<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
001-14223
COMMISSION FILE NUMBER
KNIGHT/TRIMARK GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction
of incorporation or organization)
52-2096335
(I.R.S. Employer
Identification Number)
525 Washington Boulevard, Jersey City, NJ 07310
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (201) 222-9400
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days, Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
At May 13, 1999 the number of shares outstanding of the registrant's Class A
common stock was 52,866,904 and the number of shares outstanding of the
registrant's Class B common stock was 2,592,698.
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
FORM 10-Q QUARTERLY REPORT
For the Quarter Ended March 31, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
PART I FINANCIAL INFORMATION:
Item 1. Financial Statements........................................ 3
Consolidated Statements of Income........................... 3
Consolidated Statements of Financial Condition.............. 4
Consolidated Statements of Cash Flows....................... 5
Notes to Consolidated Financial Statements.................. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk.. 15
PART II OTHER INFORMATION:
Item 1. Legal Proceedings........................................... 16
Item 2. Changes in Securities and Use of Proceeds................... 16
Item 3. Defaults Upon Senior Securities............................. 16
Item 4. Submission of Matters to a Vote of Security Holders......... 16
Item 5. Other Information........................................... 16
Item 6. Exhibits and Reports on Form 8-K............................ 16
Signatures
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
KNIGHT/TRIMARK GROUP, INC.
Consolidated Statements of Income
(unaudited)
<TABLE>
<CAPTION>
For the three months ended March 31,
-------------------------------------
1999 1998
------------------ ------------------
<S> <C> <C>
Revenues
Net trading revenue.................... $ 178,550,421 $ 62,967,499
Commissions and fees................... 2,527,182 39,066
Interest, net.......................... 1,586,533 525,651
------------------ -----------------
Total revenues....................... 182,664,136 63,532,216
------------------ -----------------
Expenses
Employee compensation and benefits..... 57,292,284 16,168,160
Payments for order flow................ 32,427,827 16,256,518
Execution and clearance fees........... 17,957,167 10,240,677
Communications and data processing..... 3,939,054 2,169,675
Depreciation and amortization.......... 1,951,291 1,291,164
Occupancy and equipment rentals........ 1,823,889 1,081,542
Professional fees...................... 1,058,827 262,746
Business development................... 660,487 376,850
Interest on Preferred Units............ -- 416,486
Other.................................. 828,881 484,692
------------------ -----------------
Total expenses....................... 117,939,707 48,748,510
------------------ -----------------
Income before income taxes............... 64,724,429 14,783,706
Income tax expense....................... 27,317,554 --
------------------ -----------------
Net income............................... $ 37,406,875 $ 14,783,706
================== =================
Basic earnings per share................. $ 0.70 $ 0.35
================== =================
Diluted earnings per share............... $ 0.67 $ 0.35
================== =================
Pro forma adjustment (Notes 5 and 6):
Income before income taxes............. $ 14,783,706
Pro forma income tax expense........... 6,356,994
-----------------
Pro forma net income................. $ 8,426,712
=================
Pro forma basic earnings per share....... $ 0.20
=================
Pro forma diluted earnings per share..... $ 0.20
=================
Shares used in basic earnings per share
calculation............................. 53,801,736 42,801,636
================== =================
Shares used in diluted earnings per share
calculation............................. 55,786,025 42,801,636
================== =================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
Consolidated Statements of Financial Condition
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------ ------------
(unaudited)
<S> <C> <C>
Assets
Cash and cash equivalents............................ $251,228,271 $117,381,556
Securities owned, at market value.................... 97,403,167 100,476,151
Receivable from clearing brokers..................... 83,981,104 107,503,274
Fixed assets and leasehold improvements, at cost,
less accumulated depreciation....................... 11,684,273 12,014,991
Goodwill, less accumulated amortization.............. 16,924,297 16,036,859
Other assets......................................... 10,258,811 5,447,544
------------ ------------
Total assets..................................... $471,479,923 $358,860,375
============ ============
Liabilities and Stockholders' Equity
Liabilities
Securities sold, not yet purchased, at market
value............................................. $ 72,220,537 $108,909,217
Short term borrowings.............................. -- 10,000,000
Accrued compensation expense....................... 28,626,766 16,529,004
Accrued execution and clearance fees............... 7,431,620 6,898,095
Accrued payments for order flow.................... 10,526,616 8,672,668
Accounts payable, accrued expenses and other
liabilities....................................... 5,767,423 5,445,112
Income taxes payable............................... 28,257,193 2,285,620
------------ ------------
Total liabilities................................ 152,830,155 158,739,716
------------ ------------
Stockholders' equity
Class A Common Stock, $0.01 par value, 200,000,000
shares authorized; 52,856,904 and 49,062,184
shares issued and outstanding at March 31, 1999
and December 31, 1998, respectively............... 528,569 490,622
Class B Common Stock, $0.01 par value, 20,000,000
shares authorized; 2,592,698 and 3,942,698 shares
issued and outstanding at March 31, 1999 and
December 31, 1998, respectively................... 25,927 39,427
Additional paid-in capital......................... 250,877,716 169,779,929
Retained earnings.................................. 67,217,556 29,810,681
------------ ------------
Total stockholders' equity....................... 318,649,768 200,120,659
------------ ------------
Total liabilities and stockholders' equity....... $471,479,923 $358,860,375
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
For the three months ended March 31,
--------------------------------------
1999 1998
------------------ ------------------
<S> <C> <C>
Cash flows from operating activities
Net income............................. $ 37,406,875 $ 14,783,706
Adjustments to reconcile net income to
net cash provided by operating
activities
Noncash items included in net income
Depreciation and amortization........ 1,951,291 1,291,164
Deferred income taxes................ (1,305,166) --
(Increase) decrease in operating assets
Securities owned..................... 3,072,984 (1,764,008)
Receivable from clearing brokers..... 23,522,170 (47,967,433)
Other assets......................... (3,506,100) (732,532)
Increase (decrease) in operating
liabilities
Securities sold, not yet purchased... (36,688,680) 33,520,287
Accrued compensation expense......... 12,097,762 1,828,418
Accrued execution and clearance
fees................................ 533,525 (176,679)
Accrued payments for order flow...... 1,853,948 1,514,006
Accounts payable, accrued expenses
and other liabilities............... 322,311 218,282
Interest payable on Preferred Units.. -- (8,494)
Income taxes payable................. 25,971,573 --
------------------ -----------------
Net cash provided by operating
activities........................ 65,232,493 2,506,717
------------------ -----------------
Cash flows from investing activities
Payment of contingent consideration.... (1,618,686) (710,086)
Purchases of fixed assets and leasehold
improvements.......................... (889,325) (1,685,469)
------------------ -----------------
Net cash used in investing
activities........................ (2,508,011) (2,395,555)
------------------ -----------------
Cash flows from financing activities
Repayment of short-term loan........... (10,000,000) --
Decrease in liability for capital
lease................................. -- (73,594)
Net proceeds from issuance of common
stock................................. 80,606,183 --
Stock options exercised................ 290,000 --
Federal income tax credit--stock
options............................... 226,050 --
Distributions on Common Units.......... -- (8,405,326)
------------------ -----------------
Net cash provided by (used in)
financing activities.............. 71,122,233 (8,478,920)
------------------ -----------------
Increase (decrease) in cash and cash
equivalents........................... 133,846,715 (8,367,758)
Cash and cash equivalents at beginning
of period............................. 117,381,556 13,797,198
------------------ -----------------
Cash and cash equivalents at end of
period................................ $ 251,228,271 $ 5,429,440
================== =================
Supplemental disclosure of cash flow
information:
Cash paid for interest............. $ 515,436 $ 432,648
================== =================
Cash paid for income taxes......... $ 2,454,458 $ --
================== =================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
(Unaudited)
1. Organization and Description of the Business
Knight/Trimark Group, Inc. ("Knight/Trimark") was organized in April 1998 as
the successor to the business of Roundtable Partners, L.L.C. ("Roundtable")
(hereafter, references to the "Company" refer to Knight/Trimark or Roundtable,
as appropriate) and to own and operate the securities market-making businesses
of its wholly-owned subsidiaries, Knight Securities, Inc. ("Knight") and
Trimark Securities, Inc. ("Trimark").
The Company operates in one segment and line of business--equity securities
market-making. Knight operates as a market maker in over-the-counter equity
securities ("OTC securities"), primarily those traded in the Nasdaq stock
market and on the OTC Bulletin Board. Trimark operates as a market maker in
the over-the-counter market for equity securities that are listed on the New
York and American Stock Exchanges ("listed securities"). Knight and Trimark
are registered as broker-dealers with the Securities and Exchange Commission
("SEC") and are members of the National Association of Securities Dealers,
Inc. ("NASD").
The accompanying unaudited consolidated financial statements include the
accounts of the Company, Knight and Trimark and, in the opinion of management,
reflect all adjustments, consisting only of normal recurring adjustments,
necessary for a fair statement of the results for the interim periods. All
significant intercompany transactions and balances have been eliminated.
Certain footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to SEC rules and regulations, although the
Company believes that the disclosures are adequate to make the information
presented not misleading. The nature of the Company's business is such that
the results of an interim period are not necessarily indicative of the results
for the full year. These consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's audited financial statements as of December 31, 1998 included in the
Company's Report on Form 10-K as filed with the SEC.
Certain prior period amounts have been reclassified to conform to the
current period presentation.
2. Reorganization of the Company, Initial Public Offering, Follow-on Offering
and Stock Split
Concurrent with the closing of the initial public offering of the Company's
Common Stock, based on the initial public offering price of $14.50 per share,
all of the member interests of Roundtable were exchanged for 36,662,415 shares
of Class A Common Stock of the Company and 3,942,698 shares of nonvoting Class
B Common Stock of the Company. In connection with the exchange, Knight became
the successor entity to Knight Securities, L.P., and Trimark became the
successor entity to Trimark Securities, L.P. (the foregoing transactions,
collectively, shall be referred to herein as the "Reorganization").
The initial public offering of 11,500,000 shares of Class A Stock included
10,188,246 newly-issued shares and 1,311,754 shares from a selling
shareholder. Proceeds received by the Company from the initial public
offering, net of the applicable underwriting discounts and offering expenses,
were approximately $136.5 million.
On February 25, 1999 a Registration Statement on Form S-1 (No. 333-71559)
was declared effective by the SEC, pursuant to which 9,000,000 shares of Class
A common stock were offered and sold at a price to the public of $35.00 per
share. Of those shares, 2,424,720 were sold by Knight/Trimark, generating
gross offering proceeds of approximately $84.9 million, and an additional
6,575,280 were sold by selling shareholders, generating gross offering
proceeds to the selling shareholders of approximately $230.1 million. The net
proceeds to Knight/Trimark from the sales of the 2,424,720 shares of Class A
common stock offered by Knight/Trimark were approximately $80.3 million after
deducting underwriting discounts and commissions of $3.6 million, or $1.505
per share, and estimated offering expenses of $950,000. Certain selling
shareholders granted the underwriters a
6
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 1999
(Unaudited)
30-day option to purchase up to an additional 1,350,000 shares of Class A
common stock to cover over-allotments. That option was exercised in full on
March 18, 1999.
In April 1999, the Company's Board of Directors approved a two-for-one stock
split of the Company's Class A and Class B Common Stock. Shareholders of
record as of the close of business on April 30, 1999 will receive, in the form
of a stock dividend, one additional share for each share held by them. On May
14, 1999, the transfer agent will distribute the additional shares. The
financial information included within this filing does not reflect the effects
of this stock split. Had such split been considered, diluted earnings per
share for the three months ended March 31, 1999 and pro forma diluted earnings
per share for the three months ended March 31, 1998 would have been
approximately $0.34 and $0.10, respectively.
The Company also has authorized 20,000,000 shares of Preferred Stock, par
value $.01 per share. As of March 31, 1999, no shares of Preferred Stock have
been issued.
3. Short-term Financing
On June 19, 1998, the Company entered into an unsecured $30.0 million loan
agreement with an affiliate of one of its clearing brokers. Such loan paid
interest monthly based on the London Interbank Offered Rate and was to mature
on June 19, 1999. The loan agreement allowed for scheduled principal pre-
payments without penalty. During 1998, the Company made principal pre-payments
under the loan of $20.0 million. On January 19, 1999, the Company repaid the
final $10.0 million.
4. Related Party Transactions
Before the Reorganization and initial public offering, Roundtable was owned
by a consortium of 31 independent securities firms and investors (the "Broker
Dealer Owners"). Under Roundtable's limited liability company agreement, the
Broker Dealer Owners, who were considered affiliated companies, shared in
Roundtable's profits in proportion to their equity interests and the quantity
of order flow they directed to the Company. After the initial public offering,
this profit sharing practice has been discontinued and, while some of the
Broker Dealer Owners still own common stock in the Company, these Broker
Dealer Owners do not receive any special inducement to provide the Company
with order flow.
Subsequent to the initial public offering, the Company considers affiliates
to be holders of 5% or more of the Company's outstanding common stock
("Affiliates"). As of March 31, 1999 there were two Affiliates of the Company.
As measured in share volume, the Affiliates represented 12% and 11% of the
Company's order flow, respectively.
Included within payments for order flow on the Consolidated Statements of
Income for the three months ended March 31, 1999 is $11,547,595 related to
Affiliates. Additionally, included within payments for order flow on the
Consolidated Statements of Income for the three months ended March 31, 1998 is
$11,313,265 related to the Broker-Dealer Owners.
As of January 1, 1998, Knight and Trimark cleared their securities
transactions through clearing brokers which owned equity interests in the
Company. Effective March 9, 1998, Knight began clearing its securities
transactions through an unaffiliated clearing broker. Included within
execution and clearance fees on the Consolidated Statement of Income for the
three months ended March 31, 1999 is $8,598,889 related to an Affiliate.
Additionally, included within execution and clearance fees on the Consolidated
Statement of Income for the three months ended March 31, 1998 is $7,579,469
related to the Broker-Dealer Owners.
Through August 1998, the Company leased certain computer and telephone
equipment and furniture from a leasing company which is wholly owned by two
key employees of Trimark. Rental expense under such leases for the three
months ended March 31, 1998 amounted to $117,644.
7
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
March 31, 1999
(Unaudited)
5. Income Taxes
The Company and its subsidiaries file a consolidated federal income tax
return. Before the Reorganization, Roundtable was a limited liability company
and was not subject to federal or state income taxes. Subsequent to the
Reorganization, the Company is subject to federal income taxes and state
income taxes in New York, New Jersey and other states.
Pro forma income represents net income adjusted to reflect pro forma income
taxes as if the Company was a C Corporation for the three months ended March
31, 1998.
6. Earnings per Share
Basic earnings per share has been calculated by dividing net income by the
sum of the weighted average shares of Class A Common Stock and Class B Common
Stock outstanding during each respective period. The diluted earnings per
share calculation includes the effect of dilutive stock options, as calculated
under the treasury stock method. All shares of Class B Common Stock, which are
non-voting, are held by a single Affiliate. Except for voting rights, the
Class B Common Stock has identical rights and rewards as the Class A Common
Stock and must be automatically converted to Class A Common Stock in the event
of a sale or a transfer by the current owner.
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations:
<TABLE>
<CAPTION>
Three months ended Three months ended
March 31, 1999 March 31, 1998
------------------------- -------------------------
Numerator / Numerator / Denominator /
net Denominator / pro forma pro forma
income shares income shares
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Shares and income used in
primary calculations..... $37,406,875 53,801,736 $8,426,712 42,801,636
Effect of dilutive stock
options.................. -- 1,984,289 -- --
----------- ---------- ---------- ----------
Shares and income used in
diluted calculations..... $37,406,875 55,786,025 $8,426,712 42,801,636
=========== ========== ========== ==========
Basic earnings per share.. $ 0.70 $ 0.20
========== ==========
Diluted earnings per
share.................... $ 0.67 $ 0.20
========== ==========
</TABLE>
Pro forma shares outstanding for the three months ended March 31, 1998 has
been determined as if the Reorganization described in Note 2 occurred as of
January 1, 1998.
7. Net Capital Requirements
As registered broker-dealers and NASD member firms, Knight and Trimark are
subject to the SEC's Uniform Net Capital Rule (the "Rule") which requires the
maintenance of minimum net capital. Knight and Trimark have elected to use the
basic method, permitted by the Rule, which requires that they each maintain
net capital equal to the greater of $1.0 million or 6 2/3% of aggregate
indebtedness, as defined.
At March 31, 1999, Knight had net capital of $119,698,385, which was
$115,501,900 in excess of its required net capital of $4,196,485 and Trimark
had net capital of $31,722,125 which was $30,637,047 in excess of its required
net capital of $1,085,078.
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion of the results of operations of the Company should
be read in conjunction with the consolidated financial statements and notes
thereto included in the Company's audited financial statements as of December
31, 1998 included within our report on Form 10-K.
We are the leading market maker in Nasdaq securities, other OTC equity
securities, and NYSE- and AMEX-listed equity securities in the Third Market.
Through our wholly-owned subsidiary, Knight, we make markets in over 6,900
equity securities in Nasdaq and on the NASD's OTC Bulletin Board. Through our
wholly-owned subsidiary, Trimark, we make markets in all NYSE- and AMEX-listed
equity securities in the Third Market.
Knight commenced Nasdaq and OTC securities market-making operations on July
24, 1995. Based on rankings published by The AutEx Group, a widely recognized
industry reporting service that publishes daily trading volume and market
share statistics reported by broker-dealer market makers, Knight was ranked
first in AutEx's Nasdaq/OTC Securities rankings, with a 15.04% market share
during March 1999. Knight's share volume totaled 12.1 billion and 5.0 billion,
or 75.8% and 67.2% of our total share volume, for the three months ended March
31, 1999, and 1998, respectively. Trimark has held the #1 market share ranking
in trading of NYSE- and AMEX-listed securities in the Third Market for over
two years. Trimark's share volume totaled 3.9 billion and 2.4 billion, or
24.2% and 32.8% of our total share volume for the three months ended March 31,
1999 and 1998, respectively.
Revenues
Our revenues consist principally of net trading revenue from market-making
activities. To date, we have only traded equity securities, and have never
traded in options, futures, forwards, swaps or other derivative instruments.
Net trading revenue, which represents trading gains net of trading losses, is
primarily affected by changes in trade and share volumes from customers, our
ability to derive trading gains by taking proprietary positions primarily to
facilitate customer transactions and, most recently, by regulatory changes and
evolving industry customs and practices. Our net trading revenue per trade for
OTC securities has historically exceeded the net trading revenue per trade for
listed securities.
In addition, we have expanded our focus on sales to institutional customers.
OTC securities transactions with institutional customers are executed as
principal, and all related profits and losses are included within net trading
revenue. Listed securities transactions with institutional customers are
executed on an agency basis, for which we earn commissions on a per share
basis. We also receive fees for providing certain information to market data
providers. Commissions and fees are primarily affected by changes in our trade
and share volumes in listed securities.
We also earn interest income from our cash and securities positions held at
banks and in trading accounts at clearing brokers, net of transaction-related
interest charged by clearing brokers for facilitating the settlement and
financing of securities sold, not yet purchased, and interest on subordinated
notes and short-term debt. Interest, net is primarily affected by the changes
in cash balances held at banks and clearing brokers, and the level of
securities sold, not yet purchased.
Expenses
Our operating expenses largely consist of employee compensation and
benefits, payments for order flow and execution and clearance fees. A
substantial portion of these expenses is variable in nature. Employee
compensation and benefits expense, which is largely profitability based,
fluctuates, for the most part, based on changes in net trading revenue and our
profitability. Payments for order flow fluctuate based on share volume, the
mix of market orders and limit orders and the mix of orders received from
broker-dealers compared to other institutional customers. Execution and
clearance fees fluctuate primarily based on changes in trade and share volume,
the mix of trades of OTC securities compared to listed securities and the
clearance fees charged by clearing brokers.
9
<PAGE>
Employee compensation and benefits expense primarily consists of salaries
and wages paid to administrative and customer service personnel and
profitability based compensation, which includes compensation and benefits
paid to market-making and sales personnel based on their individual
performance, and incentive compensation paid to all other employees based on
our overall profitability. Profitability based compensation represented 86%
and 72% of total employee compensation and benefits expense for the three
months ended March 31, 1999 and 1998, respectively. We have grown from 337
employees at March 31, 1998 to 502 employees as of March 31, 1999.
Approximately 80% of our employees are directly involved in market-making,
sales or customer service activities. Compensation for employees engaged in
market making and sales activities, the largest component of employee
compensation and benefits, is determined primarily based on a percentage of
gross trading profits net of expenses including related payments for order
flow, execution and clearance costs and overhead allocations. Employee
compensation and benefits will, therefore, be affected by changes in payments
for order flow, execution and clearance costs and the costs we allocate to
employees engaged in market making and sales activities.
Payments for order flow represent customary payments to broker-dealers, in
the normal course of business, for directing their order flow to us. We only
pay broker-dealers for orders which provide us with a profit opportunity. For
example, we make payments on market orders, but do not pay on limit orders.
Execution and clearance fees primarily represent clearance fees paid to
clearing brokers for OTC and listed securities, transaction fees paid to
Nasdaq, and execution fees paid to third parties, primarily for executing
trades in listed securities on the NYSE and AMEX and for executing orders
through electronic communications networks, commonly referred to as ECNs.
Execution and clearance fees are higher for listed securities than for OTC
securities. Due to our significant growth in share and trade volume, we have
been able to negotiate favorable rates and volume discounts from clearing
brokers and providers of execution services. As a result of these lower rates
and discounts and the increase in trade volume of OTC securities as a
percentage of total trade volume, execution and clearance fees per trade have
decreased.
Communications and data processing expense primarily consists of costs for
obtaining stock market data and telecommunications services.
Depreciation and amortization expense results from the depreciation of fixed
assets purchased by us or financed under a capital lease, and the amortization
of goodwill, which includes contingent consideration resulting from the
acquisition of the listed securities market-making businesses of Trimark and
Tradetech Securities, L.P., which we acquired in November 1997.
Occupancy and equipment rentals expense primarily consists of rental
payments on office and equipment leases.
Professional fees primarily consist of fees paid to computer programming and
systems consultants, as well as legal fees and other professional fees.
Business development expense primarily consists of marketing expenses,
including travel and entertainment and promotion and advertising costs.
Interest on Preferred Units represents required interest payments on our
Mandatorily Redeemable Preferred A and B Units at a rate approximating the
Federal Funds rate. All Preferred Units were redeemed during 1998.
Other expenses primarily consist of administrative expenses and other
operating costs incurred in connection with our business growth, as well as
directors fees.
Income Tax
Prior to our initial public offering, we were a limited liability company
and were not subject to federal or state income taxes. Subsequent to our
reorganization from a limited liability company to a corporation, which
occurred immediately before the closing of our initial public offering, we
became subject to federal income taxes and state income taxes in New York, New
Jersey and other states.
10
<PAGE>
Results of Operations
Three Months Ended March 31, 1999 and 1998
Revenues
Net trading revenue increased 183.6% to $178.6 million for the three months
ended March 31, 1999, from $63.0 million for the comparable period in 1998.
This increase was primarily due to higher trading volume and increased
efficiency in our trading methodologies. Total trade volume increased 146.9%
to 18.7 million trades for the three months ended March 31, 1999, from 7.6
million trades for the comparable period in 1998. Total share volume increased
115.3% to 15.9 billion shares traded for the three months ended March 31,
1999, from 7.4 billion shares traded for the comparable period in 1998.
Average net revenue per trade increased 14.8% to $9.55 per trade for the three
months ended March 31, 1999, from $8.32 per trade for the comparable period in
1998, principally as a result of increased efficiency in our trading
methodologies.
Commissions and fees increased to $2.5 million for the three months ended
March 31, 1999, from $39,000 for the comparable period in 1998. This increase
is primarily due to higher trade and share volumes from institutional
customers in listed securities and the receipt of fees for providing certain
information to market data providers.
Interest, net increased 201.8% to $1.6 million for the three months ended
March 31, 1999, from $526,000 for the comparable period in 1998. This increase
was primarily due to larger cash balances held at banks and our clearing
brokers, which was offset in part by increased transaction-related interest
expense resulting from a higher level of securities sold, not yet purchased.
Expenses
Employee compensation and benefits expense increased 254.4% to $57.3 million
for the three months ended March 31, 1999, from $16.2 million for the
comparable period in 1998. As a percentage of net trading revenue, employee
compensation and benefits expense increased to 32.1% for the three months
ended March 31, 1999, from 25.7% for the comparable period in 1998. The
increase on a dollar basis was primarily due to increases in gross trading
profits and growth in the number of employees. The increase as a percentage of
net trading revenue was primarily due to increased profitability, and
decreases in both payments for order flow and execution and clearance costs as
percentages of revenue. Due to increased net trading revenue and
profitability, profitability based compensation increased 324% to $49.3
million for the three months ended March 31, 1999, from $11.6 million for the
comparable period in 1998. The number of employees increased to 502 employees
as of March 31, 1999, from 337 employees as of March 31, 1998.
Payments for order flow increased 99.5% to $32.4 million for the three
months ended March 31, 1999, from $16.3 million for the comparable period in
1998. As a percentage of net trading revenue, payments for order flow
decreased to 18.2% for the three months ended March 31, 1999 from 25.8% for
the comparable period in 1998. The increase in payments for order flow on a
dollar basis was primarily due to a 115.3% increase in shares traded for the
three months ended March 31, 1999 to 15.9 billion shares, up from 7.4 billion
for the comparable period in 1998. The decrease in payments for order flow as
a percentage of net trading revenue resulted from increased profitability on a
per trade basis and growth in our institutional business.
Execution and clearance fees increased 75.4% to $18.0 million for the three
months ended March 31, 1999, from $10.2 million for the comparable period in
1998. As a percentage of net trading revenue, execution and clearance fees
decreased to 10.1% for the three months ended March 31, 1999 from 16.3% for
the comparable period in 1998. The increase on a dollar basis was primarily
due to a 146.9% increase in trades for the three months ended March 31, 1999,
which was offset, in part, by a decrease in clearance rates charged by
clearing brokers, and growth in the volume of OTC securities transactions,
which have lower execution costs than transactions in listed securities. The
decrease in execution and clearance fees as a percentage of net trading
11
<PAGE>
revenue was primarily due to the decrease in clearance rates charged by
clearing brokers, and growth in the volume of OTC securities transactions.
Communications and data processing expense increased 81.6% to $3.9 million
for the three months ended March 31, 1999, from $2.2 million for the
comparable period in 1998. This increase was generally attributable to higher
trading volumes and an increase in the number of employees.
Depreciation and amortization expense increased 51.1% to $2.0 million for
the three months ended March 31, 1999, from $1.3 million for the comparable
period in 1998. This increase was primarily due to the purchase of
approximately $889,000 of additional fixed assets and leasehold improvements
during the three months ended March 31, 1999 and the amortization of goodwill
related to the acquisition of the listed securities market-making businesses
of Trimark and Tradetech.
Occupancy and equipment rentals expense increased 68.6% to $1.8 million for
the three months ended March 31, 1999, from $1.1 million for the comparable
period in 1998. This increase was primarily attributable to additional office
space and increased computer equipment lease expense. We occupied 83,588
square feet of office space at March 31, 1999, up from 75,768 square feet of
office space at March 31, 1998.
Professional fees increased 303.0% to $1.1 million for the three months
ended March 31, 1999, up from $263,000 for the comparable period in 1998. This
increase was primarily due to increased consulting expenses related to our
investments in technology, as well as legal fees and other professional fees.
Business development expense increased 75.3% to $660,000 for the three
months ended March 31, 1999, from $377,000 for the comparable period in 1998.
This increase was primarily the result of higher travel and entertainment
costs consistent with the growth in our business and our increased focus on
the institutional sales business.
Interest on Preferred Units was zero for the three months ended March 31,
1999, and $416,000 for the comparable period in 1998. This decrease is due to
our redemption of all of the remaining Preferred A and B Units during 1998.
Other expenses increased 71.0% to $829,000 for the three months ended March
31, 1999, from $485,000 for the comparable 1998 period. This was primarily the
result of increased administrative expenses and other operating costs in
connection with our overall business growth.
Income Tax
Our effective tax rate for the three months ended March 31, 1999 and pro
forma effective tax rate for the three months ended March 31, 1998 differ from
the federal statutory rate of 35% due to state income taxes, as well as
nondeductible expenses, including the amortization of goodwill resulting from
the acquisition of Trimark and a portion of business development expenses
Liquidity
Historically, we have financed our business primarily through cash generated
by operations, as well as the proceeds from our stock offerings, the private
placement of preferred and common units and borrowings under subordinated
notes. As of March 31, 1999, we had $471.5 million in assets, 92% of which
consisted of cash or assets readily convertible into cash, principally
receivables from clearing brokers and securities owned. Receivables from
clearing brokers include interest bearing cash balances held with clearing
brokers, net of amounts related to securities transactions that have not yet
reached their contracted settlement date, which is generally within three
business days of the trade date. Securities owned principally consist of
equity securities which trade in Nasdaq and on the NYSE and AMEX markets.
12
<PAGE>
Net income plus depreciation and amortization was $39.4 million and $9.7
million during the three months ended March 31, 1999 and 1998, respectively.
Depreciation and amortization expense, which related to fixed assets and
goodwill, was $2.0 million and $1.3 million during the three months ended
March 31, 1999 and 1998, respectively. Capital expenditures were $889,000 for
the three months ended March 31, 1999 and $1.7 million for the comparable
period in 1998. Capital expenditures for the three months ended March 31, 1999
primarily related to the purchase of data processing and communications
equipment, as well as leasehold improvements and additional office facilities
to support our growth. Additionally, we made cash payments of $1.6 million for
the three months ended March 31, 1999 in connection with our acquisitions of
the listed securities market-making businesses of Trimark in 1995 and
Tradetech in 1997. We anticipate that we will meet our 1999 capital
expenditure needs out of operating cash flows.
As registered broker-dealers and market makers, Knight and Trimark are
subject to regulatory requirements intended to ensure the general financial
soundness and liquidity of broker-dealers and requiring the maintenance of
minimum levels of net capital, as defined in SEC Rule 15c3-1 ($4.2 million and
$1.1 million, respectively as of March 31, 1999). These regulations also
prohibit a broker-dealer from repaying subordinated borrowings, paying cash
dividends, making loans to its parent, affiliates or employees, or otherwise
entering into transactions which would result in a reduction of its total net
capital to less than 120.0% of its required minimum capital. Moreover, broker-
dealers, including Knight and Trimark, are required to notify the SEC prior to
repaying subordinated borrowings, paying dividends and making loans to its
parent, affiliates or employees, or otherwise entering into transactions,
which, if executed, would result in a reduction of 30.0% or more of their
excess net capital (net capital less minimum requirement). The SEC has the
ability to prohibit or restrict such transactions if the result is detrimental
to the financial integrity of the broker-dealer. At March 31, 1999, Knight had
net capital of $119.7 million, which was $115.5 million in excess of its
required net capital of $4.2 million and Trimark had net capital of $31.7
million, which was $30.6 million in excess of its required net capital of $1.1
million.
We used a portion of our capital resources before our initial public
offering to pay interest on our issued and outstanding Mandatorily Redeemable
Preferred A and B Units, and to make quarterly distributions to our members to
meet their estimated income tax obligations on their share of our taxable
income. All Preferred Units were redeemed during 1998.
PaineWebber Capital Inc., an affiliate of PaineWebber Incorporated, loaned
$30.0 million to Roundtable under a loan agreement dated as of June 19, 1998.
Roundtable used the proceeds from this loan to make distributions of
undistributed profits to the members of Roundtable before our reorganization
from a limited liability company to a Delaware corporation immediately before
our initial public offering. In connection with the dissolution of Roundtable,
we assumed all of Roundtable's obligations under the loan. We subsequently
repaid the entire loan from our operating cash flows, making principal pre-
payments of $5.0 million, $9.0 million, $6.0 million and $10.0 million on
September 15, 1998, October 20, 1998, December 15, 1998 and January 19, 1999,
respectively.
We currently anticipate that available cash resources and credit facilities
will be sufficient to meet our anticipated working capital and capital
expenditure requirements for at least the next 12 months.
On October 8, 1998, our board of directors approved a program to repurchase,
over a period of up to eighteen months, up to 3 million shares of our
outstanding Class A common stock up to a total aggregate amount not to exceed
$20 million. We may repurchase shares from time to time in the open market or
through privately negotiated transactions, depending on prevailing market
conditions, alternative use of capital and other factors. To date, we have not
repurchased any shares under this program.
13
<PAGE>
Year 2000 Compliance
Many currently installed computer systems and software products are coded to
accept or recognize only two digit entries in the date code field. These date
code fields will need to accept four digit entries to distinguish 21st century
dates from 20th century dates. As a result, computer systems and/or software
used by many companies and governmental agencies may need to be upgraded to
comply with such Year 2000 requirements or risk system failure or
miscalculations causing disruptions of normal business activities.
State of Readiness. We have made an assessment of the Year 2000 readiness of
our trading-related, communications and data processing systems. Our readiness
plan consists of: (1) quality assurance testing of our main trading-related
systems including all customer interfaces and links to exchanges and
utilities; (2) contacting third-party vendors and licensors of material
hardware, software and services that relate directly and indirectly to the
main trading systems; (3) contacting vendors of critical non-trading related
communications and data processing systems; (4) contacting our clearing
brokers; (5) assessment of repair or replacement requirements; (6) repair or
replacement; (7) implementation; and (8) creation of contingency plans for
possible Year 2000 failures. Additionally, we recently participated in the
Securities Industry Association "streetwide" testing in March 1999. We
presently believe that our main trading-related systems are currently Year
2000 compliant. We have required vendors of material hardware and software
components of our information technology systems to provide assurances of
their Year 2000 compliance. We are currently assessing the materiality of our
non-information technology systems and will seek assurances of Year 2000
compliance from providers of material non-information technology systems.
Until such testing is complete and such vendors and providers are contacted,
we will not be able to completely evaluate whether our information technology
systems or non-information technology systems will need to be revised or
replaced.
Costs. To date, we have incurred approximately $400,000 in costs in
connection with identifying and evaluating Year 2000 compliance issues. Most
of our expenses have related to, and are expected to continue to relate to,
the operating costs associated with time spent by employees in the evaluation
process and Year 2000 compliance matters generally. At this time, we estimate
that the total cost of the Year 2000 project to be approximately $500,000.
Risks. We are not currently aware of any Year 2000 compliance problems
relating to our main trading-related, communications or data processing
systems that would have a material adverse effect on our business, financial
condition and operating results, without taking into account our efforts to
avoid or fix such problems. We cannot assure that we will not discover Year
2000 compliance problems that will require substantial revisions. In addition,
we cannot assure you that third-party software, hardware or services
incorporated into our systems will not need to be revised or replaced, all of
which could be time consuming and expensive. If we fail to fix our trading-
related, communications or data processing systems or to fix or replace third-
party software, hardware or services on a timely basis our business, financial
condition and operating results could be materially adversely affected.
Moreover, the failure to adequately address Year 2000 compliance issues in our
main trading-related, communications or data processing systems could result
in litigation, which could be costly and time-consuming to defend.
In addition, we cannot assure you that customers, governmental agencies,
utility companies, securities exchanges, Internet access companies, third-
party service providers, including our clearing brokers, and others outside
our control will be Year 2000 compliant. The failure by these entities to be
Year 2000 compliant could result in a systemic failure beyond our control,
such as a prolonged Internet, telecommunications or electrical failure, which
could also prevent us from delivering our services to our customers and could
have a material adverse effect on our business, results of operations and
financial condition.
Contingency Plan. As discussed above, we are engaged in an ongoing Year 2000
assessment and are in the process of developing a contingency plan. The
results of our Securities Industry Association testing and the responses
received from third-party vendors, service providers and customers will be
taken into account in determining the nature and extent of any contingency
plans.
14
<PAGE>
Recently Issued Accounting Standards
In February 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 132, Employers
Disclosures about Pensions and Other Postretirement Benefits an amendment of
FASB No. 87, 88 and 106, which provides accounting and reporting standards for
employers' disclosures about pension and other postretirement benefit plans.
We adopted SFAS No. 132 on its effective date of January 1, 1998. The adoption
of the provisions of these standards did not have a material impact on our
financial statements.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. We
anticipate we will adopt the provisions of SFAS No. 133 effective June 15,
1999. We believe the adoption of these provisions will not have a material
impact on our financial statements.
Recent Developments
In April 1999, the Company's Board of Directors approved a two-for-one stock
split of the Company's Class A and Class B Common Stock. Shareholders of
record as of the close of business on April 30, 1999 will receive, in the form
of a stock dividend, one additional share for each share held by them. On May
14, 1999 the transfer agent will distribute the additional shares. The
accompanying financial information does not reflect the effects of this stock
split.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our market-making and trading activities expose our capital to significant
risks. These risks include, but are not limited to, absolute and relative
price movements, price volatility or changes in liquidity, over which we have
virtually no control.
We employ an automated proprietary trading and risk management system which
provides real time, on-line risk management and inventory control. We monitor
our risks by a constant review of trading positions. For each trader, we have
established a system whereby any trades that exceed pre-determined limits are
monitored by senior management as are individual and aggregate dollar and
share position totals and real-time profits and losses. The management of
trading positions is enhanced by review of mark-to-market valuations and/or
position summaries on a daily basis.
In the normal course of our market-making business, we maintain inventories
of exchange-listed and OTC securities. The fair value of these securities at
March 31, 1999 was $97.4 million in long positions and $72.2 million in short
positions. The potential change in fair value, using a hypothetical 10.0%
decline in prices, is estimated to be a $2.5 million loss as of March 31, 1999
due to the offset of losses in long positions with gains in short positions.
For working capital purposes, we invest in money market funds or maintain
interest bearing balances in our trading accounts with clearing brokers, which
are classified as cash equivalents and receivable from clearing brokers,
respectively, in the consolidated statement of financial condition. These
amounts do not have maturity dates or present a material market risk, as the
balances are short-term in nature and subject to daily repricing. Since its
inception, neither Knight/Trimark nor any of its subsidiaries has traded or
otherwise transacted in derivatives.
15
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are not currently a party to any legal proceedings the adverse outcome of
which, individually or in the aggregate, could have a material adverse effect
on our business, financial condition or operating results. We and certain of
our officers and employees have been subject to legal proceedings in the past
and may be subject to legal proceedings in the future.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
Exhibit 27. Financial Data Schedule
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto until duly authorized.
Knight/Trimark Group, Inc.
/s/ Robert I. Turner
-------------------------------------
By: Robert I. Turner
Title: Director, Treasurer,
Executive Vice President,
and Chief Financial Officer
(principal financial and
accounting officer)
Date: May 13, 1999
16
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<PAGE>
<ARTICLE> BD
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 251,228
<RECEIVABLES> 83,981
<SECURITIES-RESALE> 0
<SECURITIES-BORROWED> 0
<INSTRUMENTS-OWNED> 97,403
<PP&E> 11,684
<TOTAL-ASSETS> 471,480
<SHORT-TERM> 0
<PAYABLES> 80,610
<REPOS-SOLD> 0
<SECURITIES-LOANED> 0
<INSTRUMENTS-SOLD> 72,221
<LONG-TERM> 0
0
0
<COMMON> 555
<OTHER-SE> 318,095
<TOTAL-LIABILITY-AND-EQUITY> 471,480
<TRADING-REVENUE> 178,550
<INTEREST-DIVIDENDS> 1,587
<COMMISSIONS> 2,527
<INVESTMENT-BANKING-REVENUES> 0
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 0
<COMPENSATION> 57,292
<INCOME-PRETAX> 64,724
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
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