Back to GetFilings.com
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-K
[X]ANNUAL REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
001-14223
Commission File Number
---------------
KNIGHT/TRIMARK GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation or organization)
52-2096335
(I.R.S. Employer Identification Number)
525 Washington Boulevard, Jersey City, NJ 07310
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (201) 222-9400
---------------
Shares registered pursuant to Section 12(b) of the Act:
None.
Shares registered pursuant to Section 12(g) of the Act:
21,850,000 shares of Class A Common Stock, $0.01 par value
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [_]
The aggregate market value of the voting and nonvoting common equity held by
nonaffiliates of the registrant was approximately $1,764,678,000 at March 22,
1999 based upon the closing price for shares of the Registrant's Class A Common
Stock as reported by the National Market System of the National Association of
Securities Dealers Automated Quotation System on that date. For purposes of
this calculation, affiliates are considered to be officers, directors and
holders of 5% or more of the outstanding common stock of the Registrant.
At March 22, 1999 the number of shares outstanding of the registrant's Class
A common stock was 52,856,904, and the number of shares outstanding of the
registrant's Class B common stock was 2,592,698.
DOCUMENTS INCORPORATED BY REFERENCE
Definitive Proxy Statement relating to the Company's 1999 Annual Meeting to
be filed hereafter (incorporated into Part III hereof).
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
KNIGHT/TRIMARK GROUP, INC.
FORM 10-K ANNUAL REPORT
For the Fiscal Year Ended December 31, 1998
TABLE OF CONTENTS
PART I
Item 1. Business....................................................... 3
Item 2. Properties..................................................... 13
Item 3. Legal Proceedings.............................................. 13
Item 4. Submission of Matters to a Vote of Security Holders............ 13
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters........................................................ 14
Item 6. Selected Financial Data........................................ 15
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..... 25
Item 8. Financial Statements and Supplementary Data.................... 27
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosures.......................................... 44
PART III
Item 10. Directors...................................................... 44
Item 11. Executive Compensation......................................... 44
Item 12. Security Ownership of Certain Beneficial Owners and
Management..................................................... 44
Item 13. Certain Relationships and Related Transactions................. 44
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-
K.............................................................. 44
Exhibit Index
UNLESS OTHERWISE INDICATED, REFERENCES TO THE "COMPANY" MEAN KNIGHT/TRIMARK
GROUP, INC. AND SUBSIDIARIES OR ROUNDTABLE PARTNERS, L.L.C. AND SUBSIDIARIES,
AS APPROPRIATE. UPON THE CLOSING OF THE COMPANY'S INITIAL PUBLIC OFFERING ON
JULY 13, 1998, ROUNDTABLE PARTNERS, L.L.C. BECAME A WHOLLY-OWNED SUBSIDIARY OF
KNIGHT/TRIMARK GROUP, INC.
2
PART I
Item 1. Business
Overview
We are the leading market maker in Nasdaq securities and in the Third
Market, which is the over-the-counter market in exchange-listed equity
securities, primarily those listed on the New York Stock Exchange (NYSE) and
the American Stock Exchange (AMEX). Market makers hold themselves out to
execute trades by offering to buy or sell securities for their own account. We
have attained our leadership position as a market maker by providing best
execution services to broker-dealer and institutional customers through our
sophisticated trading systems and methods. Through our wholly-owned subsidiary,
Knight Securities, Inc. (Knight), we make markets in approximately 6,700 equity
securities in Nasdaq and on the OTC Bulletin Board of the NASD. Through our
wholly-owned subsidiary, Trimark Securities, Inc. (Trimark), we make markets in
all NYSE- and AMEX-listed equity securities in the Third Market.
Since our inception in 1995, we have significantly increased our market
share of trading volume in the markets in which we participate:
. Based on data from The AutEx Group, a widely recognized industry
reporting service that publishes daily trading volume and market share
statistics reported by broker-dealer market makers, Knight achieved a #1
market share ranking of volume in Nasdaq in February 1998. Additionally,
Knight has further increased its volumes and its market share since that
time. The volume of Nasdaq shares traded by Knight increased from 614.7
million shares in January 1997 to 3.2 billion shares in December 1998.
During the same period, Knight's market share more than tripled from
4.4%, or a rank of 6th overall, to 15.6%, or a rank of 1st overall.
. According to the NASD, Trimark has held the #1 market share ranking in
the trading of NYSE-listed securities for over two years. Additionally,
Trimark has increased its volumes and its market share over the same
period. Trimark's trading volume of NYSE-listed securities has increased
from 234.3 million shares in January 1997 to 644.0 million shares in
December 1998. During the same period, Trimark's market share
approximately doubled from 21.2% to 40.4%.
. According to the NASD, Trimark has also held the #1 market share ranking
in the trading of AMEX-listed securities for over two years.
Additionally, Trimark has further increased its volumes and its market
share over the same period. Trimark's trading volume of AMEX-listed
securities has increased from 40.3 million shares in January 1997 to 65.7
million shares in December 1998. During this same period, Trimark
increased its market share from 51.4% to 61.7%.
Industry Background
During recent years, the U.S. market for equity securities has experienced
dramatic growth in trading volumes. The average daily volume of securities
traded in Nasdaq increased from 225.0 million shares in December 1992 to 867.1
million shares in December 1998. The average daily volume of securities traded
on the NYSE increased from 222.2 million shares in December 1992 to 692.8
million shares in December 1998. During this period, the average daily trading
volume of the Third Market, which consists of trading in NYSE-and AMEX-listed
securities in the OTC market, also increased significantly. The increase in
trading volume has resulted from a number of factors, including:
. increased cash flows into equity-based mutual funds;
. historic high returns in U.S. equity markets;
. the emergence and rapid growth of on-line discount brokers;
. technological innovations, like the emergence of the Internet; and
. reduced transaction costs.
3
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 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 provide trade
executions by offering to buy securities from, or sell securities to, broker-
dealers and institutional investors. Firms that have elected to make a market
in a security display the price at which they are willing to bid, meaning buy,
or ask, meaning sell, these securities and adjust their bid and ask prices in
response to the forces of supply and demand for each security. Market makers
are either a department within larger, diversified securities firms or
independent businesses. The internal market-making departments of securities
firms often are limited in their ability to handle significant trading volumes
in a broad range of securities. Most discount brokers and on-line brokers do
not have internal market-making functions and, accordingly, rely entirely on
independent market makers for trade execution.
A market maker typically acts as principal and derives most of its revenues
from the difference between the price paid when a security is bought and the
price received when that security is sold. In the past, market makers relied on
the spreads between bid and ask prices to ensure profitability and built cost
structures based on these spreads. However, changes in regulations governing
the securities industry and, to a lesser extent, the quoting of sixteenths
rather than eighths of a dollar, have dramatically reduced average spreads.
Implemented in January 1997, the SEC's Limit Order Display Rule requires the
display or execution of customer orders to buy or sell stock at a particular
price, commonly referred to as limit orders, that (1) are priced better than a
market maker's quote or (2) in certain circumstances add to the size associated
with the market maker's quote when the market maker is at the best price in the
market. The Limit Order Display Rule enables investors to advertise directly
their trading interest to the market, allowing them to compete with market
maker quotes and affect the size of bid-ask spreads. Additional regulations
adopted by the NASD require market makers to fill a customer's limit order
before their own trades. Since the implementation of the Limit Order Display
Rule and the move to trading in sixteenths of a dollar, Nasdaq and NYSE spreads
have each significantly decreased. Spreads could further decline if Nasdaq
adopts proposed regulations under which securities would be traded in decimals
rather than in fractions.
In this new narrower spread environment, maintaining profitability has
become extremely difficult for many traditional market makers. At the same
time, market makers have become subject to an increasing demand for better
execution standards and improved customer service. To meet these demands and
remain competitive, market makers have been forced to reexamine their
traditional spread-based approach to market making and to make extensive
technological and human resource investments. To leverage these large
investments and to remain profitable, market makers must execute a larger
volume of trades and maintain increased inventory positions. However, the
significant increases in trading volumes are only a benefit for the market
maker if its cost per trade is lower than its revenues per trade and if the
market maker is able to manage the risks associated with larger inventory
positions.
4
In response to these challenges, traditional brokerage firms are
increasingly electing to focus on their core competencies and to outsource
their market-making functions to independent market makers. In addition,
Internet brokers, who are handling increased trading volume, also utilize
independent market makers. According to The AutEx Group, in December 1998, the
three largest independent market makers represented a combined market share of
28% of the trading volumes of OTC equity securities, up from 17% in March 1997.
Similarly, according to the NASD, in December 1998 the three largest Third
Market trading firms represented a combined market share of 56% of the Third
Market volume in NYSE-listed equity securities compared to 42% in June 1997.
The three largest Third Market trading firms in AMEX-listed securities
represented a combined market share of 59% in December 1998 compared to 55% in
June 1997. While large volumes of trading provides an opportunity to spread
fixed costs over a larger number of trades, net profit per trade has declined.
In addition, significant volatility in equity markets, particularly in Internet
stocks, has led to significant fluctuations in the profitability in trading
such stocks for market makers. In response to tightening spreads and increasing
volatility in the equity markets, many market makers are seeking new trading
methodologies to identify and take advantage of the profit opportunities
represented by each trade. These market makers are also seeking to increase the
number of buy and sell orders that they receive, commonly referred to as order
flow. This increased order flow will, in turn, provide increased trading profit
opportunities. These market makers require efficient and sophisticated systems
and risk management practices and personnel with the requisite expertise to
deliver superior trade execution and customer service, while handling increased
order flow and maintaining low costs per trade.
The Knight/Trimark Solution
We are committed to providing a superior execution methodology that
emphasizes automated execution and rule compliance, real-time information
access to customers and pricing plus liquidity advantages based upon our
willingness to commit capital. While most of our trades are automatically
executed electronically, automatic execution is highly dependent on the
determination and manual entry of bid-ask prices by traders. Furthermore, our
trading revenues depend significantly on the management of inventory by our
skilled and experienced trading professionals. The main elements of our
solution include:
. Superior Execution and Enhanced Liquidity. We have implemented a variety
of best execution practices that provide our customers with significantly
enhanced liquidity. These practices include the following:
Knight
--Knight provides guaranteed, automated, electronic, continuous execution
at the National Best Bid or Offer, commonly referred to as NBBO, or
better for over 4,800 Nasdaq securities in which it makes markets for
orders of up to 1,000-2,000 shares on quotes as low as 100 shares.
--Knight guarantees to execute, at the opening NBBO, all market-eligible
orders it has received before 9:25 a.m. for all issues in which it
makes a market, up to an aggregate of 250,000 shares.
--Knight guarantees that it will execute trades at the opening NBBO for
substantially all Nasdaq initial public offerings, up to an aggregate
of 250,000 shares.
--Knight has considerable expertise in handling large trades and, in
December 1998, it executed 59,256 trades of 5,000 shares or greater.
--Knight was the first market maker to accept stop orders on all Nasdaq
stocks. A stop order is an order to buy/sell a security immediately if
the security's market price falls/rises to a specified price.
To address the recent volatility in the equity markets, particularly
attributable to companies that sell products or services via the Internet,
Knight has established certain procedures that enable it to reduce or suspend
its automatic execution guarantees during periods of abnormal volatility and
volume in a particular stock or group of stocks.
5
Trimark
--Trimark guarantees to provide automated, electronic, continuous
execution in every NYSE- and AMEX-listed equity security at the NBBO
for all orders eligible for automated execution.
--Trimark accepts all orders that can be sent to a primary exchange,
i.e., short sale, all or none, or stop order.
--Trimark provides execution for orders up to 5,000 shares at the NBBO
regardless of the quote's size for a select group of approximately 500
of the most actively traded stocks.
--Trimark not only guarantees the customer's market order to receive the
best price available on any exchange or by any competing market maker,
but Trimark frequently delivers that price for many more shares than
advertised if requested by a customer.
--Trimark offers various proprietary features such as limit order
protection (based on the primary exchange price) and price improvement
guarantees.
. Sophisticated Trading Technology. We rely on sophisticated technology to
facilitate our market-making activities. Knight uses the Brass trading
system under license from Automated Securities Clearance. Brass is used
by over 130 market makers. Knight is one of only three Brass users to run
Brass on its own computers with its own personnel, while other market
makers use Automated Securities Clearance as a service bureau. Trimark
employs a TCAM/Appletree trading system. We have made significant
investments in our technology platform and infrastructure since our
inception. Our trading systems are augmented by software applications
that enable the processing of a large volume of order flow efficiently,
without diminishing speed of execution. Knight's systems are designed to
process up to 500,000 trades per day and in December 1998 handled an
average of 170,000 trades per day. Trimark's systems are designed to
process up to 150,000 trades per day and in December 1998 handled an
average of 75,000 trades per day. We continue to invest in technology to
enhance further our processing capability.
. Superior Trading Methods. Our net trading revenues are dependent on our
ability to evaluate and act rapidly on market trends and manage risk
successfully. Our methodology focuses on the dynamic, real time analysis
of market activity and price movements, which enables us to manage risk
better. Throughout the business day, we continually analyze our trading
positions in individual securities and monitor our short and long
positions and our aggregate profits and losses. Management uses this
information to assess market trends and adjust its trading strategy on a
real-time basis in an effort to maximize its trading profits.
. Commitment to Highest Quality Customer Service. We are committed to
providing the highest quality customer service. We believe that our
highly skilled, experienced and entrepreneurial workforce can effectively
address the needs of our customers. We have over 50 experienced employees
involved in customer service. Our customer service group is dedicated to
handling orders greater than the automated execution size and ensuring
consistent quality of execution.
We are currently implementing our proprietary electronic communications
gateway product, e.Knight, which enables broker-dealers and institutions to
access from their desktops the Knight and Trimark trading systems through the
Internet and other electronic communications gateways. The access afforded by
e.Knight permits broker-dealers and institutions the ability not only to enter
and cancel orders, but also to ascertain the status of orders, filled or
unfilled. In addition, e.Knight provides a backup service to certain of our
customers. If a customer's system fails, e.Knight is designed to provide the
customer with uninterrupted access to our trading systems, which enables the
customer to continue to provide services to its clients.
We supply each of our customers with monthly execution reports that provide
a level of detail exceeding regulatory requirements. The report documents the
percentage of price-improved shares and trades, the average dollar value per
share and the total dollar value of all price improvements. This report is a
valuable tool to our
6
customers as it enables them to monitor their compliance with regulatory
requirements to seek to obtain best execution for their clients' trades.
Market Share Information
Since the beginning of 1997, Knight and Trimark have significantly increased
their market share of trading volume in each of their respective markets.
Knight's market share is based on rankings published by The AutEx Group, a
widely recognized industry reporting service that provides daily trading volume
and market share statistics for broker-dealer market makers, based on data
provided by the market makers themselves.
Percentage of Total Number
Advertised Share Total Market of OTC
Month Ended Volume Share Rank Stocks Traded Rank
- ----------- ---------------- ------------- ---- ------------- ----
(in thousands)
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
7
Trimark's market share is based on trade volumes and statistics provided by
the NASD.
Third Market Volume in
-----------------------------------------------------------------
NYSE Securities AMEX Securities
-------------------------------- --------------------------------
Percentage Percentage
of Total of Total
Month Ended Share Volume Market Share Rank Share Volume Market Share Rank
- ----------- -------------- ------------ ---- -------------- ------------ ----
(in thousands) (in thousands)
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
Electronic Communications Network
An electronic communications network, commonly referred to as an ECN, is
defined by the SEC as "any electronic system that widely disseminates to third
parties orders entered therein by an exchange market maker or OTC market maker
and permits such orders to be executed against, in whole or in part." ECNs are
private trading systems used by institutional investors and broker-dealers.
ECNs provide investors with the ability to trade securities anonymously and to
obtain immediate displays of their limit orders. ECNs, however, merely provide
a neutral forum in which third parties can display and match their limit
orders. As ECNs do not buy or sell securities as principal, they cannot provide
enhanced liquidity to investors.
We entered into a joint venture with Automated Securities Clearance, the
developer and owner of the Brass order entry and trading system, to establish
an ECN, The Brass Utility, L.L.C., commonly referred to as BRUT. Subsequent to
this development, three other securities firms invested in this joint venture.
We now own 14% of the joint venture and believe that providing investors access
to the BRUT ECN will greatly enhance the breadth of our execution services.
8
Customers
Our target customers are national and regional full-service broker-dealers,
on-line discount brokers and institutional investors. A number of our customers
own shares of our Class A common stock and Class B common stock. See "Item 13.,
Certain Relationships and Related Transactions." The following table presents a
representative list of our broker-dealer customers.
Ameritrade Inc. Merrill Lynch, Pierce,
BHC Securities, Inc. Fenner & Smith
BHF Securities Corp. Incorporated
Bidwell & Company Mesirow Financial
Brown & Company Securities Nathan & Lewis Securities,
Corporation Inc.
Burke, Christensen & Lewis National Discount Brokers
Securities, Inc. National Financial Services
CIBC Wood Gundy Securities Corporation
Corp. PaineWebber Incorporated
Cowles, Sabol & Co., Inc. Primevest Financial
Dain Rauscher Incorporated Services, Inc.
David A. Noyes & Co. The R.J. Forbes Group, Inc.
Direct Access Brokerage Sanders Morris Mundy, Inc.
Services, Inc. Scottsdale Securities, Inc.
Discover Brokerage Direct, Southwest Securities, Inc.
Inc. Stockcross, Inc.
E*TRADE Securities, Inc. Thomas F. White & Co.
A.G. Edwards & Sons, Inc. U.S. Clearing Corp.
Fiserv Correspondent Van Kasper & Company
Services, Inc. Waterhouse Securities, Inc.
Howe Barnes Investments, Inc. Wedbush Morgan Securities,
International Correspondent Inc.
Trading, Inc.
J.W. Charles Securities, Inc.
Josephthal & Co. Inc.
In addition, we currently have over 500 institutional customers, including
mutual funds, investment advisors, pension plan sponsors, bank trusts,
foundations and endowments.
In 1998, our five largest customers, Ameritrade, Brown & Company, Discover
Brokerage Direct, E*TRADE Securities and Waterhouse Securities, accounted for,
in aggregate, 33.0% of our order flow. In 1998, one of our customers,
Waterhouse Securities, accounted for 10.7% of the Company's order flow.
Marketing
We seek to increase our market share through direct-response advertising,
advertising on our Web site and a public relations program. Our marketing
focuses on advertising our execution services in publications targeted at the
securities industry. In addition, we have a quarterly program of targeted
mailings to existing and potential broker-dealer and institutional customers.
We also market aggressively through one-on-one meetings with customers and
potential customers, and continuous communications with existing customers. We
maintain a comprehensive customer database that is used regularly to better
understand and address customer needs. Our marketing strategy is to continue to
differentiate Knight/Trimark from competitors by enhancing its reputation and
brand as the provider of highest quality execution solutions with superior
customer service.
Clearing Arrangements
By contract, Knight clears all of its trades through Correspondent Services
Corp., a subsidiary of PaineWebber. The contract will remain in effect until
terminated by either party upon sixty days' prior written notice or upon thirty
days' written notice in certain limited circumstances. Trimark clears all of
its trades through National Investor Services Corp., a subsidiary of Waterhouse
Investor Services, Inc. The contract will
9
remain in effect until terminated by either party upon sixty days' prior
written notice. See "Item 13., Certain Relationships and Related Transactions."
Technology
Our success is largely attributable to management's ability to identify and
deploy emerging technologies that facilitate the execution of trades.
Technology has not only enhanced our ability to handle order flow, it has also
been an important component of our strategy to comply with government
regulations, achieve the highest execution standards and provide superior
customer service. We also use our technology and technology licensed from third
parties to monitor proactively the performance of our traders, to assess our
inventory positions and to provide ongoing information to our customers. We are
electronically linked to our broker-dealer and institutional customers through
dedicated servers. Our trading volume is transacted over dedicated
communications networks, which provide immediate access to our trading
operations and facilitate the handling of customer orders. We plan to continue
to make additional investments in technology and to automate further our
execution services.
Architectural Design and Industry Standards. Our systems are designed to be
open, interoperable, scalable, redundant and flexible. We utilize leading edge
technologies including Sun Microsystems, Inc.'s client/server architecture,
C/C++ programming languages, Java, relational database management systems and
on-line analytical processing.
Electronic Commerce. Our electronic commerce architecture enables our
broker-dealer and institutional customers to send their orders through a
variety of electronic communications gateways, including the Internet and
direct customer interfaces over our private network. Our customers can use
their own order management system, an institutional portfolio management system
or can select from a variety of our electronic connections.
Knight uses the Brass trading system designed by Automated Securities
Clearance. This system has a client/server architecture that uses Sun
Microsystem Inc. workstations and servers. Knight runs a local version of
Brass. Knight also makes extensive use of application program interfaces,
commonly known as APIs, to develop software applications. Trimark uses the
Appletree trading system designed by TCAM. This system runs on Stratus Computer
Inc.'s fault tolerant platform. Trimark has also developed software
applications using APIs.
Disaster Recovery Center. We are in the process of establishing a back-up
data center and trading facility. This facility will be used primarily to
accommodate traders if a disaster or major system malfunction occurs. This
back-up data center will run a real-time copy of our trading systems and house
a small group of market makers. To provide for system continuity in the event
of short power outages, we have also equipped our three data centers and
trading rooms with uninterruptible power supply units and back up generators.
Competition
We derive substantially all of our revenues from market-making activities.
The market for these services, particularly market-making services through
electronic communications gateways, is rapidly evolving and intensely
competitive. We expect competition to continue and intensify in the future.
Knight competes primarily with wholesale, national, and regional broker-
dealers, as well as ECNs, which are third party trading systems, typically
operated by broker-dealers. Trimark competes with the NYSE, the AMEX, regional
exchanges, Third Market competitors and ECNs. We compete primarily on the basis
of execution standards, our relationship with our customers and technology.
A number of our competitors have significantly greater financial, technical,
marketing and other resources than we have. Some of our competitors also offer
a wider range of services and products than we offer and have greater name
recognition and more extensive customer bases. These competitors may be able to
respond
10
more quickly to new or evolving opportunities, technologies and customer
requirements than we can and may be able to undertake more extensive
promotional activities and offer more attractive terms to customers. Recent
advancements in computing and communications technology are substantially
changing the means by which market-making services are delivered, including
more direct access on-line to a wide variety of services and 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.
Employees
At December 31, 1998, we had a total of 446 full-time employees, of which
342 were employed at Knight and of which 104 were employed at Trimark. Of
Knight's 342 employees, 238 were engaged in market-making and sales activities,
37 in systems and technology, 33 in customer service and 34 in administration.
Of Trimark's 104 employees, 65 were engaged in market-making activities, 20 in
customer service, 7 in systems and technology and 12 in administration. None of
our employees are subject to a collective bargaining agreement. We believe that
our relations with our employees are excellent.
We recruit and retain our employees by compensating them largely on a
performance basis, measuring performance primarily in terms of revenue
generation. We are committed to improving the skill levels of our employees
and, to that end, Knight has established Knight School, a weekly training
session in which trading staff learn new trading techniques and are informed of
regulatory developments. We intend to expand this initiative and to develop
additional programs to improve the skills and productivity of its workforce. We
believe that we have high employee morale due to our performance-based
incentive compensation and our encouragement of a highly cooperative and
creative culture.
Intellectual Property and Other Proprietary Rights
We rely primarily on copyright, trade secret and trademark law to protect
our proprietary technology. Notwithstanding the precautions we take to protect
our intellectual property rights, it is possible that third parties may copy or
otherwise obtain and use our proprietary technology without authorization or
otherwise infringe on our proprietary rights. It is also possible that third
parties may independently develop technologies similar to those of
Knight/Trimark. It may be difficult for us to police unauthorized use of our
intellectual property rights. In addition, litigation may be necessary in the
future to enforce our intellectual property rights, to protect our trade
secrets, to determine the validity and scope of the proprietary rights of
others, or to defend against claims of infringement or invalidity. These
litigations, whether successful or unsuccessful, could result in substantial
costs and diversions of resources either of which could have a material adverse
effect on our business, financial condition and operating results. We may in
the future receive notices of claims of infringement of other parties'
proprietary rights.
Government Regulation
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. In addition, the SEC, the NASD,
other self regulatory organizations, commonly known as SROs, such as the
various stock exchanges, and other regulatory bodies, such as state securities
commissions, require strict compliance with their rules and regulations. As a
matter of public policy, regulatory bodies are charged with safeguarding the
integrity of the securities and other financial markets and with protecting the
interests of customers participating in those markets, not protecting creditors
or stockholders of market makers. Market makers are subject to regulation
concerning certain aspects of their business, including trade practices,
capital
11
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. We and certain of our officers and other employees
have, in the past, been subject to claims arising from the violation of such
laws, rules and regulations, which resulted in the payment of fines and
settlements.
The regulatory environment in which we operate is subject to change. Our
business, financial condition and operating results may be adversely affected
as a result of new or revised legislation or regulations imposed by the SEC,
other United States or foreign governmental regulatory authorities or the NASD.
Our business, financial condition and operating results also may be adversely
affected by changes in the interpretation or enforcement of existing laws and
rules by these governmental authorities and the NASD.
Additional regulation, changes in existing laws and rules, or changes in
interpretations or enforcement of existing laws and rules often directly affect
the method of operation and profitability of securities firms. We cannot
predict what effect any such changes might have. Both regulations directly
applicable to us and regulations of general application could have a material
adverse effect on our business, financial condition, and operating results. For
example, the volume of our market-making activities in a given period could be
affected by, among other things, existing and proposed tax legislation,
antitrust policy and other governmental regulations and policies (including the
interest rate policies of the Federal Reserve Board) and changes in
interpretation or enforcement of existing laws and rules that affect the
business and financial communities. The level of trading and market-making
activity can be affected not only by such legislation or regulations of general
applicability, but also by industry-specific legislation or regulations.
Our business, both directly and indirectly, relies on the Internet and other
electronic communications gateways. We intend to expand our use of these
gateways. To date, the use of the Internet has been relatively free from
regulatory restraints. However, the SEC, certain SROs and certain states are
beginning to address the regulatory issues that may arise in connection with
the use of the Internet. Accordingly, new regulations or interpretations may be
adopted that constrain our own and our customers' abilities to transact
business through the Internet or other electronic communications gateways.
In addition, we have recently established a London-based subsidiary and may
expand its business to other countries in the future. To expand our services
internationally, we will have to comply with the regulatory controls of each
country in which we conduct business. The brokerage industry in many foreign
countries is heavily regulated. The varying compliance requirements of these
different regulatory jurisdictions and other factors may limit our ability to
expand internationally.
Net Capital Requirements
As registered broker-dealers and members of the NASD, our subsidiaries are
subject to the SEC's Net Capital Rule. The Net Capital Rule, which specifies
minimum net capital requirements for registered brokers-dealers, is designed to
measure the general financial integrity and liquidity of a broker-dealer and
requires that at least a minimum part of its assets be kept in relatively
liquid form. In general, net capital is defined as net worth (assets minus
liabilities), plus qualifying subordinated borrowings and certain discretionary
liabilities, and less certain mandatory deductions that result from excluding
assets that are not readily convertible into cash and from valuing
conservatively certain other assets. Among these deductions are adjustments,
which are commonly called haircuts, which reflect the possibility of a decline
in the market value of an asset prior to disposition.
Failure to maintain the required net capital may subject a firm to
suspension or revocation of registration by the SEC and suspension or expulsion
by the NASD and other regulatory bodies and ultimately could require the firm's
liquidation. The Net Capital Rule prohibits payments of dividends, redemption
of stock, the prepayment of subordinated indebtedness and the making of any
unsecured advance or loan to a stockholder, employee or affiliate, if such
payment would reduce the firm's net capital below required levels.
12
The Net Capital Rule also provides that the SEC may restrict for up to 20
business days any withdrawal of equity capital, or unsecured loans or advances
to stockholders, employees or affiliates (capital withdrawal), if such capital
withdrawal, together with all other net capital withdrawals during a 30-day
period, exceeds 30% of excess net capital and the SEC concludes that the
capital withdrawal may be detrimental to the financial integrity of the broker-
dealer. In addition, the Net Capital Rule provides that the total outstanding
principal amount of a broker-dealer's indebtedness under certain subordination
agreements, the proceeds of which are included in its net capital, may not
exceed 70% of the sum of the outstanding principal amount of all subordinated
indebtedness included in net capital, par or stated value of capital stock,
paid in capital in excess of par, retained earnings and other capital accounts
for a period in excess of 90 days.
A change in the Net Capital Rule, the imposition of new rules or any
unusually large charges against net capital could limit those of our operations
that require the intensive use of capital and also could restrict our ability
to withdraw capital from our broker-dealer subsidiaries, which in turn could
limit our ability to pay dividends, repay debt and repurchase shares of our
outstanding stock. A significant operating loss or any unusually large charge
against net capital could adversely affect our ability to expand or even
maintain our present levels of business.
Item 2. Properties
Our headquarters are located in Jersey City, New Jersey. We lease
approximately 52,000 square feet under a lease which expires in March 2005. We
have an option to extend the lease term on three floors for an additional five-
year period. We also lease approximately 29,000 square feet for our offices in
Purchase, NY; Chicago, IL; Boston, MA; Jericho, NY; Ridgefield, NJ and London,
England. We believe that our present facilities, together with our current
options to extend lease terms and occupy additional space, are adequate for our
current needs.
Item 3. Legal Proceedings
We are not currently a party to any legal proceedings, the adverse outcome
of which, individually or in the aggregate, could have a material adverse
effect on our business, financial condition or operating results. We and
certain of our officers and employees have been subject to legal proceedings in
the past and may be subject to legal proceedings in the future.
Item 4. Submission of Matters to a Vote of Security Holders
None.
13
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our Class A common stock is traded on the Nasdaq National Market under the
symbol "NITE." Public trading of our Class A common stock commenced on July 8,
1998. Before that, no public market for our Class A common stock existed. The
following table sets forth, for the periods indicated, the high and low closing
sales price per share of the Class A common stock in the Nasdaq National
Market.
1998 High Low
---- ------- -------
Third Quarter (from July 8, 1998).......................... $19 $ 6 5/8
Fourth Quarter............................................. $25 3/8 $ 5 1/8
1999
----
First Quarter (through March 22, 1999)..................... $59 $22
As of March 22, 1999, there were approximately 222 holders of record of our
Class A common stock. On March 22, 1999, the last sale price reported in the
Nasdaq National Market for our Class A common stock was $59 per share.
We have never paid a dividend. We intend to retain future earnings, if any,
to finance the development and expansion of our business and, therefore, do not
anticipate paying any cash dividends in the foreseeable future. The payment of
cash dividends is within the discretion of our board of directors and will
depend on many other factors, including our results of operations, financial
condition and capital requirements, restrictions imposed by financing
arrangements and legal requirements.
Use of Proceeds
On July 8, 1998, a Registration Statement on Form S-1 (No. 333-51653) was
declared effective by the SEC, pursuant to which 10,000,000 shares of our Class
A common stock were offered and sold at a price to the public of $14.50 per
share. Of such shares, 8,688,246 were sold by Knight/Trimark, generating gross
offering proceeds of approximately $126.0 million, and an additional 1,311,754
shares of our Class A common stock were offered and sold by a selling
stockholder, generating gross offering proceeds of approximately $19.0 million.
The managing underwriters of the offering were BancBoston Robertson Stephens;
Merrill Lynch, Pierce, Fenner & Smith Incorporated; PaineWebber Incorporated;
ABN AMRO Incorporated; and Southwest Securities, Inc.
The net proceeds to Knight/Trimark from the sales of the 8,688,246 shares of
Class A common stock offered by Knight/Trimark were approximately $116.2
million after deducting underwriting discounts and commissions of approximately
$8.2 million, or $0.94 per share, and offering expenses of approximately $1.6
million paid by Knight/Trimark. On August 3, 1998, the underwriters exercised
an over-allotment option to purchase 1.5 million shares of Class A common stock
from Knight/Trimark at the offering price of $14.50. Before deducting
underwriting discounts and commissions, the underwriters' exercise of the over-
allotment option generated gross proceeds of approximately $21.7 million. The
net proceeds to Knight/Trimark from the over-allotment option were
approximately $20.3 million after deducting underwriting discounts and
commissions of $1.4 million.
The principal purposes of the offering were to increase our working capital
and equity base, to provide a public market for our Class A common stock, to
permit future acquisitions using cash or publicly tradable Class A common
stock, and to facilitate future access to capital markets. From the proceeds of
the offering, we used $13.8 million to redeem all of the outstanding
Mandatorily Redeemable Preferred B Units of Roundtable Partners L.L.C. See
"Item 7., Management's Discussion and Analysis of Financial Condition and
Results of Operations." We used the remaining proceeds of the offering for
working capital and for general corporate purposes.
14
Item 6. Selected Financial Data
The following selected consolidated financial data are qualified by the
Consolidated Financial Statements of Knight/Trimark and the Notes thereto
included elsewhere in this document. You should read the following in
conjunction with the Consolidated Financial Statements and the discussion under
"Item 7., Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this document. The Consolidated
Statement of Income Data for the years ended December 31, 1996, 1997, 1998 and
the Consolidated Statement of Financial Condition Data at December 31, 1997 and
1998 have been derived from our audited Consolidated Financial Statements
included elsewhere in this document. 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 document.
Period from Year Ended December 31,
March 27, through --------------------------------
December 31, 1995 1996 1997 1998
----------------- ---------- ---------- ----------
Consolidated Statement of
Income Data: (in thousands, except share and per share data)
Revenues
Net trading revenue........ $ 69,516 $ 183,500 $ 223,923 $ 348,099
Commissions and fees....... -- 394 705 4,043
Interest, net.............. 296 1,283 2,039 3,591
---------- ---------- ---------- ----------
Total revenues........... 69,812 185,177 226,667 355,733
---------- ---------- ---------- ----------
Expenses
Employee compensation and
benefits.................. 12,151 39,494 57,717 108,003
Payments for order flow.... 25,994 69,829 66,912 82,512
Execution and clearance
fees...................... 12,710 25,837 32,069 45,564
Communications and data
processing................ 2,202 4,360 6,809 10,869
Depreciation and
amortization.............. 1,626 2,975 4,225 5,878
Occupancy and equipment
rentals................... 849 1,777 2,657 5,745
Professional fees.......... 503 379 1,612 3,424
Business development....... 130 623 1,460 2,337
Interest on Preferred
Units..................... 1,310 2,093 1,941 715
Other...................... 996 1,049 1,188 2,334
---------- ---------- ---------- ----------
Total expenses........... 58,471 148,416 176,590 267,381
---------- ---------- ---------- ----------
Income before income taxes.. 11,341 36,761 50,077 88,352
Income tax expense.......... -- -- -- 21,751
---------- ---------- ---------- ----------
Net income.................. $ 11,341 $ 36,761 $ 50,077 $ 66,601
========== ========== ========== ==========
Basic and diluted earnings
per share.................. $ 0.26 $ 0.86 $ 1.17 $ 1.40
========== ========== ========== ==========
Pro forma adjustment
Income before income taxes.. $ 11,341 $ 36,761 $ 50,077 $ 88,352
Pro forma income tax expense
(1)........................ 5,217 15,807 21,533 37,571
---------- ---------- ---------- ----------
Pro forma net income........ $ 6,124 $ 20,954 $ 28,544 $ 50,781
========== ========== ========== ==========
Pro forma basic and diluted
earnings per share......... $ 0.14 $ 0.49 $ 0.67 $ 1.07
========== ========== ========== ==========
Weighted average shares
outstanding (2)............ 42,801,636 42,801,636 42,801,636 47,511,111
========== ========== ========== ==========
December 31,
----------------------------------
Consolidated Statement of Financial 1995 1996 1997 1998
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
- --------
(1) Before our initial public offering, we were a limited liability company and
were not subject to income taxes. Pro forma income tax expense was computed
based on an effective tax rate of 46%, 43%, 43% and 42.5%, respectively,
for the period ended December 31, 1995 and for the years ended December 31,
1996, 1997 and 1998, respectively.
(2) Weighted average shares outstanding for the period ended December 31, 1995
and for the years ended December 31, 1996, 1997 and 1998 have been
determined as if the reorganization described in Note 3 to the Consolidated
Financial Statements included elsewhere in this document occurred as of the
earliest date presented. Shares issued in connection with our initial
public offering have been considered in determining weighted average shares
outstanding only from the date they were issued. Had such shares been
considered for the full periods presented, pro forma basic and diluted
earnings per share for the period ended December 31, 1995 and for the years
ended December 31, 1996, 1997 and 1998 would be $0.12, $0.40, $0.54, and
$0.96 per share, respectively.
15
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
We are the leading market maker in Nasdaq securities, other OTC equity
securities, and NYSE- and AMEX-listed equity securities in the Third Market.
Through our wholly-owned subsidiary, Knight, we make markets in approximately
6,700 equity securities in Nasdaq and on the NASD's OTC Bulletin Board. Through
our wholly-owned subsidiary, Trimark, we make markets in all NYSE- and AMEX-
listed equity securities in the Third Market.
Knight commenced Nasdaq and OTC securities market-making operations on July
24, 1995. Based on rankings published by The AutEx Group, a widely recognized
industry reporting service that publishes daily trading volume and market share
statistics reported by broker-dealer market makers, Knight was ranked first in
AutEx's Nasdaq/OTC Securities rankings, with a 15.6% market share during
December 1998. Knight's share volume totaled 5.7 billion, 11.2 billion and 27.4
billion, or 53%, 62% and 71% of our total share volume, for the years ended
December 31, 1996, 1997 and 1998, respectively. Since commencing operations in
1995, Knight's business has grown rapidly and accounted for 76%, 75% and 80% of
our total share volume growth during the years ended December 31, 1996, 1997
and 1998, respectively. Since our acquisition of Trimark in March 1995, Trimark
has also experienced significant increases in share volume. In addition,
Trimark has held the #1 market share ranking in trading of NYSE- and AMEX-
listed securities for over two years. Trimark's share volume totaled 5.1
billion, 6.9 billion and 11.0 billion, or 47%, 38% and 29% of our total share
volume for the years ended December 31, 1996, 1997 and 1998, respectively.
We were organized in April 1998 for the purpose of succeeding to the
business of Roundtable Partners, L.L.C. Immediately before the closing of our
initial public offering, all of the member interests of Roundtable were
exchanged for shares of Class A common stock and Class B common stock of
Knight/Trimark. We received no additional consideration in connection with that
conversion of member interests into shares of common stock. In addition, some
members of Roundtable, including our management, elected to receive additional
shares of Class A common stock instead of their share of profits of Roundtable.
Other members of Roundtable elected to receive a cash distribution, in the
aggregate amount of $21,977,097, of their share of profits of Roundtable. In
connection with the exchange, effective July 31, 1998, Knight became the
successor entity to Knight Securities, L.P., and Trimark became the successor
entity to Trimark Securities, L.P. See "Item 13., Certain Relationships and
Related Transactions."
Immediately prior to our reorganization from a limited liability company to
a Delaware corporation in connection with our initial public offering, a
consortium of 27 broker-dealers or their affiliates owned 60% of the member
interests of Roundtable. Additionally, Brown & Company Securities Corporation,
a major customer of Roundtable, held subordinated debt of Roundtable and an
option to purchase a member interest in Roundtable. These broker-dealer owners,
including Brown, owned 42.5% of our common stock after our initial public
offering. For the years ended December 31, 1996, 1997 and 1998, the broker-
dealer owners were the source of 35%, 40%, and 41%, respectively of our total
order flow. For the years ended December 31, 1996, 1997 and 1998, aggregate
payments by us to our broker-dealer owners for order flow equaled $46.4
million, $50.7 million and $57.1 million, respectively. For the years ended
December 31, 1996 and 1997 and the period from January 1, 1998 through July 13,
1998, the date of the reorganization from a limited liability company to a
corporation, aggregate payments by us for profit distributions to broker-dealer
owners equaled $10.6 million, $13.4 million and $44.6 million, respectively.
See "Item 13., Certain Relationships and Related Transactions."
Under the Roundtable limited liability company agreement, our broker-dealer
owners partially shared in Roundtable's profits in proportion to their equity
interest and partially in proportion to the quantity of order flow they have
directed to us. This arrangement was discontinued when we completed our initial
public offering. The broker-dealer owners no longer receive any special
inducements to send order flow to us and are not contractually or otherwise
obligated to provide us with any order flow.
16
Revenues
Our revenues consist principally of net trading revenue from market-making
activities. To date, we have only traded equity securities, and have never
traded in options, futures, forwards, swaps or other derivative instruments.
Net trading revenue, which represents trading gains net of trading losses, is
primarily affected by changes in trade and share volumes from customers, our
ability to derive trading gains by taking proprietary positions, primarily to
facilitate customer transactions and, most recently, by regulatory changes, and
evolving industry customs and practices. These regulatory changes and the move
from securities being quoted in sixteenths rather than eighths of a dollar,
which primarily occurred in 1997, have resulted in a decrease in net trading
revenue per trade. Our net trading revenue per trade for OTC securities has
historically exceeded the net trading revenue per trade for listed securities.
In addition, we have expanded our focus on sales to institutional customers.
OTC securities transactions with institutional customers are executed as
principal, and all related profits and losses are included within net trading
revenue. Listed securities transactions with institutional customers are
executed on an agency basis, for which we earn commissions on a per share
basis. We also receive fees for providing certain information to market data
providers. Commissions and fees are primarily affected by changes in our trade
and share volumes in listed securities.
We also earn interest income from our cash and securities positions held at
banks and in trading accounts at clearing brokers, net of transaction-related
interest charged by clearing brokers for facilitating the settlement and
financing of securities sold, not yet purchased, and interest on subordinated
notes and short-term debt. Interest, net is primarily affected by the changes
in cash balances held at banks and clearing brokers, and the level of
securities sold, not yet purchased, and the principal amount outstanding under
subordinated notes and short-term debt.
Expenses
Our operating expenses largely consist of employee compensation and
benefits, payments for order flow and execution and clearance fees. A
substantial portion of these expenses is variable in nature. Employee
compensation and benefits expense, which is largely profitability based,
fluctuates, for the most part, based on changes in net trading revenue and our
profitability. Payments for order flow fluctuate based on share volume, the mix
of market orders and limit orders and the mix of orders received from broker-
dealers compared to other institutional customers. Execution and clearance fees
fluctuate primarily based on changes in trade and share volume, the mix of
trades of OTC securities compared to listed securities and the clearance fees
charged by clearing brokers.
Employee compensation and benefits expense primarily consists of salaries
and wages paid to administrative and customer service personnel and
profitability based compensation, which includes compensation and benefits paid
to market-making and sales personnel based on their individual performance, and
incentive compensation paid to all other employees based on our overall
profitability. Profitability based compensation represented 79%, 78% and 80% of
total employee compensation and benefits expense for the years ended December
31, 1996, 1997 and 1998, respectively. We have grown from 195 employees at
December 31, 1996 to 317 employees and 446 employees as of December 31, 1997
and 1998, respectively. Approximately 80% of our employees are directly
involved in market-making, sales or customer service activities. Compensation
for employees engaged in market making and sales activities, the largest
component of employee compensation and benefits, is determined primarily based
on a percentage of gross trading profits net of expenses including related
payments for order flow, execution and clearance costs and overhead
allocations. Employee compensation and benefits will, therefore, be affected by
changes in payments for order flow, execution and clearance costs and the costs
we allocate to employees engaged in market making and sales activities.
17
Payments for order flow represent customary payments to broker-dealers, in
the normal course of business, for directing their order flow to us. As a
result of the new Order Handling Rules implemented by the SEC in 1997, we
changed our order flow payment policy from paying broker-dealers for
substantially all order executions, to paying broker-dealers only for orders
which provide us with a profit opportunity. For example, we make payments on
market orders, but do not pay on limit orders. As a result of these changes,
the average order flow payment per trade has declined.
Execution and clearance fees primarily represent clearance fees paid to
clearing brokers for OTC and listed securities, transaction fees paid to
Nasdaq, and execution fees paid to third parties, primarily for executing
trades in listed securities on the NYSE and AMEX and for executing orders
through electronic communications networks, commonly referred to as ECNs.
Execution and clearance fees are higher for listed securities than for OTC
securities. Due to our significant growth in share and trade volume, we have
been able to negotiate favorable rates and volume discounts from clearing
brokers and providers of execution services. As a result of these lower rates
and discounts and the increase in trade volume of OTC securities as a
percentage of total trade volume, execution and clearance fees per trade have
decreased.
Communications and data processing expense primarily consists of costs for
obtaining stock market data and telecommunications services.
Depreciation and amortization expense results from the depreciation of fixed
assets purchased by us or financed under a capital lease, and the amortization
of goodwill, which includes contingent consideration, resulting from the
acquisition of the listed securities market-making businesses of Trimark and
Tradetech Securities, L.P. which we acquired in November 1997.
Occupancy and equipment rentals expense primarily consists of rental
payments on office and equipment leases.
Professional fees primarily consist of fees paid to computer programming and
systems consultants, as well as legal fees and other professional fees.
Business development expense primarily consists of marketing expenses,
including travel and entertainment expenses and promotion and advertising
costs.
Interest on Preferred Units represents required interest payments on our
Mandatorily Redeemable Preferred A and B Units at a rate approximating the
Federal Funds rate. On April 15, 1998, we redeemed all of the remaining
outstanding Preferred A Units for $12.5 million in cash. On April 15, 1998, we
redeemed $1.2 million of Preferred B Units and, on July 17, 1998, we used $13.8
million of the proceeds from our initial public offering to redeem all of the
remaining outstanding Preferred B Units.
Other expenses primarily consist of administrative expenses and other
operating costs incurred in connection with our business growth, as well as
directors fees and restricted stock granted to directors in connection with the
initial public offering.
Income Tax
Prior to our initial public offering, we were a limited liability company
and were not subject to federal or state income taxes. Subsequent to our
reorganization from a limited liability company to a corporation, which
occurred immediately before the closing our initial public offering, we became
subject to federal income taxes and state income taxes in New York, New Jersey
and other states. Actual income tax expense represents income taxes incurred
from July 13, 1998, the date of the reorganization, through December 31, 1998.
This period is referred to as the 1998 post-offering period. Our effective tax
rate for the 1998 post-offering period and pro-forma effective tax rate for all
periods prior to the 1998 post-offering period differ from the federal
statutory rate of 35% due to state income taxes, as well as nondeductible
expenses, including the amortization of goodwill resulting from the acquisition
of Trimark and a portion of business development expenses.
18
Results of Operations
The following table sets forth the consolidated statement of income data for
the periods indicated as a percentage of total revenues:
Year Ended December 31,
-------------------------
1996 1997 1998
------- ------- -------
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%
======= ======= =======
Years Ended December 31, 1998 and 1997
Revenues
Net trading revenue increased 55.5% to $348.1 million in 1998, from $223.9
million in 1997. This increase was primarily due to higher trading volume,
particularly higher trade volume for OTC securities, which was offset in part
by lower average net revenue per trade. Total trade volume increased 101.8% to
40.9 million trades in 1998, from 20.3 million trades in 1997. Total share
volume increased 111.7% to 38.4 billion shares traded in 1998, from 18.1
billion shares traded in 1997. Average net revenue per trade decreased 23.0% to
$8.51 per trade in 1998, from $11.05 per trade in 1997, principally as a result
of the new Order Handling Rules, which were implemented during 1997, and the
reduction in the increments by which securities are quoted.
Commissions and fees increased 473.7% to $4.0 million in 1998, from $700,000
in 1997. This increase is primarily due to higher trade and share volumes from
institutional customers in listed securities and the receipt of fees for
providing certain information to market data providers.
Interest, net increased 76.1% to $3.6 million in 1998, from $2.0 million in
1997. This increase was primarily due to larger cash balances held at banks and
our clearing brokers, which was offset in part by
19
increased transaction-related interest expense resulting from a higher level of
securities sold, not yet purchased and short-term debt.
Expenses
Employee compensation and benefits expense increased 87.1% to $108.0 million
in 1998, from $57.7 million in 1997. As a percentage of net trading revenue,
employee compensation and benefits expense increased to 31.0% in 1998, from
25.8% in 1997. The increase on a dollar basis and as a percentage of net
trading revenue was primarily due to increases in gross trading profits,
decreases in payments for order flow and execution and clearance costs and
growth in the number of employees. Due to increased net trading revenue and
profitability, profitability based compensation increased 91.6% to $86.2
million in 1998, from $45.0 million in 1997. The number of employees increased
to 446 employees as of December 31, 1998, from 317 employees as of December 31,
1997.
Payments for order flow increased 23.3% to $82.5 million in 1998, from $66.9
million in 1997. As a percentage of net trading revenue, payments for order
flow decreased to 23.7% in 1998 from 29.9% in 1997. The increase in payments
for order flow on a dollar basis was primarily due to a 111.7% increase in
shares traded in 1998 to 38.4 billion shares, up from 18.1 billion in 1997. The
decrease in payments for order flow as a percentage of total revenue resulted
from changes in our order flow payment policy, changes in the mix of market
orders versus limit orders, and changes in customer mix. Payments for order
flow made to broker-dealer owners represented 69.3% of total payments for order
flow in 1998, a decrease from 75.7% in 1997.
Execution and clearance fees increased 42.1% to $45.6 million in 1998, from
$32.1 million in 1997. As a percentage of net trading revenue, execution and
clearance fees decreased to 13.1% in 1998 from 14.3% in 1997. The increase on a
dollar basis was primarily due to a 101.8% increase in trades in 1998, which
was offset, in part, by a decrease in clearance rates charged by clearing
brokers, and growth in the volume of OTC securities transactions, which have
lower execution costs than transactions in listed securities. The decrease in
execution and clearance fees as a percentage of net trading revenue was
primarily due to the decrease in clearance rates charged by clearing brokers,
and growth in the volume of OTC securities transactions.
Communications and data processing expense increased 59.6% to $10.9 million
in 1998, from $6.8 million in 1997. This increase was generally attributable to
higher trading volumes and an increase in the number of employees.
Depreciation and amortization expense increased 39.1% to $5.9 million in
1998, from $4.2 million in 1997. This increase was primarily due to the
purchase of approximately $8.9 million of additional fixed assets and leasehold
improvements during 1998 and the amortization of goodwill related to the
acquisition of the listed securities market-making businesses of Trimark and
Tradetech.
Occupancy and equipment rentals expense increased 116.2% to $5.7 million in
1998, from $2.7 million in 1997. This increase was primarily attributable to
additional office space and increased computer equipment lease expense. We
occupied 80,718 square feet of office space at December 31, 1998, up from
56,351 square feet of office space at December 31, 1997.
Professional fees increased 112.3% to $3.4 million in 1998, up from $1.6
million in 1997. This increase was primarily due to increased consulting
expenses related to our investments in technology, as well as legal fees and
other professional fees.
Business development expense increased 60.1% to $2.3 million in 1998, from
$1.5 million in 1997. This increase was primarily the result of higher travel
and entertainment costs consistent with the growth in our business and our
increased focus on the institutional sales business.
Interest on Preferred Units decreased 63.2% to $715,000 in 1998, from $1.9
million in 1997. This decrease is primarily due to our redemption of all of the
remaining Preferred A and B Units during 1998.
20
Other expenses increased 96.7% to $2.3 million in 1998, from $1.2 million in
1997. This was primarily the result of directors fees, stock granted to
directors in connection with the initial public offering and increased
administrative expenses and other operating costs in connection with our
overall business growth.
Income Tax
Pro forma income tax expense was determined using effective tax rates of
42.5% and 43% for 1998 and 1997, respectively.
Years Ended December 31, 1997 and 1996
Revenues
Net trading revenue increased 22.0% to $223.9 million in 1997, from $183.5
million in 1996. This increase was primarily due to higher trading volume,
particularly higher trade volume for OTC securities, which was offset in part
by lower average net revenue per trade. Total trade volume increased 74.7% to
20.3 million trades in 1997, from 11.6 million trades in 1996. Total share
volume increased 68.5% to 18.1 billion shares traded in 1997, from 10.8 billion
shares traded in 1996. Average net revenue per trade decreased 30.2% to $11.05
per trade in 1997, from $15.82 per trade in 1996, principally as a result of
the new Order Handling Rules, which were implemented during 1997, and the
reduction in the increments by which securities are quoted.
Commissions and fees increased 78.7% to $705,000 in 1997 from $394,000 in
1996. This increase is primarily due to higher trade and share volumes from
institutional customers in listed securities.
Interest, net increased 59.0% to $2.0 million in 1997, from $1.3 million in
1996. This increase was primarily due to larger cash balances held at banks and
our clearing brokers, which was offset in part by increased transaction-related
interest expense resulting from a higher level of securities sold, not yet
purchased.
Expenses
Employee compensation and benefits expense increased 46.1% to $57.7 million
in 1997, from $39.5 million in 1996. As a percentage of net trading revenue,
employee compensation and benefits expense increased to 25.8% in 1997, from
21.5% in 1996. The increase on a dollar basis and as a percentage of net
trading revenue was primarily due to increases in gross trading profits,
decreases in payments for order flow and growth in the number of employees. Due
to increased net trading revenue and profitability, profitability based
compensation increased 44.2% to $45.0 million in 1997, from $31.2 million in
1996. The number of employees increased to 317 employees as of December 31,
1997, from 195 employees as of December 31, 1996.
Payments for order flow decreased 4.2% to $66.9 million, from $69.8 million
in 1996. As a percentage of net trading revenue, payments for order flow
decreased to 29.9% in 1997, as compared to 38.0% in 1996. The decrease in
payments for order flow on a dollar basis and as a percentage of total revenue
resulted from changes in our order flow payment policy, changes in the mix of
market orders versus limit orders, and changes in customer mix. Payments for
order flow made to broker-dealer owners and subordinated note holders
represented 75.7% of total payments for order flow in 1997, from 66.4% in 1996.
Execution and clearance fees increased 24.1% to $32.1 million in 1997, from
$25.8 million in 1996. As a percentage of net trading revenue, execution and
clearance fees remained relatively constant and were 14.3% of net trading
revenue in 1997 and 14.1% of net trading revenue in 1996. The increase on a
dollar basis was primarily due to increased trade volume, which was offset, in
part, by a decrease in clearance rates charged by clearing brokers, and growth
in the volume of OTC securities transactions, which have lower execution costs
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.
21
Communications and data processing expense increased 56.2% to $6.8 million
in 1997, from $4.4 million in 1996. This increase was generally attributable to
higher trading volumes, and an increase in the number of employees.
Depreciation and amortization expense increased 42.0% to $4.2 million in
1997, from $3.0 million in 1996. This increase was primarily due to the
purchase of approximately $4.8 million of additional fixed assets and leasehold
improvements during 1997 and the amortization of goodwill related to the
acquisition of the listed securities market-making business of Trimark.
Occupancy and equipment rentals expense increased 49.6% to $2.7 million in
1997, from $1.8 million in 1996. This increase was primarily attributable to
additional office space and increased computer equipment lease expense. We
occupied 56,351 square feet of office space at December 31, 1997, up from
47,598 square feet of office space at December 31, 1996.
Professional fees increased 325.0% to $1.6 million in 1997, up from $379,000
in 1996. This increase was primarily due to increased consulting expenses
related to our investments in technology.
Business development expense increased 134.1% to $1.5 million in 1997, from
$623,000 in 1996. This increase was primarily the result of higher travel and
entertainment costs consistent with the growth in our business.
Interest on Preferred Units decreased 7.2% to $1.9 million in 1997, from
$2.1 million in 1996. This decrease was primarily due to our redemption and
retirement of 1,022,208 Preferred A Units in April 1997 for $10.2 million.
Other expenses increased 13.2% to $1.2 million in 1997, from $1.0 million in
1996. This was primarily the result of increased office expenses and other
operating costs in connection with our business growth.
Income Tax
Pro forma income tax expense was determined using an effective tax rate of
43% for 1997 and 1996.
Liquidity
Historically, we have financed our business primarily through cash generated
by operations, as well as the proceeds from our initial public offering, the
private placement of preferred and common units and borrowings under
subordinated notes. As of December 31, 1998, we had $358.9 million in assets,
91% of which consisted of cash or assets readily convertible into cash,
principally receivables from clearing brokers and securities owned. Receivables
from clearing brokers include interest bearing cash balances held with clearing
brokers, net of amounts related to securities transactions that have not yet
reached their contracted settlement date, which is generally within three
business days of the trade date. Securities owned principally consist of equity
securities which trade in Nasdaq and on the NYSE and AMEX markets.
Pro forma net income plus depreciation and amortization was $56.7 million,
$32.8 million and $23.9 million during 1998, 1997 and 1996, respectively.
Depreciation and amortization expense, which related to fixed assets and
goodwill, was $5.9 million, $4.2 million and $3.0 million during 1998, 1997 and
1996, respectively. Capital expenditures were $8.9 million in 1998, $4.4
million in 1997 and $3.9 million in 1996, or 2.5%, 2.3% and 2.1% of total
revenues in each year, respectively. Capital expenditures in 1998 primarily
related to the purchase of data processing and communications equipment, as
well as leasehold improvements and additional office facilities to support our
growth. Additionally, we made cash payments of $4.1 million, $2.4 million and
$1.4 million in 1998, 1997 and 1996, respectively, in connection with our
acquisitions of the listed securities market-making businesses of Trimark in
1995 and Tradetech in 1997. The aggregate minimum rental commitments for 1999
are $5.8 million, and we expect to incur $9 million of capital expenditures
during
22
1999, which will be incurred for substantially similar purposes to those
referenced above for 1998. We anticipate that we will meet our 1999 capital
expenditure needs out of operating cash flows.
As registered broker-dealers and market makers, Knight and Trimark are
subject to regulatory requirements intended to ensure the general financial
soundness and liquidity of broker-dealers and requiring the maintenance of
minimum levels of net capital, as defined in SEC Rule 15c3-1 ($1.9 million and
$1.0 million, respectively as of December 31, 1998). These regulations also
prohibit a broker-dealer from repaying subordinated borrowings, paying cash
dividends, making loans to its parent, affiliates or employees, or otherwise
entering into transactions which would result in a reduction of its total net
capital to less than 120.0% of its required minimum capital. Moreover, broker-
dealers, including Knight and Trimark, are required to notify the SEC prior to
repaying subordinated borrowings, paying dividends and making loans to its
parent, affiliates or employees, or otherwise entering into transactions,
which, if executed, would result in a reduction of 30.0% or more of their
excess net capital (net capital less minimum requirement). The SEC has the
ability to prohibit or restrict such transactions if the result is detrimental
to the financial integrity of the broker-dealer. At December 31, 1998, Knight
had net capital of $81.0 million, which was $79.1 million in excess of its
required net capital of $1.9 million and Trimark had net capital of $28.5
million, which was $27.5 million in excess of its required net capital of $1.0
million.
We used a portion of our capital resources before our initial public
offering to pay interest on our issued and outstanding Mandatorily Redeemable
Preferred A and B Units, and to make quarterly distributions to our members to
meet their estimated income tax obligations on their share of our taxable
income. The Preferred A and B Units bore interest at a rate approximating the
Federal Funds rate. The Preferred A Units were redeemed and retired in their
entirety in April 1998 for approximately $12.5 million in cash. In April 1998,
we redeemed a portion of the Preferred B Units for approximately $1.2 million
in cash. We used $13.8 million of the proceeds of our initial public offering
to redeem all of the remaining outstanding Preferred B Units on July 17, 1998.
PaineWebber Capital Inc., an affiliate of PaineWebber Incorporated, loaned
$30.0 million to Roundtable under a loan agreement dated as of June 19, 1998.
Roundtable used the proceeds from this loan to make distributions of
undistributed profits to the members of Roundtable before our reorganization
from a limited liability company to a Delaware corporation immediately before
our initial public offering. In connection with the dissolution of Roundtable,
we assumed all of Roundtable's obligations under the loan. We subsequently
repaid the entire loan from our operating cash flows, making principal pre-
payments of $5.0 million, $9.0 million, $6.0 million and $10.0 million on
September 15, 1998, October 20, 1998, December 15, 1998 and January 19, 1999,
respectively.
We currently anticipate that available cash resources and credit facilities
will be sufficient to meet our anticipated working capital and capital
expenditure requirements for at least the next 12 months.
On October 8, 1998, our board of directors approved a program to repurchase,
over a period of up to eighteen months, up to 3 million shares of our
outstanding Class A common stock up to a total aggregate amount not to exceed
$20 million. We may repurchase shares from time to time in the open market or
through privately negotiated transactions, depending on prevailing market
conditions, alternative use of capital and other factors. To date, we have not
repurchased any shares under this program.
Year 2000 Compliance
Many currently installed computer systems and software products are coded to
accept or recognize only two digit entries in the date code field. These date
code fields will need to accept four digit entries to distinguish 21st century
dates from 20th century dates. As a result, computer systems and/or software
used by many companies and governmental agencies may need to be upgraded to
comply with such Year 2000 requirements or risk system failure or
miscalculations causing disruptions of normal business activities.
23
State of Readiness. We have made an assessment of the Year 2000 readiness of
our trading-related, communications and data processing systems. Our readiness
plan consists of; (1) quality assurance testing of its main trading-related
systems including all customer interfaces and links to exchanges and utilities;
(2) contacting third-party vendors and licensors of material hardware, software
and services that relate directly and indirectly to the main trading systems;
(3) contacting vendors of critical non-trading related communications and data
processing systems; (4) contacting our clearing brokers; (5) assessment of
repair or replacement requirements; (6) repair or replacement; (7)
implementation; and (8) creation of contingency plans for possible Year 2000
failures. Additionally, we participated in the Securities Industry Association
"streetwide" testing in June 1998 and March 1999. We presently believe that our
main trading-related systems are currently Year 2000 compliant. We will require
vendors of material hardware and software components of our information
technology systems to provide assurances of their Year 2000 compliance. We plan
to complete this process during the first half of 1999. We are currently
assessing the materiality of our non-information technology systems and will
seek assurances of Year 2000 compliance from providers of material non-
information technology systems. Until such testing is complete and such vendors
and providers are contacted, we will not be able to completely evaluate whether
our information technology systems or non-information technology systems will
need to be revised or replaced.
Costs. To date, we have incurred approximately $350,000 in costs in
connection with identifying and evaluating Year 2000 compliance issues. Most of
our expenses have related to, and are expected to continue to relate to, the
operating costs associated with time spent by employees in the evaluation
process and Year 2000 compliance matters generally. At this time, we estimate
that the total cost of the Year 2000 project to be approximately $500,000.
Although we do not anticipate that any additional amounts above this estimate
will be material, such expenses, if higher than anticipated, could have a
material adverse effect on our business, financial condition and operating
results.
Risks. We are not currently aware of any Year 2000 compliance problems
relating to our main trading-related, communications or data processing systems
that would have a material adverse effect on our business, financial condition
and operating results, without taking into account our efforts to avoid or fix
such problems. We cannot assure that we will not discover Year 2000 compliance
problems that will require substantial revisions. In addition, we cannot assure
you that third-party software, hardware or services incorporated into our
systems will not need to be revised or replaced, all of which could be time
consuming and expensive. If we fail to fix our trading-related, communications
or data processing systems or to fix or replace third-party software, hardware
or services on a timely basis our business, financial condition and operating
results could be materially adversely affected. Moreover, the failure to
adequately address Year 2000 compliance issues in our main trading-related,
communications or data processing systems could result in litigation, which
could be costly and time-consuming to defend.
In addition, we cannot assure you that customers, governmental agencies,
utility companies, securities exchanges, Internet access companies, third-party
service providers, including our clearing brokers, and others outside our
control will be Year 2000 compliant. The failure by these entities to be Year
2000 compliant could result in a systemic failure beyond our control, such as a
prolonged Internet, telecommunications or electrical failure, which could also
prevent us from delivering our services to our customers and could have a
material adverse effect on our business, results of operations and financial
condition.
Contingency Plan. As discussed above, we are engaged in an ongoing Year 2000
assessment and have not yet developed a contingency plan. The results of our
Securities Industry Association testing and the responses received from third-
party vendors, service providers and customers will be taken into account in
determining the nature and extent of any contingency plans.
Recently Issued Accounting Standards
In February 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 132, Employers
Disclosures about Pensions and Other Postretirement Benefits an amendment of
FASB No. 87, 88 and 106, which provides accounting and reporting standards for
24
employers' disclosures about pension and other postretirement benefit plans. We
adopted SFAS No. 132 on its effective date of January 1, 1998. The adoption of
the provisions of these standards did not have a material impact on our
financial statements.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. We
anticipate we will adopt the provisions of SFAS No. 133 effective June 15,
1999. We believe the adoption of these provisions will not have a material
impact on our financial statements.
Recent Developments
On February 25, 1999 a Registration Statement on Form S-1 (No. 333-71559)
was declared effective by the SEC, pursuant to which 9,000,000 shares of our
Class A common stock were offered and sold at a price to the public of $35.00
per share. Of those shares, 2,424,720 were sold by Knight/Trimark, generating
gross offering proceeds of approximately $84.9 million, and an additional
6,575,280 were sold by selling shareholders, generating gross offering proceeds
to the selling shareholders of approximately $230.1 million. The managing
underwriters of the offering were BancBoston Robertson Stephens Inc., Merrill
Lynch, Pierce Fenner & Smith Incorporated, PaineWebber Incorporated, ABN AMRO
Incorporated and Southwest Securities, Inc.
The net proceeds to Knight/Trimark from the sales of the 2,424,720 shares of
Class A common stock offered by Knight/Trimark were approximately $80.3 million
after deducting underwriting discounts and commissions of $3.6 million, or
$1.505 per share, and estimated offering expenses of $950,000. Certain selling
shareholders granted the underwriters a 30-day option to purchase up to an
additional 1,350,000 shares of Class A common stock to cover over-allotments.
That option was exercised in full on March 18, 1999.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our market-making and trading activities expose our capital to significant
risks. These risks include, but are not limited to, absolute and relative price
movements, price volatility or changes in liquidity, over which we have
virtually no control.
We employ an automated proprietary trading and risk management system which
provides real time, on-line risk management and inventory control. We monitor
our risks by a constant review of trading positions. For each trader, we have
established a system whereby any trades that exceed pre-determined limits are
monitored by senior management as are individual and aggregate dollar and share
position totals and real-time profits and losses. The management of trading
positions is enhanced by review of mark-to-market valuations and/or position
summaries on a daily basis.
25
In the normal course of our market-making business, we maintain inventories
of exchange-listed and OTC securities. The fair value of these securities at
December 31, 1998 and 1997 was $100.5 million and $61.7 million, respectively,
in long positions and $108.9 million and $21.1 million, respectively, in short
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. The following table
illustrates, for the period indicated, our average, highest and lowest month-
end inventory at market value (based on both the aggregate and the net of the
long and short positions of trading securities).
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
-------------- -------------- -------------- -------------- -------------- --------------
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)
Beginning in the fourth quarter of 1998, there has been a sharp increase in
the price volatility of many stocks, particularly of companies that sell
products or services via the Internet. This volatility has been coupled with
record trading volume in many of these stocks, which are primarily listed on
Nasdaq. Customers eager to trade Internet stocks have flooded their brokers
with larger numbers of orders, leading to large order imbalances, systems
queues, and backlogs. During these extreme market conditions, many firms have
implemented procedures that are designed to preserve the continuous execution
of customers' orders while also lessening the exposure of the firm to
extraordinary market risk.
In the fourth quarter of 1998, Knight modified its execution policies in
response to these changes in the marketplace. Knight's current policy is to
provide continuous automatic execution on orders of up to 2,000 shares for
investors in over 4,800 Nasdaq stocks under normal market conditions. Knight
reserves the right to reduce or suspend its automatic execution guarantee
during periods of abnormal volatility and volume in a particular stock or group
of stocks. Knight's own internal risk management procedures dictate the
temporary suspension of automatic execution after certain levels of liquidity
have been provided. When automatic execution has been suspended, Knight will
only provide actual liquidity available based on price and time priority.
For working capital purposes, we invest in money market funds or maintain
interest bearing balances in our trading accounts with clearing brokers, which
are classified as cash equivalents and receivable from clearing brokers,
respectively, in the consolidated statement of financial condition. These
amounts do not have maturity dates or present a material market risk, as the
balances are short-term in nature and subject to daily repricing. Since its
inception, neither Knight/Trimark nor any of its subsidiaries has traded or
otherwise transacted in derivatives.
26
Item 8. Financial Statements and Supplementary Data
KNIGHT/TRIMARK GROUP, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Accountants......................................... 28
Consolidated Statements of Financial Condition as of December 31, 1997 and
1998..................................................................... 29
Consolidated Statements of Income for the years ended December 31, 1996,
1997 and 1998............................................................ 30
Consolidated Statements of Changes in Stockholders' (Members') Equity for
the years ended December 31, 1996, 1997 and 1998......................... 31
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1997 and 1998...................................................... 32
Notes to Consolidated Financial Statements................................ 33
27
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
28
KNIGHT/TRIMARK GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31,
-------------------------
1997 1998
------------ ------------
Assets
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
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
29
KNIGHT/TRIMARK GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31,
--------------------------------------
1996 1997 1998
------------ ------------ ------------
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
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
30
KNIGHT/TRIMARK GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' (MEMBERS') EQUITY
For the Years Ended December 31, 1996, 1997 and 1998
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
-------- ----------- ------------- ---------- -------- --------- ------- ------------ -----------
Balance, January
1, 1996........ 372,648 $ 3,726,480 $ 8,472,790 -- $ -- -- $ -- $ -- $ --
Issuance of
Common Units... 365,449 3,654,490 -- -- -- -- -- -- --
Net income...... -- -- 36,760,602 -- -- -- -- -- --
Distributions on
Common Units... -- -- (22,627,844) -- -- -- -- -- --
-------- ----------- ------------ ---------- -------- --------- ------- ------------ -----------
Balance,
December 31,
1996........... 738,097 7,380,970 22,605,548 -- -- -- -- -- --
Net income...... -- -- 50,077,233 -- -- -- -- -- --
Distributions on
Common Units... -- -- (25,742,857) -- -- -- -- -- --
Resignation of
Member......... (3,600) (36,000) (311,433) -- -- -- -- -- --
-------- ----------- ------------ ---------- -------- --------- ------- ------------ -----------
Balance,
December 31,
1997........... 734,497 7,344,970 46,628,491 -- -- -- -- -- --
Distributions on
Common Units... -- -- (57,265,529) -- -- -- -- -- --
Net income for
the period from
January 1, 1998
through July
12, 1998 (see
Note 3)........ -- -- 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 --
Net proceeds
from initial
public offering
(see Note 3)... -- -- -- 10,188,246 101,883 -- -- 136,420,887 --
Issuance of
restricted
stock to
directors...... -- -- -- 15,000 150 -- -- 217,350 --
Net income for
the period from
July 13, 1998
through
December 31,
1998........... -- -- -- -- -- -- -- -- 29,810,681
-------- ----------- ------------ ---------- -------- --------- ------- ------------ -----------
Balance,
December 31,
1998........... -- $ -- $ -- 49,062,184 $490,622 3,942,698 $39,427 $169,779,929 $29,810,681
======== =========== ============ ========== ======== ========= ======= ============ ===========
Total
-------------
Balance, January
1, 1996........ $ 12,199,270
Issuance of
Common Units... 3,654,490
Net income...... 36,760,602
Distributions on
Common Units... (22,627,844)
-------------
Balance,
December 31,
1996........... 29,986,518
Net income...... 50,077,233
Distributions on
Common Units... (25,742,857)
Resignation of
Member......... (347,433)
-------------
Balance,
December 31,
1997........... 53,973,461
Distributions on
Common Units... (57,265,529)
Net income for
the period from
January 1, 1998
through July
12, 1998 (see
Note 3)........ 36,790,346
Reorganization,
July 13, 1998
(see Note 3)... --
Exercise of
Brown option
(see Notes 2
and 3)......... 71,430
Net proceeds
from initial
public offering
(see Note 3)... 136,522,770
Issuance of
restricted
stock to
directors...... 217,500
Net income for
the period from
July 13, 1998
through
December 31,
1998........... 29,810,681
-------------
Balance,
December 31,
1998........... $200,120,659
=============
The accompanying notes are an integral part of these consolidated financial
statements.
31
KNIGHT/TRIMARK GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
--------------------------------------
1996 1997 1998
----------- ----------- ------------
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
=========== =========== ============
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.
32
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.
33
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.
Preferred A Units Preferred B Units
------------------------ ------------------------
Units Amount Units Amount
---------- ------------ ---------- ------------
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................... -- $ -- -- $ --
========== ============ ========== ============
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.
34
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:
Trimark Tradetech
Additional Additional
Consideration Consideration Total
------------- ------------- ----------
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
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.
35
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
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.
36
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
6. Fixed Assets and Leasehold Improvements
Fixed assets and leasehold improvements comprise the following:
December 31,
Depreciation -----------------------
Period 1997 1998
------------- ----------- -----------
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
=========== ===========
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.
37
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Included within accrued payments for order flow on the Consolidated
Statements of Financial Condition are the following amounts payable to the
Broker-Dealer Owners:
December 31, 1997............................................... $1,990,045
December 31, 1998............................................... 5,899,037
As of December 31, 1997, Knight and Trimark cleared their securities
transactions through clearing brokers which owned equity interests in the
Company. Effective March 9, 1998, Knight began clearing its securities
transactions through an unaffiliated clearing broker. Included within accrued
execution and clearance fees on the Consolidated Statements of Financial
Condition are the following amounts payable to the Broker-Dealer Owners:
December 31, 1997............................................... $2,666,469
December 31, 1998............................................... 2,687,297
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:
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
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:
For the year ended December 31, 1996........................... $ 810,893
For the year ended December 31, 1997........................... 1,258,827
For the year ended December 31, 1998........................... 1,699,963
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:
Office
Leases Other Leases Total
----------- ------------ -----------
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
=========== ========== ===========
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.
38
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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-
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:
For the year ended December 31, 1996........................... $ 478,308
For the year ended December 31, 1997........................... 681,927
For the year ended December 31, 1998........................... 1,120,907
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:
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%
====
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
39
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
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:
Number of Weighted-Average
Options Exercise Price
--------- ----------------
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
========= ======
Range of Weighted-Average Number
Exercise Outstanding Remaining Weighted-Average Exercisable Weighted-Average
Prices at 12/31/98 Contractual Life Exercise Price at 12/31/98 Exercise Price
-------- ----------- ---------------- ---------------- ----------- ----------------
$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
========= ==== ====== ====== ======
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:
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
===========
40
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
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:
Dividend yield........................................................ 0.0%
Expected volatility................................................... 44%
Risk-free interest rate............................................... 5.5%
Expected life (in years).............................................. 5
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.
41
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)
December 31,
------------------------
1997 1998
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
=========== ============
Statements of Income
Knight/Trimark Group, Inc. (parent only)
For the Years Ended December 31,
-----------------------------------
1996 1997 1998
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
=========== =========== ===========
42
KNIGHT/TRIMARK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Statements of Cash Flows
Knight/Trimark Group, Inc. (parent only)
For the Years Ended December 31,
----------------------------------------
1996 1997 1998
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
============ ============ ============
43
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.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosures
None.
PART III
The Company's Proxy Statement for its 1999 Annual Meeting of Stockholders,
which, when filed pursuant to Regulation 14A under the Securities Exchange Act
of 1934, will be incorporated by reference in this Annual Report on Form 10-K
pursuant to General Instruction G(3) of Form 10-K, provides the information
required under Part III (Items 10, 11, 12 and 13).
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as part of this report:
Consolidated Financial Statements and Financial Statement Schedules. See
"Item 8, Financial Statements and Supplementary Data"
(b) Reports on Form 8-K:
None
(c) Exhibits
Number Description
------ -----------
3.1* Form of Amended and Restated Certificate of Incorporation of the
Registrant.
3.2* Form of Amended and Restated By-laws of the Registrant.
4.1* Specimen Common Stock certificate.
4.2* Form of Registration Rights Agreement, dated as of July 13, 1998.
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.
44
Number Description
------ -----------
10.8* License Agreement between Automated Securities Clearance, Ltd. and
Knight Securities, L.P., dated April 5th, 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.
27** Financial Data Schedule for the fiscal year ended December 31, 1998.
- --------
* Previously filed as an exhibit to the Registrant's Registration Statement on
Form S-1 (No. 333-51653) and incorporated herein by reference thereto.
** Previously filed as an exhibit to the Registrant's Registration Statement on
Form S-1 (No. 333-71559) and incorporated herein by reference thereto.
45
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Jersey City, State of New Jersey, on this 18th day of March, 1999.
KNIGHT/TRIMARK GROUP, INC.
By /s/ Kenneth D. Pasternak
_____________________________________
Kenneth D. Pasternak
Director, President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Registration Statement has been signed by the following persons in the
capacities and on the date indicated.
Name Title Date
---- ----- ----
/s/ Kenneth D. Pasternak Director, President and March 18, 1999
____________________________________ Chief Executive Officer
Kenneth D. Pasternak
/s/ Robert I. Turner Director, Executive Vice March 18, 1999
____________________________________ President and Chief
Robert I. Turner Financial Officer (principal
financial and accounting
officer)
/s/ Steven L. Steinman Director and Chairman of the March 18, 1999
____________________________________ Board
Steven L. Steinman
/s/ Walter F. Raquet Director and Executive Vice March 18, 1999
____________________________________ President
Walter F. Raquet
/s/ Robert M. Lazarowitz Director and Executive Vice March 18, 1999
____________________________________ President
Robert M. Lazarowitz
/s/ Anthony M. Sanfilippo Director and Executive Vice March 18, 1999
____________________________________ President
Anthony M. Sanfilippo
/s/ Martin Averbuch Director March 18, 1999
____________________________________
Martin Averbuch
/s/ Charles V. Doherty Director March 18, 1999
____________________________________
Charles V. Doherty
/s/ Gene L. Finn Director March 18, 1999
____________________________________
Gene L. Finn
46
Name Title Date
---- ----- ----
/s/ Gary R. Griffith Director March 18, 1999
____________________________________
Gary R. Griffith
/s/ Bruce R. McMaken Director March 18, 1999
____________________________________
Bruce R. McMaken
/s/ J. Joe Ricketts Director March 18, 1999
____________________________________
J. Joe Ricketts
/s/ Rodger O. Riney Director March 18, 1999
____________________________________
Rodger O. Riney
/s/ V. Eric Roach Director March 18, 1999
____________________________________
V. Eric Roach
/s/ Charles A. Zabatta Director March 18, 1999
____________________________________
Charles A. Zabatta
47