<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
001-14223
COMMISSION FILE NUMBER
Knight Trading Group, Inc.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction
of incorporation or organization)
22-3689303
(I.R.S. Employer
Identification Number)
525 Washington Boulevard
Jersey City, NJ 07310
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (201) 222-9400
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days, Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
At August 11, 2000 the number of shares outstanding of the registrant's
Class A common stock was 122,721,305 and there were no shares outstanding of
the registrant's Class B common stock.
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<PAGE>
KNIGHT TRADING GROUP, INC.
FORM 10-Q QUARTERLY REPORT
For the Quarter Ended JUNE 30, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
PART I FINANCIAL INFORMATION:
Item 1. Financial Statements........................................... 3
Consolidated Statements of Income.............................. 3
Consolidated Statements of Financial Condition................. 4
Consolidated Statements of Cash Flows.......................... 5
Notes to Consolidated Financial Statements..................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk..... 18
PART II OTHER INFORMATION:
Item 1. Legal Proceedings.............................................. 19
Item 2. Changes in Securities and Use of Proceeds...................... 19
Item 3. Defaults Upon Senior Securities................................ 19
Item 4. Submission of Matters to a Vote of Security Holders............ 19
Item 5. Other Information.............................................. 20
Item 6. Exhibits and Reports on Form 8-K............................... 20
Signatures.............................................................. 20
</TABLE>
2
<PAGE>
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
KNIGHT TRADING GROUP, INC.
Consolidated Statements of Income
(unaudited)
<TABLE>
<CAPTION>
For the three months ended For the six months ended
--------------------------- --------------------------
June 30, June 30, June 30, June 30,
2000 1999 2000 1999
------------- ------------- ------------ ------------
<S> <C> <C> <C> <C>
Revenues
Net trading revenue... $ 283,041,696 $ 237,046,452 $770,086,203 $430,309,416
Asset management
fees................. 10,900,200 6,373,299 20,328,694 9,796,084
Interest and
dividends............ 12,142,855 5,093,387 22,494,593 8,728,374
Commissions and fees.. 5,481,872 4,438,874 10,176,577 6,966,056
Investment income and
other................ 1,951,133 1,220,466 5,195,955 1,812,713
------------- ------------- ------------ ------------
Total revenues...... 313,517,756 254,172,478 828,282,022 457,612,643
------------- ------------- ------------ ------------
Expenses
Employee compensation
and benefits......... 102,275,294 77,141,196 277,415,954 139,355,694
Payments for order
flow................. 38,319,274 35,354,189 97,636,834 67,782,017
Execution and
clearance fees....... 27,646,413 22,027,402 57,403,931 41,742,573
Interest.............. 7,991,811 1,880,570 14,863,967 4,585,160
Communications and
data processing...... 7,103,218 4,225,659 14,235,689 8,356,358
Professional fees..... 6,232,897 2,393,126 10,764,570 3,692,392
Depreciation and
amortization......... 5,495,985 2,765,027 9,697,134 4,905,124
Occupancy and
equipment rentals.... 4,305,870 2,575,176 7,380,002 4,498,557
Business development.. 2,886,158 1,567,608 8,120,385 2,335,149
Other................. 2,345,618 2,208,884 4,908,813 4,002,997
------------- ------------- ------------ ------------
Total expenses...... 204,602,538 152,138,837 502,427,279 281,256,021
------------- ------------- ------------ ------------
Income before income
taxes.................. 108,915,218 102,033,641 325,854,743 176,356,622
Income tax expense...... 41,696,423 35,506,010 122,103,947 62,823,564
------------- ------------- ------------ ------------
Net income.............. $ 67,218,795 $ 66,527,631 $203,750,796 $113,533,058
============= ============= ============ ============
Basic earnings per
share.................. $ 0.55 $ 0.55 $ 1.67 $ 0.95
============= ============= ============ ============
Diluted earnings per
share.................. $ 0.53 $ 0.53 $ 1.60 $ 0.91
============= ============= ============ ============
Pro forma adjustments
(see Note 1)
Income before income
taxes................ $ 102,033,641 $325,854,743 $176,356,622
Adjustment for pro
forma employee
compensation and
benefits............. (2,713,499) (267,109) (4,419,564)
------------- ------------ ------------
Pro forma income
before income taxes.. 99,320,142 325,587,634 171,937,058
Pro forma income tax
expense.............. 41,288,416 122,747,234 71,962,140
------------- ------------ ------------
Pro forma net income.. $ 58,031,726 $202,840,400 $ 99,974,918
============= ============ ============
Pro forma basic
earnings per share... $ 0.48 $ 1.66 $ 0.83
============= ============ ============
Pro forma diluted
earnings per share... $ 0.46 $ 1.60 $ 0.80
============= ============ ============
Shares used in basic
earnings per share
calculations (see Note
6)..................... 122,234,246 121,421,678 122,192,533 119,774,228
============= ============= ============ ============
Shares used in diluted
earnings per share
calculations (see Note
6)..................... 126,795,238 126,672,844 127,007,447 124,647,369
============= ============= ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
3
<PAGE>
KNIGHT TRADING GROUP, INC.
Consolidated Statements of Financial Condition
(unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------------- --------------
<S> <C> <C>
Assets
Cash and cash equivalents...................... $ 383,703,422 $ 304,053,554
Securities owned, at market value.............. 1,428,211,228 910,232,916
Receivable from clearing brokers............... 317,772,210 215,423,208
Fixed assets and leasehold improvements at
cost, less accumulated depreciation........... 50,201,063 26,820,045
Goodwill, less accumulated amortization........ 39,083,425 24,899,982
Investments.................................... 57,866,551 40,408,554
Other assets................................... 34,740,195 18,447,547
-------------- --------------
Total assets................................. $2,311,578,094 $1,540,285,806
============== ==============
Liabilities and Stockholders' Equity
Liabilities
Securities sold, not yet purchased, at market
value......................................... $1,354,476,921 $ 720,919,013
Securities sold under agreements to
repurchase.................................... -- 10,409,736
Payable to clearing broker..................... 128,237,588 159,943,018
Accrued compensation expense................... 64,749,345 57,234,608
Accrued execution and clearance fees........... 9,187,248 8,371,056
Accrued payments for order flow................ 10,021,939 13,978,854
Accounts payable, accrued expenses and other
liabilities................................... 19,298,383 54,205,482
Income taxes payable........................... 19,513,907 15,992,937
-------------- --------------
Total liabilities............................ 1,605,485,331 1,041,054,704
-------------- --------------
Stockholders' equity
Class A Common Stock........................... 1,222,740 1,221,215
Additional paid-in capital..................... 303,464,434 300,355,094
Retained earnings.............................. 401,405,589 197,654,793
-------------- --------------
Total stockholders' equity................... 706,092,763 499,231,102
-------------- --------------
Total liabilities and stockholders' equity... $2,311,578,094 $1,540,285,806
============== ==============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
KNIGHT TRADING GROUP, INC.
Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
For the six months ended
June 30,
----------------------------
2000 1999
------------- -------------
<S> <C> <C>
Cash flows from operating activities
Net income....................................... $ 203,750,796 $ 113,533,058
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization.................. 9,697,134 4,905,124
(Increase) in operating assets
Securities owned............................... (517,978,312) (107,974,263)
Receivable from clearing brokers............... (102,349,002) (39,794,564)
Other assets................................... (16,292,648) (22,013,756)
Increase (decrease) in operating liabilities
Securities sold, not yet purchased............. 633,557,908 187,988,698
Securities sold under agreements to
repurchase.................................... (10,409,736) (11,191,000)
Payable to clearing broker..................... (31,705,430) (55,633,594)
Accrued compensation expense................... 7,514,737 19,654,292
Accounts payable, accrued expenses and other
liabilities................................... (34,907,099) (9,200,412)
Accrued execution and clearance fees........... 816,192 (166,477)
Accrued payments for order flow................ (3,956,915) (96,679)
Income taxes payable........................... 3,520,970 1,389,971
------------- -------------
Net cash provided by operating activities.... 141,258,595 81,400,398
------------- -------------
Cash flows from investing activities
Payment of contingent consideration.............. (4,631,141) (3,943,426)
Investments...................................... (19,007,997) (7,432,998)
Acquisitions of companies........................ (10,778,875) --
Purchases of fixed assets and leasehold
improvements.................................... (30,301,579) (6,160,980)
------------- -------------
Net cash used in investing activities........ (64,719,592) (17,537,404)
------------- -------------
Cash flows from financing activities
Repayment of short term loan..................... -- (11,016,766)
Proceeds from issuance of common stock........... -- 80,219,537
Stock options exercised, including income tax
credit.......................................... 3,110,865 1,028,638
Capital contributions from members of KFP........ -- 14,256,627
------------- -------------
Net cash provided by financing activities.... 3,110,865 84,488,036
------------- -------------
Increase in cash and cash equivalents............ 79,649,868 148,351,030
Cash and cash equivalents at beginning of
period.......................................... 304,053,554 117,704,635
------------- -------------
Cash and cash equivalents at end of period....... $ 383,703,422 $ 266,055,665
============= =============
Supplemental disclosure of cash flow information:
Cash paid for interest......................... $ 14,679,188 $ 4,550,073
============= =============
Cash paid for income taxes..................... $ 119,828,612 $ 62,738,759
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
KNIGHT TRADING GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(unaudited)
1. Organization and Description of the Business
Knight Trading Group, Inc. (the "Company") and its subsidiaries operate in
market-making and asset management business lines. Knight Securities ("KS")
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. Knight Capital Markets ("KCM," formerly known as Trimark
Securities) operates as a market maker in the over-the-counter market for New
York Stock Exchange (NYSE)- and American Stock Exchange (AMEX)-listed
securities. Knight Financial Products ("KFP") makes markets in options on
individual equities, equity indices and fixed income instruments in the U.S.
and in Europe. The Company also maintains an asset management business for
institutional investors and high net worth individuals through its Deephaven
subsidiaries. KS, KCM and KFP are registered as broker-dealers with the
Securities and Exchange Commission ("SEC" or the "Commission"). Additionally,
KS and KCM are members of the National Association of Securities Dealers, Inc.
("NASD"). In May 2000, the Company changed its name from Knight/Trimark Group,
Inc. to Knight Trading Group, Inc.
The Company was organized in January 2000 as the successor to the business
of its predecessor, Knight/Trimark Group, Inc. (the "Predecessor"). The
Predecessor was organized in April 1998 as the successor to the business of
Roundtable Partners, L.L.C. ("Roundtable").
On January 12, 2000, the Company completed a merger (the "Merger") with
Arbitrade Holdings LLC ("Arbitrade"). The transaction resulted in the newly
formed parent holding company issuing shares on a tax-free basis to holders of
the Predecessor's common stock and to the owners of Arbitrade. Following the
transaction, the Predecessor and Arbitrade became subsidiaries of the Company,
which assumed the name Knight/Trimark Group, Inc. and became the publicly
traded Nasdaq company under the same ticker symbol as the Predecessor (NITE).
Arbitrade's options market making unit subsequently changed its name to "Knight
Financial Products." The transaction was accounted for as a pooling of
interests, and, as such, the historical financial statements have been restated
to account for the merger on a retroactive basis. Pro forma adjustments for
compensation and income taxes have been made to the historical financial
statements of Arbitrade to adjust for partners' compensation, which was
previously paid as distributions of capital, and income taxes, which were
previously borne by the individual partners of Arbitrade. The foregoing
description of the Arbitrade transaction is a brief summary and is qualified in
its entirety by reference to the Merger Agreement, a copy of which was filed as
an exhibit to the Company's report on Form 8-K filed with the SEC on January
12, 2000. Unless otherwise indicated, all references to the "Company" refer to
the Company or the Predecessor, as appropriate.
2. 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 (see Note 1) and, in the opinion
of management, reflect all adjustments, consisting only of normal recurring
adjustments, necessary for a fair statement of the results for the interim
period. All significant intercompany transactions and balances have been
eliminated. Certain footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to SEC rules and regulations, although
the Company believes that the disclosures are adequate to make the information
presented not misleading. The nature of the Company's business is such that the
results of an interim period are not necessarily indicative of the results for
the full year. These consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's audited financial statements as of December 31, 1999 included in the
Company's Report on Form 10-K as filed with the SEC. All share and per share
amounts presented in this document have been adjusted to reflect the Company's
two-for-one stock split on May 14, 1999.
6
<PAGE>
Cash equivalents
Cash equivalents represent money market accounts, which are payable on
demand, or short-term investments with an original maturity of less than 30
days. The carrying amount of such cash equivalents approximates their fair
value due to the short-term nature of these instruments.
Investments
Investments on the Consolidated Statements of Financial Condition are
comprised of ownership interests in non-publicly traded companies which are
accounted for under the equity method or the cost basis of accounting.
Investments also include the Company's investments in private investment funds
for which the Company is the investment manager and sponsor.
Market-making activities
Securities owned and securities sold, not yet purchased, which primarily
consist of listed and OTC stocks, listed options contracts and futures
contracts 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 equity order executions to the Company.
Asset management fees
The Company earns asset management fees for sponsoring and managing the
investments of certain private investment funds. Such fees are recorded when
earned and are calculated as a percentage of the fund's quarterly net assets,
plus a percentage of a new high net asset value, as defined, for any six-month
period ended June 30th or December 31st.
Repurchase agreements
Securities sold under agreements to repurchase ("repurchase agreements") are
accounted for as collateralized financing transactions and are recorded at
their contracted repurchase amounts plus accrued interest. Counterparties are
major financial institutions. The Company is required to provide securities to
counterparties in order to collateralize securities sold under agreements to
repurchase.
Foreign currencies
Assets and liabilities in foreign currencies are translated into U.S.
dollars using current exchange rates at the date of the Consolidated Statements
of Financial Condition. Revenues and expenses are translated at average rates
during the periods. The functional currency of the Company's wholly owned
foreign subsidiaries are the U.S. dollar and the British Pound. The foreign
exchange gains and losses resulting from these translations are included in
other expenses 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
actual income taxes incurred through June 30, 2000. Before the Merger, KFP was
a limited liability company which was treated as a partnership for tax purposes
and its federal and state income taxes were borne by KFP's individual partners.
As such, KFP's historical financial statements do not include a provision for
income taxes. Subsequent to the Merger, the Company is subject to federal
income taxes and state income taxes based on KFP's income. Pro forma income tax
expense reflects income taxes as if the Company was subject to federal and
state income taxes on KFP's income prior to the Merger.
7
<PAGE>
The Company records deferred tax assets and liabilities based upon enacted
tax rates for the expected future tax consequences of temporary differences
between the financial reporting and tax bases of assets and liabilities.
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 and accrued expenses) 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
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.
3. Securities Owned and Securities Sold, Not Yet Purchased
Securities owned and securities sold, not yet purchased consist of the
following:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------------- ------------
<S> <C> <C>
Securities owned:
Equities......................................... $ 782,085,230 $381,240,123
Options and futures.............................. 646,125,998 518,408,094
U.S. government obligations...................... -- 10,584,699
-------------- ------------
$1,428,211,228 $910,232,916
============== ============
Securities sold, not yet purchased:
Equities......................................... $ 674,026,589 $263,614,076
Options and futures.............................. 680,450,332 457,304,937
-------------- ------------
$1,354,476,921 $720,919,013
============== ============
</TABLE>
4. Investments
The Company's wholly-owned subsidiaries, Deephaven Capital Management LLC,
Deephaven Capital LLC and Deephaven Investment Advisers LLC, are the investment
managers and sponsors of private investment funds that engage in various
trading strategies involving equities, debt instruments and derivatives. The
Company owns interests in these private investment funds. Such investments
amounted to approximately $28.9 million at June 30, 2000. In July 2000, the
Company withdrew approximately $15 million of its investment in these private
investment funds. Certain officers of the Company also own interests in these
private investment funds.
5. Significant Customers
The Company considers affiliates to be holders of 10% or more of the
Company's outstanding common stock ("Affiliates"). During the second quarter of
2000 there were no Affiliates of the Company.
8
<PAGE>
One customer provided 10% of the Company's order flow for the quarter ended
June 30, 2000 as measured in share volume. Order flow payments to this firm
amounted to $7,098,912 during the same period. This customer acts as a clearing
broker for KCM.
6. 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.
Weighted-average shares outstanding for the three and six month periods
ended June 30, 2000 and 1999 have been determined as if the Merger described in
Note 1 occurred as of the earliest date presented. The following is a
reconciliation of the numerators and denominators of the basic and diluted
earnings per share computations for the three and six month periods ended June
30, 2000 and 1999:
<TABLE>
<CAPTION>
Three months ended Three months ended
June 30, 2000 June 30, 1999
------------------------- ------------------------
Numerator/ Denominator/
Numerator/ Denominator/ pro forma pro forma
net income shares net income shares
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Shares and income used in
basic calculations........ $ 67,218,795 122,234,246 $58,031,726 121,421,678
Effect of dilutive stock
options................... -- 4,560,992 -- 5,251,166
------------ ------------ ----------- ------------
Shares and income used in
diluted calculations...... $ 67,218,795 126,795,238 $58,031,726 126,672,844
============ ============ =========== ============
Pro forma basic earnings
per share............... $ 0.55 $ 0.48
============ ============
Pro forma diluted
earnings per share...... $ 0.53 $ 0.46
============ ============
<CAPTION>
Six months ended Six months ended
June 30, 2000 June 30, 1999
------------------------- ------------------------
Numerator/ Numerator/ Denominator/
pro forma Denominator/ pro forma pro forma
net income shares net income shares
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Shares and income used in
basic calculations........ $202,840,400 122,192,533 $99,974,918 119,774,228
Effect of dilutive stock
options................... -- 4,814,914 -- 4,873,141
------------ ------------ ----------- ------------
Shares and income used in
diluted calculations...... $202,840,400 127,007,447 $99,974,918 124,647,369
============ ============ =========== ============
Pro forma basic earnings
per share............... $ 1.66 $ 0.83
============ ============
Pro forma diluted
earnings per share...... $ 1.60 $ 0.80
============ ============
</TABLE>
7. Net Capital Requirements
As registered broker-dealers, KS, KCM and KFP are subject to the SEC's
Uniform Net Capital Rule (the "Rule") which requires the maintenance of minimum
net capital. KS and KCM 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. KFP has
elected to use the alternative method, permitted by the Rule, which requires
that it maintains net capital equal to the greater of $250,000 or 2% of
aggregate debit items, as defined.
At June 30, 2000, KS had net capital of $318,427,336 which was $314,760,309
in excess of its required net capital of $3,667,027, KCM had net capital of
$54,143,318 which was $52,976,859 in excess of its required net capital of
$1,166,459 and KFP had net capital of $25,094,899 which was $24,844,899 in
excess of its required net capital of $250,000.
9
<PAGE>
8. Business Segments
The Company has two reportable business segments: securities market-making
and asset management. Securities market-making includes the operations of KS,
KCM and KFP and includes market-making in equity securities listed on Nasdaq,
on the OTCBB of the NASD, in the over-the-counter market for NYSE- and AMEX-
listed securities and in options on individual equities, equity indices, fixed
income instruments and certain commodities. The asset management segment
includes the operations of Deephaven Management LLC, Deephaven Capital LLC and
Deephaven Investment Advisers LLC and consists of investment management and
sponsorship for a series of private investment funds.
The Company's net revenues, income before income taxes and assets by
segment are summarized below:
<TABLE>
<CAPTION>
Securities
Market Making Asset Management Total
-------------- ---------------- --------------
<S> <C> <C> <C>
For the three months ended June
30, 2000:
Revenues..................... $ 301,000,117 $12,517,639 $ 313,517,756
Income before income taxes... 99,011,944 9,903,274 108,915,218
Total assets................. 2,276,767,746 34,810,348 2,311,578,094
For the three months ended June
30, 1999:
Revenues..................... 247,274,808 6,897,670 254,172,478
Pro forma income before
income taxes................ 94,830,524 4,489,618 99,320,142
Total assets................. 995,408,490 20,001,212 1,015,409,702
For the six months ended June
30, 2000:
Revenues..................... 804,789,930 23,492,092 828,282,022
Pro forma income before
income taxes................ 306,776,934 18,810,700 325,587,634
Total assets................. 2,276,767,746 34,810,348 2,311,578,094
For the six months ended June
30, 1999:
Revenues..................... 447,079,218 10,533,425 457,612,643
Pro forma income before
income taxes................ 163,307,275 8,629,783 171,937,058
Total assets................. 995,408,490 20,001,212 1,015,409,702
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion of our results of operations should be read in
conjunction with our consolidated financial statements and notes thereto
included in our audited financial statements as of December 31, 1999 included
within our report on Form 10-K. This discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results may differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including, but not limited to, those set forth
elsewhere in this document.
We have experienced and expect to continue to experience, significant
fluctuations in quarterly operating results due to a variety of factors,
including the value of our securities positions and our ability to manage the
risks attendant thereto, the volume of our market-making activities,
volatility in the securities markets, our ability to manage personnel,
overhead and other expenses, the number of limit orders received as a
percentage of net trading 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. If demand for our market-making 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.
Due to all of the foregoing factors, period-to-period comparisons of our
revenues and operating results are not necessarily meaningful and such
comparisons cannot be relied upon as indicators of future performance. There
also can be no assurance that we will be able to sustain the rates of revenue
growth that 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.
10
<PAGE>
Overview
We are the leading market maker in equity securities listed on Nasdaq, the
OTCBB of the NASD, and the over-the-counter market for New York Stock Exchange
(NYSE) and American Stock Exchange (AMEX)-listed securities. We are also a
leading market maker in options on individual equities, equity indices and
fixed income instruments in the U.S. and Europe. The firm also maintains an
asset management business for institutional investors and high net worth
individuals through our Deephaven subsidiaries.
KS commenced Nasdaq and OTC securities market-making operations on July 24,
1995. KS's share volume totaled 16.7 billion and 17.1 billion, or 78% and 80%
of our total equity share volume, for the three months ended June 30, 2000, and
1999, respectively. KCM's share volume totaled 4.8 billion and 4.2 billion, or
22% and 20% of our total equity share volume for the three months ended June
30, 2000 and 1999, respectively.
Revenues
Our revenues consist principally of net trading revenue from securities
market-making activities. Net trading revenue, which represents trading gains
net of trading losses, is primarily affected by changes in equity trade and
share volumes and option contract volumes, our ability to derive trading gains
by taking proprietary positions, changes in our execution standards, volatility
in the marketplace and by regulatory changes and evolving industry customs and
practices.
We continue to focus on increasing our 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.
Asset management fees represent fees earned for sponsoring and managing the
investments of private investment funds. Asset management fees are primarily
affected by the rates of return earned on the funds we manage and changes in
the amounts of assets under management.
Listed securities transactions with institutional customers are executed on
an agency basis, for which we earn commissions on a per share basis. We also
receive fees for providing certain information to market data providers.
Commissions and fees are primarily affected by changes in our trade and share
volumes in listed securities.
We also earn interest income from our cash and securities positions held at
banks and in trading accounts at clearing brokers. Interest income is primarily
affected by the changes in cash balances held at banks and clearing brokers.
Expenses
Our operating expenses largely consist of employee compensation and
benefits, payments for order flow and execution and clearance fees. A
substantial portion of these expenses are variable in nature. Employee
compensation and benefits expense, which is largely profitability based,
fluctuates, for the most part, based on changes in net trading revenue and our
profitability. Payments for order flow fluctuate based on share volume, the mix
of market orders and limit orders and the mix of orders received from broker-
dealers who accept payments for order flow. Execution and clearance fees
fluctuate primarily based on changes in trade, share and contract volume, and
the clearance fees charged by clearing brokers.
Employee compensation and benefits expense primarily consists of salaries
paid to administrative and customer service personnel and profitability based
compensation, which includes compensation and benefits paid to market-making
and sales personnel based on their individual performance, and incentive
compensation paid to all other employees based on our overall profitability.
Approximately 73% of our employees are directly
11
<PAGE>
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 payments for
order flow, execution and clearance costs and overhead allocations. Employee
compensation and benefits will, therefore, be affected by changes in payments
for order flow, execution and clearance costs and the costs we allocate to
employees engaged in market-making and sales activities.
Payments for order flow primarily represent customary payments to broker-
dealers, in the normal course of business, for directing their order flow in
equity securities to us. We only pay broker-dealers for orders that provide us
with a profit opportunity. For example, we make payments on market orders, but
do not pay on limit orders.
Execution and clearance fees primarily represent clearance fees paid to
clearing brokers, transaction fees paid to Nasdaq, payments made to third
parties for exchange seat leases and execution fees paid to third parties,
primarily for executing trades in listed securities on the NYSE and AMEX and
for executing orders through electronic communications networks, commonly
referred to as ECNs. Due to our significant growth in share and trade volume,
we have been able to negotiate favorable rates and volume discounts from
clearing brokers and providers of execution services. As a result of these
lower rates and discounts and the increase in trade volume of OTC securities as
a percentage of total trade volume, execution and clearance fees per trade have
decreased.
Communications and data processing expense primarily consists of costs for
obtaining stock market data and telecommunications services.
Business development expense primarily consists of advertising costs and
marketing expenses, including travel and entertainment and promotion costs.
Interest expense primarily consists of transaction-related interest charged
by clearing brokers for facilitating the settlement and financing of securities
sold, not yet purchased. Interest expense is primarily affected by the changes
in cash balances held at clearing brokers and the level of securities sold, not
yet purchased.
Professional fees primarily consist of fees paid to computer programming and
systems consultants, as well as legal and other professional fees.
Depreciation and amortization expense results from the depreciation of fixed
assets purchased by us and the amortization of goodwill, which includes
contingent consideration resulting from the acquisitions of the listed
securities market-making businesses of KCM and Tradetech Securities, L.P.,
("Tradetech") which we acquired in November 1997. Depreciation and amortization
expense also includes the amortization of goodwill related to our purchases of
the AMEX specialist operations of Gargoyle Specialists, L.P. ("Gargoyle") in
July 1999, Mesirow Financial's Professional Execution Business in May 2000 and
Binary Partners in June 2000.
Occupancy and equipment rentals expense primarily consists of rental
payments on office and equipment leases.
Other expenses primarily consist of administrative expenses and other
operating costs incurred in connection with our business growth, as well as
director fees.
Income Tax
Income tax expense in the Consolidated Statements of Income represents
actual income taxes incurred through June 30, 2000. Before the Merger, KFP was
a limited liability company which was treated as a partnership for tax purposes
and its federal and state income taxes were borne by KFP's individual partners.
As such, KFP's historical financial statements do not include a provision for
income taxes. Subsequent to the
12
<PAGE>
Merger, the Company is subject to federal income taxes and state income taxes
based on KFP's income. Pro forma income tax expense reflects income taxes as if
the Company was subject to federal and state income taxes on KFP's income prior
to the Merger.
Results of Operations
Three Months Ended June 30, 2000 and 1999
Revenues
Net trading revenue increased 19.4% to $283.0 million for the three months
ended June 30, 2000, from $237.0 million for the comparable period in 1999.
This increase was primarily due to higher equity share volume and increased
average revenue per equity share. Total equity share volume increased 0.9% to
21.5 billion equity shares traded for the three months ended June 30, 2000,
from 21.3 billion equity shares traded for the comparable period in 1999, and
average revenue per equity share increased to $.0114 per share from $.0102
during the same period.
Asset management fees increased 71.0% to $10.9 million for the three months
ended June 30, 2000, from $6.4 million for the comparable period in 1999. The
increase in fees was primarily due to an increase in fund return from 6.73% for
the second quarter of 1999 to 8.91% for the second quarter of 2000 and an
increase in the amount of funds under management from $278.1 million at June
30, 1999 to $477.1 million at June 30, 2000 in the Deephaven Market Neutral
Master Fund, which contained the majority of our funds under management.
Interest income increased 138.4% to $12.1 million for the three months ended
June 30, 2000, from $5.1 million for the comparable period in 1999. This
increase was primarily due to larger cash balances held at banks and our
clearing brokers.
Commissions and fees increased 23.5% to $5.5 million for the three months
ended June 30, 2000, from $4.4 million for the comparable period in 1999. This
increase is primarily due to higher share volumes from institutional customers
in listed securities.
Investment income and other income increased 59.9% to $2.0 million for the
three months ended June 30, 2000, from $1.2 million for the comparable period
in 1999. This increase was primarily due to an increase in income from our
investments, primarily our investments in the private hedge funds that we
sponsor and manage.
Expenses
Employee compensation and benefits expense increased 32.6% to $102.3 million
for the three months ended June 30, 2000, from $77.1 million for the comparable
period in 1999. As a percentage of total revenues, employee compensation and
benefits expense increased to 32.6% for the three months ended June 30, 2000,
from 30.3% for the comparable period in 1999. The increase on a dollar and on a
percentage basis was primarily due to increased gross trading profits, growth
in our institutional sales revenue and growth in the number of employees. Due
to increased net trading revenue, profitability based compensation increased
19.5% to $82.1 million for the three months ended June 30, 2000, from $68.7
million for the comparable period in 1999, and represented 80.3% and 89.0% of
total employee compensation and benefits expense for the three months ended
June 30, 2000 and 1999, respectively. Our number of employees increased to
1,074 employees as of June 30, 2000, from 702 employees as of June 30, 1999.
Payments for order flow increased 8.4% to $38.3 million for the three months
ended June 30, 2000, from $35.4 million for the comparable period in 1999. As a
percentage of total revenues, payments for order flow decreased to 12.2% for
the three months ended June 30, 2000 from 13.9% for the comparable period in
1999.
13
<PAGE>
The increase in payments for order flow on a dollar basis was primarily due to
a 0.9% increase in equity shares traded for the three months ended June 30,
2000 and changes in our order flow composition. The decrease in payments for
order flow as a percentage of total revenues was primarily due to an increase
in our average revenue per equity share and increases in our institutional,
asset management and options revenues, respectively.
Execution and clearance fees increased 25.5% to $27.6 million for the three
months ended June 30, 2000, from $22.0 million for the comparable period in
1999. As a percentage of total revenues, execution and clearance fees was 8.8%
and 8.7% for the three months ended June 30, 2000 and 1999, respectively. The
increase on a dollar basis was primarily due to an increase in equity trades
executed for the three months ended June 30, 2000 and an increase in our
institutional business. Total equity trade volume increased 55.2% to 33.3
million equity trades for the three months ended June 30, 2000 from 21.4
million equity trades for the comparable period in 1999. This increase was
offset, in part, by a decrease in clearance rates charged by clearing brokers
and volume discounts.
Communications and data processing expense increased 68.1% to $7.1 million
for the three months ended June 30, 2000, from $4.2 million for the comparable
period in 1999. This increase was generally attributable to higher trading
volumes and an increase in our number of employees.
Business development expense increased 84.1% to $2.9 million for the three
months ended June 30, 2000, from $1.6 million for the comparable period in
1999. This increase was primarily the result of increased advertising and
higher travel and entertainment costs consistent with the growth in our
business and our increased focus on the institutional sales business.
Interest expense increased 325.0% to $8.0 million for the three months ended
June 30, 2000, up from $1.9 million for the comparable period in 1999. This
increase was primarily due to transaction-related interest expense resulting
from a higher level of securities sold, not yet purchased.
Professional fees increased 160.5% to $6.2 million for the three months
ended June 30, 2000, up from $2.4 million for the comparable period in 1999.
This increase was primarily due to increased consulting expenses related to our
investments in technology, our European and Japanese expansion efforts and
legal and other professional fees.
Depreciation and amortization expense increased 98.8% to $5.5 million for
the three months ended June 30, 2000, from $2.8 million for the comparable
period in 1999. This increase was primarily due to the purchase of
approximately $43.8 million of additional fixed assets and leasehold
improvements between June 30, 1999 and June 30, 2000 and the amortization of
goodwill related to our acquisitions of the listed securities market-making
businesses of KCM and Tradetech and the options specialist business of
Gargoyle.
Occupancy and equipment rentals expense increased 67.2% to $4.3 million for
the three months ended June 30, 2000, from $2.6 million for the comparable
period in 1999. This increase was primarily attributable to additional office
space and increased computer equipment lease expense. We occupied 161,909
square feet of office space at June 30, 2000, up from 112,653 square feet of
office space at June 30, 1999.
Other expenses increased 6.2% to $2.3 million for the three months ended
June 30, 2000, from $2.2 million for the comparable 1999 period. This was
primarily the result of increased operating costs in connection with our
overall business growth.
Our effective and pro forma effective tax rates for the three months ended
June 30, 2000 and 1999, respectively, 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 KCM and a portion of
business development expenses. Our effective tax rate declined to 38% for the
three months ended June 30, 2000 from 42% for the three months ended June 30,
1999 primarily due to lower state and local income taxes.
14
<PAGE>
Six Months Ended June 30, 2000 and 1999
Revenues
Net trading revenue increased 79.0% to $770.1 million for the six months
ended June 30, 2000, from $430.3 million for the comparable period in 1999.
This increase was primarily due to higher equity share volume. Total equity
share volume increased 75.3% to 65.3 billion equity shares traded for the six
months ended June 30, 2000, from 37.3 billion equity shares traded for the
comparable period in 1999.
Asset management fees increased 107.5% to $20.3 million for the six months
ended June 30, 2000, from $9.8 million for the comparable period in 1999. The
increase in fees was primarily due to an increase in fund return from 11.74%
for the first half of 1999 to 18.76% for the first half of 2000 and an increase
in the amount of funds under management from $278.1 million at June 30, 1999 to
$477.1 million at June 30, 2000 in the Deephaven Market Neutral Master Fund,
which contained the majority of our funds under management.
Interest income increased 157.7% to $22.5 million for the six months ended
June 30, 2000, from $8.7 million for the comparable period in 1999. This
increase was primarily due to larger cash balances held at banks and our
clearing brokers.
Commissions and fees increased 46.1% to $10.2 million for the six months
ended June 30, 2000, from $7.0 million for the comparable period in 1999. This
increase is primarily due to higher share volumes from institutional customers
in listed securities.
Investment income and other income increased 186.6% to $5.2 million for the
six months ended June 30, 2000, from $1.8 million for the comparable period in
1999. This increase was primarily due to an increase in income from our
investments, primarily our investments in the private hedge funds that we
sponsor and manage.
Expenses
Employee compensation and benefits expense increased 99.1% to $277.4 million
for the six months ended June 30, 2000, from $139.4 million for the comparable
period in 1999. As a percentage of total revenues, employee compensation and
benefits expense increased to 33.5% for the six months ended June 30, 2000,
from 30.5% for the comparable period in 1999. The increase on a dollar and on a
percentage basis was primarily due to increased gross trading profits, growth
in our institutional sales revenue, growth in the number of employees and
higher margins. Due to increased net trading revenue, profitability based
compensation increased 94.9% to $237.7 million for the six months ended June
30, 2000, from $122.0 million for the comparable period in 1999, and
represented 85.7% and 87.5% of total employee compensation and benefits expense
for the six months ended June 30, 2000 and 1999, respectively. Our number of
employees increased to 1,074 employees as of June 30, 2000, from 702 employees
as of June 30, 1999.
Payments for order flow increased 44.0% to $97.6 million for the six months
ended June 30, 2000, from $67.8 million for the comparable period in 1999. As a
percentage of total revenues, payments for order flow decreased to 11.8% for
the six months ended June 30, 2000 from 14.8% for the comparable period in
1999. The increase in payments for order flow on a dollar basis was primarily
due to a 75.3% increase in equity shares traded for the six months ended June
30, 2000 to 65.3 billion shares, up from 37.3 billion for the comparable period
in 1999. The decrease in payments for order flow as a percentage of total
revenues was primarily due to increases in our institutional, asset management
and options revenues, respectively.
Execution and clearance fees increased 37.5% to $57.4 million for the six
months ended June 30, 2000, from $41.7 million for the comparable period in
1999. As a percentage of total revenues, execution and clearance fees decreased
to 6.9% for the six months ended June 30, 2000, from 9.1% for the comparable
period in 1999. The increase on a dollar basis was primarily due to a 92.7%
increase in equity trades executed to 77.4 million equity trades for the six
months ended June 30, 2000, from 40.1 million equity trades in the comparable
15
<PAGE>
period in 1999 and an increase in our institutional business. This increase was
offset, in part, by a decrease in clearance rates charged by clearing brokers
and volume discounts. The decrease in our execution and clearance fees as a
percentage of net trading revenue was primarily due to a decrease in clearance
rates charged by clearing brokers, volume discounts and growth in the volume of
OTC securities transactions.
Communications and data processing expense increased 70.4% to $14.2 million
for the six months ended June 30, 2000, from $8.4 million for the comparable
period in 1999. This increase was generally attributable to higher trading
volumes and an increase in our number of employees.
Business development expense increased 247.7% to $8.1 million for the six
months ended June 30, 2000, from $2.3 million for the comparable period in
1999. This increase was primarily the result of increased advertising and
higher travel and entertainment costs consistent with the growth in our
business and our increased focus on the institutional sales business.
Interest expense increased 224.2% to $14.9 million for the six months ended
June 30, 2000, up from $4.6 million for the comparable period in 1999. This
increase was primarily due to transaction-related interest expense resulting
from a higher level of securities sold, not yet purchased.
Professional fees increased 191.5% to $10.8 million for the six months ended
June 30, 2000, up from $3.7 million for the comparable period in 1999. This
increase was primarily due to increased consulting expenses related to our
investments in technology, our European and Japanese expansion efforts and
legal and other professional fees.
Depreciation and amortization expense increased 97.7% to $9.7 million for
the six months ended June 30, 2000, from $4.9 million for the comparable period
in 1999. This increase was primarily due to the purchase of approximately $43.8
million of additional fixed assets and leasehold improvements between June 30,
1999 and June 30, 2000 and the amortization of goodwill related to our
acquisitions of the listed securities market-making businesses of KCM and
Tradetech and the options specialist business of Gargoyle.
Occupancy and equipment rentals expense increased 64.1% to $7.4 million for
the six months ended June 30, 2000, from $4.5 million for the comparable period
in 1999. This increase was primarily attributable to additional office space
and increased computer equipment lease expense. We occupied 161,909 square feet
of office space at June 30, 2000, up from 112,653 square feet of office space
at June 30, 1999.
Other expenses increased 22.6% to $4.9 million for the six months ended June
30, 2000, from $4.0 million for the comparable period in 1999. This was
primarily the result of increased operating costs in connection with our
overall business growth.
Our effective and pro forma effective tax rates for the six months ended
June 30, 2000 and 1999, respectively, 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 KCM and a portion of
business development expenses. Our pro forma effective tax rate declined to 38%
for the six months ended June 30, 2000 from 42% for the six months ended June
30, 1999 primarily due to lower state and local income taxes.
Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for
Derivative Instruments and Hedging Activities. This statement established
accounting and reporting standards for derivative instruments, including
certain derivative instruments imbedded in other contracts, and for hedging
activities. In June 1999, the FASB issued SFAS No. 137, Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date
of FASB Statement No. 133-an amendment of FASB Statement No. 133. We anticipate
adopting the provisions of SFAS No. 133 and 137 effective January 1, 2001 and
do not believe that the adoption of this statement will have a material impact
on our financial statements.
16
<PAGE>
Liquidity and Capital Resources
Historically, we have financed our business primarily through cash generated
by operations, as well as the proceeds from our stock offerings, the private
placement of preferred and common units and borrowings under subordinated
notes. As of June 30, 2000, we had $2.3 billion in assets, 92% of which
consisted of cash or assets readily convertible into cash, principally
receivables from clearing brokers and securities owned. Receivables from
clearing brokers include interest bearing cash balances held with clearing
brokers, including, or 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 that trade in Nasdaq and on the NYSE and AMEX
markets and listed options contracts that trade on national exchanges.
Net income and pro forma net income plus depreciation and amortization was
$72.7 million and $60.8 million during the three months ended June 30, 2000 and
1999, respectively. Depreciation and amortization expense, which related to
fixed assets and goodwill, was $5.5 million and $2.8 million during the three
months ended June 30, 2000 and 1999, respectively. Capital expenditures were
$16.6 million and $4.6 million for the three months ended June 30, 2000 and
1999, respectively, primarily related to the purchase of data processing and
communications equipment, as well as leasehold improvements and additional
office facilities to support our growth. Additionally, we made cash payments of
$4.6 million for the three months ended June 30, 2000 in connection with our
acquisitions of the listed securities market-making businesses of KCM in 1995
and Tradetech in 1997. We anticipate that we will meet our 2000 capital
expenditure needs out of operating cash flows.
As registered broker-dealers and market makers, KS, KCM and KFP 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 ($3.7 million, $1.2 million and
$250,000, respectively as of June 30, 2000). 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 KS, KCM and KFP, are required to notify the SEC prior to repaying
subordinated borrowings, paying dividends and making loans to their parents,
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 June 30, 2000, KS had net capital
of $318.4 million, which was $314.7 million in excess of its required net
capital of $3.7 million, KCM had net capital of $54.1 million which was $52.9
million in excess of its required net capital of $1.2 million and KFP had net
capital of $25.1 million which was $24.8 million in excess of its required net
capital of $250,000.
We currently anticipate that available cash resources and credit facilities
will be sufficient to meet our anticipated working capital and capital
expenditure requirements for at least the next 12 months.
Year 2000 Compliance
Many currently installed computer systems and software products were coded
to accept or recognize only two digit entries in the date code field. These
date code fields needed 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 had to be upgraded to
comply with such Year 2000 requirements or risk system failure or
miscalculations causing disruptions of normal business activities. We estimate
that the total cost of our Year 2000 project was approximately $550,000.
To date, we have not experienced any material outages or failures as a
result of Year 2000 related issues. We cannot make any assurances that we may
not experience any such failures in the future. We have finalized a business
continuity plan and have formulated action steps to be taken in the event that
a material Year 2000 related failure should arise.
17
<PAGE>
Recent Developments
In July 2000, the Company and The Nikko Securities Co., Ltd. established a
joint venture operation that will provide wholesale market-making services in
Japanese equity securities.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our market-making activities expose our capital to significant risks. These
risks include, but are not limited to, absolute and relative price movements,
price volatility and changes in liquidity, over which we have virtually no
control.
We employ automated proprietary trading and risk management systems which
provide real time, on-line risk management and inventory control. We monitor
our risks by a constant review of trading positions and their appropriate risk
measures. For each market maker, we have established a system whereby
transactions are monitored by senior management as are individual and aggregate
dollar and inventory position totals, appropriate risk measures and real-time
profits and losses. The management of trading positions is enhanced by review
of mark-to-market valuations and position summaries on a daily basis.
In the normal course of our OTC and exchange-listed market-making business,
we maintain inventories of exchange-listed and OTC securities. The fair value
of these securities at June 30, 2000 was $227.0 million in long positions and
$284.8 million in short positions. The potential change in fair value, using a
hypothetical 10.0% decline in prices, is estimated to be a $5.8 million gain as
of June 30, 2000 due to the offset of losses in long positions with gains in
short positions.
In the normal course of options market making, we maintain inventories of
options, futures and equities. Our main exposures are from equity price and
volatility risk. We manage these exposures by constantly monitoring and
diversifying our exposures and position sizes and establishing offsetting
hedges. Our market making staff and trading room managers continuously manage
our positions and our risk exposures. Our systems incorporate trades and update
our risk profile using options pricing models on a real time basis.
Our proprietary options risk management system allows us to stress test our
portfolio on a real-time basis. On a daily basis, risk reports are distributed
to senior management and the firm's risk managers who incorporate this
information in our daily market making decisions. These reports identify
potential exposures in terms of options and futures on individual securities
and index contracts, organized in different ways such as industry sectors,
under extreme price and volatility movements. At June 30, 2000, 10% movements
in volatility and stock prices on our equity options and equity index options
portfolios, which contain the majority of our market risk, would have resulted
in approximately the following gains (losses) in our options market making
portfolio:
<TABLE>
<CAPTION>
Change in Stock Prices
------------------------------------------
-10% None +10%
------------- ------------- -------------
<S> <C> <C> <C>
Change in Volatility
+10%............................... $14.1 million $ 1.8 million $12.7 million
None............................... 11.1 million -- 11.3 million
-10%............................... 8.4 million (1.2 million) 10.1 million
</TABLE>
This stress analysis covers positions in options and futures, underlying
securities and related hedges. The 10% changes in stock prices and volatility
in the charts above make the assumption of a universal 10% movement in all of
our underlying positions. The analysis also includes a number of estimates that
we believe to be reasonable, but cannot assure that they produce an accurate
measure of future risk.
For working capital purposes, we invest in money market funds, commercial
paper, government securities or maintain interest bearing balances in our
trading accounts with clearing brokers, which are classified as cash
equivalents and receivable from clearing brokers, respectively, in the
Consolidated Statements of Financial Condition. These other 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.
18
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We and certain of our officers and employees have been subject to legal
proceedings in the past and may be subject to legal proceedings in the future.
We are currently a party to certain legal proceedings; presently, we do not
believe the outcomes of these proceedings, individually or in the aggregate,
will have a material adverse effect on our business, financial condition or
operating results.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual meeting of Shareholders on May 17, 2000 for the
purposes of: (i) approving the change of the Company's name to Knight Trading
Group, Inc.; (ii) amending the Company's Certificate of Incorporation to
increase the Company's authorized Class A Common Stock from 200 million shares
to 500 million shares; (iii) electing its Board of Directors; (iv) approving an
amendment to the Company's 1998 Long-Term Incentive Plan to increase the number
of shares of the Company's Class A Common Stock authorized for issuance
thereunder; and (v) ratifying the appointment of its independent auditors. The
Board of Directors consists of a total of fifteen persons who are elected by
the holders of the Company's Class A Common Stock. The fifteen persons were
nominated by the Board of Directors to serve as directors for terms of one
year.
The change of the Company's name to Knight Trading Group, Inc. was approved
by the Stockholders with 113,514,814 votes FOR (99.8%), 125,233 votes AGAINST
and 61,091 votes ABSTAINED OR BROKER NON-VOTES.
The Stockholders approved the amendment to the Company's Certificate of
Incorporation to increase the Company's authorized Class A Common Stock from
200 million to 500 million shares with 109,036,816 votes FOR (95.9%), 4,515,888
votes AGAINST and 148,434 votes ABSTAINED OR BROKER NON-VOTES.
The following sets forth the results of the election of directors:
DIRECTORS
<TABLE>
<CAPTION>
Name Of Nominee For % Withheld %
--------------- ----------- ------ --------- -----
<S> <C> <C> <C> <C>
Kenneth D. Pasternak......................... 105,314,470 92.62% 8,386,668 7.38%
Walter F. Raquet............................. 113,198,057 99.56% 503,087 0.44%
Robert I. Turner............................. 113,171,105 99.53% 530,033 0.47%
Robert M. Lazarowitz......................... 113,190,323 99.50% 570,815 0.50%
Anthony M. Sanfilippo........................ 105,327,912 92.64% 8,373,226 7.36%
Peter S. Hajas............................... 113,197,713 99.56% 503,425 0.44%
John G. Hewitt............................... 113,178,108 99.54% 523,030 0.46%
Charles V. Doherty........................... 104,331,772 91.76% 9,369,366 8.24%
Gene L. Finn................................. 113,196,372 99.56% 504,766 0.44%
Gary R. Griffith............................. 113,201,325 99.56% 499,813 0.44%
Bruce R. McMaken............................. 113,152,781 99.52% 548,357 0.48%
J. Joe Ricketts.............................. 113,189,586 99.55% 511,552 0.45%
Rodger O. Riney.............................. 113,160,101 99.52% 541,037 0.48%
V. Eric Roach................................ 113,189,498 99.55% 511,640 0.45%
Robert Greifeld.............................. 113,199,116 99.56% 502,022 0.44%
</TABLE>
19
<PAGE>
No proxies were solicited from the holders of the Class B Common Stock since
no such shares were outstanding. There was no solicitation in opposition to the
nominees proposed to be elected by the holders of the Class A Common Stock in
the Proxy Statement.
The amendment to the Company's 1998 Long-Term Incentive Plan to increase the
number of shares of the Company's Class A Common Stock authorized for issuance
thereunder was approved by the Stockholders with 68,432,501 votes FOR (86.1%),
10,852,813 votes AGAINST and 203,225 votes ABSTAINED OR BROKER NON-VOTES.
The ratification of the appointment of PricewaterhouseCoopers LLP as
independent auditors for the Company for the fiscal year ending December 31,
2000 was approved by the Stockholders with 113,453,494 votes FOR (99.8%),
153,510 votes AGAINST, and 94,134 votes ABSTAINED OR BROKER NON-VOTES.
Further information regarding these matters is contained in the Company's
Proxy Statement dated April 20, 2000.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 27. Financial Data Schedule.
(b) Reports on Form 8-K
The following report on Form 8-K was filed with the Securities and Exchange
Commission:
July 17, 2000 (Items 5 and 7)
A press release announcing the Company's results of operations for the
quarter ended June 30, 2000.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto until duly authorized.
Knight Trading Group, Inc.
/s/ Robert I. Turner
-------------------------------------
By: Robert I. Turner
Title: Director, Executive Vice
President, Chief Financial
Officer and Treasurer
(principal financial and
accounting officer)
Date: August 11, 2000
20
