Thomas Weisel Partners Group 10-Q 2009
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File Number: 000-51730
Thomas Weisel Partners Group, Inc.
(Exact name of registrant as specified in its charter)
One Montgomery Street
San Francisco, California 94104
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive office)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of August 5, 2009 there were 31,713,998 shares of the registrant’s common stock outstanding, including 6,337,478 exchangeable shares of TWP Acquisition Company (Canada), Inc., a wholly-owned subsidiary of the registrant. Each exchangeable share is exchangeable at any time into a share of common stock of the registrant, entitles the holder to dividend and other rights substantially economically equivalent to those of a share of common stock, and, through a voting trust, entitles the holder to a vote on matters presented to common shareholders.
TABLE OF CONTENTS
PART I — FINANCIAL INFORMATION
THOMAS WEISEL PARTNERS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except share and per share data)
See accompanying notes to unaudited condensed consolidated financial statements.
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THOMAS WEISEL PARTNERS GROUP, INC. AND SUBSIDIARIES
(In thousands, except per share data)
See accompanying notes to unaudited condensed consolidated financial statements.
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THOMAS WEISEL PARTNERS GROUP, INC. AND SUBSIDIARIES
See accompanying notes to unaudited condensed consolidated financial statements.
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THOMAS WEISEL PARTNERS GROUP, INC. AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Thomas Weisel Partners Group, Inc., a Delaware corporation, together with its subsidiaries (collectively, the “Company”), is an investment banking firm headquartered in San Francisco, California. The Company operates on an integrated basis and is managed as a single operating segment providing investment services that include investment banking, brokerage, equity research and asset management.
The Company conducts its investment banking, brokerage and equity research business through the following subsidiaries:
TWP, TWPC and TWPIL introduce on a fully disclosed basis proprietary and customer securities transactions to other broker dealers (the “clearing brokers”) for clearance and settlement.
The Company primarily conducts its asset management business through Thomas Weisel Capital Management LLC (“TWCM”), a registered investment adviser under the Investment Advisers Act of 1940, as amended (“the Investment Advisors Act”). TWCM is a general partner of a series of investment funds in venture capital and fund of funds through the following subsidiaries (the “Asset Management Subsidiaries”):
Basis of Presentation
These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and Regulation S-X, Article 10 under the Exchange Act. Because the Company provides investment services to its clients, it follows certain accounting guidance used by the brokerage and investment industry.
The preparation of the Company’s condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from those estimates, and such differences could be material to the condensed consolidated financial statements.
The condensed consolidated financial statements and these notes are unaudited and exclude some of the disclosures required in annual financial statements. Management believes it has made all necessary adjustments (consisting of only normal recurring items) so that the condensed consolidated financial statements are presented fairly and that estimates made in preparing its condensed consolidated financial statements are reasonable and prudent.
These condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2008.
Management has evaluated subsequent events through August 7, 2009, which is the date that the Company’s financial statements were issued. No material subsequent events have occurred since June 30, 2009 that required recognition or disclosure in these condensed consolidated financial statements, other than those discussed in Note 4 – Investments in Partnerships and Other Investments, Note 5 – Related Party Transactions and Note 13 – Commitments, Guarantees and Contingencies.
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Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies – In April 2009, the Financial Accounting Standards Board (“FASB”) issued amending and clarifying guidance over business combinations to address application issues raised by preparers, auditors and members of the legal profession on initial recognition and measurement, subsequent measurement and accounting and disclosure of assets and liabilities arising from contingencies in a business combination. This guidance is effective for acquisitions on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company adopted the guidance on January 1, 2009, and the adoption did not have a material impact on the Company’s condensed consolidated statements of financial condition, operations and cash flows.
Determining Whether a Market Is Not Active and a Transaction Is Not Distressed – In April 2009, the FASB issued guidance which provides additional regulation on determining whether a market for a financial asset is not active and a transaction is not distressed for fair value measurements. The guidance was effective for interim and annual periods ending after March 15, 2009 and shall be applied prospectively. The Company adopted the guidance on March 31, 2009, and the adoption did not have a material impact on its condensed consolidated statements of financial condition, operations and cash flows.
Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly – In April 2009, the FASB issued a staff position, which provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. This staff position also includes guidance for identifying circumstances that indicate a transaction is not orderly. The staff position was effective for interim and annual reporting periods ending after June 15, 2009 and shall be applied prospectively. The Company adopted the guidance on June 30, 2009, and the adoption did not have a material impact on its condensed consolidated statements of financial condition, operations and cash flows.
Interim Disclosures about Fair Value of Financial Instruments – In April 2009, the FASB issued guidance pertaining to disclosures of fair value of financial instruments that requires disclosure of fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The guidance was effective for interim reporting periods ending after June 15, 2009. The Company adopted the guidance on June 30, 2009, and the adoption did not have a material impact on the Company’s condensed consolidated statement of financial condition, operations and cash flows.
Subsequent Events – In May 2009, the FASB issued guidance which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. In particular, the guidance sets forth (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (iii) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The guidance is effective for interim or annual financial periods ending after June 15, 2009 and shall be applied prospectively. The Company adopted the subsequent events guidance on June 30, 2009, and the adoption did not have an impact on its condensed consolidated statements of financial condition, operations and cash flows.
Accounting for Transfers of Financial Assets – In June 2009, the FASB issued guidance to improve the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets, the effects of a transfer on its financial position, financial performance and cash flows, and a transferor’s continuing involvement in transferred financial assets. This guidance is effective for interim and annual periods ending after November 15, 2009 and shall be applied prospectively. The Company is currently evaluating the impact, if any, that the adoption will have on its consolidated statements of financial condition, operations and cash flows.
Consolidation of Variable Interest Entities – In June 2009, the FASB issued guidance with the objective to amend certain requirements for accounting for the consolidation of variable interest entities (“VIE”) to improve financial reporting by enterprises involved with VIEs and to provide more relevant and reliable information to users of financial statements. This guidance is effective for annual reporting periods beginning after November 15, 2009, and for interim periods within that first annual reporting period. The Company is currently evaluating the impact, if any, that the adoption will have on its consolidated statements of financial condition, operations and cash flows.
FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – In June 2009, the FASB issued guidance with the objective to replace the original hierarchy of accounting principles and to establish the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB. This is to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The guidance is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company is currently evaluating the impact, if any, that the adoption of the guidance will have on its condensed consolidated statements of financial condition, operations and cash flows.
Securities owned and securities sold, but not yet purchased were as follows (in thousands):
At June 30, 2009 and December 31, 2008, securities sold, but not yet purchased were collateralized by securities owned that are held at the clearing brokers.
At June 30, 2009 and December 31, 2008, the Company did not hold securities that cannot be publicly offered or sold unless registration has been affected under the Securities Act, of 1933 as amended (the “Securities Act”), except for warrants.
Warrants are received from time to time as partial payment for investment banking services. The warrants provide the Company with the right to purchase common shares in both public and private companies. All warrants were non-transferable as of June 30, 2009 and certain of them have restricted periods during which the warrant may not be exercised.
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Investments in partnerships and other investments consisted of the following (in thousands):
Investments in Partnerships
Investments in partnerships consist of investments in private equity partnerships and include the Company’s general partner interests in investment partnerships and the fair value adjustments recorded to reflect the investments at fair value. The Company waived certain management fees with respect to certain of these partnerships through March 31, 2007. These waived fees constitute deemed contributions to the investment partnerships that serve to satisfy the Company’s general partner commitment, as provided in the underlying investment partnerships’ partnership agreements. The Company may be allocated a special profits interest in respect of previously waived management fees based on the subsequent investment performance of the respective partnerships.
The investment partnerships in which the Company is a general partner may allocate carried interest and make carried interest distributions to the general partner if the partnerships’ investment performance reaches a threshold as defined in the respective partnership agreements. The Company recognizes the allocated carried interest if and when this threshold is met.
Some of the Company’s investments in partnerships interests meet the definition of a VIE. The Company does not consolidate these VIEs because it has determined that the Company is not the primary beneficiary. For general partnership interests that do not qualify as VIEs, the partnership agreements have established simple majority kick out rights for limited partner interests and therefore the Company does not consolidate the partnerships.
As of June 30, 2009, the Company held auction rate securities (“ARS”) with a par value of $9.7 million and fair value of $8.7 million. The ARS are variable rate debt instruments, having long-term maturity dates (approximately 25 to 31 years), but whose interest rates are reset through an auction process, most commonly at intervals of 7, 28 and 35 days. The interest earned on these investments is exempt from Federal income tax. All of the Company’s ARS are backed by pools of student loans and were rated either Aaa, Aa3, A1, Ba3 or Baa3 at June 30, 2009 and either Aaa, Aa3 or A1 at December 31, 2008. The Company continues to receive interest when due on its ARS and expects to continue to receive interest when due in the future. The weighted-average Federal tax exempt interest rate was 0.95% at June 30, 2009.
In 2008, widespread auction failures resulted in a lack of liquidity for these previously liquid securities. As a result, the principal balance of the Company’s ARS will not be accessible until successful auctions occur, a buyer is found outside of the auction process, the issuers and the underwriters establish a different form of financing to replace these securities or final payments come due according to the contractual maturities. As a result of the auction failures, the Company evaluates the credit risk and liquidity risk associated with the securities and compares the yields on its ARS to similarly rated municipal issues and determined that its ARS had a fair value decline of $0.2 million in the six months ended June 30, 2009.
In July 2009, the Company repurchased at par $13.2 million of ARS that previously had been sold from its account in January 2008 to three customers without those customers’ prior written consent. Similar to its ARS holdings at June 30, 2009, the Company evaluated the credit risk and liquidity risk associated with these securities and compared the yields on these ARS to similarly rated municipal issues. As a result of this evaluation, the Company determined that these ARS would have a fair value of $12.4 million and recorded a fair value adjustment of $0.8 million in the six months ended June 30, 2009.
Receivables from related parties consisted of the following (in thousands):
Related Party Loans
Co-Investment Funds – In 2000 and 2001, the Company established an investment program for employees wherein employees who qualified as accredited investors were able to contribute up to 4% of their compensation to private equity funds (the “Co-Investment Funds”). The Co-Investment Funds were established solely for employees of the Company and invested side-by-side with the Company’s affiliates, Thomas Weisel Capital Partners, L.P. (a private equity fund formerly managed by the Company) and Thomas Weisel Venture Partners L.P. As part of this program, the Company made loans to employees for capital contributions to the Co-Investment Funds in amounts up to 400% of employees’ contributions. The Company holds as collateral the investment in the Co-Investment Funds and establishes a reserve that reduces the carrying value of the receivable to the fair value of the collateralized ownership interest of the employees and former employees in the Co-Investment Funds. During the three and six months ended June 30, 2009, the Company increased the reserve related to the Co-Investment Funds by $0.1 and $0.5 million, respectively. There was no change to the reserve during the three and six months ended June 30, 2008. The Company discontinued the investment program for employees in 2002. The Co-Investment Funds did not make any distributions that were credited towards repayment of the loans to employees during both the three and six months ended June 30, 2009 and 2008.
Employee Loans — The Company from time to time prior to its initial public offering made unsecured loans to its employees. These loans were not part of a Company program, but were made as a matter of course. The Company previously established a reserve for the face value of these loans. In June 2007, two employees entered into agreements with the Company that provide for repayment of the loans by December 31, 2008, if they have not already been repaid, from funds generated through repurchase by the Company of shares of the Company’s common stock held by the employees.
In September 2008, the two employees and the Company amended the agreements described above to extend the repayment date of the loans to February 2011. As of June 30, 2009, the two employees have collectively repaid $0.3 million of their outstanding loan balances in cash and from proceeds they received through the repurchase by the Company of shares of the Company’s common stock held by the employees. As of June 30, 2009, the fair market value of the Company’s common stock held by each of the employees was equal to or greater than the carrying amount of their loans.
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Mr. Weisel, the Company’s Chairman and Chief Executive Officer and certain other employees of the Company from time to time use an airplane owned by Ross Investments Inc. (“Ross”), an entity wholly-owned by Mr. Weisel, for business travel. The Company and Ross have adopted a time-sharing agreement in accordance with Federal Aviation Regulation 91.501 to govern the Company’s use of the Ross aircraft, pursuant to which the Company reimburses Ross for the travel expenses in an amount generally comparable to the expenses the Company would have incurred for business travel on commercial airlines for similar trips. For the three months ended June 30, 2009 and 2008, the Company paid approximately $14,000 and $26,000, respectively, to Ross on account of such expenses. For the six months ended June 30, 2009 and 2008, the Company paid approximately $41,000 and $32,000, respectively, to Ross on account of such expenses. These amounts are included in marketing and promotion expense within the condensed consolidated statements of operations. As of June 30, 2009 and December 31, 2008, the Company did not have any amounts payable to Ross.
In addition, the Company provides personal office services to Mr. Weisel. In accordance with an agreement he has with the Company, Mr. Weisel reimburses the Company for out-of-pocket expenses the Company incurs for such services. Amounts incurred by the Company for these services for both the three months ended June 30, 2009 and 2008 were approximately $73,000. Amounts incurred for the six months ended June 30, 2009 and 2008 were approximately $139,000 and $191,000, respectively. The receivable from Mr. Weisel at June 30, 2009 and December 31, 2008 was approximately $73,000. The amount outstanding at June 30, 2009 was paid by Mr. Weisel in July 2009.
In 2009, the Company agreed to provide personal office services as needed to Mr. Conacher, its President and Chief Operating Officer. Mr. Conacher reimburses the Company for the cost of such services and for out-of-pocket expenses it incurs on his behalf. Amounts incurred by the Company for the three and six months ended June 30, 2009 were approximately $38,000 and $40,000, respectively. The receivable from Mr. Conacher at June 30, 2009 was approximately $38,000. The amount outstanding at June 30, 2009 was paid by Mr. Conacher in July 2009.
On July 27, 2009, the Company entered into a President Employment Agreement, a Relocation Agreement and a Side Agreement with Mr. Conacher, The Relocation Agreement sets forth terms and conditions applicable to Mr. Conacher’s relocation from Canada to the Company’s San Francisco office. Pursuant to the Relocation Agreement, on August 5, 2009, Computershare Trust Company of Canada, the trustee for the trust that distributes Company common stock associated with vesting restricted stock units held by Canadian employees of the Company, purchased from Mr. Conacher 175,000 shares of the Company’s common stock at $4.00 per share, and the Company granted 175,000 options to Mr. Conacher, with an exercise price of $4.00, which will vest in February 2011 and be exercisable until August 2014.
On January 2, 2008, the Company acquired Westwind Capital Corporation (“Westwind”), a full-service, institutionally oriented, independent investment bank for a purchase price of $156 million. The Company accounted for its acquisition of Westwind utilizing the purchase method.
The following sets forth the other intangible assets associated with the acquisition of Westwind as of June 30, 2009 (dollar amounts in thousands):
The difference between the net book value of the other intangible assets presented above and the amount presented within the condensed consolidated statements of financial condition is due to a currency translation adjustment of $5.2 million at June 30, 2009.
The following sets forth the remaining amortization of the other intangible assets based on accelerated and straight-line methods of amortization over the respective useful lives as of June 30, 2009 (in thousands):
Amortization expense related to other intangible assets was $2.9 million and $4.4 million for the three months ended June 30, 2009 and 2008, respectively. Amortization expense related to other intangible assets was $5.8 million and $7.7 million for the six months ended June 30, 2009 and 2008, respectively.
In connection with the allocation of the Westwind purchase price consideration, the Company recorded goodwill of $98.2 million. Subsequent to the acquisition, the Company experienced a significant decline in its market capitalization which was affected by the uncertainty in the financial markets. Based on the difficult conditions in the business climate and the Company’s perception that the climate was unlikely to change in the near term, the Company recorded a full impairment charge to the goodwill asset of $92.6 million in the third quarter of 2008. The difference between the goodwill balance recorded on the acquisition date and the amount impaired during the year ended December 31, 2008 is due to a currency translation adjustment of $5.6 million.
Notes payable consisted of the following (in thousands):
As of June 30, 2009 and December 31, 2008, the fair value for each of the notes payable presented above approximates the carrying value as of June 30, 2009 and December 31, 2008, respectively.
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The weighted-average interest rate for notes payable was 4.01% and 5.17% at June 30, 2009 and December 31, 2008, respectively.
The principal balances for the notes payable are due in February 2011.
In April 2008, TWP entered into a $25.0 million revolving note and cash subordination agreement with its primary clearing broker and incurs an annual commitment fee of 1.0%, or $0.3 million. The credit period in which TWP could draw on the note ended on April 18, 2009. TWP renewed this agreement on April 30, 2009, and the new credit period expires on April 30, 2010. As of June 30, 2009, TWP does not have any balances outstanding under this facility.
TWPC has a capital rental arrangement with a Canadian financial institution which is also a member of the IIROC. Under this arrangement, the financial institution provides subordinated loan capital to TWPC out of its capital up to CDN$8.0 million for bought deal underwriting commitments in return for a participation in the underwriting. During the six months ended June 30, 2009, TWPC was provided capital for a bought deal underwriting commitment and as a result incurred a fee of $0.1 million.
The Senior Notes include financial covenants including restrictions on additional indebtedness and other liabilities that could cause them to become callable nd requirements that the notes be repaid should the Company enter into a transaction to liquidate or dispose of all or substantially all of its property, business or assets. The Company was in compliance with all covenants at June 30, 2009.
The Company records financial assets and liabilities at fair value in the condensed consolidated statements of financial condition with unrealized gains (losses) reflected in the condensed consolidated statements of operations.
The degree of judgment used in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. Financial instruments with readily available active quoted prices for which fair value can be measured generally will have a higher degree of pricing observability and a lesser degree of judgment used in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have less, or no, pricing observability and a higher degree of judgment used in measuring fair value.
The Company’s financial assets and liabilities measured and reported at fair value are classified and disclosed in one of the following categories:
The following is a summary of the fair value of the major categories of financial instruments held by the Company (in thousands):
The following is a summary of the Company’s financial assets and liabilities as of June 30, 2009 that are accounted for at fair value on a recurring basis by level in accordance with the fair value hierarchy described above (in thousands):
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The following is a summary of changes in fair value of the Company’s financial assets that have been classified as Level 3 for the three months ended June 30, 2009 (in thousands):
The following is a summary of changes in fair value of the Company’s financial assets that have been classified as Level 3 for the six months ended June 30, 2009 (in thousands):
During the year ended December 31, 2008, ARS for which the auctions failed and where no secondary market has developed were moved to Level 3, as the assets were subject to valuation using unobservable inputs. These ARS continued to be classified in Level 3 through June 30, 2009.
The total net unrealized gains (losses) during the three and six months ended June 30, 2009 of $0.8 million and $(0.9) million, respectively, relate to financial assets held by the Company as of June 30, 2009.
Realized and unrealized gains (losses) from investments in partnerships and other investments are included in asset management revenues in the condensed consolidated statements of operations. Realized and unrealized gains (losses) from securities owned and securities sold, but not yet purchased, except those related to warrants, are included in brokerage revenues in the condensed consolidated statements of operations.
Potential dilutive shares consist of the incremental common stock issuable for outstanding restricted stock units, options and a warrant (both vested and non-vested) using the treasury stock method. Potential dilutive shares are excluded from the computation of net loss per share if their effect is anti-dilutive. The anti-dilutive options totaled 268,549 for both the three and six months ended June 30, 2009. The anti-dilutive options totaled 85,216 for both the three and six months ended June 30, 2008. The anti-dilutive warrant totaled 486,486 shares for both the three and six months ended June 30, 2009, as well as for the three and six months ended June 30, 2008.
The following table is a reconciliation of net loss reported in the Company’s condensed consolidated statements of operations to comprehensive loss (in thousands):
The Third Amended and Restated Thomas Weisel Partners Group, Inc. Equity Incentive Plan (the “Equity Incentive Plan”) provides for awards of non-qualified and incentive stock options, restricted stock and restricted stock units and other share-based awards to officers, directors, employees, consultants and advisors of the Company. At the February 2009 Special Meeting of Shareholders, the shareholders of the Company voted to approve an increase in the number of shares of the Company’s common stock available for awards under the Equity Incentive Plan by 6,000,000 shares. At June 30, 2009 the total number of shares issuable under the Equity Incentive Plan was 17,150,000 shares. Awards of stock options and restricted stock units reduce the number of shares available for future issuance. The number of shares available for future issuance under the Equity Incentive Plan at June 30, 2009 was approximately 6,050,000 shares. The Company accounts for share-based compensation at fair value.
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Restricted Stock Units
A summary of non-vested restricted stock unit activity for the six months ended June 30, 2009 is presented below:
The fair value of the shares vested during the three and six months ended June 30, 2009 was $1.2 million and $4.8 million, respectively. The fair value of the shares vested during the three and six months ended June 30, 2008 was $44,700 and $7.5 million, respectively.
As of June 30, 2009, there was $37.4 million of total unrecognized compensation expense related to non-vested restricted stock unit awards. This cost is expected to be recognized over a weighted-average period of 2.4 years.
During the three and six months ended June 30, 2009 the Company recorded $5.2 million and $9.6 million, respectively, in non-cash compensation expense with respect to grants of restricted stock units. During the three and six months ended June 30, 2008 the Company recorded $4.1 million and $8.0 million, respectively, in non-cash compensation expense with respect to grants of restricted stock units.
The Company accounts for income taxes by recognizing deferred tax assets and liabilities based upon temporary differences between the financial reporting and tax basis of its assets and liabilities. Valuation allowances are established when necessary to reduce deferred tax assets when it is more likely than not that a portion or all of the deferred tax assets will not be realized.
During the year ended December 31, 2008, the Company determined that it was more-likely-than-not that its U.S. deferred tax assets would not be realized. The Company made this determination primarily based on the significant losses it incurred in 2008 as a result of the severe economic downturn and its effect on the capital markets. As of June 30, 2009, the Company continued to carry a full valuation allowance on its U.S. and U.K. deferred tax assets due to continued losses incurred during the six months ended June 30, 2009.
The Company’s effective tax rate for the three and six months ended June 30, 2009 was 6.5% and (0.4)%, respectively. The Company’s effective tax rate for the three and six months ended June 30, 2008 was 40.0% and 35.5%, respectively. The tax provision for the six months ended June 30, 2009 relates to the Company’s operations in Canada. The change in the effective tax rate is primarily due to the increase in the valuation allowance associated with the U.S. net operating losses incurred during the three and six months ended June 30, 2009.
The Company leases office space and computer equipment under non-cancelable operating leases which extend to 2016 and which may be extended as prescribed under renewal options in the lease agreements. The Company has entered into several non-cancelable sub-lease agreements for certain facilities or floors of facilities which are co-terminus with the Company’s lease for the respective facilities or floors of facilities. Facility and computer equipment lease expenses charged to operations for the three months ended June 30, 2009 and 2008 was $3.3 million and $4.0 million, respectively, net of sublease income of $0.9 million and $1.0 million, respectively. Facility and computer equipment lease expenses charged to operations for the six months ended June 30, 2009 and 2008 was $6.8 million and $8.2 million, respectively, net of sublease income of $1.6 million and $1.9 million, respectively.
At June 30, 2009, the Company had a lease loss liability of $7.0 million related to office space that it vacated in 2008 and in prior years. The lease loss liability was estimated as the net present value of the difference between lease payments and receipts under expected sublease agreements.
Fund Capital Commitments
At June 30, 2009, the Company’s Asset Management Subsidiaries had commitments to invest in affiliated investment partnerships. These commitments are generally called as investment opportunities are identified by the underlying partnerships. The Company’s Asset Management Subsidiaries’ commitments at June 30, 2009 were as follows (in thousands):
In addition to the commitments set forth in the table above, the Company has committed $8.3 million to investments in unaffiliated funds. Through June 30, 2009, the Company has funded $4.3 million of these commitments and the Company’s remaining unfunded commitment as of June 30, 2009 was $4.0 million. These commitments may be called in full at any time.
Broker-Dealer Guarantees and Indemnification
The Company’s customers’ transactions are introduced to the clearing brokers for execution, clearance and settlement. Customers are required to complete their transactions on settlement date, generally three business days after the trade date. If customers do not fulfill their contractual obligations to the clearing brokers, the Company may be required to reimburse the clearing brokers for losses on these obligations. The Company has established procedures to reduce this risk by monitoring trading within accounts and requiring deposits in excess of regulatory requirements.
In February 2009, the Company recorded a loss of approximately $5.1 million due to a customer who failed to pay for several equity purchases that the Company executed at the customer’s request. Based on the Company’s agreement with its primary clearing broker, the Company was required to settle and pay for those transactions on the customer’s behalf. The Company recorded the loss in bad debt expense which is included in other expense in the condensed consolidated statements of operations. The Company believes the loss was incurred as a result of fraudulent activity on the part of the customer and is vigorously pursuing that customer for the losses incurred upon liquidating those positions.
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The Company is a member of various securities exchanges. Under the standard membership agreements, members are required to guarantee the performance of other members and, accordingly, if another member becomes unable to satisfy its obligations to the exchange, all other members would be required to meet the shortfall. The Company’s liability under these arrangements is not quantifiable and could exceed the cash and securities it has posted as collateral. However, management believes that the potential for the Company to be required to make payments under these arrangements is remote. The Company has not recorded any loss contingency for this indemnification.
The Company has entered into guaranteed compensation agreements, and obligations under these agreements are being accrued ratably over the related service period. Total unaccrued obligations at June 30, 2009 for services to be provided subsequent to June 30, 2009 were $2.3 million.
Director and Officer Indemnification
The Company has entered into agreements that provide indemnification to its directors, officers and other persons requested or authorized by the Board to take actions on behalf of the Company for all losses, damages, costs and expenses incurred by the indemnified person arising out of such person’s service in such capacity, subject to the limitations imposed by Delaware law. The Company has not recorded any loss contingency for this indemnification.
Tax Indemnification Agreement
In connection with its initial public offering, the Company entered into a tax indemnification agreement to indemnify the members of Thomas Weisel Partners Group LLC against the full amount of certain increases in taxes that relate to activities of Thomas Weisel Partners Group LLC and its affiliates prior to the Company’s reorganization. The tax indemnification agreement included provisions that permit the Company to control any tax proceeding or contest which might result in it being required to make a payment under the tax indemnification agreement. The Company has not recorded any loss contingency for this indemnification.
The Company is involved in a number of judicial, regulatory and arbitration matters arising in connection with its business. The outcome of matters the Company is involved in cannot be determined at this time and the results cannot be predicted with certainty. There can be no assurance that these matters will not have a material adverse effect on the Company’s results of operations in any future period, and a significant judgment could have a material adverse impact on the Company’s condensed consolidated statements of financial condition, operations and cash flows. The Company may in the future become involved in additional litigation in the ordinary course of its business, including litigation that could be material to the Company’s business.
The Company reviews the need for any loss contingency reserves and establishes reserves when, in the opinion of management, it is probable that a matter would result in liability, and the amount of loss, if any, can be reasonably estimated. Generally, in view of the inherent difficulty of predicting the outcome of those matters, particularly in cases in which claimants seek substantial or indeterminate damages, it is not possible to determine whether a liability has been incurred or to reasonably estimate the ultimate or minimum amount of that liability until the case is close to resolution, in which case no reserve is established until that time.
Additionally, the Company will record receivables for insurance recoveries for legal settlements and expenses when such amounts are covered by insurance and recovery of such losses or costs are considered probable of recovery. These amounts will be recorded as other assets in the condensed consolidated statements of financial condition and will reduce other expense to the extent such losses or costs have been incurred, in the condensed consolidated statements of operations.
The following discussion describes significant developments with respect to the Company’s litigation matters that have occurred subsequent to December 31, 2008.
Auction Rate Securities – The Company has received inquiries from FINRA requesting information concerning purchases through the Company of ARS by Private Client Services customers. Based upon press reports, approximately forty firms, including the Company, have received inquiries from the Enforcement Department of FINRA regarding retail customer purchases through those firms of ARS. The Company is cooperating with FINRA while it conducts its investigation. The Company notes that a number of underwriters of ARS entered into settlements with the SEC and other regulators in connection with those underwriters’ sales and underwriting practices. The Company did not, at any time, underwrite ARS or manage the associated auctions. In connection with such auctions, the Company merely served as agent for its customers when buying in auctions managed by those underwriters. Accordingly, the Company distinguishes its conduct from such underwriters and is prepared to assert these and other defenses should FINRA seek to bring an action in the future. Nevertheless, there can be no assurance that FINRA will not take regulatory action.
On July 23, 2009, the staff of the Enforcement Department of FINRA (the “Staff”) advised the Company, that the Staff has made a preliminary determination to recommend disciplinary action in connection with the Company’s transactions in ARS on behalf of its customers, including transactions for and with the Company. The Staff’s recommendation involves potential violations of FINRA and Municipal Securities Rulemaking Board rules and certain anti-fraud and other provisions of the federal securities laws in connection with the purchase and sales of ARS and certain statements and disclosures made in connection with those purchases and sales. A Staff preliminary determination is neither a formal allegation nor is it evidence of wrongdoing. The Company now has the opportunity to provide its perspective on relevant events and alleged conduct and to address issues raised prior to any formal action being taken.
The Company is continuing to work with the Staff to bring this matter to a close as expeditiously as practicable and, as applicable, will provide the Staff with legal and factual arguments relating to the preliminary determination, but there can be no assurance that those efforts will be successful or that a disciplinary proceeding will not be brought. The Company is prepared to contest vigorously any formal disciplinary action that would result in a censure, fine, or other sanction that could be material to its business, financial position or results of operations. If FINRA were to institute disciplinary action, it is possible that such action could result in a material adverse effect on the Company’s business, financial position or results of operations. However, the Company is unable to determine at this time the impact of the ultimate resolution of this matter.
In addition to the FINRA investigation, the Company has been named (along with two employees) in a FINRA arbitration filed by one of its retail customers who purchased ARS as part of his 401(k) Profit Sharing Plan account. The amount of the claim in that matter is not material to the Company. The Company has filed its answer to the customer’s complaint, and the parties will now proceed toward discovery. The Company believes it has meritorious defenses to the action and intends to vigorously defend such action as it applies to the Company. The Company has also received notice of a second FINRA arbitration filed by another one of its retail clients who purchased ARS as part of his account. The Company is currently reviewing and investigating the claim and will file its formal response. The Company believes it has it has meritorious defenses to this action as well and will vigorously defend such action.
While the Company’s review of the need and amount for any loss contingency reserve has led the Company to conclude that, based upon currently available information, it has adequately established a provision for loss contingencies related to ARS matters, the Company is not able to predict with certainty the outcome of any such matters, nor the amount if any, of an eventual settlement or judgment.
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In re Initial Public Offering Securities Litigation – The Company is a defendant in several purported class actions brought against numerous underwriters in connection with certain initial public offerings in 1999 and 2000. These cases have been consolidated in the United States District Court for the Southern District of New York and generally allege that underwriters accepted undisclosed compensation in connection with the offerings, entered into arrangements designed to influence the price at which the shares traded in the aftermarket and improperly allocated shares in these offerings. The actions allege violations of Federal securities laws and seek unspecified damages. Of the 310 issuers named in these cases, the Company acted as a co-lead manager in one offering, a co-manager in 32 offerings, and as a syndicate member in 10 offerings. The Company has denied liability in connection with these matters. On June 10, 2004, plaintiffs entered into a definitive settlement agreement with respect to their claims against the issuer defendants and the issuers’ present or former officers and directors named in the lawsuits, however, approval of the proposed settlement remains on hold pending the resolution of the class certification issue described below. By a decision dated October 13, 2004, the Federal district court granted plaintiffs’ motion for class certification, however, the underwriter defendants petitioned the U.S. Court of Appeals for the Second Circuit to review that certification decision. On December 5, 2006 the Second Circuit vacated the district court’s class certification decision, and the plaintiffs subsequently petitioned the Second Circuit for a rehearing. On April 6, 2007, the Second Circuit denied the rehearing request. In May 2007, the plaintiffs filed a motion for class certification on a new basis and subsequently scheduled discovery. In April 2009, the parties entered into a comprehensive settlement agreement that has been submitted to the Court (which is subject to, among other things, approval by the Court) that the Company believes will result in the resolution of this matter for an amount that will be covered by its relevant insurance policies. Settlement papers have been signed by the Court, and the insurance carriers have been notified and are prepared to make payment on the Company’s behalf on or before the court determined August 27, 2009 payment date.
In re Openwave Systems Inc. Securities Litigation – The Company has been named as a defendant in a purported class action lawsuit filed in June 2007 in connection with a secondary offering of common stock by Openwave Systems’ in December 2005 where the Company acted as a co-manager. The complaint, filed in the United States District Court for the Southern District of New York, alleges violations of Federal securities laws against Openwave Systems, various officers and directors as well as Openwave Systems’ underwriters, including the Company, based on alleged misstatements and omissions in the disclosure documents for the offering. The underwriters’ motion to dismiss was granted in October 2007, however, the plaintiffs may appeal the dismissal. The Company believes it has meritorious defenses to the action and intends to vigorously defend such action as it applies to the Company.
In re Netlist, Inc. Securities Litigation – The Company has been named as a defendant in an amended complaint for a purported class action lawsuit filed in November 2007 in connection with the initial public offering of Netlist in November 2006 where the Company acted as a lead manager. The amended complaint, filed in the United States District Court for the Central District of California, alleges violations of federal securities laws against Netlist, various officers and directors as well as Netlist’s underwriters, including the Company, based on alleged misstatements and omissions in the disclosure documents for the offering. The complaint essentially alleges that the registration statement relating to Netlist’s initial public offering was materially false and misleading. The Company denies liability in connection with this matter and has filed a motion to dismiss that was granted without prejudice by the court. Plaintiffs have now filed an amended complaint and the Company has now filed another motion to dismiss. The Company believes it has meritorious defenses to the action and intends to vigorously defend such action as it applies to the Company.
In re Vonage Holdings Corp. Securities Litigation – The Company is a defendant named in purported class action lawsuits filed in June 2006 arising out of the May 2006 initial public offering of Vonage Holdings Corp. where the Company acted as a co-manager. The complaints, filed in the United States District Court for the District of New Jersey and in the Supreme Court of the State of New York, County of Kings, allege misuse of Vonage’s directed share program and violations of Federal securities laws against Vonage and certain of its directors and senior officers as well as Vonage’s underwriters, including the Company, based on alleged false and misleading statements in the registration statement and prospectus. In January 2007, the plaintiffs’ complaints were transferred to the U.S. District Court for the District of New Jersey and the defendants filed motions to dismiss. In 2009, the court issued an order dismissing all claims against the underwriters, with leave to re-file certain of those claims. The Company believes it has meritorious defenses to these actions and intends to vigorously defend such actions as they apply to the Company.
The majority of the Company’s transactions, and consequently the concentration of its credit exposure, is with its clearing brokers. The clearing brokers are also the primary source of short-term financing for both securities purchased and securities sold, not yet purchased by the Company. The securities owned by the Company may be pledged by the clearing brokers. The amount receivable from or payable to the clearing brokers in the Company’s condensed consolidated statements of financial condition represent amounts receivable or payable in connection with the trading of proprietary positions and the clearance of customer securities transactions. As of June 30, 2009 and December 31, 2008, the Company’s cash on deposit with the clearing brokers was not collateralizing any liabilities to the clearing brokers.
In addition to the clearing brokers, the Company is exposed to credit risk from other brokers, dealers and other financial institutions with which it transacts business. In the event counterparties do not fulfill their obligations, the Company may be exposed to credit risk. The Company seeks to control credit risk by following an established credit approval process and monitoring credit limits with counterparties.
The Company’s trading activities include providing securities brokerage services to institutional and retail clients. To facilitate these customer transactions, the Company purchases proprietary securities positions (“long positions”) in equity securities, convertible, other fixed income securities and equity index funds. The Company also enters into transactions to sell securities not yet purchased (“short positions”), which are recorded as liabilities in the condensed consolidated statements of financial condition. The Company is exposed to market risk on these long and short securities positions as a result of decreases in market value of long positions and increases in market value of short positions. Short positions create a liability to purchase the security in the market at prevailing prices. Such transactions result in off-balance sheet market risk as the Company’s ultimate obligation to satisfy the sale of securities sold not yet purchased may exceed the amount recorded in the condensed consolidated statements of financial condition. To mitigate the risk of losses, these securities positions are marked to market daily and are monitored by management to ensure compliance with limits established by the Company. The associated interest rate risk of these securities is not deemed material to the Company.
The Company is also exposed to market risk through its investments in partnerships and through certain loans to employees collateralized by such investments. In addition, as part of the Company’s investment banking and asset management activities, the Company from time to time takes long and short positions in publicly traded equities and related options and other derivative instruments and makes private equity investments, all of which expose the Company to market risk. These activities are subject, as applicable, to risk guidelines and procedures designed to manage and monitor market risk.
TWP is a registered U.S. broker-dealer that is subject to the Uniform Net Capital Rule (the “Net Capital Rule”) under the Exchange Act administered by the SEC and FINRA, which requires the maintenance of minimum net capital. TWP has elected to use the alternative method to compute net capital as permitted by the Net Capital Rule, which requires that TWP maintain minimum net capital, as defined, of $1.0 million. These rules also require TWP to notify and sometimes obtain approval from the SEC and FINRA for significant withdrawals of capital or loans to affiliates.
Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends or make any unsecured advances or loans to its parent or employees if such payment would result in net capital of less than 5% of aggregate debit balances or less than 120% of its minimum dollar amount requirement.
TWPC is a registered investment dealer in Canada and is subject to the capital requirements of the IIROC. In addition, TWPIL is a registered U.K. broker-dealer and is subject to the capital requirements of the Financial Securities Authority.
The table below summarizes the minimum capital requirements for the Company’s broker-dealer subsidiaries as of June 30, 2009 (in thousands):
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The following table represents net revenues by geographic area (in thousands):
No single customer accounted for more than 10% of the Company’s net revenues during the three or six months ended June 30, 2009. During the three months ended June 30, 2008, brokerage revenue received from a single customer accounted for 10.6% of the Company’s net revenues. No single customer accounted for 10% or more of the Company’s net revenues during the six months ended June 30, 2008.
Net revenues from countries other than the United States consist primarily of net revenues from Canada. Net revenues from Canada during the three and six months ended June 30, 2009 accounted for 79% and 80%, respectively, of net revenues from other countries and during the three and six months ended June 30, 2008 accounted for 100% and 83%, respectively, of net revenues from other countries.
The following table represents long lived assets by geographic area based on the physical location of the assets (in thousands):
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The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes that appear elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. Actual results and the timing of events may differ significantly from those projected in forward-looking statements due to a number of factors, including those set forth in Part I, Item 1A – “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, and in Part II, Item 1A – “Risk Factors” of this Quarterly Report on Form 10-Q. See “Where You Can Find More Information” in Part I, Item 1 – “Business” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
This Quarterly Report on Form 10-Q in Item 2 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other sections includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended (“the Exchange Act”), and Section 21E of the Exchange Act, as amended. In some cases, you can identify these statements by forward-looking words such as “may”, “might”, “will”, “should”, “expect”, “plan”, “anticipate”, “believe”, “predict”, “potential”, “intend” or “continue”, the negative of these terms and other comparable terminology. These forward-looking statements, which are subject to risks, uncertainties and assumptions about us, may include expectations as to our future financial performance, which in some cases may be based on our growth strategies and anticipated trends in our business. These statements are based on our current expectations and projections about future events. There 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. In particular, you should consider the numerous risks outlined in Part I, Item 1A – “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 and in Part II, Item 1A – “Risk Factors” of this Quarterly Report on Form 10-Q.
Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy or completeness of any of these forward-looking statements. You should not rely upon forward-looking statements as predictions of future events. We are under no duty to update any of these forward-looking statements after the date of this filing to conform our prior forward-looking statements to actual results or revised expectations, except as required by Federal securities law.
Forward-looking statements include, but are not limited to, the following:
We are an investment bank focused principally on growth companies and growth investors. Our business is managed as a single operating segment, and we generate revenues by providing financial services that include investment banking, brokerage, equity research and asset management. We take a comprehensive approach in providing these services to growth companies.
We are exposed to volatility and trends in the general securities market and the economy. In the latter half of 2007, uncertainty and turmoil in the global financial markets began to impact our capital markets activity. In 2008 and through the first six months of 2009, we experienced a dramatic slowdown in the capital markets that led to a significant decline in the number of our investment banking transactions. As transactions declined, it was important for us to align out costs with expected revenues to maintain our capital.
During 2008, we took significant steps to reduce our cost structure and reshape our operations in an effort to preserve capital, retain key personnel and position the Company to take advantage of the dislocation in the marketplace when capital market activity returned. The most significant of these measures has been the reduction in our headcount. During 2009, we reduced our headcount by approximately 110 employees, which follows a net headcount reduction in 2008 of approximately 200 employees. As of July 31, 2009, we had approximately 455 employees, a 40% reduction from the beginning of 2008.
In addition to the headcount reductions, as a cost saving measure, we reduced base salaries for employees with titles of Vice President and above by 10%, including our Chief Executive Officer, President and our other executive officers, and we reduced the base compensation for non-employee directors from $75,000 to $50,000, effective January 1, 2009. Although we believe our professionals to be our most important asset, and their compensation and benefits have been our most significant expenditure, we undertook these reductions in an effort to align this expenditure to revenues.
In an effort to position ourselves to take advantage of the dislocation in the marketplace when the capital markets activity returns, we continue to recruit high quality talent who possess deep relationships. Since the beginning of 2008, we have hired 11 senior investment banking and 21 senior brokerage professionals, many of which came from bulge bracket firms. Over this challenging period we have maintained the same number of banking calling officers through which we expect to engage clients and generate revenues as conditions improve.
Consolidated Results of Operations
Our results of operations depend on a number of market factors, including market conditions and valuations for growth companies and growth investors, as well as general securities market conditions. Trends in the securities markets are also affected by general economic trends, including fluctuations in interest rates, flows of funds into and out of the markets and other conditions. In addition to these market factors, our revenues from period to period are substantially affected by the timing of investment banking transactions in which we are involved. Fees for many of the services we provide are earned only upon the completion of a transaction. Accordingly, our results of operations in any individual year or quarter may be affected significantly by whether and when significant transactions are completed.
Notwithstanding this exposure to volatility and trends, in order to provide value to our clients, we have made a long-term commitment to maintaining a substantial, full-service integrated business platform. As a result of this commitment, if business conditions result in decreases to our revenues, we may not experience corresponding decreases in the expense of operating our business.
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The following table provides a summary of our results of operations (dollar amounts in thousands):