GFI Group Q2 2009 Earnings Call Transcript

| About: GFI Group (GFIG)


Q2 2009 Earnings Call

July 31, 2009 8:30 am ET


Chris Giancaro – Executive Vice President Corporate Development

Michael Gooch – Chairman, Chief Executive Officer

James Peers – Chief Financial Officer

Ron Levi – Global Chief Operating Officer

[Scott Fitzgerald]


Dan Fannon – Jefferies

Daniel Harris – Goldman Sachs

Robert Rutschow – Calyon Securities (NYSE:USA) Inc.

Christopher Donat – Sandler O'Neill

Donald Fandetti – Citi

Chris Allen – Pali Capital

Niamh Alexander – Keefe, Bruyette & Woods

Mark Lane – William Blair & Co.


Welcome to the second quarter 2009 GFI Group Inc. earnings conference call. My name is [Becky] and I will be your coordinator for today. (Operator Instructions). I would now like to turn the presentation over to your host for today's call, Christopher Giancaro, Executive Vice President of GFI Group. Please proceed.

Christopher Giancaro

Good morning. Welcome to the GFI Group second quarter 2009 earnings conference call. We issued a press release yesterday proving the financial results for our fiscal quarter ended June 30, 2009, which is available on our Website at We have also posted monthly revenue information for the quarter on our Website under Supplementary Financial Information.

To begin this morning's call, Michael Gooch, our Chairman and Chief Executive Officer, will review our business performance in the second quarter of this year, highlight some developments and set our expectations for the current quarter and beyond. Next, Jim Peers, our CFO, will review in greater detail the financial results for the quarter. After Jim, Mr. Gooch will conclude with a few remarks. Thereafter we will open up the call for your questions.

Our discussions during this conference call will include certain forward-looking statements. These statements are not guarantees of future performance. Actual results may differ materially from those expressed or implied in such forward-looking statements. More detailed information about the risks, uncertainties and other factors that may cause actual results to differ from such forward-looking statements are discussed in our filings with the SEC, including our most recent annual report on Form 10-K.

Also, the discussions during this conference call may include certain financial measures that were not prepared in accordance with U.S. generally accounting principles. Reconciliations of non-U.S. GAAP financial measures to the most directly comparable U.S. GAAP financial measures were included in the company's earnings press release, which was furnished on a current report on Form 8-K dated July 30, 2009. These reports are available on our Website under the Investor Relations section.

I will now turn the call over to Michael Gooch, Chairman and Chief Executive Officer of GFI Group.

Michael Gooch

Our financial performance improved sequentially in the second quarter of 2009. Brokerage revenues increased 2% sequentially and our non-GAAP net income increased 13% sequentially from the first quarter of 2009 with further improvement in our pre-tax margin.

And while our total non-GAAP revenues were down 16% year-over-year, we realized 6% growth in the credit products brokerage category. Our results for the second quarter of 2009 reflected further stabilization and recovery in our markets in the quarter including credit markets where we see signs of normalcy in the form of narrowing credit spreads and strong corporate bond issuance.

Our results also benefited from our past initiatives including our investment in cash, fixed income brokerage and the cost restructuring we have implemented over the past few quarters. Looking more closely at our performance by product category, our revenues from credit products represented 40% of total brokerage revenues in the second quarter of 2009 up from 38% in the first quarter of 2009 and 31% in the second quarter last year.

In addition to increasing 6% year-over-year, credit products revenues rose 9% sequentially. The continued strong performance of our cash fixed income brokerage business drove that growth. In the second quarter of 2009, our revenues from cash fixed income products increased 140% year-over-year and 20% from the first quarter of 2009.

As a result, cash fixed income brokerage revenues represented 25% of total non-GAAP revenues in the second quarter of 2009. Revenues from credit derivative products represented just 12% of total non-GAAP revenues in the 2009 second quarter.

While many of the credit derivative markets are liquid and operating smoothly, they continue to be challenged by uncertainty from rapidly evolving legislative, regulatory and structural issues as well as from lower capital commitment to the market by a number of dealers in hedge funds.

At the same time, competition in our industry continues to be strong. Despite these challenges, we expect to see a return to growth in credit derivative transaction volumes next year aided by the anticipated benefits from advances in clearing, standardization and transparency and the promising traction we are seeing in certain electronic trading in the U.S.

However, there is a whole range of proposed regulatory and legislative initiatives that could have a greater or lesser effect on the credit derivatives market. Therefore, on balance, I see more upside for GFI from the potential legislative developments in credit products as certainty reenters the markets than I see downside from the risks that legislators may enact legislation that restricts trading activity in credit derivatives.

Financial products, which represented 17% of total brokerage revenues in the second quarter of 2009, were the second category in which we saw sequential growth in the quarter. Financial product revenues declined 28% from the second quarter of 2008 due to lower revenues from emerging markets generally, from currency derivatives and interest rate derivatives broadly. However, financial product revenues increased 7% from the first quarter of 2009 with growth in each region including Asia, where we are seeing renewed activity and have hired additional staff.

Equity product revenues represented 24% of total brokerage revenues in the second quarter of 2009 down from 27% in the first quarter and 28% in the second quarter of 2008. The effect of depressed share values in Europe, where commissions are based on notional values for certain cash equity and equity derivative products and the adverse foreign currency translation continue to weight on our results in equity products. Those factors led to declines in equity product revenues of 30% year-over-year and 9% sequentially.

However, countering this trend, equity product revenues in North America were up 10% year-over-year, and we are continuing to build out our cash equity business in all regions and to develop new products and services in cash equities and equity derivatives. We are positioning ourselves for more competitive posture in equity products globally.

Commodity product revenues represented 19% of total brokerage revenues in the second quarter of 2009 compared to 20% in the first quarter of 2009 and 22% in the second quarter of 2008. Commodity product revenues decreased 29% year-over-year and 3% sequentially, mainly due to continued weakness in the dry freight business in Europe and Asia and the negative effect of the economic recession and other variables on trading in the long [abated], more complex energy derivatives.

At the same time, we saw year-over-year and sequential growth in emissions brokerage and while it is not a significant revenue factor thus far, we do see it as indicative of future opportunities in emissions brokerage, data and analytics and trading systems.

Looking at our revenues by geography, brokerage revenues in all regions decreased in year-over-year comparison with the Americas down 3%, Europe, Middle East and Africa down 26%, Asia-Pacific down 31%. On a sequential basis, revenues in the Americas were nearly level with the first quarter of 2009. Europe, Middle East and Africa rose 3% and Asia-Pacific rose 13%. The strength of the U.S. dollar continued to negatively impact the value of our overseas revenues affecting the year-over-year comparisons.

Revenues from trading software, analytics, and market data products were approximately level with both the second quarter of 2008 and the first quarter of 2009 and represented 7% of our total revenues in the second quarter of 2009.

Within that category, revenues from data and analytics rose 7% from the second quarter of 2008 due to our FENICS Enterprise Solution, a suite of products able to handle FX derivative pricing, trading and risk management.

Software revenues from our Trayport subsidiary, totaled $7.3 million, which was 6% lower on a reported basis than the second quarter of 2008. But when measured in the British pound, its functional currency, Trayport's year-over-year software revenue growth was 23% due to the continued success of its global vision gateway products.

I shall now turn my review to our progress in controlling costs. As I mentioned on our last call, we took additional action in the first quarter through front and back office restructuring to build on our cost reduction initiatives in the second half of 2008.

Employee compensation expenses increased as a percentage of total revenues to 66.5%, compared with the second quarter of 2008 due to our active restructuring of our business and product focus as we adjust to rapidly changing market dynamics, lower revenues in some historically higher margin derivative markets and amortization of previously paid sign-on bonuses.

Employee compensation expenses as a percentage of revenues were generally in line with the first quarter of 2009. The balance of our expenses decreased 20% from the second quarter of 2008 and remained level with the first quarter of 2009 on a non-GAAP basis.

We saw strong improvement in non-compensation expenses as a percentage of revenues both year-over-year and sequentially due to our cost control, restructuring initiatives and product mix. In comparison to the second quarter last year the biggest improvements came in reduced spending on travel and promotion, professional fees, clearing fees and interest expense.

Turning to our outlook for the third quarter of 2009 we currently expect total non-GAAP revenues to decline by approximately 20% to 23% compared to the third quarter of 2008, which was a strong quarter for us marked by pronounced trading activity precipitated by the credit crisis. We are expecting more traditional seasonal summer patterns this year based on our preliminary results to date for July.

From a broader perspective the global regulatory and legislative changes underway will continue to affect our market and GFI in ways that are not yet determined. At the outset of the credit crisis when a stream of proposals emerged to regulate OTC derivatives, we immediately became engaged in dialogue directly with regulators and legislators in the U.S., including my testimony before the House Agricultural Committee as well as our meetings with the CFTC, the SEC and the New York Fed to offer our perspective and experience to the decisions being shaped.

Our discussions have extended to London and Brussels as well and we are active in trade groups that represent our interest and those of the broader financial community. I am optimistic that some of the market structure changes, such as central clearing and greater use of electronic execution that are likely to emerge will be generally beneficial to many of the broader financial markets.

I'm also optimistic that new opportunities will emerge for GFI to capture. In the meantime we are continuing to pursue opportunities based on our ongoing strategy and market strengths. As we discussed at this year's Investor Day we're expanding our customer base by adding complementary products and by providing services to non-traditional clients such as institutional investors for cash equities, algorithmic traders in hedge funds for commodities and tier one banks in hedge funds through our FENICS and market data products.

It continues to be our goal to embed our technology into the workflow of new and existing customers to create additional value. Before offering my concluding remarks, I would now like to turn the call over Jim Peers, our CFO, for his comments.

James Peers

On a GAAP basis, GFI's total revenues decreased in the second quarter of this year, compared to the second quarter of last year, by $36.8 million to $224.7 million, compared to $261.5 million for the prior year. On a non-GAAP basis our revenues for the second quarter of '09 are $220.5 million, compared to $261.5 million in the same quarter last year.

In the second quarter of this year brokerage revenues totaled $201.1 million and total revenues for Trayport were $7.3 million. On a sterling basis, Trayport revenues were $4.9 million for the second quarter of this year, compared to $3.9 million for the second quarter of last year.

In the first half of the year, non-GAAP revenues decreased by $143.3 million as compared to the first half of 2008. On a GAAP basis the second quarter net income was $16.4 million, compared to $23.6 million in the second quarter of '08. On a non-GAAP basis the second quarter of '09 net income was $14.6 million, compared to $26 million in the same quarter last year.

On a non-GAAP basis the second quarter net income increased to $14.6 million, compared to $12.9 million in the first quarter of '09. The first half of the year net income decreased to $27.5 million from $64.1 million for the same period in 2008 on a non-GAAP basis.

On a GAAP basis our diluted earnings per share for the second quarter of '09 was $0.13, compared to $0.20 in the second quarter of last year. On a non-GAAP basis our earnings per share for the current quarter was $0.12, compared to $0.22 for the second quarter of '08. The first half of 2009 diluted earnings per share on a non-GAAP basis was $0.23, compared to $0.54 for the same period in 2008.

Non-GAAP brokerage revenues decreased by $44.6 million in the second quarter, compared to the second quarter of '08. Credit was up 6.3%, CDS [desks] though were down approximately 52% which was offset though by 140% increase in fixed income. Financials were down approximately 28%, equity was down approximately 30% and commodities were down 29.4%.

Brokerage revenues decreased by $3.5 million in the second quarter compared to the first quarter of this year. Credit was up 9%, financials were up 7.4%, equities were down 8.5% and commodities were down 2.6%.

Sign-on bonuses paid in the second quarter of '09 were $9.3 million, compared to $31 million in the second quarter of '09 and $17.5 million in the first quarter of '09. Sign-on bonuses expensed in the second quarter of this year were $11.4 compared to $9.3 million in the second quarter of last year and $11 million in the first quarter of '09.

Our brokerage personnel headcount at the end of the second quarter stands at 1,069, up four people from the second quarter of '08 and up 30 from the first quarter of '09. Our broker productivity has decreased to $191,000 for the second quarter this year, compared to $231,000 in the second quarter of last year, but is up slightly in the first quarter which was $188,000.

Our pre-tax margin for the second quarter of '09 was 11.7%, compared to 13.9% for the same quarter last year on a GAAP basis. On a non-GAAP basis the pre-tax margin for the second quarter of '09 was 10.6%, compared to 15.3% for the same quarter last year.

For the first half of the year our pre-tax margin was 10.1%, compared to 16.3% the first half of last year on a GAAP basis. On a non-GAAP basis the pre-tax margin for the first half of the year was 10.1%, compared to 17.5% for the same period in 2008.

In summary our key performance drivers on a non-GAAP basis on as follows. Revenues for the second quarter of this year are down $41 million, compared to the second quarter of '08, and Trayport total revenues for the second quarter were $7.3 million.

Our comp costs are at 66.5% of total revenues for the second quarter, compared to 60.7% for the second quarter of '08 and 66.7% for the first quarter of '09. The first half of the year compensation costs are 66.6%, compared to 61.1% for the same period in 2008.

Our non-compensation expense in the second quarter of this year as a percentage of revenues were 22.9%, compared to 24% the same quarter in the prior year and 23.8% for the first quarter of this year. Our non-compensation ratio for the first half of the year was 23.3%, compared to 21.4% for the first half of '08.

GFI's effective tax rate for the first half of the year is now 37%, compared to 36.5% for the first half of last year.

I would now like to highlight some other areas that will be of interest to you. The number of weighted average diluted shares for the quarter were 122.2 million shares. As I've highlighted on previous calls, we are long euros on the revenue side and short sterling on the cost side in Europe.

Accordingly in the fourth quarter of last year, as in the second quarter of this year, GFI entered into a number of FX forward contracts which serve as an economic hedge of our exposure to certain euro and sterling cash flows in 2009 and 2010. These hedges were mark-to-market at the end of the second quarter, resulting in an unrealized non cash pre-tax gain of $4.2 million with no accounting offset for future cash flows.

As discussed in our last call, on April 28 of this year we amended our bank facility as follows. Revolver was decreased from $265 million to $175 million. The definition of EBITDA now better reflects our cash earnings, and our leverage ratio was lowered from 2.5 times to 2 times, and our borrowing rate is LIBOR plus 250 BPS.

Given the increased level of cash GFI has, we were comfortable lowering the revolver commitment and we additionally paid down $25 million of outstanding borrowings in the second quarter of this year. That concludes my remarks and now I will turn the presentation back to Mickey for some closing comments.

Michael Gooch

Thank you, Jim. In conclusion, our improved performance in the second quarter of 2009 reflects the further stabilization of our markets, as well as our strategic in cost control initiatives. While uncertainty about potential regulatory and legislative actions continue to weigh on our markets, we have been actively engaged in dialogue with the decision makers in the U.S. and Europe and in analyzing the implications and opportunities for GFI.

My optimism about the solutions that will emerge is based on this knowledge and in my confidence that we have the experience, agility and technology advantage to capture the new opportunities created. Due to adjustments we are making in our product offerings and our reduced exposure to any potential negative developments in the credit derivative markets, we clearly see more upside than downside in the future environment for GFI.

We are also pursuing immediate opportunities in line with our ongoing growth strategy and deep market strengths. We also will continue to focus on controlling direct and indirect costs. We have taken recent steps to improve our working capital management and thereby further strengthen our balance sheet and cash position.

We are pleased this quarter to declare our seventh consecutive quarterly cash dividend and so continue to return value to our investors. Thank you for your time and attention today. We are now ready to take your questions.

Question-and-Answer Session


(Operator Instructions). Our first question comes from Dan Fannon – Jeffries & Co.

Dan Fannon – Jeffries & Co.

Good morning and thanks for taking my questions. Mickey, you've mentioned previously in the year that you talked beyond the third quarter, you'd highlighted a return to year-over-year growth by year end. Can you update us on your thoughts there about how you think about, you know, the fourth quarter or 2010 in terms of growth returning?

Michael Gooch

Yes, I still see that. I'm still confident that we'll see year-over-year growth in the fourth quarter. Of course at that point the comp is becoming less challenging. One of the things about the third quarter of '08 was that it was very much in the run up to the, you know, peak of the credit crisis eventually culminating with the bankruptcy of Lehman.

So we're on a difficult comp this quarter and so that's why we're looking at this 20% to 23% projection down year-over-year because of the tough comp. Although even just with the activity within the last few days, I'm already leaning towards the lower end of that projection.

Of course, what is sort of uncertain to all of us right now is how August is going to be simply because it's August with potentially large European holidays and things like that, and we just without anything significant happening in the market it's difficult to really say where that's going to come out. But we're pretty confident that September's going to be a good return to business month, and then a solid quarter in the fourth quarter that will be a growth year over year.

And then 2010, I'm still fully expecting to see year over year growth over 2008. I think that by then there will be more certainty in the marketplace. One of the things that hangs over the market is uncertainty and as long as the various regulatory initiatives are being debated and some of the politicking is going on and some of the various discussions that you've probably been reading about today in the various press, vis-à-vis compensation on Wall Street and derivative trading, etc.

As long as those uncertainties are hanging over the market I think that it does depress potential trading volumes. But once the certainty – once the legislation has moved forward and we know where we'll stand – I really do think that the market will rebound very healthily.

Dan Fannon – Jeffries & Co.

And then in your supplemental data for the monthly stuff, it shows that essentially you're tracking slightly above kind of slightly above 2006 revenue levels. But if you go back and you look at your EBIT margins, you're about 300 basis points below that. And if we go back and compare to 2006, does this reflect more product mix today or is it something where the kind of comp structure and the payouts have changed and it's going to take longer to really get back to those higher margins?

Michael Gooch

Well I think if you're making a sensible comparison to 2006, if we thought our revenues were going to remain at those levels we'd probably scale back some of our infrastructure, but we don't expect that to be the case, so we've continued to invest at full speed in our technology initiatives. And on top of that, of course, along the way, as we were growing the credit business and including the the circumstances of last year with defections that we had in the credit business we do have some hangover from amortization of signing bonuses that were a function of our optimism about growth levels before the credit crisis hit.

So if you're making a comparison to 2006, I think you just have to see that 300 basis points is really a function of what I just described. It's not a function of there really being any change in the way brokers are getting paid, it's just that it's a hangover, and that is going to be washing out. And of course, if we didn't see the volume growth we would scale back the infrastructure.

But we're not doing that at this point because we generally do believe that our technology is going to be a big part of our improved performance as we go forward. Once the legislations come forward, I strongly suspect that we will see a lot more take up in some of our electronic offerings. And so the fact that we're well positioned for that I think is going to be good for us in the marketplace.

At the same time we are dynamically acting to changing market conditions. So you can see that we invested in corporate fixed income in the cash side of the market. With the uncertainty in the derivative market, clearly if you squeeze the balloon in one spot it pops out somewhere else. And so we've taken advantage of restructuring our business to do more cash corporate fixed income and cash equities and more listed products. And there's some cost associated with that which runs through the amortization on the compensation side.

So I think that we will be back to 2006 pre-tax profit margins some point by the latter part of 2010 in my opinion.


(Operator Instructions). Our next question comes from Daniel Harris – Goldman Sachs.

Daniel Harris – Goldman Sachs

So cash fixed income for you guys has certainly been a big benefit over the last year, but it seems like you started investing in that, I think according to your comments two years ago, so while CDS is still growing pretty rapidly. And I'm wondering if you can sort of talk about to some extent where you're investing today with a view out to the future, and if you can even maybe go a little bit further. It seems like you've hired thirty people sequentially. Where are you actually hiring people today to sort of grow in the more near term?

Michael Gooch

Certainly. Well the thing is, right, that we were this broker that wasn't really involved largely in the cash fixed income market, but we found ourselves an early niche in credit derivatives. So we very successfully grew a strong credit derivative business. And being the leader in that market, the natural opportunity for us there, with our thoughts about how capital market arbitrage would work, between credit derivatives and cash fixed income and equities as we all saw over the last couple of years, it inspired us to want to build a cash equities and cash fixed income business to complement that strong derivatives position.

So that was the initial 2007, and even slightly before that, but 2007 initiatives in investing in our cash fixed income business and hiring cashed fixed income brokers to complement our credit derivatives business.

Now, what has happened, of course, is the credit derivate business has taken a back seat. There's been some decline in trading volumes and credit derivatives, and the spreads in the cash fixed income have popped out and, with a lot of the dealer community committing less capital to the market and with Lehman going out of business and Bear Stearns being bought by Goldman and Merrill merging with Bank of America, it actually created an opportunity for us to take our cash fixed income business and expand our customer base.

So in dynamically reacting to market circumstances, fortunately we'd invested in this cash fixed income and cash equities business, as a result of our strong credit derivatives presence, and were then able to add to that business by actually changing our customer base and going after more institutional investor-type clients for that business.

So it's created a whole opportunity for us to restructure our business on the fly, so to speak. And that is the story behind why that is occurring. So when you talk about the 30 that we've added, we've actually added more like 100, because we've downsized a number of brokers in areas that we didn't think were going to be growing in this environment and added brokers in areas where we thought we would see growth.

It resulted in a net plus 30, but the areas where we are adding is Asia equities, Asia financials, U.S. credit in whole loans, loan CDS and, also, obviously in the cash corporate bonds. And then in Europe, we're in the financials adding in Dubai in FX, in short-term swaps in Paris. And then in credit in Europe, we've added European convertible bonds, fixed income sales. Once again, this is going towards the more institutional side of the business.

European government bonds, where we're seeing increased activity which we expect to see more of, with the significant amount of additional government debt that's being issued, credit in Paris, which includes cash, corporate fixed income in Paris, and, also, Christopher Street Capital, which is our division within the company that services the buy-side clients in European and North American fixed income. And then further, in commodities, we've been adding some brokers in the U.K. gas markets.

So we're just dynamically reacting, Dan, to where we're seeing the business potential. Downsizing where we think business will struggle to rebound and upsizing where we see areas that we think will do well in the new environment.


Our next question comes from Rob Rutschow – CLSA.

Robert Rutschow – CLSA

I was hoping you could talk a little bit more to the competitive landscape and how that's changed over, say, the past couple of quarters and more recently and what that's done to spreads and, also whether you're considering possibly committing capital to trades?

Michael Gooch

In terms of the competitive landscape in the IDB space, I would say that the hiring frenzy that was occurring in the peak of the credit bubble has subsided, so we're under less pressure from our core IDB competitors to pay bonuses to people to re-sign contracts and things like that. So that's less competitive.

But at the same time we're expanding our business with a whole new customer base of institutional buy-side accounts and that's quite a competitive business. We're sort of competing, in fact, with a broader audience of competitors because we're competing with more regional, smaller investment bank-type organizations that sell fixed income and equity products with potential research and other types of buy-side environment.

So as we're looking to expand that business, it is entirely possible that we will at some point commit a little more capital to the market, in terms of being willing to make two-way markets in certain marketplaces, but we haven't actually done that yet, Rob, but it is certainly something that would be on the horizon for us as we look to expand our business with the buy side.

Robert Rutschow – CLSA

Generally, we've seen sort of a de-risking in the market and you're obviously more involved in the cash markets than you were before. How does that, in the long term, affect your pre-tax margin, in terms of on a run rate basis and sort of when everything is optimized?

Michael Gooch

I think, as I mentioned to the question from Dan Harris from Goldman, in looking at where we'll be in terms of pre-tax profit margin, we're still dealing with the cost of restructuring of a very dynamic change in the marketplace that occurred, but the potential margins in the business, with our investment in the technology, as we think there'll be more electronic trading, more use of our RFQ, request for quote platforms, particularly in things like FENICS and through the Trayport platform.

I believe that once we get through this amortization hangover, the amortization of the signing bonuses that are still running through our P&L that are money spent but nevertheless have to run through that P&L, I believe that we will get back to pre-tax profit margins that will be in the high teens.


Our next question comes from Chris Donat – Sandler O'Neill.

Christopher Donat – Sandler O'Neill

Just one question from me on the expenses and particularly on the non-comp side, do you feel like there's much more room for trimming expenses here? And I understand a lot of this depends on your outlook for what the revenue opportunities are in the future, but is there much room to cut in terms of, say, travel and promotion? Is it possible that we'll see sort of a snapback in future quarters as people have delayed marketing and entertaining in a tougher environment and maybe some of those constraints come off? Any color there?

Michael Gooch

I was going to suggest maybe even putting Ron Levi onto the call for the question, our global COO, who has been most responsible for our cost cutting measures, to talk about areas where he still sees opportunity for us to reduce costs.

And just to quickly answer the question on the T&E, now the T&E is not going to – it's our intention, I should say, it's our strong intention, to very actively manage the T&E side of the business and even our clients are in a different mindset.

I mean there's a different mindset about entertaining right now. Now, maybe that will wash away. Like I said, Wall Street has a short memory, but right now even our clients aren't looking to be that heavily entertained. It's almost like a corporate image thing at this point. So I do believe that we're going to keep our T&E level under control and even reduce it as a percentage of revenue, as we go forward.

Ron's not actually in the office with me, I think he's on the call though. Is Ron there?

Ron Levi

I think Mickey answered the question pretty well earlier on. If we are to cut more direct costs, it would mean biting into investment spend that we make in technology. So as long as [inaudible] the investment in technology then will stay pretty much the same. There's probably a few million we could really squeeze down on, but the bulk of the indirect now, with the bulk of saving in indirect now would come from reduction in investment.

Michael Gooch

And as long as we have confidence that we're going to see year-over-year growth in 2010 and as long as we see the marketplace moving towards more electronic trading and more exchange-type reporting requirements and more electronic RFQ, we're not likely to cut into that technology spend.


Our next question comes from Don Fandetti _ Citi.

Donald Fandetti – Citi

Not bad. I know you're doing more cash these days but just thinking as you look at the OTC derivatives market over the next two to three years, I mean how do you see it shaping up or is it possible we're in sort of a slow secular decline or is there very good growth? It's just that going to be the sort of infrastructure looks a little bit different?

Michael Gooch

Yes, I think OTC derivatives don't go away. There's a lot of reasons as members of the U. S. Chamber of Commerce reported to the government boards recently, there's a lot of reasons why corporate America needs OTC derivatives for hedging that can't simply be hedged with totally standardized exchange type instruments. At the same time though, we do expect that more of the standardized OTC derivatives will be ultimately centrally cleared and will be reported to essential environment.

But with the position that the government is taking and it's slightly more aggressive in the U. S. than it is in Europe, but with the position the governments' taking we still feel very strongly that our platform which will qualify as a RETES, a regulated electronic trading platform for the purposes of transparency and reporting in the marketplace.

With the correct type of OTC clearing will actually open opportunities for us to broaden our client base and so, I think that the margins will get tighter in OTC derivatives and it'll be – it's that semantic thing about what's OTC and what's exchange when we cross the trade OTC and then post it on exchange? We've been doing that for years in equities, equity derivatives and in energy. But I think that these OTC derivatives will be crossed by us on our platform.

Some of it through the RSQ mechanism, some of it through direct bids and offers on electronic trading platform, but the central clearing mechanism and the reporting will ultimately make the market a better market for us to participate in.


Our next question comes from the line of Chris Allen – Pali Capital.

Chris Allen – Pali Capital

Just I had a quick question on the other income. Once you back out the FX hedge it's still about $6 million of premium sequentially, I wonder if you could just get some color on that.

James Peers

Sure I can do that. Of that $6 million on the non-GAAP basis, but $1 million of it is from various equity pickups which you should see on an ongoing basis from quarter to quarter. Obviously then the remaining $5 million relates to net FX gains and with, I'd say with the weakening of the dollar in the second quarter, our FX positions resulted in gains.

But since our hedges are not considered hedges for GAAP purposes as you know, we must mark to market these hedges and take the gains and losses through the P&L rather than retained earnings. So given the continued volatility though in the FX rates especially with the dollar against the euro and the sterling, it is kind of difficult to predict what the other income levels would be in future quarters.

Chris Giancaro

[Becky], just a follow up to our questioners, if they have follow-up question if they would get back into the queue we will try to entertain it before we close the call at the end, at the bottom of the hour.


Thank you very much. (Operator Instructions). Our next question comes from Niamh Alexander –KBW.

Niamh Alexander – Keefe, Bruyette & Woods

Hi, thanks for taking my question. I'd like to get back to the OTC and the regulatory headlines, Mickey, if I could, because there's probably a lot of opportunities for our GFI with kind of your investment in electronic, but with respect to the products that will not trade electronically, there's already I think it's about 60% of what you do is clear it centrally, but a lot of what you do is adding value for the less liquid products.

And it looks like the regulators are really going to start increasing capital requirements and that could spell like lower liquidity, but it could also spell wider spreads. And do you think that there's an offset for you in bills that get standardized and centrally cleared. The volume goes up and that helps offset maybe where you see liquidity get more challenged in some of those more customized derivatives as they're being classified.

Michael Gooch

Yes, Niamh, I think that you answered the question yourself correctly there, that there will be the offset. I also think that the significant increase in government debt and the corporate refinancing calendar is going to keep us busy for some time and there will be certain pockets of the market that are just not going to lend themselves to any kind of standardized electronic or centrally cleared environment, and we're going to service those markets as well so we're going to look for opportunities there.

Certainly our business has had to change from where we were a couple of years ago and I think that we're doing a really good job of dynamically changing our business to the current environment.

And there's obviously a cost associated with that which you're seeing currently in the profit margin which is most clearly evident in the jump from 60% to 65% in compensation. It's not that we're paying our brokers more; it's a function of the dynamic restructuring of the business.

And so within the next 18 months or so we should be washing through that and getting those numbers back down to closer to 60% and should therefore see our pre-tax margin getting back up into the mid to high teens.


Our next question comes from the line of Mark Lane – William Blair & Co.

Mark Lane – William Blair & Co.

Yes, good morning. I just have a quick follow-up on the expense side. Mickey, you've quantified your view on margin kind of over a longer period of time, but, Jim, if you look at your revenue guidance for the third quarter and revenue's up in the fourth quarter, and we look a modest improvement in revenue growth in 2010, say something like 5% or 10%, I mean where does comp kind of fall out in that scenario given some of the commitments you've made on the signing bonuses? Can it move down a couple of percentage points next year or what's the?

James Peers

Yes. No, let's talk about the near term first and then I think as we go forward I think with the upcoming quarter, as we said with our revenues down because of the summer, obviously the percentage on the comp will stay I think in the 66% to 67% range again. And then I think as our revenues start to increase in the fourth quarter and next year that ratio will start coming down.

We still are adding brokers and therefore we still have sign on bonuses and everything else which we're bleeding or amortizing through the next two or three years so that sort of put some fixed cost into that. But I would see as our revenues go down that comp ratios will start to come down as well as a percentage, as revenues go up, sorry.


Our next question is a follow-up question from the line of Chris Allen – Pali.

Chris Allen – Pali Capital

I just wanted to ask on, in terms of July. Mickey, you mentioned it's giving you confidence in the outlook towards the goal under the range which I assume is 20% down year-over-year. Just where is July tracking on a monthly basis right now?

Michael Gooch

That's a good question. I don't have that in front of me right now. Anyone have that handy, Jim?

James Peers

Yes, we don't normally give out those numbers until they're finalized, but right now it's fair to say sequentially July is down about 8%, second quarter.


Our next question is a follow up question from Christopher Donat – Sandler O'Neill.

Christopher Donat – Sandler O'Neill

Yes, thanks for taking the follow up. Just in terms of the amortization hangover that Mickey mentioned. Jim, is that solely the $11.4 million of bonuses that were expensed this quarter or is there anything else there for that amortization?

James Peers

Well, no that's the, well, there's two parts of our amortization. We've got RSU expense and the sign-ons. But the number I gave you on the phone was sign-ons and retention bonuses. So what was expense versus what was paid-out. And you can see so the amount last year we paid out quite a substantial amount in 2008 in total payouts of about a little shy of $80 million and with an expense of $42 million, so that still has to bleed through, plus whatever new ones we have in the current period.

And but so far this year we're down. Payments were only in the second quarter were $9.3 million compared to $31 million last year, so we're down but I still would anticipate that we could be somewhere in the, for the year, around $30 million payout.


Our next question is a follow-up from Niamh Alexander – KBW.

Niamh Alexander – Keefe, Bruyette & Woods

Thanks, if I could go back to credit derivatives. I know it's a smaller part of your business now, but you are leaders in the space, so how do I think about the clearing because it seems like a very small proportion of the total notion of value is kind of moved into the clearinghouse. So it's kind of a long, slow draw. There doesn't seem to be any rush on the dealers' part to get this done.

Is Europe going to be very different? Is there some kind of big bang expected and that might encourage single name products? If you could give us any update on that that would be really helpful. Thanks.

Michael Gooch

Sure. As I've always – as I've been saying all along since the first talk about clearing of credit derivatives, and I think I said way back that it was going to require the cooperation of the dealer community. And that does appear to be the case, which is why ICE Trust has succeeded where others have failed because they had the cooperation of the dealer community.

Meanwhile, I hear noises from the New York Fed that they would like to see competition in clearing. And that would mean that maybe there will be some efforts to persuade the banks to utilize other clearing mechanisms.

And from our perspective that's good news because the more completive the clearing function is the better it is for us because in some other markets where there's competitive clearing we actually get rebates from certain clears for steering business toward them.

So there seems to be an effort in Europe to move towards a central clearing mechanism. I have a gentleman here on the call who is representing us with the regulators and talking to Luxemburg and London about what they want to achieve in credit derivatives.

And I'll just put him on the call quickly to speak about that. His name is [Scott Fitzpatrick]. He has a strong Scottish accent. So listen up here.

[Scott Fitzpatrick]

Thank you. Yes, I –


Pardon the interruption. This is the operator. Mr. Giancaro you may want to check to see if you accidentally hit the mute function on the phone.

[Scott Fitzpatrick]

Yes, sorry. I was in – I returned yesterday from a session with a European commission, which was the final session prior to the July 31 goal set for clearing here in Europe. The position, at the moment there are two clearinghouses that have been given regulatory approval in the regions that they require it, namely Europe and the U.K. Those are EURX and obviously ICE Clear Europe.

ICE Clear Europe are actively now uploading or back loading some of the clearable trades into their clearing facility. EURX have less participation right now because some of the dealers are still in testing mode with them.

As far as the speed by which the trades could enter the clearinghouses, the dealers through, as they represented that they commenced this process in March in the U.S. and have now got something in the region of $1.6 trillion of notional and [CDS] trust.

The commission here didn't feel that there was any requirement to put any deadline dates in place for the dealers because they've been particularly impressed by how quickly they've met requirements and deadlines set for the introduction of the clearing mechanism. But what they did state was that they expected the dealers to participate and push as much as they can into the clearinghouses as quickly as possible.

James Peers

I think we seem to be having technical difficulties. So I think we have most of the questions period, pretty well come to an end. So before we finish then, what I would like to do is just clarify a point. But I think Chris Allen asked me about the July revenues and just make sure I clarify. The July revenues, as I said, we don't give out that information till the month is done and the quarter's over.

But based on the trend that we've seen in the month of July and the anticipated summer slowdown, we're anticipating that the brokerage revenues for the third quarter on a sequential basis compared to the second quarter would be down approximately 8%. So that given I think we'd like to end call and want to thank everyone for joining us.


Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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