NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Description of the Business
Knight Capital Group, Inc. (collectively with its subsidiaries, the Company) has two operating business segments, Asset Management and Global Markets, as well as a Corporate segment. As of
December 31, 2007, the Companys operating business segments comprised the following operating subsidiaries:
Asset Management
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Deephaven Capital Management LLC (Deephaven) is the registered investment adviser to and sponsor of the Deephaven investment funds (the Deephaven
Funds). In addition to being registered as an Investment Adviser with the U.S. Securities and Exchange Commission (SEC), Deephaven is also registered with the Commodity Futures Trading Commission (CFTC) as a
commodity pool operator and a commodity trading adviser, and is a member of the National Futures Association (NFA). Due to the nature of Deephavens investor base, however, Deephaven is not registered as
either a Futures Commission Merchant (FCM) or Introducing Broker with the CFTC or NFA and is exempt from many of the CFTC and NFA regulations. Deephaven also has a U.K. registered investment adviser subsidiary,
which is regulated by the U.K. Financial Services Authority (FSA), and a Hong Kong registered investment adviser subsidiary, which is regulated by the Hong Kong Securities and Futures Commission. See Footnote 24, Subsequent
Events for further discussion relating to Exercise of Option by Deephaven Managers and Closing of Deephaven Event Fund.
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Global Markets
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Knight Equity Markets, L.P. (KEM) operates as a market-maker in over-the-counter (OTC) equity securities, primarily those traded in the
NASDAQ Stock Market and on the OTC Bulletin Board. KEM also operates the Companys primary domestic institutional sales business. Donaldson & Co., a division of KEM, offers soft dollar and commission recapture services. KEM is a
broker-dealer registered with the SEC and is a member of the NASDAQ Stock Exchange (NASDAQ), Financial Industry Regulatory Authority (FINRA), the International Securities Exchange, LLC, the National Stock Exchange and the
NFA.
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Knight Capital Markets LLC (KCM) primarily operates as a market-maker in the over-the-counter market for New York Stock Exchange (NYSE) and
American Stock Exchange (AMEX) listed securities. KCM is a broker-dealer registered with the SEC and is a member of NASDAQ and FINRA.
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Knight Equity Markets International Limited (KEMIL) is a U.K. registered broker-dealer that provides execution services for institutional and
broker-dealer clients in U.S., European and international equities. KEMIL is authorized and regulated by the FSA and is a member of the London Stock Exchange, Deutsche Börse AG, Euronext N.V. (incorporating Euronext Amsterdam, Euronext
Brussels, Euronext Lisbon and Euronext Paris), Borsa Italiana, OMX (incorporating the Copenhagen Stock Exchange, Helsinki Stock Exchange and Stockholm Stock Exchange), Oslo Børs, virt-x and Weiner Börse.
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Direct Trading Institutional, L.P. (Direct Trading) provides institutions with direct market access trading through Knight Direct EMS, an advanced
electronic platform. The business of Direct Trading was acquired by the Company in June 2005. Direct Trading is a broker-dealer registered with the SEC and is a member of NASDAQ, FINRA and the NFA.
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Hotspot FX, Inc. and its subsidiaries (Hotspot) provide institutions, dealers and retail clients with spot foreign exchange executions through an
advanced, fully electronic platform. Hotspot was acquired by the Company in April 2006. One Hotspot subsidiary is regulated by the FSA, and another Hotspot subsidiary is a FCM registered with the CFTC and is a member of the NFA.
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61
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Knight BondPoint, Inc. (Knight BondPoint) (formerly known as ValuBond Securities, Inc.) provides electronic access and trade execution products for the
retail fixed income market. Knight BondPoint was acquired by the Company in October 2006. Knight BondPoint is a broker-dealer registered with the SEC and is a member of FINRA and the Municipal Securities Rulemaking Board (MSRB).
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Direct Edge ECN LLC (Direct Edge
ECN) operates as an electronic communications network (ECN). Direct Edge ECN is a liquidity destination offering the ability to match and route trades in NASDAQ, NYSE and AMEX listed securities by displaying orders in the NASDAQ
Market Center, the FINRA Alternative Display Facility and the National Stock Exchange. Direct Edge ECN is a broker-dealer registered with the SEC and is a member of NASDAQ, FINRA, the National Stock Exchange, Chicago Stock Exchange, CBOE Stock
Exchange, Boston Stock Exchange, International Securities Exchange and NYSE Arca, Inc. As described in Footnote 10, Direct Edge ECN, at the close of business on September 28, 2007, the Company deconsolidated Direct Edge ECN as it no
longer controlled Direct Edge ECN as of that date. With the exception of the minority interest in the third quarter of 2007, the results of Direct Edge ECNs operations have been included in the Consolidated Statements of Operations for all
periods presented up through September 28, 2007. The Company accounts for its interest in Direct Edge Holdings LLC (Direct Edge Holding), the newly formed immediate parent company of Direct Edge ECN (together, Direct
Edge), under the equity method for periods subsequent to September 28, 2007.
The Corporate segment includes all corporate overhead expenses and investment income earned on strategic investments and the corporate investment in the Deephaven Funds. Corporate overhead expenses primarily consist
of compensation for certain senior executives and other individuals employed at the corporate holding company, legal and other professional expenses related to corporate matters, directors fees, investor and public relations expenses and
directors and officers insurance.
Discontinued Operations
The Company completed the sale of its Derivative Markets
business to Citigroup Financial Products Inc. (Citigroup) in December of 2004. Costs associated with the Derivative Markets segment have been included within discontinued operations. For a further discussion of the sale of the
Companys Derivative Markets business and its associated accounting treatment, see Footnote 16 Discontinued Operations.
2. Significant Accounting Policies
Basis of consolidation and form of presentation
The accompanying Consolidated Financial Statements, prepared in conformity with accounting principles generally accepted in the United States of America
(GAAP), include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated.
Certain reclassifications have been made to the prior years Consolidated Financial Statements in order to conform to the current year presentation.
Such reclassifications had no effect on previously reported Net income.
Cash and cash equivalents
Cash and cash
equivalents include money market accounts, which are payable on demand, and short-term investments with an original maturity of less than 90 days. The carrying amount of such cash equivalents approximates their fair value due to the short-term
nature of these instruments.
Market-making and sales
activities
Securities owned and securities sold, not yet
purchased, which primarily consist of listed and OTC equities, are carried at market value and are recorded on a trade date basis. Net trading revenue (trading gains, net of
62
trading losses) and commissions (which includes commission equivalents earned on institutional client orders) and related expenses are also recorded on a
trade date basis. The Companys clearing agreements call for payment or receipt of interest income, net of transaction-related interest charged by clearing brokers for facilitating the settlement and financing of securities transactions.
Interest expense, which has been netted against interest income on the Consolidated Statements of Operations, was $3.7 million, $1.9 million and $0.5 million in 2007, 2006 and 2005, respectively.
Dividend income relating to securities owned and dividend expense relating to
securities sold, not yet purchased, derived from the Companys market making activities are included as a component of Net trading revenue on the Consolidated Statements of Operations. Net trading revenue includes dividend income of $5.5
million, $6.2 million and $3.4 million in 2007, 2006 and 2005, respectively. Net trading revenue includes dividend expense of $5.2 million, $6.8 million and $4.1 million in 2007, 2006 and 2005, respectively.
Payments for order flow and ECN rebates represent payments to broker-dealer
clients, in the normal course of business, for directing their order flow in U.S. equities to the Company, and rebates for providing liquidity to Direct Edge ECN through September 28, 2007. Soft dollar and commission recapture expense
represents payments to or on behalf of institutions in connection with soft dollar and commission recapture programs.
Asset management fees
Deephaven earns asset management fees for managing the Deephaven Funds. Management fees, which are received monthly, are recorded as earned and are
calculated as a percentage of each Deephaven Funds monthly net assets.
Incentive allocation fees are earned based upon the performance of the Deephaven Funds and are calculated based upon a percentage of a new high net asset value as defined in the applicable private placement offering
memorandum, for the six-month performance period ended June 30 or December 31, for some funds, and for the twelve-month performance period ended December 31 for other funds. A new high net asset value is defined as the amount by which
the net asset value of an investors account in a particular Deephaven fund exceeds the greater of either the investors highest previous net asset value in that Deephaven fund or the net asset value at the time the investor made a
purchase.
The Company records incentive allocation fees in
accordance with Method 2 of Emerging Issues Task Force (EITF) Topic D-96. Under this methodology, the Company recognizes incentive allocation fee income for each interim period based upon the amount that would be due if the investment
advisory relationship with the Deephaven Funds were terminated at the end of such period.
Incentive allocation fees may increase or decrease during the year based on the performance of the Deephaven Funds. As such, the incentive allocation fees, in certain circumstances, may be negative for certain
periods, but not lower than zero for any six-month performance period ended June 30 or December 31, for some funds, or the twelve-month performance period ended December 31 for other funds. Incentive allocation fees are paid upon the
close of each six-month performance period, or twelve-month performance period, as the case may be, and are not subject to repayment (i.e., clawback) once such performance period has closed. If a fund which has a six-month performance period incurs
losses in the performance period ended December 31, the Company may make the determination, at its sole discretion, to return all or a portion of incentive allocation fees collected for the prior six-month performance period ended June 30
of that year.
Estimated fair value of financial instruments
The market value of securities owned and securities sold,
not yet purchased is estimated using market quotations available from major securities exchanges, clearing brokers and dealers. Management estimates that the fair values of other financial instruments recognized on the Consolidated Statements of
Financial Condition
63
(including receivables, payables and accrued expenses) approximate their carrying values, as such financial instruments are short-term in nature, bear
interest at current market rates or are subject to frequent repricing.
Goodwill and Intangible Assets
The Company
applies the provisions of Statement of Financial Accounting Standards (SFAS) No. 142
Goodwill and Other Intangible Assets,
which requires that goodwill and intangible assets with an indefinite useful life are tested for
impairment annually or when an event occurs or circumstances change that signify the existence of impairment. Other intangible assets are amortized on a straight line basis over their useful lives and, as required by SFAS No.144
Accounting for
the Impairment or Disposal of Long-Lived Assets
(SFAS 144)
,
will be tested for recoverability whenever events indicate that the carrying amounts may not be recoverable.
Strategic investments and Deferred compensation investments
Strategic investments include non-controlling equity
ownership interests primarily in financial services-related businesses. Deferred compensation investments consist of investments held by the Company related to deferred compensation plans for the benefit of Knights employees and directors.
Strategic investments and Deferred compensation investments are accounted for under the equity method, at cost or at fair value. The equity method of accounting is used for investments in limited partnerships and limited liability companies that are
held by the Company or any of its non-broker-dealer subsidiaries. Investments in corporations by such non-broker-dealers are held at amortized cost. Deferred compensation related investments in mutual funds are accounted for at fair value.
Investments classified as available-for-sale are reported at
fair value with unrealized gains and losses excluded from earnings and reported in Accumulated other comprehensive income, net of tax within Stockholders equity on the Consolidated Statements of Financial Condition.
Strategic investments are reviewed on an ongoing basis to ensure that the
carrying values of the investments have not been impaired. If the Company assesses that an impairment loss on a strategic investment has occurred due to a decline in fair value or other market conditions, the investment is written down to its
estimated impaired value.
Treasury stock
The Company records its purchases of treasury stock at cost as a separate
component of Stockholders equity. The Company obtains treasury stock through purchases in the open market or through privately negotiated transactions.
Foreign currencies
The functional currency of the Companys foreign subsidiaries is the U.S. dollar. Assets and liabilities denominated in foreign currencies are
translated into U.S. dollars using current exchange rates at the date of the Consolidated Statements of Financial Condition. Revenues and expenses are translated at average rates during the periods. Gains or losses resulting from foreign currency
transactions are included in Investment income and other, net on the Companys Consolidated Statements of Operations.
Depreciation, amortization and occupancy
Fixed assets are 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 shorter of the life of the related office lease or the expected useful life of the assets. The Company capitalizes certain costs associated with the acquisition or development of internal-use software and
amortizes the software over its estimated useful life of three years, commencing at the time the software is placed in service.
64
The Company follows SFAS No. 13
Accounting for Leases
, as clarified by EITF and Financial
Accounting Standards Board (FASB) Technical Bulletins, which states that rent expense under operating leases with fixed rent escalations, lease incentives and free rent periods should be recognized on a straight-line basis over the lease
term beginning on the date the lessee takes possession of or controls the use of the space, including during free rent periods.
Lease loss accrual
It is the Companys policy to identify excess real estate capacity and where applicable, accrue for such future costs. In determining the accrual, a
nominal cash flow analysis is performed for lease losses initiated prior to December 31, 2002, the effective date of SFAS No. 146
Accounting for Costs Associated with Exit or Disposal Activities,
and costs related to the excess
capacity are accrued. For lease losses initiated after December 31, 2002, the Companys policy is to accrue future costs related to excess capacity using a discounted cash flow analysis. In an event the Company is able to sublease the
excess real estate after recording a lease loss accrual, such lease loss accrual is adjusted to the extent the actual terms of sub-leased property differ from the assumptions used in the calculation of the lease loss accrual.
Income taxes
The Company records deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and measures them using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. The
Company evaluates the recoverability of future tax deductions by assessing the adequacy of future expected taxable income from all sources, including reversal of temporary differences and forecasted operating earnings. Net deferred tax assets and
liabilities are included in Other assets and Accrued expenses and other liabilities, respectively, on the Consolidated Statements of Financial Condition.
On January 1, 2007 the Company adopted FASB Interpretation No. 48
Accounting for Uncertainty in Income Taxes
(FIN 48). The
Company recognized an immaterial adjustment in the liability for unrecognized income tax benefits as a result of the implementation of FIN 48.
Discontinued Operations
In accordance with SFAS 144, the revenues and expenses associated with a separate segment or reporting unit that has been disposed of through closure or
sale are included in (Loss) income from discontinued operations, net of tax, on the Consolidated Statements of Operations.
Stock-Based Compensation
On January 1, 2006, the Company adopted SFAS No. 123(R),
Share-Based Payment
(SFAS 123(R)), using the modified
prospective method. Under SFAS 123(R), the grant date fair values of stock-based employee awards that require future service are amortized over the relevant service period. Prior to the adoption of SFAS 123(R), the Company applied Accounting
Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees
(APB 25) and related interpretations in accounting for its stock option plans. As options that were granted to employees prior to the adoption of SFAS
123(R) were granted at the then market value, no compensation expense had been recognized for the fair values of such grants under APB 25.
Upon the adoption of SFAS 123(R), the Company changed its expense attribution method for options. For option awards granted subsequent to the adoption of
SFAS 123(R), compensation cost is recognized on a straight-line basis over the requisite service period for the entire award, which is the same methodology that the Company uses to account for restricted share awards. For unvested option awards
granted prior to the adoption of
65
SFAS 123(R), the Company continues to recognize compensation cost using a graded-vesting method (as it had on a pro-forma basis previously). The
graded-vesting method recognizes compensation cost separately for each vesting tranche.
SFAS 123(R) requires expected forfeitures to be considered in determining stock-based employee compensation expense. Prior to the adoption of SFAS 123(R), forfeiture benefits were recorded as a reduction to the
Companys actual compensation expense in the case of restricted shares, or pro-forma compensation expense in the case of options, when an employee left the Company and forfeited the award. In 2007 and 2006, the Company recorded a benefit for
expected forfeitures on all outstanding stock-based awards. The benefit recorded did not have a material impact on the results of operations in 2007 and 2006.
For stock-based payments issued after the adoption of SFAS 123(R), the Company applies a non-substantive vesting period approach whereby the expense is
accelerated for those employees and directors that receive awards and are eligible to retire prior to the award vesting. Prior to the adoption of SFAS 123(R), the Company applied a nominal vesting approach for employee stock-based compensation
awards with retirement eligible provisions. Under the nominal vesting approach, the Company recognized actual and pro-forma compensation cost over the vesting period and, if the employee retired before the end of the vesting period, the Company
recognized any remaining unrecognized compensation cost at the date of retirement. The impact of this change in the vesting period approach did not have a material impact on the results of operations for the periods presented herein.
Prior to the adoption of SFAS 123(R), the Company presented all tax benefits
resulting from stock-based compensation as cash flows from operating activities in the Consolidated Statements of Cash Flows. SFAS 123(R) requires that the benefits of tax deductions in excess of compensation cost recognized for those options
(excess tax benefits) be included in cash flows from financing activities. The income tax benefit on stock awards exercised in 2007 and 2006 of $15.2 million and $19.4 million, respectively, are included in cash flows from financing activities.
Had compensation expense for the Companys options been
determined based on the fair values at the grant dates in accordance with SFAS No. 123,
Accounting for Stock-Based Compensation
, the Companys pro-forma net income and earnings per share amounts for the year ended December 31,
2005, would have been as follows (in millions, except per share data):
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2005
|
|
Net income, as reported
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|
$
|
66.4
|
|
Pro forma compensation expense determined under fair value based method, net of tax
|
|
|
(5.5
|
)
|
Pro forma net income
|
|
|
60.8
|
|
Basic earnings per share, as reported
|
|
|
0.64
|
|
Diluted earnings per share, as reported
|
|
|
0.62
|
|
Pro forma basic earnings per share
|
|
|
0.59
|
|
Pro forma diluted earnings per share
|
|
|
0.57
|
|
Use of Estimates
The preparation of financial statements in conformity
with GAAP 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 may differ from those estimates.
66
Recently Issued Accounting Standards
In September 2006, the FASB issued SFAS No. 157
Fair Value
Measurements
(SFAS 157), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 is effective for the Company beginning as of January 1, 2008.
The Company does not expect the adoption of SFAS 157 to have a material impact on its Consolidated Financial Statements.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108
Considering the Effects of Prior Year Misstatements When Quantifying
Misstatements in Current Year Financial Statements
(SAB 108), which provides guidance on quantifying and evaluating the materiality of unrecorded prior year misstatements. The SEC staff indicates that a company should quantify the
impact of correcting all misstatements, including both the carryover and reversing effects of prior year misstatements, on the current year financial statements. Companies may choose to restate their financial statements for any material
misstatements arising from the application of SAB 108 or recognize a cumulative effect adjustment within the current year opening balance in retained earnings, with disclosure of such items. SAB 108 was effective for fiscal years ending after
November 15, 2006. SAB 108 did not have an impact on the Companys Consolidated Financial Statements as of December 31, 2007 and 2006.
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment
of FASB Statement No. 115 (
SFAS 159), which permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective for the Company beginning as of January 1, 2008. The
Company does not expect the adoption of SFAS 159 to have a material impact on the Companys Consolidated Financial Statements.
In June 2007, the AICPA issued Statement of Position No. 07-1,
Clarification of the Scope of the Audit and Accounting Guide Investment Companies
and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies
(SOP 07-1). SOP 07-1 addresses when the accounting principles of the AICPA Audit and Accounting Guide
Investment Companies
must be applied by an entity and whether those accounting principles must be retained by a parent company in consolidation or by an investor in the application of the equity method of accounting. In February 2008, the FASB deferred indefinitely
the effective date.
In December 2007, the FASB issued
SFAS No. 141 (revised 2007
), Business Combinations
(SFAS 141(R)). SFAS 141(R) requires the acquiring entity in a business combination to recognize the acquisition date fair value for all identifiable assets
acquired, and liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141(R) changes the recognition of assets acquired and liabilities assumed arising from contingencies, requires the capitalization of
in-process research and development and requires the expensing of acquisition-related and restructuring costs as incurred. SFAS 141(R) is effective as of the beginning of an entitys fiscal year that begins after December 15, 2008.
The Company is currently evaluating the potential impact, if any, of the adoption of SFAS 141(R) on the Companys Consolidated Financial Statements.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB
No. 51
(SFAS 160). SFAS 160 states that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 160 establishes accounting and
reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parents ownership interest and
the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of
the noncontrolling owners. This statement is effective as of the beginning of an entitys first fiscal year beginning after December 15, 2008. The Company is currently evaluating the potential impact, if any, of the adoption of
SFAS 160 on its Consolidated Financial Statements.
67
3. Securities Owned and Securities Sold, Not Yet Purchased
Securities owned and securities sold, not yet purchased are carried at
market value and consist of the following (in millions):
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December 31,
2007
|
|
December 31,
2006
|
Securities owned:
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|
|
|
|
|
|
Equities
|
|
$
|
406.2
|
|
$
|
703.0
|
U.S. government obligations
|
|
|
6.4
|
|
|
8.8
|
|
|
|
|
|
|
|
|
|
$
|
412.6
|
|
$
|
711.8
|
|
|
|
|
|
|
|
Securities sold, not yet purchased:
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|
|
|
|
|
|
Equities
|
|
$
|
335.3
|
|
$
|
693.1
|
|
|
|
|
|
|
|
|
|
$
|
335.3
|
|
$
|
693.1
|
|
|
|
|
|
|
|
4. Receivable from/Payable to Brokers and Dealers
Amounts receivable from and payable to brokers and dealers consist of the following (in millions):
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|
|
|
|
|
|
|
|
December 31,
2007
|
|
December 31,
2006
|
Receivable:
|
|
|
|
|
|
|
Clearing brokers and other
|
|
$
|
207.1
|
|
$
|
305.3
|
Securities failed to deliver
|
|
|
134.3
|
|
|
42.3
|
Deposits for securities borrowed
|
|
|
41.1
|
|
|
25.2
|
|
|
|
|
|
|
|
|
|
$
|
382.5
|
|
$
|
372.9
|
|
|
|
|
|
|
|
Payable:
|
|
|
|
|
|
|
Securities failed to receive
|
|
$
|
79.5
|
|
$
|
34.4
|
Clearing brokers and other
|
|
|
37.5
|
|
|
13.4
|
|
|
|
|
|
|
|
|
|
$
|
117.0
|
|
$
|
47.9
|
|
|
|
|
|
|
|
5. Investment in and Receivable from Deephaven Sponsored Funds and Asset Management Fees
Deephaven is the registered investment adviser and sponsor of the Deephaven Funds, which engage in various trading strategies involving equities, debt
instruments and derivatives. The underlying investments in the Deephaven Funds are carried at market value. Of the $3.9 billion and $4.2 billion of assets under management in the Deephaven Funds as of December 31, 2007 and 2006, respectively,
the Company had corporate investments as a limited partner or non-managing member of $83.7 million and $187.6 million, respectively. At December 31, 2007, the Company also had an $85.0 million receivable from Deephaven sponsored funds, which
represented a redemption that was effective December 31, 2007 and was received in January 2008. Deferred compensation investments on the Consolidated Statements of Financial Condition at December 31, 2007 and 2006 included $49.8 million
and $31.6 million, respectively, of investments as a limited partner or non-managing member in the Deephaven Funds related to employee and director deferred compensation plans. Separately, certain officers, directors and employees of the Company
held direct investments of approximately $27.6 million and $6.2 million as limited partners or non-managing members in the Deephaven Funds, in the aggregate, as of December 31, 2007 and 2006, respectively.
Asset management fees represent fees earned by Deephaven for sponsoring and
managing the Deephaven Funds as well as fees earned from separately managed accounts. These fees consist of management fees, calculated as fixed percentages of assets under management, and incentive allocation fees, generally calculated as
68
a percentage of the funds and managed accounts year-to-date profits, if any. Incentive allocation fees may be negative in certain interim periods
if the funds or managed accounts lose money for such period; however, such fees will not be negative on a year-to-date basis. Management fees were $44.3 million, $35.5 million and $34.8 million for 2007, 2006 and 2005, respectively. Incentive
allocation fees were $72.4 million, $178.4 million and $54.4 million for 2007, 2006 and 2005, respectively.
Included in Investment income and other, net on the Companys Consolidated Statements of Operations is income from the Companys corporate
investments in the Deephaven Funds of $17.8 million, $34.2 million and $16.3 million for 2007, 2006 and 2005, respectively. For additional information on Deephaven, see Footnote 24, Subsequent Events.
6. Fixed Assets and Leasehold Improvements
Fixed assets and leasehold improvements comprise the following (in
millions):
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|
|
|
|
|
|
|
|
|
|
Depreciation
Period
|
|
December 31,
|
|
|
|
2007
|
|
2006
|
Computer hardware and software
|
|
3 years
|
|
$
|
101.9
|
|
$
|
95.8
|
Leasehold improvements
|
|
*
|
|
|
52.5
|
|
|
51.0
|
Telephone systems
|
|
5 years
|
|
|
9.6
|
|
|
9.4
|
Furniture and fixtures
|
|
7 years
|
|
|
7.5
|
|
|
6.7
|
Trading systems and equipment
|
|
5 years
|
|
|
2.6
|
|
|
2.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
174.1
|
|
|
165.4
|
LessAccumulated depreciation and amortization
|
|
|
|
|
112.0
|
|
|
98.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
62.1
|
|
$
|
66.5
|
|
|
|
|
|
|
|
|
|
* - Shorter of life of lease or useful life of assets
7. Strategic Investments
Strategic investments of $73.7 million at December 31, 2007 consisted of a $30.8 million short-term investment in a liquid investment fund carried at fair value, $37.4 million in eight limited liability companies, limited partnership
investments and a corporation accounted for under the equity method, and $5.5 million in common stock of two private companies representing less than 20% equity ownership, which are held at cost. Included in the $37.4 million investment in limited
liability companies at December 31, 2007 is a $19.1 million equity investment in Direct Edge ECN, which is described further in Footnote 10, Direct Edge ECN.
Strategic investments of $49.4 million at December 31, 2006 consisted of $32.3 million short-term investments in two
liquid investment funds carried at fair value, $12.2 million in five limited liability companies and limited partnership investments accounted for under the equity method, $4.5 million investment in private company common stock representing less
than 20% equity ownership which is held at cost, and $0.4 million of warrants in a publicly traded entity held at fair value.
In connection with the sale of the Derivative Markets business in December 2004 (see Footnote 16, Discontinued Operations) and in light of the
reorganization of the Companys business segments, the Company transferred its investments in the International Securities Exchange, Inc. (ISE) and the NASDAQ Stock Market, Inc. (NASDAQ Inc.), which were previously held
by its broker-dealer subsidiaries, to a corporate investment holding company. During the first quarter of 2005, these equity investments became marketable and, accordingly, were accounted for as equity securities under SFAS No. 115
Accounting for Certain Investments in Debt and Equity Securities
and were classified as available-for-sale securities. In conjunction with the ISEs initial public and secondary offerings, the Company sold approximately 70% of its
original equity investment in
69
the ISE during 2005 for $41.1 million. Based on an original cost of $6.9 million, the Company recognized a pre-tax gain of $34.2 million. The Company sold
its entire NASDAQ Inc. equity investment during 2005 for $36.9 million. Based on an adjusted cost of $15.2 million, the Company recognized a pre-tax gain of $21.7 million on the NASDAQ Inc. sale. In 2006 the Company sold its remaining shares of the
ISE, having a cost basis of $2.9 million, for $33.1 million, resulting in a pre-tax gain of $30.1 million. The gains on the sales of the ISE and NASDAQ Inc. investments are included in Investment income and other, net on the Companys
Consolidated Statements of Operations.
8. Goodwill
and Intangible Assets
Goodwill and intangible assets with
indefinite useful lives are tested for impairment annually or when an event occurs or circumstances change that signify the existence of impairment. As part of the test for impairment, the Company considers the profitability of the respective
segment or reporting unit, an assessment of the fair value of the respective segment or reporting unit as well as the overall market value of the Company compared to its net book value. In June 2007 and 2006, the Company tested for the impairment of
goodwill and intangible assets and concluded that there was no impairment. Amortizable intangibles are tested for recoverability whenever events indicate that the carrying amounts may not be recoverable. No events occurred in 2007 or 2006 that would
indicate that the carrying amounts of the Companys amortizable intangibles may not be recoverable.
The goodwill balances of $132.8 million and $133.0 million at December 31, 2007 and 2006, respectively, relate to the Global Markets segment.
Goodwill is net of accumulated amortization of $21.9 million recorded through December 31, 2001, the effective date the Company adopted SFAS No. 142. Goodwill primarily represents the Companys purchases of the businesses now
operating as KCM, Direct Trading, Hotspot, Donaldson and Knight BondPoint.
The Company had intangible assets, net of accumulated amortization, of $57.8 million and $63.7 million at December 31, 2007 and 2006, respectively, all included within the Global Markets business segment.
Intangible assets decreased by $5.9 million from 2006 to 2007, primarily due to amortization expense. Intangible assets primarily represent client relationships and are being amortized over their remaining useful lives, the majority of which have
been determined to range from eight to 24 years. The weighted average remaining life of the Companys intangible assets at December 31, 2007 and 2006 is approximately 16 years.
In 2007, the Company recorded amortization expense, related to its intangible assets of $5.7 million. The estimated
amortization expense relating to the intangible assets for each of the next five years approximates $5.7 million in 2008, $5.1 million in 2009, $4.9 million in 2010 and 2011 and $4.8 million in 2012.
The following chart summarizes the Companys Goodwill and Intangible
assets, net of accumulated amortization, as of December 31, 2007 and 2006 (in millions):
|
|
|
|
|
|
|
Goodwill
|
|
December 31,
2007
|
|
December 31,
2006
|
Purchase of Trimark business
|
|
$
|
10.1
|
|
$
|
10.1
|
Purchase of Tradetech business
|
|
|
3.0
|
|
|
3.0
|
Purchase of Donaldson business
|
|
|
3.6
|
|
|
3.6
|
Purchase of remaining shares in Knight Roundtable Europe
|
|
|
2.5
|
|
|
2.5
|
Purchase of Direct Trading business
|
|
|
43.8
|
|
|
33.4
|
Purchase of ATTAIN ECN business
(1)
|
|
|
|
|
|
10.6
|
Purchase of Hotspot business
|
|
|
55.7
|
|
|
55.7
|
Purchase of Knight BondPoint business
|
|
|
14.2
|
|
|
14.1
|
|
|
|
|
|
|
|
Total
|
|
$
|
132.8
|
|
$
|
133.0
|
|
|
|
|
|
|
|
70
|
|
|
|
|
|
|
|
|
|
|
Intangible Assets
(2)
|
|
|
|
December 31,
2007
|
|
|
December 31,
2006
|
|
Customer relationships
(3)
|
|
Gross carrying amount
|
|
$
|
51.9
|
|
|
$
|
51.9
|
|
|
|
Accumulated amortization
|
|
|
(9.1
|
)
|
|
|
(5.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net carrying amount
|
|
$
|
42.8
|
|
|
$
|
46.5
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade names
(4)
|
|
Gross carrying amount
|
|
$
|
9.7
|
|
|
$
|
9.8
|
|
|
|
Accumulated amortization
|
|
|
(0.9
|
)
|
|
|
(0.6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net carrying amount
|
|
$
|
8.8
|
|
|
$
|
9.2
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
(5)
|
|
Gross carrying amount
|
|
$
|
9.2
|
|
|
$
|
9.2
|
|
|
|
Accumulated amortization
|
|
|
(2.9
|
)
|
|
|
(1.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net carrying amount
|
|
$
|
6.3
|
|
|
$
|
8.0
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
Gross carrying amount
|
|
$
|
70.8
|
|
|
$
|
70.9
|
|
|
|
Accumulated amortization
|
|
|
(13.0
|
)
|
|
|
(7.2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net carrying amount
|
|
$
|
57.8
|
|
|
$
|
63.7
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) - Goodwill associated with the purchase of ATTAIN ECN was recorded by Direct Edge ECN, which was deconsolidated effective September 28, 2007. See Footnote 10 Direct Edge ECN,
for further details.
(2) - The weighted average remaining life of the Companys intangible
assets at December 31, 2007 is approximately 16 years.
(3) - Customer relationships relate to
the Donaldson, Direct Trading and Hotspot acquisitions. The weighted average remaining life is approximately 16 years as of December 31, 2007 and 17 years as of December 31, 2006. Lives may be reduced depending upon retention rates.
(4) - Trade names relate to the Donaldson, Direct Trading and Hotspot acquisitions. The weighted
average remaining life is approximately 25 years as of December 31, 2007 and 26 years as of December 31, 2006.
(5) - Other includes technology, non-compete agreements and domain name rights used or acquired by the Company. The weighted average remaining life is approximately 5 years as of December 31, 2007 and 6 years as
of December 31, 2006.
9. Long Term Debt
On October 9, 2007, the Company entered into a
three-year $140.0 million credit agreement (Credit Agreement) with a consortium of banks led by JPMorgan Chase Bank, N.A (JPM). The Credit Agreement includes a three-year delayed-draw senior secured term loan facility of
$70.0 million and a three-year senior secured revolving facility of $70.0 million. The proceeds of the credit facilities may be used to finance share repurchases by the Company and for general corporate purposes. The Credit Agreement is repayable in
full on October 3, 2010.
As of December 31, 2007,
the Company borrowed $70.0 million under the three-year delayed-draw senior secured term loan facility but has not borrowed against the $70.0 million three-year senior secured revolving facility.
The interest and commitment fee rates vary based on changes in certain of the
Companys financial covenant ratios. The interest rate can range from the JPM Prime Rate plus 0.25% to 0.50% or London Interbank Offered Rate (LIBOR) plus 1.25% to 1.50%. The commitment fee can range from 0.30% to 0.35% on the
average daily unused portion of the delayed-draw senior secured term loan facility and the senior secured revolving facility.
As of December 31, 2007, the $70.0 million delayed draw senior secured term loan facility bears interest at 6.18% per annum. The interest is
based on the three month LIBOR rate plus 1.25% and is payable in
71
March 2008, at which time it will reset at the prevailing rate. Under the terms of the Credit Agreement, at the Companys option, it may choose an
interest rate based on the JPM Prime Rate or the LIBOR rate. Approximately $0.1 million of interest expense was accrued as of December 31, 2007, which has been included in Interest, net on the Consolidated Statements of Operations.
The Company was charged a commitment fee of 0.30% on the unused portion of
the $70.0 million senior secured revolving facility. For the year ended December 31, 2007, the Company was charged approximately $0.1 million in commitment fees, which has been included in Other expense on the Consolidated Statements of
Operations.
Under the Credit Agreement, substantially all of
the Companys material subsidiaries, other than its foreign subsidiaries, registered broker-dealer subsidiaries and subsidiaries thereof, guarantee the repayment of loans made pursuant to the credit facilities. Pursuant to the Credit Agreement,
the credit facilities have been secured by substantially all of the assets of the Company.
The Credit Agreement includes customary representations, warranties, affirmative and negative covenants (including, among others, limitations on certain payments, investments and transactions) and events of default.
It also contains financial covenants tied to the maintenance of financial ratios and metrics. These obligations may limit certain activities of the Company, including, but not limited to, certain mergers, acquisitions or dispositions of assets,
repurchases of shares and payment of dividends, each above certain thresholds as set forth in the Credit Agreement.
10. Direct Edge ECN
After the close of business on July 23, 2007 and September 28, 2007 (the latter being the Deconsolidation Date), Direct Edge
Holdings issued equity interests to Citadel Derivatives Group LLC (Citadel) in exchange for cash. Immediately following the September 28, 2007 issuance to Citadel, the Company and Citadel sold a portion of their equity interests in
Direct Edge Holdings to The Goldman Sachs Group, Inc. for cash.
As a result of these transactions, the Company no longer controls Direct Edge and, as such, as of the Deconsolidation Date it is no longer a consolidated subsidiary. The Companys investment in Direct Edge is accounted for under the
equity method following the Deconsolidation Date, and is included in Strategic investments on the December 31, 2007 Consolidated Statement of Financial Condition.
As Direct Edge was a subsidiary of the Company prior to the Deconsolidation Date, the results of its operations through the Deconsolidation
Date are included in the Consolidated Statements of Operations for all periods presented. The Company recorded a minority interest benefit of $337,000 which represents Citadels minority interest share of Direct Edges pre-tax losses for
the period July 24, 2007 through the Deconsolidation Date. This amount has been included within Other expense on the Consolidated Statements of Operations for this period. For periods following the Deconsolidation Date, the Companys share
of Direct Edges income and losses are included in Investment income and other, net on the Consolidated Statements of Operations.
As a result of Direct Edge Holdings issuance of equity interest to Citadel, during 2007 the Company recognized, pursuant to SEC Staff Accounting
Bulletin Topic 5-H, a pre-tax non-operating gain from subsidiary stock issuance of $8.8 million in the third quarter of 2007. The Company also realized a pre-tax gain of $4.2 million from the sale of a portion of its interest in Direct Edge Holdings
to The Goldman Sachs Group, Inc., which is included in Investment income and other, net for the year ended December 31, 2007.
72
11. Stock-Based Compensation
The Company has established the Knight Capital Group, Inc. 1998 Long Term Incentive Plan, the Knight Capital Group, Inc.
1998 Nonemployee Director Stock Option Plan, the Knight Capital Group, Inc. 2003 Equity Incentive Plan and the Knight Capital Group, Inc. 2006 Equity Incentive Plan (the 2006 Plan) (collectively, the Stock Plans). The purpose
of the Stock Plans is to provide long-term incentive compensation to employees and directors of the Company. The Stock Plans are administered by the Compensation Committee of the Companys Board of Directors, and allow for the grant of options,
stock appreciation rights (2006 Plan only), restricted stock and restricted stock units (collectively, the awards), as defined by the Stock Plans. The Stock Plans limit the number of awards that may be granted to a single individual as
well as limit the amount of options, stock appreciation rights (2006 Plan only) or shares of restricted stock or restricted stock units that may be awarded. As of December 31, 2007, the Company has not issued any stock appreciation rights or
restricted stock units.
Restricted Shares
Eligible employees receive restricted shares as a portion of their total
compensation. Restricted share awards generally vest ratably over three years. The Company has the right to fully vest employees in their awards upon retirement and in certain other circumstances. Awards are otherwise canceled if employment is
terminated before the end of the relevant vesting period.
The
Company measures compensation cost related to restricted shares based on the fair value of the Companys common stock at the date of grant, which the Stock Plans define as the average of the high and low sales price on the business day prior to
the grant date. In 2007, 2006 and 2005, the Company recorded compensation expense relating to restricted shares of $25.4 million, $14.0 million and $13.4 million, respectively, all of which has been included in Employee compensation and benefits on
the Consolidated Statements of Operations. The total income tax benefit recognized on the Consolidated Statements of Operations related to restricted shares was $10.1 million, $5.6 million and $5.4 million in 2007, 2006 and 2005, respectively.
The following table summarizes restricted share activity in
2007, 2006 and 2005 (shares in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
|
Number of
Restricted Shares
|
|
|
Weighted-Average
Grant date Fair Value
|
|
Number of
Restricted Shares
|
|
|
Weighted-Average
Grant date Fair Value
|
Outstanding at January 1
|
|
2,711.1
|
|
|
$
|
11.55
|
|
3,026.7
|
|
|
$
|
10.31
|
Granted
|
|
2,564.4
|
|
|
|
18.20
|
|
1,093.9
|
|
|
|
13.42
|
Vested
|
|
(1,416.8
|
)
|
|
|
13.86
|
|
(995.7
|
)
|
|
|
10.25
|
Surrendered
|
|
(209.8
|
)
|
|
|
14.06
|
|
(413.8
|
)
|
|
|
10.54
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31
|
|
3,648.9
|
|
|
$
|
15.19
|
|
2,711.1
|
|
|
$
|
11.55
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted-average
fair value of restricted shares granted in 2007, 2006 and 2005 was $18.20, $13.42 and $9.80, respectively. Based upon the value at date of vest, the cumulative fair value of restricted shares that vested in 2007, 2006 and 2005 was $22.9 million,
$13.3 million and $9.7 million, respectively.
There is $37.2
million of unamortized compensation related to the unvested restricted shares outstanding at December 31, 2007. The cost of these unvested restricted shares is expected to be recognized over a weighted average life of 1.4 years.
Stock Options
The Companys policy is to grant options for the purchase of shares of Class A Common Stock at not less than
market value, which the Stock Plans define as the average of the high and low sales price on the business day prior to the grant date. Options generally vest ratably over a three or four-year period and expire on the fifth
73
or tenth anniversary of the grant date, pursuant to the terms of the applicable option award agreement. The Company has the right to fully vest employees in
their awards upon retirement and in certain other circumstances. Awards are otherwise canceled if employment is terminated before the end of the relevant vesting period. The Companys policy is to issue new shares upon share option exercises by
its employees.
The fair value of each option granted is
estimated as of its respective grant date using the Black-Scholes option-pricing model. Stock options granted have exercise prices equal to the market value of the Companys common stock at the date of grant as defined by the Stock Plans. The
principal assumptions utilized in valuing options and the methodology for estimating such model inputs include: 1) risk-free interest rateestimate is based on the yield of U.S. zero coupon securities with a maturity equal to the expected life
of the option; 2) expected volatilityestimate is based on several factors including implied volatility of market-traded options on the Companys common stock on the grant date and the historical volatility of the Companys common
stock; and 3) expected option lifeestimate is based on internal studies of historical experience and projected exercise behavior based on different employee groups and specific option characteristics, including the effect of employee
terminations. Based on the results of the model, the weighted-average fair value of the stock options granted in 2007, 2006 and 2005 was $6.09, $4.63 and $4.03, respectively. The weighted-average assumptions used were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Dividend yield
|
|
0.0
|
%
|
|
0.0
|
%
|
|
0.0
|
%
|
Expected volatility
|
|
40.0
|
%
|
|
40.0
|
%
|
|
40.0
|
%
|
Risk-free interest rate
|
|
4.3
|
%
|
|
4.7
|
%
|
|
3.5
|
%
|
Expected life (in years)
|
|
3.5
|
|
|
3.5
|
|
|
3.5
|
|
The Company recorded
compensation expense relating to options of $5.7 million and $6.8 million in 2007 and 2006, respectively, all of which was recorded in Employee compensation and benefits on the Consolidated Statements of Operations. The total income tax benefit
recognized on the Consolidated Statements of Operations related to stock options was $2.3 million and $2.7 million in 2007 and 2006, respectively.
The following table summarizes stock option activity and stock options exercisable in 2007 (options in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
|
|
|
Number of
Options
|
|
|
Weighted-
Average
Exercise
Price
|
|
Aggregate
Intrinsic
Value
(in millions)
|
|
Weighted-
Average
Remaining
Life (years)
|
Outstanding at January 1, 2007
|
|
8.8
|
|
|
$
|
9.43
|
|
|
|
|
|
Granted at market value
|
|
0.6
|
|
|
|
17.39
|
|
|
|
|
|
Exercised
|
|
(3.5
|
)
|
|
|
6.05
|
|
|
|
|
|
Surrendered
|
|
(0.2
|
)
|
|
|
13.82
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2007
|
|
5.7
|
|
|
$
|
12.16
|
|
$
|
21.0
|
|
6.28
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested at December 31, 2007
|
|
3.4
|
|
|
$
|
12.11
|
|
$
|
19.7
|
|
6.17
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for future grants at December 31, 2007*
|
|
11.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* - represents both options and awards available for grant
74
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
Options Exercisable
|
Range of Exercise Prices
|
|
Outstanding
at 12/31/07
|
|
Weighted-
Average
Remaining
Contractual
Life
|
|
Weighted-
Average
Exercise
Price
|
|
Number
Exercisable
at 12/31/07
|
|
Weighted-
Average
Exercise
Price
|
$ 4.57-$7.98
|
|
1.0
|
|
3.93
|
|
$
|
7.09
|
|
0.8
|
|
$
|
6.89
|
$ 8.02-$9.84
|
|
1.2
|
|
5.68
|
|
|
9.41
|
|
0.7
|
|
|
9.31
|
$ 9.90-$9.94
|
|
0.5
|
|
7.25
|
|
|
9.90
|
|
0.0
|
|
|
9.94
|
$10.24-$10.30
|
|
1.0
|
|
6.84
|
|
|
10.24
|
|
1.0
|
|
|
10.24
|
$10.31-$16.32
|
|
1.0
|
|
7.47
|
|
|
13.33
|
|
0.5
|
|
|
12.99
|
$16.43-$71.38
|
|
1.0
|
|
6.98
|
|
|
22.14
|
|
0.4
|
|
|
29.06
|
The aggregate
intrinsic value is the amount by which the closing price of the Companys common stock of $14.40 exceeds the exercise price of the stock options multiplied by the number of shares at December 31, 2007. The total intrinsic value of options
exercised in 2007, 2006 and 2005 was $37.9 million, $46.1 million and $15.9 million, respectively. Cash received from the exercise of stock options in 2007 totaled $21.1 million.
There is $5.5 million of unrecognized compensation related to the unvested stock options outstanding at December 31,
2007. The cost of these unvested awards is expected to be recognized over a weighted average life of 1.1 years.
12. 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 100% of the contributions made by its employees, up to annual limits. The total expense, from continuing operations, recognized with respect to the Plan
and included in Employee compensation and benefits on the Consolidated Statements of Operations, was as follows (in millions):
|
|
|
|
For the year ended December 31, 2007
|
|
$
|
4.4
|
For the year ended December 31, 2006
|
|
|
4.1
|
For the year ended December 31, 2005
|
|
|
3.3
|
13. Writedown of Assets and Lease Loss Accrual
The Writedown of assets and lease loss accrual during 2007, 2006 and 2005 were ($2.5 million), $8.5 million, and $10.1 million, respectively. The benefit in 2007 was primarily related to an adjustment of previously
recognized lease losses with respect to the Companys 545 Washington Boulevard property in Jersey City, N.J. During 2007, the Company entered into two sub-lease agreements for a portion of the premises for which it had previously recorded a
lease loss accrual. The lease loss accrual was adjusted based on the difference between the actual terms of the sub-leases and the assumptions previously used in the calculation of the lease loss accrual.
The charges in 2006 primarily related to costs associated with excess real
estate capacity at the Companys 545 Washington Boulevard facility in Jersey City, N.J. The charges in 2005 consist of $4.5 million of costs associated with excess real estate capacity and a writedown of fixed assets related to the move from
the Companys 525 Washington Boulevard facility in Jersey City, N.J., and $5.5 million in costs associated with excess real estate capacity at the 545 Washington Boulevard facility.
14. Regulatory Charges and Related Matters
In 2006, the Company received a request from the staff of the SEC for voluntary production of certain documentation related
to options activities of its former Derivative Markets business segment which, prior to its sale by the Company in December 2004, was primarily operated through Knight Financial Products LLC. The
75
Company believes this request is part of a broader review by the staff of the SEC regarding certain trading practices in the options industry during the
period from 1999 to 2005. The Company responded to this request and is cooperating with the staff of the SEC and certain regional exchanges to resolve this matter. During 2007, the Company recorded a charge of $1.4 million, net of tax relating to
this matter. This charge has been reported in (Loss) income from discontinued operations, net of tax on the Consolidated Statements of Operations.
As disclosed in the Companys Form 10-K filing for the year-ended December 31, 2005, and in subsequent SEC filings in May 2006, Deephaven
announced that it had concluded a settlement with the SEC in connection with trading activity associated with certain Private Investments in Public Equities (PIPEs). Without admitting or denying the allegations in the SECs
complaint, and as part of the settlement, Deephaven was required to disgorge approximately $2.7 million, pay approximately $343,000 in pre-judgment interest and pay approximately $2.7 million as a civil penalty. In May 2006, the amounts were paid to
the Clerk of the Court. The settlement resolved the matters for which Deephaven received the Wells Notice from the staff of the SEC in June 2005. In 2005, the Company recorded a total pre-tax charge of $5.7 million relating to this matter. Such
charges are included in Regulatory charges and related matters on the Consolidated Statements of Operations. The Company did not record a tax benefit for the $2.7 million civil penalty portion of this settlement.
15. Income Taxes
The Company and its subsidiaries file a consolidated federal income tax
return as well as combined state income tax returns in certain jurisdictions. In other jurisdictions, the Company and its subsidiaries file separate company income tax returns.
The provision (benefit) for income taxes from continuing operations consists of (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. federal
|
|
$
|
73.4
|
|
|
$
|
106.6
|
|
|
$
|
38.1
|
|
State and local
|
|
|
13.1
|
|
|
|
7.9
|
|
|
|
(2.2
|
)
|
Non U.S.
|
|
|
4.4
|
|
|
|
7.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
90.9
|
|
|
|
121.9
|
|
|
|
35.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. federal
|
|
|
(12.5
|
)
|
|
|
(27.0
|
)
|
|
|
1.3
|
|
State and local
|
|
|
(0.7
|
)
|
|
|
3.2
|
|
|
|
1.7
|
|
Non U.S.
|
|
|
(0.1
|
)
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(13.3
|
)
|
|
|
(23.7
|
)
|
|
|
3.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense from continuing operations
|
|
$
|
77.6
|
|
|
$
|
98.2
|
|
|
$
|
38.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The preceding table
does not reflect the tax effects of unrealized gains on available for sale securities, which was recorded directly in Stockholders equity. Stockholders equity decreased by $7.1 million in 2005, as a result of the tax effects of
unrealized gains on available for sale securities and increased by $7.1 million in 2006 as such securities were sold. These tax effects are reported in the Consolidated Statements of Changes in Stockholders Equity as a component of Accumulated
other comprehensive income, net of tax.
76
The following table reconciles income tax expense (benefit) from continuing operations at the U.S.
federal statutory rate to the Companys Income tax expense (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
2005
|
|
U.S. federal income tax expense at statutory rate
|
|
$
|
70.4
|
|
|
$
|
89.8
|
|
$
|
36.8
|
|
U.S. state and local income tax expense (benefit), net of U.S. federal income tax effect
|
|
|
8.1
|
|
|
|
7.2
|
|
|
(0.3
|
)
|
Non U.S., net
|
|
|
0.6
|
|
|
|
|
|
|
|
|
Nondeductible charges
|
|
|
0.6
|
|
|
|
0.5
|
|
|
1.5
|
|
Other, net
|
|
|
(2.1
|
)
|
|
|
0.7
|
|
|
0.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
$
|
77.6
|
|
|
$
|
98.2
|
|
$
|
38.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included within
Nondeductible charges in the above table is the effect of the $2.7 million in penalties in 2005, related to the regulatory charges described in Footnote 14, Regulatory Charges and Related Matters, for which no tax benefits were recorded.
Deferred income taxes reflect the net tax effects of temporary
differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. Significant components of the
Companys deferred tax assets and liabilities at December 31, 2007 and 2006 are as follows (in millions):
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Employee compensation and benefit plans
|
|
$
|
48.0
|
|
|
$
|
31.6
|
|
Fixed assets and other amortizable assets
|
|
|
3.0
|
|
|
|
2.8
|
|
Reserves
|
|
|
10.3
|
|
|
|
9.4
|
|
Valuation of investments
|
|
|
1.8
|
|
|
|
2.5
|
|
Net operating loss carryforwards
|
|
|
40.7
|
|
|
|
42.6
|
|
Less: Valuation allowance on net operating loss carryforwards
|
|
|
(40.1
|
)
|
|
|
(41.9
|
)
|
|
|
|
|
|
|
|
|
|
Total Deferred tax assets
|
|
|
63.7
|
|
|
|
47.0
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Fixed assets and other amortizable assets
|
|
|
14.0
|
|
|
|
13.3
|
|
Valuation of investments
|
|
|
2.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
16.7
|
|
|
|
13.3
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
47.0
|
|
|
$
|
33.7
|
|
|
|
|
|
|
|
|
|
|
At December 31,
2007, the Company had U.S. federal net operating loss carryforwards, resulting from acquisitions, of $37.4 million. The Company recorded a related deferred tax asset of $13.1 million as of December 31, 2007, and an offsetting valuation
allowance as substantially all of these net operating loss carryforwards are considered more likely than not to expire unutilized. These carryforwards are subject to annual limitations on utilization and will begin to expire in 2019.
At December 31, 2007, the Company had state net operating loss
carryforwards of $63.6 million of which $33.5 million resulted from acquisitions. The Company recorded a related deferred tax asset of $3.6 million as of December 31, 2007, and an offsetting valuation allowance of $2.8 million for those
net operating loss carryforwards considered more likely than not to expire unutilized. Certain of these carryforwards are subject to annual limitations on utilization and they will begin to expire in 2011.
At December 31, 2007, the Company had U.K. net operating loss
carryforwards of $80.7 million. The Company recorded a related deferred tax asset of $24.2 million as of December 31, 2007, and an offsetting
77
valuation allowance as these net operating loss carryforwards are considered more likely than not to remain unutilized. These net operating losses may be
carried forward indefinitely.
Effective January 1, 2007,
the Company adopted FIN 48. The Company recognized no material adjustment in the liability for unrecognized income tax benefits as a result of the implementation of FIN 48. At the adoption date of January 1, 2007, the Company had $0.9 million
of unrecognized tax benefits and at December 31, 2007, the Company had $0.7 million of unrecognized tax benefits, all of which would affect the Companys effective tax rate if recognized.
As of December 31, 2007, the Company is subject to U.S. Federal income
tax examinations for the tax years 2005 and 2006, and to non U.S. income tax examinations for the tax years 2002 through 2005. In addition, the Company is subject to state and local income tax examinations in various jurisdictions for the tax years
2000 through 2006. The final outcome of these examinations is not yet determinable. However, the Company anticipates that adjustments to the unrecognized tax benefits, if any, will not result in a material change to the results of operations or
financial condition.
The Companys policy for recording
interest and penalties associated with audits is to record such items as a component of Income from continuing operations before income taxes. Penalties are recorded in Other expenses and interest paid or received is recorded in Interest, net, in
the Consolidated Statements of Operations.
16. Discontinued Operations
The Company completed the sale of its Derivative Markets business to Citigroup in December 2004. In accordance with SFAS 144, the results of the Derivative Markets segment, the revenues and expenses associated with these businesses as well
as all costs associated with the sale transaction have been included in (Loss) income from discontinued operations, net of tax on the Consolidated Statements of Operations for all periods presented. The final purchase price was subject to adjustment
based on the final determination of the book value of the Derivative Markets segment at the time the deal closed. The final determination of book value occurred in the first quarter of 2005, at which time the adjustment was recognized. The result of
this adjustment and other expenses related to the sale resulted in income of $122,000, net of tax, in 2005. As described in Footnote 14, Regulatory Charges and Related Matters, the Company recorded a charge of $1.4 million, net of tax,
related to a regulatory matter involving the Derivative Markets segment in 2007.
The revenues and results of operations of the discontinued operations for 2007, 2006 and 2005 are summarized as follows (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
2005
|
Revenues
|
|
$
|
|
|
|
$
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax loss from discontinued operations
|
|
$
|
(2.1
|
)
|
|
$
|
|
|
$
|
|
Pre-tax gain on sale of Derivative Markets business, net of transaction related costs
|
|
|
|
|
|
|
|
|
|
0.2
|
Income tax (benefit) expense
|
|
|
(0.6
|
)
|
|
|
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income from discontinued operations, net of tax
|
|
$
|
(1.4
|
)
|
|
$
|
|
|
$
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
17. Earnings per Share
Basic earnings per common share (EPS) has been calculated by dividing net income by the weighted average shares of Class A Common Stock outstanding during each respective period. Diluted EPS reflects the potential reduction
in EPS using the treasury stock method to reflect the impact of common stock equivalents if stock options were exercised and restricted stock awards were to vest.
78
The following is a reconciliation of the numerators and denominators of the basic and diluted earnings
per share computations for 2007, 2006 and 2005 (in millions, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
Numerator/
net income
|
|
Denominator/
shares
|
|
Numerator/
net income
|
|
Denominator/
shares
|
|
Numerator/
net income
|
|
Denominator/
shares
|
Income and shares used in basic calculations
|
|
$
|
122.2
|
|
|
97.1
|
|
$
|
158.3
|
|
|
101.4
|
|
$
|
66.4
|
|
|
103.5
|
Effect of dilutive stock based awards
|
|
|
|
|
|
3.7
|
|
|
|
|
|
4.8
|
|
|
|
|
|
3.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income and shares used in diluted calculations
|
|
$
|
122.2
|
|
|
100.8
|
|
$
|
158.3
|
|
|
106.2
|
|
$
|
66.4
|
|
|
106.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
|
|
|
$
|
1.26
|
|
|
|
|
$
|
1.56
|
|
|
|
|
$
|
0.64
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share
|
|
|
|
|
$
|
1.21
|
|
|
|
|
$
|
1.49
|
|
|
|
|
$
|
0.62
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The above calculations
exclude options that could potentially dilute EPS in the future but were antidilutive for the periods presented. The number of such options excluded was approximately 1.1 million, 0.5 million and 5.2 million in 2007, 2006 and 2005,
respectively.
18. Comprehensive Income
Comprehensive income includes net income and changes in
equity except those resulting from investments by, or distributions to, stockholders. Comprehensive income is as follows (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31,
|
|
|
2007
|
|
2006
|
|
|
2005
|
Net income
|
|
$
|
122.2
|
|
$
|
158.3
|
|
|
$
|
66.4
|
Other comprehensive income, net of tax:
|
|
|
|
|
|
|
|
|
|
|
Net unrealized gains on investment securities held as available-for-sale
|
|
|
|
|
|
|
|
|
|
10.4
|
Realization of gains on sales of investment securities held as available-for-sale
|
|
|
|
|
|
(10.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income, net of tax
|
|
$
|
122.2
|
|
$
|
148.0
|
|
|
$
|
76.7
|
|
|
|
|
|
|
|
|
|
|
|
Totals may not add due to rounding
Other comprehensive income, net of tax, represents net unrealized gains on the Companys
strategic investment in the ISE at December 31, 2005 and the subsequent realization of such gains in 2006.
19. Significant Clients and Investors
The Company considers significant clients to be those clients who account for 10% or more of the total U.S. equity dollar value traded by the Company
during the period. No client accounted for more than 10% of the total U.S. equity dollar value traded during 2007. One client accounted for approximately 10.9% and 10.7% of the Companys U.S. equity dollar value traded during 2006 and 2005,
respectively.
The Company considers significant investors to
be those investors who account for 10% or more of assets under management in the Deephaven Funds. One investor accounted for more than 10% of the Deephaven Funds asset under management as of December 31, 2007. No investor accounted for
more than 10% of the Deephaven Funds asset under management as of December 31, 2006.
79
20. Commitments and Contingent Liabilities
In the ordinary course of business, the nature of the Companys
business subjects it to claims, lawsuits, regulatory examinations and other proceedings. The Company is subject to several of these matters at the present time. The results of these matters cannot be predicted with certainty, and we cannot estimate
a possible range of loss for these matters at this time. There can be no assurance that these matters will not have a material adverse effect on the Companys results of operations in any future period and a material judgment could have a
material adverse impact on the Companys financial condition and results of operations. However, it is the opinion of management, after consultation with legal counsel that, based on information currently available, the ultimate outcome of
these matters will not have a material adverse impact on the business, financial condition or operating results of the Company although they might be material to the operating results for any particular period, depending, in part, upon operating
results for that period.
As described in Footnote 2
Significant Accounting Policies, if a Deephaven fund which has a six-month performance period incurs losses in the performance period ended December 31, the Company may make the determination, at its sole discretion, to return all
or a portion of incentive allocation fees collected for the prior six-month performance period ending June 30 of that year.
Based upon market conditions and industry practice, in August 2007, the Company, at its sole discretion, made the determination that if a Deephaven fund
with a six-month performance period incurs losses in the performance period ending December 31, 2007, Deephaven will return all or a portion of the incentive allocation fees collected from investors in that fund for the six-month performance
period ended June 30, 2007. Of the $68.4 million of incentive allocation fees recorded for the six-month period ended June 30, 2007, Deephaven repaid approximately $19.0 million in the fourth quarter of 2007.
The Company leases office space under noncancelable operating leases. Certain
office leases contain fixed dollar-based escalation clauses. Rental expense from continuing operations under the office leases was $9.1 million, $8.6 million and $9.2 million in 2007, 2006 and 2005, respectively, and is included in Occupancy and
equipment rentals on the Consolidated Statements of Operations.
The Company leases certain computer and other equipment under noncancelable operating leases and has entered into guaranteed employment contracts with certain of its employees. As of December 31, 2007, future minimum rental commitments
under all noncancelable office, computer and equipment leases (Operating Leases), and guaranteed employment contracts longer than one year (Other Obligations) were as follows (in millions):
Lease & Contract Obligations
|
|
|
|
|
|
|
|
|
|
|
|
Operating Leases
|
|
Other
Obligations
|
|
Total
|
Year ending December 31, 2008
|
|
$
|
11.4
|
|
$
|
28.0
|
|
$
|
39.4
|
Year ending December 31, 2009
|
|
|
11.1
|
|
|
15.4
|
|
|
26.5
|
Year ending December 31, 2010
|
|
|
10.5
|
|
|
|
|
|
10.5
|
Year ending December 31, 2011
|
|
|
11.0
|
|
|
|
|
|
11.0
|
Year ending December 31, 2012
|
|
|
11.4
|
|
|
|
|
|
11.4
|
Thereafter through October 31, 2021
|
|
|
92.4
|
|
|
|
|
|
92.4
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
147.9
|
|
$
|
43.4
|
|
$
|
191.2
|
|
|
|
|
|
|
|
|
|
|
Operating lease
obligations have not been reduced by sub-lease rentals of $7.1 million due in the future under noncancelable sub-leases.
During the normal course of business, the Company collateralizes certain leases or other contractual obligations through letters of credit or segregated
funds held in escrow accounts. As of December 31, 2007, the Company has provided a letter of credit for $6.0 million, collateralized by U.S. Treasury Bills, as a guarantee for one of the Companys lease obligations.
80
In 2003, the Company entered into long-term employment contracts with certain senior managers of
Deephaven. In December 2006, the Company entered into new long-term employment agreements (the 2006 Employment Agreements) with three senior managers of Deephaven (the Deephaven Managers), two of whom were parties to the
agreements entered into in 2003. The 2006 Employment Agreements, which became effective on January 1, 2007, were for three-year terms and included a right of renewal by the Deephaven Managers through 2012 under certain circumstances. The 2006
Employment Agreements provided profit-sharing bonuses based on the financial performance of Deephaven. According to the terms of the 2006 Employment Agreements, the Deephaven Managers were entitled to receive 50% of the first $60 million, and 75%
thereafter, of pre-tax earnings prior to the profit-sharing bonuses. Upon entering the 2006 Employment Agreements, the Deephaven Managers also received one million shares of Knight restricted common stock, which vest ratably over three years.
In connection with entering into the 2006 Employment
Agreements, the Deephaven Managers were also granted an option (the Option), exercisable after January 1, 2008 and until December 31, 2012, and conditioned on meeting certain requirements, to obtain a 49% interest in a new
limited liability company (Deephaven Holdings) to which the Companys interests in Deephaven would be contributed in exchange for the termination of their new employment agreements and associated profit-sharing bonuses. The
agreement also provides that in the event of a change of control of the Company prior to December 31, 2012, the Deephaven Managers would have the option (the Change of Control Option), in exchange for the termination of the 2006
Employment Agreements and associated profit-sharing bonuses, to obtain a 51% interest in Deephaven or, if the Option has already been exercised, to increase their 49% interest resulting from the exercise of the Option by an additional 2%. Following
any exercise of the Option or Change of Control Option by the Deephaven Managers, pre-tax earnings prior to profit sharing will be allocated between Knight and the Deephaven Managers in the same manner as under the 2006 Employment Agreements. See
Footnote 24, Subsequent Events for further discussion relating to the exercise of the Option by the Deephaven Managers.
21. Net Capital Requirements
The Companys U.S. registered broker-dealers are subject to the SECs Uniform Net Capital Rule, which requires the maintenance of minimum net
capital. As of December 31, 2007, all of the Companys broker-dealer subsidiaries were in compliance with their capital adequacy requirements. The following table sets forth the net capital levels and requirements for the following
significant U.S. registered broker-dealer subsidiaries at December 31, 2007 as filed in their respective regulatory filings (in millions):
|
|
|
|
|
|
|
|
|
|
Entity
|
|
Net Capital
|
|
Net Capital
Requirement
|
|
Excess Net
Capital
|
KEM
|
|
$
|
89.4
|
|
$
|
8.0
|
|
$
|
81.4
|
KCM
|
|
|
78.5
|
|
|
1.2
|
|
|
77.3
|
Direct Trading
|
|
|
12.9
|
|
|
0.5
|
|
|
12.4
|
In addition, the
Companys foreign registered broker-dealer, KEMIL, is subject to certain financial resource requirements of the FSA. The following table sets forth the financial resource requirement at December 31, 2007 (in millions):
|
|
|
|
|
|
|
|
|
|
Entity
|
|
Financial
Resources
|
|
Resource
Requirement
|
|
Excess
Financial
Resources
|
KEMIL
|
|
$
|
32.4
|
|
$
|
17.0
|
|
$
|
15.4
|
22. Financial Instruments with Off-Balance Sheet Risk and Concentrations of Credit Risk
As a market-maker of equities, the majority of the Companys securities transactions are conducted as principal or riskless principal with
broker-dealer and institutional counterparties primarily located in the United
81
States. The Company clears the majority of its securities transactions through clearing brokers. Foreign transactions are settled pursuant to a global
custody and clearing agreement with a major U.S. bank. Substantially all of the Companys credit exposures are concentrated with its clearing brokers and the bank (the clearing agents). These clearing agents may re-hypothecate
certain securities held on behalf of the Company. Additionally, pursuant to the terms of the agreements between the Company and the clearing agents, the clearing agents have the right to charge the Company for all losses that result from a
counterpartys failure to fulfill its contractual obligations. The Company has the ability to pursue collection from or performance with regard to this right. The Companys policy is to monitor the credit standing of the clearing agents
and all counterparties with which it conducts business.
Securities sold, not yet purchased represent obligations to purchase such securities (or underlying securities) at a future date. The Company may incur a loss if the market value of the securities subsequently increases.
The Company currently has no loans outstanding to any former or current
executive officer or director.
23. Acquisitions
During 2006, the Company acquired the following two
businesses within the Global Markets segment for a total of $95.7 million in cash:
|
|
|
Hotspot, an electronic foreign exchange marketplace that provides access to electronic foreign exchange spot trade executions through an advanced ECN-based
platform.
|
|
|
|
Knight BondPoint, a privately held firm that provides electronic access and trade execution products for the fixed income market.
|
Goodwill and intangible assets recognized upon the closing of these
transactions amounted to $69.8 million and $38.7 million, respectively. Intangible assets primarily consist of customer relationships and trade names. As these acquisitions were structured as stock purchases, none of the goodwill is expected to be
deductible for tax purposes. Refer to Footnote 8, Goodwill and Intangible Assets, for further details.
During 2006, the Company paid additional consideration of $15.5 million with respect to acquisitions made in 2005, which increased goodwill relating to
these acquisitions to $44.0 million, which is expected to be fully deductible for tax purposes as these acquisitions were structured as asset purchases for tax purposes. One final contingent purchase payment of $10.4 million was made in the third
quarter of 2007 with respect to the acquisition of Direct Trading.
See Footnote 24, Subsequent Events relating to the acquisition of EdgeTrade Inc.
24. Subsequent Events
Acquisition of EdgeTrade Inc.
On January 14, 2008, the Company completed the acquisition of EdgeTrade Inc. (EdgeTrade), a privately-held firm for $59.5 million comprising $29.5 million in cash and approximately 2.3 million shares of unregistered
Knight common stock. EdgeTrade is a leading agency-only trade execution and algorithmic software firm that allows buy- and sell-side clients to more effectively source liquidity and manage the trading process as well as maintain anonymity, reduce
market impact and lower transaction costs.
Exercise of
Option by Deephaven Managers
On January 10, 2008,
Deephaven Managing Partners, LLC (Deephaven Partners), an entity owned and controlled by the Deephaven Managers, provided notice to the Company that it was exercising the Option.
82
On February 1, 2008, after regulatory and contractual approvals were received, the Company completed
the transaction whereby the Company contributed its interest in Deephaven to Deephaven Holdings and Deephaven Partners acquired a 49% interest in Deephaven Holdings in exchange for the termination of the Deephaven Managers 2006 Employment
Agreements and associated profit sharing bonuses and an equity contribution of $1 million to Deephaven Holdings by Deephaven Partners (the Deephaven Transaction). The Deephaven Transaction did not affect or result in any change to
Deephavens role as investment manager to the funds it currently manages, or to the manner in which Deephaven carries out its duties as investment manager to those funds.
As part of the Deephaven Transaction, the Company and Deephaven Partners entered into a new Limited Liability Company
Agreement (the New LLC Agreement) for Deephaven Holdings. In addition, the 2006 Employment Agreements terminated and were replaced by new long-term employment agreements between Deephaven Holdings and each of the Deephaven Managers (the
New Employment Agreements). The New Employment Agreements do not include the profit-sharing bonuses provided under the 2006 Employment Agreements; however, the Deephaven Managers continue to be entitled to participate in certain profit
pools relating to specific Deephaven funds. Following the Deephaven Transaction, pre-tax earnings will be allocated between the Company and, through Deephaven Partners, the Deephaven Managers in a similar manner as under the 2006 Employment
Agreements. Profit-sharing bonuses under the 2006 Employment Agreements had been reported in Employee compensation and benefits on the Companys Consolidated Statements of Operations. As a result of the Deephaven Transaction, beginning in
February 2008, profits or losses that are allocated to the Deephaven Managers will instead be reported as Minority interest on the Companys Consolidated Statements of Operations and included as Minority interest on the Companys
Consolidated Statements of Financial Condition.
Under the New
LLC Agreement, the Company owns 51% of the shares in Deephaven Holdings, and Deephaven Partners owns 49% of the shares. As previously disclosed in a Form 8-K filing dated December 22, 2006, and subsequent regulatory filings, in the event of a
change of control of the Company prior to December 31, 2012, Deephaven Partners will have the option (the Change of Control Option) to increase its 49% interest by an additional 2%. Upon any exercise of the Change of Control Option,
the Company will be obligated to transfer ownership of 2% of the shares to Deephaven Partners. The Company is entitled to appoint a majority of the Board of Managers of Deephaven Holdings until such time as the Change of Control Option is exercised,
at which time Deephaven Partners will be entitled to appoint a majority of the Board of Managers.
Under the New LLC Agreement, certain corporate actions will require approval of a super-majority of members of the Board of Managers,
including representatives of both Deephaven Partners and us. Neither party is permitted to transfer any of its interests in Deephaven Holdings to any unaffiliated third person without the consent of the other party. Any sale of Deephaven Holdings
requires either (x) the consent of the holders of 75% of the shares or (y) if the aggregate consideration is in excess of $450 million, the approval of only Deephaven Partners (subject to a right of first refusal for the benefit of the
Company). Pursuant to the New LLC Agreement, proceeds from any sale or liquidation of Deephaven or Deephaven Holdings will be allocated among the Company and Deephaven Partners based upon a formula that takes into account their capital accounts at
the time of such sale or liquidation and relative profit sharing percentages over a defined period of time.
For additional information on the transaction, see Supplementary Schedule I included in this Annual Report on Form 10-K.
Closing of Deephaven Event Fund
On January 31, 2008, Deephaven announced that it had concluded that it
is in the best interests of investors in the Deephaven Event Fund LLC and the Deephaven Event Fund Ltd. (collectively, the Event Fund) that the Event Fund return investors capital. The decision to return investors capital in
the Event Fund occurred after a review by Deephaven of the Event Fund and the Event Funds viability given the current macro-economic environment, performance over the preceding nine months, declining investor interest in event-driven
investment
83
strategies and significant levels of redemption requests in the Event Fund. Substantive changes in macro-economic circumstances in the U.S. have resulted in
a reduction in the types of opportunities that Deephaven would ordinarily pursue as components of the Event Funds core event-driven strategy and the conclusion that the Event Funds core investment strategy is unlikely to produce the type
of investment results Deephaven and its investors might expect over the short and intermediate term. As a result, redemptions in the Event Fund were suspended with immediate effect and Deephaven began an orderly process to reduce trading positions
to cash and return investors capital as promptly as reasonably practicable. Beginning February 1, 2008, and through the period of time Deephaven is returning investors capital, no management or incentive allocation fee will be
charged to investors in the Event Fund.
25. Business
Segments
The Company currently has two operating business
segments, Asset Management and Global Markets as well as a Corporate segment. The Asset Management segment consists of investment management and sponsorship of the Deephaven Funds. The Global Markets segment provides market access and trade
execution services in nearly every U.S. equity security and a large number of international securities, futures, options, foreign exchange and fixed income. The Global Markets segment offers high quality trade executions through natural liquidity,
capital facilitation and trading technology, with comprehensive products and services that support alpha creation and capital formation. The Corporate segment includes all corporate overhead expenses and investment income earned on strategic
investments, subsidiary stock issuance and partial sale of Direct Edge, and the Companys corporate investment as a limited partner or non-managing member in the Deephaven Funds. Corporate overhead expenses primarily consist of compensation for
certain senior executives and other individuals employed at the corporate holding company, legal and other professional expenses relating to corporate matters, directors fees, investor and public relations expenses and directors and
officers insurance.
The Companys revenues, income
from continuing operations before income taxes and total assets by segment are summarized below (amounts in millions).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset
Management
|
|
Global
Markets
|
|
Corporate
|
|
Consolidated
Total
|
For the year ended December 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
118.2
|
|
$
|
751.4
|
|
$
|
35.7
|
|
$
|
905.3
|
Income from continuing operations before income taxes
|
|
|
16.5
|
|
|
180.4
|
|
|
4.3
|
|
|
201.2
|
Total assets
|
|
|
170.8
|
|
|
1,433.1
|
|
|
152.0
|
|
|
1,755.8
|
For the year ended December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
214.9
|
|
$
|
674.8
|
|
$
|
66.6
|
|
$
|
956.3
|
Income from continuing operations before income taxes
|
|
|
74.8
|
|
|
150.3
|
|
|
31.4
|
|
|
256.5
|
Total assets
|
|
|
199.1
|
|
|
1,670.3
|
|
|
158.8
|
|
|
2,028.2
|
For the year ended December 31, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
89.8
|
|
$
|
470.9
|
|
$
|
74.2
|
|
$
|
634.8
|
Income from continuing operations before income taxes
|
|
|
20.8
|
|
|
35.1
|
|
|
49.3
|
|
|
105.2
|
Total assets
|
|
|
82.4
|
|
|
996.1
|
|
|
337.5
|
|
|
1,416.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals may not add due to roundings.
84
26. Condensed Financial Statements of Knight Capital Group, Inc. (parent only)
Presented below are the Condensed Statements of Financial Condition,
Operations and Cash Flows for the Company on an unconsolidated basis.
Statements of Financial Condition
Knight
Capital Group, Inc. (parent only)
|
|
|
|
|
|
|
|
|
December 31,
2007
|
|
December 31,
2006
|
|
|
(in thousands)
|
Assets
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
43,759
|
|
$
|
4,907
|
Securities owned, at market value
|
|
|
6,400
|
|
|
6,343
|
Investments in subsidiaries, equity method
|
|
|
831,591
|
|
|
908,407
|
Fixed assets and leasehold improvements, at cost, less accumulated depreciation and amortization of $132 in 2007 and $31 in
2006
|
|
|
191
|
|
|
279
|
Investments in Deephaven sponsored funds
|
|
|
83,732
|
|
|
110,919
|
Receivable from Deephaven sponsored funds
|
|
|
85,000
|
|
|
|
Strategic investments
|
|
|
54,603
|
|
|
49,050
|
Other assets
|
|
|
29,209
|
|
|
22,029
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,134,485
|
|
$
|
1,101,934
|
|
|
|
|
|
|
|
Liabilities and Stockholders Equity
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
Accrued compensation expense
|
|
$
|
21,710
|
|
$
|
21,314
|
Accrued expenses and other liabilities
|
|
|
10,094
|
|
|
3,173
|
Payable to subsidiaries
|
|
|
123,276
|
|
|
95,798
|
Income taxes payable
|
|
|
24,027
|
|
|
19,162
|
Long term debt
|
|
|
70,000
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
249,107
|
|
|
139,447
|
Total stockholders equity
|
|
|
885,378
|
|
|
962,487
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$
|
1,134,485
|
|
$
|
1,101,934
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of these condensed financial statements.
Statements of Operations
Knight Capital Group, Inc. (parent only)
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31,
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
(in thousands)
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
Corporate management fees
|
|
$
|
28,165
|
|
$
|
28,000
|
|
$
|
24,261
|
|
Investment income and other, net
|
|
|
22,470
|
|
|
14,694
|
|
|
8,636
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
50,635
|
|
|
42,694
|
|
|
32,897
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
Employee compensation and benefits
|
|
|
20,505
|
|
|
20,915
|
|
|
14,327
|
|
Professional fees
|
|
|
6,492
|
|
|
10,161
|
|
|
6,512
|
|
Business development
|
|
|
432
|
|
|
597
|
|
|
460
|
|
Other
|
|
|
3,815
|
|
|
3,785
|
|
|
4,793
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses
|
|
|
31,244
|
|
|
35,458
|
|
|
26,092
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes and equity in earnings of subsidiaries
|
|
|
19,391
|
|
|
7,236
|
|
|
6,805
|
|
Income tax expense (benefit)
|
|
|
5,062
|
|
|
444
|
|
|
(1,033
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Income before equity in earnings of subsidiaries
|
|
|
14,329
|
|
|
6,792
|
|
|
7,838
|
|
Equity in earnings of subsidiaries
|
|
|
107,911
|
|
|
151,554
|
|
|
58,522
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
122,240
|
|
$
|
158,346
|
|
$
|
66,360
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes
are an integral part of these condensed financial statements.
85
Statements of Cash Flows
Knight Capital Group, Inc. (parent only)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(in thousands)
|
|
Cash flows from operating activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
122,240
|
|
|
$
|
158,346
|
|
|
$
|
66,360
|
|
Adjustments to reconcile net income to net cash provided by operating activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in earnings of subsidiaries
|
|
|
(107,911
|
)
|
|
|
(151,554
|
)
|
|
|
(58,522
|
)
|
Depreciaton and amortization
|
|
|
239
|
|
|
|
71
|
|
|
|
40
|
|
Stock-based compensation
|
|
|
4,539
|
|
|
|
3,998
|
|
|
|
2,851
|
|
Income tax benefit on stock awards exercised
|
|
|
|
|
|
|
|
|
|
|
6,626
|
|
Unrealized gains on investments in Deephaven sponsored funds
|
|
|
(17,786
|
)
|
|
|
(12,669
|
)
|
|
|
(6,849
|
)
|
Unrealized (gain) loss on strategic investments
|
|
|
(688
|
)
|
|
|
1,119
|
|
|
|
748
|
|
(Increase) decrease in operating assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities owned
|
|
|
(57
|
)
|
|
|
2,013
|
|
|
|
540
|
|
Other assets
|
|
|
(7,314
|
)
|
|
|
(3,790
|
)
|
|
|
9,320
|
|
Increase (decrease) in operating liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued compensation expense
|
|
|
396
|
|
|
|
8,406
|
|
|
|
(8,516
|
)
|
Accrued expenses and other liabilities
|
|
|
6,921
|
|
|
|
568
|
|
|
|
66
|
|
Payable to subsidiaries
|
|
|
55,612
|
|
|
|
20,296
|
|
|
|
102,509
|
|
Income taxes payable
|
|
|
4,865
|
|
|
|
(5,746
|
)
|
|
|
(21,206
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
61,056
|
|
|
|
21,058
|
|
|
|
93,967
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of fixed assets and leasehold improvements
|
|
|
(14
|
)
|
|
|
(310
|
)
|
|
|
|
|
Redemptions in Deephaven sponsored funds
|
|
|
35,000
|
|
|
|
19,575
|
|
|
|
5,000
|
|
Investment in Deephaven sponsored funds
|
|
|
|
|
|
|
(1,310
|
)
|
|
|
(55,000
|
)
|
Proceeds from sale of strategic investments
|
|
|
5,534
|
|
|
|
|
|
|
|
1,166
|
|
Purchases of strategic investments
|
|
|
(10,400
|
)
|
|
|
(38,750
|
)
|
|
|
(3,650
|
)
|
Dividends received from subsidiaries
|
|
|
129,324
|
|
|
|
250,514
|
|
|
|
38,995
|
|
Capital contributions to subsidiaries
|
|
|
(21,252
|
)
|
|
|
(235,735
|
)
|
|
|
(143,849
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities
|
|
|
138,192
|
|
|
|
(6,016
|
)
|
|
|
(157,338
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options exercised
|
|
|
21,075
|
|
|
|
26,787
|
|
|
|
22,517
|
|
Income tax benefit on stock awards exercised
|
|
|
15,172
|
|
|
|
19,405
|
|
|
|
|
|
Proceeds from long term debt borrowing
|
|
|
70,000
|
|
|
|
|
|
|
|
|
|
Cost of common stock repurchased
|
|
|
(266,643
|
)
|
|
|
(75,959
|
)
|
|
|
(147,016
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in financing activities
|
|
|
(160,396
|
)
|
|
|
(29,767
|
)
|
|
|
(124,499
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in cash and cash equivalents
|
|
|
38,852
|
|
|
|
(14,725
|
)
|
|
|
(187,870
|
)
|
Cash and cash equivalents at beginning of the year
|
|
|
4,907
|
|
|
|
19,632
|
|
|
|
207,502
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of the year
|
|
$
|
43,759
|
|
|
$
|
4,907
|
|
|
$
|
19,632
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
97
|
|
|
$
|
408
|
|
|
$
|
576
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for income taxes
|
|
$
|
66,826
|
|
|
$
|
102,747
|
|
|
$
|
52,563
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes
are an integral part of these condensed financial statements.
86
NOTES TO CONDENSED FINANCIAL STATEMENTS
KNIGHT CAPITAL GROUP, INC.
(Parent Only)
A. General
The condensed financial statements of Knight Capital Group, Inc. (parent only; the Parent Company) should be read in conjunction with the
Consolidated Financial Statements of the Company and the notes thereto.
B. Income taxes
As
stated in Footnote 15, Income Taxes, the Company and its subsidiaries file a consolidated federal income tax return as well as combined state income tax returns in certain jurisdictions. In other jurisdictions, the Company and its
subsidiaries file separate income tax returns. As such, both federal and state income taxes attributable to subsidiaries are accrued at the subsidiary level and are therefore, included in Equity in earnings of subsidiaries on the Condensed Financial
Statements. Income tax expense (benefit) included on the Parent Companys Condensed Statements of Operations represents only the income taxes attributable to the Parent Company.
87
Supplementary Schedule I
Unaudited Condensed Consolidated Pro Forma
Financial Information
For a description of the Deephaven
Transaction, see Footnote 24, Subsequent Events.
The following unaudited Pro Forma Condensed Consolidated Financial Information for the Company updates the Form 8-K filed on February 7, 2008, regarding the exercise of the Option by Deephaven Partners and reflects the balances as of
and for the year ended December 31, 2007.
The unaudited
Pro Forma Condensed Consolidated Statement of Financial Condition of the Company as of December 31, 2007 gives effect to the Deephaven Transaction as if it had occurred on December 31, 2007 and the unaudited Pro Forma Condensed Consolidated
Statement of Operations for the year ended December 31, 2007 gives effect to the Deephaven Transaction as if it had occurred on January 1, 2007 (collectively, the Pro Forma Condensed Consolidated Financial Statements).
The unaudited Pro Forma Condensed Consolidated Financial
Statements have been prepared by the Companys management and are provided for informational purposes only. The unaudited Pro Forma Condensed Consolidated Financial Statements do not purport to reflect the results of operations that would have
existed or occurred had such transaction taken place on the date indicated, nor do they purport to reflect the financial condition or results of operations that will exist or occur in the future. The unaudited Pro Forma Condensed Consolidated
Financial Statements, including the notes thereto, are qualified in their entirety by reference to, and should be read in conjunction with, the Companys historical Consolidated Financial Statements and the Notes thereto included in this Annual
Report on Form 10-K.
88
KNIGHT CAPITAL GROUP, INC.
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2007
|
|
|
|
As Reported
|
|
|
Adjustments
(Note 1)
|
|
Pro forma
|
|
|
|
(in thousands)
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
222,435
|
|
|
$
|
1,000
|
|
$
|
223,435
|
|
Securities owned, held at clearing brokers, at market value
|
|
|
412,565
|
|
|
|
|
|
|
412,565
|
|
Receivable from brokers and dealers
|
|
|
382,544
|
|
|
|
|
|
|
382,544
|
|
Asset management fees receivable
|
|
|
27,588
|
|
|
|
|
|
|
27,588
|
|
Investment in Deephaven sponsored funds
|
|
|
83,732
|
|
|
|
|
|
|
83,732
|
|
Receivable from Deephaven sponsored funds
|
|
|
85,000
|
|
|
|
|
|
|
85,000
|
|
Fixed assets and leasehold improvements, at cost, less accumulated depreciation and amortization
|
|
|
62,073
|
|
|
|
|
|
|
62,073
|
|
Strategic investments
|
|
|
73,704
|
|
|
|
|
|
|
73,704
|
|
Goodwill
|
|
|
132,832
|
|
|
|
|
|
|
132,832
|
|
Intangible assets, less accumulated amortization
|
|
|
57,845
|
|
|
|
|
|
|
57,845
|
|
Deferred compensation investments
|
|
|
85,504
|
|
|
|
|
|
|
85,504
|
|
Other assets
|
|
|
129,991
|
|
|
|
|
|
|
129,991
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,755,813
|
|
|
$
|
1,000
|
|
$
|
1,756,813
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders Equity
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
Securities sold, not yet purchased, at market value
|
|
$
|
335,280
|
|
|
$
|
|
|
$
|
335,280
|
|
Payable to brokers and dealers
|
|
|
117,001
|
|
|
|
|
|
|
117,001
|
|
Accrued compensation expense
|
|
|
228,275
|
|
|
|
|
|
|
228,275
|
|
Accrued expenses and other liabilities
|
|
|
119,879
|
|
|
|
|
|
|
119,879
|
|
Long term debt
|
|
|
70,000
|
|
|
|
|
|
|
70,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
870,435
|
|
|
|
|
|
|
870,435
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority interest in consolidated subsidiaries
|
|
|
|
|
|
|
1,000
|
|
|
1,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity
|
|
|
|
|
|
|
|
|
|
|
|
Class A Common Stock
|
|
|
1,509
|
|
|
|
|
|
|
1,509
|
|
Additional paid-in capital
|
|
|
587,025
|
|
|
|
|
|
|
587,025
|
|
Retained earnings
|
|
|
934,099
|
|
|
|
|
|
|
934,099
|
|
Treasury stock, at cost
|
|
|
(637,255
|
)
|
|
|
|
|
|
(637,255
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
885,378
|
|
|
|
|
|
|
885,378
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$
|
1,755,813
|
|
|
$
|
1,000
|
|
$
|
1,756,813
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes
to pro forma condensed consolidated financial statements.
89
KNIGHT CAPITAL GROUP, INC.
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the year ended December 31, 2007
|
|
|
|
As
Reported
|
|
|
Adjustments
(Note 2)
|
|
|
Pro forma
|
|
|
|
(in thousands, except per share
amounts)
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
447,495
|
|
|
$
|
|
|
|
$
|
447,495
|
|
Net trading revenue
|
|
|
286,199
|
|
|
|
|
|
|
|
286,199
|
|
Asset management fees
|
|
|
116,777
|
|
|
|
|
|
|
|
116,777
|
|
Interest, net
|
|
|
17,378
|
|
|
|
|
|
|
|
17,378
|
|
Non-operating gain from subsidiary stock issuance
|
|
|
8,757
|
|
|
|
|
|
|
|
8,757
|
|
Investment income and other, net
|
|
|
28,718
|
|
|
|
|
|
|
|
28,718
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
905,324
|
|
|
|
|
|
|
|
905,324
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transaction-based expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Execution and clearance fees
|
|
|
120,261
|
|
|
|
|
|
|
|
120,261
|
|
Soft dollar and commission recapture expense
|
|
|
61,367
|
|
|
|
|
|
|
|
61,367
|
|
Payments for order flow and ECN rebates
|
|
|
54,564
|
|
|
|
|
|
|
|
54,564
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total transaction-based expenses
|
|
|
236,192
|
|
|
|
|
|
|
|
236,192
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues, net of transaction-based expenses
|
|
|
669,132
|
|
|
|
|
|
|
|
669,132
|
|
|
|
|
|
Other direct expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee compensation and benefits
|
|
|
346,476
|
|
|
|
(21,580
|
)
|
|
|
324,896
|
|
Communications and data processing
|
|
|
36,956
|
|
|
|
|
|
|
|
36,956
|
|
Depreciation and amortization
|
|
|
22,075
|
|
|
|
|
|
|
|
22,075
|
|
Professional fees
|
|
|
19,360
|
|
|
|
|
|
|
|
19,360
|
|
Business development
|
|
|
15,997
|
|
|
|
|
|
|
|
15,997
|
|
Occupancy and equipment rentals
|
|
|
14,083
|
|
|
|
|
|
|
|
14,083
|
|
Writedown of assets and lease loss accrual
|
|
|
(2,470
|
)
|
|
|
|
|
|
|
(2,470
|
)
|
Other
|
|
|
15,418
|
|
|
|
|
|
|
|
15,418
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other direct expenses
|
|
|
467,895
|
|
|
|
(21,580
|
)
|
|
|
446,315
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations before income taxes and minority interest
|
|
|
201,237
|
|
|
|
21,580
|
|
|
|
222,817
|
|
Income tax expense
|
|
|
77,560
|
|
|
|
|
|
|
|
77,560
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations before minority interest
|
|
|
123,677
|
|
|
|
21,580
|
|
|
|
145,257
|
|
|
|
|
|
Minority interest in income of consolidated subsidiaries
|
|
|
|
|
|
|
(21,580
|
)
|
|
|
(21,580
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations
|
|
|
123,677
|
|
|
|
|
|
|
|
123,677
|
|
Loss from discontinued operations, net of tax
|
|
|
(1,437
|
)
|
|
|
|
|
|
|
(1,437
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
122,240
|
|
|
$
|
|
|
|
$
|
122,240
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share from continuing operations
|
|
$
|
1.27
|
|
|
$
|
|
|
|
$
|
1.27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share from continuing operations
|
|
$
|
1.23
|
|
|
$
|
|
|
|
$
|
1.23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted earnings per share from discontinued operations
|
|
$
|
(0.01
|
)
|
|
$
|
|
|
|
$
|
(0.01
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
$
|
1.26
|
|
|
$
|
|
|
|
$
|
1.26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share
|
|
$
|
1.21
|
|
|
$
|
|
|
|
$
|
1.21
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in computation of basic earnings per share
|
|
|
97,050
|
|
|
|
|
|
|
|
97,050
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in computation of diluted earnings per share
|
|
|
100,796
|
|
|
|
|
|
|
|
100,796
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes
to pro forma condensed consolidated financial statements.
90
KNIGHT CAPITAL GROUP, INC.
NOTES TO PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1.
The Pro Forma Condensed Consolidated Statement of Financial Condition gives effect to the Deephaven Transaction as if it had occurred on
December 31, 2007. The $1 million increase in Cash and cash equivalents represents the initial capital contribution by Deephaven Partners to Deephaven Holdings and has been credited to Minority interest.
Note 2.
The Pro Forma Condensed Consolidated Statement of Operations gives effect to the Deephaven Transaction as if it had occurred on January 1,
2007. Amounts that had previously been reported as Employee compensation and benefits have been reclassified to Minority interest in income of consolidated subsidiaries as such amounts are treated as allocations to Deephaven Partners for purposes of
these Pro Forma Condensed Consolidated Financial Statements.