The Difference
Knight Capital Group, Inc. 2005 Annual Report
Knight Capital Group, Inc. (Nasdaq: NITE) is a leading financial
services firm that provides comprehensive trade execution solutions
and asset management services. Our Asset Management business,
Deephaven Capital Management, is a global multi-strategy alternative
investment manager focused on delivering attractive risk-adjusted
returns with low correlation to the broader markets for institutions and
private clients. Our Global Markets business provides a broad range
of customized trade execution products and services across multiple
asset classes for broker-dealers, institutions and issuer companies. We
continually apply knowledge and innovation to the trading and asset
management processes to build lasting client partnerships through
consistent performance and superior client service. More information
about Knight can be found at www.knight.com.
Our People The financial markets are so automated, it is
easy to forget that behind the split-second executions are the people
who make those trades happen. At Knight, our people are the heart-
beat of our business. We are passionate about what we do, whether
it is putting minds together to help a client make a smart trading
decision, or building systems to improve trade execution quality and
reliability. Our clients first choose Knight because we are among
the very best at trade execution solutions and asset management
services. We will remain the first choice because we focus on turning
that initial trade or investment into a collaborative, person-to-person
relationship that keeps delivering true added value.
Our Trading Floor
$1,882,163,698,431 total U.S. dollar volume traded in 2005
2 The Knight Difference
Knight 3
Fellow Knight Shareholder:
Thomas M. Joyce, Chairman & CEO
The first step onto Knight’s trading floor is impressive. The sea of people
and technology, and perhaps the scale of the room, have an immediate
impact. But I believe it’s something else, something less tangible, that
leaves the greatest impression. It’s the confidence, the energy, the passion.
No floor on Wall Street is quite like ours.
Turning the corner on results in the Asian and European books. In addition,
The excitement on the trading floor is reflective of Deephaven managers opportunistically shifted capital
our experience in 2005 – excitement that grew as from U.S. and European volatility and convertible
the year progressed, as we improved our financial positions to a heavier allocation in Japan, leading to
performance, and as we added key businesses. outperformance in volatility-based portfolios.
Our gratification was not immediate. We had a rough However, more influential on earnings, both for
start to 2005, with pre-tax operating earnings of the year and going forward, were the sweeping
$7.8 million in the first six months. But we dug in and changes Knight enacted throughout our equities
turned it around, finishing the full year with pre-tax trading operations.
operating earnings of $120.9 million (which included
$55.9 million in gains from sales of strategic invest- Changing the economics of equity trading
ments), on revenues of $634.6 million. By comparison, To determine what needed fixing, we first scrutinized
Knight’s pre-tax operating earnings were $82.6 mil- the entire equity business, which includes our broker-
lion, on revenues of $625.8 million, in 2004. dealer and institutional operations. During the second
quarter, we restructured the segment to better recog-
Our Asset Management business, Deephaven Capital nize and meet the needs of our different clients, as
Management, erased a first-half loss in a difficult well as hone in on costs and benefits – down to each
market and posted blended annual returns of 7.2%. client, product and stock.
Deephaven experienced strong results in the event-
driven strategies and did well in credit-driven strategies With regulatory changes and competitive pressures
in the U.S., Europe and Asia. Although extreme stress negatively impacting revenue capture, our broker-
in convertible arbitrage, capital structure and volatility dealer operations were struggling the most, but they
trading challenged Deephaven in the first half, over also held the greatest opportunity for improvement.
the calendar year these strategies did well, particularly From our review, we recognized the need to focus
4 The Knight Difference
on four areas: organization; electronic trading In 2005, we also slashed costs across the board.
algorithms; execution quality; and client offering. We reduced rebates by adjusting our broker-dealer
offering to emphasize profit sharing over fixed
Knight appointed a new broker-dealer leader, rebate formulas.
Jim Smyth, who launched multiple initiatives.
We consolidated our Nasdaq and listed trading We believe our ability to deliver consistently high
under one manager and placed electronic trading – trade execution quality will always draw broker-
once a separate group of quantitative analysts and dealers to Knight, even as we continue to adjust
technology professionals who develop trading for the changing economics of the industry.
algorithms – into our broker-dealer business.
Then we started funneling a greater amount of Creating choice around trade execution
our broker-dealer order flow into this algorithmic We made more significant additions to our products
system, dramatically increasing our trading efficiency. and services in this last year than we have in our
Today, more than 90% of our over-the-counter history. Adding to our acquisition of soft dollar and
order flow and approximately 80% of our listed directed brokerage firm Donaldson & Co. in 2003,
order flow is executed automatically. we completed two more acquisitions in 2005, and
we announced yet another in January 2006.
Automation means better execution quality for our
broker-dealer clients as measured by execution speed, During our equities review, we recognized that
effective-over-quoted spread, price improvement and electronic access to multiple markets is a natural fit
other statistics. It also means greater efficiency for for Knight and a complement to our extensive voice-
our clients and for Knight. Not only have we improved based institutional client offering. Our first 2005
trade execution quality across the board, we can acquisition was Direct Trading Institutional, completed
quickly customize and adjust execution protocols in June. Direct market access is one of the fastest-
based on specific client demands. growing parts of the institutional trading business,
especially among hedge funds. We like this Texas-
based firm because, similar to us, they back up their
A rising market helped boost Knight’s profitability in 2005. But the
dramatic turnaround we made in the second half of the year really
came down to hard decisions and a critical analysis of the economics
of the broker-dealer business.
Knight 5
Total Revenues Pre-Tax Operating Net Income
(in thousands) Earnings* (in thousands)
(in thousands)
$634,623
$625,750
$120,910
$545,909
$100,094
$91,132
$82,638
$66,361
$38,073
03 04 05 03 04 05 03 04 05
*Pre-Tax Operating Earnings represent Income (loss) from continuing operations before Regulatory
charges and related matters, Writedown of assets and lease loss accrual and Income taxes.
platform with great service. With Direct Trading While much of Knight’s news in 2005 involved new
Institutional we now also have significant futures electronic access products, the sales and trading
and options routing capabilities. business at the heart of our institutional offering
steadily added clients and increased revenues and
Next, by acquiring the assets of the ATTAIN ECN, market share despite an environment in which our
sm
renamed Direct Edge ECN, we avoided the time clients saw mediocre trading opportunities. Under
and cost of building the technology from scratch the direction of Greg Voetsch, we’ve developed our
and helped expedite the regulatory approval process. business on client relationships, and in 2005 the
Through this acquisition, which closed in October distinction between Knight and our competitors
2005, Knight instantly added an engine to execute became even more clear. As many other firms cut
limit orders to complement our strength executing their sales traders and coverage, Knight stepped into
market orders. We’ve been working since then to the void with personalized service, and we continue
enhance the ECN platform for capacity and rout- to trade nearly every U.S. equity issue. The small-
ing and make it available through Direct Trading and mid-cap space remains our sweet spot, setting
Institutional. With a widening dearth of liquidity us apart. Our listed business has grown to approxi-
alternatives in the market, we believe Direct Edge mately 30% of our institutional revenues from a
ECN will be an increasingly valuable execution venue. 25%-75% listed-Nasdaq split in 2004.
With ECN and electronic access to equities, futures Leveraging our strengths
and options in place, we moved to add another asset All of our acquisitions build upon Knight’s infra-
class. In January 2006, Knight announced the pro- structure and client base, and they will provide Knight
posed acquisition of Hotspot FX, which offers an with fee-based revenue streams without high capital
ECN-based platform for spot foreign exchange commitment requirements. More importantly, for our
trading. Past and projected demand for foreign clients, we’ve established a solid foundation to grow
exchange trading is compelling, especially as more a virtual exchange for trading across multiple asset
institutions use FX to drive returns and not simply classes – hence “Global Markets” replaces “Equity
hedge currency risk. We believe the market will Markets” to describe the business segment. In an
continue to move toward electronic trading in FX, increasingly fragmented market, Knight is an impor-
just as it has in equities. The deal is expected to tant, centralized source of liquidity. Now we’re also a
close in the first half of 2006. source for access to a greater variety of asset classes.
6 The Knight Difference
In 2005, Knight expanded client touchpoints by broadening our business
beyond equities trading, opening electronic and ECN access to the markets,
and introducing technical research. In fact, we added more products and
services than in any other year in our history.
Deephaven continued its own diversification effort take a different approach to how a research product
in 2005, using its investment expertise and opera- is customized, distributed and priced.
tional structure for multiple strategies employed by
the original Deephaven Market Neutral Fund to capi- Technical research is especially interesting as the
talize on growing demand for single-strategy funds. trend toward unbundling products and services esca-
Last year, Deephaven introduced the Convertible lates. Knight is the original, unbundled, full-service
Select, Credit Opportunities and Global Convertible trade execution provider. Consolidation continues,
Opportunities funds, which join the Event Fund and as exchange-ECN mergers have the potential
launched in 2004. to raise the cost of trading, Knight stands out with
our competitive offering and client service.
The appeal of single-strategy funds is growing among
funds of funds, one of our largest client bases, which At the celebration of Knight’s 10th anniversary in
are reallocating away from multi-strategy funds. June 2005, we reflected on how much the company
Deephaven’s single-strategy products are helping to has changed. We’ve expanded beyond our role as
retain assets and diversify cash flows with new client a broker-dealer trade execution provider to become a
groups, particularly the pension and endowment leader in institutional sales trading and asset manage-
funds that have been steadily increasing allocations to ment as well. We’ve become more than a company
alternative investments. built around trading and technology, to one that
places client service above all else.
When Knight wasn’t seeking strategic acquisitions and
growing from within, we were recruiting new addi- Of course that first step onto the Knight trading floor
tions to the Knight family. Among the more visible is exhilarating. We’re proud of the work we’ve done,
additions to our product line was Knight Research, and we’re excited about where we’re going.
led by Institutional Investor-ranked technical analyst
Ralph Acampora. We always aim to provide guidance
to our clients about how to make the best trades
possible. Now, with Knight Research, we have even
Thomas M. Joyce
greater market insight to offer. In addition, as a Chairman & CEO
newcomer to research, we can start from scratch and March 14, 2006
Knight 7
Our Client Relationships
Initially, our liquidity and scope of securities covered may bring broker-
dealers, institutions and issuer companies to Knight, but we understand
that order flow alone is not enough to keep them here. Our clients want
to know that we’ll marshal all of our resources to help address any issues
they may have. That there are people here with whom they have a rela-
tionship, eager to provide direction and answer their questions. That in a
difficult market environment or with a complicated trade, our traders, sales
traders and relationship managers won’t rest until client needs are met.
Network of more than
600 broker-dealers and nearly 1,000 institutional client partnerships
Most broker-dealers and institutions have multiple trading relationships,
and Knight is focused on staying consistently at the top of every list. We
trade more U.S. equity securities than almost every competitor, and clients
understand the value of this breadth. Specialized client service is what truly
sets us apart.
Whether it’s the head of the equity trading desk at a mutual fund, a
member of an execution quality committee at an online broker-dealer, or
the CEO of a regional brokerage firm, we want each client contact to
be as proud to use and recommend Knight as we are to have them as
clients. We understand that Knight’s performance every day reflects
directly on our clients, and we take this responsibility very seriously.
8 The Knight Difference
We spend time talking with our clients about trade execution
strategies. How to trade with less impact and with greater return.
How to trade faster. How to simply trade better.
Knight 9
We useour knowledge, skill and innovation to meet client needs,
creating solutions where none exist and finding new ways to scale
common barriers to improve trade execution.
10 The Knight Difference
Our Perspective
At Knight, trading is not a commodity. It is a science.
With a unique blend of order flow from broker-dealers and institutions, we
are a resource for those who seek clarity on the direction and momentum
of the market. Successful trade execution requires instinct as much as intel-
lect, and for our clients, we take what we see and feel to identify buy and
sell opportunities. The introduction of technical research to our offering
adds an important layer to the wealth of information we analyze for and
share with our clients.
Beyond pure trade execution, we help broker-dealers and institutions
navigate a dynamic business environment. Our clients face the very same
challenges we do, including new regulations that can change the way
business is done almost overnight. We make it our job to understand these
regulations, impart what we learn and create new approaches to manage
pressures, both structural and competitive.
Ability to make a market or trade in more than
16,000 U.S. equities
One of the most important things we’ve learned over the last few years
is that our clients want multiple points of access to multiple markets. We
continue to develop our top-notch institutional voice business with the
right hires and with valuable services that help our clients uncover ideas,
improve performance and increase efficiency. On top of that, we have
added an ECN, direct market access, options trading and, soon, electronic
foreign exchange. We are continually looking for the next new product
and service that will deliver true value to our clients.
On the regulatory front, we are active participants in market structure
debates, working to help shape industry trends and regulations. We study
the issues and make our opinions known to better serve the interests of
our shareholders and clients.
Knight 11
Our Market Insight
Knight’s tremendous broker-dealer and institutional volume provides a
unique vantage point and makes us a valuable source of information
for our clients. With the addition of Knight Research, we’ve combined
technical analysis of market momentum with our intrinsic understanding
of order flow. These are the key components that help investors determine
entry and exit points for trading stocks.
Technical research, which covers historical price, volume and market
psychology, is a perfect fit for Knight and our trade execution know-how.
Technical analysis differs greatly from fundamental analysis, which reviews
management, dividends, price-to-earnings ratios and other less quantita-
tive measures. While technical research is a new product for the company,
the Knight Research team comprises industry-recognized veterans.
From the start, the research team has maintained an open dialogue with
clients, and the full Knight Research package is based on their feedback.
What our clients want most of all is customizable content and delivery.
12 The Knight Difference
Knight’s expertise in trade execution and understanding of order flow
dynamics has been combined with technical analysis of market momentum
to help our clients determine the price at which to buy and sell.
Daily technical monitoring of more than
1,500 stocks
Still in its early stages, Knight Research is designed to allow clients to choose
content based on time horizon and subject, from market caps to sectors to
single stocks. For example, a fund manager may choose to receive research
only on small-cap healthcare stocks, with a very short time horizon. Or a
buy-side analyst may want data regarding mid-cap stocks across the finan-
cial and technology sectors, with mid-to-long-term investment in mind.
Every piece of research is intended to lead to more informed trading.
The research is designed to be pushed directly to the client’s desktop or
PDA. It won’t sit on the web, waiting for the client to log in and access
it, nor will it be buried in a lengthy paper report. Knight’s technical
research, like all of our products and services, is built around our clients’
specific demands.
Whether it is analysis of historical data by our certified market technicians
or interpretations of that day’s trading environment from our floor, Knight
strives to provide relevant, actionable information to our clients.
Knight 13
Our Infrastructure
Technology empowers Knight’s entire trading process, from executing trades
and communicating up-to-the-millisecond information to our clients, to
monitoring for compliance and managing our inventory of securities.
Automation of more than
90% of Nasdaq and 80% of listed order flow
Our connectivity channels and web-based software make it easy for our
clients to interface with us and the market. That’s the part of our technology
that clients can see and use directly. It’s what they can’t see, the majority of
our platform, that has the greatest impact on their execution quality as well
as on our company’s performance. Knight has developed one of the best
order management systems in the business. Our sophisticated desktops help
traders and sales traders manage an abundance of information and auto-
mate tasks, allowing them to find trading opportunities that may exist for
mere fractions of seconds, and focus on the heart of the trade execution.
Knight’s spirit of innovation prevails in technology, where we encourage
employees to invent new and better ways to improve our operations. In
keeping with the fast pace of our trading floor, the cycle from new idea
to implementation is short. Few layers exist between the technology
creators and the decision-makers.
The relocation of the company’s headquarters in early 2005 provided an
opportunity for us to upgrade multiple systems. Thanks to significant invest-
ment in our operations, we boosted trade execution capacity, increased
speed and fortified our infrastructure. Today, our trade execution quality
is higher than ever and we’re more efficient than ever before. Greater
automation helps us reduce trade execution and other transaction costs
of trading on behalf of our clients.
14 The Knight Difference
Knight’s technological strength and flexible platform let us
new acquisitions,
quickly bolt on, improve and hit the ground running with
like our ECN and our direct market access product.
Knight 15
At Knight, we continually use knowledge and innovation to identify ways
to better serve our clients. We will always set the standard in client
service and want to be our clients’ first choice for trade execution solutions
and asset management services.
Our Offerings
Asset Management
Deephaven Capital Management is an investment manager specializing in
alternative investment strategies. Founded in 1994, Deephaven employs
more than 120 people in Minneapolis, London and Hong Kong and invests
globally across multiple asset classes and strategies.
Deephaven combines a strong intellectual foundation, outstanding people,
technology and ever-improving processes to identify market opportunities.
We seek compelling risk/reward scenarios and look to capitalize on
such opportunities to deliver consistent and attractive risk-adjusted returns
for investors.
Deephaven pursues a broad range of global strategies, including credit-
and event-driven, fundamental security selection, quantitative and
volatility-driven. We believe that the optimal model for generating long-
term investment returns is dynamically allocating and reallocating capital
on a timely and flexible basis to those different geographies, asset classes,
strategies and market sectors which offer the best risk-adjusted returns
in changing and unpredictable markets. Adaptability and an opportunistic
approach to strategy implementation and trade execution are critical.
Deephaven serves a global clientele of private clients and institutional
investors, including corporate and public pensions, endowments, founda-
tions, insurance companies and other financial intermediaries.
Building
ONE source for trade execution solutions across multiple asset classes
Global Markets
Global Markets provides a broad range of customized trade execution
products and services across multiple asset classes for broker-dealers,
institutions and issuer companies.
Our order flow, understanding of market momentum and seasoned
instincts allow us to provide clients with great market insight. We apply
this insight to every client interaction, helping devise trade execution
solutions that maximize performance and efficiency.
We work with our clients to understand and meet their needs, acting as
natural extensions of their trading desks.
Knight 17
Broker-Dealer Offering – #1 market maker in OTC Bulletin Board volume with
Knight earned its position as a leading destination for order more than 44% of market share*
flow by offering our broker-dealer clients the ability to *Source: AutEx, YTD results as of 12/31/05
execute trades according to their customers’ needs.
Sophisticated systems and trading algorithms allow us Capital Placement
to make nearly instantaneous decisions on client orders, Knight Capital Partners, a division of Knight Capital
exercising precise control over varied trade execution Markets, provides comprehensive capital placement
parameters to help them achieve best execution. services for alternative investment managers, including
private equity funds, hedge funds and non-traditional
• Consistently high execution quality, including speed, long-only strategy managers.
at-or-better percentage and price improvement*
• Unparalleled strengths in small- and mid-cap stocks* Comprised of experienced professionals, this team has
• Focus on client service established relationships with both general partners
• Flexible platform customized according to specific and investment managers as well as with a broad cross
client needs section of limited partner and institutional investors,
• Reliable and redundant technology including pension funds, endowments, banks, insurance
*According to YTD averages of SEC 11Ac1-5. Data provided by the Transaction companies, funds of funds and consultants.
Auditing Group, Inc. (TAG) “Comparison Tool”
Knight Capital Partners will engage in fund-raising
Global Markets assignments for a select group of experienced managers
representing diverse alternative investment strategies.
Cash Equity Trading
We make a market in or trade nearly every U.S. equity,
Client Commission Programs – Donaldson & Co.
including Nasdaq National Market System (NMS), Nasdaq
Through Donaldson, a division of Knight Equity Markets,
Small Cap, OTC Bulletin Board and Pink Sheets, as well
Knight offers comprehensive and highly competitive
as NYSE- and AMEX-listed securities in the Nasdaq
client commission programs to the institutional
InterMarket.sm With international trading expertise from
investment community throughout the U.S. for maxi-
our international trading desk and London-based opera-
mized commission dollar usage and lower portfolio
tions, Knight also provides trade executions in a large
management costs.
number of international securities, servicing both ordinary
and ADR execution requirements.
Clients can choose how to access our services: work with
a Knight sales trader for quality trade executions for over-
Our teams are built around clients with a single point
the-counter and listed equities and program trading; or,
of contact. Our trading floor is organized by industry
work directly with Donaldson for access to a multiple-
sectors with specific expertise, such as biotechnology
broker panel of several well-known and respected firms
within Healthcare; and semiconductors, hardware and
for trade execution.
telecom within Technology.
• Customized programs structured to meet client needs
• Make markets or trade in more than 16,000 equities
• Expert, personalized client service
• Supply liquidity to a great number of small and
• Competitive ratios
thinly-traded equities
• Access to independent third-party research
• Largest market maker in listed securities in the third
• Ability to allocate commission dollars to one or
market, 5.12% of all daily listed share volume*
multiple brokers
• Market leader in OTC equities:
• Timely and accurate reconciliation and reporting
– #2 market maker in Nasdaq volume with almost
8% market share*
– #1 market maker in Nasdaq Small Cap stocks with
more than 32% market share*
18 The Knight Difference
Corporate Services
Non-traditional institutional trade execution needs, Direct Edge ECN’s market participant identifiers are (EDGA)
including restricted stock transactions and issuer buy- for NASD ADF and (EDGX) for Nasdaq Market Center.
backs, are supported by Corporate Services.
• Anonymity
Comprised of industry leaders with experience in all • Competitive prices
aspects of trading, Corporate Services provides compre- • Liquidity
hensive trade execution services to companies, their • Market structure expertise
senior management and restricted stockholders. Clients • Speed
have access to a full-service solution, including Knight’s • Performance
liquidity, trade execution and market insight, and help
with completion of forms and filings. Electronic Foreign Exchange – Hotspot FX
In January 2006, Knight announced an agreement to
• Prospectus (S-3) sales acquire Hotspot FX, which operates a leading spot FX
• Restricted share (Rule 144) sales and 10b5-1 programs marketplace for institutions. Hotspot provides clients and
• Share repurchase programs banks with access to electronic foreign exchange spot
• Strategic accumulations and disposals trade execution through an advanced, ECN-based platform.
Direct Market Access – Direct Trading Institutional When the acquisition closes, clients will have direct access
Through Direct Trading Institutional, Knight offers institu- to neutral, anonymous and transparent marketplaces where
tions and hedge funds direct market access via an electronic they can control their trade executions, and gain the poten-
platform designed to provide superior access to multiple tial for price improvement and lower overall trading costs.
execution venues without the need for multiple systems
on the trading desk. • High-speed, reliable trade executions
on a fully electronic platform
• Posts orders directly to ECNs and Nasdaq’s • Anonymous
SuperMontage, NYSE/AMEX and all domestic • Neutral
options exchanges • Transparent
• Utilizes all native order functionality of ECNs • Direct access through multiple channels
and exchanges • Opportunity for price improvement
• Makes available advanced algorithmic order types • Liquidity in more than 24 currency pairs
• Reduces transaction and market impact costs
• Integrates options and futures capabilities Institutional Block Trading
• Provides access to an agency execution desk Knight provides block trading for NYSE, Nasdaq, interna-
tional (ordinaries and ADRs) and AMEX securities from
ECN – Direct Edge ECNsm its institutional block desk. We offer our clients superior
Direct Edge ECN allows market participants to match service, capital facilitation and access to our combined
trades in Nasdaq NMS and Nasdaq Small Cap securities by broker-dealer and institutional order flow.
displaying their orders in either the Nasdaq Market Center
(SuperMontage) or NASD Alternative Display Facility (ADF). We are a leader in trading listed securities in the third
market and can also execute through brokers on the floor.
As consolidation continues and ECNs merge with Our strength in small- and mid-cap Nasdaq securities is
exchanges, Direct Edge ECN provides market participants unparalleled. With approximately 80% of our listed
another competitive alternative trade execution venue. order flow and 90% of our Nasdaq order flow executed
Our goal is for Direct Edge ECN to offer enhanced automatically, our traders and sales traders can focus on
trading flexibility, broadened access to liquidity, ano- the complex trades and the market dynamics that impact
nymity and industry-leading order fulfillment rates at our clients’ returns.
very competitive prices.
Knight 19
• Depth and breadth of coverage International Market Access
• Access to substantial broker-dealer order flow Knight offers real-time sales and trading for broker-dealers
• Tailored service and competitive commission rates and institutions in European and international markets
• Electronic trading platform (ordinaries and ADRs) through our London-based trading
• Capital facilitation in domestic and foreign markets operation and dedicated international trading desk in
Jersey City.
Institutional Corporate Access
As the largest market maker in small- and mid-cap As a member of the London Stock Exchange, Euronext N.V.
securities, Knight is in a unique position to help establish and Deutsche Börse,* Knight offers clients broad market
relationships between corporate management and our access to major European markets. Our sales traders
institutional clients. Institutional Corporate Access focuses provide first-rate service and have the talent, capital facili-
on companies with limited sell-side coverage within the tation and liquidity to make our clients’ trades happen.
small- and mid-cap space.
• Comprehensive, unbundled execution services
Because Knight does not provide fundamental • Focus on trade execution quality
research, Institutional Corporate Access is an unbiased • State-of-the-art trading technology and connectivity
and unique platform for portfolio managers to meet using FIX, Bloomberg, Swift, ROR, Knight portal
with corporate executives. • Tailored service and competitive commission rates
• Capital facilitation in foreign markets – Asia/Far East,
We offer access to management across the U.S. and in Canada, Europe and Latin America
Europe for cash equity securities. *Exchange memberships as of March 14, 2006
• Unbiased access to small- and mid-cap companies that Knight Match
have limited or no sell-side analyst coverage Knight Match is an agency-only crossing network that
• Organization and scheduling of one-on-one meetings enables our institutional clients to cross with our broker-
with senior management of U.S., U.K. and European dealer order flow for cash equity securities.
small- and mid-cap companies
• Customized non-deal road shows, small group meetings Institutions can route orders directly to Knight Match for
and issuer site visits passive, anonymous interaction with our broker-dealer
order flow, or orders can be routed to Knight’s program
Institutional Sales Trading desk, which will manage the list of securities via Knight
At Knight, institutional sales trading means attention to Match or in the marketplace.
every order. Clients count on our experienced sales traders
and traders to help them with execution solutions, such as • Unrivaled liquidity in small- and mid-cap stocks
access to liquidity, maintaining anonymity and achieving • Agency-only crossing network
minimal market impact. • Access to more than 75% of our broker-dealer order flow
• Direct access or via our program desk
• Unrivaled liquidity created by substantial order flow in a
wide breadth of securities, supported by capital facilitation Portfolio Financing – S3 Partners
• Market insight through experienced sales traders Knight offers portfolio financing and treasury funding
• Industry-leading trade execution quality* solutions for hedge funds through a strategic relationship
• Established connectivity with S3 Partners (S3).*
• Direct market access products
• Tailored service and competitive commission rates S3 manages collateral on an agency basis and structures
*According to YTD averages of SEC 11Ac1-5. Data provided by the Transaction funding programs for hedge funds. These portfolio financing
Auditing Group, Inc. (TAG) “Comparison Tool”
solutions allow hedge fund managers to increase their
own product sophistication and footprint with their prime
20 The Knight Difference
broker, creating an opportunity for the prime broker to • AMEX
deliver more product and flow to the hedge fund. • Knight Match (crossing with broker-dealer flow)
• Knight sales traders and traders
S3’s services are designed to create greater transparency in • Bulletin Board and Pink Sheets issues
the securities finance market and enhanced portfolio returns.
Research – Technical
• Lending longs Knight Research combines expertise from one of the most
• Re-financing securities borrowed well-known teams on the Street. The team communicates
• Margin management actionable, relevant investment ideas – from intraday
• Prime broker optimization trading ideas to commentary on long-term trends across
• Cash management multiple asset classes – to add value to clients’ trade
*S3 Partners is an unaffiliated company that provides outsourced portfolio executions and portfolios.
financing for asset managers and hedge funds
Knight’s proprietary technology will allow clients to cus-
Private Placement
tomize research reports to receive only the information of
Through Knight Capital Markets, Private Placement can
interest and need. For the first time, clients will be able
provide corporate finance and capital markets services
to choose from several research products and tailor those
focused on mid-cap companies. We are committed to the
reports. We also provide customized presentations to port-
long-term success of our clients through these services
folio managers, analysts and traders through in-house
and through capital raising as placement agent for private
teach-ins as well as market presentations.
placements for public and private companies.
• More than 60 years of combined technical research
• Financial and strategic services
experience
• Capital placement
• Investment ideas across markets – equities, fixed income,
• Capital raising
currencies and commodities
• Range of investment horizons – from short-term to
Program Trading
long-term
The combination of Knight’s liquidity, technology and
• Tailored, in-house presentations and market discussions
client service sets our program trading apart. We analyze
• Customizable distribution technology
every trade list of securities before trading begins to deter-
mine the strategy best suited to achieve client objectives.
Global Markets
We give each trade the attention it deserves, aiming to
help clients eliminate market impact.
Special Situations
Specializing in risk arbitrage execution strategies, Special
Knight’s internally developed program trading platform
Situations is a valuable resource for the multi-strategist
provides our traders with the tools to handle complex
interested in tapping our experience. Because we trade
trades. Dynamic sorting and monitoring alerts enable
nearly every security, Knight can generally cover both
traders to focus on those stocks where human input is
sides of every transaction.
more valuable than black box trading. We provide pre-
and post-trade reports so clients have trade cost estimates
• Specializing in U.S. and Canadian merger activity
and can measure execution quality against any number of
• Single-stock and spread executions in equities associated
benchmarks. Web access enables clients to view real-time
with announced deals
executions versus benchmarks.
• Ability to facilitate cross-border merger and acquisition
when one entity is a U.S. company
Expansive order routing:
• Focus on speculative merger and acquisition activity,
• Internally developed algorithms
distressed equities and other special situations
• External algorithms (from Algorithm Trading Solutions)
• Capital facilitation
• ECNs
• Experienced merger arbitrage and equity trading from
• NYSE
both the buy side and sell side
Knight 21
The science of trading. The standard of trust.
TM
22 The Knight Difference
Knight Capital Group, Inc.
2005 Financial Review
Selected Financial Data 24
Management’s Discussion and Analysis of 26
Financial Condition and Results of Operations
Consolidated Quarterly Results (unaudited) 43
Consolidated Statements of Financial Condition 44
Consolidated Statements of Operations 45
Consolidated Statements of Changes in Stockholders’ Equity 46
Consolidated Statements of Cash Flows 48
Notes to Consolidated Financial Statements 49
Management’s Report on Internal Control 64
Over Financial Reporting
Report of Independent Registered Public Accounting Firm 65
Management Team and Board of Directors 67
Corporate Headquarters and Offices 68
Selected Financial Data
The following selected consolidated financial data are qualified by the Consolidated Financial Statements of Knight Capital
Group, Inc. (collectively “Knight” or the “Company”) and the Notes thereto included elsewhere in this document. The fol-
lowing should be read in conjunction with the Consolidated Financial Statements and the discussion under Management’s
Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this document. The
Consolidated Statements of Operations Data for 2005, 2004 and 2003 and the Consolidated Statements of Financial
Condition Data at December 31, 2005 and 2004 have been derived from our audited Consolidated Financial Statements
included elsewhere in this document. The Consolidated Statements of Operations Data for 2002 and 2001 and the
Consolidated Statements of Financial Condition Data at December 31, 2003, 2002 and 2001 are derived from
Consolidated Financial Statements not included in this document.
For the years ended December 31, 2005 2004 2003 2002 2001
(In thousands, except share and per share data)
Consolidated Statements of Operations Data(1):
Revenues
Commissions and fees $296,222 $276,011 $163,147 $ 75,599 $ 28,633
Net trading revenue 165,614 250,993 290,938 269,323 451,877
Asset management fees 89,227 77,658 57,903 34,510 36,757
Interest and dividends, net 9,019 4,647 3,657 5,357 16,505
Investment income and other 74,541 16,441 30,264 13,199 8,521
Total revenues 634,623 625,750 545,909 397,988 542,293
Transaction-based expenses
Execution and clearance fees 99,427 111,788 102,659 85,917 96,305
Soft dollar and commission recapture 63,671 60,118 9,986 7,372 6,252
Payments for order flow and ECN rebates 21,220 36,632 32,179 36,306 52,482
Total transaction-based expenses 184,318 208,538 144,824 129,595 155,039
Revenues, net of transaction-based expenses 450,305 417,212 401,085 268,393 387,254
Other direct expenses
Employee compensation and benefits 229,460 244,550 206,860 169,044 192,880
Communications and data processing 32,513 28,896 27,992 31,077 42,017
Professional fees 19,555 14,915 10,993 16,384 13,461
Depreciation and amortization 16,355 14,248 19,385 26,658 33,147
Occupancy and equipment rentals 13,554 16,852 17,449 21,554 21,290
Business development 6,419 8,269 7,160 6,852 9,580
Writedown of assets and lease loss accrual 10,055 3,810 16,508 15,423 17,658
Regulatory charges and related matters 5,703 79,342 – – –
International charges – – – 31,221 –
Other 11,540 6,844 11,152 13,771 14,289
Total other direct expenses 345,154 417,726 317,499 331,984 344,322
Income (loss) before income taxes, minority
interest and discontinued operations 105,151 (514) 83,586 (63,591) 42,932
Income tax expense (benefit) 38,912 9,258 32,497 (20,139) 21,813
Income (loss) before minority interest and
discontinued operations 66,239 (9,772) 51,089 (43,452) 21,119
Minority interest in consolidated subsidiaries – – – 5,101 6,477
Net income (loss) from continuing operations $ 66,239 $ (9,772) $ 51,089 $ (38,351) $ 27,596
Income (loss) from discontinued operations,
net of tax $ 122 $100,904 $ (13,016) $ (4,886) $ 8,747
Net income (loss) $ 66,361 $ 91,132 $ 38,073 $ (43,237) $ 36,343
(1) Certain prior year amounts have been reclassified to conform to current year presentation.
24 The Knight Difference
For the years ended December 31, 2005 2004 2003 2002 2001
(In thousands, except share and per share data)
Basic earnings per share from
continuing operations $ 0.64 $ (0.09) $ 0.46 $ (0.32) $ 0.22
Diluted earnings per share from
continuing operations $ 0.62 $ (0.08) $ 0.43 $ (0.32) $ 0.22
Basic earnings per share from
discontinued operations $ – $ 0.90 $ (0.12) $ (0.04) $ 0.07
Diluted earnings per share from
discontinued operations $ – $ 0.86 $ (0.11) $ (0.04) $ 0.07
Basic earnings per share $ 0.64 $ 0.81 $ 0.34 $ (0.36) $ 0.29
Diluted earnings per share $ 0.62 $ 0.77 $ 0.32 $ (0.36) $ 0.29
Shares used in computation of
basic earnings per share 103,455,791 112,423,158 112,023,419 120,771,786 123,796,181
Shares used in computation of
diluted earnings per share 106,881,855 117,636,085 117,749,743 120,771,786 125,758,863
December 31, 2005 2004 2003 2002 2001
Consolidated Statements of
Financial Condition Data:
Cash and cash equivalents $ 230,591 $ 445,539 $ 249,998 $ 236,629 $ 344,553
Securities owned, held at clearing brokers,
at market value 380,367 254,473 201,239 143,357 417,071
Investment in Deephaven sponsored funds 281,657 215,330 197,605 148,688 50,919
Assets within discontinued operations – – 2,938,223 2,411,285 1,928,946
Total assets 1,416,016 1,394,020 3,960,228 3,174,058 3,228,980
Securities sold, not yet purchased,
at market value 345,457 221,421 173,119 84,715 343,908
Liabilities within discontinued operations – – 2,808,167 2,200,504 1,747,395
Total stockholders’ equity 823,448 851,202 787,096 753,832 831,667
(1) Certain prior year amounts have been reclassified to conform to current year presentation.
Knight 25
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Executive Overview Expenses”) and (iii) income (loss) from continuing opera-
We are a leading financial services firm that provides tions before Regulatory charges and related matters and
comprehensive trade execution solutions and asset Writedown of assets and lease loss accrual and income
management services. We continually apply knowledge taxes (“Pre-Tax Operating Earnings”) of our segments
and innovation to the trading and asset management and on a consolidated basis (in millions):
processes to build lasting client partnerships through 2005 2004 2003
consistent performance and superior client service. Asset Management
We have two operating business segments, Asset Revenues $ 89.8 $ 78.2 $ 58.4
Management and Global Markets, as well as a Operating Expenses 63.2 48.6 28.9
Corporate segment. Pre-Tax Operating Earnings 26.5 29.6 29.5
Global Markets
• Asset Management – Our Asset Management business, Revenues 470.7 531.0 459.0
Deephaven Capital Management, is a global multi-strategy Operating Expenses 425.6 461.1 387.2
alternative investment manager focused on delivering Pre-Tax Operating Earnings 45.1 69.9 71.8
attractive risk-adjusted returns with low correlation to the Corporate
broader markets for institutions and private clients. Assets Revenues 74.2 16.6 28.5
under management were $2.9 billion as of December 31, Operating Expenses 24.9 33.5 29.7
2005, down from $3.6 billion of assets under manage- Pre-Tax Operating Earnings 49.3 (16.9) (1.2)
Consolidated
ment as of December 31, 2004.
Revenues 634.6 625.8 545.9
• Global Markets – We provide a broad range of custom- Operating Expenses 513.7 543.2 445.8
Pre-Tax Operating Earnings $120.9 $ 82.6 $100.1
ized trade execution products and services across multiple
asset classes for broker-dealers, institutions and issuer Totals may not add due to rounding
companies. We make a market or trade in nearly every
U.S. equity security and provide trade executions in a Consolidated revenues in 2005 increased $8.8 million, or
large number of international securities. 1% from 2004, while consolidated Operating Expenses
decreased $29.5 million or 5% from 2004. Overall,
The Company’s Corporate segment includes all corpo- Consolidated Pre-Tax Operating Earnings increased
rate overhead expenses and investment income earned $38.3 million, or 46% from 2004, primarily attributable
on strategic investments and our corporate investment in to gains on the sales of our strategic investments within
funds managed by the Asset Management segment (the our Corporate segment. The changes in our Pre-Tax
“Deephaven Funds”). Corporate overhead expenses pri- Operating Earnings by our segments from 2004 to
marily consist of compensation for certain senior executives 2005 are summarized as follows:
and other individuals employed at the corporate holding
company, legal and other professional expenses related to • Asset Management – Our 2005 Pre-Tax Operating Earn-
corporate matters, investor and public relations expenses ings from Asset Management were down slightly from
and directors’ and officers’ insurance. 2004, primarily due to the impact of higher profitability-
based compensation and other operating expenses,
In the fourth quarter of 2004, the Company completed the offset by slightly higher blended fund returns.
sale of one of its business segments, Derivative Markets, to
Citigroup Financial Products Inc. (“Citigroup”). In accordance • Global Markets – Our 2005 Pre-Tax Operating Earnings
with generally accepted accounting principles (“GAAP”), from Global Markets were down 35% from 2004, pri-
the results of this segment have been included within marily due to greater competition for broker-dealer client
discontinued operations for all periods presented. For a order flow and reduced revenue capture metrics offset,
further discussion of the sale of the Company’s Derivative in part, by decreased losses incurred from our expanded
Markets business, see Footnote 9 “Discontinued Operations” London operation.
included in the Consolidated Financial Statements con-
• Corporate – The results from our Corporate segment
tained elsewhere in this document.
were positively impacted by realized gains from the sales
The following table sets forth: (i) revenues, (ii) expenses of our corporate equity investments in the International
excluding Regulatory charges and related matters and Securities Exchange, Inc. (“ISE”) and The Nasdaq Stock
Writedown of assets and lease loss accrual (“Operating Market, Inc. (“Nasdaq”), as well as slightly higher returns
on our corporate investment in the Deephaven Funds.
26 The Knight Difference
A reconciliation of income (loss) from continuing opera- also can be no assurance that we will be able to return
tions before income taxes in accordance with GAAP to the rates of revenue growth that we have experienced
(“Pre-Tax GAAP Income”) to Pre-Tax Operating Earnings in the past or that we will be able to improve our operat-
and of total GAAP expenses to Operating Expenses is ing results.
included elsewhere in this section.
Trends
Certain Factors Affecting Results of Operations We believe that our continuing operations are currently
We have experienced, and expect to continue to experience, impacted by the following trends that may affect our
significant fluctuations in operating results due to a variety financial condition and results of operations.
of factors, including, but not limited to, introductions or
enhancements to trade execution services by us or our com- • Over the past several years, the effects of market struc-
petitors; the value of our securities positions and our ability ture changes, competition and market conditions have
to manage the risks attendant thereto; the volume of our resulted in a decline in revenue capture per U.S. equity
market-making activities; the dollar value of securities dollar value traded in our Global Markets operations.
traded; volatility in the securities markets; our market • Retail broker-dealer participation in the equity markets
share with institutional and broker-dealer clients; the has fluctuated over the past few years due to investor
performance, amount of, and volatility in, the results sentiment, market conditions and a variety of other
of our quantitative market-making and program trading factors. Retail transaction volumes may not be sustain-
portfolios; the performance of our international opera- able and are not predictable.
tions; our ability to manage personnel, overhead and
other expenses, including our occupancy expenses under • Broker-dealer clients continue to focus on statistics
our office leases and expenses and charges related to measuring the quality of equity executions (including
our legal and regulatory proceedings; the strength of our speed of executions and price improvement). In an
client relationships; changes in payments for order flow effort to improve the quality of their executions as well
and clearing, execution and regulatory transaction costs; as increase efficiencies, market-makers have increased
the level of assets under management and fund returns; the level of automation within their operations. The
the addition or loss of executive management and asset greater focus on execution quality has resulted in
management, sales and trading and technology profes- greater competition in the marketplace, which has
sionals; legislative, legal and regulatory changes; legal negatively impacted the revenue capture metrics of
and regulatory matters; geopolitical risk; the amount and the Company and other market-making firms.
timing of capital expenditures, acquisitions and divesti-
tures; the integration, performance and operation of • Market structure changes, competition and market
acquired businesses; the incurrence of costs associated conditions have triggered an industry shift toward
with acquisitions and dispositions; investor sentiment; market-makers charging explicit commissions or com-
technological changes and events; seasonality; competi- mission equivalents to institutional clients for executions
tion and market and economic conditions. Such factors in OTC securities. For the majority of our institutional client
may also have an impact on our ability to achieve our orders, we currently charge explicit fees in the form of
strategic objectives, including, without limitation, increases commissions or commission equivalents. In addition,
in our institutional market share and revenue capture in institutional commission rates have fallen in the past
our Global Markets segment and increases in our fund few years, and may continue to fall in the future.
returns and assets under management in our Asset Man- • Due to regulatory scrutiny over the past several years relat-
agement segment. If demand for our services declines in ing to equity sell-side research and the continued focus
either of our segments due to any of the above factors, by investors on execution quality and overall transaction
and we are unable to adjust our cost structure on a timely costs, more institutional clients allocate commissions to
basis, our operating results and strategic objectives could broker-dealers based on the quality of executions. In the
be materially and adversely affected. past, institutional equity commissions were primarily allo-
As a result of the foregoing factors, period-to-period cated to broker-dealers in exchange for either research
comparisons of our revenues and operating results are or soft dollar and commission recapture programs.
not necessarily meaningful and such comparisons cannot
be relied upon as indicators of future performance. There
Knight 27
Management’s Discussion and Analysis of Financial Condition and Results of Operations
• There has been increased scrutiny of equity and option We earn interest income from our cash held at banks
market-makers, hedge funds and soft dollar practices by and cash held in trading accounts at clearing brokers. The
the regulatory and legislative authorities. New legislation Company’s clearing agreements call for payment or receipt
or modifications to existing regulations and rules could of interest income, net of transaction-related interest
occur in the future. charged by clearing brokers for facilitating the settlement
and financing of securities transactions. Net interest is
• There has been consolidation among market centers primarily affected by interest rates, the changes in cash
over the past year, and several regional exchanges have balances held at banks and clearing brokers and our level
entered into joint ventures with broker-dealers to create of securities positions in which we are long compared to
their own alternative trading systems, (i.e. ECNs) and our securities positions in which we are short.
compete within the OTC and listed trading venues.
Investment income and other income primarily represents
• There has been a proliferation of alternative investment income earned, net of losses, related to our corporate
entities, which has had the effect of materially increasing investment in the Deephaven Funds and our strategic
competition for new investor assets. investments. Such income is primarily affected by the level
Income Statement Items of our corporate investments in our Deephaven Funds and
The following section briefly describes the key components rates of return earned by the Deephaven Funds as well as
of, and drivers to, our significant revenues and expenses. the performance and activity of our strategic investments.
Revenues Transaction-based expenses
Our revenues consist principally of Commissions and fees Transaction-based expenses include transaction-based
and Net trading revenue from U.S. securities trading and variable expenses directly incurred in conjunction with
market-making activities from Global Markets. Revenues generating revenues and consist of Execution and clear-
on transactions for which we charge explicit commissions ance fees, Soft dollar and commission recapture expense,
or commission equivalents, which include the majority of and Payments for order flow and ECN rebates.
our institutional client orders, are included within Com- Execution and clearance fees primarily represent clear-
missions and fees. Commissions and fees are primarily ance fees paid to clearing brokers for equities transactions,
affected by changes in our equity transaction volumes transaction fees paid to Nasdaq and other exchanges and
with institutional clients, changes in commission rates, regulatory bodies, and execution fees paid to third parties,
the growth of our soft dollar and commission recapture primarily for executing trades in listed securities on the
activity as well as by changes in fees earned for directing New York Stock Exchange (“NYSE”) and American Stock
trades to certain destinations for execution and from Exchange (“AMEX”), and for executing orders through
certain market data providers. third party ECNs. Execution and clearance fees primarily
Trading profits and losses on principal transactions are fluctuate based on changes in equity trade and share
included within Net trading revenue. These revenues volume, clearance fees charged by clearing brokers
are primarily affected by changes in the amount and and fees paid to access ECNs, exchanges and certain
mix of U.S. equity trade and share volumes, our revenue regulatory bodies.
capture, dollar value of equities traded, our ability to derive Soft dollar and commission recapture expense represent
trading gains by taking proprietary positions, changes payments to institutions in connection with our soft dollar
in our execution standards, volatility in the marketplace, and commission recapture programs. Soft dollar and
industry commission levels, our mix of broker-dealer and commission recapture expense fluctuates based on U.S.
institutional clients, and regulatory changes and evolving equity share volume executed on behalf of institutions.
industry customs and practices.
Payments for order flow and ECN rebates represent pay-
Asset management fees represent fees earned by ments to broker-dealer clients, in the normal course of
Deephaven for sponsoring and managing the Deephaven business, for directing to us their order flow in U.S. equities
Funds. These fees consist of annual management fees, and rebates for providing liquidity to our ECN, Direct Edge.
calculated as fixed percentages of assets under manage-
ment, and incentive fees, which, in general, are calculated
as a percentage of the funds’ annual profits, if any.
28 The Knight Difference
Payments for order flow and ECN rebates fluctuate as we our overall profitability. Compensation for employees
modify our rates and as our percentage of clients whose engaged in sales activities is determined primarily based
policy is not to accept payments for order flow varies. on a percentage of their gross revenues net of certain
Payments for order flow and ECN rebates also fluctuate expenses including soft dollar and commission recapture
based on U.S. equity share volume, our profitability and expenses, execution and clearance costs and overhead
the mix of market orders and limit orders. allocations. The majority of compensation in Asset Man-
agement is determined based on a profitability-based
Other direct expenses formula, subject to certain minimum guaranteed payments.
Other direct expenses mostly consist of Employee compen- Employee compensation and benefits expense fluctuates,
sation and benefits, Communications and data processing, for the most part, based on changes in our revenues,
Professional fees, Depreciation and amortization and profitability and the number of employees.
Occupancy and equipment rentals.
Communications and data processing expense primarily
Employee compensation and benefits expense, our largest consists of costs for obtaining market data, telecommuni-
expense, primarily consists of salaries and wages paid to cations services and systems maintenance.
all employees and profitability-based compensation, which
includes compensation paid to sales personnel and incen-
tive compensation paid to all other employees based on
Results of Operations
The following table sets forth the consolidated statements of operations data as a percentage of total revenues:
For the years ended December 31, 2005 2004 2003
Revenues
Commissions and fees 46.7% 44.1% 29.9%
Net trading revenue 26.1% 40.1% 53.3%
Asset management fees 14.1% 12.4% 10.6%
Interest and dividends, net 1.4% 0.8% 0.7%
Investment income and other 11.7% 2.6% 5.5%
Total revenues 100.0% 100.0% 100.0%
Transaction-based expenses
Execution and clearance fees 15.7% 17.9% 18.8%
Soft dollar and commission recapture expense 10.0% 9.6% 1.8%
Payments for order flow and ECN rebates 3.3% 5.9% 5.9%
Total transaction-based expenses 29.0% 33.3% 26.5%
Revenues, net of transaction-based expenses 71.0% 66.7% 73.5%
Other direct expenses
Employee compensation and benefits 36.2% 39.1% 37.9%
Communications and data processing 5.1% 4.6% 5.1%
Professional fees 3.1% 2.4% 2.0%
Depreciation and amortization 2.6% 2.3% 3.6%
Occupancy and equipment rentals 2.1% 2.7% 3.2%
Business development 1.0% 1.3% 1.3%
Writedown of assets and lease loss accrual 1.6% 0.6% 3.1%
Regulatory charges and related matters 0.9% 12.7% 0.0%
Other 1.8% 1.1% 2.1%
Total other direct expenses 54.4% 66.8% 58.2%
Income (loss) from continuing operations before income taxes 16.6% (0.1)% 15.3%
Income tax expense 6.1% 1.5% 6.0%
Net income (loss) from continuing operations 10.5% (1.6)% 9.4%
Income (loss) from discontinued operations, net of tax 0.0% 16.1% (2.3)%
Net income 10.5% 14.6% 7.0%
Knight 29
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Years Ended December 31, 2005 and 2004
Continuing Operations
Revenues
Asset Management
% of
For the years ended December 31, 2005 2004 Change Change
Total Revenues from Asset Management (millions) $ 89.8 $ 78.2 $ 11.6 14.9%
Average month-end balance of assets under management (millions) $3,291.1 $2,963.5 $327.7 11.1%
Annual fund return to investors* 7.2% 6.5% 0.6% 9.6%
*Annual fund return represents the blended annual return across all assets under management in the Deephaven Funds.
Total revenues from the Asset Management segment, which The average month-end balance of assets under manage-
primarily consists of Asset management fees, increased ment increased to $3.3 billion in 2005, from $3.0 billion
14.9% to $89.8 million in 2005, from $78.2 million in in 2004. The blended annual fund return across all assets
2004. The increase is due to higher incentive fees as a under management for 2005 was 7.2%, up from 6.5%
result of an increase in fund returns as well as higher in 2004.
management fees due to the growth in the average
month-end balance of assets under management.
Global Markets
% of
For the years ended December 31, 2005 2004 Change Change
Commissions and fees (millions) $ 296.2 $ 276.0 $ 20.2 7.3%
Net trading revenue (millions) 165.6 251.0 (85.4) (34.0)%
Interest and dividends, net (millions) 6.6 3.8 2.8 74.1%
Investment income and other (millions) 2.2 0.2 2.0 1,180.8%
Total Revenues from Global Markets (millions) $ 470.7 $ 531.0 $ (60.3) (11.4)%
U.S. equity dollar value traded ($ billions) 1,882.2 1,730.7 151.5 8.8%
U.S. equity trades executed (millions) 204.1 205.9 (1.8) (0.9)%
Nasdaq and Listed equity shares traded (billions) 106.3 125.5 (19.2) (15.3)%
OTC Bulletin Board and Pink Sheet shares traded (billions) 718.8 1,349.6 (630.8) (46.7)%
Average revenue capture per U.S. equity dollar value traded (bps) 1.8 2.5 (0.7) (28.2)%
Total revenues from our Global Markets segment, which the Company believes it is owed by a counterparty in
primarily comprises Commissions and fees and Net trading a trading dispute (the “Dispute Reserve”). This reserve
revenue from the domestic businesses, decreased 11.4% reduced net trading revenues by $6.5 million in 2004.
to $470.7 million in 2005, from $531.0 million in 2004.
Revenues in 2005 were positively impacted by Direct Average revenue capture per U.S. equity dollar value traded
Trading and Direct Edge, which were acquired in June was 1.8 basis points (“bps”) in 2005, down 28.2% from
and October 2005, respectively, and higher dollar volumes, 2.5 bps in 2004. Average revenue capture per U.S. equity
offset by lower average revenue capture per U.S. equity dollar value traded is calculated as the total of net trading
dollar value traded. Our revenue capture was impacted revenues plus institutional commissions and commission
during 2005 by greater competition, regulatory changes equivalents (included in Commissions and fees), less certain
and market conditions. Excluding the impact of Direct transaction-related regulatory fees (included in Execution
Trading and Direct Edge, total revenues from Global and clearance fees), (collectively “Core Equity Revenues”)
Markets would have decreased 16.2% to $444.9 million divided by the total dollar value of the related equity trans-
in 2005, from $531.0 million in 2004. In 2004, the Com- actions. We removed the impact of the Dispute Reserve
pany recorded a reserve of $6.5 million against the amount of $6.5 million from our revenue capture calculation for
2004. Core Equity Revenues were $330.4 million and
$424.7 million in 2005 and 2004, respectively.
30 The Knight Difference
Corporate
% of
For the years ended December 31, 2005 2004 Change Change
Total Revenues from Corporate (millions) $ 74.2 $ 16.6 $57.5 346.4%
Average corporate investment balance in the Deephaven Funds (millions) $272.6 $216.9 $55.7 25.7%
Total revenues from the Corporate segment, which primar- 39.1% in 2004. Excluding gains from the sales of our ISE
ily represents income from our corporate investments in the and Nasdaq investments, Employee compensation and
Deephaven Funds and other strategic investments, increased benefits as a percentage of total revenues increased slightly
to $74.2 million. In 2005, the Company sold 70% of its to 39.6% in 2005 from 39.1% in 2004. The number of
original equity ownership of the ISE and its entire Nasdaq full time employees in our continuing operations increased
equity investment which resulted in pre-tax gains of to 720 employees at December 31, 2005, from 683
$34.2 million and $21.7 million, respectively. Excluding employees at December 31, 2004, primarily due to the
these gains on our strategic investments, total revenues acquisitions of Direct Trading and Direct Edge.
from the Corporate segment were $18.3 million in 2005,
up 10% from 2004. Income from our corporate invest- Communications and data processing expense increased
ments in the Deephaven Funds rose 28.0% to $16.3 mil- 12.5% to $32.5 million in 2005, from $28.9 million in
lion in 2005 from $12.8 million in 2004. This increase was 2004. This increase was attributable to additional costs
due to a higher average investment balance and higher from Direct Trading and a general increase in technology
average returns on such investment. and market data costs.
Transaction-based expenses Depreciation and amortization expense increased 14.8%
Execution and clearance fees decreased 11.1% to to $16.4 million in 2005, from $14.2 million in 2004. This
$99.4 million in 2005, from $111.8 million in 2004. As increase was primarily due to purchases of fixed assets
a percentage of total revenue, Execution and clearance and leasehold improvements at our new facility at 545
fees decreased to 15.7% in 2005, from 17.9% in 2004. Washington Boulevard, Jersey City, N.J., as well as deprecia-
Execution and clearance fees were 17.2% of 2005 total tion and amortization related to Direct Trading and Direct
revenues excluding gains on the sales of our strategic Edge. Occupancy and equipment rentals expense decreased
investments. Execution and clearance fees fluctuate 19.6% to $13.6 million in 2005, from $16.9 million in
based on changes in transaction volumes, regulatory 2004, primarily due to lease loss accruals related to our
fees and efficiencies in processing the transactions. Jersey City, N.J. office locations.
Soft dollar and commission recapture expense increased Professional fees increased 31.1% to $19.6 million in 2005,
5.9% to $63.7 million in 2005, from $60.1 million in from $14.9 million in 2004. The increase in 2005 was pri-
2004, primarily due to the addition of the Direct marily due to an increase in legal expenses, which have
Trading business. fluctuated based on the activity relating to our various
legal and regulatory proceedings, and consulting expenses.
Payments for order flow and ECN rebates decreased
42.1% to $21.2 million in 2005, from $36.6 million in Business development expense decreased to $6.4 million
2004. As a percentage of total revenue, Payments for in 2005, compared to $8.3 million in 2004. The primary
order flow and ECN rebates decreased to 3.3% in 2005, reason for the decrease was lower travel and entertain-
from 5.9% in 2004. The decrease on a dollar basis is ment costs.
primarily due to changes in our payment for order flow Other expenses increased to $11.5 million in 2005, com-
policies initiated in the second quarter of 2005. pared to $6.8 million in 2004. Other expenses in 2004
Other direct expenses included a benefit of approximately $3.0 million related
Employee compensation and benefits expense decreased to an adjustment to legal reserves established during
6.2% to $229.5 million in 2005, from $244.5 million in 2003. Excluding the impact of this one-time adjustment
2004. As a percentage of total revenue, Employee com- in 2004, Other expenses increased 17% due to costs
pensation and benefits decreased to 36.2% in 2005 from associated with the move of our corporate headquarters,
as well as higher general and administrative costs.
Knight 31
Management’s Discussion and Analysis of Financial Condition and Results of Operations
During 2005, we incurred charges of $15.8 million, con- For a discussion of the $79.3 million charge for regulatory
sisting of $10.1 million of writedowns of assets and lease and related matters, refer to Footnote 12 “Regulatory Charges
loss accruals primarily related to the costs associated with and Related Matters” included in the Consolidated Finan-
excess real estate capacity in our Jersey City, N.J. facilities, cial Statements contained elsewhere in this document.
and $5.7 million related to charges for regulatory and
related matters. Our effective tax rate for 2005 from continuing opera-
tions of 37% differed from the federal statutory rate of
During 2004, we incurred charges of $83.2 million, con- 35% primarily due to non-deductible penalties related
sisting of $79.3 million related to charges for regulatory to charges for regulatory and related matters and state
and related matters and $3.8 million of writedowns of income taxes.
assets and lease loss accruals primarily related to the costs
associated with excess real estate capacity in Jersey City, N.J.
Years Ended December 31, 2004 and 2003
Continuing Operations
Revenues
Asset Management
% of
For the years ended December 31, 2004 2003 Change Change
Total Revenues from Asset Management (millions) $ 78.2 $ 58.4 $ 19.7 33.7%
Average month-end balance of assets under management (millions) $2,963.5 $1,359.4 $1,604.1 118.0%
Annual fund return to investors* 6.5% 13.9% (7.4)% (53.2)%
*Annual fund return represents the blended annual return across all assets under management in the Deephaven Funds.
Total revenues from the Asset Management segment, which The average month-end balance of assets under manage-
primarily consists of Asset management fees, increased ment increased to $3.0 billion in 2004, from $1.4 billion
33.7% to $78.2 million in 2004, from $58.4 million in in 2003. The blended annual fund return across all assets
2003. The increase is due to higher management fees under management for 2004 was 6.5%, down from 13.9%
as a result of the growth in assets under management. in 2003.
Global Markets
% of
For the years ended December 31, 2004 2003 Change Change
Commissions and fees (millions) $ 276.0 $ 163.2 $ 112.8 69.1%
Net trading revenue (millions) 251.0 290.9 (39.9) (13.7)%
Interest and dividends, net (millions) 3.8 2.8 1.1 38.5%
Investment income and other (millions) 0.2 2.1 (2.0) (91.9)%
Total Revenues from Global Markets (millions) $ 531.0 $ 459.0 $ 72.0 15.7%
U.S. equity dollar value traded ($ billions) 1,730.7 1,560.0 170.7 10.9%
U.S. equity trades executed (millions) 205.9 181.3 24.6 13.5%
Nasdaq and Listed equity shares traded (billions) 125.5 138.1 (12.5) (9.1)%
OTC Bulletin Board and Pink Sheet shares traded (billions) 1,349.6 305.3 1,044.3 342.0%
Average revenue capture per U.S. equity dollar value traded (bps) 2.5 2.6 (0.2) (6.8)%
Total revenues from the Global Markets segment, which purchase of the Donaldson business in December 2003, an
primarily comprises Commissions and fees and Net trading increase in our institutional revenues and higher volumes
revenue from the domestic businesses, increased 15.7% in low-priced OTC Bulletin Board and Pink Sheet shares
to $531.0 million in 2004, from $459.0 million in 2003.
Revenues in 2004 were positively impacted by the
32 The Knight Difference
from broker-dealer clients offset, in part, by lower aver- Average revenue capture per U.S. equity dollar value
age revenue capture per U.S. equity dollar value traded. traded was 2.5 bps in 2004, down 6.8% from 2.6 bps
Excluding the impact of Donaldson, total revenues from in 2003. Average revenue capture per U.S. equity dollar
Global Markets would have increased 2.2% to $463.0 mil- value traded is calculated as Core Equity Revenues divided
lion in 2004 compared to $452.9 million in 2003. In 2004, by the total dollar value of the related equity transactions.
the Company recorded a reserve of $6.5 million against the We removed the impact of the Dispute Reserve of $6.5 mil-
amount the Company believes it is owed by a counterparty lion within our revenue capture calculation for 2004. Core
in a trading dispute (the “Dispute Reserve”). This reserve Equity Revenues were $424.7 million and $410.9 million
reduced net trading revenues by $6.5 million in 2004. in 2004 and 2003, respectively.
Corporate
% of
For the years ended December 31, 2004 2003 Change Change
Total Revenues from Corporate (millions) $ 16.6 $ 28.5 $(11.9) (41.8)%
Average corporate investment balance in the Deephaven Funds (millions) $216.9 $183.5 $ 33.4 18.2%
Total revenues from the Corporate segment, which primar- Payments for order flow and ECN rebates increased 13.8%
ily represents income from our corporate investments in to $36.6 million in 2004, from $32.2 million in 2003. As
the Deephaven Funds, decreased 41.8%. Income from a percentage of total revenue, Payments for order flow
our corporate investments in the Deephaven Funds fell remained at 5.9% in both 2004 and 2003. The increase
46.7% to $12.8 million in 2004 from $23.9 million in on a dollar basis is primarily due to an increase in volumes
2003. This decrease is due to lower average returns on and changes in our payment for order flow policies.
our corporate investment offset, in part, by a higher
average investment balance. Other direct expenses
Employee compensation and benefits expense increased
Transaction-based expenses 18.2% to $244.5 million in 2004, from $206.9 million in
Execution and clearance fees increased 8.9% to $111.8 mil- 2003. As a percentage of total revenue, Employee com-
lion in 2004, from $102.7 million in 2003. As a percentage pensation and benefits increased slightly to 39.1% in 2004
of total revenue, Execution and clearance fees decreased from 37.9% in 2003. The increase on a dollar basis was
to 17.9% in 2004, from 18.8% in 2003. The increase on primarily due to the increase in headcount, which was
a dollar basis was due to the increase in equity trades, impacted by the acquisition of Donaldson in December of
the increase in fees related to the London operations 2003 and the expansion of the London operations, and
and the purchase of the Donaldson business offset, in higher profitability-based compensation within the Asset
part, by a reduction in clearance rates. The decrease as a Management business segment. The number of full time
percentage of total revenue was primarily due to lower employees in our continuing operations increased to 683
clearance rates and higher revenues from Asset Man- employees at December 31, 2004, from 677 employees
agement, which has no similar execution and clearance at December 31, 2003.
fees, offset, in part, by a lower average revenue capture
metric in Global Markets. Communications and data processing expense increased
3.2% to $28.9 million in 2004, from $28.0 million in
Soft dollar and commission recapture expense increased 2003. This increase was generally attributable to an
to $60.1 million in 2004, from $10.0 million in 2003. The increase in technology and market data costs.
increase is primarily due to the purchase of the Donaldson
business on December 1, 2003. Depreciation and amortization expense decreased 26.5%
to $14.2 million in 2004, from $19.4 million in 2003. This
decrease was primarily due to assets fully depreciating in the
normal course of business, offset, in part, by the purchases
Knight 33
Management’s Discussion and Analysis of Financial Condition and Results of Operations
of additional fixed assets during 2003 and 2004. Occu- During 2003, we incurred charges of $16.5 million, pri-
pancy and equipment rentals expense decreased 3.4% marily consisting of $9.6 million of a lease loss accrual
to $16.9 million in 2004, from $17.4 million in 2003. related to costs associated with excess real estate capa-
city primarily in Jersey City, N.J. and $6.8 million related
Professional fees increased 35.7% to $14.9 million in 2004, to the writedown of our strategic investment in Nasdaq
from $11.0 million in 2003. The increase in 2004 was pri- to fair value.
marily due to an increase in legal expenses, which have
fluctuated based on the activity relating to our various legal Our effective tax rate for 2004 from continuing operations
and regulatory proceedings, and consulting expenses. differs significantly from the federal statutory rate of 35%
primarily due to non-deductible penalties related to charges
Business development expense increased to $8.3 million for regulatory and related matters and state income taxes.
in 2004, compared to $7.2 million in 2003. The primary
reason for the increase was higher travel and entertain- Reconciliation of Total GAAP Expenses and
ment costs relating to our focus on growing our institu- Pre-Tax GAAP Income to Operating Expenses
tional client base for the Global Markets segment. and Pre-Tax Operating Earnings, Respectively
In an effort to provide additional information regarding
Other expenses decreased to $6.8 million in 2004, com- the Company’s results as determined by GAAP, the
pared to $11.2 million in 2003. The decrease was due to a Company also discloses certain non-GAAP information
benefit of approximately $3.0 million related to an adjust- which management believes provides useful information
ment to legal reserves established during 2003. Excluding to investors. Within this Annual Report, the Company has
the impact of this one-time adjustment from both 2003 disclosed its Operating Expenses and its Pre-Tax Operating
and 2004, Other expenses would have increased by 21% Earnings to assist the reader in understanding the impact
due to higher insurance, general and administrative costs. of Writedown of assets and lease loss accrual and Regula-
During 2004, we incurred charges of $83.2 million, primar- tory charges and related matters on the Company’s annual
ily consisting of $79.3 million related to charges for regula- results for 2005, 2004 and 2003 by segment, thereby
tory and related matters and $3.8 million of writedowns of facilitating more useful period-to-period comparisons of
assets and lease loss accruals primarily related to the costs the Company’s continuing businesses. For additional infor-
associated with excess real estate capacity in Jersey City, N.J. mation related to segments, see Footnote 20 “Business
For a discussion of the $79.3 million charge for regulatory Segments” included in the Consolidated Financial State-
and related matters, refer to Footnote 12 “Regulatory Charges ments contained elsewhere in this document. Charts are
and Related Matters” included in the Consolidated Finan- presented in millions.
cial Statements contained elsewhere in this document.
Total GAAP Expenses to Operating Expenses
Asset Global
For the year ended December 31, 2005 Management Markets Corporate Total
Transaction-based Expenses $ – $184.3 $ – $184.3
Other Direct Expenses 69.0 251.3 24.9 345.2
Total GAAP Expenses 69.0 435.6 24.9 529.5
Writedown of assets and lease loss accrual – (10.0) – (10.0)
Regulatory charges and related matters (5.7) – – (5.7)
Operating Expenses $63.2 $425.6 $24.9 $513.7
Asset Global
For the year ended December 31, 2004 Management Markets Corporate Total
Transaction-based Expenses $ – $208.5 $ – $208.5
Other Direct Expenses 48.6 335.7 33.5 417.7
Total GAAP Expenses 48.6 544.2 33.5 626.3
Writedown of assets and lease loss accrual – (3.8) – (3.8)
Regulatory charges and related matters – (79.3) – (79.3)
Operating Expenses $48.6 $461.1 $33.5 $543.2
34 The Knight Difference
Asset Global
For the year ended December 31, 2003 Management Markets Corporate Total
Transaction-based Expenses $ – $144.8 $ – $144.8
Other Direct Expenses 28.9 258.9 29.7 317.5
Total GAAP Expenses 28.9 403.7 29.7 462.3
Writedown of assets and lease loss accrual – (16.5) – (16.5)
Operating Expenses $28.9 $387.2 $ 29.7 $445.8
Pre-Tax GAAP Income to Pre-Tax Operating Earnings
Asset Global
For the year ended December 31, 2005 Management Markets Corporate Total
Pre-tax GAAP Income $20.8 $ 35.1 $ 49.3 $105.2
Writedown of assets and lease loss accrual – 10.0 – 10.0
Regulatory charges and related matters 5.7 – – 5.7
Pre-tax Operating Earnings $26.5 $ 45.1 $ 49.3 $120.9
Asset Global
For the year ended December 31, 2004 Management Markets Corporate Total
Pre-tax GAAP Income $29.6 $ (13.2) $(16.9) $ (0.5)
Writedown of assets and lease loss accrual – 3.8 – 3.8
Regulatory charges and related matters – 79.3 – 79.3
Pre-tax Operating Earnings $29.6 $ 69.9 $(16.9) $ 82.6
Asset Global
For the year ended December 31, 2003 Management Markets Corporate Total
Pre-tax GAAP Income $29.5 $ 55.3 $ (1.2) $ 83.6
Writedown of assets and lease loss accrual – 16.5 – 16.5
Pre-tax Operating Earnings $29.5 $ 71.8 $ (1.2) $100.1
Liquidity and Capital Resources
Historically, we have financed our business primarily through The Company has previously disclosed its intent to pursue
cash generated by operations, as well as the proceeds from selective acquisitions of (or possible joint ventures with)
our stock issuances and, in 2004, from the proceeds of the complementary businesses primarily in the markets in which
sale of our Derivative Markets segment. As of December 31, our Global Markets and Asset Management segments
2005, we had $1.4 billion in assets related to our continu- operate. We expect to fund the purchase price of any such
ing operations, 59% of which consisted of cash or assets acquisition with our current cash position or, in some cases,
readily convertible into cash, principally receivables from through the issuance of the Company’s stock. In this regard,
brokers and dealers and securities owned. Receivables we have already undertaken several selective acquisitions.
from brokers and dealers include interest bearing cash In April 2005, the Company announced that it had reached
balances held with clearing brokers, including, or net of, an agreement to acquire, for cash, the business of Direct
amounts related to securities transactions that have not Trading Institutional, Inc. (now operating as Direct Trading),
yet reached their contracted settlement date, which is a privately held firm specializing in providing institutions
generally within three business days of the trade date. with direct market access trading through an advanced
Securities owned principally consist of equity securities electronic platform. The transaction closed in June 2005
that trade in Nasdaq, on the OTC Bulletin Board and on with a $40 million initial cash payment. The acquisition of
the NYSE and AMEX markets. At December 31, 2005, the business of Direct Trading contains a two-year contin-
the Company had net current assets, which consists of gency from the date of closing for additional consideration
net assets readily convertible into cash, of approximately based on the profitability of the business. Additionally, in
$248.2 million. Additionally, our corporate investment in May 2005, the Company announced that it had reached
the Deephaven Funds was $281.7 million at December 31, an agreement to acquire, for cash, the business of the
2005. The majority of this investment can be liquidated ATTAIN ECN, an alternative trading system that operates
upon request to Deephaven subject to a ninety-day writ-
ten notification period and monthly redemption limits.
Knight 35
Management’s Discussion and Analysis of Financial Condition and Results of Operations
an electronic communications network (ECN) for the trad- support of the development and growth of our business.
ing of Nasdaq securities. The transaction closed in October Our corporate investment in the Deephaven Funds increased
2005, and currently operates under the name Direct Edge by $66.3 million, $17.7 million and $48.9 million during
ECN. The acquisition of Direct Edge ECN also contains a 2005, 2004 and 2003, respectively.
four-year contingency from the business date of closing
for additional consideration based on meeting certain Capital expenditures related to continuing operations
revenue and client retention metrics. In January 2006, the were $25.7 million, $40.2 million and $6.4 million during
Company agreed to acquire Hotspot FX, Inc., an industry- 2005, 2004 and 2003, respectively. Capital expenditures
leading electronic foreign exchange marketplace that in 2005 and 2004 primarily represented purchases of
provides access to electronic foreign exchange spot trade leaseholds and other fixed assets related to the buildout
executions through an advanced ECN-based platform, of our new headquarters at 545 Washington Boulevard
for approximately $77.5 million in cash. The acquisition in Jersey City, N.J.
is expected to close shortly and is subject to customary At its October 18, 2005 meeting, the Board of Directors
closing conditions. No assurance can be given with authorized an additional increase in the size of the Com-
respect to the operational business effect of these trans- pany’s stock repurchase program from $320 million to
actions or the timing, likelihood or business effect of any $345 million. The Company repurchased 15.9 million
possible transaction. shares during 2005 for $145.1 million under this stock
As discussed elsewhere in this document, we sold our repurchase program. Through December 31, 2005,
Derivative Markets business for approximately $237 mil- the Company had repurchased 37.6 million shares for
lion in cash as of the close of business on December 9, $295.9 million under its stock repurchase program. The
2004. The final purchase price was subject to adjustment Company may repurchase shares in the open market or
based on the final determination of the book value of the through privately negotiated transactions, depending on
Derivative Markets business at the time the deal closed. prevailing market conditions, alternative uses of capital
The result of this adjustment and other expenses related and other factors. The Company cautions that there are
to the sale resulted in additional income of $122,000, no assurances that any further repurchases may actually
net of tax, in 2005. occur. The Company had approximately 103.0 million
shares of Class A Common Stock outstanding as of
Income (loss) from continuing operations before income December 31, 2005.
taxes was $105.2 million, ($514,000) and $83.6 million
for 2005, 2004 and 2003, respectively. Included in these Our U.S. registered broker-dealers are subject to regula-
amounts were certain non-cash expenses such as depreci- tory requirements intended to ensure the general financial
ation and amortization and certain non-cash writedowns. soundness and liquidity of broker-dealers and requiring the
Depreciation expense from continuing operations was maintenance of minimum levels of net capital, as defined
$14.6 million, $13.6 million, and $19.3 million in 2005, in SEC Rule 15c3-1. These regulations also prohibit a
2004 and 2003, respectively. Amortization expense from broker-dealer from repaying subordinated borrowings,
continuing operations, which related to intangible assets, paying cash dividends, making loans to its parent, affiliates
was $1.8 million, $605,000 and $48,000 during 2005, or employees, or otherwise entering into transactions
2004 and 2003, respectively. Non-cash writedowns from which would result in a reduction of its total net capital to
continuing operations were $800,000, $1.2 million and less than 120% of its required minimum capital. Moreover,
$6.8 million during 2005, 2004 and 2003, respectively, broker-dealers are required to notify the SEC and NASD
primarily related to costs associated with fixed assets prior to repaying subordinated borrowings, paying divi-
no longer actively being used and impaired strategic dends and making loans to its parent, affiliates or employ-
investments. ees, or otherwise entering into transactions, which, if
executed, would result in a reduction of 30% or more of
Purchases, net of proceeds, from strategic investments its excess net capital (net capital less minimum require-
and acquisitions related to our continuing operations ment). The SEC has the ability to prohibit or restrict such
were $31.0 million, $11.5 million and $14.0 million transactions if the result is detrimental to the financial
during 2005, 2004 and 2003, respectively. Strategic integrity of the broker-dealer. Additionally, our foreign
investments and acquisition expenditures primarily relate registered broker-dealers are subject to capital adequacy
to outside investments and acquisitions of businesses in requirements of their respective regulatory authorities.
36 The Knight Difference
The following table sets forth the net capital levels and cash resources will be sufficient to meet our anticipated
requirements for the following significant broker-dealer working capital and capital expenditure requirements for
subsidiaries at December 31, 2005, as filed in their at least the next 12 months.
respective regulatory filings (in millions):
Contractual Obligations
Minimum Excess
Net Net Net
In connection with its operating activities, the Company
Entity Capital Capital Capital enters into certain contractual obligations. The Company’s
KEM $99.1 $6.1 $93.0 future cash payments associated with its contractual obli-
KCM 34.4 3.3 31.1 gations pursuant to its operating leases and guaranteed
employment contracts longer than one year as of
We have no long-term debt at December 31, 2005 nor do December 31, 2005 are summarized below (in millions):
we currently have any material long-term debt commit-
ments for 2006. We currently anticipate that available
Payments due in:
Thereafter through
2006 2007-2008 2009-2010 October 31, 2021 Total
Operating lease obligations1 $11.1 $21.2 $19.6 $110.1 $162.0
Other obligations1 26.5 24.3 8.0 – 58.8
Total $37.6 $45.5 $27.6 $110.1 $220.8
(1) See Footnote 11 to the Consolidated Financial Statements
Off-Balance Sheet Arrangements ness operated by Knight Financial Products LLC and Knight
As of December 31, 2005, we did not have any off-balance Execution Partners LLC to Citigroup for approximately
sheet arrangements, as defined in Item 303(a)(4)(ii) of $237.0 million in cash, subject to an adjustment based on
SEC Regulation S-K. the final determination of the book value of the Derivative
Markets business at the time the deal closed. The result of
Effects of Inflation this adjustment and other expenses related to the sale
Because the majority of the Company’s assets are liquid resulted in additional income of $122,000, net of tax,
in nature, they are not significantly affected by inflation. during 2005. The decision to sell the Derivative Markets
However, the rate of inflation may affect the Company’s segment was based on a review of the overall options
expenses, such as employee compensation, office leasing industry, the capital and risk required to maintain this busi-
costs and communications expenses, which may not be ness successfully and the business’ role in the Company’s
readily recoverable in the prices of the services offered by long-term strategy. The net income (loss) included in our
the Company. To the extent inflation results in rising inter- Income (loss) from discontinued operations, net of taxes,
est rates and has other adverse effects on the securities on the Consolidated Statements of Operations, excluding
markets, it may adversely affect the Company’s financial the gain on the sale in 2004 of $80.0 million, was approxi-
position and results of operations. mately $122,000, $21.0 million and ($10.9 million) for the
Subsequent Event years ended 2005, 2004 and 2003, respectively.
In January 2006, the Company agreed to acquire Hotspot Due to changes in market structure, the withdrawal of
FX, Inc., an industry-leading electronic foreign exchange Nasdaq Japan, poor market conditions and limited market-
marketplace that provides access to electronic foreign making opportunities in Japan, Knight Securities Japan’s
exchange spot trade executions through an advanced (“KSJ”) original business plan was significantly impaired
ECN-based platform, for approximately $77.5 million in and its operations ceased on May 2, 2003. After the cessa-
cash. The acquisition is expected to close shortly and is tion of trading, the Company and Nikko Cordial Group
subject to customary closing conditions. liquidated KSJ. The losses, net of tax, included in Loss from
Discontinued Operations discontinued operations from the KSJ business on the
As of the close of business on December 9, 2004, the Consolidated Statements of Operations were approxi-
Company sold substantially all of the assets and certain of mately $2.1 million for the year ended 2003.
the liabilities that comprised the Derivatives Markets busi-
Knight 37
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies Goodwill of $47.7 million as of December 31, 2005 is all
The preparation of financial statements in conformity related to our Global Markets segment. Goodwill is related
with GAAP requires management to make estimates and to the purchases of our listed equities market-maker, KCM,
assumptions. We believe that, of our significant account- the business of Donaldson, the shares of the minority
ing policies, the following policies involve a higher degree investors in Knight Roundtable Europe Limited, our subsi-
of judgment. diary that owns KEMIL, and the businesses now operating
as Direct Trading and Direct Edge. During our annual test
Lease Loss Accrual – It is the Company’s policy to identify for impairment done in the second quarter of 2005,
excess real estate capacity and where applicable, accrue excluding Direct Trading and Direct Edge, we determined
against such future costs. In determining the accrual, a that these assets were not impaired. Direct Edge was pur-
nominal cash flow analysis is performed for lease losses chased in October 2005 and Direct Trading was purchased in
initiated prior to December 31, 2002, the effective date June 2005; therefore, these businesses were not included
SFAS No. 146 Accounting for Costs Associated with Exit in our impairment test performed in the second quarter of
or Disposal Activities, and costs related to the excess 2005. However, the Company believes there is no impair-
capacity are accrued. For lease losses initiated after ment of these assets at December 31, 2005. As part of our
December 31, 2002, the Company’s policy is to accrue test for impairment, we considered the profitability of the
future costs related to excess capacity using a discounted applicable reporting unit, an assessment of fair value of
cash flow analysis. the reporting unit based on various valuation methodolo-
The Company incurred an additional $10.1 million of gies, as well as the overall market value of the Company,
Writedown of assets and lease loss accruals in 2005. A compared to the Company’s book value.
loss of $5.5 million is related to the lease loss accrual on Intangible assets, less accumulated amortization, of
a portion of our lease at 545 Washington Boulevard in $29.8 million as of December 31, 2005 are attributable to
Jersey City, N.J., encompassing approximately 78,000 our Global Markets segment. Substantially all of the intan-
square feet, all of which is unoccupied. The Company gible assets, net of accumulated amortization, resulted
engaged a real estate broker to sub-lease this excess from the purchase of the business of Donaldson, which
space, but to date our efforts to sub-let this space have represents $10.8 million of the balance, and the Direct
not been successful. This accrual was derived from Trading business, which represents $18.8 million of the
assumptions and estimates based on lease terms of an balance. These assets, which primarily consist of customer
anticipated sub-lease agreement, which assumed a sub- relationships, are being amortized on a straight-line basis
lease would commence in the beginning of 2007, antici- over their useful lives, which we have determined to range
pated market prices along the Jersey City waterfront and from two to thirty years. During our annual test for impair-
estimated up-front costs, including broker fees and build- ment done in June 2005, excluding Direct Trading, we
out allowances. We continually monitor the market and determined that there was no impairment of these intan-
space to assess the reasonableness of our applicable gible assets. Direct Trading was purchased in June 2005;
assumptions. therefore this business was not included in our impairment
A loss of $3.7 million is related to the lease loss accrual on test performed in the second quarter of 2005. However,
the excess real estate capacity at our former headquarters the Company believes there is no impairment of these
at 525 Washington Boulevard, Jersey City, N.J. The lease intangible assets at December 31, 2005.
on this location ends in April 2006 and we abandoned Strategic Investments – Investments include ownership
this location in the second quarter of 2005. interests of less than 20% in financial services-related busi-
Impairment of Goodwill and Intangible Assets – The useful nesses, which are accounted for under the equity method
lives of goodwill and intangible assets are determined upon or at fair value. The equity method of accounting is used
acquisition. Intangible assets are amortized over their for investments in limited partnerships and limited liability
respective lives. Goodwill and the useful lives of intangible corporations. The fair value of investments, recorded in
assets are tested for impairment, at a minimum, on an the Company’s broker-dealer subsidiaries, for which a
annual basis, or when an event occurs or circumstances
change that signify the existence of impairment.
38 The Knight Difference
quoted market or dealer price is not available for the which the net asset value of the particular Deephaven
size of our investment is based on management’s esti- fund exceeds the greater of either the highest previous net
mate. Among the factors considered by management in asset value in that Deephaven fund or the net asset value
determining the fair value of investments are the cost of at the time each investor in that fund made his purchase.
the investment, terms and liquidity, developments since The Incentive Allocation Fee may increase or decrease dur-
the acquisition of the investment, the sales price of recently ing the year based on the performance of the Deephaven
issued securities, the financial condition and operating Funds and the level of assets under management. If
results of the issuer, earnings trends and consistency of Deephaven’s Market Neutral Fund, which contains
operating cash flows, the long-term business potential approximately 50% of the assets under management
of the issuer, the quoted market price of securities with by Deephaven, recognizes a loss in the second half of a
similar quality and yield that are publicly traded, and other calendar year, the Incentive Allocation Fee is recalculated
factors generally pertinent to the valuation of investments. on an annual rather than a semi-annual basis. As such, the
The fair value of these investments is subject to a high Incentive Allocation Fee may be negative for certain periods,
degree of volatility and may be susceptible to significant but not lower than zero on a year-to-date basis.
fluctuations in the near term.
Writedown of Fixed Assets – Writedowns of fixed
Investments that are classified as available-for-sale are assets are recognized when it is determined that the
reported at fair value with unrealized gains and losses fixed assets are impaired. The amount of the impairment
excluded from earnings and reported, net of applicable is determined by the difference between the carrying
taxes, in Accumulated other comprehensive income, net amount and the fair value of the fixed asset. In determin-
of tax within Stockholders’ Equity on the Consolidated ing the impairment, an estimated fair value is obtained
Statements of Financial Condition. Investments not through research and inquiry of the market. Fixed assets
recorded in the Company’s broker-dealer subsidiaries, are reviewed for impairment on a quarterly basis.
which do not have a readily determinable fair value, are
recorded at amortized cost. Other Estimates – The preparation of financial statements
in conformity with GAAP requires management
Strategic investments are reviewed on an ongoing basis to make certain estimates and assumptions. In addition
to ensure that the carrying values of the investments have to the estimates that we make in connection with
not been impaired. If the Company assesses that an accounting for the items noted above, the use of esti-
impairment loss on a strategic investment has occurred mates is also important in determining provisions for
due to declines in fair value or other market conditions, potential losses that may arise from litigation, regulatory
the investment is written down to its impairment value. proceedings and tax audits.
As of December 31, 2005, the Company reviewed its
strategic investments for impairment and determined A portion of our Employee compensation and benefits
that an impairment loss had not occurred. expense on the Consolidated Statements of Operations
represents discretionary bonuses, generally determined
Market-Making Activities – Securities owned and at year end and paid in the subsequent months. Among
securities sold, not yet purchased, which primarily consist many factors, discretionary bonus accruals, in general,
of listed and OTC stocks, are carried at market value and are influenced by the Company’s overall performance
are recorded on a trade date basis. Market value is esti- and competitive industry compensation levels. Therefore,
mated daily using market quotations available from major for each interim period, we accrue an amount based on
securities exchanges and dealers. this analysis.
Asset Management Fees – Deephaven earns asset man- We estimate and accrue for potential losses that may arise
agement fees for sponsoring and managing the Deephaven out of litigation, regulatory proceedings and tax audits to
Funds. These fees are recorded monthly as earned and the extent that such losses are probable and can be esti-
are calculated as a percentage of each Deephaven Fund’s mated in accordance with SFAS No. 5 Accounting for
monthly net assets, plus a percentage of a new high net Contingencies. Significant judgment is required in making
asset value (the “Incentive Allocation Fee”), as defined, for these estimates and our final liabilities may ultimately be
any six month period ended June 30th or December 31st.
A new high net asset value is defined as the amount by
Knight 39
Management’s Discussion and Analysis of Financial Condition and Results of Operations
materially different. Our total liability accrued with respect unrecognized compensation cost at the date of retire-
to litigation and regulatory proceedings is determined on a ment. For stock-based payments issued after the adoption
case-by-case basis and represents an estimate of probable of SFAS No. 123-R the Company will apply a non-
losses based on, among other factors, the progress of substantive vesting period approach whereby expense
each case, our experience with and industry experience is accelerated for those employees that receive awards
with similar cases and the opinions and views of internal and are eligible to retire prior to the award vesting. The
and external legal counsel. Given the inherent difficulty impact of this change in the vesting approach would not
of predicting the outcome of our litigation and regulatory have had a material impact on the results of operations for
matters, particularly in cases or proceedings in which the periods presented herein.
substantial or indeterminate damages or fines are sought,
or where cases or proceedings are in the early stages, we Quantitative and Qualitative Disclosures
cannot estimate losses or ranges of losses for cases or About Market Risk
proceedings where there is only a reasonable possibility Market Risk
that a loss may be incurred. Our market-making and trading activities expose our
capital to significant risks. These risks include, but are
Recently Issued Accounting Standards not limited to, absolute and relative price movements,
In December 2004, the FASB issued a revision to price volatility and changes in liquidity, over which we
SFAS No. 123 Accounting for Stock-Based Compensation, have virtually no control.
SFAS No. 123-R, Share-Based Payment. SFAS No. 123-R
focuses primarily on transactions in which an entity For working capital purposes, we invest in money market
exchanges its equity instruments for employee services. funds, commercial paper and government securities or
SFAS No. 123-R eliminates the intrinsic value method maintain interest-bearing balances in our trading accounts
under Accounting Principles Board No. 25 as an alternative with clearing brokers, which are classified as cash and cash
method of accounting for stock-based awards. Addi- equivalents and receivable from clearing brokers, respec-
tionally SFAS No. 123-R clarifies SFAS No. 123’s guidance tively, in the Consolidated Statements of Financial
in several areas including measuring fair value, classifying Condition. These other amounts do not have maturity
an award as equity or as a liability and attributing com- dates or present a material market risk, as the balances
pensation cost to reporting periods. In April 2005, the SEC are short-term in nature and subject to daily repricing.
delayed the effective date for SFAS No. 123-R until the first Our cash and cash equivalents held in foreign currencies
fiscal year beginning after June 15, 2005. The Company are subject to the exposure of foreign currency fluctua-
plans to adopt the provisions of this statement, using the tions. These balances are monitored daily, and are not
“modified prospective method” for its first quarter of material to the Company’s overall cash position.
2006. We do not expect the adoption of this statement In Global Markets, we employ automated proprietary
to have a greater effect on our financial condition, results trading and position management systems that provide
of operations or cash flows than the pro forma effect in real-time, on-line position management and inventory
2005 as disclosed in Footnote 2 “Significant Accounting control. We monitor our risks by reviewing trading positions
Policies” included in the Consolidated Financial Statements and their appropriate risk measures. We have established
contained elsewhere in this document. a system whereby transactions are monitored by senior
Prior to the adoption of SFAS No. 123-R the Company management on a real-time basis as are individual and
applied a nominal vesting approach for employee stock- aggregate dollar and inventory position totals and real-time
based compensation awards with retirement eligible profits and losses. The management of trading positions
provisions. Under the nominal vesting approach, the is enhanced by review of mark-to-market valuations and
Company recognized compensation cost over the vesting position summaries on a daily basis.
period and, if the employee retired before the end of the
vesting period, the Company recognized any remaining
40 The Knight Difference
In the normal course of our equities market-making busi- a $2.7 million loss and a $2.4 million loss as of December 31,
ness, we maintain inventories of exchange-listed and 2005 and 2004, respectively, due to the offset of losses in
OTC equity securities. The fair value of these securities long positions with gains in short positions. The following
at December 31, 2005 and 2004 was $372.0 million table illustrates, for the period indicated, our average, high-
and $245.5 million, respectively, in long positions and est and lowest month-end inventory at market value (based
$345.5 million and $221.4 million, respectively, in short on both the aggregate and the net of the long and short
positions. The potential change in fair value, using a positions of trading securities from our OTC and listed
hypothetical 10% decline in prices, is estimated to be market-making business) (in millions).
2005 2004 2003
Aggregate Net Aggregate Net Aggregate Net
of Long of Long of Long of Long of Long of Long
and Short and Short and Short and Short and Short and Short
Positions Positions Positions Positions Positions Positions
Average month-end $700.3 $32.6 $525.8 $27.9 $336.4 $ 9.1
Highest month-end 874.8 46.2 627.5 74.5 485.1 32.4
Lowest month-end 496.9 10.6 411.4 1.2 200.2 (32.1)
As of December 31, 2005, we had a $281.7 million corpo- Deephaven monitors its trading risks by reviewing trading
rate investment in the Deephaven Funds, $222.1 million of positions and their appropriate risk measures. We have
which was invested in the Market Neutral Fund. The general established a system whereby transactions are monitored
objective of market neutral investment strategies is to seek by management and an independent risk control func-
to capture mispricings or spreads between related capital tion, as are individual and aggregate dollar and inventory
instruments. Within the Market Neutral Fund, Deephaven position totals and profits and losses by strategy. The
employs a variety of market neutral investment strategies, management of trading positions is enhanced by review
including convertible arbitrage, event arbitrage, relative of mark-to-market valuations and position summaries.
value equity and distressed debt. Because the primary There can be no assurances that any of the Deephaven
basis of the Deephaven Funds’ market neutral strategy is Funds’ strategy will be successful in achieving either their
endeavoring to capture mispricings or spreads between risk control or its profit objectives.
related instruments, rather than attempting to predict or
follow absolute price movements, the performance of the Operational Risk
Market Neutral Fund is intended to be substantially non- Operational risk relates to the risk of loss arising from
correlated with the general debt and equity markets, as inadequate or failed internal processes, people or systems
well as with a number of other non-traditional investment and from external events, or external trading, custody, or
strategies. However, there will be unhedged credit risk lending relationships that are important to Deephaven’s
in the convertible arbitrage portfolio and that part of business. Operational risk can arise from many factors
the portfolio will have some correlation to credit spreads. ranging from routine processing errors to potentially costly
Market neutral trading strategies also involve other incidents arising, for example, from major systems failures.
substantial risks, for example, the disruption in historical The Company incurs operational risk across all of its busi-
pricing relationships and the risk of a tightening of dealer ness activities, including revenue generating activities as
credit, forcing the premature liquidation of positions. The well as support functions. Legal and compliance risk is
Deephaven Funds also utilize leverage, to the extent avail- included in the scope of operational risk and is discussed
able and deemed by Deephaven to be consistent with the on the next page under “Legal Risk.”
Funds’ risk/reward objectives, in an attempt to increase
returns while maintaining strict risk controls.
Knight 41
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Primary responsibility for the management of operational Legal Risk
risk lies with the business segments and supporting func- Legal risk includes the risk of non-compliance with applica-
tions. The business segments maintain controls designed ble legal and regulatory requirements and standards. Legal
to manage and mitigate operational risk for existing activi- risk also includes contractual and commercial risk such as
ties. In addition, as new products and business activities the risk that a counterparty’s performance obligations will
are developed, operational risks are identified and controls be unenforceable. The Company is generally subject to
are designed to mitigate the identified risks. extensive regulation in the different jurisdictions in which
it conducts its business. The Company has established
Disaster recovery plans are in place for critical facilities and procedures based on legal and regulatory requirements
resources and redundancies are built into the systems as that are designed to foster compliance with applicable
deemed appropriate. The Company has also established statutory and regulatory requirements. The Company also
policies, procedures and technologies to protect its has established procedures that are designed to require
computer and other assets from unauthorized access. that the Company’s policies relating to conduct, ethics
and business practices are followed.
42 The Knight Difference
Consolidated Quarterly Results (unaudited)
The following table sets forth certain unaudited consolidated quarterly statement of operations data for 2005 and 2004.
In the opinion of management, this unaudited information has been prepared on substantially the same basis as the con-
solidated financial statements appearing elsewhere in this document and includes all adjustments (consisting of normal
recurring adjustments) necessary to present fairly the unaudited consolidated quarterly data. The unaudited consolidated
quarterly data should be read in conjunction with the audited consolidated financial statements and notes thereto appear-
ing elsewhere in this document. The results of any quarter are not necessarily indicative of results for any future period.
Dec. 31, Sept. 30, Jun. 30, Mar. 31, Dec. 31, Sept. 30, Jun. 30, Mar. 31,
Quarter Ended* 2005 2005 2005 2005 2004 2004 2004 2004
(in thousands, except per share amounts)
Revenues
Commissions and fees $ 83,223 $ 74,860 $ 68,022 $ 70,116 $ 72,206 $ 58,599 $ 68,569 $ 76,638
Net trading revenue 48,792 52,349 27,051 37,422 53,122 35,907 61,235 100,728
Asset management fees 21,326 41,983 8,037 17,881 48,814 6,805 8,107 13,932
Interest and dividends, net 2,700 1,763 2,216 2,340 1,819 1,199 772 858
Investment income and other 45,255 13,141 6,347 9,799 9,618 (692) 1,354 6,164
Total revenues 201,297 184,097 111,673 137,557 185,579 101,818 140,037 198,320
Transaction-based expenses
Execution and clearance fees 27,947 24,585 23,348 23,547 23,301 22,043 28,682 37,762
Soft dollar and commission
recapture expense 17,634 15,903 14,650 15,485 15,796 14,309 14,237 15,776
Payments for order flow 6,377 3,857 3,582 7,404 9,215 4,555 9,843 13,018
Total transaction-based expenses 51,958 44,344 41,580 46,435 48,312 40,907 52,762 66,556
Revenues, net of
transaction-based expenses 149,338 139,752 70,093 91,121 137,267 60,911 87,275 131,764
Other direct expenses
Employee compensation and benefits 56,140 68,268 48,194 56,857 76,086 50,109 53,250 65,104
Communications and data processing 8,578 7,969 8,151 7,814 7,313 7,867 6,963 6,754
Professional fees 5,167 6,056 4,550 3,776 3,357 4,258 3,951 3,353
Depreciation and amortization 4,109 4,209 3,734 4,302 3,377 3,390 3,561 3,920
Occupancy and equipment rentals 3,368 3,239 2,830 4,123 3,960 4,151 4,388 4,352
Business development 1,801 1,616 1,708 1,293 2,347 2,054 1,825 2,043
Writedown of assets and
lease loss accrual – 5,509 4,546 – 312 874 2,624 –
Regulatory charges and
related matters 3,703 – 2,000 – 142 – 79,200 –
Other 2,677 2,785 3,426 2,654 2,725 (820) 2,190 2,750
Total other direct expenses 85,543 99,652 79,139 80,820 99,619 71,883 157,952 88,276
Income (loss) from continuing
operations before income taxes 63,795 40,100 (9,045) 10,301 37,648 (10,972) (70,677) 43,488
Income tax expense (benefit) 21,924 16,137 (3,430) 4,281 15,194 (4,367) (19,080) 17,511
Net income (loss) from
continuing operations 41,871 23,964 (5,616) 6,020 22,454 (6,605) (51,597) 25,977
Income (loss) from discontinued
operations, net of tax – 388 – (266) 85,954 5,344 3,737 5,868
Net income (loss) $ 41,871 $ 24,352 $ (5,616) $ 5,754 $108,408 $ (1,261) $ (47,860) $ 31,845
Earnings per share from
continuing operations $ 0.41 $ 0.23 $ (0.05) $ 0.05 $ 0.19 $ (0.06) $ (0.46) $ 0.21
Earnings per share from
discontinued operations $ – $ – $ – $ – $ 0.74 $ 0.05 $ 0.03 $ 0.05
Earnings per share $ 0.41 $ 0.23 $ (0.05) $ 0.05 $ 0.94 $ (0.01) $ (0.42) $ 0.26
*Certain prior quarter amounts have been reclassified to conform to current year presentation.
Knight 43
Consolidated Statements of Financial Condition
December 31, 2005 2004
Assets
Cash and cash equivalents $ 230,591,067 $ 445,539,282
Securities owned, held at clearing brokers, at market value 380,366,778 254,473,209
Receivable from brokers and dealers 229,828,734 244,881,065
Investment in Deephaven sponsored funds 281,656,753 215,329,959
Fixed assets and leasehold improvements, at cost, less accumulated depreciation
and amortization of $99,757,958 in 2005 and $101,365,529 in 2004 67,656,533 54,382,503
Strategic investments 31,896,425 29,266,796
Goodwill 47,682,880 19,182,248
Intangible assets, less accumulated amortization of $2,434,573 in 2005
and $653,472 in 2004 29,773,442 11,546,528
Other assets 116,563,732 119,418,725
Total assets $1,416,016,344 $1,394,020,315
Liabilities and Stockholders’ Equity
Liabilities
Securities sold, not yet purchased, at market value $ 345,457,499 $ 221,420,569
Payable to brokers and dealers 35,102,415 88,480,788
Accrued compensation expense 117,763,834 123,664,383
Accrued expenses and other liabilities 94,244,447 109,252,681
Total liabilities 592,568,195 542,818,421
Commitments and contingent liabilities (Notes 11 and 18)
Stockholders’ equity
Class A Common Stock, $0.01 par value;
Shares authorized: 500,000,000 in 2005 and 2004;
Shares issued: 139,745,722 in 2005 and 133,965,513 in 2004;
Shares outstanding: 102,966,359 in 2005 and 113,295,191 in 2004 1,397,457 1,339,655
Additional paid-in capital 473,945,690 427,451,712
Retained earnings 653,513,691 587,152,786
Treasury stock, at cost; 36,779,363 shares in 2005 and 20,670,322 shares in 2004 (294,652,742) (147,636,413)
Accumulated other comprehensive income, net of tax 10,350,387 –
Unamortized stock-based compensation (21,106,334) (17,105,846)
Total stockholders’ equity 823,448,149 851,201,894
Total liabilities and stockholders’ equity $1,416,016,344 $1,394,020,315
The accompanying notes are an integral part of these consolidated financial statements.
44 The Knight Difference
Consolidated Statements of Operations
For the years ended December 31, 2005 2004 2003
Revenues
Commissions and fees $296,221,767 $276,010,852 $163,147,122
Net trading revenue 165,614,332 250,992,997 290,937,517
Asset management fees 89,226,578 77,658,193 57,903,057
Interest and dividends, net 9,019,081 4,647,059 3,657,050
Investment income and other 74,541,327 16,441,253 30,264,016
Total revenues 634,623,085 625,750,354 545,908,762
Transaction-based expenses
Execution and clearance fees 99,426,667 111,787,940 102,658,908
Soft dollar and commission recapture expense 63,670,978 60,117,556 9,985,651
Payments for order flow and ECN rebates 21,220,284 36,632,317 32,178,913
Total transaction-based expenses 184,317,929 208,537,813 144,823,472
Revenues, net of transaction-based expenses 450,305,156 417,212,541 401,085,290
Other direct expenses
Employee compensation and benefits 229,459,520 244,549,546 206,860,453
Communications and data processing 32,512,930 28,896,451 27,991,441
Professional fees 19,554,523 14,914,772 10,993,116
Depreciation and amortization 16,354,746 14,247,699 19,384,902
Occupancy and equipment rentals 13,553,631 16,852,358 17,449,489
Business development 6,418,984 8,268,973 7,159,726
Writedown of assets and lease loss accrual 10,055,252 3,810,453 16,507,981
Regulatory charges and related matters 5,703,428 79,341,732 –
Other 11,540,764 6,844,285 11,151,856
Total other direct expenses 345,153,778 417,726,269 317,498,964
Income (loss) from continuing operations before income taxes 105,151,378 (513,728) 83,586,326
Income tax expense 38,912,480 9,258,157 32,496,651
Net income (loss) from continuing operations 66,238,898 (9,771,885) 51,089,675
Income (loss) from discontinued operations, net of tax 122,007 100,903,791 (13,016,202)
Net income $ 66,360,905 $ 91,131,906 $ 38,073,473
Basic earnings per share from continuing operations $ 0.64 $ (0.09) $ 0.46
Diluted earnings per share from continuing operations $ 0.62 $ (0.08) $ 0.43
Basic earnings per share from discontinued operations $ – $ 0.90 $ (0.12)
Diluted earnings per share from discontinued operations $ – $ 0.86 $ (0.11)
Basic earnings per share $ 0.64 $ 0.81 $ 0.34
Diluted earnings per share $ 0.62 $ 0.77 $ 0.32
Shares used in computation of basic earnings per share 103,455,791 112,423,158 112,023,419
Shares used in computation of diluted earnings per share 106,881,855 117,636,085 117,749,743
The accompanying notes are an integral part of these consolidated financial statements.
Knight 45
Consolidated Statements of Changes in Stockholders‘ Equity
For the years ended Class A Common Stock Treasury Stock
December 31, 2003, 2004 and 2005 Shares Amount Shares Amount
Balance, January 1, 2003 124,705,287 $1,247,053 (6,847,467) $ (35,423,292)
Net Income – – – –
Loss recognized on translation
adjustment, net of taxes – – – –
Common stock repurchased – – (6,413,521) (34,297,186)
Stock options exercised 2,598,861 25,989 – –
Income tax benefit – stock awards exercised – – – –
Stock-based compensation 882,912 8,829 184,483 925,220
Balance, December 31, 2003 128,187,060 1,281,871 (13,076,505) (68,795,258)
Net Income – – – –
Common stock repurchased – – (7,593,817) (78,841,155)
Stock options exercised 4,527,202 45,272 – –
Income tax benefit – stock awards exercised – – – –
Stock-based compensation 1,251,251 12,512 – –
Balance, December 31, 2004 133,965,513 1,339,655 (20,670,322) (147,636,413)
Net Income – – – –
Unrealized gains on available-for-sale
securities, net of taxes – – – –
Common stock repurchased – – (16,109,041) (147,016,329)
Stock options exercised 3,952,173 39,522 – –
Income tax benefit – stock awards exercised – – – –
Stock-based compensation 1,828,036 18,280 – –
Balance, December 31, 2005 139,745,722 $1,397,457 (36,779,363) $(294,652,742)
The accompanying notes are an integral part of these consolidated financial statements.
46 The Knight Difference
Accumulated
Additional Unamortized Other
Paid-In Retained Stock-based Comprehensive
Capital Earnings Compensation Income Total
$340,211,426 $457,956,771 $ (6,791,533) $ (3,368,885) $753,831,540
– 38,073,473 – – 38,073,473
– – – 3,368,885 3,368,885
– – – – (34,297,186)
14,977,298 – – – 15,003,287
7,433,289 – – – 7,433,289
8,275,392 (9,364) (5,517,463) – 3,682,614
370,897,405 496,020,880 (12,308,996) – 787,095,902
– 91,131,906 – – 91,131,906
– – – – (78,841,155)
27,163,276 – – – 27,208,548
11,392,768 – – – 11,392,768
17,998,263 – (4,796,850) – 13,213,925
427,451,712 587,152,786 (17,105,846) – 851,201,894
– 66,360,905 – – 66,360,905
– – – 10,350,387 10,350,387
– – – – (147,016,329)
22,477,438 – – – 22,516,960
6,625,852 – – – 6,625,852
17,390,688 – (4,000,488) – 13,408,480
$473,945,690 $653,513,691 $(21,106,334) $10,350,387 $823,448,149
Knight 47
Consolidated Statements of Cash Flows
For the years ended December 31, 2005 2004 Revised* 2003 Revised*
Cash flows from operating activities
Net income $ 66,360,905 $ 91,131,906 $ 38,073,473
Income (loss) from discontinued operations, net of taxes 122,007 100,903,791 (13,016,202)
Income (loss) from continuing operations, net of taxes 66,238,898 (9,771,885) 51,089,675
Adjustments to reconcile income (loss) from continuing operations,
net of taxes to net cash provided by operating activities
Depreciation and amortization 16,354,746 14,247,699 19,384,902
Income tax benefit on stock awards exercised 6,625,852 11,392,768 7,433,289
Stock-based compensation 13,408,873 10,003,722 2,787,656
Deferred income taxes 3,000,067 (8,509,592) (1,561,197)
Deferred rent 620,714 3,793,700 (1,630,241)
Writedown of assets and lease loss accrual 10,055,252 3,810,453 16,507,981
Unrealized gain on strategic investments 747,993 – –
Operating activities from discontinued operations 122,007 43,529,819 41,817,556
(Increase) decrease in operating assets
Securities owned (125,893,569) (53,234,639) (57,861,893)
Receivable from brokers and dealers 16,979,593 (39,861,433) (142,691,409)
Other assets (7,249,671) (11,535,788) 16,042,436
Increase (decrease) in operating liabilities
Securities sold, not yet purchased 124,036,930 48,301,776 88,403,414
Payable to brokers and dealers (53,378,373) 61,667,776 (2,121,212)
Accrued compensation expense (6,113,996) 29,029,978 43,755,914
Accrued expenses and other liabilities (33,005,836) (16,678,380) 5,966,344
Net cash provided by operating activities 32,549,480 86,185,974 87,323,215
Cash flows from investing activities
Proceeds from sale of Derivative Markets business – 230,380,605 –
Investing activities from discontinued operations – – 14,777,110
Purchases of fixed assets and leasehold improvements (25,657,084) (40,184,593) (6,405,411)
Investment in Deephaven sponsored funds (66,326,795) (17,724,890) (48,917,063)
Proceeds from (purchases of) strategic investments 14,092,906 (8,967,094) (2,604,114)
Purchase of businesses, net of cash acquired (45,107,353) – (11,373,570)
Net cash (used in) provided by investing activities (122,998,326) 163,504,028 (54,523,048)
Cash flows from financing activities
Stock options exercised 22,516,960 27,192,742 14,865,537
Cost of common stock repurchased (147,016,329) (78,841,155) (34,297,186)
Purchase of shares from minority investors in Knight Roundtable Europe Limited – (2,500,000) –
Net cash used in financing activities (124,499,369) (54,148,413) (19,431,649)
(Decrease) increase in cash and cash equivalents (214,948,215) 195,541,589 13,368,518
Cash and cash equivalents at beginning of the year 445,539,282 249,997,693 236,629,175
Cash and cash equivalents at end of the year $ 230,591,067 $445,539,282 $249,997,693
Supplemental disclosure of cash flow information:
Cash paid for interest $ 576,361 $ 339,231 $ 123,893
Cash paid for income taxes $ 52,563,496 $ 26,917,732 $ 21,391,344
Supplemental disclosure of noncash investing activities
Goodwill $ 28,500,631 $ 869,583
Intangible assets 20,000,000 11,300,000
Fixed assets 3,000,000 –
Other assets – 5,714,261
Receivable from brokers and dealers 1,927,262 6,497,124
Accrued compensation expense – (2,280,533)
Other net liabilities (8,320,540) (10,726,865)
Cash paid for purchase of business, net of cash acquired $ 45,107,353 $ 11,373,570
*Amounts have been revised to separately disclose discontinued operations. See Note 2 “Significant Accounting Policies.”
The accompanying notes are an integral part of these consolidated financial statements.
48 The Knight Difference
Notes to Consolidated Financial Statements
Note 1: Organization and Description of the Business access trading through an advanced electronic platform.
Knight Capital Group, Inc. and its subsidiaries (the This business is now operated by Direct Trading Institutional,
“Company”) have two operating business segments, L.P. (“Direct Trading”), a broker-dealer registered with
Asset Management and Global Markets, as well as a the SEC and member of the NASD and the NFA.
Corporate segment. The Company’s operating business
• In October 2005, the Company acquired the business
segments from continuing operations comprise the
of the ATTAIN ECN from Domestic Securities, Inc., a
following operating subsidiaries:
privately held company, and certain of its shareholders.
Asset Management The business, operating under the name Direct Edge
• Deephaven Capital Management LLC (“Deephaven”) is ECN LLC (“Direct Edge”) operates as an electronic
the investment adviser to and sponsor of the Deephaven communications network (“ECN”). Direct Edge is a
investment funds (the “Deephaven Funds”). Deephaven liquidity destination offering the ability to match trades
also has a U.K. registered investment adviser subsidiary, in Nasdaq National Market and Nasdaq Small Cap securi-
which is regulated by the Financial Services Authority ties by displaying orders in the Nasdaq Market Center or
(“FSA”) in the U.K., and a Hong Kong registered invest- the NASD Alternative Display Facility. Direct Edge is a
ment adviser subsidiary, which is regulated by the Hong broker-dealer registered with the SEC and is a member
Kong Securities and Futures Commission. of the NASD.
Global Markets The Corporate segment includes all corporate overhead
• Knight Equity Markets, L.P. (“KEM”) operates as a expenses and investment income earned on strategic
market-maker in over-the-counter (“OTC”) equity investments and the corporate investment in the Deephaven
securities, primarily those traded in The Nasdaq Stock Funds. Corporate overhead expenses primarily consist of
Market and on the OTC Bulletin Board (“OTCBB”). compensation for certain senior executives and other indi-
Additionally, in December 2003, KEM acquired the busi- viduals employed at the corporate holding company, legal
ness of Donaldson & Co., Incorporated (“Donaldson”), and other professional expenses related to corporate
a firm that offers soft dollar and commission recapture matters, investor and public relations expenses and
services. KEM is a broker-dealer registered with the directors’ and officers’ insurance.
Securities and Exchange Commission (“SEC” or “Com-
Discontinued Operations
mission”) and is a member of the National Association
The Company completed the sale of its Derivative Markets
of Securities Dealers (“NASD”), the National Stock
business to Citigroup Financial Products Inc. (“Citigroup”)
Exchange, the Pacific Stock Exchange and the
for $237 million in cash as of the close of business on
National Futures Association (“NFA”).
December 9, 2004. In accordance with generally accepted
• Knight Capital Markets LLC (“KCM”) operates as a accounting principles (“GAAP”), the results of the
market-maker in the Nasdaq Intermarket™, the over- Derivative Markets segment have been included within
the-counter market for New York Stock Exchange (“NYSE”) discontinued operations for all periods presented. For a
and American Stock Exchange (“AMEX”) listed securities. further discussion of the sale of the Company’s Derivative
KCM is a broker-dealer registered with the SEC and is a Markets business and its associated accounting treatment,
member of the NASD. see Footnote 9 “Discontinued Operations.”
• Knight Equity Markets International Limited (“KEMIL”) Note 2: Significant Accounting Policies
is a U.K. registered broker-dealer that provides execution Basis of consolidation and form of presentation
services for predominately European institutional and The accompanying consolidated financial statements
broker-dealer clients in U.S., European and international include the accounts of the Company and its subsidiaries.
equities. KEMIL is authorized and regulated by the FSA All significant intercompany transactions and balances
and is a member of the London Stock Exchange, have been eliminated.
Euronext and Deutsche Börse.
Certain prior year amounts have been reclassified to
• In June 2005, the Company acquired the business of conform to the current year presentation.
Direct Trading Institutional, Inc., a privately held firm
specializing in providing institutions with direct market
Knight 49
Notes to Consolidated Financial Statements
Cash and cash equivalents Estimated fair value of financial instruments
Cash and cash equivalents include money market The Company’s securities owned and securities sold, not yet
accounts, which are payable on demand, or short-term purchased are carried at market value, which is estimated
investments with an original maturity of less than using market quotations available from major securities
30 days. The carrying amount of such cash equivalents exchanges, clearing brokers and dealers. Management
approximates their fair value due to the short-term estimates that the fair values of other financial instruments
nature of these instruments. recognized on the Consolidated Statements of Financial
Condition (including receivables, payables and accrued
Market-making and sales activities expenses) approximate their carrying values, as such finan-
Securities owned and securities sold, not yet purchased, cial instruments are short-term in nature, bear interest at
which primarily consist of listed and OTC equities, are current market rates or are subject to frequent repricing.
carried at market value and are recorded on a trade date
basis. Net trading revenue (trading gains, net of trading Goodwill and intangible assets
losses) and commissions (which includes commission The Company applies the provisions of Statement of
equivalents earned on institutional client orders) and Financial Accounting Standards (“SFAS”) No. 142, Good-
related expenses are also recorded on a trade date basis. will and Other Intangible Assets, which requires that
goodwill and intangible assets with an indefinite useful
Payments for order flow and ECN rebates represent pay- life no longer be amortized, but instead, be tested for
ments to broker-dealer clients for directing their order impairment annually or when an event occurs or circum-
executions to the Company. Soft dollar and commission stances change that signify the existence of impairment.
recapture expense represents payments to institutions Other intangible assets are amortized on a straight line
in connection with soft dollar and commission recapture basis over their useful lives.
programs. The Company’s clearing agreements call for
payment or receipt of interest income, net of interest Strategic investments
expense, for facilitating the settlement and financing Strategic investments include equity ownership interests of
of securities transactions. less than 20% in financial services-related businesses and
are accounted for under the equity method or at fair value.
Asset management fees The equity method of accounting is used for investments
Deephaven earns asset management fees for sponsoring in limited partnerships and limited liability corporations.
and managing the Deephaven Funds. Such fees are recorded The fair value of investments, recorded in the Company’s
monthly as earned and are calculated as a percentage of broker-dealer subsidiaries, for which a quoted market or
the Deephaven Funds’ monthly net assets, plus a percent- dealer price is not available for the size of the Company’s
age of a new high net asset value (the “Incentive Allocation investment, is based on management’s estimate. Among
Fee”), as defined, for any six month period ended June 30th the factors considered by management in determining the
or December 31st. A new high net asset value is generally fair value of investments are the cost of the investment,
defined as the amount by which the net asset value of the terms and liquidity, developments since the acquisition of the
Deephaven Funds exceeds the greater of either the highest investment, the sales price of recently issued securities,
previous net asset value in the Deephaven Funds or the the financial condition and operating results of the issuer,
net asset value at the time each investor made a purchase. earnings trends and consistency of operating cash flows,
The Incentive Allocation Fee may increase or decrease dur- the long-term business potential of the issuer, the quoted
ing the year based on the performance of the Deephaven market price of securities with similar quality and yield that
Funds. If Deephaven’s Market Neutral Master Fund, which are publicly traded, and other factors generally pertinent to
contains approximately 50% of assets under management, the valuation of investments. The fair value of these invest-
recognizes a loss in the second half of a calendar year, the ments is subject to a high degree of volatility and may be
Incentive Allocation Fee is recalculated on an annual rather susceptible to significant fluctuations in the near term.
than a semi-annual basis. As such, the Incentive Allocation
Fee may be negative for certain periods, but not lower
than zero on a year-to-date basis.
50 The Knight Difference
Investments that are classified as available-for-sale are of the leases. The Company capitalizes certain costs associ-
reported at fair value with unrealized gains and losses ated with the acquisition or development of internal-use
excluded from earnings and reported, in Accumulated software and amortizes the software over its estimated
other comprehensive income, net of tax within Stock- useful life of three years, commencing at the time the
holders’ equity on the Consolidated Statements of software is placed in service.
Financial Condition. Investments not recorded in the
Company’s broker-dealer subsidiaries which do not Writedown of fixed assets
have a readily determinable fair value, are recorded Writedowns of fixed assets are recognized when it is
at amortized cost. determined that the fixed assets are impaired. The amount
of the impairment writedown is determined by the differ-
Strategic investments are reviewed on an ongoing basis ence between the carrying amount and the fair value of
to ensure that the carrying values of the investments have the fixed asset. In determining the impairment, an esti-
not been impaired. If the Company assesses that an impair- mated fair value is obtained through research and inquiry
ment loss on a strategic investment has occurred due to of the market. Fixed assets are reviewed for impairment
declines in fair value or other market conditions, the on a quarterly basis.
investment is written down to impairment value.
Lease loss accrual
Treasury stock It is the Company’s policy to identify excess real estate
The Company records its purchases of treasury stock at cost capacity and where applicable, accrue for such future
as a separate component of Stockholders’ equity. The Com- costs. In determining the accrual, a nominal cash flow
pany obtains treasury stock through purchases in the open analysis is performed for lease losses initiated prior to
market or through privately negotiated transactions. December 31, 2002, the effective date of SFAS No. 146
Accounting for Costs Associated with Exit or Disposal
Foreign currencies Activities, and costs related to the excess capacity are
The functional currency of the Company’s foreign subsidiaries accrued. For lease losses initiated after December 31,
is the U.S. dollar. Assets and liabilities in foreign currencies 2002, the Company’s policy is to accrue future costs
are translated into U.S. dollars using current exchange rates related to excess capacity using a discounted cash
at the date of the Consolidated Statements of Financial flow analysis.
Condition. Revenues and expenses are translated at aver-
age rates during the periods. Gains or losses resulting from Income taxes
foreign currency transactions are included in Investment The Company records deferred tax assets and liabilities for
income and other on the Company’s Consolidated the expected future tax consequences of temporary differ-
Statements of Operations. Prior to its liquidation, Knight ences between the financial reporting and tax bases of
Securities Japan’s (“KSJ”) functional currency was the assets and liabilities and measures them using the enacted
Japanese yen. The foreign exchange gains and losses tax rates and laws that will be in effect when such differ-
resulting from the translation of the financial statements ences are expected to reverse. The Company evaluates
of KSJ were included within a separate component of the recoverability of future tax deductions by assessing
Stockholders’ equity until KSJ’s liquidation. As discussed the adequacy of future expected taxable income from all
in Footnote 9 “Discontinued Operations,” in the second sources, including reversal of temporary differences and
quarter of 2003, KSJ ceased its operations, and its results, forecasted operating earnings. Net deferred tax assets
including the effects of translation, are included with and liabilities are included in Other assets and Accrued
Income (loss) from discontinued operations, net of tax expenses and other liabilities, respectively, on the
on the Consolidated Statements of Operations. Consolidated Statements of Financial Condition.
Depreciation, amortization and occupancy Discontinued operations
Fixed assets are being depreciated on a straight-line basis In accordance with SFAS No. 144, Accounting for the
over their estimated useful lives of three to seven years. Disposal of Long-Lived Assets, the revenues and expenses
Leasehold improvements are being amortized on a straight- associated with a separate segment or reporting unit that
line basis over the shorter of the life of the related office
lease or the expected useful life of the assets. The Company
records rent expense on a straight-line basis over the lives
Knight 51
Notes to Consolidated Financial Statements
has been disposed of through closure or sale are included The Company records the fair market value of restricted
within Income (loss) from discontinued operations, net of awards on the date of grant as unamortized stock-based
tax, on the Consolidated Statements of Operations for all compensation in Stockholders’ equity and amortizes
periods presented. the balance to compensation expense ratably over the
vesting period.
We have revised our 2004 and 2003 Consolidated State-
ments of Cash Flows to separately disclose the operating The Company plans on adopting SFAS No. 123-R, Share-
and investing portions of the cash flows attributable to our Based Payment, using the “modified prospective method”
discontinued operations. We had previously reported these for its first quarter of 2006. We do not expect the adoption
amounts on a combined basis. of this statement to have a greater effect on our financial
condition, results of operations or cash flows than the pro
Stock-based compensation forma effect in 2005 as disclosed in the table above.
The Company applies Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Prior to the adoption of SFAS No. 123-R the Company
Employees (“APB 25”) and related interpretations in applied a nominal vesting approach for employee stock-
accounting for its stock option plans. As options are based compensation awards with retirement eligible
granted at the then market value, no compensation provisions. Under the nominal vesting approach, the
expense has been recognized for the fair values of the Company recognized compensation cost over the vest-
options granted to employees. ing period and, if the employee retired before the end
of the vesting period, the Company recognized any
Had compensation expense for the Company’s options remaining unrecognized compensation cost at the date
been determined based on the fair value at the grant of retirement. For stock-based payments issued after the
dates in accordance with SFAS No. 123, Accounting for adoption of SFAS No. 123-R the Company will apply a
Stock-Based Compensation, the Company’s net income non-substantive vesting period approach whereby expense
and earnings per share amounts for the years ended is accelerated for those employees that receive awards
December 31, 2005, 2004 and 2003, respectively, would and are eligible to retire prior to the award vesting. The
have been as follows (in millions, except per share data): impact of this change in the vesting approach would not
2005 2004 2003 have had a material impact on the results of operations
Net income, as reported $66.4 $91.1 $38.1 for the periods presented herein.
Pro forma compensation expense
determined under fair value based Other
method, net of tax (5.5) (6.7) (9.4) The preparation of financial statements in conformity
Pro forma net income 60.8 84.4 28.7 with GAAP requires management to make estimates and
Basic earnings per share,
assumptions that affect the reported amounts of assets
as reported 0.64 0.81 0.34
Diluted earnings per share,
and liabilities and disclosure of contingent assets and
as reported 0.62 0.77 0.32 liabilities at the date of the financial statements and the
Pro forma basic earnings per share 0.59 0.75 0.26 reported amounts of revenues and expenses during
Pro forma diluted earnings per share 0.57 0.72 0.24 the reporting period. Actual results may differ from
those estimates.
The fair value of each option granted is estimated as of
its respective grant date using the Black-Scholes option-
pricing model with the following assumptions:
2005 2004 2003
Dividend yield 0.0% 0.0% 0.0%
Expected volatility 40.0% 40.0% 65.0%
Risk-free interest rate 3.5% 3.8% 3.0%
Expected life (in years) 3.5 4.0 4.0
52 The Knight Difference
Note 3: Securities Owned and Securities Sold, at December 31, 2005, related to the Global Markets busi-
Not Yet Purchased ness segment. Goodwill is net of accumulated amortization
Securities owned and securities sold, not yet purchased of $21.9 million recorded through December 31, 2001,
are carried at market value and consist of the following the effective date the Company adopted SFAS No. 142.
(in millions): Goodwill increased by $28.5 million in 2005 resulting from
the purchase of the businesses now operating as Direct
December 31, 2005 2004
Trading and Direct Edge.
Securities owned:
Equities $372.0 $245.5 At December 31, 2005, the Company had intangible
U.S. government obligations 8.4 9.0 assets, net of accumulated amortization, of $29.8 million,
$380.4 $254.5 all included within the Global Markets business segment.
Substantially all of the intangible assets, net of accumu-
Securities sold, not yet purchased:
lated amortization, resulted from the purchases of the
Equities $345.5 $221.4
Donaldson business, which represents $10.8 million of
$345.5 $221.4
the balance, and the Direct Trading business, which repre-
sents $18.8 million of the balance. These amounts primarily
Note 4: Receivable from/Payable to Brokers
represent customer relationships. The carrying value of
and Dealers
these intangible assets is being amortized on a straight-
At December 31, 2005 and 2004, amounts receivable
line basis over the remaining estimated useful lives, which
from and payable to brokers and dealers consist of the
we have determined to range from two to thirty years.
following (in millions):
In 2005, the Company recorded amortization expense
December 31, 2005 2004
Receivable:
related to its intangible assets of $1.8 million. The esti-
Clearing brokers and other $182.0 $145.4 mated amortization expense relating to the intangible
Securities failed to deliver 42.1 64.5 assets for each of the next five years approximates
Deposits for securities borrowed 5.7 35.0 $2.9 million for the next two years and $2.8 million
$229.8 $244.9 in the next three years thereafter.
Payable: The chart below summarizes the activity of the Company’s
Clearing brokers and other $ 0.9 $ 47.8 Goodwill and Intangible assets, net of accumulated amor-
Securities failed to receive 34.2 40.7 tization, from continuing operations, for 2004 and 2005
$ 35.1 $ 88.5 (in millions):
Global Markets
In 2004, the Company established a full reserve of Intangible
$6.5 million against a receivable from a trading counter- Goodwill Assets
party related to a trading dispute. This dispute is now Balance at January 1, 2004 $16.7 $12.0
the subject of an NASD arbitration claim filed by KEM. Other goodwill and intangibles 2.5 0.2
Amortization expense – (0.6)
Note 5: Goodwill and Intangible Assets Balance at December 31, 2004 19.2 11.5
Goodwill and intangible assets with indefinite useful Purchase of Direct Trading business 20.7 20.0
lives are tested for impairment annually or when an event Purchase of ATTAIN ECN business 7.8 –
Amortization expense – (1.8)
occurs or circumstances change that signify the existence
Balance at December 31, 2005 $47.7 $29.8
of impairment. As part of the test for impairment, the
Company considers the profitability of the respective seg-
The acquisition of the business of Direct Trading contains
ment or reporting unit, an assessment of the fair value
a two-year contingency from the date of closing for addi-
of the respective segment or reporting unit as well as the
tional consideration based on profitability of the business.
overall market value of the Company compared to its
The acquisition of Direct Edge also contains a four-year
net book value.
contingency from the date of closing for additional con-
In June 2005, the Company tested for the impairment of sideration based on meeting certain revenue and client
goodwill and intangible assets and concluded that there retention metrics.
was no impairment. The goodwill balance of $47.7 million
Knight 53
Notes to Consolidated Financial Statements
Note 6: Investment in Deephaven-Sponsored Funds the Company sold its entire Nasdaq equity investment
and Strategic Investments during 2005 for $36.9 million. Based on an adjusted cost
The Company’s wholly-owned subsidiary, Deephaven, is the of $15.2 million, the Company recognized a pre-tax gain of
investment adviser and sponsor of the Deephaven Funds, $21.7 million on the Nasdaq sale. The gains on the sales
which engage in various trading strategies involving equities, of the ISE and Nasdaq investments are included in Invest-
debt instruments and derivatives. The underlying invest- ment income and other on the Company’s Consolidated
ments in the Deephaven Funds are carried at market value. Statements of Operations.
Of the $2.9 billion and $3.6 billion of assets under manage-
Note 7: Significant Clients
ment in the Deephaven Funds as of December 31, 2005 and
2004, respectively, the Company had corporate investments The Company considers significant clients to be those
of $281.7 million and $215.3 million, respectively. Addi- institutions who account for 10% or more of the total
tionally, Other assets on the Consolidated Statements of U.S. equity dollar value traded by the Company during
Financial Condition at December 31, 2005 and December 31, the period. One client accounted for approximately 10.7%
2004 included $17.2 million and $19.9 million, respectively, of the Company’s U.S. equity dollar value traded during
of investments in the Deephaven Funds related to employee 2005. Payments for order flow to this firm for U.S. equity
deferred compensation plans. In addition, certain officers, order flow amounted to $3.4 million during 2005.
directors and employees of the Company had direct invest- The Company’s corporate investment in the Deephaven
ments of approximately $3.7 million and $5.2 million in the Funds of $281.7 million as of December 31, 2005,
Deephaven Funds, in the aggregate, as of December 31, 2005 accounted for 9.8% of total assets under management
and 2004, respectively. as of December 31, 2005. One institutional investor
Included in Investment income and other on the Company’s accounted for 10.1% of the Deephaven Funds’ assets
Consolidated Statements of Operations is income from under management as of December 31, 2005.
the Company’s corporate investments in the Deephaven Note 8: Writedown of Assets and Lease Loss Accrual
Funds of $16.3 million, $12.8 million and $23.9 million
Writedown of assets and lease loss accrual from continuing
for the years ended December 31, 2005, 2004 and
operations during 2005, 2004 and 2003 were $10.1 million,
2003, respectively.
$3.8 million, and $16.5 million, respectively. The charges
In connection with the sale of the Derivative Markets in 2005 consist of $4.5 million of costs associated with
business (see Footnote 9, “Discontinued Operations”) excess real estate capacity and a writedown of fixed assets
and in light of the reorganization of the Company’s busi- related to the move from the Company’s 525 Washington
ness segments, the Company transferred its investments Boulevard facility in Jersey City, N.J., and an additional
in the International Securities Exchange, Inc. (“ISE”) and $5.5 million in costs associated with excess real estate
The Nasdaq Stock Market, Inc. (“Nasdaq”), which were capacity at our 545 Washington Boulevard facility in
previously held by its broker-dealer subsidiaries, to a cor- Jersey City, N.J. The charges in 2004 consist of $3.8 million
porate investment holding company. During the first quarter of costs associated with excess real estate capacity, primarily
of 2005, these equity investments became marketable and, in Jersey City, N.J. The charges in 2003 primarily consist
accordingly, were accounted for as equity securities under of $9.6 million of lease loss accruals related to costs asso-
SFAS No. 115 Accounting for Certain Investments in Debt ciated with excess real estate capacity, primarily in Jersey
and Equity Securities and were classified as available-for- City, N.J., and $6.8 million related to the writedown of
sale securities. In conjunction with the ISE’s initial public our strategic investment in Nasdaq to fair value.
and secondary offerings, the Company sold approximately
Note 9: Discontinued Operations
70% of its original equity investment in the ISE during
2005 for $41.1 million. Based on an original cost of Derivative Markets
$6.9 million, the Company recognized a pre-tax gain of The Company completed the sale of its Derivative Markets
$34.2 million. As of December 31, 2005, the Company business to Citigroup for approximately $237 million in
owned 743,000 shares of common stock of the ISE, cash as of the close of business on December 9, 2004. The
which had an aggregate fair value and amortized cost decision to sell the Derivative Markets segment was based
of $20.4 million and $2.9 million, respectively. In addition, on a review of the overall options industry, the capital and
risk required to maintain this business successfully and the
business’ role in the Company’s long-term strategy. In
54 The Knight Difference
accordance with SFAS No. 144, Accounting for the Disposal 2003
of Long-Lived Assets, the results of the Derivative Markets Derivative Global
Markets Markets (KSJ) Total
segment, the revenues and expenses associated with
Revenues $147.1 $ 0.9 $148.1
these businesses as well as all costs associated with the Pre-tax (loss) from
sale transaction have been included in Income (loss) from discontinued operations
discontinued operations, net of tax on the Consolidated before minority interest $ (17.4) $(16.1) $ (33.6)
Statements of Operations for all periods presented. The Minority interest in losses
of KSJ – 6.5 6.5
final purchase price of approximately $237 million in cash,
Pre-tax (loss) from
was subject to adjustment based on the final determina- discontinued operations (17.4) (9.7) (27.1)
tion of the book value of the Derivative Markets segment Income tax (benefit) (6.5) (7.6) (14.1)
at the time the deal closed. The result of this adjustment (Loss) from discontinued
and other expenses related to the sale resulted in addi- operations, net of tax $ (10.9) $ (2.1) $ (13.0)
tional income of $122,000, net of tax, in 2005. For the
year ended December 31, 2004, the net gain on the The Loss from discontinued operations, net of tax for
sale of the Derivative Markets business of $80 million is 2003 includes $7.6 million in income tax benefits related
included in Income (loss) from discontinued operations, to cumulative losses at KSJ. As tax benefits could not be
net of tax. recognized until there were offsetting profits or the com-
mencement of the liquidation process, no tax benefit
Global Markets – Knight Securities Japan had previously been accrued. Additionally, included in
On March 31, 2003, the Company and its joint venture the loss from the Derivative Markets business in 2003 is
partner, Nikko Cordial Group, announced that Knight $18.5 million, net of tax, in charges primarily related to
Securities Japan (“KSJ”) would cease its operations. KSJ’s the impairment of intangible assets.
business plan was significantly impaired due to changes in
market structure, the withdrawal of Nasdaq Japan, poor Note 10: Fixed Assets and Leasehold Improvements
market conditions and limited market-making opportuni- Fixed assets and leasehold improvements comprise the
ties in Japan. As a result, trading operations ceased at KSJ following (in millions):
on May 2, 2003. After the cessation of trading, the parties
Depreciation
liquidated KSJ, and all charges related to this liquidation December 31, Period 2005 2004
were incurred during the second quarter of 2003. Computer hardware
and software 3 years $ 93.2 $ 90.1
The revenues and results of operations of the discontinued Leasehold improvements Life of Lease* 57.0 47.4
operations for 2005, 2004, and 2003 are summarized as Telephone systems 5 years 8.7 7.6
follows (in millions): Furniture and fixtures 7 years 6.0 7.0
Trading systems 5 years 0.4 1.8
2005 Equipment 5 years 2.1 1.8
Derivative 167.4 155.7
Markets
Less-Accumulated
Revenues $ – depreciation and
Pre-tax gain on sale of Derivative Markets business, amortization 99.8 101.4
net of transaction-related costs $ 0.2 $ 67.7 $ 54.4
Income tax expense 0.1
Income from discontinued operations, net of tax $ 0.1 *Shorter of Life of Lease or Useful Life of Assets
2004 Note 11: Commitments and Contingent Liabilities
Derivative In the ordinary course of business, the nature of the
Markets
Revenues $176.8
Company’s business subjects it to claims, lawsuits, regula-
Pre-tax income from discontinued operations, tory examinations and other proceedings. The results of
before sale of business $ 35.5 these matters cannot be predicted with certainty. There
Pre-tax gain on sale of Derivative Markets business, can be no assurance that these matters will not have a
net of transaction-related costs 128.5
material adverse effect on the Company’s results of opera-
Pre-tax income from discontinued operations 164.0
tions in any future period and a material judgment could
Income tax expense 63.1
Income from discontinued operations, net of tax $100.9
Knight 55
Notes to Consolidated Financial Statements
have a material adverse impact on the Company’s financial on January 1, 2004, are for three-year terms, the first of
condition and results of operations. However, it is the opin- which ends on December 31, 2006. The agreements include
ion of management, after consultation with legal counsel an option for renewal by the Deephaven managers through
that, based on information currently available, the ultimate 2009 under certain circumstances. Pursuant to the terms
outcome of these matters will not have a material adverse of a simultaneously executed option agreement between
impact on the business, financial condition or operating the Company and the Deephaven managers, in the event
results of the Company although they might be material of a change of control of the Company during the initial
to the operating results for any particular period, depend- three-year employment term, the Deephaven managers
ing, in part, upon operating results for that period. would have the option (the “Option”) to obtain a 51%
interest in Deephaven in exchange for the termination of
The Company leases office space under noncancelable their employment contracts and associated profit-sharing
operating leases. Certain office leases contain fixed bonuses and other employee profit-sharing plans, which
rent escalation clauses. Rental expense, from continuing in the aggregate range from 42% to 50% of the pre-tax,
operations, under the office leases was $9.2 million, pre-profit sharing profits of Deephaven during the term of
$10.4 million and $9.9 million in 2005, 2004 and 2003, the agreements, subject to meeting certain annual guaran-
respectively, and is included in Occupancy and equipment teed amounts. If a change of control of the Company were
rentals on the Consolidated Statements of Operations. to occur, and if the Deephaven managers exercised the
The Company leases certain computer and other equipment Option, the Company would retain a 49% interest in
under noncancelable operating leases. In addition, the Com- Deephaven. In addition, during the life of the Option,
pany has entered into guaranteed employment contracts the agreements provide that the Company may not sell
with certain of its employees. As of December 31, 2005, Deephaven without the approval of the Deephaven
future minimum rental commitments under all noncancel- managers.
able office, computer and equipment leases (“Operating Note 12: Regulatory Charges and Related Matters
Leases”), and guaranteed employment contracts longer
In June 2005, Deephaven announced that it and a former
than one year (“Other Obligations”) were as follows
Deephaven employee had received Wells Notices from the
(in millions):
staff of the Division of Enforcement of the SEC. The Wells
Lease & Contract Obligations Notice to Deephaven indicated that the staff was consider-
Operating Other ing recommending that the Commission bring a civil
Leases Obligations Total
injunctive action against Deephaven alleging that Deephaven
Year ending December 31, 2006 $ 11.1 $26.5 $ 37.6
violated the anti-fraud provisions of the securities laws in
Year ending December 31, 2007 10.7 13.3 24.0
connection with trading activity associated with certain
Year ending December 31, 2008 10.5 11.0 21.5
Year ending December 31, 2009 10.1 8.0 18.1 Private Investments in Public Equities (“PIPEs”). On
Year ending December 31, 2010 9.5 – 9.5 February 9, 2006, Deephaven announced that it had
Thereafter through submitted an offer of settlement to the staff of the SEC,
October 31, 2021 110.1 – 110.1 which the staff has agreed to recommend to the Com-
$162.0 $58.8 $220.8 mission, to resolve the investigation covered by the Wells
Notice received by Deephaven. The offer of settlement is
During the normal course of business, the Company subject to final agreement on the settlement papers and
collateralizes certain leases or other contractual obliga- final approval by the SEC. Under the terms of the offer
tions through letters of credit or segregated funds held in of settlement, Deephaven would disgorge approximately
escrow accounts. As of December 31, 2005, the Company $2.7 million, pay approximately $343,000 in pre-judgment
has provided an $8.0 million letter of credit, collateralized interest and pay approximately $2.7 million as a civil penalty.
by U.S. Treasury Bills, as a guarantee for one of the During 2005, the Company recorded a $5.7 million pre-
Company’s lease obligations. tax charge relating to this matter, included in Regulatory
charges and related matters on the Consolidated State-
The Company entered into long-term employment
ments of Operations. The Company did not record a tax
contracts with the members of the senior management
benefit for the $2.7 million penalty.
team of Deephaven (the “Deephaven managers”) in 2003.
These employment agreements, which became effective
56 The Knight Difference
On December 16, 2004, Knight Securities L.P., (“KSLP,” now and pay approximately $13.2 million in interest and
known as KEM) concluded a settlement with the SEC and $25.0 million in penalties, for a total of $79.3 million,
NASD (the “Settlement”). The Settlement resolved the which is recorded as Regulatory charges and related
matters for which KSLP received Wells Notices in March matters on the Consolidated Statements of Operations.
2004 from the staffs of the SEC and NASD but did not These amounts were paid in full in the fourth quarter of
address Wells Notices received by certain former employ- 2004. The Company did not record a tax benefit for the
ees of KSLP. The terms of the Settlement provided that $25.0 million penalty.
KSLP disgorge $41.1 million in institutional trading profits,
Note 13: Comprehensive Income
Comprehensive income includes net income and changes Other comprehensive income, net of tax, represents net
in equity except those resulting from investments by, or unrealized gains on the Company’s strategic investment
distributions to, stockholders. Comprehensive income is in the ISE for 2005.
as follows (in millions):
For the years ended December 31, 2005 2004 2003
Net income $66.4 $91.1 $38.1
Other comprehensive income, net of tax:
Foreign currency translation loss adjustment – – 3.4
Net unrealized gains on investment securities held as available-for-sale 10.4 – –
Total comprehensive income, net of tax $76.7 $91.1 $41.4
Note 14: Earnings per Share
Basic earnings per common share (“EPS”) has been calcu- The following is a reconciliation of the numerators and
lated by dividing net income by the weighted-average shares denominators of the basic and diluted earnings per share
of Class A Common Stock outstanding during each respec- computations for the years ended December 31, 2005,
tive period. Diluted EPS reflects the potential reduction in 2004 and 2003 (in millions, except per share data):
EPS using the treasury stock method to reflect the impact
of common share equivalents if stock awards such as stock
options and restricted stock were exercised or converted
into common stock.
For the years ended December 31, 2005 2004 2003
Numerator/ Denominator/ Numerator/ Denominator/ Numerator/ Denominator/
net income shares net income shares net income shares
Income and shares used in basic calculations $66.4 103.5 $91.1 112.4 $38.1 112.0
Effect of dilutive stock-based awards – 3.4 – 5.2 – 5.7
Income and shares used in diluted calculations $66.4 106.9 $91.1 117.6 $38.1 117.7
Basic earnings per share $ 0.64 $ 0.81 $ 0.34
Diluted earnings per share $ 0.62 $ 0.77 $ 0.32
Knight 57
Notes to Consolidated Financial Statements
Note 15: Employee Benefit Plan Included within Nondeductible charges in the preceding
The Company sponsors 401(k) profit sharing plans (the chart is the effect of the $2.7 million and $25.0 million
“Plans”) in which substantially all of its employees are penalties in 2005 and 2004, respectively, related to the
eligible to participate. Under the terms of the Plans, regulatory charges described in Footnote 12, for which
the Company is required to make annual contributions no tax benefit was recorded.
to the Plans equal to 100% of the contributions made
Deferred income taxes reflect the net tax effects of
by its employees, up to annual limits. The total expense,
temporary differences between the financial reporting
from continuing operations, recognized with respect to
and tax bases of assets and liabilities and are measured
the Plans and included in Employee compensation and
using the enacted tax rates and laws that will be in effect
benefits on the Consolidated Statements of Operations,
when such differences are expected to reverse. Significant
was as follows (in millions):
components of the Company’s deferred tax assets and
For the years ended December 31, liabilities at December 31, 2005, 2004 and 2003 are as
2005 $3.3 follows (in millions):
2004 3.5
2003 3.1 2005 2004 2003
Deferred tax assets:
Note 16: Income Taxes Employee compensation and
benefit plans $ 14.8 $ 13.1 $ 4.0
The Company and its subsidiaries file a consolidated Fixed assets and other
federal income tax return as well as combined state amortizable assets 3.3 9.7 8.3
income tax returns in certain jurisdictions. In other Reserves 8.9 8.4 9.2
jurisdictions, the Company and its subsidiaries file Valuation of investments 0.3 2.7 2.8
separate company state income tax returns. State net operating loss
carryforwards, net of federal
tax benefit 3.0 3.3 2.7
The provision for income taxes consists of (in millions):
U.K. net operating
2005 2004 2003 loss carryforwards 27.8 27.1 24.3
Current: Less: Valuation allowance
U.S. federal $38.1 $15.2 $28.9 on U.K. net operating
loss carryforwards (27.8) (27.1) (24.3)
U.S. state and local (2.2) 2.6 5.2
Total deferred tax assets 30.3 37.2 27.0
35.9 17.8 34.1
Deferred tax liabilities
Deferred:
Valuation of investments 14.1 10.9 9.2
U.S. federal 1.3 (6.5) (0.9)
Net deferred tax assets $ 16.2 $ 26.3 $ 17.8
U.S. state and local 1.7 (2.0) (0.7)
3.0 (8.5) (1.6)
Provision for income taxes $38.9 $ 9.3 $32.5 At December 31, 2005, the Company had state net
operating loss carryforwards for tax purposes, up to
The preceding table does not reflect the tax effects of approximately $101.7 million. These state net operating
unrealized gains on available for sale securities and loss carryforwards expire between 2011 and 2012. The
translation adjustments. The tax effect of these items is Company also had U.K. net operating loss carryforwards
recorded directly in Stockholders’ equity. Stockholders’ of approximately $92.8 million which may be carried
equity decreased by $7.1 million and $2.2 million in 2005 forward indefinitely. The Company has recorded a
and 2003, respectively, as a result of these tax effects. valuation allowance for the full amount of these
U.K. tax loss carryforwards.
The following table reconciles the provision to the U.S.
federal income tax (benefit) at statutory rate (in millions): Note 17: Long-Term Incentive Plans
2005 2004 2003 The Company has established the Knight Capital Group, Inc.
U.S. federal income tax (benefit) 1998 Long-Term Incentive Plan, the Knight Capital Group,
at statutory rate $36.8 $(0.2) $29.3 Inc. 1998 Nonemployee Director Stock Option Plan and
U.S. state and local income tax the Knight Capital Group, Inc. 2003 Equity Incentive Plan
(benefit), net of U.S. federal
income tax effect (0.3) 0.3 2.9
(collectively, the “Plans”). The purpose of the Plans is to
Nondeductible charges 1.5 9.6 1.0 provide long-term incentive compensation to employees
Other, net 0.9 (0.4) (0.7) and directors of the Company. The Plans are administered
Income tax expense $38.9 $ 9.3 $32.5 by the Compensation Committee of the Company’s Board
58 The Knight Difference
of Directors, and allow for the grant of options, restricted The Company’s policy is to grant options for the purchase
stock and restricted stock units (collectively, the “awards”), of shares of Class A Common Stock at not less than market
as defined by the Plans. The maximum number of shares value, which the Plans define as the average of the high and
of Class A Common Stock reserved for the grant of low sales prices on the date prior to the grant date. Options
awards under the Plans is now 37,819,000, subject to generally vest over a three- or four-year period and expire
adjustment, of which, 6,045,806 are available for grant on the fifth or tenth anniversary of the grant date, pursuant
at December 31, 2005. In addition, the Plans limit the to the terms of the agreements. Restricted stock awards
number of options or shares that may be granted to a generally vest over three years. The Company has the
single individual and the Plans also limit the number of right to fully vest employees in their option grants and
shares of restricted stock that may be awarded. awards upon retirement and in certain other circumstances.
The following is a reconciliation of option activity for the
Plans for 2005 and 2004, and a summary of options
outstanding and exercisable at December 31, 2005:
2005 2004
Weighted- Weighted-
Average Average
Number of Exercise Number of Exercise
Options Price Options Price
Outstanding at January 1 16,787,884 $ 9.20 19,525,279 $ 8.39
Granted at market value 3,092,814 9.30 2,526,021 10.31
Exercised (3,952,173) 5.70 (4,527,202) 6.01
Surrendered (2,689,698) 19.11 (736,214) 11.16
Outstanding at December 31 13,238,827 $ 8.26 16,787,884 $ 9.20
Vested at December 31 8,735,568 $ 7.76 10,297,784 $10.42
Available for future grants at December 31* 6,045,806 8,259,980
Weighted-average fair value of grants during the year
(at market value, based on Black-Scholes) $ 4.03 $ 4.57
*Represents both options and awards available for grant
Options Outstanding Options Exercisable
Weighted-
Average Weighted- Weighted-
Remaining Average Number Average
Range of Outstanding Contractual Exercise Exercisable Exercise
Exercise Prices at 12/31/05 Life Price at 12/31/05 Price
$ 3.64 – $ 4.22 2,421,601 2.01 $ 4.16 2,420,614 $ 4.16
$ 4.43 – $ 5.97 3,597,415 1.65 5.59 3,290,694 5.63
$ 6.06 – $ 8.85 2,249,759 5.19 7.39 1,256,239 7.13
$ 9.20 – $13.85 3,988,512 8.44 10.12 857,586 10.54
$13.90 – $29.66 813,040 3.11 17.86 741,935 18.20
$30.44 – $71.38 168,500 3.12 45.56 168,500 45.56
The Company applies APB 25 and related interpretations The Company granted a total of 1,828,036 restricted shares
in accounting for its stock option plans. As options are of Class A Common Stock, net of all cancelled restricted
granted at the then market value, no compensation shares, to certain current employees of the Company under
expense has been recognized for the fair values of the the Plans in 2005. At December 31, 2005, the Company
options granted to employees. had 3,016,703 restricted shares outstanding, in aggregate,
both under and outside of the Plans. The Company recog-
nizes compensation expense for the fair values of the
Knight 59
Notes to Consolidated Financial Statements
restricted shares of Class A Common Stock granted to Note 19: Net Capital Requirements
employees ratably over the vesting period. The restricted Our U.S. registered broker-dealers are subject to the SEC’s
stock requires future service as a condition of the vesting Uniform Net Capital Rule, which requires the maintenance
of the underlying shares of common stock. In 2005, the of minimum net capital. Additionally, our foreign registered
Company recorded compensation expense, from con- broker-dealers are subject to capital adequacy requirements
tinuing operations, of $13.4 million for its outstanding of their respective regulatory authorities. As of December 31,
restricted shares. This amount has been included in 2005, our significant broker-dealer subsidiaries, KEM and
Employee compensation and benefits in the KCM, were in compliance with their capital adequacy
Consolidated Statements of Operations. requirements. The following table sets forth their net
capital levels and requirements at December 31, 2005,
Note 18: Financial Instruments with Off-Balance
as filed in their respective regulatory filings (in millions):
Sheet Risk and Concentrations of Credit Risk
As a market-maker of equities, the majority of the Minimum Excess
Net Net Net
Company’s securities transactions are conducted as princi- Entity Capital Capital Capital
pal or riskless principal with broker-dealer and institutional KEM $99.1 $6.1 $93.0
counterparties primarily located in the United States. The KCM 34.4 3.3 31.1
Company clears the majority of its securities transactions
through clearing brokers. Foreign transactions are settled Note 20: Business Segments
pursuant to a global custody and clearing agreement with The Company currently has two operating business
a major U.S. bank. Substantially all of the Company’s credit segments, Global Markets and Asset Management, and a
exposures are concentrated with its clearing brokers and Corporate segment. The Global Markets segment primarily
the bank (the “clearing agents”). These clearing agents represents the businesses that provide comprehensive trade
may re-hypothecate certain securities held on behalf of execution services in U.S. equities. The Asset Management
the Company. Additionally, pursuant to the terms of the segment consists of investment management and sponsor-
agreement between the Company and the clearing agents, ship of the Deephaven Funds. The Corporate segment
the clearing agents have the right to charge the Company includes all corporate overhead expenses and investment
for all losses that result from a counterparty’s failure to income earned on strategic investments and the Company’s
fulfill its contractual obligations. The Company has the corporate investment in the Deephaven Funds. Corporate
ability to pursue collection from or performance with regard overhead expenses primarily consist of compensation for
to this right. The Company’s policy is to monitor the credit certain senior executives and other individuals employed
standing of the clearing brokers and all counterparties at the corporate holding company, legal and other profes-
with which it conducts business. sional expenses relating to corporate matters, investor
and public relations expenses and directors’ and officers’
Securities sold, not yet purchased represent obligations
insurance.
to purchase such securities (or underlying securities) at a
future date. The Company may incur a loss if the market In 2004, the Company sold one of its business segments,
value of the securities subsequently increases. Derivative Markets. The revenues and expenses associated
with Derivative Markets have been included within Income
The Company currently has no loans to any former or
(loss) from discontinued operations, net of tax on the
current executive officers or directors.
Consolidated Statements of Operations for all periods
presented. For a discussion of discontinued operations as
well as a breakout of discontinued operations by business
segment, see Footnote 9, “Discontinued Operations.”
60 The Knight Difference
The Company’s revenues, income (loss) from continuing segment are summarized below (in millions).
operations before income taxes and total assets by
Asset Global Consolidated
Management Markets Corporate Total
For the year ended December 31, 2005:
Revenues $89.8 $470.7 $ 74.2 $ 634.6
Income from continuing operations before income taxes1 20.8 35.1 49.3 105.2
Total assets 82.4 996.1 337.5 1,416.0
For the year ended December 31, 2004:
Revenues $78.2 $531.0 $ 16.6 $ 625.8
(Loss) income from continuing operations before income taxes2 29.6 (13.2) (16.9) (0.5)
Total assets 76.8 797.9 519.3 1,394.0
For the year ended December 31, 2003:
Revenues $58.4 $459.0 $ 28.5 $ 545.9
Income (loss) from continuing operations before income taxes3 29.5 55.3 (1.2) 83.6
Total assets4 39.6 706.7 275.6 1,022.0
(1) Income from continuing operations before income taxes for December 31, 2005 includes $10.1 million in Writedown of assets and lease loss accrual
(described in Footnote 8) and $5.7 million in Regulatory charges and related matters (described in Footnote 12).
(2) (Loss) income from continuing operations before income taxes for December 31, 2004 includes $3.8 million in Writedown of assets and lease loss accrual
(described in Footnote 8) and $79.3 million in Regulatory charges and related matters (described in Footnote 12).
(3) Income (loss) from continuing operations before income taxes for December 31, 2003 includes $16.5 million in Writedown of assets and lease loss accrual
(described in Footnote 8).
(4) Total assets does not include Assets within discontinued operations of $2.94 billion at December 31, 2003.
Note 21: Subsequent Events
In January 2006, the Company agreed to acquire Hotspot
FX, Inc., an industry-leading electronic foreign exchange
marketplace that provides access to electronic foreign
exchange spot trade executions through an advanced
ECN-based platform, for approximately $77.5 million in
cash. The acquisition is expected to close shortly and is
subject to customary closing conditions.
Knight 61
Notes to Consolidated Financial Statements
Note 22: Condensed Financial Statements of Condition, Operations and Cash Flows for the Company
Knight Capital Group, Inc. (parent only) on an unconsolidated basis.
Presented below are the Condensed Statements of Financial
Statements of Financial Condition
Knight Capital Group, Inc. (parent only)
December 31, 2005 2004
Assets
Cash and cash equivalents $ 19,631,035 $207,502,727
Securities owned, at market value 8,355,588 8,895,742
Investments in subsidiaries, equity method 844,461,203 660,175,749
Investments in Deephaven sponsored funds 116,515,653 59,666,741
Strategic investments 11,418,453 9,682,070
Other assets 18,960,399 28,320,343
Total assets $1,019,342,331 $974,243,372
Liabilities and Stockholders’ Equity
Liabilities
Accrued compensation expense $ 12,907,113 $ 21,423,293
Accrued expenses and other liabilities 2,605,237 2,539,649
Payable to subsidiaries 155,473,111 52,964,083
Income taxes payable 24,908,721 46,114,453
Total liabilities 195,894,182 123,041,478
Total stockholders’ equity 823,448,149 851,201,894
Total liabilities and stockholders’ equity $1,019,342,331 $974,243,372
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, 2005 2004 2003
Revenues
Equity in earnings of subsidiaries $58,523,089 $ 87,523,708 $27,119,304
Corporate management fees 24,260,604 29,445,158 24,432,677
Investment income and other 8,635,792 7,359,866 17,029,237
Total revenues 91,419,485 124,328,732 68,581,218
Expenses
Compensation expense 14,326,736 22,175,453 20,279,738
Professional fees 6,512,269 4,873,597 3,840,406
Business development 460,384 2,001,365 2,218,373
Other 4,792,445 4,498,769 3,552,477
Total expenses 26,091,834 33,549,184 29,890,994
Income before income taxes 65,327,651 90,779,548 38,690,224
Income tax (benefit) expense (1,033,254) (352,358) 616,751
Net income $66,360,905 $ 91,131,906 $38,073,473
The accompanying notes are an integral part of these condensed financial statements.
62 The Knight Difference
Statements of Cash Flows
Knight Capital Group, Inc. (parent only)
For the years ended December 31, 2005 2004 2003
Cash flows from operating activities
Net income $ 66,360,905 $ 91,131,906 $ 38,073,473
Adjustments to reconcile net income to net cash provided by operating activities
Equity in earnings of subsidiaries (58,523,089) (87,523,708) (27,119,304)
Amortization 40,000 23,333 –
Stock-based compensation 2,850,848 2,932,288 1,193,725
Income tax credit from stock options exercised 6,625,852 11,392,768 7,433,289
(Increase) decrease in operating assets
Securities owned 540,154 2,250,099 1,723,427
Receivable from subsidiaries – 45,627,072 (45,898,322)
Income taxes receivable – – 22,327,416
Other assets 9,319,551 (28,144,909) 25,891,868
Increase (decrease) in operating liabilities
Accrued compensation expense (8,516,180) 7,951,750 2,759,123
Accrued expenses and other liabilities 65,588 256,199 (418,469)
Payable to subsidiaries 102,509,028 54,370,363 (10,232,621)
Income taxes payable (21,205,732) 36,992,313 9,122,140
Net cash provided by operating activities 100,066,925 137,259,474 24,855,745
Cash flows from investing activities
Investment in Deephaven sponsored funds (56,848,912) (23,499,375) 112,520,639
(Purchases of) proceeds from strategic investments (1,736,383) (6,924,733) (532,379)
Dividends received from subsidiaries 38,994,784 138,349,426 58,810,327
Capital contributions to subsidiaries (143,848,737) (13,512,219) (176,141,254)
Net cash (used in) provided by investing activities (163,439,248) 94,413,099 (5,342,667)
Cash flows from financing activities
Stock options exercised 22,516,960 27,192,742 15,003,287
Cost of common stock repurchased (147,016,329) (78,841,155) (34,297,186)
Net cash used in financing activities (124,499,369) (51,648,413) (19,293,899)
(Decrease) increase in cash and cash equivalents (187,871,692) 180,024,160 219,179
Cash and cash equivalents at beginning of the year 207,502,727 27,478,567 27,259,388
Cash and cash equivalents at end of the year $ 19,631,035 $207,502,727 $ 27,478,567
Supplemental disclosure of cash flow information:
Cash paid for interest $ 576,361 $ 189,241 $ 106,353
Cash paid for income taxes $ 52,563,496 $ 26,917,732 $ 21,391,344
The accompanying notes are an integral part of these condensed financial statements.
Knight Capital Group, Inc. (parent only) B. Income taxes
Notes to Condensed Financial Statements As stated in Footnote 16, the Company and its subsidiaries
A. General file a consolidated federal income tax return as well as
The condensed financial statements of Knight Capital combined state income tax returns in certain jurisdictions.
Group, Inc. (parent only; the “Parent Company”) should In other jurisdictions, the Company and its subsidiaries
be read in conjunction with the Consolidated Financial file separate state income tax returns. As such, both
Statements of the Company and the notes thereto. federal and state income taxes are accrued at the
subsidiary level and are included in Equity in earnings
(losses) of subsidiaries on the Condensed Financial
Statements. Income tax expense included on the
Condensed Financial Statements represents only the
income taxes attributable to the Parent Company.
Knight 63
Management‘s Report on Internal Control Over Financial Reporting
Knight Capital Group Inc.’s (“Knight”) management is Because of its inherent limitations, internal control over
responsible for establishing and maintaining adequate financial reporting may not prevent or detect misstate-
internal control over financial reporting. Internal control ments. Projections of any evaluation of effectiveness to
over financial reporting is defined in Rule 13a-15(f) and future periods are subject to the risks that controls may
15d-15(f) under the Securities Exchange Act of 1934, as become inadequate because of changes in conditions, or
amended, as a process designed by, or under the super- that the degree of compliance with the policies or proce-
vision of, the company’s principal executive and principal dures may deteriorate.
financial officers and effected by the company’s board of
directors, management and other personnel to provide Management assessed the effectiveness of Knight’s internal
reasonable assurance regarding the reliability of financial control over financial reporting as of December 31, 2005.
reporting and the preparation of financial statements for In making this assessment, management used the criteria
external purposes in accordance with generally accepted set forth by the Committee of Sponsoring Organizations
accounting principles and includes those policies and of the Treadway Commission in Internal Control –
procedures that: Integrated Framework.
• pertain to the maintenance of records that, in reasonable Based on our assessment, Knight’s management has
detail, accurately and fairly reflect the transactions and concluded that, as of December 31, 2005, internal
dispositions of the assets of Knight; control over financial reporting is effective.
• provide reasonable assurance that transactions are Knight management’s assessment of the effectiveness
recorded as necessary to permit preparation of finan- of the Company’s internal control over financial report-
cial statements in accordance with generally accepted ing as of December 31, 2005 has been audited by
accounting principles, and that receipts and expendi- PricewaterhouseCoopers LLP, an independent registered
tures of the company are being made only in public accounting firm, as stated in their report which
accordance with authorizations of management appears herein.
and directors of Knight; and
• provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use
or disposition of the company’s assets that could have
a material effect on the financial statements.
64 The Knight Difference
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Internal control over financial reporting
Knight Capital Group, Inc. Also, in our opinion, management’s assessment, included
We have completed integrated audits of Knight Capital in Management’s Report on Internal Control Over Financial
Group, Inc.’s 2005 and 2004 consolidated financial state- Reporting appearing on page 64, that the Company main-
ments and of its internal control over financial reporting tained effective internal control over financial reporting
as of December 31, 2005, and an audit of its 2003 con- as of December 31, 2005, based on criteria established
solidated financial statements in accordance with the in Internal Control – Integrated Framework issued by
standards of the Public Company Accounting Oversight the Committee of Sponsoring Organizations of the Tread-
Board (United States). Our opinions on Knight Capital way Commission (COSO), is fairly stated, in all material
Group, Inc.’s 2005, 2004, and 2003 consolidated finan- respects, based on those criteria. Furthermore, in our
cial statements and on its internal control over financial opinion, the Company maintained, in all material respects,
reporting as of December 31, 2005, based on our audits, effective internal control over financial reporting as of
are presented below. December 31, 2005, based on criteria established in
Internal Control – Integrated Framework issued by COSO.
Consolidated financial statements The Company’s management is responsible for maintain-
In our opinion, the consolidated financial statements ing effective internal control over financial reporting and
listed in the accompanying index present fairly, in all for its assessment of the effectiveness of internal control
material respects, the financial position of Knight Capital over financial reporting. Our responsibility is to express
Group, Inc. and its subsidiaries (the “Company”) at opinions on management’s assessment and on the effec-
December 31, 2005 and 2004, and the results of their tiveness of the Company’s internal control over financial
operations and their cash flows for each of the three years reporting based on our audit. We conducted our audit
in the period ended December 31, 2005 in conformity with of internal control over financial reporting in accordance
accounting principles generally accepted in the United States with the standards of the Public Company Accounting
of America. These financial statements are the responsi- Oversight Board (United States). Those standards require
bility of the Company’s management. Our responsibility is that we plan and perform the audit to obtain reasonable
to express an opinion on these financial statements based assurance about whether effective internal control over
on our audits. We conducted our audits of these statements financial reporting was maintained in all material respects.
in accordance with the standards of the Public Company An audit of internal control over financial reporting
Accounting Oversight Board (United States). Those stan- includes obtaining an understanding of internal control
dards require that we plan and perform the audit to obtain over financial reporting, evaluating management’s assess-
reasonable assurance about whether the financial state- ment, testing and evaluating the design and operating
ments are free of material misstatement. An audit of effectiveness of internal control, and performing such
financial statements includes examining, on a test basis, other procedures as we consider necessary in the circum-
evidence supporting the amounts and disclosures in the stances. We believe that our audit provides a reasonable
financial statements, assessing the accounting principles basis for our opinions.
used and significant estimates made by management,
and evaluating the overall financial statement presenta-
tion. We believe that our audits provide a reasonable
basis for our opinion.
Knight 65
Report of Independent Registered Public Accounting Firm
A company’s internal control over financial reporting is a Because of its inherent limitations, internal control over
process designed to provide reasonable assurance regard- financial reporting may not prevent or detect misstate-
ing the reliability of financial reporting and the preparation ments. Also, projections of any evaluation of effectiveness
of financial statements for external purposes in accordance to future periods are subject to the risk that controls may
with generally accepted accounting principles. A company’s become inadequate because of changes in conditions, or
internal control over financial reporting includes those that the degree of compliance with the policies or proce-
policies and procedures that (i) pertain to the maintenance dures may deteriorate.
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of
the company; (ii) provide reasonable assurance that trans- PricewaterhouseCoopers LLP
actions are recorded as necessary to permit preparation of New York, New York
financial statements in accordance with generally accepted March 14, 2006
accounting principles, and that receipts and expenditures
of the company are being made only in accordance with
authorizations of management and directors of the
company; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition,
use, or disposition of the company’s assets that could have
a material effect on the financial statements.
66 The Knight Difference
Management Team and Board of Directors
As of March 14, 2006
Management Team Board of Directors
Thomas M. Joyce* Thomas M. Joyce
Chairman & Chief Executive Officer Chairman & Chief Executive Officer,
Knight Capital Group, Inc.
Business Segments
Asset Management Charles V. Doherty 1,2,3
Lead Director,
Colin J. Smith Knight Capital Group, Inc.
Deephaven Capital Management Retired Managing Director,
Madison Advisory Group
Global Markets
James P. Smyth* William L. Bolster 1,3
Broker-Dealer Retired Co-Chairman & Chief Executive Officer,
CNBC International
Gregory C. Voetsch*
Institutional Gary R. Griffith 1,2
Independent Financial Consultant
Disciplines
Leonard J. Amoruso Robert M. Lazarowitz 1,3
Compliance Former Executive Vice President,
Knight Capital Group, Inc.
Bronwen Bastone
Human Resources Thomas C. Lockburner 1,2
Retired Audit Partner,
John B. Howard* Deloitte & Touche LLP
Accounting & Finance
James T. Milde 1,3
Thomas M. Merritt* Senior Vice President & Chief Information Officer,
Legal United Rentals, Inc.
Steven J. Sadoff Rodger O. Riney 1,3
Technology President,
Scottrade, Inc.
Margaret E. Wyrwas
Corporate Communications & Investor Relations
1 Member, Nominating and Corporate Governance Committee
2 Member, Finance and Audit Committee
* These executive officers are required under Section 16(a) of the Exchange Act 3 Member, Compensation Committee
to file reports of ownership and changes in ownership on Forms 3, 4 and 5
with the Securities and Exchange Commission (“SEC”) and the Nasdaq Stock
Market. Further detail is available in Knight Capital Group, Inc.’s 2005 proxy
filing with the SEC, also located on our website at www.knight.com.
Knight 67
Corporate Headquarters and Offices
Corporate Headquarters Global Markets 509 Madison Avenue
545 Washington Boulevard Suite 2002
Jersey City, New Jersey 07310 2859 Paces Ferry Road New York, NY 10022
Telephone: 201.222.9400 Atlanta, Georgia 30339 Telephone: 212.284.9927
Fax: 201.557.6853 Telephone: 800.438.4284 Fax: 212.284.9928
Toll Free: 800.544.7508 Fax: 770.333.9050
Telephone: 800.222.4891 100 Manhattanville Road
Concept and Design: www.crittgraham.com Copywriting: Margaret E. Wyrwas, Kara A. Fitzsimmons, Margaret K. Morley, Molly K. McDowell Photography: George Lange Printing: ACME Printing Co. LLC
Fax: 770.333.1096 Purchase, New York 10577
Asset Management Telephone: 914.251.5800
200 State Street, Suite 11B Fax: 914.251.5812
Deephaven Capital Management Boston, Massachusetts 02109 Toll Free: 800.677.8746
Telephone: 617.912.3200
Main Office Fax: 617.912.3250 One Independence Plaza
130 Cheshire Lane, Suite 102 Toll Free: 800.771.8099 280 Highway 35
Minnetonka, Minnesota 55305 Red Bank, New Jersey 07701
Telephone: 952.249.5700 225 West Washington Street Telephone: 732.747.3461
Fax: 952.249.5320 Suite 300 Fax: 732.747.3462
Chicago, Illinois 60606
Suite 5603, The Center Telephone: 312.553.8305 One Market Street
99 Queens Road, Central Fax: 312.553.8345 Spear Tower, Suite 1810
Hong Kong Toll Free: 800.279.7695 San Francisco, California 94105
Telephone: 852.3555.6000 Telephone: 415.541.3920
Fax: 852.3555.6111 990 Stewart Avenue, Suite 620 Fax: 415.896.6139
Garden City, New York 11530 Toll Free: 866.612.7095
6 Gracechurch Street, 1st Floor Telephone: 866.202.1095
London, EC3V 0AT Fax: 516.214.5296 4699 Old Ironsides Drive, Suite 300
United Kingdom Santa Clara, California 95054
Telephone: 44.20.7469.1900 600 East Las Colinas Boulevard Telephone: 408.855.0800
Fax: 44.20.7469.1850 Suite 2222 Fax: 408.492.1290
Irving, Texas 75039
Telephone: 800.421.9955 Regus Business Centre
Fax: 972.865.0400 Water Garden II
1601 Cloverfield Boulevard
545 Washington Boulevard 2nd Floor, South Tower, Suite 2058
Jersey City, New Jersey 07310 Santa Monica, California 90404
Telephone: 201.222.9400 Telephone: 415.541.3920
Fax: 201.557.6853 Fax: 310.828.2661
Toll Free: 800.544.7508
Guildhall House
81-87 Gresham Street, 4th Floor
London, EC2V 7NQ
United Kingdom
Telephone: 44.20.7997.2200
Fax: 44.20.7997.2220
68 The Knight Difference
Annual Meeting Outside Counsel
The 2006 Annual Meeting will take place at 1:00 p.m. EDT Skadden, Arps, Slate, Meagher & Flom LLP
on Wednesday, May 10, 2006, at Knight’s Corporate 4 Times Square
Headquarters, 545 Washington Boulevard, Jersey City, New York, New York 10036
New Jersey 07310. www.skadden.com
Common Stock Consolidated Subsidiaries
The Class A Common Stock is listed in the Nasdaq National For a list of our regulated broker-dealer subsidiaries,
Market System under the symbol “NITE.” Public trading please refer to our Annual Report on SEC Form 10-K.
of the Company’s Class A Common Stock commenced on
July 8, 1998. The Company’s common stock underwent a Transfer Agent and Registrar
2-for-1 stock split on May 14, 1999, at the close of busi- Mellon Investor Services LLC
ness. The current CUSIP number is 499005 10 6. P.O. Box 3315
South Hackensack, New Jersey 07606-1915
Dividend Policy 800.851.9677
The Company has never declared or paid a cash dividend www.melloninvestor.com
on its Class A Common Stock.
Corporate Website Knight Capital Group, Inc. provides its offerings through its Asset
Management and Global Markets business segments. Services
www.knight.com offered by Knight’s Asset Management business are provided by
Deephaven Capital Management LLC, a registered investment
adviser with the U.S. Securities and Exchange Commission (SEC).
Publications
Securities and services for the Global Markets business are offered
Copies of the Annual Report, the Annual Report on by Knight’s regulated broker-dealer subsidiaries duly registered with
SEC Form 10-K, Quarterly Reports on SEC Form 10-Q, the SEC, which are: Knight Capital Markets LLC (member National
Association of Securities Dealers (NASD) and Securities Investor
Current Reports on SEC Form 8-K, Forms 3, 4 and 5 Protection Corporation (SIPC)); Knight Equity Markets, L.P. (member
filed on behalf of directors and executive officers, Proxy NASD, SIPC, National Stock Exchange, Pacific Stock Exchange and the
Statements, press releases and general information are National Futures Association (NFA)); Direct Edge ECN LLC (member
NASD and SIPC); and Direct Trading Institutional, L.P. (member NASD,
available through the corporate website, by calling SIPC and NFA). Securities and services are also provided by Knight
Investor and Shareholder Relations at 201.356.1723, Equity Markets International Limited (member London Stock
Exchange, Euronext and Deutsche Börse, and regulated by the
or by writing Investor and Shareholder Relations at the
Financial Services Authority in the U.K.).
Corporate Headquarters address.
Unless the context otherwise requires, the “Company,” “Knight,” “We,” or
“Our” shall mean Knight Capital Group, Inc. and its consolidated subsidiaries.
Contact Information
Analyst, Investor, Media and Public Relations inquiries Certain statements contained in this annual report, including without limitation,
those under “Management’s Discussion and Analysis of Financial Condition and
should be directed to Margaret Wyrwas, Senior Managing Results of Operations” (MD&A) and statements containing the words “believes,”
Director, Corporate Communications & Investor Relations, “intends,” “expects,” “anticipates” and words of similar import, may constitute
forward-looking statements as defined in the Private Securities Litigation Report
by writing to the Corporate Headquarters address, or by Act of 1995. These forward-looking statements are not historical facts and are
calling 201.557.6954. Media inquiries may be directed to based on current expectations, estimates and projections about the Company’s
industry, management’s beliefs and certain assumptions made by management,
Kara Fitzsimmons, Vice President, Corporate Communications
many of which, by their nature, are inherently uncertain and beyond our control.
at 201.356.1523. Public Relations inquiries may be Accordingly, readers are cautioned that any such forward-looking statements are
directed to Greta Morley, Vice President, Marketing not guarantees of future performance and are subject to certain risks, uncertain-
ties and assumptions that are difficult to predict including, without limitation,
Communications & Public Relations at 201.557.6948. risks associated with the costs and integration, performance and operation of
Investor and Shareholder inquiries may be directed businesses recently acquired, or being acquired, by the Company. Since such
statements involve risks and uncertainties, the actual results and performance
to Investor and Shareholder Relations, by writing to the of the Company may turn out to be materially different from the results
Corporate Headquarters address, or by calling expressed or implied by such forward-looking statements. Given these uncertain-
ties, readers are cautioned not to place undue reliance on such forward-looking
201.356.1723. statements. Unless otherwise required by law, the Company also disclaims any
obligation to update its view of any such risks or uncertainties or to announce
publicly the result of any revisions to the forward-looking statements made in
Independent Auditor
this report. Readers should carefully review the risks and uncertainties detailed
PricewaterhouseCoopers LLP under “Certain Factors Affecting Results of Operations” in the MD&A herein
300 Madison Avenue and in other reports or documents the Company files from time to time with
the Securities and Exchange Commission. This discussion should be read in
New York, New York 10017 conjunction with the Company’s Consolidated Financial Statements and the
www.pwc.com Notes thereto contained in this report.
The science of trading. The standard of trust. TM
Corporate Headquarters
545 Washington Boulevard, Jersey City, New Jersey 07310
Telephone: 201.222.9400 Fax: 201.557.6853 Toll Free: 800.544.7508
Nasdaq: NITE
www.knight.com