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| GFIG > SEC Filings for GFIG > Form 10-Q on 10-Nov-2008 | All Recent SEC Filings |
10-Nov-2008
Quarterly Report
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:
º •
º the risks and other factors described under the heading "Risk Factors"
and elsewhere in our 2007 Form 10-K;
º •
º expansion and growth of our operations generally or of specific
products or services;
º •
º our ability to attract and retain key personnel, including highly
qualified brokerage personnel;
º •
º our entrance into new brokerage markets, including investments in
establishing new brokerage desks;
º •
º competition from current and new competitors;
º •
º 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.
º •
º future results of operations and financial condition;
º •
º the success of our business strategies;
º •
º economic, political and market factors affecting trading volumes,
securities prices or demand for our brokerage services;
º •
º financial difficulties experienced by our customers or key
participants in the markets in which we focus our brokerage services;
º •
º risks associated with potential acquisitions by us of businesses or
technologies;
º •
º the maturity of key markets and any resulting contraction of
commissions;
º •
º our ability to manage our international operations;
º •
º uncertainties associated with currency fluctuations;
º •
º our failure to protect or enforce our intellectual property rights;
º •
º changes in laws and regulations governing our business and operations
or permissible activities and our ability to comply with such laws and
regulations;
º •
º uncertainties relating to litigation; and
º •
º changes in the availability of capital.
The foregoing risks and uncertainties, as well as those risks discussed under the headings "Item 2-Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 3-Quantitative 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 an inter-dealer broker, our results of operations are impacted by a number of external market factors, including market volatility, organic growth of the derivative and other markets in which we provide our brokerage services, the particular mix of transactional activity in our various products and the competitive environment in which we operate. Outlined below are management's observations of these external market factors during the most recent fiscal period. The factors outlined below are not the only factors that have 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.
As a general rule, our business benefits from volatility in the markets that we serve, as periods of increased volatility typically coincide with more robust trading by our clients and a higher volume of transactions. 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 third quarter of 2008, particularly in September, the markets in which we operate experienced heightened volatility as the ongoing credit crisis in the U.S. resulted in historic changes to the financial industry, a substantial freezing of the credit markets and far-reaching government intervention.
The credit markets experienced periods of significant volatility in the third quarter of 2008 as Lehman Brothers and Washington Mutual Inc. declared bankruptcy. Following this period of significant volatility, the credit crisis caused a loss of investor confidence and lending substantially froze. The credit crisis also spread overseas as international banks and financial firms struggled with problematic mortgage and debt portfolios and, in September, various European governments proposed financial rescue plans. The volume of investment grade and high yield bonds issued in the third quarter fell 68% and 51%, respectively, from the prior year, according to Thomson Reuters. Volatility in the U.S. Treasury markets approached or exceeded all-time highs as investors sought safe havens. Investment grade bonds were also volatile in the quarter with the premium on double-A rated bonds over treasuries widening to 3.98 percentage points at quarter end from 2.35 at the beginning of the quarter according to Merrill Lynch indexes.
The global equity markets experienced periods of considerable volatility as demonstrated by historical price volatility of the Chicago Board Options Exchange SPX ("VIX") and Dow Jones Industrial Average ("DJIA") volatility indices. The VIX closed at a record high at the end of the quarter, reflecting investor anxiety after the U.S. House of Representatives failed to pass a financial bailout package intended to ease the credit crisis. Global equity market indices were volatile in the quarter with the DJIA decreasing 4.4% and experiencing its largest single day point decline, and the Dow Jones World Index, excluding the U.S., dropping 22% in dollar terms. The decline in equities was broad based with the pan-European Dow Jones Stoxx 600 Index down 12.0% and the Japanese Nikkei Index down 17%. Emerging markets were also generally down on global economic uncertainty and decreasing commodity prices with the Emerging Markets MSCI Index plunging 27% in the third quarter, its largest point drop on record.
Interest rate and foreign exchange markets experienced periods of heightened volatility resulting from global economic and inflationary concerns, as well as the Federal Reserve and central banks globally acting to combat the credit crisis. The U.S. Dollar Index, which measures the performance of the U.S. dollar against a basket of currencies, increased 5.0% in the quarter. The U.S. dollar strengthened 11.8% versus the Euro, rallied 12.0% against the British Pound and was little changed versus the Japanese Yen.
Commodity markets also experienced periods of heightened volatility as demonstrated by price movements on the S&P GSCI Energy and Non-Energy commodity indices as compared to the third quarter of 2007 and the second quarter of 2008. Commodity prices hit highs in early July, then dropped
sharply until early September, at which point they rallied as the U.S. government took steps to stabilize the financial system. The Reuters CRB Commodity Price Index fell 11.8% in September, the largest monthly drop in the 48-year history of the index. Oil futures prices decreased 37% in the quarter from a peak of $145.29 a barrel on July 3 to $91.15 on September 16, amid a broad commodity sell-off based on deteriorating demand. Oil futures ended the third quarter down 28%. Other commodities such as gold and grain were also volatile in the third quarter as investors shifted their funds to a strengthening U.S. dollar. Gold fell 5.6% in the quarter, but was fairly volatile throughout the period, including a decrease of up to 20%.
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 International Swaps and Derivatives Association ("ISDA") released its Mid-Year 2008 Market Survey in September 2008 detailing growth in global notional outstanding in various over-the-counter markets. The ISDA statistics indicated that there was growth in the notional outstanding for all derivative categories over the previous year's first half results, including interest rate and currency derivatives, which were up 33.9%, credit default swaps, which were up 20.1%, and equity derivatives, which were up 18.7%. However, credit default swaps decreased 12.2% from the Year-End 2007 Market Survey, its first sequential period decline. ISDA attributed this decline to the industry's efforts to reduce risk through netting of offsetting transactions.
Despite these indicators of growth in notional outstanding amount of OTC derivatives, a trend is underway of decreasing trading volumes in certain OTC derivatives products as hedge funds deploy decreased amounts of trading capital due to investor redemptions and reduced borrowing. Some impact of this trend can be seen in transaction volumes of certain products traded on futures exchanges. For several years, exchange traded derivatives have exhibited generally similar growth rates to those of related OTC derivative markets. In the third quarter, CME Group Inc. ("CME"), excluding its New York Mercantile Exchange operations, reported a 10% decrease in quarterly average daily volumes, while the New York Mercantile Exchange ("NYMEX"), Intercontinental Exchange, and International Securities Exchange's average daily volumes were up, respectively, 23%, 12% and 27%, which are somewhat lower rates of growth than in prior years. In addition, several exchanges reported decreases in average daily volumes for August versus the prior year. Because there is currently minimal or no exchange-based trading activity of credit futures, exchange-traded volumes are not an effective indicator of activity levels of OTC credit products.
In addition, newer products and our expansion into growing markets and new geographical areas have historically contributed to the growth in our brokerage revenues. New products have developed in certain wet and dry freight and property derivative markets, while the currency and interest rate derivative markets have grown, in part, due to the growth of emerging markets in Eastern Europe, Asia and Latin America. While hedge fund deleveraging in the structured credit and high yield markets have recently led to lower volumes in these products, transactional volumes in single name and index credit product derivatives have remained relatively robust. Our recent expansion with new offices in Calgary, Chile, Dubai and Tel Aviv all look to capitalize on regional growth opportunities, as does our minority interest in an Argentinean inter-dealer broker.
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 quarter as other inter-dealer brokers sought to bolster their derivative brokerage capabilities by hiring, or attempting to hire certain of our key brokerage personnel. During the third quarter, there was also consolidation in the dealer market and retraction in the hedge fund industry, which may lead to increased competition to provide brokerage services to a smaller number of market participants.
Efforts to regulate credit derivatives and to create a central clearinghouse for credit derivatives were accelerated in the third quarter as the credit crisis and failure of Lehman Brothers have highlighted the need to better understand and manage counterparty exposure. As a result, there may be increased competition as the credit markets in the U.S. and Europe emphasize clearing, automation and transparency.
Financial Overview
As more fully discussed below, our results of operations are significantly impacted by our 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 September 30, 2008:
º •
º For the three months ended September 30, 2008, revenues decreased 4.6%
from $254.7 million for the three months ended September 30, 2007 to
$243.1 million. A significant factor contributing to this decline was
an approximately $9.6 million net charge for unsettled trades directly
related to the Lehman Brothers bankruptcy, which impacted our matched
principal business. Factors which positively contributed to revenue in
the current quarter included:
º •
º the acquisition of Trayport Limited in January 2008;
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º the increase in our brokerage personnel (consisting of brokers,
trainees and clerks) from 1,021 at September 30, 2007 to 1,082 at
September 30, 2008;
º •
º heightened volatility and volume growth in certain markets in
which we provide brokerage services such as cash equities and
equity derivatives;
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º the continued development and expansion of our hybrid brokerage
capabilities, including CreditMatch® in Europe and EnergyMatch®
in the U.S.; and
º •
º the continued development, marketing and sale of our trading
software, data and analytical products.
Offsetting these growth factors were the departure of almost two dozen of our credit division personnel in New York to a competitor, as described under Part II Item 1-Legal Proceedings, decreased activity in certain structured credit products due to hedge fund deleveraging, the demise or merger of several of our major customers and thinner trading in the more complex structured credit markets.
º •
º The most significant component of our cost structure is compensation
and employee benefits, which includes salaries, sign-on bonuses,
incentive compensation and related employee benefits and taxes. Our
compensation and employee benefits have grown from $158.8 million for
the three months ended September 30, 2007 to $176.5 million for the
three months ended September 30, 2008. The main factors contributing
to the growth in compensation and employee benefits were $14.5 million
in severance and other costs from a restructuring initiative
implemented during the quarter, a $6.4 million accrual for broker
bonus compensation which will be paid in cash rather than, as
originally contemplated, in RSUs , higher fixed salaries due
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 overall compensation and employee benefits, employment costs associated with our brokerage personnel are the largest 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. Additionally, 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. These sign-on bonuses may be paid in the form of cash, 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 forfeiture provisions for the forfeiture of unvested RSUs and the repayment of all or a portion of any sign-on bonus or forgivable loan should the employee voluntarily terminate his or her employment or if the employee's employment is terminated for cause during the initial term of the agreement.
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