Executives
Chris Giancarlo - Executive Vice President
Michael Gooch - Chairman and Chief Executive Officer
Jim Peers - Chief Financial Officer
Colin Heffron - President
Analysts
Dan Fannon - Jeffries & Company
Daniel Harris - Goldman Sachs
Don Fandetti - Citigroup
Chris Donat - Sandler O’Neill
Chris Allen - Banc of America Securities
Barry Cohen - Knott Partners
Rob Rutschow - Deutsche Bank
GFI Group, Inc. (GFIG) Q3 2007 Earnings Call November 2, 2007 8:30 AM ET
Operator
Good day ladies and gentlemen and welcome to the GFI Group'sthird quarter 2007 earnings conference call. My name is Grace Anne and I willbe your coordinator for today. At this time, all participants are in alisten-only mode. We will be facilitating a question-and-answer session towardsthe end of today's conference. (Operator Instructions) I would now like to turnthe presentation over to your host for today's conference, Mr. Chris Giancarlo,Executive Vice President.
Chris Giancarlo
Good morning. Welcome to the GFI Group third quarter 2007earnings conference call. We issued a press release yesterday providing thefinancial results for our fiscal quarter ended September 30, 2007, which isavailable on our web site at www.gfigroup.com.
Let me remind you that we have also posted monthly revenueinformation on our website under supplementary financial information' as we didlast quarter in conjunction with our earnings release.
To begin this morning's call, Michael Gooch, our Chairmanand Chief Executive Officer, will review some of the highlights of our thirdquarter performance. Next, Jim Peers, our Chief Financial Officer, will reviewthe third quarter financial results in greater detail. After Jim, Michael Goochwill conclude with a few remarks. After that, we'll open up the call to yourquestions.
Before we begin, I would like to remind everyone thatcertain statements contained in this discussion are forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995.Such forward-looking statements include statements about the outlook andprospects for GFI Group and for its industry, as well as statements about GFI'sfuture, financial and operating performance.
These and other statements that relate to future events andresults are based on the current expectations of GFI Group. Actual results,performance or achievements could differ materially from those contemplated,expressed or implied because of a number of risks and uncertainties, whichinclude but are not limited to the risks and uncertainties identified in theearnings release and GFI's filing with the U.S. Securities and ExchangeCommission. GFI Group does not undertake to publicly update our revise anyforward-looking statements whether as a result of new information, futureevents or otherwise.
I will now turn the call over to Michael Gooch, Chairman andChief Executive Officer of GFI Group.
Michael Gooch
Thank you, Chris, and good morning and thank you for joiningus today. At the time of our last earnings call, we had forecasted stronggrowth in the third quarter brokerage revenues because of heightened volatilityin global credit and financial markets that reemerged late in the secondquarter.
In fact, our third quarter was a record quarter for GFI withbrokerage revenues increasing 41% over the third quarter of 2006, slightlyabove the high-end of our forecast. The fallout from the sub-prime debt turmoildrove trading in credit and equity products to record levels in the thirdquarter, especially in July and August.
After a slow start to September, moves by the FederalReserve and the European Central Bank to add liquidity to the credit market ledto a strong finish for the quarter. Looking more closely at our third quarterperformance by product line, credit product revenues increased 45% from thethird quarter of 2006 and rose 21% sequentially.
Credit derivative trading activity was impacted by thesub-prime debt market turbulence as it affects spreads to other credit sectors.Our revenues from credit derivatives reached a record level in the thirdquarter and were strong in all regions. This was accompanied by a 28% increasein cash bond revenues.
The continued success in Europe of our CreditMatchelectronic platform made an impressive contribution to our growth in creditderivative and investment-grade bonds. In total, credit product revenuesrepresented 36% of total brokerage revenues for the third quarter of 2007,generally in-line with our year-over-year quarterly results. And up from 33% ofbrokerage revenues in the second quarter of 2007.
The sub-prime market environment also triggered volatilityin the equity markets. This contributed to a 43% rise in our equity productrevenues from the third quarter of 2006, and an 11% sequential increase.
Once again, our Paris office, which is now a leader inequity brokerage in continental Europe, was an important contributor to ourgrowth in equity products while equity derivatives also did well in the U.K.and North America.
Cash equities were strong in both North America and Europe.Equity products represented 24% of our total third quarter brokerage revenues,in-line with our year-over-year sequential quarterly percentages. Financialproduct revenues rose 28% over the third quarter of 2006 and 7% over the secondquarter of 2007.
The volatility in the financial markets also led to strengthin emerging market products in all regions, especially in Europe and Asia. Wecontinued to roll out ForexMatch in all geographic regions and to add productsthat we believe we will enhance trading efficiency for clients and increasedbroker activity.
In total, financial products represented 20% of our thirdquarter brokerage revenue mix, in line with year-over-year and sequentialquarterly results. Our commodity product revenues increased 48% from the thirdquarter of 2006 mainly due to the addition of Amerex and the strength ofseveral energy products in Europe.
Commodity products represented 20% of our brokerage revenuemix, in-line with our level in the third quarter of 2006 and below the 23% ofrevenues that they represented in the second quarter of 2007.
Looking at our performance in the third quarter of 2007 bygeography, our diverse geographic revenue base enabled us to benefit fromglobal market volatility events in the quarter. Our revenues from Europe rose48%, year-over-year while we saw a 34% increase in our revenues from theAsia-Pacific region.
Our revenues from North America increased 36%, including thecontribution of Amerex. Improving our operating leverage is a major area offocus for the company. I'm pleased to report that we made tangible progress inthe third quarter and year-to-date as our earnings growth exceeded our revenue growthin both periods. Of course, our record revenue level helped in this regard.
We were successful in controlling compensation costs, ourlargest expense in the third quarter despite competitive marketplace pressures.We believe that our strong growth and deep liquidity in our markets helps usretain our talented personnel. Technology plays an increasingly important rolein employee retention. We see our investment in the CreditMatch working inEurope where it is benefiting our brokers through higher productivity andoverall compensation while at the same time improving margins for the company.
We made headway in controlling our non-compensation costs inthe quarter. On a non-GAAP basis, non-compensation costs improved to 19.8% oftotal revenues in the third quarter of 2007 versus 21.6% in the same quarter of2006 and 21.9% in the second quarter this year. I point to two areas of focusin the last quarter that were leveraged successfully in the third quarter of2007.
Travel and promotional expenses were down 2.4% sequentially,while communications expenses remained level with the second quarter of '07 andtherefore declined as a percentage of revenues, both sequentially and incomparison to the third quarter of last year. Turning to our outlook for the fourthquarter of 2007, I note that October brokerage activity levels were quitefavorable and were approximately 35% ahead at the same month last year, whichmakes October a record month, albeit with the benefit of two additional tradingdays over last October.
Please also note that this growth includes the contributionof Amerex for the first time in both periods. With the start of the fourthquarter, we currently estimate that brokerage revenues will increase between20% and 25% over the fourth quarter of 2006.
GFI strives to provide superior returns to shareholders andwe focus on growing our revenues and profitability every quarter towards thisend. As reported in yesterday's release, based on our growth update andanticipation of future opportunities, our Board of Directors has authorizedmanagement to seek stockholder approval to increase the company's authorizedshare capital for general corporate use, including authorization for an up to 4to 1 stock split in the form of a stock dividend.
A special meeting of stockholders will be calledspecifically to improve an increase in the number of our authorized shares ofcommon stock to 400 million from the current level of 100 million. We willannounce the date at the special meeting as soon as it is set.
I would now like to turn the call over to Jim Peers, ourCFO, before making my concluding remarks.
Jim Peers
Thanks, Mickey. Good morning, everyone. Our strong revenuegrowth continued in the third quarter of '07 as revenues grew by $74.7 millionto $254.7 million compared to $180 million in the third quarter of last year, a41.5% increase. Our Q3 revenue growth was mainly driven by increased marketvolatility, strong organic growth in credit, financial and equity products andthe addition of Amerex. On a year-to-date basis, our revenues increased by $170million or 30.8% on a GAAP basis.
Third quarter net income improved to $25.9 million comparedto $16.6 million from the same quarter last year on a GAAP basis. After backingup the non-GAAP items which I will discuss a more detail later, net income grew53% to $27.6 million compared to $18 million for the same quarter last year.
On a year-to-date basis, our net income grew 36.3% to $74.3million compared to $54.6 million for the same period in 2006 on a non-GAAPbasis. Our diluted earnings per share for the third quarter of '07 was $0.87compared to $0.57 for the same quarter last year.
However, on a non-GAAP basis, our diluted earnings per sharefor the third quarter of this year was $0.92 compared to $0.62 in the thirdquarter of '06, which is an increase of 49.6%. On a year-to-date basis, ourdiluted earnings per share grew by 33.4% on a non-GAAP basis to $2.50 comparedto $1.87 for the same period in 2006.
Brokerage revenues grew by over $71 million, or 41.2% in thethird quarter compared to the third quarter of '06. Credit is up approximately45%, CDS desks only are up over 53%. Financials are up approximately 28%.Equity is up approximately 43% and commodities are up over 48%.
Our brokerage sign-on bonuses paid in the third quarter were$9.1 million versus $3.1 million in the third quarter of '06 and the brokeragesign-on at the bonus expensed was $5.6 million in the third quarter of '07compared to $5.1 million in the third quarter of '06.
Our brokerage personnel headcount at the end of Septemberstands at 1021, up 194 from third quarter of '06 and a change in our brokerheadcount from the end of 2006 is 89. Our broker productivity has increased byover 10% to $703,000 for the year-to-date in 2007 from $638,000 for the sameperiod last year.
Pretax margin for the third quarter of '07 was 16.7% versus15.1% for the third quarter of last year on a GAAP basis. On a non-GAAP basis,our pre-tax margin for the third quarter this year was 17.8% compared to 16.3%for the same quarter last year. On a year-to-date basis, pre-tax margin was 16%versus 14.6% for 2006 on a GAAP basis and on a non-GAAP basis, our pre-taxmargin for the year-to-date was 17% compared to 2006 at 16.5%.
In summary, our key performance drivers on a non-GAAP basisare as follows. Revenues from the third quarter are up 40.8% compared to thethird quarter of '06, and on a year-to-date basis revenues are up 29.9% from2006. Our comp costs are at 62.4% for the third quarter of '07 compared to62.2% for the third quarter of '06 and 62.5% for the second quarter of '07. Ona year-to-date basis, comp costs are at 62.6% compared to 61.2% for 2006.
Non-compensation expenses in the third quarter as apercentage of revenue were 19.8% compared to 21.6% for the same quarter in theprior year and 21.9% for the second quarter of '07. Our non-comp ratio on ayear-to-date basis was 20.3% compared to 22.3% for the same period in 2006. Oureffective tax rate for the third quarter of '07 was 39% compared to 40% in thefiscal year 2006.
Now I would like to highlight some other areas that will beof interest to you. The number of diluted shares for the quarter ended inSeptember were 29.9 million shares. In June as I mentioned on the last call,GFI signed a lease to relocate or New York offices to 55 Water Street.
The move is scheduled to commence in the first half of 2008.Accordingly, the Company excluded $2 million before tax as nonrecurring costsin the third quarter made up of $900,000 for duplicate rent and $1.1 million onaccelerated depreciation. There will be additional adjustments to GAAP earningsfor the next three quarters as the move progresses.
Other income increased by $2 million for the third quarterof this year compared to the third quarter of last year because oftransactional unrealized foreign exchange gains mainly in the UK.
That concludes my comments, now I will turn the presentationback to Mickey for some closing remarks.
Michael Gooch
Thank you, Jim. In conclusion, we had a record the quarteras we benefited from high market volatility and our product and geographicdiversity, our investment in electronic trading platforms and expert brokeragepersonnel and our ongoing focus on controlling costs.
We will continue to execute on our strategic plan forgrowth, while making investments to support and accelerate it as we seek tobuild shareholder value. We look forward to reporting on our progress on ournext call. Thank you for your time and attention today and we're now ready totake your questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from theline Dan Fannon of Jeffries & Company.
Dan Fannon - Jeffries & Company
Good morning. And thanks for taking question. Your guys'pretax margin has bounced around a bit in recent periods. You've done a nicejob on the non-comp side this quarter. As you look going forward, do you thinkthe pre-tax margin you saw in the third quarter, is that sustainable, or do youthink you will see some expansion from here as you look out over the nextcouple of periods?
Jim Peers
That's a good question. I think we're getting a betterhandle on the non-comp costs. I think as you saw from the third quarter and thesecond quarter, even though it's down as a percentage in absolute dollars, it'sflat. And with the higher revenue base, that has improved our leverage. We hopethat that's sustainable.
However, I think one of the things that people forgetsometimes is our business is seasonal, and a good example in the fourthquarter, we would hope that we can continue to stay at that absolute dollarsfor non-comp. But obviously, I would think that we're going to see a slightincrease in T&E, which is normal for the fourth quarter because of theholiday period. And so you will see some other slight increase there.
And typically, sometimes we get some one-off costs, which wejust cannot predict. But I think we are focused on trying to maintain thatabsolute dollar level with the higher revenues that we have, so therefore wecontinue to see the leverage.
Dan Fannon - Jeffries & Company
Okay, that’s helpful. And in terms of broker retention andthe market for hiring new brokers, what do the heightened levels of volatilitydo to that market and your ability to grow, or as I said, retain employees?
Michael Gooch
I'm going to give this question to Colin Heffron, ourPresident.
Colin Heffron
The heightened loads of volatility are actually very goodfor us, in terms of the retention gain because it's a bit like playing with thenumber one team. When things are going really well and markets are trading veryactively, you think a lot more about staying where you are and enjoying themarket position and the dominance that we have in a lot of our product.
So in terms of volatility or it just being busy, it's very,very good for our business on both levels. Obviously, it just drives volume,but it also concentrates the mind and keeps people right where they should be.
Dan Fannon - Jeffries & Company
Okay. And then lastly on your capital position, obviouslyyou have a fair amount of cash now and low average. Can you give us a sense ofyour appetite for an acquisition in terms of both the size as well as what productor geographic areas you think would be most additive to your businesscurrently?
Michael Gooch
Dan, we are pretty open-minded about the opportunities inthe marketplace. Some of them are really things that we could potentially dowithout really looking to any great extent beyond the cash in the bank, so tospeak, and some of the opportunities are bigger.
I am probably not going to be very helpful here, but franklyit's across all product categories that we are interested, but we also have a focuson improving our technology positions. There are opportunities right now in themarketplace in one or two small boutique type businesses that fit well with us.
We're talking to some other companies about one or twotechnology strategies that we might enter into. So we have an appetite, we'rejust looking to make sure that we invest in the right places to basicallycreate the shareholder value.
Dan Fannon - Jeffries & Co
Okay. Well is it safe to assume that your appetite has beenincreasing at this point or you're anniversary in the Amerex deal? I mean areyou looking -- just for a sense of time period. Is it something that you withenvision you guys deploying capital in the next several quarters closer orbeyond that?
Michael Gooch
I think that we're in a good position to look to expand ourbusiness beyond organic growth. One or two of the assets in the marketplacethat we could be looking at are in my opinion priced a little richly. But ifthe economics make sense, I think we're all positioned that we have an appetiteto do something in the relative near future.
Dan Fannon - Jeffries & Co
Okay. Great. Thank you.
Operator
Your next question comes from the line of Daniel Harris ofGoldman Sachs.
Daniel Harris - Goldman Sachs
Hi, good morning, guys.
Michael Gooch
Good morning.
Daniel Harris - Goldman Sachs
Mickey, thanks again for the commentary on brokerage revenuegrowth and what your revenues are going forward. I appreciate that every quarter.I just wanted to touch, dig a little bit down into that a bit further. Withvolumes up 35% through October and your guidance of 20 to 25%, which in thepast has been last quarter, it was actually pretty spot on.
What areas do you think would actually decelerate a littlebit from the growth that we've seen so far to get to that range?
Michael Gooch
Well, we are trying to be as accurate as we can withpredicting the future, but I frankly these last four or five months, it hasbeen difficult to really say what's going to happen. And I think that we've hada lot of discussion about it internally and externally, and our crystal ball isnot necessarily any more accurate than anybody else's.
So one of the things I'm trying to do for you guys is give youto really put you in the same position that I am in as we sit looking at thebusiness. We just finished October, so let you know how October was. But bearin mind that October had 23 business days this year compared to 21 the yearbefore, and that's not an exact science.
You cannot just take the number, divide it by 23 andmultiply it by 21 to estimate your revenue growth for the rest of the yearbecause there are other factors involved in coming up with that estimation. Butif you do that, you come up with 24-point something percent, which would be thehigh end of the 20 to 25% estimate.
And then, given the fact that going into the end of theyear, we're not really sure whether the banks certainly if there are situationsin the marketplace surrounding further volatility in the credit markets, ifthere is some more issues involving concerns about write-downs in the marketand potential credit events, or just year end activity, these are all thingsthat it's very difficult sitting here today to say which way it's going to go,whether we're going to end up in the middle of December with everybody throwingthe towel in and saying, okay, it was a very, very busy year.
We did well but we're basically going to shut the books forthe year. Or, whether we're going to have one of those Decembers where we arereally active right up until literally 6 o'clock in the evening on, I don'thave a calendar in front of me, whatever the last day of December is.
So, I don't really have an ability to say what the outcomewould be, but I would still say that the driving and I think this is yourquestion driving element that is going to probably have the influence overwhere we end the year is going to be whether or not there continues to bevolatility coming from the credit sector. There is still concerns about SIVs.
Six months ago, who knew what an SIV was? But conduits,commercial paper, all these things that are now in everybody's mind, thecommercial paper auctions, there's still issues. There might be some more badnews from some of the brokerage companies. I'm not saying I know or anything,but I'm just estimating that it's possible.
And that type of literally like in the last couple of days,it has been -- and yesterday is a fine example, right, with a big down day in theDow. The fact of the matter is that, that kind of activity ends up being verygood for our revenues. So, if it continues through the rest of the year and wehave things like that, we're going to end the year in most likely at the highend of my estimate, if not above it.
Daniel Harris - Goldman Sachs
Yeah, no, I appreciate that, Mickey, and the point about thenumber of days in October is also interesting. So thank you for that. Just tostay on the credit side, because we've talked about it a little bit. Over thepast few months, obviously there has been just whipsaws and volatility.
We've put a lot of things about the CDS markets. And evenwithin people I have talked to here at the firm and on the street, you getdifferent opinions on the levels of volumes being traded, and some desks seemlike they're extremely active and some desks seem like they've taken a littlebit of a step down relative to where they were this past summer. Can you putany color around the CDS market rather than the entire credit market?
Michael Gooch
I would say that we are seeing activity across the board,even some of the more complex structures surrounding the tranches in exoticcredit. We're still seeing activity. It's bleeding out into emerging markets. Ihave to say that, when you're in the position of being the most liquidbrokerage shop that I think that even if market conditions become choppy Ithink it actually means that the business tends to go into the hands of the twoor three that have the best liquidity.
So, we probably benefit to some extent in that respect,whereas some of our competitors that maybe have much weaker sort of fourth andfifth place positions probably find it difficult to find any liquidity and getbusiness done. So, did that answer your question? Sorry.
Daniel Harris - Goldman Sachs
Yes, it basically did. I was just looking for a little it'sjust, I've heard some varying discussion of the absolute level of volumes, andobviously you guys should benefit because you are such a big participant inthat market, but the direction and I think I got a little bit…
Michael Gooch
What I want to add to it, Dan, is there is always thisconcern I think when you are very busy after some financial events. Forexample, Enron and then the energy markets where we were very busy in 2002 butthen saw a tail off in 2003 before the markets grew again simply because whatwe were seeing in 2002 was a lot of unwinding of positions.
And so, there's always that concern that, is the activity weare seeing, is it a lot of people just unwinding positions and getting out ofbusiness which would not bode well for the future, or is it real business?
And I would like to say that from where we are sitting rightnow, I and, frankly, just from candid conversations that I have had with peoplein the trenches at some of the big brokerage when retile (ph) brokerage, I meanthe Goldman Sachs', the Deutsche Banks of the world -- that they are still verypositive that the credit derivative business is here to stay and that ifanything, the recent market activity is actually only going to reconfirm theplace of credit derivatives in the marketplace and that we’re - I am being ledto expect that 2008 is actually going to be a very good year for business inthe credit sector.
And I think, that's going to bleed through into our otherbusinesses. Obviously, energy isn't directly affected by credit and there's allsorts of other market things going on that affect the energy market and alsogoing to be -- having a primary in February for the general election next year.
We're going to know who our candidates are for President,and then an election later in the year. So I think that that and some of theother developments on the international scene are going to keep generally thefinancial markets active in 2008.
Daniel Harris - Goldman Sachs
Yeah. Thanks for that, Mickey. And then just lastly here,and I will sign off. On the commodity side with Amerex now and the full year'sresults, can you give a little color about how we should think about growth?
And I guess what I'm trying to get that is, if you break outover the past year what the organic growth in the business has been versus whatit has really been related to the Amerex business, that would be very helpful.Thanks a lot, guys. Great quarter.
Michael Gooch
Thank you. Did you want me to say something about that?
Daniel Harris - Goldman Sachs
I was just wondering if you could help me understand theorganic versus the Amerex growth.
Michael Gooch
I have said that, in our business, I think, and maybe it'sjust a number I'm chucking out there, but I think 9% growth organic is, if thatis what we should do -- I don't have to come to work to do 9% growth basically.
I can stay home. And so I think 9% is organic, and theneverything that else that we do is a function of our investment, whether it'sin people or technology or just strategically thinking about our business.
And so I think that we can do the 9% with our eyes shut. Ithink that our long-term target that we've talked about, which is sort of 20%plus on the top line and working to improve the bottom line by one or twopercentage points each calendar year is something that we are extremely wellpositioned to achieve.
Daniel Harris - Goldman Sachs
That's great, Mickey. Thank you very much.
Operator
Your next question comes from the line of Don Fandetti ofCitigroup.
Don Fandetti - Citigroup
Hi good morning, Mickey, I have a quick question. Do you seeany opportunities in European derivatives around MiFID, whether it's partneringwith others or looking at new areas?
Michael Gooch
I think that MiFID really is something that actually worksto the benefit of dealer, brokers. I think that the OTC derivatives space isgrowing. And in terms of the transparency, I think it means that the dealercommunity is going to continue to look to automate processes.
So, companies like GFI that have very good, solidinvestments in good technology that can support electronic trading,straight-through processing, all of that process, we're going to benefit fromanything that comes in the marketplace that might sort of push or nudge thetrading community towards greater transparency and greater automation. I'm notsure about what you mean by any kind of acquisition opportunity, if that waspart of the question.
Don Fandetti - Citigroup
I think you answered my question, that's fine. I did have afollow-up. I was wondering if you could just give us an idea of what you'rehearing from the dealers in credit, in terms of, is there ever any pricingpressure or is everyone making a lot of money or everyone is happy? Just tryingto get a sense of what you're hearing from the dealers?
Michael Gooch
I think that right now, it's not the focus. I think that ifwe get into a period maybe one-third through 2008 if there's sort of a breatherperiod, I think the marketplace might then take a look at their cost of doingbusiness relative to their trading activity.
Right now, it isn't the focus at all. Nobody is talkingabout the commission rates. If anything, spreads are probably a little widerand I think the commission rates are at the end of the day a function of bothspread and total volume.
So, right now, we're not really under any pressure on thetransaction cost side of the business.
Don Fandetti - Citigroup
Okay. And if I could ask one last question. This has been atopic over time in terms of the threat to your business from the exchanges. Youhave done a great job, it has not become an issue. Any thoughts on where youare today on that potential threat?
Michael Gooch
No, I think we still continue to be in a good position. Isaw some recent research that showed that the volume of OTC derivativesrelative to exchange traded derivatives, it had actually widened. It had gonefrom five times the volume to 5.9 times the volume.
I think that IDB space, we are a lot like exchanges in thatwe are the place where people come to offset risk with each other, and it worksvery well. We're so far ahead of the curve in things like credit products thatthere's and we have been doing this now, it's actually more than ten years.
And we're so far down the road in new product generation andthat just beginning now to try to look at maybe some single name stuff, maybesome index stuff. So, even if the exchanges enter into that marketplace, it'slikely actually initially to boost volumes across the board.
And I wouldn't be surprised to see OTC credit derivatives growif the exchanges enter the business. But in terms of losing OTC business to theexchange space, it's only going to most likely happen in the shorter end of themarket in the most highly liquid end of the market where the commissions arethe thinnest and where the traders don't care about the margin on a trade.
So, I think we are going to grow with the exchange space. Ithink there's a lot of things about the way that the OTC market works that isvery favorable to the participants and I don't see that that is going tochange.
Don Fandetti - Citigroup
Okay. Great. Thanks for the detail.
Michael Gooch
Sure.
Operator]
Your next question comes from the line of Chris Donat ofSandler O'Neill.
Chris Donat - Sandler O’Neill
Hi, good morning gentlemen.
Michael Gooch
Good morning, Chris,
Chris Donat - Sandler O’Neill
First question for Jim here. In terms of the other incomefrom the unrealized foreign exchange gains, is that something that's a functionof currency rates, or is that like a onetime issue that we shouldn't expect tosee again?
Jim Peers
It's more of a function of currency rates. As you can see,we typically, our major currencies in the English market, believe it or not,are dollars and euros. We don't have much in the way of revenues on a sterlingpoint of view.
And so therefore, as a result of the euro continuing toimprove against the dollar, that's one of the major drivers of the increasethat quarter. So, I would assume, don't assume that we're going to have thatextra $2 million dollars every quarter.
Chris Donat - Sandler O’Neill
Okay, but if I see a similar movement in the euro anddollar.
Jim Peers
It could have something similar, yes.
Chris Donat - Sandler O’Neill
Okay. Alright, that helps me understand that one. And thenalso probably one more for you, Jim, with the volatility and additional brokersrevenues you had here, communication doesn't really vary with that, right? Youdon't see data charges that scale with volumes, right? That's pretty much afixed cost issue, is that correct?
Jim Peers
Almost, that's fairly true. Sometimes it can vary dependingon where some of the revenues are, because some of them for example in Asia,some of it is driven by volume. It tends to be more driven by headcount whereyou would see more variable, whereas, for example, clearing fees are drivenmore by volume in equities.
Chris Donat - Sandler O’Neill
Okay. Okay. And then, T&E, I think historically you seean uptick in the fourth quarter, holiday parties or something. Is thatsomething we should expect again this year?
Jim Peers
I would anticipate that we would have a bit of an uptickfrom the third quarter.
Chris Donat - Sandler O’Neill
Okay. And then, to follow-up on a couple of questions thathave been asked before, Mickey, as you and you mentioned talking yourcustomers. Does their behavior start to change when they start feelingpressure? And I am thinking more the stories of brokers trimming headcount ontheir CDO desks and places like that.
Do they start, say, keeping less inventory, and does thatbenefit you? Or how do spreads benefit you? Can you give a little more color onthat?
Michael Gooch
I think it comes back to my earlier statement about whetheror not the trimming is trimming to get out of the business, or simply trainingdown and eventually looking to retool into the marketplace. I think that oncesome of the participants in the marketplace become concerned about committingcapital, if it was a long-term situation where participants were not committingcapital, that wouldn't be positive for our business.
But in the shorter term, when our customers become anxiousabout committing capital, initially it actually makes our services morevaluable because they want to lay things off much more quickly and spreads havewidened and it's more difficult for them to find the other side of the trade.
So, I think that the market environment we're in right nowis good for our business. I don't think that participants are looking to scaleout of the business. There's obviously going to be some musical chairs over thenext month or so with traders getting downsized and moving around. It tends to,in my personal opinion, to ultimately be something of a zero-sum game.
A trader loses a job at one place, goes somewhere else. Itmight dampen some of the enthusiasm for celebration at the end of the year. Ifyou've got a lot of customers that are concerned about their year-end bonuses,I don't think it's actually good business for an IDB to go out and throw a bigsplashy year-end Christmas party.
So, what Jim said about year-end entertainment, maybeactually the year-end entertainment might be a little more music this yearfrankly.
So we might not get the pop in entertainment expense thatJim suggested. But I think generally speaking, as I said before, we are in thesweet spot right now of a marketplace where there is good demand for thebusiness services that we offer.
Colin Heffron
Its Colin I want to add today. When we get these bigvolatility spikes likely we saw in July and August, what generally happens issome of our more structured products do take a step down, but we more than makeup in volume with the more liquid area of whatever particular business we'retalking about.
So say, for credit, some of the CDO stuff might be a littlequieter or the tranche stuff, but the single-name stuff and the index stuffreally takes off. And then, as things subside as they did in September, we sawsort of a general return of health to both sectors, and then obviously as wemade public today, significant growth in October.
So I think that if you were still in the game at the end ofAugust, you're starting to make a lot more money than you were previously.
Chris Donat - Sandler O’Neill
Okay. Just to make sure I understand what you're sayingthere, Colin, basically the more structure, the more exotic products, theliquidity dries up in volatile markets?
Colin Heffron
Yes, for the initial period, spreads get wide and you willsee people actually trade on those spreads anyway because they have to. Andthen they are cutting something out or taking away something, putting aposition away. The liquid stuff becomes very active during those times.
Chris Donat - Sandler O’Neill
Okay that’s That's all helpful. I guess last question,looking at October and it being a record month. Are you seeing any productshift from what you saw before, and I'm thinking particularly with energywithin oil being up over $90 a barrel. Does that help what had been sort ofslower sequential growth quarter for energy we saw in the third quarter?
Jim Peers
Generally, it has been across the board, all productsgrowing nicely. So we haven't seen any real shift.
Chris Donat - Sandler O’Neill
Thanks very much.
Operator
Your next question comes from the line of Chris Allen, ofBanc of America Securities.
Chris Allen - Banc of America Securities
Hi guys how are you doing.
Chris Giancarlo
Hey, Chris. How are you?
Chris Allen - Banc of America Securities
I apologize if I missed this earlier. Can we talk a littlebit about the comp to revenue ratio and the potential impact from theelectronic trading over the long-term?
Michael Gooch
I think that, over the long-term, the increased productivitythat should come from technology initiatives will help us improve our margin inthe comp ratio to revenues.
One of the things that I warned about a couple of quartersback was some of the pressure in the marketplace for brokerage staff that it'sjust part of that whole situation that we face where we're doing well and someof our competitors would like to emulate that and they imagine that they maybecan achieve it through the hiring of one or two of our staff.
What it's really doing for us is it's not causing us toreally have to go out and necessarily improve the pay packages that we havewith people, but certainly it just makes it a little bit more difficult toshift the needle to the Company's favor from a margin perspective.
And in one or two cases, one of the things that how we runour business is we do sign our employees to contracts. So there will betwo-year, three-year contracts. And if the rolling-off of the contract happensto coincide with the time frame where competitors are being particularly keento hire staff, it might cause us to pay a signing bonus for the contract.
In Jim's presentation on the numbers, we were actuallylooking at what I would call them disloyalty bonuses. The bonus that you pay tostaff on a retention basis to have them sort of renew a contract. So whereyou're paying a bonus to existing employees. And that number in the thirdquarter was up from the prior year, and those signing bonuses, whether they arein cash or RSUs, are then going to bleed into the compensation number as weamortize them over the two- or three-year life of the contract. And that it isgoing to continue to be a drag on that 62.8% compensation number.
But meanwhile, we are getting benefit at the other end wherewe are actually getting productivity improvements and getting the ability tomove the needle in the Company's favor. And of course, any time we have robustrevenues, that always helps the compensation margin. So it's sort of mixed.
Jim Peers
To give you a perspective on those numbers that Mickeyreferred to which I mentioned was payments in the third quarter last year were$3.1 million, and then this quarter, third quarter this year, they were $9.1million. So, almost a threefold increase.
Chris Allen - Banc of America Securities
Okay. And I think we chatted about this before a little bit.Have you guys started to impose a levy on some of your brokers for electronictrading as some of the areas have moved increasingly electronic?
Michael Gooch
Yes, that's what we're doing. It's a partnership. You haveto remember that our employees are actually on this conference call, so theissue is that it is a partnership. We are working together to improve themargins for the Company and also make their lives better too.
So, when we do establish a strong foothold with technologyand we consider it effectively glue that is going to glue our customers to thebusiness so that the franchise business with GFI is valuable relative to therelationship value of the individual broker, then we have an opportunity toimprove the margin for the Company, and we do do that.
That is when we do institute technology charges, increasedoverhead charges, just the small incremental steps for improving the margin.And I believe that over the next couple of years, we are going to see asignificant opportunity in that respect.
We are at the moment happening to be going through a periodwhere the same two competitors are out there aggressively trying to hire andsometimes I'm not sure if they're trying to hire our staff or just trying tomake our lives miserable by offering them jobs.
But they are out there and it just makes it more difficultto institute a technology charge. We have instituted a technology charge inEurope on credit derivatives where 55% or more of the trades are fullyelectronic and it might have been the catalyst that enabled Colin to get intotwo or three brokers and hire a few and get them to take the signing bonus,whatever it was that they were getting for going over there, because maybe theemployee thought that, wow, the Company's initiating a technology charge, andin another couple of years are not going to need me or something.
So, it's a very delicate balance. We work very hard atmanaging this. And frankly, I think we do a good job of it and I think we'rewinning. For example, in credit derivatives in London where we lost what wouldhave been considered the three highest-producing employees on the desk to acompetitor, and frankly the desk that they left, we just had a record month,and the revenues were up 58% year-over-year from prior October, and that iswithout the three supposed superstars that solid tired.
And without a trading system, they're going to find it verydifficult to really get any business done of any substantial significance whenthey, we're not sure when they're going to get revenue. We told Tollett, theycan start anytime they want and they could start tomorrow for all we carebecause we don't miss them.
And to some reason, Tollett doesn't want to start them. SoI'm not even sure what's going on around there. I think they may have bittenoff more than they can chew, but we'll see.
Colin Heffron
Can I just jump in for a second? It's Colin.
Michael Gooch
You got me off on my favorite subject.
Colin Heffron
Anytime we've introduced technology or a technology charge,we have seen a jump in market share. And also, all the people, first of all, itleads us to hire more people because the market share jump we grow ourbusiness. And also, the people on that desk make more money year-on-year. Soit's a win-win if you handle it correctly.
Chris Allen - Banc of America Securities
I guess the point is that, in some areas like with thetechnology charge, the market is pretty close to tipping over to almost allelectronic trading, right? And this is what we've heard from you guys and ICAPis why you're willing to let some of the brokers walk, so to speak, if theychoose not to participate in the increased volumes. Is that fair?
Michael Gooch
I don't think the market goes fully electronic. I think thatthere is always going to be value added from having well-qualified personnel onthe phone or on the IM or on the Bloomberg, however they want communicate withtheir customers assisting them in trades where liquidity or spread is aquestion.
But you're going to increasingly see the dealer communityembracing technology, not just the electronic trading side of it, but the STP.And we now are just at the stage now where we are beginning to have some of ourcustomers actually feed us live electronic feeds of their volatility services,which populates our screen with prices all day long.
When I was a broker on the desk, the hardest job was tryingto make sure that your bids and offers were constantly populated. And at thispoint, we're getting to the stage where customers are actually feeding that tous electronically.
And I have to tell you that one or two of our competitors,they do not have the technology to actually achieve that, and that's a hugecompetitive for the Company to have invested in that. We began that processback in 1999, and at this point have really got ahead of the curve.
Chris Allen - Banc of America Securities
Great. Thanks a lot, Gooch.
Operator
Your next question comes from the line of Barry Cohen ofKnott Partners.
Barry Cohen - Knott Partners
Good morning gentlemen, thanks for taking the call.
Michael Gooch
Good morning.
Barry Cohen - Knott Partners
Earlier in the call, you were talking about the credit,having spoken to some of your larger bank customers, and they were discussingthe credit derivative markets, could you parse for us maybe a little bit finer,when you say the credit derivatives markets, what you're referring to versuslet's say CDO issuance or things along those nature?
Michael Gooch
So, CDO issuance, obviously, that is dried up now. But at thesame time, there is a ton of the stuff out there that still needs to changehands. And interestingly, once it reaches that point, our services become quitevaluable because the participants in the marketplace need price discovery.
There was never a CDO issued again that eventually I guessyou would have a sort of drying up of all the derivatives that surround thatmarketplace. But we don't think that is going to be the case. I think that whatwill happen is the street will just become much more educated on how to valuethese things and the mechanisms will go into place to make that far moreefficient and you will end up with actually a very liquid and well establishedCDO market eventually.
Barry Cohen - Knott Partners
Okay. And what are you seeing now in terms of, can you giveus a better sense of the mechanisms for price discovery in the marketplace nowfor those that are trading?
Michael Gooch
In the liquid instruments that we're involved in, I don'tknow if you're just focusing on CDOs, but in the marketplaces that we'reinvolved in which goes across many categories -- energy, currencies -- it'shighly liquid.
There are bids and offers all day long for all of theinstruments. It's the edges where things get to be a little more exotic, thatmaybe it takes a little more time end effort to dig up the prizes. But we areseeing no slowdown in terms of the number of bids and offers that we're gettingacross the board in our products.
Barry Cohen - Knott Partners
Okay. Thank you very much for your help.
Michael Gooch
The next question will have to be our last question.
Operator
Okay and your final question comes from the line of RobertRutschow, of Deutsche Bank.
Rob Rutschow - Deutsche Bank
I apologize if addressed some of these already, but thefirst question was just related to M&A activity. You've been somewhat quiterecently, and so I'm wondering what the outlook is there?
Michael Gooch
I think that we have an appetite to do a transaction. I haven'tgot anything right now that I can go on the record to tell you that we have ineminently teed up, but we are actively in conversations. Internally, that is,with ourselves.
Rob Rutschow - Deutsche Bank
Okay great.
Michael Gooch
Internally that is with our source.
Rob Rutschow - Deutsche Bank
Okay and I am wondering about the North American revenues.It seems a little flatter then they seemed a little bit flatter than what yousaw in Europe and Asia on a linked-quarter basis. So I'm wondering what theunderlying trends were there?
Michael Gooch
I think that the North American business, it still has notadopted electronic trading, in credit as an example. And I think that as aresult of that, when the markets become more difficult, spreads get wider,prices become more difficult to attain.
I think that the technology-driven market has benefited muchmore. The other thing is, we are quite crowded in our office space here. It'sone of the reasons we're moving down the street to a space where it's going tobe state-of-the-art.
And we're going to be able to increase our headcount by 50%and our productivity hopefully by another 20%. And I think that maybe some ofthe opportunity to expand the North American revenues is partly a function ofthe fact that we really need to move into new office space.
So I think once we do move to that new office space, I thinkthat you're going to see that the North American revenues from our perspectivewill start to get into line growth wise with Europe and possibly Asia.
Asia, we're coming from a smaller start, so obviously theactual percentages look much bigger in Asia but we are like I say coming from asmaller start. It's easier to double $40 million of revenue than it is $400million. But I think that we are going to see improvement in the North Americangrowth rate.
Rob Rutschow - Deutsche Bank
Okay. You talked about a couple of key competitors that arecausing some of the pressure on personnel expenses. I'm wondering if there hasbeen any other smaller competitors that are building out that have causedpressure and whether you see them still building or leaving the market orstaying steady-state?
Michael Gooch
There's no pressure coming from any small competitors.
Rob Rutschow - Deutsche Bank
Okay the other question I had was related to the pricing.You talked about slower markets allows you to add expertise to get transactionsdone. Is there interplay there between the expertise that you had and thepricing that you're able to charge?
Michael Gooch
We could put the prices up. Some people have suggested to methat in some of the more esoteric end of credit market since the spreads are sowide, we should actually be increasing our commission rate. We are not doingthat. I don't think that the commission rate is a function of the level ofexpertise.
I think the commission rate is a function of volumes andspreads. And so to simply answer your question, I don't think there's acorrelation.
Rob Rutschow - Deutsche Bank
Okay that’s helpful, I guess if I could ask one morequestion. Could you just talk about and you may have already addressed this butjust the underlying trends in terms of the types of derivatives index versussingle name in Europe and U.S. this quarter and what you have seen recently?
Michael Gooch
We haven't seen any real change. I think it has become alittle less liquid in some of the more exotic charge into the market, but thesingle name business has always been something of a function of whatever is hotthat day or whatever particular sector, whether it's the builders or whetherit's the financial sector. It has been pretty broad, the general activity inthe last quarter.
Rob Rutschow - Deutsche Bank
Okay, thank you.
Chris Giancarlo
Grace Ann, this concludes our third quarter 2007 earningsconference call. Thank you, everyone, for joining in.
Operator
Thank you for your participation in today's conference. Thisconcludes the presentation and you may now disconnect.
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