Attached files
file | filename |
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EX-32.1 - EX-32.1 - PENSON WORLDWIDE INC | d82148exv32w1.htm |
EX-32.2 - EX-32.2 - PENSON WORLDWIDE INC | d82148exv32w2.htm |
EX-31.2 - EX-31.2 - PENSON WORLDWIDE INC | d82148exv31w2.htm |
EX-12.1 - EX-12.1 - PENSON WORLDWIDE INC | d82148exv12w1.htm |
EX-31.1 - EX-31.1 - PENSON WORLDWIDE INC | d82148exv31w1.htm |
Table of Contents
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
Washington, D.C. 20549
Form 10-Q
þ
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
|
For the Quarterly Period Ended March 31, 2011 | ||
o
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
|
For the transition period from to |
Commission file number.
001-32878
Penson Worldwide,
Inc.
(Exact name of registrant as
specified in its charter)
Delaware | 75-2896356 | |
(State or other jurisdiction
of incorporation or organization) |
(I.R.S. Employer Identification No.) |
|
1700 Pacific Avenue, Suite 1400 Dallas, Texas (Address of principal executive offices) |
75201 (Zip Code) |
(214) 765-1100
(Registrants telephone
number, including area code)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of
Regulation S-T
during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such
files). Yes o No o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
large accelerated filer, accelerated
filer and smaller reporting company in
Rule 12b-2
of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o | Smaller reporting company o |
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
As of May 6, 2011, there were 28,524,496 shares of the
registrants $.01 par value common stock outstanding.
Penson
Worldwide, Inc.
INDEX TO
FORM 10-Q
1
Table of Contents
PART I.
FINANCIAL INFORMATION
Item 1. | Financial Statements |
Penson
Worldwide, Inc.
Condensed Consolidated Statements of Financial Condition
Condensed Consolidated Statements of Financial Condition
March 31, |
December 31, |
|||||||
2011 | 2010 | |||||||
(Unaudited) | ||||||||
(In thousands, except |
||||||||
par values) | ||||||||
ASSETS
|
||||||||
Cash and cash equivalents
|
$ | 146,263 | $ | 138,614 | ||||
Cash and securities segregated under federal and
other regulations (including securities at fair value of $22,085
at March 31, 2011 and $14,197 at December 31, 2010)
|
5,691,672 | 5,407,645 | ||||||
Receivable from broker-dealers and clearing organizations
(including securities at fair value of $2,500 at March 31,
2011 and $2,498 at December 31, 2010)
|
563,262 | 257,036 | ||||||
Receivable from customers, net
|
2,974,272 | 2,209,373 | ||||||
Receivable from correspondents
|
174,958 | 129,208 | ||||||
Securities borrowed
|
1,568,721 | 1,050,682 | ||||||
Securities owned, at fair value
|
206,714 | 201,195 | ||||||
Deposits with clearing organizations (including securities at
fair value of $243,640 at March 31, 2011 and $213,015 at
December 31, 2010)
|
476,427 | 423,156 | ||||||
Property and equipment, net
|
36,875 | 37,743 | ||||||
Other assets
|
394,387 | 399,532 | ||||||
Total assets
|
$ | 12,233,551 | $ | 10,254,184 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY | ||||||||
Payable to broker-dealers and clearing organizations
|
$ | 571,521 | $ | 128,536 | ||||
Payable to customers
|
8,644,401 | 7,498,626 | ||||||
Payable to correspondents
|
506,306 | 469,542 | ||||||
Short-term bank loans
|
318,312 | 338,110 | ||||||
Notes payable
|
270,834 | 259,729 | ||||||
Securities loaned
|
1,383,459 | 1,015,351 | ||||||
Securities sold, not yet purchased, at fair value
|
120,509 | 115,916 | ||||||
Accounts payable, accrued and other liabilities
|
118,272 | 127,453 | ||||||
Total liabilities
|
11,933,614 | 9,953,263 | ||||||
Commitments and contingencies
|
||||||||
STOCKHOLDERS EQUITY | ||||||||
Preferred stock, $0.01 par value, 10,000 shares
authorized; none issued and outstanding as of March 31,
2011 and December 31, 2010
|
| | ||||||
Common stock, $0.01 par value, 100,000 shares
authorized; 32,134 shares issued and 28,513 outstanding as
of March 31, 2011; 32,054 shares issued and 28,454
outstanding as of December 31, 2010
|
321 | 321 | ||||||
Additional paid-in capital
|
279,444 | 278,469 | ||||||
Accumulated other comprehensive income
|
5,385 | 4,367 | ||||||
Retained earnings
|
69,774 | 72,635 | ||||||
Treasury stock, at cost; 3,621 and 3,600 shares of common
stock at March 31, 2011 and December 31, 2010
|
(54,987 | ) | (54,871 | ) | ||||
Total stockholders equity
|
299,937 | 300,921 | ||||||
Total liabilities and stockholders equity
|
$ | 12,233,551 | $ | 10,254,184 | ||||
See accompanying notes to condensed consolidated financial
statements.
2
Table of Contents
Penson
Worldwide, Inc.
Condensed Consolidated Statements of Operations
Condensed Consolidated Statements of Operations
Three Months Ended |
||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
(Unaudited) | ||||||||
(In thousands, except per share data) | ||||||||
Revenues
|
||||||||
Clearing and commission fees
|
$ | 43,847 | $ | 34,366 | ||||
Technology
|
6,020 | 5,384 | ||||||
Interest, gross
|
28,366 | 20,590 | ||||||
Other
|
12,330 | 12,554 | ||||||
Total revenues
|
90,563 | 72,894 | ||||||
Interest expense from securities operations
|
8,254 | 5,467 | ||||||
Net revenues
|
82,309 | 67,427 | ||||||
Expenses
|
||||||||
Employee compensation and benefits
|
28,479 | 27,634 | ||||||
Floor brokerage, exchange and clearance fees
|
12,165 | 9,088 | ||||||
Communications and data processing
|
19,364 | 11,397 | ||||||
Occupancy and equipment
|
8,528 | 7,804 | ||||||
Other expenses
|
8,677 | 6,725 | ||||||
Interest expense on long-term debt
|
9,711 | 4,555 | ||||||
86,924 | 67,203 | |||||||
Income (loss) before income taxes
|
(4,615 | ) | 224 | |||||
Income tax expense (benefit)
|
(1,754 | ) | 85 | |||||
Net income (loss)
|
$ | (2,861 | ) | $ | 139 | |||
Earnings (loss) per share basic
|
$ | (0.10 | ) | $ | 0.01 | |||
Earnings (loss) per share diluted
|
$ | (0.10 | ) | $ | 0.01 | |||
Weighted average common shares outstanding basic
|
28,478 | 25,573 | ||||||
Weighted average common shares outstanding diluted
|
28,478 | 25,704 |
See accompanying notes to condensed consolidated financial
statements.
3
Table of Contents
Penson
Worldwide, Inc.
Accumulated |
||||||||||||||||||||||||||||||||
Other |
Total |
|||||||||||||||||||||||||||||||
Preferred |
Common Stock |
Additional paid-in |
Treasury |
Comprehensive |
Retained |
Stockholders |
||||||||||||||||||||||||||
Stock | Shares | Amount | Capital | Stock | Income | Earnings | Equity | |||||||||||||||||||||||||
(Unaudited) | ||||||||||||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||||||
Balance, December 31, 2010
|
$ | | 28,454 | $ | 321 | $ | 278,469 | $ | (54,871 | ) | $ | 4,367 | $ | 72,635 | $ | 300,921 | ||||||||||||||||
Net loss
|
| | | | | | (2,861 | ) | (2,861 | ) | ||||||||||||||||||||||
Foreign currency translation adjustments, net of tax of $656
|
| | | | | 1,018 | | 1,018 | ||||||||||||||||||||||||
Comprehensive loss
|
(1,843 | ) | ||||||||||||||||||||||||||||||
Purchase of treasury stock
|
| (21 | ) | | | (116 | ) | | | (116 | ) | |||||||||||||||||||||
Stock-based compensation expense
|
| 80 | | 975 | | | | 975 | ||||||||||||||||||||||||
Balance, March 31, 2011
|
$ | | 28,513 | $ | 321 | $ | 279,444 | $ | (54,987 | ) | $ | 5,385 | $ | 69,774 | $ | 299,937 | ||||||||||||||||
See accompanying notes to condensed consolidated financial
statements.
4
Table of Contents
Penson
Worldwide, Inc.
Three Months Ended |
||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
(Unaudited) | ||||||||
(In thousands) | ||||||||
Cash flows from operating activities:
|
||||||||
Net income (loss)
|
$ | (2,861 | ) | $ | 139 | |||
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
|
||||||||
Depreciation and amortization
|
5,819 | 4,503 | ||||||
Stock-based compensation
|
975 | 1,497 | ||||||
Debt discount accretion
|
1,106 | 690 | ||||||
Debt issuance costs
|
268 | 759 | ||||||
Contingent consideration accretion
|
100 | | ||||||
Changes in operating assets and liabilities :
|
||||||||
Cash and securities segregated under federal and
other regulations
|
(278,427 | ) | (186,531 | ) | ||||
Net receivable/payable with customers
|
370,655 | 555,338 | ||||||
Net receivable/payable with correspondents
|
(13,974 | ) | 9,251 | |||||
Securities borrowed
|
(511,734 | ) | 201,951 | |||||
Securities owned
|
(969 | ) | (15,552 | ) | ||||
Deposits with clearing organizations
|
(52,510 | ) | (225,653 | ) | ||||
Other assets
|
(5,977 | ) | (8,349 | ) | ||||
Net receivable/payable with broker-dealers and clearing
organizations
|
136,510 | (197,797 | ) | |||||
Securities loaned
|
366,507 | (21,768 | ) | |||||
Securities sold, not yet purchased
|
1,967 | 2,172 | ||||||
Accounts payable, accrued and other liabilities
|
2,836 | 16,662 | ||||||
Net cash provided by operating activities
|
20,291 | 137,312 | ||||||
Cash flows from investing activities:
|
||||||||
Purchase of property and equipment
|
(3,673 | ) | (7,060 | ) | ||||
Net cash used in investing activities
|
(3,673 | ) | (7,060 | ) | ||||
Cash flows from financing activities:
|
||||||||
Proceeds from revolving credit facility
|
25,000 | 11,500 | ||||||
Repayments of revolving credit facility
|
(15,000 | ) | | |||||
Net repayments on short-term bank loans
|
(20,072 | ) | (96,335 | ) | ||||
Exercise of stock options
|
| 88 | ||||||
Excess tax benefit from stock-based compensation plans
|
| 22 | ||||||
Purchase of treasury stock
|
(116 | ) | (225 | ) | ||||
Issuance of common stock
|
| 4 | ||||||
Net cash used in financing activities
|
(10,188 | ) | (84,946 | ) | ||||
Effect of exchange rates on cash
|
1,219 | 492 | ||||||
Increase in cash and cash equivalents
|
7,649 | 45,798 | ||||||
Cash and cash equivalents at beginning of period
|
138,614 | 48,643 | ||||||
Cash and cash equivalents at end of period
|
$ | 146,263 | $ | 94,441 | ||||
Supplemental cash flow disclosures:
|
||||||||
Interest payments
|
$ | 2,463 | $ | 2,579 | ||||
Income tax payments
|
$ | 275 | $ | 4,017 |
See accompanying notes to condensed consolidated financial
statements.
5
Table of Contents
Penson
Worldwide, Inc.
(in
thousands, except per share data or where noted)
1. | Basis of Presentation |
Organization and Business Penson Worldwide,
Inc. (individually or collectively with its subsidiaries,
PWI or the Company) is a holding company
incorporated in Delaware. The Company conducts business through
its wholly owned subsidiary SAI Holdings, Inc.
(SAI). SAI conducts business through its principal
direct and indirect wholly owned operating subsidiaries
including among others, Penson Financial Services, Inc.
(PFSI), Penson Financial Services Canada Inc.
(PFSC), Penson Financial Services Ltd.
(PFSL), Nexa Technologies, Inc.
(Nexa), Penson Futures, formerly known as Penson
GHCO (Penson Futures), Penson Asia Limited
(Penson Asia) and Penson Financial Services
Australia Pty Ltd (PFSA). Through these operating
subsidiaries, the Company provides securities and futures
clearing services including integrated trade execution, clearing
and custody services, trade settlement, technology services,
foreign exchange trading services, risk management services,
customer account processing and data processing services. The
Company also participates in margin lending and securities
borrowing and lending transactions, primarily to facilitate
clearing and financing activities.
PFSI is a broker-dealer registered with the Securities and
Exchange Commission (SEC), a member of the New York
Stock Exchange (NYSE) and a member of the Financial
Industry Regulatory Authority (FINRA), and is
licensed to do business in all fifty states of the United States
of America and certain territories. PFSC is an investment dealer
registered in all provinces and territories in Canada and is a
dealer member of the Investment Industry Regulatory Organization
of Canada (IIROC). PFSL provides settlement services
to the London financial community and is regulated by the
Financial Services Authority (FSA) and is a member
of the London Stock Exchange. Penson Futures is a registered
Futures Commission Merchant (FCM) with the Commodity
Futures Trading Commission (CFTC) and is a member of
the National Futures Association (NFA), various
futures exchanges and is regulated in the United Kingdom by the
FSA. PFSA holds an Australian Financial Services License and is
a market participant of the Australian Securities Exchange
(ASX) and a clearing participant of the Australian
Clearing House.
The accompanying unaudited interim condensed consolidated
financial statements include the accounts of PWI and its wholly
owned subsidiary SAI. SAIs wholly owned subsidiaries
include among others, PFSI, Nexa, Penson Execution Services,
Inc., Penson Financial Futures, Inc. (PFFI), GHP1,
Inc. (GHP1), which includes its subsidiaries GHP2,
LLC (GHP2) and Penson Futures, and Penson Holdings,
Inc. (PHI), which includes its subsidiaries PFSC,
PFSL, Penson Asia and PFSA. All significant intercompany
transactions and balances have been eliminated in consolidation.
The unaudited interim condensed consolidated financial
statements as of and for the three months ended March 31,
2011 and 2010 contained in this Quarterly Report (collectively,
the unaudited interim condensed consolidated financial
statements) were prepared in accordance with accounting
principles generally accepted in the United States
(U.S. GAAP) for all periods presented.
In the opinion of management, the accompanying unaudited interim
condensed consolidated statements of financial condition and
related statements of operations, cash flows, and
stockholders equity include all adjustments, consisting
only of normal recurring items, necessary for their fair
presentation in conformity with U.S. GAAP. Certain
information and footnote disclosures normally included in
financial statements prepared in accordance with U.S. GAAP
have been condensed or omitted in accordance with rules and
regulations of the SEC. These unaudited interim condensed
consolidated financial statements should be read in conjunction
with the Penson Worldwide, Inc. consolidated financial
statements as of and for the year ended December 31, 2010,
as filed with the SEC on
Form 10-K.
Operating results for the three months ended March 31, 2011
are not necessarily indicative of the results to be expected for
the entire year.
In connection with the delivery of products and services to its
clients and customers, the Company manages its revenues and
related expenses in the aggregate. As such, the Company
evaluates the performance of its business
6
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
activities and evaluates clearing and commission, technology,
and interest income along with the associated interest expense
as one integrated activity.
The Companys cost infrastructure supporting its business
activities varies by activity. In some instances, these costs
are directly attributable to one business activity and sometimes
to multiple activities. As such, in assessing the performance of
its business activities, the Company does not consider these
costs separately, but instead, evaluates performance in the
aggregate along with the related revenues. Therefore, the
Companys pricing considers both the direct and indirect
costs associated with transactions related to each business
activity, the client relationship and the demand for the
particular product or service in the marketplace. As a result,
the Company does not manage or capture the costs associated with
the products or services sold, or its general and administrative
costs by revenue line.
Managements Estimates and Assumptions
The preparation of financial statements in conformity with
U.S. GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts
of revenues and expenses during the period. Actual results could
differ from those estimates. The Company reviews all significant
estimates affecting the financial statements on a recurring
basis and records the effect of any necessary adjustments prior
to their issuance.
2. | Acquisitions |
Acquisition
of Ridge
On November 2, 2009, the Company entered into an asset
purchase agreement (Ridge APA) to acquire the
clearing and execution business of Ridge Clearing &
Outsourcing Solutions, Inc. (Ridge) from Ridge and
Broadridge Financial Solutions, Inc. (Broadridge),
Ridges parent company. The acquisition closed on
June 25, 2010, and under the terms of the Ridge APA, as
later amended, the Company paid $35,189. The acquisition date
fair value of consideration transferred was $31,912, consisting
of 2,456 shares of PWI common stock with a fair value of
$14,611 (based on our closing share price of $5.95 on that date)
and a $20,578 five-year subordinated note (the Ridge
Seller Note) with an estimated fair value of $17,301 on
that date (see Note 10 for a description of the Ridge
Seller Note discount), payable by the Company bearing interest
at an annual rate equal to
90-day LIBOR
plus 5.5%.
The Company recorded a liability of $4,089 attributable to the
estimated fair value of contingent consideration to be paid
14 months and 19 months after closing (subject to
extension in the event the dispute resolution procedures set
forth in the Ridge APA are invoked). The amount of contingent
consideration ultimately payable will be added to the Ridge
Seller Note. The contingent consideration is primarily composed
of two categories. The first category includes a group of
correspondents that had not generated at least six months of
revenue as of May 31, 2010 (Stub Period
Correspondents). Twelve months after closing a calculation
will be performed to adjust the estimated annualized revenues as
of May 31, 2010 to the actual annualized revenues based on
a six-month review period as defined in the Ridge APA
(Stub Period Revenues). The Ridge Seller Note will
be adjusted 14 months after closing based on .9 times the
difference between the estimated and actual annualized revenues.
As of December 31, 2010, all of the correspondents in this
category had generated at least six months of revenues. The
Company reduced its contingent consideration liability by $343,
which was included in other expenses in the consolidated
statements of operations for the year ended December 31,
2010. The second category includes a group of correspondents
that had not yet begun generating revenues (Non-revenue
Correspondents) as of May 31, 2010. A calculation
will be performed 15 months after closing to determine the
annualized revenues, based on a six-month review period, for
each such non revenue correspondent (Non-revenue
Correspondent Revenues). The Ridge Seller Note will be
adjusted 19 months after closing by an amount equal to .9
times the Non-revenue Correspondent Revenues. The estimated
undiscounted range of outcomes for this category is $4,000 to
$5,000. There is no limit to the consideration to be paid.
7
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
The Company recorded goodwill of $15,901, intangibles of $20,100
and a discount on the Ridge Seller Note of $3,277. The
qualitative factors that make up the recorded goodwill include
value associated with an assembled workforce, value attributable
to enhanced revenues related to various products and services
offered by the Company and synergies associated with cost
reductions from the elimination of certain fixed costs as well
as economies of scale resulting from the additional
correspondents. The goodwill is included in the United States
segment. A portion of the recorded goodwill associated with the
contingent consideration may not be deductible for tax purposes
if future payments are less than the $4,089 initially recorded.
The tax goodwill will be deductible for tax purposes over a
period of 15 years. The Company incurred acquisition
related costs of $5,251.
Acquisition
of the clearing business of Schonfeld Securities,
LLC
In November 2006, the Company acquired the clearing business of
Schonfeld Securities LLC (Schonfeld), a New
York-based securities firm. The Company closed the transaction
in November 2006 and in January 2007, the Company issued
approximately 1,100 shares of common stock valued at
approximately $28,300 to the previous owners of Schonfeld as
partial consideration for the assets acquired of which
approximately $14,800 was recorded as goodwill and approximately
$13,500 as intangibles. In addition, the Company agreed to pay
an annual earnout of stock and cash over a four-year period that
commenced on June 1, 2007, based on net income, as defined
in the asset purchase agreement (Schonfeld Asset Purchase
Agreement), for the acquired business. On April 22,
2010, SAI and PFSI entered into a letter agreement (the
Letter Agreement) with Schonfeld Group Holdings LLC
(SGH), Schonfeld, and Opus Trading Fund LLC
(Opus) that amends and clarifies certain terms of
the Schonfeld Asset Purchase Agreement. The Letter Agreement,
among other things, for purpose of determining the total payment
due to Schonfeld under the earnout provision of the Schonfeld
Asset Purchase Agreement: (i) removes the payment cap;
(ii) clarifies that PFSI has no obligation to compress
tickets across subaccounts (unless PFSI does so for other of its
correspondents at a later date); and (iii) reduces the
SunGard synergy credit from $2,900 to $1,450 in 2010 and $1,000
in 2011. The Letter Agreement also assigns all of
Schonfelds responsibilities under the Schonfeld Asset
Purchase Agreement to its parent company, SGH, and extends the
initial term of Opuss portfolio margining agreement with
PFSI from April 30, 2017 to April 30, 2019.
A payment of approximately $26,600 was paid in connection with
the first year earnout that ended May 31, 2008 and
approximately $25,500 was paid in connection with the second
year of the earnout that ended May 31, 2009. At
March 31, 2011, a liability of $14,427 was accrued as
result of the third year of the earnout ended May 31, 2010
($6,000) and the first ten months of the year four earnout,
which the Company does not expect to pay prior to the second
half of 2011 ($8,427). This balance is included in other
liabilities in the condensed consolidated statements of
financial condition. The offset of this liability, goodwill, is
included in other assets. In January, 2011, the Company and SGH
entered into a letter agreement setting the amount due for the
third year earnout at $6,000 due to the provisions in various
agreements related to the Schonfeld transaction, including the
termination/compensation agreement, which reduced the amount
that the Company is required to pay under the Schonfeld Asset
Purchase Agreement. This resulted in a reduction in goodwill and
other liabilities of $9,184 in the first quarter of 2011 offset
by increases related to the fourth year of the earnout. The
letter agreement also stipulated that the third year earnout
will be paid evenly over a 12 month period commencing on
September 1, 2011.
8
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
3. | Computation of earnings (loss) per share |
The following is a reconciliation of the numerators and
denominators of the basic and diluted earnings (loss) per share
computation. Common stock equivalents related to stock options
are excluded from the diluted earnings per share calculation if
their effect would be anti-dilutive to earnings (loss) per share.
Three Months Ended |
||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Basic and diluted:
|
||||||||
Net income (loss)
|
$ | (2,861 | ) | $ | 139 | |||
Weighted average common shares outstanding basic
|
28,478 | 25,573 | ||||||
Incremental shares from outstanding stock options
|
| 23 | ||||||
Non-vested restricted stock
|
| 108 | ||||||
Weighted average common shares and common share
equivalents diluted
|
28,478 | 25,704 | ||||||
Basic earnings per common share
|
$ | (0.10 | ) | $ | 0.01 | |||
Diluted earnings per common share
|
$ | (0.10 | ) | $ | 0.01 | |||
At March 31, 2010, stock options and restricted stock units
totaling 956 were excluded from the computation of diluted EPS
as their effect would have been anti-dilutive. For periods with
a net loss, basic weighted average shares are used for diluted
calculations because all stock options and unvested restricted
stock units outstanding are considered anti-dilutive.
4. | Fair value of financial instruments |
Fair value is defined as the price that would be received to
sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
In determining fair value, the Company uses various valuation
techniques, including market, income
and/or cost
approaches. The fair value model establishes a hierarchy which
prioritizes the inputs to valuation techniques used to measure
fair value. This hierarchy increases the consistency and
comparability of fair value measurements and related disclosures
by maximizing the use of observable inputs and minimizing the
use of unobservable inputs by requiring that observable inputs
be used when available. Observable inputs reflect the
assumptions market participants would use in pricing the assets
or liabilities based on market data obtained from sources
independent of the Company. Unobservable inputs reflect the
Companys own assumptions about the assumptions market
participants would use in pricing the asset or liability
developed based on the best information available in the
circumstances. The hierarchy prioritizes the inputs into three
broad levels based on the reliability of the inputs as follows:
| Level 1 Inputs are quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Valuation of these instruments does not require a high degree of judgment as the valuations are based on quoted prices in active markets that are readily and regularly available. | |
| Level 2 Inputs other than quoted prices in active markets that are either directly or indirectly observable as of the measurement date, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. These financial instruments are valued by quoted prices that are less frequent than those in active markets or by models that use various assumptions that are derived from or supported by data that is generally observable in the marketplace. Valuations in this category are inherently less reliable than quoted market prices due to the degree of subjectivity involved in determining appropriate methodologies and the applicable underlying assumptions. |
9
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
| Level 3 Valuations based on inputs that are unobservable and not corroborated by market data. The Company does not currently have any financial instruments utilizing Level 3 inputs. These financial instruments have significant inputs that cannot be validated by readily determinable data and generally involve considerable judgment by management. |
The following is a description of the valuation techniques
applied to the Companys major categories of assets and
liabilities measured at fair value on a recurring basis:
U.S.
government and agency securities
U.S. government and agency securities are valued using
quoted market prices in active markets. Accordingly,
U.S. government and agency securities are categorized in
Level 1 of the fair value hierarchy.
Canadian
government obligations
Canadian government securities include both Canadian federal
obligations and Canadian provincial obligations. These
securities are valued using quoted market prices. These bonds
are generally categorized in Level 2 of the fair value
hierarchy as the price quotations are not always from active
markets.
Corporate
equity
Corporate equity securities represent exchange-traded securities
and are generally valued based on quoted prices in active
markets. These securities are categorized in Level 1 of the
fair value hierarchy.
Corporate
debt
Corporate bonds are generally valued using quoted market prices
and are generally classified in Level 2 of the fair value
hierarchy as prices are not always from active markets.
Listed
option contracts
Listed options are exchange traded and are generally valued
based on quoted prices in active markets and are categorized in
Level 1 of the fair value hierarchy.
Certificates
of deposit and term deposits
The fair value of certificates of deposits and term deposits is
estimated using third-party quotations. These deposits are
categorized in Level 2 of the fair value hierarchy.
Money
market
Money market funds are generally valued based on quoted prices
in active markets. These securities are categorized in
Level 1 of the fair value hierarchy.
10
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
The following table summarizes by level within the fair value
hierarchy Receivable from broker-dealers and clearing
organizations, Securities owned, at fair
value, Deposits with clearing organizations
and Securities sold, not yet purchased, at fair
value as of March 31, 2011 and December 31, 2010.
March 31, 2011
|
Level 1 | Level 2 | Total | |||||||||
Cash and securities segregated under federal and
other regulations
|
||||||||||||
U.S. government and agency securities
|
$ | 22,085 | $ | | $ | 22,085 | ||||||
Receivable from broker-dealers and clearing organizations
|
||||||||||||
U.S. government and agency securities
|
$ | 2,500 | $ | | $ | 2,500 | ||||||
Securities owned
|
||||||||||||
Corporate equity
|
$ | 367 | $ | | $ | 367 | ||||||
Listed option contracts
|
95 | | 95 | |||||||||
Corporate debt
|
| 88,464 | 88,464 | |||||||||
Certificates of deposit and term deposits
|
| 26,732 | 26,732 | |||||||||
U.S. government and agency securities
|
49,867 | | 49,867 | |||||||||
Canadian government obligations
|
| 41,189 | 41,189 | |||||||||
$ | 50,329 | $ | 156,385 | $ | 206,714 | |||||||
Deposits with clearing organizations
|
||||||||||||
U.S. government and agency securities
|
$ | 237,170 | $ | | $ | 237,170 | ||||||
Money market
|
6,470 | | 6,470 | |||||||||
$ | 243,640 | $ | | $ | 243,640 | |||||||
Securities sold, not yet purchased
|
||||||||||||
Corporate equity
|
$ | 580 | $ | | $ | 580 | ||||||
Listed option contracts
|
158 | | 158 | |||||||||
Corporate debt
|
| 81,052 | 81,052 | |||||||||
Canadian government obligations
|
| 38,719 | 38,719 | |||||||||
$ | 738 | $ | 119,771 | $ | 120,509 | |||||||
11
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
December 31, 2010
|
Level 1 | Level 2 | Total | |||||||||
Cash and securities segregated under federal and
other regulations
|
||||||||||||
U.S. government and agency securities
|
$ | 6,197 | $ | | $ | 6,197 | ||||||
Money market
|
8,000 | | 8,000 | |||||||||
$ | 14,197 | $ | | $ | 14,197 | |||||||
Receivable from broker-dealers and clearing organizations
|
||||||||||||
U.S. government and agency securities
|
$ | 2,498 | $ | | $ | 2,498 | ||||||
Securities owned
|
||||||||||||
Corporate equity
|
$ | 290 | $ | | $ | 290 | ||||||
Listed option contracts
|
168 | | 168 | |||||||||
Corporate debt
|
| 79,404 | 79,404 | |||||||||
Certificates of deposit and term deposits
|
| 24,432 | 24,432 | |||||||||
U.S. government and agency securities
|
49,997 | | 49,997 | |||||||||
Canadian government obligations
|
| 46,904 | 46,904 | |||||||||
$ | 50,455 | $ | 150,740 | $ | 201,195 | |||||||
Deposits with clearing organizations
|
||||||||||||
U.S. government and agency securities
|
$ | 203,843 | $ | | $ | 203,843 | ||||||
Money market
|
9,172 | | 9,172 | |||||||||
$ | 213,015 | $ | | $ | 213,015 | |||||||
Securities sold, not yet purchased
|
||||||||||||
Corporate equity
|
$ | 264 | $ | | $ | 264 | ||||||
Listed option contracts
|
287 | | 287 | |||||||||
U.S. government and agency securities
|
90,870 | | 90,870 | |||||||||
Canadian government obligations
|
| 24,495 | 24,495 | |||||||||
$ | 91,421 | $ | 24,495 | $ | 115,916 | |||||||
5. | Segregated assets |
Cash and securities segregated under U.S. federal and other
regulations totaled $5,691,672 at March 31, 2011. Cash and
securities segregated under federal and other regulations by
PFSI totaled $4,881,830 at March 31, 2011. Of this amount,
$4,840,595 was segregated for the benefit of customers under
Rule 15c3-3
of the Securities Exchange Act of 1934, as amended (the
Exchange Act), against a requirement as of
March 31, 2011 of $4,844,268. An additional deposit of
$60,000 was made on April 4, 2011 as allowed by
Rule 15c3-3.
The remaining balance of $41,235 at the end of the period
relates to the Companys election to compute a reserve
requirement for Proprietary Accounts of Introducing
Broker-Dealers (PAIB) calculation, as defined,
against a requirement as of March 31, 2011 of $43,551. An
additional deposit of $20,000 was made on April 4, 2011.
The PAIB calculation is completed in order for each
correspondent firm that uses the Company as its clearing
broker-dealer to classify its assets held by the Company as
allowable assets in the correspondents net capital
calculation. In addition, $882,852, including $508,905 in cash
and securities, was segregated for the benefit of customers by
Penson Futures pursuant to Commodity Futures Trading Commission
Rule 1.20. Finally, $138,621 and $162,316 was segregated
under similar Canadian and United Kingdom regulations,
respectively. At December 31, 2010, $5,407,645 was
segregated for the benefit of customers under applicable U.S.,
Canadian and United Kingdom regulations.
12
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
6. | Receivable from and payable to broker-dealers and clearing organizations |
Amounts receivable from and payable to broker-dealers and
clearing organizations consists of the following:
March 31, |
December 31, |
|||||||
2011 | 2010 | |||||||
Receivable:
|
||||||||
Securities failed to deliver
|
$ | 199,540 | $ | 64,233 | ||||
Receivable from clearing organizations
|
363,722 | 192,803 | ||||||
$ | 563,262 | $ | 257,036 | |||||
Payable:
|
||||||||
Securities failed to receive
|
$ | 167,085 | $ | 60,767 | ||||
Payable to clearing organizations
|
404,436 | 67,769 | ||||||
$ | 571,521 | $ | 128,536 | |||||
Receivables from broker-dealers and clearing organizations
include amounts receivable for securities failed to deliver,
amounts receivable from clearing organizations relating to open
transactions, good-faith and margin deposits, and
floor-brokerage receivables.
Payables to broker-dealers and clearing organizations include
amounts payable for securities failed to receive, amounts
payable to clearing organizations on open transactions, and
floor-brokerage payables. In addition, the net receivable or
payable arising from unsettled trades is reflected in these
categories.
7. | Receivable from and payable to customers and correspondents |
Receivable from and payable to customers and correspondents
include amounts due on cash and margin transactions. Securities
owned by customers and correspondents are held as collateral for
receivables. This collateral includes financial instruments that
are actively traded with valuations based on quoted prices and
financial instruments in illiquid markets with valuations that
involve considerable judgment. Such collateral is not reflected
in the consolidated financial statements. Payable to
correspondents also includes commissions due on customer
transactions.
The Company generally does not lend money to customers or
correspondents except on a fully collateralized basis. When the
value of that collateral declines, the Company has the right to
demand additional collateral. In cases where the collateral
loses its liquidity, the Company might also demand personal
guarantees or guarantees from other parties. In certain
circumstances it may be necessary to acquire third party
valuation reports for illiquid financial instruments held as
collateral. These reports are used to assist management in its
assessment of the collectability of its receivables. In valuing
receivables that become less than fully collateralized/unsecured
balances, the Company compares the market value of the
collateral and any additional guarantees to the balance of the
loan outstanding and evaluates the collectability based on
various qualitative factors. To the extent that the collateral,
the guarantees and any other rights the Company has against the
customer or the related introducing broker are not sufficient to
cover any potential losses, then the Company records an
appropriate allowance for doubtful accounts. In the ordinary
course of business the Company carries less than fully
collateralized/unsecured balances for which no allowance has
been recorded due to the Companys judgment that the
amounts are collectable. The Company monitors every account that
is less than fully collateralized with liquid securities every
trading day. The Company reviews all such accounts on a monthly
basis to determine if a change in the allowance for doubtful
accounts is necessary. This specific,
account-by-account
review is supplemented by the risk management procedures that
identify positions in illiquid securities and other market
developments that could affect accounts that otherwise appear to
be fully collateralized. The corporate and local country risk
management officers monitor market developments on a daily
basis. The Company maintains an allowance for doubtful accounts
that
13
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
represents amounts, in the judgment of management, necessary to
adequately absorb losses from known and inherent losses in
outstanding receivables. Provisions made to this allowance are
charged to operations based on anticipated recoverability.
The Company generally nets receivables and payables related to
its customers transactions on a counterparty basis
pursuant to master netting or customer agreements. It is the
Companys policy to settle these transactions on a net
basis with its counterparties. The Company generally recognizes
interest income on an accrual basis as it is earned. At
March 31, 2011 and December 31, 2010, the Company had
approximately $96,896 and $97,427 in receivables
(Nonaccrual Receivables), respectively, primarily
from customers and correspondents, that were substantially
collateralized and considered collectable, for which interest
income was being recorded only when received.
With respect to the Nonaccrual Receivables, at March 31,
2011, approximately $42,580 were collateralized by bonds issued
by the Retama Development Corporation (RDC) and
certain other interests in the horse racing track and real
estate project (Project) financed by the RDCs
bonds. In each case these are owned by customers and pledged to
the Company
and/or its
affiliates. Certain related parties to the Company own
approximately $14,745 of RDC bonds that are pledged to the
Company
and/or its
affiliates (see Note 17 to our December 31, 2010
consolidated financial statements as filed with the SEC on
Form 10-K)
. There are a number of factors potentially affecting the value
of the Project and the Nonaccrual Receivables related thereto
including potential legislation in the Texas Legislature that
could expand gambling privileges at the Project. Should such
legislation be enacted there should be a positive impact on the
value of the Project and therefore upon the collateral
underlying related Nonaccrual Receivables. However, should such
legislation not be enacted, depending on other factors
potentially impacting the Project and related Nonaccrual
Receivables, it is possible that the value of the collateral
associated with the Project and related Nonaccrual Receivables
might be impaired, resulting in a write down of a portion of
these receivables that could be material in amount.
8. | Securities owned and securities sold, not yet purchased |
Securities owned and securities sold, not yet purchased consist
of trading and investment securities at quoted market if
available, or fair values as follows:
March 31, |
December 31, |
|||||||
2011 | 2010 | |||||||
Securities Owned:
|
||||||||
Corporate equity
|
$ | 367 | $ | 290 | ||||
Listed option contracts
|
95 | 168 | ||||||
Corporate debt
|
88,464 | 79,404 | ||||||
Certificates of deposit and term deposits
|
26,732 | 24,432 | ||||||
U.S. federal and agency securities
|
49,867 | 49,997 | ||||||
Canadian government obligations
|
41,189 | 46,904 | ||||||
$ | 206,714 | $ | 201,195 | |||||
Securities Sold, Not Yet Purchased:
|
||||||||
Corporate equity
|
$ | 580 | $ | 264 | ||||
Listed option contracts
|
158 | 287 | ||||||
Corporate debt
|
81,052 | | ||||||
U.S. federal
|
| 90,870 | ||||||
Canadian government obligations
|
38,719 | 24,495 | ||||||
$ | 120,509 | $ | 115,916 | |||||
14
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
9. | Short-term bank loans and stock loan |
At March 31, 2011 and December 31, 2010, the Company
had $318,312 and $338,110, respectively in short-term bank loans
outstanding with weighted average interest rates of
approximately .9% and 1.1%, respectively. As of March 31,
2011, the Company had seven uncommitted lines of credit with
seven financial institutions. Five of these lines of credit
permitted the Company to borrow up to an aggregate of
approximately $330,993 while two lines do not have specified
borrowing limits. The fair value of short-term bank loans
approximates their carrying values.
The Company also has the ability to borrow under stock loan
arrangements. At March 31, 2011 and December 31, 2010,
the Company had $659,316 and $619,833, respectively, in stock
loan with no specific limitations on additional stock loan
capacities. These arrangements bear interest at variable rates
based on various factors including market conditions and the
types of securities loaned, are secured primarily by our
customers margin account securities, and are repayable on
demand. The fair value of these borrowings approximates their
carrying values. The remaining balance in securities loaned
relates to the Companys conduit stock loan business.
10. | Notes Payable |
Senior
convertible notes
On June 3, 2009, the Company issued $60,000 aggregate
principal amount of 8.00% Senior Convertible Notes due 2014
(the Convertible Notes). The $60,000 aggregate
principal amount of Convertible Notes includes $10,000 issued in
connection with the exercise in full by the initial purchasers
of their over-allotment option. The net proceeds from the sale
of the convertible notes were approximately $56,200 after
initial purchaser discounts and other expenses.
The Convertible Notes bear interest at a rate of 8.0% per year.
Interest on the Convertible Notes is payable semi-annually in
arrears on June 1 and December 1 of each year, beginning
December 1, 2009. The Convertible Notes will mature on
June 1, 2014, subject to earlier repurchase or conversion.
Holders may convert their Convertible Notes at their option at
any time prior to the close of business on the business day
immediately preceding the maturity date for such Convertible
Notes under the following circumstances: (1) during any
fiscal quarter (and only during such fiscal quarter), if the
last reported sale price of the Companys common stock for
at least 20 trading days in the period of 30 consecutive trading
days ending on the last trading day of the immediately preceding
fiscal quarter is equal to or more than 120% of the conversion
price of the Convertible Notes on the last day of such preceding
fiscal quarter; (2) during the five
business-day
period after any five consecutive
trading-day
period in which the trading price per $1,000 (in whole dollars)
principal amount of the Convertible Notes for each day of that
period was less than 98% of the product of the last reported
sale price of the Companys common stock and the conversion
rate of the Convertible Notes on each such day; (3) upon
the occurrence of specified corporate transactions, including
upon certain distributions to holders of the Companys
common stock and certain fundamental changes, including changes
of control and dispositions of substantially all of the
Companys assets; and (4) at any time beginning on
March 1, 2014. Upon conversion, the Company will pay or
deliver, at the Companys option, cash, shares of the
Companys common stock or a combination thereof. The
initial conversion rate for the Convertible Notes was
101.9420 shares of the Companys common stock per
$1,000 (in whole dollars) principal amount of Convertible Notes
(6,117 shares), equivalent to an initial conversion price
of approximately $9.81 per share of common stock. Such
conversion rate will be subject to adjustment in certain events,
but will not be adjusted for accrued or additional interest. The
Company has received consent from its stockholders to issue up
to 6,117 shares of its common stock to satisfy its payment
obligations upon conversion of the Convertible Notes.
Following certain corporate transactions, the Company will
increase the applicable conversion rate for a holder who elects
to convert its Convertible Notes in connection with such
corporate transactions by a number of additional shares of
common stock. The Company may not redeem the Convertible Notes
prior to their stated maturity date. If the Company undergoes a
fundamental change, holders may require the Company to
repurchase all or a portion of
15
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
the holders Convertible Notes for cash at a price equal to
100% of the principal amount of the Convertible Notes to be
purchased, plus any accrued and unpaid interest, including any
additional interest, to, but excluding, the fundamental change
purchase date.
The Convertible Notes are unsecured obligations of the Company
and contain customary covenants, such as reporting of annual and
quarterly financial results, and restrictions on certain
mergers, consolidations and changes of control. The Convertible
Notes also contain customary events of default, including
failure to pay principal or interest, breach of covenants,
cross-acceleration to other debt in excess of $20,000,
unsatisfied judgments of $20,000 or more and bankruptcy events.
The Convertible Notes contain no financial covenants.
The Company was required to separately account for the liability
and equity components of the Convertible Notes in a manner that
reflected the Companys nonconvertible debt borrowing rate
at the date of issuance. The Company allocated $8,822, net of
tax of $5,593, of the $60,000 principal amount of the
Convertible Notes to the equity component, which represents a
discount to the debt and is being amortized into interest
expense using the effective interest method through June 1,
2014. Accordingly, the Companys effective interest rate on
the Convertible Notes was 15.0%. The Company is recognizing
interest expense during the twelve months ending May 2011 on the
Convertible Notes in an amount that approximates 15.0% of
$47,700, the liability component of the Convertible Notes at
June 1, 2010. The Convertible Notes were further discounted
by $2,850 for fees paid to the initial purchasers. These fees
are being accreted and other debt issuance costs are being
amortized into interest expense over the life of the Convertible
Notes. The interest expense recognized for the Convertible Notes
in the twelve months ending May 2011 and subsequent periods will
be greater as the discount is accreted and the effective
interest method is applied. The Company recognized interest
expense of $1,200 and $1,200, related to the coupon, $633 and
$548 related to the conversion feature and $179 and $179 related
to various issuance costs for the three months ended
March 31, 2011 and 2010, respectively.
The fair value of the Convertible Notes was estimated using a
discounted cash flow analysis based on our current borrowing
rate for an instrument with similar terms (currently 12.5%). At
March 31, 2011, the estimated fair value of the Convertible
Notes was $53,119.
Senior
second lien secured notes
On May 6, 2010, the Company issued $200,000 aggregate
principal amount of its 12.50% Senior Second Lien Secured
Notes due 2017 (the Notes). The Notes bear interest
at a rate of 12.5% per year and are guaranteed by SAI and PHI.
The Notes are secured, on a second lien basis, by a pledge by
PWI, SAI and PHI of the equity interests of certain of
PWIs subsidiaries. The Notes were issued pursuant to an
Indenture dated as of May 6, 2010 with U.S. Bank
National Association as Trustee and Collateral Agent (the
Trustee) and a Second Lien Pledge Agreement dated as
of May 6, 2010 with the Trustee. The rights of the Trustee
pursuant to the Second Lien Pledge Agreement are subject to an
Intercreditor Agreement entered between PWI, the Trustee and the
Administrative Agent for the Companys senior secured
credit facility.
The Notes contain customary representations and covenants, such
as reporting of annual and quarterly financial results, and
restrictions, among other things, on indebtedness, liens,
certain restricted payments and investments, asset sales,
certain mergers, consolidations and changes of control. The
Notes also contain customary events of default, including
failure to pay principal or interest, breach of covenants,
cross-acceleration to other debt in excess of $20,000,
unsatisfied judgments of $20,000 or more and bankruptcy events.
Pursuant to the Notes PFSI is required to maintain net
regulatory capital of at least 5.5% of its aggregate debt
balances.
The Company used a part of the proceeds of the sale to pay down
approximately $110,000 outstanding on its revolving credit
facility (see discussion below), and used the balance of the
proceeds to provide working capital, among other things, to
support the correspondents the Company acquired from Ridge and
for other general corporate purposes.
16
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
The Company recorded a discount of $5,500 for the costs
associated with the initial purchasers. These costs and other
debt issuance costs are being amortized into interest expense
over the life of the Notes. For the three months ended
March 31, 2011 and 2010 the Company recognized interest
expense of $6,250 and $0 related to the coupon and $240 and $0
related to various issuance costs. The fair value of the Notes
was estimated using a discounted cash flow analysis based on our
current borrowing rate for an instrument with similar terms
(currently 12.5%). At March 31, 2011, the estimated fair
value of the Notes was approximately $200,000.
Revolving
credit facility
On May 6, 2010, the Company entered into a second amended
and restated credit agreement (the Amended and Restated
Credit Facility) with Regions Bank, as Administrative
Agent, Swing Line Lender and Letter of Credit Issuer, the
lenders party thereto and other parties thereto. The Amended and
Restated Credit Facility provides for a $75,000 committed
revolving credit facility and the lenders have, additionally,
provided the Company with an uncommitted option to increase the
principal amount of the facility to up to $125,000. The
Companys obligations under the Amended and Restated Credit
Facility are supported by a guaranty from SAI and PHI and a
pledge by the Company, SAI and PHI of equity interests of
certain of the Companys subsidiaries. The Amended and
Restated Credit Facility is scheduled to mature on May 6,
2013. The Amended and Restated Credit Facility contains
customary representations, and affirmative and negative
covenants such as reporting of annual and quarterly financial
results, and restrictions, among other things, on indebtedness,
liens, investments, certain restricted payments, asset sales,
certain mergers, consolidations and changes of control. The
Amended and Restated Credit Facility also contains customary
events of default, including failure to pay principal or
interest, breach of covenants, cross-defaults to other debt in
excess of $10,000, unsatisfied judgments of $10,000 or more and
certain bankruptcy events. Pursuant to the Amended and Restated
Credit Facility PFSI is required to maintain net regulatory
capital of at least 5.5% of its aggregate debt balances. The
Company is also required to comply with several financial
covenants, including a minimum consolidated tangible net worth,
minimum fixed charges coverage ratio, maximum consolidated
leverage ratio, minimum liquidity requirement and maximum
capital expenditures. On October 29, 2010, we entered into
an amendment to the Amended and Restated Credit Facility (the
First Amendment). The First Amendment, among other
things, revises certain financial covenants in the Amended and
Restated Credit Facility and provides for the addition of a
minimum consolidated EBITDA covenant. The First Amendment also
provides additional availability under the facility in certain
circumstances. Currently, the Company has the capacity to borrow
up to $25,000 under the Amended and Restated Credit Facility. As
of March 31, 2011, $10,000 was outstanding under the
Amended and Restated Credit Facility.
Ridge
seller note
On June 25, 2010, in connection with the acquisition of the
clearing and execution business of Ridge, the Company issued a
$20,578 five-year subordinated note due June 25, 2015 (the
Ridge Seller Note), payable by PWI bearing interest
at an annual rate equal to
90-day LIBOR
plus 5.5% to be paid quarterly (5.80% at March 31, 2011).
The principal amount of the Ridge Seller Note is subject to
adjustment in accordance with the terms of the Ridge APA (see
Note 2). The Ridge Seller Note is unsecured and contains
certain covenants, including certain reporting and notice
requirements, restrictions on certain liens, guarantees by
subsidiaries, prepayments of the Convertible Notes and certain
mergers and consolidations. The Ridge Seller Note also contains
customary events of default, including failure to pay principal
or interest, breach of covenants, changes of control,
cross-acceleration to other debt in excess of $50,000, certain
bankruptcy events and certain terminations of the Companys
Master Services Agreement with Broadridge. The Ridge Seller Note
contains no financial covenants. The Company determined that the
stated rate of interest of the note was below the rate the
Company could have obtained in the open market. The Company
estimated that the interest rate it could obtain in the open
market was
90-day LIBOR
plus 9.6% (10.14% at June 25, 2010). The Company recorded a
discount of $3,277, which resulted in an estimated fair value of
$17,301 at issuance. The interest expense recognized for the
Ridge Seller Note in the twelve months ending June 30, 2011
and subsequent periods will be greater as the discount is
accreted and the effective interest
17
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
method is applied. For the three months ended March 31,
2011 and 2010, respectively, the Company recognized interest
expense of $298 and $0 related to the coupon and $134, and $0
related to the discount. The fair value of the Ridge Seller Note
approximated its carrying value of $17,694 as of March 31,
2011.
11. | Financial instruments with off-balance sheet risk |
In the normal course of business, the Company purchases and
sells securities as both principal and agent. If another party
to the transaction fails to fulfill its contractual obligation,
the Company may incur a loss if the market value of the security
is different from the contract amount of the transaction.
The Company deposits customers margin account securities
with lending institutions as collateral for borrowings. If a
lending institution does not return a security, the Company may
be obligated to purchase the security in order to return it to
the customer. In such circumstances, the Company may incur a
loss equal to the amount by which the market value of the
security on the date of nonperformance exceeds the value of the
loan from the institution.
In the event a customer fails to satisfy its obligations, the
Company may be required to purchase or sell financial
instruments at prevailing market prices to fulfill the
customers obligations. The Company seeks to control the
risks associated with its customer activities by requiring
customers to maintain margin collateral in compliance with
various regulatory and internal guidelines. The Company monitors
required margin levels on an
intra-day
basis and, pursuant to such guidelines, requires customers to
deposit additional collateral or to reduce positions when
necessary. Although the Company monitors margin balances on an
intra-day
basis in order to control our risk exposure, the Company is not
able to eliminate all risks associated with margin lending.
Securities purchased under agreements to resell are
collateralized by U.S. government or
U.S. government-guaranteed securities. Such transactions
may expose the Company to off-balance-sheet risk in the event
such borrowers do not repay the loans and the value of
collateral held is less than that of the underlying contract
amount. A similar risk exists on Canadian government securities
purchased under agreements to resell that are a part of other
assets. These agreements provide the Company with the right to
maintain the relationship between market value of the collateral
and the contract amount of the receivable.
The Companys policy is to regularly monitor its market
exposure and counterparty risk and maintains a policy of
reviewing the credit exposure of all parties, including
customers, with which it conducts business.
For customers introduced on a fully-disclosed basis by other
broker-dealers, the Company has the contractual right of
recovery from such introducing broker-dealers in the event of
nonperformance by the customer.
In addition, the Company has sold securities that it does not
currently own and will therefore be obligated to purchase such
securities at a future date. The Company has recorded these
obligations in the financial statements at March 31, 2011,
at fair values of the related securities and may incur a loss if
the fair value of the securities increases subsequent to
March 31, 2011.
12. | Stock-based compensation |
The Company grants awards of stock options and restricted stock
units (RSUs) under the Amended and Restated 2000
Stock Incentive Plan, as amended in April 2011 (the 2000
Stock Incentive Plan), under which 5,006 shares of
common stock have been authorized for issuance. Of this amount,
options and RSUs to purchase 3,349 shares of common stock,
net of forfeitures and tax withholdings have been granted and
1,657 shares remain available for future grants at
March 31, 2011. The Company also provides an employee stock
purchase plan (ESPP).
The 2000 Stock Incentive Plan includes three separate programs:
(1) the discretionary option grant program under which
eligible individuals in the Companys employ or service
(including officers, non-employee board members and consultants)
may be granted options to purchase shares of common stock of the
Company; (2) the
18
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
stock issuance program under which such individuals may be
issued shares of common stock directly or stock awards that vest
over time, through the purchase of such shares or as a bonus
tied to the performance of services; and (3) the automatic
grant program under which grants will automatically be made at
periodic intervals to eligible non-employee board members. The
Companys Board of Directors or its Compensation Committee
may amend or modify the 2000 Stock Incentive Plan at any time,
subject to any required stockholder approval.
Stock
options
During the three months ended March 31, 2011 and 2010, the
Company did not grant any stock options to employees.
The Company recorded compensation expense relating to options of
approximately $24 and $266, respectively, for the three months
ended March 31, 2011 and 2010.
A summary of the Companys stock option activity is as
follows:
Aggregate |
||||||||||||||||
Weighted |
Intrinsic |
|||||||||||||||
Weighted |
Average |
Value of |
||||||||||||||
Number of |
Average |
Contractual |
In-the-Money |
|||||||||||||
Shares | Exercise Price | Term | Options | |||||||||||||
(In whole dollars) | (In years) | |||||||||||||||
Outstanding, December 31, 2010
|
767 | $ | 17.36 | 3.05 | $ | 34 | ||||||||||
Granted
|
| | | | ||||||||||||
Exercised
|
| | | | ||||||||||||
Forfeited, cancelled or expired
|
(24 | ) | 11.21 | | | |||||||||||
Outstanding, March 31, 2011
|
743 | $ | 17.56 | 2.86 | $ | 68 | ||||||||||
Options exercisable at March 31, 2011
|
737 | $ | 17.54 | 2.85 | $ | 68 | ||||||||||
The aggregate intrinsic value of options exercised during the
three months ended March 31, 2011 and 2010 was $0 and $100,
respectively. At March 31, 2011, the Company had
approximately $23 of total unrecognized compensation expense,
net of estimated forfeitures, related to stock option plans that
will be recognized over the weighted average period of
.37 years. Cash received from stock option exercises
totaled approximately $0 and $88 for the three months ended
March 31, 2011 and 2010, respectively.
Restricted
stock units
A summary of the Companys Restricted Stock Unit activity
is as follows:
Weighted |
Weighted |
|||||||||||||||
Average |
Average |
Aggregate |
||||||||||||||
Number of |
Grant Date |
Contractual |
Intrinsic |
|||||||||||||
Units | Fair Value | Term | Value | |||||||||||||
(In whole dollars) | (In years) | |||||||||||||||
Outstanding, December 31, 2010
|
421 | $ | 8.83 | 2.1 | $ | 2,061 | ||||||||||
Granted
|
1,119 | 5.09 | | | ||||||||||||
Vested and issued
|
(79 | ) | 9.42 | | | |||||||||||
Forfeited
|
(5 | ) | 5.76 | | | |||||||||||
Outstanding, March 31, 2010
|
1,456 | $ | 5.93 | 2.50 | $ | 9,770 | ||||||||||
The Company recorded compensation expense relating to restricted
stock units of approximately $921 and $1,178 during the three
months ended March 31, 2011 and 2010, respectively.
19
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
As of March 31, 2011, there was approximately $7,226 of
unamortized compensation expense, net of estimated forfeitures,
related to unvested restricted stock units outstanding that will
be recognized over the weighted average period of
2.48 years.
Employee
stock purchase plan
In July 2005, the Companys Board of Directors adopted the
ESPP, designed to allow eligible employees of the Company to
purchase shares of common stock, at semiannual intervals,
through periodic payroll deductions. A total of 313 shares
of common stock were initially reserved under the ESPP. The
share reserve will automatically increase on the first trading
day of January each calendar year, beginning in calendar year
2007, by an amount equal to 1% of the total number of
outstanding shares of common stock on the last trading day in
December in the prior calendar year. Under the current plan, no
such annual increase may exceed 63 shares.
The ESPP may have a series of offering periods, each with a
maximum duration of 24 months. Offering periods will begin
at semi-annual intervals as determined by the plan
administrator. Individuals regularly expected to work more than
20 hours per week for more than five calendar months per
year may join an offering period on the start date of that
period. However, employees may participate in only one offering
period at a time. Participants may contribute 1% to 15% of their
annual compensation through payroll deductions, and the
accumulated deductions will be applied to the purchase of shares
on each semi-annual purchase date. The purchase price per share
shall be determined by the plan administrator at the start of
each offering period and shall not be less than 85% of the lower
of the fair market value per share on the start date of the
offering period in which the participant is enrolled or the fair
market value per share on the semi-annual purchase date. The
plan administrator has discretionary authority to establish the
maximum number of shares of common stock purchasable per
participant and in total by all participants for each offering
period. The Companys Board of Directors or its
Compensation Committee may amend, suspend or terminate the ESPP
at any time, and the ESPP will terminate no later than the last
business day of June 2015. As of March 31, 2011,
625 shares of common stock had been reserved and
495 shares of common stock had been purchased by employees
pursuant to the ESPP plan. The Company recognized expense of $30
and $53 for the three months ended March 31, 2011 and 2010,
respectively.
13. | Commitments and contingencies |
From time to time, we are involved in other legal proceedings
arising in the ordinary course of business relating to matters
including, but not limited to, our role as clearing broker for
our correspondents. In some instances, but not all, where we are
named in arbitration proceedings solely in our role as the
clearing broker for our correspondents, we are able to pass
through expenses related to the arbitration to the correspondent
involved in the arbitration.
Under its bylaws, the Company has agreed to indemnify its
officers and directors for certain events or occurrences arising
as a result of the officer or directors serving in such
capacity. The Company has entered into indemnification
agreements with each of its directors that require us to
indemnify our directors to the extent permitted under our bylaws
and applicable law. Although management is not aware of any
claims, the maximum potential amount of future payments the
Company could be required to make under these indemnification
agreements is unlimited. However, the Company has a directors
and officer liability insurance policy that limits its exposure
and enables it to recover a portion of any future amounts paid.
As a result of its insurance policy coverage, the Company
believes the estimated fair value of these indemnification
agreements is minimal and has no liabilities recorded for these
agreements as of March 31, 2011.
14. | Income taxes |
The Companys effective income tax rate for both the three
months ended March 31, 2011 and 2010 was 38.0%. The primary
factors contributing to the difference between the effective tax
rates and the federal statutory income tax rate of 35% are lower
tax rates applicable to
non-U.S. earnings,
state and local income taxes, net of
20
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
federal benefit, stock-based compensation and the return to
provision
true-up
associated with the filing of the Companys
U.S. federal tax return.
15. | Segment information |
The Company is organized into operating segments based on
geographic regions. These operating segments have been
aggregated into three reportable segments; United States, Canada
and Other. The Company evaluates the performance of its
operating segments based upon operating income before unusual
and non-recurring items. The following table summarizes selected
financial information.
United |
||||||||||||||||
As of and For the Three Months Ended March 31, 2011
|
States | Canada | Other | Consolidated | ||||||||||||
Total revenues
|
$ | 68,648 | $ | 13,292 | $ | 8,623 | $ | 90,563 | ||||||||
Interest, net
|
17,701 | 1,449 | 962 | 20,112 | ||||||||||||
Income (loss) before tax
|
(4,715 | ) | (124 | ) | 224 | (4,615 | ) | |||||||||
Net income (loss)
|
(2,841 | ) | (96 | ) | 76 | (2,861 | ) | |||||||||
Segment assets
|
9,531,547 | 2,029,790 | 672,214 | 12,233,551 | ||||||||||||
Goodwill and intangibles
|
170,214 | 538 | 1,219 | 171,971 | ||||||||||||
Capital expenditures
|
2,665 | 884 | 124 | 3,673 | ||||||||||||
Depreciation and amortization
|
3,874 | 491 | 404 | 4,769 | ||||||||||||
Amortization of intangibles
|
1,004 | | 46 | 1,050 |
United |
||||||||||||||||
As of and For the Three Months Ended March 31, 2010
|
States | Canada | Other | Consolidated | ||||||||||||
Total revenues
|
$ | 57,326 | $ | 12,223 | $ | 3,345 | $ | 72,894 | ||||||||
Interest, net
|
14,022 | 793 | 308 | 15,123 | ||||||||||||
Income (loss) before tax
|
(1,560 | ) | 1,122 | 662 | 224 | |||||||||||
Net income (loss)
|
(1,213 | ) | 878 | 474 | 139 | |||||||||||
Segment assets
|
6,417,673 | 1,198,541 | 222,525 | 7,838,739 | ||||||||||||
Goodwill and intangibles
|
134,498 | 538 | 312 | 135,348 | ||||||||||||
Capital expenditures
|
3,754 | 1,272 | 2,034 | 7,060 | ||||||||||||
Depreciation and amortization
|
3,295 | 264 | 362 | 3,921 | ||||||||||||
Amortization of intangibles
|
582 | | | 582 |
16. | Regulatory requirements |
PFSI is subject to the SEC Uniform Net Capital Rule (SEC
Rule 15c3-1),
which requires the maintenance of minimum net capital. PFSI
elected to use the alternative method, permitted by
Rule 15c3-1,
which requires that PFSI maintain minimum net capital, as
defined, equal to the greater of $250 or 2% of aggregate debit
balances, as defined in the SECs Reserve Requirement Rule
(Rule 15c3-3).
At March 31, 2011, PFSI had net capital of $141,303, and
was $90,257 in excess of its required net capital of $51,046. At
December 31, 2010, PFSI had net capital of $139,495, and
was $96,493 in excess of its required net capital of $43,002.
The Companys Penson Futures, PFSL, PFSC and PFSA
subsidiaries are also subject to minimum financial and capital
requirements. All subsidiaries were in compliance with their
minimum financial and capital requirements as of March 31,
2011.
The regulatory rules referred to above may restrict the
Companys ability to withdraw capital from its regulated
subsidiaries, which in turn could limit the Subsidiaries
ability to pay dividends and the Companys ability to
satisfy
21
Table of Contents
Penson
Worldwide, Inc.
Notes to
the Unaudited Condensed Consolidated Financial
Statements (Continued)
its debt obligations. PFSC, PFSL and PFSA are subject to
regulatory requirements in their respective countries which also
limit the amount of dividends that they may be able to pay to
their parent.
17. | Stock repurchase program |
On July 3, 2007, the Companys Board of Directors
authorized the Company to purchase up to $25,000 of its common
stock in open market purchases and privately negotiated
transactions. The repurchase program was completed in October
2007. On December 6, 2007, the Companys Board of
Directors authorized the Company to purchase an additional
$12,500 of its common stock. From December, 2007 through 2008,
the Company repurchased approximately 654 shares at an
average price of $10.32 per share. No shares were repurchased
during the 3 month periods ended March 31, 2011 and
2010. The Company had approximately $4,700 available under the
current repurchase program as of March 31, 2011; however,
our Amended and Restated Credit Facility limits our ability to
repurchase our stock.
18. | Restructuring charge |
In June 2010, in connection with the Companys outsourcing
agreement with Broadridge, the Company announced a plan to
reduce its headcount across several of its operating
subsidiaries primarily over the following six to 21 months.
The terms of the plan include both severance pay and bonus
payments associated with continuing employment (Stay
Pay) until the respective outsourcing is completed. These
payments will occur at the end of the respective severance
periods. In connection with the severance pay portion of the
plan the Company recorded a severance charge of $2,016 for the
year ended December 31, 2010 of which $1,687 was included
in the United States segment, $140 included in the Canada
segment and $189 included in the Other segment. This charge was
included in employee compensation and benefits in the
consolidated statement of operations. For the three months ended
March 31, 2011, the Company reduced its severance reserve
by approximately $140 related to the Companys Canada
segment as none of the affected employees remained employed
through the respective employment period. The severance reserve
is $1,877 as of March 31, 2011. The Company estimates that
it will incur costs of $2,065 associated with Stay Pay of which
$1,808 is related to the United States segment, and $257 related
to the Other segment. The Company recorded a charge of $864 in
connection with the Stay Pay for the year ended
December 31, 2010 of which $723 was associated with the
United States segment, $60 was related to the Canada segment and
$81 was associated with the Other segment. For the three months
ended March 31, 2011, the Company recorded a charge of $342
related to Stay Pay of which $361 was associated with the United
States segments, $(60) was related to the Canada segment and $41
was related to the Other segment. These charges are being
recorded on a straight line basis as the benefits are earned.
The $(60) in the Canada segment relates to the reversal of the
charges previously recorded in the Canada segment as no affected
employees remained employed through the period in which the
outsourcing was completed. No charges were recorded for the
three months ended March 31, 2010. The Company has accrued
$1,207 as of March 31, 2011 related to Stay Pay.
22
Table of Contents
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion and analysis should be read in
conjunction with the Managements Discussion and
Analysis of Financial Condition and Results of Operations
section and the consolidated financial statements and related
notes thereto included in our December 31, 2010 Annual
Report on
Form 10-K
(File
No. 001-32878),
filed with the SEC and with the unaudited interim condensed
consolidated financial statements and related notes thereto
presented in this Quarterly Report on
Form 10-Q.
Overview
We are a leading provider of a broad range of critical
securities and futures processing infrastructure products and
services to the global financial services industry. Our products
and services include securities and futures clearing and
execution, financing and cash management technology, foreign
exchange services and other related offerings, and we provide
tools and services to support trading in multiple markets, asset
classes and currencies.
Since starting our business in 1995 with three correspondents,
we have grown to serve approximately 375 active securities
clearing correspondents and 62 futures clearing correspondents
as of March 31, 2011. Our net revenues were
$82.3 million and $67.4 million for the three months
ended March 31, 2011 and 2010, respectively, and consist
primarily of transaction processing fees earned from our
clearing operations and net interest income earned from our
margin lending activities, from investing customers cash
and from stock lending activities. Our clearing and commission
fees are based principally on the number of trades we clear. We
receive interest income from financing the securities purchased
on margin by the customers of our correspondents. We also earn
licensing and development revenues from fees we charge to our
clients for their use of our technology solutions.
Fiscal
2011 Highlights
| We increased our correspondent count to 437 as of March 31, 2011. | |
| Our interest earning average daily balances reached $8.7 billion for the three months ended March 31, 2011. | |
| Our net revenues reached $82.3 million for the three months ended March 31, 2011. | |
| PFSC, our Canadian subsidiary, completed its Broadridge BPS conversion in February 2011. | |
| Our non-interest revenues determined on a per trading day basis reached $1.003 million for the three months ended March 31, 2011. |
Financial
overview
Net
revenues
Revenues
We generate revenues from most clients in several different
categories. Clients generating revenues for us from clearing
transactions almost always also generate significant interest
income from related balances. Revenues from clearing
transactions are driven largely by the volume of trading
activities of the customers of our correspondents and
proprietary trading by our correspondents. Our average clearing
revenue per trade is a function of numerous pricing elements
that vary based on individual correspondent volumes, customer
mix, and the level of margin debit balances and credit balances.
Our clearing revenue fluctuates as a result of these factors as
well as changes in trading volume. We focus on maintaining the
profitability of our overall correspondent relationships,
including the clearing revenue from trades and net interest from
related customer margin balances, and by reducing associated
variable costs. We collect the fees for our services directly
from customer accounts when trades are processed. We typically
only remit commissions charged by our correspondents to them
after deducting our charges.
We often refer to our interest income as Interest,
gross to distinguish this category of revenue from
Interest, net that is generally used in our
industry. Interest, gross is generated by charges to customers
or correspondents on margin balances and interest earned by
investing customers cash, and therefore these revenues
fluctuate based on the volume of our total margin loans
outstanding, the volume of the cash balances we hold for our
correspondents
23
Table of Contents
customers, the rates of interest we can competitively charge on
margin loans and the rates at which we can invest such balances.
We also earn interest from our stock borrowing and lending
activities.
Technology revenues consist of transactional, development and
licensing revenues generated by Nexa. A significant portion of
these revenues are collected directly from clearing customers
along with other charges for clearing services as described
above. Most development revenues and some transaction revenues
are collected directly from clients and are reflected as
receivables until they are collected.
Other revenues include charges assessed directly to customers
for certain transactions or types of accounts, trade aggregation
and profits from proprietary trading activities, including
foreign exchange transactions and fees charged to our
correspondents customers. Subject to certain exceptions,
our clearing brokers in the U.S., Canada, the U.K. and Australia
each generate these types of transactions.
Revenues from clearing and commission fees represented 53% and
51% of our total net revenues for the three months ended
March 31, 2011 and 2010, respectively.
Interest
expense from securities operations
Interest expense is incurred in our daily operations in
connection with interest we pay on credit balances we hold and
on short-term borrowings we enter into to fund activities of our
correspondents and their customers. We have two primary sources
of borrowing: commercial banks and stock lending institutions.
Regulations differ by country as to how operational needs can be
funded, but we often find that stock loans that are secured with
customer or correspondent securities as collateral can be
obtained at a lower rate of interest than loans from commercial
banks. Operationally, we review cash requirements each day and
borrow the requirements from the most cost effective source.
Net interest income represented 24% and 22% of our total net
revenues in each of the three months ended March 31, 2011
and 2010, respectively.
Expenses
Employee
compensation and benefits
Our largest category of expense is the compensation and benefits
that we pay to our employees, which includes salaries, bonuses,
group insurance, contributions to benefit programs, stock
compensation and other related employee costs. These costs vary
by country according to the local prevailing wage standards. We
utilize technology whenever practical to limit the number of
employees and thus keep costs competitive. In the U.S., a
majority of our employees are located in cities where employee
costs are lower than where our largest competitors primarily
operate. A portion of total employee compensation is paid in the
form of bonuses and performance-based compensation. As a result,
depending on the performance of particular business units and
the overall Company performance, total employee compensation and
benefits could vary materially from period to period.
Other
operating expenses
Expenses incurred to process trades include floor brokerage,
exchange and clearance fees, and those expenses tend to vary
significantly with the level of trading activity. The related
data processing and communication costs vary less with the level
of trading activity. Occupancy and equipment expenses include
lease expenses for office space, computers and other equipment
that we require to operate our businesses. Other expenses
include legal, regulatory, professional consulting, accounting,
travel and miscellaneous expenses. In addition, as a public
company, we incur additional costs for external advisers such as
legal, accounting, auditing and investor relations services.
Profitability
of services provided
Management records revenue for the clearing operations and
technology business separately. We record expenses in the
aggregate as many of these expenses are attributable to multiple
business activities. As such, net profitability before tax is
determined in the aggregate. We also separately record interest
income and interest expense to determine the overall
profitability of this activity.
24
Table of Contents
Comparison
of the three months ended March 31, 2011 and March 31,
2010
Overview
Results of operations declined for the three months ended
March 31, 2011 compared to the three months ended
March 31, 2010 primarily due to higher floor brokerage,
exchange and clearance fees, higher communications and data
processing costs, higher other expenses and higher interest
expense on long-term debt, partially offset by higher clearing
and commission fees and net interest income. Operating results
decreased $2.0 million during the first quarter of 2011 as
compared to the first quarter of 2010, for our U.S., Canadian,
U.K. and Australian operating businesses.
Our U.S. operating subsidiaries experienced a decrease in
operating profits of approximately $2.0 million due
primarily to higher communications and data processing, floor
brokerage, exchange and clearance fees and interest expense on
long-term debt offset by higher clearing and commission fees and
higher net interest income. Our Canadian business experienced an
operating loss of $.1 million for the March 31, 2011
quarter compared to an operating profit of $1.1 million in
the March 31, 2010 quarter due to higher operating expenses
offset by higher net revenues. The U.K. incurred an operating
loss of $1.7 million in both quarters ended March 31,
2011 and 2010. Australia incurred an operating profit of
$.4 million for the quarter ended March 31, 2011
compared to an operating loss of approximately $.9 million
in the quarter ended March 31, 2010. Australia increased
net revenues approximately $3.7 million while expenses
increased only $2.4 million. This is primarily related to
increased revenues in the March 2011 quarter as the Australian
business has continued to grow since it began clearing
operations in December 2009, offset by higher expenses primarily
attributable to its expanded operations.
The above factors resulted in lower operating results for the
three months ended March 31, 2011 compared to the three
months ended March 31, 2010.
The following is a summary of the increases (decreases) in the
categories of revenues and expenses for the three months ended
March 31, 2011 compared to the three months ended
March 31, 2010.
% |
||||||||
Change |
Change from |
|||||||
Amount | Previous Period | |||||||
(In thousands) | ||||||||
Revenues:
|
||||||||
Clearing and commission fees
|
$ | 9,481 | 27.6 | |||||
Technology
|
636 | 11.8 | ||||||
Interest:
|
||||||||
Interest on asset based balances
|
8,604 | 50.6 | ||||||
Interest on conduit borrows
|
(1,946 | ) | (53.2 | ) | ||||
Money market
|
1,118 | 1,894.9 | ||||||
Interest, gross
|
7,776 | 37.8 | ||||||
Other revenue
|
(224 | ) | (1.8 | ) | ||||
Total revenues
|
17,669 | 24.2 | ||||||
Interest expense:
|
||||||||
Interest expense on liability based balances
|
3,970 | 126.1 | ||||||
Interest on conduit loans
|
(1,183 | ) | (51.0 | ) | ||||
Interest expense from securities operations
|
2,787 | 51.0 | ||||||
Net revenues
|
14,882 | 22.1 | ||||||
Expenses:
|
||||||||
Employee compensation and benefits
|
845 | 3.1 | ||||||
Floor brokerage, exchange and clearance fees
|
3,077 | 33.9 | ||||||
Communications and data processing
|
7,967 | 69.9 | ||||||
Occupancy and equipment
|
724 | 9.3 | ||||||
Other expenses
|
1,952 | 29.0 | ||||||
Interest expense on long-term debt
|
5,156 | 113.2 | ||||||
19,721 | 29.3 | |||||||
25
Table of Contents
Net
Revenues
Net revenues increased $14.9 million, or 22.1%, to
$82.3 million from the quarter ended March 31, 2011 to
the quarter ended March 31, 2010. The increase is primarily
attributed to the following:
Clearing and commission fees increased $9.5 million, or
27.6%, to $43.8 million during this same period. This
increase is primarily due to clearing and commission fees of
$8.2 million related to the Ridge acquisition in June 2010,
an increase of $2.7 million in Australia as that business
has continued to grow, $.7 million in our futures business,
$.4 million in Canada and $.3 million in the U.K.
offset by a decrease of approximately $3.0 million in our
existing U.S. securities business. During the quarter we
encountered higher equity and option volumes in Canada,
Australia and the U.K. while equity and option volumes were
weaker in the U.S. Our futures business benefited from
higher commissions from execution business and a stronger mix.
Technology revenue increased $.6 million, or 11.8%, to
$6.0 million due to higher recurring revenues of
$.8 million offset by a reduction in development revenues
of $.2 million.
Interest, gross increased $7.8 million or 37.8%, to
$28.4 million during the quarter over quarter period.
Interest revenues from customer balances increased
$9.7 million or 57.4% to $26.7 million due to
increases in our interest income on asset balances of
$8.6 million and $1.1 million in money market revenues
The increase in our interest income on assets balances is
attributable to an increase in our average daily interest
earning assets of $2.9 billion or 49.5% to
$8.7 billion and an increase in our average daily interest
rate of one basis point or .9% to 1.17%.
Interest from our stock conduit borrows operations decreased
$1.9 million or 53.2% to $1.7 million, as a result of
a decrease in our average daily interest rate of 128 basis
points or 54.9% to 1.05%, offset by an increase in our average
daily assets of approximately $24.2 million, or 3.8% to
$652.8 million.
Other revenue decreased $.2 million, or 1.8%, to
$12.3 million primarily due to decreases in equity and
foreign exchange trading of $.9 million and approximately
$1.1 million in our trade aggregation business offset by
increased account servicing fees of approximately
$1.1 million and increased execution services revenues of
$.7 million.
Interest expense from securities operations increased
$2.8 million, or 51.0%, to $8.3 million from the
quarter ended March 31, 2010 to the quarter ended
March 31, 2011. Interest expense from clearing operations
increased approximately $4.0 million, or 126.1%, to
$7.1 million due to an increase in our average daily
balances on our short-term obligations of $2.8 billion, or
51.7%, to $8.1 billion and an 11 basis point or 45.8%
increase in our average daily interest rate to .35%.
Interest from our stock conduit loans decreased
$1.2 million, or 51.0% to $1.1 million due to a
78 basis point decrease, or 52.7% in our average daily
interest rate to .70% offset slightly by a $25.8 million,
or 4.1% increase in our average daily balances to
$652.4 million.
Interest, net increased from $15.1 million for the quarter
ended March 31, 2010 to $20.1 million for the quarter
ended March 31, 2010. This increase was due to higher
customer balances, higher money market revenues and slightly
higher conduit balances offset by a lower interest rate spread
of 10 basis points on customer balances and 50 basis
points on conduit balances.
Employee
compensation and benefits
Total employee costs increased $.8 million, or 3.1%, to
$28.5 million from the quarter ended March 31, 2010 to
the quarter ended March 31, 2011, primarily due to higher
compensation expense of approximately $.7 million in
Australia as a result of the expansion of that business,
approximately $.8 million higher costs in Canada in
connection with the conversion to the Broadridge technology
platform and higher incentive compensation, approximately
$.9 million of compensation costs associated with the Ridge
acquisition and approximately $.6 million of higher
incentive based compensation in the U.S.. These increases were
offset by lower compensation costs of approximately
$1.5 million in our existing U.S. securities business
due to reduced headcount and $.5 million in lower
stock-based compensation. Employee count decreased 6.9% to 980
as of March 31, 2011 primarily due to lower headcounts in
our U.S. and Canadian operations.
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Floor
brokerage, exchange and clearance fees
Floor brokerage, exchange and clearance fees increased
$3.1 million, or 33.9%, to $12.2 million for the
quarter ended March 31, 2011 from the quarter ended
March 31, 2010, primarily related to costs of
$2.2 million resulting from the additional volumes from the
Ridge acquisition, $.4 million in Canada resulting from
higher equity and option volumes and $.3 million in
Australia due to higher equity and option volumes as that
business has grown.
Communication
and data processing
Total expenses for our communication and data processing
requirements increased $8.0 million, or 69.9%, to
$19.4 million from the quarter ended March 31, 2010 to
the quarter ended March 31, 2011 primarily due to
outsourcing costs of approximately $6.4 million associated
with Ridge acquisition and increased communications and data
processing costs of $1.0 million associated with our
Australian business.
Occupancy
and equipment
Total expenses for occupancy and equipment increased
$.7 million, or 9.3%, to $8.5 million from the quarter
ended March 31, 2010 to the quarter ended March 31,
2011 primarily due to higher depreciation resulting from
computer equipment and software associated with our conversion
to the Broadridge technology platform.
Other
expenses
Other expenses increased $2.0 million, or 29.0%, to
$8.7 million from the quarter ended March 31, 2010 to
the quarter ended March 31, 2011, due primarily to higher
legal fees of $1.6 million, higher amortization of
$.5 million associated with the Ridge acquisition.
Interest
expense on long-term debt
Interest expense on long-term debt increased $5.1 million
from $4.6 million for the quarter ended March 31, 2010
to $9.7 million for the quarter ended March 31, 2011
resulting primarily from approximately $6.5 million
associated with our senior second lien secured notes issued on
May 6, 2010 and $.4 million associated with the Ridge
Seller Note issued on June 25, 2010 offset by
$1.9 million in lower interest costs on our revolving
credit facility due to lower balances as compared to the prior
year.
Provision
for income taxes
Income tax benefit, based on an effective income tax rate of
approximately 38.0%, was $1.8 million for the quarter ended
March 31, 2011 as compared to an effective tax rate of
38.0% and income tax expense of less than $.1 million for
the quarter ended March 31, 2010. This change is primarily
attributed to an operating loss in the current quarter.
Net
income (loss)
As a result of the foregoing, net loss was approximately
$2.9 million for the quarter ended March 31, 2011
compared to net income of $.1 million for the quarter ended
March 31, 2010.
Liquidity
and capital resources
Operating Liquidity Our clearing
broker-dealer subsidiaries typically finance their operating
liquidity needs through secured bank lines of credit and through
secured borrowings from stock lending counterparties in the
securities business, which we refer to as stock
loans. Most of our borrowings are driven by the activities
of our clients or correspondents, primarily the purchase of
securities on margin by those parties. As of March 31,
2011, we had seven uncommitted lines of credit with seven
financial institutions for the purpose of facilitating our
clearing business as well as the activities of our customers and
correspondents. Five of these lines of credit permitted us to
borrow up to an aggregate of approximately $331.0 million
while two lines had no stated limit. As of March 31, 2011,
we had approximately $318.3 million in short-term bank
loans outstanding, which left approximately $260.5 million
available under our lines of credit with stated limitations.
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As noted above, our clearing broker businesses also have the
ability to borrow through stock loan arrangements. There are no
specific limitations on our borrowing capacities pursuant to our
stock loan arrangements. Borrowings under these arrangements
bear interest at variable rates based on various factors
including market conditions and the types of securities loaned,
are secured primarily by our customers margin account
securities, and are repayable on demand. At March 31, 2011,
we had approximately $659.3 million in borrowings under
stock loan arrangements, the majority of which relates to our
customer activities.
As a result of our customers and correspondents
aforementioned activities, our operating cash flows may vary
from year to year.
Capital Resources PWI provides capital to its
subsidiaries. PWI has the ability to obtain capital through
equipment leases, typically secured by the equipment itself and
through the Amended and Restated Credit Facility. Currently we
have the capacity to borrow up to $25 million under our
Amended and Restated Credit Facility. As of March 31, 2011,
the Company had $10 million outstanding on this line of
credit. On June 3, 2009, the Company issued
$60 million aggregate principal amount of 8.00% Senior
Convertible Notes due 2014. The net proceeds from the sale of
the convertible notes were approximately $56.2 million
after initial purchaser discounts and other expenses. On
May 6, 2010, the Company issued $200 million aggregate
principal amount of 12.5% senior second lien secured notes,
due May 15, 2017. The net proceeds from the sale of the
senior second lien secured notes were approximately
$193.3 million after initial purchaser discounts and other
expenses. The Company used a part of the net proceeds of the
sale to pay down approximately $110 million outstanding on
its previous senior revolving credit facility, to provide
working capital to support the correspondents the Company
acquired from Ridge and for other general corporate purposes.
Concurrent with the closing of its Notes offering, the Company
paid off its existing Credit Facility and entered into the
Amended and Restated Credit Facility. Our obligations under the
Amended and Restated Credit Facility are supported by a guaranty
from SAI and PHI and a pledge by the Company, SAI and PHI of
equity interests of certain of our subsidiaries. The Amended and
Restated Credit Facility is scheduled to mature on May 6,
2013.
We incur a significant amount of interest on our outstanding
debt obligations. In 2010, we paid $2.2 million in interest
under our Amended and Restated Credit Facility and predecessor
facility, $4.8 million in interest under our Senior
Convertible Notes, $13.1 million in interest under our
Senior Second Lien Secured Notes (estimated to be
$25 million per year beginning in 2011) and
$.3 million in interest under the Ridge Seller Note. We
expect to continue to pay a significant amount of interest under
these debt instruments in 2011 and for the next several years.
Our significant debt obligations may restrict our ability to
effectively utilize the capital available to us, and may
adversely affect our business or operations.
On November 18, 2009, we filed a registration statement on
Form S-3,
which was declared effective by the SEC on December 17,
2009. We may utilize the registration statement in connection
with our capital raising; however, we cannot guarantee that we
will be able to issue debt or equity securities on terms
acceptable to the Company.
As a holding company, we access the earnings of our operating
subsidiaries through the receipt of dividends from these
subsidiaries. Some of our subsidiaries are subject to the
requirements of securities regulators in their respective
countries relating to liquidity and capital standards, which may
serve to limit funds available for the payment of dividends to
the holding company.
Our principal U.S. broker-dealer subsidiary, PFSI, is
subject to the SEC Uniform Net Capital Rule
(Rule 15c3-1),
which requires the maintenance of a minimum net capital. PFSI
elected to use the alternative method, permitted by
Rule 15c3-1,
which requires PFSI to maintain minimum net capital, as defined,
equal to the greater of $250,000 or 2% of aggregate debit
balances, as defined in the SECs Reserve Requirement Rule
(Rule 15c3-3).
At March 31, 2011, PFSI had net capital of
$141.3 million, which was $90.3 million in excess of
its required net capital of $51.0 million.
Our Penson Futures, PFSL, PFSC and PFSA subsidiaries are also
subject to minimum financial and capital requirements. These
requirements are not material either individually or
collectively to the unaudited interim condensed consolidated
financial statements as of March 31, 2011. All subsidiaries
were in compliance with their minimum financial and capital
requirements as of March 31, 2011.
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Contractual
obligations and commitments
We have contractual obligations to make future payments under
long-term debt and long-term non-cancelable lease agreements and
have contingent commitments under a variety of commercial
arrangements. See Note 13 to our unaudited interim
condensed consolidated financial statements for further
information regarding our commitments and contingencies.
Off-balance
sheet arrangements
We do not have any relationships with unconsolidated entities or
financial partnerships, such as entities often referred to as
structured finance or special purpose entities, which are
established for the purpose of facilitating off-balance sheet
arrangements or other contractually narrow or limited purposes.
See Note 11 to our unaudited interim condensed consolidated
financial statements for information on off-balance sheet
arrangements.
Critical
accounting policies
Our discussion and analysis of our financial condition and
results of operations are based on our unaudited interim
condensed consolidated financial statements, which have been
prepared in accordance with accounting principles generally
accepted in the U.S. The preparation of these unaudited
interim condensed consolidated financial statements requires us
to make estimates and judgments that affect the reported amounts
of assets, liabilities, revenues and expenses. We review our
estimates on an on-going basis. We base our estimates on our
experience and on various other assumptions that we believe to
be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions.
While our significant accounting policies are described in more
detail in the notes to consolidated financial statements, we
believe the accounting policies that require management to make
assumptions and estimates involving significant judgment are
those relating to revenue recognition, fair value, software
development goodwill and stock-based compensation.
Revenue
recognition
Revenues from clearing transactions are recorded in the
Companys unaudited interim condensed consolidated
financial statements on a trade date basis. Cash received in
advance of revenue recognition is recorded as deferred revenue.
There are three major types of technology revenues:
(1) completed products that are processing transactions
every month generate revenues per transaction which are
recognized on a trade date basis; (2) these same completed
products may also generate monthly terminal charges for the
delivery of data or processing capability that are recognized in
the month to which the charges apply; (3) technology development
services are recognized when the service is performed or under
the terms of the technology development contract as described
below. Interest and other revenues are recorded in the month
that they are earned.
To date, the majority of our technology development contracts
have not required significant production, modification or
customization such that the service element of our overall
relationship with the client generally does meet the criteria
for separate accounting under the FASB Codification. All of our
products are fully functional when initially delivered to our
clients, and any additional technology development work that is
contracted for is as outlined below. Technology development
contracts generally cover only additional work that is performed
to modify existing products to meet the specific needs of
individual customers. This work can range from cosmetic
modifications to the customer interface (private labeling) to
custom development of additional features requested by the
client. Technology revenues arising from development contracts
are recorded on a
percentage-of-completion
basis based on outputs unless there are significant
uncertainties preventing the use of this approach in which case
a completed contract basis is used. The Companys revenue
recognition policy is consistent with applicable revenue
recognition guidance in the FASB Codification and Staff
Accounting Bulletin No. 104, Revenue Recognition
(SAB 104).
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Fair
value
Fair value is defined as the exit price that would be received
to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
The Companys financial assets and liabilities are
primarily recorded at fair value.
In determining fair value, the Company uses various valuation
approaches, including market, income
and/or cost
approaches. The fair value model establishes a hierarchy which
prioritizes the inputs to valuation techniques used to measure
fair value. This hierarchy increases the consistency and
comparability of fair value measurements and related disclosures
by maximizing the use of observable inputs and minimizing the
use of unobservable inputs by requiring that observable inputs
be used when available. Observable inputs reflect the
assumptions market participants would use in pricing the assets
or liabilities based on market data obtained from sources
independent of the Company. Unobservable inputs reflect the
Companys own assumptions about the assumptions market
participants would use in pricing the asset or liability
developed based on the best information available in the
circumstances. The hierarchy prioritizes the inputs into three
broad levels based on the reliability of the inputs as follows:
| Level 1 Inputs are quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Assets and liabilities utilizing Level 1 inputs include corporate equity, U.S. Treasury and money market securities. Valuation of these instruments does not require a high degree of judgment as the valuations are based on quoted prices in active markets that are readily and regularly available. | |
| Level 2 Inputs other than quoted prices in active markets that are either directly or indirectly observable as of the measurement date, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Assets and liabilities utilizing Level 2 inputs include certificates of deposit, term deposits, corporate debt securities and Canadian government obligations. These financial instruments are valued by quoted prices that are less frequent than those in active markets or by models that use various assumptions that are derived from or supported by data that is generally observable in the marketplace. Valuations in this category are inherently less reliable than quoted market prices due to the degree of subjectivity involved in determining appropriate methodologies and the applicable underlying assumptions. | |
| Level 3 Valuations based on inputs that are unobservable and not corroborated by market data. The Company does not currently have any financial instruments utilizing Level 3 inputs. These financial instruments have significant inputs that cannot be validated by readily determinable data and generally involve considerable judgment by management. |
See Note 4 to our unaudited interim condensed consolidated
financial statements for a description of the financial assets
carried at fair value.
Software
development
Costs associated with software developed for internal use are
capitalized based on the applicable guidance in the FASB
Codification. Capitalized costs include external direct costs of
materials and services consumed in developing or obtaining
internal-use software and payroll for employees directly
associated with, and who devote time to, the development of the
internal-use software. Costs incurred in development and
enhancement of software that do not meet the capitalization
criteria, such as costs of activities performed during the
preliminary and post- implementation stages, are expensed as
incurred. Costs incurred in development and enhancements that do
not meet the criteria to capitalize are activities performed
during the application development stage such as designing,
coding, installing and testing. The critical estimate related to
this process is the determination of the amount of time devoted
by employees to specific stages of internal-use software
development projects. We review any impairment of the
capitalized costs on a periodic basis.
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Goodwill
Goodwill is tested for impairment annually or more frequently if
an event or circumstance indicates that an impairment loss may
have been incurred. Application of the goodwill impairment test
requires judgment, including the identification of reporting
units, assignment of assets and liabilities to reporting units,
assignment of goodwill to reporting units, and determination of
the fair value of each reporting unit.
We review goodwill for impairment utilizing a two-step process.
The first step of the impairment test requires a comparison of
the fair value of each of our reporting units to the respective
carrying value. If the carrying value of a reporting unit is
less than its fair value, no indication of impairment exists and
a second step is not performed. If the carrying amount of a
reporting unit is higher than its fair value, there is an
indication that an impairment may exist and a second step must
be performed. In the second step, the impairment is computed by
comparing the implied fair value of the reporting units
goodwill with the carrying amount of the goodwill. If the
carrying amount of the reporting units goodwill is greater
than the implied fair value of its goodwill, an impairment loss
must be recognized for the excess and charged to operations.
At March 31, 2011, our goodwill totaled
$135.5 million. Our assessment was based upon a discounted
cash flow analysis and analysis of our market capitalization.
The estimate of cash flow is based upon, among other things,
certain assumptions about expected future operating performance
and an appropriate discount rate determined by our management.
Our estimates of discounted cash flows may differ from actual
cash flows due to, among other things, economic conditions,
changes to our business model or changes in operating
performance. Significant differences between these estimates and
actual cash flows could materially adversely affect our future
financial results. These factors increase the risk of
differences between projected and actual performance that could
impact future estimates of fair value of all reporting units. We
conducted our annual impairment test of goodwill as of
October 1, 2010. As a result of this test we determined
that no adjustment to the carrying value of goodwill for any
reporting units was required. As of March 31, 2011, there
have been no events that in managements judgment requiring
an interim impairment test.
Stock-based
compensation
The Companys accounting for stock-based employee
compensation plans focuses primarily on accounting for
transactions in which an entity exchanges its equity instruments
for employee services, and carries forward prior guidance for
share-based payments for transactions with non-employees. Under
the modified prospective transition method, the Company is
required to recognize compensation cost, after the effective
date, for the portion of all previously granted awards that were
not vested, and the vested portion of all new stock option
grants and restricted stock. The compensation cost is based upon
the original grant-date fair market value of the grant. The
Company recognizes expense relating to stock-based compensation
on a straight-line basis over the requisite service period which
is generally the vesting period. Forfeitures of unvested stock
grants are estimated and recognized as a reduction of expense.
Forward-Looking
Statements
This report contains forward-looking statements that may not be
based on current or historical fact. Though we believe our
expectations to be accurate, forward-looking statements are
subject to known and unknown risks and uncertainties that could
cause actual results to differ materially from those expressed
or implied by such statements. Factors that could cause or
contribute to such differences include but are not limited to:
| interest rate fluctuations; | |
| general economic conditions and the effect of economic conditions on consumer confidence; | |
| reduced margin loan balances maintained by our customers; | |
| fluctuations in overall market trading volume; | |
| our ability to successfully implement new product offerings; | |
| our ability to obtain future credit on favorable terms; |
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| reductions in per transaction clearing fees; | |
| legislative and regulatory changes; | |
| monetary and fiscal policy changes and other actions by the Board of Governors of the Federal Reserve System; | |
| our ability to attract and retain customers and key personnel; and | |
| those risks detailed from time to time in our press releases and periodic filings with the Securities and Exchange Commission. |
Additional important factors that may cause our actual results
to differ from our projections are detailed later in this report
under the section entitled Risk Factors. You should
not place undue reliance on any forward-looking statements,
which speak only as of the date hereof. Except as required by
law, we undertake no obligation to publicly update or revise any
forward-looking statement.
Item 3. | Quantitative and Qualitative Disclosure about Market Risk |
Prior to the fourth quarter of 2007, we did not have material
exposure to reductions in the targeted federal funds rate.
Beginning in the fourth quarter of 2007, there were significant
decreases in these rates. We encountered a 50 basis point
decrease in the federal funds rate in the fourth quarter of
2007. Actual rates fell approximately 400 basis points
during 2008, to a federal funds rate of approximately .25% as of
December 31, 2008, which is the current rate as of
March 31, 2011. Based upon the December quarter average
customer balances, assuming no increase, and adjusting for the
timing of these rate reductions, we believe that each
25 basis point increase or decrease will affect pretax
income by approximately $1.3 million per quarter. Despite
such interest rate changes, we do not have material exposure to
commodity price changes or similar market risks. Accordingly, we
have not entered into any derivative contracts to mitigate such
risk. In addition, we do not maintain material inventories of
securities for sale, and therefore are not subject to equity
price risk.
We extend margin credit and leverage to our correspondents and
their customers, which is subject to various regulatory and
clearing firm margin requirements. Margin credit is
collateralized by cash and securities in the customers
accounts. Our directors, executive officers and their
affiliates, including family members, from time to time may be
or may have been indebted to one or more of our operating
subsidiaries or one of their respective correspondents or
introducing brokers, as customers, in connection with margin
account loans. Such indebtedness is in the ordinary course of
business, is on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for
comparable transactions with unaffiliated third parties who are
not our employees and, other than as discussed in Note 7 to
our unaudited interim condensed consolidated financial
statements, does not involve more than normal risk of
collectability or present other unfavorable features. Leverage
involves securing future obligations, which may be small or
large depending on any number of circumstances, with a
proportional amount of cash or securities. The risks associated
with margin credit and leverage increase during periods of fast
market movements or in cases where leverage or collateral is
concentrated and market movements occur. During such times,
customers who utilize margin credit or leverage and who have
collateralized their obligations with securities may find that
the securities have a rapidly depreciating value and may not be
sufficient to cover their obligations in the event of
liquidation. Although we monitor margin balances on an
intra-day
basis in order to control our risk exposure, we are not able to
eliminate all risks associated with margin lending.
We are also exposed to credit risk when our correspondents
customers execute transactions, such as short sales of options
and equities, which can expose them to risk beyond their
invested capital. We are indemnified and held harmless by our
correspondents from certain liabilities or claims, the use of
margin credit, leverage and short sales of their customers.
However, if our correspondents do not have sufficient regulatory
capital to cover such conditions, we may be exposed to
significant off-balance sheet risk in the event that collateral
requirements are not sufficient to fully cover losses that
customers may incur and those customers and their correspondents
fail to satisfy their obligations. Our account level margin
credit and leverage requirements meet or exceed those required
by Regulation T of the Board of Governors of the Federal
Reserve, or similar regulatory requirements in other
jurisdictions. The SEC and other self-regulated organizations
(SROs) have approved new rules permitting portfolio
margining that have the effect of permitting increased leverage
on securities held in portfolio margin
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accounts relative to non-portfolio accounts. We began offering
portfolio margining to our clients in 2007. We intend to
continue to meet or exceed any account level margin credit and
leverage requirements mandated by the SEC, other SROs, or
similar regulatory requirements in other jurisdictions as we
expand the offering of portfolio margining to our clients.
The profitability of our margin lending activities depends to a
great extent on the difference between interest income earned on
margin loans and investments of customer cash and the interest
expense paid on customer cash balances and borrowings. If
short-term interest rates fall, we generally expect to receive a
smaller gross interest spread, causing the profitability of our
margin lending and other interest-sensitive revenue sources to
decline. Short-term interest rates are highly sensitive to
factors that are beyond our control, including general economic
conditions and the policies of various governmental and
regulatory authorities. In particular, decreases in the federal
funds rate by the Federal Reserve System usually lead to
decreasing interest rates in the U.S., which generally lead to a
decrease in the gross spread we earn. This is most significant
when the federal funds rate is on the low end of its historical
range, as is the case now. Interest rates in Canada, Europe and
Australia are also subject to fluctuations based on governmental
policies and economic factors and these fluctuations could also
affect the profitability of our margin lending operations in
these markets.
Given the volatility of exchange rates, we may not be able to
manage our currency transaction
and/or
translation risks effectively, or volatility in currency
exchange rates may expose our financial condition or results of
operations to a significant additional risk.
Item 4. | Controls and Procedures |
Managements
evaluation of disclosure controls and procedures
Our management, with the participation of our Chief Executive
Officer and Chief Financial Officer, evaluated the effectiveness
of the design and operation of our disclosure controls and
procedures (as that term is defined in
Rule 13a-15(e)
of the Exchange Act) as of the end of the period covered by this
quarterly report. Based on that evaluation, our management,
including our Chief Executive Officer and our Chief Financial
Officer, concluded that our disclosure controls and procedures
were effective in recording, processing, summarizing and
reporting information required to be disclosed by us in reports
that we file or submit under the Exchange Act, within the time
periods specified by the SECs rules and regulations.
Changes
in internal control over financial reporting
There have been no changes in our internal controls or in other
factors that have materially affected, or are reasonably likely
to materially affect, our internal controls over financial
reporting during the quarter ended March 31, 2011.
PART II.
OTHER INFORMATION
Item 1. | Legal Proceedings |
In re Sentinel Management Group, Inc. is a
Chapter 11 bankruptcy case filed on August 17, 2007 in
the U.S. Bankruptcy Court for the Northern District of
Illinois by Sentinel. Prior to the filing of this action, Penson
Futures and PFFI held customer segregated accounts with Sentinel
totaling approximately $36 million. Sentinel subsequently
sold certain securities to Citadel Equity Fund, Ltd. and Citadel
Limited Partnership. On August 20, 2007, the Bankruptcy
Court authorized distributions of 95 percent of the
proceeds Sentinel received from the sale of those securities to
certain FCM clients of Sentinel, including Penson Futures and
PFFI. This distribution to the Penson Futures and PFFI customer
segregated accounts along with a distribution received
immediately prior to the bankruptcy filing totaled approximately
$25.4 million.
On May 12, 2008, a committee of Sentinel creditors,
consisting of a majority of non-FCM creditors, together with the
trustee appointed to manage the affairs and liquidation of
Sentinel (the Sentinel Trustee), filed with the
Court their proposed Plan of Liquidation (the Committee
Plan) and on May 13, 2008 filed a Disclosure
Statement related thereto. The Committee Plan allows the
Sentinel Trustee to seek the return from FCMs, including Penson
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Futures and PFFI, of a portion of the funds previously
distributed to their customer segregated accounts. On
June 19, 2008, the Court entered an order approving the
Disclosure Statement over objections by Penson Futures, PFFI and
others. On September 16, 2008, the Sentinel Trustee filed
suit against Penson Futures and PFFI along with several other
FCMs that received distributions to their customer segregated
accounts from Sentinel. The suit against Penson Futures and PFFI
seeks the return of approximately $23.6 million of
post-bankruptcy petition transfers and approximately
$14.4 million of pre-bankruptcy petition transfers. The
suit also seeks to declare that the funds distributed to the
customer segregated accounts of Penson Futures and PFFI by
Sentinel are the property of the Sentinel bankruptcy estate
rather than the property of customers of Penson Futures and PFFI.
On December 15, 2008, over the objections of Penson Futures
and PFFI, the court entered an order confirming the Committee
Plan, and the Committee Plan became effective on
December 17, 2008. On January 7, 2009 Penson Futures
and PFFI filed their answer and affirmative defenses to the suit
brought by the Sentinel Trustee. Also on January 7, 2009,
Penson Futures, PFFI and a number of other FCMs that had placed
customer funds with Sentinel filed motions with the federal
district court for the Northern District of Illinois,
effectively asking the federal district court to remove the
Sentinel suits against the FCMs from the bankruptcy court and
consolidate them with other Sentinel related actions pending in
the federal district court. On April 8, 2009, the Sentinel
Trustee filed an amended complaint, which added a claim for
unjust enrichment. Following an unsuccessful attempt to dismiss
that claim on September 1, 2009, the Court denied the
motion for reconsideration without prejudice. On
September 11, 2009, Penson Futures and PFFI filed their
amended answer and amended affirmative defenses to the Sentinel
Trustees amended complaint. On October 28, 2009, the
federal district court for the Northern District of Illinois
granted the motions of Penson Futures, PFFI, and certain other
FCMs requesting removal of the matters referenced above
from the bankruptcy court, thereby removing these matters to the
federal district court.
On February 23, 2011, the federal district court held a
continued status hearing, during which Penson Futures, PFFI and
the Sentinel Trustee agreed that coordinated discovery with
respect to the Sentinel suits against the Company and other FCMs
was still proceeding. No trial date has been set.
In one of the actions brought by the Sentinel Trustee against an
FCM whose customer segregated accounts received similar
distributions to those made to the customer segregated accounts
of Penson Futures and PFFI, the Sentinel Trustee has brought a
motion for summary judgment on certain counts asserted against
such FCM that may implicate the claims brought by the Sentinel
Trustee against the Company. There is no date set for the
resolution of that motion.
The Company believes that the Court was correct in ordering the
prior distributions and Penson Futures and PFFI intend to
continue to vigorously defend their position. However, there can
be no assurance that any actions by Penson Futures or PFFI will
result in a limitation or avoidance of potential repayment
liabilities. In the event that Penson Futures and PFFI are
obligated to return all previously distributed funds to the
Sentinel Estate, any losses the Company might suffer would most
likely be partially mitigated as it is likely that Penson
Futures and PFFI would share in the funds ultimately disbursed
by the Sentinel Estate.
Various Claimants v. Penson Financial Services, Inc.,
et al. On July 18, 2006, three claimants filed
separate arbitration claims with the NASD (which is now known as
FINRA) against PFSI related to the sale of certain
collateralized mortgage obligations by SAMCO Financial Services,
Inc. (SAMCO Financial), a former correspondent of
PFSI, to its customers. In the ensuing months, additional
arbitration claims were filed against PFSI and certain of our
directors and officers based upon substantially similar
underlying facts. These claims generally allege, among other
things, that SAMCO Financial, in its capacity as broker, and
PFSI, in its capacity as the clearing broker, failed to
adequately supervise certain registered representatives of SAMCO
Financial, and otherwise acted improperly in connection with the
sale of these securities during the time period from
approximately June, 2004 to May, 2006. Claimants have generally
requested compensation for losses incurred through the
depreciation in market value or liquidation of the
collateralized mortgage obligations, interest on any losses
suffered, punitive damages, court costs and attorneys
fees. In addition to the arbitration claims, on March 21,
2008, Ward Insurance Company, Inc., et al, filed a claim against
PFSI and Roger J. Engemoen, Jr., the Companys
Chairman of the Board, in the Superior Court of California,
County of San Diego, Central District, based upon
substantially similar facts. The Company has now settled, or
agreed in principle to settle, all claims with respect to this
matter of which the Company is aware. No further claims based on
this matter are expected at this time.
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Mr. Engemoen, the Companys Chairman of the Board, is
the Chairman of the Board, and beneficially owns approximately
52% of the outstanding stock, of SAMCO Holdings, Inc., the
holding company of SAMCO Financial and SAMCO Capital Markets,
Inc. (SAMCO Holdings, Inc. and its affiliated companies are
referred to as the SAMCO Entities). Certain of the
SAMCO Entities received certain assets from the Company when
those assets were split-off immediately prior to the
Companys initial public offering in 2006 (the
Split-Off). In connection with the Split-Off and
through contractual and other arrangements, certain of the SAMCO
Entities have agreed to indemnify the Company and its affiliates
against liabilities that were incurred by any of the SAMCO
Entities in connection with the operation of their businesses,
either prior to or following the Split-Off. During the third
quarter of 2008, the Companys management determined that,
based on the financial condition of the SAMCO Entities,
sufficient risk existed with respect to the indemnification
protections to warrant a modification of these arrangements with
the SAMCO Entities, as described below.
On November 5, 2008, the Company entered into a settlement
agreement with certain of the SAMCO Entities pursuant to which
the Company received a limited personal guaranty from
Mr. Engemoen of certain of the indemnification obligations
of various SAMCO Entities with respect to claims related to the
underlying facts described above, and, in exchange, the Company
agreed to limit the aggregate indemnification obligations of the
SAMCO Entities with respect to certain matters described above
to $2,965,243. Unpaid indemnification obligations of $800,000
were satisfied prior to February 15, 2009. Of the $800,000
obligation, $86,000 was satisfied through a setoff against an
obligation owed to the SAMCO Entities by PFSI, with the balance
paid in cash prior to December 31, 2009. Effective as of
December 31, 2009, the Company and the SAMCO entities
entered into an amendment to the settlement agreement, whereby
SAMCO Holdings, Inc. agreed to pay an additional $133,333 on the
last business day of each of the first six calendar months of
2010 (a total of $800,000). SAMCO Holdings, Inc. has fully
satisfied its obligations under the amendment. The SAMCO
Entities remain responsible for the payment of their own defense
costs and any claims from any third parties not expressly
released under the settlement agreement, irrespective of amounts
paid to indemnify the Company. The settlement agreement only
relates to the matters described above and does not alter the
indemnification obligations of the SAMCO Entities with respect
to unrelated matters.
To account for liabilities related to the aforementioned claims
that may be borne by the Company, we recorded a pre-tax charge
of $2.35 million in the third quarter of 2008 and a
$1.0 million in the second quarter of 2010. The Company
does not anticipate further liabilities with respect to this
matter.
Realtime Data, LLC d/b/a IXO v. Thomson Reuters et
al. In July and August 2009, Realtime Data, LLC
(Realtime) filed lawsuits against the Company and
Nexa (along with numerous other financial institutions,
exchanges, and financial data providers) in the United States
District Court for the Eastern District of Texas in consolidated
cases styled Realtime Data, LLC d/b/a IXO v. Thomson
Reuters et al. Realtime alleges, among other things, that the
defendants activities infringe upon patents allegedly
owned by Realtime, including our use of certain types of data
compression to transmit or receive market data. Realtime is
seeking both damages for the alleged infringement as well as a
permanent injunction enjoining the defendants from continuing
infringing activity. Discovery with respect to this matter is
proceeding.
A trial of Realtimes claims is now tentatively scheduled
for July 9, 2012. However, the United State Court of
Appeals for the Federal Circuit recently issued an order
mandating the transfer of the case to the Southern District of
New York. The Company anticipates that such a transfer may
impact the current anticipated timetable, but it is unclear
currently to what degree. Based on its investigation to date and
advice from legal counsel, the Company believes that resolution
of these claims will not result in any material adverse effect
on its business, financial condition, or results of operation.
Nevertheless, the Company has incurred and will likely continue
to incur significant expense in defending against these claims,
and there can be no assurance that future liability will be
avoided.
In the general course of business, the Company and certain of
its officers have been named as defendants in other various
pending lawsuits and arbitration and regulatory proceedings.
These other claims allege violation of federal and state
securities laws, among other matters. The Company believes that
resolution of these claims will not result in any material
adverse effect on its business, financial condition, or results
of operation.
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Item 1A. | Risk Factors |
Expansion
of our business into new markets and increasing diversification
of our client base increases our exposure to risks associated
with those markets and clients.
Expansion of our business exposes us to an increasingly
diversified client and counterparty base and to new asset
classes and new markets. As we continue to expand our presence
and operations in foreign markets, such as Australia, Asia and
Europe, we will be increasingly exposed to market risks
associated with those countries and, especially if we have
significant local market share, to the local regulatory and
legal authorities, Similarly, the diversification of our product
offering increases our exposure to the risks associated with new
markets. For example, the expansion of our futures business
increases our exposure to risks associated with the volatility
and leverage associated with the commodities market, as
demonstrated by dramatic recent volatility in certain metal and
oil commodities. We have also experienced an expansion of our
retail and direct client business, which increases our exposure
to the legal and regulatory risks associated with servicing a
retail client base. This expansion and diversification of our
business also diversifies the market, regulatory, compliance,
currency and reputational risk that we need to monitor and
manage. If we are unable to develop and implement effective
additional procedures to manage such risks on a global basis, we
could experience a negative impact on our risk profile.
Our
margin lending business subjects us to credit risks and if we
are unable to liquidate an investors securities when the
margin collateral becomes insufficient, the profitability of our
business may suffer.
With respect to the Nonaccrual Receivables, at March 31,
2011, (see Note 7 to our unaudited interim condensed
consolidated financial statements) approximately
$42.6 million were collateralized by bonds issued by the
Retama Development Corporation (RDC) and certain
other interests in the horse racing track and real estate
project (Project) financed by the RDCs bonds.
In each case these are owned by customers and pledged to the
Company
and/or its
affiliates. Certain related parties to the Company own
approximately $14.7 million of RDC bonds that are
pledged to the Company
and/or its
affiliates (see Note 17 to our December 31, 2010
consolidated financial statements as filed with the SEC on
Form 10-K)
. There are a number of factors potentially affecting the value
of the Project and the Nonaccrual Receivables related thereto
including potential legislation in the Texas Legislature that
could expand gambling privileges at the Project. Should such
legislation be enacted there should be a positive impact on the
value of the Project and therefore upon the collateral
underlying related Nonaccrual Receivables. However, should such
legislation not be enacted, depending on other factors
potentially impacting the Project and related Nonaccrual
Receivables, it is possible that the value of the collateral
associated with the Project and related Nonaccrual Receivables
might be impaired, resulting in a write down of a portion of
these receivables that could be material in amount.
In addition to the other information set forth in this report
and the risk factors discussed in this report, you should
carefully consider the factors discussed under the heading
Risk Factors in our Annual Report on
Form 10-K
filed with the SEC on March 3, 2011, which could materially
affect our business operations, financial condition or future
results. Additional risks and uncertainties not currently known
to us or that we currently deem to be immaterial also may
materially adversely affect our business operations
and/or
financial condition.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
The following table sets forth the repurchases we made during
the three months ended March 31, 2011 for shares withheld
to cover tax-withholding requirements relating to the vesting of
restricted stock units issued to employees pursuant to the
Companys shareholder-approved stock incentive plan:
Average Price |
||||||||
Total Number of |
Paid |
|||||||
Period
|
Shares Repurchased | per Share | ||||||
January
|
3,693 | $ | 4.88 | |||||
February
|
12,030 | 5.07 | ||||||
March
|
5,491 | 6.68 | ||||||
Total
|
21,214 | $ | 5.46 | |||||
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On December 6, 2007, our Board of Directors authorized us
to purchase up to $12.5 million of our common stock in open
market purchases and privately negotiated transactions. The plan
is set to expire after $12.5 million of our common stock is
purchased. No shares were repurchased under this plan in the
first quarter of 2011. The maximum number of shares that could
have been purchased under this plan for the months of January,
February and March 2011 was 960,789, 924,783 and 701,894
respectively based on the remaining dollar amount authorized
divided by the average purchase price in the month.
Item 3. | Defaults Upon Senior Securities |
None reportable
Item 4. | Reserved |
Item 5. | Other Information |
None reportable
Item 6. | Exhibits |
The following exhibits are filed as a part of this report:
Exhibit |
Method of |
|||||||
Numbers
|
Description
|
Filing
|
||||||
10 | .1+ | Penson Worldwide, Inc. Amended and Restated 2000 Stock Incentive Plan | (1) | |||||
12 | .1 | Statement regarding computations of ratios of earnings to fixed charges | (2) | |||||
31 | .1 | Rule 13a-14(a) Certification by our principal executive officer | (2) | |||||
31 | .2 | Rule 13a-14(a) Certification by our principal financial officer | (2) | |||||
32 | .1 | Section 1350 Certification by our principal executive officer | (2) | |||||
32 | .2 | Section 1350 Certification by our principal financial officer | (2) |
(1) | Incorporated by reference to Exhibit A to the registrants definitive proxy statement filed with the Securities and Exchange Commission on March 7, 2011. | |
(2) | Filed herewith. | |
+ | Management contracts or compensation plans or arrangements in which directors or executive officers are eligible to participate. |
37
Table of Contents
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
Penson Worldwide, Inc.
/s/ Philip
A. Pendergraft
Philip A. Pendergraft
Chief Executive Officer
and principal executive officer
Date: May 9, 2011
/s/ Kevin
W. McAleer
Kevin W. McAleer
Executive Vice President, Chief Financial Officer
and principal financial and accounting officer
Date: May 9, 2011
38
Table of Contents
INDEX TO
EXHIBITS
Exhibit |
Method of |
|||||||
Numbers
|
Description
|
Filing
|
||||||
10 | .1+ | Penson Worldwide, Inc. Amended and Restated 2000 Stock Incentive Plan | (1) | |||||
12 | .1 | Statement regarding computations of ratios of earnings to fixed charges | (2) | |||||
31 | .1 | Rule 13a-14(a) Certification by our principal executive officer | (2) | |||||
31 | .2 | Rule 13a-14(a) Certification by our principal financial officer | (2) | |||||
32 | .1 | Section 1350 Certification by our principal executive officer | (2) | |||||
32 | .2 | Section 1350 Certification by our principal financial officer | (2) |
(1) | Incorporated by reference to Exhibit A to the registrants definitive proxy statement filed with the Securities and Exchange Commission on March 7, 2011 | |
(2) | Filed herewith. | |
+ | Management contracts or compensation plans or arrangements in which directors or executive officers are eligible to participate. |
39