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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 COMMISSION FILE NUMBER 0--23644
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INVESTMENT TECHNOLOGY GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE IRS NO. 95-2848406
(State of incorporation) (IRS Employer Identification No.)
380 Madison Avenue, New York, New York (212) 588-4000
(Address of principal executive offices) (Registrant's telephone number, including
area code)
10017
(Zip Code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
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COMMON STOCK, $0.01 PAR VALUE NEW YORK STOCK EXCHANGE
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(Title of class) (Name of exchange on which registered)
Aggregate market value of the voting stock Number of shares outstanding of the
held by non-affiliates of the Registrant at Registrant's Class of common stock at March
March 13, 2000: 13, 2000:
$1,154,946,763 30,849,585
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to this
form 10-K [ ]
DOCUMENTS INCORPORATED BY REFERENCE:
Proxy Statement relating to the 2000 Annual Meeting of Stockholders
(incorporated, in part, in Form 10-K Part III).
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1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 11
Item 3. Legal Proceedings........................................... 12
Item 4. Submission of Matters to a Vote of Security Holders......... 12
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder
Matters................................................... 13
Item 6. Selected Financial Data..................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 16
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 22
Item 8. Financial Statements and Supplementary Data................. 24
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 47
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 47
Item 11. Executive Compensation...................................... 47
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 47
Item 13. Certain Relationships and Related Transactions.............. 47
PART IV
Item 14. Exhibits, Financial Statements, Schedules and Reports on
Form 8-K.................................................. 48
QUANTEX IS A REGISTERED TRADEMARK OF INVESTMENT TECHNOLOGY GROUP, INC.
POSIT IS A REGISTERED SERVICE MARK OF THE POSIT JOINT VENTURE.
SMARTSERVER IS A SERVICE MARK OF INVESTMENT TECHNOLOGY GROUP, INC.
TCA IS A TRADEMARK OF INVESTMENT TECHNOLOGY GROUP, INC.
ACE IS A TRADEMARK OF INVESTMENT TECHNOLOGY GROUP, INC.
i
FORWARD-LOOKING STATEMENTS
In addition to the historical information contained throughout this Annual
Report on Form 10-K, there are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),
and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). All statements regarding our expected future financial
position, results of operations, cash flows, dividends, financing plans,
business strategies, competitive positions, plans and objectives of management
for future operations, and concerning securities markets and economic trends are
forward-looking statements. Although we believe our expectations reflected in
such forward-looking statements are based on reasonable assumptions, there can
be no assurance that such expectations will prove to have been correct.
Important factors that could cause actual results to differ materially from the
expectations reflected in the forward-looking statements herein include, among
others, the actions of both current and potential new competitors, rapid changes
in technology, fluctuations in market trading volumes, market volatility,
changes in the regulatory environment, risk of errors or malfunctions in our
systems or technology, cash flows into or redemptions from equity funds, effects
of inflation, customer trading patterns, as well as general economic and
business conditions; securities, credit and financial and market conditions;
adverse changes or volatility in interest rates.
ii
PART I
ITEM 1. BUSINESS.
Investment Technology Group, Inc. ("ITG" or the "Company") was formed as a
Delaware corporation under the name Jefferies Group, Inc. on July 22, 1983 and
its principal subsidiaries include: (1) ITG Inc., a broker-dealer in equity
securities, (2) Investment Technology Group International Limited, which is a
50% partner in the ITG Europe joint venture, and (3) ITG Australia Holdings Pty
Limited, which is a 50% partner in ITG Pacific Holdings Pty Limited. We provide
equity trading services and transaction research to institutional investors and
brokers.
We are a full service trade execution firm that uses technology to increase
the effectiveness and lower the cost of trading. With an emphasis on ongoing
research, we offer the following services:
- POSIT: an electronic stock crossing system.
- QuantEX: a Unix-based decision-support, trade management and order routing
system.
- SmartServers: offer server-based implementation of trading strategies.
- Electronic Trading Desk: an agency-only trading desk offering clients the
ability to efficiently access multiple sources of liquidity.
- ITG Platform: a PC-based order routing and trade management system.
- ACE and TCA: a set of pre- and post-trade tools for systematically
analyzing and lowering transaction costs.
- ITG/Opt: a computer-based equity portfolio selection system.
- Research: research, development, sales and consulting services to our
clients.
We generate revenues on a "per transaction" basis for all orders executed.
Orders are delivered to us from our "front-end" software products, QuantEX and
ITG Platform, as well as vendors' front-ends and direct computer-to-computer
links to customers. Orders may be executed on or through (1) POSIT, (2) the New
York Stock Exchange, (3) certain regional exchanges, (4) market makers,
(5) electronic communications networks ("ECNs") and (6) alternative trading
systems ("ATSs").
POSIT
POSIT was introduced in 1987 as a technology-based solution to the trade
execution needs of quantitative and passive investment managers. It has since
grown to serve the active trading and broker-dealer community. There are 492
clients currently using POSIT, including corporate and government pension plans,
insurance companies, bank trust departments, investment advisors, broker-
dealers and mutual funds.
POSIT is an electronic stock crossing system through which clients enter buy
and sell orders to trade single stocks and portfolios of equity securities among
themselves in a confidential environment. Orders may be placed in the system
directly via QuantEX, ITG Platform or computer-to-computer links, or indirectly
via the Electronic Trading Desk, which then enters the orders in the central
computer. We also work in partnership with vendors of other popular trading
systems, allowing users the flexibility to route orders directly to POSIT from
trading products distributed by Bridge Information Systems, BRASS, Bloomberg and
others.
POSIT currently accepts orders for approximately 19,600 different equity
securities, but may be modified, as the need arises, to include additional
equity securities. An algorithm is run at scheduled times to find the maximum
possible number of buy and sell orders that match or "cross." Typically, there
is an imbalance between the number of shares available to be bought or sold in
the system.
1
When this occurs, shares are allocated pro rata across participants, resulting
in partial executions. In addition, clients may specify constraints on the
portion of a portfolio that trades, such as the requirement that net cash
resulting from buys and sells remain within specified constraints. A client may
also specify a minimum number of shares to be executed for a given order. POSIT
prices trades at the midpoint of the best bid and offer on the primary market
for each security at the time of the cross, based on information provided
directly to the system by a third-party data vendor. There are currently six
scheduled crosses every business day, scheduled hourly, on the hour, between
10:00 a.m. and 3:00 p.m. (Eastern time). Each scheduled cross is normally
executed within a five-minute window selected randomly by the system.
POSIT provides the following significant benefits to clients:
- Confidential matching of buy and sell orders eliminates market impact. In
contrast, participants in traditional or other open markets are constantly
subject to the risk that disclosure of an order will unfavorably affect
price conditions.
- Access to the substantial pool of liquidity represented by POSIT orders.
- Clients pay a low transaction fee on completed transactions relative to
the industry average of approximately 5 cents per share. POSIT generates
revenue from transaction fees charged on each share crossed through the
system.
- Immediately after each cross, the system electronically provides clients
with reports of matched and unmatched (residual) orders. Clients may then
submit the unexecuted portion of their orders to subsequent POSIT matches,
choose to execute residual orders through other means or take advantage of
the Electronic Trading Desk services (described below).
In December 1997, we introduced a new version of POSIT that gives users the
option of customizing their trading objectives and specifying additional
constraints, while preserving the functionality of the existing POSIT system.
This capability is referred to collectively as a "POSIT strategy." This
capability allows orders that might otherwise be ineligible for POSIT to
participate in the match. POSIT strategies include ResRisk, which allows users
to control the risk of the unexecuted "residual" portfolio, and Pairs, which
makes execution of one trade contingent on the execution of another, at or
better than a given relative valuation. Portfolio funding, liquidation,
restructuring and rebalancing are some of the types of transactions that are
appropriate for execution using ResRisk. Risk arbitrage, statistical arbitrage
and portfolio substitution trades are examples of transactions that can be
implemented using the Pairs strategy. We also implement custom applications upon
request. We have obtained a patent on the technology underlying such POSIT
strategies.
2
The following graph illustrates the average daily volume of shares crossed
on POSIT since 1994:
AVERAGE DAILY POSIT SHARE VOLUME
(IN MILLIONS)
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
SHARE PER DAY
1994 7.6
1995 9
1996 13.1
1997 14.5
1998 23.2
1999 25.7
QUANTEX
QuantEX is our Unix-based trade management system, an advanced tool for
technologically sophisticated clients transacting large volumes of orders.
QuantEX helps clients manage efficiently every step in the trading process: from
decision-making to execution to tracking of trade list status. From a dedicated
workstation at their desks, users can access fully-integrated real-time and
historical data and analytics, route and execute orders electronically, and
perform trade management functions. QuantEx is an integrated system that
supports multiple trade-related activities that have traditionally required the
use of several unrelated systems.
QuantEX is a rule-based decision support system that allows traders to
quantify their trading processes to create automated strategies. It is designed
to implement each client's trading styles and strategies and to apply them to
hundreds of stocks, portfolios or industry groups at once. With QuantEX, clients
can flag precisely the same kinds of moment-to-moment opportunities they would
ordinarily want to pursue, but do so much more efficiently and scientifically.
Rule-based strategies can be based on a wide range of quantitative models.
Passive traders can use QuantEx strategies to help minimize slippage from
various benchmarks, reduce tracking errors and achieve desired sector balances.
Active traders can build models to match a wide variety of trading approaches,
from pair trading to market-neutral algorithms to index or risk arbitrage.
QuantEx strategies can involve the human trader in each order decision, or can
fully automate the trading process, depending on the client's preference.
QuantEX analyzes lists of securities based on the individual user's trading
strategy. QuantEX enables clients to have access to our proprietary research,
including pre-trade, post-trade and intra-day analytical tools. QuantEX has
access to the ITG Data Center, which is a comprehensive historical database that
provides a variety of derived analytics based upon raw historical data. Our
support specialists translate the trading criteria developed by the client into
a set of rules for trading securities, which are then loaded into QuantEX.
QuantEX applies the client's proprietary trading rules to a continuous flow of
current market information on the list of securities selected by the user to
generate real-time decision support. A user's rules can be based on a wide range
of quantitative models or strategies, such as liquidity measures, technical
indicators, price benchmarks, tracking to specific
3
industries and sectors, pairs or other long or short strategies, index
arbitrage, risk measurements and liquidity parameters for trade urgency, size or
timing. These rules typically serve as a guide in support of a client's trading
decisions. In addition, QuantEX supports the ability to implement these trading
decisions automatically via an auto-trading strategy.
As such, QuantEX can automate the complex trade management requirements
typical of investment strategies that trade large volumes of securities through
multiple sources of liquidity. Orders can be electronically routed to multiple
markets, including the New York Stock Exchange, the American Stock Exchange and
certain regional stock exchanges, the Nasdaq National Market, POSIT, the
Electronic Trading Desk, over-the-counter market-makers, and selected
broker-dealers, ECNs and ATSs. We intend to create links to additional ATSs and
other liquidity sources where appropriate. Trades routed through QuantEX are
automatically tracked and summarized. Each order can be monitored by source of
execution, by trade list, by portfolio or globally with all other orders placed.
QuantEX's built-in trade allocation features provide a facility for automated
back-office clearance and settlement. QuantEX supports the Financial Information
eXchange ("FIX") messaging protocol and can link to other FIX compliant systems.
QuantEX also allows our clients to access our ISIS facility, an equity pre-
and post-trade analysis system. Via the ISIS facility, QuantEX users can request
both aggregate and stock-by-stock liquidity reports for a trade portfolio prior
to and during execution. Clients can generate standard reports or use a report
writer to design custom reports. Certain elements of these reports can also be
displayed directly on the QuantEX execution page and referenced in QuantEX
strategies. These pre-trade analyses help QuantEX users make decisions about how
best to trade a portfolio, for example by helping identify the most difficult
trades for special handling. The ISIS post-trade reporting facility allows
QuantEX users to compare actual executed prices to user-selected benchmark
prices in order to help assess trade execution quality. Available benchmarks
include the volume-weighted average price, closing price and opening price.
Our support specialists install the system, train users and provide ongoing
support for the use of QuantEX's order routing and analysis capabilities. Our
specialists are knowledgeable about portfolio management and trading as well as
the system's hardware and software. Our support team works closely with each
client to develop trading strategies and rules, explore new trading approaches,
provide system integration services and implement system upgrades and
enhancements.
Revenues are generated through commissions and transaction fees charged to
each trade electronically routed through QuantEX to the many destinations
available from the application. We do not derive royalties from the sale or
licensing of the QuantEX software. As of December 31, 1999, there were 103
installations of QuantEX at 52 client sites.
SMARTSERVERS
SmartServers are automated trading destinations that accept orders from
client workstations and execute them using a computerized trading strategy.
Clients may send orders via the ITG Platform or QuantEX, via direct connections
or via our Electronic Trading Desk. Each SmartServer is an automated trading
agent pre-programmed with a particular trading style. By using these agents,
traders can focus their attention on a subset of their orders, letting the
SmartServer trade the rest of the list.
Our first strategy-based server is the VWAP SmartServer. The VWAP
SmartServer is designed to allow clients to direct their orders to us to be
executed in a manner designed to closely track a security's volume-weighted
average price, or VWAP, throughout the trading day. The VWAP SmartServer
analyzes liquidity and market conditions and determines the appropriate order
size and order price to approximate the VWAP. Clients may choose to execute
relative to the VWAP price for the entire trading day, or for some subset of
that trading day.
4
ELECTRONIC TRADING DESK
The Electronic Trading Desk is a full-service agency execution group that
specializes in the use of our proprietary products, including extensive use of
POSIT for trade execution. For clients that do not send orders electronically to
POSIT, our account executives receive orders for POSIT matches by telephone, fax
or e-mail. The desk accepts orders until a POSIT match begins and after
completion of the match execution reports are given to clients.
In addition to order management services for POSIT, the Electronic Trading
Desk provides agency execution services. QuantEX and ITG Platform clients
deliver lists of orders electronically to our desk and, as orders are executed
by the desk, reports are automatically delivered electronically to the client's
terminal. Trading desk personnel are thereby able to assist customers with
decision support analyses generated by ITG Platform or QuantEX and with the
execution of trades. Clients give our traders single stock orders or lists of
orders to work throughout the day as well as unfilled orders that remain due to
order imbalances in POSIT matches.
For order completion outside of POSIT match windows, the Electronic Trading
Desk utilizes numerous sources of liquidity to complete trades. The trading desk
will actively seek the contra side of client orders by soliciting interest among
other clients, use QuantEX to route the orders to multiple markets, including
primary exchanges, regional exchanges, over-the-counter market makers, ECNs and
ATSs, or use our active order traders to execute the trade with floor brokers or
over-the-counter brokers.
The Portfolio Trading Group of our desk focuses on agency-only list and
program trading. By employing a step-by-step process that leverages technology
and access to multiple sources of liquidity, the Portfolio Trading Group seeks
to systematically achieve high quality execution for the client. A client
program is evaluated with a pre-trade analysis to determine aggregate portfolio
characteristics, liquidity ranking and market impact, and to quantify risk. The
group implements a number of sophisticated trading strategies using QuantEX to
meet execution objectives on an agency basis. After the execution is completed,
we provide the client with comprehensive reports analyzing execution results
utilizing ITG Research products.
ITG PLATFORM
ITG Platform, introduced in the first quarter of 1996, provides clients with
seamless connectivity from their desktop to a variety of execution destinations,
such as POSIT, the Electronic Trading Desk, our SmartServers, the New York Stock
Exchange and American Stock Exchange via SuperDOT, the Nasdaq National Market,
other over-the-counter market makers and selected ECNs. We intend to create
links to additional liquidity sources where appropriate. Orders may be corrected
or canceled electronically, and all reports are delivered electronically back to
the ITG Platform. The ITG Platform also supports special trading interfaces as
needed by POSIT strategies and SmartServers. Allocation information can be
associated with executions in the ITG Platform and delivered to us
electronically. ITG Platform has access to historical data through the ITG Data
Center, including a wide array of analytics, such as average historical share
volumes, dollar volumes, volatility and historical spread statistics. We
recently released a new version of ITG Platform which provides our clients
enhanced list trading capabilities and access to ECN order types. The new
version of ITG Platform also provides certain clients with access to real time
Nasdaq Level II data as well as the ability to communicate with us via the
Internet as well as through private networks.
The ITG Platform was intended for broad distribution to institutional
clients, so it was designed to run in conventional PC environments alongside
other applications, and be inexpensive to install, maintain and support.
5
Many technical features support these goals:
- Other applications can link to the ITG Platform using the FIX data
messaging protocol or the "drag and drop" method.
- ITG Platform incorporates a spreadsheet package, so users can extend their
trade blotter with custom calculations.
- Custom execution reports can be created to fit each user's requirements.
- ITG Platform can access Bridge and ILX quote data if those systems are
used by the client. In addition, we provide the Primark Speed Feed to
selected clients.
- New versions of ITG Platform are distributed automatically to client sites
and are easily installed with little or no user intervention required.
As of December 31, 1999, there were 296 installations of ITG Platform at 188
client sites.
ACE PRE-TRADE AND TCA POST-TRADE TRANSACTION COST ANALYSIS
Accessed through the Internet, ACE and TCA are equity pre- and post-trade
analysis systems. ACE and TCA users can request both aggregate and
stock-by-stock liquidity reports for a trade portfolio prior to and during
execution. Clients can generate standard reports built into the browser-based
applications. Reports can be viewed, printed or saved to a file.
ACE pre-trade analyses help users make decisions about how best to trade a
portfolio, for example by helping identify the most difficult trades for special
handling and by providing a reference point for evaluating principal trade
pricing. The TCA post-trade reporting facility allows users to compare actual
executed prices to user-selected benchmark prices in order to help assess trade
execution quality. Available benchmarks include the volume-weighted average
price, closing price and opening price.
ITG/OPT
ITG/Opt is a computer-based equity portfolio selection system that employs
advanced optimization techniques to help investors construct portfolios that
meet their investment objectives. Special features of the system make it
particularly useful to "long/short" and taxable investors, as well as any
investor seeking to control transaction costs. ITG/Opt is usually delivered as a
"turnkey" system that includes software and, in some cases, hardware and data.
Included in the service is telephone and on-site support to assist in training
and integration of the system with the user's other investment systems and
databases. In addition to its core portfolio construction capabilities, ITG/Opt
has powerful backtesting and batch scheduling features that permit efficient
researching of new or refined investment strategies. The system, which is
targeted at highly sophisticated investment applications, is offered primarily
to our largest clients. Typically, portfolios that are constructed using ITG/Opt
are executed via ITG, using one or more execution services, such as QuantEX, the
Electronic Trading Desk and POSIT.
6
ITG RESEARCH
In addition to its role in the firm's overall research and development
effort, Research provides both sales and consulting services to our clients and
prospective clients. Taken together, these activities are a key component of our
overall relationship development and maintenance activities.
In its sales capacity, Research introduces our clients and prospective
clients to the full range of products and services offered by our company and
provides information about features, pricing and technical/functional
specifications. The sales process includes development of an in-depth
understanding of client practices and requirements and the design and
presentation of integrated solutions based on our products.
Consulting encompasses a set of value-added services for the benefit of our
clients. These services break down into three main categories: product support,
development of customized trading strategies and provision of quantitative
analysis. The products supported by Research are QuantEX, ACE, TCA, ITG
Platform, POSIT, and ITG/Opt. Support activities include trading strategy design
and implementation, system integration, training and coordination of technical
support. Strategy development involves building customized QuantEx strategies
that automate the trading styles of specific clients. Quantitative analysis
covers a broad range of activities such as transaction cost analysis, investment
strategy simulations and provision of historical time series of proprietary
analytics. As part of its analysis activities, Research publishes and
distributes studies on topics of interest to our clients. In the same way users
of fundamental research compensate the traditional brokerages that provide such
research (i.e., directing commissions to such brokerage house), our clients
reward the firm for these value-added research services.
ITG EUROPE
We are pursuing the international market in a variety of ways, through
joint-ventures with strategic partners and the development of specially-tailored
versions of our services. In the fourth quarter of 1998, we and Societe Generale
finalized a 50/50 joint venture through the creation of Investment Technology
Group (Europe) Limited. On November 18, 1998, ITG Europe launched a new agency
brokerage operation that includes the operation of a European version of the
POSIT system which currently runs four daily matches of U.K.-listed equities, at
9:30 a.m., 11:00 a.m., 12:00 noon and 3:00 p.m., London time. ITG Europe plans
to begin matching equity securities in seven additional European countries
during the first quarter of 2000.
AUSTRALIAN POSIT
In 1997, we and Burdett, Buckeridge & Young finalized a 50/50 joint venture
through the creation of ITG Australia Limited, a new international brokerage
firm that applies our cost-saving execution and transaction research
technologies to Australian equity trading. ITG Australia is the culmination of
efforts commenced in 1995 when a license to POSIT was granted to Burdett, one of
Australia's leading brokerage firms. Through this joint venture we are pursuing
U.S. business from Australian investors and providing U.S. clients with access
to the Australian marketplace.
CANADIAN QUANTEX
We have developed a version of QuantEX for the Canadian markets. This
software is licensed on a perpetual, non-exclusive, royalty-free basis to VERSUS
Technologies, Inc., a Canadian technology-focused trade automation firm based in
Toronto. Pursuant to this license and a series of transactions with RBC Dominion
Securities, the predecessor owner of the VERSUS assets, we received an equity
interest in VERSUS. We and VERSUS have also entered into three agreements for
trade execution by us in POSIT and other United States markets: (a) a routing
agreement pursuant to which VERSUS routes orders of Canadian registered brokers
to us, (b) an introducing broker agreement pursuant to which VERSUS's registered
broker affiliate sends institutional orders to us and (c) an introducing broker
agreement pursuant to which VERSUS's registered broker affiliate sends retail
orders to us.
7
REGULATION
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. The SEC is the federal agency
responsible for the administration of the federal securities laws. Regulation of
broker-dealers has been primarily delegated to self-regulatory organizations,
principally the National Association of Securities Dealers, Inc. and national
securities exchanges. The National Association of Securities Dealers has been
designated by the SEC as our self-regulatory organization. The self-regulatory
organizations conduct periodic examinations of member broker-dealers in
accordance with rules they have adopted and amended from time to time, subject
to approval by the SEC. Securities firms are also subject to regulation by state
securities administrators in those states in which they conduct business.
ITG Inc. is a registered broker-dealer in 49 states and the District of
Columbia.
Broker-dealers are subject to regulations covering all aspects of the
securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of clients' funds and securities, capital
structure of securities firms, record-keeping and conduct of directors, officers
and employees. Additional legislation, changes in the interpretation or
enforcement of existing laws and rules may directly affect the mode of operation
and profitability of broker-dealers. The SEC, self-regulatory organizations and
state securities commissions may conduct administrative proceedings, which can
result in censure, fine, the issuance of cease-and-desist orders or the
suspension or expulsion of a broker-dealer, its officers or employees. The
principal purpose of regulation and discipline of broker-dealers is the
protection of clients and the securities markets, rather than the protection of
creditors and stockholders of broker-dealers.
ITG Inc. is required by law to belong to the Securities Investor Protection
Corporation. In the event of a broker-dealer's insolvency, the Securities
Investor Protection Corporation fund provides protection for client accounts up
to $500,000 per customer, with a limitation of $100,000 on claims for cash
balances.
REGULATION ATS
Since the formation of the POSIT joint venture, POSIT had operated under a
"no-action" letter from the SEC staff that it would not recommend that the SEC
commence an enforcement action if POSIT were operated without registering as an
exchange. Since effectiveness of Regulation ATS on April 21, 1999, we have
operated POSIT as part of our broker-dealer operations in accordance with
Regulation ATS. Accordingly, POSIT is not registered with the SEC as an
exchange. There can be no assurance that the SEC will not in the future seek to
impose more stringent regulatory requirements on the operation of alternative
trading systems such as POSIT. In addition, certain of the securities exchanges
have actively sought to have more stringent regulatory requirements imposed upon
automated trade execution systems. There can be no assurance that Congress will
not enact legislation applicable to alternative trading systems.
NET CAPITAL REQUIREMENT
As a registered broker-dealer, ITG Inc. is subject to the SEC's uniform net
capital rule. The net capital rule is designed to measure the general integrity
and liquidity of a broker-dealer and requires that at least a minimum part of
its assets be kept in a relatively liquid form.
The net capital rule prohibits a broker-dealer doing business with the
public from allowing the aggregate amount of its indebtedness to exceed 15 times
its adjusted net capital or, alternatively, its adjusted net capital to be less
than 2% of its aggregate debit balances (primarily receivables from clients and
broker-dealers) computed in accordance with the net capital rule. We use the
latter method of calculation.
A change in the net capital rule, imposition of new rules or any unusually
large charge against capital could limit certain operations of ITG Inc., such as
trading activities that require the use of significant amounts of capital.
8
As of December 31, 1999, ITG Inc. had net capital of $39.3 million, which
exceeded minimum net capital requirements by $39.1 million. Although we believe
that the combination of our existing net regulatory capital and operating cash
flows will be sufficient to meet regulatory capital requirements, a shortfall in
net regulatory capital would have a material adverse effect on our business and
our results of operations.
CREDIT RISK
Although ITG Inc. is registered as a broker-dealer, we generally do not
perform traditional broker-dealer services. We do not act as a market-maker with
respect to any securities or otherwise act as a principal in any securities
transactions; we act only on an agency basis. Therefore, we do not have exposure
to credit risks in the way that traditional broker-dealers have such exposure.
The relatively low credit risk of our businesses is reflected in the minimal net
capital requirements imposed on ITG Inc. as a broker-dealer.
LICENSE AND RELATIONSHIP WITH BARRA
In 1987, Jefferies & Company, Inc. and BARRA Inc. formed a joint venture for
the purpose of developing and marketing POSIT. In 1993, Jefferies &
Company, Inc. assigned all of its rights relating to the joint venture and the
license agreement, discussed below, to us.
The technology used to operate POSIT is licensed to us pursuant to a
perpetual license agreement between us and the joint venture. The license
agreement grants us the exclusive right to use certain proprietary software
necessary to the continued operation of POSIT and a non-exclusive license to use
proprietary software that operates in conjunction with POSIT. We pay quarterly
royalties to the joint venture to use other proprietary software that operates
in conjunction with POSIT equal to specified percentages of the transaction fees
charged by us on each share crossed through POSIT. For the years ended
December 31, 1999, 1998 and 1997, BARRA received aggregate royalty payments from
the joint venture of $16.9 million, $15.2 million, and $9.8 million,
respectively, under the license agreement. Under the terms of the joint venture,
we and BARRA are prohibited from competing directly or indirectly with POSIT.
The license agreement permits BARRA on behalf of the joint venture to
terminate the agreement upon certain events of bankruptcy or insolvency or upon
an uncured breach by us of certain covenants, the performance of which are all
within our control. Although we do not believe that we will experience
difficulty in complying with our obligations under the license agreement, any
termination of the license agreement resulting from an uncured default would
have a material adverse effect on us.
Under the license agreement and the terms of the joint venture, BARRA
continues to provide certain support services to us in connection with the
operation of POSIT, including computer time, software updates and the
availability of experienced personnel. BARRA also provides support for the
development and maintenance of POSIT.
Under the terms of the joint venture, BARRA generally has the right to
approve any sale, transfer, assignment or encumbrance of our interest in the
joint venture. The POSIT joint venture may earn a royalty from licensing the
POSIT technology to other businesses. The joint venture licensed to us and
Burdett the right to use the POSIT technology for crossing equity securities in
Australia.
In the third quarter of 1997, BARRA finalized a joint venture with Prebon
Yamane to market POSIT-FRA, the first computer-based system for crossing forward
rate agreements. The POSIT joint venture licensed the POSIT software to Prebon.
POSIT-FRA provides a confidential electronic environment where major financial
institutions can match specific sets of forward rate agreements contracts to
offset interest rate risk, a condition that is pervasive in interest rate swap
portfolios.
In the fourth quarter of 1998, we finalized the formation of ITG Europe with
Societe Generale. The POSIT joint venture has licensed the POSIT software to ITG
Europe.
9
COMPETITION
The automated trade execution and analysis services offered by us compete
with services offered by leading brokerage firms and transaction processing
firms, and with providers of electronic trading and trade order management
systems and financial information services. POSIT also competes with various
national and regional securities exchanges and execution facilities, Nasdaq,
ATSs and ECNs such as Instinet, for trade execution services. Many of our
competitors have substantially greater financial, research and development and
other resources. We believe that our services compete on the basis of access to
liquidity, transaction cost and market impact cost reduction, timeliness of
execution and probability of trade completion. Although we believe that POSIT,
QuantEX, ITG Platform and the Electronic Trading Desk and Research services have
established certain competitive advantages, our ability to maintain these
advantages will require continued investment in the development of our services,
additional marketing activities and customer support services. There can be no
assurance that we will have sufficient resources to continue to make this
investment, that our competitors will not devote significantly more resources to
competing services or that we will otherwise be successful in maintaining our
current competitive advantages. In addition, we cannot predict the effect that
changes in regulation may have on the competitive environment. In particular,
the adoption of Regulation ATS may make it easier for securities exchanges,
Nasdaq or others to establish competing trading systems.
RESEARCH AND PRODUCT DEVELOPMENT
We believe that fundamental changes in the securities industry have
increased the demand for technology-based services. We devote a significant
portion of our resources to the development and improvement of these services.
Important aspects of our research and development effort include enhancements of
existing software, the ongoing development of new software and services and
investment in technology to enhance our efficiency. The software programs which
are incorporated into our services, are subject, in most cases, to copyright
protection. Research and development costs were $9.7 million, $8.6 million and
$5.3 million for 1999, 1998 and 1997, respectively.
In connection with such research and product development and capital
expenditures to improve other aspects of our business, we incur substantial
expenses that do not vary directly, at least in the short term, with
fluctuations in securities transaction volumes and revenues. In the event of a
material reduction in revenues, we may not reduce such expenses quickly and, as
a result, we could experience reduced profitability or losses. Conversely,
sudden surges in transaction volumes can result in increased profit and profit
margin. To ensure that we have the capacity to process projected increases in
transaction volumes, we have historically made substantial capital and operating
expenditures in advance of such projected increases, including during periods of
low transaction volumes. In the event that such growth in transaction volumes
does not occur, the expenses related to such investments could, as they have in
the past, cause reduced profitability or losses.
We work closely with BARRA on the development of POSIT enhancements. We
expect to continue this level of investment to improve existing services and
continue the development of new services.
DEPENDENCE ON PROPRIETARY INTELLECTUAL PROPERTY; RISKS OF INFRINGEMENT
Our success is dependent, in part, upon our proprietary intellectual
property. We generally rely upon patents, copyrights, trademarks and trade
secrets to establish and protect our rights in our proprietary technology,
methods and products. A third party may still try to challenge, invalidate or
circumvent the protective mechanisms that we select. We cannot assure that any
of the rights granted under any patent, copyright or trademark we may obtain
will protect our competitive advantages. In addition, the laws of some foreign
countries may not protect our proprietary rights to the same extent as the laws
of the United States.
In the past several years, there has been a proliferation of so-called
"business method patents" applicable to the computer and financial services
industries. News articles have also reported that there
10
has been a substantial increase in the number of such patent applications filed.
Under current law, U.S. patent applications remain secret for 18 months and may,
depending upon where else such applications are filed, remain secret until
issuance of a patent. In light of these factors, it is not economically
practicable to determine in advance whether our products or services may
infringe the present or future patent rights of others. We believe that factors
such as technological and creative skills of our personnel, new product
developments, frequent product enhancements, name recognition and reliable
product maintenance are essential to establishing and maintaining a
state-of-the-art technological system. There can be no assurance that we will be
able to protect our technology from disclosure or that others will not develop
technologies that are similar or superior to our technology. It is likely that
from time to time, we will receive notices from others of claims or potential
claims of intellectual property infringement or we may be called upon to defend
a joint venture partner, customer, vendee or licensee against such third party
claims. Responding to these kinds of claims, regardless of merit, could consume
valuable time, result in costly litigation or cause delays, all of which could
have a material adverse effect on us. Responding to these claims could also
require us to enter into royalty or licensing agreements with the third parties
claiming infringement. Such royalty or licensing agreements, if available, may
not be available on terms acceptable to us.
In February 1999, we became aware of patents purportedly owned by Belzberg
Financial Markets & News International Inc. and Sydney Belzberg, an officer of
that company (the "Belzberg Patents"). One or more of the Belzberg Patents may
relate to the devices, means and/or methods that we and/or our customers,
licensees or joint venture partners use in the conduct of business. On March 5,
1999, a Canadian licensee of some of our technology, received a letter asserting
that the licensee was infringing one of the Belzberg Patents. The licensee has
denied the claims of infringement and has asserted that the Belzberg Patent at
issue is invalid or unenforceable. Under certain conditions, we may have a duty
to defend or indemnify the licensee for any costs or damages arising out of an
infringing use of the technology we have licensed to them. We are monitoring the
matter and may participate in any challenge to the Belzberg Patent the licensee
may make.
We are unaware of any actual claims of patent infringement leveled against
us or any of our customers or joint venture partners by any of the title owners
of the Belzberg Patents. Based upon our review to date we believe that any such
claims arising out of the Belzberg Patents would be without merit and we would
vigorously defend any such claim, including, if warranted, initiating legal
proceedings. However, intellectual property disputes are subject to inherent
uncertainties and there can be no assurance that any potential claim would be
resolved favorably to us or that it would not have a material adverse affect on
us. We will monitor the Belzberg Patent situation and take action accordingly.
EMPLOYEES
As of December 31, 1999, we employed 318 personnel.
ITEM 2. PROPERTIES
Our principal offices are located at 380 Madison Avenue in New York City. We
currently lease the entire 4(th) floor and part of the 7(th) floor or
approximately 61,024 square feet of office space. In anticipation of future
expansion we have also leased a portion of the 5(th) floor (approximately 12,726
square feet of office space). This additional space on the 5(th) floor and a
portion of the 7(th) floor is currently being sublet. The lease payments as
compared to the rental income for the 5(th) and 7(th) floors, will have an
immaterial effect upon our operating results. The fifteen-year lease terms for
the 4(th) and 5(th) floors and the thirteen-year lease term for the 7(th) floor
expire in January 2013.
We also maintain a research, development and technical support services
facility in Culver City, California where we occupy approximately 48,202 square
feet of office space. We have leased an additional 23,520 square feet in this
facility, which we currently sublet. The lease payments as compared
11
to the rental income will have an immaterial effect upon our operating results.
We lease the California facility pursuant to lease agreements that expire
between December 2005 and April 2006.
Additionally, we also maintain a "hot" backup and regional office for
Financial Engineering Research and QuantEX support in Boston, Massachusetts
where we occupy approximately 10,588 square feet of office space. The ten-year
lease term for this space expires in April 2005.
During 1999, we opened a research facility in Herzelya, Israel where we
occupy approximately 5,712 square feet of office space. We lease the Israel
space pursuant to a four-year lease agreement that expires in November 2003.
ITEM 3. LEGAL PROCEEDINGS
In 1998, we received a "30-day letter" proposing certain adjustments which,
if sustained, would result in a tax deficiency of approximately $9.6 million
plus interest. The adjustments proposed relate to (i) the disallowance of
deductions taken in connection with the termination of certain compensation
plans at the time of our initial public offering in 1994 and (ii) the
disallowance of tax credits taken in connection with certain research and
development expenditures. We believe that the tax benefits in question were
taken properly and intend to vigorously contest the proposed adjustments. Based
on the facts and circumstances known at this time, we are unable to predict when
this matter will be resolved or the costs associated with its resolution.
In February 1999, we became aware of patents purportedly owned by Belzberg
Financial Markets & News International Inc. and Sydney Belzberg, an officer of
that company (the "Belzberg Patents"). One or more of the Belzberg Patents may
relate to the devices, means and/or methods that we and/or customers, licensees
or joint venture partners use in the conduct of business. On March 5, 1999, a
Canadian licensee of some of our technology, received a letter asserting that
the licensee was infringing one of the Belzberg Patents. The licensee has denied
the claims of infringement and has asserted that the Belzberg Patent at issue is
invalid or unenforceable. Under certain conditions, we may have a duty to defend
or indemnify the licensee for any costs or damages arising out of an infringing
use of the technology we have licensed to them. We are monitoring the matter and
may participate in any challenge to the Belzberg Patent the licensee may make.
We are unaware of any actual claims of patent infringement leveled against
us or any of our customers or joint venture partners by any of the title owners
of the Belzberg Patents. Based upon our review to date we believe that any such
claims arising out of the Belzberg Patents would be without merit and we would
vigorously defend any such claim, including, if warranted, initiating legal
proceedings. However, intellectual property disputes are subject to inherent
uncertainties and there can be no assurance that any potential claim would be
resolved favorably to us or that it would not have a material adverse affect on
us. We will monitor the Belzberg Patent situation and take action accordingly.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter ended December 31, 1999.
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
COMMON STOCK DATA
Our common stock was quoted on the Nasdaq National Market under the symbol
"ITGI" until April 26, 1999. Effective April 27, 1999, and in connection with
our spin-off from Jefferies Group, Inc., our common stock split based upon a
1.5955 to 1 exchange ratio and began trading on the New York Stock Exchange
under the symbol "ITG".
The following table sets forth, for the periods indicated, the range of the
high and low closing sales prices per share of our common stock as reported on
the Nasdaq National Market or the New York Stock Exchange, as applicable.
NASDAQ(1) NYSE
------------------- -------------------
HIGH LOW HIGH LOW
-------- -------- -------- --------
1998
First Quarter............................................. $23.50 $15.28 N/A N/A
Second Quarter............................................ 22.25 15.98 N/A N/A
Third Quarter............................................. 21.31 17.08 N/A N/A
Fourth Quarter............................................ 38.90 11.60 N/A N/A
1999
First Quarter............................................. 43.53 22.96 N/A N/A
Second Quarter (through April 26)......................... 43.28 31.91 N/A N/A
Second Quarter (from April 27)............................ N/A N/A $46.98 $29.24
Third Quarter............................................. N/A N/A 35.40 22.31
Fourth Quarter............................................ N/A N/A 28.55 19.27
- ------------------------
(1) High and low closing sales prices per share of our common stock as
reported on the Nasdaq National Market have been adjusted to reflect our
common stock split in connection with the spin-off at an exchange ratio of
1.5955 to 1.
On March 13, 2000, the closing sales price per share for our common stock as
reported on the New York Stock Exchange was $37.44. On March 13, 2000, we
believe that our common stock was held by approximately 4,700 stockholders of
record or through nominees in street name accounts with brokers.
In connection with our spin-off from Jefferies Group, Inc. we paid a special
cash dividend of $4.00 per share to each stockholder of record as of April 20,
1999. Our dividend policy is to retain earnings to finance the operations and
expansion of our businesses. We do not anticipate paying any cash dividends on
our common stock in the foreseeable future.
13
ITEM 6. SELECTED FINANCIAL DATA
The selected Consolidated Statement of Operations data and the Consolidated
Statement of Financial Condition data presented below as of and for each of the
years in the five-year period ended December 31, 1999, are derived from our
consolidated financial statements, which financial statements have been audited
by KPMG LLP, independent auditors. Earnings per share information prior to 1997
has been retroactively restated to conform with the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 128, EARNINGS PER SHARE, and earnings per share information prior
to 1999 has been retroactively restated to reflect our spin-off from Jefferies
Group, Inc. See Note 1, ORGANIZATION AND BASIS FOR PRESENTATION--SPIN-OFF FROM
JEFFERIES GROUP, in the Notes to Consolidated Financial Statements on page 31.
Such data should be read in connection with the consolidated financial
statements contained on pages 24 through 46.
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Total revenues............................. $232,044 $212,205 $137,042 $111,556 $72,381
Total expenses............................. 149,183 131,270 89,782 70,555 47,493
-------- -------- -------- -------- -------
Income before income taxes................. 82,861 80,935 47,260 41,001 24,888
Income tax expense......................... 37,435 37,541 20,343 17,666 9,983
-------- -------- -------- -------- -------
Net income................................. $ 45,426 $ 43,394 $ 26,917 $ 23,335 $14,905
======== ======== ======== ======== =======
Basic net earnings per share of common
stock.................................... $ 1.48 $ 1.48 $ 0.93 $ 0.80 $ 0.51
======== ======== ======== ======== =======
Diluted net earnings per share of common
stock.................................... $ 1.42 $ 1.41 $ 0.89 $ 0.79 $ 0.51
======== ======== ======== ======== =======
Basic weighted average shares outstanding
(in millions)............................ 30.7 29.3 29.0 29.2 29.5
Diluted weighted average shares and common
stock equivalents outstanding (in
millions)................................ 31.9 30.8 30.2 29.7 29.5
CONSOLIDATED STATEMENT OF FINANCIAL
CONDITION DATA:(1)
Total assets............................... $179,488 $180,706 $113,641 $ 82,798 $55,318
Total stockholders' equity................. $115,652 $143,709 $ 93,763 $ 67,093 $45,479
OTHER SELECTED FINANCIAL DATA:
Revenues per trading day (in thousands).... $ 921 $ 842 $ 542 $ 439 $ 287
Shares executed per day (in millions)...... 46 43 27 22 15
Revenues per average number of employees
(in thousands)........................... $ 802 $ 888 $ 733 $ 814 $ 689
Average number of employees................ 290 239 187 137 105
Total number of customers(1,2)............. 572 535 452 417 354
POSIT(2)................................. 492 490 414 396 330
QuantEX(3)............................... 52 52 43 55 81
ITG Platform(3).......................... 188 140 48 36 N/A
Total number of customer
installations:(1,3)
QuantEX.................................. 103 97 84 109 97
ITG Platform............................. 296 201 69 67 N/A
Return on average stockholders' equity..... 34.4% 37.4% 33.9% 45.5% 39.3%
Book value per share(4).................... $ 3.86 $ 4.85 $ 3.23 $ 2.30 $ 1.46
Tangible book value per share(4)........... $ 3.83 $ 4.80 $ 3.16 $ 2.22 $ 1.36
Price to earnings ratio using diluted net
earnings per share of common stock....... 19.9 27.6 19.7 15.3 11.4
14
The following graph represents the number of shares ITG Inc. executed as a
percentage of the market volume in the U.S. market since 1994.(5)
ITG VOLUME AS PERCENTAGE OF MARKET VOLUME
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
SHARE PER DAY
1994 1.7
1995 1.9
1996 2.26
1997 2.24
1998 2.94
1999 2.45
- ------------------------
(1) Numbers are as of December 31(st) of each year.
(2) Total customers and POSIT customers include those customers who have
generated revenues in excess of $1,000 in each year.
(3) For the years ended December 31, 1999, 1998 and 1997, QuantEx and ITG
Platform customers and customer installations include those customers and
installations that have either (a) traded 100,000 shares in the last quarter
of each calendar year or (b) traded shares on at least 12 different days
during such quarter. For the years ended December 31, 1996 and 1995, QuantEx
and ITG Platform customers and customer installations include those
customers who have generated revenues in excess of $1,000 in each year
(4) The prior years have been restated to reflect the Company's spin-off from
Jefferies Group, Inc. See Note 1, ORGANIZATION AND BASIS FOR
PRESENTATION--SPIN-OFF FROM JEFFERIES GROUP, in the Notes to Consolidated
Financial Statements on page 31.
(5) The percentages on the graph are total ITG shares executed divided by the
"market" volume. Total ITG shares executed includes total POSIT shares,
QuantEX shares and shares executed by the Electronic Trading Desk. Market
volume includes shares executed by and as provided by the New York Stock
Exchange and Nasdaq. Market volume excludes ITG shares executed.
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with our
consolidated financial statements, including the notes thereto.
GENERAL
REVENUES:
We generate substantially all of our revenues from the following four
products and services, each contributing to our single line of business:
- POSIT: a confidential electronic stock crossing system;
- Electronic Trading Desk: an agency-only trading desk;
- Front End Software;
- QuantEX: a Unix-based front-end software system providing market
analysis, trade management and electronic connectivity to POSIT and
multiple trade execution destinations; and
- ITG Platform: a PC-based front-end software system providing market
analysis, trade management and electronic connectivity to POSIT and
multiple trade execution destinations.
Revenues primarily consist of commissions from customers' use of our trade
execution and analytical services. Because these commissions are paid on a
per-transaction basis, revenues fluctuate from period to period depending on the
volume of securities traded through our services. We record as POSIT revenue any
order that is executed on the POSIT system regardless of the manner in which the
order was submitted to POSIT. ITG collects a commission from each side of a
trade matched on POSIT. We record as Electronic Trading Desk revenue any order
that is handled by our trading desk personnel and executed at any trade
execution destination other than POSIT. We record as Client revenue any order
that is sent by our clients, through ITG's front-end systems but without
assistance from the Electronic Trading Desk, to any third party trade execution
destination. Other revenue includes interest income/expense and market
gains/losses and financing costs resulting from temporary positions in
securities assumed in the normal course of our agency trading business.
EXPENSES:
Expenses consist of compensation and employee benefits, transaction
processing, software royalties, occupancy and equipment, telecommunications and
data processing services, net loss on long-term investments, spin-off costs and
other general and administrative expenses. Compensation and employee benefits
expenses include base salaries, bonuses, employment agency fees, part-time
employee compensation, fringe benefits, including employer contributions for
medical insurance, life insurance, retirement plans and payroll taxes, offset by
capitalized software. Transaction processing expenses consist of floor brokerage
and clearing fees and connection fees for use of certain third party execution
services. Software royalties are payments to our POSIT joint venture partner,
BARRA. Occupancy and equipment expenses include rent, depreciation, amortization
of leasehold improvements, maintenance, utilities, occupancy taxes and property
insurance. Telecommunications and data processing services include costs for
computer hardware, office automation and workstations, data center equipment,
market data services and voice, data, telex and network communications. Net loss
on long-term investments includes gains on the sale of equity investments, as
offset by amortization of goodwill, equity gain/loss and initial start-up costs.
Spin-off costs include legal, accounting, consulting and various other expenses
in connection with the spin-off from Jefferies Group and related transactions.
Other general and administrative expenses include amortization of software and
goodwill, legal, audit, tax, consulting and promotional expenses.
16
RESULTS OF OPERATIONS
The table below sets forth certain items in the statement of income
expressed as a percentage of revenues for the periods indicated:
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Revenues:................................................... 100.0% 100.0% 100.0%
Commissions
POSIT................................................... 55.7 55.1 55.0
Electronic trading desk................................. 20.5 23.4 22.0
Client.................................................. 22.0 19.9 22.0
Other..................................................... 1.8 1.6 1.0
Expenses:
Compensation and employee benefits........................ 22.3 24.3 22.2
Transaction processing.................................... 13.9 12.7 15.6
Software royalties........................................ 7.3 7.2 7.2
Occupancy and equipment................................... 5.7 5.6 6.7
Telecommunications and data processing services........... 4.1 3.8 4.8
Net loss on long-term investments......................... 1.1 0.1 0.2
Spin-off costs............................................ 2.8 0.9 0.0
Other general and administrative.......................... 7.1 7.3 8.8
Total expenses.......................................... 64.3 61.9 65.5
Income before income tax expense............................ 35.7 38.1 34.5
Income tax expense.......................................... 16.1 17.7 14.8
Net income.................................................. 19.6 20.4 19.6
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
EARNINGS PER SHARE
Basic net earnings per share for both 1999 and 1998 were $1.48. Diluted net
earnings per share increased $0.01, or 1%, from $1.41 to $1.42. Diluted net
earnings per share for 1999 and 1998, excluding non-recurring charges (net of
tax benefits) of $3.9 million and $1.9 million, respectively, incurred in
connection with our spin-off from Jefferies Group, Inc. were $1.54 and $1.47,
respectively.
REVENUES
Total revenues increased $19.8 million, or 9%, from $212.2 million to
$232.0 million. There were 252 trading days in both 1998 and 1999. Revenues per
trading day increased by $79,000, or 9%, from $842,000 to $921,000. Revenues per
employee decreased $83,000, or 10%, from $813,000 to $730,000.
The increases in POSIT and Client revenues were attributable to an increase
in trading volume by existing customers and an increase in the number of
customers. The number of shares crossed on the POSIT system increased
0.7 billion, or 12%, from 5.8 billion to 6.5 billion. The number of shares
crossed on the POSIT system per day increased 2.5 million, or 11%, from
23.2 million to 25.7 million. In addition, on both June 24, and July 15, 1999, a
record breaking 49.7 and 59.9 million shares were crossed on the POSIT system,
respectively. Of Client revenues, ITG Platform revenue increased 169%
representing 55% of the increase in Client revenues. Electronic Trading Desk
revenues decreased due to a number of factors, including, our clients winning
fewer portfolio transitions, increased competition from principal bids and lower
turnover of portfolios for some of our clients. Other revenues increased
primarily due to incremental royalty income from international versions of
POSIT, larger average balances in our investment portfolio and decreased errors
and accommodations. These were partially
17
offset by increased financing costs resulting from temporary positions in
securities assumed in the normal course of our agency trading business.
EXPENSES
Total expenses excluding income tax expense for 1999 increased
$17.9 million, or 14%, from $131.3 million to $149.2 million.
The following table itemizes expenses by category (in thousands):
YEAR ENDED
DECEMBER 31,
1999 1998 CHANGE % CHANGE
-------- -------- -------- --------
Compensation and employee benefits....................... $51,717 $51,462 255 0.5%
Transaction processing................................... 32,282 26,920 5,362 19.9
Software royalties....................................... 16,851 15,247 1,604 10.5
Occupancy and equipment.................................. 13,295 11,886 1,409 11.9
Telecommunications and data processing services.......... 9,428 8,138 1,290 15.9
Net loss on long-term investments........................ 2,674 204 2,470 1,210.8
Spin-off costs........................................... 6,516 1,936 4,580 236.6
Other general and administrative......................... 16,420 15,477 943 6.1
Income taxes............................................. 37,435 37,541 (106) (0.3)
COMPENSATION AND EMPLOYEE BENEFITS: Salaries, bonuses and related employee
benefits increased primarily due to growth in our employee base of 22% from 261
to 318, and additional compensation necessary to attract and retain quality
personnel. Approximately 70% of the increase in employees were staffed in
technology, product development and production infrastructure. This is
consistent with our ongoing effort to respond to continuous changes in the
securities industry and demand for increased efficiencies by enhancing existing
software and developing new software and services. Average compensation and
employee benefits expenses per person decreased $34,000, or 17%, from $197,000
to $163,000.
TRANSACTION PROCESSING: Transaction processing as a percentage of revenues
increased from 12.7% to 13.9% of revenues. Ticket charges increased 23%,
primarily as a result of customers allocating transactions to a larger number of
accounts. With only a 9% increase in execution volume, we did not realize
significant savings from volume-discounted clearing and execution costs.
SOFTWARE ROYALTIES: Because software royalties are contractually fixed at
13% of POSIT revenues, the increase is wholly attributable to an increase in
POSIT revenues.
OCCUPANCY AND EQUIPMENT: The increase in headcount, infrastructure
enhancements and costs to address potential problems related to the Year 2000
issue resulted in increased equipment purchases and the associated depreciation
and maintenance expenses. In addition, the expansion of our research and
development facility in Culver City, California, in July 1998 resulted in an
increase in rent expense.
TELECOMMUNICATIONS AND DATA PROCESSING SERVICES: The $1.3 million increase
in telecommunications and data processing services stems primarily from fees to
upgrade client data feeds, including market data line connections, increase in
communication charges from linking clients to ITG in New York and Boston, and
increases in dial-up costs related to the increase in ITG Platform
installations. This increase was offset primarily by a decrease in spending on
contingency-related planning and implementation.
NET LOSS ON LONG-TERM INVESTMENTS: The increase in loss on long-term
investment in 1999 over 1998 primarily resulted from the recorded gain on sale
of our equity investment in the LongView Group,
18
Inc. in 1998 totaling $3.8 million. Excluding the effects of this gain on sale,
losses incurred by our investments in ITG Europe and ITG Australia were
$0.2 million less in 1999 than 1998. In 1999, we also recognized a $0.4 million
deferred gain on the sale of the LongView Group that was held in escrow for one
year.
SPIN-OFF COSTS: The spin-off expenses are attributable to our legal,
accounting, consulting and other expenses incurred for the spin-off
transactions, as discussed in Note 1, ORGANIZATION AND BASIS OF
PRESENTATION--SPIN-OFF FROM JEFFERIES GROUP, in the Notes to Consolidated
Financial Statements on page 31.
OTHER GENERAL AND ADMINISTRATIVE: The increase in other general and
administrative expenses reflects software amortization for certain products that
were released in late 1998 and increased spending on advertisement and
promotion, offset in part by a decline in consulting expenses for projects such
as network migration and strategic market studies.
Additionally, subsequent to our spin-off, specified administrative services
previously provided to us at a fixed monthly fee by Jefferies Group, Inc. were
performed by ITG. This change resulted in higher legal, audit and accounting
fees offset in part by reduced administrative service fees.
INCOME TAX EXPENSE
The decrease in the effective tax rate from 46.4% in 1998 to 45.2% in 1999
was due to decreases in certain non-deductible expenses and an increase in
dividends received deduction.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
EARNINGS PER SHARE
Basic net earnings per share increased $0.55, or 59%, from $0.93 in 1997 to
$1.48 in 1998. Diluted net earnings per share increased $0.52, or 58%, from
$0.89 to $1.41.
REVENUES
Total revenues increased $75.2 million, or 54.9%, from $137.0 million to
$212.2 million. The number of trading days were 252 in 1998 compared to 253 in
1997. Revenues per trading day increased by $300,000, or 55.5%, from $542,000 to
$842,000. Revenues per employee increased $182,000, or 28.8%, from $631,000 to
$813,000. The increases were attributable to increases in the number of our
customers and increases in trading volume by our existing customers. Revenues
from the Electronic Trading Desk increased $19.5 million, or 64.9%, from
$30.1 million to $49.6 million. The number of shares crossed on the POSIT system
increased 2.1 billion, or 56.8%, from 3.7 billion to 5.8 billion. POSIT revenues
in turn increased $41.6 million, or 55.2%, from $75.4 million to
$117.0 million. QuantEX revenues increased $12.0 million, or 39.9%, from
$30.1 million to $42.1 million.
EXPENSES
Total expenses increased $41.5 million, or 46.2%, from $89.8 million to
$131.3 million.
19
The following table itemizes expenses by category (in thousands):
YEAR ENDED
DECEMBER 31,
1998 1997 CHANGE % CHANGE
-------- -------- -------- --------
Compensation and employee benefits...................... $51,462 $30,479 $20,983 68.8%
Transaction processing.................................. 26,920 21,413 5,507 25.7
Software royalties...................................... 15,247 9,848 5,399 54.8
Occupancy and equipment................................. 11,886 9,204 2,682 29.1
Telecommunications and data processing services......... 8,138 6,605 1,533 23.2
Net loss on long-term investments....................... 204 297 (93) (31.3)
Spin-off costs.......................................... 1,936 -- 1,936 N/A
Other general and administrative........................ 15,477 11,936 3,541 29.7
Income taxes............................................ 37,541 20,343 17,198 84.5
COMPENSATION AND EMPLOYEE BENEFITS. Salaries, bonuses and related employee
benefits increased approximately $21.0 million over the prior year. Such
increases were primarily due to our profitability-based compensation plan,
growth in our employee base of 44 or 20.3%, from 217 to 261 and additional
compensation necessary to attract and retain quality personnel. Over 50% of the
increase in new employees were staffed in technology, product development and
production infrastructure. In addition, our board of directors voted to
accelerate the vesting of the options of our deceased President and Chief
Executive Officer, Scott P. Mason, resulting in a $2.8 million charge to
compensation expense, representing 13% of the increase.
TRANSACTION PROCESSING. The increase in transaction processing is primarily
due to an increase in ticket charges associated with a higher volume of
transactions in 1998. The increase in ticket charges of 28% was not
proportionate with the increase in revenues of 55% due to volume discounts
associated with clearing and execution services. A decrease in specialist fees
of 26% and floor broker fees of 3%, was offset by the volume increases in shares
executed by specialists of 49% and floor brokers of 51%, resulting in a net
increase in transaction processing expenses. Transaction processing as a
percentage of revenues decreased from 15.6% in 1997 to 12.7% in 1998.
SOFTWARE ROYALTIES. As software royalties are contractually fixed at 13% of
POSIT revenues, the increase is wholly attributable to an increase in POSIT
revenues.
OCCUPANCY AND EQUIPMENT. The increase in occupancy and equipment is
primarily attributable to additional depreciation and amortization of leasehold
improvements (representing 65% of the increase) and rent expense (representing
33% of the increase) related to the relocation and expansion of our corporate
headquarters (occupied in June 1997), combined with increases in headcount and
purchases of additional technologically advanced software.
TELECOMMUNICATIONS AND DATA PROCESSING SERVICES. The increase in
technological and data communications processing expenses stems primarily from
the data feed upgrades for clients, primarily market data line connections, and
expenses relating to a telecommunication network conversion and contingency
planning.
NET LOSS ON LONG-TERM INVESTMENTS. The decrease in net loss on long-term
investments is due to income of $3.8 million recognized from the sale of our
37.4% equity ownership interest in the LongView Group, Inc., offset by initial
start-up costs for ITG Europe of $1.3 million and the combined costs of equity
loss pick-up and amortization of goodwill on ITG Australia of $0.2 million and
the LongView Group, Inc, of $0.8 million.
SPIN-OFF COSTS. The spin-off expenses are attributable to our legal,
accounting, consulting and other expenses incurred for the spin-off
transactions.
20
OTHER GENERAL AND ADMINISTRATIVE. The increase in other general and
administrative expenses was the result of a write-off of a net receivable from
the former Global POSIT joint venture of approximately $1.0 million, accelerated
software amortization for specific products, increases in business development
costs, such as advertising and active sales efforts, and additional
administrative costs, associated with ITG Europe. Additionally, we had an
increase in consulting expense primarily due to accounting and financial
research of international joint venture opportunities and a major
telecommunication system conversion.
INCOME TAX EXPENSE
The increase in income tax expense is the result of an increase in pretax
income and an increase in the effective tax rate from 43.0% in 1997 to 46.4% in
1998. The increase in the effective rate was due to certain non-deductible
expenses, such as goodwill amortization and spin-off costs and the inability to
offset international losses with United States profits in calculating income tax
expense, that were not present in 1997.
DEPENDENCE ON MAJOR CUSTOMERS
During 1999, revenue from our 10 largest customers accounted for
approximately 33.0% of our total revenue while revenue from each of our three
largest customers accounted for 5.8%, 4.7%, and 4.7%, respectively, of total
revenue. During 1998, revenue from our 10 largest customers accounted for
approximately 30.7% of our total revenue while revenue from each of our three
largest customers accounted for 7.9%, 4.5% and 3.2%, respectively, of total
revenue. During 1997, revenue from our 10 largest customers accounted for
approximately 34.5% of our total revenue while revenue from each of our three
largest customers accounted for 8.8%, 5.9% and 3.4%, respectively, of total
revenue. Customers may discontinue use of our services at any time. The loss of
any significant customers could have a material adverse effect on our results of
operations. In addition, the loss of significant POSIT customers could result in
lower share volumes of securities offered through POSIT, which may adversely
affect the liquidity of the system.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity and capital resource requirements result from our working
capital needs, primarily consisting of compensation and benefits, transaction
processing fees and software royalty fees. Historically, cash from operations
has met all working capital requirements. A substantial portion of our assets
are liquid, consisting of cash and cash equivalents or assets readily
convertible into cash.
We believe that our cash flow from operations and existing cash balances
will be sufficient to meet our cash requirements. We generally invest our excess
cash in money market funds and other short-term investments that generally
mature within 90 days or less. Additionally, securities owned at fair value
include highly liquid, variable rate municipal securities, auction rate
preferred stock and common stock. At December 31, 1999, cash equivalents and
securities owned at fair value amounted to $96.7 million and net receivables
from brokers, dealers and other, of $16.6 million were due within 30 days. A
special cash dividend of $74.6 million was paid on April 21, 1999 in connection
with the spin-off from Jefferies Group. See Note 1, ORGANIZATION AND BASIS OF
PRESENTATION--SPIN-OFF FROM JEFFERIES GROUP, in the Notes to Consolidated
Financial Statements on page 31.
We also invest a portion of our excess cash balances in cash enhanced
strategies, which we believe should yield higher returns without any significant
effect on risk. As of December 31, 1999, we had investments in limited
partnerships investing in marketable securities, a hedged convertible managed
account, and a venture capital fund amounting to $21.4 million in the aggregate.
The limited partnerships employ either a hedged convertible strategy or a
long/short strategy to capitalize on short term price movements. Our managed
account is employing a hedged convertible strategy. We classify
21
the securities under our managed account within securities owned, at fair value
and securities sold, not yet purchased, at fair value.
Historically, all regulatory capital needs of ITG Inc. have been provided by
cash from operations. We believe that cash flows from operations will provide
ITG Inc. with sufficient regulatory capital. As of December 31, 1999, we had net
excess regulatory capital of $39.1 million. We had an agreement with a bank to
borrow up to $20 million on a revolving basis to enable ITG Inc. to satisfy its
regulatory net capital requirements. This commitment expired on March 14, 2000.
Although we believe that the combination of our existing net regulatory capital
and operating cash flows will be sufficient to meet regulatory capital
requirements, a shortfall in net regulatory capital would have a material
adverse effect on us.
In 1998, we established a $2 million credit line with a bank to fund
temporary regulatory capital shortfalls encountered periodically by ITG
Australia. The lender charges us interest at the federal funds rate plus 1%. We
lend amounts borrowed to ITG Australia and charge interest at the federal funds
rate plus 2%. At December 31, 1999, no amounts were outstanding under this bank
credit line and no amounts were owed to us by ITG Australia.
EFFECTS OF INFLATION
We do not believe that the relatively moderate levels of inflation which
have been experienced in North America in recent years have had a significant
effect on our revenue or profitability. However, high inflation may lead to
higher interest rates which might cause investment funds to move from equity
securities to debt securities or cash equivalents.
THE YEAR 2000 ISSUE
We spent an aggregate of $2.8 million, of which we spent $1.3 million in
1999, to upgrade or replace computer and software systems in order to address
potential problems related to the Year 2000 issue.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the Accounting Standards Executive Committee issued Statement
of Position 98-1 ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR
OBTAINED FOR INTERNAL USE ("SOP 98-1"). SOP 98-1 provides guidance on accounting
for the costs of computer software developed or obtained for internal use. It
identifies the characteristics of internal-use software and provides examples to
assist in determining when the computer software is for internal use. The
Company has adopted this SOP effective January 1, 1999 which has had no material
effect on the financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
MARKET PRICE RISK
As part of our full service equity trade execution business we do not engage
in proprietary trading; however, at times we do hold positions overnight due to
client or Company errors. Accordingly, we maintain policies and procedures
regarding the management of our errors and accommodations proprietary trading
accounts. It is our policy to attempt to trade out of all positions arising from
errors and accommodations immediately while balancing our exposure to market
risk which can arise from liquidating such positions. Accordingly, certain
positions may be liquidated over a period of time in an effort to minimize
market impact.
We have established approval policies that include review by the President
(or his designee) and our compliance department of any proprietary trading
activity. Our operations department reviews all open trades intraday in an
effort to ensure that any open issues are addressed and resolved by the
22
close of the trading day. Additionally, our clearing broker notifies us of all
known trade discrepancies on the day following the trade date.
We employ a cash management strategy which seeks to optimize excess liquid
assets by preserving principal, maintaining liquidity to satisfy capital
requirements, minimizing risk and maximizing our after tax rate of return. For
working capital purposes, we invest only in money market instruments. Cash which
is not needed for normal operations is invested in a tax efficient manner in
instruments with appropriate maturities and levels of risk to correspond to
expected liquidity needs. We currently have investments in municipal bonds,
auction rate preferred bonds, common stock and convertible bonds. To the extent
that we invest in marketable equity securities, we ensure portfolio liquidity by
investing in marketable securities with active secondary or resale markets. We
do not use derivative financial instruments in our investment portfolio. At
December 31, 1999 our cash and cash equivalents and securities owned were
approximately $96.7 million.
We will from time to time, make investments that are considered strategic.
These investments require approval of executive management and/or the board of
directors. This component of our cash management strategy is reevaluated
periodically. At December 31, 1999, investments in limited partnerships, venture
capital investments and securities available for sale were approximately
$15.9 million.
INTEREST RATE RISK
Our exposure to interest rate risk relates primarily to the interest-bearing
portions of our investment portfolio. Our policy is to invest in high quality
credit issuers, limit the amount of credit exposure to any one issuer and invest
in tax efficient strategies. Our first priority is to reduce the risk of
principal loss. We seek to preserve our invested funds by limiting default risk,
market risk, and re-investment risk. We attempt to mitigate default risk by
investing in high quality credit securities that we believe to be low risk and
by positioning our portfolio to respond appropriately to reductions in the
credit rating of any investment issuer or guarantor that we believe is adverse
to our investment strategy.
Our interest-bearing investment portfolio primarily consists of short-term,
high-credit quality money market funds, highly liquid variable rate municipal
securities, convertible bonds and preferred stock. These investments totaled
approximately $92.6 million at December 31, 1999. Our interest-bearing
investments are not insured and because of the short-term high quality nature of
the investments are not likely to fluctuate significantly in market value.
FOREIGN CURRENCY RISK
We are pursuing the international market in a variety of ways, including
joint-ventures in Europe and Australia and the development of specially tailored
versions of our services. Additionally, we maintain development facilities in
Israel which focus on developing services for the European market. Our
investments in these joint-ventures and development activities expose us to
currency exchange fluctuations between the U.S. Dollar and the British Pound
Sterling, Australian Dollar, Canadian Dollar and Israeli New Shekel. To the
extent that our international activities recorded in local currencies increase
in the future, our exposure to fluctuations in currency exchange rates will
correspondingly increase. We have not engaged in foreign currency hedging
activities. However, non-U.S. dollar cash balances held overseas are generally
kept at levels necessary to meet current operating and capitalization needs.
23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL REPORTS SECTION
PAGES
--------
Management's Responsibility for Compliance and Financial
Reporting................................................. 25
Independent Auditors' Report................................ 26
Consolidated Statements of Financial Condition.............. 27
Consolidated Statements of Income........................... 28
Consolidated Statements of Changes in Stockholders'
Equity.................................................... 29
Consolidated Statements of Cash Flows....................... 30
Notes to Consolidated Financial Statements.................. 31
24
MANAGEMENT'S RESPONSIBILITY FOR COMPLIANCE AND FINANCIAL REPORTING
TO THE SHAREHOLDERS:
The management of Investment Technology Group, Inc. is responsible for the
integrity and objectivity of the financial information presented in this Annual
Report. Financial information appearing throughout the Annual Report is
consistent with that in the accompanying financial statements. The financial
statements have been prepared by management of our company in conformity with
generally accepted accounting principles in the United States. The financial
statements reflect, where applicable, management's best judgments and estimates.
The management of our company has established and maintains an internal
control structure and monitors that structure for compliance with established
policies and procedures. The objectives of an internal control structure are to
provide reasonable, but not absolute, assurance as to the integrity and
reliability of the financial statements, the protection of assets from
unauthorized use or disposition, and that transactions are executed in
accordance with management's authorization.
Management also recognizes its responsibility to foster and maintain a
strong ethical environment within our company to ensure that its business
affairs are conducted with integrity and in accordance with high standards of
personal and corporate conduct. This responsibility is characterized and
reflected in our company's Statement of Policy on Standards of Employee Conduct,
which is distributed to all of our employees. As part of the monitoring system,
we maintain Corporate Compliance Personnel, who have oversight responsibilities
for administering and coordinating the application of these standards of
conduct. Senior legal and compliance personnel have been directed to report
compliance concerns directly to the President of our company. Ongoing oversight
of compliance activities is the responsibility of our President.
Our board of directors appoints an audit committee composed solely of
outside directors. The function of the audit committee is to oversee the
accounting, reporting, audit and internal control policies and procedures
established by our management. The committee meets regularly with management and
the internal and independent auditors. The auditors have free access to the
audit committee without the presence of management. The audit committee reports
regularly to our board of directors on its activities, and such other matters as
it deems necessary.
Our company's annual consolidated financial statements have been audited by
KPMG LLP, independent auditors, who were appointed by the board of directors.
Management has made available to KPMG LLP all of our company's financial records
and related data, as well as the minutes of directors' meetings.
Furthermore, management believes that all its representations to KPMG LLP
are valid and appropriate. In addition, KPMG LLP, in determining the nature and
extent of their auditing procedures, considered our company's accounting
procedures and policies and the effectiveness of the related internal control
structure.
Management believes that, as of December 31, 1999, our company's internal
control structure was adequate to accomplish the objectives discussed herein.
Raymond L. Killian, Jr. Howard C. Naphtali Angelo Bulone
Chairman, Chief Executive Managing Director Vice President
Officer and President and Chief Financial Officer and Controller
25
INDEPENDENT AUDITORS' REPORT
Board of Directors
Investment Technology Group, Inc. and Subsidiaries:
We have audited the accompanying consolidated statements of financial
condition of Investment Technology Group, Inc. and subsidiaries (the "Company")
as of December 31, 1999 and 1998, and the related consolidated statements of
income, changes in stockholders' equity, and cash flows for each of the years in
the three-year period ended December 31, 1999. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Investment
Technology Group, Inc. and subsidiaries as of December 31, 1999 and 1998, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1999, in conformity with generally
accepted accounting principles.
KPMG LLP
New York, New York
January 19, 2000
26
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31,
-------------------
1999 1998
-------- --------
ASSETS
Cash and cash equivalents................................... $ 53,081 $ 77,518
Securities owned, at fair value............................. 43,612 39,615
Receivables from brokers, dealers and other, net............ 19,181 24,127
Due from affiliates......................................... -- 722
Investments in limited partnerships......................... 13,922 1,000
Securities, available-for-sale, at fair value............... 2,023 --
Premises and equipment...................................... 20,229 19,662
Capitalized software........................................ 5,629 6,450
Goodwill.................................................... 824 1,373
Deferred taxes.............................................. 13,324 2,784
Other assets................................................ 7,663 7,455
-------- --------
Total assets................................................ $179,488 $180,706
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses....................... 33,459 24,349
Payable to brokers, dealers and other....................... 3,932 3,015
Software royalties payable.................................. 4,874 4,070
Securities sold, not yet purchased, at fair value........... 5,861 288
Due to affiliates........................................... -- 1,422
Income taxes payable........................................ 15,710 --
Income taxes payable to affiliate........................... -- 3,853
-------- --------
Total liabilities......................................... 63,836 36,997
-------- --------
Commitments and Contingencies (Notes 14 and 16)
STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.01; shares authorized:
1,000,000; shares issued: none.......................... -- --
Common stock, par value $0.01; shares authorized:
100,000,000; shares issued: 32,179,106 in 1999 and
30,961,253 in 1998...................................... 322 310
Additional paid-in capital................................ 96,534 51,395
Retained earnings......................................... 75,727 104,925
Common stock held in treasury, at cost; shares: 2,213,721
in 1999 and 1,300,333 in 1998........................... (58,052) (12,760)
Accumulated other comprehensive income (loss):
Currency translation adjustment......................... (7) (161)
Unrealized gain on securities, available-for-sale, net
of tax................................................ 1,128 --
-------- --------
Total stockholders' equity............................ 115,652 143,709
-------- --------
Total liabilities and stockholders' equity.................. $179,488 $180,706
======== ========
The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
27
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
REVENUES:
Commissions
POSIT................................................... $129,364 $116,950 $ 75,362
Electronic trading desk................................. 47,577 49,613 30,084
Client.................................................. 51,019 42,151 30,136
Other..................................................... 4,084 3,491 1,460
-------- -------- --------
Total revenues........................................ 232,044 212,205 137,042
EXPENSES:
Compensation and employee benefits........................ 51,717 51,462 30,479
Transaction processing.................................... 32,282 26,920 21,413
Software royalties........................................ 16,851 15,247 9,848
Occupancy and equipment................................... 13,295 11,886 9,204
Telecommunications and data processing services........... 9,428 8,138 6,605
Net loss on long-term investments......................... 2,674 204 297
Spin-off costs............................................ 6,516 1,936 --
Other general and administrative.......................... 16,420 15,477 11,936
-------- -------- --------
Total expenses........................................ 149,183 131,270 89,782
-------- -------- --------
Income before income tax expense............................ 82,861 80,935 47,260
Income tax expense.......................................... 37,435 37,541 20,343
-------- -------- --------
NET INCOME.................................................. $ 45,426 $ 43,394 $ 26,917
======== ======== ========
Basic net earnings per share of common stock................ $ 1.48 $ 1.48 $ 0.93
======== ======== ========
Diluted net earnings per share of common stock.............. $ 1.42 $ 1.41 $ 0.89
======== ======== ========
Basic weighted average shares outstanding................... 30,691 29,302 29,004
======== ======== ========
Diluted weighted average shares and common stock equivalents
outstanding............................................... 31,947 30,775 30,219
======== ======== ========
The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
28
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
COMMON
ADDITIONAL STOCK ACCUMULATED TOTAL
PREFERRED COMMON PAID-IN RETAINED HELD IN COMPREHENSIVE STOCKHOLDERS'
STOCK STOCK CAPITAL EARNINGS TREASURY INCOME (LOSS) EQUITY
--------- -------- ---------- -------- -------- -------------- -------------
Balance at December 31, 1996.......... $ -- $298 $35,944 $34,614 $(3,763) $ -- $ 67,093
Net income............................ -- -- -- 26,917 -- -- 26,917
Issuance of restricted stock (38,641
shares)............................. -- -- 630 -- -- -- 630
Issuance of common stock in connection
with the employee stock option plan
(150,327 shares).................... -- 2 1,868 -- -- -- 1,870
Purchase of common stock for treasury
(242,995 shares).................... -- -- -- -- (2,747) -- (2,747)
---- ---- ------- ------- -------- ------ --------
Balance at December 31, 1997.......... -- 300 38,442 61,531 (6,510) -- 93,763
Issuance of common stock in connection
with the employee stock option plan
(917,377 shares).................... -- 10 12,648 -- -- -- 12,658
Issuance of common stock in connection
with the employee stock purchase
plan (19,010 shares)................ -- -- 305 -- -- -- 305
Purchase of common stock for treasury
(347,021 shares).................... -- -- -- -- (6,250) -- (6,250)
Comprehensive income/(loss):
Net income.......................... -- -- -- 43,394 -- -- 43,394
Other comprehensive loss,
net of tax ($0.00):
Currency translation adjustment... -- -- -- -- -- (161) (161)
--------
Comprehensive income.................. 43,233
---- ---- ------- ------- -------- ------ --------
Balance at December 31, 1998.......... -- 310 51,395 104,925 (12,760) (161) 143,709
Retirement of common stock held in
treasury (1,300,333 shares)......... -- (13) (12,747) -- 12,760 -- --
Purchase of common stock for treasury
(2,213,721 shares).................. -- -- -- -- (58,052) -- (58,052)
Payment of special cash dividend...... -- -- -- (74,624) -- -- (74,624)
Issuance of common stock in connection
with the employee stock option plan
(2,484,665 shares).................. -- 25 57,023 -- -- -- 57,048
Issuance of common stock in connection
with the employee stock purchase
plan (34,206 shares)................ -- -- 863 -- -- -- 863
Comprehensive income:
Net income.......................... -- -- -- 45,426 -- -- 45,426
Other comprehensive income:
Currency translation adjustment... -- -- -- -- -- 154 154
Unrealized holding gain on
securities available-for-sale,
net of tax ($895)............... -- -- -- -- -- 1,128 1,128
--------
Comprehensive income.................. 46,708
---- ---- ------- ------- -------- ------ --------
Balance at December 31, 1999.......... $ -- $322 $96,534 $75,727 $(58,052) $1,121 $115,652
==== ==== ======= ======= ======== ====== ========
The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
29
INVESTMENT TECHNOLOGY GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Cash flows from operating activities:
Net income.................................................. $45,426 $43,394 $26,917
Adjustments to reconcile net income to net cash provided by
operating activities:
Deferred income tax benefit............................... (11,435) (324) (103)
Depreciation and amortization............................. 12,835 11,599 6,642
Undistributed loss of affiliates.......................... 2,985 3,535 441
Provision for doubtful receivables........................ 228 96 84
Decrease (increase) in operating assets:
Securities owned, at fair value........................... (3,997) (2,258) (12,199)
Receivables from brokers, dealers and other, net.......... 4,718 (14,092) (2,468)
Due from affiliates....................................... 722 643 94
Investments in limited partnerships....................... (422) 9,935 (5,742)
Other assets.............................................. (397) (4,620) (6,930)
Increase (decrease) in operating liabilities:
Accounts payable and accrued expenses..................... 9,210 11,786 4,118
Payable to brokers, dealers and other..................... 917 2,078 933
Software royalties payable................................ 804 1,407 389
Securities sold, not yet purchased, at fair value......... 5,573 285 (1,223)
Due to affiliates......................................... (1,422) (701) 200
Income taxes payable...................................... 15,710 -- --
Income taxes payable to affiliate......................... (3,853) 2,365 (147)
------- ------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES............... 77,602 65,128 11,006
------- ------- -------
Cash flows from investing activities:
Purchase of premises and equipment.......................... (8,792) (7,658) (15,679)
Sale of equity investment................................... -- 8,049 --
Purchase of investments in limited partnerships............. (12,500) -- --
Investment in joint venture................................. (2,897) (4,790) --
Capitalization of software development costs................ (3,239) (4,025) (4,422)
------- ------- -------
NET CASH USED IN INVESTING ACTIVITIES................... (27,428) (8,424) (20,101)
------- ------- -------
Cash flows from financing activities:
Dividends paid.............................................. (74,624) -- --
Purchase of common stock for treasury....................... (58,052) (6,250) (2,747)
Issuance of common stock in connection with employee stock
option plan............................................... 57,911 12,962 2,500
------- ------- -------
NET CASH (USED IN)/PROVIDED BY FINANCING ACTIVITIES..... (74,765) 6,712 (247)
------- ------- -------
Effect of foreign currency translation on cash and cash
equivalents............................................. 154 (161) --
Net (decrease) increase in cash and cash equivalents.... (24,437) 63,255 (9,342)
Cash and cash equivalents -- beginning of year.............. 77,518 14,263 23,605
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Cash and cash equivalents -- end of year.................... $53,081 $77,518 $14,263
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Supplemental cash flow information:
Interest paid............................................. $ 39 $ 20 $ 146
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Income taxes paid to non-affiliate........................ $ 248 $ -- $ --
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Income taxes paid to affiliate............................ $ 6,538 $30,296 $19,947
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The accompanying Notes to Consolidated Financial Statements are integral parts
of this statement.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND BASIS OF PRESENTATION
The Consolidated Financial Statements include the accounts of Investment
Technology Group, Inc. and its wholly-owned subsidiaries ("ITG"), which
principally include: (1) ITG Inc., a broker-dealer in equity securities,
(2) Investment Technology Group International Limited, which is a 50% partner in
the ITG Europe joint venture, and (3) ITG Australia Holdings Pty Limited, which
is a 50% partner in ITG Pacific Holdings Pty Limited. Our investments in the ITG
Europe joint venture and ITG Pacific Holdings Pty Limited are accounted for
using the equity method.
We are a leading financial technology firm that provides a fully integrated
set of value-added electronic equity analysis and trade execution tools. We
provide services that help our clients optimize their portfolio construction and
trading strategies, efficiently access liquidity in multiple markets and achieve
superior, low-c