Fellow Knight Shareholder:
In 2008, we witnessed a confluence of extraordinary events that academics and economists will study for years to come.
From the outset, the magnitude, rapidity and severity of the crisis was startling and unprecedented. From the dislocations in the credit markets and historic spikes in volatility, to the government-led bailouts of major financial institutions and steep declines in global market indexes, investors and firms suffered a series of potentially devastating events.
In the latter stages of the year, as valuations increasingly grew disconnected from fundamentals, market activity tipped heavily to portfolio liquidation over accumulation. The difficult market conditions have largely continued into 2009.
Despite the current market environment, which began in the summer of 2007, Knight’s continued growth and progress in Global Markets is a remarkable demonstration of our resilience.
Financial Performance
Knight achieved exceptional financial performance in 2008, propelled by the successful and ongoing execution of the growth strategy in Global Markets, which dramatically grew trade volumes and gained market share.
Unfortunately, in Asset Management, the results were different. The unprecedented market conditions and broad-based deleveraging among alternative investment managers contributed to poor performance of the Deephaven Funds and a loss for the year.
Nevertheless, on a consolidated basis, we made considerable progress:
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Revenues increased 17% to $1.03 billion in 2008, from $885 million in 2007
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Pre-tax earnings after minority interest increased 53% to $308 million in 2008, from $201 million in 2007
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Pre-tax margins increased to 30% in 2008, from 23% in 2007
We’ve developed specialized expertise in Global Markets which is supported by a base of sustainable results across market cycles. We will continue to play to our strengths and build off the momentum generated both by design and events in the markets.
In Global Markets, average daily U.S. equity trade volume increased 91% from 2007 to 2008, while average daily shares and dollar value traded rose 6% and 50%, respectively.
Expanding Global Markets
The performance of Global Markets is due to the diversification of revenues across clients, offerings, order flow, asset classes and geographies, and continuous investments in trading technology. Recently, we’ve invested in expanding our operations in Europe and Asia.
We are fast-becoming an indispensable partner to leading buy- and sell-side firms, which is reflected by deepening client relationships and growth of trade volumes, particularly in Listed securities. We derived approximately 58% of net trade execution revenues from Listed securities in 2008, up from 43% in 2007 and 32% in 2006.
Among the highlights:
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In 2008, Knight executed greater share volume than any U.S.-based exchange*; among securities firms, we ranked # 2 in shares traded of Listed securities, # 1 in NASDAQ securities and # 1 in Bulletin Board securities for the year**
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Revenues from electronic trade execution services topped 50% of total Global Markets revenues, which helped drive pre-tax margins in the segment to 36% in 2008, from 24% in 2007
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In 2008, Knight Link, a dark, electronic access point into Knight’s off-exchange liquidity, experienced exceptional growth
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Knight’s high-velocity algorithmic trading models, which analyze trade data and interact with Street flow to look for price dislocations in individual U.S. equities, added to revenues and enhanced pre-tax margins
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Knight Direct augmented its platform by adding EdgeTrade agency-only algorithmic trading strategies, access to European equities and foreign exchange, and transaction cost analysis (TCA) tools
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The acquisition of Knight Libertas added institutional fixed income sales, trading and research capabilities to our offering and resulted in immediate contributions
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The relaunch of Knight BondPoint, electronic fixed income trading solutions for broker-dealers, resulted in the addition of more than 60 new clients through cross-selling
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We relocated the London office to a larger space to facilitate the expansion of our offering to clients in Europe and prepared to open a Hong Kong office to serve clients in the Asia-Pacific region
A priority in 2009 is to continue building liquidity across global equities and other asset classes. The expansion of operations in Europe and Asia as well as increased contributions in fixed income from Knight Libertas and Knight BondPoint demonstrate our resolve to build off of our well-earned position in U.S. equities.
Exiting Asset Management
At Deephaven Capital Management, the macro-economic environment, negative performance of Deephaven Funds and redemption requests prompted us to review options for Knight’s 51% stake in the alternative asset manager.
As part of the third quarter 2008 earnings press release, we stated Deephaven would consider all alternatives to protect its fund investors. Subsequently, on January 27, 2009, we disclosed that Deephaven entered into an asset purchase agreement with a third party. Finalization of the transaction is subject to the approval of Deephaven investors.
On February 20, 2009, Deephaven committed to the process of winding down its operations by reducing its workforce by approximately 15% in anticipation of a sale. Deephaven plans further workforce reductions in the first half of 2009, along with lease and contract terminations. As disclosed on February 26, 2009, Knight expects it will incur pre-tax charges of approximately $35 million to $45 million related to the wind-down.
Strong, Liquid Balance Sheet
Knight has a solid financial foundation to withstand the current turmoil in the global capital markets.
As of December 31, 2008, Knight had $2.0 billion in assets, approximately 62% of which consisted of cash or assets readily convertible to cash. We employ limited leverage, as evidenced by our low 0.14 debt to equity ratio. Finally, at the end of 2008, Knight had $1.0 billion in shareholders’ equity, which was equivalent to a book value of $11.53 per diluted share.
In 2009, our priorities include growing our share of global equity and fixed income trade volume, building pools of liquidity across asset classes, investing in our trading technology and infrastructure, developing and refining innovative algorithmic models, and increasing cross-selling efforts to our buy- and sell-side clients.
Summary
While the global capital markets will present further challenges – and the major market indexes have continued to decline in 2009 – I remain confident in Knight’s long-term prospects.
We have strong relationships with the world’s leading buy- and sell-side firms, a differentiated offering in the marketplace, superior trading technology and abundant opportunities.
In the coming year, we’ll work to further diversify revenues, expand our offering and aggressively build our presence internationally in Europe and Asia. And because the changing political and regulatory climate could impact market structure and execution costs, we will be an active participant in the dialogue taking place in Washington, D.C.
We will look for opportunities to capitalize on the dislocation in the financial sector by investing in new teams and new products. At the same time, as we pursue growth we will maintain our fiscal and risk discipline. There is an evolutionary process taking place and we believe Knight will play an important role on the new Wall Street. We are committed to maintaining high standards for client service, improving our capabilities through constant innovation and managing for the long-term.
Knight’s success in 2008 is a direct result of the dedication of our management team and employees, who persevered amid the extraordinary events that engulfed Wall Street. Pressing ahead, we will maintain our client focus, continue to execute the growth strategy and balance prudence with opportunity in evaluating each undertaking.
On behalf of our directors, management team and employees, thank you for your support.
Thomas M. Joyce
Chairman & CEO
March 17, 2009