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EX-31.2 - EX-31.2 - GFI Group Inc.a11-8548_1ex31d2.htm

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011

 

 

OR

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM                  TO                

 

Commission File No: 000-51103

 

GFI GROUP INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

80-0006224

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

55 Water Street, New York, NY

 

10041

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (212) 968-4100

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES o     NO o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o  NO x

 

The number of shares of registrant’s common stock outstanding on April 29, 2011 was 123,101,506.

 

 

 



Table of Contents

 

Table of Contents

 

 

Part I—Financial Information

 

 

 

 

Item 1.

Financial Statements

 

 

Condensed Consolidated Statements of Financial Condition as of March 31, 2011 (unaudited) and December 31, 2010

 

 

Condensed Consolidated Statements of Income for the three months ended March 31, 2011 (unaudited) and March 31, 2010 (unaudited)

 

 

Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2011 (unaudited) and March 31, 2010 (unaudited)

 

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2011 (unaudited) and March 31, 2010 (unaudited)

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

Item 4.

Controls and Procedures

 

 

 

 

 

Part II—Other Information

 

 

 

 

Item 1.

Legal Proceedings

 

Item 1A.

Risk Factors

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

Item 6.

Exhibits

 

 

2



Table of Contents

 

Available Information

 

Our internet website address is www.gfigroup.com. Through our website, we make available, free of charge, the following reports as soon as reasonably practicable after electronically filing them with, or furnishing them to, the Securities and Exchange Commission (the “SEC”): our annual reports on Form 10-K; our proxy statements for our annual and special stockholder meetings; our quarterly reports on Form 10-Q; our current reports on Form 8-K; Forms 3, 4 and 5 filed on behalf of directors and executive officers; and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended (the ‘‘Exchange Act’’).

 

In addition, you may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E., Room 1580, Washington D.C. 20549. You also may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains our reports, proxy and information statements, and other information regarding the Company that we file electronically with the SEC at http://www.sec.gov.

 

Information relating to the corporate governance of the Company is also available on the Investor Relations page of our website, including information concerning our directors, board committees, including committee charters, our corporate governance guidelines, our code of business conduct and ethics for all employees and for senior financial officers and our compliance procedures for accounting and auditing matters. In addition, the Investor Relations page of our website includes certain supplemental financial information that we make available from time to time.

 

Our website and the information contained therein or connected thereto are not incorporated into this Quarterly Report on Form 10-Q.

 

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Table of Contents

 

PART I—FINANCIAL INFORMATION

 

ITEM 1.                    FINANCIAL STATEMENTS

 

GFI GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)

(In thousands, except share and per share amounts)

 

 

 

March 31,
2011

 

December 31,
2010

 

Assets

 

 

 

 

 

Cash and cash equivalents

 

$

276,809

 

$

313,875

 

Cash segregated under federal and other regulations

 

12,065

 

24,927

 

Deposits with clearing organizations

 

40,633

 

26,845

 

Commissions receivable, net of allowance for doubtful accounts of $1,576 and $1,591 at March 31, 2011 and December 31, 2010, respectively

 

133,288

 

103,010

 

Receivables from brokers, dealers and clearing organizations

 

397,095

 

243,811

 

Property, equipment and leasehold improvements, net of depreciation and amortization of $136,137 and $130,479 at March 31, 2011 and December 31, 2010, respectively

 

61,438

 

60,612

 

Goodwill

 

269,842

 

268,288

 

Intangible assets, net

 

64,644

 

66,816

 

Other assets

 

171,559

 

162,840

 

TOTAL ASSETS

 

$

1,427,373

 

$

1,271,024

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Accrued compensation 

 

$

88,625

 

$

112,535

 

Accounts payable and accrued expenses

 

74,438

 

64,672

 

Payables to brokers, dealers and clearing organizations

 

283,381

 

172,418

 

Payables to clearing services customers

 

122,906

 

125,968

 

Short-term borrowings, net

 

157,611

 

132,703

 

Long-term obligations, net

 

59,773

 

59,743

 

Other liabilities

 

146,503

 

111,163

 

Total Liabilities

 

$

933,237

 

$

779,202

 

Commitments and contingencies

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

 

 

 

 

Preferred stock, $0.01 par value; 5,000,000 shares authorized, none outstanding at March 31, 2011 and December 31, 2010

 

 

 

Common stock, $0.01 par value; 400,000,000 shares authorized; 130,460,516 and 128,703,324 shares issued at March 31, 2011 and December 31, 2010, respectively

 

1,305

 

1,287

 

Additional paid in capital

 

349,276

 

350,230

 

Retained earnings

 

183,662

 

183,016

 

Treasury stock, 7,049,732 and 6,577,833 shares of common stock at cost, at March 31, 2011 and December 31, 2010, respectively

 

(43,585

)

(43,433

)

Accumulated other comprehensive loss

 

997

 

(389

)

Total Stockholders’ Equity

 

491,655

 

490,711

 

Non-controlling interests

 

2,481

 

1,111

 

Total Equity

 

494,136

 

491,822

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

1,427,373

 

$

1,271,024

 

 

See notes to condensed consolidated financial statements

 

4



Table of Contents

 

GFI GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(In thousands, except share and per share amounts)

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Revenues

 

 

 

 

 

Agency commissions

 

$

147,483

 

$

143,830

 

Principal transactions

 

70,487

 

60,296

 

Total brokerage revenues

 

217,970

 

204,126

 

Clearing services revenues

 

27,670

 

 

Interest income from clearing services

 

342

 

 

Equity in earnings of unconsolidated brokerage businesses

 

2,374

 

 

Software, analytics and market data

 

17,088

 

14,900

 

Other (loss) income(1)

 

(2,546

)

1,749

 

Total revenues

 

262,898

 

220,775

 

Interest and transaction-based expenses

 

 

 

 

 

Transaction fees on clearing services

 

27,069

 

 

Transaction fees on brokerage services

 

6,605

 

7,424

 

Interest expense from clearing services

 

326

 

 

Total interest and transaction-based expenses

 

34,000

 

7,424

 

Revenues, net of interest and transaction-based expenses

 

228,898

 

213,351

 

Expenses

 

 

 

 

 

Compensation and employee benefits

 

159,481

 

144,663

 

Communications and market data

 

15,071

 

11,886

 

Travel and promotion

 

10,203

 

8,893

 

Rent and occupancy

 

5,873

 

5,431

 

Depreciation and amortization

 

9,874

 

8,184

 

Professional fees

 

7,103

 

6,597

 

Interest on borrowings

 

2,936

 

2,575

 

Other expenses

 

8,081

 

5,008

 

Total other expenses

 

218,622

 

193,237

 

Income before provision for income taxes

 

10,276

 

20,114

 

Provision for income taxes

 

2,672

 

6,738

 

Net income before attribution to non-controlling shareholders

 

7,604

 

13,376

 

Less: Net income attributable to non-controlling interests

 

858

 

 

GFI’s net income

 

$

6,746

 

$

13,376

 

Earnings per share available to common shareholders

 

 

 

 

 

Basic

 

$

0.06

 

$

0.11

 

Diluted

 

$

0.05

 

$

0.11

 

Weighted average shares outstanding

 

 

 

 

 

Basic

 

119,524,627

 

118,606,954

 

Diluted

 

128,209,107

 

122,861,743

 

 

 

 

 

 

 

Dividends declared per share of common stock

 

$

0.05

 

$

0.05

 

 


(1)          As adjusted — see Note 2

 

See Note 2 for discussion of change in presentation made in 2010

 

See notes to condensed consolidated financial statements

 

5



Table of Contents

 

GFI GROUP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(In thousands)

 

 

 

Three Months Ended March, 31

 

 

 

2011

 

2010

 

Net income before attribution to non-controlling shareholders

 

$

7,604

 

$

13,376

 

Other comprehensive income (loss):

 

 

 

 

 

Foreign currency translation adjustment, net of tax(1)

 

1,690

 

(412

)

Unrealized gain (loss) on available-for-sale securities, net of tax(2)

 

(304

)

(341

)

Comprehensive income

 

8,990

 

12,623

 

Net income attributable to non-controlling interests

 

858

 

 

Other comprehensive (loss) income attributable to non-controlling interests

 

(281

)

 

GFI’s comprehensive income

 

$

8,413

 

$

12,623

 

 


(1)          Amounts are net of provision for (benefit from) income taxes of $1,141 and $(296) for the three months ended March 31, 2011 and 2010, respectively.

(2)          Amounts are net of benefit from income taxes of $(117) and $(133) for the three months ended March 31, 2011 and 2010, respectively.

 

See notes to condensed consolidated financial statements

 

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Table of Contents

 

GFI GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income before attribution to non-controlling shareholders

 

$

7,604

 

$

13,376

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

9,874

 

8,129

 

Amortization of loan fees

 

241

 

231

 

Provision for doubtful accounts

 

8

 

83

 

Share-based compensation

 

7,492

 

6,784

 

(Benefit from) provision for deferred taxes

 

(6,683

)

340

 

Losses (gains) on foreign exchange derivative contracts, net

 

7,081

 

(3,079

)

Losses (gains) from equity method investments, net

 

2,391

 

(103

)

Tax (benefit) expense related to share-based compensation

 

(1,078

)

348

 

Other non-cash charges, net

 

165

 

(23

)

Decrease (increase) in operating assets:

 

 

 

 

 

Cash segregated under federal and other regulations

 

12,862

 

 

Deposits with clearing organizations

 

(13,788

)

(1,978

)

Commissions receivable

 

(30,229

)

(11,372

)

Receivables from brokers, dealers and clearing organizations

 

(153,284

)

(127,189

)

Other assets

 

5,051

 

(9,035

)

(Decrease) increase in operating liabilities:

 

 

 

 

 

Accrued compensation

 

(23,910

)

(40,230

)

Accounts payable and accrued expenses

 

9,766

 

(6,343

)

Payables to brokers, dealers and clearing organizations

 

110,963

 

116,724

 

Payables to clearing services customers

 

(3,047

)

 

Other liabilities

 

25,830

 

39,412

 

Cash used in operating activities

 

(32,691

)

(13,925

)

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Business acquisitions

 

(139

)

 

Issuance of notes receivable

 

(2,000

)

 

Proceeds from notes receivable

 

 

1,000

 

Proceeds from other investments

 

562

 

 

Purchases of other investments

 

(4,300

)

(8,338

)

Purchase of property, equipment and leasehold improvements

 

(6,195

)

(3,859

)

Proceeds on foreign exchange derivative contracts

 

576

 

4,984

 

Payments on foreign exchange derivative contracts

 

(4,902

)

(1,248

)

Cash used in investing activities

 

(16,398

)

(7,461

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from short-term borrowings

 

45,000

 

 

Repayment of short-term borrowings

 

(20,000

)

 

Purchases of treasury stock

 

(3,330

)

 

Cash dividends paid

 

(6,100

)

(5,928

)

Payment of loan fees

 

(417

)

 

Proceeds from exercise of stock options

 

10

 

471

 

Cash paid for taxes on vested restricted stock units

 

(6,354

)

(4,632

)

Tax benefit (expense) related to share-based compensation

 

1,078

 

(348

)

Cash provided by (used in) financing activities

 

9,887

 

(10,437

)

Effects of exchange rate changes on cash and cash equivalents

 

2,136

 

(130

)

DECREASE IN CASH AND CASH EQUIVALENTS

 

(37,066

)

(31,953

)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

313,875

 

342,379

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

276,809

 

$

310,426

 

SUPPLEMENTAL DISCLOSURE:

 

 

 

 

 

Interest paid

 

$

3,837

 

$

3,556

 

Income taxes paid, net of refunds

 

$

6,846

 

$

(1,023

)

 

Non-Cash Investing and Financing Activities:

During the three months ended March 31, 2010, the Company recorded $2,286 within Other Assets with respect to 414,938 contingently issuable shares of the Company’s common stock in connection with an equity method investment described in Note 5.

 

See notes to condensed consolidated financial statements

 

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Table of Contents

 

GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands except share and per share amounts)

 

1.      ORGANIZATION AND BUSINESS

 

The condensed consolidated financial statements include the accounts of GFI Group Inc. and its subsidiaries (collectively, “GFI” or the “Company”). The Company, through its subsidiaries, provides brokerage services, clearing services, trading system software and market data and analytical software products to institutional clients in markets for a range of fixed income, financial, equity and commodity instruments. The Company complements its brokerage capabilities with value-added services, such as market data and software systems and products for decision support, which it licenses primarily to companies in the financial services industry. The Company’s principal operating subsidiaries include: GFI Securities LLC, GFI Brokers LLC, GFI Group LLC, GFI Securities Limited, GFI Brokers Limited, GFI (HK) Securities LLC, GFI (HK) Brokers Ltd., GFI Group Pte. Ltd., GFI Korea Money Brokerage Limited, Amerex Brokers LLC, Fenics Limited (“Fenics”), Trayport Limited (“Trayport”), and The Kyte Group Limited and Kyte Capital Management Limited (collectively “Kyte”). As of March 31, 2011, Jersey Partners, Inc. (“JPI”) owned approximately 40% of the Company’s outstanding shares of common stock. The Company’s chief executive officer, Michael Gooch, is the controlling shareholder of JPI.

 

2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of PresentationThe Company’s condensed consolidated financial statements (unaudited) are prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingencies in the consolidated financial statements. Certain estimates and assumptions relate to the accounting for acquired goodwill and intangible assets, fair value measurements, compensation accruals, tax liabilities and the potential outcome of litigation matters. Management believes that the estimates utilized in the preparation of the consolidated financial statements are reasonable and prudent. Actual results could differ materially from these estimates.

 

All intercompany transactions and balances have been eliminated.

 

Interest income on short-term investments for the three months ended March 31, 2010 totaling $240 was previously presented in a line item called “Interest income” but has been combined with “Other (loss) income” to conform with the current year’s presentation.

 

In the fourth quarter of 2010, the Company changed its presentation of certain revenues and expenses in the Condensed Consolidated Statements of Income, and adjusted the prior periods accordingly. In order to enhance transparency in the presentation of the Condensed Consolidated Statements of Income and to provide a clearer picture of the financial performance of the Company’s operations, the Company adjusted its presentation of certain revenues and expenses as follows:

 

·                  Revenues that were previously presented as “Interest income” have been presented as “Interest income from clearing services” and “Other (loss) income” to present the portion of income that relates to clearing services separate from interest income earned on short-term investments. Interest income earned on short-term investments is included in “Other (loss) income”.

 

·                  Expenses have been presented in the following two components: (1) Interest and transaction-based expenses and (2) Other expenses, in order to present the subtotal “Revenues, net of interest and transaction-based expenses” on the Condensed Consolidated Statements of Income. “Revenues, net of interest and transaction-based expenses” represent revenues, net of direct, incremental costs incurred to obtain those revenues. Expenses that were previously reported as “Clearing fees” have been presented as “Transaction fees on clearing services” and “Transaction fees on brokerage services” in order to more clearly present the nature of the expense in relation to the Company’s revenues. These accounts are included within “Interest and transaction-based expenses” as they are directly attributable to the Company’s clearing and brokerage revenues.

 

·                  Expenses that were previously reported as “Interest expenses” have been presented as “Interest expense from clearing services” and “Interest on borrowings”. Interest expenses from clearing services are included within “Interest and transaction-based expenses” as they are directly attributable to the Company’s interest expense earned on customer deposits. Interest on borrowings are included within “Total other expenses” as they relate to the Company’s borrowings, not revenues.

 

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Table of Contents

 

GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

The condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (the “2010 Form 10-K”). The condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for the fair statement of the results for the interim period. The results of operations for interim periods are not necessarily indicative of results for the entire year.

 

Consolidation Policies—The condensed consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and subsidiaries that are treated as such and other entities in which the Company has a controlling financial interest. For consolidated subsidiaries that are less than wholly-owned, the equity interests that are not owned by the Company are referred to as non-controlling interests. The portion of net income attributable to non-controlling interests for such subsidiaries is presented as Net income attributable to non-controlling interests on the Condensed Consolidated Statements of Income, and the portion of the shareholders’ equity of such subsidiaries is presented as Non-controlling interests in the Condensed Consolidated Statements of Financial Condition.

 

Variable Interest Entities—The Company determines whether the Company holds any interests in entities deemed to be a variable interest entity (“VIE”). A VIE is an entity that either (i) has equity investors that lack certain essential characteristics of a controlling financial interest or (ii) does not have sufficient equity to finance its activities without additional subordinated financial support from other parties. If an entity has either of these characteristics, it is considered a VIE and must be consolidated by its primary beneficiary. The primary beneficiary is the party that has both (i) the power to direct the activities of the VIE that most significantly impact the economic performance of the entity and (ii) the obligation to absorb losses of the entity that could be potentially significant to the VIE or the right to receive benefits from the entity that could be potentially significant. As of March 31, 2011, the Company holds variable interests in certain VIEs. One of these VIEs is consolidated as it is determined that the Company is the primary beneficiary. The remaining VIEs are not consolidated as it is determined that the Company is not the primary beneficiary. See Note 13 for disclosures on Variable Interest Entities.

 

Cash and Cash Equivalents—Cash and cash equivalents consist of cash and highly liquid investments with maturities, when purchased, of three months or less.

 

Cash segregated under federal and other regulations—The Company holds cash that belongs to customers as support for their trading activities. As a result, certain of the Company’s subsidiaries are required to segregate or set aside such cash to satisfy regulations designed to protect customer assets.

 

Deposits with Clearing Organizations—Deposits with clearing organizations consist of deposits of cash and cash equivalents or short-term investments, recorded at fair value, at various clearing companies and organizations that perform clearing and custodial functions for the Company.

 

Goodwill and Intangible Assets— Goodwill represents the excess of the purchase price allocation over the fair value of tangible and identifiable intangible net assets acquired. The goodwill associated with each business combination is allocated to the related reporting units, which are determined based on how the Company’s businesses are managed and how they are reviewed by the Company’s chief operating decision maker. Other intangible assets are recorded at their fair value upon completion of a business combination or certain other transactions.

 

In accordance with Accounting Standards Codification (“ASC”) 350 IntangiblesGoodwill and Other (“ASC 350”), goodwill and other indefinite lived intangible assets are not amortized, but instead are periodically tested for impairment. The Company reviews goodwill and other indefinite lived intangible assets for impairment on an annual basis during the fourth quarter of each fiscal year or whenever an event occurs or circumstances change that could reduce the fair value of a reporting unit below its carrying amount. ASC 350 prescribes a two step process for goodwill impairment testing whereby management first compares the fair value of each reporting unit with recorded goodwill to that reporting unit’s book value. If management determines, as a result of this first step, that the fair value of the reporting unit is less than its carrying value, a second step in the impairment test process would require that the recorded goodwill at that reporting unit be written down to the value implied by the reporting unit’s recent valuation and the estimated fair value of the assets and liabilities.

 

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Table of Contents

 

GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

The primary valuation methods used to estimate the fair value of its reporting units are the income and market approach.  In applying the income approach, projected cash flows available for distribution and the terminal value are discounted to present value to derive an indication of fair value of the business enterprise. The market approach compares the reporting unit to selected reasonably similar publicly-traded companies. Trading and transaction comparables are used as general indicators to assess the general reasonableness of the estimated fair values.

 

Intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives.

 

The Company’s accounting policy was to conduct the annual goodwill impairment test as of January 1. Effective in the fourth quarter of 2010, the Company elected to change its accounting policy to begin conducting the annual goodwill impairment test on November 1. The change in the goodwill impairment test date is preferable as it provides the Company with additional time to complete the required testing and evaluate the results prior to the year-end closing and reporting activities when resources are more constrained. The change in accounting principle did not accelerate, delay, avoid, or cause a goodwill impairment charge. As it was impracticable to objectively determine projected cash flows and related valuation estimates as of each November 1 for periods prior to November 1, 2010, the Company has prospectively applied the change in the annual goodwill impairment testing date from November 1, 2010.

 

Prepaid Bonuses and Forgivable Employee Loans—Prepaid bonuses and forgivable loans to employees are stated at historical value net of amortization when the agreement between the Company and the employee provides for the return of proportionate amounts of the bonus or loan outstanding if employment is terminated in certain circumstances prior to the end of the term of the agreement. Amortization is calculated using the straight-line method over the term of the contract, which is generally two to four years, and is recorded in compensation and employee benefits. The Company generally expects to recover the unamortized portion of prepaid bonuses and forgivable loans when employees voluntarily terminate their employment or if their employment is terminated for cause prior to the end of the term of the agreement. The prepaid bonuses and forgivable loans are included in Other assets in the Condensed Consolidated Statements of Financial Condition.

 

Investments—When the Company does not have a controlling financial interest in an entity but can exert significant influence over the entity’s operating and financial policies, the investment is accounted for under the equity method of accounting in accordance with ASC 323-10, Investments—Equity Method and Joint Ventures (“ASC 323-10”). Significant influence generally exists when the Company owns 20% to 50% of the entity’s common stock or in-substance common stock. The Company initially records the investment at cost and adjusts the carrying amount each period to recognize its share of the earnings and losses of the investee based on the percentage of ownership. At March 31, 2011 and December 31, 2010, the Company had equity method investments with a carrying value of $28,350 and $30,057, respectively. Investments for which the Company holds less than 20% of the outstanding shares of the investee’s stock or for which the Company does not have the ability to exert significant influence over operating and financial policies are accounted for using the cost method of accounting in accordance with ASC 325-10, Investments — Other (“ASC 325-10”). At March 31, 2011 and December 31, 2010, the Company had cost method investments of $3,751 and $3,116, respectively. The Company monitors its equity and cost method investments for indicators of impairment each reporting period. During the three months ended March 31, 2011, the Company recorded a $1,863 loss related to the accounting impact of an increased ownership stake in an equity method investment previously accounted for under the cost method.

 

The Company accounts for its marketable equity securities in accordance with ASC 320-10, Investments—Debt and Equity Securities. Investments designated as available-for-sale are recorded at fair value with unrealized gains or losses reported as a separate component of other comprehensive income, net of tax. The fair value of the Company’s available-for-sale securities was $4,658 and $4,925 as of March 31, 2011and December 31, 2010, respectively.

 

All of the Company’s investments are included in Other assets in the Condensed Consolidated Statements of Financial Condition.

 

Fair Value of Financial Instruments In accordance with ASC 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”), the Company estimates fair values of financial instruments using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment in interpreting market data and, accordingly, changes in assumptions or in market conditions could adversely affect the estimates.  The Company also discloses the fair value of its financial instruments in accordance with the fair value hierarchy as set forth by ASC 820-10.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

Trading securities are reported at fair value, with gains and losses resulting from changes in fair value recognized currently in Other (loss) income.

 

Derivative Financial Instruments The Company uses foreign exchange derivative contracts to reduce the effects of fluctuations in certain receivables and payables denominated in foreign currencies. Derivative contracts that are not designated as foreign currency cash flow hedges are recorded at fair value and all realized and unrealized gains and losses are included in Other (loss) income in the Condensed Consolidated Statements of Income.

 

Payables to clearing services customersPayables to clearing services customers include amounts due on cash and margin transactions, including futures contracts transacted on behalf of customers.

 

Brokerage Transactions—The Company provides brokerage services to its clients in the form of either agency or principal transactions.

 

Agency Commissions—In agency transactions, the Company charges commissions for executing transactions between buyers and sellers. Agency commissions revenues and related expenses are recognized on a trade date basis.

 

Principal Transactions—Principal transactions revenue is primarily derived from matched principal and principal trading transactions. Principal transactions revenues and related expenses are recognized on a trade date basis. The Company earns revenue from principal transactions on the spread between the buy and sell price of the security that is brokered. In matched principal transactions, the Company simultaneously agrees to buy instruments from one customer and sell them to another customer.

 

In the normal course of its matched principal and principal trading businesses, the Company holds securities positions overnight. These positions are marked to market on a daily basis.

 

Clearing Services Revenues—The Company charges fees to customers for clearing services provided for cash and derivative transactions. Clearing services revenues are recorded on a trade date basis as customer transactions occur and are presented net of any customer negotiated rebates.

 

Software, Analytics and Market Data Revenue Recognition—Software revenue consists primarily of fees charged for Trayport electronic trading software, which are typically billed on a subscription basis and is recognized ratably over the term of the subscription period, which ranges from one to five years. Analytics revenue consists primarily of software license fees for Fenics pricing tools which are typically billed on a subscription basis, and is recognized ratably over the term of the subscription period, which is generally three years. Market data revenue primarily consists of subscription fees and fees from customized one-time sales. Market data subscription fees are recognized on a straight-line basis over the term of the subscription period, which ranges from one to two years. Market data revenue from customized one-time sales is recognized upon delivery of the data.

 

The Company markets its software, analytics and market data products through its direct sales force and, in some cases, indirectly through resellers. In general, the Company’s license agreements for such products do not provide for a right of return.

 

Other (Loss) Income—Included within Other (loss) income on the Company’s Condensed Consolidated Statements of Income are revaluations of foreign currency derivative contracts, realized and unrealized transaction gains and losses on certain foreign currency denominated items and gains and losses on certain investments and interest income earned on short-term investments.

 

Compensation and Employee Benefits—The Company’s compensation and employee benefits have both a fixed and variable component. Base salaries and benefit costs are primarily fixed for all employees while bonuses constitute the variable portion of compensation and employee benefits. The Company may pay certain performance bonuses in restricted stock units (“RSUs”). The Company also may grant sign-on and retention bonuses for certain newly-hired or existing employees who agree to long-term employment agreements. These sign-on and retention bonuses are typically amortized

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

using the straight-line method over the term of the respective agreements.

 

Share-Based Compensation—The Company’s share-based compensation consists of stock options and RSUs. The Company accounts for share-based compensation in accordance with ASC 718 Compensation-Stock Compensation (“ASC 718”). This accounting guidance requires measurement of compensation expense for equity-based awards at fair value and recognition of compensation expense over the service period, net of estimated forfeitures. In all periods presented, the only share-based compensation issued by the Company has been RSUs. The Company determines the fair value of RSUs based on the number of units granted and the grant date fair value of the Company’s common stock, measured as of the closing price on the date of grant.

 

Income Taxes—In accordance with ASC 740, Income Taxes, the Company provides for income taxes using the asset and liability method under which deferred income taxes are recognized for the estimated future tax effects attributable to temporary differences and carry-forwards that result from events that have been recognized either in the financial statements or the income tax returns, but not both. The measurement of current and deferred income tax liabilities and assets is based on provisions of enacted tax laws. Valuation allowances are recognized if, based on the weight of available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized. Effective January 1, 2007, the Company adopted ASC 740-10. It is the Company’s policy to provide for uncertain tax positions and the related interest and penalties based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities.

 

Treasury stock—The Company accounts for Treasury stock using the cost method. Treasury stock held by the Company may be reissued with respect to vested RSUs in qualified jurisdictions. The Company’s policy is to account for these shares as a reduction of Treasury stock on a first-in, first-out basis.

 

Foreign Currency Translation Adjustments and Transactions—Assets and liabilities of foreign subsidiaries having non-U.S. dollar functional currencies are translated at the period end rates of exchange, and revenue and expenses are translated at the average rates of exchange for the period. Gains or losses resulting from translating foreign currency financial statements are reflected in foreign currency translation adjustments and are reported as a separate component of comprehensive income and included in accumulated other comprehensive loss in stockholders’ equity. Net gains (losses) resulting from remeasurement of foreign currency transactions and balances for the three months ended March 31, 2011 and 2010 were $2,244 and $(2,294), respectively, and are included in Other (loss) income.

 

Recent Accounting Pronouncements— In May 2009, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 165, Subsequent Events, which is now a sub-topic within ASC 855-10 Subsequent Events (“ASC 855-10”). ASC 855-10 provides guidance for accounting for and disclosure of subsequent events that are not addressed in other applicable generally accepted accounting principles. ASC 855-10 was effective for interim and annual reporting periods ending after June 15, 2009, and has been applied prospectively by the Company. In February 2010, the FASB amended ASC 855-10 through the issuance of Accounting Standards Update No. 2010-09 (“ASU 2010-09”), Amendments to Certain Recognition and Disclosure Requirements. ASU 2010-09 removed the requirement for an SEC filer to disclose the date of final review for disclosure of subsequent events and was effective upon issuance. See Note 16 for disclosures on Subsequent Events.

 

In October 2009, the FASB issued Accounting Standards Update No. 2009-13 (“ASU 2009-13”) Revenue Recognition (Topic 605) Multiple-Deliverable Revenue Arrangements. ASU 2009-13 establishes the accounting and reporting guidance for arrangements with multiple-revenue generating activities. ASU 2009-13 addresses how to separate deliverables and how to measure and allocate arrangement consideration to one or more units of accounting and provides a selling price hierarchy for determining the selling price of a deliverable. ASU 2009-13 was effective for fiscal years beginning on or after June 15, 2010. The adoption of ASU 2009-13 did not have a material impact on the Company’s consolidated financial statements.

 

In October 2009, the FASB issued Accounting Standards Update No. 2009-14 (“ASU 2009-14”) Software (Topic 985) Certain Revenue Arrangements That Include Software Elements. ASU 2009-14 provides guidance on how to allocate arrangement consideration to deliverables in an arrangement that includes both tangible products and software. ASU 2009-14 also provides additional guidance on how to determine which software, if any, relating to the tangible product would be excluded from software revenue recognition. ASU 2009-14 was effective for fiscal years beginning on or after June 15, 2010.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

The adoption of ASU 2009-14 did not have a material impact on the Company’s consolidated financial statements.

 

In January 2010, the FASB issued Accounting Standards Update No. 2010-06 (“ASU 2010-06”) Fair Value Measurements and Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements. ASU 2010-06 provides amendments to Subtopic 820-10 that require new disclosures, including the amounts of and reasons for transfers in and out of Levels 1 and 2 fair value measurements and reporting activity in the reconciliation of Level 3 fair value measurements on a gross basis. ASU 2010-06 provides amendments that clarify existing disclosures regarding the level of disaggregation for providing fair value measurement disclosures for each class of assets and liabilities. In addition, it clarifies existing disclosures about inputs and valuation techniques used to measure fair value for both recurring and nonrecurring fair value measurements that are required for either Level 2 or Level 3. ASU 2010-06 was effective for interim and annual reporting periods ending after December 15, 2009 except for the disclosures about the roll forward of activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 31, 2010 and for interim periods within those fiscal years. The adoption of ASU 2010-06 did not have a material impact on the Company’s consolidated financial statements.

 

In July 2010, the FASB issued Accounting Standards Update No. 2010-20 (“ASU 2010-20”) Receivables (Topic 310) Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The main objective of ASU 2010-20 is to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables. ASU 2010-20 requires disclosure of additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. This ASU is effective for all public companies for interim and annual reporting periods ending on or after December 15, 2010, except for disclosures relating to loan modifications, which were subsequently extended to interim and annual filings after June 15, 2011. The adoption of ASU 2010-20 did not have a material impact on the Company’s consolidated financial statements.

 

3.    RECEIVABLES FROM AND PAYABLES TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS

 

Amounts receivable from and payable to brokers, dealers and clearing organizations consisted of the following:

 

 

 

March 31,
2011

 

December 31,
2010

 

Receivables from brokers, dealers and clearing organizations:

 

 

 

 

 

Contract value of fails to deliver

 

$

282,065

 

$

138,534

 

Balance receivable from clearing organizations and financial institutions

 

106,642

 

105,277

 

Net pending trades

 

8,388

 

 

Total

 

$

397,095

 

$

243,811

 

Payables to brokers, dealers and clearing organizations:

 

 

 

 

 

Contract value of fails to receive

 

$

271,083

 

$

156,989

 

Balance payable to clearing organizations and financial institutions

 

12,298

 

797

 

Net pending trades

 

 

14,632

 

Total

 

$

283,381

 

$

172,418

 

 

Substantially all fail to deliver and fail to receive balances at March 31, 2011 and December 31, 2010 have subsequently settled at the contracted amounts.

 

4.    GOODWILL AND INTANGIBLE ASSETS

 

On May 27, 2010, the Company completed the acquisition of a mortgage-backed security brokerage business for consideration of $5,095. The purchase price was comprised of 681,433 shares of the Company’s common stock with a fair value of $4,095 and contingent consideration estimated at $1,000, which has been recorded as a liability within Other liabilities. This contingent liability will be remeasured to fair value at each reporting date until the liability is settled and the change in fair value will be recognized in earnings. This acquisition was accounted for as a business combination under the acquisition method. Assets acquired were recorded at fair value and the results of the acquired company have been included

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

within the consolidated financial statements since the acquisition. The purchase price was allocated among tangible and intangible assets as follows: fixed assets of $15, customer relationships of $1,700 with an estimated useful life of 6 years, non compete agreements of $340 with an estimated useful life of 3.3 years and goodwill of $3,040. The weighted average amortization for the intangible assets is 5.6 years.

 

On July 1, 2010, the Company acquired a 70% equity ownership interest in each of The Kyte Group Limited and Kyte Capital Management Limited (collectively “Kyte”). The Company will acquire the residual 30% equity interest in Kyte for an additional cash payment to be made in or about the third quarter of 2013 in an amount to be determined pursuant to a formula based on Kyte’s post-acquisition earnings. Kyte has been included in the consolidated financial statements as a wholly-owned subsidiary since the acquisition date, with a liability recorded for the future payment to be made in 2013. Included as part of the purchase price is £5,000 that was deposited into an escrow account with a third-party escrow agent and 1,339,158 contingently issuable shares of the Company’s common stock, all of which will be delivered to the selling shareholders of Kyte upon the satisfaction of certain conditions related to one of Kyte’s investments in a third party.

 

Kyte, which is a member of leading exchanges, including NYSE Euronext, NYSE LIFFE and Eurex, provides clearing, brokerage, settlement and back-office services to proprietary traders, brokers, market makers and hedge funds. Kyte provides capital to select start-up trading groups, small hedge funds, market-makers and individual traders. As part of the purchase agreement, over the period from initial acquisition to when the Company will acquire the residual 30% equity interest in Kyte, the Company agreed to make up to £20,000 available to Kyte Capital Management Limited for investments in new trading entities subject to certain approvals. The Company acquired Kyte because of its expertise in listed derivative markets, its risk management platforms and its unique clearing, broking and investment services business model. The cash portion of the purchase price of the transaction was financed from the Company’s internal cash resources. The purchase price consisted of the following:

 

Fair value of consideration transferred:

 

 

 

Cash paid at closing

 

$

33,996

 

Cash paid for surplus working capital

 

7,050

 

Common stock issued at closing (2,810,662 shares)

 

15,993

 

Contingently issuable shares (1,339,158 shares)

 

7,620

 

Estimated future purchase commitment

 

19,264

 

Total

 

$

83,923

 

 

The fair value of the 4,149,820 common shares issued and issuable was determined based on the closing market price of the Company’s common shares on July 1, 2010, the closing date of the acquisition.

 

The future purchase commitment requires the Company to pay an additional cash payment based on the performance of Kyte during the three year period ending June 30, 2013. The Company elected the fair value option for this purchase commitment as of the date of acquisition and determined the fair value using the income approach. Subsequent changes in the fair value of the future purchase commitment are recorded in Other (loss) income in the Condensed Consolidated Statements of Income. The fair value of the future purchase commitment at the acquisition date was $19,264 which has been recorded as a liability within Other liabilities. In applying the income approach, the Company assumed a 17.7% discount rate and used forecasted financial information for Kyte for the remaining three year period ending June 30, 2013. As of March 31, 2011 and December 31, 2010, the amount accrued in the condensed consolidated financial statements increased to $20,885 and $19,604, respectively, due to an increase in the net present value of the liability due to the passage of time and foreign currency translation, offset by differences between actual results and initial forecasts and changes to the forecasted financial information for Kyte for the remaining period ending June 30, 2013.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

This acquisition was accounted for as a business combination under the acquisition method. Assets acquired and liabilities assumed were recorded at their fair values as of July 1, 2010. Management determined the fair value of the identifiable intangible assets acquired based upon an independent valuation performed by a third-party specialist. The purchase price allocation, as presented below, was translated into U.S. dollars based on the foreign exchange rate on July 1, 2010:

 

 

 

 

 

Useful Life

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

21,488

 

 

 

Cash segregated under federal and other regulations

 

8,086

 

 

 

Deposits with clearing organizations

 

16,734

 

 

 

Commissions receivable

 

19,035

 

 

 

Receivables from brokers, dealers and clearing organizations

 

94,849

 

 

 

Intangible assets subject to amortization:

 

 

 

 

 

Customer relationships

 

14,485

 

6 Years

 

Trade name

 

1,020

 

10 Years

 

Internally developed software

 

3,170

 

3 Years

 

Non compete agreements

 

211

 

5 Years

 

Goodwill (1)

 

41,282

 

 

 

Other assets (1)

 

19,606

 

 

 

Total assets acquired

 

239,966

 

 

 

 

 

 

 

 

 

Liabilities and non-controlling interests:

 

 

 

 

 

Accounts payable and accrued expenses

 

24,925

 

 

 

Payables to clearing services customers

 

116,623

 

 

 

Other liabilities (2)

 

13,758

 

 

 

Non-controlling interests

 

737

 

 

 

Total liabilities and non-controlling interests assumed

 

156,043

 

 

 

 

 

 

 

 

 

Net assets acquired

 

$

83,923

 

 

 

 


(1)          During the fourth quarter of 2010, the Company recorded an adjustment to its purchase price allocation for Kyte in the amount of $4,928 in Other assets for a receivable related to one of Kyte’s investments in a third party. The Company recognized this adjustment based on new information which supported the collectability of the receivable with the third party. The Company adjusted residual goodwill accordingly.

(2)          During the fourth quarter of 2010, the Company reclassified $1,219 from “Intangible assets, net” to “Other liabilities” in the Consolidated Statements of Financial Condition. These amounts related to the fair value of contractual obligations that were deemed unfavorable and therefore recognized and valued as such as of the date of the acquisition as part of the Company’s purchase price allocation.

 

Total intangible assets acquired in the Kyte transaction that are subject to amortization totaled $18,886 and have a weighted-average useful life of approximately 6 years.

 

All of the goodwill acquired was assigned to our Clearing and Backed Trading segment. None of the goodwill is expected to be deductible for income tax purposes.

 

On November 1, 2010, the Company purchased the remaining 67% of the shares of an over-the-counter brokerage business in the U.K. The business has been included in the consolidated financial statements as a wholly-owned subsidiary since the acquisition date. The business primarily engages in executing bond trades on a matched principal basis. The allocation of the purchase price to the net assets as of November 1, 2010 consisted of the following:

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

Cash paid at closing

 

$

11,229

 

Common stock issued at closing (2,343,758 shares)

 

7,938

 

Cash paid as additional consideration to selling shareholders

 

1,076

 

Total fair value of consideration transferred

 

$

20,243

 

Total fair value of previous equity interest

 

$

7,677

 

Total fair value

 

$

27,920

 

 

The cash paid at closing and as additional consideration was financed from the Company’s internal cash resources.

 

The fair value of the 2,343,758 common shares issued was determined using the closing market price of the Company’s common shares on November 1, 2010 and applying a discount to that price due to certain restrictions on the shares issued over a 2.5 and 5 year period from the date of acquisition. The Company utilized a third party valuation firm to assist management in the determination of an appropriate discount rate based on the results of various quantitative methods under the assumption that there is a discount in the value of a company’s stock that is and is not marketable. These methods are commonly used valuation practices.

 

This acquisition was accounted for as a business combination achieved in stages under the acquisition method. Prior to the acquisition date, the Company accounted for its 33% interest in the business as an equity-method investment. The acquisition date fair value of the previous equity interest was $7,677 and is included in the measurement of the total fair value of the business.

 

The following table summarizes the assets acquired and liabilities assumed at their acquisition date fair values. Management determined the fair value of the identifiable intangible assets acquired based upon an independent valuation performed by a third-party specialist. The purchase price allocation, as presented below, was translated into U.S. dollars based on the foreign exchange rate on November 1, 2010:

 

 

 

 

 

Useful Life

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

3,800

 

 

 

Deposits with clearing organizations

 

1,792

 

 

 

Receivables from brokers, dealers and clearing organizations

 

2,377

 

 

 

Intangible assets subject to amortization:

 

 

 

 

 

Customer relationships

 

13,474

 

6 Years

 

Trade name

 

160

 

5 Years

 

Goodwill

 

12,419

 

 

 

Other assets

 

312

 

 

 

Total assets acquired

 

34,334

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable and accrued expenses

 

1,555

 

 

 

Deferred tax liabilities

 

3,691

 

 

 

Other liabilities

 

1,168

 

 

 

Total liabilities assumed

 

6,414

 

 

 

 

 

 

 

 

 

Net assets acquired

 

$

27,920

 

 

 

 

Total intangible assets acquired in the transaction that are subject to amortization totaled $13,634 and have a weighted-average useful life of approximately 6 years.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

All of the goodwill acquired was assigned to the EMEA Brokerage segment. None of the goodwill is expected to be deductible for income tax purposes.

 

Goodwill activity for the three months ended March 31, 2011 is as follows:

 

 

 

December 31,
2010

 

Goodwill
acquired

 

Foreign
currency
translation

 

March 31,
2011

 

Goodwill

 

 

 

 

 

 

 

 

 

Americas Brokerage

 

$

83,289

 

$

 

$

 

$

83,289

 

EMEA Brokerage

 

13,895

 

 

344

 

14,239

 

Asia Brokerage

 

 

 

 

 

Clearing and Backed Trading

 

42,413

 

 

1,210

 

43,623

 

All Other

 

128,691

 

 

 

128,691

 

 

 

$

268,288

 

$

 

$

1,554

 

$

269,842

 

 

Goodwill is required to be tested for impairment at least annually and more frequently when indicators of impairment exist. All of the Company’s goodwill is allocated to its reporting units and the goodwill impairment tests are performed at the reporting unit level. As discussed in Note 2, during the fourth quarter of 2010, the Company changed the testing date for its annual goodwill impairment tests from January 1 to November 1. As a result, the Company performed goodwill impairment tests as of January 1, 2010 and November 1, 2010, and concluded there was no impairment of the carrying value of the goodwill. The Company will continue to evaluate goodwill on an annual basis as of November 1, and whenever events and changes in circumstances indicate that there may be a potential impairment. Subsequent to November 1, 2010, no events or changes in circumstances occurred which would indicate any goodwill impairment.

 

Intangible assets consisted of the following:

 

 

 

March 31, 2011

 

December 31, 2010

 

 

 

 

 

Accumulated

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

amortization

 

 

 

 

 

amortization

 

 

 

 

 

 

 

and foreign

 

Net

 

 

 

and foreign

 

Net

 

 

 

 

 

currency

 

carrying

 

Gross

 

currency

 

carrying

 

 

 

Gross amount

 

translation

 

value

 

amount

 

translation

 

value

 

Amortized intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer relationships

 

$

76,951

 

$

19,804

 

$

57,147

 

$

76,951

 

$

18,165

 

$

58,786

 

Trade names

 

8,951

 

5,076

 

3,875

 

8,951

 

4,866

 

4,085

 

Core technology

 

6,400

 

3,888

 

2,512

 

6,400

 

3,686

 

2,714

 

Non compete agreements

 

3,874

 

3,149

 

725

 

3,874

 

3,048

 

826

 

Favorable lease agreements

 

620

 

360

 

260

 

620

 

340

 

280

 

Patents

 

31

 

16

 

15

 

31

 

16

 

15

 

Unamortized intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Proprietary knowledge

 

110

 

 

110

 

110

 

 

110

 

Total

 

$

96,937

 

$

32,293

 

$

64,644

 

$

96,937

 

$

30,121

 

$

66,816

 

 

Amortization expense for the three months ended March 31, 2011 and 2010 was $3,032 and $1,397, respectively.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

At March 31, 2011, expected amortization expense for the definite lived intangible assets is as follows:

 

2011 (remaining nine months)

 

$

8,847

 

2012

 

10,702

 

2013

 

8,776

 

2014

 

8,057

 

2015

 

7,962

 

Thereafter

 

20,190

 

Total

 

$

64,534

 

 

5.    OTHER ASSETS AND OTHER LIABILITIES

 

On February 28, 2010, the Company purchased a 40% interest in the outstanding membership interests of an independent brokerage firm with a proprietary trading platform. The aggregate purchase price was comprised of $10,000 in cash and 414,938 shares of the Company’s common stock. The target retained $8,000 of the cash portion of the purchase for working capital. This investment is included within Other assets and accounted for under the equity method. Additionally, the Company committed to purchase the remaining membership interests in increments of 20% by the third quarter of 2013, subject to customary closing conditions. The purchase price for the remaining membership interests will be paid in cash and established by a formula based on the target’s future results of operations.

 

On August 1, 2010, the Company purchased a 33% interest in the outstanding membership interests of an independent CFTC-registered Futures Commission Merchant for $11,000 in cash. The firm is also a Foreign Exchange Dealer Member of the National Futures Association and provides direct market access in certain foreign exchange markets. This investment will be accounted for under the equity method.

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

6.    SHORT-TERM BORROWINGS AND LONG-TERM OBLIGATIONS

 

In January 2008, pursuant to a note purchase agreement with certain institutional investors (the “2008 Note Purchase Agreement”), the Company issued $60,000 in aggregate principal amount of senior secured notes due in January 2013 (the “Senior Notes”) in a private placement. The Senior Notes currently bear interest at 7.17%. From June 2008 until June 2010, the Senior Notes bore interest at 8.17% due to a change in the risk based capital factor attributed to the Senior Notes by one of the purchasers pursuant to generally applicable insurance regulations for U.S. insurance companies. The Senior Notes ceased to accrue this premium interest in June 2010, when the risk based capital factor attributed to the Senior Notes was subsequently reduced. Interest is payable semi-annually in arrears on the 30th of January and July. The Company’s obligations under the Senior Notes are secured by substantially all of the assets of the Company and certain assets of the Company’s subsidiaries. The 2008 Note Purchase Agreement includes covenants with which the Company is required to comply, including among others, maintenance of certain financial ratios and restrictions on additional indebtedness, liens and dispositions. At March 31, 2011 and December 31, 2010, the Senior Notes were recorded net of unamortized deferred financing fees of $227 and $257, respectively, and the Company was in compliance with all applicable covenants as of each date.

 

In December 2010, the Company entered into a second amended and restated credit agreement (as amended and restated, the “Credit Agreement”) with Bank of America, N.A. and certain other lenders. The Credit Agreement matures on December 20, 2013 and provides for maximum borrowings of up to $200,000, which includes up to $50,000 for letters of credit. Revolving loans may be either base rate loans or Eurocurrency rate loans. Eurocurrency rate loans bear interest at the annualized rate of one-month LIBOR plus the application margin, letter of credit fees per annum are equal to the applicable margin times the outstanding amount drawn under such letter of credit and base rate loans bear interest at a rate per annum equal to a prime rate plus the applicable margin in effect for that interest period. As long as no default has occurred under the Credit Agreement, the applicable margin for both the base rate and Eurocurrency rate loans is based on a matrix that varies with a ratio of outstanding debt to EBITDA, as defined in the Credit Agreement. At March 31, 2011, in relation to Eurocurrency rate loans, the applicable margin was 2.50% and the one-month LIBOR was 0.24%. Amounts outstanding under the Credit Agreement are secured by substantially all the assets of the Company and certain assets of the Company’s subsidiaries. The Credit Agreement ranks pari passu with the Senior Notes in relation to the security provided by the Company in support of both obligations.

 

The Company had outstanding borrowings under its Credit Agreement as of March 31, 2011 and December 31, 2010 as follows:

 

 

 

March 31,
2011

 

December 31,
2010

 

Loans Available (1)

 

$

200,000

 

$

200,000

 

Loans Outstanding

 

$

160,000

 

$

135,000

 

 


(1)          Amounts available include up to $50,000 for letters of credit as of March 31, 2011 and December 31, 2010.

 

The Company’s commitments for outstanding letters of credit relate to potential collateral requirements associated with its matched principal business. Since commitments associated with these outstanding letters of credit may expire unused, the amounts shown above do not necessarily reflect actual future cash funding requirements.

 

The weighted average interest rate of the outstanding loans was 2.75% and 3.06% at March 31, 2011 and December 31, 2010, respectively. At March 31, 2011 and December 31, 2010, short-term borrowings under the Credit Agreement were recorded net of unamortized deferred financing fees of $2,389 and $2,297, respectively.

 

The Credit Agreement contains certain financial and other covenants. The Company was in compliance with all applicable covenants at March 31, 2011 and December 31, 2010.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

7.    STOCKHOLDERS’ EQUITY

 

In August 2007, the Company’s Board of Directors authorized the Company to implement a stock repurchase program to repurchase a limited number of shares of the Company’s common stock. Under the repurchase plan, the Board of Directors authorized the Company to repurchase shares of the Company’s common stock on the open market in such amounts as determined by the Company’s management provided that such amounts do not exceed, during any calendar year, the number of shares issued upon exercise of stock options plus the number of shares underlying grants of RSUs that are granted during such calendar year, or which management reasonably anticipates will be granted in such calendar year. During the three months ended March 31, 2011, the Company repurchased 650,000 shares of its common stock on the open market at an average price of $5.09 per share for a total cost of $3,330, including sales commissions. During the three months ended March 31, 2010, the Company did not repurchase any of its common stock. The repurchased shares were recorded at cost as treasury stock in the Condensed Consolidated Statements of Financial Condition.

 

On March 31, 2011 and March 29, 2010, the Company paid a cash dividend of $0.05 per share, which, based upon the number of shares outstanding on the record date for such dividends, totaled $6,100 and $5,928, respectively. The dividends were reflected as reductions of retained earnings in the Condensed Consolidated Statements of Financial Condition.

 

8.    EARNINGS PER SHARE

 

Basic and diluted earnings per share for the three months ended March 31, 2011 and 2010 were as follows:

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Basic earnings per share

 

 

 

 

 

GFI’s net income

 

$

6,746

 

$

13,376

 

Weighted average common shares outstanding

 

119,524,627

 

118,606,954

 

Basic earnings per share

 

$

0.06

 

$

0.11

 

Diluted earnings per share

 

 

 

 

 

GFI’s net income

 

$

6,746

 

$

13,376

 

Weighted average common shares outstanding

 

119,524,627

 

118,606,954

 

Effect of dilutive options, RSUs, restricted stock, and other contingently issuable shares

 

8,684,480

 

4,254,790

 

Weighted average shares outstanding and common stock equivalents

 

128,209,107

 

122,861,744

 

Diluted earnings per share

 

$

0.05

 

$

0.11

 

 

Excluded from the computation of diluted earnings per share because their effect would be anti-dilutive were the following: 4,083,752 RSUs and 96,424 options for the three months ended March 31, 2011 and 1,944,074 RSUs and 14,836 options for the three months ended March 31, 2010.

 

9.    SHARE-BASED COMPENSATION

 

The Company issues RSUs to its employees under the GFI Group Inc. 2008 Equity Incentive Plan, which was approved by the Company’s stockholders on June 11, 2008, and subsequently amended by the Company’s stockholders on June 11, 2009 and June 10, 2010 (as amended, the “2008 Equity Incentive Plan”). Prior to June 11, 2008, the Company issued RSUs under the GFI Group Inc. 2004 Equity Incentive Plan (the “2004 Equity Incentive Plan”).

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

The 2008 Equity Incentive Plan permits the grant of non-qualified stock options, stock appreciation rights, shares of restricted stock, restricted stock units and performance units to employees, non-employee directors or consultants. The Company issues shares from authorized but unissued shares, which are reserved for issuance upon the vesting of RSUs granted pursuant to the 2008 Equity Incentive Plan. As of March 31, 2011, there were 3,088,947 shares of common stock available for future grants of awards under this plan, which amount, pursuant to the terms of the 2008 Equity Incentive Plan, may be increased for the number of shares subject to awards under the 2004 Equity Incentive Plan that are ultimately not delivered to employees. The fair value of RSUs is based on the closing price of the Company’s common stock on the date of grant and is recorded as compensation expense over the service period, net of estimated forfeitures.

 

Modified RSUs are reflected as cancellations and grants in the summary of RSUs below.

 

The following is a summary of RSU transactions under both the 2008 Equity Incentive Plan and the 2004 Equity Incentive Plan during the three months ended March 31, 2011:

 

 

 

RSUs

 

Weighted-
Average
Grant Date
Fair Value

 

Outstanding December 31, 2010

 

14,545,137

 

$

5.14

 

Granted

 

5,892,360

 

5.02

 

Vested

 

(3,131,335

)

5.14

 

Cancelled

 

(70,051

)

6.55

 

Outstanding March 31, 2011

 

17,236,111

 

$

5.09

 

 

The weighted average grant-date fair value of RSUs granted for the three months ended March 31, 2011 was $5.02 per unit, compared with $5.64 per unit for the same period in the prior year. Total compensation expense and related income tax benefits recognized in relation to RSUs are as follows:

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

Compensation expense

 

$

7,492

 

$

6,766

 

Income tax benefits

 

$

1,948

 

$

2,267

 

 

At March 31, 2011, total unrecognized compensation cost related to the RSUs prior to the consideration of expected forfeitures was approximately $79,361 and is expected to be recognized over a weighted-average period of 2.31 years. The total fair value of RSUs vested during the three months ended March 31, 2011 and 2010 was $16,095 and $12,853, respectively.

 

As of March 31, 2011, the Company had stock options outstanding under the GFI Group Inc. 2002 Stock Option Plan (the “GFI Group 2002 Plan”) and the GFInet inc. 2000 Stock Option Plan (the “GFInet 2000 Plan”). No additional grants will be made under these plans. For stock options previously granted or modified, the fair value was estimated on the date of grant or modification using the Black-Scholes option pricing model.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

The following is a summary of stock option transactions during the three months ended March 31, 2011:

 

 

 

GFI Group 2002 Plan

 

GFInet 2000 Plan

 

 

 

Options

 

Weighted
Average
Exercise Price

 

Options

 

Weighted
Average
Exercise Price

 

Outstanding December 31, 2010

 

606,804

 

$

3.33

 

96,248

 

$

3.96

 

Exercised

 

 

 

(2,104

)

4.75

 

Expired

 

 

 

(12,736

)

4.96

 

Outstanding March 31, 2011

 

606,804

 

$

3.33

 

81,408

 

$

3.78

 

 

During the three months ended March 31, 2010, there were 30,420 stock options exercised under the GFI Group 2002 Plan and 159,132 stock options exercised under the GFInet 2000 Plan.

 

10.    COMMITMENTS AND CONTINGENCIES

 

Purchase Obligations—The Company has various unconditional purchase obligations. These obligations are for the purchase of market data from a number of information service providers during the normal course of business. As of March 31, 2011, the Company had total purchase commitments for market data of approximately $22,742 with $18,962 due within the next twelve months and $3,780 due between one to three years. Additionally, the Company has purchase commitments for capital expenditures of $3,494, primarily related to network implementations in the U.S. and U.K., and $1,992 for hosting and software license agreements. Of these purchase commitments, capital expenditures of approximately $1,203 and fees for hosting and software license agreements of approximately $1,002 are due within the next twelve months.

 

In connection with the acquisition of 40% of the outstanding membership interests of an independent brokerage firm, the Company has committed to purchase the remaining membership interests in increments of 20% by the third quarter of 2013, subject to customary closing conditions. The purchase price for the remaining membership interests will be paid in cash and established by a formula based on the target’s future results of operations. See Note 5 to the Condensed Consolidated Financial Statements for further information.

 

In connection with the acquisition of 70% of the equity ownership interests in Kyte, the Company agreed to purchase the residual 30% equity interest in Kyte for an additional cash payment in an amount to be determined pursuant to a formula based on Kyte’s earnings, such payment to be made following June 30, 2013. See Note 4 to the Condensed Consolidated Financial Statements for further information.

 

Contingencies—In the normal course of business, the Company and certain subsidiaries included in the consolidated financial statements are, and have been in the past, named as defendants in various lawsuits and proceedings and are, and have been in the past, involved in certain regulatory examinations. Additional actions, investigations or proceedings may be brought from time to time in the future. The Company is subject to the possibility of losses from these various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies. An accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. The Company accrues a liability for the estimated costs of adjudication or settlement of asserted and unasserted claims existing as of the reporting period.

 

The Company is subject to regular examinations by various tax authorities in jurisdictions in which the Company has significant business operations. The Company regularly assesses the likelihood of additional tax assessments that may result from these examinations in each of the tax jurisdictions. A tax accrual has been established, which the Company believes to be adequate in relation to the potential for additional tax assessments. Once established, the accrual may be adjusted based on new information or events. The imposition of additional tax assessments, penalties or fines by a tax authority could have a material impact on the Company’s effective tax rate.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

Additionally, the Company has recorded reserves for certain contingencies to which it may have exposure, such as reserves for certain litigation contingencies and contingencies related to the employer portion of National Insurance Contributions in the U.K.

 

The staff (the “Staff”) of the Market Regulation Department of the Financial Industry Regulatory Authority Inc. (“FINRA”) has been conducting an inquiry into the activities of interdealer brokerage firms in connection with the determination of the commission rates paid to them in 2005 and 2006 by certain dealers for brokering transactions in credit default swaps. In October 2010, the Staff commenced a disciplinary proceeding by filing a complaint against GFI Securities LLC and four of its former employees in connection with allegedly improper communications between certain of these former employees and those at other interdealer brokerage firms, purportedly inconsistent with just and equitable principles of trade and certain antifraud and supervisory requirements under FINRA rules and the federal securities laws. All of the former employees of GFI Securities LLC who were named in the complaint resigned in April 2008 to become employed by affiliates of Compagnie Financiere Tradition. None of the Company’s current employees were named in the complaint. GFI Securities LLC intends to vigorously contest this disciplinary action which could result in a censure, fine or other sanction.

 

Based on currently available information, the outcome of the Company’s outstanding matters are not expected to have a material adverse impact on the Company’s financial position. However, the outcome of any such matters may be material to the Company’s results of operations or cash flows in a given period. It is not presently possible to determine the Company’s ultimate exposure to these matters and there is no assurance that the resolution of the Company’s outstanding matters will not significantly exceed any reserves accrued by the Company.

 

Risks and Uncertainties—The Company primarily generates its revenues by executing and facilitating transactions for third parties. Revenues for these services are transaction based. As a result, the Company’s revenues vary based upon, among other things, the volume of transactions in various securities, commodities, foreign exchange and derivative markets in which the Company provides services.

 

Guarantees— The Company, through its subsidiaries, is a member of certain exchanges and clearing houses. Under the membership agreements, members are generally required to guarantee certain obligations. To mitigate the performance risks of its members, the exchanges and clearing houses may, from time to time, require members to post collateral, as well as meet certain minimum financial standards. The Company’s maximum potential liability under these arrangements cannot be quantified. However, management believes that the potential for the Company to be required to make payments under these arrangements is not likely. Accordingly, no contingent liability is recorded in the Condensed Consolidated Statements of Financial Condition for these arrangements.

 

11.    MARKET AND CREDIT RISKS

 

Disclosure regarding the Company’s financial instruments with off-balance sheet risk is described in “Note 15—Market and Credit Risks” of the Notes to the Consolidated Financial Statements contained in the Company’s 2010 Form 10-K. There have been no material changes to our off-balance sheet risk during the three months ended March 31, 2011.

 

12.    FINANCIAL INSTRUMENTS

 

Fair Value of Financial Instruments— Substantially all of the Company’s assets and liabilities are carried at fair value or contracted amounts that approximate fair value. Assets and liabilities that are recorded at contracted amounts approximating fair value consist primarily of receivables from and payables to brokers, dealers and clearing organizations and payables to clearing services customers. These receivables and payables to brokers, dealers and clearing organizations are short-term in nature, and following March 31, 2011, substantially all have settled at the contracted amounts.  The Company’s marketable equity securities are recorded at fair value based on their quoted market price. The Company’s investments that are accounted for under the cost and equity methods are investments in companies that are not publicly traded and for which no established market for their securities exists.  The fair value of these investments is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment.  The Company’s debt obligations are carried at historical amounts.  The fair value of the Company’s Senior Notes was estimated using market rates of interest available to the Company for debt obligations of similar types and was

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

approximately $65,297 at March 31, 2011. The fair value of the Company’s short term borrowings outstanding under the Credit Agreement approximated the carrying value at March 31, 2011 and December 31, 2010.

 

The Company’s financial assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with ASC 820-10.  In accordance with ASC 820-10, the Company has categorized its financial assets and liabilities, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy as set forth below.

 

Level 1 — Financial assets and liabilities whose values are based on unadjusted quoted prices for identifiable assets or liabilities in an active market that the company has the ability to access at the measurement date (examples include active exchange-traded equity securities, listed derivatives, and most U.S. Government and agency securities).

 

Level 2 — Financial assets and liabilities whose values are based on quoted prices in markets where trading occurs infrequently or whose values are based on quoted prices of instruments with similar attributes in active markets.  Level 2 inputs include the following:

 

·                  Quoted prices for identifiable or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds which trade infrequently); and

 

·                  Inputs other than quoted prices that are observable for substantially the full term of the asset or liability (examples include interest rate and currency swaps).

 

Level 3 — Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.  These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability.

 

Valuation Techniques

 

The Company used the following valuation techniques in valuing the financial instruments at March 31, 2011 and December 31, 2010:

 

The Company has determined that certain of its investments in marketable securities should be classified as trading securities or available-for-sale securities and reported at fair value at March 31, 2011 and December 31, 2010.  To the extent that the values of the Company’s trading and available-for-sale marketable securities are based on quoted market prices in active markets, these securities were categorized as Level 1.

 

Fair value of the Company’s over-the-counter foreign exchange derivative contracts is based on the indicative prices obtained from the banks that are counter parties to these foreign exchange derivative contracts, as well as management’s own calculations and analyses, which are based upon period end forward and spot foreign exchange rates. At March 31, 2011 and December 31, 2010, the Company’s foreign exchange derivative contracts have been categorized as Level 2 of the ASC 820-10 fair value hierarchy.

 

The fair value of trading securities owned as a result of matched principal transactions and principal trading business is estimated using either (i) recently executed transactions and market price quotations in active markets, which trading securities are primarily categorized as Level 1, or (ii) a modified Black Scholes model using observable market inputs, which trading securities are categorized as Level 2.

 

The fair value of the Company’s future purchase commitment and contingent consideration liabilities reflect inputs that are both unobservable and significant to the overall fair value measurement of these liabilities. These liabilities are categorized as Level 3.

 

In the three months ended March 31, 2011, the Company did not have any transfers amongst Level 1, Level 2 and Level 3.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

Assets and Liabilities measured at fair value on a recurring basis as of March 31, 2011:

 

 

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Netting(1)

 

Balance at
March 31,
2011

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Deposits with clearing organizations:

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

500

 

$

 

$

 

$

 

$

500

 

Other assets: Financial instruments owned:

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

$

3,816

 

$

160

 

$

 

$

(519

)

$

3,457

 

Foreign exchange derivative contracts

 

 

96,218

 

 

(94,921

)

1,297

 

Total financial instruments owned

 

$

3,816

 

$

96,378

 

$

 

$

(95,440

)

$

4,754

 

Other assets: Investments:

 

 

 

 

 

 

 

 

 

 

 

Equity security, available-for-sale

 

$

4,658

 

$

 

$

 

$

 

$

4,658

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Other liabilities: Financial instruments sold, not yet purchased:

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

$

3,638

 

$

 

$

 

$

 

$

3,638

 

Corporate bonds

 

 

132

 

 

 

132

 

Foreign exchange derivative contracts

 

 

102,309

 

 

(94,921

)

7,388

 

Total financial instruments sold, not yet purchased

 

$

3,638

 

$

102,441

 

$

 

$

(94,921

)

$

11,158

 

Other liabilities: Future purchase commitment and contingent consideration liabilities

 

$

 

$

 

$

23,557

 

$

 

$

23,557

 

 


(1)          Represents the impact of netting on a net-by-counterparty basis.

 

Excluded from the table above is variation margin on long and short derivative contracts related to exchange traded futures and options in the amount of $7,161 and $167 which are included within Receivables from brokers, dealers and clearing organizations and Payables to brokers, dealers and clearing organizations, respectively.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

Assets and Liabilities measured at fair value on a recurring basis as of December 31, 2010:

 

 

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Netting(1)

 

Balance at
December 31,
2010

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Deposits with clearing organizations:

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

500

 

$

 

$

 

$

 

$

500

 

Other assets: Financial instruments owned:

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

$

549

 

$

161

 

$

 

$

 

$

710

 

Foreign exchange derivative contracts

 

 

76,057

 

 

(74,934

)

1,123

 

Fixed income derivative contracts

 

89

 

 

 

 

89

 

Equity derivative contracts

 

3,849

 

 

 

 

3,849

 

Total financial instruments owned

 

$

4,487

 

$

76,218

 

$

 

(74,934

)

$

5,771

 

Other assets: Investments:

 

 

 

 

 

 

 

 

 

 

 

Equity securities, available-for-sale

 

$

4,925

 

$

 

$

 

$

 

$

4,925

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Other liabilities: Financial instruments sold, not yet purchased:

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange derivative contracts

 

$

 

$

79,368

 

$

 

$

(74,908

)

$

4,460

 

Fixed income derivative contracts

 

87

 

 

 

 

87

 

Equity derivative contracts

 

2,286

 

 

 

 

2,286

 

Total financial instruments sold, not yet purchased

 

$

2,373

 

$

79,368

 

$

 

(74,908

)

$

6,833

 

Other liabilities: Future purchase commitment and contingent consideration liabilities

 

$

 

$

 

$

22,415

 

$

 

$

22,415

 

 


(1)          Represents the impact of netting on a net-by-counterparty basis.

 

Excluded from the table above is variation margin on long and short derivative contracts related to exchange traded futures and options in the amount of $18 and $206 which are included within Receivables from brokers, dealers and clearing organizations and Payables to brokers, dealers and clearing organizations, respectively.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

Changes in Level 3 Assets and Liabilities measured at fair value on a recurring basis for the three months ended March 31, 2011 and 2010:

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Liabilities

 

 

 

 

 

Beginning balance

 

$

22,415

 

$

 

Transfers into Level 3

 

 

 

Transfers out of Level 3

 

 

 

Total realized and unrealized (gains) losses

 

 

 

 

 

Included in earnings (or change in net assets)

 

731

 

 

Included in other comprehensive (income) loss

 

550

 

 

Purchases, issuances, sales, and settlements

 

 

 

 

 

Purchases

 

 

 

Issuances

 

 

 

Sales

 

 

 

Settlements

 

139

 

 

Ending balance

 

$

23,557

 

$

 

 

 

 

 

 

 

The amount of total gains or losses for the period included in earnings (or changes in net assets) attributable to the change in unrealized (gains) losses relating to liabilities still held at the reporting date

 

$

731

 

$

 

 

Derivative Financial Instruments—The Company uses foreign exchange derivative contracts, including forward contracts and foreign currency swaps, to reduce the effects of fluctuations in certain assets and liabilities denominated in foreign currencies. The Company also hedges a portion of its foreign currency exposures on anticipated foreign currency denominated revenues and expenses by entering into forward foreign exchange contracts.  As of March 31, 2011 and December 31, 2010, none of these contracts were designated as foreign currency cash flow hedges under ASC 815-10, Derivatives and Hedging (“ASC 815-10”).

 

The Company provides brokerage services to its customers for exchange-traded and over-the-counter derivative products, which include futures, forwards and options contracts.  The Company may enter into principal transactions for exchange-traded and over-the-counter derivative products to facilitate customer trading activities or to engage in principal trading for the Company’s own account.

 

The Company monitors market risk exposure from its matched principal business and principal trading business by regularly monitoring its concentration of market risk to financial instruments, countries or counterparties and regularly monitoring trades that have not settled within prescribed settlement periods or volume thresholds.  Additionally, market risks are monitored and mitigated by the use of the Company’s proprietary, electronic risk monitoring system, which provides daily credit reports in each of the Company’s geographic regions that analyze credit concentration and facilitates the regular monitoring of transactions against key risk indicators.

 

For certain derivative contracts, the Company has entered into master netting agreements and collateral arrangements with counterparties.  These agreements provide the Company with the ability to offset a counterparty’s rights and obligations, request additional collateral when necessary or liquidate the collateral in the event of counterparty default. The Company reports these derivative contracts on a net-by-counterparty basis when management believes that a legal and enforceable right of offset exists under these agreements.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

Fair values of derivative contracts on a gross basis as of March 31, 2011 and December 31, 2010 are as follows:

 

 

 

March 31, 2011

 

December 31, 2010

 

Derivatives not designated as hedging instruments
under ASC 815-10

 

Derivative
Assets

 

Derivative
Liabilities

 

Derivative
Assets

 

Derivative
Liabilities

 

Foreign exchange derivative contracts (1)

 

$

96,218

 

$

102,309

 

$

76,057

 

$

79,368

 

Commodity derivative contracts (2)

 

10,405

 

10,531

 

3,955

 

4,143

 

Fixed income derivative contracts (2)

 

1,832

 

1,189

 

89

 

87

 

Equity derivative contracts (2)

 

30,135

 

49,270

 

3,849

 

2,286

 

 


(1)          Included within Other assets and Other liabilities.

(2)          Included within Receivables from brokers, dealers and clearing organizations and Payables to brokers, dealers and clearing organizations.

 

As of March 31, 2011, the Company had outstanding forward foreign exchange contracts with a combined notional value of $144,929.  Approximately $56,696 of these forward foreign exchange contracts represent a hedge of euro-denominated balance sheet positions at March 31, 2011.  The remaining contracts are hedges of anticipated future cash flows. As of December 31, 2010, the Company had outstanding forward foreign exchange contracts with a combined notional value of $149,350.  Approximately $53,480 of these forward foreign exchange contracts represent a hedge of euro-denominated balance sheet positions at December 31, 2010.  The remaining contracts are hedges of anticipated future cash flows.

 

In addition to the Company’s outstanding forward foreign exchange contracts, the following table includes the outstanding long and short notional amounts on a gross basis of derivative financial instruments as of March 31, 2011 and December 31, 2010:

 

 

 

March 31, 2011

 

December 31, 2010

 

 

 

Long

 

Short

 

Long

 

Short

 

Foreign exchange spot and options contracts

 

$

7,498,710

 

$

7,498,710

 

$

5,682,858

 

$

5,681,923

 

Commodity derivative contracts

 

2,384,184

 

2,497,138

 

501,953

 

803,357

 

Fixed income derivative contracts

 

1,481,728

 

1,538,796

 

18,346

 

18,399

 

Equity derivative contracts

 

229,300

 

259,491

 

40,040

 

92,840

 

 

The following is a summary of the effect of derivative contracts on the Condensed Consolidated Statements of Income for the three months ended March 31, 2011 and 2010:

 

 

 

Location of Gain (Loss)

 

Amount of Gain(Loss) Recognized in Income on
Derivatives

 

Derivatives not designated as hedging
instruments under ASC 815-10

 

Recognized in Income
on Derivatives

 

For the Three Months
Ended March 31, 2011

 

For the Three Months
Ended March 31, 2010

 

Foreign exchange derivative contracts

 

(1)

 

$

(5,858

)

$

3,181

 

Commodity derivative contracts

 

Principal transactions

 

2,621

 

1,140

 

Fixed income derivative contracts

 

Principal transactions

 

5,441

 

 

Equity derivative contracts

 

Principal transactions

 

2,666

 

 

 


(1)  For the three months ended March 31, 2011, approximately $7,081 of losses on foreign exchange derivative contracts were included within Other (loss) income and approximately $1,223 of gains on foreign currency options were included within Principal transactions.  For the three months ended March 31, 2010, approximately $3,079 of gains on foreign exchange derivative contracts were included within Other (loss) income and approximately $102 of gains on foreign currency options were included within Principal transactions.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

13. VARIABLE INTEREST ENTITIES

 

Consolidated Variable Interest Entities

 

In December 2010, Kyte entered into an investment with a limited liability partnership (“LLP”), which is focused on developing a proprietary trading business.  The LLP is a VIE, and effective January 1, 2011, it was determined that the Company is the primary beneficiary of the LLP because Kyte is the provider of the majority of the LLP’s start-up capital and has the power to direct the activities of the VIE that most significantly impact the economic performance of the entity.

 

Non-consolidated Variable Interest Entities

 

The Company holds interests in certain variable interest entities (“VIEs”) which it does not consolidate as it determined that the Company is not the primary beneficiary. The Company’s involvement with such entities is in the form of direct equity interests and secured loans. The entities include an independent brokerage firm with a proprietary trading platform, trading entities in which the Company has provided initial capital to fund trading activities and a commodity pool operator. As of March 31, 2011 and December 31, 2010, assets recognized in the Condensed Consolidated Statements of Financial Condition related to the Company’s interests in these non-consolidated VIEs were $14,477 and $15,247, respectively, and are reflected in Other assets. The Company has not recorded any liabilities with respect to VIEs not consolidated. The Company’s maximum exposure to loss relating to non-consolidated VIEs as of March 31, 2011 and December 31, 2010 was $16,477 and $18,047, respectively. The maximum exposure to loss represents assets recognized by the Company relating to non-consolidated entities and notes receivable on loans made to VIEs in which the Company holds a variable interest.

 

14.    REGULATORY REQUIREMENTS

 

GFI Securities LLC is a registered broker-dealer with the SEC and FINRA. GFI Securities LLC is also a registered introducing broker with the National Futures Association and the Commodity Futures Trading Commission. Accordingly, GFI Securities LLC is subject to the net capital rules under the Exchange Act and the Commodity Exchange Act. Under these rules, GFI Securities LLC is required to maintain minimum Net Capital, as defined by applicable regulations, of not less than the greater of $250 or 2% of aggregate debits, as defined by applicable regulations.

 

GFI Brokers Limited, GFI Securities Limited, The Kyte Group Limited and Kyte Broking Limited are subject to the capital requirements of the Financial Services Authority in the United Kingdom (“FSA”). In addition, GFI Securities Limited and The Kyte Group Limited are subject to the FSA consolidated capital requirements.

 

GFI (HK) Securities LLC is subject to the capital requirements of the Securities and Futures Commission in Hong Kong (the “SFC”).

 

The following table sets forth information about the minimum regulatory capital that certain of the Company’s subsidiaries were required to maintain as of March 31, 2011:

 

 

 

GFI
Securities LLC

 

GFI Brokers
Limited

 

GFI Securities
Limited

 

The Kyte
Group
Limited

 

Kyte
Broking
Limited

 

GFI (HK)
Securities
LLC

 

Regulatory capital

 

$

9,600

 

$

47,427

 

$

69,883

 

$

11,054

 

$

3,409

 

$

1,842

 

Minimum regulatory capital required

 

250

 

24,024

 

33,815

 

7,788

 

2,708

 

386

 

Excess regulatory capital

 

$

9,350

 

$

23,403

 

$

36,068

 

$

3,266

 

$

701

 

$

1,456

 

 

GFI Securities Limited’s Japanese branch is subject to certain licensing requirements established by the Financial Instruments and Exchange Law (the “FIEL”) in Japan. As part of the licensing requirements, GFI Securities Limited’s Japanese branch is required to maintain minimum “brought-in” capital and stockholders’ equity of 50,000 Japanese Yen each (or approximately $601). GFI Securities Limited’s Japanese branch is also subject to the FIEL’s net capital rule. At March 31, 2011, GFI Securities Limited’s Japanese branch was in compliance with these capital requirements.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

GFI (HK) Brokers Ltd. is registered with and regulated by the Hong Kong Monetary Authority. As part of this registration, GFI (HK) Brokers Ltd. is required to maintain stockholders’ equity of 5,000 Hong Kong dollars (or approximately $643).  At March 31, 2011, GFI (HK) Brokers Ltd. had stockholders’ equity of 24,958 Hong Kong dollars (or approximately $3,210), which exceeded the minimum requirement by 19,958 Hong Kong dollars (or approximately $2,567).

 

GFI Group Pte. Ltd. is subject to the compliance requirements of the Monetary Authority of Singapore, which requires that GFI Group Pte. Ltd., among other things, maintain stockholders’ equity of 3,000 Singapore dollars (or approximately $2,388), measured annually. At December 31, 2010, GFI Group Pte. Ltd. exceeded the minimum requirement by approximately 19,137 Singapore dollars (or approximately $15,230).

 

GFI Korea Money Brokerage Limited is licensed and regulated by the Ministry of Finance and Economy to engage in foreign exchange brokerage business, and is subject to certain regulatory requirements under the Foreign Exchange Transaction Act. As a licensed foreign exchange brokerage company, GFI Korea Money Brokerage Limited is required to maintain minimum paid-in capital of 5,000,000 Korean Won (or approximately $4,560). At March 31, 2011, GFI Korea Money Brokerage Limited exceeded the minimum requirement for paid-in-capital by approximately 6,123,627 Korean Won (or approximately $5,585).

 

These regulatory rules may restrict the Company’s ability to withdraw capital from its regulated subsidiaries. In addition to the requirements set forth above, certain of our other subsidiaries are subject to minimum net capital, minimum stockholders’ equity or similar requirements of the jurisdictions in which they operate. The Company was in compliance with all of these requirements at December 31, 2010 and March 31, 2011, with the exception of The Kyte Group Limited’s U.K. consolidated group capital requirement which had fallen below the required minimum amount on these dates. The FSA has been notified of such breach and the Company is in the process of increasing the consolidated capital of The Kyte Group Limited’s U.K. consolidated group to comply with these requirements. The Company does not expect this will have any material impact on its operations.

 

15.    SEGMENT AND GEOGRAPHIC INFORMATION

 

As a result of the acquisition of Kyte on July 1, 2010, the Company now operates a new segment which was initially disclosed as “Clearing, Execution and Trading” for the Company’s quarterly report on Form 10-Q for the period ended September 30, 2010. During the fourth quarter of 2010, the Company changed the name of this operating segment to “Clearing and Backed Trading” in order to better describe the material operations of this segment, which is to provide clearing, risk management and settlement services and, in some instances, capital to start-up trading groups, small hedge funds, market-makers and individual traders. Management describes the investments in these trading entities as “Backed Trading.” In this operating segment, the Company also provides certain execution and back-office services. The Company believes the presentation of these operations as a stand-alone segment best reflects the economic realities of these operations, as well as how the Company is managed and the manner in which the Company’s performance is evaluated by the Company’s chief operating decision makers. As of July 1, 2010, in accordance with ASC 280-10, Segment Reporting (“ASC 280-10”), the Company determined that it has four operating segments: (i) Americas Brokerage, (ii) Europe, Middle East and Africa (“EMEA”) Brokerage,  (iii) Asia Brokerage, and (iv) Clearing and Backed Trading. The Company’s brokerage operations provide brokerage services in four broad product categories: fixed income, financial, equity and commodity. Additionally, in accordance with the criteria set forth in ASC 280-10, the Company presents its operating segments as five reportable segments: the four operating segments described above and “All Other”. The All Other segment captures costs that are not directly assignable to one of the operating segments, primarily consisting of the Company’s corporate business activities and operations from software, analytics and market data.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

Selected financial information for the Company’s reportable segments is presented below for periods indicated:

 

 

 

Three Months Ended March 31, 2011

 

 

 

Americas
Brokerage

 

EMEA
Brokerage

 

Asia
Brokerage

 

Clearing and
Backed
Trading

 

All Other

 

Total

 

Total revenues

 

$

77,472

 

$

109,823

 

$

22,576

 

$

40,899

 

$

12,128

 

$

262,898

 

Revenues, net of interest and transaction-based expenses

 

73,551

 

106,954

 

22,560

 

13,392

 

12,441

 

228,898

 

Income (loss) before income taxes

 

20,050

 

32,894

 

5,683

 

1,232

 

(49,583

)

10,276

 

 

 

 

Three Months Ended March 31, 2010

 

 

 

Americas
Brokerage

 

EMEA
Brokerage

 

Asia
Brokerage

 

Clearing and
Backed
Trading

 

All Other

 

Total

 

Total revenues

 

$

77,836

 

$

107,882

 

$

18,848

 

$

 

$

16,209

 

$

220,775

 

Revenues, net of interest and transaction-based expenses

 

73,405

 

104,560

 

18,825

 

 

16,561

 

213,351

 

Income (loss) before income taxes

 

18,117

 

37,051

 

4,299

 

 

(39,353

)

20,114

 

 

In addition, with the exception of goodwill, the Company does not identify or allocate assets by operating segment, nor does its chief operating decision maker evaluate operating segments using discrete asset information.  See Note 4 for goodwill by reportable segment.

 

Geographic information regarding revenues for the three months ended March 31, 2011 and 2010, respectively, and information regarding long-lived assets (defined as property, equipment, leasehold improvements and software inventory) in each geographic area as of March 31, 2011 and December 31, 2010, respectively, are as follows:

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Revenues:

 

 

 

 

 

United States

 

$

76,738

 

$

77,653

 

United Kingdom

 

130,049

 

101,722

 

Other

 

56,111

 

41,400

 

Total

 

$

262,898

 

$

220,775

 

 

 

 

March 31,
2011

 

December 31,
2010

 

Long-lived Assets, as defined:

 

 

 

 

 

United States

 

$

51,574

 

$

52,649

 

United Kingdom

 

14,096

 

14,132

 

Other

 

4,349

 

4,493

 

Total

 

$

70,019

 

$

71,274

 

 

Revenues are attributed to geographic areas based on the location of the Company’s relevant subsidiary.

 

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GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands except share and per share amounts)

 

16.    SUBSEQUENT EVENTS

 

In April 2011, the Board of Directors declared a quarterly cash dividend of $0.05 per share payable on May 31, 2011 to shareholders of record on May 17, 2011.

 

Subsequent events have been evaluated for recording and disclosure in the notes to the Condensed Consolidated Financial Statements through the filing date of this Form 10-Q.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

GFI Group Inc.

New York, New York

 

We have reviewed the accompanying condensed consolidated statement of financial condition of GFI Group Inc. and subsidiaries (the “Company”) as of March 31, 2011, the related condensed consolidated statements of income, comprehensive income and cash flows for the three-month periods ended March 31, 2011 and 2010.  These interim financial statements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition of the Company as of December 31, 2010, and the related consolidated statements of income, comprehensive income, cash flows and changes in stockholders’ equity for the year then ended (not presented herein); and in our report dated March 16, 2011, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying condensed consolidated statement of financial condition as of December 31, 2010 is fairly stated, in all material respects, in relation to the consolidated statement of financial condition from which it has been derived.

 

/s/ Deloitte & Touche LLP

New York, New York
May 10, 2011

 

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ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This Quarterly Report on Form 10-Q (this “Form 10-Q”) contains ‘‘forward-looking statements’’ within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words ‘‘believe,’’ ‘‘anticipate,’’ ‘‘expect,’’ ‘‘estimate,’’ ‘‘intend,’’ ‘‘project,’’ ‘‘will be,’’ ‘‘will likely continue,’’ ‘‘will likely result,’’ or words or phrases of similar meaning. These forward-looking statements are based largely on the expectations of management and are subject to a number of risks and uncertainties including, but not limited to, the following:

 

·                  the risks and other factors described under the heading “Risk Factors” and elsewhere in this Form 10-Q and in our 2010 Form 10-K;

 

·                  our ability to attract and retain key personnel, including highly qualified brokerage personnel;

 

·                  our entrance into new brokerage markets, including investments in establishing new brokerage desks;

 

·                  competition from current and new competitors;

 

·                  risks associated with our matched principal and principal trading businesses, including risks arising from specific brokerage transactions, or series of brokerage transactions, such as credit risk, market risk or the risk of fraud or unauthorized trading;

 

·                  the extensive regulation of the Company’s business, changes in laws and regulations governing our business and operations or permissible activities and our ability to comply with such laws and regulations;

 

·                  our ability to obtain and maintain regulatory approval to conduct our business in light of certain proposed changes in laws and regulations in the U.S. and Europe and increased operational costs related to compliance with such changes in laws and regulations;

 

·                  our ability to keep up with rapid technological change and to continue to develop and support our electronic brokerage systems in a cost-effective manner;

 

·                  future results of operations and financial condition;

 

·                  the success of our business strategies;

 

·                  economic, political and market factors affecting trading volumes, securities prices, or demand for our brokerage services, including recent conditions in the world economy and financial markets in which we provide our services;

 

·                  financial difficulties experienced by our customers or key participants in the markets in which we focus our brokerage services;

 

·                  our ability to assess and integrate acquisitions of businesses or technologies;

 

·                  the maturing of key markets and any resulting contraction in commissions;

 

·                  risks associated with the expansion and growth of our operations generally or of specific products or services, including, in particular, our ability to manage our international operations;

 

·                  uncertainties associated with currency fluctuations;

 

·                  our failure to protect or enforce our intellectual property rights;

 

·                  uncertainties relating to litigation;

 

·                  liquidity and clearing capital requirements and the impact of the conditions in the world economy and the

 

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financial markets in which we provide our services on the availability and terms of additional or future capital;

 

·                  our ability to identify and remediate any material weakness in our internal controls that could affect our ability to prepare financial statements and reports in a timely manner; and

 

·                  the effectiveness of our risk management policies and procedures and the impact of unexpected market moves and similar events.

 

The foregoing risks and uncertainties, as well as those risks discussed under the headings ‘‘Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations’’, ‘‘Item 3—Quantitative and Qualitative Disclosures About Market Risk’’ and “Part II, Item 1A Risk Factors” and elsewhere in this Form 10-Q, may cause actual results to differ materially from the forward-looking statements. The information included herein is given as of the filing date of this Form 10-Q with the Securities Exchange Commission (the “SEC”) and future events or circumstances could differ significantly from these forward-looking statements. The Company does not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Business Environment

 

As a leading provider of wholesale brokerage services, clearing services and electronic execution and trading support products for global financial markets, our results of operations are impacted by a number of external market factors, including market volatility and transactional volumes, the organic growth or contraction of the derivative and cash markets in which we provide our brokerage services, the particular mix of transactional activity in our various products, the competitive and regulatory environment in the various jurisdictions and markets in which we operate and the financial condition of the dealers, hedge funds, traders and other market participants to whom we provide our services. Outlined below are management’s observations of these external market factors during the most recent fiscal period. The factors outlined below are not the only factors that impacted our results of operations for the most recent fiscal period, and additional or other factors may impact, or have different degrees of impact, on our results of operations in future periods.

 

Market Volatility

 

As a general rule, our business typically benefits from volatility in the markets that we serve, as periods of increased volatility often coincide with more robust trading by our clients and a higher volume of transactions. However, periods of extreme volatility may result in significant market dislocations that can also lead clients to reduce their trading activity.

 

Market volatility is driven by a range of external factors, some of which are market specific and some of which are correlated to general macro-economic conditions.  During the first quarter of 2011, the markets in which we operate experienced generally higher volatility compared to the same period of 2010 due, in part, to political and economic uncertainties. The increased volatility led to a more favorable trading environment across all our geographic regions, especially in emerging markets.

 

Growth or Decline in Underlying Markets

 

Our business has historically benefited from growth in the over-the-counter (“OTC”) derivatives markets due to either the expansion of existing markets, including increased notional amounts outstanding or increased transaction volumes, or the development of new products or classes of products.  The level of growth in these markets is difficult to measure on a quarterly basis as there are only a few independent, objective measures of growth in outstanding notional amount of OTC derivatives, all of which are published retrospectively and do not measure transactional volumes.  Therefore, to help gauge growth in any particular quarter, management also looks to the published results of  large OTC derivatives dealers and certain futures exchanges as potential indicators of transactional activity in the related OTC derivative markets.

 

Futures exchanges, in many cases, reported year-over-year growth in the first quarter of 2011. The CME Group, Inc. reported a 19% increase in average daily volumes and IntercontinentalExchange, Inc. (“ICE”) reported a 24% increase in the average daily volume of its futures products and a 19% increase in the average daily commissions from its OTC energy products in the first quarter of 2011 as compared to the first quarter of 2010. However, revenues from ICE’s credit default swap trade execution, processing and clearing businesses were down 9% as compared to the first quarter of 2010.

 

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According to the Bank of International Settlements, the global derivative markets have recently moderated or decreased in size after years of rapid growth (as measured by outstanding notional amount). As of June 30, 2010, the latest period reported, the compound annual rates of decline in OTC and exchange-traded notional amounts outstanding over the two year period ended June 30, 2010 were 6.9% and 4%, respectively, compared to compound annual growth rates of 31.7% and 16.5%, respectively, over the five years ending June 30, 2008. However, the notional amounts outstanding for all exchange-traded derivatives increased 19.3% to $75.5 trillion, as of June 30, 2010, from $63.3 trillion, as of June 30, 2009, while the notional amounts outstanding for all OTC derivatives decreased 2% to $582.7 trillion, as of June 30, 2010, from $594.5 trillion, as of June 30, 2009. The disparity between the recent growth in the amount of outstanding exchange-traded derivatives versus the decline in the amount of OTC derivatives highlights a  recent shift in market preference towards standardized, cleared or shorter-dated products that typically trade on an exchange. We believe the decline in notional amounts outstanding of OTC derivatives can be attributed to the regulatory uncertainty and the industry’s effort to net derivative exposure, especially in credit derivatives, through bilateral and multilateral netting arrangements and the advent of central clearing for certain derivatives.

 

Competitive and Regulatory Environment

 

Another major external market factor affecting our business and results of operations is competition, which may take the form of competitive pressure on the commissions we charge for our brokerage services or competition for brokerage and technology development personnel with extensive experience in the specialized markets we serve. Competition for the services of productive brokers remained intense in the first quarter of 2011. The consolidation and personnel layoffs by dealers, hedge funds and other market participants over the last few years has led to increased competition to provide brokerage services to a smaller number of market participants in the near term.

 

In addition, we believe the continuing  global regulatory overhaul of many of the markets in which we provide our services has led to uncertainty that continued into the first quarter of 2011 and resulted in lower trading volumes and fewer participants in these markets. Regulators and legislators in the U.S. and abroad have proposed and, in some instances, already adopted, a slate of regulatory changes that call for, among other things, central clearing of certain derivatives, greater transparency and reporting of derivatives transactions, mandatory trading of certain derivatives transactions on regulated exchanges or swap execution facilities and the required or increased use of electronic trading system technologies.  We believe that the new regulation has not eliminated the uncertainty that has persisted in many OTC derivatives markets since the financial crisis.

 

We are optimistic that unfolding regulatory reform, including enhanced regulatory transparency, central clearing and efficient execution will benefit and eventually grow the global derivatives markets. We remain confident that our business will qualify in the U.S. as a Swap Execution Facility, and in Europe as an Organized Trading Facility. We believe that several of our hybrid electronic trading platforms built upon their past successes in the first quarter of 2011, becoming more engrained in customer work-flows. We believe this will enable us to more readily adjust to the new financial regulations.

 

Financial Overview

 

The following factors had a significant impact on our revenues and employee costs during the three month period ended March 31, 2011:

 

Our total revenues increased 19.1% to $262.9 million for the three months ended March 31, 2011 from $220.8 million for the three months ended March 31, 2010. The main factors contributing to this increase in our revenues were:

 

·                  $40.9 million in revenues contributed from Kyte, which was acquired in July of 2010;

·                  Increased volatility in the markets in which we operate;

·                  Improved economic and market conditions in emerging markets;

·                  Increased trading activity in certain financial and commodity product markets in which we have a leading market share;

·                  Higher share and commodity values, on average, as they relate directly to the commissions revenue we receive in certain equity and commodity products, respectively, in Europe;

·                  Increased electronic trading activity on our hybrid electronic trading platforms in all regions, notably in emerging markets, interest rate options and credit indices in the U.S.;

·                  Contributions from new brokerage desks and new brokers hired across all product categories; and

·                  The strong performance of our Trayport subsidiary.

 

Partially offsetting these factors were several negative factors that affected our brokerage and other revenues, including:

 

·                  Our reduced corporate fixed income presence in the U.S. compared to the first quarter of 2010 and increased

 

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competition in certain cash fixed income markets globally;

·                  Lower equity trading volumes in the U.S; and

·                  Regulatory and governmental uncertainty as it relates to market structure and operations in OTC derivative markets.

 

The most significant component of our cost structure is employee compensation and benefits, which includes salaries, sign-on bonuses, incentive compensation and related employee benefits and taxes.  Our employee compensation and benefits expense increased 10.2% to $159.5 million for the three months ended March 31, 2011 from $144.7 million for the three months ended March 31, 2010.

 

Our compensation and employee benefits for all employees have both a fixed and variable component. Base salaries and benefit costs are primarily fixed for all employees while bonuses constitute the variable portion of our compensation and employee benefits. Within overall compensation and employee benefits, the employment cost of our brokerage personnel is the key component. Bonuses for brokerage personnel are primarily based on individual performance and/or the operating results of their related brokerage desk. Additionally, a portion of our bonus expense is subject to contractual guarantees that may require us to make bonus payments to brokers regardless of their performance in any particular period. For many of our brokerage employees, their bonus constitutes a significant component of their overall compensation. Broker performance bonuses increased to $69.4 million for the three months ended March 31, 2011 from $64.4 million for the three months ended March 31, 2010.

 

Further, we may pay sign-on bonuses to certain newly-hired brokers and retention bonuses to certain of our existing brokers who agree to long-term employment agreements. These bonuses may be paid in the form of cash or restricted stock units (“RSUs”) and are typically expensed over the term of the related employment agreement for cash bonuses and the related service period for RSUs, which is generally two to four years. These employment agreements typically contain repayment of all or a portion of the cash payment and forfeiture provisions for unvested RSUs should the employee voluntarily terminate his or her employment or if the employee’s employment is terminated for cause during the initial term of the agreement. Expense related to bonuses paid to brokerage personnel increased to $7.9 million for the three months ended March 31, 2011 from $7.2 million for the three months ended March 31, 2010.

 

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Results of Consolidated Operations

 

The following table sets forth our condensed consolidated results of operations for the periods indicated. Beginning in the fourth quarter ended December 31, 2010, we included the subtotal “Revenues, net of interest and transaction-based expenses,” or net revenues, which is defined as total revenues less certain direct incremental costs associated with those revenues. We believe that net revenues provide a useful insight into our business. This revised format has been applied to all periods presented:

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010