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KCG Holdings, Inc. (NYSE:KCG)

Q3 2013 Earnings Conference Call

October 30, 2013 09:00 AM ET

Executives

Jonathan Mairs - Managing Director of Investor Relations

Daniel Coleman - Chief Executive Officer

Steve Bisgay - Chief Financial Officer

Analysts

Rich Repetto - Sandler O’Neill

Ken Worthington - JP Morgan

Niamh Alexander - KBW

Ken Hill - Barclays

Chris Harris - Wells Fargo

Patrick O'Shaughnessy - Raymond James

Chris Allen - Evercore

Operator

Welcome to KCG’s Third Quarter Earnings Conference Call. Today’s Conference is being recorded. Our presenters today will be Chief Executive Officer, Daniel Coleman, and Chief Financial Officer, Steve Bisgay. As a reminder, we will be conducting a question-and-answer session following the presentation.

And now to kick off our program, I would like to turn the call over to Jonathan Mairs, Managing Director of Investor Relations. Please go ahead.

Jonathan Mairs

Thank you. Good morning, I am Jonathan Mairs. Welcome to KCG’s third quarter 2013 earnings call. On the line this morning are CEO, Daniel Coleman and CFO, Steve Bisgay. Before we begin, please direct your attention to cautionary terms regarding forward-looking statements in today’s discussion, certain statements contained herein, and the documents incorporated by reference may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, take a minute to read the Safe Habor statement contained in the earnings per share, which is incorporated herein by reference.

In terms of the agenda for the call, we’ll plan to cover a lot and also leave plenty time for questions. Daniel will open with a few remarks, Steve will provide details on the quarter including financials and then Daniel will return to discuss progress to-date and what’s ahead before we take questions.

And now I’ll turn the line over to Daniel Coleman.

Daniel Coleman

Thanks, John. Good morning and welcome to our first earnings call as KCG. For those of you who don’t know me, my name is Daniel Coleman, I am the CEO of KCG. I came to this from via the merger with GETCO. I was CEO of GETCO for about a year and half and joined GETCO in 2010.

My career before that goes to UBS where I was Global Head and Co-global Head of Equities for five years and my career started at a firm called O’Connor & Associates. Just to take you back for a second and explain my past as well as why we put these firms together, when I started my career at O’Connor in 1986, we were a proprietary trading group, we traded options on exchanges and any products have cleared essentially.

Shortly after I joined, the partners decided that they had to get a balance sheet, because a lot of that business was going over the counter. They first did a joint venture with a firm called First National Bank of Chicago which is now part of JP Morgan and then with Swiss Bank Corporation who later bought them. I followed this firm as Swiss Bank merged into UBS. And towards the end of carrier at UBS I was dealing with a lot of issues that came about as large banks started to lose money on the fixed income side. And during this timeframe I realized that the marketplace was going to change significantly, I realized the first 10, because I was spending a lot of time with regulators from Switzerland, UK, and the U.S., and I felt to myself that the intermediary providers, the providers of liquidity for liquid financial assets would eventually no longer be banks, banks who are regulated heavily banks that can draw upon Federal Reserve or other central banks for overnight liquidity banks that have taken tax payer money.

And when I left UBS, I decided that I wanted to find a firm, a bit like O’Connor they have the ambition to go after this opportunity. And what I thought that when I left UBS that this firm would also have to be technologically driven because unlike when I started my carrier technology is the core just so much what happens in financial markets today. When I sat down the founders of GETCO, I felt like they have the ambition and the technology to do this, but we had a long way to go. And when we laid out our plans we realized it would take years to build a firm we both wanted to build or all three of us wanted to build. And when we had the opportunity to come together with Knight we saw this dream fulfilled.

GETCO was a great firm in many ways but there are other firms like it, the other firm that are technologically driven, that traded partners money. Knight in many ways was unique firm with respect to its client base, with respect its scale, with respect to its independence. Bringing these two firms together, I believe will enable us to pursue the ambition of becoming a leading financial intermediary in the new world. But today we are focused on the business in hand. We have three businesses. We’re Market Making firm providing markets directly to clients and on exchanges around the world. We are an agency execution firm providing algo execution, primarily in U.S. equities and European equities. And we are the owner of venues Knight Match, GETMatched but also Hotspot and BondPoint.

We think having these three businesses we can share intellectual property, we can share technology, we can share continuous innovation that can make us better in each of these businesses individually and doing away that’s cost efficient across all three. We look to leverage technology and everything we do. We would look to leverage our client franchise and provide multiple products for the same clients. Since the close, we have been focused on creating a more efficient firm leveraging our technology and more efficient firm from a capital point of view.

So that’s a quick brief of who we are at KCG today. Now I like to turn it over to Steve to go through third quarter numbers.

Steve Bisgay

Thank you, Daniel and good morning. On an operating basis KCG posted a solid quarter. As a recap during the third quarter of 2013, KCG’s GAAP net income was approximately $98.9 million or $0.86 per diluted share. Of that total net income of roughly $99.6 million was derived from continuing operations.

Included in net income is a non-recurring tax benefit and certain severance and merger related items including a deferred income tax benefit of a $103.5 million related to a change in tax status as GETCO became subject to U.S. corporate income taxes at the merger close. Severance of $17.4 million from reductions in headcount attributable primarily to the organization of ETF team and professional and other fees of $7.3 million related to the merger in Knight’s August 1st technology issue. Excluding these items KCG’s pretax operating income was $17.5 million.

Now let’s turn to our segments; first, Market Making. During the third quarter, the Market Making segment generated revenues of $240.1 million and pretax operating earnings of $50.3 million, which excludes expenses of $2.4 million of severance and a small lease loss accrual.

During the quarter, KCG Market Making accounted for approximately 14% of consolidated U.S. equity share volume, comprised in NYSE and NASDAQ listed stocks. KCG’s Market Making volumes include all client and exchange based activities.

The results for this segment are impressive considering the quarter-over-quarter decline of 13% in consolidated U.S. equity volume and 37% in realized volatility. While KCG’s average daily of U.S. equity dollar volume traded declined to $25.4 billion, revenue capture rose to 1.01 basis points. The performance is due to improvements to order routing and trading strategies as well as other efficiencies. And while still early, we began to see benefits from the integration in the form of both the higher percentage of internalized orders and better volume based rates on public markets.

For listeners, who maybe relatively new to KCG, the majority of our trading revenue can be derived by multiplying our total U.S. equity dollar value traded during the quarter by our average revenue capture. The balance of our trading revenues are derived from Market Making and other asset classes and geographies and to a lesser extent trading activity within Global Execution Services.

As a simple reference, included in the third quarter earnings press release is a table titled Exhibit 1, which contains combined quarterly Market Making average daily volume and revenue capture dating back to the start of 2012. The figures represent consolidated activities from affiliated broker dealers of GETCO and Knight. Outside of U.S. equities KCG Market Making activity covers European and Asian equities options fixed income, FX and commodities. We provided Market Making liquidity on all major cash and features markets. Performance is contingent on market conditions the effectiveness of our advanced technologies and our development of effective trading strategies.

As one example KCG’s GETDirect provides streaming by lateral liquidity in fixed income. GETDirect offers additive liquidity primarily in U.S. treasuries to the largest most active traders in the market. In that regard GETDirect functions in much the same way as Knight Link and Equities. The team has done a great job getting established and is actively interacting as a direct market maker to a variety of institutional clients.

Moving on to Global Execution Services. During the quarter this segment generated revenues of $91.4 million and a modest pre-tax operating loss of $1.2 million, which excludes expenses of $15.1 million of severance primarily related to the organization of the ETF team. Results were negatively impacted by a decline in revenues from ETF as well as more broadly the seasonal market-wide decline in global institutional equity volume.

In agency execution we made tremendous progress on the integration. Upon the close we began integrating the algorithmic and EMS offering. As part of the process we’re expanding GETAlpha distribution through KCG EMS, third party assistance and direct connectivity to existing Knight Direct clients.

During the quarter we achieved impressive growth. In aggregate KCG EMS, Knight Direct and GETAlpha accounted for 4.7% of consolidated U.S. equity share volume comprised of NYSE and NASDAQ [listed] stocks, a record high.

Year-to-date, KCG’s algorithmic and EMS U.S. equity shares traded were up more than 21% compared to the same period a year ago. As a point of comparison, consolidated U.S. equity share volume declined 3% over the same period. In cooperation of GETAlpha follows the premerger consolidation of the legacy Knight high and low touch institutional equity sales teams in the U.S. and Europe.

The driving [patterns] is right now are the sharpened KCG’s competitive positioning, increase internal coordination among teams, grow our client base and incorporate tools to maximize scale. Q3 reforms and [training] venues was characteristically strong. During the quarter KCG Hotspot, our institutional spot FX ECN continue to gain market share from competitors.

Hotspot offers access to a deep and diverse pool of liquidity in more than 60 currency pairs with depth of the transparency and extremely tight spreads. During the quarter, KCG Hotspot accounted for 12.8% of the institutional spot FX volume among reporting venues, a record high.

Year-to-date, KCG Hotspot notional FX dollar value traded was up nearly 12% compared to the same period a year ago. As a point of comparison, institutional spot FX volume among reporting venues declined 2% over the same period. KCG Bond Point is our fixed income ATS offering centralized liquidity, place discovery and efficient trade executions in our blast for corporate bonds, agency bonds and municipals.

KCG Bond Point provides our clients with access to customize trading solutions and surveillance tools. During the quarter, KCG Bond Point accounted for 17.4% of interdealer corporate bond transactions reported to trace other 250 bonds. Year-to-date, KCB Bond Point fixed income par value traded was up nearly 9% compared to the same period a year ago. As a point of comparison interdealer corporate bond transactions reported to trace under 250 bonds declined 6% over the same period.

In our corporate and other segments we generated revenues of $8.4 million and a pre-tax loss of $39.6 million during the quarter. Expenses included $8.1 million in professional and other fees related to the merger and Knight’s August 1st technology error, as well as a small lease accrual. Corporate expenses during the quarter were further elevated due to the additional interest expense on the new debt that was incurred with respect to the merger.

Among the strategic investments held in the corporate and other segment the largest are KCG’s 15.2% stake in Bats and 19.9% stake in Direct Edge. As you may be aware, during the third quarter, Bats and Direct Edge agreed to merge to form a larger more competitive stock exchange.

Turning now to consolidated expenses, in the third quarter compensation expense of $129.6 million was 38% of total revenues and 53.5% of net trading revenues. We define net trading revenues as the sum of trading revenues plus commissions and fees plus execution and clearance and payments for order flow. Net trading revenues for the third quarter were $242.1 million.

Excluding the $17.4 million in severance during the quarter, compensation as a percentage of net trading revenues was 46%. As to the other expenses during the quarter, execution and clearance fees were $81 million or 24% of total revenues and payment for order flow was $16.4 million or 5% of total revenues. All other expenses totaled $112.7 million excluding the $8.2 million in professional and other fees primarily related to the merger in August 1st.

Included in all other expenses is interest expense. The interest expense line is comprised primarily as interest on long and short-term debt and to a lesser extent interest from stock lending activity. In conjunction with the merger, KCG entered into a 5.75% first lien term loan totaling $535 million and an 8.25% senior secured loan or $205 million. Following the close of the merger, KCG successfully called all, but $180 million of the $375 million legacy Knight 3.5% convertible bonds.

These three debt instruments totaled $950 million and comprise substantially all of KCG’s long and short-term debt. The corresponding interest expense on this debt in the third quarter was approximately $16.2 million. We are committed to aggressively reducing the debt. Last week KCG completed a prepayment of $200 million on the first lien debt. As a result we will save roughly $11 million in annual interest expense.

Further as part of the post merger integration and repositioning, a few coming events will provide additional flexibility including the sale of Urban which is expected to close in fourth quarter and the separate consolidations of KCG’s U.S. and UK broker-dealers which are expected to release capital.

A quick update on our financial condition. We intend to maintain a strong and liquid balance sheet. As previously stated, a priority is to reduce the debt and get to a more ultimate capital structure for the firm. As of September 30th, KCG has $799 million in cash and cash equivalents. Aggregate long and short-term debt totaled $970 million and the firm’s debt-to-equity ratio stood at 0.64. KCG had $1.5 billion in stockholders’ equity, a book value of $12.34 per share and intangible book value of $10.63 per share. Following last week's $200 million prepayments, aggregate debt was reduced to approximately $770 million and KCG's debt-to-equity ratio fell to roughly 0.51.

Finally, headcount as of September 30th was 1,304 full time employees, which excludes employees of Urban. Subsequent to the third quarter, we further reduced headcount by 5% under the global workforce, which will result in a severance charge of approximately $9.4 million.

I appreciate your time and attention. And now I'll turn the call back over to Daniel.

Daniel Coleman

Thanks, Steve. Well, I'm happy with the progress we made, we worked very hard over the past really 4.5 months and I'm pleased to be able to talk about an operating profit net of restructuring cost given the amount of work we've been doing on integration. We’ve seen some hints of progress on the revenue side and our market making business and our option market making business and we are very pleased with the market share and the get off to Knight Direct business. So on the revenue side, we're seeing progress and we hope to see more progress.

But we’ve been very focused on the cost side. We have announced that we'll have synergies realized this year between $20 million and $30 million we're very comfortable with that number. And we're hopeful to be closer to 30 than 20. We have also announced that by the end of 2014, we expect a run rate of synergies, cost synergies between $90 million and $110 million.

We're working very hard to realize these synergies both with respect to quantity, but also with respect to speed. The faster we go the faster we realize the benefits on the cost side, the faster we bring down operational risk and the faster we free up very talented people to focus on revenue generation and innovation and that’s really where we want to be as soon as possible.

We're very focused on reps as we bring these firms together integrating technology is one way to get there, but also we've set up an entire new risk framework. And we have a real-time risk management group dealing with operational risk immediately as they arrive. Our future growth, we're looking first and foremost at our core business U.S. market making, making sure we can be as efficient and as effective as possible for our clients. We think we have a large opportunity in electronic agency execution especially leveraging our institutional sales traders to penetrate the asset managers more.

We're focused on opportunities and [thick] market making especially as we see the marketplace changing over the coming quarters with the rules changing. And we're focused on growing our European client base looking at the European retail aggregators which tend to be the regional banks and large banks, but not bulge bracket banks.

I am excited about new recruits to the firm, Greg [Tussauds] joined us from Goldman a few months ago as did Ryan Primmer from UBS. They’re terrific guys who are going to have a big impact and have already started to have a big impact. And I am very excited to announce today that Charles as we call him Ed Haldeman has joined us as our Non-Executive Chairman of the Board. I am very pleased with the talent we've attracted the talent that want to be here. I am very excited about the talent that is here and the impact to we’re all going to have together. So thank you very much for joining us this morning and we are glad to take any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions). We’ll go next to Rich Repetto with Sandler O’Neill.

Rich Repetto - Sandler O’Neill

Yeah. Good morning Dan, good morning Steve.

Daniel Coleman

Good morning.

Rich Repetto - Sandler O’Neill

The first question is on the revenue capture. So the revenue capture become higher than whatever the previous seven quarters I believe, six quarters. So I guess the question is after the integration or month or since July, how is the GETCO part of the Market Making improving their revenue capture? And also see the bulletin board, shares trading jumped up. I was just trying to see historically that’s been high revenue capture product, did that help, was that outsized in the mix of in the dollar volume, the OTC Bulletin Board?

Daniel Coleman

Let me start with the first part of your question. If you go back and you look at the Exhibit 1, you see are firm is existed prior Rich, you see in the revenue capture in the 85 to 90 range, and that really reflects businesses that were not able to take advantage of the opportunity of coming together, I would point out in the second quarter that revenue capture jumped up and that reflects I think simply improved performance on the legacy Knight side.

I think the 1.01 is number we’re pretty happy with, I think it reflects the beginnings of opportunities we have both with on the legacy GETCO and Knight side, working together. It reflects more order flow or higher internalization rate less rounded out. But I would say also reflects a good performance on the legacy Knight side. So we can’t, it’s hard to say if the 1.01 is a future run rate, in fact I couldn’t say that. And then it’s difficult breakout I would say very strong performance on legacy ETG side, as well as against what the benefits we are getting bringing together. But I would say the following we have, not realized all the benefits of bringing the two together and then we will probably come over the next two quarters. But I don’t think it’s unreasonable to expect a higher revenue capture than what we saw previously in the 85 to 90 range because that revenue capture rate really didn’t have the two firms together. So we are pretty happy on that.

As far as the bulletin board side we don’t think it had a huge impact on the revenue cap.

Steve Bisgay

Yeah. It’s Steve. Rich, I agree with that. Although we did see an uptick in the volumes it certainly did not have a significant impact on the overall revenue capture.

Rich Repetto - Sandler O’Neill

Okay, alright. And then my next question is on the cost synergy side. We looked at your fixed expenses and that’s expenses when you excluding the trading relate like execution and clearing and payment for order flow. So those came down dramatically compared to the pro forma run rate. So I guess the question Dan or Steve is where are we in the cost synergy side? And then as you try to get the 20 to 30 before year end and 100 next year what’s the base or where should we be -- what’s the number we should be comparing it to?

Daniel Coleman

I think as you are comparing information today, versus what you see for the first half of the year through the [ATI], I guess if you are looking at some average. The biggest driver there is really compensation overall. I think rather than looking at individual improvement. Certainly we see some benefit throughout the organization, obviously we are going to the process now of trying to take advantage of certain synergies. So you are going to see reductions in certain costs, but it really is more so on the comp line, but I think as where we are seeing the benefit of that reduction and cost, so that is helpful.

Rich Repetto - Sandler O’Neill

Okay. And well, the other thing would be the compare, like where we try to judge the $100 million or $20 million to $30 million, but if you have that?

Daniel Coleman

I understand your question on the non-personnel costs that were taken out $100 million compared to what. I think we have been looking at numbers compared to when the firm came together. So I would suggest perhaps a run rate of Q2 sort of number would be the number we are talking about. And Steve is right, we have reduced some costs on the compensation line, which I think reflects reduction in the headcount, and still want to be place that attracts really talented people and pays well.

But we are very, very focused on the non-personnel cost which is going to take some time because infrastructure expense and similar expenses really take time to bring down whether it’s renegotiating contracts or shrinking colo footprints or bringing technology system together. But the direct answer I will go to Q2, our Q2 cost line and I think that will be a good starting point.

Rich Repetto - Sandler O’Neill

Okay. And just one last quick one. The tangible book value look like it went down on a pro forma basis at the time of the July, in early July in the combined firm. Just was peculiar to me any explanation given the big deferred tax benefit?

Daniel Coleman

No, no, the deferred tax benefit was actually baked into the pro forma June 30’s 8-K number to begin with. The difference is really in the share counts or the denominator actually increased, there we had initially a denominator of shares outstanding, I believe of about $117 million. The number that you use now currently is about a $123 million and the difference really…..

Steve Bisgay

Shares.

Daniel Coleman

I am sorry, 123 million shares, thank you, which really reflects the incremental shares granted during the period largely for retention actually. So that really is we have done to math.

Rich Repetto - Sandler O’Neill

Okay. Thank you.

Daniel Coleman

You are welcome, Rich.

Operator

We will go next to Ken Worthington with JP Morgan.

Daniel Coleman

Hey, Ken.

Ken Worthington - JP Morgan

Hi, good morning. First on the Global Execution business, if I get this right, lost money, even excluding the severance. I believe that GETCO is losing modest amounts of money and Knight was making money. So as we think about 3Q, maybe walk through why the business lost money in 3Q when excluding the severance? Were there other one-time costs in there? I know there’s been some changes in kind of the business lineup. If you could just get us up to speed there? And then on the cost savings, how much of the, I’ll call it $25 million is the mid-point in 2013 or $100 million in 2014, impacts the Global Execution business?

Daniel Coleman

Okay. Let me start with the performance of Global Execution Services business. I would say on the GETCO side, the business was very small. I think we had a good product on a GETCO side, which we look to scale, but the business itself was very small. I think the performance really reflects the seasonality that you’ve seen from a lot of our competitors or similar type companies over the third quarter. And in addition the restructuring ETF business hurt a little bit. And I think that largely reflects at a very strong second quarter and then the third quarter both with the changes of the team and just that business itself was not a strong. And prior quarters Urban was also a part of the Global Execution Services business, now discontinued operation. That has a small impact but an impact nonetheless.

And Ken what was the second half of your question?

Ken Worthington - JP Morgan

Just in terms of getting back to profitability, maybe how long does it take and I assume part of that business getting the profitability is the cost savings program you have. So of the $25 million and $100 million or so how much of that saving kind of is applicable to the Global Execution business?

Daniel Coleman

That’s a good question. I think when we look at infrastructure that’s a big part of what we’re doing as well as FTE reduction, but I think on the infrastructure side it’s pretty shared overtime and that’s going to take several quarters to attain where we want to get to. On the reduction of headcount I would say that we had a large focus in London and probably a slightly disproportional focus towards the Global Execution business here in Jersey City. So I think we’ll get some cost off that way. But I think the real that you hear is going to be on revenues for this business, and how well we can leverage -- the products we have, how well we can leverage the client relationships so we have on the institutional side. I think the real, the work that a lot of the sales traders do for example I think is going to start showing up in the low touch side. So I think on the global execution side, I really think cost a part of it, but it’s more of a revenue issue and it’s a revenue issue where a lot of works can be done by a lot of people and it should be showing up under Knight Direct and GetAlpha.

Ken Worthington - JP Morgan

Okay. Thank you there. And just because I think it’s really important, can you give us an update on Urban. You mentioned that, we knew it’s expected to close, how certain is this closure and if the deal weren’t going to close, what might the risk be that could lead to that transaction falling apart and it’s really ultimately de minimis, please, please let me know?

Steve Bisgay

Sure, Ken. It’s Steve. From my perspective there is a very high degree of confidence that Urban will be closing just to be clear. We were working very hard to try to get it close actually as aggressively as early as end of October to be truthful. With that said, obviously with the government shutdown things were on a bit of a temporary slowdown which took us slightly off track, we’re back on track full speed ahead. And we’re working extremely aggressively to get something closed certainly within Q4 and ideally as of maybe right around Thanksgiving. So from that perspective, it is a very strong, we don’t have all the approvals yet, things are lined up nicely to be clear, but things are fitting, are really forming in place beautifully at this point, a very, very high degree of confidence in my, from my perspective that we’re going to close.

Ken Worthington - JP Morgan

Okay. And if something derails it like what could happen that could feasibly derail that closing?

Steve Bisgay

I guess [inferior] there could be, we could not seek an approval perhaps I guess the remaining regulatory approval could not come in hypothetically. I think that’s a very low probability, I think this transaction we’ve had a tremendous amount of opportunity to talk to the regulators about what we are doing. This is not just on socialized, but there is a lot preplanning that went through this. So there is really in my mind very extreme likelihood that that would occur, but hypothetically to answer your question I guess if that were to occur, I guess inferior that could be a possible derailment of that.

Ken Worthington - JP Morgan

Okay. And then lastly you guys had the 8-K out a couple of days ago about the risk in October, how much does that contribute to getting to the $20 million to $30 million of savings? And did, what kind of savings were already present in 3Q like, are we starting from zero at the end of 3Q or was there a couple of million bucks in that 20 to 30 that have already been achieved and that how much does that contribute?

Daniel Coleman

I would just say it’s a part of it, I don’t think we’ve disclosed the amount of savings in Q3, but I would say there was definitely some savings in Q3. We’re not going to see $25 million or $30 million just hitting Q4. There is some of that was in Q3. But I would say that was part of it as we announced approximately 5% of the headcount of about 1,300 people. And so that definitely will be part of the $20 million to $30 million of savings.

Ken Worthington - JP Morgan

And where was it, was it a particular line, was it across the Board?

Daniel Coleman

It was a little concentrated in London where we have restructured the office and we think we are at a point where we can run a profitable business going forward in London, we’re very excited about the opportunities there. So I think it was little heavy towards London and then it was in different pockets primarily here in New York, New Jersey area.

Ken Worthington - JP Morgan

Okay. Thank you very much.

Daniel Coleman

Sure, Ken.

Operator

We will go next to Niamh Alexander with KBW.

Niamh Alexander - KBW

Hi. Thanks for taking my questions. If I could just move back to the balance sheet and so you’ve repaid $200 million of debt in October, you freed up some other cash which was very pretty good to see kind of you’re getting those milestones early. But can you remind now is there another like $100 million to $200 million potentially freed up from merging the broker-dealer entities and what’s the timeline on that? And then with respect to Urban that freeze up $135 million, is that kind of already in the $200 million that you paid down. I am just trying to get a sense of is there another maybe 200 to 300 that you could free up in the next six months to kind of repay six to nine months that you could use to repay this over there?

Steve Bisgay

Sure. Niamh, this is Steve. How are you doing? To be clear, the first pay down of $200 million had nothing to do with Urban. That was a combination of two things; one was that we saw, in 8-K we got a consent process, we had $180 million of cash collateral that was holding other assets so that was held to as an offset if you will against legacy Knight $170 million or $180 million of bonds.

We were able to get the consent and that was cheaper of course than the $575 million, so we are able to see consent, we see consent from the holders to use that to pay down and we also had significant, as you could see our balance sheet has been probably liquid. We are sitting with the significant excess cash pool, we use the portion of that roughly about $80 million or so combined with the $180 million to the effect that first payment of $200 million.

So to be clear, none of that first payment had anything to do with Urban or the broker-dealers. The Urban transaction as I mentioned a moment ago is moving along nicely, we expect that that’s going to free up a significant amount of cash. The number of value you could throw out at 130, I think is definitely in the zipcode it’s in the $100 million we’ll say a combination of net proceeds from the transaction and also a slight reduction of our liquidity reserve for items that were specifically attributable to the Urban business.

So we feel very comfortable about that and that should occur in Q4. And then also as you also pointed out we do have the consolidation process underway. The U.S. consolidation process is moving nicely towards a year-end, we're tracking towards year-end. We are still targeting approximately $100 million of release of trapped capital. That amount of money would become available to us of course after the merger. That merger, our best case scenario is slated for an effective date of 1/1, so therefore early 2014 would be another opportunity for another pay down.

And then finally, we have a UK broker-dealer merger process underway. That is a little bit more complicated. It's not simply just getting approval from the FCH merge the BDs that process is going along well. There is also some regulatory filings, an ICAP filing, an ILA filing. Those take months to prepare, we’ll prepare those shortly after the merger which we expect to be Q1. But that may take 4, 5, 6 months, there is a regulatory approval process that occurs. So we're not going to necessarily expect to see untrapped capital being released back into KCG to -- down probably until the second half of 2014.

But having said that, we feel comfortable that we have a significant amount between Urban, as well as the broker-dealer U.S. consolidation in the coming months that will pay down significantly against the 535 residual or in this case 335.

Niamh Alexander - KBW

That's very helpful. Thank you, Steve, so another $200 million kind of within the sites. Can you remind me, what's kind of a good leverage level that you feel comfortable with? And can you start kind of refocusing on just maybe going into cash balance and think about repurchases?

Steven Bisgay

Sure. Well, certain low rate where it is today obviously. Right now we're working hard to get to what I would deem to be an optimal capital structure for this company. From that perspective, I would think somewhere around a third of our tangible book value and our tangible book value being about $1.3 billion, we're looking at about a debt level say 4, 450 somewhere in that range I think is very, very comfortable.

Niamh Alexander - KBW

Okay. That’s helpful. Thank you. And then if I could just go back to the core business this is your first quarter to report emerged entity and a lot of the data we're getting is all in equities, but you’re a pretty big fixed income and futures market players to, so what can you share with us to give us a sense of maybe your market share there or whether those differences helped or not to capture because I imagine the second quarter that all the volatility in the fixed income markets really helped Direct capture on the former GETCO site and what not. So I am just trying to get, what can you share with us with respect to those business units?

Steve Bisgay

I would say that we haven’t broken out yet, but we had a good quarter, these are primarily GETCO former legacy GETCO businesses trading fixed income products treasuries and futures, commodity futures, FX futures around the world. As you all know many of the large bank fixed income divisions were down anywhere from 10% to 45% quarter-on-quarter. It was a difficult quarter relative to Q2 in fixed income trading where we’re not immune to that from a revenue point of view. So, but I would say it was a decent quarter and the environment kind of dominated I think our performance. And we're happy with the performance, but we think there is some upside, we just think it was pretty tough trading quarter for fixed income.

Niamh Alexander - KBW

Okay. Fair enough. And then lastly, if I could just go back to the commissions line which stronger than we’d expected when we kind of [axed] out the former Libertas business and what not. Is there anything in there that was kind of unusually strong during the quarter or all as equal as volumes the same in the fourth quarter should the revenue be the same for that commissions line global execution services?

Steve Bisgay

I think it was, there was nothing extraordinary in the commission line for that quarter. I think that we were doing a lot in the third quarter, with respect to restructuring, reorganizing businesses, I am hopeful in the coming quarters, lot of people generating that commission line would be more focused on picking up more market share and revenue. But I think there was nothing extraordinary in the commission line this past quarter.

Niamh Alexander - KBW

Okay. Thanks so much, I’ll get back to line.

Daniel Coleman

Thank you.

Steve Bisgay

Thank you.

Operator

We’ll go next to Ken Hill with Barclays.

Ken Hill - Barclays

Hey good morning Daniel and Steve.

Daniel Coleman

Good morning.

Steve Bisgay

Good morning.

Ken Hill - Barclays

Question, so if you look at the businesses more holistically and I think about like Market Making put a bit every quarter for you guys Execution struggled a little bit as we talked about on the call. But looking at that kind of from the Knight perspective, that Execution business tended to have 20% to 30% margin associate with it, Market Making maybe a little bit better. How can we think about some of the margin potentials for these businesses going forward, what point do you think we get more of a run rate basis for them?

Daniel Coleman

Well I can’t speak completely through the margin as an eyesight and may I will get Steve to talk to it, but I think before Knight might had, Urban had a lot of things that are not in our current business. Our Global Execution Services business has a large equities execution business and as well as Hotspot and BondPoint. And I think going earlier to another question, I think the focus here is going to be on the revenue side in generating more revenue and developing a margin that’s higher than what we obviously have at the previous quarter. I don’t think we really prepared to give out guidance on margin of at different business lines, but we are definitely focused on making this a profitable business, this is not a loss leader business and no portion of this business should be a loss leader business. So I am hopeful of the coming quarters you will see margin expansion on the Global Execution Services side.

Ken Hill - Barclays

Okay. And I guess related to that, I think historically you have also spoken about easing some of the Knight distribution network to help that business along. How has that progressed kind of since the merger is closed and what kind of things should we expect to over the near term and that kind of given you any new inlets of the customers or asset segments?

Daniel Coleman

That’s a great question. I would say a couple of things. I think we’ve seen in the market-share on the electronic execution, we’ve seen some progress. I think with Greg joining and also with Charlie Susi joining who ran direct execution services at UBS. I think we have a really good team to really put this business together. And also on the technology side we are working very hard to put the business together. What I would like to see from the business going forward is continued growth in market share but also growth in penetration asset managers and that’s where we leverage the traditional nice sales trader that’s where we need to focus because that will improve the margin of the business as well as the volume. And that’s where -- it will take some time probably several quarters to have the impact we want to have based on my own experience from previous career. But we are very happy on the progress so far but it does take time for clients to sign up and start using and I would say we are on track, but I think we should all see results in the coming quarters.

Ken Hill - Barclays

Okay. Thanks for taking my questions.

Daniel Coleman

You are welcome.

Operator

We’ll take our next question from Chris Harris with Wells Fargo.

Chris Harris - Wells Fargo

Hey guys should. So when I step back and look at volumes this quarter just more broadly, you guys actually had a very easy comp for the year ago because the year ago was when you had the Knight betraying here and there and volumes were still down on the year-over-year basis. So if we assume that legacy Knight has kind of recovered, that would imply, it’s really bad volume core for GETCO. And just wonder if you can explain a little bit on some of the drivers of that and whether you see anything on the horizon and it might make the volume outcome a little bit better for the GETCO business?

Daniel Coleman

Not sure. There is that big of a difference in the market share year-over-year for the GETCO side it might have been a little bit but I don’t think it was massively different. So I am not 100% sure of all the questions, but I would suggest that and maybe imply in the question is GETCO performance and how is it going. And while I want to move away from talking about legacy firms I completely understand people maybe get their bearing as they just model this new firm.

And I would say we made progress on the GETCO side, but I don’t think you have seen or we have seen a big revenue turnaround. And we, to be honest lot of people we have working on the GETCO side and working on integration as well. We haven’t seen deterioration for sure, but we have seen progress on what we are doing and from a market share point of view, we have not seen deterioration last few quarters.

So I would suggest that there is upside over the coming quarters as we reengineer that portion of business and there should be upside as we continue or work closely with ETG side and to offer more Market Making products for our client.

Chris Harris - Wells Fargo

Okay. Kind of a similar related question, I guess more directed at legacy Knight and I know you want to try to get away from taking things that way. But back when Knight was standalone, you guys had some initiatives in the works, including growing the options in European Market Making business. And just wondering I know we’re focused on debt reduction and synergies, but whether these are still a priority for the new firm and kind of where you are with these initiatives?

Daniel Coleman

There are priorities in the firm, there were priorities actually from both firms previously. And I think what we have now is critical math in both places to have better product and hopefully gain some efficiencies as we put these together.

On the European side, there is an opportunity to work closely with banks that are reviewing their own business lines and want to focus perhaps on other things but keep their clients. And I think this will fit well into our roll out of Knight Direct in Europe as well as our Market Making capabilities directly to clients in Europe. So those that are both still priorities for us and frankly there are priorities for both firms. So it's easy to see them as priorities to this firm. And there is some cost opportunities on both sides and we have realized some of that so far specially in London over the last quarter.

Chris Harris - Wells Fargo

Okay. Last question from me, then, a quick one on the synergies. Sorry, I missed it guys, if you had already addressed it, but where should we expect the majority of the synergies to come with respect to the segments? Is it going to be concentrated in one area or the other, any kind of breakdown you can give us there would be helpful?

Daniel Coleman

We haven’t given a breakdown on that. But I think, to the extent that there are FTEs as part of the synergy, we did see some in London and we have seen some here in Jersey City. A lot of the infrastructure synergies that we expect to see overtime will impact a lot of different parts of the business. So even giving a breakdown by businesses it may not be quite as relevant because it directly reflects opinions of allocation. So we don’t give it out but we should see profitability by all businesses improve.

Chris Harris - Wells Fargo

Okay. Thank you.

Daniel Coleman

Welcome.

Operator

We’ll go next to Patrick O'Shaughnessy with Raymond James.

Patrick O'Shaughnessy - Raymond James

Hey, good morning guys.

Daniel Coleman

Good morning Patrick.

Steve Bisgay

Good morning.

Patrick O'Shaughnessy - Raymond James

First question on the competitive landscape in the Market Making business side of things you tried to sold or we’ll be selling this Market Making into Susquehanna, do you anticipate that really changing the competitive dynamics at all? And then I guess more broadly can you talk about what you’re seeing in the space right now?

Daniel Coleman

I would say that to some extent, well I mean I think Susquehanna is well respected firm I’ve known them for my entire career. And the fact that they have I believe a 70% lock up in order flow I expect it would be some change in dynamics.

But this business I was in this business at UBS and we bought strong capital markets and I have been a big admirer of Knight in this business for years. And it does fluctuate from quarter-to-quarter the dynamics do change. I think the one thing that’s consistent is Knight’s position has been pretty consistent over the last decade. Some of the dynamics would be if Charles Schwab looks to re-up their deal with UBS in a year or not, that’s a big question mark, could be dynamics from some of our competitors in other ways as they look at their businesses. But generally speaking I think from our point of view there could be a modest change given the lock up to Susquehanna, we think they’ll be a strong competitor. But overall, it’s not really a new entrant coming in it’s the consolidation of an entrant. And so there is still the same number of players as before slightly more locked up than before, but I could change with swap.

Patrick O'Shaughnessy - Raymond James

All right. I appreciate that. And then my follow-up question would be so during the quarter Tradeweb agreed to buy BondDesk for a relatively healthy sum, at least has been reported. Does that cause you to re-evaluate your long-term plans for BondPoint?

Daniel Coleman

Well, I see BondPoint as a pretty strategic asset for several reasons. One is, it plays directly into our core client base, financial advisors directly, many of our core clients use it in a wide [labelling]. So that's pretty powerful. So that’s an exciting asset because it is one of the last standalone significant bond ECNs around. It is focused on retail and it’s a matter of time, I think before retail and institutional converge, which also plays into our other client base.

We understand the valuation that BondDesk received and we think BondPoint is a very good well run business, but we see it as a really important business to us. As with all assets we review them and we review their strategic importance and we review their value to us versus the value away from us. And we have to do that for our shareholders. But we do see BondPoint as being very important to our core clients. We also see, think we can bring a lot of value to BondPoint as the corporate bond markets about to undergo a significant change.

Patrick O'Shaughnessy - Raymond James

All right. I appreciate it. Thank you.

Daniel Coleman

You’re welcome.

Operator

We’ll go next to Chris Allen with Evercore.

Chris Allen - Evercore

Good morning, guys.

Daniel Coleman

Good morning.

Chris Allen - Evercore

I was wondering if you could give us a sense of where do you think pre-tax margins, the competition to revenue ratio can go once you have the fully embedded synergies in the platform?

Daniel Coleman

We are not giving out our expectation of pre-tax margins. I think that I mean we expect them to improve from here and as you can take the cost synergies and just apply them and come up with margins, but I think the real difficultly in predicting this is the revenue synergies, the revenue potential is very hard to predict. So for that reason we are not giving our pre-tax margin, but you could definitely take the cost synergies out and come up with some I think reasonably conservative margins.

Chris Allen - Evercore

Got it. And I guess just going back to Ken’s question earlier, so you’re going to apply the full synergies to your base, what’s in the run rate currently from the synergies from a number perspective?

Daniel Coleman

We haven’t given that out yet.

Chris Allen - Evercore

Okay. Can you guys give us 2Q operating expenses on a pro forma basis for the combined company ex the one-timers and ex any sales?

Daniel Coleman

Q2. Yes.

Steve Bisgay

Give me a second. It’s about 245, 250, 260 roughly on a pro forma basis.

Daniel Coleman

That’s literally back at the (inaudible) obviously I’m not literally sitting here studying that.

Chris Allen - Evercore

I mean that just seems very relative to the 348 we’re seeing this quarter?

Daniel Coleman

Are you including, I guess maybe that my number also....

Chris Allen - Evercore

Do you think that $25 million still 320 versus 345 to 360 were the missing piece interest or?

Steve Bisgay

So my number actually, I am sorry, my number was excluding the actual direct trading cost as well. So I wasn’t including the execution clearance and payment for other [flows] including, I thought your question was on our operating expenses.

Chris Allen - Evercore

Yeah. I mean that’s actually thus far that I get back into that.

Steve Bisgay

Okay.

Chris Allen - Evercore

And then can you give us any reason back into kind of the implied revenues in the market making off of the equity businesses. The other revenue bucket which is options and everything else which is about $76 million this quarter, how does that compare on a year-over-year basis and what were the drivers?

Daniel Coleman

I don’t think we’ve disclosed that from previous year, so we don’t have that. I think that would include our fixed income and commodities business which I have already talked to. And the options business, this is okay. It was more of a, we’re focused on integration, but I think the options businesses quite have the same headwinds as fixed income it also includes our Asia trading which had I would say a fair amount of headwinds volumes across Asia and volatility was down quarter-over-quarter.

So those fragments include Asia which is primarily an equities business that’s on exchange traded. Our fixed income commodities and currency businesses which are primarily on exchange traded, as well as our options business. And I would say for at least for two of those businesses the environment was very difficult and options was not great, but not as difficult.

Chris Allen - Evercore

Got it. And last question, how are you guys thinking about the BATS Direct Edge investments, any thoughts in terms of potentially monetizing that moving forward?

Daniel Coleman

Well, I would say that anything we're not allowed to own more than 20% of it would be hard to say it's strategic. We also think it's a great merger and as a shareholder we are very excited about the synergies they can take out and the opportunities they have to create value. So for us the real question is the timing to monetize and the opportunities to monetize and maybe a while from now. But I would say it's not strategic, it was important for the GETCO side in the early days to create a competitor with BATS, it was important for Knight side to help create a competitor with the founding of Direct Edge. But right now I would say we’re shareholders, we’re pretty happy shareholders, but overtime I expect we would monetize that.

Chris Allen - Evercore

Thanks, guys.

Daniel Coleman

You’re welcome.

Operator

And we have time for one final question. We'll go to Daniel Fannon with Jefferies. And Mr. Fannon has removed himself from the queue. We have no further questions.

Daniel Coleman

Okay. Well, thank you very much for participating in the call. We look forward to updating you all on the progress in the near future. Thank you.

Operator

This does conclude today's conference. We thank you for your participation.

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