<PAGE>
As filed with the Securities and Exchange Commission on February 1, 1999
Registration No.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
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. Skadden, Alexander D. Lynch, Esq. Babak Yaghmaie,
Arps, Slate, Meagher & Flom LLP919 Esq.Brobeck, Phleger & Harrison LLP1633
Third AvenueNew York, New York Broadway, 47th FloorNew York, New York
10022 (212) 735-3000 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. [_]
CALCULATION OF REGISTRATION FEE
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Title of Each Class Proposed Maximum Aggregate
of Securities to be Registered Offering Price(1) Amount of Registration Fee
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
Class A Common Stock, par value
$.01 per share........................... $469,683,000 $130,572
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1)Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(o) of the Securities Act of 1933.
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 1, 1999
[LOGO] KNIGHT TRIMARK
Group, Inc.
9,000,000 Shares
Class A Common Stock
Knight/Trimark Group, Inc. is offering 2,419,137 shares of its Class A
Common Stock and the selling stockholders are selling an additional 6,580,863
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 January 29, 1999 was $45.38 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...................................... $45.38 $408,420,000
Underwriting Discounts and Commissions..................... $ 1.95 $ 17,550,000
Proceeds to the Company.................................... $43.43 $105,063,120
Proceeds to the Selling Stockholders....................... $43.43 $285,806,880
</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. In this prospectus,
references to the "Company," "Knight/Trimark," "we," "us" and "our" refer to
Knight/Trimark Group, Inc. and its subsidiaries. Any reference to "Knight"
refers to Knight Securities, Inc. or Knight Securities, L.P., as appropriate,
and any reference to "Trimark" refers to Trimark Securities, Inc. or Trimark
Securities, L.P., as appropriate.
---------------------
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............................................. 64
Shares Eligible for Future Sale.......................................... 66
Underwriting............................................................. 68
Legal Matters............................................................ 70
Experts.................................................................. 70
Additional Information................................................... 70
Index to Consolidated Financial Statements............................... F-1
</TABLE>
---------------------
We own or have rights to trademarks or trade names that we use in
conjunction with the sale of our services. Knight/Trimark, Knight, Trimark,
e.Knight and eKnight are trademarks that are owned by us. This prospectus also
makes reference to trademarks of other companies.
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 such forward-
looking statements as a result of certain factors, as more fully 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
We are the leading market maker in Nasdaq securities and in the Third
Market, which is the over-the-counter (OTC) market in exchange-listed equity
securities, primarily those listed on the New York Stock Exchange (NYSE) and
the American Stock Exchange (AMEX). We have attained this leadership position
by providing best execution services to broker-dealer and institutional
customers through our sophisticated trading systems and proprietary 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. (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 (AutEx), a widely recognized industry
reporting service that provides daily trading volume and market share
statistics for broker-dealer market makers, Knight achieved a #1 market
share ranking of advertised 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%.
. 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 grew
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 and ask 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 AutEx, 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.
. 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.
According to the NASD, 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 order flow in an effort to
increase the number of trades they handle, which, in turn will provide them
with 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 execution and customer service.
4
<PAGE>
Our Solution
We provide "best execution" services to our broker-dealer and institutional
customers. Pursuant to 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 proprietary trading practices, we
are committed to providing a value-added execution methodology that emphasizes
automated execution and rule compliance, real-time information access by
customers, and pricing plus liquidity advantages based upon 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 the efficient processing
of large volumes of order flow, without diminishing speed of execution.
Our combined systems currently are designed to process up to 650,000
trades per day, and in December 1998, handled a combined average of
245,000 trades per day. The Company executed a record number of trades,
over 400,000, on January 11, 1999.
. A trading methodology focused on the dynamic, 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.
. Providing the highest quality customer service. We believe that our
highly skilled, experienced and entrepreneurial workforce can effectively
address the needs of our customers.
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. Certain 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 and 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. Concurrent with the consummation of 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, certain 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 share of
undistributed income of Roundtable Partners. Other members of Roundtable
Partners elected to receive a cash distribution, in the aggregate amount of
$21,977,097, of their share of undistributed income of Roundtable Partners.
Pursuant to the terms of Roundtable Partners' limited liability company
agreement, our broker-dealer owners shared our profits in proportion to their
equity interest and the quantity of order flow they directed to us. This
arrangement was discontinued upon the consummation of 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 contractually or otherwise
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 the Company............... 2,419,137 shares
Class A Common Stock Offered by the Selling Stockholders.. 6,580,863 shares
Common Stock to be Outstanding after the Offering:
Class A Common Stock............................... 52,381,321 shares
Class B Common Stock............................... 3,042,698 shares
Total.......................................... 55,424,019 shares (1)
Use of Proceeds........................................... To support the growth of
our market making
business. See "Use of
Proceeds."
Nasdaq National Market Symbol............................. NITE
</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
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)
<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 (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, 1998
-----------------------
Actual As Adjusted(4)
-------- --------------
<S> <C> <C>
Consolidated Statement of Financial Condition Data:
Cash and cash equivalents.............................. $117,382 $221,495
Receivable from clearing brokers....................... 107,503 107,503
Securities owned, at market value...................... 100,476 100,476
Total assets........................................... 358,860 462,973
Securities sold, not yet purchased, at market value.... 108,909 108,909
Total stockholders' equity............................. 200,121 304,234
</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
(5).................... 26 46 80 162 103 216
Average daily net
trading revenue (6).... $ 356 $ 722 $ 885 $ 1,381 $ 1,004 $ 1,798
</TABLE>
- -------
(1) Before the Company's initial public offering, the Company was a limited
liability company and was 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 the Company's 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.
(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.
(4) As adjusted to reflect the sale of 2,419,137 shares of Class A Common Stock
offered hereby at the offering price of $45.38 per share. See "Use of
Proceeds" and "Capitalization".
(5) Average daily trades was computed by dividing total trades executed by the
aggregate number of trading days in each respective period.
(6) Average daily net trading revenue was computed by dividing net trading
revenue by the aggregate number of trading days in each respective period.
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 impair 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 such
forward-looking statements as a result of certain factors, as more fully
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; 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 such fluctuations better.
However, we cannot assure you that the operational controls we have
implemented will effectively manage these fluctuations. 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 and
thus, could have a material adverse effect on our business, financial
condition and operating results.
Our operating results may fluctuate significantly in the future due to 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;
.the amount of revenue derived from limit orders as a percentage of total
revenues;
.changes in payments for order flow;
.changes in execution and clearance fees;
.the addition or loss of sales and trading professionals;
.regulatory changes and compliance issues;
.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 services declines
and we are unable to adjust our cost structure on a timely basis, our
operating results could be materially and adversely affected. We have
experienced, and may experience in the future, significant seasonality in our
business. Historically, we have experienced an increase in revenues in the
fourth quarter of the year, which we believe is due largely to higher trading
8
<PAGE>
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.
Due to all of the foregoing factors, period-to-period comparisons of our
revenues and operating results are not necessarily meaningful and reliance upon
such comparisons as indicators of future performance should be avoided. We also
cannot assure you that we will be able to sustain the rates of revenue growth
we have 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. 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."
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 received by market makers. We cannot assure you that the spreads market
makers receive upon 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 securities that trade in Nasdaq. 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 pursuant to which securities will trade in decimals rather than in
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, it could
have a material adverse effect on our business, financial condition and
operating results.
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, among other things, inflation, rising interest rates and related economic
issues as well as a slowdown or reversal of 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 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 of such 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.
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Risks Associated with Recent Change in 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 upon our reorganization from a limited liability company to
a Delaware corporation immediately before our initial public offering.
Accordingly, our broker-dealer owners are no longer obligated,
contractually or otherwise,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
such 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.
Furthermore, certain of our broker-dealer owners are selling some or all of
their shares in this offering and 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 such broker-dealers' ownership interest will not reduce further
their incentive to send order flow to us. The loss of, or a significant
reduction of, order flow from certain of our broker-dealer owners would have a
material adverse effect on our business, financial condition and operating
results. Certain of our broker-dealer owners may engage in market-making
activities on their own in the future. In such event, 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 in Managing Our Growth
Since we commenced operations in 1995, we have experienced significant
growth in our business activities and the number of our employees. For example,
our share volume has increased from 2.0 billion shares traded for the quarter
ended December 31, 1995 to 12.0 billion shares traded for the quarter ended
December 31, 1998. The number of our employees has increased from 152 as of
December 31, 1995 to 446 as of December 31, 1998. The growth of our business
and expansion of our customer base has placed, and will continue to place, a
significant strain on our management and operations. This growth has required
and will continue to require increased 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 certain measures to address such
difficulties, we cannot assure you that we will not experience similar
difficulties in the future. Any such difficulties could have a material adverse
effect on our business, financial condition and operating results.
We believe that our current and anticipated future growth will require
implementation of new and enhanced communications and information systems, and
the training of personnel to operate such 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. We have
implemented and continue to implement formal compliance procedures to respond
to these changes and the impact of our growth. 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.
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We cannot assure you that we will be able to manage or continue to manage
our recent or future 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 and our ability to respond to regulatory and
technological changes, as well as 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; Risks Associated with
International Expansion
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. In addition, the U.S. Securities
and Exchange Commission (the SEC), the NASD, other self-regulatory
organizations (SROs) and state securities commissions require strict compliance
with their respective rules and regulations. As a matter of public policy,
these regulatory bodies are responsible for safeguarding the integrity of the
securities and other financial 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
censure, fines, the issuance of cease-and-desist orders or the suspension or
disqualification of our 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
employees, have, in the past, been subject to claims arising from acts in
contravention 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 similar
claims. An adverse ruling against us and/or our officers and other employees,
including censure or suspension, 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, which could have a material adverse
effect on our business, financial condition and operating results.
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
the method of operation and profitability of securities firms. We cannot
predict what effect any such changes might have. Furthermore, our business,
financial condition and operating results may be materially affected by both
regulations that are directly applicable to us and
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regulations of general application. 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 Board of
Governors of the Federal Reserve System) and changes in interpretation or
enforcement of existing laws and rules that affect the business and financial
communities. 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 such
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. 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.
In addition, 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 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. Moreover, there are certain 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."
Risks Associated with SEC Enforcement Action against Trimark
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
Staff'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.
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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 and market acceptance of recently introduced services
and products is subject to a high level of uncertainty. Our electronic services
may involve alternative approaches to market making and, accordingly,
substantial marketing and sales efforts may be necessary to educate prospective
customers regarding the use and benefit of 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 of such broker-
dealers 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, including security, reliability, cost, ease of use, accessibility and
quality of service all may negatively affect the growth of Internet use for
such activities. The success of the Internet will also depend on the
development of necessary infrastructure and complementary services and
products, such as 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 with respect to 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 government regulation and 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 OTC 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."
Pursuant to the terms of our agreements with our clearing brokers, 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 that any such counterparty will not
default on its obligations. Any such default could have a material adverse
effect on our business, financial condition and operating results. 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
such clearing brokers. As of December 31, 1997 and 1998, our credit exposures
were concentrated with the clearing brokers and amounted to $30.2 million and
$107.5 million, respectively. Additionally, as of December 31, 1997 and 1998,
the clearing brokers held, as custodian, securities owned by us with a market
value of $61.7 million and $100.5 million, respectively. Consequently, 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 failure by our clearing brokers to remain solvent, or any
event adversely affecting our clearing brokers, could have a material adverse
effect on our business, financial condition and operating results.
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.
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These risks may limit or restrict our ability to either resell securities
we purchase or to repurchase securities we sell in such 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
previously. 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.
Such a concentration has in the past resulted and might in the future result 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 such securities, which
are frequently exacerbated by the relatively limited volume of such securities
available for trading.
The success of our market-making activities depends upon:
. 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 to 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 such risk successfully or that
we will not experience significant losses from such activities, either of which
could materially adversely affect our business, financial condition and
operating results.
We Depend on Our Ability to Attract and Retain Key Personnel
Our future success depends, in significant part, upon the continued service
of key executive officers, managers, sales, trading, compliance and technical
personnel, 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 or 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."
Our success also depends, in significant part, on the highly skilled, and
often specialized, individuals we employ. Our ability to attract and retain
management, sales, trading, compliance and technical professionals is
particularly important to our business strategy. We strive to provide high
quality services that will allow us to establish and maintain long-term
relationships with our customers. Our ability to do so depends, in large part,
upon the individual employees who represent us in our dealings with such
customers.
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From time to time, other companies in the securities industry have
experienced losses of sales and trading professionals. The level of competition
to attract such professionals is intense. We cannot assure you that we will not
lose such 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.
We expect that the number of our personnel will continue to grow,
particularly if current equity market activity continues and grows. Competition
for employees with the qualifications we desire is intense, especially
competition for equity trading professionals. We cannot assure you that we will
be able to recruit and retain a sufficient number of new employees with the
qualifications we desire in a timely manner or that our personnel costs will
not increase significantly. If we fail to retain personnel or experience a
significant increase in personnel costs, it could have a material adverse
effect 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, among others:
.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 such 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 thereby reduce 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.
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
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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, and is expected to continue to account, for
a substantial portion of our revenues. Knight only began its operation in 1995.
Our management has limited experience with respect to the operations of Knight
and in operating the Company on a consolidated basis. Accordingly, we have
limited consolidated operating history upon which an evaluation of our
performance and our prospects can be based. Our prospects must be considered in
light of the risks, uncertainties, expenses and difficulties 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, among other things:
.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 such
requirements. The failure to do so could have a material adverse effect on our
business, financial condition and operating results.
Third Parties May Infringe Upon Our Intellectual Property Rights; 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, Ltd. (ASC), and the other is known as the "Appletree System," which
we license from TCAM Systems (TCAM), pursuant to license agreements. Although
we have rights to modify the licensed software under the license agreements,
the licensors own all modifications and enhancements to the licensed software,
and the licensors can use the modifications and enhancements to the licensed
software without our consent. While we do not believe that ASC or TCAM has
incorporated any such modifications in software licensed to third parties, we
cannot assure you that they will not do so in the future or that any such
license will not have a material adverse effect on our competitive position. We
rely on ASC to monitor the daily operation of the Brass System to detect
problems with the Brass
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System's operation. We rely on both licensors to support and maintain the Brass
and Appletree Systems. The licenses, and the licensors' daily operation and
support obligations, are terminable if we breach our obligations under the
license agreements. Our failure to maintain these relationships, or to find a
replacement for such technology in a timely and cost-effective manner, could
have a material adverse effect on our business, financial condition and
operating results.
We also license other software from third parties, which is 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 such replacements would be available on reasonable terms, if at all.
Such events would have a material adverse effect upon our business, financial
condition and operating results. 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. Such
litigation, whether successful or unsuccessful, could result in substantial
costs and diversions of resources, 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 assure you that such royalties or licenses
would be available on reasonable terms, if at all, and the assertion or
prosecution of any such 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, in
part, on our ability to respond to the demand for new services, products and
technologies on a timely and cost-effective basis and adapt to technological
advancements and changing standards to address the increasingly sophisticated
requirements of our customers. We cannot assure you that we will be successful
in developing, introducing or marketing new services, products and
technologies. Any failure on our part to anticipate or respond adequately to
technological advancements, customer requirements or changing industry
standards, or any significant delays in the development, introduction or
availability of new services, products or enhancements could have a material
adverse effect on our business, financial condition and operating results.
Concentration of Ownership by Our Broker-Dealer Owners as a Group
Immediately after this offering, our broker-dealer owners will continue to
own 34.1% of our capital stock and therefore as a group may be able to control
the election of all of the members of the 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.
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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, including 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, and also
could 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."
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 or risk system failure or miscalculations causing disruptions of
normal business activities. Significant uncertainty exists concerning the
potential effects associated with the failure to achieve such 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 (SIA) "streetwide" testing in June 1998, and
plan to participate in the March 1999 SIA test. We presently believe that our
main trading-related systems are currently Year 2000 compliant, and we plan to
require vendors of material hardware and software components of our information
technology (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 also 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 evaluate completely whether our IT systems or non-IT 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, all of which could be
time consuming and expensive. If we fail to fix our trading-related,
communications or data processing systems or to fix or replace third-party
software, hardware or services on a timely basis, our business, financial
condition and operating results would be materially adversely affected.
Moreover, our failure to address adequately Year 2000 compliance issues in our
main trading-related, communications or data processing systems could result in
litigation, which could be costly and time-consuming to defend.
In addition, we cannot assure you that our customers, governmental
agencies, utility companies, Internet access companies, third-party service
providers and others outside our control, particularly other broker-dealers and
market makers, will be Year 2000 compliant. The failure by such entities to be
Year 2000 compliant could result in a systematic failure beyond our control,
such as 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, which could prevent us from engaging
in trading activities and would have a material adverse effect on our business,
results of operations and financial condition.
18
<PAGE>
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 (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, 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 our competitors
also offer a wider range of services and products than we offer, and have
greater name recognition and more extensive customer bases than we have. These
competitors may be able to respond more quickly to new or evolving
opportunities, technologies and customer requirements than we may, 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 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.
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 are heavily dependent 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 (e.g., on-line service providers, record retention and data
processing functions performed by third parties, and third-party software, such
as Internet browsers) could cause customers to suffer delays in trading. Such
delays could cause substantial losses for customers and could subject us to
claims from customers for losses, including litigation claiming fraud or
negligence. We cannot assure you that our network protections will work
appropriately from computer systems
19
<PAGE>
failure, or from a tornado, fire or any other natural disaster, power or
telecommunications failure, act of God or war, we will not suffer an extended
computer systems failure. 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 More Difficult
We are organized under the laws of the State of Delaware. Certain
provisions of Delaware law may have the effect of delaying, deferring, 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 rights, preference, privileges and restrictions of unissued
series of preferred stock and to fix the number of shares of any series of
preferred stock and the designation of any such series, without any vote or
action by our stockholders. Thus, 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, deferring, or
preventing a change of control, as the terms of the preferred stock that might
be issued could potentially prohibit the consummation of any merger,
reorganization, sale of substantially all of our assets, liquidation or other
extraordinary corporate transaction without the approval of the holders of the
outstanding shares of our Common Stock.
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. Accordingly, 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 businesses, products or
technologies that are complementary to those of the Company, and a portion of
the net proceeds may be used for such acquisitions. See "Use of Proceeds."
We Cannot Predict Our Future Capital Needs or Our Ability to Secure Additional
Financing
Our business is dependent upon 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, based on our experience and current
industry trends, that our available cash resources, combined with the net
proceeds to us 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. However, if we 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
(including shares issued upon the exercise of outstanding options) 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 52,381,321
20
<PAGE>
shares of Class A Common Stock and 3,042,698 shares of Class B Common Stock. Of
these shares, the 9,000,000 shares being offered hereby are freely tradeable.
This leaves 46,424,019 shares eligible for sale in the public market as
follows:
<TABLE>
<CAPTION>
Number of Shares Date
---------------- ----------------------------------------------------
<C> <S>
11,500,000 After the date of this prospectus
At various times after 90 days from the date of this
34,924,019 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 Inc. 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. Such registration statement became effective
immediately upon filing, and 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 31,866,321 shares of our Class A Common Stock and 3,042,698
shares of our Class B Common Stock, will continue to have the right, subject to
conditions, to include their shares in certain registration statements relating
to our securities. 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 the common stock to fall. In addition, any demand to
include such 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 the Company from the sale of the 2,419,137 shares of
Class A Common Stock offered by the Company hereby are approximately
$104,113,120 million at the public offering price of $45.38 per share after
deducting underwriting discounts and commissions and estimated offering
expenses payable by the Company. 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 the Company's market making business. The Company 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
its own. The Company currently does not have any commitments or agreements with
respect to any such acquisitions. Pending such uses, the Company intends to
invest the net proceeds of this offering in short-term, investment-grade,
interest-bearing securities.
PRICE RANGE OF CLASS A COMMON STOCK
The Company's Class A Common Stock is traded on the Nasdaq National Market
under the symbol "NITE." Public trading of the Company's Class A Common Stock
commenced on July 8, 1998. Before that, no public market for the Class A Common
Stock. The following table sets forth, for the periods indicated, the high and
low closing sales price per share of the Class A Common Stock on 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 January 29, 1999)................... $54 1/8 $22
</TABLE>
As of December 31, 1998, there were approximately 171 holders of record of
the Company's Class A Common Stock. On January 29, 1999, the last sale price
reported on the Nasdaq National Market for the Company's Class A Common Stock
was $45.38 per share.
DIVIDEND POLICY
Before the reorganization of the Company 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 the
reorganization of the Company 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 all of
their undistributed profits in the aggregate amount of $26.5 million (other
than $26.1 million that certain members elected not to have distributed and to
receive in exchange therefor additional shares of Common Stock), as well as all
of their taxable income earned during the period beginning April 1, 1998 and
ending with the closing of the initial public offering in the aggregate amount
of $22.0 million. See "Certain Transactions--The Reorganization."
The Company intends to retain future earnings, if any, to finance the
development and expansion of its business and, therefore, does not anticipate
paying any cash dividends on its Common Stock in the foreseeable future. The
payment of cash dividends is within the discretion of the Company's Board of
Directors and will be dependent upon, among other factors, the Company's
results of operations, financial condition and capital requirements,
restrictions imposed by the Company's financing arrangements and legal
requirements.
22
<PAGE>
CAPITALIZATION
The following table sets forth as of December 31, 1998, (i) the actual
capitalization of the Company and (ii) the as adjusted capitalization of the
Company after giving effect to the sale by the Company of 2,419,137 shares of
Class A Common Stock at an assumed public offering price of $45.38 per share,
the last reported sale price of the Class A Common Stock on the Nasdaq National
Market on January 29, 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
appearing 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; 52,381,321 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................................ 169,780 273,869
Retained earnings......................................... 29,811 29,811
-------- --------
Total stockholders' equity.............................. 200,121 304,234
-------- --------
Total capitalization.................................... $200,121 $304,234
======== ========
</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 the Company's
stock option plans.
23
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data are qualified by the
Consolidated Financial Statements of the Company and the Notes thereto included
elsewhere in this Prospectus and should be read in conjunction therewith 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 the Company's 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 the Company's initial public offering, the Company was a limited
liability company and was 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 the Company's 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
The Company is the leading market maker in Nasdaq securities, other OTC
equity securities, and NYSE- and AMEX-listed equity securities in the Third
Market. Through its wholly-owned subsidiary, Knight, the Company makes markets
in approximately 6,700 equity securities in Nasdaq and on the NASD's OTC
Bulletin Board. Through its wholly-owned subsidiary, Trimark, the Company makes
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 AutEx, a widely recognized industry
reporting service that provides daily trading volume and market share
statistics for 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 the Company's 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
the Company's total share volume growth during the years ended December 31,
1996, 1997 and 1998, respectively. Since the Company's 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 the
Company's total share volume for the years ended December 31, 1996, 1997 and
1998, respectively.
The Company was organized in April 1998 for the purpose of succeeding to
the business of Roundtable Partners, L.L.C. (the LLC). Concurrent with the
closing of the Company's initial public offering, all of the member interests
of the LLC were exchanged for shares of Class A Common Stock and Class B Common
Stock of the Company. The Company received no additional consideration in
connection with such conversion of member interests into shares of Common
Stock. In addition, certain members of the LLC, including the Company's
management, elected to receive additional shares of Class A Common Stock
instead of their share of profits of the LLC. Other members of the LLC elected
to receive a cash distribution, in the aggregate amount of $21,977,097, of
their share of profits of the LLC. 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 the reorganization of the Company from a limited
liability company to a Delaware corporation in connection with the Company's
initial public offering, a consortium of 27 broker-dealers or their affiliates
owned 60% of the member interests of the LLC. Additionally, Brown & Company
Securities Corporation (Brown), a major customer of the Company, held
subordinated debt of the LLC and an option to purchase a member interest in the
LLC (the Brown Option). Such broker-dealer owners (including Brown) owned 44.6%
of the Company's Common Stock after the Company's initial public offering, and
will own 34.1% of the Company's 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 the
Company's total order flow. For the years ended December 31, 1996, 1997 and
1998, aggregate payments by the Company to its 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 of the Company from a
limited liability company to a corporation, aggregate payments by the Company
for profit distributions to broker-dealer owners equaled $10.6 million, $13.4
million and $44.6 million, respectively. See "Certain Transactions."
Pursuant to the limited liability company agreement of the LLC, its broker-
dealer owners partially shared in the LLC profits in proportion to their equity
interest and partially in proportion to the quantity of order flow they have
directed to the Company. This arrangement was discontinued upon consummation of
the Company's initial public offering. The broker-dealer owners no longer
receive any special inducements to send order flow to the Company and are not
contractually or otherwise obligated to provide the Company with any order
flow. See "Risk Factors--Risks Associated with Recent Change of Our Ownership
Structure."
25
<PAGE>
Revenues
The Company's revenues consist principally of net trading revenue from
market-making activities. To date, the Company has only traded equity
securities, and has 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; the Company's 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. The Company's net
trading revenue per trade for OTC securities has historically exceeded the net
trading revenue per trade for listed securities.
In addition, the Company has expanded its 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 the Company earns
commissions on a per share basis. The Company also receives fees for providing
certain information to market data providers. Commissions and fees are
primarily affected by changes in the Company's trade and share volumes in
listed securities.
The Company also earns interest income from the Company's 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
The Company's 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 the
Company's 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 the overall
profitability of the Company (Profitability Based Compensation). 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. The Company has 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 the Company's 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 the
Company allocates 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 the Company.
As a result of the new Order Handling Rules
26
<PAGE>
implemented by the SEC in 1997, the Company changed its order flow payment
policy from paying broker-dealers for substantially all order executions, to
paying broker-dealers only for orders which provide the Company with a profit
opportunity. For example, the Company makes payments on market orders, but does
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 (ECNs). Execution and clearance fees
are higher for listed securities than for OTC securities. Due to the Company's
significant growth in share and trade volume, the Company has 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 the Company 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. (Tradetech) which the
Company 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 the
Company's Mandatorily Redeemable Preferred A and B Units at a rate
approximating the Federal Funds rate. On April 15, 1998, the Company redeemed
all of the remaining outstanding Preferred A Units for $12.5 million in cash.
On April 15, 1998, the Company redeemed $1.2 million of Preferred B Units and,
on July 17, 1998, the Company used $13.8 million of the proceeds from the
Company's initial public offering to redeem all of the remaining outstanding
Preferred B Units.
Other expenses primarily consist of administrative expenses and other
operating costs of the Company incurred in connection with its business growth,
as well as directors fees and restricted stock granted to directors in
connection with the initial public offering.
Income Tax
Prior to the Company's initial public offering, the Company was a limited
liability company and was not subject to federal or state income taxes.
Subsequent to the Reorganization, which occurred concurrently with the
consummation of the Company's initial public offering, the Company 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 of the Company from a
limited liability company to a corporation, through December 31, 1998 (the 1998
Post-Offering Period). The Company's 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>
Year 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
the Company's 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 the Company's 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, down 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. The
Company 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 the Company's 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 the business of the
Company and its 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 the Company's 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 of the Company in connection
with its 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.
Year 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
the Company's 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 the Company's 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. The
Company 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 the Company's 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 the business of the
Company.
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 the redemption and
retirement of 1,022,208 Preferred A Units by the Company 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 of the company in connection with its 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 the Company's 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>
32
<PAGE>
- --------
(1) Before the Company's initial public offering, the Company was a limited
liability company and was 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 as the Company was a C corporation for
the entire quarter.
32--1
<PAGE>
The Company has recently experienced a significant increase in its trading
volume. The Company believes that this increase in trading volume has been
largely due 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 the Company's
operating results and have, on occasion, caused significant fluctuations in the
Company's 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
its business, financial condition and operating results.
The Company has experienced and expects to continue to experience,
significant fluctuations in quarterly operating results as a result of a
variety of factors, including the value of the Company's securities positions
and the Company's ability to manage the risks attendant thereto, the volume of
its market-making activities, volatility in the securities markets, its 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. The Company's expense structure is based on historical
expense levels and the levels of demand for the Company's market-making
services. If demand for the Company's market-making services declines and the
Company is unable to adjust its cost structure on a timely basis, it could have
a material adverse effect on the Company's business, financial condition and
operating results. The Company has experienced, and may experience in the
future, significant seasonality in its business. The Company has historically
experienced an increase in revenues in the fourth quarter of the year, which
the Company believes is due, in large part, to higher trading volumes in the
securities markets at year end. The Company believes that this seasonal trend
will continue for the foreseeable future and that the Company's 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 the
revenues and operating results of the Company are not necessarily meaningful
and such comparisons cannot be relied upon as indicators of future performance.
There also can be no assurance that the Company will be able to sustain the
rates of revenue growth that it has experienced in the past, that it will be
able to improve its operating results or that it will be able to sustain its
profitability on a quarterly basis. See "Risk Factors--Our Business is Highly
Volatile; Our Quarterly Results May Fluctuate Significantly."
Liquidity
Historically, the Company has financed its business primarily through cash
generated by operations, as well as the proceeds from its initial public
offering, the private placement of preferred and common units and borrowings
under subordinated notes. As of December 31, 1998, the Company 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 the
Company's growth. Additionally, the Company made cash payments of $4.1 million,
$2.4 million and $1.4 million in 1998, 1997 and 1996, respectively, in
connection
33
<PAGE>
with its acquisitions of the listed securities market-making businesses of
Trimark in 1995 and Tradetech in 1997. The Company's aggregate minimum rental
commitments for 1999 are $5.8 million, and it expects that it will incur $9
million of capital expenditures during 1999, which expenditures will be
incurred for substantially similar purposes to those referenced above for 1998.
The Company anticipates that it will meet its 1999 capital expenditure needs
out of operating cash flows.
As registered broker-dealers and market makers, Knight and Trimark are
subject to regulatory requirements intended to ensure the general financial
soundness and liquidity of broker-dealers and requiring the maintenance of
minimum levels of net capital, as defined in SEC Rule 15c3-1 ($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.
The Company used a portion of its capital resources before its initial
public offering to pay interest on its issued and outstanding Mandatorily
Redeemable Preferred A and B Units, and to make quarterly distributions to its
members to meet their estimated income tax obligations on their share of the
Company's 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, the Company redeemed a portion of the Preferred B Units
for approximately $1.2 million in cash. The Company used $13.8 million of the
proceeds of its 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 the LLC pursuant to a loan agreement dated as of June 19, 1998
(the PaineWebber Loan). The LLC used the proceeds from the PaineWebber Loan to
make distributions of undistributed profits to the members of the LLC prior to
the reorganization of the Company from a limited liability company to a
Delaware corporation immediately prior to the Company's initial public
offering. In connection with the dissolution of the LLC, the Company assumed
all of the LLC's obligations under the PaineWebber Loan. The Company
subsequently repaid the entire loan from its 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.
The Company and its subsidiaries currently anticipate that net proceeds
from this offering together with their available cash resources and credit
facilities will be sufficient to meet their anticipated working capital and
capital expenditure requirements for at least the next 12 months.
On October 8, 1998, the Company's Board of Directors approved a program to
repurchase, over a period of up to eighteen months, up to 3 million shares of
the Company's outstanding Class A Common Stock up to a total aggregate amount
not to exceed $20 million. The Company 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, the Company has 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
34
<PAGE>
information about market risk exposures. Since its inception, neither the
Company nor its subsidiaries has traded or otherwise transacted in derivatives.
In the normal course of its market-making business, the Company maintains
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 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, the Company invests in money market funds or
maintains interest bearing balances in its 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. The Company has made an assessment of the Year 2000
readiness of its trading-related, communications and data processing systems.
The Company's 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 are both directly and indirectly
related to the main trading systems; (3) contacting vendors of critical non-
trading related communications and data processing systems; (4) assessment of
repair or replacement requirements; (5) repair or replacement; (6)
implementation; and (7) creation of contingency plans in the event of Year 2000
failures. Additionally, the Company participated in the Securities Industry
Association (SIA) "streetwide" testing in June 1998 and plans to participate in
the March 1999 SIA test. The Company presently believes that its main trading-
related systems are currently Year 2000 compliant. The Company will require
vendors of material hardware and software components of its IT systems to
provide assurances of their Year 2000 compliance. The Company plans to complete
this process during the first half of 1999. The Company is currently assessing
the materiality of its 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, the Company will not be
able to completely evaluate whether its IT systems or non-IT systems will need
to be revised or replaced.
Costs. To date, the Company has incurred approximately $350,000 in costs in
connection with identifying and evaluating Year 2000 compliance issues. Most of
its 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, the Company
estimates that the total cost of the Year 2000 project to be approximately
$500,000. Although the Company does 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 the Company's business,
financial condition and operating results.
Risks. The Company is not currently aware of any Year 2000 compliance
problems relating to its main trading-related, communications or data
processing systems that would have a material adverse effect on the Company's
business, financial condition and operating results, without taking into
account the Company's efforts to avoid or fix such problems. There can be no
assurance that the Company will not discover Year 2000
35
<PAGE>
compliance problems that will require substantial revisions. In addition, there
can be no assurance that third-party software, hardware or services
incorporated into the Company's systems will not need to be revised or
replaced, all of which could be time consuming and expensive. The failure of
the Company to fix its 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 the Company's business, financial condition and
operating results. Moreover, the failure to adequately address Year 2000
compliance issues in its main trading-related, communications or data
processing systems could result in litigation, which could be costly and time-
consuming to defend.
In addition, there can be no assurance that governmental agencies, utility
companies, securities exchanges, Internet access companies, third-party service
providers and others outside the Company's control will be Year 2000 compliant.
The failure by such entities to be Year 2000 compliant could result in a
systemic failure beyond the control of the Company, such as a prolonged
Internet, telecommunications or electrical failure, which could also prevent
the Company from delivering its services to its customers and could have a
material adverse effect on the Company's business, results of operations and
financial condition.
Contingency Plan. As discussed above, the Company is engaged in an ongoing
Year 2000 assessment and has not yet developed a contingency plan. The results
of the Company's SIA 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.
The Company 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
the Company's 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. The
Company anticipates it will adopt the provisions of SFAS No. 133 effective June
15, 1999. The Company believes the adoption of these provisions will not have a
material impact on the Company's financial statements.
36
<PAGE>
BUSINESS
Overview
The Company is the leading market maker in Nasdaq securities, other OTC
equity securities and NYSE- and the AMEX-listed equity securities in the Third
Market. The Company has attained this leadership position by providing best
execution services to broker-dealers and institutional customers through its
sophisticated trading systems and proprietary methods. Through its wholly-owned
subsidiary, Knight Securities (Knight), the Company makes markets in
approximately 6,700 equity securities in Nasdaq and on the NASD's OTC Bulletin
Board. The Company, through its wholly-owned subsidiary, Trimark Securities
(Trimark), makes markets in all NYSE- and AMEX-listed equity securities in the
Third Market.
Since the beginning of 1997, Knight and Trimark have significantly
increased their market share of trading volume in each of their respective
markets. According to AutEx, Knight's advertised share volume in Nasdaq
increased from 614.7 million shares representing 4.4% of total market share (or
a rank of 6th overall) for the month of January 1997 to 3.2 billion shares
representing 15.57% of total market share (or a rank of 1st overall) for the
month of December 1998. According to the NASD, Trimark's reported share volume
of the NYSE-listed securities increased from 234.3 million shares representing
21.2% of total NYSE Third Market volume (or a rank of 1st overall) in January
1997 to 644.0 million shares representing 40.4% of total NYSE Third Market
volume (or a rank of 1st overall) in December 1998. Trimark's reported share
volume of AMEX-listed securities increased from 40.3 million shares
representing 51.4% of total AMEX Third Market volume (or a rank of 1st overall)
in January 1997, to 65.7 million shares representing 61.7% of total AMEX Third
Market volume (or a rank of 1st overall) in December 1998.
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, such as 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.
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
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<PAGE>
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 buy (bid)
or sell (ask) 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 limit orders (orders to buy or sell stock at a
particular price) 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, thereby 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 AutEx, 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 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
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profitability in trading such stocks for market makers. In response to
tightening spreads and increasing volatility in the equity markets, certain
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 (order flow) which, in turn, will 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
The Company is 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. The Company has attained a leadership position by providing best
execution services to broker-dealer and institutional customers through its
sophisticated trading systems and proprietary methods. Pursuant to 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, the Company makes
markets in approximately 6,700 equity securities in NASDAQ and on the NASD's
OTC Bulletin Board. The Company, through Trimark, makes markets in all NYSE-and
AMEX-listed equity securities in the Third Market. The Company is committed to
providing a value-added execution methodology that emphasizes automated
execution and rule compliance, real-time information access to customers and
pricing plus liquidity advantages based upon the Company's willingness to
commit capital. While most of the Company's trades are automatically executed
electronically, automatic execution is highly dependent on the determination
and manual entry of bid-ask prices by traders. Furthermore, the Company's
trading revenues depend significantly on the management of inventory by its
skilled and experienced trading professionals. The main elements of the
Company's solution include:
.Superior Execution and Enhanced Liquidity. The Company has implemented a
variety of best execution practices that provide its 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 (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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<PAGE>
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. The Company relies on sophisticated
technology to facilitate its market-making activities. Knight uses the
Brass trading system under license from Automated Securities Clearance,
Ltd. (ASC). 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 ASC as a service bureau.
Trimark employs a TCAM/Appletree trading system. The Company has made
significant investments in its technology platform and infrastructure
since its inception. The Company's 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. The Company
continues to invest in technology to enhance further its processing
capability.
.Proprietary Trading Methods. The Company's net trading revenues are
dependent on its ability to evaluate and act rapidly on market trends
and manage risk successfully. The Company's methodology focuses on the
dynamic, real time analysis of market activity and price movements,
which enables the Company to manage risk better. Throughout the business
day, the Company continually analyzes its trading positions in
individual securities and monitors its short and long positions and its
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. The Company is committed
to providing the highest quality customer service. The Company believes
that its highly skilled, experienced and entrepreneurial workforce can
effectively address the needs of its customers. The Company has over 50
experienced employees involved in customer service. The Company's
customer service group is dedicated to handling orders greater than the
automated execution size and ensuring consistent quality of execution.
The Company is currently implementing its 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 the Company's
customers. If a customer's system fails, e.Knight is designed to provide
the customer with uninterrupted access to the Company's trading systems
thereby enabling the customer to continue to provide services to its
clients.
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The Company supplies each of its 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 the Company's customers as it enables them to monitor their
compliance with regulatory requirements to seek to obtain best execution
for their clients' trades.
Strategy
The Company's goal is to maintain and enhance its leadership position in
the market-making industry through the following key strategies:
Continue to Invest in Leading Technologies. The Company believes that its
future growth and profitability will depend largely on its continued investment
in leading technologies. For example, the Company believes that an increasing
number of customers and proportion of order flow will reach market makers
through the Internet and other electronic communications gateways. The Company
intends 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. The Company also intends to augment its Brass
and TCAM/Appletree trading systems with proprietary software applications, and
enter into strategic joint ventures with leading technology firms to develop
new state-of-the-art trading platforms to ensure that it has the capability to
process significantly greater trading volumes in the future.
Aggressively Capture New Order Flow. The Company believes that extensive
order flow is critical to creating opportunities for trading revenues. The
Company is focused on increasing order flow to enhance its position as a
leading market maker and create additional revenue opportunities. The Company
intends to retain and expand customer relationships by continuing to provide
low-cost, high quality execution services, and intends to continue to respond
to evolving customer needs through the development of new services and customer
service excellence.
Significantly Expand Institutional Market Share. The Company believes it
has an opportunity to significantly increase its institutional customer base.
Trades for institutional investors generally have higher margins because these
investors generally do not receive payments for order flow. The Company is
seeking to increase its 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, the Company plans to
hire an additional 25 institutional sales professionals, which will bring its
total institutional sales force to over 50 professionals.
Invest in and Develop the Best Human Capital. The Company believes that
investing in human capital is key to delivering best execution practices and
high quality customer service. The Company intends to continue its practice of
aggressively recruiting high caliber personnel and retaining such personnel by
providing appropriate compensation incentives. The Company believes that it has
high employee morale due to its competitive performance-based incentive
compensation structure and its 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. The Company intends to
expand this initiative and to develop additional programs to improve the skills
and productivity of its workforce.
Expand Internationally. As part of its strategy to increase its
institutional sales market share, the Company recently established a London-
based subsidiary, Knight Securities International Limited (Knight
International). Knight International will initially arrange transactions
between institutional customers and Knight. In October 1998, Knight
International filed an application for authorization with The Securities and
Futures Authority, and expects to commence operations in the second quarter of
1999. The Company believes that developing a sales presence in Europe will
allow it to expand more rapidly its institutional customer base.
Develop New Services. The Company intends to continue to develop new
services that address evolving customer needs and technological requirements.
The Company recently launched e.Knight, which it plans to
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provide to the majority of its institutional and broker-dealer customers and
use as a means of establishing new customer relationships. Additionally, the
Company holds a minority stake in Adirondack Trading Partners, the funding
vehicle for the International Securities Exchange (ISE) which, upon approval by
the SEC, will be the first entirely electronic options market in the United
States. In the future, the Company may establish and capitalize a subsidiary to
focus on opportunities to become a primary market maker on the ISE, however,
the Company currently does 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 AutEx, a
widely recognized industry reporting service that provides daily trading volume
and market share statistics for broker-dealer market makers.
<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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<PAGE>
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
Advertised Share Total Market Advertised Share Total Market
Month Ended Volume Share Rank Volume Share Rank
- ----------- ---------------- ------------- ---- ---------------- ------------- ----
(in thousands) (in 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 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.
The Company entered into a joint venture with ASC, the developer and owner
of the Brass order entry and trading system, to establish The Brass Utility,
L.L.C. (BRUT). Subsequent to this development, three other securities firms
invested in this joint venture. The Company now owns 14% of the joint venture
and believes that providing investors access to the BRUT ECN will greatly
enhance the breadth of the Company's execution services.
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Customers
The Company's target customers are national and regional full-service
broker-dealers, on-line discount brokers and institutional investors. Selected
customers of the Company own equity interests in the Company. See "Certain
Transactions with Affiliates." The following table presents a representative
list of the Company's broker-dealer customers.
Ameritrade Inc. Josephthal & Co. Inc.
BHC Securities, Inc. Merrill Lynch, Pierce, Fenner &
BHF Securities Corp. Smith Incorporated
Bidwell & Company Mesirow Financial
Nathan & Lewis Securities, Inc.
Brown & Company Securities Corporation
National Discount Brokers
Burke, Christensen & Lewis Securities, Inc.
CIBC Wood Gundy Securities Corp. National Financial Services
Cowles, Sabol & Co., Inc. Corporation
Dain Rauscher Incorporated PaineWebber Incorporated
David A. Noyes & Co. Primevest Financial Services, Inc.
The R.J. Forbes Group, Inc.
Direct Access Brokerage Services, Inc.
Discover Brokerage Direct Sanders Morris Mundy, Inc.
E*TRADE Securities, Inc. Scottsdale Securities, Inc.
A.G. Edwards & Sons, Inc. Southwest Securities, Inc.
Fiserv Correspondent Services, Inc. Stockcross, Inc.
Howe Barnes Investments, Inc. Thomas F. White & Co.
U.S. Clearing Corp.
International Correspondent Trading, Inc.
J.W. Charles Securities, Inc. Van Kasper & Company
Waterhouse Securities, Inc.
Wedbush Morgan Securities, Inc.
In addition, the Company currently has over 500 institutional customers,
including mutual funds, investment advisors, pension plan sponsors, bank
trusts, foundations and endowments.
In 1998, the Company's five largest customers, Ameritrade, Brown & Company,
Discover Brokerage Direct, E*TRADE Securities and Waterhouse Securities,
accounted for, in aggregate, 33.0% of the Company's order flow. In 1998, one of
the Company's customers, Waterhouse Securities, accounted for 10.7% of the
Company's order flow.
Marketing
The Company seeks to increase its market share through direct-response
advertising, advertising on its Web site and a public relations program. The
Company's marketing focuses on advertising its execution services in
publications targeted at the securities industry. In addition, the Company has
a quarterly program of targeted mailings to existing and potential broker-
dealer and institutional customers.
The Company also markets aggressively through one-on-one meetings with
customers and potential customers, and continuous communications with existing
customers. The Company maintains a comprehensive customer database that is used
regularly to better understand and address customer needs. The Company's
marketing strategy is to continue to differentiate itself 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 Incorporated (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
The Company's 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 the Company's ability to handle order
flow, it has also been an important component of the Company's strategy to
comply with government regulations, achieve the highest execution standards and
provide superior customer service. The Company also uses its technology and
technology licensed from third parties to monitor proactively the performance
of its traders, to assess its inventory positions and to provide ongoing
information to its customers. The Company is electronically linked to its
broker-dealer and institutional customers through dedicated servers. The
Company's trading volume is transacted over dedicated communications networks,
which provide immediate access to the Company's trading operations and
facilitate the handling of customer orders. The Company plans to continue to
make additional investments in technology and to automate further its execution
services.
Architectural Design and Industry Standards. The Company's systems are
designed to be open, interoperable, scalable, redundant and flexible. The
Company utilizes leading edge technologies including Sun Microsystems, Inc.'s
client/server architecture, C/C++ programming languages, Java, relational
database management systems and online analytical processing.
Electronic Commerce. The Company's electronic commerce architecture enables
its broker-dealer and institutional customers to send their orders through a
variety of electronic communications gateways, including the Internet and
direct customer interfaces over the Company's private network. The Company's
customers can use their own order management system, an institutional portfolio
management system or can select from a variety of the Company's electronic
connections.
Knight uses the Brass trading system designed by ASC. 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 (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. The Company is 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 the Company's trading systems and house a small group of market makers. To
provide for system continuity in the event of short power outages, the Company
has also equipped its three data centers and trading rooms with uninterruptible
power supply units and back up generators.
Competition
The Company derives substantially all of its revenues from market-making
activities. The market for these services, particularly market-making services
through electronic communications gateways, is rapidly evolving and intensely
competitive. The Company expects 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. The Company competes
primarily on the basis of execution standards, its relationship with its
customers and technology.
A number of the Company's competitors have significantly greater financial,
technical, marketing and other resources than the Company. Some of the
Company's competitors also offer a wider range of services and products than
the Company and have greater name recognition and more extensive customer bases
than the Company. These competitors may be able to respond more quickly to new
or evolving opportunities, technologies and customer requirements than the
Company 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
45
<PAGE>
delivered, including more direct access on-line to a wide variety of services
and 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, the Company may
experience a reduction in its limit order flow. There can be no assurance that
ECNs will not continue to capture a greater amount of limit order flow. A
substantial reduction in the Company's limit order flow could have a material
adverse effect on the Company's business, financial condition and operating
results.
There can be no assurance that the Company will be able to compete
effectively with current or future competitors or that the competitive
pressures faced by the Company will not have a material adverse effect on the
Company's business, financial condition and operating results.
Employees
At December 31, 1998, the Company 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 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
the Company's employees are subject to a collective bargaining agreement. The
Company believes that its relations with its employees are excellent.
The Company recruits and retains its employees by compensating them largely
on a performance basis, measuring performance primarily in terms of revenue
generation. The Company is committed to improving the skill levels of its
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. The Company intends to expand this
initiative and to develop additional programs to improve the skills and
productivity of its workforce. The Company believes that it has high employee
morale due to its performance-based incentive compensation and its
encouragement of a highly cooperative and creative culture.
Intellectual Property and Other Proprietary Rights
The Company relies primarily on copyright, trade secret and trademark law
to protect its proprietary technology. Notwithstanding the precautions taken by
the Company to protect its intellectual property rights, it is possible that
third parties may copy or otherwise obtain and use the Company's proprietary
technology without authorization or otherwise infringe on the Company's
proprietary rights. It is also possible that third parties may independently
develop technologies similar to those of the Company. It may be difficult for
the Company to police unauthorized use of its intellectual property rights.
There can be no assurance that the steps taken by the Company will prevent
misappropriation of its technology. In addition, litigation may be necessary in
the future to enforce the Company's intellectual property rights, to protect
the Company's trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or
invalidity. Such litigation, whether successful or unsuccessful, could result
in substantial costs and diversions of resources either of which could have a
material adverse effect on the Company's business, financial condition and
operating results. The Company may in the future receive notices of claims of
infringement of other parties' proprietary rights. There can be no assurance
that claims for infringement or invalidity (or claims for indemnification
resulting from infringement claims) will not be asserted or prosecuted against
the Company. 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 the Company to enter into royalty or licensing agreements.
There can be no assurance that such royalties or licenses would be available on
reasonable terms, if at all, and
46
<PAGE>
the assertion or prosecution of any such claims could have a material adverse
effect on the Company's 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 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 the Company's business, financial condition and operating
results. The Company and certain of its 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. There
can be no assurance that the Company and/or its 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 the Company and/or
its employees, including censure or suspension, could result in the Company
and/or its 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 the Company's 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, the Company is 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 the Company operates is subject to
change. The Company's 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. The Company's 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. The Company
cannot predict what effect any such changes might have. Both regulations
directly applicable to the Company and regulations of general application could
have a material adverse effect on the Company's business, financial condition,
and operating results. For example, the volume of the Company's 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.
The Company's business, both directly and indirectly, relies on the
Internet and other electronic communications gateways. The Company intends to
expand use of such 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.
47
<PAGE>
Accordingly, new regulations or interpretations may be adopted that constrain
the Company's and its 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 the
Company's business, financial condition and operating results.
In addition, the Company has recently established a London-based subsidiary
and may expand its business to other countries in the future. To expand its
services internationally, the Company will have to comply with the regulatory
controls of each country in which it conducts 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 the Company's ability to expand internationally. There can be no
assurance that the Company will be successful in obtaining the necessary
regulatory approvals for any such expansion, or if such approvals are obtained,
that the Company 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 the Company's business, financial condition and operating results.
Net Capital Requirements
As registered broker-dealers and members of the NASD, the Company's
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 (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 operations of the
Company that require the intensive use of capital and also could restrict the
Company's ability to withdraw capital from its broker-dealer subsidiaries,
which in turn could limit the Company's ability to pay dividends, repay debt
and repurchase shares of its outstanding stock. A significant operating loss or
any unusually large charge against net capital could adversely affect the
ability of the Company to expand or even maintain its present levels of
business, which could have a material adverse effect on the Company's business,
financial condition and operating results.
Risk Management
The Company's market-making and trading activities expose the Company's
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 the Company has virtually no control.
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The Company employs an automated proprietary trading and risk management
system which provides real time, on-line risk management and inventory control.
The Company monitors its risks by a constant review of trading positions. For
each trader, the Company has 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.
The Company takes long and short positions in securities in which it makes
a market. The following table illustrates, for the period indicated, the
Company's 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 (Internet issuers). 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
The Company's headquarters are located in Jersey City, New Jersey. The
Company leases approximately 52,000 square feet under a lease which expires in
March 2005. The Company has an option to extend the lease term on three floors
for an additional five-year period. The Company also leases approximately
29,000 square feet for its offices in Purchase, NY; Chicago, IL; Boston, MA;
Jericho, NY; Ridgefield, NJ and London, England. The Company believes that its
present facilities, together with its current options to extend lease terms and
occupy additional space, are adequate for its current needs.
Legal Proceedings
The Company is 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 its business, financial condition or operating results. The
Company and certain of its 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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<PAGE>
MANAGEMENT
Executive Officers and Directors
As of December 31, 1998, the executive officers and directors of the
Company 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 the Company, 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 the LLC, along with Messrs. Pasternak, Raquet and Lazarowitz,
and served as the Chairman of the LLC until the Company's initial public
offering and has served as Chairman of the Company 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
the Company, 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 the LLC and Knight Securities, L.P., Mr. Pasternak
served as the 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 the Company 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 the LLC 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 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.
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<PAGE>
Robert I. Turner, Executive Vice President, Chief Financial Officer,
Treasurer and Director of the Company 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 the LLC on which he served until the Company's
initial public offering, at which time he joined the Board of Directors of the
Company. 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 the Company
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 the LLC. 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 the Company
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
the Company, joined the Company 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 the Company 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 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.
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<PAGE>
Martin Averbuch, Director of the Company, has served on the Board of the
Company since the Company's initial public offering and as an advisory board
member of the LLC 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 the Company, has served on the Board of the
Company since the Company's initial public offering and, before that, as an
advisory board member of the LLC 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 to 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 the Company, has served on the Board of the
Company since the Company's initial public offering and, before that, as an
advisory board member of the LLC 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 the Company, has served on the Board of the
Company since the Company's initial public offering and, before that, as an
advisory board member of the LLC since March 1995. He has been an independent
financial 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. Mr. Griffith received a B.S. in
Business Administration from Ohio State University.
Bruce R. McMaken, Director of the Company, has served on the Board of the
Company since the Company's initial public offering and, before that, as an
advisory board member of the LLC since March 1995. He also has been employed by
Sanders Morris Mundy, Inc. (SMM), 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 SMM. Before joining SMM, 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 the Company, 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 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.
52
<PAGE>
Rodger O. Riney, Director of the Company, has served on the Board of the
Company since the Company's initial public offering and, before that, as an
advisory board member of the LLC 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 the Company, has served on the Board of the
Company since the Company's initial public offering and, before that, as an
advisory board member of the LLC 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, a wholly-owned subsidiary of Morgan
Stanley Dean Witter, 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 the Company, 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 the Company's annual
audit and meeting with the Company's independent accountants to review the
Company'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 the Company's 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 the Company's 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 the Company 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 the Company's initial public offering, the
Company's Compensation Committee consists of Messrs. Doherty, Averbuch and
Finn, none of whom has ever been an officer or employee of the Company. 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
the Company's Board of Directors. No other executive officer of the Company
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 the
Company's Board of Directors or Compensation Committee. Certain members of the
Company's Board of Directors are parties to transactions with the Company. See
"Certain Transactions."
53
<PAGE>
Limitation of Liability and Indemnification Matters
The Company utilizes certain provisions in Delaware corporate law to limit
the liability of corporate officers and directors. The Company believes that
the provisions of its Certificate of Incorporation and Bylaws and the separate
indemnification agreements outlined below are necessary to attract and retain
qualified persons as directors and officers. The Company's Certificate of
Incorporation limits the liability of directors to the maximum extent permitted
by Delaware law. This provision is intended to allow the Company's 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. The
Company's Bylaws provide that the Company shall indemnify officers and
directors to the fullest extent provided by Delaware law.
The Company holds 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 the Company as to which indemnification is being
sought, nor is the Company 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, the Company's Chief Executive Officer, and the Company's four other
most highly compensated executive officers (together with the Chief Executive
Officer, the Named Executive Officers) for services rendered in all capacities
to the Company 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 the LLC, as well as $5,000
contributed on behalf of each of the executive officers by the Company
under the Company's 401(k) defined contribution plan.
(3) The number of shares covered by options to purchase the Company's Class A
Common Stock granted during the fiscal year ended December 31, 1998.
54
<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 the
Company's 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. The Company, with
the approval of its stockholders, adopted the 1998 Long-Term Incentive Plan
(the 1998 Plan) which took effect prior to the Company's 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 upon the
occurrence of any increase in, decrease in or exchange of the outstanding
shares of Common Stock through merger, consolidation, recapitalization,
reclassification, stock split, stock dividend or similar corporate transaction.
During 1998, the Company issued options to purchase 5,174,000 shares at a
weighted average price of $14.48 under the 1998 Plan to its 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 (the Committee). The 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 (Awards) will be
made, the size of such 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 (Options), restricted stock (Restricted
Stock) and restricted stock units (Restricted Stock Units) may be made under
the 1998 Plan to selected employees and independent contractors of the Company
and its present or future subsidiaries and affiliates, in the discretion of the
Committee. Substantially all employees of the Company will be eligible to
receive Awards under the 1998 Plan. Stock options may be either "incentive
stock options," as such term is defined in Section 422 of the Internal Revenue
Code of 1986, as amended (the Code), 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 pursuant to 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
such times 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 the Company, 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. The Company
granted a total of 15,000 shares of restricted Class A Common Stock to certain
directors in connection with the Company's 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 such Award will be
deemed fully vested and (3) any performance conditions imposed with respect to
Awards will be deemed to be fully achieved.
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 such 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 (the Spread). The Company will generally be
entitled to a tax deduction at the time and in the amount that the holder
recognizes ordinary income.
56
<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 (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 (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. The Company 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 such 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 such 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 such shares. A holder may, however, elect to be taxed at the
time of the grant. The Company 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. The Company 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. The
Company, with the approval of its stockholders, adopted the 1998 Nonemployee
Director Stock Option Plan (the Nonemployee Director Plan). The Nonemployee
Director Plan took effect upon the consummation of the Company's 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 upon the occurrence of any increase in, decrease in or exchange of
the outstanding shares of Class A Common Stock through merger, consolidation,
recapitalization, reclassification, stock split, stock dividend or similar
corporate transaction.
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 (Director Options) 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 upon
election to the Board of Directors. In addition, on the first business day
following
57
<PAGE>
each annual meeting of the Company's 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
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 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, the Company 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. The
Company has established a profit-pool incentive plan (the Incentive Plan),
currently consisting of three sub-profit pools, one for the Company
(disregarding its subsidiary companies) (the Company Sub-Pool), one for Knight
(the Knight Sub-Pool) and one for Trimark (the Trimark Sub-Pool). 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 Company subsidiary, to be allocated by
such person or persons as determined by a committee of the Board of Directors
consisting of its executive officers (the Executive Board).
The annual Company Sub-Pool will equal 15% of the before-tax profits of the
Company (on an unconsolidated basis) earned by the Company 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 the Company. 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. Such
officers may not themselves receive an allocation from any sub-profit pool in
any year unless the entire Company, 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
The Company has a Section 401(k) Plan (the 401(k) Plan), a tax-qualified
plan covering substantially all of the Company's employees. Under the terms of
the 401(k) Plan, participants may elect to defer a portion of their
compensation, subject to certain limitations, and the Company is 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 the Company's initial public offering, the Company entered
into a new employment agreement substantially the same as the prior LLC
employment agreement with Mr. Pasternak and amended the LLC agreements of
Messrs. Raquet, Steinman and Lazarowitz, as well as the prior Trimark
employment
58
<PAGE>
agreement with Mr. Sanfilippo (collectively, the Executives). The term of Mr.
Pasternak's agreement (the New Agreement) is four years, beginning on the date
of the consummation of the Company's 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
(the Amended Agreements) 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 Company 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 the Company;
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 the Company and Chief Executive Officer of
Trimark. Mr. Sanfilippo's Amended Agreement provides that he is Executive Vice
President of the Company 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.
The New Agreement and each of the Amended Agreements provide for the
payment of annual bonuses pursuant to the Incentive Plan (see Knight/Trimark
Group, Inc. 1998 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 the Company's 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
The Company was organized in April 1998 for the purpose of succeeding to
the business of the LLC (the Reorganization). Concurrent with the closing of
the Company's initial public offering, all of the member interests of the LLC
were exchanged for 36,662,415 shares of Class A Common Stock of the Company and
3,942,698 shares of Class B Common Stock of the Company. Before the
Reorganization, management owned 40% and the broker-dealer owners owned 60% of
the LLC. By agreement among the members of the LLC, the allocation of Common
Stock to the broker-dealer owners was based upon an approximation of the fair
market value of each such broker-dealer owner's interest in the LLC. One
broker-dealer owner of Common Unit of the LLC 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, the Company entered into a $500,000 subordinated note
agreement with Brown & Company Securities Corporation (Brown), a major customer
of the Company, which paid interest quarterly at a market rate approximating
the prevailing Federal Funds Rate. The subordinated note was repaid in full by
the Company on July 13, 1998. Concurrent with the execution of the subordinated
note, the Company granted Brown certain benefits, including the right to
receive additional payments based on the amount of order flow provided to the
Company 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 the Company's order flow.
Payments by the Company to Brown during these periods amounted
59
<PAGE>
to $2.1 million, $6.2 million, $7.5 million and $7.5 million, respectively.
Additionally, in April 1996, the Company granted Brown the right to purchase
7,143 Common Units in the LLC at the then prevailing market price of $10.00
per Common Unit (the Brown Option). As of the date of grant, the right to
purchase the Common Units had de minimis value. Brown elected to exercise the
Brown Option at the closing of the Company's initial public offering for
394,887 shares of the Company's Class A Common Stock at an aggregate price of
$71,430. Pursuant to the terms of the subordinated note, Brown shared in the
LLC profits based on the quantity of order flow it directed to the Company.
This arrangement was discontinued upon the consummation of the Reorganization.
Transactions with Affiliates
Transactions with Affiliates. Immediately prior to the Reorganization, 60%
of the Common Units of the LLC 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 the Company's initial public offering. Immediately
after the closing of the Company's initial public offering, broker-dealer
owners owned 44.6% of the Company's Common Stock and immediately after the
closing of this offering, the broker-dealer owners will own 34.1% of the
Company's Common Stock.
Set forth below is a list of broker-dealers which directly or indirectly
own the Company's capital stock:
<TABLE>
<CAPTION>
<S> <C> <C>
Ameritrade Inc. Direct Access Brokerage Services, Inc. Primevest Financial Services, Inc.
BHC Securities, Inc. Discover Brokerage Direct R.J. Forbes Group, Inc.
BHF Securities Corp. E*TRADE Securities, Inc. Sanders Morris Mundy, Inc.
Bidwell & Company Fiserv Correspondent Services, Inc. Scottsdale Securities, Inc.
Brown & Company Securities Corporation Howe Barnes Investments, Inc. Southwest Securities, Inc.
Burke, Christensen & Lewis Securities International Correspondents Trading, Inc. Stockcross, Inc.
Cowles, Sabol & Co., Inc. J.W. Charles Securities, Inc. Thomas F. White & Co.
Dain Rauscher Incorporated Josephthal & Co. Inc. Van Kasper & Company
David A. Noyes & Co. Nathan & Lewis Securities, Inc. Waterhouse Securities, Inc.
</TABLE>
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 the Company's 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 by
the Company to its 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, the Company made aggregate
profit distributions to broker-dealer owners amounting to $1.7 million, $10.6
million, $13.4 million and $44.6 million, respectively. Pursuant to the
limited liability company agreement of the LLC, the Company's broker-dealer
owners shared in the LLC profits partially in proportion to their equity
interest and partially in proportion to the quantity of order flow they
directed to the Company. This arrangement was discontinued upon consummation
of the Reorganization. The broker-dealer owners no longer receive any special
inducements to send order flow to the Company and are not contractually or
otherwise obligated to provide the Company with any order flow in the future.
Although the Company believes that, based on the high-quality execution
services it provides, these broker-dealer owners will continue to use the
Company's services, there can be no assurance that the absence of such
incentives will not cause the Company's broker-dealer owners to reduce the
level of or discontinue order flow they direct to the Company in the future.
See "Risk Factors--Risks Associated with Recent Changes in Our Ownership
Structure" and "Selling and Principal Stockholders."
Ameritrade. Upon the closing of this offering, Ameritrade Holding
Corporation (Ameritrade) will own 3,953,675 shares of the Company's Class A
Common Stock. Mr. J. Joe Ricketts, the Chairman and Chief Executive Officer of
Ameritrade, is a Director of the Company. 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
the Company's order flow. During the same periods, aggregate payments by the
Company to Ameritrade for order flow, equalled $3.1 million, $8.2 million,
$6.9 million and $11.7 million, respectively. Additionally, the Company made
profit distributions to Ameritrade for the period
60
<PAGE>
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.
Discover Brokerage Direct. Upon the closing of this offering, Discover
Brokerage Direct, Inc. (Discover) will own 1,201,963 shares of the Company's
Class A Common Stock. Mr. V. Eric Roach, the President of Discover, is a
Director of the Company. 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 the Company's order flow.
During the same periods, aggregate payments by the Company to Discover for
order flow, equaled $1.0 million, $4.4 million, $5.5 million and $4.2 million,
respectively. Additionally, the Company 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. Upon the closing of this offering, E*TRADE Securities, Inc.
(E*TRADE) will own 1,816,432 shares of the Company's 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 the Company's order flow. During the same periods,
aggregate payments by the Company to E*TRADE for order flow, equaled $645,000,
$3.5 million, $5.3 million and $8.4 million, respectively. Additionally, the
Company 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 & Co., L.L.C. (Gruntal)
owned 1,311,754 shares of the Company's Class A Common Stock, all of which
shares were sold by Gruntal in the Company's 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 the Company's order flow. During the same periods,
aggregate payments by the Company to Gruntal for order flow equaled $421,000,
$434,000, $415,000 and $337,000, respectively. Additionally, the Company 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, the Company utilized Gruntal as its clearing
broker. For the period from March 27, 1995 through December 31, 1995 and the
years ended December 31, 1996, 1997, and 1998, the Company paid Gruntal
clearing fees in the amount of $11.7 million, $21.5 million, $14.8 million and
$1.6 million. The Company terminated its clearing arrangements with Gruntal as
of March 1998.
Sanders Morris Mundy. Upon the closing of this offering, Sanders Morris
Mundy, Inc. (SMM) will not own any shares of the Company's Class A Common
Stock. Mr. Bruce R. McMaken, a Managing Director of SMM, is a Director of the
Company. For the period from March 27, 1995 through December 31, 1995 and the
years ended December 31, 1996, 1997 and 1998, SMM was the source of 0.1%,
0.046%, 0.033% and 0.011%, respectively, of the Company's order flow. During
the same periods, aggregate payments by the Company to SMM for order flow,
equaled $34,000, $64,000, $45,000 and $5,600, respectively. Additionally, the
Company made profit distributions to SMM 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. Upon the closing of this offering, employees and
affiliates of Scottsdale Securities, Inc. (Scottsdale Securities) will own
987,097 shares of the Company's Class A Common Stock. Mr. Rodger O. Riney, the
President of Scottsdale Securities, is a Director of the Company. For the
period from March 27, 1995 through December 31, 1995 and the years ended
December 31, 1996, 1997 and 1998,
61
<PAGE>
Scottsdale Securities was the source of 0.9%, 1.5%, 1.4% and 1.5%,
respectively, of the Company's order flow. During the same periods, aggregate
payments by the Company to Scottsdale Securities for order flow equaled
$662,000, $2.2 million, $1.3 million, and $1.8 million, respectively.
Additionally, the Company made profit distributions to Scottsdale Securities
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.
Southwest Securities. Upon the closing of this offering, Southwest
Securities, Inc. (Southwest) will own 1,674,850 shares of the Company's 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 the Company's order flow. During
the same periods, aggregate payments by the Company 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, the Company 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. Upon the closing of this offering,
Waterhouse Investor Services, Inc. (Waterhouse) will own 2,139,623 shares of
the Company's Class A Common Stock and 3,042,698 shares of the Company's Class
B Common Stock. Waterhouse is an affiliate of Waterhouse Securities, Inc.
(Waterhouse Securities, together with Waterhouse, is herein referred to as the
Waterhouse Entities). For the period from March 27, 1995 through December 31,
1995 and the years ended December 31, 1996, 1997 and 1998, Waterhouse
Securities was the source of 5.8%, 6.5%, 10.1% and 10.7%, respectively, of the
Company's order flow. During the same periods, aggregate payments by the
Company to the Waterhouse Entities for order flow equaled $2.0 million, $6.8
million, $10.2 million and $14.3 million, respectively. In addition, Trimark
utilizes National Investor Services Corp. (NISC), a subsidiary of Waterhouse,
as its clearing broker. In the years ended December 31, 1997 and 1998, the
Company paid NISC clearing fees in the amounts of $9.5 million and $22.1
million, respectively. Additionally, the Company 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, the Company 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 the Company. 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. The Company holds a minority stake in
Adirondack Trading Partners LLC (ATP), the funding vehicle for the
International Securities Exchange (ISE) which, upon approval by the SEC, will
be the first entirely electronic option market maker in the United States.
Martin Averbuch, a member of the Company's Board of Directors, is President and
Chief Executive Officer of ATP.
PaineWebber Incorporated
Knight clears all its trades through Correspondent Services Corp. (CSC), a
subsidiary of PaineWebber Incorporated (PaineWebber). In the year ended
December 31, 1998, the Company paid CSC clearing fees in the amount of $9.0
million. PaineWebber is acting as an underwriter in connection with this
offering. PaineWebber Capital Inc., an affiliate of PaineWebber, loaned $30.0
million to the LLC pursuant to a loan agreement dated as of June 19, 1998 (the
PaineWebber Loan). The Company guaranteed the LLC's obligations under the
PaineWebber Loan. After the closing of the Company's initial public offering,
the Company assumed all of the LLC's obligations under the PaineWebber Loan and
the LLC was dissolved. The Company 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, the Company paid the
final $10.0 million outstanding on January 19, 1999. In 1998, aggregate
interest payments to PaineWebber under the PaineWebber Loan totaled $913,000.
The Company believes that the terms and conditions of the PaineWebber Loan were
reasonable and customary for loans of this type.
62
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information known to the Company
regarding beneficial ownership of the Company's 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 the Company to own beneficially
more than 5% of its outstanding shares of Common Stock, (2) each director and
Named Executive Officer of the Company, (3) all directors and executive
officers of the Company as a group and (4) the Selling Stockholders. Except as
otherwise indicated below, to the knowledge of the Company, 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 7.05
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 7.05
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......... -- 0.00 -- -- 0.00
Bruce R. McMaken........ -- 0.00 -- -- 0.00
Rodger O. Riney......... -- 0.00 -- -- 0.00
V. Eric Roach........... -- 0.00 -- -- 0.00
Charles A. Zabatta...... 1,000 * -- 1,000 *
Ameritrade Holding
Corporation(8)......... 3,953,675 7.46 -- 3,953,675 7.13
E*TRADE Securities,
Inc.(9)................ 2,566,432 4.84 750,000 1,816,432 3.28
Discover Brokerage
Direct(10)............. 2,101,963 3.97 900,000 1,201,963 2.17
Waterhouse Investor
Services, Inc.(7)(11).. 6,082,321 11.48 900,000 5,182,321 9.35
BHF Securities
Corporation(12)........ 150,220 * 75,000 75,220 *
Bidwell & Company(13)... 449,024 * 50,000 399,024 *
Brown & Company
Securities
Investments(14)........ 394,887 * 394,887 -- 0.0
Cowles Family
Trust(15).............. 57,485 * 17,485 40,000 *
Dain Rauscher
Incorporated(16)....... 460,192 * 460,192 -- 0.0
David A. Noyes &
Company(17)............ 58,111 * 25,000 33,111 *
Howe Barnes Investments,
Inc.(18)............... 130,759 * 75,000 55,759 *
J.W. Charles Financial
Services, Inc.(19)..... 299,353 * 225,000 74,353 *
NL Holding
Corporation(20)........ 125,970 * 125,970 -- 0.0
The R.J. Forbes Group,
Inc.(21)............... 288,948 * 288,948 -- 0.0
R.P. Assignee
Corp.(22).............. 341,747 * 50,000 291,747 *
Sanders Morris Mundy
Inc.(23)............... 134,566 * 134,566 -- 0.0
Scottsdale Securities,
Inc.(24)............... 1,012,097 1.91 25,000 987,097 1.78
Thomas F. White &
Co.(25)................ 471,638 * 46,000 425,638 *
Van Kasper & Co.(26).... 120,931 * 50,000 70,931 *
WBM, LLC(27)............ 183,500 * 83,500 100,000 *
William L. and Diane E.
Sabol(28).............. 57,485 * 28,700 28,785 *
William Lewke(29)....... 209,615 * 25,615 184,000 *
All executive officers
and directors as a
group (17 persons)..... 17,886,211 33.7% 1,850,000 16,036,211 28.9%
</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.
63
<PAGE>
(5) Mr. Steinman owns a nominal amount of the Company's 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 the Company's 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 address of Ameritrade Holding Corporation is Fourteen Wall Street, New
York, NY 10005-2176.
(9) The address of E*TRADE Securities, Inc. is 2400 Geng Road, Palo Alto, CA
94303.
(10) The address of Discover Brokerage Direct, Inc. is 333 Market Street, 25th
Floor, San Francisco, CA 94105.
(11) The address of Waterhouse Investor Services, Inc. is 100 Wall Street, 29th
Floor, NY, NY 10005.
(12) The address of BHF Securities Corporation is 590 Madison Avenue, 28th
Floor, NY, NY 10022.
(13) The address of Bidwell & Company is 209 Southwest Oak Street, Portland, OR
97204.
(14) The address of Brown & Company Securities Investments is One Beacon
Street, 18th Floor, Boston, MA 02108.
(15) The address of Cowles Family Trust is 2437 Green View Place, Los Angeles,
CA 90046.
(16) The address of Dain Rauscher Incorporated is 60 South Sixth Street, Dain
Bosworth Plaza, Minneapolis, MN 55402.
(17) The address of David A. Noyes & Company is 208 LaSalle Street, Ste. 610,
Chicago IL 60604.
(18) The address of Howe Barnes Investments, Inc. is 135 LaSalle Street, Ste.
1500, Chicago, IL 60603.
(19) The address of J.W. Charles Financial Services, Inc. is 980 North Federal
Hwy, Ste. 210, Boca Raton, FL 33432.
(20) The address of NL Holding Corporation is 1140 Avenue of the Americas, 4th
Floor, NY, NY 10036.
(21) The address of The R.J. Forbes Group, Inc. is 8 Fletcher Place, Melville,
NY 11747.
(22) The address of R.P. Assignee Corp. is 525 Washington Blvd., Ste. 2401,
Jersey City, NJ 07310.
(23) The address of Sanders Morris Mundy, Inc. is 3100 Texas Commerce Tower,
Houston, TX 77002.
(24) The address of Scottsdale Securities, Inc. is 12855 Flushing Meadow Dr.,
PO Box 31759, St. Louis, MO 63131.
(25) The address of Thomas F. White & Co. is One Second Street, 5th Floor, San
Francisco, CA 94105.
(26) The address of Van Kasper & Co. is 600 California Street, Ste. 1700, San
Francisco, CA 94108.
(27) The address of WBM, LLC is 200 Park Avenue, 24th Floor, NY, NY 10166.
(28) The address of William L. and Diane E. Sabol is 16820 Ventura Blvd.-2nd
Floor, Encino CA 91436.
(29) The address of William Lewke is 1120 Asbury Eventon, IL 60202.
63--1
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The following summary description of the capital stock of the Company does
not purport to be complete and is subject to the provisions of the Certificate
of Incorporation and Bylaws of the Company.
Authorized and Outstanding Capital Stock
The authorized capital stock of the Company 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 (the Preferred Stock). Of the 220,000,000
authorized shares of the Company's 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
the Company's 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 the Company, 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 the Company of whatever kind available for distribution to
stockholders ratably in proportion to the number of shares of Common Stock held
by them. Pursuant to 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 the Company which are by law available, dividends payable either in cash, in
property or in shares of capital stock. Pursuant to the Certificate of
Incorporation, no dividend will be declared or paid in respect of any class of
Common Stock by the Company, 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.
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<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 (DGCL). The Company has 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 stockholders of the Company (the Rightsholders) are entitled to
require the Company to register under the Securities Act, up to a total of
34,909,019 shares (the Registrable Shares) of outstanding Common Stock pursuant
to the terms of a Registration Rights Agreement (the Registration Rights
Agreement). The Registration Rights Agreement provides that in the event the
Company proposes to register any of its 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 the Company to prepare and file a registration
statement under the Securities Act with respect to their Registrable Shares.
The Company is generally required to bear the expenses of all such
registrations, except underwriting discounts and commissions. Certain
Rightsholders are selling 6,580,863 Registrable Shares in this offering.
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 the Company.
Delaware Takeover Statute. The Company is 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
65
<PAGE>
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 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 offered hereby by the Company will be upon issuance,
validly issued, fully paid and nonassessable.
Transfer Agent and Registrar
The Transfer Agent and Registrar for the Company's Common Stock is
ChaseMellon Shareholder Services, L.L.C.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have an aggregate of
55,424,019 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 the Company, as that term is defined in
Rule 144 (Rule 144) under the Securities Act (an Affiliate), may generally be
sold only in compliance with Rule 144 as described below.
In addition, certain stockholders have the right to cause the Company to
register the sale of certain shares of Class A Common Stock owned by them
and/or to include their shares in future registrable statements relating to the
Company's securities.
Approximately 34,924,019 of the outstanding shares of Common Stock are
"restricted securities" as that term is defined under Rule 144 (the Restricted
Shares). Of these Restricted Shares, 34,909,019 shares will be subject to lock-
up agreements as described below. 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 554,240 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 Securities and Exchange Commission. 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
the Company. 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. The Company is unable to estimate
accurately the number of Restricted
66
<PAGE>
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."
On January 29, 1999, the Company filed a registration statement under the
Securities Act on Form S-8 to register all shares of Common Stock issuable
pursuant to the Company's stock option plans. Such registration statement
became effective immediately upon filing. Accordingly, shares issued under the
Company's 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 the Company and the Selling
Stockholders, who upon the completion of this offering will hold in the
aggregate 27,002,592 shares of Common Stock, 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 the Company's future ability to obtain capital
through an offering of equity securities.
67
<PAGE>
UNDERWRITING
The Underwriters named below (the Underwriters), acting through their
representatives, BancBoston Robertson Stephens Inc., Merrill Lynch, Pierce,
Fenner & Smith Incorporated, PaineWebber Incorporated, ABN AMRO Incorporated
and Southwest Securities, Inc. (the Representatives), have severally agreed
with the Company and certain Selling Stockholders of the Company (the Selling
Stockholders) subject to the terms and conditions of the Underwriting
Agreement, to purchase from the Company 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 the Company 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>
68
<PAGE>
The Company estimates expenses payable by the Company 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, the Company 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 the Company and certain of
our 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 the Company's stockholders
providing consent to the sale of shares prior to the expiration of the lock-up
period.
Future Sales. In addition, the Company has agreed that during the lock-up
period the Company 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 the Company 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 such Underwriter or syndicate member are purchased by the
Representatives in a syndicate covering transaction and have therefore not been
effectively placed by such 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
69
<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.
The Company's subsidiary, Knight, is a party to a clearing contract with an
affiliate of PaineWebber, whereby such 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 the LLC pursuant to a loan
agreement dated June 19, 1998. All amounts outstanding under the loan agreement
have been repaid by the Company and the loan agreement has been terminated. The
Company believes that the terms and conditions of the PaineWebber Loan were
reasonable and customary for loans of this type. One of the Underwriters,
Southwest Securities, Inc., is a stockholder of the Company. See "Certain
Transactions."
LEGAL MATTERS
The validity of the Class A Common Stock offered hereby will be passed upon
for the Company 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
The Company is subject to the informational requirements of the Exchange
Act, and in accordance therewith, is 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 will contain all information filed electronically by
the Company with the SEC.
This Prospectus, which constitutes a part of a Registration Statement on
Form S-1 (the Registration Statement) filed by the Company with the SEC under
the Securities Act, does not contain all of the information set forth in the
Registration Statement, including the exhibits thereto. For further information
with respect to the Company and the Class A Common Stock offered hereby,
reference is made to the Registration Statement and the exhibits thereto.
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 the Company
under the Exchange Act.
70
<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
Members' equity
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>
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>
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
F-11
<PAGE>
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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>
For the year ended December 31, 1996.......................... $ 810,893
<S> <C>
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>
KNIGHT [LOGO] 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.
** Included as part of the signature pages hereto.
+ 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 28th day
of January, 1999.
Knight/Trimark Group, Inc.
/s/ Kenneth D. Pasternak
By___________________________________
Name:Kenneth D. Pasternak
Title: Director, President and
Chief Executive Officer
KNOWN TO ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Kenneth D. Pasternak and Walter F.
Raquet, and each of them (with full power of each of them to act alone), his
true and lawful attorney-in-fact, with full power of substitution and
resubstitution for him and on his behalf, and in his name, place and stead, in
any and all capacities, to sign any amendments to this registration statement
(including post-effective amendments), and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his substitute or substitutes, may do or cause to be done
by virtue hereof.
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 January 28, 1999
/s/ Kenneth D. Pasternak Chief Executive Officer
____________________________________
Kenneth D. Pasternak
Director, Executive Vice January 28, 1999
/s/ Robert I. Turner President and Chief
____________________________________ Financial Officer
Robert I. Turner (principal financial and
accounting officer)
Director and Chairman of the January 28, 1999
/s/ Steven L. Steinman Board
____________________________________
Steven L. Steinman
Director and Executive Vice January 28, 1999
/s/ Walter F. Raquet President
____________________________________
Walter F. Raquet
</TABLE>
II-5
<PAGE>
<TABLE>
<S> <C> <C>
Director and Executive Vice January 28, 1999
/s/ Robert M. Lazarowitz President
____________________________________
Robert M. Lazarowitz
Director and Executive Vice January 28, 1999
/s/ Anthony M. Sanfilippo President
____________________________________
Anthony M. Sanfilippo
Director January 28, 1999
/s/ Martin Averbuch
____________________________________
Martin Averbuch
Director January 28, 1999
/s/ Charles V. Doherty
____________________________________
Charles V. Doherty
Director January 28, 1999
/s/ Gene L. Finn
____________________________________
Gene L. Finn
Director January 28, 1999
/s/ Gary R. Griffith
____________________________________
Gary R. Griffith
Director January 28, 1999
/s/ Bruce R. McMaken
____________________________________
Bruce R. McMaken
/s/ J. Joe Ricketts Director January 28, 1999
____________________________________
J. Joe Ricketts
Director January 28, 1999
/s/ Rodger O. Riney
____________________________________
Rodger O. Riney
Director January 28, 1999
/s/ V. Eric Roach
____________________________________
V. Eric Roach
Director January 28, 1999
/s/ Charles A. Zabatta
____________________________________
Charles A. Zabatta
</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 Price Waterhouse 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.
** Included as part of the signature pages hereto.
+ To be filed by amendment.
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We hereby consent to the use in 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 1, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 117,381,556
<RECEIVABLES> 107,503,274
<SECURITIES-RESALE> 0
<SECURITIES-BORROWED> 0
<INSTRUMENTS-OWNED> 100,476,151
<PP&E> 12,014,991
<TOTAL-ASSETS> 358,860,375
<SHORT-TERM> 10,000,000
<PAYABLES> 39,830,499
<REPOS-SOLD> 0
<SECURITIES-LOANED> 0
<INSTRUMENTS-SOLD> 108,909,217
<LONG-TERM> 0
0
0
<COMMON> 200,120,659
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 358,860,375
<TRADING-REVENUE> 348,098,874
<INTEREST-DIVIDENDS> 3,591,276
<COMMISSIONS> 4,042,919
<INVESTMENT-BANKING-REVENUES> 0
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 0
<COMPENSATION> 108,002,843
<INCOME-PRETAX> 88,352,236
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 66,601,027
<EPS-PRIMARY> 1.40
<EPS-DILUTED> 1.40
</TABLE>
