KCG's (KCG) CEO Daniel Coleman on Q2 2014 Results - Earnings Call Transcript

Aug. 4.14 | About: KCG Holdings, (KCG)

KCG Holdings Inc. (NYSE:KCG)

Q2 2014 Earnings Call

August 1, 2014 9:00 AM ET


Jonathan Mairs – Managing Director of Investor Relations

Daniel Coleman – Chief Executive Officer

Steve Bisgay – Chief Financial Officer


Rich Repetto – Sandler O'Neill

Ken Worthington – JPMorgan

Patrick O'Shaughnessy – Raymond James

Niamh Alexander – KBW

Chris Allen – Evercore

Chris Harris – Wells Fargo Securities


Please standby we are about to begin. Good morning and welcome to the KCG's Second Quarter Earnings Conference Call. As a reminder, today's call is being recorded and will be available by playback.

On the line are Chief Executive Officer, Daniel Coleman; and Chief Financial Officer Steve Bisgay. A question-and-answer session will follow remarks on the quarter. To begin, I'll turn the conference 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 second quarter 2014 earnings call. On the line this morning are CEO, Daniel Coleman and CFO, Steve Bisgay. Before we begin, please direct your attention to the 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 Harbor statement contained in the earnings press release, which is incorporated herein by reference.

Also point out that a presentation deck on the second quarter results is available in the Investor Relations section of our website at investors.kcg.com. In terms of the agenda for the call, Daniel will open with a few remarks, Steve will provide details on the quarter, including financials, and then Daniel will return with a few additional comments before we take questions.

Now I'll turn the line over to Daniel.

Daniel Coleman

Thanks, Jon and good morning, everyone. During the second quarter, we made further progress in several important fronts. The core market conditions more than offset revenue benefits from KCG’s modest market share gains and expense reductions. The market felt a bit like a replay of the fourth quarter of 2014 during which a strong start gave away to a steady slide in market volumes and volatility.

In Q2, to the first half of April, the US equity market daily trading volume averaged approximately 6.8 billion a day. From April 16 to the end of June, the average US equity trading volume was about 1 billion shares a the day lower, at about 5.8 billion. This extraordinary drop in volume reflects a slowing of activity across asset classes around the world from a more robust first quarter.

The single biggest factor impacting KCG's results was the approximate 20% sequential decline in retail share volume. During the quarter, conventional wisdom attributed the declining darts to negative attention on market structure issues. From the flows we see, retail investors continue to put capital into US equities throughout the quarter.

From our point of view, the significant activity up to April 15 probably reflected a large amount of profit taking in shares that appreciated significantly over the previous year in time for paying taxes. And this activity clearly dropped off after-taxes were due. As for the macro issues, I personally believe the current market environment reflects the continuing after effects of the great financial crisis.

With central banks pushing interest rates close to zero for 4.5 years and running, interest rate risk itself is seen by investors as non-existent. Over time, the market has begun to view the volatility of future cash flow as well assets due to any interest movement as negligible. This view is one of the reasons that realized volatility of most investable assets or at multi-decade lows.

New regulations on trading imposed on the big global banks are now being implemented. These rules in areas like prop trading and OTC derivatives are clearly limiting the participation in markets of some who were among the biggest intermediaries only a few years ago. The capital rules that are forcing banks to shrink inventory in areas like corporate bonds are causing the activity in this market to dry up.

The regulatory focus on how the FX market currently operates is also dampening volume, as evidenced by the daily FX notional trading volume among reporting venues dropping 19% from Q1 to Q2 this year. These new market rules, new capital requirements and regulatory investigations into established practices do more than curtail the animal spirits of traders.

These government-led changes are generational and should cause all investors to ask themselves how will liquid market risk be intermediated in the future? Where will the liquidity come from? How will markets operate? Perhaps in the low volatility environment we're now and these questions can be postponed.

So we will not be in this environment forever. For KCG and firms like us, the near-term is painful. We thrive when investors need to transfer risk when this demand is low, our business is challenged. For the intermediate term, however, these changes are positive.

These changes that are hurting volume now are changes that enabled new intermediaries like KCG to play a more significant role in the risk transference process of the future. Our two ECNs, Hotspot and Bond Point are part of the solution how FX and corporate bonds will be intermediated.

Our role as an independent non-bank market maker will grow as markets such as interest rate swaps become more accessible to firms like ours due to new trading rules in clearing corporations. And from my point of view, the prospects of our equity market making and agency execution business is bright long term as we are able to continuously invest in technology and talent.

Now I'll hand the call over to Steve to bring us back to the near term, the second quarter. He'll take us through the numbers we produced in what is a very difficult market environment. I will follow with a few more comments before we go to questions. Steve?

Steve Bisgay

Thank you Daniel and good morning everyone. As a recap, during the second quarter of 2014, KCG’s GAAP pre-tax earnings from continuing operations was $14.5 million. Operating pre-tax income was approximately $21.5 million, after stripping out $7 million of expenses unrelated to co-operations, including $3,1 million in compensation related to reduction in workforce, a $2 million write-down in capitalized debt costs and loss accruals of $1.9 million.

As we’ve previously noted, last quarter, KCG began assessing charges for debt interest to the market-making and global execution services segments based on capital limits and requirements.

Prior to then, the charges were contained in the corporate and other segments. The change has no impact on consolidated results. We've broken out the respective charges to the segments in the press release and the discussion of segment results to allow for comparisons to previous quarters.

The change will only be reported prospectively and therefore will not be reflected in any period prior to the first quarter of 2014.

Getting into the segments. First, Market-making. The Market-making segment encompasses all direct-to-client and non-client exchange based market-making across asset classes. During the second quarter, this segment generated revenues of $218.4 million and pre-tax earnings of $36 million. The net interest charge for the quarter was $5.0 million.

Direct-to-client market-making in US equities, which is the primary driver of financial results for the segment, was adversely affected by a steep decline in retail trading activity during the quarter.

Retail trading activity, as measured by total SEC rule 605 share volume, handled by the leading market-makers, declined an estimated 20% quarter-on-quarter. The drop in retail volume was greater than that of consolidated US equity volume for the quarter.

KCG's market share of SEC rule 605 share volume, which covers exchange listed stocks, picked up modestly from the first quarter and we continue to be the clear market leader in OTC stocks.

As for non-client exchange based market-making in US equities, we continue to integrate, test and refine medium and short-term strategies. The market conditions during the past quarter of course were not helpful. In terms of volatility, May and June was lowest two month period of realized volatility for the S&P 500 in the post-financial crisis era.

For the quarter, KCG’s average daily dollar for US equity market-making of $25.1 billion was down 8% sequentially, while consolidated US equity notional value traded was down 12%.

Meanwhile, revenue capture per US equity dollar volume traded which encompasses client and non-client market-making activity was nonetheless as fairly strong 1.07 basis points. Based on revenue capture and our total US equity dollar volume traded during the quarter of $1.58 trillion. Revenues from US equity market-making were approximately $170 million.

I comparison, revenues from US equity market-making were approximately $210 million in the first quarter. Revenues from market-making activity outside US equities were approximately $49 million during the second quarter, down from $67million in the first quarter.

Market-making effect was adversely impacted by declines of 3% to 20% in market volumes of products traded. Market-making in Asian equities was challenged by a 17% drop in consolidated Asian equity shares traded across the dot markets and market-making in European equities was hampered by 11% decline in consolidated European equity notional value traded from the first quarter.

Shifting over to Global Execution Services. The Global Execution Services segment comprises agency execution services and trading venues. During the quarter, the segment generated revenues of $85.9 million and pre-tax income of $736,000. The debt interest charge for the quarter was $1.9 million..

Results also included compensation related to a reduction in workforce of $1.9 million. Excluding this item, pre-tax income for the segment was $2.6 million in the second quarter.

Despite the deterioration in market conditions, revenues declined just 1.5% from the first quarter. Institutional equities in the US and Europe held up due impart to a more effective alignment of sales to strategic accounts.

The segment results benefited from improved performance of the Global ETF team. In addition, KCG’s Algorithmic Services reported modest market share gains in both the US and Europe. During the second quarter, KCG’s trading venues continue to make nice contribution even amid deteriorating market conditions.

KCG hotspot accounts were up approximately 13.8% of all volume among institutional spot FX reporting venues. However, the reporting venues together witnessed a decline in notional value traded of more than 18% from the first quarter. KCG Bond Point posted record highs in market share inter-deal transactions, under 250 bonds with 18.4% of all corporate and 6.4% of munis.

Unfortunately, total corporate and munis transactions each declined approximately 9% from the first quarter. KCG's registered ATS Knight Match accounted for 4.6% of US equity share volume reported to Rosenblatt's Dart Liquidity Tracker in the second quarter.

According to figures from Rosenblatt's, the leading Dart liquidity venues accounted for approximately 15.8% of consolidated US equity share volume in the second quarter.

Turning now to consolidated expenses. Total expenses for the quarter were $292.6 million, excluding $7 million from compensation related to reduction in workforce, write-down of capitalized debt cost, and lease loss accruals.

Excluding the $3.1 million related to the reduction in workforce, the compensation expense was $100.4 million in the second quarter, which represented 46.4% of net revenues. As a reminder, net revenues is defined as total revenues less execution in currencies, payment for order flow, and collateralized financing interest as well as any one-time gains.

The decrease in compensation from the first quarter is largely due to a reduction in bonus accruals given the decline in second quarter performance, as well as lower headcount. We continue to strive for a targeted compensation to net revenue ratio at or below 45%.

As for the other primary expenses during the quarter, execution and clearance fees were $73.2 million. The decrease from the first quarter was perhaps smaller than anticipated as the decline in trading volumes kept us from reaching better tiers.

Communication and data processing rose slightly to $38.3 million due to higher market data costs, payment for order flow declined to $18.1 million on lower retail trading activity. Corporate debt interest decreased to 7.5 million as a result of the forward payment of the first lien term loan during the quarter.

The $2 million write-down of capitalized debt cost was due to the early termination of the facility, and collateralized financing interest which is the interest expense incurred to finance our inventory, increased slightly to $6.4 million during the quarter. Excluding non-recurring charges disclosed in Reg G reconciliations, all other expenses totaled $48.8 million, compared to $44.1 million in the first quarter.

The increase was driven by higher professional fees relating to legal consulting, as well as an insurance recovery last quarter. Additionally, we incurred higher cost related to client events.

A quick update on the balance sheet. As you are aware, a priority for the firm is for our financial condition to be strong and liquid at all times. As of June 30, KCG had $600.9 million in cash and cash equivalents. During the quarter, we applied more than $100 million to debt reduction and share repurchases.

We paid down the remaining $59 million during the first lien term loan and repurchased 4.5 million shares for $52.9 million. As of June 30, $97.1 million remained in the $150 million share repurchase program.

Total debt at June 30 was $422.3 million and the firm’s debt to tangible equity ratio was 0.32. KCG had $1.5 billion in stockholder’s equity, a book value of $12.66 per share and a tangible book value of $11.04 per share.

Finally, headcount as of June, 30 was 1207 full-time employees, compared to 1230 employees as of March 31. That concludes my report on the quarter. Now I'll turn it back over Daniel.

Daniel Coleman

Thanks, Steve. While we acknowledge the difficult environment, these financial results for the second quarter are not satisfactory, from our point of view. We are working hard to keep our compensation expense under control in a low revenue environment while ensuring we can pay competitively for performance.

Our non-personnel expenses ticked up and while we are continuing to invest in our business and our brand. We will stay focused on this number to make sure that over the next few quarters, our non-personnel costs will continue to show improvement.

Most importantly, we need to continue to increase our revenue generation capability by taking market share and client businesses and improving our trading capabilities with many of our market-making businesses. And we need to do this as we continue to integrate the technology and processes of two firms.

Despite the second quarter financial results, I am proud of what our team at KCG has accomplished in our first full year of operations. We have integrated broker/dealers, trading teams, support teams and technology.

We have enhanced core capabilities building new technology and processes that neither firm had before. We’ve significantly reduced the non-personnel and non-personnel cost structure that we had at the close of our deal.

In addition, we’ve rapidly deleveraged our balance sheet and we’ve begun to return cash to shareholders via buyback. Our businesses are moving their focus from the past use of integrating two firms, we are now on a front foot which is evident in the modest and broad-based market share gains we’ve achieved.

There is doubt that the markets remain and appear to transformation and we at KCG still have a lot of work to do to reach an optimal level of efficiency and effectiveness.

One year in, however the challenges that are under our control are proving more manageable and are beginning to yield tangible results. I know you are all anxious to get to the questions. So thank you again for making time this morning. Let’s open up the lines.

Question-and-Answer Session


(Operator Instructions) And we’ll take our first question from Rich Repetto from Sandler, O'Neill.

Rich Repetto – Sandler O'Neill

Yes, hi. Good morning. The first question would be – and I apologize, because I had to – I just jumped on the call here late. But on the expenses, it seemed like the first quarter, you were significantly under street expectations, it appears this quarter, you were above street expectations.

So can you give us some more guidance on what you could expect – how you would expect the run rate of the fixed, or whether it be comp or fixed non-personnel costs to trend and when is the step down? Are we still looking at the step down of expenses a 2015 event rather than 2014 even with this volume environment?

Daniel Coleman

Yes, I understand. When I talk about talk about comp and non-personnel – and I’ll hand over to Steve to talk about the counter with trading execution costs. The comp expense ticked up and our goal is to run it around 45% in net revenues and that’s our goal for now to the end of the year.

So, in this environment, given the way we breakdown comp, it was very difficult to make it any tighter, but our anticipation is a 45% or lower. On the non-personnel costs, we came in approximately 94 versus approximately 90, that did tick up. Some of these costs are little noisy.

There is some timing issues and a few things. While I am not happy to see that tick up, I wouldn’t read too much into it and our view is that overtime we are going to bring this down and to the answer your question more explicitly on communications and data, specifically we expect to see a step-down next year relative to our current run rate and especially where we were at the beginning of this year.

So, we don’t think we are off-track with respect to the infrastructure cost and bringing those down over time. We do have some noise around various cost of billings that ticked up this last quarter and we are going to be very focused to make sure we can control it as closely as possible from quarter-to-quarter. But the trend should continue to move down over time.

Steve Bisgay

Yes, Rich, in terms of the contrary expenses or the direct trading expenses, specifically, first execution clearance, there that came in a little bit higher. Volumes were lower we didn’t get it = have the ability to take advantage of the same advantage of lower pricing.

Thanks to the volumes and tier pricing that is. But just to be mindful, the margin against total revs came in 23.5% that is down from – that is up rather from the 20% last quarter. Revenue capture was much higher of course last quarter 1.26 it came in at 1.07.

But if you look back over the last trailing, since we became KCG, quarter-after-quarter, it’s been about 24% in the first two quarters, it was 20% last quarter, now it’s at 23%. I think in this volume environment, I think a 23% margin is probably fairly reasonable. Payment for order flow or PFOF, that margin came in consistent and it has been consistent around 6% over the last trailing four quarters and as far as stock loan or repo interest expense is concerned, it did tick up slightly.

There our volumes did pick up slightly during the course of – at the end of the quarter. It was more effective of financing some of our less liquid inventory that comes at a slightly variable cost.

It does free up liquidity which is a positive for KCG. So that’s a good thing, but there is a slight cost that as well. So, hence the $6.4 million number that you are looking at versus the $6.2 million last quarter.

Rich Repetto – Sandler, O'Neill

Okay, thank you for the sort of the detailed response there. I guess, just one follow-up question, Daniel. The revenue capture, if you're looking for a bright spot in the quarter, at least to us, the $1.07 million in such a low volatility, low volume environment – the old Knight, we'd expect to be at the bottom end of the $0.8 million to $1.2 million range, and maybe even below the range.

So I guess, as we look at $1.26 million in 1Q, $1.07 million in this quarter, is it the – are we seeing any helpfulness of the get go ability to sort of pick off the exhaust flow. And I guess the question is, is the range of 0.8 to 1.2, should we just be at a higher range, or should we just have tightened the range? Given that the combined model now has more interaction with the order flow?

Daniel Coleman

Well, I’d say, we are pretty happy with the 1.07 Rich, but I think, it’s probably premature with four quarters under our belt to tighten the range too much. The first part of April is clearly better than May and June and I would say, since June there has been a bit of an increasing competition among the wholesalers.

So, while I am hopeful over time that maybe we can tighten this range at a higher level. I think right now, let’s get through the cycle of both low volume and higher competition and see where it comes out.

I think there is improvement due to a combination and simply due to the people who were in the legacy Knight businesses are doing a very good job improving the trading capabilities. But, I think it is premature to tighten unfortunately.

Rich Repetto – Sandler, O'Neill

Understood. That's logical and conservative. Okay, thanks for taking the questions and that's helpful.

Daniel Coleman

All right. Thank you.


And we’ll go next to Ken Worthington from JPMorgan.

Ken Worthington – JPMorgan

Hi, good morning. First, I'd love to just follow-up on that comment you just made about more competition among the wholesalers in June. Does it appear to be – well, can you give us more color on it? Does it appear to be driven by one or the reaction of many? What are you seeing there?

Daniel Coleman

I’ve been involved in the business for about 10 years and when I was at UBS, we bought Schwab Capital Markets, we bought it into I would say, a very, very competitive environment and I recall that in 2004.

This business goes through cycles of high competition and I think we are in one right now. I am not – I don’t want to go into which competitor is doing which and I don’t think that’s appropriate, but it’s a very competitive group. The retail definitely benefits from that.

I think competition has been notched up perhaps people see the potential of more clients becoming available like Schwab in October and are getting ready. I am not sure what the reason is. But I do believe and perhaps the people want to demonstrate a very good quality of execution in these times. I am not sure.

But I will say this, that the environment is very competitive right and it may have to do with the drop-off in volumes that people have to try to compete to keep market share.

And that’s probably a major factor. But, the only thing I know for sure is that the environment right now for wholesale market making is as competitive as I’ve seen it in a long, long time and we will go through these cycles. So that makes a little tougher for us. It’s not a huge deal, but it is a little tough.

Ken Worthington – JPMorgan

And I'm sorry, you said June, in terms of the competition, is just the month of June or the June quarter?

Daniel Coleman

No, no. I’d say, it’s June and July. I mean, June and it’s now, I think it’s been very competitive and in thinking about it, I imagine there is a lot to do with the volumes dropping off and people trying to position themselves well in a low volume environment is my expectation, what’s really going on.

Ken Worthington – JPMorgan

Okay, I think this is more housekeeping, but you combined the UK broker/dealers this quarter. Have you released and deployed that capital or is that still yet to come?

Daniel Coleman

It’s still yet to come. We have done everything that we could do in terms of – we are on track from a process perspective. A, we’ve combined the broker/dealers. We’ve done the regulatory filings with the regulator and the UK is reviewing our application conducting more hopefully finalizing their examination at this point and we expect that that should wrap up, say late August or in September, we are hopeful that we are still on track for a release of capital. And again, we are still in the range of say, $50 million to $70 million – $75 million.

Ken Worthington – JPMorgan

Okay, great. And then, in terms of initiatives, I'm sorry, I missed the first two minutes of the call too. There is a couple I was interested in, the sale of algos to the buy side and then maybe any update on KCG's relationship to the mid-cap banks – mid-sized banks in Europe and the outsourcing of trading there?

Daniel Coleman

I think in the last call, I just wanted to provide context. We are hoping to show some tangible improvement in the algos by Q4 and some tangible improvement from our efforts in Europe next year. We’ve made progress, things move a bit slowly when – especially in the summer time in Europe.

But we made progress with two very important clients and we hope to have them on-boarded and at the end of this quarter beginning Q4. But again, I expect the numbers to be probably more – for Europe to be evident next year not this year.

On the Algos side, you saw an uptick in market share for us in a lower market environment and think that reflects some improvement in the algos side. I also think that if you look at our Global Execution Services numbers quarter-on-quarter, given that’s down slightly, but it’s in an really tough environment and think this reflects progress both here in the US and in Europe on our client businesses.

So I’d say modest progress with Algos institutions but I think the overall client business showed good resiliency in Q2 and I am optimistic we can talk something a little more clear and by Q4.

Ken Worthington – JPMorgan

Okay. Thank you.


And we’ll go next to Patrick O'Shaughnessy from Raymond James

Patrick O'Shaughnessy – Raymond James

Good morning, guys.

Daniel Coleman

Good morning, Pat.

Patrick O'Shaughnessy – Raymond James

So, with the minimum tick size pilot that the SEC is going to implement, one of the components within that pilot is going to be to test the trade-out rule. So I was curious to get your updated thoughts on what do you think that pilot is actually going to show and what sort of risk you think trade at poses to your market share and your revenue capture?

Daniel Coleman

I’ll call that thee different pilots and one has a trade at, but there is a retail exemption for it. The real question is going to be what is the definition of retail and how that impacts – with respect to how it impacts, it doesn’t impact our business.

I think that, first of all, starting at the beginning, I think that the idea of widening tick sizes is not a great idea. It increases friction cost for investors and that in of itself is the wrong direction to go in.

But, I do appreciate the fact that the SEC is trying to settle the debate by gathering evidence and that’s really important and that’s the approach we really appreciate. I think the problem with combining a trade at with the pilot is that you end up really with a lot of noise and if you have a significant trade at, I think that’s going to overwhelm in a kind of views on the pilot.

I still believe that – well, the second thing I would say is, we need to see what the rules of a trade at look like before we really know and I still believe that the regulators are very focused on trying to solve real problems and there are many ways to deal with issues like price discovery, other issues people are concerned about without having a trade at and I’ve gone in record before saying.

The only thing I think trade at will solve the returns for the publicly traded exchanges. I think it’s really important that our clients were able to interact with us directly, they benefit from that in many different ways and they want to interact with us directly.

I think it’s important to deal, innovate and compete. And so, having a regulator not only for order flow, because of price but also because of what an entity to that entity really goes in the wrong direction.

But I am pretty optimistic that how the trade at plays out over time will not have major impact on our business partly because of retail exemption but also partly because I feel very confident that the SEC will focus on the real problems and I think there are many ways to solve those problems we are not creating new ones.

Patrick O'Shaughnessy – Raymond James

Great, that's very helpful. And I guess in a similar vein, it seems like there has been a lot of conversation in the last few weeks about retail brokers having to pay more attention to the quality of execution and making sure that they're meeting their best execution requirements. Do think that's maybe played a role in some of the increased competition in the wholesaling landscape over the last couple of months?

Daniel Coleman

It’s possible, but our clients pay pretty close attention all the time and I think it probably has more to do with this volume environment. But it’s possible. And there is a microscope on this part of the business or people examining payment and everything else. So, it is possible, but I would just tell you that our clients have always been very, very focused on their execution quality.

Patrick O'Shaughnessy – Raymond James

Okay great, and then last one from me, as we look at your market-making in asset classes other than US equities, I'm getting a 27% quarter-over-quarter decline. That's a little bit more than the decline in the Asian and European volumes that Steve talked about.

And so is there something else going on there? Is there a loss of market share spreads coming in, so, the profitability just isn't there? And in addition to that, can you talk about your growth initiatives in other asset classes?

Daniel Coleman

Sure, so, I think the one thing about those business is it’s different than our US equity market-making as these businesses are pure on exchange businesses generally speaking. And so they – it’s a good example of the difference of volatility of a franchise business and a non-franchise business meaning, this business will be more subject to the wins of the marketplace than client businesses usually are.

I think there was a lot going on in these different markets, in these businesses include everything from US options to trade in Japan to where we had significant market structure changes in the Q1 and Q2 to trading European equities to trading fixed income products.

And without going into the detail there were significant exogenous changes in many of these markets on top of a significant drop in volume of volatility and fixed income products, particular rates products.

So, I don’t think there is anything internally going on that with causes drop we are very focused on improving these businesses because we think the long-term potential of these businesses is very, very high, but I will say that there are many factors impacting these businesses around the world in addition to volume and volatility that made Q2 particularly difficult.

As far as the future of lot of these businesses, I think, – I think from a market-making point of view, we have a very small effort in FX and corporate bonds and much larger efforts in rates and in governments.

I think, if we look at the swap market, our view is that being second mover is okay, because there is a lot of things to figure out and how things would play out and it would be expensive to put shifts on three or four numbers.

But, it’s very important for us from being a large rates trader around the world is being involved in the swaps market. And so, I think that will one of the areas we focus on over the next few quarters and I’ve said that before but the swaps market really, the market structure really hasn’t really evolved completely yet and really until it evolves, I don’t think you are going to see us make a huge effort there.

But that would be one of the most important area. FX is similar it’s – we have a small effort now on the spot market-making as well as futures trading. This is a market that we expect over the next year or so will change dramatically with respect to transparency and accessibility.

And this is in my view largely due to the regulatory pressures are likely to come out of various investigations and what happened in the FX market. So, it’s hard to predict how that will come out. Our view was to continue to build a market-making presence and over time, as accessibility and transparency of the overall market increases.

I think it will be a much better marketplace for us. And in addition, our ability to make markets – as a market-maker directly to clients will also be important. So that’s where we are in those initiatives.

To some extent, we are focused on, on the market-making part knowing that the environments will come our way and to some extent we are being patient with respect to not spending too much money in areas where it’s not clear how it’s exactly going to play out.

Patrick O'Shaughnessy – Raymond James

Great. That's very helpful. Thank you.

Daniel Coleman

You are welcome.


And we’ll go next to Niamh Alexander from KBW.

Niamh Alexander – KBW

Hi, thanks, good morning. Thanks for taking my questions.

Daniel Coleman

Good morning Niamh.

Niamh Alexander – KBW

Good morning. The capital distribution, I mean, you did some pretty hefty share repurchases during the quarter. You still have, it looks like the capital to be released from the UK. So help me think about is this a good run rate? Or is it just like kind of like you wanted to start out strong and give yourself some more flexibility going forward?

Daniel Coleman

No I think, I will give my usual answer on this. With the excess cash we could do several things. We can acquire things. We can pay dividends. We can invest in our businesses and we can buy back stock and we pay down debt. And that’s really our choice. I think at this point we have the right amount of capital on our businesses.

At this point I don’t think paying dividends makes sense, where a stock price is. I would say today, I don’t see it really attractive opportunity and given that we are still integrating, I would say the threshold for attractive opportunity would have to be very high.

So I think with excess cash and our share price here, we think it’s a good way to deploy cash and it’s a good way reward our shareholders as we are still integrating two firms. So, as of today, we think buying back shares is a good way to deploy it and – but things could change over the next few weeks or quarters depending on the other opportunities to put our cash to use.

Niamh Alexander – KBW

Okay, fair enough, Daniel. I guess, going back and I know you've given some color in different ways to the answers to the questions. But is it’s outside of the wholesale market-maker? Is it’s kind of that whole former deco business that's more difficult to predict for us?

What can you share – you've given us the color in terms of the areas of the market areas are taken in, but is there anything you can guide us to, is it like 50% fixed income, even if it's global, not just US, if it's 30% futures, if it's 30% international equities. I know it can vary in any one quarter. But what's maybe the two biggest product areas in that group? I know you were big US market-makers in US Treasuries, for example.

Daniel Coleman

Yes, I mean, the biggest area in that’s fixed income, but it can vary, it can definitely vary from quarter-to-quarter but the biggest area is definitely fixed income which for us is primarily US Treasuries and rates futures around the world.

Niamh Alexander – KBW

Okay, that's helpful. Thanks, Daniel. And then, I guess, back to the market structure discussion, I saw you were down in DC during the week and with a lot of other CEOs in the exchanges and the market structures space.

So it was good to hear KCG be representative, but, there seem to be, just in that group of policymakers who knows if it ends up in any changes in the rules in three years time, but there seems to be some momentum building for maybe eliminating maker taker pricing structure in equities and that might impact maybe those that just trade for the rebates.

Help me think about potential opportunities or risks for KCG if that movement starts to get some more legs there?

Daniel Coleman

Let me tell you, what I think will happen and what I think the impacts are and then I will get to us. I am on the Board of SIFMA and I was very involved in SIFMA’s market structure letter which recommended dropping access fees from 30 to 5 mills.

And we supported that – KCG supports that and SIFMA supports it not mainly to simplify things and we wanted incremental change because there is no one is really sure what happens when you make changes in the market. They are always on intent to consequences.

So, as opposed to getting rid of it completely, let’s drop it by about 80% and see what happens. The reason why we this is important is because, the size of the access fees which in turn enables large rebates as well has really created the store sense in our market. Reg NMS causes us to send orders where there is best price, but then take access fees in consideration.

A lot of the order types are all about avoiding access fees and quite frankly a lot of the dark pool volume is about avoiding access fees. And the underlying issue we think is the complexity of the marketplace that is really undermining confidence in the marketplace and we think a few incremental changes can really reduce complexity or at least have complexity get to the level of desirability by market standards and let’s not create things that enhance complexity for no good reason.

And we think the access fees does that. I don’t know, I don’t know if this will be passed. I know the SEC is aware and I actually think from that round table, people were coalescing around this idea as a reasonable idea including Matt Andresen, who was one of the first people to promote maker taker many years ago when he was at Ireland.

So, I think, I think this could be a positive for the market and a positive for the market in the long run is obviously positive for us. In the near-term I don’t think it matters to us in any way with respect to our revenue or profitability or any strategies we run.

Niamh Alexander – KBW

I see. Okay. Thanks. I'll get back in line.


And we’ll go next to Chris Allen with Evercore.

Chris Allen – Evercore

Good morning, guys.

Daniel Coleman

Good morning Chris.

Chris Allen – Evercore

I want to go back to the non-US market-making. You talked about some exogenous changes impacting the business. I mean. from your perspective, with these changes and the full run rate of the business at present or is it still more to go? And are they temporary or are they permanent, can you just give us more color in terms of how you're thinking about it?

Daniel Coleman

Yes, Chris, let me give you a couple examples and the reason be esoteric, but they do change market-making business Japan changed the tick size twice for its more active stocks it’s in the Q1 and then for like the next seventy or so approximately. And this was a disruptive – this disrupted the way we traded and it took us a little while to adapt.

I think that’s a one-time change. I think we done a really good job of adapting, but it hurt our revenues a little bit. There has been some changes in Korea with respect to technology that has caused us to have to adapt.

And so, these are one-time changes but when deals in many countries around the world sometimes stay it will happen frequently and these were two big markets for us and they both happened pretty much at the same time in the second quarter.

So those are the two of the things I am referring to. I think, and they had real impact, but I also would say that the other issue has really been the volume and volatility in the rates complex around the world.

Chris Allen – Evercore

Sure, and in terms of the impact, we thought a couple million dollars, or is it even more than that or?

Daniel Coleman

I think, we don’t want to go into too much detail, but it was more than a couple million bucks.

Chris Allen – Evercore

Got it. And then you mentioned increased market data costs impacting communications and data processing. Was this driven by increased pricing now that you were seeing, or is there some other issue?

Daniel Coleman

No, no, I think it’s more timing of expenses. It was pretty mundane stuff. It wasn’t increased – I wouldn't read anything in the increased pricing. In fact, what I’d probably do is take Q1 and Q2 and divide it by 2 and say that’s the appropriate number.

Chris Allen – Evercore

Got it. Okay, fair, and then I know you guys are managing to the 45% comp to revenue ratio or trying to, obviously, 3Q is typically seasonally slowest time of the year. But without an improvement in revenues, I mean, should we expect it to maintain a little bit higher than the 45%, like closer to the 46.5% range we saw this quarter?

Daniel Coleman

That’s a good question, Chris. I mean, our intent is to do retain to get to 45 for the year and we will have to play quarter-by-quarter, but we have that’s we are going to do everything we can to get to 45 by the end the year.

Chris Allen – Evercore

And just with the recent CME GFI transaction when (inaudible), it's raising a lot of questions around players who have potential properties and opportunities to monetize them. Any updated thoughts on hotspot here?

Daniel Coleman

Nothing to update. I can repeat what I’ve always said, which is probably worth doing is, it’s a really important asset to us in many ways. We think FX market is likely to become more transparent in trade-on venues like hotspot. So in the long run we think it’s very valuable. It also gives us an entry into clients in Asia it’s only really Asia-based client business.

That said, we always have to review our assets to make sure we are the best owner and not just for shareholders but also for the employees of the asset. And so we have no update, but it’s important to us and we think it’ s really valuable and we review our holdings all the time.

Chris Allen – Evercore

Thanks a lot, guys.

Daniel Coleman

Thank you.


And we’ll go next to Chris Harris with Wells Fargo.

Chris Harris – Wells Fargo Securities

Hey guys. Just a quick one on the share count. I apologize if you covered this in the prepared remarks. But you bought back a lot of stock, but your average share count didn't really go down much. Just wondering, was that buyback kind of back-end loaded toward the end of the quarter or did you had some issuance that maybe diluted the efforts of that?

Steve Bisgay

No, well, it’s two-fold, it’s really buyback activity as you pointed out towards the later part of the quarter. It also has to do with Q1’s issuance or bonus awards where they only had two months of vesting in Q1 versus a full three months of vesting in Q2 as well. So, those two had a bearing as well.

Chris Harris – Wells Fargo Securities

Okay. And what was the end of period share count?

Steve Bisgay

The end of period share count – well, weighted average share – weighted average it is 117.6. The absolute value of our shares out including RSUs is 121.1.

Chris Harris – Wells Fargo Securities

Okay. Thank you.


And this concludes our question answer session. I would like to turn the conference back over to our speakers for any additional or closing remarks.

Daniel Coleman

I want to thank everyone for joining us this morning. The second quarter was tough as you saw from the numbers but we are very – as I said before, very proud of what we have accomplished in our first year working together. And I look forward to talking to many of you over this quarter and giving you an update three months from now. Thank you.


And this concludes our conference. Thank you for your participation.

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KCG Holdings (NYSE:KCG): Q2 EPS of $0.08 may not be comparable to consensus of $0.17. Revenue of $206.8M (-19.9% Y/Y) misses by $81M.