07.29.2016

Highlights from ITG’s Frank Troise and the Q2 Earnings Conference Call

The following are excerpts from ITG’s second quarter conference call. All remarks are made by CEO Frank Troise.

Let’s move on and talk about the opportunity set in front of ITG.
Our top-down analysis highlighted just how significant the opportunity is to capture share in all of our operating regions.
According to Greenwich Associates, the global cash equities fee pool is approximately $21 billion:

$8 billion is earmarked for discretionary execution

Another $8 billion is paid for bundled execution and research services  Rounding out the $21 billion is $5 billion allocated to commission sharing agreements, with $2 billion of the $5 billion paying for execution  The upshot is, we currently compete for $10 billion of the total $21 billion fee pool.
With MiFID II regulations in Europe and the trend globally towards unbundling of research from execution, we expect a portion of the $8 billion currently paid for bundled execution and research services to be up for grabs for brokers such as ITG. This would expand our addressable market and is likely to offset any potential decline in the size of the overall wallet.
According to a third-party analysis of cash equity commissions, ITG currently ranks in the high teens among brokers in the Americas, and the low 20s in both Europe and Asia Pacific.
Just for context, the gap from our current ranking to the number 10 ranked broker is sizeable – more than $500 million in annual commissions globally. We intend to compete vigorously for additional share by improving our competitive position across all of our technology-based execution channels – electronic, single stock, and portfolio trading.
We have the capability to take share from independent brokers, regional players, researchfocused brokers as well as some larger firms which have focused their investment priorities elsewhere.
Our opportunity is both in strengthening existing client relationships as well as in acquiring new ones –  about 55% of the gap to the number 10 ranked broker can be attributed to current accounts  and 45% is from prospects. o According to this third-party analysis, there is a universe of approximately 200 meaningfully-sized trading prospects available for us to pursue.
Gaining market share unlocks the operating leverage in our model – our incremental margins on each additional dollar of commission revenue are over 50% in all of our regions.
That leverage is greatest in our largest region by revenue, the US. For reference, every 10 basis points in US consolidated trading market share translates into approximately $0.08 in annual earnings per share at current average commission rates.
This driver was at work prior to the SEC settlement, when our U.S. market share ranged between 2.4% and 2.9% for the previous eight quarters.  In the first quarter of 2015, with US share of just 2.8%, and market share similar to current levels in our other regions, we generated pro forma quarterly earnings of $0.40 per share, excluding the impacts of the divested research businesses, the related sales trader restructure, and the two business exits.

I am confident that with the right focus and the right investments in our core business we can regain that share and then, surpass it.
Our European operations offer a good roadmap. In 2012, we handled less than 2% of total European value traded. Since then our share has more than doubled.

Strategic Operating Plan

Let me tell you about our path forward.
To achieve this market share growth, we have drawn up a strategic operating plan to evolve our product offerings and deliver the industry’s leading client experience.
The plan starts with an intense focus on four key synergistic offerings: liquidity, execution, analytics and workflow technology. It– there are significant synergies among them and it is our expectation to be best in class in all of them.
We will also sharpen our brand identity. Through delivery and action we will consistently clarify the message that we are committed to being a trusted provider of solutions throughout the trade implementation life-cycle.
We plan to make targeted investments in technology and invest in adding talented team members in key areas such as client coverage and product management.
And we will continue to emphasize a best operator culture throughout our firm.

Our Strategic Operating Plan draws on some key insights from the end-to-end business review and our client feedback:
– Our offerings are very relevant to our clients and there is clear demand from clients for partnering with leading technology driven independents. – We have a rich product set, and we must continue to invest to stay ahead of the competition. – Streamlining client desk top access to our products is a differentiator – We know how to deliver world class service and we must apply tools and best practices across our client coverage model globally. And, consistently.
These steps, actioned by the entire squad with a shared understanding of our mission, and a commitment to deliver for our clients, will make our offering best in class.
Targets/Timing/Cost Saves
The path forward includes a rigorous and disciplined set of revenue and cost savings targets.
With that in mind, we intend to invest organically in our business over the next ten quarters. – We expect to make $40MM of incremental investments over this period in technology and people. – These investments will begin in the back half of 2016 and the bulk will take place in 2017. – At least $10 million of the $40 million investment will come from current cost reduction measures. We expect to cut at least $5 million annually starting in 2017 in areas including compensation, connectivity, market data and vendors. – We expect roughly half the investment to be capitalized hardware and software development, subject to a three-year amortization period, and half to be in operating expenses. – In addition, we expect the investments we are making in technology and process to yield at least $5 million in annual savings from efficiency opportunities starting in 2019.
On subsequent calls we will provide updates on our investment program to offer transparency on our progress.

Investment Specifics
Technology Moving on to some of the specifics, the majority of our investment will be in technology to enhance the client experience, and to optimize operations and drive scale in our business. Over the next 10 quarters, we will be working on 5 key initiatives:
– First: Enhanced liquidity, execution, analytics, and workflow products and services. including a global customization toolkit for Triton and our algo offering
– Second: Upgrades of client workflow and user experience for Alert, smart order router, Triton, and TCA
– Third: Further globalization of our portfolio trading capabilities, including more robust analytics — pre-trade, intra-trade, and post trade
– Fourth: An enhanced commission management platform that will integrate commission budgeting and vendor management with CSA payment capabilities
– Fifth: Enhancements to our core trading and post-trade processing plant, with a focus on driving scalability, further reducing latency and boosting reliability

We haven’t been standing still, we have already made some notable investments this year:

– Our PowerMatch functionality in POSIT Alert, which delivers average block crossing sizes of 64 thousand shares. That’s almost double our US average, while the size of PowerMatch small and mid-cap prints is nearly 50% of the average daily volume traded.
– Our enhanced Smart Order Router, which provides significant price improvement and more than 35% size improvement versus the displayed markets.
– And we have upgraded our European trading plant, improving performance across the platform and enhancing our core POSIT matching engine.
People
In addition to technology we’re investing in people. We must ensure that we are attracting, developing, and retaining high quality, high integrity team members.
– We have reduced our headcount to 963 people globally, down by over 100 from this time last year, primarily through our non-core business exits. We expect headcount to remain generally flat through year-end.
– In 2017 and 2018 we plan to hire more staff for our client coverage teams for Alert, Algos, Triton, and Portfolio Trading as well as additional staff in technology development and product management – – in total, targeting at least 60 new hires.

Process
This plan is not just about investment dollars – it is about being a best operator in all of our businesses and regions. To achieve this,  We will continually seek opportunities for economies of scale and scope within our trading plant.  We will enhance our client coverage tools so that we can be more efficient in how we service our clients across multiple products and geographies  We will consistently apply best practices in client coverage; including rigorous pursuit of cross sell opportunities

This is crucial – when we work with clients to solve their most challenging problems we have the opportunity to capture outsize share of wallet and to sell a broader range of our offerings.

We are already doing this for a number of clients. For example, with one large global investment manager which is very focused on quantitative measurement of performance, we rank #1 or #2 in all four of our operating regions. The client uses multiple ITG products and we have grown global revenues by nearly 100% over the past year.

This is solutions sales. And we are committed to doing this with consistency and scale across our client base.
Financial Targets
So, what are our financial expectations for this strategic operating plan?
Assuming current global trading activity, the goal of this investment plan is to exit 2018 at a runrate for global revenues which is at least 25% higher than pro forma full-year 2015 levels of $478 million, excluding divestitures and closed businesses.
– This translates into a compound annual growth rate for total revenues in the mid-to-high single digits between now and the end of 2018.
– We expect this revenue CAGR to be back-end loaded – after the initial investment period it should ramp up starting in mid-2017 and into 2018.
– Given our high incremental margins and the impact of the expense saves related to these investments, we expect this revenue growth to push our pre-tax margins to approximately 15% by the fourth quarter of 2018.

– With this revenue growth and strong operating leverage, we expect the incremental investment of $40m will generate attractive double-digit returns on invested capital, well in excess of our cost of capital, and delivering meaningfully higher returns on capital.

Capital Allocation
These investments will take time to accelerate revenue growth. Along the way, we are committed to returning capital to shareholders. – As Steve noted we have approximately $50 million in excess cash above the $40 million investment plan.
– We intend to maintain our current dividend level of $0.07 per quarter, or about $10 million per year. – In the second half of 2016 we expect to buy back shares at roughly the same level as the first half of the year: $15 million, for total full-year capital return of $40 million. – In 2017 we expect to return a similar level of capital to shareholders.

M&A Outlook
– Let me turn briefly to the subject of acquisitions. As we have noted, our plan is focused on building on ITG’s strengths organically. – We believe that this plan is the best use of our capital to generate higher shareholder returns.
– We remain open to acquisition opportunities, but they would have to be exceptional from an operational and financial standpoint and in keeping with our business focus. We will not be distracted from our goals.
Closing thoughts
Before I wrap up I’d like to speak briefly about the culture of ITG.
I’ve built high-performing teams and capabilities while at other firms and also in my earlier tenure at ITG. I have first-hand experience with what the right team, the right technology, and the right culture can do for delivering results.
Our future success will be built on a best operator culture, adhering to three core values— passion, discipline and commitment.

ITG was founded three decades ago on a passion for innovating on behalf of our clients. This is core to the firm. It’s in our DNA.
We must combine this passion with the discipline to deliver innovative solutions at a high standard, consistently. And we must maintain our commitment to always doing the right thing for our clients and for our shareholders. We are not just paying lip service to the importance of culture – promoting and being held accountable for these values is an integral part of our newly implemented management scorecard, right alongside financial performance and market share targets.

I firmly believe that with passion, disciplined investment, and a commitment to excellence we can gain significant share – and I am extremely excited about the opportunities which lie ahead

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