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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For the fiscal year ended December 31, 1997 Commission File Number 0 --
23644
INVESTMENT TECHNOLOGY GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3757717
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(State of incorporation) (IRS Employer Identification No.)
380 MADISON AVENUE, NEW YORK, NEW YORK (212) 588-4000
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(Address of principal executive offices) (Registrant's telephone number, including area code)
10017
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(Zip Code)
Securities registered pursuant to Section 12(b) of
the Act:
None
Securities registered pursuant to Section 12(g) of
the Act:
NATIONAL ASSOCIATION OF SECURITIES DEALERS
COMMON STOCK, $0.01 PAR VALUE AUTOMATED QUOTATION SYSTEM
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(Title of class) (Name of exchange on which registered)
Aggregate market value of the voting stock held Number of shares outstanding of the
by non-affiliates of the Registrant at March Registrant's
16, 1998: class of common stock at March 16, 1998:
$110,616,506 18,229,679
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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 if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to this
form 10-K / /
Documents incorporated by reference:
Proxy Statement relating to the 1998 Annual Meeting of Stockholders
(incorporated, in part, in Form 10-K Part III).
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1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business.................................................................... 3
Item 2. Properties.................................................................. 11
Item 3. Legal Proceedings........................................................... 11
Item 4. Submission of Matters to a Vote of Security Holders......................... 11
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters........ 12
Item 6. Selected Financial Data..................................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................ 14
Item 8. Financial Statements and Supplementary Data................................. 21
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................ 43
PART III
Item 10. Directors and Executive Officers of the Registrant.......................... 43
Item 11. Executive Compensation...................................................... 43
Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 43
Item 13. Certain Relationships and Related Transactions.............................. 43
PART IV
Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K........... 43
FORWARD-LOOKING STATEMENTS
In addition to the historical information contained throughout this Annual
Report on Form 10-K, there are forward-looking statements that reflect
management's expectations for the future. A variety of important factors could
cause results to differ materially from such statements. These factors are noted
throughout this Annual Report on Form 10-K and include: the actions of both
current and potential new competitors, rapid changes in technology, financial
market volatility, evolving industry regulation, cash flows into or redemption
from equity funds, effects of inflation, customer trading patterns, and new
products and services.
2
PART I
ITEM 1. BUSINESS
Investment Technology Group, Inc., was formed as a Delaware corporation on
March 10, 1994, and its wholly-owned subsidiaries (collectively, the "Company"),
principally ITG Inc. ("ITG"), a registered broker-dealer in securities under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), ITG Global
Trading, Inc. ("Global Trading") which is a 50% partner in the Global POSIT
joint venture, ITG Australia PTY Limited, which is a 50% partner in ITG Pacific
Holding, and ITG Ventures Inc. provide automated equity trading services and
transaction research to institutional investors and brokers. ITG, a full service
execution firm, utilizes transaction processing technology to increase the
effectiveness and lower the cost of institutional and other trading. With an
emphasis on ongoing research, ITG offers the following services:
- ITG POSIT. An electronic stock crossing system.
- ITG QuantEX. A decision-support and routing system.
- Electronic Trading Desk Services. Offers customers trading capabilities
through the ITG trading desk, which utilizes multiple sources of
liquidity.
- ITG Platform. A PC based routing system.
- ITG ISIS. A set of analytical tools for systematically lowering
transaction costs.
The Company generates substantially all of its revenue from its POSIT,
QuantEX, and Electronic Trading Desk Services.
POSIT-REGISTERED TRADEMARK-1
POSIT was introduced in 1987 as a technology-based solution to the trade
execution needs of quantitative and passive investment managers. It has since
grown to encompass a large part of the active trading community as well. In
addition to its traditional customer base of quantitative and passive investors,
POSIT's liquidity serves fundamental institutional investors, broker-dealers and
international institutional investors. The POSIT system is currently used by
approximately 460 customers, including corporate and government pension plans,
insurance companies, bank trust departments, investment advisors and mutual
funds. POSIT is an electronic stock crossing system through which customers
enter buy and sell orders to trade single stocks and portfolios of equity
securities confidentially among themselves. Orders may be placed in the system
either through direct computer links to the Company's central computer or
indirectly by communicating with the Company's trading desk, which then enters
the orders in the central computer. ITG also strategically aligns itself with
partners of other popular trading systems allowing users the flexibility to
route orders directly to POSIT from sources such as links with ESI Securities,
Bridge Information Systems and BRASS. In 1998, the Company hopes to complete a
connection through Bloomberg and Spear Leads. The system, which currently
accepts orders for approximately 14,000 different equity securities, may be
modified, as the need arises, to include additional equity securities registered
pursuant to Section 12 of the Exchange Act. Using an algorithm, which
establishes the maximum possible matching of buy and sell orders at scheduled
times, the system matches or "crosses" these orders. Unless otherwise specified
by customers, POSIT will match orders (including multiple orders) that do not
contain equal numbers of shares, resulting in partial order execution. POSIT has
been designed to allow customers trade execution flexibility. Customers may
specify constraints on the portion of a portfolio that trades, such as a
requirement that the execution of a buy order be conditioned upon the concurrent
execution of a sell order. Trades are priced at the midpoint of the best bid and
offer on the primary market for each security at the time of the cross. Price
information is provided directly to the
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1 POSIT-Registered Trademark- is a registered service mark of the POSIT Joint
Venture.
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system from a third-party data vendor. There are five scheduled crosses every
business day at approximately 10:00 a.m., 11:30 a.m., 12:30 p.m., 1:30 p.m., and
3:00 p.m. Each scheduled cross is executed within a seven minute window selected
randomly by the system.
Significant attributes of POSIT:
- POSIT's midpoint pricing saves each party an amount equivalent to half the
bid/offer spread.
- POSIT's confidentiality virtually eliminates market impact. In contrast,
participants in traditional or other open markets constantly face the risk
that disclosure of an order will unfavorably affect price conditions.
- Clients pay a low transaction fee on completed transactions, relative to
the industry average of 5 to 6 cents per share. The Company's revenue from
the operation of POSIT is derived from transaction fees charged on each
share crossed through the system.
- Immediately after each cross, customers are electronically provided with
comprehensive reports of matched and unmatched (residual) orders.
Customers can then execute residual orders by traditional means or take
advantage of the Company's Electronic Trading Desk services (described
below).
- Electronic application on client instructions for allocating trades to
specific customer accounts utilizes average prices and average
commissions.
In December 1997, the Company announced the launch of POSIT 4, a
technological enhancement to POSIT. POSIT 4 preserves all the features of the
existing system and adds two important new dimensions to POSIT: dynamic
substitution and real-time control. Dynamic substitution allows investors to
substitute another security if the preferred security is not immediately
available for a cross. Real-time control allows POSIT 4 users to control
virtually any dimension of their portfolios such as expected return as well as
risk and yield. POSIT 4 can be used to control the tracking error of a portfolio
relative to a benchmark, a critical consideration for index fund managers.
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
AVERAGE DAILY POSIT SHARE VOLUME
Year Shares Per Day
1989 642,857
1990 1,703,557
1991 2,320,158
1992 4,330,709
1993 6,142,405
1994 7,737,742
1995 9,040,978
1996 13,067,553
1997 14,527,878
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QUANTEX-REGISTERED TRADEMARK-2
ITG QuantEX is the Company's order management trading system, an advanced
tool for technologically sophisticated clients transacting medium-to-large
volumes of orders. QuantEX equips clients to manage every step in the trading
process more efficiently: from decision-making to execution to tracking of trade
list status. From a dedicated Sun workstation at their desks, users can access
fully-integrated real-time and historical data and analytics, execute electronic
order routing and perform trade management functions. To date, trading systems
have generally addressed just one or two of these functions -- a situation that
has left many users with the inefficiency of multiple unrelated systems.
QuantEX is a customized, rules-based expert system that allows traders to
quantify their decision support processes. It is designed to embody each
client's trading styles and strategies, and apply them to data on hundreds of
stocks, portfolios or industry groups at once. With QuantEX, clients can flag
precisely the same kinds of moment-to-moment opportunities they would ordinarily
want to pursue -- but do it much more efficiently and rapidly.
QuantEX analyzes lists of securities based on the individual user's trading
strategy. QuantEX enables clients to have access to sophisticated ITG research
developed pre-trade, post-trade and intra-day analytical tools including
"instant" analytics built on widely-used measures. Clients also have a direct
line to the ITG Data Center which is a comprehensive historical database that
provides a variety of derived analytics based upon the raw historical data. The
Company's support specialists translate the trading criteria developed by the
user into a set of proprietary rules for trading securities, which are then
encoded into QuantEX. QuantEX applies the customer's proprietary trading rules
to a continuous flow of current market information on the list of securities
selected by the user to generate real-time decision support. A user's rules can
be based on a wide range of quantitative models or strategies, such as liquidity
measures, technical indicators, price benchmarks, tracking to specific
industries and sectors, pairs or other long or short strategies, index
arbitrage, risk measurements and liquidity parameters for trade urgency, size or
timing.
As such, QuantEX can automate the complex trade management requirements
typical of investment strategies that trade large volumes of securities through
multiple sources of liquidity. Orders can be electronically routed to multiple
markets -- not just the New York, American, and regional Stock Exchanges, but
also POSIT, the ITG Trading Desk, OTC market-makers, AZX, and selected broker-
dealers. Trades routed through QuantEX are automatically tracked and summarized.
Each order can be monitored by source of execution, by trade list, by portfolio
or globally with all other orders placed. QuantEX's built-in trade allocation
features provides a facility for automated back-office clearance and settlement.
The Company's support specialists install the system, train users and
provide ongoing support for the use of QuantEX's order routing and analysis
capabilities. Specialists are knowledgeable about portfolio management and
trading as well as the system's hardware and software. The Company's support
team works closely with each customer to develop trading strategies and rules,
explore new trading approaches, provide system integration services, and
implement system upgrades and enhancements.
Revenue generation is realized through transaction fees attached to each
trade electronically routed through QuantEX to the many destinations available
from the application. The Company does not derive royalties from the sale or
licensing of the QuantEX software.
ELECTRONIC TRADING DESK
To supplement the automated trade execution and analysis services offered by
POSIT and QuantEX, the Company also offers customers trading capabilities
through the Company's trading desk, which is staffed with more than 30 traders.
QuantEX and Platform clients can deliver electronically lists of orders
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2 QuantEX-Registered Trademark- is a registered trademark of the Company.
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to the ITG Trading Desk. As orders are executed by ITG, reports are
automatically delivered to the client's terminal. Trading desk personnel are,
thereby, able to assist customers with decision support analyses generated by
QuantEX and with the execution of trades. The Trading Desk is a full-service
agency execution group that specializes in the Company's proprietary products.
Clients give traders orders to work throughout the day as well as residual
orders that remain due to order imbalances in POSIT matches.
If a customer wishes to trade a portfolio outside a scheduled POSIT cross or
fails to submit a portfolio in time for a scheduled POSIT cross, at the
customer's request, the Company will communicate with and seek interest from
other potentially interested customers and conduct an unscheduled cross.
Unmatched or residual orders may be filled by (i) keeping orders in POSIT for
future crosses which will offer different liquidity profiles, (ii) routing
trades electronically through QuantEX to multiple markets, including primary
exchanges, regional exchanges and OTC market-makers or (iii) using the Company's
trading desk to complete trades on an agency basis. The Company has also
developed pricing mechanisms that allow customers to enter orders to cross
shares before the market opens subject to prices determined by specified
formulas, such as weighted average prices throughout the trading day, or the
day's closing prices.
ITG PLATFORM
ITG Platform, introduced in the first quarter of 1996, provides seamless
connectivity to a variety of execution destinations, such as POSIT, ITG's
Electronic Trading Desk, New York Stock Exchange and American Stock Exchange via
SuperDOT and OTC market markers. The Platform requires a standard modem but does
not require a dedicated terminal because it runs on any 486 or Pentium PC in
almost any Windows environment, while allowing access to a wide range of
execution capabilities.
To enter an order, a ticker symbol (or multiple tickers) is typed in to the
system with buy/sell side and size. A list can be loaded in by using a diskette,
or from a network or copying and pasting from an Excel-Registered Trademark-3
file. Once orders have been loaded, execution instructions can be input. The
execution sources range from POSIT, ITG Electronic Trading Desk and SuperDOT, to
OTC market makers. The Platform also allows automatic rerouting of any residual
POSIT orders. For instance, a trader may designate that any "listed orders" not
crossed in POSIT which are under a certain size be rerouted to the New York
Stock Exchange via SuperDOT. The trader may also choose to reroute the orders
back to POSIT for the rest of the day's matches, or to ITG's Electronic Trading
Desk. As the orders are executed, reports are automatically delivered back to
the Platform giving the users constant feedback on their orders. The orders are
displayed in real-time and the Platform also provides a running average price
for each order. Order status is color-coded to indicate whether the order has
been filled, partially executed, or is awaiting action.
Platform users can access historical data through a direct link with the ITG
Data Center, including a wide array of analytics such as average historical
share volumes, dollar volumes, volatility, and historical spread statistics. The
Platform also allows custom tailored execution reports to fit each user's
requirements.
As of December 31, 1997, there were 138 Platform client sites, with 229
software installations.
ISIS RESEARCH
Accessed through ITG QuantEX, ISIS encompasses an equity transaction
database, pre- and post-trade analytics, a proprietary transaction-cost model, a
framework for development of trading strategies and a set of model strategies.
Together, these tools assist clients in making the most cost-effective trading
decisions by measuring the cost impacts of alternative courses of action. With
ISIS, clients can also:
- Increase the cost-effectiveness of trading strategies.
- Construct portfolios to minimize the cost of execution.
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3 Excel is a registered trademark of the Microsoft Corporation.
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- Minimize transaction costs of trading lists by targeting positions that
are especially illiquid, difficult, or costly to trade.
- Focus resources on the most consequential transactions.
- Estimate the cost of trading on a principal versus agency basis.
- Measure the cost-effectiveness of completed trades against any benchmark.
With the release of QuantEX 3.0, users can define, store and run custom pre-
and post-trade reports, selecting from a wide variety of analytics. Analytics
can also be viewed directly on the execution page and incorporated into trading
strategies. Among the available analytics are measures of momentum, price
volatility and liquidity, including an explicit estimate of market impact.
GLOBAL POSIT
The Company is pursuing the international market in a variety of ways,
joint-venturing with strategic partners and developing specially-tailored
versions of ITG services. The Company developed a global version of POSIT, which
provides U.S. and global clients with electronic trade-matching capabilities for
international equities. Besides housing the operation of Global POSIT, the
Company's Boston office offers services to foreign investors trading in the U.S.
and worldwide clientele trading non-U.S. securities.
AUSTRALIAN POSIT
In the third quarter of 1997, the Company and Burdett, Buckeridge & Young
("BBY"), finalized a 50/50 joint venture through the creation of ITG Australia
Limited ("ITG Australia"), a new international brokerage firm that will apply
ITG's cost-saving execution and transaction research technologies to Australian
equity trading. ITG Australia is the culmination of efforts commenced in 1995
when a license to POSIT was granted to BBY, one of Australia's leading brokerage
firms. Through this joint venture the Company is pursuing U.S. business from
Australian investors and providing U.S. clients with access to the Australian
marketplace.
CANADIAN QUANTEX
The Company was party to a license agreement with RBC Dominion Securities
("RBC"), under which the Company was entitled to receive royalties for licensing
the rights to the Company's QuantEX product to RBC beginning in 1991. RBC used
the QuantEX license to develop a version of QuantEX for the Canadian markets. In
conjunction with the spin-off of VERSUS Technologies, Inc. ("VERSUS") from RBC
in 1995, the Company exchanged its licensing agreement asset with RBC for a 9%
equity interest in VERSUS. VERSUS is a Canadian technology focused trade
automation firm based in Toronto. Currently, Canadian QuantEX is the only direct
electronic access to the Canadian exchanges for U.S. and Canadian institutions.
The Company is also providing Canadian investors with access to POSIT and other
ITG services.
AZX
AZX, Inc., the operators of the Arizona Stock Exchange4 ("AZX") and the
Company announced in February 1995, that the Company's wholly-owned
broker-dealer subsidiary, ITG, had been named the executing broker for all
transactions executed on AZX. AZX is the only open screen call market for equity
trading. Several new auctions were added in 1997 bringing the total to four
daily auctions at 9:15 a.m., 10:30 a.m., 4:20 p.m. and 5:00 p.m. Eastern time.
The auctions are designed to allow institutional investors
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4 The Arizona Stock Exchange, ( "AZX") operated by AZX, Inc., is not registered
with the SEC nor is it a self-regulatory organization. Due to the low volume
of trading on AZX, the SEC granted it an exemption from exchange registration.
The AZX is subject to limited oversight by the SEC.
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and broker-dealer participants to trade anonymously at true market prices and
benefit from low transaction costs. In February 1995, ITG developed the
capability to route unmatched portions of client portfolio from POSIT into AZX's
daily auction. Since ITG is the executing broker for all AZX trades, ITG clients
have the option of obtaining one combined average price for orders crossed on
both systems (i.e., the POSIT cross is combined with the previous night's AZX
auction). The Company performs this function as a courtesy to its clients. The
Company charges its direct incremental costs to AZX.
AMERICAN DEPOSITARY RECEIPTS ("ADRS")
ITG intends to add to POSIT one or more daily crossing sessions in ADRs. The
roll out of ADR matches is planned for the last half of 1998. Initially, ITG
plans to operate a daily 8:45 a.m. pre-opening matching session. Additionally,
ITG may include ADRs in its five regularly scheduled daily matches. Eligible
issues will include issuer-sponsored and unsponsored ADR programs.
REGULATION
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. The Securities and Exchange
Commission ("SEC") is the federal agency responsible for the administration of
the federal securities laws. Regulation of broker-dealers has been primarily
delegated to self-regulatory organizations ("SROs"), principally the National
Association of Securities Dealers, Inc. (the "NASD") and national securities
exchanges. The NASD has been designated by the SEC as ITG's SRO. The SROs
conduct periodic examinations of member broker-dealers in accordance with rules
they have adopted and amended from time to time, subject to approval by the SEC.
Securities firms are also subject to regulation by state securities
administrators in those states in which they conduct business. ITG is a
registered broker-dealer in 49 states and the District of Columbia.
Broker-dealers are subject to regulations covering all aspects of the
securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of customers' funds and securities, capital
structure of securities firms, record-keeping and conduct of directors, officer
and employees. Additional legislation, changes in the interpretation or
enforcement of existing laws and rules may directly affect the mode of operation
and profitability of broker-dealers. The SEC, SROs and state securities
commissions may conduct administrative proceedings, which can result in censure,
fine, the issuance of cease-and-desist orders or the suspension or expulsion of
a broker-dealer, its officers or employees. The principal purpose of regulation
and discipline of broker-dealers is the protection of customers and the
securities markets, rather than the protection of creditors and stockholders of
broker-dealers.
ITG is required by law to belong to the Securities Investor Protection
Corporation ("SIPC"). In the event of a broker-dealer's insolvency, the SIPC
fund provides protection for customer accounts up to $500,000 per customer, with
a limitation of $100,000 on claims for cash balances.
NET CAPITAL REQUIREMENTS. As a registered broker-dealer, ITG is subject to
the SEC's Uniform Net Capital Rule ( the "Net Capital Rule"). This Net Capital
Rule, which specifies the minimum net capital requirements for registered
broker-dealers, is designed to measure the general integrity and liquidity of a
broker-dealer and requires that at least a minimum part of its assets be kept in
a relatively liquid form.
The Net Capital Rule provides that a broker-dealer doing business with the
public shall not permit its aggregate indebtedness to exceed 15 times its
adjusted net capital or, alternatively, that it not permit its adjusted net
capital to be less than 2% of its aggregate debit balances (primarily
receivables from customers and broker-dealers) computed in accordance with such
Net Capital Rule. ITG uses the latter method of calculation.
A change in the Rule, imposition of new rules or any unusually large charge
against capital could limit certain operations of ITG such as trading activities
that require the use of significant amounts of capital.
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As of December 31, 1997, ITG had net capital of $35.0 million which exceeded
minimum net capital requirements by $34.8 million. See note 9 of Notes to
Consolidated Financial Statements.
NO ACTION LETTER
In connection with the development of POSIT, Jefferies & Company, Inc.
("Jefferies & Co.") obtained a no action letter in which the staff of the
Securities and Exchange Commission (the "SEC" or "Commission") indicated that it
would take no action with respect to the fact that POSIT would be operated
without registration as an exchange. As a result, POSIT has not been registered
with the Commission as an exchange, although ITG is registered as a
broker-dealer and is subject to regulation as such. Material changes to POSIT
will require prior notice to the Commission under rule 17a-23. One of the stated
purposes of Rule 17a-23 is to provide the Commission with information necessary
to monitor and evaluate automated trade execution systems. There can be no
assurance that the Commission will not in the future seek to impose more
stringent regulatory requirements on the operation of automated trade execution
systems such as POSIT. In addition, certain of the securities exchanges have
actively sought to have more stringent regulatory requirements imposed upon
automated trade execution systems. There can be no assurance that Congress will
not enact legislation applicable to automated trade execution systems.
LICENSE AND RELATIONSHIP WITH BARRA
In 1987, Jefferies & Co. and BARRA Inc. ("BARRA") formed a joint venture for
the purpose of developing and marketing POSIT. In 1993, Jefferies & Co. assigned
all of its rights relating to the joint venture and the license agreement
(discussed below) to ITG.
The technology used to operate POSIT is licensed to ITG pursuant to a
perpetual license agreement between the Company and the joint venture. The
license agreement grants ITG the exclusive right to use certain proprietary
software necessary to the continued operation of POSIT and a non-exclusive
license to use proprietary software that operates in conjunction with POSIT. The
Company pays quarterly royalties to the joint venture to use other proprietary
software that operates in conjunction with POSIT equal to specified percentages
of the transaction fees charged by the Company on each share crossed through
POSIT. For the years ended December 31, 1997, 1996 and 1995, BARRA received
aggregate royalty payments from the joint venture of $9.8 million, $8.8 million,
and $6.0 million, respectively, under the license agreement. Under the terms of
the joint venture, the Company and BARRA are prohibited from competing directly
or indirectly with POSIT.
The license agreement permits BARRA on behalf of the joint venture to
terminate the agreement upon certain events of bankruptcy or insolvency or upon
an uncured breach by the Company of certain covenants, the performance of which
are all within the control of the Company. Although the Company does not believe
that it will experience difficulty in complying with its obligations under the
license agreement, any termination of the license agreement resulting from an
uncured default would have a material adverse effect on the Company's results of
operations.
Under the license agreement and the terms of the joint venture, BARRA
continues to provide certain support services to the Company in connection with
the operation of POSIT, including computer time, software updates and the
availability of experienced personnel. BARRA also provides support for the
development and maintenance of POSIT.
Under the terms of the joint venture, BARRA generally has the right to
approve any sale, transfer, assignment or encumbrance of the Company's interest
in the joint venture. The POSIT joint venture may earn a royalty from licensing
the POSIT technology to other businesses. The joint venture licensed to ITG and
BBY, the right to use the POSIT technology for crossing equity securities in
Australia.
In the third quarter of 1997, BARRA finalized a joint venture with Prebon
Yamane to market POSIT-FRA, the first computer-based system for crossing forward
rate agreements (FRAs). The POSIT joint
9
venture has licensed to Prebon the POSIT-JV software. POSIT-FRA will provide a
confidential electronic environment where major financial institutions can match
specific sets of FRA contracts to offset interest rate risk, a condition which
pervades in interest rate swap portfolios.
In May 1990, Global Trading and BARRA International, Ltd., an affiliate of
BARRA, formed a joint venture for the purposes of developing Global POSIT. The
joint venture granted to Global Trading the exclusive rights to use Global
POSIT. In connection with the May 1994 initial public offering (the "Offering"),
Jefferies Group, Inc. ("Jefferies Group") contributed Global Trading and its
respective rights in Global POSIT to the Company. Any net earnings will be
divided equally between the Company and BARRA International, Ltd. Under the
terms of the joint venture, the Company and BARRA International, Ltd. are
prohibited from competing directly or indirectly with Global POSIT.
COMPETITION
The automated trade execution and analysis services offered by the Company
compete with services offered by leading brokerage firms and other information
services and transaction processing firms. Many of the Company's competitors
have substantially greater financial, research and development and other
resources than the Company. The Company believes that its services compete on
the basis of cost, timeliness of execution and probability of trade completion.
Although the Company believes that POSIT, QuantEX, the Platform and the
Electronic Trading Desk services have established certain competitive
advantages, the Company's ability to maintain these advantages will require
continued investment in the development of the Company's services, additional
marketing activities and customer support services. There can be no assurance
that the Company will have sufficient resources to continue to make this
investment, that the Company's competitors will not devote significantly more
resources to competing services or that the Company will otherwise be successful
in maintaining its current competitive advantages.
The Company also competes with various national and regional securities
exchanges for trade execution services. Some of these exchanges have made
efforts to regain transaction volume lost to automated trade execution services.
The Arizona Stock Exchange and Instinet crossing systems operate during and
after market hours. There can be no assurance that these or other exchanges will
not take further steps to regain transaction volume from POSIT or to limit its
future growth.
The Company is aware of new alternatives such as a growing number of
Electronic Commercial Networks ("ECN's") like those sponsored by Bloomberg/ESI,
among others. There are future developments that may or may not compete
directly, including the NASD's limit order book and Optimark, ECN's like
Bloomberg/ESI and alternative systems like Lattice/AutEx. The Company feels that
it is well positioned to provide clients with the technology and order routing
capabilities for clients to access and potentially take advantage of these
systems via its PC Platform, QuantEX and research provided smart trading
strategies.
RESEARCH AND PRODUCT DEVELOPMENT
The Company believes that fundamental changes in the securities industry
have increased the demand for technology-based services. The Company devotes a
significant portion of its resources to the development and improvement of these
services. Important aspects of the Company's research and development effort
include enhancements of existing software, the ongoing development of new
software and services and investment in technology to enhance the Company's
efficiency. The software programs, which are incorporated into the Company's
services, are subject, in most cases, to copyright protection. Research and
development costs were $7.1 million, $6.0 million and $4.9 million for 1997,
1996 and 1995, respectively.
In connection with such research and product development and capital
expenditures to improve other aspects of its business, the Company incurs
substantial expenses that do not vary directly, at least in the short term, with
fluctuations in securities transaction volumes and revenues. In the event of a
material
10
reduction in revenues, the Company may not reduce such expenses quickly and, as
a result, the Company could experience reduced profitability or losses.
Conversely, sudden surges in transaction volumes can result in increased profit
and profit margin. To ensure that it has the capacity to process projected
increases in transaction volumes, the Company has historically made substantial
capital and operating expenditures in advance of such projected increases,
including during periods of low transaction volumes. In the event that such
growth in transaction volumes does not occur, the expenses related to such
investments could, as they have in the past, cause reduced profitability or
losses. Additionally, during recent periods of high transaction volumes and
increased revenues, the Company has also made substantial capital and operating
expenditures to enhance future growth prospects.
As of December 31, 1997, the Company employed approximately 74 personnel and
utilized the services of 2 consultants in software development, management and
implementation. The Company also works closely with BARRA on the development of
POSIT enhancements. The Company expects to continue this level of investment to
improve existing services and continue the development of new services.
The Company's operations are not subject to any known seasonal conditions.
JEFFERIES GROUP AND THE COMPANY ANNOUNCE INTENTION TO CONSIDER SEPARATING INTO
TWO INDEPENDENT COMPANIES
On March 17, 1998, Jefferies Group and the Company jointly announced that
they are considering the separation, through a spin-off and a restructuring, of
Jefferies & Co. and other Jefferies Group subsidiaries ("JEFCO") from the
Company. (See Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations).
NUMBER OF PERSONS EMPLOYED
As of December 31, 1997, the Company employed 217 personnel.
ITEM 2. PROPERTIES
The Company's principal offices are located at 380 Madison Avenue in New
York City where the Company occupies the entire 4th floor or approximately
44,704 square feet of office space. In anticipation of future expansion the
Company has leased a portion of the 5th floor (approximately 12,726 square feet
of office space). This space is currently vacant and will be sub-let with an
expected commencement date of May 1, 1998. The lease payment as compared to the
rental income will have an immaterial effect upon the Company's operating
results. The fifteen year lease term for both the fourth and fifth floors expire
in 2012.
The Company also maintains a research, development and technical support
services facility in Culver City, California where the Company occupies
approximately 20,254 square feet of office space. The California facility is
leased by the Company pursuant to a ten year lease agreement which expires in
December 2005. The Company is currently negotiating leasing an additional 20,347
square feet of office space within the same building. The lease is anticipated
to commence on August 1, 1998. The additional space will be used in connection
with future research and development projects.
In April 1995, the Company completed the build-out and occupancy of a 10,588
square feet office in Boston, Massachusetts. The site is planned to be a "hot"
backup facility for the Company's operations. The site is currently used as a
regional office for Financial Engineering Research, QuantEX support and the
Global POSIT operations. The ten year lease term for this space expires in 2005.
ITEM 3. LEGAL PROCEEDINGS
The Company is not party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter ended December 31, 1997.
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
COMMON STOCK DATA
The Company's common stock is quoted on The Nasdaq Stock Market National
Market System under the symbol: ITGI. At March 16, 1998, the Company believed
that its Common Stock was held by approximately 1,000 stockholders of record or
through nominee or street name accounts with brokers.
The range of the high and low closing sale prices for the Common Stock as
reported by Nasdaq for the last eight full quarterly periods were as follows:
MARKET PRICE
-------------------------------
THREE MONTHS ENDED HIGH LOW END
- ------------------------------------------------------------------------------- --------- --------- ---------
December 31, 1997.............................................................. 31.25 26.25 28.00
September 30, 1997............................................................. 32.00 26.31 27.25
June 30, 1997.................................................................. 26.88 17.88 26.88
March 31, 1997................................................................. 23.75 18.38 19.00
December 31, 1996.............................................................. 21.50 17.25 19.25
September 30, 1996............................................................. 18.00 12.75 17.75
June 30, 1996.................................................................. 18.25 13.00 13.50
March 31, 1996................................................................. 15.00 9.25 15.00
The Company has not paid a dividend since May 4, 1994. There are no
restrictions on the Company's present ability to pay dividends on Common Stock,
other than applicable provisions of the Delaware General Corporation Law.
ITEM 6. SELECTED FINANCIAL DATA
The selected data presented below as of and for each of the years in the
five-year period ended December 31, 1997, are derived from the consolidated
financial statements of Investment Technology Group, Inc., which financial
statements have been audited by KPMG Peat Marwick LLP, independent auditors.
Earnings per share information prior to 1997 has been retroactively restated to
conform with the Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standards (SFAS) No. 128, EARNINGS PER SHARE. Such data
should be read in connection with the consolidated financial statements
contained on pages 22 through 42.
12
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1997 1996 1995 1994* 1993
---------- ---------- --------- ---------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenues......................................... $ 137,042 $ 111,556 $ 72,381 $ 56,716 $ 49,370
Total expenses......................................... 89,782 70,555 47,493 69,106 42,944
---------- ---------- --------- ---------- ---------
Earnings (loss) before income taxes.................... 47,260 41,001 24,888 (12,390) 6,426
Income tax expense (benefit)........................... 20,343 17,666 9,983 (4,529) 3,099
---------- ---------- --------- ---------- ---------
Net earnings (loss).................................... $ 26,917 $ 23,335 $ 14,905 $ (7,861) $ 3,327
---------- ---------- --------- ---------- ---------
---------- ---------- --------- ---------- ---------
1997 1996 1995 1994 1993
---------- ---------- --------- ---------- ---------
Basic net earnings (loss) per share of common stock.... $ 1.48 $ 1.28 $ 0.81 $ (0.45)
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Diluted net earnings (loss) per share of common
stock................................................ $ 1.42 $ 1.26 $ 0.81 $ (0.45)
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Basic weighted average shares outstanding (in
millions)............................................ 18.2 18.3 18.5 17.5
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Diluted weighted average shares and common stock
equivalents outstanding (in millions)................ 18.9 18.6 18.5 17.5
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Revenues per trading day............................... $ 542 $ 439 $ 287 $ 225 $ 191
---------- ---------- --------- ---------- ---------
---------- ---------- --------- ---------- ---------
Shares executed per day (in millions).................. 27 22 15 10 9
---------- ---------- --------- ---------- ---------
---------- ---------- --------- ---------- ---------
Revenues per average number of employees............... $ 733 $ 814 $ 689 $ 675 $ 837
---------- ---------- --------- ---------- ---------
---------- ---------- --------- ---------- ---------
Average number of employees............................ 187 137 105 84 59
---------- ---------- --------- ---------- ---------
---------- ---------- --------- ---------- ---------
Number of customers:
POSIT................................................ 461 445 393 303 205
QuantEX and Platform................................. 188 91 81 58 43
---------- ---------- --------- ---------- ---------
649 536 474 361 248
---------- ---------- --------- ---------- ---------
---------- ---------- --------- ---------- ---------
Return on average stockholders' equity................. 33.9% 45.5% 39.3% (35.0)%
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Book value per share................................... $ 5.15 $ 3.68 $ 2.47 $ 1.72
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Tangible book value per share.......................... $ 5.04 $ 3.54 $ 2.27 $ 1.52
---------- ---------- --------- ----------
---------- ---------- --------- ----------
Price to earnings ratio using diluted net earnings per
share of common stock................................ 19.7 15.3 11.4 N/A
---------- ---------- --------- ----------
---------- ---------- --------- ----------
- ------------------------------
* In connection with the Company's initial public offering (the "Offering") in
May 1994, certain management employment agreements, the performance share
plans (consisting of a 12.7% phantom equity interest in ITG and an annual
profits bonus component) and non-compensatory ITG stock options (on 10% of
the outstanding shares of ITG common stock) were terminated as of May 1,
1994 in exchange for $31.1 million in cash, a portion of which was used to
purchase Jefferies Group common stock. The Company, prior to December 31,
1993, had expensed and paid to Jefferies Group an additional $9.4 million
related to the above-mentioned Performance Share Plans. Immediately prior to
the consummation of the Offering, Jefferies Group transferred its $9.4
million liability and an equivalent amount of cash to the Company to be
applied by the Company as part of the termination of the Performance Share
Plans. The total liability in connection with the above-mentioned plans was
$40.5 million. Of the non- recurring expense of $31.1 million, approximately
$900,000 was recorded in Performance Share Plans expense in the first two
quarters of 1994 under the terms of the prior agreement. The total
Performance Share Plans expense recorded for the first two quarters of 1994
was $1.5 million. The remaining $600,000 of such expense was for the annual
profits bonus component of the Performance Share Plans for January 1, 1994
through May 1, 1994 (the termination date of the above-mentioned plans).
Only the future annual profits bonus component (post Offering) of the
above-mentioned plans was determined to be a component of the $40.5 million
liability. The annual profits bonus component was earned during the period
January 1, 1994 through May 1, 1994 by the payees regardless of the
Offering. The remaining liability of $30.2 million was recorded as
termination of plans expense in the second quarter of 1994.
13
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION DATA:
(DOLLARS IN THOUSANDS)
DECEMBER 31,
------------------------------------------------------
1997 1996 1995 1994 1993
---------- --------- --------- --------- ---------
Total assets.............................................. $ 113,641 $ 82,798 $ 55,318 $ 38,354 $ 23,496
Total stockholders' equity................................ $ 93,763 $ 67,093 $ 45,479 $ 31,893 $ 13,844
The following graph represents the number of shares ITG executed as a
percentage of the market volume in the U.S. market.5
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
ITG VOLUME AS A PERCENTAGE OF MARKET VOLUME
Year % of Market
1993 1.53%
1994 1.70%
1995 1.90%
1996 2.26%
1997 2.24%
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
1997 1996 CHANGE % CHANGE
---------- --------- --------- -----------
(DOLLARS IN THOUSANDS, EXCEPT AS NOTED)
Total Assets........................................................ $ 113,641 $ 82,798 $ 30,843 37.3%
Total Liabilities................................................... $ 19,878 $ 15,705 $ 4,173 26.6%
The increase in total assets is primarily due to an increase in premises and
equipment, cash and cash equivalents and other assets. Current assets made up
approximately 65% of total assets. The primary increase in premises and
equipment related to leasehold improvements constructed at the new corporate
headquarters at 380 Madison Avenue, while the cash and cash equivalents
increased as a function of the proceeds from operations. The Company's other
assets increased primarily as a result of new joint venture interests made
during 1997.
The increase in total liabilities is mostly due to an increase in accounts
payable and accrued expenses, which consisted primarily of soft dollar
liabilities of $3.1 million and rent accruals of $2.3 million.
- ------------------------
5 The percentages on the graph are total ITG shares executed divided by the
"market" volume. Total ITG shares executed includes total POSIT shares,
QuantEX shares and shares executed by the Electronic Trading Desk. Market
volume includes shares executed by and as provided by the New York Stock
Exchange and the National Association of Securities Dealers Automated
Quotation System. Market volume excludes ITG shares executed.
14
RESULTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT AS NOTED)
COMPARISON OF 1997 WITH 1996
1997 1996 CHANGE % CHANGE
--------- --------- ----------- -----------
Revenues............................................................. $ 137.0 $ 111.6 $ 25.4 22.8%
Number of Trading Days............................................... 253 254 (1) (0.4)%
Revenues per Trading Day (Dollars in thousands)...................... $ 542 $ 439 $ 103 23.5%
Increased revenues were attributed to a growing use of POSIT, QuantEX and
the Company's other electronic trading desk services. For the year ended
December 31, 1997, POSIT revenues were approximately 12% or $8.2 million above
the comparable period for 1996, while QuantEX revenues were approximately 23% or
$5.6 million above the comparable period for 1996. For the year ended December
31, 1997, other electronic trading desk services were 67% or $11.9 million above
the comparable period for 1996.
1997 1996 CHANGE % CHANGE
--------- --------- ----------- -----------
Compensation and employee benefits expense........................... $ 30.5 $ 25.0 $ 5.5 22.0%
Number of employees at period end.................................... 217 157 60 38.2%
Revenue per employee at period end (Dollars in thousands)............ $ 631 $ 711 $ (80) (11.3)%
Compensation and employee benefits expense per employee (Dollars in
thousands)......................................................... $ 141 $ 159 $ (18 ) (11.3 )%
The increase in compensation and employee benefits expense is due to an
increase in the number of employees offset by an increase in capitalized
software. Capitalized software development costs increased approximately $4.4
million over the comparable year ended December 31, 1996 primarily due to
additional projects and an increase in staff engaged in software development.
1997 1996 CHANGE % CHANGE
--------- --------- ----------- -----------
Transaction processing expense....................................... $ 21.4 $ 15.7 $ 5.7 36.3%
Transaction processing expenses as a percentage of revenues.......... 15.6% 14.1% 1.5pts 10.6%
The increase is primarily due to the expense associated with a higher volume
of transactions and shares in the year ended December 31, 1997. The increase as
a percentage of revenues increased 1.5 points primarily from a shift in the
business mix towards QuantEX and electronic trading desk services. Those
products have slightly lower margins than POSIT due to charges for floor
brokerage fees which are not incurred with the POSIT business.
1997 1996 CHANGE % CHANGE
--------- --------- --------- -----------
Software royalties expense........................................... $ 9.8 $ 8.8 $ 1.0 11.4%
Software royalties expenses as a percentage of POSIT revenues........ 13.0% 13.1% (0.1 pts (0.8)%
Software royalties are a fixed percentage of POSIT revenue. The increase is
due to higher revenue associated with POSIT.
1997 1996 CHANGE % CHANGE
--------- --------- ----------- -----------
Occupancy and equipment.............................................. $ 9.2 $ 6.1 $ 3.1 50.8%
The increase is due primarily to the Company's relocation of its corporate
headquarters from 900 Third Avenue to 380 Madison Avenue in mid-June. Rent
expense increased accordingly as the rental square footage increased by more
than 100%. The Company also had to accelerate the write-off of the unamortized
leasehold improvements from the 900 Third Avenue location. In addition,
depreciation increased approximately $1.7 million as a result of purchases of
additional equipment associated with both the move and increased headcount.
15
1997 1996 CHANGE % CHANGE
--------- --------- ----------- -----------
Consulting expense................................................... $ 2.0 $ 2.5 $ (0.5) (20.0)%
Consulting is primarily for functions which the Company currently believes
are advantageous to out-source. The decrease is due primarily to the Company
undertaking nonrecurring special projects related to contingency planning and
systems' security.
1997 1996 CHANGE % CHANGE
--------- --------- ----------- -----------
Telecommunications and data processing services expense.............. $ 6.6 $ 4.8 $ 1.8 37.5%
The increase is due primarily to communications costs incurred in 1995 and
1996 relating to the POSIT Joint Venture, which were presented for payment in
the second quarter of 1997. In addition, duplicate services were required for
900 Third Avenue and 380 Madison Avenue location in connection with the move of
the Company's headquarters.
1997 1996 CHANGE % CHANGE
--------- --------- ----------- -----------
Other general and administrative expense............................. $ 10.2 $ 7.6 $ 2.6 34.2%
The increase is largely attributable to the increase in headcount of 60
employees. Related costs, primarily services provided by Jefferies & Co.,
increased by approximately $374,000. Travel and entertainment costs increased by
approximately $1.1 million primarily from an increased effort to promote the
Company's products. Lastly, legal fees increased by approximately $510,000 as a
result of exploring several strategic initiatives and the costs associated with
outsourcing legal services pending the hiring of a new in-house general counsel.
1997 1996 CHANGE % CHANGE
--------- --------- ----------- -----------
Income tax expense................................................... $ 20.3 $ 17.7 $ 2.6 14.7%
The increase is primarily due to an increase in pretax earnings. The
effective tax rate in 1997 and 1996 was 43.0% and 43.1%, respectively.
COMPARISON OF 1996 WITH 1995
1996 1995 CHANGE % CHANGE
--------- --------- ----------- -----------
Revenues............................................................. $ 111.6 $ 72.4 $ 39.2 54.1%
Number of Trading Days............................................... 254 252 2 0.8%
Revenues per Trading Day (Dollars in thousands)...................... $ 439 $ 287 $ 152 53.0%
Increased revenues is due to a growing use of POSIT, QuantEX and the
Company's other electronic trading desk services. For the year ended December
31, 1996, POSIT revenues were approximately 49% or $22.1 million above the
comparable period for 1995, while QuantEX revenues were approximately 57% or
$9.0 million above the comparable period for 1995. For the year ended December
31, 1996, other electronic trading desk services were 83% or $8.1 million above
the comparable period for 1995.
The Company currently reports revenues net of soft dollars collected. The
Company previously reported soft dollars on a "gross" basis. Soft dollars
collected were reported as revenues and, in an equal and offsetting amount, as
soft dollar expense. The historical financial statements have been reclassified
to reflect revenue net of soft dollars collected. Soft dollars are those
incremental amounts of commission dollars collected in addition to the Company's
charge for executions. These incremental amounts are used to satisfy customers'
third-party research services.
16
1996 1995 CHANGE % CHANGE
--------- --------- ----------- -----------
Compensation and employee benefits expense........................... $ 25.0 $ 16.4 $ 8.6 52.4%
Number of employees at period end.................................... 157 118 39 33.1%
Revenue per employee at period end (Dollars in thousands)............ $ 711 $ 614 $ 97 15.8%
Compensation and employee benefits expense per employee (Dollars in
thousands)......................................................... $ 159 $ 139 $ 20 14.4%
The increase in compensation and employee benefits expense is due primarily
to an increase in the number of employees and an increase in profitability based
compensation.
1996 1995 CHANGE % CHANGE
--------- --------- --------- -----------
Transaction processing expense....................................... $ 15.7 $ 10.9 $ 4.8 44.0%
Transaction processing expenses as a percentage of revenues.......... 14.1% 15.1% (1.0 pts (6.6)%
The increase is primarily due to the expense associated with a higher volume
of transactions in 1996. In addition, QuantEX is a larger portion of total
volume, causing higher execution charges. The Company received a $621,000
adjustment in the fourth quarter of 1996 against charges incurred in the first
three quarters of 1996 for exchange-related execution fees.
1996 1995 CHANGE % CHANGE
--------- --------- --------- -----------
Software royalties expense........................................... $ 8.8 $ 6.0 $ 2.8 46.7%
Software royalties expenses as a percentage of POSIT revenues........ 13.1% 13.3% (0.2 pts (1.5)%
The increase is due to higher revenue associated with POSIT.
1996 1995 CHANGE % CHANGE
--------- --------- ----------- -----------
Occupancy and equipment.............................................. $ 6.1 $ 3.6 $ 2.5 69.4%
The increase is due primarily to depreciation of premises and equipment
acquired since the beginning of 1996 and accelerated depreciation of leasehold
improvements and furniture related to the relocation of the New York office
scheduled to occur in the second quarter of 1997.
1996 1995 CHANGE % CHANGE
--------- --------- ----------- -----------
Consulting expense................................................... $ 2.5 $ 1.7 $ 0.8 47.1%
Consulting is primarily for functions which the Company currently believes
are advantageous to out-source. The increase is due primarily to the Company
undertaking special projects related to contingency planning and systems'
security.
1996 1995 CHANGE % CHANGE
--------- --------- ----------- -----------
Telecommunications and data processing services expense.............. $ 4.8 $ 2.9 $ 1.9 65.5%
The increase is due primarily to an increase in quotation services and
communications charges associated with the increased number of QuantEX
installations. In addition, an increased level of activity in the existing
QuantEX business raised the semi-variable component of the quotation services
and communications charges.
17
1996 1995 CHANGE % CHANGE
--------- --------- ----------- -----------
Other general and administrative expense............................. $ 7.6 $ 6.1 $ 1.5 24.6%
The increase is largely due to an increase in amortization of capitalized
software and allowances for general legal and bad debt expenses.
1996 1995 CHANGE % CHANGE
--------- --------- ----------- -----------
Income tax expense................................................... $ 17.7 $ 10.0 $ 7.7 77.0%
The increase is primarily due to an increase in pretax earnings. The
effective tax rate in 1996 and 1995 was 43.1% and 40.1%, respectively. Income
tax expense in 1995 was favorably impacted by a lower tax rate resulting from
the recognition of research and development tax credits attributable to prior
periods.
DEPENDENCE ON MAJOR CUSTOMERS
During 1997, revenue received by the Company from its 10 largest customers
accounted for approximately 34.5% of the Company's total revenue while revenue
received from the three largest customers accounted for 8.8%, 5.9% and 3.4% of
total revenue. During 1996, revenue received by the Company from its 10 largest
customers accounted for approximately 39.6% of the company's total revenue while
revenue received from the three largest customers accounted for 9.3%, 6.8%, and
5.6% of total revenue. Customers may discontinue use of the Company's services
at any time. The loss of any significant customers could have a material adverse
effect on the Company's results of operations. In addition, the loss of
significant POSIT customers could result in lower share volumes of securities
offered through POSIT, which may adversely affect the liquidity of the system.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its business through cash flow from
operations, equity investments made by Jefferies Group and, to a lesser extent,
through operating lease agreements with Jefferies Group for premises and
equipment. Since November 1994, the Company has purchased its own equipment. The
Company's liquidity and capital resource requirements are the result of the
funding of working capital needs, primarily consisting of compensation, benefits
and transaction processing fees and software royalty fees. Historically, all
working capital requirements have been met by cash from operations and
subordinated loans and equity investments made by Jefferies Group.
In May 1994, the Company and Jefferies Group entered into an Intercompany
Borrowing Agreement which provides for aggregate borrowings under the facility
of up to $15.0 million. Amounts borrowed under the facility are not restricted
as to their use by the Company. The facility bears interest at a floating rate
equal to 1.75% above the average one month London Interbank Offered Rate.
Jefferies Group is not committed to advance funds, and the Company is not
obligated to borrow funds, under the facility. The Company may borrow funds from
other parties. The facility may be terminated by Jefferies Group in the event of
an uncured default by the Company.
The Company believes that its cash flow from operations and its existing
cash balances will be sufficient to meet its cash requirements. The Company
generally invests its excess cash in money market funds, municipal securities
and other short-term investments. At December 31, 1997 and 1996, such cash
equivalents amounted to $49.3 million and $43.9 million, respectively. Cash
equivalents are part of the cash management activities of the Company and
generally mature within 90 days. Additionally, the trade receivable from
affiliate of $2.9 million is due within 30 days.
The Company also invests a portion of its excess cash balances in cash
enhanced strategies, which the Company believes should yield higher returns
without any significant effect on risk. As of December 31, 1997, the Company had
an investment in an arbitrage fund. The fund's strategy is to invest in a hedged
portfolio of convertible securities. This strategy seeks an enhanced level of
capital appreciation by focusing
18
on current income and capital appreciation. At December 31, 1997 and 1996,
investment in the limited partnership was $10.9 million and $5.2 million,
respectively.
REPORTING COMPREHENSIVE INCOME
In June of 1997, the Financial Accounting Standards Board issued SFAS No.
130 "Reporting Comprehensive Income". This SFAS requires that all items that are
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. This SFAS requires that an
enterprise (1) classify items of other comprehensive income by their nature in a
financial statements and (2) display the accumulated balance of other
comprehensive income separately from retained earnings and additional
paid-in-capital in the equity section of a statement of financial condition. No
earnings per share disclosure of the effect comprehensive income is required
under this SFAS.
The SFAS is effective for fiscal years beginning after December 15, 1997,
although earlier application is permitted. At December 31, 1997, the Company did
not have items of Comprehensive Income.
EFFECTS OF INFLATION
The Company does not believe that the relatively moderate levels of
inflation which have been experienced in North America in recent years have had
a significant effect on its revenue or its profitability. However, high
inflation may lead to higher interest rates which might cause money to move from
equity funds to bond funds or money market funds.
THE YEAR 2000 ISSUE
OVERVIEW
Computer systems and software products were originally designed to accept
only two digit entries in the data code field. As a result, certain computer
systems and software packages will not be able to interpret dates beyond
December 31, 1999 and thus will interpret dates beginning January 1, 2000 to
represent January 1, 1900. This could potentially result in computer failure or
miscalculations, causing operating disruptions, including an inability to
process transactions, send invoices or engage in normal business operations.
Therefore, companies may have to upgrade or replace computer and software
systems in order to comply with the "Year 2000" requirements.
ITG'S STRATEGY
The Company is well aware of and is actively addressing the Year 2000 issue
and the potential problems that can arise in any computer and software system.
Planning and evaluation work began in 1997 including the identification of those
systems affected. The Company has engaged a consultant to provide advice on Year
2000 issues and to assist the Company in its efforts to meet industry standards.
The Company also is working with Jefferies & Co. as a result of the Company's
client/vendor relationship regarding clearing services.
The Company has isolated its efforts into three major areas:
i) VENDORS
ii) COMPANY PROPRIETARY PRODUCTS
iii) CLIENTS
VENDORS--The Company's ability to successfully meet the Year 2000 challenge
is also dependent on vendors. The Company has created a vendor database and
expects to send letters to all vendors by the end
19
of the first quarter of 1998 to determine their plans for successfully
completing this project. The major vendors have already been contacted.
COMPANY PROPRIETARY PRODUCTS--The Company is evaluating all trading systems
and intends to examine all code. The evaluation and examinations are scheduled
to be completed by the end of the first half of 1998. Testing is scheduled to be
completed by the end of 1998. The Company plans to release Year 2000 compliant
versions of its products by the beginning of 1999.
CLIENTS--The Company has begun to contact clients in an effort to keep them
informed of the Company's Year 2000 Plans and progress. In 1999, the Company
plans to provide testing opportunities for all clients.
RISKS
The Company currently expects to implement the necessary changes to ensure
that its internal operations are Year 2000 compliant prior to December 31, 1999.
The Company also does not believe that the costs incurred to ready its systems
for the Year 2000 will have a material effect on its financial condition. Total
costs for the whole project are estimated to be between $2.5 and $3.0 million,
which includes the cost of personnel, consultants and software and hardware
costs.
The Year 2000 issue however, can affect all businesses that use computers.
Accordingly, if the Year 2000 issue adversely affects the Company's customers,
this in turn could have a material adverse effect on the Company's trading
revenues and collections. Should the Company, third party information vendors,
other third party electronic vendors, or the Company's customers fail to
adequately address this issue, the Company's business, financial condition and
results of operations could be materially adversely affected.
JEFFERIES GROUP AND THE COMPANY ANNOUNCE INTENTION TO CONSIDER SEPARATING INTO
TWO INDEPENDENT COMPANIES
On March 17, 1998, Jefferies Group and the Company jointly announced that
they are considering the separation of Jefferies & Co. and other Jefferies Group
subsidiaries from the Company through a spin-off.
If the separation is completed, Jefferies Group shareholders will own 100%
of JEFCO and approximately 82.3% of the Company. The public Company shareholders
will continue to own 17.7% of the Company. (The Company percentage ownership
interests could change slightly as a result of the Company's stock repurchases
or issuances before the transaction closing date.) The spin-off will be
accomplished by a tax-free distribution of 100% of the shares of a new company,
JEFCO, to Jefferies Group shareholders. Jefferies Group's 15 million shares of
the Company would then be its only asset. The spin-off would be followed
immediately by a tax-free merger of Jefferies Group and the Company, with the
Company's public shareholders receiving shares of Jefferies Group. Jefferies
Group would then be renamed Investment Technology Group, Inc.
The spin-off and restructuring transactions are contingent on a number of
factors, including receipt of all Board of Directors and shareholder approvals
of Jefferies Group and the Company, receipt of a favorable tax ruling from the
Internal Revenue service and other required regulatory and contractual
approvals.
20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL REPORTS SECTION
PAGES
-----
Management's Responsibility for Compliance and Financial Reporting......................................... 22
Independent Auditor's Report............................................................................... 23
Consolidated Statement of Operations....................................................................... 24
Consolidated Statement of Financial Condition.............................................................. 25
Consolidated Statement of Changes in Stockholders' Equity.................................................. 26
Consolidated Statement of Cash Flows....................................................................... 27
Notes to Consolidated Financial Statements................................................................. 28
21
MANAGEMENT'S RESPONSIBILITY FOR COMPLIANCE AND FINANCIAL REPORTING
TO THE SHAREHOLDERS:
The management of Investment Technology Group, Inc. (the "Company") is
responsible for the integrity and objectivity of the financial information
presented in this Annual Report. Financial information appearing throughout the
Annual Report is consistent with that in the accompanying financial statements.
The financial statements have been prepared by management of the Company in
conformity with generally accepted accounting principles in the United States
and comply, in all material respects, with guidelines of the International
Accounting Standards Committee. The financial statements reflect, where
applicable, management's best judgments and estimates.
The management of the Company has established and maintains an internal
control structure and monitors that structure for compliance with established
policies and procedures. The objectives of an internal control structure are to
provide reasonable, but not absolute, assurance as to the integrity and
reliability of the financial statements, the protection of assets from
unauthorized use or disposition, and that transactions are executed in
accordance with management's authorization.
Management also recognizes its responsibility to foster and maintain a
strong ethical environment within the Company to ensure that its business
affairs are conducted with integrity and in accordance with high standards of
personal and corporate conduct. This responsibility is characterized and
reflected in the Company's Statement of Policy on Standards of Employee Conduct,
which is distributed to all employees of the Company. As part of the monitoring
system, the Company maintains Corporate Compliance Personnel, who have oversight
responsibilities for administering and coordinating the application of these
standards of conduct. Senior legal and compliance personnel have been directed
to report compliance concerns directly to the President of the Company. Ongoing
oversight of compliance activities is the responsibility of the Company's
President.
The Company's Board of Directors appoints an Audit Committee composed solely
of outside directors. The function of the Audit Committee is to oversee the
accounting, reporting, audit and internal control policies and procedures
established by the Company's management. The Committee meets regularly with
management and the internal and independent auditors. The auditors have free
access to the Audit Committee without the presence of management. The Committee
reports regularly to the Board of Directors on its activities, and such other
matters as it deems necessary. Ernst & Young LLP, independent auditors, performs
an internal audit program for the Company and reports directly to the Audit
Committee on matters of internal control.
The Company's annual consolidated financial statements have been audited by
KPMG Peat Marwick LLP, independent auditors, who were appointed by the Board of
Directors. Management has made available to KPMG Peat Marwick LLP all of the
Company's financial records and related data, as well as the minutes of
directors' meetings.
Furthermore, management believes that all its representations to KPMG Peat
Marwick LLP are valid and appropriate. In addition, KPMG Peat Marwick LLP, in
determining the nature and extent of their auditing procedures, considered the
Company's accounting procedures and policies and the effectiveness of the
related internal control structure.
Management believes that, as of December 31, 1997, the Company's internal
control structure was adequate to accomplish the objectives discussed herein.
Raymond L. Killian, Jr. Scott P. Mason John R. MacDonald
Chairman President Senior Vice President and
Chief Executive Officer Chief Financial Officer
22
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Investment Technology Group, Inc.:
We have audited the accompanying consolidated statement of financial
condition of Investment Technology Group, Inc. and subsidiaries as of December
31, 1997 and 1996 and the related consolidated statements of operations, changes
in stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Investment
Technology Group, Inc. and subsidiaries as of December 31, 1997 and 1996 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997 in conformity with generally accepted
accounting principles in the United States and International Accounting
Standards.
KPMG PEAT MARWICK LLP
Los Angeles, California
January 20, 1998, except as to note 16
to the Consolidated Financial Statements,
which is as of March 17, 1998.
23
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
Revenues..................................................................... $ 137,042 $ 111,556 $ 72,381
Expenses:
Compensation and employee benefits......................................... 30,479 25,047 16,404
Transaction processing..................................................... 21,413 15,737 10,861
Software royalties......................................................... 9,848 8,798 5,985
Occupancy and equipment.................................................... 9,204 6,111 3,606
Consulting................................................................. 2,017 2,492 1,699
Telecommunications and data processing services............................ 6,605 4,789 2,879
Other general and administrative........................................... 10,216 7,581 6,059
---------- ---------- ----------
Total Expenses........................................................... 89,782 70,555 47,493
Earnings before income tax expense......................................... 47,260 41,001 24,888
Income tax expense........................................................... 20,343 17,666 9,983
---------- ---------- ----------
Net earnings................................................................. $ 26,917 $ 23,335 $ 14,905
---------- ---------- ----------
---------- ---------- ----------
Basic net earnings per share of common stock................................. $ 1.48 $ 1.28 $ 0.81
---------- ---------- ----------
---------- ---------- ----------
Diluted net earnings per share of common stock............................... $ 1.42 $ 1.26 $ 0.81
---------- ---------- ----------
---------- ---------- ----------
Basic weighted average shares outstanding.................................... 18,178 18,284 18,473
---------- ---------- ----------
---------- ---------- ----------
Diluted weighted average shares and common stock equivalents outstanding..... 18,940 18,586 18,473
---------- ---------- ----------
---------- ---------- ----------
The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
24
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31,
---------------------
1997 1996
---------- ---------
ASSETS
Cash and cash equivalents.................................................................. $ 51,263 $ 43,955
Securities owned........................................................................... 358 4,808
Investment in limited partnership (at market; cost $10,000 and $5,000)..................... 10,935 5,193
Trade receivables, net of allowance for doubtful accounts of $308 and $309................. 7,071 4,806
Trade receivables from affiliate........................................................... 2,931 2,812
Due from affiliates........................................................................ 1,365 1,459
Premises and equipment..................................................................... 19,506 8,442
Capitalized software....................................................................... 5,973 3,028
Other assets............................................................................... 9,857 3,467
Goodwill................................................................................... 1,922 2,471
Deferred tax asset......................................................................... 2,460 2,357
---------- ---------
$ 113,641 $ 82,798
---------- ---------
---------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses...................................................... $ 12,725 $ 8,648
Software royalties payable................................................................. 2,663 2,274
Securities sold, not yet purchased......................................................... 3 1,226
Due to affiliates.......................................................................... 2,999 1,922
Income taxes payable to affiliate.......................................................... 1,488 1,635
---------- ---------
19,878 15,705
---------- ---------
Lease commitments (note 13)
STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.01; shares authorized:
5,000,000; shares issued: none........................................................... -- --
Common stock, par value $0.01; shares authorized:
30,000,000; shares issued: 18,818,468 in 1997 and 18,700,000 in 1996..................... 188 187
Additional paid-in capital................................................................. 38,554 36,055
Retained earnings.......................................................................... 61,531 34,614
Common stock held in treasury, at cost; shares:
597,500 in 1997 and 445,200 in 1996...................................................... (6,510) (3,763)
---------- ---------
Total stockholders' equity............................................................. 93,763 67,093
---------- ---------
$ 113,641 $ 82,798
---------- ---------
---------- ---------
The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
25
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
RETAINED COMMON
ADDITIONAL EARNINGS STOCK TOTAL
PREFERRED COMMON PAID-IN (ACCUMULATED HELD IN STOCKHOLDERS'
STOCK STOCK CAPITAL DEFICIT) TREASURY EQUITY
----------- ----------- ----------- ------------ --------- ------------
Balance at December 31, 1994............ $ -- $ 187 $ 36,055 $ (3,626) $ (723) $ 31,893
Net earnings............................ -- -- -- 14,905 -- 14,905
Purchase of common stock for treasury
(184,500 shares)...................... -- -- -- -- (1,319) (1,319)
----- ----- ----------- ------------ --------- ------------
Balance at December 31, 1995............ -- 187 36,055 11,279 (2,042) 45,479
Net earnings............................ -- -- -- 23,335 -- 23,335
Purchase of common stock for treasury
(135,000 shares)...................... -- -- -- -- (1,721) (1,721)
----- ----- ----------- ------------ --------- ------------
Balance at December 31, 1996............ -- 187 36,055 34,614 (3,763) 67,093
Net earnings............................ -- -- -- 26,917 -- 26,917
Issuance of restricted stock (24,219
shares)............................... -- -- 630 -- -- 630
Issuance of common stock in connection
with the employee stock option plan
(92,249 shares)....................... -- 1 1,869 -- -- 1,870
Purchase of common stock for treasury
(152,300 shares)...................... -- -- -- -- (2,747) (2,747)
----- ----- ----------- ------------ --------- ------------
Balance at December 31, 1997............ $ -- $ 188 $ 38,554 $ 61,531 $ (6,510) $ 93,763
----- ----- ----------- ------------ --------- ------------
----- ----- ----------- ------------ --------- ------------
The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
26
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
Cash flows from operating activities:
Net earnings.................................................................. $ 26,917 $ 23,335 $ 14,905
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Deferred income tax (benefit) expense....................................... (103) (2,027) 2,663
Depreciation and amortization............................................... 6,642 3,957 2,248
Unrealized gain on investment in limited partnership........................ (742) (193) --
Undistributed loss (income) of affiliates................................... 476 (267) (441)
Provision for doubtful accounts receivable.................................. 84 352 57
Decrease (increase) in operating assets:
Securities owned............................................................ 4,450 3,701 (8,509)
Trade receivables........................................................... (2,349) (2,676) (1,704)
Trade receivables from affiliate............................................ (119) 4,953 (2,832)
Income taxes receivable from affiliate...................................... -- -- 1,511
Due from affiliates......................................................... 94 3,541 (4,501)
Other assets................................................................ (6,967) (1,977) (609)
Increase (decrease) in operating liabilities:
Accounts payable and accrued expenses....................................... 4,177 4,956 702
Software royalties payable.................................................. 389 480 723
Termination of plans expense payable........................................ - - (758)
Securities sold, not yet purchased.......................................... (1,223) 1,226 -
Due to affiliates........................................................... 1,077 (321) 813
Income taxes payable to affiliate........................................... (147) 945 690
---------- ---------- ----------
Net cash provided by operating activities................................. 32,656 39,985 4,958
---------- ---------- ----------
Cash flows from financing activities:
Purchase of common stock for treasury....................................... (2,747) (1,721) (1,319)
Issuance of common stock.................................................... 2,500 -- --
---------- ---------- ----------
Net cash used in financing activities..................................... (247) (1,721) (1,319)
---------- ---------- ----------
Cash flows from investing activities:
Purchase of premises and equipment.......................................... (15,679) (5,624) (5,003)
Investment in limited partnership........................................... (5,000) (5,000) --
Capitalization of software development costs................................ (4,422) (1,645) (2,122)
---------- ---------- ----------
Net cash used in investing activities..................................... (25,101) (12,269) (7,125)
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents...................... 7,308 25,995 (3,486)
Cash and cash equivalents--beginning of year.................................. 43,955 17,960 21,446
---------- ---------- ----------
Cash and cash equivalents--end of year........................................ $ 51,263 $ 43,955 $ 17,960
---------- ---------- ----------
---------- ---------- ----------
Supplemental cash flow information:
Interest paid............................................................... $ 146 $ 223 $ 53
---------- ---------- ----------
---------- ---------- ----------
Income taxes paid to affiliate.............................................. $ 19,947 $ 18,798 $ 5,072
---------- ---------- ----------
---------- ---------- ----------
The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The Consolidated Financial Statements include the accounts of Investment
Technology Group, Inc. and its wholly-owned subsidiaries (collectively, the
"Company"), principally ITG Inc. ("ITG"), a Delaware corporation, registered as
a broker-dealer in securities under the Securities Exchange Act of 1934, ITG
Global Trading, Inc. ("Global Trading") which is a 50% partner in the Global
POSIT joint venture ITG Australia PTY Limited, which is a 50% partner in ITG
Pacific holdings, and ITG Ventures Inc. Jefferies Group, Inc. ("Jefferies
Group") owned over 80% of the Company's common stock at December 31, 1997.
All material intercompany balances and transactions have been eliminated in
consolidation. The consolidated financial statements reflect all adjustments
which are, in the opinion of management, necessary for the fair statement of
results.
BUSINESS SEGMENT
Through its wholly-owned, broker/dealer subsidiary, ITG, the Company, is a
leading provider of technology-based equity trading services and transaction
research to institutional investors and brokers. ITG services help clients to
access liquidity, execute trades more efficiently and make better trading
decisions.
GOODWILL
In May 1991, Jefferies Group acquired Integrated Analytics Corporation
("IAC") and contributed its business to ITG in 1992. IAC's principal product,
MarketMind, was used to develop the Company's QuantEX product. Goodwill, which
represents the excess of purchase price for IAC over the fair value of the IAC
net assets acquired, is amortized on a straight-line basis over ten years. The
Company assesses the recoverability of this intangible asset by determining
whether the amortization of the goodwill balance over its remaining life can be
recovered through undiscounted future operating cash flows of the acquired
operation. At December 31, 1997 and 1996, goodwill amounted to $1.9 million and
$2.5 million, net of accumulated amortization of $3.4 million and $2.8 million,
respectively.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost and are depreciated using the
straight-line method over the estimated useful lives of the assets (generally
three to five years). Leasehold improvements are amortized using the
straight-line method over the lesser of the estimated useful lives of the
related assets or the non cancelable lease term.
REVENUES
Revenues primarily consist of commission revenues. TRADE RECEIVABLE FROM
AFFILIATE consists of commissions receivable. Transactions in securities,
commission revenues and related expenses are recorded on a trade-date basis.
EXPENSES
COMPENSATION AND EMPLOYEE BENEFITS include base salaries, bonuses,
employment agency fees, part-time employees, commissions paid to Jefferies & Co.
employees (note 7), capitalized software (note 3) and fringe benefits, including
employer contributions for medical insurance, life insurance, retirement plans
and payroll taxes. TRANSACTION PROCESSING consists of floor brokerage and
clearing fees. SOFTWARE ROYALTIES are payments to BARRA, Inc., the Company's
joint venture partner in POSIT. Royalty payments are
28
calculated at an effective rate of 13% of adjusted POSIT revenues. The royalty
payments related to Global Trading are calculated at an effective rate of 50% of
pretax earnings. OCCUPANCY AND EQUIPMENT includes rent, depreciation,
amortization of leasehold improvements, maintenance, utilities, occupancy taxes
and property insurance. CONSULTING is for equity research, product development
and other activities which the Company believes it is advantageous to
out-source. TELECOMMUNICATIONS AND DATA PROCESSING services include costs for
computer hardware, office automation and workstations, data center equipment,
market data services and voice, data, telex and network communications. OTHER
GENERAL AND ADMINISTRATIVE includes goodwill amortization, legal, audit, tax and
promotional expenses.
INCOME TAXES
The Company is a member of the Jefferies affiliated group ("Group") for
purposes of filing a Federal income tax return (i.e., Jefferies Group owns more
than 80% of the Company). The Company's tax liability is determined on a
"separate return" basis. That is, the Company is required to pay to Jefferies
Group its proportionate share of the consolidated tax liability plus any excess
of its "separate" tax liability (assuming a separate tax return were to be filed
by the Company) over its proportionate amount of the consolidated Group tax
liability. Alternatively, Jefferies Group is required to pay the Company an
"additional amount" to the extent the consolidated tax liability of the Group is
decreased by reason of inclusion of the Company in the Group.
Deferred tax assets and liabilities reflect the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
reverse. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Past effects of such changes in the rates were not material to the combined
financial statements.
CAPITALIZED SOFTWARE
The Company capitalizes software development costs where technological
feasibility of the product has been established. The establishment of
technological feasibility and the ongoing assessment of recoverability of
capitalized software development costs requires considerable judgment by
management with respect to certain external factors, including, but not limited
to, technological feasibility, anticipated future gross revenues, estimated
economic life and changes in software and hardware technologies. The Company is
amortizing capitalized software costs using the straight-line method over the
estimated economic useful life, the average life of which is under two years.
Amortization begins when the product is available for release to customers.
RESEARCH AND DEVELOPMENT
Research and development costs were $7.1 million, $6.0 million and $4.9
million for 1997, 1996 and 1995, respectively. In addition, in 1997, 1996 and
1995, $4.4 million, $1.6 million and $2.1 million, respectively, were
capitalized (note 3).
CASH AND CASH EQUIVALENTS
The Company generally invests its excess cash in money market funds and
other short-term investments that generally mature within 90 days. At December
31, 1997 and 1996, such cash equivalents amounted to $49.3 million and $43.9
million, respectively.
29
INVESTMENT IN LIMITED PARTNERSHIP
Investment in limited partnership consists of an investment in TQA Arbitrage
Fund L.P. ( the "Fund"), a Delaware limited partnership. The Fund invests
primarily in convertible securities, and seeks capital appreciation from its
convertible securities portfolio through a combination of convertible securities
purchases and short sales of related stocks focusing on the current income and
capital appreciation available from such strategies with convertibles. The
Company may withdraw any or all of its investment from the Fund upon at least
thirty days notice. Investment in limited partnership is valued at market, and
unrealized gains or losses are reflected in revenues.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the Company's financial instruments are carried at fair
value or amounts approximating fair value.
SECURITIES OWNED
Securities owned are valued at market, and unrealized gains or losses are
reflected in revenues. Securities owned consisted of municipal securities as of
December 31, 1997 and 1996.
USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets, liabilities, revenues and expenses and the
disclosure of contingent assets, liabilities, revenues and expenses to prepare
these financial statements in conformity with generally accepted accounting
principles. Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior years' amounts to
conform to the current year's presentation.
EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, EARNINGS PER SHARE,
which is effective for financial statements for both interim and annual periods
ending after December 15, 1997. As of December 31, 1997 the Company was required
to change the method currently used to compute earnings per share and to restate
all prior periods presented. Under the new SFAS, the Company is required to
report both basic and diluted earnings per share. Basic earnings per share is
determined by dividing earnings by the average number of shares of common stock
outstanding, while diluted earnings per share is determined by dividing earnings
by the average number of shares of common stock adjusted for the dilutive effect
of common stock equivalents. Earnings per share for 1997, 1996, and 1995 have
been restated to conform with the provisions of this statement.
DIVIDENDS
Any future payments of dividends will be at the discretion of the Company's
Board of Directors and will depend on the Company's financial condition, results
of operations, capital requirements and other factors deemed relevant. However,
the Company anticipates that, for the foreseeable future, all earnings will be
retained by the Company for working capital and that the Company will not pay
any dividends to its stockholders.
30
(2) PREMISES AND EQUIPMENT
The following is a summary of premises and equipment as of December 31, 1997
and 1996:
1997 1996
--------- ---------
(DOLLARS IN
THOUSANDS)
Furniture, fixtures and equipment.................................... $ 22,120 $ 11,051
Leasehold improvements............................................... 6,257 1,647
--------- ---------
Total............................................................ 28,377 12,698
Less accumulated depreciation and amortization....................... 8,871 4,256
--------- ---------
$ 19,506 $ 8,442
--------- ---------
--------- ---------
JEFFERIES GROUP PREMISES AND EQUIPMENT
Prior to November 1994, premises and equipment for the Company were
purchased by Jefferies Group. Jefferies Group owns and recorded such assets.
Jefferies Group charges the Company depreciation and amortization on such
premises and equipment on a monthly basis. The following is a summary of such of
premises and equipment as of December 31, 1997 and 1996 as recorded by Jefferies
Group:
1997 1996
--------- ---------
(DOLLARS IN
THOUSANDS)
Furniture, fixtures and equipment..................................... $ 4,803 $ 6,154
Leasehold improvements................................................ 942 942
--------- ---------
Total............................................................. 5,745 7,096
Less accumulated depreciation and amortization........................ 5,297 5,481
--------- ---------
$ 448 $ 1,615
--------- ---------
--------- ---------
Most of the capital expenditures in the two schedules above are for
computer-related equipment.
Depreciation and amortization expense amounted to $4,614,000, $2,034,000 and
$788,000 in 1997, 1996 and 1995, respectively.
(3) CAPITALIZED SOFTWARE COSTS
The following is a summary of capitalized software costs as of December 31,
1997 and 1996:
1997 1996
--------- ---------
(DOLLARS IN
THOUSANDS)
Capitalized software costs........................................... $ 10,210 $ 5,787
Less accumulated amortization........................................ 4,237 2,759
--------- ---------
Total............................................................ $ 5,973 $ 3,028
--------- ---------
--------- ---------
Approximately $4,423,000 of software costs were capitalized in 1997
primarily for the development of new versions of POSIT and QuantEX. In addition,
approximately $5,067,000 of total capitalized software costs were not subject to
amortization as of December 31, 1997, as the ITG Platform and certain versions
of POSIT and QuantEX had not yet been released.
Capitalized software costs are being amortized over one to two years, with
an average remaining life of under two years. In 1997, 1996 and 1995, the
Company included $1,478,000, $1,374,000 and $894,000, respectively, of amortized
software costs in other expenses.
31
(4) INCOME TAXES
The Company's operations are included in the consolidated Federal income tax
return of Jefferies Group. All income tax liabilities/assets are due to/from
Jefferies Group.
Total income taxes for the years ended December 31, 1997, 1996 and 1995 were
allocated as follows:
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Income from operations........................................ $ 20,343 $ 17,666 $ 9,983
Stockholders' equity, for compensation expense for tax
purposes in excess of amounts recognized for financial
reporting purposes.......................................... (646) -- --
--------- --------- ---------
$ 19,697 $ 17,666 $ 9,983
--------- --------- ---------
--------- --------- ---------
Income tax expense (benefit) consists of the following components:
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Current
Federal..................................................... $ 14,220 $ 13,722 $ 5,224
State....................................................... 6,226 5,971 2,096
--------- --------- ---------
Total......................................................... 20,446 19,693 7,320
--------- --------- ---------
Deferred
Federal..................................................... (62) (1,408) 1,430
State....................................................... (41) (619) 1,233
--------- --------- ---------
(103) (2,027) 2,663
--------- --------- ---------
Total......................................................... $ 20,343 $ 17,666 $ 9,983
--------- --------- ---------
--------- --------- ---------
Deferred income taxes are provided for temporary differences in reporting
certain items, principally deferred compensation. The tax effects of temporary
differences that gave rise to the deferred tax asset at December 31, 1997 and
1996 were as follows:
1997 1996
--------- ---------
(DOLLARS IN
THOUSANDS)
Deferred compensation................................................. $ 2,144 $ 1,560
State income tax...................................................... 870 860
Premises and equipment................................................ (970) (139)
Other................................................................. 416 76
--------- ---------
Total................................................................. $ 2,460 $ 2,357
--------- ---------
--------- ---------
At December 31, 1997 and 1996, the Company had income taxes payable to
Jefferies Group of $1,488,000 and $1,635,000, respectively.
32
The provision for income tax expense differs from the expected Federal
income tax rate of 35% for 1997, 1996 and 1995 for the following reasons:
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Computed expected income tax expense............................ $ 16,541 $ 14,350 $ 8,711
Increase in income taxes resulting from:
Amortization of goodwill...................................... 268 192 198
State income tax expense, net of Federal income taxes......... 4,020 3,479 2,163
Research and development tax credits.......................... (320) (159) (863)
Non-taxable interest income................................... (317) (473) (308)
Other......................................................... 151 277 82
--------- --------- ---------
Total income tax expense........................................ $ 20,343 $ 17,666 $ 9,983
--------- --------- ---------
--------- --------- ---------
The Company believes that it is more likely than not that the deferred tax
asset will be realized pursuant to the Company's Tax Sharing Agreement with
Jefferies Group which entitles the Company to a compensating tax payment from
Jefferies Group.
(5) DEBT
The Company has an intercompany borrowing agreement with Jefferies Group
permitting the Company to borrow up to $15.0 million. Outstanding balances, if
any, will be due March 31, 1999 and will accrue interest at 1.75% above the one
month London Interbank Offering Rate. No amounts were borrowed under this
agreement in 1997 or 1996.
(6) EMPLOYEE BENEFIT PLANS
Certain employees of the Company are covered by a defined benefit pension
plan sponsored by Jefferies Group. The defined benefit pension plan is subject
to the provisions of the Employee Retirement Income Security Act of 1974. The
Jefferies Group funding policy is to contribute to the defined benefit pension
plan at least the minimum amount that can be deducted for Federal Income Tax
purposes. The plan is designed so that no more than 60% or no less than 40% can
solely be invested in stocks or bonds individually.
The net periodic pension cost allocated to the Company was $208,000,
$151,000 and $101,000 in 1997, 1996 and 1995, respectively.
Jefferies Group incurs expenses related to various benefit plans covering
substantially all employees, including an Employee Stock Purchase Plan and a
profit sharing plan, which includes a salary reduction feature designed to
qualify under Section 401(k) of the Internal Revenue Code. Employee
contributions under the Employee Stock Purchase Plan are voluntary and are made
via payroll deduction. The employee contributions are used to purchase the
Jefferies Group common stock which is then held in an outside trust account. The
Company matches employee contributions at a rate of 15% (more, if profits exceed
targets set by the Company's Board of Directors). The Company's match vests
after two years.
Jefferies Group has a Capital Accumulation Plan (CAP) for certain officers
and key employees of Jefferies Group and ITG. Participation in the CAP is
optional, with those who elect to participate agreeing to defer graduated
percentages of their compensation. The plan allows selected employees to acquire
the Jefferies Group common stock at a 15% discount with 50% of the amount
deferred. The remaining 50% of the amount deferred is placed in a Profit-Based
Deferred Compensation Account that earns interest at a rate based on the
performance of the Company. Jefferies Group will from time to time repurchase
shares of its common stock in the open market for use in this plan. The Company
recognizes compensation cost related to the 15% discount and interest on
Profit-Based Deferred Compensation Accounts.
33
For 1997, 1996 and 1995, the Company expensed and contributed to these plans
$2,096,000, $1,590,000, and $567,000, respectively.
In November 1997, the Board of Directors of the Company approved the ITG
Employee Stock Purchase Plan ("ESPP"). The ESPP allows all full-time employees
to purchase the Company's common stock at a 15% discount through automatic
payroll deductions. Employees can contribute from 1% to 10% of their respect
earnings, up to certain maximums specified in the Internal Revenue Code or
$25,000 per year, to the plan. All contributions are deducted on an after tax
basis and every six months, the contributions are used to purchase shares of ITG
common stock. The purchase price will be calculated at 85% of the higher of (i)
the mean of the closing "bid" and "ask" prices on the last day of trading of
each period or (ii) the average fair market value as of the first or last
trading day of the offering period (whichever is lower). The ESPP is qualified
as an employee stock purchase plan under Section 423 of the Internal Revenue
Code. It is not a stock bonus, pension, or profit sharing plan, and is not
subject to or considered a qualified plan under any provisions of the Employee
Retirement Income Security Act of 1974 (ERISA) or Section 401(a) of the Internal
Revenue Code. The ESPP is administered by a committee of officers of the Company
who are appointed by the Board of Directors to interpret the terms and
provisions of the plan. The ESPP is subject to amendment, modification, or
termination by the Board of Directors at anytime. The ESPP become effective
February 1, 1998, but is subject to approval by ITG's stockholders prior to the
first purchase following the initial offering period. In the event that
stockholders fail to approve the ESPP, all purchase rights granted under the
ESPP will be canceled, payroll contributions will be refunded, and the ESPP will
be terminated. As of February 1, 1998, ITG employees are prohibited from
participation in the Jefferies Employee Stock Purchase Plan.
(7) RELATED PARTY TRANSACTIONS
The Company entered into certain agreements (e.g., tax sharing agreement,
service agreements, clearing agreement, development rights agreement, revenue
sharing agreement and lease agreements) as described below:
Jefferies & Co. has provided specified administrative services to the
Company at fixed monthly costs. Services performed outside the scope of the
service agreements have been provided at jointly negotiated costs.
Administrative services include human resources, telecommunications and data
processing, legal, accounting and compliance. The costs of such services to the
Company during 1997, 1996 and 1995 were $1,162,000, $690,000 and $584,000,
respectively.
Employees of the Company have also been provided with certain employee
benefits, including medical, dental, life and disability insurance under plans
maintained by Jefferies & Co., which have been charged to the Company based on
Jefferies & Co.'s actual costs. In addition, third party expenses including
telecommunication and quotation costs, floor brokerage, legal and accounting
fees, exchange fees and other insurance costs, including fidelity bond coverage
and directors and officers liability coverage, have been provided at cost.
The Company paid to Jefferies & Co. an aggregate of $247,000, $502,000 and
$432,000 for 1997, 1996 and 1995, respectively, as compensation to Jefferies &
Co.'s account executives for introducing customers to POSIT.
In addition, Jefferies & Co. has provided substantially all clearing
services to the Company. Aggregate costs of such services to the Company were
$9.3 million, $7.3 million and $4.6 million during 1997, 1996 and 1995,
respectively, included in transaction processing expenses.
Occupancy and equipment rental expense has been partially provided to the
Company at cost by Jefferies Group.
W & D Securities, Inc. performs certain execution services at the New York
Stock Exchange and other exchanges for the Company. In order to comply with
regulatory requirements of the NYSE that generally
34
prohibit NYSE members and their affiliates from executing, as principal and, in
certain cases, as agent, transactions in NYSE-listed securities off the NYSE,
Jefferies Group gave up its formal legal control of W & D, effective January 1,
1983, by exchanging all of the W & D common stock owned by it for non-voting
preferred stock of W & D. In the event that Jefferies Group were to regain
ownership of such common stock, Jefferies Group believes that the NYSE would
assert that W & D would be in violation of the NYSE's rules unless similar
arrangements satisfactory to the NYSE were made with respect to the ownership of
the common stock. While the NYSE has generally approved the above arrangements,
there can be no assurance that it will not raise objections in the future. The
Company believes that it can make satisfactory alternative arrangements for
executing transactions in listed securities on the NYSE if it were precluded
from doing so through W & D. The cost of these execution services was $10.8
million, $6.5 million and $5.4 million in 1997, 1996 and 1995, respectively, and
is included in transaction processing expenses. Included in other general and
administrative expenses are fees paid to Jefferies International Limited of
$330,000 for various broker and administrative services, of which $330,000 was
reimbursed to the Company by its affiliate Global Trading. Included in revenues
are financing costs of $415,000 paid to Jefferies & Co. Also included in
revenues, are licensing fees paid by W & D Securities, Inc. amounting to
$150,000.
Jefferies & Co. executes trades in an agency capacity for certain of its
customers using ITG's services. Transaction fees from such trades were $3.1
million, $1.7 million and $1.1 million in 1997, 1996 and 1995, respectively, and
are included in the Company's revenues.
The Company believes all the foregoing transactions were on terms
substantially no less favorable to the Company than could have been obtained
from unaffiliated parties and that all costs of doing business have been
included. Amounts due from affiliates and amounts due to affiliates are
generally settled on a monthly basis.
(8) MARKET RISK AND CONCENTRATIONS OF CREDIT RISK
In the normal course of business, the Company is involved in the execution
of various customer securities transactions. Securities transactions are subject
to the risk of counter party or customer nonperformance. However, transactions
are collateralized by the underlying security, thereby reducing the associated
risk to changes in the market value of the security through settlement date.
The settlement of these transactions is not expected to have a material
effect upon the Company's financial statements.
(9) NET CAPITAL REQUIREMENT
ITG is subject to the Securities and Exchange Commission Uniform Net Capital
Rule (Rule 15c3-1), which requires the maintenance of minimum net capital. ITG
has elected to use the alternative method permitted by Rule 15c3-1, which
requires that ITG maintain minimum net capital, as defined, equal to $250,000 or
2% of aggregate debit balances arising from customer transactions, as defined.
At December 31, 1997, ITG had net capital of $35.0 million which was $34.8
million in excess of required net capital.
(10) ITGI STOCK OPTIONS
At December 31, 1997, the Company had a non-compensatory stock option plan.
Under the 1994 Stock Option and Long-term Incentive Plan, non-compensatory
options to purchase 3,650,000 shares of the Company's Common Stock are reserved
for issuance under the plan. Except for certain options granted in conjunction
with the Offering the majority of the options will vest in one-third increments
on the first, second, and third anniversaries of the date the options were
priced. Shares of Common Stock which are attributable to awards which have
expired, terminated or been canceled or forfeited during any
35
calendar year are generally available for issuance or use in connection with
future awards during such calendar year. Options that have been granted under
the 1994 Stock Option and Long-Term Incentive Plan are exercisable on dates
ranging from May 1997 to November 2007. The Plan will remain in effect until
March 31, 2007, unless sooner terminated by the Board of Directors. After this
date, no further stock options shall be granted but previously granted stock
options shall remain outstanding in accordance with their applicable terms and
conditions, as stated in the Stock Option and Long-term Incentive Plan.
In June 1995, the Board of Directors adopted, subject to stockholder
approval, the Non-Employee Directors' Plan. The Non-Employee Directors' Plan
generally provides for an annual grant to each non-employee director of an
option to purchase 2,500 shares of Common Stock. In addition, the Non-Employee
Directors' Plan provides for the automatic grant to a non-employee director, at
the time he or she is initially elected, of a stock option to purchase 10,000
shares of Common Stock. Stock options granted under the Non-Employee Directors'
Plan are non-qualified stock options having an exercise price equal to the fair
market value of the Common Stock at the date of grant. All stock options become
exercisable three months after the date of grant. Stock options granted under
the Non-Employee Directors' Plan expire five years after the date of grant. A
total of 125,000 shares of Common Stock are reserved and available for issuance
under the Non-Employee Directors' Plan.
At the time of the Company's initial public offering in May 1994, stock
options to acquire an aggregate of 2,728,000 shares of Common Stock were granted
to officers and other employees of the Company. Of these options granted,
2,442,000 shares were 100% vested on May 4, 1994. In 1995, the Compensation
Committee of the Board of Directors determined that a value-neutral repricing of
such options would serve to provide enhanced incentives to officers and
employees of the Company. Accordingly, on the recommendation of the Compensation
Committee, the Company offered a stock option repricing program pursuant to
which all holders (options granted under the Non-Employee Directors' Plan were
not eligible for repricing) of outstanding stock options with an exercise price
of $13.00 per share were permitted to elect to exchange all or a portion of such
stock options for a smaller number of stock options to acquire shares of Common
Stock at exercise price of $13.00, $11.06 and $9.13 per share. The repricing
program was offered to option holders on a value neutral basis using the Black
Scholes option valuation model. In all, approximately 66% of the outstanding
stock options eligible for repricing were repriced at the election of the
holders of such options.
The Company applies APB Opinion No. 25 and related Interpretations in
accounting for its non-compensatory stock option plans. Accordingly, no
compensation costs have been recognized for its stock option plan. Had
compensation cost for the Company's stock option plans been determined
consistent with FASB Statement No. 123, the Company's net earnings and earnings
per share would have been reduced to the pro forma amounts indicated below
(dollars in thousands, except per share data):
1997 1996 1995
--------- --------- ---------
Net earnings........................................... As reported $ 26,917 $ 23,335 $ 14,905
Pro forma $ 23,375 $ 20,279 $ 11,899
Basic net earnings per share of common stock........... As reported $ 1.48 $ 1.28 $ 0.81
Pro forma $ 1.29 $ 1.11 $ 0.64
Diluted earnings per share common stock................ As reported $ 1.42 $ 1.26 $ 0.81
Pro forma $ 1.23 $ 1.09 $ 0.64
The fair value of each option grant is estimated on the date of grant using
the Black Scholes option valuation model with the following weighted average
assumptions used for grants in 1997 and 1996, respectively: zero dividend yield
for all years; risk free interest rates of 6.6, 6.1 and 6.3 percent; expected
volatility of 54, 49 and 51 percent; and expected lives of five, four and four
years.
36
A summary of the status of the Company's stock option plan as of December
31, 1997 and 1996 and changes during the years ended on those dates is presented
below:
1997 1996 1995
----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
FIXED OPTIONS SHARES PRICE SHARES PRICE SHARES PRICE
- ---------------------------------------------- ---------- ----------- ---------- ----------- ---------- -----------
Outstanding at beginning of year.............. 2,311,059 $ 11.96 2,271,351 $ 11.82 2,731,678 $ 13.00
Granted....................................... 1,241,904 22.29 49,877 16.96 27,500 7.71
Exercised..................................... (94,249) 13.00 -- -- -- --
Conversion:
Surrendered upon conversion................. -- -- -- -- (478,646) 13.00
Converted from.............................. -- -- -- -- (870,976) 13.00
Converted to................................ -- -- -- -- 435,493 9.13
Converted to................................ -- -- -- -- 435,483 11.06
Forfeited..................................... (498) 13.00 (10,169) 13.00 (9,181) 13.00
---------- ----------- ---------- ----------- ---------- -----------
Outstanding at end of year.................... 3,458,216 $ 15.63 2,311,059 $ 11.96 2,271,351 $ 11.82
---------- ----------- ---------- ----------- ---------- -----------
---------- ----------- ---------- ----------- ---------- -----------
Options exercisable at year-end............... 1,737,923 $ 15.25 None None
Weighted average fair value per share of
options granted during the year............. $ 10.76 $ 7.93 $ 3.48
The following table summarizes information about fixed stock options
outstanding at December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- --------------------------
WEIGHTED NUMBER
NUMBER AVERAGE WEIGHTED EXERCISABLE WEIGHTED
OUTSTANDING AT REMAINING AVERAGE AT AVERAGE
DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
RANGE OF EXERCISE PRICES 1997 LIFE (YEARS) PRICE 1997 PRICE
- --------------------------------------------------- -------------- --------------- ----------- ------------- -----------
$ 7.33 10.00................................... 455,603 2.9 $ 9.07 9,934 $ 7.90
11.00 15.00................................... 1,728,332 1.7 12.52 1,296,008 13.01
16.00 20.00................................... 167,177 4.4 19.23 12,377 18.43
21.00 25.00................................... 1,019,604 4.1 22.21 419,604 22.25
26.00 27.80................................... 87,500 9.8 27.60 -- --
-------------- -------------
$ 7.33 27.80................................... 3,458,216 2.9 $ 15.63 1,737,923 $ 15.25
-------------- -------------
-------------- -------------
Although the 1994 Plan allows for the granting of performance-based stock
options and restricted stock awards, no such options were granted during 1997,
1996 and 1995 and no such options were outstanding at December 31, 1997, 1996
and 1995.
Restricted stock of 24,219 shares was granted in 1997 as part of the
Company's settlement for its equity investment in The Long View Group. The
restriction period is for one year.
In January of 1997, the Company granted to Scott P. Mason, President and
CEO, a non-qualified stock option to acquire 1,000,000 shares of Common Stock of
the Company, having an exercise price of $22.175. On May 4, 1997, 200,000 of
these options became exercisable and an additional 200,000 shares became
exercisable on December 10, 1997. Furthermore, 200,000 shares will become
exercisable on each of December 10, 1998, 1999 and 2000, the anniversary date of
Scott P. Mason's employment contract execution. Such options granted were
approved by the Compensation Committee of the Board of Directors in March 1997.
The options expire in January 2002.
37
(11) INTEREST
Included in revenues is interest income of $498,000, $571,000 and $46,000
for 1997, 1996 and 1995, respectively.
Included in other general and administrative and transaction processing
expenses is interest expense totalling $146,000, $223,000 and $53,000 for 1997,
1996 and 1995, respectively.
(12) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31, 1997 and 1996
consisted of the following;
1997 1996
--------- ---------
(DOLLARS IN
THOUSANDS)
Accounts payable and accrued expenses................................. $ 4,275 $ 4,199
Accrued soft dollar expenses.......................................... 3,125 2,104
Accrued Bonus expense................................................. 2,849 1,926
Accrued rent expense.................................................. 2,276 119
Deferred revenues..................................................... 200 300
--------- ---------
Total................................................................. $ 12,725 $ 8,648
--------- ---------
--------- ---------
(13) LEASE COMMITMENTS
In March 1994, the Company entered into lease and sublease agreements with
Jefferies Group, Jefferies & Co. and third parties for certain offices and
equipment, which expire at various dates through 2005. Rent expense for the
years ended December 31, 1997, 1996 and 1995 was $2.6 million, $1.9 million and
$1.2 million, respectively. Minimum future rentals under non cancelable
operating leases follow (dollars in thousands):
YEAR ENDING DECEMBER 31,
1998............................................................... $ 2,569
1999............................................................... 2,577
2000............................................................... 2,592
2001............................................................... 2,631
2002............................................................... 2,631
Thereafter......................................................... 25,353
---------
Total.............................................................. $ 38,353
---------
---------
38
(14) EARNINGS PER SHARE
Net earnings per share of common stock is based upon an adjusted weighted
average number of shares of common stock outstanding. The average number of
outstanding shares for the years ended December 31, 1997, 1996 and 1995 were
18.2 million, 18.3 million and 18.5 million, respectively.
The following is a reconciliation of the basic and diluted earnings per
share computations for the years ended December 31, 1997, 1996 and 1995.
1997 1996 1995
--------- --------- ---------
(AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
Net earnings for basic and diluted earnings per share.................. $ 26,917 $ 23,335 $ 14,905
--------- --------- ---------
--------- --------- ---------
Shares of common stock and common stock equivalents:
Average number of common shares...................................... 18,178 18,284 18,473
--------- --------- ---------
Average shares used in basic computation............................. 18,178 18,284 18,473
Effect of dilutive securities -- options............................. 762 302 --
--------- --------- ---------
Average shares used in diluted....................................... 18,940 18,586 18,473
--------- --------- ---------
--------- --------- ---------
Earnings per share:
Basic................................................................ $ 1.48 $ 1.28 $ 0.81
--------- --------- ---------
--------- --------- ---------
Diluted.............................................................. $ 1.42 $ 1.26 $ 0.81
--------- --------- ---------
--------- --------- ---------
(15) UNAUDITED SUPPLEMENTARY FINANCIAL INFORMATION
The following tables set forth certain unaudited financial data for the
Company's quarterly operations in 1997, 1996 and 1995. The following information
has been prepared on the same basis as the annual information presented
elsewhere in this report and, in the opinion of management, includes all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the information for the quarterly periods presented. The
operating results for any quarter are not necessarily indicative of results for
any future period.
39
INVESTMENT TECHNOLOGY GROUP, INC.
YEAR ENDED DECEMBER 31, 1997 YEAR ENDED DECEMBER 31, 1996
-------------------------------------------------- -------------------------------------
FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Total Revenue..................... $ 36,272 $ 33,437 $ 36,679 $ 30,654 $ 29,892 $ 28,684 $ 26,313
Expenses:
Compensation and employee
benefits...................... 8,999 7,599 7,007 6,874 6,947 6,225 6,006
Transaction processing.......... 5,718 5,110 5,682 4,903 3,922 4,340 3,776
Software royalties.............. 2,579 2,306 2,581 2,382 2,283 2,272 2,022
Occupancy and equipment......... 2,814 2,521 2,010 1,859 1,928 1,899 1,257
Consulting...................... 487 585 574 371 494 452 692
Telecommunications and data
processing services........... 1,988 1,504 2,156 957 1,396 1,217 925
Other general and
administrative................ 3,039 2,486 2,744 1,947 1,614 2,072 1,783
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total expenses.............. 25,624 22,111 22,754 19,293 18,584 18,477 16,461
----------- ----------- ----------- ----------- ----------- ----------- -----------
Earnings before income tax
expense.......................... 10,648 11,326 13,925 11,361 11,308 10,207 9,852
Income tax expense................ 4,739 4,857 5,917 4,830 4,813 4,330 4,285
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net earnings...................... $ 5,909 $ 6,469 $ 8,008 $ 6,531 $ 6,495 $ 5,877 $ 5,567
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
Basic net earnings per share of
common stock..................... $ 0.32 $ 0.36 $ 0.44 $ 0.36 $ 0.36 $ 0.32 $ 0.30
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
Diluted net earnings per share of
common stock..................... $ 0.31 $ 0.34 $ 0.43 $ 0.35 $ 0.35 $ 0.32 $ 0.30
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
Basic weighed average shares
outstanding...................... 18,188 18,144 18,128 18,254 18,255 18,256 18,262
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
Diluted weighted average shares
and common stock equivalents
outstanding...................... 19,107 19,104 18,702 18,809 18,727 18,558 18,572
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
YEAR ENDED DECEMBER 31, 1995
--------------------------------------------------
FIRST FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- ----------- -----------
Total Revenue..................... $ 26,667 $ 19,933 $ 19,405 $ 16,700 $ 16,343
Expenses:
Compensation and employee
benefits...................... 5,869 4,579 4,754 3,529 3,542
Transaction processing.......... 3,699 3,221 2,707 2,727 2,206
Software royalties.............. 2,221 1,775 1,565 1,264 1,381
Occupancy and equipment......... 1,027 992 913 883 818
Consulting...................... 854 442 298 396 563
Telecommunications and data
processing services........... 1,251 853 864 676 486
Other general and
administrative................ 2,112 1,729 1,432 1,332 1,566
----------- ----------- ----------- ----------- -----------
Total expenses.............. 17,033 13,591 12,533 10,807 10,562
----------- ----------- ----------- ----------- -----------
Earnings before income tax
expense.......................... 9,634 6,342 6,872 5,893 5,781
Income tax expense................ 4,238 2,844 1,990 2,543 2,606
----------- ----------- ----------- ----------- -----------
Net earnings...................... $ 5,396 $ 3,498 $ 4,882 $ 3,350 $ 3,175
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Basic net earnings per share of
common stock..................... $ 0.29 $ 0.19 $ 0.26 $ 0.18 $ 0.17
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Diluted net earnings per share of
common stock..................... $ 0.29 $ 0.19 $ 0.26 $ 0.18 $ 0.17
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Basic weighed average shares
outstanding...................... 18,364 18,390 18,429 18,531 18,543
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Diluted weighted average shares
and common stock equivalents
outstanding...................... 18,435 18,391 18,429 18,531 18,543
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Earnings per share for quarterly periods are based on average common shares
outstanding in individual quarters; thus, the sum of earnings per share of the
quarters may not equal the amounts reported for the full year. Earnings per
share for prior periods have been restated to conform with Statement of
Financial Accounting Standards No. 128 EARNINGS PER SHARE.
40
INVESTMENT TECHNOLOGY GROUP, INC.
YEAR ENDED DECEMBER 31, 1997 YEAR ENDED DECEMBER 31, 1996
-------------------------------------------------- -------------------------------------
FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- ----------- ----------- ----------- -----------
(AS A PERCENTAGE OF TOTAL REVENUES)
Total Revenues.................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Expenses:
Compensation and employee
benefits...................... 24.8 22.7 19.1 22.4 23.2 21.7 22.8
Transaction processing.......... 15.8 15.3 15.5 16.0 13.1 15.1 14.4
Software royalties.............. 7.1 6.9 7.0 7.8 7.6 7.9 7.7
Occupancy and equipment......... 7.8 7.5 5.5 6.1 6.4 6.6 4.8
Consulting...................... 1.3 1.7 1.6 1.2 1.7 1.6 2.6
Telecommunications and data
processing services........... 5.5 4.5 5.9 3.1 4.7 4.2 3.5
Other general and
administrative................ 8.4 7.4 7.5 6.4 5.4 7.2 6.8
----- ----- ----- ----- ----- ----- -----
Total expenses.............. 70.7 66.0 62.1 63.0 62.1 64.3 62.6
----- ----- ----- ----- ----- ----- -----
Earnings before income tax
expense......................... 29.3 34.0 37.9 37.0 37.9 35.7 37.4
Income tax expense................ 13.0 14.7 16.1 15.7 16.2 15.2 16.2
----- ----- ----- ----- ----- ----- -----
Net earnings...................... 16.3% 19.3% 21.8% 21.3% 21.7% 20.5% 21.2%
----- ----- ----- ----- ----- ----- -----
----- ----- ----- ----- ----- ----- -----
YEAR ENDED DECEMBER 31, 1995
--------------------------------------------------
FIRST FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- ----------- -----------
Total Revenues.................... 100.0% 100.0% 100.0% 100.0% 100.0%
Expenses:
Compensation and employee
benefits...................... 22.0 23.0 24.5 21.1 21.7
Transaction processing.......... 13.9 16.2 14.0 16.3 13.5
Software royalties.............. 8.3 8.9 8.1 7.6 8.5
Occupancy and equipment......... 3.9 5.0 4.7 5.3 5.0
Consulting...................... 3.2 2.2 1.5 2.4 3.4
Telecommunications and data
processing services........... 4.7 4.3 4.5 4.0 3.0
Other general and
administrative................ 7.9 8.7 7.4 8.0 9.6
----- ----- ----- ----- -----
Total expenses.............. 63.9 68.3 64.7 64.7 64.7
----- ----- ----- ----- -----
Earnings before income tax
expense......................... 36.1 31.7 35.3 35.3 35.3
Income tax expense................ 15.9 14.2 10.1 15.2 15.9
----- ----- ----- ----- -----
Net earnings...................... 20.2% 17.5% 25.2% 20.1% 19.4%
----- ----- ----- ----- -----
----- ----- ----- ----- -----
41
(16) JEFFERIES GROUP AND THE COMPANY ANNOUNCE INTENTION TO CONSIDER SEPARATING
INTO TWO INDEPENDENT COMPANIES
On March 17, 1998, Jefferies Group and the Company jointly announced that
they are considering the separation of Jefferies & Co. and other Jefferies Group
subsidiaries from the Company through a spin-off.
If the separation is completed, Jefferies Group shareholders will own 100%
of JEFCO and approximately 82.3% of the Company. The public Company shareholders
will continue to own 17.7% of the Company. (The Company percentage ownership
interests could change slightly as a result of the Company's stock repurchases
or issuances before the transaction closing date.) The spin-off will be
accomplished by a tax-free distribution of 100% of the shares of a new company,
JEFCO, to Jefferies Group shareholders. Jefferies Group's 15 million shares of
the Company would then be its only asset. The spin-off would be followed
immediately by a tax-free merger of Jefferies Group and the Company, with the
Company's public shareholders receiving shares of Jefferies Group. Jefferies
Group would then be renamed Investment Technology Group, Inc.
The spin-off and restructuring transactions are contingent on a number of
factors, including receipt of all Board of Directors and shareholder approvals
of Jefferies Group and the Company, receipt of a favorable tax ruling from the
Internal Revenue Service and other required regulatory and contractual
approvals.
42
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants reportable
herein.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to this item will be contained in the Proxy
Statement for the 1998 Annual Meeting of Stockholders, which is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to this item will be contained in the Proxy
Statement for the 1998 Annual Meeting of Stockholders, which is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to this item will be contained in the Proxy
Statement for the 1998 Annual Meeting of Stockholders, which is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to this item will be contained in the Proxy
Statement for the 1998 Annual Meeting of Stockholders, which is incorporated
herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS
Included in Part II of this report:
PAGE
-----
Independent Auditor's Report........................................................... 23
Consolidated Statement of Operations................................................... 24
Consolidated Statement of Financial Condition.......................................... 25
Consolidated Statement of Changes in Stockholders' Equity.............................. 26
Consolidated Statement of Cash Flows................................................... 27
Notes to Consolidated Financial Statements............................................. 28
(a)(2) SCHEDULES
Schedules are omitted because the required information either is not
applicable or is included in the financial statements or the notes thereto.
(a)(3) EXHIBITS
3.1 Certificate of Incorporation of the Company (incorporated by reference to Exhibit
3.1 to Registration Statement Number 33-76474 on Form S-1 as declared effective by
the Securities and Exchange Commission on May 4, 1994 (the "Registration
Statement")).
3.2 By-laws of the Company (incorporated by reference to Exhibit 3.2 to Registration
Statement).
4.1 Form of Certificate for Common Stock of the Company (incorporated by reference to
Exhibit 4.1 to Registration Statement).
43
10.1 Joint Venture Agreement, dated October 1, 1987, between Jefferies & Company, Inc.
and BARRA, Inc. (formerly Barr Rosenberg Associates, Inc.) (incorporated by
reference to Exhibit 10.1.1 to Registration Statement).
10.1.1 Exclusive Software License Agreement, dated October 1, 1987, between the POSIT
Joint Venture and Jefferies & Company, Inc. (incorporated by reference to Exhibit
10.1.2 to Registration Statement).
10.1.2 Amendment No. 1 to Exclusive Software License Agreement, dated August 1, 1990,
between the POSIT Joint Venture and Jefferies & Company, Inc. (incorporated by
reference to Exhibit 10.1.3 to Registration Statement).
10.1.3 Consent of BARRA, Inc. to the assignment to the Company of the interests of
Jefferies & Company, Inc. in the POSIT Joint Venture referenced in item 10.1.1 and
rights in the Software License Agreement referenced in item 10.1.2 (incorporated
by reference to Exhibit 10.1.4 to Registration Statement).
10.1.4 Joint Venture Agreement, dated May 31, 1990, between BARRA International (U.K.),
Ltd. and Jefferies Global Trading Incorporated (incorporated by reference to
Exhibit 10.1.5 to Registration Statement).
10.1.5 Exclusive Software License Agreement, dated May 31, 1990, between the Global POSIT
Joint Venture and Jefferies International Limited (incorporated by reference to
Exhibit 10.1.6 to Registration Statement).
10.1.6 Consent of BARRA International (U.K.), Ltd. to the assignment to the Company of
the interests of Jefferies Global Trading Incorporated in the Global POSIT Joint
Venture referenced in item 10.1.5 (incorporated by reference to Exhibit 10.1.7 to
Registration Statement).
10.1.7 Form of QuantEX Software and Hardware License Agreement (incorporated by reference
to Exhibit 10.3.3 to Registration Statement).
10.2 Tax Sharing Agreement, dated March 15, 1994 between Jefferies Group, Inc. and the
Company (incorporated by reference to Exhibit 10.2.1 to Registration Statement).
10.2.1 Service Agreement, dated March 15, 1994, between Jefferies & Company, Inc. and the
Company (incorporated by reference to Exhibit 10.2.2 to Registration Statement).
10.2.2 Service Agreement, dated March 15, 1994, between W & D Securities, Inc. and the
Company (incorporated by reference to Exhibit 10.2.3 to Registration Statement).
10.2.3 Fully Disclosed Clearing Agreement, dated March 15, 1994, between Jefferies &
Company, Inc. and the Company (incorporated by reference to Exhibit 10.2.4 to
Registration Statement).
10.2.4 Intercompany Borrowing Agreement between Jefferies Group, Inc. and the Company
(incorporated by reference to Exhibit 10.2.5 to Registration Statement).
10.2.5 Development Rights Agreement, dated March 15, 1994, between Jefferies Group, Inc.
and the Company (incorporated by reference to Exhibit 10.2.6 to Registration
Statement).
10.2.6 Revenue Sharing Agreement, dated March 15, 1994, between the Company and Jefferies
& Company, Inc. (incorporated by reference to Exhibit 10.2.7 to Registration
Statement).
10.2.7 Equipment Lease Agreement, dated March 15, 1994, between the Company, Jefferies &
Company, Inc. and Jefferies Group, Inc. (incorporated by reference to Exhibit
10.2.8 to Registration Statement).
10.2.8 Form of Promissory Note between the Company and Jefferies Group, Inc.
(incorporated by reference to Exhibit 10.2.9 to Registration Statement).
10.3 Employment Agreement between the Company, ITG Inc. and Raymond L. Killian, Jr.
(incorporated by reference to Exhibit 10.3.2 to Registration Statement).
44
10.3.1 Agreement to Terminate Employment Agreement and Stock Options between the Company,
Raymond L. Killian, Jr. and Jefferies Group, Inc. (incorporated by reference to
Exhibit 10.1 to the Quarterly Report on Form 10-Q for the quarter ended June 24,
1994).
10.3.1A Amendment No. 2 to Employment Agreement between Raymond L. Killian, Jr., the
Company and ITG Inc. (incorporated by reference to Exhibit 10.3.2A to the Annual
Report on Form 10-K for the year ended December 31, 1996).
10.3.2 Employment Agreement between the Company and Scott P. Mason (incorporated by
reference to Exhibit 10.3.18 to the Annual Report on Form 10-K for the year ended
December 31, 1996).
10.3.2A Stock Option Agreement between the Company and Scott P. Mason (incorporated by
reference to Exhibit 10.3.3 to Registration Statement).
10.3.2B Agreement to Terminate Stock Option between the Company, Scott P. Mason and
Jefferies Group, Inc. (incorporated by reference to Exhibit 10.13 to the Quarterly
Report on Form 10-Q for the quarter ended June 24, 1994).
10.3.3 Employment Agreement between the Company, ITG Inc. and Dale A. Prouty
(incorporated by reference to Exhibit 10.3.3 to Registration Statement).
10.3.3A Agreement to Terminate Employment Agreement, Phantom Equity Rights and Profits
Bonus Rights between the Company, Jefferies Group, Inc., Jefferies & Company, Inc.
and Dale A. Prouty (incorporated by reference to Exhibit 10.2 to the Quarterly
Report on Form 10-Q for the quarter ended June 24, 1994).
10.3.3B Amendment No. 2 to Employment Agreement between the Company, ITG Inc. and Dale A.
Prouty (incorporated by reference to Exhibit 10.3.18 to the Annual Report on Form
10-K for the year ended December 31, 1996).
10.3.4 Form of Employment Agreement between the Company and Joshua D. Rose (incorporated
by reference to Exhibit 10.3.4 to Registration Statement).
10.3.4A Agreement to Modify Bonus Share between the Company and Joshua D. Rose
(incorporated by reference to Exhibit 10.3.13 to Registration Statement Number
33-76474 on Amendment Number 3 to Form S-1 as filed with the Securities and
Exchange Commission on April 21, 1994).
10.3.5 Employment Agreement between the Company, ITG Inc. and Yossef A. Beinart
(incorporated by reference to Exhibit 10.3.6 to Registration Statement Number
33-76474 on Amendment Number 3 to Form S-1 as filed with the Securities and
Exchange Commission on May 2, 1994).
10.3.5A Agreement to Terminate Phantom Equity Rights and Profits Bonus Rights between the
Company, Jefferies Group, Inc., Jefferies & Company, Inc. and Yossef Beinart
(incorporated by reference to Exhibit 10.5 to the Quarterly Report on Form 10-Q
for the quarter ended June 24, 1994).
10.3.6 Employment Agreement between the Company, ITG Inc. and Robert K. Laible
(incorporated by reference to Exhibit 10.3.5 to Registration Statement Number
33-76474 on Amendment Number 3 to Form S-1 as filed with the Securities and
Exchange Commission on May 2, 1994).
10.3.6A Agreement to Modify Bonus Share between the Company and Robert K. Laible
(incorporated by reference to Exhibit 10.3.12 to Registration Statement Number
33-76474 on Amendment Number 3 to Form S-1 as filed with the Securities and
Exchange Commission on April 21, 1994).
10.3.7 Amendment to Form of Employment Agreement between the Company, ITG Inc. and Senior
Vice Presidents Electing to Reprice Stock Options (incorporated by reference to
Exhibit 10.3.4A to the Annual Report on Form 10-K for the year ending December 31,
1996).
45
10.4 1994 Stock Option and Long-Term Incentive Plan of the Company (incorporated by
reference to Exhibit 10.3.1 to Registration Statement).
10.4.1A Amended and restated 1994 Stock Option and Long-Term Incentive Plan (incorporated
by reference to Exhibit 10.3.1B to the Annual Report on Form 10-K for the year
ended December 31, 1996).
10.4.1B Amended Non-Employee Directors' Stock Option Plan (incorporated by reference to
Exhibit 10.3.1A to the Annual Report on Form 10-K for the year ended December 31,
1996).
10.4.2 Capital Accumulation Plan for key employees of Jefferies Group, Inc. (incorporated
by reference to Exhibit 10.3.7 to Registration Statement).
10.4.3 Form of Stock Option Agreement between the Company and certain employees of the
Company (incorporated by reference to Exhibit 10.3.3 to Registration Statement).
10.4.4 ITG Incentive Compensation Plan (incorporated by reference to Exhibit 10.3.16 to
Registration Statement Number 33-76474 on Amendment Number 3 to Form S-1 as filed
with the Securities and Exchange Commission on April 21, 1994).
10.4.5 Phantom Equity Agreement and Profits Bonus Rights Plan (incorporated by reference
to Exhibit 10.3.17 to Registration Statement Number 33-76474 on Amendment Number 3
to Form S-1 as filed with the Securities and Exchange Commission on April 21,
1994).
10.4.6* Employee Stock Purchase Plan.
10.5 Lease, dated July 11, 1990, between AEW/LBA Acquisition Co. LLC (as successor to
400 Corporate Pointe, Ltd.) and Integrated Analytics Corporation, as assigned by
Integrated Analytics Corporation to the Company (incorporated by reference to
Exhibit 10.3.3 to Registration Statement).
10.5.1 First Amendment to Lease, dated as of June 1, 1995, between AEW/LBA Acquisition
Co. LLC (as successor to 400 Corporate Pointe, Ltd.) and the Company (incorporated
by reference to Exhibit 10.5.7 to Annual Report of Form 10-K for the year ended
December 31, 1996).
10.5.2* Second Amendment to Lease, dated as of December 5, 1996, between Arden Realty
Limited Partnership and the Company.
10.5.3* Lease, dated October 4, 1996, between Spartan Madison Corp. and the Company.
10.5.4* First Supplemental Agreement, dated as of January 29, 1997, between Spartan
Madison Corp. and the Company.
10.5.5* Second Supplemental Agreement, dated as of November 25, 1997, between Spartan
Madison Corp. and the Company.
10.5.6* Lease, dated March 10, 1995, between Boston Wharf Co. and the Company.
23* Consent of KPMG Peat Marwick LLP.
27.1* Financial Data Schedule.
27.2* Financial Data Schedule.
27.3* Financial Data Schedule.
- ------------------------
* Filed herewith
(B) REPORTS ON FORM 8-K
There were no reports filed on Form 8-K for the quarter ended December 31,
1997.
(C) INDEX TO EXHIBITS
See list of exhibits at Item 14(a)(3) above and exhibits following.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
INVESTMENT TECHNOLOGY GROUP, INC.
By: /s/ RAYMOND L. KILLIAN, JR.
-----------------------------------------
Raymond L. Killian, Jr.
CHAIRMAN OF THE BOARD
Dated: March 18, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ RAYMOND L. KILLIAN, JR.
- ------------------------------ Chairman of the Board and March 18, 1998
Raymond L. Killian, Jr. Director
President, Chief Executive
/s/ SCOTT P. MASON Officer and Director
- ------------------------------ (Principal Executive March 18, 1998
Scott P. Mason Officer)
Senior Vice President and
/s/ JOHN R. MACDONALD Chief Financial Officer
- ------------------------------ (Principal Financial and March 18, 1998
John R. MacDonald Accounting Officer)
/s/ FRANK E. BAXTER
- ------------------------------ Director March 18, 1998
Frank E. Baxter
/s/ RICHARD G. DOOLEY
- ------------------------------ Director March 18, 1998
Richard G. Dooley
/s/ WILLIAM I JACOBS
- ------------------------------ Director March 18, 1998
William I Jacobs
47
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ ROBERT L. KING
- ------------------------------ Director March 18, 1998
Robert L. King
/s/ MICHAEL L. KLOWDEN
- ------------------------------ Director March 18, 1998
Michael L. Klowden
/s/ DALE A. PROUTY
- ------------------------------ Director March 18, 1998
Dale A. Prouty
/s/ MARK A. WOLFSON
- ------------------------------ Director March 18, 1998
Mark A. Wolfson
48
EXHIBIT INDEX
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- --------- ----------------------------------------------------------------------------------------- ---------------
3.1 Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to
Registration Statement Number 33-76474 on Form S-1 as declared effective by the
Securities and Exchange Commission on May 4, 1994 (the "Registration Statement")).
3.2 By-laws of the Company (incorporated by reference to Exhibit 3.2 to Registration
Statement).
4.1 Form of Certificate for Common Stock of the Company (incorporated by reference to Exhibit
4.1 to Registration Statement).
10.1 Joint Venture Agreement, dated October 1, 1987, between Jefferies & Company, Inc. and
BARRA, Inc. (formerly Barr Rosenberg Associates, Inc.) (incorporated by reference to
Exhibit 10.1.1 to Registration Statement).
10.1.1 Exclusive Software License Agreement, dated October 1, 1987, between the POSIT Joint
Venture and Jefferies & Company, Inc. (incorporated by reference to Exhibit 10.1.2 to
Registration Statement).
10.1.2 Amendment No. 1 to Exclusive Software License Agreement, dated August 1, 1990, between
the POSIT Joint Venture and Jefferies & Company, Inc. (incorporated by reference to
Exhibit 10.1.3 to Registration Statement).
10.1.3 Consent of BARRA, Inc. to the assignment to the Company of the interests of Jefferies &
Company, Inc. in the POSIT Joint Venture referenced in item 10.1.1 and rights in the
Software License Agreement referenced in item 10.1.2 (incorporated by reference to
Exhibit 10.1.4 to Registration Statement).
10.1.4 Joint Venture Agreement, dated May 31, 1990, between BARRA International (U.K.), Ltd. and
Jefferies Global Trading Incorporated (incorporated by reference to Exhibit 10.1.5 to
Registration Statement).
10.1.5 Exclusive Software License Agreement, dated May 31, 1990, between the Global POSIT Joint
Venture and Jefferies International Limited (incorporated by reference to Exhibit 10.1.6
to Registration Statement).
10.1.6 Consent of BARRA International (U.K.), Ltd. to the assignment to the Company of the
interests of Jefferies Global Trading Incorporated in the Global POSIT Joint Venture
referenced in item 10.1.5 (incorporated by reference to Exhibit 10.1.7 to Registration
Statement).
10.1.7 Form of QuantEX Software and Hardware License Agreement (incorporated by reference to
Exhibit 10.3.3 to Registration Statement).
10.2 Tax Sharing Agreement, dated March 15, 1994 between Jefferies Group, Inc. and the Company
(incorporated by reference to Exhibit 10.2.1 to Registration Statement).
10.2.1 Service Agreement, dated March 15, 1994, between Jefferies & Company, Inc. and the
Company (incorporated by reference to Exhibit 10.2.2 to Registration Statement).
10.2.2 Service Agreement, dated March 15, 1994, between W & D Securities, Inc. and the Company
(incorporated by reference to Exhibit 10.2.3 to Registration Statement).
10.2.3 Fully Disclosed Clearing Agreement, dated March 15, 1994, between Jefferies & Company,
Inc. and the Company (incorporated by reference to Exhibit 10.2.4 to Registration
Statement).
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- --------- ----------------------------------------------------------------------------------------- ---------------
10.2.4 Intercompany Borrowing Agreement between Jefferies Group, Inc. and the Company
(incorporated by reference to Exhibit 10.2.5 to Registration Statement).
10.2.5 Development Rights Agreement, dated March 15, 1994, between Jefferies Group, Inc. and the
Company (incorporated by reference to Exhibit 10.2.6 to Registration Statement).
10.2.6 Revenue Sharing Agreement, dated March 15, 1994, between the Company and Jefferies &
Company, Inc. (incorporated by reference to Exhibit 10.2.7 to Registration Statement).
10.2.7 Equipment Lease Agreement, dated March 15, 1994, between the Company, Jefferies &
Company, Inc. and Jefferies Group, Inc. (incorporated by reference to Exhibit 10.2.8 to
Registration Statement).
10.2.8 Form of Promissory Note between the Company and Jefferies Group, Inc. (incorporated by
reference to Exhibit 10.2.9 to Registration Statement).
10.3 Employment Agreement between the Company, ITG Inc. and Raymond L. Killian, Jr.
(incorporated by reference to Exhibit 10.3.2 to Registration Statement).
10.3.1 Agreement to Terminate Employment Agreement and Stock Options between the Company,
Raymond L. Killian, Jr. and Jefferies Group, Inc. (incorporated by reference to Exhibit
10.1 to the Quarterly Report on Form 10-Q for the quarter ended June 24, 1994).
10.3.1A Amendment No. 2 to Employment Agreement between Raymond L. Killian, Jr., the Company and
ITG Inc. (incorporated by reference to Exhibit 10.3.2A to the Annual Report on Form 10-K
for the year ended December 31, 1996).
10.3.2 Employment Agreement between the Company and Scott P. Mason (incorporated by reference to
Exhibit 10.3.18 to the Annual Report on Form 10-K for the year ended December 31, 1996).
10.3.2A Stock Option Agreement between the Company and Scott P. Mason (incorporated by reference
to Exhibit 10.3.3 to Registration Statement).
10.3.2B Agreement to Terminate Stock Option between the Company, Scott P. Mason and Jefferies
Group, Inc. (incorporated by reference to Exhibit 10.13 to the Quarterly Report on Form
10-Q for the quarter ended June 24, 1994).
10.3.3 Employment Agreement between the Company, ITG Inc. and Dale A. Prouty (incorporated by
reference to Exhibit 10.3.3 to Registration Statement).
10.3.3A Agreement to Terminate Employment Agreement, Phantom Equity Rights and Profits Bonus
Rights between the Company, Jefferies Group, Inc., Jefferies & Company, Inc. and Dale A.
Prouty (incorporated by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q
for the quarter ended June 24, 1994).
10.3.3B Amendment No. 2 to Employment Agreement between the Company, ITG Inc. and Dale A. Prouty
(incorporated by reference to Exhibit 10.3.18 to the Annual Report on Form 10-K for the
year ended December 31, 1996).
10.3.4 Form of Employment Agreement between the Company and Joshua D. Rose (incorporated by
reference to Exhibit 10.3.4 to Registration Statement).
10.3.4A Agreement to Modify Bonus Share between the Company and Joshua D. Rose (incorporated by
reference to Exhibit 10.3.13 to Registration Statement Number 33-76474 on Amendment
Number 3 to Form S-1 as filed with the Securities and Exchange Commission on April 21,
1994).
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- --------- ----------------------------------------------------------------------------------------- ---------------
10.3.5 Employment Agreement between the Company, ITG Inc. and Yossef A. Beinart (incorporated by
reference to Exhibit 10.3.6 to Registration Statement Number 33-76474 on Amendment Number
3 to Form S-1 as filed with the Securities and Exchange Commission on May 2, 1994).
10.3.5A Agreement to Terminate Phantom Equity Rights and Profits Bonus Rights between the
Company, Jefferies Group, Inc., Jefferies & Company, Inc. and Yossef Beinart
(incorporated by reference to Exhibit 10.5 to the Quarterly Report on Form 10-Q for the
quarter ended June 24, 1994).
10.3.6 Employment Agreement between the Company, ITG Inc. and Robert K. Laible (incorporated by
reference to Exhibit 10.3.5 to Registration Statement Number 33-76474 on Amendment Number
3 to Form S-1 as filed with the Securities and Exchange Commission on May 2, 1994).
10.3.6A Agreement to Modify Bonus Share between the Company and Robert K. Laible (incorporated by
reference to Exhibit 10.3.12 to Registration Statement Number 33-76474 on Amendment
Number 3 to Form S-1 as filed with the Securities and Exchange Commission on April 21,
1994).
10.3.7 Amendment to Form of Employment Agreement between the Company, ITG Inc. and Senior Vice
Presidents Electing to Reprice Stock Options (incorporated by reference to Exhibit
10.3.4A to the Annual Report on Form 10-K for the year ending December 31, 1996).
10.4 1994 Stock Option and Long-Term Incentive Plan of the Company (incorporated by reference
to Exhibit 10.3.1 to Registration Statement).
10.4.1A Amended and restated 1994 Stock Option and Long-Term Incentive Plan (incorporated by
reference to Exhibit 10.3.1B to the Annual Report on Form 10-K for the year ended
December 31, 1996).
10.4.1B Amended Non-Employee Directors' Stock Option Plan (incorporated by reference to Exhibit
10.3.1A to the Annual Report on Form 10-K for the year ended December 31, 1996).
10.4.2 Capital Accumulation Plan for key employees of Jefferies Group, Inc. (incorporated by
reference to Exhibit 10.3.7 to Registration Statement).
10.4.3 Form of Stock Option Agreement between the Company and certain employees of the Company
(incorporated by reference to Exhibit 10.3.3 to Registration Statement).
10.4.4 ITG Incentive Compensation Plan (incorporated by reference to Exhibit 10.3.16 to
Registration Statement Number 33-76474 on Amendment Number 3 to Form S-1 as filed with
the Securities and Exchange Commission on April 21, 1994).
10.4.5 Phantom Equity Agreement and Profits Bonus Rights Plan (incorporated by reference to
Exhibit 10.3.17 to Registration Statement Number 33-76474 on Amendment Number 3 to Form
S-1 as filed with the Securities and Exchange Commission on April 21, 1994).
10.4.6* Employee Stock Purchase Plan.
10.5 Lease, dated July 11, 1990, between AEW/LBA Acquisition Co. LLC (as successor to 400
Corporate Pointe, Ltd.) and Integrated Analytics Corporation, as assigned by Integrated
Analytics Corporation to the Company (incorporated by reference to Exhibit 10.3.3 to
Registration Statement).
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- --------- ----------------------------------------------------------------------------------------- ---------------
10.5.1 First Amendment to Lease, dated as of June 1, 1995, between AEW/LBA Acquisition Co. LLC
(as successor to 400 Corporate Pointe, Ltd.) and the Company (incorporated by reference
to Exhibit 10.5.7 to Annual Report of Form 10-K for the year ended December 31, 1996).
10.5.2* Second Amendment to Lease, dated as of December 5, 1996, between Arden Realty Limited
Partnership and the Company.
10.5.3* Lease, dated October 4, 1996, between Spartan Madison Corp. and the Company.
10.5.4* First Supplemental Agreement, dated as of January 29, 1997, between Spartan Madison Corp.
and the Company.
10.5.5* Second Supplemental Agreement, dated as of November 25, 1997, between Spartan Madison
Corp. and the Company.
10.5.6* Lease, dated March 10, 1995, between Boston Wharf Co. and the Company.
23* Consent of KPMG Peat Marwick LLP.
27.1* Financial Data Schedule.
27.2* Financial Data Schedule.
27.3* Financial Data Schedule.
- ------------------------
* Filed herewith