Back to GetFilings.com
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 COMMISSION FILE NUMBER 0--23644
------------------------
INVESTMENT TECHNOLOGY GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3757717
(State of incorporation) (IRS Employer Identification No.)
380 MADISON AVENUE, NEW YORK, NEW YORK (212) 588-4000
(Address of principal executive offices) (Registrant's telephone number, including
area code)
10017
(Zip Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
------------------------
COMMON STOCK, $0.01 PAR VALUE NASDAQ NATIONAL MARKET
(Title of class) (Name of exchange on which registered)
Aggregate market value of the voting stock held Number of shares outstanding of the
Registrant's
by non-affiliates of the Registrant at March Class of common stock at March 15, 1999:
15, 1999:
$168,832,991 18,630,817
------------------------
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 1999 Annual Meeting of Stockholders
(incorporated, in part, in Form 10-K Part III).
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
-----
PART I
Item 1. Business............................................................................ 4
Item 2. Properties.......................................................................... 14
Item 3. Legal Proceedings................................................................... 14
Item 4. Submission of Matters to a Vote of Security Holders................................. 15
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters................ 16
Item 6. Selected Financial Data............................................................. 17
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................... 19
Item 7A. Quantitative and Qualitative Disclosure about Market Risk........................... 27
Item 8. Financial Statements and Supplementary Data......................................... 28
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.......................................................................... 51
PART III
Item 10. Directors and Executive Officers of the Registrant.................................. 51
Item 11. Executive Compensation.............................................................. 51
Item 12. Security Ownership of Certain Beneficial Owners and Management...................... 51
Item 13. Certain Relationships and Related Transactions...................................... 51
PART IV
Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K................... 52
QUANTEX -REGISTERED TRADEMARK- ("QUANTEX") IS A REGISTERED TRADEMARK OF
INVESTMENT TECHNOLOGY GROUP, INC.
POSIT -REGISTERED TRADEMARK- ("POSIT") IS A REGISTERED SERVICE MARK OF THE POSIT
JOINT VENTURE.
SMARTSERVER IS A SERVICE MARK OF INVESTMENT TECHNOLOGY GROUP, INC.
2
FORWARD-LOOKING STATEMENTS
In addition to the historical information contained throughout this Annual
Report on Form 10-K, there are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),
and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). All statements regarding our expected future financial
position, results of operations, cash flows, dividends, financing plans,
business strategies, competitive positions, plans and objectives of management
for future operations, and concerning securities markets and economic trends are
forward-looking statements. Although we believe our expectations reflected in
such forward-looking statements are based on reasonable assumptions, there can
be no assurance that such expectations will prove to have been correct.
Important factors that could cause actual results to differ materially from the
expectations reflected in the forward-looking statements herein include, among
others, the actions of both current and potential new competitors, rapid changes
in technology, fluctuations in market trading volumes, market volatility,
changes in the regulatory environment, risk of errors or malfunctions in our
systems or technology, cash flows into or redemptions from equity funds, effects
of inflation, customer trading patterns, securities industry participants'
responses to Year 2000 issues, as well as general economic and business
conditions; securities, credit and financial and market conditions; adverse
changes or volatility in interest rates.
3
PART I
ITEM 1. BUSINESS.
Investment Technology Group, Inc. ("ITGI" or the "Company") was formed as a
Delaware corporation on March 10, 1994 and its principal subsidiaries include:
(1) ITG Inc., a broker-dealer in securities registered under the Exchange Act,
(2) Investment Technology Group International Limited, which is a 50% partner in
the ITG Europe joint venture, and (3) ITG Australia Holdings Pty Limited, which
is a 50% partner in ITG Pacific Holdings Pty Limited. We provide equity trading
services and transaction research to institutional investors and brokers.
We are a full service trade execution firm that uses technology to increase
the effectiveness and lower the cost of trading. With an emphasis on ongoing
research, we offer the following services:
- POSIT: an electronic stock crossing system.
- QuantEX: a decision-support, trade management and routing system.
- SmartServers: offers server based implementation of trading strategies.
- Electronic Trading Desk: an agency-only trading desk offering clients
efficient trading services accessing multiple sources of liquidity.
- ITG Platform: a PC-based routing and trade management system.
- ISIS: a set of pre- and post-trade tools for systematically analyzing and
lowering transaction costs.
- ITG/Opt: a computer-based equity portfolio selection system.
- Research: research, development, sales and consulting services to our
clients.
We generate revenues on a "per transaction" basis for all orders executed.
Orders are delivered to us from our "front-end" software products, QuantEX and
ITG Platform, as well as vendors' front-ends and directcomputer-to-computer
links to customers. Orders may be executed on (1) POSIT, (2) the New York Stock
Exchange, (3) certain regional exchanges, (4) market makers, (5) electronic
communications networks and (6) alternative trading systems.
POSIT
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 serve the active trading and broker-dealer community. There are
approximately 490 clients currently using POSIT, 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 clients enter buy
and sell orders to trade single stocks and portfolios of equity securities among
themselves in a confidential environment. Orders may be placed in the system
directly via QuantEX and ITG Platform and computer-to-computer links or
indirectly via the Electronic Trading Desk, which then enters the orders in the
central computer. We also work in partnership with vendors of other popular
trading systems, allowing users the flexibility to route orders directly to
POSIT from trading products distributed by Bridge Information Systems, BRASS,
Bloomberg and others.
POSIT currently accepts orders for approximately 18,000 different equity
securities, but may be modified, as the need arises, to include additional
equity securities registered pursuant to Section 12 of the Exchange Act. An
algorithm is run at scheduled times to find the maximum possible number of buy
and sell orders that match or "cross." Typically, there is an imbalance between
the number of shares
4
available to be bought or sold in the system. When this occurs, shares are
allocated pro rata across participants, resulting in partial execution. POSIT
has been designed to allow clients trade execution flexibility. Clients may
specify constraints on the portion of a portfolio that trades, such as the
requirement that net cash resulting from buys and sells remain within specified
constraints. A client may also specify a minimum number of shares to be executed
for a given order. POSIT prices trades at the midpoint of the best bid and offer
on the primary market for each security at the time of the cross, based on
information provided directly to the system by a third-party data vendor. There
are seven scheduled crosses every business day: six regular crosses scheduled
hourly, on the hour, between 10:00 a.m. and 3:00 p.m. (Eastern time) and an
American Depositary Receipts cross at 8:45 a.m. (Eastern time). Each scheduled
cross is normally executed within a five minute window selected randomly by the
system.
POSIT provides the following significant benefits to clients:
- Confidential matching of buy and sell orders 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.
- Access to the substantial pool of liquidity represented by POSIT orders.
- Clients pay a low transaction fee on completed transactions relative to
the industry average of 5 to 6 cents per share. POSIT generates revenue
from transaction fees charged on each share crossed through the system.
- Immediately after each cross, the system electronically provides clients
with reports of matched and unmatched (residual) orders. Clients can then
execute residual orders by traditional means or take advantage of the
Electronic Trading Desk services (described below).
Since December 1997, we have offered POSIT 4. POSIT 4 gives POSIT users the
option of customizing their trading objective and specifying additional
constraints, while preserving the functionality of the existing POSIT system.
This capability is referred to collectively as a POSIT 4 "strategy." This
capability allows orders that might otherwise be ineligible for POSIT to
participate in the match. POSIT 4 strategies include ResRisk, which allows users
to control the risk of the unexecuted "residual" portfolio, and Pairs, which
makes execution of one trade contingent on the execution of another, at or
better than a given relative valuation. Portfolio funding, liquidation,
restructuring and rebalancing are some of the types of transactions that are
appropriate for execution using ResRisk. Risk arbitrage, statistical arbitrage
and portfolio substitution trades are examples of transactions that can be
implemented using the Pairs strategy. We also implement custom applications upon
request. Total volume attributable to POSIT 4 in 1998 is 66 million shares. We
have obtained a patent on the technology underlying POSIT 4.
5
The following graph illustrates the average daily volume of shares crossed
on POSIT:
AVERAGE DAILY POSIT SHARE VOLUME
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
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
1998 23,151,105
QUANTEX
QuantEX is our trade management system, an advanced tool for technologically
sophisticated clients transacting large volumes of orders. QuantEX helps clients
manage efficiently every step in the trading process: from decision-making to
execution to tracking of trade list status. From a dedicated 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 rule-based decision support system that allows traders to
quantify their trading processes. It is designed to implement each client's
trading styles and strategies and to apply them to 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 so 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 our proprietary research,
including pre-trade, post-trade and intra-day analytical tools. QuantEX has
access to the ITG Data Center, which is a comprehensive historical database that
provides a variety of derived analytics based upon raw historical data. Our
support specialists translate the trading criteria developed by the client into
a set of trading rules for trading securities, which are then loaded into
QuantEX. QuantEX applies the client'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. These
rules typically serve as a guide in support of a client's trading decisions.
Additionally, QuantEX supports the ability to implement these trading decisions
automatically via an auto-trading strategy.
6
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, including the New York, American and certain regional stock exchanges,
the Nasdaq National Market, POSIT, the Electronic Trading Desk, over-the-counter
market-makers, Bloomberg's Tradebook and selected broker-dealers. We intend to
create links to additional electronic communications networks and other
liquidity sources where appropriate. 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.
Our 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. Our support team works closely with each
client to develop trading strategies and rules, explore new trading approaches,
provide system integration services and implement system upgrades and
enhancements.
Revenues are generated through commissions and transaction fees attached to
each trade electronically routed through QuantEX to the many destinations
available from the application. We do not derive royalties from the sale or
licensing of the QuantEX software.
SMARTSERVERS
SmartServers allow clients to send orders to a computer for execution using
a designated trading strategy. Clients may send orders via the Platform and
QuantEX, via direct connections and via our Electronic Trading Desk.
SmartServers implement a trading strategy in an automated fashion and thereby
serve as an additional trading resource, allowing clients to focus their time
and attention on other trading issues.
We have introduced our first server-based trading strategy with the VWAP
SmartServer. The VWAP SmartServer is designed to allow clients to direct their
orders to us to be executed in a manner designed to closely track a security's
volume-weighted average price, or VWAP, throughout the trading day. The VWAP
SmartServer analyzes trade size and liquidity and determines the appropriate
order size and order price to approximate the VWAP. Clients may choose to
execute relative to the VWAP price for the entire trading day, or for some
subset of that trading day.
ELECTRONIC TRADING DESK
The Electronic Trading Desk is a full-service agency execution group that
specializes in the use of our proprietary products, including extensive use of
POSIT for trade execution. For clients that do not send orders electronically to
POSIT, our account executives receive orders for POSIT matches by telephone, fax
or e-mail. The desk accepts orders until a POSIT match begins and after
completion of the match execution reports are given verbally to clients who have
placed verbal or fax orders with the desk.
In addition to order management services for POSIT, the Electronic Trading
Desk provides agency execution services. QuantEX and Platform clients deliver
lists of orders electronically to our desk and, as orders are executed by the
desk, reports are automatically delivered electronically to the client's
terminal. Trading desk personnel are thereby able to assist customers with
decision support analyses generated by ITG Platform or QuantEX and with the
execution of trades. Clients give traders single stock orders or lists of orders
to work throughout the day as well as unfilled orders that remain due to order
imbalances in POSIT matches.
7
For order completion outside of POSIT match windows, the Electronic Trading
Desk utilizes numerous sources of liquidity to complete the trade. The trading
desk will actively seek the contra side of client orders by soliciting interest
among other clients, use QuantEX to route the orders to multiple markets,
including primary exchanges, regional exchanges, over-the-counter market makers
and electronic communications networks, or use our active order traders to
execute the trade with floor brokers or over-the-counter brokers.
The Portfolio Trading Group of our desk focuses on agency-only list and
program trading. By employing a step-by-step process that leverages technology
and access to multiple sources of liquidity, the Portfolio Trading Group seeks
to systematically achieve high quality execution for the client. A client
program is evaluated with a pre-trade analysis to determine aggregate portfolio
characteristics, liquidity ranking and market impact, and to quantify risk. The
group implements a number of sophisticated trading strategies using QuantEX to
meet execution objectives on an agency or agency incentive basis. After the
execution is completed, we provide the client with comprehensive reports
analyzing execution results utilizing ITG Research products.
ITG PLATFORM
ITG Platform, introduced in the first quarter of 1996, provides clients with
seamless connectivity from their desktop to a variety of execution destinations,
such as POSIT, the Electronic Trading Desk, our SmartServers, New York Stock
Exchange and American Stock Exchange via SuperDOT, and the Nasdaq National
Market and other over-the-counter market makers. We intend to create links to
additional electronic communications networks and other liquidity sources where
appropriate. Orders may be corrected or canceled electronically, and all reports
are delivered electronically back to the ITG Platform. The ITG Platform also
supports special trading interfaces as needed by POSIT 4 applications.
Allocation information can be associated with executions in the ITG Platform and
delivered to us electronically. ITG Platform has access to historical data
through the ITG Data Center, including a wide array of analytics, such as
average historical share volumes, dollar volumes, volatility and historical
spread statistics.
The ITG Platform was intended for broad distribution to institutional
clients, so it was designed to run in conventional PC environments alongside
other applications, and be inexpensive to install, maintain and support.
Many technical features support these goals:
- Other PC applications can interact with the ITG Platform using the
Financial Information eXchange, or FIX, data messaging protocol or using
"drag and drop."
- ITG Platform incorporates a spreadsheet package, so users can extend their
trade blotter with custom calculations.
- Custom execution reports can be created to fit each user's requirements.
- ITG Platform can access Bridge and ILX quote data if those systems are
used by the client.
- New versions of ITG Platform are distributed automatically to client sites
and installed without user or our intervention.
As of December 31, 1998, there were 507 installations of ITG Platform at 266
client sites.
"ISIS" PRE- AND POST-TRADE ANALYSIS
Accessed through QuantEX, ISIS is an equity pre- and post-trade analysis
system. Via the ISIS facility, QuantEX users can request both aggregate and
stock-by-stock liquidity reports for a trade portfolio prior to and during
execution. Clients can generate standard reports or use a report writer to
8
design custom reports. Reports can be viewed, printed or saved to a file.
Certain elements of these reports can also be displayed directly on the QuantEX
execution page and referenced in QuantEX strategies. These pre-trade analyses
help QuantEX users make decisions about how best to trade a portfolio, for
example by helping identify the most difficult trades for special handling and
by providing a reference point for evaluating principal trade pricing.
The ISIS post-trade reporting facility allows QuantEX users to compare
actual executed prices to user-selected benchmark prices in order to help assess
trade execution quality. Available benchmarks include the volume-weighted
average price, closing price and opening price. Post-trade reports generated by
ISIS have the same output options as the pre-trade facility, namely on screen,
to a printer or to a file.
ITG/OPT
ITG/Opt is a computer-based equity portfolio selection system that employs
advanced optimization techniques to help investors construct portfolios that
meet their investment objectives. Special features of the system make it
particularly useful to "long/short" and taxable investors, as well as any
investor seeking to control transaction costs. ITG/Opt is usually delivered as a
"turnkey" system that includes software and, in some cases, hardware and data.
Included in the service is telephone and on-site support to assist in training
and integration of the system with the user's other investment systems and
databases. In addition to its core portfolio construction capabilities, ITG/Opt
has powerful backtesting and batch scheduling features that permit efficient
researching of new or refined investment strategies. The system, which is
targeted at highly sophisticated investment applications, is offered primarily
on a value-added basis to our largest clients. Typically, portfolios that are
constructed using ITG/Opt are executed via ITG, using one or more execution
services, such as QuantEX, the Electronic Trading Desk and POSIT 4.
ITG RESEARCH
In addition to its role in the firm's overall research and development
effort, Research provides both sales and consulting services to our clients and
prospects. Taken together, these activities are a key component of our overall
relationship development and maintenance activities.
In its sales capacity, Research introduces our clients and prospects to the
full range of products and services offered by the firm and provides information
about features, pricing and technical/ functional specifications. The sales
process includes development of an in-depth understanding of client practices
and requirements and the design and presentation of integrated solutions based
on our products.
Consulting encompasses a set of value-added services for the benefit of our
clients. These services break down into two main categories: support for our
products and provision of quantitative analysis. The products supported by
Research are QuantEX, ISIS, Platform, POSIT 4 and ITG/Opt. Support activities
include trading strategy design and implementation, system integration, training
and coordination of technical support. Quantitative analysis covers a broad
range of activities such as transaction cost analysis, investment strategy
simulations and provision of historical time series of proprietary analytics. As
part of its analysis activities, Research publishes and distributes studies on
topics of interest to its clients. In the same way users of fundamental research
compensate the traditional brokerages that provide such research (i.e.,
directing commissions to such brokerage house), our clients reward the firm for
these value-added research services.
ITG EUROPE
We are pursuing the international market in a variety of ways, through
joint-ventures with strategic partners and the development of specially-tailored
versions of our services. In the fourth quarter of
9
1998, we and Societe Generale finalized a 50/50 joint venture through the
creation of Investment Technology Group (Europe) Limited. On November 18, 1998,
ITG Europe launched a new agency brokerage operation that includes the operation
of a European version of the POSIT system, which currently matches buyers and
sellers of U.K.-listed equities twice daily, at 11:00 a.m. and 3:00 p.m., London
time.
AUSTRALIAN POSIT
In 1997, we and Burdett, Buckeridge & Young finalized a 50/50 joint venture
through the creation of ITG Australia Limited, a new international brokerage
firm that applies our 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 Burdett, one of
Australia's leading brokerage firms. Through this joint venture we are pursuing
U.S. business from Australian investors and providing U.S. clients with access
to the Australian marketplace.
CANADIAN QUANTEX
We have developed a version of QuantEX for the Canadian markets. This
software is licensed on a perpetual, exclusive, royalty-free basis to VERSUS
Technologies, Inc., a Canadian technology-focused trade automation firm based in
Toronto. The period of exclusivity for the Canadian QuantEX license expires on
December 31, 1999. Pursuant to this license and a series of transactions with
RBC Dominion Securities, the predecessor owner of the VERSUS assets, we received
a minority interest in VERSUS. We and VERSUS have also entered into three
agreements for trade execution by us in POSIT and other United States markets:
(a) a routing agreement pursuant to which VERSUS routes orders of Canadian
registered brokers to us, (b) an introducing broker agreement pursuant to which
VERSUS's registered broker affiliate sends institutional orders to us and (c) an
introducing broker agreement pursuant to which VERSUS's registered broker
affiliate sends retail orders to us.
ARIZONA STOCK EXCHANGE
We are the executing broker for all transactions executed on the Arizona
Stock Exchange. We perform this function as a courtesy to our clients. We share
revenues generated from these transactions with the Arizona Stock Exchange.
REGULATION
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. The 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,
principally the National Association of Securities Dealers, Inc. and national
securities exchanges. The National Association of Securities Dealers has been
designated by the SEC as our self-regulatory organization. The self-regulatory
organizations 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
Inc. 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 clients' funds and securities, capital
structure of securities firms, record-keeping and conduct of directors, officers
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, self-regulatory organizations and
state securities commissions may conduct administrative proceedings,
10
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 clients and the securities markets, rather than the protection of
creditors and stockholders of broker-dealers.
ITG Inc. is required by law to belong to the Securities Investor Protection
Corporation. In the event of a broker-dealer's insolvency, the Securities
Investor Protection Corporation fund provides protection for client accounts up
to $500,000 per customer, with a limitation of $100,000 on claims for cash
balances.
REGULATION ATS
Since the formation of the POSIT joint venture, POSIT has operated under a
no-action letter from the SEC staff that it would take no enforcement action if
POSIT were operated without registering as an exchange. As a result, POSIT has
not been registered with the SEC as an exchange, although ITG Inc. is registered
as a broker-dealer and is subject to regulation as such. Material changes to
POSIT currently require prior notice to the SEC pursuant to the conditions of
the no-action letter and under Rule 17a-23 under the Exchange Act. On December
2, 1998, the SEC adopted Regulation ATS, which repeals Rule 17a-23 and
establishes a new regulatory framework for alternative trading systems such as
POSIT. Regulation ATS will allow alternative trading systems to choose to
register as exchanges or as broker-dealers and will require compliance with
informational requirements that are similar to Rule 17a-23. However, POSIT will
no longer be subject to the restrictions of the no-action letter. Upon
effectiveness of Regulation ATS on April 21, 1999, we anticipate that we will
continue to operate POSIT as part of our broker-dealer operations and will not
register POSIT as an exchange. There can be no assurance that the SEC will not
in the future seek to impose more stringent regulatory requirements on the
operation of alternative trading 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 alternative
trading systems.
NET CAPITAL REQUIREMENT
As a registered broker-dealer, ITG Inc. is subject to the SEC's uniform net
capital rule. The net capital rule 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 prohibits a broker-dealer doing business with the
public from allowing the aggregate amount of its indebtedness to exceed 15 times
its adjusted net capital or, alternatively, its adjusted net capital to be less
than 2% of its aggregate debit balances (primarily receivables from clients and
broker-dealers) computed in accordance with the net capital rule. We use the
latter method of calculation.
A change in the net capital rule, imposition of new rules or any unusually
large charge against capital could limit certain operations of ITG Inc., such as
trading activities that require the use of significant amounts of capital.
As of December 31, 1998, ITG Inc. had net capital of $72.0 million, which
exceeded minimum net capital requirements by $71.7 million. Jefferies Group,
Inc. ("Jefferies Group") and we have previously announced plans to separate
Jefferies & Company, Inc. ("Jefferies & Company") and other Jefferies Group
subsidiaries from our company through a spin-off and upstream merger and the
related transactions. If the spin-off and upstream merger and the related
transactions had been completed on December 31, 1998, on a pro forma basis ITG
Inc. would have had regulatory net capital of $10 million, which includes pro
forma borrowing of approximately $1.4 million. Based on a closing of the
upstream merger of March 31, 1999, we estimate that ITG Inc. will have excess
net regulatory
11
capital of approximately $20 million. In addition, we have arranged a $20
million revolving credit facility that we will be entitled to draw on to
increase net regulatory capital. For a discussion of these transactions and the
anticipated effects on operating and regulatory capital, see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources and--Jefferies Group and ITGI Plan
to Separate into Two Independent Companies". Although we believe that the
combination of our existing net regulatory capital, operating cash flows and the
revolving credit facility will be sufficient to meet regulatory capital
requirements, a shortfall in net regulatory capital would have a material
adverse effect on our business and our results of operations.
CREDIT RISK
Although ITG Inc. is registered as a broker-dealer, we generally do not
perform traditional broker-dealer services. We do not act as a market-maker with
respect to any securities or otherwise as a principal in any securities
transactions; we act only on an agency basis. Therefore, we do not have exposure
to credit risks in the way that traditional broker-dealers have such exposure.
The relatively low credit risk of our businesses is reflected in the minimal net
capital requirements imposed on ITG Inc. as a broker-dealer.
LICENSE AND RELATIONSHIP WITH BARRA
In 1987, Jefferies & Company and BARRA Inc. formed a joint venture for the
purpose of developing and marketing POSIT. In 1993, Jefferies & Company assigned
all of its rights relating to the joint venture and the license agreement,
discussed below, to us.
The technology used to operate POSIT is licensed to us pursuant to a
perpetual license agreement between us and the joint venture. The license
agreement grants us 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. We pay 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 us on each share crossed through POSIT. For the years ended December
31, 1998, 1997 and 1996, BARRA received aggregate royalty payments from the
joint venture of $15.2 million, $9.8 million, and $8.8 million, respectively,
under the license agreement. Under the terms of the joint venture, we 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 us of certain covenants, the performance of which are all
within our control. Although we do not believe that we will experience
difficulty in complying with our obligations under the license agreement, any
termination of the license agreement resulting from an uncured default would
have a material adverse effect on us.
Under the license agreement and the terms of the joint venture, BARRA
continues to provide certain support services to us 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 our 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 us and
Burdett 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. The POSIT joint
12
venture licensed the POSIT software to Prebon. POSIT-FRA provides a confidential
electronic environment where major financial institutions can match specific
sets of forward rate agreements contracts to offset interest rate risk, a
condition that is pervasive in interest rate swap portfolios.
In the fourth quarter of 1998, we finalized the formation of ITG Europe with
Societe Generale. The POSIT joint venture has licensed to ITG Europe the POSIT
software.
COMPETITION
The automated trade execution and analysis services offered by us compete
with services offered by leading brokerage firms and transaction processing
firms, and with providers of electronic trading and trade order management
systems and financial information services. POSIT also competes with various
national and regional securities exchanges and execution facilities, Nasdaq and
electronic communications networks such as Instinet, for trade execution
services. Many of our competitors have substantially greater financial, research
and development and other resources. We believe that our services compete on the
basis of access to liquidity, transaction costs, market impact cost, timeliness
of execution and probability of trade completion. Although we believe that
POSIT, QuantEX, ITG Platform and the Electronic Trading Desk and Research
services have established certain competitive advantages, our ability to
maintain these advantages will require continued investment in the development
of our services, additional marketing activities and customer support services.
There can be no assurance that we will have sufficient resources to continue to
make this investment, that our competitors will not devote significantly more
resources to competing services or that we will otherwise be successful in
maintaining our current competitive advantages. In addition, we cannot predict
the effect that changes in regulation may have on the competitive environment.
In particular, the adoption of Regulation ATS may make it easier for securities
exchanges, Nasdaq or others to establish competing trading systems.
RESEARCH AND PRODUCT DEVELOPMENT
We believe that fundamental changes in the securities industry have
increased the demand for technology-based services. We devote a significant
portion of our resources to the development and improvement of these services.
Important aspects of our research and development effort include enhancements of
existing software, the ongoing development of new software and services and
investment in technology to enhance our efficiency. The software programs, which
are incorporated into our services, are subject, in most cases, to copyright
protection. Research and development costs were $11.0 million, $8.4 million and
$6.8 million for 1998, 1997 and 1996, respectively.
In connection with such research and product development and capital
expenditures to improve other aspects of our business, we incur 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 reduction in revenues, we may not reduce such expenses quickly and, as
a result, we could experience reduced profitability or losses. Conversely,
sudden surges in transaction volumes can result in increased profit and profit
margin. To ensure that we have the capacity to process projected increases in
transaction volumes, we have 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, we have also made
substantial capital and operating expenditures to enhance future growth
prospects.
We work closely with BARRA on the development of POSIT enhancements. We
expect to continue this level of investment to improve existing services and
continue the development of new services.
13
DEPENDENCE ON PROPRIETARY INTELLECTUAL PROPERTY; RISKS OF INFRINGEMENT
Our success is dependent, in part, upon our proprietary intellectual
property. We generally rely upon patents, copyrights and trademarks to establish
and protect our rights in our proprietary technology, methods and products. A
third party may still try to challenge, invalidate or circumvent the protective
mechanisms that we select. We cannot assure that any of the rights granted under
any patent, copyright or trademark we may obtain will protect our competitive
advantages. In addition, the laws of some foreign countries may not protect our
proprietary rights to the same extent as the laws of the United States.
There are numerous patents in the computer and financial industries and new
patents are being issued at a rapid rate. Therefore, it is not economically
practicable to determine in advance whether any of our products or any of its
components or a service or method infringes the patent rights of others. It is
likely that from time to time, we will receive notices from others of claims or
potential claims of intellectual property infringement or we may be called upon
to defend a joint venture partner, customer, vendee or licensee against such
third party claims. Responding to these kinds of claims, regardless of merit,
could consume valuable time, result in costly litigation or cause delays, all of
which could have a material adverse effect on us. Responding to these claims
could also require us to enter into royalty or licensing agreements with the
third parties claiming infringement. Such royalty or licensing agreements, if
available, may not be available on terms acceptable to us.
EMPLOYEES
As of December 31, 1998, we employed 261 personnel.
ITEM 2. PROPERTIES
Our principal offices are located at 380 Madison Avenue in New York City
where we occupy the entire 4(th) floor or approximately 44,704 square feet of
office space. In anticipation of future expansion we have leased a portion of
the 5(th) floor (approximately 12,726 square feet of office space). This space
is currently being sub-let. The lease payment as compared to the rental income
will have an immaterial effect upon our operating results. The fifteen-year
lease term for both the fourth and fifth floors expire in 2012.
We also maintain a research, development and technical support services
facility in Culver City, California where we occupy approximately 44,316 square
feet of office space. We lease the California facility pursuant to a ten-year
lease agreement that expires in December 2005.
Additionally, we also maintain a "hot" backup and regional office for
Financial Engineering Research and QuantEX support in Boston, Massachusetts
where we occupy approximately 10,588 square feet of office space. The ten-year
lease term for this space expires in 2005.
ITEM 3. LEGAL PROCEEDINGS
In 1998, we received a "30-day letter" proposing certain adjustments which,
if sustained, would result in a tax deficiency of approximately $9.6 million
plus interest. The adjustments proposed relate to (i) the disallowance of
deductions taken in connection with the termination of certain compensation
plans at the time of our initial public offering in 1994 and (ii) the
disallowance of tax credits taken in connection with certain research and
development expenditures. We believe that the tax benefits in question were
taken properly and intend to vigorously contest the proposed adjustments. Based
on the facts and circumstances known at this time, we are unable to predict when
this matter will be resolved or the costs associated with its resolution.
In February 1999, we became aware of patents purportedly owned by Belzberg
Financial Markets & News International Inc. and Sydney Belzberg, an officer of
that company (the "Belzberg
14
Patents"). One or more of the Belzberg Patents may relate to the devices, means
an or methods that we and/or customers, licensees or joint venture partners use
in the conduct of business. On March 5, 1999, a Canadian licensee of some of our
technology, received a letter asserting that the licensee was infringing one of
the Belzberg Patents. The licensee has denied the claims of infringement and has
asserted that the Belzberg Patent at issue is invalid or unenforceable. Under
certain conditions, we may have a duty to defend or indemnify the licensee for
any costs or damages arising out of an infringing use of the technology we have
licensed to them. We are monitoring the matter and may participate in any
challenge to the Belzberg Patent the licensee may make.
We are unaware of any actual claims of patent infringement leveled against
us or any of our customers or joint venture partners by any of the title owners
of the Belzberg Patents. Based upon our review to date we believe that any such
claims arising out of the Belzberg Patents would be without merit and we would
vigorously defend any such claim, including, if warranted, initiating legal
proceedings. However, intellectual property disputes are subject to inherent
uncertainties and there can be no assurance that any potential claim would be
resolved favorable to us or that it would not have a material adverse affect on
us. We will monitor the Belzberg Patent situation and take action accordingly.
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, 1998.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
COMMON STOCK DATA
Our common stock is quoted on the Nasdaq National Market under the symbol
"ITGI". In connection with the spin-off and upstream merger and the related
transactions, we have applied for listing of New ITGI common stock on the New
York Stock Exchange under the symbol "ITG."
The following table sets forth, for the periods indicated, the range of the
high and low closing sales prices per share of our common stock as reported on
the Nasdaq National Market.
HIGH LOW
--------- ---------
1998
First Quarter............................................................ $ 37.50 $ 24.38
Second Quarter........................................................... 35.50 25.50
Third Quarter............................................................ 34.00 27.25
Fourth Quarter........................................................... 62.06 18.50
1997
First Quarter............................................................ 23.75 18.38
Second Quarter........................................................... 26.88 17.88
Third Quarter............................................................ 32.00 26.31
Fourth Quarter........................................................... 31.25 26.25
On March 15, 1999, the closing sales price per share for our common stock as
reported on the Nasdaq National Market was $46.50. On March 15, 1999, we believe
that our common stock was held by approximately 1,500 stockholders of record or
through nominee in street name accounts with brokers.
We have not paid a dividend since May 4, 1994. Prior to and subject to the
satisfaction of the conditions to the upstream merger, we will pay a special
cash dividend of $4.00 per share to each stockholder of record as of April 20,
1999. Our revolving credit facillity restricts our ability to pay dividends. See
"Management's Discussion of Financial Condition and Results of
Operations--Liquidity and Capital Resources." Our dividend policy following
consummation of the upstream merger will be to retain earnings to finance the
operations and expansion of our businesses. Other than the special cash
dividend, we do not anticipate paying any cash dividends on our common stock in
the foreseeable future.
16
ITEM 6. SELECTED FINANCIAL DATA
The selected Consolidated Statement of Operations data and the Consolidated
Statement of Financial Condition data presented below as of and for each of the
years in the five-year period ended December 31, 1998, are derived from our
consolidated financial statements, which financial statements have been audited
by KPMG LLP, independent auditors. Earnings per share information prior to 1997
has been retroactively restated to conform with the FASB SFAS No. 128, EARNINGS
PER SHARE. Such data should be read in connection with the consolidated
financial statements contained on pages 28 through 51.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1998 1997 1996 1995 1994(1)
---------- ---------- ---------- --------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenues................................................ $ 212,205 $ 137,042 $ 111,556 $ 72,381 $ 56,716
Total expenses................................................ 131,270 89,782 70,555 47,493 69,106
---------- ---------- ---------- --------- ----------
Income (loss) before income taxes............................. 80,935 47,260 41,001 24,888 (12,390)
Income tax expense (benefit).................................. 37,541 20,343 17,666 9,983 (4,529)
---------- ---------- ---------- --------- ----------
Net income (loss)............................................. $ 43,394 $ 26,917 $ 23,335 $ 14,905 $ (7,861)
---------- ---------- ---------- --------- ----------
---------- ---------- ---------- --------- ----------
Basic net earnings (loss) per share of common stock........... $ 2.36 $ 1.48 $ 1.28 $ 0.81 $ (0.45)
---------- ---------- ---------- --------- ----------
---------- ---------- ---------- --------- ----------
Diluted net earnings (loss) per share of common stock......... $ 2.25 $ 1.42 $ 1.26 $ 0.81 $ (0.45)
---------- ---------- ---------- --------- ----------
---------- ---------- ---------- --------- ----------
Basic weighted average shares outstanding (in millions)....... 18.4 18.2 18.3 18.5 17.5
Diluted weighted average shares and common stock equivalents
outstanding (in millions)................................... 19.3 18.9 18.6 18.5 17.5
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION DATA:
Total assets.................................................. $ 180,512 $ 113,641 $ 82,798 $ 55,318 $ 38,354
Total stockholders' equity.................................... $ 143,709 $ 93,763 $ 67,093 $ 45,479 $ 31,893
OTHER SELECTED FINANCIAL DATA:
Revenues per trading day (in thousands)....................... $ 842 $ 542 $ 439 $ 287 $ 225
Shares executed per day (in millions)......................... 43 27 22 15 10
Revenues per average number of employees (in thousands)....... $ 888 $ 733 $ 814 $ 689 $ 675
Average number of employees................................... 239 187 137 105 84
Total number of customers(2).................................. 535 452 417 354 274
POSIT....................................................... 490 414 396 330 253
QuantEX..................................................... 54 50 55 81 58
Platform.................................................... 266 138 36 N/A N/A
Total number of customer installations:
QuantEX..................................................... 144 138 109 97 78
Platform.................................................... 507 204 67 N/A N/A
Return on average stockholders' equity........................ 37.4% 33.9% 45.5% 39.3% (35.0)%
Book value per share.......................................... $ 7.73 $ 5.15 $ 3.68 $ 2.47 $ 1.72
Tangible book value per share................................. $ 7.66 $ 5.04 $ 3.54 $ 2.27 $ 1.52
Price to earnings ratio using diluted net earnings per share
of common stock............................................. 27.6 19.7 15.3 11.4 N/A
17
The following graph represents the number of shares ITG Inc. executed as a
percentage of the market volume in the U.S. market.( 3)
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
ITG VOLUME AS A PERCENTAGE OF MARKET VOLUME
1993 0.0153
1994 0.017
1995 0.019
1996 0.0226
1997 0.0224
1998 0.0294
- ------------------------------
(1) In connection with our 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 Inc. and an annual
profits bonus component) and non-compensatory ITG stock options (on 10% of
the outstanding shares of ITG Inc. 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. Prior to December 31, 1993, we
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 us and it was to be applied
by the us 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.
(2) Customers include those clients who have generated revenues in each year
in excess of $1,000.00.
(3) 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 Nasdaq. Market volume excludes ITG shares executed.
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion and analysis along with our
financial statements, including the notes.
GENERAL
We are a leading provider of automated securities trade execution and
analysis services to institutional equity investors. We are a full-service
execution firm that utilizes transaction processing technology to increase the
effectiveness and lower the cost of institutional and other trading. We generate
substantially all of our revenues from a single line of business consisting of
the following four services:
- POSIT, an electronic stock crossing system;
- QuantEX, a decision-support, trade management and routing system;
- ITG Platform, a PC-based routing and trade management system; and
- Electronic Trading Desk, an agency-only trading desk offering clients
efficient trading services with multiple sources of liquidity.
REVENUES primarily consist of commissions and fees from customers' use of
our transaction processing and analysis services. Because these commissions and
fees are paid on a per-transaction basis, revenues fluctuate from period to
period depending on the volume of securities traded through our services.
EXPENSES consist of compensation and employee benefits, transaction
processing, software royalties, occupancy and equipment, consulting,
telecommunications and data processing services, net loss on long-term
investments, spin-off costs and other general and administrative expenses.
Compensation and employee benefits expenses include base salaries, bonuses,
employment agency fees, part-time employee compensation, commissions paid to
employees of Jefferies Group, fringe benefits, including employer contributions
for medical insurance, life insurance, retirement plans and payroll taxes,
reduced by the employee portion of capitalized software. Transaction processing
expenses consist of floor brokerage and clearing fees. Software royalties
expenses are payments to our POSIT joint venture partner, BARRA. Occupancy and
equipment expenses include rent, depreciation, amortization of leasehold
improvements, maintenance, utilities, occupancy taxes and property insurance.
Consulting expenses are fees and commissions paid to non-employee consultants
for equity research, product development and other activities.
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. Net loss on
long-term investments includes gains on the sale of equity investments, as
offset by amortization of goodwill, equity loss pickup and initial start-up
costs. Spin-off costs include legal, accounting, consulting and various other
expenses related to the Company's proposed spin-off and upstream merger and the
related transactions. Other general and administrative expenses include
amortization of goodwill, legal, audit, tax and promotional expenses.
19
RESULTS OF OPERATIONS
The table below sets forth certain items in the statement of income
expressed as a percentage of revenues for the periods indicated:
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Revenues................................................................................. 100.0% 100.0% 100.0%
Expenses.................................................................................
Compensation and employee benefits..................................................... 24.3 22.2 22.5
Transaction processing................................................................. 12.7 15.6 14.1
Software royalties..................................................................... 7.2 7.2 7.9
Occupancy and equipment................................................................ 5.6 6.7 5.5
Consulting............................................................................. 1.1 1.5 2.2
Telecommunications and data processing services........................................ 3.8 4.8 4.3
Net loss on long-term investments...................................................... 0.1 0.2 0.0
Spin-off costs......................................................................... 0.9 0.0 0.0
Other general and administrative....................................................... 6.2 7.3 6.8
Total expenses................................................................... 61.9 65.5 63.2
Operating income......................................................................... 38.1 34.5 36.8
Income tax expense....................................................................... 17.7 14.8 15.8
Net income............................................................................... 20.4 19.6 20.9
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES
Total revenues increased $75.2 million, or 54.9%, from $137.0 million to
$212.2 million. The number of trading days were 252 in 1998 compared to 253 in
1997. Revenues per trading day increased by $300,000, or 55.5%, from $542,000 to
$842,000. Revenues per employee increased $182,000, or 28.8%, from $631,000 to
$813,000. The increases were attributable to increases in the number of our
customers and increases in trading volume by our existing customers. Revenues
from the Electronic Trading Desk increased $19.5 million, or 64.9%, from $30.1
million to $49.6 million. Number of shares crossed on the POSIT system increased
2.1 billion, or 56.8%, from 3.7 billion to 5.8 billion. POSIT revenues in turn
increased $41.6 million, or 55.2%, from $75.4 million to $117.0 million. QuantEX
revenues increased $12.0 million, or 39.9%, from $30.1 million to $42.1 million.
EXPENSES
Total expenses increased $41.5 million, or 46.2%, from $89.8 million to
$131.3 million.
20
The following table itemizes expenses by category (in thousands):
YEAR ENDED DECEMBER
31,
--------------------
1998 1997 CHANGE % CHANGE
--------- --------- --------- -----------
Compensation and employee benefits................................... $ 51,462 $ 30,479 $ 20,983 68.8%
Transaction processing............................................... 26,920 21,413 5,507 25.7
Software royalties................................................... 15,247 9,848 5,399 54.8
Occupancy and equipment.............................................. 11,886 9,204 2,682 29.1
Consulting........................................................... 2,338 2,017 321 15.9
Telecommunications and data processing services...................... 8,138 6,605 1,533 23.2
Net loss on long-term investments.................................... 204 297 (93) (31.3)
Spin-off costs....................................................... 1,936 -- 1,936 N/A
Other general and administrative..................................... 13,139 9,919 3,220 32.5
Income taxes......................................................... 37,541 20,343 17,198 84.5
COMPENSATION AND EMPLOYEE BENEFITS. Salaries, bonuses and related employee
benefits increased approximately $21.0 million over the prior year. Such
increases were primarily due to our profitability-based compensation plan,
growth in our employee base of 44 or 20.3%, from 217 to 261 and additional
compensation necessary to attract and retain quality personnel. Over 50% of the
increase in new employees were staffed in technology, product development and
production infrastructure. In addition, our board of directors voted to
accelerate the vesting of the options of our recently deceased President and
Chief Executive Officer, Scott P. Mason, resulting in a $2.8 million charge to
compensation expense, representing 13% of the increase.
TRANSACTION PROCESSING. The increase in transaction processing is primarily
due to an increase in ticket charges associated with a higher volume of
transactions in 1998. The increase in ticket charges of 28% was not
proportionate with the increase in revenues of 55% due to volume discounts
associated with clearing and execution services. A decrease in specialist fees
of 26% and floor broker fees of 3%, was offset by the volume increases in shares
executed by specialists of 49% and floor brokers of 51%, resulting in a net
increase in transaction processing expenses. Transaction processing as a
percentage of revenues decreased from 15.6% in 1997 to 12.7% in 1998.
SOFTWARE ROYALTIES. As software royalties are contractually fixed at 13% of
POSIT revenues, the increase is wholly attributable to an increase in POSIT
revenues.
OCCUPANCY AND EQUIPMENT. The increase in occupancy and equipment is
primarily attributable to additional depreciation and amortization of leasehold
improvements (representing 65% of the increase) and rent expense (representing
33% of the increase) related to the relocation and expansion of our corporate
headquarters (occupied in June 1997), combined with increases in headcount and
purchases of additional technologically advanced software.
CONSULTING. The increase in consulting expense is primarily due to costs
incurred for accounting and financial research of international joint venture
opportunities and a major telecommunication system conversion.
TELECOMMUNICATIONS AND DATA PROCESSING SERVICES. The increase in
technological and data communications processing expenses stems primarily from
the data feed upgrades for clients, primarily market data line connections, and
expenses relating to a telecommunication network conversion and contingency
planning.
NET LOSS ON LONG-TERM INVESTMENTS. The decrease in net loss on long-term
investments is due to income of $3.8 million recognized from the sale of our
37.4% equity ownership interest in the
Long-
21
View Group, Inc., offset by initial start-up costs for ITG Europe of $1.3
million and the combined costs of equity loss pick-up and amortization of
goodwill on ITG Australia of $0.2 million and the LongView Group, Inc, of $0.8
million.
SPIN-OFF COSTS. The spin-off expenses are attributable to our legal,
accounting, consulting and other expenses incurred for the spin-off
transactions.
OTHER GENERAL AND ADMINISTRATIVE. The increase in other general and
administrative expenses was the result of a write-off of a net receivable from
the former Global POSIT joint venture of approximately $1.0 million, accelerated
software amortization for specific products, increases in business development
costs, such as advertising and active sales efforts, and additional
administrative costs, associated with ITG Europe.
INCOME TAX EXPENSE
The increase in income tax expense is the result of an increase in pretax
income and an increase in the effective tax rate from 43.0% in 1997 to 46.4% in
1998. The increase in the effective rate was due to certain non-deductible
expenses, such as goodwill amortization and spin-off costs and the inability to
offset international losses with United States profits in calculating income tax
expense, that were not present in 1997.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES
Total revenues increased $25.4, or 22.9%, from $111.6 million to $137.0
million. Increased revenues were attributed to a growing use of POSIT, QuantEX
and Electronic Trading Desk services. POSIT revenues increased $8.2 million, or
12.2%, from $67.2 million to $75.4 million while QuantEX revenues increased $5.2
million, or 21.2%, from $24.9 million to $30.1 million. Electronic Trading Desk
services increased $12.3 million, or 69.2%, from $17.8 million to $30.1 million.
Revenues per trading day increased by $103,000, or 23.5%, from $439,000 to
$542,000. Revenues per employee decreased $80,000, or 11.3%, from $711,000 to
$631,000.
EXPENSES
Total expenses increased $19.2 million, or 27.3%, from $70.6 million to
$89.8 million.
The following table itemizes expenses by category (in thousands):
YEAR ENDED DECEMBER
31,
--------------------
1997 1996 CHANGE % CHANGE
--------- --------- --------- -----------
Compensation and employee benefits..................................... $ 30,479 $ 25,047 $ 5,432 21.7%
Transaction processing................................................. 21,413 15,737 5,676 36.1
Software royalties..................................................... 9,848 8,798 1,050 11.9
Occupancy and equipment................................................ 9,204 6,111 3,093 50.6
Consulting............................................................. 2,017 2,492 (475) (19.1)
Telecommunications and data processing services........................ 6,605 4,789 1,816 37.9
Net loss on long-term investments...................................... 297 -- 297 N/A
Spin-off costs......................................................... -- -- -- N/A
Other general and administrative....................................... 9,919 7,581 2,338 30.8
Income taxes........................................................... 20,343 17,666 2,677 15.2
COMPENSATION AND EMPLOYEE BENEFITS. The increase in compensation and
employee benefits expenses is due to an increase in the number of employees
offset by an increase in capitalized software.
22
Capitalized software development costs increased approximately $4.4 million,
primarily due to additional projects and an increase in staff engaged in
software development. Compensation and employee benefits expenses per person
decreased $18,000, or 11.3%, from $159,000 to $141,000.
TRANSACTION PROCESSING. The increase in transactions processing expenses is
primarily due to the expense associated with a higher volume of transactions and
shares. Transaction processing expenses as a percentage of revenues increased
from 14.1% to 15.6%, 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.
SOFTWARE ROYALTIES. As software royalties are contractually fixed at 13% of
POSIT revenues, the increase is wholly attributable to an increase in POSIT
revenues.
OCCUPANCY AND EQUIPMENT. The increase in occupancy and equipment expense is
due primarily to relocation of our corporate headquarters from 900 Third Avenue
to 380 Madison Avenue in mid-June 1997. Rent expense increased accordingly as
the rental square footage increased by more than 100%. We also had to accelerate
the write-off of the unamortized leasehold improvements from the 900 Third
Avenue location. In addition, depreciation expense increased approximately $1.7
million as a result of purchases of additional equipment associated with both
the move and increased headcount.
CONSULTING. Consulting is primarily for functions, which we currently
believe, are advantageous to out-source. The decrease is due primarily to our
undertaking in 1996 nonrecurring special projects related to contingency
planning and systems' security.
TELECOMMUNICATIONS AND DATA PROCESSING SERVICE. 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 the 900 Third Avenue and
380 Madison Avenue locations in connection with the move of our headquarters.
NET LOSS ON LONG-TERM INVESTMENTS. The increase in the net loss on
long-term investments is due to the combined costs of equity loss pick-up and
amortization of goodwill on ITG Australia and the LongView Group, Inc, of
$79,000 and $218,000, respectfully.
OTHER GENERAL AND ADMINISTRATIVE EXPENSE. The increase is largely
attributable to the increase in headcount of 60 employees. Related costs,
primarily services provided by Jefferies & Company, increased by approximately
$374,000. Travel and entertainment costs increased by approximately $1.1 million
primarily from an increased effort to promote our products. 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.
INCOME TAX EXPENSE
Income tax expense increased by $2.6 million, or 14.7% from $17,700 to
$20,300. The increase is primarily due to an increase in pretax income. The
effective tax rate in 1997 and 1996 was 43.0% and 43.1%, respectively.
DEPENDENCE ON MAJOR CUSTOMERS
During 1998, revenue from our 10 largest customers accounted for
approximately 30.7% of our total revenue while revenue from each of our three
largest customers accounted for 7.9%, 4.5% and 3.2%, respectively, of total
revenue. During 1997, revenue from our 10 largest customers accounted for
approximately 34.5% of our total revenue while revenue from each of our three
largest customers accounted for 8.8%, 5.9%, and 3.4%, respectively, of total
revenue. Customers may discontinue use of our services at any time. The loss of
any significant customers could have a material adverse effect on
23
our 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
Our 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. A
substantial portion of our assets is liquid, consisting of cash and cash
equivalents or assets readily convertible into cash.
We believe that our cash flow from operations and existing cash balances
will be sufficient to meet our cash requirements. We generally invest our excess
cash in money market funds and other short-term investments that generally
mature within 90 days or less. Additionally, securities owned, at fair value,
include highly liquid, variable rate municipal securities, auction rate
preferred stock and common stock. At December 31, 1998, cash equivalents
amounted to $77.3 million and receivables from brokers, dealers and other of
$24.1 million were due within 30 days.
We also invest a portion of our excess cash balances in cash enhanced
strategies, which we believe should yield higher returns without any significant
effect on risk. As of December 31, 1998, we 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 on current income and capital appreciation. At December 31, 1998, the
amount of these investments was $1.0 million.
Historically, all regulatory capital needs of ITG Inc. have been provided by
cash from operations. See "Business--Regulation." We believe that cash flows
from operations and the payment of the exercise price upon the exercise of
expiring options will provide ITG Inc. with sufficient regulatory capital. On
March 16, 1999, we entered into an agreement with a bank to borrow, effective
upon the closing of the merger, up to $20 million on a revolving basis to enable
ITG Inc. to satisfy its regulatory net capital requirements. The commitment will
expire on March 14, 2000. Any amounts drawn may be prepaid at any time, but no
later than March 15, 2001. We have agreed to pay an up-front fee totaling 1.5%
of the commitment and will incur a fee at a rate per annum equal to 0.35% on the
daily amount of the unused commitment to March 13, 2000. The interest rate on
any amounts drawn will be prime; if such amounts are not repaid within two
weeks, the interest rate will increase to prime plus 2%. The credit facility is
secured by a pledge of the stock of ITG Inc., ITG Ventures, Inc. and ITG Global
Trading Incorporated. This agreement limits our ability to pay cash dividends or
incur indebtedness and requires us to comply with certain financial covenants.
Assuming that the merger and related transactions will close on March 31, 1999,
following payment of the special cash dividend we estimate that ITG Inc. will
have excess net regulatory capital of approximately $20 million (not including
the $20 million available under the new revolving credit facility). Although we
believe that the combination of our existing net regulatory capital, operating
cash flows and the revolving credit facility will be sufficient to meet
regulatory capital requirements, a shortfall in net regulatory capital would
have a material adverse effect on us.
In 1998, we established a $2 million credit line with a bank to fund
temporary regulatory capital shortfalls encountered periodically by ITG
Australia. The lender charges us interest at the federal funds rate plus 1%. We
lend amounts borrowed to the ITG Australia and charge interest at the federal
funds rate plus 2%. At December 31, 1998, no amounts were outstanding under this
bank credit line and no amounts were owed to us by the ITG Australia. Borrowings
from the bank and loans to the ITG Australia will not be permitted during the
period that the revolving credit agreement discussed above is effective.
24
EFFECTS OF INFLATION
We do 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 our revenue or profitability. However, high inflation may lead to
higher interest rates which might cause investment funds to move from equity
securities to debt securities or cash equivalents.
THE YEAR 2000 ISSUE
Some 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
incorrectly. 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.
STRATEGY
We are well aware of and are 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. We established a "Year 2000 working group" to address the Year 2000
issue. We have targeted our efforts into three major areas: (1) vendors; (2)
company proprietary products; and (3) clients.
VENDORS. Our ability to successfully meet the Year 2000 challenge is in
part dependent on our vendors. We have contacted our vendors to determine the
status of their Year 2000 programs and have created a database recording each
vendor's readiness status. Over 95% of our vendors have responded that their
systems are currently Year 2000 compliant, and substantially all of our vendors
have indicated that they expect their systems to be Year 2000 compliant by
September 30, 1999. Based upon the results of our testing to date, we are
satisfied with the representations we have received from our vendors. We are in
the process of integrating Year 2000 compliant versions of our vendors' software
and hardware with our proprietary products.
COMPANY PROPRIETARY PRODUCTS. We have evaluated our trading systems and
have endeavored to examine all code contained in our internally produced
software. We have completed regression testing of all mission critical systems
and released Year 2000 compliant versions of all such systems other than
QuantEX. We plan to complete date-forward testing of all mission critical
systems and release a Year 2000 compliant version of QuantEX by the end of June
1999. We also intend to participate in the Securities Industry Association's
industry-wide testing program in 1999.
CLIENTS. We sent a letter explaining our Year 2000 strategy to all clients
in July 1998. In addition, we contacted clients on a project-by-project basis to
ascertain compatibility between our systems and changes made to the clients'
systems. We plan to provide point-to-point testing opportunities for our clients
starting in April 1999.
YEAR 2000 CONTINGENCY PLANNING
We are in the early stages of establishing a Year 2000 contingency plan to
deal with both internal and external failures of critical systems. The Year 2000
issue can affect all businesses that rely heavily on automated systems. Our Year
2000 contingency plan is therefore intended to address failures of internal
systems, client connections and connections to trading destinations, as well as
failures of major infrastructure components. We intend to have our contingency
plan in place by July 1999 and to update and refine such plan as needed on a
continuing basis. We believe, however, that such contingency plan
25
will not provide satisfactory solutions for our worst-case scenario--the general
failure of computer and communication systems relied upon by the securities
industry, such as the systems provided by long distance telephone companies, the
stock exchanges, Nasdaq, The Depository Trust Company and ADP Brokerage
Services, and the failure of Jefferies & Company and W&D to provide services
under their clearing and execution agreement with us. Such failure would prevent
us from operating in whole or in part until such systems or services have been
restored and could have a material adverse effect on us.
In the event any of our internally developed systems fails, we will
undertake to remediate such system on an emergency basis at the time of such
failure. To ensure that adequate staff will be available to handle any such
emergencies in January of 2000, we have imposed a moratorium on employee
vacations during the first two weeks of January 2000, and have made arrangements
to have a number of software development personnel (normally based in our Culver
City office) at our New York headquarters during the final week of December 1999
and the first week of January 2000. Our inability to remediate a failure of any
of our internally developed mission critical systems would prevent us from
operating in whole or in part until such systems have been restored and could
have a material adverse effect on us.
COSTS
We do not believe that the costs incurred to ready our systems for the Year
2000 will have a material effect on our 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. Through
December 31, 1998, we had spent approximately $1.5 million on the Year 2000
project.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION". SFAS 131 requires that public business
enterprises report certain information about operating segments in complete sets
of financial statements of the enterprise and in condensed financial statements
of interim periods issued to shareholders. It also requires that these
enterprises report certain information about their products and services, the
geographical areas in which they operate, and their major customers. SFAS 131 is
effective for fiscal years beginning after December 15, 1997, although earlier
application was permitted. The disclosure requirements of this standard were not
applicable since the Company manages its operations through a single line of
business (institutional agency trade executions).
In March 1998, the Accounting Standards Executive Committee issued Statement
of Position 98-1 "ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR
OBTAINED FOR INTERNAL USE". SOP 98-1 provides guidance on accounting for the
costs of computer software developed or obtained for internal use. It identifies
the characteristics of internal-use software and provides examples to assist in
determining when the computer software is for internal use. SOP 98-1 is
effective for financial statements for fiscal years beginning after December 15,
1998, although earlier application is encouraged, and should be applied to
internal-use computer software costs incurred in those fiscal years for all
projects, including those in progress upon initial application of this SOP. We
do not anticipate that the implementation of this statement will have a material
impact on our consolidated financial statements.
JEFFERIES GROUP AND ITGI PLAN TO SEPARATE INTO TWO INDEPENDENT COMPANIES
On March 17, 1998, we announced that we were planning the separation of
Jefferies & Company and other Jefferies Group subsidiaries from our company
through a series of transactions, including a special cash dividend, the
transfer of Jefferies Group's assets and liabilities (other than those related
to our company), a spin-off and a merger. Upon the consummation of the spin-off
and upstream merger
26
and the related transactions, the stockholders of Jefferies Group will be
stockholders of our company and Jefferies Group will cease to be our parent
company.
First, the Company will pay a special cash dividend of $4.00 per share,
payable pro rata to all of our stockholders of record on April 20, 1999,
including Jefferies Group. The aggregate amount of the special cash dividend
will be up to $75 million, of which we will pay $60.0 million to Jefferies
Group.
Following the payment of the special cash dividend, Jefferies Group will
transfer all of its assets (other than its approximately 80.5% equity interest
in our company) and all of its liabilities (other than liabilities related to
our company) to a new company ("New Jefferies"). After such transfers have been
completed and certain other conditions have been satisfied, Jefferies Group will
distribute all of the outstanding common stock of New Jefferies pro rata to
Jefferies Group stockholders.
The spin-off will be followed immediately by a tax-free merger of our
company into Jefferies Group, with our public shareholders receiving shares of
Jefferies Group. Jefferies Group will then be renamed Investment Technology
Group, Inc. ("New ITGI"). Based on the number of shares of Jefferies Group
common stock expected to be outstanding on the date of the spin-off and upstream
merger (approximately 23,900,000) and the number of shares of our common stock
held by Jefferies Group (15,000,000), our public stockholders other than
Jefferies Group will receive approximately 1.59 shares of common stock of New
ITGI for each share of our common stock held by them.
The spin-off and upstream merger and the related transactions are contingent
on a number of factors, including receipt of all board of directors and
shareholder approvals of Jefferies Group and our company and other required
regulatory and contractual approvals. The spin-off and upstream merger and the
related transactions are expected to close in April 1999.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
None.
27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL REPORTS SECTION
PAGES
-----
Management's Responsibility for Compliance and Financial Reporting............................... 29
Independent Auditors' Report..................................................................... 30
Consolidated Statements of Income................................................................ 31
Consolidated Statements of Financial Condition................................................... 32
Consolidated Statements of Changes in Stockholders' Equity....................................... 33
Consolidated Statements of Cash Flows............................................................ 34
Notes to Consolidated Financial Statements....................................................... 35
28
MANAGEMENT'S RESPONSIBILITY FOR COMPLIANCE AND FINANCIAL REPORTING
TO THE SHAREHOLDERS:
The management of Investment Technology Group, Inc. 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 our company in conformity with
generally accepted accounting principles in the United States. The financial
statements reflect, where applicable, management's best judgments and estimates.
The management of our 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 our 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 our company's Statement of Policy on Standards of Employee Conduct,
which is distributed to all of our employees. As part of the monitoring system,
we maintain 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 our company. Ongoing oversight
of compliance activities is the responsibility of our President.
Our 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 our 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 audit committee reports
regularly to our board of directors on its activities, and such other matters as
it deems necessary.
Our company's annual consolidated financial statements have been audited by
KPMG LLP, independent auditors, who were appointed by the board of directors.
Management has made available to KPMG LLP all of our company's financial records
and related data, as well as the minutes of directors' meetings.
Furthermore, management believes that all its representations to KPMG LLP
are valid and appropriate. In addition, KPMG LLP, in determining the nature and
extent of their auditing procedures, considered our company's accounting
procedures and policies and the effectiveness of the related internal control
structure.
Management believes that, as of December 31, 1998, our company's internal
control structure was adequate to accomplish the objectives discussed herein.
Raymond L. Killian, Jr. John R. MacDonald Angelo Bulone
Chairman, Chief Executive Officer Senior Vice President Vice President
and President and Chief Financial Officer and Controller
29
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Investment Technology Group, Inc.:
We have audited the accompanying consolidated statements of financial
condition of Investment Technology Group, Inc. and subsidiaries as of December
31, 1998 and 1997, and the related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated 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, 1998 and 1997, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1998, in conformity with generally
accepted accounting principles.
KPMG LLP
New York, New York
January 20, 1999
30
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
REVENUES:
Commissions................................................................ $ 205,163 $ 133,700 $ 108,821
Interest and dividends..................................................... 3,635 2,650 1,751
Other...................................................................... 3,407 692 984
---------- ---------- ----------
Total revenues........................................................... 212,205 137,042 111,556
EXPENSES:
Compensation and employee benefits......................................... 51,462 30,479 25,047
Transaction processing..................................................... 26,920 21,413 15,737
Software royalties......................................................... 15,247 9,848 8,798
Occupancy and equipment.................................................... 11,886 9,204 6,111
Consulting................................................................. 2,338 2,017 2,492
Telecommunications and data processing services............................ 8,138 6,605 4,789
Net loss on long-term investments.......................................... 204 297 --
Spin-off costs............................................................. 1,936 -- --
Other general and administrative........................................... 13,139 9,919 7,581
---------- ---------- ----------
Total expenses........................................................... 131,270 89,782 70,555
Income before income tax expense............................................. 80,935 47,260 41,001
Income tax expense........................................................... 37,541 20,343 17,666
---------- ---------- ----------
NET INCOME................................................................... $ 43,394 $ 26,917 $ 23,335
---------- ---------- ----------
---------- ---------- ----------
Basic net earnings per share of common stock................................. $ 2.36 $ 1.48 $ 1.28
---------- ---------- ----------
---------- ---------- ----------
Diluted net earnings per share of common stock............................... $ 2.25 $ 1.42 $ 1.26
---------- ---------- ----------
---------- ---------- ----------
Basic weighted average shares outstanding.................................... 18,365 18,178 18,284
---------- ---------- ----------
---------- ---------- ----------
Diluted weighted average shares and common stock
equivalents outstanding.................................................... 19,289 18,940 18,586
---------- ---------- ----------
---------- ---------- ----------
The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
31
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31,
----------------------
1998 1997
---------- ----------
ASSETS
Cash and cash equivalents................................................................. $ 77,324 $ 14,263
Securities owned, at fair value........................................................... 39,615 37,358
Receivables from brokers, dealers and other, net.......................................... 24,127 10,131
Due from affiliates....................................................................... 722 1,365
Investments............................................................................... 1,000 10,935
Premises and equipment.................................................................... 19,662 19,506
Capitalized software...................................................................... 6,450 5,973
Goodwill.................................................................................. 1,373 1,922
Deferred taxes............................................................................ 2,784 2,460
Other assets.............................................................................. 7,455 9,728
---------- ----------
Total assets.............................................................................. $ 180,512 $ 113,641
---------- ----------
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses..................................................... $ 24,154 $ 12,664
Payable to brokers, dealers and other..................................................... 1,881 61
Software royalties payable................................................................ 4,070 2,663
Securities sold, not yet purchased, at fair value......................................... 288 3
Due to affiliates......................................................................... 2,557 2,999
Income taxes payable to affiliate......................................................... 3,853 1,488
---------- ----------
Total liabilities..................................................................... 36,803 19,878
---------- ----------
Lease commitments (note 14)
Contingencies (note 17)
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: 19,405,361 in 1998 and 18,818,468 in 1997.................... 194 188
Additional paid-in capital................................................................ 51,511 38,554
Retained earnings......................................................................... 104,925 61,531
Common stock held in treasury, at cost; shares:
815,000 in 1998 and 597,500 in 1997..................................................... (12,760) (6,510)
Accumulated other comprehensive loss:
Currency translation adjustment......................................................... (161) --
---------- ----------
Total stockholders' equity............................................................ 143,709 93,763
---------- ----------
Total liabilities and stockholders' equity................................................ $ 180,512 $ 113,641
---------- ----------
---------- ----------
The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
32
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
COMMON
ADDITIONAL STOCK ACCUMULATED
PREFERRED COMMON PAID-IN RETAINED HELD IN COMPREHENSIVE
STOCK STOCK CAPITAL EARNINGS TREASURY LOSS
----------- ----------- ----------- ----------- ----------- -----------------
Balance at December 31, 1995.......... $ -- $ 187 $ 36,055 $ 11,279 $ (2,042) $ --
Net income............................ -- -- -- 23,335 -- --
Purchase of common stock for treasury
(135,000 shares).................... -- -- -- -- (1,721) --
----------- ----- ----------- ----------- ----------- -----
Balance at December 31, 1996.......... -- 187 36,055 34,614 (3,763) --
Net income............................ -- -- -- 26,917 -- --
Issuance of restricted stock (24,219
shares)............................. -- -- 630 -- -- --
Issuance of common stock in connection
with the employee stock option plan
(92,249 shares)..................... -- 1 1,869 -- -- --
Purchase of common stock for treasury
(152,300 shares).................... -- -- -- -- (2,747) --
----------- ----- ----------- ----------- ----------- -----
Balance at December 31, 1997.......... -- 188 38,554 61,531 (6,510) --
Issuance of common stock in connection
with the employee stock option plan
(574,978 shares).................... -- 6 12,652 -- -- --
Issuance of common stock in connection
with the employee stock purchase
plan (11,915 shares)................ -- -- 305 -- -- --
Purchase of common stock for treasury
(217,500 shares).................... -- -- -- -- (6,250) --
Comprehensive income/(loss):
Net income.......................... -- -- -- 43,394 -- --
Other comprehensive loss, net of tax
($0.00):
Currency translation adjustment... -- -- -- -- -- (161)
Comprehensive income..................
----------- ----- ----------- ----------- ----------- -----
Balance at December 31, 1998.......... $ -- $ 194 $ 51,511 $ 104,925 $ (12,760) $ (161)
----------- ----- ----------- ----------- ----------- -----
----------- ----- ----------- ----------- ----------- -----
TOTAL
STOCKHOLDERS'
EQUITY
-------------
Balance at December 31, 1995.......... $ 45,479
Net income............................ 23,335
Purchase of common stock for treasury
(135,000 shares).................... (1,721)
-------------
Balance at December 31, 1996.......... 67,093
Net income............................ 26,917
Issuance of restricted stock (24,219
shares)............................. 630
Issuance of common stock in connection
with the employee stock option plan
(92,249 shares)..................... 1,870
Purchase of common stock for treasury
(152,300 shares).................... (2,747)
-------------
Balance at December 31, 1997.......... 93,763
Issuance of common stock in connection
with the employee stock option plan
(574,978 shares).................... 12,658
Issuance of common stock in connection
with the employee stock purchase
plan (11,915 shares)................ 305
Purchase of common stock for treasury
(217,500 shares).................... (6,250)
Comprehensive income/(loss):
Net income.......................... 43,394
Other comprehensive loss, net of tax
($0.00):
Currency translation adjustment... (161)
-------------
Comprehensive income.................. 43,233
-------------
Balance at December 31, 1998.......... $ 143,709
-------------
-------------
The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
33
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
---------- ---------- ---------
Cash flows from operating activities:
Net income..................................................................... $ 43,394 $ 26,917 $ 23,335
Adjustments to reconcile net income to net cash provided by operating
activities:
Deferred income tax benefit.................................................. (324) (103) (2,027)
Depreciation and amortization................................................ 11,599 6,642 3,957
Undistributed loss (income) of affiliates.................................... 3,535 441 (267)
Provision for doubtful accounts receivable................................... 96 84 352
Decrease (increase) in operating assets:
Securities owned, at fair value.............................................. (2,258) (12,199) (899)
Receivables from brokers, dealers and other.................................. (14,092) (2,468) 2,149
Due from affiliates.......................................................... 643 94 3,541
Investments.................................................................. 9,935 (5,742) (5,193)
Other assets................................................................. (4,620) (6,930) (1,849)
Increase (decrease) in operating liabilities:
Accounts payable and accrued expenses........................................ 11,592 4,118 5,069
Payable to brokers, dealers and other........................................ 1,820 56 (113)
Software royalties payable................................................... 1,407 389 480
Securities sold, not yet purchased, at fair value............................ 285 (1,223) 1,226
Due to affiliates............................................................ (443) 1,077 (321)
Income taxes payable to affiliate............................................ 2,365 (147) 945
---------- ---------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES.................................. 64,934 11,006 30,385
---------- ---------- ---------
Cash flows from investing activities:
Purchase of premises and equipment........................................... (7,658) (15,679) (5,624)
Sale of equity investment.................................................... 8,049 -- --
Investment in joint venture.................................................. (4,790) -- --
Capitalization of software development costs................................. (4,025) (4,422) (1,645)
---------- ---------- ---------
NET CASH USED IN INVESTING ACTIVITIES...................................... (8,424) (20,101) (7,269)
---------- ---------- ---------
Cash flows from financing activities:
Purchase of common stock for treasury........................................ (6,250) (2,747) (1,721)
Issuance of common stock..................................................... 12,962 2,500 --
---------- ---------- ---------
NET CASH PROVIDED BY/(USED) IN FINANCING ACTIVITIES........................ 6,712 (247) (1,721)
---------- ---------- ---------
Effect of foreign currency translation on cash and cash equivalents.......... (161) -- --
Net increase (decrease) in cash and cash equivalents....................... 63,061 (9,342) 21,395
Cash and cash equivalents--beginning of year................................... 14,263 23,605 2,210
---------- ---------- ---------
Cash and cash equivalents--end of year......................................... $ 77,324 $ 14,263 $ 23,605
---------- ---------- ---------
---------- ---------- ---------
Supplemental cash flow information:
Interest paid................................................................ $ 20 $ 146 $ 223
---------- ---------- ---------
---------- ---------- ---------
Income taxes paid to affiliate............................................... $ 30,296 $ 19,947 $ 18,798
---------- ---------- ---------
---------- ---------- ---------
The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND BASIS OF PRESENTATION
The Consolidated Financial Statements include the accounts of Investment
Technology Group, Inc. and its wholly-owned subsidiaries ("ITGI" or the
"Company"), which principally include: (1) ITG Inc., a broker-dealer in
securities registered under the Exchange Act, (2) Investment Technology Group
International Limited, which is a 50% partner in the ITG Europe joint venture,
and (3) ITG Australia Holdings Pty Limited, which is a 50% partner in ITG
Pacific Holdings Pty Limited. Investments in companies of fifty percent or less
are accounted for using the equity method. Jefferies Group, Inc. ("Jefferies
Group") owned over 80% of the Company's common stock at December 31, 1998.
The Company is a leading provider of various sophisticated software
solutions for automated institutional agency trade execution and the related
services. The Company's line of business offers products and services to help
clients access liquidity, execute trades more efficiently, and make better
trading decisions. These software solution products include: POSIT, the world's
largest intra-day electronic equity matching system; QuantEX, a fully-integrated
trade routing, analysis and management system; ITG Platform, a tool that
provides connection to POSIT, ITG's electronic trading desk and SuperDOT; ISIS,
a set of analytical tools for systematically lowering the costs of trading;
SmartServers, which offer server based implementation of trading strategies;
ITG/OPT, a computer-based equity portfolio selection system; and research,
development, sales and consulting services to clients.
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.
Jefferies Group and the Company have previously announced plans to separate
Jefferies & Company and other Jefferies Group subsidiaries from the Company
through a spin-off and upstream merger and the related transactions (see Note
16--Jefferies Group and the Company Plan to Separate into Two Independent
Companies).
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
The Company has defined cash and cash equivalents as highly liquid
investments, with original maturities of less than ninety days, which are part
of the cash management activities of the Company.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the Company's financial instruments are carried at fair
value or amounts approximating fair value. Cash and cash equivalents, securities
owned and certain receivables, are carried at fair value or contracted amounts
which approximate fair value due to the short period to maturity and repricing
characteristics. Similarly, liabilities are carried at amounts approximating
fair value. Securities sold, not yet purchased are valued at quoted market
prices.
SECURITIES TRANSACTIONS
Revenues substantially consist of commission revenues. Receivable from
brokers, dealers and other, net consists of commissions receivable and
receivable from a partial liquidation of the TQA Arbitrage Fund L.P.
Transactions in securities, commission revenues and related expenses are
recorded on a trade-date basis.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Securities owned, at fair value consisted of highly liquid, variable rate
municipal securities and auction rate preferred stock as of December 31, 1998
and 1997.
CAPITALIZED SOFTWARE
The Company capitalizes software development expenses where technological
feasibility of the product has been established. Technological feasibility is
established when the Company has completed all planning, designing, coding and
testing activities that are necessary to establish that the product can be
produced to meet design specifications. The assessment of recoverability of
capitalized software development costs requires considerable judgment by
management with respect to certain external factors, including, but not limited
to, 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 life of which is generally under two years. Amortization begins when
the product is available for release to customers.
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, 1998 and 1997, net goodwill amounted to $1.4 million
and $1.9 million, net of accumulated amortization of $3.9 million and $3.4
million, respectively.
INCOME TAXES
The Company is a member of the Jefferies Group 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.
Income taxes are accounted for on the asset and liability method. Deferred
tax assets and liabilities are recognized for 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
be recovered or settled. 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.
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
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
amortized using the straight-line method over the lesser of the estimated useful
lives of the related assets or the non-cancelable lease term.
EXPENSES
COMPENSATION AND EMPLOYEE BENEFITS include base salaries, bonuses,
employment agency fees, part-time employee compensation, commissions paid to
Jefferies & Company employees (note 8), capitalized software (note 4) 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
calculated at an effective rate of 13% of adjusted POSIT revenues. 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 that 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. NET LOSS ON LONG-TERM INVESTMENTS includes goodwill
amortization, equity loss pick-up, and initial start up costs associated with
ITG Europe and ITG Australia and the net gain on the sale of the investment in
the LongView Group, Inc. SPIN-OFF COSTS include legal, accounting, consulting
and various other expenses related to the Company's proposed spin-off and
upstream merger discussed in Note 16. OTHER GENERAL AND ADMINISTRATIVE includes
goodwill amortization, legal, audit, tax and promotional expenses.
RESEARCH AND DEVELOPMENT
All research and development costs are expensed as incurred. Research and
development costs were $11.0 million, $8.4 million and $6.8 million for 1998,
1997 and 1996, respectively.
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
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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
and 1996 have been restated to conform to 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. The
Company's revolving credit facility substantially limits the ability of the
Company to pay dividends.
(3) PREMISES AND EQUIPMENT
The following is a summary of premises and equipment as of December 31, 1998
and 1997:
1998 1997
--------- ---------
(DOLLARS IN
THOUSANDS)
Furniture, fixtures and equipment.................................... $ 29,007 $ 22,120
Leasehold improvements............................................... 6,505 6,257
--------- ---------
Total............................................................ 35,512 28,377
Less: accumulated depreciation and amortization...................... 15,850 8,871
--------- ---------
$ 19,662 $ 19,506
--------- ---------
--------- ---------
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, 1998 and 1997 as recorded by Jefferies
Group:
1998 1997
--------- ---------
(DOLLARS IN
THOUSANDS)
Furniture, fixtures and equipment...................................... $ 4,803 $ 4,803
Leasehold improvements................................................. 942 942
--------- ---------
Total.............................................................. 5,745 5,745
Less: accumulated depreciation and amortization........................ 5,745 5,297
--------- ---------
$ -- $ 448
--------- ---------
--------- ---------
Most of the capital expenditures in the two schedules above are for
computer-related equipment.
Depreciation and amortization expense amounted to $7,502,000, $4,614,000 and
$2,034,000 in 1998, 1997 and 1996, respectively.
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) CAPITALIZED SOFTWARE COSTS
The following is a summary of capitalized software costs as of December 31,
1998 and 1997:
1998 1997
--------- ---------
(DOLLARS IN
THOUSANDS)
Capitalized software costs........................................... $ 14,235 $ 10,210
Less: accumulated amortization....................................... 7,785 4,237
--------- ---------
Total............................................................ $ 6,450 $ 5,973
--------- ---------
--------- ---------
Approximately $4,025,000 of software costs were capitalized in 1998
primarily for the development of new versions of QuantEX and ITG Platform. In
addition, approximately $2,540,000 of total capitalized software costs were not
subject to amortization as of December 31, 1998, as certain products have
reached technological feasibility but are not yet available for release.
Capitalized software costs are being amortized over one to two years, the
life of which is generally less than two years. In 1998, 1997 and 1996, the
Company included $3,548,000, $1,478,000 and $1,374,000, respectively, of
amortized software costs in other general and administrative expenses.
(5) 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.
Income tax expense (benefit) consists of the following components:
1998 1997 1996
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Current
Federal.................................................... $ 26,624 $ 14,220 $ 13,722
State...................................................... 11,241 6,226 5,971
--------- --------- ---------
Total........................................................ 37,865 20,446 19,693
--------- --------- ---------
Deferred
Federal.................................................... (338) (62) (1,408)
State...................................................... 14 (41) (619)
--------- --------- ---------
(324) (103) (2,027)
--------- --------- ---------
Total........................................................ $ 37,541 $ 20,343 $ 17,666
--------- --------- ---------
--------- --------- ---------
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, 1998 and
1997 were as follows:
1998 1997
--------- ---------
(DOLLARS IN
THOUSANDS)
Deferred compensation.................................................. $ 1,745 $ 2,144
State income tax....................................................... 1,345 870
Premises and equipment................................................. (916) (970)
Other.................................................................. 610 416
--------- ---------
Total.................................................................. $ 2,784 $ 2,460
--------- ---------
--------- ---------
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) INCOME TAXES (CONTINUED)
At December 31, 1998 and 1997, the Company had income taxes payable to
Jefferies Group of $3,853,000 and $1,488,000, respectively.
The provision for income tax expense differs from the expected Federal
income tax rate of 35% for 1998, 1997 and 1996 for the following reasons:
1998 1997 1996
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Computed expected income tax expense......................... $ 28,327 $ 16,541 $ 14,350
Increase in income taxes resulting from:
Amortization of goodwill................................... 192 268 192
State income tax expense, net of
Federal income taxes....................................... 7,316 4,020 3,479
Research and development tax credits....................... (320) (320) (159)
Non-taxable interest income................................ (664) (317) (473)
Limited deductibility of meals and entertainment........... 228 209 168
Non-deductible spin-off expenses........................... 678 -- --
Dividend received deduction................................ (217) -- --
Non-deductible foreign losses.............................. 860 -- --
Other...................................................... 1,141 (58) 109
--------- --------- ---------
Total income tax expense..................................... $ 37,541 $ 20,343 $ 17,666
--------- --------- ---------
--------- --------- ---------
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.
(6) 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 have ever been borrowed under
this agreement. In 1998, we established a $2 million credit line with a bank to
fund temporary regulatory capital shortfalls encountered periodically by ITG
Australia. The lender charges us interest at the Federal Funds rate plus 1%. We
lend amounts borrowed to the ITG Australia and charge interest at the Federal
Funds rate plus 2%. At December 31, 1998, no amounts were outstanding under this
bank credit line.
(7) EMPLOYEE BENEFIT PLANS
JEFFERIES GROUP PLANS
All employees of the Company who are citizens or residents of the United
States, who are 21 years of age, whose initial date of service was before April
1, 1997 and who have completed one year of service with the Company are covered
by the Jefferies Group Employees' Pension Plan (the "Pension Plan"), a defined
benefit plan. The plan is subject to the provisions of the Employee Retirement
Income Security Act of 1974. However, benefit accruals for the Company's
employees will cease as of February 15, 1999, and the entire benefit of each
employee who was actually employed on December 31, 1998 will be vested at that
time. Additionally, participants who have attained age 45 and are credited with
at least 5 years of vesting service as of February 15, 1999 will receive
enhanced benefits
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) EMPLOYEE BENEFIT PLANS (CONTINUED)
under the Pension Plan, and the Company's employees whose initial date of
service is on or after April 1, 1997 and prior to January 1, 1998 will
retroactively become participants in the Pension Plan.
The net periodic pension cost allocated to the Company was $819,000,
$208,000 and $151,000 in 1998, 1997 and 1996, respectively.
Jefferies Group incurs expenses related to various benefit plans covering
substantially all employees, including an Employee Stock Purchase Plan ("ESPP")
and a profit sharing plan, which includes a salary reduction feature designed to
qualify under Section 401(k) of the Internal Revenue Code. As of February 1,
1998, employees of the Company were no longer eligible to participate in the
ESPP and as of December 31, 1998 were no longer eligible to participate in the
profit sharing plan.
Jefferies Group also incurs expenses related to a Capital Accumulation Plan
for certain officers and key employees of Jefferies Group and the Company.
Participation in the plan was optional, with those who elected to participate
agreeing to defer graduated percentages of their compensation. As of January 1,
1998 employees of the Company were no longer eligible to defer compensation in
the Capital Accumulation Plan. This was replaced with the Company's Stock Unit
Award Program as described below.
For 1998, 1997 and 1996, the Company expensed and contributed to these plans
$2,568,000, $2,096,000, and $1,590,000, respectively.
ITG PLANS
Effective as of January 1, 1999, all employees employed as of that date were
immediately eligible to participate in the Investment Technology Group, Inc.
Retirement Savings Plan and the Investment Technology Group, Inc. Guaranteed
Money Purchase Pension Plan (the "Plans"). These Plans include all eligible
compensation (base salary, bonus, commissions and overtime) up to the Internal
Revenue Service annual maximum currently at $160,000. The Plans' features
include a guaranteed company contribution of 3% of eligible pay to be made to
all eligible employees regardless of participation in the Plans, a discretionary
company contribution based on total consolidated company profits between 0% and
8% regardless of participation in the Plans and a Company matching contribution
of 66 2/3% of voluntary employee contributions up to a maximum of 6% of eligible
compensation per year.
Effective January 1, 1998, selected members of senior management and key
employees participated in the Stock Unit Award Program ("SUA"), a mandatory
tax-deferred compensation program established under the 1994 Option Plan. Under
the SUA, the selected participants of the Company are required to defer receipt
of (and thus defer taxation on) a graduated portion of their total cash
compensation for units representing common stock equal in value to 115% of the
compensation deferred. Each participant is automatically granted units, as of
the last day of each calendar quarter based on participant's actual or assigned
compensation reduction. The units are at all times fully vested and
non-forfeitable. The units are to be settled on or after the third anniversary
of the date of grant. In 1998, the Company included the participant's deferral
in compensation expense and recognized additional compensation expense of
$477,000, which represents the 15% excess over the amount actually deferred by
the participants. As of December 31, 1998, we had 111,683 units issued to the
employees in the SUA. Such units are included in the calculation of diluted
weighted average shares outstanding in order to determine diluted earnings per
share.
In 1997, the Board of Directors of the Company approved the ITG Employee
Stock Purchase Plan ("ITG ESPP"). The ITG ESPP became effective February 1, 1998
and allows all full-time employees to
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) EMPLOYEE BENEFIT PLANS (CONTINUED)
purchase the Company's common stock at a 15% discount through automatic payroll
deductions. The ITG ESPP is qualified as an employee stock purchase plan under
Section 423 of the Internal Revenue Code.
(8) RELATED PARTY TRANSACTIONS
Jefferies & Company has provided to the Company pursuant to a service
agreement, specified administrative services, at fixed monthly costs during
1998. Administrative services included accounting, payroll, compliance services,
personnel services, legal services, data processing and telecommunications.
All services were terminated on December 31, 1998, except for accounting
services, and preparation of regulatory accounting reports, and certain
personnel services, including administering certain employee benefit plans. The
accounting and administrative services will continue until June 30, 1999 unless
the Company terminates them earlier. The personnel services will continue until
transfer of the assets under certain Jefferies Group employee benefit plans to
Company Plans. The costs of such services to the Company during 1998, 1997 and
1996 were $1,186,000, $1,162,000 and $690,000, respectively.
The Company has paid to Jefferies & Company an aggregate of $250,000,
$247,000 and $502,000 for 1998, 1997 and 1996, respectively, as compensation to
Jefferies & Company's account executives for introducing customers to POSIT
pursuant to a revenue sharing agreement. This agreement terminates according to
its terms on March 15, 1999. Such termination will not affect fees payable in
accordance with the above formula with respect to customers introduced prior to
January 1, 1999.
Jefferies & Company has provided substantially all clearing services to the
Company, pursuant to a Fully Disclosed Clearing Agreement. Aggregate costs of
such services to the Company were $11.9 million, $9.3 million and $7.3 million
during 1998, 1997 and 1996, respectively, included in transaction processing
expenses.
The Clearing Agreement is for a term of five years ending March 15, 1999 and
is subject to termination at any time by either party on 180 days' written
notice or upon default by the other party. ITG Inc. and Jefferies & Company are
entering into a new clearing agreement on substantially similar terms as the
Clearing Agreement with an initial term of January 2, 1999 to June 30, 2000.
Various other affiliates of Jefferies Group, including Jefferies & Company,
Inc., W & D Securities, Inc. and Jefferies International Limited, have provided
other services to the Company. Certain occupancy and equipment expense has been
provided to the Company at cost by Jefferies Group and Jefferies & Company. W &
D Securities, Inc. performed certain execution services on the New York Stock
Exchange and other exchanges for the Company. The cost of these execution
services were $13.6 million, $10.8 million and $6.5 million in 1998, 1997 and
1996, respectively, and is primarily included in transaction processing expense.
W & D Securities Inc. and ITG Inc. are entering into a new execution agreement
on substantially similar terms as the current execution agreement with an
initial term of January 2, 1999 to June 30, 2000. Included in other general and
administrative expenses are fees paid to Jefferies International Limited of
$767,000 for various broker and administrative services, of which $764,000 was
reimbursed to the Company by its affiliates ITG Global Trading Incorporated and
ITG International Limited. Included in revenues are financing costs of $911,000
paid to Jefferies & Company. Also, included in revenues, are licensing and
consulting fees paid by W&D Securities, Inc. amounting to $165,000.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) RELATED PARTY TRANSACTIONS (CONTINUED)
Jefferies & Company has executed trades in an agency capacity for certain of
its customers using ITG's services. Commission fees of $4.8 million, $3.1
million and $1.7 million in 1998, 1997 and 1996, respectively, and are included
in the Company's revenues.
Transactions with Jefferies Group and its affiliates are provided at arms
length and are settled in the normal course of business by the Company.
Throughout the Notes to Consolidated Financial Statements there are other
related party transactions (see Notes 3, 5 and 7).
(9) OFF BALANCE SHEET 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 credit 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. Therefore, the settlement of these transactions is not expected
to have a material effect upon the Company's financial statements. It is also
the Company's policy to review, as necessary, the credit worthiness of each
counter party and customer.
(10) NET CAPITAL REQUIREMENT
ITG Inc. is subject to the Uniform Net Capital Rule (Rule 15c3-1) under the
Securities Exchange Act of 1934, which requires the maintenance of minimum net
capital. ITG Inc. has elected to use the alternative method permitted by Rule
15c3-1, which requires that ITG Inc. maintain minimum net capital, as defined,
equal to the greater of $250,000 or 2% of aggregate debit balances arising from
customer transactions, as defined.
At December 31, 1998, ITG Inc. had net capital of $72.0 million, which was
$71.7 million in excess of required net capital. See Note 16 for the Company's
proposed spin-off and upstream merger and the related dividend transactions.
(11) ITGI STOCK OPTIONS
At December 31, 1998, the Company had a non-compensatory stock option plan.
Under the 1994 Stock Option and Long-term Incentive Plan (the "1994 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 initial public offering in May 1994, 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 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
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) ITGI STOCK OPTIONS (CONTINUED)
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 prices 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 income and earnings
per share would have been reduced to the pro forma amounts indicated below
(dollars in thousands, except per share data):
1998 1997 1996
--------- --------- ---------
Net income.............................. As reported $ 43,394 $ 26,917 $ 23,335
Pro forma $ 41,713 $ 23,375 $ 20,279
Basic net earnings per share of common
stock................................. As reported $ 2.36 $ 1.48 $ 1.28
Pro forma $ 2.27 $ 1.29 $ 1.11
Diluted earnings per share common
stock................................. As reported $ 2.25 $ 1.42 $ 1.26
Pro forma $ 2.16 $ 1.23 $ 1.09
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 1998 and 1997, respectively: zero dividend yield
for all years; risk free interest rates of 5.5, 6.6 and 6.1 percent; expected
volatility of 45, 54 and 49 percent; and expected lives of seven, five and four
years.
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) ITGI STOCK OPTIONS (CONTINUED)
A summary of the status of the Company's stock option plan as of December
31, 1998, 1997 and 1996 and changes during the years ended on those dates is
presented below:
1998 1997 1996
----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
FIXED OPTIONS SHARES PRICE SHARES PRICE SHARES PRICE
- ------------------------------------------------------- ---------- ----------- ---------- ----------- ---------- -----------
Outstanding at beginning of year....................... 3,458,216 $ 15.63 2,311,059 $ 11.96 2,271,351 $ 11.82
Granted................................................ 22,500 29.55 1,241,904 22.29 49,877 16.96
Exercised.............................................. (568,312) 12.94 (94,249) 13.00 -- --
Forfeited.............................................. (24,298) 20.43 (498) 13.00 (10,169) 13.00
---------- ----------- ---------- ----------- ---------- -----------
Outstanding at end of year............................. 2,888,106 $ 16.21 3,458,216 $ 15.63 2,311,059 $ 11.96
---------- ----------- ---------- ----------- ---------- -----------
---------- ----------- ---------- ----------- ---------- -----------
Options exercisable at year-end........................ 2,722,282 $ 15.77 1,737,923 $ 15.25 None
Weighted average fair value per share of options
granted during the year.............................. $ 15.68 $ 10.76 $ 7.93
The following table summarizes information about fixed stock options
outstanding at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------ -------------------------
NUMBER WEIGHTED NUMBER
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
AT REMAINING AVERAGE AT AVERAGE
DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
RANGE OF EXERCISE PRICES 1998 LIFE (YEARS) PRICE 1998 PRICE
- -------------------------------------------------- ------------ --------------- ----------- ------------ -----------
$ 7.50 10.00.................................... 445,909 1.9 $ 9.08 445,909 $ 9.08
11.00 15.00.................................... 1,167,117 0.9 12.30 1,167,117 12.30
16.00 20.00.................................... 157,976 3.4 19.22 73,256 18.94
21.00 25.00.................................... 1,019,604 3.1 22.21 1,010,000 22.19
26.00 30.00.................................... 92,500 8.4 27.80 26,000 27.97
31.00 32.10.................................... 5,000 4.3 32.10 -- --
------------ ------------
$ 7.50 32.10.................................... 2,888,106 2.2 $ 16.21 2,722,282 $ 15.77
------------ ------------
------------ ------------
During 1998, the Company granted 111,683 units representing restricted stock
awards under our Stock Unit Award deferred compensation plan. See note
7--Employee Benefit Plans. Although the 1994 Plan allows for the granting of
performance-based stock options, no such options were granted during 1998, 1997
and 1996 and no such options were outstanding at December 31, 1998, 1997 and
1996.
Restricted stock of 24,219 shares was granted in 1997 as part of the
Company's settlement for its equity investment in The LongView Group. The
restriction period was for one year.
In 1997, the Company granted to Scott P. Mason, its then President and CEO,
a non-qualified stock option to acquire 1,000,000 shares of Common Stock, having
an exercise price of $22.175. During 1997, 400,000 of these options became
exercisable. Upon Mr. Mason's death in 1998, the remaining 600,000 options were
deemed by the board to be exercisable. The effects of such decision resulted in
additional compensation expense of $2.8 million at December 31, 1998. The
options expire in September 2000.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) INTEREST EXPENSE
Included in other general and administrative expenses is interest expense of
$20,000, $146,000 and $223,000 for 1998, 1997 and 1996, respectively.
(13) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31, 1998 and 1997
consisted of the following;
1998 1997
--------- ---------
(DOLLARS IN
THOUSANDS)
Accounts payable and accrued expenses................................ $ 6,581 $ 4,150
Deferred compensation plan........................................... 3,801 --
Deferred options..................................................... 2,778 64
Accrued soft dollar expenses......................................... 6,692 3,125
Accrued bonus expense................................................ 1,757 2,849
Accrued rent expense................................................. 2,445 2,276
Deferred revenues.................................................... 100 200
--------- ---------
Total............................................................ $ 24,154 $ 12,664
--------- ---------
--------- ---------
(14) LEASE COMMITMENTS
The Company entered into lease and sublease agreements with third parties
for certain offices and equipment, which expire at various dates through 2005.
Rent expense for the years ended December 31, 1998, 1997 and 1996 was $3.2
million, $2.6 million and $1.9 million, respectively. Minimum future rentals
under non-cancelable operating leases follow (dollars in thousands):
YEAR ENDING DECEMBER 31,
- -----------------------------------------------------------------------------------
1999............................................................................... $ 3,059
2000............................................................................... 3,116
2001............................................................................... 2,712
2002............................................................................... 2,524
2003............................................................................... 2,914
Thereafter......................................................................... 18,818
---------
Total.......................................................................... $ 33,143
---------
---------
(15) 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, 1998, 1997 and 1996 were
18.4 million, 18.2 million and 18.3 million, respectively.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(15) EARNINGS PER SHARE (CONTINUED)
The following is a reconciliation of the basic and diluted earnings per
share computations for the years ended December 31, 1998, 1997 and 1996.
1998 1997 1996
--------- --------- ---------
(AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
Net income for basic and diluted earnings per share.............................. $ 43,394 $ 26,917 $ 23,335
--------- --------- ---------
--------- --------- ---------
Shares of common stock and common stock equivalents:
Average number of common shares................................................ 18,365 18,178 18,284
--------- --------- ---------
Average shares used in basic computation....................................... 18,365 18,178 18,284
Effect of dilutive securities--options......................................... 924 762 302
--------- --------- ---------
Average shares used in diluted computation..................................... 19,289 18,940 18,586
--------- --------- ---------
--------- --------- ---------
Earnings per share:
Basic.......................................................................... $ 2.36 $ 1.48 $ 1.28
--------- --------- ---------
--------- --------- ---------
Diluted........................................................................ $ 2.25 $ 1.42 $ 1.26
--------- --------- ---------
--------- --------- ---------
(16) JEFFERIES GROUP AND THE COMPANY PLAN TO SEPARATE INTO TWO INDEPENDENT
COMPANIES
On March 17, 1998, the Company announced plans for the separation of
Jefferies & Company and other Jefferies Group subsidiaries from the Company
through a series of transactions, including a special cash dividend, the
transfer of most of Jefferies Group's assets and liabilities (other than those
related to the Company), a spin-off and an upstream merger (collectively, the
"Transactions"). Upon the consummation of the upstream merger and the related
transactions, the stockholders of Jefferies Group will be stockholders of the
Company and Jefferies Group will cease to be the Company's parent.
First, the Company will pay a special cash dividend of $4.00 per share,
payable pro rata to all of its stockholders of record, including Jefferies Group
(the "Special Cash Dividend"). The aggregate amount of the Special Cash Dividend
will be up to $75.0 million, of which the Company will pay $60.0 million to
Jefferies Group.
Following the payment of the Special Cash Dividend, Jefferies Group will
transfer all of its assets (other than its equity interest in the Company) and
all of its liabilities (other than liabilities related to the Company) to a new
company ("New Jefferies"). After such transfers have been completed and certain
other conditions have been satisfied, Jefferies Group will distribute (the
"Spin-Off") all of the outstanding common stock of New Jefferies pro rata to its
stockholders.
The Spin-Off will be followed immediately by a tax-free merger of the
Company into Jefferies Group, with the Company's public shareholders receiving
shares of Jefferies Group. Jefferies Group will then be renamed Investment
Technology Group, Inc. ("New ITGI"). Based on the number of shares of Jefferies
Group common stock expected to be outstanding on the date of the spin-off and
upstream merger (approximately 23,900,000) and the number of shares of the
Company's common stock held by Jefferies Group (15,000,000), the Company's
public stockholders other than Jefferies Group will receive approximately 1.59
shares of common stock of New ITGI for each share of the Company's common stock
held by them.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(16) JEFFERIES GROUP AND THE COMPANY PLAN TO SEPARATE INTO TWO INDEPENDENT
COMPANIES (CONTINUED)
The upstream merger and the related 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. The upstream merger and the related transactions are currently
expected to close in April 1999.
(17) CONTINGENCIES
In 1998, the Company received a "30-day letter" proposing certain
adjustments which, if sustained, would result in a tax deficiency of
approximately $9.6 million plus interest. The adjustments proposed relate to (i)
the disallowance of deductions taken in connection with the termination of
certain compensation plans at the time of our initial public offering in 1994
and (ii) the disallowance of tax credits taken in connection with certain
research and development expenditures. We believe that the tax benefits in
question were taken properly and intend to vigorously contest the proposed
adjustments. Based on the facts and circumstances known at this time, we are
unable to predict when this matter will be resolved or the costs associated with
its resolution.
(18) SUPPLEMENTARY FINANCIAL INFORMATION (UNAUDITED)
The following tables set forth certain unaudited financial data for the
Company's quarterly operations in 1998, 1997 and 1996. 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.
48
INVESTMENT TECHNOLOGY GROUP, INC.
YEAR ENDED
DECEMBER
YEAR ENDED DECEMBER 31, 1998 31, 1997
-------------------------------------------------- -----------
FOURTH THIRD SECOND FIRST FOURTH
QUARTER QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Total Revenue............................................. $ 62,216 $ 57,697 $ 50,905 $ 41,387 $ 36,272
Expenses:
Compensation and employee benefits...................... 14,500 14,152 12,225 10,585 8,999
Transaction processing.................................. 7,639 6,917 6,710 5,564 5,718
Software royalties...................................... 4,072 4,416 3,774 2,985 2,579
Occupancy and equipment................................. 3,195 3,071 2,823 2,797 2,814
Consulting.............................................. 767 357 393 821 487
Telecommunications and data processing services......... 1,853 2,179 2,325 1,781 1,988
Net (gain) loss on long-term investments................ 1,749 (3,632) 1,085 1,002 --
Spin-off costs.......................................... 1,083 479 374 -- 297
Other general and administrative........................ 3,871 4,027 2,529 2,712 2,742
----------- ----------- ----------- ----------- -----------
Total expenses........................................ 38,729 31,966 32,238 28,337 25,624
----------- ----------- ----------- ----------- -----------
Income before income tax expense.......................... 23,487 25,731 18,667 13,050 10,648
Income tax expense........................................ 11,267 11,847 8,739 5,688 4,739
----------- ----------- ----------- ----------- -----------
Net income................................................ $ 12,220 $ 13,884 $ 9,928 $ 7,362 $ 5,909
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Basic net earnings per share of common stock.............. $ 0.66 $ 0.75 $ 0.54 $ 0.40 $ 0.32
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Diluted net earnings per share of common stock............ $ 0.63 $ 0.72 $ 0.52 $ 0.38 $ 0.31
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Basic weighed average shares outstanding.................. 18,484 18,420 18,330 18,233 18,188
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Diluted weighted average shares and common stock
equivalents outstanding................................. 19,468 19,234 19,208 19,154 19,107
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
YEAR ENDED DECEMBER 31,
1996
------------------------
THIRD SECOND FIRST FOURTH THIRD
QUARTER QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- ----------- -----------
Total Revenue............................................. $ 33,437 $ 36,679 $ 30,654 $ 29,892 $ 28,684
Expenses:
Compensation and employee benefits...................... 7,599 7,007 6,874 6,947 6,225
Transaction processing.................................. 5,110 5,682 4,903 3,922 4,340
Software royalties...................................... 2,306 2,581 2,382 2,283 2,272
Occupancy and equipment................................. 2,521 2,010 1,859 1,928 1,899
Consulting.............................................. 585 574 371 494 452
Telecommunications and data processing services......... 1,504 2,156 957 1,396 1,217
Net (gain) loss on long-term investments................ -- -- -- -- --
Spin-off costs.......................................... -- -- -- -- --
Other general and administrative........................ 2,486 2,744 1,947 1,614 2,072
----------- ----------- ----------- ----------- -----------
Total expenses........................................ 22,111 22,754 19,293 18,584 18,477
----------- ----------- ----------- ----------- -----------
Income before income tax expense.......................... 11,326 13,925 11,361 11,308 10,207
Income tax expense........................................ 4,857 5,917 4,830 4,813 4,330
----------- ----------- ----------- ----------- -----------
Net income................................................ $ 6,469 $ 8,008 $ 6,531 $ 6,495 $ 5,877
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Basic net earnings per share of common stock.............. $ 0.36 $ 0.44 $ 0.36 $ 0.36 $ 0.32
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Diluted net earnings per share of common stock............ $ 0.34 $ 0.43 $ 0.35 $ 0.35 $ 0.32
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Basic weighed average shares outstanding.................. 18,144 18,128 18,254 18,255 18,256
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Diluted weighted average shares and common stock
equivalents outstanding................................. 19,104 18,702 18,809 18,727 18,558
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
SECOND FIRST
QUARTER QUARTER
----------- -----------
Total Revenue............................................. $ 26,313 $ 26,667
Expenses:
Compensation and employee benefits...................... 6,006 5,869
Transaction processing.................................. 3,776 3,699
Software royalties...................................... 2,022 2,221
Occupancy and equipment................................. 1,257 1,027
Consulting.............................................. 692 854
Telecommunications and data processing services......... 925 1,251
Net (gain) loss on long-term investments................ -- --
Spin-off costs.......................................... -- --
Other general and administrative........................ 1,783 2,112
----------- -----------
Total expenses........................................ 16,461 17,033
----------- -----------
Income before income tax expense.......................... 9,852 9,634
Income tax expense........................................ 4,285 4,238
----------- -----------
Net income................................................ $ 5,567 $ 5,396
----------- -----------
----------- -----------
Basic net earnings per share of common stock.............. $ 0.30 $ 0.29
----------- -----------
----------- -----------
Diluted net earnings per share of common stock............ $ 0.30 $ 0.29
----------- -----------
----------- -----------
Basic weighed average shares outstanding.................. 18,262 18,364
----------- -----------
----------- -----------
Diluted weighted average shares and common stock
equivalents outstanding................................. 18,572 18,435
----------- -----------
----------- -----------
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.
49
INVESTMENT TECHNOLOGY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1998 YEAR ENDED DECEMBER 31, 1997
-------------------------------------------------- -------------------------------------
FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- ----------- ----------- ----------- -----------
(AS A PERCENTAGE OF TOTAL REVENUES)
Total Revenue....................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Expenses:
Compensation and employee
benefits........................ 23.3 24.5 24.0 25.6 24.8 22.7 19.1
Transaction processing............ 12.3 12.0 13.2 13.7 15.8 15.3 15.5
Software royalties................ 6.5 7.7 7.4 7.2 7.1 6.9 7.0
Occupancy and equipment........... 5.1 5.3 5.5 6.8 7.8 7.5 5.5
Consulting........................ 1.2 0.6 0.8 2.0 1.3 1.7 1.6
Telecommunications and data
processing services............. 3.0 3.8 4.6 4.3 5.5 4.5 5.9
Net (gain) loss on investments.... 2.8 (6.3) 2.1 2.4 0.2 0.0 0.0
Spin-off costs.................... 1.7 0.8 0.7 0.0 0.0 0.0 0.0
Other general and
administrative.................. 6.2 7.0 5.0 6.6 7.3 7.4 7.5
----- ----- ----- ----- ----- ----- -----
Total expenses.................. 62.2 55.4 63.3 68.5 70.7 66.0 62.1
----- ----- ----- ----- ----- ----- -----
Income before income tax expense.... 37.8 44.6 36.7 31.5 29.3 34.0 37.9
Income tax expense................ 18.1 20.5 17.2 13.7 13.0 14.7 16.1
----- ----- ----- ----- ----- ----- -----
Net income.......................... 19.6% 24.1% 19.5% 17.8% 16.3% 19.3% 21.8%
----- ----- ----- ----- ----- ----- -----
----- ----- ----- ----- ----- ----- -----
YEAR ENDED DECEMBER 31, 1996
--------------------------------------------------
FIRST FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- ----------- -----------
Total Revenue....................... 100.0% 100.0% 100.0% 100.0% 100.0%
Expenses:
Compensation and employee
benefits........................ 22.4 23.2 21.7 22.8 22.0
Transaction processing............ 16.0 13.1 15.1 14.4 13.9
Software royalties................ 7.8 7.6 7.9 7.7 8.3
Occupancy and equipment........... 6.1 6.4 6.6 4.8 3.9
Consulting........................ 1.2 1.7 1.6 2.6 3.2
Telecommunications and data
processing services............. 3.1 4.7 4.2 3.5 4.7
Net (gain) loss on investments.... 0.0 0.0 0.0 0.0 0.0
Spin-off costs.................... 0.0 0.0 0.0 0.0 0.0
Other general and
administrative.................. 6.4 5.4 7.2 6.8 7.9
----- ----- ----- ----- -----
Total expenses.................. 63.0 62.1 64.3 62.6 63.9
----- ----- ----- ----- -----
Income before income tax expense.... 37.0 37.9 35.7 37.4 36.1
Income tax expense................ 15.7 16.2 15.2 16.2 15.9
----- ----- ----- ----- -----
Net income.......................... 21.3% 21.7% 20.5% 21.2% 20.2%
----- ----- ----- ----- -----
----- ----- ----- ----- -----
50
(19) SUBSEQUENT EVENTS (UNAUDITED)
On March 16, 1999, the Company entered into an agreement with a bank to
borrow, effective upon the closing of the merger, up to $20 million (the
"Commitment") on a revolving basis to enable ITG Inc. to satisfy its regulatory
net capital requirements. The Commitment will expire on March 14, 2000. Any
amounts drawn may be prepaid at any time, but no later than March 15, 2001. We
have agreed to pay an up-front fee totaling 1.5% of the Commitment and will
incur a fee at a rate per annum equal to 0.35% on the daily amount of the unused
Commitment to March 13, 2000. The interest rate on any amounts drawn will be
prime; if such amounts are not repaid within two weeks, the interest rate will
increase to prime plus 2%. The credit facility is secured by a pledge of the
stock of ITG Inc., ITG Ventures, Inc. and ITG Global Trading Incorporated. This
agreement limits the Company's ability to pay cash dividends or incur
indebtedness and requires the Company to comply with certain financial
covenants.
The intercompany borrowing agreement with Jefferies Group terminated on
March 15, 1999. In addition, the credit line established with our bank to fund
temporary regulatory capital shortfalls encountered periodically by ITG
Australia will not be permitted during the period that the revolving credit
agreement discussed above is effective.
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 1999 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 1999 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 1999 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 1999 Annual Meeting of Stockholders, which is incorporated
herein by reference.
51
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 Auditors' Report........................................................... 30
Consolidated Statements of Income...................................................... 31
Consolidated Statements of Financial Condition......................................... 32
Consolidated Statements of Changes in Stockholders' Equity............................. 33
Consolidated Statements of Cash Flows.................................................. 34
Notes to Consolidated Financial Statements............................................. 35
(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
2.1* Agreement and Plan of Merger, dated as of March 17, 1999, by and between Jefferies
Group, Inc. and the Company.
2.2* Distribution Agreement, dated as of March 17, 1999, by and among Jefferies Group,
Inc. and JEF Holding Company, Inc.
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 as of November 17, 1998, by and among Investment
Technology Group International Limited, Societe Generale, Investment Technology
Group SG Limited, Investment Technology Group Limited and Investment Technology
Group Europe Limited.
10.2 Service Agreement, dated March 15, 1994, by and between Jefferies & Company, Inc.
and ITG Inc. (incorporated by reference to Exhibit 10.2.2 to Registration
Statement).
52
10.2.1* Amendment No. 1 to Service Agreement, dated as of January 1, 1999, by and between
Jefferies & Company, Inc. and ITG Inc.
10.2.2* Execution Agreement, dated as of January 1, 1999, by and between W & D Securities,
Inc. and ITG Inc.
10.2.3* Fully Disclosed Clearing Agreement, dated as of January 1, 1999, by and between
Jefferies & Company, Inc. and ITG Inc.
10.2.4* Benefits Agreement, dated as of March 17, 1999, by and between Jefferies Group,
Inc. and JEF Holding Company, Inc.
10.2.5* Amended and Restated Tax Sharing Agreement, dated as of March 17, 1999, by and
among Jefferies Group, Inc., JEF Holding Company, Inc. and the Company.
10.2.6* Tax Sharing and Indemnification Agreement, dated as of March 17, 1999, by and among
Jefferies Group, Inc., JEF Holding Company, Inc. and the Company.
10.2.7* Credit Agreement dated as of March 16, 1999, among Investment Technology Group,
Inc., as Borrower and the Bank of New York, as Lender
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 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 0.3.18 to the Annual Report on Form 10-K for the year ended
December 31, 1996).
10.3.3 Stock Option Agreement between the Company and Scott P. Mason (incorporated by
reference to Exhibit 10.3.3 to Registration Statement).
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).
10.3.5 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).
10.3.6 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 ended December 31,
1996).
10.4. Amended and Restated 1994 Stock Option and Long-Term Incentive Plan. (incorporated
by reference to Exhibit A to the 1997 Annual Meeting Proxy Statement).
10.4.1 Non-Employee Directors' Stock Option Plan. (incorporated by reference to Appendix A
to the 1996 Annual Meeting Proxy Statement).
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 Pay-For-Performance Incentive Plan (incorporated by reference to Exhibit B to the
1997 Annual Meeting Proxy Statement).
10.4.5 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.3.1A to the
Annual Report on Form 10-K for the year ended December 31, 1997)
53
10.4.6* 1998 Amended and Restated Stock Unit Award Program
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. (incorporated by reference to Exhibit 10.5.2
to the Annual Report on Form 10-K for the year ended December 31, 1997.)
10.5.3 Lease, dated October 4, 1996, between Spartan Madison Corp. and the Company.
(incorporated by reference to Exhibit 10.5.3 to the Annual Report on Form 10-K for
the year ended December 31, 1997.)
10.5.4 First Supplemental Agreement, dated as of January 29, 1997, between Spartan Madison
Corp. and the Company. (incorporated by reference to Exhibit 10.5.4 to the Annual
Report on Form 10-K for the year ended December 31, 1997.)
10.5.5 Second Supplemental Agreement, dated as of November 25, 1997, between Spartan
Madison Corp. and the Company. (incorporated by reference to Exhibit 10.5.5 to the
Annual Report on Form 10-K for the year ended December 31, 1997.)
10.5.6 Lease dated March 10, 1995, between Boston Wharf Co. and the Company. (incorporated
by reference to Exhibit 10.5.6 to the Annual Report on Form 10-K for the year ended
December 31, 1997.)
10.6 Form of QuantEX Software and Hardware License Agreement (incorporated by reference
to Exhibit 10.3.3 to Registration Statement).
21* Subsidiaries of Company.
23* Consent of KPMG LLP.
27* Financial Data Schedule.
- ------------------------
* Filed herewith
(b) Reports on Form 8-K.
On November 6, 1998, the Company filed a Form 8-K reporting updated
financial information regarding the previously announced plan by Jefferies Group
and the Company to separate Jefferies Group's 100% owned subsidiary, Jefferies &
Company and Jefferies Group's 80.5% owned subsidiary, the Company, through a
proposed spin-off and related transactions.
(c) Index to Exhibits
See list of exhibits at Item 14(a)(3) above and exhibits following.
54
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, Chief Executive
Officer and President
Dated: March 18, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons and on behalf of the
Registrant in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ RAYMOND L. KILLIAN, JR. Chairman of the Board,
- ------------------------------ Chief Executive Officer March 18, 1999
Raymond L. Killian, Jr. President and Director
Senior Vice President and
/s/ JOHN R. MACDONALD Chief Financial Officer
- ------------------------------ (Principal Financial March 18, 1999
John R. MacDonald Officer)
/s/ ANGELO BULONE Vice President and
- ------------------------------ Controller (Principal March 18, 1999
Angelo Bulone Accounting Officer)
/s/ FRANK E. BAXTER
- ------------------------------ Director March 18, 1999
Frank E. Baxter
/s/ NEAL S. GARONZIK
- ------------------------------ Director March 18, 1999
Neal S. Garonzik
/s/ WILLIAM I JACOBS
- ------------------------------ Director March 18, 1999
William I Jacobs
/s/ ROBERT L. KING
- ------------------------------ Director March 18, 1999
Robert L. King
/s/ MARK A. WOLFSON
- ------------------------------ Director March 18, 1999
Mark A. Wolfson
55
EXHIBIT INDEX
SEQUENTIALLY
EXHIBITS NUMBERED
NUMBER DESCRIPTION PAGE
- --------- ------------------------------------------------------------------------------------------ -------------
2.1* Agreement and Plan of Merger, dated as of March 17, 1999, by and between Jefferies Group,
Inc. and the Company.
2.2* Distribution Agreement, dated as of March 17, 1999, by and among Jefferies Group, Inc. and
JEF Holding Company, Inc.
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 as of November 17, 1998, by and among Investment Technology
Group International Limited, Societe Generale, Investment Technology Group SG Limited,
Investment Technology Group Limited and Investment Technology Group Europe Limited.
10.2 Service Agreement, dated March 15, 1994, by and between Jefferies & Company, Inc. and ITG
Inc. (incorporated by reference to Exhibit 10.2.2 to Registration Statement).
10.2.1* Amendment No. 1 to Service Agreement, dated as of January 1, 1999, by and between
Jefferies & Company, Inc. and ITG Inc.
10.2.2* Execution Agreement, dated as of January 1, 1999, by and between W & D Securities, Inc.
and ITG Inc.
10.2.3* Fully Disclosed Clearing Agreement, dated as of January 1, 1999, by and between Jefferies
& Company, Inc. and ITG Inc.
10.2.4* Benefits Agreement, dated as of March 17, 1999, by and between Jefferies Group, Inc. and
JEF Holding Company, Inc.
56
SEQUENTIALLY
EXHIBITS NUMBERED
NUMBER DESCRIPTION PAGE
- --------- ------------------------------------------------------------------------------------------ -------------
10.2.5* Amended and Restated Tax Sharing Agreement, dated as of March 17, 1999, by and among
Jefferies Group, Inc., JEF Holding Company, Inc. and the Company.
10.2.6* Tax Sharing and Indemnification Agreement, dated as of March 17, 1999, by and among
Jefferies Group, Inc., JEF Holding Company, Inc. and the Company.
10.2.7* Credit Agreement dated as of March 16, 1999, among Investment Technology Group, Inc., as
Borrower and the Bank of New York, as Lender
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 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 0.3.18 to the Annual Report on Form 10-K for the year ended December 31, 1996).
10.3.3 Stock Option Agreement between the Company and Scott P. Mason (incorporated by reference
to Exhibit 10.3.3 to Registration Statement).
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).
10.3.5 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).
10.3.6 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 ended December 31, 1996).
10.4. Amended and Restated 1994 Stock Option and Long-Term Incentive Plan. (incorporated by
reference to Exhibit A to the 1997 Annual Meeting Proxy Statement).
10.4.1 Non-Employee Directors' Stock Option Plan. (incorporated by reference to Appendix A to the
1996 Annual Meeting Proxy Statement).
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 Pay-For-Performance Incentive Plan (incorporated by reference to Exhibit B to the 1997
Annual Meeting Proxy Statement).
10.4.5 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.3.1A to the Annual
Report on Form 10-K for the year ended December 31, 1997)
10.4.6* 1998 Amended and Restated Stock Unit Award Program
57
SEQUENTIALLY
EXHIBITS NUMBERED
NUMBER DESCRIPTION PAGE
- --------- ------------------------------------------------------------------------------------------ -------------
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. (incorporated by reference to Exhibit 10.5.2 to the Annual
Report on Form 10-K for the year ended December 31, 1997.)
10.5.3 Lease, dated October 4, 1996, between Spartan Madison Corp. and the Company. (incorporated
by reference to Exhibit 10.5.3 to the Annual Report on Form 10-K for the year ended
December 31, 1997.)
10.5.4 First Supplemental Agreement, dated as of January 29, 1997, between Spartan Madison Corp.
and the Company. (incorporated by reference to Exhibit 10.5.4 to the Annual Report on Form
10-K for the year ended December 31, 1997.)
10.5.5 Second Supplemental Agreement, dated as of November 25, 1997, between Spartan Madison
Corp. and the Company. (incorporated by reference to Exhibit 10.5.5 to the Annual Report
on Form 10-K for the year ended December 31, 1997.)
10.5.6 Lease dated March 10, 1995, between Boston Wharf Co. and the Company. (incorporated by
reference to Exhibit 10.5.6 to the Annual Report on Form 10-K for the year ended December
31, 1997.)
10.6 Form of QuantEX Software and Hardware License Agreement (incorporated by reference to
Exhibit 10.3.3 to Registration Statement).
21* Subsidiaries of Company.
23* Consent of KPMG LLP.
27* Financial Data Schedule.
- ------------------------
* Filed herewith
58