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EX-10.3 - EX-10.3 - INVESTMENT TECHNOLOGY GROUP, INC.a15-11995_1ex10d3.htm
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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 fiscal period ended June 30, 2015

 

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 Number 001-32722

 

INVESTMENT TECHNOLOGY GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

95 - 2848406

(State or Other Jurisdiction of Incorporation or
Organization)

 

(I.R.S. Employer Identification No.)

 

165 Broadway, New York, New York

 

10006

(Address of Principal Executive Offices)

 

(Zip Code)

 

(212) 588 - 4000

(Registrant’s Telephone Number, Including Area Code)

 

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 x  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.:

 

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

 

At July 15, 2015, the Registrant had 33,966,660 shares of common stock, $0.01 par value, outstanding.

 

 

 



Table of Contents

 

QUARTERLY REPORT ON FORM 10-Q

 

TABLE OF CONTENTS

 

 

 

Page

 

 

 

 

PART I. — Financial Information

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Financial Condition: June 30, 2015 (unaudited) and December 31, 2014

3

 

 

 

 

Condensed Consolidated Statements of Operations (unaudited): Three and Six Months Ended June 30, 2015 and 2014

4

 

 

 

 

Condensed Consolidated Statements of Comprehensive Loss and Income (unaudited): Three and Six Months Ended June 30, 2015 and 2014

5

 

 

 

 

Condensed Consolidated Statement of Changes in Stockholders’ Equity (unaudited): Three and Six Months Ended June 30, 2015

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows (unaudited): Six Months Ended June 30, 2015 and 2014

7

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

8

 

 

 

Item 2.

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

19

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

32

 

 

 

Item 4.

Controls and Procedures

32

 

 

 

 

PART II. — Other Information

 

 

 

 

Item 1.

Legal Proceedings

32

 

 

 

Item 1A.

Risk Factors

33

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

34

 

 

 

Item 3.

Defaults Upon Senior Securities

34

 

 

 

Item 4.

Mine Safety Disclosures

34

 

 

 

Item 5.

Other Information

35

 

 

 

Item 6.

Exhibits

36

 

 

 

 

Signature

37

 

Investment Technology Group, ITG, AlterNet, ITG Net, MATCH Now, POSIT, POSIT Alert, RFQ-hub and Triton are registered trademarks of the Investment Technology Group, Inc. companies. ITG Derivatives is a trademark of the Investment Technology Group, Inc. companies.

 

1



Table of Contents

 

PRELIMINARY NOTES

 

When we use the terms “ITG,” the “Company,” “we,” “us” and “our,” we mean Investment Technology Group, Inc. and its consolidated subsidiaries.

 

FORWARD-LOOKING STATEMENTS

 

In addition to the historical information contained throughout this Quarterly Report on Form 10-Q, there are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the Private Securities Litigation Reform Act of 1995. All statements regarding our expectations related to our future financial position, results of operations, revenues, cash flows, dividends, financing plans, business and product strategies, competitive positions, as well as the plans and objectives of management for future operations, and all expectations concerning securities markets, client trading and economic trends are forward-looking statements. In some cases, you can identify these statements by forward-looking words such as “may,” “might,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue” and the negative of these terms and other comparable terminology.

 

Although we believe our expectations reflected in such forward-looking statements are based on reasonable assumptions and beliefs, and on information currently available to our management, there can be no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements herein include, among others, general economic, business, credit and financial market conditions, both internationally and domestically, financial market volatility, fluctuations in market trading volumes, effects of inflation, adverse changes or volatility in interest rates, fluctuations in foreign exchange rates, evolving industry regulations and increased regulatory scrutiny, the ultimate resolution of the SEC’s AlterNet investigation and any customer or shareholder actions resulting from the matter or the underlying circumstances, the volatility of our stock price, changes in tax policy or accounting rules, the actions of both current and potential new competitors, changes in commission pricing, rapid changes in technology, errors or malfunctions in our systems or technology, cash flows into or redemptions from equity mutual funds, ability to meet liquidity requirements related to the clearing of our customers’ trades, customer trading patterns, the success of our products and service offerings, our ability to continue to innovate and meet the demands of our customers for new or enhanced products, our ability to successfully integrate companies we have acquired and our ability to attract and retain talented employees.

 

Certain of these factors, and other factors, are more fully discussed in Item 1A, Risk Factors, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 7A, Quantitative and Qualitative Disclosures about Market Risk, in our Annual Report on Form 10-K for the year ended December 31, 2014, which you are encouraged to read.  Our 2014 Annual Report on Form 10-K is also available through our website at http://investor.itg.com under “SEC Filings.”

 

We disclaim any duty to update any of these forward-looking statements after the filing of this report to conform our prior statements to actual results or revised expectations and we do not intend to do so. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the filing of this report.

 

2



Table of Contents

 

PART I. — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Financial Condition

(In thousands, except share amounts)

 

 

 

June 30,
2015

 

December 31,
2014

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

Cash and cash equivalents

 

$

211,787

 

$

275,210

 

Cash restricted or segregated under regulations and other

 

35,426

 

38,080

 

Deposits with clearing organizations

 

110,033

 

72,527

 

Securities owned, at fair value

 

10,612

 

12,073

 

Receivables from brokers, dealers and clearing organizations

 

1,010,335

 

644,614

 

Receivables from customers

 

105,551

 

107,935

 

Premises and equipment, net

 

55,236

 

60,306

 

Capitalized software, net

 

39,283

 

38,333

 

Goodwill

 

12,945

 

12,803

 

Intangibles, net

 

29,985

 

31,595

 

Income taxes receivable

 

3,642

 

105

 

Deferred taxes

 

29,419

 

37,209

 

Other assets

 

24,241

 

20,059

 

Total assets

 

$

1,678,495

 

$

1,350,849

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable and accrued expenses

 

$

189,904

 

$

199,211

 

Short-term bank loans

 

81,149

 

78,360

 

Payables to brokers, dealers and clearing organizations

 

954,103

 

600,041

 

Payables to customers

 

31,324

 

11,132

 

Securities sold, not yet purchased, at fair value

 

6,996

 

8,253

 

Income taxes payable

 

7,525

 

19,772

 

Deferred taxes

 

 

703

 

Term debt

 

11,962

 

17,781

 

Total liabilities

 

1,282,963

 

935,253

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

Preferred stock, $0.01 par value; 1,000,000 shares authorized; no shares issued or outstanding

 

 

 

Common stock, $0.01 par value; 100,000,000 shares authorized; 52,265,654 and 52,229,962 shares issued at June 30, 2015 and December 31, 2014, respectively

 

523

 

522

 

Additional paid-in capital

 

235,766

 

240,135

 

Retained earnings

 

491,600

 

487,462

 

Common stock held in treasury, at cost; 18,299,591 and 18,000,756 shares at June 30, 2015 and December 31, 2014, respectively

 

(321,443

)

(306,629

)

Accumulated other comprehensive income (net of tax)

 

(10,914

)

(5,894

)

Total stockholders’ equity

 

395,532

 

415,596

 

Total liabilities and stockholders’ equity

 

$

1,678,495

 

$

1,350,849

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

3



Table of Contents

 

INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations (unaudited)

(In thousands, except per share amounts)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2015

 

2014

 

2015

 

2014

 

Revenues:

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

110,860

 

$

106,453

 

$

229,786

 

$

214,877

 

Recurring

 

26,447

 

24,975

 

53,379

 

50,552

 

Other

 

3,187

 

7,038

 

7,056

 

10,646

 

Total revenues

 

140,494

 

138,466

 

290,221

 

276,075

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

53,899

 

52,720

 

111,307

 

103,897

 

Transaction processing

 

25,187

 

20,109

 

49,760

 

40,605

 

Occupancy and equipment

 

14,470

 

14,985

 

28,842

 

30,063

 

Telecommunications and data processing services

 

13,011

 

12,655

 

25,783

 

25,352

 

Other general and administrative

 

42,408

 

20,715

 

60,165

 

39,820

 

Interest expense

 

468

 

594

 

973

 

1,230

 

Total expenses

 

149,443

 

121,778

 

276,830

 

240,967

 

(Loss) income before income tax expense

 

(8,949

)

16,688

 

13,391

 

35,108

 

Income tax expense

 

1,261

 

3,762

 

6,868

 

8,562

 

Net (loss) income

 

$

(10,210

)

$

12,926

 

$

6,523

 

$

26,546

 

 

 

 

 

 

 

 

 

 

 

(Loss) income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.30

)

$

0.36

 

$

0.19

 

$

0.74

 

Diluted

 

$

(0.30

)

$

0.35

 

$

0.18

 

$

0.72

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average number of common shares outstanding

 

34,076

 

35,720

 

34,172

 

35,900

 

Diluted weighted average number of common shares outstanding

 

34,076

 

36,641

 

35,329

 

36,933

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

4



Table of Contents

 

INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Loss and Income (unaudited)

(In thousands)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(10,210

)

$

12,926

 

$

6,523

 

$

26,546

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

Currency translation adjustment

 

5,832

 

4,147

 

(5,020

)

2,182

 

Other comprehensive income (loss)

 

5,832

 

4,147

 

(5,020

)

2,182

 

Comprehensive (loss) income

 

$

(4,378

)

$

17,073

 

$

1,503

 

$

28,728

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

 

INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statement of Changes in Stockholders’ Equity (unaudited)

Three Months Ended June 30, 2015

(In thousands, except share amounts)

 

 

 

Preferred
Stock

 

Common
Stock

 

Additional
Paid-in
Capital

 

Retained
Earnings

 

Common
Stock
Held in
Treasury

 

Accumulated
Other
Comprehensive
Income

 

Total
Stockholders’
Equity

 

Balance at January 1, 2015

 

$

 

$

522

 

$

240,135

 

$

487,462

 

$

(306,629

)

$

(5,894

)

$

415,596

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

6,523

 

 

 

6,523

 

Other comprehensive loss

 

 

 

 

 

 

(5,020

)

(5,020

)

Issuance of common stock in connection with director stock option exercises (46,024 shares) and restricted share awards (1,000,778 shares), including a net excess tax benefit of $2.9 million

 

 

 

(14,447

)

 

18,031

 

 

3,584

 

Issuance of common stock for the employee stock purchase plan (35,692 shares)

 

 

1

 

557

 

 

 

 

558

 

Shares withheld for net settlement of share-based awards (374,454 shares)

 

 

 

 

 

(8,300

)

 

(8,300

)

Purchase of common stock for treasury (972,159 shares)

 

 

 

 

 

(24,562

)

 

(24,562

)

Dividend declared on common stock ($0.07 per share) (976 shares)

 

 

 

10

 

(2,385

)

17

 

 

(2,358

)

Share-based compensation

 

 

 

9,511

 

 

 

 

9,511

 

Balance at June 30, 2015

 

$

 

$

523

 

$

235,766

 

$

491,600

 

$

(321,443

)

$

(10,914

)

$

395,532

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

 

INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (unaudited)

(In thousands)

 

 

 

Six Months Ended June 30,

 

 

 

2015

 

2014

 

Cash flows from Operating Activities:

 

 

 

 

 

Net income

 

$

6,523

 

$

26,546

 

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

 

 

 

 

 

Depreciation and amortization

 

22,273

 

25,865

 

Deferred income tax expense

 

7,842

 

3,859

 

Provision for doubtful accounts

 

366

 

276

 

Non-cash share-based compensation

 

9,511

 

8,334

 

 

 

 

 

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Cash restricted or segregated under regulations and other

 

2,604

 

(424

)

Deposits with clearing organizations

 

(37,506

)

31,295

 

Securities owned, at fair value

 

903

 

(6,764

)

Receivables from brokers, dealers and clearing organizations

 

(368,633

)

194,712

 

Receivables from customers

 

2,255

 

(102,362

)

Accounts payable and accrued expenses

 

(8,202

)

(2,215

)

Payables to brokers, dealers and clearing organizations

 

355,782

 

(219,882

)

Payables to customers

 

20,627

 

15,014

 

Securities sold, not yet purchased, at fair value

 

(682

)

6,179

 

Income taxes receivable/payable

 

(13,084

)

164

 

Excess tax benefit from share-based payment arrangements

 

(2,878

)

(1,007

)

Other, net

 

(4,802

)

(8,448

)

Net cash used in operating activities

 

(7,101

)

(28,858

)

 

 

 

 

 

 

Cash flows from Investing Activities:

 

 

 

 

 

Capital purchases

 

(3,668

)

(5,994

)

Capitalization of software development costs

 

(13,310

)

(13,633

)

Net cash used in investing activities

 

(16,978

)

(19,627

)

 

 

 

 

 

 

Cash flows from Financing Activities:

 

 

 

 

 

Repayments of long term debt

 

(5,819

)

(6,251

)

Proceeds from (repayments of) borrowing under short-term bank loans

 

2,789

 

68,115

 

Excess tax benefit from share-based payment arrangements

 

2,878

 

1,007

 

Common stock issued

 

1,286

 

445

 

Common stock repurchased

 

(24,562

)

(27,047

)

Dividends paid

 

(2,358

)

 

Shares withheld for net settlements of share-based awards

 

(8,300

)

(6,426

)

Net cash (used in) provided by financing activities

 

(34,086

)

29,843

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

(5,258

)

(4,140

)

Net decrease in cash and cash equivalents

 

(63,423

)

(22,782

)

Cash and cash equivalents — beginning of year

 

275,210

 

261,897

 

Cash and cash equivalents — end of period

 

$

211,787

 

$

239,115

 

 

 

 

 

 

 

Supplemental cash flow information

 

 

 

 

 

Interest paid

 

$

1,688

 

$

1,866

 

Income taxes paid

 

$

12,004

 

$

4,629

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

 

INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (unaudited)

 

(1) Organization and Basis of Presentation

 

Investment Technology Group, Inc. was formed as a Delaware corporation on July 22, 1983. Its principal subsidiaries include: (1) ITG Inc., AlterNet Securities, Inc. (“AlterNet”) and ITG Derivatives LLC (“ITG Derivatives”), institutional broker-dealers in the United States (“U.S.”), (2) ITG Canada Corp., an institutional broker-dealer in Canada, (3) Investment Technology Group Limited, an institutional broker-dealer in Europe, (4) ITG Australia Limited, an institutional broker-dealer in Australia, (5) ITG Hong Kong Limited, an institutional broker-dealer in Hong Kong, (6) ITG Software Solutions, Inc., our intangible property, software development and maintenance subsidiary in the U.S., and (7) ITG Solutions Network, Inc., a holding company for ITG Analytics, Inc., a provider of pre- and post-trade analysis, fair value and trade optimization services, ITG Investment Research, Inc., a provider of independent data-driven investment research, and ITG Platforms Inc., a provider of trade order and execution management technology and network connectivity services for the financial community.

 

ITG is an independent execution broker and research provider that partners with global portfolio managers and traders to provide unique data-driven insights throughout the investment process. From investment decision through to settlement, ITG helps clients understand market trends, improve performance, mitigate risk and navigate increasingly complex markets. A leader in electronic trading since launching the POSIT crossing network in 1987, ITG takes a consultative approach in delivering the highest quality institutional liquidity, execution services, analytical tools and proprietary research. The firm is headquartered in New York with offices in North America, Europe, and the Asia Pacific region.

 

The Company’s business is organized into four reportable operating segments (see Note 14, Segment Reporting, to the condensed consolidated financial statements):

 

·                  U.S. Operations

 

·                  Canadian Operations

 

·                  European Operations and

 

·                  Asia Pacific Operations

 

The four operating segments offer a wide range of solutions for asset managers and broker-dealers in the areas of electronic brokerage; research, sales and trading; platforms; and analytics. These offerings include trade execution services and solutions for portfolio management, as well as investment research, pre-trade analytics and post-trade analytics and processing.

 

Effective in the first quarter of 2015, the Company is presenting its regional segment results excluding the impact of corporate activity. For this purpose, corporate activity includes investment income from all treasury activity as well as costs not associated with operating the businesses within the Company’s regional segments. These costs include, among others, (a) the costs of being a public company, such as certain staff costs, a portion of external audit fees, and reporting, filing and listing costs, (b) intangible asset amortization, (c) interest expense, (d) professional fees associated with our global transfer pricing structure, (e) foreign exchange gains or losses and (f) certain non-operating expenses.  Prior to this change in segment measure, corporate activity was included in the region where the income/expense was earned/incurred, which primarily was in the U.S. Operations segment. Prior period segment data has been restated to conform to the 2015 presentation.

 

The condensed consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”). All material intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for the fair presentation of results. Certain reclassifications have been made to the following prior year asset balances to conform to the current year presentation: (i) cash restricted or segregated under regulations and other, (ii) deposits with clearing organizations, (iii) receivables from brokers, dealers and clearing organizations and (iv) other assets.

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets, liabilities, revenues and expenses. Actual results could differ from those estimates.

 

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Table of Contents

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted in accordance with Securities and Exchange Commission (“SEC”) rules and regulations; however, management believes that the disclosures herein are adequate to make the information presented not misleading. This report should be read in conjunction with the audited financial statements and the notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

 

Accounting Standard to be Adopted in Future Period

 

In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-03, Simplifying the Presentation of Debt Issuance Costs which changes the presentation of debt issuance costs in financial statements. ASU 2015-03 requires an entity to present such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs will continue to be reported as interest expense. It is effective for annual reporting periods beginning after December 15, 2016. Early adoption is permitted. The new guidance will be applied retrospectively to each prior period presented. The Company is currently in the process of evaluating the impact of adoption of the ASU on its condensed consolidated balance sheets.

 

(2) Fair Value Measurements

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, various methods are used including market, income and cost approaches. Based on these approaches, certain assumptions that market participants would use in pricing the asset or liability are used, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market-corroborated, or generally unobservable firm inputs. Valuation techniques that are used maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, fair value measured financial instruments are categorized according to the fair value hierarchy prescribed by ASC 820, Fair Value Measurements and Disclosures. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:

 

·                  Level 1: Fair value measurements using unadjusted quoted market prices in active markets for identical, unrestricted assets or liabilities.

 

·                  Level 2: Fair value measurements using correlation with (directly or indirectly) observable market-based inputs, unobservable inputs that are corroborated by market data, or quoted prices in markets that are not active.

 

·                  Level 3: Fair value measurements using inputs that are significant and not readily observable in the market.

 

Level 1 consists of financial instruments whose value is based on quoted market prices such as exchange-traded mutual funds and listed equities.

 

Level 2 includes financial instruments that are valued based upon observable market-based inputs.

 

Level 3 is comprised of financial instruments whose fair value is estimated based on internally developed models or methodologies utilizing significant inputs that are generally less readily observable.

 

Fair value measurements for those items measured on a recurring basis are as follows (dollars in thousands):

 

June 30, 2015

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Tax free money market mutual funds

 

$

33

 

$

33

 

$

 

$

 

Money market mutual funds

 

5,770

 

5,770

 

 

 

Securities owned, at fair value:

 

 

 

 

 

 

 

 

 

Corporate stocks-trading securities

 

7,087

 

7,087

 

 

 

Mutual funds

 

3,525

 

3,525

 

 

 

Total

 

$

16,415

 

$

16,415

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Securities sold, not yet purchased, at fair value:

 

 

 

 

 

 

 

 

 

Corporate stocks-trading securities

 

6,996

 

6,996

 

 

 

Total

 

$

6,996

 

$

6,996

 

$

 

$

 

 

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December 31, 2014

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Tax free money market mutual funds

 

$

33

 

$

33

 

$

 

$

 

Money market mutual funds

 

6,965

 

6,965

 

 

 

Securities owned, at fair value:

 

 

 

 

 

 

 

 

 

Corporate stocks-trading securities

 

8,160

 

8,160

 

 

 

Mutual funds

 

3,913

 

3,913

 

 

 

Total

 

$

19,071

 

$

19,071

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Securities sold, not yet purchased, at fair value:

 

 

 

 

 

 

 

 

 

Corporate stocks-trading securities

 

8,253

 

8,253

 

 

 

Total

 

$

8,253

 

$

8,253

 

$

 

$

 

 

Cash and cash equivalents other than bank deposits are measured at fair value and primarily include U.S. government money market mutual funds.

 

Securities owned, at fair value and securities sold, not yet purchased, at fair value include corporate stocks, equity index mutual funds and bond mutual funds, all of which are exchange traded.

 

Certain of the Company’s assets and liabilities are carried at 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, clearing organizations and customers. These receivables and payables to brokers, dealers and clearing organizations and customers are short-term in nature, and following June 30, 2015, substantially all have settled at the contracted amounts.

 

The Company believes the carrying amounts of its term-debt obligations at June 30, 2015 and December 31, 2014 approximate fair value because the interest rates on these instruments change with, or approximate, market interest rates.

 

(3) Restructuring Charges

 

2011 Restructuring

 

In the second and fourth quarters of 2011, the Company implemented restructuring plans to improve margins and enhance stockholder returns.

 

Activity and liability balances recorded as part of the 2011 restructuring plan through June 30, 2015 are as follows (dollars in thousands):

 

 

 

Consolidation
of leased facilities

 

Balance at December 31, 2014

 

$

833

 

Utilized—cash

 

(301

)

Balance at June 30, 2015

 

$

532

 

 

The payment of the remaining accrued costs related to the vacated leased facilities will continue through December 2016.

 

2010 Restructuring

 

In the fourth quarter of 2010, the Company closed its Westchester, NY office and relocated the staff, primarily sales traders and support, to its New York City office.

 

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Activity and liability balances recorded as part of the 2010 restructuring plan through June 30, 2015 are as follows (dollars in thousands):

 

 

 

Consolidation
of leased facilities

 

Balance at December 31, 2014

 

$

1,391

 

Utilized—cash

 

(209

)

Balance at June 30, 2015

 

$

1,182

 

 

The payment of the remaining accrued costs related to the vacated leased facilities will continue through December 2016.

 

(4) Cash Restricted or Segregated Under Regulations and Other

 

Cash restricted or segregated under regulations and other represents (i) funds on deposit for the purpose of securing working capital facilities for clearing and settlement activities in Hong Kong, (ii) a special reserve bank account for the exclusive benefit of customers (“Special Reserve Bank Account”) maintained by ITG Inc. in accordance with SEC Rule 15c3-3 (“Customer Protection Rule”) or agreements for proprietary accounts of broker dealers (“PABs”), (iii) funds on deposit for Canadian foreign exchange trade clearing and settlement activity, (iv) segregated balances under a collateral account control agreement for the benefit of certain customers, and (v) funds relating to the securitization of bank guarantees supporting the Company’s Australian lease.

 

(5) Securities Owned and Sold, Not Yet Purchased

 

 

 

Securities Owned

 

Securities Sold, Not Yet
Purchased

 

 

 

June 30,
2015

 

December 31,
2014

 

June 30,
2015

 

December 31,
2014

 

Corporate stocks—trading securities

 

$

7,087

 

$

8,160

 

$

6,996

 

$

8,253

 

Mutual funds

 

3,525

 

3,913

 

 

 

Total

 

$

10,612

 

$

12,073

 

$

6,996

 

$

8,253

 

 

Trading securities owned and sold, not yet purchased primarily consists of temporary positions obtained in the normal course of agency trading activities, including positions held in connection with the creation and redemption of exchange-traded funds on behalf of clients.

 

(6) Income Taxes

 

A tax benefit from an uncertain tax position may be recognized only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution.

 

During the six months ended June 30, 2015, the Company benefitted from a net positive reduction in income tax expense of $0.7 million reflecting the resolution in June 2015 of uncertain tax positions in the U.S. for fiscal years 2006 through 2009, which reduced tax reserves by $1.5 million, offset by decreases in deferred tax assets from enacted tax law changes resulting in additional expense of $0.8 million.

 

The Company had reserves for tax positions taken of $12.5 million and $14.4 million at June, 30, 2015 and December 31, 2014, respectively. The Company had accrued interest expense related to tax reserves of $2.6 million and $2.9 million, net of related tax effects, at June 30, 2015 and December 31, 2014, respectively.

 

(7) Goodwill and Other Intangibles

 

The following table presents the changes in the carrying amount of goodwill by our European Operations segment for the six months ended June 30, 2015 (dollars in thousands):

 

 

 

Total

 

Balance at December 31, 2014

 

$

12,803

 

2015 Activity:

 

 

 

Currency translation adjustment

 

142

 

Balance at June 30, 2015

 

$

12,945

 

 

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Acquired other intangible assets consisted of the following at June 30, 2015 and December 31, 2014 (dollars in thousands):

 

 

 

June 30, 2015

 

December 31, 2014

 

 

 

 

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Useful Lives
(Years)

 

Trade name

 

$

8,545

 

$

 

$

8,545

 

$

 

 

Customer-related intangibles

 

30,272

 

12,398

 

30,272

 

11,210

 

13.3

 

Proprietary software

 

23,558

 

20,381

 

23,558

 

19,959

 

6.3

 

Trading rights

 

339

 

 

339

 

 

 

Other

 

50

 

 

50

 

 

 

Total

 

$

62,764

 

$

32,779

 

$

62,764

 

$

31,169

 

 

 

 

At June 30, 2015, indefinite-lived intangibles not subject to amortization amounted to $8.9 million, of which $8.4 million related to the POSIT trade name.

 

Amortization expense for definite-lived intangibles was $0.8 million and $1.6 million for the three and six months ended June 30, 2015, respectively, compared with $1.2 and $2.5 million in the respective prior-year periods. These amounts are included in other general and administrative expense in the Condensed Consolidated Statements of Income.

 

During the six months ended June 30, 2015, no intangibles were deemed impaired, and accordingly, no adjustment was required.

 

(8) Receivables and Payables

 

Receivables from, and Payables to, Brokers, Dealers and Clearing Organizations

 

The following is a summary of receivables from, and payables to, brokers, dealers and clearing organizations (dollars in thousands):

 

 

 

Receivables from

 

Payables to

 

 

 

June 30,
2015

 

December 31,
2014

 

June 30,
2015

 

December 31,
2014

 

Broker-dealers

 

$

184,313

 

$

147,240

 

$

94,943

 

$

51,615

 

Clearing organizations

 

7,898

 

1,447

 

10,049

 

39,433

 

Securities borrowed

 

819,051

 

496,596

 

 

 

Securities loaned

 

 

 

849,111

 

508,993

 

Allowance for doubtful accounts

 

(927

)

(669

)

 

 

Total

 

$

1,010,335

 

$

644,614

 

$

954,103

 

$

600,041

 

 

Receivables from, and Payables to, Customers

 

The following is a summary of receivables from, and payables to, customers (dollars in thousands):

 

 

 

Receivables from

 

Payables to

 

 

 

June 30,
2015

 

December 31,
2014

 

June 30,
2015

 

December 31,
2014

 

Customers

 

$

106,142

 

$

108,518

 

$

31,324

 

$

11,132

 

Allowance for doubtful accounts

 

(591

)

(583

)

 

 

Net

 

$

105,551

 

$

107,935

 

$

31,324

 

$

11,132

 

 

Securities Borrowed and Loaned

 

As of June 30, 2015, securities borrowed as part of the Company’s matched book operations with a fair value of $797.9 million were delivered for securities loaned. The gross amounts of interest earned on cash provided to counterparties as collateral for securities borrowed, and interest incurred on cash received from counterparties as collateral for securities loaned, and the resulting net amount included in other revenue on the Condensed Consolidated Statements of Income for the three and six months ended June 30, 2015 and 2014, respectively, were as follows (dollars in thousands):

 

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Table of Contents

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2015

 

2014

 

2015

 

2014

 

Interest earned

 

$

1,451

 

$

6,455

 

$

2,859

 

$

10,858

 

Interest incurred

 

(1,080

)

(4,337

)

(2,126

)

(7,403

)

Net

 

$

371

 

$

2,118

 

$

733

 

$

3,455

 

 

Deposits paid for securities borrowed and deposits received for securities loaned are recorded at the amount of cash collateral advanced or received. Deposits paid for securities borrowed transactions require the Company to deposit cash with the lender. With respect to deposits received for securities loaned, the Company receives collateral in the form of cash in an amount generally in excess of the market value of the securities loaned. The Company monitors the market value of the securities borrowed and loaned on a daily basis, with additional collateral obtained or refunded, as necessary.

 

The Company’s securities borrowing and lending is generally done under industry standard agreements (“Master Securities Lending Agreements”) that may allow, following an event of default by either party, the prompt close-out of all transactions (including the liquidation of securities held) and the offsetting of obligations to return cash or securities, as the case may be, by the non-defaulting party. Events of default under the Master Securities Lending Agreements generally include, subject to certain conditions: (i) failure to timely deliver cash or securities as required under the transaction, (ii) a party’s insolvency, bankruptcy, or similar proceeding, (iii) breach of representation, and (iv) a material breach of the agreement. The counterparty that receives the securities in these transactions generally has unrestricted access in its use of the securities.  For financial statement purposes, the Company does not offset securities borrowed and securities loaned.

 

The following table summarizes the transactions under certain Master Securities Lending Agreements that may be eligible for offsetting if an event of default occurred and a right of offset was legally enforceable (dollars in thousands):

 

 

 

Gross Amounts of
Recognized Assets/
(Liabilities)

 

Gross Amounts
Offset in the
Consolidated
Statement of
Financial Condition

 

Net Amounts
Presented in the
Consolidated
Statement of
Financial Condition

 

Collateral
Received or
Pledged
(including
Cash)

 

Net
Amount

 

As of June 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

Deposits paid for securities borrowed

 

$

819,051

 

$

 

$

819,051

 

$

818,761

 

$

290

 

Deposits received for securities loaned

 

(849,111

)

 

(849,111

)

(835,260

)

(13,851

)

As of December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

Deposits paid for securities borrowed

 

$

496,596

 

$

 

$

496,596

 

$

496,374

 

$

222

 

Deposits received for securities loaned

 

(508,993

)

 

(508,993

)

(497,462

)

(11,531

)

 

(9) Accounts Payable and Accrued Expenses

 

The following is a summary of accounts payable and accrued expenses (dollars in thousands):

 

 

 

June 30,
2015

 

December 31,
2014

 

Accrued research payables

 

$

55,340

 

$

56,736

 

Accrued compensation and benefits

 

35,483

 

62,271

 

Accrued settlement costs

 

20,338

 

 

Accrued rent

 

18,362

 

19,169

 

Trade payables

 

15,563

 

19,547

 

Deferred revenue

 

13,841

 

13,836

 

Deferred compensation

 

3,529

 

3,918

 

Accrued transaction processing

 

3,801

 

2,981

 

Accrued restructuring

 

1,714

 

2,224

 

Other

 

21,933

 

18,529

 

Total

 

$

189,904

 

$

199,211

 

 

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Table of Contents

 

(10) Borrowings

 

Short-term Bank Loans

 

The Company’s international securities clearance and settlement activities are funded with operating cash or with short-term bank loans in the form of overdraft facilities.  At June 30, 2015, there was $81.1 million outstanding under these facilities at a weighted average interest rate of approximately 2% associated with international settlement activities.

 

In the U.S., securities clearance and settlement activities are funded with operating cash, securities loaned or with short-term bank loans under a committed credit agreement.  On January 31, 2014, ITG Inc. as borrower, and Investment Technology Group, Inc. (“Parent Company”) as guarantor entered into a $150 million two-year revolving credit agreement (the “Credit Agreement”) with a syndicate of banks and JPMorgan Chase Bank, N.A., as Administrative Agent. The Credit Agreement includes an accordion feature that allows for potential expansion of the facility up to $225 million. At June 30, 2015, there were no amounts outstanding under the Credit Agreement.

 

Term Debt

 

Term debt is comprised of the following (dollars in thousands):

 

 

 

June 30,
2015

 

December 31,
2014

 

Term loan

 

$

 

$

2,653

 

Obligations under capital lease

 

11,962

 

15,128

 

Total

 

$

11,962

 

$

17,781

 

 

On June 1, 2011, Parent Company as borrower, entered into a $25.5 million Master Loan and Security Agreement (“Term Loan Agreement”) with Banc of America Leasing & Capital, LLC (“Bank of America”). The four-year term loan established under this agreement is secured by a security interest in existing furniture, fixtures and equipment owned by the Parent Company and certain U.S. subsidiaries as of June 1, 2011. The primary purpose of this financing was to provide capital for strategic initiatives. At June 30, 2015 the four-year term loan was fully paid.

 

Along with the Term Loan Agreement, Parent Company entered into a $5.0 million master lease facility with Bank of America (“Master Lease Agreement”), under which purchases of new equipment were financed. Each equipment lease under the Master Lease Agreement is structured as a capital lease and has a separate 48-month term from its inception date, at the end of which Parent Company may purchase the underlying equipment for $1. At June 30, 2015, there was $0.6 million outstanding under this facility.

 

On August 10, 2012, Parent Company entered into a $25.0 million master lease facility with BMO Harris Equipment Finance Company (“BMO”) to finance equipment and construction expenditures related to the build-out of the Company’s new headquarters in lower Manhattan. The original amount borrowed of $21.2 million has a 3.39% fixed-rate term financing structured as a capital lease with a 48-month term, at the end of which Parent Company may purchase the underlying assets for $1.  At June 30, 2015, there was $11.4 million outstanding under this facility.

 

(11) Earnings Per Share

 

The following is a reconciliation of the basic and diluted earnings per share computations (dollars in thousands, except per share amounts):

 

 

 

June 30,

 

 

 

2015

 

2014

 

Three Months Ended

 

 

 

 

 

Net (loss) income for basic and diluted (loss) earnings per share

 

$

(10,210

)

$

12,926

 

Shares of common stock and common stock equivalents:

 

 

 

 

 

Average common shares used in basic computation

 

34,076

 

35,720

 

Effect of dilutive securities

 

 

921

 

Average common shares used in diluted computation

 

34,076

 

36,641

 

(Loss) earnings per share:

 

 

 

 

 

Basic

 

$

(0.30

)

$

0.36

 

Diluted

 

$

(0.30

)

$

0.35

 

 

 

 

 

 

 

Six Months Ended

 

 

 

 

 

Net income for basic and diluted earnings per share

 

$

6,523

 

$

26,546

 

Shares of common stock and common stock equivalents:

 

 

 

 

 

Average common shares used in basic computation

 

34,172

 

35,900

 

Effect of dilutive securities

 

1,157

 

1,033

 

Average common shares used in diluted computation

 

35,329

 

36,933

 

Earnings per share:

 

 

 

 

 

Basic

 

$

0.19

 

$

0.74

 

Diluted

 

$

0.18

 

$

0.72

 

 

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Table of Contents

 

The following is a summary of anti-dilutive equity awards not included in the detailed earnings per share computations (share units in thousands).  The impact of all 3.3 million common stock equivalents at the second quarter of 2015 was anti-dilutive due to the fact that the Company reported a loss.

 

 

 

June 30,

 

 

 

2015

 

2014

 

Three months ended

 

3,294

 

83

 

Six months ended

 

7

 

220

 

 

(12) Accumulated Other Comprehensive Income

 

The components and allocated tax effects of accumulated other comprehensive income for the periods ended June 30, 2015 and December 31, 2014 are as follows (dollars in thousands):

 

 

 

Before Tax
Effects

 

Tax
Effects

 

After Tax
Effects

 

June 30, 2015

 

 

 

 

 

 

 

Currency translation adjustment

 

$

(10,914

)

$

 

$

(10,914

)

Total

 

$

(10,914

)

$

 

$

(10,914

)

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

Currency translation adjustment

 

$

(5,894

)

$

 

$

(5,894

)

Total

 

$

(5,894

)

$

 

$

(5,894

)

 

Deferred taxes have not been provided on the cumulative undistributed earnings of foreign subsidiaries or the cumulative translation adjustment related to those investments since there is currently no need to repatriate funds from certain foreign subsidiaries to the U.S. by way of dividends.

 

(13) Net Capital Requirement

 

ITG Inc., AlterNet and ITG Derivatives are subject to the SEC’s Uniform Net Capital Rule (Rule 15c3-1), which requires the maintenance of minimum net capital.  ITG Inc. has elected to use the alternative method permitted by Rule 15c3-1, which requires that ITG Inc. maintain minimum net capital equal to the greater of $1.0 million or 2% of aggregate debit balances arising from customer transactions, as defined. AlterNet and ITG Derivatives have elected to use the basic method permitted by Rule 15c3-1, which requires that they each maintain minimum net capital equal to the greater of 6 2/3% of aggregate indebtedness or $100,000 and $1.0 million, respectively. Dividends or withdrawals of capital cannot be made if capital is needed to comply with regulatory requirements.

 

Net capital balances and the amounts in excess of required net capital at June 30, 2015 for the U.S. Operations are as follows (dollars in millions):

 

 

 

Net Capital

 

Excess

 

U.S. Operations

 

 

 

 

 

ITG Inc.

 

$

73.1

 

$

72.1

 

AlterNet

 

3.6

 

3.3

 

ITG Derivatives

 

2.0

 

1.0

 

 

As of June 30, 2015, ITG Inc. and ITG Derivatives had $7.3 million and $0.1 million, respectively, of cash in a Special Reserve Bank Account for the benefit of customers under the Customer Protection Rule pursuant to SEC Rule 15c3-3, Computation for Determination of Reserve Requirements and $1.4 million under PABs.

 

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In addition, the Company’s Canadian, European and Asia Pacific Operations have subsidiaries with regulatory capital requirements. The regulatory net capital balances and amount of regulatory capital in excess of the minimum requirements applicable to each business at June 30, 2015, is summarized in the following table (dollars in millions):

 

 

 

Net Capital

 

Excess

 

Canadian Operations

 

 

 

 

 

Canada

 

$

28.6

 

$

28.2

 

European Operations

 

 

 

 

 

Ireland

 

68.5

 

18.2

 

U.K.

 

3.5

 

2.7

 

Asia Pacific Operations

 

 

 

 

 

Australia

 

14.6

 

6.0

 

Hong Kong

 

30.1

 

13.4

 

Singapore

 

0.5

 

0.3

 

 

As of June 30, 2015, Canadian Operations, European Operations and Asia Pacific Operations had restricted cash with banks of $0.4 million, $25.9 million and $0.4 million, respectively.

 

(14) Segment Reporting

 

The Company is organized into four geographic operating segments through which the Company’s chief operating decision maker manages the Company’s business. The U.S., Canadian, European and Asia Pacific Operations segments provide the following categories of products and services:

 

·                  Electronic Brokerage — includes self-directed trading using algorithms, smart routing and matching through POSIT in cash equities (including single stocks and portfolio lists), futures and options

 

·                  Research, Sales and Trading — includes (a) differentiated, unbiased, data-driven equity research through the use of innovative data mining and analysis, as well as detailed analysis of energy plays, and (b) portfolio trading and high-touch trading desks providing execution expertise and trading ideas based on investment research

 

·                  Platforms — includes trade order and execution management software applications in addition to network connectivity

 

·                  Analytics — includes tools enabling portfolio managers and traders to improve pre-trade and real-time execution performance, portfolio construction and optimization decisions and securities valuation.

 

The accounting policies of the reportable segments are the same as those described in Note 2, Summary of Significant Accounting Policies, in our Annual Report on Form 10-K for the year ended December 31, 2014 except for the change reported in Note 1, Organization and Basis of Presentation, and described below. The Company allocates resources to, and evaluates the performance of, its reportable segments based on income or loss before income tax expense. Consistent with the Company’s resource allocation and operating performance evaluation approach, the effects of inter-segment activities are eliminated except in limited circumstances where certain technology related costs are allocated to a segment to support that segment’s revenue producing activities. Commissions and fees revenue for trade executions and commission share revenues are principally attributed to each segment based upon the location of execution of the related transaction except that commissions and fees for trade executions by Canadian clients in the U.S. market are attributed to the Canadian Operations instead of the U.S. Operations. Recurring revenues are principally attributed based upon the location of the client using the respective service.

 

Effective in the first quarter of 2015, the Company is presenting its regional segment results excluding corporate activity. For this purpose, corporate activity includes investment income from all treasury activity as well as costs not associated with operating the businesses within the Company’s regional segments. These costs include, among others, (a) the costs of being a public company, such as certain staff costs, a portion of external audit fees, and reporting, filing and listing costs, (b) intangible asset amortization, (c) interest expense, (d) professional fees associated with our global transfer pricing structure, (e) foreign exchange gains or losses and (f) certain non-operating expenses. Prior to this change in segment measure, corporate activity was included in the region where the income/expense was earned/incurred, which primarily was in the U.S. Operations segment. Prior period segment data has been restated to conform to the 2015 presentation.  Identifiable assets all relate to an operating segment and are not separately identified as corporate activity.

 

A summary of the segment financial information is as follows (dollars in thousands):

 

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U.S.
Operations

 

Canadian
Operations

 

European
Operations

 

Asia Pacific
Operations

 

Corporate

 

Consolidated Total

 

Three Months Ended June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

75,474

 

$

16,705

 

$

33,574

 

$

14,512

 

$

229

 

$

140,494

 

Income (loss) before income tax expense (benefit) (1)

 

5,735

 

3,615

 

7,763

 

1,602

 

(27,664

)

(8,949

)

Identifiable assets

 

1,209,355

 

96,370

 

286,607

 

86,163

 

 

1,678,495

 

Three Months Ended June 30, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

77,266

 

$

17,794

 

$

31,064

 

$

12,063

 

$

279

 

$

138,466

 

Income (loss) before income tax expense (benefit)

 

9,861

 

4,060

 

8,789

 

(314

)

(5,708

)

16,688

 

Identifiable assets

 

984,027

 

106,834

 

317,532

 

61,945

 

 

1,470,338

 

Six Months Ended June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

155,928

 

$

35,617

 

$

70,180

 

$

28,034

 

$

462

 

$

290,221

 

Income (loss) before income tax expense (benefit) (1)

 

16,791

 

7,369

 

18,893

 

2,709

 

(32,371

)

13,391

 

Six Months Ended June 30, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

152,873

 

$

37,012

 

$

63,854

 

$

21,760

 

$

576

 

$

276,075

 

Income (loss) before income tax expense (benefit)

 

20,117

 

8,570

 

19,613

 

(2,132

)

(11,060

)

35,108

 

 


(1)         In the second quarter of 2015, the Company reserved $20.3 million for a probable settlement with the SEC.  In addition, the Company incurred related legal and related costs of $2.3 million.

 

The table below details the total revenues for the categories of products and services provided by the Company (dollars in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2015

 

2014

 

2015

 

2014

 

Revenues by Product Group:

 

 

 

 

 

 

 

 

 

Electronic Brokerage

 

$

75,048

 

$

73,192

 

$

155,502

 

$

146,076

 

Research, Sales and Trading

 

30,379

 

30,311

 

62,892

 

59,556

 

Platforms

 

23,550

 

23,333

 

48,623

 

47,066

 

Analytics

 

11,288

 

11,351

 

22,742

 

22,801

 

Corporate

 

229

 

279

 

462

 

576

 

Total Revenues

 

$

140,494

 

$

138,466

 

$

290,221

 

$

276,075

 

 

(15)                          Dividend Program

 

In April 2015, the Company’s Board of Directors initiated a dividend program under which the Company intends to pay quarterly dividends, subject to quarterly declarations by the Board of Directors. During the second quarter of 2015, the Board of Directors declared and the Company paid a quarterly dividend of $0.07 per share totaling $2.4 million. In August 2015, the Board of Directors declared its second quarterly dividend of $0.07 per share payable on September 10, 2015 to stockholders of record on August 21, 2015.

 

(16)                          Off-Balance Sheet Risk and Concentration of Credit Risk

 

The Company is a member of various U.S. and non-U.S. exchanges and clearing houses that trade and clear, respectively, equities and/or derivative contracts.  Associated with the Company’s membership, the Company may be required to pay a proportionate share of financial obligations of another member who may default on its obligations to the exchanges or the clearing house.  While the rules governing different exchange or clearing house memberships vary, in general, the Company’s obligations would arise only if the exchanges and clearing houses had previously exhausted other remedies. The maximum potential payout under

 

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these memberships cannot be estimated. The Company has not recorded any contingent liability in the condensed consolidated financial statements for these agreements and believes that any potential requirement to make payments under these agreements is remote. In the ordinary course of business, the Company guarantees obligations of subsidiaries which may arise from third-party clearing relationships and trading counterparties. The activities of the subsidiaries covered by these guarantees are included in the Company’s condensed consolidated financial statements.

 

The Company’s customer financing and securities settlement activities may require the Company to pledge customer securities as collateral in support of various secured financing transactions such as bank loans. In the event the counterparty is unable to meet its contractual obligation to return customer securities pledged as collateral, the Company may be exposed to the risk of acquiring the securities at prevailing market prices in order to satisfy its customer obligations. The Company controls this risk by monitoring the market value of securities pledged on a daily basis and by requiring adjustments of collateral levels in the event of excess market exposure.

 

Financial instruments that potentially subject the Company to concentrations of credit risk are primarily cash and cash equivalents, securities owned at fair value, receivables from brokers, dealers and clearing organizations and receivables from customers. Cash and cash equivalents and securities owned, at fair value are deposited with high credit quality financial institutions.

 

The Company loans securities temporarily to other brokers in connection with its securities lending activities. The Company receives cash as collateral for the securities loaned. Increases in security prices may cause the market value of the securities loaned to exceed the amount of cash received as collateral. In the event the counterparty to these transactions does not return the loaned securities, the Company may be exposed to the risk of acquiring the securities at prevailing market prices in order to satisfy its obligations. The Company controls this risk by requiring credit approvals for counterparties, by monitoring the market value of securities loaned on a daily basis, and by requiring additional cash as collateral or returning collateral when necessary.

 

The Company borrows securities temporarily from other brokers in connection with its securities borrowing activities. The Company deposits cash as collateral for the securities borrowed. Decreases in security prices may cause the market value of the securities borrowed to fall below the amount of cash deposited as collateral. In the event the counterparty to these transactions does not return collateral, the Company may be exposed to the risk of selling the securities at prevailing market prices. The Company controls this risk by requiring credit approvals for counterparties, by monitoring the collateral values on a daily basis, and by depositing additional collateral with counterparties or receiving cash when deemed necessary.

 

The Company may at times maintain inventories in equity securities on both a long and short basis. Whereas long inventory positions represent the Company’s ownership of securities, short inventory positions represent obligations of the Company to deliver specified securities at a contracted price, which may differ from market prices prevailing at the time of completion of the transaction. Accordingly, both long and short inventory positions may result in losses or gains to the Company as market values of securities fluctuate. To mitigate the risk of losses, long and short positions are marked to market daily and are continuously monitored by the Company.

 

(17)  Contingencies — Legal Matters

 

The Company is not a party to any pending legal proceedings other than claims and lawsuits arising in the ordinary course of business, although a putative class action lawsuit has been filed with respect to the Company and certain of its executives in connection with the Company’s announcement of the SEC matter described in the following paragraph, and other related actions could be filed. As previously disclosed, the Company’s broker-dealer subsidiaries are involved in ongoing investigations and other proceedings by government agencies and self-regulatory organizations regarding its business. Such claims, lawsuits, investigations and other proceedings may result in judgments, settlements, fines, penalties, injunctions or other relief.

 

During the second quarter of 2015, the Company commenced settlement discussions with the Staff of the Division of Enforcement of the SEC (the “SEC Enforcement Division”) in connection with the SEC’s investigation into a proprietary trading pilot operated within AlterNet for sixteen months in 2010 through mid-2011. The investigation is focused on customer disclosures, Form ATS regulatory filings and customer information controls relating to the pilot’s trading activity, which included (a) crossing against sell-side clients in POSIT and (b) violations of Company policy and procedures by a former employee.  These violations principally involved information breaches for a period of several months in 2010 regarding sell-side parent orders flowing into ITG’s algorithms and executions by all customers in non-POSIT markets that were not otherwise available to ITG clients.  The Company has negotiated a potential settlement with the Staff of the SEC Enforcement Division.  Based on the terms of the potential settlement, the Company would pay an aggregate amount of $20.3 million representing a civil penalty of $18 million, disgorgement of approximately $2.1 million in trading revenues and prejudgment interest of approximately $250,000.  As a result, the Company reserved $20.3 million for a probable settlement with the SEC and incurred $2.3 million in legal and other related costs associated with this matter during the second quarter of 2015.

 

Final resolution of this matter is subject to preparation and negotiation of documentation satisfactory to all the parties and authorization by the SEC. The Company can provide no assurances that

 

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a satisfactory final agreement will be reached and that authorization by the SEC will be obtained or with respect to the timing or definitive terms of any such agreement or approvals.

 

In addition, if the Company does not reach final settlement on the SEC’s AlterNet investigation on the expected terms or if the necessary approvals do not occur, the Company may either enter into further discussions with the SEC to resolve such matter on different terms and conditions or the Company may litigate the matter. The Company cannot predict the timing of any such further discussions or the terms of such alternative settlement. If the Company does not reach a settlement with the SEC, or if the necessary approvals do not occur, the Company cannot predict the outcome of any subsequent litigation with the SEC, but such litigation could have a material adverse effect on the Company’s consolidated financial position or on the results of operations for any particular period.

 

Until this matter is fully resolved, the Company expects to continue to incur costs, primarily professional fees and expenses, which may be significant.

 

The Company is unable to provide a reasonable estimate of any potential liability for any other ongoing investigations, lawsuits or other proceedings given the stage of such proceedings. However, the Company believes, based on information currently available, that the outcome of such proceedings, individually or in the aggregate, will not likely have a material adverse effect on its consolidated financial position. In light of the inherent uncertainties of such proceedings, an adverse outcome of such proceedings may have a material impact on the results of operations for any particular period.

 

(18) Subsequent Event

 

On August 3, 2015, the Company announced the departure of its President and Chief Executive Officer Robert C. Gasser, effective immediately. R. Jarrett Lilien, a member of the Company’s board, will serve as the interim President and Chief Executive Officer until a permanent President and Chief Executive Officer is identified and appointed.

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements, including the notes thereto.

 

Overview

 

ITG is an independent execution broker and research provider that partners with global portfolio managers and traders to provide unique data-driven insights throughout the investment process. From investment decision through settlement, ITG helps clients understand market trends, improve performance, mitigate risk and navigate increasingly complex markets. A leader in electronic trading since launching the POSIT crossing network in 1987, ITG takes a consultative approach in delivering the highest quality institutional liquidity, execution services, analytical tools and proprietary research. ITG is headquartered in New York with offices in North America, Europe and the Asia Pacific region.

 

Our business is organized into four reportable operating segments: U.S. Operations, Canadian Operations, European Operations and Asia Pacific Operations (see Note 14, Segment Reporting, to the condensed consolidated financial statements). Our four operating segments provide the following categories of products and services:

 

·                  Electronic Brokerage — includes self-directed trading using algorithms, smart routing and matching through POSIT in cash equities (including single stocks and portfolio lists), futures and options

 

·                  Research, Sales and Trading — includes (a) differentiated, unbiased, data-driven equity research through the use of innovative data mining and analysis, as well as detailed analysis of energy plays, and (b) portfolio trading and high-touch trading desks providing execution expertise and trading ideas based on investment research

 

·                  Platforms — includes trade order and execution management software applications in addition to network connectivity

 

·                  Analytics — includes tools enabling portfolio managers and traders to improve pre-trade and real-time execution performance, portfolio construction and optimization decisions and securities valuation

 

Effective in the first quarter of 2015, our regional segment results are presented excluding the impact of corporate activity. For this purpose, corporate activity includes investment income from all treasury activity as well as costs not associated with operating the businesses within our regional segments. These costs include, among others, (a) the costs of being a public company, such as certain staff costs, a portion of external audit fees, and reporting, filing and listing costs, (b) intangible asset amortization, (c) interest expense, (d) professional fees associated with our global transfer pricing structure,  (e) foreign exchange gains or losses and (f) certain non-operating expenses. Prior to this change in segment measure, corporate activity was included in the region where the income/expense was earned/incurred, which primarily was in the U.S. Operations. Prior period segment data has been restated to conform to the 2015 presentation.

 

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Sources of Revenues

 

Revenues from our products and services are generated from commissions and fees, recurring (subscriptions) and other sources.

 

Commissions and fees are derived primarily from (i) commissions charged for trade execution services, (ii) income generated on net executions, whereby equity orders are filled at different prices within or at the National Best Bid and Offer (“NBBO”) and (iii) commission sharing arrangements between ITG Net (our private value-added FIX-based financial electronic communications network) and third-party brokers and alternative trading systems whose trading products are made available to our clients on our order management system (“OMS”) and execution management system (“EMS”) applications in addition to commission sharing arrangements for our ITG Single Ticket Clearing Service and our RFQ-hub request-for-quote service. Because commissions are earned on a per-transaction basis, such revenues fluctuate from period to period depending on (a) the volume of securities traded through our services in the U.S. and Canada, (b) the contract value of securities traded in Europe and the Asia Pacific region and (c) our commission rates. Certain factors that affect our volumes and contract values traded include: (i) macro trends in the global equities markets that affect overall institutional equity trading activity, (ii) competitive pressure, including pricing, created by a proliferation of electronic execution competitors and (iii) potential changes in market structure in the U.S. and other regions. In addition to share volume, revenues from net executions are also impacted by the width of spreads within the NBBO. Trade orders are delivered to us from our OMS and EMS products and other vendors’ products, direct computer-to-computer links to customers through ITG Net and third-party networks and phone orders from our customers.

 

Recurring revenues are derived from the following primary sources: (i) connectivity fees generated through ITG Net for the ability of the sell-side to receive orders from, and send indications of interest to, the buy-side and for the sell-side to receive requests-for-quotes through RFQ-hub, (ii) subscription revenue generated from providing research, (iii) software and analytical products and services and (iv) maintenance and customer technical support for our OMS.

 

Other revenues include: (i) income from principal trading in Canada, including arbitrage trading, (ii) the net spread on foreign exchange transactions executed on a principal basis to facilitate equity trades by clients in different currencies as well as on other foreign exchange transactions unrelated to equity trades, (iii) the net interest spread earned on securities borrowed and loaned matched book transactions, (iv) transaction advisory services provided to potential purchasers of energy-related investments, (v) non-recurring consulting services, such as one-time implementation and customer training related activities, (vi) investment and interest income, (vii) interest income on securities borrowed in connection with customers’ settlement activities and (viii) market gains/losses resulting from temporary positions in securities assumed in the normal course of our agency trading business (including errors and accommodations).

 

Expenses

 

Compensation and employee benefits, our largest expense, consists of salaries and wages, incentive compensation, employee benefits and taxes. Incentive compensation fluctuates based on revenues, profitability and other measures, taking into account the landscape for key talent. Incentive compensation includes a combination of cash and deferred share-based awards.  Only the cash portion, which represents a lesser portion of our total compensation costs, is expensed in the current period. As a result, our ratio of compensation expense to revenues may fluctuate from period-to-period based on revenue levels.

 

Transaction processing expense consists of costs to access various third-party execution destinations and to process, clear and settle transactions. These costs tend to fluctuate with share and trade volumes, the mix of trade execution services used by clients and the rates charged by third parties.

 

Occupancy and equipment expense consists primarily of rent and utilities related to leased premises, office equipment and depreciation and amortization of fixed assets and leasehold improvements.

 

Telecommunications and data processing expenses primarily consist of costs for obtaining market data, telecommunications services and systems maintenance.

 

Other general and administrative expenses primarily include software amortization, consulting, business development, professional fees and intangible asset amortization.

 

Interest expense consists primarily of costs associated with outstanding debt and credit facilities.

 

Non-GAAP Financial Measures

 

To supplement our financial information presented in accordance with U.S. GAAP, management uses certain “non-GAAP financial measures” as such term is defined in SEC Regulation G, to clarify and enhance understanding of past performance and prospects for the future. Generally, a non-GAAP financial measure is a numerical measure of a company’s operating performance,

 

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financial position or cash flows that excludes or includes amounts that are included in, or excluded from, the most directly comparable measure calculated and presented in accordance with U.S. GAAP. For example, non-GAAP measures may exclude the impact of certain unique and/or non-operating items such as acquisitions, divestitures, restructuring charges, large write-offs or items outside of management’s control. Management believes that the following non-GAAP financial measures described below provide investors and analysts useful insight into our financial position and operating performance.

 

Adjusted expenses and adjusted net income together with related per share amounts are non-GAAP performance measures that we believe are useful to assist investors in gaining an understanding of the trends and operating results for our core business. These measures should be viewed in addition to, and not in lieu of, results reported under U.S. GAAP.

 

Reconciliations of adjusted expenses and adjusted net income to expenses and net income and related per share amounts as determined in accordance with U.S. GAAP for the three months and six months ended June 30, 2015 are provided below (dollars in thousands except per share amounts).

 

 

 

Three Months
Ended
June 30, 2015

 

Six Months
Ended
June 30, 2015

 

Total revenues

 

$

140,494

 

$

290,221

 

 

 

 

 

 

 

Total expenses

 

149,443

 

276,830

 

Less:

 

 

 

 

 

Reserve for SEC settlement and related costs (1)

 

(22,647

)

(22,647

)

Adjusted expenses

 

126,796

 

254,183

 

 

 

 

 

 

 

(Loss) income before income tax expense

 

(8,949

)

13,391

 

Effect of adjustments

 

22,647

 

22,647

 

Adjusted pre-tax income

 

13,698

 

36,038

 

 

 

 

 

 

 

Income tax expense

 

1,261

 

6,868

 

Tax effect of adjustments (1)

 

1,077

 

1,077

 

Adjusted income tax expense

 

2,338

 

7,945

 

 

 

 

 

 

 

Net (loss) income

 

(10,210

)

6,523

 

Net effect of adjustments

 

21,570

 

21,570

 

Adjusted net income

 

$

11,360

 

$

28,093

 

 

 

 

 

 

 

Diluted (loss) earnings per share

 

$

(0.30

)

$

0.19

 

Net effect of adjustments

 

0.62

 

0.61

 

Adjusted diluted earnings per share

 

$

0.32

 

$

0.80

 

 


(1)         In the second quarter of 2015, we reserved $20.3 million for a probable settlement with the SEC.  In addition, we incurred related legal and related costs of $2.3 million.  An offsetting tax benefit of $1.1 million was recorded primarily on the legal and other related costs.

 

Executive Summary for the Quarter Ended June 30, 2015

 

Consolidated Overview

 

While we started the year with strong momentum in the first quarter, we saw sequential declines in market-wide trading in all of our operating regions except Asia Pacific due to lower volatility primarily from the realization that interest rate increases in the U.S. would not commence until September 2015 at the earliest. Revenues of $140.5 million in the second quarter of 2015 did improve over the $138.5 million in the second quarter of 2014, with Asia Pacific posting its second consecutive quarterly record. Offsetting the revenue growth was the impact of a shift in the U.S. and Europe toward a higher proportion of trading from sell-side clients, which negatively impacted margins.

 

On a U.S. GAAP basis, we incurred a net loss of $10.2 million, or $0.30 per diluted share. Our U.S. GAAP net loss for the second quarter of 2015 included a reserve for a probable settlement with the SEC and related legal and other fees totaling $22.6 million pre-tax and $21.6 million after taxes, or $0.62 per diluted share. The probable SEC settlement relates to customer disclosures,

 

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Form ATS regulatory findings and customer information controls relating to a proprietary trading pilot operated by AlterNet in 2010 through mid-2011, which included (a) crossing against sell-side clients in POSIT and (b) violations of Company policy and procedures by a former employee. Over the past four years, we have enhanced our client disclosure policies and strengthened our information controls.

 

Adjusted net income (see Non-GAAP Financial Measures) for the second quarter of 2015 fell to $11.4 million, or $0.32 per diluted share from $12.9 million, or $0.35 per diluted share for the second quarter of 2014.  Adjusted expenses (see Non-GAAP Financial Measures) of $126.8 million increased 4% over the second quarter of 2014 largely driven by increased transaction processing costs associated with higher sell-side trading levels.

 

Segment Discussions

 

Regional segment results exclude the impact of corporate activity.  Corporate activity reduced second quarter net income by $24.5 million on a U.S. GAAP basis and $3.0 million on an adjusted basis excluding the reserve for a probable settlement with the SEC and related legal and other fees totaling $21.6 million after taxes.

 

Our U.S. average daily volume was 183 million shares, up 23% compared to the second quarter of 2014.  This compares favorably to U.S. consolidated market volume, which was 5% higher than a year ago.  However, the favorable impact of higher volumes was largely offset by a significant business mix shift to lower-rate sell-side trading volume, which increased to 59% of overall volume, compared to 49% in the second quarter of 2014. While this sell-side flow helped increase volumes in POSIT, which had average daily volume of 93 million shares in the second quarter versus 67 million shares in the second quarter of 2014, it also diluted our overall revenue capture rate per share down to $0.0042 compared to $0.0050 in the second quarter of 2014.

 

In Canada, our business performed well in a difficult market environment. While our commissions and fees were down 6% in U.S. dollar terms versus the second quarter of 2014, they were up 12% in local currency terms, ahead of the 7% growth in volumes market-wide. Our dark pool, MATCH Now, hit new record volumes, growing more than 50% over the second quarter of 2014.

 

In Europe, market-wide value traded increased 25% over the second quarter of 2014 due to increased volatility, based in part on the latest financial crisis in Greece, and higher equity valuations.  During the quarter, our commissions and fees grew 5% in U.S. Dollar terms and 15% in local currency terms compared to the second quarter of 2014.  While higher volatility contributed to higher trading market-wide, it also caused global asset managers, who represent our core client base, to limit their exposure to these markets, particularly from mid-May onwards. This resulted in a higher concentration of sell-side business, which tends to rise along with volatility, resulting in the dilution of our average commission rate and pre tax margin.

 

In the Asia-Pacific region, higher market-wide value traded was seen across all key markets in the region, particularly in Hong Kong, due in part to the impact of increased volatility in China. We achieved our second consecutive quarterly record of revenues and profitability in the region, and our pre-tax earnings of $1.6 million was our fourth consecutive quarter of profitability. Asia Pacific commissions and fees increased 25% over the prior-year quarter, driven by strong order flow by local and U.S. clients trading into the Hong Kong, Japan and Australian markets with POSIT Alert continuing to be a key source of growth in the region.

 

Capital Resource Allocation

 

During the second quarter of 2015, we repurchased 280,000 shares for $8.1 million and declared and paid our first ever cash dividend of $2.4 million. Towards the end of the first quarter, we announced a change in our targeted capital returns to stockholders for 2015, providing guidance that we would base our target on free cash flow instead of net income.  For this purpose, we are calculating free cash flow as net income as determined under U.S. GAAP increased by non-cash stock-based compensation charges, depreciation and amortization, and reduced by capital expenditures and capitalized software. On a year-to-date basis, our total return of capital to stockholders (including both share repurchases and dividends) totaled $26.9 million, $5.6 million more than our free cash flow. We may elect to conduct future share repurchases through open market purchases, private transactions or automatic share repurchase programs under SEC Rule 10b5-1.

 

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Table of Contents

 

Results of Operations — Three Months Ended June 30, 2015 Compared to Three Months Ended June 30, 2014

 

U.S. Operations

 

 

 

Three Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2015

 

2014

 

Change

 

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

54,829

 

$

54,294

 

$

535

 

1

 

Recurring

 

19,470

 

17,882

 

1,588

 

9

 

Other

 

1,175

 

5,090

 

(3,915

)

(77

)

Total revenues

 

75,474

 

77,266

 

(1,792

)

(2

)

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

32,907

 

32,624

 

283

 

1

 

Transaction processing

 

11,811

 

9,231

 

2,580

 

28

 

Other expenses

 

25,021

 

25,550

 

(529

)

(2

)

Interest expense

 

 

 

 

 

Total expenses

 

69,739

 

67,405

 

2,334

 

3

 

Income before income tax expense

 

$

5,735

 

$

9,861

 

$

(4,126

)

(42

)

 

Commissions and fees were relatively unchanged from the three months ended June 30, 2014 despite a 23% increase in our average daily trading volumes due to a decline in our average revenue per share and a reduction in commissions on equity derivatives. The growth in average daily volumes was entirely from an increase in executions from our lower-priced sell-side clients whose proportion of average daily volumes increased to 59% from 49% in the second quarter 2014. This change in mix, together with a reduction in the average revenue per share earned from sell-side clients, drove the reduction in our average revenue per share as buy-side client activity remained unchanged in both average daily volume and rates.

 

 

 

Three Months Ended June 30,

 

 

 

 

 

U.S. Operations: Key Indicators*

 

2015

 

2014

 

Change

 

% Change

 

Total trading volume (in billions of shares)

 

11.5

 

9.4

 

2.1

 

22

 

Trading volume per day (in millions of shares)

 

182.6

 

149.0

 

33.6

 

23

 

Average revenue per share

 

$

0.0042

 

$

0.0050

 

$

(0.0008

)

(16

)

U.S. market trading days

 

63

 

63

 

 

 

 


* Excludes activity from ITG Net commission share arrangements.

 

Recurring revenues increased due to higher research and analytical product subscriptions in addition to higher connectivity fees.  Connectivity fees increased primarily from an increase in revenue from global connections previously recorded in our Canadian, European and Asia Pacific operating segments as a result of a change in our attribution method, offset by connections lost due to the impact of client attrition from our OMS product. Research subscriptions increased from higher subscription revenues from new accounts subscribing to our investment research products and an increase in market research subscriptions which included a shift in the recognition of corporate subscriptions revenue in energy research to the U.S. Operations segment from the Canadian Operations segment.

 

Other revenues decreased 77% primarily due to declines in revenues generated from our transaction advisory services provided by our energy research team and stock loan matched book transactions.

 

Compensation and employee benefits increased only 1% as increases in salary, severance and deferred stock-based compensation were offset by a reduction in incentive-based compensation in the second quarter due to lower quarterly sequential profits in the segment and a reduction for the executive management team based on the lower overall global profitability.

 

Transaction processing costs increased 28% due primarily to an increase in volume traded, an increase in the proportion of trading by clients where liquidity was taken (which typically costs more than transactions in which clients are providing liquidity on an execution venue), more settlement tickets processed and higher costs from outsourcing the clearing of select accounts to a third party.  These costs increased as a percentage of commissions and fees to 22% from 17% in the second quarter of 2014 due in large part to the impact of our lower average revenue per share.

 

Other expenses decreased slightly due to lower software amortization from assets being fully amortized and a higher credit for research and development costs charged to other operating segments as more of those resources have been centralized in the U.S.

 

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Canadian Operations

 

 

 

Three Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2015

 

2014

 

Change

 

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

13,401

 

$

13,540

 

$

(139

)

(1

)

Recurring

 

1,534

 

2,420

 

(886

)

(37

)

Other

 

1,770

 

1,834

 

(64

)

(3

)

Total revenues

 

16,705

 

17,794

 

(1,089

)

(6

)

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

4,650

 

4,781

 

(131

)

(3

)

Transaction processing

 

2,292

 

2,061

 

231

 

11

 

Other expenses

 

6,148

 

6,892

 

(744

)

(11

)

Total expenses

 

13,090

 

13,734

 

(644

)

(5

)

Income before income tax expense

 

$

3,615

 

$

4,060

 

$

(445

)

(11

)

 

Currency translation from a weaker Canadian Dollar decreased total Canadian revenues and expenses by $2.0 million and $1.5 million, respectively, resulting in a decrease of $0.5 million to pre-tax income.

 

Canadian commissions and fees decreased only $0.1 million despite an unfavorable currency translation of $1.6 million as volumes increased in our electronic brokerage offering through the increased usage of our algorithms and MATCH Now.

 

Recurring revenues decreased primarily from lower revenue from global connections due to a change in our attribution method and from a shift in the recognition of energy research subscription revenue from corporations to the U.S. Operations segment.

 

Compensation and employee benefits costs declined primarily from the impact from currency translation.

 

Despite a small decrease in commissions and fees, transaction processing costs increased due to higher clearing and settlement charges from an increase in settlement tickets processed.

 

Other expenses were down due to lower consulting fees and research distribution fees paid to the U.S. Operations, as well as the impact of currency translation.

 

European Operations

 

 

 

Three Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2015

 

2014

 

Change

 

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

29,444

 

$

28,092

 

$

1,352

 

5

 

Recurring

 

3,968

 

3,131

 

837

 

27

 

Other

 

162

 

(159

)

321

 

202

 

Total revenues

 

33,574

 

31,064

 

2,510

 

8

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

9,810

 

8,683

 

1,127

 

13

 

Transaction processing

 

7,855

 

6,098

 

1,757

 

29

 

Other expenses

 

8,146

 

7,494

 

652

 

9

 

Total expenses

 

25,811

 

22,275

 

3,536

 

16

 

Income before income tax expense

 

$

7,763

 

$

8,789

 

$

(1,026

)

(12

)

 

Currency translation from a weaker British Pound during the quarter decreased European revenues and expenses by $3.4 million and $2.3 million, respectively, reducing pre-tax income by $1.1 million.

 

European results include the results of RFQ-hub operations since the July 30, 2014 acquisition date, adding $1.1 million in revenues, mostly recurring, and $1.4 million in expenses, primarily in compensation and employee benefits.

 

Our European commissions and fees grew by 5% despite an unfavorable currency translation of $2.9 million.  The growth was driven primarily by an increase in sell-side clients trading in POSIT and an increase in institutional clients using our trading algorithms.

 

Recurring revenues increased primarily from the new RFQ-hub revenue noted above.

 

Compensation and employee benefits increased due to the impact of the RFQ-hub acquisition and investments in our sales team.  We also had higher deferred stock-based compensation associated with awards granted for the 2014 and 2013 fiscal years.

 

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Transaction processing costs increased as a result of an increase in the average daily notional value traded.  As a percentage of commissions and fees, transaction processing costs increased to 27% from 22% in the second quarter of 2014 due to the impact of a higher proportion of value traded by lower-rate sell-side clients and by an increase in the amount of trading in more expensive markets such as Spain and Italy.

 

Other expenses increased $0.7 million due to higher charges for global research and development costs, higher business development and increased connectivity costs, as well as the incremental costs from RFQ-hub.

 

Asia Pacific Operations

 

 

 

Three Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2015

 

2014

 

Change

 

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

13,186

 

$

10,527

 

$

2,659

 

25

 

Recurring

 

1,475

 

1,542

 

(67

)

(4

)

Other

 

(149

)

(6

)

(143

)

(2,383

)

Total revenues

 

14,512

 

12,063

 

2,449

 

20

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

5,128

 

5,242

 

(114

)

(2

)

Transaction processing

 

3,229

 

2,719

 

510

 

19

 

Other expenses

 

4,553

 

4,416

 

137

 

3

 

Total expenses

 

12,910

 

12,377

 

533

 

4

 

Income (loss) before income tax expense (benefit)

 

$

1,602

 

$

(314

)

$

1,916

 

610

 

 

Currency translation from a weaker Australian Dollar decreased total Asia Pacific revenues and expenses by $1.3 million and $0.8 million, respectively, resulting in a decrease of $0.5 million to pre-tax income.

 

Asia Pacific commissions and fees increased 25% over the prior-year period primarily due to strong order flow by U.S. clients and local Asian clients trading into Hong Kong, Japan and Australia and the increased use of our trading algorithms and our POSIT Alert block crossing system, as well as higher commission sharing revenues from trades executed on our Triton EMS.

 

Recurring revenues declined by 4% primarily from lower revenue earned for global connections due to a change in our attribution method.   Other revenues decreased due to higher client accommodations and errors.

 

Compensation and employee benefits decreased slightly due to a reduction in salaries from lower headcount and lower retirement-related costs, offset in part by higher incentive-based compensation related to improved performance.

 

Transaction processing costs increased due to an increase in the average daily notional value traded. However, transaction costs declined as a percentage of commissions and fees to 24% from 26% in 2014 due primarily to a higher proportion of our trading in markets where our costs are lower, such as Hong Kong.

 

Other expenses increased due to higher charges for global research and development costs and higher software amortization, largely offset by a decrease from lower software maintenance costs, software license fees, and depreciation of certain assets.

 

Corporate

 

Corporate activity includes investment income from all treasury activity as well as costs not associated with operating the businesses within our regional segments.  These costs include, among others, (a) the costs of being a public company, such as certain staff costs, a portion of external audit fees, and reporting, filing and listing costs, (b) intangible asset amortization, (c) interest expense, (d) professional fees associated with our global transfer pricing structure, (e) foreign exchange gains or losses and (f) certain non-operating expenses.

 

For the second quarter of 2015, we reported a pre-tax loss from Corporate activity of $27.7 million, reflecting $0.2 million of investment income and $27.9 million of costs. The costs include a reserve in the U.S. for a probable settlement with the SEC for $20.3 million and related legal and other fees of $2.3 million.  We expect to continue to incur additional costs, primarily legal fees and expenses, which may be significant, until this matter is resolved.  For the second quarter of 2014, we incurred a pre-tax loss from Corporate activity of $5.7 million, reflecting investment income of $0.3 million and costs of $6.0 million.  Excluding the reserve and

 

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Table of Contents

 

related costs, expenses declined compared to the prior-year period from lower intangible asset amortization due to the full amortization of certain assets.

 

Consolidated income tax expense

 

In the second quarter of 2015, we reported a tax expense of $1.3 million despite reporting a pre-tax loss of $8.9 million largely due to the non-deductibility of substantially all of the $20.3 million reserve for the SEC matter. Excluding the reserve and related costs from our results (see Non-GAAP Financial Measures above), the effective tax rate on our pre-tax income would have been lower than the second quarter of 2014 due in part to a favorable resolution of a U.S. state tax contingency in the second quarter of 2015. In addition, a high portion of our consolidated pre-tax income was earned in Europe, which is currently taxed at a lower rate.  Our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings.

 

Results of Operations — Six Months Ended June 30, 2015 Compared to Six Months Ended June 30, 2014

 

U.S. Operations

 

 

 

Six Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2015

 

2014

 

Change

 

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

113,284

 

$

108,823

 

$

4,461

 

4

 

Recurring

 

39,458

 

36,334

 

3,124

 

9

 

Other

 

3,186

 

7,716

 

(4,530

)

(59

)

Total revenues

 

155,928

 

152,873

 

3,055

 

2

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

66,675

 

63,793

 

2,882

 

5

 

Transaction processing

 

23,277

 

18,171

 

5,106

 

28

 

Other expenses

 

49,185

 

50,792

 

(1,607

)

(3

)

Total expenses

 

139,137

 

132,756

 

6,381

 

5

 

Income before income tax expense

 

$

16,791

 

$

20,117

 

$

(3,326

)

(17

)

 

Commissions and fees increased 4% on a 20% increase in our average daily trading volumes that was partially offset by a 12% decrease in our average revenue per share to $0.0043 and a reduction in commissions on equity derivatives.  The average revenue per share decrease was largely attributable to an increase in the proportion of volumes executed by our lower-priced sell-side clients, which increased to 57% of total average daily volume from 50% for the first half of 2014, as well as a 20% decrease in the average rate per share from sell-side clients. The average revenue per share from buy-side clients grew 3% compared to the first half of 2014.

 

 

 

Six Months Ended June 30,

 

 

 

 

 

U.S. Operations: Key Indicators*

 

2015

 

2014

 

Change

 

% Change

 

Total trading volume (in billions of shares)

 

23.2

 

19.4

 

3.8

 

20

 

Trading volume per day (in millions of shares)

 

186.9

 

156.5

 

37.9

 

20

 

Average revenue per share

 

$

0.0043

 

$

0.0049

 

$

0.0006

 

(12

)

U.S. market trading days

 

124

 

124

 

 

 

 


* Excludes activity from ITG Net commission share arrangements.

 

Recurring revenues increased due to higher research and analytical product subscriptions in addition to higher connectivity fees.  Connectivity fees increased primarily from an increase in revenue from global connections previously recorded in our Canadian, European and Asia Pacific operating segments as a result of a change in our attribution method, offset by connections lost due to the impact of client attrition from our OMS product.  Research subscriptions increased from higher subscription revenues from new accounts subscribing to our investment research products and an increase in market research subscriptions which included a shift in the recognition of corporate subscriptions revenue in energy research to the U.S. Operations segment from the Canadian Operations segment.

 

Other revenues decreased primarily due to declines in transaction advisory services revenues from our energy research team and stock loan matched book transactions.

 

Compensation and employee benefits increased as a result of increases in salaries, severance costs as well as higher deferred stock-based compensation associated with awards granted for the 2014 and 2013 fiscal years.

 

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Table of Contents

 

Transaction processing costs increased 28% due to an increase in volume traded, an increase in the proportion of trading by clients where liquidity was taken (which typically costs more than transactions in which clients are providing liquidity on an execution venue), more settlement tickets processed and higher costs from outsourcing the clearing of select accounts to a third party. These costs increased as a percentage of commissions and fees to 21% from 17% in the first half of 2014 due in large part to the impact of our lower average revenue per share.

 

Other expenses decreased $1.6 million due to a higher credit for research and development costs charged to other segments as more of these resources have been centralized in the U.S., along with lower depreciation and lower software amortization.

 

Canadian Operations

 

 

 

Six Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2015

 

2014

 

Change

 

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

29,040

 

$

28,619

 

$

421

 

1

 

Recurring

 

2,875

 

4,852

 

(1,977

)

(41

)

Other

 

3,702

 

3,541

 

161

 

5

 

Total revenues

 

35,617

 

37,012

 

(1,395

)

(4

)

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

11,640

 

10,487

 

1,153

 

11

 

Transaction processing

 

4,670

 

4,627

 

43

 

1

 

Other expenses

 

11,938

 

13,328

 

(1,390

)

(10

)

Total expenses

 

28,248

 

28,442

 

(194

)

(1

)

Income before income tax expense

 

$

7,369

 

$

8,570

 

$

(1,201

)

(14

)

 

Currency translation from a weaker Canadian Dollar decreased total Canadian revenues and expenses by $4.2 million and $3.0 million, respectively, resulting in a decrease of $1.2 million to pre-tax income.

 

Canadian commissions and fees increased $0.4 million despite an unfavorable currency translation of $3.4 million as volumes increased in our electronic brokerage offering through the increased usage of our algorithms and  MATCH Now.

 

Recurring revenues decreased primarily from lower revenue from global connections due to a change in our attribution method and from a shift in the recognition of energy research subscription revenue from corporations to the U.S. Operations segment.

 

Other revenues increased due to lower client trade accommodations.

 

Compensation and employee benefits costs increased due to an increase in share-based compensation, which fluctuates for legacy awards to Canadian employees based on the changes in the market price of our stock, as well as higher deferred stock-based compensation associated with awards granted for the 2014 and 2013 fiscal years.  This was offset by the impact of currency translation of $1.5 million, reductions in salaries from lower headcount and lower severance costs.

 

Transaction processing grew in line with commissions and fees, as higher charges from an increase in settlement tickets processed offset decreases in execution fees and a favorable impact from currency translation of $0.6 million.

 

Other expenses were down due to lower consulting fees and research distribution fees paid to the U.S. Operations, as well as the impact of currency translation.

 

European Operations

 

 

 

Six Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2015

 

2014

 

Change

 

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

61,986

 

$

57,813

 

$

4,173

 

7

 

Recurring

 

8,106

 

6,304

 

1,802

 

29

 

Other

 

88

 

(263

)

351

 

NA

 

Total revenues

 

70,180

 

63,854

 

6,326

 

10

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

19,878

 

17,151

 

2,727

 

16

 

Transaction processing

 

15,670

 

12,556

 

3,114

 

25

 

Other expenses

 

15,739

 

14,534

 

1,205

 

8

 

Total expenses

 

51,287

 

44,241

 

7,046

 

16

 

Income before income tax expense

 

$

18,893

 

$

19,613

 

$

(720

)

(4

)

 

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Table of Contents

 

Currency translation from a weaker British Pound decreased total European revenues and expenses by $7.2 million and $5.2 million, respectively, resulting in a decrease of $2.0 million to pre-tax income.

 

European results include the results of RFQ-hub operations since the July 30, 2014 acquisition date, adding $2.2 million in revenues, mostly recurring, and $2.3 million in expenses, primarily in compensation and employee benefits.

 

Our European commissions and fees increased 7% despite an unfavorable currency impact of $6.0 million primarily due to an increase in sell-side clients trading in POSIT and an increase in institutional clients using our trading algorithms.

 

Recurring revenues grew $1.8 million of which $1.7 million was from the new RFQ-hub revenue noted above.

 

Compensation and employee benefits increased due to the impact of the RFQ-hub acquisition and investments in our sales team.  We also had higher deferred stock-based compensation associated with awards granted for the 2014 and 2013 fiscal years.

 

Transaction processing costs increased as a result of an increase in the average daily notional value traded.  As a percentage of commissions and fees, transaction processing costs increased to 25% from 22% in the first half of 2014 due to the impact of a higher proportion of value traded by lower-rate sell-side clients and an increase in the amount of trading in more expensive markets such as Spain and Italy.

 

Other expenses increased $1.2 million due to higher charges for global research and development costs, an increase in connectivity costs and the incremental costs from RFQ-hub.

 

Asia Pacific Operations

 

 

 

Six Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2015

 

2014

 

Change

 

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

25,476

 

$

19,622

 

$

5,854

 

30

 

Recurring

 

2,940

 

3,062

 

(122

)

(4

)

Other

 

(382

)

(924

)

542

 

59

 

Total revenues

 

28,034

 

21,760

 

6,274

 

29

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

10,205

 

9,790

 

415

 

4

 

Transaction processing

 

6,143

 

5,251

 

892

 

17

 

Other expenses

 

8,977

 

8,851

 

126

 

1

 

Total expenses

 

25,325

 

23,892

 

1,433

 

6

 

Income (loss) before income tax expense (benefit)

 

$

2,709

 

$

(2,132

)

$

4,841

 

227

 

 

Currency translation from a weaker Australian Dollar decreased total Asia Pacific revenues and expenses by $2.1 million and $1.4 million, respectively, resulting in a decrease of $0.7 million to pre-tax income.

 

Asia Pacific commissions and fees increased from the prior-year period primarily due to strong order flow by U.S. clients and local Asian clients trading into Hong Kong, Australia and Japan, and the increased use of our trading algorithms and our POSIT Alert block crossing system, as well as higher commission sharing revenues from trades executed on our Triton EMS.

 

Recurring revenues decreased primarily from lower revenue from global connections due to a change in our attribution method.  Other revenues improved over the prior-year period due to a decrease in client accommodations and errors.

 

Compensation and employee benefits increased due to higher incentive-based compensation related to improved performance, partially offset by a reduction in salaries from lower headcount and lower retirement-related costs.

 

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Table of Contents

 

Transaction processing costs increased due to an increase in the average daily notional value traded. However, transaction costs declined as a percentage of commissions and fees to 24% from 27% in 2014 primarily due to a higher proportion of our trading in markets where our costs are lower such as Hong Kong and Australia.

 

Other expenses increased due to higher charges for global research and development costs, higher software amortization, and recruiting fees, partially offset by lower software-related costs and depreciation.

 

Corporate

 

For the first half quarter of 2015, we reported a pre-tax loss from Corporate activity of $32.4 million, reflecting $0.4 million of investment income and $32.8 million of costs. The costs include a reserve in the U.S. for a probable settlement with the SEC for $20.3 million and related legal and other fees of $2.3 million. For the first half of 2014, we incurred a pre-tax loss from Corporate activity of $11.1 million, reflecting investment income of $0.6 million and costs of $11.7 million.  Excluding the reserve and related costs, expenses declined compared to the prior-year period as a result of lower intangible asset amortization due to the full amortization of certain assets and an increase in foreign exchange gains on intercompany activities.

 

Consolidated income tax expense

 

Our effective tax rate was 51% in the first half of 2015 compared to 24% in the first half of 2014.  The rate in 2015 increased significantly as a result of not recording a benefit on substantially all of the $20.3 million reserve for the SEC matter. Excluding the reserve and related costs from our results, the effective tax rate would be in line with the first half of 2014. Both periods have low effective rates due to the higher proportion of our pre-tax income earned in Europe, which is taxed at a lower rate. Our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings.

 

Liquidity and Capital Resources

 

Liquidity

 

Our primary source of liquidity is cash provided by operations. Our liquidity requirements result from our working capital needs, which include clearing and settlement activities, as well as our regulatory capital needs. A substantial portion of our assets is liquid, consisting of cash and cash equivalents or assets readily convertible into cash. Cash is principally invested in U.S. government money market mutual funds and other money market mutual funds. At June 30, 2015, unrestricted cash and cash equivalents totaled $211.8 million. Included in this amount is $107.7 million of cash and cash equivalents held by subsidiaries outside the United States. Due to our current capital structure, we currently do not foresee a need to repatriate funds from certain foreign subsidiaries to the U.S. in 2015 by way of dividends. Should we need to do so in the future, our effective tax rate may increase.

 

As a self-clearing broker-dealer in the U.S., we are subject to cash deposit requirements with clearing organizations that may be large in relation to total liquid assets and may fluctuate significantly based upon the nature and size of customers’ trading activity and market volatility. At June 30, 2015, we had interest-bearing security deposits totaling $51.6 million with clearing organizations in the U.S. for the settlement of equity trades. In the normal course of our U.S. settlement activities, we may also need to temporarily finance customer securities positions from short settlements or delivery failures. These financings may be funded from existing cash resources, borrowings under stock loan transactions or short-term bank loans under our committed facility. In January 2014, we entered into a $150 million two-year revolving credit agreement with a syndicate of banks and JP Morgan Chase Bank, N.A. as administrative agent to finance these temporary positions and to satisfy temporary spikes in clearing margin requirements.

 

We believe that the regulatory capital levels in our U.S. broker-dealer subsidiaries at June 30, 2015 (detailed below in “Regulatory Capital”), which reflect the impact of the SEC settlement reserve, will be sufficient to meet the historical peak requirements of our U.S. business including obligations associated with the clearing and settling of trades.

 

We self-clear equity trades in Hong Kong and Australia and maintain restricted cash deposits of $25.8 million to support overdraft facilities and had deposits with clearing organizations of $13.9 million at June 30, 2015. In Europe, we had a deposit with our settlement agent of $44.6 million at June 30, 2015.

 

Capital Resources

 

Capital resource requirements relate to capital purchases, as well as business investments, and are generally funded from operations. When required, as in the case of a major acquisition, our strong cash generating ability has historically allowed us to access U.S. capital markets.

 

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Table of Contents

 

Operating Activities

 

The table below summarizes the effect of the major components of operating cash flow.

 

 

 

Six Months Ended June 30,

 

(in thousands)

 

2015

 

2014

 

Net income

 

$

6,523

 

$

26,546

 

Non-cash items included in net income

 

39,992

 

38,334

 

Effect of changes in receivables/payables from/to customers and brokers

 

10,031

 

(112,518

)

Effect of changes in other working capital and operating assets and liabilities

 

(63,647

)

18,780

 

Net cash used in operating activities

 

$

(7,101

)

$

(28,858

)

 

The cash flow used in operating activities during the first six months of 2015 was driven by an increase in deposits with clearing organizations, a reduction in bonus accruals from paying full-year 2014 incentive compensation in February 2015 and taxes paid, offset by an increase in accounts payable for the $20.3 million reserve for the probable settlement with the SEC.

 

In the normal course of our clearing and settlement activities worldwide, cash is typically used to fund restricted or segregated cash accounts (under regulations and other), broker and customer fails to deliver/receive, securities borrowed, deposits with clearing organizations and net activity related to receivables/payables from/to customers and brokers. The cash requirements vary from day to day depending on volume transacted and customer trading patterns.

 

Investing Activities

 

Net cash used in investing activities of $17.0 million includes our investments in software development projects and computer hardware and software.

 

Financing Activities

 

Net cash used by financing activities of $34.1 million primarily reflects our repurchases of ITG common stock, shares withheld for net settlements of share-based awards, our dividend payment and repayments of long-term debt.

 

On January 31, 2014, ITG Inc. as borrower, and Investment Technology Group, Inc. (“Parent Company”) as guarantor entered into a $150 million two-year revolving credit agreement (the “Credit Agreement”) with a syndicate of banks and JPMorgan Chase Bank, N.A., as Administrative Agent. The Credit Agreement includes an accordion feature that allows for potential expansion of the facility up to $225 million. Under the Credit Agreement, interest accrues at a rate equal to (a) a base rate, determined by reference to the higher of the (1) federal funds rate or (2) the one month Eurodollar LIBOR rate,  plus (b) a margin of 2.50%. Available but unborrowed amounts under the Credit Agreement are subject to an unused commitment fee of 0.50%. The purpose of this credit line is to provide liquidity for ITG Inc.’s brokerage operations to satisfy clearing margin requirements and to finance temporary positions from delivery failures or non-standard settlements. As a result, we have additional flexibility with our existing cash and future cash flows from operations to strategically invest in growth initiatives and to return capital to stockholders. Depending on the borrowing base, availability under the Credit Agreement is limited to either (i) a percentage of the clearing deposit required by the National Securities Clearing Corporation, or (ii) a percentage of the market value of temporary positions pledged as collateral.  Among other restrictions, the terms of the Credit Agreement include negative covenants related to (a) liens, (b) maintenance of a consolidated leverage ratio (as defined) and a liquidity ratio (as defined), as well as maintenance of minimum levels of tangible net worth (as defined) and regulatory capital (as defined), and (c) restrictions on investments, dispositions and other restrictions customary for financings of this type. 

 

During the first six months of 2015, we repurchased approximately 1.4 million shares of our common stock at a cost of $32.9 million, which was funded from our available cash. Of these shares, nearly 1.0 million were purchased under our Board of Directors’ authorization for a total cost of $24.6 million (average cost of $25.27 per share). An additional 0.4 million shares repurchased for $8.3 million pertained to the satisfaction of minimum statutory withholding tax upon the net settlement of equity awards and the net settlement of director option exercises.  As of June 30, 2015, the total remaining number of shares currently available for repurchase under ITG’s stock repurchase program was 3.8 million.

 

In March 2015, we noted a change in our targeted capital returns to stockholders for 2015, providing guidance that we would base our target on free cash flow instead of net income.  For this purpose we are calculating free cash flow as net income determined under U.S. GAAP increased by non-cash stock-based compensation charges, depreciation and amortization, and reduced by capital expenditures and capitalized software. We expect our capital return activity to include a combination of increased share repurchases

 

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and our recently-announced quarterly dividend program. We may elect to conduct future share repurchases through open market purchases, private transactions or automatic share repurchase programs under SEC Rule 10b5-1.

 

Regulatory Capital

 

ITG Inc., AlterNet and ITG Derivatives are subject to the SEC’s Uniform Net Capital Rule (Rule 15c3-1), which requires the maintenance of minimum net capital.  ITG Inc. has elected to use the alternative method permitted by Rule 15c3-1, which requires that ITG Inc. maintain minimum net capital equal to the greater of $1.0 million or 2% of aggregate debit balances arising from customer transactions, as defined. AlterNet and ITG Derivatives have elected to use the basic method permitted by Rule 15c3-1, which requires that they each maintain minimum net capital equal to the greater of 6 2/3% of aggregate indebtedness or $100,000 and $1.0 million, respectively. Dividends or withdrawals of capital cannot be made if capital is needed to comply with regulatory requirements.

 

Net capital balances and the amounts in excess of required net capital at June 30, 2015 for the U.S. Operations are as follows (dollars in millions):

 

 

 

Net Capital

 

Excess

 

U.S. Operations

 

 

 

 

 

ITG Inc.

 

$

73.1

 

$

72.1

 

AlterNet

 

3.6

 

3.3

 

ITG Derivatives

 

2.0

 

1.0

 

 

As of June 30, 2015, ITG Inc. had $7.3 million of cash in a Special Reserve Bank Account for the benefit of customers under the Customer Protection Rule pursuant to SEC Rule 15c3-3, Computation for Determination of Reserve Requirements and $1.4 million under PABs.

 

In addition, the Company’s Canadian, European and Asia Pacific Operations have subsidiaries with regulatory capital requirements. The regulatory net capital balances and amount of regulatory capital in excess of the minimum requirements applicable to each business at June 30, 2015, is summarized in the following table (dollars in millions):

 

 

 

Net Capital

 

Excess

 

Canadian Operations

 

 

 

 

 

Canada

 

$

28.6

 

$

28.2

 

European Operations

 

 

 

 

 

Ireland

 

68.5

 

18.2

 

U.K.

 

3.5

 

2.7

 

Asia Pacific Operations

 

 

 

 

 

Australia

 

14.6

 

6.0

 

Hong Kong

 

30.1

 

13.4

 

Singapore

 

0.5

 

0.3

 

 

Liquidity and Capital Resource Outlook

 

Historically, our working capital, stock repurchase, dividend program and investment activity requirements have been funded from cash from operations and short-term loans, with the exception of strategic acquisitions, which at times have required long-term financing. We believe that our cash flow from operations, existing cash balances and our available credit facilities will be sufficient to meet our ongoing operating cash and regulatory capital needs, while also complying with the terms of our Credit Agreement.  However, our ability to borrow additional funds may be inhibited by financial lending institutions’ ability or willingness to lend to us on commercially acceptable terms.

 

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

 

We are a member of various U.S. and non-U.S. exchanges and clearing houses that trade and clear, respectively, equities and/or derivative contracts.  Associated with our membership, we may be required to pay a proportionate share of financial obligations of another member who may default on its obligations to the exchanges or the clearing house.  While the rules governing different exchange or clearinghouse memberships vary, in general, our guarantee obligations would arise only if the exchange had previously exhausted its resources.  The maximum potential payout under these memberships cannot be estimated.  We have not recorded any contingent liability in the condensed consolidated financial statements for these agreements and believe that any potential requirement to make payments under these agreements is remote.

 

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As of June 30, 2015, our other contractual obligations and commercial commitments consisted principally of fixed charges, including minimum future rentals under non-cancelable operating leases, minimum future purchases under non-cancelable purchase agreements and minimum compensation under employment agreements.

 

There has been no significant change to such arrangements and obligations since December 31, 2014.

 

New Accounting Pronouncements

 

In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-03, Simplifying the Presentation of Debt Issuance Costs which changes the presentation of debt issuance costs in financial statements. ASU 2015-03 requires an entity to present such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs will continue to be reported as interest expense. It is effective for annual reporting periods beginning after December 15, 2016. Early adoption is permitted. The new guidance will be applied retrospectively to each prior period presented. The Company is currently in the process of evaluating the impact of adoption of the ASU on its condensed consolidated balance sheets.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. The standard provides companies with a single five step revenue recognition model for use in accounting for revenue arising from contracts with customers and supersedes current revenue recognition guidance, including industry-specific revenue guidance. The core principle of the model is to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification. The standard will also require significant additional qualitative and quantitative disclosures describing the nature, amount, timing, and uncertainty of revenues. Entities have the option of using either a full retrospective or modified approach to adopt ASU 2014-09. The original standard was effective for fiscal years beginning after December 15, 2016, however, in April 2015, the FASB proposed a one-year deferral of this standard, with a new effective date of December 15, 2017. The Company is currently evaluating the new guidance and has not yet selected a transition method nor has it determined the impact of adoption on its financial statements.

 

Critical Accounting Estimates

 

There has been no significant change to our critical accounting estimates, which are more fully described in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the year ended December 31, 2014.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Please see our Annual Report on Form 10-K (Item 7A) for the year ended December 31, 2014. There has been no material change in this information.

 

Item 4. Controls and Procedures

 

a)            Evaluation of Disclosure Controls and Procedures. The Company’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, the Company’s disclosure controls and procedures were effective in reporting, on a timely basis, information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act and this Quarterly Report on Form 10-Q.

 

b)            Changes in Internal Controls over Financial Reporting. There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of such internal control that occurred during the Company’s latest fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II. — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

See Note 17, Contingencies—Legal Matters, to the consolidated financial statements included herein.

 

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1A. Risk Factors

 

Risk factors describing the major risks to our business can be found under Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2014.  Except for the addition of the risk factors below, there has been no significant change to the risks or uncertainties that may affect our results of operations since December 31, 2014.

 

Our business could be adversely affected by our customers’ reaction to a settlement, or uncertainty of settlement, with the SEC.

 

In the second quarter of 2015, we reserved $20.3 million for the potential settlement negotiated with the Staff of the SEC Enforcement Division in connection with the SEC’s AlterNet investigation and incurred $2.3 million in legal and other related costs associated with this matter.  Our customers’ reaction to such settlement, or uncertainty around such settlement, could result in reputational and financial harm which could have a material adverse effect on the Company.

 

We could incur additional expenses or harm if we are unable to finalize the settlement.

 

If we do not reach final settlement on the SEC’s AlterNet investigation on the expected terms or if the necessary approvals do not occur, we may either enter into further discussions with the SEC to resolve such matter on different terms and conditions or we may litigate the matter.  We cannot predict the timing of any such further discussions or the terms of such alternative settlement.  If we do not reach a settlement with the SEC, or if the necessary approvals do not occur, we cannot predict the outcome of any subsequent litigation with the SEC, but such litigation could have a material adverse effect on the Company’s consolidated financial position or on the results of operations for any particular period.

 

We could be subject to additional actions based on the circumstances relating to the SEC’s AlterNet investigation. 

 

Although we are not aware of any other governmental investigations or actions as of the date of this report that relate to the circumstances of the SEC’s AlterNet investigation, we could be subject to further governmental investigations or actions relating to such circumstances, and a putative class action lawsuit has been filed with respect to the Company and certain of its executives in connection with the Company’s announcement of the SEC’s AlterNet investigation matter, and other related actions could be filed.  Any further governmental investigations or actions, any private litigation, and the defense and any related settlement thereof, could have a material adverse effect on the Company’s consolidated financial position or on the results of operations for any particular period, and may result in significant ongoing expenses. 

 

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Table of Contents

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

The following table sets forth our stock repurchase activity during the first six months of 2015, including the total number of shares purchased, the average price paid per share, the number of shares repurchased as part of a publicly-announced plan or program, and the number of shares yet to be purchased under the plan or program.

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period

 

Total Number of
Shares (or Units)
Purchased
(a)

 

Average
Price Paid per
Share (or Unit)

 

Total Number of
Shares (or Units)
Purchased as Part of
Publicly Announced
Plans or Programs

 

Maximum Number
of Shares (or Units)
that
May Yet Be Purchased
Under the Plans or
Programs

 

From: January 1, 2015

 

 

 

 

 

 

 

 

 

To: January 31, 2015

 

108,037

 

$

19.88

 

108,037

 

4,667,766

 

 

 

 

 

 

 

 

 

 

 

From: February 1, 2015

 

 

 

 

 

 

 

 

 

To: February 28, 2015

 

595,954

 

22.14

 

234,800

 

4,432,966

 

 

 

 

 

 

 

 

 

 

 

From: March 1, 2015

 

 

 

 

 

 

 

 

 

To: March 31, 2015

 

353,642

 

25.88

 

349,322

 

4,083,644

 

 

 

 

 

 

 

 

 

 

 

From: April 1, 2015

 

 

 

 

 

 

 

 

 

To: April 30, 2015

 

7,830

 

29.20

 

7,500

 

4,076,144

 

 

 

 

 

 

 

 

 

 

 

From: May 1, 2015

 

 

 

 

 

 

 

 

 

To: May 31, 2015

 

272,852

 

29.06

 

272,500

 

3,803,644

 

 

 

 

 

 

 

 

 

 

 

From: June 1, 2015

 

 

 

 

 

 

 

 

 

To: June 30, 2015

 

8,298

 

25.40

 

 

3,803,644

 

Total

 

1,346,613

 

$

24.40

 

972,159

 

 

 

 


(a) This column includes the acquisition of 374,454 common shares from employees in order to satisfy minimum statutory withholding tax requirements upon net settlement of restricted share awards.

 

During the first six months of 2015, we repurchased approximately 1.4 million shares of our common stock at a cost of $32.9 million, which was funded from our available cash. Of these shares, 1.0 million were purchased under our Board of Directors’ authorization for a total cost of $24.6 million (average cost of $25.27 per share). An additional 0.4 million shares repurchased for $8.3 million pertained to the satisfaction of minimum statutory withholding tax upon the net settlement of equity awards and the net settlement of director option exercises.  As of June 30, 2015, the total remaining number of shares currently available for repurchase under ITG’s stock repurchase program was 3.8 million.

 

In April 2015, the Board of Directors initiated a dividend program under which we intend to pay quarterly dividends, subject to quarterly declarations by the Board of Directors. During the second quarter of 2015, the Board of Directors declared and we paid a quarterly dividend of $0.07 per share totaling $2.4 million. In August 2015, the Board of Directors declared our second quarterly dividend of $0.07 per share payable on September 10, 2015 to stockholders of record on August 21, 2015.

 

Item 3. Defaults Upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

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Item 5. Other Information

 

Not applicable.

 

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Item 6. Exhibits

 

(A)

EXHIBITS

 

 

 

 

10.1*

 

Amended and Restated Variable Compensation Stock Unit Award Program Subplan

 

 

 

 

 

10.2*

10.3*

31.1*

 

Amended and Restated Directors’ Equity Subplan

 

Amended and Restated Directors’ Retainer Fee Subplan

Rule 13a-14(a) Certification

 

 

 

 

 

31.2*

 

Rule 13a-14(a) Certification

 

 

 

 

 

32.1**

 

Section 1350 Certification

 

101*

 

Interactive Data File

 

 

 

The following furnished materials from Investment Technology Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, formatted in XBRL (Extensible Business Reporting Language), are collectively included herewith as Exhibit 101:

 

 

 

 

 

 

 

101. INS XBRL Instance Document.

 

 

 

101. SCH XBRL Taxonomy Extension Schema.

 

 

 

101. CAL XBRL Taxonomy Extension Calculation Linkbase.

 

 

 

101. DEF XBRL Taxonomy Extension Definition Linkbase.

 

 

 

101. LAB XBRL Taxonomy Extension Label Linkbase.

 

 

 

101. PRE XBRL Taxonomy Extension Presentation Linkbase.

 


 

*

 

Filed herewith.

 

**

 

Furnished herewith.

 

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

INVESTMENT TECHNOLOGY GROUP, INC.

 

 

(Registrant)

 

 

 

Date: August 10, 2015

By:

/s/ STEVEN R. VIGLIOTTI

 

 

Steven R. Vigliotti
Chief Financial Officer and Duly Authorized Signatory of Registrant

 

37