Table of ContentsWHERE YOU CAN FIND MORE INFORMATION
Where You Can Find More Information
We are required to file annual, quarterly and current reports, proxy statements and other information required by the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with the Securities and Exchange Commission, or SEC. You may read and copy any document we file with the SEC at the SEC'sSEC’s public reference room located at 100 F Street, N.E., Washington, D.C. 20549, U.S.A. Please call the SEC at1-800-SEC-0330 for further information on the public reference room. Our SEC filings are also available to the public from the SEC'sSEC’s internet site athttp://www.sec.gov.www.sec.gov.
On our Internet website,http://www.lpl.com, we post the following recent filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our annual reports onForm 10-K, our quarterly reports onForm 10-Q, our current reports onForm 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. Hard copies of all such filings are available free of charge by request via email (investor.relations@lpl.com), telephone(617) 897-4574, or mail (LPL Financial Investor Relations at One Beacon Street, 22nd Floor, Boston, MA 02108). The information contained or incorporated on our website is not a part of this Annual Report onForm 10-K.
When we use the terms "LPLIH"“LPLIH”, "we"“we”, "us"“us”, "our"“our”, and the "firm"“firm” we mean LPL Investment Holdings Inc., a Delaware corporation, and its consolidated subsidiaries, taken as a whole, as well as any predecessor entities, unless the context otherwise indicates.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Special Note Regarding Forward-Looking Statements
Item
7—"Management's7 — “Management’s Discussion and Analysis of Financial Condition and Results of
Operations"Operations” —and other sections of this Annual Report on
Form 10-K contain forward-looking statements (regarding
economic conditions,future financial position, budgets, business strategy, projected costs, plans, objectives of management
expectations, strategic objectives, business prospects, anticipated expense savings, financial results,for future operations, and other similar matters) that involve risks and uncertainties. Forward-looking statements can be identified by words such as
"anticipates," "expects," "believes," "plans," "predicts,"“anticipates”, “expects”, “believes”, “plans”, “predicts”, and similar terms. Forward-looking statements are not guarantees of future performance and
our actual results may differ significantly from the results discussed in the forward-looking statements. Therethere are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from the results, level of activity, performance or achievements expressed or implied by the forward-looking statements including, but not limited to, changes in general economic and financial market conditions, fluctuations in the value of assets under management, effects of competition in the financial services industry, changes in the number of our financial advisors and institutions and their ability to effectively market financial products and services, the effect of current, pending and future legislation and regulation and regulatory actions. In particular, you should consider the numerous risks outlined in Part I, Item
1A—"Risk Factors"1A — “Risk Factors”.
Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. You should not rely upon forward-looking statements as predictions of future events. WeUnless required by law, we will not undertake and we specifically disclaim any obligation to release publicly the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of events, whether or not anticipated. In that respect, we wish to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made.
ITEM 1. BUSINESS
General Corporate Overview
We
are a leading providerprovide an integrated platform of
proprietary technology, brokerage and investment advisory services
through business relationships withto over 12,400 independent financial advisors
and financial advisors
employed byat financial institutions
registered investment advisors ("RIAs"(our “advisors”)
, and financial institutions (collectively, our "customers"). Through our proprietary technology, custody and clearing platforms, we offer our customers access to a broad array of financial products and services that enable across the country, enabling them to
more effectively provide financial advice and brokerage services tosuccessfully service their retail investors
(their "clients"). We partner with
over 4,800 businesses consisting of independent advisor practices, banks, credit unions and insurance companies. Through these relationshipsunbiased, conflict-free financial advice. In addition, we support approximately
16,0004,000 financial
professionals of which approximately 12,000 are licensedadvisors with
our broker-dealer subsidiaries,customized clearing, advisory platforms and
3.9 million client accounts with $279.4 billion in client assets as of December 31, 2009. With $2.7 billion in net revenue in 2009, we are a leading national broker-dealer and have been the largest independent broker-dealer as reported inFinancial Planning magazine 1996-2009, based on total revenues. In 2005, we sold an approximately 61% ownership stake in our firm to two private equity partners, Hellman & Friedman LLC and TPG. We were formed in 1989 through the merger of two brokerage firms, Linsco Financial Group, Inc. (established in 1968) and Private Ledger Financial Services, Incorporated (established in 1973). We have our primary corporate offices in Boston, San Diego, and Charlotte.technology solutions. Our customers operate in all 50 states, Washington D.C. and Puerto Rico.
Our Business
Our business philosophysingular focus is to support our customersadvisors with the front, middle and back-office support they need to serve the large and growing market for independent investment advice, particularly in providingthe mass affluent market (which we define as investors with $100,000-$1,000,000 in investable assets). We believe we are the only company that offers advisors the unique combination of an integrated technology platform, comprehensive self-clearing services and full open architecture access to leading financial products, all delivered in an environment unencumbered by conflicts from product manufacturing, underwriting or market making.
For over 20 years we have served the independent advisor market. We currently support the largest independent advisor base and the fourth largest overall advisor base in the United States. Through our advisors, we are also one of the largest distributors of financial products in the United States. Our scale is a substantial competitive advantage and enables us to more effectively attract and retain advisors. Our unique model allows us to invest more resources in our advisors, increasing their revenues and creating a virtuous cycle of growth. We are headquartered in Boston and currently have over 2,500 employees across our locations in Boston, Charlotte and San Diego.
Our Business
With our focus and scale, we are not only a beneficiary of the secular shift among advisors toward independence, but an active catalyst of this trend. We enable our advisors to provide their clients with high quality independent financial advice and investment solutions, throughand support our open architecture product platform and to support themadvisors in managing the complexity of running their business. Through ourbusinesses by providing a comprehensive integrated platform of technology and service offerings,clearing services. We provide these services through an open architecture product platform with no proprietary manufactured products, which enables an unbiased, conflict-free environment. Additionally, we establish lasting relationshipsoffer our advisors the highest average payout ratios among the five largest U.S. broker-dealers, as ranked by number of advisors, which we believe provides us with an important competitive advantage. Our business is dedicated exclusively to our customers that enable their growth. Unlike many traditional brokerage firms,advisors; we are not a market-maker nor do not manufacture products, providewe offer investment banking services, conduct market-making activity, or compete with our customers by offering investment services directly to retail investors. underwriting services.
The size of our organization and scalability of our
solution allowssolutions allow us to continually reinvest in our technology and clearing platforms, tailor our services to the needs of our
customers,advisors and provide them with an attractive value proposition.
As a result, we have successfully grownWe believe that our
customer base from 5,843 financialtechnology and service platforms allow our advisors
licensedto spend more time with
our broker-dealer subsidiaries in 2004 to 11,950 as of December 31, 2009.their clients and enhance and grow their businesses.
Our revenues are derived primarily from commissions and fees
from products and advisory services offeredgenerated by our
customers to their clients, a substantial portion of which we pay out to our customers.advisors. We also generate asset-based fees from our
financial product sponsor relationships, our cash sweep programs and
sub-transfer agencyomnibus processing and networking services. Under our self-clearing platform, we custody the majority of client assets invested in these products, which includes providing statements, transaction processing and ongoing account management for which we receive a fee.
Our CustomersFinancial Advisors Our customers are leaders within their communities.
Serving retail investorsclients in communities across the nation, theyour advisors build long-term relationships with their clients by guiding them through the complexities of investment decisions, retirement solutions, financial planning and wealth management. By providingwealth-management. We support the evolution of our advisors’ businesses over time and provide a comprehensiverange of solutions as their needs change.
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The relationship with our advisors is embodied in our Commitment Creed, which serves as a set of guiding principles for our relationships with our advisors. For more than 20 years it has been ingrained in our culture and flexible platform,reflects our singular focus on the advisors we distinguish ourselves byserve. The size and growth of our abilitybusiness has benefited from this focus. Our advisor base has grown from 3,596 advisors in 2000 to 12,444 as of December 31, 2010, representing a Compound Annual Growth Rate (“CAGR”) of 13.2%. Our historical advisor growth rate does not guarantee that we will attract advisors from otherat comparable rates in the future.
Our advisor base includes independent broker-dealers, regionalfinancial advisors, registered investment advisors (“RIAs”) and wirehouse firms,advisors at small and mid-sized financial institutions. In order to license with us, advisors must meet our stringent requirements which include a thorough review of the advisor’s education, experience, credit and compliance history. These advisors are licensed with our wholly owned subsidiary, LPL Financial LLC (“LPL Financial”) and enter into a registered representative agreement that establishes the duties and responsibilities of each party. Pursuant to the registered representative agreement, each advisor makes a series of representations, including that the advisor will disclose to all customers and prospective customers that the advisor is acting as our registered representative, that all orders for securities will be placed through us, that the advisor will sell only products we have approved and that the advisor will comply with LPL policies and procedures as well as RIAssecurities rules and financial institutions.regulations. These advisors also agree not to engage in any outside business activity without prior approval from us and not to act as an agent for any of our competitors.
In return for a high level of services provided by us, including, among others, transaction processing and technology services we provide to the advisors to support their daily activities, we typically retain a range of 10 to 15 percent of the commission and advisory fee revenue generated by our advisors and pay out the remaining 85 to 90 percent to them. In addition, advisors pay certain fees directly to us relating to technology and platform access, insurance coverage and licensing fees. The registered representative agreement is terminable without cause on 30 days notice and for cause immediately upon notice.
Our advisors average over 15 years of industry experience. This substantial industry experience allows us to focus on enhancing our advisors’ businesses without the need for basic training or subsidizing advisors that are new to the industry. Our independent advisors join us from a broad range of firms including wirehouses, regional and insurance broker dealers, banks and other independent firms. Our flexible business platform allows our
customersadvisors to choose the most
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appropriate business model to support their clients, whether they conduct brokerage business, offer brokerage and fee-based services throughon our corporate RIA platforms or provide fee-based services through their own RIA. We support the evolution of our customers' businesses over time and provide a range of solutions as their needs change.
Our customers are dedicated to fulfilling the needs of retail investors in both the growing mass affluent and high net worth markets. Typically, financial advisors affiliated with more traditional brokerage firms are focused primarily on high net worth individuals. As a result, we believe the mass affluent market, defined as households with investable assets between $100,000 and $1,000,000, is currently under-served. We believe that our independent financial advisors are well positioned to capitalize on the opportunities in both the mass affluent and high net worth markets, particularly as the baby boomer generation approaches retirement and increasingly seeks financial advice.
RIAs.
Our independent
financial advisors and RIAs are entrepreneurial independent contractors who
maintainmarket their
own offices and general support staff. These financial advisors generally have many years of industry experience and typically join us from other brokerage institutions including wirehouses, regional broker-dealers, banks, insurance companies and other independent broker-dealers.services through over 4,200 branch offices. They are primarily located in rural and suburban areas and as such are viewed as local providers of independent advice.
Approximately 70% of these advisors operate under their own brand name. We also partnerapprove and assist these advisors with financial institutionstheir own branding, marketing and promotion.
Among our 12,444 advisors, we believe we are the market leader in providing support to over 2,400 advisors at more than 750 banks and credit unions seeking to provide a broad array of services for their clients.financial advisors. For banks, credit unions and insurance companies,these institutions, whose core capabilities may not include investment and financial planning services, or who find the technology, infrastructure and regulatory requirements to be cost-prohibitive,cost prohibitive, we provide their financial representativesadvisors with the services they need to be successful. Our custom clearing platform offers a technology, custody and clearing solution to insurance companies to support over 4,000 of their financial professionals who are affiliated and licensed with them. Financialsuccessful, allowing the institutions are drawn to our services because we allow them to focus their energy and capital on their core businesses. The institutions
We also provide support to approximately 4,000 additional financial advisors who are ableaffiliated and licensed with insurance companies. These outsourcing arrangements provide customized clearing, advisory platforms and technology solutions that enable financial advisors at these insurance companies to efficiently provide a breadth of serviceservices to their client base, while enjoying the benefits of scale and reinvestment we dedicate to their financial representatives. base.
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Our goal is to work directly with the financial institutions to form a closely knit partnership that is efficient and profitable for all sides.OurService Value Proposition
We believe one
The core of
the primary factors in our
successbusiness is
our dedicationdedicated to meeting the evolving needs of our
customersadvisors and providing the platform and tools to
run a more profitable practice. This dedication is embodied ingrow and enhance the
firm's Commitment Creed, which reflectsprofitability of their businesses. We support our
singular focus on the financial advisors
by providing front, middle and
institutions we serve. Our customers experience the Commitment Creed through their individual interactions with our employees andback-office solutions through the
support we provide to help them manage their businesses successfully and profitably. Our support forfour pillars of our
customers is built upon four pillars:distinct value proposition: enabling technology, comprehensive clearing and compliance services, practice management
programs and training,
programs, and independent research.
These pillars help us deliver what we believe is an exceptional customer experience and are key to our success, representing the breadth and sophistication of our value proposition. The comprehensive and automated nature of our offering enables our
customersadvisors to focus on their clients while successfully and efficiently managing the complexities of running their own practice.
We
offer aprovide our technology and service to advisors through BranchNet, our proprietary,
web-basedintegrated technology platform that
allows customers tois server-based and web-accessed. Using the BranchNet workstation, our advisors effectively manage
all critical aspects of their
businessbusinesses while remaining highly efficient and responsive to their
clients'clients’ needs. Time-consuming
processes—processes, such as account opening and management, document imaging, transaction execution, and account
rebalancing—rebalancing, are automated to improve efficiency and accuracy.
Substantially all of our advisors utilize BranchNet as their core technology platform. Through
our
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technology platform,BranchNet, our customersadvisors have direct access to a fully-integrated array of tools and support systems, including:
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| • | comprehensive account lookup for accounts and direct business data; |
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| • | straight-through processing of trade orders and account maintenance requests and |
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| • | secure and reliable data maintenance. |
In addition to the account management capabilities of BranchNet, the Resource Center, embedded within BranchNet, provides advisors with access to our research, training, compliance and
client-management tools
•Resources for client presentationssupport services and communications
•Productthe ability to review products and market research
•Customizabledevelop marketing programs to attract and retain clientsmaterials, including:
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| • | direct access to financial product information, exclusive research commentaries, detailed regulatory requirements, valuable marketing tools, operational details, comprehensive training and technical support; |
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| • | client management and business development tools; |
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| • | trading and research tools and |
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| • | business management resources. |
Many
customersadvisors also subscribe to premium features, such as performance reporting, financial planning and customized websites. Select third-party resources have been integrated into our technology software, enabling seamless access to important tools, broadening our range of offerings and reducing duplicate operational functions.
The interface for our technology and our self-clearing platform is BranchNet, our proprietary financial advisor workstation. BranchNet is a diverse and comprehensive technology that provides for the seamless flow of information between our employees and our customers.
We believe BranchNet allows our
customersadvisors to transact and monitor their business more efficiently, lowering operating costs for their business.
In addition to the account management capabilities ofOnce on BranchNet,
the Resource Center, embedded within BranchNet, provides customers with access to our research, training and compliance services andadvisors have the ability to
review products and develop marketing materials.choose which services suit their business plan, purchasing only the services that are needed to grow their business.
Comprehensive Clearing and Compliance Services We custody and clear the majority of our customers'advisors’ transactions, providing an enhanced customeradvisor experience and expedited processing capabilities. Our self-clearing platform enables us to better control client data, more efficiently process and report trades, facilitate platform development, reduce costs and ultimately enhance the quality of the services we provide our advisors. Our self-clearing platform also enables us to serve a wider variety of advisors, including RIAs and hybrid RIAs.
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Because we are
a self-clearing,
firm, we can address all facets of securities transaction processing, including:
•Order routing, trading support, execution and clearing, and position keeping
•Regulatory and tax compliance and reporting
•Investment accounting and recordkeeping
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| • | order routing, trading support, execution and clearing, and position keeping; |
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| • | regulatory and tax compliance and reporting and |
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| • | investment accounting and recordkeeping. |
All of these services are backed by our service center and operations organizations focused on providing timely, accurate and consistent support, with each employee committed to delivering best in class service. This shared commitment allows us to meet our
customers'financial advisors’ and institutions’ needs so they can best serve their clients.
Furthermore,
In 2010, we launched Service360, a new service paradigm for our top producing advisors. Service360 offers a wide array of organizational support, adopting a team-based approach to service, in which teams are dedicated to a defined set of advisors. This new service structure was fully implemented in December 2010, and now services over 6,700 advisors with timely, accurate and efficient service delivered in a more personal, relationship-focused manner and with greater accountability and ownership on the years, wepart of the service teams.
We have made sizeable investments in our compliance
offering. By integrating compliance functionality intooffering to enable our
technology and our financial advisors' practices, we enable many of their proceduresadvisors to
be fully automated. We work closely with our customers and act proactively on their behalf so they can run a fully compliant
practice. Atoffice. Since 2000, our commitment of resources and focus on compliance have enabled us to maintain one of the
same time, approximatelybest regulatory compliance records, based upon the number of regulatory events reported in the Financial Industry Regulatory Authority’s (“FINRA”) BrokerCheck Reports, among the ten largest U.S. broker-dealers, ranked by number of advisors. Several years ago we made the strategic decision to fully integrate our compliance tools into our technology platform to further enhance compliance effectiveness and scalability. Approximately 300 employees assist our
financial advisors
through our supervisory platform through a broad array of compliance support, including: | | |
| • | training advisors on new products, new FINRA guidelines, compliance tools, security policies and procedures, anti-money laundering and best practices; |
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| • | review and approval of advertising materials; |
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| • | technology-enabled surveillance of trading activities and sales practices; |
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| • | oversight and monitoring of registered investment advisory activities; |
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| • | securities registration, advisory and insurance licensing of advisors and |
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| • | audits of branch offices. |
Training on new products and new Financial Industry Regulatory Authority ("FINRA") guidelines
•Review and approval of advertising materials
•Technology-enabled surveillance of trading activities and sales practices
•Oversight and monitoring of registered investment advisory activities
•Securities registration, advisory and insurance licensing of financial advisors
•Audits of branch offices
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Practice Management Programs and Training
We consistently seek ways to
Our practice management programs help our
customers increaseadvisors enhance and grow their
productivity.businesses. Our experience
combined with the size and diversity of our customer base, gives us the ability to benchmark the best practices of successful
financial advisors and
financial institution-based investment programs. Not only do we understand what makes an investment advice practice successful, but we also recognize the unique attributes of our customers' businesses, allowing us to develop customized recommendations to meet the specific needs of
their markets. In addition, becausean advisor’s business and market. Because of our scale, we are able to dedicate an experienced
and diverse setgroup of
approximately 100 professionals
tothat work with
customers, helping themour advisors to build and
better manage their business and client relationships through
one-on-one consulting
as well as group training. In addition, we hold over 130 conferences and group
training. The following represents a sampletraining events annually for the benefit of theour advisors. Our practice management and training services we offer:
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| • | personalized business consulting support that helps advisors enhance the value and operational efficiency of their businesses; |
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| • | advisory and brokerage consulting to support advisors in growing their businesses with our broad range of products and fee-based offerings, as well as wealth management services to |
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| | assist advisors serving high net worth clients with comprehensive estate, tax, philanthropic, and financial planning processes; |
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| • | marketing campaigns and consultation to enable advisors to build awareness of their services and capitalize on opportunities in their local markets; |
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| • | transition services to help advisors establish independent practices and migrate client accounts to us and |
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| • | training programs on topics including technology, use of advisory platforms and business development. |
Independent Research
We provide our advisors with integrated access to comprehensive proprietary research on mutual funds, separate accounts, insurance and annuities, asset allocation strategies, financial
markets and the economy, among other areas. Our research team consists of 29 professionals with an average of 12 years of industry experience, dedicated to providing unbiased and conflict-free advice. Our research is designed to empower our advisors
banks,to give their clients thoughtful advice in an efficient manner. In particular, our research facilitates the growth of our advisory platform through generation of model portfolio and
credit unions enhanceasset allocation overlay services and the
value and operational efficiencydistribution of
their business
•Advisory and brokerage consulting to support customers in growing their businesspackaged solutions. Our research team actively works with our broad product due diligence group in screening financial products offered through our platform. Our lack of proprietary products or investment banking services helps ensure that our research remains unbiased and fee-based offering, as well as wealth management services to assist financial advisors serving high-net-worth clients with comprehensive estate, tax, philanthropic, and financial planning processes
•Marketing campaigns and consultation to enable financial advisors to build awareness of their services and capitalize on opportunities in their local markets
•Transition services to help financial advisors establish independent practices and migrate client accounts to our firmIndependent Research
objective.
With a focus on performance, service and transparency, our research team
deliversutilizes a wide spectrum of available tools to deliver timely perspectives on the ever-changing economic marketplace and products, enabling
financial advisors to help their clients understand and adjust to the latest developments.
In addition, research provides recommendations on mutual funds, separately managed accounts, and investment products, complemented by an array of asset allocation models and portfolio construction capabilities, to assist advisors. Through
theirits objective recommendations and portfolio management, the research group helps
financial advisors
to meet a broad range of investor needs effectively. Our research enables
financial advisors to:
•Keep abreast of changes in markets and the global economy
•Proactively respond to emerging trends
•Leverage
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| • | keep abreast of changes in markets and the global economy, through our daily market update call and email, published materials, blogs and media presence; |
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| • | proactively respond to emerging trends; |
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| • | leverage the expertise and experience of our research team in building individual investment portfolios that are fully integrated in our technology platform and |
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| • | seek specific advice through our ASK (accurate, swift and knowledgeable) Research Service Desk, a team of research professionals dedicated exclusively to advisor investment-research inquiries via phone and email. |
A substantial portion of our research teamis compliance-approved so that advisors are able to share it with clients when working with them to make investment decisions.
Our Economic Value Proposition
We offer a compelling economic value proposition that is a key factor in
building individual investment portfolios that are fully integrated in our technology platform The key to our ability to deliverattract and retain advisors. The independent advice ischannels pay advisors a greater share of brokerage commissions and advisory fees than the fact thatcaptive channels — generally80-90% compared to30-50%. Because of our scale and efficient operating model, we offer our advisors the highest average payout ratios among the ten largest U.S. broker-dealers, ranked by number of advisors, which we believe provides us with an important competitive advantage. We believe our superior technology and service platforms enable our advisors to operate their practices at a lower cost than other independent advisors. As a result, we believe owners of practices associated with us earn meaningfully more pre-tax profit than owners of practices affiliated with other independent brokerage firms. We attribute this difference in profitability in part to lower fixed costs driven by the need for fewer staff at our associated practices.
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Finally, as business owners, independent financial advisors, unlike captive advisors, also have no proprietary products, investment banking business, or anythe opportunity to build equity in their own businesses.
We also believe our solutions enable our financial institutions to be more productive and therefore generate greater profitability relative to other
conflicts that hinder the delivery of unbiased and objective recommendations.financial institutions supported by third party firms.
We do not manufacture any financial products. Instead, we provide open-architectureour advisors open architecture access to a wideunique variety of commission, fee-based, cash and money-marketmoney market products and services. This distribution includesOur product due diligence group conducts extensive diligence on substantially all of the new products we offer, including annuities, real estate investment trusts, alternative investments and mutual funds. Our platform provides access to over 7,500 investment8,500 financial products, including mutual funds, annuities and insurance, offered throughmanufactured by over 400 product sponsors. Typically, we enter into arrangements with these product sponsors pursuant to the sponsor’s standard distribution agreement.
The sales and administration of these products are facilitated through BranchNet and the Resource Center, which allow financialour advisors to access client accounts, product information, asset allocation models, investment recommendations, and economic insight as well as perform trade execution.
TableAs of
ContentsDecember 31, 2010, advisory and brokerage assets totaled $315.6 billion, of which $93.0 billion was in advisory assets. In 2010, brokerage sales were over $26 billion, including over $9 billion in mutual funds and $15 billion in annuities. Advisory sales were over $27 billion, which consisted primarily of mutual funds. As a result of this scale and significant distribution capabilities, we can offer leading products and services with attractive economics to our advisors.
Commission-Based Products Commission-based products are those for which we and our
customersadvisors receive an
up frontupfront commission and, for certain products, a trailing commission. Our brokerage offerings include variable and fixed annuities, mutual funds, general securities, alternative investments, retirement and 529 education savings plans, fixed income and insurance. Our insurance offering is provided through LPL Insurance Associates, Inc.
("LPLIA"(“LPLIA”), a brokerage general agency which provides personalized advance case design,
point-of-sale service and product support for a broad range of life, disability and long-term care products. As of December 31,
2009,2010, the total assets in our commission-based products
exceeded $183.6were approximately $222.6 billion.
Fee-Based Advisory Platforms and Support We have been an innovator in fee-based solutions since
ourthe introduction of our Strategic Asset Management platform in 1991. Today we have five fee-based advisory platforms that provide centrally managed or customized solutions
financialfrom which advisors can choose
from to meet the investment needs of their mass affluent and high net worth clients. The fee structure aligns the interests of our
financial advisors with their clients, while establishing a valuable recurring revenue stream for the
financial advisor and for us. Our fee-based platforms provide access to no-load/load-waived mutual funds, exchange-traded funds, stocks, bonds, conservative option strategies, unit investment trusts and no-load, institutional money managers and multi-manager variable annuities.
Our research department provides model portfolio allocations, mutual fund and fixed income recommendations and access toWe also provide third-party equity
research.research and asset-management services as well as fee-based advisory and consulting services to retirement plans. As of December 31,
2009,2010, the total assets in these platforms
exceeded $77.2were $93.0 billion.
We assist our customersadvisors in managing their clients'clients’ cash balances through two primary cash sweep programs depending on account type: a money market sweep vehiclesvehicle involving multiple money market fund providers and an insured bank deposit sweep vehicle. Our insured bank deposit sweep vehicle
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allocates client cash balances across multiple non-affiliated banks to provide customersadvisors with up to $1.5 million ($3.0 million joint) of insurance through the Federal Deposit Insurance Corporation ("FDIC"(“FDIC”). As of December 31, 2009,2010, the total assets in our cash sweep programs, exceeded $18.6which are held within brokerage and advisory accounts, were approximately $19.1 billion.
In addition to the products above, we also offer trust, investment management oversight and custodial services for estates and families through our subsidiary, The Private Trust Company, N.A. (“PTC”).
Our Financial Model
We have a proven track record of strong financial performance. We have increased our annual Adjusted EBITDA for the past five consecutive years with only one decline in annual revenue in 2009 in conjunction with the major market downturn. We have experienced greater variability in our net income primarily due to amortization of purchased assets and interest expense from our senior secured credit facilities and subordinated notes, a result of our merger transaction in 2005 with TPG Capital and Hellman & Friedman LLC (collectively, the “Majority Holders”), and expenses associated with our acquisition integration and restructuring initiatives. In 2010, we generated a net loss due to equity issuance and other costs related to our initial public offering (“IPO”) that was completed in the fourth quarter. Accordingly, the presentation of net income CAGR is not meaningful. Since 2005, we have grown our net revenues at a 17.2% CAGR, our Adjusted EBITDA at a 16.9% CAGR and our Adjusted Earnings at a 17.1% CAGR. Our historical growth rates do not guarantee future results, levels of activity, performance or achievements. A reconciliation of non-GAAP measures Adjusted EBITDA and Adjusted Earnings, to GAAP measures, along with an explanation of these metrics, is provided in Item 7 — “Management’s Discussion and Analysis”.
As we demonstrated during the financial crisis of 2008 and 2009, our financial model has inherent resilience, and our overall financial performance is a function of the following favorable characteristics:
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| • | Our revenues stem from diverse sources, including advisor-generated commission and advisory fees as well as fees from product manufacturers, recordkeeping, cash sweep balances and other ancillary services. They are not concentrated by advisor, product or geography. For the year ended December 31, 2010, no single relationship with our independent advisor practices, banks, credit unions, or insurance companies accounted for more than 3% of our net revenues, and no single advisor accounted for more than 1% of our net revenues. |
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| • | Furthermore, a majority of our revenue base is recurring in nature, with over 60% recurring revenue in 2010. |
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| • | Our expenses are primarily variable, as they consist principally of payouts on advisor-generated revenues. |
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| • | Our profit margins are stable and should expand over time because we actively manage our general and administrative expenses. |
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| • | We are able to operate with low capital expenditures and limited capital requirements, and as a result our cash flow is not encumbered. |
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| • | We generate substantial free cash flow which we reinvest into our business. |
We have demonstrated the resilience of our financial model through market downturns, particularly in the financial crisis of 2008 and 2009. This inherent resilience is a function of the following dynamics of our business:
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| • | A significant proportion of our revenues are not correlated with the equity financial markets, such as software licensing, account and client fees. |
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| • | The variable component of our cost base is directly linked to revenues generated by our advisors. Furthermore, the payout percentages are tied to advisor productivity levels. |
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| • | Our general and administrative expenses can be actively managed. |
Our Competitive Strengths
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| • | Significant Scale and Market Leadership Position. We are an established leader in the independent advisor market, which is our core business focus. Our scale enables us to benefit from the following dynamics: |
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| • | We actively reinvest in our comprehensive technology platform and practice support, which further improves the productivity of our advisors. |
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| • | As one of the largest distributors of financial products in the United States, we are able to obtain attractive economics from product manufacturers. |
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| • | Among the ten largest U.S. broker-dealers by number of advisors, we offer the highest average payout ratios to our advisors. |
The combination of our ability to reinvest in the business and maintain highly competitive payout ratios allows us to attract and retain advisors successfully. This, in turn, drives our growth and leads to a virtuous cycle that reinforces our established scale advantage.
| | |
| • | Unique Value Proposition for Independent Advisors. We deliver a comprehensive and integrated suite of products and services to support the practices of our independent advisors. We believe we are the only institution that offers a conflict-free, open architecture and scalable platform. The benefits of our purchasing power lead to high average payouts and greater economics to our advisors. Our platform also creates an entrepreneurial opportunity that empowers independent advisors to build equity in their businesses. This generates a significant opportunity to attract and retain highly qualified advisors who are seeking independence. |
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| • | Unique Value Proposition for Institutions. We provide solutions to financial institutions, such as regional banks, credit unions and insurers, who seek to provide a broad array of services for their customers. We believe many institutions find the technology, infrastructure and regulatory requirements associated with delivering financial advice to be cost-prohibitive. We provide comprehensive solutions that enable financial advisors at these institutions to offer financial advice. |
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| • | Ability to Profitably Serve the Mass-Affluent Market. Since inception, our core focus has been on advisors who serve the mass-affluent market. We have designed and integrated all aspects of our platforms and services to profitably meet the needs of these advisors. We believe there is an attractive opportunity in the mass-affluent market, in part because wirehouses have not historically focused on the mass affluent market. We believe our scale position will sustain and strengthen our competitive advantage in the mass-affluent market. |
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| • | Ability to Serve a Broad Range of Advisor Models. As a result of our integrated technology platform and the resulting flexibility, we are able to attract and retain advisors from multiple channels, including wirehouses, regional broker-dealers and other independent broker-dealers. This platform serves a variety of independent advisor models, including independent financial advisors, RIAs and hybrid-RIAs. Additionally, we are able to give our advisors flexibility in choosing how they conduct their business. This enables us to better retain our existing advisor base by facilitating their ability to transition among independent advisor models as preferences evolve within the market. In addition, although we have grown through our focus on the mass affluent market, the breadth of our platform has facilitated growing penetration of the high net worth market. As of December 31, 2010, our advisors supported accounts with more than $1 million in assets that in the aggregate represented $48.2 billion in advisory and brokerage assets, 17.6% of our total. Although our advisors average production is typically below that of |
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| | some of the wirehouse channel firms, our array of integrated technology and services can support advisors with significant production and compete directly with wirehouses. |
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| • | Experienced and Committed Senior Management Team. We have an experienced and committed senior management team that provides stable and long-standing leadership for our business. On average, our senior management has 26 years of industry experience. The team has a track record of delivery and success as demonstrated in the company’s financial performance through the recent market downturn. As the current management team has played a significant role in building out the business, they have a fundamental and thorough understanding of the operations. The management team is aligned with stockholders and holds significant equity ownership in the company. |
Our Sources of Growth
We expect to increase our revenue and profitability by benefiting from favorable industry trends and by executing strategies to accelerate our growth beyond that of the broader markets in which we operate.
Favorable Industry Trends
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| • | Growth in Investable Assets. According to Cerulli Associates, over the next four years, total assets under management in the United States are anticipated to grow at 8% and retirement assets are expected to grow 6% per year (in part due to the retirement of the baby boomer generation and the resulting assets which are projected to flow out of retirement plans and into individual retirement accounts). In addition, individual retirement account rollovers are projected to grow from $4.6 trillion as of 2010 to $6.2 trillion by 2014. |
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| • | Increasing Demand for Independent Financial Advice. Retail investors, particularly in the mass affluent market, are increasingly seeking financial advice from independent sources. We are highly focused on helping independent advisors meet the needs of the mass-affluent market, which constitutes a significant and underserved portion of investable assets, according to Cerulli Associates, and we believe presents significant opportunity for growth. |
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| • | Advisor Migration to Independence. Independent channels are gaining market share from captive channels. We believe that we are not just a beneficiary of this secular shift, but an active catalyst in the movement to independence. |
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| • | Macroeconomic Trends. As the macroeconomic environment continues to stabilize, we anticipate an appreciation in asset prices and a rise in interest rates from current, historically low levels. We expect that our business will benefit from growth in advisory and brokerage assets as well as increasing asset-based and cash sweep fees. |
LPL-Specific Growth Opportunities
| | |
| • | Attracting New Advisors to Our Platform. We intend to grow the number of advisors — either independent or with financial institutions — who are served by our platform. Based on the number of financial advisors, we have only 3.6% market share of the approximately 334,000 financial advisors in the United States, according to Cerulli Associates, and we have the ability to attract seasoned advisors of any practice size and from any channel, including wirehouses, regional broker-dealers and other independent broker-dealers. Additionally, we are able to support a wide range of business models, including independent financial advisors, RIAs and hybrid-RIAs. This flexibility drives sustainable growth in new advisors who seek to transfer to our platform. We also expect to significantly expand our developing share of the RIA market. |
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| • | Ramp-up of Newly-Attracted Advisors. We predominately attract experienced advisors who have established practices. In our experience, it takes an average of three years for newly |
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| | hired advisors to fully re-establish their practices and associated revenues. This seasoning process creates accelerated growth of revenue from new advisors. |
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| • | Increasing Productivity of Existing Advisor Base. The productivity of advisors increases over time as we enable them to add new clients, gain shares of their clients’ investable assets, and expand their existing practices with additional advisors. We facilitate these productivity improvements by helping our advisors better manage their practices in an increasingly complex environment. |
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| • | Our Business Model has Inherent Economies of Scale. The largely fixed costs necessary to support our advisors delivers higher marginal profitability as client assets and revenue grow. Historically, this dynamic has been demonstrated through the growth in our operating margins. |
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| • | Opportunistic Pursuit of Acquisitions. We have a proven history of expanding our business through opportunistic acquisitions. In the past six years, we have successfully completed four transactions. Our scalable business model and operating platform make us an attractive acquirer in a fragmented market. |
We believe we offer a unique and dedicated value proposition to independent financial advisors and financial institutions who are focused primarily on mass affluent investors. This value proposition is built upon the delivery of our services through our scale, independence and integrated technology, which we believe is not replicated in the industry, and as a result we do not have any direct competitors to our business model. For example, because we do not have any proprietary manufacturing products, we do not view firms that manufacture asset management products and other financial products as competitors.
We compete
with a variety of financial institutions to attract and retain experienced and productive
advisors with a variety of financial
advisors. The retail advisor market is divided broadly into six channels, as defined by Cerulli Associates. As the largest broker-dealer infirms. Within the independent channel,
we not only compete with other independentthe industry is highly fragmented, comprised primarily of small regional firms
to support financial advisors, but with the four employee model channels as well, which include insurance, wirehouse, regional and bank broker-dealers. In addition to independent advisors, we support RIAs, which represents the sixth of Cerulli Associates' channels, and compete with otherthat rely on third-party custodians and technology providers to
servicesupport their
business.operations. Within the captive wirehouse channel, which tends to consist of large nationwide firms with multiple lines of business, competitors include Morgan Stanley Smith Barney LLC; Merrill Lynch, Pierce, Fenner, & Smith Incorporated; UBS Financial Services Inc.; Wells Fargo Advisors, LLC; who typically focus on the highly competitive high net worth investor market. Competition for advisors also includes regional firms, such as Edward D. Jones & Co., L.P. and Raymond James Financial Services, Inc. RIAs, who are licensed directly with the SEC and not through a broker-dealer, select third-party firms for custodial services, and competitors include Charles Schwab & Co. and Fidelity Brokerage Services LLC.
Our competitors who do not offer a complete solution for advisors are frequently enabled by third-party firms. Pershing LLC, a subsidiary of Bank of New York Mellon, offers custodial services to independent firms who are not self-clearing and to RIAs. Other examples include not only broker-dealers, but also clearing firmsAlbridge Solutions, a subsidiary of PNC Financial Services LLC, Advent Software, Inc. and financial services companies thatMorningstar, Inc., who provide an array of technology and research. research resources.
Our
financial advisors compete for clients with
financial advisors of brokerage firms, banks, insurance companies, asset management and investment advisory firms. In addition, they also compete with a number of firms offering
direct to investor on-line financial services and discount brokerage
services. Typically the principal factors considered by customers when choosing a broker-dealer are reputation, customer service, pay-out, technology, advisory platforms,services, such as Charles Schwab & Co. and depth and breadth of products and services. We believe our unique culture, independent business model and innovative and
Fidelity Brokerage Services LLC.
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scalable technology offer a competitive advantage and enhance our strategic position to recruit and successfully retain customers.
Our Competitive Strengths
Our Singular Focus We have a singular focus on our customers' needs with no competing agendas or conflicts of interest. While traditional brokerage firms divert significant resources to support their efforts in product manufacturing, investment banking, discount brokerage, or proprietary trading, we dedicate our resources to the success of our customers and their clients. This focus on our customers contributes to our strong customer retention and growth.
Leveraging Our Scale to Create the Best Economics for our Customers
Fundamental to our industry leadership position is our core commitment to creating the best possible economics for our customers in growing their business or investment practice. Supported by our scale we are able to provide an attractive payout structure which results in our customers earning more income per dollar of commissions and fees than most of their peers. Our technology and service offering allows our customers to outsource many of the complexities of running their business to us, enabling them to operate more cost effectively and focus on growing their practice. In addition, our independent financial advisors can build substantial equity in their own practices providing an additional incentive for growth.
Established Leader in Growing Market
The rising consumer demand for objective investment advice, coupled with the desire of financial advisors for greater autonomy in directing their practices, has resulted in an increasing number of financial advisors choosing to go independent, whether affiliating with an independent broker-dealer or as an RIA. According to Cerulli Associates in their Advisor Metrics 2009 report, from 2004 through 2008, the regional and wirehouse employee-based channels each declined 2.6% while the RIA channel grew 10.3%. As the largest provider of independent, conflict-free advice, we believe we are well positioned to continue to capitalize on this increasing demand.
Comprehensive Solution Supports Diversity of Business Development Sources
Our comprehensive business solutions, compared to many of our competitors, enable us to recruit from a broader variety of channels, including wirehouses, regional and other independent broker-dealers, as well as banks and insurance companies, and we do so across a national geographic footprint. We also support a broader range of financial advisor production than our competitors and are able to do so profitably. In addition, our platform attracts a diverse range of financial advisors with varied business models. This diversity speaks to the breadth of our business development success and the sustainability of our growth.
Industry Leader in Advisory Platforms
We were a pioneer in the development of fee-based platforms and continue to be an industry leader in creating a wide range of advisory programs to meet the varying needs of financial advisors and their clients. According to Cerulli Associates, we are the third largest mutual fund wrap program in the country. With $77.2 billion in fee-based assets under management, our leadership extends beyond simply providing these platforms and includes training and consulting to support our financial advisors in making advisory services a larger part of their business. This training differentiates us from our competitors and our ability to assist financial advisors in building valuable recurring revenue streams is one reason many of them move to our firm.
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Quality of Revenue
Our recurring revenues include trailing commissions, advisory fees, asset-based fees, technology and service fees, and interest earned on margin accounts. Although the level of these revenue sources can be impacted by external market conditions, their recurring nature provides a level of business stability. The proportion of our net revenue that is recurring has grown significantly from approximately 52.4% for the year ended December 31, 2004 to 57.3% for the year ended December 31, 2009.
For the year ended December 31, 2009, no single business relationship with our 4,800 independent advisor practices, banks, credit unions, and insurance companies accounted for more than 3% of our revenues. Within our customer base, no financial advisor relationship accounted for more than 1% of our revenues. In addition, we have a geographically diverse national presence with our customers in all 50 states, Washington D.C. and Puerto Rico.
Management Team
We believe that we have cultivated a diverse set of expertise in our senior management throughout our organization. Our senior management team draws upon a broad range of prior experiences throughout the financial services industry, but also exhibits the benefits of tenure within our company, averaging nine years experience at our firm and 26 years experience in our industry.
Our Growth Strategies
Continued development of new customers
We believe there is a large pool of financial advisors who are attracted to the growing appeal of the independent advice model. Although we are the largest independent broker-dealer in the industry and the sixth largest overall as measured by number of financial advisors, we currently have only 4% market share, based upon Cerulli Associates' estimate of 309,694 financial advisors across the industry. We seek to capitalize on this market opportunity by leveraging our strong reputation, economic advantage and business development infrastructure to continue to add experienced and productive financial advisors to our firm. We seek to attract financial advisors who are business leaders with strong industry experience and a track record of regulatory compliance. To execute this strategy, we have developed what we believe is one of the largest and most capable business development staffs in the industry.
In particular, based on the 10.3% industry growth the RIA channel experienced between 2004 and 2008, we believe the RIA sub-segment of the independent advisor model continues to be an attractive growth opportunity that we are uniquely positioned to capture. We offer the only conflict-free, fully integrated brokerage and fee-based solution in the industry. We have leveraged our scale to tailor a solution for this market to drive our growth.
We also believe that we have one of the most capable business development forces in the industry focused on financial institutions. We seek to partner with financial institutions nationally, whether through supporting the growth of financial institutions with an existing investment program or providing services to start-up programs. In addition to attracting entire financial institutions, we work with existing financial institution customers to help them locate and recruit qualified financial advisors to serve their clients.
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Additional custom clearing customers represents another opportunity for organic growth. Potential customers include large insurance company-owned broker/dealers where the insurance firm either elects to outsource most of their broker-dealer functions to us or utilize our advisory platform in order to better focus upon their core businesses.
Investment in services, platforms, and technology to support the growth of our existing customers
Through consistent reinvestment in our platform we contribute to the growth of our existing customers. We continue to improve our ability to assist them in managing the complexities of their businesses, enabling them to have more time and resources to deepen their relationships with existing clients and to manage new clients.
Leverage our scale to add incremental profitability
Driven by revenue growth derived from new customers and increased productivity of existing customers, we seek to add incremental profitability by leveraging the scalability of our technology and services. We will continue to invest in our infrastructure to maintain our scalability and competitive advantages.
Focus on our Customers
Historically, our independent business model and singular focus on our customers have been the drivers of our growth. We believe our success, especially in light of recent economic challenges, has validated this strategy, and we remain committed to delivering this unique value proposition in the future. This focus translates into enduring customer relationships, leading to strong retention of our existing customers. For the year ended December 31, 2009, we retained over 92% of our existing business, which is inclusive of the attrition we experienced during the integration of the operations of certain of our broker-dealer subsidiaries. Excluding the attrition from this integration, our retention was over 96%, in line with our historical performance.
Employees
As of December 31, 2009,2010, we had approximately 2,4002,583 full-time employees. None of our employees are subject to collective bargaining agreements governing their employment with us. Our continued growth is dependent, in part, on our ability to recruit and retain skilled technical sales and professional personnel. We believe that our relationship with our employees is strong.
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LPL Investment Holdings Inc. is the parent company of our collective businesses. Our original broker-dealer, LPL Financial,
Corporation ("LPL Financial"), was formed in 1989.
In 2005, investment funds affiliated with the Majority Holders acquired a majority ownership stake in LPL Investment Holdings Inc., with the remaining interest owned primarily by our founders, senior management and advisors.
In recent years we have grown our business through a number of opportunistic acquisitions. We strengthened our position as a leading independent broker-dealer through our acquisition on June 20, 2007 of Pacific Select Group, LLC (renamed LPL Investment AdvisoryIndependent Advisor Services Group, LLC) and its wholly owned subsidiaries: Mutual Service Corporation ("MSC"(“MSC”), Associated Financial Group, Inc. ("AFG"(“AFG”), Associated Securities Corp. ("Associated"(“Associated”), Associated Planners Investment Advisory, Inc. ("APIA"(“APIA”) and Waterstone Financial Group, Inc. ("WFG"(“WFG”) (MSC, AFG, Associated, AFG, APIA and WFG, are collectively referred to herein as the "Affiliated Entities"“Affiliated Entities”). In September of 2009, we consolidated the operations of the Affiliated Entities with those of LPL Financial. The consolidation involved the transfer of securities licenses of certain registered representatives associated with the Affiliated Entities and their client accounts. Following the completion of these transfer activities, the registered representatives and client accounts that transferred are now associated with LPL Financial. On February 5, 2011,Forms BD-W for Associated and WFG were approved by the SEC and as a result, Associated and WFG are no longer registered as broker-dealers.
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Our acquisitions of UVEST Financial Services Group, Inc.
("UVEST"(“UVEST”), and IFMG Securities, Inc., Independent Financial Marketing Group, Inc. and LSC Insurance Agency of Arizona, Inc. (collectively
"IFMG"“IFMG”) further expanded our reach in offering financial services through banks, savings and loan institutions and credit unions nationwide.
Our subsidiary, Independent Advisers Group Corporation ("IAG"(“IAG”), offers an investment advisory solution to insurance companies to support their financial advisors who are licensed with them. Our subsidiary, LPLIA, operates as a brokerage general agency which offers life, long-term care and disability insurance sales and services. Through our subsidiary The Private Trust Company, N.A. ("PTC"),PTC we offer trust, investment management oversight and custodial services for estates and families.
The financial services industry is subject to extensive regulation by U.S. federal and state regulatory agencies and securities exchanges and by
non-U.S. government agencies or regulatory bodies and securities exchanges. We take an active leadership role in the development of the rules and regulations that govern our industry. Given the recent turmoil in the financial services
space,industry, we anticipate continued heightened scrutiny and significant modifications in these rules and regulations. We strive to be at the forefront of influencing this change. Throughout our history we have also invested heavily, with the benefit of our scale, in our compliance functions to monitor our compliance with the numerous legal and regulatory requirements applicable to our business.
LPL Financial, is a registered broker-dealer with the
Securities and Exchange Commission ("SEC"),SEC, a member of FINRA, a member of various self-regulatory organizations and a participant
ofin various clearing organizations including
Thethe Depository Trust Company, the National Securities Clearing Corporation and the Options Clearing
Corporation, and conducts businessCorporation. LPL Financial is registered as a broker-dealer in
alleach of the 50 states,
Washington D.C.the District of Columbia, Puerto Rico and
Puerto Rico.the U.S. Virgin Islands.
Our subsidiaries UVEST MSC, Associated and WFGMSC are also registered broker-dealers with the SEC, and are members of FINRA. Similar to LPL Financial, UVEST conducts business on a national basis; however it acts as an introducing firm, using a third-party firm for securities clearing and custody functions. Prior to the consolidation of the Affiliated Entities, each broker-dealerMSC also conducted business on a national basis as an introducing firm, using a third-party firm for securities clearing and custody functions.
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Broker-dealers are subject to
rules and regulations covering all aspects of the securities business, including sales and trading practices, public offerings, publication of research reports, use and safekeeping of
clients'clients’ funds and securities, capital
structure, record-keepingadequacy, recordkeeping and reporting, and the conduct of directors,
managers, officers and employees.
Broker-dealersBroker dealers are also regulated by
state securities administrators in those
statesjurisdictions where they do business. Compliance with many of the
rules and regulations applicable to us involves a number of risks because
rules and regulations are subject to varying interpretations. Regulators make periodic examinations and review annual, monthly and other reports on our operations, track record and financial condition. Violations of
rules and regulations governing a
broker-dealer'sbroker dealer’s actions could result in censure,
fine,penalties and fines, the issuance of
cease-and-desist orders, the suspension or expulsion from the securities industry of such
broker-dealerbroker dealer or its officers or employees, or other similar
adverse consequences. The rules of the Municipal Securities Rulemaking Board, which are enforced by
the SEC and FINRA, apply to the municipal securities activities of LPL Financial, UVEST
MSC, Associated and
WFG.MSC.
Our margin lending is regulated by the Federal Reserve Board'sBoard’s restrictions on lending in connection with client purchases and short sales of securities, and FINRA rules also require such subsidiaries to impose maintenance requirements on the value of securities contained in margin accounts. In many cases, our margin policies are more stringent than these rules.
TableSignificant new rules and regulations are likely to arise as a result of
Contentsthe Dodd-Frank Wall Street Reform and Consumer Protection Act, which was enacted in July 2010, including development by the SEC of a new fiduciary standard of conduct applicable to broker-dealers and investment advisors. These new rules and regulations may adversely affect our business by increasing our costs and exposure to litigation.
Investment Adviser Regulation As investment advisers registered with the SEC, our subsidiaries LPL Financial, UVEST,
the Affiliated Entities, and IAG are subject to the requirements of the Investment Advisers Act of 1940,
as amended, and the
SEC'sSEC’s regulations thereunder, as well as to examination by the
SEC'sSEC’s staff. Such requirements relate to, among other things, fiduciary duties to clients, performance fees, maintaining an effective compliance program, solicitation arrangements, conflicts of interest, advertising, limitations on agency cross and principal transactions between
a financialthe advisor and advisory clients, recordkeeping and reporting requirements, disclosure requirements and general anti-fraud provisions. In addition, certain of our subsidiaries are subject to
ERISA, and Sections 4975(c)(1)(A), (B), (C) or (D) of the
Employee Retirement Income Security Act of 1974 ("ERISA"), as amended,Internal Revenue Code, and to regulations promulgated thereunder, insofar as they are a
"fiduciary"“fiduciary” under ERISA with respect to
benefit plan clients or otherwise deal with benefit plan clients. ERISA and applicable provisions of the Internal Revenue Code,
of 1986, as amended (the "Code"), impose certain duties on persons who are fiduciaries under ERISA, prohibit certain transactions involving ERISA plan clients
(including, without limitation, employee benefit plans (as defined in Section 3(3) of ERISA), individual retirement accounts and Keogh plans) and provide monetary penalties for violations of these prohibitions.
The SEC is authorized to institute proceedings and impose sanctions for violations of the Advisers Act, ranging from fines and censure to termination of an investment adviser’s registration. Investment advisers also are subject to certain state securities laws and regulations. Non-compliance with the Advisers Act or other federal and state securities laws and regulations could result in investigations, sanctions, disgorgement, fines or other similar consequences.
Commodities and Futures Regulation LPL Financial is licensed as a futures commission merchant ("FCM"(“FCM”) and commodity pool operator with the Commodities Future Trading Commission ("CFTC"(“CFTC”) and is a member of the National Futures Association ("NFA"(“NFA”). Although licensed as a FCM and a commodity pool operator, LPL Financial'sFinancial’s futures activities are limited to conducting business as a guaranteed introducing broker. LPL Financial is regulated by the CFTC and NFA. Violations of the rules of the CFTC and the NFA
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could result in remedial actions including fines, registration terminations or revocations of exchange memberships. As a guaranteed introducing broker, LPL Financial clears commodities and futures products through ADM Investor Services International Limited
("ADM"(“ADM”), and all commodities accounts and related client positions are held by ADM.
Through our subsidiary PTC we offer trust, investment management oversight and custodial services for estates and families. PTC is chartered as a non-depository national banking association. As a limited purpose national bank, PTC is regulated and regularly examined by the Office of the Comptroller of the Currency
("OCC"(“OCC”). PTC files reports with the OCC within 30 days after the conclusion of each calendar quarter. Because the powers of PTC are limited to providing fiduciary services and investment advice, it does not have the power or authority to accept deposits or make loans. For this reason, trust assets under
PTC'sPTC’s management are not insured by the FDIC.
As PTC is not a
"bank"“bank” as defined under the Bank Holding Company Act of 1956, neither its parent, PTC Holdings, Inc.
, nor PTC is regulated by the Board of Governors of the Federal Reserve System as a bank holding company.
However, because it is subject to regulation by the OCC, PTC is subject to various laws and regulations enforced by the OCC, such as capital adequacy, change of control restrictions and regulations governing fiduciary duties, conflicts of interest, self-dealing and anti-money laundering. For example, the Change in Bank Control Act, as implemented by OCC supervisory policy, imposes restrictions on parties who wish to acquire a controlling interest in a trust company or the holding company of a trust company such as LPL Investment Holdings Inc. In general, an acquisition of 10% or more of our common stock, or an acquisition of “control” as defined in OCC regulations, would require OCC approval. These laws and regulations are designed to serve specific bank regulatory and supervisory purposes and are not meant for the protection of PTC, LPL or its stockholders.
The SEC, FINRA, OCC, CFTC and the NFA have stringent rules and regulations with respect to the maintenance of specific levels of net capital by regulated entities. Generally, a
broker-dealer'sbroker-dealer’s net capital is net worth plus qualified subordinated debt less deductions for certain types of assets. The net capital rule under the Exchange Act requires that at least a minimum part of a
broker-dealer'sbroker-dealer’s assets be maintained in a relatively liquid form.
Since we areBecause LPL Financial is a guaranteed introducing broker for commodities and futures that is also a registered broker-dealer, CFTC rules require us to comply with higher net capital requirements of the net capital rule under the Exchange Act.
The SEC, FINRA and CFTC impose rules that require notification when net capital falls below certain predefined criteria. These rules also dictate the ratio of debt to equity in the regulatory capital composition of a broker-dealer, and constrain the ability of a broker-dealer to expand its business
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under certain circumstances. If a broker-dealer fails to maintain the required net capital, it may be subject to suspension or revocation of registration by the applicable regulatory agency, and suspension or expulsion by these regulators ultimately could lead to the broker-dealer'sbroker-dealer’s liquidation. Additionally, the net capital rule and certain FINRA rules impose requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital, and that require prior notice to the SEC and FINRA for certain capital withdrawals. All of our subsidiaries that are subject to net capital rules have been, and currently are, in compliance with those rules and have net capital in excess of the minimum requirements.
The USA PATRIOT Act of 2001 (the "PATRIOT Act"“PATRIOT Act”) contains anti-money laundering and financial transparency laws and mandates the implementation of various regulations applicable to broker-dealers, FCMs and other financial services companies. Financial institutions subject to the PATRIOT
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Act generally must have anti-money laundering procedures in place, implement specialized employee training programs, designate an anti-money laundering compliance officer and are audited periodically by an independent party to test the effectiveness of compliance. We have established policies, procedures and systems designed to comply with these regulations.
Regulatory activity in the areas of privacy and data protection continues to grow worldwide and is generally being driven by the growth of technology and related concerns about the rapid and widespread dissemination and use of information. We must comply with these information-related regulations, including, but not limited to, the 1999 Gramm-Leach-Bliley Act, SEC
Regulation S-P, the Fair Credit Reporting Act of 1970, as amended, and the 2003 Fair and Accurate Credit Transactions Act, to the extent they are applicable to us.
Sources of RevenuesTrademarks For revenue information by source
LPL Financial®, LPL®, LPL Career Match®, the LPL Financial logo, LPL Partners Program®, Integrated Advisory Services®, Manager Access Select®, OMP® and BranchNet® are our registered trademarks. Applications for
the three years ended December 31, 2009, see "Item 7—Management's Discussionregistered trademarks are pending for DO IT SMARTER and
Analysis ofManager Access Network. Service360tm, LPL Financial
ConditionAdvisorFirsttm, ClientsFirsttm, LPL Financial RolloverNettm and
Results of Operations—Results of Operations—Revenues."LPL Accounttm are unregistered trademarks that we use as well.
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| Item 1A. | ITEM 1A. RISK FACTORS
Risk Factors |
Risks Related to Our Business and Industry
We depend on our ability to attract and retain experienced and productive financial advisorsadvisors.
We derive a large portion of our revenues from commissions and
financial institutions.fees generated by our advisors. Our ability to attract and retain experienced and productive financial advisors and financial institutions has contributed significantly to our growth and success, and our strategic plan is premised upon continued growth in the number of our financial advisors. If we fail to attract new financial advisors and financial institutions or to retain and motivate our current financial advisors, and financial institutions, our business may suffer.
The market for experienced and productive
financial advisors is highly
competitive.competitive, and we devote significant resources to attracting and retaining the most qualified advisors. In attracting
financialand retaining advisors, we compete directly with a variety of financial institutions such as wirehouses, regional broker-dealers, banks, insurance companies and other independent broker-dealers.
If we are not successful in attracting or retaining highly qualified advisors, we may not be able to recover the expense involved in attracting and training these individuals. There can be no assurance that we will be successful in our efforts to
recruitattract and retain the
financial advisors needed to achieve our growth objectives.
Financial advisors licensed with us
Our financial condition and results of operations may leave us at any timebe adversely affected by market fluctuations and other economic factors.
Our financial condition and results of operations may be adversely affected by market fluctuations and other economic factors. Significant downturns and volatility in equity and other financial markets have had and could continue to
pursue other opportunities. We devote considerable resources to encouraginghave an adverse effect on our financial
advisorscondition and
financial institutions to remain with us and can give no assurances that our efforts will succeed.
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Our business is exposed to market risk.
Our financial results are influenced by the willingness or ability of customers to maintain or increase their investment activities in the financial products distributed by us. As a result, generaloperations.
General economic and market factors can affect our commission and fee revenue. For example, a decrease in market levels can:
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| • | reduce new investments by both new and existing clients in financial products that are linked to the stock market, such as variable life insurance, variable annuities, mutual funds and managed accounts; |
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| • | reduce trading activity, thereby affecting our brokerage commissions; |
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| • | reduce the value of advisory and brokerage assets, thereby reducing asset-based fee income and |
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| • | motivate clients to withdraw funds from their accounts, reducing advisory and brokerage assets, advisory fee revenue and asset-based fee income. |
In addition, because certain of our expenses are fixed, our ability to reduce them over short periods of time is limited, which could negatively impact our profitability.
Significant interest rate changes could affect our profitability and financial condition.
Our revenues are exposed to interest rate risk primarily from changes in the interest rates payable to us from banks participating in our cash sweep program. In the current low interest rate environment, our revenue from our cash sweep program has declined and may decline further due to changes in interest rates or clients moving assets out of our cash sweep program. We may also be limited in the amount we can reduce interest rates payable to clients in our cash sweep program and still offer a competitive return.
Lack of liquidity or access to capital could impair our business and financial productscondition.
Liquidity, or ready access to funds, is essential to our business. We expend significant resources investing in our business, particularly with respect to our technology and service platforms. In addition, we must maintain certain levels of required capital. As a result, reduced levels of liquidity could have a significant negative effect on us. Some potential conditions that could negatively affect our liquidity include:
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| • | illiquid or volatile markets; |
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| • | diminished access to debt or capital markets or |
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| • | unforeseen cash or capital requirements, adverse legal settlements or judgments (including, among others, risks associated with auction rate securities). |
The capital and credit markets continue to experience varying degrees of volatility and disruption. In some cases, the markets have exerted downward pressure on availability of liquidity and credit capacity for businesses similar to ours. Without sufficient liquidity, we could be required to curtail our operations, and our business would suffer.
Notwithstanding the self-funding nature of our operations, we may sometimes be required to fund timing differences arising from the delayed receipt of client funds associated with the settlement of client transactions in securities markets. These timing differences are linkedfunded either with internally generated cash flow or, if needed, with funds drawn under the revolving credit facility at the holding company,and/or uncommitted lines of credit at our broker-dealer subsidiary LPL Financial.
In the event current resources are insufficient to satisfy our needs, we may need to rely on financing sources such as bank debt. The availability of additional financing will depend on a variety of factors such as
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| • | market conditions; |
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| • | the general availability of credit; |
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| • | the volume of trading activities; |
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| • | the overall availability of credit to the financial services industry; |
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| • | our credit ratings and credit capacity and |
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| • | the possibility that our stockholders, advisors or lenders could develop a negative perception of our long-or short-term financial prospects if the level of our business activity decreases due to a market downturn. |
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Similarly, our access to funds may be impaired if regulatory authorities or rating organizations take negative actions against us.
Disruptions, uncertainty or volatility in the capital and credit markets may also limit our access to capital required to operate our business. Such market conditions may limit our ability to satisfy statutory capital requirements, generate commission, fee and other market-related revenue to meet liquidity needs and access the capital necessary to grow our business. As such, we may be forced to delay raising capital, issue different types of capital than we would otherwise, less effectively deploy such capital or bear an unattractive cost of capital, which could decrease our profitability and significantly reduce our financial flexibility.
If the counterparties to the stock market, such as variable life insurance, variable annuities, mutual fundsderivative instruments we use to hedge our interest rate risk default, we may be exposed to risks we had sought to mitigate.
We use derivative instruments to hedge our interest rate risk. If our counterparties fail to honor their obligations under the derivative instruments, we could be subject to the risk of loss and
managed accounts;
•reduce trading activity, thereby affecting our brokerage commissions;
•reducehedges of the value of assets under management, thereby reducing asset-based fee income; and
•motivate clients to withdraw funds from their accounts, reducing assets under management, advisory fee revenue, and asset-based fee income. In addition, a decline in interest ratesrate risk will be ineffective. That failure could have an adverse effect on our financial condition, results of operations and cash flows that could be material. For the names of key counterparties upon which we currently rely, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Quantitative and Qualitative Disclosures About Risk — Interest Rate Risk”.
A loss of our cash sweep programsmarketing relationships with manufacturers of financial products could harm our relationship with our advisors and, in turn, their clients.
We operate on an open architecture product platform with no proprietary financial products. To help our advisors meet their clients’ needs with suitable investment options, we have relationships with most of the industry-leading providers of financial and insurance products. We have sponsorship agreements with some manufacturers of fixed and variable annuities and mutual funds that, subject to the survival of certain terms and conditions, may be terminated upon notice. If we lose our relationships with one or more of these manufacturers, our ability to serve our advisors and our business
in general.may be materially and adversely affected.
Risks Related to Our Regulatory Environment
We face intense competition in our industry. Our competitors may have greater financial resources than we have. This may allow them to respond more quickly to new technologies and changes in market demand, to devote greater resources to developing and promoting their services, to create pricing pressures and to make more attractive offers to potential financial advisors.
Poor service or performance of the investment products that we offer or competitive pressures on pricing of such service or products may cause retail investors to withdraw their assets on short notice.
Retail investors control the aggregate amount of their assets under management with us. Poor service or performance of the investment products that we offer or competitive pressures on pricing of such service or products may result in the loss of accounts. The decrease in revenue that could result from such an event could have a material adverse effect on our business.
Regulatory developments and our failure to comply with regulations could adversely affect our business.business by increasing our costs and exposure to litigation, affecting our reputation and making our business less profitable.
Our business is subject to extensive United StatesU.S. regulation and supervision, including securities and investment advisory services. The securities industry in the United States is subject to extensive regulation under both federal and state laws. Our broker-dealer subsidiary, LPL Financial, is:
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| • | registered as a broker-dealer with the SEC, each of the 50 states, and the District of Columbia, Puerto Rico and the U.S. Virgin Islands; |
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| • | registered as an investment advisor with the SEC; |
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| • | a member of FINRA; |
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| • | regulated by the CFTC with respect to the futures and commodities trading activities it conducts as an introducing broker and |
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| • | a member of the NASDAQ Global Select Market (“NASDAQ”) and the Chicago Stock Exchange. |
Much of the regulation of broker-dealers has been delegated to self-regulatory organizations (“SROs”), namely FINRA and the Municipal Securities Rulemaking Board (“MSRB”). The primary
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regulators of LPL Financial are FINRA, and for municipal securities, the MSRB. The CFTC has designated the NFA as LPL Financial’s primary regulator for futures and commodities trading activities.
The SEC, FINRA, CFTC,
OCC, various securities and futures exchanges and other U.S. governmental or regulatory authorities continuously review legislative and regulatory initiatives and may adopt new or revised laws and regulations. There can also be no assurance that
existing regulations will not changeother federal or
that federal, state
or foreign agencies will not attempt to further regulate our business. These legislative and regulatory initiatives may affect the way in which we conduct our business and may make our business
model less profitable.
Our ability to conduct business in the jurisdictions in which we currently operate depends on our compliance with the laws, rules and regulations promulgated by federal regulatory bodies and the regulatory authorities in each of these jurisdictions. Our ability to comply with all applicable laws, rules and regulations is largely dependent on our establishment and maintenance of compliance, audit and reporting systems and procedures, as well as our ability to attract and retain qualified compliance, audit and risk management personnel. While we have adopted policies and procedures reasonably designed to comply with all applicable laws, rules and regulations, these systems and procedures may not be fully effective, and there can be no assurance that regulators or third parties will not raise material issues with respect to our past or future compliance with applicable regulations.
TableOur profitability could also be affected by rules and regulations that impact the business and financial communities generally and, in particular, our advisors’ clients, including changes to the laws governing taxation (including the classification of
Contents We also are subject to various laws, regulations, and rules setting forth requirements regardingindependent contractor status of our advisors), electronic commerce, privacy and data protection. If our policies, procedures and systems are foundFailure to not comply with these requirements, wenew rules and regulations, including in particular, rules and regulations that may arise pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, could be subject us to regulatory actions or litigation thatand it could have a material adverse effect on our business, results of operations, cash flows or financial condition. In addition, new rules and regulations could result in limitations on the lines of business we conduct, modifications to our business practices, increased capital requirements or additional costs. For example, the U.S. Department of Labor has issued a proposed rule that, if adopted as currently proposed, would broaden the circumstances under which we may be considered a “fiduciary” under Section 3(21) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).
We are subject to various regulatory ownership requirements, which, if not complied with, could result in the restriction of the ongoing conduct, growth or even liquidation of parts of our business.
The business activities that we may conduct are limited by various regulatory agencies. Our membership agreement with FINRA may be amended by application to include additional business activities. This application process is time-consuming and may not be successful. As a result, we may be prevented from entering new potentially profitable businesses in a timely manner, or at all. In addition, as a member of FINRA, we are subject to certain regulations regarding changes in control of our ownership. Rule 1017 of the National Association of Securities Dealers (“NASD”) generally provides, among other things, that FINRA approval must be obtained in connection with any transaction resulting in a change in our equity ownership that results in one person or entity directly or indirectly owning or controlling 25% or more of our equity capital. Similarly, the OCC imposes advance approval requirements for a change of control, and control is presumed to exist if a person acquires 10% or more of our common stock. These regulatory approval processes can result in delay, increased costsand/or impose additional transaction terms in connection with a proposed change of control, such as capital contributions to the regulated entity. As a result of these regulations, our future efforts to sell shares or raise additional capital may be delayed or prohibited.
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We are subject to various regulatory capital requirements, which, if not complied with, could result in the restriction of the ongoing conduct, growth, or even liquidation of parts of our business. The SEC, FINRA,
CFTC, OCC and
CFTCNFA have extensive rules and regulations with respect to capital requirements.
The net capital ruleAs a registered broker-dealer, LPL Financial is subject toRule 15c3-1 (“Uniform Net Capital Rule”) under the Exchange Act,
requiresand related SRO requirements. The CFTC and NFA also impose net capital requirements. The Uniform Net Capital Rule specifies minimum capital requirements that
at leastare intended to ensure the general soundness and liquidity of broker-dealers. Because we are not a
minimum part of a broker-dealer's assets be maintained in a relatively liquid form. Ourregistered broker-dealer, we are not subject to the Uniform Net Capital Rule. However, our ability to withdraw capital from
LPL Financialour broker-dealer subsidiaries could be restricted, which in turn could limit our ability to
fund operations, repay debt and redeem or purchase shares of our outstanding stock. A large operating loss or charge against net capital could adversely affect our ability to expand or even maintain our present levels of business.
Failure to comply with ERISA regulations could result in penalties against us. We are subject to ERISA
and Sections 4975(c)(1)(A), (B), (C) and (D) of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), and to regulations promulgated thereunder, insofar as we act as a
"fiduciary"“fiduciary” under ERISA with respect to
benefit plan clients or otherwise deal with benefit plan clients. ERISA and applicable provisions of the Internal Revenue Code impose duties on persons who are fiduciaries under ERISA, prohibit specified transactions involving ERISA plan clients
(including, without limitation, employee benefit plans (as defined in Section 3(3) of ERISA), individual retirement accounts and Keogh plans) and impose monetary penalties for violations of these prohibitions. Our failure to comply with these requirements could result in significant penalties against us that could have a material adverse effect on our business (or, in a worst case, severely limit the extent to which we could act as fiduciaries for any plans under ERISA).
Risks Related to Our Competition
Our business is subjectWe operate in an intensely competitive industry, which could cause us to risks related to litigation, arbitration actionslose advisors and governmentaltheir assets, thereby reducing our revenues and self regulatory organization investigations.net income.We are subject to
legal proceedings arising outcompetition in all aspects of our business,
operations, including
lawsuits, arbitration claims, regulatory, governmental or self regulatory organization subpoenas, investigations and actions, and other claims. Many of our legal claims are client initiated and involve the purchase or sale of investment securities. In our investment advisory programs, we have fiduciary obligations that require us and our financial advisors to act in the best interests of our financial advisors' clients. We may face liabilities for actual or alleged breaches of these fiduciary duties. In addition, we, along with other industry participants, are subject to risks related to litigation and settlements arising from market events such as the failures in the auction rate securities market. The outcome of any such actions cannot be predicted, and although we believe we have adequate insurance coverage for these matters (see "Our insurance coverage may be inadequate or expensive"), no assurance can be given that such legal proceedings would not have a material adverse effect on our business, results of operations, cash flows or financial condition.Our insurance coverage may be inadequate or expensive.
We are subject to claims in the ordinary course of business. These claims may involve substantial amounts of money and involve significant defense costs. It is not always possible to prevent or detect activities giving rise to claims, and the precautions we take may not be effective in all cases.
We maintain voluntary and required insurance coverage, including, among others, general liability, property, director and officer, excess-SIPC, business interruption, errors and omissions, excess entity errors and omissions and fidelity bond insurance. Recently, premium and deductible costs associated with certain insurance coverages have increased, coverage terms have become more restrictive and the number of insurers has decreased. While we endeavor to purchase coverage that is appropriate to our assessment of our risk, we are unable to predict with certainty the frequency, nature or magnitude of
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claims for direct or consequential damages. Our business may be negatively affected if in the future our insurance proves to be inadequate or unavailable. In addition, insurance claims may harm our reputation or divert management resources away from operating our business.
Our risk management policies and procedures may not be fully effective in mitigating our risk exposure in all market environments or against all types of risks.
We have adopted policies and procedures to identify, monitor and manage our operational risks, including, among other things, establishing our Governance, Risk & Compliance group with an internal audit function. These policies and procedures, however, may not be fully effective. Some of our risk evaluation methods depend upon information provided by others and public information regarding markets, clients or other matters that are otherwise accessible by us. In some cases, however, that information may not be accurate, complete or up-to-date. Also, because our financial advisors work in small, decentralized offices, additional risk management challenges may exist. If our policies and procedures are not fully effective or we are not always successful in capturing all risks to which we are or may be exposed, our business could be materially adversely affected.
Misconduct and errors by our employees and our customers could harm our business.
Misconduct and errors by our employees and our customers could result in violations of law by us, regulatory sanctions and/or serious reputational or financial harm. We cannot always deter misconduct and errors by our employees and our customers, and the precautions we take to prevent and detect this activity may not be effective in all cases. Prevention and detection among our customers, who are not our employees and some of whom tend to be located in small, decentralized offices, present additional challenges. There cannot be any assurance that misconduct and errors by our employees and customers will not lead to a material adverse effect on our business.
The securities settlement process exposes us to risks that may impact our liquidity and profitability.
LPL Financial provides clearing services and trade processingcompetition for our financial advisors and their clients, from:
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| • | asset management firms; |
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| • | commercial banks and thrift institutions; |
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| • | insurance companies; |
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| • | other clearing/custodial technology companies and |
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| • | brokerage and investment banking firms. |
Many of our competitors have substantially greater resources than we do and may offer a broader range of services, including financial products, across more markets. Some operate in a different regulatory environment than we do which may give them certain competitive advantages in the services they offer. For example, certain of our competitors only provide clearing services and consequently would not have any supervision or oversight liability relating to actions of their financial institutions. Broker-dealersadvisors. We believe that clear their own trades are subjectcompetition within our industry will intensify as a result of consolidation and acquisition activity and because new competitors face few barriers to substantially more regulatory requirements than brokers that outsource these functionsentry.
If we fail to third-party providers. Errors in performing clearing functions, including clerical, technological and other errors relatedcontinue to the handling of funds and securities held byattract highly qualified advisors or advisors licensed with us on behalf of clients, could lead to censures, fines or other sanctions imposed by applicable regulatory authorities as well as losses and liability in related lawsuits and proceedings brought by our financial advisors' clients and others. Any unsettled securities transactions or wrongly executed transactions may expose our financial advisors andleave us to adverse movementspursue other opportunities, or if current or potential clients of our advisors decide to use one of our competitors, we could face a significant decline in market share, commission and fee revenues and
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net income. If we are required to increase our payout of commissions and fees to our advisors in order to remain competitive, our net income could be significantly reduced.
Poor service or performance of the pricesfinancial products that we offer or competitive pressures on pricing of such securities.Our networksservices or products may be vulnerable to security risks.
The secure transmission of confidential information over public networks is a critical elementcause clients of our operations. Our application service provider systems maintain and process confidential data on behalf of financial advisors and their clients, some of which is critical to financial advisors' business operations. If our application service provider systems are disrupted or fail for any reason, or if our systems or facilities are infiltrated or damaged by unauthorized persons, customers could experience data loss, financial loss, harm to reputation and significant business interruption. If such a disruption or failure occurs, we may be exposed to unexpected liability, customers may withdraw their assets on short notice.
Clients of our
reputationadvisors control their assets under management with us. Poor service or performance of the financial products that we offer or competitive pressures on pricing of such services or products may
be tarnished,result in the loss of accounts. In addition, we must monitor the pricing of our services and
therefinancial products in relation to competitors and periodically may need to adjust commission and fee rates, interest rates on deposits and margin loans and other fee structures to remain competitive. Competition from other financial services firms, such as reduced commissions to attract clients or trading volume or higher deposit rates to attract client cash balances, could
be a material adverse effect onadversely impact our business.
Our networks may be vulnerable to unauthorized access, computer viruses and other security problems The decrease in the future. Persons who circumvent security measuresrevenue that could wrongfully use our confidential information or our clients' confidential information or cause interruptions or malfunctions in our
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operations. We may be required to expend significant additional resources to protect against the threat of security breaches or to alleviate problems caused by any breaches. We may not be able to implement security measures that will protect against all security risks.
Failure to maintain technological capabilities, flaws in existing technology, difficulties in upgrading our technology platform, or the introduction of a competitive platformresult from such an event could have a material adverse effect on our business.
We believe that our technology platform, particularly our BranchNet system, is one of our competitive strengths. Our future success will depend in part on our ability to anticipate and adapt to technological advancements required to meet the changing demands of our financial advisors. In particular, the emergence of new industry standards and practices could render our existing systems obsolete or uncompetitive. Any upgrades or expansions may require significant expenditures of funds and may also increase the probability that we will suffer system degradations, outages and failures. There cannot be any assurance that we will have sufficient funds to adequately update and expand our networks, nor can there be any assurance that any upgrade or expansion attempts will be successful and accepted by our current and prospective financial advisors and financial institutions. Our failure to adequately update and expand our systems and networks could have a material adverse effect on our business. In addition, system degradations, outages or failures could have a material adverse effect on our business.
Disruption of our disaster recovery plans and procedures in the event of a catastrophe could adversely affect our business. We have made a significant investment in our infrastructure, and our operations are dependent on our ability to protect the continuity of our infrastructure against damage from catastrophe or natural disaster, breach of security, loss of power, telecommunications failure or other natural or man-made events. A catastrophic event could have a direct negative impact on us by adversely affecting our employees or facilities, or an indirect impact on us by adversely affecting our clients, the financial markets or the overall economy. While we have implemented business continuity and disaster recovery plans and maintain business interruption insurance, it is impossible to fully anticipate and protect against all potential catastrophes. If our business continuity and disaster recovery plans and procedures were disrupted or unsuccessful in the event of a catastrophe, we could experience a material adverse interruption of our operations.
We face competition in attracting and retaining key talent.
Our success and future growth depends upon our ability to attract and retain qualified employees. There is significant competition for qualified employees in the broker-dealer industry. We may not be able to retain our existing employees or fill new positions or vacancies created by expansion or turnover. The loss or unavailability of these individuals could have a material adverse effect on our business.
Moreover, our success depends upon the continued services of our key senior management personnel, including our executive officers and senior managers. The loss of one or more of our key senior management personnel, and the failure to recruit a suitable replacement or replacements, could have a material adverse effect on our business.
A loss of our marketing relationships with a variety of leading manufacturers of investment products could harm our business. We operate on an open architecture product platform with no proprietary investment products. To help our financial advisors meet their clients' needs with suitable options, we have relationships with most of the industry leading providers of investment and insurance products. We have sponsorship agreements with some manufacturers of fixed and variable annuities and mutual funds that, subject to the survival of certain terms and conditions, may be terminated upon notice. If we lose our relationships with one or more of these manufacturers, our business may be materially and adversely affected.
We rely on outsourced service providers to perform key functions.
We rely on service providers to perform certain key technology, processing and support functions. Any significant failures by them could cause us to incur losses and could harm our reputation. If we had to change these service providers, we would experience a disruption to our business. Although we believe we have the resources to make such transitions with minimal disruption, we cannot predict the costs and time for such conversions. We cannot provide any assurance that the disruption caused by a change in our service providers would not have a material adverse affect on our business.
Our business could be materially adversely affected as a result of the risks associated with acquisitions and investments.
We may seek to opportunistically acquire businesses that offer complementary products, services or technologies. These acquisitions are accompanied by the risks commonly encountered in an acquisition of a business. For instance, the acquisition could have a negative effect on our financial and strategic position and reputation or the acquired business could fail to further our strategic goals. We could incur significant costs when integrating an acquired business and may not be successful in doing so. We may have a lack of experience in new markets, products or technologies brought on by the acquisition and we may have an initial dependence on unfamiliar supply or distribution partners. The acquisition may create an impairment of relationships with customers or suppliers of the acquired business or our customers or suppliers. All of these, and other, potential risks may serve as a diversion of our management's attention from other business concerns and any of these factors could have a material adverse effect on our business.
Lack of liquidity or access to capital could impair our business and financial condition.
Liquidity, or ready access to funds, is essential to our business. A compromise to our liquidity could have a significant negative effect on us. Some potential conditions that could negatively affect our liquidity include illiquid or volatile markets, diminished access to debt or capital markets, unforeseen cash or capital requirements, adverse legal settlements or judgments (including, among others, risks associated with auction rate securities).
Our indebtedness could adversely affect our financial health and may limit our ability to use debt to fund future capital needs.
At December 31,
2009,2010, we had total indebtedness of $1.4 billion.
Our level of indebtedness could increase our vulnerability to general adverse economic and industry conditions. It could also require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes. In addition, our level of indebtedness may limit our flexibility in planning for changes in our business and the industry in which
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we operate, place us at a competitive disadvantage compared to our competitors that have less debt and limit our ability to borrow additional funds.
Furthermore, if an event of default were to occur with respect to our credit agreement or other indebtedness, our creditors could, among other things, accelerate the maturity of our indebtedness.
Our ability to make scheduled payments on or to refinance indebtedness obligations depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control.
We may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. In addition, as discussed above, we are limited in the amount of capital that we can draw from our broker-dealer subsidiaries. If our cash flows and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and could be forced to sell assets, seek additional capital or seek to restructure or refinance our indebtedness. These alternative measures may not be successful or feasible. Our Third Amended and Restated Credit Agreement (“senior secured credit agreementagreement”) restricts our ability to sell assets. Even if we could consummate those sales, the proceeds that we
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realize from them may not be adequate to meet any debt service obligations then due.
Furthermore, if an event of default were to occur with respect to our senior secured credit agreement or other indebtedness, our creditors could, among other things, accelerate the maturity of our indebtedness.
In addition, as a result of reduced operating performance or weaker than expected financial condition, rating agencies could downgrade our senior unsecured subordinated notes, which would adversely affect the value of
shares of our common
shares.stock.
Our senior secured credit agreement permits us to incur additional indebtedness. Although our senior secured credit agreement contains restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of significant qualifications and exceptions, and the indebtedness incurred in compliance with these restrictions could be substantial. Also, these restrictions do not prevent us from incurring obligations that do not constitute
"indebtedness"“indebtedness” as defined in our senior secured credit agreement. To the extent new debt or other obligations are added to our currently anticipated debt levels, the substantial indebtedness risks described above would increase.
Restrictions under certain of our indebtednessesindebtedness may prevent us from taking actions that we believe would be in the best interest of our business. Certain of our indebtedness contain customary restrictions on our activities, including covenants that may restrict us
from incurring additional indebtedness or issuing disqualified stock or preferred stock; paying dividends on, redeeming or repurchasing our capital stock; making investments or acquisitions; creating liens; selling assets; restricting dividends or other payments to us; guaranteeing indebtedness; engaging in transactions with affiliates; and consolidating, merging or transferring all or substantially all of our assets.from:
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| • | incurring additional indebtedness or issuing disqualified stock or preferred stock; |
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| • | paying dividends on, redeeming or repurchasing our capital stock; |
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| • | making investments or acquisitions; |
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| • | creating liens; |
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| • | selling assets; |
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| • | restricting dividends or other payments to us; |
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| • | guaranteeing indebtedness; |
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| • | engaging in transactions with affiliates and |
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| • | consolidating, merging or transferring all or substantially all of our assets. |
We are also required to meet specified financial ratios. These restrictions may prevent us from taking actions that we believe would be in the best interest of our business. Our ability to comply with these restrictive covenants will depend on our future performance, which may be affected by events beyond our control. If we violate any of these covenants and are unable to obtain waivers, we would be in default under the applicable agreements and payment of the indebtedness could be accelerated. The acceleration of our indebtedness under one agreement may permit acceleration of indebtedness under other agreements that contain cross-default or cross-acceleration provisions. If our indebtedness is accelerated, we may not be able to repay that indebtedness or borrow sufficient funds to refinance it. Even if we are able to obtain new financing, it may not be on commercially reasonable terms or on terms that are acceptable to us. If our indebtedness is in default for any reason, our business could be materially and adversely affected. In addition, complying with these covenants may also cause us to take actions that are not favorable to holders of the common stock and may make it more difficult for us to successfully execute our business strategy and compete against companies whothat are not subject to such restrictions.
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Provisions of our senior secured credit agreement could discourage an acquisition of us by a third party. Certain provisions of our senior secured credit agreement could make it more difficult or more expensive for a third party to acquire us.us, and any of our future debt agreements may contain similar
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provisions. Upon the occurrence of certain transactions constituting a change of control, all indebtedness under our senior secured credit agreement may be accelerated and become
due.due and payable. A potential acquirer may not have sufficient financial resources to purchase our outstanding indebtedness in connection with a change of control.
Risks Related to Our Technology
We rely on technology in our business, and technology and execution failures could subject us to losses, litigation and regulatory actions.
Our business relies extensively on electronic data processing and communications systems. In addition to better serving our advisors and clients, the effective use of technology increases efficiency and enables firms like ours to reduce costs. Our continued success will depend, in part, upon:
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| • | our ability to successfully maintain and upgrade the capability of our systems; |
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| • | our ability to address the needs of our advisors and their clients by using technology to provide products and services that satisfy their demands and |
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| • | our ability to retain skilled information technology employees. |
Failure of our systems, which could result from events beyond our control, or an inability to effectively upgrade those systems or implement new technology-driven products or services, could result in financial losses, liability to clients and damage to our reputation.
Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, the computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code and other events that could have a security impact. If the counterpartiesone or more of these events occur, this could jeopardize our own, our advisors’ or their clients’ or counterparties’ confidential and other information processed, stored in and transmitted through our computer systems and networks, or otherwise cause interruptions or malfunctions in our own, our advisors’ or their clients’, our counterparties’ or third parties’ operations. We may be required to expend significant additional resources to modify our protective measures, to investigate and remediate vulnerabilities or other exposures or to make required notifications, and we may be subject to litigation and financial losses that are either not insured or are not fully covered through any insurance we maintain.
The securities settlement process exposes us to risks that may expose our advisors and us to adverse movements in price.
LPL Financial, one of our subsidiaries, provides clearing services and trade processing for our advisors and their clients and certain financial institutions. Broker-dealers that clear their own trades are subject to substantially more regulatory requirements than brokers that outsource these functions to third-party providers. Errors in performing clearing functions, including clerical, technological and other errors related to the derivative instrumentshandling of funds and securities held by us on behalf of clients, could lead to censures, fines or other sanctions imposed by applicable regulatory authorities as well as losses and liability in related lawsuits and proceedings brought by our advisors’ clients and others. Any unsettled securities transactions or wrongly executed transactions may expose our advisors and us to adverse movements in the prices of such securities.
Our networks may be vulnerable to security risks.
The secure transmission of confidential information over public networks is a critical element of our operations. As part of our normal operations, we usemaintain and transmit confidential information about clients of our advisors as well as proprietary information relating to hedge our business risks default,operations. Our application service provider systems maintain and process confidential data on behalf of advisors
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and their clients, some of which is critical to our advisors’ business operations. If our application service provider systems are disrupted or fail for any reason, or if our systems or facilities are infiltrated or damaged by unauthorized persons, our advisors could experience data loss, financial loss, harm to reputation and significant business interruption. If such a disruption or failure occurs, we may be exposed to
risks we had sought to mitigate. We use derivative instruments to hedge several business risks. Ifunexpected liability, advisors may withdraw their assets, our counterparties fail to honor their obligations under the derivative instruments, our hedges of the related risk willreputation may be ineffective. That failuretarnished and there could have anbe a material adverse effect on our business.
Our networks may be vulnerable to unauthorized access, computer viruses and other security problems in the future. We rely on our advisors to comply with our policies and procedures to safeguard confidential data. The failure of our advisors to comply with such policies and procedures could result in the loss or wrongful use of their clients’ confidential information or other sensitive information. In addition, even if we and our advisors comply with our policies and procedures, persons who circumvent security measures could wrongfully use our confidential information or clients’ confidential information or cause interruptions or malfunctions in our operations. Such loss or use could, among other things:
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| • | seriously damage our reputation; |
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| • | allow competitors access to our proprietary business information; |
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| • | subject us to liability for a failure to safeguard client data; |
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| • | result in the termination of relationships with our advisors; |
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| • | subject us to regulatory sanctions or burdens, based on the authority of the SEC and FINRA to enforce regulations regarding business continuity planning and |
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| • | require significant capital and operating expenditures to investigate and remediate the breach. |
Failure to maintain technological capabilities, flaws in existing technology, difficulties in upgrading our technology platform or the introduction of a competitive platform could have a material adverse effect on our business.
We depend on highly specialized and, in many cases, proprietary technology to support our business functions, including among others:
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| • | securities trading and custody; |
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| • | portfolio management; |
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| • | customer service; |
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| • | accounting and internal financial processes and controls and |
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| • | regulatory compliance and reporting. |
In addition, our continued success depends on our ability to effectively adopt new or adapt existing technologies to meet client, industry and regulatory demands. We might be required to make significant capital expenditures to maintain competitive technology. For example, we believe that our technology platform, particularly our BranchNet system, is one of our competitive strengths, and our future success will depend in part on our ability to anticipate and adapt to technological advancements required to meet the changing demands of our advisors. The emergence of new industry standards and practices could render our existing systems obsolete or uncompetitive. Any upgrades or expansions may require significant expenditures of funds and may also cause us to suffer system degradations, outages and failures. There cannot be any assurance that we will have sufficient funds to adequately update and expand our networks, nor can there be any assurance that any upgrade or expansion attempts will be successful and accepted by our current and prospective advisors. If our technology systems were to fail and we were unable to recover in a timely way, we would be unable to fulfill critical business functions, which could lead to a loss of advisors and could harm our reputation. A technological breakdown could also interfere with our ability to comply with financial condition,reporting and
23
other regulatory requirements, exposing us to disciplinary action and to liability to our advisors and their clients. There cannot be any assurance that another company will not design a similar platform that affects our competitive advantage.
Inadequacy or disruption of our disaster recovery plans and procedures in the event of a catastrophe could adversely affect our business.
We have made a significant investment in our infrastructure, and our operations are dependent on our ability to protect the continuity of our infrastructure against damage from catastrophe or natural disaster, breach of security, loss of power, telecommunications failure or other natural or man-made events. A catastrophic event could have a direct negative impact on us by adversely affecting our advisors, employees or facilities, or an indirect impact on us by adversely affecting the financial markets or the overall economy. While we have implemented business continuity and disaster recovery plans and maintain business interruption insurance, it is impossible to fully anticipate and protect against all potential catastrophes. If our business continuity and disaster recovery plans and procedures were disrupted or unsuccessful in the event of a catastrophe, we could experience a material adverse interruption of our operations.
We rely on outsourced service providers to perform key functions.
We rely on outsourced service providers to perform certain key technology, processing and support functions. For example, we have an agreement with Thomson Reuters BETA Systems, a division of Thomson Reuters, under which they provide us operational support, including data processing services for securities transactions and back office processing support. Any significant failures by these service providers could cause us to incur losses and could harm our reputation. If we had to change these service providers, we would experience a disruption to our business. Although we believe we have the resources to make such transitions with minimal disruption, we cannot predict the costs and time for such conversions. We cannot provide any assurance that the disruption caused by a change in our service providers would not have a material adverse affect on our business.
Risks Related to Our Business Generally
Any damage to our reputation could harm our business and lead to a loss of revenues and net income.
We have spent many years developing our reputation for integrity and superior client service, which is built upon our four pillars of support for our advisors: enabling technology, comprehensive clearing and compliance services, practice management programs and training, and independent research. Our ability to attract and retain advisors and employees is highly dependent upon external perceptions of our level of service, business practices and financial condition. Damage to our reputation could cause significant harm to our business and prospects and may arise from numerous sources, including:
| | |
| • | litigation or regulatory actions; |
|
| • | failing to deliver minimum standards of service and quality; |
|
| • | compliance failures and |
|
| • | unethical behavior and the misconduct of employees, advisors or counterparties. |
Negative perceptions or publicity regarding these matters could damage our reputation among existing and potential advisors and employees. Adverse developments with respect to our industry may also, by association, negatively impact our reputation or result in greater regulatory or legislative scrutiny or litigation against us. These occurrences could lead to loss of revenue and net income.
24
Our business is subject to risks related to litigation, arbitration actions and governmental and SRO investigations.
We are subject to legal proceedings arising out of our business operations, including lawsuits, arbitration claims, regulatory, governmental or SRO subpoenas, investigations and actions and other claims. Many of our legal claims are client initiated and involve the purchase or sale of investment securities. In our investment advisory programs, we have fiduciary obligations that require us and our advisors to act in the best interests of our advisors’ clients. We may face liabilities for actual or alleged breaches of legal duties to our advisors’ clients, in respect of issues related to the suitability of the financial products we make available in our open architecture product platform or the investment advice of our advisors based on their clients’ investment objectives (including, for example, auction rate securities or exchange traded funds). In addition, we, along with other industry participants, are subject to risks related to litigation and settlements arising from market events such as the failures in the auction rate securities market. We may also become subject to claims, allegations and legal proceedings that we infringe or misappropriate intellectual property or other proprietary rights of others. In addition, we may be subject to legal proceedings related to employment matters, including wage and hour, discrimination or harassment claims. The outcome of any such actions cannot be predicted, and a negative outcome in such a proceeding could result in substantial legal liability, loss of intellectual property rights and injunctive or other equitable relief against us. Further, such outcome may cause us significant reputational harm and could have a material adverse effect on our business, results of operations, and cash flows or financial condition.
Our risk management policies and procedures may not be fully effective in mitigating our risk exposure in all market environments or against all types of risks.
We have adopted policies and procedures to identify, monitor and manage our operational risk. These policies and procedures, however, may not be fully effective. Some of our risk evaluation methods depend upon information provided by others and public information regarding markets, clients or other matters that are otherwise accessible by us. In some cases, however, that information may not be accurate, complete orup-to-date. Also, because our advisors work in small, decentralized offices, additional risk management challenges may exist. If our policies and procedures are not fully effective or we are not always successful in capturing all risks to which we are or may be exposed, we may suffer harm to our reputation or be subject to litigation or regulatory actions that could have a material adverse effect on our business and financial condition.
Misconduct and errors by our employees and our advisors, who operate in a decentralized-environment, could harm our business.
Misconduct and errors by our employees and our advisors could result in violations of law by us, regulatory sanctionsand/or serious reputational or financial harm. We cannot always prevent misconduct and errors by our employees and our advisors, and the precautions we take to prevent and detect these activities may not be material.effective in all cases. Prevention and detection among our advisors, who are not our direct employees and some of whom tend to be located in small, decentralized offices, present additional challenges. There cannot be any assurance that misconduct and errors by our employees and advisors will not lead to a material adverse effect on our business.
Our insurance coverage may be inadequate or expensive.
We are subject to claims in the ordinary course of business. These claims may involve substantial amounts of money and involve significant defense costs. It is not always possible to prevent or detect activities giving rise to claims, and the precautions we take may not be effective in all cases.
We maintain voluntary and required insurance coverage, including, among others, general liability, property, director and officer, excess-SIPC, business interruption, errors and omissions,
25
excess entity errors and omissions and fidelity bond insurance. Recently, premium and deductible costs associated with certain insurance coverages have increased, coverage terms have become more restrictive and the number of insurers has decreased. While we endeavor to purchase coverage that is appropriate to our assessment of our risk, we are unable to predict with certainty the frequency, nature or magnitude of claims for direct or consequential damages. Our business may be negatively affected if in the future our insurance proves to be inadequate or unavailable. In addition, insurance claims may harm our reputation or divert management resources away from operating our business.
Our business could be materially adversely affected as a result of the risks associated with acquisitions and investments.
We may seek to opportunistically acquire businesses that offer complementary products, services or technologies. These acquisitions are accompanied by risks. For instance, the acquisition could have a negative effect on our financial and strategic position and reputation or the acquired business could fail to further our strategic goals. We could incur significant costs when integrating an acquired business and may not be successful in doing so. We may have a lack of experience in new markets, products or technologies brought on by the acquisition and we may have an initial dependence on unfamiliar supply or distribution partners. The acquisition may create an impairment of relationships with customers or suppliers of the acquired business or our advisors or suppliers. All of these and other potential risks may serve as a diversion of our management’s attention from other business concerns and any of these factors could have a material adverse effect on our business.
Changes in U.S. federal income tax law could make some of the products distributed by our advisors less attractive to clients.
Some of the financial products distributed by our advisors, such as variable annuities, enjoy favorable treatment under current U.S. federal income tax law. Changes in U.S. federal income tax law, in particular with respect to variable annuity products or with respect to tax rates on capital gains or dividends, could make some of these products less attractive to clients and, as a result, could have a material adverse effect on our business, results of operations, cash flows or financial condition.
Risks Related to Ownership of Our Common Stock
The Majority Holders will have the ability to control usthe outcome of matters submitted for stockholder approval and may have conflictsinterests that differ from those of interest with us.our other stockholders. Investment
As of December 31, 2010, investment funds affiliated with
TPG and Hellman & Friedman LLC (collectively, the "Majority Holders"), own approximately 57.1% of our capital stock, on a fully-diluted basis, as of December 31, 2009. Although certain members of our executive team have the contractual ability to terminate their employment agreements and receive certain payments if the Majority Holders
enter intoown approximately 62.9% of our common stock, or 56.2% on a
transaction our executive team does not approve, thefully diluted basis. The Majority Holders have significant influence over corporate transactions. So long as investment funds associated with or designated by the Majority Holders continue to own a significant amount of the outstanding shares of our common stock, even if such amount is less than 50%, the Majority Holders will continue to be able to strongly influence or effectively control our
decisions.Anti-takeover provisionsdecisions, regardless of our certificatewhether or not other stockholders believe that the transaction is in their own best interests. Such concentration of incorporation and bylaws may reducevoting power could also have the likelihoodeffect of any potentialdelaying, deterring or preventing a change of control or unsolicited acquisition proposalother business combination that might otherwise be considered favorable.beneficial to our stockholders. If the Majority Holders enter into a change in control transaction, certain members of our executive team have the contractual ability to terminate their employment within the thirty day period immediately following the twelve month anniversary of a change in control and receive severance payments.
In addition, the Majority Holders and their affiliates are in the business of making investments in companies and may, from time to time in the future, acquire interests in businesses that directly or indirectly compete with certain portions of our business. To the extent the Majority Holders invest in such other businesses, the Majority Holders may have differing interests than our other stockholders. The Majority Holders may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us.
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The price of our common stock may be volatile and fluctuate substantially, which could result in substantial losses for our investors.
The market price of our common stock is likely to be highly volatile and may fluctuate substantially due to the following factors (in addition to the other risk factors described in this section):
| | |
| • | actual or anticipated fluctuations in our results of operations; |
|
| • | variance in our financial performance from the expectations of equity research analysts; |
|
| • | conditions and trends in the markets we serve; |
|
| • | announcements of significant new services or products by us or our competitors; |
|
| • | additions or changes to key personnel; |
|
| • | the commencement or outcome of litigation; |
|
| • | changes in market valuation or earnings of our competitors; |
|
| • | the trading volume of our common stock; |
|
| • | future sale of our equity securities; |
|
| • | changes in the estimation of the future size and growth rate of our markets; |
|
| • | legislation or regulatory policies, practices or actions and |
|
| • | general economic conditions. |
In addition, the stock markets in general have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the particular companies affected. These broad market and industry factors may materially harm the market price of our common stock irrespective of our operating performance. In addition, in the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against the affected company. This type of litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.
We are a holding company and rely on dividends, distributions and other payments, advances and transfers of funds from our subsidiaries to meet our debt service and other obligations.
We have no direct operations and derive all of our cash flow from our subsidiaries. Because we conduct our operations through our subsidiaries, we depend on those entities for dividends and other payments or distributions to meet any existing or future debt service and other obligations. The deterioration of the earnings from, or other available assets of, our subsidiaries for any reason could limit or impair their ability to pay dividends or other distributions to us. In addition, FINRA regulations restrict dividends in excess of 10% of a member firm’s excess net capital without FINRA’s prior approval. Compliance with this regulation may impede our ability to receive dividends from LPL Financial.
We currently do not intend to pay dividends on our common stock and, consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.
We do not anticipate that we will pay any cash dividends on shares of our common stock for the foreseeable future. Furthermore, our senior secured credit agreement places substantial restrictions on our ability to pay cash dividends. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend on results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board of directors deems relevant. Accordingly, realization of a gain on your investment will depend on the appreciation
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Provisions
of the price of our common stock, which may never occur. Please see the section titled “Dividend Policy” for additional information.
Upon expiration oflock-up agreements between the underwriters and our officers, directors and certain holders of our common stock in mid-May 2011, a substantial number of shares of our common stock could be sold into the public market, which could depress our stock price.
Our officers, directors and certain holders of our common stock, options and warrants, holding substantially all of our outstanding shares of common stock immediately prior to completion of our IPO, have entered intolock-up agreements with our underwriters which prohibit, subject to certain limited exceptions, the disposal or pledge of, or the hedging against, any of their common stock or securities convertible into or exchangeable for shares of common stock for a period through May 16, 2011, subject to extension in certain circumstances. Our Stockholders Agreement also restricts the parties thereto from transferring their shares of common stock or any securities convertible into or exchangeable or exercisable for shares of common stock through May 16, 2011. The market price of our common stock could decline as a result of sales by our stockholders in the market after the expiration of theselock-up periods, or the perception that these sales could occur. After theselock-up periods expire, many of our stockholders will have an opportunity to sell their stock for the first time. These factors could also make it difficult for us to raise additional capital by selling stock.
Anti-takeover provisions in our certificate of incorporation and bylaws could deter,prevent or delay a change in control of our company.
Our certificate of incorporation and our bylaws contain certain provisions that may discourage, delay or prevent a
third-party from acquiringchange in our management or control over us
even if doing so would benefit our stockholders. These provisions include a fixed numberthat stockholders may consider favorable, including the following, some of
board of directors, limitations on who may call special meetings of stockholders and a requirement that vacancies and newly created directorshipswhich may only
be filled by those directors that are in office.Changes in U.S. federal income tax law could make somebecome effective when the Majority Holders collectively own less than 40% of our outstanding shares of common stock:
| | |
| • | the division of our board of directors into three classes and the election of each class for three-year terms; |
|
| • | the sole ability of the board of directors to fill a vacancy created by the expansion of the board of directors; |
|
| • | advance notice requirements for stockholder proposals and director nominations; |
|
| • | limitations on the ability of stockholders to call special meetings and to take action by written consent; |
|
| • | when the Majority Holders collectively own 50% or less of our outstanding shares of common stock, the approval of holders of at least two-thirds of the shares entitled to vote generally on the making, alteration, amendment or repeal of our certificate of incorporation or bylaws, will be required to adopt, amend or repeal our bylaws, or amend or repeal certain provisions of our certificate of incorporation; |
|
| • | the required approval of holders of at least two-thirds of the shares entitled to vote at an election of the directors to remove directors and, following the classification of the board of directors, removal only for cause and |
|
| • | the ability of our board of directors to designate the terms of and issue new series of preferred stock, without stockholder approval, which could be used to institute a rights plan, or a poison pill, that would work to dilute the stock ownership or a potential hostile acquirer, likely preventing acquisitions that have not been approved by our board of directors. |
The existence of the products distributed byforegoing provisions and anti-takeover measures could limit the price that investors might be willing to pay in the future for shares of our financial advisors less attractive to clients.common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that you could receive a premium for your common stock in the acquisition.
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Some of the products distributed by our financial advisors enjoy favorable treatment under current U.S. federal income tax law. Changes in U.S. federal income tax law could make some of these products less attractive to clients and, as a result, could have a material adverse effect on our business, results of operations, cash flows or financial condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS
| |
| Item 1B. | Unresolved Staff Comments |
Our corporate
headquartersoffices are located in Boston, Massachusetts where we lease approximately 36,000 square feet of space under a lease agreement that expires on June 30, 2012, and approximately 21,000 square feet of space under a lease agreement that expires on May 31,
2013,2013; in San Diego, California where we lease approximately 407,000 square feet of space under lease agreements that
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expire starting on May 31, 2012, and2012; in Charlotte, North Carolina where we lease a total of approximately 238,000 square feet of space under lease agreements expiring on November 30, 2016 and February 28, 2017.
Our subsidiary PTC, located in Cleveland, Ohio, leases approximately 6,000 square feet of space under a lease agreement that expires on March 31, 2012.
Our subsidiary UVEST, located in Charlotte, North Carolina, leases approximately 42,000 square feet of space under a lease agreement that expires on December 31, 2013, all of which has been vacated. In 2009, UVEST moved into our corporate headquarters in Charlotte, North Carolina.
Our subsidiary MSC leases approximately 38,000 square feet of space in West Palm Beach, Florida under a lease agreement that expires February 28, 2018, included in this amount is approximately 25,000 square feet of vacated space.
Our subsidiary WFG leases approximately 17,000 square feet of space in Itasca, Illinois under a lease agreement that expires June 30, 2016.
Our subsidiary AFG leases approximately 24,000 square feet of space in El Segundo, California under a lease agreement that expires February 14, 2012, included in this amount is approximately 22,000 square feet of vacated space.
We own approximately
4.54.4 acres of land in San Diego. We believe that our existing properties are adequate for the current operating requirements of our business and that additional space will be available as needed.
ITEM 3. LEGAL PROCEEDINGS
We are presently and regularly involved in legal proceedings in the ordinary course of our business, including lawsuits, arbitration claims, regulatory
and/or governmental subpoenas, investigations and actions, and other claims. Many of our legal proceedings are initiated by our
customers'advisors’ clients and involve the purchase or sale of investment securities.
In connection with various acquisitions, and
pursuant tounder the
applicable purchase and sale
agreements,agreement, we have received third-party indemnification for certain legal proceedings and claims. These matters have been defended and paid directly by the indemnifying party. On October 1, 2009, our subsidiary, LPL Holdings, Inc.
("LPLH"(“LPLH”), received written notice from a third-party indemnitor under a certain purchase and sale agreement asserting that it is no longer obligated to indemnify the
Companycompany for certain claims under the provisions of the purchase and sale agreement. We believe that this assertion is without merit and we have commenced litigation to enforce our indemnity rights.
On November 20, 2009, LPLH and three of its affiliated broker-dealers filed suit to enforce the indemnitor’s performance pursuant to the provisions of the contract. In February 2010, these plaintiffs filed a motion for summary judgment with the court, which was opposed by the third party indemnitor. In May 2010, the court heard oral argument on the motion. In March 2011, the court granted the motion for summary judgment in all respects, denied all counterclaims by the third party indemnitor and awarded attorney fees to the plaintiffs.
In 2010, we settled two arbitrations that involve activities covered under the third-party indemnification agreement described above. In connection with these settlements, we have recorded legal expenses of $8.9 million. We will seek to recover the costs associated with defending and settling these matters, plus other costs incurred on matters that we believe are subject to indemnification.
We believe, based on the information available at this time, after consultation with counsel, consideration of insurance, if any, and the indemnifications provided by the third-party indemnitors, notwithstanding the assertions by an indemnifying party noted in the preceding
paragraph,paragraphs, that the outcome of such matters will not have a material adverse impact on our business, results of operations, cash flows or financial condition.
We cannot predict at this time the effect that any future legal proceeding will have on our business. Given the current regulatory environment and our business operations throughout the country, it is likely that we will become subject to further legal proceedings. Our ultimate liability, if any, in connection with any future such matters is uncertain and is subject to contingencies not yet known.
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| Item 4. | Removed and Reserved |
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| |
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
There is
The Company’s common stock commenced trading on the NASDAQ under the symbol “LPLA” on November 18, 2010. Prior to that time, there was no
established tradingpublic market for our common
equity.Stock Split
We affected a ten-for-one stock split as of January 1, 2008. All per share amounts, average shares and options outstanding, and shares and options outstanding have been adjusted retroactively to reflect the stock split.
Holders
stock. As of December 31, 2009,2010, we have 75 holders1,191 stockholders of 86,790,789record and 108,714,757 shares of our common stock outstanding. The following table sets forth theintra-day high and low sale prices of the Company’s common stock from the IPO date of November 18, 2010 to December 31, 2010, as well as 1,070 holdersreported by the NASDAQ.
| | | | | | | | | |
2010 | | High | | Low |
| |
| Fourth Quarter (beginning November 18, 2010) | | | 37.22 | | | | 31.50 | |
Performance Graph
The following graph compares the cumulative total stockholder return since November 18, 2010, the date our common stock began trading on the NASDAQ, with the Standard & Poor’s 500 Financial Sector Index and the Dow Jones U.S. Financial Services Index. The graph assumes that the value of
7,423,973 shares ofthe investment in our
restricted common
stock.stock and the S&P 500 was $100 on November 18, 2010.
We have not paid any dividends
have been paidon our common stock during the past four
fiscal years
norand we do
wenot currently anticipate
declaring or paying
cash dividends
on our common stock in the foreseeable future.
For a description We currently intend to retain all of our future earnings, if any, to finance operations and repay debt. Our senior secured credit facilities contain restrictions on our ability to payactivities, including paying dividends on the common equity,our capital stock. For an explanation of these restrictions see "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations—Indebtedness."Operations — Indebtedness”. In addition, FINRA regulations restrict dividends in excess of 10% of a member firm’s excess net capital without FINRA’s prior approval, potentially impeding our ability to receive dividends from LPL Financial. Any future determination relating to our dividend policy will be made at the discretion of our board of directors and will
30
depend on a number of factors, including future earnings, capital requirements, financial conditions, future prospects, contractual restrictions and covenants and other factors that our board of directors may deem relevant.
Equity Compensation Plan Information The table below sets forth as of December 31, 20092010 information on compensation plans under which our equity securities are authorized for issuance:
| | | | | | | | | | | | | |
| | | Number of Securities
| | | | | | Number of Securities
| |
| | | to be Issued
| | | Weighted Average
| | | Remaining Available
| |
| | | upon Exercise of
| | | Exercise Price of
| | | for Future
| |
| | | Outstanding Options,
| | | Outstanding Options,
| | | Issuance under Equity
| |
Plan category | | Warrants and Rights | | | Warrants and Rights | | | Compensation Plans | |
| |
| Equity compensation plans approved by security holders | | | 10,253,843 | | | $ | 18.09 | | | | 10,315,678 | (1) |
| Equity compensation plans not approved by security holders | | | 2,859,647 | | | | 0.28 | | | | — | (2) |
| | | | | | | | | | | | | |
| Total | | | 13,113,490 | | | $ | 14.21 | | | | 10,315,678 | |
| | | | | | | | | | | | | |
| | | | | | | | | |
Plan category | | Number of securities
to be issued
upon exercise of
outstanding options,
warrants and rights | | Weighted average
exercise price of
outstanding options,
warrants and rights | | Number of securities
remaining available
for future
issuance under equity
compensation plans |
|---|
Equity compensation plans approved by security holders | | | 22,661,951 | | $ | 6.96 | | (1) |
Equity compensation plans not approved by security holders | | | 10,287,943 | | | 0.09 | | (1) |
| | | | | | | |
| | Total | | | 32,949,894 | | $ | 4.82 | | (1) |
| | | | | | | |
| | |
| (1) | | Includes shares available for future issuance under our 2010 Omnibus Equity Incentive Plan. Following our IPO, grants will no longer be made under our 2005 Stock Option Plan for Incentive Stock Options, 2005 Stock Option Plan for Non-Qualified Stock Options, 2008 Stock Option Plan and Advisor Incentive Plan. |
|
| (2) | | Pursuant to the terms thereof, there are no securities remaining for future issuance under the 2008 Nonqualified Deferred Compensation Plan. In addition, following our IPO, grants will no longer be made under our Financial Institution Incentive Plan. |
(1)Our 2008 Stock Option Plan, Advisor Incentive Plan and Financial Institution Incentive Plan provide for an aggregate allocation of up to 2.5% of the outstanding stock determined at January 1 on a fully diluted basis, adjusted for forfeited awards. On January 1, 2010, there were 3,074,033 securities remaining available for future issuance under such plans.
Issuance Under Fifth Amended and Restated LPL Investment Holdings Inc. 2000 Stock Bonus Plan
As of December 31, 2009, we issued and had outstanding 7,423,973 shares of restricted common stock under our Fifth Amended and Restated LPL Investment Holdings Inc. 2000 Stock Bonus Plan. Each holder of restricted stock has full voting rights over his or her shares. The shares of restricted stock shall become fully vested shares of our common stock upon (i) a sale of all or substantially all of
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the business or assets of our subsidiary, LPLH or LPLIH that also constitutes a change in control event under Section 409A of the Code or the regulations thereunder, or (ii) an initial public offering of our common stock. These restricted stock shares may not be sold, assigned or transferred and are not entitled to receive dividends or non-cash distributions until either a sale of LPLIH that constitutes a change in control or an initial public offering. The plan relating to the shares of restricted stock shares has not been approved by security holders. The intent of the plan was to aid us in attracting, motivating and retaining financial advisors of outstanding ability by offering such financial advisors an opportunity to receive grants of stock-based awards, thereby increasing their personal interest in our growth and success.
Issuance Under 2008 Nonqualified Deferred Compensation Plan
As of December 31,
2009,2010, we issued and had outstanding 2,823,452 restricted stock units under our 2008 Nonqualified Deferred Compensation Plan (the
"Deferred“Deferred Compensation
Plan"Plan”). The purpose of the Deferred Compensation Plan is to permit employees and former employees of the Company and its subsidiaries that held stock options issued under the 2005 Option Plans that were to expire in 2009 or 2010 to receive stock units under the Deferred Compensation Plan that are paid out at a later date in the form of shares of our common stock. The Deferred Compensation Plan is administered by the Board, or such other committee as may be appointed by the Board to administer the Deferred Compensation Plan (the
"Administrator"“Administrator”). The Administrator has all powers necessary to administer the Deferred Compensation Plan, including discretionary authority to determine eligibility for benefits and to decide claims under the Deferred Compensation Plan.
Current and former employees of LPLIH and its subsidiaries that held stock options under the 2005 Option Plans that were scheduled to expire in 2009 or 2010 (the "Expiring Options"“Expiring Options”) were able to make a one-time election to participate in the Deferred Compensation Plan. Participants elected to cancel their Expiring Options and receive stock units held in an account under the Deferred Compensation Plan. Each stock unit is a bookkeeping entry of which one stock unit is the economic equivalent of one share of our common stock. The Administrator created an account on each participant'sparticipant’s behalf to which the participant'sparticipant’s initial balance was credited, which will then be converted into stock units. A participant'sparticipant’s initial balance was an amount equal to the fair market value on December 31, 2008 of the shares underlying the stock options the participant elected to defer, less the aggregate exercise price of these options. The initial number of stock units in a participant'sparticipant’s account equals his or her initial balance divided by the fair market value of a share of our common stock on December 31, 2008.
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an aggregate total of 18,76317,223,230 shares of our common stock at an exercisea price of $30.00 per share, as presented below:
| | | | | | | | | |
| | | Number of
| | | | |
| | | Shares
| | | Aggregate
| |
| | | Offered in the
| | | Offering Price
| |
| | | IPO | | | (In thousands) | |
| |
| Common stock offered by selling stockholders | | | 15,657,482 | | | $ | 469,724 | |
| Common stock sold by Company pursuant to the over-allotment option granted to the underwriters | | | 1,465,748 | | | | 43,972 | |
| Common stock sold by stockholder pursuant to over-allotment option granted to the underwriters | | | 100,000 | | | | 3,000 | |
| | | | | | | | | |
| Over-allotment option granted to the underwriters | | | 1,565,748 | | | | 46,972 | |
| | | | | | | | | |
| Total shares offered in the IPO | | | 17,223,230 | | | $ | 516,696 | |
| | | | | | | | | |
Goldman, Sachs & Co., Morgan Stanley, Bank of $23.02,America Merrill Lynch and J.P. Morgan acted as joint book running managers of the offering. The offering commenced on November 18, 2010 and closed on November 23, 2010. The sale of shares pursuant to the over-allotment option occurred on November 23, 2010.
As a result of our Financial Institution Incentive Plan. No consideration was paidIPO, we raised a total of $44.0 million in gross proceeds, and approximately $33.5 million in net proceeds after deducting underwriting discounts and commissions of $5.9 million, and $4.6 million of offering costs related to the sale of common stock by us and the selling shareholders. We did not receive any recipient of any of the foregoing warrants for the grant of stock. The warrants vest in equal increments of 20.0% over a five-year period and expire on the 10th anniversary following the date of grant. The transactions were conducted in reliance upon the available exemptionsproceeds from the registration requirementssale of shares of common stock by the Securities Act, including those containedselling stockholders.
On January 31, 2011, we repaid $40.0 million of term loans under our senior secured credit facilities using net proceeds received in
Section 4(2).
the IPO, as well as other cash on hand.
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ITEM 6. SELECTED FINANCIAL DATA
| |
| Item 6. | Selected Financial Data |
The following table sets forth our selected historical financial information for the past five fiscal years. The selected historical financial information presented below should be read in conjunction with the information included under the heading
"Management's“Management’s Discussion and Analysis of Financial Condition and Results of
Operations"Operations” and our
historical consolidated financial statements and related notes included elsewhere in this Annual Report on
Form 10-K. Our selected historical financial
We have derived the consolidated statements of operations data
may not be comparable from period to period and may not be indicative of future results. Additionally, historical dividends per share are presented as declared by the predecessor company under its capital structure at that time. Common shares of our predecessor company are not equal to common shares under our current capital structure and are not necessarily indicative of amounts that would have been received per common share of current ownership. | | | | | | | | | | | | | | | | |
| | For the Year Ended December 31, | |
|---|
| |
| |
| |
| |
| | Predecessor(2) | |
|---|
| | 2009(1) | | 2008(1) | | 2007(1) | | 2006 | | 2005 | |
|---|
| | (in thousands)
| |
|---|
Consolidated statements of income data: | | | | | | | | | | | | | | | | |
Net revenues | | $ | 2,749,505 | | $ | 3,116,349 | | $ | 2,716,574 | | $ | 1,739,635 | | $ | 1,406,320 | |
Total expenses | | | 2,676,938 | | | 3,023,584 | | | 2,608,741 | | | 1,684,769 | | | 1,290,570 | |
Income from continuing operations before provision for income taxes | | | 72,567 | | | 92,765 | | | 107,833 | | | 54,866 | | | 115,750 | |
Provision for income taxes | | | 25,047 | | | 47,269 | | | 46,764 | | | 21,224 | | | 46,461 | |
Discontinued operations | | | — | | | — | | | — | | | — | | | (26,200 | ) |
Net income | | | 47,520 | | | 45,496 | | | 61,069 | | | 33,642 | | | 43,089 | |
Cash dividends per common share | | | n/a | | | n/a | | | n/a | | | n/a | | | n/a | |
Cash dividends per common share—Class A & C (Predecessor) | | | n/a | | | n/a | | | n/a | | | n/a | | $ | 6.36 | |
Cash dividends per common share—Class B (Predecessor) | | | n/a | | | n/a | | | n/a | | | n/a | | $ | 1.47 | |
| | | | | | | | | | | | | | | | |
| | As of December 31, | |
|---|
| |
| |
| |
| |
| | Predecessor(2) | |
|---|
| | 2009(1) | | 2008(1) | | 2007(1) | | 2006 | | 2005 | |
|---|
| | (in thousands)
| |
|---|
Consolidated statements of financial condition data: | | | | | | | | | | | | | | | | |
Total assets | | $ | 3,336,936 | | $ | 3,381,779 | | $ | 3,287,349 | | $ | 2,797,544 | | $ | 2,638,486 | |
Long-term obligations | | | 1,369,223 | | | 1,467,647 | | | 1,451,071 | | | 1,344,375 | | | 1,345,000 | |
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| | | | | | | | | | | | | | | | |
| | As of and For the Year Ended December 31, | |
|---|
| |
| |
| |
| |
| | Predecessor(2) | |
|---|
| | 2009(1) | | 2008(1) | | 2007(1) | | 2006 | | 2005 | |
|---|
Other financial and operating data: | | | | | | | | | | | | | | | | |
Gross margin(3) (in thousands) | | | 844,926 | | | 953,301 | | | 781,102 | | | 508,530 | | | 407,019 | |
Gross margin as a % of net revenue(3) | | | 30.7 | % | | 30.6 | % | | 28.8 | % | | 29.2 | % | | 28.9 | % |
Number of financial advisors(4) | | | 11,950 | | | 11,920 | | | 11,089 | | | 7,006 | | | 6,481 | |
Full-time employees | | | 2,409 | | | 2,760 | | | 2,621 | | | 1,423 | | | 1,145 | |
AUM(5) (in billions) | | $ | 279.4 | | $ | 233.9 | | $ | 283.2 | | $ | 164.7 | | $ | 105.4 | |
Total funded client accounts(6) (in thousands) | | | 3,923 | | | 3,454 | | | 3,276 | | | 2,444 | | | 2,046 | |
(1)Financial results as of and for the years ended December 31, 2010, 2009 and 2008 and 2007 include the acquisitionsconsolidated statements of UVEST (acquired on January 2, 2007), the Affiliated Entities (acquired on June 20, 2007) and IFMG (acquired on November 7, 2007). Consequently, the results of operations for 2009, 2008 and 2007 may not be directly comparable to prior years.
(2)On December 28, 2005, we sold approximately 61% ownership stake in our firm through a merger transaction to two private equity partners, Hellman & Friedman LLC and TPG. Activitiesfinancial condition data as of December 28, 200531, 2010 and periods prior are those2009 from our audited financial statements. We have derived the consolidated statements of operations data for the Predecessor.
(3)Gross margin is calculated as net revenues less production expenses. Production expenses consist of commissionsyears ended December 31, 2007 and advisory fees as well as brokerage, clearing2006 and exchange fees.
(4)Numberconsolidated statements of financial advisors is definedcondition data as those investment professionals whoof December 31, 2008, 2007 and 2006 from our audited financial statements not included in this Annual Report onForm 10-K. Our historical results for any prior period are licensednot necessarily indicative of results to do business with our broker-dealer subsidiaries.
(5)Assets under management ("AUM") is comprised of custodied, networked and non-networked brokerage and advisory assets and reflect market movementbe expected in addition to new assets, inclusive of recruiting and net of attrition.
(6)Represents custodied, networked and non-networked client accounts that have been funded. In the third quarter of 2009, we enhanced our methodology for calculating client accounts to include networked variable annuities that were not previously available. This change resulted in an increase of 0.6 million client accounts.
any future period.| | | | | | | | | | | | | | | | | | | | | |
| | | For the Year Ended December 31, |
| | | 2010 | | 2009 | | 2008 | | 2007 | | 2006(1) |
| |
Consolidated statements of operations data: | | | | | | | | | | | | | | | | | | | | |
| Net revenues | | $ | 3,113,486 | | | $ | 2,749,505 | | | $ | 3,116,349 | | | $ | 2,716,574 | | | $ | 1,739,635 | |
| Total expenses | | | 3,202,335 | | | | 2,676,938 | | | | 3,023,584 | | | | 2,608,741 | | | | 1,684,769 | |
| (Loss) Income from operations before (benefit from) provision for income taxes | | | (88,849 | ) | | | 72,567 | | | | 92,765 | | | | 107,833 | | | | 54,866 | |
| (Benefit from) Provision for income taxes | | | (31,987 | ) | | | 25,047 | | | | 47,269 | | | | 46,764 | | | | 21,224 | |
| Net (loss) income | | | (56,862 | ) | | | 47,520 | | | | 45,496 | | | | 61,069 | | | | 33,642 | |
Per share data: | | | | | | | | | | | | | | | | | | | | |
| (Loss) Earnings per basic share | | $ | (0.64 | ) | | $ | 0.54 | | | $ | 0.53 | | | $ | 0.72 | | | $ | 0.41 | |
| (Loss) Earnings per diluted share | | $ | (0.64 | ) | | $ | 0.47 | | | $ | 0.45 | | | $ | 0.62 | | | $ | 0.35 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | As of December 31, |
| | | 2010 | | 2009 | | 2008 | | 2007 | | 2006(1) |
| |
Consolidated statements of financial condition data: | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 419,208 | | | $ | 378,594 | | | $ | 219,239 | | | $ | 188,003 | | | $ | 245,163 | |
| Total assets | | | 3,646,167 | | | | 3,336,936 | | | | 3,381,779 | | | | 3,287,349 | | | | 2,797,544 | |
| Total debt(2) | | | 1,386,639 | | | | 1,369,223 | | | | 1,467,647 | | | | 1,451,071 | | | | 1,344,375 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | As of and for the Year Ended December 31, |
| | | 2010 | | 2009 | | 2008 | | 2007 | | 2006(1) |
| |
Other financial and operating data: | | | | | | | | | | | | | | | | | | | | |
| Adjusted EBITDA (in thousands)(3) | | $ | 413,113 | | | $ | 356,068 | | | $ | 350,171 | | | $ | 329,079 | | | $ | 247,912 | |
| Adjusted Earnings (in thousands)(3) | | $ | 172,720 | | | $ | 129,556 | | | $ | 108,863 | | | $ | 107,404 | | | $ | 65,372 | |
| Adjusted Earnings per share(3) | | $ | 1.71 | | | $ | 1.32 | | | $ | 1.09 | | | $ | 1.08 | | | $ | 0.68 | |
| Gross margin (in thousands)(4) | | $ | 937,933 | | | $ | 844,926 | | | $ | 953,301 | | | $ | 781,102 | | | $ | 508,530 | |
| Gross margin as a % of net revenue(4) | | | 30.1 | % | | | 30.7 | % | | | 30.6 | % | | | 28.8 | % | | | 29.2 | % |
| Number of advisors(5) | | | 12,444 | | | | 11,950 | | | | 11,920 | | | | 11,089 | | | | 7,006 | |
| Advisory and brokerage assets (in billions)(6) | | $ | 315.6 | | | $ | 279.4 | | | $ | 233.9 | | | $ | 283.2 | | | $ | 164.7 | |
| Advisory assets under management (in billions)(7) | | $ | 93.0 | | | $ | 77.2 | | | $ | 59.6 | | | $ | 73.9 | | | $ | 51.1 | |
| Insured cash account balances (in billions)(7) | | $ | 12.2 | | | $ | 11.6 | | | $ | 11.2 | | | $ | 8.6 | | | $ | 5.8 | |
| Money market account balances (in billions)(7) | | $ | 6.9 | | | $ | 7.0 | | | $ | 11.2 | | | $ | 7.4 | | | $ | 3.5 | |
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
34
| | |
| (1) | | Financial results as of and for the years ended December 31, 2010, 2009, 2008 and 2007 include several broker-dealer acquisitions that occurred in 2007. Consequently, the results of operations for 2006 may not be directly comparable to later periods. |
|
| (2) | | Total debt consists of our senior secured credit facilities, senior unsecured subordinated notes, revolving line of credit facility and bank loans payable. |
|
| (3) | | See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — How We Evaluate Growth” for an explanation of Adjusted EBITDA, Adjusted Earnings and Adjusted Earnings per share. |
|
| (4) | | Gross margin is calculated as net revenues less production expenses. Production expenses consist of the following expense categories from our consolidated statements of operations: (i) commissions and advisory fees and (ii) brokerage, clearing and exchange. All other expense categories, including depreciation and amortization, are considered general and administrative in nature. Because our gross margin amounts do not include any depreciation and amortization expense, our gross margin amounts may not be comparable to those of others in our industry. In 2010, upon closing our IPO in the fourth quarter, the restriction on approximately 7.4 million shares of common stock issued to our advisors under the Fifth Amended and Restated 2000 Stock Bonus Plan was released. Accordingly, we recorded a share-based compensation charge of $222.0 million in the fourth quarter of 2010, representing the offering price of $30.00 per share multiplied by 7.4 million shares. This charge has been classified as production expense in 2010. Gross margin as calculated for 2010 above does not include this charge for comparability purposes with previous years shown. |
|
| (5) | | Number of advisors is defined as those investment professionals who are licensed to do business with our broker-dealer subsidiaries. In 2009, we attracted record levels of new advisors due to the dislocation in the marketplace that impacted many of our competitors. This record recruitment was offset by attrition related to the consolidation of the operations of the Affiliated Entities. Excluding this attrition, we added 750 net new advisors during 2009, representing 6.3% advisor growth. |
|
| (6) | | Advisory and brokerage assets are comprised of assets that are custodied, networked andnon-networked and reflect market movement in addition to new assets, inclusive of new business development and net of attrition. |
|
| (7) | | Advisory assets under management, insured cash account balances and money market balances are components of advisory and brokerage assets. |
35
| |
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion of our financial condition and results of operations should be read in conjunction with theour consolidated financial statements and accompanyingthe notes theretoto those consolidated financial statements included in Item 8 of thisForm 10-K. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those set forth under “Risk Factors” and elsewhere in thisForm 10-K, our actual results may differ materially from those anticipated in these forward-looking statements. We
are a leading providerprovide an integrated platform of
proprietary technology, brokerage and investment advisory services
through business relationships withto over 12,400 independent financial advisors
and financial advisors
employed byat financial institutions
registeredacross the country, enabling them to successfully service their retail investors with unbiased, conflict-free financial advice. In addition, we support approximately 4,000 financial advisors with customized clearing, advisory platforms and technology solutions. Our singular focus is to support our advisors with the front, middle and back-office support they need to serve the large and growing market for independent investment
advice, particularly in the mass affluent market. We believe we are the only company that offers advisors
("RIAs")the unique combination of an integrated technology platform, comprehensive self-clearing services and
financial institutions (collectively, our "customers"). Through our proprietary technology, custody and clearing platforms, we provide our customers withfull open architecture access to
a broad array ofleading financial products,
and services that enable them to provide independent financial advice and brokerage services to retail investors (their "clients").all delivered in an environment unencumbered by conflicts from product manufacturing, underwriting or market making.
Our Sources of Revenue
Our revenues are derived primarily from fees and commissions from products and advisory services offered by our
customersadvisors to their clients, a substantial portion of which we pay out to our
customers,advisors, as well as fees we receive from our
customersadvisors for use of our technology, custody and clearing platforms. We also generate
asset management-basedasset-based fees through
athe distribution of financial products for a broad
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range of product manufacturers. Under our self-clearing platform, we custody the majority of client assets invested in these financial products, which includes providing statements, transaction processing and ongoing account management. In return for these services, mutual funds, insurance companies, banks and other financial product manufacturers pay us fees based on asset levels or number of accounts managed. We also earn fees for margin lending to our customers'advisors’ clients.
We track recurring revenue, which we define to include our revenues from asset-based fees, advisory fees, our trailing commissions, cash sweep programs and certain transaction and other fees that are based upon accounts and advisors. Because recurring revenue is associated with asset balances, it will fluctuate depending on the market value of the asset balances and current interest rates. Accordingly, recurring revenue can be negatively impacted by adverse external market conditions. However, recurring revenue is meaningful to us despite these fluctuations because it is not based on transaction volumes or other activity-based fees, which are more difficult to predict, particularly in declining or volatile markets.
36
The table below summarizes the sources of our revenue and the underlying drivers:
| | |
| • | Commissions and Advisory Fees. Transaction-based commissions and advisory fees both represent advisor-generated revenue, generally85-90% of which is paid to advisors. |
| | |
| | Commissions. Transaction-based commission revenues represent gross commissions generated by our advisors, primarily from commissions earned on the sale of various financial products such as fixed and variable annuities, mutual funds, general securities, alternative investments and insurance and can vary from period to period based on the overall economic environment, number of trading days in the reporting period and investment activity of our clients. We also earn trailing commission type revenues (a commission that is paid over time, such as 12(b)-1 fees) on mutual funds and variable annuities held by clients of our advisors. Trail commissions are recurring in nature and are earned based on the current market value of investment holdings. |
|
| | Advisory Fees. Advisory fee revenues represent fees charged by us and our advisors to their clients based on the value of advisory assets. Some of our advisors conduct their advisory business through separate entities by establishing their own Registered Investment Advisor (“RIA”) pursuant to the Investment Advisers Act of 1940, rather than using our corporate registered RIA. These stand-alone RIAs engage us for technology, clearing, regulatory and custody services, as well as access to our investment advisory platforms. The fee-based production generated by the stand-alone RIA is earned by the advisor, and accordingly not included in our advisory fee revenue. We charge fees to stand-alone RIAs including administrative fees based on the value of assets within these advisory accounts. Such fees are included within asset-based fees and transaction and other fees, as described below. |
37
| | |
| • | Asset-Based Fees. Asset-based fees are comprised of fees from cash sweep programs, our financial product manufacturer sponsorship programs, and omnibus processing and networking services. Pursuant to contractual arrangements, uninvested cash balances in our advisors’ client accounts are swept into either insured deposit accounts at various banks or third-party money market funds, for which we receive fees, including administrative and record-keeping fees based on account type and the invested balances. In addition, we receive fees from certain financial product manufacturers in connection with sponsorship programs that support our marketing and sales-force education and training efforts. We also earn fees on mutual fund assets for which we provide administrative and record-keeping services. Our networking fees represent fees paid to us by mutual fund and annuity product manufacturers in exchange for administrative and record-keeping services that we provide to clients of our advisors. Networking fees are correlated to the number of positions we administer, not the value of assets under administration. |
| | |
| • | Transaction and Other Fees. Revenues earned from transaction and other fees primarily consist of transaction fees and ticket charges, subscription fees, IRA custodian fees, contract and license fees, conference fees and small/inactive account fees. We charge fees to our advisors and their clients for executing transactions in brokerage and fee-based advisory accounts. We earn subscription fees for the software and technology services provided to our advisors and on IRA custodial services that we provide for their client accounts. We charge monthly administrative fees to our advisors. We charge fees to financial product manufacturers for participating in our training and marketing conferences and fees to our advisors and their clients for accounts that do not meet certain specified thresholds of size or activity. In addition, we host certain advisor conferences that serve as training, sales and marketing events in our first and third fiscal quarters and as a result, we anticipate higher transaction and other fees resulting from the collection of revenues from sponsors and advisors, in comparison to other periods. |
|
| • | Interest and Other Revenue. Other revenue includes marketing re-allowances from certain financial product manufacturers as well as interest income from client margin accounts and cash equivalents, net of operating interest expense. |
Our Operating Expenses
| | |
| • | Production Expenses. Production expenses are comprised of the following: gross commissions and advisory fees that are earned and paid out to advisors based on the sale of various products and services; production bonuses for achieving certain levels of production; recognition of share-based compensation expense from stock options and warrants granted to advisors and financial institutions based on the fair value of the awards at each interim reporting period; amounts designated by advisors as deferred commissions in a non-qualified deferred compensation plan that are marked to market at each interim reporting period; and brokerage, clearing and exchange fees. We refer to these expenses as the production “payout”. Substantially all of the production payout is variable and correlated to the revenues generated by each advisor. |
Upon closing of our IPO in the fourth quarter of 2010, the restriction of approximately 7.4 million shares of common stock issued to advisors under the Fifth Amended and Restated 2000 Stock Bonus Plan was released. Accordingly, we recorded a share-based compensation charge of $222.0 million in the fourth quarter of 2010, representing the offering price of $30.00 per share multiplied by 7.4 million shares. This charge has been classified as production expense, but has been excluded from our production payout for consistency and comparability to other periods presented.
38
| | |
| • | Compensation and Benefits Expense. Compensation and benefits expense includes salaries and wages and related employee benefits and taxes for our employees (including share-based compensation), as well as compensation for temporary employees and consultants. |
|
| • | General and Administrative Expenses. General and administrative expenses include promotional fees, occupancy and equipment, communications and data processing, regulatory fees, travel and entertainment and professional services. We host certain advisor conferences that serve as training, sales and marketing events in our first and third fiscal quarters and as a result, we anticipate higher general and administrative expenses in comparison to other periods. |
|
| • | Depreciation and Amortization Expense. Depreciation and amortization expense represents the benefits received for using long-lived assets. Those assets represent significant intangible assets established through our acquisitions, as well as fixed assets which include internally developed software, hardware, leasehold improvements and other equipment. |
|
| • | Restructuring Charges. Restructuring charges represent expenses incurred as a result of our 2009 consolidation of the Affiliated Entities and our strategic business review committed to and implemented in 2008 to reduce our cost structure and improve operating efficiencies. |
|
| • | Other Expenses. Other expenses include bank fees, other taxes, bad debt expense and other miscellaneous expenses. In 2010, other expenses also includes $8.1 million of transaction costs related to our IPO which was completed in the fourth quarter, as well as $8.9 million for legal settlements that related to pre-acquisition legal matters for certain of our acquired businesses. |
We focus on several business and key financial and non-financial metrics in evaluating the success of our business relationships and our resulting financial position and operating performance. Our key metrics as of and for the years ended December 31, 2010, 2009, 2008, and 20072008 are as follows:
| | | | | | | | | | | | | |
| | | As of and for the Year Ended
|
| | | December 31, |
| | | 2010 | | 2009 | | 2008 |
| |
| | | | | | | | | | | | | |
Business Metrics | | | | | | | | | | | | |
| Advisors(1) | | | 12,444 | | | | 11,950 | | | | 11,920 | |
| Advisory and brokerage assets (in billions)(2) | | $ | 315.6 | | | $ | 279.4 | | | $ | 233.9 | |
| Advisory assets under management (in billions)(3) | | $ | 93.0 | | | $ | 77.2 | | | $ | 59.6 | |
| Net new advisory assets (in billions)(3)(4) | | $ | 8.5 | | | $ | 7.0 | | | | N/A | |
| Insured cash account balances (in billions)(3) | | $ | 12.2 | | | $ | 11.6 | | | $ | 11.2 | |
| Money market account balances (in billions)(3) | | $ | 6.9 | | | $ | 7.0 | | | $ | 11.2 | |
| | | | | | | | | | | | | |
Financial Metrics | | | | | | | | | | | | |
| Revenue growth (decline) from prior year | | | 13.2 | % | | | (11.8 | )% | | | 14.7 | % |
| Recurring revenue as a % of net revenue(5) | | | 60.7 | % | | | 57.3 | % | | | 58.5 | % |
| Gross margin (in millions)(6) | | $ | 937.9 | | | $ | 844.9 | | | $ | 953.3 | |
| Gross margin as a % of net revenue(6) | | | 30.1 | % | | | 30.7 | % | | | 30.6 | % |
| Net (loss) income (in millions) | | $ | (56.9 | ) | | $ | 47.5 | | | $ | 45.5 | |
| Adjusted EBITDA (in millions) | | $ | 413.1 | | | $ | 356.1 | | | $ | 350.2 | |
| Adjusted Earnings (in millions) | | $ | 172.7 | | | $ | 129.6 | | | $ | 108.9 | |
| (Loss) Earnings Per Share (diluted) | | $ | (0.64 | ) | | $ | 0.47 | | | $ | 0.45 | |
| Adjusted Earnings per Share (diluted) | | $ | 1.71 | | | $ | 1.32 | | | $ | 1.09 | |
| | |
| (1) | | Advisors are defined as those investment professionals who are licensed to do business with our broker-dealer subsidiaries. In 2009, we attracted record levels of new advisors due to the dislocation in the marketplace that impacted many of our competitors. This record recruitment was offset, however, by the attrition of approximately 720 advisors license through the Affiliated Entities related to the consolidation of the operations of the Affiliated Entities with LPL Financial. Excluding this attrition, we added 750 new advisors during 2009, representing 6.3% advisor growth. |
39
| | |
| (2) | | Advisory and brokerage assets are comprised of assets that are custodied, networked andnon-networked and reflect market movement in addition to new assets, inclusive of new business development and net of attrition. |
|
| (3) | | Advisory assets under management, insured cash account balances, money market balances and net new advisory assets are components of advisory and brokerage assets. |
|
| (4) | | Represents net new advisory assets that are custodied in the Company’s fee-based advisory platforms. Amounts prior to 2009 are not available. |
|
| (5) | | Recurring revenue is derived from sources such as advisory fees, asset-based fees, trailing commission fees, fees related to our cash sweep programs, interest earned on margin accounts and technology and service fees. In 2009, we revised our definition of recurring revenues. Accordingly, prior period amounts have been recast to reflect this change. |
|
| (6) | | Gross margin is calculated as net revenues less production expenses. Production expenses consist of the following expense categories from our consolidated statements of operations: (i) commissions and advisory fees and (ii) brokerage, clearing and exchange. All other expense categories, including depreciation and amortization, are considered general and administrative in nature. Because our gross margin amounts do not include any depreciation and amortization expense, our gross margin amounts may not be comparable to those of others in our industry. In 2010, upon closing our IPO in the fourth quarter, the restriction on approximately 7.4 million shares of common stock issued to our advisors under the Fifth Amended and Restated 2000 Stock Bonus Plan was released. Accordingly, we recorded a share-based compensation charge of $222.0 million in the fourth quarter of 2010, representing the offering price of $30.00 per share multiplied by 7.4 million shares. This charge has been classified as production expense in 2010. Gross margin as calculated for 2010 above does not include this charge for comparability purposes with previous years shown. |
| | | | | | | | | | |
| | 2009 | | 2008 | | 2007 | |
|---|
Non-Financial Metrics | | | | | | | | | | |
Financial advisors(1) | | | 11,950 | | | 11,920 | | | 11,089 | |
Total funded client accounts (in millions) | | | 3.9 | | | 3.5 | | | 3.3 | |
AUM(3) (in billions) | | $ | 279.4 | | $ | 233.9 | | $ | 283.2 | |
Financial Metrics | | | | | | | | | | |
Revenue growth from prior year | | | (11.8 | )% | | 14.7 | % | | 56.2 | % |
Recurring revenue as a % of net revenue(4) | | | 57.3 | % | | 58.5 | % | | 57.1 | % |
Gross margin(5) (in thousands) | | | 844,926 | | | 953,301 | | | 781,102 | |
Gross margin as a % of net revenue(5) | | | 30.7 | % | | 30.6 | % | | 28.8 | % |
Adjusted EBITDA (in millions) | | $ | 356.1 | | $ | 350.2 | | $ | 329.1 | |
(1)Financial advisors are defined as those investment professionals who are licensed to do business with our broker-dealer subsidiaries.
(2)Represents custodied, networked and non-networked client accounts that have been funded. In the third quarter of 2009, we enhanced our methodology for calculating client accounts to include networked variable annuities that were not previously available. This change resulted in an increase of 0.6 million client accounts.
(3)AUM is comprised of custodied, networked and non-networked brokerage and advisory assets and reflect market movement in addition to new assets, inclusive of recruiting and net of attrition.
(4)Revenue is derived from recurring sources such as advisory fees, asset-based fees, trailing commission fees, fees related to our cash sweep programs, interest earned on margin accounts and technology and service fees. In 2009, we revised our definition of recurring revenues. Accordingly, prior period amounts have been recast to reflect this change.
(5)Gross margin is calculated as net revenues less production expenses, which include commissions and advisory fees as well as brokerage, clearing and exchange fees.
EBITDA and Adjusted EBITDA
Adjusted EBITDA is defined as
netEBITDA (net income plus interest expense, income tax expense, depreciation and
amortization. Adjusted EBITDA, as we use it, is EBITDAamortization), further adjusted to exclude certain non-cash charges
infrequent or unusual items and other adjustments set forth below. We
believe that the presentation of EBITDA and Adjusted EBITDA is appropriate to provide additional information to investors about the calculation of, and compliance with, certain financial covenants in our senior credit facilities. Our senior secured credit facilities and the indenture governing the senior unsecured subordinated notes contain various covenants that limit our ability to engage in specified types of transactions. The
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achievement of certain financial ratio targets increases our ability to engage in certain activities such as incurring indebtedness, making investments and paying dividends. Adjusted EBITDA is a material component of these covenants.
We also present EBITDA and Adjusted EBITDA because we consider themit an important supplemental measure of our performance and believe they are frequently used by security analysts, investors and other interested parties in the evaluation of high-yield issuers, many of which present EBITDA andperformance. Adjusted EBITDA when reporting their results. EBITDA and Adjusted EBITDA areis a useful financial metricsmetric in assessing our operating performance from period to period by excluding certain items that we believe are not representative of our core business, such as certain material non-cash items and infrequent or unusual itemsother adjustments.
We believe that
we do not expect to continue in the future and are outside the control of operating management. EBITDA and Adjusted EBITDA, viewed in addition to, and not in lieu of, our reported GAAP results, provides useful information to investors regarding our performance and overall results of operations for the following reasons:
| | |
| • | because non-cash equity grants made to employees at a certain price and point in time do not necessarily reflect how our business is performing at any particular time, stock-based compensation expense is not a key measure of our operating performance and |
|
| • | because costs associated with acquisitions and the resulting integrations, debt refinancing, restructuring and conversions can vary from period to period and transaction to transaction, expenses associated with these activities are not considered a key measure of our operating performance. |
We use Adjusted EBITDA:
| | |
| • | as a measure of operating performance; |
|
| • | for planning purposes, including the preparation of budgets and forecasts; |
|
| • | to allocate resources to enhance the financial performance of our business; |
|
| • | to evaluate the effectiveness of our business strategies; |
|
| • | in communications with our board of directors concerning our financial performance and |
|
| • | as a bonus target for our employees. |
40
Adjusted EBITDA is a non-GAAP
measures as defined by Regulation G under the Securities Actmeasure and
dodoes not purport to be an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measure of liquidity. The
terms EBITDA andterm Adjusted EBITDA
areis not defined under GAAP, and
EBITDA and Adjusted EBITDA
areis not
measuresa measure of net income, operating income or any other performance measure derived in accordance with GAAP, and
areis subject to important limitations.
Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
| | |
| • | Adjusted EBITDA does not reflect all cash expenditures, future requirements for capital expenditures or contractual commitments; |
|
| • | Adjusted EBITDA does not reflect changes in, or cash requirements for, working capital needs and |
|
| • | Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt. |
In addition, Adjusted EBITDA can differ significantly from company to company depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which companies operate and capital investments. Because of these limitations,
EBITDA and Adjusted EBITDA should not be considered as
measuresa measure of discretionary cash available to us to invest in our business. We compensate for these limitations by relying primarily on the GAAP results and using
EBITDA and Adjusted EBITDA as supplemental information.
Set forth below is a reconciliation from our net (loss) income to EBITDA and Adjusted EBITDA for the years ended December 31, 2010, 2009 and 2008 and 2007:(in thousands):
| | | | | | | | | | | | | |
| | | For the Year Ended December 31, | |
| | | 2010 | | | 2009 | | | 2008 | |
| |
| Net (loss) income | | $ | (56,862 | ) | | $ | 47,520 | | | $ | 45,496 | |
| Interest expense | | | 90,407 | | | | 100,922 | | | | 115,558 | |
| Income tax (benefit) expense | | | (31,987 | ) | | | 25,047 | | | | 47,269 | |
| Amortization of purchased intangible assets and software(1) | | | 43,658 | | | | 59,577 | | | | 61,702 | |
| Depreciation and amortization of all other fixed assets | | | 42,379 | | | | 48,719 | | | | 38,760 | |
| | | | | | | | | | | | | |
| EBITDA | | | 87,595 | | | | 281,785 | | | | 309,785 | |
| EBITDA Adjustments: | | | | | | | | | | | | |
| Share-based compensation expense(2) | | | 10,429 | | | | 6,437 | | | | 4,160 | |
| Acquisition and integration related expenses(3) | | | 12,569 | | | | 3,037 | | | | 18,326 | |
| Restructuring and conversion costs(4) | | | 22,835 | | | | 64,078 | | | | 15,122 | |
| Debt amendment and extinguishment costs(5) | | | 38,633 | | | | — | | | | — | |
| Equity issuance and IPO related costs(6) | | | 240,902 | | | | 580 | | | | — | |
| Other(7) | | | 150 | | | | 151 | | | | 3,778 | |
| | | | | | | | | | | | | |
| Total EBITDA Adjustments | | | 325,518 | (8) | | | 74,283 | | | | 41,386 | |
| | | | | | | | | | | | | |
| Adjusted EBITDA | | $ | 413,113 | | | $ | 356,068 | | | $ | 350,171 | |
| | | | | | | | | | | | | |
| | | | | | | | | | |
| | 2009 | | 2008 | | 2007 | |
|---|
| | (in thousands)
| |
|---|
Net income | | $ | 47,520 | | $ | 45,496 | | $ | 61,069 | |
Interest expense(a) | | | 100,922 | | | 115,558 | | | 122,817 | |
Income tax expense | | | 25,047 | | | 47,269 | | | 46,764 | |
Depreciation and amortization | | | 108,296 | | | 100,462 | | | 78,748 | |
| | | | | | | | |
EBITDA(f) | | | 281,785 | | | 308,785 | | | 309,398 | |
Non-cash items(b) | | | 23,978 | | | 11,751 | | | 11,457 | |
Infrequent items(c) | | | 46,369 | | | 15,627 | | | 6,157 | |
Other adjustment items(d) | | | 3,936 | | | 14,008 | | | 2,067 | |
| | | | | | | | |
Adjusted EBITDA(f) | | | 356,068 | | | 350,171 | | | 329,079 | |
Pro-forma adjustments(e) | | | — | | | 9,829 | | | 13,354 | |
| | | | | | | | |
Adjusted EBITDA as defined under the Credit Agreement(f) | | $ | 356,068 | | $ | 360,000 | | $ | 342,433 | |
| | | | | | | | |
(a)Represents interest | | |
| (1) | | Represents amortization of intangible assets and software as a result of our purchase accounting adjustments from our merger transaction in 2005 with the Majority Holders and our 2007 acquisitions of UVEST, the Affiliated Entities and IFMG. |
|
| (2) | | Represents share-based compensation expense from borrowings under our senior credit facilities, senior unsecured subordinated notes and revolving line of credit facilities, as defined under the terms of our credit agreement.
(b)Represents asset impairment charges related to vested stock options awarded to employees and non-executive directors based on the grant date fair value under the Black-Scholes valuation model. |
41
| | |
| (3) | | Represents acquisition and integration costs primarily as a result of our 2007 acquisitions of UVEST, the Affiliated Entities and IFMG. Included in the year ended December 31, 2010, is $8.9 million of expenditures for certain legal settlements that have not been resolved with the indemnifying party. See “Item 3. Legal Proceedings”. |
|
| (4) | | Represents organizational restructuring charges incurred for severance and one-time termination benefits, asset impairments, lease and contract termination fees and other transfer costs. |
|
| (5) | | Represents debt amendment costs incurred in 2010 for amending and restating our credit agreement to establish a new term loan tranche and to extend the maturity of an existing tranche on our senior credit facilities, and debt extinguishment costs to redeem our subordinated notes, as well as certain professional fees incurred. |
|
| (6) | | Represents equity issuance and related costs for our IPO, which was completed in the fourth quarter of 2010. For 2009, $0.6 million of costs that were previously classified as restructuring and conversion have been reclassified to equity issuance and IPO related costs to conform to the current period presentation. Upon closing of the offering, the restriction on approximately 7.4 million shares of common stock issued to advisors under our Fifth Amended and Restated 2000 Stock Bonus Plan was released. Accordingly, the Company recorded a share-based compensation charge of $222.0 million, representing the offering price of $30.00 per share multiplied by 7.4 million shares. |
|
| (7) | | Represents impairment charges in 2008 for our equity investment in Blue Frog Solutions, Inc. (See Note 4 of our consolidated financial statements), other taxes and employment tax withholding related to a nonqualified deferred compensation plan. |
|
| (8) | | The following table shows the adjustments to the revenue and expense classifications identified in our consolidated statements of operations used to arrive at our Total EBITDA Adjustments for the year ended December 31, 2010 (in thousands): |
| | | | | | | | | |
| | | Year Ended December 31, 2010 | |
| | | GAAP | | | Adjustments | |
| |
Revenues | | | | | | | | |
| Commissions | | $ | 1,620,811 | | | $ | — | |
| Advisory fees | | | 860,227 | | | | — | |
| Asset-based fees | | | 317,505 | | | | — | |
| Transaction and other fees | | | 274,148 | | | | 1,317 | |
| Other | | | 40,795 | | | | 5 | |
| | | | | | | | | |
Net revenues | | | 3,113,486 | | | | 1,322 | |
| | | | | | | | | |
Expenses | | | | | | | | |
| Production | | | 2,397,535 | | | | (222,028 | ) |
| Compensation and benefits | | | 308,656 | | | | (20,760 | ) |
| General and administrative | | | 233,015 | | | | (7,511 | ) |
| Depreciation and amortization | | | 86,037 | | | | — | |
| Restructuring charges | | | 13,922 | | | | (13,922 | ) |
| Other | | | 34,826 | | | | (21,996 | ) |
| | | | | | | | | |
Total operating expenses | | | 3,073,991 | | | | (286,217 | ) |
| Non-operating interest expense | | | 90,407 | | | | — | |
| Loss on extinguishment of debt | | | 37,979 | | | | (37,979 | ) |
| Gain on equity method investment | | | (42 | ) | | | — | |
| | | | | | | | | |
Total expenses | | | 3,202,335 | | | | (324,196 | ) |
| | | | | | | | | |
(Loss) income before (benefit from) provision for income taxes | | $ | (88,849 | ) | | $ | 325,518 | |
| | | | | | | | | |
42
Adjusted Earnings and Adjusted Earnings per share
Adjusted Earnings represents net income before: (a) share-based compensation expense, for(b) amortization of intangible assets and software, a component of depreciation and amortization, resulting from our employee stock option awardsmerger transaction in 2005 with the Majority Holders and compensation benefits realized pursuant to the purchase and sale agreements of certainour 2007 acquisitions, as defined under the terms of our credit agreement.
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- (c)
Represents organizational restructuring charges, employment tax withholding related to a non-qualified deferred compensation plan, and regulatory fines and related costs, as permitted under the terms of our credit agreement.
(d)Represents acquisition and integration related expenses including legal and other professional service fees(d) restructuring and retention payments,conversion costs, (e) debt amendment and extinguishment costs, (f) equity issuance and IPO related costs and (g) other. Reconciling items are tax effected using the income tax rates in effect for the applicable period, adjusted for any potentially non-deductible amounts.
In reporting our financial and operating results for the years ended December 31, 2010, 2009 and 2008, we renamed our non-GAAP performance measures to Adjusted Earnings and Adjusted Earnings per share (formerly known as defined underAdjusted Net Income and Adjusted Net Income per share).
Adjusted Earnings per share represents Adjusted Earnings divided by weighted average outstanding shares on a fully diluted basis.
We prepared Adjusted Earnings and Adjusted Earnings per share to eliminate the termseffects of items that we do not consider indicative of our credit agreement.
(e)Includes pro-forma adjustments for generalcore operating performance.We believe that Adjusted Earnings and administrative expenditures from our acquisitionAdjusted Earnings per share, viewed in addition to, and resulting shutdown of IFMG, as defined under the termsnot in lieu of, our credit agreement.
(f)EBITDAreported GAAP results provide useful information to investors regarding our performance and overall results of operations for the following reasons: | | |
| • | because non-cash equity grants made to employees at a certain price and point in time do not necessarily reflect how our business is performing at any particular time, stock-based compensation expense is not a key measure of our operating performance; |
|
| • | because costs associated with acquisitions and related integrations, debt refinancing, restructuring and conversions, and equity issuance and IPO related costs can vary from period to period and transaction to transaction, expenses associated with these activities are not considered a key measure of our operating performance and |
|
| • | because amortization expenses can vary substantially from company to company and from period to period depending upon each company’s financing and accounting methods, the fair value and average expected life of acquired intangible assets and the method by which assets were acquired, the amortization of intangible assets obtained in acquisitions are not considered a key measure in comparing our operating performance. |
We have historically not used Adjusted Earnings for internal management reporting and evaluation purposes; however, we believe Adjusted Earnings and Adjusted EBITDAEarnings per share are useful to investors in evaluating our operating performance because securities analysts use them as supplemental measures to evaluate the overall performance of companies, and our investor and analyst presentations include Adjusted Earnings and Adjusted Earnings per share.
Adjusted Earnings and Adjusted Earnings per share are not measures of our financial performance under GAAP and should not be considered as an alternative to net income or earnings per share or any other performance measure derived in accordance with GAAP, or as an alternative to cash flows from operating activities as a measure of our profitability or liquidity.
We understand that, although Adjusted Earnings and Adjusted Earnings per share are frequently used by securities analysts and others in their evaluation of companies, they have limitations as an analytical tool,tools, and theyyou should not be consideredconsider Adjusted Earnings and Adjusted Earnings per share in isolation, or as substitutes for an analysis of our results as reported under GAAP. Some of theseIn particular you should consider:
| | |
| • | Adjusted Earnings and Adjusted Earnings per share do not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments; |
43
| | |
| • | Adjusted Earnings and Adjusted Earnings per share do not reflect changes in, or cash requirements for, our working capital needs and |
|
| • | Other companies in our industry may calculate Adjusted Earnings and Adjusted Earnings per share differently than we do, limiting their usefulness as comparative measures. |
Management compensates for the inherent limitations
are:
•EBITDAassociated with using Adjusted Earnings and Adjusted EBITDA do not reflect all cash expenditures, future requirements for capital expenditures or contractual commitments;
•EBITDAEarnings per share through disclosure of such limitations, presentation of our financial statements in accordance with GAAP and reconciliation of Adjusted Earnings to the most directly comparable GAAP measure, net income.
The following table sets forth a reconciliation of net (loss) income to Adjusted Earnings and Adjusted EBITDA do not reflect changes in, or cash requirementsEarnings per share for working capital needs;
•EBITDAthe years ended December 31, 2010, 2009 and Adjusted EBITDA do not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;2008:| | | | | | | | | | | | | |
| | | For the Year Ended December 31, | |
| | | 2010 | | | 2009 | | | 2008 | |
| | | (In thousands, except per share data) | |
| |
| Net (loss) income | | $ | (56,862 | ) | | $ | 47,520 | | | $ | 45,496 | |
| After-Tax: | | | | | | | | | | | | |
| EBITDA Adjustments(1) | | | | | | | | | | | | |
| Share-based compensation expense(2) | | | 8,400 | | | | 5,146 | | | | 3,553 | |
| Acquisition and integration related expenses | | | 7,638 | | | | 1,833 | | | | 11,080 | |
| Restructuring and conversion costs | | | 13,877 | | | | 38,669 | | | | 9,143 | |
| Debt amendment and extinguishment costs | | | 23,477 | | | | — | | | | — | |
| Equity issuance and IPO related costs(3) | | | 149,568 | | | | 350 | | | | — | |
| Other | | | 91 | | | | 91 | | | | 2,269 | |
| | | | | | | | | | | | | |
| Total EBITDA Adjustments | | | 203,051 | | | | 46,089 | | | | 26,045 | |
| Amortization of purchased intangible assets and software(1) | | | 26,531 | | | | 35,947 | | | | 37,322 | |
| | | | | | | | | | | | | |
| Adjusted Earnings(4) | | $ | 172,720 | | | $ | 129,556 | | | $ | 108,863 | |
| | | | | | | | | | | | | |
| Adjusted Earnings per share(4)(5) | | $ | 1.71 | | | $ | 1.32 | | | $ | 1.09 | |
| Weighted average shares outstanding — diluted | | | 100,933 | | | | 98,494 | | | | 100,334 | |
| | |
| (1) | | EBITDA Adjustments and amortization of purchased intangible assets and software have been tax effected using a federal rate of 35.0% and the applicable effective state rate which ranged from 4.23% to 4.71%, net of the federal tax benefit. In April 2010, a step up in basis of $89.1 million for internally developed software that was established at the time of the 2005 merger transaction became fully amortized, resulting in lower balances of intangible assets that are amortized. |
|
| (2) | | Represents the after-tax expense of non-qualified stock options in which we receive a tax deduction upon exercise, and the full expense impact of incentive stock options granted to employees that have vested and qualify for preferential tax treatment and conversely, we do not receive a tax deduction. Share-based compensation for vesting of incentive stock options was $5.3 million, $3.2 million and $2.6 million, respectively, for the years ended December 31, 2010, 2009 and 2008. |
|
| (3) | | Represents the after-tax expense of equity issuance and IPO related costs in which we receive a tax deduction, as well as the full expense impact of $8.1 million of offering costs incurred in the fourth quarter of 2010 in which the we do not receive a tax deduction. |
|
| (4) | | In reporting our financial and operating results for the years ended December 31, 2010, 2009 and 2008, we renamed our non-GAAP performance measures to Adjusted Earnings and Adjusted Earnings per share (formerly known as Adjusted Net Income and Adjusted Net Income per share). |
•Adjusted EBITDA reflects additional adjustments as provided in the agreement governing our senior credit facilities; and
•Other companies in our industry may calculate EBITDA and Adjusted EBITDA differently, limiting its usefulness as a comparative measure.44
| | |
| (5) | | Represents Adjusted Earnings divided by weighted average number of shares outstanding on a fully diluted basis. Set forth is a reconciliation of (loss) earnings per share on a fully diluted basis as calculated in accordance with GAAP to Adjusted Earnings per share: |
| | | | | | | | | | | | | |
| | | For the Year Ended December 31, | |
| | | 2010 | | | 2009 | | | 2008 | |
| |
| (Loss) earnings per share — diluted | | $ | (0.64 | ) | | $ | 0.47 | | | $ | 0.45 | |
| Adjustment to include dilutive shares, not included in GAAP loss per share | | | 0.08 | | | | — | | | | — | |
| Adjustment for allocation of undistributed earnings to stock units | | | — | | | | 0.01 | | | | — | |
| After-Tax: | | | | | | | | | | | | |
| EBITDA Adjustments per share | | | 2.01 | | | | 0.47 | | | | 0.26 | |
| Amortization of purchased intangible assets and software per share | | | 0.26 | | | | 0.37 | | | | 0.38 | |
| | | | | | | | | | | | | |
| Adjusted Earnings per share | | $ | 1.71 | | | $ | 1.32 | | | $ | 1.09 | |
| | | | | | | | | | | | | |
Economic Overview and Impact of Financial Market Events During 2009, equity and fixed income
Equity markets
experienced a steep fall during the first quarter, continuing a trend from the market turbulence that characterized the latter half of 2008. From the market lows that occurred in March 2009, the equity and fixed income markets recovered steadily over the last nine months of the year. The market's decline and recovery is reflected incontinued to have positive performance with the S&P 500
which beganincreasing 12.8% from December 31, 2009
at 903, dropped to
667 on March 6, 2009, and recovered to end the year at 1115, an increase of 23.5% from the onset of 2009. The recovery in the equity marketDecember 31, 2010. This improvement positively influenced our
AUMadvisory and brokerage assets and improved those revenue sources which are directly driven by asset-based
pricing over the last nine months of 2009. Despite the market's partial recovery, overall economic activity including consumer discretionary income, employment and consumer confidence remained weak. These economic factors limited the impact of the market's recovery on our transactional commission revenues. Despite the equity market recovery, average market indices for 2009 remained well below prior year levels. The average daily S&P 500 index was 948 during 2009, down 22.3% from 2008. During the fourth quarter of 2009, the average daily S&P 500 index was 1089, up 19.4% from the daily average of 912 for the comparable period of 2008. pricing.
In response to the
market turbulence andoverall economic
slowdown,environment, the central banks, including the Federal Reserve, have maintained historically low interest
rates. The average effective rate for federal funds was 0.16% in 2009, compared to 1.92% for 2008. The effective rate for federal funds averaged 0.12% during the fourth quarter of 2009, a decline of 39 basis points or 76.5% from the comparable period of 2008. The low rate environmentrates which negatively
impactedimpact our revenues from client assets in our cash sweep programs.
In response The average effective rate for federal funds was 0.18% during 2010, compared to the lower levels of revenues that result from these volatile conditions, we persist0.16% in our efforts to reduce costs and control our expenditures. In the fourth quarter of 2008, we initiated a series of cost reduction measures through a strategic business review. Those efforts included the December 31, 2008 decision to reduce our workforce by approximately 250 employees, or
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approximately 10%, which resulted in additional expenditures2009. The average effective rate for federal funds was 0.19% during the fourth quarter of 2008, reduced compensation and benefits expense by approximately $27.0 million during 2009 in comparison2010, compared to 2008. In0.12% for the thirdfourth quarter of 2009, we furthered2009.
While our
restructuring plans by consolidating the operationsbusiness has improved as a result of the
Affiliated Entities with those of LPL Financial. Whilemore favorable equity markets, our outlook on the economic environment remains cautiously optimistic and we
expect to incur one-time charges of approximately $74.2 million for severance and termination benefits, asset impairments, contract termination fees and other conversion costs, we anticipate that the consolidation will result in annual cost savings of $29.8 million. We estimate that this restructuring initiative provided cost savings of $6.9 million in 2009. We continue to attempt to mitigate the impact of financial market events on our earnings with a strategic focus on attractive growth opportunities such as recruiting business relationshipsdevelopment to attract new advisors and through productivity and simplicity initiatives, in addition to our expense management activities described earlier. We plan to continue these efforts into future periods as they may help mitigate some of the negative financial risks associated with current market conditions and bolster our growth capabilities. We remain focused on retaining our customers and enabling them to provide their clients with independent and unbiased financial advice. This strategy is a key advantage and we believe it provides sustainable success for our customers and our firm.
activities.
Recent Acquisitions and Divestitures From time to time we
performundertake acquisitions
and/or divestitures based on opportunities in the competitive landscape. These activities are part of our overall growth strategy, but can distort comparability when reviewing revenue and expense trends for periods presented. The following describes significant acquisition and divestiture activities that have impacted our
2007, 2008,
2009 and
20092010 results.
On June 20, 2007, we acquired the Affiliated Entities, which increased the number of our financial advisors and strengthened our position as a leading independent broker-dealer. Accordingly, our 2007 results of operations include the activities of the Affiliated Entities beginning on June 21, 2007. Total purchase consideration was $120.5 million comprised of $63.3 million in cash funded primarily through borrowings under our senior credit facility, and the issuance of 2,645,400 shares of common stock with an estimated fair value of $21.60 per share on the date of acquisition.
On November 7, 2007, we acquired all of the outstanding capital stock of IFMG, further expanding our reach in offering financial services to banks, savings and loan institutions and credit unions nationwide. Accordingly, our 2007 results of operations include the activities of IFMG beginning on November 7, 2007. Purchase consideration at closing was $25.7 million and was financed with borrowings against our senior secured credit facilities. At the time of acquisition, we announced a plan (the "Shutdown Plan") to transfer existing IFMG financial institutional relationships to our other broker-dealer subsidiaries, LPL Financial and UVEST. In accordance with the Shutdown Plan, we made several post-closing payments based on the successful recruitment, retention and transition of these relationships during the third and fourth quarter of 2008.
On December 31, 2007, we ceased the operations of our subsidiary, Innovex Mortgage, Inc. ("Innovex"). Prior to that date, Innovex provided comprehensive mortgage services for residential properties of the clients of our financial advisors.
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On September 1, 2009, we consolidated the operations of the Affiliated Entities with those of LPL Financial. The consolidation involved the transfer of securities licenses of certain registered representatives associated with the Affiliated Entities and their client accounts. Following the
completion of these transfer activities,consolidation, the registered representatives and client accounts that
were transferred are now associated with LPL Financial. The consolidation of the Affiliated Entities was
affectedeffected to enhance service offerings to
customersour advisors while also generating efficiencies.
While our acquisitionsacquisition of the Affiliated Entities and IFMG havehas contributed to the overall growth of our customer base of advisors and related revenue and market position, we have incurred significant non-recurring costs related tothe consolidation into LPL Financial resulted in acquisition integration and the subsequent shutdown and/or conversion. Many of these expenditures arecosts in the form of restructuring charges, personnel costs, system costs and professional fees. For example, the consolidation of the Affiliated Entities with LPL Financial in September 2009 resulted infees, as well as restructuring charges including severance and one-time termination benefits, lease and contract termination fees, asset impairments and transfer and conversion costs. See Note 3 of our
45
consolidated financial statements for further discussion on restructuring costs incurred to date, and total expected restructuring costs related to our consolidation of the Affiliated Entities.
On July 14, 2010, we announced a definitive agreement pursuant to which our subsidiary, LPLH would acquire certain assets from National Retirement Partners, Inc. (“NRP”). In the fourth quarter of 2010, 206 advisors previously registered with (or licensed through) NRP transferred their securities and advisory licenses and registrations to LPL Financial. Approximately 3,800 client accounts with advisory and brokerage assets of $564.3 million were converted from NRP’s former clearing firm to LPL Financial. The transaction closed on February 9, 2011.
The following discussion presents an analysis of our results of operations for the years ended December 31, 2010, 2009 2008 and 2007.2008. Where appropriate, we have identified specific events and changes that affect comparability or trends, and where possible and practical, have quantified the impact of such items.
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | | | Percentage Change | |
| | | 2010 | | | 2009 | | | 2008 | | | ‘10 vs. ‘09 | | | ‘09 vs. ‘08 | |
| | | (In thousands) | | | | | | | |
| |
Revenues | | | | | | | | | | | | | | | | | | | | |
| Commissions | | $ | 1,620,811 | | | $ | 1,477,655 | | | $ | 1,640,218 | | | | 9.7 | % | | | (9.9 | )% |
| Advisory fees | | | 860,227 | | | | 704,139 | | | | 830,555 | | | | 22.2 | % | | | (15.2 | )% |
| Asset-based fees | | | 317,505 | | | | 272,893 | | | | 352,293 | | | | 16.3 | % | | | (22.5 | )% |
| Transaction and other fees | | | 274,148 | | | | 255,574 | | | | 240,486 | | | | 7.3 | % | | | 6.3 | % |
| Other | | | 40,795 | | | | 39,244 | | | | 52,797 | | | | 4.0 | % | | | (25.7 | )% |
| | | | | | | | | | | | | | | | | | | | | |
Net revenues | | | 3,113,486 | | | | 2,749,505 | | | | 3,116,349 | | | | 13.2 | % | | | (11.8 | )% |
| | | | | | | | | | | | | | | | | | | | | |
Expenses | | | | | | | | | | | | | | | | | | | | |
| Production | | | 2,397,535 | | | | 1,904,579 | | | | 2,163,048 | | | | 25.9 | % | | | (11.9 | )% |
| Compensation and benefits | | | 308,656 | | | | 270,436 | | | | 343,171 | | | | 14.1 | % | | | (21.2 | )% |
| General and administrative | | | 233,015 | | | | 218,416 | | | | 266,447 | | | | 6.7 | % | | | (18.0 | )% |
| Depreciation and amortization | | | 86,037 | | | | 108,296 | | | | 100,462 | | | | (20.6 | )% | | | 7.8 | % |
| Restructuring charges | | | 13,922 | | | | 58,695 | | | | 14,966 | | | | (76.3 | )% | | | 292.2 | % |
| Other | | | 34,826 | | | | 15,294 | | | | 17,558 | | | | 127.7 | % | | | (12.9 | )% |
| | | | | | | | | | | | | | | | | | | | | |
Total operating expenses | | | 3,073,991 | | | | 2,575,716 | | | | 2,905,652 | | | | 19.3 | % | | | (11.4 | )% |
| Non-operating interest expense | | | 90,407 | | | | 100,922 | | | | 115,558 | | | | (10.4 | )% | | | (12.7 | )% |
| Loss on extinguishment of debt | | | 37,979 | | | | — | | | | — | | | | | * | | | | * |
| (Gain) loss on equity method investment | | | (42 | ) | | | 300 | | | | 2,374 | | | | | * | | | (87.4 | )% |
| | | | | | | | | | | | | | | | | | | | | |
Total expenses | | | 3,202,335 | | | | 2,676,938 | | | | 3,023,584 | | | | 19.6 | % | | | (11.5 | )% |
| | | | | | | | | | | | | | | | | | | | | |
(Loss) income before (benefit from) provision for income taxes | | | (88,849 | ) | | | 72,567 | | | | 92,765 | | | | | * | | | (21.8 | )% |
(Benefit from) provision for income taxes | | | (31,987 | ) | | | 25,047 | | | | 47,269 | | | | | * | | | (47.0 | )% |
| | | | | | | | | | | | | | | | | | | | | |
Net (loss) income | | $ | (56,862 | ) | | $ | 47,520 | | | $ | 45,496 | | | | | * | | | 4.4 | % |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | Year Ended December 31, | | Percentage Change | |
|---|
| | 2009 | | 2008 | | 2007 | | '09 vs. '08 | | '08 vs. '07 | |
|---|
| | (in thousands)
| |
| |
| |
|---|
Revenues | | | | | | | | | | | | | | | | |
Commissions | | $ | 1,477,655 | | $ | 1,640,218 | | $ | 1,470,285 | | | (9.9 | )% | | 11.6 | % |
Advisory fees | | | 704,139 | | | 830,555 | | | 738,938 | | | (15.2 | )% | | 12.4 | % |
Asset-based fees | | | 272,893 | | | 352,293 | | | 260,935 | | | (22.5 | )% | | 35.0 | % |
Transaction and other fees | | | 255,574 | | | 240,486 | | | 184,604 | | | 6.3 | % | | 30.3 | % |
Other | | | 39,244 | | | 52,797 | | | 61,812 | | | (25.7 | )% | | (14.6 | )% |
| | | | | | | | | | | | | | |
| | Net revenues | | | 2,749,505 | | | 3,116,349 | | | 2,716,574 | | | (11.8 | )% | | 14.7 | % |
| | | | | | | | | | | | | | |
Expenses | | | | | | | | | | | | | | | | |
Production | | | 1,904,579 | | | 2,163,048 | | | 1,935,472 | | | (11.9 | )% | | 11.8 | % |
Compensation and benefits | | | 270,436 | | | 343,171 | | | 257,200 | | | (21.2 | )% | | 33.4 | % |
General and administrative | | | 218,416 | | | 266,447 | | | 199,895 | | | (18.0 | )% | | 33.3 | % |
Depreciation and amortization | | | 108,296 | | | 100,462 | | | 78,748 | | | 7.8 | % | | 27.6 | % |
Restructuring charges | | | 58,695 | | | 14,966 | | | — | | | 292.2 | % | | N/M | |
Other | | | 15,294 | | | 17,558 | | | 13,931 | | | (12.9 | )% | | 26.0 | % |
| | | | | | | | | | | | | | |
| | Total operating expenses | | | 2,575,716 | | | 2,905,652 | | | 2,485,246 | | | (11.4 | )% | | 16.9 | % |
Interest expense | | | 100,922 | | | 115,558 | | | 122,817 | | | (12.7 | )% | | (5.9 | )% |
Loss on equity method investment | | | 300 | | | 2,374 | | | 678 | | | (87.4 | )% | | 250.1 | % |
| | | | | | | | | | | | | | |
| | Total expenses | | | 2,676,938 | | | 3,023,584 | | | 2,608,741 | | | (11.5 | )% | | 15.9 | % |
| | | | | | | | | | | | | | |
Income before provision for income taxes | | | 72,567 | | | 92,765 | | | 107,833 | | | (21.8 | )% | | (14.0 | )% |
Provision for income taxes | | | 25,047 | | | 47,269 | | | 46,764 | | | (47.0 | )% | | 1.1 | % |
| | | | | | | | | | | | | | |
Net income | | $ | 47,520 | | $ | 45,496 | | $ | 61,069 | | | 4.4 | % | | (25.5 | )% |
| | | | | | | | | | | | | | |
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Table of Contents
Revenues
CommissionsCommissions
Commission-based revenues represent gross commissions generated by our customers, primarily from commissions earned on the sale of various products such as fixed and variable annuities, mutual funds, general securities, alternative investments and insurance. We also earn trailing commission type revenues (such as 12(b)-1 fees) on mutual funds and variable annuities held by clients of our customers. Trail commissions (a commission that is paid over time) are recurring in nature and are earned based on the current market value of previously purchased investments.
The following table sets forth our commission revenue, by product category included in our consolidated statements of incomeoperations for the periods indicated (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Years Ended December 31, | |
| | | 2010 | | | % Total | | | 2009 | | | % Total | | | 2008 | | | % Total | |
| |
| Variable annuities | | $ | 672,369 | | | | 41.5 | % | | $ | 551,345 | | | | 37.3 | % | | $ | 627,021 | | | | 38.2 | % |
| Mutual funds | | | 457,947 | | | | 28.2 | % | | | 389,458 | | | | 26.4 | % | | | 474,948 | | | | 28.9 | % |
| Fixed annuities | | | 138,753 | | | | 8.6 | % | | | 225,342 | | | | 15.3 | % | | | 179,743 | | | | 11.0 | % |
| Alternative investments | | | 97,606 | | | | 6.0 | % | | | 77,079 | | | | 5.2 | % | | | 112,706 | | | | 6.9 | % |
| Equities | | | 93,961 | | | | 5.8 | % | | | 86,606 | | | | 5.8 | % | | | 85,586 | | | | 5.2 | % |
| Fixed income | | | 85,250 | | | | 5.2 | % | | | 75,210 | | | | 5.1 | % | | | 65,309 | | | | 4.0 | % |
| Insurance | | | 72,297 | | | | 4.5 | % | | | 69,907 | | | | 4.7 | % | | | 91,327 | | | | 5.6 | % |
| Other | | | 2,628 | | | | 0.2 | % | | | 2,708 | | | | 0.2 | % | | | 3,578 | | | | 0.2 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Total commission revenue | | $ | 1,620,811 | | | | 100.0 | % | | $ | 1,477,655 | | | | 100.0 | % | | $ | 1,640,218 | | | | 100.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | Years Ended December 31, | |
|---|
| | 2009 | | % Total | | 2008 | | % Total | | 2007 | | % Total | |
|---|
Variable annuities | | $ | 551,345 | | | 37.3 | % | $ | 627,021 | | | 38.2 | % | $ | 605,318 | | | 41.2 | % |
Mutual funds | | | 389,458 | | | 26.4 | % | | 474,948 | | | 28.9 | % | | 498,880 | | | 33.9 | % |
Fixed annuities | | | 225,342 | | | 15.3 | % | | 179,743 | | | 11.0 | % | | 42,775 | | | 2.9 | % |
Equities | | | 86,606 | | | 5.8 | % | | 85,586 | | | 5.2 | % | | 82,215 | | | 5.6 | % |
Alternative investments | | | 77,079 | | | 5.2 | % | | 112,706 | | | 6.9 | % | | 113,183 | | | 7.7 | % |
Fixed income | | | 75,210 | | | 5.1 | % | | 65,309 | | | 4.0 | % | | 48,552 | | | 3.3 | % |
Insurance | | | 69,907 | | | 4.7 | % | | 91,327 | | | 5.6 | % | | 77,613 | | | 5.3 | % |
Other | | | 2,708 | | | 0.2 | % | | 3,578 | | | 0.2 | % | | 1,749 | | | 0.1 | % |
| | | | | | | | | | | | | | |
| | Total commission revenue | | $ | 1,477,655 | | | 100.0 | % | $ | 1,640,218 | | | 100.0 | % | $ | 1,470,285 | | | 100.0 | % |
| | | | | | | | | | | | | | |
Commission revenue decreased by $162.6 million, or 9.9%, for 2009 compared to 2008.
Transaction-basedSales-based commissions decreased as a result of market turbulence and volatility that dampened client demand for purchases of new
investmentfinancial products, particularly in the more market sensitive products such as mutual funds, alternative investments and variable annuities. This decline was partially offset by increased sales of products with more predictable cash flows such as fixed annuities and fixed income
securities.securities, which investors normally favor during periods of uncertain equity markets. Trail commissions
reflect the effectsalso decreased as a result of the
market declines offset by growth ineffect of the market’s decline on the underlying assets eligible for trail
commissions, partially offset by additional sales of assets eligible for trail payment.
Commission revenue
Advisory Fees
Advisory fees increased by
$169.9$156.1 million, or
11.6%22.2%,
in 2008 from 2007, fueledfor 2010 compared to 2009. The increase was primarily
bydue to the
commission base obtained through our acquisitionseffect of the
Affiliated Entities and IFMG. Organic commission revenue growth remained relatively flat during this same period, attributed torebounding market, which resulted in a significant increase in the
successful recruitmentvalue of
our customer base which increased 7.5% to 11,920client assets in
2008advisory programs, as well as net new advisory assets. For 2010, the S&P 500 index averaged 1,140, up 20.3% from
11,089 in 2007, largely offset by a decline in commissionable transactions and brokeragethe average of 948 for 2009. Our advisory assets under management
dueincreased 20.5% from $77.2 billion at December 31, 2009 to
$93.0 billion at December 31, 2010. The increase in advisory assets was primarily driven by a continued shift toward a higher percentage of advisory business within our existing advisor base, as well as by assets from advisors who joined the
unfavorable market conditionsfirm in
2008.Advisory fees
Advisory fee revenues represent fees charged by us2009 and whose business began to ramp up on our customers to clients based on the value of assets under management.
platform in 2010.
Advisory fees decreased by $126.4 million, or 15.2%, for 2009 compared to 2008. The decrease is primarily due toreflects the effect of the declining marketdecline in the equity markets during 2009 as compared to 2008. For 2009, the S&P 500 index averaged 948, down 22.3% from the average for 2008. This decrease was partially offset by increasing net new advisory assets attributed to new advisory relationships.
47
The following table summarizes the activity within our advisory assets under management for the periods ended December 30, 2010 and 2009 (in billions):
| | | | | | | | | |
| | | 2010 | | | 2009 | |
| |
| Beginning balance at January 1 | | $ | 77.2 | | | $ | 59.6 | |
| Net new advisory assets | | | 8.5 | | | | 7.0 | |
| Market impacts | | | 7.3 | | | | 10.6 | |
| | | | | | | | | |
| Ending balance at December 31 | | $ | 93.0 | | | $ | 77.2 | |
| | | | | | | | | |
Asset-Based Fees
Asset-based fees increased $44.6 million, or 16.3%, for 2010 compared to 2009. Revenues from product sponsors and for record-keeping services, which are largely based on the underlying asset values, increased due to the impact of the market’s recovery on the value of
those underlying assets. The average for the S&P 500 index increased 20.3% from 2009 to 2010. This increase was offset by lower revenues from our
clientcash sweep programs, which declined by $0.7 million, or 0.6%, to $119.7 million for the year ended December 31, 2010 from $120.4 million for the year ended December 31, 2009, as a result of lower assets in
advisory programs, offset by increasing sales attributed to new advisory relationships. Advisory fees increased by $91.6 million, or 12.4%, in 2008 from 2007, driven in part by the advisory fee base obtained through our acquisitions of the Affiliated Entities and IFMG, in addition to a trend amongst our customer relationships (including customers of acquired subsidiaries) to provide a higher percentage of fee-based advisory services to their clients, which are recurring revenue streams.
Table of Contents
Consequently our recurring revenues as a percentage of net revenue remained relatively unchanged through the unfavorable market conditions in 2008.
Asset-based fees
Asset-based fees are comprised of fees from cash sweep vehicles,programs. Assets in our product manufacturer sponsorshipcash sweep programs averaged $18.5 billion and sub-transfer agency$20.5 billion for the years ended December 31, 2010 and networking services. Pursuant2009, respectively. The decrease of assets in cash sweep programs is due to contractual arrangements, uninvestedthe redeployment of cash balances into other securities as investors and advisors gain confidence in client accounts are swept into either insured deposit accounts at various banks or third-party money marketthe market. For the year ended December 31, 2010, the effective federal funds rate averaged 0.18% compared to 0.16% for which we receive fees, including administrative and record keeping fees based on account type and the invested balances. In addition, we receive fees from certain product manufacturers in connection with programs that support our marketing and sales-force education and training efforts. We also earn fees on mutual fund assets for which we provide administrative and recordkeeping services as a sub-transfer agent. Our networking fees represent fees paid to us by mutual fund and annuity product manufacturers in exchange for administrative and recordkeeping services that we provide to clients of our financial advisors. Networking fees are correlated to the number of positions we administer, not the value of assets under administration.
prior year.
Asset-based fees decreased $79.4 million, or 22.5%, for 2009 compared to 2008. This decrease
was primarily drivenresulted in part from the decline in the market value of assets included in our various sponsor and asset-based record- keeping programs, as the average for the S&P 500 index declined 22.3% from 2008 to 2009. Asset-based revenues in 2009 were also negatively impacted by the declining interest rate environment as reflected by the average effective federal funds rate and its influence on fees associated with our cash sweep programs. For the year ended December 31, 2009, the effective federal funds rate averaged 0.16% compared to 1.92% for the prior year. Assets in our cash sweep programs averaged $20.5 billion and
$18.8$19.3 billion for the years ended December 31, 2009 and 2008, respectively.
Asset-based fees increased $91.4 million, or 35.0%, from 2007 to 2008.
Transaction and Other Fees from our cash sweep vehicles increased $60.9 million driven primarily by a 72.7% increase in the average assets custodied in these programs which can be attributed to prevailing negative market conditions and the resulting shift of client assets from invested capital to our cash sweep programs. For 2008, the increase associated with this trend is partially offset by the negative interest rate environment and its influence on the margins associated with these products.
Transaction and other fees
Revenues earned from transaction increased $18.6 million, or 7.3%, for 2010 compared to 2009. This increase is due, in part, to increased prices and other fees primarily consist of transaction fees and ticket charges, subscription fees, IRA custodian fees, contract and license fees, conference fees and small/inactive account fees. We chargecorresponding fees to our customersadvisors for licensing, technology, and their clients for executing transactionsprofessional liability insurance services of $3.9 million, $3.5 million and $2.5 million, respectively, and increased revenue of $2.6 million from additional advisor conferences held in brokerage and fee-based advisory accounts. We earn subscription fees for the software and technology services provided to our customers and on IRA custodial services that we provide for their client accounts. We charge monthly administrative fees to our customers, as well as regulatory licensing fees. We charge fees to product manufacturers for participating in our training and marketing conferences and fees to our customers and clients for accounts that fail to meet certain specified thresholds of size or activity.
2010.
Transaction and other fees increased $15.1 million, or 6.3%, for 2009 compared to 2008. This increase
iswas primarily attributed to
fees associated with increases in our number of
customersadvisors and their client accounts. We also had increases of $6.6 million in charges to
customersadvisors largely for
professional liability insurance
programspremiums and $5.3 million in IRA custodial
fees, offset by a $4.4 million decline in conference related revenues.fees. Transaction and other fees include revenues from conferences held for advisors; these revenues declined by $4.4 million from 2008 to 2009, as we cancelled various conferences as a part of our cost containment efforts.
Other Revenue
Other revenue increased $55.9$1.6 million, or 30.3%4.0%, in 2008 from 2007.for 2010 compared to 2009. The increase iswas primarily attributed primarily to an increasehigher direct investment marketing allowances received from product sponsors, largely based on sales volumes, which was offset by unrealizedmark-to-market losses in trade volume. Specifically, our trade volume increased by 4.8 million, or 59.3%, in 2008, which is primarily attributable to an increase in the number of underlying client accounts opened through our acquisitions of the Affiliated Entitiessecurities owned and IFMG.certain other assets.
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Table of Contents
Other revenue
Other revenue includes marketing re-allowances from certain product manufacturers as well as interest income from client margin accounts and cash equivalents, net of operating interest expense. Prior to our dissolution of our mortgage subsidiary, Innovex, other revenue also consisted of gains on the sale of mortgage loans held for sale.
Other revenue decreased $13.6 million, or 25.7%, for 2009 compared to 2008. The decrease
in the current year iswas due primarily to lower interest revenue from client margin lending activities and to a lesser extent, by lower interest income earned on our cash equivalents. Our average client margin balances decreased 33.5% from $328.3 million in 2008 to $218.3 million in 2009, reflecting a reduced demand by clients for margin
leverage. Other revenueleverage in reaction to volatility in the equity markets. Margin balances have typically decreased $9.0during periods of declining, volatile markets such as those experienced beginning in 2008.
Expenses
Production Expenses
Upon closing of our IPO in the fourth quarter of 2010, the restriction on approximately 7.4 million shares of common stock issued to advisors under the Fifth Amended and Restated 2000 Stock Bonus Plan was released. Accordingly, we recorded a share-based compensation charge of $222.0 million in the fourth quarter of 2010, representing the offering price of $30.00 per share multiplied by 7.4 million shares. This charge has been classified as production expense in 2010. Excluding this charge, production expenses increased $271.0 million, or
14.6%,14.2% for 2010 compared to 2009. This increase was a result of a 13.7% increase in
2008 from 2007. Through our
mortgage affiliate Innovex, we recognized gains related to mortgage loans held for sale during 2007 that did not recur in 2008 because we ceased the operations of Innovex on December 31, 2007.Expenses
Production expenses
Production expenses consist of commissionscommission and advisory fees as well as brokerage, clearingrevenues during the same period. Our production payout averaged 86.3% in 2010 and exchange fees. We pay out the majority of commissions and advisory fees received from sales or services provided by our customers. Substantially all of these pay-outs are variable and correlated to the revenues generated by each customer.
85.8% in 2009.
Production expenses decreased $258.5 million, or 11.9%, for 2009 compared to 2008. Commission and advisory revenues declined $289.0 million, or 11.7%
, during the same period, resulting in a corresponding decrease in our production payout to our
customers.advisors. Our production payout averaged 85.8% in 2009 and 86.3% in 2008.
Production expenses increased $227.6 million, or 11.8%, in 2008 from 2007. The increase in production expenses is highly correlated with our increase in commission and advisory revenues, which increased by $261.6 million, or 11.8%, in 2008 from 2007. Our production pay-out averaged 86.3% in 2008 and 86.4% in 2007.
Compensation and benefitsBenefits Expense Compensation and benefits
increased $38.2 million, or 14.1%, for 2010 compared to 2009. Expenses in 2010 include $5.8 million in employer taxes arising from non-qualified stock option exercises in connection with our IPO. The remaining increase was primarily attributed to the restoration of certain employee-related items, including increases in bonus levels and contributions to employee retirement plans in 2010 that were reduced in 2009 as a result of our cost management initiatives. In addition, share-based compensation expense
includes salariesrelated to employee stock option awards increased to $10.4 million in 2010, compared to $6.5 million in 2009. Our average number of full-time employees was 2,517 and
wages,2,430 for 2010 and
related employee benefits and taxes for our employees (including share-based compensation), as well as compensation for temporary employees and consultants.2009, respectively, representing an increase of 3.6%.
Compensation and benefits decreased $72.7 million, or 21.2%, for 2009 compared to 2008. The decrease
iswas primarily attributed to our ongoing strategic business review and resulting cost management initiatives.
As a result ofThese initiatives, along with ordinary attrition
and retirements,
and our reductionresulted in
workforce implemented in the fourth quarter of 2008, our average number of full-time employees
has declineddeclining by 383, or 13.6%, to 2,430 for 2009, compared to 2,813 for 2008.
Compensation and benefits increased $86.0 million, or 33.4%,expense in 2009 was further reduced from 2008 from 2007. The increase is attributed to salaries and benefits and the average number of full-time employees, which grew by 729, or 35.0%, to 2,813 in 2008, compared to 2,084 in 2007, primarilylevels due to our acquisitions of the Affiliated Entitiesa reduction in employee related-items including bonuses and IFMG and resulting integration efforts, and our initiativeemployer contributions to strengthen our service infrastructure.
retirement plans.
General and administrative expenses
include promotionalincreased by $14.6 million, or 6.7%, for 2010 compared to 2009. The increase compared to the prior year was due to the reinstatement of general and administrative expenses to levels necessary to support growth and service to our advisors. During 2010, we restored certain advisor conference services, which contributed to $6.4 million of the change. Other increases were primarily due to expenses for travel related costs and licensing fees
occupancythat increased by $4.6 million and
equipment, communications and data processing, regulatory fees, travel and entertainment, and professional services.$1.6 million, respectively.
General and administrative expenses decreased by $48.0 million, or 18.0%, for 2009 compared to 2008. The decrease iswas primarily attributable to our ongoing strategic business review and resulting cost reduction measures which led to decreases of $38.3 million in promotional fees, $8.3
49
$8.3 million in occupancy and equipment, $5.8 million in travel and entertainment and $3.8 million in communications and data processing.
General and administrative expenses increased by $66.6 million, or 33.3%, from 2008 to 2007. The increase was primarily attributable to increases of $35.4 million in promotional fees and recruiting, $15.3 million in occupancy and equipment and $12.2 million in communication and data processing. The increase in these expenditures was primarily due to our acquisitions of the Affiliated Entities and IFMG, and resulting integration efforts to support our overall growth.
Depreciation and amortizationAmortization Expense Depreciation and amortization expense
represents the benefits receiveddecreased by $22.3 million, or 20.6%, for
using long-lived assets. Those assets represent significant intangible assets established through2010 compared to 2009. The decrease is primarily attributed to a step up in basis of $89.1 million in our
acquisitions, as well as fixed assets which include internally developed software
hardware, leasehold improvementsthat was established at the time of our 2005 merger transaction and
other equipment.became fully amortized in April 2010. We recorded $6.3 million and $19.1 million in amortization expense for these assets for 2010 and 2009, respectively. In addition, we recorded asset impairments of $19.9 million in the third and fourth quarter of 2009 in the consolidation of our Affiliated Entities, which resulted in lower balances remaining in those intangible assets that continue to be amortized.
Depreciation and amortization expense increased by $7.8 million, or 7.8%, for 2009 compared to 2008. The increase
iswas attributed to capital expenditures made to support integration efforts
related to the Affiliated Entities and the general growth of our business.
Depreciation and amortization expense increased by $21.7 million, or 27.6%, from 2008 to 2007, attributed to amortization of identifiable intangible assets and depreciation and amortization of fixed assets resulting from our acquisitions of the Affiliated Entities and IFMG, as well as capital expenditures made to support integration efforts and the general growth of our business.
Restructuring chargesCharges Restructuring charges represent expenses incurred as a result of our
2008 strategic business review and our 2009 consolidation of the Affiliated
Entities.Entities and our strategic business review committed to in 2008 to reduce our cost structure and improve operating efficiencies.
Restructuring charges were $13.9 million in 2010, compared to $58.7 million in 2009. In 2010, restructuring charges were incurred for severance and termination benefits of $2.0 million, contract termination costs of $5.4 million related to the abandonment of certain lease facilities, asset impairment charges of $0.8 million, and $5.7 million in conversion and transfer costs primarily attributed to advisor retention.
Restructuring charges were $58.7 million in 2009, compared to $15.0 million in 2008. In 2009, restructuring charges were incurred for severance and termination benefits of $9.5 million, contract termination costs of $15.9 million, asset impairment charges of $19.9 million and $13.9 million in other expenditures principally relating to the conversion and transfer of
customersadvisors and their client accounts from the Affiliated Entities to LPL Financial. These costs were
partially offset by $0.5 million in adjustments that were recorded in the first half of 2009 for changes in cost estimates associated with
post employmentpost-employment benefits provided to employees impacted by our 2008 strategic business review.
In 2008, we committed
Other Expenses
Other expenses increased by $19.5 million, or 127.7%, from 2009 to
and implemented a strategic business review, resulting2010. The increase is due primarily to $8.1 million in
a reduction in our overall workforce of approximately 250 employees, or approximately 10%transaction costs that were expensed at the completion of our
workforce. Accordingly, we recorded a $15.0IPO in the fourth quarter of 2010, as well as $8.9 million
restructuring charge at the time such plan was communicatedfor legal settlements that related to
our employees.Other expenses
Other expenses include bank fees, other taxes, bad debt expense and other miscellaneous expenses.
Tablepre-acquisition legal matters for certain of Contents
acquired businesses.
Other expenses decreased by $2.3 million, or 12.9%, from 2008 to 2009. The decrease
iswas primarily due to cost reduction measures.
Other expenses increased by $3.6 million, or 26.0%, from 2007 to 2008. The increase was due primarily to increases in bad debt expense and customer write-off activity. The remaining increase was due to storage services, which grew by $1.1 million in 2008.
Interest expense includes non-operating interest expense for our senior secured term loan,credit facilities and our senior unsecured subordinated notes.
Interest expense decreased by $10.5 million, or 10.4%, for 2010 compared with 2009. The reduction in interest expense is attributed to our debt refinancing in the second quarter of 2010, which included the redemption of our senior unsecured subordinated notes, and revolving lineresulting in a lower cost of credit facility.borrowing. In addition, two of our interest rate swap agreements matured during 2010, which resulted in interest savings of approximately $3.8 million.
50
Interest expense decreased by $14.6 million, or 12.7%, for
the year ended December 31, 2009 compared with
the year ended December 31, 2008. The decline
reflectsreflected lower average interest rates on our borrowings due in part to a credit rating upgrade received in the third quarter of
2008. This trend is2008, partially offset by an increase in the average principal amount of debt outstanding due primarily to borrowings
onunder our revolving credit facility. Our average outstanding borrowing activity in the revolving and uncommitted line of credit facilities
have increased by $7.8 million from $48.7 million for 2008 compared to $56.5 million for 2009.
Interest expense decreased by $7.3 million,
Gain or 5.9%, from 2007 to 2008, reflecting lower average interest ratesloss on our borrowings due in part by a credit rating upgrade, offset by an increase in the principal amount of debt outstanding.Loss on equity method investmentEquity Method Investment
Loss
The loss or gain on equity method investment represents our share of
gains or losses related to our
2007 investment in a privately held technology company.
The gain on equity method investment was $42,000 for 2010 compared to a loss of $0.3 million for 2009.
Loss on equity
method investment
was $0.3decreased by $2.1 million,
or 87.4%, for 2009 compared to
$2.4 million for 2008. The decrease
of $2.1 million in the current year iswas attributed to a $1.7 million other than temporary impairment charge incurred during the second quarter of 2008.
Loss on equity method investment increased $1.7 million from 2007 to 2008, due to the $1.7 million other than temporary impairment during the second quarter of 2008.
Provision for Income Taxes During 2010, we recorded an income tax benefit of $32.0 million compared to an income tax expense of $25.0 million for 2009. The 2010 tax benefit was a result of the net loss resulting from IPO related expenses. Our effective income tax rates were 36.0% and 34.5% for 2010 and 2009, respectively. Our 2010 effective tax rate reflects $8.1 million of transaction expenses that are not deductible for tax purposes, which reduced the tax benefit by 3.2%. Our 2009 effective tax rate reflects a benefit of approximately 8.0% from a newly enacted change to California’s income sourcing rules which were enacted in 2009 and effective as of January 1, 2011.
Our provision for income taxes decreased by $22.2 million, or 47.0%, between 2008 and 2009. The decrease
in income tax expense iswas primarily the result of a decrease in the effective income tax rate under GAAP, which was 34.5% for 2009 as compared to 51.0% for 2008, as well as a decline in pre-tax
income.income due to restructuring charges that were incurred in 2009. In addition, our
current2009 effective tax rate reflects a benefit
of approximately 8% from a
newly enacted change to
California'sCalifornia’s income sourcing rules,
which required that
is scheduled to take effect on January 1, 2011. This change requires us towe revalue our deferred tax liabilities to the rate that will be in effect when the tax liabilities are utilized.
Our provision for income taxes increased by $0.5 million, or 1.1%, between 2007 and 2008. The increase in income tax expense was primarily the result of an increase in the effective income tax rate under GAAP, which was 51.0% for 2008 as compared to 43.4% for 2007, offset largely by a decline in pre-tax income. Changes in our effective tax rates reflect additional expenses and/or changes in our estimates for expenses that cannot be deducted for income tax purposes; namely a change in our estimates for certain state income tax rates and the impact of that change on our deferred tax liabilities. Additional increases in our effective tax rates relate to increases in items such as meals and entertainment and compensation for incentive stock options.
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Liquidity and Capital Resources Senior management establishes our liquidity and capital policies. These policies include senior management'smanagement’s review of short- and long-term cash flow forecasts, review of monthly capital expenditures and daily monitoring of liquidity for our subsidiaries. Decisions on the allocation of capital include projected profitability and cash flow, risks of the business, regulatory capital requirements and future liquidity needs for strategic activities. Our Treasury Department assists in evaluating, monitoring and controlling the business activities that impact our financial condition, liquidity and capital structure and maintains relationships with various lenders. The objectives of these policies are to support the executive business strategies while ensuring ongoing and sufficient liquidity.
51
A summary of changes in cash flow data is provided as follows (in thousands):
| | | | | | | | | | | | | |
| | | December 31, | |
| | | 2010 | | | 2009 | | | 2008 | |
| |
| Net cash flows (used in) provided by: | | | | | | | | | | | | |
| Operating activities | | $ | (22,914 | ) | | $ | 271,157 | | | $ | 89,277 | |
| Investing activities | | | (39,192 | ) | | | (13,724 | ) | | | (76,202 | ) |
| Financing activities | | | 102,720 | | | | (98,078 | ) | | | 18,161 | |
| | | | | | | | | | | | | |
| Net increase in cash and cash equivalents | | | 40,614 | | | | 159,355 | | | | 31,236 | |
| Cash and cash equivalents — beginning of year | | | 378,594 | | | | 219,239 | | | | 188,003 | |
| | | | | | | | | | | | | |
| Cash and cash equivalents — end of year | | $ | 419,208 | | | $ | 378,594 | | | $ | 219,239 | |
| | | | | | | | | | | | | |
| | | | | | | | | | |
| | December 31, | |
|---|
| | 2009 | | 2008 | | 2007 | |
|---|
Net cash flows provided by (used in): | | | | | | | | | | |
Operating activities | | $ | 271,157 | | $ | 89,277 | | $ | 10,072 | |
Investing activities | | | (13,724 | ) | | (76,202 | ) | | (168,275 | ) |
Financing activities | | | (98,078 | ) | | 18,161 | | | 101,043 | |
| | | | | | | | |
Net increase (decrease) in cash and cash equivalents | | | 159,355 | | | 31,236 | | | (57,160 | ) |
Cash and cash equivalents—beginning of year | | | 219,239 | | | 188,003 | | | 245,163 | |
| | | | | | | | |
Cash and cash equivalents—end of year | | $ | 378,594 | | $ | 219,239 | | $ | 188,003 | |
| | | | | | | | |
Cash requirements and liquidity needs are primarily funded through our cash flow from operations and our capacity for additional borrowing.
Net cash
provided by operating activities for 2009, 2008 and 2007 totaled $271.2 million, $89.3 million and $10.1 million, respectively. Net cash(used in) provided by operating activities includes net
(loss) income adjusted for non-cash expenses such as depreciation and amortization,
restructuring charges, share-based compensation, deferred income tax provision and changes in operating assets and liabilities.
Net cash used in operating activities for 2010 was $22.9 million, compared to net cash provided by operating activities for 2009 and 2008 of $271.2 million and $89.3 million, respectively. In 2010, net cash used in operating activities includes $93.4 million of excess tax benefits resulting from stock options exercised related to our IPO, and a $73.8 million change in tax receivables that arose primarily from a tax benefit resulting from the release on the restriction on 7.4 million shares of our common stock. Operating assets and liabilities include balances related to settlement and funding of client transactions, receivables from product sponsors and accrued commissions and advisory fees due to our
customers. Those operatingadvisors. Operating assets and liabilities
whichthat arise from the settlement and funding of
client transactions
by our advisors’ clients are the principal cause of changes to our net cash from operating activities and can fluctuate significantly from
day to day and period to period depending on overall trends and client behaviors.
Net cash used in investing activities for
2010, 2009
and 2008,
and 2007, totaled
$39.2 million, $13.7 million
and $76.2 million,
respectively. The increase in 2010 as compared to 2009 was principally due to an increase of $14.8 million in capital expenditures and
$168.3an increase in restricted cash deposits of $11.4 million. Included in the deposits of restricted cash in 2010 is $20.0 million
respectively.to fund a pending acquisition that was completed in the first quarter of 2011. The decrease in 2009 as compared to 2008
isof $62.5 million was principally due to a decrease in capital expenditures
of $54.5 million, and acquisition
activity. The decreaseactivity of $13.3 million. Capital expenditures decreased in 2009 in response to economic conditions and due to the completion in 2008
as compared to 2007 is principally dueof capital projects related to our 2007
acquisitions of UVEST, the Affiliated Entities and IFMG.acquisitions.
Net
cash provided by financing activities for 2010 was $102.7 million, compared to net cash used in financing activities for 2009
wasof $98.1
million, compared toand net cash provided by financing activities for 2008
and 2007, whichof $18.2 million. Cash flows from financing activities in 2010 include $93.4 million from excess tax benefits arising from stock options exercised related to our IPO. Financing activities in 2010 also include $37.2 million in net proceeds from the sale of stock pursuant to the over-allotment option exercised by the underwriters, in connection with our IPO. This activity was
$18.2offset in part by the pay down of the principal amount of the 2015 Term Loans of $550.0 million and
$101.0a premium of $29.6 million
respectively. The decreaseincurred to redeem the 2015 Term Loans, and proceeds of $566.7 million received from the 2017 Term Loans during the year ended December 31, 2010. In addition, $7.2 million of debt issuance costs were paid in
2010. In 2009,
as compared to 2008 is primarily related to athe primary use of cash in financing activities was the $90.0 million pay down
on ourof the revolving line of credit
which occurred in 2009. The decrease in 2008 as compared to 2007 is primarily related to borrowings under our senior secured credit facilities, which did not recur at the same level in fiscal year 2008. These borrowings were principally related to our 2007 acquisitions of UVEST, the Affiliated Entities and IFMG.facility.
We believe that based on current levels of operations and anticipated growth, cash flow from operations, together with other available sources of funds, will be adequate to satisfy our working
52
capital needs, the payment of all of our obligations and the funding of anticipated capital expenditures for the foreseeable future.
In 2010, upon closing our IPO in the fourth quarter, the restriction on 7.4 million shares of
Contentscommon stock issued to our advisors under the Fifth Amended and Restated 2000 Stock Bonus Plan was released. Accordingly, we recorded a share-based compensation charge and a corresponding tax deduction of $222.0 million in the fourth quarter of 2010, representing the offering price of $30.00 per share multiplied by 7.4 million shares. We were able to take a tax deduction for the share-based compensation charge, as noted below.
We also expect to realize in connection with our IPO, a tax deduction of $383.0 million resulting from (a) the exercise of non-qualified stock options by current and former employees; (b) the exercise of non-qualified stock options and warrants by advisors and financial institutions; and (c) the exercise of incentive stock options and subsequent sale of common stock resulting in a disqualifying disposition.
As a result of the tax deduction related to the release on the restriction of shares of common stock held by advisors, as well as stock option and warrant exercises, we expect the tax deduction available to be $605.0 million, resulting in total expected tax benefits in connection with the IPO of $237.3 million. The aggregate tax deduction generated a net operating loss (“NOL”) for tax purposes in 2010. Such NOLs are available to be applied to prior years operating income to recover taxes previously paid and are eligible to be carried forward to offset any future taxable income for federal tax purposes. Rules regarding carryback and carryforward vary by state.
The following table shows the tax deduction available and the tax benefit expected to be realized in connection with the IPO (in thousands):
| | | | | | | | | | | | | |
| | | | | | Stock
| | | | |
| | | Release on the
| | | Option
| | | | |
| | | Restriction of
| | | and
| | | | |
| | | Shares of
| | | Warrant
| | | | |
| | | Common Stock | | | Exercises | | | Total | |
| |
| Tax deduction available | | $ | 221,982 | | | $ | 382,990 | | | $ | 604,972 | |
| Tax benefit expected to be realized | | $ | 87,072 | | | $ | 150,228 | | | $ | 237,300 | |
| Tax benefit recorded in 2010 as income tax receivables on the consolidated statements of financial condition | | $ | (87,072 | ) | | $ | (57,474 | ) | | $ | (144,546 | )(1) |
| Tax benefit utilized in the fourth quarter of 2010 by not making a quarterly payment | | | — | | | $ | (37,534 | ) | | $ | (37,534 | ) |
| Tax benefit expected to be utilized in future periods through the use of NOLs from tax deductions resulting from the IPO | | | — | | | $ | (55,220 | ) | | $ | (55,220 | ) |
(1) On January 20, 2011, we received a $45.0 million tax refund for federal taxes paid in 2010. We anticipate filing a tax refund in April 2011 for federal taxes paid in 2009 and 2008, and expect to receive refunds of $55.3 million and $44.3 million, respectively.
Operating Capital Requirements Our primary requirement for working capital relates to funds we loan to our advisors’ clients for trading done on margin and funds we are required to maintain at clearing organizations to support clients'these clients’ trading activities. We require that our advisors’ clients deposit funds with us in support of their trading activities and we hypothecate securities held as margin collateral, which we in turn use to lend to clients for margin transactions and deposit with our clearing organizations. These activities
53
account for the majority of our working capital requirements, which are primarily funded directly or indirectly by
our advisors’ clients. Our other working capital needs are primarily limited to regulatory capital requirements and software development, which we have satisfied in the past from internally generated cash flows.
Notwithstanding the self-funding nature of our operations, we may sometimes be required to fund timing differences arising from the delayed receipt of client funds associated with the settlement of client transactions in securities markets.
Historically, theseThese timing differences
wereare funded either with internally generated cash flow or, if needed, with funds drawn under
short-term borrowing facilities, including both committed unsecured lines ofthe revolving credit
andfacility at the holding company,and/or uncommitted lines of credit
secured by client securities. LPL Financial, one ofat our broker-dealer
subsidiaries, utilizes uncommitted lines secured by client securities to fund margin loans and other client transaction-related timing differences.subsidiary LPL Financial.
Our registered broker-dealers are subject to the
SEC'sSEC’s Uniform Net Capital Rule, which requires the maintenance of minimum net capital. LPL Financial
and Associated computecomputes net capital requirements under the alternative method, which requires firms to maintain minimum net capital, as defined, equal to the greater of $250,000 or 2% of aggregate debit balances arising from
customers'client transactions plus 1% of net commission payable, as defined. LPL Financial is also subject to the
Commodity Futures Trading Commission'sCFTC’s minimum financial requirements, which require that it maintain net capital, as defined, equal to 4% of customer funds required to be segregated pursuant to the Commodity Exchange Act, less the market value of certain commodity options, all as defined. UVEST
MSC and
WFG allMSC compute net capital requirements under the aggregate indebtedness method, which requires firms to maintain minimum net capital, as defined, of not less than 6.67% of aggregate indebtedness plus 1% of net commission payable, also as defined.
Our subsidiary, PTC, is subject to various regulatory capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our consolidated financial statements.
Our ability to meet our debt service obligations and reduce our total debt will depend upon our future performance which, in turn, will be subject to general economic, financial, business, competitive, legislative, regulatory and other conditions, many of which are beyond our control. In addition, our operating results, cash flow and capital resources may not be sufficient for repayment of our indebtedness in the future. Some risks that could materially adversely affect our ability to meet our debt service obligations include, but are not limited to, general economic conditions and economic activity in the financial markets. The performance of our business is correlated with the economy and financial markets, and a continuing slowdown in the economy or financial markets could adversely affect our business, results of operations, cash flows or financial condition.
If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments, seek additional capital or restructure or refinance our
indebtedness, including the senior unsecured subordinated notes as discussed below.indebtedness. These measures may not be successful and may not permit us to meet our scheduled debt service obligations. In the absence of sufficient cash flows and capital resources, we could face substantial liquidity constraints and might be required to dispose of material assets or operations to meet our debt service and other
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obligations. However, our senior secured credit facilities and the indenture governing the senior unsecured subordinated notesagreement will restrict our ability to dispose of assets and the use of proceeds from any such dispositions. We may not be able to consummate those dispositions, and even if we could consummate such dispositions, or to obtain the proceeds that we could realize from them and, in any event, the proceeds may not be adequate to meet any debt service obligations then due.
Indebtedness As of December 31, 2009,
On May 24, 2010, we had outstanding $819.2 million of borrowings underamended and restated our senior secured credit facilities andagreement to add a new term loan tranche of $580.0 million maturing at June 28, 2017, which we used, together with cash on hand, to redeem our $550.0 million of senior unsecured subordinated notes, as described below. We
54
also extended the maturity of a $500.0 million tranche of our term loan facility to June 25, 2015, with the remaining $317.1 million tranche maturing at the original maturity date of June 28, 2013.
On May 24, 2010, we gave notice of redemption of all of our outstanding senior unsecured subordinated notes. The redemption price of the senior unsecured subordinated notes was 105.375% of the outstanding aggregate principal amount, plus accrued and unpaid interest thereon up to but not including June 22, 2010 (the “Redemption Date”). The senior unsecured subordinated notes were redeemed on the Redemption Date.
We also maintain a revolving credit facility which is provided through the senior secured credit
facilities also include a $100.0 million revolving credit facility, $10.0 million of which is currently being utilized to support the issuance of an irrevocable letter of credit issued for the benefit of PTC.facilities. On January 25, 2010, we amended our senior secured credit facilitiesagreement to increase ourthe revolving credit facility from $100.0$100 million to $218.2 million. We alsoIn connection with this amendment, we extended the maturity of a $163.5 million tranche of ourthe revolving credit facility to June 28, 2013, with the2013. The remaining $54.7 million tranche maturing at theretains its original maturity date of December 28, 2011. The tranche maturing in 2013 is priced at London Interbank Offered Rate ("LIBOR") + 3.50% with a commitment fee of 0.75%. The tranche maturing in 2011 maintains its current pricing of LIBOR + 2.00% with a commitment fee of 0.375%.
We also maintain two uncommitted lines of credit, which havecredit. One of the lines has an unspecified limit, and is primarily dependent on our ability to provide sufficient collateral. Additionally,The other line had a limit of $100 million, which was increased to $150 million on May 27, 2010, and allows for both collateralized and uncollateralized (unsecured) borrowings.
We also are a party to interest rate swap agreements, in an
effortaggregate notional amount of $210 million, to mitigate interest rate risk
we maintain interest rate swap agreements to hedgeby hedging the variability
on $400.0 millionof a portion of our
floating ratefloating-rate senior secured
credit facilities.term loan.
Borrowings under our senior secured credit facilities bear interest at a base rate equal to the one, two, three, six, nine or twelve-month LIBOR plus our applicable margin, or an alternative base rate ("ABR"(“ABR”) plus our applicable margin. The ABR is equal to the greatergreatest of (a) the prime rate orin effect on such day, (b) the effective federal funds rate in effect on such day plus1/2 0.5% and (c) solely in the case of 1.00%the 2015 Term Loans and the 2017 Term Loans, 2.50%.
The applicable margin for borrowings
is currently 1.00%(a) with respect to the
2013 Term Loans is currently 0.75% for base rate borrowings and 1.75% for LIBOR borrowings, (b) with respect to the 2015 Term Loans is currently 1.75% for base rate borrowings and 2.75% for LIBOR borrowings, (c) with respect to the 2017 Term Loans is currently 2.75% for base rate borrowings and 3.75% for LIBOR borrowings, (d) with respect to revolver tranche maturing in 2011 is currently 1.00% for base rate borrowings and 2.00%
for LIBOR borrowings and (e) with respect to
LIBOR borrowings under the revolving credit facility, and 0.75% with respect torevolver tranche maturing in 2013 is currently 2.50% for base rate borrowings and
1.75% with respect to3.50% for LIBOR
borrowings under the senior secured term loan facility.borrowings. The applicable margin on
the senior secured term loan facilityour 2013 Term Loans could change depending on our credit rating.
In September 2008, our corporate credit rating was upgradedThe LIBOR Rate with respect to
Ba3 from B1, which has reduced the
interest rate on2015 Term Loans and the
senior secured credit facilities from LIBOR plus 200 basis points to LIBOR plus 175 basis points.2017 Term Loans shall in no event be less than 1.50%.
In addition to paying interest on outstanding principal under the senior secured credit facilities, we are required to pay a commitment fee to the lenders under the revolving credit facility in respect of the unutilized commitments thereunder. The commitment fee
raterates at December 31,
2009 is2010 were 0.375%
per annum,for our revolver tranche maturing in 2011 and 0.75% for our revolver tranche maturing in 2013, but
isare subject to
changeschange depending on our leverage ratio. We must also pay customary letter of credit fees.
The senior secured credit facilities (other than the revolving credit facility) will require us to prepay outstanding amounts under our senior secured term loan facility subject to certain exceptions, with:
| | |
| • | 50% (percentage will be reduced to 25% if our total leverage ratio is 5.00 or less and to 0% if our total leverage ratio is 4.00 or less) of our annual excess cash flow (as defined in our senior |
55
•50% (percentage will be reduced to 25% if our total leverage ratio is 5.00x or less and to 0% if our total leverage ratio is 4.00x or less) of our annual excess cash flow (as defined under our credit agreement) adjusted for, among other things, changes in our net working capital;
•100% of the net cash proceeds of all nonordinary course asset sales or other dispositions of property, if we do not reinvest or commit to reinvest those proceeds in assets to be used in our
| | |
| | secured credit agreement) adjusted for, among other things, changes in our net working capital; |
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| | |
| • | 100% of the net cash proceeds of all nonordinary course asset sales or other dispositions of property, if we do not reinvest or commit to reinvest those proceeds in assets to be used in our business or to make certain other permitted investments within 15 months as long as such reinvestment is completed within 180 days and |
|
| • | 100% of the net cash proceeds of any incurrence of debt, other than proceeds from debt permitted under the senior secured credit agreement. |
The foregoing mandatory prepayments will be applied to scheduled installments of principal of the senior secured term loan facility in direct order.
We may voluntarily repay outstanding loans under the senior secured credit
facilitiesagreement at any time without premium or penalty, other than customary
"breakage"“breakage” costs with respect to LIBOR loans.
We are required to repay the loans under the senior secured term loan facility in equal quarterly installments in aggregate annual amounts equal to 1% of the original funded principal amount of such facility, with the balance being payable on the final maturity date of
suchthe facility.
Principal amounts outstanding under the revolving credit facilities are due and payable in full at maturity.
The senior secured
credit facilities are secured primarily through pledges of the capital stock in our subsidiaries.
Certain Covenants and Events of Default The senior secured credit
facilities containagreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, our ability to:
•incur additional indebtedness;
•create liens;
•enter into sale and leaseback transactions;
•engage in mergers or consolidations;
•sell or transfer assets;
•
| | |
| • | incur additional indebtedness; |
|
| • | create liens; |
|
| • | enter into sale and leaseback transactions; |
|
| • | engage in mergers or consolidations; |
|
| • | sell or transfer assets; |
|
| • | pay dividends and distributions or repurchase our capital stock; |
|
| • | make investments, loans or advances; |
|
| • | prepay certain subordinated indebtedness; |
|
| • | engage in certain transactions with affiliates; |
|
| • | amend material agreements governing certain subordinated indebtedness and |
|
| • | change our lines of business. |
Our senior secured credit facilities prohibit us from paying dividends and distributions or repurchaserepurchasing our capital stock;
•make investments, loansstock except for limited purposes, including, but not limited to payments in connection with: (i) redemption, repurchase, retirement or advances;other acquisition of our equity interests from present or former officers, managers, consultants, employees and directors upon the death, disability, retirement, or termination of employment of any such person or otherwise in accordance with any
•prepay56
stock option or stock appreciate rights plan, any management or employee stock ownership plan, stock subscription plan, employment termination agreement or any employment agreements or stockholders’ agreement, in an aggregate amount not to exceed $5.0 million in any fiscal year plus the amount of cash proceeds from certain
subordinated indebtedness;
•engageequity issuances to such persons, the amount of equity interests subject to a certain deferred compensation plan and the amount of certain key-man life insurance proceeds, (ii) franchise taxes, general corporate and operating expenses not to exceed $3.0 million in certain transactions with affiliates;
•amend material agreements governing certain subordinated indebtedness;any fiscal year, and
•change our lines of business. In addition, fees and expenses related to any unsuccessful equity or debt offering permitted by the senior secured credit facilities, require us(iii) tax liabilities to maintain the following financial covenants:
•a minimum interest coverage ratio;extent attributable to our business and
•a maximum total leverage ratio.
At December 31, 2009, we were our subsidiaries and (iv) dividends and other distributions in compliance with all covenants under our senior secured credit facilities.
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Interest Rate Swaps
An interest rate swap is a financial derivative instrument whereby two parties enter into a contractual agreementan aggregate amount not to exchange payments based on underlying interest rates. We use interest rate swap agreements to hedge the variability on our floating rate for $400.0 millionexceed 50% of our term loan undercumulative consolidated net income available to stockholders at such time so long as at the time of such payment of dividend or the making of such distribution, and after giving effect thereto, our senior secured credit facility. We are required to pay the counterparty to the agreement fixed interest payments on a notional balance and in turn receive variable interest payments on that notional balance. Payments are settled quarterly on a net basis. As of December 31, 2009, we assessedleverage ratio is less than 3.50:1.00.
In addition, our
interest rate swaps as being highly effective and we expect them to continue to be highly effective. While approximately $419.2 million of our term loan remains unhedged as of December 31, 2009, the risk of variability on our floating interest rate is partially mitigated by our client margin loans on which we carry floating interest rates. At December 31, 2009, our receivables from clients for margin loan activity were approximately $227.9 million.Senior Unsecured Subordinated Notes
Our senior unsecured subordinated notes are due in 2015 and bear interest at 10.75% per annum. Interest payments are payable semi-annually in arrears. We are not required to make mandatory redemption or sinking fund payments with respect to the notes and at December 31, 2009, $550.0 million was still outstanding. We may voluntarily repurchase our senior unsecured subordinated notes at any time, pursuant to certain prepayment penalties.
Covenant Compliance
Our financial covenant requirements include a leverage ratio test and an interest coverage ratio test. Under our leverage ratio test, we covenant not to allow the ratio of our consolidated total debt (as defined in our senior secured credit agreement) to an adjusted EBITDA reflecting financial covenants in our senior secured credit facilities (“Credit Agreement Adjusted EBITDAEBITDA”) to exceed certain prescribed levels set forth in the agreement. Under our interest coverage ratio test, we covenant not to allow the ratio of our Credit Agreement Adjusted EBITDA to our consolidated interest expense (as defined in our senior secured credit agreement) to be less than certain prescribed levels set forth in the agreement. Each of our financial ratios is measured at the end of each fiscal quarter.
Our senior secured credit agreement provides us with a right to cure in the event we fail to comply with our leverage ratio test or our interest coverage test. We have beenmust exercise this right to cure within ten days of the delivery of our quarterly certificate calculating the financial ratio for that quarter.
If we fail to comply with these covenants and currently are unable to cure, we could face substantial liquidity problems and could be forced to sell assets, seek additional capital or seek to restructure or refinance our indebtedness. These alternative measures may not be successful or feasible. Our senior secured credit agreement restricts our ability to sell assets. Even if we could consummate those sales, the proceeds that we realize from them may not be adequate to meet any debt service obligations then due. Furthermore, if an event of default were to occur with respect to our senior secured credit agreement, our creditors could, among other things, accelerate the maturity of our indebtedness. See “Risk Factors — Our indebtedness could adversely affect our financial health and may limit our ability to use debt to fund future capital needs”.
As of December 31, 2010, we were in compliance with all of our financial covenant requirements.
Our covenant requirements and actual ratios as of December 31, 2010 are as follows:
| | | | | | | | | |
| | | December 31, 2010 |
| | | Covenant
| | Actual
|
Financial Ratio | | Requirement | | Ratio |
| |
| Leverage Test (Maximum) | | | 3.70 | | | | 2.64 | |
| Interest Coverage (Minimum) | | | 2.60 | | | | 4.81 | |
57
Set forth below is a reconciliation from EBITDA, Adjusted EBITDA and Credit Agreement Adjusted EBITDA to our net income (loss) for the years ending December 31, 2010 and December 31, 2009 (in thousands):
| | | | | | | | | |
| | | For the Year Ended December 31, | |
| | | 2010 | | | 2009 | |
| |
| Net (loss) income | | $ | (56,862 | ) | | $ | 47,520 | |
| Interest expense | | | 90,407 | | | | 100,922 | |
| Income tax (benefit) expense | | | (31,987 | ) | | | 25,047 | |
| Amortization of purchased intangible assets and software(1) | | | 43,658 | | | | 59,577 | |
| Depreciation and amortization of all other fixed assets | | | 42,379 | | | | 48,719 | |
| | | | | | | | | |
| EBITDA | | | 87,595 | | | | 281,785 | |
| EBITDA Adjustments: | | | | | | | | |
| Share-based compensation expense(2) | | | 10,429 | | | | 6,437 | |
| Acquisition and integration related expenses(3) | | | 12,569 | | | | 3,037 | |
| Restructuring and conversion costs(4) | | | 22,835 | | | | 64,078 | |
| Debt amendment and extinguishment costs(5) | | | 38,633 | | | | — | |
| Equity issuance and IPO related costs(6) | | | 240,902 | | | | 580 | |
| Other(7) | | | 150 | | | | 151 | |
| | | | | | | | | |
| Total EBITDA Adjustments | | | 325,518 | | | | 74,283 | |
| | | | | | | | | |
| Adjusted EBITDA | | | 413,113 | | | | 356,068 | |
| Pro-forma adjustments(8) | | | — | | | | — | |
| | | | | | | | | |
| Credit Agreement Adjusted EBITDA | | $ | 413,113 | | | $ | 356,068 | |
| | | | | | | | | |
| | |
| (1) | | Represents amortization of intangible assets and software as a result of our purchase accounting adjustments from our merger transaction in 2005 with the Majority Holders and our 2007 acquisitions of UVEST, the Affiliated Entities and IFMG. |
|
| (2) | | Represents share-based compensation expense related to vested stock options awarded to employees and non-executive directors based on the grant date fair value under the Black-Scholes valuation model. |
|
| (3) | | Represents acquisition and integration costs primarily as a result of our 2007 acquisitions of UVEST, the Affiliated Entities and IFMG. Included in the year ended December 31, 2010 are expenditures for certain legal settlements that have not been resolved with the indemnifying party. See “Item 3. Legal Proceedings”. |
|
| (4) | | Represents organizational restructuring charges incurred for severance and one-time termination benefits, asset impairments, lease and contract termination fees and other transfer costs. |
|
| (5) | | Represents debt amendment costs incurred in 2010 for amending and restating our credit agreement to establish a new term loan tranche and to extend the maturity of an existing tranche on our senior credit facilities, and debt extinguishment costs to redeem our subordinated notes, as well as certain professional fees incurred. |
|
| (6) | | Represents equity issuance and related costs for our IPO, which was completed in the fourth quarter of 2010. For 2009, $0.6 million of costs that were previously classified as restructuring and conversion have been reclassified to equity issuance and IPO related costs to conform to the current period presentation. Upon closing of the offering, the restriction on approximately 7.4 million shares of common stock issued to advisors under our Fifth Amended and Restated 2000 Stock Bonus Plan was released. Accordingly, the Company recorded a share-based compensation charge of $222.0 million, representing the offering price of $30.00 per share multiplied by 7.4 million shares. |
|
| (7) | | Represents excise and other taxes. |
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| | |
| (8) | | Credit Agreement Adjusted EBITDA excludes pro-forma general and administrative expenditures from acquisitions, as defined under the terms of our senior secured credit agreement. There were no such adjustments for the years ended December 31, 2010 and 2009. |
Interest Rate Swaps
An interest rate swap is a financial derivative instrument whereby two parties enter into a contractual agreement to exchange payments based on underlying interest rates. We use interest rate swap agreements to hedge the variability on our floating rate for $210.0 million of our term loan under our senior secured credit facilities. We are required to pay the counterparty to the agreement fixed interest payments on a notional balance and in turn receive variable interest payments on that notional balance. Payments are settled quarterly on a net basis. As of December 31, 2010, we assessed our interest rate swaps as being highly effective and we expect them to continue to be highly effective. While approximately $1.2 billion of our term loan remains unhedged as of December 31, 2010, the risk of variability on our floating interest rate is partially mitigated by the client margin loans on which we carry floating interest rates. At December 31, 2010, our receivables from our advisors’ clients for margin loan activity were approximately $233.5 million.
Bank Loans Payable
We maintain two uncommitted lines of credit at LPL Financial. One line has an unspecified limit, and is primarily dependent on the company’s ability to provide sufficient collateral. The other line has a $150.0 million limit and allows for both collateralized and uncollateralized borrowings. Both lines were utilized in 2010 and 2009; however, there were no balances outstanding at December 31, 2010.
Off-Balance Sheet Arrangements and Contractual Obligations The SEC defines off-balance sheet arrangements in Item 303 of Regulation S-K of the Securities Act as:
•Any obligation under certain guarantee contracts;
•A retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets;
•Any obligation under certain derivative instruments; and
•Any obligation arising out of a material variable interest held by the registrant in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging or research and development services with the registrant.
We enter into various off-balance-sheet arrangements in the ordinary course of business, primarily to meet the needs of our financial advisors'advisors’ clients. These arrangements include firm commitments to extend credit. For information on these arrangements, see Notes 14 and 1920 to our consolidated financial statements.
The following table provides information with respect to our commitments and obligations as of December 31, 2009:2010:
| | | | | | | | | | | | | | | | | | | | | |
| | | Payments Due by Period | |
| | | Total | | | < 1 Year | | | 1-3 Years | | | 4-5 Years | | | > 5 Years | |
| | | (In thousands) | |
| |
| Leases and other obligations(1) | | $ | 97,225 | | | $ | 31,380 | | | $ | 41,380 | | | $ | 16,557 | | | $ | 7,908 | |
| Senior secured term loan facilities(2) | | | 1,386,639 | | | | 13,971 | | | | 333,168 | | | | 492,850 | | | | 546,650 | |
| Commitment fee on revolving line of credit(3) | | | 3,086 | | | | 1,364 | | | | 1,722 | | | | — | | | | — | |
| Variable interest payments:(4) | | | | | | | | | | | | | | | | | | | | |
| 2013 Loan Hedged | | | 3,520 | | | | 2,849 | | | | 671 | | | | — | | | | — | |
| 2013 Loan Unhedged | | | 12,615 | | | | 3,665 | | | | 8,950 | | | | — | | | | — | |
| 2015 Loan Unhedged | | | 93,856 | | | | 21,302 | | | | 42,015 | | | | 30,539 | | | | — | |
| 2017 Loan Unhedged | | | 192,779 | | | | 30,525 | | | | 60,205 | | | | 58,889 | | | | 43,160 | |
| Interest rate swap agreements(5) | | | 7,791 | | | | 6,296 | | | | 1,495 | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | | |
| Total contractual cash obligations | | $ | 1,797,511 | | | $ | 111,352 | | | $ | 489,606 | | | $ | 598,835 | | | $ | 597,718 | |
| | | | | | | | | | | | | | | | | | | | | |
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| | |
| (1) | | Minimum payments have not been reduced by minimum sublease rental income of $6.5 million due in the future under noncancelable subleases. Note 14 of our consolidated financial statements provides further detail on operating lease obligations and obligations under noncancelable service contracts. |
|
| (2) | | Represents principal payments on our senior secured term loan facilities. See Note 12 of our consolidated financial statements for further detail. |
|
| (3) | | Represents commitment fees for unused borrowings on our senior secured revolving line of credit facility. See Note 12 of our consolidated financial statements for further detail. |
|
| (4) | | Our senior secured term loan facilities bear interest at floating rates. Variable interest payments are shown assuming the applicable LIBOR rates at December 31, 2010 remain unchanged. See Note 12 of our consolidated financial statements for further detail. |
|
| (5) | | Represents fixed interest payments net of variable interest received on our interest rate swap agreements. See Note 13 of our consolidated financial statements for further detail. |
| | | | | | | | | | | | | | | | | |
| | Payments due by period | |
|---|
| | (in thousands)
| |
|---|
| | Total | | <1 year | | 1-3 years | | 4-5 years | | >5 years | |
|---|
Leases and Other Obligations(1) | | | 112,952 | | | 27,543 | | | 47,940 | | | 21,145 | | | 16,324 | |
Senior Secured Credit Facilities and Senior Unsecured Subordinated Notes(2)(3) | | | 1,369,223 | | | 8,424 | | | 16,848 | | | 793,951 | | | 550,000 | |
Fixed Interest Payments | | | 352,286 | | | 59,125 | | | 118,250 | | | 118,250 | | | 56,661 | |
Variable Interest Payments(2)(3) | | | 96,716 | | | 18,274 | | | 62,160 | | | 16,282 | | | | |
Interest Rate Swap Agreements(2)(3) | | | 22,457 | | | 14,227 | | | 8,230 | | | | | | | |
| | | | | | | | | | | | |
| | Total contractual cash obligations | | $ | 1,953,634 | | $ | 127,593 | | $ | 253,428 | | $ | 949,628 | | $ | 622,985 | |
| | | | | | | | | | | | |
(1)Note 14 of our consolidated financial statements provides further detail on operating lease obligations and obligations under non-cancelable service contracts.
(2)Notes 12 and 13 of our consolidated financial statements provide further detail on these debt obligations.
(3)Our senior credit facilities bear interest at floating rates. Of the $819.2 million outstanding at December 31, 2009, we have hedged the variable rate cash flows using interest rate swaps of $400.0 million of principle (see Notes 12 and 13 of our consolidated financial statements). Variable interest payments are shown for the unhedged ($419.2 million) portion of the senior credit facilities assuming the one-month LIBOR at December 31, 2009 remains unchanged (see Note 12 of our consolidated financial statements for more information).
As of December 31, 2009,2010, we reflect a liability for unrecognized tax benefits of $22.0$21.1 million, which we have included in income taxes payable onin the consolidated statements of financial condition. This amount has been excluded from the contractual obligations table because we are unable to reasonably predict the ultimate amount or timing of future tax payments.
Fair Value of Financial Instruments We use fair value measurements to record certain financial assets and liabilities at fair value and to determine fair value disclosures.
We use prices obtained from an independent third-party pricing service to measure the fair value of our trading securities. We validate prices received from the pricing service using various methods including, comparison to prices received from additional pricing services, comparison to available
quotes market prices and review of other relevant market data including implied yields of major categories of securities. At December 31,
2009,2010, we did not adjust prices received from the independent third-party pricing service. For certificates of deposit and treasury securities, we utilize market-based inputs including observable market interest rates that correspond to the remaining maturities or next interest reset dates.
Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with GAAP, which require management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We believe that of our critical accounting policies, the following are noteworthy because they require management to make estimates regarding
Table of Contents
matters that are uncertain and susceptible to change where such change may result in a material adverse impact on our financial position and reported financial results.
We record commissions received from mutual funds, annuity, insurance, equity, fixed income, direct investment, option and commodity transactions on a trade-date basis. Commissions also include mutual fund and variable annuity trails, which are recognized as a percentage of assets under management over the period for which services are performed. Due to the significant volume of mutual fund and variable annuity purchases and sales transacted by financial advisersadvisors directly with product manufacturers, management must estimate a portion of its upfront commission and trail revenues for each accounting period for which the proceeds have not yet been received. These estimates are based primarily on a number of factors including market levels, the volume of transactions in previous prior
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periods
as well asand cash receipts in the current period. We record commissions payable based upon standard payout ratios for each product as it accrues for commission revenue.
Certain advisors conduct their advisory business through separate entities by establishing their own Registered Investment Advisor (“RIA”) pursuant to the Investment Advisers Act of 1940, rather than using our corporate registered RIA. These stand-alone RIAs engage us for technology, clearing, regulatory and custody services, as well as access to our investment advisory platforms. The fee-based production generated by the stand-alone RIA is earned by the advisor, and accordingly not included in our advisory fee revenue. We charge administrative fees based on the value of assets within these advisory accounts, and classify such revenues as asset-based fees and transaction and other fees.
We record reserves for legal proceedings in accounts payable and accrued liabilities in our consolidated statements of financial condition. The determination of these reserve amounts requires significant judgment on the part of management. We consider many factors including, but not limited to, the amount of the claim, the amount of the loss in the
client'sclient’s account, the basis and validity of the claim, the possibility of wrongdoing on the part of
a financialan advisor, likely insurance coverage, previous results in similar cases, and legal precedents and case law. Each legal proceeding is reviewed with counsel in each accounting period and the reserve is adjusted as deemed appropriate by management. Any change in the reserve amount is recorded as professional services in our consolidated statements of
income.operations.
Valuation of Goodwill and Other Intangibles Goodwill is required to be tested
We test goodwill for impairment at least annually, or whenever indications of impairment exist.
AnWe test other intangible assets whenever indications of impairment
exist. Impairment exists when the carrying amount of goodwill exceeds its implied fair value, resulting in an impairment charge for the excess.
The value of intangible assets, including goodwill, could be impacted by future adverse changes such as: (i) significant declines in our operating results, (ii) a significant decline in the valuation of comparable company stocks, (iii) a further significant slowdown of the worldwide economy or industry or (iv) any failure to meet the performance projections included in our forecasts of future operating results.
We have elected October 1 asperform an impairment analysis on our goodwill on an annual goodwill impairment testing date.basis on the first day of the fourth fiscal quarter (October 1). In testing for a potential impairment of goodwill on October 1, 2009, we2010, the estimated the fair value of each of our reporting units (generally defined as businesses for which financial information is available and reviewed regularly by management) and compared this value to the carrying value of the reporting unit. The estimated fair value of each reporting unit was significantly greater than its carrying value, and therefore we concluded that no amount of goodwill was impaired. TheAt a reporting unit level, the estimated fair value was, at a minimum, 2.5 times its carrying value.
The fair value of theour reporting units was establishedestimated using athe income approach methodology that includes the discounted cash flow modelmethod, and the market approach methodology that includes the use of market multiples. The discounted cash flows for each reporting unit were based on discrete financial forecasts developed by management for planning purposes and include significant assumptions about revenue growth, operating margins, discount rates and capital expenditures. Cash flows beyond the discrete forecasts were estimated using a terminal value calculation, which incorporated historical and forecasted financial trends for each identified reporting unit and considered long-term earnings growth for publicly traded peer companies. Future cash flows were discounted to present value by incorporating the present value techniques discussed in Financial Accounting Standards Board Concepts Statement 7,Using Cash Flow Information and Present Value in Accounting Measurements.
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In addition, publicly available information regarding peer companies with comparable market capitalization was also considered in assessing the reasonableness of cumulative fair values of our reporting units estimated using the market approach methodology. In our analysis, we developed appropriate valuation multiples for each of our reporting units. Specifically, we considered valuation multiples of our peer companies including revenue, EBITDA, net income and after-tax cash flows.
The income approach valuations included reporting unit cash flow discount rates ranging from 11.9% to 16.3% and terminal growth rates of 3.0%. Our discount rate represents our weighted average cost of capital adjusted for company-specific risk premium. The development of the weighted average cost of capital used in our estimate of fair value considered current market conditions for the equity-risk premium and risk-free interest rate, benchmark capital structures for guideline companies with characteristics similar to our reporting units, the size and industry of our reporting units and risks related to the forecast of future revenues and profitability of our reporting units. The company-specific risk premium was reduced primarily due to lower long-term growth and profitability assumptions associated with the 2011 forecast. The weighted average cost of capital used in the estimate of fair value in future periods may be impacted by changes in market conditions (including those of market participants), as well as the future performance of our reporting units and is subject to change, based on changes in specific facts and circumstances.
Significant management judgment is required in the forecasts of future operating results
that are used in the discounted cash flow method of valuation. The estimates we have used are consistent with the plans and
cash flows of each reporting unit. Adverse changesestimates that we use to manage or business. It is possible, however, that the plans may change and estimates used may prove to be inaccurate. Changes in our planned business operations such as unanticipated competition, a loss of key personnel, the sale of a reporting unit or a significant portion of a reporting unit or other unforeseen developments could result in an impairment of our recorded goodwill.
Changes in forecasted operating results and other assumptions could materially affect those estimates.
We review our property, equipment, capitalized software and intangible assets,
including goodwill, for
indications of impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Such events or changes may include a deterioration in the business climate or a significant adverse change in the extent or manner in which a long-lived asset is being used. If the total of projected future undiscounted cash flows is less than the carrying amount of an asset, we may need to record an impairment loss based on the excess of the carrying amount over the fair value of the assets.
Table We have concluded that no such indications of Contents
impairment of goodwill and other intangibles exist as of December 31, 2010.
We estimate income tax expense based on the various jurisdictions where we conduct business. We must then assess the likelihood that the deferred tax assets will be realized. A valuation allowance is established to the extent that it is more-likely-than-not that such deferred tax assets will not be realized. When we establish a valuation allowance or modify the existing allowance in a certain reporting period, we generally record a corresponding increase or decrease to
tax expensethe provision for income taxes in the consolidated statements of
income.operations. We make significant judgments in determining the provision for income taxes, the deferred tax assets and liabilities and any valuation allowances recorded against the deferred tax asset. Changes in the estimate of these taxes occur periodically due to changes in the tax rates, changes in the business operations, implementation of tax planning strategies, resolution with taxing authorities of issues where we have previously taken certain tax positions and newly enacted statutory, judicial and regulatory guidance. These changes, when they occur, affect accrued taxes and can be material to our operating results for any particular reporting period.
Additionally, we account for uncertain tax positions in accordance with GAAP. The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. We are required to make many subjective assumptions and
62
judgments regarding our income tax exposures. Interpretations of and guidance surrounding income tax laws and regulations change over time. As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in our consolidated financial statements.
Valuation and Accounting for Financial Derivatives We periodically use financial derivative instruments, such as interest rate swap agreements, to protect us against changing market prices or interest rates and the related impact to our assets, liabilities, or cash flows. We also evaluate our contracts and commitments for terms that qualify as embedded derivatives. All derivatives are reported at their corresponding fair value in our consolidated statements of financial condition.
Financial derivative instruments expected to be highly effective hedges against changes in cash flows are designated as such upon entering into the agreement. At each reporting date, we reassess the effectiveness of the hedge to determine whether or not it can continue to use hedge accounting. Under hedge accounting, we record the increase or decrease in fair value of the derivative, net of tax impact, as other comprehensive income or losses. If the hedge is not determined to be a perfect hedge, yet still considered highly effective, we will calculate the ineffective portion and record the related change in its fair value as additional interest income or expense in the consolidated statements of
income.operations. Amounts accumulated in other comprehensive income are generally reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings.
Share-Based Compensation Share-based
Certain employees, advisors, officers and directors who contribute to our success participate in various stock option plans. In addition, certain financial institutions participate in a warrant plan. Stock options and warrants generally vest in equal increments over a three to five-year period and expire on the 10th anniversary following the date of grant.
We recognize share-based compensation cost is measured at the grant dateexpense related to employee stock option awards in net income based on the estimatedgrant-date fair value over the requisite service period of the individual grants, which generally equals the vesting period. We account for stock options and warrants awarded to our advisors and financial institutions based on the fair value of the award and is recognizedat each interim reporting period. We record the increase in price of the option or warrant as commission expense during such period. If the value of our common stock increases over the requisite servicea given period, based on the number of awards for which the requisite service is expected to be rendered. this accounting treatment results in additional commission expense.
As there are no observable market prices for identical or similar instruments, we estimate fair value using a Black-Scholes valuation model. We must make assumptions regarding the number of share-based awards that will be forfeited. The forfeiture assumption is ultimately adjusted to the actual forfeiture rate. Therefore, changes in the forfeiture assumptions do not impact the total amount of expense ultimately recognized over the vesting period. Rather, different forfeiture assumptions would only impact the timing of expense recognition over the vesting period.
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TableThe following table presents the weighted average assumptions used by us in calculating the fair value of
Contentsour stock options and warrants with the Black-Scholes valuation model for the years ended December 31, 2010, 2009 and 2008:
| | | | | | | | | | | | | |
| | | December 31, |
| | | 2010 | | 2009 | | 2008 |
| |
| Expected life (in years) | | | 6.50 | | | | 7.13 | | | | 6.52 | |
| Expected stock price volatility | | | 49.22 | % | | | 51.35 | % | | | 33.78 | % |
| Expected dividend yield | | | — | | | | — | | | | — | |
| Annualized forfeiture rate | | | 3.00 | % | | | 4.35 | % | | | 1.51 | % |
| Fair value of options | | $ | 17.43 | | | $ | 12.30 | | | $ | 9.96 | |
| Risk-free interest rate | | | 2.70 | % | | | 2.93 | % | | | 2.73 | % |
The risk-free interest rates are based on the implied yield available on U.S. Treasury constant maturities in effect at the time of the grant with remaining terms equivalent to the respective expected terms of the options. The dividend yield of zero is based on the fact that we have no present intention to pay cash dividends. In the future, as we gain historical data for volatility of our stock and the actual term over which employees hold our options, expected volatility and the expected term may change, which could substantially change the grant-date fair value of future awards of stock options and, ultimately, compensation recorded on future grants. We estimate the expected term for our employee option awards using the simplified method in accordance with Staff Accounting Bulletin 110,Certain Assumptions Used in Valuation Methods, because we do not have sufficient relevant historical information to develop reasonable expectations about future exercise patterns. We estimate the expected term for stock options and warrants awarded to our advisors using the contractual term. Expected volatility is calculated based on companies of similar growth and maturity and our peer group in the industry in which we do business because we do not have sufficient historical volatility data. We will continue to use peer group volatility information until our historical volatility is relevant to measure expected volatility for future grants.
We have assumed an annualized forfeiture rate for our stock options and warrants based on a combined review of industry and employee turnover data, as well as an analytical review performed of historical pre-vesting forfeitures occurring over the previous year. We record additional expense if the actual forfeiture rate is lower than estimated and record a recovery of prior expense if the actual forfeiture is higher than estimated.
The expected life was based on our historical stock option activity. The risk-free interest rate was determined by reference to the United States Treasury rates with the remaining term approximating the expected life assumed at the date of grant.
Recent Accounting Pronouncements Refer to Note 2 of our
notes to the consolidated financial statements for a discussion of recent accounting standards and pronouncements.
| |
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
We bear some market risk on margin transactions affected for our financial advisors' clients. In margin transactions we extend credit to clients collateralized by cashmaintain trading securities owned and securities sold but not yet purchased in order to facilitate client transactions, to meet a portion of our clearing deposit requirements at various clearing organizations, and to track the client's account. Asperformance of our research models. These securities include mutual funds, debt securities issued by the U.S. government, money market funds, corporate debt securities, certificates of deposit and equity securities.
Changes in value of our trading inventory may result from fluctuations in interest rates, credit
ratings of the issuer, equity prices and the correlation among these factors. We manage our trading
64
inventory by product type. Our activities to facilitate client transactions generally involve
mutual fund activities, including dividend reinvestments. The balances are based upon pending
client activities which are monitored by our broker dealer support services department. Because
these positions arise from pending client transactions, there are no specific trading or position
limits. Positions held to meet clearing deposit requirements consist of U.S. government securities.
The amount of securities deposited depends upon the requirements of the clearing organization. The
level of securities deposited is monitored by the settlement area within our broker dealer support
services department. Our research department develops model portfolios that are used by advisors in developing client portfolios. We currently maintain 173 accounts based on model portfolios. At the time the portfolio is developed, we purchase the securities in that model portfolio in an amount equal to the account minimum for a client. Account minimums vary by product and can range from $10,000 to $50,000 per model. We utilize these positions to track the performance of the research department. The limits on this activity are based at the inception of each new model.
At December 31, 2010, the fair value of our trading securities owned were $9.3 million. Securities sold but not yet purchased were $4.8 million at December 31, 2010. See Note 5 of our consolidated financial advisors execute margin transactions on behalfstatements for information regarding the fair value of their clients, we may incur losses if clientstrading securities owned and securities sold but not yet purchased associated with our client facilitation activities. See Note 5 of our consolidated financial statements for information regarding the fair value of securities held to maturity.
We do not
fulfill their obligations, the collateral in the client's account is insufficient to fully cover losses from such investments, and ourenter into contracts involving derivatives or other similar financial
advisors fail to reimburse usinstruments for
such losses. The risk of default depends on the creditworthiness of the client. To minimize this risk we assess the creditworthiness of the clients and monitor the margin level daily. Clients are required to deposit additional collateral,trading or
reduce positions, when necessary.proprietary purposes.
We also have market risk on the fees we earn that are based on the market value of
assets in advisory
AUM,and brokerage assets, assets on which trail commissions are paid and assets eligible for sponsor payments.
We do not enter into derivatives or other similar financial instruments for trading or speculative purposes.We are exposed to risk associated with changes in interest rates. As of December 31, 2009,2010, all of the outstanding debt under our senior secured credit facilities, $819.2 million,$1.4 billion, was subject to floating interest rate risk. To provide some protection against potential rate increases associated with our floating senior secured credit facilities, we have entered into derivative instruments in the form of interest rate swap agreements with Morgan Stanley Capital Services, Inc. covering a significant portion ($400.0210.0 million) of our senior secured indebtedness. The interest rate swap agreements qualify for hedge accounting and have been designated as cash flow hedges against specific payments due on our senior secured term loan. Accordingly, any interest rate differential is reflected in an adjustment to interest expense over the lives of the interest rate swap agreements. While the unhedged portion of our senior secured debt is subject to increases in interest rates, we believe that this risk is offset with variable interest rates associated with client borrowings. At December 31, 2009, we had $419.2 million in unhedged senior secured borrowings, the variable cost of which is partially offset by variable interest income on $227.9 million of client margin receivables. Because of this relationship, and our expectation for outstanding balances in the future, we do not believe that a short-term change in interest rates would have a material impact on our income before taxes. For a discussion
The following table summarizes the impact of suchincreasing interest rate swap agreements, see Note 13 torates on our audited consolidated financial statements.interest expense from the variable portion of our debt outstanding at December 31, 2010 (in thousands):
| | | | | | | | | | | | | | | | | | | | | |
| | | Outstanding at
| | | Annual Impact of an Interest Rate Increase of | |
| | | Variable Interest
| | | 10 Basis
| | | 25 Basis
| | | 50 Basis
| | | 100 Basis
| |
Senior Secured Term Loans | | Rates | | | Points | | | Points | | | Points | | | Points | |
| |
| 2013 Term Loan (Hedged)(1) | | $ | 210,000 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| 2013 Term Loan (Unhedged)(2) | | | 104,739 | | | | 104 | | | | 259 | | | | 518 | | | | 1,035 | |
| 2015 Term Loan (Unhedged)(3) | | | 496,250 | | | | — | | | | — | | | | — | | | | — | |
| 2017 Term Loan (Unhedged)(3) | | | 575,650 | | | | — | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | | |
| Variable Rate Debt Outstanding | | $ | 1,386,639 | | | $ | 104 | | | $ | 259 | | | $ | 518 | | | $ | 1,035 | |
| | | | | | | | | | | | | | | | | | | | | |
3-month LIBOR(4) | | | 0.30 | % | | | 0.40 | % | | | 0.55 | % | | | 0.80 | % | | | 1.30 | % |
| | |
| (1) | | Represents the portion of our 2013 Term Loan that is hedged by interest rate swap agreements, which have been designated as cash flow hedges against specific payments due on the 2013 |
65
| | |
| | Term Loan. Accordingly, any interest rate differential is reflected in an adjustment to interest expense over the term of the interest rate swap agreements. |
|
| (2) | | Represents the unhedged portion of our 2013 Term Loan outstanding at December 31, 2010. |
|
| (3) | | The variable interest rate for our 2015 Term Loan and our 2017 Term Loan is based on the greater of the three-month LIBOR of 0.30% or 1.50%, plus an applicable interest rate margin. |
|
| (4) | | Represents the three-month LIBOR rate at December 31, 2010. |
We offer our customersadvisors and their clients two primary cash sweep programs that are interest rate sensitive: our bank sweepinsured cash programs and money market sweep vehicles involving multiple money market fund providers. Our bank sweepinsured cash programs use multiple non-affiliated banks to provide up to $1.5 million ($3.0 million joint) of FDIC insurance for client deposits custodied at the banks. While clients earn interest for balances on deposit in the bank sweepinsured cash programs, we earn a fee. Our fees from the bank sweepinsured cash programs are not based on prevailing interest rates in the current interest rate environment, but may be adjusted in a decliningan increasing or decreasing interest rate environment or for other reasons. Changes in interest rates and fees for the bank sweepinsured cash programs are monitored by our Feefee and Rate Setting Committeerate setting committee (the "FRS Committee"“FRS committee”), which governs and approves any changes to our fees. By meeting promptly after interest rates change, or for other market or non-market reasons, the FRS Committeecommittee balances financial risk of the bank sweepinsured cash programs with products that offer competitive client yields. However, as short-term interest rates hit lower levels, the FRS Committeecommittee may be compelled to lower fees.
The average Federal Reserve effective federal funds rate for December
20092010 was
0.12%0.18%. A
downward change
of 10 basis points in short-term interest rates,
of
Tableif accompanied by a commensurate change in fees for our insured cash programs, could result in a decrease of Contents
10$12.2 million in income before taxes on an annual basis (assuming that client balances at December 31, 2010 remain unchanged). Assuming client balances at December 31, 2010 do not change, each 25 basis point increase in short-term interest rates between the current federal funds effective rate and 125 basis points, if accompanied by a commensurate change in fees for our insured cash sweep programs, could result in an incremental increase or decreaseof $14.9 million in income before income taxes of $11.6 million on an annual basis, (assuming that client balances at December 31, 2009 did not change).after consideration of amounts paid to clients. Actual impacts may vary depending on interest rate levels, the significance of change, and the FRS Committee'scommittee’s strategy in responding to that change.
Credit Risk
Credit risk is the risk of loss due to adverse changes in a borrower’s, issuer’s or counterparty’s ability to meet its financial obligations under contractual or agreed upon terms. We bear credit risk on the activities of our advisors’ clients, including the execution, settlement, and financing of various transactions on behalf of these clients.
These activities are transacted on either a cash or margin basis. Our credit exposure in these transactions consists primarily of margin accounts, through which we extend credit to clients collateralized by cash and securities in the client’s account. Under many of these agreements, we are permitted to sell or repledge these securities held as collateral and use these securities to enter into securities lending arrangements or to deliver to counterparties to cover short positions.
As our advisors execute margin transactions on behalf of their clients, we may incur losses if clients do not fulfill their obligations, the collateral in the client’s account is insufficient to fully cover losses from such investments, and our advisors fail to reimburse us for such losses. Our loss on margin accounts is immaterial and did not exceed $0.1 million during the years ended December 31, 2010, 2009 and 2008. We monitor exposure to industry sectors and individual securities and perform analyses on a regular basis in connection with our margin lending activities. We adjust our margin requirements if we believe our risk exposure is not appropriate based on market conditions.
66
We are subject to concentration risk if we extend large loans to or have large commitments with a single counterparty, borrower, or group of similar counterparties or borrowers (e.g. in the same industry). Receivables from and payables to clients and stock borrowing and lending activities are conducted with a large number of clients and counterparties and potential concentration is carefully monitored. We seek to limit this risk through careful review of the underlying business and the use of limits established by senior management, taking into consideration factors including the financial strength of the counterparty, the size of the position or commitment, the expected duration of the position or commitment and other positions or commitments outstanding.
Operational risk generally refers to the risk of loss resulting from our operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our technology or financial operating systems and inadequacies or breaches in our control processes. We operate in diverse markets and are reliant on the ability of our employees and systems to process a large number of transactions. These risks are less direct
and quantifiable than credit and market risk, but managing them is critical, particularly in a rapidly changing environment with increasing transaction volumes. In the event of a breakdown or improper operation of systems or improper action by employees
or advisors, we could suffer financial loss, regulatory sanctions and damage to our reputation. Business continuity plans exist for critical systems, and redundancies are built into the systems as deemed appropriate. In order to mitigate and control operational risk, we have developed and continue to enhance specific policies and procedures that are designed to identify and manage operational risk at appropriate levels throughout our organization and within various departments. These control mechanisms attempt to ensure that operational policies and procedures are being followed and that our employees
and advisors operate within established corporate policies and limits.
We have established various committees of the
Boardboard of
Directorsdirectors to manage the risks associated with our business. Our Audit Committee was established for the primary purpose of overseeing (i) the integrity of our consolidated financial statements, (ii) our compliance with legal and regulatory requirements that may impact our consolidated financial statements or financial operations, (iii) the independent
auditor'sauditor’s qualifications and independence and (iv) the performance of our independent auditor and internal audit function. Our Compensation
and Human Resources Committee was established for the primary purpose of (i) overseeing our efforts to attract, retain and motivate members of our senior management team in partnership with the
Chief Executive Officer,chief executive officer, (ii) to carry out the
Board'sboard’s overall responsibility relating to the determination of compensation for all executive officers, (iii) to oversee all other aspects of our compensation and human resource policies and (iv) to oversee our management resources, succession planning and management development activities.
We also have established a Risk Oversight Committee comprised of a group of senior executives to oversee the management of our business risks.
In addition to various committees, we have written policies and procedures that govern the conduct of business by our
customers andadvisors, our employees, our relationship with clients and the terms and conditions of our relationships with product manufacturers. Our client and
financial advisor policies address the extension of credit for client accounts, data and physical security, compliance with industry regulation and codes of ethics to govern employee and
financial advisor conduct among other matters.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
| |
| Item 8. | Financial Statements and Supplementary Data |
The Consolidated Financial Statements and Supplementary Data are included as an annex to this Annual Report onForm 10-K. See the Index to Consolidated Financial Statements and Supplementary Data onpage F-1.
67
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Table of Contents
ITEM 9A. CONTROLS AND PROCEDURES
| |
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
| |
| Item 9A. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures Our Disclosure Committee, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures, as defined in
Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report were effective.
Change in Internal Control over Financial Reporting There were no changes in our internal control over financial reporting that occurred during the fourth quarter ended December 31,
2009,2010, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management'sManagement’s Annual Report on Internal Control Over Financial ReportingOur management is responsible for establishing and maintaining adequate internal control over our financial reporting. Internal control over financial reporting is defined in
Rules 13a-15(f) and
15d-15(f) under the Exchange Act as the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our consolidated financial statements for external purposes in accordance with generally accepted accounting principles.
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the
Company'sCompany’s assets that could have a material effect on our consolidated financial statements.
As of December 31,
2009,2010, management conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework established in
Internal Control—Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has determined that our internal control over financial reporting as of December 31, 20092010 was effective.Deloitte & Touche LLP, our independent registered public accounting firm, has issued an audit report appearing on the following page on the effectiveness of our internal control over financial reporting as of December 31, 2009.2010.
68
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
LPL Investment Holdings Inc.
We have audited the internal control over financial reporting of LPL Investment Holdings Inc. and subsidiaries (the
"Company"“Company”) as of December 31,
2009,2010, based on criteria established in
Internal Control—Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company'sCompany’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management'sManagement’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company'sCompany’s internal control over financial reporting based on our audit.We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A
company'scompany’s internal control over financial reporting is a process designed by, or under the supervision of, the
company'scompany’s principal executive and principal financial officers, or persons performing similar functions, and effected by the
company'scompany’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A
company'scompany’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
company'scompany’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31,
2009,2010, based on the criteria established in
Internal Control—Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31,
20092010 of the Company and our report dated March 9,
20102011 expressed an unqualified opinion on those
consolidated financial statements.
/s/ Deloitte & Touche LLP
Costa Mesa, California
March 9, 20102011
69
| |
| Item 9B. | Other Information |
None.
Table of Contents ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The
| |
| Item 10. | Directors, Executive Officers and Corporate Governance |
Other than the information relating to
directors of LPLIHour executive officers provided below, the information required to be furnished pursuant to this item is incorporated by reference to the
Company'sCompany’s definitive proxy statement for the
20102011 Annual Meeting of Stockholders.
Such proxy statement will be filed with the SEC prior to April 30, 2010. The following table provides certain information about each of the
Company'sCompany’s current executive officers as of the date this Annual Report on
Form 10-K has been filed with the SEC:
| | | | | |
Name
| | Age | | Position(1) |
|---|
Mark S. Casady
| | | 49 | | | |
Name | | Age | | Position |
|
| Mark S. Casady | | | 50 | | | Chief Executive Officer and Chairman of the Board |
Esther M. Stearns | | | 4950 | | | President and Chief Operating Officer |
Robert J. Moore | | | 4849 | | | Chief Financial Officer and Treasurer |
William E. Dwyer | | | 5253 | | | Managing Director, President — National Sales and Marketing |
Denise M. Abood | | | 4849 | | | Managing Director, Human Capital |
Dan H. Arnold | | | 4546 | | | Managing Director and Divisional President, Financial Institution Services |
Stephanie L. Brown | | | 5758 | | | Managing Director, General Counsel and Secretary |
Jonathan G. Eaton | | | 5152 | | | Managing Director, Custom Clearing Services |
Christopher F. Feeney | | | 5455 | | | Managing Director, Chief Information Officer |
Mark R. Helliker | | | 4647 | | | Managing Director, Broker-Dealer Support Services |
John J. McDermott | | | 5354 | | | Managing Director, Chief Enterprise Risk Officer |
| | | | | | |
Executive Officers
Mark S. Casady—Chairman andCasady — Chief Executive Officer and Chairman of the Board Mr. Casady
has beenis chairman of the board of directors and our
chairman and chief executive
officer since December 2005.officer. He joined us in May 2002 as chief operating officer, became our president in April 2003, and became our chief executive officer
president and chairman in December 2005. Before joining
theour firm, Mr. Casady was managing director, mutual fund group for Deutsche Asset Management,
Americas—Americas — formerly Scudder Investments. He joined Scudder in 1994 and held roles as managing
director—director — Americas; head of global mutual fund group and head of defined contribution services. He was also a member of the Scudder, Stevens and Clark Board of Directors and Management Committee. He is former chairman and a current board member of the Insured Retirement Institute and serves on
the Financial Industry Regulatory AuthorityFINRA’s board of governors. Mr. Casady received his B.S. from Indiana University and his M.B.A. from DePaul University.
Esther M. Stearns—Stearns — President and Chief Operating Officer Ms. Stearns has been our president since March 2007 and our chief operating officer since 2003.September 2004. She joined us in July 1996 as chief information officer. Today, Ms. Stearns is responsible for oversight of our Broker/DealerBroker-Dealer Support Services, Business Technology Services and Custom Clearing Services business units, in addition to several Corporate Shared Services areas, such as Corporate Communication, Human Capital, Strategic Planning and Sponsor Relations. Prior to joining us, she was vice president of information systems at Charles Schwab & Co., Inc., where she worked for 14 years in a variety of leadership roles. She received her B.A. from the University of Chicago.
70
Table of Contents
Robert J. Moore—Moore — Chief Financial Officer and Treasurer Mr. Moore joined us in September 2008 as chief financial officer. He is responsible for formulating financial policy and planning as well as ensuring the effectiveness of the financial functions within
theour firm. He also has oversight of our research and risk management functions.
Prior to joining us,From2006-2008, Mr. Moore served as chief executive officer and chief financial officer at ABN AMRO North America and LaSalle Bank Corporation. Before this role, Mr. Moore worked for Diageo PLC, Europe and Great Britain, in a number of finance management positions, ultimately serving as chief financial officer. Mr. Moore
hasserves as an independent board member for Legal and General Investment Management America. He holds a
Bachelor of Business AdministrationB.B.A. in finance from the University of Texas, Austin and a
Master of ManagementM.M. in finance, marketing and international business from Northwestern
University.University and is a Chartered Financial Analyst (CFA).
William E. Dwyer—Dwyer — Managing Director, President — National Sales and Marketing Mr. Dwyer has served as managing director,
and president
of— National Sales and Marketing since
September 2009. He joined us in July 1992 and became managing director, branch development in
2002,January 2004, managing director, national sales in
July 2005, and managing director, president of Independent Advisor Services in
February 2007. Mr. Dwyer is responsible for the management, satisfaction, retention and recruitment of our
independent advisor and financial institution customers.advisors. Mr. Dwyer serves
on the Private Client Services Executive Committee and as vice chair of the Financial Services Institute Board of Directors. He is also a member of the
Boardsboards of
Directors fordirectors of the Securities Industry and Financial Markets Association and
the Financialserves on its Private Client Services
Institute, Inc.Executive Committee. He received his B.A. from Boston College.
Denise Abood—M. Abood — Managing Director, Human Capital Ms. Abood has served as managing director
since January 2008 and the leader of our Human Capital group since
January 2007. In this role, she is responsible for several functions critical to
theour firm, including organizational development and training, human resources, employee recruiting, compensation and benefits, real estate and facilities, payroll and mail services. Ms. Abood was formerly chief financial officer for UVEST
Financial Services Group, Inc.(prior to our acquisition of UVEST) where she also led the UVEST Mortgage Company. Prior to joining UVEST,
from1998-2002, she held two roles at Wachovia Bank, initially as the chief financial officer for capital markets services and then as head of the technology business office. Ms. Abood holds a
B.A. in Business AdministrationB.B.A. from Wittenberg
University in Springfield, Ohio.University.
Dan H. Arnold—Arnold — Managing Director and Divisional President, Financial Institution Services Mr. Arnold serves as managing director and divisional president of our Institution Services
business.business since June 2007. He is responsible for new business development and business consulting, as well as for Insurance Associates Incorporated, which provides insurance solutions for
theour firm. Mr. Arnold joined
theour firm in January 2007 following our acquisition of
UVEST Financial Services Group, Inc.UVEST. Prior to joining us, Mr. Arnold worked at UVEST
Financial Services Group, Inc. for 13 years, serving most recently as president and chief operating officer. Mr. Arnold is a graduate of Auburn University and holds an
MBAM.B.A. in finance from Georgia State University.
Stephanie L. Brown—Brown — Managing Director, General Counsel and Secretary Ms. Brown joined us in August 1989 and has been responsible for the Legal Department throughout her tenure. From 1989 to 2004, Ms. Brown was also responsible for our Compliance organization. Ms. Brown is currently serving as a member of FINRA’s National Adjudicatory Council’s Statutory Disqualification Committee and also as a member of FINRA’s Independent Broker/Dealer and Membership Committees, the SIFMA Private Client Legal Committee, and the IRI Government Relations Committee. Ms Brown is also a member representative of the Financial Services Roundtable as well as a member of the Financial Services Roundtable’s Lawyers’ Council, the Regulatory Oversight Committee, and the Securities Working Group. Prior to joining us, Ms. Brown was an
71
associate attorney with the law firm of Kelley Drye & Warren in Washington, D.C., specializing in corporate and securities law. Ms. Brown received her B.A.cum laudefrom Bryn Mawr College and her J.D. from the Catholic University of America.
Table of Contents
Jonathan Eaton—G. Eaton — Managing Director, Custom Clearing Services Mr. Eaton joined us in June 1997 and became managing director, Custom Clearing Services in
2007.January 2008. He is also responsible for our Sponsor Relations Group and The Private Trust Company, N.A. Prior to this position, Mr. Eaton served as our executive vice president of product marketing. Before joining us, Mr. Eaton spent 14 years at MFS Investment Management. His positions at MFS included national account management, corporate marketing, product development, and market research.
He holds a B.A. in journalism fromMr. Eaton attended the University of Maine.
Christopher Feeney—F. Feeney — Managing Director, Chief Information Officer Mr. Feeney joined us in January 2008 as chief information officer and managing director for the Business Technology Services business unit. Mr. Feeney is responsible for enhancing the technology offerings and support we provide to our
financial advisors and their clients.
Prior to joining us,From2005-2007, Mr. Feeney was global managing director of wealth management at Thomson Financial. Mr. Feeney was chief executive officer of Telerate, Inc., from July 2003 until its sale to Reuters in December 2004. He holds a B.A. in literature from the State University of New York, Oneonta, and completed the Securities Industry Institute at the Wharton School.
Mark Helliker—R. Helliker — Managing Director, Broker-Dealer Support Services Mr. Helliker joined us in July 2008 as managing director of
Broker/DealerBroker-Dealer Support Services. He is responsible for the
day-to-day management of
customer-side operations
for advisors and new-advisor transitions, as well as for enhancing the
customerfinancial professional experience. Prior to joining us, Mr. Helliker worked at Charles Schwab for 10 years, most recently as senior vice president of Charles Schwab Institutional. Mr. Helliker has a B.A. in political science from the University of Portsmouth in England and an
MBAM.B.A. in management from San Diego State University.
John McDermott—J. McDermott — Managing Director, Chief Enterprise Risk Officer Mr. McDermott joined us in July 2009 as managing director and chief risk officer. In this role, he is focused on optimizing resources dedicated to risk and compliance across
theour firm, building consistency, and continuing to strengthen all teams with a holistic and strategic approach. Prior to joining us, Mr. McDermott worked for 35 years at Merrill Lynch, where he held a series of leadership roles including global head of compliance and internal audit. Mr. McDermott has a B.A. from Wesleyan University and a J.D. from Rutgers University.
ITEMS 11, 12, 13 AND 14.
The information required by Items 11, 12, 13, and 14 is incorporated by reference
tofrom the
Company'sCompany’s definitive proxy statement for the
20102011 Annual Meeting of Stockholders.
Such proxy statement will be filed with the SEC prior to April 30, 2010.
72
| |
| Item 15. | Exhibits and Financial Statement Schedules |
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
- (a)
- Consolidated Financial Statements
Our consolidated financial statements appearing on pages F-1 through F-40F-35 are incorporated herein by reference.
(b) Exhibits
| | | | | |
Exhibit No. | | Description of Exhibit |
| |
| | 3 | .1 | | Amended and Restated Certificate of Incorporation of LPL Investment Holdings Inc., dated November 23, 2010. (1) |
| | 3 | .2 | | Second Amended and Restated Bylaws of LPL Investment Holdings Inc. (2) |
| | 4 | .1 | | Stockholders’ Agreement, dated as of December 28, 2005, among LPL Investment Holdings Inc., LPL Holdings, Inc. and other stockholders party thereto. (3) |
| | 4 | .2 | | First Amendment to Stockholders’ Agreement dated December 28, 2005, among LPL Investment Holdings Inc., LPL Holdings, Inc. and other stockholders party thereto, dated November 23, 2010.* |
| | 4 | .3 | | Stockholders’ Agreement among the Company and Hellman & Friedman Capital Partners IV, L.Pl, Hellman & Friedman Capital Partners V (Parallel), L.P., Hellman & Friedman Capital Associates V, L.P. and TPG Partners IV, L.P., dated November 23, 2010.* |
| | 4 | .4 | | Fifth Amended and Restated LPL Investment Holdings Inc. 2000 Stock Bonus Plan. (4) |
| | 4 | .5 | | Management Stockholders’ Agreement among the Company, Stephanie L. Brown, Mark S. Casady, William E. Dwyer III, Robert J. Moore, and Esther M. Stearns, dated November 23, 2010.* |
| | 10 | .1 | | 2005 Stock Option Plan for Incentive Stock Options. (5) |
| | 10 | .2 | | 2005 Stock Option Plan for Non-Qualified Stock Options. (5) |
| | 10 | .3 | | Amended and Restated Executive Employment Agreement among Mark S. Casady, the Company, LPL Holdings, Inc. and LPL Financial Corporation, dated July 23, 2010. (2) |
| | 10 | .4 | | Amended and Restated Executive Employment Agreement among Esther M. Stearns, the Company, LPL Holdings, Inc. and LPL Financial Corporation, dated July 23, 2010. (2) |
| | 10 | .5 | | Amended and Restated Executive Employment Agreement among William E. Dwyer III, the Company, LPL Holdings, Inc. and LPL Financial Corporation, dated July 23, 2010. (2) |
| | 10 | .6 | | Executive Employment Agreement between Dan H. Arnold and UVEST Financial Services Group Inc. dated January 2, 2007. (6) |
| | 10 | .7 | | Amendment dated September 28, 2009 to the Executive Employment Agreement between Dan H. Arnold and UVEST Financial Services Group Inc. dated January 2, 2007. (6) |
| | 10 | .8 | | Amended and Restated Executive Employment Agreement among Stephanie L. Brown, the Company, LPL Holdings, Inc. and LPL Financial Corporation dated July 23, 2010. (2) |
| | 10 | .9 | | Executive Employment Agreement between Jonathan G. Eaton and LPL Holdings Inc., dated December 28, 2005. (5) |
| | 10 | .10 | | Executive Employment Agreement among Robert J. Moore, the Company, LPL Holdings, Inc. and LPL Financial Corporation, dated July 23, 2010. (2) |
| | 10 | .11 | | Form of Indemnification Agreement. (1) |
| | 10 | .12 | | LPL Investment Holdings Inc. 2008 Stock Option Plan. (7) |
| | 10 | .13 | | Form of LPL Investment Holdings Inc. Stock Option Agreement. (6) |
| | 10 | .14 | | LPL Investment Holdings Inc. 2008 Nonqualified Deferred Compensation Plan. (8) |
| | 10 | .15 | | LPL Investment Holdings Inc. Advisor Incentive Plan. (9) |
| | 10 | .16 | | LPL Investment Holdings Inc. Financial Institution Incentive Plan. (6) |
| | 10 | .17 | | LPL Investment Holdings Inc. and Affiliates Corporate Executive Bonus Plan. (10) |
73
| | | | | |
Exhibit No. | | Description of Exhibit |
| |
| | 10 | .18 | | Thomson Transaction Services Master Subscription Agreement dated as of January 5, 2009 between LPL Financial Corporation and Thomson Financial LLC. (11)† |
| | 10 | .19 | | Third Amended and Restated Credit Agreement, dated as of May 24, 2010, by and among LPL Investment Holdings, Inc., LPL Holdings, Inc., the several lenders from time to time party thereto, Morgan Stanley Senior Funding, Inc., as Administrative Agent and Morgan Stanley & Co., as Collateral Agent. (12) |
| | 10 | .20 | | LPL Investment Holdings Inc. 2010 Omnibus Equity Incentive Plan. (1) |
| | 10 | .21 | | Form of Senior Executive Stock Option Award granted under the LPL Investment Holdings Inc. 2010 Omnibus Equity Incentive Plan. (13) |
| | 10 | .22 | | Form of Senior Management Stock Option Award granted under the LPL Investment Holdings Inc. 2010 Omnibus Equity Incentive Plan. (13) |
| | 10 | .23 | | LPL Financial LLC Executive Severance Plan, effective as of November 23, 2010.* |
| | 10 | .24 | | Relocation Bonus Agreement between Mark R. Helliker and LPL Financial LLC, dated January 25, 2011.* |
| | 21 | .1 | | List of Subsidiaries of LPL Investment Holdings Inc.* |
| | 23 | .1 | | Consent of Deloitte & Touche LLP, independent registered public accounting firm.* |
| | 31 | .1 | | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a).* |
| | 31 | .2 | | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a).* |
| | 32 | .1 | | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
| | 32 | .2 | | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
| | |
| * | |
Exhibit No. | | Description of Exhibit | Filed herewith. |
|---|
| | 3.1 | | Certificate of Incorporation of LPL Investment Holdings Inc.(1) |
|
3.2 |
|
Amendment to the Certificate of Incorporation of LPL Investment Holdings Inc., dated December 20, 2005.(1) |
|
3.3 |
|
Amendment to the Certificate of Incorporation of LPL Investment Holdings Inc., dated March 10, 2006(1) |
|
3.4 |
|
Certificate of Amendment of Certificate of Incorporation of LPL Investment Holdings Inc., dated December 26, 2007.(4) |
|
3.5 |
|
Certificate of Correction of Certificate of Amendment of Certificate of Incorporation of LPL Investment Holdings Inc., dated March 31, 2008.(5) |
|
3.6 |
|
Amended and Restated Bylaws of LPL Investment Holdings Inc.(6) |
|
4.1 |
|
Indenture, dated December 28, 2005, between LPL Holdings, Inc., each of the Guarantors party thereto and Wells Fargo Bank, N.A., as trustee.(1) |
|
4.2. |
|
First Supplemental Indenture, dated as of May 10, 2006, among LPL Holdings, Inc., LPL Investment Holdings Inc., the other Guarantors party thereto and Wells Fargo Bank, N.A., as trustee.(1) |
|
4.3 |
|
Form of Stock Bonus Agreement under the Fourth Amended and Restated LPL Investment Holdings Inc. 2000 Stock Bonus Plan.(1) |
|
4.4 |
|
Fifth Amended and Restated LPL Investment Holdings Inc. 2000 Stock Bonus Plan.(9) |
|
4.5 |
|
LPL Investment Holdings Inc. Advisor Incentive Plan.(7) |
|
10.1 |
|
2005 Stock Option Plan for Incentive Stock Options.(1) |
|
10.2 |
|
2005 Stock Option Plan for Non-Qualified Stock Options.(1) |
|
10.3 |
|
Executive Employment Agreement between Mark S. Casady and LPL Holdings, Inc., dated December 28, 2005.(1) |
|
10.4 |
|
Indemnification Agreement between LPLIH Investment Holdings Inc., LPL Holdings, Inc., and Mark S. Casady, dated December 28, 2005.(1) |
|
10.5 |
|
Executive Employment Agreement between Esther M. Stearns and LPL Holdings, Inc., dated December 28, 2005.(1) |
|
10.6 |
|
Indemnification Agreement between LPLIH Investment Holdings Inc., LPL Holdings, Inc., and Esther M. Stearns, dated December 28, 2005.(1) |
|
10.7 |
|
Executive Employment Agreement between C. William Maher and LPL Holdings, Inc., dated December 28, 2005.(1) |
Table of Contents
| † | | Confidential treatment requested as to certain portions, which portions have been omitted and filed separately with the Securities and Exchange Commission. | |
Exhibit No. | | Description of Exhibit |
|---|
| |
10.8(1) | | Indemnification Agreement between LPLIH Investment Holdings Inc., LPL Holdings, Inc., and C. William Maher, dated December 28, 2005.(1)Incorporated by reference to the Amendment No. 2 to the Registration Statement onForm S-1 filed on July 9, 2010. |
|
10.9 |
|
Executive Employment Agreement between William E. Dwyer III and LPL Holdings, Inc., dated December 28, 2005.(1) |
(2) |
10.10 |
|
Incorporated by reference to current report onIndemnification Agreement between LPLIH Investment Holdings Inc., LPL Holdings, Inc., and William E. Dwyer III, dated December 28, 2005.(1)Form 8-K filed on July 23, 2010. |
|
10.11 |
|
Executive Employment Agreement between Steven M. Black and LPL Holdings, Inc., dated December 28, 2005.(1) |
(3) |
10.12 |
|
Indemnification Agreement between LPLIH Investment Holdings Inc., LPL Holdings, Inc., and Steven M. Black, dated December 28, 2005.(1) |
|
10.13 |
|
Services Agreement between Linsco/Private Ledger Corp. and GPA Group, Inc., dated October 27, 2005.(2) |
|
10.14 |
|
Stockholders' Agreement, dated December 28, 2005, among LPLIH Investment Holdings Inc., LPL Holdings, Inc. and other stockholders party thereto.(2) |
|
10.15 |
|
LPL Investment Holdings Inc. 2008 Stock Option Plan.(3) |
|
10.16 |
|
Second Amended and Restated Credit Agreement, dated as of June 18, 2007,Incorporated by and among LPL Investment Holdings Inc., LPL Holdings, Inc., Goldman Sachs Credit Partners L.P., as sole lead arranger, sole bookrunner and syndication agent, and the several lenders from timereference to time party thereto, Morgan Stanley Senior Funding, Inc. as administrative agent, and Morgan Stanley & Co. as collateral agent.(1) |
|
10.17 |
|
2008 Nonqualified Deferred Compensation Plan.(8) |
|
10.18 |
|
LPL Investment Holdings Inc. and Affiliates 2009 Corporate Executive Bonus Plan, approved on March 31, 2009.(10) |
|
10.19 |
|
Amendment No. 1 dated as of December 9, 2009 to the Second Amended and Restated Credit Agreement, dated as of June 18, 2007, among LPL Investment Holdings, Inc., a Delaware corporation, LPL Holdings, Inc., a Massachusetts corporation, the lending institutions from time to time parties thereto, Goldman Sachs Credit Partners L.P., as sole lead arranger, sole book runner and syndication agent, Morgan Stanley Senior Funding, Inc., as Administrative Agent, and Morgan Stanley & Co., as Collateral Agent.(11)Registration Statement on Form 10 filed on July 10, 2007. |
|
10.20 |
|
Incremental and Extension Agreement, dated as of January 25, 2010 among LPL Investment Holdings, Inc., a Delaware corporation, LPL Holdings, Inc., a Massachusetts corporation, the other Credit Parties signatory thereto, the Incremental Revolving Credit Commitment Increase Lenders signatory thereto, each 2013 Revolving Credit Lender signatory thereto, Morgan Stanley Senior Funding, Inc., as Administrative Agent, Letter of Credit Issuer and Swingline Lender, and Morgan Stanley & Co., as Collateral Agent.(12) |
|
21.1 |
|
List of Subsidiaries of LPL Investment Holdings Inc. |
|
23.1 |
|
Independent Registered Public Accounting Firm's Consent. |
|
31.1 |
|
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a). |
|
31.2 |
|
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a). |
Table of Contents
| | | |
Exhibit No. | | Description of Exhibit |
|---|
| |
32.1(4) | | Certification ofIncorporated by reference to the Chief Executive Officer pursuant toForm 8-K filed on December 18, U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.2008. |
|
32.2(5) |
|
Certification ofIncorporated by reference to the Chief Financial Officer pursuantRegistration Statement on Form 10 filed on April 30, 2007. |
|
| (6) | | Incorporated by reference to 18 U.S.C. Section 1350, as adopted pursuantthe Registration Statement onForm S-1 filed on June 4, 2010. |
|
| (7) | | Incorporated by reference to Section 906 oftheForm 8-K filed on February 21, 2008. |
|
| (8) | | Incorporated by reference to theForm 8-K filed on November 25, 2008. |
|
| (9) | | Incorporated by reference to theForm S-8 on June 5, 2008. |
|
| (10) | | Incorporated by reference to the Sarbanes-Oxley Act of 2002.Schedule 14A filed on April 27, 2010. |
|
| (11) | | Incorporated by reference to Amendment No. 2 to the Registration Statement onForm S-1 filed on June 22, 2010. |
|
| (12) | | Incorporated by reference to theForm 8-K filed on May 28, 2010. |
|
| (13) | | Incorporated by reference to Amendment No. 4 to the Registration Statement onForm S-1 filed on November 3, 2010. |
74
(1)Included in Registration Statement on Form 10 of the Company filed on April 30, 2007.
(2)Included in Amendment No. 1 to Registration Statement on Form 10 of the Company filed on July 10, 2007.
(3)Included in Current Report on Form 8-K filed on February 21, 2008.
(4)Included in Current Report on Form 8-K filed on January 4, 2008.
(5)Included in Annual Report on Form 10-K filed on March 31, 2008.
(6)Included in Current Report on Form 8-K filed on June 3, 2008.
(7)Included in Registration Statement on Form S-8 filed on June 5, 2008.
(8)Included in Current Report on Form 8-K filed on November 25, 2008.
(9)Included in Current Report on Form 8-K filed on December 18, 2008.
(10)Included in Quarterly Report on Form 10-Q filed on May 14, 2009.
(11)Included in Current Report on Form 8-K filed on December 11, 2009.
(12)Included in Current Report on Form 8-K filed on January 27, 2010.
SIGNATURE
Table of Contents
SIGNATURE
Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report on
Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
LPL Investment Holdings Inc.
| | | | |
| | By: | LPL INVESTMENT HOLDINGS INC. |
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|
By: |
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/s/ MARK S. CASADY
Mark S. Casady
Chief Executive Officer and Chairman |
Dated: March 9, 2010 |
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|
|
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Mark S. Casady
Chief Executive Officer and Chairman
Dated: March 9, 2011
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
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Signature
| | Title
| | Date
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Signature | | Title | | Date |
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| | | | |
/s/ MARK S. CASADY
Mark S. Casady
Mark S. Casady | | Chief Executive Officer and Chairman | | March 9, 20102011 |
| | | | |
/s/ ROBERT J. MOORE
Robert J. Moore
Robert J. Moore |
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Chief Financial Officer |
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March 9, 20102011 |
| | | | |
/s/ THOMAS D. LUX
Thomas D. Lux
Thomas D. Lux |
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Chief Accounting Officer |
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March 9, 20102011 |
| | | | |
/s/ RICHARD W. BOYCE
Richard W. Boyce |
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Director |
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March 9, 2010 |
/s/ JOHN J. BRENNAN
John J. Brennan |
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Director |
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March 9, 2010 |
/s/ JAMES S. PUTNAM
James S. Putnam |
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Director, Vice-Chairman |
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March 9, 2010 |
/s/ ERIK D. RAGATZ
Erik D. Ragatz |
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Director |
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March 9, 2010 |
Table of Contents
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Signature
| | Title
| | Date
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/s/ JAMES S. RIEPE
James S. RiepeRichard W. Boyce | | Director | | March 9, 20102011 |
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/s/ RICHARD P. SCHIFTERJohn J. Brennan
John J. Brennan | | Director | | March 9, 2011 |
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/s/ James S. Putnam
James S. Putnam | | Director, Vice-Chairman | | March 9, 2011 |
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/s/ Erik D. Ragatz
Erik D. Ragatz | | Director | | March 9, 2011 |
| | | | |
/s/ James S. Riepe
James S. Riepe | | Director | | March 9, 2011 |
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/s/ Richard P. Schifter
Richard P. Schifter |
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Director |
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March 9, 20102011 |
75
| | | | | | |
Signature | | Title | | Date |
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/s/ JEFFREY E. STIEFLER
Jeffrey E. StielferStiefler
Jeffrey E. Stiefler |
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Director |
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March 9, 20102011 |
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/s/ ALLEN R. THORPE
Allen R. Thorpe
Allen R. Thorpe |
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Director |
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March 9, 20102011 |
76
| | | | | |
Exhibit No. | | Description of Exhibit |
| |
| | 3 | .1 | | Amended and Restated Certificate of Incorporation of LPL Investment Holdings Inc., dated November 23, 2010. (1) |
| | 3 | .2 | | Second Amended and Restated Bylaws of LPL Investment Holdings Inc. (2) |
| | 4 | .1 | | Stockholders’ Agreement, dated as of December 28, 2005, among LPL Investment Holdings Inc., LPL Holdings, Inc. and other stockholders party thereto. (3) |
| | 4 | .2 | | First Amendment to Stockholders’ Agreement dated December 28, 2005, among LPL Investment Holdings Inc., LPL Holdings, Inc. and other stockholders party thereto, dated November 23, 2010.* |
| | 4 | .3 | | Stockholders’ Agreement among the Company and Hellman & Friedman Capital Partners IV, L.Pl, Hellman & Friedman Capital Partners V (Parallel), L.P., Hellman & Friedman Capital Associates V, L.P. and TPG Partners IV, L.P., dated November 23, 2010.* |
| | 4 | .4 | | Fifth Amended and Restated LPL Investment Holdings Inc. 2000 Stock Bonus Plan. (4) |
| | 4 | .5 | | Management Stockholders’ Agreement among the Company, Stephanie L. Brown, Mark S. Casady, William E. Dwyer III, Robert J. Moore, and Esther M. Stearns, dated November 23, 2010.* |
| | 10 | .1 | | 2005 Stock Option Plan for Incentive Stock Options. (5) |
| | 10 | .2 | | 2005 Stock Option Plan for Non-Qualified Stock Options. (5) |
| | 10 | .3 | | Amended and Restated Executive Employment Agreement among Mark S. Casady, the Company, LPL Holdings, Inc. and LPL Financial Corporation, dated July 23, 2010. (2) |
| | 10 | .4 | | Amended and Restated Executive Employment Agreement among Esther M. Stearns, the Company, LPL Holdings, Inc. and LPL Financial Corporation, dated July 23, 2010. (2) |
| | 10 | .5 | | Amended and Restated Executive Employment Agreement among William E. Dwyer III, the Company, LPL Holdings, Inc. and LPL Financial Corporation, dated July 23, 2010. (2) |
| | 10 | .6 | | Executive Employment Agreement between Dan H. Arnold and UVEST Financial Services Group Inc. dated January 2, 2007. (6) |
| | 10 | .7 | | Amendment dated September 28, 2009 to the Executive Employment Agreement between Dan H. Arnold and UVEST Financial Services Group Inc. dated January 2, 2007. (6) |
| | 10 | .8 | | Amended and Restated Executive Employment Agreement among Stephanie L. Brown, the Company, LPL Holdings, Inc. and LPL Financial Corporation dated July 23, 2010. (2) |
| | 10 | .9 | | Executive Employment Agreement between Jonathan G. Eaton and LPL Holdings Inc., dated December 28, 2005. (5) |
| | 10 | .10 | | Executive Employment Agreement among Robert J. Moore, the Company, LPL Holdings, Inc. and LPL Financial Corporation, dated July 23, 2010. (2) |
| | 10 | .11 | | Form of Indemnification Agreement. (1) |
| | 10 | .12 | | LPL Investment Holdings Inc. 2008 Stock Option Plan. (7) |
| | 10 | .13 | | Form of LPL Investment Holdings Inc. Stock Option Agreement. (6) |
| | 10 | .14 | | LPL Investment Holdings Inc. 2008 Nonqualified Deferred Compensation Plan. (8) |
| | 10 | .15 | | LPL Investment Holdings Inc. Advisor Incentive Plan. (9) |
| | 10 | .16 | | LPL Investment Holdings Inc. Financial Institution Incentive Plan. (6) |
| | 10 | .17 | | LPL Investment Holdings Inc. and Affiliates Corporate Executive Bonus Plan. (10) |
| | 10 | .18 | | Thomson Transaction Services Master Subscription Agreement dated as of January 5, 2009 between LPL Financial Corporation and Thomson Financial LLC. (11)† |
| | 10 | .19 | | Third Amended and Restated Credit Agreement, dated as of May 24, 2010, by and among LPL Investment Holdings, Inc., LPL Holdings, Inc., the several lenders from time to time party thereto, Morgan Stanley Senior Funding, Inc., as Administrative Agent and Morgan Stanley & Co., as Collateral Agent. (12) |
| | 10 | .20 | | LPL Investment Holdings Inc. 2010 Omnibus Equity Incentive Plan. (1) |
| | 10 | .21 | | Form of Senior Executive Stock Option Award granted under the LPL Investment Holdings Inc. 2010 Omnibus Equity Incentive Plan. (13) |
77
| | | | | |
Exhibit No. | | Description of Exhibit |
| |
| | 10 | .22 | | Form of Senior Management Stock Option Award granted under the LPL Investment Holdings Inc. 2010 Omnibus Equity Incentive Plan. (13) |
| | 10 | .23 | | LPL Financial LLC Executive Severance Plan, effective as of November 23, 2010.* |
| | 10 | .24 | | Relocation Bonus Agreement between Mark R. Helliker and LPL Financial LLC, dated January 25, 2011.* |
| | 21 | .1 | | List of Subsidiaries of LPL Investment Holdings Inc.* |
| | 23 | .1 | | Consent of Deloitte & Touche LLP, independent registered public accounting firm.* |
| | 31 | .1 | | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a).* |
| | 31 | .2 | | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a).* |
| | 32 | .1 | | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
| | 32 | .2 | | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
Table of Contents
EXHIBIT INDEX
| | |
| * | |
Exhibit No. | | Description of Exhibit | Filed herewith. |
|---|
| | 3.1 | | Certificate of Incorporation of LPL Investment Holdings Inc.(1) |
|
3.2 |
|
Amendment to the Certificate of Incorporation of LPL Investment Holdings Inc., dated December 20, 2005.(1) |
|
3.3 |
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Amendment to the Certificate of Incorporation of LPL Investment Holdings Inc., dated March 10, 2006(1) |
|
3.4 |
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Certificate of Amendment of Certificate of Incorporation of LPL Investment Holdings Inc., dated December 26, 2007.(4) |
|
3.5 |
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Certificate of Correction of Certificate of Amendment of Certificate of Incorporation of LPL Investment Holdings Inc., dated March 31, 2008.(5) |
|
3.6 |
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Amended and Restated Bylaws of LPL Investment Holdings Inc.(6) |
|
4.1 |
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Indenture, dated December 28, 2005, between LPL Holdings, Inc., each of the Guarantors party thereto and Wells Fargo Bank, N.A., as trustee.(1) |
|
4.2. |
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First Supplemental Indenture, dated as of May 10, 2006, among LPL Holdings, Inc., LPL Investment Holdings Inc., the other Guarantors party thereto and Wells Fargo Bank, N.A., as trustee.(1) |
|
4.3 |
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Form of Stock Bonus Agreement under the Fourth Amended and Restated LPL Investment Holdings Inc. 2000 Stock Bonus Plan.(1) |
|
4.4 |
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Fifth Amended and Restated LPL Investment Holdings Inc. 2000 Stock Bonus Plan.(9) |
|
4.5 |
|
LPL Investment Holdings Inc. Advisor Incentive Plan.(7) |
|
10.1 |
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2005 Stock Option Plan for Incentive Stock Options.(1) |
|
10.2 |
|
2005 Stock Option Plan for Non-Qualified Stock Options.(1) |
|
10.3 |
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Executive Employment Agreement between Mark S. Casady and LPL Holdings, Inc., dated December 28, 2005.(1) |
|
10.4 |
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Indemnification Agreement between LPLIH Investment Holdings Inc., LPL Holdings, Inc., and Mark S. Casady, dated December 28, 2005.(1) |
|
10.5 |
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Executive Employment Agreement between Esther M. Stearns and LPL Holdings, Inc., dated December 28, 2005.(1) |
|
10.6 |
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Indemnification Agreement between LPLIH Investment Holdings Inc., LPL Holdings, Inc., and Esther M. Stearns, dated December 28, 2005.(1) |
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10.7 |
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Executive Employment Agreement between C. William Maher and LPL Holdings, Inc., dated December 28, 2005.(1) |
|
10.8 |
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Indemnification Agreement between LPLIH Investment Holdings Inc., LPL Holdings, Inc., and C. William Maher, dated December 28, 2005.(1) |
|
10.9 |
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Executive Employment Agreement between William E. Dwyer III and LPL Holdings, Inc., dated December 28, 2005.(1) |
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10.10 |
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Indemnification Agreement between LPLIH Investment Holdings Inc., LPL Holdings, Inc., and William E. Dwyer III, dated December 28, 2005.(1) |
Table of Contents
| † | | Confidential treatment requested as to certain portions, which portions have been omitted and filed separately with the Securities and Exchange Commission. | |
Exhibit No. | | Description of Exhibit |
|---|
| |
10.11(1) | | Executive Employment Agreement between Steven M. Black and LPL Holdings, Inc., dated December 28, 2005.(1)Incorporated by reference to the Amendment No. 2 to the Registration Statement onForm S-1 filed on July 9, 2010. |
|
10.12 |
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Indemnification Agreement between LPLIH Investment Holdings Inc., LPL Holdings, Inc., and Steven M. Black, dated December 28, 2005.(1) |
(2) |
10.13 |
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Incorporated by reference to current report onServices Agreement between Linsco/Private Ledger Corp. and GPA Group, Inc., dated October 27, 2005.(2)Form 8-K filed on July 23, 2010. |
|
10.14 |
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Stockholders' Agreement, dated December 28, 2005, among LPLIH Investment Holdings Inc., LPL Holdings, Inc. and other stockholders party thereto.(2) |
(3) |
10.15 |
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LPL Investment Holdings Inc. 2008 Stock Option Plan.(3) |
|
10.16 |
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Second Amended and Restated Credit Agreement, dated as of June 18, 2007,Incorporated by and among LPL Investment Holdings Inc., LPL Holdings, Inc., Goldman Sachs Credit Partners L.P., as sole lead arranger, sole bookrunner and syndication agent, and the several lenders from timereference to time party thereto, Morgan Stanley Senior Funding, Inc. as administrative agent, and Morgan Stanley & Co. as collateral agent.(1) |
|
10.17 |
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2008 Nonqualified Deferred Compensation Plan.(8) |
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10.18 |
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LPL Investment Holdings Inc. and Affiliates 2009 Corporate Executive Bonus Plan, approved on March 31, 2009.(10) |
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10.19 |
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Amendment No. 1 dated as of December 9, 2009 to the Second Amended and Restated Credit Agreement, dated as of June 18, 2007, among LPL Investment Holdings, Inc., a Delaware corporation, LPL Holdings, Inc., a Massachusetts corporation, the lending institutions from time to time parties thereto, Goldman Sachs Credit Partners L.P., as sole lead arranger, sole book runner and syndication agent, Morgan Stanley Senior Funding, Inc., as Administrative Agent, and Morgan Stanley & Co., as Collateral Agent.(11)Registration Statement on Form 10 filed on July 10, 2007. |
|
10.20 |
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Incremental and Extension Agreement, dated as of January 25, 2010 among LPL Investment Holdings, Inc., a Delaware corporation, LPL Holdings, Inc., a Massachusetts corporation, the other Credit Parties signatory thereto, the Incremental Revolving Credit Commitment Increase Lenders signatory thereto, each 2013 Revolving Credit Lender signatory thereto, Morgan Stanley Senior Funding, Inc., as Administrative Agent, Letter of Credit Issuer and Swingline Lender, and Morgan Stanley & Co., as Collateral Agent.(12) |
(4) |
21.1 |
|
Incorporated by reference to theList of Subsidiaries of LPL Investment Holdings Inc.Form 8-K filed on December 18, 2008. |
|
23.1 |
|
Independent Registered Public Accounting Firm's Consent. |
(5) |
31.1 |
|
Certification ofIncorporated by reference to the Chief Executive Officer pursuant to Rule 13a-14(a).Registration Statement on Form 10 filed on April 30, 2007. |
|
31.2 |
|
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a). |
(6) |
32.1 |
|
Certification ofIncorporated by reference to the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.Registration Statement onForm S-1 filed on June 4, 2010. |
|
32.2(7) |
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Incorporated by reference to theCertification ofForm 8-K filed on February 21, 2008. |
|
| (8) | | Incorporated by reference to theForm 8-K filed on November 25, 2008. |
|
| (9) | | Incorporated by reference to theForm S-8 on June 5, 2008. |
|
| (10) | | Incorporated by reference to the Chief Financial Officer pursuantSchedule 14A filed on April 27, 2010. |
|
| (11) | | Incorporated by reference to 18 U.S.C. Section 1350, as adopted pursuantAmendment No. 2 to Section 906 of the Sarbanes-Oxley Act of 2002.Registration Statement onForm S-1 filed on June 22, 2010. |
|
| (12) | | Incorporated by reference to theForm 8-K filed on May 28, 2010. |
|
| (13) | | Incorporated by reference to Amendment No. 4 to the Registration Statement onForm S-1 filed on November 3, 2010. |
78
(1)Included in Registration Statement on Form 10 of the Company filed on April 30, 2007.
(2)Included in Amendment No. 1 to Registration Statement on Form 10 of the Company filed on July 10, 2007.
Table of Contents
(3)Included in Current Report on Form 8-K filed on February 21, 2008.
(4)Included in Current Report on Form 8-K filed on January 4, 2008.
(5)Included in Annual Report on Form 10-K filed on March 31, 2008.
(6)Included in Current Report on Form 8-K filed on June 3, 2008.
(7)Included in Registration Statement on Form S-8 filed on June 5, 2008.
(8)Included in Current Report on Form 8-K filed on November 25, 2008.
(9)Included in Current Report on Form 8-K filed on December 18, 2008.
(10)Included in Quarterly Report on Form 10-Q filed on May 14, 2009.
(11)Included in Current Report on Form 8-K filed on December 11, 2009.
(12)Included in Current Report on Form 8-K filed on January 27, 2010.
Table of Contents
LPL INVESTMENT HOLDINGS INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements of LPL Investment Holdings Inc. are included in response to Item 8:
| | | | |
| | Page | |
|---|
Consolidated Financial Statements
| | | | |
| | Page |
|
Consolidated Financial Statements | | | | |
Report of Independent Registered Public Accounting Firm | | | F-2 | |
Consolidated Statements of IncomeOperations for the years ended December 31, 2010, 2009 2008 and 2007 2008 | | | F-3 | |
Consolidated Statements of Financial Condition as of December 31, 20092010 and 2008 2009 | | | F-4 | |
Consolidated Statements of Stockholders'Stockholders’ Equity for the years ended December 31, 2010, 2009 2008 and 2007 2008 | | | F-5 | |
Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009 2008 and 2007 2008 | | | F-6 | |
Notes to Consolidated Financial Statements | | | F-8 | |
F-1
To the Board of Directors and Stockholders of
LPL Investment Holdings Inc.
We have audited the accompanying consolidated statements of financial condition of LPL Investment Holdings Inc.
, and subsidiaries (the
"Company"“Company”) as of December 31,
20092010 and
2008,2009, and the related consolidated statements of
income, stockholders'operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31,
2009.2010. These consolidated financial statements are the responsibility of the
Company'sCompany’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of LPL Investment Holdings Inc. and subsidiaries as of December 31,
20092010 and
2008,2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31,
2009,2010, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
Company'sCompany’s internal control over financial reporting as of December 31,
2009,2010, based on the criteria established in
Internal Control—Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 20102011 expressed an unqualified opinion on the Company'sCompany’s internal control over financial reporting./s/ Deloitte & Touche LLP
Costa Mesa, California
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBERConsolidated Statements of Operations
For the Years Ended December 31, 2010, 2009 and 2008 AND 2007
(Dollars in thousands)
thousands, except per share data)
| | | | | | | | | | | | | | | | | |
| | | 2010 | | | 2009 | | | 2008 | | | | |
| |
| REVENUES: | | | | | | | | | | | | | | | | |
| Commissions | | $ | 1,620,811 | | | $ | 1,477,655 | | | $ | 1,640,218 | | | | | |
| Advisory fees | | | 860,227 | | | | 704,139 | | | | 830,555 | | | | | |
| Asset-based fees | | | 317,505 | | | | 272,893 | | | | 352,293 | | | | | |
| Transaction and other fees | | | 274,148 | | | | 255,574 | | | | 240,486 | | | | | |
| Interest income, net of interest expense | | | 19,807 | | | | 20,545 | | | | 33,684 | | | | | |
| Other | | | 20,988 | | | | 18,699 | | | | 19,113 | | | | | |
| | | | | | | | | | | | | | | | | |
| Total net revenues | | | 3,113,486 | | | | 2,749,505 | | | | 3,116,349 | | | | | |
| | | | | | | | | | | | | | | | | |
| EXPENSES: | | | | | | | | | | | | | | | | |
| Commissions and advisory fees | | | 2,362,910 | | | | 1,872,478 | | | | 2,132,050 | | | | | |
| Compensation and benefits | | | 308,656 | | | | 270,436 | | | | 343,171 | | | | | |
| Depreciation and amortization | | | 86,037 | | | | 108,296 | | | | 100,462 | | | | | |
| Promotional | | | 69,191 | | | | 61,451 | | | | 99,707 | | | | | |
| Occupancy and equipment | | | 50,159 | | | | 50,475 | | | | 58,752 | | | | | |
| Professional services | | | 39,521 | | | | 38,071 | | | | 31,492 | | | | | |
| Brokerage, clearing and exchange | | | 34,625 | | | | 32,101 | | | | 30,998 | | | | | |
| Communications and data processing | | | 34,372 | | | | 36,194 | | | | 39,967 | | | | | |
| Regulatory fees and expenses | | | 26,143 | | | | 23,217 | | | | 21,747 | | | | | |
| Restructuring charges | | | 13,922 | | | | 58,695 | | | | 14,966 | | | | | |
| Travel and entertainment | | | 13,629 | | | | 9,008 | | | | 14,782 | | | | | |
| Other | | | 34,826 | | | | 15,294 | | | | 17,558 | | | | | |
| | | | | | | | | | | | | | | | | |
| Total operating expenses | | | 3,073,991 | | | | 2,575,716 | | | | 2,905,652 | | | | | |
| Interest expense from senior credit facilities, subordinated notes and revolving line of credit | | | 90,407 | | | | 100,922 | | | | 115,558 | | | | | |
| Loss on extinguishment of debt | | | 37,979 | | | | — | | | | — | | | | | |
| (Gain) loss on equity method investment | | | (42 | ) | | | 300 | | | | 2,374 | | | | | |
| | | | | | | | | | | | | | | | | |
| Total expenses | | | 3,202,335 | | | | 2,676,938 | | | | 3,023,584 | | | | | |
| | | | | | | | | | | | | | | | | |
| (LOSS) INCOME BEFORE (BENEFIT FROM) PROVISION FOR INCOME TAXES | | | (88,849 | ) | | | 72,567 | | | | 92,765 | | | | | |
| (BENEFIT FROM) PROVISION FOR INCOME TAXES | | | (31,987 | ) | | | 25,047 | | | | 47,269 | | | | | |
| | | | | | | | | | | | | | | | | |
| NET (LOSS) INCOME | | $ | (56,862 | ) | | $ | 47,520 | | | $ | 45,496 | | | | | |
| | | | | | | | | | | | | | | | | |
| (LOSS) EARNINGS PER SHARE (Note 16): | | | | | | | | | | | | | | | | |
| Basic | | $ | (0.64 | ) | | $ | 0.54 | | | $ | 0.53 | | | | | |
| Diluted | | $ | (0.64 | ) | | $ | 0.47 | | | $ | 0.45 | | | | | |
| | | | | | | | | | | | |
| | 2009 | | 2008 | | 2007 | |
|---|
REVENUES: | | | | | | | | | | |
| | Commissions | | $ | 1,477,655 | | $ | 1,640,218 | | $ | 1,470,285 | |
| | Advisory fees | | | 704,139 | | | 830,555 | | | 738,938 | |
| | Asset-based fees | | | 272,893 | | | 352,293 | | | 260,935 | |
| | Transaction and other fees | | | 255,574 | | | 240,486 | | | 184,604 | |
| | Interest income, net of interest expense | | | 20,545 | | | 33,684 | | | 35,677 | |
| | Other | | | 18,699 | | | 19,113 | | | 26,135 | |
| | | | | | | | |
| | | Total net revenues | | | 2,749,505 | | | 3,116,349 | | | 2,716,574 | |
| | | | | | | | |
EXPENSES: | | | | | | | | | | |
| | Commissions and advisory fees | | | 1,872,478 | | | 2,132,050 | | | 1,908,666 | |
| | Compensation and benefits | | | 270,436 | | | 343,171 | | | 257,200 | |
| | Depreciation and amortization | | | 108,296 | | | 100,462 | | | 78,748 | |
| | Promotional | | | 61,451 | | | 99,707 | | | 64,302 | |
| | Restructuring charges | | | 58,695 | | | 14,966 | | | — | |
| | Occupancy and equipment | | | 50,475 | | | 58,752 | | | 43,419 | |
| | Professional services | | | 38,071 | | | 31,492 | | | 31,478 | |
| | Communications and data processing | | | 36,194 | | | 39,967 | | | 27,822 | |
| | Brokerage, clearing and exchange | | | 32,101 | | | 30,998 | | | 26,806 | |
| | Regulatory fees and expenses | | | 23,217 | | | 21,747 | | | 17,939 | |
| | Travel and entertainment | | | 9,008 | | | 14,782 | | | 14,935 | |
| | Other | | | 15,294 | | | 17,558 | | | 13,931 | |
| | | | | | | | |
| | | Total operating expenses | | | 2,575,716 | | | 2,905,652 | | | 2,485,246 | |
| | Interest expense from senior credit facilities, subordinated notes and revolving line of credit | | | 100,922 | | | 115,558 | | | 122,817 | |
| | Loss on equity method investment | | | 300 | | | 2,374 | | | 678 | |
| | | | | | | | |
| | | Total expenses | | | 2,676,938 | | | 3,023,584 | | | 2,608,741 | |
| | | | | | | | |
INCOME BEFORE PROVISION FOR INCOME TAXES | | | 72,567 | | | 92,765 | | | 107,833 | |
PROVISION FOR INCOME TAXES | | | 25,047 | | | 47,269 | | | 46,764 | |
| | | | | | | | |
NET INCOME | | $ | 47,520 | | $ | 45,496 | | $ | 61,069 | |
| | | | | | | | |
See notes to consolidated financial statements.
F-3
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF DECEMBERConsolidated Statements of Financial Condition
As of December 31, 2010 and 2009 AND 2008
(Dollars in thousands, except par value)
| | | | | | | | | |
| | | 2010 | | | 2009 | |
| |
ASSETS |
| Cash and cash equivalents | | $ | 419,208 | | | $ | 378,594 | |
| Cash and securities segregated under federal and other regulations | | | 373,634 | | | | 288,608 | |
| Receivables from: | | | | | | | | |
| Clients, net of allowance of $655 at December 31, 2010 and $792 at December 31, 2009 | | | 271,051 | | | | 257,529 | |
| Product sponsors, broker-dealers and clearing organizations | | | 203,332 | | | | 171,900 | |
| Others, net of allowances of $6,796 at December 31, 2010 and $6,159 at December 31, 2009 | | | 169,391 | | | | 139,317 | |
| Securities owned: | | | | | | | | |
| Trading | | | 9,259 | | | | 15,361 | |
| Held-to-maturity | | | 9,563 | | | | 10,454 | |
| Securities borrowed | | | 8,391 | | | | 4,950 | |
| Income taxes receivable | | | 144,041 | | | | — | |
| Fixed assets, net of accumulated depreciation and amortization of $276,501 at December 31, 2010 and $239,868 at December 31, 2009 | | | 78,671 | | | | 101,584 | |
| Debt issuance costs, net of accumulated amortization of $14,106 at December 31, 2010 and $15,724 at December 31, 2009 | | | 23,711 | | | | 16,542 | |
| Goodwill | | | 1,293,366 | | | | 1,293,366 | |
| Intangible assets, net of accumulated amortization of $172,726 at December 31, 2010 and $136,177 at December 31, 2009 | | | 560,077 | | | | 597,083 | |
| Other assets | | | 82,472 | | | | 61,648 | |
| | | | | | | | | |
| Total assets | | $ | 3,646,167 | | | $ | 3,336,936 | |
| | | | | | | | | |
| |
| LIABILITIES AND STOCKHOLDERS’ EQUITY |
| |
| LIABILITIES: |
| Drafts payable | | $ | 182,489 | | | $ | 125,767 | |
| Payables to clients | | | 383,289 | | | | 493,943 | |
| Payables to broker-dealers and clearing organizations | | | 39,070 | | | | 18,217 | |
| Accrued commissions and advisory fees payable | | | 130,408 | | | | 110,040 | |
| Accounts payable and accrued liabilities | | | 154,586 | | | | 129,898 | |
| Income taxes payable | | | — | | | | 24,226 | |
| Unearned revenue | | | 53,618 | | | | 45,844 | |
| Interest rate swaps | | | 7,281 | | | | 17,292 | |
| Securities sold but not yet purchased — at fair value | | | 4,821 | | | | 4,003 | |
| Senior credit facilities and subordinated notes | | | 1,386,639 | | | | 1,369,223 | |
| Deferred income taxes — net | | | 130,211 | | | | 147,608 | |
| | | | | | | | | |
| Total liabilities | | | 2,472,412 | | | | 2,486,061 | |
| | | | | | | | | |
| STOCKHOLDERS’ EQUITY: | | | | | | | | |
| Common stock, $.001 par value; 600,000,000 shares authorized; 108,714,757 shares issued and outstanding at December 31, 2010, and 94,214,762 shares issued and outstanding at December 31, 2009 of which 7,423,973 are restricted | | | 109 | | | | 87 | |
| Additional paid-in capital | | | 1,051,722 | | | | 679,277 | |
| Stockholder loans | | | — | | | | (499 | ) |
| Accumulated other comprehensive loss | | | (4,496 | ) | | | (11,272 | ) |
| Retained earnings | | | 126,420 | | | | 183,282 | |
| | | | | | | | | |
| Total stockholders’ equity | | | 1,173,755 | | | | 850,875 | |
| | | | | | | | | |
| Total liabilities and stockholders’ equity | | $ | 3,646,167 | | | $ | 3,336,936 | |
| | | | | | | | | |
| | | | | | | | | |
| | 2009 | | 2008 | |
|---|
ASSETS | | | | | | | |
Cash and cash equivalents | | $ | 378,594 | | $ | 219,239 | |
Cash and securities segregated under federal and other regulations | | | 288,608 | | | 341,575 | |
Receivables from: | | | | | | | |
| | Clients, net of allowance of $792 at December 31, 2009 and $972 at December 31, 2008 | | | 257,529 | | | 295,797 | |
| | Product sponsors, broker-dealers and clearing organizations | | | 171,900 | | | 231,400 | |
| | Others, net of allowances of $6,159 at December 31, 2009 and $4,076 at December 31, 2008 | | | 139,317 | | | 93,771 | |
Securities owned: | | | | | | | |
| | Trading | | | 15,361 | | | 10,811 | |
| | Held-to-maturity | | | 10,454 | | | 10,504 | |
Securities borrowed | | | 4,950 | | | 604 | |
Fixed assets, net of accumulated depreciation and amortization of $239,868 at December 31, 2009 and $185,537 at December 31, 2008 | | | 101,584 | | | 161,760 | |
Debt issuance costs, net of accumulated amortization of $15,724 at December 31, 2009 and $11,981 at December 31, 2008 | | | 16,542 | | | 19,927 | |
Goodwill | | | 1,293,366 | | | 1,293,366 | |
Intangible assets, net of accumulated amortization of $136,177 at December 31, 2009 and $106,563 at December 31, 2008 | | | 597,083 | | | 654,703 | |
Other assets | | | 61,648 | | | 48,322 | |
| | | | | | |
Total assets | | $ | 3,336,936 | | $ | 3,381,779 | |
| | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | |
LIABILITIES: | | | | | | | |
| | Drafts payable | | $ | 125,767 | | $ | 154,431 | |
| | Revolving line of credit | | | — | | | 90,000 | |
| | Payables to clients | | | 493,943 | | | 463,011 | |
| | Payables to broker-dealers and clearing organizations | | | 18,217 | | | 21,734 | |
| | Accrued commissions and advisory fees payable | | | 110,040 | | | 100,327 | |
| | Accounts payable and accrued liabilities | | | 129,898 | | | 120,882 | |
| | Income taxes payable | | | 24,226 | | | 12,281 | |
| | Unearned revenue | | | 45,844 | | | 36,658 | |
| | Interest rate swaps | | | 17,292 | | | 25,417 | |
| | Securities sold but not yet purchased—at market value | | | 4,003 | | | 3,910 | |
| | Senior credit facilities and subordinated notes | | | 1,369,223 | | | 1,377,647 | |
| | Deferred income taxes—net | | | 147,608 | | | 185,169 | |
| | | | | | |
| | | Total liabilities | | | 2,486,061 | | | 2,591,467 | |
| | | | | | |
COMMITMENTS AND CONTINGENCIES (Notes 14 and 19) | | | | | | | |
STOCKHOLDERS' EQUITY: | | | | | | | |
| | Common stock, $.001 par value; 200,000,000 shares authorized; 94,214,762 shares issued and outstanding at December 31, 2009 of which 7,423,973 are restricted, and 93,967,967 shares issued and outstanding at December 31, 2008 of which 7,423,973 are restricted | | | 87 | | | 87 | |
| | Additional paid-in capital | | | 679,277 | | | 670,897 | |
| | Stockholder loans | | | (499 | ) | | (936 | ) |
| | Accumulated other comprehensive loss | | | (11,272 | ) | | (15,498 | ) |
| | Retained earnings | | | 183,282 | | | 135,762 | |
| | | | | | |
| | | Total stockholders' equity | | | 850,875 | | | 790,312 | |
| | | | | | |
Total liabilities and stockholders' equity | | $ | 3,336,936 | | $ | 3,381,779 | |
| | | | | | |
See notes to consolidated financial statements.
F-4
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
For the Years Ended December 31, 2010, 2009 and 2008
(In thousands)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | Accumulated
| | | | | | | |
| | | | | | | | | Additional
| | | | | | Other
| | | | | | Total
| |
| | | Common Stock | | | Paid-In
| | | Stockholder
| | | Comprehensive
| | | Retained
| | | Stockholders’
| |
| | | Shares | | | Amount | | | Capital | | | Loans | | | Loss | | | Earnings | | | Equity | |
| |
| BALANCE — December 31, 2007 | | | 86,250 | | | $ | 86 | | | $ | 664,568 | | | $ | (1,242 | ) | | $ | (6,512 | ) | | $ | 90,266 | | | $ | 747,166 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | | | | | | | | | | | | | | | | | | | | | 45,496 | | | | 45,496 | |
| Unrealized loss on interest rate swaps, net of tax benefit of $5,596 | | | | | | | | | | | | | | | | | | | (8,986 | ) | | | | | | | (8,986 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | 36,510 | |
| Stockholder loans | | | | | | | | | | | | | | | 306 | | | | | | | | | | | | 306 | |
| Excess tax benefits from stock options exercised | | | | | | | | | | | 668 | | | | | | | | | | | | | | | | 668 | |
| Exercise of stock options | | | 286 | | | | 1 | | | | 585 | | | | | | | | | | | | | | | | 586 | |
| Share-based compensation | | | | | | | | | | | 4,859 | | | | | | | | | | | | | | | | 4,859 | |
| Issuance of restricted stock awards | | | 7,424 | | | | | | | | | | | | | | | | | | | | | | | | | |
| Issuance of common stock | | | 144 | | | | | | | | 4,000 | | | | | | | | | | | | | | | | 4,000 | |
| Repurchase of common stock | | | (136 | ) | | | | | | | (3,783 | ) | | | | | | | | | | | | | | | (3,783 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| BALANCE — December 31, 2008 | | | 93,968 | | | $ | 87 | | | $ | 670,897 | | | $ | (936 | ) | | $ | (15,498 | ) | | $ | 135,762 | | | $ | 790,312 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | | | | | | | | | | | | | | | | | | | | | 47,520 | | | | 47,520 | |
| Unrealized gain on interest rate swaps, net of tax expense of $3,899 | | | | | | | | | | | | | | | | | | | 4,226 | | | | | | | | 4,226 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | 51,746 | |
| Stockholder loans | | | | | | | | | | | | | | | 437 | | | | | | | | | | | | 437 | |
| Exercise of stock options | | | 257 | | | | | | | | 290 | | | | | | | | | | | | | | | | 290 | |
| Excess tax benefits from stock options exercised | | | | | | | | | | | 147 | | | | | | | | | | | | | | | | 147 | |
| Share-based compensation | | | | | | | | | | | 8,124 | | | | | | | | | | | | | | | | 8,124 | |
| Repurchase of common stock | | | (10 | ) | | | | | | | (181 | ) | | | | | | | | | | | | | | | (181 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| BALANCE — December 31, 2009 | | | 94,215 | | | $ | 87 | | | $ | 679,277 | | | $ | (499 | ) | | $ | (11,272 | ) | | $ | 183,282 | | | $ | 850,875 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Comprehensive loss: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | | | | | | | | | | | | | | | | | | | | | (56,862 | ) | | | (56,862 | ) |
| Unrealized gain on interest rate swaps, net of tax expense of $3,235 | | | | | | | | | | | | | | | | | | | 6,776 | | | | | | | | 6,776 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total comprehensive loss | | | | | | | | | | | | | | | | | | | | | | | | | | | (50,086 | ) |
| Stockholder loans | | | | | | | | | | | | | | | 499 | | | | | | | | | | | | 499 | |
| Revocation of restricted stock awards | | | (25 | ) | | | | | | | | | | | | | | | | | | | | | | | | |
| Exercise of stock options and warrants | | | 13,039 | | | | 13 | | | | 88 | | | | | | | | | | | | | | | | 101 | |
| Release on the restriction of stock awards | | | | | | | 7 | | | | 221,975 | | | | | | | | | | | | | | | | 221,982 | |
| Excess tax benefits from share-based compensation | | | | | | | | | | | 93,445 | | | | | | | | | | | | | | | | 93,445 | |
| Share-based compensation | | | | | | | | | | | 15,137 | | | | | | | | | | | | | | | | 15,137 | |
| Issuance of common stock | | | 1,486 | | | | 2 | | | | 41,800 | | | | | | | | | | | | | | | | 41,802 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| BALANCE — December 31, 2010 | | | 108,715 | | | $ | 109 | | | $ | 1,051,722 | | | $ | — | | | $ | (4,496 | ) | | $ | 126,420 | | | $ | 1,173,755 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
See notes to consolidated financial statements.
F-5
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
TableConsolidated Statements of ContentsCash Flows
For the Years Ended December 31, 2010, 2009 and 2008
(Dollars in thousands)
| | | | | | | | | | | | | |
| | | 2010 | | | 2009 | | | 2008 | |
| |
| CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | | | | | | | |
| Net (loss) income | | $ | (56,862 | ) | | $ | 47,520 | | | $ | 45,496 | |
| Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: | | | | | | | | | | | | |
| Noncash items: | | | | | | | | | | | | |
| Benefits received from retention plans | | | — | | | | — | | | | 4,347 | |
| Depreciation and amortization | | | 86,037 | | | | 108,296 | | | | 100,462 | |
| Amortization of debt issuance costs | | | 4,896 | | | | 3,757 | | | | 3,742 | |
| Impairment of fixed assets | | | 840 | | | | 1,288 | | | | — | |
| Loss on disposal of fixed assets | | | 160 | | | | 329 | | | | 47 | |
| Share-based compensation | | | 237,119 | | | | 8,124 | | | | 4,859 | |
| Excess tax benefits related to share-based compensation | | | (93,445 | ) | | | (147 | ) | | | (668 | ) |
| Provision for bad debts | | | 1,621 | | | | 3,319 | | | | 3,471 | |
| Deferred income tax provision | | | (21,619 | ) | | | (41,460 | ) | | | (26,138 | ) |
| Loss on extinguishment of debt | | | 37,979 | | | | — | | | | — | |
| (Gain) loss on equity method investment | | | (42 | ) | | | 300 | | | | 2,374 | |
| Impairment of intangible assets | | | — | | | | 18,636 | | | | — | |
| Lease abandonment | | | 5,383 | | | | 6,612 | | | | — | |
| Loan forgiveness | | | 4,359 | | | | 2,072 | | | | — | |
| Other | | | (118 | ) | | | (647 | ) | | | 1,815 | |
| Changes in operating assets and liabilities: | | | | | | | | | | | | |
| Cash and securities segregated under federal and other regulations | | | (85,026 | ) | | | 52,967 | | | | (145,764 | ) |
| Receivables from clients | | | (13,522 | ) | | | 38,268 | | | | 114,833 | |
| Receivables from product sponsors, broker-dealers and clearing organizations | | | (31,432 | ) | | | 59,500 | | | | (71,247 | ) |
| Receivables from others | | | (35,546 | ) | | | (50,937 | ) | | | 423 | |
| Securities owned | | | 6,297 | | | | (3,832 | ) | | | 2,542 | |
| Securities borrowed | | | (3,441 | ) | | | (4,346 | ) | | | 8,434 | |
| Other assets | | | (3,877 | ) | | | (8,061 | ) | | | (6,687 | ) |
| Drafts payable | | | 56,722 | | | | (28,664 | ) | | | 27,287 | |
| Payables to clients | | | (110,654 | ) | | | 30,932 | | | | 56,334 | |
| Payables to broker-dealers and clearing organizations | | | 20,853 | | | | (3,517 | ) | | | (26,191 | ) |
| Accrued commissions and advisory fees payable | | | 20,368 | | | | 9,713 | | | | (26,257 | ) |
| Accounts payable and accrued liabilities | | | 15,279 | | | | (236 | ) | | | 26,628 | |
| Income taxes receivable/payable | | | (73,835 | ) | | | 12,092 | | | | 2,301 | |
| Unearned revenue | | | 7,774 | | | | 9,186 | | | | (4,239 | ) |
| Securities sold but not yet purchased | | | 818 | | | | 93 | | | | (8,927 | ) |
| | | | | | | | | | | | | |
| Net cash (used in) provided by operating activities | | | (22,914 | ) | | | 271,157 | | | | 89,277 | |
| | | | | | | | | | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | | | | | |
| Capital expenditures | | | (23,095 | ) | | | (8,313 | ) | | | (62,812 | ) |
| Proceeds from disposal of fixed assets | | | — | | | | 200 | | | | — | |
Purchase of securities classified asheld-to-maturity | | | (5,392 | ) | | | (3,746 | ) | | | (7,732 | ) |
F-6
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
Consolidated Statements of Cash Flows — (Continued)
(Dollars in thousands)
| | | | | | | | | | | | | |
| | | 2010 | | | 2009 | | | 2008 | |
| |
Proceeds from maturity of securities classified asheld-to-maturity | | | 6,200 | | | | 3,700 | | | | 7,600 | |
| Proceeds from the sale of equity investment | | | — | | | | 31 | | | | — | |
| Deposits of restricted cash | | | (24,121 | ) | | | (12,759 | ) | | | — | |
| Release of restricted cash | | | 7,216 | | | | 7,163 | | | | — | |
| Acquisitions, net of existing cash balance | | | — | | | | — | | | | (13,258 | ) |
| | | | | | | | | | | | | |
| Net cash used in investing activities | | | (39,192 | ) | | | (13,724 | ) | | | (76,202 | ) |
| | | | | | | | | | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | | | | | |
| Net (repayment of) proceeds from revolving line of credit | | | — | | | | (90,000 | ) | | | 25,000 | |
| Repayment of senior credit facilities | | | (12,584 | ) | | | (8,424 | ) | | | (8,424 | ) |
| Proceeds from senior credit facilities | | | 566,700 | | | | — | | | | — | |
| Redemption of subordinated notes | | | (579,563 | ) | | | — | | | | — | |
| Payment of debt amendment costs | | | (7,181 | ) | | | (372 | ) | | | — | |
| Excess tax benefits related to share-based compensation | | | 93,445 | | | | 147 | | | | 668 | |
| Repayment of stockholder loans | | | — | | | | 462 | | | | 114 | |
| Proceeds from stock options and warrants exercised | | | 101 | | | | 290 | | | | 586 | |
| Issuance of common stock | | | 41,802 | | | | — | | | | 4,000 | |
| Repurchase of common stock | | | — | | | | (181 | ) | | | (3,783 | ) |
| | | | | | | | | | | | | |
| Net cash provided by (used in) financing activities | | | 102,720 | | | | (98,078 | ) | | | 18,161 | |
| | | | | | | | | | | | | |
| NET INCREASE IN CASH AND CASH EQUIVALENTS | | | 40,614 | | | | 159,355 | | | | 31,236 | |
| CASH AND CASH EQUIVALENTS — Beginning of year | | | 378,594 | | | | 219,239 | | | | 188,003 | |
| | | | | | | | | | | | | |
| CASH AND CASH EQUIVALENTS — End of year | | $ | 419,208 | | | $ | 378,594 | | | $ | 219,239 | |
| | | | | | | | | | | | | |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: | | | | | | | | | | | | |
| Interest paid | | $ | 92,888 | | | $ | 101,128 | | | $ | 116,581 | |
| | | | | | | | | | | | | |
| Income taxes paid | | $ | 63,387 | | | $ | 54,919 | | | $ | 71,487 | |
| | | | | | | | | | | | | |
| NONCASH DISCLOSURES: | | | | | | | | | | | | |
| Capital expenditures purchased through short-term credit | | $ | 4,023 | | | $ | 2,640 | | | $ | 1,294 | |
| | | | | | | | | | | | | |
| Increase (decrease) in unrealized gain (loss) on interest rate swaps, net of tax expense (benefit) | | $ | 6,776 | | | $ | 4,226 | | | $ | (8,986 | ) |
| | | | | | | | | | | | | |
| Discount on proceeds from senior credit facilities recorded as debt issuance costs | | $ | 13,300 | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | |
| Acquisitions: | | | | | | | | | | | | |
| Fair value of assets acquired | | | | | | | | | | $ | 17,556 | |
| Cash paid for common stock acquired | | | | | | | | | | | — | |
| Additional consideration for post-closing payments | | | | | | | | | | | (13,258 | ) |
| Common stock issued for acquisitions | | | | | | | | | | | — | |
| | | | | | | | | | | | | |
| Liabilities assumed | | | | | | | | | | $ | 4,298 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | Common
Stock | | Additional
Paid-In
Capital | | Stockholder
Loans | | Accumulated
Other
Comprehensive
Income (Loss) | | Retained
Earnings | | Total
Stockholders'
Equity | |
|---|
BALANCE—December 31, 2006 | | $ | 83 | | $ | 591,254 | | $ | — | | $ | 1,938 | | $ | 33,642 | | $ | 626,917 | |
| | | | | | | | | | | | | | |
| | Comprehensive income: | | | | | | | | | | | | | | | | | | | |
| | | Net income | | | | | | | | | | | | | | | 61,069 | | | 61,069 | |
| | | Unrealized loss on interest rate swaps, net of tax benefit of $5,573 | | | | | | | | | | | | (8,450 | ) | | | | | (8,450 | ) |
| | | | | | | | | | | | | | | | | | | |
| | Total comprehensive income | | | | | | | | | | | | | | | | | | 52,619 | |
| | Cumulative effect of change in accounting principle upon adoption of new tax guidance, net of tax benefit of $2,101 | | | | | | | | | | | | | | | (4,445 | ) | | (4,445 | ) |
| | Stockholder loans | | | | | | | | | (1,242 | ) | | | | | | | | (1,242 | ) |
| | Tax benefit from stock options exercised | | | | | | 191 | | | | | | | | | | | | 191 | |
| | Exercise of stock options | | | | | | 52 | | | | | | | | | | | | 52 | |
| | Share-based compensation | | | | | | 2,160 | | | | | | | | | | | | 2,160 | |
| | Issuance of common stock for acquisitions | | | 3 | | | 70,911 | | | | | | | | | | | | 70,914 | |
| | | | | | | | | | | | | | |
BALANCE—December 31, 2007 | | $ | 86 | | $ | 664,568 | | $ | (1,242 | ) | $ | (6,512 | ) | $ | 90,266 | | $ | 747,166 | |
| | | | | | | | | | | | | | |
| | Comprehensive income: | | | | | | | | | | | | | | | | | | | |
| | | Net income | | | | | | | | | | | | | | | 45,496 | | | 45,496 | |
| | | Unrealized loss on interest rate swaps, net of tax benefit of $5,596 | | | | | | | | | | | | (8,986 | ) | | | | | (8,986 | ) |
| | | | | | | | | | | | | | | | | | | |
| | Total comprehensive income | | | | | | | | | | | | | | | | | | 36,510 | |
| | Stockholder loans | | | | | | | | | 306 | | | | | | | | | 306 | |
| | Tax benefit from stock options exercised | | | | | | 668 | | | | | | | | | | | | 668 | |
| | Exercise of stock options | | | 1 | | | 585 | | | | | | | | | | | | 586 | |
| | Share-based compensation | | | | | | 4,859 | | | | | | | | | | | | 4,859 | |
| | Issuance of 143,884 shares of common stock | | | | | | 4,000 | | | | | | | | | | | | 4,000 | |
| | Repurchase of 136,470 shares of common stock | | | | | | (3,783 | ) | | | | | | | | | | | (3,783 | ) |
| | | | | | | | | | | | | | |
BALANCE—December 31, 2008 | | $ | 87 | | $ | 670,897 | | $ | (936 | ) | $ | (15,498 | ) | $ | 135,762 | | $ | 790,312 | |
| | | | | | | | | | | | | | |
| | Comprehensive income: | | | | | | | | | | | | | | | | | | | |
| | | Net income | | | | | | | | | | | | | | | 47,520 | | | 47,520 | |
| | | Unrealized gain on interest rate swaps, net of tax expense of $3,899 | | | | | | | | | | | | 4,226 | | | | | | 4,226 | |
| | | | | | | | | | | | | | | | | | | |
| | Total comprehensive income | | | | | | | | | | | | | | | | | | 51,746 | |
| | Stockholder loans | | | | | | | | | 437 | | | | | | | | | 437 | |
| | Exercise of stock options | | | | | | 290 | | | | | | | | | | | | 290 | |
| | Tax benefit from stock options exercised | | | | | | 147 | | | | | | | | | | | | 147 | |
| | Share-based compensation | | | | | | 8,124 | | | | | | | | | | | | 8,124 | |
| | Repurchase of 10,000 shares of common stock | | | | | | (181 | ) | | | | | | | | | | | (181 | ) |
| | | | | | | | | | | | | | |
BALANCE—December 31, 2009 | | $ | 87 | | $ | 679,277 | | $ | (499 | ) | $ | (11,272 | ) | $ | 183,282 | | $ | 850,875 | |
| | | | | | | | | | | | | | |
See notes to consolidated financial statements.
F-7
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
(Dollars in thousands)
| | | | | | | | | | | | | |
| | 2009 | | 2008 | | 2007 | |
|---|
CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | | | | | |
| | Net income | | $ | 47,520 | | $ | 45,496 | | $ | 61,069 | |
| | Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | |
| | | Noncash items: | | | | | | | | | | |
| | | | Benefits received from retention plans | | | — | | | 4,347 | | | 8,293 | |
| | | | Depreciation and amortization | | | 108,296 | | | 100,462 | | | 78,748 | |
| | | | Amortization of debt issuance costs | | | 3,757 | | | 3,742 | | | 3,675 | |
| | | | Impairment of fixed assets | | | 1,288 | | | — | | | — | |
| | | | Loss on disposal of fixed assets | | | 329 | | | 47 | | | 129 | |
| | | | Share-based compensation | | | 8,124 | | | 4,859 | | | 2,160 | |
| | | | Provision for bad debts | | | 3,319 | | | 3,471 | | | 3,142 | |
| | | | Deferred income tax provision | | | (41,460 | ) | | (26,138 | ) | | (21,320 | ) |
| | | | Loss on equity method investment | | | 300 | | | 2,374 | | | 678 | |
| | | | Impairment of intangible assets | | | 18,636 | | | — | | | — | |
| | | | Lease abandonment | | | 6,612 | | | — | | | — | |
| | | | Loan forgiveness | | | 2,072 | | | — | | | — | |
| | | | Other | | | (647 | ) | | 1,815 | | | 561 | |
| | | Mortgage loans held for sale: | | | | | | | | | | |
| | | | Originations of loans | | | — | | | — | | | (114,755 | ) |
| | | | Proceeds from sale of loans | | | — | | | — | | | 120,193 | |
| | | | Gain on sale of loans | | | — | | | — | | | (1,061 | ) |
| | | Changes in operating assets and liabilities: | | | | | | | | | | |
| | | | Cash and securities segregated under federal and other regulations | | | 52,967 | | | (145,764 | ) | | (143,633 | ) |
| | | | Receivables from clients | | | 38,268 | | | 114,833 | | | (85,024 | ) |
| | | | Receivables from product sponsors, broker-dealers and clearing organizations | | | 59,500 | | | (71,247 | ) | | (52,508 | ) |
| | | | Receivables from others | | | (50,937 | ) | | 423 | | | (37,109 | ) |
| | | | Securities owned | | | (3,832 | ) | | 2,542 | | | (3,771 | ) |
| | | | Securities borrowed | | | (4,346 | ) | | 8,434 | | | 3,648 | |
| | | | Other assets | | | (8,061 | ) | | (6,687 | ) | | (6,103 | ) |
| | | | Drafts payable | | | (28,664 | ) | | 27,287 | | | 22,257 | |
| | | | Payables to clients | | | 30,932 | | | 56,334 | | | 112,103 | |
| | | | Payables to broker-dealers and clearing organizations | | | (3,517 | ) | | (26,191 | ) | | 17,570 | |
| | | | Accrued commissions and advisory fees payable | | | 9,713 | | | (26,257 | ) | | 16,442 | |
| | | | Accounts payable and accrued liabilities | | | (236 | ) | | 26,628 | | | 13,750 | |
| | | | Income taxes payable | | | 11,945 | | | 1,633 | | | 475 | |
| | | | Unearned revenue | | | 9,186 | | | (4,239 | ) | | 8,432 | |
| | | | Securities sold but not yet purchased | | | 93 | | | (8,927 | ) | | 2,031 | |
| | | | | | | | |
| | | Net cash provided by operating activities | | | 271,157 | | | 89,277 | | | 10,072 | |
| | | | | | | | |
CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | | | |
| | Capital expenditures | | | (8,313 | ) | | (62,812 | ) | | (71,294 | ) |
| | Proceeds from disposal of fixed assets | | | 200 | | | — | | | 41 | |
| | Purchase of securities classified as held-to-maturity | | | (3,746 | ) | | (7,732 | ) | | (5,493 | ) |
| | Proceeds from maturity of securities classified as held-to-maturity | | | 3,700 | | | 7,600 | | | 5,604 | |
| | Purchase of equity method investment | | | — | | | — | | | (5,000 | ) |
| | Proceeds from the sale of equity investment | | | 31 | | | — | | | — | |
| | Deposits of restricted cash | | | (12,759 | ) | | — | | | — | |
| | Release of restricted cash | | | 7,163 | | | — | | | — | |
| | Purchase of intangible assets | | | — | | | — | | | (3,444 | ) |
| | Acquisitions, net of existing cash balance | | | — | | | (13,258 | ) | | (88,689 | ) |
| | | | | | | | |
| | | Net cash used in investing activities | | | (13,724 | ) | | (76,202 | ) | | (168,275 | ) |
| | | | | | | | |
Notes to Consolidated Financial StatementsTable of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
(Dollars in thousands)
| | | | | | | | | | | | | |
| | 2009 | | 2008 | | 2007 | |
|---|
CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | | | |
| | Net (repayment of) proceeds from revolving line of credit | | $ | (90,000 | ) | $ | 25,000 | | $ | 65,000 | |
| | Repayment of senior credit facilities | | | (8,424 | ) | | (8,424 | ) | | (8,304 | ) |
| | Proceeds from senior credit facilities | | | — | | | — | | | 50,000 | |
| | Payment of debt amendment costs | | | (372 | ) | | — | | | (936 | ) |
| | Excess tax benefit related to stock options exercised | | | 147 | | | 668 | | | 191 | |
| | Loans to stockholders | | | — | | | — | | | (1,242 | ) |
| | Repayment of stockholder loans | | | 462 | | | 114 | | | — | |
| | Proceeds from stock options exercised | | | 290 | | | 586 | | | 52 | |
| | Issuance of common stock | | | — | | | 4,000 | | | — | |
| | Repurchase of common stock | | | (181 | ) | | (3,783 | ) | | — | |
| | Proceeds from warehouse lines of credit | | | — | | | — | | | 114,781 | |
| | Repayment of warehouse lines of credit | | | — | | | — | | | (118,499 | ) |
| | | | | | | | |
| | | Net cash (used in) provided by financing activities | | | (98,078 | ) | | 18,161 | | | 101,043 | |
| | | | | | | | |
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | | | 159,355 | | | 31,236 | | | (57,160 | ) |
CASH AND CASH EQUIVALENTS—Beginning of year | | | 219,239 | | | 188,003 | | | 245,163 | |
| | | | | | | | |
CASH AND CASH EQUIVALENTS—End of year | | $ | 378,594 | | $ | 219,239 | | $ | 188,003 | |
| | | | | | | | |
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: | | | | | | | | | | |
| | Interest paid | | $ | 101,128 | | $ | 116,581 | | $ | 124,382 | |
| | | | | | | | |
| | Income taxes paid | | $ | 54,919 | | $ | 71,487 | | $ | 66,079 | |
| | | | | | | | |
NONCASH DISCLOSURES: | | | | | | | | | | |
| | Capital expenditures purchased through short-term credit | | $ | 2,640 | | $ | 1,294 | | | | |
| | | | | | | | | |
| | Increase (decrease) in unrealized gain (loss) on interest rate swaps, net of tax expense (benefit) | | $ | 4,226 | | $ | (8,986 | ) | $ | (8,450 | ) |
| | | | | | | | |
| | Income taxes payable recorded as a cumulative effect of change in accounting principle upon the adoption of new tax guidance, net of tax benefit | | | | | | | | $ | (4,445 | ) |
| | | | | | | | | | |
| | Acquisitions: | | | | | | | | | | |
| | | Fair value of assets acquired | | | | | $ | 17,556 | | $ | 322,057 | |
| | | Cash paid for common stock acquired | | | | | | — | | | (167,071 | ) |
| | | Additional consideration for post-closing payments | | | | | | (13,258 | ) | | — | |
| | | Common stock issued for acquisitions | | | | | | — | | | (68,552 | ) |
| | | | | | | | | |
| | | | Liabilities assumed | | | | | $ | 4,298 | | $ | 86,434 | |
| | | | | | | | | |
| | | Common stock issued to acquire intangible assets | | | | | | | | $ | 1,118 | |
| | | | | | | | | | |
| | | Common stock issued to satisfy accrued liability | | | | | | | | $ | 1,244 | |
| | | | | | | | | | |
See notes to consolidated financial statements
| |
| 1. | Organization and Description of the Company |
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND DESCRIPTION OF THE COMPANY
LPL Investment Holdings Inc.
("LPLIH"(“LPLIH”), a Delaware holding corporation, together with its consolidated subsidiaries (collectively, the
"Company"“Company”)
is a providerprovides an integrated platform of
proprietary technology, brokerage and investment advisory services
supporting a broad range ofto independent financial advisors
and financial advisors
employed by financial institutions, registered investment advisors andat financial institutions (collectively
"customers"“advisors”)
, in the United States of America. Through its proprietary technology, custody and clearing platforms, the Company provides access to diversified financial products and services enabling its
customersadvisors to offer independent financial advice and brokerage services to retail investors (their
"clients"“clients”).
On December 28, 2005, LPL Holdings, Inc.
("LPLH"(“LPLH”), and its subsidiaries were acquired through a merger transaction with BD Acquisition Inc., a wholly owned subsidiary of LPLIH (previously named BD Investment Holdings, Inc.). LPLIH was formed by investment funds affiliated with TPG
Capital and Hellman & Friedman LLC (collectively, the
"Majority Holders"“Majority Holders”). The acquisition was accomplished through the merger of BD Acquisition Inc. with and into LPLH, with LPLH being the surviving entity (the
"Acquisition"“Acquisition”). The Acquisition was financed by a combination of borrowings under the
Company'sCompany’s senior credit facilities, the issuance of senior unsecured subordinated notes and direct and indirect equity investments from the Majority Holders, co-investors, management and the
Company's financialCompany’s advisors.
Description of Our Subsidiaries—LPLH, a Massachusetts holding corporation, owns 100% of the issued and outstanding common stock of LPL Financial Corporation ("LLC (“LPL Financial"Financial”), UVEST Financial Services Group, Inc. ("UVEST"(“UVEST”), LPL Independent Advisor Services Group LLC ("IASG"(“IASG”), Independent Advisers Group Corporation ("IAG"(“IAG”) and LPL Insurance Associates, Inc. ("LPLIA"(“LPLIA”). LPLH is also the majority stockholder in PTC Holdings, Inc. ("PTCH"(“PTCH”), and owns 100% of the issued and outstanding voting common stock. As required by the Office of the Comptroller of the Currency, members of the Board of Directors of PTCH own shares of nonvoting common stock in PTCH. LPL Financial, headquartered in Boston, San Diego and Charlotte, is a clearing broker-dealer and an investment adviser that principally transacts business as an agent for its
customersadvisors and financial institutions on behalf of their clients in a broad array of financial products and services. LPL Financial is licensed to operate in all 50 states, Washington D.C. and Puerto Rico.
UVEST, headquartered in Charlotte, is an introducing broker-dealer and investment adviser that provides independent, nonproprietary third-party brokerage and advisory services to banks, credit unions and other financial institutions. UVEST is licensed to operate in all 50 states and Washington D.C.
IASG is a holding company for Mutual Service Corporation
("MSC"(“MSC”), Associated Financial Group, Inc.
("AFG"(“AFG”), Associated Securities Corp., Inc.
("Associated"(“Associated”), Associated Planners Investment Advisory, Inc.
("APIA"(“APIA”) and Waterstone Financial Group, Inc.
("WFG"(“WFG”) (together, the
"Affiliated Entities"“Affiliated Entities”).
TheOn July 10, 2009, the Company committed to a corporate restructuring plan to consolidate the operations of the Affiliated Entities with those of LPL Financial. Prior to the consolidation of operations, the Affiliated Entities engaged primarily in introducing brokerage and advisory transactions to unaffiliated third-party clearing broker-dealers.
OnThe Affiliated Entities ceased operations as active broker-dealers on September 14, 2009
and the securities licenses of
customersadvisors associated with the Affiliated Entities who elected to transfer, as well as their respective client accounts which had previously cleared through a third-party platform, were transferred to the LPL Financial clearing platform. Following the completion of these transfer activities,
customers
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
advisors and client accounts previously associated with the Affiliated Entities are now associated with LPL Financial. The Affiliated Entities had no active employees, advisors or client accounts as of December 31, 2010. Associated and WFG have withdrawn their registration with the Financial Industry Regulatory Authority’s (“FINRA”) effective February 5, 2011, and MSC expects to withdraw its registrations with FINRA and has maintained
F-8
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
sufficient capital to carry out any remaining activities during the interim. See
NotesNote 3
and 4 for further discussion.
IAG is a registered investment adviser which offers an investment advisory platform for clients of
financial advisors working for other financial institutions.
LPLIA operates as a brokerage general agency, which offers life, long-term care and disability insurance sales and services.
PTCH is a holding company for The Private Trust Company, N.A.
("PTC"(“PTC”). PTC is chartered as a non-depository limited purpose national bank, providing a wide range of trust, investment management
oversight and custodial services for estates and families. PTC also provides Individual Retirement Account custodial services for
its affiliates. Innovex Mortgage, Inc. ("Innovex"), which conducted real estate mortgage banking and brokerage activities, ceased operations on December 31, 2007. Innovex originated residential mortgage loans for clients of financial advisors licensed with LPL Financial. Innovex performed underwriting, loan origination and funding for a variety of mortgage and home equity loan products to suit the needs of borrowers. Innovex's revenues were derived from the referral of loans to lenders and the origination and sale of residential real estate loans for placement in the secondary market. Innovex was a Housing and Urban Development approved Title II nonsupervised mortgagee.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
| |
| 2. | Summary of Significant Accounting Policies |
Basis of Presentation—These consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"(“GAAP”), which require the Company to make estimates and assumptions regarding the valuation of certain financial instruments, intangible assets, allowance for doubtful accounts, valuation of stock compensation, accruals for liabilities, income taxes, revenue and expense accruals, and other matters that affect the consolidated financial statements and related disclosures. Actual results could differ materially from those estimates under different assumptions or conditions and the differences may be material to the consolidated financial statements. Certain reclassifications were made to previously reported amounts in the consolidated financial statements and notes thereto to make them consistent with the current period presentation. The Company has evaluated subsequent events up to and including the date these consolidated financial statements were issued.
Consolidation—These consolidated financial statements include the accounts of LPLIH and its subsidiaries. Intercompany transactions and balances have been eliminated. Equity investments in which the Company exercises significant influence but does not exercise control and is not the primary beneficiary are accounted for using the equity method. Revenue Recognition Policies: Commission—The Company records commissions received from mutual funds, annuity, insurance, equity, fixed income, direct investment, option and commodity transactions on a trade-date basis. Commissions also include mutual fund and variable annuity trails, which are recognized as earned. Due to the significant volume of mutual fund and variable annuity purchases and sales transacted by customersadvisors directly with product manufacturers, management estimates its trail revenues and upfront commission for each accounting period for which the proceeds have not yet been received. These
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
estimates are based on a number of factors, primarily on market levels and the volume of similar transactions in prior periods. The amount of such accruals are shown as commissions receivable from product sponsors and others (see Note 7) included in the caption, receivables from product sponsors, broker-dealers and clearing organizations in the consolidated statements of financial condition. The Company also records commissions payable based upon standard payout ratios for each product as it accrues for commission revenue.
Advisory and Asset-Based Fees—The Company charges investment advisory fees based on a customer'san advisor’s portfolio value, generally at the beginning of each quarter. Advisory fees collected in advance are recorded as unearned revenue and are recognized ratably over the period in which such fees are earned. Advisory fees collected in arrears are recorded as earned. Asset-based fees are primarily derivedcomprised of fees from the Company's marketing, sub-transfer agency agreements, and customer cash sweep productsprograms, financial product manufacturer sponsorship programs,
F-9
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
and omnibus processing and networking services and are recorded and recognized ratably over the period in which services are provided.
Certain advisors conduct their advisory business through separate entities by establishing their own Registered Investment Advisor (“RIA”) pursuant to the Investment Advisers Act of 1940, rather than using the Company’s corporate registered RIA. These stand-alone RIAs engage the Company for technology, clearing, regulatory and custody services, as well as access to the Company’s investment advisory platforms. The fee-based production generated by the stand-alone RIA is earned by the advisor, and accordingly not included in the Company’s advisory fee revenue. The Company charges fees to stand-alone RIAs including administrative fees based on the value of assets within these advisory accounts. Such fees are included within asset-based fees and transaction and other fees on the consolidated statements of operations, as described below.
Transaction and Other Fees—The Company charges transaction fees for executing noncommissionable transactions onin client accounts. Transaction related charges are recognized on a trade-date basis. Other fees relate to services provided and other account charges generally outlined in the Company'sCompany’s agreements with its clients, advisors and customers.financial institutions. Such fees are recognized as services are performed or as earned, as applicable. In addition, the Company offers various software-related products, for which fees are charged on a subscription basis and are recognized over the subscription period. Interest Income, netNet of interest expenseInterest Expense—The Company earns interest income from its cash equivalents and client margin balances, less interest expense on related transactions. Because interest expense incurred in connection with cash equivalents and client margin balances is completely offset by revenue on related transactions, the Company considers such interest to be an operating expense. Gain on Sale of Mortgage Loans Held Interest expense from operations for Sale—The Company, through its mortgage affiliate Innovex, recognized gains on the sale of mortgage loans held for sale on the date of settlement. Onyears ended December 31, 2007, Innovex ceased operations. Prior to that date, a gain was recognized based on the difference between the selling price2010, 2009 and the carrying value of the related mortgage loans sold, including deferred loan origination fees and certain direct origination costs. All loans were sold on a servicing-released basis (i.e. the Company2008 did not service the loans after they were sold, and all loans were sold before the first payment was made). Loans were accounted for as sold when control of the mortgage loans was surrendered. Control over mortgage loans was deemed to be surrendered when (i) the mortgage loans were isolated from the Company, (ii) the buyer had the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the loans, and (iii) the Company did not maintain effective control of the mortgage loans through either (a) an agreement that entitled and obligated the Company to repurchase or redeem the mortgage loans before maturity or (b) the ability to unilaterally cause the buyer to return specific mortgage loans.
exceed $1.0 million in any fiscal year presented.
Compensation and Benefits—The Company records compensation and benefits for all cash and deferred compensation, benefits and related taxes as earned by its employees. Compensation and benefits expense also includes fees earned by temporary employees and contractors who perform similar services to those performed by the Company'sCompany’s employees, primarily software development and project management activities. Temporary employee and contractor services of $21.8 million, $18.0 million, $36.9 million, and $25.4$36.9 million were incurred during the years ended December 31, 2010, 2009, and 2008, and 2007, respectively. Share-Based Compensation—The Company recognizes share-based compensation expense related to employee stock option awards in net income based on the grant-date fair value over the requisite service period of the individual grants, which generally equals the vesting period. The Company
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
accounts for non-employee stock options and warrants awarded to its advisors and financial institutions based on the fair value of the awardsaward at each interim reporting period.
Stock Split—The Company affected a ten-for-one stock split as of January 1, 2008. All per share amounts, average shares and options outstanding, and shares and options outstanding have been adjusted retroactively to reflect the stock split.Income Taxes—In preparing the consolidated financial statements, the Company estimates income tax expense based on various jurisdictions where it conducts business. The Company must then assess the likelihood that the deferred tax assets will be realized. A valuation allowance is established to the extent that it is more-likely-than-not that such deferred tax assets will not be realized. When the Company establishes a valuation allowance or modifies the existing allowance in a certain reporting period, the Company generally records a corresponding increase or decrease to tax expense in the consolidated statements of income.operations. Management makes significant judgments in determining the provision for income taxes, the deferred tax assets and liabilities, and any valuation allowances recorded against the deferred tax asset. Changes in the estimate of these taxes occur periodically due to changes in the tax rates, changes in the business operations, implementation of
F-10
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
tax planning strategies, resolution with taxing authorities of issues where the Company had previously taken certain tax positions and newly enacted statutory, judicial and regulatory guidance. These changes could have a material
affecteffect on the
Company'sCompany’s consolidated statements of financial condition,
incomeoperations or cash flows in the period or periods in which they occur.
The Company recognizes the tax effects of a position in the financial statements only if it is more-likely-than-not to be sustained based solely on its technical merits, otherwise no benefits of the position are to be recognized. The more-likely-than-not threshold must continue to be met in each reporting period to support continued recognition of a benefit. Moreover, each tax position meeting the recognition threshold is required to be measured as the largest amount that is greater than 50 percent likely to be realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. See Note 11 for additional detail regarding the
Company'sCompany’s uncertain tax positions.
Employee Health Care Self-Insurance— The Company is partially self-insured for benefits paid under employee healthcare programs. Self-insurance estimates are determined with the assistance of insurance actuaries, based on historical experience and trends related to claims and payments, information provided by the insurance broker, and industry experience. The Company has coverage for excess losses on either an individual or an aggregate case basis. Estimates of future claim costs are recorded on an undiscounted basis, and are recognized as a liability within accounts payable and accrued liabilities in the consolidated statements of financial condition.
Cash and Cash Equivalents—Cash and cash equivalents are composed of interest and noninterest-bearing deposits, money market funds and U.S. government obligations that meet the definition of a cash equivalent. Cash equivalents are highly liquid investments, with original maturities of less than 90 days that are not required to be segregated under federal or other regulations. Cash and Securities Segregated Under Federal and Other Regulations—Certain subsidiaries of the Company are subject to requirements related to maintaining cash or qualified securities in a segregated reserve account for the exclusive benefit of its customers in accordance with SECRule 15c3-3 and other regulations. Receivables From and Payables to Clients—Receivables from and payables to clients includes amounts due on cash and margin transactions. The Company extends credit to its clients to finance their purchases of securities on margin. The Company receives income from interest charged on such extensions of credit. The Company pays interest on certain client free credit balances held pending investment. Loans to clients are generally fully collateralized by client securities, which are not included in the consolidated statements of financial condition. To the extent that margin loans and other receivables from clients are not fully collateralized by client securities, management establishes an allowance that it believes is sufficient to cover any probable losses. When establishing this allowance, management considers a number of factors, including
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
its ability to collect from the clientand/or the client's financialclient’s advisor and the Company'sCompany’s historical experience in collecting on such transactions.
The following schedule reflects the Company'sCompany’s activity in providing for an allowance for uncollectible amounts due from clients for the years ended December 31, 20092010 and 20082009 (in thousands):
| | | | | | | | | |
| | | 2010 | | | 2009 | |
| |
| Beginning balance — January 1 | | $ | 792 | | | $ | 972 | |
| Charge-offs — net of recoveries | | | (137 | ) | | | (180 | ) |
| | | | | | | | | |
| Ending balance — December 31 | | $ | 655 | | | $ | 792 | |
| | | | | | | | | |
F-11
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
| | | | | | | |
| | 2009 | | 2008 | |
|---|
Beginning balance—January 1 | | $ | 972 | | $ | 529 | |
Provision | | | — | | | 443 | |
Recoveries | | | (180 | ) | | — | |
| | | | | | |
Ending balance—December 31 | | $ | 792 | | $ | 972 | |
| | | | | | |
Notes to Consolidated Financial Statements — (Continued)
Receivables From Product Sponsors, Broker-Dealers and Clearing Organizations—Receivables from product sponsors, broker-dealers and clearing organizations primarily consists of commission and transaction-related receivables. Receivables From Others—Receivables from others primarily consists of other accrued fees from product sponsors and financial advisors. The Company periodically extends credit to its financial advisors in the form of recruiting loans, commission advances, and other loans. The decisions to extend credit to financial advisors are generally based on either the financial advisors'advisors’ credit history, their ability to generate future commissions, or both. Management maintains an allowance for uncollectible amounts using an aging analysis that takes into account the financial advisors'advisors’ registration status and the specific type of receivable. The aging thresholds and specific percentages used represent management'smanagement’s best estimates of probable losses. Management monitors the adequacy of these estimates through periodic evaluations against actual trends experienced. The following schedule reflects the Company'sCompany’s activity in providing for an allowance for uncollectible amounts due from others for the years ended December 31, 20092010 and 20082009 (in thousands):
| | | | | | | | | |
| | | 2010 | | | 2009 | |
| |
| Beginning balance — January 1 | | $ | 6,159 | | | $ | 4,076 | |
| Provision for bad debts(1) | | | 1,621 | | | | 3,319 | |
| Charge-offs — net of recoveries | | | (984 | ) | | | (1,236 | ) |
| | | | | | | | | |
| Ending balance — December 31 | | $ | 6,796 | | | $ | 6,159 | |
| | | | | | | | | |
| | | | | | | |
| | 2009 | | 2008 | |
|---|
Beginning balance—January 1 | | $ | 4,076 | | $ | 5,266 | |
Provision for bad debts(1) | | | 3,319 | | | 3,028 | |
Charge-offs—net of recoveries | | | (1,236 | ) | | (4,218 | ) |
| | | | | | |
Ending balance—December 31 | | $ | 6,159 | | $ | 4,076 | |
| | | | | | |
| | |
| (1) | | For the year ended December 31, 2009, the Company has classified $0.3 million of the provision for bad debt as restructuring charges with the consolidated statements of operations. |
(1)For the year ended December 31, 2009, the Company has classified $0.3 million of the provision for bad debt as restructuring charges with the consolidated statements of income (see Note 4).
Classification and Valuation of Certain Investments—The classification of an investment determines its accounting treatment. The Company generally classifies its investments in debt and equity instruments (including mutual funds, annuities, corporate bonds, government bonds and municipal bonds) as trading securities, except for government notes held by PTCH,PTC, which are classified asheld-to-maturity based on management'smanagement’s intent and ability to hold them to maturity. The Company has not classified any investments asavailable-for-sale. Investment classifications are subject to ongoing review and can change. Securities classified as trading are carried at fair value, while securities
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
classified asheld-to-maturity are carried at cost or amortized cost. When possible, the fair value of securities is determined by obtaining quoted market prices. The Company also makes estimates about the fair value of investments and the timing for recognizing losses based on market conditions and other factors. If its estimates change, the Company may recognize additional losses. Both unrealized and realized gains and losses on trading securities are recognized in other revenue on a net basis in the consolidated statements of income.
operations.
Securities Owned and Sold But Not Yet Purchased—Securities owned and securities sold but not yet purchased are reflected on a trade-date basis at market value with realized and unrealized gains and losses being recorded in other revenue in the consolidated statements of income. Clients' securities transactionsoperations. Interest income is accrued as earned and dividends are recorded on a settlement-date basis, with related commission income and expense reported on a trade-date basis.the ex-dividend date.
U.S. government notes are carried at amortized cost and classified asheld-to-maturity, as the Company has both the intent and ability to hold them to maturity. Interest income is accrued as earned. Premiums and discounts are amortized, using a method that approximates the effective yield method, over the term of the security and recorded as an adjustment to the investment yield.
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Interest income is accrued as earned and dividends are recorded on the ex-dividend date.
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
Securities Borrowed and Loaned—Securities borrowed and securities loaned are accounted for as collateralized financings and are recorded at the amount of the cash provided for securities borrowed transactions and cash received for securities loaned (generally in excess of market values). The adequacy of the collateral deposited for securities borrowed is continuously monitored and adjusted when considered necessary to minimize the risk associated with this activity. At December 31, 20092010 and December 31, 2008,2009, the Company had $5.0$8.4 million and $0.6$5.0 million, respectively, in securities borrowed. The collateral received for securities loaned is generally cash and is adjusted daily through the Depository Trust Company's ("DTC"Company’s (“DTC”) net settlement process, and securities loaned is included in payable to broker-dealers and clearing organizations in the consolidated statements of financial condition. Securities loaned generally represent client securities that can be pledged under standard margin loan agreements. At December 31, 20092010 and December 31, 2008,2009, the Company had $7.2$8.1 million and $5.3$7.2 million, respectively, of pledged securities loaned under the DTC Stock Borrow Program. Fixed Assets—Furniture, equipment, computers, purchased software, capitalized software and leasehold improvements are recorded at historical cost, net of accumulated depreciation and amortization. Depreciation is recognized using the straight-line method over the estimated useful lives of the assets. Furniture, equipment, computers and purchased software are depreciated over a period of three to seven years. Automobiles have depreciable lives of five years. Leasehold improvements are amortized over the lesser of their useful lives or the terms of the underlying leases. Management reviews fixed assets for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. In 2010, the Company recorded a fixed asset impairment charge of $0.6 million for certain fixed assets that were attributed to the Affiliated Entities business, whose use has since been discontinued, as well as $0.2 million related to fixed assets at the abandoned lease locations.
Software Development Costs—Software development costs are charged to operations as incurred. Software development costs include costs incurred in the development and enhancement of software used in connection with services provided by the Company that do not otherwise qualify for capitalization. The costs of internally developed software that qualify for capitalization are capitalized as fixed assets and subsequently amortized over the estimated useful life of the software, which is generally three years. The costs of internally developed software are included in fixed assets at the point at which
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
the conceptual formulation, design and testing of possible software project alternatives are complete and management authorizes and commits to funding the project. The Company does not capitalize pilot projects and projects where it believes that the future economic benefits are less than probable.
Reportable Segment—The Company'sCompany’s internal reporting is organized into three service channels; Independent Advisor Services, Institution Services and Custom Clearing Services, which are designed to enhance the services provided to the Company's customers.its advisors and financial institutions. These service channels qualify as individual operating segments, but are aggregated and viewed as one single reportable segment due to their similar economic characteristics, products and services, production and distribution process, regulatory environment and quantitative thresholds. Goodwill, Intangible Assets and Trademarks and Trade Names—The Company classifies intangible assets into three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. The Company determines the useful lives of identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors considered when determining useful lives
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
include the contractual term of any agreement, the history of the asset, the
Company'sCompany’s long-term strategy for the use of the asset, any laws or other local regulations which could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, on a straight-line basis, over their useful lives, generally ranging from 5
-— 20 years. See Note
109 for further discussion.
When facts and circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, the Company assesses the recoverability of the carrying value by preparing estimates of future cash flows. The Company recognizes an impairment loss if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. The Company uses a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions the Company believes hypothetical marketplace participants would use. For the year ended December 31, 2009, the Company recorded a $17.5 million charge for the impairment of
customeradvisor and financial institution relationship intangible
assets.assets which is included in restructuring charges within the consolidated statements of operations. See Notes
43 and
109 for further discussion. No impairment occurred for the years ended December 31,
20082010 and
2007.2008.
The Company tests intangible assets determined to have indefinite useful lives, including trademarks trade names and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. The Company performs these annual impairment reviews as of the first day of the fourth quarter (October 1). The Company uses a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions the Company believes hypothetical marketplace participants would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. For the year ended December 31, 2009, the Company recorded a $1.1 million charge for the impairment of trademarks and trade
names.names which is included in restructuring charges within the consolidated statements of operations. See Notes
43 and
109 for further discussion. No impairment occurred for the years ended December 31,
20082010 and
2007.2008.
The Company performs impairment tests of goodwill at the reporting unit level, which represent its operating segments. There were no changes to the
Company'sCompany’s reporting units in
2009.2010. The goodwill impairment test consists of a two-step process, if necessary. The first step is to compare the fair value of a reporting unit to its carrying value, including goodwill. The Company typically uses
discounted cash
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
flow modelsincome approach methodology to determine the fair value of a reporting unit.unit, which includes the discounted cash flow method and the market approach methodology that includes the use of market multiples. The assumptions used in these models are consistent with those the Company believes hypothetical marketplace participants would use. If the fair value of the reporting unit is less than its carrying value, the second step of the impairment test must be performed in order to determine the amount of impairment loss, if any. The second step compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit'sunit’s goodwill exceeds its implied fair value, an impairment charge is recognized in an amount equal to that excess. The loss recognized cannot exceed the carrying amount of goodwill. No impairment occurred for the years ended December 31, 2010, 2009 2008 and 2007.2008.
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
Deferred Loan Issuance and Amendment Costs—Debt issuance and amendment costs have been capitalized and are being amortized as additional interest expense over the expected terms of the related debt agreements. Equity Method Investment—The Company'sCompany’s equity method investment is accounted for under the equity method when it exerts significant influence and ownership does not exceed 50% of the common stock. The Company records the investment at cost in the consolidated statements of financial condition and adjusts the carrying amount of the investment to recognize its share of earnings or losses while recording such earnings or losses within the consolidated statements of income.operations.
Mortgage Loans Held for Sale—Through its mortgage affiliate, Innovex, the Company originated residential mortgage loans through a warehouse line of credit facility or as a broker for other banks. The Company ceased the operations of Innovex on December 31, 2007. Prior to this date, mortgage loans held for sale were carried at the lower of aggregate cost or fair value and were sold on a nonrecourse basis with certain representations and warranties. Fair value was determined by outstanding commitments from investors. The Company evaluated the need for market valuation reserves on mortgage loans held for sale based on a number of quantitative and qualitative factors, primarily changes in interest rates and collateral values. The Company sold all mortgage loans that it originated.
The Company had an agreement with certain third-party financial institutions for them to purchase loans originated by the Company, as long as such loans met certain criteria, generally within 30 days from funding. Loan origination and processing fees and certain direct origination costs were deferred until the related loan was sold.
Drafts Payable—Drafts payable represent checks drawn against the Company that have not yet cleared through the bank. At December 31, 2009,2010, the Company had amounts drawn of $111.1$168.0 million related to client activities, and $14.7$14.5 million of corporate overdrafts under a sweep agreement with a bank.
overdrafts.
Legal Reserves—The Company records reserves for legal proceedings in accounts payable and accrued liabilities in the statementstatements of financial condition. The determination of these reserve amounts requires significant judgment on the part of management. Management considers many factors including, but not limited to, future legal expenses, the amount of the claim, the amount of the loss in the client'sclient’s account, the basis and validity of the claim, the possibility of wrongdoing on the part of a customer,advisors and financial institutions, likely insurance coverage, previous results in similar cases, and legal precedents and case law. Each legal proceeding is reviewed with counsel in each accounting period and the reserve is adjusted as deemed appropriate by management. Any change in the reserve amount is recorded as professional services in the consolidated statementstatements of income.operations.
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Derivative Instruments and Hedging Activities—The Company uses interest rate swap agreements to protect itself against changing interest rates and the related impact to the Company'sCompany’s cash flows. The Company also evaluates its contracts and commitments for terms that qualify as embedded derivatives. All derivatives are reported at their corresponding fair value in the Company'sCompany’s consolidated statements of financial condition. Financial derivative instruments expected to be highly effective hedges against changes in cash flows are designated as such upon entering into the agreement. At each reporting date, the Company reassesses the effectiveness of the hedge to determine whether or not it can continue to use hedge accounting. Under hedge accounting, the Company records the increase or decrease in fair value of the derivative, net of tax impact, as other comprehensive income or loss. If the hedge is not determined to be a perfect hedge, yet is still considered highly effective, the Company will calculate the ineffective portion and record the related change in its fair value as additional interest income or expense in the consolidated statements of
income.operations. Amounts accumulated in other comprehensive income (loss) are reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings.
Fair Value of Financial Instruments—The Company'sCompany’s financial assets and liabilities are carried at fair value or at amounts that, because of their short-term nature, approximate current fair value, with the exception of its indebtedness. The Company carries its indebtedness at amortized cost.cost and measures the implied fair value of its debt instruments using trading levels obtained from a third-party service provider. As of December 31, 2010, the carrying amount and fair value of the Company’s indebtedness was approximately $1,387 million and $1,390 million, respectively. As of December 31, 2009, the carrying amount and fair value of the Company's indebtedness was approximately $1,369 million and $1,278 million, respectively. As of December 31, 2008, the carrying amount and fair value was approximately $1,468 million and $1,057 million, respectively. See Note 65 for additional detail regarding the Company'sCompany’s fair value measurements. Commitments and Contingencies—The Company recognizes liabilities for contingencies when analysis indicates it is both probable that a liability has been incurred and the amount of loss
F-15
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
can be reasonably estimated. When a range of probable loss can be estimated, the Company accrues the most likely amount.
Comprehensive (Loss) Income (Loss)—The Company'sCompany’s comprehensive (loss) income (loss) is composed of net income and the effective portion of the unrealized gains (losses) on financial derivatives in cash flow hedge relationships, net of related tax effects. Recently Issued Accounting Pronouncements—Recent accounting pronouncements or changes in accounting pronouncements during the year ended December 31, 2009,2010, that are of significance, or potential significance, to the Company are discussed below. In June 2009,January 2010, the Financial Accounting Standards Board ("FASB"(“FASB”) issued guidance now codified as Accounting Standards Codification (the "Codification" or "ASC"Update (“ASU”) Topic 105,No. 2010-06,Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements (“ASUGenerally Accepted Accounting Principles2010-6”). ASU, which established a single source2010-6 requires new disclosures regarding significant transfers into and out of authoritative, non-governmental GAAP, exceptLevel 1 and Level 2 fair value measurements and separate disclosures about purchases, sales, issuances and settlements relating to Level 3 fair value measurements. This ASU also clarifies existing disclosures of inputs and valuation techniques for rulesLevel 2 and interpretive releasesLevel 3 fair value measurements. The adoption of the SEC, which are sources of authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literature that was not included in the Codification became non-authoritative. The Codification is effective for financial statements for interim or annual reporting periods ending after September 15, 2009. The Company adopted the new guidelines and numbering system prescribed by the Codification when referring to GAAP. As the Codification was not intended to change or alter existing GAAP, itASU2010-6 did not have a material impact on the Company'sCompany’s consolidated financial statements.
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In April 2009, the FASB issued three staff positions intended to provide additional application guidance and enhance the disclosures regarding fair value measurements and impairments of securities. This guidance is now codified within ASC Topic 820,Financial Measurements and Disclosures ("ASC Topic 820"), ASC Topic 825,Financial Instruments ("ASC Topic 825") and ASC Topic 320,Investments—Debt and Equity Securities ("ASC Topic 320"). ASC Topic 820 provides guidance on determining fair value when market activity has decreased. Updates contained within ASC Topic 825 enhance consistency in financial reporting by increasing the frequency of fair value disclosures. ASC Topic 320 provides additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on debt securities. Except for the addition of required disclosures, the adoption of the provisions contained in these topics did not have a material impact on the Company's consolidated financial statements.
In May 2009, the FASB issued guidance now codified as ASC Topic 855,Subsequent Events ("ASC Topic 855"), which established a general standard of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The Company adopted the provisions of ASC Topic 855, which did not have a material impact on its consolidated financial statements.
In June 2009, the FASB issued guidance now codified as ASC Topic 810,Consolidation ("ASC Topic 810"), which amends the evaluation criteria to identify the primary beneficiary of a variable interest entity ("VIE") and requires ongoing reassessment of whether an enterprise is the primary beneficiary of the VIE. ASC Topic 810 significantly changes the consolidation rules for VIEs including the consolidation of common structures, such as joint ventures, equity method investments and collaboration arrangements. The guidance is applicable to all new and existing VIEs. The provisions of ASC Topic 810 are effective for interim and annual reporting periods ending after November 15, 2009. The Company adopted ASC Topic 810, which did not have a material impact on its consolidated financial statements.
In August 2009, the FASB issued Accounting Standards Update ("ASU") No. 2009-05,Fair Value Measurements and Disclosures (Topic 820)—Measuring Liabilities at Fair Value ("ASU 2009-05"). ASU 2009-05 provides clarification in measuring the fair value of liabilities in circumstances in which a quoted price in an active market for the identical liability is not available and in circumstances in which a liability is restricted from being transferred. This ASU also clarifies that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. The Company adopted ASU 2009-05, which did not have a material impact on its consolidated financial statements.
3. ACQUISITIONS AND DIVESTITURES
On January 2, 2007, the Company completed its acquisition of all of the outstanding capital stock of UVEST, augmenting the Company's position in providing services to banks, credit unions and other financial institutions. The purchase price totaled $89.5 million; $78.0 million in cash and the issuance of 603,660 shares of common stock at an estimated fair value of $18.90 per share. As part of the purchase price allocation, the Company recorded intangible assets for relationships with customers and product sponsors. The value assigned to these relationships was $54.3 million, which is being amortized on a straight-line basis over the expected useful life of 20 years. Additionally, the Company assigned value to the trademark and trade name in the amount of $0.5 million. The trademark and trade name was
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
determined to have an expected useful life of 18 months and therefore amortized over the same period. As of December 31, 2008, the trademark and trade name were fully amortized. Goodwill in the amount of $27.4 million was created for the excess purchase price over the value of assets and liabilities assumed.
Immediately following the acquisition, the Company satisfied certain obligations under a phantom stock plan for UVEST employees by issuing 65,820 shares of common stock at an estimated fair value of $18.90 per share.
On June 20, 2007, the Company acquired the Affiliated Entities. This acquisition increased the number of independent financial advisors and strengthened the Company's position as a leading independent broker-dealer in the United States.
The total purchase price was approximately $120.5 million; $63.3 million in cash and the issuance of 2,645,500 shares of common stock with an estimated fair value of $21.60 per share. As part of the purchase price allocation, the Company estimated the value of intangible assets for relationships with customers and product sponsors to be $67.1 million, which was amortized on a straight-line basis over their expected useful lives ranging from 10 to 20 years. Additionally, the Company estimated the value of trademarks and trade names in the amount of $2.3 million. The trademarks and trade names were determined to have an expected useful life of three to five years and therefore amortized over the same period. Goodwill in the amount of $11.3 million was also recorded as part of the acquisition. Subsequent to the purchase, the Company settled an outstanding state tax audit. This settlement, which was favorable to the Company, resulted in a $0.1 million reduction to goodwill.
On July 10, 2009, the Company committed to a corporate restructuring plan to consolidate the operations of the Affiliated Entities with LPL Financial. See Note 4 for further discussion.
On November 7, 2007, the Company completed its acquisition of IFMG Securities, Inc., Independent Financial Marketing Group, Inc. and LSC Insurance Agency of Arizona, Inc. (collectively "IFMG"). The purpose of this acquisition was to transfer IFMG's relationships with financial institution clients to other broker-dealer subsidiaries of the Company. In conjunction with its acquisition of IFMG, the Company announced a shutdown plan (the "Shutdown Plan"), which offered relocation and employment to certain employees and terminated the remaining operations of IFMG within twelve months following the acquisition.
The total purchase price was $39.0 million, including initial purchase consideration of $25.7 million, as well as $7.1 million in post-closing payments made through 2008 based on the successful recruitment and retention of certain institutional relationships. As part of the purchase price allocation, the Company estimated the value of intangible assets for relationships with customers and product sponsors to be $25.6 million, which will be amortized on a straight-line basis over their expected useful lives of 10 years. Additionally, the value of certain technology and non-compete agreements has been estimated at $1.1 million and $0.6 million, respectively, both of which are being amortized over 3 years.
In conjunction with the acquisition, the Company made retention payments to financial institutions doing business through IFMG as an incentive to convert to one of the Company's other technology and clearing platforms. As of December 31, 2009, the Company has paid $0.9 million in retention payments, which are classified as other assets in the consolidated statements of financial condition, and are being amortized over the life of the contractual agreements, ranging from six months to six years.
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As part of the Shutdown Plan, the Company evaluated whether or not it will utilize certain long term contractual relationships with vendors of IFMG. Consequently, the Company cancelled various contracts resulting in $2.3 million in cancellation charges. Cancellation fees and any estimated losses attributable to vendor and or lease contracts have been recorded as additional purchase price consideration.
4. RESTRUCTURING
Strategic Business Review Initiative
On December 29, 2008, the Company committed to and implemented an organizational restructuring plan intended to reduce its cost structure and improve operating efficiencies, which resulted in a reduction in its overall workforce of approximately 250 employees. In accordance with
ASCthe FASB Accounting Standards Codification (“ASC”) Topic 420,
Accounting for Costs Associated with Exit or Disposal Activities, the Company has recorded severance and one-time involuntary termination benefit accruals in accounts payable and accrued liabilities within the consolidated statements of financial condition. The Company completed this initiative and expects to pay all costs by April 2011.The following table summarizes the balance of accrued expenses related to the strategic business review and the changes in the accrued amounts as of and for the year ended December 31, 20092010 (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Accrued
| | | | | | | | | | | | Accrued
| | | Cumulative
| |
| | | Balance at
| | | | | | | | | | | | Balance at
| | | Costs
| |
| | | December 31,
| | | Costs
| | | | | | | | | December 31,
| | | Incurred
| |
| | | 2009 | | | Incurred(1) | | | Payments | | | Non-cash | | | 2010 | | | to Date(2) | |
| |
| Severance and benefits | | $ | 1,996 | | | $ | 43 | | | $ | (1,442 | ) | | $ | — | | | $ | 597 | | | $ | 14,548 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | Accrued
Balance at
December 31,
2008 | | Costs
Incurred(1) | | Payments | | Non-cash | | Accrued
Balance at
December 31,
2009 | | Cumulative
Costs
Incurred
to Date(2) | |
|---|
Severance and benefits | | $ | 14,533 | | $ | (467 | ) | $ | (12,070 | ) | $ | — | | $ | 1,996 | | $ | 14,505 | |
| | | | | | | | | | | | | | |
| | |
| (1) | | Represent changes in the Company’s estimates for the cost of providing post employment benefits to employees impacted by its restructuring activities. |
|
| (2) | | At December 31, 2010, cumulative costs incurred to date represent the total expected costs. |
(1)Represent changes in the Company's estimates for the cost of providing post employment benefits to employees impacted by its restructuring activities.
(2)At December 31, 2009, cumulative costs incurred to date represent the total expected costs.
Consolidation of Affiliated Entities Initiative
On July 10, 2009, the Company committed to a corporate restructuring plan that consolidated the operations of the Affiliated Entities with LPL Financial. This restructuring was affectedeffected to enhance service offerings to customersfinancial advisors while also generating efficiencies. The Company expects total costs associated with the initiative to be approximately $74.2$77.3 million. The Company incurred the majority of these costs in 2009 and anticipates recognizing the remaining costs by December 2013; however,
F-16
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
adjustments may occur due to estimates of abandoned lease obligations with terms that extend through 2018.
The Company paid charges related to the conversion and transfer of certain customersadvisors associated with the Affiliated Entities and their client accounts. Following the completion of these transfer activities, the registered representatives and client accounts that transferred are associated with LPL Financial. AsIn 2009, as a condition for the regulatory approval of the transfer, the Affiliated Entities were required to deposit $12.8 million into escrow accounts pending the resolution of certain matters, of which $7.3 million has been released as of December 31, 2009. The adequacy of thesewas released. During 2010, the Company deposited an additional $4.1 million into the escrow accounts is evaluated quarterly.and withdrew $7.2 million. These escrow accounts are considered restricted cash and included in other assets within the consolidated statements of financial condition.
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company
paid charges related to early termination costs associated with certain contracts held by the Affiliated Entities (see Note 14). Additionally, the Company recorded severance costs and one-time involuntary termination benefits associated with the elimination of 189 positions and will recognize these accruals ratably over the employees' remaining service period. The Company recorded non-cash charges for the impairment of intangible assets resulting from customer attrition and discontinued use of certain brand names and logos (see Note 10), and fixed assets associated with abandoned lease arrangements. The Company also recognized charges related to the early termination and partial abandonment of certain lease arrangements offset by estimates forsub-lease efforts. The Company anticipates additional costsalso recorded non-cash charges for the impairment of approximately $2.8 million related tofixed assets associated with the abandonmentoperations of the affiliated entities and recorded accruals for employee related costs, including severance and one-time involuntary termination benefits that will be recognized ratably over the employees’ remaining office space, which can not be fully estimated until the date of abandonment.
service period.
The following table summarizes the balance of accrued expenses and the changes in the accrued amounts as of and for the year ended December 31, 20092010 (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Accrued
| | | | | | | | | | | | Accrued
| | | Cumulative
| | | Total
| |
| | | Balance at
| | | | | | | | | | | | Balance at
| | | Costs
| | | Expected
| |
| | | December 31,
| | | Costs
| | | | | | | | | December 31,
| | | Incurred
| | | Restructuring
| |
| | | 2009 | | | Incurred | | | Payments | | | Non-cash | | | 2010 | | | to Date | | | Costs | |
| |
| Severance and benefits | | $ | 2,759 | | | $ | 2,034 | | | $ | (3,717 | ) | | $ | (456 | ) | | $ | 620 | | | $ | 11,470 | | | $ | 11,470 | |
| Lease and contract termination fees | | | 7,458 | | | | 5,340 | | | | (4,071 | ) | | | 224 | | | | 8,951 | | | | 21,259 | | | | 21,359 | |
| Asset impairments | | | — | | | | 840 | | | | — | | | | (840 | ) | | | — | | | | 20,764 | | | | 20,764 | |
| Conversion and transfer costs | | | 304 | | | | 5,665 | | | | (1,963 | ) | | | (3,797 | ) | | | 209 | | | | 19,548 | | | | 23,662 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 10,521 | | | $ | 13,879 | | | $ | (9,751 | ) | | $ | (4,869 | ) | | $ | 9,780 | | | $ | 73,041 | | | $ | 77,255 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| |
| 4. | Equity Method Investment |
| | | | | | | | | | | | | | | | | | | |
| | Accrued
Balance at
December 31,
2008 | | Costs
Incurred(1) | | Payments | | Non-cash | | Accrued
Balance at
December 31,
2009 | | Total
Expected
Restructuring
Costs | |
|---|
Severance and benefits | | | $— | | $ | 9,436 | | $ | (6,551 | ) | $ | (126 | ) | $ | 2,759 | | $ | 11,356 | |
Lease and contract termination fees | | | — | | | 15,919 | | | (8,358 | ) | | (103 | ) | | 7,458 | | | 19,079 | |
Asset impairments | | | — | | | 19,924 | | | — | | | (19,924 | ) | | — | | | 20,238 | |
Conversion and transfer costs | | | — | | | 13,883 | | | (11,222 | ) | | (2,357 | ) | | 304 | | | 23,483 | |
| | | | | | | | | | | | | | |
Total | | | $— | | $ | 59,162 | | $ | (26,131 | ) | $ | (22,510 | ) | $ | 10,521 | | $ | 74,156 | |
| | | | | | | | | | | | | | |
(1)At December 31, 2009, costs incurred represent the total cumulative costs incurred.
5. EQUITY METHOD INVESTMENT
On May 11, 2007, the Company acquired for $5.0 million, an approximate 22.6% ownership interest in Blue Frog Solutions, Inc. ("(“Blue Frog"Frog”). This investment provides the Company with a strategic ownership interest in one of its vendors that provides technology for variable annuity order entry and monitoring. The Company follows the equity method of accounting, as it has the ability to exercise significant influence over operating and financial policies, primarily through a representation on the Board of Directors. The Company has classified its equity method investment within other assets in the consolidated statements of financial condition, and has recognized its share of earnings or losses in the consolidated statements of incomeoperations in loss on equity method investment. Such losses were $0.3 million and $0.6earnings did not exceed $0.1 million for the yearsyear ended December 31, 2009 and 2008, respectively.
2010 compared to a loss of $0.3 million for the year ended December 31, 2009.
In June 2008, the Company determined that an other than temporary impairment existed due to the recapitalization of Blue Frog by an outside investor. Accordingly, the Company recognized an impairment loss of $1.7 million, representing the difference in the carrying value of its investment compared with the per share value implied by the transaction. Such loss is calculated on the consolidated statements of incomeoperations as a loss on equity method investment. The Company has retained a 13.9% ownership interest and a seat on the Board of Directors.
F-17
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSNotes to Consolidated Financial Statements — (Continued)6. FAIR VALUE MEASUREMENTS
| |
| 5. | Fair Value Measurements |
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Inputs used to measure fair value are prioritized within a three-level fair value hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
•Level 1—Quoted prices in active markets for identical assets or liabilities.
•Level 2—Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
•Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
| | |
| • | Level 1 — Quoted prices in active markets for identical assets or liabilities. |
|
| • | Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. |
|
| • | Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. |
The
Company'sCompany’s fair value measurements are evaluated within the fair value hierarchy, based on the nature of inputs used to determine the fair value at the measurement date. At December 31,
2008,2010, the Company had the following financial assets and liabilities that are measured at fair value on a recurring basis:
Cash Equivalents—The Company'sCompany’s cash equivalents include money market funds, which are short term in nature with readily determinable values derived from active markets. Securities Segregated Under Federal and Other Regulations—The Company'sCompany’s segregated accounts contain U.S. treasury securities that are short term in nature with readily determinable values derived from quoted prices in active markets. Securities Owned and Securities Sold But Not Yet Purchased—The Company'sCompany’s trading securities consist of house account model portfolios for the purpose of benchmarking the performance of its fee based advisory platforms and temporary positions resulting from the processing of client transactions. Examples of these securities include money market funds, U.S. treasuries, mutual funds, certificates of deposit, traded equity securities and debt securities. The Company uses prices obtained from independent third-party pricing services to measure the fair value of its trading securities. Prices received from the pricing services are validated using various methods including comparison to prices received from additional pricing services, comparison to available quoted market prices and review of other relevant market data including implied yields of major categories of securities. In general, these quoted prices are derived from active markets for identical assets or liabilities. When quoted prices in active markets for identical assets and liabilities are not available, the quoted prices are based on similar assets and liabilities or inputs other than the quoted prices that are observable, either directly or indirectly. For certificates of deposit and treasury securities, the Company utilizes market-based inputs including observable market interest rates that correspond to the remaining maturities or the next interest reset dates. At December 31, 2009,2010, the Company did not adjust prices received from the independent third-party pricing services.
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Other Assets—The Company'sCompany’s other assets include deferred compensation plan assets that are invested in money market funds and mutual funds which are actively traded and valued based on quoted market prices in active markets.
F-18
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
Interest Rate Swaps—The Company'sCompany’s interest rate swaps are not traded on a market exchange; therefore, the fair values are determined using externally developed valuation models which include assumptions about the London Interbank Offered Rate ("LIBOR"(“LIBOR”) yield curve at interim reporting dates as well as counterparty credit risk and the Company'sCompany’s own non-performance risk. The Company has segregated all recurring
There have been no transfers of assets or liabilities between fair value measurements intomeasurement classifications during the most appropriate level withinyears ended December 31, 2010 and 2009.
The following table summarizes the Company’s financial assets and financial liabilities measured at fair value hierarchy in the tables below, based on an evaluation of inputs used to determine the fair valuea recurring basis at December 31, 2009 and 20082010 (in thousands).:
| | | | | | | | | | | | | | | | | |
| | | Quoted
| | | | | | | | | | |
| | | Prices in
| | | | | | | | | | |
| | | Active
| | | Significant
| | | | | | | |
| | | Markets for
| | | Other
| | | Significant
| | | | |
| | | Identical
| | | Observable
| | | Unobservable
| | | | |
| | | Assets
| | | Inputs
| | | Inputs
| | | Fair Value
| |
| | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Measurements | |
| |
At December 31, 2010: | | | | | | | | | | | | | | | | |
Assets | | | | | | | | | | | | | | | | |
| Cash equivalents | | $ | 279,048 | | | $ | — | | | $ | — | | | $ | 279,048 | |
| Securities owned — trading: | | | | | | | | | | | | | | | | |
| Money market funds | | | 316 | | | | — | | | | — | | | | 316 | |
| Mutual funds | | | 7,300 | | | | — | | | | — | | | | 7,300 | |
| Equity securities | | | 17 | | | | — | | | | — | | | | 17 | |
| Debt securities | | | — | | | | 516 | | | | — | | | | 516 | |
| U.S. treasury obligations | | | 1,010 | | | | — | | | | — | | | | 1,010 | |
| Certificates of deposit | | | — | | | | 100 | | | | — | | | | 100 | |
| | | | | | | | | | | | | | | | | |
| Total securities owned — trading | | | 8,643 | | | | 616 | | | | — | | | | 9,259 | |
| | | | | | | | | | | | | | | | | |
| Other assets | | | 17,175 | | | | — | | | | — | | | | 17,175 | |
| | | | | | | | | | | | | | | | | |
| Total assets at fair value | | $ | 304,866 | | | $ | 616 | | | $ | — | | | $ | 305,482 | |
| | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | |
| Securities sold but not yet purchased: | | | | | | | | | | | | | | | | |
| Mutual funds | | $ | 4,563 | | | $ | — | | | $ | — | | | $ | 4,563 | |
| Equity securities | | | 204 | | | | — | | | | — | | | | 204 | |
| Debt securities | | | — | | | | 54 | | | | — | | | | 54 | |
| | | | | | | | | | | | | | | | | |
| Total securities sold but not yet purchased | | | 4,767 | | | | 54 | | | | — | | | | 4,821 | |
| | | | | | | | | | | | | | | | | |
| Interest rate swaps | | | — | | | | 7,281 | | | | — | | | | 7,281 | |
| | | | | | | | | | | | | | | | | |
| Total liabilities at fair value | | $ | 4,767 | | | $ | 7,335 | | | $ | — | | | $ | 12,102 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | Level 1 | | Level 2 | | Level 3 | | Fair Value
Measurements | |
|---|
At December 31, 2009: | | | | | | | | | | | | | |
Assets | | | | | | | | | | | | | |
| | Cash equivalents | | $ | 223,665 | | $ | — | | | $— | | $ | 223,665 | |
| | Securities segregated under federal and other regulations | | | 279,579 | | | — | | | — | | | 279,579 | |
| | Securities owned—trading: | | | | | | | | | | | | | |
| | | Money market funds | | | 181 | | | — | | | — | | | 181 | |
| | | Mutual funds | | | 6,694 | | | — | | | — | | | 6,694 | |
| | | Equity securities | | | 11 | | | — | | | — | | | 11 | |
| | | Debt securities | | | — | | | 425 | | | — | | | 425 | |
| | | U.S. treasury obligations | | | 7,797 | | | — | | | — | | | 7,797 | |
| | | Certificates of deposit | | | — | | | 253 | | | — | | | 253 | |
| | | | | | | | | | |
| | Total securities owned—trading | | | 14,683 | | | 678 | | | — | | | 15,361 | |
| | | | | | | | | | |
| | Other assets | | | 12,739 | | | — | | | — | | | 12,739 | |
| | | | | | | | | | |
| | | Total assets at fair value | | $ | 530,666 | | $ | 678 | | | $— | | $ | 531,344 | |
| | | | | | | | | | |
Liabilities | | | | | | | | | | | | | |
| | Securities sold but not yet purchased: | | | | | | | | | | | | | |
| | | Mutual funds | | $ | 3,773 | | $ | — | | | $— | | $ | 3,773 | |
| | | U.S. treasury obligations | | | 5 | | | — | | | — | | | 5 | |
| | | Equity securities | | | 7 | | | — | | | — | | | 7 | |
| | | Certificates of deposit | | | — | | | 123 | | | — | | | 123 | |
| | | Debt securities | | | — | | | 95 | | | — | | | 95 | |
| | | | | | | | | | |
| | Total securities sold but not yet purchased | | | 3,785 | | | 218 | | | — | | | 4,003 | |
| | | | | | | | | | |
| | Interest rate swaps | | | — | | | 17,292 | | | — | | | 17,292 | |
| | | | | | | | | | |
| | | Total liabilities at fair value | | $ | 3,785 | | $ | 17,510 | | | $— | | $ | 21,295 | |
| | | | | | | | | | |
Certain assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value measurement in certain circumstances, for example, when evidence of impairment exists. During the year ended December 31, 2010, the Company recorded asset impairment charges of $0.6 million for certain fixed assets that were determined to have no estimated fair value. The fair value was determined based on the loss of future expected cash flows of the discontinued use of
F-19
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
assets attributed to the Affiliated Entities business. The Company has determined that the impairment qualifies as a non-recurring Level 3 measurement under the fair value hierarchy.
The following table summarizes the Company’s financial assets and financial liabilities measured at fair value on a recurring basis at December 31, 2009 (in thousands):
| | | | | | | | | | | | | | | | | |
| | | Quoted
| | | | | | | | | | |
| | | Prices in
| | | | | | | | | | |
| | | Active
| | | Significant
| | | | | | | |
| | | Markets for
| | | Other
| | | Significant
| | | | |
| | | Identical
| | | Observable
| | | Unobservable
| | | | |
| | | Assets
| | | Inputs
| | | Inputs
| | | Fair Value
| |
| | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Measurements | |
| |
At December 31, 2009: | | | | | | | | | | | | | | | | |
Assets | | | | | | | | | | | | | | | | |
| Cash equivalents | | $ | 223,665 | | | $ | — | | | $ | — | | | $ | 223,665 | |
| Securities segregated under federal and other regulations | | | 279,579 | | | | — | | | | — | | | | 279,579 | |
| Securities owned — trading: | | | | | | | | | | | | | | | | |
| Money market funds | | | 181 | | | | — | | | | — | | | | 181 | |
| Mutual funds | | | 6,694 | | | | — | | | | — | | | | 6,694 | |
| Equity securities | | | 11 | | | | — | | | | — | | | | 11 | |
| Debt securities | | | — | | | | 425 | | | | — | | | | 425 | |
| U.S. treasury obligations | | | 7,797 | | | | — | | | | — | | | | 7,797 | |
| Certificates of deposit | | | — | | | | 253 | | | | — | | | | 253 | |
| | | | | | | | | | | | | | | | | |
| Total securities owned — trading | | | 14,683 | | | | 678 | | | | — | | | | 15,361 | |
| | | | | | | | | | | | | | | | | |
| Other assets | | | 12,739 | | | | — | | | | — | | | | 12,739 | |
| | | | | | | | | | | | | | | | | |
| Total assets at fair value | | $ | 530,666 | | | $ | 678 | | | $ | — | | | $ | 531,344 | |
| | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | |
| Securities sold but not yet purchased: | | | | | | | | | | | | | | | | |
| Mutual funds | | $ | 3,773 | | | $ | — | | | $ | — | | | $ | 3,773 | |
| U.S. treasury obligations | | | 5 | | | | — | | | | — | | | | 5 | |
| Equity securities | | | 7 | | | | — | | | | — | | | | 7 | |
| Certificates of deposit | | | — | | | | 123 | | | | — | | | | 123 | |
| Debt securities | | | — | | | | 95 | | | | — | | | | 95 | |
| | | | | | | | | | | | | | | | | |
| Total securities sold but not yet purchased | | | 3,785 | | | | 218 | | | | — | | | | 4,003 | |
| | | | | | | | | | | | | | | | | |
| Interest rate swaps | | | — | | | | 17,292 | | | | — | | | | 17,292 | |
| | | | | | | | | | | | | | | | | |
| Total liabilities at fair value | | $ | 3,785 | | | $ | 17,510 | | | $ | — | | | $ | 21,295 | |
| | | | | | | | | | | | | | | | | |
During the year ended December 31, 2009, the Company recorded asset impairment charges of $18.6 million for certain intangible assets that were determined to have no estimated fair value (see Note
10)9). The fair value was determined based on the loss of future expected cash flows for
customersadvisors who were not retained as a result of the consolidation of the Affiliated Entities, as well as
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
the discontinued use of certain brand names and logos and their lack of marketability. The Company has determined that the impairment qualifies as a non-recurring Level 3 measurement under the fair value hierarchy.value.
F-20
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
| | | | | | | | | | | | | | | |
| | Level 1 | | Level 2 | | Level 3 | | Fair Value
Measurements | |
|---|
At December 31, 2008: | | | | | | | | | | | | | |
Assets | | | | | | | | | | | | | |
| | Cash equivalents | | $ | 56,122 | | $ | — | | | $— | | $ | 56,122 | |
| | Securities owned—trading: | | | | | | | | | | | | | |
| | | Money market funds | | | 238 | | | — | | | — | | | 238 | |
| | | Mutual funds | | | 6,659 | | | — | | | — | | | 6,659 | |
| | | Equity securities | | | 585 | | | — | | | — | | | 585 | |
| | | Debt securities | | | — | | | 510 | | | — | | | 510 | |
| | | U.S. treasury obligations | | | 2,819 | | | — | | | — | | | 2,819 | |
| | | | | | | | | | |
| | Total securities owned—trading | | | 10,301 | | | 510 | | | — | | | 10,811 | |
| | | | | | | | | | |
| | Other assets | | | 6,965 | | | — | | | — | | | 6,965 | |
| | | | | | | | | | |
| | | Total assets at fair value | | $ | 73,388 | | $ | 510 | | | $— | | $ | 73,898 | |
| | | | | | | | | | |
Liabilities | | | | | | | | | | | | | |
| | Securities sold but not yet purchased: | | | | | | | | | | | | | |
| | | Mutual funds | | $ | 3,585 | | $ | — | | | $— | | $ | 3,585 | |
| | | Equity securities | | | 87 | | | — | | | — | | | 87 | |
| | | Debt securities | | | — | | | 238 | | | — | | | 238 | |
| | | | | | | | | | |
| | Total securities sold but not yet purchased | | | 3,672 | | | 238 | | | — | | | 3,910 | |
| | | | | | | | | | |
| | Interest rate swaps | | | — | | | 25,417 | | | — | | | 25,417 | |
| | | | | | | | | | |
| | | Total liabilities at fair value | | $ | 3,672 | | $ | 25,655 | | | $— | | $ | 29,327 | |
| | | | | | | | | | |
7. HELD-TO-MATURITY SECURITIESNotes to Consolidated Financial Statements — (Continued) | |
| 6. | Held-to-Maturity Securities |
The Company holds certain investments in securities including U.S. government notes. The Company has both the intent and the ability to hold these investments to maturity and classifies them as such. Interest income is accrued as earned. Premiums and discounts are amortized using a method that approximates the effective yield method over the term of the security and are recorded as an adjustment to the investment yield.
The amortized cost, gross unrealized gains and fair value of securitiesheld-to-maturity were as follows (in thousands):
| | | | | | | | | | | | | |
| | | | | | Gross
| | | | |
| | | Amortized
| | | Unrealized
| | | Fair
| |
| | | Cost | | | Gains | | | Value | |
| |
At December 31, 2010: | | | | | | | | | | | | |
| U.S. government notes | | $ | 9,563 | | | $ | 69 | | | $ | 9,632 | |
| | | | | | | | | | | | | |
At December 31, 2009: | | | | | | | | | | | | |
| U.S. government notes | | $ | 10,354 | | | $ | 49 | | | $ | 10,403 | |
| Certificate of deposit | | | 100 | | | | — | | | | 100 | |
| | | | | | | | | | | | | |
| Total | | $ | 10,454 | | | $ | 49 | | | $ | 10,503 | |
| | | | | | | | | | | | | |
| | | | | | | | | | |
| | Amortized Cost | | Gross Unrealized
Gains | | Fair Value | |
|---|
At December 31, 2009: | | | | | | | | | | |
U.S. government notes | | $ | 10,354 | | | $ 49 | | $ | 10,403 | |
Certificate of deposit | | | 100 | | | — | | | 100 | |
| | | | | | | | |
Total | | $ | 10,454 | | | $ 49 | | $ | 10,503 | |
| | | | | | | | |
At December 31, 2008: | | | | | | | | | | |
U.S. government notes | | $ | 10,404 | | | $173 | | $ | 10,577 | |
Certificate of deposit | | | 100 | | | — | | | 100 | |
| | | | | | | | |
Total | | $ | 10,504 | | | $173 | | $ | 10,677 | |
| | | | | | | | |
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The maturities of securitiesheld-to-maturity at December 31, 2009,2010, were as follows (in thousands):
| | | | | | | | | | | | | |
| | | Within 1 Year | | 1-2 Years | | Total |
| |
| U.S. government notes — at amortized cost | | $ | 6,049 | | | $ | 3,514 | | | $ | 9,563 | |
| U.S. government notes- at fair value | | $ | 6,075 | | | $ | 3,557 | | | $ | 9,632 | |
| |
| 7. | Receivables from Product Sponsors, Broker-Dealers and Clearing Organizations and Payables to Broker-Dealers and Clearing Organizations |
| | | | | | | | | | |
| | Within 1 Year | | 1-2 Years | | Total | |
|---|
U.S. government notes | | $ | 5,126 | | $ | 5,228 | | $ | 10,354 | |
Certificate of deposit | | | 100 | | | — | | | 100 | |
| | | | | | | | |
Total amortized cost | | $ | 5,226 | | $ | 5,228 | | $ | 10,454 | |
| | | | | | | | |
Total fair value | | $ | 5,256 | | $ | 5,247 | | $ | 10,503 | |
| | | | | | | | |
8. RECEIVABLES FROM PRODUCT SPONSORS, BROKER-DEALERS AND CLEARING ORGANIZATIONS AND PAYABLES TO BROKER-DEALERS AND CLEARING ORGANIZATIONS
Receivables from product sponsors, broker-dealers and clearing organizations and payables to broker-dealers and clearing organizations were as follows (in thousands):
| | | | | | | | | |
| | | December 31, | |
| | | 2010 | | | 2009 | |
| |
| Receivables: | | | | | | | | |
| Commissions receivable from product sponsors and others | | $ | 114,829 | | | $ | 102,920 | |
| Receivable from clearing organizations | | | 65,501 | | | | 49,793 | |
| Receivable from broker-dealers | | | 12,507 | | | | 12,195 | |
Securitiesfailed-to-deliver | | | 10,495 | | | | 6,992 | |
| | | | | | | | | |
| Total receivables | | $ | 203,332 | | | $ | 171,900 | |
| | | | | | | | | |
| Payables: | | | | | | | | |
| Securities loaned | | $ | 8,113 | | | $ | 7,239 | |
Securitiesfailed-to-receive | | | 11,425 | | | | 5,495 | |
| Payable to broker-dealers | | | 1,023 | | | | 2,787 | |
| Payable to clearing organizations | | | 18,509 | | | | 2,696 | |
| | | | | | | | | |
| Total payables | | $ | 39,070 | | | $ | 18,217 | |
| | | | | | | | | |
F-21
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
| | | | | | | | |
| | December 31, | |
|---|
| | 2009 | | 2008 | |
|---|
Receivables: | | | | | | | |
| | Commissions receivable from product sponsors and others | | $ | 102,920 | | $ | 87,078 | |
| | Receivable from clearing organizations | | | 49,793 | | | 88,722 | |
| | Receivable from broker-dealers | | | 12,195 | | | 45,630 | |
| | Securities failed-to-deliver | | | 6,992 | | | 9,970 | |
| | | | | | |
Total receivables | | $ | 171,900 | | $ | 231,400 | |
| | | | | | |
Payables: | | | | | | | |
| | Securities loaned | | $ | 7,239 | | $ | 5,252 | |
| | Securities failed-to-receive | | | 5,495 | | | 9,227 | |
| | Payable to broker-dealers | | | 2,787 | | | 4,079 | |
| | Payable to clearing organizations | | | 2,696 | | | 3,176 | |
| | | | | | |
Total payables | | $ | 18,217 | | $ | 21,734 | |
| | | | | | |
Notes to Consolidated Financial Statements — (Continued)
LPL Financial clears commodities transactions for its customers through another broker-dealer on a fully disclosed basis. The amount payable to broker-dealers relates to the aforementioned transactions and is collateralized by securities owned by LPL Financial.
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. FIXED ASSETS
The components of fixed assets arewere as follows (in thousands):
| | | | | | | | | |
| | | December 31, | |
| | | 2010 | | | 2009 | |
| |
| Internally developed software | | $ | 206,002 | | | $ | 193,682 | |
| Computers and software | | | 84,241 | | | | 82,459 | |
| Leasehold improvements | | | 41,772 | | | | 41,559 | |
| Furniture and equipment | | | 16,585 | | | | 17,180 | |
| Property | | | 6,572 | | | | 6,572 | |
| | | | | | | | | |
| Total fixed assets | | | 355,172 | | | | 341,452 | |
| Accumulated depreciation and amortization | | | (276,501 | ) | | | (239,868 | ) |
| | | | | | | | | |
| Fixed assets — net | | $ | 78,671 | | | $ | 101,584 | |
| | | | | | | | | |
| | | | | | | | |
| | December 31, | |
|---|
| | 2009 | | 2008 | |
|---|
Internally developed software | | $ | 193,682 | | $ | 190,949 | |
Computers and software | | | 82,459 | | | 87,113 | |
Leasehold improvements | | | 41,559 | | | 42,547 | |
Furniture and equipment | | | 17,180 | | | 20,116 | |
Property | | | 6,572 | | | 6,572 | |
| | | | | | |
| | Total fixed assets | | | 341,452 | | | 347,297 | |
Accumulated depreciation and amortization | | | (239,868 | ) | | (185,537 | ) |
| | | | | | |
Fixed assets—net | | $ | 101,584 | | $ | 161,760 | |
| | | | | | |
Depreciation and amortization expense for fixed assets was $49.0 million, $69.3 million $60.2 million and $43.7$60.2 million for the years ended December 31, 2010, 2009 and 2008, and 2007, respectively.
10. GOODWILL AND INTANGIBLE ASSETS
On September 15, 2009, and in conjunction with the
Company'sCompany’s consolidation initiative, intangible assets residing at the Affiliated Entities were transferred to LPL Financial. This exchange has occurred between entities under common control and accordingly, the Company transferred
customeradvisor relationship and sponsor relationship intangible assets at their approximate carrying amounts of $30.9 million and $11.9 million, respectively. There was no change in the useful lives of the intangible assets, which continue to be amortized over a period of 10 to 20 years.
At the time of consolidation, a portion of the customeradvisor relationships and trademarks and trade names of the Affiliated Entities were determined to have no future economic benefit. Accordingly, the Company recorded impairment charges of $16.1 million for customeradvisor relationships and $1.1 million for trademarks and trade names. In the fourth quarter of 2009, the Company recorded an additional impairment charge of $1.4 million for customeradvisor relationships. The impairment of customeradvisor relationships was determined based upon the attrition of customersadvisors and their related revenue streams during the period of consolidation. The impairment of trademarks and trade names was based upon the discontinued use of brand names and logos of the Affiliated Entities. The Company has recorded the asset impairments as restructuring charges (see Note 4)3) and has classified them as such on its consolidated statements of income.operations.
F-22
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSNotes to Consolidated Financial Statements — (Continued)The components of intangible assets as of December 31, 2010 and 2009 and 2008 arewere as follows (in thousands):
| | | | | | | | | | | | | |
| | | Gross
| | | | | | Net
| |
| | | Carrying
| | | Accumulated
| | | Carrying
| |
| | | Value | | | Amortization | | | Value | |
| |
At December 31, 2010: | | | | | | | | | | | | |
| Definite-lived intangible assets: | | | | | | | | | | | | |
| Advisor and financial institution relationships | | $ | 458,424 | | | $ | (116,687 | ) | | $ | 341,737 | |
| Product sponsor relationships | | | 231,930 | | | | (55,255 | ) | | | 176,675 | |
| Trust client relationships | | | 2,630 | | | | (784 | ) | | | 1,846 | |
| | | | | | | | | | | | | |
| Total definite-lived intangible assets | | $ | 692,984 | | | $ | (172,726 | ) | | $ | 520,258 | |
| | | | | | | | | | | | | |
| Indefinite-lived intangible assets: | | | | | | | | | | | | |
| Trademark and trade name | | | | | | | | | | | 39,819 | |
| | | | | | | | | | | | | |
| Total intangible assets | | | | | | | | | | $ | 560,077 | |
| | | | | | | | | | | | | |
At December 31, 2009: | | | | | | | | | | | | |
| Definite-lived intangible assets: | | | | | | | | | | | | |
| Advisor and financial institution relationships | | $ | 458,424 | | | $ | (91,586 | ) | | $ | 366,838 | |
| Product sponsor relationships | | | 231,930 | | | | (43,482 | ) | | | 188,448 | |
| Trust client relationships | | | 2,630 | | | | (652 | ) | | | 1,978 | |
| Trademarks and trade names | | | 457 | | | | (457 | ) | | | — | |
| | | | | | | | | | | | | |
| Total definite-lived intangible assets | | $ | 693,441 | | | $ | (136,177 | ) | | $ | 557,264 | |
| | | | | | | | | | | | | |
| Indefinite-lived intangible assets: | | | | | | | | | | | | |
| Trademark and trade name | | | | | | | | | | | 39,819 | |
| | | | | | | | | | | | | |
| Total intangible assets | | | | | | | | | | $ | 597,083 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | |
| | Gross
carrying
value | | Accumulated
amortization | | Net
carrying
value | |
|---|
At December 31, 2009: | | | | | | | | | | |
Definite-lived intangible assets: | | | | | | | | | | |
| | Customer relationships | | $ | 458,424 | | $ | (91,586 | ) | $ | 366,838 | |
| | Product sponsor relationships | | | 231,930 | | | (43,482 | ) | | 188,448 | |
| | Trust client relationships | | | 2,630 | | | (652 | ) | | 1,978 | |
| | Trademarks and trade names | | | 457 | | | (457 | ) | | — | |
| | | | | | | | |
| | | Total definite-lived intangible assets | | $ | 693,441 | | $ | (136,177 | ) | $ | 557,264 | |
| | | | | | | | |
Indefinite-lived intangible assets: | | | | | | | | | | |
| | Trademark and trade name | | | | | | | | | 39,819 | |
| | | | | | | | | | |
| | | Total intangible assets | | | | | | | | $ | 597,083 | |
| | | | | | | | | | |
At December 31, 2008: | | | | | | | | | | |
Definite-lived intangible assets: | | | | | | | | | | |
| | Customer relationships | | $ | 482,397 | | $ | (71,318 | ) | $ | 411,079 | |
| | Product sponsor relationships | | | 233,663 | | | (33,442 | ) | | 200,221 | |
| | Trust client relationships | | | 2,630 | | | (521 | ) | | 2,109 | |
| | Trademarks and trade names | | | 2,757 | | | (1,282 | ) | | 1,475 | |
| | | | | | | | |
| | | Total definite-lived intangible assets | | $ | 721,447 | | $ | (106,563 | ) | $ | 614,884 | |
| | | | | | | | |
Indefinite-lived intangible assets: | | | | | | | | | | |
| | Trademark and trade name | | | | | | | | | 39,819 | |
| | | | | | | | | | |
| | | Total intangible assets | | | | | | | | $ | 654,703 | |
| | | | | | | | | | |
Total amortization expense of intangible assets was $37.0 million, $39.0 million $40.3 million and $35.1$40.3 million for the years ended December 31, 2010, 2009 2008 and 2007,2008, respectively. Amortization expense for each of the fiscal years ended December 20102011 through 20142015 and thereafter is estimated as follows (in thousands):
| | | | | |
| 2011 | | $ | 36,840 | |
| 2012 | | | 36,548 | |
| 2013 | | | 35,927 | |
| 2014 | | | 35,927 | |
| 2015 | | | 35,927 | |
| Thereafter | | | 339,089 | |
| | | | | |
| Total | | $ | 520,258 | |
| | | | | |
F-23
| | | | |
2010 | | $ | 37,006 | |
2011 | | | 36,840 | |
2012 | | | 36,548 | |
2013 | | | 35,927 | |
2014 | | | 35,927 | |
Thereafter | | | 375,016 | |
| | | | |
Total | | $ | 557,264 | |
| | | | |
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSNotes to Consolidated Financial Statements — (Continued)11. INCOME TAXES
The Company's provision (benefit) for income taxes is
| |
| 10. | Accounts Payable and Accrued Liabilities |
Accounts payable and accrued liabilities were as follows (in thousands):
| | | | | | | | | |
| | | December 31, | |
| | | 2010 | | | 2009 | |
| |
| Accounts payable accruals | | $ | 56,377 | | | $ | 47,145 | |
| Accrued net payroll | | | 44,401 | | | | 36,203 | |
| Legal accrual | | | 17,602 | | | | 13,715 | |
| Advisor deferred compensation plan liability | | | 16,542 | | | | 12,305 | |
| Deferred rent | | | 11,391 | | | | 14,121 | |
| Other accrued liabilities | | | 8,273 | | | | 6,409 | |
| | | | | | | | | |
| Total payables | | $ | 154,586 | | | $ | 129,898 | |
| | | | | | | | | |
| | | | | | | | | | | | |
| | 2009 | | 2008 | | 2007 | |
|---|
Current provision: | | | | | | | | | | |
| | Federal | | $ | 53,757 | | $ | 61,498 | | $ | 58,123 | |
| | State | | | 12,750 | | | 11,909 | | | 9,961 | |
| | | | | | | | |
| | | Total current provision | | | 66,507 | | | 73,407 | | | 68,084 | |
| | | | | | | | |
Deferred benefit: | | | | | | | | | | |
| | Federal | | | (24,360 | ) | | (25,385 | ) | | (18,151 | ) |
| | State | | | (17,100 | ) | | (753 | ) | | (3,169 | ) |
| | | | | | | | |
| | | Total deferred benefit | | | (41,460 | ) | | (26,138 | ) | | (21,320 | ) |
| | | | | | | | |
Provision for income taxes | | $ | 25,047 | | $ | 47,269 | | $ | 46,764 | |
| | | | | | | | |
The principal items accountingCompany’s (benefit from) provision for the differences in income taxes computed atwas as follows (in thousands):
| | | | | | | | | | | | | |
| | | 2010 | | | 2009 | | | 2008 | |
| |
| Current (benefit) provision: | | | | | | | | | | | | |
| Federal | | $ | (6,316 | ) | | $ | 53,757 | | | $ | 61,498 | |
| State | | | (4,052 | ) | | | 12,750 | | | | 11,909 | |
| | | | | | | | | | | | | |
| Total current (benefit) provision | | | (10,368 | ) | | | 66,507 | | | | 73,407 | |
| | | | | | | | | | | | | |
| Deferred benefit: | | | | | | | | | | | | |
| Federal | | | (17,877 | ) | | | (24,360 | ) | | | (25,385 | ) |
| State | | | (3,742 | ) | | | (17,100 | ) | | | (753 | ) |
| | | | | | | | | | | | | |
| Total deferred benefit | | | (21,619 | ) | | | (41,460 | ) | | | (26,138 | ) |
| | | | | | | | | | | | | |
| (Benefit from) Provision for income taxes | | $ | (31,987 | ) | | $ | 25,047 | | | $ | 47,269 | |
| | | | | | | | | | | | | |
A reconciliation of the U.S. federal statutory rate (35%) andincome tax rates to the Company’s effective income tax rate comprise the following:rates is set forth below:
| | | | | | | | | | | | | |
| | | 2010 | | | 2009 | | | 2008 | |
| |
| Federal statutory income tax rates | | | (35.0 | )% | | | 35.0 | % | | | 35.0 | % |
| State income taxes — net of federal benefit | | | (5.7 | ) | | | (3.9 | ) | | | 7.8 | |
| Share-based compensation | | | 1.5 | | | | 1.5 | | | | 1.0 | |
| Uncertain tax positions | | | (0.1 | ) | | | 1.8 | | | | 3.6 | |
| Non-deductible expenses | | | 0.7 | | | | 0.6 | | | | 1.6 | |
| Change in valuation allowance | | | — | | | | 0.1 | | | | 1.2 | |
| Transaction costs | | | 3.2 | | | | — | | | | — | |
| Research and development credits | | | (1.2 | ) | | | — | | | | (0.5 | ) |
| Other | | | 0.6 | | | | (0.6 | ) | | | 1.3 | |
| | | | | | | | | | | | | |
| Effective income tax rates | | | (36.0 | )% | | | 34.5 | % | | | 51.0 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | |
| | 2009 | | 2008 | | 2007 | |
|---|
Taxes computed at statutory rate | | | 35.0 | % | | 35.0 | % | | 35.0 | % |
State income taxes—net of federal benefit | | | (3.9 | ) | | 7.8 | | | 4.1 | |
Share-based compensation | | | 1.5 | | | 1.0 | | | — | |
Uncertain tax positions | | | 1.8 | | | 3.6 | | | 3.7 | |
Non-deductible expenses | | | 0.6 | | | 1.6 | | | 1.3 | |
Change in valuation allowance | | | 0.1 | | | 1.2 | | | — | |
Other | | | (0.6 | ) | | 0.8 | | | (0.7 | ) |
| | | | | | | | |
Provision for income taxes | | | 34.5 | % | | 51.0 | % | | 43.4 | % |
| | | | | | | | |
The Company's currentCompany’s 2009 effective tax rate reflects a benefit of approximately 8% from a newly enacted change to California'sCalifornia’s income sourcing rules that is scheduled to taketook effect on January 1, 2011. This change requiresrequired the Company to revalue its deferred tax liabilities to the rate that will beis in effect when the tax liabilities are utilized.
F-24
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSNotes to Consolidated Financial Statements — (Continued)liabilities are utilized. The current effective tax rate includes $8.1 million in transaction expenses, which are not deductible for tax purposes.
The components of the net deferred tax liabilities included in the consolidated statements of financial condition were as follows (in thousands):
| | | | | | | | | |
| | | December 31, | |
| | | 2010 | | | 2009 | |
| |
| Deferred tax assets: | | | | | | | | |
| State taxes | | $ | 10,507 | | | $ | 15,019 | |
| Reserves for litigation, vacation, and bonuses | | | 26,539 | | | | 24,030 | |
| Unrealized gain on interest rate swaps | | | 2,786 | | | | 5,675 | |
| Deferred rent | | | 4,557 | | | | 5,649 | |
| Share-based compensation | | | 8,091 | | | | 6,905 | |
| Provision for bad debts | | | 7,495 | | | | 2,849 | |
| Net operating losses | | | 107 | | | | 172 | |
| Other | | | 1,625 | | | | 1,841 | |
| | | | | | | | | |
| Subtotal | | | 61,707 | | | | 62,140 | |
| Valuation allowance | | | (1,323 | ) | | | (1,340 | ) |
| | | | | | | | | |
| Total deferred tax assets | | | 60,384 | | | | 60,800 | |
| | | | | | | | | |
| Deferred tax liabilities: | | | | | | | | |
| Amortization of intangible assets and trademarks and trade names | | | (179,590 | ) | | | (191,108 | ) |
| Depreciation of fixed assets | | | (11,005 | ) | | | (17,300 | ) |
| Other | | | — | | | | — | |
| | | | | | | | | |
| Total deferred tax liabilities | | | (190,595 | ) | | | (208,408 | ) |
| | | | | | | | | |
| Deferred income taxes — net | | $ | (130,211 | ) | | $ | (147,608 | ) |
| | | | | | | | | |
| | | | | | | | | |
| | December 31, | |
|---|
| | 2009 | | 2008 | |
|---|
Deferred tax assets: | | | | | | | |
| | State taxes | | $ | 15,019 | | $ | 19,976 | |
| | Reserves for litigation, vacation, and bonuses | | | 24,030 | | | 19,003 | |
| | Unrealized gain on interest rate swaps | | | 5,675 | | | 9,920 | |
| | Deferred rent | | | 5,649 | | | 6,457 | |
| | Share-based compensation | | | 6,905 | | | 5,212 | |
| | Provision for bad debts | | | 2,849 | | | 2,041 | |
| | Net operating losses of acquired subsidiaries | | | 172 | | | 236 | |
| | Other | | | 1,841 | | | 2,777 | |
| | | | | | |
| | | Subtotal | | | 62,140 | | | 65,622 | |
| | Valuation allowance | | | (1,340 | ) | | (1,290 | ) |
| | | | | | |
| | | Total deferred tax assets | | | 60,800 | | | 64,332 | |
| | | | | | |
Deferred tax liabilities: | | | | | | | |
| | Amortization of intangible assets and trademarks and trade names | | | (191,108 | ) | | (228,163 | ) |
| | Depreciation of fixed assets | | | (17,300 | ) | | (21,338 | ) |
| | Other | | | — | | | — | |
| | | | | | |
| | | Total deferred tax liabilities | | | (208,408 | ) | | (249,501 | ) |
| | | | | | |
Deferred income taxes—net | | $ | (147,608 | ) | $ | (185,169 | ) |
| | | | | | |
At January 1,
2009, the Company had gross unrecognized tax benefits of $20.3 million. Of this total, $2.6 million represents amounts acquired during the Company's acquisition of the Affiliated Entities. The acquired unrecognized tax benefits will have no impact on the Company's annual effective tax rate as these are fully indemnified by the seller in accordance with the purchase and sale agreement. Of the remaining $17.7 million, $13.1 million (net of the federal benefit on state issues) represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods. The following table reflects a reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits including interest and penalties (in thousands):
| | | | | | | | | | | |
| | 2009 | | 2008 | | 2007 | |
|---|
Balance—Beginning of year | | $ | 20,258 | | $ | 15,139 | | $ | 8,533 | |
| | Increases related to acquired tax positions | | | 142 | | | 969 | | | 2,725 | |
| | Increases related to current year tax positions | | | 4,066 | | | 6,480 | | | 5,657 | |
| | Reductions as a result of a lapse of the applicable statute of limitations related to acquired tax positions | | | (627 | ) | | (596 | ) | | (524 | ) |
| | Reductions as a result of a lapse of the applicable statute of limitations related to prior period tax positions | | | (1,881 | ) | | (1,734 | ) | | (1,252 | ) |
| | | | | | | | |
Balance—End of year | | $ | 21,958 | | $ | 20,258 | | $ | 15,139 | |
| | | | | | | | |
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
At December 31, 2009,2010, the Company had gross unrecognized tax benefits of $22.0 million. Of this total, $2.1 million represents amounts acquired due toduring the Company'sCompany’s acquisition of the Affiliated Entities. The acquired unrecognized tax benefits will have no impact on the Company'sCompany’s annual effective tax rate as these are fully indemnified by the seller in accordance with the purchase and sale agreement. At December 31, 2009,January 1, 2010, the Company hashad recorded a receivable from the seller in the amount of $2.1 million, which is included in other assets in the accompanying consolidated statements of financial condition. Of the remaining $19.9 million, $14.4 million (net of the federal benefit on state issues) represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods.
F-25
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
The following table reflects a reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits including interest and penalties (in thousands):
| | | | | | | | | | | | | |
| | | 2010 | | | 2009 | | | 2008 | |
| |
| Balance — Beginning of year | | $ | 21,958 | | | $ | 20,258 | | | $ | 15,139 | |
| Increases related to acquired tax positions | | | 111 | | | | 142 | | | | 969 | |
| Increases related to current year tax positions | | | 4,076 | | | | 4,066 | | | | 6,480 | |
| Reductions as a result of a lapse of the applicable statute of limitations related to acquired tax positions | | | (858 | ) | | | (627 | ) | | | (596 | ) |
| Reductions as a result of a lapse of the applicable statute of limitations related to prior period tax positions | | | (4,230 | ) | | | (1,881 | ) | | | (1,734 | ) |
| | | | | | | | | | | | | |
| Balance — End of year | | $ | 21,057 | | | $ | 21,958 | | | $ | 20,258 | |
| | | | | | | | | | | | | |
At December 31, 2010, the Company had gross unrecognized tax benefits of $21.1 million. Of this total, $1.3 million represents amounts acquired due to the Company’s acquisition of the Affiliated Entities. The acquired unrecognized tax benefits will have no impact on the Company’s annual effective tax rate as these are fully indemnified by the seller in accordance with the purchase and sale agreement. At December 31, 2010, the Company has recorded a receivable from seller in the amount of $1.3 million, which is included in other assets in the accompanying consolidated statements of financial condition. Of the remaining $19.8 million, $14.3 million (net of the federal benefit on state issues) represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods.
The Company accrues interest and penalties related to unrecognized tax benefits in its provision for income taxes within the consolidated statements of financial condition. At January 1,
2009,2010, the Company had
$1.3$1.9 million accrued for interest and
$2.9$3.4 million accrued for penalties. At December 31,
2009,2010, the liability for unrecognized tax benefits included accrued interest of
$1.9$2.0 million and penalties of
$3.4$3.3 million. Tax expense for the year ended December 31,
20092010 includes interest expense of
$0.6 million and penalties of $0.5$0.1 million.
The Company and its subsidiaries file income tax returns in the federal jurisdiction, as well as most state jurisdictions, and are subject to routine examinations by the respective taxing authorities. The Company has concluded all federal and state income tax matters for years through
2004, with the exception of California, which has concluded income tax matters for years through 2003.2005.
The tax years of
20052006 to
20092010 remain open to examination by major taxing jurisdictions to which the Company is
subject, with the exception of California discussed above.subject. In the next 12 months,
it is reasonably possible that the Company expects a reduction in unrecognized tax benefits of
$3.9$5.7 million primarily related to the statute of limitations expiration in various state jurisdictions.
12. INDEBTEDNESS
Senior Secured Credit Facilities— Term Loans— On May 24, 2010, the Company entered into a Third Amended and Restated Credit Agreement (the “Amended Credit Agreement”). The Amended Credit Agreement amended and restated the Company’s Second Amended and Restated Credit Agreement, dated as of June 18, 2007. Pursuant to the Amended Credit Agreement, the Company established a new term loan tranche of $580.0 million maturing on June 28, 2017 (the “2017 Term Loans”) and recorded $16.6 million in debt issuance costs that are capitalized in the consolidated statements of financial condition. The Company also extended the maturity of a $500.0 million tranche of its term loan facility to June 25, 2015 (the “2015 Term Loans”), with the remaining $317.1 million tranche of the term loan facility maturing on the original maturity date of June 28, 2013 (the “2013 Term Loans”).
F-26
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
The applicable margin for borrowings with respect to the (a) 2013 Term Loans is currently 0.75% for base rate borrowings and 1.75% for LIBOR borrowings and could change depending on the Company’s credit rating; (b) 2015 Term Loans is currently 1.75% for base rate borrowings and 2.75% for LIBOR borrowings, and (c) 2017 Term Loans is currently 2.75% for base rate borrowings and 3.75% for LIBOR borrowings. The LIBOR Rate with respect to the 2015 Term Loans and the 2017 Term Loans shall in no event be less than 1.50%.
Borrowings under the
Company'sCompany’s senior secured
creditterm loan facilities bear interest at a base rate equal to either one, two, three, six, nine or twelve-month LIBOR plus the applicable margin, or an alternative base rate
("ABR"(“ABR”) plus the applicable margin. The ABR is equal to the greater of the prime rate or the effective federal funds rate plus
1/
2 of 1.00%
. The applicable margin on for the
senior secured term credit facilities could change depending on2013 Term Loans and the
Company's credit rating.greater of the prime rate, effective federal funds rate plus1/2 of 1.00%, or 2.50% for the 2015 Term Loans and the 2017 Term Loans. The senior secured credit facilities are subject to certain financial and nonfinancial covenants. As of December 31,
2010 and 2009, the Company was in compliance with
all such covenants.
Senior Unsecured Subordinated Notes—The Company has $550.0 million ofmay voluntarily repay outstanding loans under its senior unsecured subordinated notes due December 15, 2015. The notes bear interestsecured credit facilities at 10.75% per annum and interest payments are payable semiannually in arrears. The Company is not required to make mandatory redemptionany time without premium or sinking-fund paymentspenalty, other than customary “breakage” costs with respect to the notes. The indenture underlying the senior unsecured subordinated notes contains various restrictions with respect to the issuer, including one or more restrictions relating to limitations on liens, sale and leaseback arrangements and funded debt of subsidiaries.
LIBOR loans.
Senior Secured Credit Facilities — Revolving Line of Credit—The Company maintains a $100.0 million revolving line of credit facility, $10.0 million of which is being used to support the issuance of an irrevocable letter of credit for its subsidiary, PTC. Borrowings under the Company's revolving credit facility bear interest at a base rate equal to the one, two, three, six, nine or twelve-month LIBOR plus an interest rate margin of an additional 2.00% or an ABR plus the applicable margin of 1.00%. The Company also pays a fee of 0.375% for the unused balance. At December 31, 2008, the Company had a balance outstanding of $90.0 million. There was no outstanding balance on the revolving line of credit at December 31, 2009.
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On January 25, 2010, the Company amended its senior secured credit facilities to increase the revolving credit facility from $100.0 million to $218.2 million.million, $10.0 million of which is being used to support the issuance of an irrevocable letter of credit for its subsidiary, PTC. As a result of the amendment, the Company paid $2.8 million in debt issuance costs, which have been capitalized within the consolidated statements of financial condition and are being amortized as additional interest expense over the expected term of the related debt agreement. The Company also extended the maturity of a $163.5 million tranche of the revolving credit facility to June 28, 2013, withwhile the remaining $54.7 million tranche maturing at theretains its original maturity date of December 28, 2011. The tranche maturing in 2013 is priced at LIBOR + 3.50% with a commitment fee of 0.75%. The tranche maturing in 2011 maintains its currentprevious pricing of LIBOR + 2.00% with a commitment fee of 0.375%.
There was no outstanding balance on the revolving facility at December 31, 2010.
Senior Unsecured Subordinated Notes— On May 24, 2010, the Company gave notice of redemption of all of its outstanding senior unsecured subordinated notes due 2015 (the “2015 Notes”), representing an aggregate principal amount of $550.0 million. The redemption price of the 2015 Notes was 105.375% of the outstanding aggregate principal amount, or approximately $579.6 million, plus accrued and unpaid interest thereon up to but not including June 22, 2010 (the “Redemption Date”). The Company redeemed the 2015 Notes on the Redemption Date and accordingly, recorded the charge as a loss on debt extinguishment within its consolidated statements of operations. None of the 2015 Notes remain outstanding. The Company used the proceeds from the 2017 Term Loans under its Amended Credit Agreement and additional cash on hand to finance the redemption. The aggregate cash payment for the redemption, including accrued and unpaid interest, was approximately $610.4 million.
Prior to the Redemption Date, the Company had $550.0 million of senior unsecured subordinated notes due December 15, 2015 bearing interest at 10.75% per annum. The interest payments were payable semiannually in arrears.
Bank Loans Payable—The Company maintains two uncommitted lines of credit. One line has an unspecified limit, and is primarily dependent on the Company'sCompany’s ability to provide sufficient collateral. The other line has a $100.0$150.0 million limit and allows for both collateralized and uncollateralized borrowings. Both lines were utilized during the years, butin 2010 and 2009; however, there were no balances outstanding at December 31, 2009 and 2008.2010 or December 31, 2009.
F-27
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
The Company'sCompany’s outstanding borrowings were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | December 31, 2010 | | | December 31, 2009 | |
| | | | | | | | | Interest
| | | | | | Interest
| |
| | | Maturity | | | Balance | | | Rate | | | Balance | | | Rate | |
| |
| Senior secured term loan: | | | | | | | | | | | | | | | | | | | | |
| Hedged with interest rate swaps | | | 6/28/2013 | | | $ | 210,000 | | | | 2.05% | (1) | | $ | 400,000 | | | | 2.00% | (6) |
| Unhedged: | | | | | | | | | | | | | | | | | | | | |
| 2013 Term Loans | | | 6/28/2013 | | | | 104,739 | | | | 2.01% | (2) | | | 419,223 | | | | 2.00% | (7) |
| 2015 Term Loans | | | 6/25/2015 | | | | 496,250 | | | | 4.25% | (3) | | | — | | | | | |
| 2017 Term Loans | | | 6/28/2017 | | | | 575,650 | | | | 5.25% | (4) | | | — | | | | | |
| Senior unsecured subordinated notes | | | (5 | ) | | | — | | | | | | | | 550,000 | | | | 10.75% | |
| | | | | | | | | | | | | | | | | | | | | |
| Total borrowings | | | | | | | 1,386,639 | | | | | | | | 1,369,223 | | | | | |
| Less current borrowings (maturities within 12 months) | | | | | | | 13,971 | | | | | | | | 8,424 | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Long-term borrowings — net of current portion | | | | | | $ | 1,372,668 | | | | | | | $ | 1,360,799 | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | December 31, | |
|---|
| | 2009 | | 2008 | |
|---|
| | Maturity | | Balance | | Interest
Rate | | Balance | | Interest
Rate | |
|---|
Revolving line of credit | | | 12/28/2011 | | $ | — | | | — | % | $ | 90,000 | | | 2.46 | %(3) |
Senior secured term loan: | | | | | | | | | | | | | | | | |
| | Unhedged | | | 6/28/2013 | | | 419,223 | | | 2.00 | %(1) | | 332,647 | | | 2.23 | %(4) |
| | Hedged with interest rate swaps | | | 6/28/2013 | | | 400,000 | | | 2.00 | %(2) | | 495,000 | | | 3.21 | %(5) |
Senior unsecured subordinated notes | | | 12/15/2015 | | | 550,000 | | | 10.75 | % | | 550,000 | | | 10.75 | % |
| | | | | | | | | | | | | | | |
| | | Total borrowings | | | | | | 1,369,223 | | | | | | 1,467,647 | | | | |
Less current borrowings (maturities within 12 months) | | | | | | 8,424 | | | | | | 8,424 | | | | |
| | | | | | | | | | | | | | | |
Long-term borrowings—net of current portion | | | | | $ | 1,360,799 | | | | | $ | 1,459,223 | | | | |
| | | | | | | | | | | | | | | |
| | |
| (1) | | As of December 31, 2010, the variable interest rate for the hedged portion of the 2013 Term Loans is based on the three-month LIBOR of 0.30%, plus the applicable interest rate margin of 1.75%. |
|
| (2) | | As of December 31, 2010, the variable interest rate for the unhedged portion of the 2013 Term Loans is based on the one-month LIBOR of 0.26%, plus the applicable interest rate margin of 1.75%. |
|
| (3) | | As of December 31, 2010, the variable interest rate for the unhedged portion of the 2015 Term Loans is based on the greater of the one-month LIBOR of 0.26% or 1.50%, plus the applicable interest rate margin of 2.75%. |
|
| (4) | | As of December 31, 2010, the variable interest rate for the unhedged portion of the 2017 Term Loans is based on the greater of the one-month LIBOR of 0.26% or 1.50%, plus the applicable interest rate margin of 3.75%. |
|
| (5) | | On June 22, 2010, the Company redeemed its 2015 Notes, which had an original maturity date of December 15, 2015. |
|
| (6) | | As of December 31, 2009, the variable interest rate for the hedged portion of the 2013 Term Loans is based on the three-month LIBOR of 0.25%, plus the applicable interest rate margin of 1.75%. |
|
| (7) | | As of December 31, 2009, the variable interest rate for the unhedged portion of the 2013 Term Loans is based on the three-month LIBOR of 0.25% plus the applicable interest rate margin of 1.75%. |
(1)As of December 31, 2009, the variable interest rate for the unhedged portion of the senior secured term loan is based on the three-month LIBOR of 0.25%, plus the applicable interest rate margin of 1.75%.
(2)As of December 31, 2009, the variable interest rate for the hedged portion of the senior secured term loan is based on the three-month LIBOR of 0.25%, plus the applicable interest rate margin of 1.75%.
(3)As of December 31, 2008, the variable interest rate for the revolving line of credit is based on the one-month LIBOR of 0.46% plus the applicable interest rate margin of 2.00%.
(4)As of December 31, 2008, the variable interest rate for the unhedged portion of the senior secured term loan is based on a weighted average of the one- and three-month LIBOR of 0.46% and 1.46%, respectively, plus the applicable interest rate margin of 1.75%.
(5)As of December 31, 2008, the variable interest rate for the hedged portion of the senior secured term loan is based on the three-month LIBOR of 1.46%, plus the applicable interest rate margin of 1.75%.
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following summarizes borrowing activity in the revolving and uncommitted line of credit facilities (in thousands):
| | | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2010 | | 2009 | | 2008 |
| |
| Average balance outstanding | | $ | 2,074 | | | $ | 56,472 | | | $ | 48,725 | |
| Weighted-average interest rate | | | 1.16 | % | | | 2.41 | % | | | 4.74 | % |
F-28
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
| | | | | | | | | | |
| | Year ended December 31, | |
|---|
| | 2009 | | 2008 | | 2007 | |
|---|
Average balance outstanding | | $ | 56,472 | | $ | 48,725 | | $ | 6,282 | |
Weighted-average interest rate | | | 2.41 | % | | 4.74 | % | | 6.93 | % |
Notes to Consolidated Financial Statements — (Continued)
The minimum calendar year payments and maturities of the senior secured borrowings as of December 31, 20092010 are as follows (in thousands):
| | | | | |
| 2011 | | $ | 13,971 | |
| 2012 | | | 13,971 | |
| 2013 | | | 319,197 | |
| 2014 | | | 10,800 | |
| 2015 | | | 482,050 | |
| Thereafter | | | 546,650 | |
| | | | | |
| Total | | $ | 1,386,639 | |
| | | | | |
| | | | | | | | | | |
| | Senior
Secured | | Senior
Unsecured | | Total
Amount | |
|---|
2010 | | $ | 8,424 | | $ | — | | $ | 8,424 | |
2011 | | | 8,424 | | | — | | | 8,424 | |
2012 | | | 8,424 | | | — | | | 8,424 | |
2013 | | | 793,951 | | | — | | | 793,951 | |
2014 | | | — | | | — | | | — | |
Thereafter | | | — | | | 550,000 | | | 550,000 | |
| | | | | | | | |
Total | | $ | 819,223 | | $ | 550,000 | | $ | 1,369,223 | |
| | | | | | | | |
13. INTEREST RATE SWAPS
An interest rate swap is a financial derivative instrument whereby two parties enter into a contractual agreement to exchange payments based on underlying interest rates. The Company uses interest rate swap agreements to hedge the variability on its floating rate senior secured term loan. The Company is required to pay the counterparty to the agreement fixed interest payments on a notional balance and in turn, receives variable interest payments on that notional balance. Payments are settled quarterly on a net basis.
The following table summarizes information related to the Company'sCompany’s interest rate swaps as of December 31, 20092010 (in thousands):
| | | | | | | | | | | | | | | | | | | |
| | | | | Variable
| | | | |
Notional
| | Fixed
| | Receive
| | Fair
| | Maturity
|
Balance | | Pay Rate | | Rate(1) | | Value | | Date |
| |
| | $145,000 | | | | 4.83% | | | | 0.30% | | | | $(3,235) | | | | June 30, 2011 | |
| | 65,000 | | | | 4.85% | | | | 0.30% | | | | (4,046) | | | | June 30, 2012 | |
| | | | | | | | | | | | | | | | | | |
| | $210,000 | | | | | | | | | | | | $(7,281) | | | | | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | |
Notional
Balance | | Fixed
Pay Rate | | Variable
Receive
Rate(1) | | Fair
Value | | Maturity
Date |
|---|
| | 70,000 | | | 3.43 | % | | 0.25 | % | $ | (1,087 | ) | June 30, 2010 |
| | 120,000 | | | 4.79 | % | | 0.25 | % | | (2,672 | ) | June 30, 2010 |
| | 145,000 | | | 4.83 | % | | 0.25 | % | | (8,406 | ) | June 30, 2011 |
| | 65,000 | | | 4.85 | % | | 0.25 | % | | (5,127 | ) | June 30, 2012 |
| | | | | | | | | | | |
| $ | 400,000 | | | | | | | | $ | (17,292 | ) | |
| | | | | | | | | | | |
| | |
| (1) | | The variable receive rate reset on the last day of the period, based on the applicable three-month LIBOR. The effective rate from September 30, 2010 through December 30, 2010, was 0.29%. As of December 31, 2010, the effective rate was 0.30%. |
(1)The variable receive rate reset on the last day of the period, based on the applicable three-month LIBOR. The effective rate from September 30, 2009 through December 30, 2009, was 0.28%. As of December 31, 2009, the effective rate was 0.25%.
The interest rate swap agreements qualify for hedge accounting and have been designated as cash flow hedges against specific payments due on the Company'sCompany’s senior secured term loan. As of December 31, 2009,2010, the Company assessed the interest rate swap agreements as being highly effective
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
and expects them to continue to be highly effective. Accordingly, the changes in fair value of the interest rate swaps have been recorded as other comprehensive loss, with the fair value included as a liability on the Company'sCompany’s consolidated statements of financial condition. The Company has reclassified $16.6recorded net unrealized gains of $10.0 million and $6.0$8.1 million from other comprehensive loss as additional interest expense for the years ended December 31, 2010 and 2009, respectively, to accumulated other comprehensive loss related to the change in the fair value of its interest rate swap agreements. The Company has reclassified $13.4 million and 2008,$16.6 million to interest expense from accumulated other comprehensive loss for the years ended December 31, 2010 and 2009, respectively. Based on current interest rate assumptions and assuming no additional interest rate swap agreements are entered into, the Company expects to reclassify $17.3$9.5 million, or $11.3$6.1 million after tax, from other comprehensive loss as additional interest expense over the next 12 months.
F-29
14. COMMITMENTSLPL INVESTMENT HOLDINGS INC. AND CONTINGENCIESSUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
| |
| 14. | Commitments and Contingencies |
Leases—The Company leases certain office space and equipment at its headquarter locations under various operating leases. These leases are generally subject to scheduled base rent and maintenance cost increases, which are recognized on a straight-line basis over the period of the leases. Service Contracts—The Company is party to certain long-term contracts for systems and services that enable back office trade processing and clearing for its product and service offerings. One agreement, for clearing services, contains no minimum annual purchase commitment, but the agreement provides for certain penalties should the Company fail to maintain a certain threshold of client accounts. In 2009, the number of client accounts declined below the threshold, and as a result, the Company incurred fees of $9.1 million, which have been classified as restructuring charges within the consolidated statements of income. Further declines in accounts on this clearing platform could subject the Company to future costs or penalties. Future minimum payments under leases, lease commitments and other noncancellable contractual obligations with remaining terms greater than one year as of December 31, 2009,2010, are as follows (in thousands):
| | | | | |
| 2011 | | $ | 31,380 | |
| 2012 | | | 25,235 | |
| 2013 | | | 16,145 | |
| 2014 | | | 9,400 | |
| 2015 | | | 7,157 | |
| Thereafter | | | 7,908 | |
| | | | | |
| Total(1) | | $ | 97,225 | |
| | | | | |
| | | | |
Years ending December 31 | | | | |
2010 | | $ | 27,543 | |
2011 | | | 27,445 | |
2012 | | | 20,495 | |
2013 | | | 13,662 | |
2014 | | | 7,483 | |
Thereafter | | | 16,324 | |
| | | | |
Total | | $ | 112,952 | |
| | | | |
| | |
| (1) | | Minimum payments have not been reduced by minimum sublease rental income of $6.5 million due in the future under noncancelable subleases. |
Total rental expense for all operating leases was approximately
$17.1 million, $20.1 million
$22.1 million and
$14.4$22.1 million for the years ended December 31,
2010, 2009
and 2008,
and 2007, respectively.
Guarantees—The Company occasionally enters into certain types of contracts that contingently require it to indemnify certain parties against third-party claims. The terms of these obligations vary and, because a maximum obligation is not explicitly stated, the Company has determined that it is not possible to make an estimate of the amount that it could be obligated to pay under such contracts. The
Company'sCompany’s subsidiaries provide guarantees to securities clearing houses and exchanges under their standard membership agreements, which require a member to guarantee the performance of other members. Under these agreements, if a member becomes unable to satisfy its obligations to the clearing houses and exchanges, all other members would be required to meet any shortfall. The
Company'sCompany’s liability under these arrangements is not quantifiable and may exceed the cash and
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
securities it has posted as collateral. However, the potential requirement for the Company to make payments under these agreements is remote. Accordingly, no liability has been recognized for these transactions.
Loan Commitments—From time to time, the Company makes loans to its financial advisors, primarily to newly recruited advisors to assist in the transition process. Due to timing differences, the Company may make commitments to issue such loans prior to actually funding them. These commitments are generally contingent upon certain events occurring, including but not limited to the financial advisor joining the Company, and may be forgivable. The Company had no significant unfunded commitments at December 31, 2009.2010.
Litigation—The Company has been named as a defendant in various legal actions, including arbitrations. In view of the inherent difficulty of predicting the outcome of such matters, particularly in
F-30
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
cases in which claimants seek substantial or indeterminate damages, the Company cannot predict with certainty what the eventual loss or range of loss related to such matters will be. The Company recognizes a legal liability when it believes it is probable a liability has occurred and the amount can be reasonably estimated. Defense costs are expensed as incurred and classified as professional services within the consolidated statements of
income.operations. When there is indemnification or insurance, the Company may engage in defense of settlement and subsequently seek reimbursement for such matters.
In connection with various acquisitions, and pursuant to the purchase and sale agreements, the Company has received third-party indemnification for certain legal proceedings and claims. These matters have been defended and paid directly by the indemnifying party.
On October 1, 2009, LPLH received written notice from a third-party indemnitor under a certain purchase and sale agreement asserting that it is no longer obligated to indemnify the Company for certain claims under the provisions of the purchase and sale agreement. The Company believes that this assertion is without merit and has commenced litigation to enforce its indemnity rights.
On November 20, 2009, LPLH and three of its affiliated broker-dealers, filed suit to enforce the indemnitor’s performance pursuant to the provisions of the contract. In February 2010, the plaintiffs filed a motion for summary judgment with the court, which was opposed by the third party indemnitor. In May 2010, the court heard oral argument on the motion and see Note 22 for further discussion on this matter.
During the third quarter of 2010, the Company settled two arbitrations that involve activities covered under the third-party indemnification agreement described above. In connection with these settlements, the Company has recorded legal expenses of $8.9 million. These legal expenses have been included in professional services within the consolidated statements of operations. The Company will seek to recover the costs associated with defending and settling these matters, plus other costs incurred on matters that the Company believes are subject to the indemnification. The remaining claims outstanding for which the indemnifying party is disputing its obligation involve alleged damages that are not material to the Company’s consolidated statements of financial condition, operations or cash flows.
The Company believes, based on the information available at this time, after consultation with counsel, consideration of insurance, if any, and
the indemnifications provided by the third-party indemnitors, notwithstanding the assertions by an indemnifying party noted in the preceding
paragraph,paragraphs, that the outcome
of such matters will not have a material adverse impact on consolidated statements of financial condition,
incomeoperations or cash flows.
Other Commitments— As of December 31, 2010, the Company had received collateral primarily in connection with client margin loans with a market value of approximately $326.9 million, which it can sell or repledge. Of this amount, approximately $167.4 million has been pledged or sold as of December 31, 2010; $145.8 million was pledged to banks in connection with unutilized secured margin lines of credit, $13.5 million was pledged with client-owned securities to the Options Clearing Corporation, and $8.1 million was loaned to the DTC through participation in its Stock Borrow Program. As of December 31, 2009, the Company had received collateral primarily in connection with client margin loans with a market value of approximately $227.9 million, which it can sell or repledge. Of this amount, approximately $158.8 million has been pledged or sold as of December 31, 2009; $141.6 million was pledged to banks in connection with unutilized secured margin lines of credit, $10.0 million was pledged with client-owned securities to the Options Clearing Corporation, and $7.2 million was loaned to the DTC through participation in its Stock Borrow Program. As of December 31, 2008, the Company had received collateral primarily in connection with client margin loans with a market value of approximately $335.9 million, which it can sell or repledge. Of this amount, approximately $152.3 million has been pledged or sold as of December 31, 2008; $143.8 million was pledged to banks in connection with unutilized secured margin lines of credit, $3.2 million was pledged with client-owned securities to the Options Clearing Corporation, and $5.3 million was loaned to the DTC through participation in its Stock Borrow Program.
F-31
Innovex ceased operations on December 31, 2007. Prior to that date, Innovex sold its mortgage loans without recourse. Innovex was usually required by the buyers (investors) of these loans to make certain representations concerning credit information, loan documentation, and collateral. Innovex did not repurchase any loans during the year ended December 31, 2007.
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSNotes to Consolidated Financial Statements — (Continued)In August of 2007, pursuant to agreements with a large global insurance company, LPL Financial began providing brokerage, clearing and custody services on a fully disclosed basis; offering its investment advisory programs and platforms; and providing technology and additional processing and related services to its
financial advisors and
their clients. The terms of the agreements are five years, subject to additional
24-month extensions. Termination fees may be payable by a terminating or breaching party depending on the specific cause of termination.
| |
| 15. | Share-Based Compensation |
15. SHARE-BASED COMPENSATIONStock Option and Warrant PlansCertain employees,
financial advisors, officers and directors who contribute to the success of the Company participate in various stock option plans. In addition, certain financial institutions participate in a warrant plan. Stock options and warrants generally vest in equal increments over a three- to five-year period and expire on the
10th10th anniversary following the date of grant.
The Company recognizes share-based compensation expense related to employee stock option awards based on the grant date fair value over the requisite service period of the award, which generally equals the vesting period. The Company recognized
$10.3 million, $6.5 million
$4.6 million and
$2.2$4.6 million of share-based compensation related to
the vesting of employee stock option awards during the years ended December 31,
2010, 2009
and 2008,
respectively, which is included in compensation and
2007, respectively.benefits on the consolidated statements of operations. As of December 31,
2009,2010, total unrecognized compensation cost related to non-vested share-based compensation arrangements granted was
$31.9$53.0 million, which is expected to be recognized over a weighted-average period of
3.984.14 years.
The Company recognizes share-based compensation expense for stock options and warrants awarded to its advisors and financial institutions based on the fair value of awards at each interim reporting period. The Company recognized
$4.7 million, $1.6 million, and
$0.30$0.3 million of
share basedshare-based compensation during the years ended December 31,
2010, 2009 and 2008, respectively, related to the vesting of stock options and warrants awarded to
non-employees. The Company recognizes share-based compensation expense for non-employee awards basedits advisors and financial institutions, which is classified within commission and advisory fees on the
fair valueconsolidated statements of
awards at each interim reporting period.operations. As of December 31,
2009,2010, total unrecognized compensation cost related to non-vested share-based compensation arrangements granted was
$11.4$12.2 million for
non-employees,advisors and financial institutions, which is expected to be recognized over a weighted-average period of
4.363.37 years.
The following table presents the weighted-average assumptions used by the Company in calculating the fair value of its stock options and warrants with the Black-Scholes valuation model forthat have been granted during the years ended December 31, 2010, 2009 2008 and 2007:2008:
| | | | | | | | | | | | | |
| | | 2010 | | 2009 | | 2008 |
| |
| Expected life (in years) | | | 6.50 | | | | 7.13 | | | | 6.52 | |
| Expected stock price volatility | | | 49.22 | % | | | 51.35 | % | | | 33.78 | % |
| Expected dividend yield | | | — | | | | — | | | | — | |
| Annualized forfeiture rate | | | 3.00 | % | | | 4.35 | % | | | 1.51 | % |
| Fair value of options | | $ | 17.43 | | | $ | 12.30 | | | $ | 9.96 | |
| Risk-free interest rate | | | 2.70 | % | | | 2.93 | % | | | 2.73 | % |
| | | | | | | | | | |
| | 2009 | | 2008 | | 2007 | |
|---|
Expected life (in years) | | | 7.13 | | | 6.52 | | | 6.50 | |
Expected stock price volatility | | | 51.35 | % | | 33.78 | % | | 31.08 | % |
Expected dividend yield | | | — | | | — | | | — | |
Annualized forfeiture rate | | | 4.35 | % | | 1.51 | % | | 1.00 | % |
Fair value of options | | $ | 12.30 | | $ | 9.96 | | $ | 9.86 | |
Risk-free interest rate | | | 2.93 | % | | 2.73 | % | | 4.93 | % |
The risk-free interest rates are based on the implied yield available on U.S. Treasury constant maturities in effect at the time of the grant with remaining terms equivalent to the respective expected terms of the options. The dividend yield of zero is based on the fact that the Company has no present intention to pay cash dividends. In the future, as the Company gains historical data for volatility of its own stock and the actual term over which employees hold its options, expected volatility and the expected term may change, which could substantially change the grant-date fair value of future awards of stock options and, ultimately, compensation recorded on future grants. The Company estimates the expected term for its employee option awards using the simplified method in accordance with Staff Accounting Bulletin 110,Certain
F-32
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
Assumptions Used in Valuation Methods, because the Company does not have sufficient relevant historical information to develop reasonable expectations about future exercise patterns. The Company estimates the expected term for its non-employee stock options and
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
warrants awarded to advisors and financial institutions using the contractual term. Expected volatility is calculated based on companies of similar growth and maturity and the Company'sCompany’s peer group in the industry in which the Company does business because the Company does not have sufficient historical volatility data. The Company will continue to use peer group volatility information until historical volatility of the Company is relevantavailable to measure expected volatility for future grants.
In the future, as the Company gains historical data for volatility of its own stock and the actual term over which stock options and warrants are held, expected volatility and the expected term may change, which could substantially change the grant-date fair value of future awards of stock options and warrants and, ultimately, compensation recorded on future grants.
The Company has assumed an annualized forfeiture rate for its stock options and warrants based on a combined review of industry,
employee and
employeeadvisor turnover data, as well as an analytical review performed of historical pre-vesting forfeitures occurring over the previous year. The Company records additional expense if the actual forfeiture rate is lower than estimated and records a recovery of prior expense if the actual forfeiture is higher than estimated.
The following table summarizes the Company'sCompany’s activity in its stock option and warrant plans for the yearyears ended December 31, 2009:2010, 2009 and 2008:
| | | | | | | | | | | | | | | | | |
| | | | | | | | | Weighted-
| | | | |
| | | | | | | | | Average
| | | | |
| | | | | | | | | Remaining
| | | Aggregate
| |
| | | | | | Weighted-
| | | Contractual
| | | Intrinsic
| |
| | | Number of
| | | Average
| | | Term
| | | Value
| |
| | | Shares | | | Exercise Price | | | (Years) | | | (In thousands) | |
| |
| Outstanding — December 31, 2007 | | | 21,748,080 | | | | 2.46 | | | | | | | | | |
| Granted | | | 1,936,206 | | | | 27.55 | | | | | | | | | |
| Exercised | | | (286,968 | ) | | | 2.04 | | | | | | | | | |
| Forfeited | | | (3,319,035 | ) | | | 2.59 | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Outstanding — December 31, 2008 | | | 20,078,283 | | | | 4.87 | | | | | | | | | |
| Granted | | | 3,209,361 | | | | 21.32 | | | | | | | | | |
| Exercised | | | (256,795 | ) | | | 1.13 | | | | | | | | | |
| Forfeited | | | (328,380 | ) | | | 21.83 | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Outstanding — December 31, 2009 | | | 22,702,469 | | | | 6.99 | | | | | | | | | |
| Granted | | | 1,804,759 | | | | 33.79 | | | | | | | | | |
| Exercised | | | (13,883,847 | ) | | | 1.85 | | | | | | | | | |
| Forfeited | | | (344,329 | ) | | | 22.36 | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Outstanding — December 31, 2010 | | | 10,279,052 | | | $ | 18.12 | | | | 6.66 | | | $ | 187,568 | |
| | | | | | | | | | | | | | | | | |
| Exercisable — December 31, 2010 | | | 4,954,868 | | | $ | 8.95 | | | | 4.43 | | | $ | 135,886 | |
| | | | | | | | | | | | | | | | | |
F-33
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
| | | | | | | | | | | | | |
| | Number of
Shares | | Weighted-Average
Exercise Price | | Weighted Average
Remaining
Contractual
Term (Years) | | Aggregate
Intrinsic
Value
(in thousands) | |
|---|
Outstanding—December 31, 2008 | | | 20,078,283 | | $ | 4.87 | | | | | | | |
Granted | | | 3,209,361 | | | 21.32 | | | | | | | |
Exercised | | | (256,795 | ) | | 1.13 | | | | | | | |
Forfeited | | | (328,380 | ) | | 21.83 | | | | | | | |
| | | | | | | | | | | | |
Outstanding—December 31, 2009 | | | 22,702,469 | | $ | 6.99 | | | 5.00 | | $ | 380,301 | |
| | | | | | | | | | | | |
Exercisable—December 31, 2009 | | | 17,884,685 | | $ | 2.64 | | | 3.91 | | $ | 373,153 | |
| | | | | | | | | | | | |
Notes to Consolidated Financial Statements — (Continued)
The following table summarizes information about outstanding stock options and warrants:
| | | | | | | | | | | | | | | | | | | | | |
| | | Outstanding | | | Exercisable | |
| | | | | | Weighted-
| | | | | | | | | | |
| | | | | | Average
| | | Weighted-
| | | | | | Weighted-
| |
| | | Total
| | | Remaining
| | | Average
| | | | | | Average
| |
| | | Number of
| | | Life
| | | Exercise
| | | Number of
| | | Exercise
| |
Range of Exercise Prices | | Shares | | | (Years) | | | Price | | | Shares | | | Price | |
| |
| At December 31, 2010: | | | | | | | | | | | | | | | | | | | | |
| $1.35 — $2.38 | | | 3,350,900 | | | | 2.96 | | | $ | 1.69 | | | | 3,350,900 | | | $ | 1.69 | |
| $10.30 — $19.74 | | | 896,294 | | | | 7.92 | | | | 18.38 | | | | 198,992 | | | | 16.91 | |
| $21.60 — $22.08 | | | 2,053,100 | | | | 8.42 | | | | 22.02 | | | | 519,040 | | | | 21.94 | |
| $23.02 — $27.80 | | | 2,242,775 | | | | 7.52 | | | | 26.55 | | | | 885,936 | | | | 26.99 | |
| $30.00 — $34.61 | | | 1,735,983 | | | | 9.98 | | | | 34.21 | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | 10,279,052 | | | | 6.66 | | | $ | 18.12 | | | | 4,954,868 | | | $ | 8.95 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | Outstanding | | Exercisable | |
|---|
Range of Exercise Prices | | Total
Number of
Shares | | Weighted-
Average
Remaining
Life
(Years) | | Weighted-
Average
Exercise
Price | | Number of
Shares | | Weighted-
Average
Exercise
Price | |
|---|
At December 31, 2009: | | | | | | | | | | | | | | | | |
| | $ 1.07 - $ 2.38 | | | 17,185,660 | | | 3.75 | | $ | 1.74 | | | 17,185,660 | | $ | 1.74 | |
| | $10.30 - $19.74 | | | 952,164 | | | 8.90 | | | 18.30 | | | 90,262 | | | 15.00 | |
| | $21.60 - $22.08 | | | 2,247,650 | | | 9.43 | | | 22.02 | | | 124,499 | | | 21.60 | |
| | $23.02 - $27.80 | | | 2,316,995 | | | 8.43 | | | 26.68 | | | 484,264 | | | 27.34 | |
| | | | | | | | | | | | |
| | | 22,702,469 | | | 5.00 | | $ | 6.99 | | | 17,884,685 | | $ | 2.64 | |
| | | | | | | | | | | | |
2008 Nonqualified Deferred Compensation Plan
On November 19, 2008, the Company established an unfunded, unsecured deferred compensation plan to permit employees and former employees that held non-qualified stock options issued under the 2005 Stock Option Plan for Incentive Stock Options and 2005 Stock Option Plan for Non-qualified Stock Options that were expiringto expire in 2009 and 2010, to receive stock units ofunder the 2008 Nonqualified Deferred Compensation Plan. Stock units represent the right to receive one share of common stock. Distribution will occur at the earliest of (a) December 31, 2012;a date in 2012 to be determined by the Board of Directors; (b) a change in control of the Company; or (c) death or disability of the participant. The issuanceIssuance of stock units, which occurred in December 2008, is not taxable for federal and state income tax purposes until the participant receives a distribution under the deferred compensation plan. At December 31, 2009 and 2008,2010, the Company had 2,823,452 stock units outstanding under the 2008 Nonqualified Deferred Compensation Plan.
Initial Public OfferingTable of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Restricted Shares
The Company's financial
In 2008, certain advisors
participate in the fifth amended and restated 2000 Stock Bonus Plan (the "Stock Bonus Plan"), which provided for the grant and allocation of bonus credits. Each bonus credit represented the right to receivewere issued 7.4 million shares of common stock.
Participation in the Stock Bonus Plan was dependent upon meeting certain eligibility criteria, and bonus credits were allocated to eligible participants based on certain performance metrics, including amount and type of commissions, as well as tenure with the firm. Bonus credits vested annually in equal increments over a three-year period and expired on the tenth anniversary following the date of grant. Unvested bonus credits held by financial advisors who terminated prior to vesting were forfeited and reallocated to other financial advisors eligible under the plan. In 2008, the Company amended and restated its Stock Bonus Plan to provide the financial advisors with physical ownership of common stockTransferability of the
Company. Consequently, on December 28, 2008,shares was restricted until the
Company issued 7,423,973 restricted shares in exchange for bonus credits. These restricted shares may not be sold, assigned or transferred and are not entitled to receive dividends or non-cash distributions, until either a salecompletion of
the Company that constitutes a change in control
event or an initial public
offering.offering (“IPO”). The Company accountshas accounted for restricted shares granted to its financial advisors by measuring such grants at their then-current lowest aggregate value. Since the value isof the award was contingent upon the Company'sCompany’s decision to sell itself or issue its common stock to the public through a registered initial public offering,an IPO, the current aggregate value will behad been zero until such event occurs. Upon the occurrence of such an event,had occurred.
On November 17, 2010, the Company will recordsold shares of common stock in an IPO. Upon closing of the par value, additionalIPO, the Company recorded a share-based compensation charge of $222.0 million, representing the IPO price of $30.00 per share multiplied by 7.4 million shares that were issued and outstanding at the time of the offering, which is classified within commission and advisory fees on the consolidated statements of operations. The Company was able to take a tax deduction for the share-based compensation charge, as noted below.
The Company also expects to realize in connection with the IPO, a $383.0 million tax deduction resulting from (a) the exercise of non-qualified stock options by current and former employees of the Company and (b) the exercise of incentive stock options by current employees of the Company, and subsequent sale of common stock, resulting in a disqualifying disposition.
F-34
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
As a result of the tax deduction related to the release of the restriction of shares of common stock held by advisors, as well as option and warrant exercises; the Company is in a net operating loss position for income tax reporting purposes. Accordingly, in the fourth quarter of 2010, the Company recognized a tax benefit of $144.5 million representing the anticipated refund of taxes paid in capital2008, 2009 and expense basedthe first three quarters of 2010. Such amount has been recorded as tax receivables on the consolidated statements of financial condition.
Director Restricted Stock Plan
In March 2010, the Company established a Director Restricted Stock Plan (the “Director Plan”). Eligible participants include non-employee directors who are in a position to make a significant contribution to the success of the Company. Restricted stock awards vest on the second anniversary of the date of grant and upon termination of service, unvested awards shall immediately be forfeited. On March 15, 2010 and December 22, 2010, the Company issued 6,408 and 4,284, respectively, of restricted stock awards to certain of its directors at a fair value of $23.41 and $35.61 per share, respectively. A summary of the status of the Company’s restricted stock awards under the Director Plan as of and for the year ending December 31, 2010 was as follows:
| | | | | | | | | | | | | |
| | | | | | Weighted-Average
| | | | |
| | | Number of
| | | Grant-Date
| | | | |
| | | Shares | | | Fair Value | | | | |
| |
| Nonvested at January 1, 2010 | | | — | | | $ | — | | | | | |
| Granted | | | 10,692 | | | | 28.30 | | | | | |
| Vested | | | — | | | | — | | | | | |
| Forfeited | | | — | | | | — | | | | | |
| | | | | | | | | | | | | |
| Nonvested at December 31, 2010 | | | 10,692 | | | $ | 28.30 | | | | | |
| | | | | | | | | | | | | |
The Company accounts for restricted stock awards granted to its non-employee directors by measuring such awards at their grant date fair value. Share-based compensation expense is recognized ratably over the requisite service period, which generally equals the vesting period. Based upon the Company’s history of termination of non-employee directors, management has assumed zero forfeitures for restricted stock awards. The Company recognized $0.1 million of share-based compensation related to the vesting of restricted stock awards granted to its directors during the year ended December 31, 2010, which is included in compensation and benefits on the consolidated statements of operations. As of December 31, 2010, total unrecognized compensation cost was $0.2 million, which is expected to be recognized over a weighted-average remaining period of 1.64 years.
Share Reservations
As of December 31, 2010, the Company had approximately 10.3 million of authorized unissued shares reserved for issuance upon exercise and conversion of outstanding awards.
In calculating (loss) earnings per share using the two-class method, the Company is required to allocate a portion of its earnings to employees that hold stock units that contain non-forfeitable rights to dividends or dividend equivalents under its 2008 Nonqualified Deferred Compensation Plan. Basic earnings per share is computed by dividing income less earnings attributable to employees that hold stock units under the 2008 Nonqualified Deferred Compensation Plan by the basic weighted average
F-35
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
number of restricted shares underoutstanding. Diluted earnings per share is computed in a manner similar to basic earnings per share, except the weighted average number of shares outstanding is increased to include the dilutive effect of outstanding stock bonus plan multiplied byoptions, warrants and other stock-based awards.
A reconciliation of the fair market value determined at(loss) income used to compute basic and diluted earnings per share for the event date.years noted was as follows:
| | | | | | | | | | | | | |
| | | For the Year Ended
| |
| | | December 31, | |
| | | 2010 | | | 2009 | | | 2008 | |
| | | (In thousands) | |
| |
| Basic earnings per share: | | | | | | | | | | | | |
| Net (loss) income, as reported | | $ | (56,862 | ) | | $ | 47,520 | | | $ | 45,496 | |
| Less: allocation of undistributed earnings to stock units | | | — | | | | (919 | ) | | | (4 | ) |
| | | | | | | | | | | | | |
| Net (loss) income, for computing basic earnings per share | | $ | (56,862 | ) | | $ | 46,601 | | | $ | 45,492 | |
| | | | | | | | | | | | | |
| Diluted earnings per share: | | | | | | | | | | | | |
| Net (loss) income, as reported | | $ | (56,862 | ) | | $ | 47,520 | | | $ | 45,496 | |
| Less: allocation of undistributed earnings to stock units | | | — | | | | (810 | ) | | | (3 | ) |
| | | | | | | | | | | | | |
| Net (loss) income, for computing diluted earnings per share | | $ | (56,862 | ) | | $ | 46,710 | | | $ | 45,493 | |
| | | | | | | | | | | | | |
A reconciliation of the weighted average number of shares outstanding used to compute basic and diluted earnings per share for the years noted was as follows:
| | | | | | | | | | | | | |
| | | For the Year Ended
| |
| | | December 31, | |
| | | 2010 | | | 2009 | | | 2008 | |
| | | (In thousands) | |
| |
| Basic weighted average number of shares outstanding | | | 89,441 | | | | 86,649 | | | | 86,447 | |
| Dilutive common share equivalents | | | — | | | | 11,845 | | | | 13,887 | |
| | | | | | | | | | | | | |
| Diluted weighted average number of shares outstanding | | | 89,441 | | | | 98,494 | | | | 100,334 | |
| | | | | | | | | | | | | |
Basic and diluted (loss) earnings per share for the years noted was as follows:
| | | | | | | | | | | | | |
| | | For the Year Ended
|
| | | December 31, |
| | | 2010 | | 2009 | | 2008 |
| |
| Basic (loss) earnings per share | | $ | (0.64 | ) | | $ | 0.54 | | | $ | 0.53 | |
| Diluted (loss) earnings per share | | $ | (0.64 | ) | | $ | 0.47 | | | $ | 0.45 | |
Basic weighted average shares outstanding and diluted weighted average shares outstanding were the same for the year ended December 31, 2010, because the effect of potential shares of common stock was anti-dilutive since the Company generated a net loss.
F-36
16. EMPLOYEELPL INVESTMENT HOLDINGS INC. AND ADVISOR BENEFIT PLANS SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
The computation of diluted earnings per share excluded stock options and warrants to purchase 3,162,901 shares, 3,443,146 shares and 2,076,762 shares for the years ended December 31, 2010, 2009 and 2008, respectively, because the effect would have been anti-dilutive.
| |
| 17. | Employee and Advisor Benefit Plans |
The Company participates in a 401(k) defined contribution plan sponsored by LPL Financial. All employees meeting minimum age and length of service requirements are eligible to participate. The Company has an employer matching program whereby employer contributions were made to the 401(k) plan. For
2010, contributions were made in an amount equal to the lesser of 40% of the amount designated by the employee for withholding or 4% of the employee’s eligible compensation. For 2009, contributions were made in an amount equal to the lesser of 20% of the amount designated by the employee for withholding or 2% of the
employee'semployee’s eligible compensation. For 2008,
and 2007, contributions were made in an amount equal to the lesser of 50% of the amount designated by the employee for withholding or 5% of the
employee'semployee’s eligible compensation. The
Company'sCompany’s total cost under the 401(k) plan was
$3.5 million, $1.7 million
$4.8 million and
$3.8$4.8 million for the years ended December 31,
2010, 2009
and 2008,
and 2007, respectively.
On January 1, 2008, the Company adopted a non-qualified deferred compensation plan for the purpose of attracting and retaining financial advisors who operate, for tax purposes, as independent contractors, by providing an opportunity for participating financial advisors to defer receipt of a portion of their gross commissions generated primarily from commissions earned on the sale of various products. The deferred compensation plan has been fully funded to date by participant contributions. Plan assets are invested in mutual funds, which are held by the Company in a Rabbi Trust. The liability for benefits accrued under the non-qualified deferred compensation plan totaled $12.3$16.5 million at December 31, 2009,2010, which is included in accounts payable and accrued liabilities in the consolidated statements of financial condition. The cash values of the related trust assets was $12.0$16.2 million at December 31, 2009,2010, which is measured at fair value and included in other assets in the consolidated statements of financial condition.
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Certain employees and
financial advisors of the
Company'sCompany’s subsidiaries participated in non-qualified deferred compensation plans (the
"Plans"“Plans”) that permitted participants to defer portions of their compensation and earn interest on the deferred amounts. The Plans have been closed to new participants and no contributions have been made since the acquisition date. Plan assets are held by the Company in a Rabbi Trust and accounted for in the manner described above. As of December 31,
2009,2010, the Company has recorded assets of approximately
$0.8$1.0 million and liabilities of
$1.6$1.1 million, which are included in other assets and accounts payable and accrued liabilities, respectively, in the consolidated statements of financial condition.
17. RELATED-PARTY TRANSACTIONS
| |
| 18. | Related Party Transactions |
AlixPartners, LLP
("AlixPartners"(“AlixPartners”), a company majority-owned by one of the
Company'sCompany’s majority
shareholders,stockholders, provides
LPL Financial with consulting services pursuant to an agreement for interim management and
consulting services.consulting. The Company paid $0.6 million
$4.2 million and
$0.9$4.2 million to AlixPartners during the years ended December 31, 2009
and 2008,
and 2007, respectively.
One of the Company’s majority stockholders owns a minority interest in Artisan Partners Limited Partnership ("Artisan"(“Artisan”), a company majority-owned by one of the Company's majority shareholders,which pays fees to LPL Financial in exchange for product distribution and record-keeping services. During the years ended December 31, 2010, 2009 2008 and 2007,2008, the Company earned $2.3 million, $1.5 million $1.6 million and $1.9$1.6 million, respectively, in fees from Artisan. Additionally, as of December 31, 20092010 and 2008,2009, Artisan owed the Company $0.6 million and $0.5 million, and $0.3 million, respectively,
F-37
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
which is included in receivables from product sponsors, broker-dealers and clearing organizations on the consolidated statements of financial condition.
American Beacon Advisor, Inc.
("Beacon"(“American Beacon”), a company majority-owned by one of the
Company'sCompany’s majority
shareholders,stockholders, pays fees
to LPL Financial in exchange for product distribution and record-keeping services. During the years ended December 31,
2010, 2009 and 2008, the Company earned
$0.2 million, $0.4 million, and $0.3 million, respectively, in fees from
American Beacon. Additionally, as of December 31, 2009,
and 2008,American Beacon owed the Company $0.1 million, which is included in receivables from product sponsors, broker-dealers and clearing organizations on the consolidated statements of financial condition.
One of the Company’s majority stockholders owns a minority interest in XOJET, Inc. (“XOJET”), which provides chartered aircraft services. The Company paid $1.4 million to XOJET during the year ended December 31, 2010.
Certain entities affiliated with SunGard Data Systems Inc.
("SunGard"(“SunGard”), a company majority-owned by one of the
Company'sCompany’s majority
shareholders,stockholders, provide
LPL Financial and MSC with data center recovery services. The Company paid
$0.3 million and $0.5 million to SunGard during the
yearyears ended December 31,
2009.2010 and 2009, respectively.
Blue Frog, a privately held technology company in which the Company holds an equity interest, provides
LPL Financial with software licensing for annuity order entry and compliance. The Company paid
$1.1 million, $0.8 million and $0.3 million to Blue Frog for such services during the years ended December 31,
2010, 2009 and 2008, respectively.
As of December 31, 2010, the Company had a payable to Blue Frog of $0.7 million, which is included in accounts payable and accrued liabilities on the consolidated statements of financial condition.
TPG Capital (“TPG”), one of the Company’s majority stockholders, provided certain consulting services. The Company paid $0.3 million to TPG during the year ended December 31, 2010.
In conjunction with the acquisition of UVEST Financial Services Group, Inc. (“UVEST”), the Company made full-recourse loans to certain members of UVEST’s management (also selling stockholders), most of whom are now stockholders of the Company. In February 2010, the Company forgave approximately $0.4 million to a stockholder. As of December 31, 2009, and 2008, outstanding stockholder loans, which are reported as a deduction from stockholders'stockholders’ equity, were approximately $0.5 million. At December 31, 2010, there were no loans outstanding.
An immediate family member of one of the Company’s executive officers, is an executive officer of CresaPartners LLC (“CresaPartners”). CresaPartners provides the Company and its subsidiaries real estate advisory, transaction and project management services. The Company paid $0.1 million
and $0.9 million, respectively.18. NET CAPITAL/REGULATORY REQUIREMENTS
to CresaPartners during the year ended December 31, 2010.
| |
| 19. | Net Capital/Regulatory Requirements |
The
Company'sCompany’s registered broker-dealers are subject to the
SEC'sSEC’s Uniform Net Capital Rule
(Rule(Rule 15c3-1 under the Securities Exchange Act of 1934), which requires the maintenance of minimum
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
net capital, as defined. Net capital is calculated for each broker-dealer subsidiary individually. Excess net capital of one broker-dealer subsidiary may not be used to offset a net capital deficiency of another broker-dealer subsidiary. Net capital and the related net capital requirement may fluctuate on a daily basis.
F-38
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
Net capital and net capital requirements for the Company'sCompany’s broker-dealer subsidiaries as of December 31, 20092010 are presented in the following table (in thousands):
| | | | | | | | | | | | | |
| | | December 31, 2010 | |
| | | | | | Minimum
| | | | |
| | | Net
| | | Net Capital
| | | Excess Net
| |
| | | Capital | | | Required | | | Capital | |
| |
| LPL Financial LLC | | $ | 95,362 | | | $ | 6,416 | | | $ | 88,946 | |
| UVEST Financial Services Group, Inc. | | | 7,884 | | | | 1,451 | | | | 6,433 | |
| | | | | | | | | | | | | |
| Total | | $ | 103,246 | | | $ | 7,867 | | | $ | 95,379 | |
| | | | | | | | | | | | | |
| | | | | | | | | | |
| | December 31, 2009 | |
|---|
| | Net
Capital | | Minimum
Net Capital
Required | | Excess Net
Capital | |
|---|
LPL Financial Corporation | | $ | 64,149 | | $ | 6,221 | | $ | 57,928 | |
UVEST Financial Services Group, Inc. | | | 10,099 | | | 1,673 | | | 8,426 | |
Mutual Service Corporation | | | 15,125 | | | 393 | | | 14,732 | |
Associated Securities Corp. | | | 7,618 | | | 250 | | | 7,368 | |
Waterstone Financial Group, Inc. | | | 2,972 | | | 72 | | | 2,900 | |
| | | | | | | | |
Total | | $ | 99,963 | | $ | 8,609 | | $ | 91,354 | |
| | | | | | | | |
LPL Financial is a clearing broker-dealer and
the remaining broker-dealer subsidiaries areUVEST is an introducing
broker-dealers.broker-dealer.
PTC is also subject to various regulatory capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the
Company'sCompany’s consolidated financial statements. As of December 31,
2009,2010, the
Company hasCompany’s registered broker-dealers and PTC have met all capital adequacy requirements to which it is subject.
The Company operates in a highly regulated industry. Applicable laws and regulations restrict permissible activities and investments. These policies require compliance with various financial and customer-related regulations. The consequences of noncompliance can include substantial monetary and nonmonetary sanctions. In addition, the Company is also subject to comprehensive examinations and
supervisionssupervision by various governmental and self-regulatory agencies. These regulatory agencies generally have broad discretion to prescribe greater limitations on the operations of a regulated entity for the protection of investors or public interest. Furthermore, where the agencies determine that such operations are unsafe or unsound, fail to comply with applicable law, or are otherwise inconsistent with the laws and regulations or with the supervisory policies, greater restrictions may be imposed.
19. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET CREDIT RISK AND CONCENTRATIONS OF CREDIT RISK
| |
| 20. | Financial Instruments with Off-Balance-Sheet Credit Risk and Concentrations of Credit Risk |
LPL Financial'sFinancial’s client securities activities are transacted on either a cash or margin basis. In margin transactions, LPL Financial extends credit to the client, subject to various regulatory and internal margin requirements, collateralized by cash and securities in the client'sclient’s account. As clients write options contracts or sell securities short, LPL Financial may incur losses if the clients do not fulfill their obligations and the collateral in the clients'clients’ accounts is not sufficient to fully cover losses that clients may incur from these strategies. To control this risk, LPL Financial monitors margin levels daily and clients are required to deposit additional collateral, or reduce positions, when necessary.
Table of Contents
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
LPL Financial is obligated to settle transactions with brokers and other financial institutions even if its clients fail to meet their obligation to LPL Financial. Clients are required to complete their transactions on the settlement date, generally three business days after the trade date. If clients do not fulfill their contractual obligations, LPL Financial may incur losses. LPL Financial has established
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LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
procedures to reduce this risk by generally requiring that clients deposit cash
and/or securities into their account prior to placing an order.
LPL Financial may at times maintain inventories in equity securities on both a long and short basis that are recorded on the consolidated statements of financial condition at market value. While long inventory positions represent LPL
Financial'sFinancial’s ownership of securities, short inventory positions represent obligations of LPL Financial to deliver specified securities at a contracted price, which may differ from market prices prevailing at the time of completion of the transaction. Accordingly, both long and short inventory positions may result in losses or gains to LPL Financial as market values of securities fluctuate. To mitigate the risk of losses, long and short positions are
marked-to-market daily and are continuously monitored by LPL Financial.
UVEST is engaged in buying and selling securities and other financial instruments for clients of
financial advisors. Such transactions are introduced and cleared through a third-party clearing firm on a fully disclosed basis. While introducing broker-dealers generally have less risk than clearing firms, their clearing agreements expose them to credit risk in the event that their clients
don'tdon’t fulfill contractual obligations with the clearing broker-dealer.
The Affiliated Entities were engaged in buying and selling securities and other financial instruments for clients of financial advisors. Such transactions were introduced and cleared through a third-party clearing firm on a fully disclosed basis. These firms no longer conduct such activities. The registered representatives and their client accounts have either transitioned or are in the process of transitioning to LPL Financial or to new firms.
| |
| 21. | Selected Quarterly Financial Data (Unaudited) |
| | | | | | | | | | | | | | | | | |
| | | 2010 |
| | | | | (In thousands) | | |
| | | First
| | Second
| | Third
| | Fourth
|
| | | Quarter | | Quarter | | Quarter | | Quarter |
| |
| Revenues | | $ | 743,452 | | | $ | 790,185 | | | $ | 759,988 | | | $ | 819,972 | |
| Net revenues | | | 743,406 | | | | 790,161 | | | | 759,964 | | | | 819,955 | |
| Gross margin(1)(2) | | | 230,204 | | | | 233,623 | | | | 234,336 | | | | 239,770 | |
| Net income (loss) | | $ | 25,554 | | | $ | 8,000 | | | $ | 26,144 | | | $ | (116,560 | ) |
| | | | | | | | | | | | | | | | | |
| | | 2009 |
| | | | | (In thousands) | | |
| | | First
| | Second
| | Third
| | Fourth
|
| | | Quarter | | Quarter | | Quarter | | Quarter |
| |
| Revenues | | $ | 643,040 | | | $ | 669,366 | | | $ | 702,378 | | | $ | 734,906 | |
| Net revenues | | | 642,978 | | | | 669,317 | | | | 702,326 | | | | 734,884 | |
| Gross margin(1) | | | 200,447 | | | | 205,329 | | | | 221,144 | | | | 218,006 | |
| Net income (loss) | | $ | 14,797 | | | $ | 15,581 | | | $ | (1,456 | ) | | $ | 18,598 | |
| | |
| (1) | | Gross margin is calculated as net revenues less production expenses. Production expenses consist of the following expense categories from the consolidated statements of operations: (i) commissions and advisory fees and (ii) brokerage, clearing and exchange. All other expense categories, including depreciation and amortization, are considered general and administrative in nature. Because the Company’s gross margin amounts do not include any depreciation and amortization expense, the gross margin amounts may not be comparable to those of others in the Company’s industry. |
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20. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
LPL INVESTMENT HOLDINGS INC. AND SUBSIDIARIES
| | | | | | | | | | | | | |
| | 2009 | |
|---|
| | First
Quarter | | Second
Quarter | | Third
Quarter | | Fourth
Quarter | |
|---|
Revenues | | $ | 643,040 | | $ | 669,366 | | $ | 702,378 | | $ | 734,906 | |
Net revenues | | | 642,978 | | | 669,317 | | | 702,326 | | | 734,884 | |
Gross margin(1) | | | 200,447 | | | 205,329 | | | 221,144 | | | 218,006 | |
Net income (loss) | | $ | 14,797 | | $ | 15,581 | | $ | (1,456 | ) | $ | 18,598 | |
| | | | | | | | | | | | | |
| | 2008 | |
|---|
| | First
Quarter | | Second
Quarter | | Third
Quarter | | Fourth
Quarter | |
|---|
Revenues | | $ | 798,647 | | $ | 814,947 | | $ | 799,537 | | $ | 703,999 | |
Net revenues | | | 798,449 | | | 814,720 | | | 799,341 | | | 703,839 | |
Gross margin(1) | | | 245,118 | | | 244,551 | | | 251,788 | | | 211,844 | |
Net income | | $ | 11,665 | | $ | 14,303 | | $ | 17,168 | | $ | 2,360 | |
| | |
| (2) | | In 2010, upon closing of the Company’s IPO in the fourth quarter, the restriction on approximately 7.4 million shares of common stock issued to its advisors under the Fifth Amended and Restated 2000 Stock Bonus Plan was released. Accordingly, the Company recorded a share-based compensation charge of $222.0 million in the fourth quarter of 2010, representing the offering price of $30.00 per share multiplied by 7.4 million shares. This charge has been classified as production expense in 2010. Gross margin as calculated for 2010 above does not include this charge for comparability purposes with previous years shown. |
On January 20, 2011, the Company received a $45.0 million tax refund for federal taxes paid in 2010.
On January 31, 2011, the Company repaid $40.0 million of term loans under its senior secured credit facilities using net proceeds received in the IPO, as well as other cash on hand.
On March 4, 2011, the Company received notification from the court that its motion for summary judgment that was filed in February 2010, and that is calculated as net revenues less commissionsdescribed above in Note 14, has been granted in all respects and advisory fees, and brokerage, clearing and exchange expenses.that all counterclaims by the third party indemnitor have been denied.
******
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