transaction Services costs as mentioned below .
Our Technology Services segment cost of revenue increased $1.6 million,
or 22%, to $9.0 million for the three months ended March 31, 2005 compared to
$7.4 million for the three months ended March 31, 2004. This increase was
primarily attributable to the previously discussed increases in allocated
corporate expenses, such as data center labor, telecommunications expenses,
depreciation and amortization of fixed assets and amortization of product
enhancements in the aggregate of $1.4 million. Included in the increase were
additional capital sale cost of revenue of $0.5 million, or 63%, to $1.3 million
for the three months ended March 31, 2005, from $0.8 million for the three
months ended March 31, 2004, and additional service contract cost of revenue of
$0.3 million, or 33%, to $1.2 million for the three months ended March 31, 2005,
from $0.9 million for the three months ended March 31, 2004. These increases
29
NYFIX, INC.
were primarily due to increased labor costs to support our products. As a
percentage of revenue, cost of revenue decreased to 52% in 2005, from 54% in
2004, as the increase in our revenue grew at a faster rate than the cost
increases, discussed above. We expect to see a slight decrease in our cost of
revenue as a percentage of revenue in the remainder of 2005 as many of the
investments in property and equipment in our data center and network
infrastructure made in recent years should yield lower costs as a percentage of
revenue.
Our Transaction Services segment cost of revenue increased $1.3 million,
or 48%, to $4.0 million for the three months ended March 31, 2005 compared to
$2.7 million for the three months ended March 31, 2004. In addition to the
previously discussed increase of $0.7 million in transaction related expenses,
allocated corporate expenses, such as data center labor, telecommunications
expenses, depreciation and amortization of fixed assets and amortization of
product enhancement costs increased by $0.4 million. As a percentage of revenue,
cost of revenue decreased to 56% for the three months ended March 31, 2005, from
69% for the three months ended March 31, 2004, as the increase in the our
revenue grew at a faster rate than the cost increases discussed above. We expect
our cost of revenue to decline as a percentage of Transaction Services segment
revenue in 2005. 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, including those for self-clearing of our trades through NYFIX
Clearing, over a greater revenue base.
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 MARCH 31,
----------------------------------------------------
2005 2004
$ % $ %
------------------------- ------------------------
($ in thousands)
Technology Services:
Subscription $ 5,484 46% $ 3,689 39%
Capital sale 1,117 46% 1,171 59%
Service contract 1,776 60% 1,563 63%
-------- --------
Sub-total 8,377 48% 6,423 46%
-------- --------
Transaction Services:
Subscription 455 40% 25 4%
Service contract 10 0% -- 0%
Transaction 2,674 45% 1,188 35%
-------- --------
Sub-total 3,139 44% 1,213 31%
-------- --------
Eliminations:
Subscription (8) n/a (92) n/a
Transaction 8 n/a 92 n/a
-------- --------
Sub-total -- --
-------- --------
Total gross profit:
Subscription 5,931 48% 3,622 39%
Capital sale 1,117 46% 1,171 59%
Service contract 1,786 60% 1,563 63%
Transaction 2,682 45% 1,280 38%
-------- --------
Consolidated gross profit $ 11,516 49% $ 7,636 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.
30
NYFIX, INC.
Consolidated gross profit increased $3.9 million to $11.5 million for
the three months ended March 31, 2005 from $7.6 million for the three months
ended March 31, 2004. The increase in revenue outpaced the increase in cost of
revenue, as previously discussed. Accordingly, our gross profit margin increased
to 49% for the three months ended March 31, 2005, as compared to 45% for the
three months ended March 31, 2004.
Our Technology Services segment gross profit increased $2.0 million to
$8.4 million for the three months ended March 31, 2005 from $6.4 million for the
three months ended March 31, 2004. As a percentage of segment revenue, gross
profit margin increased to 48% for the three months ended March 31, 2005 from
46% for the three months ended March 31, 2004. The increase in gross profit is
primarily attributable to the increase in our technology subscription revenue,
which grew faster than the increases in our costs, as discussed. We expect to
see slight improvements in our Technology Services segment gross profit margin
in the remainder of 2005, as many of the improvements to our data center and
network infrastructure made in recent years should yield lower costs as a
percentage of revenue.
Our Transaction Services segment gross profit increased $1.9 million to
$3.1 million for the three months ended March 31, 2005 from $1.2 million for the
three months ended March 31, 2004. Transaction Services segment gross profit
margin increased to 44% for the three months ended March 31, 2005, as compared
to 31% for the three months ended March 31, 2004. The increase in gross profit
was primarily attributable to the increase in our transaction revenue, which
grew faster than the increases in our costs. We expect our Transaction Services
segment gross margin, as a percentage of revenue, to continue to improve as a
percentage of Transaction Services segment revenue in 2005. 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, including clearing
expenses as a result of self-clearing our trades through NYFIX Clearing, over a
greater revenue base.
SG&A
The following table presents an overview of our SG&A expense:
THREE MONTHS ENDED MARCH 31,
---------------------------------------------
2005 2004
$ % $ %
-------------------- --------------------
($ in thousands)
Salaries and benefits $ 6,068 56% $ 5,317 62%
Occupancy and related 885 8% 953 11%
Marketing, travel and entertainment 563 5% 636 7%
Professional fees 1,820 17% 660 8%
General and other 1,568 14% 1,036 12%
------- -------
Total SG&A $10,904 46% $ 8,602 50%
======= =======
The total SG&A is presented as a percentage of consolidated revenue.
SG&A expense increased $2.3 million, or 27%, to $10.9 million for the
three months ended March 31, 2005, as compared to $8.6 million for the three
months ended March 31, 2004. The increase was primarily attributable to
increased professional and consulting fees of $1.2 million due principally to
legal and audit fees incurred in connection with the restatement of our
previously issued consolidated financial statements, SEC matters and consulting
fees related to Sarbanes-Oxley initial compliance; and increased salaries and
benefits of $0.8 million primarily due to increased staffing related to our
growth and increased primary health insurance costs. As a percentage of total
revenue, SG&A expense decreased to 46% for the three months ended March 31, 2005
from 50% for the three months ended March 31, 2004, as the increase in revenue
grew at a faster rate than the increase in SG&A expense. We expect that our
31
NYFIX, INC.
general and administrative expenses, particularly related to our legal, audit
and consulting fees incurred in connection with SEC matters and continuing
Sarbanes-Oxley compliance will not decrease in the near term. In addition, we
expect our employee benefit costs to increase in 2005 as our primary health
insurance policies, which increased 19%, renewed on January 1, 2005. To
partially offset the anticipated cost increases in 2005, we deferred most of our
employees' annual merit increases to be effective July 1, 2005.
R&D
R&D expense decreased $0.2 million to $0.1 million for the three months
ended March 31, 2005, from $0.3 million for the three months ended March 31,
2004, as our software developers and quality assurance personnel focused their
efforts on enhancing and extending the lives of our products. As a percentage of
total revenue, research and development expense decreased to less than 1% for
the three months ended March 31, 2005, from 2% for the three months ended March
31, 2004, due to the decrease in R&D expense and the increase in revenue. We
expect a similar amount of R&D expense for each of the remaining quarters of
2005.
EQUITY IN LOSS OF UNCONSOLIDATED AFFILIATE
We recognized equity in the loss of EuroLink, our unconsolidated
affiliate, of $0.1 million for the three months ended March 31, 2004. Effective
March 29, 2004, we acquired the remaining 60% of EuroLink that we did not
already own, and consolidated EuroLink as of that date.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense remained constant at $0.5 million
for both the three months ended March 31, 2005 and 2004. As a percentage of
total revenue, depreciation and amortization expense decreased to 2% for the
three months ended March 31, 2004 from 3% for the three months ended March 31,
2004. The decrease as a percentage of total revenue was attributable to the
increased revenue.
INCOME (LOSS) FROM OPERATIONS
Income from operations was $13,000 for the three months ended March 31,
2005, as compared to a loss from operations of $1.9 million for the three months
ended March 31, 2004. The improvement in operating results was primarily due to
increased revenue, partially offset by increased cost of revenue and SG&A
expense, as described above. As a percentage of total revenue, income from
operations was less than 1% for the three months ended March 31, 2005, as
compared to a deficit of 11% on the loss from operations for the three months
ended March 31, 2004. The improvement as a percentage of total revenue was
attributable to revenue growing at a faster rate than the increase in cost of
revenue and SG&A expense.
INTEREST EXPENSE
Interest expense increased $0.1 million, or 100%, to $0.2 million for
the three months ended March 31, 2005 from $0.1 million for the three months
ended March 31, 2004, primarily due to interest on the convertible note issued
on December 30, 2004. We expect to see higher interest expense in the future as
a result of the convertible note issuance.
INCOME TAXES
We recorded an income tax provision of $14,000 and an income tax benefit
of $0.8 million for the three months ended March 31, 2005 and 2004,
respectively. We have a valuation allowance of $25.7 million at March 31, 2005
and $25.6 million at December 31, 2004. Until we can achieve and sustain an
appropriate level of profitability, we plan to maintain a valuation allowance on
our deferred tax assets and we expect our effective tax rate to be minimal. Our
effective tax rate was 12% and 40% for the three months ended March 31, 2005 and
2004, respectively. Our effective tax benefit rate for the three months ended
32
NYFIX, INC.
March 31, 2005 is lower than the Federal statutory rate primarily due to the
valuation allowance recorded on our deferred tax assets. Our effective tax
benefit rate for the three months ended March 31, 2004 is higher than the
Federal statutory rate primarily due to the benefits 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 $1.6 million from 2002 through
March 31, 2005. 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 in our 2004 Form 10-K.
We used cash from operations of $1.5 million in the three months ended
March 31, 2005, primarily as a result of increased accounts receivable and
decreased accounts payable, as a result of the availability of cash due to the
issuance of the $7.5 million convertible note on December 30, 2004. 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 operating expenses, including
salaries and benefits, marketing, travel and entertainment, office rent and
related occupancy, and other general and administrative expenses.
We invested $0.4 million for the three months ended March 31, 2005 and
$1.4 million for the three months ended March 31, 2004 in our data center
infrastructure and other property and equipment to keep current with technology
trends. We expect to continue to invest at a lower level in 2005 as compared to
2004.
We have capitalized product enhancements of $1.2 million for the three
months ended March 31, 2005 and $1.8 million for the three months ended March
31, 2004 to keep our products competitive. The increase in capitalized product
enhancement costs since 2003 is primarily attributable to our Javelin and
Renaissance product lines. We have many product enhancements in development
which we expect to release into production during 2005. We anticipate that we
will capitalize a lower amount in 2005 for product enhancements as compared to
2004.
We acquired net cash of $1.4 million in 2004 related to our acquisitions
primarily related to the receipt of escrowed funds of $1.2 million held pursuant
to a settlement agreement with a representative of the former shareholders of
Javelin. In connection with our Renaissance acquisition, we issued outstanding
notes payable over the next several years, aggregating $3.0 million, payable, at
our option, in cash or our common stock. During 2004, pursuant to notice from
certain payees after default on the notes, we issued shares of our common stock
as payment 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 remaining 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 transaction with $24,000 in cash
33
NYFIX, INC.
and one-year promissory notes payable in our common stock or cash, at our
option, valued at $0.5 million. We intend to pay the notes using our common
stock. Due to the delay in issuing our 2004 consolidated financial statements,
we were unable to issue our common stock to satisfy this debt. We intend to
settle this obligation through the issuance of common stock as soon as
practicable subsequent to the filing of our 2004 Form 10-K and our Report on
Form 10-Q for the three months ended March 31, 2005. We intend to integrate
EuroLink with NYFIX International. We have no current plans or agreements,
commitments or understandings 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, and the rate at which we invest in new technologies to modify our
NYFIX Network and products. We have ongoing needs for capital, including working
capital for operations and capital expenditures to maintain and expand our
operations.
At March 31, 2005, our principal sources of liquidity were cash, cash
equivalents and short-term investments in the aggregate of $23.6 million and
accounts receivable of $16.0 million. At March 31, 2005, we had current accounts
payable and accrued expenses aggregating $15.6 million. We do not expect to make
any significant income tax payments in 2005 due to available net operating loss
carryforwards and research and development tax credits. In connection with the
restatement of our accounting for previously granted stock options, we do expect
to amend certain tax filings. We do not expect this to have a material impact on
our 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. NYFIX International, as an FSA-registered broker-dealer, is also
subject to minimum net capital requirements. During the year ended December 31,
2003, we funded $10.8 million to NYFIX Clearing in order to maintain its minimum
excess net capital requirement of $10.0 million as a condition of its approval
by the DTCC. During the year ended December 31, 2004, we provided aggregate
additional capital of $1.3 million in the form of capital contributions and
subordinated loans to enable our US broker-dealer subsidiaries to individually
and collectively exceed their net capital requirements, and another $1.3 million
to NYFIX International in the form of capital contributions as a condition of
NYFIX International's approval by the FSA. In the first quarter of 2005, we
provided our broker-dealer subsidiaries aggregate additional capital of $2.8
million in the form of capital contributions. At March 31, 2005, our
broker-dealer subsidiaries had aggregate net capital of $15.4 million, which
exceeded the aggregate minimum net capital required by $4.0 million. At March
31, 2005, we had an aggregate of $15.4 million of our consolidated cash,
cash-equivalents and short-term investments committed to maintain our
broker-dealer subsidiaries' minimum and, in the case of NYFIX Clearing, its
minimum excess net capital requirements of $11.4 million. Our broker-dealer
subsidiaries may need 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.
As a result of the reduced availability of cash due to our broker-dealer
net capital requirements, as described above, and our continued operating
losses, on December 30, 2004, we issued a $7.5 million Convertible Note with an
interest rate of 5% due in December 2009 (the "Note") through a private
placement to a lender. The interest is payable in cash or, at our option as
described below, by the issuance of shares of our common stock, semi-annually in
arrears on June 30 and December 30 of each year, beginning June 30, 2005.
The Note is subordinated to all of our existing and future secured
indebtedness. The Lender has certain rights to require that we register the
common stock issuable, upon conversion of the Note or for payment of interest,
under the Securities Act of 1933, as amended. Such registration statement is to
be effective by September 30, 2005 and if it is not, we will be required to pay
additional interest, in cash, for each month the effectiveness is delayed. The
additional interest varies by month and has an aggregate cap of $500,000 for the
34
NYFIX, INC.
duration of the Note. The entire outstanding principal amount of the Note
together with all accrued but unpaid interest is due in cash on December 30,
2009; and except under certain conditions, we have no right of early prepayment
on the Note.
At the option of the Lender, the Note is convertible into our common
stock at $6.94 per common share, which was a 20% premium over the average of our
common stock closing price for the five trading days preceding December 30,
2004. At our option, the Note is convertible into our common stock according to
a formula based on the market price of our stock during the term of the Note
which requires among other things for our common stock to exceed 150% of the
price at which the Lender can convert the Note (or $10.41 per common share).
If we issue our common stock to convert the Note or to make interest
payments, we are required to pay a 5% premium based on an average of the closing
price of our common stock for the previous ten days. If we convert the Note
prior to December 30, 2007, we are required to pay an additional make-whole
interest payment in either cash or our stock at our discretion.
As a result of the restatement of our financial statements for the year
ended December 31, 2003, we were in breach of certain representations and
warranties relating to those financial statements that constituted an event of
default under the Note. On June 24, 2005, the Lender waived all defaults under
the Note and extended the requirement to have a registration statement be
effective for the shares of our common stock that may be issued as payment of
principal or interest under the Note to March 31, 2006. In exchange, we agreed
to reduce the price at which the lender can convert the Note into common stock
from $6.94 per share, as described above, to $5.75 per share, which was a 16%
premium over the average of our common stock closing price for the five trading
days preceding June 24, 2005. Accordingly, our option to convert the Note into
our common stock is based on the market price of our stock during the term of
the Note which requires, among other things, our common stock to exceed 150% of
the price (or $8.63 per common share on a revised basis) at which the Lender can
convert the Note.
In addition, at the option of the Lender, we may issue to the Lender up
to an additional $2.5 million note under terms substantially similar to those of
the Note. The Lender requested, and we agreed to extend the termination date of
the option to issue the additional $2.5 million note from March 30, 2005 to
until ten days after the date we filed our 2004 Form 10-K.
We believe that our cash and short-term investments of $23.6 million at
March 31, 2005, together with anticipated cash to be generated from operations,
will be sufficient to support our capital and operating needs and the net
capital requirements of our broker-dealer operations for at least the next
twelve months.
WORKING CAPITAL
At March 31, 2005, we had working capital of $22.9 million as compared
to $20.8 million at December 31, 2004. The increase in working capital was
principally due to the increased revenue which resulted in a higher accounts
receivable balance, partially offset by cash used to acquire property and
equipment and to enhance our products.
CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES
Net cash used in operating activities in the three months ended March
31, 2005 was $1.5 million, as our net loss of $0.1 million, adjusted for
non-cash items, such as depreciation, amortization and deferred income taxes,
provided $3.8 million. Unfavorable working capital and other asset and liability
changes of $5.3 million, including accounts receivable of $2.7 million, accounts
payable and other liabilities of $2.0 million and prepaid expenses and other
assets of $0.7 million were partially offset by an increase in deferred revenue
of $0.2 million.
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NYFIX, INC.
Net cash provided by operating activities in the three months ended
March 31, 2004 was $1.9 million, as our net loss of $1.2 million, adjusted for
non-cash items, such as depreciation, amortization, deferred taxes and equity in
loss of unconsolidated affiliates, provided $2.4 million. Unfavorable changes of
$0.5 million, including prepaid and other assets of $1.3 million and accounts
receivable of $1.1 million, were partially offset by increases in brokerage
payables (net of brokerage receivables) of $0.4 million, accounts payable and
other liabilities of $1.4 million and deferred revenue of $0.1 million.
CASH PROVIDED BY (USED IN) PROVIDED BY INVESTING ACTIVITIES
For the three months ended March 31, 2005, net cash provided by
investing activities was $1.0 million. This consisted primarily of the net sale
of short-term investments of $2.6 million, partially offset by product
enhancement costs of $1.2 million and capital expenditures, primarily for data
center equipment and software, of $0.4 million. On a quarterly basis in 2005, we
expect to invest a similar amount of cash for capital expenditures for property
and equipment as well as product enhancement costs, as compared to the first
quarter of 2005.
For the three months ended March 31, 2004, net cash used in investing
activities was $4.8 million. This consisted primarily of the net purchase of
short-term investments of $2.7 million, product enhancement costs of $1.9
million, capital expenditures, primarily for data center equipment and software,
of $1.4 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.
CASH USED IN FINANCING ACTIVITIES
For the three months ended March 31, 2005, net cash used in financing
activities totaled $0.2 million, consisting primarily of principal payments
under capital lease obligations. In 2005, we expect to repay debt of $0.4
million and capital lease obligations of $0.6 million. We may elect to pay our
promissory note obligations with our common stock, thus not requiring cash.
For the three months ended March 31, 2004, net cash used in financing
activities totaled $0.1 million, consisting primarily of principal payments
under capital lease obligations of $0.2 million, partially offset by net
proceeds from the issuance of common stock resulting from the exercise of stock
options by employees of $0.1 million.
SEASONALITY AND INFLATION
We believe that our operations have not been significantly affected by
seasonality or inflation.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123(R), SHARE-BASED PAYMENTS.
SFAS No. 123(R) is a revision of SFAS No. 123 and supersedes APB No. 25 and its
related implementation guidance. SFAS 123(R) establishes standards for the
accounting for transactions in which an entity exchanges its equity for goods or
services. It also addressed transactions in which an entity incurs liabilities
in exchange for goods or services that are based on the fair value of the
entity's equity instruments or that may be settled by the issuance of those
equity instruments. SFAS No. 123(R) focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123(R) allows entities to apply a modified retrospective
application to periods before the required effective date. SFAS No. 123(R) is
effective for public entities that do not file as small business issuers as of
the beginning of the first interim or annual reporting period that begins after
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NYFIX, INC.
June 15, 2005, or in our case January 1, 2006. The Company is evaluating the
impact of SFAS No. 123(R), which could have a material impact on its
consolidated financial statements.
In December 2004, the FASB issued SFAS No. 153, EXCHANGES OF NONMONETARY
ASSETS. SFAS No. 153 addresses the measurement of exchanges of nonmonetary
assets. SFAS No. 153 eliminates the exception from the fair value measurement
for nonmonetary exchanges of similar product assets in paragraph 21(b) of APB
Opinion No. 29, ACCOUNTING FOR NONMONETARY TRANSACTIONS, and replaces it with an
exception for exchanges that do not have commercial substance. SFAS No. 153
specifies that a nonmonetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of the
exchange. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in
fiscal periods beginning after June 15, 2005. We have not completed our analysis
of the impact of SFAS No. 153, but as we have not been involved in significant
nonmonetary exchanges in the past, we do not expect that the provisions of SFAS
No. 153 will have a material impact on our consolidated financial statements.
In November 2004, the FASB issued SFAS No. 151, INVENTORY COSTS. SFAS
No. 151 amends Accounting Research Bulleting ("ARB") No. 43 INVENTORY Pricing to
clarify that abnormal amounts of idle facility expense, freight, handling costs,
and wasted materials (spoilage) should be recognized as current-period charges.
SFAS No. 151 also requires that allocation of fixed production overheads to the
cost of conversion be based on the normal capacity of the production facilities.
SFAS No. 151 is effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. We have not completed our analysis of the impact
of SFAS No. 151, but as inventory is not a material component of our
consolidated financial statements, we do not expect that the provisions of SFAS
No. 151 will have a material impact on our consolidated financial statements.
In March 2005, the FASB issued Interpretation No. 47, ACCOUNTING FOR
CONDITIONAL ASSET RETIREMENT OBLIGATIONS ("FIN 47"). FIN 47 clarifies that the
term conditional asset retirement obligations as used in Statement of Financial
Accounting Standards No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS,
refers to a legal obligation to perform an asset retirement activity in which
the timing and/or method of settlement are conditional on a future event. FIN 47
requires that these obligations be recognized if their fair value is reasonably
estimable. FIN 47 is effective for fiscal years ending after December 15, 2005.
We do not expect the provisions of FIN 47 to have a material impact on our
consolidated financial statements.
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 AND QUALITATIVE 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.
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NYFIX, INC.
We are exposed to market risk principally through changes in interest
rates and equity prices. Our short and long-term investment portfolios of $1.9
million and $4.5 million at March 31, 2005 and December 31, 2004, respectively,
consisted of $0.6 million and $1.2 million, respectively, of auction rate
certificates. 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.
We are subject to interest rate risk on our $1.3 million and $3.3
million of treasury bills at March 31, 2005 and December 31, 2004, respectively.
A hypothetical 10% change in interest rates would not result in a material
change in their fair value.
FOREIGN CURRENCY RISK
Our earnings are affected by fluctuations in the value of the US 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 US dollar, British pounds sterling or the Euro. 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. For the three months ended March 31, 2005
and 2004, we recorded a foreign exchange translation loss of $0.1 million for
each period.
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
DISCLOSURE CONTROLS AND PROCEDURES
"Disclosure controls and procedures" are defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934 (the "Exchange Act"). These
rules refer to the controls and other procedures of a company that are designed
to ensure that the information required to be disclosed by a company in the
reports that it files under the Exchange Act is recorded, processed, summarized
and reported within required time periods. Disclosure controls and procedures
also include, without limitation, controls and procedures designed to ensure
that information required to be disclosed in our Exchange Act reports is
accumulated and communicated to management, including our Chief Executive
Officer and our Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure. There are inherent limitations to the
effectiveness of any system of disclosure controls and procedures, including the
38
NYFIX, INC.
possibility of human error and the circumvention or overriding of the controls
and procedures. Accordingly, even effective disclosure controls and procedures
can only provide reasonable assurance of achieving their control objectives.
We, including our Chief Executive Officer and Chief Financial Officer,
have conducted an evaluation of the effectiveness of the design and operation of
our disclosure controls and procedures, as defined in Rules 13a-15(e) and
15d-15(e) under the Exchange Act, as amended, as of March 31, 2005. Based on our
evaluation of the effectiveness of the design and operation of the disclosure
controls and procedures, because of the matters discussed below, our Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were not effective as of March 31, 2005.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting (as defined in Rule 13a-15(f) under
the Securities Exchange Act of 1934, as amended). NYFIX, Inc.'s internal control
over financial reporting was designed to provide reasonable assurance to our
management and NYFIX, Inc.'s Board of Directors regarding the reliability of
financial reporting and the preparation of consolidated financial statements for
external purposes in accordance with accounting principles generally accepted in
the United States of America ("generally accepted accounting principles"), and
includes those policies and procedures that:
- Pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of
NYFIX, Inc.'s assets;
- Provide reasonable assurance that transactions are recorded as
necessary to permit preparation of consolidated financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures are being made only
in accordance with authorizations of management and directors; and
- Provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of NYFIX,
Inc.'s assets that could have a material effect on the consolidated
financial statements.
All internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation. These inherent limitations include the realities
that judgments in decision-making can be faulty, and that breakdowns can occur
because of simple error or mistake. Additionally, controls can be circumvented
by the individual acts of some people, by collusion of two or more people, or by
management override. The design of any system of controls also is based in part
upon certain assumptions about the likelihood of future events, and there can be
no assurance that any design will succeed in achieving its stated goals under
all potential future conditions; over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected. A material weakness in internal control over financial
reporting is a control deficiency (within the meaning of the Public Company
Accounting Oversight Board ("PCAOB") Auditing Standard No. 2), or combination of
control deficiencies, that results in there being more than a remote likelihood
that a material misstatement of the annual or interim financial statements will
not be prevented or detected. PCAOB Auditing Standard No. 2 identifies a number
of circumstances that, because of their likely significant negative effect on
internal control over financial reporting, are to be regarded as at least
significant deficiencies as well as strong indicators that a material weakness
exists, including the restatement of previously issued consolidated financial
statements to reflect the correction of a misstatement.
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NYFIX, INC.
Management assessed the effectiveness of NYFIX, Inc.'s internal control
over financial reporting as of March 31, 2005. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission, or COSO, in its Internal
Control-Integrated Framework. Based on this assessment, management has concluded
that, as of March 31, 2005, NYFIX, Inc. did not maintain effective internal
control over financial reporting, due to the following material weakness: NYFIX,
Inc. did not design and implement adequate policies and procedures to review
certain transactions for compliance with generally accepted accounting
principles. The material weakness resulted in the misapplication of generally
accepted accounting principles related to accounting for compensation expense
attributable to stock options granted, a tenant allowance and the recognition of
rent expense as of the lease commencement date contained in an operating lease,
and deferred income taxes in connection with certain acquisitions, as summarized
below:
1) We determined that our accounting for compensation expense
attributable to stock options granted to certain employees and
directors between 1993 and 2004 was incorrect for the following
reason: the intrinsic value of certain stock options granted to
employees and directors was calculated as of a date other than the
measurement date. The adjustments required us to correct the
accounting for compensation expense attributable to stock options
granted, resulting in a material adjustment to our previously
issued consolidated financial statements. As a result, we restated
our previously issued consolidated financial statements contained
in our 2004 Form 10-K. In addition, we intend to amend our tax
filings, as necessary.
2) Based on an internal review of our accounting for leases, which was
encouraged by a letter on the subject from the Office of the Chief
Accountant of the Securities and Exchange Commission to the
American Institute of Certified Public Accountants on February 7,
2005, we determined that our accounting for a tenant allowance and
the recognition of rent expense as of the lease commencement date
contained in an operating lease, effective in 2004, for one of our
offices was incorrect for the following reasons: a) we recognized
rent expense as of the date we began operations within the premises
rather than the lease commencement date; and b) we reduced the cost
basis of our leasehold improvements by the amount of the tenant
allowance rather than recording it as deferred rent and amortizing
such amount as a credit to lease expense over the term of the
lease. We corrected these errors and properly accounted for this
lease as of December 31, 2004.
3) We determined that our accounting for deferred income taxes in
connection with certain acquisitions was incorrect, because we did
not correctly identify and account for the allocation of deferred
tax assets and liabilities acquired. As a result, we restated our
previously issued consolidated financial statements contained in
our 2004 Form 10-K.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
As a result of the breadth and depth of the reviews performed to
implement and to maintain compliance with the provisions of the Sarbanes-Oxley
Act of 2002, we have made, and intend to continue to make, various improvements
to our system of internal control over financial reporting. The Company made the
following changes in the fourth quarter of the year ended December 31, 2004 and
in 2005 that it believes will have a material affect on internal control over
financial reporting. These improvements include additional and enhanced
reconciliations and controls over the disclosure process. In addition to the
above remediation, we have supplemented, and intend to continue supplementing,
our internal and external expertise in accounting and tax, and also intend to
enhance our internal review procedures for all new, unusual or non-recurring
transactions to ensure proper treatment and disclosure.
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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 against the complaint.
SEC MATTERS
In connection with the 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. On January 25, 2005, we filed a current report on Form 8-K, which
indicated that the matter was a formal 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 related to our stock options granted. On
February 25, 2005, we filed a current report on Form 8-K, which indicated that
we believed that the matter was a formal inquiry. We are cooperating with the
SEC with respect to both matters. We are unable to predict the outcome of either
matter at this time and can give no assurances that the outcome of either or
both matters will not have a material impact on us.
ITEM 6. EXHIBITS
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and
Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended ("the
Exchange Act").
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and
Rule 15d-14(a) of the Exchange Act.
32.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(b) and
Rule 15d-14(b) of the Exchange Act and 18 U.S.C. 1350.
32.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(b) and
Rule 15d-14(b) of the Exchange Act and 18 U.S.C. 1350.
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: June 29, 2005
42
Exhibits Index
Exhibit
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and
Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended ("the
Exchange Act").
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and
Rule 15d-14(a) of the Exchange Act.
32.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(b) and
Rule 15d-14(b) of the Exchange Act and 18 U.S.C. 1350.
32.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(b) and
Rule 15d-14(b) of the Exchange Act and 18 U.S.C. 1350.