<PAGE>
As filed with the Securities and Exchange Commission on February 22, 1999
Registration No. 333-71559
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
KNIGHT/TRIMARK GROUP, INC.
(Exact name of Registrant as specified in its charter)
---------------
Delaware 6211 52-2096335
(State or other (Primary Standard Industrial (I.R.S. Employer
jurisdiction Classification Code Number) Identification Number)
of incorporation
or organization)
Newport Tower, 29th Floor
525 Washington Boulevard
Jersey City, New Jersey 07310
(201) 222-9400
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
---------------
Michael T. Dorsey, Esq.
Senior Vice President and General Counsel
Knight/Trimark Group, Inc.
Newport Tower, 29th Floor
525 Washington Boulevard
Jersey City, New Jersey 07310
(201) 222-9400
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
---------------
Copies to:
Matthew J. Mallow, Esq. Alexander D. Lynch, Esq.
Skadden, Arps, Slate, Meagher & Flom LLP Babak Yaghmaie, Esq.
919 Third Avenue Brobeck, Phleger & Harrison LLP
New York, New York 10022 1633 Broadway, 47th Floor
(212) 735-3000 New York, New York 10019
(212) 581-1600
---------------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering.
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until this Registration Statement shall become
effective on such date as the Securities and Exchange Commission, acting
pursuant to said Section 8(a), may determine.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This prospectus is not an +
+offer to sell securities, and we are not soliciting offers to buy these +
+securities, in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED FEBRUARY 3, 1999
[LOGO] KNIGHT TRIMARK GROUP, INC.
9,000,000 Shares
Class A Common Stock
Knight/Trimark Group, Inc. is offering 2,424,720 shares of its Class A
common stock and the selling stockholders are selling an additional 6,575,280
shares. Knight/Trimark Group, Inc. will not receive any of the proceeds from
the sale of shares by the selling stockholders. Knight/Trimark Group, Inc.'s
Class A common stock is traded in the Nasdaq National Market under the symbol
"NITE." The last reported sale price of the Class A common stock on the Nasdaq
National Market on February 2, 1999 was $45.44 per share.
---------------
Investing in our Class A Common Stock involves risks.
See "Risk Factors" beginning on page 8.
---------------
<TABLE>
<CAPTION>
Per
Share Total
------ -------
<S> <C> <C>
Public Offering Price........................................... $ $
Underwriting Discounts and Commissions.......................... $ $
Proceeds to the Company......................................... $ $
Proceeds to the Selling Stockholders............................ $ $
</TABLE>
The Securities and Exchange Commission and state securities regulators have
not approved or disapproved these securities or determined if this prospectus
is truthful or complete. Any representation to the contrary is a criminal
offense.
Certain selling stockholders have granted the underwriters a 30-day option
to purchase up to an additional 1,350,000 shares of Class A common stock to
cover over-allotments. BancBoston Robertson Stephens Inc. expects to deliver
the shares of Class A common stock to purchasers on , 1999.
---------------
BancBoston Robertson Stephens Merrill Lynch & Co.
---------------
PaineWebber Incorporated
ABN AMRO Rothschild
a division of ABN AMRO Incorporated
Southwest Securities
The date of this Prospectus is , 1999.
<PAGE>
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of our Class A common stock only in jurisdictions where offers and
sales are permitted. The information contained in this prospectus is accurate
only as of the date of this prospectus, regardless of the time of delivery of
this prospectus or of any sale of our Class A common stock.
---------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Summary.................................................................. 3
Risk Factors............................................................. 8
Use of Proceeds.......................................................... 22
Price Range of Class A Common Stock...................................... 22
Dividend Policy.......................................................... 22
Capitalization........................................................... 23
Selected Consolidated Financial Data..................................... 24
Management's Discussion and Analysis of Financial Condition and Results
of Operations.......................................................... 25
Business................................................................. 37
Management............................................................... 50
Certain Transactions..................................................... 59
Principal and Selling Stockholders....................................... 63
Description of Capital Stock............................................. 65
Shares Eligible for Future Sale.......................................... 67
Underwriting............................................................. 69
Legal Matters............................................................ 71
Experts.................................................................. 71
Additional Information................................................... 71
Index to Consolidated Financial Statements............................... F-1
</TABLE>
2
<PAGE>
SUMMARY
Because this is only a summary, it does not contain all the information
that may be important to you. You should read the entire prospectus, especially
"Risk Factors" and the Consolidated Financial Statements and the Notes, before
deciding to invest in shares of our Class A Common Stock. This prospectus
contains forward-looking statements based on our current expectations,
assumptions, estimates and projections about our company and our industry.
These forward-looking statements involve risks and uncertainties. Our actual
results could differ materially from those anticipated in our forward-looking
statements.
Our Business
We are the leading market maker in Nasdaq securities and in the Third
Market, which is the over-the-counter market in exchange-listed equity
securities, primarily those listed on the New York Stock Exchange and the
American Stock Exchange. Market makers typically hold themselves out to execute
trades by offering to buy or sell securities for their own account. We have
attained our leadership position as a market maker by providing best execution
services to broker-dealer and institutional customers through our sophisticated
trading systems and methods. Through our wholly-owned subsidiary, Knight, we
make markets in approximately 6,700 equity securities in Nasdaq and on the OTC
Bulletin Board of the National Association of Securities Dealers, Inc. Through
our wholly-owned subsidiary, Trimark, we make markets in all NYSE- and AMEX-
listed equity securities in the Third Market.
Since our inception in 1995, we have significantly increased our market
share of trading volume in the markets in which we participate:
. Based on data from 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 achieved a #1
market share ranking of volume in Nasdaq in February 1998. Additionally,
Knight has further increased its volumes and its market share since that
time. The volume of Nasdaq shares traded by Knight increased from 614.7
million shares in January 1997 to 3.2 billion shares in December 1998.
During the same period, Knight's market share more than tripled from
4.4%, or a rank of 6th overall, to 15.6%, or a rank of 1st overall.
. According to the NASD, Trimark has held the #1 market share ranking in
the trading of NYSE-listed securities for over two years. Additionally,
Trimark has increased its volumes and its market share over the same
period. Trimark's trading volume of NYSE-listed securities has increased
from 234.3 million shares in January 1997 to 644.0 million shares in
December 1998. During the same period, Trimark's market share
approximately doubled from 21.2% to 40.4%.
. According to the NASD, Trimark has also held the #1 market share ranking
in the trading of AMEX-listed securities for over two years.
Additionally, Trimark has further increased its volumes and its market
share over the same period. Trimark's trading volume of AMEX-listed
securities has increased from 40.3 million shares in January 1997 to 65.7
million shares in December 1998. During this same period, Trimark
increased its market share from 51.4% to 61.7%.
3
<PAGE>
Our Industry
In recent years, the U.S. market for equity securities has experienced
dramatic growth. This growth is evidenced by the trading volumes in the Nasdaq,
NYSE and AMEX markets, as well as trading volume in the Third Market:
. The average daily volume of securities traded in Nasdaq increased from
225.0 million shares in December 1992 to 867.1 million shares in December
1998.
. The average daily volume of securities traded on the NYSE increased from
222.2 million shares in December 1992 to 692.8 million shares in December
1998.
. The average daily volume of securities traded on the AMEX increased from
14.2 million shares in December 1992 to 40.2 million shares in December
1998.
The trading volume growth in all of these markets is driven by many
factors, including:
. increased cash flows into equity-based mutual funds;
. historic high returns in U.S. equity markets;
. the emergence and rapid growth of on-line discount brokers;
. technological innovations, such as the emergence of the Internet; and
. reduced transaction costs.
Since early 1997, average spreads between bid, or buy, and ask, or sell,
prices have declined significantly as a result of changes in regulations
governing the securities market and, to a lesser extent, the quoting of
securities prices in sixteenths rather than eighths of a dollar. As a result,
we believe that traditional brokerage firms are increasingly focusing on their
core competencies and are outsourcing their market-making functions to
independent market makers, which are capturing increased market share.
. According to The AutEx Group, in December 1998, the three largest
independent market makers represented a combined market share of 28% of
the trading volumes of over-the-counter equity securities, up from 17% in
March 1997.
. According to the NASD, in December 1998, the three largest Third Market
trading firms represented a combined market share of 56% of the Third
Market volume in NYSE equity securities compared to 42% in June 1997.
NASD statistics also indicate that the three largest Third Market trading
firms in AMEX-listed securities represented a combined market share of
59% in December 1998 compared to 55% in June 1997.
While large trading volumes have provided market makers with an opportunity
to spread fixed costs over a larger number of trades, net profits per trade
have declined. As a result, market makers are seeking new trading methodologies
to identify and take advantage of the profit opportunities represented by each
trade. These market makers also seek to increase their order flow. Order flow
is the volume of buy and sell orders received by a market maker. Increased
order flow provides market makers with a greater number of trades and increased
trading profit opportunities. To succeed, these market makers require
sophisticated trading methodologies, computerized trading systems, and risk
management practices that can handle increased order flow while maintaining low
costs per trade. They also need personnel with the requisite expertise to
deliver superior trade executions and customer service.
4
<PAGE>
Our Solution
We provide "best execution" services to our broker-dealer and institutional
customers. Under the NASD Conduct Rules, best execution requires broker-dealers
to buy and sell securities in a manner that provides their customers with a
price as favorable as possible under prevailing market conditions. Through our
sophisticated trading systems and trading practices, we are committed to
providing a superior execution methodology that emphasizes automated execution
and rule compliance, real-time information access by customers, and pricing
plus liquidity advantages based on our willingness to commit our capital. The
main elements of our solution include:
. a variety of best execution practices that are designed to provide our
customers with significantly enhanced liquidity;
. significant investments in technology to enable us to more efficiently
process large volumes of orders, without diminishing our speed of
execution. Our combined systems currently are designed to process up to
650,000 trades per day. In December 1998, our systems handled a combined
average of 245,000 trades per day. We executed a record number of trades,
over 400,000, on January 11, 1999;
. a trading methodology focused on real-time analysis of market activity
and price movements. This enables us to manage risk better and quickly
adjust our trading strategy in an effort to maximize our trading profits;
and
. providing the highest quality customer service. We believe that our
highly skilled, experienced and entrepreneurial workforce can address the
needs of our customers effectively.
Our Strategy
Our goal is to maintain and enhance our leadership position in the market-
making industry by:
. continuing to invest in leading technologies to ensure that we have the
capability to process greater volumes of order flow while complying with
regulatory requirements;
. increasing order flow to enhance our position as a leading market maker,
to create additional profit opportunities, and to achieve further
economies of scale;
. accelerating our penetration of the market for institutional investors,
which we believe provides an opportunity for growth and offers higher
profit margins;
. investing in human capital, by aggressively recruiting and retaining high
caliber personnel to deliver best execution and high quality customer
service;
. increasing our international presence by establishing a London-based
institutional sales subsidiary; and
. developing new services that address evolving customer and technological
needs to establish new customer relationships.
Our Customers
Our target customers are national and regional full-service broker-dealers,
on-line discount brokers and institutional investors. Some of our broker-dealer
customers include Ameritrade, Brown & Company, Discover Brokerage Direct,
E*TRADE Securities, Merrill Lynch, PaineWebber and Waterhouse Securities. We
also currently have over 500 institutional customers. We are actively marketing
to gain new full service broker-dealer, on-line discount broker and
institutional customers. Our marketing strategy is to continue to differentiate
ourselves from our competitors by enhancing our reputation as the provider of
high quality execution solutions and superior customer service.
5
<PAGE>
Our History
We were organized under Delaware law in April 1998 to succeed to the
business of Roundtable Partners, L.L.C. Immediately before our initial public
offering in July 1998, all of the limited liability company member interests in
Roundtable Partners were exchanged for shares of our Class A and Class B common
stock. In addition, some members of Roundtable Partners, including our
management, elected to receive additional shares of our Class A common stock
instead of a cash distribution of their respective share of undistributed
profits of Roundtable Partners. Other members of Roundtable Partners elected to
receive a cash distribution of their respective share of undistributed profits
of Roundtable Partners. Roundtable Partners' limited liability company
agreement provided that our broker-dealer owners would share our profits in
proportion to their equity interest and the quantity of order flow they
directed to us. This arrangement was discontinued after our initial public
offering. While we believe that we will continue to receive significant order
flow from our broker-dealer owners based on the high quality execution services
we provide, the broker-dealer owners no longer receive any special inducement
to provide us with order flow and are not obligated to provide us with their
order flow. For the period from January 1, 1998 to June 30, 1998, the period
before our initial public offering, order flow from our broker-dealer owners
represented 41.0% of our total order flow. For the period July 1, 1998 to
December 31, 1998, order flow from our broker-dealer owners represented 40.4%
of our total order flow. See "Risk Factors--Risks Associated with Recent Change
in Our Ownership Structure," "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview" and "Certain Transactions."
Our principal executive offices are located at Newport Tower, 29th Floor,
525 Washington Boulevard, Jersey City, New Jersey 07310 and our telephone
number is (201) 222-9400.
The Offering
<TABLE>
<C> <S>
Class A Common Stock Offered by Knight/Trimark............ 2,424,720 shares
Class A Common Stock Offered by the Selling Stockholders.. 6,575,280 shares
Common Stock to be Outstanding after the Offering:
Class A Common Stock............................... 52,386,904 shares
Class B Common Stock............................... 3,042,698 shares
Total.......................................... 55,429,602 shares
Use of Proceeds........................................... To support the growth of
our market making
business. See "Use of
Proceeds."
Nasdaq National Market Symbol............................. NITE
</TABLE>
In the table above, the total shares to be outstanding after this offering
do not include outstanding options at December 31, 1998 to purchase a total of
approximately 5,120,000 shares of Class A common stock at a weighted average
exercise price of $14.48 per share and an additional 2,289,500 shares reserved
for future grants under our stock option plans.
6
<PAGE>
Summary Consolidated Financial and Operating Data
(in thousands, except share and per share data)
Set forth below is the Consolidated Statement of Income Data for the period
from March 27 through December 31, 1995, the years ended December 31, 1996,
1997 and 1998 and the three month periods ended December 31, 1997 and 1998.
Also set forth below are the Consolidated Statement of Financial Condition Data
at December 31, 1998, (1) on an actual basis and (2) on an as adjusted basis to
give effect to the sale of 2,424,720, shares of our Class A common stock at an
assumed public offering price of $45.44 per share, after deducting the
underwriting discount and estimated offering expenses payable by us, and the
application of the net proceeds from this offering. Before our initial public
offering, we were a limited liability company and were not subject to income
taxes. Pro forma income tax expense was computed based on an effective tax rate
of 46%, 43%, 43% and 42.5%, respectively, for the period ended December 31,
1995 and the years ended December 31, 1996, 1997 and 1998, and 43% for the
three months ended December 31, 1997. Weighted average shares outstanding for
the period ended December 31, 1995, for the years ended December 31, 1996, 1997
and 1998 and for the three months ended December 31, 1997 have been determined
as if the reorganization described in Note 3 to the Consolidated Financial
Statements included elsewhere in this prospectus occurred as of the earliest
date presented. Shares issued in connection with our initial public offering
have been considered in determining weighted average shares outstanding only
from the date they were issued. Had such shares been considered for the full
periods presented, pro forma basic and diluted earnings per share for the
period ended December 31, 1995, for the years ended December 31, 1996, 1997 and
1998 and for the three months ended December 31, 1997 would be $0.12, $0.40,
$0.54, $0.96 and $0.18 per share, respectively.
<TABLE>
<CAPTION>
Period from
March 27 through Three Months Ended
December 31, Year Ended December 31, December 31,
---------------- -------------------------------- ---------------------
1995 1996 1997 1998 1997 1998
---------------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Consolidated Statement
of Income Data:
Total revenues.......... $ 69,812 $ 185,177 $ 226,667 $ 355,733 $ 67,024 $ 119,279
---------- ---------- ---------- ---------- ---------- ----------
Employee compensation
and benefits........... 12,151 39,494 57,717 108,003 18,178 40,189
Payments for order
flow................... 25,994 69,829 66,912 82,512 15,806 26,402
Execution and clearance
fees................... 12,710 25,837 32,069 45,564 10,209 13,361
All other expenses...... 7,616 13,256 19,892 31,302 5,694 9,298
---------- ---------- ---------- ---------- ---------- ----------
Total expenses.......... 58,471 148,416 176,590 267,381 49,887 89,250
---------- ---------- ---------- ---------- ---------- ----------
Income before income
taxes.................. 11,341 36,761 50,077 88,352 17,137 30,029
Income tax expense...... -- -- -- 21,751 -- 12,492
---------- ---------- ---------- ---------- ---------- ----------
Net income.............. $ 11,341 $ 36,761 $ 50,077 $ 66,601 $ 17,137 $ 17,537
========== ========== ========== ========== ========== ==========
Basic and diluted
earnings per share..... $ 0.26 $ 0.86 $ 1.17 $ 1.40 $ 0.40 $ 0.33
========== ========== ========== ========== ========== ==========
Pro forma adjustment
Income before income
taxes.................. $ 11,341 $ 36,761 $ 50,077 $ 88,352 $ 17,137
Pro forma income tax
expense................ 5,217 15,807 21,533 37,571 7,369
---------- ---------- ---------- ---------- ----------
Pro forma net income.... $ 6,124 $ 20,954 $ 28,544 $ 50,781 $ 9,768
========== ========== ========== ========== ==========
Pro forma basic and
diluted earnings per
share.................. $ 0.14 $ 0.49 $ 0.67 $ 1.07 $ 0.23
========== ========== ========== ========== ==========
Weighted average shares
outstanding............ 42,801,636 42,801,636 42,801,636 47,511,111 42,801,636 53,004,882
========== ========== ========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998
-----------------------
Actual As Adjusted(4)
-------- --------------
<S> <C> <C>
Consolidated Statement of Financial Condition Data:
Cash and cash equivalents.............................. $117,382 $221,883
Receivable from clearing brokers....................... 107,503 107,503
Securities owned, at market value...................... 100,476 100,476
Total assets........................................... 358,860 463,361
Securities sold, not yet purchased, at market value.... 108,909 108,909
Total stockholders' equity............................. 200,121 304,622
</TABLE>
<TABLE>
<CAPTION>
Period from
March 27, through Three Months Ended
December 31, Year Ended December 31, December 31,
----------------- -------------------------------- --------------------
1995 1996 1997 1998 1997 1998
----------------- ---------- ---------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Other Operating Data:
Total shares traded..... 4,741,868 10,757,930 18,122,830 38,372,592 6,110,546 12,017,815
Total trades executed... 4,993 11,598 20,264 40,894 6,792 13,796
Average daily trades.... 26 46 80 162 103 216
Average daily net
trading revenue........ $ 356 $ 722 $ 885 $ 1,381 $ 1,004 $ 1,798
</TABLE>
7
<PAGE>
RISK FACTORS
You should consider carefully the following risks before you decide to buy
our Class A common stock. The risks and uncertainties described below are not
the only ones facing our company. Additional risks and uncertainties not
presently known to us may also adversely impact our business operations. If any
of the following risks actually occur, our business, financial condition or
operating results could be materially adversely affected. In such case, the
trading price of our Class A common stock could decline, and you may lose all
or part of the money you paid to buy our Class A common stock.
This prospectus contains forward-looking statements based on our current
expectations, assumptions, estimates and projections about our company and our
industry. These forward-looking statements involve risks and uncertainties. Our
actual results could differ materially from those anticipated in these forward-
looking statements as a result of various factors described in this section and
elsewhere in this prospectus. We undertake no obligation to update publicly any
forward-looking statements for any reason, even if new information becomes
available or other events occur in the future.
Our business is highly volatile and our quarterly results may fluctuate
significantly
Recently, we have experienced a significant increase in our trading volume.
We believe that this increase in trading volume has been due largely to a high
level of retail demand for Internet-related securities by on-line investors.
This demand has resulted in unprecedented fluctuations and volatility in
Internet-related securities. These fluctuations have had a direct impact on our
operating results and have, on occasion, caused significant fluctuations in our
intra-day profitability. As a result, we have implemented certain operational
controls to manage these fluctuations better. However, we cannot assure you
that the operational controls we have implemented will manage these
fluctuations effectively. We cannot assure you that the volatility in Internet-
related securities will not continue. Moreover, the continued volatility in the
securities markets, particularly in Internet-related securities, could result
in significant trading losses. These losses could have a material adverse
effect on our business, financial condition and operating results.
Our operating results may fluctuate significantly in the future because of
a number of other factors, including:
.changes in the value of our securities positions and our ability to
manage related risks;
.changes in the volume of order flow and our market-making activities;
.volatility in the securities markets;
.our ability to manage personnel, overhead and other expenses;
.changes in payments for order flow;
.changes in execution fees and clearance fees, which are fees we pay to our
clearing brokers;
.the addition or loss of sales and trading professionals;
.regulatory changes and compliance issues;
.the amount and timing of capital expenditures;
.costs associated with acquisitions; and
.general economic conditions.
Our expense structure is based on historical expense levels and the levels
of demand for our market-making services. If demand for our services declines
and we are unable to adjust our cost structure on a timely
8
<PAGE>
basis, our business, financial condition and operating results may be
materially adversely affected. We have experienced, and may experience in the
future, significant variations in our business from season to season.
Historically, we have experienced an increase in revenues in the fourth quarter
of the year. We believe this is due largely to higher trading volumes in the
securities markets at year end. We believe that this seasonal trend will
continue for the foreseeable future and that our business, financial condition
and operating results may be affected by this trend.
Due to these factors, period-to-period comparisons of our revenues and
operating results are not necessarily meaningful. You should not rely on these
comparisons as indicators of our future performance. We also cannot assure you
that we will be able to:
.sustain the rates of revenue growth we have experienced in the past;
.improve our operating results; or
. sustain our profitability on a quarterly basis.
In addition, our operating results in future periods may be below the
expectations of securities analysts and investors. In that event, the market
price of our Class A common stock would be materially and adversely affected.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business--Industry Overview" and "--Risk Management."
We are subject to risks associated with the securities industry generally
The securities industry has undergone several fundamental changes as a
result of:
. the emergence of on-line discount brokers;
. the increased prominence of on-line retail investors;
. the increased prominence of institutional investors;
. consolidation among firms in the securities industry;
.new regulations at the federal and state level; and
. the increased use of technology.
These changes have resulted in an increase in the volume of equity
securities traded in the U.S. equity markets and a general decrease in the
spreads between bid and ask, or buy and sell, prices. We cannot assure you that
the spreads market makers receive for execution of trades in equity securities
will not continue to decrease in the future. We derive a substantial portion of
our revenues from market-making activities relating to Nasdaq securities. In
the past, Nasdaq has taken regulatory actions to reduce spreads between bid and
ask prices for securities. Nasdaq, NYSE and AMEX are currently examining
proposed regulations that will require securities to trade in decimals instead
of fractions. The adoption of these regulations would likely result in a
further decrease in spreads between bid and ask prices, which could make the
execution of trades and market making less profitable. If there is any further
decline in the spreads that market makers receive in trading equity securities,
our business, financial condition and operating results may be materially
adversely affected.
Although we derive most of our revenue from trading in existing securities,
our volume of market-making activities also depends on the number and size of
new equity offerings. By increasing the number and volume of securities
available for trading, new offerings increase the potential for secondary
market trading activity. However, the market for equity offerings historically
has experienced significant volatility not only in the number and size of
equity offerings, but also in the secondary market trading volume and prices of
newly-issued securities. The number and size of equity offerings may decline
during periods of market uncertainty. This decline might be caused by concerns
over inflation, rising interest rates, other economic issues and a reduction in
cash flows by mutual funds and other institutional and retail investors into
the U.S. equity markets. The recent demand for new equity offerings has been
driven in part by mutual funds and other institutional and
9
<PAGE>
retail investors. Any reduction in revenues resulting from a decline in the
number and size of new equity offerings or the secondary market trading volume
for these offerings could have a material adverse effect on our business,
financial condition and operating results. Additionally, a decline in cash
flows into the U.S. equity markets or a slowdown in investment activity by
mutual funds and other institutional and retail investors may have an adverse
effect on the securities markets generally and could result in lower revenues
from our market-making activities.
The securities business is also subject to various other risks, including
customer default, employees' misconduct, errors and omissions and litigation.
Losses associated with these risks could have a material adverse effect on our
business, financial condition and operating results.
We have recently changed our ownership structure
Historically, we have derived a substantial portion of our order flow from
our broker-dealer owners. In the years ended December 31, 1996, 1997 and 1998,
order flow from broker-dealer owners represented 35%, 40% and 41% of our total
order flow, respectively. Before our initial public offering, our broker-dealer
owners shared in profits partially in proportion to their equity interest and
partially in proportion to the quantity of order flow they directed to us. This
arrangement ceased when we were reorganized from a limited liability company to
a Delaware corporation immediately before our initial public offering.
Accordingly, our broker-dealer owners are no longer obligated to provide us
with any order flow and may no longer have sufficient inducement to do so. We
cannot assure you that the absence of special incentives will not cause our
broker-dealer owners to reduce or discontinue the level of order flow they
direct to us in the future. For the period from January 1, 1998 to June 30,
1998, the period before our initial public offering, order flow from broker-
dealer owners represented 41.0% of our total order flow. For the period July 1,
1998 to December 31, 1998, order flow from broker-dealer owners represented
40.4% of our total order flow. In addition, some of our broker-dealer owners
are selling some or all of their shares in this offering. Others may, from time
to time, choose to sell some or all of their shares in the future. We cannot
assure you that a reduction in these broker-dealers' ownership interest will
not reduce their incentive to send order flow to us. The loss or a significant
reduction in order flow from our broker-dealer owners would have a material
adverse effect on our business, financial condition and operating results. Some
of our broker-dealer owners may engage in market-making activities on their own
in the future. If so, they may use our execution services less frequently and
will compete with us for order flow. See "Certain Transactions--The
Reorganization" and "Shares Eligible For Future Sale."
We may have difficulty managing our growth
Since we commenced operations in 1995, we have experienced significant
growth in our business activities and the number of our employees. The growth
of our business has placed a significant strain on our management and
operations and we expect it to continue to do so in the future. This growth has
required and will continue to require us to increase our investment in
management personnel, financial and management systems and controls, and
facilities. In the absence of continued revenue growth, the costs associated
with our expected growth would cause our operating margins to decline from
current levels. In addition, as is common in the securities industry, we are
and will continue to be highly dependent on the effective and reliable
operation of our communications and information systems. In the past, we have
experienced occasional difficulties with the performance of our systems during
periods of abnormally high volumes of market activity. While we have
implemented a number of measures to address these difficulties, we cannot
assure you that we will not experience similar difficulties in the future. If
we experience similar difficulties in the future, our business, financial
condition and operating results could be materially adversely affected.
We believe that our growth will require implementation of new and improved
communications and information systems. In addition, the scope of procedures
for assuring compliance with applicable rules and regulations has changed as
the size and complexity of our business has increased. In response, we have
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implemented and continue to revise formal compliance procedures. Our future
operating results will depend on our ability to continue:
. to improve our systems for operations, financial control, and
communication and information management;
. to refine our compliance procedures and enhance our compliance
oversight; and
. to recruit, train, manage and retain our employee base.
We cannot assure you that we will be able to manage our growth
successfully. Our inability to do so could have a material adverse effect on
our business, financial condition and operating results. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Business--Market Share Information," "--Technology" and "--Risk Management."
We depend entirely on our market-making activities
We derive substantially all of our revenues from market-making activities.
We expect our market-making activities to continue to account for substantially
all of our revenues for the foreseeable future. Any factor adversely affecting
market-making in general, or our market-making activities in particular, could
have a material adverse effect on our business, financial condition and
operating results. Our future success will depend on:
. continued growth in demand for our market-making services;
. our ability to respond to regulatory and technological changes; and
. our ability to respond to customer demands.
If demand for our market-making services fails to grow, grows more slowly than
we currently anticipate, or declines, our business, financial condition and
operating results would be materially and adversely affected.
We are subject to extensive government regulation
The securities industry is subject to extensive regulation under both
federal and state laws. In addition, the SEC, the NASD, other self-regulatory
organizations, commonly referred to as SROs, and state securities commissions
require strict compliance with their respective rules and regulations. These
regulatory bodies are responsible for safeguarding the integrity of the
securities markets and protecting the interests of participants in those
markets. As a market maker, we are subject to regulation concerning certain
aspects of our business, including:
. trade practices;
. capital structure;
. record retention; and
. the conduct of our directors, officers and employees.
Failure to comply with any of these laws, rules or regulations could result in
adverse consequences. We, and certain of our officers and employees, have, in
the past, been subject to claims arising from acts in contravention of these
laws, rules and regulations. These claims have resulted in the payment of fines
and settlements. We cannot assure you that we and/or our officers and other
employees will not, in the future, be subject to similar claims. An adverse
ruling against us and/or our officers and other employees could result in us
and/or our officers and other employees being required to pay a substantial
fine or settlement and could result in suspension or expulsion. This could have
a material adverse effect on our business, financial condition and operating
results.
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The regulatory environment in which we operate is subject to change. New or
revised legislation or regulations imposed by the SEC, other United States or
foreign governmental regulatory authorities, SROs or the NASD could have a
material adverse effect on our business, financial condition and operating
results. Changes in the interpretation or enforcement of existing laws and
rules by these governmental authorities, SROs and the NASD could also have a
material adverse effect on our business, financial condition and operating
results.
Additional regulation, changes in existing laws and rules, or changes in
interpretations or enforcement of existing laws and rules often directly affect
securities firms. We cannot predict what effect any such changes might have.
Our business, financial condition and operating results may be materially
affected by both regulations that are directly applicable to us and regulations
of general application. Our level of trading and market-making activities can
be affected not only by such legislation or regulations of general
applicability, but also by industry-specific legislation or regulations.
Our business, both directly and indirectly, relies on the Internet and
other electronic communications gateways. We intend to expand our use of these
gateways. To date, the use of the Internet has been relatively free from
regulatory restraints. However, the SEC, SROs and some states are beginning to
address the regulatory issues that may arise in connection with the use of the
Internet. Accordingly, new regulations or interpretations may be adopted that
constrain our and our customers' ability to transact business through the
Internet or other electronic communications gateways. Any additional regulation
of the use of such gateways could have a material adverse effect on our
business, financial condition and operating results.
We face risks associated with our international expansion
We have recently formed a subsidiary in the United Kingdom in anticipation
of expanding our operations into London. To expand our services in the United
Kingdom and internationally, we will have to comply with regulations of each
country in which we conduct business. We may in the future expand our business
to other countries. However, we currently have limited experience in operating
our business internationally. The brokerage industry in many foreign countries
is heavily regulated. The compliance requirements of these different regulatory
jurisdictions may limit our ability to expand internationally. We cannot assure
you that we will be successful in obtaining the necessary regulatory approvals
for our expansion, or, if approvals are obtained, that we will be able to
continue to comply with these regulations. The failure to obtain these
approvals or comply with these regulations could have a material adverse effect
on our business, financial condition and operating results. In addition, there
are other risks inherent in doing business in international markets, including:
. unexpected changes in regulatory requirements;
. potentially adverse tax consequences;
. export restrictions;
. tariffs and other trade barriers;
. difficulties in staffing and supervising foreign operations;
. political instability;
. fluctuations in currency exchange rates; and
. seasonal reductions in business activity during the summer months in
Europe.
Any of the above could have a material adverse effect on the success of our
international operations and, consequently, on our business, financial
condition and operating results. See "Business--Government Regulation."
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Trimark is subject to possible SEC enforcement action
In 1996, the SEC advised Trimark that it was conducting an inquiry with
respect to Trimark and asked that Trimark voluntarily provide the SEC with some
documents. In March 1997, Trimark provided the SEC with the information it had
requested. Based on the request for documents, it appears that the SEC's
inquiry concerns four areas:
. price improvement;
. protection of limit orders;
. payment for order flow; and
. trade reporting.
The SEC has not given any indication that it intends to carry out enforcement
actions against Trimark at this time. At this juncture, we are unable to
determine whether the SEC, after completion of its inquiry, will institute any
action and, if so, what the outcome will be. If the SEC brings an enforcement
action against Trimark it could have a material adverse effect on our business,
financial condition and operating results.
Our success will depend on the level of market acceptance of new services,
products and the Internet
We receive substantially all of our order flow through electronic
communications gateways, including a variety of computer-to-computer interfaces
and the Internet. The market for market-making services that rely on the
Internet is at an early stage of development and is rapidly evolving. As a
result, the demand for these services is subject to a high level of
uncertainty. Our electronic services may involve alternative approaches to
market making. Accordingly, substantial marketing and sales efforts may be
necessary to educate prospective customers about our electronic services and
products.
We depend on the business we receive from broker-dealers who increasingly
rely on the Internet to conduct transactions with their customers. The need for
our services and products depends on whether the customers are willing to adopt
the Internet as a medium for commerce and communication. We believe that there
has been a significant growth in the use of the Internet as a means of trading
in securities. However, customer concerns may negatively affect the growth of
Internet use for trading activities. The success of the Internet will also
depend on the development of necessary infrastructure and complementary
services and products, like high speed modems and high speed communication
lines. As the number of users and the amount of traffic on the Internet
continues to increase, we cannot assure you that the infrastructure needed to
support the Internet will be able to meet the demands placed on it.
Recently, due to the high volume of trading activity, particularly in
Internet-related securities, many Internet-based broker-dealers have
experienced delays in executing customers' transactions. Finally, the success
of the Internet will also depend on the ability of Internet users to develop
and adopt new standards and protocols to handle increased levels of activity.
As a result, we cannot assure you that the number of transactions generated
over the Internet will continue to increase. Any reluctance of the clients of
our broker-dealer customers to obtain brokerage services over the Internet
could have a material adverse effect on our business, financial condition and
operating results.
Counterparties may fail to pay us; clearing brokers may not perform adequately
As a market maker of over-the-counter and listed stocks, the majority of
our securities transactions are conducted as principal with broker-dealer
counterparties located in the United States. We clear our securities
transactions through affiliated and unaffiliated clearing brokers. See "Certain
Transactions." Our clearing brokers have the right to charge us for losses that
result from a counterparty's failure to fulfill its contractual obligations.
Our policy is to monitor the credit standing of the counterparties with which
we conduct business. However, we cannot assure you any of these counterparties
will not default on their obligations. If any do, our
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business, financial condition and operating results could be materially
adversely affected. In addition, at any time, a substantial portion of our
assets are held at one or more clearing brokers. Accordingly, we are subject to
credit risk with respect to these clearing brokers. As of December 31, 1998,
our credit exposures were concentrated with the clearing brokers and amounted
to $107.5 million. Additionally, as of December 31, 1998, the clearing brokers
held, as custodian, securities owned by us with a market value of $100.5
million. As a result, we rely on our clearing brokers to discharge adequately
their obligations on a timely basis. We are dependent also on the solvency of
our clearing brokers. Any failure by our clearing brokers to discharge
adequately their obligations on a timely basis or any event adversely affecting
our clearing brokers, could have a material adverse effect on our business,
financial condition and operating results.
We face risks associated with our market making and trading transactions
We conduct our market-making activities predominantly as a principal, which
subjects our capital to significant risks. These activities involve the
purchase, sale or short sale of securities for our own account. These
activities are subject to a number of risks, including risks of price
fluctuations and rapid changes in the liquidity of markets.
These risks may limit our ability to either resell securities we purchase
or to repurchase securities we sell in these transactions. In addition, we may
experience difficulty borrowing securities to make delivery to purchasers to
whom we sold short, or lenders from whom we have borrowed. From time to time,
we have large position concentrations in securities of a single issuer or
issuers engaged in a specific industry. We have recently experienced large
position concentrations with the securities of a number of issuers engaged in
business and services related to the Internet. This concentration has resulted
in higher trading losses than would occur if our positions and activities were
less concentrated. Moreover, the risks related to large position concentrations
in Internet-related securities are particularly significant due to the rapid
and extensive fluctuations in the bid and ask prices for these securities,
which are compounded by the relatively limited volume of these securities
available for trading.
The success of our market-making activities depends on:
. the price volatility of specific securities;
. our ability to attract order flow;
. the skill of our personnel;
. the availability of capital; and
. general market conditions.
To attract order flow, we must be competitive on:
. providing enhanced liquidity to our customers;
. the speed of our order execution;
. payment for order flow;
. the sophistication of our trading technology; and
. the quality of our customer service.
In our role as a market maker, we attempt to derive a profit from the
difference between the prices at which we buy and sell securities. However,
competitive forces often require us to:
. match the quotes other market makers display; and
. hold varying amounts of securities in inventory.
By having to maintain inventory positions, we are subjected to a high
degree of risk. We cannot assure you that we will be able to manage our
inventory risk successfully or that we will not experience significant losses,
either of which could materially adversely affect our business, financial
condition and operating results.
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We depend on our ability to attract and retain key personnel
Our future success depends on the continued service of key employees,
particularly Kenneth D. Pasternak, our president and chief executive officer.
We have entered into employment agreements with Mr. Pasternak and other key
employees.
We also maintain "key person" life insurance policies on Mr. Pasternak and
other key employees. Competition for key personnel and other highly qualified
management, sales, trading, compliance and technical personnel is intense. We
cannot assure you that we will be able to retain our key personnel. We cannot
assure you that we will be able to attract, assimilate or retain other highly
qualified personnel in the future. The loss of the services of any of our key
personnel or the inability to identify, hire, train and retain other qualified
personnel in the future could have a material adverse effect on our business,
financial condition and operating results. See "Management-- Employment
Agreements."
From time to time, other companies in the securities industry have
experienced losses of sales and trading professionals. The level of competition
to attract these professionals is intense. We cannot assure you that we
ourselves will not lose professionals due to increased competition or other
factors in the future. The loss of a sales and trading professional,
particularly a senior professional with broad industry expertise, could have a
material adverse affect on our business, financial condition and operating
results.
Our revenues may be impacted by diminished market activity due to adverse
economic, political and market conditions
The securities business generally is, by its nature, volatile. It is
directly affected by numerous national and international factors that are
beyond our control, including:
.economic, political and market conditions;
.the availability of short-term and long-term funding and capital;
.the level and volatility of interest rates;
.legislative and regulatory changes; and
.currency values and inflation.
Any one or more of these factors may contribute to reduced levels of
activity in the securities markets generally, which could result in lower
revenues from our market-making activities. Any reduction in revenues or any
loss resulting from these factors could have a material adverse effect on our
business, financial condition and operating results.
Our revenues may decrease due to declines in market volume, prices or liquidity
Our revenues may decrease due to a decline in market volume, prices or
liquidity. Declines in the volume of securities transactions and in market
liquidity generally result in lower revenues from market-making activities.
Lower price levels of securities also may result in reduced trading activity
and reduce our revenues from market-making transactions. Lower price levels
also can result in losses from declines in the market value of securities held
in inventory. Sudden sharp declines in market values of securities can result
in:
.illiquid markets;
.declines in the market values of securities held in inventory;
. the failure of buyers and sellers of securities to fulfill their
settlement obligations; and
. increases in claims and litigation.
Any decline in market volume, price or liquidity or any other of these
factors could have a material adverse effect on our business, financial
condition and operating results.
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We depend significantly on a small group of customers
Historically, a small number of customers have accounted for a significant
portion of our market-making activities. We expect a significant portion of the
future demand for our market-making services to remain concentrated within a
limited number of customers. For the year ended December 31, 1996, our five
largest customers, Ameritrade, Brown & Company, E*TRADE Securities, Southwest
Securities and Waterhouse Securities, were broker-dealer owners and accounted
for, in the aggregate, 22.3% of our order flow. For the years ended December
31, 1997 and 1998, our five largest customers, Ameritrade, Brown & Company,
Discover Brokerage Direct, E*TRADE Securities and Waterhouse Securities,were
broker-dealer owners and accounted for, in the aggregate, 29.4% and 33.0%,
respectively, of our order flow. During these same periods one of our
customers, Waterhouse Securities, accounted for 10.1% and 10.7% of our order
flow. None of these customers are obligated contractually to use our market-
making services. Accordingly, these customers may direct their trading
activities to other market makers at any time. We cannot assure you that we
will be able to retain these or other major customers or they will maintain or
increase their demand for our market-making activities. The loss of, or a
significant reduction of demand for our services from, any of these customers
could have a material adverse effect on our business, financial condition and
operating results. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business--Customers."
We have a limited operating history
We began our operations in 1995 with the acquisition of the listed
securities market-making business of Trimark and the formation of Knight.
Historically, Knight has accounted for a substantial portion of our revenues.
We expect this to continue. Knight only began its operation in 1995. Our
management has limited experience with respect to the operations of Knight and
in operating Knight/Trimark on a consolidated basis. Accordingly, we have
limited consolidated operating history which you can use to evaluate our
performance and prospects. Our prospects must be considered in light of the
risks and uncertainties frequently encountered by similarly situated companies,
particularly companies in the securities industry that are subject to evolving
regulatory, technological and customer requirements. To address these risks, we
must:
. maintain existing customer relationships and effectively develop new
relationships;
. respond to regulatory and competitive developments;
. attract, retain and motivate qualified personnel; and
. develop and upgrade our technology.
We cannot assure you that we will be successful in addressing these
requirements. The failure to do so could have a material adverse effect on our
business, financial condition and operating results.
Third parties may infringe on our intellectual property rights and licenses to
essential intellectual property may not be renewed
We rely primarily on copyright, trade secret and trademark laws to protect
our proprietary technology. Notwithstanding the precautions we have taken to
protect our intellectual property rights, it is possible that third parties may
copy or otherwise obtain and use our proprietary technology without
authorization. It is also possible that third parties may independently develop
technologies similar to ours. It may be difficult for us to monitor
unauthorized use of our proprietary technology and intellectual property
rights. We cannot assure you that the steps we have taken will prevent
misappropriation of our technology or intellectual property rights.
We are heavily dependent on two order entry and execution software systems.
One is known as the "Brass System," which we license from Automated Securities
Clearance, and the other is known as the "Appletree System," which we license
from TCAM Systems. Although we have rights to modify the licensed software,
Automated Securities Clearance and TCAM Systems own all modifications and
enhancements to the licensed software. In addition, Automated Securities
Clearance and TCAM Systems can use the modifications
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and enhancements to the licensed software without our consent. While we do not
believe that Automated Clearance Systems or TCAM Systems has incorporated any
of these modifications in software licensed to third parties, we cannot assure
you that they will not do so in the future. This may have a material adverse
effect on our competitive position. We rely on Automated Securities Clearance
to monitor the daily operation of the Brass System to detect problems with the
Brass System's operation. We rely on both licensors to support and maintain the
Brass and Appletree Systems. The licenses are terminable if we breach our
obligations under the license agreements. So are the licensors' daily operation
and support obligations. Our failure to maintain these relationships could have
a material adverse effect on our business, financial condition and operating
results.
We also license other software from third parties. These licenses are
integral to our business. If any of these relationships were terminated or if
any of these third parties were to cease doing business, we would be forced to
spend significant time to replace the licensed software. However, we cannot
assure you that we would be able to replace these licenses. This could have a
material adverse effect on our business, financial condition and operating
results. In addition, litigation may be necessary in the future to:
.enforce our intellectual property rights;
.protect our trade secrets;
.determine the validity and scope of the proprietary rights of others; or
.defend against claims of infringement or invalidity.
Litigation, whether successful or unsuccessful, could result in substantial
costs and diversions of resources. This could have a material adverse effect on
our business, financial condition and operating results. We may in the future
receive notices of claims of infringement of other parties' proprietary rights.
We cannot assure you that claims for infringement or invalidity will not be
asserted or prosecuted against us. These claims, with or without merit, could
be time consuming to defend, result in costly litigation, divert management's
attention and resources or require us to enter into royalty or licensing
agreements. We cannot assure you that these will be available on reasonable
terms, if at all. The assertion or prosecution of these claims, whether
successful or unsuccessful, could have a material adverse effect on our
business, financial condition and operating results.
Our future success will depend on our response to the demand for new services,
products and technologies
The demand for market-making services, particularly services that rely on
electronic communications gateways, is characterized by:
.rapid technological change;
.changing customer demands;
.the need to enhance existing or introduce new services and products; and
.evolving industry standards.
New services, products and technologies may render our existing services,
products and technologies less competitive. Our future success will depend on
our ability to respond to the demand for new services, products and
technologies on a timely and cost-effective basis. We cannot assure you that we
will be successful in developing, introducing or marketing new services,
products and technologies. Our business, financial condition and operating
results may be materially adversely affected if we fail to:
.respond adequately to technological advancements;
.respond to customer requirements; or
.develop and introduce new services, products and technologies.
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Concentration of ownership by our broker-dealer owners as a group
Immediately after this offering, our broker-dealer owners will continue to
own 32.2% of our capital stock. Therefore, as a group, they may be able to:
.control the election of all of the members of our board of directors;
.significantly influence the approval of all matters requiring stockholder
approval; and
.continue to have significant control over our affairs.
Although we have no reason to believe that the broker-dealer owners will
seek to act as a group in this manner, we cannot assure you that they will not
do so.
We are subject to net capital requirements
The SEC, the NASD and various other regulatory agencies have stringent
rules with respect to the maintenance of specific levels of net capital by
securities brokers. These rules include the SEC's Uniform Net Capital Rules.
The net capital rules govern the net capital requirements of each of our
subsidiaries. Failure to maintain the required net capital may subject us to
suspension or revocation of registration by the SEC and suspension or expulsion
by the NASD and other regulatory bodies. In addition, a change in the net
capital rules, the imposition of new rules or any unusually large charge
against net capital could limit our operations that require the intensive use
of capital. They could also restrict our ability to withdraw capital from our
brokerage subsidiaries. Any limitation on our ability to withdraw capital could
limit our ability to pay cash dividends, repay debt and repurchase shares of
our outstanding stock. A significant operating loss or any unusually large
charge against net capital could adversely affect our ability to expand or even
maintain our present levels of business, which could have a material adverse
effect on our business, financial condition and operating results. See
"Business--Government Regulation."
We face risks associated with the Year 2000
Many currently installed computer systems and software products are coded
to accept 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, including computers involved in the
securities industry, may need to be upgraded to comply with such Year 2000
requirements. Otherwise, these systems risk system failure or miscalculations
causing disruptions of normal business activities. Significant uncertainty
exists concerning the potential effects associated with the failure to achieve
compliance.
We have made an assessment of the Year 2000 readiness of our trading-
relating, communications and data processing systems. We participated in the
Securities Industry Association "streetwide" testing in June 1998. We plan to
participate in the March 1999 test to be conducted by the Securities Industry
Association. We presently believe that our main trading-related systems are
currently Year 2000 compliant. We plan to require vendors of material hardware
and software components of our information technology systems to provide
assurances of their Year 2000 compliance. We plan to complete this process
during the first half of 1999. We are currently assessing the materiality of
our non-information technology systems and will also seek assurances of Year
2000 compliance from providers of material non-information technology systems.
Until testing is complete and we have contacted these vendors, we will not be
able to evaluate completely whether our information technology systems or non-
information technology systems will need to be revised or replaced.
We cannot assure you 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
computer systems will not need to be revised or replaced. This 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
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operating results would be materially adversely affected. In addition, our
failure to address adequately Year 2000 compliance issues in our main trading-
related, communications or data processing systems could result in litigation.
Litigation could be costly and time-consuming to defend.
In addition, we cannot assure you that our customers, governmental
agencies, utility companies, Internet access companies, third-party service
providers, including our clearing agents, and others outside our control,
particularly other broker-dealers and market makers, will be Year 2000
compliant. The failure by any of these entities to be Year 2000 compliant could
result in a systematic failure beyond our control, including:
. a loss or reduction in our order flow;
. limitations on our ability to effectively engage in market-making
activities; or
. prolonged Internet, telecommunications or electrical failure.
Any of these problems, if they occur, could prevent us from engaging in
trading activities and would have a material adverse effect on our business,
results of operations and financial condition.
We are subject to intense competition
We derive substantially all of our revenues from market-making activities.
The market for these services, particularly market-making services through
electronic communications gateways, is rapidly evolving and intensely
competitive. We expect competition to continue and intensify in the future.
Knight competes primarily with wholesale, national, and regional broker-
dealers, as well as electronic communications networks, commonly referred to as
ECNs. ECNs are third party trading systems which are typically operated by
broker-dealers. Trimark competes with the NYSE, the AMEX, regional exchanges,
Third Market competitors and ECNs. We compete primarily on the basis of
execution standards, relationships with our customers and technology.
A number of our competitors have significantly greater financial,
technical, marketing and other resources than we have. Some of them may:
. offer a wider range of services and products than we offer;
. have greater name recognition; and
. have more extensive customer bases.
These competitors may be able to respond more quickly to new or evolving
opportunities and customer requirements. They may also be able to undertake
more extensive promotional activities and offer more attractive terms to
customers. Recent advancements in computing and communications technology are
substantially changing the means by which market-making services are delivered,
including more direct access on-line to a wide variety of services and
information. This has created demand for more sophisticated levels of customer
service. Providing these services may entail considerable cost without an
offsetting increase in revenues. In addition, current and potential competitors
have established or may establish cooperative relationships or may consolidate
to enhance their services and products. New competitors or alliances among
competitors may emerge and they may acquire significant market share.
More recently, ECNs have emerged as an alternative forum to which broker-
dealers and institutional investors can direct their limit orders. This allows
them to avoid facilitating their trades through market makers. As a result, we
may experience a reduction in our flow of limit orders. We cannot assure you
that ECNs will not continue to capture a greater amount of limit order flow. A
substantial reduction in our limit order flow could have a material adverse
effect on our business, financial condition and operating results.
We cannot assure you that we will be able to compete effectively with
current or future competitors or that the competitive pressures we face will
not have a material adverse effect on our business, financial condition and
operating results.
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We are subject to risks relating to litigation and potential securities laws
liability
Many aspects of our business involve substantial risks of liability. A
market maker is exposed to substantial liability under federal and state
securities laws, other federal and state laws and court decisions, as well as
rules and regulations promulgated by the SEC and the NASD. We are also subject
to the risk of litigation and claims that may be without merit. As we intend to
defend actively any such litigation, significant legal expenses could be
incurred. An adverse resolution of any future lawsuits or claims against us
could have a material adverse effect on our business, financial condition and
operating results.
We depend significantly on our computer and communications systems
Our market-making activities depend on the integrity and performance of the
computer and communications systems supporting them. Extraordinary trading
volumes or other events could cause our computer systems to operate at an
unacceptably low speed or even fail. Any significant degradation or failure of
our computer systems or any other systems in the trading process could cause
customers to suffer delays in trading. These delays could cause substantial
losses for customers and could subject us to claims from customers for losses.
We cannot assure you that our network protections will work. Our systems may
also fail as a result of:
. a tornado;
. fire or other natural disasters;
. power or telecommunications failure;
. act of God; or
. war.
Any computer or communications system failure or decrease in computer
systems performance that causes interruptions in our operations could have a
material adverse effect on our business, financial condition and operating
results. See "Business--Technology."
Certain provisions of Delaware law and our charter may make a takeover of our
company difficult
We are organized under the laws of the State of Delaware. Certain
provisions of Delaware law may have the effect of delaying or preventing a
change in our control. In addition, certain provisions of our certificate of
incorporation may have anti-takeover effects and may delay, defer or prevent a
takeover attempt that a stockholder might consider in its best interest. Our
certificate of incorporation authorizes the board to determine the terms of our
unissued series of preferred stock and to fix the number of shares of any
series of preferred stock without any vote or action by our stockholders. As a
result, the board can authorize and issue shares of preferred stock with voting
or conversion rights that could adversely affect the voting or other rights of
holders of our common stock. In addition, the issuance of preferred stock may
have the effect of delaying or preventing a change of control,because the
rights given to the holders of a series of preferred stock may prohibit a
merger, reorganization, sale, liquidation or other extraordinary corporate
transaction.
We have substantial discretion in use of proceeds
We intend to use the net proceeds of this offering to support the growth of
our market-making business. We will have significant flexibility in applying
the net proceeds of this offering. Although we have no plans, commitments or
agreements regarding any material acquisitions as of the date of this
prospectus, we may seek acquisitions of complementary businesses, products or
technologies. A portion of the net proceeds may be used for these acquisitions.
See "Use of Proceeds."
20
<PAGE>
WE CANNOT PREDICT OUR FUTURE CAPITAL NEEDS OR OUR ABILITY TO SECURE ADDITIONAL
FINANCING
Our business depends on the availability of adequate funding and regulatory
capital under applicable regulatory requirements. Historically, we have
satisfied these needs from internally generated funds and from our initial
public offering. We currently anticipate that our available cash resources and
the net proceeds from this offering will be sufficient to meet our presently
anticipated working capital and capital expenditure requirements for at least
the next 12 months. We expect that we will incur approximately $9 million in
capital expenditures in 1999. We may need to raise additional funds to:
. increase capital available for inventory positions;
. support more rapid expansion;
. develop new or enhanced services and products;
. respond to competitive pressures;
. acquire complementary businesses, products or technologies; or
. respond to unanticipated requirements.
We cannot assure you that additional financing will be available when
needed on terms favorable to us. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity."
FUTURE SALES BY EXISTING STOCKHOLDERS COULD DEPRESS THE MARKET PRICE OF OUR
COMMON STOCK
If our stockholders sell substantial amounts of our Class A common stock in
the public market following this offering, the market price of our Class A
common stock could fall. Such sales also might make it more difficult for us to
sell equity securities in the future at a time and price that we deem
appropriate. After this offering, we will have outstanding 52,386,904 shares of
Class A common stock and 3,042,698 shares of Class B common stock. These shares
are eligible for sale in the public market as follows:
<TABLE>
<CAPTION>
NUMBER OF SHARES DATE
---------------- ----------------------------------------------------
<C> <S>
20,500,000 After the date of this prospectus
At various times after 90 days from the date of this
34,929,602 prospectus
</TABLE>
Our directors and officers and certain of our stockholders have agreed that
they will not sell, directly or indirectly, any common stock without the prior
written consent of BancBoston Robertson Stephens for a period of 90 days from
the date of this prospectus.
We filed on January 29, 1999, a Form S-8 registration statement under the
Securities Act to register 7,409,500 shares of Class A common stock issuable
under our stock option plans. The registration statement became effective
immediately on filing. Shares covered by that registration statement are
eligible for sale in the public markets, subject to certain lock-up agreements
and Rule 144 limitations applicable to affiliates.
After this offering, certain of our stockholders, representing
approximately 31,871,904 shares of our Class A common stock and 3,042,698
shares of our Class B common stock, will continue to have registration rights.
By exercising their registration rights and causing a large number of shares to
be registered and sold in the public market, these holders may cause the price
of our common stock to fall. In addition, any demand to include these shares in
our registration statements could have an adverse effect on our ability to
raise needed capital. See "Management," "Principal and Selling Stockholders," "
Description of Capital Stock--Registration Rights," "Shares Eligible for Future
Sale" and "Underwriting."
21
<PAGE>
USE OF PROCEEDS
The net proceeds to Knight/Trimark from the sale of the 2,424,720 shares of
Class A common stock we are offering are approximately $104,501,073 at the
public offering price of $45.44 per share after deducting underwriting
discounts and commissions and estimated offering expenses. We will not receive
any proceeds from the sale of Class A common stock by the selling stockholders.
See "Principal and Selling Stockholders."
The principal purpose of this offering is to raise capital to support the
growth of our market making business. We may also use a portion of the proceeds
of this offering to pursue acquisitions of or investments in businesses,
products or technologies that are complementary to our business. We do not have
any commitments or agreements with respect to any acquisitions. Pending such
uses, we intend to invest the net proceeds of this offering in short-term,
investment-grade, interest-bearing securities.
PRICE RANGE OF CLASS A COMMON STOCK
Our Class A common stock is traded on the Nasdaq National Market under the
symbol "NITE." Public trading of our Class A common stock commenced on July 8,
1998. Before that, no public market for the Class A common stock existed. The
following table sets forth, for the periods indicated, the high and low closing
sales price per share of the Class A common stock in the Nasdaq National
Market.
<TABLE>
<CAPTION>
1998 High Low
---- ---- ---
<S> <C> <C>
Third Quarter (from July 8, 1998).......................... $ 19 $6 5/8
Fourth Quarter............................................. $25 3/8 $5 1/8
<CAPTION>
1999
----
<S> <C> <C>
First Quarter (through February 2, 1999)................... $54 1/8 $22
</TABLE>
As of December 31, 1998, there were approximately 171 holders of record of
our Class A common stock. On February 2, 1999, the last sale price reported in
the Nasdaq National Market for our Class A common stock was $45.44 per share.
DIVIDEND POLICY
Before our reorganization from a limited liability company to a Delaware
corporation, the limited liability company was treated as a partnership for
federal and state income tax purposes. Since inception, the limited liability
company generated taxable income and made distributions to its members to
facilitate the payment of the tax liability associated with the allocation of
limited liability company income of an aggregate of $2.9 million, $17.6
million, $22.3 million and $8.8 million in 1995, 1996, 1997, and the period
from January 1, 1998 through July 13, 1998, the date of our reorganization from
a limited liability company to a Delaware corporation, respectively. In
addition, before the initial public offering, the limited liability company
distributed to its non-management members an aggregate amount of $26.5 million,
representing all of their respective shares of undistributed profits. This did
not include $26.1 million that some members elected to receive in the form of
additional shares of common stock rather than in cash. In addition, the members
received a distribution of profits for the period beginning April 1, 1998 and
ending with the closing of the initial public offering, amounting in the
aggregate to $22.0 million. See "Certain Transactions--The Reorganization."
We intend to retain future earnings, if any, to finance the development and
expansion of our business and, therefore, do not anticipate paying any cash
dividends in the foreseeable future. The payment of cash dividends is within
the discretion of our board of directors and will depend on many other factors,
including our results of operations, financial condition and capital
requirements, restrictions imposed by financing arrangements and legal
requirements.
22
<PAGE>
CAPITALIZATION
The following table sets forth as of December 31, 1998, (1) our actual
capitalization and (2) our capitalization as adjusted after giving effect to
the sale of 2,424,720 shares of Class A common stock at an assumed public
offering price of $45.44 per share, the last reported sale price of the Class A
common stock in the Nasdaq National Market on February 2, 1999. This table
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Consolidated Financial
Statements and Notes thereto included elsewhere in this prospectus.
<TABLE>
<CAPTION>
DECEMBER 31, 1998
--------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
STOCKHOLDERS' EQUITY:
<S> <C> <C>
Class A common stock, $0.01 par value; 200,000,000 shares
authorized; 49,062,184 shares issued and outstanding,
actual; 52,386,904 shares issued and outstanding, as
adjusted(1)............................................. $ 491 $ 524
Class B common stock, $0.01 par value; 20,000,000 shares
authorized; 3,942,698 shares issued and outstanding,
actual; 3,042,698 shares issued and outstanding, as
adjusted................................................ 39 30
Additional paid-in capital................................ 169,780 274,257
Retained earnings......................................... 29,811 29,811
-------- --------
Total stockholders' equity.............................. 200,121 304,622
-------- --------
Total capitalization.................................... $200,121 $304,622
======== ========
</TABLE>
- --------
(1) Does not include outstanding options to purchase a total of approximately
5,120,000 shares of Class A common stock at a weighted average exercise
price equal to $14.48 per share as of the date of this prospectus and an
additional 2,289,500 shares reserved for future grants under our stock
option plans.
23
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data are qualified by the
Consolidated Financial Statements of Knight/Trimark and the Notes thereto
included elsewhere in this prospectus. You should read the following in
conjunction with the Consolidated Financial Statements and the discussion under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this prospectus. The Consolidated Statement
of Income Data for the years ended December 31, 1996, 1997, 1998 and the
Consolidated Statement of Financial Condition Data at December 31, 1997 and
1998 have been derived from our audited Consolidated Financial Statements
included elsewhere in this prospectus. The Consolidated Statement of Income
Data for the three months ended December 31, 1997 and 1998 are derived from the
unaudited Consolidated Financial Statements which, in the opinion of
management, have been prepared on the same basis as the audited Consolidated
Financial Statements and contain all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the results of
operations for such periods. The Consolidated Statement of Income Data for the
period ended December 31, 1995 and the Consolidated Statement of Financial
Condition Data at December 31, 1995 and 1996 are derived from audited
Consolidated Financial Statements not included in this prospectus.
<TABLE>
<CAPTION>
Period from
March 27, through Three Months Ended
December 31, Year Ended December 31, December 31,
----------------- -------------------------------- ---------------------
1995 1996 1997 1998 1997 1998
----------------- ---------- ---------- ---------- ---------- ----------
(in thousands, except share and per share data)
Consolidated Statement of
Income Data:
<S> <C> <C> <C> <C> <C> <C>
Revenues
Net trading revenue..... $ 69,516 $ 183,500 $ 223,923 $ 348,099 $ 66,257 $ 115,076
Commissions and fees.... -- 394 705 4,043 169 2,496
Interest, net........... 296 1,283 2,039 3,591 598 1,707
---------- ---------- ---------- ---------- ---------- ----------
Total revenues....... 69,812 185,177 226,667 355,733 67,024 119,279
---------- ---------- ---------- ---------- ---------- ----------
Expenses
Employee compensation
and benefits........... 12,151 39,494 57,717 108,003 18,178 40,189
Payments for order
flow................... 25,994 69,829 66,912 82,512 15,806 26,402
Execution and clearance
fees................... 12,710 25,837 32,069 45,564 10,209 13,361
Communications and data
processing............. 2,202 4,360 6,809 10,869 1,937 3,209
Depreciation and
amortization........... 1,626 2,975 4,225 5,878 1,143 1,727
Occupancy and equipment
rentals................ 849 1,777 2,657 5,745 889 1,764
Professional fees....... 503 379 1,612 3,424 498 1,193
Business development.... 130 623 1,460 2,337 462 741
Interest on Preferred
Units.................. 1,310 2,093 1,941 715 425 --
Other................... 996 1,049 1,188 2,334 340 664
---------- ---------- ---------- ---------- ---------- ----------
Total expenses....... 58,471 148,416 176,590 267,381 49,887 89,250
---------- ---------- ---------- ---------- ---------- ----------
Income before income
taxes................... 11,341 36,761 50,077 88,352 17,137 30,029
Income tax expense....... -- -- -- 21,751 -- 12,492
---------- ---------- ---------- ---------- ---------- ----------
Net income............... $ 11,341 $ 36,761 $ 50,077 $ 66,601 $ 17,137 $ 17,537
========== ========== ========== ========== ========== ==========
Basic and diluted
earnings per share...... $ 0.26 $ 0.86 $ 1.17 $ 1.40 $ 0.40 $ 0.33
========== ========== ========== ========== ========== ==========
Pro forma adjustment
Income before income
taxes................... $ 11,341 $ 36,761 $ 50,077 $ 88,352 $ 17,137
Pro forma income tax
expense (1)............. 5,217 15,807 21,533 37,571 7,369
---------- ---------- ---------- ---------- ----------
Pro forma net income..... $ 6,124 $ 20,954 $ 28,544 $ 50,781 $ 9,768
========== ========== ========== ========== ==========
Pro forma basic and
diluted earnings per
share................... $ 0.14 $ 0.49 $ 0.67 $ 1.07 $ 0.23
========== ========== ========== ========== ==========
Weighted average shares
outstanding (2)(3)...... 42,801,636 42,801,636 42,801,636 47,511,111 42,801,636 53,004,882
========== ========== ========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
December 31,
----------------------------------
1995 1996 1997 1998
------- -------- -------- --------
<S> <C> <C> <C> <C>
Consolidated Statement of Financial
Condition Data:
Cash and cash equivalents................... $ 1,668 $ 15,353 $ 13,797 $117,382
Securities owned, at market value........... 33,763 46,781 61,726 100,476
Receivable from clearing brokers............ 11,437 23,156 30,152 107,503
Total assets............................... 65,182 106,035 127,872 358,860
Securities sold, not yet purchased, at
market value............................... 11,001 19,021 21,061 108,909
Mandatorily Redeemable Preferred Units...... 28,415 37,706 27,484 --
Total stockholders' (members') equity...... 12,199 29,987 53,973 200,121
</TABLE>
- -------
(1) Before our initial public offering, we were a limited liability company and
were not subject to income taxes. Pro forma income tax expense was computed
based on an effective tax rate of 46%, 43%, 43% and 42.5%, respectively, for
the period ended December 31, 1995, and the years ended December 31, 1996,
1997 and 1998, and 43% for the three months ended December 31, 1997,
respectively.
(2) Weighted average shares outstanding for the period ended December 31, 1995,
for the years ended December 31, 1996, 1997 and 1998 and for the three months
ended December 31, 1997 have been determined as if the reorganization
described in Note 3 to the Consolidated Financial Statements included
elsewhere in this prospectus occurred as of the earliest date presented.
Shares issued in connection with our initial public offering have been
considered in determining weighted average shares outstanding only from the
date they were issued. Had such shares been considered for the full periods
presented, pro forma basic and diluted earnings per share for the period
ended December 31, 1995 and for the years ended December 31, 1996, 1997 and
1998 and for the three months ended December 31, 1997 would be $0.12, $0.40,
$0.54, $0.96 and $0.18 per share, respectively.
(3) The 53,004,882 shares used to calculate earnings per share for the three
months ended December 31, 1998 reflect the actual weighted average shares
outstanding for the three months ended December 31, 1998.
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
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 approximately
6,700 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 15.6% market share during
December 1998. Knight's share volume totaled 5.7 billion, 11.2 billion and 27.4
billion, or 53%, 62% and 71% of our total share volume, for the years ended
December 31, 1996, 1997 and 1998, respectively. Since commencing operations in
1995, Knight's business has grown rapidly and accounted for 76%, 75% and 80% of
our total share volume growth during the years ended December 31, 1996, 1997
and 1998, respectively. Since our acquisition of Trimark in March 1995, Trimark
has also experienced significant increases in share volume. In addition,
Trimark has held the #1 market share ranking in trading of NYSE- and AMEX-
listed securities for over two years. Trimark's share volume totaled 5.1
billion, 6.9 billion and 11.0 billion, or 47%, 38% and 29% of our total share
volume for the years ended December 31, 1996, 1997 and 1998, respectively.
We were organized in April 1998 for the purpose of succeeding to the
business of Roundtable Partners, L.L.C. Immediately before the closing of our
initial public offering, all of the member interests of Roundtable were
exchanged for shares of Class A common stock and Class B common stock of
Knight/Trimark. We received no additional consideration in connection with that
conversion of member interests into shares of common stock. In addition, some
members of Roundtable, including our management, elected to receive additional
shares of Class A common stock instead of their share of profits of Roundtable.
Other members of Roundtable elected to receive a cash distribution, in the
aggregate amount of $21,977,097, of their share of profits of Roundtable. In
connection with the exchange, effective July 31, 1998, Knight became the
successor entity to Knight Securities, L.P., and Trimark became the successor
entity to Trimark Securities, L.P. See "Certain Transactions--The
Reorganization."
Immediately prior to our reorganization from a limited liability company to
a Delaware corporation in connection with our initial public offering, a
consortium of 27 broker-dealers or their affiliates owned 60% of the member
interests of Roundtable. Additionally, Brown & Company Securities Corporation,
a major customer of Roundtable, held subordinated debt of Roundtable and an
option to purchase a member interest in Roundtable. These broker-dealer owners,
including Brown, owned 42.5% of our common stock after our initial public
offering, and will own 32.2% of our common stock after the closing of this
offering. For the years ended December 31, 1996, 1997 and 1998, the broker-
dealer owners were the source of 35%, 40%, and 41%, respectively of our total
order flow. For the years ended December 31, 1996, 1997 and 1998, aggregate
payments by us to our broker-dealer owners for order flow equaled $46.4
million, $50.7 million and $57.1 million, respectively. For the years ended
December 31, 1996 and 1997 and the period from January 1, 1998 through July 13,
1998, the date of the reorganization from a limited liability company to a
corporation, aggregate payments by us for profit distributions to broker-dealer
owners equaled $10.6 million, $13.4 million and $44.6 million, respectively.
See "Certain Transactions."
Under the Roundtable limited liability company agreement, our broker-dealer
owners partially shared in Roundtable's profits in proportion to their equity
interest and partially in proportion to the quantity of order flow they have
directed to us. This arrangement was discontinued when we completed our initial
public offering. The broker-dealer owners no longer receive any special
inducements to send order flow to us and are not contractually or otherwise
obligated to provide us with any order flow. See "Risk Factors--Risks
Associated with Recent Change of Our Ownership Structure."
25
<PAGE>
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. These regulatory changes and the move
from securities being quoted in sixteenths rather than eighths of a dollar,
which primarily occurred in 1997, have resulted in a decrease in net trading
revenue per trade. 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, and the principal amount outstanding under
subordinated notes and short-term debt.
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.
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 79%, 78% and 80% of
total employee compensation and benefits expense for the years ended December
31, 1996, 1997 and 1998, respectively. We have grown from 195 employees at
December 31, 1996 to 317 employees and 446 employees as of December 31, 1997
and 1998, respectively. 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. As a
result of the new Order Handling Rules implemented by the
26
<PAGE>
SEC in 1997, we changed our order flow payment policy from paying broker-
dealers for substantially all order executions, to paying broker-dealers only
for orders which provide us with a profit opportunity. For example, we make
payments on market orders, but do not pay on limit orders. As a result of these
changes, the average order flow payment per trade has declined.
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 expenses 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. On April 15, 1998, we redeemed all of the remaining
outstanding Preferred A Units for $12.5 million in cash. On April 15, 1998, we
redeemed $1.2 million of Preferred B Units and, on July 17, 1998, we used $13.8
million of the proceeds from our initial public offering to redeem all of the
remaining outstanding Preferred B Units.
Other expenses primarily consist of administrative expenses and other
operating costs incurred in connection with our business growth, as well as
directors fees and restricted stock granted to directors in connection with the
initial public offering.
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 our initial public offering, we became
subject to federal income taxes and state income taxes in New York, New Jersey
and other states. Actual income tax expense represents income taxes incurred
from July 13, 1998, the date of the reorganization, through December 31, 1998.
This period is referred to as the 1998 post-offering period. Our effective tax
rate for the 1998 post-offering period and pro-forma effective tax rate for all
periods prior to the 1998 post-offering period 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.
27
<PAGE>
Results of Operations
The following table sets forth the consolidated statement of income data
for the periods indicated as a percentage of total revenues:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Revenues
Net trading revenue................................ 99.1% 98.8% 97.9%
Commissions and fees............................... 0.2 0.3 1.1
Interest, net...................................... 0.7 0.9 1.0
------- ------- -------
Total revenues.................................. 100.0 100.0 100.0
------- ------- -------
Expenses
Employee compensation and benefits................. 21.3 25.5 30.3
Payments for order flow............................ 37.7 29.5 23.2
Execution and clearance fees....................... 14.0 14.1 12.8
Communications and data processing................. 2.4 3.0 3.1
Depreciation and amortization...................... 1.6 1.9 1.7
Occupancy and equipment rentals.................... 1.0 1.2 1.6
Professional fees.................................. 0.2 0.7 1.0
Business development............................... 0.3 0.6 0.7
Interest on Preferred Units........................ 1.1 0.9 0.2
Other.............................................. 0.6 0.5 0.6
------- ------- -------
Total expenses.................................. 80.2 77.9 75.2
------- ------- -------
Income before income taxes........................... 19.8 22.1 24.8
Income tax expense................................... 0.0 0.0 6.1
------- ------- -------
Net income........................................... 19.8% 22.1% 18.7%
======= ======= =======
Pro forma adjustment
Income before income taxes........................... 19.8 22.1 24.8
Pro forma income tax expense......................... 8.5 9.5 10.5
------- ------- -------
Pro forma net income................................. 11.3% 12.6% 14.3%
======= ======= =======
</TABLE>
Years Ended December 31, 1998 and 1997
Revenues
Net trading revenue increased 55.5% to $348.1 million in 1998, from $223.9
million in 1997. This increase was primarily due to higher trading volume,
particularly higher trade volume for OTC securities, which was offset in part
by lower average net revenue per trade. Total trade volume increased 101.8% to
40.9 million trades in 1998, from 20.3 million trades in 1997. Total share
volume increased 111.7% to 38.4 billion shares traded in 1998, from 18.1
billion shares traded in 1997. Average net revenue per trade decreased 23.0% to
$8.51 per trade in 1998, from $11.05 per trade in 1997, principally as a result
of the new Order Handling Rules, which were implemented during 1997, and the
reduction in the increments by which securities are quoted.
Commissions and fees increased 473.7% to $4.0 million in 1998, from
$700,000 in 1997. 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 76.1% to $3.6 million in 1998, from $2.0 million in
1997. 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 and short-term debt.
28
<PAGE>
Expenses
Employee compensation and benefits expense increased 87.1% to $108.0
million in 1998, from $57.7 million in 1997. As a percentage of net trading
revenue, employee compensation and benefits expense increased to 31.0% in 1998,
from 25.8% in 1997. The increase on a dollar basis and as a percentage of net
trading revenue was primarily due to increases in gross trading profits,
decreases in payments for order flow and execution and clearance costs and
growth in the number of employees. Due to increased net trading revenue and
profitability, profitability based compensation increased 91.6% to $86.2
million in 1998, from $45.0 million in 1997. The number of employees increased
to 446 employees as of December 31, 1998, from 317 employees as of December 31,
1997.
Payments for order flow increased 23.3% to $82.5 million in 1998, from
$66.9 million in 1997. As a percentage of net trading revenue, payments for
order flow decreased to 23.7% in 1998 from 29.9% in 1997. The increase in
payments for order flow on a dollar basis was primarily due to a 111.7%
increase in shares traded in 1998 to 38.4 billion shares, up from 18.1 billion
in 1997. The decrease in payments for order flow as a percentage of total
revenue resulted from changes in our order flow payment policy, changes in the
mix of market orders versus limit orders, and changes in customer mix. Payments
for order flow made to broker-dealer owners represented 69.3% of total payments
for order flow in 1998, a decrease from 75.7% in 1997.
Execution and clearance fees increased 42.1% to $45.6 million in 1998, from
$32.1 million in 1997. As a percentage of net trading revenue, execution and
clearance fees decreased to 13.1% in 1998 from 14.3% in 1997. The increase on a
dollar basis was primarily due to a 101.8% increase in trades in 1998, 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 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 59.6% to $10.9 million
in 1998, from $6.8 million in 1997. This increase was generally attributable to
higher trading volumes and an increase in the number of employees.
Depreciation and amortization expense increased 39.1% to $5.9 million in
1998, from $4.2 million in 1997. This increase was primarily due to the
purchase of approximately $8.9 million of additional fixed assets and leasehold
improvements during 1998 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 116.2% to $5.7 million in
1998, from $2.7 million in 1997. This increase was primarily attributable to
additional office space and increased computer equipment lease expense. We
occupied 80,718 square feet of office space at December 31, 1998, up from
56,351 square feet of office space at December 31, 1997.
Professional fees increased 112.3% to $3.4 million in 1998, up from $1.6
million in 1997. 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 60.1% to $2.3 million in 1998, from
$1.5 million in 1997. 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 decreased 63.2% to $715,000 in 1998, from $1.9
million in 1997. This decrease is primarily due to our redemption of all of the
remaining Preferred A and B Units during 1998.
29
<PAGE>
Other expenses increased 96.7% to $2.3 million in 1998, from $1.2 million
in 1997. This was primarily the result of directors fees, stock granted to
directors in connection with the initial public offering and increased
administrative expenses and other operating costs in connection with our
overall business growth.
Income Tax
Pro forma income tax expense was determined using effective tax rates of
42.5% and 43% for 1998 and 1997, respectively.
Years Ended December 31, 1997 and 1996
Revenues
Net trading revenue increased 22.0% to $223.9 million in 1997, from $183.5
million in 1996. This increase was primarily due to higher trading volume,
particularly higher trade volume for OTC securities, which was offset in part
by lower average net revenue per trade. Total trade volume increased 74.7% to
20.3 million trades in 1997, from 11.6 million trades in 1996. Total share
volume increased 68.5% to 18.1 billion shares traded in 1997, from 10.8 billion
shares traded in 1996. Average net revenue per trade decreased 30.2% to $11.05
per trade in 1997, from $15.82 per trade in 1996, principally as a result of
the new Order Handling Rules, which were implemented during 1997, and the
reduction in the increments by which securities are quoted.
Commissions and fees increased 78.7% to $705,000 in 1997 from $394,000 in
1996. This increase is primarily due to higher trade and share volumes from
institutional customers in listed securities.
Interest, net increased 59.0% to $2.0 million in 1997, from $1.3 million in
1996. 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 46.1% to $57.7 million
in 1997, from $39.5 million in 1996. As a percentage of net trading revenue,
employee compensation and benefits expense increased to 25.8% in 1997, from
21.5% in 1996. The increase on a dollar basis and as a percentage of net
trading revenue was primarily due to increases in gross trading profits,
decreases in payments for order flow and growth in the number of employees. Due
to increased net trading revenue and profitability, profitability based
compensation increased 44.2% to $45.0 million in 1997, from $31.2 million in
1996. The number of employees increased to 317 employees as of December 31,
1997, from 195 employees as of December 31, 1996.
Payments for order flow decreased 4.2% to $66.9 million, from $69.8 million
in 1996. As a percentage of net trading revenue, payments for order flow
decreased to 29.9% in 1997, as compared to 38.0% in 1996. The decrease in
payments for order flow on a dollar basis and as a percentage of total revenue
resulted from changes in our order flow payment policy, changes in the mix of
market orders versus limit orders, and changes in customer mix. Payments for
order flow made to broker-dealer owners and subordinated note holders
represented 75.7% of total payments for order flow in 1997, from 66.4% in 1996.
Execution and clearance fees increased 24.1% to $32.1 million in 1997, from
$25.8 million in 1996. As a percentage of net trading revenue, execution and
clearance fees remained relatively constant and were 14.3% of net trading
revenue in 1997 and 14.1% of net trading revenue in 1996. The increase on a
dollar basis was primarily due to increased trade volume, 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
30
<PAGE>
than transactions in listed securities. The increase in execution and
clearance fees as a percentage of net trading revenue was primarily due to the
decrease in the average net trading revenue per trade.
Communications and data processing expense increased 56.2% to $6.8 million
in 1997, from $4.4 million in 1996. This increase was generally attributable
to higher trading volumes, and an increase in the number of employees.
Depreciation and amortization expense increased 42.0% to $4.2 million in
1997, from $3.0 million in 1996. This increase was primarily due to the
purchase of approximately $4.8 million of additional fixed assets and
leasehold improvements during 1997 and the amortization of goodwill related to
the acquisition of the listed securities market-making business of Trimark.
Occupancy and equipment rentals expense increased 49.6% to $2.7 million in
1997, from $1.8 million in 1996. This increase was primarily attributable to
additional office space and increased computer equipment lease expense. We
occupied 56,351 square feet of office space at December 31, 1997, up from
47,598 square feet of office space at December 31, 1996.
Professional fees increased 325.0% to $1.6 million in 1997, up from
$379,000 in 1996. This increase was primarily due to increased consulting
expenses related to our investments in technology.
Business development expense increased 134.1% to $1.5 million in 1997,
from $623,000 in 1996. This increase was primarily the result of higher travel
and entertainment costs consistent with the growth in our business.
Interest on Preferred Units decreased 7.2% to $1.9 million in 1997, from
$2.1 million in 1996. This decrease was primarily due to our redemption and
retirement of 1,022,208 Preferred A Units in April 1997 for $10.2 million.
Other expenses increased 13.2% to $1.2 million in 1997, from $1.0 million
in 1996. This was primarily the result of increased office expenses and other
operating costs in connection with our business growth.
Income Tax
Pro forma income tax expense was determined using an effective tax rate of
43% for 1997 and 1996.
31
<PAGE>
Consolidated Quarterly Results
The following table sets forth certain unaudited consolidated quarterly
statement of income data, such data as a percentage of total revenues and
certain unaudited consolidated quarterly operating data for the years ended
December 31, 1997 and 1998. In the opinion of our management, this unaudited
information has been prepared on substantially the same basis as the
consolidated financial statements appearing elsewhere in this prospectus and
includes all adjustments (consisting of normal recurring adjustments) necessary
to present fairly the unaudited consolidated quarterly data. The unaudited
consolidated quarterly data should be read in conjunction with the audited
consolidated financial statements and notes thereto appearing elsewhere in this
prospectus. The results for any quarter are not necessarily indicative of
results for any future period.
<TABLE>
<CAPTION>
Quarter Ended
------------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
1997 1997 1997 1997 1998 1998 1998 1998
-------- -------- --------- -------- -------- -------- --------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues
Net trading revenue.... $50,425 $49,410 $57,831 $66,257 $62,967 $80,094 $89,962 $115,076
Commissions and fees... 57 246 229 169 40 156 1,351 2,496
Interest, net.......... 496 435 510 598 526 297 1,062 1,707
------- ------- ------- ------- ------- ------- ------- --------
Total revenues....... 50,978 50,091 58,570 67,024 63,533 80,547 92,375 119,279
------- ------- ------- ------- ------- ------- ------- --------
Expenses
Employee compensation
and benefits.......... 12,013 12,492 15,034 18,178 16,168 23,323 28,323 40,189
Payments for order
flow.................. 18,129 16,841 16,136 15,806 16,257 19,503 20,351 26,402
Execution and
clearance fees........ 6,411 6,873 8,576 10,209 10,241 10,189 11,773 13,361
Communications and
data processing....... 1,319 1,721 1,832 1,937 2,170 2,470 3,020 3,209
Depreciation and
amortization.......... 936 1,062 1,083 1,143 1,291 1,344 1,516 1,727
Occupancy and
equipment rentals..... 537 565 666 889 1,082 1,314 1,585 1,764
Professional fees...... 109 440 566 498 263 711 1,256 1,193
Business development... 245 432 321 462 377 612 607 741
Interest on Preferred
Units................. 604 477 435 425 416 262 37 0
Other.................. 256 297 294 340 484 362 824 664
------- ------- ------- ------- ------- ------- ------- --------
Total expenses....... 40,559 41,200 44,943 49,887 48,749 60,090 69,292 89,250
------- ------- ------- ------- ------- ------- ------- --------
Income before income
taxes................. 10,419 8,891 13,627 17,137 14,784 20,457 23,083 30,029
Income tax expense/pro
forma income tax
expense (1)............ 4,480 3,823 5,860 7,369 6,357 8,797 9,926 12,492
------- ------- ------- ------- ------- ------- ------- --------
Net income/pro forma net
income................ $ 5,939 $ 5,068 $ 7,767 $ 9,768 $ 8,427 $11,660 $13,157 $ 17,537
======= ======= ======= ======= ======= ======= ======= ========
Revenues
Net trading revenue.... 98.9% 98.6% 98.7% 98.9% 99.1% 99.4% 97.4% 96.5%
Commissions and fees... 0.1 0.5 0.4 0.2 0.1 0.2 1.5 2.1
Interest, net.......... 1.0 0.9 0.9 0.9 0.8 0.4 1.1 1.4
------- ------- ------- ------- ------- ------- ------- --------
Total revenues....... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
------- ------- ------- ------- ------- ------- ------- --------
Expenses
Employee compensation
and benefits.......... 23.6 24.9 25.7 27.1 25.4 29.0 30.7 33.7
Payments for order
flow.................. 35.6 33.6 27.5 23.6 25.6 24.2 22.0 22.1
Execution and
clearance fees........ 12.6 13.7 14.6 15.2 16.1 12.6 12.7 11.2
Communications and
data processing....... 2.6 3.4 3.1 2.9 3.4 3.1 3.3 2.7
Depreciation and
amortization.......... 1.8 2.1 1.8 1.7 2.0 1.7 1.6 1.4
Occupancy and
equipment rentals..... 1.0 1.1 1.2 1.3 1.7 1.6 1.7 1.5
Professional fees...... 0.2 1.0 1.0 0.7 0.4 0.9 1.4 1.0
Business development... 0.5 0.9 0.5 0.7 0.6 0.8 0.7 0.6
Interest on Preferred
Units................. 1.2 1.0 0.8 0.6 0.7 0.3 0.0 0.0
Other.................. 0.5 0.6 0.5 0.6 0.8 0.4 0.9 0.6
------- ------- ------- ------- ------- ------- ------- --------
Total expenses....... 79.6 82.3 76.7 74.4 76.7 74.6 75.0 74.8
------- ------- ------- ------- ------- ------- ------- --------
Income before income
taxes................. 20.4 17.7 23.3 25.6 23.3 25.4 25.0 25.2
Income tax expense/pro
forma income tax
expense (1)............ 8.8 7.6 10.0 11.0 10.0 10.9 10.8 10.5
------- ------- ------- ------- ------- ------- ------- --------
Net income/pro forma net
income................ 11.6% 10.1% 13.3% 14.6% 13.3% 14.5% 14.2% 14.7%
======= ======= ======= ======= ======= ======= ======= ========
Other Operating Data
Total shares traded (in
millions).............. 3,393 3,594 5,025 6,111 7,406 9,477 9,471 12,018
Total trades executed... 3,780 4,141 5,550 6,793 7,572 9,016 10,510 13,796
Average daily trades.... 63 65 88 103 124 143 164 216
Average daily net
trading revenues....... $ 840 $ 772 $ 918 $ 1,004 $ 1,032 $ 1,271 $ 1,406 $ 1,798
</TABLE>
- --------
(1) Before our initial public offering, we were a limited liability company and
were not subject to income taxes. For the six quarters ended June 30, 1998,
pro forma income taxes were computed based on an effective tax rate of 43%.
Of the $9,926 in income taxes for the quarter ended September 30, 1998, $667
represents pro forma income taxes for the period from July 1, 1998 through
July 12, 1998, and $9,259 represents actual income taxes for the period from
July 13, 1998 through September 30, 1998. The entire income tax amount of
$12,492 for the quarter ended December 31, 1998 represents actual income
taxes. See Note 12 of the Notes to the Consolidated Financial Statements.
32
<PAGE>
We have recently experienced a significant increase in our trading volume.
We believe that this increase in trading volume has been due largely to a very
high level of retail demand by on-line investors for Internet-related
securities. This high retail demand for Internet-related securities has
resulted in unprecedented fluctuations and volatility in such securities. These
fluctuations have had a direct impact on our operating results and have, on
occasion, caused significant fluctuations in our intra-day profits and losses.
The continued volatility in the securities markets, particularly in Internet-
related securities, could result in significant trading losses and, therefore,
could have a material effect on our business, financial condition and operating
results.
We have experienced and expect to continue to experience, significant
fluctuations in quarterly operating results as a result of a variety of
factors, including the value of our securities positions and our ability to
manage the attendant risks, the volume of our market-making activities,
volatility in the securities markets, our ability to manage personnel, overhead
and other expenses, the amount of revenue derived from limit orders as a
percentage of total revenues, changes in payments for order flow, clearing
costs, the addition or loss of sales and trading professionals, regulatory
changes, the amount and timing of capital expenditures, the incurrence of costs
associated with acquisitions and general economic conditions. Our expense
structure is based on historical expense levels and the levels of demand for
our market-making services. If demand for our market-making services declines
and we are unable to adjust our cost structure on a timely basis, it could have
a material adverse effect on our business, financial condition and operating
results. We have experienced, and may experience in the future, significant
variations in our business from season to season. We have historically
experienced an increase in revenues in the fourth quarter of the year, which we
believe is due, in large part, to higher trading volumes in the securities
markets at year end. We believe that this seasonal trend will continue for the
foreseeable future and that our business, financial condition and operating
results may be affected by such trends in the future.
Due to all of the foregoing factors, period-to-period comparisons of our
revenues and operating results are not necessarily meaningful and reliance upon
these comparisons as indicators of future performance should be avoided. We
cannot assure you that we will be able to sustain the rates of revenue growth
that we experienced in the past, that we will be able to improve our operating
results or that we will be able to sustain our profitability on a quarterly
basis. See "Risk Factors--Our Business is Highly Volatile; Our Quarterly
Results May Fluctuate Significantly."
Liquidity
Historically, we have financed our business primarily through cash
generated by operations, as well as the proceeds from our initial public
offering, the private placement of preferred and common units and borrowings
under subordinated notes. As of December 31, 1998, we had $358.9 million in
assets, 91% 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.
Pro forma net income plus depreciation and amortization was $56.7 million,
$32.8 million and $23.9 million during 1998, 1997 and 1996, respectively.
Depreciation and amortization expense, which related to fixed assets and
goodwill, was $5.9 million, $4.2 million and $3.0 million during 1998, 1997 and
1996, respectively. Capital expenditures were $8.9 million in 1998, $4.4
million in 1997 and $3.9 million in 1996, or 2.5%, 2.3% and 2.1% of total
revenues in each year, respectively. Capital expenditures in 1998 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 $4.1 million, $2.4 million and
$1.4 million in 1998, 1997 and 1996, respectively, in connection with our
acquisitions of the listed securities market-making businesses of Trimark in
1995 and Tradetech in 1997. The aggregate minimum rental commitments for 1999
are $5.8 million, and we expect to incur $9 million of capital expenditures
during 1999, which will be incurred for substantially similar purposes to those
referenced above for 1998. We anticipate that we will meet our 1999 capital
expenditure needs out of operating cash flows.
33
<PAGE>
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 ($1.9 million and
$1.0 million, respectively as of December 31, 1998). 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 December 31, 1998, Knight
had net capital of $81.0 million, which was $79.1 million in excess of its
required net capital of $1.9 million and Trimark had net capital of $28.5
million, which was $27.5 million in excess of its required net capital of $1.0
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. The Preferred A and B Units bore interest at a rate approximating the
Federal Funds rate. The Preferred A Units were redeemed and retired in their
entirety in April 1998 for approximately $12.5 million in cash. In April 1998,
we redeemed a portion of the Preferred B Units for approximately $1.2 million
in cash. We used $13.8 million of the proceeds of our initial public offering
to redeem all of the remaining outstanding Preferred B Units on July 17, 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 net proceeds from this offering together with
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.
Market Risk
On January 28, 1997, the SEC adopted new rules (Securities Act Release No.
7386) that require disclosures about the policies used to account for
derivatives, and certain quantitative and qualitative information about market
risk exposures. Since its inception, neither Knight/Trimark nor any of its
subsidiaries has traded or otherwise transacted in derivatives.
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
December 31, 1998 and 1997 was $100.5 million and $61.7 million, respectively,
in long positions and $108.9 million and $21.1 million, respectively, in short
34
<PAGE>
positions. The potential change in fair value, using a hypothetical 10.0%
decline in prices, is estimated to be a $0.8 million gain and a $4.0 million
loss as of December 31, 1998 and 1997, respectively, 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.
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
systems and software products 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 its 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 participated in the Securities
Industry Association "streetwide" testing in June 1998 and plan to participate
in the March 1999 Securities Industry Association test. We presently believe
that our main trading-related systems are currently Year 2000 compliant. We
will require vendors of material hardware and software components of our IT
systems to provide assurances of their Year 2000 compliance. We plan to
complete this process during the first half of 1999. We are currently assessing
the materiality of our non-IT systems and will seek assurances of Year 2000
compliance from providers of material non-IT systems. Until such testing is
complete and such vendors and providers are contacted, we will not be able to
completely evaluate whether our IT systems or non-IT systems will need to be
revised or replaced.
Costs. To date, we have incurred approximately $350,000 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.
Although we do not anticipate that any additional amounts above this estimate
will be material, such expenses, if higher than anticipated, could have a
material adverse effect on our business, financial condition and operating
results.
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. Our failure to fix our main trading-related,
communications or data processing systems or to fix or replace third-party
software, hardware or services on a timely basis could result in lost revenues,
increased operating costs, the loss of customers and other business
interruptions, any of which could have a material adverse effect on our
business, financial condition and operating results. 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.
35
<PAGE>
In addition, we cannot assure you that governmental agencies, utility
companies, securities exchanges, Internet access companies, third-party service
providers 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 have not yet developed 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.
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.
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<PAGE>
BUSINESS
OVERVIEW
We are the leading market maker in Nasdaq securities and in the Third
Market, which is the over-the-counter market in exchange-listed equity
securities, primarily those listed on the NYSE and the AMEX. Market makers
typically hold themselves out to execute trades by offering to buy or sell
securities for their own account. We have attained our leadership position as a
market maker by providing best execution services to broker-dealer and
institutional customers through our sophisticated trading systems and methods.
Through our wholly-owned subsidiary, Knight, we make markets in approximately
6,700 equity securities in Nasdaq and on the OTC Bulletin Board of the NASD.
Through our wholly-owned subsidiary, Trimark, we make markets in all NYSE- and
AMEX-listed equity securities in the Third Market.
Since our inception in 1995, we have significantly increased our market
share of trading volume in the markets in which we participate:
. Based on data from 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 achieved a #1
market share ranking of volume in Nasdaq in February 1998. Additionally,
Knight has further increased its volumes and its market share since that
time. The advertised volume of Nasdaq shares traded by Knight increased
from 614.7 million shares in January 1997 to 3.2 billion shares in
December 1998. During the same period, Knight's market share more than
tripled from 4.4%, or a rank of 6th overall, to 15.6% or a rank or 1st
overall.
. According to the NASD, Trimark has held the #1 market share ranking in
the trading of NYSE-listed securities for over two years. Additionally,
Trimark has increased its volumes and its market share over the same
period. Trimark's trading volume of NYSE-listed securities has increased
from 234.3 million shares in January 1997 to 644.0 million shares in
December 1998. During the same period, Trimark's market share
approximately doubled from 21.2% to 40.4%.
. According to the NASD, Trimark has also held the #1 market share ranking
in the trading of AMEX-listed securities for over two years.
Additionally, Trimark has further increased its volumes and its market
share over the same period. Trimark's trading volume of AMEX-listed
securities has increased from 40.3 million shares in January 1997 to
65.7 million shares in December 1998. During this same period, Trimark
increased its market share from 51.4% to 61.7%.
INDUSTRY BACKGROUND
During recent years, the U.S. market for equity securities has experienced
dramatic growth in trading volumes. The average daily volume of securities
traded in Nasdaq increased from 225.0 million shares in December 1992 to 867.1
million shares in December 1998. The average daily volume of securities traded
on the NYSE increased from 222.2 million shares in December 1992 to 692.8
million shares in December 1998. During this period, the average daily trading
volume of the Third Market, which consists of trading in NYSE- and AMEX-listed
securities in the OTC market, also increased significantly. The increase in
trading volume has resulted from a number of factors, including:
.increased cash flows into equity-based mutual funds;
.historic high returns in U.S. equity markets;
.the emergence and rapid growth of on-line discount brokers;
.technological innovations, like the emergence of the Internet; and
.reduced transaction costs.
In addition, due to favorable market conditions, companies have
increasingly raised capital through the U.S. equity markets, which has resulted
in a significant increase in the number of companies that are quoted in Nasdaq
or listed on the NYSE. At December 31, 1998, there were approximately 5,100 and
3,114 companies, respectively, quoted in Nasdaq and listed on the NYSE, as
compared to approximately 4,100 and 2,008 at December 31, 1992.
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The retail brokerage business has been impacted by advances in technology
that have provided new and inexpensive means for individual investors to access
and participate in the market for equity securities. For example, the Internet
has facilitated individual investors' access to market information and has
significantly reduced transaction costs. The proliferation of Internet brokers
has resulted in dramatically lowered commissions charged for trading
securities. While handling an increasing number of trades for a wide range of
securities, Internet brokers provide more immediate access to the market place
than many other retail brokers. Additionally, mutual funds and other
institutional investors are also demanding better execution of their trades and
are seeking to reduce trading costs. The Internet brokerage business model and
the demands of institutional investors have forced traditional brokers to
change their approach to their business and seek ways to manage increased
trading volumes while providing improved trade execution and reducing costs.
These changes have caused significant pressure on market makers, a critical
and lesser known part of the securities industry. Market makers typically
provide trade executions by offering to buy securities from, or sell securities
to, broker-dealers and institutional investors. Firms that have elected to make
a market in a security display the price at which they are willing to bid,
meaning buy, or ask, meaning sell, these securities and adjust their bid and
ask prices in response to the forces of supply and demand for each security.
Market makers are either a department within larger, diversified securities
firms or independent businesses. The internal market-making departments of
securities firms often are limited in their ability to handle significant
trading volumes in a broad range of securities. Most discount brokers and on-
line brokers do not have internal market-making functions and, accordingly,
rely entirely on independent market makers for trade execution.
A market maker typically acts as principal and derives most of its revenues
from the difference between the price paid when a security is bought and the
price received when that security is sold. In the past, market makers relied on
the spreads between bid and ask prices to ensure profitability and built cost
structures based on these spreads. However, changes in regulations governing
the securities industry and, to a lesser extent, the quoting of sixteenths
rather than eighths of a dollar, have dramatically reduced average spreads.
Implemented in January 1997, the SEC's Limit Order Display Rule requires the
display or execution of customer orders to buy or sell stock at a particular
price, commonly referred to as limit orders, that (1) are priced better than a
market maker's quote or (2) in certain circumstances add to the size associated
with the market maker's quote when the market maker is at the best price in the
market. The Limit Order Display Rule enables investors to advertise directly
their trading interest to the market, allowing them to compete with market
maker quotes and affect the size of bid-ask spreads. Additional regulations
adopted by the NASD require market makers to fill a customer's limit order
before their own trades. Since the implementation of the Limit Order Display
Rule and the move to trading in sixteenths of a dollar, Nasdaq and NYSE spreads
have each significantly decreased. Spreads could further decline if Nasdaq
adopts proposed regulations under which securities would be traded in decimals
rather than in fractions.
In this new narrower spread environment, maintaining profitability has
become extremely difficult for many traditional market makers. At the same
time, market makers have become subject to an increasing demand for better
execution standards and improved customer service. To meet these demands and
remain competitive, market makers have been forced to reexamine their
traditional spread-based approach to market making and to make extensive
technological and human resource investments. To leverage these large
investments and to remain profitable, market makers must execute a larger
volume of trades and maintain increased inventory positions. However, the
significant increases in trading volumes are only a benefit for the market
maker if its cost per trade is lower than its revenues per trade and if the
market maker is able to manage the risks associated with larger inventory
positions.
In response to these challenges, traditional brokerage firms are
increasingly electing to focus on their core competencies and to outsource
their market-making functions to independent market makers. In addition,
Internet brokers, who are handling increased trading volume, also utilize
independent market makers. According to The AutEx Group, in December 1998, the
three largest independent market makers represented a combined market share of
28% of the trading volumes of OTC equity securities, up from 17% in March 1997.
Similarly, according to the NASD, in December 1998 the three largest Third
Market trading firms represented a
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<PAGE>
combined market share of 56% of the Third Market volume in NYSE-listed equity
securities compared to 42% in June 1997. The three largest Third Market trading
firms in AMEX-listed securities represented a combined market share of 59% in
December 1998 compared to 55% in June 1997. While large volumes of trading
provides an opportunity to spread fixed costs over a larger number of trades,
net profit per trade has declined. In addition, significant volatility in
equity markets, particularly in Internet stocks, has led to significant
fluctuations in the profitability in trading such stocks for market makers. In
response to tightening spreads and increasing volatility in the equity markets,
many market makers are seeking new trading methodologies to identify and take
advantage of the profit opportunities represented by each trade. These market
makers are also seeking to increase the number of buy and sell orders that they
receive, commonly referred to as order flow. This increased order flow will, in
turn, provide increased trading profit opportunities. These market makers
require efficient and sophisticated systems and risk management practices and
personnel with the requisite expertise to deliver superior trade execution and
customer service, while handling increased order flow and maintaining low costs
per trade.
The Knight/Trimark Solution
We are the leading market maker in Nasdaq securities, other OTC equity
securities and equity securities listed on the NYSE and the AMEX in the Third
Market. We have attained our leadership position by providing best execution
services to broker-dealer and institutional customers through our sophisticated
trading systems and methods. Under the NASD Conduct Rules, best execution
requires broker-dealers to buy and sell securities in a manner that provides
the customers with a price as favorable as possible under prevailing market
conditions. Through Knight, we make markets in approximately 6,700 equity
securities in Nasdaq and on the NASD's OTC Bulletin Board. Through Trimark, we
make markets in all NYSE-and AMEX-listed equity securities in the Third Market.
We are committed to providing a superior execution methodology that emphasizes
automated execution and rule compliance, real-time information access to
customers and pricing plus liquidity advantages based upon our willingness to
commit capital. While most of our trades are automatically executed
electronically, automatic execution is highly dependent on the determination
and manual entry of bid-ask prices by traders. Furthermore, our trading
revenues depend significantly on the management of inventory by our skilled and
experienced trading professionals. The main elements of our solution include:
.Superior Execution and Enhanced Liquidity. We have implemented a variety
of best execution practices that provide our customers with
significantly enhanced liquidity. These practices include the following:
Knight
--Knight provides guaranteed, automated, electronic, continuous
execution at the National Best Bid or Offer, commonly referred to as
NBBO, or better for over 4,800 Nasdaq securities in which it makes
markets for orders of up to 1,000-2,000 shares on quotes as low as 100
shares.
--Knight guarantees to execute, at the opening NBBO, all market-eligible
orders it has received before 9:25 a.m. for all issues in which it
makes a market, up to an aggregate of 250,000 shares.
--Knight guarantees that it will execute trades at the opening NBBO for
substantially all Nasdaq initial public offerings, up to an aggregate
of 250,000 shares.
--Knight has considerable expertise in handling large trades and, in
December 1998, it executed 59,256 trades of 5,000 shares or greater.
--Knight was the first market maker to accept stop orders on all Nasdaq
stocks. A stop order is an order to buy/sell a security immediately if
the security's market price falls/rises to a specified price.
To address the recent volatility in the equity markets, particularly
attributable to companies that sell products or services via the Internet,
Knight has established certain procedures that enable it to reduce or suspend
its automatic execution guarantees during periods of abnormal volatility and
volume in a particular stock or group of stocks. See "--Risk Management."
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Trimark
--Trimark guarantees to provide automated, electronic, continuous
execution in every NYSE- and AMEX-listed equity security at the NBBO
for all orders eligible for automated execution.
--Trimark accepts all orders that can be sent to a primary exchange,
i.e., short sale, all or none, or stop order.
--Trimark provides execution for orders up to 5,000 shares at the NBBO
regardless of the quote's size for a select group of approximately 500
of the most actively traded stocks.
--Trimark not only guarantees the customer's market order to receive the
best price available on any exchange or by any competing market maker,
but Trimark frequently delivers that price for many more shares than
advertised if requested by a customer.
--Trimark offers various proprietary features such as limit order
protection (based on the primary exchange price) and price improvement
guarantees.
.Sophisticated Trading Technology. We rely on sophisticated technology to
facilitate our market-making activities. Knight uses the Brass trading
system under license from Automated Securities Clearance. Brass is used
by over 130 market makers. Knight is one of only three Brass users to
run Brass on its own computers with its own personnel, while other
market makers use Automated Securities Clearance as a service bureau.
Trimark employs a TCAM/Appletree trading system. We have made
significant investments in our technology platform and infrastructure
since our inception. Our trading systems are augmented by software
applications that enable the processing of a large volume of order flow
efficiently, without diminishing speed of execution. Knight's systems
are designed to process up to 500,000 trades per day and in December
1998 handled an average of 170,000 trades per day. Trimark's systems are
designed to process up to 150,000 trades per day and in December 1998
handled an average of 75,000 trades per day. We continue to invest in
technology to enhance further our processing capability.
.Superior Trading Methods. Our net trading revenues are dependent on our
ability to evaluate and act rapidly on market trends and manage risk
successfully. Our methodology focuses on the dynamic, real time analysis
of market activity and price movements, which enables us to manage risk
better. Throughout the business day, we continually analyze our trading
positions in individual securities and monitor our short and long
positions and our aggregate profits and losses. Management uses this
information to assess market trends and adjust its trading strategy on a
real-time basis in an effort to maximize its trading profits.
.Commitment to Highest Quality Customer Service. We are committed to
providing the highest quality customer service. We believe that our
highly skilled, experienced and entrepreneurial workforce can
effectively address the needs of our customers. We have over 50
experienced employees involved in customer service. Our customer service
group is dedicated to handling orders greater than the automated
execution size and ensuring consistent quality of execution.
We are currently implementing our proprietary electronic communications
gateway product, e.Knight, which enables broker-dealers and institutions
to access from their desktops the Knight and Trimark trading systems
through the Internet and other electronic communications gateways. The
access afforded by e.Knight permits broker-dealers and institutions the
ability not only to enter and cancel orders, but also to ascertain the
status of orders, filled or unfilled. In addition, e.Knight provides a
backup service to certain of our customers. If a customer's system
fails, e.Knight is designed to provide the customer with uninterrupted
access to our trading systems, which enables the customer to continue to
provide services to its clients.
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We supply each of our customers with monthly execution reports that
provide a level of detail exceeding regulatory requirements. The report
documents the percentage of price-improved shares and trades, the
average dollar value per share and the total dollar value of all price
improvements. This report is a valuable tool to our customers as it
enables them to monitor their compliance with regulatory requirements to
seek to obtain best execution for their clients' trades.
Strategy
Our goal is to maintain and enhance our leadership position in the market-
making industry through the following key strategies:
Continue to Invest in Leading Technologies. We believe that our future
growth and profitability will depend largely on our continued investment in
leading technologies. For example, we believe that an increasing number of
customers and proportion of order flow will reach market makers through the
Internet and other electronic communications gateways. We intend to expand into
this growing market segment by increasing the number of customers with access
to e.Knight and by examining other possible electronic means of capturing order
flow. We also intend to augment our Brass and TCAM/Appletree trading systems
with customized software applications, and enter into strategic joint ventures
with leading technology firms to develop new state-of-the-art trading platforms
to ensure that we have the capability to process significantly greater trading
volumes in the future.
Aggressively Capture New Order Flow. We believe that extensive order flow
is critical to creating opportunities for trading revenues. We are focused on
increasing order flow to enhance our position as a leading market maker and
create additional revenue opportunities. We intend to retain and expand
customer relationships by continuing to provide low-cost, high quality
execution services, and intend to continue to respond to evolving customer
needs through the development of new services and customer service excellence.
Significantly Expand Institutional Market Share. We believe we have an
opportunity to significantly increase our institutional customer base. Trades
for institutional investors generally have higher margins because these
investors generally do not receive payments for order flow. We are seeking to
increase our penetration of this market by marketing e.Knight to institutions
that manage more than $1 billion in assets and invest predominantly in equity
securities. By the end of 1999, we plan to hire an additional 25 institutional
sales professionals, which will bring our total institutional sales force to
over 50 professionals.
Invest in and Develop the Best Human Capital. We believe that investing in
human capital is key to delivering best execution practices and high quality
customer service. We intend to continue our practice of aggressively recruiting
high caliber personnel and retaining these personnel by providing appropriate
compensation incentives. We believe that we have high employee morale due to
our competitive performance-based incentive compensation structure and our
encouragement of a highly cooperative and creative culture. In addition, Knight
has its own in-house training program for trading staff, Knight School, which
provides ongoing training and skill-development to Knight's sales and trading
personnel. We intend to expand this initiative and to develop additional
programs to improve the skills and productivity of its workforce.
Expand Internationally. As part of our strategy to increase our
institutional sales market share, we recently established a London-based
subsidiary, Knight Securities International. Knight Securities International
will initially arrange transactions between institutional customers and Knight.
In October 1998, Knight Securities International filed an application for
authorization with The Securities and Futures Authority, and expects to
commence operations in the second quarter of 1999. We believe that developing a
sales presence in Europe will allow us to expand more rapidly our institutional
customer base.
Develop New Services. We intend to continue to develop new services that
address evolving customer needs and technological requirements. We recently
launched e.Knight, which we plan to provide to the majority of our
institutional and broker-dealer customers and use as a means of establishing
new customer relationships.
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Additionally, we hold a minority stake in Adirondack Trading Partners, the
funding vehicle for the International Securities Exchange which, upon approval
by the SEC, will be the first entirely electronic options market in the United
States. In the future, we may establish and capitalize a subsidiary to focus on
opportunities to become a primary market maker on the International Securities
Exchange. However, we currently do not have any commitments or agreements in
this regard.
Market Share Information
Since the beginning of 1997, Knight and Trimark have significantly
increased their market share of trading volume in each of their respective
markets. Knight's market share is based on rankings published by The AutEx
Group, a widely recognized industry reporting service that provides daily
trading volume and market share statistics for broker-dealer market makers,
based on data provided by the market makers themselves.
<TABLE>
<CAPTION>
Percentage of Total Number
Advertised Share Total Market of OTC
Month Ended Volume Share Rank Stocks Traded Rank
- ----------- ---------------- ------------- ---- ------------- ----
(in thousands)
<S> <C> <C> <C> <C> <C>
1998
- ----
December................. 3,226,587 15.57% 1 6,275 2
November ................ 2,562,152 13.88 1 6,032 2
October ................. 2,149,187 10.46 1 5,984 2
September................ 1,844,526 10.83 1 5,941 2
August................... 1,853,938 11.04 1 6,009 2
July..................... 2,166,178 11.49 1 5,904 2
June..................... 1,864,020 10.50 1 5,631 2
May...................... 1,985,235 12.18 1 5,828 2
April.................... 2,096,261 11.36 1 6,161 2
March ................... 1,856,972 9.91 1 6,497 1
February................. 1,451,983 8.95 1 5,954 2
January.................. 1,125,939 7.50 2 5,873 2
1997
- ----
December ................ 1,248,282 8.11% 2 6,174 2
November ................ 993,276 8.20 2 5,710 2
October.................. 1,396,968 7.14 2 5,997 2
September................ 1,073,493 6.99 2 5,651 1
August................... 890,829 6.39 3 5,386 1
July..................... 859,161 5.84 3 5,395 1
June..................... 671,845 5.22 5 5,131 1
May...................... 651,441 4.93 6 5,013 1
April.................... 636,927 4.99 6 4,884 1
March ................... 562,336 4.67 6 4,938 1
February................. 572,895 4.72 6 4,963 1
January.................. 614,692 4.38 6 4,952 1
</TABLE>
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Trimark's market share is based on trade volumes and statistics provided by
the NASD.
<TABLE>
<CAPTION>
Third Market Volume in
-------------------------------------------------------------------
NYSE Securities AMEX Securities
--------------------------------- ---------------------------------
Percentage of Percentage of
Total Market Total Market
Month Ended Share Volume Share Rank Share Volume Share Rank
- ----------- ------------ ------------- ---- ------------ ------------- ----
(in (in
thousands) thousands)
<S> <C> <C> <C> <C> <C> <C>
1998
- ----
December... 644,029 40.43% 1 65,675 61.68% 1
November... 571,101 40.32 1 41,099 54.94 1
October.... 557,704 35.75 1 41,491 41.34 1
September.. 446,304 31.94 1 36,567 55.36 1
August..... 446,207 32.99 1 44,237 60.98 1
July....... 438,269 32.95 1 52,632 63.23 1
June....... 342,106 29.11 1 46,076 57.42 1
May........ 344,837 30.84 1 60,098 64.77 1
April...... 438,226 32.59 1 73,971 70.31 1
March...... 445,662 33.10 1 80,443 68.90 1
February .. 383,719 34.40 1 70,301 69.10 1
January.... 337,126 29.20 1 58,427 69.00 1
1997
- ----
December... 338,433 30.50% 1 78,793 66.40% 1
November... 247,468 28.50 1 59,410 64.90 1
October.... 647,815 29.20 1 84,323 65.80 1
September.. 262,594 25.70 1 58,731 57.90 1
August..... 238,652 24.10 1 40,517 52.10 1
July....... 251,631 22.50 1 42,540 46.70 1
June....... 216,472 20.70 1 33,554 44.00 1
May........ 202,036 20.70 1 27,629 42.00 1
April...... 180,502 20.60 1 23,666 41.50 1
March...... 181,938 20.20 1 25,088 43.10 1
February .. 209,402 22.40 1 25,807 46.50 1
January.... 234,291 21.20 1 40,271 51.40 1
</TABLE>
Electronic Communications Network
An electronic communications network, commonly referred to as an ECN, is
defined by the SEC as "any electronic system that widely disseminates to third
parties orders entered therein by an exchange market maker or OTC market maker
and permits such orders to be executed against, in whole or in part." ECNs are
private trading systems used by institutional investors and broker-dealers.
ECNs provide investors with the ability to trade securities anonymously and to
obtain immediate displays of their limit orders. ECNs, however, merely provide
a neutral forum in which third parties can display and match their limit
orders. As ECNs do not buy or sell securities as principal, they cannot provide
enhanced liquidity to investors.
We entered into a joint venture with Automated Securities Clearance, the
developer and owner of the Brass order entry and trading system, to establish
an ECN, The Brass Utility, L.L.C., commonly referred to as BRUT. Subsequent to
this development, three other securities firms invested in this joint venture.
We now own 14% of the joint venture and believe that providing investors access
to the BRUT ECN will greatly enhance the breadth of our execution services.
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CUSTOMERS
Our target customers are national and regional full-service broker-dealers,
on-line discount brokers and institutional investors. A number of our customers
own shares of our Class A common stock and Class B common stock. See "Certain
Transactions with Affiliates." The following table presents a representative
list of our broker-dealer customers.
<TABLE>
<S> <C>
Ameritrade Inc. Josephthal & Co. Inc.
BHC Securities, Inc. Merrill Lynch, Pierce, Fenner & Smith Incorporated
BHF Securities Corp. Mesirow Financial
Bidwell & Company Nathan & Lewis Securities, Inc.
Brown & Company Securities Corporation National Discount Brokers
Burke, Christensen & Lewis Securities, Inc. National Financial Services Corporation
CIBC Wood Gundy Securities Corp. PaineWebber Incorporated
Cowles, Sabol & Co., Inc. Primevest Financial Services, Inc.
Dain Rauscher Incorporated The R.J. Forbes Group, Inc.
David A. Noyes & Co. Sanders Morris Mundy, Inc.
Direct Access Brokerage Services, Inc. Scottsdale Securities, Inc.
Discover Brokerage Direct, Inc. Southwest Securities, Inc.
E*TRADE Securities, Inc. Stockcross, Inc.
A.G. Edwards & Sons, Inc. Thomas F. White & Co.
Fiserv Correspondent Services, Inc. U.S. Clearing Corp.
Howe Barnes Investments, Inc. Van Kasper & Company
International Correspondent Trading, Inc. Waterhouse Securities, Inc.
J.W. Charles Securities, Inc. Wedbush Morgan Securities, Inc.
</TABLE>
In addition, we currently have over 500 institutional customers, including
mutual funds, investment advisors, pension plan sponsors, bank trusts,
foundations and endowments.
In 1998, our five largest customers, Ameritrade, Brown & Company, Discover
Brokerage Direct, E*TRADE Securities and Waterhouse Securities, accounted for,
in aggregate, 33.0% of our order flow. In 1998, one of our customers,
Waterhouse Securities, accounted for 10.7% of the Company's order flow.
MARKETING
We seek to increase our market share through direct-response advertising,
advertising on our Web site and a public relations program. Our marketing
focuses on advertising our execution services in publications targeted at the
securities industry. In addition, we have a quarterly program of targeted
mailings to existing and potential broker-dealer and institutional customers.
We also market aggressively through one-on-one meetings with customers and
potential customers, and continuous communications with existing customers. We
maintain a comprehensive customer database that is used regularly to better
understand and address customer needs. Our marketing strategy is to continue to
differentiate Knight/Trimark from competitors by enhancing its reputation and
brand as the provider of highest quality execution solutions with superior
customer service.
CLEARING ARRANGEMENTS
By contract, Knight clears all of its trades through Correspondent Services
Corp., a subsidiary of PaineWebber. The contract will remain in effect until
terminated by either party upon sixty days' prior written notice or upon thirty
days' written notice in certain limited circumstances. Trimark clears all of
its trades through National Investor Services Corp., a subsidiary of Waterhouse
Investor Services, Inc. The contract will remain in effect until terminated by
either party upon sixty days' prior written notice. See "Certain Transactions."
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Technology
Our success is largely attributable to management's ability to identify and
deploy emerging technologies that facilitate the execution of trades.
Technology has not only enhanced our ability to handle order flow, it has also
been an important component of our strategy to comply with government
regulations, achieve the highest execution standards and provide superior
customer service. We also use our technology and technology licensed from third
parties to monitor proactively the performance of our traders, to assess our
inventory positions and to provide ongoing information to our customers. We are
electronically linked to our broker-dealer and institutional customers through
dedicated servers. Our trading volume is transacted over dedicated
communications networks, which provide immediate access to our trading
operations and facilitate the handling of customer orders. We plan to continue
to make additional investments in technology and to automate further our
execution services.
Architectural Design and Industry Standards. Our systems are designed to be
open, interoperable, scalable, redundant and flexible. We utilize leading edge
technologies including Sun Microsystems, Inc.'s client/server architecture,
C/C++ programming languages, Java, relational database management systems and
on-line analytical processing.
Electronic Commerce. Our electronic commerce architecture enables our
broker-dealer and institutional customers to send their orders through a
variety of electronic communications gateways, including the Internet and
direct customer interfaces over our private network. Our customers can use
their own order management system, an institutional portfolio management system
or can select from a variety of our electronic connections.
Knight uses the Brass trading system designed by Automated Securities
Clearance. This system has a client/server architecture that uses Sun
Microsystem Inc. workstations and servers. Knight runs a local version of
Brass. Knight also makes extensive use of application program interfaces,
commonly known as APIs, to develop software applications. Trimark uses the
Appletree trading system designed by TCAM. This system runs on Stratus Computer
Inc.'s fault tolerant platform. Trimark has also developed software
applications using APIs.
Disaster Recovery Center. We are in the process of establishing a back-up
data center and trading facility in Ridgefield, New Jersey. This facility will
be used primarily to accommodate traders if a disaster or major system
malfunction occurs. This back-up data center will run a real-time copy of our
trading systems and house a small group of market makers. To provide for system
continuity in the event of short power outages, we have also equipped our three
data centers and trading rooms with uninterruptible power supply units and back
up generators.
Competition
We derive substantially all of our revenues from market-making activities.
The market for these services, particularly market-making services through
electronic communications gateways, is rapidly evolving and intensely
competitive. We expect competition to continue and intensify in the future.
Knight competes primarily with wholesale, national, and regional broker-
dealers, as well as ECNs, which are third party trading systems, typically
operated by broker-dealers. Trimark competes with the NYSE, the AMEX, regional
exchanges, Third Market competitors and ECNs. We compete primarily on the basis
of execution standards, our relationship with our customers and technology.
A number of our competitors have significantly greater financial,
technical, marketing and other resources than we have. Some of our competitors
also offer a wider range of services and products than we offer and have
greater name recognition and more extensive customer bases. These competitors
may be able to respond more quickly to new or evolving opportunities,
technologies and customer requirements than we can and may be able to undertake
more extensive promotional activities and offer more attractive terms to
customers. Recent advancements in computing and communications technology are
substantially changing the means by which market-making services are delivered,
including more direct access on-line to a wide variety of services and
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information, and have also created demand for more sophisticated levels of
customer service. The provision of such services may entail considerable cost
without an offsetting increase in revenues. Moreover, current and potential
competitors have established or may establish cooperative relationships among
themselves or with third parties or may consolidate to enhance their services
and products. New competitors or alliances among competitors may emerge and
they may acquire significant market share.
More recently, ECNs have emerged as an alternative forum to which broker-
dealers and institutions can direct their limit order flow and avoid
facilitating their trades through market makers. As a result, we may experience
a reduction in our limit order flow. We cannot assure you that ECNs will not
continue to capture a greater amount of limit order flow. A substantial
reduction in our limit order flow could have a material adverse effect on our
business, financial condition and operating results.
We cannot assure you that we will be able to compete effectively with
current or future competitors or that the competitive pressures we face will
not have a material adverse effect on our business, financial condition and
operating results.
Employees
At December 31, 1998, we had a total of 446 full-time employees, of which
342 were employed at Knight and of which 104 were employed at Trimark. Of
Knight's 342 employees, 238 were engaged in market-making and sales activities,
37 in systems and technology, 33 in customer service and 34 in administration.
Of Trimark's 104 employees, 65 were engaged in market-making activities, 20 in
customer service, 7 in systems and technology and 12 in administration. None of
our employees are subject to a collective bargaining agreement. We believe that
our relations with our employees are excellent.
We recruit and retain our employees by compensating them largely on a
performance basis, measuring performance primarily in terms of revenue
generation. We are committed to improving the skill levels of our employees
and, to that end, Knight has established Knight School, a weekly training
session in which trading staff learn new trading techniques and are informed of
regulatory developments. We intend to expand this initiative and to develop
additional programs to improve the skills and productivity of its workforce. We
believe that we have high employee morale due to our performance-based
incentive compensation and our encouragement of a highly cooperative and
creative culture.
Intellectual Property and Other Proprietary Rights
We rely primarily on copyright, trade secret and trademark law to protect
our proprietary technology. Notwithstanding the precautions we take to protect
our intellectual property rights, it is possible that third parties may copy or
otherwise obtain and use our proprietary technology without authorization or
otherwise infringe on our proprietary rights. It is also possible that third
parties may independently develop technologies similar to those of
Knight/Trimark. It may be difficult for us to police unauthorized use of our
intellectual property rights. We cannot assure you that the steps we take will
prevent misappropriation of our technology. In addition, litigation may be
necessary in the future to enforce our intellectual property rights, to protect
our trade secrets, to determine the validity and scope of the proprietary
rights of others, or to defend against claims of infringement or invalidity.
These litigations, whether successful or unsuccessful, could result in
substantial costs and diversions of resources either of which could have a
material adverse effect on our business, financial condition and operating
results. We may in the future receive notices of claims of infringement of
other parties' proprietary rights. We cannot assure you that claims for
infringement or invalidity (or claims for indemnification resulting from
infringement claims) will not be asserted or prosecuted against us. Any such
claims, with or without merit, could be time-consuming to defend, result in
costly litigation, divert management's attention and resources or require us to
enter into royalty or licensing agreements. We cannot
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assure you that these royalties or licenses would be available on reasonable
terms, if at all, and the assertion or prosecution of any such claims could
have a material adverse effect on our business, financial condition and
operating results.
Government Regulation
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. In addition, the SEC, the NASD,
other self regulatory organizations, commonly known as SROs, such as the
various stock exchanges, and other regulatory bodies, such as state securities
commissions, require strict compliance with their rules and regulations. As a
matter of public policy, regulatory bodies are charged with safeguarding the
integrity of the securities and other financial markets and with protecting the
interests of customers participating in those markets, not protecting creditors
or stockholders of market makers. Market makers are subject to regulation
concerning certain aspects of their business, including trade practices,
capital structure, record retention and the conduct of directors, officers and
employees. Failure to comply with any of these laws, rules or regulations could
result in censure, fine, the issuance of cease-and-desist orders or the
suspension or disqualification of its directors, officers or employees, and
other adverse consequences, which could have a material adverse effect on our
business, financial condition and operating results. We and certain of our
officers and other employees have, in the past, been subject to claims arising
from the violation of such laws, rules and regulations, which resulted in the
payment of fines and settlements. We cannot assure you that we and/or our
officers and other employees will not, in the future, be subject to claims
arising from the violation of such laws, rules and regulations. An adverse
ruling against us and/or our employees, including censure or suspension, could
result in our and/or our officers and other employees being required to pay a
substantial fine or settlement, and could result in their suspension or
expulsion, which could have a material adverse effect on our business,
financial condition and operating results.
In 1996, the SEC advised Trimark that it was conducting an inquiry with
respect to Trimark and asked that Trimark voluntarily provide the SEC with
certain documents. In March 1997, Trimark provided the SEC with the information
it had requested. Based upon the request for documents, it appears that the
SEC's inquiry concerns four areas: price improvement, protection of limit
orders, payment for order flow and trade reporting. The SEC has not given any
indication that it intends to carry out enforcement actions against Trimark at
this time. At this juncture, we are unable to determine whether the SEC, after
completion of its inquiry, will institute any action and, if so, what the
outcome will be.
The regulatory environment in which we operate is subject to change. Our
business, financial condition and operating results may be adversely affected
as a result of new or revised legislation or regulations imposed by the SEC,
other United States or foreign governmental regulatory authorities or the NASD.
Our business, financial condition and operating results also may be adversely
affected by changes in the interpretation or enforcement of existing laws and
rules by these governmental authorities and the NASD.
Additional regulation, changes in existing laws and rules, or changes in
interpretations or enforcement of existing laws and rules often directly affect
the method of operation and profitability of securities firms. We cannot
predict what effect any such changes might have. Both regulations directly
applicable to us and regulations of general application could have a material
adverse effect on our business, financial condition, and operating results. For
example, the volume of our market-making activities in a given period could be
affected by, among other things, existing and proposed tax legislation,
antitrust policy and other governmental regulations and policies (including the
interest rate policies of the Federal Reserve Board) and changes in
interpretation or enforcement of existing laws and rules that affect the
business and financial communities. The level of trading and market-making
activity can be affected not only by such legislation or regulations of general
applicability, but also by industry-specific legislation or regulations.
Our business, both directly and indirectly, relies on the Internet and
other electronic communications gateways. We intend to expand our use of these
gateways. To date, the use of the Internet has been relatively free from
regulatory restraints. However, the SEC, certain SROs and certain states are
beginning to address the regulatory issues that may arise in connection with
the use of the Internet.
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Accordingly, new regulations or interpretations may be adopted that constrain
our own and our customers' abilities to transact business through the Internet
or other electronic communications gateways. Any additional regulation of the
use of such gateways could have a material adverse effect on our business,
financial condition and operating results.
In addition, we have recently established a London-based subsidiary and may
expand its business to other countries in the future. To expand our services
internationally, we will have to comply with the regulatory controls of each
country in which we conduct business. The brokerage industry in many foreign
countries is heavily regulated. The varying compliance requirements of these
different regulatory jurisdictions and other factors may limit our ability to
expand internationally. We cannot assure you that we will be successful in
obtaining the necessary regulatory approvals for any such expansion, or if such
approvals are obtained, that we will be able to continue to comply with such
regulations. The failure to obtain or comply with such approvals could have a
material adverse effect on our business, financial condition and operating
results.
Net Capital Requirements
As registered broker-dealers and members of the NASD, our subsidiaries are
subject to the SEC's Net Capital Rule. The Net Capital Rule, which specifies
minimum net capital requirements for registered brokers-dealers, is designed to
measure the general financial integrity and liquidity of a broker-dealer and
requires that at least a minimum part of its assets be kept in relatively
liquid form. In general, net capital is defined as net worth (assets minus
liabilities), plus qualifying subordinated borrowings and certain discretionary
liabilities, and less certain mandatory deductions that result from excluding
assets that are not readily convertible into cash and from valuing
conservatively certain other assets. Among these deductions are adjustments,
which are commonly called haircuts, which reflect the possibility of a decline
in the market value of an asset prior to disposition.
Failure to maintain the required net capital may subject a firm to
suspension or revocation of registration by the SEC and suspension or expulsion
by the NASD and other regulatory bodies and ultimately could require the firm's
liquidation. The Net Capital Rule prohibits payments of dividends, redemption
of stock, the prepayment of subordinated indebtedness and the making of any
unsecured advance or loan to a stockholder, employee or affiliate, if such
payment would reduce the firm's net capital below required levels.
The Net Capital Rule also provides that the SEC may restrict for up to 20
business days any withdrawal of equity capital, or unsecured loans or advances
to stockholders, employees or affiliates (capital withdrawal), if such capital
withdrawal, together with all other net capital withdrawals during a 30-day
period, exceeds 30% of excess net capital and the SEC concludes that the
capital withdrawal may be detrimental to the financial integrity of the broker-
dealer. In addition, the Net Capital Rule provides that the total outstanding
principal amount of a broker-dealer's indebtedness under certain subordination
agreements, the proceeds of which are included in its net capital, may not
exceed 70% of the sum of the outstanding principal amount of all subordinated
indebtedness included in net capital, par or stated value of capital stock,
paid in capital in excess of par, retained earnings and other capital accounts
for a period in excess of 90 days.
A change in the Net Capital Rule, the imposition of new rules or any
unusually large charges against net capital could limit those of our operations
that require the intensive use of capital and also could restrict our ability
to withdraw capital from our broker-dealer subsidiaries, which in turn could
limit our ability to pay dividends, repay debt and repurchase shares of our
outstanding stock. A significant operating loss or any unusually large charge
against net capital could adversely affect our ability to expand or even
maintain our present levels of business, which could have a material adverse
effect on our business, financial condition and operating results.
Risk Management
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.
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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.
We take long and short positions in securities in which we make a market.
The following table illustrates, for the period indicated, our average, highest
and lowest month-end inventory at market value (based on both the aggregate and
the net of the long and short positions of trading securities).
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------------------------
1996 1997 1998
----------------------------- ----------------------------- -----------------------------
Aggregate of Net of Aggregate of Net of Aggregate of Net of
Long and Short Long and Short Long and Short Long and Short Long and Short Long and Short
Positions Positions Positions Positions Positions Positions
-------------- -------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Average month-end....... $48,010,762 $15,833,096 $73,545,271 $20,946,420 $129,322,342 $ 5,139,424
Highest month-end....... 65,802,039 27,759,237 84,466,227 40,665,188 208,099,843 38,821,031
Lowest month end........ 37,865,308 8,968,927 56,988,279 11,535,551 73,005,491 (54,587,150)
</TABLE>
Beginning in the fourth quarter of 1998, there has been a sharp increase in
the price volatility of many stocks, particularly of companies that sell
products or services via the Internet. This volatility has been coupled with
record trading volume in many of these stocks, which are primarily listed on
Nasdaq. Customers eager to trade Internet stocks have flooded their brokers
with larger numbers of orders, leading to large order imbalances, systems
queues, and backlogs. During these extreme market conditions, many firms have
implemented procedures that are designed to preserve the continuous execution
of customers' orders while also lessening the exposure of the firm to
extraordinary market risk.
In the fourth quarter of 1998, Knight modified its execution policies in
response to these changes in the marketplace. Knight's current policy is to
provide continuous automatic execution on orders of up to 2,000 shares for
investors in over 4,800 Nasdaq stocks under normal market conditions. Knight
reserves the right to reduce or suspend its automatic execution guarantee
during periods of abnormal volatility and volume in a particular stock or group
of stocks. Knight's own internal risk management procedures dictate the
temporary suspension of automatic execution after certain levels of liquidity
have been provided. When automatic execution has been suspended, Knight will
only provide actual liquidity available based on price and time priority.
Properties
Our headquarters are located in Jersey City, New Jersey. We lease
approximately 52,000 square feet under a lease which expires in March 2005. We
have an option to extend the lease term on three floors for an additional five-
year period. We also lease approximately 29,000 square feet for our offices in
Purchase, NY; Chicago, IL; Boston, MA; Jericho, NY; Ridgefield, NJ and London,
England. We believe that our present facilities, together with our current
options to extend lease terms and occupy additional space, are adequate for our
current needs.
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. See "Risk
Factors--We are Subject to Extensive Government Regulation."
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MANAGEMENT
Executive Officers and Directors
As of December 31, 1998, the executive officers and directors of
Knight/Trimark are as follows:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Steven L. Steinman...... 50 Chairman of the Board of Directors
Kenneth D. Pasternak.... 44 President, Chief Executive Officer and Director
Walter F. Raquet........ 54 Executive Vice President and Director
Robert I. Turner........ 46 Executive Vice President, Chief Financial Officer,
Treasurer and Director
Robert M. Lazarowitz.... 42 Executive Vice President and Director
Anthony M. Sanfilippo... 42 Executive Vice President and Director
Michael T. Dorsey....... 42 Senior Vice President, General Counsel and Secretary
Simon D. Spenser........ 39 Senior Vice President, Chief Strategy and Technology Officer
Martin Averbuch(l)...... 46 Director
Charles V. Doherty(l)... 65 Director
Gene L. Finn(l)......... 66 Director
Gary R. Griffith(2)..... 59 Director
Bruce R. McMaken(2)..... 39 Director
J. Joe Ricketts......... 57 Director
Rodger O. Riney......... 53 Director
V. Eric Roach........... 35 Director
Charles A. Zabatta(2)... 56 Director
</TABLE>
- --------
(1) Member of Compensation Committee
(2) Member of Finance and Audit Committee
Steven L. Steinman, Chairman of the Board of Directors of Knight/Trimark,
has more than 20 years of experience in the securities industry. For the past
12 years, Mr. Steinman has been the chief executive officer of Trimark and its
predecessor Trimark Securities, L.P., which he founded in 1986. Mr. Steinman is
a co-founder of Roundtable Partners, L.L.C., along with Messrs. Pasternak,
Raquet and Lazarowitz, and served as the chairman of Roundtable until
Knight/Trimark's initial public offering and has served as chairman of
Knight/Trimark since then. Before founding Trimark Securities, L.P., Mr.
Steinman held trading positions at a number of trading firms, including Troster
Singer and M.H. Meyerson & Co., Inc., and was Trading Room Manager for Stix
Friedman and Co., Gattini & Co., Traubner Bach Co. Inc. and Monvest Securities.
Mr. Steinman attended Columbia University.
Kenneth D. Pasternak, president, chief executive officer and director of
Knight/Trimark, has 20 years of experience in the securities industry. For the
past three years, Mr. Pasternak has been the president, chief executive officer
and a trading room supervisor for Knight and its predecessor Knight Securities,
L.P. Before co-founding Roundtable and Knight Securities, L.P., Mr. Pasternak
served as senior vice president, limited partner and trading room manager for
Spear Leeds & Kellogg/Troster Singer, a trading firm, from July 1979 to July
1994. Mr. Pasternak received his B.A. degree from the State University of New
York at New Paltz in 1976.
Walter F. Raquet, Executive Vice President and Director of Knight/Trimark
and chief operating officer of Knight, has 30 years of experience in the
securities industry. For the past three years, Mr. Raquet has been the chief
operating officer of Knight and its predecessor Knight Securities, L.P. Mr.
Raquet was one of the co-founders of Roundtable and Knight. From 1992 to 1994,
he was a senior vice president with Spear, Leeds & Kellogg/Troster Singer
managing their technology and marketing functions. From 1982 to 1992, Mr.
Raquet was a partner at Herzog Heine & Geduld, Inc., a trading firm, where he
directed the firm's technology and marketing efforts. Mr. Raquet was also
corporate controller for PaineWebber Incorporated between 1980 and
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1982. He was executive vice president of Cantor Fitzgerald from 1977 to 1980
and controller for Weeden & Co. from 1968 to 1976. He is a CPA and practiced at
the accounting firm of Price Waterhouse. Mr. Raquet received a B.S. degree in
accounting from New York University in 1966.
Robert I. Turner, executive vice president, chief financial officer,
treasurer and director of Knight/Trimark and chief financial officer of Knight,
has 20 years of experience in the financial services and securities industries.
For the past three years, Mr. Turner has served as the chief financial officer
for Knight and its predecessor Knight Securities, L.P. and in April 1996 he was
elected to the advisory board of Roundtable on which he served until
Knight/Trimark's initial public offering, at which time he joined the board of
directors of Knight/Trimark. From 1988 to 1995, Mr. Turner was a corporate vice
president at PaineWebber Incorporated, serving in a variety of financial
management positions in the fixed income, financial services, merchant banking
and commodities trading divisions. From 1982 to 1987, Mr. Turner worked for
Citicorp in the treasury and investment banking divisions. From 1979 to 1981,
Mr. Turner practiced at the accounting firm of Price Waterhouse where he became
a CPA. Mr. Turner received his B.A. from the State University of New York at
Binghamton in 1973 and his M.S.B.A. from the University of Massachusetts at
Amherst in 1976.
Robert M. Lazarowitz, executive vice president and director of
Knight/Trimark and chief operating officer of Trimark, has 20 years of
experience in the securities and financial services industries. For the past 10
years, Mr. Lazarowitz served first as chief financial officer and then as chief
operating officer of Trimark and its predecessor Trimark Securities, L.P. Mr.
Lazarowitz was also a co-founder of Roundtable. From 1985 to 1987, he served as
chief financial officer of Bach Management/Investment Banking and, from 1984 to
1985, as chief operating officer of Traubner Bach Co. Inc. He has been a member
of the NASD's Intermarket Trading System Committee for the past three years.
Mr. Lazarowitz received his B.S. in accounting from the University of South
Florida in 1978.
Anthony M. Sanfilippo, executive vice president and director of
Knight/Trimark and president of Trimark, has over 22 years of experience in the
securities industry. For the past year, he has been the president of Trimark
and its predecessor Trimark Securities, L.P. From 1993 to 1997, Mr. Sanfilippo
was president and chief executive officer of Tradetech Securities, a market
maker in the Third Market which he founded in 1993. From 1988 to 1993, he
served as executive vice president at Mesirow Financial, managing the
Institutional Equity Division and Regional Exchange Specialist Operations. From
1980 to 1986, he was vice president of Jefferies & Co., an investment bank,
where he co-managed the firm's capital commitments in listed securities. Mr.
Sanfilippo is a member of the National Organization of Investment
Professionals. He has also served as president of the Security Traders
Association of Chicago and is currently serving on the NASDR Business District
Conduct Committee. Mr. Sanfilippo attended DePaul University.
Michael T. Dorsey, senior vice president, general counsel and secretary of
Knight/Trimark, joined Knight/Trimark in March 1998. From June 1994 to March
1998, Mr. Dorsey served as the chief legal officer to Prudential Investment
Management Services LLC and its predecessor in the institutional money
management unit of The Prudential Insurance Company of America. From March 1986
until June 1994, Mr. Dorsey served as an attorney in the SEC's Division of
Market Regulation, holding various posts, including special counsel to the
Assistant Director and then branch chief of the Office of Compliance
Inspections and Oversight. Mr. Dorsey received a B.S.B.A. in Finance from St.
Louis University in 1981, a J.D. from the University of Missouri-Columbia in
1984 and an LL.M. in Securities Regulations from Georgetown University Law
Center in 1989. Mr. Dorsey is admitted to the Missouri and Illinois state bars.
Simon D. Spenser, senior vice president and chief strategy and technology
officer, joined Knight/Trimark in April 1998. From 1993 to 1998, Mr. Spenser
served as the senior vice president of D.E. Shaw & Co., where he headed the
firm's Third Market division and participated in the development of other
customer-based securities businesses. From 1992 to 1993, Mr. Spenser worked for
TCAM Systems, Inc. where he was responsible for developing and enhancing
proprietary trading software for securities firms active in the third market.
Prior to that, Mr. Spenser designed custom computer and telecommunication
software for a
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London-based software development firm. Mr. Spenser graduated from University
College, London in 1981 with a BSc in Physics and spent four years conducting
postgraduate research in the Astrophysics Department at Oxford University.
Martin Averbuch, director of Knight/Trimark, has served on the board of
Knight/Trimark since Knight/Trimark initial public offering and, before that,
as an advisory board member of Roundtable since 1996. Mr. Averbuch is a founder
of the International Securities Exchange, and is president and chief executive
officer of Adirondack Trading Partners LLC. Mr. Averbuch has been with
Adirondack Trading Partners since August 1998. From August 1993 until August
1998, Mr. Averbuch served in various positions at E*TRADE Group, Inc.,
including president of E*TRADE Capital, vice president of On-Line Ventures and
vice president of special projects. Mr. Averbuch is also a member of the TAG
Industry Advisory Board on Execution Quality. Mr. Averbuch was a member of the
Hofstra University faculty from 1977 to 1978 as a professor in the finance
department. He received a B.S. in economics, magna cum laude, from The Wharton
School of Business at the University of Pennsylvania in 1974 and a J.D./M.B.A.
from the University of Chicago in 1977.
Charles V. Doherty, director of Knight/Trimark, has served on the board of
Knight/Trimark since Knight/Trimark initial public offering and, before that,
as an advisory board member of Roundtable since March 1995. He has also been a
managing director of Madison Asset Group, an investment advisory firm, since
1993. From 1986 to 1992, Mr. Doherty was president and chief operating officer
of the Chicago Stock Exchange specializing in information technology,
marketing, floor operations and compliance. He is a CPA and founder of Doherty,
Zable & Company, an accounting firm, where he served as president between 1974
and 1985. Mr. Doherty received his B.A. in accounting, magna cum laude, from
the University of Notre Dame in 1955 and his M.B.A. from the University of
Chicago in 1967.
Gene L. Finn, director of Knight/Trimark, has served on the board of
Knight/Trimark since Knight/Trimark initial public offering and, before that,
as an advisory board member of Roundtable since March 1995. He served as vice
president and chief economist of the NASD from 1983 to 1995 and as chief
economist and senior economic adviser for the SEC from 1969 to 1982. In such
capacities, Mr. Finn provided policy advice on stock market and investment
company regulation and oversight. Mr. Finn is an independent consultant and has
been a director of Ameritrade Holding Corporation since December 1996. Mr. Finn
holds a Ph.D. in economics from the University of Wisconsin.
Gary R. Griffith, director of Knight/Trimark, has served on the board of
Knight/Trimark since Knight/Trimark's initial public offering and, before that,
as an advisory board member of Roundtable since March 1995. He has been an
independent consultant since 1990 and has been in investment banking and
financial consulting since 1980. Before 1980, Mr. Griffith was with CBS, Inc.
and Price Waterhouse. Mr. Griffith is a CPA, and received a B.S. in Business
Administration from Ohio State University.
Bruce R. McMaken, director of Knight/Trimark, has served on the board of
Knight/Trimark since Knight/Trimark initial public offering and, before that,
as an advisory board member of Roundtable since March 1995. He also has been
employed by Sanders Morris Mundy, Inc., an investment banking firm, since 1992,
and is currently serving as a Managing Director of Corporate Finance. Mr.
McMaken serves as one of the managers of Environmental Opportunities Fund, Ltd.
and Environmental Opportunities Funds II, two private equity funds managed by
affiliates of Sanders Morris Mundy. Before joining Sanders Morris Mundy, Mr.
McMaken provided independent corporate finance and venture capital advisory
services to clients primarily in the environmental services, biotechnology and
real estate development industries. He is also a director of Independent
Environmental Services, Inc., a private solid waste collection and disposal
company. He received his B.A. degree from Cornell University in 1981.
J. Joe Ricketts, director of Knight/Trimark, is chairman and chief
executive officer of Ameritrade Holding Corporation. Mr. Ricketts has been with
Ameritrade since 1975. Previously, Mr. Ricketts was an investment advisor with
Ricketts & Co., a registered representative with Dean Witter, and a branch
manager at Dun & Bradstreet. Mr. Ricketts is a member of the board of directors
of Creighton University, a director of
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CSS Management, Inc. of Denver, Colorado and a member of the District Business
Conduct Committee of the NASD, District No. 4. In 1968, he received his B.A.
degree in economics from Creighton University in Omaha, Nebraska.
Rodger O. Riney, director of Knight/Trimark, has served on the board of
Knight/Trimark since Knight/Trimark's initial public offering and, before that,
as an advisory board member of Roundtable since March 1995. He is also the
president of Scottsdale Securities, Inc., a discount brokerage firm he founded
in 1980. In 1969, he joined Edward Jones & Co., a brokerage firm, and in 1975
became a general partner of that firm. Mr. Riney received a B.S. degree in
civil engineering in 1968 and an M.B.A. in 1969, both from the University of
Missouri-Columbia.
V. Eric Roach, director of Knight/Trimark, has served on the board of
Knight/Trimark since Knight/Trimark's initial public offering and, before that,
as an advisory board member of Roundtable since 1995. He founded Lombard
Brokerage, a brokerage firm, in 1992 and was chairman and chief executive
officer until Dean Witter, Discover & Co. acquired the company in 1997. Until
July 1998, he was President of Discover Brokerage Direct, Inc., a wholly-owned
subsidiary of Morgan Stanley Dean Witter & Co., managing the company's
strategy, marketing and public relations areas. In July 1998, he joined the
direct business group of Morgan Stanley Dean Witter. He attended Brigham Young
University and also attended the Executive M.B.A. program of Pepperdine
University.
Charles A. Zabatta, director of Knight/Trimark, is president and chief
operating officer of Wall Street Connect, a national financial services
company. He has over 30 years of brokerage experience. From January 1995 until
1998, Mr. Zabatta served as executive vice president of corporate development
at Waterhouse Investor Services. From January 1993 until January 1995, Mr.
Zabatta served as executive vice president of marketing at Kennedy Cabot & Co.
He also served as director of marketing for Securities Settlement, a national
clearing organization. He received his B.A. degree from Iona College in 1964.
Board Committees
The board of directors has created a finance and audit committee and a
compensation committee of the board. The finance and audit committee was
established in April 1998 and is charged with reviewing Knight/Trimark's annual
audit and meeting with Knight/Trimark's independent accountants to review
Knight/Trimark's internal controls and financial management practices. As of
the date of this prospectus, the finance and audit committee is composed of
Gary R. Griffith, Charles A. Zabatta and Bruce R. McMaken. The compensation
committee was established in April 1998, and is charged with recommending to
the board of directors compensation for our key employees and administers the
1998 Long-Term Incentive Plan. As of the date of this prospectus, the
compensation committee is composed of Charles V. Doherty, Martin Averbuch and
Gene L. Finn. See "--Executive Compensation."
Director Compensation
Nonemployee directors receive $18,000 per year, with committee chairpersons
receiving an additional $3,000 per year, in addition to $1,000 for each board
or committee meeting attended. Each nonemployee director receives stock options
pursuant to the automatic option grant provisions of our Nonemployee Director
Stock Option Plan. See "--Executive Compensation." All directors receive
reimbursement of reasonable out-of-pocket expenses incurred in connection with
meetings of the board of directors. No director who is an employee of
Knight/Trimark receives compensation for services rendered as a director.
Compensation Committee Interlocks and Insider Participation
During 1997, and prior to the formation of the compensation committee,
decisions concerning the compensation of executive officers were made by the
entire board of directors. Since our initial public offering, our compensation
committee consists of Messrs. Doherty, Averbuch and Finn, none of whom has ever
been an
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officer or employee of Knight/Trimark. Kenneth Pasternak is a member of the
board of directors of Adirondack Trading Partners LLC., whose president and
chief executive officer, Martin Averbuch, serves on Knight/Trimark's board of
directors. No other executive officer of Knight/Trimark serves as a member of
the board of directors or compensation committee of any entity that has one or
more executive officers serving as a member of our board of directors or
compensation committee. Certain members of our board of directors are parties
to transactions with us. See "Certain Transactions."
Limitation of Liability and Indemnification Matters
We utilize certain provisions in Delaware corporate law to limit the
liability of corporate officers and directors. We believe that the provisions
of our certificate of incorporation and bylaws and the separate indemnification
agreements outlined below are necessary to attract and retain qualified persons
as directors and officers. Our certificate of incorporation limits the
liability of directors to the maximum extent permitted by Delaware law. This
provision is intended to allow our directors the benefit of Delaware General
Corporation Law, which provides that directors of Delaware corporations may be
relieved of monetary liabilities for breach of their fiduciary duties as
directors, except under certain circumstances, including breach of their duty
of loyalty, acts or omissions not in good faith or involving intentional
misconduct or a knowing violation of law, unlawful payments or dividends or
unlawful stock repurchases or redemptions or any transaction from which the
director derived an improper personal benefit. Our bylaws provide that we shall
indemnify officers and directors to the fullest extent provided by Delaware
law.
We hold officer and director liability insurance with respect to
liabilities arising out of certain matters, including matters arising under the
Securities Act.
There is no pending litigation or proceeding involving a director, officer,
associate or other agent of Knight/Trimark as to which indemnification is being
sought, nor are we aware of any threatened litigation that may result in claims
for indemnification by any director, officer, associate or other agent.
Executive Compensation
The following table sets forth all compensation awarded to Kenneth
Pasternak, our chief executive officer, and our four other most highly
compensated executive officers who, together with the chief executive officer,
comprise the named executive officers, for services rendered in all capacities
to us in 1998.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Annual Compensation Compensation
----------------------------------- ------------
Securities
All Other Underlying
Name and Principal Position Salary Bonus(1) Compensation(2) Options(3)
--------------------------- ------ -------- --------------- ----------
<S> <C> <C> <C> <C>
Kenneth Pasternak, President
and Chief Executive
Officer.................... $250,000 $5,081,905 $3,714,990 1,000,000
Steven Steinman, Chairman of
the Board of Directors..... 250,000 626,855 3,714,990 175,000
Walter Raquet, Executive Vice
President.................. 250,000 1,829,588 3,714,990 375,000
Robert Lazarowitz, Executive
Vice President............. 250,000 878,752 3,714,990 175,000
Anthony Sanfilippo, Executive
Vice President............. 250,000 496,399 385,457 175,000
</TABLE>
- --------
(1)Includes discretionary incentive cash bonuses paid pursuant to the Incentive
Plan described below.
(2) Includes self-employment earnings reported for Roundtable, as well as
$5,000 contributed on behalf of each of the executive officers by
Knight/Trimark under our 401(k) defined contribution plan.
(3) The number of shares covered by options to purchase our Class A common
stock granted during the fiscal year ended December 31, 1998.
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<PAGE>
Option Grants During Fiscal 1998
The following table sets forth grants of stock options to each of the named
executive officers during the fiscal year ended December 31, 1998.
<TABLE>
<CAPTION>
Individual Grants
--------------------------------------------------
Potential Realizable
Value at Assumed
Number of Annual Rates of Stock
Securities Percent of Total Price Appreciation for
Underlying Options Granted Exercise or Option Term(1)
Options to Employees in Base Price Expiration ----------------------
Name Granted Fiscal Year Per Share Date 5% 10%
---- ---------- ---------------- ----------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Kenneth Pasternak....... 1,000,000 19.3% $14.50 7/8/08 $9,118,972 $23,109,266
Steven Steinman......... 175,000 3.4 14.50 7/8/08 1,595,820 4,044,121
Walter Raquet........... 375,000 7.2 14.50 7/8/08 3,419,615 8,665,975
Robert Lazarowitz....... 175,000 3.4 14.50 7/8/08 1,595,820 4,044,121
Anthony Sanfilippo...... 175,000 3.4 14.50 7/8/08 1,595,820 4,044,121
</TABLE>
- --------
(1) Amounts that may be realized upon exercise of the options immediately
before the expiration of their term, assuming the specified compound rates
of appreciation (5% and 10%) on the market value of the common stock on the
date of option grant over the term of the options. These numbers are
calculated based on rules promulgated by the SEC and do not reflect our
estimate of future stock price growth. Actual gains, if any, on stock
option exercises and common stock holdings are dependent on the timing of
exercise and the future performance of the common stock. There can be no
assurance that the rates of appreciation assumed in this table can be
achieved or that the amounts reflected will be received by the individuals.
Fiscal Year-End Option Values
The following table sets forth certain information concerning the number
and value of unexercised options held by each of the named executive officers
on December 31, 1998. None of the named executive officers exercised stock
options in the fiscal year ended December 31, 1998.
<TABLE>
<CAPTION>
Number of Shares
Underlying Value of Unexercised
Unexercised Options at In-the-Money Options at
December 31, 1998 December 31, 1998(1)
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Kenneth Pasternak........... -- 1,000,000 -- $9,440,000
Steven Steinman............. -- 175,000 -- 1,652,000
Walter Raquet............... -- 375,000 -- 3,540,000
Robert Lazarowitz........... -- 175,000 -- 1,652,000
Anthony Sanfilippo.......... -- 175,000 -- 1,652,000
</TABLE>
- --------
(1) Assumes a per share fair market value equal to $23 15/16, the closing price
per share on December 31, 1998 of the Class A common stock as reported on
the Nasdaq National Market.
Knight/Trimark Group, Inc. 1998 Long-Term Incentive Plan. With the approval
of our stockholders, we adopted the 1998 Long-Term Incentive Plan which took
effect before our initial public offering. A maximum of 7,145,500 shares of
Class A common stock was reserved for issuance under the 1998 Plan, subject to
equitable adjustment in the event of a change in our capitalization. During
1998, we issued options to purchase 5,174,000 shares at a weighted average
price of $14.48 under the 1998 Plan to our employees, of which 54,000 were
surrendered during the year.
55
<PAGE>
The 1998 Plan is administered by a committee established by the board of
directors, the composition of which will at all times satisfy the provisions of
Rule 16b-3 of the Securities Exchange Act of 1934, as in effect from time to
time, including any successor thereof. This committee has full authority,
subject to the provisions of the 1998 Plan, to determine, among other things,
the persons to whom awards under the 1998 Plan will be made, the size of these
awards, and the specific terms and conditions applicable to awards, including,
but not limited to, the duration, vesting and exercise or other realization
periods, the circumstances for forfeiture and the form and timing of payment.
The 1998 Plan limits the number of shares of Class A common stock that may be
the subject of awards to any grantee in any calendar year to one million
shares.
Awards, including stock options, restricted stock and restricted stock
units may be made under the 1998 Plan to selected employees and independent
contractors of Knight/Trimark and its present or future subsidiaries and
affiliates, in the discretion of the committee. Substantially all of our
employees will be eligible to receive awards under the 1998 Plan. Stock options
may be either "incentive stock options," as that term is defined in Section 422
of the Internal Revenue Code of 1986, as amended, or nonqualified stock
options. The exercise price of an option will not be less than the fair market
value per share of Class A common stock on the date of grant. The exercise
price of an option may be paid in cash or Class A common stock or by way of a
"broker's cashless exercise" or other similar arrangement approved by the
committee. Options that have a term of not more than 10 years will become
exercisable at that time and upon such terms as the committee may determine,
and may be exercised following termination of employment as determined by the
committee in the document evidencing the award.
Restricted stock is Class A common stock transferred to the grantee,
generally without payment to us, which shares are subject to certain
restrictions and to a risk of forfeiture. A restricted stock unit is a right to
receive shares of Class A common stock or cash at the end of a specified
period, subject to a risk of forfeiture. The vesting of restricted stock and
restricted stock units may be conditioned upon the satisfaction of specified
performance criteria. The maximum number of shares of Class A common stock that
may be awarded as restricted stock under the 1998 Plan is 500,000. We granted a
total of 15,000 shares of restricted Class A common stock to certain directors
in connection with our initial public offering.
In the event of a "change of control," as defined in the 1998 Plan, (1) any
award carrying a right to exercise that was not previously exercisable and
vested will become fully exercisable and vested, (2) the restrictions, deferral
limitations, payment conditions and forfeiture conditions applicable to any
other award granted under the 1998 Plan will lapse and that award will fully
vest and (3) any performance conditions imposed with respect to awards will
have been met.
The 1998 Plan may, at any time and from time to time, be altered, amended,
suspended, or terminated by the board of directors, in whole or in part,
provided that no amendment that, in the opinion of counsel, requires
stockholder approval will be effective unless such amendment has received the
requisite approval of stockholders. In addition, no amendment may be made that
adversely affects any of the rights of a grantee under any award theretofore
granted, without such grantee's consent.
Set forth below is a brief discussion of certain federal income tax
consequences relating to Awards that may be granted pursuant to the 1998 Plan.
Nonqualified Stock Options. In the case of a nonqualified stock option, an
option holder generally will not be taxed upon the grant of the option. Rather,
at the time of exercise of that nonqualified stock option, the option holder
will generally recognize ordinary income for federal income tax purposes in an
amount equal to the excess of the then fair market value of the shares
purchased over the option price, which is referred to as the spread. We will
generally be entitled to a tax deduction at the time and in the amount that the
holder recognizes ordinary income.
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<PAGE>
Incentive Stock Options. In the case of an incentive stock option, the tax
recognition event will generally occur upon the disposition of the shares
acquired upon exercise of the incentive stock option, rather than upon the
grant of the incentive stock option or upon its exercise within the employment-
related period prescribed by the code for this purpose, which is referred to as
timely exercise. The spread will, however, be an item of tax adjustment for
purposes of the "alternative minimum tax" imposed by Section 55 of the code.
If, upon disposition of the shares acquired upon exercise, the special holding
period requirements prescribed in the Code with respect to incentive stock
options have been satisfied, which is referred to as a qualifying disposition,
any taxable income will constitute capital gain in an amount equal to the
excess of the sale proceeds over the exercise price. We will not be entitled to
a tax deduction with respect to the timely exercise of an incentive stock
option or the subsequent qualifying disposition of shares so acquired. The tax
consequences of any untimely exercise of an incentive stock option or non-
qualifying disposition of acquired shares will be determined in accordance with
the rules applicable to nonqualified stock options, as described in the
preceding paragraph, except that, in the case of a non-qualifying disposition,
the tax recognition event will occur upon that disposition.
Exercise with Shares. An option holder who pays the option price upon
exercise of an option, in whole or in part, by delivering already owned shares
of stock will generally not recognize gain or loss on the shares surrendered at
the time of such delivery, except under certain circumstances. Rather,
recognition of that gain or loss will generally occur upon disposition of the
shares acquired in substitution for the shares surrendered.
Restricted Stock. Generally, the grant of restricted stock has no federal
income tax consequences at the time of grant. Rather, at the time the shares
are no longer subject to a substantial risk of forfeiture (as defined in the
Code), the holder will recognize ordinary income in an amount equal to the fair
market value of those shares. A holder may, however, elect to be taxed at the
time of the grant. We generally will be entitled to a deduction at the time and
in the amount that the holder recognizes ordinary income.
Restricted Stock Units. In the case of restricted stock units, a holder
generally will not be taxed upon the grant of such units or upon the lapse of
restrictions on such units but, rather, will recognize ordinary income in an
amount equal to the value of the shares and cash received at the time of such
receipt. We will be entitled to a deduction at the time and in the amount that
the holder recognizes ordinary income.
The foregoing summary constitutes a brief overview of the principal federal
income tax consequences relating to the above-described awards based upon
current federal income tax laws. This summary is not intended to be exhaustive
and does not describe state, local or foreign tax consequences. Participants in
the 1998 Plan should consult their personal tax advisors to determine the
specific tax consequences to them of awards and other transactions relating
thereto.
Knight/Trimark Group, Inc. 1998 Nonemployee Director Stock Option
Plan. With the approval of our stockholders, we adopted the 1998 Nonemployee
Director Stock Option Plan. The Nonemployee Director Plan took effect at the
time of our initial public offering. A maximum of 264,000 shares of Class A
common stock have been reserved for issuance under the Nonemployee Director
Plan, subject to equitable adjustment in the event of any change in our
capitalization.
Under the Nonemployee Director Plan, any questions of administration that
arise are resolved by the board of directors. Nine directors are currently
eligible to receive awards under the plan. All stock options granted under the
Nonemployee Director Plan are nonqualified stock options.
A director option to purchase 8,000 shares of Class A common stock was
granted upon the effective date of the Nonemployee Director Plan to each then
nonemployee director and, thereafter, to each new nonemployee director at the
time of his election to the board of directors. In addition, on the first
business day following
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<PAGE>
each annual meeting of our stockholders, each continuing nonemployee director
will be granted a director option to purchase 4,000 shares of Class A common
stock. The exercise price of a director option will be the fair market value
per share of Class A common stock on the date of grant and may be paid in cash
or common stock or pursuant to a "broker's cashless exercise." Director options
will have a term of 10 years, will become exercisable in four equal annual
installments commencing with the first anniversary of the date of grant and may
be exercised following a director's termination of service, as determined by
the board of directors in the document evidencing the grant. In the event of a
"change of control" (as defined in the Nonemployee Director Plan), any
outstanding director options not yet exercisable in whole or in part will
become exercisable in full. The Nonemployee Director Plan may, at any time and
from time to time, be altered, amended, suspended or terminated by the board of
directors, in whole or in part; provided that no amendment that, in the opinion
of counsel, requires stockholder approval will be effective unless that
amendment has received the requisite approval of stockholders. In addition, no
amendment may be made that adversely affects any of the rights of a grantee
under any director option theretofore granted, without such grantee's consent.
For a discussion of certain federal income tax consequences relating to
options granted pursuant to the Nonemployee Director Plan, see "Knight/Trimark
Group, Inc. 1998 Long-Term Incentive Plan."
During 1998, we issued options to purchase 72,000 shares at a weighted
average exercise price of $14.50 under the Nonemployee Director Plan to its
directors.
Knight/Trimark Group, Inc. Management Incentive Performance Plan. We have
established a profit-pool incentive plan, currently consisting of three sub-
profit pools, one for Knight/Trimark (disregarding its subsidiary companies),
one for Knight and one for Trimark. The Incentive Plan also provides for the
creation of a new sub-pool at the time of each future formation or acquisition
of a new Knight/Trimark subsidiary, to be allocated by that person or those
persons as determined by a committee of the board of directors consisting of
its executive officers.
The annual Knight/Trimark sub-pool will equal 15% of the before-tax profits
of Knight/Trimark (on an unconsolidated basis) earned by Knight/Trimark during
each fiscal quarter (not taking into account amounts paid out pursuant to the
incentive plan) and will be allocated on a quarterly basis by the chief
executive officer of Knight/Trimark. The annual Knight sub-pool equals 15% of
the before-tax profits earned by Knight during each fiscal quarter (not taking
into account amounts paid out pursuant to the incentive plan), and is allocated
on a quarterly basis by the president, chief executive officer and chief
operating officer of Knight. The annual Trimark sub-pool equals 15% of the
before-tax profits earned by Trimark during each fiscal quarter (not taking
into account amounts paid out pursuant to the incentive plan), and is allocated
on a quarterly basis by the president, chief executive officer and chief
operating officer of Trimark. These officers may not themselves receive an
allocation from any sub-profit pool in any year unless Knight/Trimark, on a
consolidated basis, earns a before-tax profit. All allocations will be subject
to the approval of the Chief Executive Officer of the Company.
401(k) Plan
We have a Section 401(k) Plan, a tax-qualified plan covering substantially
all of our employees. Under the terms of our 401(k) plan, participants may
elect to defer a portion of their compensation, subject to certain limitations,
and we are required to make annual contributions to the 401(k) plan equal to
50% of the contributions made by its employees, subject to certain limitations.
Employment Agreements
Shortly before our initial public offering, we entered into a new
employment agreement substantially the same as the prior Roundtable employment
agreement with Mr. Pasternak and amended the Roundtable agreements of Messrs.
Raquet, Steinman and Lazarowitz, as well as the prior Trimark employment
agreement with Mr. Sanfilippo. The term of Mr. Pasternak's agreement is four
years, beginning on the date of completion
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<PAGE>
of our initial public offering, with annual, automatic one-year extensions
beginning on the fourth anniversary of such date unless either party gives
notice of nonrenewal at least 60 days prior to such anniversary. The term of
the amended agreements of the remaining executives ends on March 23, 2000,
subject to annual automatic one-year extensions beginning on such date, unless
either party serves notice of nonrenewal at least 60 days prior to such date.
Mr. Pasternak's new agreement provides that he is president and chief
executive officer of the Knight/Trimark and president and chief executive
officer of Knight. Each of Messrs. Raquet and Lazarowitz's amended agreements
provides, respectively, that the executive is executive vice president of
Knight/Trimark; Mr. Raquet is also chief operating officer of Knight and Mr.
Lazarowitz is also chief operating officer of Trimark. Mr. Steinman's amended
agreement provides that he is chairman of the board of Knight/Trimark and chief
executive officer of Trimark. Mr. Sanfilippo's amended agreement provides that
he is executive vice president of Knight/Trimark and president of Trimark. Each
executive receives an annual salary of $250,000, which is, from time to time,
increased by the board of directors.
Mr. Pasternak's new agreement and each of the amended agreements of the
other executives provide for the payment of annual bonuses under the incentive
plan and for participation in current and future employee benefit plans. In
addition, the new agreement of Mr. Pasternak and the amended agreement of Mr.
Sanfilippo provide for the payment of a sales commission equal to a percentage
(in the case of Mr. Pasternak, 35%; in the case of Mr. Sanfilippo, a percentage
consistent with our other traders) of the net, before-tax trading profits of
the executive's personal trading account; and the respective amended agreements
of Messrs. Steinman and Lazarowitz provide for the payment of an additional
annual bonus until March 31, 2000, equal in each case to 5% of the before-tax
earnings of Trimark.
CERTAIN TRANSACTIONS
The Reorganization
We were organized in April 1998 for the purpose of succeeding to the
business of Roundtable. Immediately before the closing of our initial public
offering, all of the member interests of Roundtable were exchanged for
36,662,415 shares of our Class A common stock and 3,942,698 shares of our Class
B common stock. Before the reorganization, management owned 40% and the broker-
dealer owners owned 60% of Roundtable. By agreement among the members of
Roundtable, the allocation of common stock to the broker-dealer owners was
based upon an approximation of the fair market value of each broker-dealer
owner's respective interest in Roundtable. One broker-dealer owner of common
units of Roundtable received Class B common stock for some of its common units
in lieu of Class A common stock due to certain regulatory constraints that
limit the amount of voting stock this particular broker-dealer can own. In
connection with the reorganization, Knight became the successor entity to
Knight Securities, L.P., and Trimark became the successor entity to Trimark
Securities, L.P.
Brown & Company Securities Corporation
On April 24, 1996, we entered into a $500,000 subordinated note agreement
with Brown & Company Securities Corporation, one of our major customers, which
paid interest quarterly at a market rate approximating the prevailing Federal
Funds Rate. We repaid the subordinated note in full on July 13, 1998. At the
same time as the execution of the subordinated note, we granted Brown certain
benefits, including the right to receive additional payments based on the
amount of order flow provided to us by Brown. For the period from March 27,
1995 through December 31, 1995 and for the years ended December 31, 1996, 1997
and 1998, Brown was the source of 4.0%, 4.6%, 4.3% and 3.1%, respectively, of
our order flow. Payments by us to Brown during these periods amounted to $2.1
million, $6.2 million, $7.5 million and $6.3 million, respectively.
Additionally, in April 1996, we granted Brown the right to purchase 7,143
common units in Roundtable at the then prevailing market price of $10.00 per
common unit. As of the date of grant, the right to purchase the
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<PAGE>
common units had de minimis value. Brown elected to exercise its option at the
closing of our initial public offering for 394,887 shares of our Class A
common stock at an aggregate price of $71,430. Under the terms of the
subordinated note, Brown shared in Roundtable's profits based on the quantity
of order flow it directed to us. This arrangement was discontinued at the time
of the reorganization.
Transactions with Affiliates
Transactions with Affiliates. Immediately before the reorganization, 60%
of the common units of Roundtable were owned by a consortium of 27 broker-
dealers or their affiliates. One of the broker-dealer owners, Gruntal & Co.
L.L.C., sold all of its shares in our initial public offering. Immediately
after the closing of our initial public offering, broker-dealer owners owned
42.5% of our common stock and immediately after the closing of this offering,
the broker-dealer owners will own 32.2% of our common stock.
Set forth below is a list of broker-dealers which directly or indirectly
own our capital stock:
Ameritrade Inc. Direct Access Brokerage Services, Inc.
Primevest Financial
BHC Securities, Inc. Services, Inc.
Discover Brokerage Direct
BHF Securities Corp. E*TRADE Securities, Inc. R.J. Forbes Group, Inc.
Bidwell & Company Sanders Morris Mundy,
Inc.
Fiserv Correspondent Services, Inc.
Brown & Company Securities Corporation
Howe Barnes Investments, Inc.
Burke, Christensen & Lewis Securities Scottsdale Securities,
Inc.
International Correspondents Trading, Inc.
Cowles, Sabol & Co., Inc. J.W. Charles Securities, Inc.
Dain Rauscher Incorporated Josephthal & Co. Inc. Southwest Securities,
David A. Noyes & Co. Inc.
Nathan & Lewis Securities, Inc.
Stockcross, Inc.
Thomas F. White & Co.
Van Kasper & Company
Waterhouse Securities,
Inc.
For the period from March 27, 1995 through December 31, 1995 and the years
ended December 31, 1996, 1997 and 1998, the broker-dealer owners were the
source of 31.3%, 35.1%, 39.8% and 40.6% of our order flow, respectively. For
the period from March 27, 1995 through December 31, 1995 and for the years
ended December 31, 1996, 1997 and 1998, aggregate payments we made to our
broker-dealer owners for order flow amounted to $14.4 million, $46.4 million,
$50.7 million and $57.1 million, respectively. For the period from March 27,
1995, through December 31, 1995, for the years ended December 31, 1996 and
1997 and for the period from January 1, 1998 through July 13, 1998, the date
of the reorganization, we made aggregate profit distributions to broker-dealer
owners amounting to $1.7 million, $10.6 million, $13.4 million and $44.6
million, respectively. Under the limited liability company agreement of
Roundtable, Roundtable's broker-dealer owners shared in Roundtable profits
partially in proportion to their equity interest and partially in proportion
to the quantity of order flow they directed to us. This arrangement was
discontinued at the time of the reorganization. The broker-dealer owners no
longer receive any special inducements to send order flow to us and are not
contractually or otherwise obligated to provide us with any order flow in the
future. Although we believe that, based on the high-quality execution services
we provide, these broker-dealer owners will continue to use our services, we
cannot assure you that the absence of such incentives will not cause our
broker-dealer owners to reduce the level of or discontinue order flow they
direct to us in the future. See "Risk Factors--Risks Associated with Recent
Changes in Our Ownership Structure" and "Selling and Principal Stockholders."
Ameritrade. At the closing of this offering, Ameritrade Holding
Corporation will own 3,953,675 shares of our Class A common stock. Mr. J. Joe
Ricketts, the chairman and chief executive officer of Ameritrade, is a
director of Knight/Trimark. For the period from March 27, 1995 through
December 31, 1995 and the years ended December 31, 1996, 1997 and 1998,
Ameritrade was the source of 6.8%, 5.7%, 5.8% and 9.2%, respectively, of our
order flow. During the same periods, aggregate payments by us to Ameritrade
for order flow, equalled $3.1 million, $8.2 million, $6.9 million and $11.7
million, respectively. Additionally, we made profit distributions to
Ameritrade for the period from March 27, 1995 through December 31, 1995, for
the years ended December 31, 1996 and 1997 and for the period from January 1,
1998 through July 13, 1998 aggregating $529,000, $2.7 million, $2.6 million
and $8.9 million, respectively.
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Discover Brokerage Direct. At the closing of this offering, Discover
Brokerage Direct, Inc. will own 1,201,963 shares of our Class A common stock.
Mr. V. Eric Roach, the president of Discover, is a director of Knight/Trimark.
For the period from March 27, 1995 through December 31, 1995 and the years
ended December 31, 1996, 1997 and 1998, Discover was the source of 2.1%, 2.3%,
3.5% and 2.5%, respectively, of our order flow. During the same periods,
aggregate payments by us to Discover for order flow, equaled $1.0 million, $4.4
million, $5.5 million and $4.2 million, respectively. Additionally, we made
profit distributions to Discover for the period from March 27, 1995 through
December 31, 1995, for the years ended December 31, 1996 and 1997 and for the
period from January 1, 1998 through July 13, 1998 aggregating $185,000,
$964,000, $1.3 million and $3.5 million, respectively.
E*TRADE. At the closing of this offering, E*TRADE Securities, Inc. will own
1,816,432 shares of our Class A common stock. For the period from March 27,
1995 through December 31, 1995 and the years ended December 31, 1996, 1997 and
1998, E *TRADE was the source of 1.8%, 3.2%, 5.7% and 7.5%, respectively of our
order flow. During the same periods, aggregate payments by us to E*TRADE for
order flow, equaled $645,000, $3.5 million, $5.3 million and $8.4 million,
respectively. Additionally, we made profit distributions to E*TRADE for the
period from March 27, 1995 through December 31, 1995, for the years ended
December 31, 1996 and 1997 and for the period from January 1, 1998 through July
13, 1998 aggregating $190,000, $825,000, $1.7 million and $4.9 million,
respectively.
Gruntal & Co. After the reorganization, Gruntal owned 1,311,754 shares of
our Class A common stock, all of which shares were sold by Gruntal in our
initial public offering. For the period from March 27, 1995 through December
31, 1995 and the years ended December 31, 1996, 1997 and 1998, Gruntal was the
source of 1.0%, 0.6%, 0.3% and 0.1%, respectively, of our order flow. During
the same periods, aggregate payments by us to Gruntal for order flow equaled
$421,000, $434,000, $415,000 and $337,000, respectively. Additionally, we made
profit distributions to Gruntal in the period from March 27, 1995 through
December 31, 1995, for the years ended December 31, 1996 and 1997 and for the
period from January 1, 1998 through July 13, 1998 aggregating $341,000, $1.2
million, $845,000 and $2.9 million, respectively. In addition, from its
inception until March 1998, we utilized Gruntal as our clearing broker. For the
period from March 27, 1995 through December 31, 1995 and the years ended
December 31, 1996, 1997, and 1998, we paid Gruntal clearing fees in the amount
of $11.7 million, $21.5 million, $14.8 million and $1.6 million. We terminated
our clearing arrangements with Gruntal as of March , 1998.
Sanders Morris Mundy. At the closing of this offering, Sanders Morris
Mundy, Inc. will not own any shares of our Class A common stock. Mr. Bruce R.
McMaken, a managing director of Sanders Morris Mundy, is a director of
Knight/Trimark. For the period from March 27, 1995 through December 31, 1995
and the years ended December 31, 1996, 1997 and 1998, Sanders Morris Mundy was
the source of 0.1%, 0.046%, 0.033% and 0.011%, respectively, of our order flow.
During the same periods, aggregate payments by us to Sanders Morris Mundy for
order flow, equaled $34,000, $64,000, $45,000 and $5,600, respectively.
Additionally, we made profit distributions to Sanders Morris Mundy for the
period from March 27, 1995 through December 31, 1995, for the years ended
December 31, 1996 and 1997 and for the period from January 1, 1998 through July
13, 1998 aggregating $31,000, $115,000, $85,000 and $289,000, respectively.
Scottsdale Securities. At the closing of this offering, employees and
affiliates of Scottsdale will own 1,004,680 shares of our Class A common stock.
Mr. Rodger O. Riney, the president of Scottsdale, is a director of
Knight/Trimark, and has beneficial ownership of 815,606 of such shares. For the
period from March 27, 1995 through December 31, 1995 and the years ended
December 31, 1996, 1997 and 1998, Scottsdale was the source of 0.9%, 1.5%, 1.4%
and 1.5%, respectively, of our order flow. During the same periods, aggregate
payments by us to Scottsdale for order flow equaled $662,000, $2.2 million,
$1.3 million, and $1.8 million, respectively. Additionally, we made profit
distributions to Scottsdale for the period from March 27, 1995 through December
31, 1995, for the years ended December 31, 1996 and 1997 and for the period
from January 1, 1998 through July 13, 1998 aggregating $170,000, $798,000,
$649,000 and $2.2 million, respectively.
61
<PAGE>
Southwest Securities. At the closing of this offering, Southwest
Securities, Inc. will own 1,674,850 shares of our Class A common stock. For the
period from March 27, 1995 through December 31, 1995 and the years ended
December 31, 1996, 1997 and 1998, Southwest was the source of 2.7%, 2.3%, 1.4%
and 1.1%, respectively, of our order flow. During the same periods, aggregate
payments by us to Southwest for order flow, equaled $1.6 million, $3.1 million,
$1.8 million and $1.3 million, respectively. In addition, Southwest is acting
as an underwriter in connection with this offering. See "Underwriting."
Additionally, we made profit distributions to Southwest for the period from
March 27, 1995 through December 31, 1995, for the years ended December 31, 1996
and 1997 and for the period from January 1, 1998 through July 13, 1998
aggregating $451,000, $1.6 million, $1.1 million and $3.9 million,
respectively.
Waterhouse Investor Services, Inc. At the closing of this offering,
Waterhouse Investor Services, Inc. will own 2,139,623 shares of our Class A
common stock and 3,042,698 shares of our Class B common stock. Waterhouse is an
affiliate of Waterhouse Securities, Inc. For the period from March 27, 1995
through December 31, 1995 and the years ended December 31, 1996, 1997 and 1998,
Waterhouse was the source of 5.8%, 6.5%, 10.1% and 10.7%, respectively, of our
order flow. During the same periods, aggregate payments by us to the Waterhouse
entities for order flow equaled $2.0 million, $6.8 million, $10.2 million and
$15.6 million, respectively. In addition, Trimark utilizes National Investor
Services Corp., a subsidiary of Waterhouse, as its clearing broker. In the
years ended December 31, 1997 and 1998, we paid National Investor Services
Corp. clearing fees in the amounts of $9.5 million and $22.1 million,
respectively. Additionally, we made profit distributions to the Waterhouse
entities for the period from March 27, 1995 through December 31, 1995, for the
years ended December 31, 1996 and 1997 and for the period from January 1, 1998
through July 13, 1998 aggregating $697,000, $2.9 million, $3.9 million and
$12.6 million, respectively.
Trimark Leasing. Through August 1998, we leased certain computer and
telephone equipment and furniture from Trimark Leasing, Inc., an entity which
is wholly-owned by Steven L. Steinman and Robert M. Lazarowitz, executive
officers and directors of Knight/Trimark. For the period from March 27, 1995
through December 31, 1995 and the years ended December 31, 1996, 1997 and 1998,
rental expenses under such leases were $261,000, $530,000, $539,000, and
$293,000, respectively.
Adirondack Trading Partners LLC. We hold a minority stake in Adirondack
Trading Partners LLC, the funding vehicle for the International Securities
Exchange which, upon approval by the SEC, will be the first entirely electronic
options market maker in the United States. Our investment in Adirondack Trading
Partners amounted to approximately $1.5 million. Martin Averbuch, a member of
Knight/Trimark's board of directors, is president and chief executive officer
of Adirondack Trading Partners.
PaineWebber Incorporated
Knight clears all its trades through Correspondent Services Corp., a
subsidiary of PaineWebber. In the year ended December 31, 1998, we paid
Correspondent Services Corp. clearing fees in the amount of $9.0 million.
PaineWebber is acting as an underwriter in connection with this offering.
PaineWebber Capital, an affiliate of PaineWebber, loaned $30.0 million to
Roundtable under a loan agreement dated as of June 19, 1998. Knight/Trimark
guaranteed Roundtable's obligations under this loan. After the closing of our
initial public offering, Knight/Trimark assumed all of Roundtable's obligations
under the loan and Roundtable was dissolved. We made principal repayments under
the loan of $5.0 million, $9.0 million and $6.0 million on September 15, 1998,
October 20, 1998 and December 15, 1998, respectively. Additionally, we paid the
final $10.0 million outstanding on January 19, 1999. In 1998, aggregate
interest payments to PaineWebber under the loan totaled $913,000. We believe
that the terms and conditions of this loan were reasonable and customary for
loans of this type.
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<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information known to us regarding
beneficial ownership of our common stock as of February 1, 1999 and as adjusted
to reflect the sale of the shares pursuant to this offering, by (1) each person
who is known by us to own beneficially more than 5% of its outstanding shares
of common stock, (2) each director and named executive officer of
Knight/Trimark, (3) all directors and executive officers of Knight/Trimark as a
group and (4) the selling stockholders. Except as otherwise indicated below, to
our knowledge Knight/Trimark, each person listed below has sole voting power
and investment power with respect to the shares beneficially owned by such
person, subject to community property laws where applicable.
<TABLE>
<CAPTION>
Shares Beneficially Owned Shares Beneficially Owned
Prior to this Offering(1) Shares Offered After this Offering(1)(4)
------------------------------ by the Selling -----------------------------
Name and Address(2) Number Percent(3) Stockholders Number Percent
- ------------------- --------------- -------------- -------------- --------------- -------------
<S> <C> <C> <C> <C> <C>
Steven L. Steinman(5)... 4,429,699 8.36% 450,000 3,979,699 7.18%
Kenneth D. Pasternak.... 4,354,644 8.22 450,000 3,904,644 7.04
Walter F. Raquet........ 4,279,753 8.07 450,000 3,829,753 6.91
Robert M.
Lazarowitz(6).......... 4,354,644 8.22 450,000 3,904,644 7.04
Anthony M. Sanfilippo... 415,971 * 50,000 365,971 *
Robert I. Turner........ 15,000 * -- 15,000 *
Michael T. Dorsey....... 6,000 * -- 6,000 *
Simon D. Spenser........ 7,000 * -- 7,000 *
Martin Averbuch......... 1,500 * -- 1,500 *
Charles V. Doherty...... 5,000 * -- 5,000 *
Gene L. Finn............ 7,000 * -- 7,000 *
Gary R. Griffith........ 10,000 * -- 10,000 *
J. Joe Ricketts......... -- -- -- -- --
Bruce R. McMaken........ -- -- -- -- --
Rodger O. Riney(8)...... 815,606 1.54 -- 815,606 1.47
V. Eric Roach........... -- -- -- -- --
Charles A. Zabatta...... 2,000 * -- 2,000 *
Ameritrade Holding
Corporation(9)......... 3,953,675 7.46 -- 3,953,675 7.13
E*TRADE Securities,
Inc.(10)............... 2,566,432 4.84 750,000 1,816,432 3.28
Discover Brokerage
Direct(11)............. 2,101,963 3.97 900,000 1,201,963 2.17
Waterhouse Investor
Services, Inc.(7)(12).. 6,082,321 11.48 900,000 5,182,321 9.35
BHF Securities
Corporation(13)........ 150,220 * 75,000 75,220 *
Bidwell & Company(14)... 449,024 * 50,000 399,024 *
Brown & Company
Securities
Investments(15)........ 394,887 * 394,887 -- --
Cowles Family
Trust(16).............. 57,485 * 17,485 40,000 *
Dain Rauscher
Incorporated(17)....... 460,192 * 460,192 -- --
David A. Noyes &
Company(18)............ 58,111 * 25,000 33,111 *
Howard Braff(19)........ 235 * 235 -- --
Howe Barnes Investments,
Inc.(20)............... 130,759 * 75,000 55,759 *
J.W. Charles Financial
Services, Inc.(21)..... 299,353 * 225,000 74,353 *
NL Holding
Corporation(22)........ 125,970 * 125,970 -- --
Primevest Financial
Services, Inc.(23)..... 124,051 * 62,000 62,051 *
Randy Redmond(24)....... 5,472 * 1,400 4,072 *
Raymond Pawloski(25).... 7,036 * 5,000 2,036 *
The R.J. Forbes Group,
Inc.(26)............... 288,948 * 288,948 -- --
Sanders Morris Mundy
Inc.(27)............... 134,566 * 134,566 -- --
Thomas F. White &
Co.(28)................ 471,638 * 46,000 425,638 *
Van Kasper & Co.(29).... 120,931 * 50,000 70,931 *
WBM, LLC(30)............ 83,500 * 83,500 -- --
William Forsgren(31).... 782 * 782 -- --
William L. and Diane E.
Sabol(32).............. 57,485 * 28,700 28,785 *
William Lewke(33)....... 209,615 * 25,615 184,000 *
All executive officers
and directors as a
group (17 persons)..... 18,703,817 35.3% 1,850,000 16,853,817 30.4%
</TABLE>
- -------
* Less than one percent of the outstanding common stock.
(1) Beneficial ownership is determined in accordance with the rules of the SEC
and includes voting or investment power with respect to the shares.
(2) See "Management--Executive Officers and Directors." Unless otherwise
indicated, the address for each beneficial owner is c/o Knight/Trimark
Group, Inc., Newport Tower, 29th Floor, 525 Washington Boulevard, Jersey
City, New Jersey 07310.
(3) The percentage of total outstanding for each stockholder immediately prior
to this offering is calculated by dividing (i) the number of shares of
Class A and Class B common stock deemed to be beneficially owned by such
stockholder at such time by (ii) the sum of the number of shares of Class
A and Class B common stock outstanding at such time.
(4) Assumes that the underwriters' over-allotment option to purchase up to an
additional 1,350,000 shares from the selling stockholders is not exercised.
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<PAGE>
(5) Mr. Steinman owns a nominal amount of our Class A common stock, and the
remainder of the shares attributed to him are owned by Steinman Family
Associates, L.P., a Delaware limited partnership, in which he is the
general partner and the limited partners are his wife and a trust for the
benefit of certain members of his immediate family.
(6) Mr. Lazarowitz owns a nominal amount of our Class A common stock, and the
remainder of the shares attributed to him are owned by Lazarowitz Family
Associates, L.P., a Delaware limited partnership, in which he is the
general partner and the limited partners are his wife and a trust for the
benefit of certain members of his immediate family.
(7) 3,942,698 of shares beneficially owned prior to the offering are shares of
Class B Common Stock which are non-voting. 3,042,698 shares of Class B
common stock will be beneficially owned subsequent to this offering.
(8) The shares attributed to Mr. Riney are owned by four trusts for the benefit
of Mr. Riney and his immediate family. Mr. Riney has voting power over each
of the trusts.
(9) The address of Ameritrade Holding Corporation is Fourteen Wall Street, New
York, NY 10005-2176.
(10) The address of E*TRADE Securities, Inc. is 2400 Geng Road, Palo Alto, CA
94303.
(11) The address of Discover Brokerage Direct, Inc. is 333 Market Street, 25th
Floor, San Francisco, CA 94105.
(12) The address of Waterhouse Investor Services, Inc. is 100 Wall Street, 29th
Floor, NY, NY 10005.
(13) The address of BHF Securities Corporation is 590 Madison Avenue, 28th
Floor, NY, NY 10022.
(14) The address of Bidwell & Company is 209 Southwest Oak Street, Portland, OR
97204.
(15) The address of Brown & Company Securities Investments is One Beacon
Street, 18th Floor, Boston, MA 02108.
(16) The address of Cowles Family Trust is 2437 Green View Place, Los Angeles,
CA 90046.
(17) The address of Dain Rauscher Incorporated is 60 South Sixth Street, Dain
Bosworth Plaza, Minneapolis, MN 55402.
(18) The address of David A. Noyes & Company is 208 LaSalle Street, Ste. 610,
Chicago IL 60604.
(19) The address of Howard Braff is 4 Mews Court, Holtsville, NY 11742.
(20) The address of Howe Barnes Investments, Inc. is 135 LaSalle Street, Ste.
1500, Chicago, IL 60603.
(21) The address of J.W. Charles Financial Services, Inc. is 980 North Federal
Hwy, Ste. 210, Boca Raton, FL 33432.
(22) The address of NL Holding Corporation is 1140 Avenue of the Americas, 4th
Floor, NY, NY 10036.
(23) The address of Primevest Financial Services, Inc. is 400 First St. South,
Ste. 300, St. Cloud, MN 56301
(24) The address of Randy Redmond is 1335 W. Shellfish, Gilbert, AZ 85233.
(25) The address of Raymond Pawloski is 2554 Barrett Springs Dr., Ballwin, MD
63021.
(26) The address of The R.J. Forbes Group, Inc. is 8 Fletcher Place, Melville,
NY 11747.
(27) The address of Sanders Morris Mundy, Inc. is 3100 Texas Commerce Tower,
Houston, TX 77002.
(28) The address of Thomas F. White & Co. is 301 Mission Street, San Francisco,
CA 94105.
(29) The address of Van Kasper & Co. is 600 California Street, Ste. 1700, San
Francisco, CA 94108.
(30) The address of WBM, LLC is 200 Park Avenue, 24th Floor, NY, NY 10166.
(31) The address of William Forsgren is 2141 Espadrille Cr., Salt Lake City, UT
84118.
(32) The address of William L. and Diane E. Sabol is 16820 Ventura Blvd.; 2nd
Floor, Encino CA 91436.
(33) The address of William Lewke is 1120 Asbury Eventon, IL 60202.
64
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The following summary description of our capital stock does not purport to
be complete and is subject to the provisions of our certificate of
incorporation and bylaws.
Authorized and Outstanding Capital Stock
Our authorized capital stock consists of 220,000,000 shares of common
stock, par value $.01 per share, and 20,000,000 shares of preferred stock, par
value $.01 per share. Of the 220,000,000 authorized shares of our common stock,
200 million shares are designated Class A common stock and 20,000,000 shares
are designated as Class B common stock. As of December 31, 1998, 49,062,184
shares of Class A common stock are issued and outstanding and 3,942,698 shares
of Class B common stock are issued and outstanding.
Common Stock
Voting Rights. Except as otherwise required by law or, as described below
by the certificate of incorporation, the holders of shares of Class A common
stock vote together as a single class. Each share of Class A common stock will
entitle the registered holder thereof to one vote. There is no cumulative
voting and, therefore, holders of a majority of the shares of Class A common
stock can elect all of the directors.
The holders of Class A common stock are entitled to elect all members of
our board of directors and the holders of Class B common stock have no voting
rights, except as otherwise provided by law.
Conversion into Class A Common Stock. Pursuant to the certificate of
incorporation, each share of Class B common stock is exchangeable at any time
upon sale or other transfer thereof, subject to certain limitations on such
sale or transfer, for one fully paid and nonassessable share of Class A common
stock, subject to adjustment for any stock split. Subject to certain
limitations and upon satisfaction of certain conditions, holders of Class B
common stock are entitled to convert their shares into the same number of
shares of Class A common stock.
Liquidation. In the event of any voluntary or involuntary liquidation,
dissolution or winding up of Knight/Trimark, after payment in full to creditors
and distribution in full of the preferential amounts, if any, to be distributed
to holders of shares of preferred stock, unless otherwise required by law,
holders of shares of common stock will be entitled to receive all the remaining
assets of Knight/Trimark of whatever kind available for distribution to
stockholders ratably in proportion to the number of shares of common stock held
by them. As provided by the certificate of incorporation, the holders of common
stock will participate in the distribution of such assets as if all classes and
series of common stock constituted a single class of stock.
Dividends. Subject to the preferential rights of holders of preferred
stock, if any, the holders of shares of common stock will be entitled to
receive, when, as and if declared by the board of directors, out of the assets
of Knight/Trimark which are by law available, dividends payable either in cash,
in property or in shares of capital stock. As provided by the certificate of
incorporation, no dividend will be declared or paid in respect of any class of
common stock by Knight/Trimark, unless the holders of all classes of common
stock receive the same per share dividend payable in the same amount and type
of consideration, as if such classes constituted a single class, except that if
any dividend is declared that is payable in shares of common stock, or in
subscription or other rights to acquire shares of common stock, then such
dividend will be declared and paid at the same rate per share with respect to
each class of common stock, the dividend payable on shares of Class A common
stock will be payable only in shares of, or in subscription or other rights to
acquire shares of, Class A common stock, and the dividend payable on shares of
Class B common stock will be payable only in shares of, or in subscription or
other rights to acquire shares of Class B common stock.
65
<PAGE>
Preferred Stock
Under the certificate of incorporation, the board of directors is expressly
authorized, without further stockholder approval, to provide for the issuance
of all or any shares of preferred stock in one or more classes or series, and
to fix for each such class or series such voting powers, full or limited, or no
voting powers, and such distinctive designations, preferences and relative,
participating, optional or other special rights and such qualifications,
limitations or restrictions thereof, as shall be stated and expressed in the
resolution or resolutions adopted by the board of directors providing for the
issuance of such class or series and as may be permitted by the Delaware
General Corporation Law. We have no present plans to issue any shares of
preferred stock. See "--Anti-Takeover Effects of Provisions of the Certificate
of Incorporation and Bylaws and the DGCL."
Registration Rights
Certain of our stockholders, the rightsholders, are entitled to require us
to register under the Securities Act, up to a total of 34,914,602 shares of
outstanding common stock pursuant to the terms of a registration rights
agreement. The registration rights agreement provides that in the event we
propose to register any of our securities under the Securities Act at any time
or times, the rightsholders, subject to certain exceptions, shall be entitled
to include registrable shares in such registration. However, the managing
underwriter of any such offering may exclude for marketing reasons some of such
registrable shares from such registration. In addition, certain rightsholders
have additional rights, subject to certain conditions and limitations, to
require us to prepare and file a registration statement under the Securities
Act with respect to their registrable shares. We are generally required to bear
the expenses of all such registrations, except underwriting discounts and
commissions. Certain rightsholders are selling 6,575,280 registrable shares in
this offering, assuming no exercise of the underwriters' over-allotment option.
Anti-Takeover Effects of Provisions of the Certificate of Incorporation, Bylaws
and the DGCL
Certificate of Incorporation and Bylaws. The certificate of incorporation
provides that stockholders are not entitled to call a special meeting of
stockholders, nor may they require the board of directors to call such a
meeting. The certificate of incorporation provides that stockholders are not
entitled to act by written consent in lieu of a meeting, except where such
consent is unanimous. These provisions of the certificate of incorporation
could discourage potential acquisition proposals and could delay or prevent a
change of control of Knight/Trimark.
Delaware Takeover Statute. We are subject to Section 203 of the DGCL
(Section 203) which, subject to certain exceptions, prohibits a publicly-held
Delaware corporation from engaging in any business combination with any
interested stockholder for a period of three years following the date that such
stockholder became an interested stockholder, unless: (1) prior to such date,
the board of directors of the corporation approved either the business
combination or the transaction that resulted in the stockholder becoming an
interested stockholder; (2) upon consummation of the transaction that resulted
in the stockholder becoming an interested stockholder, the interested
stockholder owned at least 85% of the voting stock of the corporation
outstanding at the time the transaction commenced, excluding for purposes of
determining the number of shares outstanding those shares owned (a) by persons
who are directors and also officers and (b) by employee stock plans in which
employee participants do not have the right to determine confidentially whether
shares held subject to the plan may be tendered in a tender or exchange offer;
or (3) on or subsequent to such date, the business combination is approved by
the board of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at least
66% of the outstanding voting stock that is not owned by the interested
stockholder.
Section 203 defines "business combination" to include: (1) any merger or
consolidation involving the corporation and the interested stockholder; (2) any
sale, transfer, pledge or other disposition of 10% or more of the assets of the
corporation involving the interested stockholder; (3) subject to certain
exceptions, any transaction that results in the issuance or transfer by the
corporation of any stock of the corporation to the
66
<PAGE>
interested stockholder; (4) any transaction involving the corporation that has
the effect of increasing the proportionate share of the stock of any class or
series of the corporation beneficially owned by the interested stockholder; or
(5) the receipt by the interested stockholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation. In general, Section 203 defined an interested
stockholder as any entity or person beneficially owning 15% or more of the
outstanding voting stock of the corporation and any entity or person affiliated
with, or controlling or controlled by, such entity or person.
Other Provisions. The holders of common stock are not entitled to
preemptive or subscription rights. In any merger, consolidation or business
combination, the consideration to be received per share by holders of Class A
common stock is identical to that to be received by holders of Class B common
stock. No class of common stock may be subdivided, consolidated, reclassified
or otherwise changed unless the other class of common stock is concurrently
subdivided, consolidated, reclassified or otherwise changed in the same
proportion and in the same manner. All outstanding shares are, and the shares
of Class A common stock being sold by Knight/Trimark in this offering will be
upon issuance, validly issued, fully paid and nonassessable.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is ChaseMellon
Shareholder Services, L.L.C.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, we will have an aggregate of 55,429,602
shares of common stock outstanding (assuming no exercise of the underwriters'
over-allotment option). Of these shares, 11,500,000 of the Class A common stock
shares are presently freely tradeable, and 9,000,000 shares of Class A common
stock sold in this offering will be freely tradable without restriction or
further registration under the Securities Act, except that any shares purchased
by an "affiliate" of Knight/Trimark, as that term is defined in Rule 144 under
the Securities Act, may generally be sold only in compliance with Rule 144 as
described below.
In addition, some stockholders have the right to cause us to register the
sale of some shares of Class A common stock owned by them and/or to include
their shares in future registrable statements relating to our securities.
Approximately 34,929,602 of the outstanding shares of common stock are
"restricted securities" as that term is defined under Rule 144. Of these
restricted shares, 34,814,602 shares will be subject to lock-up agreements as
described below, assuming no exercise of the underwriters' over-allotment
option. Upon expiration of these agreements all of the restricted shares will
be available for sale in the public market, subject to the provisions of Rule
144 under the Securities Act.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including an affiliate who has beneficially owned
restricted shares for at least one year, is entitled to sell within any three-
month period a number of such shares that does not exceed the greater of (1)
one percent of the then outstanding shares of Class A common stock
(approximately 523,869 shares immediately after this offering) or (2) the
average weekly trading volume in the Class A common stock in the Nasdaq
National Market during the four calendar weeks preceding the date on which
notice of such sale is filed with the SEC. Such sales under Rule 144 are also
subject to certain manner of sale provisions and notice requirements and to the
availability of current public information about Knight/Trimark. In addition, a
person who is not an affiliate and has not been an affiliate for at least three
months prior to the sale and who has beneficially owned restricted shares for
at least two years may resell such shares without regard to the requirements
described above. We are unable to estimate accurately the number of restricted
shares that ultimately will be sold under Rule 144 because the number of shares
will depend in part on the market price for the common stock, the personal
circumstances of the sellers and other factors. See "Risk Factors--Future Sales
by Existing Shareholders Could Depress the Market Price of Our Common Stock."
67
<PAGE>
On January 29, 1999, we filed a registration statement under the Securities
Act on Form S-8 to register all shares of common stock issuable under our stock
option plans. This registration statement became effective immediately upon
filing. Accordingly, shares issued under our stock plans will be eligible for
sale in the public markets upon vesting and exercise of options or awards,
subject to Rule 144 volume restrictions applicable to affiliates and, in
certain cases, lock-up agreements.
All executive officers and directors of Knight/Trimark and the selling
stockholders, who after the completion of this offering will hold in the
aggregate 26,692,479 shares of common stock, assuming no exercise of the
underwriters' over-allotment option, have agreed that they will not, without
the prior written consent of BancBoston Robertson Stephens Inc., directly or
indirectly, offer to sell, sell, contract to sell or otherwise dispose of any
shares of common stock beneficially owned by them for a period of 90 days after
the date of this prospectus, subject to certain exceptions. BancBoston
Robertson Stephens Inc. may, in its sole discretion and at any time, without
notice, release all or any portion of the securities subject to lock-up
agreements. See "Underwriting."
Sales of substantial amounts of common stock, or the perception that such
sales could occur, could adversely affect prevailing market prices for the
common stock and could impair our future ability to obtain capital through an
offering of equity securities.
68
<PAGE>
UNDERWRITING
The underwriters named below, acting through their representatives,
BancBoston Robertson Stephens Inc., Merrill Lynch, Pierce, Fenner & Smith
Incorporated, PaineWebber Incorporated, ABN AMRO Incorporated and Southwest
Securities, Inc., have severally agreed with Knight/Trimark and certain selling
stockholders of Knight/Trimark subject to the terms and conditions of the
underwriting agreement, to purchase from Knight/Trimark and certain selling
stockholders the number of shares of Class A common stock set forth below
opposite their respective names. The underwriters are committed to purchase and
pay for all shares if any are purchased.
<TABLE>
<CAPTION>
Number of
Underwriter Shares
----------- ---------
<S> <C>
BancBoston Robertson Stephens Inc..................................
Merrill Lynch, Pierce, Fenner & Smith Incorporated.................
PaineWebber Incorporated...........................................
ABN AMRO Incorporated..............................................
Southwest Securities, Inc..........................................
---------
Total............................................................. 9,000,000
=========
</TABLE>
The representatives have advised us that the underwriters propose to offer
the shares of Class A common stock to the public at the public offering price
set forth on the cover page of this prospectus and to certain dealers at such
price less a concession not in excess of $ per share, of which $ may be
reallowed to other dealers. After the completion of this offering, the public
offering price, concession and reallowance to dealers may be reduced by the
representatives. No such reduction shall change the amount of proceeds to be
received by Knight/Trimark or the selling stockholders as set forth on the
cover page of this prospectus. The Class A common stock is offered by the
underwriters as stated herein, subject to receipt and acceptance by them and
subject to their right to reject any order in whole or in part.
The underwriters have advised us that they do not intend to confirm sales
to any accounts over which they exercise discretionary authority.
Over-Allotment Option. Certain of the selling stockholders have granted to
the underwriters an option, exercisable during the 30-day period after the date
of this prospectus, to purchase up to 1,350,000 additional shares of Class A
common stock to cover over-allotments, if any, at the public offering price
less the underwriting discount set forth on the cover page of this prospectus.
If the underwriters exercise their over-allotment option to purchase any of
such additional 1,350,000 shares of Class A common stock, the underwriters have
severally agreed, subject to certain conditions, to purchase approximately the
same percentage thereof as the number of shares to be purchased by each of them
bears to the total number of shares of Class A common stock offered hereby. If
purchased, such additional shares will be sold by the underwriters on the same
terms as those on which the shares offered hereby are being sold. The selling
stockholders will be obligated, pursuant to the over-allotment option, to sell
shares to the underwriters to the extent such over-allotment option is
exercised. The underwriters may exercise such option only to cover over-
allotments made in connection with the sale of the shares of Class A common
stock offered hereby.
The following table summarizes the compensation to be paid to the
underwriters by the Company and the selling stockholders:
<TABLE>
<CAPTION>
Total
--------------------
Per Without With
Share Over-allotment Over-allotment
----- -------------- --------------
<S> <C> <C> <C>
Underwriting Discounts and Commissions
paid by the Company.......................
Underwriting Discounts and Commissions
paid by the Selling Stockholders..........
</TABLE>
69
<PAGE>
Knight/Trimark estimates expenses payable by Knight/Trimark in connection
with this offering (other than the underwriting discounts and commissions
referred to above) will be $950,000.
Indemnity. The underwriting agreement contains covenants of indemnity among
the underwriters, Knight/Trimark and the selling stockholders against certain
civil liabilities, including liabilities under the Securities Act of 1933, as
amended, and liabilities arising from breaches of representations and
warranties contained in the underwriting agreement.
Lock-Up Agreements. Each officer and director of Knight/Trimark and certain
of its stockholders have agreed, during the period ending 90 days after the
date of this prospectus (the lock-up period), subject to certain exceptions,
not to offer to sell, sell, contract to sell, or otherwise sell, dispose of,
loan, pledge or grant any rights with respect to any shares of Class A common
stock or any options or warrants to purchase any shares of Class A common
stock, or any securities convertible into or exchangeable for shares of Class A
common stock owned as of the date of this prospectus or thereafter acquired
directly by such holders or with respect to which they have the power of
disposition, without the prior written consent of BancBoston Robertson Stephens
Inc. However, BancBoston Robertson Stephens Inc. may, in its sole discretion
and at any time or from time to time, without notice, release all or any
portion of the securities subject to those lock-up agreement. There are no
existing agreements between the representatives and any of Knight/Trimark's
stockholders providing consent to the sale of shares prior to the expiration of
the lock-up period.
Future Sales. In addition, Knight/Trimark has agreed that during the lock-
up period Knight/Trimark will not, without the prior written consent of
BancBoston Robertson Stephens Inc., subject to certain exceptions, (1) consent
to the disposition of any shares held by stockholders subject to lock-up
agreements prior to the expiration of the lock-up period or (2) issue, sell,
contract to sell, or otherwise dispose of, any shares of Class A common stock,
any options to purchase any shares of Class A common stock or any securities
convertible into, exercisable for or exchangeable for shares of Class A common
stock other than our sale of shares in this offering, the issuance of shares of
Class A common stock upon the exercise of outstanding options and the issuance
of options under existing stock option and incentive plans, provided such
options do not vest prior to the expiration of the lock-up period. See "Shares
Eligible for Future Sale."
Stabilization. The representatives have advised Knight/Trimark that,
pursuant to Regulation M under the Securities Exchange Act of 1934, as amended,
certain persons participating in the offering may engage in transactions,
including stabilizing bids, syndicate covering transactions or the imposition
of penalty bids, which may have the effect of stabilizing or maintaining the
market price of the shares of Class A common stock at a level above that which
might otherwise prevail in the open market. A "stabilizing bid" is a bid for,
or the purchase of, shares of Class A common stock on behalf of the
underwriters for the purpose of fixing or maintaining the price of the shares
of Class A common stock. A "syndicate covering transaction" is the bid for, or
purchase of, shares of Class A common stock on behalf of the underwriters to
reduce a short position incurred by the underwriters in connection with the
offering. A "penalty bid" is an arrangement permitting the representatives to
reclaim the selling concession otherwise accruing to an underwriter or
syndicate member in connection with the offering if the shares of Class A
common stock originally sold by that underwriter or syndicate member are
purchased by the representatives in a syndicate covering transaction and have
therefore not been effectively placed by that underwriter or syndicate member.
The representatives have advised us that such transactions may be effected on
the Nasdaq National Market or otherwise and, if commenced, may be discontinued
at any time.
In connection with this offering, certain underwriters and selling group
members (if any) who are qualified market makers on the Nasdaq Market may
engage in passive market making transactions in the Class A common stock on the
Nasdaq National Market in accordance with Rule 103 of Regulation M under the
Securities Exchange Act of 1934, as amended, during the business day prior to
the pricing of the offering before the commencement of offers or sales of the
Class A common stock. Passive market makers must comply with applicable volume
and price limitations and must be identified as such. In general, a passive
70
<PAGE>
market maker must display its bid at a price not in excess of the highest
independent bid of such security; if all independent bids are lowered below the
passive market maker's bid, however, such bid must then be lowered when certain
purchase limits are exceeded.
Knight/Trimark's subsidiary, Knight, is a party to a clearing contract with
an affiliate of PaineWebber, under which that affiliate clears all of Knight's
trades for usual and customary fees. In addition, PaineWebber Capital, Inc., an
affiliate of PaineWebber, loaned $30.0 million to Roundtable under a loan
agreement dated June 19, 1998. All amounts outstanding under the loan agreement
have been repaid by Knight/Trimark and the loan agreement has been terminated.
We believe that the terms and conditions of the loan were reasonable and
customary for loans of this type. One of the underwriters, Southwest, is a
stockholder of Knight/Trimark. See "Certain Transactions."
LEGAL MATTERS
The validity of the Class A common stock offered hereby will be passed upon
for Knight/Trimark by Michael T. Dorsey, Senior Vice President and General
Counsel to Knight/Trimark. In addition, certain legal matters will be passed on
for Knight/Trimark by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New
York. Certain legal matters will be passed on for the underwriters by Brobeck,
Phleger & Harrison LLP, New York, New York.
EXPERTS
The consolidated financial statements as of December 31, 1997 and 1998 and
for each of the three years in the period ended December 31, 1998 included in
this prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
ADDITIONAL INFORMATION
We are subject to the informational requirements of the Exchange Act, and,
consequently, are required to file periodic reports and other information with
the SEC. Such information can be inspected without charge at the public
reference facilities of the SEC at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549 and at the regional offices of the SEC
located at Suite 1400, Northwest, Atrium Center, 500 West Madison Street,
Chicago, Illinois 60661 and Seven World Trade Center, 13th Floor, New York, New
York 10048. Copies of such material may also be obtained at prescribed rates
from the Public Reference Section of the SEC, 450 Fifth Street, N.W.,
Washington, D.C. 20549. The SEC also maintains a web site (http://www.sec.gov)
that contains all information we file electronically with the SEC.
This prospectus, which constitutes a part of a registration statement on
Form S-1 filed by us with the SEC under the Securities Act, does not contain
all of the information set forth in the registration statement, including the
exhibits to that registration statement. For further information with respect
to Knight/Trimark and the Class A common stock offered hereby, reference is
made to the registration statement and to its exhibits. Statements contained in
this prospectus as to the contents of any contract or other document are not
necessarily complete, and, with respect to each such contract or document filed
as an exhibit to the registration statement, reference is made to the copy of
such contract or document, and each such statement is qualified in all respects
by such reference. A copy of the registration statement, including the exhibits
thereto, may be inspected and copies thereof may be obtained as described in
the preceding paragraph with respect to periodic reports and other information
to be filed by Knight/Trimark under the Exchange Act.
71
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants......................................... F-2
Consolidated Statements of Financial Condition as of December 31, 1997 and
1998.................................................................... F-3
Consolidated Statements of Income for the years ended December 31, 1996,
1997 and 1998........................................................... F-4
Consolidated Statements of Changes in Stockholders' (Members') Equity for
the years ended December 31, 1996, 1997 and 1998........................ F-5
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1997 and 1998..................................................... F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Knight/Trimark Group, Inc.
In our opinion, the accompanying consolidated statements of financial
condition and the related consolidated statements of income, of changes in
stockholders' (members') equity and of cash flows present fairly, in all
material respects, the financial position of Knight/Trimark Group, Inc. and its
subsidiaries at December 31, 1997 and 1998, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
PricewaterhouseCoopers LLP
New York, New York
January 19, 1999
F-2
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
December 31,
-------------------------
1997 1998
------------ ------------
Assets
<S> <C> <C>
Cash and cash equivalents............................ $ 13,797,198 $117,381,556
Securities owned, at market value.................... 61,726,045 100,476,151
Receivable from clearing brokers..................... 30,151,720 107,503,274
Fixed assets and leasehold improvements, at cost,
less accumulated depreciation
and amortization of $3,884,743 in 1997 and
$6,477,147 in 1998................................. 7,353,429 12,014,991
Goodwill, less accumulated amortization of $4,465,484
in 1997 and $6,748,361 in 1998..................... 14,192,840 16,036,859
Other assets......................................... 651,190 5,447,544
------------ ------------
Total assets.................................... $127,872,422 $358,860,375
============ ============
Liabilities And Stockholders' (Members') Equity
Liabilities
Securities sold, not yet purchased, at market
value............................................... $ 21,060,857 $108,909,217
Short-term borrowings............................... -- 10,000,000
Distributions on Common Units payable to members.... 8,405,326 --
Accrued compensation expense........................ 6,112,562 16,529,004
Accrued execution and clearance fees................ 3,966,145 6,898,095
Accrued payments for order flow..................... 3,764,391 8,672,668
Liability for capital lease......................... 786,801 --
Accounts payable, accrued expenses and other
liabilities........................................ 1,394,288 5,445,112
Income taxes payable................................ -- 2,285,620
Interest payable on Preferred Units................. 424,981 --
Subordinated note................................... 500,000 --
Mandatorily Redeemable Preferred A Units............ 12,483,610 --
Mandatorily Redeemable Preferred B Units............ 15,000,000 --
------------ ------------
Total liabilities............................... 73,898,961 158,739,716
------------ ------------
Commitments and contingent liabilities (Notes 9 and 14)
Stockholders' equity
Class A Common Stock, $0.01 par value, 200,000,000
shares authorized; 49,062,184 shares issued and
outstanding at December 31, 1998................... -- 490,622
Class B Common Stock, $0.01 par value, 20,000,000
shares authorized; 3,942,698 shares issued and
outstanding at December 31, 1998................... -- 39,427
Additional paid-in capital.......................... -- 169,779,929
Retained earnings................................... -- 29,810,681
Common units, $10 par value, 750,000 units
authorized; 734,497 units issued and outstanding
at December 31, 1997............................... 7,344,970 --
Undistributed income................................ 46,628,491 --
------------ ------------
Total stockholders' (members') equity........... 53,973,461 200,120,659
------------ ------------
Total liabilities and stockholders' (members')
equity........................................ $127,872,422 $358,860,375
============ ============
</TABLE>
Members' equity
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Revenues
Net trading revenue.................... $183,499,260 $223,922,643 $348,098,874
Commissions and fees................... 394,394 704,759 4,042,919
Interest, net.......................... 1,282,522 2,039,244 3,591,276
------------ ------------ ------------
Total revenues..................... 185,176,176 226,666,646 355,733,069
------------ ------------ ------------
Expenses
Employee compensation and benefits..... 39,494,032 57,716,994 108,002,843
Payments for order flow
Affiliates........................... 46,374,341 50,662,461 57,149,752
Non-affiliates....................... 23,454,327 16,249,579 25,362,462
Execution and clearance fees
Affiliates........................... 21,461,560 24,262,767 23,957,338
Non-affiliates....................... 4,375,397 7,805,806 21,606,413
Communications and data processing..... 4,359,785 6,809,086 10,869,251
Depreciation and amortization.......... 2,975,152 4,225,286 5,878,327
Occupancy and equipment rentals........ 1,776,806 2,657,402 5,745,263
Professional fees...................... 379,346 1,612,277 3,423,567
Business development................... 623,492 1,459,822 2,336,472
Interest on Preferred Units............ 2,092,593 1,940,972 714,904
Other.................................. 1,048,743 1,186,961 2,334,241
------------ ------------ ------------
Total expenses..................... 148,415,574 176,589,413 267,380,833
------------ ------------ ------------
Income before income taxes............. 36,760,602 50,077,233 88,352,236
Income tax expense..................... -- -- 21,751,209
------------ ------------ ------------
Net income............................. $ 36,760,602 $ 50,077,233 $ 66,601,027
============ ============ ============
Basic and diluted earnings per share... $ .86 $ 1.17 $ 1.40
============ ============ ============
Weighted average shares of Class A and
Class B Stock outstanding (see Note
10).................................. 42,801,636 42,801,636 47,511,111
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' (MEMBERS') EQUITY
For the Years Ended December 31, 1996, 1997 and 1998
<TABLE>
<CAPTION>
Roundtable Partners, L.L.C. Knight/Trimark Group, Inc.
----------------------------------- --------------------------------------------------------------
Class A Class B
Common Units Common Stock Common Stock Additional
-------------------- Undistributed ------------------- ----------------- Paid-in Retained
Units Amount Income Shares Amount Shares Amount Capital Earnings Total
-------- ---------- ------------- ---------- -------- --------- ------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January
1, 1996........ 372,648 $3,726,480 $ 8,472,790 -- $ -- -- $ -- $ -- $ -- $ 12,199,270
Issuance of
Common Units... 365,449 3,654,490 -- -- -- -- -- -- -- 3,654,490
Net income...... -- -- 36,760,602 -- -- -- -- -- -- 36,760,602
Distributions on
Common Units... -- -- (22,627,844) -- -- -- -- -- -- (22,627,844)
-------- ---------- ----------- ---------- -------- --------- ------- ------------ ----------- ------------
Balance,
December 31,
1996........... 738,097 7,380,970 22,605,548 -- -- -- -- -- -- 29,986,518
Net income...... -- -- 50,077,233 -- -- -- -- -- -- 50,077,233
Distributions on
Common Units... -- -- (25,742,857) -- -- -- -- -- -- (25,742,857)
Resignation of
Member......... (3,600) (36,000) (311,433) -- -- -- -- -- -- (347,433)
-------- ---------- ----------- ---------- -------- --------- ------- ------------ ----------- ------------
Balance,
December 31,
1997........... 734,497 7,344,970 46,628,491 -- -- -- -- -- -- 53,973,461
Distributions on
Common Units... -- -- (57,265,529) -- -- -- -- -- -- (57,265,529)
Net income for
the period from
January 1, 1998
through July
12, 1998 (see
Note 3)........... -- -- 36,790,346 -- -- -- -- -- -- 36,790,346
Reorganization,
July 13, 1998
(see Note 3)... (734,497) (7,344,970) (26,153,308) 38,464,051 384,640 3,942,698 39,427 33,074,211 -- --
Exercise of
Brown option
(see Notes 2
and 3)......... -- -- -- 394,887 3,949 -- -- 67,481 -- 71,430
Net proceeds
from initial
public offering
(see Note 3)... -- -- -- 10,188,246 101,883 -- -- 136,420,887 -- 136,522,770
Issuance of
restricted
stock to
directors...... -- -- -- 15,000 150 -- -- 217,350 -- 217,500
Net income for
the period from
July 13, 1998
through
December 31,
1998........... -- -- -- -- -- -- -- -- 29,810,681 29,810,681
-------- ---------- ----------- ---------- -------- --------- ------- ------------ ----------- ------------
Balance,
December 31,
1998........... -- $ -- $ -- 49,062,184 $490,622 3,942,698 $39,427 $169,779,929 $29,810,681 $200,120,659
======== ========== =========== ========== ======== ========= ======= ============ =========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income........................... $ 36,760,602 $ 50,077,233 $ 66,601,027
Adjustments to reconcile net income
to net cash provided by operating
activities
Depreciation and amortization........ 2,975,152 4,225,286 5,878,327
Issuance of restricted stock to
Directors.......................... -- -- 217,500
(Increase) in operating assets
Securities owned.................... (13,017,591) (14,945,407) (38,750,106)
Receivable from clearing brokers.... (11,719,123) (6,995,944) (77,351,554)
Other assets........................ (115,061) (225,200) (4,846,354)
Increase (decrease) in operating
liabilities
Securities sold, not yet purchased.. 8,020,480 2,039,456 87,848,360
Accrued compensation expense........ 2,727,038 1,926,644 10,416,442
Accrued execution and clearance
fees.............................. 779,119 791,673 2,931,950
Accrued payments for order flow..... 1,286,965 865,790 4,908,277
Accounts payable, accrued expenses
and other liabilities............. 582,102 (517,700) 3,883,770
Income taxes payable................ -- -- 2,285,620
Interest payable on Preferred
Units............................. 163,438 (171,897) (424,981)
------------ ------------ ------------
Net cash provided by operating
activities........................ 28,443,121 37,069,934 63,598,278
------------ ------------ ------------
Cash flows from investing activities
Purchase of business and net assets
of Tradetech Securities, L.P........ -- (750,000) --
Payment of contingent consideration.. (1,351,447) (1,685,385) (4,076,896)
Sale of fixed assets................. -- 1,413,115 --
Purchases of fixed assets and
leasehold improvements............. (3,939,871) (4,429,389) (8,876,759)
------------ ------------ ------------
Net cash used in investing
activities........................ (5,291,318) (5,451,659) (12,953,655)
------------ ------------ ------------
Cash flows from financing activities
Proceeds from short-term loan........ -- -- 30,000,000
Repayment of short-term loan......... -- -- (20,000,000)
Proceeds from issuance of
subordinated note.................. 500,000 -- --
Repayment of subordinated note....... -- -- (500,000)
Net proceeds from initial public
offering........................... -- -- 136,522,770
Net proceeds from exercise of Brown
option............................. -- -- 71,430
Proceeds from issuance of Mandatorily
Redeemable Preferred A Units....... 8,870,410 -- --
Proceeds from issuance of Common
Units.............................. 2,940,200 -- --
Decrease in liability for capital
lease.............................. (267,664) (283,228) --
Redemptions of Mandatorily Redeemable
Preferred A Units.................. (3,865,730) (10,147,050) (12,483,610)
Redemptions of Mandatorily Redeemable
Preferred B Units.................. -- -- (15,000,000)
Resignation of Member................ -- (422,463) --
Distributions on Common Units........ (17,643,870) (22,321,502) (65,670,855)
------------ ------------ ------------
Net cash (used in) provided by
financing activities.............. (9,466,654) (33,174,243) 52,939,735
------------ ------------ ------------
Increase (decrease) in cash and cash
equivalents........................ 13,685,149 (1,555,968) 103,584,358
Cash and cash equivalents at
beginning of year.................. 1,668,017 15,353,166 13,797,198
------------ ------------ ------------
Cash and cash equivalents at end of
year............................... $ 15,353,166 $ 13,797,198 $117,381,556
============ ============ ============
Supplemental disclosure of cash flow
information:
Cash paid for interest.............. $ 2,016,244 $ 2,144,877 $ 2,069,809
============ ============ ============
Cash paid for income taxes.......... $ -- $ -- $ 19,662,278
============ ============ ============
</TABLE>
Supplemental information pertaining to noncash investing and financing
activities:
Effective January 1, 1996, a subordinated note holder exchanged its
$5,000,000 subordinated note for 71,429 Common Units and 428,571 Preferred A
Units issued by the Company with an aggregate value of $5,000,000.
During April 1998, the Company terminated a capital lease with a remaining
obligation of $713,207. The net book value of the equipment under such capital
lease was $619,747.
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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")
(see Note 2) (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"
or the "Commission") and are members of the National Association of Securities
Dealers, Inc. ("NASD").
2. Roundtable Partners, L.L.C.
Roundtable was organized in March 1995 to own and operate the securities
market-making businesses of Knight Securities, L.P. and Trimark Securities,
L.P., predecessors to Knight and Trimark, respectively. Roundtable was owned
40% by key employees (the "Management Investors") and 60% by a consortium of
independent securities firms and investors (the "Non-Management Investors").
Certain Management Investors also received Mandatorily Redeemable Preferred B
Units (the "Preferred B Units") of Roundtable in consideration for the
contribution of their business to Roundtable, while the Non-Management
Investors received Mandatorily Redeemable Preferred A Units (the "Preferred A
Units") in return for cash consideration in a ratio of six Preferred A Units to
one Common Unit. In connection with a reorganization and initial public
offering of the Company's Common Stock (the "initial public offering") on July
13, 1998, the owners of Roundtable elected to exchange their membership
interests in Roundtable for shares of Common Stock of the Company (see Note 3).
Additionally, the Preferred A and B Units were redeemed and retired in their
entirety. The following is a summary of the capital structure of Roundtable.
Roundtable's equity consisted of Common Units, which had one-for-one voting
rights (except for the units owned by one owner, which were nonvoting.)
Roundtable's net income (after distributions to holders of Preferred A and B
Units) was allocated to holders of Common Units based upon a formula which
considered the volume of order flow such holders had provided to Roundtable
during each period and each holder's proportionate share of total Common Units.
Net losses were shared ratably in proportion to each member's ownership
percentage. The Common Units were generally not transferable, although a member
was permitted to resign from Roundtable at any time by providing written notice
to Roundtable.
The Preferred A Units were non-voting and had preference to all other units
in the event of liquidation. The Preferred A Units paid quarterly distributions
at a rate approximating the Federal Funds rate and were subject to mandatory
redemption annually, on April 15th, at book value, in an aggregate amount equal
to at least 25% of Roundtable's consolidated net income on an annual basis. Any
units not redeemed by the fifth anniversary of the issuance date were
convertible into Common Units on a one-for-one basis, at the holder's option.
The Preferred B Units were non-voting and had preference only to the Common
Units in liquidation. The Preferred B Units paid quarterly distributions at a
rate approximating the Federal Funds rate and, after the redemption of all
Preferred A Units, were subject to mandatory redemption annually, on April
15th, at book value, in an aggregate amount equal to at least 25% of
Roundtable's consolidated net income on an annual basis, if certain levels of
earnings were achieved in the prior year. The Preferred B Units were not
convertible into Common Units.
F-7
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table presents activity for Preferred A Units and Preferred B
Units for the years ended December 31, 1996, 1997 and 1998. All redemptions
were made at book value.
<TABLE>
<CAPTION>
Preferred A Units Preferred B Units
------------------------ ------------------------
Units Amount Units Amount
---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Balance, January 1, 1996.. 1,341,530 $ 13,415,300 1,500,000 $ 15,000,000
Issuance of Preferred A
Units................... 1,315,612 13,156,120 -- --
Redemption of Preferred A
Units................... (386,573) (3,865,730) -- --
---------- ------------ ---------- ------------
Balance, December 31,
1996.................... 2,270,569 22,705,690 1,500,000 15,000,000
Resignation of Member..... (7,503) (75,030) -- --
Redemption of Preferred A
Units................... (1,014,705) (10,147,050) -- --
---------- ------------ ---------- ------------
Balance, December 31,
1997.................... 1,248,361 12,483,610 1,500,000 15,000,000
Redemption of Preferred A
Units................... (1,248,361) (12,483,610) -- --
Redemption of Preferred B
Units................... -- -- (1,500,000) (15,000,000)
---------- ------------ ---------- ------------
Balance, December 31,
1998.................... -- $ -- -- $ --
========== ============ ========== ============
</TABLE>
Additionally, Brown & Company Securities Corporation ("Brown"), a major
customer, held a $500,000 subordinated note which paid interest quarterly at a
market rate approximating the Federal Funds rate. The subordinated note was to
mature on April 23, 1999. The subordinated note was senior in liquidation to
the Common Units and Mandatorily Redeemable Preferred A and B Units, but was
subordinate to the claims of all other creditors. Concurrent with the execution
of the subordinated note, the Company granted Brown certain benefits accorded
to holders of Common Units, including the right to receive additional payments
based on the amount of order flow provided by Brown. Additionally, Roundtable
granted Brown the option to purchase 7,143 Common Units at the then prevailing
market price of $10.00 per Common Unit during the term that the subordinated
note remained outstanding (the "Brown Option").
3. Reorganization of the Company and Initial Public Offering
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. Certain members, who so elected, also received,
in aggregate, 1,801,636 additional shares of Class A Common Stock valued at the
initial public offering price with respect to their share of the undistributed
income of Roundtable through March 31, 1998 (the "Undistributed Profits").
Management of the Company elected to receive shares of Class A Common Stock,
valued at the initial public offering price, for all of their Undistributed
Profits. The Company received no additional consideration in connection with
such conversion of member interests into shares of Class A and Class B Common
Stock. Additionally, Brown agreed to exercise its option to purchase 7,143
Common Units of Roundtable by purchasing the equivalent shares of Class A
Common Stock of the Company (394,887 shares) at the closing of the initial
public offering. 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
(including an underwriters' over-allotment option of 1,500,000 shares) 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.
F-8
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company also has authorized 20,000,000 shares of Preferred Stock, par
value $.01 per share. As of December 31, 1998, no preferred shares have been
issued.
4. Goodwill
The Company's acquisition of the business of Trimark Securities L.P. during
1995 was recorded under the purchase method and the carrying values of the
assets and liabilities acquired were adjusted to their fair market values as of
the acquisition date. The excess of the purchase price over the fair value of
the net assets acquired of $13,960,195 was recorded as goodwill and is being
amortized over a period of 10 years. In connection with the acquisition, the
Company entered into an agreement which entitles the former owners to receive
additional consideration during the five years immediately subsequent to the
acquisition, equal to 10% of Trimark's pre-tax earnings, before amortization of
goodwill and depreciation on fixed assets initially purchased. The additional
consideration represents contingent consideration to be paid in connection with
the Trimark acquisition. All amounts paid under this arrangement are being
capitalized as additional purchase price (goodwill) and amortized over the
remainder of the original ten-year amortization period.
Pursuant to an agreement effective November 17, 1997, Trimark purchased the
business and the related fixed assets of Tradetech Securities, L.P.
("Tradetech"), an Illinois Limited Partnership, in exchange for $750,000 in
cash and contingent consideration. Tradetech was a direct competitor of Trimark
operating as a market maker in listed stocks and, after the acquisition, its
business and operations were integrated into Trimark's. The acquisition was
accounted for under the purchase method and the carrying values of the assets
acquired were adjusted to their fair market values as of the acquisition date.
The excess of the purchase price over the fair value of the assets acquired of
$400,000 was recorded as goodwill and is being amortized over a period of five
years.
In connection with the acquisition, Trimark entered into an agreement with
Tradetech which entitles Tradetech to additional consideration equal to 10% of
Trimark's pretax earnings during the period from the acquisition date through
December 31, 2000 (the "Earnout Period"). If, after the Earnout Period, the
owners of Tradetech have not received payments which total $3.0 million, the
payments shall continue until the earlier of (1) December 31, 2002, or (2) an
aggregate of $3.0 million has been paid. All amounts paid under this
arrangement will be capitalized as additional purchase price (goodwill) and
amortized over the remainder of the original five-year amortization period.
The total contingent consideration paid and recorded as goodwill by the
Company was as follows:
<TABLE>
<CAPTION>
Trimark Tradetech
Additional Additional
Consideration Consideration Total
------------- ------------- ----------
<S> <C> <C> <C>
For the year ended December 31,
1996........................... $1,351,447 $ -- $1,351,447
For the year ended December 31,
1997........................... 1,466,812 218,573 1,685,385
For the year ended December 31,
1998........................... 2,155,007 1,921,889 4,076,896
</TABLE>
5. Significant Accounting Policies
Basis of consolidation and form of presentation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant intercompany
transactions and balances have been eliminated.
Cash equivalents
Cash equivalents represent money market accounts, which are payable on
demand. The carrying amount of such cash equivalents approximates their fair
value due to the short-term nature of these instruments.
F-9
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Trading activities
Securities owned and securities sold, not yet purchased, which primarily
consist of listed and OTC stocks, are carried at market value and are recorded
on a trade date basis. Net trading revenue (trading gains, net of trading
losses) and commissions, and related expenses, including compensation and
benefits, execution and clearance fees and payments for order flow, are also
recorded on a trade date basis. Payments for order flow represent payments to
other broker-dealers for directing their order executions to the Company.
Mandatorily redeemable preferred units
The Preferred A and Preferred B Units were mandatorily redeemable and have
been classified as liabilities in the Consolidated Statements of Financial
Condition, and the related distributions on such units have been classified as
interest expense in the Consolidated Statements of Income.
Depreciation, amortization and occupancy
Fixed assets are being depreciated on a straight-line basis over their
estimated useful lives of three to seven years. Leasehold improvements are
being amortized on a straight-line basis over the life of the related office
lease. The Company records rent expense on a straight-line basis over the life
of the lease.
Income taxes
Income tax expense in the Consolidated Statements of Income represents
income taxes incurred from July 13, 1998, the date of the Reorganization,
through December 31, 1998. 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.
The Company records deferred tax assets and liabilities, where material,
for the expected future tax consequences of temporary differences between the
accruing amounts and tax bases of assets and liabilities using enacted tax
rates.
Estimated fair value of financial instruments
The Company's securities owned and securities sold, not yet purchased are
carried at market value. Management estimates that the fair values of other
financial instruments recognized on the Consolidated Statements of Financial
Condition (including receivables, payables, accrued expenses, subordinated debt
and mandatorily redeemable preferred units) approximate their carrying values,
as such financial instruments are short-term in nature, bear interest at
current market rates or are subject to frequent repricing.
Other
Equity investments in limited liability companies, which are included in
"Other Assets" on the Consolidated Statements of Financial Condition, are
accounted for under the equity method of accounting.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Certain prior year amounts have been reclassified to conform to the current
year presentation.
F-10
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Fixed Assets and Leasehold Improvements
Fixed assets and leasehold improvements comprise the following:
<TABLE>
<CAPTION>
December 31,
Depreciation -----------------------
Period 1997 1998
------------- ----------- -----------
<S> <C> <C> <C>
Computer hardware and software......... 3 years $ 5,307,119 $ 9,580,193
Trading systems........................ 5 years 2,648,326 1,425,347
Leasehold improvements................. Life of Lease 1,666,288 3,620,916
Furniture and fixtures................. 7 years 735,341 911,107
Telephone system....................... 5 years 537,585 2,193,653
Equipment.............................. 5 years 343,513 760,922
----------- -----------
11,238,172 18,492,138
Less--Accumulated depreciation and amortization...... 3,884,743 6,477,147
----------- -----------
$ 7,353,429 $12,014,991
=========== ===========
</TABLE>
Through April 1998, Knight leased its trading system under a capital lease.
Knight cancelled its remaining obligation under the capital lease, which
amounted to $713,207. The net book value of the equipment recorded under such
capital lease was $619,747, resulting in a gain of $93,460. Depreciation of the
capitalized asset was included in depreciation and amortization expense on the
Consolidated Statements of Income.
7. 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. Interest expense incurred on such loan for the year ended
December 31, 1998 amounted to $946,752.
8. Related Party Transactions
A substantial portion of the Company's securities transactions are
conducted with securities firms that own Common Stock of the Company (the
"Broker-Dealer Owners"). As measured in share volume, the Broker-Dealer Owners
(including Brown) accounted for 35%, 40% and 41% of the Company's order flow
during the years ended December 31, 1996, 1997 and 1998, respectively.
Moreover, five of these affiliates accounted for 33% of the Company's total
order flow for the year ended December 31, 1998, one of which accounted for 11%
of the Company's total order flow for the year ended December 31, 1998. During
the period the subordinated note was outstanding (see Note 2), the Company also
made enhanced order flow payments to Brown amounting to $1,088,924, $1,865,222
and $1,189,331 for the years ended December 31, 1996, 1997 and 1998,
respectively.
Included within accrued payments for order flow on the Consolidated
Statements of Financial Condition are the following amounts payable to the
Broker-Dealer Owners:
<TABLE>
<S> <C>
December 31, 1997.............................................. $1,990,045
December 31, 1998.............................................. 5,899,037
</TABLE>
F-11
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As of December 31, 1997, 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 accrued
execution and clearance fees on the Consolidated Statements of Financial
Condition are the following amounts payable to the Broker-Dealer Owners:
<TABLE>
<CAPTION>
<S> <C>
December 31, 1997............................................... $2,666,469
December 31, 1998............................................... 2,687,297
</TABLE>
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 was as follows:
<TABLE>
<S> <C>
For the year ended December 31, 1996............................ $529,852
For the year ended December 31, 1997............................ 539,082
For the year ended December 31, 1998............................ 292,623
</TABLE>
9. Commitments and Contingent Liabilities
The Company leases office space under noncancellable operating leases. The
office leases contain certain escalation clauses whereby the rental commitments
may be increased if certain conditions are satisfied and specify yearly
adjustments to the lease amounts based on annual adjustments to the Consumer
Price Index. Rental expense under the office leases was as follows:
<TABLE>
<CAPTION>
<S> <C>
For the year ended December 31, 1996.......................... $ 810,893
For the year ended December 31, 1997.......................... 1,258,827
For the year ending December 31, 1998......................... 1,699,963
</TABLE>
Additionally, the Company leases computer and other equipment under
noncancellable operating leases. As of December 31, 1998, future minimum rental
commitments under all noncancellable operating leases were as follows:
<TABLE>
<CAPTION>
Office Other
Leases Leases Total
----------- ---------- -----------
<S> <C> <C> <C>
Year ending December 31, 1999.......... $ 2,162,022 $3,650,428 $ 5,812,450
Year ending December 31, 2000.......... 1,995,659 2,157,474 4,153,133
Year ending December 31, 2001.......... 2,012,758 499,546 2,512,304
Year ending December 31, 2002.......... 2,067,200 -- 2,067,200
Year ending December 31, 2003.......... 2,069,016 -- 2,069,016
Thereafter through December 15, 2008... 5,674,548 -- 5,674,548
----------- ---------- -----------
$15,981,203 $6,307,448 $22,288,651
=========== ========== ===========
</TABLE>
As of December 31, 1998, the Company had deposited an irrevocable letter of
credit, which was collateralized by U.S. Treasury securities with a market
value of $1,285,525, as security for one of its operating leases.
10. Earnings per Share
Basic and diluted earnings per common share have 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. All
shares of Class B Common Stock, which are non-voting, are held by a single
broker-
F-12
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
dealer owner. 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. Weighted-average shares outstanding for the years ended December
31, 1996, 1997 and 1998 have been determined as if the Reorganization described
in Note 3 occurred as of the earliest date presented. For all periods
presented, the Company's outstanding options do not have a dilutive effect on
earnings and, as such, do not affect the calculation.
11. Employee Benefit Plan
The Company sponsors a 401(k) Profit Sharing Plan (the "Plan") in which
substantially all of its employees are eligible to participate. Under the terms
of the Plan, the Company is required to make annual contributions to the Plan
equal to 50% of the contributions made by its employees, up to certain
limitations. The total expense recognized with respect to the Plan was as
follows:
<TABLE>
<CAPTION>
For the year ended December 31, 1996.......................... $ 478,308
<S> <C>
For the year ended December 31, 1997.......................... 681,927
For the year ended December 31, 1998.......................... 1,120,907
</TABLE>
12. Income Taxes
The Company and its subsidiaries file a consolidated federal income tax
return. The Company has not recognized deferred taxes since such amounts are
not material. 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 was subject to federal income taxes and state
income taxes in New York, New Jersey and other states. Actual income tax
expense on the Consolidated Statements of Income represents income taxes
incurred from July 13, 1998, the date of the Reorganization, through December
31, 1998. The following is a reconciliation of the actual provision for income
taxes for the period from July 13, 1998 through December 31, 1998 and the
amount computed by applying the Federal statutory rate to income before income
taxes for the period from July 13, 1998 to December 31, 1998:
<TABLE>
<S> <C>
Federal statutory income tax rate................................... 35.0%
State and local income taxes, net of federal income tax benefit..... 5.9
Other, net, primarily the amortization of goodwill and a portion of
business development expenses..................................... 1.3
-----
42.2%
=====
</TABLE>
13. Long-Term Incentive Plans
In connection with the Reorganization and Offering, the Company established
the Knight/Trimark Group, Inc. 1998 Long Term Incentive Plan and the
Knight/Trimark Group, Inc. 1998 Nonemployee Director Stock Option Plan
(together, the "Plans") to provide long-term incentive compensation to selected
employees and directors of Knight/Trimark and its subsidiaries. The Plans are
administered by the compensation committee of the Company's Board of Directors,
and allow for the grant of options, restricted stock and restricted stock
units, as defined by the Plans. The maximum number of shares of Class A Common
Stock reserved for the grant of awards under the Plans is 7,409,500, subject to
adjustment. In addition, the Plans limit the number of shares which may be
granted to a single individual, and the Plans also limit the number of shares
of restricted stock which may be awarded.
F-13
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
It is the Company's policy to grant options for the purchase of shares of
Class A Common Stock at an exercise price not less than the market value on the
date prior to the grant date. During 1998, the Company issued to employees and
directors options to purchase shares of the Company's Class A Stock at exercise
prices of $14.50 and $13.07 per share. Such options vest over a four-year
period and expire on the tenth anniversary of the grant date. The Company has
the right to fully vest employees in their option grants upon retirement. The
following is a reconciliation of option activity for the Plans through December
31, 1998 and a summary of options outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Number of Weighted-Average
Options Exercise Price
--------- ----------------
<S> <C> <C>
Outstanding, January 1, 1998................... -- $ --
Granted at market value........................ 5,099,000 14.50
Granted above market value..................... 75,000 13.07
Surrendered.................................... (54,000) 14.50
--------- ------
Outstanding at December 31, 1998............... 5,120,000 $14.48
========= ======
</TABLE>
<TABLE>
<CAPTION>
Range of Weighted-Average Number Weighted-
Exercise Outstanding at Remaining Weighted Average Exercisable at Average Exercise
Prices 12/31/98 Contractual Life Exercise Price 12/31/98 Price
- -------- -------------- ---------------- ---------------- -------------- ----------------
<S> <C> <C> <C> <C> <C>
$13.07 75,000 9.80 $13.07 -- $ --
$14.50 5,045,000 9.52 14.50 40,000 14.50
--------- ---- ------ ------ ------
$13.07--$14.50 5,120,000 9.52 $14.48 40,000 $14.50
========= ==== ====== ====== ======
</TABLE>
In addition, concurrent with the closing of the initial public offering,
the Company granted a total of 15,000 restricted shares of Class A Common Stock
to certain directors of the Company under the 1998 Non-employee Director Stock
Option Plan and recorded compensation expense of $217,500 for the fair value of
the shares on the date of grant, which has been included in Other Expenses in
the Consolidated Statements of Income.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" and related interpretations in accounting for
its stock option plans. Accordingly, no compensation expense has been
recognized for the fair values of the options granted to employees. Had
compensation expense for the Company's options been determined based on the
fair value at the grant dates in accordance with Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation," the
Company's net income and earnings per share amounts for the year ended December
31, 1998 would have been as follows:
<TABLE>
<S> <C>
Net income, as reported...................................... $66,601,027
===========
Pro forma net income......................................... $62,899,203
===========
Basic and diluted earnings per share, as reported............ $ 1.40
===========
Pro forma basic and diluted earnings per share............... $ 1.32
===========
</TABLE>
The weighted average fair values of options granted during the year ended
December 31, 1998 were $5.47 and $1.91 per share for options granted with
exercise prices of $14.50 and $13.07 per share, respectively.
F-14
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The fair value of each option granted is estimated as of its respective
grant date using the Black-Scholes option-pricing model with the following
assumptions:
<TABLE>
<S> <C>
Dividend yield.................................... 0.0%
Expected volatility............................... 44%
Risk-free interest rate........................... 5.5%
Expected life (in years).......................... 5
</TABLE>
14. Financial Instruments with Off-Balance Sheet Risk and Concentrations of
Credit Risk
As a market maker of OTC and listed stocks, the majority of the Company's
securities transactions are conducted as principal with broker-dealer and
institutional counterparties located in the United States. The Company clears
all of its securities transactions through affiliated and unaffiliated clearing
brokers on a fully disclosed basis (see Note 8). Pursuant to the terms of the
agreement between the Company and the clearing brokers, the clearing brokers
have the right to charge the Company for losses that result from a counter-
party's failure to fulfill its contractual obligations. The Company's policy is
to monitor the credit standing of the clearing brokers and all counterparties
with which it conducts business. Additionally, as of December 31, 1998, the
Company's credit exposures were concentrated with the clearing brokers and
amounted to $107.5 million. As of December 31, 1998, the clearing brokers also
held, as custodian, securities owned by the Company with a market value of
$100.5 million.
The net payable for securities transactions that have not reached their
contractual settlement date amounted to $5,126,772 and $12,004,530 at December
31, 1997 and 1998, respectively. Such amounts are included within receivable
from clearing brokers on the Consolidated Statements of Financial Condition.
Securities sold, not yet purchased represent obligations to purchase such
securities at a future date. The Company may incur a loss if the market value
of the securities subsequently increases.
15. Net Capital Requirements
As registered broker-dealers and NASD member firms, Trimark and Knight are
subject to the SEC's Uniform Net Capital Rule (the "Rule") which requires the
maintenance of minimum net capital. Trimark and Knight 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 December 31, 1998, Knight had net capital of $80,985,914, which was
$79,047,864 in excess of its required net capital of $1,938,050 and Trimark had
net capital of $28,482,004 which was $27,482,004 in excess of its required net
capital of $1.0 million.
F-15
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
16. Condensed Financial Statements of Knight/Trimark Group, Inc. (parent only)
Presented below are the Condensed Statements of Financial Condition, Income
and Cash Flows for the Company on an unconsolidated basis.
Statements of Financial Condition
Knight/Trimark Group, Inc. (parent only)
<TABLE>
<CAPTION>
December 31,
------------------------
1997 1998
----------- ------------
<S> <C> <C>
Assets
Cash and cash equivalents............................ $ 1,219,374 $ 28,088,538
Securities owned, at market value.................... 1,541,038 1,285,525
Investments in subsidiaries, equity method........... 88,630,081 183,367,366
Other assets......................................... 222,908 512,372
----------- ------------
Total assets....................................... $91,613,401 $213,253,801
=========== ============
Liabilities and Stockholders' (Members') Equity
Liabilities
Short-term loan...................................... $ -- $ 10,000,000
Distributions on Common Units payable to members..... 8,405,326 --
Interest payable on Preferred Units.................. 424,981 --
Accounts payable and accrued expenses................ 826,023 847,522
Income taxes payable................................. -- 2,285,620
Subordinated note.................................... 500,000 --
Mandatorily Redeemable Preferred A Units............. 12,483,610 --
Mandatorily Redeemable Preferred B Units............. 15,000,000 --
----------- ------------
Total liabilities.................................. 37,639,940 13,133,142
Total stockholders' equity......................... -- 200,120,659
Total members' equity.............................. 53,973,461 --
----------- ------------
Total liabilities and stockholders' (members')
equity........................................... $91,613,401 $213,253,801
=========== ============
</TABLE>
F-16
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Statements of Income
Knight/Trimark Group, Inc. (parent only)
<TABLE>
<CAPTION>
For the Years Ended
December 31,
-----------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Revenues
Equity in earnings of subsidiaries......... $40,094,824 $54,202,490 $73,518,890
Other...................................... 216,554 148,533 266,970
----------- ----------- -----------
Total revenues........................... 40,311,378 54,351,023 73,785,860
----------- ----------- -----------
Expenses
Compensation expense....................... -- -- 1,200,000
Payments for order flow.................... 1,088,924 1,865,222 1,189,331
Interest on Preferred Units................ 2,092,593 1,940,972 714,905
Other...................................... 369,259 467,596 1,735,172
----------- ----------- -----------
Total expenses........................... 3,550,776 4,273,790 4,839,408
----------- ----------- -----------
Income before income taxes................. 36,760,602 50,077,233 68,946,452
Income tax expense......................... -- -- 2,345,425
----------- ----------- -----------
Net income............................... $36,760,602 $50,077,233 $66,601,027
=========== =========== ===========
</TABLE>
F-17
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Statements of Cash Flows
Knight/Trimark Group, Inc. (parent only)
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income........................... $ 36,760,602 $ 50,077,233 $ 66,601,027
Adjustments to reconcile net income
to net cash provided by operating
activities
Equity in earnings of subsidiaries... (40,094,824) (54,202,490) (73,518,890)
Issuance of restricted stock to
directors.......................... -- -- 217,500
(Increase) decrease in operating
assets
Securities owned.................... (46,578) 494,419 255,513
Other assets........................ 298,736 90,557 (2,629,524)
Increase (decrease) in operating
liabilities
Accounts payable, accrued expenses
and other liabilities............. (133,880) 365,879 2,307,120
Interest payable on Preferred
Units............................. 163,438 (171,898) (424,981)
------------ ------------ ------------
Net cash used in operating
activities....................... (3,052,506) (3,346,300) (7,192,235)
------------ ------------ ------------
Cash flows from investing activities
Capital contributions to
subsidiaries....................... -- -- (71,448,000)
------------ ------------ ------------
Net cash used in investing
activities....................... -- -- (71,448,000)
------------ ------------ ------------
Cash flows from financing activities
Proceeds from short-term loan........ -- -- 30,000,000
Repayment of short-term loan......... -- -- (20,000,000)
Proceeds from issuance of
subordinated notes................. 500,000 -- --
Repayment of subordinated note....... -- -- (500,000)
Net proceeds from initial public
offering........................... -- -- 136,522,770
Net proceeds from exercise of Brown
option............................. -- -- 71,430
Proceeds from issuance of Common
Units.............................. 2,940,200 -- --
Proceeds from issuance of Mandatorily
Redeemable Preferred A Units....... 8,870,410 -- --
Dividends received from
subsidiaries....................... 14,191,301 34,604,999 52,569,664
Redemptions of Mandatorily Redeemable
Preferred A Units.................. (3,865,730) (10,147,050) (12,483,610)
Redemptions of Mandatorily Redeemable
Preferred B Units.................. -- -- (15,000,000)
Resignation of Member................ -- (422,463) --
Distributions on Common Units........ (17,643,870) (22,321,502) (65,670,855)
------------ ------------ ------------
Net cash provided by financing
activities....................... 4,992,311 1,713,984 105,509,399
------------ ------------ ------------
Increase (decrease) in cash and cash
equivalents........................ 1,939,805 (1,632,316) 26,869,164
Cash and cash equivalents at
beginning of year.................. 911,885 2,851,690 1,219,374
------------ ------------ ------------
Cash and cash equivalents at end of
year............................... $ 2,851,690 $ 1,219,374 $ 28,088,538
============ ============ ============
Supplemental disclosure of cash flow
information
Cash paid for interest............. $ 2,016,244 $ 2,144,877 $ 2,069,809
============ ============ ============
Cash paid for income taxes......... $ -- $ -- $ 16,926,278
============ ============ ============
</TABLE>
Supplemental information pertaining to noncash investing and financing
activities.
Effective January 1, 1996, a subordinated note holder exchanged its $5.0
million subordinated note for 71,429 Common Units and 428,571 Preferred A Units
issued by the Company with an aggregate value of $5.0 million.
F-18
<PAGE>
[LOGO] KNIGHT TRIMARK GROUP, INC.
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The expenses of the offering are estimated to be as follows:
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee............. $130,572
NASD filing fee................................................. 30,500
Nasdaq listing fee.............................................. 17,500
Legal fees and expenses......................................... 300,000
Accounting fees and expenses.................................... 150,000
Blue Sky fees and expenses (including legal fees)............... 10,000
Printing expenses............................................... 200,000
Transfer Agent fees............................................. 25,000
Miscellaneous................................................... 86,428
--------
TOTAL......................................................... $950,000
========
</TABLE>
Item 14. Indemnification of Directors and Officers
The Company, a Delaware corporation, is empowered by Section 145 of the
Delaware General Corporation Law (the DGCL), subject to the procedures and
limitations stated therein, to indemnify any person who was or is a party or is
threatened to be made a party to any threatened, pending or completed action,
suit or proceeding by reason of the fact that such person is or was a director,
officer, employee or agent of the Company, or is or was serving at the request
of the Company as a director, officer, employee or agent of another corporation
or other enterprise, against reasonable expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually incurred by him in
connection with such action, suit or proceeding, if such director, officer,
employee or agent acted in good faith and in a manner he reasonably believed to
be in or not opposed to the best interests of the Company and, with respect to
any criminal action or proceeding, had no reasonable cause to believe his
conduct was unlawful. The Company is required by Section 145 to indemnify any
person against reasonable expenses (including attorneys' fees) actually
incurred by him in connection with an action, suit or proceeding in which he is
a party because he is or was a director, officer, employee or agent of the
Company or is or was serving at the request of the Company as a director,
officer, employee or agent of another corporation or other enterprise, if he
has been successful, on the merits or otherwise, in the defense of the action,
suit or proceeding. Section 145 also allows a corporation to purchase and
maintain insurance on behalf of any such person against any liability asserted
against him in any such capacity, or arising out of his status as such, whether
or not the corporation would have the power to indemnify him against such
liability under the provisions of Section 145. In addition, Section 145
provides that indemnification pursuant to its provisions is not exclusive of
other rights of indemnification to which a person may be entitled under any
bylaw, agreement, vote of shareholders or disinterested directors, or
otherwise.
Article 7 of the Company's Certificate of Incorporation (the Charter)
provides that the Company shall indemnify and hold harmless any person who was,
is or is threatened to be made a party to a proceeding by reason of the fact
that he or she (i) is or was a director or officer of the Company or (ii) while
a director or officer of the Company, is or was serving at the request of the
Company as a director, officer, partner, venturer, proprietor, trustee,
employee, agent, or similar functionary of another foreign or domestic
corporation, partnership, joint venture, sole proprietorship, trust, employee
benefit plan or other enterprise, to the fullest extent permitted under the
DGCL. The right to indemnification under Article 7 of the Charter is a contract
right which includes, with respect to directors and officers, the right to be
paid by the Company the expenses incurred in defending any such proceeding in
advance of its disposition.
II-1
<PAGE>
Item 15. Recent Sales of Unregistered Securities
On March 27, 1995, Roundtable Partners, L.L.C. (the LLC) sold an aggregate
of 304,407 common units of the LLC (Common Units) to 22 investors, at a price
of $10.00 per unit, for an aggregate purchase price of $3,044,070. The LLC also
sold an aggregate of 1,095,864 Series A preferred units of the LLC (Series A
Preferred Units) to 18 investors, at a price of $10.00 per unit, for an
aggregate purchase price of $10,958,640. In addition, on such date, the LLC
sold an aggregate of 1,500,000 Series B preferred units of the LLC to Trimark
Securities, Inc., at a price of $10.00 per unit, for an aggregate purchase
price of $15.0 million.
On June 28, 1995, the LLC sold an aggregate of 23,331 Common Units to five
investors, at a price of $10.00 per unit, for an aggregate purchase price of
$233,310. The LLC also sold an aggregate of 83,992 Series A Preferred Units to
a single investor, at a price of $10.00 per unit, for an aggregate purchase
price of $839,920.
On July 26, 1995, the LLC sold an aggregate of 33,574 Common Units to eight
investors, at a price of $10.00 per unit, for an aggregate purchase price of
$335,740. The LLC also sold an aggregate of 120,866 Series A Preferred Units to
four investors, at a price of $10.00 per unit, for an aggregate purchase price
of $1,208,660.
On October 25, 1995, the LLC sold an aggregate of 7,167 Common Units to six
investors, at a price of $10.00 per unit, for an aggregate purchase price of
$71,670. The LLC also sold an aggregate of 25,800 Series A Preferred Units to
two investors, at a price of $10.00 per unit, for an aggregate purchase price
of $258,000.
On November 29, 1995, the LLC sold an aggregate of 1,190 Common Units, at a
price of $10.00 per unit, for an aggregate purchase price of $11,900. The LLC
also sold an aggregate of 4,284 Series A Preferred Units, at a price of $10.00
per unit, for an aggregate purchase price of $42,840.
On December 27 1995, the LLC sold an aggregate of 2,979 Common Units to six
investors, at a purchase price of $10.00 per unit, for an aggregate purchase
price of $29,790. The LLC also sold an aggregate of 10,724 Series A Preferred
Units to two investors, at a price of $10.00 per unit, for an aggregate
purchase price of $107,240.
On January 1, 1996, the LLC sold an aggregate of 120,849 Common Units to
five investors, at a price of $10.00 per unit, for an aggregate purchase price
of $1,208,490. The LLC also sold an aggregate of 435,056 Series A Preferred
Units to a single investor, at a price of $10.00 per unit, for an aggregate
purchase price of $4,350,560.
On January 24, 1996, the LLC sold an aggregate of 1,699 Common Units to
five investors, at a price of $10.00 per unit, for an aggregate purchase price
of $16,990. The LLC also sold an aggregate of 6,116 Series A Preferred Units to
a single investor, at a price of $10.00 per unit, for an aggregate purchase
price of $61,160.
On February 21, 1996, the LLC sold an aggregate of 1,783 Common Units to
five investors, at a price of $10.00 per unit, for an aggregate purchase price
of $17,830. The LLC also sold an aggregate of 6,418 Series A Preferred Units to
a single investor, at a price of $10.00 per unit, for an aggregate purchase
price of $64,180.
On March 27, 1996, the LLC sold an aggregate of 1,190 Common Units to six
investors, at a price of $10.00 per unit, for an aggregate purchase price of
$11,900. The LLC sold an aggregate of 4,284 Series A Preferred Units to two
investors, at a price of $10.00 per unit, for an aggregate purchase price of
$42,840.
On April 24, 1996, the LLC sold an aggregate of 4,189 Common Units to five
investors, at a price of $10.00 per unit, for an aggregate purchase price of
$41,890. The LLC also sold an aggregate of 15,080 Series A Preferred Units to a
single investor, at a price of $10.00 per unit, for an aggregate purchase price
of $150,800.
On May 29, 1996, the LLC sold an aggregate of 60,160 Common Units to seven
investors, at a price of $10.00 per unit, for an aggregate purchase price of
$601,600. The LLC also sold an aggregate of 216,575 Series A Preferred Units to
three investors, at a price of $10.00 per unit, for an aggregate purchase price
of $2,165,750.
II-2
<PAGE>
On June 26, 1996, the LLC sold an aggregate of 29,809 Common Units to 10
investors, at a price of $10.00 per unit, for an aggregate purchase price of
$298,090. The LLC also sold an aggregate of 107,312 Series A Preferred Units to
six investors, at a price of $10.00 per unit, for an aggregate purchase price
of $1,073,120.
On July 24, 1996, the LLC sold an aggregate of 12,001 Common Units to seven
investors, at a price of $10.00 per unit, for an aggregate purchase price of
$120,010. The LLC also sold an aggregate of 43,203 Series A Preferred Units to
three investors, at a price of $10.00 per unit, for an aggregate purchase price
of $432,030.
On October 1, 1996, the LLC sold an aggregate of 133,769 Common Units to 12
investors, at a price of $10.00 per unit, for an aggregate purchase price of
$1,337,690. The LLC also sold an aggregate of 481,568 Series A Preferred Units
to eight investors, at a price of $10.00 per unit, for an aggregate purchase
price of $4,815,680.
In January 1999, the Company sold 20,000 shares of Class A Common Stock to
one investor, upon exercise of options awarded under the Company's 1998 Long-
Term Incentive Plan at a price of $14.50 per share for an aggregate purchase
price of $290,000.
Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits:
<TABLE>
<C> <S>
+1.1 Form of Underwriting Agreement.
*3.1 Form of Amended and Restated Certificate of Incorporation of the
Registrant.
*3.2 Form of Amended and Restated Bylaws of the Registrant.
*4.1 Specimen Common Stock certificate.
*4.2 Form of Registration Rights Agreement, dated as of July 13, 1998.
**5.1 Opinion of Michael T. Dorsey, General Counsel of the Registrant.
*10.1 Clearing Agreement between Knight Securities, L,P. and Correspondent
Services Corporation, dated April 23, 1997.
*10.2 Clearing Agreement between Trimark Securities, L.P. and National
Investor Service Corporation, dated June 29, 1997.
*10.3 Lease Agreement between Newport L.P., Inc. and Knight Securities, L.P.
dated December 6, 1994 (the Knight Lease Agreement) for office space
situated in Newport Office Tower, 525 Washington Boulevard, Jersey
City, New Jersey 07310.
*10.4 Amendment to the Knight Lease Agreement, dated May 28, 1996.
*10.5 Second Amendment to the Knight Lease Agreement, dated September 30,
1997.
*10.6 Third Amendment to the Knight Lease Agreement, dated March 18, 1998.
*10.7 Lease Agreement between Nestle USA, Inc. and Trimark Securities L.P.,
dated March 20, 1996, for the office space situated at 100
Manhattanville Road, Purchase, New York 10577.
*10.8 License Agreement between Automated Securities Clearance, Ltd. and
Knight Securities, L.P., dated April 5, 1995.
*10.9 Master Program Product License Agreement between TCAM Systems, Inc.
and Trimark Securities, Inc. dated May 1, 1990.
*10.10 Form of Employment Agreement between the Registrant and Kenneth
Pasternak.
*10.11 Form of Employment Agreement between the Registrant and Walter Raquet.
*10.12 Form of Employment Agreement between the Registrant and Steven
Steinman.
*10.13 Form of Employment Agreement between the Registrant and Robert
Lazarowitz.
*10.14 Form of Employment Agreement between the Registrant and Anthony
Sanfilippo.
*10.15 Form of Registrant's 1998 Stock Option and Award Plan.
*10.16 Form of Registrant's 1998 Nonemployee Director Stock Option Plan.
*10.17 Form of Registrant's Management Incentive Performance Plan.
*10.18 Loan Agreement between PaineWebber Capital Inc. and Roundtable
Partners, L.L.C. dated June 19, 1998.
* 21.1 Subsidiaries of the Registrant.
</TABLE>
II-3
<PAGE>
<TABLE>
<C> <S>
23.1 Consent of Price Waterhouse LLP.
**23.2 Consent of Michael T. Dorsey, General Counsel of the Registrant
(contained in Exhibit 5.1 hereto).
**24.1 Powers of Attorney.
**27 Financial Data Schedule.
</TABLE>
- --------
* Previously filed as an exhibit to the Registrant's Registration Statement
on Form S-1 (No. 333-51653) and incorporated herein by reference thereto.
** Previously filed.
+ To be filed by amendment.
(b) Consolidated Financial Statement Schedules
All schedules are omitted because the required information is inapplicable
or the information is presented in the Consolidated Financial Statements or
related notes.
Item 17. Undertakings
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that, in the opinion of the SEC, such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question of whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.
The undersigned Registrant hereby undertakes to provide to the Underwriters
at the closing specified in the underwriting agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-1 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Jersey City, State of New Jersey, on this 19th day
of February, 1999.
Knight/Trimark Group, Inc.
/s/ Kenneth D. Pasternak
By___________________________________
Name:Kenneth D. Pasternak
Title: Director, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed by the following persons in the capacities and on the
date indicated.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
Director, President and February 19, 1999
/s/ Kenneth D. Pasternak Chief Executive Officer
____________________________________
Kenneth D. Pasternak
Director, Executive Vice February 19, 1999
/s/ Robert I. Turner President and Chief
____________________________________ Financial Officer
Robert I. Turner (principal financial and
accounting officer)
/s/ Steven L. Steinman Director and Chairman of the February 19, 1999
____________________________________ Board
Steven L. Steinman
/s/ Walter F. Raquet Director and Executive Vice February 19, 1999
____________________________________ President
Walter F. Raquet
/s/ Robert M. Lazarowitz Director and Executive Vice February 19, 1999
____________________________________ President
Robert M. Lazarowitz
/s/ Anthony M. Sanfilippo Director and Executive Vice February 19, 1999
____________________________________ President
Anthony M. Sanfilippo
</TABLE>
II-5
<PAGE>
<TABLE>
<S> <C> <C>
/s/ Martin Averbuch Director February 19, 1999
____________________________________
Martin Averbuch
/s/ Charles V. Doherty Director February 19, 1999
____________________________________
Charles V. Doherty
/s/ Gene L. Finn Director February 19, 1999
____________________________________
Gene L. Finn
/s/ Gary R. Griffith Director February 19, 1999
____________________________________
Gary R. Griffith
/s/ Bruce R. McMaken Director February 19, 1999
____________________________________
Bruce R. McMaken
/s/ J. Joe Ricketts
____________________________________ Director February 19, 1999
J. Joe Ricketts
/s/ Rodger O. Riney Director February 19, 1999
____________________________________
Rodger O. Riney
/s/ V. Eric Roach Director February 19, 1999
____________________________________
V. Eric Roach
/s/ Charles A. Zabatta Director February 19, 1999
____________________________________
Charles A. Zabatta
/s/ Kenneth D. Pasternak February 19, 1999
By: ____________________________
Kenneth D. Pasternak
As Attorney-in-Fact
</TABLE>
II-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<C> <S>
+1.1 Form of Underwriting Agreement.
*3.1 Form of Amended and Restated Certificate of Incorporation of the
Registrant.
*3.2 Form of Amended and Restated Bylaws of the Registrant.
*4.1 Specimen Common Stock certificate.
*4.2 Form of Registration Rights Agreement, dated as of July 13, 1998.
**5.1 Opinion of Michael T. Dorsey, General Counsel of the Company.
*10.1 Clearing Agreement between Knight Securities, L,P. and Correspondent
Services Corporation, dated April 23, 1997.
*10.2 Clearing Agreement between Trimark Securities, L.P. and National
Investor Service Corporation, dated June 29, 1997.
*10.3 Lease Agreement between Newport L.P., Inc. and Knight Securities, L.P.
dated December 6, 1994 (the Knight Lease Agreement) for office space
situated in Newport Office Tower, 525 Washington Boulevard, Jersey
City, New Jersey 07310.
*10.4 Amendment to the Knight Lease Agreement, dated May 28, 1996.
*10.5 Second Amendment to the Knight Lease Agreement, dated September 30,
1997.
*10.6 Third Amendment to the Knight Lease Agreement, dated March 18, 1998.
*10.7 Lease Agreement between Nestle USA, Inc. and Trimark Securities L.P.,
dated March 20, 1996, for the office space situated at 100
Manhattanville Road, Purchase, New York 10577.
*10.8 License Agreement between Automated Securities Clearance, Ltd. and
Knight Securities, L.P., dated April 5, 1995.
*10.9 Master Program Product License Agreement between TCAM Systems, Inc.
and Trimark Securities, Inc. dated May 1, 1990.
*10.10 Form of Employment Agreement between the Registrant and Kenneth
Pasternak.
*10.11 Form of Employment Agreement between the Registrant and Walter Raquet.
*10.12 Form of Employment Agreement between the Registrant and Steven
Steinman.
*10.13 Form of Employment Agreement between the Registrant and Robert
Lazarowitz.
*10.14 Form of Employment Agreement between the Registrant and Anthony
Sanfilippo.
*10.15 Form of Registrant's 1998 Stock Option and Award Plan.
*10.16 Form of Registrant's 1998 Nonemployee Director Stock Option Plan.
*10.17 Form of Registrant's Management Incentive Performance Plan.
*10.18 Loan Agreement between PaineWebber Capital Inc. and Roundtable
Partners, L.L.C. dated June 19, 1998.
*21.1 Subsidiaries of the Registrant.
23.1 Consent of PricewaterhouseCoopers LLP.
**23.2 Consent of Michael T. Dorsey, General Counsel of the Company
(contained in Exhibit 5.1 hereto).
**24.1 Powers of Attorney.
**27 Financial Data Schedule.
</TABLE>
- --------
* Previously filed as an exhibit to the Registrant's Registration Statement
on Form S-1 (No. 333-51653) and incorporated herein by reference thereto.
** Previously filed.
+ To be filed by amendment.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We hereby consent to the use in this Amendment No. 2 to the Prospectus
constituting part of this Registration Statement on Form S-1 of our report dated
January 19, 1999, relating to the consolidated financial statements of
Knight/Trimark Group, Inc., which appears in such Prospectus. We also consent to
the reference to us under the heading "Experts" in such Prospectus.
PricewaterhouseCoopers LLP
New York, New York
February 22, 1999
