Knight's on a Long Day's Journey From Profit

The year is off to a bad start for

Knight Trading

(NITE)

, and the rest of 2002 could be just as bleak, analysts said.

Shares of Knight were falling 2.4% to $6.98 Thursday after the company warned it expects to post a loss in the first quarter instead of the 10-cent profit analysts were forecasting.

The biggest market-maker in

Nasdaq

securities, Knight has been hard hit by decimalization, which took effect in April 2001, and dramatically reduced its revenue per trade.

Weak trading volume and an 18-month low in volatility also weighed on its equities business in the first quarter, while both volume and volatility are seasonally weak during the summer months, analysts said.

In addition, several executive departures have left management in disarray. And attempts to bolster flagging profits with moves abroad and into the options market and bulletin board stocks haven't panned out so far.

Lean Year

Analysts said the company probably won't turn a profit again until 2003. Putnam Lovell analyst Richard Repetto cut his 2002 estimates to a loss of 13 cents a share. Raymond James & Associates analyst Michael Vinciquerra downgraded the stock to underperform and Robertson Stephens analyst Justin Hughes put his estimates under review.

"I don't know why anyone would want to own this stock that may post a loss for all of 2002 and

have no significant profit in 2003," said Vinciquerra. "The company has been working to get into new markets with wider margins, but they really haven't been successful in doing so. They became a big player in the options market at the same time that overall volatility began to decline. We're not sure how this shakes out longer term."

While Knight's core domestic equities market-making business was profitable in the first quarter, its European business posted a loss of 5 cents to 7 cents a share, and the sharp drop in volatility depressed its options business, the company said in a filing with the

Securities Exchange Commission

. Knight also took a noncash charge of 3 cents a share for asset writedowns.

In all, the company expects to report a loss of 10 cents to 12 cents a share for the first quarter ended March 31, 2002. On average, analysts were expecting a 10-cent profit for the first quarter and 52 cents for the full year.

Trouble Abroad

Knight said it plans to cut costs in the U.S. and Europe, which has not made it to profitability as quickly as the company had hoped. "We are exploring opportunities to introduce efficiencies in the U.S. and overseas," said interim CEO Anthony Sanfiliippo. "In Europe, our losses have been reduced, but we are not satisfied with our progress. Japan remains a bright spot, and while the first quarter was not profitable, we're pleased with its performance to date."

Hughes said Knight's European business is costly now, but could be valuable longer term. "The question is at what point do they throw in the towel in the international business," said Justin Hughes. "Maybe if they toss Europe, they could get back to break-even, but Europe should have very good growth in the longer term."

It may take an industry consolidation to really turn the company around, he said.

"Margins aren't going to get any wider until we have a consolidation in the industry," said Hughes. "There are well over 100 market makers in the industry, and when volumes slow down this year, we should see more consolidations."

Hughes and other analysts said that consolidation would probably entail smaller guys just getting out of the business. But it's also possible that Knight would get bought out by a brokerage, which could then funnel its order flow through Knight.

Goldman Sachs and Merrill Lynch have acquired market-makers for top dollar and don't have much to show for it, said Vinciquerra. But Knight is currently relatively cheap. The company's book value is just over $6.60 a share and it's trading at $6.98. Knight shares traded as high as $18.78 in April 2001.

Repetto urged that Knight needs to select a new CEO. "We believe near-term profitability pressures require immediate leadership and direction of the company."

As profits dropped last year, Knight went through a series of executive changes. The company's CEO, Kenneth Pasternak, made plans to step down last December. Last June, John G. Hewitt, president of the trading arm, and David Sphilberg, Knight's chief operating officer, left as the company set plans to cut about 3% of its U.S. workforce. Other key executives Irv Kessler and Peter Hajas have also left.