KCG Holdings, Inc. (NYSE: KCG) today reported a GAAP net loss of $9.6 million, or $0.09 per share, for the third quarter of 2014.
The third quarter 2014 GAAP net loss from continuing operations was $9.4 million, or a loss of $0.09 per share. The third quarter pre-tax loss from continuing operations was $15.2 million which includes a $15.1 million net gain related to the Company’s strategic investment in tradeMONSTER Group, Inc. (“tradeMONSTER”), which combined with OptionsHouse LLC (“OptionsHouse”), $10.5 million in compensation related to a reduction in workforce and other employee separations and a $0.3 million lease loss accrual. Excluding these items, on a non-GAAP basis, third quarter 2014 loss from continuing operations before income taxes was $19.5 million. A reconciliation of GAAP to non-GAAP results is included in Exhibit 4.
KCG was formed July 1, 2013 as a result of the merger between Knight Capital Group, Inc. and GETCO Holding Company, LLC. Financial results for the periods prior to the third quarter of 2013 contained herein solely represent the results of GETCO Holding Company, LLC as the accounting acquirer.
Third Quarter Highlights
Whilst the overall corporate performance at KCG resulted in a negative income figure, the firm grew its market share of consolidated U.S. equity share volume executed by KCG market making from the second quarter, as well as increased algorithmic trading volumes and net revenues from institutional clients for the second consecutive quarter.
In congruence with many institutions in North America, KCG announced the sale of KCG’s futures commission merchant (FCM), whilst also repurchasing 3.6 million shares for $42.1 million.
Daniel Coleman, Chief Executive Officer of KCG, said, “KCG’s financial results for the third quarter of 2014 were impacted by the subdued market environment in U.S. equities. In particular, the muted retail trading activity and single-digit realized volatility within a heightened competitive environment cut into Market Making segment results.
Consecutive quarters in a market cycle trough reaffirm the importance of reducing the cost structure while diversifying in select asset classes in ways that are scalable and non-capital intensive. During the quarter, KCG continued to carry out our strategic plan, pursue opportunities to unlock additional value and return capital to stockholders.”
In the first quarter of 2014, the Company began to charge the Market Making and Global Execution Services segments for the cost of aggregate debt interest. The interest amount charged to each of the segments is based on capital limits and requirements. Historically, debt interest was included within the Corporate and Other segment. This change in the measurement of segment profitability, which has no impact to the consolidated results, is reported prospectively and, therefore, is not reflected in the financial results for any period prior to January 1, 2014.
Market Making
The Market Making segment encompasses direct-to-client and non-client, exchange-based market making across multiple asset classes and is an active participant in all major cash, options and futures markets in the U.S., Europe and Asia. During the third quarter of 2014, the segment generated total revenues of $166.6 million and a pre-tax loss of $8.0 million, which included a debt interest charge of $6.1 million. The results also included compensation related to a reduction in workforce and other employee separations of $2.8 million. Excluding this item, Market Making generated a pre-tax loss of $5.2 million in the third quarter.
In the second quarter of 2014, the segment generated total revenues of $218.4 million and pre-tax income of $36.0 million, which included a debt interest charge of $5.9 million. In the third quarter of 2013, the segment reported total revenues of $240.1 million and pre-tax income of $47.9 million.
During the third quarter of 2014, results from U.S. equity market making were adversely affected by the decline in retail trading activity, heightened competition for retail order flow and challenging market conditions late in the quarter. According to SEC Rule 605 data, average daily U.S. equity share volume handled by the leading market makers was 11 percent below the quarterly average over the past five years while price improvement on retail orders rose approximately 7.5 percent market-wide from the second quarter of 2014 and 27.5 percent from the third quarter of 2013. Results from non-U.S. equity market making were largely static quarter over quarter amid mixed market conditions in European and Asian equities, fixed income, currencies and commodities.
Mr. Coleman commented, “A number of factors coalesced to pressure revenues and revenue capture in U.S. equities during the quarter. The seasonally slow July and August were followed by an active yet challenging September. The elevated levels of price improvement put added pressure on revenue capture. Nonetheless, we grew market share of consolidated U.S. equity share volume during the quarter and made important progress in certain other strategic asset classes.”
Global Execution Services
The Global Execution Services segment comprises agency execution services and trading venues. During the third quarter of 2014, the segment generated total revenues of $79.2 million and a pre-tax loss of $1.7 million, which included a debt interest charge of $1.6 million. The results also included compensation related to a reduction in workforce and other employee separations of $3.6 million. Excluding this item, Global Execution Services generated pre-tax income of $1.9 million in the third quarter.
In the second quarter of 2014, the segment generated total revenues of $85.9 million and pre-tax income of $0.7 million, which included a debt interest charge of $1.8 million. The results also included compensation related to a reduction in workforce of $1.9 million.
Excluding this item, Global Execution Services generated pre-tax income of $2.6 million in the second quarter of 2014. In the third quarter of 2013, the segment reported total revenues of $91.4 million and a pre-tax loss of $16.4 million, which included $15.1 million in compensation charges related to a reduction in workforce. Excluding this item, Global Execution Services generated a pre-tax loss of $1.2 million in the third quarter of 2013.
During the third quarter of 2014, results were impacted by the quarter over quarter declines in market volumes of U.S. and European equities, offset in part by additional progress in algorithmic trading as well as a rise in market volumes of foreign exchange and ETFs.
In algorithmic trading, the contributions from institutional clients grew for the second consecutive quarter to 24 percent of U.S. equity share volume and 63 percent of net revenues for the unit. KCG Hotspot benefitted from a 15 percent quarter over quarter rise in overall notional foreign exchange dollar volume among reporting venues. KCG’s U.S. ETF trading team continued to build momentum amid an approximate 5 percent quarter over quarter increase in overall ETF share volume.
Mr. Coleman commented, “We have made steady progress to date in algorithmic trading. In the first half of the year, we introduced a new algorithm employing a market maker’s approach and made several, targeted new hires. As a result of all the efforts, we’ve onboarded 50 new institutional clients through the third quarter. We continue to beta test new intuitive algorithms that leverage KCG’s intellectual capital and technology to add to the product portfolio.”
As KCG continues to evaluate how best to realize untapped value throughout the company, KCG has begun to explore strategic options for KCG Hotspot, with the goal of executing on opportunities if it creates additional value for our stockholders, clients and employees. KCG has not made a decision to enter into any transaction at this time, and there can be no assurance that KCG will enter into such a transaction in the future.
Corporate and Other
The Corporate and Other segment includes strategic investments and corporate overhead expenses. During the third quarter of 2014, the segment recorded total revenues of $26.5 million and a pre-tax loss of $5.5 million.
Included in the results was a net gain of $15.1 million related to KCG’s investment in tradeMONSTER, in conjunction with tradeMONSTER’s combination with OptionsHouse in the third quarter, compensation related to a reduction in workforce and other employee separations of $4.2 million and a lease loss accrual of $0.3 million. Excluding these items, the Corporate and Other segment’s pre-tax loss for the third quarter was $16.2 million.
In the second quarter of 2014, the segment recorded total revenues of $9.8 million and a pre-tax loss of $22.2 million. Included in the results was a $2.0 million writedown of capitalized debt costs related to the principal repayment of debt, $0.8 million in compensation related to a reduction in workforce, and a lease loss accrual of $1.5 million.
Excluding these items, the Corporate and Other segment’s pre-tax loss for the second quarter was $17.9 million. In the third quarter of 2013, the segment recorded total revenues of $137.9 million and pre-tax income of $89.9 million. Included in the results was revenue of $128.0 million resulting from the gain on investment in Knight Capital Group, Inc. as well as professional and other fees related to the Mergers and August 1st technology issue of $7.3 million and lease loss accruals of $0.8 million. Excluding these items, the Corporate and Other segment’s pre-tax loss for the third quarter of 2013 was $30.0 million.
Financial Condition
As of September 30, 2014, KCG had $540.5 million in cash and cash equivalents. Total outstanding debt was $422.3 million, of which $117.3 million is due in March 2015. The Company had $1.5 billion in stockholders’ equity equivalent to a book value of $12.68 per share and tangible book value of $11.05 per share based on total shares outstanding of 117.2 million, including restricted stock units.
KCG’s headcount at September 30, 2014 was 1,153 full-time employees as compared to 1,207 full-time employees at June 30, 2014. Approximately 45 full-time employees will be affected by the announced sale of KCG’s futures commission merchant (FCM), which is expected to close in the fourth quarter of 2014.
During the third quarter of 2014, KCG repurchased 3.6 million shares for approximately $42.1 million under the Company’s initial $150.0 million stock repurchase program. As of September 30, 2014, KCG had approximately $55.0 million of remaining capacity available to repurchase additional shares under the program. The Company cautions that there are no assurances that any further repurchases may actually occur.
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