GFI Group 10-Q 2010
WASHINGTON, D.C. 20549
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010
FOR THE TRANSITION PERIOD FROM TO
Commission File No: 000-51103
GFI GROUP INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (212) 968-4100
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES x NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO x
The number of shares of registrants common stock outstanding on July 30, 2010 was 122,210,223.
Table of Contents
Our Internet website address is www.gfigroup.com. Through our Internet website, we make available, free of charge, the following reports as soon as reasonably practicable after electronically filing them with, or furnishing them to, the Securities and Exchange Commission (the SEC): our annual reports on Form 10-K; our proxy statements for our annual and special stockholder meetings; our quarterly reports on Form 10-Q; our current reports on Form 8-K; Forms 3, 4 and 5 filed on behalf of directors and executive officers; and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended (the Exchange Act).
Information relating to the corporate governance of the Company is also available on our website, including information concerning our directors, board committees, including committee charters, our code of business conduct and ethics for all employees and for senior financial officers and our compliance procedures for accounting and auditing matters. In addition, the Investor Relations page of our website includes certain supplemental financial information that we make available from time to time.
Our Internet website and the information contained therein or connected thereto are not incorporated into this Quarterly Report on Form 10-Q.
GFI GROUP INC. AND SUBSIDIARIES
(In thousands, except share and per share amounts)
See notes to condensed consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
(In thousands, except share and per share amounts)
(1) As adjusted see Note 2
See notes to condensed consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
See notes to condensed consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
Non-Cash Investing Activities:
During the six months ended June 30, 2010, the Company recorded $5,080 within other assets, which included the issuance of 681,433 shares of the Companys common stock and $1,000 within Other liabilities in connection with the business combination described in Note 4 and $2,286 within Other assets with respect to the issuance of 414,938 shares of the Companys common stock in connection with the investment described in Note 5.
See notes to condensed consolidated financial statements
(In thousands except share and per share amounts)
1. ORGANIZATION AND BUSINESS
The condensed consolidated financial statements include the accounts of GFI Group Inc. and its subsidiaries (collectively, the Company). The Company, through its subsidiaries, provides brokerage services, trading system software and market data and analytical software products to institutional clients in markets for a range of fixed income, financial, equity and commodity instruments. The Company complements its brokerage capabilities with value-added services, such as market data and software systems and products for decision support, which it licenses primarily to companies in the financial services industry. The Companys principal operating subsidiaries include: GFI Securities LLC, GFI Brokers LLC, GFI Group LLC, GFI Securities Limited, GFI Brokers Limited, GFI (HK) Securities LLC, GFI (HK) Brokers Ltd., GFI Group Pte. Ltd., GFI Korea Money Brokerage Limited, Amerex Brokers LLC, Fenics Limited (Fenics) and Trayport Limited (Trayport). As of June 30, 2010, Jersey Partners, Inc. (JPI) owned approximately 43% of the Companys outstanding shares of common stock. The Companys chief executive officer, Michael Gooch, is the controlling shareholder of JPI.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of PresentationThe Companys condensed consolidated financial statements (unaudited) are prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingencies in the consolidated financial statements. Certain estimates and assumptions relate to the accounting for acquired goodwill and intangible assets, fair value measurements, compensation accruals, tax liabilities and the potential outcome of litigation matters. Management believes that the estimates utilized in the preparation of the consolidated financial statements are reasonable and prudent. Actual results could differ materially from these estimates.
All intercompany transactions and balances have been eliminated.
Certain amounts totaling $519 and $935 related to insurance expense were previously presented in the Rent and occupancy line item in the Condensed Consolidated Statements of Income for the three and six months ended June 30, 2009, respectively, but should have been presented in Other expenses in the Condensed Consolidated Statements of Income for these periods. These amounts have been properly reclassified to Other expenses for this period.
The condensed consolidated financial statements should be read in conjunction with the Companys consolidated financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2009 (the 2009 Form 10-K). The condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for the fair statement of the results for the interim period. The results of operations for interim periods are not necessarily indicative of results for the entire year.
Brokerage TransactionsThe Company provides brokerage services to its clients by executing transactions on either an agency or principal transaction basis.
Agency CommissionsIn agency transactions, the Company charges commissions for executing transactions between buyers and sellers. Agency commissions revenues and related expenses are recognized on a trade date basis.
Principal TransactionsPrincipal transactions revenue is primarily derived from matched principal and principal trading transactions. Principal transactions revenues and related expenses are recognized on a trade date basis. The Company earns revenue from principal transactions on the spread between the buy and sell price of the security that is brokered. In matched principal transactions, the Company simultaneously agrees to buy instruments from one customer and sell them to another customer.
In the normal course of its matched principal and principal trading businesses, the Company holds securities positions overnight. These positions are marked to market on a daily basis.
GFI GROUP INC. AND SUBSIDIARIES
Software, Analytics and Market Data Revenue RecognitionSoftware revenue consists primarily of fees charged for Trayport electronic trading software, which are typically billed on a subscription basis and is recognized ratably over the term of the subscription period, which ranges from one to five years. Analytics revenue consists primarily of software license fees for Fenics pricing tools which are typically billed on a subscription basis, and is recognized ratably over the term of the subscription period, which is generally three years. Market data revenue primarily consists of subscription fees and fees from customized one-time sales. Market data subscription fees are recognized on a straight-line basis over the term of the subscription period, which ranges from one to two years. Market data revenue from customized one-time sales is recognized upon delivery of the data.
The Company markets its software, analytics and market data products through its direct sales force and, in some cases, indirectly through resellers. In general, the Companys license agreements for such products do not provide for a right of return.
Goodwill and Intangible AssetsGoodwill represents the excess of the purchase price allocation over the fair value of tangible and identifiable intangible net assets acquired. In accordance with ASC 350, Intangibles Goodwill and Other (formerly Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Intangible Assets), goodwill and intangible assets with indefinite lives are no longer amortized, but instead are tested for impairment annually or more frequently if circumstances indicate impairment may have occurred. In the event the Company determines that the value of goodwill has become impaired, it will incur a charge for the amount of impairment during the fiscal quarter in which such determination is made. The Company has selected January 1st as the date to perform the annual impairment test. Intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives.
Fair Value of Financial Instruments In accordance with ASC 820-10, Fair Value Measurements and Disclosures (ASC 820-10) (formerly SFAS No.157, Fair Value Measurements), the Company estimates fair values of financial instruments using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment in interpreting market data and accordingly, changes in assumptions or in market conditions could adversely affect the estimates. The Company also discloses the fair value of its financial instruments in accordance with the fair value hierarchy as set forth by ASC 820-10.
In addition, the Company uses foreign exchange derivative contracts to reduce the effects of fluctuations in certain receivables and payables denominated in foreign currencies. Derivative contracts that are not designated as foreign currency cash flow hedges are recorded at fair value and all realized and unrealized gains and losses are included in Other income in the Condensed Consolidated Statements of Income.
Income Taxes In accordance with ASC 740, Income Taxes (formerly SFAS No. 109, Accounting for Income Taxes), the Company provides for income taxes using the asset and liability method under which deferred income taxes are recognized for the estimated future tax effects attributable to temporary differences and carry-forwards that result from events that have been recognized either in the financial statements or the income tax returns, but not both. The measurement of current and deferred income tax liabilities and assets is based on provisions of enacted tax laws. Valuation allowances are recognized if, based on the weight of available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized. Effective January 1, 2007, the Company adopted ASC 740-10 (formerly Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109). It is the Companys policy to provide for uncertain tax positions and the related interest and penalties based upon managements assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities.
Foreign Currency Translation Adjustments and TransactionsAssets and liabilities of foreign subsidiaries having non-U.S. dollar functional currencies are translated at the period end rates of exchange, and revenue and expenses are translated at the average rates of exchange for the period. Gains or losses resulting from translating foreign currency financial statements are reflected in foreign currency translation adjustments and are reported as a separate component of comprehensive income and included in accumulated other comprehensive loss in stockholders equity. Gains or losses resulting from foreign currency transactions are included in Other income in the Condensed Consolidated Statements of Income. Net (gains) losses resulting from remeasurement of foreign currency transactions and balances were $7,042 and
GFI GROUP INC. AND SUBSIDIARIES
($8,138), respectively, for the three months ended June 30, 2010 and 2009 and $9,336 and ($2,913), respectively, for the six months ended June 30, 2010 and 2009 and are included in Other income.
Share-Based CompensationThe Companys share-based compensation consists of stock options and restricted stock units (RSUs). The Company follows ASC 718, Compensation-Stock Compensation (ASC 718) (formerly SFAS No. 123(R), Share-Based Payment), to account for its stock-based compensation. ASC 718 revised the fair value-based method of accounting for share-based payment liabilities, forfeitures and modifications of stock-based awards and clarified guidance in several areas, including measuring fair value, classifying an award as equity or as a liability and attributing compensation cost to service periods. Additionally, under ASC 718, actual tax benefits recognized in excess of tax benefits previously established upon grant are reported as a financing cash flow, as opposed to operating cash flows. In recent periods, the only form of share-based compensation issued by the Company has been RSUs. The Company determines the fair value of RSUs based the grant date fair value of the Companys common stock, measured as the closing price on the date of grant.
Other IncomeIncluded within Other income on the Companys Condensed Consolidated Statements of Income are revaluations of foreign currency derivative contracts, realized and unrealized transaction gains and losses on certain foreign currency transactions and balances and gains and losses on certain investments.
Recent Accounting Pronouncements
In May 2009, the Financial Accounting Standards Board (FASB) issued SFAS No. 165, Subsequent Events, which is now a sub-topic within ASC 855-10 Subsequent Events (ASC 855-10). ASC 855-10 provides guidance for accounting for and disclosure of subsequent events that are not addressed in other applicable generally accepted accounting principles. ASC 855-10 was effective for interim and annual reporting periods ending after June 15, 2009, and has been applied prospectively by the Company. In February 2010, the FASB amended ASC 855-10 through the issuance of Accounting Standards Update No. 2010-09 (ASU 2010-09), Amendments to Certain Recognition and Disclosure Requirements. ASU 2010-09 removed the requirement for an SEC filer to disclose the date of final review for disclosure of subsequent events and was effective upon issuance. See Note 16 for disclosures on Subsequent Events.
In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167). SFAS 167 amends certain requirements of FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, which is now a sub-topic within ASC 810 Consolidation. This guidance was codified by the FASB in December 2009 through the issuance of Accounting Standards Update No. 2009-17 (ASU 2009-17) Consolidations (Topic 810) Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. ASU 2009-17 was issued to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. ASU 2009-17 requires an enterprise to perform an analysis to determine whether the enterprises variable interest or interests provide a controlling financial interest in a variable interest entity. The determination is based on, among other things, the other entitys purpose and design and the reporting entitys ability to direct the activities of a variable interest entity that most significantly impact the entitys economic performance. ASU 2009-17 was effective as of the beginning of the first annual reporting period that begins after November 15, 2009, for interim periods within the first annual reporting period and for interim and annual reporting periods thereafter. The adoption of ASU 2009-17 did not have a material impact on the Companys consolidated financial statements.
In October 2009, the FASB issued Accounting Standards Update No. 2009-13 (ASU 2009-13) Revenue Recognition (Topic 605) Multiple-Deliverable Revenue Arrangements. ASU 2009-13 establishes the accounting and reporting guidance for arrangements with multiple-revenue generating activities. ASU 2009-13 addresses how to separate deliverables and how to measure and allocate arrangement consideration to one or more units of accounting and provides a selling price hierarchy for determining the selling price of a deliverable. ASU 2009-13 is effective for fiscal years beginning on or after June 15, 2010. Early adoption is permitted but must be retrospectively applied to the beginning of the fiscal year of adoption. The Company does not expect the adoption of ASU 2009-13 to have a material impact on its consolidated financial statements.
GFI GROUP INC. AND SUBSIDIARIES
In October 2009, the FASB issued Accounting Standards Update No. 2009-14 (ASU 2009-14) Software (Topic 985) Certain Revenue Arrangements That Include Software Elements. ASU 2009-14 provides guidance on how to allocate arrangement consideration to deliverables in an arrangement that includes both tangible products and software. ASU 2009-14 also provides additional guidance on how to determine which software, if any, relating to the tangible product would be excluded from software revenue recognition. ASU 2009-14 is effective for fiscal years beginning on or after June 15, 2010. Early adoption is permitted but must be retrospectively applied to the beginning of the fiscal year of adoption. The Company does not expect the adoption of ASU 2009-14 to have a material impact on its consolidated financial statements.
In January 2010, the FASB issued Accounting Standards Update No. 2010-06 (ASU 2010-06) Fair Value Measurements and Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements. ASU 2010-06 provides amendments to Subtopic 820-10 that require new disclosures, including the amounts of and reasons for transfers in and out of Levels 1 and 2 fair value measurements and reporting activity in the reconciliation of Level 3 fair value measurements on a gross basis. ASU 2010-06 provides amendments that clarify existing disclosures regarding the level of disaggregation for providing fair value measurement disclosures for each class of assets and liabilities. In addition, it clarifies existing disclosures about inputs and valuation techniques used to measure fair value for both recurring and nonrecurring fair value measurements that are required for either Level 2 or Level 3. ASU 2010-06 was effective for interim and annual reporting periods ending after December 15, 2009 except for the disclosures about the roll forward of activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 31, 2010 and for interim periods within those fiscal years. The adoption of ASU 2010-06 did not have a material impact on the Companys consolidated financial statements and the adoption of ASU 2010-06 with respect to disclosures of the roll forward of activity in Level 3 fair value measurements is not expected to have a material impact on the Companys consolidated financial statements.
3. RECEIVABLES FROM AND PAYABLES TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS
Amounts receivable from and payable to brokers, dealers and clearing organizations consisted of the following:
Substantially all fail to deliver and fail to receive balances at June 30, 2010 and December 31, 2009 have subsequently settled at the contracted amounts.
4. GOODWILL AND INTANGIBLE ASSETS
On November 1, 2009, the Company completed the acquisition of certain assets of a retail energy brokerage and consulting business for contingent consideration with an estimated present value of $2,400. The purchase price will be paid out of the future collections of accounts receivable of the business over the next four years and such contingent payment has been recorded as a liability within Other liabilities. This contingent liability will be remeasured to fair value at each reporting date until the liability is settled and the change in fair value will be recognized in earnings. This acquisition was accounted for as a business combination under the acquisition method. Assets acquired were recorded at fair value and the results of the acquired company have been included within the consolidated financial statements since the acquisition. The purchase price
was allocated among intangible assets as follows: customer relationships of $1,010 with an estimated useful life of 6 years, non compete agreement of $139 with an estimated useful life of 4 years and goodwill of $1,251. The weighted average amortization for the intangible assets is 5.8 years.
On May 27, 2010, the Company completed the acquisition of a mortgage-backed security brokerage business for consideration of $5,095. The purchase price was comprised of 681,433 shares of the Companys common stock with a fair value of $4,095 and contingent consideration estimated at $1,000, which has been recorded as a liability within Other liabilities. This contingent liability will be remeasured to fair value at each reporting date until the liability is settled and the change in fair value will be recognized in earnings. This acquisition was accounted for as a business combination under the acquisition method. Assets acquired were recorded at fair value and the results of the acquired company have been included within the consolidated financial statements since the acquisition. The purchase price was allocated among tangible and intangible assets as follows: fixed assets of $15, customer relationships of $1,700 with an estimated useful life of 6 years, non compete agreements of $340 with an estimated useful life of 3.3 years and goodwill of $3,040. The weighted average amortization for the intangible assets is 5.6 years.
Changes in the carrying amount of the Companys goodwill for the six months ended June 30, 2010 were as follows:
Based on the results of the annual impairment tests that are required by ASC 350, the Company determined that no impairment of goodwill existed as of January 1, 2010. ASC 350 prescribes a two step process for impairment testing whereby management first compares the fair value of each reporting unit with recorded goodwill to that reporting units book value. If management determines, as a result of this first step, that the fair value of the reporting unit is less than its carrying value, a second step in the impairment test process would require that the recorded goodwill at that business unit be written down to the value implied by the reporting units recent valuation. The Company will continue to evaluate goodwill on an annual basis as of the beginning of each new fiscal year, and whenever events and changes in circumstances indicate that there may be a potential impairment. Subsequent to January 1, 2010, no events or changes in circumstances occurred which would indicate any goodwill impairment.
Intangible assets consisted of the following:
Amortization expense for the three months ended June 30, 2010 and 2009 was $1,432 and $1,356, respectively, and $2,829 and $2,729 for the six months ended June 30, 2010 and 2009, respectively.
At June 30, 2010, expected amortization expense for the definite lived intangible assets is as follows:
5. OTHER ASSETS
On February 28, 2010, the Company completed an acquisition of 40% of the outstanding membership interests of an independent brokerage firm with a proprietary trading platform. The aggregate purchase price was comprised of $8,000 in cash and 414,938 shares of the Companys common stock. The target retained $6,000 of the cash portion of the purchase for working capital. This investment is included within Other assets and accounted for under the equity method. Additionally, the Company committed to purchase the remaining membership interests in increments of 20% over the next 3 years, subject to customary closing conditions. The purchase price for the remaining membership interests will be paid in cash and established by a formula based on the targets future results of operations. Included in Other assets at December 31, 2009 was a note receivable from the target in the amount of $1,000 which was forgiven by the Company and credited against the purchase price described above at closing.
6. SHORT-TERM BORROWINGS AND LONG-TERM OBLIGATIONS
In January 2008, pursuant to a note purchase agreement with certain institutional investors (the 2008 Note Purchase Agreement), the Company issued $60,000 in aggregate principal amount of senior secured notes due in January 2013 (the Senior Notes) in a private placement. The Senior Notes currently bear interest at 8.17%, including a premium of 100 basis points due to a change in the risk based capital factor attributed to the Senior Notes by one of the purchasers pursuant to generally applicable insurance regulations for U.S. insurance companies. The premium interest will cease to accrue if the risk based capital factor attributed to the Senior Notes is subsequently reduced. Interest is payable semi-annually in arrears on the 30th of January and July. The Companys obligations under the Senior Notes are secured by substantially all of the assets of the Company and certain assets of the Companys subsidiaries. The 2008 Note Purchase Agreement includes operational covenants with which the Company is required to comply, including among others, maintenance of certain financial ratios and restrictions on additional indebtedness, liens and dispositions. At June 30, 2010, the Senior Notes were recorded net of unamortized deferred financing fees of $319 and the Company was in compliance with all applicable covenants at June 30, 2010 and December 31, 2009.
The Company maintains a credit agreement with Bank of America, N.A. and certain other lenders (as amended, the Credit Agreement). The Credit Agreement provides for maximum borrowings of $175,000, which includes up to $50,000 for letters of credit, and has an expiration date of February 24, 2011. Revolving loans may be either base rate loans or currency rate loans. Currency rate loans and the letters of credit bear interest at the annual rate of LIBOR plus the applicable
margin in effect for that interest period. Base rate loans bear interest at a rate per annum equal to a base rate plus the applicable margin in effect for that interest period. As long as no default has occurred under the Credit Agreement, the applicable margin for both the base rate and currency rate loans is based on a matrix that varies with a ratio of outstanding debt to EBITDA, as defined in the Credit Agreement. At June 30, 2010, the applicable margin was 2.5% and the one-month LIBOR was 0.3%. Amounts outstanding under the Credit Agreement are secured by substantially all the assets of the Company and certain assets of the Companys subsidiaries. The Credit Agreement provides for the Senior Notes to rank pari passu with the commitments under the Credit Agreement, in relation to the security provided.
The Company had outstanding borrowings under its Credit Agreement as of June 30, 2010 and December 31, 2009 as follows:
(1) Amounts available include up to $50,000 for letters of credit as of June 30, 2010 and December 31, 2009.
The Companys commitments for outstanding letters of credit relate to potential collateral requirements associated with our matched principal business. Since commitments associated with these outstanding letters of credit may expire unused, the amounts shown above do not necessarily reflect actual future cash funding requirements.
The weighted average interest rate of the outstanding loans was 2.85% and 2.73% at June 30, 2010 and December 31, 2009. At June 30, 2010 and December 31, 2009, short-term borrowings under the Credit Agreement were recorded net of unamortized deferred financing fees of $545 and $931, respectively.
The Credit Agreement contains certain financial and other covenants. The Company was in compliance with all applicable covenants at June 30, 2010 and December 31, 2009, respectively.
7. STOCKHOLDERS EQUITY
In August 2007, the Companys Board of Directors authorized the Company to implement a stock repurchase program to repurchase a limited number of shares of the Companys common stock. Under the repurchase plan, the Board of Directors authorized the Company to repurchase shares of the Companys common stock on the open market in such amounts as determined by the Companys management, provided, however, such amounts are not to exceed, during any calendar year, the number of shares issued upon the exercise of stock options plus the number of shares underlying grants of RSUs that are granted or which management reasonably anticipates will be granted in such calendar year. During the three and six months ended June 30, 2010, the Company repurchased 975,000 shares of its common stock on the open market at an average price of $6.10 per share for a total cost of $5,980, including sales commissions. During the three months ended June 30, 2009, the Company repurchased 109,300 shares of its common stock on the open market at an average price of $3.55 per share for a total cost of $388, including sales commissions. During the six months ended June 30, 2009, the Company repurchased 1,115,922 shares of its common stock on the open market at an average price of $2.66 per share for a total cost of $2,970, including sales commissions. These repurchased shares were recorded at cost as treasury stock in the Condensed Consolidated Statements of Financial Condition.
On each of March 29 and May 28, 2010, the Company paid a cash dividend of $0.05 per share, which, based upon the number of shares outstanding on the record date for such dividends, totaled $5,928 and $5,956, respectively. On each of March 31 and May 30, 2009, the Company paid a cash dividend of $0.05 per share, which, based upon the number of shares outstanding on the record date for such dividends, totaled $5,883 and $5,891, respectively. The dividends were reflected as reductions of retained earnings in the Condensed Consolidated Statements of Financial Condition.
8. EARNINGS PER SHARE
Basic and diluted earnings per share for the three and six months ended June 30, 2010 and 2009 were as follows:
Excluded from the computation of diluted earnings per share because their effect would be anti-dilutive were the following: 1,048,356 RSUs for the three months ended June 30, 2010; 1,840,858 RSUs and 15,256 stock options for the three months ended June 30, 2009; 1,493,741 RSUs and 7,377 stock options for the six months ended June 30, 2010; 2,609,654 RSUs and 111,503 stock options for the six months ended June 30, 2009.
9. SHARE-BASED COMPENSATION
The Company issues RSUs to its employees under the GFI Group Inc. 2008 Equity Incentive Plan, which was approved by the Companys stockholders on June 11, 2008, and subsequently amended by the Companys stockholders on June 11, 2009 and June 10, 2010 (as amended, the 2008 Equity Incentive Plan). Prior to June 11, 2008, the Company issued RSUs under the GFI Group Inc. 2004 Equity Incentive Plan (the 2004 Equity Incentive Plan).
The 2008 Equity Incentive Plan permits the grant of non-qualified stock options, stock appreciation rights, shares of restricted stock, restricted stock units and performance units to employees, non-employee directors or consultants. The Company issues shares from authorized but unissued shares, and in certain cases, from treasury shares, which are reserved for issuance upon the vesting of RSUs granted pursuant to the 2008 Equity Incentive Plan. As of June 30, 2010, there were 8,990,397 shares of our common stock available for future grants of awards under this plan, which amount, pursuant to the terms of the 2008 Equity Incentive Plan, may be increased for the number of shares subject to awards under the 2004 Equity Incentive Plan that are ultimately not delivered to employees. The fair value of RSUs is based on the closing price of the Companys common stock on the date of grant and is recorded as deferred compensation and amortized to compensation expense over the vesting period of the grants, which is generally three years.
Modified RSUs are reflected as cancellations and grants in the summary of RSUs below.
The following is a summary of RSU transactions under both the 2008 Equity Incentive Plan and the 2004 Equity Incentive Plan during the six months ended June 30, 2010:
The weighted average grant-date fair value of RSUs granted for the six months ended June 30, 2010 was $5.75 per unit, compared with $3.57 per unit for the same period in the prior year. Total compensation expense and related income tax benefits recognized in relation to RSUs are as follows:
At June 30, 2010, total unrecognized compensation cost related to the RSUs prior to the consideration of expected forfeitures was approximately $61,708 and is expected to be recognized over a weighted-average period of 1.91 years. The total fair value of RSUs vested during the six months ended June 30, 2010 and 2009 was $15,246 and $12,128, respectively.
As of June 30, 2010, the Company had stock options outstanding under the GFI Group Inc. 2002 Stock Option Plan (the GFI Group 2002 Plan) and the GFInet inc. 2000 Stock Option Plan (the GFInet 2000 Plan). No additional grants will be made under these plans. For stock options previously granted or modified, the fair value was estimated on the date of grant or modification using the Black-Scholes option pricing model.
The following is a summary of stock option transactions during the six months ended June 30, 2010:
During the six months ended June 30, 2009, there were 6,000 stock options exercised under the GFI Group 2002 Plan and 2,104 stock options exercised under the GFInet 2000 Plan.
10. COMMITMENTS AND CONTINGENCIES
Purchase ObligationsThe Company has various unconditional purchase obligations. These obligations are for the purchase of market data from a number of information service providers during the normal course of business. As of June 30, 2010, the Company had total purchase commitments for market data of approximately $23,903 with $18,299 due within the next twelve months and $5,604 due between one to three years. Additionally, the Company has purchase commitments for capital expenditures of $2,053, primarily related to network implementations in the U.S and U.K, and $814 for hosting and software license agreements. Of these purchase commitments, capital expenditures of approximately $1,254 and fees for hosting and software licensing agreements of approximately $412 are due within the next twelve months.
In connection with the acquisition of 40% of the outstanding membership interests of an independent brokerage firm, the Company has committed to purchase the remaining membership interests in increments of 20% over the next 3 years, subject to customary closing conditions. The purchase price for the remaining membership interests will be paid in cash and established by a formula based on the targets future results of operations.
ContingenciesIn the normal course of business, the Company and certain subsidiaries included in the consolidated financial statements are, and have been in the past, named as defendants in various lawsuits and proceedings and are, and have been in the past, involved in certain regulatory examinations. Additional actions, investigations or proceedings may be brought from time to time in the future. The Company is subject to the possibility of losses from these various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies. An accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. The Company accrues a liability for the estimated costs of adjudication or settlement of asserted and unasserted claims existing as of the reporting period.
The Company is subject to regular examinations by various tax authorities in jurisdictions in which the Company has significant business operations. The Company regularly assesses the likelihood of additional tax assessments that may result from these examinations in each of the tax jurisdictions. A tax accrual has been established, which the Company believes to be adequate in relation to the potential for additional tax assessments. Once established, the accrual may be adjusted based on new information or events. The imposition of additional tax assessments, penalties or fines by a tax authority could have a material impact on the Companys effective tax rate.
Additionally, the Company has recorded reserves for certain contingencies to which it may have exposure, such as reserves for contingencies related to the employer portion of National Insurance Contributions in the U.K.
The staff of the Market Regulation Department of the Financial Industry Regulatory Authority Inc. (FINRA) (the Staff) has been conducting an inquiry into the activities of interdealer brokerage firms in connection with the determination of the commission rates paid to them in 2005 and 2006 by certain dealers for brokering transactions in credit default swaps. GFI Securities LLC has been cooperating with the Staff in this inquiry by responding to requests for documents, testimony and other information. In January 2009, the Staff advised GFI Securities LLC that it has made a preliminary determination to recommend disciplinary action in connection with allegedly improper communications between certain of GFI Securities LLCs brokers and those at other interdealer brokers, purportedly inconsistent with just and equitable principles of trade and certain antifraud and supervisory requirements under FINRA rules and the federal securities laws. All but one of these brokers who made the allegedly improper communications resigned in April 2008 to become employed by affiliates of Compagnie Financiere Tradition. During the past few months, certain of the other inter-dealer brokerage firms that were the subject of the same inquiry have settled the matter. In the event that GFI Securities LLC and FINRA are unable to reach a
settlement soon on this matter, FINRA has indicated that it will file a complaint against GFI Securities LLC based on these allegations which, if brought and/or settled, could result in a censure, fine or other sanction. GFI Securities LLC intends to vigorously contest any such disciplinary action which, if brought and/or settled, could result in a censure, fine or other sanction.
Based on currently available information, the outcome of the Companys outstanding matters are not expected to have a material adverse impact on the Companys financial position. However, the outcome of any such matters may be material to the Companys results of operations or cash flows in a given period. It is not presently possible to determine the Companys ultimate exposure to these matters and there is no assurance that the resolution of the Companys outstanding matters will not significantly exceed any reserves accrued by the Company.
Risks and UncertaintiesThe Company primarily generates its revenues by executing and facilitating transactions for third parties. Revenues for these services are transaction based. As a result, the Companys revenues vary based upon, among other things, the volume of transactions in various securities, commodities, foreign exchange and derivative markets in which the Company provides services.
Guarantees The Company, through its subsidiaries, is a member of certain exchanges and clearing houses. Under the membership agreements, members are generally required to guarantee certain obligations. To mitigate the performance risks of its members, the exchanges and clearing houses may, from time to time, require members to post collateral, as well as meet certain minimum financial standards. The Companys maximum potential liability under these arrangements cannot be quantified. However, management believes that the potential for the Company to be required to make payments under these arrangements is not likely. Accordingly, no contingent liability is recorded in the Condensed Consolidated Statements of Financial Condition for these arrangements.
11. FINANCIAL INSTRUMENTS WITH MARKET AND CREDIT RISKS
Disclosure regarding the Companys financial instruments with off-balance sheet risk is described in Note 16Financial Instruments with Market and Credit Risks of the Notes to the Consolidated Financial Statements contained in the Companys 2009 Form 10-K. There have been no material changes to our off-balance sheet risk during the six months ended June 30, 2010.
12. FINANCIAL INSTRUMENTS
Substantially all of the Companys assets and liabilities are carried at fair value or contracted amounts that approximate fair value. Assets and liabilities that are recorded at contracted amounts approximating fair value consist primarily of receivables from and payables to brokers, dealers and clearing organizations. These receivables and payables are short-term in nature, and following June 30, 2010, substantially all receivables and payables have settled at the contracted amounts. The Companys marketable equity securities are recorded at fair value based on their quoted market price. The Companys investments that are accounted for under the cost and equity methods are investments in companies that are not publicly traded and for which no established market for their securities exists. The fair value of these investments is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. The Companys debt obligations are carried at historical amounts. The fair value of the Companys Senior Notes was estimated using market rates of interest available to the Company for debt obligations of similar types and was approximately $64,559 at June 30, 2010. The fair value of the Companys short-term borrowings outstanding under the Credit Agreement approximated the carrying value at June 30, 2010 and December 31, 2009.
The Companys financial assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with ASC 820-10. In accordance with ASC 820-10, the Company has categorized its financial assets and liabilities, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy as set forth below.
Level 1 Financial assets and liabilities whose values are based on unadjusted quoted prices for identifiable assets or
liabilities in an active market that the company has the ability to access at the measurement date (examples include active exchange-traded equity securities, listed derivatives, and most U.S. Government and agency securities).
Level 2 Financial assets and liabilities whose values are based on quoted prices in markets where trading occurs infrequently or whose values are based on quoted prices of instruments with similar attributes in active markets. Level 2 inputs include the following:
· Quoted prices for identifiable or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds which trade infrequently); and
· Inputs other than quoted prices that are observable for substantially the full term of the asset or liability (examples include interest rate and currency swaps).
Level 3 Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect managements own assumptions about the assumptions a market participant would use in pricing the asset or liability. As of and for the six months ended June 30, 2010 and for the year ended December 31, 2009, the Company did not have any Level 3 financial assets or liabilities.
The Company uses the following valuation techniques in valuing the financial instruments at June 30, 2010 and December 31, 2009:
The Company has determined certain of its investments in marketable securities should be classified as trading securities or available-for-sale securities and reported at fair value at June 30, 2010 and December 31, 2009. To the extent that the values of the Companys trading and available-for-sale marketable securities are based on quoted market prices in active markets, these securities were categorized as Level 1.
Fair value of the Companys foreign exchange derivative contracts is based on the indicative prices obtained from the banks that are counter-parties to these foreign exchange derivative contracts and managements own calculations and analyses. At June 30, 2010 and December 31, 2009, the Companys foreign exchange derivative contracts have been categorized in Level 2.
The fair value of trading securities owned as a result of matched principal transactions and principal trading business is estimated using either (i) recently executed transactions and market price quotations, which trading securities are primarily categorized as Level 1, or (ii) a modified Black Scholes model using observable market inputs, which trading securities are categorized as Level 2.
Financial Assets and Liabilities measured at fair value on a recurring basis as of June 30, 2010:
(1) Represents the impact of netting on a net-by-counterpary basis.
The Companys financial instruments at fair value are included within Other assets and Other liabilities with the exception of long and short futures contracts of $324 and $390, which are included within Receivables from and Payables to brokers, dealers and clearing organizations, respectively.
Financial Assets and Liabilities measured at fair value on a recurring basis as of December 31, 2009:
Derivative Financial Instruments
The Company uses foreign exchange derivative contracts, including forward contracts and foreign currency swaps, to reduce the effects of fluctuations in certain assets and liabilities denominated in foreign currencies. The Company also hedges a portion of its foreign currency exposures on anticipated foreign currency denominated revenues and expenses by entering into forward foreign exchange contracts. For the six months ended June 30, 2010 and year ended December 31, 2009, none of these contracts were designated as foreign currency cash flow hedges under ASC 815-10, Derivatives and Hedging (ASC 815-10) (formerly SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended). Contracts that are not designated as foreign currency cash flow hedges are recorded at fair value and all realized and unrealized gains and losses are included in Other income in the Condensed Consolidated Statements of Income.
The Company provides brokerage services to its customers for exchange traded and over-the-counter derivative products, which include futures, forwards and options contracts. The Company may enter into principal transactions for exchange traded and over-the-counter derivative products to facilitate customer trading activities or to engage in principal trading for the Companys own account.
The Company monitors market risk exposure from its matched principal business and principal trading business by regularly monitoring its concentration of market risk to financial instruments, countries or counterparties and regularly monitoring trades that have not settled within prescribed settlement periods or volume thresholds. Additionally, market risks are monitored and mitigated by the use of the Companys proprietary, electronic risk monitoring system, which provides daily credit reports in each of the Companys geographic regions that analyze credit concentration and facilitates the regular monitoring of transactions against key risk indicators.
For certain derivative contracts, the Company has entered into agreements with counterparties that allow for netting. The Company reports these derivative contracts on a net-by-counterparty basis when management believes that a legal and enforceable right of offset exists under these agreements.
Fair values of derivative contracts on a gross basis as of June 30, 2010 and December 31, 2009 are as follows:
(1) Included within Other assets and Other liabilities.
(2) Included within Receivables from brokers, dealers and clearing organizations, and Payables to brokers, dealers and clearing organizations.
As of June 30, 2010, the Company had outstanding forward foreign exchange contracts with a combined notional value of $112,680. Approximately $48,916 of these forward foreign exchange contracts represents a hedge of euro-denominated balance sheet positions at June 30, 2010. The remaining contracts are hedges of anticipated future cash flows. In addition, the Company had outstanding long and short foreign exchange spot and options contracts of approximately $5,410,924 and approximately $5,410,924, respectively. The Company also had outstanding long and short futures and forwards commodity contracts with notional values of approximately $71,069 and approximately $133,201, respectively.
As of December 31, 2009, the Company had outstanding forward foreign exchange contracts with a combined notional value of approximately $126,251. Approximately $64,422 of these forward foreign exchange contracts represents a hedge of euro-denominated balance sheet positions at December 31, 2009. The remaining contracts are hedges of anticipated future cash flows.
The following is a summary of the effect of derivative contracts on the Condensed Consolidated Statements of Income for the three and six months ended June 30, 2010 and 2009:
(1) For the three months ended June 30, 2010, approximately $7,744 of gains on foreign exchange derivative contracts were included within Other income and approximately $1,473 of gains on foreign currency options were included within Principal transactions. For the six months ended June 30, 2010, approximately $10,823 of gains on foreign exchange derivative contracts were included within Other income and approximately $1,575 of gains on foreign currency options were included within Principal transactions.
13. REGULATORY REQUIREMENTS
GFI Securities LLC is a registered broker-dealer with the SEC and FINRA. GFI Securities LLC is also a registered introducing broker with the National Futures Association and the Commodity Futures Trading Commission. Accordingly, GFI Securities LLC is subject to the net capital rules under the Exchange Act and the Commodity Exchange Act. Under these rules, GFI Securities LLC is required to maintain minimum Net Capital, as defined by applicable regulations, of not less than the greater of $250 or 2% of aggregate debits, as defined by applicable regulations.
GFI Brokers Limited and GFI Securities Limited are subject to the capital requirements of the Financial Services Authority in the United Kingdom (FSA).
GFI (HK) Securities LLC is subject to the capital requirements of the Securities and Futures Commission in Hong Kong (the SFC), which require that GFI (HK) Securities LLC maintain minimum capital, as defined by applicable regulations, of approximately $385.
The following table sets forth information about the minimum regulatory capital that certain of the Companys subsidiaries were required to maintain as of June 30, 2010:
In addition to the minimum regulatory capital requirements outlined above, certain of the Companys subsidiaries are subject to additional regulatory requirements.
GFI Securities Limiteds Japanese branch is subject to certain licensing requirements established by the Financial Instruments and Exchange Law (the FIEL) in Japan. As part of the licensing requirements, GFI Securities Limiteds Japanese branch is required to maintain minimum brought-in capital and stockholders equity of 50,000 Japanese Yen each (or approximately $566), as defined under the FIEL. In addition, GFI Securities Limiteds Japanese branch is also subject to the net capital rule promulgated by the FIEL, which requires that net worth, including brought-in capital, exceed a ratio of 120.0% of the risk equivalent amount including relevant expenditure. At June 30, 2010, GFI Securities Limiteds Japanese branch was in compliance with these capital requirements.
GFI (HK) Brokers Ltd. is registered with and regulated by the Hong Kong Monetary Authority. As part of this registration, GFI (HK) Brokers Ltd. is required to maintain stockholders equity of 5,000 Hong Kong dollars (or approximately $642). At June 30, 2010, GFI (HK) Brokers Ltd. had stockholders equity of 21,019 Hong Kong dollars (or approximately $2,699), which exceeded the minimum requirement by 16,019 Hong Kong dollars (or approximately $2,057).
GFI Group Pte. Ltd. is subject to the compliance requirements of the Monetary Authority of Singapore (MAS), which requires that GFI Group Pte. Ltd., among other things, maintain stockholders equity of 3,000 Singapore dollars (or
approximately $2,132), measured annually. At December 31, 2009, GFI Group Pte. Ltd. exceeded the minimum requirement by approximately 14,464 Singapore dollars (or approximately $10,295).
GFI Korea Money Brokerage Limited is licensed and regulated by the Ministry of Finance and Economy to engage in foreign exchange brokerage business, and is subject to certain regulatory requirements under the Foreign Exchange Transaction Act and regulations thereunder. As a licensed foreign exchange brokerage company, GFI Korea Money Brokerage Limited is required to maintain minimum paid-in capital of 5,000,000 Korean Won (or approximately $4,087). At June 30, 2010, GFI Korea Money Brokerage Limited met the minimum requirement for paid-in-capital of 5,000,000 Korean Won.
14. SEGMENT AND GEOGRAPHIC INFORMATION
The Company has three operating segments: Americas Brokerage, Europe, Middle East and Africa (EMEA) Brokerage and Asia Brokerage. Additionally, the Company presents its operating segments as four reportable segments: Americas Brokerage, EMEA Brokerage, Asia Brokerage and All Other. The All Other segment captures costs that are not directly assignable to one of the operating business segments, primarily consisting of the Companys corporate business activities and operations from software, analytics and market data.
Selected financial information for the Companys reportable segments is presented below for periods indicated:
In addition, with the exception of goodwill, the Company does not identify or allocate assets by operating segment, nor does its chief operating decision maker evaluate operating segments using discrete asset information. See Note 4 for goodwill by reportable segment.
Geographic information regarding revenues for the three and six months ended June 30, 2010 and 2009, respectively, and information regarding long-lived assets (defined as property, equipment, leasehold improvements and software inventory) in each geographic area as of June 30, 2010 and December 31, 2009, respectively, are as follows:
Revenues are attributed to geographic areas based on the location of the Companys relevant subsidiary.
15. OTHER COMPREHENSIVE INCOME (LOSS)
16. SUBSEQUENT EVENTS
In July 2010, the Board of Directors declared a quarterly cash dividend of $0.05 per share payable on August 31, 2010 to shareholders of record on August 17, 2010.
On July 1, 2010, the Company acquired a 70% equity ownership interest in The Kyte Group Limited and Kyte Capital Management Limited (collectively Kyte). Kyte, which is a member of leading exchanges including NYSE Euronext, NYSE LIFFE and Eurex, provides clearing, broking, settlement and back-office services to proprietary traders, brokers, market makers and hedge funds. Kyte also provides capital to start-up trading groups, small hedge funds, market-makers and individual traders.
The Company paid approximately £37,958 (or $57,609), subject to certain adjustments, to acquire the 70% equity ownership. The purchase price is comprised of £22,400 (or $33,996) in cash and 4,149,820 shares of the Companys common stock, of which 2,810,662 shares have been issued, with a fair value of $23,613. The final purchase price will be subject to various adjustments, including the amount of Kytes surplus working capital at closing and the satisfaction of certain legal, financial and other criteria. The Company will acquire the residual 30% equity interest in Kyte for an additional cash payment, which will be calculated based on the performance of Kyte during the three year period ending June 30, 2013.
The Company is in the process of completing the purchase price allocation related to this transaction. The acquired assets and assumed liabilities will be recorded by the Company at their estimated fair values which will be determined with the assistance of third party specialists.
On August 1, 2010, the Company completed the acquisition of 33% of the outstanding membership interests of an independent CFTC-registered Futures Commission Merchant for $11,000 in cash. The firm is also a Foreign Exchange Dealer member of the National Futures Association and provides direct market access in certain foreign exchange markets. This investment will be accounted for under the equity method.
Subsequent events have been evaluated for recording and disclosure in the notes to the Condensed Consolidated Financial Statements through the filing date of this Form 10-Q.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
GFI Group Inc.
New York, New York
We have reviewed the accompanying condensed consolidated statement of financial condition of GFI Group Inc. and subsidiaries (the Company) as of June 30, 2010, the related condensed consolidated statements of income and comprehensive income for the three-month and six-month periods ended June 30, 2010 and 2009, and the condensed consolidated statements of cash flows for the six-month periods ended June 30, 2010 and 2009. These interim financial statements are the responsibility of the Companys management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition of the Company as of December 31, 2009, and the related consolidated statements of income, comprehensive income, cash flows and changes in stockholders equity for the year then ended (not presented herein); and in our report dated March 15, 2010, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial condition as of December 31, 2009 is fairly stated, in all material respects, in relation to the consolidated statement of financial condition from which it has been derived.
/s/ Deloitte & Touche LLP
New York, New York
This Quarterly Report on Form 10-Q (this Form 10-Q) contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words believe, anticipate, expect, estimate, intend, project, will be, will likely continue, will likely result, or words or phrases of similar meaning. These forward-looking statements are based largely on the expectations of management and are subject to a number of risks and uncertainties including, but not limited to, the following:
· the risks and other factors described under the heading Risk Factors and elsewhere in our 2009 Form 10-K;
· market conditions, including trading volume and volatility;
· our ability to attract and retain key personnel, including highly qualified brokerage personnel;
· our entrance into new brokerage markets, including investments in establishing new brokerage desks;
· competition from current and new competitors;
· risks associated with our matched principal and principal trading business, including risks arising from specific brokerage transactions, or series of brokerage transactions, such as credit risk and market risk;
· the extensive regulation of the Companys business, changes in laws and regulations governing our business and operations or permissible activities and our ability to comply with such laws and regulations;
· our ability to keep up with rapid technological change and to continue to develop and support our electronic brokerage systems in a cost-effective manner;
· future results of operations and financial condition and the success of our business strategies;
· economic, political and market factors affecting trading volumes, securities prices, or demand for our brokerage services, including recent conditions in the world economy and financial markets in which we provide our services;
· financial difficulties experienced by our customers or key participants in the markets in which we focus our brokerage services;
· risks associated with our ability to assess and integrate potential acquisitions of businesses or technologies;
· the maturing of key markets and any resulting contraction in commissions;
· risks associated with the expansion and growth of our operations generally or of specific products or services, including, in particular, our ability to manage our international operations;
· uncertainties associated with currency fluctuations;
· our failure to protect or enforce our intellectual property rights;
· uncertainties relating to litigation;
· liquidity and clearing capital requirements and the impact of the recent conditions in the world economy and the financial markets in which we provide our services on the availability and terms of additional or future capital; and
· the effectiveness of our risk management policies and procedures.
The foregoing risks and uncertainties, as well as those risks discussed under the headings Item 2Managements Discussion and Analysis of Financial Condition and Results of Operations and Item 3Quantitative and Qualitative Disclosures About Market Risk and elsewhere in this Quarterly Report, may cause actual results to differ materially from the forward-looking statements. The information included herein is given as of the filing date of this Form 10-Q with the SEC and future events or circumstances could differ significantly from these forward-looking statements. The Company does not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
As a wholesale broker, our results of operations are impacted by a number of external market factors, including market volatility, the organic growth or contraction of the derivative and cash markets in which we provide our brokerage services, the particular mix of transactional activity in our various products, the competitive and regulatory environment in which we operate and the financial condition of the dealers, hedge funds and other market participants to whom we provide our services. Outlined below are managements observations of these external market factors during the most recent fiscal period. The factors outlined below are not the only factors that impacted our results of operations for the most recent fiscal period, and additional or other factors may impact, or have different degrees of impact, on our results of operations in future periods.
Market Volatility and General Business Environment
As a general rule, our business typically benefits from volatility in the markets that we serve, as periods of increased volatility often coincide with more robust trading by our clients and a higher volume of transactions. However, periods of extreme volatility may result in significant market dislocations that can also lead certain clients to reduce their trading activity.
Market volatility is driven by a range of external factors, some of which are market specific and some of which are correlated to general macro-economic conditions. During the second quarter of 2010, many of the markets in which we operate experienced a brief period of increased volatility driven by the European sovereign debt crisis and signs of a slower than expected economic recovery in the U.S. This brief period of increased volatility subsided in June and market trading volumes decreased considerably from the first two months of the quarter. During the second quarter of 2010, our cash fixed income business suffered from narrower credit spreads, on average, lower bond issuance globally in the first half of 2010 and competitive pressures, all of which led to our decision to reduce our corporate fixed income presence in the U.S. during the quarter. The combination of these and other factors led to brokerage revenues being down slightly year-over-year in the second quarter of 2010.
Growth in Underlying Markets and New Product Offerings
Our business has historically benefited from growth in the OTC derivatives markets due to either the expansion of existing markets, including increased notional amounts outstanding or increased transaction volumes, or the development of new products or classes of products. The level of growth in these markets is difficult to measure on a quarterly basis as there are only a few independent, objective measures of growth in outstanding notional amount of OTC derivatives, all of which are published retrospectively and do not measure transactional volumes. Therefore, to help gauge growth in any particular quarter, management also looks to the published results of large OTC derivatives dealers and certain futures exchanges as potential indicators of transactional activity in the related OTC derivative markets.
The Bank of International Settlements (BIS) released its Year-End 2009 Market Survey in May 2010 detailing growth in global notional amounts outstanding in various OTC markets. Notional amounts outstanding included new transactions and those from previous periods. The BIS statistics indicated that there was an increase in the notional amounts outstanding for many derivative categories over the previous year-end and mid-year results. Interest rate contracts, the largest category, were up 16.6% year-over-year and 2.9% sequentially, while foreign exchange contracts and equity-linked contracts were up 11.3% and 7.1%, respectively, year-over-year and up slightly sequentially. Credit default swaps were down 21.9% year over year and 9.3% sequentially, while commodity contracts were down 32.5% year-over-year and 21.1% sequentially. BIS
attributed the lower notional value in credit default swaps to a combination of factors, including reduced spreads and ongoing netting of these contracts.
Many OTC derivatives products trended toward lower trading volumes in 2009 as market participants deployed less trading capital due to investor redemptions and reduced borrowing capacity. Evidence of this trend was seen in the reduced transaction volumes of certain products traded on futures exchanges. However, as the economy and markets showed signs of recovery in 2010, the year-over-year comparisons returned to growth in many cases. In the second quarter of 2010, the CME Group, Inc., reported a 31% increase in average overall daily volumes. IntercontinentalExchange, Inc. (ICE) reported a 36% increase in futures average daily volumes and a 26% increase in OTC energy average daily commissions year-over-year for the second quarter. Revenues from ICEs credit default swap trade execution, processing and clearing businesses were down 3% when compared to the second quarter of 2009.
In addition, newer products and our expansion into growing markets and new geographical areas historically contributed to the growth in our brokerage revenues. For example, we recently invested in new businesses in ethanol, mortgage-backed securities, and soft and agricultural commodities in the U.S. In the U.K, we completed the acquisition of The Kyte Group Limited and Kyte Capital Management Limited on July 1, 2010 and invested in our natural gas and iron ore businesses.
Competitive and Regulatory Environment
Another major external market factor affecting our business and results of operations is competition, which may take the form of competitive pressure on the commissions we charge for our brokerage services or competition for brokerage personnel with extensive experience in the specialized markets we serve. Competition for the services of productive brokers remained intense in the second quarter of 2010. The consolidation and personnel layoffs by dealers, hedge funds and other market participants during the last few years also led to increased competition to provide brokerage services to a smaller number of market participants in the near term. Additionally, many of the large dealer firms recently began to commit additional resources, including hiring additional brokerage personnel and committing additional capital in the cash markets, which led us to reduce our corporate fixed income presence in the U.S. Despite these factors, there were indications in the first half of 2010 that trading activity by our customers increased year-over-year in certain derivative markets.
During the last year, we believe that the legislative and regulatory proposals for increased transparency, position limits and collateral or capital requirements caused increased uncertainty in the markets and led investors and banks to commit less capital to many OTC markets. During the second quarter of 2010, the U.S. Congress completed work on the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was enacted in July 2010. We are optimistic that the regulatory solutions, including centralized clearing, increased transparency and centralized trade reporting, will be generally beneficial to the long-term health of the broader financial markets. The legislation in the U.S. requires certain OTC derivatives to be executed through a registered exchange or swap execution facility. We believe that we will be able to qualify as a swap execution facility and we believe that our product expertise, proven technology, depth of liquidity and long-standing relationships position us well to capture any newly created opportunities in these markets.
As more fully discussed below, our results of operations are significantly impacted by our ability to generate revenue growth and the amount of compensation and benefits we provide to our employees. The following factors had a significant impact on our revenues and employee costs during the three month period ended June 30, 2010:
Our revenues decreased 6.7% to $209.6 million for the three months ended June 30, 2010 from $224.7 million for the three months ended June 30, 2009. The main factors contributing to this decrease in our revenues were:
· Increased competition in certain cash fixed income markets, which led us to reduce our corporate fixed income presence in the U.S;
· Narrower credit spreads, on average, and lower debt issuances globally, as it relates to our cash fixed income business;
· Lower cash equity and equity derivative trading volumes in the U.S.;
· A net decrease of $15.1 million related to remeasurement of foreign currency transactions and balances partially offset by a net increase of $6.4 million in realized and unrealized gains on foreign currency hedges; and
· Regulatory and governmental uncertainty as it relates to market structure and operations in OTC derivative markets.
Partially offsetting these factors were several positive factors that affected our brokerage and other revenues, including:
· The stabilization of economic conditions in key markets in which we provide our brokerage services;
· Improved global economic and market conditions in emerging markets and Asia;
· Increased trading activity in certain financial and commodity product markets in which we have a leading market share;
· Higher share and commodity values, on average, which positively affected our equities and commodities revenues, respectively, in Europe;
· Volatility centered on the European sovereign debt crisis and its effect on fixed income derivative and equity volumes in Europe;
· Increased electronic trading activity in Europe and the U.S. on our hybrid brokerage platforms;
· Strong performance of our Trayport subsidiary; and
· New brokerage desks and new brokers hired across all product categories.
The most significant component of our cost structure is employee compensation and benefits, which includes salaries, sign-on bonuses, incentive compensation and related employee benefits and taxes. Our employee compensation and benefits expense decreased 3.7% to $141.1 million for the three months ended June 30, 2010 from $146.6 million for the three months ended June 30, 2009.
Our compensation and employee benefits for all employees have both a fixed and variable component. Base salaries and benefit costs are primarily fixed for all employees while bonuses constitute the variable portion of our compensation and employee benefits. Within this overall compensation and employee benefits, employment costs of our brokerage personnel are the key component. Bonuses for brokerage personnel are primarily based on the operating results of their related brokerage desk as well as their individual performance. For many of our brokerage employees, their bonus constitutes a significant component of their overall compensation. Broker performance bonuses decreased to $59.6 million for the three months ended June 30, 2010 from $68.5 million for the three months ended June 30, 2009. A portion of our bonus expense is subject to contractual guarantees that may require us to make bonus payments to brokers regardless of their performance in any particular period.
Further, we grant sign-on bonuses for certain newly-hired brokers or for certain of our existing brokers who agree to long-term employment agreements. Expenses relating to sign-on bonuses decreased to $10.1 million for the three months ended June 30, 2010 from $10.8 million for the three months ended June 30, 2009. These sign-on bonuses may be paid in the form of cash, restricted stock units (RSUs) or forgivable loans and are typically amortized over the term of the related employment agreement, which is generally two to four years. These employment agreements typically contain repayment or forfeiture provisions for unvested RSUs or all or a portion of the sign-on bonus and forgivable loan should the employee voluntarily terminate his or her employment or if the employees employment is terminated for cause during the initial term of the agreement.
Results of Consolidated Operations
The following table sets forth our condensed consolidated results of operations for the periods indicated: