"Instinet's first quarter results reflect the challenging operating environment," said Mark Nienstedt, Acting President & CEO, and Chief Financial Officer, Instinet Group Incorporated. "While transaction fee revenues and operating earnings were affected by market share declines and lackluster market volumes along with our price reductions, we believe the actions we have taken are improving our competitive position. Our market share has increased recently, and we are on schedule with our cost restructuring. We expect this will lead to improved financial performance in the second half of 2002," he said.
Business Highlights
- Customers executed 15.2 billion U.S. equity shares through Instinet in the first quarter of 2002, consisting of 12.0 billion Nasdaq-listed shares and 3.1 billion exchange-listed shares. This compares to 22.7 billion, 20.1 billion and 2.7 billion shares respectively in the first quarter of 2001.
- Instinet's market share of Nasdaq-listed volume was 11.0% in the first quarter, compared to 11.7% in the previous quarter and 15.1% in the first quarter of 2001. Market share of exchange-listed volume was 3.0% in the first quarter, compared to 3.2% in the previous quarter, and 3.0% in the first quarter of 2001. For April month-to-date, Instinet's shares of Nasdaq-listed volume and exchange-listed volume are 12.3% and 2.8% respectively.
- Instinet's annualized fixed-cost base in the first quarter of 2002 was 25% below its level in the first quarter of 2001, at $746 million compared to $994 million. The fixed-cost base excludes non-operating expenses (restructuring costs and goodwill impairment) and variable costs (soft dollar and commission recapture, broker-dealer rebates and brokerage, clearing and exchange fees).
- Instinet continued to develop its core trading technology. Deployment of two new trading applications - Instinet Trading Portal, for active asset managers and hedge funds, and patent-pending NewportTM, for passive and quantitative fund managers - is on schedule.
Revenues
Transaction fee revenue for the first quarter was $267.0 million, down 36% from $415.5 million in the comparable period in 2001. Net of soft dollar and commission recapture expenses, and commission rebates to broker-dealers, first quarter transaction fee revenues declined 42% from the first quarter of 2001. Net revenue from U.S. equity transactions decreased 44% from the first quarter of 2001 due to the combination of an 18% decrease in Instinet's average pricing, a contraction in our Nasdaq market share, and a 15% decline in average daily volume in the Nasdaq market overall. Net revenue from non-U.S. equities decreased 34%, and represented approximately 19% of net transaction revenues in the first quarter, compared to 17% in the year-ago quarter.
Interest income for the first quarter was $9.1 million, down 29% from the comparable period in 2001, mainly as a result of a decline in interest rates. During the quarter, Instinet recorded a net investment loss of $5.7 million, compared with a net gain of $2.4 million in the comparable period in 2001. The investment loss was in large part due to a write-off of our investment in Vencast, Inc. This company, which used the Internet to facilitate capital-raising for the private equity industry, terminated operations during the first quarter.
Expenses
Instinet's total expenses for the first quarter were $315.0 million. Excluding the restructuring and goodwill impairment charges, first quarter operating costs were $280.9 million, approximately 18% below the first quarter of 2001. The decrease in expense levels was primarily due to our cost-reduction initiatives. Compensation and benefits expense fell 31% to $92.2 million compared to $133.8 million in the first quarter of 2001. The decrease primarily reflected a decline in headcount to 1,937 at the end of the first quarter of 2002 from 2,267 at the end of the first quarter of 2001, as well as lower levels of incentive compensation. Communication and equipment expense fell by 22% to $35.5 million compared to $45.4 million in the first quarter of 2001, reflecting efforts to gain network and systems efficiencies. Soft dollar and commission recapture costs fell 4% to $54.6 million from $56.1 million in the first quarter of 2001, but increased as a percentage of total revenues to 20% from 13%. The discretionary spending areas of professional fees and marketing and business development both fell by over 60% compared to the year-ago quarter. Occupancy costs were $14.2 million, or 30% higher than in the first quarter of 2001, primarily due to our move to new headquarters in Times Square, New York, in May 2001.
Broker-dealer rebates were $3.3 million. This new expense category records commission rebates offered under Instinet's new broker-dealer pricing plan, which was instituted on March 12, 2002.
Instinet incurred a charge of $19.0 million related to the write-down of the carrying value of goodwill related to businesses acquired. Pursuant to SFAS 142, as of January 1, 2002 the company stopped recording an annual charge of approximately $8 million related to the amortization of existing goodwill. Instinet incurred a $15.0 million pre-tax restructuring charge in the first quarter in connection with its previously announced cost-reduction program.
Fixed Income
Instinet has decided to close its fixed income electronic brokerage business. To permit the orderly termination of customer trading, the service will operate through Friday, May 3. The company began developing its fixed income business in 1998, and started trading in the spring of 2000. This decision has been taken against the background of a global economic slowdown and the uneven pace of acceptance of electronic fixed income trading platforms. The fixed income business had 107 employees at the end of March 2002. As a result of closing this business, Instinet is expected to incur a charge of $15 million-$20 million, and realize a net annual cost saving of approximately $37 million.
Business Review
During the first quarter, Instinet continued to develop its technology, pricing and service options. "Our aim is to provide solutions that improve our clients' performance," said Jean-Marc Bouhelier, Chief Operating Officer of Instinet Group Incorporated. "We are working with our customers to craft products that reflect actual needs. We believe our initiatives are gaining market acceptance, and will contribute to future revenues and margin growth," he said.
In March, Instinet introduced a new service initiative for U.S. broker-dealer customers that includes faster response times, enhanced functionality, reduced fees for taking liquidity and rebates offered for providing liquidity. These actions were designed to stimulate growth in Instinet's Nasdaq liquidity. The first two weeks of April constituted Instinet's best period for Nasdaq market share in the past six months.
Instinet continued to improve its core trading functionality to enhance traders' ability to execute large share blocks cost-efficiently. The company also made considerable progress in deploying its new Direct-FIX technology, an upgrade that offers flexible order-management, fast response times and access to external global liquidity pools for both institutional and sell-side customers. Instinet has switched more than 40 clients to its new connectivity model, and is targeting an additional 90 clients by the end of the second quarter of 2002. Instinet Trading Portal, the new trading application primarily for active asset managers and hedge funds, successfully went through its first major round of beta testing during the first quarter, and is expected to move to production rollout in the second half of 2002. The application's Internet-based deployment strategy is designed to substantially reduce communication and field service costs associated with the traditional client-site model. Twenty customers were using Portal by the end of the first quarter, and Instinet expects to have 50 installed clients by mid-year.
Patent-pending NewportTM , a program-trading solution aimed primarily at passive and quantitative fund managers, which combines global liquidity with sophisticated trading analytics and support for collaboration, was being used by four beta clients in the U.S. and Europe by the end of the quarter. Newport is expected to go into full production deployment in the second half of the year.
Cost Reduction
Instinet continued to implement its cost-reduction program. As previously announced, this program is intended to reduce fixed operating costs by reducing staff levels and related occupancy costs, improving system and network efficiencies, and restructuring non-core businesses. "We aim to meet or exceed the $120 million cost-reduction target we announced last month," Nienstedt said. This target includes the planned shutdown of Instinet's fixed income business.
During the first quarter, the company incurred a pre-tax restructuring charge of $15 million in connection with the cost-reduction program, and expects to incur an additional pre-tax charge of approximately $40 million during the second quarter.
Commenting on Instinet's outlook for 2002, Nienstedt said: "Our cost-reduction program is on schedule, our technology and trading product rollouts are proceeding well, and we have seen recent gains in market share. We believe these actions, and the alignment of our products and services more directly with our clients' needs, will strengthen Instinet's competitive position and improve our financial performance."
