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, 2011

 

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.)

 

 

 

380 Madison Avenue, New York, New York

 

10017

(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 x

 

Accelerated filer o

 

 

 

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 26, 2011 the Registrant had 41,009,189 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, 2011 (unaudited) and December 31, 2010

 

3

 

 

 

 

 

Condensed Consolidated Statements of Operations (unaudited):
Three and Six Months Ended June 30, 2011 and 2010

 

4

 

 

 

 

 

Condensed Consolidated Statement of Changes in Stockholders’ Equity (unaudited):
Six Months Ended June 30, 2011

 

5

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows (unaudited):
Six Months Ended June 30, 2011 and 2010

 

6

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

 

7

 

 

 

 

Item 2.

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

 

21

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

37

 

 

 

 

Item 4.

Controls and Procedures

 

38

 

 

 

 

 

PART II. — Other Information

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

38

 

 

 

 

Item 1A.

Risk Factors

 

38

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

38

 

 

 

 

Item 3.

Defaults Upon Senior Securities

 

39

 

 

 

 

Item 6.

Exhibits

 

39

 

 

 

 

 

Signature

 

39

 

Investment Technology Group, ITG, the ITG logo, AlterNet, ITG Net, and POSIT are registered trademarks or service marks of the Investment Technology Group, Inc. companies. ITG Derivatives is a service mark of the Investment Technology Group, Inc. companies.

 

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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 (the “Securities Act”), 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, the actions of both current and potential new competitors, fluctuations in market trading volumes, financial market volatility, changes in commission pricing, potential impairment charges related to goodwill and other long-lived assets, evolving industry regulations, errors or malfunctions in our systems or technology, rapid changes in technology, cash flows into or redemptions from equity mutual funds, effects of inflation, 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, changes in tax policy or accounting rules, fluctuations in foreign exchange rates, adverse changes or volatility in interest rates, our ability to attract and retain talented employees, general economic, business, credit and financial market conditions, internationally and nationally as well as our ability to achieve cost savings from our cost reduction plan.

 

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, 2010, which you are encouraged to read.  Our 2010 Annual Report on Form 10-K is also available through our website at http://investor.itg.com.

 

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.

 

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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,
2011

 

December 31,
2010

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

Cash and cash equivalents

 

$

268,832

 

$

317,010

 

Cash restricted or segregated under regulations and other

 

68,495

 

68,965

 

Deposits with clearing organizations

 

19,567

 

14,235

 

Securities owned, at fair value

 

8,481

 

25,789

 

Receivables from brokers, dealers and clearing organizations

 

1,834,343

 

865,251

 

Receivables from customers

 

1,140,878

 

606,256

 

Premises and equipment, net

 

36,977

 

34,790

 

Capitalized software, net

 

63,264

 

62,507

 

Goodwill

 

274,289

 

468,479

 

Other intangibles, net

 

41,770

 

36,784

 

Income taxes receivable

 

7,583

 

5,561

 

Deferred taxes

 

12,795

 

4,902

 

Other assets

 

25,307

 

20,324

 

Total assets

 

$

3,802,581

 

$

2,530,853

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable and accrued expenses

 

$

176,874

 

$

195,109

 

Short-term bank loans

 

19,874

 

 

Payables to brokers, dealers and clearing organizations

 

1,407,236

 

1,139,958

 

Payables to customers

 

1,478,360

 

272,027

 

Securities sold, not yet purchased, at fair value

 

3,305

 

19,362

 

Income taxes payable

 

12,350

 

16,215

 

Deferred taxes

 

356

 

18,114

 

Term loan

 

25,469

 

 

Total liabilities

 

3,123,824

 

1,660,785

 

 

 

 

 

 

 

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; 51,835,395 and 51,790,608 shares issued at June 30, 2011 and December 31, 2010, respectively

 

518

 

518

 

Additional paid-in capital

 

240,860

 

246,085

 

Retained earnings

 

646,539

 

833,133

 

Common stock held in treasury, at cost; 10,892,939 and 10,524,757 shares at June 30, 2011 and December 31, 2010, respectively

 

(223,709

)

(220,161

)

Accumulated other comprehensive income (net of tax)

 

14,549

 

10,493

 

Total stockholders’ equity

 

678,757

 

870,068

 

Total liabilities and stockholders’ equity

 

$

3,802,581

 

$

2,530,853

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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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,

 

 

 

2011

 

2010

 

2011

 

2010

 

Revenues:

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

111,850

 

$

130,500

 

$

230,526

 

$

252,418

 

Recurring

 

26,514

 

22,761

 

53,735

 

44,732

 

Other

 

4,253

 

2,061

 

8,434

 

4,862

 

Total revenues

 

142,617

 

155,322

 

292,695

 

302,012

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

55,679

 

54,587

 

113,157

 

108,051

 

Transaction processing

 

23,104

 

23,581

 

46,130

 

44,240

 

Occupancy and equipment

 

15,063

 

14,969

 

30,005

 

30,166

 

Telecommunications and data processing services

 

14,870

 

12,971

 

29,941

 

26,606

 

Other general and administrative

 

22,762

 

21,928

 

44,922

 

50,085

 

Goodwill impairment

 

225,035

 

5,375

 

225,035

 

5,375

 

Restructuring charges

 

17,678

 

2,337

 

17,678

 

2,250

 

Acquisition related costs

 

2,523

 

 

2,523

 

 

Interest expense

 

494

 

206

 

764

 

430

 

Total expenses

 

377,208

 

135,954

 

510,155

 

267,203

 

(Loss) income before income tax (benefit) expense

 

(234,591

)

19,368

 

(217,460

)

34,809

 

Income tax (benefit) expense

 

(38,448

)

11,860

 

(30,866

)

18,869

 

Net (loss) income

 

$

(196,143

)

$

7,508

 

$

(186,594

)

$

15,940

 

 

 

 

 

 

 

 

 

 

 

(Loss) earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(4.77

)

$

0.17

 

$

(4.52

)

$

0.37

 

Diluted

 

$

(4.77

)

$

0.17

 

$

(4.52

)

$

0.36

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average number of common shares outstanding

 

41,112

 

43,226

 

41,272

 

43,525

 

Diluted weighted average number of common shares outstanding

 

41,112

 

43,704

 

41,272

 

44,129

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES

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

Six Months Ended June 30, 2011

(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, 2011

 

$

 

$

518

 

$

246,085

 

$

833,133

 

$

(220,161

)

$

10,493

 

$

870,068

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (loss)

 

 

 

 

(186,594

)

 

 

(186,594

)

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency translation adjustment

 

 

 

 

 

 

4,142

 

4,142

 

Unrealized holding gain on securities available-for-sale (net of tax)

 

 

 

 

 

 

(86

)

(86

)

Comprehensive (loss) income

 

 

 

 

 

 

 

 

 

 

 

 

 

$

(182,538

)

Issuance of common stock for stock options (111,792 shares) share awards (634,585 shares) and employee stock unit awards (178,818 shares), including tax benefit decrease of $2.0 million

 

 

 

(15,861

)

 

19,273

 

 

3,412

 

Issuance of common stock for the employee stock purchase plan (44,787 shares)

 

 

 

594

 

 

 

 

594

 

Shares withheld for net settlements of share-based awards (278,877 shares)

 

 

 

 

 

(4,993

)

 

(4,993

)

Purchase of common stock for treasury (1,014,500 shares)

 

 

 

 

 

(17,828

)

 

(17,828

)

Share-based compensation

 

 

 

10,042

 

 

 

 

10,042

 

Balance at June 30, 2011

 

$

 

$

518

 

$

240,860

 

$

646,539

 

$

(223,709

)

$

14,549

 

$

678,757

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (unaudited)

(In thousands)

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

Cash flows from Operating Activities:

 

 

 

 

 

Net (loss) income

 

$

(186,594

)

$

15,940

 

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities

 

 

 

 

 

Depreciation and amortization

 

29,265

 

31,837

 

Deferred income tax (benefit) expense

 

(27,686

)

2,602

 

Provision for doubtful accounts

 

28

 

153

 

Share-based compensation

 

8,397

 

7,890

 

Capitalized software write-off

 

 

6,091

 

Non-cash restructuring charges

 

2,298

 

836

 

Goodwill impairment

 

225,035

 

5,375

 

Changes in operating assets and liabilities:

 

 

 

 

 

Cash restricted or segregated under regulations and other

 

1,228

 

12,357

 

Deposits with clearing organizations

 

(5,332

)

(23,965

)

Securities owned, at fair value

 

15,328

 

132

 

Receivables from brokers, dealers and clearing organizations

 

(938,730

)

(620,492

)

Receivables from customers

 

(507,424

)

(654,855

)

Accounts payable and accrued expenses

 

(23,334

)

(46,964

)

Payables to brokers, dealers and clearing organizations

 

252,617

 

996,377

 

Payables to customers

 

1,166,388

 

298,953

 

Securities sold, not yet purchased, at fair value

 

(16,167

)

3,994

 

Income taxes payable

 

(5,891

)

14,554

 

Other, net

 

(1,123

)

(8,965

)

Net cash (used in) provided by operating activities

 

(11,697

)

41,850

 

 

 

 

 

 

 

Cash flows from Investing Activities:

 

 

 

 

 

Acquisition of subsidiaries, net of acquired cash

 

(36,185

)

(3,000

)

Capital purchases

 

(11,059

)

(7,571

)

Capitalization of software development costs

 

(18,342

)

(21,549

)

Proceeds from sale of investments

 

2,095

 

 

Net cash used in investing activities

 

(63,491

)

(32,120

)

 

 

 

 

 

 

Cash flows from Financing Activities:

 

 

 

 

 

Proceeds from short-term bank loans

 

19,874

 

29,918

 

Proceeds from (repayments of) term loans

 

25,469

 

(23,800

)

Debt issuance costs

 

(2,908

)

 

Common stock issued

 

5,973

 

6,671

 

Common stock repurchased

 

(17,828

)

(25,127

)

Shares withheld for net settlements of share-based awards

 

(4,993

)

(3,449

)

Net cash provided by (used in) financing activities

 

25,587

 

(15,787

)

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

1,423

 

1,104

 

Net decrease in cash and cash equivalents

 

(48,178

)

(4,953

)

Cash and cash equivalents — beginning of year

 

317,010

 

330,879

 

Cash and cash equivalents — end of period

 

$

268,832

 

$

325,926

 

 

 

 

 

 

 

Supplemental cash flow information

 

 

 

 

 

Interest paid

 

$

751

 

$

731

 

Income taxes paid

 

$

7,561

 

$

2,953

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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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. (a self clearing broker-dealer of equity securities), AlterNet Securities, Inc. (“AlterNet”) and ITG Derivatives LLC (“ITG Derivatives”), United States (“U.S.”) broker-dealers, (2) ITG Canada Corp. (“ITG Canada”), an institutional broker-dealer in Canada, (3) Investment Technology Group Limited, an institutional broker-dealer in Europe, (4) ITG Australia Limited (“ITG Australia”), an institutional broker-dealer in Australia, (5) ITG Hong Kong Limited (“ITG Hong Kong”), 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. (“ITG Analytics”), a provider of pre- and post-trade analysis, fair value and trade optimization services, The MacGregor Group, Inc. (“MacGregor”), a provider of trade order management technology and network connectivity services for the financial community and ITG Investment Research, Inc. (“ITG Investment Research”), a provider of independent data driven investment and market research.

 

ITG is an independent agency research broker that partners with asset managers globally to improve performance throughout the investment process. 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 insights grounded in data.  Asset managers rely on ITG’s independence, experience and intellectual capital to help mitigate risk, improve performance and navigate increasingly complex markets. The firm is headquartered in New York with offices in North America, Europe, and the Asia Pacific region.

 

The Company’s reportable operating segments are: U.S. Operations, Canadian Operations, European Operations and Asia Pacific Operations (see Note 16, Segment Reporting, to the consolidated financial statements, which also includes financial information about geographic areas). The U.S. Operations segment provides trade execution, trade order management, network connectivity and research services. The Canadian Operations segment provides trade execution, network connectivity and research services. The European Operations segment provides trade execution, trade order management, network connectivity and research services in Europe and includes a technology research and development facility in Israel. The Asia Pacific Operations segment provides trade execution, network connectivity and research services.

 

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.

 

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.

 

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, 2010.

 

Recent Accounting Pronouncements

 

In June 2011, the FASB issued Accounting Standards Update (ASU) 2011-5, Comprehensive Income (Topic 220).  Companies will have two choices of how to present items of net income, items of comprehensive income and total comprehensive income.  Companies can create one continuous statement of comprehensive income or two separate consecutive statements and will be required to present reclassification adjustments in both other comprehensive income and net income.  The guidance is effective for interim and annual periods beginning after December 15, 2011 with early adoption permitted.

 

In October 2009, the FASB issued ASU 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements, providing guidance relating to revenue recognition in multiple element arrangements. The new guidance requires entities to allocate consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices (the relative-selling-price method) and eliminates the use of the residual method of allocation. The relative-selling-price method requires

 

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that the determination for each deliverable be consistent with the objective of determining vendor-specific evidence of fair value (the price at which each element would be sold on a stand-alone basis), and requires the use of a hierarchy designed to maximize the use of available, objective evidence to support its selling price.

 

In October 2009, the FASB issued ASU 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, providing guidance relating to revenue arrangements that include software elements. Currently, if the software is considered more than incidental to the product or services, the entire arrangement is accounted for under Accounting Standards Codification (“ASC”), Software—Revenue Recognition. Under the new guidance many of these arrangements will be accounted for as multiple element arrangements as follows: (i) the tangible element of the product will always be outside the scope of ASC 985-605, (ii) the software elements of tangible products are outside the scope of ASC 985-605 when the software elements and non-software elements function together to deliver the product’s essential functionality and (iii) undelivered elements in the arrangement related to the non-software components are excluded from the software revenue recognition guidance.

 

The above guidance must be adopted no later than the first fiscal year beginning on or after June 15, 2010. The adoption of these standards and amendments did not have a material impact on the Company’s consolidated results of operations or financial condition.

 

In December 2010, the FASB issued ASU 2010-28, Intangibles — Goodwill and Other (Topic 350): When to Perform Step two of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (“ASU 2010-28”).  ASU 2010-28 modifies Step one of the goodwill impairment test for reporting units with zero or negative carrying amounts and requires the company to perform Step two if it is more likely than not that a goodwill impairment may exist.  ASU 2010-28 is effective for fiscal years and interim periods within those years, beginning after December 15, 2010. The adoption of these standards and amendments did not have a material impact on the Company’s consolidated results of operations or financial condition.

 

In December 2010, the FASB issued ASU No. 2010-29, Business Combinations (Topic 805) — Disclosure of Supplementary Pro Forma Information for Business Combinations. ASU 2010-29 specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period. The amendments also require a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for business combinations that are material on an individual or aggregate basis for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  The adoption of this guidance concerns disclosure only and did not have a material impact on the Company’s consolidated results of operations or financial condition.

 

(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.

 

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Table of Contents

 

Level 2 includes financial instruments that are valued using models or other valuation methodologies. These models are primarily standard models that consider various assumptions including time value, yield curve and other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category include non-exchange-traded derivatives such as currency forward contracts.

 

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, 2011

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Tax free money market mutual funds

 

$

4,453

 

$

4,453

 

$

 

$

 

U.S. government money market mutual funds

 

133,330

 

133,330

 

 

 

Money market mutual funds

 

4,531

 

4,531

 

 

 

Securities owned, at fair value:

 

 

 

 

 

 

 

 

 

Trading securities

 

3,487

 

3,487

 

 

 

Equity index mutual funds

 

3,359

 

3,359

 

 

 

Bond mutual funds

 

1,635

 

1,635

 

 

 

Total

 

$

150,795

 

$

150,795

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses:

 

 

 

 

 

 

 

 

 

Currency forward contracts

 

$

 

$

 

$

 

$

 

Securities sold, not yet purchased, at fair value:

 

 

 

 

 

 

 

 

 

Common stock

 

3,305

 

3,305

 

 

 

Total

 

$

3,305

 

$

3,305

 

$

 

$

 

 

December 31, 2010

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Tax free money market mutual funds

 

$

5,061

 

$

5,061

 

$

 

$

 

U.S. government money market mutual funds

 

192,617

 

192,617

 

 

 

Money market mutual funds

 

7,971

 

7,971

 

 

 

Securities owned, at fair value:

 

 

 

 

 

 

 

 

 

Trading securities

 

19,051

 

19,051

 

 

 

Available-for-sale securities

 

1,662

 

1,662

 

 

 

Equity index mutual funds

 

3,402

 

3,402

 

 

 

Bond mutual funds

 

1,674

 

1,674

 

 

 

Total

 

$

231,438

 

$

231,438

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses:

 

 

 

 

 

 

 

 

 

Currency forward contracts

 

$

9

 

$

 

$

9

 

$

 

Securities sold, not yet purchased, at fair value:

 

 

 

 

 

 

 

 

 

Common stock

 

19,362

 

19,362

 

 

 

Total

 

$

19,371

 

$

19,362

 

$

9

 

$

 

 

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

 

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

 

Currency forward contracts are valued based upon forward exchange rates and approximate the credit risk adjusted discounted net cash flow that would have been realized if the contracts had been sold at the balance sheet date.

 

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Table of Contents

 

Certain items are measured at fair value on a non-recurring basis. The table below details the portion of those items that were measured at fair value during the six months ended June 30, 2011 and the resultant loss recorded (dollars in thousands):

 

 

 

 

 

Fair Value Measurements Using

 

Total

 

 

 

June 30, 2011

 

Level 1

 

Level 2

 

Level 3

 

Losses

 

Goodwill — U.S. Operations

 

245,118

 

 

 

245,118

 

225,035

 

Total

 

$

245,118

 

$

 

$

 

$

245,118

 

$

225,035

 

 

Goodwill allocated to the Company’s U.S. Operations reporting unit with a carrying value of $470.1 million was written down to its implied fair value of $245.1 million resulting in an impairment charge of $225.0 million in the second quarter of 2011.

 

(3) Restructuring Charges

 

2011 Restructuring

 

In the second quarter of 2011, the Company decided to implement a restructuring plan to improve margins and enhance stockholder returns primarily focused on reducing workforce, consulting and infrastructure costs in the U.S. and Europe.  The cost reduction plan resulted in a restructuring charge of $17.7 million, consisting of employee separation and related costs ($17.4 million) and lease consolidation costs ($0.3 million).  Employee severance costs relate to the termination of approximately 100 employees and the lease consolidation costs relate to office space that was vacated.  Most of the accrued costs are expected to be paid in 2011, except payments related to the leased facilities, which will continue until March 2013, and the settlement of restricted share awards, which will continue through February 2014.

 

Westchester Office Closing - 2010

 

The Company decided to close its Westchester, NY office, relocate the staff, primarily sales traders and support, to its New York City office, and incurred a restructuring charge of $2.3 million.  The restructuring charge consisted of lease abandonment costs ($2.2 million) and employee severance costs ($0.1 million).

 

The following table summarizes the changes in the Company’s liability balance related to the Westchester office restructuring plan, which is included in accounts payable and accrued expenses in the Consolidated Statements of Financial Condition (dollars in thousands):

 

 

 

Employee
separation and
related costs

 

Consolidation
of leased
facilities

 

Total

 

Balance at December 31, 2010

 

$

90

 

$

2,164

 

$

2,254

 

Utilized — cash

 

(82

)

(263

)

(345

)

Balance at June 30, 2011

 

$

8

 

$

1,901

 

$

1,909

 

 

The remaining accrued costs related to employee separation are expected to be paid during 2011 while the payments related to the leased facilities will continue through 2016.

 

Asia Pacific Restructuring - 2010

 

In the second quarter of 2010, the Company implemented a plan to close its on-shore operations in Japan to lower costs and reduce capital requirements.  The annual expenses for the on-shore Japanese operations were approximately $4 million and the amount of regulatory capital deployed exceeded $20 million. In connection with this move, a one-time charge of $2.1 million was recorded for employee severance, contract termination costs and non-cash write-offs of fixed assets and capitalized software, net of a partial offset in the fourth quarter of 2010 for cumulative translation gains that were reclassified to operations following the substantial liquidation of the Japanese subsidiary.

 

The following table summarizes the changes in the Company’s liability balance related to the Asia Pacific restructuring plan, which is included in accounts payable and accrued expenses in the Consolidated Statements of Financial Condition (dollars in thousands):

 

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Table of Contents

 

 

 

Contract
termination
charges

 

Balance at December 31, 2010

 

$

11

 

Utilized — cash

 

(11

)

Balance at June 30, 2011

 

$

 

 

2009 Restructuring

 

In the fourth quarter of 2009, the Company committed to a restructuring plan (aimed primarily at its U.S. Operations) to reengineer its operating model to focus on a leaner cost structure and a more selective deployment of resources towards those areas of our business that provide a sufficiently profitable return. As a result, a $25.4 million restructuring charge was recorded, which included costs related to employee separation, the consolidation of leased facilities and write-offs of capitalized software and certain intangible assets primarily due to changes in product priorities.  Employee separation and related costs pertain to the termination of 144 employees primarily from the U.S. Operations. The consolidation of leased facilities charges relate to non-cancelable leases which were vacated.

 

The following table summarizes the changes in the Company’s liability balance related to the 2009 restructuring plan included in accounts payable and accrued expenses in the Consolidated Statements of Financial Condition (dollars in thousands):

 

 

 

Employee
separation and
related costs

 

Consolidation
of leased
facilities

 

Total

 

Balance at December 31, 2010

 

$

77

 

$

853

 

$

930

 

Utilized — cash

 

(27

)

(360

)

(387

)

Other

 

3

 

 

3

 

Balance at June 30, 2011

 

$

53

 

$

493

 

$

546

 

 

The remaining accrued costs relate to payments related to the leased facilities and the settlement of restricted share awards which will continue through April 2012.

 

(4) Derivative Instruments

 

Derivative Contracts

 

All derivative instruments are recorded on the Condensed Consolidated Statements of Financial Condition at fair value in other assets or accounts payable and accrued expenses. Recognition of the gain or loss that results from recording and adjusting a derivative to fair value depends on the intended purpose for entering into the derivative contract. Gains and losses from derivatives that are not accounted for as hedges under ASC 815, Derivatives and Hedging, are recognized immediately in income. For derivative instruments that are designated and qualify as a fair value hedge, the gains or losses from adjusting the derivative to its fair value will be immediately recognized in income and, to the extent the hedge is effective, offset the concurrent recognition of changes in the fair value of the hedged item. Gains or losses from derivative instruments that are designated and qualify as a cash flow hedge will be recorded on the Consolidated Statements of Financial Condition in accumulated other comprehensive income (“OCI”) until the hedged transaction is recognized in income. However, to the extent the hedge is deemed ineffective, the ineffective portion of the change in fair value of the derivative will be recognized immediately in income. For discontinued cash flow hedges, prospective changes in the fair value of the derivative are recognized in income. Any gain or loss in accumulated OCI at the time the hedge is discontinued will continue to be deferred until the original forecasted transaction occurs. However, if it is determined that the likelihood of the original forecasted transaction is no longer probable, the entire related gain or loss in accumulated OCI is immediately reclassified into income.

 

Economic Hedges

 

The Company enters into three month forward contracts to sell Euros and buy British Pounds to economically hedge against the risk of currency movements on Euro deposits held in banks across Europe for equity trade settlement. When a contract matures, an assessment is made as to whether or not the contract value needs to be amended prior to entering into another, to ensure continued economic hedge effectiveness. As these contracts are not designated as hedges, the changes to their fair value are recognized immediately in income. The related counterparty agreements do not contain any credit-risk related contingent features. There were no open three month forward contracts outstanding at June 30, 2011.

 

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Table of Contents

 

When clients request trade settlement in a currency other than the currency in which the trade was executed, the Company enters into foreign exchange contracts in order to close out the resulting foreign currency position. The foreign exchange deals are executed the same day as the underlying equity trade.  As these contracts are not designated as hedges, the changes to their fair value are recognized immediately in income. These foreign exchange contracts are reflected in the tables below.

 

Fair Values and Effects of Derivatives Held

 

Asset derivatives are included in other assets while liability derivatives are included in accounts payable and accrued expenses on the Condensed Consolidated Statements of Financial Condition.  The following table summarizes the fair values of our derivative instruments at June 30, 2011 and December 31, 2010 (dollars in thousands).  There were no derivatives designated as hedging instruments in either period.

 

 

 

Asset / (Liability) Derivatives

 

 

 

Fair Value

 

 

 

June 30, 2011

 

December 31, 2010

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

Currency forward contracts

 

$

 

$

(9

)

Total derivatives not designated as hedging instruments

 

 

(9

)

Total derivatives

 

$

 

$

(9

)

 

The following table summarizes the impact that derivative instruments not designated as hedging instruments under ASC 815 had on the results of operations at June 30, which are recorded in other general and administrative expense in the Condensed Consolidated Statements of Operations (dollars in thousands).

 

 

 

Gain/(Loss) Recognized in Income

 

Derivatives Not Designated as Hedging Instruments

 

June 30, 2011

 

June 30, 2010

 

Three Months Ended

 

 

 

 

 

 

 

Currency forward contracts

 

$

(62

)

$

206

 

Total

 

$

(62

)

$

206

 

 

 

 

 

 

 

Six Months Ended

 

 

 

 

 

Currency forward contracts

 

$

(180

)

$

268

 

Total

 

$

(180

)

$

268

 

 

(5) 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 and brokers (“Special Reserve Bank Account”) maintained by ITG Inc. in accordance with Rule 15c3-3 of the Exchange Act (“Customer Protection Rule”), (iii) funds relating to the collateralization of a letter of credit and a bank guarantee supporting two MacGregor leases, (iv) funds on deposit for European trade clearing and settlement activity, (v) segregated balances under a collateral account control agreement for the benefit of certain customers, (vi) funds relating to the securitization of bank guarantees supporting Australian and Israeli leases and (vii) funds relating to the securitization of a letter of credit supporting an ITG Investment Research lease.

 

(6) Securities Owned and Sold, Not Yet Purchased

 

The following is a summary of securities owned and securities sold, not yet purchased (dollars in thousands):

 

 

 

Securities Owned

 

Securities Sold, Not Yet
Purchased

 

 

 

June 30,
2011

 

December 31,
2010

 

June 30, 
2011

 

December 31,
2010

 

Corporate stocks—trading securities

 

$

3,487

 

$

19,051

 

$

3,305

 

$

19,362

 

Corporate stocks—available-for-sale

 

 

1,662

 

 

 

Mutual funds

 

4,994

 

5,076

 

 

 

Total

 

$

8,481

 

$

25,789

 

$

3,305

 

$

19,362

 

 

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Table of Contents

 

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.

 

Available-for-Sale Securities

 

Unrealized holding gains and losses on available-for-sale securities, net of tax effects, which are reported in accumulated other comprehensive income until realized, are as follows (dollars in thousands):

 

 

 

After-Tax Unrealized Holding
Gain/(Loss)

 

 

 

June 30,
2011

 

December 31,
2010

 

Positions with net gains

 

$

 

$

86

 

Positions with net (losses)

 

 

 

Total gain/(loss)

 

$

 

$

86

 

 

Unrealized holding gains on securities, available-for-sale as of December 31, 2010 relates to shares of NYSE Euronext, Inc. the Company received as part of the merger of the New York Stock Exchange and Archipelago Holdings Inc. on March 9, 2006.  During the first quarter of 2011, the Company sold all of the available-for-sale securities it held for gross proceeds of $2.1 million and recorded a pre-tax gain of $0.5 million in other revenues.  There were no sales of available-for-sale securities during the six month period ending June 30, 2010.

 

(7) Income Taxes

 

The tax benefit from an uncertain tax position is recognized only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities based on the technical merits of the position. 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, 2010, uncertain tax positions in the U.S. were resolved for the 2006 and 2008 fiscal years resulting in a decrease in our liability of $0.8 million and the related deferred tax asset of $0.3 million.  As a result of this, we recognized a net tax benefit of $0.1 million.

 

During the six months ended June 30, 2011, no uncertain tax positions in the U.S. were resolved.

 

The Company had unrecognized tax benefits for tax positions taken of $13.2 million and $12.4 million at June 30, 2011 and December 31, 2010, respectively.  The Company had accrued interest expense of $1.4 million and $1.2 million, net of related tax effects, related to unrecognized tax benefits at June 30, 2011 and December 31, 2010, respectively.

 

(8) Acquisitions

 

Ross Smith Energy Group Ltd.

 

On June 3, 2011, the Company completed its acquisition of Ross Smith Energy Group Ltd. (“RSEG”), a Calgary-based independent provider of research on the oil and gas industry. RSEG provides detailed technical and financial analysis of North American resource plays, public and private corporations, as well as coverage of international and macroeconomic energy issues, for more than 200 clients in North America and Europe, a number of which are new clients for ITG. The acquisition of RSEG (now renamed ITG Investment Research ULC) will expand the ITG research platform to include differentiated views into the exploration and production activities of North American and international energy companies.

 

The results of RSEG have been included in the Company’s consolidated financial statements since its acquisition date. The $38.6 million purchase price for RSEG consists of all cash with no contingent payment provisions. In connection with the acquisition, the Company also incurred approximately $0.7 million of acquisition related costs, including legal fees and other professional fees, as well as $1.8 million in connection with the termination of a distribution agreement with a third party, net of a $1.0 million recovery from RSEG’s former owners.  These costs were classified in the Consolidated Statements of Operations as acquisition related costs.

 

The assets and liabilities of RSEG were recorded as of the acquisition date, at their respective fair values, under business combination accounting. The purchase price allocation is based on estimates of the fair value of assets acquired and liabilities assumed as follows (dollars in thousands):

 

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Table of Contents

 

Cash

 

$

2,540

 

Accounts receivable, net

 

1,422

 

Customer related intangible asset

 

6,950

 

Accounts payable and accrued liabilities

 

(1,505

)

Deferred income

 

(2,151

)

Other assets and liabilities, net

 

611

 

Goodwill

 

30,715

 

Total purchase price

 

$

38,582

 

 

The goodwill and customer related intangible asset were assigned to the U.S. Operations segment, which is expected to be the primary beneficiary of the synergies achieved from the business combination. The goodwill is deductible for tax purposes over 15 years. The acquired customer related intangible asset of $7.0 million has a 10 year useful life. The pro forma results of the RSEG acquisition would not have been material to the Company’s result of operations.

 

(9) Goodwill and Other Intangibles

 

The following table presents the changes in the carrying amount of goodwill by reportable segment for the period ended June 30, 2011 (dollars in thousands):

 

 

 

U.S. Operations

 

European
Operations

 

Asia Pacific
Operations

 

Total

 

Balance as of December 31, 2010

 

$

439,294

 

$

28,484

 

$

701

 

$

468,479

 

Impairment loss

 

(225,035

)

 

 

(225,035

)

Acquisition of Ross Smith Energy

 

30,715

 

 

 

30,715

 

ITG Investment Research price adjustment

 

144

 

 

 

144

 

Currency translation adjustment

 

 

(14

)

 

(14

)

Balance as of June 30, 2011

 

$

245,118

 

$

28,470

 

$

701

 

$

274,289

 

 

Goodwill impairment

 

The Company tests the carrying value of goodwill for impairment at least annually and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

 

During 2010, indicators of potential impairment prompted the Company to perform goodwill impairment tests at the end of each quarterly interim period. These indicators included a prolonged decrease in market capitalization, a decline in recent operating results in comparison to prior years, and the significant near-term uncertainty related to both the global economic recovery and the outlook for the Company’s industry.  As the indicators of potential impairment have not improved, the Company continued to perform interim goodwill impairment testing at the end of each quarterly period during 2011.  The interim impairment tests apply the same valuation techniques and sensitivity analyses used in the Company’s prior annual impairment test to updated cash flow and profitability forecasts.

 

Based upon tests performed during the second quarter of 2011, the Company recorded an impairment charge of $225.0 million in connection with the goodwill allocated to its U.S. Operations reporting unit. This impairment charge reflects continued weakness in institutional trading volumes, which lowered estimated future cash flows of the U.S. Operations reporting unit, and a decline in industry market multiples.

 

No impairment was indicated for the European or Hong Kong Operations as the fair values of these reporting units were determined to be in excess of their respective carrying values by 20% and 167%. In addition, none of the outcomes of the Company’s sensitivity analyses performed led to a conclusion that the goodwill for these two reporting units are impaired.

 

Although no impairment of goodwill was indicated for the European and Hong Kong operations, the Company recognizes the reasonable possibility that one of these reporting units might become impaired in future periods given the persistently unfavorable environment for the Company’s business. Similarly, while the U.S. Operations goodwill was determined to be only partially impaired, the Company also recognizes the reasonable possibility that it could become further impaired in such an environment.  It is not possible at this time to determine if any such future impairment charge would result or, if it does, whether such charge would be material. The use of the term “reasonable possibility” refers to a potential occurrence that is more than remote, but less than probable in management’s judgment. The Company will continue to monitor economic trends related to its business as well as re-examine the key assumptions used in its impairment testing.

 

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Table of Contents

 

Other Intangible Assets

 

Acquired other intangible assets consisted of the following at June 30, 2011 and December 31, 2010 (dollars in thousands):

 

 

 

June 30, 2011

 

December 31, 2010

 

 

 

 

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Useful Lives
(Years)

 

Trade names

 

$

10,400

 

$

1,165

 

$

10,400

 

$

1,036

 

5.0

 

Customer related intangibles

 

27,851

 

3,389

 

20,901

 

2,571

 

7.8

 

Proprietary software

 

20,876

 

13,018

 

20,876

 

12,001

 

17.6

 

Trading rights

 

165

 

 

165

 

 

 

Other

 

50

 

 

50

 

 

 

Total

 

$

59,342

 

$

17,572

 

$

52,392

 

$

15,608

 

 

 

 

In the second quarter of 2011, the Company recorded a $7.0 million customer related intangible asset with a useful life of 10 years related to the acquisition of RSEG.

 

At June 30, 2011, other intangibles not subject to amortization amounted to $8.6 million, of which $8.4 million related to the POSIT trade name.

 

Amortization expense of other intangibles was $1.0 million and $2.0 million for the three months and six months ended June 30, 2011, respectively, compared with $0.7 million and $1.4 million in the respective prior year periods. These amounts are included in other general and administrative expense in the Condensed Consolidated Statements of Operations.

 

During the six months ended June 30, 2011, no other intangible assets were deemed impaired, and accordingly, no adjustment was required.

 

(10) 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,
2011

 

December 31,
2010

 

June 30,
2011

 

December 31,
2010

 

Broker-dealers

 

$

807,740

 

$

246,560

 

$

776,696

 

$

403,432

 

Clearing organizations

 

408,854

 

413

 

32

 

108,526

 

Securities borrowed

 

618,100

 

618,662

 

 

 

Securities loaned

 

 

 

630,508

 

628,000

 

Allowance for doubtful accounts

 

(351

)

(384

)

 

 

Total

 

$

1,834,343

 

$

865,251

 

$

1,407,236

 

$

1,139,958

 

 

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,
2011

 

December 31,
2010

 

June 30,
2011

 

December 31,
2010

 

Customers

 

$

1,142,046

 

$

607,286

 

$

1,478,360

 

$

272,027

 

Allowance for doubtful accounts

 

(1,168

)

(1,030

)

 

 

Total

 

$

1,140,878

 

$

606,256

 

$

1,478,360

 

$

272,027

 

 

15



Table of Contents

 

Securities Borrowed and Loaned

 

As of June 30, 2011, securities borrowed as part of the Company’s matched book operations with a fair value of $591.0 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 Operations for the three and six months ended June 30, were as follows (dollars in thousands):

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Interest earned

 

$

6,328

 

$

1,159

 

$

9,680

 

$

1,326

 

Interest incurred

 

(5,003

)

(779

)

(7,420

)

(843

)

Net

 

$

1,325

 

$

380

 

$

2,260

 

$

483

 

 

(11) Accounts Payable and Accrued Expenses

 

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

 

 

 

June 30,
2011

 

December 31,
2010

 

Accrued research payables

 

$

48,191

 

$

41,569

 

Accrued compensation and benefits

 

34,932

 

63,423

 

Trade payables

 

22,388

 

24,235

 

Accrued restructuring

 

17,837

 

3,196

 

Deferred revenue

 

15,996

 

15,852

 

Deferred compensation

 

11,381

 

16,531

 

Accrued transaction processing

 

3,493

 

3,336

 

Acquisition payment obligation

 

507

 

9,314

 

Other

 

22,149

 

17,653

 

Total

 

$

176,874

 

$

195,109

 

 

(12) Borrowings

 

Short-term Bank Loans

 

The Company’s international securities clearance and settlement operations are funded with operating cash, securities loaned or with short-term bank loans in the form of overdraft facilities.  At June 30, 2011 there was $19.9 million outstanding under these facilities at a weighted average interest rate of 2.0% primarily associated with European settlement transactions.

 

On January 31, 2011, ITG Inc., as borrower, and Investment Technology Group, Inc., as guarantor, entered into a $150 million three-year revolving credit agreement (“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 $250 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, the Company has additional flexibility with its existing cash and future cash flows from operations to strategically invest in growth initiatives and to return profits 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 (“NSCC”), 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.

 

The events of default under the Credit Agreement include, among others, payment defaults, cross defaults with certain other indebtedness, breaches of covenants, loss of collateral, judgments, changes in control and bankruptcy events. In the event of a default, the Credit Agreement requires ITG Inc. to pay incremental interest at the rate of 2.0% and, depending on the nature of the default, the commitments will either automatically terminate and all unpaid amounts immediately become due and payable, or the lenders may in their discretion terminate their commitments and declare due all unpaid amounts outstanding.

 

16



Table of Contents

 

At June 30, 2011 there were no amounts outstanding under the Credit Agreement.

 

Term Loan

 

On June 1, 2011, Investment Technology Group, Inc. (“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 (“Term Loan”) 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 is to provide capital for strategic initiatives.  Among other obligations and restrictions, the terms of the Term Loan Agreement include compliance with the financial covenants of the Credit Agreement for as long as the Credit Agreement is outstanding.

 

The events of default under the Term Loan Agreement include, among others, cross default on the Credit Agreement, default on payment, failure to maintain required equipment insurance, certain negative judgments and bankruptcy events. In the event of a default, the terms of the Term Loan Agreement require the Company to pay additional interest at a rate of 3.0% and, the lender may in its discretion terminate the loan agreement and declare all unpaid amounts outstanding to be immediately due and payable.

 

The Term Loan is payable in monthly principal installments of $530,600 beginning in July 2011 and accrues interest at 3.0% plus the average one month London Interbank Offered Rate (LIBOR) for dollar deposits. The remaining scheduled principal repayments are as follows (dollars in thousands):

 

Year

 

Aggregate Amount

 

2011

 

$

3,184

 

2012

 

6,367

 

2013

 

6,367

 

2014

 

6,367

 

2015

 

3,184

 

 

 

$

25,469

 

 

Along with the Term Loan Agreement, Parent Company entered into a $5 million master lease facility with Banc of America Leasing & Capital, LLC (“Master Lease Agreement”), under which purchases of new equipment may be financed.  Each equipment lease under the Master Lease Agreement shall be structured as a capital lease and will have a separate 48 month term from its inception date, at the end of which Parent Company may purchase the underlying equipment for $1.  Each lease under the Master Lease Agreement will require principal repayment on a monthly schedule and will accrue interest at the same rate prescribed for the Term Loan.

 

As of June 30, 2011, no equipment leases were outstanding under the Master Lease Agreement.

 

(13) Earnings Per Share

 

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

 

 

 

June 30,

 

 

 

2011

 

2010

 

Three Months Ended

 

 

 

 

 

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

 

$

(196,143

)

$

7,508

 

Shares of common stock and common stock equivalents:

 

 

 

 

 

Average common shares used in basic computation

 

41,112

 

43,226

 

Effect of dilutive securities

 

 

478

 

Average common shares used in diluted computation

 

41,112

 

43,704

 

(Loss) earnings per share:

 

 

 

 

 

Basic

 

$

(4.77

)

$

0.17

 

Diluted

 

$

(4.77

)

$

0.17

 

 

 

 

 

 

 

Six Months Ended

 

 

 

 

 

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

 

$

(186,594

)

$

15,940

 

Shares of common stock and common stock equivalents:

 

 

 

 

 

Average common shares used in basic computation

 

41,272

 

43,525

 

Effect of dilutive securities

 

 

604

 

Average common shares used in diluted computation

 

41,272

 

44,129

 

(Loss) earnings per share:

 

 

 

 

 

Basic

 

$

(4.52

)

$

0.37

 

Diluted

 

$

(4.52

)

$

0.36

 

 

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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 (amounts in thousands):

 

 

 

June 30,

 

 

 

2011

 

2010

 

Three months ended

 

1,849

 

1,031

 

Six months ended

 

1,438

 

708

 

 

The impact of all common stock equivalents on 2011 per share amounts is anti-dilutive due to the fact that the Company is reporting a loss.

 

(14) Other Comprehensive Income

 

The components and allocated tax effects of other comprehensive income for the periods ended June 30, 2011 and December 31, 2010 are as follows (dollars in thousands):

 

 

 

Before Tax
Effects

 

Tax
Effects

 

After Tax
Effects

 

June 30, 2011

 

 

 

 

 

 

 

Currency translation adjustment

 

$

14,549

 

$

 

$

14,549

 

Unrealized holding gain/(loss) on securities, available-for-sale

 

 

 

 

 

 

 

Beginning balance

 

144

 

(58

)

86

 

Less: Reclassification adjustment for gains recognized in net income

 

(144

)

58

 

(86

)

Net unrealized holding gain/(loss) on securities, available-for-sale

 

 

 

 

Total

 

$

14,549

 

$

 

$

14,549

 

 

 

 

 

 

 

 

 

December 31, 2010

 

 

 

 

 

 

 

Currency translation adjustment

 

$

10,407

 

$

 

$

10,407

 

Unrealized holding gain/(loss) on securities, available-for-sale

 

144

 

(58

)

86

 

Total

 

$

10,551

 

$

(58

)

$

10,493

 

 

Unrealized holding gains and losses on securities, available-for-sale relates to shares of NYSE Euronext, Inc. the Company received as part of the merger of the New York Stock Exchange and Archipelago Holdings Inc. on March 9, 2006.  During the first quarter of 2011, the Company sold all of the available-for-sale securities it held for gross proceeds of $2.1 million and recorded a pre-tax gain of $0.5 million.

 

Deferred taxes have not been provided on the cumulative undistributed earnings of foreign subsidiaries or the cumulative translation adjustment related to those investments since such amounts are expected to be reinvested indefinitely.

 

(15) Net Capital Requirement

 

ITG Inc., AlterNet, Blackwatch Brokerage Inc. (“Blackwatch”) 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, ITG Derivatives and Blackwatch have elected to use the basic method permitted by Rule 15c3-1, which requires that they maintain minimum net capital equal to the greater of 6 2/3% of aggregate indebtedness or $100,000, $1.0 million and $5,000, respectively. Dividends or withdrawals of capital cannot be made if capital is needed to comply with regulatory requirements.

 

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Table of Contents

 

Net capital balances and the amounts in excess of required net capital at June 30, 2011 for the U.S. Operations are as follows (dollars in millions):

 

 

 

Net Capital

 

Excess Net Capital

 

U.S. Operations

 

 

 

 

 

ITG Inc.

 

$

78.4

 

$

77.4

 

AlterNet

 

4.0

 

3.8

 

Blackwatch

 

3.2

 

3.2

 

ITG Derivatives

 

2.5

 

1.5

 

 

As of June 30, 2011, ITG Inc. had a $10.8 million cash balance in a Special Reserve Bank Account for the benefit of customers and brokers under the Customer Protection Rule pursuant to SEC Rule 15c3-3, Computation for Determination of Reserve Requirements.

 

In addition, the Company’s Canadian, European and Asia Pacific Operations have subsidiaries with regulatory capital requirements. The net capital balances and amount of regulatory capital in excess of the minimum requirements applicable to each business at June 30, 2010, is summarized in the following table (dollars in millions):

 

 

 

Net Capital

 

Excess Net Capital

 

Canadian Operations

 

 

 

 

 

Canada

 

$

47.4

 

$

46.8

 

European Operations

 

 

 

 

 

Europe

 

44.2

 

2.5

 

Asia Pacific Operations

 

 

 

 

 

Australia

 

17.6

 

12.6

 

Hong Kong

 

31.2

 

12.0

 

Singapore

 

0.4

 

0.2

 

 

(16) Segment Reporting

 

The Company is organized into four operating segments through which the Company’s chief operating decision makers manage the Company’s business. The U.S. Operations segment provides trade execution, trade order management, network connectivity and research services. The Canadian Operations segment provides trade execution, network connectivity and research services. The European Operations segment provides trade execution, trade order management, network connectivity and research services in Europe, and includes a technology research and development facility in Israel. The Asia Pacific Operations segment provides trade execution, network connectivity and research services.

 

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, 2010.  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. Recurring revenues are principally attributed based upon the location of the client using the respective service.

 

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

 

19


 


Table of Contents

 

 

 

U.S.
Operations
(1)(2)(3)(4)

 

Canadian
Operations (1)

 

European
Operations (1)

 

Asia Pacific
Operations
(1)(5)

 

Consolidated

 

Three Months Ended June 30, 2011

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

93,893

 

$

20,828

 

$

17,501

 

$

10,395

 

$

142,617

 

(Loss) income before income tax (benefit) expense

 

(236,250

)

4,526

 

(906

)

(1,961

)

(234,591

)

Identifiable assets

 

1,302,240

 

118,814

 

1,761,016

 

620,511

 

3,802,581

 

Three Months Ended June 30, 2010

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

108,089

 

$

21,494

 

$

17,940

 

$

7,799

 

$

155,322

 

Income (loss) before income tax expense (benefit)

 

24,173

 

6,292

 

937

 

(12,034

)

19,368

 

Identifiable assets

 

1,542,913

 

441,224

 

451,038

 

491,432

 

2,926,607

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2011

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

194,404

 

$

42,667

 

$

35,876

 

$

19,748

 

$

292,695

 

(Loss) income before income tax (benefit) expense

 

(222,701

)

9,643

 

(400

)

(4,002

)

(217,460

)

Six Months Ended June , 2010

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

207,997

 

$

39,930

 

$

38,309

 

$

15,776

 

$

302,012

 

Income (loss) before income tax expense (benefit)

 

37,386

 

10,882

 

2,480

 

(15,939

)

34,809

 

 


(1)         Income (loss) before income tax expense for the three and six months ended June 30, 2011 includes the impact of restructuring charges of $15.4 million, $0.7 million, $1.2 million and $0.3 million for the U.S., Canadian, European and Asia Pacific Operations, respectively.

(2)         Income (loss) before income tax expense for the three and six months ended June 30, 2011 includes the impact of a $225.0 million goodwill impairment charge.

(3)         Income (loss) before income tax expense for the three and six months ended June 30, 2011 includes the impact of acquisition related costs of $2.5 million.

(4)         Income (loss) before income tax expense for the six months ended June 30, 2010 includes the impact of a $6.1 million charge to write-off certain capitalized software initiatives.

(5)         Income (loss) before income tax expense for the three and six months ended June 30, 2010 includes the impacts of a $5.4 million impairment charge related to Australian goodwill and a restructuring charge of $2.5 million to close the Company’s on-shore Japanese operations.

 

(17)                          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 equities and/or derivative contracts.  The Company also accesses certain clearing houses through the memberships of third-parties. Associated with these memberships and third-party relationships, 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 houses.  While the rules governing different exchange or clearinghouse memberships vary, in general the Company’s obligations would arise only if the exchanges and clearinghouses had previously exhausted other remedies.  The maximum potential payout under 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 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.

 

20



Table of Contents

 

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.

 

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 consolidated financial statements, including the notes thereto.

 

Overview

 

ITG is an independent agency research broker that partners with asset managers globally to improve performance throughout the investment process. 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 insights grounded in data. Asset managers rely on ITG’s independence, experience and intellectual capital to identify investment and trading opportunities, help mitigate risk, improve performance and navigate increasingly complex markets. The firm is headquartered in New York with offices in North America, Europe and the Asia Pacific region.

 

Our reportable operating segments are: U.S. Operations, Canadian Operations, European Operations and Asia Pacific Operations. The U.S. Operations segment provides trade execution, trade order management, network connectivity and research services. The Canadian Operations segment provides trade execution, network connectivity and research services. The European Operations segment provides trade execution, trade order management, network connectivity and research services in Europe, and includes a technology research and development facility in Israel. The Asia Pacific Operations segment provides trade execution, network connectivity and research services.

 

Sources of Revenues

 

Our revenues consist of commissions and fees, recurring and other.

 

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 buy-side clients on our order management system (“OMS”) and execution management system (“EMS”) applications. 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: (x) macro trends in the global equities markets that affect overall institutional equity trading activity, (y) competitive pressure, including pricing, created by a proliferation of electronic execution competitors and (z) 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, (ii) software and analytical products and services, (iii) maintenance and customer technical support on our OMS and (iv) subscription revenue generated from the usage of our investment research.

 

Other revenues include: (i) income from principal trading, (ii) the net interest spread earned on securities borrowed and loaned matched book transactions, (iii) non-recurring professional services, such as one-time implementation and customer training related activities, (iv) investment and interest income, (v) interest income on securities borrowed in connection with customers’ settlement activities and (vi) market gains/losses resulting from temporary positions in securities assumed in the normal course of our agency trading business (including client errors and accommodations).

 

Expenses

 

Compensation and employee benefits, our largest expense, consists of salaries and wages, incentive compensation, share-based compensation and related employee benefits and taxes. Incentive compensation fluctuates based on revenues, profitability and other measures, taking into account the competitive landscape for key talent.

 

21



Table of Contents

 

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 and professional fees.

 

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, 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-recurring items such as acquisitions, divestitures, restructuring charges, large write-offs or items outside of management’s control, such as foreign currency exchange rates. Management believes that the non-GAAP financial measures described below provide investors and analysts useful insight into our financial position and operating performance.

 

Disclosures of commissions and fees excluding currency translation, which exclude the impact of fluctuations in foreign currency exchange rates, is provided to facilitate relevant period-to-period comparisons of the underlying growth in commissions and fees by excluding these fluctuations outside of management’s control that impact the overall comparability. Underlying commissions and fees should be viewed in addition to, and not as an alternative to, commissions and fees as determined in accordance with U.S. GAAP.

 

Adjusted expense and adjusted net income disclosures excluding certain non-operating items are provided to facilitate the relevant period-to-period comparison of expenses and net income by excluding these unusual items that impact overall comparability. These non-GAAP measures should be viewed in addition to, and not as an alternative to, expenses and net income as determined in accordance with U.S. GAAP.

 

Reconciliations of adjusted expenses and adjusted net income to expenses and net (loss) income and related per share amounts as determined in accordance with U.S. GAAP are provided below.

 

Quarter Ended June 30, 2011:

 

ITG Consolidated

 

U.S.

 

Canada

 

Europe

 

Asia Pacific

 

U.S. GAAP expenses

 

$

377,208

 

$

330,143

 

$

16,302

 

$

18,407

 

$

12,356

 

Less:

 

 

 

 

 

 

 

 

 

 

 

Acquisition related costs

 

2,523

 

2,523

 

 

 

 

 

 

 

Goodwill impairment charge

 

225,035

 

225,035

 

 

 

 

 

 

 

Restructuring charges

 

17,678

 

15,444

 

685

 

1,235

 

314

 

Adjusted expenses

 

$

131,972

 

$

87,141

 

$

15,617

 

$

17,172

 

$

12,042

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. GAAP net loss

 

$

(196,143

)

 

 

 

 

 

 

 

 

Net effect of adjustments

 

201,976

 

 

 

 

 

 

 

 

 

Adjusted net income

 

$

5,833

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. GAAP diluted loss per share

 

$

(4.77

)

 

 

 

 

 

 

 

 

Net effect of adjustments

 

4.91

 

 

 

 

 

 

 

 

 

Adjusted diluted earnings per share

 

$

0.14

 

 

 

 

 

 

 

 

 

 

22



Table of Contents

 

Quarter Ended June 30, 2010:

 

ITG Consolidated

 

U.S.

 

Canada

 

Europe

 

Asia Pacific

 

U.S. GAAP expenses

 

$

135,954

 

$

83,916

 

$

15,202

 

$

17,003

 

$

19,833

 

Less:

 

 

 

 

 

 

 

 

 

 

 

Acquisition related costs

 

 

 

 

 

 

 

 

 

 

 

Goodwill impairment charge

 

5,375

 

 

 

 

 

 

 

5,375

 

Restructuring charges

 

2,337

 

(165

)

(16

)

 

 

2,518

 

Adjusted expenses

 

$

128,242

 

$

84,081

 

$

15,218

 

$

17,003

 

$

11,940

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. GAAP net income

 

$

7,508

 

 

 

 

 

 

 

 

 

Net effect of adjustments

 

7,784

 

 

 

 

 

 

 

 

 

Adjusted net income

 

$

15,292

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. GAAP diluted earnings per share

 

$

0.17

 

 

 

 

 

 

 

 

 

Net effect of adjustments

 

0.18

 

 

 

 

 

 

 

 

 

Adjusted diluted earnings per share

 

$

0.35

 

 

 

 

 

 

 

 

 

 

Executive Summary for the Quarter Ended June 30, 2011

 

Consolidated Overview

 

During the quarter ended June 30, 2011 our U.S. and Europe businesses continued to encounter persistently weak institutional trading volumes.  In the U.S., outflows from domestic equity funds re-accelerated, resulting in a shift in the mix of our business, which has reduced our average revenue capture rate per share and, as a result, our revenues and profitability. In Europe, institutional market turnover has fallen dramatically as economic uncertainty continues in the Euro zone with the prevailing sovereign debt crisis. Canadian revenues lost some momentum during the second quarter, despite favorable exchange rates, while our Asia Pacific business continues to improve, narrowing its quarterly operating loss to less than $2.0 million. Adjusted net income (see Non-GAAP Financial Measures), for the quarter was $5.8 million, or $0.14 per diluted share, compared to $15.3 million, or $0.35 per diluted share, during the second quarter of 2010.  Consolidated revenues decreased 8% to $142.6 million compared to $155.3 million generated in the second quarter of 2010.

 

Faced with significant competition for commission dollars (with more than half of the available U.S. equity commission pool being dedicated to research and advisory services), last year we took the first major step in our competitive strategy of expanding our addressable market by transforming our business into a combined content and execution model.  In October 2010, we acquired Majestic Research Corp (now ITG Investment Research).  In the second quarter of 2011, we completed the next step of our build-out of ITG Investment Research by acquiring Ross Smith Energy Group Ltd.  RSEG provides detailed technical and financial analysis of North American resource plays, public and private corporations, as well as coverage of international and macroeconomic energy issues, for more than 200 clients in North America and Europe, a number of which are new clients for ITG. The RSEG acquisition provides sector expansion into energy as well as geographic expansion into Canada for our research offering.  In connection with the RSEG acquisition, we incurred acquisition and related costs of $2.5 million consisting of professional fees associated with the transaction of $0.7 million and $1.8 million to terminate a distribution agreement with a third party. We also launched new coverage in the Canadian wireless, medical devices and softline retail sectors and continued to establish new trading relationships with accounts to pay for our research.

 

In the current environment, we are proceeding cautiously given the lack of visibility as to when conditions will become more favorable for our business.  As we weather this period of uncertainty, we are focused on improving profitability while also maintaining flexibility to allocate additional resources to our research build-out.  Accordingly, in the second quarter we established a restructuring plan to improve margins and enhance stockholder returns primarily focused on reducing workforce, consulting and infrastructure costs in the U.S. and Europe. The cost reduction plan resulted in a restructuring charge during the second quarter of $17.7 million consisting of employee separation and related costs ($17.4 million) and lease consolidation costs ($0.3 million).  Annualized cost savings for 2012 are estimated to exceed $20 million, with a significant portion of these savings beginning to take effect in the third quarter of 2011. Employee severance costs relate to the termination of approximately 100 employees while the lease consolidation costs relate to vacated office space.

 

In the second quarter, we also recorded a goodwill impairment charge in our U.S. operations of $225.0 million resulting from weak institutional trading activity and a decline in industry market multiples (see Critical Accounting Estimates).  This non-cash charge has no impact on debt covenants, cash flows or day-to-day business operations.

 

As a result of the above charges, we incurred a net loss on a U.S. GAAP basis of $196.1 million, or ($4.77) per diluted share, for the second quarter compared to net income on a U.S. GAAP basis of $7.5 million, or $0.17 per diluted share, during the second quarter of 2010.

 

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Consolidated expenses for the quarter were $377.2 million compared to $136.0 million in the second quarter of 2010 primarily due to the impairment, restructuring and acquisition related costs described above which collectively contributed $245.3 million to expense growth.  Adjusted expenses for the quarter were $132.0 million compared to adjusted expenses of $128.2 million in the second quarter of 2010.  In the U.S., adjusted expenses were $87.1 million compared to adjusted expenses of $84.1 million during the second quarter of 2010. The growth in adjusted U.S. expenses related to the inclusion of expenses for our research operations of $7.8 million, which was partially offset by savings from earlier cost reduction initiatives. Our adjusted non-U.S. expenses were $44.8 million during the second quarter of 2011 compared to adjusted expenses of $44.2 million in the second quarter of 2010 as cost saving initiatives offset most of the $3.4 million increase from foreign currency translation, $0.2 million of costs associated with our research operations and $0.6 million of additional global research and development expenses that were allocated from our U.S. operations to our international operations.  This reallocation more accurately reflects the global manner in which these resources are managed and consumed (see Non-GAAP Financial Measures for all adjusted amounts).

 

Segment Discussions

 

U.S. equity volumes during the second quarter were at the lowest levels since late 2007. While the U.S. equity market valuations remain near multiyear highs, investors continue to pull money out of domestic stock funds in favor of fixed income, non-U.S equity and exchange-traded funds, thereby diminishing the pool of available commissions.  Execution-only brokers have been particularly challenged as research-driven commission spending is generally given priority by investment managers. During the first two months of 2011, domestic equity fund flows briefly turned positive, with inflows of approximately $20.6 billion (according to the Investment Company Institute), before reverting to outflows of approximately $5.0 billion in March followed by approximately $25.1 billion in outflows in the second quarter. This negative sentiment continues to cast uncertainty as to when a real, sustainable recovery in domestic institutional equity activity will materialize, as well as the extent to which it will recover.

 

During the second quarter of 2011, our average daily executed volumes in the U.S. declined by 4% to 191.1 million shares per day as compared to the second quarter of 2010, outperforming the 31% decline in the overall combined average daily market volume of NYSE and NASDAQ-listed securities during the same period. Increased flows from our sell-side client segment, including those that trade through us on a net basis, and from funds employing quantitative strategies compensated in part for the reduced flows from our core actively managed institutional accounts. This shift in our volume mix has reduced our average revenue capture per share, resulting in a net reduction to commissions and fees of 21% versus the second quarter of 2010.  Our total U.S. revenues were $93.9 million, declining from the $108.1 million generated in the second quarter of 2010.

 

We are continuing to manage costs in the U.S. with the only meaningful increase coming from our new research operations. While our current results reflect the unfavorably leveraged effects of our largely fixed cost structure, our now leaner cost structure is positioned to provide more positive leverage from future revenue growth.

 

Our Canadian business also faced challenges with commission revenues falling 7% on lower institutional volumes and revenue capture per share.  As in the U.S., our plan is to expand our market reach with research services following our acquisition of RSEG.

 

In Europe, economic uncertainty has led investors to remain cautious and minimize their exposure to equities and to hold more of their remaining equity exposure in passive funds. As a result, market turnover has fallen dramatically, resulting in lower broker commissions across the market, particularly for execution-only brokers. In this environment, our European commission revenues fell only 2%, including a favorable currency translation effect of nearly $1.3 million.  A higher percentage of trades internally crossed and cost saving initiatives implemented for our clearance and settlement activities helped us control transaction processing costs and preserve profitability on an adjusted basis. On a U.S. GAAP basis we incurred a pre-tax loss of $0.9 million in Europe due to $1.2 million of restructuring costs. There is considerable uncertainty surrounding the economic climate in the region, which could have an impact on our near-term results.

 

Our Asia Pacific Operations posted record revenues of $10.4 million, 33% higher than the second quarter of 2010. We continue to view Asia Pacific as a significant opportunity for ITG as our POSIT Marketplace gains traction in the Hong Kong marketplace, which ranks among the highest of all equity markets in the developed world for trading costs. As a result of the improved revenues and various cost savings initiatives implemented throughout 2010, we were able to significantly reduce our pre-tax operating loss in the region to less than $2.0 million.

 

Capital Resource Allocation

 

In the second quarter of 2011, we acquired RSEG for $38.6 million, which was partially financed by a $25.5 million four-year term loan from Bank of America. This loan is secured by a security interest in equipment owned by Investment Technology Group, Inc. and certain U.S. subsidiaries as of June 1, 2011. We also returned $5.2 million to stockholders in the form of stock repurchases, bringing the year-to-date total to $17.8 million, representing 116% of our year-to-date adjusted net income.  Going

 

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forward, we intend to utilize our capital resource flexibility, including our debt capacity, to continue to capitalize on strategic investment opportunities while we return profits to stockholders through stock repurchases.

 

Results of Operations — Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

 

U.S. Operations

 

 

 

Three Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2011

 

2010

 

Change

 

% Change

 

Revenues

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

70,504

 

$

89,776

 

$

(19,272

)

(21

)

Recurring

 

20,791

 

17,398

 

3,393

 

20

 

Other

 

2,598

 

915

 

1,683

 

184

 

Total revenues

 

93,893

 

108,089

 

(14,196

)

(13

)

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

36,892

 

35,675

 

1,217

 

3

 

Transaction processing

 

13,439

 

12,975

 

464

 

4

 

Other expenses

 

36,316

 

35,225

 

1,091

 

3

 

Goodwill impairment

 

225,035

 

 

225,035

 

 

Restructuring charges

 

15,444

 

(165

)

15,609

 

 

Acquisition related costs

 

2,523

 

 

2,523

 

 

Interest expense

 

494

 

206

 

288

 

140

 

Total expenses

 

330,143

 

83,916

 

246,227

 

293

 

(Loss) income before income tax expense

 

$

(236,250

)

$

24,173

 

$

(260,423

)

 

Pre-tax margin

 

NA

 

22.4

%

NA

 

 

 

 

Our 2011 U.S. results include the operations of Majestic (now ITG Investment Research) following the acquisition in late October 2010. Following the acquisition of RSEG in early June 2011, the U.S. results include revenues from RSEG’s U.S. clients along with RSEG’s operating expenses, net of a charge to our Canadian operations for costs attributable to the amount of RSEG revenue recognized in Canada.

 

Our U.S. trading volumes decreased 4% over the second quarter of 2010, while overall U.S. equity volumes (as measured by the combined share volume in NYSE and NASDAQ-listed securities) were 31% lower.  Our average daily volume decreased as reduced flows from our core actively managed institutional accounts more than offset growth from our sell-side-client segment, including those clients that trade with us on a net basis, and from funds that employ quantitative strategies.  This shift in our volume mix has reduced our average revenue capture per share, resulting in a net reduction to commissions and fees of 21% versus the second quarter of 2010.

 

 

 

Three Months Ended June 30,

 

 

 

 

 

 

 

2011

 

2010

 

Change

 

% Change

 

U.S. Operations: Key Indicators*

 

 

 

 

 

 

 

 

 

Total trading volume (in billions of shares)

 

12.0

 

12.6

 

(0.6

)

(4

)

Trading volume per day (in millions of shares)

 

191.1

 

199.9

 

(8.8

)

(4

)

Average revenue per share ($)

 

$

0.0051

 

$

0.0061

 

$

(0.0010

)

(17

)

U.S. market trading days

 

63

 

63

 

 

 

 


* Excludes activity from ITG Derivatives and ITG Net commission share arrangements.

 

Recurring revenues increased primarily due to the $5.4 million of billed revenue from ITG Investment Research (including $1.0 million from RSEG), which more than offset lower revenues from our connectivity and analytical products.  A portion of the revenue attributable to ITG Investment Research during the second quarter of 2011 was recognized as commissions and fees as certain clients pay for research services through higher trading flows as part of bundled commission arrangements. The use of this payment method is an important part of our research content strategy as it provides an opportunity for revenue synergies through the use of our trading products and a more flexible way to up-sell additional research content.

 

Other revenues primarily increased from higher stock borrow revenues and a decrease in trading errors and client accommodations.  Our matched book business began in April 2010 and has grown since the second quarter of 2010.

 

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Total expenses, including the goodwill impairment, restructuring charges and acquisition related costs were up $246.2 million compared to the second quarter of 2010.  Excluding these charges, adjusted expenses (see Non-GAAP Financial Measures) were $87.1 million, compared to $84.1 million due to $7.8 million of expenses from ITG Investment Research, offset in part by savings from prior cost reduction initiatives.

 

Compensation and employee benefits increased 3% as the additional headcount related to ITG Investment Research more than offset decreases in incentive compensation, which fluctuates based on revenues, profitability and other measures, taking into account the competitive landscape for key talent.

 

Transaction processing costs increased 4% despite lower volumes, primarily due to the change in the mix of our executed trades.

 

Other expenses increased $1.1 million due primarily to costs associated with the research business, including costs for data providers, offset in part by decreases in capitalized software amortization, fixed asset depreciation and professional services fees, primarily consisting of legal fees.

 

In the second quarter of 2011, we recorded goodwill impairment charges of $225.0 million reflecting the continued weakness in institutional trading volumes, which lowered estimated future cash flows of the U.S. Operations reporting unit, and a decline in industry market multiples (see Critical Accounting Estimates for further detail).

 

Restructuring charges primarily include costs related to employee separation and related costs.  Related savings in the U.S. are estimated to exceed $16.9 million in 2012.

 

Acquisition related costs were incurred in connection with the RSEG acquisition, consisting of $0.7 million in professional services, such as legal and accounting services, as well as $1.8 million in costs to terminate a distribution agreement with a third party, net of a $1.0 million recovery from RSEG’s former owners.

 

The interest expense incurred in the second quarter of 2011 relates primarily to debt issuance cost amortization and commitment fees relating to the three-year $150 million revolving credit agreement we entered into in January 2011 to provide liquidity for our U.S. brokerage operations and the long-term debt financing we obtained in the second quarter of 2011 to provide capital for strategic initiatives (see Liquidity and Capital Resources and Note 12, Borrowings, to the condensed consolidated financial statements for further detail).  Interest expense incurred in the second quarter of 2010 relates to the term loan under our 2006 credit agreement, which was fully repaid as of December 31, 2010.

 

Canadian Operations

 

 

 

Three Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2011

 

2010

 

Change

 

% Change

 

Revenues

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

17,795

 

$

19,097

 

$

(1,302

)

(7

)

Recurring

 

1,541

 

987

 

554

 

56

 

Other

 

1,492

 

1,410

 

82

 

6

 

Total revenues

 

20,828

 

21,494

 

(666

)

(3

)

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

5,359

 

5,861

 

(502

)

(9

)

Transaction processing

 

3,503

 

4,320

 

(817

)

(19

)

Other expenses

 

6,755

 

5,037

 

1,718

 

34

 

Restructuring charges

 

685

 

(16

)

701

 

 

Total expenses

 

16,302

 

15,202

 

1,100

 

7

 

Income before income tax expense

 

$

4,526

 

$

6,292

 

$

(1,766

)

(28

)

Pre-tax margin

 

21.7

%

29.3

%

(7.6

)%

 

 

 

Currency translation increased total Canadian revenues and expenses by $1.2 million and $0.7 million, respectively, resulting in a $0.5 million increase to pre-tax income.

 

Trading on all Canadian markets was relatively flat to prior year levels.  While our total average daily volume in Canada increased slightly over the second quarter of 2010, this was attributable to growth from sell-side clients as the average daily trading

 

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volumes from institutions decreased 7%.  The change in the mix, along with pricing pressure combined to reduce commissions and fees 12% when excluding the favorable currency impact of the stronger Canadian Dollar (see Non-GAAP Financial Measures).

 

Recurring revenues benefited from the RSEG acquisition as the new vertical contributed $0.2 million in recurring revenues from Canadian clients, with an additional $0.1 million of Canadian revenues from this vertical included in commissions and fees.  Recurring revenues also benefited from increased ITG Net connections.

 

Compensation and employee benefits decreased $0.5 million as lower share-based compensation, which fluctuates for our Canadian operations based on changes in the price of our stock, as well as lower incentive-based compensation more than offset unfavorable currency translation ($0.3 million).

 

Transaction processing costs were lower despite the impact of unfavorable currency translation ($0.2 million) due to savings from the migration to a new clearing broker and lower volumes.

 

The increase in other expenses was primarily driven by higher consulting costs incurred to enhance our product offerings, a $0.2 million charge allocated for investment research costs, a $0.6 million increase in the amount allocated for research and development and unfavorable exchange rate translation.

 

Restructuring charges primarily include costs related to employee separation and related costs.  Related savings are estimated to exceed $0.5 million in 2012.

 

European Operations

 

 

 

Three Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2011

 

2010

 

Change

 

% Change

 

Revenues

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

14,185

 

$

14,433

 

$

(248

)

(2

)

Recurring

 

3,268

 

3,771

 

(503

)

(13

)

Other

 

48

 

(264

)

312

 

118

 

Total revenues

 

17,501

 

17,940

 

(439

)

(2

)

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

7,817

 

8,036

 

(219

)

(3

)

Transaction processing

 

4,080

 

4,450

 

(370

)

(8

)

Other expenses

 

5,275

 

4,517

 

758

 

17

 

Restructuring charges

 

1,235

 

 

1,235

 

 

Total expenses

 

18,407

 

17,003

 

1,404

 

8

 

(Loss) income before income tax expense

 

$

(906

)

$

937

 

$

(1,843

)

(197

)

Pre-tax margin

 

NA

 

5.2

%

(10.4

)%

 

 

 

Currency translation increased our total European revenues and expenses by $1.6 million and $2.0 million, respectively, resulting in a $0.4 million decrease to pre-tax income.

 

Economic uncertainty continues across Europe as the sovereign debt crises continues to prevail. This has led investors to remain cautious and minimize their exposure to equities and to hold more of their remaining equity exposure in passive funds. As a result, market turnover has fallen dramatically, resulting in lower broker commissions across the market, particularly for execution only brokers. However, lower liquidity levels in an already fragmented market has forced asset managers to search all available pools and enabled POSIT to grow its market share.

 

Our European commissions and fees fell 2%, including a favorable currency translation effect of nearly $1.3 million, as overall market turnover declined approximately 10%. Excluding currency translation impact, commissions and fees fell $1.5 million (see Non-GAAP Financial Measures) as price competition and lower turnover has led to lower portfolio and self-directed business. POSIT revenues and commissions from our new Single Ticket Clearing offering made strong gains.

 

Recurring revenues fell $0.5 million, despite a favorable currency impact of $0.3 million, due to order management system and analytical product subscription cancellations. Other revenues increased $0.3 million due to lower trading errors and accommodations.

 

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Total expenses were up $1.4 million compared to the second quarter of 2010.  Excluding the restructuring charge of $1.2 million, adjusted expenses in Europe were up only $0.2 million or 1% compared to the second quarter of 2010 (see Non-GAAP Financial Measures) including $2.0 million of unfavorable currency translation effect.

 

Compensation and employee benefits decreased $0.9 million, when excluding unfavorable currency translation impact of $0.7 million (see Non-GAAP Financial Measures), due primarily to a 12% reduction in headcount and decreases in incentive compensation.

 

Transaction processing costs declined 8% due to cost reduction initiatives, such as changing settlement agents, negotiating lower rates and implementing our own books and records for our clearance and settlement activities, as well as a higher percentage of volume internally crossed.  Excluding unfavorable currency translation impact of $0.6 million, transaction processing costs decreased 23% (see Non-GAAP Financial Measures).

 

Other expenses increased $0.8 million related to software licenses associated with the implementation of an in-house back office books and records system and market surveillance systems, connectivity costs associated with direct market data feeds from exchanges to improve latency and resiliency, professional fees relating to advice on new business initiatives and less foreign exchange gains.

 

Restructuring charges primarily include employee separation and related costs.  Cost savings are estimated to exceed $2.4 million in 2012.

 

Asia Pacific Operations

 

 

 

Three Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2011

 

2010

 

Change

 

% Change

 

Revenues

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

9,366

 

$

7,194

 

$

2,172

 

30

 

Recurring

 

914

 

605

 

309

 

51

 

Other

 

115

 

 

115

 

100

 

Total revenues

 

10,395

 

7,799

 

2,596

 

33

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

5,611

 

5,015

 

596

 

12

 

Transaction processing

 

2,082

 

1,836

 

246

 

13

 

Other expenses

 

4,349

 

5,089

 

(740

)

(15

)

Goodwill impairment

 

 

5,375

 

(5,375

)

(100

)

Restructuring charges

 

314

 

2,518

 

(2,204

)

(88

)

Total expenses

 

12,356

 

19,833

 

(7,477

)

(38

)

Loss before income tax expense

 

$

(1,961

)

$

(12,034

)

$

10,073

 

84

 

Pre-tax margin

 

NA

 

NA

 

NA

 

 

 

 

Currency translation, primarily from the stronger Australian dollar, increased total Asia Pacific revenues and expenses by $0.7 million each, with no material impact on pre-tax income.

 

Commission and fees increased 30% over the prior year quarter driven by increased market turnover and market share as a result of the trading flow from both U.S. and local clients.  Commissions and fees also benefitted from favorable currency translation.

 

The growth in recurring revenues primarily reflects growth in the number of billable network connections in our ITG Net connectivity business.  Other revenues increased as a result of a reduction in trading errors and accommodations.

 

Compensation and employee benefits reflect higher incentive compensation, share-based compensation and pension expense, as well as unfavorable translation of $0.4 million.

 

Transaction processing costs grew at a slower pace than related trading revenues as a higher percentage of trades executed in lower cost venues and cost saving initiatives implemented for our clearance and settlement activities reduced transaction processing costs.

 

Other expenses reflect the savings achieved from the closing of our on-shore Japanese operations in the second quarter of 2010 and other cost savings efforts partially offset by unfavorable currency translation.

 

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The restructuring charges recorded in 2011 include lease abandonment charges while the 2010 charges include costs related to employee severance, contract termination costs and non-cash write-offs of fixed assets and capitalized software in connection with closing our on-shore Japanese operations.  The goodwill impairment charge recorded in 2010 relates to the write-off of the entire balance of goodwill in our Australia reporting unit.

 

Consolidated income tax expense

 

Our effective tax rate was 16.4% in the second quarter of 2011 compared to 61.2% in the second quarter of 2010.  The decrease in the second quarter 2011 effective tax rate on the reported pre-tax loss is directly attributed to the significant impairment charge in the U.S. which is only partially deductible. The higher effective rate on the reported pre-tax income in the second quarter of 2010 resulted from significant pre-tax losses in the Asia Pacific region where we are not currently recording tax benefits. The pre-tax losses in the Asia Pacific region included restructuring charges of $2.5 million and a goodwill impairment charge of $5.4 million.  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, 2011 Compared to Six Months Ended June 30, 2010

 

U.S. Operations

 

 

 

Six Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2011

 

2010

 

Change

 

% Change

 

Revenues

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

146,335

 

$

171,486

 

$

(25,151

)

(15

)

Recurring

 

42,731

 

34,432

 

8,299

 

24

 

Other

 

5,338

 

2,079

 

3,259

 

157

 

Total revenues

 

194,404

 

207,997

 

(13,593

)

(7

)

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

75,170

 

69,945

 

5,225

 

7

 

Transaction processing

 

26,385

 

23,251

 

3,134

 

13

 

Other expenses

 

71,784

 

77,237

 

(5,453

)

(7

)

Goodwill impairment

 

225,035

 

 

225,035

 

 

Restructuring charges

 

15,444

 

(252

)

15,696

 

 

Acquisition related costs

 

2,523

 

 

2,523

 

 

Interest expense

 

764

 

430

 

334

 

78

 

Total expenses

 

417,105

 

170,611

 

246,494

 

144

 

(Loss) income before income tax expense

 

$

(222,701

)

$

37,386

 

$

(260,087

)

 

Pre-tax margin

 

NA

 

18.0

%

NA

 

 

 

 

Our U.S. trading volumes increased slightly over the first half of 2010, while overall U.S. equity volumes (as measured by the combined share volume in NYSE and NASDAQ-listed securities) were 20% lower.  Our average daily volume increased slightly, largely driven by growth from our sell-side-client segment and funds that employ quantitative strategies, which more than offset reduced flows from our core actively managed institutional accounts.  This shift in our volume mix has reduced our average revenue capture per share, resulting in a net reduction to commissions and fees of 15% versus the first half of 2010.

 

 

 

Six Months Ended June 30,

 

 

 

 

 

 

 

2011

 

2010

 

Change

 

% Change

 

U.S. Operations: Key Indicators*

 

 

 

 

 

 

 

 

 

Total trading volume (in billions of shares)

 

23.9

 

23.4

 

0.5

 

2

 

Trading volume per day (in millions of shares)

 

191.3

 

189.3

 

2.0

 

1

 

Average revenue per share ($)

 

$

0.0053

 

$

0.0064

 

$

(0.0011

)

(17

)

U.S. market trading days

 

125

 

124

 

1

 

1

 

 


* Excludes activity from ITG Derivatives and ITG Net commission share arrangements.

 

Recurring revenues increased primarily due to the $11.2 million of billed revenue from ITG Investment Research (including $1.0 million from RSEG), which more than offset lower revenues from our connectivity and analytical products due primarily to cancellations.  A portion of the revenue attributable to ITG Investment Research during the first quarter of 2011 was recognized as commissions and fees as certain clients are paying for research services through higher trading flows as part of bundled commission

 

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arrangements. The use of this payment method is an important part of our research content strategy as it provides an opportunity for revenue synergies through the use of our trading products and a more flexible way to up-sell additional research content.

 

Other revenues primarily increased from higher stock borrow revenues from our matched book business which started in April 2010, a gain of $0.5 million on the sale of our entire common stock holdings in NYSE Euronext, Inc. and gains resulting from temporary positions in securities.

 

Total 2011 expenses of $417.1 million include the following non-operating adjustments: a goodwill impairment charge ($225.0 million), restructuring charges ($15.4 million), acquisition related costs ($2.5 million) as well as the inclusion of costs for ITG Investment Research ($15.1 million), while 2010 expenses include a $6.1 million write-off of certain capitalized software initiatives.

 

Compensation and employee benefits increased 7% as the additional headcount related to ITG Investment Research more than offset cost savings initiatives and decreases in incentive compensation, which fluctuates based on revenues, profitability and other measures, taking into account the increasing competitive landscape for key talent. Also contributing to the 7% increase were other employee-related costs including relocation, training and temporary staffing needs.

 

Transaction processing costs increased 13% primarily due to higher volumes and the change on the mix of our executed trades.

 

Other expenses decreased primarily due to the $6.1 million write-off of certain capitalized software initiatives in the first quarter of 2010.  Additional cost savings in areas of capitalized software amortization, fixed asset depreciation and professional services, primarily legal fees, were virtually offset by the inclusion of ITG Investment Research expenses.

 

In the second quarter of 2011 we recorded goodwill impairment charges of $225.0 million reflecting continued weakness in institutional trading volumes, which lowered estimated future cash flows of the U.S. Operations reporting unit, and a decline in industry market multiples (see Critical Accounting Estimates for further detail).

 

Restructuring charges primarily include employee separation and related costs.  Related savings are estimated to exceed $16.9 million in 2012.

 

Acquisition related costs were incurred in connection with the RSEG acquisition, consisting of $0.7 million in professional services, such as legal and accounting services, as well as $1.8 million in costs to terminate a distribution agreement with a third party, net of a $1.0 million recovery from RSEG’s former owners.

 

The interest expense incurred in the first half of 2011 relates primarily to debt issuance cost amortization and commitment fees relating to the three-year $150 million revolving credit agreement we entered into in January 2011 to provide liquidity for our U.S. brokerage operations and the long-term debt financing we obtained in the second quarter of 2011 to provide capital for strategic initiatives (see Liquidity and Capital Resources and Note 12, Borrowings, to the condensed consolidated financial statements for further detail).  Interest expense incurred in the second quarter of 2010 relates to the term loan under our 2006 credit agreement, which was fully repaid as of December 31, 2010.

 

Canadian Operations

 

 

 

Six Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2011

 

2010

 

Change

 

% Change

 

Revenues

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

37,145

 

$

35,211

 

$

1,934

 

5

 

Recurring

 

2,753

 

1,842

 

911

 

49

 

Other

 

2,769

 

2,877

 

(108

)

(4

)

Total revenues

 

42,667

 

39,930

 

2,737

 

7

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

11,704

 

11,062

 

642

 

6

 

Transaction processing

 

7,338

 

8,001

 

(663

)

(8

)

Other expenses

 

13,297

 

10,001

 

3,296

 

33

 

Restructuring charges

 

685

 

(16

)

701

 

 

Total expenses

 

33,024

 

29,048

 

3,976

 

14

 

Income before income tax expense

 

$

9,643

 

$

10,882

 

$

(1,239

)

(11

)

Pre-tax margin

 

22.6

%

27.3

%

4.7

%

 

 

 

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Currency translation increased total Canadian revenues and expenses by $2.4 million and $1.6 million, respectively, resulting in a $0.8 million increase to pre-tax income.

 

Our Canadian average daily volume increased by 18% in the first half of 2011 primarily due to growth from sell-side clients, as volumes from institutions were up 6%. The shift in business mix along with continued pricing pressure from institutions reduced the amount of growth in commissions and fees to $1.9 million, or 5%, which was entirely attributable to the stronger Canadian dollar.

 

Recurring revenues benefited from the RSEG acquisition as the new vertical contributed $0.2 million in revenues, with an additional $0.1 million of revenues from this vertical included in commissions and fees. Recurring revenues also benefited from increased ITG Net connections and favorable currency translation.

 

Compensation and employee benefits costs were driven higher primarily due to unfavorable currency translation.

 

Transaction processing decreased $0.7 million from last year due to a reduction in clearance and settlement charges as a result of the migration to a new clearing broker in August 2010, offset in part by unfavorable currency translation.

 

The increase in other expenses was primarily driven by consulting costs incurred to enhance our product offerings, a $0.2 million charge allocated for investment research costs, a $1.4 million increase in the amount allocated for research and development and unfavorable currency translation.

 

European Operations

 

 

 

Six Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2011

 

2010

 

Change

 

% Change

 

Revenues

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

29,278

 

$

31,399

 

$

(2,121

)

(7

)

Recurring

 

6,503

 

7,345

 

(842

)

(11

)

Other

 

95

 

(435

)

530

 

122

 

Total revenues

 

35,876

 

38,309

 

(2,433

)

(6

)

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

15,767

 

16,844

 

(1,077

)

(6

)

Transaction processing

 

8,297

 

9,274

 

(977

)

(11

)

Other expenses

 

10,977

 

9,711

 

1,266

 

13

 

Restructuring charges

 

1,235

 

 

1,235

 

 

Total expenses

 

36,276

 

35,829

 

447

 

1

 

(Loss) income before income tax expense

 

$

(400

)

$

2,480

 

$

(2,880

)

(116

)

Pre-tax margin

 

NA

 

6.5

%

NA

 

 

 

 

Currency translation increased our total European revenues and expenses by $2.1 million and $2.5 million, respectively, resulting in a $0.4 million decrease to pre-tax income.

 

European commissions and fees fell 7%, despite a favorable currency translation effect of $1.7 million. Excluding this currency translation impact, commissions and fees fell $3.8 million or 12% (see Non-GAAP Financial Measures).  All products were affected by reduced institutional flow, with the exception of Single Ticket Clearing, which is a new offering that commenced in late 2010 and contributed $0.6 million of revenues in the first half of 2011.

 

Recurring revenues fell $0.8 million, despite a favorable currency impact of $0.4 million, due to order management system and analytical product subscription cancellations. Other revenues increased $0.5 million due to less trading errors and accommodations.

 

Total expenses were relatively flat compared to the prior year, despite the inclusion of the restructuring charge ($1.2 million) and unfavorable currency translation effect ($2.5 million).

 

Compensation and employee benefits decreased $2.0 million, when excluding unfavorable currency translation impact of $0.9 million (see Non-GAAP Financial Measures), due primarily to a 12% reduction in headcount and decreases in incentive compensation.

 

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Transaction processing costs were $1.0 million lower than the same period last year despite unfavorable currency translation impact of $0.8 million due to cost reduction initiatives, such as changing settlement agents, negotiating lower rates and implementing our own books and records for our clearance and settlement activities.

 

Other expenses increased $1.3 million due to unfavorable currency translation impact of $0.8 million, software licenses associated with the implementation of an in-house back office books and records system and market surveillance systems, connectivity costs associated with direct market data feeds from exchanges to improve latency and resiliency and professional fees.

 

Restructuring charges primarily include employee separation and related costs.  Cost savings are estimated to exceed $2.4 million in 2012.

 

Asia Pacific Operations

 

 

 

Six Months Ended June 30,

 

 

 

 

 

$ in thousands

 

2011

 

2010

 

Change

 

% Change

 

Revenues

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

17,768

 

$

14,322

 

$

3,446

 

24

 

Recurring

 

1,748

 

1,113

 

635

 

57

 

Other

 

232

 

341

 

(109

)

(32

)

Total revenues

 

19,748

 

15,776

 

3,972

 

25

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

10,516

 

10,200

 

316

 

3

 

Transaction processing

 

4,110

 

3,714

 

396

 

11

 

Other expenses

 

8,810

 

9,908

 

(1,098

)

(11

)

Goodwill impairment

 

 

5,375

 

(5,375

)

(100

)

Restructuring charges

 

314

 

2,518

 

(2,204

)

(88

)

Total expenses

 

23,750

 

31,715

 

(7,965

)

(25

)

Loss before income tax expense

 

$

(4,002

)

$

(15,939

)

$

11,937

 

75

 

Pre-tax margin

 

NA

 

NA

 

NA

 

 

 

 

Currency translation, primarily from the stronger Australian dollar, increased total Asia Pacific revenues and expenses by $1.0 million and $1.2 million, respectively, reducing pre-tax income by $0.2 million.

 

Commissions and fees increased 24% over the prior year largely due to increased market turnover and market share as a result of the growth in trading flow from both U.S. and local clients.  Commissions and fees also benefitted from favorable currency translation.

 

The growth in recurring revenues primarily reflects growth in the number of billable network connections in our ITG Net connectivity business.

 

Compensation and employee benefits costs reflects unfavorable currency translation of $0.5 million, as well as higher incentive compensation, share-based compensation and pension expense, partially offset by decreases in head count and other employee related expenses.

 

Transaction processing costs grew at a slower pace than related trading revenues as a higher percentage of trades were executed in lower cost venues, and cost saving initiatives implemented for our clearance and settlement activities reduced transaction processing costs.

 

Other expenses reflect the savings achieved from the closing of our on-shore Japanese operations in the second quarter of 2010 and other cost savings efforts partially offset by unfavorable currency translation.

 

The restructuring charges recorded in 2011 include lease abandonment charges while the 2010 charges include costs related to employee severance, contract termination costs and non-cash write-offs of fixed assets and capitalized software in connection with closing our on-shore Japanese operations.  The goodwill impairment charge recorded in 2010 relates to the write-off of the entire balance of goodwill in our Australia reporting unit.

 

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Table of Contents

 

Consolidated income tax expense

 

Our effective tax rate was 14.2% in the first half of 2011 compared to 54.2% in the first half of 2010.  The decrease in the 2011 effective tax rate on the reported pre-tax loss is directly attributed to the significant impairment charge in the U.S., which is only partially deductible. The higher effective rate on the reported pre-tax income in 2010 resulted from significant pre-tax losses in the Asia Pacific region where we are not currently recording tax benefits. The pre-tax losses in the Asia Pacific Region included restructuring charges of $2.5 million and a goodwill impairment charge of $5.4 million.  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 are 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, 2011, unrestricted cash and cash equivalents totaled $268.8 million.

 

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, 2011, we had interest-bearing security deposits totaling $19.6 million with clearing organizations in the U.S. for the settlement of equity trades. In the normal course of our settlement activities, we may also need to temporarily finance customer securities positions for short settlements or delivery failures. These financings may be funded from existing cash resources, borrowings under stock loan transactions or short-term bank loans.

 

On January 31, 2011, we entered into a $150 million three-year revolving credit agreement with a syndicate of banks and JPMorgan Chase Bank, N.A., as administrative agent. As described in more detail below, this credit agreement is specifically designed to meet the liquidity needs of our U.S. broker-dealer clearance and settlement operations.

 

We self-clear equity trades in Hong Kong and Australia and maintain restricted cash deposits of $25.8 million to support overdraft facilities.  In Europe, we maintain $27.3 million in restricted cash deposits supporting working capital facilities primarily in the form of overdraft protection for our European clearing and settlement activities.

 

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.

 

Operating Activities

 

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

 

 

 

Six Months Ended June 30,

 

(in thousands)

 

2011

 

2010

 

Net (loss) income

 

$

(186,594

)

$

15,940

 

Non-cash items included in net income

 

237,337

 

54,784

 

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

 

(27,149

)

19,983

 

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

 

(35,291

)

(48,857

)

Net cash (used in) provided by operating activities

 

$

(11,697

)

$

41,850

 

 

The net decrease in operating cash flow during the first half of 2011 from receivables/payables from/to customers and brokers primarily related to European settlement activities at June 30, 2011 that were partially financed by a short-tem bank loan of $19.9 million. The decrease during the first half of 2011 from the changes in other working capital and operating assets and liabilities reflected in part the reduction of accounts payable and accrued expenses, which included the payment of the cash portion of our 2010 incentive compensation program and the payment of acquisition obligations.

 

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Table of Contents

 

In the normal course of clearing and settlement operations 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 $63.5 million includes our acquisition of RSEG, investments in capitalizable software development projects and computer hardware, software and facilities, reduced by proceeds received from the sale of common stock holdings.

 

Financing Activities

 

Net cash provided by financing activities of $25.6 million primarily reflects proceeds a term loan (described below), short-term bank borrowings from overdraft facilities arising from international clearing and settlement activities and the reduction of deferred compensation amounts through issuances of our common stock, partially offset by repurchases of ITG common stock and debt issuance cost incurred related to the credit agreement and the term loan, which were both entered into during 2011.

 

On January 31, 2011, we entered into a $150 million three-year revolving 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 $250 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 our U.S. brokerage operations to satisfy clearing margin requirements and to finance temporary positions from delivery failures and non-standard settlements. As a result, we will 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 (see note 12, “Borrowings,” to the consolidated financial statements for more details).

 

On June 1, 2011, we entered into a $25.5 million Term Loan Agreement featuring a four year term loan under the agreement secured by a security interest in equipment owned by our Investment Technology Group, Inc. and certain U.S. subsidiaries as of June 1, 2011.  The primary purpose of this financing is to provide capital for strategic initiatives.  Among other obligations and restrictions, the terms of the Term Loan Agreement include compliance with the terms and financial covenants of the three-year revolving credit agreement while that agreement is still outstanding. The term loan is payable in monthly principal installments of $530,600 beginning in July 2011 and accrues interest at 3.0% plus the average one month London Interbank Offered Rate (LIBOR) for dollar deposits.

 

The Term Loan Agreement also provides a $5 million master lease financing commitment expiring on June 28, 2012, to finance new purchases of equipment.  Each equipment lease would have a separate 48 month term from its inception date, a $1 purchase provision at the end of its term and would accrue interest at the same rate of interest prescribed for the term loan.  At June 30, 2011, no equipment leases were outstanding under this agreement.

 

During the first half of 2011, we repurchased approximately 1.3 million shares of our common stock at a cost of approximately $22.8 million, which was funded from our available cash resources. Of these shares, 1.0 million were purchased under our Board of Directors’ authorization for a total cost of $17.8 million (average cost of $17.57 per share). An additional 278,877 shares repurchased ($5.0 million) pertained solely to the satisfaction of minimum statutory withholding tax upon the net settlement of equity awards.  The total remaining number of shares currently available for repurchase under ITG’s stock repurchase program is 1.9 million.  The specific timing and amount of repurchases will vary based on market conditions and other factors.

 

Regulatory Capital

 

Under the SEC’s Uniform Net Capital Rule, our U.S. broker-dealer subsidiaries are required to maintain at least the minimum level of net capital required under Rule 15c3-1 at all times. Dividends or withdrawals of capital cannot be made from these entities if the capital is needed to comply with regulatory requirements.

 

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Table of Contents

 

Our net capital balances and the amounts in excess of required net capital at June 30, 2011 for our U.S. Operations are as follows (dollars in millions):

 

 

 

Net Capital

 

Excess Net Capital

 

U.S. Operations

 

 

 

 

 

 

 

ITG Inc.

 

$

8.4

 

$

77.4

 

AlterNet

 

4.0

 

3.88

 

Blackwatch

 

3.2

 

3.2

 

ITG Derivatives

 

2.5

 

1.5

 

 

As of June 30, 2011, ITG Inc. had a $10.8 million cash balance in a Special Reserve Bank Account for the exclusive benefit of customers and brokers under the Customer Protection Rule pursuant to SEC Rule 15c3-3, Computation for Determination of Reserve Requirements.

 

In addition, the Company’s Canadian, European and Asia Pacific Operations have subsidiaries with regulatory requirements. The net capital balances and the amount of regulatory capital in excess of the minimum requirements applicable to each business as of June 30, 2011, are summarized in the following table (dollars in millions):

 

 

 

Net Capital

 

Excess Net Capital

 

Canadian Operations

 

 

 

 

 

Canada

 

$

47.4

 

$

46.8

 

European Operations

 

 

 

 

 

Europe

 

44.2

 

2.5

 

Asia Pacific Operations

 

 

 

 

 

Australia

 

17.6

 

12.6

 

Hong Kong

 

31.2

 

12.0

 

Singapore

 

0.4

 

0.2

 

 

Liquidity and Capital Resource Outlook

 

Historically, our working capital and stock repurchase requirements as well as most investment activity have been funded from cash from operations and short-term loans. 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 2011 revolving credit agreement (see Financing Activities).  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 members of various U.S. and non-U.S. exchanges and clearing houses that trade and clear equities and/or derivative contracts.  Associated with these memberships, 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 consolidated financial statements for these agreements and believe that any potential requirement to make payments under these agreements is remote.

 

As of June 30, 2011, 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, 2010.

 

Critical Accounting Estimates

 

The following describes an update 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, 2010.

 

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Table of Contents

 

Goodwill Impairment: Testing Methodology and Valuation Considerations

 

We obtained goodwill and intangible assets as a result of the acquisitions of subsidiaries. Goodwill represents the excess of the cost over the fair market value of net assets acquired. In accordance with ASC 350, Intangibles—Goodwill and Other, we test goodwill for impairment at least annually and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. Goodwill is tested for impairment using a two-step process as follows:

 

·                  Step one—the fair value of each reporting unit is compared to its carrying value in order to identify potential impairment. If the fair value of a reporting unit exceeds the carrying value of its net assets, goodwill is not considered impaired and no further testing is required. If the carrying value of the net assets exceeds the fair value of a reporting unit, potential impairment is indicated at the reporting unit level and step two of the impairment test is performed in order to determine the implied fair value of the reporting unit’s goodwill and measure the potential impairment loss.

 

·                  Step two—when potential impairment is indicated in step one, we compare the implied fair value of goodwill with the carrying amount of that goodwill. Determining the implied fair value of goodwill requires a valuation of the reporting unit’s tangible and (non-goodwill) intangible assets and liabilities in a manner similar to the allocation of the purchase price in a business combination. Any excess in the value of a reporting unit over the amounts assigned to its assets and liabilities is referred to as the implied fair value of goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

 

The impairment assessment requires management to make estimates regarding the fair value of the reporting unit to which goodwill has been assigned. The fair values of our reporting units are determined by considering the income approach, and where appropriate, a combination of the income and market approaches to valuation.

 

Under the income approach, the fair value of the reporting unit is estimated based on the present value of expected future cash flows. The income approach is dependent on a discounted cash flow model for each of our reporting units which incorporates a cash flow forecast plus a terminal value (a commonly used methodology to capture the present value of perpetual cash flows assuming an estimated sustainable long term growth rate). Such forecasts consider business plans, historical and anticipated future results based upon our expectations for future product offerings, our market opportunities and challenges and other factors. The discount rates used to determine the present value of future cash flows are based upon an adjusted version of the Capital Asset Pricing Model (“CAPM”) to estimate the required rate of return on equity capital. The CAPM measures the rate of return required by investors given a company’s risk profile. Significant revisions to any of these estimates could lead to an impairment of all or a portion of goodwill in future periods.

 

Under the market approach, the fair value is derived from multiples which are (i) based upon operating data of similar guideline companies, (ii) evaluated and adjusted based on the strengths and weaknesses of our company compared to the guideline companies and (iii) applied to our company’s operating data to arrive at an indication of value. We also consider prices paid in recent transactions that have occurred in our industry or related industries. In the latter case, valuation multiples based upon actual transactions are used to arrive at an indication of value. Under the market approach, we make certain judgments about the selection of comparable guideline companies, comparable recent company and asset transactions and transaction control premiums. Although we have based the fair value estimate on assumptions we believe to be reasonable, those assumptions are inherently unpredictable and uncertain and actual results could differ from the estimate.

 

In our impairment testing, we also examine the sensitivity of the fair values of our reporting units by reviewing other scenarios relative to the initial assumptions we used to see if the resulting impact on fair values would have resulted in a different step one conclusion. Accordingly, we perform sensitivity analyses based on more conservative terminal growth scenarios and higher discount rates in which the fair values of these reporting units are recalculated. In the first sensitivity analysis, we lower our terminal growth rate assumptions (holding all other critical assumptions constant), while in our second sensitivity analysis, we increase each reporting unit’s discount rate (holding all other critical assumptions constant). We then evaluate the outcomes of the sensitivity analyses performed to assess their impact on our step one conclusions.

 

As a corroborative source of fair value reasonability assessment, we reconcile the aggregate fair values of our reporting units to the market capitalization of ITG to derive an implied control premium (an adjustment reflecting the estimated incremental fair value of a controlling stake in a company). In performing this reconciliation, we may, depending on the volatility of our stock price, use either the stock price on the valuation date or the average stock price over a range of dates around the valuation date, generally 30 days. We then compare the implied control premium to premiums paid in observable recent transactions of comparable companies to verify the reasonableness of the fair value of our reporting units obtained through our primary valuation methods.

 

We continually monitor and evaluate business and competitive conditions that affect our operations for indicators of potential impairment.  As a result, we performed quarterly interim impairment testing in 2010 in addition to our annual test due to the presence

 

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of adverse economic and business conditions such as significant outflows from domestic equity mutual funds (which comprise a core component of our client base), a prolonged decrease in our market capitalization below book value, a decline in our current and expected financial performance, and the significant near-term uncertainty related to both the global economic recovery and the outlook for our industry.  As these adverse circumstances indicating potential impairment have not subsided, we continued to perform interim impairment testing in 2011.  Our interim impairment tests apply the same valuation techniques, terminal growth rates and sensitivity analyses used in our prior annual impairment test to each updated quarterly cash flow forecast.

 

During the first two months of 2011, domestic equity fund flows turned positive with inflows of approximately $20.7 billion (according to the Investment Company Institute), before reverting back to outflows of $5.0 billion in March.  While our first quarter 2011 average daily executed volumes increased by 7% in the U.S. over the first quarter of 2010, a significantly higher portion of our volume was from our lower-priced sell-side clients resulting in a contraction in our overall average revenue per share.  Based upon these mixed results, it was not readily apparent whether the strong inflows in the first two months indicated the early stages of an asset allocation shift back to domestic equity mutual funds, or merely a brief respite from an ongoing redirection of funds from domestic equity mutual funds into other asset classes.  Our first quarter interim testing at March 31 did not indicate any step one goodwill impairment as fair value of each of our U.S., European and Hong Kong reporting units was determined to be in excess of its carrying value by 17%, 50% and 158%, respectively.  Also, none of the outcomes of the sensitivity analyses performed impacted the step one conclusions.

 

In the second quarter, outflows from domestic equity mutual funds re-accelerated driving our revenues sharply below the levels projected in our March 31 forecast.  Consequently, we revised our assumptions, in light of the increased uncertainty regarding the recovery of our core client trading activity, to reflect our adjusted expectations for a slower, more prolonged recovery in our revenue growth and to reduce the multiple used in our market approach to reflect the decline in industry market multiples. These revisions resulted in a fair value for our U.S. reporting unit that was determined to be $34.6 million (or 5%) below its carrying value, indicating a potential impairment and causing us to proceed to step two.  Our required step two valuation test yielded an aggregate fair value for the tangible and (non-goodwill) intangible assets in our U.S. Operations of $190.4 million above their aggregate carrying value, which reduced the amount of the implied fair value attributable to goodwill.  As a result we recorded a $225.0 million impairment charge for goodwill in our U.S. Operations.

 

Fair value for our U.S. Operations is based upon a valuation approach combining the discounted cash flow method (income approach) and the guideline company method (market approach).  The relative weighting of these two components of our fair value calculation and our 5% terminal value growth rate assumptions have been consistently applied in both our annual and interim testing. Our June 30 U.S. discount rate of 13.0% was only 50 basis points higher than the prior quarter impairment test and, was not a significant factor in our fair value diminution.  We did, however, reduce the multiple applied to our 2012 forecasted earnings under the guideline company method to 15.1 from the 18.0 used in the prior quarter’s test to reflect further weakness in industry and market conditions.

 

No impairment was indicated for our European or Hong Kong Operations as the fair values of these reporting units were determined to be in excess of their respective carrying values by 20% and 167%. In addition, none of the outcomes of our sensitivity analyses performed led us to conclude that the goodwill for these two reporting units are impaired.

 

Although no impairment of goodwill was indicated for our European and Hong Kong operations, we recognize the reasonable possibility that one of these reporting units might become impaired in future periods given the persistently unfavorable environment for our business. Similarly, while our U.S. Operations goodwill was determined to be only partially impaired, we also recognize the reasonable possibility that it could become further impaired in such an environment.  It is not possible at this time to determine if any such future impairment charge would result or, if it does, whether such charge would be material. Our use of the term “reasonable possibility” refers to a potential occurrence that is more than remote, but less than probable in our judgment. We will continue to monitor economic trends related to our business as well as re-examine the key assumptions used in our impairment testing.

 

As events and circumstances have not yet shown any meaningful signs of imminent improvement, we continue to maintain a heightened awareness of such trends and their resultant impact on our near-term profitability as well as the market price of our common stock, which has consistently traded below book value for most of the last eighteen months.  Accordingly, we will continue to perform interim goodwill impairment evaluation until such indicators of potential impairment subside.

 

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, 2010. There has been no material change in this information.

 

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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 Securities 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

 

We are not a party to any pending legal proceedings other than claims and lawsuits arising in the ordinary course of business. We do not believe these proceedings will have a material adverse effect on our financial position or results of operations.

 

Item 1A. Risk Factors

 

There has been no significant change to the risks or uncertainties that may affect our results of operations since December 31, 2010. Please see Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

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

 

The following table sets forth our share repurchase activity during the first six months of 2011, 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, 2011

 

 

 

 

 

 

 

 

 

To: January 31, 2011

 

92,404

 

$

16.79

 

 

2,896,840

 

From: February 1, 2011

 

 

 

 

 

 

 

 

 

To: February 28, 2011

 

499,548

 

18.85

 

354,500

 

2,542,340

 

From: March 1, 2011

 

 

 

 

 

 

 

 

 

To: March 31, 2011

 

350,023

 

18.45

 

320,000

 

2,222,340

 

From: April 1, 2011

 

 

 

 

 

 

 

 

 

To: April 30, 2011

 

11,402

 

16.97

 

 

2,222,340

 

From: May 1, 2011

 

 

 

 

 

 

 

 

 

To: May 31, 2011

 

320,000

 

15.31

 

320,000

 

1,902,340

 

From: June 1, 2011

 

 

 

 

 

 

 

 

 

To: June 30, 2011

 

20,000

 

14.89

 

20,000

 

1,882,340

 

Total

 

1,293,377

 

$

17.64

 

1,014,500

 

 

 

 


(a) This column includes the acquisition of 278,877 common shares from employees in order to satisfy minimum statutory withholding tax requirements upon net settlement of restricted share awards.

 

During the first half of 2011, we repurchased approximately 1.3 million shares of our common stock at a cost of approximately $22.8 million, which was funded from our available cash resources. Of these shares, 1.0 million were purchased under our Board of Directors’ authorization for a total cost of $17.8 million (average cost of $17.57 per share). An additional 278,877 shares repurchased ($5.0 million) pertained solely to the satisfaction of minimum statutory withholding tax upon the net settlement of equity

 

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awards.  The total remaining number of shares currently available for repurchase under ITG’s stock repurchase program is 1.9 million.  The specific timing and amount of repurchases will vary based on market conditions and other factors.

 

We have not paid a cash dividend to stockholders during any period of time covered by this report.  Our policy is to retain earnings to finance the operations and expansion of our businesses and to return capital to stockholders through repurchases. As a result, we currently have no intention of paying cash dividends on common stock.

 

Item 3. Defaults Upon Senior Securities

 

Not applicable.

 

Item 6. Exhibits

 

(A)

EXHIBITS

 

 

 

 

 

31.1*

Rule 13a-14(a) Certification

 

 

 

 

31.2*

Rule 13a-14(a) Certification

 

 

 

 

32.1*

Section 1350 Certification

 

 

 

 

101.1

XBRL Instance Document

 

 

 

 

101.2

XBRL Taxonomy Extension Schema Document

 

 

 

 

101.3

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

 

101.4

XBRL Taxonomy Extension Definition Linkbase Document

 

 

 

 

101.5

XBRL Taxonomy Extension Label Linkbase Document

 

 

 

 

101.6

XBRL Taxonomy Extension Presentation Linkbase Document

 


 

*

Filed herewith.

 

 

 

 

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 9, 2011

By:

/s/ STEVEN R. VIGLIOTTI

 

 

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

 

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