itg_Current_Folio_10Q

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the fiscal period ended June 30, 2018

 

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

 

for the transition period from          to            

 

Commission File Number 001-32722

 

INVESTMENT TECHNOLOGY GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

95 - 2848406

(State or Other Jurisdiction of Incorporation or
Organization)

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

 

 

165 Broadway, New York, New York

10006

(Address of Principal Executive Offices)

(Zip Code)

 

(212) 588 - 4000

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

 

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 ☒  No ☐

 

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

 

Large accelerated filer ☒

 

Accelerated filer ☐

 

 

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

(Do not check if a smaller reporting company)

 

 

 

 

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)  Yes ☐  No ☒

 

 

At July 10, 2018, the Registrant had 32,989,116 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, 2018 (unaudited) and December 31, 2017

4

 

 

 

 

Condensed Consolidated Statements of Operations (unaudited) Three and Six Months Ended June 30, 2018 and 2017

5

 

 

 

 

Condensed Consolidated Statements of Comprehensive (Loss) Income (unaudited) Three and Six Months Ended June 30, 2018 and 2017

6

 

 

 

 

Condensed Consolidated Statement of Changes in Stockholders’ Equity (unaudited) Six Months Ended June 30, 2018

7

 

 

 

 

Condensed Consolidated Statements of Cash Flows (unaudited) Six Months Ended June 30, 2018 and 2017

8

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

9

 

 

 

Item 2. 

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

27

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

44

 

 

 

Item 4. 

Controls and Procedures

44

 

 

 

 

PART II. — Other Information

 

 

 

 

Item 1. 

Legal Proceedings

45

 

 

 

Item 1A. 

Risk Factors

45

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

45

 

 

 

Item 3. 

Defaults Upon Senior Securities

46

 

 

 

Item 4. 

Mine Safety Disclosures

46

 

 

 

Item 5. 

Other Information

46

 

 

 

Item 6. 

Exhibits

47

 

 

 

 

Signature

48

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Table of Contents

 

Investment Technology Group, ITG, the ITG logo, AlterNet, ITG Net, POSIT, POSIT Alert, RFQ‑hub and Triton are registered trademarks or service marks of the Investment Technology Group, Inc. companies. Single Ticket Clearing and Algo Wheel are trademarks or service marks of the Investment Technology Group, Inc. companies.

 

PRELIMINARY NOTES

 

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

 

FORWARD-LOOKING STATEMENTS

In addition to the historical information contained throughout this Quarterly Report on Form 10‑Q, there are forward‑looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the Private Securities Litigation Reform Act of 1995. All statements regarding our expectations related to our future financial position, results of operations, revenues, cash flows, dividends, stock repurchases, 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,” “could,” “should,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “trend,” “potential” or “continue” and the negative of these terms and other comparable terminology.

Although we believe our expectations reflected in such forward‑looking statements are based on reasonable assumptions and beliefs, and on information currently available to our management, there can be no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the expectations reflected in the forward‑looking statements herein include, among others, general economic, business, credit, political and financial market conditions, both internationally and domestically, financial market volatility, fluctuations in market trading volumes, effects of inflation, adverse changes or volatility in interest rates, fluctuations in foreign exchange rates, evolving industry regulations and increased regulatory scrutiny, the outcome of contingencies such as legal proceedings or governmental or regulatory investigations and customer or shareholder reaction to, or further proceedings or sanctions based on, such matters, the volatility of our stock price, changes in tax policy or accounting rules, the ability of the Company to utilize its loss and tax credit carryforwards, the actions of both current and potential new competitors, changes in commission pricing, rapid changes in technology, errors or malfunctions in our systems or technology, operational risks related to misconduct or errors by our employees or entities with which we do business, cash flows into or redemptions from equity mutual funds, ability to meet the capital and liquidity requirements of our securities businesses and the related 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 protect our intellectual property, our ability to execute on strategic initiatives or transactions, our ability to attract and retain talented employees, and our ability to pay dividends or repurchase our common stock in the future.

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, 2017 and Part II, Item 1A, Risk Factors in our Quarterly Reports on Form 10-Q, which you are encouraged to read.  Our 2017 Annual Report on Form 10-K and Quarterly Reports on Form 10-Q are available through our website at http://investor.itg.com under “SEC Filings.”

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

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Table of Contents

PART I. — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Financial Condition

(In thousands, except share amounts)

 

 

 

 

 

 

 

 

 

 

 

June 30, 

 

December 31, 

 

 

    

2018

    

2017

 

Assets

 

 

 

 

 

    

 

Cash and cash equivalents

 

$

236,446

 

$

287,452

 

Cash restricted or segregated under regulations and other

 

 

18,263

 

 

18,599

 

Deposits with clearing organizations

 

 

80,373

 

 

57,388

 

Securities owned, at fair value

 

 

939

 

 

1,559

 

Receivables from brokers, dealers and clearing organizations

 

 

259,982

 

 

193,907

 

Receivables from customers

 

 

164,583

 

 

74,695

 

Premises and equipment, net

 

 

52,091

 

 

53,960

 

Capitalized software, net

 

 

41,462

 

 

41,259

 

Goodwill

 

 

10,788

 

 

11,054

 

Intangibles, net

 

 

13,481

 

 

14,040

 

Income taxes receivable

 

 

128

 

 

3,917

 

Deferred tax assets

 

 

4,389

 

 

4,902

 

Other assets

 

 

44,009

 

 

22,124

 

Total assets

 

$

926,934

 

$

784,856

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

198,193

 

$

166,495

 

Short-term bank loans

 

 

72,997

 

 

101,422

 

Payables to brokers, dealers and clearing organizations

 

 

178,886

 

 

119,278

 

Payables to customers

 

 

113,340

 

 

23,568

 

Securities sold, not yet purchased, at fair value

 

 

 —

 

 

 1

 

Income taxes payable

 

 

4,287

 

 

6,003

 

Deferred tax liabilities

 

 

1,768

 

 

1,750

 

Term debt

 

 

2,329

 

 

3,104

 

Total liabilities

 

 

571,800

 

 

421,621

 

Commitments and contingencies

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

 

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

 

 

 —

 

 

 —

 

Common stock, $0.01 par value; 100,000,000 shares authorized; 52,748,475 and 52,639,823 shares issued at June 30, 2018 and December 31, 2017, respectively

 

 

527

 

 

526

 

Additional paid-in capital

 

 

247,897

 

 

250,216

 

Retained earnings

 

 

483,639

 

 

486,957

 

Common stock held in treasury, at cost; 19,757,705 and 20,038,809 shares at June 30, 2018 and December 31, 2017, respectively

 

 

(349,906)

 

 

(353,067)

 

Accumulated other comprehensive loss (net of tax)

 

 

(27,023)

 

 

(21,397)

 

Total stockholders’ equity

 

 

355,134

 

 

363,235

 

Total liabilities and stockholders’ equity

 

$

926,934

 

$

784,856

 

 

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

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

    

2018

    

2017

    

2018

    

2017

 

Revenues:

 

 

    

 

 

    

 

 

    

 

 

    

 

Commissions and fees

 

$

106,451

 

$

100,564

 

$

216,020

 

$

200,444

 

Recurring

 

 

20,082

 

 

18,933

 

 

39,644

 

 

37,883

 

Other

 

 

1,944

 

 

2,084

 

 

4,297

 

 

4,089

 

Total revenues

 

 

128,477

 

 

121,581

 

 

259,961

 

 

242,416

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

 

45,099

 

 

45,994

 

 

90,886

 

 

92,678

 

Transaction processing

 

 

25,969

 

 

25,482

 

 

53,049

 

 

50,338

 

Occupancy and equipment

 

 

15,055

 

 

14,680

 

 

29,830

 

 

30,302

 

Telecommunications and data processing services

 

 

12,988

 

 

12,129

 

 

25,591

 

 

24,156

 

Restructuring charges

 

 

 —

 

 

 —

 

 

7,165

 

 

 —

 

Other general and administrative

 

 

29,132

 

 

17,699

 

 

46,823

 

 

35,014

 

Interest expense

 

 

488

 

 

510

 

 

974

 

 

1,030

 

Total expenses

 

 

128,731

 

 

116,494

 

 

254,318

 

 

233,518

 

(Loss) income before income tax expense

 

 

(254)

 

 

5,087

 

 

5,643

 

 

8,898

 

Income tax expense (benefit)

 

 

2,781

 

 

444

 

 

4,301

 

 

(1,047)

 

Net (loss) income

 

$

(3,035)

 

$

4,643

 

$

1,342

 

$

9,945

 

(Loss) income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.09)

 

$

0.14

 

$

0.04

 

$

0.30

 

Diluted

 

$

(0.09)

 

$

0.14

 

$

0.04

 

$

0.29

 

Basic weighted average number of common shares outstanding

 

 

33,035

 

 

33,125

 

 

32,963

 

 

33,037

 

Diluted weighted average number of common shares outstanding

 

 

33,035

 

 

34,222

 

 

33,986

 

 

34,180

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

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INVESTMENT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive (Loss) Income (unaudited)

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

    

2018

    

2017

    

2018

    

2017

 

Net (loss) income

 

$

(3,035)

 

$

4,643

 

$

1,342

 

$

9,945

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency translation adjustment

 

 

(6,695)

 

 

4,730

 

 

(5,626)

 

 

6,756

 

Other comprehensive (loss) income

 

 

(6,695)

 

 

4,730

 

 

(5,626)

 

 

6,756

 

Comprehensive (loss) income

 

$

(9,730)

 

$

9,373

 

$

(4,284)

 

$

16,701

 

 

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, 2018

(In thousands, except share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Common

    

Accumulated

    

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

Stock

 

Other

 

Total

 

 

 

Preferred

 

Common

 

Paid-in

 

Retained

 

Held in

 

Comprehensive

 

Stockholders’

 

 

 

Stock

 

Stock

 

Capital

 

Earnings

 

Treasury

 

Income/(Loss)

 

Equity

 

Balance at January 1, 2018

 

$

 —

 

$

526

 

$

250,216

 

$

486,957

 

$

(353,067)

 

$

(21,397)

 

$

363,235

 

Net income

 

 

 —

 

 

 —

 

 

 —

 

 

1,342

 

 

 —

 

 

 —

 

 

1,342

 

Other comprehensive loss

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(5,626)

 

 

(5,626)

 

Issuance of common stock in connection with restricted stock unit awards (1,048,639 shares)

 

 

 —

 

 

 1

 

 

(17,005)

 

 

 —

 

 

17,214

 

 

 —

 

 

210

 

Issuance of common stock for the employee stock purchase plan (30,769 shares)

 

 

 —

 

 

 —

 

 

523

 

 

 —

 

 

 —

 

 

 —

 

 

523

 

Shares withheld for net settlements of share-based awards (409,431 shares)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(8,366)

 

 

 —

 

 

(8,366)

 

Purchase of common stock for treasury (282,980 shares)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(5,736)

 

 

 —

 

 

(5,736)

 

Dividends declared on common stock

 

 

 —

 

 

 —

 

 

 9

 

 

(4,614)

 

 

49

 

 

 —

 

 

(4,556)

 

Share-based compensation

 

 

 —

 

 

 —

 

 

14,154

 

 

 —

 

 

 —

 

 

 —

 

 

14,154

 

Cumulative effect of accounting change

 

 

 —

 

 

 —

 

 

 —

 

 

(46)

 

 

 

 

 

 —

 

 

(46)

 

Balance at June 30, 2018

 

$

 —

 

$

527

 

$

247,897

 

$

483,639

 

$

(349,906)

 

$

(27,023)

 

$

355,134

 

 

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, 

 

 

 

2018

 

2017

 

Cash Flows from Operating Activities:

    

 

    

    

 

    

 

Net income

 

$

1,342

 

$

9,945

 

Adjustments to reconcile net income to net cash used in operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

22,220

 

 

22,437

 

Deferred income tax expense (benefit)

 

 

729

 

 

(7,407)

 

Provision for doubtful accounts

 

 

192

 

 

155

 

Non-cash share-based compensation

 

 

14,154

 

 

10,818

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Deposits with clearing organizations

 

 

(24,118)

 

 

(9,673)

 

Securities owned, at fair value

 

 

620

 

 

634

 

Receivables from brokers, dealers and clearing organizations

 

 

(74,048)

 

 

(83,582)

 

Receivables from customers

 

 

(93,681)

 

 

(117,877)

 

Accounts payable and accrued expenses

 

 

33,964

 

 

(29,254)

 

Payables to brokers, dealers and clearing organizations

 

 

63,422

 

 

90,673

 

Payables to customers

 

 

92,600

 

 

91,320

 

Securities sold, not yet purchased, at fair value

 

 

(1)

 

 

(249)

 

Income taxes receivable/payable

 

 

2,074

 

 

1,314

 

Other, net

 

 

(20,011)

 

 

290

 

Net cash provided by (used in) operating activities

 

 

19,458

 

 

(20,456)

 

Cash Flows from Investing Activities:

 

 

 

 

 

 

 

Investment in venture

 

 

(612)

 

 

 —

 

Capital purchases

 

 

(7,534)

 

 

(5,657)

 

Capitalization of software development costs

 

 

(13,380)

 

 

(14,357)

 

Net cash used in investing activities

 

 

(21,526)

 

 

(20,014)

 

Cash Flows from Financing Activities:

 

 

 

 

 

 

 

Repayments of long term debt

 

 

(775)

 

 

(3,317)

 

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

 

 

(26,623)

 

 

13,359

 

Debt issuance costs

 

 

(751)

 

 

(762)

 

Common stock issued

 

 

733

 

 

745

 

Common stock repurchased

 

 

(5,736)

 

 

(4,983)

 

Dividends paid

 

 

(4,581)

 

 

(4,595)

 

Shares withheld for net settlements of share-based awards

 

 

(8,366)

 

 

(9,882)

 

Net cash used in financing activities

 

 

(46,099)

 

 

(9,435)

 

Effect of exchange rate changes on cash, cash equivalents and restricted cash

 

 

(3,175)

 

 

520

 

Net decrease in cash, cash equivalents and restricted cash

 

 

(51,342)

 

 

(49,385)

 

Cash, cash equivalents and restricted cash—beginning of period

 

 

306,051

 

 

318,330

 

Cash, cash equivalents and restricted cash—end of period

 

$

254,709

 

$

268,945

 

 

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

 

Interest paid

 

$

2,775

 

$

2,326

 

Income taxes paid, net

 

$

1,496

 

$

4,859

 

 

 

 

 

 

 

 

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

 

 

Investment in venture

 

$

1,393

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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. (the “Company” or “ITG”) was formed as a Delaware corporation on July 22, 1983. Its principal subsidiaries include: (1) ITG Inc., AlterNet Securities, Inc. (“AlterNet”) and ITG Derivatives LLC (through February 16, 2018) (“ITG Derivatives”), institutional broker-dealers in the United States (“U.S.”), (2) ITG Canada Corp., an institutional broker-dealer in Canada, (3) Investment Technology Group Limited, an institutional broker-dealer in Europe, (4) ITG Australia Limited, an institutional broker-dealer in Australia, (5) ITG Hong Kong Limited, an institutional broker-dealer in Hong Kong, (6) ITG Software Solutions, Inc., the Company’s intangible property, software development and maintenance subsidiary in the U.S., and (7) ITG Solutions Network, Inc., a holding company for ITG Analytics, Inc., a provider of pre- and post-trade analysis, fair value and trade optimization services, and ITG Platforms Inc., a provider of workflow technology solutions and network connectivity services for the financial community.

 

ITG is a global financial technology company that helps leading brokers and asset managers improve returns for investors around the world. ITG empowers traders to reduce the end-to-end cost of implementing investments via liquidity, execution, analytics and workflow technology solutions. ITG has offices in Asia Pacific, Europe and North America and offers execution services in more than 50 countries.

 

The Company’s business is organized into four reportable operating segments: U.S. Operations, Canadian Operations, European Operations and Asia Pacific Operations (see Note 16, Segment Reporting).

 

The four operating segments offer a wide range of solutions for asset managers and broker‑dealers in the areas of execution services, workflow technology and analytics. These offerings include trade execution services and solutions for portfolio management, as well as pre‑trade analytics and post‑trade analytics and processing.

Regional segment results exclude the impact of Corporate activity, which is presented separately and includes investment income from treasury activity, certain non-operating revenues and other gains as well as costs not associated with operating the businesses within the Company’s regional segments.  These costs include, among others, (a) the costs of being a public company, such as certain staff costs, a portion of external audit fees, and reporting, filing and listing costs, (b) intangible asset amortization, (c) interest expense, (d) professional fees associated with the Company's global transfer pricing structure, (e) foreign exchange gains or losses and (f) certain non-operating expenses.

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 the financial statements.

 

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, 2017.

 

Recently Adopted Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014‑09, Revenue from Contracts with Customers. This standard created Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, (“ASC 606”), providing companies with a single five step revenue recognition model for use in accounting for revenue arising from contracts with customers and supersedes current revenue recognition guidance, including industry‑specific revenue guidance. On January 1, 2018, the Company adopted

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ASC 606, using the modified retrospective transition method applied to all contracts as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior period. See Note 3, Revenue from Contracts with Customers, for additional information.

 

In May 2017, the FASB issued Accounting Standards Update (“ASU”) 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting.  The amendments in this ASU clarify which changes to the terms or conditions of a share-based payment award must be accounted for as modifications.  The new guidance allows entities to make non-substantive changes to awards without accounting for them as modifications, which results in fewer changes to the terms of an award being accounted for as modifications and reduces diversity in practice when applying modification accounting.  ASU 2017-09 is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods.  This new guidance was adopted on January 1, 2018 and did not have a material effect on the Company’s financial statements.

In November 2016, the FASB issued ASU 2016‑18, Statement of Cash Flows (Topic 230): Restricted Cash. The amendments in this ASU require that the statement of cash flows explain the change during the period in the total of cash, cash equivalents and restricted cash. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016‑18 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. This new guidance was adopted on January 1, 2018 and did not have a material effect on the Company’s financial statements.

 

(2) Fair Value Measurements

 

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

*

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

*

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

*

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

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

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

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

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2018

    

Total

    

Level 1

    

Level 2

    

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market mutual funds

 

$

 1

 

$

 1

 

$

 —

 

$

 —

 

Securities owned, at fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate stocks - trading securities

 

 

 1

 

 

 1

 

 

 —

 

 

 —

 

Mutual funds

 

 

938

 

 

938

 

 

 —

 

 

 —

 

Total

 

$

940

 

$

940

 

$

 —

 

$

 —

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

None

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

    

Total

    

Level 1

    

Level 2

    

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities owned, at fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate stocks - trading securities

 

$

78

 

$

78

 

$

 —

 

$

 —

 

Mutual funds

 

 

1,481

 

 

1,481

 

 

 —

 

 

 —

 

Total

 

$

1,559

 

$

1,559

 

$

 —

 

$

 —

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold, not yet purchased, at fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate stocks - trading securities

 

 

 1

 

 

 1

 

 

 —

 

 

 —

 

Total

 

$

 1

 

$

 1

 

$

 —

 

$

 —

 

 

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

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

Certain of the Company’s assets and liabilities are carried at contracted amounts that approximate fair value. Assets and liabilities that are recorded at contracted amounts approximating fair value consist primarily of receivables from and payables to brokers, dealers, clearing organizations and customers. These receivables and payables to brokers, dealers, clearing organizations and customers are short-term in nature and, following June 30, 2018, substantially all have settled at the contracted amounts.

 

The Company believes the carrying amounts of its term-debt obligations at June 30, 2018 and December 31, 2017 approximate fair value because the interest rates on these instruments change with, or approximate, market interest rates.

 

 

(3) Revenue from Contracts with Customers

 

Under ASC 606, revenues are recognized when control of the promised goods or services is transferred to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for transferring those goods or services. The following is a description of the Company’s revenue recognition policies and balances as it relates to revenue from contracts with customers.

 

Revenue from contracts with customers was $127.0 million and $256.9 million for the three and six months ended June 30, 2018, respectively. The majority of the Company’s revenues fall under the scope of ASC 606, with the exception of investment and dividend income, gains and losses on temporary securities positions assumed and other miscellaneous income, all of which are presented within the other revenue line item on the condensed consolidated statements of operations. The tables within Note 16, Segment Reporting, provide revenue disaggregated by reportable geographic operating segment and by product group.

 

Upon adoption, the Company recorded a net cumulative-effect decrease to opening retained earnings of approximately $50 thousand as of January 1, 2018, which is primarily related to:

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(i)

the deferral of commissions allocated to analytics products in bundled commission arrangements where the analytics services have not yet been transferred to the customer as of December 31, 2017, but whose commissions were appropriately recognized in the previous year under the superseded revenue recognition guidance; and

(ii)

the acceleration of revenue for certain product license fees associated with the licenses of software recognized at the point in time the customer is able to use and benefit from the license, instead of being appropriately recognized over the license period under the superseded revenue recognition guidance.

The net impacts to the condensed consolidated statements of operations of adopting ASC 606 for the three and six months ended June 30, 2018 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months

Ended

June 30, 

 

Six Months

Ended

June 30, 

 

    

2018

 

2018

Net decrease in commissions and fees

 

$

(1,068)

 

$

(4,915)

Net increase in recurring revenues

 

 

442

 

 

868

Net decrease in total revenues

 

$

(626)

 

$

(4,047)

 

At June 30, 2018, the condensed consolidated statements of financial condition include an increase to receivables from customers of $1.4 million related to the acceleration of license fees and an increase to accounts payable and accrued expenses of $5.8 million related to the deferral of commissions in bundled commission arrangements.

The following provides detailed information on the Company’s material performance obligations and how revenue is recognized.

 

Execution Services

The Company earns commissions for providing equity trade execution services to customers, with each trade executed on the client’s behalf representing a separate performance obligation that is satisfied at a point in time. Commission rates are fixed and revenue is recognized on the trade date. These revenues are presented within the commissions and fees line item on the Company’s condensed consolidated statements of operations.

 

The Company also permits institutional customers to allocate a portion of their gross commissions to pay for research, commonly known as soft dollars. The customer controls the use of the soft dollars and directs payments to third party service providers on its behalf. All amounts allocated to soft dollar arrangements are netted against commission revenues.

 

Workflow Technology

 

Through its front-end workflow solutions and network capabilities, the Company provides order and trade execution management and order routing services.

 

The Company provides trade order routing from its execution management system (“EMS”) to its execution services offerings, with each trade order routed through the EMS representing a separate performance obligation that is satisfied at a point in time. A portion of the commissions earned on the trade is then allocated to Workflow Technology based on the stand-alone selling price paid by third-party brokers for order routing. The remaining commission is allocated to Execution Services using a residual allocation approach. Commissions earned are fixed and revenue is recognized on the trade date. Commissions are presented within the commissions and fees line item on the Company’s condensed consolidated statements of operations.

 

The Company participates in commission share arrangements, where trade orders are routed to third-party brokers from its EMS and its order management system (“OMS”). Commission share revenues from third-party brokers are generally fixed and revenue is recognized at a point in time on the trade date. Commission share revenues are presented within the commissions and fees line item on the Company’s condensed consolidated statements of operations.

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The Company provides OMS and related software products and connectivity services to customers and recognizes license fee revenues and monthly connectivity fees. License fee revenues, generated for the use of the Company’s OMS and other software products, is fixed and recognized at the point in time at which the customer is able to use and benefit from the license. Connectivity revenue is variable in nature, based on the number of live connections, and is recognized over time on a monthly basis using a time-based measure of progress. These revenues are presented within the recurring line item on the Company’s condensed consolidated statements of operations.

 

Analytics

 

The Company provides customers with analytics products and services, including trading and portfolio analytics tools.

 

The Company provides analytics products and services to customers and recognizes subscription fees, which are fixed for the contract term, based on when the products and services are delivered.  Analytics services can be delivered either over time (when customers are provided with distinct ongoing access to analytics data) or at a point in time (when reports are only delivered to the customer on a periodic basis). Over time performance obligations are recognized using a time-based measure of progress on a monthly basis, since the analytics products and services are continually provided to the client. Point in time performance obligations are recognized when the analytics reports are delivered to the client. These revenues are presented within the recurring line item on the Company’s condensed consolidated statements of operations.

 

Analytics products and services can also be paid for through variable bundled arrangements with trade execution services. Customers agree to pay for analytics products and services with commissions generated from trade execution services, and commissions are allocated to the analytics performance obligation(s) using:

(i)

the commission value for each customer for the products and services it receives, which is priced using the value for similar stand-alone subscription arrangements; and

(ii)

a calculated ratio of the commission value for the products and services relative to the total amount of commissions generated from the customer.

For these bundled commission arrangements, the allocated commissions to each analytics performance obligation are then recognized as revenue when the analytics product is delivered, either over time or at a point in time. These allocated commissions may be deferred if the allocated amount exceeds the amount recognizable based on delivery. Commissions are presented within the commissions and fees line item on the Company’s condensed consolidated statements of operations.

 

Remaining Performance Obligations and Revenue Recognized from Past Performance Obligations

 

The Company elected not to disclose information about remaining performance obligations pertaining to (i) contracts with an original expected length of one year or less or (ii) contracts with variable consideration that cannot be estimated, as permitted under the guidance.

 

The Company’s remaining unsatisfied performance obligations that do not meet the criteria above primarily relate to analytics products and services that have fixed subscription fees. As of June 30, 2018, the future revenue the Company expects to recognize for these performance obligations is not material.

 

For the three months ended June 30, 2018, the Company recognized revenue of $0.8 million related to performance obligations satisfied in previous periods.

 

 

Contract Balances

 

The timing of the Company’s revenue recognition may differ from the timing of payment by customers. The Company records a receivable when revenue is recognized prior to payment and has an unconditional right to payment. Alternatively, when payment precedes the provision of the related services, the Company records deferred revenue until the performance obligations are satisfied.

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Receivables related to contracts with customers were $41.4 million and $38.2 million as of June 30, 2018 and December 31, 2017, respectively. The Company did not identify any contract assets.  There were no impairment losses on receivables as of June 30, 2018.

 

Deferred revenue primarily relates to deferred commissions allocated to analytics products and subscription fees billed in advance of satisfying the performance obligations. Deferred revenue related to contracts with customers was $12.6 million and $6.9 million as of June 30, 2018 and December 31, 2017, respectively. During the three and six months ended June 30, 2018, the Company recognized revenue of $7.4 million and $14.5 million, respectively, that was initially recorded as deferred revenue.

 

The Company has not identified any costs to obtain or fulfill associated with its contracts under ASC 606.

 

(4) Equity Investment

 

In February 2018, the Company established a venture with Option Technology Solutions LLC (“Optech”) to form Matrix Holding Group (“Matrix”), a derivatives execution and technology business.  Matrix offers derivatives trading technology and execution services to broker dealers, professional traders and select hedge funds.  Matrix has dedicated sales, client services, operations, and technology staff located in Chicago and New York.

 

The Company contributed the ITG Derivatives entity, including its broker-dealer license and professional trader client base with revenues of $5.3 million during the year ended December 31, 2017, along with certain derivatives-focused software and technology for an initial minority stake of approximately 20%. Optech contributed the management team, a retail-focused trading and analytics platform and capital. The board of directors of Matrix consists of two members appointed by Optech and one member appointed by the Company. Unanimous approval of the full board is required for all significant operating activities, including but not limited to: approval and amendment of annual business plans or operating budgets, establishing an incentive compensation plan, approving significant loans and expenditures, appointment of officers and entering into material agreements.    

 

The Company’s initial investment in Matrix was recorded at $2.0 million, representing the fair value of the net assets contributed. This investment included cash and restricted cash of $0.6 million and net non-cash assets of $1.4 million. No gain or loss was recognized upon the closing of this transaction as the book value of the contributed net assets approximated fair value. The Company’s interest in Matrix is accounted for in the condensed consolidated financial statements using the equity method.      

 

(5) Restructuring Charges

 

2018 Restructuring

 

In the first quarter of 2018, the Company implemented a restructuring plan to improve margins and enhance stockholder returns through the elimination of certain positions in the U.S.

 

Activity and liability balances recorded as part of the restructuring plan through June 30, 2018 are as follows (dollars in thousands):

 

 

 

 

 

 

    

Amount

Restructuring charges recognized

 

$

7,165

Cash payments (primarily severance related)

 

 

(3,328)

Acceleration of share-based compensation

 

 

(2,561)

Balance at June 30, 2018

 

$

1,276

 

The payment of the accrued costs for the 2018 restructuring is expected to continue through the first quarter of 2019.

 

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2016 Restructuring

 

As part of an end-to-end review of its business in 2016, the Company determined that its strategy is to increasingly focus its resources on its core capabilities in liquidity, execution, analytics and workflow technology solutions. To that end, in 2016, the Company implemented restructuring plans to (i) reduce headcount in its single stock sales trading and sales organizations, (ii) close its U.S. matched-book securities lending operations and its Canadian arbitrage trading desk and (iii) identify additional annual cost savings from management delayering and the elimination of certain positions.

 

Activity and liability balances recorded as part of the restructuring plan through June 30, 2018 are as follows (dollars in thousands):

 

 

 

 

 

 

    

Amount

Balance at December 31, 2017

 

$

 6

Asset write-off

 

 

(6)

Balance at June 30, 2018

 

$

 —

 

 

(6) Cash

 

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.

 

Cash Restricted or Segregated Under Regulations and Other

 

Cash restricted or segregated under regulations and other represents (i) a special reserve bank account for the exclusive benefit of customers (“Special Reserve Bank Account”) maintained by ITG Inc. in accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, as amended (“Customer Protection Rule”), or agreements for proprietary accounts of broker dealers (“PABs”), (ii) funds on deposit for Canadian and European trade clearing and settlement activity, (iii) segregated balances under a collateral account control agreement for the benefit of certain customers, and (iv) funds relating to the securitization of bank guarantees supporting the Company’s Australian and French leases.

 

The following table provides a reconciliation of cash and cash equivalents together with restricted cash as reported within the condensed consolidated statements of financial condition to the sum of the same such amounts shown in the condensed consolidated statements of cash flows.

 

 

 

 

 

 

 

 

 

 

June 30, 

 

December 31, 

 

    

2018

 

2017

Cash and cash equivalents

 

$

236,446

 

$

287,452

Cash restricted or segregated under regulations and other

 

 

18,263

 

 

18,599

Total cash, cash equivalents and restricted cash shown in the statement of cash flows

 

$

254,709

 

$

306,051

 

 

 

 

 

(7) 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 Sold, Not Yet

 

 

 

Securities Owned

 

Purchased

 

 

 

June 30, 

 

December 31, 

 

June 30, 

 

December 31, 

 

 

 

2018

 

2017

 

2018

 

2017

 

Corporate stocks - trading securities

    

$

 1

    

$

78

    

$

 —

    

$

 1

 

Mutual funds

 

 

938

 

 

1,481

 

 

 —

 

 

 —

 

Total

 

$

939

 

$

1,559

 

$

 —

 

$

 1

 

 

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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.

 

(8) Income Taxes

 

The U.S. Tax Cuts and Jobs Act of 2017 (the “Tax Cuts and Jobs Act”) was enacted on December 22, 2017, and introduced significant changes to U.S. income tax law. Effective in 2018, the Tax Cuts and Jobs Act reduced the U.S. statutory corporate tax rate from 35% to 21% and created new taxes in the U.S. on income in certain foreign controlled corporations, which are referred to as the global intangible low-taxed income tax (“GILTI”), and imposed a new tax on certain related party payments under the base erosion anti-abuse tax (“BEAT”).  The inclusion of income earned in controlled foreign corporations under the GILTI regime did not result in any incremental U.S. tax expense during the three and six months ended June 30, 2018 due to the impact of a U.S. tax loss in the current period. The Company does not expect to be subject to the BEAT tax in 2018.

Due to the timing of the enactment and the complexity involved in applying the provisions of the Tax Cuts and Jobs Act, the Company has made reasonable estimates of the effects and recorded provisional amounts in its 2017 results. As the Company collects and prepares necessary data and interprets the Tax Cuts and Jobs Act and any additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, additional adjustments to the provisional amounts may be made. Information needed to adjust provisional amounts include the completion of all international 2017 income tax returns. These additional adjustments may materially impact the provision for income taxes and effective tax rate in the period in which the adjustments are made. We expect the final accounting for the tax effects of the Tax Cuts and Jobs Act to be completed in 2018.

 

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

 

During the six months ended June 30, 2018, the Company realized a $1.9 million tax benefit related to the resolution of a multi-year contingency in the U.S.

 

The Company maintained reserves for unrecognized tax benefits of $5.6 million at June 30, 2018 and $7.7 million at December 31, 2017. At June 30, 2018, $4.2 million of the unrecognized tax benefits was netted against fully reserved U.S. deferred tax assets. The Company had accrued interest expense related to tax reserves of $1.2 million and $1.6 million, net of related tax effects, at June 30, 2018 and December 31, 2017, respectively.

 

(9) Goodwill and Other Intangibles

 

Goodwill

The following table presents the changes in the carrying amount of goodwill by the Company’s European Operations segment for the six months ended June 30, 2018 (dollars in thousands):

 

 

 

 

 

 

 

Total

Balance at December 31, 2017

 

$

11,054

Currency translation adjustment

 

 

(266)

Balance at June 30, 2018

 

$

10,788

 

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Other Intangible Assets

Acquired other intangible assets consisted of the following at June 30, 2018 and December 31, 2017 (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2018

 

December 31, 2017

 

 

 

 

 

Gross Carrying

 

Accumulated

 

Gross Carrying

 

Accumulated

 

Useful Lives

 

 

 

Amount

 

Amortization

 

Amount

 

Amortization

 

(Years)

 

Trade name

    

$

8,525

    

$

 —

    

$

8,529

    

$

 —

    

 —

 

Customer-related intangibles

 

 

9,691

 

 

6,018

 

 

10,217

 

 

6,219

 

17

 

Proprietary software

 

 

23,278

 

 

22,384

 

 

23,321

 

 

22,197

 

8.4

 

Trading rights

 

 

339

 

 

 —

 

 

339

 

 

 —

 

 —

 

Other

 

 

50

 

 

 —

 

 

50

 

 

 —

 

 —

 

Total

 

$

41,883

 

$

28,402

 

$

42,456

 

$

28,416

 

 

 

 

At June 30, 2018, indefinite-lived intangibles not subject to amortization amounted to $8.9 million, of which $8.4 million related to the POSIT trade name.

 

Amortization expense for definite-lived intangibles was $0.3 million and $0.5 million for the three and six months ended June 30, 2018, respectively, compared with $0.4 million and $0.7 million in the respective prior year periods. These amounts are included in other general and administrative expense in the condensed consolidated statements of operations.

 

The following table represents the changes in the carrying amount of net intangible assets for the six months ended June 30, 2018 (dollars in thousands):

 

 

 

 

 

 

 

 

Total

 

Balance at December 31, 2017

    

$

14,040

 

Amortization

 

 

(513)

 

Currency translation adjustment

 

 

(46)

 

Balance at June 30, 2018

 

$

13,481

 

 

 

(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, 

 

December 31, 

 

June 30, 

 

December 31, 

 

 

   

2018

   

2017

   

2018

   

2017

 

Broker-dealers

 

$

178,520

 

$

189,817

 

$

143,919

 

$

105,022

 

Clearing organizations

 

 

40,124

 

 

708

 

 

12,357

 

 

10,011

 

Securities borrowed

 

 

42,089

 

 

4,246

 

 

 —

 

 

 —

 

Securities loaned

 

 

 —

 

 

 —

 

 

22,610

 

 

4,245

 

Allowance for doubtful accounts

 

 

(751)

 

 

(864)

 

 

 —

 

 

 —

 

Total

 

$

259,982

 

$

193,907

 

$

178,886

 

$

119,278

 


*

See Securities Borrowed and Loaned below.

 

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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, 

 

December 31, 

 

June 30, 

 

December 31, 

 

 

    

2018

    

2017

    

2018

    

2017

 

Customers

 

$

165,075

 

$

75,062

 

$

113,340

 

$

23,568

 

Allowance for doubtful accounts

 

 

(492)

 

 

(367)

 

 

 —

 

 

 —

 

Net

 

$

164,583

 

$

74,695

 

$

113,340

 

$

23,568

 

 

Securities Borrowed and Loaned

 

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

 

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

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

    

Gross Amounts

    

Net Amounts

    

Collateral

    

 

 

 

 

 

 

 

 

Offset in the

 

Presented in the

 

Received or

 

 

 

 

 

 

Gross Amounts of

 

Consolidated

 

Consolidated

 

Pledged

 

 

 

 

 

 

Recognized Assets/

 

Statement of

 

Statement of

 

(including

 

Net

 

 

 

(Liabilities)

 

Financial Condition

 

Financial Condition

 

 Cash)

 

Amount

 

As of June 30, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits paid for securities borrowed

 

$

42,089

 

$

 —

 

$

42,089

 

$

42,089

 

$

 —

 

Deposits received for securities loaned

 

 

(22,610)

 

 

 —

 

 

(22,610)

 

 

(22,529)

 

 

(81)

 

As of December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits paid for securities borrowed

 

$

4,246

 

$

 —

 

$

4,246

 

$

4,246

 

$

 —

 

Deposits received for securities loaned

 

 

(4,245)

 

 

 —

 

 

(4,245)

 

 

(4,229)

 

 

(16)

 

 

 

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(11) Accounts Payable and Accrued Expenses

 

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

 

 

 

 

 

 

 

 

 

 

    

June 30, 

    

December 31, 

 

 

 

2018

 

2017

 

Accrued research payables

 

$

67,149

 

$

51,275

 

Accrued compensation and benefits

 

 

20,136

 

 

37,911

 

Accrued costs for potential class action lawsuit settlement

 

 

18,000

 

 

 —

 

Accrued costs for potential SEC settlement

 

 

12,000

 

 

 —

 

Accrued rent

 

 

13,864

 

 

14,821

 

Trade payables

 

 

17,372

 

 

20,820

 

Deferred revenue

 

 

13,861

 

 

8,057

 

Deferred compensation

 

 

2,030

 

 

2,525

 

Accrued restructuring

 

 

1,276

 

 

 6

 

Accrued transaction processing

 

 

4,027

 

 

3,257

 

Other

 

 

28,478

 

 

27,823

 

Total

 

$

198,193

 

$

166,495

 

 

 

(12) Borrowings

 

Short-term Bank Loans

 

The Company’s international securities clearance and settlement activities are funded with operating cash or with short-term bank loans in the form of overdraft facilities. At June 30, 2018, there was $73.0 million outstanding under these facilities at a weighted average interest rate of approximately 1.80% associated with international settlement activities.

 

In the U.S., securities clearance and settlement activities are funded with operating cash, securities loaned or with short-term bank loans under a committed credit agreement described below.

 

ITG Inc., as borrower, and Investment Technology Group, Inc. (“Parent Company”), as guarantor, maintained a $150 million 364-day revolving credit agreement with a syndicate of banks and JPMorgan Chase Bank, N.A., as Administrative Agent, that matured in January 2018. On January 26, 2018, ITG Inc., as borrower, and Parent Company, as guarantor, entered into a new $150 million 364-day revolving credit agreement (the “Credit Agreement”) with a syndicate of banks and JPMorgan Chase Bank, N.A., as Administrative Agent. The agreement expires on January 25, 2019. At June 30, 2018, there were no amounts outstanding under the Credit Agreement.

 

Term Debt

 

The Company had term loans of $2.3 million and $3.1 million outstanding at June 30, 2018 and December 31, 2017, respectively. 

 

On December 21, 2017, the Company entered into a three year, $0.7 million note and security agreement with Hewlett-Packard Financial Services (“H-P Veritas Loan”), under which purchases of new software licenses and support were financed.  The loan principal is payable in three installments, of which approximately $240 thousand was paid in January 2018 and two installments of approximately $230 thousand are payable in January and March of 2019.  The loan does not accrue interest.

 

On December 30, 2015, the Parent Company entered into a five year, $3.6 million note and security agreement with Hewlett-Packard Financial Services (“H-P Loan”), under which purchases of new server equipment, software license fees, maintenance fees and fees for other services were financed. The loan principal is payable in twenty quarterly installments of $195,000 that began in April 2016 and accrues interest at 2.95%. At June 30, 2018 and December 31, 2017, there was $1.9 million and $2.4 million, respectively, outstanding under the H-P Loan.

 

 

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(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, 

 

 

 

2018

    

2017

    

Three Months Ended

 

 

 

 

 

 

 

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

    

$

(3,035)

    

$

4,643

 

Shares of common stock and common stock equivalents:

 

 

 

 

 

 

 

Average common shares used in basic computation

 

 

33,035

 

 

33,125

 

Effect of dilutive securities

 

 

 —

 

 

1,097

 

Average common shares used in diluted computation

 

 

33,035

 

 

34,222

 

(Loss) income per share:

 

 

 

 

 

 

 

Basic

 

$

(0.09)

 

$

0.14

 

Diluted

 

$

(0.09)

 

$

0.14

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

 

 

 

 

Net income for basic and diluted income per share

    

$

1,342

    

$

9,945

 

Shares of common stock and common stock equivalents:

 

 

 

 

 

 

 

Average common shares used in basic computation

 

 

32,963

 

 

33,037

 

Effect of dilutive securities

 

 

1,023

 

 

1,143

 

Average common shares used in diluted computation

 

 

33,986

 

 

34,180

 

Income per share:

 

 

 

 

 

 

 

Basic

 

$

0.04

 

$

0.30

 

Diluted

 

$

0.04

 

$

0.29

 

 

There were no anti-dilutive equity awards for the three months ended June 30, 2018 due to the fact that the Company recorded a loss. For the six months ended June 30, 2018, there were approximately 0.2 million average shares that were anti-dilutive and thus not included in the computation of diluted EPS. For both the three and six month periods ended June 30, 2017, there were approximately 0.1 million average shares that were anti-dilutive and thus not included in the computation of diluted EPS.

 

 

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(14) Accumulated Other Comprehensive (Loss) Income

 

The components and allocated tax effects of accumulated other comprehensive (loss) income for the three and six months ended June 30, 2018 and 2017 are as follows (dollars in thousands):

 

 

 

 

 

 

Three Months Ended June 30, 2018

 

 

 

Balance at March 31, 2018

 

$

(20,328)

 

Other comprehensive loss

 

 

(6,695)

 

Balance at June 30, 2018

 

$

(27,023)

 

 

 

 

 

 

Three Months Ended June 30, 2017

 

 

 

Balance at March 31, 2017

 

$

(31,951)

 

Other comprehensive income

 

 

4,730

 

Balance at June 30, 2017

 

$

(27,221)

 

 

 

 

 

 

Six Months Ended June 30, 2018

 

 

 

Balance at December 31, 2017

 

$

(21,397)

 

Other comprehensive loss

 

 

(5,626)

 

Balance at June 30, 2018

 

$

(27,023)

 

 

 

 

 

 

Six Months Ended June 30, 2017

 

 

 

Balance at December 31, 2016

 

$

(33,977)

 

Other comprehensive income

 

 

6,756

 

Balance at June 30, 2017

 

$

(27,221)

 

 

Deferred taxes have not been provided on the cumulative undistributed earnings of foreign subsidiaries or the cumulative translation adjustment related to those investments due to the internal capital structure for the Company’s foreign subsidiaries and the inclusion of foreign earnings and profits in U.S. taxable income pursuant to the Tax Cuts and Jobs Act.

 

 

 

 

 

 

 

 

 

 

 

 

(15) Net Capital Requirement

 

ITG Inc. and AlterNet 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 has elected to use the basic method permitted by Rule 15c3‑1, which requires the maintenance of minimum net capital equal to the greater of 6  2/3% of aggregate indebtedness or $100,000. Dividends or withdrawals of capital cannot be made if capital is needed to comply with regulatory requirements.

 

Net capital balances and the amounts in excess of required net capital at June 30, 2018 for the U.S. Operations are as follows (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

    

Net Capital

    

Excess

 

U.S. Operations

 

 

 

 

 

 

 

ITG Inc.

 

$

81,659

 

 

80,659

 

AlterNet

 

 

5,447

 

 

5,347

 

 

As of June 30, 2018, ITG Inc. had $9.2 million of cash in a Special Reserve Bank Account for the benefit of customers under the Customer Protection Rule pursuant to SEC Rule 15c3-3, Computation for Determination of Reserve Requirements and $3.5 million under PABs.

 

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In addition, the Company’s Canadian, European and Asia Pacific Operations have subsidiaries with regulatory capital requirements. The regulatory net capital balances and amount of regulatory capital in excess of the minimum requirements applicable to each business at June 30, 2018, is summarized in the following table (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Net Capital

    

Excess

 

Canadian Operations

 

 

 

 

 

 

 

Canada

 

$

23,118

 

 

22,738

 

European Operations

 

 

 

 

 

 

 

Ireland

 

 

43,807

 

 

13,648

 

U.K.

 

 

1,513

 

 

526

 

Asia Pacific Operations

 

 

 

 

 

 

 

Australia

 

 

29,273

 

 

15,746

 

Hong Kong

 

 

3,137

 

 

2,747

 

Singapore

 

 

1,122

 

 

1,049

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(16) Segment Reporting

 

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

·

Execution Services — includes (a) liquidity matching through POSIT, (b) self-directed trading using algorithms (including single stocks and portfolio lists) and smart routing, (c) portfolio trading and single stock sales trading desks providing execution expertise and (d) futures and options trading

 

·

Workflow Technology — includes trade order and execution management software applications in addition to network connectivity

 

·

Analytics — includes (a) tools enabling portfolio managers and traders to improve pre-trade, real-time and post-trade execution performance, (b) portfolio construction and optimization decisions and (c) securities valuation

 

The accounting policies of the reportable segments are the same as those described in Note 2, Summary of Significant Accounting Policies, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. The Company allocates resources to, and evaluates the performance of, its reportable segments based on income or loss before income tax expense (benefit). 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 costs are allocated to a segment to support that segment’s activities. Commissions and fees revenue for trade executions and commission share revenues are principally attributed to each segment based upon the location of execution of the related transaction except that commissions and fees for trade executions by Canadian clients in the U.S. market are attributed to the Canadian Operations instead of the U.S. Operations. Recurring revenues are principally attributed based upon the location of the client using the respective service.

Regional segment results exclude the impact of Corporate activity, which is presented separately and includes investment income from treasury activity, certain non-operating revenues and other gains as well as costs not associated with operating the businesses within the Company’s regional segments.  These costs include, among others, (a) the costs of being a public company, such as certain staff costs, a portion of external audit fees, and reporting, filing and listing costs, (b) intangible asset amortization, (c) interest expense, (d) professional fees associated with the Company's global transfer pricing structure, (e) foreign exchange gains or losses and (f) certain non-operating expenses.

 

In 2018, the Company changed the way it measures the profitability of its regional segments to reflect the global nature of its business operations. Certain costs for senior management, product management, marketing, management information systems and infrastructure that are incurred in the U.S. on behalf of the entire Company are now being allocated to the international segments. For comparability purposes, the Company has restated previously reported segment results for the three and six months ended June 30, 2017 to reflect these changes.

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

U.S.

    

Canadian

    

European

    

Asia Pacific

    

 

 

    

 

 

 

 

    

Operations

    

Operations

    

Operations

    

Operations

    

Corporate

    

Consolidated

 

Three Months Ended June 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

48,026

 

$

17,730

 

$

42,911

 

$

19,430

 

$

380

 

$

128,477

 

(Loss) income before income tax (benefit) expense (1)

 

 

(988)

 

 

3,050

 

 

10,440

 

 

4,000

 

 

(16,756)

 

 

(254)

 

Identifiable assets

 

 

400,709

 

 

110,536

 

 

341,736

 

 

73,953

 

 

 —

 

 

926,934

 

Three Months Ended June 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

52,763

 

$

15,984

 

$

38,739

 

$

13,720

 

$

375

 

$

121,581

 

(Loss) income before income tax (benefit) expense (2)

 

 

(2,370)

 

 

2,465

 

 

9,570

 

 

799

 

 

(5,377)

 

 

5,087

 

Identifiable assets

 

 

456,071

 

 

108,698

 

 

339,337

 

 

52,570

 

 

 —

 

 

956,676

 

Six Months Ended June 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

96,512

 

$

35,777

 

$

87,741

 

$

39,037

 

$

894

 

$

259,961

 

(Loss) income before income tax (benefit) expense (1)(3)

 

 

(2,354)

 

 

6,879

 

 

22,349

 

 

8,680

 

 

(29,911)

 

 

5,643

 

Six Months Ended June 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

106,156

 

$

32,466

 

$

75,451

 

$

27,663

 

$

680

 

$

242,416

 

(Loss) income before income tax (benefit) expense (4)

 

 

(6,313)

 

 

5,296

 

 

19,508

 

 

1,913

 

 

(11,506)

 

 

8,898

 


Notes:

 

(1)

During the three and six months ended June 30, 2018, the Company incurred a charge to establish an accrual of $12.0 million for a potential settlement with the SEC of an investigation into the operational features of U.S. POSIT and access to U.S. POSIT data, together with certain related disclosures, and incurred related legal fees of $0.2 million. For more information, see Note 19, Contingencies – Legal Matters.

(2)

The Company has restated segment results for the three months ended June 30, 2017, resulting in a decrease in U.S. expenses of $2.7 million and increases in expenses in Canada, Europe and Asia Pacific of $0.7 million, $1.3 million and $0.7 million, respectively.

(3)

During the six months ended June 30, 2018, the Company incurred restructuring charges of $7.2 million related to the elimination of certain positions in the U.S.

(4)

The Company has restated segment results for the six months ended June 30, 2017, resulting in a decrease in U.S. expenses of $5.3 million and increases in expenses in Canada, Europe and Asia Pacific of $1.3 million, $2.5 million and $1.5 million, respectively.

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

 

2018

    

2017

    

2018

    

2017

 

Revenues:

    

 

    

    

 

    

 

 

    

    

 

    

 

Execution Services

 

$

89,959

 

$

86,797

 

$

184,315

 

 

173,084

 

Workflow Technology

 

 

27,112

 

 

23,352

 

 

53,687

 

 

46,452

 

Analytics

 

 

11,026

 

 

11,057

 

 

21,065

 

 

22,200

 

Corporate (non-product)

 

 

380

 

 

375

 

 

894

 

 

680

 

Total Revenues

 

$

128,477

 

$

121,581

 

$

259,961

 

$

242,416

 

 

The product group revenues noted above are consistent with the revenues recognized under ASC 606, except that the table includes revenue of $0.6 million and $1.1 million, respectively, for the three and six months ended June 30, 2018 in Analytics for functionality that is not a separate performance obligation from products and services provided by Workflow Technology and Execution Services.

 

 

(17) Dividend Program

 

During the three months ended June 30, 2018, the Board of Directors declared, and the Company paid, a quarterly dividend of $0.07 per share totaling $2.3 million, including less than $0.1 million in stock under the Company’s equity award plans. Dividends declared and paid during the six months ended June 30, 2018 totaled $0.14 per share for $4.6 million, including less than $0.1 million in stock under the Company’s equity award plans.

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

 

The Company is a member of various U.S. and non-U.S. exchanges and clearing houses that trade and clear, respectively, equities and/or derivative contracts. Associated with the Company’s membership, the Company may be required to pay a proportionate share of financial obligations of another member who may default on its obligations to the exchanges or the clearing house. While the rules governing different exchange or clearing house memberships vary, in general, the Company’s obligations would arise only if the exchanges and clearing houses had previously exhausted other remedies. The maximum potential payout under these memberships cannot be estimated. The Company has not recorded any contingent liability in the condensed consolidated financial statements for these agreements and believes that any potential requirement to make payments under these agreements is remote. In the ordinary course of business, the Company guarantees obligations of subsidiaries which may arise from third-party clearing relationships and trading counterparties. The activities of the subsidiaries covered by these guarantees are included in the Company’s condensed consolidated financial statements. The Company is also subject to indemnification provisions within agreements with third-party clearing brokers in certain jurisdictions whereby the Company is obligated to reimburse the clearing broker, without limit, for losses incurred due to a counterparty’s failure to satisfy its contractual obligations.

 

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 financing counterparty is unable to meet its contractual obligation to return customer securities pledged as collateral, the Company may be exposed to the risk of acquiring the securities at prevailing market prices in order to satisfy its customer obligations. The Company controls this risk by monitoring the market value of securities pledged on a daily basis and by requiring adjustments of collateral levels in the event of excess market exposure.

 

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

 

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

 

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

 

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

 

(19) Contingencies – Legal Matters

 

The Company is presently engaged in discussions with the SEC staff regarding a possible resolution of an investigation relating to the operational features of the U.S. POSIT alternative trading system and access to U.S. POSIT data, together with certain related disclosures.

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With regard to the operational features of U.S. POSIT, the potential resolution is focused on: (i) the technological infrastructure supporting the matching engine from 2010 through mid-2014, which affected the ability of mainly clients engaged in low-latency trading to interact with other POSIT flow and (ii) a delay feature added in 2014 to ITG’s Liquidity Guard anti-gaming technology designed to prevent latency arbitrage by temporarily preventing day orders submitted by certain clients engaged in low-latency trading from interacting with day orders from other clients.  The potential resolution is also focused on: (i) overbroad internal access to, and internal sharing of, U.S. POSIT data, (ii) between October 2010 and July 2015, the sharing of anonymized lists of the top 100 symbols executed in U.S. POSIT and the top 100 symbols sent to U.S. POSIT as immediate-or-cancel orders on the prior trading day mainly with clients or prospective clients engaged in low-latency trading, (iii) between June 2009 and November 2017, the sharing of a venue analysis report that contained up to 15 symbols (and associated aggregated, anonymized volume) executed in U.S. POSIT on the prior trading day with users of the Company’s algorithms and (iv) instances of sharing of anonymized U.S. POSIT execution information with clients.

The Company has taken meaningful remedial actions during the course of the SEC’s investigation, including imposing additional limitations on access to U.S. POSIT data as well as enhancing POSIT’s Form ATS and other disclosures.

While the Company is engaged in discussions with the SEC staff to resolve the investigation, there can be no assurance that these discussions will be successful. Based on recent discussions, the Company incurred a charge of $12.0 million during the three and six months ended June 30, 2018 to establish an accrual for a potential settlement of this matter. The SEC staff has indicated that they will recommend this penalty amount to the Commission. The Company also incurred approximately $0.2 million in legal fees associated with this matter during the second quarter of 2018.  Resolution of the matter is subject to further discussions with the SEC staff and agreement with the SEC staff on the terms of a settlement, which would be subject to review and approval by the Commission. The Company cannot predict the timing of any settlement or the ultimate resolution of the SEC investigation.  It is possible that a materially higher amount than the amount accrued could be required to achieve a resolution of the matter. In addition, the Company cannot predict the impact that the matter may have on its business going forward.

 

In addition to the above, the Company’s broker-dealer subsidiaries are subject to, or involved in, investigations and other proceedings by government agencies and self-regulatory organizations, with respect to which the Company is cooperating. Such investigations and other proceedings may result in judgments, settlements, fines, disgorgements, penalties, injunctions or other relief. Given the inherent uncertainties and the current stage of these inquiries, and the Company’s ongoing reviews, the Company is unable to predict the outcome of these matters at this time.

 

The Company is not a party to any pending material legal proceedings other than claims and lawsuits arising in the ordinary course of business, except a putative class action lawsuit and a derivative action have been filed with respect to the Company and certain of its current and former directors and/or executives in connection with the Company’s announcement of the SEC matter described in the following paragraph (and other related actions could be filed).

 

On August 12, 2015, the Company reached a final settlement with the SEC in connection with the SEC’s investigation into a proprietary trading pilot operated within AlterNet for sixteen months in 2010 through mid-2011. The investigation was focused on customer disclosures, Form ATS regulatory filings and customer information controls relating to the pilot’s trading activity, which included (a) crossing against sell-side clients in POSIT and (b) violations of Company policy and procedures by a former employee. These violations principally involved information breaches for a period of several months in 2010 regarding sell-side parent orders flowing into ITG’s algorithms and executions by all customers in non-POSIT markets that were not otherwise available to ITG clients.  According to the terms of the settlement, the Company paid an aggregate amount of $20.3 million, representing a civil penalty of $18 million, disgorgement of approximately $2.1 million in trading revenues and prejudgment interest of approximately $0.25 million. 

 

In connection with the announcement of the SEC investigation regarding AlterNet, two putative class action lawsuits were filed with respect to the Company and certain of its current and former executives, which were consolidated into a single action captioned In re Investment Technology Group, Inc. Securities Litigation before the U.S. District Court for the Southern District of New York. The complaint alleges, among other things, that the defendants made material misrepresentations or omitted to disclose material facts concerning, among other subjects, the matters that

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were the subject of the SEC settlement regarding AlterNet and the SEC investigation that led to the SEC settlement. The complaint seeks an unspecified amount of damages under the federal securities laws. On April 26, 2017, the court granted in part and denied in part the Company’s motion to dismiss the complaint and granted the plaintiff leave to file a motion to amend its complaint. On June 12, 2017, the plaintiff filed a motion to amend its complaint against certain of the individual defendants who were dismissed from the case in the court’s April opinion. On March 23, 2018, the court denied plaintiff’s motion to amend, thereby affirming its dismissal of certain of the individual defendants from the case.

 

On April 19, 2018, the Company reached an agreement in principle to settle the consolidated securities class action lawsuit. In exchange for a release of claims and a dismissal with prejudice, the settlement includes a payment to class members of $18 million, which is well within the policy limits of, and is expected to be paid by, the Company’s insurance carrier. The condensed consolidated statements of financial condition as of June 30, 2018 include a payable to class members of $18.0 million in accounts payable and accrued expenses (also, see Note 11, Accounts Payable and Accrued Expenses) that is fully offset by a receivable from the Company’s insurance carrier in other assets. As a result, the settlement is not expected to impact the Company’s results. The settlement reached is solely to eliminate the uncertainties, burden and expense of further protracted litigation and does not constitute an admission of liability by the Company or its current or former executives or directors.  Specifically, the Company and its current and former executives and directors deny any liability or responsibility for the claims made and make no admission of any wrongdoing. The parties anticipate entering into a final settlement agreement outlining the complete terms of the settlement. The settlement is subject to certain conditions, including, among others, preliminary and final court approval and notice to the class of plaintiffs in the lawsuit. There is no assurance that a final settlement will be completed, court approval will be obtained or that class member participation will be sufficient.

 

On November 27, 2015, a purported shareholder of the Company filed a shareholder derivative action captioned Watterson v. Gasser et al. against eleven current or former officers and directors of the Company in the Supreme Court for the State of New York. The Company is named as a nominal defendant, and the plaintiff purports to seek recovery on its behalf. The complaint generally alleges that the individual defendants breached their fiduciary duties to the Company in connection with the matters that were the subject of the SEC settlement regarding AlterNet.

 

While the Company cannot predict the outcome of the derivative lawsuit, the Company intends to defend it as appropriate. No reserve has been established for the derivative lawsuit since the Company is unable to provide a reasonable estimate of any potential liability given the stage of the proceeding. The Company believes, based on information currently available, that the outcome of the derivative lawsuit will not likely have a material adverse effect on its consolidated financial position.  In light of the inherent uncertainties of such proceeding, an adverse outcome may have a material impact on the results of operations for any particular period.

 

 

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

 

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

Overview

ITG is a global financial technology company that helps leading brokers and asset managers improve returns for investors around the world. ITG empowers traders to reduce the end-to-end cost of implementing investments via liquidity, execution, analytics and workflow technology solutions. ITG has offices in Asia Pacific, Europe and North America and offers execution services in more than 50 countries.

Our business is organized into four reportable operating segments: U.S. Operations, Canadian Operations, European Operations and Asia Pacific Operations (see Note 16, Segment Reporting, to the condensed consolidated financial statements). These four operating segments provide the following categories of products and services:

·

Execution Services — includes (a) liquidity matching through POSIT, (b) self-directed trading using algorithms (including single stocks and portfolio lists) and smart routing, (c) portfolio trading and single stock sales trading desks providing execution expertise and (d) futures and options trading

 

·

Workflow Technology — includes trade order and execution management software applications in addition to network connectivity

 

·

Analytics — includes (a) tools enabling portfolio managers and traders to improve pre-trade, real-time and post-trade execution performance, (b) portfolio construction and optimization decisions and (c) securities valuation

 

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

 

In 2018, we changed the way we measure the profitability of our regional segments to reflect the global nature of our business operations. Certain costs for senior management, product management, marketing, management information systems and infrastructure that are incurred in the U.S. on behalf of the entire Company are now being allocated to the international segments. For comparability purposes, we have restated previously reported segment results for the prior-year periods to reflect these changes.

 

Sources of Revenues

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

Commissions and fees are derived primarily from (i) commissions charged for trade execution services, (ii) income generated on net executions, whereby equity orders are filled at different prices within or at the National Best Bid and Offer (“NBBO”) and (iii) commission sharing arrangements between ITG Net (our private value‑added FIX‑based financial electronic communications network) and third‑party brokers and alternative trading systems whose trading products are made available to our clients on our order management system (“OMS”), and our execution management system (“EMS”), including the new Algo Wheel functionality we have embedded within Triton. The Algo Wheel is a broker-neutral tool for allocating trades to broker algorithms in an unbiased systematic fashion using a quantifiable method for evaluating and rewarding brokers for execution performance. We also have commission sharing arrangements for our Single Ticket Clearing service and our RFQ‑hub request‑for‑quote service. Because commissions are earned on a per‑transaction basis, such revenues fluctuate from period-to-period depending on (a) the volume of securities traded through our services in the U.S. and Canada, (b) the contract value of securities traded in Europe and the Asia Pacific region and (c) our commission rates. Certain factors that affect our volumes and contract values traded

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include: (i) macro trends in the global equities markets that affect overall institutional equity trading activity, (ii) competitive pressure, including pricing, created by the existence of electronic execution competitors and (iii) potential changes in market structure in the U.S. and other regions. In addition to share volume, revenues from net executions are also impacted by the width of spreads within the NBBO. Trade orders are delivered to us from our OMS and EMS products and other vendors’ products, direct computer‑to‑computer links to customers through ITG Net and third‑party networks and phone orders from our customers.

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

Other revenues primarily include: (1) the net spread on foreign exchange transactions executed on a principal basis to facilitate equity trades by clients in different currencies, as well as on other foreign exchange transactions unrelated to equity trades, (2) non-recurring consulting services, such as one-time implementation and customer training related activities, (3) investment income from treasury activity, (4) interest income on securities borrowed in connection with customers’ settlement activities, (5) market gains/losses resulting from temporary positions in securities assumed in the normal course of agency trading (including trade errors and client trade accommodations), (6) non‑recurring gains and losses such as divestitures, (7) fees earned for clearing securities transactions on behalf of other broker-dealers and (8) fees earned for commission aggregation services.

As a result of adopting ASC 606 on January 1, 2018, we identified two key accounting changes that affect the timing of revenue recognition as it relates to bundled commission arrangements and fees for software licenses.  The financial impact of these accounting changes includes (1) a deferral of revenues primarily generated in the first half of the year for commissions attributable to analytics products under bundled arrangements that will be recognized over the course of the year as the performance obligations for those analytics products are satisfied and (2) an acceleration of license fee revenues to the delivery date for software provided for a specified period.  These changes only relate to the timing of when revenue is recognized and have no effect on the underlying transaction price of the products and services we perform.  For more information on our evaluation of the revenue recognition standard and its impact on our financial statements, see Note 3, Revenue from Contracts with Customers, to the condensed consolidated financial statements.

 

Expenses

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

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

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

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

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

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

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Non-GAAP Financial Measures

To supplement our financial information presented in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”), management uses certain “non-GAAP financial measures” as such term is defined in Regulation G promulgated by the SEC. 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. Management believes the presentation of these measures provides investors with greater transparency and supplemental data relating to our financial condition and results of operations, and therefore a more complete understanding of factors affecting our business than U.S. GAAP measures alone. In addition, management believes the presentation of these measures is useful to investors for period‑to‑period comparison of results as the items described below reflect certain unique and/or non‑operating items such as acquisitions, divestitures, restructuring charges, write‑offs and impairments, charges associated with litigation or regulatory matters together with related expenses or items outside of management’s control.

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

 

Reconciliations of adjusted expenses, adjusted pre-tax income, adjusted income tax expense and adjusted net income to expenses, (loss) income before income tax expense, income tax expense and net (loss) income and related per share amounts as determined in accordance with U.S. GAAP for the three and six months ended June 30, 2018 are provided below (dollars in thousands except per share amounts).  There were no such adjustments during the three and six months ended June 30, 2017.

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

June 30,

 

June 30,

 

    

2018

 

2018

Total expenses

 

$

128,731

 

$

254,318

Less:

 

 

 

 

 

 

SEC settlement accrual and related fees (1)

 

 

(12,216)

 

 

(12,216)

Restructuring (2)

 

 

 —

 

 

(7,165)

Adjusted expenses

 

$

116,515

 

$

234,937

 

 

 

 

 

 

 

(Loss) income before income tax expense

 

$

(254)

 

$

5,643

Effect of adjustments

 

 

12,216

 

 

19,381

Adjusted pre-tax income

 

$

11,962

 

$

25,024

 

 

 

 

 

 

 

Income tax expense

 

$

2,781

 

$

4,301

Tax effect of adjustments (1)(2)

 

 

 —

 

 

 —

Reduction in tax reserves (3)

 

 

 —

 

$

1,862

Adjusted income tax expense

 

$

2,781

 

$

6,163

 

 

 

 

 

 

 

Net (loss) income

 

$

(3,035)

 

$

1,342

Net effect of adjustments

 

 

12,216

 

 

17,519

Adjusted net income

 

$

9,181

 

$

18,861

 

 

 

 

 

 

 

Diluted (loss) income per share

 

$

(0.09)

 

$

0.04

Net effect of adjustments

 

 

0.36

 

 

0.51

Adjusted diluted income per share

 

$

0.27

 

$

0.55


(1)

During the three and six months ended June 30, 2018, we incurred a charge to establish an accrual of $12.0 million for a potential settlement with the SEC of an investigation into the operational features of U.S. POSIT and access to U.S. POSIT data, together with certain related disclosures, and incurred related legal fees of $0.2 million. Due to non-deductibility of the settlement charge and the full valuation allowance on U.S. deferred tax assets, there is no tax effect on this adjustment. For more information, see Note 19, Contingencies – Legal Matters, to the condensed consolidated financial statements.

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(2)

During the six months ended June 30, 2018, we incurred restructuring charges of $7.2 million related to the elimination of certain positions in the U.S. Due to the full valuation on U.S. deferred tax assets, there is no tax effect on this adjustment.

 

(3)

During the six months ended June 30, 2018, we resolved a multi-year tax contingency in the U.S. and reduced tax reserves by $1.9 million.

 

 

Executive Summary for the Quarter Ended June 30, 2018

 

Consolidated Overview

 

Our overall results for the second quarter were strong, with solid performance from our international operations and continued growth in global commission share revenues from our Workflow Technology products despite lower levels of market-wide trading activity. Our U.S. loss narrowed sequentially, due in part to improved market share as well as the impact of cost savings measures taken in the first quarter of 2018.

 

Our revenues during the second quarter of 2018 were $128.5 million, up 6% from revenues of $121.6 million in the second quarter of 2017. We incurred a GAAP net loss of $3.0 million, or $0.09 per diluted share inclusive of a charge of $12.0 million to establish an accrual for a potential settlement of an SEC investigation along with related legal fees of $0.2 million, for a combined impact of $0.36 per share.

 

We are presently engaged in discussions with the SEC staff regarding the possible resolution of an investigation relating to operational features of the U.S. POSIT alternative trading system and access to U.S. POSIT data, together with certain related disclosures. We have taken meaningful remedial actions during the course of this investigation, including imposing additional limitations on access to U.S. POSIT data as well as enhancing POSIT’s Form ATS and other disclosures. It is possible that an amount materially higher than the amount accrued could be required to achieve a resolution and we cannot predict the impact the matter will have on our business going forward. For more information, see Note 19, Contingencies – Legal Matters, to the condensed consolidated financial statements.

 

On an adjusted basis, we generated net income of $9.2 million, or $0.27 per diluted share, compared with net income of $4.6 million, or $0.14 per diluted share in the second quarter of 2017.

 

Second quarter 2018 results continued to reflect the impact of a new accounting rule, implemented in January 2018, which requires global commission revenues attributed to analytics products under bundled arrangements to be recognized over the course of the annual service period. This change resulted in the deferral of $1.1 million in commission revenues in the second quarter of 2018, which was lower than the $3.8 million commission revenue deferral in the first quarter of 2018. These revenue deferrals are expected to be recognized in the second half of the year. This accounting change also accelerated the recognition of software license fees, increasing revenues by $0.4 million during the three months ended June 30, 2018.

 

We are continuing our focus on the execution of our Strategic Operating Plan (“SOP”), which aims to enhance global capabilities in liquidity, execution, analytics and workflow technology solutions. As of June 30, 2018, our total investment under the plan since its inception in late July 2016 is approximately $32 million. The total cost reduction measures we have implemented since launching the SOP have resulted in annual savings of more than $30 million. These savings are fully funding investments we are making under the SOP and in strategic hires. 

 

Segment Discussions

 

In 2018, we changed the way we measure the profitability of our regional segments to reflect the global nature of our business operations. Certain expenses that are incurred in the U.S. on behalf of the entire Company are now being allocated to the international segments. For comparability purposes, we have restated previously reported segment results for the three and six months ended June 30, 2017. The impact on the previously reported results for the second quarter of 2017 was a decrease in U.S. expenses of $2.7 million and increases in expenses in Canada, Europe and Asia Pacific of $0.7 million, $1.3 million and $0.7 million, respectively.

 

In the U.S., our average daily volume (“ADV”) was 3% lower than the first quarter of 2018 and 10% lower than the second quarter of 2017. Consolidated market-wide trading activity was down 10% from the volatile first quarter of 2018 and flat compared to the second quarter of 2017. Overall revenues were down 9% as compared to the prior-year quarter, reflecting in part decreased trading in our POSIT Alert block crossing system, a decline in lower-margin sell-

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side trading and the impact of the commission deferral. These decreases were offset in part by an increase in commission sharing revenues for trades executed with third-party brokers via Triton and the Algo Wheel.    

 

Our trading activity in Canada was robust during the quarter, with commissions up 13% as compared to the second quarter of 2017. Average daily volume executed in our Canadian broker was 16% higher than the second quarter of 2017, while market-wide volumes were down 6% versus the prior-year quarter. Overall revenues were up 11% compared to the prior-year quarter.

 

In Europe, our executed daily value decreased 6% in British pound terms compared to the second quarter of 2017 versus a 1% decrease in daily market-wide trading activity due to implementation of the dark pool volume caps under the new Markets in Financial Instruments Directive (“MiFID”) II regulations. Despite the drop in value traded, overall revenues were up 11% versus the second quarter of 2017, driven in part by a 36% increase, in British pound terms, in value traded in our POSIT Alert block crossing system, whose large-in-scale executions are generally exempt from the volume caps, strong growth in commission sharing revenues for trades executed with third-party brokers via Triton and the Algo Wheel and currency movements.  

 

In Asia Pacific, we achieved another quarter of strong performance, driven by increased use of algos, our POSIT Alert block crossing system and portfolio trading services. Market-wide daily value traded in our five largest regional markets was up 19% versus the second quarter of 2017, while our daily value traded was up 53%. Overall Asia Pacific revenues rose 42% over the prior-year quarter.

 

Corporate activity in the second quarter of 2018 reduced GAAP pre-tax income and adjusted pre-tax income by $16.7 million and $4.5 million, respectively. Corporate activity in the second quarter of 2017 reduced pre-tax income by $5.4 million.

 

Capital Resource Allocation

 

During the second quarter of 2018, we repurchased 102,647 shares under our authorized repurchase program for $2.2 million, or an average cost of $21.09 per share. On a year-to-date basis, we have repurchased 292,980 shares for $5.7 million, or $20.27 per share. We also maintained our $0.07 quarterly dividend program, paying out $2.3 million in cash.

 

Our goal over the long term is to use our share repurchase program to offset dilution from the issuance of stock under employee compensation plans, although the number of shares repurchased may vary from period-to-period. We may repurchase additional shares opportunistically, depending on various factors including, among others, market conditions and competing needs for the use of our capital. We have suspended share repurchases under our program pending the final resolution of the U.S. POSIT matter with the SEC.

 

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Results of Operations — Three Months Ended June 30, 2018 Compared to Three Months Ended June 30, 2017

 

U.S. Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

 

 

 

 

 

$ in thousands

    

2018

    

2017*

    

Change

    

% Change

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

35,039

 

$

40,089

 

$

(5,050)

 

(13)

%

Recurring

 

 

12,191

 

 

11,882

 

 

309

 

 3

%

Other

 

 

796

 

 

792

 

 

 4

 

 1

%

Total revenues

 

 

48,026

 

 

52,763

 

 

(4,737)

 

(9)

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

 

21,477

 

 

24,230

 

 

(2,753)

 

(11)

%

Transaction processing

 

 

7,900

 

 

10,047

 

 

(2,147)

 

(21)

%

Other expenses

 

 

19,637

 

 

20,856

 

 

(1,219)

 

(6)

%

Total expenses

 

 

49,014

 

 

55,133

 

 

(6,119)

 

(11)

%

Loss before income tax

 

$

(988)

 

$

(2,370)

 

$

1,382

 

58

%


*  Restated for comparability purposes, resulting in a decrease in U.S. expenses of $2.7 million for costs incurred in the U.S. on behalf of the global business that are now being allocated to the international segments.

The 13% decline in commissions and fees was attributable to reduced trading in our POSIT Alert block crossing system, a reduction in lower-margin sell-side trading and the spin-out of our derivatives business to the Matrix venture in mid-February of this year. Our average commission rate declined slightly to $0.0035 in the second quarter of 2018 from $0.0036 in the prior-year period. Although our market share increased sequentially to 1.93% in the second quarter of 2018 from 1.80% in the first quarter of 2018, it was still below the 2.15% share we achieved in the second quarter of 2017. In addition, the new revenue recognition standard we adopted at the beginning of the year resulted in a $0.3 million reduction to commissions and fees attributable to bundled commission arrangements for analytics products during the second quarter of 2018. We expect to recognize these deferred commissions and the $2.0 million of deferred commissions from the first quarter of 2018 in the second half of the year.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

 

 

 

 

 

U.S. Operations: Key Indicators*

    

2018

    

2017

    

Change

    

% Change

Total trading volume (in billions of shares)

 

 

8.5

 

 

9.3

 

 

(0.8)

 

(9)

%

Average trading volume per day (in millions of shares)

 

 

132.6

 

 

147.7

 

 

(15.1)

 

(10)

%

Average revenue per share

 

$

0.0035

 

$

0.0036

 

$

(0.0001)

 

(3)

%

U.S. market trading days

 

 

64

 

 

63

 

 

 1

 

 2

%


* Excludes activity from the trading of derivatives and Latin America equities, commission share arrangements and the deferral of commissions under bundled trading arrangements for analytics products.

 

Recurring revenues increased 3% from the second quarter of 2017 primarily due to an increase in OMS license fees from the revenue acceleration required by the new accounting standard that was offset by a decrease in connectivity revenue.

 

Other revenues increased slightly from the second quarter of 2017 as an increase in fees earned for commission aggregation services was mostly offset by a decrease in market data tape rebate revenue.

 

Compensation and employee benefits decreased 11% from the prior-year period primarily due to the impact of cost savings measures taken in the first quarter of 2018 and employee termination costs incurred in the second quarter of 2017 of $1.2 million.

 

Transaction processing costs decreased 21% compared to the second quarter of 2017, outpacing the 10% reduction in ADV as a result of the impact of the spin-out of our derivatives business to the Matrix venture in mid-February 2018 and reduced trade execution costs from lower liquidity taking.  As a percentage of commissions and fees, transaction processing costs decreased to 22.5% in the current period from 25.1% during the prior-year period due to the factors mentioned above, slightly offset by the impact of deferring commissions and fees attributable to bundled arrangements for analytics products.

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Other expenses decreased 6% compared to the prior-year period due to a decrease in occupancy and equipment costs related to the reduction of office space in our New York headquarters completed in late December 2017. We also had lower market data and travel and entertainment costs.

 

Canadian Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

 

 

 

 

 

$ in thousands

    

2018

    

2017*

    

Change

    

% Change

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

15,438

 

$

13,604

 

$

1,834

 

13

%

Recurring

 

 

1,235

 

 

1,284

 

 

(49)

 

(4)

%

Other

 

 

1,057

 

 

1,096

 

 

(39)

 

(4)

%

Total revenues

 

 

17,730

 

 

15,984

 

 

1,746

 

11

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

 

5,106

 

 

4,905

 

 

201

 

 4

%

Transaction processing

 

 

3,209

 

 

2,780

 

 

429

 

15

%

Other expenses

 

 

6,365

 

 

5,834

 

 

531

 

 9

%

Total expenses

 

 

14,680

 

 

13,519

 

 

1,161

 

 9

%

Income before income tax

 

$

3,050

 

$

2,465

 

$

585

 

24

%


*  Restated for comparability purposes, resulting in an increase in Canadian expenses of $0.7 million for costs incurred in the U.S. on behalf of the global business that are now being allocated to the international segments.

 

Currency translation from a stronger Canadian Dollar increased total Canadian revenues and expenses by $0.6 million and $0.4 million, respectively, resulting in an increase of $0.2 million to pre-tax income.

 

Overall commissions and fees increased 13% compared to the second quarter of 2017, including a $0.5 million favorable currency impact. The ADV in our Canadian broker grew by 16% as compared to the prior-year period despite a 6% decline in market-wide volumes due to growth from both buy-side and sell-side clients. We also achieved growth in ADV of 20% in our MATCHNow marketplace as compared to the prior-year period.

 

Recurring revenues decreased 4% compared to the second quarter of 2017 due to a decrease in connectivity fees. Other revenues decreased 4% due to a decline in revenue earned on foreign exchange transactions.

 

Compensation and employee benefits costs increased 4% compared to the second quarter of 2017 primarily due to the impact of unfavorable currency movements.

 

Transaction processing costs increased 15% compared to the second quarter of 2017, in line with the 16% growth in the ADV of our Canadian broker. As a percentage of commissions and fees, transaction processing costs remained relatively unchanged at 20.8% in the second quarter of 2018 compared to 20.4% in the second quarter of 2017.

 

Other expenses increased 9% compared to the second quarter of 2017 due to increases in hardware and software maintenance, connectivity, consulting and legal expenses.  

 

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European Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

 

 

 

 

 

$ in thousands

    

2018

    

2017*

    

Change

    

% Change

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

38,373

 

$

34,859

 

$

3,514

 

10

%

Recurring

 

 

4,699

 

 

4,048

 

 

651

 

16

%

Other

 

 

(161)

 

 

(168)

 

 

 7

 

 4

%

Total revenues

 

 

42,911

 

 

38,739

 

 

4,172

 

11

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

 

11,356

 

 

10,038

 

 

1,318

 

13

%

Transaction processing

 

 

10,371

 

 

9,821

 

 

550

 

 6

%

Other expenses

 

 

10,744

 

 

9,310

 

 

1,434

 

15

%

Total expenses

 

 

32,471

 

 

29,169

 

 

3,302

 

11

%

Income before income tax

 

$

10,440

 

$

9,570

 

$

870

 

 9

%


*  Restated for comparability purposes, resulting in an increase in European expenses of $1.3 million for costs incurred in the U.S. on behalf of the global business that are now being allocated to the international segments.

 

Overall currency rate changes in the European region increased revenues and expenses by $2.3 million and $1.6 million, respectively, resulting in an increase of $0.7 million to pre-tax income. This increase in pre-tax income was largely attributable to the strengthening of the Euro as revenues and expenses originated in British pounds largely offset each other.

 

Commissions and fees increased 10% over the second quarter of 2017, which included $2.1 million in growth from favorable currency movements. The remaining growth was attributable to a record level of value traded in our POSIT Alert block crossing system, growth in algorithmic trading and an increase in commission sharing revenues for trades executed with third-party brokers via Triton and the Algo Wheel. These increases were partially offset by reduced levels of non-block trading in POSIT from the implementation in March of the dark pool volume caps required under the MiFID II regulations. 

 

Recurring revenues increased 16% from the prior-year period due to higher billed analytics revenues from delivery timing, new revenues for research payment account (“RPA”) administration fees as a result of MiFID II regulations for unbundling that went into effect in January 2018 and higher connectivity fees. Other revenues were comparable to the prior-year period, primarily reflecting the impact of client trade accommodations. 

           

Compensation and employee benefits increased 13% from the second quarter of 2017 due to increases in salaries and incentive compensation, as well as the unfavorable impact of currency movements.

 

Transaction processing costs increased 6% from the second quarter of 2017, primarily due to a $0.6 million increase from unfavorable currency movements. The less than 1% decline in transaction processing costs excluding the impact of currency was below the 6% reduction in average daily value traded in British pound terms due to an increase in rebates paid to introducing firms and the impact of a lower crossing rate in POSIT. As a percentage of commissions and fees, transaction processing costs decreased to 27.0% in the second quarter of 2018 from 28.2% in the prior-year quarter.

 

Other expenses increased 15% from the second quarter of 2017 due to higher costs for facilities, software, and market data. In addition, other expenses increased by $0.4 million from the unfavorable impact of currency movements.

 

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Asia Pacific Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

 

 

 

 

 

$ in thousands

    

2018

    

2017*

    

Change

    

% Change

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

17,601

 

 

12,012

 

$

5,589

 

47

%

Recurring

 

 

1,957

 

 

1,719

 

 

238

 

14

%

Other

 

 

(128)

 

 

(11)

 

 

(117)

 

nm

 

Total revenues

 

 

19,430

 

 

13,720

 

 

5,710

 

42

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

 

5,395

 

 

5,165

 

 

230

 

 4

%

Transaction processing

 

 

4,489

 

 

2,834

 

 

1,655

 

58

%

Other expenses

 

 

5,546

 

 

4,922

 

 

624

 

13

%

Total expenses

 

 

15,430

 

 

12,921

 

 

2,509

 

19

%

Income before income tax

 

$

4,000

 

$

799

 

$

3,201

 

401

%


*  Restated for comparability purposes, resulting in an increase in Asia Pacific expenses of $0.7 million for costs incurred in the U.S. on behalf of the global business that are now being allocated to the international segments.

nm – not meaningful

 

Currency translation increased total Asia Pacific revenues and expenses by $0.2 million and $0.1 million, respectively, resulting in an increase of $0.1 million to pre-tax income.

 

Commissions and fees increased 47% over the second quarter of 2017 due to record trading in our POSIT Alert block crossing system and strong growth in algorithmic trading and portfolio trading. We also benefitted from higher commission sharing revenues from trades executed via our Triton EMS and the Algo Wheel. Our average daily value traded in the region increased by 53%, outperforming the 19% increase in average daily value traded market-wide.

 

Recurring revenues increased 14% compared to the second quarter of 2017 due primarily to an increase in connectivity fees, while other revenues decreased due to a larger impact from client trade accommodations.

 

Compensation and employee benefits increased 4% compared to the second quarter of 2017 primarily due to employee termination costs and higher incentive compensation, offset in part by an increase in capitalized compensation for software development.

 

Transaction processing costs increased 58% compared to the second quarter of 2017, which was slightly higher than the 53% growth in daily value executed, due primarily to the impact of a higher proportion of our trading in markets where costs are higher. As a percentage of commissions and fees, transaction processing costs increased to 25.5% from 23.6% in the second quarter of 2017 due primarily to the impact of a lower average commission rate.

 

Other expenses increased 13% over the second quarter of 2017 due to costs for expanded office space in Hong Kong, higher hardware and software costs and an increase in market data fees.

 

Corporate

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

In the second quarter of 2018, we incurred a pre-tax loss from Corporate activities of $16.7 million, reflecting $0.4 million of investment income and $17.1 million of costs, compared to a pre-tax loss of $5.4 million in the prior-year period, reflecting $0.4 million of investment income and $5.8 million of costs. Corporate costs in the second quarter of 2018 included a charge of $12.0 million to establish an accrual for a potential settlement with the SEC of the U.S. POSIT matter along with related legal fees of $0.2 million. For more information, see Note 19, Contingencies – Legal Matters, to the condensed consolidated financial statements. On an adjusted basis excluding this charge, corporate costs were $4.9 million, a decrease from the prior-year period due to lower legal fees, offset in part by higher general taxes,

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corporate insurance premiums and tax consulting fees. We expect legal expenses within Corporate to increase in the third quarter of 2018 as we seek to resolve the U.S. POSIT matter. Corporate costs, including legal fees, can vary from period-to-period as we work through litigation, regulatory and other corporate matters.

 

Consolidated income tax expense

We incurred tax expense of $2.8 million on a pre-tax loss of $0.2 million during the three months ended June 30, 2018 due primarily to taxes incurred on pre-tax profits in Europe and Canada and the impact of the non-deductible $12.0 million charge taken to establish a settlement accrual for the U.S. POSIT matter. We are not incurring tax expense on pre-tax profits in Asia Pacific due to fully reserved tax loss carryforwards. Our effective tax rate was 8.7% in the second quarter of 2017 due in part to a tax benefit recorded on losses in the U.S. In the third quarter of 2017, we recorded a full valuation allowance against our U.S. deferred tax assets and discontinued recording any tax benefits on U.S. losses.

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, 2018 Compared to Six Months Ended June 30, 2017

 

U.S. Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

 

 

 

 

 

$ in thousands

    

2018

    

2017*

    

Change

    

% Change

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

70,666

 

$

80,650

 

$

(9,984)

 

(12)

%

Recurring

 

 

24,079

 

 

23,803

 

 

276

 

 1

%

Other

 

 

1,767

 

 

1,703

 

 

64

 

 4

%

Total revenues

 

 

96,512

 

 

106,156

 

 

(9,644)

 

(9)

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

 

43,886

 

 

49,221

 

 

(5,335)

 

(11)

%

Transaction processing

 

 

16,209

 

 

20,995

 

 

(4,786)

 

(23)

%

Other expenses

 

 

38,771

 

 

42,253

 

 

(3,482)

 

(8)

%

Total expenses

 

 

98,866

 

 

112,469

 

 

(13,603)

 

(12)

%

(Loss) income before income tax

 

$

(2,354)

 

$

(6,313)

 

$

3,959

 

nm

 


*  Restated for comparability purposes, resulting in a decrease in U.S. expenses of $5.3 million for costs incurred in the U.S. on behalf of the global business that are now being allocated to the international segments.

nm – not meaningful

 

We adopted the new revenue recognition standard on January 1, 2018, which resulted in a $2.3 million reduction in commissions and fees from deferring revenue attributable to bundled commission arrangements for analytics products during the first half of the year. The remaining decline in commissions and fees was attributable to reduced trading in our POSIT Alert block crossing system, a reduction in lower-margin sell-side trading and the spin-out of our derivatives business to the Matrix derivatives venture in mid-February. Our ADV decreased 10% over the first half of 2017 and overall revenue per share remained unchanged from the prior-year period at $0.0036. The decreases in

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commissions and fees noted above were offset in part by an increase in commission sharing revenues for trades executed with third-party brokers via Triton and the Algo Wheel.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

 

 

 

 

 

U.S. Operations: Key Indicators*

    

2018

    

2017

    

Change

 

% Change

Total trading volume (in billions of shares)

 

 

16.9

 

 

18.7

 

 

(1.8)

    

(10)

%

Average trading volume per day (in millions of shares)

 

 

135.0

 

 

149.3

 

 

(14.3)

 

(10)

%

Average revenue per share

 

$

0.0036

 

$

0.0036

 

$

 —

 

 —

%

U.S. market trading days

 

 

125

 

 

125

 

 

 —

 

 —

%


* Excludes activity from the trading of derivatives and Latin America equities, commission share arrangements and the deferral of commissions under bundled trading arrangements for analytics products.

 

Recurring revenues were comparable to the first half of 2017 as an increase in OMS license fees from the revenue acceleration required by the new accounting standard was largely offset by a decrease in connectivity.

 

Other revenues increased 4% from the first half of 2017 primarily due to the recording of dividend income on short settlements in the current period and an increase in fees earned for commission aggregation services, offset in part by a decrease in market data tape rebate revenue.

 

Compensation and employee benefits decreased 11% from the prior-year period primarily due to the impact of cost savings measures taken in 2017 and the first quarter of 2018 and employee termination costs incurred in the first half of 2017 of $3.7 million.

 

Transaction processing costs decreased 23% compared to the first half of 2017, outpacing the 10% reduction in ADV as a result of the impact of the spin-out of our derivatives business to the Matrix venture in mid-February 2018 and reduced trade execution costs from lower liquidity taking.  As a percentage of commissions and fees, transaction processing costs decreased to 22.9% in the current period from 26.0% during the prior-year period due to the factors mentioned above, offset in part by the impact of deferring commissions attributable to bundled arrangements for analytics products.

 

Other expenses decreased 8% compared to the prior-year period due primarily to decreases in occupancy and equipment expenses related to the reduction of office space in our New York headquarters in late December 2017 and the reduction in office space in Boston in late March 2017. We also had lower market data and travel and entertainment costs.

 

Canadian Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

 

 

 

 

 

$ in thousands

    

2018

    

2017*

    

Change

    

% Change

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

31,215

 

$

27,836

 

$

3,379

 

12

%

Recurring

 

 

2,567

 

 

2,587

 

 

(20)

 

(1)

%

Other

 

 

1,995

 

 

2,043

 

 

(48)

 

(2)

%

Total revenues

 

 

35,777

 

 

32,466

 

 

3,311

 

10

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

 

10,496

 

 

9,769

 

 

727

 

 7

%

Transaction processing

 

 

6,152

 

 

5,711

 

 

441

 

 8

%

Other expenses

 

 

12,250

 

 

11,690

 

 

560

 

 5

%

Total expenses

 

 

28,898

 

 

27,170

 

 

1,728

 

 6

%

Income before income tax

 

$

6,879

 

$

5,296

 

$

1,583

 

30

%


*  Restated for comparability purposes, resulting in an increase in Canadian expenses of $1.3 million for costs incurred in the U.S. on behalf of the global business that are now being allocated to the international segments.

 

Currency translation from a stronger Canadian Dollar increased total Canadian revenues and expenses by $1.2 million and $0.9 million, respectively, resulting in an increase of $0.3 million to pre-tax income.

 

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Overall commissions and fees increased 12% compared to the first half of 2017, including a $1.1 million favorable currency impact. The ADV in our Canadian broker grew by 13% compared to the prior-year period while market-wide volumes declined 4% due to growth from both buy-side and sell-side clients. We also achieved growth in ADV of 28% compared to the first half of 2017.

 

Recurring revenues were comparable to the prior-year period as an increase in billed revenue for analytics products was offset by a decrease in connectivity fees. Other revenues decreased by 2% due primarily to a decline in revenue earned on foreign exchange transactions.

 

Compensation and employee benefits costs increased 7% compared to the prior-year period due to the impact of unfavorable currency movements and higher incentive compensation.

 

Transaction processing costs increased 8% compared to the prior-year period as the impact of a 13% growth in executed daily volume was offset by a higher crossing rate in MATCHNow and a reduction in costs from self-clearing trades in U.S. stocks by Canadian clients. As a percentage of commissions and fees, transaction processing costs decreased to 19.7% compared to 20.5% in the prior-year period.

 

Other expenses increased 5% from 2017 due to increases in connectivity, hardware and software maintenance, consulting, travel and entertainment and legal expenses.  

 

European Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

 

 

 

 

 

$ in thousands

    

2018

    

2017*

    

Change

    

% Change

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

 

$

78,886

 

$

67,640

 

$

11,246

 

17

%

Recurring

 

 

9,062

 

 

8,030

 

 

1,032

 

13

%

Other

 

 

(207)

 

 

(219)

 

 

12

 

 5

%

Total revenues

 

 

87,741

 

 

75,451

 

 

12,290

 

16

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

 

22,321

 

 

19,900

 

 

2,421

 

12

%

Transaction processing

 

 

21,894

 

 

17,967

 

 

3,927

 

22

%

Other expenses

 

 

21,177

 

 

18,076

 

 

3,101

 

17

%

Total expenses

 

 

65,392

 

 

55,943

 

 

9,449

 

17

%

Income before income tax

 

$

22,349

 

$

19,508

 

$

2,841

 

15

%


*  Restated for comparability purposes, resulting in an increase in European expenses of $2.5 million for costs incurred in the U.S. on behalf of the global business that are now being allocated to the international segments.

 

Overall currency rate changes in the European region increased revenues and expenses by $6.6 million and $4.4 million, respectively, resulting in an increase of $2.2 million to pre-tax income. This increase in pre-tax income was largely attributable to the strengthening of the Euro as revenues and expenses originated in British pounds largely offset.

 

Commissions and fees increased 17% compared to the first half of 2017, which included $6.2 million in growth from favorable currency movements. The remaining growth was attributable to record trading in our POSIT Alert block crossing system, growth in algorithmic trading and an increase in commission sharing revenues for trades executed with third-party brokers via Triton and the Algo Wheel. These increases were partially offset by reduced levels of non-block trading in POSIT from the implementation in March of the dark pool volume caps required under the MiFID II regulations.

 

Recurring revenues increased 13% from the prior-year period due to higher billed analytics revenues from delivery timing, new revenues for RPA administration fees as a result of MiFID II regulations for unbundling that went into effect in January 2018 and higher connectivity fees. Other revenues were comparable to the prior-year period, primarily reflecting the impact of client trade accommodations. 

           

Compensation and employee benefits increased 12% from the prior-year period due to increased salaries and incentive compensation, as well as the unfavorable impact of currency movements.

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Transaction processing costs increased 22% from the first half of 2017, which included a $1.7 million increase from unfavorable currency movements. The remaining increase was attributable to an increase in rebates paid to introducing firms, higher costs to execute ETF trades, increased settlement financing and the impact of a lower crossing rate in POSIT. As a percentage of commissions and fees, transaction processing costs increased to 27.8% compared to 26.6% in the prior-year period.

 

Other expenses increased 17% from the prior-year period due to higher costs for facilities, hardware and software maintenance and market data costs. In addition, other expenses increased by $1.1 million from the unfavorable impact of currency movements.

 

Asia Pacific Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

 

 

 

 

 

$ in thousands

    

2018

    

2017*

    

Change

    

% Change

Revenues:

 

 

    

 

 

    

 

 

    

 

    

 

Commissions and fees

 

$

35,253

 

$

24,318

 

$

10,935

 

45

%

Recurring

 

 

3,936

 

 

3,463

 

 

473

 

14

%

Other

 

 

(152)

 

 

(118)

 

 

(34)

 

(29)

%

Total revenues

 

 

39,037

 

 

27,663

 

 

11,374

 

41

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

 

10,640

 

 

10,328

 

 

312

 

 3

%

Transaction processing

 

 

8,794

 

 

5,665

 

 

3,129

 

55

%

Other expenses

 

 

10,923

 

 

9,757

 

 

1,166

 

12

%

Total expenses

 

 

30,357

 

 

25,750

 

 

4,607

 

18

%

Income before income tax

 

$

8,680

 

$

1,913

 

$

6,767

 

nm

 


*  Restated for comparability purposes, resulting in an increase in Asia Pacific expenses of $1.5 million for costs incurred in the U.S. on behalf of the global business that are now being allocated to the international segments.

nm – not meaningful

 

 

Currency translation increased total Asia Pacific revenues and expenses by $0.6 million and $0.2 million, respectively, resulting in an increase of $0.4 million to pre-tax income.

 

Commissions and fees increased 45% over the prior-year period due to record trading in our POSIT Alert block crossing system and strong growth in algorithmic trading and portfolio trading. We also benefitted from higher commission sharing revenues from trades executed via our Triton EMS and the Algo Wheel and for trading technology licensed to regional broker-dealers. Our average daily value traded in the region increased by 60%, outperforming the 34% increase in average daily value traded market-wide.

 

Recurring revenues increased 14% over the first half of 2017 due primarily to an increase in connectivity revenue, while other revenues decreased due to a larger impact from client trade accommodations.

 

Compensation and employee benefits increased 3% over the prior-year period primarily due to employee termination costs and higher incentive compensation, offset in part by an increase in capitalized compensation for software development.

 

Transaction processing costs increased 55% over the first half of 2017, which was slightly less than the 60% growth in daily value executed. As a percentage of commissions and fees, transaction processing costs increased to 24.9% from 23.2% in the prior-year period.

 

Other expenses increased 12% over the prior-year period due to costs for expanded office space in Hong Kong, higher hardware and software costs and an increase in market data fees.

 

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Corporate

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

In the first half of 2018, we incurred a pre-tax loss from Corporate activities of $29.9 million, reflecting $0.9 million of investment income and $30.8 million of costs, compared to a pre-tax loss of $11.5 million in the prior-year period, reflecting $0.7 million of investment income and $12.2 million of costs. Corporate costs in the first half of 2018 included a charge of $12.0 million to establish an accrual for a potential settlement of the U.S. POSIT matter along with related legal fees of $0.2 million and a restructuring charge of $7.2 million to eliminate certain positions in the U.S. On an adjusted basis excluding these charges, corporate costs were $11.4 million, a decrease from the prior-year period due to lower legal fees, offset in part by higher general taxes, corporate insurance premiums and tax consulting fees. Corporate costs, including legal fees, can vary from period-to-period as we work through litigation, regulatory and other corporate matters.

 

Consolidated income tax expense

 

Our effective tax rate was 76% on our pre-tax income in the first half of 2018 compared to a benefit rate of 11.8% on our pre-tax income in the first half of 2017. Our effective tax rate in the first half of 2018 primarily reflects the impact of the non-deductible $12.0 million charge taken to establish a settlement accrual for the U.S. POSIT matter, offset in part by a $1.9 million benefit to reverse tax reserves following the resolution of uncertain tax positions in the U.S. for fiscal years 2011 and 2012 and significantly higher profits generated in Asia Pacific, where we are not incurring tax expense due to fully reserved loss carryforwards. The benefit rate in the first half of 2017 included the impact of a tax benefit recorded on losses in the U.S. In the third quarter of 2017, we recorded a full valuation allowance against our U.S. deferred tax assets and discontinued recording any tax benefits on U.S. losses.

 

 

Liquidity and Capital Resources

 

Liquidity

 

Our primary source of liquidity is cash provided by operations. Our liquidity requirements result from our working capital needs, which include clearing and settlement activities, as well as our regulatory capital needs. A substantial portion of our assets is liquid, consisting of cash and cash equivalents or assets readily convertible into cash. Cash is principally invested in money market mutual funds. At June 30, 2018, unrestricted cash and cash equivalents totaled $236.4 million. Included in this amount is $90.8 million of cash and cash equivalents held by subsidiaries outside the United States. Due to the internal capital structure of our foreign subsidiaries and the inclusion of foreign earnings and profits in U.S. taxable income pursuant to the Tax Cuts and Jobs Act, we do not anticipate a need to repatriate funds from certain foreign subsidiaries to the U.S. by way of taxable dividends in the foreseeable future.

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, 2018, we had interest‑bearing security deposits totaling $39.1 million with clearing organizations in the U.S. for the settlement of equity trades. In the normal course of our U.S. settlement activities, we may also need to temporarily finance customer securities positions from non-standard settlements or delivery failures. These financings may be funded from existing cash resources, borrowings under stock loan transactions or short‑term bank loans under our committed facility. On January 26, 2018, we entered into a new $150 million 364‑day revolving credit agreement (the “Credit Agreement”) in the U.S. with a syndicate of banks and JPMorgan Chase Bank, N.A., as Administrative Agent (see Note 12, Borrowings, to the condensed consolidated financial statements).

 

We also self‑clear equity trades in Australia, maintaining a deposit with clearing organizations of $3.4 million at June 30, 2018. In Europe, we maintained $5.1 million in restricted cash related to protected client funds and we had deposits with our clearing and settlement agents of $37.9 million at June 30, 2018. As part of our European settlement

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activities, we may need to temporarily finance customer securities positions from non-standard settlements or delivery failures.  These financings may be funded from existing cash resources or short-term bank loans under uncommitted overdraft facilities with our clearing agent and a commercial bank.

Capital Resources

 

Capital resource requirements relate to capital purchases, as well as business investments, and are generally funded from operations.

 

Operating Activities

 

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

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

(in thousands)

    

2018

    

2017

 

Net income

 

$

1,342

 

$

9,945

 

Non-cash items included in net income

 

 

37,295

 

 

26,003

 

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

 

 

(11,707)

 

 

(19,466)

 

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

 

 

(7,472)

 

 

(36,938)

 

Net cash provided by (used in) operating activities

 

$

19,458

 

$

(20,456)

 

 

 

Our operating activities resulted in net cash provided during the six months ended June 30, 2018, compared to a net use of cash in the prior-year period.  This was due to an increase to the adjustment for non-cash items included in net income as the prior-year period included a significant negative adjustment for deferred taxes in the U.S. We also had a decrease in cash temporarily tied up in settlement receivables that was offset by reduced short-term bank borrowings in our financing activities. In addition, we had a lower reduction of cash from other working capital items due in part to the impact of the settlement accrual for the U.S. POSIT matter and an increase in accrued research payables under client commission arrangements.

In the normal course of our clearing and settlement activities worldwide, cash is typically used to fund restricted or segregated cash accounts (under regulations and otherwise), 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 value transacted and customer trading patterns.

Investing Activities

 

Net cash used in investing activities of $21.5 million during the six months ended June 30, 2018 primarily includes investments in software development and asset purchases of computer hardware, software and office equipment, as well as $0.6 million of cash included in our investment in the Matrix derivatives venture.

 

Financing Activities

 

Net cash used in financing activities of $46.1 million primarily reflects repayment of short‑term bank borrowings that are used to support our settlement activities, shares withheld for net settlements of share-based awards and capital returns through repurchases of our stock and our dividend program.

During the first six months of 2018, we repurchased approximately 0.7 million shares of our common stock at a cost of $14.1 million, which was funded from our available cash resources. Nearly 0.3 million of these shares were purchased under our Board of Directors’ authorization for a total cost of $5.7 million (average cost of $20.27 per share) and 0.4 million of these shares were repurchased for $8.4 million pertaining solely to the satisfaction of minimum statutory withholding tax upon the net settlement of equity awards. In February 2018, the Board of Directors increased our share repurchase authorization by an additional 4.0 million shares. As of June 30, 2018, the total remaining number of shares currently available for repurchase under ITG’s stock repurchase program was 4.3 million. The specific timing and amount of repurchases will vary depending on various factors, including, among others, market conditions and competing needs for the use of our capital. We may elect to conduct future share repurchases through open market

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purchases, private transactions or automatic share repurchase programs under SEC Rule 10b5-1. We have suspended share repurchases under our program pending the final resolution of the U.S. POSIT matter with the SEC.

 

Regulatory Capital

 

ITG Inc. and AlterNet 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 has elected to use the basic method permitted by Rule 15c3‑1, which requires the maintenance of minimum net capital equal to the greater of 62/3% of aggregate indebtedness or $100,000. Dividends or withdrawals of capital cannot be made if capital is needed to comply with regulatory requirements.

 

Net capital balances and the amounts in excess of required net capital at June 30, 2018 for the U.S. Operations are as follows (dollars in thousands):

 

 

 

 

 

 

 

 

 

U.S. Operations

    

Net Capital

    

Excess

 

ITG Inc.

 

$

81,659

 

$

80,659

 

AlterNet

 

 

5,447

 

 

5,347

 

 

As of June 30, 2018, ITG Inc. had $9.2 million of cash in a special reserve bank account for the benefit of customers under the Customer Protection Rule pursuant to SEC Rule 15c3-3 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and $3.5 million under proprietary accounts of broker dealers.

 

In addition, our Canadian, European and Asia Pacific Operations have subsidiaries with regulatory capital requirements. The regulatory net capital balances and amount of regulatory capital in excess of the minimum requirements applicable to each business at June 30, 2018, is summarized in the following table (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

    

Net Capital

    

Excess

 

Canadian Operations

 

 

 

 

 

 

 

Canada

 

$

23,118

 

$

22,738

 

European Operations

 

 

 

 

 

 

 

Ireland

 

 

43,807

 

 

13,648

 

U.K.

 

 

1,513

 

 

526

 

Asia Pacific Operations

 

 

 

 

 

 

 

Australia

 

 

29,273

 

 

15,746

 

Hong Kong

 

 

3,137

 

 

2,747

 

Singapore

 

 

1,122

 

 

1,049

 

 

 

Liquidity and Capital Resource Outlook

 

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

 

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

 

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

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consolidated financial statements for these agreements and believe that any potential requirement to make payments under these agreements is remote.

 

As of June 30, 2018, 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 compensation under employment agreements.

 

There has been no significant change to such arrangements and obligations since December 31, 2017.

 

New Accounting Pronouncements

 

In June 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.  The amendments in this ASU expand the scope of ASC 718 to include share-based payment awards to nonemployees, which were previously covered under Subtopic 505-50: Equity – Equity-Based Payments to Non-Employees.  ASU 2018-07 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that fiscal year.  Early adoption is permitted, but no earlier than an entity’s adoption date of Topic 606.  The new guidance is not expected to have any effect on our financial statements.

In January 2017, the FASB issued ASU 2017‑04, Intangibles – Goodwill and other (Topic 350): Simplifying the test for goodwill impairment. The amendments in this ASU address concerns over the cost and complexity of the two-step goodwill impairment test and removes the second step of the test. An entity will apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment. ASU 2017‑04 is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. We are currently evaluating the new guidance and have not yet determined the impact of adoption on our financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires lessees to recognize leases on the balance sheet and disclose key information about leasing arrangements. The new standard requires a lessee to recognize an asset and lease liability on the balance sheet for all leases with a term longer than 12 months.  Leases will be classified as finance or operating, with classification affecting the pattern of expense recognition in the income statement. Classification will be based on criteria that are largely similar to those applied in current lease accounting, but more significant management judgment will be required. The new standard is effective for us on January 1, 2019, with early adoption permitted.

 

In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842) – Targeted Improvements, which provides entities with an alternative transition method of adoption in addition to the previously required modified retrospective transition approach.  Under the new transition method, comparative periods presented in the financial statements in the period of adoption will not need to be restated, whereas under the modified retrospective transition approach, leases are to be recognized and measured at the beginning of the earliest period presented in the financial statements. This additional transition method changes only when an entity is required to initially apply the transition requirements of the new leases standard; it does not change how those requirements apply.  We have not yet selected a transition method of adoption.

 

We have completed the assessment phase of our evaluation of this guidance, where we identified and assessed the complete population of our lease arrangements, which includes real estate leases, equipment leases and equipment lease arrangements embedded within our service contracts. Real estate leases pertaining to office space and data centers make up the majority of our lease arrangements. We are currently in the design and implementation phase of our assessment, which includes collecting and reviewing the data inputs required to calculate the financial statement impact of the new guidance, evaluating the transition expedients and other accounting policy elections required to develop a formal accounting policy and developing preliminary updates to processes and internal controls as a result of adopting this new guidance.

 

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Critical Accounting Estimates

 

There has been no significant change to our critical accounting estimates, which are more fully described in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

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, 2017. There has been no material change in this information.

 

Item 4. Controls and Procedures

 

a)

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

 

b)

Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Information pertaining to legal proceedings can be found in “Item 1. Financial Statements—Note 19. Contingencies—Legal Matters” and is incorporated herein by reference.

 

Item 1A. Risk Factors

 

Risk factors describing the major risks to our business can be found under Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2017.  Except for the addition of the risk factor below, there have been no material changes to the risk factors included in our Form 10-K.

 

The SEC investigation regarding the operational features of U.S. POSIT and access to U.S. POSIT data, and any settlement and/or litigation resulting from such investigation, could negatively impact our business, reputation and financial condition.

 

As discussed in Note 19, Contingencies—Legal Matters, to the condensed consolidated financial statements, we are presently engaged in discussions with the SEC staff regarding a possible resolution of an investigation relating to the operational features of U.S. POSIT and access to U.S. POSIT data, together with certain related disclosures.  The Company has taken meaningful remedial actions during the course of the SEC’s investigation, including imposing additional limitations on access to U.S. POSIT data as well as enhancing POSIT’s Form ATS and other disclosures.

 

While the Company is engaged in discussions with the SEC staff to resolve the investigation, there can be no assurance that these discussions will be successful. Based on recent discussions, we incurred a charge of $12.0 million during the second quarter 2018 to establish an accrual for a potential settlement of this matter. The SEC staff has indicated that they will recommend this penalty amount to the Commission. The Company also incurred approximately $0.2 million in legal fees associated with this matter during the second quarter of 2018. Resolution of the matter is subject to agreement with the SEC staff on the terms of a settlement, followed by review and approval by the Commission.  We cannot predict the timing of any settlement or what the ultimate resolution of the SEC investigation will be. It is possible that a materially higher amount than the amount accrued could be required to achieve a resolution of the matter. If we are not successful in settling the matter on acceptable terms or if the necessary settlement approvals do not occur, we may either enter into further discussions with the SEC staff to resolve such matter on different terms or conditions or we may enter into litigation with the SEC.  We cannot predict the timing or outcome of any further discussions or subsequent litigation with the SEC.

Even if the investigation is resolved on acceptable terms, there are still potential risks we may face.  Among other possible adverse impacts, customer reaction to the charges or the settlement could result in reputational and financial harm. In addition, we could be subject to further proceedings or sanctions based on the matters at issue in the SEC investigation, including other governmental investigations or private litigation. 

The above-described contingencies and risks could materially and adversely affect our business, consolidated financial position, cash flows, or results of operations.

 

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

 

The following table sets forth our stock repurchase activity during the first six months of 2018, 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.

 

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ISSUER PURCHASES OF EQUITY SECURITIES

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

 

    

 

    

Maximum Number

 

 

 

 

 

 

 

 

Total Number of

 

of Shares (or Units)

 

 

 

 

 

 

 

 

Shares (or Units)

 

that May Yet

 

 

 

Total Number of

 

Average

 

Purchased as Part of

 

Be Purchased

 

 

 

Shares (or Units)

 

Price Paid per

 

Publicly Announced

 

Under the Plans or

 

Period

 

Purchased (a)

 

Share (or Unit) (a)

 

Plans or Programs (b)

 

Programs (b)

 

From: January 1, 2018

 

 

 

 

 

 

 

 

 

 

To: January 31, 2018

 

163,434

 

$

21.36

 

13,425

 

548,130

 

From: February 1, 2018

 

 

 

 

 

 

 

 

 

 

To: February 28, 2018

 

401,355

 

 

19.81

 

144,006

 

4,404,124

 

From: March 1, 2018

 

 

 

 

 

 

 

 

 

 

To: March 31, 2018

 

22,902

 

 

19.69

 

22,902

 

4,381,222

 

From: April 1, 2018

 

 

 

 

 

 

 

 

 

 

To: April 30, 2018

 

25,544

 

 

19.79

 

24,424

 

4,356,798

 

From: May 1, 2018

 

 

 

 

 

 

 

 

 

 

To: May 31, 2018

 

2,955

 

 

20.44

 

2,500

 

4,354,298

 

From: June 1, 2018

 

 

 

 

 

 

 

 

 

 

To: June 30, 2018

 

76,221

 

 

21.56

 

75,723

 

4,278,575

 

Total

 

692,411

 

$

20.37

 

282,980

 

 

 


(a)

This column includes the acquisition of 409,431 common shares from employees in order to satisfy statutory withholding tax requirements upon net settlement of equity awards.

(b)

In February 2018, our Board of Directors authorized the repurchase of an additional 4.0 million shares. This authorization has no expiration date. As of June 30, 2018, there were 4.3 million shares remaining available for repurchase under ITG’s stock repurchase program. The specific timing and amount of repurchases will vary depending on various factors including, among others, market conditions and competing needs for the use of our capital.

 

During the first six months of 2018, we repurchased approximately 0.7 million shares of our common stock at a cost of $14.1 million, which was funded from our available cash. Of these shares, nearly 0.3 million were purchased under our Board of Directors’ authorization for a total cost of $5.7 million (average cost of $20.27 per share). In addition, nearly 0.4 million shares repurchased for $8.4 million pertained solely to the satisfaction of statutory withholding tax upon the net settlement of equity awards.  As of June 30, 2018, the total remaining number of shares currently available for repurchase under ITG’s stock repurchase program was 4.3 million.

 

During the second quarter of 2018, the Board of Directors declared, and we paid, a quarterly dividend of $0.07 per share, totaling $2.3 million, including less than $0.1 million in stock under the Company’s equity award plans.

 

Item 3. Defaults Upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

On July 27, 2018, a former employee filed a Statement of Claim requesting a FINRA arbitration, which was followed by his filing of a parallel action in the Commercial Division of New York State Supreme Court on July 30, 2018.  In each case, the former employee alleges that the Company breached the non-disparagement clause in his July 2011 separation agreement and tortiously interfered with his business relations.  The Company intends to defend itself against these claims vigorously.

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Item 6. Exhibits

 

 

 

 

 

 

 

10.1*(†)

 

 

Investment Technology Group, Inc. Amended and Restated Employee Stock Purchase Plan.

 

 

 

 

 

 

 

 

 

 

 

 

31.1*

 

 

Rule 13a-14(a) Certification

 

 

 

 

31.2*

 

 

Rule 13a-14(a) Certification

 

 

 

 

32.1**

 

 

Section 1350 Certification

 

 

 

 

101*

 

 

Interactive Data File

 

 

 

 

 

 

 

The following furnished materials from Investment Technology Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018, formatted in XBRL (Extensible Business Reporting Language), are collectively included herewith as Exhibit 101:

 

 

 

 

 

 

 

101. INS XBRL Instance Document.

 

 

 

101. SCH XBRL Taxonomy Extension Schema.

 

 

 

101. CAL XBRL Taxonomy Extension Calculation Linkbase.

 

 

 

101. DEF XBRL Taxonomy Extension Definition Linkbase.

 

 

 

101. LAB XBRL Taxonomy Extension Label Linkbase.

 

 

 

101. PRE XBRL Taxonomy Extension Presentation Linkbase.

 


 

 

 

*

 

Filed herewith.

**

 

Furnished herewith.

(†)

 

Management contracts or compensatory plans or arrangements.

 

 

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SIGNATURE

 

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

 

 

 

 

INVESTMENT TECHNOLOGY GROUP, INC.

 

 

 

(Registrant)

 

 

 

 

Date: August 8, 2018

 

By:

/s/ STEVEN R. VIGLIOTTI

 

 

 

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

 

 

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